11 Accountancy: Introduction to Accounting- Notes

Meaning of Accounting

The American Institute of Certified Public Accountants (AICPA) had defined accounting as the art of
recording, classifying, and summarising in a significant manner and in terms of money, transactions
and events which are, in part at least, of financial character, and interpreting the results thereof’.
Accounting can therefore be defined as the process of identifying, measuring, 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 relevant aspects of the definition:
• Economic Events
• Identification, Measurement, Recording and Communication
• Organisation
• Interested Users of Information

Characteristics of Accounting
Characteristics of

Identification of Financial Transactions and Events

Accounting

Measurement of Transactions (in terms of money)

Recording (in journal or subsidiary books)

Classification (through ledger)

Summarising (by preparing Trial Balance, Trading and Profit and

Loss A/c and Balance Sheet)
Analysing and Interpreting (to make sound judgement about
profitability and financial position of the business)

Communicating (to the interested parties)

Objectives of Accounting
1. To keep systematic and complete records of financial transactions in the books of
accounts according to specified principles and rules to avoid the possibility of omission and
fraud.
2. To ascertain the profit earned or loss incurred during a particular accounting period which further
helps in knowing the financial performance of a business.
3. To ascertain the financial position of the business by the means of financial statement i.e. Balance
Sheet which shows assets on one side and capital & liabilities on the other side.
4. To provide useful accounting information to users like owners, investors, creditors, banks,
employees and government authorities etc., who analyse them as per their requirements.
5. To provide financial information to the management which helps in decision making, budgeting and
forecasting.
6. To prevent frauds by maintaining regular and systematic accounting records.

Advantages of Accounting

1. It provides information which is useful to management for making economic decisions.

2. It help owners to compare one year’s results with those of other years to locate the factors which
leads to changes.
3. It provide information about the financial position of the business by means of Balance Sheet which
shows assets on one side and Capital & Liabilities on the other side.
4. It helps in keeping systematic and complete records of business transactions in the books of
accounts according to specified principles and rules, which is accepted by the Courts as
evidence.
5. It helps a firm in the assessment of its correct tax Liabilities such as income tax, sales tax, VAT,
excise duty etc.
6. Properly maintained accounts help a business entity in determining its proper purchase price.
7. Systematic accounting records provide documentary evidence in the court in case of disputes.

Limitations of Accounting

1. It is historical in nature it does not reflect the current worth of a business. Moreover, the
figures given in financial statements ignore the effects of changes in price level.
2. It contains only that information which can be expressed in terms of money. It ignores qualitative
elements such as efficiency of management, quality of staff, customers satisfactions etc.
3. It may be affected by window dressing i.e. manipulation in accounts to present a more favourable
position of a business firm than its actual position.
4. It is not free from personal bias and personal judgment of the people dealing with it. For example,
different people have different opinions regarding life of asset for calculating depreciation, provision
for doubtful debts etc.
5. It is based on various concepts and conventions which may hamper the disclosure of realistic
financial position of a business firm. For example, assets in balance sheet are shown at their cost and
not at their market value which could be realised on their sale.

Book Keeping - The Basis of Accounting

Book keeping is the record-making phase of accounting which is concerned with the recording of
financial transactions and events relating to business in a significant and orderly manner.
Book Keeping should not be confused with accounting. Book keeping is the recording phase while
accounting is concerned with the summarizing phase of an accounting system. The distinction between
the two are as under.

Basis Book keeping Accounting

1. Scope It is the recording phase of an It is the summarizing phase of an
accounting system. accounting system.
2. Stage It is a primary stage and basis for It is a Secondary Stage which begins
accounting. where the Book keeping process ends.
3. Nature of job It is routine in nature and does not It is analytical in nature and required
require any special skill or knowledge. special skill or knowledge.
4. Performance It is done by junior staff called book- It is done by senior staff called
keepers accountants.
5. Completeness It does not give the complete picture of It gives the complete picture of the
the financial conditions of the business financial conditions of the business
unit. unit.

Types of accounting information

Accounting information can be categorized into following:

1. Information relating to profit or loss i.e. income statement, shows the net profit of business
operations of a firm during a particular accounting period.
2. Information relating to Financial position i.e. Balance Sheet. It shows assets on one side and Capital
& Liabilities on the other side.
3. Schedules and notes forming part of balance sheet and income statement to give details of
various items shown in both of them.
Role of Accounting

For centuries, the role of accounting has been changing with the changes in economic development
and increasing societal demands. Its role can be described in the following points:
1.) It describes and analyses a mass of data of an enterprise through measurement, classification
and summarisation, and reduces those date into reports and statements, which show the financial
condition and results of operations of that enterprise. Hence, it is regarded as a language of business.
2.) It also performs the service activity by providing quantitative financial information that helps the
users in various ways.
3.) Accounting as an information system collects and communicates economic information about an
enterprise to a wide variety of interested parties.
4.) Accounting records are often accepted as evidence in courts in case of disputes.

Branches of Accounting

1. Financial Accounting: - It is that branch of accounting which is concerned with recording of

business transactions of financial nature in a systematic manner, to ascertain the profit or loss of the
accounting period and to present the financial position of the business.
2. Cost Accounting: - It is that branch of accounting which is concerned with ascertainment of total
cost and per unit cost of goods or services produced/ provided by a business firm.
3. Management Accounting: - It is that branch of accounting which is concerned with presenting the
accounting information in such a manner that help the management in planning and controlling the
operations of a business and in better decision making.

Users of Accountings information

There are number of users interested in knowing about the financial soundness and the profitability of
the business.

A) Internal
1. Owner- Return on their investment, financial health of their company/business.
2. Management- To evaluate the performance to take various decisions.

B) External
1. Investors and potential investors- Safety and growth of their investments, future of the business.
2. Creditors- Assessing the financial capability, ability of the business to pay its debts.
3. Lenders- Repaying capacity, credit worthiness.
4. Tax Authorities- Assessment of due taxes, true and fair disclosure of accounting information.
5. Employees- Profitability to claim higher wages and bonus, whether their dues (PF, ESI, etc.) are
deposited regularly.
6. Others- Customers, Researchers etc., may seek different information for different reasons.

Qualitative Characteristics of Accounting Information

Accounting information is useful for interested users only if it possesses the following
characteristics:
1. Reliability: Means the information must be based on facts and be verified through source
documents by anyone. It must be free from bias and errors.
2. Relevance: To be relevant, information must be available in time and must influence the decisions
of users by helping them to form prediction about the outcomes.
3. Understandability: The information should be presented in such a manner that users can
understand it well.
4. Comparability: The information should be disclosed in such a manner that it can be compared with
previous year’s figures of business itself and other firm’s data.
 Let’s Recapitulate

Characteristics of Accounting

Identification of
Measurements of
Financial Recording
Transactions Transactions

Analysing and
Classifying Summarising Interpreting

Communicating

Branches of
Accounting

Financial

Cost

Management
 Objectives of Accounting

Keeping Ascertain Ascertain Useful to Helpful in Prevents

Systematic Financial Financial decision
Users Frauds
Records Performance Position making

Advantages of Accounting Limitations of Accounting

Provides useful
information Historical
Systematic record
keeping
Window dressing
Provides financial
position
Ignores qualitative
Correct assessment elements
of tax liability
May not reflect correct
Evidence in court financial position

Determines purchase Not free from personal

price of business bias

Users of Accounting Information

Owners
Management
Internal Users
 • Investors and Potential Investors
External Users • Researchers
• Customers
• Creditors
• Lenders
• Employees
• Tax Authorities