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Introduction to Accounting

DEFINITIONS OF ACCOUNTING:
Accounting is considered as an important part for any business house. The entire structure of
business is based on the concept of accounting, as without accounting the business will not
survive. Accounting has several definitions by different authors and books. However, certain
definitions are mentioned below.
According to A.I.C.P.A., “Accounting may be defined as 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 financial character, and interpreting the results thereof.”
In the words of H. Chakravorty, “Accounting is the science of recording, classifying and
summarizing transactions so that relation with outsiders is exactly determined and result of
operation during a particular period can be calculated, and the financial position as the end of
the period may be shown.”

FUNCTIONS OF ACCOUNTING:
Accounting is the language of business, as a man is incomplete without language, business is
incomplete without accounting, and if the transactions are not recorded then by no means they
can be communicated to the users. Some of the functions are discussed under:
1) Proper record of business transactions: Keeping a systematic record of the business
monetary transactions, posting them to the ledger and preparing final accounts for each
accounting year, is considered as the main function of accounting.
2) Analysis and Interpretation: the recorded information is analysed and interpreted properly
so that the end users can make a proper use of the data and judge about the financial conditions
and profitability of business.
3) Communication of results to the interested users: Accounting is concerned with
supplying the meaningful information to the interested users like creditors, owner, suppliers,
employees, government, public etc about the financial activities of the business.
4) Protecting business property: Accounting is concerned with protecting the business
property, by keeping a systematic record of the assets of the company, so that they are not
misused by anyone.
5) Assistance to Management: Decision making process is concerned with the management
and they can take appropriate decisions only when assisted with proper accounting information.
Decisions relating to budget making, ratio analysis, dividend declaration etc can be taken easily
with the help of accounting information.
6) Fulfilling legal requirement: All the registered companies are required to get its accounts
audited from time to time, by a registered auditor. Auditing means checking for the validity
and accuracy of the financial transactions. For checking the accuracy, proper evidence is
required, such as records, documents, statements, which is prepared with the help of
accounting.

ASST PROF DR HIRAL MEHTA DRB COMMERCE & BCP BBA COLLEGE
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Introduction to Accounting

LIMITATIONS OF ACCOUNTING:
Following are some of the limitations affecting accounting:
1) Only monetary transactions are recorded: Accounting records only the transactions that
are capable of being presented in terms of money, and does not include the events of non-
monetary nature, even though it is of great importance to the business. Example: Strikes by the
labour, efficiency of the R&D department.
2) Personal biasness involved: Accountants are involved in the process of recording the
accounting information, it may be affected by his personal biasness, such as, he may select any
way of depreciating the machinery, valuing the stock and treating deferred revenue
expenditure. The judgement of accountant will definitely affect the preparation and
presentation of accounting information.
3) Historical in Nature: The information supplied is on the basis of the already prepared Profit
and Loss account and Balance Sheet. This means that only the information about already
happened events is disclosed and no information about future is presented. Hence, accounting
is historic in nature.
4) Allows different treatments: Accounting allows different treatments within Generally
Accepted Accounting Concepts (GAAP). An accountant for example, can either use the LIFO
(last in first out) method or FIFO (first in first out) method in order to value the closing stock.
Applying different methods might lead to different results and as a result the comparable
quality of information might get lost.
5) Changes in price are not considered: Accounting transactions are recorded in the books
of accounts at cost basis, whereas the effect of changes in price level is not considered and not
recorded in the books. As a result, comparing the data of various years becomes quite difficult.

BRANCHES OF ACCOUNTING:
Accounting is divided into different branches:
1. Financial Accounting
2. Cost Accounting
3. Management Accounting

ACCOUNTING CONCEPT: MEANING

The term concept also known as postulates refer to such ideas which are accompanied with
different accounting procedures. These are the fundamental ideas or the general assumptions
underlying the theory and practice of financial accounting and are broad working rules for all
accounting activities and developed by the accounting profession. The important concepts are
listed below:

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1) Business Entity Concept

2) Money Measurement Concept
3) Going Concern Concept
4) Cost Concept
5) Dual Aspect Concept
6) Accounting Period
7) Matching Concept
8) Realization Concept
9) Objective Evidence Concept
10) Accrual Concept

