TOPICS

 MEANING OF ACCOUNTING
 DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING
 DISTINCTION BETWEEN ACCOUNTING AND ACCOUNTANCY
 NATURE OF ACCOUNTING
 OBJECTIVES OF ACCOUNTING
 USERS OF ACCOUNTING INFORMATION
 BRANCHES OF ACCOUNTING
 ROLE OF ACCOUNTING
 LIMITATIONS OF FINANCIAL ACCOUNTING
 ACCOUNTING PRINCIPLES
 ACCOUNTING STANDARDS
 JOURNAL,LEDGER,TRIAL BALANCE.
1.3 MEANING OF ACCOUNTING

The main purpose of accounting is to ascertain profit or loss during a specified period, to
show financial condition of the business on a particular date and to have control over the
firm's property. Such accounting records are required to be maintained to measure the
income of the business and communicate the information so that it may be used by
managers, owners and other interested parties. Accounting is a discipline which records,
classifies, summarizes and interprets financial information about the activities of a
concern so that intelligent decisions can be made about the concern. The American

Institute of Certified Public Accountants has defined the Financial Accounting as "the art
of recording, classifying and summarising in as significant manner and in terms of money
transactions and events which in part, at least of a financial character, and interpreting the
results thereof". American Accounting Association defines accounting as "the process of
identifying, measuring, and communicating economic information to permit informed
judgements and decisions by users of the information.

From the above the following attributes of accounting emerge :

(i) Recording : It is concerned with the recording of financial transactions in an orderly
manner, soon after their occurrence In the proper books of accounts.
(ii) Classifying : It Is concerned with the systematic analysis of the recorded data so as to
accumulate the transactions of similar type at one place. This function is performed by
maintaining the ledger in which different accounts are opened to which related
transactions are posted.
(iii) Summarising : It is concerned with the preparation and presentation of the classified
data in a manner useful to the users. This function involves the preparation of financial
statements such as Income Statement, Balance Sheet, Statement of Changes in Financial
Position, Statement of Cash Flow, Statement of Value Added.
(iv) Interpreting : Nowadays, the aforesaid three functions are performed by electronic
data processing devices and the accountant has to concentrate mainly on the
interpretation aspects of accounting. The accountants should interpret the statements in a
manner useful to action. The accountant should explain not only what has happened but
also (a) why it happened, and (b) what is likely to happen under specified conditions.

1.4 DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING

Book-keeping is a part of accounting and is concerned with the recording of transactions

which is often routine and clerical in nature, whereas accounting performs other functions
as well, viz., measurement and communication, besides recording. An accountant is
required to have a much higher level of knowledge, conceptual understanding and
analytical skill than is required of the book-keeper.
An accountant designs the accounting system, supervises and checks the work of the
book-keeper, prepares the reports based on the recorded data and interprets the reports.
Nowadays, he is required to take part in matters of management, control and planning of
economic resources.

1.5 DISTINCTION BETWEEN ACCOUNTING AND ACCOUNTANCY

Although in practice Accountancy and Accounting are used interchangeably yet there is a
thin line of demarcation between them. The word Accountancy is used for the profession
of accountants - who do the work of accounting and are knowledgeable persons.
Accounting is concerned with recording all business transactions systematically and then
arranging in the form of various accounts and financial statements. And it is a distinct
discipline like economics, physics, astronomy etc. The word accounting tries to explain
the nature of the work of the accountants (professionals) and the word Accountancy
refers to the profession these people adopt.

1.6 NATURE OF ACCOUNTING

The various definitions and explanations of accounting has been propounded by different
accounting experts from time to time and the following aspects comprise the nature of
accounting :

i ) Accounting as a service activity

Accounting is a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities that is intended to be useful in
making economic decisions, in making reasoned choices among alternative courses of
action. It means that accounting collects financial information for the various users for
taking decisions and tackling business issues.
Accounting in itself cannot create wealth though, if it produces information which
is useful to others, it may assist in wealth creation and maintenance.
(ii) Accounting as a profession
Accounting is very much a profession. A profession is a career that involve the acquiring
of a specialised formal education before rendering any service. Accounting is a
systematized body of knowledge developed with the development of trade and business
over the past century. The accounting education is being imparted to the examinees by
national and international recognised the bodies like The Institute of Chartered
Accountants of India (ICAI), New Delhi in India and American Institute of Certified
Public Accountants (AICPA) in USA etc. The candidate must pass a vigorous
examination in Accounting Theory,
Accounting Practice, Auditing and Business Law. The members of the professional
bodies usually have their own associations or organisations, where in they are required to
be enrolled compulsorily as Associate member of the Institute of Chartered Accountants
(A.C.A.) and fellow of the Institute of Chartered Accountants (F.C.A.). In a way,
accountancy as a profession has attained the stature comparable with that of lawyer,
medicine or architecture.
(iii) Accounting as a social force
In early days, accounting was only to serve the interest of the owners. Under the
changing business environment the discipline of accounting and the accountant both have
to watch and protect the interests of other people who are directly or indirectly linked
with the operation of modern business. The society is composed of people as customer,
shareholders, creditors and investors. The accounting information/data is to be used to
solve the problems of the public at large such as determination and controlling of prices.
Therefore, safeguarding of public interest can better be facilitated with the help of proper,
adequate and reliable accounting information and as a result of it the society at large is
benefited.
(iv) Accounting as a language
Accounting is rightly referred the "language of business". It is one means of reporting
and communicating information about a business. As one has to learn a new language to
converse and communicate, so also accounting is to be learned and practised to
communicate business events.A language and accounting have common features as
regards rules and symbols. Both are based and propounded on fundamental rules and
symbols. In language these are known as grammatical rules and in accounting, these are
termed as accounting rules. The expression, exhibition and presentation of accounting
data such as a numerals and words and debits and credit are accepted as symbols which
are unique to the discipline of accounting.
(v) Accounting as science or art
Science is a systematised body of knowledge. It establishes a relationship of cause and
effect in the various related phenomenon. It is also based on some fundamental
principles. Accounting has its own principles e.g. the double entry system, which
explains that every transaction has two fold aspect i.e. debit and credit. It also lays down
rules of journalising. So we can say that accounting is a science. Art requires a perfect
knowledge, interest and experience to do a work efficiently. Art also teaches us how to
do a work in the best possible way by making the best use of the available resources.
Accounting is an art as it also requires knowledge, interest and experience to maintain the
books of accounts ina systematic manner. Everybody cannot become a good accountant.
It can be concluded from the above discussion that accounting is an art as well as a
science.
(vi) Accounting as an information system
Accounting discipline will be the most useful one in the acquisition of all the business
knowledge in the near future. You will realise that people will be constantly exposed to
accounting information in their everyday life. Accounting information serves both profit-
seeking business and non-profit organisations. The accounting system of a profit-seeking
organisation is an information system designed to provide relevant financial information
on the resources of a business and the effect of their use. Information is relevant and
valuable if the decision makers can use it to evaluate the financial consequences of
various alternatives.

