Introduction to Accounting 1

O ver the centuries, accounting has remained

confined to the financial record-keeping
functions of the accountant. But, today’s rapidly
changing business environment has forced the
accountants to reassess their roles and functions
both within the organisation and the society. The
role of an accountant has now shifted from that of a
mere recorder of transactions to that of the member
LEARNING OBJECTIVES providing relevant information to the decision-
After studying this chapter
making team. Broadly speaking, accounting today
you will be able to: is much more than just book-keeping and the
state the meaning and
need of accounting; now capable of working in exciting new growth
discuss accounting as areas such as: forensic accounting (solving crimes
a source of information;
such as computer hacking and the theft of large
and external users of amounts of money on the internet); e-commerce
accounting information;
planning, environm ental accounting, etc. This
of accounting;
realisation came due to the fact that accounting is
accounting; capable of providing the kind of information that
explain the basic terms managers and other interested persons need in order
used in accounting. to make better decisions. This aspect of accounting
2 Account

gradually assumed so much importance that it has now been raised to the

and communicates economic information about the organisation to a wide

variety of users whose decisions and actions are related to its performance.
This introductory chapter therefore, deals with the nature, need and scope of
accounting in this context.

1.1 Meaning of Accounting

With greater economic development resulting in changing role of accounting,

economic information to permit informed judgments and decisions by users

of information’.

Fig. 1.1 : Showing the process of accounting

Introduction to Accounting 3

the function of accounting is to provide quantitative information, primarily

nancial in nature, about economic entities, that is intended to be useful in
making economic decisions.

recording and communicating the required information relating to the economic

events of an organisation to the interested users of such information. In order
to appreciate the exact nature of accounting, we must understand the following

Box 1
History and Development of Accounting

their treasuries where gold and other valuables were kept. The incharge of treasuries
had to send day wise reports to their superiors known as Wazirs (the prime minister)
and from there month wise reports were sent to kings. Babylonia, known as the city of
commerce, used accounting for business to uncover losses taken place due to frauds

received among treasuries, maintaining total receipts, total payments and balance of

receipts and payments were recorded and wherefrom they were posted to ledgers on

kingdom wrote a book named Arthashasthra, which also described how accounting
records had to be maintained.
Summa de
Arithmetica, Geometria, Proportion at Proportionality
4 Account

but spread the knowledge of it. It shows that he probably relied on then–current book-
keeping manuals as the basis for his masterpiece. In his book, he used the present

debito which comes from

the Latin debita and debeo
the Italian credito credo’ which means trust or belief (in

you must make some debtor’. He also stated that a merchants responsibility include

accounting procedures.

1.1.1 Economic Events

as a happening of consequence to a business organisation which consists

purchase of machinery, installing and keeping it ready for manufacturing is

a machine, transportation of machine, site preparation for installation of

a machine, expenditure incurred on its installation and trial runs. Thus,

event involves transactions between an outsider and an organisation, these are

known as . The following are the examples of such transactions:

an economic event that occurs entirely between the

internal wings of an enterprise, e.g., supply of raw material or components by
the stores department to the manufacturing department, payment of wages to
the employees, etc.
Introduction to Accounting 5

: It means determining what transactions to record, i.e., to identity

events which are to be recorded. It involves observing activities and selecting

organisation. The business transactions and other economic events therefore

are evaluated for deciding whether it has to be recorded in books of account.

appointment of personnel are important but none of these are recorded in books
of account. However, when a company makes a sale or purchase, whether on
cash or credit, or pays salary it is recorded in the books of account.
Measurement :

items like the appointment of a new managing director, signing of contracts or

changes in personnel are not shown in the books of accounts.
Recording
terms, these are recorded in books of account in monetary terms and in a

information is summarised as per well-established practice and is made

available as and when required.
Communication :
in order that the pertinent information is generated and communicated in
a certain form to management and other internal and external users. The
information is regularly communicated through accounting reports. These
reports provide information that are useful to a variety of users who have an

planning and controlling business activities and making necessary decisions

from time to time. The accounting information system should be designed in
such a way that the right information is communicated to the right person at

information.
6 Account

Organisation

company, local authority, municipal corporation or any other association of

persons.

users can be divided into two broad categories: internal users and external
users.

primary function of accounting is to provide useful information for decision-

making, it is a means to an end, with the end being the decision that is helped
by the availability of accounting information. You will study about the types
of accounting information and its users later in this chapter.

Box 2
Why do the Users Want Accounting Information?