BUSINESS ENTITY CONCEPT

The concept implies that a business unit is separate and distinct from the persons who supply
capital to it (owners). Means that business has a separate legal entity from its owners. For the
purpose of accounting the business and its owners are to be treated as two separate entities.
Irrespective of the form of organisation, a business unit has got its own separate identity as
distinguished from the persons who own or control it(owners). Business is kept separate from
the proprietor so that transactions of the business may not be recorded with him. In case this
concept is not followed, affairs of the business will be mixed up with the private affairs of the
proprietor and the true picture of the business will not be revealed. Thus, in the books of the
sole trader, a firm or a limited company, only business transactions are recorded and no note is
taken of the personal transactions of the sole proprietor, the partners of the firm and the
shareholders respectively.
For Example: if the proprietor of the business invests Rs 6,00,000 into the business, it will be
deemed that he has given that much of money to the business as a loan which will be shown as
a liability in the books of the firm. On receipt of the amount, cash account will be debited and
the proprietor’s capital account will be credited. Similarly, on withdrawal of the amount from
the business for personal use of the proprietor, the proprietor’s capital account will be debited
and Cash account will be credited.

MONEY MEASUREMENT CONCEPT

The concept of money measurement states that only those transactions, events and happenings
in the organisation which can be expressed in terms of money (such as sale of goods, receipt
of income etc) are to be recorded in the book of accounts. All those transactions that cannot be
expressed in monetary terms (such as appointment of the manager, creativity of its production
department) should not be recorded. The advantage of maintaining business transactions in
terms of money is that money

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serves a common denominator by means of which homogenous factors about a business can
be expressed in terms of numbers (money), which are capable of additions and subtractions in
future.
For Example: The business unit has the following assets as on March 31,2015
Cash in hand and Bank: Rs 50000
Sundry Debtors: Rs 45000
Furniture: 400 tables
Bills Receivable: Rs 16500
In the above example furniture is not expressed in terms of money, therefore the items given
in the different units of measurement cannot be added together to get an idea of the total value
of the assets owned by the enterprise, to get an idea of the total value of the assets, all items
should be expressed in terms of money as given below:
Cash in hand and Bank: Rs 50000
Sundry Debtors: Rs 45000
Furniture: Rs 15000
Bills Receivable: Rs 16500
TOTAL: Rs 126500
The money measurement concept faces certain limitations:
(1) It restricts the scope of accounting because it is not capable of recording transactions which
cannot be expressed in terms of money, though being important.
(2) It does not take care of the effects of inflation because it assumes a stability of money
measurement unit.

GOING CONCERN CONCEPT

The concept of going concern assumes that a business firm would continue to carry out its
operations indefinitely, i.e., for a fairly long period of time and would not be liquidated or
terminated in the foreseeable future. This is an important assumption of accounting as it
provides the very basis for showing the value of assets in the balance sheet.
A business unit is deemed to be a going concern and not a gone concern. This assumption
provides much of the justification of recording fixed assets at original cost and depreciating
them in a systematic manner year after year without reference to their current realisable value.
For Example: A business purchases machinery for a sum of Rs 40,000. What the business is
buying really is the services of the machinery that the business shall be getting over the
estimated life span, say 10 years. It will not be fair to charge the whole amount of Rs 40,000
from the revenue of the year in which the asset is purchased. The assumption regarding the

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continuity of the business, allows to charge from the revenue of a period only that part of the
asset that has been consumed or used to earn
that revenue in that period, and carry forward the remaining amount to the next years. Thus,
the business may charge Rs 4000 every year for 10 years from the profit and loss account. In
case, the continuity assumption is not there, the whole cost (Rs 40,000 in the present example)
will need to be charged from the revenue of the year in which the machinery was purchased.

