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INTRODUCTION TO ACCOUNTING

Definition of Accounting
Accounting is a systematic process of recording, classifying, summarising, analysing
and interpreting the financial transactions and communicating the results to the users
thereof.

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”.

Today, accounting is used by everyone and a good understanding of it is beneficial

to all. Accountancy act as a language of business. To understand accounting
efficiently, it is important to understand the aspects of accounting.

 Economic Events- It is a consequence of a company has to undergo when the number

of monetary transactions is involved. Such as purchasing new machinery, transportation,
machine installation on-site, etc.
 Identification, Measurement, Recording, and Communication- The accounting
system should be outlined in such a way that the right data is identified, measured,
recorded and communicated to the right individual and at the right time.
 Organization-In refers to the size of activities and level of a business operation.
 Interested Users of Information- It is about communicating important financial
information to the customers, according to which they will make the correct decision.

Attributes (Characteristics) of Accounting

1. Identification- Identifying the events and transactions that can be measured in terms of
money i.e. part of economic activity.
2. Measuring- Financial transactions and events are measured in terms of money. *Focus
on quantitative, rather than qualitative aspect.
3. Recording- Recording the business transactions of financial character, in terms of
money, in book of original entry (Journal)
4. Classifying- grouping transactions of one nature at one place. The transactions
recorded in journals and other subsidiary books are classified or posted in main book of
accounting (ledger)
5. Summarising- Presenting classified data in a manner which is understandable and
useful for internal and external users of financial statements. Preparation of Trial balance
to prepare Trading and PNL a/c and Balance sheet.
6. Analysis and Interpretation- carried out so that the users can make a meaningful
judgement of the profitability and the financial position of the business.
 7. Communicating- Communicating the financial info i.e. the financial statements to the
users in time so that appropriate decisions can be taken at appropriate time.

Fundamentals of Accounting
1. Assets- The economic value of an item which is possessed by the enterprise is referred
to as Assets. To put it in other words, assets are those items that can be transformed into
cash or that generates income for the enterprise shortly. It is useful in paying any
expenses of the business entity or debt.
2. Liabilities- The economic value of an obligation or debt that is payable by the enterprise
to other establishment or individual is referred to as liability. To put it in other words,
liabilities are the obligations that are rising out of previous transactions, which is payable
by the enterprise, through the assets possessed by the enterprise.
3. Owner’s Equity- Owner’s equity is one of the 3 vital segments of a sole proprietorship’s
balance sheet and one of the main aspects of the accounting equation: Assets =
Liabilities + Owner’s Equity. It depicts the owner’s investment in the trade minus the
owner’s withdrawal from the trade + the net income since the business concern
commenced. * Owner’s equity is referred to as the rights of the owners in the assets
of the business. The term owner’s equity is most appropriately used in case of a sole
proprietorship business, but it can be known as stockholders equity or shareholders
equity in case the business is structured as an LLC or a corporation.

Objectives of Accounting
The main objectives of accounting are:

1. To maintain a systematic record of business transactions {PRIMARY

FUNCTION OF ACCOUNTING}

 Accounting is used to maintain a systematic record of all the financial transactions in a

book of accounts.
 For this, all the transactions are recorded in chronological order in Journal and then
posted to principle book i.e. Ledger.

2. Preparation of financial statement

 To check whether the business has earned profits or incurred losses, we prepare a
“Profit & Loss Account”. {Income Statement}
 Another important objective is to determine the financial position of the business to check
the value of assets and liabilities. For this purpose, we prepare a “Balance Sheet”.
{Position Statement}

3. Meeting legal requirements

 Accepted as evidence by the court of law if they are maintained systematically following
the accounting principles and concepts.
 The Companies Act, Income Tax Act, GST Act, etc. require submissions of returns which
can be submitted if a/c records are maintained systematically and timely.

4. To provide information to various users

  Providing information to the various interested parties or stakeholders is one of the most
important objectives of accounting.
 It helps them in making good financial decisions.

