Chapter 1: Introduction to Accounting

1. Meaning of Accounting

• Definition: Accounting is the process of identifying, measuring, recording,

classifying, summarizing, analyzing, and communicating financial information to
stakeholders for decision-making.

• It is a systematic and scientific process of recording business transactions in

monetary terms.

• According to the American Institute of Certified Public Accountants (AICPA):

"Accounting is the art of recording, classifying, and summarizing in a significant
manner and in terms of money, transactions, and events which are, in part at least,
of a financial character, and interpreting the results thereof."

2. Objectives of Accounting

• Recording Transactions: To maintain a systematic record of all financial

transactions.

• Ascertaining Profit or Loss: To determine the financial performance (profit or loss)

of a business through the preparation of a Profit and Loss Account.

• Determining Financial Position: To assess the financial health of a business by

preparing a Balance Sheet.

• Providing Information to Stakeholders: To provide relevant financial information to

users like owners, creditors, investors, government, etc.

• Assisting in Decision-Making: To help management make informed decisions

based on financial data.

• Ensuring Statutory Compliance: To comply with legal requirements (e.g., taxation,

audits).

• Preventing and Detecting Errors/Frauds: To identify and rectify errors or fraudulent

activities.

3. Characteristics of Accounting

• Economic Events: Only transactions measurable in monetary terms are recorded.

• Systematic Process: Follows a structured process (recording, classifying,

summarizing).
 • Communication: Results are communicated to users through financial statements.

• Historical Nature: Records past transactions.

• Interpretation: Provides insights into financial performance and position.

4. Functions of Accounting

• Maintaining complete and systematic records.

• Protecting business assets.

• Facilitating decision-making.

• Meeting legal requirements.

• Communicating financial results to stakeholders.

5. Users of Accounting Information

1. Internal Users:

o Owners: To assess profitability and business performance.

o Management: For planning, controlling, and decision-making.

o Employees: To evaluate job security and incentives.

2. External Users:

o Creditors: To assess the creditworthiness of the business.

o Investors: To evaluate investment opportunities.

o Government: For taxation, regulation, and policy-making.

o Customers: To ensure the continuity of supply.

o Researchers: For economic and financial analysis.

6. Branches of Accounting

• Financial Accounting: Recording and reporting financial transactions for external

users (e.g., Balance Sheet, Profit and Loss Account).

• Cost Accounting: Analyzing and controlling costs to improve efficiency.

• Management Accounting: Providing information for internal decision-making (e.g.,

budgeting, forecasting).

• Tax Accounting: Preparing tax returns and ensuring compliance with tax laws.
 • Social Responsibility Accounting: Measuring the social and environmental impact
of business activities.

7. Accounting Process

The accounting process involves the following steps:

1. Identification: Recognizing financial transactions (e.g., sale, purchase).

2. Measurement: Quantifying transactions in monetary terms.

3. Recording: Entering transactions in the books of accounts (e.g., Journal).

4. Classification: Grouping similar transactions under appropriate heads (e.g.,

Ledger).

5. Summarization: Preparing Trial Balance and Financial Statements.

6. Analysis and Interpretation: Drawing conclusions from financial data.

7. Communication: Sharing financial information with stakeholders.

8. Basic Accounting Terms

• Transaction: An economic event that affects the financial position of a business

(e.g., sale, purchase).

• Capital: The amount invested by the owner in the business.

• Assets: Resources owned by the business (e.g., cash, machinery).

• Liabilities: Obligations or debts owed by the business (e.g., loans, creditors).

• Revenue: Income earned from business activities (e.g., sales, rent received).

• Expense: Costs incurred to earn revenue (e.g., salaries, rent paid).

• Profit: Excess of revenue over expenses.

• Loss: Excess of expenses over revenue.

• Debtor: A person who owes money to the business.

• Creditor: A person to whom the business owes money.

• Voucher: A document that serves as evidence of a transaction (e.g., receipt,

invoice).

• Goods: Items bought or sold in the course of business.

 • Drawings: Amount or goods withdrawn by the owner for personal use.

9. Advantages of Accounting

• Provides financial information for decision-making.

• Helps in assessing business performance.

• Facilitates comparison of financial results over time.

• Ensures legal compliance.

• Assists in securing loans or investments.

10. Limitations of Accounting

• Records only monetary transactions (non-monetary factors like employee morale

are ignored).

• Based on historical data, not future projections.

• Subject to personal bias or errors in judgment.

• Ignores the effect of inflation (unless adjusted).

• May not reflect the true market value of assets.

11. Difference Between Bookkeeping and Accounting

Aspect Bookkeeping Accounting

Limited to recording Includes recording, analyzing, and

Scope
transactions. interpreting.

Nature Clerical and routine. Analytical and dynamic.

Objective Maintaining accurate records. Providing financial insights for decisions.

Skill Basic knowledge of

Advanced knowledge and expertise.
Required accounting.

Financial Statements (P&L, Balance

Output Journal, Ledger, Trial Balance.
Sheet).

12. Qualitative Characteristics of Accounting Information

• Relevance: Information should be useful for decision-making.

 • Reliability: Information should be accurate and verifiable.

• Comparability: Information should allow comparison over time or with other

businesses.

• Consistency: Same accounting methods should be applied consistently.

• Understandability: Information should be clear and easy to comprehend.

Key Points to Remember

• Accounting is both an art and a science.

• It serves both internal and external users.

• The accounting process follows a cycle: identification → recording →

communication.

• Financial statements (Balance Sheet, Profit and Loss Account) are the end products
of accounting.

• Understanding basic terms like assets, liabilities, and capital is crucial for further
chapters.