UNIT 1: INTRODUCTION TO ACCOUNTING
Accounting is the language of business. It is the system of recording, summarizing, and analyzing an economic entity’s financial transactions.
The American Accounting Association offers this definition: “The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.”
In other words, accounting is the basis of all decision-making.
Effectively communicating this information is key to the success of every business. Those who rely on financial information include internal users, such as a company’s managers and employees, and external users, such as banks, investors, governmental agencies, financial analysts, and labour unions. These users depend upon data supplied by accountants to answer the following types of questions:
• Is the company profitable?
• Is there enough cash to meet payroll needs?
• How much debt does the company have?
• How does the company’s net income compare to its budget?
• What is the balance owed by customers?
• Has the company consistently paid cash dividends?
• How much income does each division generate?
• Should the company invest money to expand?
Accountants must present an organization’s financial information in clear, concise reports that help make questions like these easy to answer. The most common accounting reports are called financial statements.
Types of Accounting
Social Responsibility Accounting
1) Financial Accounting
The main purpose of this branch of accounting is to record the business transaction in a systematic manner, to ascertain the profit or loss of the accounting by preparing a profit and loss account and to present the financial position of the business by preparing a balance sheet. This branch of accounting provides information required by the management and various interested parties.
2) Cost Accounting
The main purpose of cost accounting is to ascertain the total cost and per unit cost of goods produced and serviced rendered by a business. It also estimates the cost in advance and helps the management in exercising strict control over cost.
3) Management Accounting
The main purpose of management accounting is to present the accounting information in such a way as to assist the management in planning and controlling the operation of a business. The management accountant uses various techniques and concepts to make the accounting data more useful for managerial decision making .These techniques include ratio analysis budgetary control, fund flow statement, cash flow statement.
4) Tax Accounting:
The branch of accounting which is used for tax purpose is called Tax accounting. Income tax and sales tax are computed on the basis of this accounting.
5) Social Responsibility Accounting:
The society provides the infrastructure and the facilities without which business cannot operate at all.Hence the business also has a responsibility to the society.
Classification of Accounting
Personal: In this segment, all persons, who are either give something or takes something, are placed
Individual – Individual personal accounts are for any living person like you & me. (Example: Ratan Tata A/c)
Artificial – Artificial personal accounts referred to any non living, but artificially created entity. (Example: Tata motors Pvt. ltd. A/c)
Representative – When an account indicate another person or group of persons, is called Representative personal account. Any prepaid or outstanding expenses accounts are fall in this category. (Example: Salary payable A/c , Prepaid office rent A/c)
Impersonal: All other accounts, which are not personal accounts.
Real – Accounts of the asset. Also called ‘Permanent account’.
Tangible: A real account with the physical entity is called ‘Tangible real account’, such as land, furniture, machinery, vehicles. These accounts are depreciated with time lapse, except ‘Land’.
Intangible: You can not touch an intangible real account but it still have logical value, which can be measurable by money and it helps to increase the profitability of the business. (Example: Goodwill, patent, copyright, Trademark)
Nominal – Accounts of income, expense, profit and loss. Nominal accounts are the root causes of the financial performance of a business.
Income: Any account, which is a cause of inflow of asset without rising liability is called income. (Example: Sale A/c, Interest received A/c)
Expenses: Any account, which is a cause of outflow of asset without minimizing liability is called income. (Example: Purchase A/c, Interest paid A/c)
Profit : Profit is the excess part of income over expenses, where incomes are greater than expenses. (Example: Profit on sales on machine a/c, Profit& loss A/c – in case of net profit)
Loss : Loss is the excess part of expenses over incomes, where incomes are less than expenses. (Example: Loss on sales on machine a/c, Profit& loss A/c – in case of net loss)
Valuation -When an account paired with another balance sheet account (Asset or Liability) to recognize the balance to be carry forward, is called ‘Valuation account’. Such accounts are linked with a ‘Provision for doubtful accounts’. (Example: ‘Provision for depreciation on furniture A/c’ which is linked to an asset account, say ‘Furniture A/c’. Another example is ‘Provision for tax A/c’ which is linked with a liability account, say ‘Tax payable A/c’.)
Principles of Accounting
The principles can be classified mainly into three categories:
Basic assumption or concepts
Basic assumption or concepts
These assumptions provide a foundation for accounting process. No enterprises can prepare its financial statement without considering these basic assumptions or concepts. On the basis of this basic assumption, the accounting profession has developed principles that guide how the transaction should be recorded and reported. Following may be treated as basic assumption or concepts.
Business entity assumption: According to this assumption, the accounting for a business or organization is kept separate from the personal affairs of its owner, or from any other business or organization. This means that the owner of a business should not place any personal assets on the business balance sheet. The balance sheet of the business must reflect the financial position of the business alone. Also, when transactions of the business are recorded, any personal expenditures of the owner are charged to the owner and are not allowed to affect the operating results of the business.
