Lesson-1 Introduction to Accounting Learning Objectives • • • • • • • To understand the meaning of accounting To understand the scope and objectives of financial

accounting To know about the branches of accounting To understand the importance and limitations of financial accounting To know more about accountancy, accounting and bookkeeping To understand the systems of bookkeeping and accounting To know more about the users of accounting information

Introduction In this lesson, our objective is to get acquainted with the basic need, development and definition of basic terms. The accounting records that have been maintained help various interested parties in a variety of manner. For some persons, these records are informative whereas others may take crucial investment decisions based on the information. Accounting is the language of the business, the basic function of which is to serve as a means of communication. If you ask to whom does it communicate the results of business operations, the various interested parties are owners, creditors, investors, governments and other agencies. A language has following three important jobs to perform: • • • To act as a medium of communication To help in understanding the existing literature To make additions to the already existing literature

Accounting has been performing all these roles. As a language, it is responsible for preparing financial statements with its own syntax. The syntax of accounting language comprises the following: • • Total system of recording and analyzing business transactions called the double entry system of bookkeeping The basic principles on which it is based like Accounting Standards or Generally Accepted Accounting Principles (GAAP)

Definition of Accounting Accounting is concerned with the processes of recording, sorting and summarizing data resulting from the business operations and events. The definition given by the American Institute of Certified Public Accountants clearly brings out the meaning and functions of accounting. According to it, 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 result thereof.”

the progress it has made and how well it is getting along. This is done by opening accounts in a book called ledger. . 5. Accounting involves Communication The results of analysis and interpretation are communicated to management and to other interested parties.A Means and Not an End After analyzing properly the information supplied by the accounting statements. accounting is not an end in itself but a means to an end. 2. 4. it performs a service function and simultaneously represents the economic position of an entity. Records Transaction in Terms of Money Recording business transaction in terms of money is the common measure of recording and helps in better understanding of the state of affairs of the business. Involves Recording. Analysis and interpretation of the financial data is the art of accounting. Therefore. Summarizing involves the preparation of reports and statements from the classified data (ledger). the users of the same take decisions for future activities. Classifying is the process of grouping transactions or entries of similar nature at a place. the understanding of accounts is not the basic objective. Thus. On the contrary. it will not be measured in terms of money and hence will not be recorded. If a transaction has no financial character. 3. This involves preparation of final accounts. It only helps to realize a specific objective. As such. Accounting-. Interpretation Interpretation is the art of interpreting the results of operations to determine the financial position of an enterprise. it is clear that keeping accounts is not the primary objective of a person or an entity. the primary objective is to take decision on the basis of the financial facts given by the accounting statements. understandable and useful to management and other interested parties.Meaning of Accounting 1. Since accounting supplies the necessary information. 6. Deals with Financial Transactions Accounting records only those transactions and events which are of financial character. Classifying and Summarizing Recording means systematically writing down the transactions and events in account books soon after their occurrence. requiring special knowledge. Accounting is an Art Accounting classifies as an art as it helps in attaining the goal of ascertaining the financial results. experience and judgment.

classifying and summarizing the business events that have already occurred. the statement of periodical earning. Let us now look at its other objectives and functions. orderly and efficient running of business. taxes. These are as follows: • • • • • • • • • Provides necessary information about the financial activities to the interested parties Provides necessary information about the efficiency or otherwise of management with regard to the proper utilization of scarce resources Provides necessary information for making predictions (financial forecasting) Facilitates to evaluate the earning capacity of a firm by supplying the statement of financial position. Its aim is to collate the information about income and financial position on the basis of business events that have taken place during a particular period of time. Financial Accounting Accounting deals with recording. Cost Accounting Cost accounting deals with the detailed study of cost pertaining to cost ascertainment. That is why it is called historical accounting or postmortem accounting or more popularly financial accounting. cost accounting and management accounting. 2. therefore. together with the statement of financial activities to various interested parties Facilitates in decision-making with regard to the changes in the manner of acquisition. Information provided by the financial accounting system about financial results and financial position on historical basis is though significant yet inadequate for smooth. Objectives and Functions The primary or basic objective of accounting is to supply the necessary information to the users and analysts for taking futuristic decisions. historical in nature.Accounting is essentially a service function designed to provide relevant information concerning an entity to those who are interested in interpreting and using that information. The emphasis is on historical costs as well as future decision-making costs. The answer lies in two more forms of accounting viz. Devices remedial measures for the deviations of the actual from the budgeted performance Provides necessary data and information to managers for internal reporting and formulation of overall policies Branches of Accounting 1. utilization. Management needs more information for planning and control of the business activities. It is. cost reduction and cost control. preservation and distribution of scarce resources Facilitates in decision-making with regard to the replacement of fixed assets and expansion of the firm Provides necessary data to the government to enable it to take proper decisions concerning to duties. . price control etc.

