INSTRUCTOR: KRISTOFER DOMINIQUE A.

JO, MM
 Business is an economic activity undertaken with the motive of earning profits and
to maximize the wealth for the owners.
 The rules of business are based on general principles of trade, social values, and
statutory framework encompassing national or international boundaries. While
these variables could be different for different businesses, different countries etc.,
the basic purpose is to add value to a product or service to satisfy customer
demand.
 The business activities require resources (which are limited & have multiple uses)
primarily in terms of material, labour, machineries, factories and other services.
The success of business depends on how efficiently and effectively these resources
are managed.
 Definition by the American Institute of Certified Public Accountants (Year
1961):
“Accounting is the art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions”

 Definition by the American Accounting Association (Year 1966):

“The process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by the users of
accounting”.
 (i) Providing Information to the Users for Rational Decision-making
The primary objective of accounting is to provide useful information for
decision-making to stakeholders such as owners, management, creditors, investors, etc.
Various outcomes of business activities such as costs, prices, sales volume, value under
ownership, return of investment, etc. are measured in the accounting process. All these
accounting measurements are used by stakeholders (owners, investors,
creditors/bankers, etc.) in course of business operation. Hence, accounting is identified
as ‘language of business’.
 (ii) Systematic Recording of Transactions
To ensure reliability and precision for the accounting measurements, it is
necessary to keep a systematic record of all financial transactions of a business
enterprise which is ensured by bookkeeping. These financial records are classified,
summarized and reposted in the form of accounting measurements to the users of
accounting information i.e., stakeholder.
 (iii) Ascertainment of Results of above Transactions
‘Profit/loss’ is a core accounting measurement. It is measured by preparing profit
and loss account for a particular period. Various other accounting measurements such as
different types of revenue expenses and revenue incomes are considered for preparing
this profit and loss account. Difference between these revenue incomes and revenue
expenses is known as result of business transactions identified as profit/loss. As this
measure is used very frequently by stockholders for rational decision making, it has
become the objective of accounting.
For example, Income Tax Act requires that every business should have an accounting
system that can measure taxable income of business and also explain nature and source
of every item reported in Income Tax Return.
 (iv) Ascertain the Financial Position of Business
‘Financial position’ is another core accounting measurement. Financial position is
identified by preparing a statement of ownership i.e., Assets and Owings i.e., liabilities of
the business as on a certain date. This statement is popularly known as balance sheet.
Various other accounting measurements such as different types of assets and different
types of liabilities as existed at a particular date are considered for preparing the
balance sheet. This statement may be used by various stakeholders for financing and
investment decision.
 (v) To Know the Solvency Position
Balance sheet and profit and loss account prepared as above give useful
information to stockholders regarding concerns potential to meet its obligations in
the short run as well as in the long run.
 Measurement: Accounting measures past performance of the business entity and
depicts its current financial position.
 Forecasting: Accounting helps in forecasting future performance and financial position
of the enterprise using past data.
 Decision-making: Accounting provides relevant information to the users of accounts to
aid rational decision-making.
 Comparison & Evaluation: Accounting assesses performance achieved in relation to
targets and discloses information regarding accounting policies and contingent
liabilities which play an important role in predicting, comparing and evaluating the
financial results.
 Control: Accounting also identifies weaknesses of the operational system and provides
feedbacks regarding effectiveness of measures adopted to check such weaknesses.
