Unit-1: Theoretical Frame Work

Introduction to Accounting

 Accounting- concept, meaning, as a source of information, objectives, advantages and

limitations, types of accounting information; users of accounting information and their
needs. Qualitative Characteristics of Accounting Information. Role of Accounting in Business.

The modern era is one of trade, business, and commerce. Business is growing and getting more
complicated as a result of globalization, deregulation, and privatization. An organization cannot recall
all of its transactions for an extended period of time. As a result, keeping a written record of all
company activities on a daily basis becomes required, leading to the formation of accounting.

Luca Pacioli ( 1447 – 1517) was the first person to publish detailed material on the double-entry
system of accounting. He was an Italian mathematician and known as the father of accounting.

DEFINITION OF ACCOUNTING

In 1941, The American Institute of Certified Public Accountants (AICPA) had defined accounting as the
art of recording, classifying, and summarising 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’.

MEANING OF ACCOUNTING

Accounting is a systematic process of identifying recording measuring classify verifying some rising
interpreter and communicating financial information.

ACCOUNTING AS A SOURCE OF INFORMATION

Every step in the process of accounting generates information. Generation of information is not an end
in itself. It is a means to facilitate the dissemination of information among different user groups. Such
information enables the interested parties to take appropriate decisions. Therefore, dissemination of
information is an essential function of accounting. To be useful, the accounting information should
ensure to:

• provide information for making economic decisions;

• serve the users who rely on financial statements as their principal source of information;

• provide information useful for predicting and evaluating the amount, timing and uncertainty of
potential cash-flows;
• provide information for judging management’s ability to utilise resources effectively in meeting
goals;

• provide factual and interpretative information by disclosing underlying assumptions on matters

subject to interpretation, evaluation, prediction, or estimation; and

• provide information on activities affecting the society.

ATTRIBUTES/CHARACTERISTICS/FEATURES/NATURE OF ACCOUNTING

 Identification of financial transactions and events - It means to determine what transactions

to record. i.e., to identify the financial events which are to be recorded in the books of
accounts. It involves observing all business activities and selecting those events or transactions
which can be considered as financial transactions.
 Measuring the identified transactions - In Accounting we record only those transactions
which can be measured in terms of money or which are of financial nature. If a transactions
or event cannot be measured in monetary terms, it is not considered for recording in financial
accounts. There are few events directly or indirectly make effect on the working of a business
firm but cannot be recorded in the books of accounts because they cannot be measured in
terms of money. For example : appointment of a new managing director, signing of contracts,
strikes, death of an employee etc are not shown in the books of accounts.
 Recording : A transaction will be recorded in the books of accounts only if it is considered as
an economic event and can be measured in terms of money. Once the economic events are
identified and measured in financial terms, these are recorded in books of account in
monetary terms and in a chronological order. Recording should be done in a systematic
manner so that the information can be made available when required. i.e., Journal.
 Classifying : Once the financial transactions are recorded in journal or subsidiary books, all the
financial transactions are classified by grouping the transactions of one nature at one place in
a separate account. This is known as preparation of Ledger.
 Summarising : It is concerned with presentation of data and it begins with balance of ledger
accounts and the preparation of trial balance with the help of such balances. Trial balance is
required to prepare the financial statements i.e., Trading Account, Profit & Loss Account and
Balance Sheet.
 Analysis and Interpretation : It is done so that the users of financial data can make a
meaningful judgement of the profitability and financial position of the business.
 Communication : The main purpose of accounting is to communicate the financial information
the users who analyse them as per their individual requirements. Providing financial
information to its users is a regular process.

PROCESS OF ACCOUNTING

IDENTIFYING FINANCIAL
TRANSACTIONS AND EVENTS

RECORDING

CLASSIFYING

SUMMARISING

ANALYSIS AND
INTERPRETATION

COMMUNICATING TO USERS
OBJECTIVES OF ACCOUNTING

1. Maintaining Accounting Records : It is vital to keep systematic records of every business

transaction since it is beyond the human capacity to recall such a vast number of transactions.
Skipping any of the transactions may result in incorrect and defective results.
2. Determining profit or loss : Profit or loss must be calculated at the end of an accounting period
in order to ascertain the net result. Trading and profit and loss statements are created for this
purpose. It details the number of goods acquired and sold, the costs paid, and the amount
gained over the course of a year.
3. Determining Financial position : Profit or loss is not enough; the business's owner is also
interested in understanding the financial position of his/her business. This goal is met by
generating a balance sheet, which aids in determining the real financial status of the
organization.
4. Facilitating Management : Systematic accounting assists management in making successful
decisions, maintaining effective control over financial policies, generating budgets and
forecasts, and so on.
5. Providing Accounting Information to users - The communication of accounting information to
various users, including both internal and external users such as owners, management,
government, labour, tax authorities, and so on, is a crucial phase in the accounting process.
This helps users comprehend and analyse accounting data in a relevant and suitable manner,
free of uncertainty.
6. Protecting Business Assets – Accounting maintains record of assets owned by the business
which enables the management to exercise control and protect them.

ADVANTAGES OF ACCOUNTING

 Financial information about business - Accounting easily makes the organization's financial
information available to users such as owners, creditors, workers, consumers, the government,
and so on.
 Assistance to management - Management can make better decisions if financial transactions
are properly recorded. Accounting information helps management plan future actions, create
budgets, and coordinate department activities.
 Replaces memory- Accounting record-keeping eliminates the need to remember transactions.
 Facilitates comparative study - It allows for easy comparison of financial outcomes from one
year to the next. Furthermore, the management may examine the systematic recording of all
financial transactions in accordance with the entity's policies.
 Facilitates settlement of tax liabilities – A systematic accounting record immensely helps in
settlement of income tax and Goods and Services tax (GST) liabilities, since it is good evidence
of the correct recording of transactions.
 Facilitates loans – Loan is granted by the financial institutions on the basis of growth potential
which is supported by the performance and security of loans. Accounting makes available the
information with respect to performance and also assets that are available as security.
 Evidence in court - In a court of law, the detailed, systematic and organized records of financial
transactions serve as evidence.
 Assistance in the event of insolvency – Insolvency proceedings involve explaining many
transactions that have taken place in the past. Systematic accounting records assist a great
deal in such situation.
 LIMITATIONS OF ACCOUNTING

1. Historical cost - Accounting takes historical costs into account when measuring the values.
However, this method does not permit taking into account crucial accounting factors like
inflation, price variations, and similar things.
2. Estimates - Accounting has another significant limitation: estimate. The reason for this is
that not every accounting can be done to determine the exact amount, hence it is
necessary to estimate. The disadvantage of this situation is that the accountant estimates
based on his or her own judgment. This evaluation is very subjective because it is
dependent on the expectation of future occurrences
3. Only monetary transactions are counted : Accounting cannot record events or things that
are not valued in money. These occurrences or things, which cannot be quantified in
monetary terms and have no place in accounting. Eg: loyalty of employees.
4. May lead to Window dressing - Window dressing in accounting refers to the process of
changing the accounts to present the firm in a more attractive position than its true
condition through its financial statements. Consequently, it is impossible to determine the
company's genuine financial status from such financial documents.
5. Errors and frauds - Accounting is handled by humans, thus there is always the chance of
mistakes. Accounts are sometimes manipulated in order to conceal fraud. Fraud is tough
to detect since it is an intentional action.

Book Keeping

 Recording of business transactions in a systematic manner in the books of account is called

bookkeeping. It is mainly concerned with the maintenance of books of accounts. It includes
identification of financial transactions, measuring this transaction in terms of money,
recording these transactions and classifying them into ledger.

According to A.J. Favell “Book–keeping is the art of recording the financial transactions of a business
in a methodical manner so that information on any point in relation to them may be quickly obtained”.
SYSTEMS OF ACCOUNTING

1. Double entry system

It is the system of accounting which recognises and records both aspects – debit and credit of
a financial transaction. This system is based on the ‘Dual aspect concept’ and is universally
applied in accounting.