The owners/shareholders use them to see if they are getting a satisfactory return

comparisons in their attempts to evaluate the performance. They may compare the

ensuring that the money invested in the company/organisation is generating an

Introduction to Accounting 7

adequate return and that the company/organisation is able to pay its debts and
remain solvent.

particularly at liquidity, which is the ability of the company/organisation to pay

its debts as they become due.

in the company/organisation.

protecting the interests of investors, creditors(lenders), and also to satisfy the legal

1.2 Accounting as a Source of Information

in itself. It is a means to facilitate the dissemination of information among

appropriate decisions. Therefore, dissemination of information is an essential

function of accounting. To be useful, the accounting information should
ensure to:

of information;

effectively in meeting goals;

assumptions on matters subject to interpretation, evaluation, prediction,

or estimation; and
8 Account

Test Your Understanding - I

(b) Internal users are the ..................... of the business entity.

whether or not the business entity is eligible for a loan.

reports to users.
(e) ..................... users are groups outside the business entity, who uses the
information to make decisions about the business entity.
(f) Information is said to be relevent if it is ......................
(g) The process of accounting starts with ............ and ends with ............

The role of an accountant in generating accounting information is to observe,

screen and recognise events and transactions to measure and process them,
and thereby compile reports comprising accounting information that are
communicated to the users. These are then interpreted, decoded and used by
management and other user groups. It must be ensured that the information
provided is relevant, adequate and reliable for decision-making. The apparently
divergent needs of internal and external users of accounting information have
resulted in the development of sub-disciplines within the accounting discipline
namely, , cost accounting and management accounting x 3).
Financial accounting

relates to the past period, serves the stewardship

function and is monetary in
all stakeholders.
Cost accounting assists in analysing the expenditure for ascertaining the
Introduction to Accounting 9

Management accounting deals with the provision of necessary accounting

information to people within the organisation to enable them in decision-making,

decisions, capital expenditure decisions and so on. Besides, it

generates other
relates to the future and is relevant for decision-making in
the organisation.
manpower needs, environmental data about effects on
air, water, land, natural

like human resource accounting, social accounting, responsibility accounting

have also gained prominance.
1.3 Objectives of Accounting

information to the interested group of users, both external and internal. The
necessary information, particularly in case of external users, is provided in

sheet. Besides these, the management is provided with additional information

from time to time from the accounting records of business. Thus, the primary
objectives of accounting include the following:

cannot accurately remember the numerous amount of varied transactions

such as purchases, sales, receipts, payments, etc. that takes place in business
everyday. Hence, a proper and complete records of all business transactions

acts as an evidence.

The owners of business are keen to have an idea about the net results of their
Introduction to Accounting 1

earned or loss sustained by a business during an accounting period which can

be easily workout with help of record of incomes and expenses relating to the

excess of revenue (income), over expenses. If the total revenue of a given period
is 6,00,000 and total expenses are
60,000( 6,00,000 – 5,40,000). If however, the total expenses exceed the

concern in the form of its assets and liabilities at the end of every accounting

and claims against such resources (Liabilities) facilitates the preparation of a

statement known as balance sheet position statement.

The accounting information generated by the accounting process is

communicated in the form of reports, statements, graphs and charts to the

two main user groups, viz. internal users, mainly management, who needs

and decision-making and external users who have limited authority, ability and

users are interested in the following:

investment;

distribution of wealth within the business;

the company and its ability to repay loans and pay interest;

repaid when due, and on the continued existence of the business;

thus the probability of a continued supply of products, parts and after

sales service;
1 Account

resources and the compliance to regulations;

on the impact on environment and its protection;

competition and for comparative and benchmarking purposes. Whereas the

above categories of users share in the wealth of the company, competitors
require the information mainly for strategic purposes.

Test Your Understanding - III

Wh

_____________________________ (b) the potential for pay awards and bouns deals

service or producing a product.

1.4 Role of Accounting

turies, the role of accounting has been changing with the changes
in economic development and increasing societal demands. It describes and

and summarisation, and reduces those date into reports and statements,

Hence, it is regarded as a language of business. It also performs the service

economic information about an enterprise to a wide variety of interested

parties. However, accounting information relates to the past transactions and

while making use of the accounting information.

Introduction to Accounting 1

Test Your Understanding - IV

Tick the Correct Answer

1. Which of the following is not a business transaction?
a. Bought furniture of 10,000 for business
5,000
20,000
2,000

relevant data for his decision?

10,00,000
b. Building cost details of 2003
c. Building cost details of 1998
25,00,000
3. Which is the last step of accounting as a process of information?

b.

accounting information is clearly presented?

Box 4
Different Roles of Accounting

communicate information on enterprises;

of an organisation at actual amounts involved;

of an entity namely the change of wealth over time;

1 Account

(the accountant) to a set of receivers (external users) by means of a channel of

communication;

in society, with accountants being willing to and capable of providing it.

