Chapter 1 - Basics of Accounting

Certificate in Accounting Fundamentals

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Certificate in Accounting Fundamentals

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Contents
Chapter - 1 Basics of Accounting ..................................................................................... 4
Introduction ..................................................................................................................... 4
1.1
Introduction to Accounting Part 1 ...................................................................... 5
1.1.1 Accounting Process........................................................................................... 5
1.1.2 Purpose for accounting ..................................................................................... 6
1.1.3 Who uses Accounting? ...................................................................................... 7
1.1.4 Terms Used in Accounting ................................................................................ 8
1.2
Introduction to Accounting Part 2 .................................................................... 10
1.2.1 Users of Accounting ........................................................................................ 10
1.2.2
Accounting Assumptions, Concepts and Principles ..................................... 12
1.2.3 Accounting Cycle .............................................................................................13
1.2.4
Bases of Accounting .................................................................................... 14
1.3
Book-keeping and Double Entry System ............................................................ 15
1.3.1 Double Entry System ...................................................................................... 15
References ..................................................................................................................... 19

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Certificate in Accounting Fundamentals

Chapter - 1

TCS Business Domain Academy

Basics of Accounting

Introduction
This course is designed to equip the associates in understanding each of the Accounting
Terminologies in detail right from its purpose to its usage. Prior knowledge of accounting is
not essential to understand this course as it is designed in for everyone to understand. This
Chapter tries to explain about the scope of accounting, in terms of purpose, usage,
branches and useINR It also explains the Accounting Concepts, Principles, Conventions and
Book-keeping System.

Learning Objectives
On completion of this chapter, you will understand the:

Scope of Accounting

Accounting Assumptions, Concepts and Principles

Book-keeping

Double-Entry System

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1.1

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Introduction to Accounting Part 1

Whether it is a nearby grocery store or a large corporate entity, recording of transactions is

always there. Hence for any business or non-business activities of organizations (may it be
business organizations or not-for profit organizations) where there is money and other
economic resources involved, there has to be accounting in place. This helps them keep
track of these resources. To put it in simple words, whenever a transaction pertaining to
money or its equivalent is involved there has to be accounting to account for it. Accounting
is considered to be the language of a business. Meaning, it communicates the functioning
of the business.
Did you know?
As per the Indian Mythology, Chitra Gupta is responsible for maintaining accounts in
the Gods court which is where accounting originated.

Accounting is a system which collects and processes financial information of a business.

This information is reported to the users to enable them to take appropriate decisions.

American Institute of Certified Public Accountants (AICPA) defined accounting as The art
of recording, classifying, summarizing, analysing and interpreting the business transactions
systematically and communicating business results to interested users is accounting.
1.1.1

Accounting Process

Based on the above definition, accounting process can be described as shown in Figure 1.

Figure 1 Accounting Process

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The process given above may be put into an accounting cycle which is an end-to-end
sequence of accounting process, which begins with the recording of business transactions
and ends with the preparation of the final accounts as shown in Figure 2.

Figure 2 Flow of Accounting

The day-to-day transactions pertaining to company activities are recorded in a Journal.

These transactions are then consolidated in Ledger where the accounts are written. The
ledger has combined effect of debit and credit pertaining to each account in the form of
balances. These balances are then transferred to a statement called Trial Balance to prove
accuracy of the work done. Then the Trading and Profit & Loss (P&L) account are created.
P&L gives net result of the business transactions. Balance sheet is prepared at the end to
know financial position of the business. The previous years figures are carried forward to
the starting point i.e. journal and they move with new transactions of the next year.
1.1.2

Purpose for accounting

The process of accounting is done to achieve the following purposes:

To have a systematic record: Since it is difficult to remember all the business

transactions, accounting serves the purpose of recording the business transactions in
books of account.

To determine the business results: Accounting helps computing the performance of

business for a given period of time. Trading or a Profit & Loss Account is prepared for
this purpose where the income and expenditure for a particular period (called as
accounting period) are matched.
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To determine the financial position of a business: Profit & Loss Account gives a
financial performance for a given time period but if the overall financial position of a
business is to be determined (like the available cash, total assets & liabilities etc..,)
balance sheets are prepared. This shows the financial strength of the business entity.