 Government Regulation and Taxation: Accounting provides necessary information to
the government to exercise control on die entity as well as in collection of tax revenues.
 (a) Financial Accounting
It is commonly termed as Accounting. The American Institute of Certified
Public Accountants defines Accounting as “an art of recoding, classifying and
summarizing in a significant manner and in terms of money, transactions and events
which are in part at least of a financial character, and interpreting the results
thereof.”
 (b) Cost Accounting
According to the Chartered Institute of Management Accountants (CIMA),
Cost Accountancy is defined as “application of costing and cost accounting
principles, methods and techniques to the science, art and practice of cost control
and the ascertainment of profitability as well as the presentation of information for
the purpose of managerial decision-making.”
 (c) Management Accounting
Management Accounting is concerned with the use of Financial and Cost
Accounting information to managers within organizations, to provide them with the
basis in making informed business decisions that would allow them to be better
equipped in their management and control functions.
 As defined by Carter, ‘Book-keeping is a science and art of correctly recording in
books-of accounts all those business transactions that result in transfer of money or
money’s worth’.
 Book-keeping is an activity concerned with recording and classifying financial data
related to business operation in order of its occurrence.
 Collection of basic financial information.
 Identification of events and transactions with financial character i.e.,
economic transactions.
 Measurement of economic transactions in terms of money.
 Recording financial effects of economic transactions in order of its
occurrence.
 Classifying effects of economic transactions.
 Preparing organized statement known as trial balance.
 (a) Recording of Transaction: As soon as a transaction happens it is at first
recorded in subsidiary book.
 (b) Journal: The transactions are recorded in Journal chronologically.
 (c) Ledger: All journals are posted into ledger chronologically and in a classified
manner.
 (d) Trial Balance: After taking all the ledger account closing balances, a Trial
Balance is prepared at the end of the period for the preparations of financial
statements.
 (e) Adjustment Entries: All the adjustments entries are to be recorded properly
and adjusted accordingly before preparing financial statements.
 (f) Adjusted Trial Balance: An adjusted Trail Balance may also be prepared.
 (g) Closing Entries: All the nominal accounts are to be closed by the transferring
to Trading Account and Profit and Loss Account.
 (h) Financial Statements: Financial statement can now be easily prepared which
will exhibit the true financial position and operating results.
 (i) Transaction: It means an event or a business activity which involves exchange of
money or money’s worth between parties. The event can be measured in terms of
money and changes the financial position of a person e.g. purchase of goods would
involve receiving material and making payment or creating an obligation to pay to the
supplier at a future date. Transaction could be a cash transaction or credit transaction.
When the parties settle the transaction immediately by making payment in cash or by
cheque, it is called a cash transaction. In credit transaction, the payment is settled at a
future date as per agreement between the parties.
 (ii) Goods/Services : These are tangible article or commodity in which a business
deals. These articles or commodities are either bought and sold or produced and sold.
At times, what may be classified as ‘goods’ to one business firm may not be ‘goods’ to
the other firm. e.g. for a machine manufacturing company, the machines are ‘goods’ as
they are frequently made and sold. But for the buying firm, it is not ‘goods’ as the
intention is to use it as a long term resource and not sell it. Services are intangible in
nature which are rendered with or without the object of earning profits.
 (iii) Profit: The excess of Revenue Income over expense is called profit. It could be
calculated for each transaction or for business as a whole.
 (iv) Loss: The excess of expense over income is called loss. It could be calculated
for each transaction or for business as a whole.
 (v) Asset: Asset is a resource owned by the business with the purpose of using it for
generating future profits. Assets can be Tangible and Intangible. Tangible Assets
