 Accounting is the language of the business,

the basic function of which is to serve as a

means of communication. It communicate
the results of business operations to the
various interested parties -owners, creditors,
investors, governments and other agencies.
 Accounting consists of three basic activities
—identifies, records, and communicates the
economic events of an organization to
interested users. Let's take a closer look at
these three activities
American Accounting Association Committee as:
 “the process of identifying, measuring and
communicating economic information to permit
informed judgments and decisions by users of the
information”.

 American Institute of Certified Public Accountants

Accounting is “the art of recording, classifying and
summarizing 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 is an Art

 Involves
Recording, Classifying and
Summarizing

 Records Transaction in Terms of Money

 Deals with Financial Transactions

 Interpretation
 Identifying: Identifying the business transactions from the source
documents.
 Recording: The next function of accounting is to keep a systematic record
of all business transactions, which are identified in an orderly manner, soon
after their occurrence in the journal or subsidiary books.
 Classifying: This is concerned with the classification of the recorded
business transactions so as to group the transactions of similar type at one
place. i.e., in ledger accounts. In order to verify the arithmetical accuracy of
the accounts, trial balance is prepared.
 Summarising: The classified information available from the trial balance
are used to prepare profit and loss account and balance sheet in a manner
useful to the users of accounting information.
 Analysing: It establishes the relationship between the items of the profit
and loss account and the balance sheet. The purpose of analysing is to
identify the financial strength and weakness of the business. It provides the
basis for interpretation.
 Interpreting: It is concerned with explaining the meaning and significance
of the relationship so established by the analysis. Interpretation should be
useful to the users, so as to enable them to take correct decisions.
 Communicating: The results obtained from the summarised, analysed
and interpreted information are communicated to the interested parties.
 Provides necessary information about the financial
activities to the interested parties
 Provides necessary information about the efficiency or
otherwise of management with regard to the proper
utilization of scarce resources
 Provides necessary information for making predictions
(financial forecasting)
 Facilitates to evaluate the earning capacity of a firm by
supplying the statement of financial position, the
statement of periodical earning, together with the
statement of financial activities to various interested
parties
 Facilitates in decision-making with regard to the
changes in the manner of acquisition, utilization,
preservation and distribution of scarce resources
 Facilitatesin decision-making with regard to
the replacement of fixed assets and
expansion of the firm
 Provides necessary data to the government
to enable it to take proper decisions
concerning to duties, taxes, price control
etc.
 Devices remedial measures for the deviations
of the actual from the budgeted
performance
 Provides necessary data and information to
managers for internal reporting and
formulation of overall policies
 External Users of Accounting Information
External users are those groups or persons who
are outside the organisation for whom
accounting function is performed. Following
can be the various external users of
accounting information:
 INVESTORS
 CREDITORS
 REGULATORS
 CUSTOMERS
 COMPETITORS
Internal users of accounting information are
those persons or groups which are within the
organisation. Following are such internal
users :
 OWNERS
 MANAGERS
 EMPLOYEES
Financial Accounting
Accounting deals with recording, classifying
and summarizing the business events that
have already occurred.
Historical in nature so also called historical
accounting or postmortem accounting
Its aim is to collate the information about
income and financial position on the basis of
business events that have taken place during
a particular period of time.
 Management Accounting
Management accounting provides information
to management not only about cost but also
about revenue, profits, investments etc. to
enable managers to discharge their duties
more efficiently and effectively. Thus, it
provides required database to managers to
plan and control the activities of business.
 Cost Accounting
Cost accounting deals with the detailed study
of cost pertaining to cost ascertainment, cost
reduction and cost control. The emphasis is
on historical costs as well as future decision-
making costs
 Relevance- Accounting information must have
the ability to influence decisions.
 Reliability- Accounting should be free from
significant error or bias. It should be capable of
being relied upon by users to represent what it is
supposed to represent.
 Comparability- This quality will enable users to
identify changes in the business over time. It will
also help users to evaluate the performance of
the business in relation to other similar
businesses.
 Understandability- Accounting reports should be
expressed as clearly as possible and should be
understood by those at whom the information is
aimed.
 The accounting information system has
certain features that are common to all
information systems within a business. These
are:
 identifying and capturing relevant information
(in this case financial information);
 recording in a systematic manner the
information collected;
 analysing and interpreting the information
collected;
 reporting the information in a manner that
suits the needs of users.
 SYSTEMS OF
ACCOUNTING

