INTRODUCTION TO ACCOUNTING

“Book- keeping is the art of recording business transactions in a systematic manner” or in other
words “Book- keeping is the science and art of correctly recording in books of account all those
business transactions that result in the transfer of money or money’s worth”.

Objectives of Book- keeping

i) Book- keeping provides a permanent record of each transactions.
ii) Soundness of a firm can be assessed from the records of assets and abilities on a particular
date.
iii) Entries related to incomes and expenditures of a concern facilitate to know the profit and
loss for a given period.
iv) It enables to prepare a list of customers and suppliers to ascertain the amount to be received
or paid.
v) It is a method gives opportunities to review the business policies in the light of the past
records.
vi) Amendment of business laws, provision of licenses, assessment of taxes etc., are based on
records.

Meaning of Accounting
Accounting, as an information system is the process of identifying, measuring and
communicating the economic information of an organization to its users who need the
information for decision making. It identifies transactions and events of a specific entity.

Definition of Accounting
Accounting as “the art of recording, 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”.

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Objective of Accounting
Objective of accounting may differ from business to business depending upon their specific
requirements. However, the following are the general objectives of accounting.
i) To keeping systematic record: It is very difficult to remember all the business transactions
that take place. Accounting serves this purpose of record keeping by promptly recording all the
business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in ascertaining result i.e.,
profit earned or loss suffered in business during a particular period. For this purpose, a business
entity prepares either a Trading and Profit and Loss account or an Income and Expenditure
account which shows the profit or loss of the business by matching the items of revenue and
expenditure of the same period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman
must know his financial position i.e., availability of cash, position of assets and liabilities etc.
This helps the businessman to know his financial strength. Financial statements are barometers
of health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about
how an enterprise obtains and spends cash, about its borrowing and repayment of borrowing,
about its capital transactions, cash dividends and other distributions of resources by the
enterprise to owners and about other factors that may affect an enterprise’s liquidity and
solvency.
(liquidity, is a term that refers to the ease with which you can convert an asset to cash, without
affecting its market value)
v) To protect business properties: Accounting provides up to date information about the
various assets that the firm possesses and the liabilities the firm owes, so that nobody can claim
a payment which is not due to him.
vi) To facilitate rational decision – making: Accounting records and financial statements
provide financial information which help the business in making rational decisions about the
steps to be taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts
are compulsorily required to maintain accounts as per the law governing their operations such
as the Companies Act, Societies Act, and Public Trust Act etc.
Maintenance of accounts is also compulsory under the Sales Tax Act and Income Tax Act.

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Importance of Accounting
i) Owners: The owners provide funds or capital for the organization. They possess curiosity in
knowing whether the business is being conducted on sound lines or not and whether the capital
is being employed properly or not. Owners, being businessmen, always keep an eye on the
returns from the investment. Comparing the accounts of various years helps in getting good
pieces of information.
ii) Management: The management of the business is greatly interested in knowing the position
of the firm. The accounts are the basis, the management can study the merits and demerits of
the business activity. Thus, the management is interested in financial accounting to find
whether the business carried on is profitable or not. The financial accounting is the “eyes and
ears of management and facilitates in drawing future course of action, further expansion etc.”
iii) Creditors: Creditors are the persons who supply goods on credit, or bankers or lenders of
money. It is usual that these groups are interested to know the financial soundness before
granting credit. The progress and prosperity of the firm, two which credits are extended, are
largely watched by creditors from the point of view of security and further credit. Profit and
Loss Account and Balance Sheet are nerve centers to know the soundness of the firm.
iv) Employees: Payment of bonus depends upon the size of profit earned by the firm. The more
important point is that the workers expect regular income for the bread. The demand for wage
rise, bonus, better working conditions etc. depend upon the profitability of the firm and in turn
depends upon financial position. For these reasons, this group is interested in accounting.
v) Investors: The prospective investors, who want to invest their money in a firm, of course
wish to see the progress and prosperity of the firm, before investing their amount, by going
through the financial statements of the firm. This is to safeguard the investment. For this, this
group is eager to go through the accounting which enables them to know the safety of
investment.
vi) Government: Government keeps a close watch on the firms which yield good amount of
profits. The state and central Governments are interested in the financial statements to know
the earnings for the purpose of taxation. To compile national accounting is essential.
vii) Consumers: These groups are interested in getting the goods at reduced price. Therefore,
they wish to know the establishment of a proper accounting control, which in turn will reduce
to cost of production, in turn less price to be paid by the consumers. Researchers are also
interested in accounting for interpretation.