Features –

 It maintains a complete record of each transaction.

 It recognises two-fold aspect of every transaction i.e. receiving and giving
 In this system, one aspect is debited and the other aspect is credited following the rules of
credit and debit.
 Since one aspect of a transaction is debited and the other is credited, the total of all debits is
always equal to total of all credits. It helps in establishing arithmetical accuracy by preparing
the Trial Balance

Advantages –

a) It helps to keep a complete and systematic record of all business transactions ;

b) Since both the aspects of a transaction are recorded under this system, it facilitates a check on the
arithmetical accuracy of the accounting books ;

c) It reveals the results of business activities. By preparing trading and profit and loss account, profit
earned or loss suffered by the business is ascertained ;

d) By preparing position statement (Balance sheet), the financial position of the business is correctly
estimated.

e) It keeps complete records of transactions

f) It helps to do comparative study with the previous year’s results.

g) It helps management in decision making.

h) It helps in detecting frauds and misappropriations.

Disadvantages –

a) This system fails to ascertain actual profits if there are errors of principle in the records;

b) A mistake committed at the time of journalizing or an omission of a transaction from journalising

cannot be disclosed under this system ;

c) There is possibility of fraud and misappropriations in the system.

Single-entry bookkeeping, also known as, single-entry accounting, is a method of bookkeeping that
relies on a one-sided accounting entry to maintain financial information. This system ignores the two-
fold aspect of each transaction as done in double entry system. In this only cash and personal accounts
are maintained. It is also known as Accounts from incomplete records.

BRANCHES/ SUB-FIELDS OF ACCOUNTING

1. Financial Accounting: It is that branch of accounting, which involves the recording of the
transactions, inclined towards the preparation of trial balance and final accounts.
 2. Cost Accounting: Cost account is the accounting discipline, which deals with costs, i.e. the unit
costs of the goods produced and services provided. It helps the management of the
organization in fixing the price, controlling costs and providing relevant information for the
purpose of decision making.

3. Management Accounting: The accounting system which supplies the necessary information
to the management, for rational decision making. The information may be concerned with
funds, costs, profits and losses and so forth. This information is helpful in determining the
effect of the decisions and analysing the performance of the entity.

4. Tax Accounting: The accounting system that deals with the tax return and its payment,
instead of preparation of final accounts of the enterprise, is called tax accounting.

5. Social Accounting: This branch of accounting is commonly termed as social responsibility

accounting. It aims at unveiling the facilities provided by the entity to the society, in terms of
medical, housing, education, and so forth.

ACCOUNTING INFORMATION AND ITS TYPES

“Accounting is a service activity. Its function is to provide qualitative information, primarily financial in
nature, about economic entities that is intended to be useful in making economic decisions.” –
ACCOUNTING PRINCIPLES BOARD

1. INFORMATION RELATING TO PROFIT OR SURPLUS – The income statement makes available the
accounting information about the profit earned or loss incurred as a result of business
operations.
 A firm prepares trading and profit and loss account for ascertaining profit of loss of the
business.
 A company prepares Statement of profit and loss in the prescribed form mentioned in PART II
of the Companies Act 2013 to determine the profit/loss of the company.
 A Not-for-Profit Organisation prepares Income and Expenditure account to determine
surplus/deficit.
2. INFORMATION RELATING TO FINANCIAL POSITION – The position statement i.e., Balance sheet
makes the information about the financial position of the business. Its shows assets, capital
and liabilities.
3. INFORMATION ABOUT CASH FLOW – Cash flow statement is a statement that shows flows,
both inflow and outflow, of cash during a specific period. It is usually helpful for making cash
forecast to enable short term planning.

USERS OF ACCOUNTING INFORMATION

 o INTERNAL USERS – They are the users who have access to information that can be
taken from the accounting records
1. Owners – They contribute money in the business and have maximum risk. So,
they are interested in knowing the profit earned or loss incurred by the
business.
2. Management - Accounting information is required by management to make
numerous decisions, such as determining the selling price and other
strategies. It is also required for comparing performance with similar firms in
the industry and making future strategies for development, reduction, and so
on.
o EXTERNAL USERS – They are the users who do not have access to accounting records
and have to base their decision on financial statements.

