ACCOUNTING

Accounting is the language of business.

The affairs and the results of the
business are communicated to others
through accounting information, which
has to be systematically recorded and
presented.
 Accounting - Definition

Accounting can be defined as the process of

identifying, measuring, recording and
communicating the economic events of an
organization to the interested users of the
information.
 Characteristics of Accounting

 Economic events
 Identification, measuring, recording
and communication
 Organization
 Interested users of information
 Economic Events

An economic event has been defined as ‘a

happening of consequence’ to a business
entity. Economic events are classified into

• External types

• Internal types.
 Economic Events Continue…

An external event which involves the

transfer or exchange of something of value
between two or more entities.
 Economic Events Continue…

Sale of goods to customers.

• Payment of monthly rent to the landlord.
Purchase of raw materials by an
enterprise from some other business
enterprise.
Rendering of services to customers, etc.
 Economic Events Continue…

An internal event is an economic event that

occurs entirely within one enterprise.

Eg : Supply of raw materials or equipment

by the stores department to the
manufacturing department.
 Identification

It means determining what to record, i.e. to

identify recordable events. It involves
observing activities and selecting those
events that are considered to be evidence
of economic activity.
 Identification continue …

The value of human resources, changes in

managerial policies or changes in personnel
are important but none of these items is
recorded in financial accounts. However,
when a company makes a cash sale or
purchase, even if the item is small, it is
recorded in the books of account.
 Measurement

It means quantification, including estimates

of business transactions into financial terms,
i.e. rupees and paise. If an event cannot be
quantified in monetary terms, it is not
considered for recording in financial
accounts.
 Recording

Once the economic events are identified

and measured in financial terms, they are
recorded, i.e. a chronological diary of these
measured events is kept in an orderly and
systematic manner.
 Communication

The economic events are identified,

measured and recorded is communicated in
some form to management and others for
internal and external uses. The information
is communicated through the preparation
and distribution of accounting reports. The
most common reports are in the form of
financial statements (Balance Sheet and
Profit and Loss Statement).
 Organization

It can be a business entity or a non-

business entity, depending upon the profit
or non-profit motive.
Users of Accounting Information

Different categories of users need different

kinds of information for making decisions.
These users can be divided into :

•Internal Users; and

•External Users.
 Internal Users

These are the persons who manage the

business, i.e. management at the top,
middle, and lower levels. Their requirements
of information are different because they
make different types of decisions.
 Internal Users continue…

The top level is more concerned with

planning; the middle level is concerned
equally with planning and control; and the
lower level is concerned more with
controlling operations. Information is
supplied on different aspects, e.g. cash
resources, sales estimates, results of
operations, financial position, etc.
 External Users

All persons other than internal users come

in the group of external users. External
users can be divided into two groups:
       those having direct interest; and
       those having indirect interest
in a business organization.
 External Users continue…

The main sources of information for

external users are annual reports of
business organizations, which state the
financial position and performance and give
the auditor’s report, director’s report and
other information.
 External Users continue…

Investors and creditors are the external

users having direct interest. Tax authorities,
regulatory agencies, customers, labour
unions, trade associations, stock exchanges,
investors, etc are indirectly interested in the
company’s financial strength, its ability to
meet short-term and long-term obligations,
its future earning power, etc for making
various decisions.
ACCOUNTING PRINCIPLES

Accounting principles can be subdivided into

two categories:

        Accounting Concepts; and

        Accounting Conventions.

 ACCOUNTING PRINCIPLES
        Accounting Concepts
        Accounting Conventions
The term ‘concept’ is used to connote
accounting postulates, that is necessary
assumptions and conditions upon which
accounting is based. The term ‘convention’
is used to signify customs and traditions as
a guide to the presentation of accounting
statements.
 ACCOUNTING PRINCIPLES

Accounting Concepts
• Business Entity Concept
• Money Measurement Concept
• Cost Concept
• Going Concern Concept
• Dual Aspect Concept
• Realization Concept
• Accounting Period Concept
 ACCOUNTING PRINCIPLES

Accounting Conventions
• Convention of Consistency
• Convention of Disclosure
• Convention of Conservation
 ACCOUNTING PRINCIPLES

Accounting Concepts
The term ‘concept’ is used to connote
accounting postulates, that is necessary
assumptions and conditions upon which
accounting is based.
 Business Entity Concept

Business is treated as a separate entity or

unit apart from its owner and others. All the
transactions of the business are recorded in
the books of business from the point of view
of the business as an entity and even the
owner is treated as a creditor to the extent
of his/her capital.
Money Measurement Concept

In accounting, we record only those

transactions which are expressed in terms
of money. In other words, a fact which can
not be expressed in monetary terms, is not
recorded in the books of accounts.
 Cost Concept

Transactions are entered in the books of

accounts at the amount actually involved.
Suppose a company purchases a car for
Rs.1,50,000/- the real value of which is
Rs.2,00,000/-, the purchase will be recorded
as Rs.1,50,000/- and not any more. This is
one of the most important concept and it
prevents arbitrary values being put on
transactions.
 Going Concern Concept

It is persuaded that the business will exists

for a long time and transactions are
recorded from this point of view.
 Dual Aspect Concept

Each transaction has two aspects, that is,

the receiving benefit by one party and the
giving benefit by the other. This principle is
the core of accountancy.
 Dual Aspect Concept continue…

For example, the proprietor of a business

starts his business with Cash Rs.1,00,000/-,
Machinery of Rs.50,000/- and Building of
Rs.30,000/-, then this fact is recorded at
two places. That is Assets account (Cash,
Machinery & Building) and Capital accounts.
The capital of the business is equal to the
assets of the business.
 Dual Aspect Concept continue…

