CHAPTER - 1

INTRODUCTION TO ACCOUNTING

Meaning : Accounting is a systematic process of identifying, measuring, recording, classifying, business

transactions and events of financial character and summarising, interpreting these transactions and events into
useful financial information and finally communicating this financial information to its users.
Accounting is also known as language of business because it act as a medium of communication through
financial information.

Meaning of transaction and events in the context of business:

Transaction : A monetary activity which has effect on financial statements.

i.e., A firm purchased goods from supplier for ₹ 5000.

Event : An event is outcome/result of a transaction.

i.e., A firm sold the goods worth ₹ 5000 for ₹ 6000.

The outcome of this transaction is firm earned a profit of ₹ 100.

Characteristics of accounting

ID - Identification

Means - Measuring

Re - Recording

Cla - Classification

S - Summarising

I - Interpretation

C - Communicating

ID MEANS CLASIC : (Trick to remember characteristics)

1. Identification of financial transaction and events : Those transactions and events which are part of
economic activity are recorded in the books of accounts.

Identification of these transactions is done with the help of bills and receipts as the evidence of the transaction.

i.e., Purchase of raw material, sale of goods etc.

2. Measuring the identified transaction : These transactions and events are measured in terms of money.

Transactions which cannot be measured in terms of money are not recorded in the books of accounts even if
they affect business significantly.

i.e., Quality of management team or skills of manager cannot be measured in terms of money where as
purchased furniture for ₹ 5000 is a monetary transaction.

3. Recording : Business transactions of financial character are recorded in the book of original entry.

Journal is known as book of original entry/prime entry because transactions are first recorded in journal.

Other subsidiary books like cash book, purchase book, sales book are known as special journals.

4. Classification : Transaction or original entries of one nature which are recorded in journal or subsidiary
books are grouped together and posted in ledger accounts.

* ledger is an individual account like Ram A/C, Plant A/C, Debtors A/C etc.

By doing classification a firm/enterprise can ascertain how much a firm/enterprise owes to these accounts or
how much these accounts owes to firm/enterprise.

5. Summarising : This involves preparing financial information from classified data into Trial Balance, Trading
and Profit and Loss account (for non-profit-organisations ) or statement of Profit and Loss account (for
companies) and Balance Sheet. These statements are known as financial statements.

6. Interpretation : With the help of analysis and interpretation of financial statements users can assess the
profitability and financial position of the firm/enterprise or companies.

7. Communicating : Finally financial information (financial statement) are communicated to its users so that
they can take appropriate decisions and can make plan for future in a better way.

Objectives of accounting

1. Maintaining accounting records : Recording financial transaction and events of the firm/enterprise in the
books of accounts by following the accounting principles.
2. Determining profit and loss : Accounting helps in determining profit or loss of an enterprise during the
given accounting period. Profit or loss is ascertained from financial information called income statement which
is trading and profit and loss account or statement of profit and loss account.

* Profit and loss : Case 1 Goods sold for ₹5000 is revenue and cost incurred in manufacturing product and
expenses for selling the product is ₹4000.

Therefore, Profit = Revenue – Expenses

₹5000 – ₹4000 = ₹1000 Profit.

Case 2 suppose expenses are increased to ₹6000, in this situation firm/enterprise will incur a loss

Therefore, Loss = Expenses – Revenue

₹6000 - ₹5000 = ₹1000 Loss.

3. Determining financial position : Financial position of an enterprise is identified from position statement
(Balance sheet) which provides information about assets, liabilities and capital and net effect on them at the end
of accounting period.

4. Facilitating management : Management requires financial data such as financial statements which includes
balance sheet, income statement for decision making, effective control on management, budgeting and
forecasting.

5. Providing information to its users : Providing accounting information to its users.

* Internal users : Those users which are owners of the company or working in the company.

* External users : Which are not working in the company and not the owners of the company or have no direct
link with company and its management.

6. Protecting business assets : Accounting maintains records of assets which are owned by business and helps
in analysing effects of transaction on the value of assets, so that management can exercise control on these
assets.

Functioning of accounting records

1. Maintaining systematic accounting record :