FUNDAMENTALS OF ACCOUNTING 1st BBA Introduction to Accounting

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UNIT 1-Introduction to Accounting

Accounting
Meaning-Accounting is the process of recording, summarizing, analyzing, and reporting financial
transactions of a business to oversight agencies, regulators, etc. It involves tracking revenues, expenses,
assets, and liabilities to provide a clear financial status of the business or individual, which helps in making
informed financial decisions.
Definition-

 According to the Committee of Terminology of American Institute of Certified Public Account:”

Accounting is the art of recording, classifying summarising in a significant manner and in terms of
money, transaction, and events which are, in part at least of a financial character and interpreting the
results thereof.”
 According to Bierman and Drebin:” Accounting may be defined as identifying, measuring, recording
and communicating of financial information.”

BOOK-KEEPING

As defined by Carter, ‘Book-keeping is a science and art of correctly recording in books-of accounts all those
business transactions that result in transfer of money or money’s worth’.

Objectives of Accounting

 Maintenance of Records of Business Transactions: A proper, accurate, and regular, systematic

recording of business transactions is essential for every organization. Accounting helps an
organization in recording and maintaining the records of business transactions.
 Depiction of Financial Position: Another objective of accounting is the ascertainment of an
organization’s financial position in the form of its liabilities and assets at the end of each financial
year. An organization can depict the financial position for the accounting year with the help of
financial statements.
 Calculation of Profit and Loss: The central aim of every organization is to earn and maximize profit.
Therefore, accounting aims at ascertaining the loss sustained and profit earned by an organization
during the financial year.
 Providing Accounting Information to its Users: The Accounting information generated by an
organization in the form of financial statements, reports, charts, etc., for the accounting year is used
by different external and internal users. Accounting provides relevant information about the
organization to these users. Some of the users of accounting information are management, employees,
investors, creditors, banks, financial institutions. etc.
 To know the Solvency Position: Financial statements gives information regarding concern’s ability
to meet its liabilities in short run and also in long run.

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FUNDAMENTALS OF ACCOUNTING 1st BBA Introduction to Accounting

Functions of Accounting

 Measurement: Accounting measures past performance of the business entity and depicts its current
financial position.
 Forecasting: Accounting helps in forecasting future performance and financial position of the
enterprise using past data.
 Decision-making: Accounting provides relevant information to the users of accounts to aid rational
decision-making.
 Comparison & Evaluation: Accounting assesses performance achieved in relation to targets and
discloses information regarding accounting policies and contingent liabilities which play an important
role in predicting, comparing and evaluating the financial results.
 Control: Accounting also identifies weaknesses of the operational system and provides feedbacks
regarding effectiveness of measures adopted to check such weaknesses.
 Government Regulation and Taxation: Accounting provides necessary information to the
government to exercise control on the entity as well as in collection of tax revenues.

Limitations of accounting:

 Accounting is not precise: Accounting is not completely free from personal bias or judgment.
 Accounting is done on historic values of assets: Accounting records assets at their historical cost
less depreciation. It does not reflect their current market value.
 Ignore the effect of price level changes: Accounting statements are prepared at historical cost. So
changes in the value of money are ignored.
 Ignore the qualitative information: Accounting records only monetary transactions. It ignores the
qualitative aspects.
 Affected by window dressing: Window dressing means manipulation in accounting to present a
more favourable position of the business than the actual position.

Users of Accounting Information

1. Internal Users
 Owners: The owners of an organization contribute their savings as capital in the business. Therefore,
the owners are exposed to the risks involved with the business and, hence, want to ensure the safety of
their capital.
 Employees: The employees of an organization are interested in the accounting information to
determine the ability of the firm to pay their bonuses and salary.
 Management: The management of an organization has to make various decisions for its success,
growth, and accomplishment of goals. For this, the management uses the accounting information to
make certain essential decisions.
2. External Users
 Investors: Investors are the people or groups of people who invest their money in organizations.
These investors want to know about the earning capacity of the organization so they can decide the
safety and risk level of investing in an organization.
 Banks and Financial Institutions: The banks and financial institutions provide loans to different
businesses. They use the accounting information to ensure the repayment of their loan.

