Lecture Note#1 Introduction to Accounting

Dr. Mahmoud Arafa

E-mail: [email protected]
Page: http://scholar.cu.edu.eg/mahmoudarafa
Contents
1.1 Objectives of lecture
1.2 Introduction
1.3 Development of accounting discipline
1.4 An accountant‗s job profile: functions of accounting
1.5 Utility of accounting
1.6 Types of accounting
1.6.1 Financial accounting
1.6.2 Management accounting
1.6.3 Cost accounting
1.7 Distinction between financial and management accounting
1.8 Distinction between financial and Cost accounting
1.9 Summary
1.10 Glossaries
1.11 Self-assessment questions
1.12 References/suggested readings

1.1 Objectives of lecture

After going through this lesson, you will be able to:
 Understand the meaning and nature of accounting.
 Differentiate between various types of accounting.
 Know development of accounting principle.
 Explain the importance of accounting.
1.2 Introduction
Accounting is a system meant for measuring business activities, processing of information
into reports and making the findings available to decision-makers. The documents, which
communicate these findings about the performance of an organization in monetary terms,
are called financial statements. Usually, accounting is understood as the Language of
Business. However, a business may have a lot of aspects which may not be of financial
nature. As such, a better way to understand accounting could be to call it The Language of
Financial Decisions.
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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa
 The knowledge of accounting is an added advantage in performing different roles.
However, we shall limit our scope of discussion to a business organization and the various
financial aspects of such an organization.
When we focus our thoughts on a business organization, many questions (is our business
profitable, should a new product line be introduced, are the sales sufficient, etc.) strike our

People make decision

Business transactions occur

Accountants prepare reports to show the results of

business operations

Fig. 1.1 the Accounting System

Source of figure: Liorngren, Harrison and Robinson, Financial and Management

Accounting, Prentice Hall, New Jersey, 1994.

mind. To answer questions of such nature, we need to have information generated through
the accounting process. The people who take policy decisions and frame business plans
use such information. Figure 1.1 shows how an accounting system operates in business
and how the flow of information occurs.

1.3 Development of accounting discipline

The history of accounting can be traced back to ancient times. According to some beliefs,
the very art of writing originated in order to record accounting information. Though this
may seem to be an exaggeration, but there is no denying the fact that accounting has a long
history. Accounting records can be traced back to the ancient civilizations of China,
Babylonia, Greece and Egypt. Accounting was used to keep records regarding the cost of
labor and materials used in building great structures like the Pyramids.
During 1400s, accounting grew further because the needs for information of merchants in
the Venis City of Italy increased. The first known description of double entry book keeping
was first published in 1994 by Lucas Pacioli. He was a mathematician and a friend of
Leonardo Ileda Vinci.
The onset of the industrial revolution necessitated the development of more sophisticated
accounting system, rather than pricing the goods based on guesses about the costs. The
increase in competition and mass production of goods led to the rise of accounting as a

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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa
 formal branch of study.
With the passage of time, the corporate world grew. In the nineteenth century, companies
came up in many areas of infrastructure like the railways, steel, communication, etc. It led
to a rapid growth in accounting. As the complexities of business grew, ownership and
management of business was divorced. As such, managers had to come up with well-
defined, structured systems of accounting to report the performance of the business to its
owners.
Government also has had a lot to do with more accounting developments. The Income Tax
brought about the concept of ‘income‗. Government takes a host of other decisions,
relating to education, health, economic planning, for which it needs accurate and reliable
information. As such, the government demands stringent accountability in the corporate
sector, which forces the accounting process to be as objective and formal as possible.
1.4 An accountant’s job profile: functions of accounting
A man who is involved in the process of book keeping and accounting is called an
accountant. With the coming up accounting as a specialized field of knowledge, an
accountant has a special place in the structure of an organization, because he performs
certain vital functions.
The following paragraphs examine the functions of accounting and what role does an
accountant play in discharging these functions.
An accountant is a person who does the basic job of maintaining accounts as he is the man
who is engaged in book keeping. Since the managers would always want to know the
financial performance of the business. An accountant prepares profit and loss account
which reports the profits/losses of the business during the accounting period, Balance
Sheet, which is a statement of assets and liabilities of the business at a point of time, is also
proposed by all accountants. Since both statements are called financial statements, the
person who prepares them is called a financial accountant.
Accounting information serves many purposes. A part from revealing the level of
performance, it throws light on the causes of weakness and deviation from plans (in any).
In this way an accountant becomes an important functionary who plays a vital role in the
process of management control, which is a process of diagnosing and solving a problem.
Seen from this point of view, an accountant can be referred to as a management
accountant.
Tax planning is an important area as far as the fiscal management of a company is
concerned. An accountant has a suggestive but very specific job to do in this regard by
indicating ways to minimise the tax liability through his knowledge of concessions and

