Chapter 1 Introduction to Accounting Need for Accounting A businessman invests capital with the objective of making profit and thereby increasing his resources, He incurs various expenses: like salaries, rent and stationery to operate his business. He receives income from different sources like commission, interest and discount. He deals with several persons in the course of buying and selling of goods, purchasing and sélling of assets and borrowing money for financing the business. He acquires various properties and assets like building, machinery, furniture to geneiate revenue. “Sflective management of business requires control over expenses to reduce the cost of operation and to make the business profitable. Assets must be properly maintained to increase their productivity. Liabilities of a business have to be repaid in due time. Dealings with customers and suppliers must be managed properly to keep them satisfied. In order to maintain property in good condition, to repay debts in time, to reduce the expenses and to increase sales, the businessman requires complete information about all his business transactions, In practice, it is impossible for any businessman to memorise and recollect all his business dealings. Moreover, he will be interested in knowing at the end of each year (i) what he owns? (ii) what he owes? (iii) how much profit he has eared? (iv) what his financial position is? To relieve businessmen from the burden of memorising all the business dealings and for providing necessary information, Accounting was developed. Businessmen also require accounting records to submit in courts to prove their claims or to defend in courts against claims made by outsiders. They are Tequired to produce business records to tax authorities whenever demanded. Similarly, financiers require accounting records of businessmen to decide about sanctioning of loans. Thus, transactions telating to business have become so important that their recording has become a necessity, ACCOUNTING AS THE LANGUAGE OF BUSINESS Amold W. Johnson in his book ‘Elementary Accounting’ says that “modern accounting has often been called ‘the language of business. "Its responsibility is applying a thorough knowledge of the theory of accountin, .¢., generally accepted Principles of accounting to the practical field of business in order that income and financial position may be stated fairly” ze, _—-12 ‘ _ouc-Financial Accounting i communicati The, basic: function of language is to serve as @ nee hes mn neti Accounting’ serves. the purpose of communicating the res ess, a : i ers, credit Operations to all.the interested parties such as proprietors manage lors and investors. Definition of Accounting ; \ According to the American Institute of Certified Public Accountants| ee) “Accounting is the art of recording, classifying and summarizing ina significant manner and in terms of money transactions and events which are of a financial character and interpreting the results thereof”. ; This comiprehensive definition highlights in a logical sequence the different steps in the accounting process and some important attributes of accounting. ‘The following detailed explanation makes each of them clear. ATTRIBUTES AND STEPS OF ACCOUNTING 1. Recording: Systematic recording of business transactions is the first step in the accounting process. Each and every transaction is recorded as and when it occurs, in chronological order. Every entry recorded has to be supported by reliable documentary evidence. Recording of business transactions is usually done in journal or in subsidiary books which are ‘books of original entry’. The method of recording is adjusted according to the size and nature of business and the type of transactions, Small firms and individuals may adopt the journal system. Bigger firms follow subsidiary books system which consists of purchases book, sales book, purchase returns book, sales returns book, bills receivable book, bills payable book, cash book and journal proper. 2. Classification: It is the process of grouping transactions or entries ona predetermined basis. The classification takes the form of ‘accounts? ina separate book known as Ledger. Separate accounts are opened for each expense, income, Property, liability and persons with whom the business has dealings Classification facilitates segregation of numerous business transactions We; identifiable groups. For example, goods sold to a customer on credit are r ii cash received from him is recorded in cash book. Gods retirnat ae shown in sales returns book. They are grouped in one place in the ledge ‘h tis personal account. Thus, each ledger account Provides the complete See the dealings in relation to that particular person or Property or expense ied \ 3. Summarising : The classified ‘data in the ledger is Presented period; ina manner which is understandable and useful to the owners and ieee) parties. Summarising takes place in the form of trial balance, tradin, ae 1c profit and loss account and balance sheet. The trig 8 account, " 1 I balance en, arithmetical accuracy of the recording and classification Process, Bach