it provides required database to managers to plan and control the activities of business. • To ascertain the net results of operations and financial position • To communicate information to the interested parties 4. Basic The basic objective of bookkeeping The basic objectives of is to maintain systematic records of accounting are as follows: financial transactions. Knowledge A bookkeeper is not required to have An accountant is required to level a higher level of knowledge than have a higher level of knowledge than that of a that of an accountant. in addition to functions: bookkeeping. involves the following functions: • Identifying the transactions • Summarizing the classified • Measuring the identified transactions transactions • Analyzing the summarized • Recording the measured results transactions • Interpreting the analyzed • Classifying the recorded results transactions • Communicating the interpreted information to the interested parties 2. profits. to enable managers to discharge their duties more efficiently and effectively.3. Social Responsibility Accounting Social responsibility accounting involves accounting of social costs incurred by an enterprise and reporting of social benefits created by it. Scope Bookkeeping involves the following Accounting. investments etc. 3. It starts where bookkeeping ends. accounting work. bookkeeper. Distinction between Bookkeeping and Accounting Bookkeeping differs from accounting in the following respects: Basis of Distinction Bookkeeping Accounting 1. Stage Bookkeeping is a primary stage. Management Accounting Management accounting provides information to management not only about cost but also about revenue. 4. 5. . Accounting is the secondary stage. Thus. Who performs Junior staff performs bookkeeping Senior staff performs work.

An accountant should possess analytical skills. they can draw conclusions about their job security and future prospects. 5. 6. Owner(s) Owner(s) refers to a person or a group of persons who has provided capital for running the business. Nature of job 8. Analytical skills 7. Government . Accounting covers designing of accounting system. management requires adequate information about financial results and financial position. Managers For managing business profitably. Users of Accounting Information 1. Designing accounting system 9. Investors Prospective investors would be keen to know about the past performance of business before making investment in that concern. It refers to an individual in case of proprietor. 3. partners in case of partnership firm and shareholders in case of a joint stock company. Both of these are intimately related with the performance of business. A bookkeeper does not supervise An accountant supervises and and check the work of an checks the work of a bookkeeper. By analyzing historical information provided by accounting records. The information needs of shareholders have assumed a greater significance in the corporate business world because of the separation of ownership and management in the case of joint stock companies. credit worthiness etc. 2. accounting helps managers in efficient and smooth running of the business. Employees Employees are concerned about job security and future prospects. Usually. of Bookkeeping does not cover designing of accounts system. Creditors and Financial Institutions Whosoever is extending credit or loan to a business enterprise would like to have information about its repaying capacity. 4. by analyzing the financial statements. accountant. they can arrive at a decision about the expected return and the risk involved in investing in a particular business. Analyzing and interpreting the financial statements of an enterprise can help in obtaining the required information.6. an owner is interested in the financial information to know about the safety of amount invested and the return on investment. The job of a bookkeeper is often routine and clerical in nature. By providing this information. Supervision and checking A bookkeeper may or may not possess analytical skills. The job of an accountant is analytical in nature. Thus.

