Introduction to Accounting

CHAPTER ONE
INTRODUCTIONTOBOOK-KEEPINGAND ACCOUNTING

Accounting not only measured business activities, but processing of information into reports
and making the findings available to decision-makers.
Accounting is known as the Language of Business. However, a business may have many
aspects and all may not be of financial nature. In other words to understand accounting could be to
call it “The Language of Financial Decisions”. The better the understanding of the language, the
better is the management of financial aspects of living. Many aspects of human are based on
accounting like personal financial planning, investments, income-tax, loans, etc. Every person has
different roles to perform in life-the role of a student, of a family head, of a manager, of an investor,
etc. The knowledge of accounting is useful for getting advantage in performing different roles.
However, we shall limit our scope of discussion to a business organization and the various financial
aspects of such an organization.

Businessman takes various decisions like profitability of business, introductions of new

product line, sale, etc. To answer questions of such nature, businessman needs to have a lot of
information. Such information is generated through the accounting process. Entire policy decisions
and frame business plans is based on accounting information.

All business organizations work in an ever-changing dynamic environment. Any new

programme of the organization or of its competitor will affect the business. Accounting serves as an
effective tool for measuring the financial pulse rate of the company.

BOOK- KEEPING
Book- keeping includes recording of business transactions. It consist of journal, ledgers and
balancing of accounts. In other words recording of business transaction means journalized the
transaction; post them in to ledgers and balancing of accounting. All the records before the
preparation of trail balance are the subject matter of book- keeping. Thus, book- keeping may be

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 Introduction to Accounting
defined as the science and art of recording monetary transactions accurately and systematically, in a
certain set of books. Bookkeeping recorded only monetary transaction of business.

Definition
“Book- keeping is the art of recording business transactions in a systematic manner”. A.H.
Rosenkamph.
“Book- keeping is the science and art of correctly recording in books of
account all those business transactions that result in the transfer of money or money’s worth”.

R.N.Carter
“Book-keeping is the process of analyzing, classifying and recording transaction in
accordance with preconceived plans.” Finney and Miller.

Features of Book-keeping:
1) Book-keeping in process of recording business transactions.
2) Books-keeping is a science.
3) Book-keeping is an art.
4) In book-keeping only records of monetary transactions are recorded.
5) Monetary transactions are only recorded.
6) The records of business transactions are prepared for specific period of time say one year.
7) The result of business activities is ascertained on the basis of book-keeping records.

Objectives of Book- keeping:

1) Book- keeping provides a permanent record of each monetary transaction.
2) To know the Solvency of a firm. It can be accessed from the records of assets and liabilities
on a particular date.
3) To ascertain the Profit or loss for a particular period. It is indicated by entries related to

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 Introduction to Accounting
incomes and expenditures.
4) To know the details of customers and suppliers. Due to number of customer and supplier
bookkeeping easily show the total amount is to be received or paid.
5) It is a method gives opportunities to review the business policies in the light
of the past records.
6) It helps to update the various fields. Like amendment of business laws, provision of licenses,
assessment of taxes etc., are based on records.

Accounting
Accounting as an information system. It is the process of identifying, measuring
and communicating the economic information of an organization to its users. This information is
useful for decision making. It identifies transactions and events of a specific
entity. A transaction is an exchange with money, in which each participant receives or sacrifices
value (e.g. purchase of raw material). An event (whether internal or external) is a
happening of consequence to an entity (e.g. use of raw material for production). An entity means an
economic unit that performs economic activities.

Definition of Accounting
American Institute of Certified Public Accountants (AICPA) which defines accounting as
“the art of recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events, which are, in part at least, of a financial character and
interpreting the results thereof”.
“Accounting refers to the process of indentifying, measuring, recording, classifying,
summarizing, analyzing and communicating economic information to permit informed judgments
and decision by the user of accounts.”

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 Introduction to Accounting
Objective of Accounting
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record:
The main purpose of accounting is to systematically record the financial aspects of
business transactions. Accounting not only record the transaction but classify and
summaries the same for preparation of financial statement.
ii) To ascertain the results of the operation:
One of the objectives of accounting is to measure the financial performance of an enterprise.
Accounting ascertaining result i.e., in a particular period how much profit earned or loss
suffered in business. For same purpose, a business entity prepares either a Trading and Profit
and Loss account or an Income and Expenditure account. These accounts show the profit or
loss of the business by matching the items of revenue and expenditure of the same period.
iii) To ascertain the financial position of the business:
After knowing the profit, a businessman must know the financial position of business i.e.
availability of cash, position of assets and liabilities etc. It indicates the financial strength of
organization. Financial statements are indicators of health of a business entity.
iv) To show the liquidity position:
Liquidity means easily conversion of assets in to cash. Financial reporting provide
information about cash inflow and cash outflow, about its borrowing and repayment of
borrowing, about its capital transactions, cash dividends and other distributions of resources
by the enterprise to owners. Accounting also focus on various factors that may affect an
enterprise’s liquidity and solvency.
v) To protect business properties:
Accounting provides updated financial information. It means accounting provides the
latest information of assets that the firm possesses and the liabilities the firm owes, therefore
that nobody can claim due payment. In this way it helps to protect business assets.

