JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

MC4104 - FUNDAMENTALS OF ACCOUNTING

UNIT I INTRODUCTION TO ACCOUNTING

Introduction to Financial, Cost and Management Accounting - Objectives of Financial
Accounting – Accounting Principles, Concepts and Conventions – Book keeping and
Accounting .

I. INTRODUCTION TO FINANCIAL, COST AND MANAGEMENT ACCOUNTING

1. Financial Accounting

Financial accounting may be defined as the science and art of systematically

recording, classifying and summarizing business transactions of financial character
and finally interpreting the results for determining the financial profit or loss at the
end of an accounting year.

It also shows the financial position of the firm, and thus, records and reports
financial statements – Balance sheet, income statement and statement of cash
flows.

Objectives

 Maintaining Systematic Records Of Transactions

 Ascertaining Profit Or Loss
 Ascertaining Financial Position
 Assisting The Management
 Provide Accounting Information To Users

2. Cost Accounting

Cost accounting is that branch of the accounting information system, which

records, measures and reports information about costs.

The primary purpose of cost accounting is cost ascertainment and its use in
decision making and performance evaluation.

Cost accounting is concerned with recording, classifying and appropriate allocation

of expenditure for the determination of the costs of products or services, and for
the suitably arranged data for purposes of control and guidance of information to
management for decision making.

It deals with the cost of every unit, job, process, order, service, etc, whichever is
applicable and includes the cost of production, cost of selling and cost of
distribution.

1
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

Cost means “the price paid for something” Cost ascertainment is computation of
actual costs incurred Cost estimation is a process of predetermining costs of goods
and service.

Objectives of Cost Accounting:

Objectives of cost accounting are ascertainment of cost, fixation of selling price,

proper recording and presentation of cost data to management for measuring
efficiency and for cost control and cost reduction, ascertaining the profit of each
activity, assisting management in decision making and determination of break-
even point.

3. Management Accounting
Management accounting involves furnishing of the accounting data to the
management in such a way that it facilitates the decision making and improve the
efficiency within the organization and finally helps in achieving the goals of the
organization.

Definitions – Management Accounting

• According to American Accounting Association: Management Accounting includes
the methods and concepts necessary for control through the evaluation and
interpretations of performances.
• According to Robert N. Anthony: Management Accounting is concerned with
accounting information that is useful to the management.

Objectives of Management Accounting:

 Assistance in Planning and Formulation of Future Policies
 Helps in the Interpretation of Financial Information
 Helps in Controlling Performance 4. Helps in Organizing
 Helps in the Solution of Strategic Business Problems
 Helps in Coordinating Operations
 Helps in Motivating Employees
 Communicating Up-to-date Information
 Helps in Evaluating the Efficiency and Effectiveness of Policies
☟☟☟☟☟☟☟☟

II. OBJECTIVES OF FINANCIAL ACCOUNTING

1. Identification and recording of transactions

The primary object of accounting is to identify the financial transactions and to

record these systematically in the books of accounts. As a result, the true nature of
each and every transaction is known without much exercise of memory.

2
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

With this end in view, the transactions are primarily recorded in general and in a
special journal and later on permanently various accounts are kept in the ledger.

2. Ascertainment of results

Every business concern is interested to know its operating results at the end of a
particular period.

The amount of profit or loss for a particular period of a business concern can be
ascertained by preparing an income statement with the help of The primary object
of accounting is to identify the financial transactions and to record these
systematically in the books of accounts. As a result, the true nature of each and
every transaction is known without much exercise ledger account balances of revenue
nature.

Surplus or deficit of revenue for a particular period of a non-trading concern can also be
ascertained by preparing income and expenditure account or statement.

3. Ascertainment of financial affairs

Ascertainment of debts-liabilities, property, and assets i.e. total financial affairs of an

organization at a particular date is another important object of Accounting.

Financial affairs of concern at a particular date can be ascertained by preparing a

balance sheet.

The balance sheet is the statement of assets and liabilities of concern at a

particular date.

4. Keeping accounts of cash

Cash book is a prominent book of the books of accounts.