Anyone having interest in an enterprise can use the information for decision-making. 1956 requires a company to maintain proper books of accounts on accrual basis. a customer to many suppliers. Section 44AA of the Income Tax Act. are guided by the relevance of industries in the economic development of the country. Information about past performance is provided by the accounting system. Collection of taxes is also based on accounting records. Accounting helps to overcome this limitation. Facilitates to Comply with Legal Requirements Accounting facilitates to comply with legal requirements of an enterprise to maintain books of accounts. 1961 requires certain persons to maintain specified books of accounts etc. public at large is always interested in knowing the future directions of an enterprise and the only window to peep inside an enterprise is through their financial statements. Human memory is limited by its very nature. Researchers Researchers need financial information for testing hypothesis and development of theories and models. a provider of amenities in the locality or a cause of concern to the public due to pollution. For example. 9. The policies also consider the past performance of industries. Hence. They certainly want to know about the future directions of the enterprise with which they are associating themselves. . 3. Advantages of Accounting 1. The above-mentioned list of group of users of accounting information is not exhaustive. 7. Facilitates to Replace Memory Accounting facilitates to replace human memory by maintaining a complete record of financial transactions. Facilitates to Ascertain Net Result of Operations Accounting facilitates to ascertain net results of operations by preparing income statement. Public An enterprise affects the public at large in many ways as it acts as a provider of employment to a number of persons. The required information is provided by accounting system. Customers The customers who have developed loyalties toward a business are those who are certainly interested in the continuance of the business. 8. The way to information about the enterprise is through their financial statements. 2. providing subsidies etc.Government policies relating to taxation. Section 209 of the Companies Act.

The users include the following: • • • • • • • • Short-term creditors Long-term creditors Present investors Potential investors Employees’ groups Management General public Tax authorities 6. projected cash flow statement facilitates management to know future receipts and payments and to take decision regarding anticipated surplus or shortage of funds. Comparison of actual figures with standard or budgeted figures for the same period and for the same firm. intra-firm comparison.4. Facilitates the Users to take Decisions Accounting facilitates the users to take decisions by communicating accounting information to them. Facilitates the Ascertainment of Value of Business . b. i.e. Facilitates Control over Assets Accounting facilitates control over assets by providing information regarding cash balance. 8. i. Assist Management Accounting assists management in planning and controlling business activities and in taking decisions. Comparison of actual figures of a period with those of another period for the same firm. i. bank balance. c. Facilitates to Ascertain Financial Position Accounting facilitates to ascertain financial position by preparing the position statement. 9. pattern comparison. d.e. Comparison of actual figures of a firm with those of another standard firm belonging to the same industry. Facilitates the Settlement of Tax Liability Accounting facilitates the settlement of tax liability with the authorities by maintaining proper books of accounts in a systematic manner. fixed assets. 7. 10. debtors. Facilitates a Comparative Study Accounting facilitates a comparative study in the following four ways: a. inter-firm comparison. 5. For example.e. Comparison of actual figures of a firm with those of industry to which the firm belongs. stock etc.

12. department-wise or any other line of activity. 11. i.). Provides Information about the Concern as a Whole In financial accounting. 3. . Today. It does not suggest what should be done to increase the efficiency of the concern. Some of the limitations of financial accounting are discussed below: 1. One can find information about total expenses and total receipts only. The concern may be required to quote a price for the supply of goods in the near future (for submitting tenders etc. The impact of future uncertainties has no place in financial accounting. The information is not recorded product-wise. Price fixation requires information about both variable and fixed costs as well as direct and indirect costs. Indirect expenses are estimated on the basis of previous records for price determination purposes. so it is unhelpful in price determination. but activitywise so that it could be helpful for cost determination and cost control purposes. Management needs information for planning. Facilitates Raising Loans Accounting facilitates raising loans from lenders by proving them historical and projected financial statements. information is recorded for the whole concern.Accounting facilitates the ascertainment of value of business in case of transfer of business to another entity. It is because of the limitations of financial accounting that cost accounting and management accounting have developed. profit and loss account and balance sheet.e. Financial accounting cannot supply all these information. As management needs information for future planning. It is not possible to determine the price in advance. Unhelpful in Price Fixation Financial accounting is unhelpful in fixing the price of a product. controlling and coordinating business activities. Historical Nature Financial accounting is historical in nature in the sense that it keeps a record of all those transactions that have taken place in the business during a particular period of time. The cost of a product can be obtained only when all expenses have been incurred. the scenario in which business has become so complex that mere final accounts information is not sufficient in meeting information needs. Acts as Legal Evidence Proper books of accounts maintained in a systematic manner act as legal evidence in case of disputes. process-wise. financial accounting can only give information about what has happened and not about what will happen. Limitations of Accounting The financial accounting is mainly concerned with the preparation of final accounts. 2.