Accounting generally does not generate the basic information (raw financial data), rather
the raw financial data result from the day to day transactions of the business.
As an information system, accounting links an information source or transmitter
(generally the accountant), a channel of communication (generally the financial
statements) and a set of receivers (external users).

1.7 OBJECTIVES OF ACCOUNTING

The following are the main objectives of accounting :

1. To keep systematic records : Accounting is done to keep a systematic record of

financial transactions. In the absence of accounting there would have been terrific burden
on human memory which in most cases would have been impossible to bear.
2. To protect business properties : Accounting provides protection to
business properties from unjustified and unwarranted use. This is possible on
account of accounting supplying the following information to the manager or the
proprietor:
(i) The amount of the proprietor's funds invested in the business.
(ii) How much the business have to pay to others?
(iii) How much the business has to recover from others?
(iv) How much the business has in the form of (a) fixed assets, (b) cash
in hand, (c) cash at bank, (d) stock of raw materials, work-in-progress
and finished goods?
Information about the above matters helps the proprietor in assuring
that the funds of the business are not necessarily kept idle or underutilised.

3. To ascertain the operational profit or loss : Accounting helps in ascertaining the net
profit earned or loss suffered on account of carrying the business. This is done by keeping
a proper record of revenues and expense of a particular period. The Profit and Loss
Account is prepared at the end of a period and if the amount of revenue for the period is
more than the expenditure incurred in earning that revenue, there is said to be a profit. In
case the expenditure exceeds the revenue, there is said to be a loss.Profit and Loss
Account will help the management, investors,creditors, etc. in knowing whether the
business has proved to be remunerative or not. In case it has not proved to be
remunerative or profitable, the cause of such a state of affairs will be investigated and
necessary remedial steps will be taken.
4. To ascertain the financial position of the business : The Profit and Loss
Account gives the amount of profit or loss made by the business during a particular
period. However, it is not enough. The businessman must know about his financial
position i.e. where he stands ?, what he owes and what he owns? This objective is
served by the Balance Sheet or Position Statement. The Balance Sheet is a statement of
assets and liabilities of the business on a particular date. It serves as
barometer for ascertaining the financial health of the business.
5. To facilitate rational decision making : Accounting these days has taken upon itself
the task of collection, analysis and reporting of information at the required points of time
to the required levels of authority in order to facilitate rational decision-making. The
American Accounting Association has also stressed this point while defining the term
accounting when it says that accounting is the process of identifying, measuring and
communicating economic information to permit informed judgements and decisions by
users of the information. Of course,this is by no means an easy task. However, the
accounting bodies all over the world and particularly the International Accounting
Standards Committee, have been trying to grapple with this problem and have achieved
success in laying down some basic postulates on the basis of which the accounting
statements have to be prepared.
6. Information System : Accounting functions as an information system for collecting
and communicating economic information about the business enterprise.This information
helps the management in taking appropriate decisions. This
function, as stated, is gaining tremendous importance these days.

1.8 USERS OF ACCOUNTING INFORMATION

The basic objective of accounting is to provide information which is useful for persons
inside the organisation and for persons or groups outside the organisation. Accounting is
the discipline that provides information on which external and internal users of the
information may base decisions that result in the allocation of economic resources in
society.
I. External Users of Accounting Information : External users are those groups or
persons who are outside the organisation for whom accounting function is performed.
Following can be the various external users of accounting information:
1. Investors, Those who are interested in investing money in an organization are
interested in knowing the financial health of the organisation of know how safe the
investment already made is and how safe their proposed investment will be. To know the
financial health, they need accounting information which will help them in evaluating the
past performance and future prospects of the organisation. Thus, investors for their
investment decisions are dependent upon accounting information included in the financial
statements. They can know the profitability and the financial position of the organisation
in which they are interested to make that investment by making a study of the accounting
information given in the financial statements of the organisation.
2. Creditors. Creditors (i.e. supplier of goods and services on credit, bankers and other
lenders of money) want to know the financial position of a concern before giving loans or
granting credit. They want to be sure that the concern will not experience difficulty in
making their payment in time i.e. liquid position of the concern is satisfactory. To know
the liquid position, they need accounting information relating to current assets, quick
assets and current liabilities which is available in the financial statements.
3. Members of Non-profit Organisations. Members of non-profit
organisations such as schools, colleges, hospitals, clubs, charitable institutions
etc. need accounting information to know how their contributed funds are being
utilised and to ascertain if the organisation deserves continued support or support
should be withdrawn keeping in view the bad performance depicted by the
accounting information and diverted to another organisation. In knowing the
performance of such organisations, criterion will not be the profit made but the
main criterion will be the service provided to the society.
4. Government. Central and State Governments are interested in the accounting
information because they want to know earnings or sales for a particular period
for purposes of taxation. Income tax returns are examples of financial reports
which are prepared with information taken directly from accounting records.
Governments also needs accounting information for compiling statistics
concerning business which, in turn helps in compiling national accounts.
5. Consumers. Consumers need accounting information for establishing good
accounting control so that cost of production may be reduced with the resultant
reduction of the prices of goods they buy. Sometimes, prices for some goods are
fixed by the Government, so it needs accounting information to fix reasonable
prices so that consumers and manufacturers are not exploited. Prices are fixed
keeping in view fair return to manufacturers on their investments shown in the
accounting records.
6. Research Scholars. Accounting information, being a mirror of the financial
performance of a business organisation, is of immense value to the research
scholars who wants to make a study to the financial operations of a particular
firm. To make a study into the financial operations of a particular firm, the research
scholar needs detailed accounting information relating to purchases, sales,
expenses, cost of materials used, current assets, current liabilities, fixed assets,
long term liabilities and shareholders' funds which is available in the accounting
records maintained by the firm.