To represent the liquidity & solvency positions: In financial reporting, it is mandatory

to provide the source and deployment of funds i.e., its borrowing and repayment of
capital, dividends other deployment of resources which alters the solvency and liquidity
factors of the entity

To assist in decision-making: Financial statements provide a lot of financial

information with which businesses can take rational decisions with respect to the
various aspects of business

To comply with statutory requirements: The are a lot of regulations and statutes
governing the entities like companies, trusts, co-operative bodies, societies as they
have to register their operations under few of these Companies Act, Societies Act etc..,
and their maintenance of accounts must comply with the Sales Tax Act and the Income
Tax Act.

1.1.3

Who uses Accounting?

The different types of organization which require process of accounting to be followed are
shown in Figure 3.

Figure 3 Scope of Accounting in the Business World

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As explained earlier, irrespective of the type of organization, if there are any cash
transactions involved accounting will be in place. So, all the Government organizations,
non-profit organizations, for-profit organizations like sole proprietorship companies or
partnership firms, private firms or publicly traded companies will have accounting.
A sole proprietorship company is a business which is owned by a single person. It is one of
the most of common forms of business entities and is relatively free from legal
complexities. This type of organization is generally seen with shopkeepers and selfemployed professionals like lawyers, doctors and accountants.
In a partnership, two or more individuals called as partners come together in a legal
relationship for doing business with a motive of making profits. Every partner will have their
own rights and responsibilities which will be mentioned in the document of partnership
agreement. There are different types of partnership like, General Partnership, Limited
Partnership and Limited Liability Partnership and there are different types of partners like
general partner (active partner, sleeping partner), special partner, other partner (secret
partner, nominal partner, minor partner, partner at will, partners in profit only, partner by
Estoppel)
A corporation is the predominant form of business in the current world. It is a legal entity
that distinguishes owners from itself. It enjoys equal rights and responsibilities that an
individual possesses where it can enter into contracts, hire employees, borrow money,
purchase and own assets, pay taxes. Corporations are of two types - privately owned or
publicly traded. Private firms are owned by less number of individuals when compared to
publicly traded corporations that are listed on one/few stock exchanges and owned by a
larger number of individuals. The ownership unit of public corporations is called as equity.
1.1.4

Terms Used in Accounting

For understanding accounting it is necessary to acquaint yourself with following terms:

Transaction is an activity concerned with businesses which involve transfer of

money or goods or services between two entities. For example, purchase of goods,
salaries paid, etc. Cash transaction involves cash receipt or payment of cash, for
example buying goods by paying cash. Credit transaction involves transaction on
credit where receipt or payment happens later.

Proprietor owns a business and contributes capital to the business to earn profit.

Asset is a thing of value to the business or significant property belonging to the

business. Some examples include Cash, plant and machinery. Tangible Assets have
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physical existence. It can be seen and touched. For example, plant & machinery,
cash, etc. Intangible Assets have no physical existence but their possession gives
rights and benefits, to the owner. It cannot be seen and touched. Goodwill, patents
are some of the examples.

Liabilities are financial obligations of a business towards others e.g. loans from
bank, creditors for goods supplied.

Drawings are cash or value of goods withdrawn from the business/company by the
proprietor for his personal use. It is deducted from the capital. Debtor is a person,
individual, or firm which receives benefit but promises to pay in future. Debtors
form part of firms assets. Creditors give benefit to the company first and claim it in
future. Creditors form liability in the balance sheet.

Purchases are goods bought for resale or for use in the process of production.
Purchases can be cash purchases or credit purchases. Sometimes these purchases
are returned due to poor quality or not as per the terms of purchase, it is called
purchases return. Net purchases are equal to Total purchases (cash+credit) minus
purchase return.

Sales is the amount of goods sold from already bought goods or manufactured
goods. Sales can be cash sales or credit sales. Sometimes customer may return
goods due to poor quality or not as per terms of sale, it is termed as sales return or
return inward. Net sales are equal to Total sales (cash+credit) minus Sales return.

In accounting, stock includes goods unsold on a particular date. Opening stock

means goods unsold in the beginning of the accounting period whereas the term
closing stock includes goods unsold at the end of the accounting period.

Revenue includes amount received or receivable from sale of goods and other
earnings in the form of interest, dividend, commission, etc.

Expense is all spending in order to produce and sell the goods and services. For
example, spending for raw materials, wages, etc.

Income is the difference between revenue and expense.

