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Introduction to Accounting
(Classroom Notes)

Accountancy

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Introduction to Accounting
Need for Accounting
Whenever we start doing business, a number of transactions take place. For example, if we start a
business of say, a book store (i.e. we’ll be buying books from wholesalers and publishers, and
selling them to customers), following things pop up in our minds at the first instance:

1. Taking an office/shop on rent for the purpose of our business

2. Contacting the wholesalers and the publishers
3. Purchasing books from them
4. Advertising
5. Selling the books to customers

Now, when the business starts functioning, we’ll want to know how much profit we have earned
from the business in a year. It is practically impossible to just remember whatever happened in the
whole year. For example, we may have bought books from the wholesalers or publishers on credit
(credit: the ability of a business entity to obtain goods before payment), so we would want to
know how much money we owe them. On the other hand, we may have sold certain books to our
customers on credit (credit: the ability of customers to obtain goods before payment), and we
would want to know how much money our customers owe us.

Therefore, it is advisable to record all the Financial Transactions that take place, as and when they
take place. Hence, the need for “Accounting” arises. A Financial Transaction is a transaction which
involves money. The financial transactions are recorded in what is called “Books of Accounts”.

Book Keeping, Accounting, and Accountancy

Book Keeping
Book Keeping is mainly concerned with record keeping or maintenance of books of accounts. The
maintenance of books of accounts includes the following four activities:
1. Identifying the transactions of financial nature from amongst the various transactions.
2. Measuring the identified transactions in terms of money.
3. Recording the identified transactions.
Recording is done in what is called the “Books of Original Entry”, also known as “Journal”.
4. Classifying them.
Classification is done in what is called “Ledger”.

Account
In actual practice, the individual transactions of like nature are recorded, added and
Subtracted at one place. Such a place is customarily termed as an
“Account”. It is abbreviated as “A/c”.
Examples:
o Any organisation these days needs a computer. Many a times, more than one
computer is required. Old Computers would be sold off and new Computers would be
bought for as long as the Business continues. The purchase and sale of computers will
be recorded in one place, called the “Computer Account” or the “Computer A/c”.

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o All the transactions related to a particular supplier*, say, Ram, would be recorded
in a place called “Ram A/c”.
*Supplier: a person from whom the business purchases goods for further sale; for
example, in the business of a book store, the wholesalers or the publishers from
whom the business purchases books, are suppliers.
o All the transactions related to Cash will be recorded in a place called “Cash A/c”.
When a transaction of a particular nature occurs for the first time, it is said that an
Account is opened for that type of transaction. For example, in case of a new supplier, say
Shyam, with whom no business has ever been transacted, a new Account, called the
“Shyam A/c” will be opened in the books of accounts, and all the transactions related to
Shyam, i.e. Purchase of Goods and Payment to the supplier will be done in Shyam A/c.

Ledger
Ledger is a book containing various “Accounts”.

Accounting
Accounting starts where Book-Keeping ends. It includes the following activities:

1. Summarising the classified transactions.

Summarising is done in the following three
forms: Trial Balance
Trading and Profit & Loss
Account Balance Sheet

2. Analysing and interpreting the summarised results.

3. Communicating the information to the interested parties.

However, in actual practice, the accounting process includes the book-keeping function also.

Therefore, the definition of Accounting is as follows:

Accounting is a systematic process of identifying, measuring, recording, classifying, summarising,

interpreting and communicating Financial Information.

Thus, Accounting involves the following processes:

1. Identifying,
2. Measuring,
3. Recording,
4. Classifying,
5. Summarising,
6. Interpreting, and
7. Communicating.

On taking a look at the above definition, we find that these processes revolve around one thing,
i.e.
“Financial Information”. Financial Information is explained in a while.

Hence, it is clear that Accounting concerns itself with only Financial Information. Any kind of Non-
Financial Information is out of the scope of Accounting.

