ACCOUNTING

This is the process of analyzing, classifying and interpreting information from book-keeping
so that owners, managers and other interested persons can make decisions that will keep a
business alive. The individual responsible for the accounting process is the accountant.

USERS OF ACCOUNTING INFORMATION

Accounting information consists of sets of financial statements which is useful for internal
users (primary users) of an organisation as well as external users (secondary users).
Internal Users (Primary Users)

Following are some of the primary users of accounting system:

Management – Organization’s management requires accounting information for analyzing

the performance and actual position of the business. Accounting information helps the
management to arrive at an evaluated decision. It helps with cost determination, investment
decisions, helps to identify warning signals in case of a down fall etc.

Owners/Partners – Owners are more concerned on the returns they get out of their
investment in the organisation and this purpose if fulfilled through the accounting
information. Not only do they want their capital safe they are also interested in knowing the
profit earned or loss incurred by the business time to time.

Employees – Employees are interested to know the accounting details of their organisation so
that they are aware about overall profitability of the company which has a direct impact on
their remuneration and job security.

External Users (Secondary Users)

Following are some of the secondary users of accounting system:

Investors – Similar to owners, external investors are concerned about their ROI (Return on
Investment) from the organisation. Since investors do not have a direct control over the
business operations, they use accounting information to find out how their money is being
spent by the managers. It helps them in decision-making such as whether to increase, decrease
or hold their investments.

Banks & NBFCs – (non-banking financial company). They are a crucial part of any business
environment since they advance both short & long-term loans to a business. Accounting
information helps them in determining the credit worthiness of the organisation. Based on
financial health of an organisation, the future terms and conditions of credit are assessed by
the Banks and NBFCs.

Regulatory and Tax Authorities – Regulatory Authorities including the govt. agencies
ensure that the accounting information is prepared based on the accounting principles,
standards and rules & regulations governing the organisation. The primary objective is to
protect the interest of the stakeholders of the organisation. Correct tax evaluation is also done
by the authorities after analysing the financial statements.

Customers – They are a complex group which include producers at every level of processing,
wholesalers and retailers & the end users. Good financial health shows that customers at each
level are comfortable with continuous inflow of stock from the business. Customers use the
accounting information for assessing the financial position of its suppliers which is essential
for maintaining stable source of supply in future.

Suppliers – Other businesses which supply goods to an organization on credit would also
want to assess the repaying capacity of that organization before providing any form of credit.
Accounting information play a crucial role in this case.

Public – General public would want to know the financial health of a business to get a fair
idea of the firm’s niche & overall economy of the nation. It can help to analyze employment
trends, general financial stability of a country etc.

THE ACCOUNTING EQUATION

The accounting equation states that Assets = Capital + Liabilities

ASSETS: Anything of value that the business OWNS e.g., Motor vehicle, buildings and cash
at bank. Assets are divided into two groups, fixed and current Assets

FIXED ASSETS: These are permanent in nature and they remain in the business for a long
period of time e.g., Premises, buildings.

CURRENT ASSETS: These are liquid assets, that is, they keep changing their form e.g.,
Stock of goods, Debtors, cash in hand/bank.

LIABILITY: These are anything of value that the business OWES e.g., Creditors there are
two types of liability. Long term and short term.

LONG-TERM LIABILITY: These are debts that are due for payment over a long period of
time e.g., Mortgage and some bank loans

CURRENT/SHORT-TERM LIABILITY: These are debts that are due for payment over a
relatively short period of time e.g., Bank loans under a year and creditors

CAPITAL: This is the amount invested in a business or the total resources supplied to a
business by its owners.
TRANSACTIONS

These are business activities involving exchanges of things with financial values. Every
transaction contains and affects two items, whether it is the assets, capital or liability.
The way in which these items are affected is that there will be either an increase or a decrease
in the item.
Example: Bought a motor van by cash $50,000.
The items must first be identified, they are assets in the form of motor van and cash in hand.
There is an increase in the asset of motor van and a decrease in the asset of cash in hand.

DOUBLE ENTRY

Each transaction affects two items. For every debit entry, there is a corresponding credit
entry.
Debit means the left-hand side of an account and credit means the right hand side of an
account.
To record an increase in an asset, debit the account
To record a decrease in an asset, credit the account
To record an increase in liability and capital, credit the liability and capital accounts
To record a decrease in liability and capital, debit the liability and capital accounts.

POSTING ENTRIES TO JOURNALS

All items of monetary value bought and sold by a business must be recorded, usually on a
daily basis so that the accounts are kept up to date.
The initial entries of each item are recorded in the BOOKS OF ORIGINAL ENTRY OR
JOURNALS.

The journals are:

Sales journals for credit sales to customers
Purchases journal for credit purchases from suppliers
Returns inward journal to record goods sent back by customers
Returns outward journal to record goods sent back to suppliers
Cash book for cash receipts e.g., Cash sales and cash payments
General journals for other items such as purchase of fixed assets.

At the end of the month these entries are posted in the sales, purchases and general ledger
accounts.

TRIAL BALANCE

At the end of the accounting period, the balances in the ledger accounts are summarized into a
statement called the trial balance. The purpose of the trial balance is to check back the
balances. If it is correct, then the company prepares the INCOME STATEMENT AND A
BALANCE SHEET.
THE ACCOUNTING CYCLE

In order to prepare accounting records, it is essential that a particular sequence of events and
processes is followed. This sequence is often referred to as the ·accounting cycle. The term
'cycle' is used because the sequences of activities is continuous.

Step 1

Collecting source documents. That is, where the original information is to be found eg.
Invoices, petty cash vouchers, receipts etc.

Step 2

Extract key facts from source documents and record in the books of original entry eg. Sales
journal, purchases journal, return inwards journal etc.

Step 3

Post information from books of original entry to the ledger accounts eg. General ledger, sales
ledger, etc.

Step 4

Prepare a Trial Balance to check accuracy of the double entry records.

Step 5

Prepare end of year financial statements that is Trading and Profit and Loss Accounts
(INCOME STATEMENT) and The Balance Sheet (Statement of Financial Position) and Cash
Flow Statements.