XI / Accountancy / Ch.

1/P1

Chapter 1. Introduction to Accounting

Introduction of Accounting
In India, accounting could be traced back to twenty three centuries ago when Kautilya, a minister
in Chandragupta’s kingdom wrote a book titled ‘ Arthashasthra’ which described how
accounting records had to be kept. However, the presently followed system of double entry
book-keeping has been developed only in the 15th Century. Its development goes to the genius of
Luca Pacioli, a multi-talented mathematician and philosopher of Venice. The present day popular
terms of accounting Debit (Dr.) and Credit (Cr.) were first mentioned by him in this book.
Meaning and Definition
Accounting is the art of recording, classifying, summarizing, analyzing and interpreting the
financial transactions and communicating the results thereof to the persons interested in such
information.
“ Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events, which are, in part at least, of a financial character, and
interpreting the results there of.”
- American Institute of Certified Public Accountants
Functions of Accounting
1. Identifying : The first function of accounting is to identify the transactions of a financial
character and measure them in terms of money.
2. Recording : This is the basic functions of accounting .It is concerned with the systematic
recording of business transactions of financial character in an orderly manner. Recording
is done in the books called Journal.
3. Classifying : It is the systematic analysis of the recorded data with a view to bringing
together the items of similar nature at one place. The Classification work is done in the
books called Ledger.
4. Summarising : This is the presenting of the classified data in a way which is
understandable and useful to the internal as well as external users. This process leads to
the preparation of statements like Trial balance, Income Statement and Balance Sheet.
5. Analysis and Interprets : The recorded financial data are analysed and interpreted in
such a way that the end users can make a meaningful judgment about the financial
position and operating result of the business.
6. Communicates : After being analysed and interpreted, the accounting information has to
be communicated in a proper form and manner to the proper person.
Objectives of Accounting
The following are the main objectives of accounting :-
1. Maintenance of records of business transactions :
The main objective of accounting is to keep complete record of business transactions
according to specific rules. Complete record of business transactions helps to avoid the
possibility of omission and fraud.
2. Calculation of profit and loss :
The second objective is to ascertain the profit or loss on account of business transactions
during a particular period . For this purpose Trading and Profit and Loss Account is
prepared at the end of each accounting period.
3. Depiction of financial position
The next main objective of accounting to know the financial position of the business. For
this purpose, after preparing the profit and loss account a statement called ‘ Balance
Sheet’ is prepared at the end of each accounting period.
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4. Providing Accounting Information to its users