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FUNDAMENTALS OF ACCOUNTING 1st BBA Introduction to Accounting

 Creditors: Creditors provide an organization with goods on credit. They take the help of accounting
information to understand the credibility and financial soundness of the organization to pay their
money.
 Consumers: Consumers use the accounting information of an organization to establish good
accounting control over the business that can reduce the production cost.
 Government: The Government uses accounting information to determine and assess the tax liability
of an organization.
 Researchers: Researchers use the accounting information of an organization to complete their
research work and provide actual facts and figures in their work.
 Investment agencies: These institutions use accounting information to serve their clients better
regarding the safety and assurance o investments.
 General Public: General public will get to know the contribution of business to the society in the
form of payment of tax, employment generation and contribution to socially beneficial activities.
Basic terms and Concepts
 Transaction: It means an event or a business activity which involves exchange of money or money’s
worth between parties. The event can be measured in terms of money and changes the financial
position of a person e.g. purchase of goods would involve receiving material and making payment or
creating an obligation to pay to the supplier at a future date.

 Cash transaction: When the parties settle the transaction immediately by making payment in cash or
by cheque, it is called a cash transaction.
 Credit transaction-The payment is settled at a future date as per agreement between the parties

 Goods: These are tangible article or commodity in which a business deals. These articles or
commodities are either bought and sold or produced and sold.
 Services: They are intangible in nature which is rendered with or without the object of earning profits.

 Profit: The excess of Revenue Income over expense is called profit. It could be calculated for each
transaction or for business as a whole.

 Loss: The excess of expense over income is called loss. It could be calculated for each transaction or for
business as a whole.

 Asset: Asset is a resource owned by the business with the purpose of using it for generating future
profits.

 Tangible Assets: They are the Capital assets which have some physical existence. They can, therefore,
be seen, touched and felt, e.g. Plant and Machinery, Furniture and Fittings, Land and Buildings, Books,
Computers, Vehicles, etc.

 Intangible Assets: The capital assets which have no physical existence and whose value is limited by
the rights and anticipated benefits that possession confers upon the owner are known as intangible
Assets.

 Current Assets/Floating assets: Current assets are those which are meant for Short-term use and whose
quantities vary very frequently.

 Non-Current Assets/Fixed Assets: Fixed assets are those which are meant for long term use and whose
quantity does not vary very frequently.
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FUNDAMENTALS OF ACCOUNTING 1st BBA Introduction to Accounting

 Fictitious assets: Fictitious assets are intangible assets that lack a physical presence but are recorded on
a company's balance sheet. These assets represent deferred expenses or losses that are carried forward
for future periods.

 Goodwill: It is the reputation of a firm which enables it to earn higher profits in comparison to the
normal profits earned by other firms in the same business.

 Depreciation: Depreciation can be defined as a continuing, permanent and gradual decrease in the book
value of fixed assets.

 Liability: It is an obligation of financial nature to be settled at a future date. It represents amount of

money that the business owes to the other parties.
 Current Liabilities/Short-term liabilities – Current liabilities are a company's short-term financial
obligations that are due within one year or within a normal operating cycle.

 Non-Current Liabilities/Long term liabilities/Fixed liabilities – Non-current liabilities are financial

obligations that a business has that are not due to be paid within a year.
 Stock: It refers to the unused and unsold goods lying with the business at any given point of time.

 Internal Liability: These represent proprietor’s equity, i.e. all those amount which are entitled to the
proprietor, e.g., Capital, Reserves, Undistributed Profits, etc

 Contingent Liability: It represents a potential obligation that could be created depending on the
outcome of an event

 Capital: It is amount invested in the business by its owners. It may be in the form of cash, goods, or any
other asset which the proprietor or partners of business invest in the business activity.

 Drawings: It represents an amount of cash, goods or any other assets which the owner withdraws from
business for his or her personal use. Drawings will result in reduction in the owners’ capital. The concept
of drawing is not applicable to the corporate bodies like limited companies.
 Debtor: Debtors are those persons from whom a business has to recover money on account of goods
sold or service rendered on credit. Also known as Sundry Debtors or Trade Debtors, or Trade Payable, or
Book-Debts or Debtors.

 Creditor: A creditor is a person to whom the business owes money or money’s worth. e.g. money
payable

 Capital Expenditure: This represents expenditure incurred for the purpose of acquiring a fixed asset
which is intended to be used over long term for earning profits there from.
 Revenue expenditure: This represents expenditure incurred to earn revenue of the current period.

 Balance Sheet: It is the statement of financial position of the business entity on a particular date. It lists
all assets, liabilities and capital.

