L-1-Introduction to Accounting

2

CHAPTER 1 Introduction to Accounting

Every Individual performs some kind of economic activity. A salaried person gets salary and spends to buy Grocery and clothing, for children’s education, construction of house, etc. A business run by an individual or a group of individuals also carries many economic activities like purchase of goods, sale of goods, payment of shop rent, payment of salaries to employees etc. Similarly, a government raises money through taxes and spends on various developmental activities.

Everybody wants to keep record of its transactions to have adequate information about the economic activities it undertakes so that these records help it in its decision making. For Example, the salaried person would like to know to whom he owes money, to whom he has given the money. A business would like to know whether it has earned profit or incurred loss and to whom it has sold goods on credit and from whom money is to be recovered. Government would like to know whether it is in surplus or it runs in deficit.

Accounting discipline has been developed to serve this purpose as it deals with the measurement of economic activities involving inflow and outflow of economic resources, which helps to develop useful information for decision-making process.

Accounting has a universal application for recording transactions and events and presenting suitable information to aid decision-making regarding any type of economic activity ranging from a family function to functions of national government. But hereinafter we shall concentrate only on business activities and their accounting as this book is made in line with the syllabus prescribed for your exam.

“The history of accounting is as old as human civilisation. The seeds of accounting were most likely first sown in Babylonia and Egypt around 4000 B.C. who recorded transactions of payment of wages and taxes. Historical evidences reveal that Egyptians used some form of accounting for their treasuries where gold and other valuables were kept.”

Meaning of Accounting

Accounting is an 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’.

The process of accounting starts by first identifying the events & transactions which are of financial nature and then these transactions are recorded in the books. This recording is done in Journal or subsidiary books, also known as primary books. After recording, they are

---

3

transferred to secondary books i.e., Ledger. In ledger, transactions are classified in terms of income, expense, assets and liabilities (meaning of these terms are in chapter 2). After ledger posting, the balances of each ledger are firstly summarized in Trial balance to check arithmetical accuracy of transactions and then further summarized in Profit & Loss account and Balance sheet.

Modern Accounting is based on double entry system which was Invented by Luca Pacioli. He is known as father of Accounting. He wrote the first book on double entry book-keeping in 1494.

Accounting is also called the language of business. Accounting is done of economic events which are called as Transactions.

Accounting can also be described as a system meant of measuring business activities, processing of information into reports and making the findings available to decision-makers. The documents, which communicate these findings about the performance of an organization in monetary terms, are called financial statements.

Economic Events

An economic event is known as a happening of consequence to a business organisation which consists of transactions and which are measurable in monetary terms. For example, purchase of goods, sales, etc.

Objectives of Accounting

1. Systematic recording of transactions: - Basic objective of accounting is to systematically record the financial aspects of business transactions i.e. book-keeping. These recorded transactions are later on classified and summarized logically for the preparation of financial statements and for their analysis and interpretation.
2. Ascertainment of results of above recorded transactions i.e., Calculation of Profit or 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. Thus, another objective of accounting is to ascertain the profit earned or loss sustained by a business during an accounting period which can be easily workout with help of record of incomes and expenses relating to the business by preparing a profit or loss account for the period. Profit represents excess of revenue (income), over expenses. If the total revenue of a given period is 6,00,000 and total expenses are 5,40,000 the profit will be equal to 60,000( 6,00,000 – ` 5,40,000). If however, the total expenses exceed the total revenue, the difference reflects the loss.

---

4

3. Ascertainment of Financial Position of the business: - 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 organisation (Assets) and claims against such resources (Liabilities) facilitates the preparation of a statement known as balance sheet/position statement.
4. Providing information to the users for rational decision-making: - Accounting as a ‘language of business’ communicates the financial results of an enterprise to various stakeholders (known as Internal & external users) by means of financial statements.

Branches of Accounting

1. Financial Accounting
2. Cost Accounting
3. Management Accounting
4. Social Responsibility Accounting
5. Human Resource Accounting

Note: - We have to study Financial Accounting only. Besides, we will be studying Social Responsibility Accounting at the end, as the same is also in your syllabus.

Financial Accounting

Financial accounting deals with the preparation of financial statements for the basic purpose of providing information to various interested groups like creditors, banks, shareholders, financial institutions, government, consumers, etc.

The two major reports (financial statements) prepared in Financial Accounting are: -

1. Profit & Loss Account: - This Account shows whether the business has earned profit or incurred Loss in that year for which it is prepared. I.e., P&L Accounts shows Financial performance of the business.
2. Balance sheet: - This Statement shows the financial position of the business on a particular date. i.e., Balance sheet shows Financial position of a business

---

5

Identification, Measurement, Recording and Communication

1. Identification of 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.
2. Measurement of 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.
3. Recording of transactions: - 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 is done in a manner that the necessary financial information is summarised as per well-established practice and is made available as and when required.
4. Communication of results of these transactions: - 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.

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. 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.

---

6

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.

Bookkeeping & Accounting

Bookkeeping is the process of recording of monetary transactions. Bookkeeping should not be confused with Accounting. Bookkeeping is the recording phase while as the Accounting is concerned with the summarizing phase of an accounting system. Bookkeeping provides necessary data for accounting and accounting starts where bookkeeping ends.

YouTube Link for Lecture: https://youtu.be/MUCN4VQqXDY

(Since 1st lecture was primarily recorded for class 11th, you can skip first 17 minutes of this video as I had discussed syllabus of Accountancy in that part)

Channel Name: Lateef’s Commerce Academy