Introduction to Accounting

Accounting: - Accounting is a process of indentifying financial transactions, measuring them in money

terms, recording them in primary books, classifying, summarizing, analyzing, interpreting them and
communicating the result to the users.

Characteristics/Features of Accounting
1. Identification of Financial Transactions and Events: - Accounting simply keeps track of
transactions and events that can be measured in monetary terms. This includes identifying
whether transactions are considered to be part of economic activity or not. Bills and receipts of
transactions are used as evidence to identify such transactions.

2. Measuring the Identified Transactions: - Accounting measures transactions and events in terms
of a standard unit of measurement (that is the currency of a country). An event that cannot be
quantified in monetary terms is not recorded in the accounting records. For example, events such
as the level or quality of a management team or the employment of a manager are not recorded in
the books of account.

3. Recording: - Accounting is the practice of documenting company transactions in accounting

books. Recording is the process of recording financial transactions in a book of original entry,
such as a journal. Journal is the first step of accounting.

4. Classifying: - Classification is the process of arranging transactions or entries of the same type
together in one place. The transactions in the ‘Journal’ are grouped or posted to the Ledger.
Individual account heads are used in this book to aggregate all financial transactions of the same
type. For example, transactions for the purchase of items are placed in the Purchases Account in
the Ledger so that the total purchase of products may be determined. Ledger is the second step of
accounting.

5. Summarizing: - This includes presenting the classified data in a way that is both comprehensible
and valuable to internal and external accounting statement users. As a result of this procedure, the
following statements are created: 1.Trial Balance 2.Trading and Profit and Loss Account or
Statement of Profit loss (in case of Companies) 3.Balance Sheet

6. Analysis and Interpretation: - Financial data is analyzed and interpreted so that users of
financial data may assess the profitability and financial status of the company. This makes it
easier to plan on a sound basis.

7. Communicating: - Finally, the accounting function includes conveying financial information to

its users, i.e., financial statements. Accounting data must be made available to users in a timely
manner so that choices may be made at the right time.

Advantages of Accounting
 The advantages of accounting are explained as follows:-

1. Replacement of Memory: - It is not possible for any human being to remember all the
transactions of business. Accounting has replaced the need of such sharp memory. All financial
transactions are recorded in a systematic manner in the books of accounts so that there is no need
to rely only on memory.
2. Planning: - Accounting information is helpful in preparing business plans. The basis of past
records and comparative study of financial statements future events may be estimated.
3. Decision Making: - The accountant helps the management in decision making by providing the
relevant information. Determining selling price, allowing discount and credit facility to regular
customers, etc. are few of the important decisions.
4. Controlling: - To make effective controlling actual performance is compared with the desired or
planned targets. The actual data is supplied by accounting books, without that the controlling may
not be possible.
5. Provides information to users: - Accounting provides necessary information to various parties
or groups like owners, creditors, management, employees, government, consumers, and debtors.
6. Evidence in courts: - When any matter relating to business is referred to the court of law,
accounting records of business transactions are treated as satisfactory evidence. These are used in
settling the disputes between parties.
7. Assessment of tax-liability: - Business concerns have to pay sales tax, excise duty, income tax,
etc. as per the government rules. Accounting books are the basis of conclusive proof of tax
liability of the business.
8. Assessing the performance and financial position of the business: - A statement of P & L
discloses profit earned (or loss incurred) during a particular accounting period. Profit is a
measurement of the performance of the business. A balance sheet states the financial position of
the business on a particular data. Thus, accounting helps in assessing the performance and
financial positions of the business.

Functions of Accounting
1. Recording business transactions systematically: - It is necessary to maintain systematic records
of every business transaction, as it is beyond human capacities to remember such large number of
transactions.

2. Determining profit earned or loss incurred: - Another most important objective of accounting
is to ascertain profit or loss at the end of the accounting year. It gives information regarding how
much of goods have been purchased and sold, expenses incurred and amount earned during a
year.

3. Ascertaining financial position of the firm: - Ascertaining profit earned or loss incurred is not
enough; proprietor is also interested in knowing the financial position of his/her firm, i.e. the
value of the assets, amount of liabilities owed, net increase or decrease in his/her capital. This
purpose is served by preparing the balance sheet that facilitates in ascertaining the true financial
position of the business.
4. Assisting management: - Systematic accounting helps the management in effective decision
making, efficient control on cash management policies, preparing budget and forecasting, etc.

5. Assessing the progress of the business: - Accounting helps in assessing the progress of business
from year to year, as accounting facilitates the comparison both inter-firm as well as intra-firm.

6. Detecting and preventing frauds and errors: - It is necessary to detect and prevent fraud and
errors, mismanagement and wastage of the finance. Systematic recording helps in the easy
detection and rectification of frauds, errors and inefficiencies, if any.

7. Communicating accounting information to various users: - The important step in the

accounting process is to communicate financial and accounting information to various users
including both internal and external users like owners, management, government, labour, tax
authorities, etc.

Limitations of Accounting
1. Accounting is not fully exact: - Accounting information is not necessarily exact. A lot of
information presented in the books of account is based on personal judgment. There cannot be the
absolute guarantee of accuracy when assumptions are based on personal opinion.

2. Financial accounting does not show the exact realizable value: - The values of most of the
assets in the books are presented on the basis of their purchase price, which is known as historical
figures. Their present market values or realizable values are usually quite different. In other
words, the books of accounts fail to show the exact value of assets or liabilities.

3. A problem with window dressing: - Balance sheet figures are often modified to make it look
better. This process conceals many weaknesses of the business. Thus the accounting information
becomes unreliable for accurate judgment.

4. Accounting ignores qualitative instruments: - Another limitation of accounting is that it only

records quantitative instruments and completely ignores qualitative instruments such as skill of
labor, quality of stock etc.

5. No effect of inflationary trends: - Currency is not a stable unit of measurement of value.

Inflation can make the value of the currency itself different. Measurement with this “elastic tape”
can give conflicting results.

Explain the Users of Accounting Information:

Users may be categorized into internal users and external users.

(A) Internal Users

1. 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.

2. Management: - Accounting information is used by management for taking various decisions.

3. Employees: - Employees are interested in the financial statements to assess the ability of the
business to pay higher wages and bonuses.

(B) External Users

1. Banks and financial institutions: - Banks and Financial Institutions provide loans to business.
So, they are interested in financial information to ensure the safety and recovery of the loan.

2. Investors: - Investors are interested to know the earning capacity of business and safety of the
investment.

3. Creditors: - Creditors provide the goods on credit. So they need accounting information to
ascertain the financial soundness of the firm.

4. Government: - The government needs accounting information to assess the tax liability of the
business entity.

5. Researchers: - Researchers use accounting information in their research work.

6. Consumers: - They require accounting information for establishing good accounting control,
which will reduce the cost of production.

Difference between Book Keeping and Accounting

Scope Book-Keeping Accounting
1. Scope It is a process of identifying financial It is the process of summarizing the
transactions and events, measuring recorded transactions and events,
them in monetary terms, recording interpreting them and communicating
and classifying them. the results to the users.
2. Objective Its objective is to maintain Its objective is to ascertain results of
systematic records of financial operations and financial position and
transactions and events. to communicate information.
3. Stage It is the primary stage. It is the basis It is the secondary stage where book
for accounting. keeping ends.
4. Nature It is regular in nature. It is dynamic and analytical in nature.
5. Performance It can be performed by not so trained It can only be performed by trained
staff. staff.
6. Level of Skills It doesn’t require special skills. It required special skills to analyse
and interpret.