5. To assist the management

 By analysing financial data and providing interpretations in the form of reports,

accounting assists management in handling business operations effectively.
 Helps in decision-making and assist in protecting assets and also exercising control.

What are the Different Branches of Accounting?

The following are the main branches of accounting:

(a) Financial accounting:

Financial Accounting is that branch of accounting which involves identifying,

measuring, recording, classifying, summarising the business transactions, i.e. it
involves the steps from Identifying, Recording of transactions to Summarisation, and
communicating the financial data.

(b) Cost accounting:

Cost Accounting is that branch of accounting which is concerned with the process of
ascertaining and controlling the cost of products or services, helps the management
in decision-making (like, price fixation) and exercising control.

(c) Management accounting

Management accounting refers to that branch of accounting which is concerned with

presenting the accounting information in such a way that helps the management in
planning and controlling the operations of a business and in decision making.
*generated info regarding funds, costs, profits, etc.

Steps of the Accounting Process:

Accounting process is the process of collecting, recording, classifying, summarising
and communicating financial information to the users for judgement and decision-
making. The following steps are involved in accounting process:

(1) Identification: It is the process of identifying and analysing business transactions.

(2)Recording: For recording, we use ‘Journal’ or Subsidiary Books.

(3) Classification of transactions: Classification means segregation of transactions on
the basis of nature and posting them in a format known as Ledger Account.

(4) Summarisation: It includes preparation of Trial Balance and Financial

Statements.

(5) Analysis & Interpretation: It includes an assessment of the financial reports and
making some meaningful conclusions.

(6) Communicating information to the users: It includes sharing the financial reports
and interprets results to the users of financial statements.

Define the term Bookkeeping, Accounting and Accountancy.

Bookkeeping Book Keeping is a part of Accounting and it is the process of identifying, measuring,
recording and classifying the financial transactions. *JOURNAL & LEDGER

Accounting Accounting is a wider concept and actually, it begins where Book Keeping ends. It includes
summarizing, interpreting and communicating the financial data to the users of financial
statements. *TRIAL BALANCE, TRADING & PNL A/C, BALANCE SHEET

Accountancy Accountancy refers to systematic knowledge of the principles and the techniques which are
applied in Accounting.

Blue: Accountancy
Green: Accounting
Yellow: Book keeping

*Accountancy – knowledge of accounting

*Accounting – Application of accountancy

Bookkeeping v.s. Accounting?

Parameters Bookkeeping Accounting

Scope Bookkeeping involves identifying, In addition to bookkeeping, Accounting also includes

measuring, recording & classifying summarizing, interpreting and communicating the
financial transactions in the ledger financial data to the users of financial statements.
accounts.

Objective The main aim is to maintain systematic The main aim is to ascertain the profitability and
 records of financial transactions. financial position of the business.

Stage It is a primary stage of accounting It is a second stage and begins where book-keeping
ends.

Nature of job This job is in routine and repetitive in This job is analytical in nature.
nature.

Level of Bookkeeping does not require special It requires specialized skill to analyse, so it is
skills skills. It is performed by Junior Staff. performed by senior staff.

What are the Advantages of Accounting?

The following are the main advantages of accounting:

1. Provide information about financial performance

 Accounting provides factual information about financial performance during a given

period of time
 Like, profit earned or loss incurred over a period and financial position at a particular
point of time.

2. Provide assistance to management

 Accounting helps management in business planning, decision making and in exercising

control.
 For this, it provides financial information in the form of reports.

3. Facilitates comparative study

 By keeping systematic records and preparation of reports at regular intervals, accounting

helps in making a comparison. {two competitors or position in 2 different years}

4. Helps in settlement of tax liability

 Systematic accounting records help in settlement of various tax liabilities. Such as –

Income Tax, GST, etc.

5. Helpful in raising loan

 Banks and Financial Institutions grant a loan to the firm on the basis of growth and
potential of the financial statement of the firm. *Performance and assets available as
security

6. Replaces memory

 Accounting obviates the necessity to remember the transactions.

7. Evidence in Court

 Systematic record of transactions is often accepted by courts as good evidence.