 Profit and Loss Account or Income Statement: This account shows the revenue earned by the
business and the expenses incurred by the business to earn that revenue
 Trade Discount: It is the discount usually allowed by the wholesaler to the retailer computed on the list
price or invoice price.
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FUNDAMENTALS OF ACCOUNTING 1st BBA Introduction to Accounting

 Cash Discount: This is allowed to encourage prompt payment by the debtor. This has to be recorded in
the books of accounts. This is calculated after deducting the trade discount.

 Purchases: It refers to acquisition of goods. Other than goods when something else are acquired, the
term ‘Purchases’ is not used for accounting purposes.
 Sales: It refers to disposal of goods for a consideration.
 Good debts: The debts which are sure to be realized are called good debts.
 Doubtful Debts: The debts which may or may not be realized are called doubtful debts.
 Bad debts: The debts which cannot be realized at all are called bad debts.

Steps of the Accounting Cycle

 Identify the Transaction-The accounting cycle begins with: transactions. Every transaction involving
the company must be recorded appropriately.

 Record Transactions in a Journal-The second step of the accounting cycle steps is to use journal
entries for each transaction. Journal entries must be entered in full compliance with double-entry
accounting guidelines. Every time a transaction takes place, debit and credit must be recorded in the
journal.

 Post to the General Ledger-A transaction should be posted to a general ledger account after it has been
entered as a journal entry. The general ledger provides an account-by-account breakdown of all
accounting activities.

This allows a bookkeeper to monitor account-specific financial positions and statuses. One of the most
frequently referred to accounts in the general ledger is the cash account, which details the available cash.

 Create a Trial Balance-Transactions must be balanced at the end of the period. The trial balance shows
the company how much money is in each account and if there are any problems.

 Create Financial Statements-At this step, we take the trial balance and use it to make the balance sheet,
income statement, and cash flow statement.

 Closing the Books-In the accounting cycle steps, the last step is for a company to close its books at the
end of the day on the closing date. The closing statements give a report that can be used to look at how
well things went over the period.

Branches Of Accounting
 Financial Accounting
Financial accounting records summarize and review firm business transactions through monetary
statements. These include the earnings announcement, the stability sheet, the cash flow declaration, and
the declaration of retained income. Those economic reviews provide insight into a company’s overall
performance to its lenders, buyers, and tax authorities.

 Managerial Accounting
As per corporate Finance institutions, Managerial accounting is the procedure of identification,
measurement, evaluation, and interpretation of accounting data. It allows commercial enterprise leaders
to make financial selections and correctly manage their daily operations.

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FUNDAMENTALS OF ACCOUNTING 1st BBA Introduction to Accounting

 Cost Accounting
As per the definition issued by the Institute of Cost and Management Accounting, Cost accounting is the
application of costing and principles that includes methods and techniques as per science, art, and the
practice of ascertaining the costs

BASIS OF ACCOUNTING
 Accrual Basis of Accounting
Accrual Basis of Accounting is a method of recording transactions by which revenue, costs, assets and
liabilities are reflected in the accounts for the period in which they accrue. This basis includes
consideration relating to deferrals, allocations, depreciation and amortization. This basis is also referred
to as mercantile basis of accounting.

 Cash Basis of Accounting

Cash Basis of Accounting is a method of recording transactions by which revenues, costs, assets and
liabilities are reflected in the accounts for the period in which actual receipts or actual payments are
made.

Accounting Principles
Accounting principles are the common guidelines and rules related to accounting transactions that are
followed to prepare financial statements successfully. These principles are the founding guidelines for
preparing and recording financials for proper analysis. These accounting principles are also known as
Generally Accepted Accounting Principles or GAAP.

Accounting • Accounting Concepts

Principles • Accounting Conventions

Accounting Concepts
 Business Entity Concept
This concept explains that the business is distinct from the proprietor. Thus, the transactions of business
only are to be recorded in the books of business.
 Going Concern Concept
This concept assumes that the business has a perpetual succession or continued existence.
 Money Measurement Concept
According to this concept only those transactions which are expressed in money terms are to be recorded
in accounting books.
 The Accounting Period Concept
The accounting period concept separates a company's economic existence into discrete periods, often a
fiscal year, for financial reporting. This approach enables timely and consistent reporting, assisting
stakeholders to evaluate a company's performance and make educated decisions at precise intervals.
 The Accrual Concept
The accrual concept mandates that revenues and costs be recognised as they are received or spent,
regardless of financial movements.
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FUNDAMENTALS OF ACCOUNTING 1st BBA Introduction to Accounting

