1 Introduction to Accounting

Contents

☞ Meaning and Definition of accounting ☞ Features / characteristics of

accounting ☞ Branches/ types / subfields of accounting ☞ Demerits /
Shortcomings / disadvantages / limitations of accounting
☞ Features/Characteristics of accounting information ☞ Parties / Users /
Groups interested in financial statements ☞ Functions of accounting ☞
Objectives of accounting ☞ Systems of accounting ☞ Book keeping ☞ Difference
between book keeping and accounting ☞ Unsolved questions.

Meaning of accounting
Accounting is basically concerned with recording of financial transactions, summarizing them and
communicating the financial information to various parties such as owners, creditors, debtors, investors,
government agencies, employees etc for decision making. Accounting is generally associated with
business but it is not only business which makes use of accounting.
For Example
A housewife has to keep a record of money received and spend by her during a particular period. She can
record receipts and payments in a chronological order.

Accounting helps us in knowing about

1. The sources from where funds have been received and the purposes for which it is utilized.
2. The surplus or deficit at the end of the period.
3. The cash balance at the end of the period.

Definition of Accounting

"Accounting is a means of measuring and reporting the results of economic activities".

Smith and Ashburne

"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 a financial character and interpreting the
results thereof."
American Institute of Certified Public Accountants
1
 2 Fundamentals of Accounting

Features/characteristics of accounting
The features of accounting are as follows:

1. Identification of financial transactions and events

Accounting records only those transactions and events which are of financial nature such as
purchase of raw material, sale of finished goods, payment to creditors, interest received etc. It can be
related to inflow and outflow of cash. Non economic activities like love, respect etc. are not
recorded.

2. Measuring the identified transaction

Accounting transactions are recorded according to the common measuring unit (currency of the
country). In India, accounts are made in terms of rupees.

3. Recording
All the business transactions are recorded in the books of original entry (journal).Every transaction
has a credit and debit aspect. The total of debit side is always equal to total of credit side. This book
(journal) may be further subdivided into various subsidiary books such as:
Purchases journal : For recording credit purchases of goods.
Sales journal : For recording credit sales of goods.
Cash journal : For recording cash transactions.

4. Classifying
All the transactions of a similar nature are then posted in a main book of accounts which is called
ledger. This book contains on different pages individual account heads under which all the financial
transactions of a similar nature are collected.
This helps us to find out the total expenditure incurred under each head.
For example
In Rahul's account all the transactions related to Rahul are posted to determine the net amount due
to him or due from him.

5. Summarizing
This step involves preparation of financial statements (trading account, profit and loss account and
balance sheet) to determine the net results of business. These financial statements should be
understandable and useful to internal and external users of accounting.

6. Analysis and interpretation

This data is analyzed from the point of view of liquidity, solvency, profitability to make judgments,
decisions and plans in a better way. It is also used for preparing future plans and framing policies for
executing such plans. The figures provided in the financial statements will help the accountants only
when they are put in a simplified manner.
 [Chapter 1 → Introduction to Accounting] 3

7. Communication
These financial statements are communicated to the final users so that they can take right decisions
at the right time. These statements are also supported by additional information in the form of
accounting ratios, graphs, diagrams, funds flow statements etc.

Branches/types/sub fields of accounting

The different branches of accounting are as follows:
1. Financial accounting
It is that branch of accounting which records financial transactions and events and summarizes
them to report final results to ultimate users. The end result is preparation of financial statements
and reports based on it. The main tasks in financial accounting are:
a. Recording of business related transactions.
b. Preparation of ledger accounts and balance sheet.
c. Communicating the results of business.

2. Cost accounting
It is that branch of accounting which helps in determining cost of products or services provided. It
helps in price fixation and control.
It is the systematic process of determining unit cost at different levels of production. It deals with
classification, recording, allocation, summarizing and reporting of present and future costs. It serves
the needs of management and outsiders.

3. Management accounting
It is that branch of accounting which fulfils the needs of a particular department (finance,
production, accounting, and human resource). It serves as an effective tool for determining the right
line of action in near future. It is a mixture of financial accounting, cost accounting and all aspects of
financial management. It is the reproduction of final accounts in such a way so as to enable the
management to take decisions and control activities.

