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INTRODUCTION TO ACCOUNTING
Meaning of Accounting
Accounting is an information system that provides accounting information to the users for correct decision making.

Definition of Accounting

“Accounting is 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 financial character, and Interpreting the Results thereof.”
The American Institute of Certified Public Accountants (AICPA)

Objectives of Accounting
1. To maintain Systematic and complete records of Business Transactions.
2. To Calculate Profit and Loss
3. To ascertain the Financial Position of the Business.
4. To compare results with Competitors.
5. To compare results with our past records.

Interested Users of Accounting - Information

Internal Users:
1. Owner: Information required knowing the return on their Investment and Financial Health of their business.
2. Management: To Evaluate the Performance and to take various Decisions.
External Users:
1. Creditors: They assess the financial capability of the Business to pay its Debts.
2. Lenders: They also assess the repaying capacity and credit worthiness.
3. Employees: They look after the profitability to claim Higher Wages and Bonus.

4. Government: To assess the amount of tax due.

5. Potential Investors: To see the safety, growth of their Investments and the future of the Business.
6. Researchers: To make in-depth study of the financial operations of an enterprise.

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Qualitative Characteristics of Accounting – Information

Accounting information is useful for interested users only if it possess the following characteristics:

1. RELIABILITY: It means the Information must be based on facts and be verified through source document
by anyone. It must be free from bias.
2. RELEVANCE: Information must be available in Time and must influence the decision of users by helping
them form prediction about the Outcomes.
3. UNDERSTANDABILITY: The information should be presented in such a manner that users can
understand it well.
4. COMPARIBILITY: The information should be disclosed in a manner that it can be compared with previous
year’s figures of business itself and other firm’s data.

Limitations of Accounting
The Accounting information suffers from the following limitations:

1. It is based on Historical Data.

2. Biasness
3. Qualitative Information is not shown in the books.
4. It ignores price level changes.

Process of Accounting
Accounting
1. Identification of the Economic Transactions and Events. (Selection of important event)
2. Measurement in terms (Monetary value transaction.),
3. Recording of business transactions (As per accounting principal)
4. Classification of the business transaction (Assets, liability, expenses, income).
5. Summarizing the business transaction (Trial balance and Balance sheet.)
6. Analysis and interpreting the business transactions. (Various reports, ratio etc.)
7. Communication (provide information to internal and external users.)

Branches of Accounting
1. Financial Accounting: It includes Book Keeping and Preparation of Financial Statements.
2. Cost Accounting: It determines the unit cost at different levels of productions.
3. Management Accounting: It blends Financial and Cost Accounting to get maximum profit at minimum cost.
4. Tax Accounting: It is done for the purpose of ascertaining Sales tax and Income tax etc.
5. Social Responsibility Accounting: It focuses on Social benefits given to the society.

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Distinction between Book Keeping and Accounting

BASIS OF BOOK – KEEPING ACCOUNTING
DISTINCITON
Scope It Includes: In Addition to Book Keeping, It Includes:
1.Identifying the Financial Transaction 1. Summarizing the Classified transactions.
2. Measuring in terms of Money 2. Analyzing and Interpreting Results
3. Recording the measured transaction 3. Communicating the results to its users.
4. Classifying them into ledger.
Level or Stage Primary Secondary
Objectives To maintain Systematic Records To ascertain the Net Results.
Nature of Job Routine and Clerical Analytical
Performed by Junior Staff Senior Staff
Knowledge Limited Level of Knowledge Higher Level of Knowledge
Skill Required Not required to possess any Analytical The Accountant is required to possess
Skill. Analytical skills.

BASIC ACCOUNTING TERMS

1. ENTITY: It means existence of an Individual. It includes two things :
a) Business Entity b) Non Business Entity

2. TRANSACTION: It is an Economic Activity that affects financial positions of the business and can measured
in terms of money. For e.g. Sale of Goods; Payment of Expenses.

3. VOUCHER: The Documentary Evidence in support of a Transaction. For e.g. If we buy Goods for Cash
then we get cash memo.
4. CAPITAL: Amount invested by the owner in the firm. It may be brought in the form of Cash or any Asset by
the owner.

5. ASSETS: Resources which are owned by the Business for generating Future Economic Benefits.
a) Fixed Assets: Assets which are used for normal operations and held for a long period. For e.g. Land,
Building, Plant, Machinery, Vehicles, Furniture and Fixtures.
b) Current Assets: Theses assets are held for a short term and converted into cash within ONE Year such as
Stock, Debtors and Bills Receivables.

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6. LIABILITIES: These are the obligations that an enterprise has to pay at some time in future.
a) Long Term Liabilities: Which are usually payable after a period of one year. E.g. Long term loan from a
Financial Institution.
b) Short Term Liabilities: Which are payable within a period of one year. For E.g. Creditors

7. SALES: These are total revenues from GOODS sold or SERVICES provided to Customers.

8. REVENUES: It means Income from any source which should be of regular nature. For e.g. Sale of Goods,
Rent received, commission received etc.