 Realization Concept
This concept speaks about recording of only those transactions which are actually realized. For example
Sale or Profit on sales will be taken into account only when money is realized i.e. either cash is received
or legal ownership is transferred.
 Matching Concept
It is referred to as matching of expenses against incomes. It means that all incomes and expenses relating
to the financial period to which the accounts relate should be taken in to account without regard to the
date of receipts or payment.
 Full Disclosure Concept
As per this concept, all significant information must be disclosed. Practically, this principle emphasizes
on the materiality, objectivity and consistency of accounting data which should disclose the true and fair
view of the state of affairs of a firm.
 Duality Concept
According to this concept every transaction has two aspects i.e. the benefit receiving aspect and benefit
giving aspect. These two aspects are to be recorded in the books of accounts.
 Verifiable Objective Evidence Concept
Under this principle, accounting data must be verified. In other words, documentary evidence of
transactions must be made which are capable of verification by an independent respect
 Historical Cost Concept
The historical cost concept assesses assets at their original cost, giving financial reporting a solid and
objective foundation. This notion improves dependability by minimising subjective values and
guaranteeing that financial statements accurately represent asset purchase costs.
 Balance Sheet Equation Concept
Under this principle, all which has been received by us must be equal to that has been given by us
Naturally every debit must have a corresponding credit and vice-e-versa.

Accounting Conventions

Conservatism: One of the most important accounting conventions that accountants apply in the
business is the conservatism principle. This principle suggests that if two values are associated with a
specific transaction, the lowest must be recorded on the asset or income side of the financial statement.
In this case, the possibility of loss is taken care of. This accounting convention aims to understate profits
and assets while dealing with business losses. Such practice mostly helps in enhancing the overall
reliability of company stakeholders on the financial statements.

Consistency: Consistency convention denotes that the same principles of accounting must be
implemented to prepare the business financial statements, year after year. From the prepared financial
statements, it is important to draw a meaningful conclusion of the same company when a comparison is
made of the statements over a period. Such financial comparisons can only be made if the same
accounting practices and principles are followed uniformly by the firm over a period of time. In the case
of different accounting policies implemented every year, the comparison will not stand fruitful, and the
result can also impact financial decisions.

Materiality: This accounting convention is related to all the relative information available for an item or
event of a company's financial transactions. An item is generally considered material with respect to the
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FUNDAMENTALS OF ACCOUNTING 1st BBA Introduction to Accounting

influence it has on an investor's decisions. The aspect of materiality differs from one organisation to
another. For instance, in the case of a small company, certain information can be material but the same
information may not be material for a large organisation. Hence, the application of materiality
convention entirely depends on the context of analysis.

Convention of full disclosure: The principle of full disclosure mandates the comprehensive revelation
of all pertinent details in financial statements. This entails a thorough, impartial, and ample disclosure of
accounting information. ‘Adequate’ denotes a satisfactory amount of information to be divulged, ‘fair’
implies equitable treatment for users, and ‘full’ demands a complete and detailed presentation.
Consequently, the convention underscores the necessity for financial statements to fully disclose all
pertinent information.

Accounting Equation

Accounting equation can be simply defined as a relationship between assets, liabilities and owner’s equity in
the business.

Assets= Liabilities + Capital

Problems
1. Commenced Business with Cash- Rs 120,000
2. Purchases assets for cash Rs 25,000.
3. Sold Assets of Rs 10,000 for Rs 12,000.
4. Goods destroyed by fire Rs 1,000.
5. Withdrew cash for personal use Rs 5,000.
6. Rent outstanding Rs 5,000.
7. Insurance paid in advance Rs 400.
8. Interest on loan allowed Rs 6,000.
9. Depreciation on furniture Rs 2,500.
10. Bought goods on credit from Ramesh Rs 80,000.
11. Sold goods on credit to Vimal Rs 25,000.
12. Bought furniture from Ram Rs 2,000.
13. Sold goods to Ramesh Rs 2,000.
14. Returned damaged goods by Ramesh Rs 100.
15. Sold securities costing Rs 2,000 for Rs 2,500.

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NOTE- Students are instructed to refer to the text books also.

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