secon‘Antroduction. to" Accounting 43 in the ledger is balanced and the net balance is shown in the trial balance. The trading account reveals the gross profit of the business. Profit and:loss account, shows net profit or loss for the accounting period. The balance sheet 7 ‘portrays the financial position of the business. : 4, Significant manner : The accounting process of recording, classifying and summarising must be carried on in a significant manner. Each business has its.own peculiarities, special problems and particular requirements. The ~ management of the business needs specific types of information for controlling and decision-making purposes. Sales and purchases may have to be shown for cach product, division, department, and branch separately., Profit or loss may be required independently for each product or service. “Significant manner’ as per the requirement of the firm has to be incorporated at every stage in the process of recording, classifying and summarising business transactions. 5. In terms of money : All business transactions have'to be recorded in terms of money. It is the medium through which all the business transactions are expressed. Land and buildings in square feet, furniture and fixtures in number, stock in units are all recorded as per their monetary values. ‘Money measurement* is the basis for accounting. 6. Transactions and events of financial character: All those business transactions and events which are financial in character are recorded in accounts, All the events, dealings and happenings which have no financial effect are completely ignored in the accounting process, For example, working conditions, skilled work force, sales policies, employees’ morale ete., are all important for a business. But they have no ‘financial character’ and are omitted from accounting Process. 7. Interpreting the results: Interpretation of the results is needed for various Purposes. The trends observed in sales, purchases, expenses etc., are useful for future planning of operations. Data about customers and suppliers have to be interpreted to decide about credit policies. The owners are interested in the amount and growth of profit. The creditors are interested in the liquidity and. stability of the business. Interpretation is usually done through Ratios and Flow statements. They are Useful in evaluating past performance and providing guidance for future plans and operations. BOOK-KEEPING Vs ACCOUNTING The terms book-keeping and accounting are used interchangeably by laymen. In practice, they are different in their nature and scope. Book-keeping is concerned with the recording of business transactions in a Systematic manner. This work is mechanical and repetitive in nature. It does not heed specialised skill and knowledge. It is usually entrusted to the junior level Employees of the accounts department who are known as Book - keepers. a.a +. Financial Accotinting = i i tions of finang, ing i ible for recording business transacti ‘ancia} jook-keeping is responsible ness ‘ ni ie in the hooks of original entry. Each transaction is cera wie as details as possible. ‘The date of the transactions, quantities an: ae involved, the accounts to be debited and credited respectively, the ae oo number are all shown systematically. Each entry is made on the basis o! Supporting, verifiable documentary evidence. Book-keeping is also responsible for posting every transaction to the ledger, The debit and credit aspects are posted separately to the respective accounts with the correct amount, In the ledger, the date of the transaction, the j journal folio number and the amount are clearly shown whenever a Posting is made into an account, Balancing of all the ledger accounts and subsidiary books at the end of the reccunting year, is another major work for book-keeping. Each account in the ledger has to be balanced by totalling both si shows larger total amount. Balane, accounting period. Extracting Trial Balance is also a task for book-keeping. The Trial Balance ensures arithmetical accuraey of the accounts maintained. When there is any difference between the debits and credits, verifying the ledger accounts, postings and balancing is essential to identify mi stakes and adjust the trial balance. Book- keeping prepares the ground f for the important steps of finalisation and interpretation which are usually performed by “accounting”, Accounting includes the designing of suitable accounting system, Preparation of financial statements, cost Studies, income tax work ete. It is also responsible for analysing and interpreting the accounting i i and Profit & Loss account is to be prepared in a Systematic ma, of generally accepted accounting practices, Similarly, Prepared, portraying true and fair Picture of the financial The financial statements are to be anal, and useful information as per the req creditors etc, nner on the basis Balance g Position lysed. and interpreted to extract additional urements of the management, owners,Introduction to Accounting 15 Ina broad sense, accounting includes book-keeping also, But in practice, book-keeping and accounting differ in their scope and nature of their functions, Insmall businesses, both the functions may by performed by a single accountant. In bigger firms, the accounts department may be divided into book keeping and accounting sections. Objectives of Accounting Objectives of Accounting may differ from business to business depending upon their specific requirements. However, the following are the general objectives of accounting: 1. Maintenance of Accounting Records: Accounting records are the basis for the accounting work. The records have to be maintained systematically. While maintaining the accounting records, the generally accepted accounting conventions and concepts have to be followed. In the recent years, maintenance of books and records is relegated to the lower level employees. Still, required guidance has to be provided to them as and when necessary. 2, Ascertainment of Profit or Loss: Accounting is expected to ascertain and reveal the net results of the operations of a business. Various interested parties like owners, management, investors and creditors should be supplied with the results of operations as per their specific requirements. While finalising the accounts, objective approach is essential, combined with consistency and conservatism. 3. Depiction of financial position: A true and fair view of the financial position should be presented. The properties and assets possessed by the business should be shown at appropriate values as per the prevailing practices. The stake of creditors and owners in the business should be clearly presented. All the material information must be clearly disclosed. 4, Providing Information: In the recent years, providing information has become the most important objective of accounting. The American Accounting Association (AAA) has listed out the following purposes for which accounting should provide information. . (a) Making decisions concerning the use of limited resources including identification of crucial decision areas and determination of objectives and goals. (b) Effectively directing the controlling of an organisation’s human and material resources. (©) Maintaining and reporting on the custodianship of resources. (@) Facilitating social functions and control.‘Advantages of Accounting" eae . The following are the main advantages of accounting: a et ' ds: All the business transactions are recorded in the (a By ate fees i ich has financial effect is includ, books of accounts. Any event or happening which has led in the'accounting records, They are always at the disposal of the Management fordecisionmaking, r “3 (2) Preparation of financial statements: Results of | business Operations and the financial position of the concern are provided by accounting periodically, This is essential for distribution of profits to the owners and for planning the future policies and programmes by the management. G) Assessment of progress: Accounting analyses and interprets financial statements to reveal the progress made in different areas and it also identifies areas of weakness and stagnation. Management is provided with a complete Picture of the liquidity, profitability and stability aspects of the business, (A) Aid to decision making: Management ofa firm has to make innumerable routine and policy decisions while discharging its functions. Accounting provides the relevant data to make the decisions appropriate and effective. 5) Statutory requirements: Various legal requirements like maintenance of Provident fund for employees, Employees State Insurance contributions, deduction of tax at source, filing of tax returns etc., are properly fulfilled with the help of accounting. (© Information to interested groups: Accounting supplies appropriate information to different interested groups such financiers, tax authorities and government, (7) Evidence in Courts: Accounting records are usuall evidence in courts of law in the settlement of disputes. (8) Taxation Problems: Accounting records are the basic source for Computation and settlement of sales tax, income tax and other local taxes, (9) Merger of firms: When two or more existi nas owners, creditors, employees, 'y accepted as authentic Limitations of Accounting In spite of its indispensable position i ‘ . actousting has its own limitation. on in modern business establishments, It cannot record all the events and transacti i + It ignores transactions which cannot be expresee1 Tee an enterprise. measure the qualitative aspects of the Products, policies, aan ney. It cannot workers. It cannot quantify the morale of. employees in the on; i meat and the Accounting relies on estimates, and forecasts in several a sation, like useful life of machinery, market value of investment: ‘portant matters a ; 'S. Similarl jecti opinions of the accountant can influence valuation of stocks, Provision tie\jntroduction to Accounting 7 foXdoubtful debts and discounts etc. Accounting results may not be accurate and reliable due to such estimates and subjective influence of individual accountants.,’ ~ Accountants rely on historical cost for recording the fixed assets. Depreciation is also provided on the