1.5 Basic Terms in Accounting

1.5.1 Entity

Jewellers,
business entity (also called accounting entity).

of goods, receipt of money, payment to a creditor, incurring expenses, etc. It

can be a cash transaction or a credit transaction.

1.5.3

the enterprise. This item will be shown on the asset side of the balance sheet
Introduction to Accounting 1

Figure 1.4 :
1 Account

Liabilities are obligations or debts that an enterprise has to pay at some time

Figure 1.5 :

Box 5

Distinction between current and non-current items:

ash equivalent.

in the form of cash or assets by the owner for the business entity capital is
an obligation and a claim on the assets of business. It is, therefore, shown as
capital on the liabilities side of the balance sheet.
Introduction to Accounting 1

These are the amounts of the business earned by selling its products or
providing services to customers, called sales revenue. Other items of revenue
common to many businesses are: commission, interest, dividends, royalities,

1.5.8 Expenses

or services used during an accounting period. The usual items of expenses are:
depreciation, rent, wages, salaries, interest, cost of heater, light and water,
telephone, etc.

expenditure is exhausted within a year, it is treated as an expense (also called

for more than a year, it is treated as an asset (also called capital expenditure)
such as purchase of machinery, furniture, etc.

The excess of revenues of a period over its related expenses during an accounting

an asset.

The excess of expenses of a period over its related revenues its termed as loss.
It decreases in owner’s equity. It also refers to money or money’s worth lost
 Account

ways. Offering deduction of agreed percentage of list price at the time selling

It is generally offered by manufactures to wholesellers and by wholesellers

certain deduction in amount due in case if they pay the amount within the
stipulated period or earlier. This deduction is given at the time of payment on

as an incentive that encourages prompt payment by the debtors.

The documentary evidence in support of a transaction is known as voucher.

we get an invoice; when we make a payment we get a receipt and so on.

1.5.15 Goods
It refers to the products in which the business unit is dealing, i.e. in terms of
which it is buying and selling or producting and selling. The items that are

furniture dealer purchase of chairs and tables is termed as goods, while for

stationery is goods, whereas for others it is an item of expense (not purchases)

Withdrawal of money and/or goods by the owner from the business for personal

cash, for use or sale. In a trading concern, purchases are made of merchandise
for resale with or without processing. In a manufacturing concern, raw materials

may be cash purchases or credit purchases.

Introduction to Accounting

1.5.18 Stock
measure of something on hand-goods, spares and other
items in a business. It is called Stock in hand. In a trading concern, the stock
on hand is the amount of goods which are lying unsold as at the end of an
accounting period is called closing stock (ending inventory). In a manufacturing

opening stock (beginning

inventory) is the amount of stock at the beginning of the accounting period.

nd/or other entities who owe to an enterprise an amount

for buying goods and services on credit. The total amount standing against such
persons and/or entities on the closing date, is shown in the balance sheet as
sundry debtors on the asset side.

an amount for providing the enterprise goods and services on credit. The total
amount standing to the favour of such persons and/or entities on the closing
sundry creditors on the liabilities side.

Test Your Understanding - V

5,00,000 as an
initial investment. Of which he paid 1,00,000 for furniture, 2,00,000 for buying

paid 5,000 as their salaries. Out of the stationery bought he sold some stationery for
1,50,000 for cash and some other stationery for

30,000 worth of stationery.

40,000, was sold for 45,000.

3. What is the value of the goods purchased?

4. Who is the creditor and state the amount payable to him?
5. What are the expenses?
6. What is the gain he earned?
 Account

7. What is the loss he incurred?

8. Who is the debtor? What is the amount receivable from him?
9. What is the total amount of expenses and losses incurred?

these: sales, debtors, creditors, salary to manager, discount to debtors, drawings

by the owner.

1. Meaning of Accounting
the business transactions and communicating thereof the required information to the
interested users.
2. Accounting as a source of information
is the process of identifying, measuring, recording and communicating the economic
events of an organisation to interested users of the information.
3. Users of accounting information

interest in the enterprise, such as present and potential investors and creditors.

as regulatory agencies, tax authorities, customers, labour unions, trade associations,

stock exchanges and others.
4. : To make accounting information decision
useful, it should possess the following qualitative characteristics.

5. : The primary objectives of accounting are to :

6. Role of accounting
the role of a :

Short Answers
Introduction to Accounting

4. Who are the users of accounting information.

6. Who are the external users of information?

11. If the accounting information is not clearly presented, which of the qualitative
characteristic of the accounting information is violated?

15. What is the primiary reason for the business students and others to familiarise
themselves with the accounting discipline?

4. What do you mean by an asset and what are different types of assets?