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Accountancy
It refers to a systematic knowledge of accounting, concerned with the principles and techniques,
which are applied in accounting. It tells us the following:

1. How to prepare the books of accounts,

2. How to summarise the accounting information, and
3. How to communicate it to the interested parties.

Overview of Book Keeping, Accounting, and Accountancy

 Understanding the relationship between Accounting and Accountancy:

o Accounting is a process and Accountancy is knowledge.
o Accountancy frames rules and principles which are to be followed and
complied in the Accounting process.
o It is therefore said that accountancy is the knowledge of accounting and
accounting is the application of accountancy

 Differences between Book Keeping and Accounting:

Sr.
Basis Book Keeping Accounting
no.
1 Meaning It is a part of accounting, as it It is the art of recording, classifying
and involves identification of financial and summarising in a significant
Scope transactions, measurement of manner and in terms of money,
such transactions in monetary transactions and events which are,
terms, recording of such in part at least, of a financial
transactions in the books of character and interpreting result
account and classifying the thereof.
transactions and events by way of
posting them.
2 Stage First stage of accounting and is Second stage, starts where
therefore, considered as a basis Book Keeping ends.
of accounting.

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3 Purpose Purpose is to maintain systematic Purpose is to ascertain net results

records of the financial
transactions.
4 Nature It is of routine nature.
5 Skills It is mechanical in nature and
therefore, does not require
special skills.
6 Performed It is performed by junior staff.
of operations and financial
position of the enterprise so as to
communicate information to the
interested parties.
It is analytical and dynamic in
nature.
It requires special skills and ability
to interpret the information
effectively.
It is performed by senior staff.

Characteristics, Objectives, Process and Branches of Accounting:

 Characteristics or Attributes:
o Identification of the economic events and financial transactions:
In order to record the transactions in the books of account, it is
necessary to identify the transactions which are considered as a part
of economic activity for the entity. This is done with the help of bills and
invoices issued for the respective transactions.
o Measurement in terms of money: In order to measure all the
identified transactions and events in terms of a common
measurement unit, all the transactions are to be measured in terms
of money. This is because, accounting records only those
transactions which are measurable in monetary terms.
o Recording of business transactions: This is the process of entering the
business transactions in the primary or original book of account i.e.,
Journal which is further divided into specific subsidiary books such Cash
Book, Purchases Book, Sales Book, etc.
o Classification of business transactions: It is the process of classifying
the identified transactions or entries of similar nature at one place. This is
done by posting the entries from the Journal to the respective Ledger
Accounts under which all the transactions of similar nature are collected.
o Summarising business transactions: This involves presenting the
classified data in a manner that is useful and understandable to the users
of financial statements. Summary is prepared by presenting the data in
various statements like Trial Balance, Trading and Profit and Loss
Account and Balance Sheet. These are collectively known as Final
Accounts.
o Analysing and Interpreting the business transactions: In order to
make valuable judgments and financial decisions, the information
presented in various statements is analysed and interpreted in a
systematic manner.
o Communicating the results and conclusions to the interested users
in the form of various statements: Involves communicating the valuable
accounting information to the interested users so as to aid them in taking
important decisions.

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 Objectives:

o It maintains a systematic record of all financial transactions in book of

accounts.
o It gives an idea about the net results of the business operation
periodically. The owner of business organisation can ascertain the profit
earned or loss incurred during an accounting period based on the records
maintained.
o It helps to determine the financial position of the business in terms of
assets and liabilities on a particular date which is usually the last day of an
accounting year. It also gives a proper account of assets held in the
business and the liabilities due for payment.
o It provides valuable information to the users in the form of reports,
statements, graphs and charts.
o It facilitates proper planning and effective decision making based on the
detailed accounting information maintained.
 Accounting Process: Steps involved in an accounting process are based on
the attributes of Accounting which are presented below in the form of a
diagram:

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 Branches of Accounting: Due to increased scale of business operations,

the management function has become more complex now. We have
specialized branches of accounting to handle these situations.

o Financial Accounting: This branch of accounting records financial

transactions, summarises and interprets them to present and
communicate the financial results and performance to the interested
users.
o Cost Accounting: This branch of accounting takes into account all the
business operations, processes or activities in order to ascertain the cost
of products and simultaneously reduce and control costs.
o Management Accounting: This branch of accounting is said to address
the needs of a single user group i.e., the management, as it enables the
management to gather information relating to funds, costs, profits, etc.
which enables them to take proper decisions.