are the Capital assets which have some physical existence. They can, therefore, be
seen, touched and felt, e.g. Plant and Machinery, Furniture and Fittings, Land and
Buildings, Books, Computers, Vehicles, etc. The capital assets which have no
physical existence and whose value is limited by the rights and anticipated
benefits that possession confers upon the owner are known as lntangible Assets.
 They cannot be seen or felt although they help to generate revenue in future, e.g.
Goodwill, Patents, Trade-marks, Copyrights, Brand Equity, Designs, Intellectual
Property, etc.
 Assets can also be classified into Current Assets and Non-Current Assets.
 Current Assets – An asset shall be classified as Current when it
satisfies any of the following :
(a) It is expected to be realized in, or is intended for sale or
consumption in the Company’s normal Operating Cycle,
(b) It is held primarily for the purpose of being traded ,
(c) It is due to be realized within 12 months after the Reporting
Date, or
(d) It is Cash or Cash Equivalent unless it is restricted from
being exchanged or used to settle a Liability for at least 12 months
after the Reporting Date.
 Non-Current Assets – All other Assets shall be classified as Non-
Current Assets. e.g. Machinery held for long term etc.
 It is an obligation of financial nature to be settled at a future date. It represents
amount of money that the business owes to the other parties. E.g. when goods are
bought on credit, the firm will create an obligation to pay to the supplier the price
of goods on an agreed future date or when a loan is taken from bank, an obligation
to pay interest and principal amount is created. Depending upon the period of
holding, these obligations could be further classified into Long Term on non-
current liabilities and Short Term or current liabilities.
 Current Liabilities – A liability shall be classified as Current when it
satisfies any of the following :
(a) It is expected to be settled in the Company’s normal
Operating Cycle,
(b) It is held primarily for the purpose of being traded,
(c) It is due to be settled within 12 months after the Reporting
Date, or
(d) The Company does not have an unconditional right to defer
settlement of the liability for at least 12 months after the reporting
date (Terms of a Liability that could, at the option of the counterparty,
result in its settlement by the issue of Equity Instruments do not affect
its classification)
 Non-Current Liabilities – All other Liabilities shall be classified as
Non-Current Liabilities. E.g. Loan taken for 5 years, Debentures
issued etc.
 (vii) Internal Liability : These represent proprietor’s equity, i.e. all those amount
which are entitled to the proprietor, e.g., Capital, Reserves, Undistributed Profits,
etc.
 (viii) Working Capital : In order to maintain flows of revenue from operation, every
firm needs certain amount of current assets. For example, cash is required either to
pay for expenses or to meet obligation for service received or goods purchased,
etc. by a firm. On identical reason, inventories are required to provide the link
between production and sale. Similarly, Accounts Receivable generate when goods
are sold on credit. Cash, Bank, Debtors, Bills Receivable, Closing Stock,
Prepayments etc. represent current assets of firm. The whole of these current assets
form the working capital of a firm which is termed as Gross Working Capital.
 Gross Working capital = Total Current Assets
= Long term internal liabilities plus long term debts plus the
current liabilities minus the amount blocked in the fixed
assets.
 There is another concept of working capital. Working capital is the excess of
current assets over current liabilities. That is the amount of current assets that
remain in a firm if all its current liabilities are paid. This concept of working capital
is known as Net Working Capital which is a more realistic concept.
 Working Capital (Net) = Current Assets – Currents Liabilities.
 (ix) Contingent Liability : It represents a potential obligation that
could be created depending on the outcome of an event. E.g. if
supplier of the business files a legal suit, it will not be treated as a
liability because no obligation is created immediately. If the verdict
of the case is given in favor of the supplier then only the obligation is
created. Till that it is treated as a contingent liability. Please note that
contingent liability is not recorded in books of account, but disclosed
by way of a note to the financial statements.