Another main objective of accounting is to communicate the accounting information to
various interested parties like owners, investors, creditors, banks, employees and
government authorities.
Interested Users of Accounting Information/ Parties Interested in Accounting Information
The following are the interested users of accounting information:
a) Owners
b) Potential investors
c) Creditors
d) Bank
e) Employees
f) Government
g) Researchers
Branches of Accounting
To meet the increasing requirement of management, various specialized branch of accounting
have come into existence. They are as follows :
1. Financial Accounting
The main purpose of this branch of accounting is to ascertain the profit or loss by
preparing a profit and loss account and to present the financial position of the business by
preparing a Balance Sheet.
2. Cost Accounting
The main purpose of cost accounting is to ascertain the total cost and per unit cost of
goods produced and services rendered by a business.
3. Management Accounting
The main purpose of management accounting is to present the accounting information in
such a way as to assist the management in planning and controlling the operations of a
business.
Qualitative Characteristics of Accounting Information
Accounting information to be useful, should possess the following charecteristics :
1. Reliability
Accounting information is said to be reliable if it is free from errors and bias and
faithfully represents the facts. To ensure this it must be verifiable and neutral.
2. Relevance
Information to be relevant, it must be available in time.
3. Understandability
It must be understood by those to whom it is communicated. In other words, the receiver
of information should mean the same thing as was meant by the sender.
4. Comparability
Accounting information should have the charecteristics of comparability. This means that
the accounting reports should be comparable with other firms to identify similarities or
differences.
Advantages of Accounting
 It serves as a historical record
 It facilitates the preparation of financial statements which depicts the result of operation
and financial position of the business.
 It supplies information to all those who are interested in the business, i.e., owners,
creditors, employees, etc.
 It helps the management in taking important business decisions by analysing the financial
statements
 It facilitates comparative study of the performance of the business over different periods
of time and with other firms.
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Basic Accounting Terms
There are certain basic accounting terms which are daily used in the business world. Before
recording the transactions in the books, it is essential to understand these terms. These basic
terms are called accounting terminology.
1. Business transactions
The term business transaction refers to any business dealing or event which has a value
measurable in terms of money and which involves transfer of money or money’s worth
between the business and others.
A transaction may be cash or credit. A cash transaction refers to any business transaction
which involves immediate payment or receipt of cash. A credit transaction is one wherein
payment or receipt of money is postponed for a future date.
2. Entity
An entity is something that maintains separate existence. In business an entity is an
organizational structure that has its own goal, processes and record.
3. Assets
These are the material thing or possessions or properties of the business including the
amounts due to it from others.
Assets can be broadly classified into two types: Fixed assets and current assets
Fixed assets are those assets which are acquired for relatively longer periods for carrying
on the business are called Fixed assets. They help in generation of income and are not
meant for sale. The example of such assets are Land and building, Plant and machinery,
Furniture, Machinery , Motorcar etc,
Fixed assets are classified into the following categories :
(a) Tangible Assets : Assets having definite shape and physical existence are called
tangible assets. Examples ; land, buildings, machinery, furniture, etc.
(b) Intangible assets : Assets having no physical existence but are represented by rights
in certain things are called intangible assets. Examples: goodwill, patent , trademark,
etc.
Current assets are those assets which are held for a short period. These are assets
acquired with the intention of converting them into cash. The examples of such assets are
Debtors, Bills Receivable, Closing stock, cash in hand, cash at bank, accrued income ,
prepaid expense etc.
4. Liabilities
These denote the amounts which a business owes to others either for money borrowed or
for goods and assets purchased on credit .It can be divided into two categories
Fixed or long term liabilities
Liabilities which are payable after a long period (usually more than a year) are termed as
fixed or long term liabilities . Debentures, long term loan etc are examples of fixed
liabilities.
Current liabilities
These are liabilities which become payable within a short time. ( usually one year or
less). The example of such liabilities are Creditors, Bills Payable, Bank overdraft,
outstanding expenses, income received in advance etc.
5. Capital
Capital refers to the money or money’s worth introduced or invested by the owner into
the business. In other words it is the excess of assets over liabilities.
6. Drawings
It is the amount of cash or other assets withdrawn by the owner for his personal use.
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7. Revenue
Revenue represents the amounts the business earns by selling its products or providing
services to its customers. These are of recurring in nature. Sale is the major revenue of
the business. Other sources of revenues common to many business are : commission,
interest, dividends, rent received, etc.
8. Expenses
Expense is the cost incurred in producing and selling the goods and services. Examples
are cost of goods sold, rent paid, interest paid, salary paid, commission paid,
advertisement etc.
9. Profit
Profit is the excess of revenues over expenses in an accounting year. It represents
increase in owner’s equity.
10. Loss
Loss is the excess of expenses over revenue in an accounting year. It represents reduction
in owner’s equity.
11. Income
Income is the increase in the net worth of an organisation either from business activity or
other activities. It is a comprehensive term and includes profit also. It is the position
change in the wealth of the firm over a period of time.
12. Goods
Goods refer to commodities, products, articles or things in which a trader deals. In other
words, they refer to commodities which are purchased and are meant for resale.
For correct accounting records, they are called by different names, namely purchases,
sales, purchase returns, sales returns and stock.
13. Purchases
The total amounts of goods procured by a business concern both for cash and credit and
are meant for sale is termed as purchases. Return of goods to suppliers is called purchase
return.
14. Sales
It refers to the proceeds of goods sold or receipts for services rendered by the business. It
is the major source of revenue of any business. It can be cash sale or a credit sale. Assets
do not come under this. Return of goods by the customer to the business is called sales
return.
15. Stock
The goods lying with a business for sale on any given date are called stock. The value of
goods remaining unsold at the end of an accounting period is known as closing stock. The
closing stock of a particular period becomes the opening stock for the next period.
16. Debtors
A debtor is a person who owes money to the business as he has received some benefit
from the business. The amount due from different persons are totaled on the close of the
accounting period and are shown under the heading “ Sundry Debtors” or “ Accounts
Receivable “ in the balance sheet as asset.
17. Creditor
A creditor is a person to whom the business owes money as he has given some benefit to
the business. The amount due to various persons are totaled on the close of the
accounting period and are shown under the heading “Sundry creditors” or “ Accounts
Payable” in the balance sheet as liability.
18. Entry
When a transaction is recorded in the books of accounts, it is called entry.
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19. Solvent
A person or an enterprise which is in position to pay its debt is called solvent.
20. Insolvent
A person or enterprise which is not in a position to pay its debt is called insolvent
21. Vouchers
The documents on the basis of which transactions are recorded in the books of accounts
are known as source documents or vouchers. If we buy goods for cash, we get cash
memo, if we buy on credit we get an invoice; when we make a payment we get a receipt
and so on.
22. Discounts
Discounts are deduction allowed either on the selling price or on the amount due. Thus there
are of two types :
1. Trade discount :
The concession given by the seller to the buyer for making bulk purchase is called trade
discount or quantity discount. Trade discount will not come in the books of accounts
2. Cash discount :
It is a deduction granted by the creditor to the debtor as an inducement for making
prompt payment. Cash discount will come in the books of accounts.