recorded cost of the assets. When the time for replacement : comes, replacement cost is usually far more than the accumulated funds through depreciation, Accouitting also ignores the price level changes which drastically alter the values of ‘assets and liabilities. Inflation which is an universal phenomenon makes the profit ascertained and financial position shown by accounting unrealistic and unreliable. Every one of these limitations has been engaging the attention of the professional bodies. Recent developments like human resource accounting, Inflation Accounting, International Accounting Standards etc., have been aimed at,improving the usefulness of Accounting by overcoming the limitations. Groups interested in Accounting information Accounting information ig used by different groups of people, both inside and outside the organisation. According to Siawin and Reynolds “Conceptually, accounting is the discipline that provides information on which external and internal users of the information may base decisions that result in the aliocation of economic resources in society”. L Internal Users of Accounting Information ‘The intemal users comprise of owners, management and employees. (i) Owners: The sole trader or partners or shareholders who have provided the capital of a business unit are interested in its performance and progress. “They are primarily interested in the revenues and expenses, profit or loss, net worth and external liabilities. They expect reasonable return on their investment in the form of profits. They are also concerned about the risk and uncertainty attached’ to their investment. They require detailed data about comparative earnings of the business, future prospects and divisible profits. (ii) Managenient: Sole traders and partners usually manage their own business. But companies are managed by paid professionals. Management of a business involves making day to day decisions on routine matters and. also policy decisions, whenever needed. Accounting data is the basis for most of the decisions made by management. The trends in sales and purchases, relationship of expenses to the turnover, productivity of workers, comparative profitability of different products and divisions etc., are some of the vital data required by management for planning and controlling the business operations. : (ii) Employees: The work force is interested in the profitability of the business which affects their bonus, incentives and working conditions. The success Of failure of the business is linked to their livelihood. Labour unions use the accounting data in their bargaining strategies with the management.L ovis Financial Accounting 18. L Jl. External Users: eint Various outside groups and individuals . S: it i i = ie vse Gd Final! Suppliers of goods and services, Commercia iy Cre tc., are included in this category banks, public deposit holders, orang on ying capacity ofthe initia ‘They are interested in the liquidity p ho are interested in investing their surplug (ii) Potential Investors: ee ndition of a business unit while making ee ape scion Tay a ore interested in future earnings and risk, ir i nt decisions. ; nt ty Cunlaner Those who use the products and services of a finn are interested in knowing the justification for the prices charged to ee a saree the expenses, sales and profits to see if they are paying fair prices for the products and services. . . (iv) Tax authorities:. Accounting information helps them in computing Sales tax, Income tax ete., to be collected from business units. They scrutinise the revenues and expenses of business firms to determine their accuracy. (v) Government: The scarce financial resources of the country are used by business enterprises. Performance of business units in different industries helps the Government in policy formulation for development of trade and industry. Government also administers prices of certain trades. In such cases, Government agencies have to ensure that the guidelines for pricing are followed, (vi) Research Scholars: The published financial statement used by researchers to evaluate the performance of individual and trade. They make use of the data relati taxes etc., in their analysis and evaluatio: ing Information aa of Accounting make use of accounting information its are especially firms, industries ing to sales, profits, dividends, interest, n, BRANCHES OF ACCOUNTING Providing information according to the needs of in has been recognised as the primary objective of aces ; unting, i Pog hes become highly competitive and technology orien ea oem business business units has become hi; oriented, Management of ighly complex, needing varied i nae peanag ny the additional demand of management for infor eO™mation, pranches of accounting have been developed. The folie wom Several New important of the branches of accouriting NING are the most ~-1, Financial Accounting: The accountin, and liabilities that is commonly carried on in ty Of PenSeS: assets 5 rs © general offices of busi . known as Financial Accounting. The financial accounti,. 