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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa
 incentives available under the existing taxation framework of the country.
An accountant can influence a company even by not being an employee. He can act as a
man who verifies and certifies the authenticity of accounts of a company by auditing the
accounts. It is a strictly professional job and is done by persons who are formally trained
and qualified for the purpose. They have an educational status and a prescribed code of
conduct like the Chartered Accountants in India and Certified Public Accountants in USA.
Information management is another area which keeps an accountant busy. He is the one
who classifies the financial information into information for internal use (management
accounting function); and information or external use (financial accounting function).
Irrespective of the size and degree of automation of a business, information management is
a key area and many organizations are known to have perished because they failed to
recognize this as an important function of an accountant because information system is
imperative for effective cost control, to forecast cash needs and to plan for future growth of
the organization.
1.5 Utility of accounting
The preceding section has just brought out the importance of information. Effective
decisions require accurate, reliable and timely information. The need for quantity and
quality of information varies with the importance of the decision that has to be taken on
the basis of that information. The following paragraphs throw light on the various users of
accounting information and what do they do with that information.
Individuals may use accounting information to manage their routine affairs like operating
and managing their bank accounts, to evaluate the worthwhileness of a job in an
organization, to invest money, to rent a house, etc. Business Managers have to set goals,
evaluate progress and initiate corrective action in case of unfavourable deviation from the
planned course of action. Accounting information is required for many such decisions—
purchasing equipment, maintenance of inventory, borrowing and lending, etc.
Investors and creditors are keen to evaluate the profitability and solvency of a company
before they decide to provide money to the organization. Therefore, they are interested to
obtain financial information about the company in which they are contemplating an
investment. Financial statements are the principal source of information to them which are
published in annual reports of a company and various financial dailies and periodicals.
Government and Regulatory agencies are charged with the responsibility of guiding the
socio-economic system of a country in such a way that it promotes common good. For
example, the Securities and Exchange Board of India (SEBI) makes it mandatory for a
company to disclose certain financial information to the investing public. The

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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa
 government‗s task of managing the industrial economy becomes simplify if the accounting
information such as profits, costs, taxes, etc. is presented in a uniform manner without any
manipulation or ‘window-dressing‗.
Central and State governments levy various taxes. The taxation authorities, therefore, need
to know the income of a company to calculate the amount of tax that the company would
have to pay. The information generated by accounting helps them in such computations
and also to detect any attempts of tax evasion. Employees and trade unions use the
accounting information to settle various issues related to wages, bonus, profit sharing, etc.
Consumers and general public are also interested in knowing the amount of income
earned by various business houses. Accounting information helps in finding whether or
not a company is over charging or exploiting the customers, whether or not companies are
showing improved business performance, whether or not the country is emerging from the
economic recession, etc. All such aspects draw heavily on accounting information and are
closely related to our standard of living.
1.6 Types of accounting
The financial literature classifies accounting into three broad categories: Financial
Accounting, Management Accounting, and Cost accounting. Financial accounting is
primarily concerned with the preparation of financial statements whereas management
accounting covers areas such as interpretation of financial statements, cost accounting, etc.
Both these types of accounting are examined in the following paragraphs.
1.6.1 Financial accounting
As mentioned earlier, financial accounting deals with the preparation of financial
statements for the basic purpose of providing information to various interested groups
like creditors, banks, shareholders, financial institutions, government, consumers, etc.
Financial statements, i.e. the income statement and the balance sheet indicate the way in
which the activities of the business have been conducted during a given period of time.
Financial accounting is charged with the primary responsibility of external reporting. The
users of information generated by financial accounting, like bankers, financial institutions,
regulatory authorities, government, investors, etc. want the accounting information to be
consistent so as to facilitate comparison. Therefore, financial accounting is based on certain
concepts and conventions which include separate business entity, going concern concept,
money measurement concept, cost concept, dual aspect concept, accounting period
concept, matching concept, realization concept and conventions of conservatism,
disclosure, consistency, etc. All such concepts and conventions would be dealt with detail
in subsequent lessons. The significance of financial accounting lies in the fact that it aids

