CONTENTS } INTRODUCTION TO FINANCIAL ACCOUNTING 1. Nature and Scope of Accounting "W122 2. | Accounting Principles (Concepts and Conventions) V/2:1-2-15 3. Indian Accounting Standards (Including IFRS) : /3-1-3-17 [Yin ea ACCOUNTING PROCESS 1. Accounting Equation | W1-1-1-14 2. Double Entry System ~ W21-27 3. Goods and Service Tax (GST) W/3-1-3-11 4, Journal 4.14.27 5. . Ledger and Trial Balance 1/5-1—-5-39 ermine) SUBSIDIARY BOOKS _ 1. Subsidiary Books-1 WV/1-1-1:35 2. | Subsidiary Books-Il 3. Bank Reconciliation Statement W31-3.22| FSSA FINAL ACCOUNTS OF PROPRIETARY CONCERNS 1. Final Accounts of of Proprietary Con Concerns _ | baht TT ACCOUNTING SOFTWARE _ _ 1. Accounting § Sofware VALI—1:39 |__| Skill Development Activities 1Nature and Scope of Accounting eeu oe Oe) Ts * To know the meaning, need and objectives of Accounting. > To understand the meaning of Book keeping and how it is different from Accounting. > To understand the advantages and limitations of Accounting. > To know the systems of accounting and differentiate between them. » To compare between the accrual and cash basis of Accounting, > To-Classify different types of Accounts. Origin and Growth of Accounting Accounting is as old as money itself. However, the act of accounting was not as devel- oped as it is today because in the early stages of civilisation, the number of transactions to be recorded was so small that each businessman was able to record and check for himself all his transactions. Accounting was practised in India twenty-three centuries ago as is clear from the book named ‘Arthashastra’ written by Kautilya, King Chandragupta’s minister. This book not only relates to politics and economics, but also explains the art of proper keeping of accounts. The chapter ‘The Business of Keeping up Accounts in the Office of Accountants’ describes records of accounts to be maintained in accountant’s office and methods of checking accounts. In the recent years large scale production, cut throat competition, widening of the market and changes in the technology have brought remarkable changes in the field of accounting. In the words of Gordon and Gordon Shillinglaw : “It has come to be recognised as a tool for mastering the various economic problems which a business organisation may have to face, It systematically writes the economic history of theira NATURE AND SCOPE OF ACCOUNJING organisation, It provides information that can be drawn upon by those responsible for, decisions affecting the organisation's future. This history is written mostly in quantitative terms. It consists partly of files of data, partly of reports summarising various portions of these data, and partly of the plan established by management, to} guide its operations.” : Need for Accounting __ The main aim of a business is to earn profit. For earning profit, a businessman will either purchase the goods in one market at certain price and sell it in another market at higher price or will convert the raw materials into finished products and sell it to the different customers at a price which will give him some percentage of profit on cost of production. But this may not be true in all cases. Sometimes it may happen that the goods purchased or produced may go out of fashion and may be unsaleable simply because of depression in the market, or keen competition. He may be able to sell the goods either at a loss or at a very small margin of profit. However, he will be anxious at the end of the year to find out whether his goods taken together have been sold at a profit or at a loss and what is financial position on a particular date. Moreover in a big business information is required for planning, control, evaluation of performance and decision making. This information can be provided only when business transactions are recorded, classified and summarised properly. In order to achieve these purposes it would be necessary to record business transactions according to a well devised system. Book- keeping (in elementary stage) and Accounting (in advanced stage) is the name given to such a system. Meaning of Book-keeping Book-keeping is the art and science of recording, classifying and summarizing business transactions in money or money’s worth accurately and systematically so that the businessman may be able to know his profit or loss during a specified period and also his financial position on a particular date. Book-keeping is thus the recording of business transactions in a systematic manner. In the words of Carter “Book-keeping is the science and art of correctly recording in books of accounts all those transactions that result in the transfer of money or money’s worth.” Meaning of Accounting The actual record making phase (i.e. recording, classifying and summarising) of accounting is usually called book-keeping. However, accounting extends far beyond the _ actual making of records. Accounting is concerned with the use to which these records are put, their analysis and interpretation. An accountant should be concerned with more than the record making phase. In particular he should be interested in the relationship between the financial results and the events which have created them. He should be , studying the various alternatives open to the firm, and be using his accounting: experience in order to aid the management to select the best plan of action for the firm. The owners and manager of a firm will need some accounting knowledge to understand what the accountant is telling them. Investors and others will need accounting knowledge so that they may read and understand the financial statements issued by the firm and adjust their relationships with the firm accordingly. Thus accounting is a wider termand) includes the recording, classifying and summarising of business transactions in term of money, the preparation of financial reports, the analysis and interpretation of these reports for the information and guidance of management.NATURE AND SCOPE-OF ACCOUNTING Definition of Accounting Important purposes of accounting are to ascertain profit or loss during a specified period, to show financial position 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 parties. Accounting is a discipline which records, ~‘glassifies, summarises and interprets financial information about the activities of a concern so that intelligent decisions can be made about the concern. “Financial Accounting is the art of recording, classifying and summarising in a significant manner 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 ‘Accounting is “the process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information”. — American Accounting Association ‘Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic activities that is useful in making economic decision in making reasoned choices among alternative course of action. —Accounting Principles Board (APB) ‘Accounting may be defined “as the identifying, measuring, recording and communicating of financial information.” —H. Bierman and AR Drebin “Accounting is the science of recording and classifying business transactions and events, primarily of a financial character and the act of making significant summaries analysis and interpretation of these transactions and events and communicating the results to persons who must _make decisions or form judgements.” —Smith & Ashburne From the above the following attributes of accounting emerge : (i Identifying the transactions and events. Accounting identifies transactions and events of a separate entity. A transactions is a particular type of external event which can be expressed in terms of money and bring change in the financial position of a business unit, An event (whether internal or external) is a happening of consequence to an entity (e.g. use of raw material for production). An entity means an economic unit that performs economic activities (e.g. Reliance Industries Ltd., TISCO). (ii) It is the art of recording business transactions. First of all financial transactions should!bé recorded in the journal oF inthe books of original entry known as subsidiary books as and when they take place so that a complete record of financial transactions is available. (ii) It is the art of classifying business transactions. All entries in the journal or subsidiary boc':1 should be classified by posting them to the appropriate ledger ‘accounts to find out at a glance the total effect of all such transactions in a particular ‘account, For example, all transactions relating to Shyam Sunder in the journal or various subsidiary books will be posted to Shyam Sunder’s Account. It may be noted that business transactions are recorded and classified in such a way so that it may be possible to determine profit or loss made by the business and its financial position on a specified date. (iv) The transactions or events of a business must be recorded in monetary terms. If there are certain events which cannot be measured in terms of money, they will Hot be ‘recorded in financial accounting, For example, a quarrel between production manager and finance manager may be affecting the business but it cannot be measured in terms of money and thus will not be recorded in the books of accounts.NATURE AND Scope oF 4 IC (o) It fs the art of summarising financial transactions, classifying financial transactions next stage is to prepare the ti accounts with a view to ascertaining the profit or loss made di and the financial position of the business on a particular date, (vi) It is an art of analysis and interpretation of these tp, Msacti accounting information must be analysed and interpreted by calculatin varie. and percentages or other relationship in order to evaluate the Past Performa. business and to make sound plans for the future. ee (oii) The results of such analysis must be communicated to a are to make decisions or form judgements. All information must je DmaekS Why and presented to the different categories of the persons so that @PPropriate deg ting be taken at the right time. ons mae Objectives of Accounting The starting point for any area of study is to set forth its boundaries and dao its objectives. Developments in the field of science and mathematice have brought «tine significant change in the field of accounting. The “oUnting The objectives of accounting (as given by the American Accountin Association) are to provide information for the following purposes : e ( Making decisions concerning the use of limited resources including identification of crucial decision areas and determination of objectives and goals. and controlling the organisation's human and materials resources, ii) Maintaining systematic records and rep. (iv) Facilitating special functions and contro From the objectives as given above three main objectives of accounting can be given as follows : 1. To ascertain whether the business operations have been profitable or not, Accounting helps us to know whether a b. the accounting period. It will ive us an idea of efficiency f th orting on the custodianship of resources, Balance Sheet or Position ition of the business on a Position of an enterprise is indicated by its assets on a that date. Excess of assets over liabilities represent the nancial soundness of an enterprise. A properly drawn UP given date and its liabilities on capital and is indicative of the fi adNATURE AND SCOPE OF ACCOUNTING Ea balance sheet gives information relating to (i) the nature and value of assets, (ii) the nature and extent of liabilities, (iii) whether the enterprise is solvent, (iv) whether the business concern is over trading. 3. To generate information. Accounting records generate such information which may be helpful to various persons in planning, control, evaluation of performance and decision-making. Functions of Accounting Important functions of accounting are : 1. Systematic record of business transactions. “To keep Systematic record OF business transactions, post them to the ledger and ultimately to prepare the final accounts is the first main function of accounting. 2. Protecting the property of the business{/For performing this function the accountant is required to devise such a system of recording information so that assets of the business are not put to wrong use and a complete record of the assets of the concern is. available without any difficulty. 3. Communicating results to interested parties. This function requires to supply the meaningful information about the financial activities of the business to the various parties i.e. owners, creditors, investors, employees, government, public, research scholars and the managers at the right time. 4. Compliance with legal requirements. ‘The accounting system must be euch which may be able to comply with the legal requirements. Under various enactments a businessman is required to file various statements e.g. income tax return, return for sale tax purposes etc. 5. Stewardship. In case of companies, the management is entrusted with the resources of the enterprise. The managers are expected to act as true trustee of the funds and accounting helps them to achieve the same. 6. Assistance to Management. Accouiiting/assets| thé management in planning) evaluation of performance, control and decision making by providing required information. 7. Fixing Responsibility. Accounting helps in determination of the profitability of different departments of the enterprise and ultimately helps in fixing the responsibility of departmental heads. Is Accounting a Science or an Art ? Accounting is both a Scienee|andan|art! Before we decide whether it is a science or an art or both, it is better to know the meaning of the two terms. Science may be defined as a systematised body of knowledge based on certain principles which have universal application. It establishes relationship of cause and effect about any occurrence or happening. Scientific knowledge is based on observation, experiments and testing of facts. Art, on the other hand, is the application of knowledge comprising of some accepted theories, principles, rules, concepts and conventions, It helps us to achieve our goals and tells us the manner in which we may attain our objectives in the best possible way. The more we practice an art the more expert we become in it.NATURE AND Scope oF ic Accounting is a science because recording, classifying and summarig, | transactions is done on the basis of certain principles such as principes Of bg system which re universally applicable. However, in accounting the rela2 {ble qt and effect is not studied which isa basic feature of pure sciences. 1 mat hip ote? said that accounting isa science but not-a pure science, *therefrs Since accounting has to be applied in different organisations and varieg a has nat been possible to develop principles which have universal applicabiig tion, is based on certain concepts and conventions and is subject to some tat ting influenced by bias and personal judgement of the accountant. The more gst I accounting, the more proficient he becomes in it." this extent, accounting — oes It tells us the manner in which some special objectives like ascertaining the oan. results for a period and the financial position of the business on a partieuls, date ading achieved. 