9. EXPENSES: Cost incurred by a Business for earning revenue are known as expenses. For e.g. Rent, Wages
and Salaries etc.

10. EXPENDITURE: It is spending money or incurring a liability for acquiring assets, goods or services is called
expenditure.
a) Revenue Expenditure: The benefit of expenditure is received within An year. It is of regular nature. It affects
Trading or Profit and Loss A/c. For e.g. Rent, Interest etc.
b) Capital Expenditure: If any expenditure lasts for More than An year, it is treated capital expenditure. Such
as Purchase of Fixed Assets. It affects the Balance Sheet.

11. PROFIT: The excess of Revenues over its related expenses during a period.
Profit = Total Revenues – Total Expenses

12. GAIN: A non recurring profit from transactions which are Incidental to Business. Such as Sale of Fixed assets.

13. LOSS: The excess of expenses of a period over its related revenues is termed as Loss. For e.g. Cash or Goods lost
by theft or fire etc.
Loss = Total Expenses – Total Revenues
14. DISCOUNT: It is the rebate given by the seller to the buyer.
a) Trade Discount: Purpose is to persuade the buyer to buy more goods. It is offered as a fixed percentage on
List Price. It is not recorded in the books.
b) Cash Discount: Objective is to encourage the Debtors to pay their dues promptly. It is recorded in the books.

15. GOODS: The products in which business deals. In other words, the items which are purchased for the purpose of
resale.

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16. PURCHASES: The term purchases are used only for the GOODS bought for the purpose of Resale. It may
be Cash purchases or Credit purchases.

17. DEBTORS: To whom goods have been sold on Credit and Amount has not received yet.

18. CREDITORS: From whom the goods have been bought on Credit and Amount is still to be paid.

19. INVENTORY: It is the value of the Goods lying unsold at the end of an accounting period. Closing Stock of
one year becomes Opening Stock of next year.

20. DRAWINGS: The amount or goods withdrawn by the owner for Personal Use

Differences between Capital Expenditure and Revenue Expenditure:

1. Capital Expenditure is incurred on Acquisition of Fixed Assets; Whereas Revenue Expenditure is incurred for
the day to day running expenses.

2. Capital Expenditure is incurred or the purpose of increasing the earning capacity of the business, whereas revenue
expenditure is incurred for maintenance of earning capacity.

3. Capital expenditure yields benefit normally over a long period, whereas Revenue expenditure yields benefit for a
maximum period of one year.

4. Capital expenditure is written in the balance sheet, whereas revenue expenditure is written in Trading or Profit &
Loss account.

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THEORY BASE OF ACCOUNTING

Meaning of Accounting PRINICIPLES:
Accounting principles are the rules of action adopted by accountants universally while recording accounting transactions.

Features of Accounting Principles:

(1) Accounting principles are Manmade.
(2) Accounting principles are Flexible in nature
(3) Accounting principles are generally accepted.

Necessity of Accounting Principles:

Accounting information is meaningful and useful for users if the accounting records and financial statements are prepared
by following generally accepted accounting information in standard forms which are understood.

Basic Accounting CONCEPTS

(1) BUSINESS ENTITY CONCEPTS

As per this concept, Business has Distinct and Separate entity from its owners. Therefore business transactions are
recorded in the books from the business point of view and not owners.
For example, If owner brings Rs. 1, 00,000 as capital in business. It is treated as liability of business to owner. Similarly
if owner withdrew Rs. 5,000 from business for personal use, it is treated as reduction of owner’s capital.

(2)MONEY MEASUREMENT CONCEPT

This concept states that “Only those Transactions and Events are recorded in the books of accounts which can be expressed
in terms of Money”. Hence, Non-monetary transactions cannot be recorded in the books like appointment of manager,
capabilities of human resources etc.

Another aspect is that the records of transactions are NOT to be kept not in Physical Unit But in Monetary units.

For example, an organization has 5 Buildings, 20 Cars and 10 Computer tables are not recorded because they are
physical unit and not in monetary unit.

Limitation of this concept is the value of Rupee does not remain same over a period of time. As changes in the value of
money is not reflected in books does not reflect fair view of business affairs.

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(3) GOING CONCERN CONCEPT

This concept assumes that “Business shall continue to carry-out its operations indefinitely and would not be liquidated in
the foreseeable future”. It provides the basis for showing the value of assets in the balance sheet.
For e.g. a machine purchased for Rs.2, 00,000 and its estimated useful life is 10 years. The cost of machinery is spread on
suitable basis over next 10 years for ascertaining the profit or loss for each year. The total cost of the machine is not treated
as an expense in the year of purchase itself.

(4) ACCOUNTING PERIOD CONCEPT

Accounting period refers to the span of time at the end of which financial statements are prepared to know the profits or
loss and financial position of business. Information is required by different users at regular intervals for decision making.
For example, Management requires information at regular interval to assess the performance and funds requirement.
Therefore they are prepared at regular interval, normally a period of one year. Financial year starts from 1st April and
ends on 31st March of the next year. Period starting from 1st April and ends on 30th June is known as 1st Quarter of a
financial year.