Voucher is a written document supporting a transaction. It is evidence that a

particular transaction has taken place for the value given in the voucher. The
voucher may be in different forms, for example, invoice, cash memo, etc.

Invoice is a business document or statement prepared by the seller of goods

containing information about seller and buyer, the date of sale and description of
goods with quantity and price.
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Receipt is an acknowledgement given by seller for cash received. Seller issues it to

buyer who pays cash. Cash book entries are based on these receipts.

Account is a summary of business transactions (financial transactions) at one place

relating to a person, asset, expense or revenue named in the heading. An account
has two sides called debit side and credit side.

1.2

Introduction to Accounting Part 2

With the growth in the scale of business operations, management has become more
complex. And it has given rise to the specialized branches of accounting. Major branches of
accounting are financial accounting, cost accounting and management accounting.
Financial accounting refers to recording of business transactions in the book of accounts in
a manner where the operating results pertaining to a particular period and the financial
position as on a particular date can be ascertained.
Cost accounting refers to ascertainment of cost of production for various jobs performed
by the firm.
Management accounting makes use of accounting data generated by financial accounting
and cost accounting in order to formulate policies, take managerial decisions, and make
investment decisions.
1.2.1

Users of Accounting

The different type of users of accounting is shown in Figure 4.

Figure 4 Users of Accounting

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Accounting information of an entity is essential for a number of reasons, it could be for

knowing the financial status of his company by its proprietor or to do a financial analysis of
the company by the potential investors or to keep a check on the functioning of business
and adherence to laws by the regulatory bodies.

Let us see the several users of accounting in detail:

Internal Users: These individuals or groups are closely associated with the functioning of
the organization and are within the organization.

Owners: Owners could be a proprietor or a partner if it is a partnership firm or a

shareholder if it is a public listed firm. All these people have their interests in the
firm and would like to have the financial transactions recorded so that they can be
accessed at any point of time and ascertain the financial soundness of the business.

Management: In order to take timely decisions for managing the business

efficiently, management needs the accounting information.

Employees & Trade Unions: Since the remuneration and the bonus of these
people depend on the earning capacity of the firm, only with accounting they can
make the judgments about it.

External Users: These individuals or groups are outside the organization but have interest
in the organization.

Creditors, Banks & other Lending institutions: These are the entities which lend
money to the organization for running its business and for evaluating the
repayment capacity (principal & interest) of the organization the need this
accounting information

Present Investors: Existing investors would want to know the current position and
progress of the business so that

Potential Investors: In order to decide on investing in the business, potential

investors need the financial information of the organization

Government & Tax Authorities: To compute the tax liabilities of the organization,
these entities need the earnings of the organization

Regulatory Agencies: In order to monitor whether the business operations are

complying with the regulations

Researchers: For preparing research reports, researchers need financials of the

organization
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1.2.2

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Accounting Assumptions, Concepts and Principles

Accounting is called as language of the business. This language has certain assumptions,
concepts, and principles which are necessary for all interested parties to know to
understand accounting results of the company. These are shown in Figure 5.

Figure 5 Accounting Principles

Following are the accounting assumptions, which are also called as pillars of accounting:

Business Entity Assumption: Business is an entity which is separate from the

owners/creditors etc. The logic being, owners capital is credit to the company.

Money Measurement Assumption: Only financial transactions and events get

recorded in accounting

Accounting Period Assumption: Users of the financial reports are interested in

periodical reports because they want to know financial position for certain period
by certain date. Generally accounting period is for 1 year.

Going Concern Assumption: Business shall go on without winding it up in

foreseeable future - this is the assumption while recording transaction.

In accounting there are certain concepts which guide recording of business transactions.
Assumptions mentioned above have given rise to following concepts:
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All business transactions are recorded in TWO aspects. When business acquires
asset, it is receiving benefit but it must pay for receiving the benefit. This is called
Dual aspect principle which is the basis for Double Entry System of book-keeping.

Any revenue is recognized as income earned on a date only when it is realized. This
is Revenue Realization (Recognition) Concept. Unrealized revenue should not be
considered as it may inflate income and hence profits.

All the assets are recorded at their acquisition price and further accounting
treatment is based on this cost. For example land bought at INR 500,000 might
fetch INR 800,000 at the time of preparing statements but figure shown will be INR
500000 and not INR 800,000. This is historical cost concept.