Limitations/Demerits/Shortcomings/Disadvantages of Accounting
The limitations of accounting are as follows:
1. Accounting is not fully exact
Most of the transactions in accounts are recorded on the basis of evidence such as receipts for sales
or purchases. But some estimates are made for depreciation, provision for bad debts etc.

2. Ignores qualitative factors

Accounting considers only monetary items. It ignores qualitative aspects like motivation level of
employees, quality of work force etc. These aspects do not find any place in accounting.

3. Ignores the effect of price level changes

Accounting statements does not indicate the effect of changes in price levels. Unless the price level
are not considered accounting statements does not reflect true results.
 4 Fundamentals of Accounting

4. Does not indicate realizable value

It does not show the amount which can be realized from the sale of assets. It only shows the cost less
depreciation. In this way, it fails to show present sales value of assets.

5. Window dressing
It means manipulation of accounts in such a manner so as to show a better position than what it
actually is. It depends upon personal attributes of accountant.

Features/Characteristics of accounting information

1. Relevance
The accounting information should help the users in analyzing past, present and future events and
take appropriate decisions at the right time. It is affected by its nature and materiality. It should
faithfully represent what it is meant to represent.

2. Reliability
It means the users should have confidence in accounting information. In other words, the
information should be free from errors and it should be factual. Reliability covers faithful
representation, completeness and neutrality.

3. Understandability
It means the information should be understandable by those groups who are having a reasonable
knowledge of accounts, economics and related areas. A message is said to be understandable when it
is understood by the user in the same sense as it is send by the sender.

4. Comparability
The information should be presented in such a manner that it facilitates comparison over a period of
time. It must enable inter firm comparison (between two firms at the same time) and intra firm
comparison (between same firm over two different times).

5. Completeness
The information should be complete in all respects. It should provide all material information which
is needed by investors, management, and creditors etc. to make decisions.

Parties/Users/Groups interested in financial statements

1. Owners
They invest capital in the business and they undertake risk. So, they are interested in knowing the
profit earned or loss suffered. Owners are:
Proprietors: In sole proprietorship concern.
Partners: In partnership firms.
Shareholders or legal owners: In Company.
 [Chapter 1 → Introduction to Accounting] 5

2. Management
The management needs accounting information for making various decisions such as:
➢ Fixation of selling price
➢ Determining profit
➢ Make or buy decisions
➢ Accept or reject an order
➢ Making investment

3. Employees
Employees and workers get bonus on the basis of profit earned by the firm. The labour unions need
accounting information to properly evaluate salary and fringe benefit packages. So, they are
interested in financial statements.

4. Banks
They are interested in financial statements because the safety and recovery of loans given by them
depends upon the net results shown by the accounting information. They would like to know the
data relating to past and present performance of the business and details of the decisions taken for
future programmes.

5. Creditors
They are those parties who supply raw materials, goods, services and financial resources on credit.
Before giving credit for goods they satisfy themselves about the credit worthiness of business. They
are interested in knowing whether an enterprise can make payments on a scheduled date or not.

6. Investors
A potential investor would like to know the earning capacity of business and the safety of
investment. This information is made available through accounting information after which they
can take decision regarding the investment to be made in a particular business.

7. Government
The government makes use of financial information to determine national income and tax structure
(Excise Duty, VAT, Service Tax, Goods & Service Tax, Income Tax etc.). For this it is necessary that
proper accounts are made available to government.

8. Consumers
They need accounting information for knowing price of those products which are fixed by
government so that they should not feel exploited.

9. Public
They want to know accounting information to ensure that the business is contributing to the
economy in many ways such as employment of people, social welfare etc.

10. Researchers
They are interested in interpreting the financial statements of a concern for a given objective.
 6 Fundamentals of Accounting

Functions of accounting

1. To systematically maintain accounting records

It is the primary function of accounting. It helps us to maintain accounting records as per accounting
principles and concepts so that there is no need to rely on memory.

2. Preparation of financial statements

Financial statements include trading account, profit and loss account and balance sheet. These
statements determine the performance of the business in the form of net profit or net loss which is a
measure of successful running of a business.

3. Meeting legal requirements

Accounting records helps in fulfilling requirements of various laws such as Companies Act, Income
Tax Act, Sales Tax Laws etc. In settlement of taxation matters, systematic maintenance of records is a
big help.