Thus, the dual aspect can be expressed as

under
 
Capital + Liabilities = Assets
or
Capital = Assets – Liabilities
 Realization Concept

Accounting is a historical record of

transactions. It records what has happened.
It does not anticipate events. This is of
great important in preventing business firms
from inflating their profits by recording sales
and income that are likely to accrue.
 Accounting Period Concept

Strictly speaking, the net income can be

measured by comparing the assets of the
business existing at the time of its
liquidation. But as the life of the business is
assumed to be infinite, the measurement of
income according to the above concept is
not possible. So a twelve month period is
normally adopted for this purpose. This time
interval is called accounting period.
 ACCOUNTING PRINCIPLES

Accounting Conventions

The term ‘convention’ is used to signify

customs and traditions as a guide to the
presentation of accounting statements.
 Convention of Consistency

In order to enable the management to draw

important conclusions regarding the working
of the company over a few years, it is
essential that accounting practices and
methods remain unchanged from one
accounting period to another. The
comparison of one accounting period with
that of another is possible only when the
convention of consistency is followed.
 Convention of Disclosure

This principle implies that accounts must be

honestly prepared and all material
information must be disclosed therein. The
contents of Balance Sheet and Profit and
Loss Account are prescribed by law. These
are designed to make disclosure of all
material facts compulsory.
 Convention of Conservation

Financial statements are always drawn up

on rather a conservative basis. That is,
showing a position better than what it is,
not permitted. It is also not proper to show
a position worse than what it is. In other
words, secret reserves are not permitted.
 FUNCTIONS OF
ACCOUNTING
• Keeping systematic records
• Protecting properties of the business
• Communicating the results
• Meeting legal requirements
 Keeping systematic records

The first function of accounting is to keep a

systematic record of financial transactions,
to post them to the ledger accounts and
ultimately prepare final statements.
 Protecting properties of the
business

The second important function is to protect

the property of the business. The system
accounting is designed in such a way that it
protects its assets from an unjustified and
unwarranted use.
 Meeting legal requirements

The fourth and the last function of

accounting is to meet the legal
requirements under the Companies Act,
Income Tax Act, Sales Tax Act and so on.
THE ACCOUNTING CYCLE

Recording transactions in subsidiary books.

Classifying data by posting from subsidiary
books to the accounts.
Closing the books and preparation of final
accounts.
CLASSIFICATION OF ACCOUNTS

Every business deal with other “Person”,

possesses “Assets”, pay “Expenses” and receive
“Income”.
So from the above, we can see every business
has to keep
• An account for each person
• An account for each asset and
• An account for each expense or income.
CLASSIFICATION OF ACCOUNTS

• Accounts in the names of persons are known as

“Personal Accounts”
• Accounts in the names of assets are known as
“Real Accounts”
• Accounts in respect of expenses and incomes
are known as “Nominal Accounts”
CLASSIFICATION OF ACCOUNTS

ACCOUNTS

PERSONAL IMPERSONAL
ACCOUNTS ACCOUNTS

REAL NOMINAL
ACCOUNTS ACCOUNTS
 PERSONAL ACCOUNTS

Accounts in the name of persons are known as

personal accounts.
Eg: Babu A/C,
Babu & Co. A/C,
Outstanding Salaries A/C, etc.
 REAL ACCOUNTS

These are accounts of assets or properties. Assets

may be tangible or intangible. Real accounts are
impersonal which are tangible or intangible in
nature.
Eg:- Cash a/c, Building a/c, etc are Real
Accounts related to things which we can feel,
see and touch.
Goodwill a/c, Patent a/c, etc Real Accounts
which are of intangible in nature.
 NOMINAL ACCOUNTS

These accounts are impersonal, but invisible and

intangible. Nominal accounts are related to those
things which we can feel, but can not see and
touch. All “expenses and losses” and all “incomes
and gains” fall in this category.
Eg:- Salaries A/C, Rent A/C, Wages A/C, Interest
Received A/C, Commission Received A/C,
Discount A/C, etc.
 DEBIT AND CREDIT

Each accounts have two sides – the left side and

the right side. In accounting, the left side of an
account is called the “Debit Side” and the right
side of an account is called the “Credit Side”. The
entries made on the left side of an account is
called a “Debit Entry” and the entries made on the
right side of an account is called a “Credit Entry”.
RULES FOR DEBIT AND CREDIT

Debit the Receiver

Personal
Account Credit the Giver

Debit what comes in

Real Accounts Credit what goes
out
Debit all Expenses
Nominal and Losses
Accounts Credit all Incomes
and Gains
Steps for finding the debit and credit aspects
of a particular transaction

• Find out the two accounts involved in the

transaction.
• Check whether it belongs to Personal, Real or
Nominal account.
• Apply the debit and credit rules for the two
accounts.
 Exercise

• Purchased a Building for Rs.20,000/-.

• Paid Cash Rs.1,000/- to Satheesh.
• Paid Salary Rs.1000/-.
• Received Commission Rs.250/-.
• Sold goods for Cash Rs.3500/-.
 Subsidiary Books
• General Journal
• Special Journals
• Purchase Book
• Sales Book
• Purchase Return Book
• Sales Return Book
• Bills Receivable Book
• Bills Payable Book
• Cash Book
• Petty Cash Book
 Journal

Journal is the prime or original book of entry in

which all transactions are recorded in the form of
entries. Journalising is an act of recording or
entering transactions in a Journal in the order of
date.
Date Particulars LF Debit Credit
Amount Amount
 Journal Entry

Jan 1, 1981 Prakash Started a business Rs.

15,000/-
Date Particulars LF Debit Credit
Amount Amount
1981 Cash a/c 15,000
Jan 1 Dr. 15,000
To Prakash’s Capital
a/c
(Being cash invetsed to
business)