MODULE 1

Introduction to Accounting

Accounting is the language of business. It is the systematic process of identifying, recording, classifying, summarizing,
interpreting and communicating financial information to users.

Definition

According to American Institute of Certified Public Accountants “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”
Characteristics of Accounting
The above definition contains four essential characteristics of accounting:
1. Identifying and Recording Financial Transactions(Economic Events)
Only those transactions and events are recorded in accounting which is of a financial character.
Recording is done in the book called Journal.
2. Classifying
After recording the transactions in subsidiary book or journal proper, the transactions are to be
classified. The classification work is done in the book called Ledger, where various types of accounts
are maintained.
3. Summarizing
This involves presenting the classified data in a manner which is understandable and useful for
internal as well as external users of accounting system. Summarizing leads to the preparation of the
following statements:
 Trial Balance
 Trading and Profit and Loss Account
 Balance Sheet
4. Analysis and interpretation
Analysis and interpretation of financial data are carried out so that the users of financial data can
make a meaningful judgment of the profitability and financial position of the business.
5. Communicating
Finally, accounting involves communicating financial data to its users. Users include owners,
managers, employees, investors creditors etc. The accounting information must be provided in time
and presented to the users so that appropriate decisions may be taken at the right time.

Need/ Objectives/ Functions of Accounting

1. Maintaining Accounting records

The main objective of accounting is to maintain systematic record of business transactions and events
through following accounting rules, principles and concepts.
2. Ascertainment of result
The second objective of accounting is to ascertain the net profit earned or loss suffered on account of
business transactions during a particular year.
3. Determining the Financial Position
The business man also knows the financial position of the business.
4. Provide Information to Various Parties
 Another main objective of accounting is to communicate accounting information to various parties like
owners, investors, creditors, banks, employees and Government. The information helps them in taking
sound and judicious decisions about the business entity.
5. Meeting Legal Requirements
Accounting records are accepted as evidence by the court of law if they are maintained systematically
following the accounting rules, principles and concepts.
6. Assistance to Management
Management often requires financial information for decision making and ensures efficient
management.

Advantages of Accounting

1. Accounting keeps a prompt and systematic record of all transactions.

2. Accounting helps the management in taking business decisions by analyzing the financial
statements and other information.
3. Accounting reports net result of business activities of an accounting period by preparing Trading profit
and loss account.
4. Accounting reports the financial position of the business by preparing a Balance Sheet at the end of
the accounting period.
5. It facilitates comparative study of the performance of the business over different periods of
time and with other firms.
6. Court accepts these records as evidence in case of disputes.
Limitations of Accounting

1. Recording past events

Accounting is historical in nature.ie.what has happened in the past. From the decision making view
point, information is needed not only of past but also about the present and the future.
2. Recording only monetary items
It record only transactions which can be recorded in monetary terms.
3. Application of different methods
Use of different accounting methods by different firms reduces the reliability of accounts.

Difference between Book-keeping and Accounting

Basis Book Keeping Accounting

Meaning Book keeping is an activity of recording the Accounting consists of preparation,
financial transactions analysis and interpretation of financial
of the company in a systematic manner. statements

Decision making On the basis of book keeping records, Decisions can be taken on the basis of
decisions cannot be taken accounting records
Tools Journal and Ledger Profit and Loss Account, Balance Sheet
and Cash Flow Statement
 Scope Just maintains records of business Preparation of financial statements,
transactions interpreting results and
communicating it to interested
parties
Sub Fields Single entry system and double entry Financial accounting, cost
system of book keeping accounting, management
accounting, human resource
accounting
Nature Clerical and repetitive, it can easily Analysis and interpretation,
performed by a clerk requires qualified accountants

Accountancy

 Accountancy refers to a systematic knowledge of accounting. It gives knowledge of how

to make accounting works.
 According to Kohler “Accountancy refers to the entire body of the theory and
practice of accounting”

Branches (Sub-disciplines) of Accounting

1. Finanancial accounting
It is the original form of accounting. The object of financial accounting is to find out the result of
operation (profit/loss) and to disclose information about the financial position (Strength/weakness) of
the business. It also provides financial information to the management and other interested parties.
2. Cost accounting
This branch of accounting is concerned with ascertaining cost of products, operations; process etc. The
purpose of cost accounting is to analyse the expenditure so as to ascertain the cost of various
products manufactured by the firm and fix the prices. It also helps in controlling the costs and
providing necessary costing information to management for decision-making.
3. Management Accounting
It is concerned with generating accounting information relating to funds, costs, profits etc. The main
purpose of management accounting is to present the accounting information in such a way as to assist
the management in planning and controlling the operations of a business.

