Summary Sheet

–
Introduction to Accounting

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 1 Meaning of Accounting
• Accounting can be defined as the process of
1. Identifying, measuring, recording and communicating the required information
2. Relating to the economic events
3. of an organization
4. to the interested users of such organization

Now for better conceptual clarity, we will understand each component of the above
definition one by one.

1.1.1 Economic Events

An economic event is known as a happening of consequence to a business organization which
consists of transactions and which are measurable in monetary terms.

Example, If the employees goes on strike this is an important event but it may not be
regarded as an economic event as this cannot be measured in monetary terms. However, if
company paid salaries to employees , it is an economic event as it can be measured in
monetary terms.

Moving ahead, Economic Events are of two types:

1. Internal Economic Event.
2. External Economic Event.

1.1.1.1 Internal Economic Event

An internal event is an economic event that occurs entirely between the internal wings of an
enterprise.

Example - Supply of raw material or components by the stores department to the

manufacturing department. It is happening within the internal wings of the company. So, it
is an internal economic event.

1.1.1.2 External Economic Event

If an event involves transactions between an outsider and an organization, these are known
as external events.

Examples - Sale of Reebok shoes to the customers. Customers are outside the company so;
it is an external economic event.

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 1.1.2 Identification, Measurement, Recording and Communication
Moving ahead, first we identify the economic event of the business and thereafter we move
to identification, measurement, recording and communication of the economic events.

Now, let’s understand more about Identification, Measurement, Recording and

Communication

1.1.2.1 Identification
• It means determining what transactions to record, i.e., to identity events which are to
be recorded.
• Example: The value of human resources, changes in managerial policies or
appointment of personnel are important but none of these are recorded in books of
account. However, when a company makes a sale or purchase, whether on cash or
credit, or pays salary it is recorded in the books of account.

1.1.2.2 Measurement
• It means quantification (including estimates) of business transactions into financial
terms by using monetary unit, viz. rupees and paise as a measuring unit.
• If an event cannot be quantified in monetary terms, it is not considered for recording
in financial accounts.
• Example: Important items like the appointment of a new managing director, signing
of contracts or changes in personnel are not shown in the books of accounts.
However, Payment of Salary worth Rs 1000 will be recorded in the books of accounts.

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 1.1.2.3 Recording
• After Measurement we have to record the business transactions and this recording
is done in chronological order.
• Chronological order means recording transaction “Date-wise”.
• Example:
A business sold 10 bottles of worth total 500 Rs on 1st Jan and 20 bottles worth Rs
1000 total on 21 st Jan.
Since, both these transactions are economic events and can be measured in monetary
terms.
This will be recorded in chronological order in the books of accounts. So, the entry of
1st Jan will be mentioned first and the entry of 21 st Jan will be mentioned later.

1.1.2.4 Communication
• The economic events are identified, measured and recorded in order that the
pertinent information is generated and communicated in a certain form to
management and other internal and external users.

Now, will understand about organization and interested users of the accounting information.

1.1.3 Organization
• Organisation refers to a business enterprise, whether for profit or not-for-profit
motive.

1.1.4 Interested Users of Information

• Interested user is the one who needs the information to make any type of decision.
• Many users need financial information in order to make important decisions.

These users can be divided into two broad categories:

1. Internal users
2. External users.

1.1.4.1 Internal Users

• Internal users include managers and other employees who use financial information
to confirm past results and help make adjustments for future activities. Example
includes Chief executive, store managers, plant managers etc.

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 1.1.4.2 External Users
• External users are those outside of the organization who use the financial information
to make decisions or to evaluate an entity's performance. Example includes
Customers, government, investors etc.

Now, having covered up the four very basic components of the accounting system, now we
will learn, that how each and every step is aligned in an proper flow.

2 Flow of Accounting Information

The accounting process is a series of steps starting with recording business transactions and
leading up to the preparation of financial statements. This financial process demonstrates
the purpose of financial accounting–to create useful financial information in the form of
general-purpose financial statements.

The accounting process start with the identification of an economic event, then economic
transactions are identified, measured and recorded and communicated.

So, the Accounting Process in itself consists of identifying, measuring, recording and
communication.

Then this information is communicated to the outside world, where this information is used
by the interested users for making decision.

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 3 Sub-Discipline or Branches of Accounting
3.1 Financial Accounting
• Financial accounting assists keeping a systematic record of financial transactions the
preparation and presentation of financial reports like
o Income Statement: It focuses on the revenue, expenses, gains, and losses of a
company during a particular period. Also known as the profit and loss (P&L)
statement or the statement of revenue and expense, an income statement.
o Balance sheet: It refers to a financial statement that reports a company's
assets, liabilities, and shareholder equity at a specific point in time.
o Cash Flow Statement: It is a financial statement that provides aggregate data
regarding all cash inflows a company receives from its ongoing operations and
external investment sources. It also includes all cash outflows that pay for
business activities and investments during a given period.
• All these reports are very important from the shareholder perspective as these tells
us the Revenue, Profit etc. of the company.
• It is the most important branch of accounting.

3.2 Cost Accounting

• Cost accounting assists in analyzing the expenditure for ascertaining the cost of
various products manufactured.

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 • Once the expenditure is known the selling price can be fixed.
• This is for internal management of the company.

3.3 Management Accounting

• Management accounting provides financial information for the organization's internal
management, its employees, managers and executives, in order to inform decision-
making and improve performance.
• Management accounting deals with providing Information for decision making in
following domains
o Budgeting
o Taking Pricing Decisions
o Capital Expenditure Decisions
o Sales Forecast
o Manpower needs

Having covered the branches of accounting, now we will understand various features and
characteristics of the accounting information.