4. Communicating the financial data

It helps us to communicate accounting data to internal and external users of accounting such as
banks, government, employees, owners, creditors, investors, management, researchers, consumers
etc.

5. Help to management
Management often requires accounting information for making decisions regarding:
➢ Credit policies
➢ Discount pattern
➢ Selling price
➢ Make or buy
➢ Accept or reject an order.

Objectives of accounting
1. To record financial transactions and events in the books of accounts as per principles of accounting.
2. To determine the net profit or net loss at the end of accounting period by preparing final accounts.
3. To determine the financial position of the business at the end of accounting period, budgeting and
controlling.
4. To communicate the accounting information to different users as per their individual requirements.
5. To protect the assets of the business which are necessary for the control of business.
6. To help the management in decision making, budgeting and controlling.

Systems of accounting

1. Double entry system

It is that system of accounting in which both debit and credit aspects of accounting are recorded.
Every transaction has two parts debit and credit. Every transaction is recorded once on debit side and
once on credit side.
 [Chapter 1 → Introduction to Accounting] 7

For example
When goods are purchased for cash purchases are debited and cash is credited.
If more than two accounts are effected than the sum of debit entries must be equal to the sum of
credit entries.

2. Single entry system

It is that system of accounting in which transactions are not recorded on the basis of double entry
system. In this system either the transactions are not recorded at all or only one aspect is recorded.
Instead of maintaining all the records only the personal and cash accounts are maintained. The
accounts maintained are incomplete, unsystematic and unsatisfied. It is also called accounting from
incomplete records.

3. Cash system of accounting

Under cash system of accounting, transactions are made only when cash is actually received or
actually paid. No entries are made when cash is payable to a creditor or receivable from a debtor.
In such cases, financial statements prepared by them for determining income take the form of
receipts and payments account.

4. Mercantile or accrual system of accounting

It is a system in which transactions are recorded on "due basis" that is when amounts become due for
payment or receipt. This system is considered to be a better system of accounting because it takes
into account the effect of all transactions. It is followed by many industrial and commercial concerns.

Book keeping and accounting

Book keeping is mainly concerned with recording of financial data relating to the operations of the
business in an orderly pattern. It is the science of correctly recording business transactions in proper
books of accounts. This task is of clerical nature and is being done by the use of electronic devices.
Accounting is concerned with recording, summarizing, classifying the recorded data and
communicating this information to internal and external users of accounting. Thus, the accountant
should possess knowledge, analytical understanding and certain special skills.

Difference between Book Keeping and Accounting

S. No. Book Keeping Accounting

1 Book Keeping is a primary task of Accounting is a secondary task.
maintaining accounts.
2 Book Keeping is done by clerical and Accounting is done by highly skilled and
junior staff. senior staff.
3 Book Keeping does not produce final Accounting gives us final results of business in
results of business. the form of financial statements (Trading
account, profit and loss account and balance
sheet).
 8 Fundamentals of Accounting

4 Book Keeping is done with the help of Accounting has its own principles.
accounting principles.
5 Book Keeping is a routine work. Accounting is a specialized work.

Test your understanding

Q1. Determine whether the following statements are true or false:

1. Fixed assets must always be shown at market value.
2. Accounting is concerned with monetary and non-monetary transactions.
3. Current liabilities are those liabilities which can be paid in cash within one year.
4. Bills receivable is an example of current assets.
5. Book keeping and accounting are different terms.
6. Accounting is as old as money itself.
Answer:
1. False
2. False
3. True
4. True
5. False
6. True

Q2. Fill in the blanks:

1. Financial accounting is more or less ___________ for every business.
2. Cash in hand is an example of __________ asset.
3. _________ accounting helps in ascertaining and controlling costs.
4. Management accounting provides services to management in performing all _______ functions.
5. _________ are persons to whom goods are sold on credit.
6. _________ is the language of business.
7. Accounting is as old as _________ itself.
Answer:
1. Compulsory
2. Current
3. Cost
4. Management
5. Sundry debtors
6. Accounting
7. Money
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Q3. Objective type questions:

1. Single entry system is also called as:
a. cash basis of accounting
b. accrual basis of accounting
c. double entry system
d. accounting from incomplete records
2. Cost accounting is one of the:
a. branches of accounting
b. limitations of accounting
c. advantages of accounting
d. none of these
3. The government needs financial information:
a. to determine national income
b. to levy taxes
c. both a and b
d. none of these
4. A system in which accounting entries are made only when cash is received or paid is known as:
a. single entry system
b. double entry system
c. cash basis of accounting
d. mercantile basis of accounting
5. Book Keeping refers to:
a. designing the system for classifying data
b. interpreting the data for different users
c. recording of financial data relating to business operations
d. all of these
6. The accounting which is more or less compulsory for every business is:
a. financial accounting
b. management accounting
c. cost accounting
d. none of these
7. Outstanding Rent Account is an example for:
a. Nominal account
b. Personal account
c. Representative personal account
d. None of these
8. The giving aspect in a transaction is called as:
a. Debit aspect
b. Credit aspect
c. Neither of the two
d. Both of them
 10 Fundamentals of Accounting

Answer:
1. d
2. a
3. c
4. c
5. c
6. a
7. a
8. a

Multiple Choice Questions

Q1. The main objectives of book-keeping are:

(a) Complete Recording of Transactions
(b) Ascertainment of financial effect on business
(c) Analysis and Interpretation of data
(d) (a) and (b) both
Q2. Financial Statements are a part of:
(a) Accounting
(b) Book-keeping
(c) Both
(d) None
Q3. The direct advantage of accounting do not include:
(a) Preparation of financial statements
(b) Competitive advantage
(c) Ascertainment of profit or loss
(d) Information to interested groups
Q4. The problems related to price-rise are handled under:
(a) Management Accounting
(b) Cost Accounting
(c) Financial Accounting
(d) Inflation Accounting
Q5. Financial statements users include:
(a) Shareholders
(b) Government
(c) Vendors
(d) All of the above
Q6. ` 5000 paid as rent of office premises in an/a:
(a) Event
(b) Transaction
(c) Both
(d) None
 [Chapter 1 → Introduction to Accounting] 11

Q7. Which of the following is correct?

Owner's equity is:
(a) (Current Asset + Fixed Asset) + (Current Liabilities + Long term Liabilities)
(b) (Current Asset + Fixed Asset) - (Current Liabilities + Long term Liabilities)
(c) (Current Asset - Fixed Asset) - (Current Liabilities + Long term Liabilities)
(d) None of the above
Q8. If owner's equity is ` 50,000 liabilities is ` 30,000 and fixed assets are ` 70,000 then what is the value
of current assets?
(a) ` 10,000
(b) ` 40,000
(c) ` 80,000
(d) ` 1,00,000
Q9. Net profit or loss will be derived at ____________ stage of accounting.
(a) Classifying
(b) Interpretation
(c) Recording
(d) Summarizing
Q10. Which one of the following is not a main objective of accounting?
(a) Systematic recording of the transactions.
(b) Ascertainment of the financial profitability of the business.
(c) Ascertainment of the financial position of the business.
(d) Solving tax disputes with tax authorities.
Q11. At the end of the financial year, Mr. X earns a profit of ` 57,000 in his business. This is:
(a) a transaction
(b) an event
(c) a transaction as well as an event
(d) neither a transaction nor an event
Q12. Which of the following is an event?
(a) Sale of goods for ` 5,000
(b) Closing stock of worth ` 4,000
(c) Purchase of goods for ` 8,000
(d) Rent paid ` 2,000
Q13. When fixed assets are sold:
(a) Total assets will increase
(b) Total liabilities will increase
(c) Total assets will decrease
(d) There is no change in total assets
Q14. The Accounting Equation is based on:
 12 Fundamentals of Accounting