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 Introduction to Accounting
vi) To facilitate rational decision - making:
Decision-making is the soul of business. In regular day, businessman takes various decisions.
Accounting provides financial information by way of financial statement. It helps the
business in making rational decisions about the steps to be taken in respect of various aspects of
business.
vii) To satisfy the requirements of law:
Every entities such as companies, societies, public trusts, etc are compulsorily required to
maintain accounts as per the special law. Company is governing their operations as per
Companies Act, Society governing their operations by Societies Act, and Public trust
governing as per Public Trust Act etc. Maintenance of accounts is also essential as per the
Sales Tax Act and Income Tax Act.

viii) To Communicate the information to users:

The last but not least objective of the financial accounting is to communicate the various
information to various groups which are internally and externally related with organization.
All the information is communicated very fats to various interested groups viz. owners,
creditors, employees, investors, taxation authorities etc.

Advantages of Financial Accounting

1) Financial information about business :-

Accounting explains financial information, it means the profit earned or loss suffered
it also explain the assets and liabilities of the enterprise. It provides useful information for the
taking various business decision .Some business related people have limited authority or
resource to obtain information. Thus accounting and financial statement is the principal
source of information about the economic activities of a business.

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2) Facilitates comparative study :-
Some of the business users need of comparative study like investors and creditors.
Accounting provides useful information to investors and creditors for predicting comparing
and evaluating cash flow in terms of amount timing and related uncertainty.

3) Assistance to Manager :
The management is responsible for every action of the business. For smoothly
running of business activity they take various decisions and make different plan. The
management performs this function on the basis of accounting information. Accounting
provides such factual and interpretive information of business transactions to management for
their effective working.

4) Replace memory :
Due to limited human memory it impossible for business man to remember everything
about his business. It is necessary to record transaction in the book of accounts punctually.
There is no necessity of remembering various transactions. If required, the records will
furnish the necessary information.

5) Facilitates loan :
Any financial institutions or bank granted loan on the past performance of
organization. Accounting makes available such information. Such information is valuable for
financial institutions or bank for granting amount of loan, period of loan, to fixed the terms
and conditions of the loan, etc.

Disadvantages or Limitations of Financial Accounting

1. Accounting is not Fully Exact:

Accounting is affected by personal judgment in respect of various terms. People are bound to
have different ideas and the estimates. Naturally it will be differ from person to person. Thus this

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will guide to different amount of profit shown by different person. Thus the profit cannot be
treated as exact.

2. Accounting does not Indicate the Releasable Value:

The value indicated by financial accounting does not releasable. The value of assets which
given in balance sheet does not show the releasable value. E.g. cash balance shown on assets side
which the firm may realize by the sale of all assets.

3. Accounting Ignores Qualitative Elements:

Financial accounting records only that information which can be quantitatively measured in other
words it can be measured in terms of money. There are important events of business, such as
government policies, loss due ideal of equipment and ideal time of labour, etc. Such type of events
cannot be measured in terms of money. It will not consider in the accounts even though t is
important for the business.

4. Accounting ignores the effect of price level change:

Accounting system is based on historical cost. Time value of money does consider in it, it
considered that time value money is constant. Effect of price level changes does show in financial
statement. While preparing financial statement accounting information will not show the true
result because the assets remain undervalue in many case particular land and building.

5. Accounting may Lead to Window Dressing:

The term window dressing means manipulation of accounts in a way so as to hide vital facts.
And also present the financial statement in a way to show better position than what it is in reality.
In this solution income statement fails to provide a true and fair view of the result of operation.
The balance sheet also fails to provide a true and fair view of the financial position of the
enterprise.

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6. Historical in Nature:-
Financial accounting is historical in the nature in the sense that accounting data are summarized
only at the end of accounting period or financial year. Financial statement focused on what has
happened during a particular period. The impact of future events, uncertainties i.e. what will happen
has no place in financial accounting. It does not explain or suggest what should be done to increase
the efficiency of the enterprise or business.

Scope of Accounting:

Accounting is not limited to the business world but spread over in all over the area of the society
as well as profession. Accounting has very wide scope and area of application. Any type of
organization, profit making or nonprofit making, financial transactions must take place. To find out the
net results of every organization it is necessary to recording and summarizing the business transactions
when they occur. After making results it is also the necessary for interpretation and communication of
that information to the appropriate persons.

In the modern world, accounting system is not only followed by business institutions but also in
many non-trading or not profit making institutions such as Schools, Colleges, Hospitals, Charitable Trust
Clubs, Co-operative Society etc. and also Government and Local Self-Government in the form of
Municipality, Panchayat. Every type of professional persons like Medical practitioners, practicing
Lawyers, Chartered Accountants etc. also adopt some suitable types of accounting methods.

