A C C O U N TA N C Y

Ch.1: Introduction to Accounting

Meaning of Accounting
Accounting is a systematic process of identifying, measuring, recording the business transactions
and communicating the required information to the interested users.

Definition of Accounting
The American Institute of Certified Public Accountants (AICPA) had defined accounting as

“the art of recording, classifying and summarising in a

s i g n i f i c a n t m a n n e r a n d i n t e r m s o f m o n e y, t ra n s a c t i o n s a n d
e v e n t s w h i c h a r e , i n p a r t a t l e a s t , o f f i n a n c i a l c h a r a c t e r, a n d
interpreting the results thereof”

Relevant aspects of the definition

1. Economic Events:
Accounting records only those transactions and events which are part of economic activities.
E.g.: purchase of goods, sale of goods, payment of wages and salaries, etc
2. Identification, measuring, recording and communicating
Identification – Transactions are identified with help of bills and receipts and recorded
Measuring – Accounting measures the transactions and events in terms of a common
measurement unit (i.e., currency of a country)
Recording – Transactions are recorded in the books of accounts
Communication – The information is regularly communicated to the internal and external users
through accounting reports.
3. Organisation
Accounting is done for business enterprises like sole-proprietary concern, partnership firms or
companies, or not-for-profit organisations like charitable trusts, sports clubs or government
organisations.
4. Interested users of Information
Accounting is also called the language of business, as it communicates the results of business to
the internal as well as the external users.

Users of Accounting Information and the need for such information

I. INERNAL USERS
Owners: They are interested in knowing the profit earned or loss incurred by the business besides
the safety of their capital
Management: Management require accounting information to decide on investment in new
projects, expansion of existing facilities, pricing of products, etc.
Employees and workers: They may require to know the financial performance in order to demand
for salary or wage increase, bonus and other benefits
II. EXTERNAL USERS
Banks and Financial Institutions: To make decisions on granting loans, ensure the safety and
recovery of the loan and interest amount
Investors: To assess the earning capacity of the enterprise and safety of their investments
Creditors (Suppliers): To assess the credit-worthiness of the business and make decisions on the
amount and extent of credit sale of goods or service
Government and its tax authorities: The government needs to compile its national income, etc
and tax authorities to assess GST and other income taxes.
Accounting as a source of Information
• Accounting is a definite process of interlinked activities that begins with the identification
of transactions and ends with the preparation of financial statements.
• Every step in the accounting process generates information.
• Generation of information is a means of facilitating the dissemination of financial results to
different user groups.
• Accounting information help different user groups to take appropriate economic decisions.
• Therefore communication (dissemination) of economic information is the essential function
of accounting.

Branches of Accounting
I. Financial Accounting
• It assists in the systematic maintenance of accounting records, preparation and presentation
of financial reports.
• It measures the organisational success and financial soundness.
• It serves the stewardship function, as it maintains and safeguards the capital invested by
owners and also monitors and controls the debts of the business.
• It is primarily concerned with the communication of financial information to all stakeholders
(i.e., the parties having interests in the business)
II. Cost Accounting:
• It is concerned with ascertaining cost of products or services rendered by the business
• It deals with recording costs with the objective of reducing and controlling such costs
• It helps the business in fixation of selling price of the product or service.
• It provides necessary costing information to the management for decision making.
III. Management Accounting
• It draws information mainly from Financial Accounting and Cost Accounting
• It addresses the needs of a single user group, i.e., the management.
• It generates and provides accounting information relating to funds, costs, profits, etc.
• It provides financial data for budgeting and forecasting.

Objectives of Accounting
Main objectives of accounting are:
1. To maintain a systematic record of business transactions

• Accounting is used to maintain a systematic record of all the financial transactions in a

book of accounts.
• For this, all the transactions are recorded in chronological order in Journal and then
posted to principle book i.e. Ledger.
2. To ascertain profit and loss

• Every businessman is keen to know the net results of business operations periodically.
• To check whether the business has earned profits or incurred losses, we prepare a “Profit
& Loss Account”.
3. To determine the financial position

• Another important objective is to determine the financial position of the business to

check the value of assets and liabilities.
• For this purpose, we prepare a “Balance Sheet”.
 4. To provide information to various users

• Providing information to the various interested parties or stakeholders is one of the most
important objectives of accounting.
• It helps them in making good financial decisions.

Advantages of Accounting
Following are the main advantages of accounting:
1. Provide information about financial performance

• Accounting provides factual information about financial performance during a given

period of time, i.e., profit earned or loss incurred over a period and financial position at a
particular point of time.
2. Provide assistance to management

• Accounting helps management in business planning, decision making and in exercising

control. For this, it provides financial information in the form of reports.
3. Facilitates comparative study

• By keeping systematic records and preparation of reports at regular intervals, accounting

helps in making a comparison.
4. Helps in settlement of tax liability

• Systematic accounting records help in settlement of various tax liabilities. Such as –

Income Tax, GST etc.
5. Helpful in raising loan

• Banks and Financial Institutions grant a loan to the firm on the basis of appraisal of the
financial statement of the firm.
6. Helpful in decision making

• Accounting provides useful information to the management for taking decisions.

Limitation of Accounting
(1) Estimates and assumptions in accounting make it unrealistic and inexact.
(3) Accounting ignores the qualitative elements in a business
(4) Manipulation of Accounts (Window dressing)
(5) Accounting ignores the effect of price level changes
(6) Not free from bias of accountants and others
Qualitative Characteristics of Accounting
Qualitative characteristics are the attributes of accounting information, which enhance its
understandability and usefulness:
1. Reliability: Reliability implies that the information must be free from material error and personal
bias.

