MODULE - 1

INTRODUCTION TO ACCOUNTING

1.1 Introduction
1.2 Meaning and Definition
1.3 Objectives of Accounting
1.4 Functions of Accounting
1.5 Users of Accounting Information
1.6 Limitations of Accounting
1.7 Accounting Cycle
1.8 Accounting Principles
1.9 Accounting Concepts and Accounting Conventions
1.10 Accounting Standards – Objectives- Significance of Accounting Standards.
1.11 List of Indian Accounting Standards.

1.1 Introduction

The success of a business entity depends on the combined effects of four factors – land, labor, capital
and management. The contribution of each factor has to be properly measured: only then can the
resultant performance of the entity be properly evaluated. Hence Accounting is the language of
business which is necessary for both business as well as non-business activities.

1.2 Meaning and Definition

The art of recording, classifying and summarizing in a significant manner and in terms of money,
transactions and events which are, in a part at least of a financial character, and interpreting the
results thereof.
- The American Institute of Certified Public Accountants

1.3 Objectives 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: It is very difficult to remember all the business transactions
that take place. Accounting serves this purpose of record keeping by promptly recording all
the business transactions in the books of account.

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 ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e.,
profit earned or loss suffered in business during a particular period. For this purpose, a
business entity prepares either a Trading and Profit and Loss account or an Income and
Expenditure account which shows the profit or loss of the business by matching the items of
revenue and expenditure of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman
must know his financial position i.e., availability of cash, position of assets and liabilities etc.
This helps the businessman to know his financial strength. Financial statements are
barometers of health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about
how an enterprise obtains and spends cash, about its borrowing and repayment of borrowing,
about its capital transactions, cash dividends and other distributions of resources by the
enterprise to owners and about other factors that may affect an enterprise’s liquidity and
solvency.
v) To protect business properties: Accounting provides up to date information about the
various assets that the firm possesses and the liabilities the firm owes, so that nobody can
claim a payment which is not due to him.
vi) To facilitate rational decision – making: Accounting records and financial statements
provide financial information which help 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: Entities such as companies, societies, public trusts
are compulsorily required to maintain accounts as per the law governing their operations such
as the Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is
also compulsory under the Sales Tax Act and Income Tax act.

1.4 Functions of Accounting;

The following are the major functions of accounting:

(a) Keeping Systematic Records:
As a language of business, accounting is to report the results of most business events. Hence, its
main function is to keep a systematic record of these events. This function embraces recording
transactions in journal and subsidiary books like cashbook, sales book etc., posting them to ledger
accounts and ultimately preparing the financial statements [final accounts].

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(b) Communicating the Results:
The second main function of accounting is to communicate the financial facts of the enterprise to the
various interested parties like owners, investors, creditors, employees, government, and research
scholars, etc. The purpose of this function is to enable these parties to have better understanding of
the business and take sound and realistic economic decisions.

(c) Meeting the Legal Requirements:

Accounting aims at fulfilling the legal requirements, especially of the tax authorities and regulators
of the business. It discharges this function in accordance with certain fundamental truths and uniform
enforcement of generally accepted accounting principles.
(d) Protecting the Properties of the Business:
Accounting helps protecting the property of the business.

(e) Planning and Controlling the Business Activities:

Accounting also helps planning future activities of an enterprise and controlling its day-to-day
operations. This function is done mainly to promote maximum operational efficiency.

1.5 Users of Accounting Information

A. Internal Users
Internal users use a mix of management and financial accounting information. Some internal users of
accounting information and their needs are briefly discussed below:

1. Management

Management uses accounting information for evaluating and analyzing organization’s financial
performance and position, to take important decisions and appropriate actions to improve the
business performance in terms of profitability, financial position and cash flows. One of the major
roles of management is to set rules and procedures to achieve organizational goals. For this purpose,
management uses information generated by financial as well as managerial accounting system of the
organization.

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2. Owners

Owners invest capital to start and run business with the primary objective to earn profit. They need
accurate financial information to know what they have earned or lost during a particular period of
time. On the basis of this information they decide their future course of actions such as expansion or
contraction of business.

In small businesses (like sole proprietorship and partnership) owners themselves perform the
function of management.

External users

External users normally use only financial accounting information. Some external users of
accounting information and their needs are briefly discussed below:

1. Investors

In corporate form of business, the ownership is often separated from the management. Normally
investors provide capital and management runs the business.

The accounting information is used by both actual and potential investors. Actual investors use this
information to know how their funds are used by the management and what is the expected
performance of business in future in terms of profitability and growth. On the basis of this
information, they decide whether to increase or decrease investment in corporation in future.
Potential investors use accounting information to decide whether or not a particular corporation is
suitable for their investment needs.

2. Lenders

Lenders are individuals or financial institutions that normally lend money to businesses and earn
interest income on it. They need accounting information to assess the financial performance and
position and to have a reasonable assurance that the business to whom they are going to lend money
would be able to return the principal amount as well as pay interest there on.