1. Employees - - Employer stability and profitability are matters of importance to both the
workforce and the organizations that serve as its representatives. They are also
seeking information that would allow them to determine if the firm can afford to pay salaries,
provide retirement benefits, and generate job opportunities.
2. Prospective Investors - The persons who are interested to make an investment in business will
like to know about its profitability and financial position. Thus, they derive this information
from the accounting reports of the business.
3. Government - The Government is interested in the financial statements of business
organization on account of taxation, labour, and corporate laws.
4. Creditors, Bankers, and other Lending Institutions - Trade creditors, bankers, and other
lending institutions would like to be ensured that they will be paid on time. Moreover, the
financial reports help them in judging such position. Thus, Banks and other lending agencies
rely upon accounting statements for determining the acceptability of a loan application.
5. Customers: Customers are curious about an organisation’s future, especially if they depend
on it or have a long-standing relationship with it. Accounting information increases or
decreases a firm’s goodwill amongst its customers.
6. Public: The public is impacted by businesses in a number of different ways. For instance,
businesses may have a significant positive impact on the community’s economy through their
employment of locals and the use of their suppliers. Financial statements can help the public
by informing them of recent changes and trends that have affected the enterprise’s success
and the scope of its activities.

Qualitative Characteristics of Accounting Information

Qualitative characteristics are the attributes of accounting information which tend to enhance its
understandability and usefulness. In order to assess whether accounting information is decision useful,
it must possess the characteristics of reliability, relevance, understandability and comparability.

1. Reliability
Reliability means the users must be able to depend on the information. The reliability of
accounting information is determined by the degree of correspondence between what the
information conveys about the transactions or events that have occurred, measured and
 displayed. A reliable information should be free from error and bias and faithfully represents
what it is meant to represent. To ensure reliability, the information disclosed must be credible,
verifiable by independent parties use the same method of measuring, and be neutral and
faithful.
2. Relevance

To be relevant, information must be available in time, must help in prediction and

feedback, and must influence the decisions of users by :

(a) helping them form prediction about the outcomes of past, present or

future events; and/or

(b) confirming or correcting their past evaluations.

3. Understandability

Understandability means decision-makers must interpret accounting information in the same

sense as it is prepared and conveyed to them. The qualities that distinguish between good and
bad communication in a message are fundamental to the understandability of the message. A
message is said to be effectively communicated when it is interpreted by the receiver of the
message in the same sense in which the sender has sent. Accountants should present the
comparable information in the most intelligible manner without sacrificing relevance and
reliability.
4. Comparability

It is not sufficient that the financial information is relevant and reliable at particular time, in a particular
circumstance or for a particular reporting entity. But it is equally important that the users of the
general-purpose financial reports are able to compare various aspects of an entity over different time
period and with other entities. To be comparable, accounting reports must belong to a common period
and use common unit of measurement and format of reporting.
ROLE OF ACCOUNTING IN BUSINESS

For centuries, the role of accounting has been changing with the changes in economic development
and increasing societal demands. It describes and analyses a mass of data of an enterprise through
measurement, classification and summarisation, and reduces those date into reports and statements,
which show the financial condition and results of operations of that enterprise. Hence, it is regarded
as a language of business. It also performs the service activity by providing quantitative financial
information that helps the users in various ways. Accounting as an information system collects and
communicates economic information about an enterprise to a wide variety of interested parties.
However, accounting information relates to the past transactions and is quantitative and financial in
nature, it does not provide qualitative and non-financial information. These limitations of accounting
must be kept in view while making use of the accounting information.

REFERENCE:

 NCERT textbook Grade 11 Accountancy

 T S Grewal’s Double entry Book keeping Financial Accounting, Sultan Chand , Textbook for
CBSE Class 11
 Toppr.com
 Slideshare.net
 https://www.sarthaks.com/
 businessjargons.com