2M be In the light ofthe above diseussion, it may be concluded that accounting i 7 science as well as an art. oth a Distinction Between Book-keeping and Accounting Book- keeping is recording of the financial transactions of a business in a method manner so that information on any point in relation to them may be quickly obtained, book-keeper may be responsible for keeping all the financial records of a business or cut @ minor segment such as maintenance of the customers’ accounts in a departmental store, Much of the work of a book-keeper is clerical in nature and can be accomplished through the use of mechanical and electronic equipment. On the other hand, Accounting is primarily concerned with the design of the system of records, the preparation of reports based on the recorded data, the interpretation of the reports and finally communicating the results of the interpretation to persons who are interested in such results. Accountants often direct and review the work of book-keepers, The work of accountants at the beginning may include some book-keeping but accountants must possess a much higher level of knowledge, conceptual understanding and analytical skill than is required of the book-keepers. Welsch and Anthony have beautifully given the distinction between book-keeping and accounting as follows : neg, “Some people naively confuse a book-keeper with an accountant and book- keeping with accounting. In effect they confuse one of the minor parts with the whole of accounting. It is tantamount to comparing the simple administration of first aid with the complex practice of medicine by the physician. Book- keeping is the routine and clerical side of accounting and requires only minimal knowledge of the accounting model. A book-keeper records the repetitive and uncomplicated transactions in most businesses and may maintain the simple records of a very small business. In contrast, the accountant is a professional competent in the design of information systen analysis of complex economic events, interpretative and analytical processe reporting, financial advising, and management consulting.”NATURE AND SCOPE OF ACCOUNTING 1 Important differences between Book-keeping and Accounting are as follows : Book-keeping The object of book-keeping Is to prepare original books of accounts, trial balance and final accounts and to maintain systematic records of financial results. It has limited scope and is concerned with recording, classifying, and ‘summarising of business transactions. It is restricted to clerical work and is done by lower levels of management. It has to depend on accounting for making the accounting records more useful. It shows the net result and financial position of the business as the scope extends to the preparation of final accounts. Bookkeeping is a primary stage. the Business 6. Stages 7. Nature of Job 8. Knowledge Required The job of book-keeper is often routine and clerical in nature. The book-keeper is not required to have higher level of knowledge than that of an accountant. Book keeping work is performed by junior staff. 9. Staff for Performing Work Users of Accounting information ‘Accounting The object of accounting Is to record, classify, summarise, analyse and interpret the business transactions and to ascertain operating results & financial position and to communicate to various users. It has a wide scope and covers book- keeping plus analysis and in- terpretation. It is concerned with all !vels of management. Lower level prepare the accounts, medium report it and top level interpret it. It has to depend on book-keeping ior getting the required information from accounting records and for making them useful for planning, control and decision making. It analyses the operating results and financial position of the business. Accounting is the secondary stage. It begins where book-keeping ends. The job of an accountant is analytical in nature. The accountant must have higher level of knowledge than that of bookkeeper. Accounting work is performed by senior staff. Accounting is an information system, As an information system, it collects data and communicates economic information about the organisation to a wide variety of users whose decisions and actions are related to its performance. Accounting process begins with the identification of transactions and ends with the preparation of financial statements. Every step in the process of accounting generates information. Generation of information is not an end in itself. It is a means to facilitate the dissemenation of information among different user groups. Such information enables the interested parties to take appropriate decisions. Accounting is the language of the business. As the primary aim of a language is to serve as a means of communication, accounting is used to communicate business information. The basic objective of accounting is to provide information which is useful for persons inside the organisation and for persons or groups outside the organisation.pve 9 NATURE AND SCoPE op hoe 0 According to Slavin and Reynolds, Professors of Accounting, re is ie ic h external and interned’ Pra re is the dis ¢ that prot 7 n information may base decisions that result in the allocation of econorn fee or yt society.” Urey (@ External Users of Accounting Information. External users are those groups or persons who are outside the oFganieas: whom accounting function is performed. Following can be the various externa tion fy, accounting information : Users ot ; . Those who are interested in investing money in an organ ___ stata eee the financial health of the organisation to know ge'S8ton a, investment already made is and how safe their Proposed investment will be, 0 Rake the financial health, they need accounting information which will help them i. ev the the past performance and future prospects of the organisation. Thus, investq ting investment decisions are dependent upon accounting information included °° for financial statements. They can know the profitability and the financial Position op te organisation in which they are interested to make that investment by mating ae the the accounting information given in the financial statements of the organisation '24Y of . Creditors. Creditors (i.e., suppliers of goods and services on credit, bankers other lenders of money) want to know the financial position of a concers before gna loans or granting credit. They want to be sure that the concern will not expeei® difficulty in making their payment in time, i.e., liquid position of the concer satisfactory. To know the liquid position, they need accounting information relatin re current assets, quick assets and current liabilities which is available in the financial statements. 3. Members of Not-for-profit Organisations. “Members or not-for-profit organisations such as schools, colleges, hospitals, clubs, charitable institutions ete, need accounting information to know how their contributed funds are being utilised and to ascertain if the organisation deserves continued support or support should be Withdrawn, keeping in view the bad performance depicted by the accounting information and diverted to another organisation. In knowing the performance of such organisations, eriterie, will not be the profit made but the chief criterion will be the service provided to the society. 4. GovernmentCentralyand)state governments are:interested-in the accounting information because they want to know earnings or sales for a particular period for Purposes of taxation. Income tax returns are examples of financial reports which are Prepared with information taken directly from accounting records. Government alee needs accounting information for compiling statistics concerning business which, in turn helps in compiling national accounts. 5. Consumers.