COST CONCEPT
The cost concept states that, an asset is recorded in the books at the price paid to acquire it and
that this cost is the basis for all subsequent accounting for that asset. This does not mean that
the asset will always be shown at cost, but it means that the acquiring cost becomes basis for
all future accounting for the asset. Asset is recorded at cost at the time of its purchase but is
reduced systematically in its value by charging depreciation by following any of the method.
In simple terms, the market value of an asset may change with the passage of time but for
accounting purposes it continues to be shown in the books at its book value, i.e., the cost at
which it was purchased minus Depreciation provided up to date. In the absence of cost concept,
assets will be shown at their market values which will depend on the subjective views of
persons who furnish financial statements; hence consistency will be hampered.
For Example: A machine was purchased by Goel Limited for Rs 800000, for manufacturing
shoes. Amount of Rs 10000 was spent on transporting it. In addition, Rs 12000 was spent on
its instalment. The total amount at which the machinery will be recorded in the books would
be sum of all three items i.e. Rs 822000. This is also known as historical cost. Now suppose,
the market price of the same is now Rs 90000 it will not be shown at this value. Further, it
should be made clear that cost means original or acquisition cost only for new assets and for
the old ones, cost means original cost less depreciation.

DUAL ASPECT CONCEPT

It is the foundation or main principle of accounting. It provides the very basis of recording
business transactions in the books of accounts. This concept assumes that every transaction has
a dual effect (a) yielding of a benefit (b) the giving of that benefit. This means it affects two
accounts in their respective opposite sides (Debit or Credit). Therefore, the transaction should
be recorded at two places. It means, both aspects of the transaction should be recorded, debit
or credit.
For Example: if the business has acquired an asset, it must have given up some other asset
(such as cash). There must be a dual entry to have a complete record of each business
transaction, an entry should be passed in the receiving account and an entry of the same amount
in the giving account. The receiving account is termed as debtor and the giving account is called
creditor. Thus, every debit must have a corresponding credit and vice versa, with the same
amount.

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Thus, the dual concept is commonly expressed in terms of fundamental accounting equation:
Assets= Liabilities+ Capital

ACCOUNTING PERIOD/ PERIODICITY CONCEPT

All the transactions are recorded in the books of accounts on the assumption that profits on
these transactions are to be ascertained for a specified period. This is known as accounting
period concept. Accounting period refers to the period of time at the end of which the financial
statements of an enterprise are prepared to know whether it has earned profits or incurred losses
during that period and what exactly is the position of its assets and liabilities at the end of that
particular period. Thus, this concept requires that the balance sheet and profit and loss account
should be prepared at regular intervals. This is necessary for different purposes like, calculation
of profits, ascertaining financial position, tax computation etc.
Further this concept assumes that, indefinite life of business is divided into small parts. These
parts are known as accounting periods. It may be of one year, six months, three months or one
month. But mostly, one year is taken as one accounting period which may be a calendar or
financial year.
CALENDER YEAR: Year which starts from January1st and ends on December 31st
FINANCIAL YEAR: Year which starts from April 1st and ends on March 31st
In India business enterprises usually follow Financial Year to prepare their accounts

As per accounting period concept, all the transactions are recorded in the books of accounts for
that specific period of time. Hence goods purchased and sold during 2013, rent, salaries etc.
paid for 2013 are accounted for and against that period only (2013).

MATCHING CONCEPT
This concept is based on the accounting period concept. The most important objective of
running a business is to ascertain profit periodically. The determination of profit of a particular
accounting period is essentially a process of matching the revenue recognised during that
period and the costs to be allocated to the period to obtain the revenue. It is, thus a concept of
matching revenues and expected costs, the residual amount being the net profit or net loss for
the period.
For Example: Let us study the following transactions of a business during the month of
December, 2013
(i) Sale: cash Rs.12000 and credit Rs.11000
(ii) Salaries Paid Rs.20000
(iii) Commission Paid Rs.11500
(iv) Interest Received Rs.5000
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(v) Rent received Rs.1140, out of which Rs.140 received for the year 2012
(vi) Carriage paid Rs.200
(vii) Postage Rs.300
(viii) Rent paid Rs.1200, out of which Rs.50 belong to the year 2011
(ix) Goods purchased in the year for cash Rs.11500 and on credit Rs.5000
(x) Depreciation on machine Rs.2000
Let us record the above transactions under the heading of Expenses and Revenue.