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Advantages of Accounting
The following are the advantages of accounting to a business:
i) It helps in having complete record of business transactions.
ii) It gives information about the profit or loss made by the business at the close of a year and
its financial conditions. The basic function of accounting is to supply meaningful information
about the financial activities of the business to the owners and the managers.
iii) It provides useful information form making economic decisions.
iv) It facilitates comparative study of current year’s profit, sales, expenses etc., with those of
the previous years.
v) It supplies information useful in judging the management’s ability to utilise enterprise
resources effectively in achieving primary enterprise goals.
vi) It helps in complying with certain legal formalities like filing of income-tax and sales-tax
returns. If the accounts are properly maintained, the assessment of taxes is greatly facilitated.

Limitations of Accounting
i) Accounting is historical in nature: It does not reflect the current financial position or worth
of a business.
ii) Transactions of non-monetary mature do not find place in accounting. Accounting is limited
to monetary transactions only. It excludes qualitative elements like management, reputation,
employee morale, labour strike etc.
iii) Facts recorded in financial statements are greatly influenced by accounting conventions and
personal judgements of the Accountant or Management. Valuation of inventory, provision for
doubtful debts and assumption about useful life of an asset may, therefore, differ from one
business house to another.
v) Cost concept is found in accounting. Price changes are not considered. Money value is bound
to change often from time to time. This is a strong limitation of accounting.
vi) Accounting statements do not show the impact of inflation.

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ACCOUNTING TERMINOLOGY
It is necessary to understand some basic accounting terms which are daily in business world.
These terms are called accounting terminology.
1. Transaction
“An event the recognition of which gives rise to an entry in accounting records. It is an event
which results in change in the balance sheet equation. That is, which changes the value of assets
and equity. In a simple statement, transaction means the exchange of money or money’s worth
from one account to another account Events like purchase and sale of goods, receipt and
payment of cash for services or on personal accounts, loss or profit in dealings etc., are the
transactions”. Cash transaction is one where cash receipt or payment is involved in the
exchange. Credit transaction, on the other hand, will not have ‘cash’ either received or paid,
for something given or received respectively.
2. Debtor
A person who owes money to the firm mostly on account of credit sales of goods is called a
debtor. For example, when goods are sold to a person on credit that person pays the price in
future, he is called a debtor because he owes the amount to the firm.
3. Creditor
A person to whom money is owing by the firm is called creditor. For example, Rahul is a
creditor of the firm when goods are purchased on credit from him.
4. Capital
It means the amount (in terms of money or assets having money value) which the proprietor
has invested in the firm or can claim from the firm. It is also known as owner’s equity or net
worth. Owner’s equity means owner’s claim against the assets.
It will always be equal to assets less liabilities, say:
Capital = Assets - Liabilities.
5. Liability
It means the amount which the firm owes to outsiders that is, excepting the proprietors. In the
words, “Liabilities are debts; they are amounts owed to creditors; thus the claims of those who
ate not owners are called liabilities”.
Liabilities are classified as given below.
(i) Owner's capital: Capital is the amount contributed by the owners of the business. In
addition to initial capital introduced, proprietors may introduce additional capital and withdraw
some amounts from business over a period of time. Owner’s capital is also called ‘net worth’.

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Net worth is the total fund of proprietors on a particulars date. It consists of capital, profits and
interest on capital subject to reduction of drawings and interest on drawings. In case of limited
companies, capital refers to capital subscribed by shareholders. Net worth refers to paid up
equity capital plus reserves and profits, minus losses.
(ii) Long term Liabilities: Liabilities repayable after specific duration of long period of time
are called long term liabilities. They do not become due for payment in the ordinary ‘operating
cycle’ of business or within a short period of lime. Examples are long term loans and
debentures. Long term liabilities may be secured or unsecured, though usually they are secured.
(iii) Current liabilities: Liabilities which are repayable during the operating cycle of business,
usually within a year, are called short term liabilities or current liabilities. They are paid out of
current assets or by the creation of other current liabilities. Examples of current liabilities are
trade creditors, bills payable, outstanding expenses, bank overdraft, taxes payable and
dividends payable.
(iv) Contingent liabilities: Contingent liabilities will result into liabilities only if certain events
happen. Examples are: Bills discounted and endorsed which may be dishonored, unpaid calls
on investments.
6. Asset
Any physical thing or right owned that has a money value is an asset. In other words, an asset
is that expenditure which results in acquiring of some property or benefits of a lasting nature.
Different types of assets are:
(i) Fixed assets: Fixed assets are the assets which are acquired and held permanently and used
in the business with the objective of making profits. Land and building, Plant and machinery,
Furniture and Fixtures are examples of fixed assets.
(ii) Current assets: The assets of the business in the form of cash, debtors bank balances, bill
receivable and stock are called current assets as they can be realized within an operating cycle
of one year to discharge liabilities.
(iii) Tangible assets: Tangible assets have definite physical shape or identity and existence;
they can be seen, felt and have volume such as land, cash, stock etc.
Thus tangible assets can be both fixed assets and current assets.
(iv) Intangible assets: The assets which have no physical shape which cannot be seen or felt
but have value are called intangible assets. Goodwill, patents, trademarks and licenses are
examples of intangible assets. They are usually classified under fixed assets.