01 CUsiness is expressed in two main types of financial Statements, yiz: ‘nting information is @ Profit & Loss “Account (matching the inco, 1 accounting period to ascertain the Profit or toss! “xPenses of the (i) The Balance sheet (showing assets ang liabilitie: position as on that date) s The owners, creditors, management, employees, financier, information provided by financial accounting, Setc., make use of ternal and extemal users ig for reven, » Tevealing financialIntroduction to-Accoiinting soo __ ys 2. Cost Accounting: It is that branch of accounting which deals ‘with classification, recording, allocation, summarisation of current and. Prospective cost. It determines cost of production and distribution by departments, functions, products etc, Cost accounting is essential for pricing of products and services and for, cost reduction and cost control. Cost accounting data, is useful, to the. management of the business; outsiders are not usually provided with costing data. 0 A 3, Management Accounting: It is that branch of accounting which is meant exclusively for managerial decision making. It provides necessary information to. the management for discharging its functions of planning, organising, co- ordinating, directing and controlling, It usually provides data on funds and cash flows, investment projects, preparation and implementation of budgets etc, Almost all the policy decisions of management are made on the basis of primary data provided by management accounting. METHODS OF ACCOUNTING Basically all methods of accounting are classified under two headings:- 1, Single entry system . Double entry system. Single entry system The term single entry is vaguely used to define the method of maintaining accounts which do not conform to strict principles of double entry. It is wrong to define it as system. The term ‘single entry’ does not mean that there is only one entry for each transaction. It simply signifies that principles of double entry book-keeping have not been observed in all cases. Under this system, only the personal accounts of the debtors and creditors and cash book of the trader are maintained. Impersonal accounts such as sales accounts, purchase accounts etc., as well as the assets accounts are ignored, The absence of the two fold effect of each transaction makes it impossible to prepare a trial balance and to check the arithmetical accuracy of the books of accounts, engendering a spirit of laxity and inviting fraud and misappropriations. Owing to the absence of purchases and sales accounts, the preparation of trading account is not possible, Again Profit & Loss account and Balance Sheet cannot be prepared due to the absence ofnominal accounts and real accounts, Hence, single entry is not only incomplete but the final results are also not reliable. Practically this system is followed by those firms whose transactions are limited and at the same time, who maintain only the essential records. There is no hard and fast rule for maintaining records under this system. ic., it depends on the circumstances and the needs of the firm. - Double entry system ap pubis system was invented by an Italian named Iuco Pacioli in 1494 AD. ea ee Spread all over the world, becoming as popular as Arabic Se “cording to this system, every transaction has two aspects. One is bene reFinancial Adeovintn A Hee aspect or incoming aspect and the other one is benefit giving tet at eS pect or outgoing aspect, The benefit receiving aspect is said to be a ‘debit’ and the is sai ‘credit’. For every transaction, one account ivi ect is said to be a ‘credit r ever i suaoiecal another account is to be credited in order to have acomplete ceo of the transaction, Therefore, every transaction affects two accounts in ite direction.“ ena s oor example, ‘if furniture is purchased for cash’, it isa monetary transaction, Furniture is benefit receiving aspect, it is debited. Cash is benefit Biving aspect, itis credited, | . : no Therefore, the basic principle, under this system is that for every debit, there must be a corresponding-and equal credit and for every credit there must be a corresponding and equal debit. Meaning of debit and credit The word Debitisderived from the Latin word Debitum which means Due for that, In short, the benefit receiving aspect of a transaction is known as debit, The word Credit is derived from the Latin word Creder which means Due to ‘hat. The benefit giving aspect of a transaction is known as credit, The abbreviations ‘Dr’ for debit and ‘Cr’ for credit are usually used. By convention, the-left hand side of an account is termed as debit side and right hand side of an account is termed as credit side. Advantages of Double Entry System (Complete record: Double entry system enables bu: complete, systematic and accurate record of all business transactions. Details of any transactions or events can be verified at any time. (i) Ascertainment of Profit or loss: The systematic record maintained under double entry system enabl les a business to ascertain the result of business Operations for any given period, The * owners can know the profitability of business operations periodically. Gi) Knowledge of financial position: With the Tent the financial position of the business can be This is done by preparing balance sheet, isinessmen to keep a help of Real and Personal ascertained with accuracy, can be tested by preparing a Statement called ‘Tyja] Balance’, (vy) No scope, Sor fraud: The firm is Saved from frauds and misappropriations since full information about all assets and liabilities will be available, (vi) Tax authorities: The businessmen Can satisfy the tax authorities if he maintains his accounts books Properly under th. ¢ double entry system. * (vii) Amount due from customers: The 2ccount books will reveal the amount due by customers, reminders can be sent to the customers who do not settle their accounts promptly.Introduction to Accounting (viii) Amount due to suppliers: The trader can as accounts the sums he owes his creditors and make. Pp them promptly. LL ‘certain from the books of. oper arrangements to pay (ix) Comparative study: Results of one year may be'compared with thos previous years and reasons for the change may be ascertained, TYPES OF ACCOUNTS The object of book keeping is to keep a complete record of all the transactions that take place in the business, Practically every se of business (i) deals with other persons, firms and companies. Gi) possesses assets like cash, stock, buildings, furniture etc., and receives incomes such as commission, interest etc, Itis necessary to maintain the following to record all.the above dealings: (1) Anaccount of each person, firm, or company with which the business deals. The accounts under this class are known.as Personal Accounts. e.g, ifMr. X, a cloth dealer, has dealings with four wholesalers and has twenty customers to whom he sells on credit, he must operate an account for each one of them separately, @) An account of each type of asset which a business owns. it comes under the class of Real Accounts. . @) Anaccount for each expense and gain. The accounts under this class are known as Nominal or Fictitious Accounts, An account is a statement in the ledger which records the transactions relevant to the person, asset, expense or profit named in the heading. Accounts can be divided into: (@) Personal Accounts (b) Impersonal Accounts Impersonal accounts can be further divided into real and nominal accounts. Thus, there are three kinds of accounts maintained by a business, (1) Personal Accounts (2) Real Accounts @) Nominal Accounts , 1, Personal Accounts: Accounts of persons with whom the business has dealings are known as personal accounts. It takes the following forms: (@) Natural Persons: The name of an individual — customers or suppliers.” (€.g,) Sudhir’s account, Sharma’s account, Anusha’s account, Priya’s account. Both males and females are included in it. - (®) Artificial persons or legal bodies: Firms’ accounts, limited companies SScounts, educational institutions’ accounts, bank account, co-operative society account ete., are known as artificial persons’ accounts._ EY Pinancial Absg i ——————_soniladcounts: All accounts representing ouisiany a i ccounts; All account ain : 3 Ce fos personal actounis: (2) me i expenses and accrued © ote Gone i i es, salary, rent etc. ‘i 3 ae en toi, he is called proprietor. This Proprietor fs bia ‘ Veil aouat it all that he invests in business and by drawings capital it fora i" ae ay for ai that which he withdraws from business. So, capital account ang i onal ‘accounts. drawings account are also personal a ; 2, Real Accounts: Accounts in which the business records the real things owed byit i.e, assets of the business are known as real accounts. Real accounts are of two types i.e. tangible real accounts and intangible real accounts. Building, furniture, cash and inichinery etc., are examples of tangible real accounts, because these can be.touched and felt and they have a physical shape. There are some intangible real accounts, which cannot be touched because they have no physical shape, such as trademark, goodwill, patents and copyright etc. 3.Nominal Accounts: Itrelates tothe items which exist in name only. Expenses, incomes ete., are there in business activities. A ccounts which record expenses, losses, incomes and gains of the business are known as nominal accounts, e, g. rent Ale, salaries A/c, telephone charges A/c, postage Alc, advertising Alc Commission received A/c, interest received A/c. Accounts - I Personal Impersonal et Proprietor Creditors Debtors Reai Nominal i 1 i * Assets Goods Expenses Incomes Mien Mane E88es Gains for use for resale ACCOUNTING RULES a The double entry system of book- ke ler nee, the transactions should be reco we have already discusse receiving aspect and ben two aspects, (1) Debit aspect (2). Credit aspect eping is a Scientific and com © ~ plete system. each tan nod #€C0rding to the following rules, As efit giving aspecs erst have two aspects, The be cht Pect. A transaction should be divided intoIntroduction | to-Accounting No ~ “The rules for making entries under double entry System can be summarised as follows:- 1, Personal accounts: Debit thereceiver : Credit the giver. 