Cash receipts and cash payments are accounted for in this book. A number of daily cash
receipts, payments, cash in hand and cash at the bank can be known from this book.

Fraud, forgery, and misappropriation of money are reduced by keeping cash book
scientifically and accurately.

5. Control over assets and liabilities

For running a business successfully a businessman is to acquire various assets like land,
building, machinery, etc.

He is to face various debts and liabilities like accounts payable, notes payable, loan, bank
overdraft, etc. side by side with die acquisition of assets.

3
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

The actual position of these debts-liabilities, property, and assets can be ascertained
through the proper keeping of accounts.

A businessman can take the right steps for controlling the quantity of assets decrease
and liability increase.

6. Controlling money defalcation and cost

Prevention of money defalcation through fraud and forgery and controlling the cost of
concern are also the main objects of Accounting.

Prevention of money defalcation and cost control become easier if accounts are kept
scientifically.

7. Providing economic data

Another noble object of accounting is to provide the concerned parties with all
economic information preparing financial statements and reports etc. in time.

8. Helping tax fixation

Accounts prepared on the basis of accepted accounting principles in considered

reliable to the income tax and VAT authorities for easy determination and settlement of
tax and VAT.

9. Determination and evaluation of policy

The object of accounting is to help the management in determining and

evaluating the management policies in running the business successfully by
supplying necessary, information, interpreting and analyzing the financial statements.

10. Testing the arithmetical accuracy of accounts

One of the main objects of scientific methods of accounting is to make sure that
accounts have been kept in a proper way. The arithmetical accuracy of accounts kept
in the ledger can be assured by preparing a trial balance.

Agreement of a trial balance is the proof of the arithmetical accuracy of accounts. The
advantage of taking loans due to the insufficiency of capital, borrowing capital from
outsiders is felt necessary to run a business.

4
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

Loan givers are not willing to give a loan without knowing the financial position of a
business. The financial statement of a business concern reflects the solvency or
loan repayment capability of that concern.

11. Acceptability to others

Banks or financial institutions are interested to know the accurate financial position of
business concern for sanctioning loans.

On the other hand, the government or other authorities may also ask about the financial
position of business concern for various reasons.

In these cases, the accounts maintained in a disciplined way become easily acceptable to
the interested institutions or authorities.

12. Creation of values and accountability

The object of accounts maintained in an acceptable way is to create higher values

among individuals and organizations and thereby creating awareness in preventing
money defalcation, misappropriation of fund and cost control by ensuring transparency
and accountability.

13. Following legal bindings and prohibition

As all kinds of business organizations have to abide by some legal bindings and
prohibitions, they are to maintain their accounts accurately.

For example;

Partnership law, income tax law, and company law, etc. compel business organizations
to maintain their accounts in an appropriate manner.

The main objectives of accounting are maintaining a complete and systematic record of
all transactions and analyzing the financial position of a business.

Every individual or a business concern is interested to know the results of financial

transactions and their results are ascertained through the accounting process.

A businessman can ascertain the operating results and financial position of his business
at any time through Accounting.

☟☟☟☟☟☟☟☟

III. ACCOUNTING PRINCIPLES, CONCEPTS AND CONVENTIONS

A. ACCOUNTING PRINCIPLES

5
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

Accounting principles are the rules that an organization follows when reporting financial
information. A number of basic accounting principles have been developed through
common usage. They form the basis upon which the complete suite of accounting
standards has been built. The best-known of these principles are as follows:

 Accrual principle. This is the concept that accounting transactions should be

recorded in the accounting periods when they actually occur, rather than in the
periods when there are cash flows associated with them. This is the foundation of
the accrual basis of accounting. It is important for the construction of financial
statements that show what actually happened in an accounting period, rather than
being artificially delayed or accelerated by the associated cash flows. For example,
if you ignored the accrual principle, you would record an expense only when you
paid for it, which might incorporate a lengthy delay caused by the payment terms
for the associated supplier invoice.

 Conservatism principle. This is the concept that you should record expenses and
liabilities as soon as possible, but to record revenues and assets only when you
are sure that they will occur. This introduces a conservative slant to the financial
statements that may yield lower reported profits, since revenue and asset
recognition may be delayed for some time. Conversely, this principle tends to
encourage the recordation of losses earlier, rather than later. This concept can be
taken too far, where a business persistently misstates its results to be worse than
is realistically the case.