(a) Going concern concept

(b) Dual aspect concept
(c) Money measurement concept
(d) All of these

Q15. Capital as on 01-04-05 ` 90,000

Capital introduced ` 25,000
Drawings made ` 35,000
Capital as on 31-03-06 ` 1,25,000
What is the amount of profit added to the capital?
(a) ` 50,000
(b) ` 60,000
(c) ` 70,000
(d) ` 45,000
Q16. Ram starts business with ` 90,000 and then buys goods from Shyam on credit for ` 23,000. The
accounting equation based on assets = capital+ liabilities will be:
(a) 1,13,000 = 90,000 + 23,000
(b) 1,13,000 = 1,13,000 + 0
(c) 90,000 = 67,000 + 23,000
(d) 67,000 = 90,000 - 23,000
Q17. Ram purchased a car for ` 10,000 paid ` 3,000 as cash and balance amount will be paid in there equal
installments. Due to this:
(a) Total assets increase by ` 10,000
(b) Total liabilities increase by ` 3,000
(c) Assets will increase by ` 7,000 with corresponding increase in liability by ` 7,000
(d) Both (b) and (c)
Q18. What is the effect on the net assets if cash is received from debtors of ` 50,000?
(a) Increase
(b) Decrease
(c) No change
(d) None of these
Q19. "For every debit there is an equivalent credit" this statement demonstrates:
(a) Matching concept
(b) Cost concept
(c) Money measurement concept
(d) Dual aspect concept
Q20. The area wherein different accounting policies can be adopted are:
(a) Valuation of inventories
 [Chapter 1 → Introduction to Accounting] 13

(b) Retirement benefits

(c) Treatment of goodwill
(d) All of the above
Q21. Capital of business is ` 75,000 and liability is ` 25,000 then total assets of business would be:
(a) ` 1,00,000
(b) ` 15,000
(c) ` 75,000
(d) ` 50,000

Q22. Journal records the transactions of the firm in a:

(a) Analytical manner
(b) Chronological manner
(c) Periodical manner
(d) Summarized manner
Q23. If two or more transactions of the same nature are journalized together it is known as:
(a) Compound journal entry
(b) Separate journal entry
(c) Posting
(d) None of the above
Q24. The rule regarding Personal Account is:
(a) Debit what comes in, credit what goes out
(b) Debit all expenses and losses, credit all incomes and gains
(c) Debit the receiver, credit the giver
(d) None
Q25. The Rule 'Debit all expenses and losses and credit all incomes and gains' relates to:
(a) Personal Account
(b) Real Account
(c) Nominal Account
(d) None of these
Q26. ` 1,500 withdrawn for personal should be debited to:
(a) Expense Account
(b) Purchases Account
(c) Sales Account
(d) Drawings Account
Q27. Good worth ` 10,000 were withdrawn by the proprietor for his personal use. The account to be
credited is:
(a) Sales A/c
(b) Drawings A/c
(c) Purchases A/c
 14 Fundamentals of Accounting

(d) Expenses A/c

Q28. Purchase of second- hand computer on credit by a cloth merchant will be recorded in:
(a) Journal
(b) Cash Book
(c) Purchase
(d) None of the above
Q29. ` 5,000 received from Ram on 1.1.09 for the old furniture sold to him on 1.06.08 which of the
following entry should be passed for recording the transaction in the book of accounts?
(a) Cash A/c Dr. 5,000
To Furniture A/c 5,000
(b) Cash A/c Dr. 5,000
To Suspense A/c 5,000

(c) Cash A/c Dr. 5,000

To Bad - debts Recovered A/c 5,000
(d) Cash A/c Dr. 5,000
To Ram A/c 5,000
Q30. If wages are paid for construction of business premises, __________ A/c is credited and ________
A/c is debited.
(a) Wages, Cash
(b) Premises, Cash
(c) Cash, Wages
(d) Cash, Premises
Q31. M/S Stationer Mart will debit purchase of stationery to:
(a) Stationery Account
(b) General Expenses Account
(c) Purchase Account
(d) Stock Account
Q32. Which of the following account may have a debit or a credit balance?
(a) Partner's Current Account
(b) Purchase Account
(c) Commission (Recd.) Account
(d) None
Q33. The process of transferring the transaction relating to changes in a particular item at one place in
the form of an account is called ____________ .
(a) Balancing
(b) Casting
(c) Journalizing
(d) Posting
Q34. The miscellaneous expenses account is likely to have:
(a) Only debit entries
(b) Only credit entries
(c) Both of the above
 [Chapter 1 → Introduction to Accounting] 15