All revenues earned are matched with expenses (cost) during a given accounting
period to come to the final financial position. This is matching concept. This
concept helps in determining accurate profit forgiven period.

The above mentioned assumptions and concepts have been modified to become following
accounting conventions:

All the information related to the material facts must be disclosed in the financial
statements and also accompanying noted must be provided so that users can be
informed about the decisions. This is called as convention of materiality.

Various interested parties expect full and complete disclosure of information so

that they can make rational decision. This is Full Disclosure Concept.

There has to be a consistency in the rules, principles, concepts and practices and
will have to be followed and observed every accounting period. This is called as
convention of consistency.

Profits cannot be recorded until they are recognized; also the losses which are even
remotely possible will have to be mentioned in the book of accounts. This is called
convention of conservatism.

Each business transaction in the books of accounts should have adequate evidence
to support it and free from any bias. This is Verifiable and Objective Evidence
Concept.

1.2.3

Accounting Cycle

Accounting has a sequence of steps. It starts with preparation of Journal from Source
documents, later transferring those to Ledger, consolidating them in trial balance, from
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which the financial statements (Trading account, Profit & Loss account, Balance Sheet) are
prepared. These are shown in Figure 6.

Figure 6 Sequential steps in Accounting

1.2.4

Bases of Accounting

As we all know one of the primary functions of accounting is to determine the profit earned
by a business entity for a given period of time and that profit figure can be calculated based
on two methods:

Cash basis of accounting: In this system of accounting, the transactions are

recorded only when the cash is paid or received, meaning revenue is recognized
only on the actual receipt and expenses are recorded only when they are paid.
Hence in this model, outstanding expenses and accrued revenue are not considered
while computing the total revenue and total expenses, the difference of which
actually gives the profit or loss of a business for a given accounting period.
Outstanding expenses are those expenses which are due to be paid. Accrued
revenue is the revenue earned but not yet received.

Accrual basis of accounting: In this system of accounting, for a given accounting

period all the revenue and expenses pertaining to it are considered irrespective of
actual receipts and actual payments. Meaning income accrued for a given
accounting period is income for that period even if it is not received in that period.
Similarly expenses payable for a given accounting period are expenses for that
period even if they are not paid in that period. For instance, credit sales are included
in the income even if cash is not received on that account, similarly if the entity has

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purchased some goods and is yet to pay for them it has to be recorded as an
expense though not paid.

Consider the following illustration for an understanding of both the models:

For the financial year 2011-12, Ranjith had cash sales of INR 15, 00,000 and credit sales of
INR 5, 00,000. And his expenses amount to INR 8, 00,000 of which INR 2, 00,000 are yet to
be paid. Compute the income of Ranjith for FY 2011-12 based on cash basis of accounting
and accrual basis of accounting.

Cash Basis of Accounting

Amount (INR)

Revenue (in terms of Cash Inflows)

10, 00,000

Less: Expenses (Outflow of cash) (i.e. INR 8, 00,000- 2, 00,000)

6, 00,000

Net Income (Cash Basis of Accounting)

4, 00,000

Accrual Basis of Accounting

Amount (INR)

Total Sales:
Cash Sales (10, 00,000) + Credit Sales (5, 00,000)

15, 00,000

Less: Total Expenses for year 2011-12

8, 00,000

Net Income (Accrual Basis of Accounting)

7, 00,000

1.3

Book-keeping and Double Entry System

As there will be hundreds and thousands of business transactions happening on a day-today basis, only if they are recorded in a systematic manner can they be tracked easily. Such
recording of business transactions is called as book-keeping. In book-keeping, only those
transactions related business which can be represented in terms of money are recorded.
Book-keeping is defined as The art of keeping a permanent record of business transactions
in a systematic manner Book-keeping is the initial step to accounting and it works as the
basis for accounting information. While book-keeping is restricted to identifying and
recording individual financial transactions, accounting is concerned with classifying,
summarizing, interpreting and communicating the results.
1.3.1

Double Entry System

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It is one of the methods of recording business transactions. In this method for any given
transaction, there will be one debit and a corresponding credit entry. Hence a single
transaction affects two accounts in this system and hence the double entry system.
Transactions can be recorded in two approaches. They are:

Accounting Equation Approach: A transaction is an economic event that affects

an element of the accounting equation and must be recorded. Accounting equation
is used for recording and summarizing transactions.
Assets= Liabilities + Owners Equity

Traditional Approach: In this model, business transactions are formed on the basis
of the existence of two aspects (debit and credit) in each transaction. All the
business transactions are recorded to the book of accounts under the Double Entry
System.