3. Suppliers

Suppliers are business individuals or organizations that normally sell merchandise or raw materials

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to other businesses on credit. They use accounting information to have an idea about the future
creditworthiness of the business and to decide whether or not to continue providing goods on credit.

4. Government agencies

Government agencies use financial information of businesses for the purpose of imposing taxes and
regulations.

5. General public

General public also uses accounting information of business organizations. For example, accounting
information is:

 a source of education for students of accounting and finance.

 a source of valuable data for those researching on organizational impacts on individuals and
economy as a whole.
 a source of information for the people looking for job opportunities.
 a source of information about the future of a particular enterprise

6. Customers

Accounting information provides important information to customers about current position of a

business organization and to make a judgment about its future. Customers can be divided into three
groups – manufactures or producers at various stages of production, wholesalers and retailers and
end users or final consumers.

Manufacturers or producers at every stage of processing need assurance that the organization in
question will continue providing inputs such as raw materials, parts, components and support etc.
The wholesalers and retailers must be assured of consistent supply of products. The end users or final
consumers are interested in continuous availability of products and related accessories. Because of
these reasons, the accounting information is of significant importance for all three types of
customers.

7. Employees

Employees who do not have a hand in core management of the business are considered external users

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of accounting information. They are interested in financial information because their present and
future is tied up with the success or failure of the business. The success and profitability of business
ensures job security, better remuneration, job promotion and retirement benefits.

1.6 Limitations of Accounting

 Accounting is historical in nature: It does not reflect the current financial position or worth of
a business.
 Transactions of non-monetary mature do not find place in accounting. Accounting is limited to
monetary transactions only. It excludes qualitative elements like management, reputation,
employee morale, labour strike etc.

 Facts recorded in financial statements are greatly influenced by accounting conventions and
personal judgements of the Accountant or Management. Valuation of inventory, provision for
doubtful debts and assumption about useful life of an asset may, therefore, differ from one
business house to another.
 Accounting principles are not static or unchanging-alternative accounting procedures are often
equally acceptable. Therefore, accounting statements do not always present comparable data
 Cost concept is found in accounting. Price changes are not considered. Money valueis bound
to change often from time to time. This is a strong limitation of accounting.
 Accounting statements do not show the impact of inflation.
 The accounting statements do not reflect those increase in net asset values that are not
considered realized.

1.7 Accounting Cycle

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 When a businessman starts his business activities, he records the day-to-day transactions in the
Journal. From the journal the transactions move further to the ledger where accounts are written up.
Here, the combined effect of debit and credit pertaining to each account is arrived at in the form of
balances.
To prove the accuracy of the work done, these balances are transferred to a statement called trial
balance. Preparation of trading and profit and loss account is the next step. The balancing of profit
and loss account gives the net result of the business transactions.
To know the financial position of the business concern balance sheet is prepared at the end. These
transactions which have completed the current accounting year, once again come to the starting point
– the journal – and they move with new transactions of the next year. Thus, this cyclic movement of
the transactions through the books of accounts (accounting cycle) is a continuous process.

1.8 Accounting Principles

The rules and guidelines that companies must follow when reporting financial data. The commonset
of accounting principles is the generally accepted accounting principles (GAAP).
To be generally acceptable it has to meet the following criteria–
a) Relevance: It should result in useful or meaningful information to the users.
b) Objectivity: It should be reliable and the results should be verifiable.
c) Feasibility: Can be implemented without undue complexity or cost

1.9 Accounting Concepts and Accounting Conventions

Accounting Concepts:
1. Business Entity Concept: A business unit is separate and distinct from the persons who
supply funds to it in order to get a true position of the business.
2. Money Measurement Concept: Only those transactions which can be expressed in terms
of money are recorded in the books of accounts.
3. Accounting Period Concept: A life of business is divided into suitable accounting period.
It is made to ascertain the profit or loss of the business for a particular period (i.e., 31st March) and
to know the financial position of a business on a particular date.
4. Going Concern Concept: Refers to continuous existence of the business concern. The
business is carried on for a number of years in future.

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 5. Dual Aspect Concept: Every transaction involves two fold aspects –
a) Receiving aspect
b) Giving aspect
6. Historical Record Concept: Only those transactions which have actually taken place must
be recorded.
7. Revenue Recognition Concept: It is mainly concerned with the revenue being recognized
in the income statement (Profit and Loss A/c) of a business. It is recognized in the period in
which it is earned irrespective of the fact whether it is received or not during the period.
8. Matching Concept: The expenses incurred in an accounting period should be matched
with the revenues recognized in that period.
9. Realization Concept: A business has to record revenue or income, only after it has been
legitimately realized.
10. Objective Evidence Concept: All accounting transactions should be evidenced and
supported by documents such as invoices, receipts, vouchers, etc. These form the basis for
making entries in the books of accounts.
11. Cost Concept: An asset is recorded in the books at the price paid to acquire it and this is
the basis for all subsequent accounting for that asset.
12. Accrual Concept: While preparing Profit and Loss Account of a concern, all revenue
items relating to that period are taken into consideration irrespective of the fact that these
items are paid or payable.
13. Legal Aspect Concept: The accounting record should reflect the legal validity of the
transaction entered in the books.

