Introduction to accounting
Chapter-1
(Introduction to accounting)
History of
Accounting
There
was a king named as Fra lucas Pacioli
who was from Italy, He wrote a book named ”Everything about Arithmetic and
Geometry and proportion. This book contained principles of book-keeping, as he
was from Italy double entry book keeping is called Italian method.
During the middle ages, tradesman taught
Book keeping to their children in the form of apprenticeship, later on private
teachers began to teach book keeping. In India Hindustani Bahi khata was taught
by ‘’Munims’’ Through Apprenticeship.
In India formal teaching of book
keeping was started in 1886 in 1st commercial school established in
madras by the trustees of pachyappa charities.
Meaning of
Accounting
Accounting is the process of collecting, recording,
classifying, summarising and communicating financial information system
that provides Accounting information to
users for correct decision making.
Defination of
Accounting
‘’Accounting
is the art of recording, classifying and summarising in a significant manner
and in terms of money; transaction and events which are ,in part at least, of
financial character, and interpreting the result thereof .” (Committee on
terminology of American institute of certified public Accountants)
Attributes (characteristics)
of Accounting
Accounting
records only those transactions which are of financial character
Accounting
records only those transactions which
can be measured in terms of money. There are so many transactions in the business which are very important for
business but which cannot be measured and expressed in terms of money and hence
such transactions will not be recorded. For example, the Fight between two
employees cannot be recorded in books of account.
Accounting
records by expressing them in terms of money
Account
records transaction by expressing them in terms of money. Example – If business
is having 15 machines, 120 chairs and 15 computers than it is not possible to
record in books of account and hence they are first expressed in terms of money
and then recorded.
Recording
Accounting
is an art of recording business transactions in a methodical way, according to
some specified rules, so that complete information can be quickly obtained. In
a small business where the number of transaction is quite small, all
transactions are first of all recorded in the journal. But in a big business
where the number of transaction is quite large , the journal is further
subdivided into various subsidiary books like cash book, purchase book , sales
book, purchase and sales Return book etc.
Classifying
Accounting
is the process of classifying business transactions. It involves the grouping
of transactions of same nature under one head, in a separate account. The book
in which various accounts are opened is called(ledger) for example, all
transactions relating to purchase will be shown in purchases account and all
transactions relating to wages will be shown in wages account.
Summarising
Accounting
is the art of presenting business transactions in a summary form which is
useful to the management and other interested parties. This involves presenting
the classified data in such a manner which is understandable and useful to
internal as well as external users. This process leads to preparation of
(a)Trial
balance, (b) Trading and profit and
loss account (c) Balance sheet
Interpreting
This
is the final stage in accounting. This helps to make meaningful judgement about
profitability.
Meaning of book
keeping
Branch
of knowledge which educates us as to how financial records are to be
maintained. Book keeping is concerned with
1)
Identifying financial transactions.
2)
Measurement in terms of money.
3)
Recording the financial transactions so identified in the books of account.
4)
Classifying recorded transaction in ledger account.
Definition
“Book
keeping is the art of recording business transactions in systematic manner” (A.N ROSEN KAMPFF)
Difference
between book keeping and accounting
|
Basis |
Book keeping |
Accounting |
|
Stage |
It is
primary stage |
It is
secondary stage |
|
Performance |
Junior staff |
Senior staff |
|
Nature of
job |
clerical
and routine in nature |
Analytical
and dynamic in nature |
|
Relation |
Basis of
accounting |
it begins
where book keeping ends |
|
Special skills |
Requires no
special skill. |
Require
special skill. |
|
Aspect |
It
represents the art aspect |
it represents
the science aspect. |
|
Scope |
It has
limited scope |
it has
wider scope |
Branches of Accounting
1-Financial
Accounting 2- Cost Accounting 3- Management Accounting
Financial
Accounting-
It
is that branch of accounting which records financial transactions and events,
summarises and interprets them and communicates the result to the users. It
ascertains profit earned or loss incurred during an accounting period and
financial position on the date when the accounting period ends.
Objectives or
functions of accounting
1-Record of
Financial Transactions and Events:
The objective of accounting is to record
financial transactions and events of the organisation in the books of accounts
following the principles of accounting in a systematic manner.
Determine profit
and loss:
Another
objective of accounting is to determine the financial performance (profit and
loss) for the accounting period.
Determine
financial position:
Another
objective of accounting is to determine financial position. It is known from the balance sheet.
Assisting the Management:
Another
objective of accounting is to assist the management by providing financial
information to it .The management often requires financial information for
decision-making, exercising control, budgeting and forecasting.
Communicating systematic accounting records:
Another
objective of accounting is to provide accounting information to users who
analyse them as per their individual requirements.
Advantages or
utility of accounting
Proof in court
The
proper accounting is a good proof in the court regarding the transactions of
the businessman with others.