II Internal Users of Accounting Information. Internal users of accounting

information are those persons or groups which are within the organisation.
Following are such internal users :

1. Owners. The owners provide funds for the operations of a business and
they want to know whether their funds are being properly used or not. They need
accounting information to know the profitability and the financial position of the
concern in which they have invested their funds. The financial statements prepared
from time to time from accounting records depicts them the profitability and the
financial position.
2. Management. Management is the art of getting work done through others,
the management should ensure that the subordinates are doing work properly.
Accounting information is an aid in this respect because it helps a manager in
appraising the performance of the subordinates. Actual performance of the
employees can be compared with the budgeted performance they were expected
to achieve and remedial action can be taken if the actual performance is not upto
the mark. Thus, accounting information provides "the eyes and ears to
management".The most important functions of management are planning and
controlling. Preparation of various budgets, such as sales budget, production
budget, cash budget, capital expenditure budget etc., is an important part of
planning function and the starting point for the preparation of the budgets is the
accounting information for the previous year. Controlling is the function of seeing
that programmes laid down in various budgets are being actually achieved i.e. actual
performance ascertained from accounting is compared with the budgeted
performance, enabling the manager to exercise controlling case of weak
performance. Accounting information is also helpful to the management in fixing
reasonable selling prices. In a competitive economy, a price should be based on
cost plus a reasonable rate of return. If a firm quotes a price which exceeds cost
plus a reasonable rate of return, it probably will not get the order. On the other
hand, if the firm quotes a price which is less than its cost, it will be given the
order but will incur a loss on account of price being lower than the cost. So,
selling prices should always be fixed on the basis of accounting data to get the
reasonable margin of profit on sales.

3. Employees. Employees are interested in the financial position of a concern

they serve particularly when payment of bonus depends upon the size of the profits
earned. They seek accounting information to know that the bonus being paid to
them is correct.

1.9 BRANCHES OF ACCOUNTING

To meet the ever increasing demands made on accounting by different
interested parties such as owners, management, creditors, taxation authorities etc.,
the various branches have come into existence. There are as follows :

1. Financial accounting. The object of financial accounting is to ascertain

the results (profit or loss) of business operations during the particular period and
to state the financial position (balance sheet) as on a date at the end of the period.

2. Cost accounting. The object of cost accounting is to find out the cost of
goods produced or services rendered by a business. It also helps the business in
controlling the costs by indicating avoidable losses and wastes.

3. Management accounting. The object of management accounting is to supply

relevant information at appropriate time to the management to enable it to take
decisions and effect control. In this lesson we are concerned only with financial
accounting.Financial accounting is the oldest and other branches have developed from it.
The objects of financial accounting, as stated above, can be achieved only by recording
the financial transactions in a systematic manner according to a set of principles.
The art of recording financial transactions and events in a systematic manner in
the books of account is known as book-keeping. However, mere record of
transactions is not enough. The recorded information has to be classified, analysed
and presented in a manner in which business results and financial position can be
ascertained.

1.10 ROLE OF ACCOUNTING

Accounting plays an important and useful role by developing the
information for providing answers to many questions faced by the users of
accounting information :

(1) How good or bad is the financial condition of the business?

(2) Has the business activity resulted in a profit or loss ?
(3) How well the different departments of the business have performed in the
past?
(4) Which activities or products have been profitable?
(5) Out of the existing products which should be discontinued and the production
of which commodities should be increased?
(6) Whether to buy a component from the market or to manufacture the same?
(7) Whether the cost of production is reasonable or excessive?
(8) What has been the impact of existing policies on the profitability of the
business?
(9) What are the likely results of new policy decisions on future earning
capacity of the business?
(10) In the light of past performance of the business how should it plan for future
to ensure desired results?
Above mentioned are few examples of the types of questions faced
by the users of accounting information. These can be satisfactorily answered with
the help of suitable and necessary information provided by accounting.
Besides, accounting is also useful in the following respects :
(a) Increased volume of business results in large number of transactions and
no businessman can remember everything. Accounting records obviate the
necessity of remembering various transactions.
(b) Accounting records, prepared on the basis of uniform practices, will enable
a business to compare results of one period with another period.
(c) Taxation authorities (both income tax and sales tax) are likely to believe
the facts contained in the set of accounting books if maintained according
to generally accepted accounting principles.
(d) Accounting records, backed up by proper and authenticated vouchers, are
good evidence in a court of law.
(e) If a business is to be sold as a going concern, then the values of different
assets as shown by the balance sheet helps in bargaining proper price for
the business.

1.11 LIMITATIONS OF FINANCIAL ACCOUNTING

Advantages of accounting discussed in this lesson do not suggest that
accounting is free from limitations. Any one who is using accounting information
should be well aware of its limitations also. Following are the limitations :
(a) Financial accounting permits alternative treatments .No doubt accounting is based
on concepts and it follows "generally accepted accounting principles", but there exist
more than one principle for the treatment of any one item. This permits alternative
treatments within the framework of generally accepted accounting principles. For
example, the closing stock of a business may be valued by any one of the following
methods : FIFO (First-in-first-out); LIFO (Last-in-first-out); Average price, Standard
price etc., Application of different methods will give different results but the methods are
generally accepted. So, the results are not comparable.

(b) Financial accounting is Influenced by personal judgements Inspite of the fact that
convention of objectivity is respected in accounting but to record certain events estimates
have to be made which requires personal judgement. It is very difficult to expect
accuracy in future estimates and objectivity suffers. For example, in order to determine
the amount of depreciation to be charged every year for the use of fixed asset it is
required to estimate (a) future life of the asset, and (b) scrap value of the asset. Thus in
accounting we do not determine but measure the income. In other words, the income
disclosed by accounting is not authoritative but approximation.