Accounting Conventions:
1. Consistency convention: The accounting rules, practices and conventions followed should
remain the same every year and only then the results of different years can be compared. A
change can be done if it is really necessary by stating its effects clearly.
2. Full disclosure convention: The financial statements should act as a means of conveying
and not concealing. They must disclose all the relevant and reliable information. The
disclosure should be full, fair and adequate.
3. Conservatism convention: It is also known as the concept of prudence. It means that the
accountant should have a cautious approach. He should record lowest possible value for

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 assets and revenues and highest possible value for liabilities and expenses. Consequently, net
assets are more likely to be understated and income more likely to be overstated.

4. Materiality convention: It reveals that only important items should be recorded in the
books.

1.10 Indian Accounting Standards – Brief Overview only

“Accounting standards are the policy documents or written statements issued, from time to time, by
an apex expert accounting body in relation to various aspects of measurement, treatment and
disclosure of accounting transactions or events for ensuring uniformity in accounting practices and
reporting.”

Objectives of Accounting Standards:

 Accounting standards provide the norms on the basis of which financial statements should be
prepared.
 Accounting standards ensure uniformity in the preparation and presentation of financial
statements: by removing the effect of diverse accounting practices.
 Accounting standards make financial statements meaningful and comparable.
 Accounting standards provide a useful system to resolve potential financial conflicts of
interest between various groups.
 Accounting standards help auditors in the audit of accounts. Accounting standards raise the
standard of an audit of accounts.

Significance of Accounting Standards:

 Determining managerial Accountability
 Assists Auditors
 Improves reliability of financial statements
 Attains uniformity in Accounting
 Prevents fraud and accounting manipulations
 Comparability

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1.11 List of Indian Accounting Standards
Following are the Indian Accounting Standards:
No. Name of the Accounting Standard Status

AS 1 Disclosure of the accounting policies Compulsory

AS 2 Valuation of inventories (revised)

AS 3 Cash Flow statements (revised)

AS 4 Contingencies & Events occurring after the (revised)

Balance Sheet Date

AS 5 Net Profit or Loss for the period, Prior period (revised)

items and Changes in Accounting policies

AS 6 Depreciation accounting (revised)

AS 7 Accounting for construction contracts (revised)

AS 9 Revenue recognition Mandatory

AS 10 Accounting for fixed assets These standards are

withdrawn either in full
or in parts of with the
issuance of AS 26

AS 11 The effects of changes in foreign exchange (revised)

Rates

AS 12 Accounting for government grants Mandatory

AS 13 Accounting for investments Mandatory

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AS 14 Accounting for amalgamation Mandatory

AS 15 Accounting for retirement benefits in the Mandatory

financial statements of employers

AS 16 Borrowing costs Mandatory

AS 17 Segment reporting Mandatory

AS 18 Related party disclosures Mandatory

AS 19 Leases Mandatory

AS 20 Earnings per share Mandatory

AS 21 Consolidated Financial Statements Mandatory

AS 22 Accounting for taxes on income Mandatory

AS 23 Accounting for investments in associates in Mandatory

consolidated financial statements

AS 24 Discounting operations Mandatory

AS 25 Interim financial reporting Mandatory

AS 26 Intangible assets Mandatory

AS 27 Financial reporting of interests in joint ventures Mandatory

AS 28 Impairment of assets Mandatory

AS 29 Provisions, contingent Liabilities and Mandatory

contingent assets

AS 30 Financial instruments: Recognition and Mandatory w.e.f. 1-4-

measurement 2011

AS 31 Financial instruments: Presentations Mandatory w.e.f. 1-4-

2011

AS 32 Financial instruments: Disclosures Mandatory w.e.f. 1-4-

2011

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B. Self-Assessment;
Section A
1. Name the three principles of accounting
2. Define Accounting
3. What is going concern concept?
4. What is dual aspect concept?
5. What is conservatism concept?
6. Name the following Indian accounting standards – AS 2, AS 6, AS 9 and AS 10
7. What are the objectives of accounting?

Section B
1. Briefly explain accounting conventions
2. What are the limitations of accounting?
3. Write a note on internal users of accounting?
4. Write a brief note on – Materiality, Matching principle and objective concept.
5. What are the objectives of accounting

Section C
1. What is accounting? Define its objectives.
2. Describe information needs of external users
3. Explain the functions of accounting
4. Explain accounting concepts?
5. What is need for accounting?

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