1

Introduction to Accounting
Meaning of Accounting:
Accounting is the language that a business enterprise uses to communicate
with others about its working results and progress. Basic purpose of
accounting is to ascertain the profit or loss of business and also to know the
financial position of business. Accounting information helps management to
take important decisions regarding business and chalking out future
policies.

Definitions of Accounting:
1. According to the ‘American institute of Certified public Accountants’
(AICPA), “Accounting is a 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 financial character, and interpreting the results
thereof.”
2. The ‘American Accounting Association’ (AAA) in 1956, defined
accounting as “The process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users
of information.”

Book Keeping:
Book keeping is an art of recording daily business transactions in a set of
books.
Book keeping is a primary and basic function in the process of accounting
and concerned with recording and maintenance of books of accounts only.
It is mainly concerned with record keeping or maintenance of books of
accounts.
The book keeping function is routine and clerical in nature and can be
performed by persons having limited knowledge of accounting. At present
this function is increasingly done by computers.

Accounting:
Accounting is the process of identifying , recording and analyzing the
financial transactions of business and transferring the analyzed information
to the interested parties like creditors, bank etc.
It means to prepare and present the accounts to know the results of the
business.

Accountancy:
It refers to a systematic knowledge of accounting concerned with the
principles and techniques which are applied in accounting. It tells us how to
prepare the books of accounts, how to summarize the accounting
information and how to communicate it to the interested parties.
Accounting depends on the rules and principles framed by Accountancy.

1
 2

Difference between Book Keeping and Accounting:

Book Keeping Accounting
1. It is an art of identifying and It is an art of recording, classifying
recording of all financial and analyzing and interpreting of
transactions in a set of books. recorded transactions to draw
some conclusion.
2. Major objective is to keep record To know the financial position of
of all the financial transactions of business.
business.
3. It is a part of accounting so has a It includes book keeping also so
limited scope. has a wider scope.
4. It is a primary stage. It is the secondary stage. It begins
wher book keeping ends.
5. It does not require any special It requires special skills and
skill. ability to analyse.
It needs a knowledgeable person
6. It can be done by a junior so require senior accountant.
accountant.

Users of Accounting Information:

(A) Internal Users:
Internal users are the persons which are within an organization i.e., the
persons working in the business.
1. Owners:
Owners are the persons who have invested their money in the business. They
need accounting information to know the Profit & Loss and financial
position of the business in which their money is invested.

2. Management:
Management is responsible for planning, organizing, decision making, and
controlling. Management is interested in assessing the capacity of the
business to earn profits in future. Accounting helps in decision making for
management.

3. Employees:
Employees are interested in knowing the profitability of business as they
would like to claim higher salaries, higher bonus and better perks.

(B) External Users:

External Users are the persons which are outside the organization like
investors, buyers, creditors, government etc.

1. Investors:
Investors are those who invest money in business. They will be interested in
earning capacity of business and safety of the investment.

2. Creditors:
Creditors are the persons who supply goods on credit. Creditors would like
to know whether their money is safe and whether they would get their
money back in due time or not.
2
 3

3. Bank and other Financial Institutions:

Bank will provide loan to business. Bank want to know whether the business
will be able to pay the principle as well as interest in due time or not.

4. Government:
Government is interested in the financial statements of business for the
assessment of tax liability such as income tax, sales tax, service tax etc.

5. Consumers:
On the basis of accounting information, customers can know about the
continued supply of the products and services rendered by business
enterprise.

6. General Public:
General Public is interested in accounting to know the employment
opportunities provided by the business and the steps taken by business to
check the pollution. Such information is available from the annual reports of
the enterprise.

OBJECTIVES OF ACCOUNTING:
Following are the various objectives of Accounting:
(1) To keep systematic record of business transactions:
The accounting records should be made properly and systematically, so
that requisite information may be obtained from the books of the accounts
whenever needed.

(2) To calculate Profit or Loss of Business:

The second main objective of accounting is to ascertain the net profit
earned or loss suffered by a business enterprise. By comparing Incomes and
Expenses, Profit or Loss can be calculated.

(3) To know the Financial Position of Business:

The businessman must also know the financial health of the business.
With the help of assets and liabilities we can judge the financial health of the
business. Financial position is related to the loan repaying capacity of
business.