Basic Terms in Accounting

Entity
Entity means a reality that has a definite individual existence. Business entity means a specifically identifiable
business enterprise like Wipro, Reliance Industries Ltd, ITC Limited, Kalyan Silks etc.

Business Transaction

The term Business transaction means a financial transaction or economic event involving some value between
two or more entities. Business transaction may be a cash transaction or a credit transaction.

Examples:
 Purchased goods worth Rs 2000 from Rajan.
 Sold goods for cash Rs.5000
 Salary paid Rs.10,000
 Furniture purchased from A Ltd Rs.8000
 Anil started business with cash Rs.60,000
Assets

These are material things or possessions or properties of the business including the amounts due to it from
others. Assets help to generate income.

 Physical properties include assets like land and building, furniture, motor car, cash, stock etc. owned
by a business.
 Rights in certain things called intangible assets such as goodwill, patents, trademarks etc possessed by
the business.
 Amount due to the business from others like debtors, bills receivables, accrued income etc
Example:

Land and building, Plant and machinery, cash and bank balance, stock, bills receivable, money owing
by debtors etc.

Assets can be classified into the following categories

1. Non-current Assets

2. Current Assets

3. Fictitious Assets
1. Non –Current Assets

Non-current asset refers to those assets which are held for continued use in the business for the purpose of
producing goods or services and are not meant for sale. Non-current assets are held by the business from a
long-term point of view.

Example-Fixed assets like Land and building, plant and machinery, furniture, computer, motor vehicles and
long term investment

Non current assets are further classified into:

 (a) Tangible assets
Tangible assets are those assets which have physical existence, i.e., they can be seen and touched.

Example: Land, building, machinery, furniture etc.

(b)Intangible assets
Intangible assets are those assets which do not have physical existence i.e., they cannot be seen and touched.

Example: Patents, good will, trademarks, computer software, prepaid expenses etc.

Like tangible assets, intangible assets also help to generate income to the firm. For example, with the help of
Patents businessman is able to produce goods and his goodwill helps in attracting customers easily.

2. Current Assets

Current assets are those assets which are meant for sale or which can be converted into cash within a year.
For example, goods are purchased with a purpose to resell and earn profit, debtors can be converted into
cash within a short period.

Example-debtors, stock, bills receivable, cash in hand and cash at bank

3. Fictitious Assets

Fictitious assets are neither tangible assets nor intangible assets. They are losses not written off in the year in
which they are incurred but in more than one accounting period.

Example-Advertisement expenditure, discount on issue of debentures Note:

Wasting Asset:

Assets, whose value goes on declining with the passage of time, are known as wasting assets. Example

Mines, patents, assets taken on lease etc.

Liabilities

It refers to the amount which the firm owes to outsiders. They represent creditors’ claims on the firm’s
assets.

Liabilities =Assets – Capital

 Example-Creditors, Bills Payable, Salary outstanding, Loan from bank

Both small and big businesses find it necessary to borrow money from bank at one time or the other, and to
purchase goods on credit from suppliers.

Liabilities can be classified into two:

1. Current Liabilities

2. Non-Current Liabilities

1. Current Liabilities (Short term liabilities)

Current liabilities refer to those liabilities which are to be paid within 12 months from the end of the
accounting period.

Example-Creditors, bank overdraft, bills payable, outstanding expenses, short term loans etc.

2. Non-Current Liabilities (Long term liabilities)

Non –Current liabilities are those liabilities are those liabilities which are to be paid after a period of more
than a year from the end of the accounting period.