 Consistency principle. This is the concept that, once you adopt an accounting
principle or method, you should continue to use it until a demonstrably better
principle or method comes along. Not following the consistency principle means
that a business could continually jump between different accounting treatments of
its transactions that make its long-term financial results extremely difficult to
discern.

 Cost principle. This is the concept that a business should only record its assets,
liabilities, and equity investments at their original purchase costs. This principle is
becoming less valid, as a host of accounting standards are heading in the direction
of adjusting assets and liabilities to their fair values.

 Economic entity principle. This is the concept that the transactions of a business
should be kept separate from those of its owners and other businesses. This
prevents intermingling of assets and liabilities among multiple entities, which can
cause considerable difficulties when the financial statements of a fledgling business
are first audited.

 Full disclosure principle. This is the concept that you should include in or alongside
the financial statements of a business all of the information that may impact a

6
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

reader's understanding of those statements. The accounting standards have

greatly amplified upon this concept in specifying an enormous number of
informational disclosures.

 Going concern principle. This is the concept that a business will remain in
operation for the foreseeable future. This means that you would be justified in
deferring the recognition of some expenses, such as depreciation, until later
periods. Otherwise, you would have to recognize all expenses at once and not
defer any of them.

 Matching principle. This is the concept that, when you record revenue, you should
record all related expenses at the same time. Thus, you charge inventory to the
cost of goods sold at the same time that you record revenue from the sale of
those inventory items. This is a cornerstone of the accrual basis of accounting. The
cash basis of accounting does not use the matching the principle.

 Materiality principle. This is the concept that you should record a transaction in the
accounting records if not doing so might have altered the decision making process
of someone reading the company's financial statements. This is quite a vague
concept that is difficult to quantify, which has led some of the more picayune
controllers to record even the smallest transactions.

 Monetary unit principle. This is the concept that a business should only record
transactions that can be stated in terms of a unit of currency. Thus, it is easy
enough to record the purchase of a fixed asset, since it was bought for a specific
price, whereas the value of the quality control system of a business is not
recorded. This concept keeps a business from engaging in an excessive level of
estimation in deriving the value of its assets and liabilities.

 Reliability principle. This is the concept that only those transactions that can be
proven should be recorded. For example, a supplier invoice is solid evidence that
an expense has been recorded. This concept is of prime interest to auditors, who
are constantly in search of the evidence supporting transactions.

 Revenue recognition principle. This is the concept that you should only recognize
revenue when the business has substantially completed the earnings process. So
many people have skirted around the fringes of this concept to commit reporting
fraud that a variety of standard-setting bodies have developed a massive amount
of information about what constitutes proper revenue recognition.

 Time period principle. This is the concept that a business should report the results
of its operations over a standard period of time. This may qualify as the most
glaringly obvious of all accounting principles, but is intended to create a standard
set of comparable periods, which is useful for trend analysis.

7
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

These principles are incorporated into a number of accounting frameworks, from which
accounting standards govern the treatment and reporting of business transactions.

B. ACCOUNTING CONCEPTS

1. Business entity concept: A business and its owner should be treated separately
as far as their financial transactions are concerned.

2. Money measurement concept: Only business transactions that can be expressed

in terms of money are recorded in accounting, though records of other types of
transactions may be kept separately.

3. Dual aspect concept: For every credit, a corresponding debit is made. The
recording of a transaction is complete only with this dual aspect.

4. Going concern concept: In accounting, a business is expected to continue for a

fairly long time and carry out its commitments and obligations. This assumes that
the business will not be forced to stop functioning and liquidate its assets at “fire-
sale” prices.

5. Cost concept: The fixed assets of a business are recorded on the basis of their
original cost in the first year of accounting. Subsequently, these assets are
recorded minus depreciation. No rise or fall in market price is taken into account.
The concept applies only to fixed assets.

6. Accounting year concept: Each business chooses a specific time period to

complete a cycle of the accounting process—for example, monthly, quarterly, or
annually—as per a fiscal or a calendar year.