Expenses Amount (Rs) Revenue Amount (Rs)

1. Salaries 20000 1. Sales 23000
2. Commission 11500 Cash 12000 5000
3. Carriage 200 Credit 11000 1000
4. Postage 300 2. Interest received 29000
5. Rent paid 1200 1150 3. Rent received 1140
Less for 2011 (50) 16500 Less for 2012 (140)
6. Goods purchased 2000 Total
Cash 11500 51650
Credit 5000
7. Depreciation on machine
Total

In the above example expenses have been matched with revenue i.e., (Revenue Rs.29000-
Expenses Rs.51650). This comparison has resulted in loss of Rs.22650. If the revenue is more
than the expenses, it is called profit.
If the expenses are more than revenue it is called loss. This is what exactly has been done by
applying the matching concept. Therefore, the matching concept implies that all revenues
earned during an accounting year, whether received/not received during that year and all cost
incurred, whether paid/not paid during the year should be taken into account while ascertaining
profit or loss for that year.

REALIZATION CONCEPT
This concept states that revenue from any business transaction should be included in the
accounting records only when it is realised. The term realisation means creation of legal right
to receive money. Selling goods is realisation, receiving order is not.
In other words, it can be said that: Revenue is said to have been realised when cash has been
received or right to receive cash on the sale of goods or services or both has been created.

Let us study the following examples:

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(i) Sheel Jeweller received an order to supply gold ornaments worth Rs.1800000. They supplied
ornaments worth Rs.1600000 up to the year ending 31st December 2013 and rest of the
ornaments were supplied in January 2013.
(ii) Mr. Ram sold goods for Rs.400000 for cash in 2014 and the goods have been delivered
during the same year.
(iii) Akshay and Sons Ltd sold goods on credit for Rs.50,000 during the year ending 31st
December 2013. The goods have been delivered in 2013 but the payment was received in
March 2014.
Now, let us analyse the above examples to ascertain the correct amount of revenue realised for
the year ending 31st December 2013.
(i) The revenue for the year 2013 for Sheel Jeweller is Rs.1600000. Mere getting an order is
not considered as revenue until the goods have been delivered.
(ii) The revenue for Mr. Ram for year 2013 is Rs.400000 as the goods have been delivered in
the year 2013. Cash has also been received in the same year.
(iii) Akshay & Sons Ltd’s revenue for the year 2013 is Rs.50,000, because the goods have been
delivered to the customer in the year 2013. Revenue became due in the year 2013 itself. In the
above examples, revenue is realised when the goods are delivered to the customers.
The concept of realisation states that revenue is realized at the time when goods or services
are actually delivered.

OBJECTIVE EVIDENCE CONCEPT

Objectivity connotes reliability, trustworthiness and verifiability, which means that there is
some evidence in ascertaining the correctness of the information reported. Entries in the
accounting records and data reported in financial statements must be based on objectively
determined evidence or proof. Without close adherence to this principle, the confidence of
many users of the financial statements could not be maintained. Invoices and vouchers for
purchases and sales, bank statements for amount of cash at bank, physical checking of stock in
hand etc are examples of objective evidence which are capable of verification. In simple terms,
this concept means that accounting transactions should be recorded in an objective manner,
free from biasness of accountants. This can be possible when each transaction is supported by
verifiable documents or vouchers, that serve as a proof to those studying the accounts.
Only those transactions that are supported by physical evidence, can be recorded in the books
of accounts
For Example: the transaction for the purchase of machinery by ABC Ltd. may be supported by
the cash receipt for the money paid, if the same is purchased on cash. Or copy of invoice and
delivery challan if the same is purchased on credit. Similarly, receipt for the amount paid for
purchase of machine becomes the documentary evidence (proof) for the cost of machinery and
provides an objective basis for verifying this transaction.

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ACCRUAL CONCEPT
The essence of the accrual concept is that revenue is recognised when it is realised, that is when
sale is complete or services are given and it is considered immaterial whether cash is received
or not. Similarly, according to this concept, expenses are recognised in the same accounting
period in which they help in earning the revenue whether cash is paid or not. An exception to
this general rule is the preparation of cash flow statement whose main purpose is to present the
cash flow effects of transaction during an accounting period. Thus, to ascertain correct financial
position of the enterprise for an accounting period, we make record of all expenses and incomes
relating to the accounting period whether actual cash has been paid or received or not.
Therefore, as a result of the accrual concept, outstanding expenses and incomes are taken into
consideration while preparing final accounts of a business entity.