The recorded costs cannot provide correct information or exact value of assets. no matter how much is it important for the business. 9. A person who is not conversant with accounting subject has a little utility of financial accounts. nothing can be done to control it. There is no procedure to assign responsibility for higher costs. This is because information is recorded for the whole concern and is available only when the event has taken place. The amount paid for purchasing materials. The profitability is the only yardstick for evaluating managerial performance. There is no technique for comparing actual performance with budgeted targets. Cost Control not Possible Cost control is impossible in financial accounting. The only criterion for determining efficiency is to see profits at the end of a financial period. 6. introduction of a new product. The cost figures are known only at the end of a financial period. Anything that cannot be quantitatively measured will not form a part of financial accounting. 5. Not Helpful in taking Strategic Decisions Management has to take strategic decisions like replacement of labor by machinery. The prices of goods and assets vary from time to time. The policies and plans of the government have a direct bearing on the working of business. Technical Subject Financial accounting is a technical subject. 8. property or other assets is recorded in the account books. The current prices of assets may be absolutely different from the recorded costs. it is not a reliable test for ascertaining efficiency of management. Financial accounts do not record price level changes. The impact of these decisions and cost involved will have to be ascertained in anticipation. Appraisal of Policies not Possible It is not possible to evaluate various policies and programs in financial accounting. It is essential to determine the impact of government decisions on the entrepreneurial . Quantitative Information Financial accounting records only that information which can be quantitatively measured. When the cost has already been incurred. Various alternative suggestions are to be studied before taking a final decision. A number of outside factors influence profits of an enterprise. expansion of capacity etc. The costing process requires a constant review of actual costs from time to time and this thing is not possible in financial accounting. It is also difficult to determine whether the work is going on as per schedule. discontinuation of an existing line of production.4. Only Actual Costs Recorded Financial accounting records only actual cost figures. So. There is no technique in financial accounting which can help to ascertain whether the cost is more or less while the expenses are being incurred. 7. The recording of transactions and their use require knowledge of accounting principles and conventions. if any.

10. The amount represents something which is permanently lost. Lack of Unanimity about Accounting Principles Different accountants apply accounting principles differently. The possibility of manipulating financial accounts reduces their reliability. For example. writing off of deferred revenue expenditure etc. there is a lack of unanimity on the use of accounting principles and procedures. The matching of revenue and expenses of a period can be done on the basis of accounting. A cause-effect relationship can be established with the revenue earned. . It amounts to some kind of systematic allocation of an already incurred cost in the past. rent paid. 11. salaries paid etc. The over valuation or under valuation of inventory may change the figures of profits. It is always calculated at the end of a period and hence is an ex-post or actual income. The basis of accounting comprises the following three bases: • • • Accrual basis Pure cash basis Modified cash basis or hybrid basis Accrual Basis Under this base. loss of material by fire or theft etc. For example. More profits may be shown to get more remuneration.policies. The use of different accounting methods reduces the usefulness and reliability of accounts. irrespective of the fact whether received in cash or not. revenue are recognized if they belong to a period. salaries etc. For example. d. For example. c. b. The methods of valuing inventory and charging depreciation are the most controversial issues on which unanimity has not been possible. issue more dividends or to raise the prices of company’s shares. In spite of the efforts of International Accounting Standards Committee. incomes as well as expenses are considered on the basis of their occurrence in an accounting period and not on the basis of their actual receipts/ payments. Hence. Expenses are recognized in an accounting period in the following cases: a. Chances of Manipulation Financial accounting can be used to suit the whims of management. The preference for the use of different accounting principles brings in an element of subjectivity and human biasedness. depreciation. purchases. Financial accounts will avoid qualitative factors because they cannot be quantitatively measured. wages. Less profit may be shown to save taxes for not paying bonus to workers etc. Basis of Accounting The income of business belongs to the owner and is a direct result of matching of revenue and expenses of a period. It amounts to expenses related to the period.