Financial Information
Financial Information arises from Business Transactions. So, let us first understand what are
Business Transactions.

Business Transaction
1. The term “Business Transaction” means a financial transaction or event entered into by
two parties and is recorded in the books of account.
2. It is a financial event expressed in terms of money which brings a change in the financial
position of an enterprise.
3. It is an agreement between two parties involving the transfer or exchange of goods or
services.
4. Examples of business transactions are:
a. Sale of Goods
b. Purchase of Goods
c. Receipt from Debtors (Debtor: A customer who owes money to the Business)
d. Payment to Creditors (Creditor: A supplier to whom the Business owes money)
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e. Payment of Interest on Loan taken

f. Purchase of Diesel for Generators
g. Conveyance Expenses, etc.

So, a business transaction gives rise to Financial Information. Now, the last process in the
definition of Accounting is Communicating the Financial Information. Since Accounting helps in
Communication, it is known as the “Language of Business”.

Accounting Cycle
Remember when we started learning English? We started off by learning Alphabets, then we joined
Alphabets to form Words, then we joined Words to form Sentences, then we joined Sentences to form
Paragraphs, then we joined Paragraphs to form a whole Chapter, and finally a set of Chapters
became a Book!
So, we can say that following is the cycle of English Language:

Alphabets → Words → Sentences → Paragraphs → Chapters → Book

Similarly, we have an Accounting Cycle:

Voucher → Journal → Ledger → Trial Balance → Trading and Profit & Loss Account → Balance
Sheet

We’ll eventually learn each of these in detail.

Financial Statements
Throughout the year, a number of Business Transactions take place. At the end of the year, any
businessman would want to know whether he has made any profit during the year, and if so, what
is the amount of profit that he has made. Apart from Profit, there are certain other things that a
businessman would like to know, for example:

1. Assets (Asset: Anything which is in the possession or is the property of a business

enterprise
including the amounts due to it from others, is called an Asset. Example: Cash Balance,
Bank Balance, Furniture, Computers, Debtors, etc.)
2. Liabilities (Liability: It refers to the amount which the business enterprise owes to
outsiders.
Example: Creditors, Loan taken from Bank, etc.)

This is only possible if we have a summary of the transactions that took place throughout the year.
As per the definition of Accounting, it is a systematic process of identifying, measuring, recording,
classifying, summarising, interpreting and communicating Financial Information.

This summary is known as the “Financial Statements”.

Therefore, “Financial Statements” is a summary report that shows how a Business has used the
funds invested into it by the owner, and what is its current Financial Position. The three basic
Financial Statements are:

1. Balance Sheet – This shows Business’s Assets, Liabilities, and Net Worth * on a stated date,
2. Income Statement (also called Profit & Loss Account) – This shows how the Net Income of
the Business is arrived at over a stated period, and
3. Cash Flow Statement – This shows the inflows and outflows of cash caused by the
Business’s activities during a stated period.
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*Net Worth is basically Assets minus Liabilities.

Users of Financial Statements

1. As is evident from above, the first and foremost user of the Financial Statements would be
the owner of the Business.
2. Apart from owner, there are certain other parties who could be the users of the Financial
Statements.
3. Examples:
a. An organization has taken a loan from the Bank for the purpose of carrying on its
business. Now, that Bank would also like to know whether the organisation is
profitable or not. This can be only be known from the Financial Statements. Hence,
Bank also becomes a “user” of the Financial Statements.
b. The creditors, i.e. the people to whom the organisation owes money, would also
like to know whether the business is profitable or not, and hence, Creditors are
also
“users” of the Financial Statements.
4. Therefore, any person, who has a stake in the business of an organisation will become a
“user” of the Financial Statements of that organisation.