MEANING OF ACCOUNTING CONVENTIONS

The dictionary meaning of convention states that it is a custom or a way of acting or doing
things that is widely accepted and followed. Basically, the term convention includes those
customs and traditions which guide the accountant while preparing the accounting statements.
It is not a legal binding upon them but the general agreement on the usage and practices in
social and economic life i.e. it is a customary practice, rule or usage. They are derived from
usage and continuous practice. The accountancy bodies of the world may change any of the
convention to improve the quality and standard of accounting information.
According to MWE Glautier and B Underdown, “the term accounting conventions serve in
another sense to understand the freedom which accountants have enjoyed in determining their
own rules.”
WHY CONVENTIONS MATTERS
Accounting conventions provide a standardized methodology that creates a reliable means of
comparing financial results from industry to industry and from year to year within one industry.
Accordingly, accounting conventions govern how companies and accountants prepare
quarterly balance sheets or income statements, or annual reports. Following the set conventions
increases the reliability of the data, maintains uniformity, and helps the accountants in
recording only the relevant information, thus saving time and energy.
CLASSIFICATION OF ACCOUNTING CONVENTIONS
There are four widely recognized accounting conventions that guide the accountants
throughout:
Be Conservative – Conservatism
Disclose in Full – Full Disclosure
Be Consistent – Consistency
Report only that thing which is important – Materiality

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CONVENTION OF CONSISTENCY
Accounting rules, methods, practices and conventions should be continuously and consistently
observed and applied i.e. they should not change from one year to another. The accounting
information provided by the financial statements would be useful in drawing conclusion
regarding the working of an enterprise only when it allows comparisons over a period of time
as well as with the working of other enterprises and this comparison is possible only when
consistency is maintained throughout.
According to auditing interpretations of section 420, Consistency of Application of Generally
Accepted Accounting Principles, paragraph 02, states: “the objective of the consistency
standard is to ensure that if comparability of financial statements between periods has been
materially affected by changes in accounting principles there will be appropriate reporting by
the independent auditor regarding such changes.”
The rationale behind this concept is that frequent changes in accounting treatment, would make
the financial statements unstable, incomparable and unreliable and may seem difficult to be
compared by the persons who use them. For Example: the principle of “valuing stock at cost
or market price whichever is less” should be followed year after year without any change to
get comparable results. Similarly, if depreciation on fixed assets is provided on straight line
method in one accounting year, it should be followed year after year to maintain uniformity.
Consistency serves to eliminate personal bias because the accountant will have to follow
consistent rules, practices and conventions year after year and cannot apply his own judgement
or views while maintaining records.
Consistency also means external consistency, i.e. the financial statements of one enterprise
should be comparable with another. It means that every enterprise should follow same
accounting methods, and procedures of recording and reporting business transactions. This will
help in inter-firm as well as inter-period comparison. It should be pointed that the development
of international and national accounting standards is due to the convention of consistency; they
are framed so as to maintain global uniformity in accounts.
This convention does not completely prohibit changes. It does not debar from introducing
improved accounting techniques. However, if a change becomes desirable, the change and its
effects on profits and financial position of the company as compared to the previous year should
be clearly stated in the financial statements. According to Yorston, Smith and Brown,
“Consistency serves to eliminate personal bias and to even out personal judgement but it must
not become a fetish so as to ignore changed conditions or need for improvements in technique.”
For Example: A company purchased a fixed asset for Rs 500000 and it charges depreciation
@20% on straight line method. At the end of the second year, the book value of the assets will
be:
(Rs)
Cost of the fixed asset 500000 Less: 20% depreciation for first year 100000
400000 Less: 20% depreciation for second year 100000 Book Value at the end of second year
300000

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Now, if the method is changed to “reducing balance method” in the second year, the book value
of the asset at the end of 2nd year will be:
(Rs)
Cost of the fixed asset 500000 Less: 20% depreciation for first year 100000
400000 Less: 20% depreciation for second year 80000 (400000*20%) Book Value at the end
of second year 320000
The effect of change will be that depreciation of Rs 100000 will be reduced to Rs 80000 in the
second year making an increase of Rs 20000 in profit, and asset will be shown in the Balance
Sheet at Rs 320000 and not at Rs 300000.
The above cited example clearly highlights the importance of consistency convention and
shows that violating this convention will directly affect the balance sheet of the company and
ultimately the image of the enterprise.

