Grade 11 Accounting Study Guide

Imagine a small spaza shop in Soweto that grows into a busy hardware business in Polokwane. The owner starts by keeping cash in a biscuit tin and writing sales on the back of a cigarette box. Within a year the business buys stock on credit from suppliers in Johannesburg, hires two assistants, and applies for a loan of R150 000 from a bank. Suddenly the biscuit tin is not enough. The bank wants to know whether the business actually makes a profit, the supplier wants to know whether it will be paid, and the South African Revenue Service (SARS) wants to know how much tax is owed. Accounting is the language that answers all of these questions. It is the orderly recording, classifying, summarising and reporting of the financial activities of a business so that owners and outsiders can make good decisions.

1.1 What accounting is and why it matters

Accounting is often called the language of business because it turns thousands of separate transactions into a few meaningful reports. We must distinguish two related words. Bookkeeping is the routine, day-to-day recording of transactions, for example writing up a cash sale of R200. Accounting is the wider process that includes bookkeeping but also interprets the numbers, prepares financial statements, and advises on decisions. Every business in South Africa, from a street trader to a listed company on the JSE, relies on this process to survive.

The purpose of accounting is to provide useful information to users. We divide users into two groups. Internal users work inside the business and include the owner and the managers, who use the information to plan, control spending and judge performance. External users stand outside the business and include the bank that grants loans, creditors who supply goods on credit, SARS which collects tax, and potential investors. Because outsiders cannot see inside the business, they trust the financial statements only if those statements follow agreed rules.

1.2 The Generally Accepted Accounting Practice (GAAP)

Generally Accepted Accounting Practice (GAAP) is the set of agreed rules, conventions and principles that govern how financial records are kept and reported. GAAP makes statements reliable and comparable, so that the profit of one business can be measured against another in a fair way. The most important GAAP principles examined in Grade 11 are explained below.

• The business entity rule: the business is treated as completely separate from its owner. The private car or groceries of the owner are not business expenses. When the owner takes cash for personal use it is recorded as drawings, not as an expense of the business.
• The going concern principle: we assume the business will continue trading into the foreseeable future and will not be closed down soon. This allows us to value assets at cost rather than at a forced-sale price.
• The historical cost principle: assets are recorded at the actual price paid for them. A delivery vehicle bought for R220 000 is shown at R220 000 even if its market value later changes.
• The prudence (conservatism) principle: when there is doubt, we never overstate profit or assets and never understate losses or liabilities. For example, we provide for possible bad debts rather than ignore them.
• The matching principle: the expenses of a period must be matched against the income of the same period to calculate a fair profit. Rent for June is recorded in June even if it is paid in July.
• The materiality principle: only information large enough to influence a decision must be shown separately. A box of paper clips can be treated as an expense rather than recorded as an asset.

1.3 The accounting equation in concept

Every business owns things and owes things. The resources a business controls are its assets (for example cash, vehicles, equipment and stock). The amounts it owes to outsiders are its liabilities (for example a loan or amounts due to creditors). What is left over and belongs to the owner is the owner equity. These three always balance in the basic accounting equation:

In Grade 11 you will apply this equation in detail in the next chapter. For now, understand the logic: everything the business owns was financed either by the owner or by outsiders. If a business has assets of R500 000 and owes a loan of R150 000, the owner equity must be \( R500\,000 - R150\,000 = R350\,000 \).

1.4 Forms of ownership and the accounting cycle

South African businesses take several legal forms of ownership. A sole trader is owned and run by one person who carries unlimited liability. A partnership is owned by two or more partners who share profits and losses. A company is a separate legal person with shareholders. Grade 11 focuses mainly on the sole trader and the partnership.

The work of accounting follows a repeating accounting cycle each financial period:

• A transaction takes place and a source document (such as a receipt or invoice) is created as proof.
• The transaction is recorded in a journal.
• Entries are posted to the ledger accounts.
• A trial balance is drawn up to test that debits equal credits.
• Financial statements are prepared and then interpreted.

Understanding these foundations, the users, the GAAP principles and the cycle, gives you the firm base on which all of Grade 11 Accounting is built.