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(v) Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses
which are capitalized for the time being, expenses for promotion of organisations preliminary
expenses), discount on issue of shares, debit balance of profit and loss account etc. are the
examples of fictitious assets.
(vi) Wasting assets: These assets are also called depleting assets. Assets such as mines, Timber
forests, quarries etc. which become exhausted in value by way of excavation of the minerals,
cutting of wood etc. are known as wasting assets. Such assets are usually natural resources with
physical limitations.
(vii) Contingent assets: Contingent assets are assets, the existence, value possession of which
is based on happening or otherwise of specific events. For example, if a business firm has filed
a suit for a particular property now in possession of other persons, the firm will get the property
if the suit is decided in its favour. Till the suit is decided, it is a contingent asset.

7. Goods
It is a general term used for the articles in which the business deals; that is, only those articles
which are bought for resale for profit are known as Goods.

8. Revenue
It means the amount which, as a result of operations, is added to the capital. It is defined as the
inflow of assets which result in an increase in the owner’s equity. It includes all incomes like
sales receipts, interest, commission, brokerage etc.

9. Expense
The terms ‘expense’ refers to the amount incurred in the process of earning revenue. If the
benefit of an expenditure is limited to one year, it is treated as an expense such as payment of
salaries and rent.

10. Expenditure
Expenditure takes place when an asset or service is acquired. The purchase of goods is
expenditure, whereas cost of goods sold is an expense. Similarly, if an asset is acquired during
the year, it is expenditure, if it is consumed during the same year, it is also an expense of the
year.

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11. Stock
The goods purchased are for selling, if the goods are not sold out fully, a part of the total goods
purchased is kept with the trader unlit it is sold out, it is said to be a stock. If there is stock at
the end of the accounting year, it is said to be a closing stock. This closing stock at the year-
end will be the opening stock for the subsequent year.

12. Drawings
It is the amount of money or the value of goods which the proprietor takes for his domestic or
personal use. It is usually subtracted from capital.

13. Proprietor
The person who makes the investment and bears all the risks connected with the business is
known as proprietor.

14. Discount
When customers are allowed any type of deduction in the prices of goods by the businessman
that is called discount. When some discount is allowed in prices of goods on the basis of sales
of the items, that is termed as trade discount, but when debtors are allowed some discount in
prices of the goods for quick payment, that is termed as cash discount.

15. Solvent
A person who has assets with realizable values which exceeds his liabilities is insolvent.

16. Insolvent
A person whose liabilities are more than the realizable values of his assets is called an insolvent.

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Meaning of Debit and Credit
The term ‘debit’ is supposed to have derived from ‘debit’ and the term ‘credit’ from
‘creditable’. For convenience ‘Dr’ is used for debit and ‘Cr’ is used for credit.
Recording of transactions require a thorough understanding of the rules of debit and
credit relating to accounts. Both debit and credit may represent either increase or decrease,
depending upon the nature of account.

Types of Accounts

Personal Accounts: Accounts recording transactions with a person or group of persons are
known as personal accounts. These accounts are necessary, in particular, to record credit
transactions. Personal accounts are of the following types:

(a) Natural persons: An account recording transactions with an individual human

being is termed as a natural persons’ personal account.

(b) Artificial or legal persons: An account recording financial transactions with an

artificial person created by law or otherwise is termed as an artificial person,
personal account.

(c) Groups/Representative personal Accounts: An account indirectly representing a

person or persons is known as representative personal account. When accounts are
of a similar nature and their number is large, it is better tot group them under one
head and open a representative personal accounts. e.g., prepaid insurance,
outstanding salaries, rent, wages etc.