8. Facilitates sale of business

 Accounting enables ascertainment of the proper purchase price if desire to sell.

9. Assistance in the event of insolvency

 Insolvency proceedings involve explaining transactions taken place in the past.

10. helpful in partnership accounts

 In case of adm/retirement/death of a partner or dissolution of firm, a/c record provides

basis to reach settlement.

What Are the Limitations of Accounting?

Following are the limitations of accounting:

1. Accounting is not fully exact: Although it is recorded on the basis of evidence, yet
estimates are made in ascertaining profit and loss, ex, estimating the life of useful asset.
2. Affected by window dressing: Window dressing means manipulation in accounting to
present a more favourable position of the business than the actual position.
3. Unrealistic information: Assets are recorded at historical cost and depreciated over
their estimated useful time. The useful life of an asset is also estimated which make the
info unrealistic.
4. Ignores qualitative elements: Confined to monetary terms; qualitative elements like
efficiency of staff, PR, etc. are ignored.
5. Ignores effect of price level change: Accounting presumes that value of money
remains stable. Unless it is considered, A/c info will not show correct results.

Explain the Users of Accounting Information:

Users may be categorised into internal users and external users.

(A) Internal Users

 Owners: Owners contribute capital in the business and thus they are exposed to
maximum risk. So, they are always interested in the safety of their capital. *know profit
and loss; decide whether to invest more capital or withdraw the capital
 Management: Accounting information is used by management for taking various
decisions. *plan future strategies; decide costs/prices; compare their a/c info with similar
enterprises.
 Employees: Employees are interested in the financial statements to assess the ability of
the business to pay higher wages and bonuses.

(B) External Users

 Banks and financial institutions: Banks and Financial Institutions provide loans to
business. So, they are interested in financial information to ensure the safety and
recovery of the loan. *track progress; evaluate the potential
  Investors: Investors are interested to know the earning capacity of business and safety
of the investment.
 Creditors: Creditors provide the goods on credit. So they need accounting information to
ascertain the financial soundness of the firm. *determine the paying ability
 Government: The government needs accounting information to assess the tax liability of
the business entity. *assess the correct amount of taxes; calculation of national income
for policy making
 Researchers: Researchers use accounting information in their research work.
 Consumers: They require accounting information for establishing good accounting
control, which will reduce the cost of production.
 Public: assess contribution to the economy, to be aware about change in management,
concerned whether enterprise is performing its duties

Qualitative Characteristics of Accounting Information

Qualitative characteristics are the attributes of accounting information, which
enhance its understandability and usefulness:

 Reliability: Reliability implies that the information must be free from material error and
personal bias.
 Relevance: Accounting information must be relevant to the decision-making
requirements of the users.
 Understandability: Information should be disclosed in financial statements in such a
manner that these are easily understandable.
 Comparability: Both intra-firm and inter-firm comparison must be possible over different
time periods. *intra- comp b/w two periods; inter- comp b/w two competitiors

Explain the System of Accounting

System of accounting

 There are following two systems of recording transactions in the books of accounts:
 Double Entry System
 Single Entry System

Double-entry system

 The double entry system is based on the Dual Aspect Principle.

 Every transaction has two aspects, ‘a Debit’ and ‘a credit’ of an equal amount.
 This system of accounting recognises and records both aspects of the transaction.

Single entry system

 Under this system, both aspects are not recorded for all the transactions.
 Either only one aspect is recorded or both the aspects are not recorded for all the
transactions.
What Are the Advantages of the Double-entry System of
Accounting?
Following are the main advantages of the double-entry system of accounting:

Scientific system

 As compared to the other systems, this system of recording transactions is more

scientific and useful to achieve the objective of accounting.

A complete record of the transaction

 Since both the aspects of transactions are considered there is a complete recording of
each and every transaction.
 Using these records we are able to compute profit or loss easily.

Checks arithmetical accuracy of accounts

 Under this system, by preparing a Trial Balance we are able to check the arithmetical
accuracy of the records.

