Introduction to Accounting

Accounting is the language of business that helps in recording business transactions in chronological order in the books of accounts. It records only financial transactions related to the business.

Definition: According to the American Institute of Certified Public Accountants, "Accounting is the art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events which are, in part at least of a financial character and interpreting the result thereof."

Accounting Process:

• Recording of financial transactions in the Journal (Journalizing)
• Recording in the Ledger (Posting to Ledger)
• Summarising the Activities / Transactions
• Analysis and Interpretation
• Communicating the results

Objectives of Accounting:

• Maintaining Records
• Estimating Profit or Loss
• Presenting the financial position
• Providing useful information to users

Advantages of Accounting:

• Availability of information
• Identifies strengths and weaknesses of business
• Enables comparison between time periods and similar companies
• Evidence in the court of law
• Payment of tax
• Helps in realisation of debts

Limitations of Accounting:

• Financial accounting is not absolutely exact
• Does not show the exact worth of business
• Problem of window dressing
• Worthless assets are often shown in the balance sheet
• No effect of inflationary trends
• Qualitative factors are ignored

Branches of Accounting:

• Financial accounting
• Cost accounting
• Management accounting

Types of Accounting Information: Accounting information refers to the financial statements generated through bookkeeping, which help users make decisions. The main financial statements are the Income Statement (Profit and Loss Account) and the Position Statement (Balance Sheet). The types of accounting information include:

• Information Relating to Profit or Surplus: Income Statement shows profit earned or loss incurred during an accounting period.
• Information Relating to Financial Position: Balance Sheet provides information about assets, liabilities, and owner's equity.
• Information about Cash Flow: Cash Flow Statement shows inflow and outflow of cash during a specific period, useful for decisions like payment of liabilities, dividends, and expansion.

Users of Accounting Information:

Internal Users:

• Owner: To know about return on investment and financial health.
• Management: To evaluate performance and make decisions.

External Users:

• Investors: To ensure safety and growth of investments.
• Creditors: To assess financial capability to pay debts.
• Lenders: To assess repayment capacity and creditworthiness.
• Tax authorities: To assess taxes due and ensure true and fair disclosure.
• Others: Customers, researchers, etc., seeking information for various reasons.

Qualitative Characteristics of Accounting Information:

• Reliability: Information should be verifiable, free from errors and unbiased.
• Relevance: Information should be essential, appropriate, timely, and avoid irrelevant data.
• Understandability: Information should be presented clearly for easy interpretation.
• Comparability: Enables comparison over time and between firms to assess growth and performance.

Role of Accounting in Business: Accounting measures, analyses, and summarises financial data to produce reports showing financial condition and results of operations. It acts as the language of business, providing quantitative financial information to stakeholders such as management, investors, and creditors. However, it relates only to past transactions and quantitative data, excluding qualitative and non-financial information.

Basic Accounting Terms:

• Entity: A business with a definite individual existence for which accounting is maintained.
• Business Transaction: An activity involving exchange of money or money’s worth that changes financial position, classified as cash or credit transactions.
• Asset: Properties owned by a business, classified as non-current (long-term use) and current (short-term use, convertible to cash within one year).
• Liability: Claims of creditors against the business, classified as current (to be paid within one year), non-current (long-term), and contingent (possible liabilities dependent on future events).
• Capital: Owner’s investment in the business, representing net worth (Assets minus Liabilities). Includes fixed capital (investment in fixed assets) and working capital (current assets minus current liabilities).
• Drawings: Withdrawal of cash or goods by owner for personal use, reducing capital.
• Revenue: Increase in current assets without corresponding increase in liabilities or capital, from main business operations.
• Goods: Articles purchased for resale or use in manufacturing.
• Stock / Inventories: Goods unsold at a particular date, classified as opening stock (beginning of period) and closing stock (end of period), further divided into raw materials, work-in-progress, and finished goods.
• Purchases: Goods bought for resale or conversion into products; excludes purchase of fixed assets.
• Sales: Sale of goods purchased for resale, including cash and credit sales; excludes sale of assets.
• Debtors: Persons or firms to whom goods have been sold on credit and payment is pending.
• Creditors: Persons or firms to whom the business owes money for goods or expenses.
• Profit: Excess of sales over cost of goods sold from business operations.
• Income: Synonymous with profit; excess of total revenues over total expenses.
• Gain: Monetary benefit from transactions other than main operations, e.g., sale of building at profit.
• Expense: Amount spent to produce and sell goods or services, e.g., salaries, rent, depreciation.
• Expenditure: Amount spent to acquire fixed assets (capital expenditure) or to earn revenue (revenue expenditure).
• Loss: Excess of expenses over revenues; includes normal losses (expected) and abnormal losses (unexpected).
• Outstanding Expenses: Expenses incurred but unpaid at period end.
• Prepaid Expenses: Expenses paid in current year but relating to future periods.

Key Words

Capital: Owner’s investment in business; net worth of the business. Divided into fixed capital (investment in fixed assets) and working capital (current assets minus current liabilities).

Accounting Cycle: Sequence of steps in accounting for financial transactions, including recording, ledger posting, trial balance, and preparation of financial statements.

Types of Business Transactions:

• Cash Transaction: Payment made immediately.
• Credit Transaction: Payment postponed to a future date.