2, Real accounts + Debit what comes in . Credit what goes out 3. Nominal accounts wt Debit all expenses and losses Credit all.incomes a gains. BASES OF ACCOUNTING , There are three bases of accounting in common usage. Any one of the following bases may be used to finalise accounts. . (1) Cash basis 2) Accrual or Mercantile basis Q) Mixed ot Hybrid basis aa 1, Accounting on ‘Cash basis’: Under cash basis of accounting, all incomes are considered to be earned only when they are actually received in cash. Expenses are considered to be incurred only when they are actually paid. The difference between total income and expenses represents profit. No adjustments are needed for outstanding and prepaid ex; enses. Similarly, accrued incomes and incomes received in advance are also not adjusted. Thus, income is recognised only when cash is received. Expense is recognised only when cash is paid. . Government system of accounting is mostly on cash basis. Professionals like doctors, lawyers, brokers also prefer to follow this method, since it is simple to understand and easy to practice. 2. Accrual Basis of Accounting or Mercantile system: It is a system in which accounting entries are made on the basis of amounts having become due for payment or receipt. Incomes are credited to the period in which they are earned, whether cash is received or not. Similarly, expenses and losses are debited to the period in which they are incurred, whether cash is paid or not. The profit or loss of any accounting period is the difference between incomes eamed and expenses incurred, irrespective of cash payment or receipt. All outstanding expenses and prepaid expenses, accrued incomes and incomes teceived in advance are adjusted while finalising the accounts. This method is followed by all the merchants, trade and industry. That is why itis known as Mercantile system,| 14 ; “Financial Accouning 3. Mixed or Hybrid Basis of Accounting: This is asystem of: accounting, which some items of income are taken on cash basis while most of the expen, are shown on accrual basis. It is a hybrid system because it combines both “cach basis’ and ‘accrual basis’. 8 : In practice, the profit or loss shown will not be realistic. Conservative People who prefer recognising income when received, but cautious to Provide for all expenses, whether paid or not prefer this system. It is not widely practised dug to its inconsistency. ACCOUNTING TERMINOLOGY Itis necessary to understand some basic accounting terms which are routinely used in business world. The following are some of the important terms which enable a student to comprehend accounting in a better way: 1. Capital: It represents owners’ funds invested in a business. It may be the original amount invested by the owner or original contribution adjusted for profits and drawings. It is also known as owners equity or net worth. Capital represents owners’ claim against the assets of the business. It is equal to the total assets minus outside liabilities. 2. Liability: It represents temporary interest of outside creditors in the assets of a business. In the words of Finny and Miller, “Liabilities are debts; they are amounts ed to creditors; thus the claims of those who are not owners are called liabilities”. in simple terms, debts repayable to outsiders by the business are called liabilities. 3. Assets: Assets are defined as ‘anything of value owned by a business. According to Finny and Miller, “Assets are future economic benefits, the rights, which are owned or controlled by an organisation or individual. 4. Revenue: It is defined as the inflow of assets which results in an increase in the owners’ equity. ‘It includes all incomes like sales receipts, interest, commission, brokerage etc. However, Teceipts of capital nature like additional capital, sale of assets etc., are not a part of revenue. 5. Expense: It is any amount spent in order to produce and sell the goods and services which bring in the revenue, Expense may be defined as the fos athe use of things or services for the purpose of Sanne Expense can be capital expense and rey generates revenue over several accounting y revenue in the current accounting year, Capital expense includes acquisition of long term assets like machinery whereas revenue expense includes current ‘expenses like salary, rent, lighting etc. 6. Debtors: A person who tecelvesa benefit without giving money or money's worth immediately but, liable to pay in future is a debtor, Debtor can be a ‘trade debtor’ if he buys goods on credit. Others are non trade debtors. < ‘enue expense. Capital expense ‘ears. Revenue expense generates ae 4Introduction to Accounting 115 7, Creditors: A person who gives a benefit without receiving money,or money's worth immediately but, liable to claim in future is a creditor, Creditor can bea ‘trade creditor’ ifhe supplies goods on credit. Others are non trade creditors, 8. Tangible Assets: Asscts which have physical existence. i, @,, they can be seen or felt or touched, are termed as tangible assets, Examples: cash, machinery, buildings. 9. Intangible Assets: Assets which have no physical existence. i, e., they cannot be seen or felt or touched, are termed as intangible assets. Examples: goodwill, patent rights, copyrights. 