000 Under Pure Cash Basis Income = Revenue Received – Expenses Paid = Rs. 45. 2.000 (including Rs. 1. The practical utility of these two systems is minimal. The application of pure cash basis of accounting is without sound logic.00.000 . Pure Cash Basis Under this method. will be treated as expense. Professionals who term their income statement as receipt and expenditure account normally follow such system. 40. the one having widespread applicability. The practice of GAAP does not permit application of cash basis of accounting for any kind of business entity. The acquisition of fixed assets will have to be treated as expense of the period in which they are paid instead of periods in which benefits are derived from them. 2. Solution Under Accrual Basis Income = = = Revenue Earned – Expenses Incurred Rs. In fact. the matching concept and accrual concept are used interchangeably. 1.000 as credit sales) and expenses amount to Rs. inventories should be treated as expense when they are sold. Hence. when purchased and paid for in cash. 60. Illustration A business generates sales of Rs. revenue are not recognized and recorded unless they are received in cash. accrual basis are followed normally for expenses and cash basis are followed normally for revenue.60. It would mean that inventories.15. in accrual basis.000 = Rs. we match the revenue earned and expenses incurred during a particular period. Compute the profit of the business as per the above-mentioned bases of accounting for the accounting period. expenses are recognized only when they are paid in cash. 1. The most genuine and authentic system. expense recognition and matching.000 – Rs.00. Logically.000 Rs.000 still payable) during the accounting period. Similarly.000 (including Rs. 1. In this.It is immaterial whether expenses are paid in cash or not. income of a period is calculated by setting off expenses paid in cash against revenue received during a period. is accrual system and the other two systems are quite infrequently used.e. Hence.000 – Rs.40. Modified Cash Basis or Hybrid System The system is a mixture of both the basis of accounting discussed above.40. This matching is in line with the GAAP of realization (or revenue recognition). 25. i.

paid up share capital in a corporate enterprise. In manufacturing operations. 5. The Institute of Chartered Accountants of India (ICAI) has done an excellent compilation of the various terms used in the business under “Guidance Note on Terms Used in Financial Statements. Assets Assets refer to the tangible objects or intangible rights owned by an enterprise and carrying probable future benefits. it is necessary to understand some important terms which are used in the business world. receivables or other consideration. Revenue Revenue is the gross inflow of cash. Profit Profit is a general term for the excess of revenue over related cost. revenue is the amount of commission and not the gross inflow of cash. Capital Capital generally refers to the amount invested in an enterprise by its owners. Cost of Goods Sold It is the cost of goods sold during an accounting period. Liability Liability is the financial obligation of an enterprise other than owners’ funds. Capital also refers to the interest of owners in the assets of an enterprise. In an agency relationship. It excludes amounts collected on behalf of third parties such as certain taxes. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. royalties and dividends. When the result of this computation is negative. 4. 6. 3.Basic Terms in Accounting For the proper understating of accounting system. it includes the following: • • Cost of materials Labor and factory overheads Selling and administrative expenses are normally excluded. 7. 2. it is referred to as loss. For example. receivables or other considerations arising in the course of ordinary activities of an enterprise’s resources yielding interest. Expenditure .” Some important terms explained in the guidance note are reproduced below: 1.