(4) To Provide Information to various Interested Parties:

Another main objective of accounting is to communicate the accounting
information to various interested parties like owners, investors, banks,
employees, etc. The information helps them in taking sound and judicious
decisions about the business.

ADVANTAGES OF ACCOUNTING:
(1) Helps in remembering:
As human memory is limited, no businessman can remember everything
about his business. It is, therefore, necessary that all business transactions
are properly recorded, so as to derive the necessary information when
required.
3
 4

(2) Comparative Study is possible:

If proper accounts are maintained than the results of business can be
compared for different periods. The comparison will help in ascertaining the
progress of the business.

(3) Helpful in providing documentary evidence:

Systematically recorded accounting information can be produced as
evidence in a court of law.

(4) Helpful in the Valuation of Business at the Time of Sale and Purchase:
If a business man wants to sell or purchase any bus iness the proper
accounting will help in ascertaining the true value of a particular business.

(5) Helpful in taking loans:

For the expansion of business , funds can be raised by taking loans from
Banks. Banks provide loan on the basis of profitability and repaying
capacity of business which can be measured through books of accounts.

(6) Helpful in Determining Tax Liability:

Accounting helps in providing correct profit or loss, sales etc. so will be
helpful in the settlement of various taxes like income tax, sales tax , etc.

(7) Assistance to Management:

Accounting assists the management in the task of planning, controlling
and coordination of business activities.

LIMITATIONS OF ACCOUNTING:
(1) Influenced by Personal Judgments:
The accountants of different concerns use their own personal judgments
for the same problems. Due to these different personal opinions, the results
cannot be treated as exact. For ex. possible bad debts, estimated useful life of
an asset, market price of the stock.

(2) Historical in nature:

Fixed Assets are recorded in the books of accounts at original cost not at
current price. The direct result of this practice is that balance sheet does not
represent the true financial position of the business.

(3) Records only Monetary Transactions:

Accounting provides only incomplete information as accounting records
only those transactions which can be expressed and measured in terms of
money. Non Financial Transactions are not recorded in the books of
accounts though they are of great importance. For ex. quality of staff;
market conditions, change of government policies etc.

(4) Window Dressing:

Window dressing means the practice of manipulating accounts so that the
financial statements may show a more favourable position than the actual.
Accountants may show the results of the business, as desired by the owners

4
 5

of the business. For ex. showing more expanses than the actual expanses to
decrease the profit so that less tax and bonus to be paid.

(5) Unsuitable for Forecasting:

Accounts provide information pertaining to past. In the changing world,
past data will not be of much use for making future predictions.

Branches of Accounting:
(A) Financial Accounting:
The main purpose of this branch of Accounting is to record the business
transactions properly, to determine the profit or loss and to know the
financial position of the business. This branch of accounting gives the
information to interested parties such as management, bankers,
government, suppliers etc.

(B) Cost Accounting:

The main objectives of cost accounting are to ascertain the cost of a
product and help the management in the control of costs. It determines the
accurate cost per unit of a product which helps the business in fixing the
proper selling price.

(C) Management Accounting:

That branch of accounting which provides necessary information to the
management for discharging its functions. The main object of this branch is
to provide all the relevant information that may be required by the
management to take decisions related to business. Such information
includes: sales forecast, purchase requirements, manpower needs etc.

(D) Tax Accounting:

The branch of accounting which is used for computation of tax is called
Tax Accounting. Income Tax and Sales tax are computed on the basis of the
tax accounting. This branch of accounting contain rules to calculate
different types of taxes in most accurate manner.

(E) Social Responsibility Accounting:

This branch of accounting is the process of identifying, measuring and
communicating the contribution of business to the society. The contribution
of the business to the society consist of providing employment, supplying
good quality products and services at cheaper rates, paying fair wages to
employees , customer satisfaction, Pollution control, etc. This information is
available in the Annual Reports of the companies.

Qualitative Characteristics of Accounting:

(1) Reliability:
An information will be considered as factual and verifiable if
information is verified by some source documents or we can say an
information is based on some facts or some evidence. For example for cash
sales there is cash memos. So if some facts of the transactions are available
and supported by some documentary evidence then it will make the
information reliable.
5
 6

Moreover accounting information should be free from personal bias than it

should be considered reliable.

(2) Relevance:
Information which can influence the decisions of the users is said to be
relevant . The accounting information should contain only that information
which is relevant for the users. It should not be crowded with unnecessary
and irrelevant data. It must facilitate the users in decision making process.
It means relevant accounting information must be available to the users in
time so that corrective measures can be taken and future events can be
predicted.