Determination of profit/loss and depiction of financial position

 Under this system by preparing ‘Profit & Loss A/c’ we get to know about the profit earned
or loss incurred.
 By preparing the ‘Balance Sheet’ the financial position of the business can be
ascertained, i.e. position of assets and liabilities is depicted.

Helpful in decision making

 Administration and management are able to take decisions on the basis of factual
information under the double-entry system of accounting.

ACCOUNTING TERMS
1. Entity – An economic unit, which maybe a business entity (enterprise) or a non-business
activity.
2. Business Transaction – A business transaction is a financial event between two or
more parties. It involves an exchange of goods, services or money and gets recorded in
the books of accounts for the organisations involved.
3. Capital – Capital is a critical component of any business to run its daily operations and help
its future growth. The capital for a business comes either from its owners or from outsiders
(shares, debentures or bonds).
4. Drawings – Drawings refer to the withdrawals made by the owners of a business for
personal use. It gets deducted from the Owner’s Capital in the Liabilities side of a
Balance Sheet.
5. Liabilities (Non-Current and Current) – Current Liabilities are the amount due to the
creditors of a business that has to be paid back within twelve months. Non-Current
Liabilities are the long-term obligations of a company that are not due for payment before
a year.
6. Assets (Non-Current and Current) – Current Assets are the assets that a firm can
liquidate within twelve months. Non-Current Assets are the long-term investments of a
business that they cannot liquidate within a year.
7. Fixed assets (Tangible and Intangible) – Tangible Fixed Assets are the long-term
investments of a business that have a physical existence. Intangible Fixed Assets are the
long-term investments made by a company that doesn’t have a physical existence.
8. Expenditure (Capital and Revenue) – A business incurs Capital Expenditure to acquire
assets for long-term income generation. It also incurs Revenue Expenditure to run the
day-to-day operations of a business.
9. Expense – Expenses in accounting refer to the cost incurred or money the business
owners spend to generate revenue. A business must keep its expenses under control to
generate profits both in the short and long run.
10. Income – Income is the revenue that a business earns from the sale of its goods or
services. It is essential for the survival and growth of any enterprise, and the failure to
generate revenue can lead to a shutdown of the business.
11. Profit – Profit is the positive difference between the income generated from selling goods
or services and the Expenses incurred to perform that business activity. Profit is the
excess of revenues over the expenses.
12. Gain – A Gain is an increase in the total value of an asset of a business. It takes place
when the current price of the asset exceeds its original purchase price. It can occur at
any time during the useful life of an asset.
13. Loss – Loss is the excess of the Expenses incurred from selling goods or services over
the income generated to perform that business activity. Sustained losses over time can
lead to the shutdown of a business organisation.
14. Purchase – Purchase is the activity of buying an item to either use it in the production of
goods and services or resell it to another entity.
15. Sales – Sales is an economic activity where a business exchanges goods or services
with another entity for money. It is the primary source of revenue for any organisation.
16. Goods – Goods are the items that a company manufactures to sell to another entity in
exchange for money. When an organisation buys goods, it is known as purchases, and
when it sells goods, it is known as sales.
17. Stock – A stock is a financial instrument that represents the part ownership of a
company. Organisations use this instrument to raise capital for their business.
18. Debtor – A debtor is an individual or entity that owes money to a business. Companies
treat it as an asset because they will get money from them in the near or distant future.
19. Creditor – A creditor is an individual or entity to whom a business owes money.
Companies treat it as a liability because they will have to pay them in the near or distant
future.
20. Voucher – A Voucher is an internal document that a company uses as supporting
evidence for accounting entries. Businesses treat it as a redeemable transaction bond as
it has a monetary value and is helpful in specific cases.
21. Discount (Trade Discount and Cash Discount) – A Trade Discount is a discount that a
seller can offer to the buyer by reducing the price of an item. It helps to increase sales of
a product, and it doesn’t get recorded in the accounting books. A Cash Discount is a
discount that a seller can offer to the buyer at the time of payment by reducing the
invoice price of an item. It helps to ensure timely payment for a product, and it gets
recorded in the accounting books.