CHAPTER – 1 : INTRODUCTION TO ACCOUNTING

MEANING OF ACCOUNTING: Accounting is a process of identifying, measuring, recording,

classifying, summarising, analysing, interpreting and communicating the financial business
transactions in a useful manner.

CHARACTERISTICS OR FEATURES OF ACCOUNTING:

1. Identification of Financial Transactions: A business is full of events, which are both

financial and non-financial. Accounting identifies financial transactions for recording as
they bring a change in the resources of a firm.
2. Measurement of Transactions: Accounting records the transitions only in terms of
money. it involves quantifying business transaction into financial terms using monetary
units.
3. Recording: Accounting involves recording the financial transactions in the books of
accounts.
4. Classifying: Accounting classify financial transactions of one nature at one place in a
separate account known as ‘Ledger’.
5. Summarising: Accounting summarise the classified data in a manner which is
understandable and useful to management and other users of such data.
6. Analysing and Interpreting: In accounting, the results of business are analysed and
interpreted so that users of financial statements can make a meaningful and soundful
judgement about the profitability and financial position of the business
7. Communicating: Accounting and Verbs communicating the financial data to the
interested parties through annual accountant periodical reports.

OBJECTIVES OF ACCOUNTING

1. To maintain a systematic record of business transaction: The main objective of

accounting is to identify the financial transaction and record them into proper books of
account in a systematic manner.
2. To ascertain profit or loss: The next objective of accounting is to determine the financial
performance i.e., profit earned or loss suffered by a business during a particular period.
For this purpose, Trading and Profit and Loss account is prepared at the end of each
accounting period.
3. To determine Financial Position: The objective of accounting is to ascertain the financial
position of the business concern. Financial Position can be determined by preparing
Balance Sheet.
4. To provide information to various users: Yet another objective of accounting is to
provide accounting information to users, both internal and external, who analyse them
according to their requirements.
5. To assist the management: Another objective of accounting is to provide financial
information to the management. Management requires it for decision making and for
exercising effective control.

ADVANTAGES OF ACCOUNTING
1. Provides financial information: Accounting helps in providing information about the
financial performance i.e., net profit and financial position of the business of an
accounting period.
2. Provides assistance to management: The management draws business plans take
decisions and exercises control on the basis of accounting information.
3. Replaces memory: A systematic and timely recording of transactions obviates the
necessity to remember transactions.
4. Facilitates comparative study: A systematic record enables comparison of one
year’s profit with those of other years and also with one firm with another firm.
5. Helps in settlement of text liability: Properly maintained accounting reccords are
helpful in the settlement of various text liabilities like Income Tax and GST liabilities.
6. Helpful in raising loans: Accounting facilitates raising loans from banks of other
financial institutions as such institutions grant loan to firm on the basis of appraisal
of financial statements of the firm.
7. Evidence in Court: Systematic record of transaction is often accepted by the Courts
as good evidence.
8. Facilitates sale of business: If the business entity is being sold, then the accounting
records help to determine the proper purchase price of the business.

DISADVANTAGES OR LIMITATION OF ACCOUNTING

1. Accounting is not fully exact: Accounting is not fully exact in spite of the fact
that transactions are recorded on the basis of evidence since at few places
estimates are made for determining profit or loss. For example, estimating the
useful life of an asset, net realisable value of closing stock etc.
2. Unrealistic Information: Assets recorded in the books of accounts at historical
cost and depreciation over their estimated useful life. As a result, current values
are not shown. Also, the estimation of useful life of an asset makes the
information unrealistic.
3. Accounting ignores Qualitative Elements: Accounting is confined to monetary
matters only, therefore, qualitative elements like quality or skill of Management
and staff, industrial relations and public relations are ignored.
4. Ignore effects on Price Level Changes: Accounting statements are prepared at
historical cost (i.e., the original cost). However, value of money is bound to
change from time to time. As a result, figures given in the financial statements
ignore the price level changes.
5. Affected by Window Dressing: Window dressing refers to the practice of
manipulation of accounts to present a more favourable position of the business
than the actual position. In such a situation, financial statements fail to provide
a true and fair view of the financial position of the enterprise.

ACCOUNTING INFORMATION

Accounting Information refers to the Financial Statements prepared through the

process of Book Keeping. Financial Statements present a formal record of the
 financial activity of an entity. They reflect the financial effects of business
transactions and event on the entity.

TYPES OF ACCOUNTING INFORMATION

1. Income Statement: It provides accounting information about the profit on and

loss impact during an accounting. For this
 A firm prepares Trading, Profit and Loss Account.
 A company prepares Statement of Profit and Loss
 A Not-For-Profit organisation prepares income and Expenditure Account.
2. Statement of Financial Position: The Financial Position of an entity at a given
date is depicted by the Balance Sheet. The Balance Sheet provides information
about the Assets owned by the entity, amount due to outsiders, i.e. Liabilities and
amount due to owners, i.e. Capital.
3. Cash Flow Statement: This statement provide information about inflow and
outflow of cash during a specific period.

QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION

1. Reliability: Accounting Information should be reliable. Reliability of information

means it is verifiable, free from bias and material errors.
2. Relevance: Accounting Information must be relevant to the user. Information is
relevant if it meets the needs of the users in decision making.
3. Understandability: It means that the information provided through the financial
statement must be presented in a manner that the users understand it.
4. Comparability: It means that the user should be able to compare the accounting
information of an enterprise of the period either with that of other periods,
known as intra-firm comparison or with the accounting information of other
enterprises, known as inter-firm comparison.

USERS OF ACCOUNTING INFORMATION

Users of accounting information may be categorised into internal users and external
users.

1. Internal Users
a. Owners: Owners contribute capital in the business and as such they want
to know about the profitability and financial soundness of the business.
Accounting information provide the profitability and financial soundness
of the business enterprises.
b. Management: Accounting information is used by the management for
taking various decisions. Management is also concerned with ensuring
that the money invested in the organisation is generating an adequate
return and that the organisation is able to pay its debts and remain
solvent.
2. External users
 a. Potential Investors: Potential investors need information to choose how
safe and rewarding the proposed investment will be.
b. Bank and Financial Institutions: Bank and Financial Institutions want to
judge whether their principal and interest thereof will be repaid when
due and whether they should extend, maintain or restrict their
investment to the enterprise.
c. Creditors: They provide goods on credit to the business. So, they need
accounting information to ascertain financial soundness of the firm and to
ensure creditworthiness of the firm.
d. Employees and Workers: They are interested in financial statement to
assess the ability of the business to pay higher wages and bonus.
e. Government and their Agencies: The government authority collect
various taxes from the businesses. So, Government needs accounting
information to assess the tax liability of the business entity.
f. Researchers: They use accounting information to undertake research in
various economic, business and other related areas.
g. Consumers: They are interested in getting good quality product at
reasonable price. So, they require accounting information for establishing
good accounting control, which will reduce the cost of production and less
price is to be paid by them.
h. Public: Business is an indispensable part of society and gets it manpower
and other resources from society. The general public is interested in its
accounting information to know the contribution of business towards the
welfare of the society.

ROLE OF ACCOUNTING IN BUSINESS

Following points highlight the role of business in accounting in business

1. Maintenance of Systematic Records: The primary role of accounting is to

maintain systematic records of financial transactions in order to ascertain
net profit or loss for the accounting period and financial position of the
enterprise as on a particular date.
2. Assistance to Management: Accounting assists management by making
available financial information for effective functioning and rational
decision making.
3. Facilitates Comparative Study: A systematic record of business
transactions enable comparison of one year’s result with those of other
years and identifies reasons leading to change, if any.
4. Evidence in Court: Accounting records are often accepted by Courts as
good evidence.

