Chapter 1 Introduction to Accountings

Learning Objectives This Chapter would enable you to understand: Definitions of Accounting Meaning of Accounting Attributes of Accounting Accounting Process Branches of Accounting Book Keeping, Accounting and Accountancy Difference between Book Keeping and Accounting

Learning Objectives Objectives of Accounting Functions of Accounting Advantages of Accounting Limitations of Accounting Accounting Information and its' Types Users of Accounting Information Systems of Accounting

DEFINITION OF ACCOUNTING "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 results thereof." -American Institute of Certified Public Accountants

DEFINITION OF ACCOUNTING "Accounting is the science of recording and classifying business transactions and events, primarily of a financial character, and the art of making significant summaries, analysis and interpretations of those transactions and events and communicating the results to persons who must make decisions or form judgment." -Smith and Ashburne

DEFINITION OF ACCOUNTING "Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information." -American Accounting Association

Meaning of Accounting Thus, accounting is a process of collecting, recording, summarising and communicating financial information to the users for decision-making.

ATTRIBUTES (CHARACTERISTICS) OF ACCOUNTING The definitions of accounting bring to light the following attributes of Accounting: Identification of Financial Transactions and Events Measuring the Identified Transactions Recording Classifying Summarising Analysis and Interpretation Communicating

ACCOUNTING PROCESS Financial Transactions or Events Communicating to the Users Recording Journal Cash Book Purchase Book Sales Book Purchases Return Book Sales Return Book Bills Payable Book Bills Receivable Book Journal Proper Analysis and Interpretation Summarizing Trial Balance Trading and Profit and Loss Account Balance Sheet. Classifying (Posting into Ledger)

BRANCHES OF ACCOUNTING Financial Accounting Cost Accounting Management Accounting

Financial Accounting Financial Accounting is that branch of accounting, which records financial transactions and events, summarises and interprets them and communicates the results to the users. The end-product of Financial Accounting is the Profit and Loss Account for the period ended and the Balance Sheet as on the last day of the accounting period.

Cost Accounting The limitation of Financial Accounting in respect of information relating to the cost of products or services led to the development of a specialised branch, i.e., Cost Accounting. It ascertains the cost of products manufactured or services rendered and helps the management in decision-making (say price fixation) and exercising controls.

Management Accounting Management Accounting is the most recently developed branch of accounting. It is concerned with generating accounting information relating to funds, costs, profits, etc., as it enables the management in decision-making. We may say that Management Accounting addresses the needs of a single user group, i.e., the management.

BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY Meaning of Book Keeping Book Keeping is part of and it is concerned with: Identifying financial transactions and events, Measuring them in terms of money, Recording the financial transactions and events so identified in the books of accounts, and Classifying recorded transactions and events, i.e., posting them into Ledger accounts.

BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY Definitions of Book Keeping "Book Keeping is an art of recording in the books of accounts the monetary aspect of commercial and financial transactions." -Northcott "Book Keeping is an art of recording business dealings in a set of books." -J.R. Batliboi "Book Keeping is the science and art of recording correctly in the books of accounts all those business transactions that result in the transfer of money or money's worth." -R.N. Carter "Bool: Keeping is the art of recording business transactions in a systematic manner." -A.N. Rosen Kampff

BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY Accounting is an art of recording, classifying and summarising the financial data and interpreting the results thereof. Accounting is a wider concept than Book Keeping. It starts where Book Keeping ends. In other words, Book Keeping is a part of accounting.

BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY DIFFERENCE BETWEEN BOOK KEEPING AND ACCOUNTING Basis Book Keeping Accounting 1. Scope Book Keeping is concerned with identifying financial transactions; measuring them in money terms; recording them in the books of accounts and classifying them. Accounting is concerned with summarising the recorded transactions, interpreting them and communicating the results. 2. Stage It is a primary stage. It is a secondary stage. It begins where Book Keeping ends. 3. Objective The objective of Book Keeping is to maintain systematic records of financial transactions. The objective of accounting is to ascertain net results of operations and financial position and to communicate information to the interested parties.

BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY DIFFERENCE BETWEEN BOOK KEEPING AND ACCOUNTING 4. Nature of Job This job is routine in nature. This job is analytical and dynamic in nature. 5. Performance Junior staff performs this function. Senior staff performs this function. 6. Relation Book Keeping is the basis for accounting. Accounting begins where Book Keeping ends. 7. Special Skills Book Keeping is mechanical in nature and thus, does not require special skills. Accounting requires special skills and ability to analyse and interpret.

BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY Accountancy refers to a systematic knowledge of accounting. It explains how to deal with various aspects of accounting. It educates us why and how to maintain the books of accounts and how to summarise the accounting information and communicate it to the users. In the words of Kohler, accountancy refers to the entire body of the theory and practice of accounting

BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY Accountancy is an area of knowledge whereas accounting is the action or process used in this area. Accounting depends on the rules and principles framed by the Accountancy but Accountancy does not depend on Accounting. It may be said that Accountancy is the whole thing while Accounting is the application part of accountancy.

OBJECTIVES OF ACCOUNTING The objectives or functions of accounting are: Maintaining Systematic Records of Financial Transactions an Events Ascertaining Profit or Loss Ascertaining Financial Position Assisting the Management Communicating Accounting Information to Users

FUNCTIONS OF ACCOUNTING The functions of accounting are: Maintaining Systematic Records Communicating the Financial Results Meeting Legal Requirements Protecting Business Assets Assistance to Management Stewardship

ADVANTAGES OF ACCOUNTING Followings are the advantages of Accounting Financial Information about Business Assistance to Management Replaces Memory Facilitates Comparative Study Facilitates Settlement of Tax Liabilities Facilitates Loans Evidence in Court Facilitates Sale of Business Assistance in the Event of Insolvency Helpful in Partnership Accounts

LIMITATIONS OF ACCOUNTING Followings are the limitations of accounting Accounting is not Fully Exact Accounting does not Indicate the Realisable Value Accounting Ignores the Qualitative Elements Accounting Ignores the Effect of Price Level Changes Accounting may Lead to Window Dressing

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." -Accounting Principles Board

Types of Accounting Information The Accounting Information can be categorised into the following: Information Relating to Profit or Surplus; Information Relating to Financial Position; and Information about Cash Flow.

USERS OF ACCOUNTING INFORMATION Internal Users Owners Management Employees and Workers External Users Banks and Financial Institutions Investors and Potential Investors Creditors Government and its Authorities Researchers Consumers Public

QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION Reliability 2. Relevance 3. Understandability 4. Comparability

SYSTEMS OF ACCOUNTING The systems of recording transactions in the books of accounts are two namely: Double Entry System and Single Entry System.

Double Entry System The Double Entry System of accounting was developed in the 15th Century in Italy by Lucas Pacioli. Under the system, every transaction has two aspects-Debit and Credit and at the time of recording a transaction, it is recorded once on the debit side and again on the credit side. The Double Entry System has proved to be a scientific and complete system of accounting followed by every enterprise and organisation.

Double Entry System For example, at the time of cash purchases, goods are acquired and in return cash is paid. In the transaction, above two aspects are involved, i.e., receiving goods and paying cash Under the Double Entry System, both these aspects are recorded. One part, i.e., the receipt of goods is debited and the second part, i.e., payment of cash is credited. The method of Debit and Credit will be discussed in “Accounting Procedure – Rule of Debit and Credit”

Features of the Double Entry System It maintains a complete record of each transaction. It recognises the two-fold aspect of every transaction, viz., the aspect of receiving (value in) and the aspect of giving (value out). In this system, one aspect is debited and other aspect is credited following the rules of debit and credit. Since, one aspect of a transaction is debited and the other is credited, the total of all debits is always equal to total of all credits. It helps in establishing arithmetical accuracy by preparing the Trial Balance.

Stages of Double Entry System The following are the three different stages of a complete system of a double entry book keeping: Recording the transactions in the Journal. Classifying the transactions in the Journal by posting them to the appropriate ledger accounts and then preparing the Trial Balance. Closing the books and preparing the final accounts. All these stages shall be discussed one by one in succeeding chapters.

Advantages of the Double Entry System The main advantages of Double Entry System are Scientific System Complete Record of Transactions A Check on the Accuracy of Accounts Ascertainment of Profit or Loss Knowledge of Financial Position Full Details for Purposes of Control Comparative Study is Possible Helps Management in Decision-Making No Scope of Fraud

Single Entry System Single Entry System of recording transactions in the books of accounts, may be defined to be an incomplete Double Entry System. In this system, all transactions are not recorded on the double entry basis. As regards some transactions, both aspects of the transactions 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.

Single Entry System The accounts maintained under this system are incomplete and unsystematic and therefore, not reliable. The Single Entry System is also known as Accounts from Incomplete Records. Since all transactions are not recorded under double entry principle, it is not possible to prepare a Trial Balance. As a result, the Profit and Loss Account and the Balance Sheet cannot be prepared.