(5) COST CONCEPT

According to this concept “All assets are recorded in the books of accounts at the purchase price which includes the
purchase price, transportation cost and installation costs.
For example, if an asset purchased for Rs. 1,00,000 and spent Rs. 10,000 on its installation. Therefore asset will be
recorded in the books of accounts at Rs. 1,10,000.
This concept is historical in nature. For example, if machine purchased for Rs. 75,000, the purchase or acquisition price
will remain same for all years to come, though its market value may change.

(6) DUAL ASPECT CONCEPT

According to this concept, every business transaction has two aspects- a Debit and a Credit of equal amount. In other
words, For Every Debit there is a Credit of equal amount in one or more accounts and vice-versa. Due to this principle,
the two sides of Balance Sheet are always equal.
For example, Man has started business with cash Rs. 50,000. In this transaction asset (cash) increases and liability
(capital of owner) also increases. This principle is also known as duality principle.
Assets = Liabilities + Capital
This equation states that Assets of business are Always Equal to the Claims of Owners and Outsiders.

(7) REVENUE RECOGNITION CONCEPT

According to this principle, Revenue is considered realized when we receive Right to Receive Revenue than it is called
revenue is realized. For example, sales made in March, 2013 and receives amount in April, 2013. Revenue of these sales
should be recognized in February month, when the goods sold.
For example commission for the March, 2013 even if received in April 2013 will be taken into profit and loss A/c of
March, 2013.
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(8) MATCHING CONCEPT

The matching concept states that Expenses incurred in an accounting period should be matched with Revenues during
that period. In other words, Revenue and Expenses incurred to earn these revenues must belong to the same accounting
period.
For example, Salary for the month of March, 2013 paid in April, 2013 is recorded in the profit and loss A/c of financial
year ending March, 2013 and not in the year when it realized.
Another example is Income Received in advance.

(9) FULL DISCLOSURE CONCEPT

Apart from legal requirements, Good accounting practice requires all Material and Significant information must be
disclosed. Financial statements are the basic means of communicating financial information to its users for taking useful
financial decisions.
This concept states that all material and relevant fact and financial performance must be fully disclosed in financial
statements of the business. Disclosure of material information results in better understanding. For example, the reasons for
low turnover should be disclosed.
Another Example is “Contingent Liabilities” Which is not certain but depends upon result of some event. Like Any issue
pending in the court.

(10)CONSISTENCY CONCEPT

This concept states that accounting practices should be uniform and consistent over a period of time.
For example if an enterprise has adopted straight line method of charging depreciation then it has to be followed year
after year. If we adopt written down value method from second year for charging depreciation than the financial
information will not be comparable.

Consistency eliminates the personal bias helps in achieving the results that are comparable.
However consistency does not prohibits the change accounting policies.
Necessary changes can be adopted and should be disclosed.

(11) CONSERVATISM CONCEPT (PRUDENCE CONCEPT)

This concept takes into consideration all Expected losses but not the anticipated profits. It means profit should not be
recorded until it realized but all losses are to be recorded in the books.
For example, Valuing Closing Stock at Cost or Market value whichever is lower. Another Example is Creating provision
for doubtful debts.
This concept ensures that the financial statements provide the real picture of the enterprise.
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(12) MATERIALITY CONCEPT

This concept states that accounting should focus on material fact. Whether the item is material or not shall depend upon
nature and amount involved in it.
If the knowledge of any information may effect the decision of a user of account, then it is termed as material information.
For example, amount spent on repair of building Rs. 5,00,000 is material for enterprise having the sales turnover of
Rs.2,00,000 But not material for enterprise having turnover of Rs. 2,00,00,000.

BASIS OF ACCOUNTING:

(1) Cash Basis

Under this system of accounting, Transactions are recorded in the books of accounts when cash is received or paid and not
when the receipt or payment becomes due. Outstanding expenses and accrued income are not treated. This method is
contrary to Matching Principle.

For example, if salary Rs. 7,000 of January 2013 paid in February 2013, it would be recorded in the books of accounts
only in February, 2013.

(2) Accrual Basis

Under this method Revenues and costs are recognized in the period in which they occur rather when they are paid. It is
more appropriate basis for calculation of profits as expenses are matched against revenue earned in the relation thereto.
Outstanding expenses, Prepaid expenses, accrued income and income received in advance are Identified. Under the
Companies Act, 1956 all companies are required to maintain their accounts according to accrual basis of accounting.
For example, raw materials consumed are matched against the cost of goods sold for the accounting period.

Difference between Cash Basis and Accrual Basis Of Accounting:

BASIS CASH BASIS ACCRUAL BASIS

Recording of Only Cash Transaction are Recorded. Both Cash and Credit
Transactions Transactions are Recorded.
Profit or Loss Not Correct Correct ascertainment of Profit.
Capital and Does not make a Distinguish. It makes a Distinction between
Revenue Items Capital and Revenue nature item.
Legal Position Not recognized Recognized under The Companies
Act, 1956.

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