IMPORTANCE OF CONSISTENCY:
Being consistent in preparation of final accounts simply means that the organisation is
following the set rules and standards and maintaining its financial image on the higher side in
the eyes of the
outsiders/investors. Consistent approach improves the comparability of the accounts with those
of others or with themselves over years and removes the chance of biasness as well as reduces
confusion in the minds of investors.

CONVENTION OF FULL DISCLOSURE

Information provided by the financial statements is used by the different group of people such
as owners, investors, lenders, suppliers etc in taking various financial decisions. So, in order to
make sure that correct financial decisions are taken, the accounts should be prepared in such a
manner that all the information whether good or bad should be disclosed in the report and no
information be concealed from the interested parties.
According to this convention, all accounting statements should be honestly prepared and to that
end full disclosure of all significant information should be made. All information that carries
some interest to proprietors, creditors and investors should be disclosed in accounting
statements, in full. Since, financial statements are the only mode of communicating the
financial information to all interested parties, it becomes essential that the accounts make a full,
fair and adequate disclosure of the information which is relevant for taking financial decisions.
An obligation is put on the shoulders of those preparing the accounts to see that the books of
accounts are as correct, reliable and informative as the circumstances allow and the important
facts concerning the financial performance of the enterprise are fairly disclosed in:
1)The financial statements
2) The accompanying footnotes of such statements

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3)Special communications
4)The president’s letter or other management reports in the annual report
To ensure proper disclosure of accounting information, the Indian Companies Act, 1956 has
provided a format for the preparation of profit and loss account and balance sheet of a company,
which needs to be compulsorily adhered to and makes sure that neither of the important
information is let out (intentionally or otherwise). The regulatory bodies like SEBI, also
mandates complete disclosures to be made by the companies, to give a real and transparent
view of profitability and the state of affairs of the company.
If there is no detailed disclosure in the profit and loss account, undisclosed reserves
accumulated in the past periods may be used to increase the profits in years to come when the
company is working badly and the shareholders may be misled into thinking that company is
making profits. In such a case, the shareholders, investors and their advisers will not have the
correct information to enable them to estimate the real value of the shares.
For Example: in case of sundry debtors not only the total amount of sundry debtors should be
disclosed, but also the amount of good and secured debtors and amount of doubtful debtors
should be stated. This does not mean disclosure of each and every item of information. It only
means disclosure of such information which is of importance to owners, investors and creditors.
IMPORTANCE OF FULL DISCLOSURE PRINCIPLE:
For an accountant, the full disclosure principle is important because the notes to the financial
statements and other financial accounts are subject to audit. To obtain an unqualified (or clean)
opinion, one must have an intrinsic understanding of the full disclosure principle to ensure
sufficient information for an unqualified opinion on the financial audit by the auditor. An
opinion is said to be unqualified when the auditor concludes that the financial statements give
a true, fair and transparent view in accordance with the financial reporting framework.

CONVENTION OF CONSERVATISM
The concept of conservatism (also called prudence) provides guidance for recording
transactions in the book of accounts and is based on the policy of caution or playing safe and
has its origin as a protection against possible losses in the business world of uncertainty. This
concept states that a conscious approach should be adopted in ascertaining income, so that
profits of the enterprise are not overstated.
It compels a businessman to wear a “risk proof jacket” for the working rule is: anticipate no
profits, but provide for all possible losses. This means over optimism in reporting results is
considered more undesirable than over passionism results, because it shows position better than
what actual financial position is. Some of the examples of the application of convention of
conservatism are Valuing closing stock at cost or market value whichever is lower, creating
provisions for doubtful debts, writing off intangible assets like goodwill and discount on
debtors.
For Example: closing stock is valued at cost or market price whichever is lower. If market price
is higher than the cost, the higher amount is ignored in the accounts and closing stock will be
valued at cost which is lower than the market price. But if the market price is lower than the
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cost, the higher amount of cost will be ignored and stock will be valued at market price which
is lower than the cost. Thus, as per the above example the principle of conservatism is inherent
in the valuation of stock.