Money measurement assumption: Only those transaction and events are recorded in accountancy which is capable of being expressed in terms of money.
Going concern concept: As per this assumption, it is assumed that the business will continue to exist for a long period in the future. The transaction is recorded in the books of the business on the assumption that it is a continuing enterprise. It is on this assumption that we recorded fixed assets at their original cost and depreciation is charged on their assets without reference to their market value.
On the basis of the assumption discussed above, certain principles have been developed that guide how the transaction should be recorded and reported. These basic accounting principles are as follows
Duality Principle: According to this principles, every business transaction is recorded as having a dual aspect, in other words, each affects at least two accounts. If one account is debited, any other account must be credited. The system of recording transaction based on this principle is called a ‘’Double entry system.’’
Verifiability and objectivity of evidence principle: The principle means that all accounting transaction that are recorded in the books of account should be evidenced and supported by business document are cash memos, invoice, vouchers etc
Historical cost Principles: According to this principles an asset is ordinarily recorded in the books of account at the price at which it was acquired.
Principle of full discloser: The principle requires that all significant information relating to the economic affairs of the enterprise should be complete disclosed.
There are certain accounting principles which can be slightly modified by different accountant according to the situation and requirements of the business. This is done in order to make the financial statement more relevant and reliable. These principles are as follows:
Principle of Timeliness: The principle requires that the financial statement should be prepared quickly at the end of the accounting period and made external users at the earliest possible time.
Principle of Materiality: This principle is an exception to the principles of full discloser. As such it is termed as modifying principles. According to these principles, items having an insignificant effect or being irrelevant to the users need not be disclosed. These unimportant items are either left out or merged with other items, otherwise accounting statement will be unnecessarily overburdened.
Principle of consistency: This principle states that accounting principle and methods should remain consistent from one year to another. These should not be changed from year to year.
Principle of conservatism: According to this principle, all anticipated losses should be recorded in the books of accounts, but all anticipated or unrealized gains should be ignored.
System of Accounting
The systems of recording transaction in the books of accounts are two types.
Double Entry System
Single Entry System
Double Entry System
Double entry is an almost universally used system of business record keeping. It is a system of recording business transaction which recognises that each transaction has a dual aspect. It is so named because the principle of double entry bookkeeping are based upon every transaction having two aspect or two parts, i.e. two account are always affected by each transaction. Under this system, each transaction is seen as a flow of value from one account to another. The receiving account is debited with the amount and the giving account is credited. Therefore, every debit has an equal and offsetting credit.
If only two accounts are affected (as in the purchase of building for cash), one account, building is debited and the other account, cash is credit for the same amount. If more than two accounts are affected by a transaction, the sum of the debit entries must be equal to the sum of the credit entries.
It is therefore, necessary to decide for each transaction, the following:
a) Which are the two accounts involved ,and
b) Whether the entries to those accounts are debit or credit.
Applying the principles of double entry will result in the amount being debited to an account being equal to the amount being credited to another account. The rule of double entry system can be explained in terms of the basic accounting equation. Liabilities + Capital = Assets.
Single Entry System
Single Entry system of recording transaction in the books of accounts may be defined as an incomplete Double Entry System, In this system, all transaction are not recorded on double entry basis. As regards some transaction, both aspects of the transaction are recorded, as regards others , either one aspect is recorded or not recorded at all. Instead of maintaining all the accounts ,only Personal Accounts and Cash Book are maintained under this system. The account maintained under this system are incomplete and unsystematic and , therefore. not reliable. The single entry system also is known as Accounts From Incomplete Records.
Generally Accepted Accounting Principles (GAAP)
Generally accepted accounting principles (GAAP) are a common set of accounting principles, standards and procedures that companies must follow when they compile their financial statements. GAAP is a combination of authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting accounting information. GAAP improves the clarity of the communication of financial information.
GAAP (generally accepted accounting principles) is a collection of commonly-followed accounting rules and standards for financial reporting. The acronym is pronounced “gap.”
GAAP specifications include definitions of concepts and principles, as well as industry-specific rules. The purpose of GAAP is to ensure that financial reporting is transparent and consistent from one organization to another.
There is no universal GAAP standard and the specifics vary from one geographic location or industry to another.
In the United States, the Securities and Exchange Commission (SEC) mandates that financial reports adhere to GAAP requirements.
In India, the Institute of Chartered Accountants of India (ICAI) mandates the GAAP requirements.
Many countries around the world have adopted the International Financial Reporting Standards (IFRS). IFRS is designed to provide a global framework for how public companies prepare and disclose their financial statements. Adopting a single set of worldwide standards simplifies accounting procedures for international countries and provides investors and auditors with a cohesive view of finances.