When a person starts a business, he is known as proprietor. This proprietor is represented by

capital account for all that he invests in business and by drawings accounts for all that which
he withdraws from business. So, capital accounts and drawings account are also personal
accounts.
The rule for personal accounts is: Debit the receiver
Credit the giver

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Real Accounts
Accounts relating to properties or assets are known as ‘Real Accounts’. A separate account is
maintained for each asset e.g., Cash Machinery, Building, etc.,
Real accounts can be further classified into tangible and intangible.

(a) Tangible Real Accounts: These accounts represent assets and properties which can
be seen, touched, felt, measured, purchased and sold. e.g. Machinery account Cash
account, Furniture account, stock account etc.

(b) Intangible Real Accounts: These accounts represent assets and properties which
cannot be seen, touched or felt but they can be measured in terms of money. e.g.,
Goodwill accounts, patents account, Trademarks account, Copyrights account, etc.
The rule for Real accounts is: Debit what comes in
Credit what goes out

Nominal Accounts
Accounts relating to income, revenue, gain expenses and losses are termed as nominal
accounts. These accounts are also known as fictitious accounts as they do not represent any
tangible asset. A separate account is maintained for each head or expense or loss and gain or
income. Wages account, Rent account Commission account, Interest received account are some
examples of nominal account

The rule for Nominal accounts is: Debit all expenses and losses
Credit all incomes and gains

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Accounting Concepts:
The following are the common accounting concepts adopted by many business concerns.
i) Business Entity Concept: A business unit is an organization of persons established to
accomplish an economic goal. Business entity concept implies that the business unit is separate
and distinct from the persons who provide the required capital to it. This concept can be
expressed through an accounting equation, viz.,
Assets = Liabilities + Capital.

ii) Money Measurement Concept: In accounting all events and transactions are recorded in
terms of money. Money is considered as a common denominator, by means of which various
facts, events and transactions about a business can be expressed in terms of numbers. In other
words, facts, events and transactions which cannot be expressed in monetary terms are not
recorded in accounting. Hence, the accounting does not give a complete picture of all the
transactions of a business unit.

iii) Going Concern Concept: Under this concept, the transactions are recorded assuming that
the business will exist for a longer period of time, i.e., a business unit is considered to be a
going concern and not a liquidated one. Keeping this in view, the suppliers and other companies
enter into business transactions with the business unit.

.iv) Dual Aspect Concept: According to this basic concept of accounting, every transaction
has a two-fold aspect, Viz., 1.giving certain benefits and 2. Receiving certain benefits. The
basic principle of double entry system is that every debit has a corresponding and equal amount
of credit. This is the underlying assumption of this concept.
The accounting equation viz., Assets = Capital + Liabilities or
Capital = Assets – Liabilities

v) Periodicity Concept: Under this concept, the life of the business is segmented into different
periods and accordingly the result of each period is ascertained. Though the business is
assumed to be continuing in future (as per going concern concept), the measurement of income
and studying the financial position of the business for a shorter and definite period will help in
taking corrective steps at the appropriate time. Each segmented period is called “accounting
period” and the same is normally a year.

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vi) Historical Cost Concept: According to this concept, the transactions are recorded in the
books of account with the respective amounts involved. For example, if an asset is purchases,
it is entered in the accounting record at the price paid to acquire the same and that cost is
considered to be the base for all future accounting. It means that the asset is recorded at cost at
the time of purchase but it may be methodically reduced in its value by way of charging
depreciation.

vii) Matching Concept: The essence of the matching concept lies in the view that all costs
which are associated to a particular period should be compared with the revenues associated to
the same period to obtain the net income of the business.

viii) Realization Concept: This concept assumes or recognizes revenue when a sale is made.
Sale is considered to be complete when the ownership and property are transferred from the
seller to the buyer and the consideration is paid in full.

ix) Accrual Concept: According to this concept the revenue is recognized on its realization
and not on its actual receipt. Similarly, the costs are recognized when they are incurred and not
when payment is made.

x) Objective Evidence Concept: This concept ensures that all accounting must be based on
objective evidence, i.e., every transaction recorded in the books of account must have a
verifiable document in support of its, existence. Only then, the transactions can be verified by
the auditors and declared as true or otherwise. The verifiable evidence for the transactions
should be free from the personal bias, i.e., it should be objective in nature and not subjective.

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