Example-Long-term loans, debentures Note:

Contingent Liability (Doubtful liability)

These are not real liabilities. Future events can only decide whether it is really a liability or not. Due to their
uncertainty they are termed as contingent (doubtful) liabilities

 Cases pending in the court (Court’s decision may be favorable or unfavorable)

 Guarantees undertaken by the business
Capital

Amount invested by the owner in the business is known as capital. It may be brought in the form of cash or
assets by the owner for the business entity. Capital is an obligation to the business and it is the owner’s claim
on the assets of the business. Capital is also known as owner’s equity.

Capital= Assets- Liabilities

 Drawings

Withdrawal of money and/or goods by the owner from the business for his personal use is known as drawings.
Drawings reduce the investment of the owners.

Example:

 Amount withdrawn by the owner for his personal use

 Goods taken by the proprietor for his personal use
 Acquiring personal assets with business funds.
 Using business vehicles for domestic use.

Sales

Sales are total amount of revenue from goods or services sold or provided to customers. Sales may be cash
sales or credit sales.

Example:

 Sold goods to Biju for Rs.8,000

 Cash sales Rs.5,000
Sales Return

Sales return or return inwards is that part of sales of goods which is actually returned to us by customers. The
return may be due to defective supply of goods, violation of terms of agreement etc.It should be deducted
from sales to calculate Net Sales.

Example:

Goods returned by Biju Rs.400

Purchases

The term purchase is used only for the purchase of ‘Goods’. In case of manufacturing concern goods means
purchase of raw materials for the purpose of conversion of finished products and then sale. In case of trading
concern ‘goods’ are those things which are purchased for resale .In both the cases the purpose is to make a
profit by its resale. The term purchases include both cash and credit purchases of goods..It is the major
expense of a business concern.

Example:

 Purchased goods from Anju traders Rs.5000

 Purchased goods for cash Rs.4000
  A furniture merchant purchased chairs for Rs.8000 is considered as purchase because here chair is his
goods and its purpose is to resale and to earn profit. But if a furniture merchant purchase chairs for his
office use, it is never considered as purchase, its purpose is not resale but helps to generate
imcome.Here chair is an asset.

Purchase Return

When purchased goods are returned to the suppliers, these are known as purchase return or return
outwards. It should be deducted from purchase to calculate Net Purchase.

Example: Returned goods by Anju Traders Rs.300

Revenues
Revenue of a business constitutes Sales revenue and other revenues. The amount earned by business by
selling its products or providing services to customers are called sales revenue. Sales are the major revenue of
a business. Other items of revenue common to many businesses are: commission received, interest received,
dividend received, royalties, rent received etc.
Total Revenue = Sales Revenue + Other Revenue
Expenses
Expenses are costs incurred by a business in the process of earning revenue. It is the cost of use things or
services for the purpose of generating revenue.
Example:
Cost of things like Purchase cost of goods, stationery etc
Cost of services like salary, advertisement, insurance, electricity, telephone, repairs etc
Decline in the value of asset caused by the use of such assets for business like depreciation.
Expenditure

Expenditure is funds used by a business to attain new assets, improve existing ones, or reduce a liability.
Expenditure can be classified into capital expenditure and revenue expenditure.

Capital Expenditure

Expenditure which has been incurred to derive long term advantage for the business is a capital expenditure.
Capital expenditure is concerned with acquiring fixed assets, increasing the value of fixed assets or investment
made to increase the earning capacity of the business. The benefit of capital expenditure must extend more
than one fiscal year and they are non- recurring in nature.

Example:

Amount spent to purchase fixed assets like land and building, P& M, Furniture, Goodwill etc
Revenue expenditure

Revenue expenses are shorter-term expenses that are broken down into two categories:

Expenditures for generating revenue include expenses required to meet all day-to-day expenses
needed to operate a business.

Example: Salaries, wages, rent, advertisement, depreciation etc.

Expenditures for maintenance of revenue-generating assets Revenue expenditures are often discussed
in the context of fixed assets .It include expenses like ordinary repair and maintenance costs that are
necessary to keep the asset in working order.