IMPORTANCE OF CONSERVATISM:
The benefit in being conservative while preparing the accounts is that at the end of the
accounting year it is always better that the net assets and net income are understated rather than
being overstated and misleading the investors by depicting their false image outside, which
might ruin after the investors come to face the reality. And also, more of a rosy image of the
organisation may also attract more tax liabilities as well. Following the conservatism approach,
will keep the organisation on a safer side as this approach makes the management wear a risk
proof jacket.

CONSERVATISM OF MATERIALITY
The concept of materiality requires that accounting should focus on material facts. It means
whether something should be disclosed or not in the financial statements will depend on
whether it is material or not. Efforts and time should not be wasted in recording and presenting
facts which are immaterial in the determination of income. The term “materiality” is a
subjective term. The accountant should record an item as material even though it is of small
amount and its knowledge seems to influence the decision of the proprietors or auditors or
investors. For Example: commission paid to sole selling
agents should be disclosed separately in the profit and loss account. Similarly, amount due to
the directors or other officers should be disclosed separately in the balance sheet of Bank to
know the exact amount of advances due from the directors or officers who are managing the
affairs of bank.
Any fact would be considered as material if it is strongly believed that its knowledge would
influence the decision of informed users of financial statements. For Example: money spend
on creation of additional capacity of a customer interaction hall would be a material fact as it
is going to increase the future earning capacity of the enterprise. Similarly, information about
change in the method of depreciation adopted or any liability which is likely to arise in the near
future would be considered an important information.
IMPORTANCE OF MATERIALITY APPROACH
If an organisation follows the materiality approach, it means that its financial statements are
full of relevant data and the immaterial things are not shown in the accounts. This will maintain
the accuracy of the accounts and only that information which is important to different users is
disclosed. As a result, only accurate accounts are communicated to the outside/inside world.

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Introduction to Accounting

TYPES OF ACCOUNTS:
Also known as English Approach, is the method of accounting where the accounts are divided
into various categories. And on the basis of which, the rules for debit and credit are applied on
different accounts respectively.
A detailed description of the accounts in given below:

A) IMPERSONAL ACCOUNTS: are the accounts which are not associated to any person,
directly or indirectly. It is further divided into real and nominal accounts.

1) REAL ACCOUNT: the account which is related to the recording of financial transactions
of the business, in terms of property or assets. The real account is divided into tangible and
intangible accounts.
(a) TANGIBLE ACCOUNT: is the account related to the assets of the business, which can be
touched, seen and felt. Example: machinery, table, building etc.
(b) INTANGIBLE ACCOUNT: is the account which is concerned with the concerned with
those assets, which cannot be seen, felt, touched etc. example: goodwill, patent, copyright.
2) NOMINAL ACCOUNT: all the transactions connected with the expenses, incomes, gain
or loss of the business, are grouped under the nominal account. For example: rent account,
interest account etc.

B) PERSONAL ACCOUNTS: it refers to the accounts of all the persons/ individuals with
whom the business transacts in the entire course of the business. It is further classified into
three types:

ASST PROF DR HIRAL MEHTA DRB COMMERCE & BCP BBA COLLEGE
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Introduction to Accounting

1) NATURAL: all individual persons with whom the business transacts in its entire life, are
grouped under one head, natural person’s account. Example: Rowan’s Account.
2) ARTIFICIAL: this is an account including the financial dealings of the business with the
artificial personal (bodies created by law). Example: firm’s account, bank account.
3) REPRESENTATIVE: representative person’s account includes the accounts that act as a
representative for a person or individual. Outstanding expenses or accrued income accounts
form a part of this category. Example: accrued rent is a personal account representing rent
received by the business.

RULES OF DEBIT AND CREDIT

After discussing the types of accounts in detail, the general rules of debit and credit, concerned
with the traditional approach are discussed below:
1) Personal Account: in case of personal account, “Debit the Receiver, Credit the Giver” rule
is applicable.
2) Real Account: here the rule “Debit what comes in, Credit what goes out” rule is followed.
3) Nominal Account: the rule applied in case of nominal accounts is “Debit all expenses and
losses, Credit all incomes and gains.”
The rules mentioned above are tabulated below:

ACCOUNT DEBIT CREDIT

Real What Comes In What Goes Out
Personal The Receiver The Giver
Nominal All Expenses & Losses All Incomes & Gains

ASST PROF DR HIRAL MEHTA DRB COMMERCE & BCP BBA COLLEGE