Chapter 01: Introduction 1

Accounting:
“Accounting is an art of analyzing, 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.”
… American Institute of Certified Public Accountants (AICPA)

Transaction:
A piece of business or an exchange of value – In broader sense, it is an act of carrying out a
business deal.

Financial Character:
Accounting deals with only those events which are of financial character. Those events, which
are not of financial character, are not recorded.

Recording:
The main purpose of accounting is to keep a systematic record of all business transaction
through;
 General Journal
 Special Journals
 Cash Book
 Petty Cash Book
 Purchase Journal
 Purchase Return & Allowance Journal
 Sales Journal
 Sales Return & Allowance Journal

Classifying:
Accounting also facilitates all business transactions through General Ledger – The Central
Book of Accounting.

Summarizing:
This involves financial statements,
1. Income Statement
2. Balance Sheet
3. Cash Flow Statement
4. Statement of Changes in Equity
5. Notes to the Financial Statement

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Interpretation:
It is an ultimate accounting function. It reflects the over all performance of the business
activities and forecast the future events.

Heads of Accounts
Every language has vocabulary. Accounting is also a language which is written, read, spoken
and understood in all over the world. The vocabulary of accounting is termed as “account”. There are
five Heads of Accounts,
1) Assets 2) Liabilities 3) Capital 4) Revenues 5) Expenses
The explanation of these heads of accounts is as follows,

1) Asset:
“A resource controlled by an entity as a result of past events from which future economic
benefits are expected to flow to an entity.”

(Substance over form)

Accounting should be done as per the economic substance of the transaction and not merely there legal
form.

Current Assets Non – Current Assets

Cash / Cash on Hand Equipment
Bank / Cash at Bank Furniture
Petty Cash Fund Automobile
Merchandise Inventory / Stock Machinery
Accounts Receivable Premises
Bills Receivable Building
Notes Receivable Land
Income Receivable Goodwill
Supplies Patents
Prepaid Trade Marks
Advance to Supplier Franchise
Investment / Short Term Investment Long Term Investment

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2) Liability:
“A liability is a present obligation of the entity arising from past events, the settlement of which
is expected to result in an outflow from the entity of resources embodying economic benefits.”

Current Liabilities Non – Current Liabilities

Accounts Payable Long Term Loan Payable
Bills Payable Debenture Payable
Notes Payable Mortgage Debenture Payable
Expenses Payable Bonds Payable
Bank Loan Mortgage Bonds Payable
Loan Payable
Short Term Loan
Unearned Revenue
Advance From Customers

3) Capital:
Equity is the residual interest in the assets of an entity after deducting all its liabilities. Equity
includes investments by the owners of the entity, plus additions to those investments earned through
profitable operations and retained for use in the entity’s operations, minus reductions to owners’
investments as a result of unprofitable operations and distributions to owners.
(Entity Concept)
Entity means an object, person or body. Entity Concept means business unit is a separate entity
from its owner(s). Accounting is operated from the point of view of the business not of the owners.

Investments are of two types;

 Direct investment
If owner(s) bring any asset in the form of capital
 Indirect Investment
If owner(s) pay any expense or debt personally on behalf of firm
Contra Account: Drawings
The amount that decreases the residual interest in the assets of an entity is termed as
‘drawings’. In other words, decrease in resources due to owner(s) personal use is called ‘drawings’.
Withdrawals are of two types;
 Direct Withdrawals
If owner(s) withdraw any asset in the form of drawings
 Indirect Withdrawals
If firm pays any personal expense or debt on behalf of owner(s)
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4) Revenues:
“Revenue is the gross inflow of economic benefits during the period arising in the course of the
ordinary activities of an entity when those inflows result in increases in equity, other than increases
relating to contributions from equity participants.”
Revenue is different from Income. Income is complete profit, while Revenue also has cost as
well. It means, every Income is Revenue but every Revenue is not Income, there are two types of
revenues.
a. Sales
b. Service Income
 Rent Income / Rental Revenue
 Interest Income
 Bank Profit
 Commission Income
 Consulting Fee Income

5) Expenses:
“…decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that result in decreases in equity, other than those
relating to distributions to equity participants. (IFRS Framework, F.70)”
1) Purchases 12) Transportation out
2) Salaries Expense 13) Cartage in
3) Rent Expense 14) Cartage out
4) Insurance Expense 15) Traveling Expenses
5) Interest Expense / Markup Charges 16) Conveyance Expenses
6) Utilities Expense 17) Repairs Charges
7) Freight in 18) Depreciation Expense
8) Freight out 19) Depletion Expense
9) Carriage in 20) Amortization Expense
10) Carriage out 21) Advertising Expense
11) Transportation in 22) Bad Debts / Doubtful Debts / Uncollectible Debts Expense

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