Professional Documents
Culture Documents
Objectives-
· To study the fundamental Accounting concepts, terms, jargons and learn the
process of recording of financial transactions in the books of Accounts.
· To develop the foundation for higher studies in the field of accounting.
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Compiled by : Barkha Makheja
1. Introduction to Accounting
The main purpose of accounting is to ascertain profit or loss during a specified period, to
show financial condition of the business on a particular date and to have control over the
firm's property. Such accounting records are required to be maintained to measure the
income of the business and communicate the information so that it may be used by
managers, owners and other interested parties
Accounting is a discipline which records, classifies, summarises and interprets financial
information about the activities of a concern so that intelligent decisions can be made about
the concern.
The American Institute of Certified Public Accountants has defined the Financial Accounting
as
"the art of recording, classifying and summarising in as significant manner and in terms of
money transactions and events which in part, at least of a financial character, and
interpreting the results thereof".
(ii) Classifying : It Is concerned with the systematic analysis of the recorded data so as to
accumulate the transactions of similar type at one place. This function is performed by
maintaining the ledger in which different accounts are opened to
which related transactions are posted.
(iii) Summarising : It is concerned with the preparation and presentation of the classified
data in a manner useful to the users. This function involves the preparation of financial
statements such as Income Statement, Balance Sheet, Statement of Changes in Financial
Position, Statement of Cash Flow, Statement of Value Added.
(iv) Interpreting : Nowadays, the aforesaid three functions are performed by electronic data
processing devices and the accountant has to concentrate mainly on the interpretation
aspects of accounting. The accountants should interpret the statements in a manner useful
to action. The accountant should explain not only what has happened but also (a) why it
happened, and (b) what is likely to happen under specified conditions.
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1.2 Objectives and scope of Financial Accounting
OBJECTIVES OF ACCOUNTING
3. To ascertain the operational profit or loss : Accounting helps in ascertaining the net
profit earned or loss suffered on account of carrying the business. This is done by keeping a
proper record of revenues and expense of a particular period. The Profit and Loss Account is
prepared at the end of a period and if the amount of revenue for the period is more than
the expenditure incurred in earning that revenue, there is said to be a profit. In case the
expenditure exceeds the revenue, there is said to be a loss.
Profit and Loss Account will help the management, investors, creditors, etc. in knowing
whether the business has proved to be remunerative or not. In case it has not proved to be
remunerative or profitable, the cause of such a state of affairs will be investigated and
necessary remedial steps will be taken.
4. To ascertain the financial position of the business : The Profit and Loss Account gives the
amount of profit or loss made by the business during a particular period. However, it is not
enough. The businessman must know about his financial position i.e. where he stands ?,
what he owes and what he owns?
This objective is served by the Balance Sheet or Position Statement. The Balance Sheet is a
statement of assets and liabilities of the business on a particular date. It serves as
barometer for ascertaining the financial health of the business.
5. To facilitate rational decision making : Accounting these days has taken upon itself the
task of collection, analysis and reporting of information at the required points of time to the
required levels of authority in order to facilitate rational decision-making. The American
Accounting Association has also stressed this point while defining the term accounting when
it says that accounting is the process of identifying, measuring and communicating
economic information to permit informed judgements and decisions by users of the
information. Of course, this is by no means an easy task. However, the accounting bodies all
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over the world and particularly the International Accounting Standards Committee, have
been trying to grapple with this problem and have achieved success in laying down some
basic postulates on the basis of which the accounting statements have to be prepared.
SCOPE OF ACCOUNTING:
Accounting has got a very wide scope and area of application. Its use is not confined to the
business world alone, but spread over in all the spheres of the society and in all professions.
Now-a-days, in any social institution or professional activity, whether that is profit earning
or not, financial transactions must take place. So there arises the need for recording and
summarizing these transactions when they occur and the necessity of finding out the net
result of the same after the expiry of a certain fixed period.
Besides, the is also the need for interpretation and communication of those information to
the appropriate persons. Only accounting use can help overcome these problems.
In the modern world, accounting system is practiced no only in all the business institutions
but also in many non-trading institutions like Schools, Colleges, Hospitals, Charitable Trust
Clubs, Co-operative Society etc.and also Government and Local Self-Government in the form
of Municipality, Panchayat.The professional persons like Medical practitioners, practicing
Lawyers, Chartered Accountants etc.also adopt some suitable types of accounting methods.
As a matter of fact, accounting methods are used by all who are involved in a series of
transactions.