(c) Financial accounting ignores important non-monetary information

Financial accounting takes into consideration only those transactions and events which
can be described in money. The transactions and events, however important, if non-
monetary in nature are ignored i.e., not recorded. For example, extent of competition
faced by the business, technical innovations possessed by the business, loyalty and
efficiency of the employees etc. are the important matters in which management of the
business is highly interested but accounting is not tailored to take note of such matters.
Thus any user of financial information is, naturally, deprived of vital information which
is of non-monetary character.
(d) Financial accounting does not provide timely information
Financial accounting is designed to supply information in the form of statements
(Balance Sheet and Profit and Loss Account) for a period, normally, one year. So the
information is, at best, of historical interest and only postmortem analysis of the past can
be conducted. The business requires timely information at frequent intervals to enable the
management to plan and take corrective action.
For example, if a business has budgeted that during the current year sales should
be Rs. 12,00,000 then it requires information – whether the sales in the first
month of the year amounted to Rs. 1,00,000 or less or more? Traditionally,
financial accounting is not supposed to supply information at shorter intervals
than one year.
(e) Financial accounting does not provide detailed analysis: The information supplied
by the financial accounting is in reality aggregate of the financial transactions during the
course of the year. Of course, it enables to study the overall results of the business
activity during the accounting period. For proper running of the business the information
is required regarding the cost, revenue and profit of each product but financial accounting
does not provide such detailed information product-wise. For example, if a business has
earned a total profit of, say, Rs. 5,00,000 during the accounting year and it sells
three products namely petrol, diesel and mobile oil and wants to know profit earned
by each product. Financial accounting is not likely to help him.
(f) Financial accounting does not disclose the present value of the business
In financial accounting the position of the business as on a particular
date is shown by a statement known as balance sheet. In balance sheet the assets
are shown on the basis of going concern concept. Thus it is presumed that business
has relatively longer life and will continue to exist indefinitely, hence the asset
values are going concern values. The realised value of each asset if sold today
can't be known by studying the balance sheet.

1.12 SYSTEMS OF ACCOUNTING

The following are the main systems of recording business
transactions:
(a) Cash System. Under this system, actual cash receipts and actual cash
payments are recorded. Credit transactions are not recorded at all until the cash
in actually received or paid. The Receipts and Payments Account prepared in case
of non-trading concerns such as a charitable institution, a club, a school, a college,
etc. and professional men like a lawyer, a doctor, a chartered accountant etc. can
be cited as the best example of cash system. This system does not make a complete
record of financial transactions of a trading period as it does not record
outstanding transactions like outstanding expenses and outstanding incomes. The
system being based on a record of actual cash receipts and actual cash payments
will not be able to disclose correct profit or loss for a particular period and will
not exhibit true financial position of the business on a particular day.
(b) Mercantile (Accrual) system. Under this system all transactions relating to
a period are recorded in the books of account i.e., in addition to actual receipts
and payments of cash income receivable and expenses payable are also recorded.
This system gives a complete picture of the financial transactions of the business
as it makes a record of all transactions relating to a period. The system being
based on a complete record of the financial transactions discloses correct profit
or loss for a particular period and also exhibits true financial position of the
business on a particular day.
ACCOUNTING PRINCIPLES
In dealing with the framework of accounting theory, we are confronted with a serious
problem arising from differences in terminology. A number of words and terms have
been used by different authors to express and explain the same idea or notion. The
various terms used for describing the basic ideas are: concepts, postulates, propositions,
assumptions, underlying principles, fundamentals, conventions, doctrines, rules, axioms,
etc. Each of these terms is capable of precise definition. But, the accounting profession
has served to give them lose and overlapping meanings. One author may describe the
same idea or notion as a concept and another as a convention and still another as
postulate. For example, the separate business entity idea has been described by one
author as a concept and by another as conventions. It is better for us not to waste our time
to discuss the precise meaning of generic terms as the wide diversity in these terms can
only serve to confuse the learner. We do feel, however, that some of these terms/ideas
have a better claim to be called ‘concepts ‘ while the rest should be called ‘conventions’.
The term ‘Concept’ is used to connote the accounting postulates, i.e., necessary
assumptions and ideas which are fundamental to accounting practice. In other words,
fundamental accounting concepts are broad general assumptions which underline the
periodic financial statements of business enterprises. The reason why some of the these
terms should be called concepts is that they are basic assumptions and have a direct
bearing on the quality of financial accounting information. The term ‘convention’
is used to signify customs or tradition as a guide to the preparation of accounting
statements. The following are the important accounting concepts and conventions:

Accounting Concepts
 Separate Business EntityConcept 
2. Money Measurement Concept 
3. Dual Aspect Concept
4. Going Concern Concept
5. Accounting Period Concept
6. Cost Concept
7. The Matching Concept
8. Accrual Concept
9. Realisation Concept
Accounting Conventions
1. Convention of Materiality
 2. Convention of Conservatism
3. Convention of consistency
4. Convention of Full Disclosure