(d) Initially only debit entries and subsequently credit entries

Q35. Discount Account will always have:
(a) Only debit balance
(b) Nil balance
(c) Only credit balance
(d) Debit or credit balance
Q36. Cash Sales ` 50,000
Cash collected from Debtors ` 1,30,000
Bad debts during year ` 5,000
Debtors at beginning ` 10,000
Total sales will be:
(a) ` 1,75,000
(b) ` 1,70,000
(c) ` 1,80,000
(d) ` 1,78,000
Q37. What will be the journal entry when goods purchased are returned?
(a) Creditors A/c Dr.
To Purchase Return A/c
(b) Purchase Return A/c Dr.
To Creditors A/c
(c) Creditors A/c Dr.
To Sales A/c
(d) None of these.
Q38. Methods of preparation of trial balance are:
(a) Balance Method
(b) Total Method
(c) Total and Balance Method
(d) All of these
Q39. Trial Balance is a:
(a) Statement
(b) Account
(c) Summary
(d) Ledger
Q40. Difference of totals of both debit and credit side of trial balance is transferred to:
(a) Trading Account
(b) Suspense Account
(c) Difference Account
(d) Miscellaneous Account
Q41. Goods sold for cash ` 10,000 plus 10% Sales Tax. Sales A/c will be credited by:
 16 Fundamentals of Accounting

(a) ` 11,000
(b) ` 10,000
(c) ` 9,000
(d) None
Q42. A note sent by buyer on return of goods is:
(a) Promissory Note
(b) Fake Note
(c) Return Note
(d) None of these
Q43. Purchase of furniture on credit should be recorded in ___________ .
(a) Purchase book
(b) Sales book
(c) Cash book
(d) Journal
Q44. Small payments are recorded in a book called:
(a) Cash book
(b) Small payments book
(c) Purchase book
(d) Petty cash book
Q45. Where two aspects of transaction are posted in the cash book, such an entry is called:
(a) Double Entry
(b) Debit Entry
(c) Credit Entry
(d) Contra Entry
Q46. Rent paid for the month of March will appear __________ in the cash book.
(a) On the receipt side
(b) On the payment side
(c) As a contra entry
(d) No where
Q47. Postage stamps purchased for ` 30 by business. This transaction will be recorded in:
(a) Purchase book
(b) Cash book
(c) Petty cash book
(d) Journal
Q48. ` 2,500 spent on the overhauling purchase of second hand machinery:
(a) Capital expenditure
(b) Revenue expenditure
(c) Deferred revenue expenditure
(d) None of the above
Q49. Machinery was purchased for ` 10,000 and ` 500 paid as wages for erection of machinery. The
whole amount should be debited to:
 [Chapter 1 → Introduction to Accounting] 17

(a) Wages A/c

(b) Machinery A/c
(c) Repairs A/c
(d) None of these
Q50. 'A' purchased a car on 01.06.2010 for ` 5,60,000 and incurred ` 25,000 for repairs etc. He paid `
10,000 as insurance ` 1,500 for petrol. What amount should be debited to Car A/c?
(a) ` 5,60,000
(b) ` 5,96,500
(c) ` 5,95,000
(d) ` 5,85,000
Answer:
1 (a) 2 (a) 3 (b) 4 (d) 5 (d) 6 (b) 7 (b) 8 (a) 9 (d) 10 (d)
11 (b) 12 (b) 13 (c) 14 (b) 15 (d) 16 (a) 17 (c) 18 (c) 19 (d) 20 (a)
21 (a) 22 (b) 23 (d) 24 (c) 25 (c) 26 (d) 27 (c) 28 (a) 29 (d) 30 (d)
31 (c) 32 (a) 33 (d) 34 (a) 35 (d) 36 (a) 37 (a) 38 (d) 39 (c) 40 (b)
41 (b) 42 (d) 43 (d) 44 (d) 45 (d) 46 (b) 47 (c) 48 (c) 49 (b) 50 (d)

Essay type Questions

Q1. Explain the need of accounting in modern business.

Q2. What are the functions of accounting? How does 'book-keeping' differs from 'accounting'?
Q3. Name the parties or groups interested in accounting information.
Q4. Explain the branches of accounting.
Q5. Discuss in brief the limitations of accounting.
Q6. Difference between book keeping and accounting.
Q7. Explain the characteristics of accounting information.

Space for writing important points for revision