1 Introduction to accounting
Definition of Accounting
Accounting is the process of identifying, measuring, recording,
and communicating financial information about an
organization to interested users.
Objectives of Accounting
1. Recording Transactions: Systematic recording of
financial
transactions in books of accounts.
2. Classifying Transactions: Grouping similar transactions at
one place, i.e., in the Ledger.
3. Summarizing Transactions: Preparation of financial
statements, i.e., Trading Account, Profit & Loss Account, and
Balance Sheet.
4. Analyzing and Interpreting Financial Data: Drawing
meaningful conclusions from financial statements to aid
decision-making.
5. Communicating Financial Information: Sharing the
financial results with stakeholders like owners, creditors, and
investors.
Basic Terms in Accounting
1. Transaction: Any business activity that involves the
exchange of money or money’s worth.
• Example: Sale of goods, purchase of raw materials.
2. Capital: The amount invested by the owner(s) in the
business.
• Example: Owner investing ₹50,000 in the business.
3. Liabilities: Obligations or debts that the business has to pay
in the future.
• Example: Loans, creditors.
4. Assets: Resources owned by the business that are expected
to bring future benefits.
• Example: Machinery, buildings, inventory.
5. Revenue: Income earned by the business from its operating
activities.
• Example: Sales revenue, service revenue.
6. Expenses: Costs incurred by the business in the process of
earning revenue.
• Example: Rent, salaries, utility bills.
7. Profit: The excess of revenue over expenses.
• Example: If revenue is ₹100,000 and expenses are
₹70,000, profit is ₹30,000.
8. Loss: The excess of expenses over revenue.
• Example: If revenue is ₹70,000 and expenses are
₹100,000, loss is ₹30,000.
9. Drawings: The amount withdrawn by the owner for
personal use.
• Example: Owner withdrawing ₹5,000 for personal
expenses.
10. Debtors: Individuals or entities that owe money to the
business.
• Example: Customers who have purchased goods on
credit.
11. Creditors: Individuals or entities to whom the business
owes money.
• Example: Suppliers who have provided goods on
credit.
Accounting Principles and Concepts
1. Business Entity Concept: Business is treated as a separate
entity from its owner(s).
2. Money Measurement Concept: Only transactions that can
be measured in monetary terms are recorded.
3. Going Concern Concept: Assumes that the business will
continue to operate indefinitely.
4. Accounting Period Concept: Financial statements are
prepared for a specific period, usually a year.
5. Cost Concept: Assets are recorded at their cost price.
6. Dual Aspect Concept: Every transaction has a dual effect
on the accounting equation (Assets = Liabilities + Capital).
7. Revenue Recognition Concept: Revenue is recognized
when it is earned, not necessarily when it is received.
8. Matching Concept: Expenses are matched with the
revenues of the same period to ascertain profit or loss.
9. Full Disclosure Concept: All material information should
be disclosed in the financial statements.
10. Consistency Concept: The same accounting methods
should be applied consistently from period to period.
11. Conservatism Concept: Anticipate no profits but provide
for all possible losses.
12. Materiality Concept: Only those items should be recorded
that are significant enough to affect decisions.
Importance of Accounting
1. Financial Information: Provides vital information about the
financial performance and position of the business.
2. Decision Making: Aids in making informed business
decisions.
3. Compliance: Ensures compliance with legal and regulatory
requirements.
4. Financial Control: Helps in controlling and managing the
financial resources of the business.
5. Planning and Forecasting: Assists in planning future
activities and forecasting financial outcomes.
6. Communication: Communicates financial information to
various stakeholders like owners, investors, and creditors.
Branches of Accounting
1. Financial Accounting: Focuses on the preparation of
financial statements for external users.
2. Cost Accounting: Deals with determining the cost of
production and controlling costs.
3. Management Accounting: Provides information for internal
management for decision-making, planning, and control.
4. Tax Accounting: Focuses on tax-related matters and
compliance with tax laws.
Accounting Cycle
1. Identifying Transactions: Identifying economic events and
transactions.
2. Recording Transactions: Recording transactions in the
Journal.
3. Posting to Ledger: Transferring journal entries to the
Ledger.
4. Trial Balance: Preparing a trial balance to check the
arithmetical accuracy of the books.
5. Adjusting Entries: Making necessary adjustments at the
end of the accounting period.
6. Financial Statements: Preparing financial statements, i.e.,
Trading Account, Profit & Loss Account, and Balance Sheet.
7. Closing Entries: Closing the books for the accounting
period.
Example
Journal Entry:
• Transaction: Purchased machinery for ₹50,000 in cash.
• Journal Entry:
• Debit Machinery Account: ₹50,000
• Credit Cash Account: ₹50,000
Trial Balance:
• Lists all ledger balances to ensure debits equal credits.
Profit & Loss Account:
• Shows the revenue and expenses for the period to
determine profit or loss.
Balance Sheet:
• Shows the financial position of the business by listing
assets, liabilities, and capital.