Classification of accounts under the double entry system:

In the double entry book-keeping system, accounts are classified into two types, personal
and impersonal accounts. Impersonal accounts are further classified into two types,
nominal and real accounts. These are further described in figure 8.

Figure 7 Classification of accounts under the double entry system

Personal Accounts: Accounts related to any natural persons, artificial persons and
representative personal accounts are termed as personal accounts.
o

For example:

Rajeshs A/c, Khannas A/c Natural Persons (Accounts which relate to

individuals),

SVR Trading Co. A/c, Reliance Industries Ltd. A/c - Artificial Persons
(Accounts which relate to a group of persons or firms or institutions),
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Outstanding Salaries A/c, Rent receivable A/c Representative Persons

(Accounts which represent a particular person or group of persons)

Real Accounts: Real accounts pertains to tangible and intangible assets

o

For example: Building A/c, Machinery A/c, Cash A/c Tangible Assets

Patent A/c, Goodwill A/c, Copyright A/c Intangible Assets

Nominal Accounts: Accounts related to income, expenses, profit and losses are
related to nominal accounts.
o

For example: Purchases A/c, Salaries A/c Expenses

Depreciation, Bad Debts, Abnormal Losses Losses

Sales A/c, Commission received A/c Income

Bad debts recovered, increase in value of assets Profit

Classification of accounts according to accounting equation approach:

Different types of accounts according to accounting equation approach are as described in
table 1.

Table 1 Different Types of Accounts

Types of Accounts

Meaning

Examples

Asset Account

Deals with tangible

intangible real assets

and Land a/c, Building a/c, Plant & Machinery

a/c, Cash a/c etc..,

Liabilities Account

Deals with the financial Long term Loans, Debentures, Bank Loans,
obligations of the firm to Trade Creditors, Outstanding expenses
outsiders

Capital Account

Deals with the accounts of the Capital a/c, Drawings a/c

owners of the company

Revenue Account

Deals with amount charged Sales a/c, Royalty received a/c, interest
for goods sold or services received a/c, dividend received a/c
rendered and other incomes

Expenses Account

Deals with the expenses Purchases a/c, Discount allowed a/c,

incurred in the process of Interest paid a/c, Loss by fire a/c
earning revenue

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Summary

For any business or non-business activities of organizations (may it be business

organizations or not-for profit organizations) where there is money and other
economic resources involved, there has to be accounting in place to keep a track of
those resources.

Accounting is considered to be the language of a business.

Accounting is a system which collects and processes financial information of a

business. This information is reported to the users to enable them to take
appropriate decisions.

American Institute of Certified Public Accountants (AICPA) defined accounting as

The art of recording, classifying, summarizing, analysing and interpreting the
business transactions systematically and communicating business results to
interested users is accounting.

Purpose for accounting:

o

To have a systematic record

To determine the business results

To determine the financial position of a business

To represent the liquidity & solvency positions

To assist in decision-making

To comply with statutory requirements V

Branches of Accounting:
o

Financial accounting

Cost accounting

Management accounting

Book-keeping is defined as The art of keeping a permanent record of business

transactions in a systematic manner. Book-keeping is the initial step to accounting
and it works as the basis for accounting information.

Accounting Equation Approach: A transaction is an economic event that affects

an element of the accounting equation and must be recorded. Accounting equation
is used for recording and summarizing transactions.

Traditional Approach: In this model, business transactions are formed on the basis
of the existence of two aspects (debit and credit) in each transaction. All the
business transactions are recorded to the book of accounts under the Double Entry
System.
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References
Class 12 Accountancy, NCERT Publications, 2004 Edition
Financial and Management Accounting, Sikkim Manipal University Publications, 2010
Edition
Intermediate Accountancy, Telugu Academy Publications, 2009 Edition
www.sgbau.ac.in/accounting-for-manageINRpdf
www.accountingcoach.com/online-accounting-course/60Xpg01.html
www.pitt.edu/~super7/23011-24001/23941.ppt
www.accsoft.ch/download/accountingconcepts.pdf
www.accounting-basics-for-students.com

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