BASIC ACCOUNTING TERMS

1. Entity: An entity refers to an economic unit which is engaged in performing economic

activities. For example, Tata Motors, Reliance Industries Limited etc.
2. Business Transaction: Business transaction is an economic activity of the business,
which changes its financial position. The business transactions may change the
financial position in terms of change in the values of values of assets, liabilities or
capital.
3. Capital: Capital is the amount invested by the owner or proprietor in the business.
4. Drawings: Withdrawal of money and/or goods by the owner from the business for
personal use is known as drawings.
5. Liabilities: Liabilities are obligations or debts that an enterprise has to pay in future
i.e. it is the amount owed by the business.
Liabilities can be classified as:
a. Non-Current Liabilities: It refers to liability, which is payable after a period of
more than 12 months from the date of last Balance Sheet.
b. Current Liabilities: It refers to a liability which is payable within a period of one
year from the date of last Balance Sheet. For example, Creditors, Bills Payable,
Bank Overdraft, Outstanding Expenses etc.
6. Assets: An asset refers to a resource controlled by a business that has economic
value and is expected to provide future benefits. For example, Land & Building, Plant
& Machinery, Furniture etc.
Assets can be classified as:
a. Non-Current Assets: Non-Current Assets are those assets which are held for
long-term use in the business and are not meant for resale. It includes Fixed
Assets Long Term Investment etc.
Fixed Assets: Fixed assets are those Non-Current Assets which are held for use
in the business and are not meant for resale.
Fixed Assets classified as:
i. Tangible Assets: Tangible Assets refer to those assets which have physical
existence, i.e. they can be seen and touched. For example, Plant &
Machinery Land & Building Furniture etc.
ii. Intangible Assets: Intangible assets are those assets which do not have a
physical existence i.e. they cannot be seen or touched. For example,
Goodwill, Patents, Trademarks, Computer Software, etc
b. Current Assets: Current Assets are those assets which are held by the business
with the purpose of converting them into cash within one year. For example,
Cash in Hand, Cash at Banks, Debtors, Prepaid expenses etc.
c. Fictitious Assets: Fictitious assets are those assets which neither have any real
value nor have any physical form, but are called asset on the basis of legal
grounds. These assets are neither tangible assets nor intangible assets. For
example, Advertisement Suspense Account.
7. Receipts: Receipts refer to the amount received by the business organisation.
Receipts are of two types:
a. Revenue Receipt: Revenue receipt refers to the amount received in the normal
course of business. For example, sale of goods, amount received for services
rendered, commission received, interest received etc.
 b. Capital Receipts: Capital Receipts refers to the amount received against
transactions which are not revenue in nature i.e. non-recurring in nature. For
example, sale of fixed assets etc.
8. Expenditure: Expenditure refers to the amount spent or liability incurred for
acquiring assets, goods or services. Expenditure can be classified as:
a. Revenue Expenditure: It refers to an expenditure incurred during an
accounting period and the benefit of which is also exhausted within the same
accounting period. For example, purchase of goods and services, payment of
salary, rent, advertisement etc.
b. Capital Expenditure: It refers to an expenditure incurred for acquiring or
increasing the value of existing fixed assets. For example, purchase of
Building, Furniture, Machinery, Installation of Machinery etc.
c. Deferred Revenue Expenditure: It refers to a revenue expenditure the benefit
of which is likely to be accrue to a firm in more than one accounting period.
For example, advertisement expenditure.
9. Expense: Expense is the cost incurred by a business in the process of earning
revenue. For example, salaries, wages, rent, commission etc.
10. Revenue: it is a total amount received or receivable from the sale of goods or
services in the normal course of business. For example, amount received from sale of
goods, rent received, commission received, etc
11. Income: It is the surplus of revenue over expenses.
12. Profit: Profit is the excess of total revenue over total expenses of the business
enterprise for an accounting period.
13. Gain: It is a monetary benefit or advantages resulting from event or transaction
which are not the operating activity of the business but are incidental to business
such as sale of fixed assets, winning a court case or appreciation in the value of an
asset.
14. Loss: Lost is the excess of total expenses over total of revenue.
15. Purchase: Purchase refers to the amount of goods bought by a business for resale or
for use in the production.
Purchase Return or Return Outward: When purchase goods are returned to the
seller due to some reason like not according to specifications or due to some defect,
then it is termed as purchase return or return outward.
16. Sales: Sales refer to the amount of goods sold that are already bought or
manufactured by the business.
Sales Return or Return Inward: When sold goods are returned by the producer due
to some reasons like not according to specifications or due to some defect, then it is
termed as sales return or return inward.
17. Goods: Goods refers to the product in which the business unit is dealing, i.e. goods
means all the items which are purchased and sold in the ordinary course of business.
18. Stock: Stock or inventory refers to the goods held by a business for sale in the
ordinary course of business or for consumption in production of goods or services for
 sale. In other words, value of goods lying unsold or unused at the end of the year is
called stock.
19. Trade Receivable: Trade Receivable refers to the amount due on account of goods
sold or services rented in the normal course of business. Trade Receivable includes
Debtors and Bills Receivable.
a. Debtors: Debtor is a person or a firm to whom goods have been sold or
services rendered on credit and the payment has not been received.
b. Bills Receivable: It means the Bills of Exchange drawn by a seller (drawer) on
the buyer (drawee) in which the seller directs the buyer to pay the specified
amount at a specific future date.
20. Trade Payable: Trade Payable refers to the amount due on account of goods
purchased or service rendered in the normal course of business. It includes Creditors
and Bills Payable.
a. Creditors: Creditor is a person or a firm from whom goods are have been
purchased or services have been taken on credit and payment has not been
made.
b. Bills Payable: It refers to a Bill of Exchange accepted by the person who has
purchased goods on credit, the amount of which is payable on a specified
date.
21. Voucher: Voucher is documentary evidence in support of a business transaction. For
example, Cash Memo, Invoice, Debit Note, Credit Note, etc.
22. Discount: Discount is a type of reduction in the price by the seller to the buyer.
Discount may be of two types:
a. Trade Discount: When discount is allowed by a seller to its customer at a fixed
percentage on the list or catalogue price of the goods it is called Trade
Discount. It is not recorded in books of account as it is deducted in the invoice
or cash memo itself from the gross value of goods.
b. Cash Discount: When discount is allowed to the customers for making prompt
payment it is called Cash Discount.