(3) Comparability:
Comparison reveals the strong and weak points of the business
enterprise. The previous years performance can be compared with the
current (present) years performance(Intra firm). Similarly the results of two
similar concerns can also be compared(Inter firm) . Comparison is to be done
to know the growth and progress of the business.

(4) Understandability:
Accounting information must be prepared and presented in such a
manner that it can be easily understood and interpreted by their users such
as investors, lenders, creditors, workers etc. Thus, the accounts must be
prepared in such a manner that even those persons who do not possess
special knowledge in accounting can easily understand them.

BASIC ACCOUNTING TERMS:

(1) Entity:
Entity means a thing that has a definite individual existence. For ex. Big
Bazaar, Asian Paints Ltd. etc.

(2) Transaction:
A business transaction is an economic activity of the business that changes its
financial position.
For ex. Sales, Purchase, etc.

(3) Assets:
Any type of property owned by business is known as assets.
OR
The economic resources which will enable a business enterprise to get cash or a
benefit in future is an asset.
Following are the various of Assets:
(i) Non Current Assets or Fixed Assets:
Fixed assets refer to those assets which are held for continued use in the
business for the purpose of producing goods or services and are not meant for
resale. They will remain in the business. For ex. Land & Building , Plant &
Machinery, Furniture etc.
6
 7

Non Current Assets are of two types:

(a) Tangible Assets:
Assets having some physical existence means which can be seen and
touched like Land & Building, Machinery, Stock etc.

(b) Intangible Assets:

Intangible assets are those assets which can’t be seen or touched means
assets which do not have any physical existence. Moreover they can’t be
purchased or sold in the open market in general circumstances. For ex.
Goodwill, Patents, Trademarks, etc.

(ii) Current Assets:

Current Assets are those assets which can be converted into cash within a
short period say in one year. For ex. Cash in hand, debtors, stock, bank balance,
bills receivable etc.

(iii) Liquid Assets:

Liquid assets are those assets which are available to business either in the
form of Cash or which are likely to be converted into cash within a very short
period. For example – cash , cash at bank, Debtors , Short term investments, etc.

(iv) Fictitious Assets:

These are the Assets which cannot be realized in Cash or no further benefit
can be derived from these assets

(v) Wasting Assets:

Are those when with the passage of time value of assets decreases. For Ex.
Mines , Oilwells etc.

(4) Liabilities:
Liabilities are obligations or debts(loans) that an enterprise has to pay at some
time in the future.
OR
Any amount which is to be paid by business in future is known as liabilities.
Liabilities are of following types:

(i) Non Current Liabilities:

Long term liabilities are those liabilities which are payable after a long
period or normally after one year. For Ex. Long term loans, debentures etc.

(ii) Current Liabilities:

Current Liabilities are those liabilities which are payable within a year.
For ex. Bills payable, creditors, Bank Overdrafts, Short term loan,etc.

(iii) Contingent Liabilities:

Contingent Liabilities are those liabilities which are not a liability for
today but it may be a liability in future depending upon the future events. For
ex. case pending in the court.

7
 8

(5) Capital:
Capital refers to amount invested by the proprietor in the business. It may in
the form of cash or assets in money form.

(6) Goods:
Goods are the commodities which a business possesses or purchase for the
purpose of sale or used as a raw material. (or) The Product in which business is
dealing.

(7) Sales:
Sale means sale of those commodities in which a business deals. For ex. if a
business is dealing in furniture then sale of furniture will be considered as sale
otherwise it will be known as sale of an asset.

(8) Revenue:
Revenue is total amount realized or receivable from the sale of goods or
services. For ex. receipt from sale of goods, rent received, commission received
etc.

(9) Expenses:
Cost incurred by a business in the process of earning revenue is known as
expenses. For ex. salaries, wages, rent, commission etc.

(10) Expenditure:
When some amount is spent or a liability incurred to acquire some assets, goods
or services then it is called expenditure.
Expenditure may be of two types:
(i) Capital Expenditure:
When the expenditure incurred is for the purpose of acquiring fixed assets
or for the improvement of fixed assets then it is called capital expenditure. For
ex. expenditure incurred in the purchase of furniture, machinery , etc.