10. Fictitious Assets: Items shown along with other assets on the assets side of a balance sheet, but actually representing unadjusted losses are termed as fictitious assets. Examples: preliminary expenses, profit and loss account debit balance etc, 11, Wasting Assets: Those assets which certainly lose value with usage are termed as wasting assets. Mines, forests etc., become waste once the mineral is fully extracted or the timber is fully cut. 12. Fixed Assets: Assets acquired for income generation, but not for tesale are called fixed assets, The benefit from them is derived for a longer period than one year. (e.g.,) machinery. 13. Current or Floating Assets: Those assets which are converted into cash in normal course of business in less than one year are termed as current or floating assets. (e.g.,) stock, debtors. 14. Purchases: Buying of goods with the intention of resale is called Purchases. If cash is paid immediately for the purchase, itis cash purchases. If the payment is postponed, it is credit purchases, 15. Sales: Selling of goods in the normal course of business is termed as sales. If the sale is for immediate cash payment, it is cash sales, If Payment for sales is postponed, it is credit sales. 16. Stock: The term ‘stock’ refers to goods lying unsold ona Particular date. The stock of goods at the end of the accounting period is called ‘closing stock’ ad 7 Stock of goods at the beginning ofan accounting period is called ‘opening tock’, 17. Losses: ‘Loss’ really indicates something against which a firm receives no benefit. It Tepresents money given up without any return, It may be noted that expense leads to revenue but losses do not, (2.g.,) loss due to fire, theft and damages Payable to others, ownt Drawings: Any amount of money or money’s worth withdrawn by the en of the business is termed as drawings. It is usually subtracted from $)2a Financial Aco “116 ared by a seller of goods to.be sen ce 19. Invoice: It is a statement prep: a Of etots fo beset i it ice, value etc., of the goods and any qi buyer: It shows: details of quantity, He : : rable by the oe cous ven, finally. showing the net am: i es a 20. Voucher: It is the-written record and evidence of a transaction, : docuntentary evidence of any transaction is called a voucher. Voucher, a S arg essential for audit of accounts. Example: cheque book counterfoils, cash, recent, invoices, 21. Goods: The term ‘goods’ includes all merchandise, commodities et, jy which a trader deals in the normal course of business. Thus, commodities bough for resale are treated as goods. For a furniture dealer, furniture is goods but, for other firms furniture is an asset. | 22, Current liability: Those liabilities which are payable within one yearn the normal course of a business are termed as current liabilities. Example: trade creditors, bills payable. 23. Long term Lial Liabilities repayable beyond a period of one year are treated as long term liabilities. Example: bank loans, mortgage loans, 24, Solvent: A person who has assets with realisable values which exceed his liabilities is solvent. 25, Insolvent: A person whose liabilities are more than the realisable values of his assets is called an insolvent. Theory Questions (A) Short Answer Questions : 1. Whatis Accounting? Define Accounting? What are the objectives of Accounting? What is Book-keeping? Who are the different persons interested in Accounting information? ‘What are the Limitations of Accounting? ‘What is ‘Double-entry system’? ‘ What do you understand by ‘Debit’ and ‘Credit’? | State the rules for debiting and crediting, 10. Describe the three kinds of Personal Accounts? 11, What are ‘Real Accounts’? Give examples, 12, What are ‘Nominal Accounts’ Give examples, 13. What is ‘Mercantile system’ of Accounting? : __ 14, Write short notes on : (a) Assets (b) Liabilities (©) Capital | “15. Explain the Meaning of (a) Tangible Assets (6) intangible Assets (©) Fictitious Asse | “16. Distinguish between Fixed Assets and Current Assets, Per AwanIntroduction to Accounting 117 17. What are ‘Goods’? Explain. 18, Write'short notes on : (a) Revenue (b) Expense (c) Losses 19. What is the difference between ‘Current Liability’ and ‘Long Term Liability’? (B) Long Answer Questions : 1, What is Accounting? What is the need for it? 2. “Accounting is the Language of business”, Elucidate, 3. Explain the ‘Steps in the process of Accounting’ in detail. 4, What is book-keeping? Distinguish between Accounting and Book-keeping. 5. Describe the Advantages and Limitations of Accounting. Describe the ‘Internal’ and ‘External’ users of Accounting information and their requirements. 7. Briefly describe various ‘Branches of Accounting’, 8, Explain the methods of Accounting. 9. What is double entry system? What are its advantages? 10. Classify ‘Accounts’ and explain them in detail. 11. What are the three kinds of Accounts? What are the ‘rules’ governing ‘Debiting’ and ‘Crediting’ of those accounts? 12, Explain the ‘Bases of Accounting’? 15. Distinguish between ‘Cash basis” and ‘Accrual Basis’ of Accounting,