Profit

Profit is the excess of revenues over expenses in an accounting year. Profit increases the investment/capital of
the owner. Profit is calculated by deducting the cost from the sale or revenue, which is earned by the regular
business transaction.
Gain
A gain is referred to as any economic benefit derived from outside of the usual business operations. A profit
that arises from events or transactions which are incidental to business such as profit sale of fixed assets,
winning a court case, appreciation in the value of an asset.
 Profit Gain
Profit is the excess of total income over total Gain is the benefit derived from outside of the
expenses usual business operations like profit on sale of fixed
assets etc
It is generated from usual business operations It is generated outside of business operations

Income

Income is the increase in the net worth of an organization either from business activity or from other
activities.

Income=Profit + Gain

Loss

Loss is excess of expenses of a period over its related revenues. It decreases in owner’s equity. The term loss
conveys two different meanings.

First it conveys the result of the business for period when total expenses exceeds total revenues.

Example-If revenues are 3, 00,000 and expenses are 3, 50,000, the loss will be Rs.50, 000.

Second, It refers to money or money’s worth lost (or cost incurred) without receiving any benefit in return,
e.g., cash or goods lost by theft or a fire accident, etc. It also includes loss on sale of fixed assets.

It may be noted that losses differ from expenses. Expenses are incurred to generate revenues whereas losses
do not.

Discount

Discount is a rebate or an allowance given by the seller to the buyer. It is offered in two ways- discount offered
at the time of sale (Trade discount) and discount offered at the time of collection of sales price from debtors
(Cash discount)

Trade Discount-When goods are purchased in bulk quantities, the seller may give certain concession on the
listed price to the buyer. This concession is called trade discount. It is not recorded in the books of account as
it is deducted in the invoice (bill) itself from the gross value of goods.

Example-Purchased goods worth Rs 50,000 from Raj at a trade discount of 10%.Here value of purchase is
recorded as Rs.45,000 (50000-5000).Therefore trade discount Rs.5000 never recorded in the books of account.
Cash Discount-When discount is allowed to the customers for making prompt (timely) payment, it is called
cash discount. It is always recorded in the books of account. It is a loss to the creditor (discount allowed) and a
gain to the debtor (discount received)

Example-Received cash from Mohan Rs.3850 allowed him discount Rs.150 and settled his account Rs.4000.

Debtors/Account Receivables

A debtor is a person who owes money to the business for buying goods and services on credit. The total
amount standing against such persons and/or entities on the closing date is shown in the balance sheet as
sundry debtors on the asset side.

Example

 Sold goods to Vijay on credit Rs.40, 000.Here Vijay owes Rs.40,000 to the
business, so he is a debtor.

Creditors/Accounts Payable

Creditor is a person/or other entities to whom the business owes money as he has given some benefit to the
business. The total amount standing to the favour of such persons and/or entities on the closing date is shown
in the Balance Sheet as sundry creditors on the liabilities side.

 Purchased goods from Meera Traders on credit Rs.3000.Here business owes Rs.30000 to Meera
traders,so Meera Traders is a creditor to the business.

Goods

Goods include all those things which are purchased for resale or raw materials which are used for producing
the finished products.

Example:

Kalyan Silks purchased 100 shirts for Rs.12500 from Aravind Mills Ltd. Here, shirt is the goods for Kalyan Silks.

Note:

 For a furniture dealer purchase of chairs and tables is termed as goods, while for others business firm
it is furniture and is termed as an asset.
 For a stationery trader, stationery is goods, whereas for others it is expense.
Drawings

Withdrawal of money or goods by the owner from the business for personal use is known as drawings.
Drawings reduce the investment (Capital) of the owners.
Example

 Raj, proprietor withdraws Rs.5000 for personal purpose.

 Owner withdraws goods worth Rs.200 for personal purpose.
Stock

The goods lying with a business for sale on any given date are called stock. The value of goods
remaining unsold at the end of an accounting period is known as closing stock.

Closing stock in case of manufacturing concern consists of raw-materials; work –in –progress and
finished goods. The closing stock of a particular year becomes the opening stock for the next
year.

Voucher

Voucher is a documentary evidence of a business transaction.

*************