2.4 ACCOUNTING CONCEPTS

The more important accounting concepts are briefly described as follows:
1. Separate Business Entity Concept. In accounting we make a distinction
between business and the owner. All the books of accounts records
day to day financial transactions from the view point of the business rather
than from that of the owner. The proprietor is considered as a creditor to
the extent of the capital brought in business by him. For instance, when a
person invests Rs. 10 lakh into a business, it will be treated that the business
has borrowed that much money from the owner and it will be shown as
a ‘liability’ in the books of accounts of business. Similarly, if the owner of
a shop were to take cash from the cash box for meeting certain personal
expenditure, the accounts would show that cash had been reduced even though
it does not make any difference to the owner himself. Thus, in recording a
transaction the important question is how does it affects the business ? For
example, if the owner puts cash into the business, he has a claim against the
business for capital brought in.In so far as a limited company is concerned, this
distinction can be easily maintained because a company has a legal entity of its own. Like
a natural person it can engage itself in economic activities of buying, selling, producing,
lending, borrowing and consuming of goods and services. However, it is difficult to show
this distinction in the case of sole proprietorship and partnership. Nevertheless,
accounting still maintains separation of business and owner. It may be noted that it is
only for accounting purpose that partnerships and sole proprietorship are treated as
separate from the owner (s), though law does not make such distinction. Infact, the
business entity concept is applied to make it possible for the owners to assess the
performance of their business and performance of those whose manage the enterprise.
The managers are responsible for the proper use of funds supplied by owners,
banks and others.
2. Money Measurement Concept. In accounting, only those business transactions are
recorded which can be expressed in terms of money. In other words, a fact or transaction
or happening which cannot be expressed in terms of money is not recorded in the
accounting books. As money is accepted not only as a medium of exchange but also as a
store of value, it has a very important advantage since a number of assets and equities,
which are otherwise different, can be measured and expressed in terms of a common
denominator. We must realise that this concept imposes two limitations. Firstly, there are
several facts which though very important to the business, cannot be recorded in the
books of accounts because they cannot be expressed in money terms. For example,
general health condition of the Managing Director of the company, working conditions in
which a worker has to work, sales policy pursued by the enterprise, quality of product
introduced by the
enterprise, though exert a great influence on the productivity and profitability of the
enterprise, are not recorded in the books. Similarly, the fact that a strike is about to begin
because employees are dissatisfied with the poor working conditions in the factory will
not be recorded even though this event is of great concern to the business. You will agree
that all these have a bearing on the future profitability of the company. Secondly, use of
money implies that we assume stable or constant value of rupee. Taking this assumption
means that the changes in the money value in future dates are conveniently ignored. For
example, a piece of land purchased in 1990 for Rs. 2 lakh and another bought for the
same amount in 1998 are recorded at the same price, although the first purchased in 1990
may be worth two times higher than the value recorded in the books because of rise in
land values. Infact, most accountants know fully well that purchasing power of rupee
does change but very few recognise this fact in accounting books and make allowance for
changing price level.
3. Dual Aspect Concept. Financial accounting records all the transactions and events
involving financial element. Each of such transactions requires two aspects to be
recorded. The recognition of these two aspects of every transaction is known as a dual
aspect analysis. According to this concept every business transactions has dual effect. For
example, if a firm sells goods of Rs. 10,000 this transaction involves two aspects. One
aspect is the delivery of goods and the other aspect is immediate receipt of cash (in the
case of cash sales). Infact, the term ‘double entry’ book keeping has come into vogue
because for every transaction two entries are made. According to this system the total
amount debited always equals the total amount credited. It follows from ‘dual aspect
concept’ that at any point in time owners’ equity and liabilities for any accounting entity
will be equal to assets owned by that entity. This idea is fundamental to accounting and
could be expressed as the following equalities:
Assets = Liabilities + Owners Equity ...............(1)
Owners Equity = Assets - Liabilities ...............(2)
The above relationship is known as the ‘Accounting Equation’. The term
‘Owners Equity’ denotes the resources supplied by the owners of the entity while the
term ‘liabilities’ denotes the claim of outside parties such as creditors, debenture-holders,
bank against the assets of the business. Assets are the resources owned by a business. The
total of assets will be equal to total of liabilities plus owners capital because all assets of
the business are claimed by either owners or outsiders.
4. Going Concern Concept. Accounting assumes that the business entity will continue to
operate for a long time in the future unless there is good evidence to the contrary. The
enterprise is viewed as a going concern, that is, as continuing in operations, at least in the
foreseeable future. In other words, there is neither the intention nor the necessity to
liquidate the particular business venture in the predictable future. Because of this
assumption, the accountant while valuing the assets do not take into account forced sale
value of them. Infact, the assumption that the business is not expected to be liquidated in
the foreseeable future establishes the basis for many of the valuations and allocations in
accounting. For example, the accountant charges depreciation of fixed assets values. It is
this assumption which underlies the decision of investors to commit capital to enterprise.
Only on the basis of this assumption can the accounting process remain stable and
achieve the objective of correctly reporting and recording on the capital invested, the
efficiency of management, and the position of the enterprise as a going concern.
However, if the accountant has good reasons to believe that the business, or some part of
it is going to be liquidated or that it will cease to operate (say within six-month or a year),
then the resources could be reported at their current values. If this concept is not
followed, International Accounting Standard requires the disclosure of the fact in the
financial statements together with reasons.
5. Accounting Period Concept. This concept requires that the life of the business should
be divided into appropriate segments for studying the financial results shown by the
enterprise after each segment. Although the results of operations of a specific enterprise
can be known precisely only after the business has ceased to operate, its assets have been
sold off and liabilities paid off, the knowledge of the results periodically is also
necessary. Those who are interested in the operating results of business obviously cannot
wait till the end. The requirements of these parties force the businessman ‘to stop’ and
‘see back’ how things are going on. Thus, the accountant must report for the changes in
the wealth of a firm for short time periods. A year is the most common interval on
account of prevailing practice, tradition and government requirements. Some firms adopt
financial year of the government, some other calendar year. Although a twelve month
period is adopted for external reporting, a shorter span of interval, say one month or three
month is applied for internal reporting purposes. This concept poses difficulty for the
process of allocation of long term costs. All the revenues and all the cost relating to the
year in operation have to be taken into account while matching the earnings and the cost
of those earnings for the any accounting period. This holds good irrespective of whether
or not they have been received in cash or paid in cash. Despite the difficulties which stem
from this concept, short term reports are of vital importance to owners, management,
creditors and other interested parties. Hence, the accountants have no option but to
resolve such difficulties.
6. Cost Concept. The term ‘assets’ denotes the resources land building, machinery etc.
owned by a business. The money values that are assigned to assets are derived from the
cost concept. According to this concept an asset is ordinarily entered on the accounting