4 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, comparability,
consistency and verifiability.

4.1 Reliability
• Reliability means the users must be able to depend on the information.
• A reliable information should be free from error and bias and faithfully represents
what it is meant to represent.

4.2 Relevance
• To be relevant, information must be available in time, must help in prediction and
feedback, and must influence the decisions of users by:
o helping them form prediction about the outcomes of past, present or future
events; and/or
o confirming or correcting their past evaluations.

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 4.3 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.

4.4 Comparability
• It is not sufficient that the financial information is relevant and reliable at a 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.

4.5 Consistency
• According to the consistency concept, once a business has decided on a particular
method for treating an accounting item, it will treat all similar items in the same way
in the future.

4.6 Verifiability
• Verifiability is the extent to which information is reproducible given the same data
and assumptions.
• Verifiability refers to the ability for anyone to confirm the numbers reported in the
transaction.
• The accountant needs to ensure that anyone can review the transaction and arrive at
the same conclusion.

5 Objectives of Accounting
5.1 Maintenance of Records of Business Transactions
• Accounting is used for the maintenance of a systematic
record of all financial transactions in book of accounts.
• Hence, a proper and complete records of all business
transactions are kept regularly.
• Moreover, the recorded information enables verifiability
and acts as an evidence.

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 5.2 Calculation of Profit and Loss
• The owners of business are keen to have an idea about the net results of their business
operations periodically, i.e. whether the business has earned profits or incurred
losses.
• Profit represents excess of revenue (income), over expenses.
If the total revenue of a given period is Rs 6,00,000 and total expenses are Rs 5,40,000
the profit will be equal to Rs 60,000 (6,00,000 – 5,40,000).
• If however, the total expenses exceed the total revenue, the difference reflects the
loss.

5.3 Depiction of Financial Position

• Accounting also aims at ascertaining the financial position of the business concern in
the form of its assets and liabilities at the end of every accounting period.
• A proper record of resources owned by business organization (Assets) and claims
against such resources (Liabilities) facilitates the preparation of a statement known as
balance sheet position statement.

5.4 Providing Accounting Information to its Users

• The accounting information generated by the accounting process is communicated in
the form of reports, statements, graphs and charts to the users who need it in
different decision situations.

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 6 Basic Terms in Accounting
Accounting can be defined as the language of business and there are multiple words and
concepts which are commonly used, now let’s discuss regarding basic terms which are used
in accounts.

6.1 Assets
• Assets are economic resources of an enterprise that can be usefully expressed in
monetary terms.
• Assets are items of value used by the business in its operations.
• Examples: Cash, Furniture, Plant and Machinery, Vehicles, Building, Stock, Equipment,
Computers, etc.

Assets can be broadly classified into two types:

1. Fixed Assets
2. Current Assets.

6.1.1 Fixed Assets

• Fixed assets are those assets that have a useful life of more than one year.
• Examples: Furniture, Plant and Machinery, Vehicles, Building, Equipment, Computers,
etc.

6.1.2 Current Assets

• A current asset is a company's cash and its other assets that are expected to be
converted to cash within one year.
• Examples: Cash and Stock. Stock is also known as inventory, it will get converted into
cash once it is sold and it can be done within 1 year.

6.2 Liabilities
• Liabilities are obligations or debts that an enterprise has to pay at some time in the
future.
• They represent creditors’ claims on the firm’s assets.
• Example: Loan Taken by a company for 10 years, Raw material bought on credit for
which payment is to be made in 10 days, etc.

Liabilities are of two types:

1. Current Liability or Short-Term Liabilities

2. Non-Current Liability or Long Term Liability.

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 6.2.1 Current Liabilities
• Short-term liabilities are obligations that are payable within a period of one year.
• Example: Raw material bought on credit for which payment is to be made in 10 days
is a short-term liability,etc.

6.2.2 Non-Current Liabilities

• Long-term liabilities are those that are usually payable after a period of one year.
• Example: Loan Taken by Company for 10 years is an example of Long-Term Liability,
etc.

6.3 Capital
• Amount invested by the owner in the firm is known as capital.
• It may be brought in the form of cash or assets by the owner for the business entity
capital is an obligation and a claim on the assets of business.
• It is, therefore, shown as capital on the liabilities side of the balance sheet.
• Example - Rohan has started a business that is indulged in selling of chemicals. He, has
brought or invested Rs 5,00,000 as cash. This 5,00,000 will be considered as capital for
the business.

6.4 Sales
• Sales are total revenues from goods or services sold or provided to customers.
• Sales may be cash sales or credit sales.
• Example: Rohan, the owner of chemicals business, sold 500 bottles of chemical on
cash and 50 bottles on credit. So, these transactions will be recorded as Cash Sales
and Credit Sales respectively.

6.5 Creditors
• Creditors are persons and/or other entities who have to be paid by an enterprise an
amount for providing the enterprise goods and services on credit.
• The total amount standing to the favour of such persons and/or entities on the closing
date, is shown in the Balance Sheet as sundry creditors on the liabilities s ide.
• For example, if business A has borrowed money from a bank then bank is a creditor
for business A.

6.6 Debtors
• Debtors are persons and/or other entities who owe to an enterprise an amount for
buying goods and services on credit.

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 • The total amount standing against such persons and/or entities on the closing date, is
shown in the balance sheet as sundry debtors on the asset side.
• For example, if business A has borrowed money from a bank then business A is a
debtor for the bank.

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