2. Relevance: Accounting information must be relevant to the decision-making requirements of the

users.

3. Understandability: Information should be disclosed in financial statements in such a manner that

these are easily understandable.

4. Comparability: Both intra-firm and inter-firm comparison must be possible over different time
periods.

Changing Role of Accounting

The role of accounting has changed from that of a mere record keeping during the decade of
20th century to the present stage, when it is accepted as information system and decision-
making activity.
The role of accounting at present is assured:
i. To provide information for judging management ability to utilise resources effectively in
achieving goals.
ii. To provide factual and interpretative information by disclosing underlying assumptions on
matters subject to interpretation, evaluation, prediction or estimation.
iii. To provide information or activities affecting society.

Basic accounting terms

1. Entity:
A person, partnership, organization, or business that has a legal and separately identifiable
existence.

2. Transactions (Business Transaction):

An Economic activity that affects financial position of the business and can be measured in terms
of money e.g., expenses etc.

3. Assets:
Assets are valuable and economic resources of an enterprise useful in its operations. Assets can
be broadly classified as:
(i) Current Assets: Current Assets are those assets which are held for short period and can be
converted into cash within one year. For example: Debtors, stock etc.
(ii) Non-Current Assets: Non-Current Assets are those assets which are hold for long period and
used for normal business operation. For example: Land, Building, Machinery etc.
Non-current assets are further classified into:
(a) Tangible Assets: Tangible Assets are those assets which have physical existence and can be
seen and touched. For Example: Furniture, Machinery etc.
(b) Intangible Assets: Intangible Assets are those assets which have no physical existence and can
be felt by operation. For example: Goodwill, Patent, Trade mark etc.
4. Liabilities:
Liabilities are obligations or debts that an enterprise has to pay after some time in the future.
Liabilities can be classified as:
(i) Current Liabilities: Current Liabilities are obligations or debts that are payable within a period
of one year. For Example: Creditors, Bill Payable etc.
(ii) Non-Current Liabilities: Non-Current Liabilities are those obligations or debts that are payable
after a period of one year. Example: Bank Loan, Debentures etc.

5. Capital:
Amount invested by the owner in the firm is known as capital. It may be brought in the form of
cash or assets by the owner.

6. Sales:
Sales are total revenues from goods sold or services provided to customers. Sales may be cash
sales or credit sales.

7. Revenue:
In accounting, revenue is the income that a business has from its normal business activities, usually
from the sale of goods and services to customers, revenue from interest, royalties, or other fees.
Revenue may refer to business income in general, or it may refer to the amount, in a monetary
unit, earned during a period of time

8. Expenses:
Costs incurred by a business for earning revenue are known as expenses. For example: Rent,
Wages, Salaries, Interest etc.

9. Expenditure: Spending money or incurring a liability for acquiring assets, goods or services is
called expenditure. The expenditure is classified as:
(i) Revenue Expenditure: It is the amount spent to purchase goods and services that are used
during an accounting period is called revenue expenditure. For Example: Rent, Interest etc.
(ii) Capital Expenditure: If benefit of expenditure is received for more than one year, it is called
capital expenditure. Example: Purchase of Machinery.
(Deferred Revenue Expenditure: There are certain expenditures which are revenue in nature but
benefit of which is derived over number of years. For Example: Huge Advertisement Expenditure.)

10. Profit: The excess of revenues over its related expenses during an accounting year is profit.
Profit = Revenue – Expenses

11. Gain: A non-recurring profit from events or transactions incidental to business such as sale
of fixed assets, appreciation in the value of an asset etc.

12. Loss:
The excess of expenses of a period over its related revenues is termed as loss.
Loss = Expenses – Revenue

13. Discount: Discount is the rebate/deduction in the price given by the seller to the buyer. It
can be classified as:
1. Trade Discount: The purpose of this discount is to persuade the buyer to buy more goods. It is
offered at an agreed percentage of list price at the time of selling goods. This discount is not
recorded in the accounting books as it is deducted in the invoice/cash memo.
2. Cash Discount: The objective of providing cash discount is to encourage the debtors to pay the
dues promptly. This discount is recorded in the accounting books. It can be ‘discount allowed’ (in
the books of creditor) or ‘discount received/earned’ (in the books of debtor)

14. Voucher: The documentary evidence in support of a transaction is known as voucher.

For example, if we buy goods for cash, we get cash memo, if we buy goods on credit, we get an
invoice, when we make a payment, we get a receipt.

15. Goods: The products in which the business deal in. The items that are purchased for the
purpose of resale and not for use in the business are called goods.

16. Drawings: The money or goods or both withdrawn by owner from business for personal use,
is known as drawings. Example: Purchase of car for wife by withdrawing money from business.

17. Purchases: The term purchase is used only for the goods procured by a business for resale.
In case of trading concerns it is purchase of final goods and in manufacturing concern it is purchase
of raw materials. Purchases may be cash purchases or credit purchases.

18. Stock: The goods available with the business for sale on a particular date is known as stock.
In accounting, the stock is the amount of goods which are lying unsold as at the end of an
accounting periods. It is called Stock-in-hand or inventory. Stock in the beginning of the accounting
period is called ‘Opening Stock’ and at the end of the period, it is called ‘Closing Stock’.

19. Debtors: Debtors are persons and/or other entities to whom business has sold goods and
services on credit and amount has not received yet. These are assets of the business. Total all
debtors are termed as ‘sundry debtors’.

20. Creditors: If the business buys goods/services on credit and amount is still to be paid to the
persons and/or other entities, these are called creditors. These are liabilities for the business. Total
of all creditors are termed as ‘sundry creditors’.

Prepared by
Maria Waltin
The Asian School
Kingdom of Bahrain