 Users:

o Internal Users:
i. Owners: These are those who contribute capital in the business.
Since, they invest their money in the entity, they are interested in
knowing the profits earned or losses incurred by the business which
determines the returns they would earn on their investments.
ii. Management: They are the one who is responsible for the
operations and decisions taken for the business entity. They are
those who extensively use the accounting information to make
decisions and plan further actions to improve the profitability of the
operations.
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iii. Employees and workers: These are those who are entitled to the
salary, bonus, etc. which are directly linked to the profitability of the
organisation. In order to determine whether the organisation is in a
position to pay out such amounts, these employees and workers are
interested to know the profitability and financial position of their
organisation. Also, financial statements keeps them informed
regarding compliance with various provisions related to the
Provident Fund, Insurance, Gratuity, etc.

o External Users:
i. Creditors: The parties who supply raw material/goods/services on
credit based on the credibility and past experiences with that
particular entity. In order to decide whether to supply anything on
credit to a particular party or not, these creditors analyse the
financial statements to determine the liquidity and solvency of that
party to ensure timely payment for the supplies made on credit.
ii. Banks and financial Institutions: They provide timely financial
assistance for the business activities in the form of loans, credit
facilities, etc. In order to decide whether to sanction such financial
assistance for a particular business, Banks and financial institutions
analyse financial statements to satisfy themselves about the credit
worthiness of the company and ensure timely repayment of loans
and the interest thereon.
iii. Investors and Potential Investors: They do not have direct control
on the business affairs and thus rely on the accounting information
available in the financial statements. They are basically concerned
about the returns earned on their investments. The profitability and
earning capacity of the business is the only area of their concern.
iv. Customers: Consumers or the users are concerned about the
prices of the goods they buy and therefore, want to establish good
accounting control so that the cost of production may be reduced
with the resultant reductions in the prices of the products they buy.
v. Government and tax authorities: They use the financial
information of the business to compile national income accounts
and other information so as to take some policy decisions. Also,
with the help of accounting information, it becomes clear if the
business entity has complied all the necessary tax requirements
related to excise duty, GST, income tax, etc.
vi. Researchers: They use the financial information in their research
work and therefore, analysis and interpretation of the information in
financial statements becomes necessary for such users.
vii. Public: They are interested in knowing the substantial contribution
that an entity makes to the economy as a whole in terms of
employment, development, etc. Accounting information helps them
to understand such contribution towards the economy.

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Introduction to Systems of Accounting

Understanding Meaning, Features, Stages and Advantages of

Double Entry System:

 Meaning:
o It is a complete system of recording transaction in the books of accounts.
o Each transaction reveals two aspects:
i. receiving or incoming or expenses/loss aspect known as debit aspect
and
ii. giving or outgoing or income/gain aspect known as credit aspect.

 Features:
o It maintains a complete record of each transaction by recognizing two-fold
aspect of every transaction i.e., the receiving and giving aspect.
o It follows the rule of debit and credit and therefore, for every transaction,
one aspect is debited and the other aspect is credited.
o It ensures that for every debit there is a corresponding credit and
therefore, at the end of a particular period the total of all debits will be
equal to the totals of all credits which ensures the arithmetical accuracy of
the records maintained.

 Stages:
o Record all the financial transactions in the Journal.
o Classify the recorded transactions by posting them to the appropriate ledger
accounts.
o Prepare a Trial Balance using the debit and credit balances of all the ledger
accounts.
o Close the books and prepare the final accounts comprising of the necessary
statements.
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 Advantages:
o It is scientific system of recording transactions which helps in attaining the
accounting objectives.
o It is a complete record of transactions as it takes into consideration both
debit and credit aspects of every transaction.
o It ensures arithmetical accuracy of accounting records by preparing a Trial
Balance.
o It determines correct profit or loss for a particular accounting period by
preparing Profit and Loss Account.
o It provides correct information of the financial position of an entity on a
particular date by preparing Balance Sheet on that date.
o It facilitates comparison of an entity’s financial performance over a period of
time.
o It assists the management in taking correct functional and financial
decisions.
o It helps in detecting errors and frauds and thereby prevents the wastage of
resources.

Understanding Meaning, Features and Advantages Single Entry System:

 Meaning:
o It is a simple form of book keeping and accounting in which each financial
transaction is recorded with a single entry in a journal.
o It does not record both the aspect of the transaction. It records single
aspect of the transaction and therefore it is an incomplete system of
recording financial transaction.
o It maintains only personal accounts and cash book. The amount of each
cash inflow or outflow is entered with the description of transaction.

