Ch 1-Introduction

to Accounting
 Concept and Objectives

Meaning of Accounting:
• Accounting can be defined as a process of reporting,
recording, interpreting and summarizing economic data.
• The introduction of accounting helps the decision-makers
of a company to make effective choices, by providing
information on the financial status of the business.
• Today, accounting is used by everyone and a good
understanding of it is beneficial to all.
• Accountancy act as a language of finance.
• To understand accounting efficiently it is important to
understand various aspects of accounting.
 Attributes/ Features/
Characteristics of Accounting
• Identification of financial transactions: It means determining what
transactions to record, i.e., to identity events which are to be recorded.
It involves observing activities and selecting those events that are of
considered financial character and relate to the organisation.
• Measurement of identified transactions: 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.
• Recording: 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. Primary recording of transactions
is done in Journal which is called the book of original entry.
• Classification: Various transactions are grouped and classified into
specific categories. Ledgers are maintained for this purpose. It gives
detailed information about a particular aspect of business transactions.
• Summarizing: The business transactions of the complete year are
summarized to know the end result of the events in an accounting year.
It is done through preparing Trading and Profit & Loss account and
Balance Sheet at the end of the year.
• Analysis and interpretation: The position of business relating to
profitability, performance and financial position is analyzed using
various tools.
• Communication: The information is regularly communicated through
accounting reports. These reports provide information that are useful to
a variety of users who have an interest in assessing the financial
performance and the position of an enterprise. Reports can be daily,
weekly, monthly, or quarterly, depending upon the needs of the users.
 Objectives of Accounting

1. To maintain a systematic record of business transactions

•Accounting is used to maintain a systematic record of all the
financial transactions in a book of accounts.
•For this, all the transactions are recorded in chronological order
in Journal and then posted to principle book i.e. Ledger.
2. To ascertain profit and loss
•Every businessman is keen to know the net results of business
operations periodically.
•To check whether the business has earned profits or incurred
losses, we prepare a “Profit & Loss Account”.
3. To determine the financial position
•Another important objective is to determine the financial
position of the business to check the value of assets and
liabilities.
•For this purpose, we prepare a “Balance Sheet”.
4. To provide information to various users
• Providing information to the various interested parties or
stakeholders is one of the most important objectives of
accounting.
• It helps them in making good financial decisions.
5. To assist the management
• By analysing financial data and providing interpretations in
the form of reports, accounting assists management in
handling business operations effectively.
6. To protect business assets
• By maintaining the records of the assets owned by the
business, accounting enables the management to protect
them and exercise control.
 Advantages of Accounting

1. Provide information about financial performance-

Accounting provides factual information about financial
performance during a given period of time Like, profit earned or
loss incurred over a period and financial position at a particular
point of time.
2. Provide assistance to management- Accounting helps
management in business planning, decision making and in
exercising control. For this, it provides financial information in
the form of reports.
3. Facilitates comparative study- By keeping systematic
records and preparation of reports at regular intervals,
accounting helps in making a comparison.
4. Replaces memory- A systematic and timely recording of
transactions obviates the necessity to memorise transactions.
4. Helps in settlement of tax liability- Systematic
accounting records help in settlement of various tax
liabilities. Such as – Income Tax, GST etc
5. Helpful in raising loan- Banks and Financial Institutions
grant a loan to the firm on the basis of appraisal of the
financial statement of the firm.
6. Helpful in decision making- Accounting provides useful
information to the management for taking decisions
7. Evidence in court- Systematic records of transactions are
accepted by the courts as sufficient evidence.
8. Facilitates sale of business- The accounts maintained by
a businessman enables him to ascertain proper sale price of
his business, if he wish to sell the business.
 Limitations of Accounting

• Accounting is not precise: Accounting is not completely free

from personal bias or judgement.
• Accounting is done on historic values of assets: Accounting
records assets at their historical cost less depreciation. It does
not reflect their current market value.
• Ignore the effect of price level changes: Accounting
statements are prepared at historical cost. So changes in the
value of money are ignored.
• Ignore the qualitative information:Accounting records only
monetary transactions. It ignores the qualitative aspects.
• Affected by window dressing: Window dressing means
manipulation in accounting to present a more favourable
position of the business than the actual position.
 Accounting Information and its types
As an information system, accounting collects financial data,
records it in the books of account, classifies and summarises it to
produce financial information which is communicated to its users.
Types of Accounting Information
• Information related to Profit or surplus- highlighted bythe
Income Statement i.e., Trading and Profit and Loss Account
which shows revenue and expenses during an accounting period
• Information related to Financial Position: highlighted by the
Position Statement i.e., Balance Sheet which shows various
assets, liabilities and capital.
• Information about Cash Flow: highlighted by Cash Flow
Statement which shows inflow and outflow of cash during a
specific period.
Qualitative Characteristics of Accounting Information

Qualitative characteristics are the attributes of accounting

information, which enhance its understandability and
usefulness. These are explained as under:
• Reliability: Reliability implies that the accounting
information must be free from material error and personal
bias.
• Relevance: Accounting information must be relevant to the
decision-making requirements of the users.
• Understandability: Information should be disclosed in
financial statements in such a manner that these are easily
understandable.
• Comparability: Both intra-firm (within the enterprise over
different periods) and inter-firm (with other enterprises)
comparison must be possible over different time periods.
 Users of Accounting Information

Users of accounting information may be categorised into

internal users and external users.
(A) Internal Users
• Owners: Owners contribute capital in the business and thus
they are exposed to maximum risk. So, they are always
interested in the safety of their capital and profitability of
the business. The owners/shareholders use them to see if
they are getting a satisfactory return on their investment,
and to assess the financial health of their
company/business.
• Management: Accounting information is used by
management for taking various decisions such as
determining sale price, investment into new projects, etc.
They may compare the financial analysis of their company
with the industry figures in order to ascertain the
• Employees and workers: Employees are interested in the
financial statements to assess the ability of the business to pay
higher wages and bonus. They want to have the information on
the stability, profitability and distribution of wealth within the
business.
(B) External Users
• Banks and financial institutions: Banks and Financial
Institutions provide loans to business. So, they are interested in
getting the information on the creditworthiness of the company
and its ability to repay loans and pay interest
• Investors and potential investors: Investors are interested to
know the earning capacity of business and safety of the
investment and information on the risks and return on
investment.
• Researchers: Researchers use accounting information in their
research work.
• Creditors: Creditors provide the goods on credit. So they need
accounting information to ascertain the financial soundness of the firm.
They are interested in having the information on whether amounts owed
will be repaid when due, and on the continued existence of the business.
• Government and its authorities: The government needs accounting
information to assess the tax liability of the business entity such as
Goods and services tax (GST), Income Tax (IT), Customs and Excise
duties for protecting the interests of investors, creditors(lenders),
compiling national income accounts and also to satisfy the legal
obligations imposed by various acts.
• Consumers: They require accounting information for establishing good
accounting control, which will reduce the cost of production, information
on the continued existence of the business and the probability of a
continued supply of products, parts and after sales service
• Public: They want to see the business running since it makes significant
contribution to the society in many ways like employment to people,
patronage to suppliers, etc. Information on corporate social responsibility
is desired by the public in general.