Helpful in
declaring as an insolvent
If
a businessman does not have sufficient assets to meet his liabilities and want him
to be declared insolvent. The accounts will help him in this matter in the
court.
Helpful in determination
of tax liability
If
proper accounts are maintained .taxation problems are solved to a great extent.
Proper accounting will avoid heavy tax penalties from income tax and sales tax
department.
Complement of memory
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.
Knowledge of
important information
Proper
accounting helps in knowing the important information of business like
financial position of business, capital, liabilities, purchases, sales, stock
position and income and expenditure of the business.
Limitations/Disadvantages
of accounting
Accounting is not
fully exact
Although
most of the transactions are recorded on the basis of evidence but some
estimates are also made like useful life of an asset, possible bad debts etc. This
could lead to different amount of profit and loss.
Accounting does
not indicate the Realisable value
The
balance sheet does not show the amount of cash which firm may realise by sale
of all the assets.
Accounting
ignores qualitative aspect
Accounts
record only those transaction which can be measured in terms of money therefore
it ignores quality management, labour force etc.
Accounting
ignores the effect of price level changes
Accounting
statement are prepared at historical cost. Money, as a measurement unit,
changes in value. It does not remain stable.
Accounting may
lead to window dressing
The
term window dressing means manipulation of accounts so as to conceal vital
facts and present the financial statements in such a way as to show better
position than what it actually is. In this situation, income statement (profit
and loss) fails to provide a true and fair view of the result of operations and
balance sheet fails to provide a true and fair view of the financial position
of the enterprise.
Accounting
Information
‘’Accounting
is a service activity. Its function is to provide qualitative information,
primarily financial in nature, about economic entities that is intended to be
useful in making economic decisions.’’
Types of accounting
information
1-Information
relating to profit or surplus 2-
Information relating to financial position
3- Information about cash flow
Users of accounting information
Internal users
1) Owners: They are the ones who
contribute capital and thus are always exposed to risk and hence they are
always interested in knowing the profit earned or loss suffered by the
business.
2) Management: Business is managed by professionals and they
have the responsibility to safeguard owner’s investment and increase its value,
so they are in need of information to arrive at informed decisions like what should
be selling price, investment in to new products etc.
3) Employees and workers: They are entitled to bonus at the
end of the year beside the salary and wages.
External users:
1) Banks and
financial institutions
Banks
and financial institutions are essential parts of business organisation and are
essential parts of any business as they provide loans to the business.
2) Investors:
Investors
are the one who have invested and hence involves risk, so they rely on the
account information available to them.
3) Creditors:
They
are those parties who supply goods or service on credit .It is common business.
Creditors are interested to know the worthiness of business.
4) Government and
its authorities:
The
government use financial statement to compile national income account and other
information to take decision. Tax
is charged by government like excise duty, vat, services tax .The government
authority assess tax due from analysis of financial statement.
5) Researchers:
Researchers
undertake research in topic areas like accounting theory and business
practices, stock brokers also carry out research o financial statement to
assess the future profitability and to assess what should be the value of
share.
6) Public
Public
want to see the business running since it makes substantial contribution to the
economy in many ways, e.g., employment of people thus, financial accounting
provides useful financial information to various user groups for
decision-making.
Qualitative
characteristics of accounting information
Two
fundamental characteristics of financial statements are their truth and fairness.
Other qualitative characteristics which make financial statement
meaningful
Reliability
Accounting
information must be reliable. The factors that make it reliable are
1-transaction
should be evidenced by documents.
2-
It should be free from personal bias.
Relevance
The
accounting information, besides disclosing legal required disclosures should
disclose other information. Example- Interest on borrowing is disclosed without
stating the rate of interest, in this case users cannot link.
Understandability
Information
provided through the financial statement must be presented in such a manner
that6 it can be easily understood by the users. If information is considered
relevant for the users decision making it must be disclosed even if it is complex for common users.
Comparability
Accounting
should follow standardised accounting policies so that users can be able to
compare the accounting information inter firm (with other firms) and intra firm
(with in department)
Systems of
accounting
Double Entry
system
It
was developed in 15th century in Italy by Fra Lucas pacioli. Under
this system every transaction has two aspect Debit and credit. One is recorded
on debit side and other on credit side.
Features of
double entry system
* It recognises two aspects (receiving and
giving).
*
One aspect is debited and other is credited.
*
Total of all debits is credit.
*
Maintain complete record.
Advantages of
double entry system
·
Double entry system is a complete record of transactions.
·
With the help of double entry system a check on accuracy can be
maintained.
·
Double entry system helps in ascertainment of profit or loss.
·
Comparative study is possible.
·
No scope of fraud
·
Helps in decision making.
Single entry
system
It
is incomplete double entry system. In
this system all the transactions are not recorded on the double entry basis.
Instead of making all the accounts only personal account and cash book a
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