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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa
 the management in directing and controlling the activities of the firm and to frame relevant
managerial policies related to areas like production, sales, financing, etc. However, it
suffers from certain drawbacks which are discussed in the following paragraphs.
o The information provided by financial accounting is consolidated in nature. It does not
indicate a break-up for different departments, processes, products and jobs. As such, it
becomes difficult to evaluate the performance of different sub-units of the
organization.
o Financial accounting does not help in knowing the cost behavior as it does not
distinguish between fixed and variable costs.
o The information provided by financial accounting is historical in nature and as such the
predictability of such information is limited.
The management of a company has to solve certain ticklish questions like expansion of
business, making or buying a component, adding or deleting a product line, deciding on
alternative methods of production, etc. The financial accounting information is of little help
in answering these questions. The limitations of financial accounting, however, should not
lead one to believe that it is of no use. It is the basic foundation on which other branches
and tools of accounting analysis are based. It is the source of information, which can be
further analyzed and interpreted according to the tailor-made requirements of decision-
makers.
1.6.2 Management accounting
Management accounting is ‘tailor-made‗ accounting. It facilitates the management by
providing accounting information in such a way so that it is conducive for policy making
and running the day-to-day operations of the business. Its basic purpose is to communicate
the facts according to the specific needs of decision-makers by presenting the information
in a systematic and meaningful manner. Management accounting, therefore, specifically
helps in planning and control. It helps in setting standards and in case of variances
between planned and actual performances, it helps in deciding the corrective action.
An important characteristic of management accounting is that it is forward looking. Its
basic focus is one future activity to be performed and not what has already happened in
the past. Since management accounting caters to the specific decision needs, it does not
rest upon any well-defined and set principles. The reports generated by a management
accountant can be of any duration– short or long, depending on purpose. Further, the
reports can be prepared for the organisation as a whole as well as its segments.
1.6.3 Cost accounting
One important variant of management accounting is the cost analysis. Cost accounting

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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa
 makes elaborate cost records regarding various products, operations and functions. It is
the process of determining and accumulating the cost of a particular product or
activity. Any product, function, job or process for which costs are determined and
accumulated, are called cost centers.
The basic purpose of cost accounting is to provide a detailed breakup of cost of different
departments, processes, jobs, products, sales territories, etc., so that effective cost control
can be exercised. Cost accounting also helps in making revenue decisions such as those
related to pricing, product-mix, profit-volume decisions, expansion of business,
replacement decisions, etc.
The objectives of cost accounting, therefore, can be summarized in the form of three
important statements, viz, to determine costs, to facilitate planning and control of business
activities and to supply information for short- and long-term decision. Cost accounting has
certain distinct advantages over financial accounting. Some of them have been discussed
succeeding. The cost accounting system provides data about profitable and non-profitable
products and activities, thus prompting corrective measures. It is easier to segregate and
analyze individual cost items and to minimize losses and wastages arising from the
manufacturing process. Production methods can be varied so as to minimize costs and
increase profits. Cost accounting helps in making realistic pricing decisions in times of low
demand, competitive conditions, technology changes, etc.
Various alternative courses of action can be properly evaluated with the help of data
generated by cost accounting. It would not be an exaggeration if it is said that a cost
accounting system ensures maximum utilization of physical and human resources. It
checks frauds and manipulations and directs the employer and employees towards
achieving the organizational goal.
1.7 Distinction between financial and management accounting
Financial and management accounting can be distinguished on a variety of basis like, users
of information, criterion for decision making, behavioral implications, time frame, type of
reports. Table 1.1 presents a summary of distinctions between financial and management
accounting.
Financial accounting Management accounting
Primary user Outside parties and manager Business managers
of the business
Decision Accounts are based on generally Comparison of costs and benefits of
criterion accepted accounting principles proposed action