7. Matching concept: This principle dictates that for every entry of revenue
recorded in a given accounting period, an equal expense entry has to be recorded
for correctly calculating profit or loss in a given period.

8. Realisation concept: According to this concept, profit is recognised only when it

is earned. An advance or fee paid is not considered a profit until the goods or
services have been delivered to the buyer.

III. ACCOUNTING CONVENTIONS

There are four main conventions in practice in accounting: conservatism; consistency;

full disclosure; and materiality.

Conservatism is the convention by which, when two values of a transaction are

available, the lower-value transaction is recorded. By this convention, profit should
never be overestimated, and there should always be a provision for losses.

8
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

Consistency prescribes the use of the same accounting principles from one period of an
accounting cycle to the next, so that the same standards are applied to calculate profit
and loss.

Materiality means that all material facts should be recorded in accounting. Accountants
should record important data and leave out insignificant information.

Full disclosure entails the revelation of all information, both favourable and detrimental
to a business enterprise, and which are of material value to creditors and debtors.

☟☟☟☟☟☟☟☟

IV. BOOK KEEPING AND ACCOUNTING

A. BOOK KEEPING

Book–keeping is that branch of knowledge which tells us how to keep a record of

business transactions. It is often routine and clerical in nature. It is important to note
that only those transactions related to business which can be expressed in terms of
money are recorded. The activities of book-keeping include recording in the journal,
posting to ledger and balancing the accounts.
DEFINITION OF BOOK KEEPING

R.N. Carter says, “book-keeping is the science and art of correctly recording in the
books of account all those business transactions that result in transfer of money or
money’s worth.”
MEANING OF BOOK KEEPING

Book-Keeping: Is a part of accounting and is concerned with record keeping or

maintenance of books of accounts. It is often routine and clerical. Book-keeping is an
act of keeping permanent records of the financial transactions of a business in a
systematic and orderly manner.

The financial transactions of the business are identified, recorded and classified in
different books. In modern entities, records of financial transactions are maintained
under a double entry system.

The double entry system has been recognized as a systematic and complete system for
recording financial transactions. Double entry system recognizes that every financial
transaction has two aspects. It then records two aspects of a transaction simultaneously
in two separate accounts with equal amounts. It provides the aspects of a transaction
with their names of debit and credit.

Thereafter, with the help of ledger accounts, profit and loss account and the balance
sheet are prepared to ascertain the profit and loss and the financial position of the

9
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

business. Thus, the double-entry system is the most systematic and complete system of
book-keeping.

Therefore double entry system is the technique or method of book-keeping which

recognizes the fact that every financial transaction has two aspects and records two
aspects of each transaction simultaneously in two separate account giving their names
'debit' and 'credit' respectively.
OBJECTIVES OF BOOK KEEPING

1.To have permanent record of all the business transactions.

2.To keep records of incomes and expenses in such a way that the net profit or net
loss may be calculated.
3. To keep records of assets and liabilities in such a way that the financial position of the
business may be ascertained.
4. To keep control on expenses with a view to minimize the same in order to minimize
the profit.
5. To know the names of the customer and the amount due from them.
6. To know the names of the suppliers and the amount due to them.
7. To have important information for legal and tax purpose.

B. ACCOUNTING

MEANING OF ACCOUNTING:

“Accounting is the process of identifying, recording, classifying and summarizing in a

significant manner and in terms of money, transactions and events which are, in part at
least, of financial character, interpreting and communicating the results thereof”.

Attributes of Accounting:

The above definition of accounting brings out the following attributes of accounting:

Economic Events: It is the “happening of consequence” to a business entity and can be

divided into two parts:

Internal Events: It is an economic event that occurs entirely within business. Example:
Supply of raw materials from stores department to manufacturing department.

External Events: It is a transaction which involves the transfer or exchange of something

for value between two or more persons. Example: Sale of shoes by Bata and company
to its customers.

Identifying: Accounting records only those transactions and events which are of financial
character, therefore it is necessary to identify the recordable transactions. If an event
cannot be expressed in terms of money, then it is not considered for recording.