“Consumers neéd accounting information for establishing good accounting control so that cost of production may be reduced with the resultant reduction of the prices of goods they buy. Sometimes, prices for some goods are fixed by the government, s0 it needs accounting information to fix reasonable prices so that consumers and manufacturers are not exploited, Prices are fixed keeping in view fait return to manufacturers on their investment shown in the accounting records. / 8. Research Scholars. Aécounting information) being al mirror-of the financial performance of a business organisation, is of immense value to the research scholaz we wants to make a study into the financial operations of a particular firm. To make a into the financial operations of a particular firm, the research scholar needs detailed accounting information relating to purchases, sales, expenses, cost of materials used, — | !NATURE AND SCOPE OF ACCOUNTING current assets, current liabilities, fixed assets, long term liabilities and shareholders’ funds which is available in the accounting records maintained by the firm. (ii) Internal Users of Accounting Information. Internal users of accounting information are those persons or groups which are {within the organisation, Following are such internal users : 1, Owners. The owners provide funds for the operations of a business and they want to know whether their funds are being properly used or not. They need accounting information to know the profitability and the financial position of the concern in which they have invested their funds. The financial statements prepared from time to time from accounting records tell them the profitability and the financial position. 2, Management. Management is the art of getting things done through others, the management should ensure that the subordinates are doing work properly. Accounting information is an aid in this respect because it helps a manager in planning, control, decision making and appraising the performance of the subordinates. Actual performance of the employees can be compared with the budgeted performance they were expected to achieve and remedial action can be taken if the actual performance is not upto the mark. Management needs information to review the firm's short term and long-term solvency, profitability in relation to turnover, effective utilisation of available resources and profitability in relation to investment and take necessary action to run the business effectively. Thus, accounting information provides “the eyes and ears to management.” 3. Employees. Employees are interested in the financial position of a concern they serve particularly when payment of bonus depends upon the size of the profits earned. They seek accounting information to know that the bonus being paid to them is correct. Branches of Accounting Following are the main branches of accounting : 1. Financial Accounting. The main purpose of this branch of accounting is to ascertain profit or loss during a specific period, to show financial position of the business on a particular date and to have control over the firm’s property. Such accounting records are used to impart useful information to outsiders and to meet the legal requirements. 2. Cost Accounting. The main aim of cost accounting is to ascertain cost relating to the various activities of the business and to have cost control. The cost accountant is required to assemble and interpret cost data for the use of management in controlling current operations and in planning for the future. 3. Management Accounting. It supplies the management significant information in order to assist the management to discharge its various functions such as planning, control, evaluation of performance and decision making ete. 4. Tax Accounting. Different types of taxes have to be paid by an enterprise on behalf of itself or on behalf of others, such as, employees, shareholders etc. Tax Accounting is helpful in complying with the provisions of complex tax laws governing income-tax, sales tax, excise duties, custom duties and estate duties. 5. Social Responsibility Accounting. It is concerned with social responsibility aspects of a business. Management is held responsible for what it contributes to the social well being ond progress. It is the process of identifying, measuring and communicating the social effects of the business decisions to permit informed judgements and decisions by the users of information.NATURE AND SCOPE of ne Following are main advantages of accounting : 1. Replacement of memory. In a large business it is very difficult for man to remember all the transactions, Accounting provides records whit. wetting, information as and when desired and thus it replaces human memory, ll furnish 32. Evidence in court, Properly maintained accounts are often treateg evidence in the court to settle a dispute. asa 3. Settlement of taxation liability. If accounts are properly maintaineg ;, of great assistance to the businessman in settling the income tax and sale te, ‘will be otherwise tax authorities may impose any amount of tax which the businesgm, lity have to pay. an wil, 4. Comparative study. It provides the facility of comparative study of the aspects of the business such as profits, sales, expenses etc. with that of Previous 9 otius helps the businessman to locate significant factor leading to the change, ifany, "and 5. Sale of business. If accounts are properly maintained, it helps to aseertg: Proper purchase price in case the businessman is interested to sell his busines” the | 6. Assistance to the insolvent person. Ifa person is maintaining Proper acco and unfortunately he becomes insolvent (i.e. when he is unable to pay to hie creditors) can explain many things about the past with the help of accounts and ean starts head 7. Assistance to various parties, It provides information to various Parties, j,__ owmers, creditors, investors, government, managers, research scholars, bh), employees and financial position of a business enterprise from their own view point 8. Facilitate in raising loans. Accounting facilitates raising loans from lenderg by Providing them the required financial information. 9. Assistance to management. Accounting assists the management in taki managerial decisions. For example, Projected Cash Flow Statement facilitates tr. management to know the future receipts and payments and to take decisions regarding anticipated surplus or shortage of funds. 10. Facilitate control over assets. Accounting facilitates control over assets by Providing information regarding Cash Balance, Bank Balance, Stock, Debtors, Fixed Assets, etc. Limitations of Accounting Following are the main limitations of accounting : 1, Records only monetary transactions. 2. Effect of price level changes not considered. example, the sales to total assets in 2021 would be much higher than in rising prices, fixed assets being shown at cost and not at market price. adNATURE AND SCOPE OF ACCOUNTING 8. No realistic information. ‘Accounting information may not bé\ realistic) as accounting statements are prepared by following basic concepts and conventions, For example, going concern concept gives us an idea that the business will continue and assets are to be recorded at cost but the book value which the asset is showing may not be actually realisable. Similarly, by following the principle of conservatism the financial statements will not reflect the true position of the business. 4. Personal bias of Accountant affects the accounting statements. Accounting statements are influenced by the personal judgement of the accountant. He may select any method of depreciation, valuation of stock, amortisation of fixed assets, treatment of deferred revenue expenditure. Such judgement based on integrity and competency of the accountant will definitely affect the preparation of accounting statements. 5. Permits alternative treatments. Accounting permits alternative treatments within generally accepted accounting concepts and conventions. For example, method of charging depreciation may be straight line method or diminishing balance method or some other method. Similarly, closing stock may be valued by FIFO (First-in-First- Out) or LIFO (Last-in-First-out) or average price method. Application of different methods may give different results and results may not be comparable. 