records at the price paid to acquire it. For example, if a business buys a plant for Rs. 5
lakh the asset would be recorded in the books at Rs. 5 lakh, even if its market value at
that time happens to be Rs. 6 lakh. Thus, assets are recorded at their original purchase
price and this cost is the basis for all subsequent accounting for the business. The assets
shown in the financial statements do not necessarily indicate their present market values.
The term ‘book value’ is used for amount shown in the accounting records.
The cost concept does not mean that all assets remain on the accounting records at their
original cost for all times to come. The asset may systematically be reduced in its value
by charging ‘depreciation’, which will be discussed in detail in a subsequent lesson.
Depreciation have the effect of reducing profit of each period. The prime purpose of
depreciation is to allocate the cost of an asset over its useful life and not to adjust its cost.
However, a balance sheet based on this concept can be very misleading as it shows assets
at cost even when there are wide difference between their costs and market values.
Despite this limitation you will find that the cost concept meets all the three basic norms
of relevance, objectivity and feasibility.
7. The Matching concept. This concept is based on the accounting period concept. In
reality we match revenues and expenses during the accounting periods. Matching is the
entire process of periodic earnings measurement, often described as a process of
matching expenses with revenues.In other words, income made by the enterprise during a
period can be measuredonly when the revenue earned during a period is compared with
the expenditure incurred for earning that revenue. Broadly speaking revenue is the total
amount realised from the sale of goods or provision of services together with earnings
from interest, dividend, and other items of income. Expenses are cost incurred in
connection with the earnings of revenues. Costs incurred do not become expenses until
the goods or services in question are exchanged. Cost is not synonymous with expense
since expense is sacrifice made, resource consumed in relation to revenues earned during
an accounting period. Only costs that have expired during an accounting period are
considered as expenses. For example, if a commission is paid in January, 2002, for
services enjoyed in November, 2001, that commission should be taken as the cost for
services rendered in November 2001. On account of this concept, adjustments are made
for all prepaid expenses, outstanding expenses, accrued income, etc, while preparing
periodic reports.
8. Accrual Concept. It is generally accepted in accounting that the basis of reporting
income is accrual. Accrual concept makes a distinction between the receipt of cash and
the right to receive it, and the payment of cash and the legal obligation to pay it. This
concept provides a guideline to the accountant as to how he should treat the cash receipts
and the right related thereto. Accrual principle tries to evaluate every transaction in terms
of its impact on the owner’s equity. The essence of the accrual concept is that net income
arises from events that change the owner’s equity in a specified period and that these are
not necessarily the same as change in the cash position of the business. Thus it helps in
proper measurement of income.
9. Realisation Concept. Realisation is technically understood as the process of
converting non-cash resources and rights into money. As accounting principle, it is used
to identify precisely the amount of revenue to be recognised and the amount of expense
to be matched to such revenue for the purpose of income measurement. According to
realisation concept revenue is recognised when sale is made. Sale is considered to be
made at the point when the property in goods passes to the buyer and he becomes legally
liable to pay. This implies that revenue is generally realised when goods are delivered or
services are rendered. The rationale is that delivery validates a claim against the
customer. However, in case of long run construction contracts revenue is often
recognized on the basis of a proportionate or partial completion method. Similarly, in
case of long run installment sales contracts, revenue is regarded as realised only in
proportion to the actual cash collection. In fact, both these cases are the exceptions to
the notion that an exchange is needed to justify the realisation of revenue.
2.5 ACCOUNTING CONVENTIONS
1. Convention of Materiality. Materiality concept states that items of small significance
need not be given strict theoretically correct treatment. Infact, there are many events in
business which are insignificant in nature. The cost of recording and showing in financial
statement such events may not be well justified by the utility derived from that
information. For example, an ordinary calculator costing Rs. 100 may last for ten years.
However, the effort involved in allocating its cost over the ten year period
is not worth the benefit that can be derived from this operation. The cost incurred on
calculator may be treated as the expense of the period in which it is purchased. Similarly,
when a statement of outstanding debtors is preparedfor sending to top management,
figures may be rounded to the nearest ten or hundred. This convention will unnecessarily
overburden an accountant withmore details in case he is unable to find an objective
distinction between material and immaterial events. It should be noted that an item
material for one party may be immaterial for another. Actually, there are no hard and
fast rule to draw the line between material and immaterial events and hence,
It is a matter of judgement and common sense. Despite this limitation, It is necessary to
disclose all material information to make the financial statements clear and
understandable. This is required as per IAS-1 and also reiterated in IAS-5. As per IAS-1,
materiality should govern the selection and application of accounting policies.
2. Convention of Conservatism. This concept requires that the accountants
must follow the policy of ‘’playing safe” while recording business
transactions and events. That is why, the accountant follow the rule
anticipate no profit but provide for all possible losses, while recording the
business events. This rule means that an accountant should record lowest
possible value for assets and revenues, and the highest possible value for
liabilities and expenses. According to this concept, revenues or gains should
be recognised only when they are realised in the form of cash or assets
(i.e. debts) the ultimate cash realisation of which can be assessed with reasonable
certainty. Further, provision must be made for all known liabilities, expenses and losses,
Probable losses regarding all contingencies should also be provided for. ‘Valuing the
stock in trade at market price or cost price which ever is less’, ‘making the provision for
doubtful debts on debtors in anticipation of actual bad debts’, ‘adopting written down
value method of depreciation as against straight line method’, not providing for
discount on creditors but providing for discount on debtors’, are some of the examples of
the application of the convention of conservatism. The principle of conservatism may
also invite criticism if not applied cautiously. For example, when the accountant create
secret reserves, by creating excess provision for bad and doubtful debts, depreciation, etc.
The financial statements do not present a true and fair view of state of affairs. American
Institute of Certified Public Accountant have also indicated that this concept need to be
applied with much more caution and care as over conservatism may result in
misrepresentation.
4. Convention of Consistency. The convention of consistency requires
that once a firm decided on certain accounting policies and methods and has used these
for some time, it should continue to follow the same methods or procedures for all
subsequent similar events and transactions unless it has a sound reason to do otherwise.
In other worlds, accounting practices should remain unchanged from one period to
another. For example, if depreciation is charged on fixed assets according to straight line
method, this method should be followed year after year. Analogously, if stock is
valued at ‘cost or market price whichever is less’, this principle should be applied in each
subsequent year. However, this principle does not forbid introduction of improved
accounting techniques. If for valid reasons the company makes any departure
from the method so far in use, then the effect of the change must be clearly stated in the
financial statements in the year of change. The application of the principle of consistency
is necessary for the purpose of comparison. One could draw valid conclusions from the
comparison of data drawn from financial statements of one year with that of the other
year. But the inconsistency in the application of accounting methods might significantly
affect the reported data.