 Features:
o Suitable for small-size business: It is considered suitable for small-size
business having less number of transactions.
o No Uniformity: It is a mere adjustment to double entry system of
accounting based on the requirements and convenience. Therefore, it
may differ from firm to firm.
o Personal Accounts Only: It maintains only personal accounts and
ignores preparation of real and nominal accounts.
o Cash Book: It maintains cash book which mixes the business and personal
transactions.
o Information based on Vouchers: It takes into consideration information
available from the respective vouchers.
o Difficult to prepare final accounts: It is very difficult to prepare final
accounts as no complete record is available to ascertain the correct
profitability and determine the exact financial position of the entity.
 Advantages:
o Simple: It is a simple method of maintaining books of accounts and
therefore, ascertaining profit or loss also becomes very easy.
o Economical: It does not require preparation of multiple accounts and
statements and therefore, is a conventional and economical system of
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accounting.
o Less time consuming: It records only one effect as there is no need to
record the corresponding second effect and therefore, it is less time
consuming.
o No expertise required: Since, this method does not follow the prescribed
concepts and conventions, expert knowledge and professional experience
is not required to follow this system of accounting

Bases of Accounting
“Bases” is the plural of “Basis”. “Basis” means the system or principles according to which an
activity or process is carried on.

One of the main objectives of accounting is to ascertain the profit or loss of a business enterprise
at the end of an accounting period. There are two bases of ascertaining profit or loss, namely:

1. Cash Basis, and

2. Accrual Basis
Cash Basis
1. Under this basis, incomes are not recorded unless they are received in cash.
2. Similarly, expenses are recorded only when they are paid in cash.
3. In other words, credit transactions are not recorded at all and are ignored till cash is
actually received or paid for them.
4. Thus, profit is merely the excess of actual cash receipts in respect of
a. sale of goods and
b. other incomes
over actual payments in respect of
a. purchase of goods,
b. expenses on wages,
c. expenses on salary,
d. expenses on rent etc.
5. Example:
Question: During a year, Ashok had cash sales of ₹3,90,000 and credit sales of ₹1,60,000.
His expenses for the year were ₹2,70,000, out of which ₹80,000 is still to be paid. Find out
Ashok’s income for the year following the Cash Basis of Accounting.
Solution:
Particulars Amount (₹)
Revenues (Inflow of Cash, i.e. Cash Sales) 3,90,000
Less: Expenses (Outflow of Cash) (₹2,70,000 – ₹80,000) 1,90,000
Net Income 2,00,000
Note: Credit Sales of ₹1,60,000 and Outstanding Expenses of ₹80,000 will not be
considered under Cash Basis of Accounting.

Accrual Basis
1. Under this basis, incomes are recorded when they are earned or accrued, irrespective of
the fact whether cash is received or not. Example: Sales made on credit will be included in
the total sales of the period.
2. Similarly, expenses are recorded when they are incurred or become due and not when the
cash is paid for them. Example: Rent due to the landlord but not paid will be treated as
expense for the period when it is due and not in the period when it is paid.

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3. Hence, in accrual basis, profit or loss of a particular period is the result of matching of the
revenues earned and expenses incurred during the period.
4. This makes it necessary to consider outstanding expenses, prepaid expenses, accrued
incomes, incomes received in advance, etc. for the preparation of financial statements.
5. Example:
Question: During a year, Ashok had cash sales of ₹3,90,000 and credit sales of ₹1,60,000.
His expenses for the year were ₹2,70,000, out of which ₹80,000 is still to be paid. Find out
Ashok’s income for the year following the Accrual Basis of Accounting.
Solution:
Particulars Amount (₹)
Total Sales (Cash Sales, i.e. ₹3,90,000 + Credit Sales, i.e. ₹1,60,000) 5,50,000
Less: Expenses for the year 2,70,000
Net Income 2,80,000

Note: ₹80,000 expenses still to be paid belong to this year and

hence are to be charged against the revenue of this year. Similarly,
credit sales of ₹1,60,000 are taken in the year in which sales
transaction is done.

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