6. Profit no real test of managerial performance. Profit earned during an accounting period is the test of managerial performance. Profit may be shown in excess by manipulation of accounts by supressing such costs as depreciation, advertisement and research and development or taking excess value of closing stock. Consequently real idea of managerial performance may not be available by manipulated profit. 7. Historical in nature..Usually accounting Supplies information in| the form of Profit and Loss Account and Balance Sheet at the end of the year. So, the information provided is of historical interest and only gives post-mortem analysis of the past accounting information. For control and planning purposes management is interested in quick and timely information which is not provided by financial accounting. 8. Window Dressing in Balance Sheet. When an accountant resorts to window dressing in the Balance Sheet, then Balance Sheet cannot exhibit the true and fair view of the state of affairs of the business. RELATIONSHIP OF ACCO! Accounting and Economics Economies studies those acts of human beings which are related with the consumption, production, exchange and distribution of wealth aiming at maximising human satisfaction. Economics can also be defined as a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses. Thus, in all types of economic problems, the problem of choice arises. It may be mentioned that the economist limits his study of human behaviour to problems of allocating resources which can be evaluated in terms of money. Thus, the study of human behaviour in economics is restricted to only those aspects which can be expressed in terms of money. In accounting too, only those transactions are recorded which can be expressed in terms of money. In other words, accounting deals with those transactions which are economic in fact. Much of the data used by the economist for making a choice of the best alternative is made available by the accountant. Accounting is applied economics concerned with the measurement of economic variables. The accountant can provide meaningful information when he understands the basic concepts of value and wealth asWET AnD SCOPE OF ACCOUNTING given in economics. In the same way the economist must understand the basic concept, and conventions followed by the accountant in providing information for his use. National Accounting and function of exchange of goods and services can be best understood if one knows the principles of economics and accounting. Accounting and Mathematics Knowledge of arithmetic and algebra will be useful for accounting calculations and measurements. The fundamental double entry system of accounting is expressed in the form of a mathematical equation, popularly known as ‘Accounting Equation’. With the advent of computer accounting, knowledge of mathematics has become a very important part of accounting. The use of the technique of operations research in accounting has made mathematics a vital part of accounting. Analysis and interpretation of the financial statements is made possible with the help of accounting ratios which are based on mathematical equations. An accountant is better equipped if he has knowledge of mathematics. Accounting and Statistics Both accounting and statistics deal with the collection, classification, summarising, analysis and interpretation of data. As a matter of fact, accounting is concerned with the data which can be expressed in terms of money whereas the field of statistics is not so limited. It deals with both quantitative and financial data. Statistical methods and techniques can be used for the purpose of comparison between past and present accounting results. With the help of statistical methods, effect of seasonal changes, boom or slump can be forecast with a fair degree of accuracy. Accounting and Law Financial transactions recorded in books of accounts are affected by law in the sense that in some cases accounting data must comply with the requirements of a particular enactment. For example, in India there is no statutory obligation upon sole Proprietorship or partnership firm to prepare final accounts but joint stock companies have a statutory obligation to prepare final accounts as required under Section 210 of the Companies Act. Every Profit and Loss Account of a company should comply with the requirements of Part II of Schedule VI as given in the Companies Act, 1956, Similarly, every Balance Sheet of a company should be prepared in the form given in Part I of the Schedule VI of the Companies Act, 1956 or as near thereto as circumstances admit, or in such other form as may be approved by the Central Government either generally or ina Particular case. Likewise special acts make provisions for the preparation of the final accounts of the insurance, electricity supply and banking companies. Keeping in view the relationship of accounting and law, the accountant must be well versed in the legal Provisions which are to be applied in the preparation of financial statements or in the maintenance of books of accounts. Accounting processes also influence the laws, The nature of information provided by accounting records may help the Government in framing new laws or amending existing laws. Companies Act, 1956 has been amended from time to time keeping in view the requirements of accounting. A lawyer or advocate should have sufficient knowledge of accounting if he is to be a successful income tax advocate or to fight successfully the cases relating to accounting problems.MATURE AND SCOPE OF ACCOUNTING ‘Accounting and Engineering ‘An engineer takes help of accounting while making an estimate of the cost of a new project. Keeping in view the limited funds available with the concern, all capital expenditure plans cannot be started. Out of alternative plans, the capital expenditure plan which is the most profitable is to be commissioned. In this respect, accounting provides reliable accounting data relating to cost and profitability of various capital projects available and a sound investment decision can be taken. Accountants and engineers should co-operate each other in arriving at correct decision because engineers can give judgement on the technical feasibility of the project and accountants can give judgement on the financial feasibility of the project. Similarly, both engineers and ‘accountants can prove helpful in cost reduction programmes. Accounting and Management ‘The main objective of the management is to manage the business in a systematic way following a plan, allocating responsibilities to implement the plan and organising methods to execute the plan with efficiency. To achieve this, accounting can be useful by providing timely accounting information to the management in such a form so that it may be helpful in formulating policies, making decisions, planning activities and controlling business operations. Accounting is the language of the business. As the primary aim of a language is to serve as a means of communication, accounting is used to communicate business information to the management for discharging efficiently its functions of planning, controlling, organising, staffing and of taking sound decisions. Accounting data are used by the management as a basic source document for planning and controlling activities of the management. Accounting and Sociology Sociology is derived from the Latin word ‘socio’ meaning society and the Greek word ‘Jogos’ meaning science. Sociology is the study of individuals as well as groups in a society. The basic objective of sociology is to search for the pattern of relationships between human beings in order to prove the way for the betterment of individuals in relation to society. Every society has a social structure—a complex of major institutions and a social institution is an organised complex pattern of behaviour in which a number of persons participate in order to further group interest. Thus, society