10
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

Example: manager’s honesty cannot be expressed in terms of money, hence not

recorded in books.
Recording: It is concerned with recording of identified events and transactions in the
book of original entry i.e. in journal

Classifying: It is concerned with classification of the recorded transactions of the basis of

their nature at one place. Book containing several separate accounts is called ledger.

Summarizing: This involves presenting the classified data in an understandable manner,

useful for internal as well as external users. This involves preparation of trial balance and
final accounts (trading account, profit and loss account and balance sheet).

Analyzing and interpreting: The recorded and classified data is analyzed and interpreted
in a manner so that the end users such as creditors, bankers, managers, proprietors etc,
can make a meaningful judgment about the financial condition and profitability of the
company.

Communicating: It involves presenting the analyzed data in the form of financial reports
or statements, to the end users of the financial information i.e. insiders and outsiders
like officers, staff members, shareholders, creditors, government, etc.

FUNCTIONS OF ACCOUNTING: Accounting process involves following functions:

(1) To keep systematic record of the financial activities: The first important function of
accounting is to keep a systematic record of the financial transactions of the business. In
accounting only those business transactions are recorded which can be expressed in
terms of money. Business transactions are properly recorded, classified into appropriate
accounts and summarized into financial statements.

(2) To protect the properties of the business: Another important function of accounting
is to protect the properties of the business by maintaining proper records and providing
up-to-date information to the management. Thus, accounting records are called the
eyes and ears of the business.

(3) To communicate the financial results: Accounting communicates the financial results
and other valuable financial information to the various interested groups such as officers,
creditors, employees, government, consumers.

(4) To prevent and detect errors and frauds: The most important function of accounting
is that it helps in detecting errors and frauds, if any take place by maintaining proper
records.

ADVANTAGES OF ACCOUNTING: The main advantages of accounting are:

11
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

(1) Helpful in taking managerial decisions: Accounting provides operating and financial
performance of the business which is needed by management for taking planning and
controlling decisions.

(2) Facilitates comparative study: A systematic record enables a businessman to

compare one year’s results with those of other years and locate significant factors
leading to the change, if any.

(3) Facilitates control: Accounting records enable a business concern to keep a good
control over various activities and properties.

(4) Information about debtors and creditors: Accounting records disclose the amounts
due to a business and the persons from whom the amounts are due.

(5) Helpful in assessment of tax liability: A systematic accounting record helps in

assessing the tax liability. The tax requirements can be satisfied and tax liability can be
calculated easily with the help of accounting records.

(6) Facilitates sale of business: if someone desires to sell his business, the accounts
maintained by him will enable the ascertainment of the proper purchase price.

Limitations of Accounting

Based on accounting concepts and conventions: The results disclosed by financial

statements are not realistic as they are based on various accounting concepts and
conventions. For instance, fixed assets are shown at their historical cost and not at their
market price.

Accounting may lead to window dressing: The management of the business may present
the financial statements to suit their own requirement by showing more profit or less
profit than the actual value. This is done by window dressing, i.e. showing the items as
per the convenience of the management. For example, closing stock may be over or
under valued than the true value.

Accounting ignores the effect of changes in price level: Accounting statements are
prepared at historical cost. Assets are shown in the books of account at the original cost.
Thus, assets do not disclose true and fair view and balance sheet does not reflect about
true financial position of the entity.

Accounting ignores the qualitative elements: Accounting is concerned with quantitative

elements only; qualitative elements like quality of management and labor force are
ignored.
Based on Unrealistic information: Actual profit of the business can be known only when
the business is shut down and closing stock is valued at realizable value. For example,
assets are recorded at historical cost and accounts are prepared on going concern basis,
which provide unrealistic financial information.

12
 JAYARAM COLLEGE OF ENGINEERING AND TECHNOLOGY

DIFFERENCE BETWEEN BOOK-KEEPING AND ACCOUNTING:

☟☟☟☟☟☟☟☟

Compiled By

Prof. S.SENTHILKUMAR, M.Com., B.Ed., M.B.A., M.Phil.,

Department of Science and Humanities

❉❉❉❉❉❉❉❉❉❉

13