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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa
 Behavioral Concern about adequacy of disclosure. Concern about how reports will affect
implications Behavioral implications are secondary employee
behavior
Time focus Past orientation Future orientation
Reports Summary reports regarding the whole Detailed reports on the parts of the
entity entity
Source: Horngren, Harrison and Robinson, Financial and Management Accounting, Prentice Hall, New
Jersey, 1994
1.8 Distinction between financial and Cost accounting
Financial and Cost accounting can be distinguished on a variety as it showing in table 1.2
which presents a summary of distinctions between Financial and Cost accounting.
Financial Accounting Cost Accounting
It is the process of determining and accumulating It is deals with the preparation of financial
the cost of a particular product or activity. It is statements
easier to separate and analyze individual cost
items and to minimize losses and wastages arising
from the manufacturing process.
It is provide a detailed break-up of cost of It is providing information to various interested
different departments, processes, jobs, products, groups like creditors, banks, shareholders,
sales territories, etc., It is provides data about financial institutions, government, consumers,
profitable and non-profitable products and etc. it does not indicate a break-up for different
activities, thus prompting corrective measures. departments, processes, products and jobs
It helps in making revenue decisions such as it aids the management in directing and
those related to pricing, product-mix, profit- controlling the activities of the firm and to frame
volume decisions, expansion of business, relevant managerial policies related to areas like
replacement decisions, etc. production, sales, financing, etc.
It helps in knowing the cost behavior as it does It is based on certain concepts and conventions. It
distinguish between fixed and variable costs does not help in knowing the cost behavior as it
does not distinguish between fixed and variable
costs
It is Deals with the Project activities relationships. It is Deals with the external Customers and
It is charged with the primary responsibility of project relationships. It is charged with the
internal reporting primary responsibility of external reporting
1.9 Summary
Accounting can be understood as the language of financial decisions. It is an ongoing
process of performance measurement and reporting the results to decision-makers. The
discipline of accounting can be traced back to very early times of human civilization. With
the advancement of industry, modern day accounting has become formalized and
structured. A person who maintains accounts is known as the accountant. He is engaged in

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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa
 multifarious activities like preparing financial statements, facilitating the control process,
tax planning, auditing, and information management. The information generated by
accountant is used by various groups like, individuals, managers, investors, creditors,
government, regulatory agencies, taxation authorities, employees, trade unions, consumers
and general public.
Depending upon purpose and method, accounting can be of broadly two types– financial
accounting and management accounting. Financial accounting is primarily concerned with
the preparation of financial statements mainly for outsiders. It is based on certain well-
defined concepts and conventions and helps in framing broad financial policies.
However, it suffers from certain limitations which are taken care of by the other branch of
accounting, viz.; management accounting. Management accounting is meant to help in
decision-making by analyzing and interpreting the information generated by financial
accounting. As such, management accounting is futuristic and decision-oriented.
The methods of management accounting are not very exact as they have to be varied
according to the requirements of the decision. Cost accounting is an important aspect of
management accounting. It emphasizes on cost determination, aiding the planning and
control process and supplying information for short- and long-run decisions. The basic
differences between financial and management accounting arises due to differences in
users of information, differences in time frame and type of reports generated. The criterion
for decision making and the behavioral implications of both types of accounting are also
different.
1.10. Glossaries:
 Accrual: Recognition of revenues and costs as they are earned or incurred. It includes
recognition of transaction relating to assets and liabilities as they occur irrespective of
the actual receipts or payment.
 Cost: The amount of expenditure incurred on or attributable to a specified article,
product or activity.
 Expenses: A cot relating to the operations of an accounting period.
 Revenue: Total amount received from sales of goods/services.
 Income: Excess of revenue over expenses.
 Loss: Excess of expenses over revenue.
 Capital: Generally refers to the amount invested in an enterprise by its owner.
 Fund: An account usually of the nature of a reserve or provision which is represented
by specifically Ear Market Assets.

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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa
  Gain: A monetary benefit, profit or advantage resulting from a transaction or group of
transactions.
 Investment: Expenditure on assets held to earn interest, income, profit or other
benefits.
 Liability: The financial obligation of an enterprise other than owners‗ funds.
 Net Profit: The excess of revenue over expenses during a particular accounting
period.
1.11 Self-assessment questions
1. Define accounting. What purpose is served by accounting?
2. Discuss the role and activities of an accountant.
3. What are the various interested parties which use accounting information? How is such
information used?
4. Explain the different types of accounting.
5. Differentiate Financial Accounting and Management Accounting in detail.
1.12 References/suggested readings
1. Ashish K. Bhattacharyya (2004), ―Financial Accounting for Business Managers‖, Prentice
Hall of India Pvt. Ltd., New Delhi.
2. R.L. Gupta (2001), ―Advanced Accountancy‖, Sultan Chand & Sons, New Delhi.
3. P.C. Tulsian (2000), ―Financial Accounting‖, Tata McGraw Hill, New Delhi.
4. Shashi K. Gupta (2002), ―Contemporary Issues in Accounting‖, Kalyani Publishers, New
Delhi.
5. S.N. Maheshwari (2004), ―Management Accounting and Financial Control‖, Sultan
Chand and Sons, New Delhi.

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Lecture Note#1 Introduction to Accounting Dr. Mahmoud Arafa