 (x) Capital : It is amount invested in the business by its owners. It

may be in the form of cash, goods, or any other asset which the
proprietor or partners of business invest in the business activity.
From business point of view, capital of owners is a liability which is to
be settled only in the event of closure or transfer of the business.
Hence, it is not classified as a normal liability. For corporate bodies,
capital is normally represented as share capital.
 (xi) Drawings : It represents an amount of cash, goods or
any other assets which the owner withdraws from business
for his or her personal use. e.g. if the life insurance
premium of proprietor or a partner of business is paid from
the business cash, it is called drawings. Drawings will result
in reduction in the owners’ capital. The concept of drawing
is not applicable to the corporate bodies like limited
companies.
 (xii) Net worth : It represents excess of total assets over
total liabilities of the business. Technically, this amount is
available to be distributed to owners in the event of closure
of the business after payment of all liabilities. That is why it
is also termed as Owner’s equity. A profit making business
will result in increase in the owner’s equity whereas losses
will reduce it.
 (xiii) Non-current Investments : Non-current Investments
are investments which are held beyond the current period
as to sale or disposal. e. g. Fixed Deposit for 5 years.

 (xiv) Current Investments : Current investments are

investments that are by their nature readily realizable and
are intended to be held for not more than one year from the
date on which such investment is made. e. g. 11 months
Commercial Paper
 (xv) Debtor : The sum total or aggregate of the amounts which the customer owe to
the business for purchasing goods on credit or services rendered or in respect of
other contractual obligations, is known as Sundry Debtors or Trade Debtors, or
Trade Payable, or Book-Debts or Debtors. In other words, Debtors are those
persons from whom a business has to recover money on account of goods sold or
service rendered on credit. These debtors may again be classified as under:
(i) Good debts : The debts which are sure to be realized are called good
debts.
(ii) Doubtful Debts : The debts which may or may not be realized are called
doubtful debts.
(iii) Bad debts : The debts which cannot be realized at all are called bad
debts.
 It must be remembered that while ascertaining the debtors balance at the end of
the period certain adjustments may have to be made e.g. Bad Debts, Discount
Allowed, Returns Inwards, etc.
 (xvi) Creditor : A creditor is a person to whom the business owes
money or money’s worth. e.g. money payable to supplier of goods or
provider of service. Creditors are generally classified as Current
Liabilities.

 (xvii)Capital Expenditure : This represents expenditure incurred

for the purpose of acquiring a fixed asset which is intended to be
used over long term for earning profits there from. e. g. amount paid
to buy a computer for office use is a capital expenditure. At times
expenditure may be incurred for enhancing the production capacity
of the machine. This also will be a capital expenditure. Capital
expenditure forms part of the Balance Sheet.
 (xviii) Revenue expenditure : This represents expenditure incurred
to earn revenue of the current period. The benefits of revenue
expenses get exhausted in the year of the incurrence. e.g. repairs,
insurance, salary & wages to employees, travel etc. The revenue
expenditure results in reduction in profit or surplus. It forms part of
the Income statement.
 (xix) Balance Sheet : It is the statement of financial position of the
business entity on a particular date. It lists all assets, liabilities and
capital. It is important to note that this statement exhibits the state of
affairs of the business as on a particular date only. It describes what
the business owns and what the business owes to outsiders (this
denotes liabilities) and to the owners (this denotes capital). It is
prepared after incorporating the resulting profit/losses of Income
statement.
 (xx) Profit and Loss Account or Income Statement : This account
shows the revenue earned by the business and the expenses
incurred by the business to earn that revenue. This is prepared
usually for a particular accounting period, which could be a month,
quarter, a half year or a year. The net result of the Profit and Loss
Account will show profit earned or loss suffered by the business
entity.
 (xxi) Trade Discount : It is the discount usually allowed by the
wholesaler to the retailer computed on the list price or invoice price.
e.g. the list price of a TV set could be ` 15000. The wholesaler may
allow 20% discount thereof to the retailer. This means the retailer will
get it for ` 12000 and is expected to sale it to final customer at the list
price. Thus the trade discount enables the retailer to make profit by
selling at the list price. Trade discount is not recorded in the books of
accounts. The transactions are recorded at net values only. In above
example, the transaction will be recorded at `12000 only.
 (xxii) Cash Discount : This is allowed to encourage prompt payment
by the debtor. This has to be recorded in the books of accounts. This
is calculated after deducting the trade discount. e.g. if list price is `
15,000 on which a trade discount of 20% and cash discount of 2%
apply, then first trade discount of ` 3000 (20% of ` 15000) will be
deducted and the cash discount of 2% will be calculated on`12000
(`15000 – `3000). Hence the cash discount will be `240 (2% of ` 12000)
and net payment will be ` 11,760 (`12,000 - ` 240)