2.6 ACCOUNTING STANDARDS

The accounting concepts and conventions discussed in the foregoing pages are the core
elements in the theory of accounting. These principles, however, permit a variety of
alternative practices to co-exist. On account of this the financial results of different
companies can not be compared and evaluated unless full information is available about
the accounting methods which have been used. The lack of uniformity among accounting
practices have made it difficult to compare the financial results of different companies. It
means that there should not be too much discretion to companies and their accountants to
present financial information the way they like. In other words, the information contained
in financial statements should conform to carefully considered standards. Obviously,
accounting standards are needed to :
a) provide a basic framework for preparing financial statements to be uniformly followed
by all business enterprises,
b) make the financial statements of one firm comparable with the other firm and the
financial statements of one period with the financial statements of another period of the
same firm,
c) make the financial statements credible and reliable, and
d) create general sense of confidence among the outside users of financial statements.

In this context unless there are reasonably appropriate standards, neither the purpose of
the individual investor nor that of the nation as a whole can be served. In order to
harmonise accounting policies and to evolve standards the need in the USA was felt with
the establishment of Securities and Exchange Commission (SEC) in 1933. In 1957, a
research oriented organisation called Accounting Principles Boards (APB) was formed to
spell out the fundamental accounting principles. After this the Financial Accounting
Standards Board (FASB) was formed in 1973, in USA. At the international level, the
need for standardisation was felt and therefore, an International Congress of accountants
was organised in Sydney, Australia in 1972 to ensure the desired level of uniformity in
accounting practices. Keeping this in view, International Accounting Standards
Committee (IASC) was formed and was entrusted with the responsibility of formulating
international standards.
In order to harmonise varying accounting policies and practices, the Institute of Chartered
Accountants of India (ICAI) formed the Accounting Standards Board (ASB) in April,
1977. ASB includes representatives from industry and government. The main function of
the ASB is to formulate accounting standards. This Board of the Institute of Chartered
Accountants of India has so far formulated around 27 Accounting Standards, the list of
these accounting standards is furnished. Regarding the position of Accounting standards
in India, it has been stated that the standards have been developed without first
establishing the essential theoretical framework. As a result, accounting standards lack
direction and coherence. This type of limitation also existed in UK and USA but it was
remedied long back. Hence, there is an emergent need to make an attempt to develop a
conceptual framework and also revise suitably the Indian Accounting Standards to reduce
the number of alternative treatments.

RULES OF DEBIT AND CREDIT

Basically, debit means to enter an amount to the left side of an account
and credit means to enter an amount to the right side of an account. In the
abbreviated form Dr. stands for debit and Cr. stands for credit. Both debit and
credit may represent either increase or decrease depending upon the nature of an
account.
The Rules for Debit and Credit are given below :

Types of Accounts Rules for Debit Rules for Credit

(a) For Personal Accounts Debit the receiver Credit the giver
(b) For Real Accounts Debit what comes in Credit what goes out
(c) For Nominal Accounts Debit all expenses Credit all incomes and
and losses gains

MEANING AND FORMAT OF A JOURNAL

Journal is a historical record of business transactions or events. The word
journal comes from the French word "Jour" meaning "day". It is a book of original
or prime entry written up from the various source documents. Journal is a primary
book for recording the day to day transactions in a chronological order i.e. in the
order in which they occur. The journal is a form of diary for business transactions.
This is also called the book of first entry since every transaction is recorded
firstly in the journal. The format of a journal is shown as follows :

Journal
Date Particular L.F Debit Amt(Rs.) Credit Amt(Rs.)

(a) Date Column : This column shows the date on which the transaction is
recorded. The year and month is written once, till they change.
(b) Particular Column : Under this column, first the names of the accounts to
be debited, then the names of the accounts to be credited and lastly, the narration
(i.e. a brief explanation of the transaction) are entered.
(c) L.F., i.e. Ledger Folio Column : Under this column, the ledger page number
containing the relevant account is entered at the time of posting.
(d) Debit amount Column : Under this column, the amount to be debited is
entered.
(e) Credit amount Column : Under this column, the amount to be credited is
entered.
3.4.1 Meaning of Journalising
The process of recording a transaction in the journal is called journalising. The various
steps to be followed in journalising business transactions are given below :
Step 1 Ascertain what accounts are involved in a transaction.
Step 2 Ascertain what is the nature of the accounts involved.
Step 3 Ascertain which rule of debit and credit is applicable for each of the
accounts involved.
Step 4 Ascertain which account is to be debited and which is to be credited.
Step 5 Record the date of transaction in the 'Date column'.
Step 6 Write the name of the account to be debited, very close to the left hand
side i.e. the line demarcating the 'Date column' and the 'Particular column') along with the
abbreviation 'Dr.' on the same line against the name of the account in the 'Particulars
column' and the amount to bedebited in the 'Debit Amount column' against the name of
the account.
Step 7 Write the name of the account to be credited in the next line preceded by
the word 'To' at a few spaces towards right in the 'Particulars column' and
the amount to be credited in the 'Credit Amount column' against the name
of the account.
Step 8 Write 'Narration' (i.e. a brief description of the transaction) within brackets
in the next line in the 'Particulars column'.
Step 9 Draw a line across the entire 'Particulars column' to separate one Journal
Entry from the other.
Advantages of Journal
1. The transactions are recorded in journal as and when they occur so the
chances of error is minimized.
2. It help in preparation of ledger.
3. Any transfer from one account to another account is made through Journal.
4. The entry recorded in journal are self explanatory as it includes narration also.
5. It can record any such transaction which cannot be entered in any other
books of account.
6. Every transaction is recorded in chronological order (date wise) so the chances of
manipulations are reduced.
7. Journal shows all information in respect of a transaction at one place.
8. The closing balances of previous year of accounts related to assets and
liabilities can be brought forward to the next year by passing journal entry in journal.

3.5 LEDGER
Journal is a daily record of all business transactions. In the journal all transactions
relating to persons, expenses, assets, liabilities and incomes are recorded. Journal does
not give a complete picture of the fundamental elements of book keeping i.e. properties,
liabilities, proprietorship accounts and expenses and incomes at a glance and at one place.
Business transactions being recurring in nature, a number of entries are made for a
particular type of transactions such as sales, purchases, receipts and payments of cash,
expenses etc., through out the accounting year. The entries are therefore scattered over in
the Journal. In fact, the whole Journal will have to be gone through to find out the
combined effect of various transactions on a particular account. In case, at any time, a
businessman wants to now :
i) How much he has to pay to the suppliers/creditors of goods ?
ii) How much he has to receive from the customers ?
iii) What is the total amount of purchases and sales made during a particular
period?
iv) How much cash has been spent/incurred on various items of expenses such
as salaries, rent, carriage, stationery etc.
v) What is the amount of profit or loss made during a particular period ?
vi) What is the financial position of the unit on a particular date ?