8. The terms gross turnover and net turnover (or gross sales and net sales) are sometimes used to distinguish the sales aggregate before and after deduction of returns and trade discounts. Sales Turnover Sales turnover includes the total amount for which sales are affected or services rendered by an enterprise. Expenses Expense is the cost relating to the operation of an accounting period. It is also known as profit and loss account. 11. 9. This is also referred to as deferred revenue expenditure. or the revenue eared during the period. Prior Period Item Prior period item is a material change or credit that arises in the current period as a result of errors or omissions in the preparation of financial statements of one or more prior periods. showing application of profits toward dividends. . 15. Appropriation Account Appropriation account is an account. or in the process of the production for such sale. Deferred Expenditure Deferred expenditure is the expenditure for which payment has been made or a liability incurred but which is carried forward on the presumption that it will be a benefit over a subsequent period or periods. 12. 13. or the consumption in the production of goods or services for sale. or the benefit of which do not extend that period. Inventory Inventory includes tangible property held for sale in the ordinary course of business. Accumulated Depreciation Accumulated depreciation includes the total up-to-date of the periodic depreciation charges on depreciable assets. disbursement of cash or transfer of property for the purpose of obtaining assets.Expenditure includes incurring a liability. 10. Profit and Loss Statement Profit and loss statement is a financial statement which presents the revenue and expenses of an enterprise for an accounting period and shows the excess of revenue over expenses (or vice versa). 14. including maintenance supplies and consumables other than machinery spares. goods or services. reserves etc. sometimes included as a separate section of the profit and loss statement.

replacement value etc. reserves and other account balances at their respective book value. costs. Sundry Creditor Sundry creditor is the amount owed by an enterprise on account of goods purchased or services received. 19. 23. cost. depreciation and amortization. 21. Sundry Debtor Sundry debtors are persons from whom amounts are due for goods sold or services rendered. trade debtor and account receivable. 18. . For example. capital. allocations. or in respect of contractual obligations. This basis is also referred to as mercantile basis of accounting. costs. liabilities. Cash Basis of Accounting Cash basis of accounting is the method of recording transactions by which revenue. assets and liabilities are reflected in the accounts in the period in which actual receipts or actual payments are made. The accrual basis of accounting includes considerations relating to deferrals. It does not refer to any particular basis on which the amount is determined. Balance Sheet Balance sheet is a statement of financial position of an enterprise at a given date. 17. Accounting Policies Accounting policies include the specific accounting principles and methods of applying those principles adopted by an enterprise in the preparation and presentation of financial statements. Accrual Basis of Accounting Accrual basis of accounting is the method of recording transactions by which revenue. 22. or in respect of contractual obligations. assets and liabilities are reflected in the accounts in the period in which they accrue. Goodwill Goodwill is an intangible asset arising from business connection or trade name or reputation of an enterprise. Book Value Book value is the amount at which an item appears in the books of account or financial statement. It exhibits a company’s assets.16. 20. These are also termed as debtor. It is also termed as trade creditor or account payable.

government and prospective investors. Over a period. Contingent Liability Contingent liability is an obligation relating to an existing condition or situation which may arise in future depending on the occurrence or non-occurrence of one or more uncertain future events. Define the term accounting. 25. maintenance of records manually. Contingent Asset Contingent asset is an asset. Initially. However. Explain how accounting is different from bookkeeping? 2. State its functions. the nature of the functions of accounting has changed. i. more thrust was on bookkeeping. the role of accountants is more inclined toward analysis and interpretation than mere maintenance of the data. where computerized accounting software are used. Questions 1. employees.e. the existence. today. ownership or value of which may be known or determined only on the occurrence or non-occurrence of one or more uncertain future events. The accounting information is useful not only for the owners and management but also for the creditors.24. Who are the interested persons in the accounting information? . The main objective of accounting is to reflect the true and fair picture of profitability and financial position which helps management to take corrective actions and future decisions. Summary Accounting is that language of business through which a business house communicates with the outside world.

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