CHAPTER - 1

INTRODUCTION TO ACCOUNTING

Meaning : Accounting is a systematic process of identifying, measuring, recording, classifying, business

transactions and events of financial character and summarising, interpreting these transactions and events into
useful financial information and finally communicating this financial information to its users.
Accounting is also known as language of business because it act as a medium of communication through
financial information.

Meaning of transaction and events in the context of business:

Transaction : A monetary activity which has effect on financial statements.

i.e., A firm purchased goods from supplier for ₹ 5000.

Event : An event is outcome/result of a transaction.

i.e., A firm sold the goods worth ₹ 5000 for ₹ 6000.

The outcome of this transaction is firm earned a profit of ₹ 100.

Characteristics of accounting

ID - Identification

Means - Measuring

Re - Recording

Cla - Classification

S - Summarising

I - Interpretation

C - Communicating

ID MEANS CLASIC : (Trick to remember characteristics)

Identification of these transactions is done with the help of bills and receipts as the evidence of the transaction.

i.e., Purchase of raw material, sale of goods etc.

2. Measuring the identified transaction : These transactions and events are measured in terms of money.

Transactions which cannot be measured in terms of money are not recorded in the books of accounts even if
they affect business significantly.

i.e., Quality of management team or skills of manager cannot be measured in terms of money where as
purchased furniture for ₹ 5000 is a monetary transaction.

3. Recording : Business transactions of financial character are recorded in the book of original entry.

Journal is known as book of original entry/prime entry because transactions are first recorded in journal.

Other subsidiary books like cash book, purchase book, sales book are known as special journals.

4. Classification : Transaction or original entries of one nature which are recorded in journal or subsidiary
books are grouped together and posted in ledger accounts.

* ledger is an individual account like Ram A/C, Plant A/C, Debtors A/C etc.

By doing classification a firm/enterprise can ascertain how much a firm/enterprise owes to these accounts or
how much these accounts owes to firm/enterprise.

5. Summarising : This involves preparing financial information from classified data into Trial Balance, Trading
and Profit and Loss account (for non-profit-organisations ) or statement of Profit and Loss account (for
companies) and Balance Sheet. These statements are known as financial statements.

6. Interpretation : With the help of analysis and interpretation of financial statements users can assess the
profitability and financial position of the firm/enterprise or companies.

7. Communicating : Finally financial information (financial statement) are communicated to its users so that
they can take appropriate decisions and can make plan for future in a better way.

Objectives of accounting

1. Maintaining accounting records : Recording financial transaction and events of the firm/enterprise in the
books of accounts by following the accounting principles.
2. Determining profit and loss : Accounting helps in determining profit or loss of an enterprise during the
given accounting period. Profit or loss is ascertained from financial information called income statement which
is trading and profit and loss account or statement of profit and loss account.

* Profit and loss : Case 1 Goods sold for ₹5000 is revenue and cost incurred in manufacturing product and
expenses for selling the product is ₹4000.

Therefore, Profit = Revenue – Expenses

₹5000 – ₹4000 = ₹1000 Profit.

Case 2 suppose expenses are increased to ₹6000, in this situation firm/enterprise will incur a loss

Therefore, Loss = Expenses – Revenue

₹6000 - ₹5000 = ₹1000 Loss.

3. Determining financial position : Financial position of an enterprise is identified from position statement
(Balance sheet) which provides information about assets, liabilities and capital and net effect on them at the end
of accounting period.

4. Facilitating management : Management requires financial data such as financial statements which includes
balance sheet, income statement for decision making, effective control on management, budgeting and
forecasting.

5. Providing information to its users : Providing accounting information to its users.

* Internal users : Those users which are owners of the company or working within the company.

* External users : Which are not working in the company and not the owners of the company or have no direct
link with company and its management.

6. Protecting business assets : Accounting maintains records of assets which are owned by business and helps
in analysing effects of transaction on the value of assets, so that management can exercise control on these
assets.

Functioning of accounting records

1. Maintaining systematic accounting record : Recording financial transaction and event of the enterprise in
the book of account by following the accounting principles so that reliable financial statements can be drawn.
2. Preparation of financial statements : Financial statements includes income statement ( trading and profit
and loss account or statement of profit and loss account ) and position statement 9 balance sheet ) both the
statements are important for all users for taking future decisions by analysing financial performance.

i.e., Profit earned or loss incurred by business during the current accounting period.

3. Meeting legal requirements : Accounting records prepared by following the accounting principles and
accounting standards are accepted as evidence by court of law, some acts like income tax act, companies act,
GST act requires to file the return for an accounting period and with the help of proper record maintained by
following accounting rules and principles, returns can be submitted easily.

4. communicating the financial information : Communicating financial information to its users both internal
and external.

5. assistance to management : Management requires financial information for decision making, exercising
control over management in efficient manner and also assisting management in protecting assets.

Users of accounting information

Internal users

1. owners : owners invest capital in business and bear maximum risk that’s why they are interested in knowing
financial performance through financial statements. They will get to know if business has earned profit or
incurred losses.

2. management : Management needs financial information for taking decisions like cost reduction, optimum
use of resources, determining selling price of product or services, investments in new projects.

3. Employees and workers : Employees are interested in financial information to ascertain their bonus which
they are entitled at the year end which is linked to profit earned by business and also whether enterprise has
deposited dues toward employee’s provident fund and employee’s state insurance.

External users

1. banks and financial institutions ; They are essential part of any business because they provide loans to the
business and to ensure safety of their loans and interest they need financial information to know financial
performance and whether business is making any progress or not.
2. Investors and potential investors : Those investors who already invested in the business and potential
investors are those investors which are planning to invest in the business both of them needs financial
information to analyse earning capacity , future growth and risk related to their investments.

3. Creditors : Parties which supply goods/services on credit. Before granting goods on credit creditors analyse
financial statements of business and satisfy themselves about credit worthiness of business.

4. government and its authorities : government use financial information to assess national income, for
implementing GST and income tax, custom duty etc.

5. Researchers : Researchers need financial information for their research work such as accounting theory as
well as business practices.

6. consumers : consumers needs accounting information when they have involvement in that business or for
establishing good accounting control so that cost of production may be reduced which will eventually result in
reduction of the price of products.

7. Public : Any person who is interested in finances of that business for his personal interest.

i.e., TCS- An MBA student wants financial information of TCS for his project work.

Advantages of accounting

1. Financial information about business : Whether business is earning profit or incurring loss and financial
position at the end of the accounting period is known through accounting.

2. Assistance to management : Management take decision like cost reduction, control over day to day
operations.

3.Replaces memory : Systematic record of transactions the necessity to remember numerous transactions.

4. Facilitate comparative study : Accounting records are used to compare current accounting period’s result
with other previous year’s results.

5. Facilitate settlement of tax Liability : Systematic accounting records helps in settlement of income tax and
GST, besides this it is a good evidence in court of law.

6. Facilitates loans : Loans are granted by banks and financial institutions after analysing business performance
and growth