is interested in better utilisation of resources so that standard of living of the masses may improve. Accounting can give meaningful information whether economic resources are being properly utilised in an economic institution by the cooperative behaviour of the members of that institution. In this regard, Welsch and Anthony express their views as follows : “The growth of business organisations in size, particularly public held corporations, has brought pressure from stockholders, potential investors, creditors, governmental agencies, and the public at large, for increased financial disclosure. The public’s right to know more about organisations that directly and indirectly affect them (whether or not they are shareholders) is being increasingly recognised as essential. An open society is one that has a high degree of freedom at the individual level and typically evidences an effective commitment to measuring the quality of life attained. These characteristics make it essential that the members of that society be provided adequate, understandable, and dependable financial information from the major institutions that comprise it. Voters are asked to decide upon revenue raising proposals, allocations of resources to many sources, and other questions. All of these decisions should be based upon adequatefinancial knowledge. Labour negotiations, environmental pro NATURE AND SCOPE OF ACCOUNT nig grammes, economic opportunity programmes, foreign aid and education programmes are but a few of the difficult problems areas important to all citizens that, for enlightened decision making require extensive use of accounting information”. ” For recording business transactions, there are three approaches to accoun are widely accepted : (a) Cash basis (b) Accrual basis (c) Hybrid or Mixed b; know, all business transactions ultimately result into realisation of revenue of expense. Truly speaking, the approaches to accounting which are to be dis tell how revenues and expenses are to be recognised. BASIS OF ACCOUNTING iting which asis. As you or incurring iscussed here Cash Basis of Accounting Under cash basis of accounting actual cash receil recorded. Credit transactions are not recorded at actually received or paid. Income is merely the diffe cash payments. The Receipts and Payments Acco organisations such as a charitable institution, professional men like lawyer, doctor, example of cash basis. ipts and actual cash payments are all and are ignored till the cash ig rence between the cash receipts and unt prepared in case of not for profit a club, a school, a college ete. and chartered accountant ete. can be cited as the best Advantages Important advantages of cash basis of accounting are : (1) Cash basis of accounting has considerable appeal to many people because it is so (2) (3) (2) @ @ ) ) ) simple, appears to be so realistic, is verifiable and satisfies the conservative instinct. This approach is more objective as very few estimates and judgements are required. This basis of accounting is suitable for those enterprises where most of the transactions are on cash basis. Disadvantages Important disadvantages of cash basis of accounting are : (1) Cash basis of accounting does not give a true and fair view of profit and loss and financial position of the enterprise because it ignores outstanding and prepaid expenses and accrued income and income received in advance. This approach does not follow matching principle of accounting. Cash basis of accounting does not distinguish between capital and revenue items and as a result there is no consistency in the profits of the two years. In this approach actual cash inflows and outflows are considered, there is a great possibility of profit manipulation e.g., payments may be delayed or prepaid, similarly incomes may be postponed or collected early. (5) The basis of accounting does not follow Companies Act. (ES During the financial year 2020-21, Rajan had cash sales of € 90,000 and credit sales of & 60,000. His expenses for the year were % 70,000 out of which & 30,000 expenses are still to be paid. Find out Rajan’s income for 2020-21 following cash basis of accounting.NATURE AND SCOPE OF ACCOUNTING Eo SOLUTION z Revenues (Inflows of cash) 90,000 Less : Expenses (outflows of cash) 40,000 Profit 50,000 Note : Credit sales and expenses outstanding will not be considered in cash basis of accounting. Accrual Basis of Accounti Keeping in view the disadvantages of the cash basis of accounting, the accrual basis of accounting has been developed by accountants. In accounting every cash receipt cannot be treated income for determining the true profit of the accounting entity of the period. ‘Accrual basis of accounting rejects the circumstances of receipt or payment of cash as criteria for associating either income or expense with a period. Rather this basis of ‘accounting is based on concept of realisation and expiration and follows two basic accounting principles viz. the revenue recognition and the matching principle. Ii) thé accrual basis of accounting, the income whether received or not but has been earned or accrued during the period forms part of the total income of that period e.g., sales made on credit will be included in the total sales of the period irrespective of the fact when cash is actually realised. Similarly, if the firm has taken benefit of a particular service, but has not paid within that period, the expense will relate to the period in which the service has been utilised and not to the period in which the payment for it is made, e.g., rent due to the landlord but not paid will be taken as an expense for the period when it is due and not in the period when it is paid. Thus, under accrual basis of accounting net income for a period is the result of matching of revenue realised in the period and costs expired during the period. Advantages Important advantages of accrual basis of accounting are : (1). Accrual basis of accounting is preferred by accountants as it is more scientific as compared to cash basis of accounting. (2) This basis of accounting gives a complete picture of the financial transactions of the business as it makes a record of all transactions relating to a period and takes into account adjustments like outstanding expenses, prepaid expenses, income received in advance and income earned but not received etc. (3) This system discloses correct profit or loss for a particular period and also exhibit true financial position of the business on a particular day. (4) Accrual basis of accounting has wide acceptability as the Companies Act, 1956 has amended section 209 of the Companies Act, 1956 with effect from 15th June, 1988 requiring all companies to maintain their accounts on accrual basis of accounting so that fairest possible periodic net income and the financial position may be reported to the public. Disadvantages Important disadvantages of accrual basis of accounting are : (1) This system is not as simple as cash basis of accounting. (2) A quick appraisal of the profit or loss is not possible as a lot of adjustments are required for finding the true financial position of the business. (3) This basis of accounting is too elaborate.ILLUSTRATION 2 NATURE AND SCOPE OF. ACCOUNTING Taking the figures given in Illustration 1, find out net income according to accrual basis of accounting. SOLUTION Total Sales = Cash Sales (¥ 90,000) + Credit Sales (€ 60,000) z = 1,50,000 70,000 80,000 Revenues = % 90,000 + % 60,000 Less : Total Expenses for the year Profit Note : 7 30,000 expenses still to be paid belong to this year and hence are to be charged to the revenue of this year. Similarly credit sales of 7 60,000 are taken in the year in which sale transactions are done. Difference Between Accrual Basis of Accounting and Cash Basis of Accounting Following are the main differences between the Accrual Basis of