In earlier day the scope of accounting was undergone. In recent times it has made lot of changes.
Accordingly dynamic change in society the scope and area of accounting operations also change.
Therefore, continuous research in this fields the new areas of application of accounting principles and
policies are materialized. National accounting, environment accounting, human resources accounting and
social Accounting are some of the examples of the newareas of application of accounting systems.

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Difference between Book keeping and Accounting:-
Book-keeping
Bookkeeping is process of identifying,
measuring, recording and classifying
financial transactions..
It constitutes as base for
accounting.
Managerial decisions cannot be taken
with the help of these records.
Financial statements do not form part of
this process.
There is no sub-field of book-keeping.
Financial position of the business cannot
be prepared from book-keeping records.
It is the beginning stage and acts as a
base for accounting.
Bookkeeping doesn’t require any special
skills as it is mechanical in nature.
It is a incomplete record of the financial
transaction.
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Accounting
Accounting is the process of summarizing,
interpreting and communicating financial
transactions
It is considered as a language of the business.
Management takes decisions on the
basis of these records.
Financial statements are prepared in this process
on the basis of Book-keeping records.
It has several sub-fields like financial accounting,
management accounting etc.
A financial position of the business is to be
prepared from the accounting reports.
Accounting begins where bookkeeping ends.
Accounting, on the other side, requires special
skills due to its analytical and somewhat complex
nature.
It is a complete record of the financial
transaction.
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 Introduction to Accounting
Users of Accounting Information:-
Financial accounting information may be useful to many member of groups. These groups may
be internal or external. External users are the outside parties who may be directly or indirectly interested
in the working of the business.

Internal External

Owners Investors
Management Creditors
Employees Lenders
Government
Customers
Owner:-
The owners are the person provides funds or capital for the business. Owners are interested and also have
curiosity in the profitability and financial soundness of the business. Owners, being businessmen, always
keep and look at on the returns from the investment made in business. Maintain the books of accounts
are good proof in dispute, they determine the amount of goodwill and facilitate in assessing various
taxes. The owners of a business enterprise like to try to find the answers to the following questions:-

How much have we earned this year?

How much during the past year?
Is Out business improving?
Financial accounting information provides the suitable answer of all types of these questions.
Owners are interested in the value of their investment and the return on their investment in the current
years as well as in future also.

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Management:-
The management of the business is majorly interested in knowing the position of the firm. The
management can study the merits (advantages) and demerits (disadvantages) of the business activity
from the accounts. Thus, the management is interested in financial accounting. From the financial
accounting they find whether the business carried on is profitable or not. The financial accounting is the
“eyes and ears of management and facilitates in drawing future course of action, future policies,
decisions, further expansion etc.”
Management uses accounting information as a tool of self-evaluation. Management evaluates its
managerial skill the through the financial statements. Management would like to find the answers to the
following questions:
How much profit did the company make during the years?
Is the return to shareholders adequate?
Employees:-
Like owners, employees of the business enterprise are also interested in the good running for the
enterprise and net profit of the business because their livelihood depends on the earnings of the
enterprise. Employees used accounting information for claiming increase in wages, bonus and other
benefits. Accounting information is also used for deciding workers’ share in profits and settling wage
disputes. They also used accounting information to ensure that total profit is correctly ascertained and
their share in the profit is also correctly ascertained.

Investors:-
Investor means a person who interested to invest their money in the business. Before taking any
investment decision, investors would like to know that his investment would be safe of not. Accounting
information provides information to investors as various indicators of past performance and future
prospects of the organization. A study of the financial statements also helps and guide investors in this
respect.

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Creditors:-
Creditors are the persons who provide business enterprise raw materials, goods and services and
financial resources on the credit basis that are payable within one year. Creditors are interested in
accounting information regarding liquidity of the business enterprise. They want to determine whether
the business enterprise in a position to meet its obligations. They are interested to know the information
like the existing cash position, outstanding debts, payments and efficiency with which the liquid
resources have been employed.
Lenders:-
Lenders mean a person or creditors who provide loan to business enterprise. Bankers and
financial institutions are long-term creditors who lend money to a business enterprise. They provide
loans with a view to earn interest. Such coeditors (bank/financial institutions) are interested in the
solvency of the company i.e. the financial soundness of the company to repay the principal amount at the
time of maturity. Such creditors are also interested to ensure from the financial statements that the
interest is well covered by the profits so that the payment of interest will be made regularly throughout
the term of loans.
Government:-
Government needs the accounting information for fixing the fiscal policy. The central and state
governments have a regulatory role to ensure a balance industrial and fiscal policy through collection of
taxes. Taxes like GST, income tax, etc. Accounting information is useful for government for the filing
of Income tax returns. Accounting information is also useful for the different government departments
for framing policies.
Customers:-
Consumers are the persons who use the products or services produced by the enterprise.
Accounting information is useful for customers to suggest the enterprise about the reduction of the prices
by reducing cost of production. Consumers can create public opinion against the enterprises which
exploit the consumers by charging very high price. For this purpose, consumers have to watch and
evaluate financial statements carefully.

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