(ii) Revenue Expenditure:

When expenditure is done to get full benefit in one accounting year it is
known as revenue expenditure. These expenditure do not increase the earning
capacity of the business but are done to maintain the existing earning capacity.
Revenue expenses are incurred for meeting the day to day operations of the
business. For ex. purchase of goods and services, payment of wages etc.

(iii) Deferred Revenue Expenditure:

All those revenue expenditures which are likely to give benefits for more than
one accounting period , are termed as deferred revenue expenditure. For ex.
huge amount spent on advertisement, white wash etc.

(11) Profit:
Profit is the excess of revenues over its costs. Profit should be generated
through business activities. Profit increases the capital of the proprietor.

8
 9

(12) Gain:
Profit that arises from events or transactions which are incidental to business
is termed as gain. Ex. sale of fixed assets, winning a court case, appreciation in
the value of fixed assets, etc. These profits are irregular in nature.

(13) Loss:
The excess of expenses of a period over its related revenues is termed as loss. It
decreases the owner’s capital.
Loss = Revenue – Expenses

(14) Income:
The Profit of business activities and other activities that increases net worth of
the business enterprise are known as income.

(15) Discount:
Discount is any type of reduction in the price by the seller to the buyer. It may
be of two types:
(a) Cash Discount: When discount is given to get an early payment.
(b) Trade Discount: When discount is given to increase sales.

(16) Voucher:
The documentary evidence in support of a transaction in known as voucher.
For ex. Cash Memo, Invoice or Bill, etc.

(17) Drawings:
Goods or cash withdrawn from the business by the owner of the business for
personal purpose is called drawings. For ex. if the owner of the business pays
fees of his children from the business or he takes furniture from the business
for his home etc.

(18) Purchase:
Purchase means purchase of goods in which business deals for resale purpose
in the ordinary course of business with the intention of profit.

(19) Stock:
Value of goods lying unsold at the beginning of year or at the end of the year is
called stock or inventory.

(20) Debtors:
Debtor is a person or party who has to give money to the business.
(Or) Debtors are the persons to whom goods are sold on credit. For ex. goods
worth Rs.2,000 are sold to Mr. A on credit then A will be the debtor of the firm
because he has to give money to the firm.

(21) Creditors:
Creditor is a person or party who has to take money from the business. Or
Creditors are the persons from whom goods are purchased on credit. For ex.
9
 10

goods purchased from Mr. B on credit worth Rs.1,000 then Mr. B will be
creditor of the firm as he has to take money from the business .
If some expenses like salaries, wages are outstanding then there will be
creditors.

(22) Purchase Return/Return Outwards:

When purchase goods are returned due to some defect or not according to
sample then it is called purchase return or return outward.

(23) Sales Return or Return Inward:

When sold goods are returned by the customer due to some reason then it is
called sales return or return inward.

(24) Receivables:
Total amount due from debtors and bills receivables is called receivables. (Any
amount to be received)

(25) Payables:
Total amount due to creditors and for bill payable is called as payables.(Any
amount to be paid)

(26) Receipts:
The amount received or to be received from selling of assets , goods or services
is called a receipt.
Receipts are of two types:
(i) Capital Receipts:
The amount received by business entity from proprietor(owner) or
partners as capital or money received by way of issue of share capital or
debentures or by raising loan is a capital receipt. Similarly, the money received
or receivable by the business by sale of fixed assets like land, building,
machinery etc. is also a capital receipt.
(ii) Revenue Receipt:
Revenue receipt refers to the amount received or receivable by the
business on regular basis from its operations. For ex. Amount received from
sale of goods or services, commission, rent, interest, royalties, etc.

(28) Live Stock:

When animals are use for commercial activities like transportation, dairy farm,
etc. Such animals are termed as Live Stock.

(29) Invoice or Bill:

An Invoice or Bill is prepared by the seller of goods when he sells his good to
buyer on credit. It contains details like date of goods sold, rate, quantity,
amount of sale, brand name, etc.

(30) Allowance:
If some reduction in sales price is given is given to a customer due to some
minor defect in the product, it is called allowance.
10
 11

(31) Bad Debts:

Bad debt is the amount that has become irrecoverable from the debtor due to
dispute or insolvency of the debtor.

(32) Solvent:
A person or a business who is in a position to pay its debts in full, is called a
solvent.

(33) Insolvent:
If a person or a business is not in a position to pay its debts in full, he/it is said
to be insolvent.

11