Accounting and Cash Basis of Accounting : Accrual Basis of Accounting Cash Basis of Accounting Under this basis there may be outstanding expenses, prepaid expenses, accrued income and income received in advance in the Balance Sheet Income statement will show relatively higher income if there are items of prepaid expenses and accrual income. Income statement will show relatively lower income if there are items of outstanding expenses and income received in advance. This basis is recognised under the Companies Act, 1956. . Under this basis the accountant has the option f following alternative method of depreciation (i.e. SLM or DBM) or method of valuation of inventory (i.e LIFO or FIFO etc.) Enterprises with cash and credit transactions prefer this basis. Business enterprises with profit motive ascertain their profit or loss under accrual basis of accounting. It is a reliable basis of accounting because it makes a complete record of all cash and credit transactions. It ascertains correct profit ‘or loss. Under this basis there are no outstanding or prepaid expenses and income accrued or received in advance in the Balance Sheet, Income statement will show lower income in case there are items of prepaid expenses and accrued income. Income statement will show relatively higher income if there are items of outstanding expenses and income received in advance. This basis is not recognised under the Companies Act, 1956. Under this method the accountant has no such option to follow alternative method of depreciation or valuation of inventory. Enterprises with mostly cash transactions prefer this basis of accounting. Professional people like doctors, lawyers, etc. and small non-trading concerns ascertain their profit or loss under cash basis. It is not a reliable basis of accounting because acourate profit or loss can not be ascertained under this basis.NATURE AND SCOPE OF ACCOUNTING Ha 9. This basis of accounting is technical because it involves the adjustments of accounts for preparing the final accounts. This basis of accounting is simple because it does not require technical knowledge. 10. This basis of accounting being based on a complete record of the financial transactions gives a true and fair view of profit or loss for a particular period and also exhibits true financial position of the business on a particular day. This basis does not give true and fair view of profit or loss and the financial position of the business because it does not take in to consideration outstanding transactions. Hybrid or Mixed Basis of Accounting Cash basis of accounting is by far the simplest system whereas accrual basis of accounting is scientific and reliable. So accountants have tried to club the advantages of the two systems and have come up with mixed or hybrid basis of accounting. Under mixed basis of accounting both cash basis and accrual basis are followed. Incomes are recorded on cash basis whereas expenses are taken on accrual basis. The net income is ascertained by matching expenses on accrual basis with income on cash basis. This is the most conservative basis of ascertaining income because all possible expenses relating to the period whether actually paid or not are considered whereas income only received in cash is taken into consideration. When all the expenses are taken into account, there is reduction in taxable income and hence this system is popular among professionals like doctors, lawyers, chartered accountants ete. Dae Rajat supplies you the following information about his income and expenses for the financial year 2020-21. z z Expenses paid 80,000 Income received 1,20,000 Expenses paid in advance 20,000 Income received in advance 15,000 Expenses not paid yet 10,000 Income not received yet 12,000 Find out the net income or profit of Rajat if he adopts (a) Cash basis (b) Accrual basis (c) Hybrid basis of accounting. SOLUTION (a) Cash Basis Revenues : Income received Less: Expenses : Expenses paid Profit (0) Accrual Basis Revenues : Income received + Income not received yet — Income received in advance7 | pias NATURE AND SCOPE OF ACCOUNTING : z Expenses paid 80,000 + Expenses not paid yet 10,000 — Expenses paid in advance Profit =(A)-(B) z = 1,17,000 - & 70,000 47,000 (0) Hybrid Basis Revenues : z Income received 1,20,000 Expenses : Expenses paid 80,000 + Expenses not paid yet Expenses paid in advance Profit = Revenues — Expenses = & 1,20,000 - = 70,000 50,000 Systems of Accounting _ Following are two systems of Accounting. le Entry System. 2. Double Entry System. Double Entry system owes its origin to an Italian merchant named Luco Pacioli who wrote the first book entitled ‘De Computis et Scripturis’ on double entry accounting in the For example, when we purchase goods for cash, we receive goods and give cash in return ; similarly in a credit sale of goods, goods are given to the customer and the customer becomes debtor for the amount of goods sold to him. Few Basic Terms ; (® Business Transactions. Any exchange of money or money’s worth as goods and | services between two parties is called a business transaction. It may relate to purchase | and sale of goods, receipt and payment of cash and rendering of service by one party to another. In accounting, only business transactions are recorded. A business transaction is : an event which can be expressed in terms of money. An event which cannot be expressed in terms of money and does not affect the financial position of a business enterprise will | not be recorded in accounting. Therefore, all business transactions are events but all(NATURE AND SCOPE OF ACCOUNTING Ea events are not business transactions. When payment for a business activity is made immediately, it is called a cash transaction but when the payment is postponed to a future date, it is called a credit transaction. (ii) Event. An event is the end result of any transaction. (iii) Account. In accounting, transactions of similar nature are added or subtracted at a particular place, known as an ‘account’. ‘An account is a ledger record in a summarised form of all the transactions that have taken place with the particular person or things specified’ (iv) Debtor. A debtor is a person who owes money. The amount due from him is called debt. The amount due from a person as per the books of account is called a book debt. (v) Creditor. A person to whom money is owing or payable is called a creditor. (vi) Capital. This is the owner’s financial interest or holding in the business and is represented by the value of net assets (i.e., total assets less liabilities.) (vii) Goods. This includes all articles, commodities or merchandise in which the business deals. Thus, cloth would be goods for a dealer in cloth, furniture would be goods for a dealer in furniture and so on. (viii) Assets. Any physical thing or right owned that has a money value is an asset. In other words, an asset is that expenditure which results in acquiring of some property or benefit of a lasting nature. (ix) Liability. Any amount for which the business is liable to pay to other parties (except the owner of the business). ‘Liabilities are debts, they are amounts owed to creditors.’ (x) Equity. A claim which can be enforced against the assets of the firm is called equity. In other words, the rights to properties are called equities. Equities are of two types : the right of creditors and the right of owners. The equities of creditors represent debts of the business and are called liabilities. The equity of the owners is called capital, proprietorship or owner's equity. Thus assets must be the sum of liabilities and capital (xi) Income. It is the favourable change in owner's equity which results from business operations. In other words, income is an inflow of assets which results in an increase in the owner's equity. (xi) Expenditure. An expenditure takes place when an asset or service is acquired. Expenditure will include both payment of a sum immediately and a promise to pay it at a future date. (xiii) Expense. It means an expenditure whose benefit is finished or enjoyed immediately such as salaries, rent etc. The purchase of goods is an expenditure whereas cost of goods sold is an expense. Similarly, if an asset is acquired during the year, it is an expenditure, if it is consumed during the same year, it is also an expense of the year. (xiv) Drawings. Any amount or goods withdrawn by the owner of a business for personal use is called drawings. (xv) Loss. A loss is an expenditure without any benefit to the concern. On the other hand, expense is incurred to result in some benefit. Thus, amount spent on lighting is an expense but loss due to fire is loss. (xvi) Voucher. Any written document in support of a business transaction is called a voucher. It is an objective evidence in support of a transaction.Po NATURE AND SCOPE OF ACCOUNTiNg (xvii) Turnover. It means total trading income from cash sales and credit sales, (xviii) Net Worth. It means assets minus outside liabilities. Profits of a business increase the net worth whereas losses reduce net worth of a business, (ix) Insolvent. A person who cannot pay his debts is called insolvent. His liabilities are more than his assets. (x) Cost. Cost is the amount of expenditure (actual or notional) incurred on, or attributable to a specified thing or activity. (xi) Bad Debts. An amount which has become irrecoverable from the trade debtors and treating it a business loss, it is written off in the debit side of the profit and loss account. Role of Accountants in Society An accountant with his education, training, analytical mind and experience is best qualified to provide multiple need-based services to the society. The accountants of today can do full justice not only to matters relating to taxation, costing, management accounting, financial layout, company legislation and procedures but they can act in the fields relating to financial policies, budgetary policies and even economic principles. The modern accountant’s role in the society is quite myriad and include mainly the following : @ To act as an accountant to maintain the proper books of account which portray the true and fair view of the results of the business and its financial position, (ii) To provide information and reports to the management to enable them to discharge their duties effectively. \ 2% ii) To act as a statutory auditor for attestation of account as per requirement of the . law. (iv) To provide financial advice regarding investments, insurance, expansion, ete. (v) To act as a service provider to assist in share registration, arbitration, preparation of memorandum of association, registration of a company, ete. (vi) To act as an internal auditor to assist and strength the hands of the management. (vii) To act as tax consultant and to handle the tax matters of the business. (viii) To act as a management consultant to provide services regarding financial planning of the business to provide opinions about the current state of final monetary policies, laws of hand, etc. affecting business and suggest the changes that should take place. Qualitative Characteristics of Accounting information Accounting information must possess some qualitative characteristics. These are the attributes that make the information provided in financial statement useful to users. The four main qualitative characteristics are : 1, Reliability. Accounting information must be reliable. It should be free from bias and personal influence or judgement. However, it is not possible to record all transactions in this manner. For example, an entry for the provision for doubtful debts, in this case, a provision is made for debts that are considered doubtful for recovery but the exact amount of bad debts can never be determined in advance.NATURE AND SCOPE OF ACCOUNTING 2. Relevance. Accounting information must be relevant to the user. Information is relevant if it meets the needs of the user in decision making. For example, dividend paid by a company in the previous year is relevant information for the investors. This is because it provides a basis for forecasting dividends in future years and also provides a review of the past performance of the company. Thus, the accountants must study the needs of the various users and determine which information is relevant to the existing and potential decision makers. 8, Understandability. Accounting information must be presented is a manner for the users to understand. It is assumed that the users have a basic knowledge of business transactions and they devote time and effort in analysing the financial statements. However, the accountant has a basic responsibility to describe business transactions clearly and concisely. 4, Comparability. Accounting information is more useful when it is comparable with similar information for the same enterprise in different periods. It is also useful when similar information across different enterprises during the same period can be compared. Comparability is therefore a useful quality of accounting information. To achieve comparability, consistency and disclosure of accounting policies are necessary. EE Questions : 1. (a) Define Book-keeping. (b) What are the objectives of Book keeping ? 2, Whatis Accounting ? (BBM Bangalore, Dec. 2004 & 2008) 8. Distinguish between Book-keeping and Accounting. (BBM Bangalore, Dec. 2007 & 2009) (a) What do you mean by Accounting information ? (6) Name the users of Accounting information. 5. State four objectives of Accounting. 6. State four limitations of Accounting. 7. State the branches of Accounting. 8. 9. » Give two bases of Accounting. How does a business transaction differ from an event ? 10. Distinguish between assets and liabilities. 11. Distinguish between revenue and expense. 12. Explain the two systems of accounting. (BBM, Bangalore) 13. What are the functions of Accounting ? (BBM, Hangalore) 14, State the difference between Assets and Goods. (BBM, Bangalore) 15. State any three advantages of Book Keeping. (BBM, Bangalore) 16. Give briefly the role of Accountants in society. 17. Whois a debtor? (BBM Bangalore, Dec. 2007 & 2008) 18. Give the meaning of an asset. (BBM Bangalore, Dee. 2007) 19, Name the external users directly concerned with accounting information.Tea NATURE AND SCOPE OF ACCOUNTg SECTION B TYPE QUESTIONS . 1 { 1. Why is it necessary to record the business transactions properly ?. Give the Meaning of. Book-keeping and Accounting. 2 Define accounting and give the main attributes of accounting, 8. Explain the main objectives and functions of accounting. 4. Give the main divisions of accounting and discuss briefl 5. Discuss in detail the importance of accounting, 6. State the main limitations of accounting. Discuss the main bases of accounting. 8. Distinguish between Book-keeping and Accountancy. 9. Is accounting a science or an art or both ? Discuss, 10. Explain the uses and limitations of accounting, 11. Explain the relationship of accounting with economics, law, statistics and engineering. 12. What do you mean by cash basis of accounting ? What are its disadvantages ? 18, Explain accrual basis of accounting. How is it better than cash basis of accounting ? 14. Discuss the basis of accounting recommended by Companies (Amendment) Act. 15. What is hybrid or mixed basis of accounting ? 16. Write in brief on : (a) Cash basis vs. Accrual basis. (b) Hybrid basis of accounting. 17. Explain the following terms : @)_ Business Transactions ; (ii) Expenses ; (iii) Equity ; (iv) Asset ; (v) Net Worth 1 (vi) Losses and (vii) Revenue. (viii) Creditor ; (ix) Insolvent. 18. Briefly explain the advantages of accounting. (BBM Bangalore, Dec. 2007 & 2008) 19. What are the qualitative characteristics of accounting information ? ly the scope of each, s