The above mentioned information cannot be easily gathered from the

journal itself because the details of such information is scattered all over the
journal. It is thus of dire need to get a summarised/grouped record of all the
transactions relating to a particular person, or a thing or an expenditure to take
managerial decisions. The mechanics of collecting, assembling and summarising
all transactions of similar nature at one place can better be served by a book known
as 'ledger' i.e. a classified head of accounts. Ledger is a principal book of accounts of the
enterprise. It is rightly called as the 'King of Books'. Ledger is a set of accounts. Ledger
contains the various personal, real and nominal accounts in which all business
transactions of the entity are recorded. The main function of the ledger is to classify and
summarise all the items appearing in Journal and other books of original entry under
appropriate head/set of accounts so that at the end of the accounting period, each account
contains the complete information of all transaction relating to it. A ledger therefore is a
collection of accounts and may be defined as a summary statement of all the transactions
relating to a person, asset, expense or income which have taken place during a given
period of time and shows their net effect.

3.5.1 Relationship between Journal and Ledger

Journal and Ledger are the most useful books kept by a business entity. The points of
distinction between the two are given below :
1. The journal is a book of original entry where as the ledger is the main book of account.
2. In the journal business transactions are recorded as and when they occur i.e. date-wise.
However posting from the journal is done periodically, may be weekly, fortnightly as per
the convenience of the business.
3. The journal does not disclose the complete position of an account. On the other hand,
the ledger indicates the position of each account debit wise or credit wise, as the case
may be. In this way, the net position of each account is known immediately.
4. The record of transactions in the journal is in the form of journal entries whereas the
record in the ledger is in the form of an account.
Utility of a Ledger
The main utilities of a ledger are summarised as under :
(a) It provides complete information about all accounts in one book.
(b) It enables the ascertainment of the main items of revenues and expenses
(c) It enables the ascertainment of the value of assets and liabilities.
(d) It facilitates the preparation of Final Accounts.

Format of a Ledger Account

A ledger account can be prepared in any one of the following two forms:
Form 1
Name of the Account ...........

Date Part JF Amt Date Part JF Amt

Trial balance

A Trial Balance is a two-column schedule listing the titles and balances of all the
accounts in the order in which they appear in the ledger. The debit balances are listed in
the left-hand column and the credit balances in the right-hand column. In the case of the
General Ledger, the totals of the two columns should agree. We, now, know the
fundamental principle of double entry system of accounting where for every debit, there
must be a corresponding credit. Therefore, for every debit or a series of debits given to
one or several accounts, there is a corresponding credit or a series of credits of
an equal amount given to some other account or accounts and vice versa. Hence,
according to this principle, the sum total of debit amounts must equal the credit amounts
of the ledger at any date. If the various accounts in the ledger are balanced, then the total
of all debit balances must be equal to the total of all credit balances. If the same is not
true then the books of accounts are arithmetically inaccurate. It is, therefore, at the end of
the financial year or at any other time, the balances of all the ledger accounts are
extracted and are recorded in a statement known as Trial Balance and finally totalled up
to see whether the total of debit balances is equal to the total of credit balances. A Trial
Balance may thus be defined as a statement of debit and credit totals or balances
extracted from the various accounts in the ledger books with a view to test the
arithmetical accuracy of the books. The agreement of the Trial Balance reveals that both
the aspects of each transaction have been recorded and that the books are
arithmetically accurate. If both the sides of Trial Balance do not agree to each other, it
shows that there are some errors, which must be detected and rectified if the correct final
accounts are to be prepared. Thus, Trial Balance forms a connecting link between the
ledger accounts and the final accounts.

4.2 OBJECTIVES OF PREPARING TRIAL BALANCE

The following are the main objectives of preparing the trial balance:
(i) To check the arithmetical accuracy of books of accounts: According to the
principle of double entry system of book-keeping, every business transaction has two
aspects, debit and credit. So, the agreement of the trial balance is a proof of the
arithmetical accuracy of the books of accounts. However, it is not a conclusive evidence
of their accuracy as their may be certain errors, which the Trial Balance may not be able
to disclose.
(ii) Helpful in preparing final accounts: The trial balance records the balances of all the
ledger accounts at one place which helps in the preparation of final accounts, i.e.
Trading and Profit and Loss Account and Balance Sheet. But, unless the trial balance
agrees, the final accounts cannot be prepared. So, if the trial balance does not agree,
errors are located and necessary corrections are made at the earliest, so that there may not
be unnecessary delay in the preparation of the final accounts.
(iii) To serve as an aid to the management: By comparing the trial balances of different
years changes in figures of certain important items such as purchases, sales, debtors etc.
are ascertained and their analysis is made for taking managerial decisions. So, it serves as
an aid to the management.

4.3 LIMITATIONS OF TRIAL BALANCE

The following are the main limitations of the Trial Balance:
(i) Trial Balance can be prepared only in those concerns where double entry system of
accounting is adopted.
(ii) Though trial balance gives arithmetic accuracy of the books of accounts but there are
certain errors, which are not disclosed by the trial balance. That is why it is said that
trial balance is not a conclusive proof of the accuracy of the books of accounts.
(iii) If trial balance is not prepared correctly then the final accounts prepared will not
reflect the true and fair view of the state of affairs of the business. Whatever conclusions
and decisions are made by the various groups of persons will not be correct and will
mislead such persons.

4.4 METHODS OF PREPARATION OF TRIAL BALANCE

A trial balance can be prepared by the following two methods:
1. Total method: In this method, the debit and credit totals of each account are shown in
the two amount columns (one for the debit total and the other for the credit total).
2. Balance Method: In this method, the difference of each amount is extracted. If debit
side of an account is bigger in amount than the credit side, the difference is put in the
debit column of the Trial Balance and if the credit side is bigger, the difference is written
in the credit column of the Trial Balance.