The scope of accounting as it was in earlier days has undergone lots of changes in recent
times. As accounting is a dynamic subject, its scope and area of operation have been always
increasing keeping pace with the changes in socio-economic changes. As a result of
continuous research in this field the new areas of application of accounting principles and
policies are emerged. National accounting, human resources accounting and social
Accounting are examples of the new areas of application of accounting systems.
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1.3 Meaning and use of Book Keeping
Bookkeepers are individuals who manage all financial data for companies. Without
bookkeepers, companies would not be aware of their current financial position, as well as
the transactions that occur within the company.
Accurate bookkeeping is also crucial to external users, which include investors, financial
institutions, or the government that need access to reliable information to make
better investment or lending decisions. Simply put, the entire economy relies on accurate
and reliable bookkeeping for both internal and external users.
Definition of Bookkeeping
"the art of recording the business transactions in the books of accounts in a systematic manner."
A person who is responsible for and who maintains and keeps a record of the business transactions
is known as Bookkeeper. His work is primarily clerical in nature. On the other hand, Accounting is
primarily concerned with the recording, classifying, summarizing, interpreting the financial data and
communicating the information disclosed by the accounting records to those persons interested in
the accounting information relating to the business.
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1.4 Accounting v/s Book Keeping
BASIS FOR
BOOKKEEPING ACCOUNTING
COMPARISON
Decision Making On the basis of bookkeeping Decisions can be taken on the basis of
records, decisions cannot be accounting records.
taken.
Tools Journal and Ledgers Balance Sheet, Profit & Loss Account
and Cash Flow Statement
Determination of Bookkeeping does not reflect the Accounting clearly shows the financial
Financial Position financial position of an position of the entity.
organization.
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1.4 Advantages and Limitations of Financial Accounting.
Advantages of accounting
· Ascertainment of profit or loss during a period
Accounting records assist a businessman in accurately calculating his profit or loss over a
particular period. For a person who depends solely on his business for his daily bread, it is
very important that he should know the exact amount of his profit for a particular month so
that his drawings from the business in that month do not exceed his profit. Profit is the sole
motive of most businessmen and it is imperative that they should be well informed of how
they are doing towards achieving this objective.
Accounting records and statements help a businessman in taking decisions about his
business like expansion, opening up a new branch, closing down a loss-making department,
etc. They also help him in drawing up his future plans.
Accounting provides information about the financial position and worth of the business. This
fact alone is necessary for a number of reasons. For example, no businessman can
reasonably expect to be granted a loan or overdraft facility without producing evidence, in
the form of accounting statements, of his financial health. Similarly, should a businessman
decide to sell his business the things that will help most in the determination of the business
unit’s worth undoubtedly be his accounting records?
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· Collection and payment of cash
Accounts are of particular importance to a trader who buys or sells goods on credit. He
needs well kept, detailed accounts, for prompt recovery of his debts from his customers and
for setting his dues to his suppliers.
Accounts are necessary for income and other tax purposes. In the absence of proper
accounting records, it would be extremely difficult to prove to the tax authorities the
correct income on which the tax could be levied. Similarly, taxes like sales tax, excise duty,
etc. are collected on the basis of a businesses unit’s turnover. Hence, computation and
proof of sales revenue are essential.
Inspite of the fact that convention of objectivity is respected in accounting but to record
certain events estimates have to be made which requires personal judgement. It is very
difficult to expect accuracy in future estimates and objectivity suffers. For example, in order
to determine the amount of depreciation to be charged every year for the use of fixed asset
it is required to estimate (a) future life of the asset, and (b) scrap value of the asset. Thus in
accounting we do not determine but measure the income. In other words, the income
disclosed by accounting is not authoritative but approximation.
Financial accounting takes into consideration only those transactions and events which can
be described in money. The transactions and events, however important, if non monetary in
nature are ignored i.e., not recorded. For example, extent of competition faced by the
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business, technical innovations possessed by the business, loyalty and efficiency of the
employees etc. are the important matters in which management of the business is highly
interested but accounting is not tailored to take note of such matters. Thus any user of
financial information is, naturally, deprived of vital information which is of non-monetary
character.
The information supplied by the financial accounting is in reality aggregate of the financial
transactions during the course of the year. Of course, it enables to study the overall results
of the business activity during the accounting period. For proper running of the business the
information is required regarding the cost, revenue and profit of each product but financial
accounting does not provide such detailed information product-wise. For example, if a
business has earned a total profit of, say, Rs. 5,00,000 during the accounting year and it sells
three products namely petrol, diesel and mobile oil and wants to know profit earned by
each product. Financial accounting is not likely to help him.
(f) Financial accounting does not disclose the present value of the business
CHAPTER ENDS!
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Compiled by : Barkha Makheja