CASH SYSTEM ACCRUAL SYSTEM

Actual Cash Receipts and
All transactions relating to
Actual Cash Payments are
recorded a period are recorded in
the books of account
Cash System-Actual Cash Receipts and Actual Cash
Payments are recorded. Credit transactions are not
recorded at all. Until the cash in actually received or
paid. The Receipts and Payments Account prepared in
case of non-trading concerns such as a charitable
institution, a club, a school, a college, etc. and
professional men like a lawyer, a doctor, a chartered
accountant etc. can be cited as the best example of
cash system. This system does not make a complete
record of financial transactions of a trading period as
it does not record outstanding transactions like
outstanding expenses and outstanding incomes. The
system being based on a record of actual cash
receipts and actual cash payments will not be able to
disclose correct profit or loss for a particular period
and will not exhibit true financial position of the
business on a particular day.
 Mercantile (Accrual) system- Under this
system all transactions relating to a period are
recorded in the books of account i.e., in addition
to actual receipts and payments of cash income
receivable and expenses payable are also
recorded. This system gives a complete picture
of the financial transactions of the business as it
makes a record of all transactions relating to a
period. The system being based on a complete
record of the financial transactions discloses
correct profit or loss for a particular period and
also exhibits true financial position of the
business on a particular day.
 A business generates sales of Rs. 2,00,000
(including Rs. 40,000 as credit sales) and
expenses amount to Rs. 1,40,000 (including Rs.
25,000 still payable) during the accounting
period. Compute the profit of the business as per
the above-mentioned systems of accounting for
the accounting period.
 Solution
Under Accrual Basis
Income = Revenue Earned – Expenses Incurred
= Rs. 2,00,000 – Rs. 1,40,000 = Rs. 60,000
Under Cash Basis
Income = Revenue Received – Expenses Paid
= Rs. 1,60,000 – Rs. 1,15,000 = Rs. 45,000
1. Facilitates to Replace Memory
2. Facilitates to Comply with Legal Requirements
3. Facilitates to Ascertain Net Result of Operations
4. Facilitates to Ascertain Financial Position
5. Facilitates the Users to take Decisions
6. Facilitates a Comparative Study
7. Assist Management
8. Facilitates Control over Assets
9. Facilitates the Settlement of Tax Liability
10. Facilitates the Ascertainment of Value of Business
11. Facilitates Raising Loans
12. Acts as Legal Evidence
1. Historical Nature
2. Provides Information about the Concern
as a Whole
3. Ignores the qualitative elements
4. Not free from bias
5. Ignores the price level changes in case of
financial statements prepared on
historical costs.
6. Lack of Unanimity about Accounting
Principles
7. Chances of Manipulation/Window
Dressing
 Book-keeping is that branch of knowledge
which tells us how to keep a record of
business transactions. It is often routine and
clerical in nature. It is important to note that
only those transactions related to business
which can be expressed in terms of money
are recorded. The activities of book-keeping
include recording in the journal, posting to
the ledger and balancing of accounts.
R.N. Carter says, “Book-keeping is the science
and art of correctly recording in the books of
account all those business transactions that
result in the transfer of money or money’s
worth”.
 To have permanent record of all the business
transactions.
 To keep records of income and expenses in such a
way that the net profit or net loss may be calculated.
 To keep records of assets and liabilities in such a way
that the financial position of the business may be
ascertained.
 To keep control on expenses with a view to minimise
the same in order to maximise profit.
 To know the names of the customers and the amount
due from them.
 To know the names of suppliers and the amount due
to them.
 To have important information for legal and tax
purposes.
 Book-keeping
provides the basis for
accounting and it is
complementary to
accounting process.
Accounting begins
where book-keeping
ends. Accountancy
includes accounting
and book-keeping.
The terms Accounting
and Accountancy are
used synonymously.
Basis of Book-keeping Accounting
Distinction
Scope Recording and maintenance of It is not only recording and maintenance
books of accounts. of books of accounts but also includes
analysis, interpreting and communicating
the information.
Stage Primary stage. Secondary stage.
Secondary To maintain systematic To ascertain the net result of the business
stage. records of business transactions. operation.
Nature Often routine and clerical in nature. Analytical and executive in nature.
Responsibility A book-keeper is responsible for An accountant is also responsible for the
recording business transactions. work of a book-keeper.
Supervision The book-keeper does not An accountant supervises and checks the
supervise and check the work of an work of the book-keeper.
Accountant.
Staff involved Work is done by the junior Senior staff performs the accounting
involved of the organisation. work.
Scope Recording and maintenance of It is not only recording and maintenance
books of accounts. of books of accounts but also includes
analysis, interpreting and communicating
the information.
 Entity- An economic unit that perform economic
activities.
 Event- An event is an happening of consequence
to an entity.
 Transactions-Transactions are those activities of
a business, which involve transfer of money or
goods or services between two persons or two
accounts. For example, purchase of goods, sale
of goods, borrowing from bank, lending of
money, salaries paid, rent paid, commission
received and dividend received. Transactions are
of two types, namely, cash and credit
transactions.
 Cash Transaction is one where cash receipt or
payment is involved in the transaction.
 Credit Transaction is one where cash is not
involved immediately but will be paid or
received later.
 Proprietor- A person who owns a business is called its
proprietor. He contributes capital to the business
with the intention of earning profit.
 Capital-Capital generally refers to the amount
invested in an enterprise by its owners. Capital also
refers to the interest of owners in the assets of an
enterprise.
 Assets- Assets are the properties of every description
belonging to the business. Cash in hand, plant and
machinery, furniture and fittings, bank balance,
debtors, bills receivable, stock of goods,
investments, Goodwill are examples for assets. Assets
can be classified into tangible and intangible.
 Tangible Assets: These assets are those having
physical existence. It can be seen and touched. For
example, plant & machinery, cash, etc.
 Intangible Assets: Intangible assets are those assets
having no physical existence but their possession
gives rise to some rights and benefits to the owner. It
cannot be seen and touched. Goodwill, patents,
trademarks are some of the examples.
 Liabilities- Liabilities refer to the financial
obligations of a business. These denote the amounts
which a business owes to others, e.g., loans from
banks or other persons, creditors for goods supplied,
bills payable, outstanding expenses, bank overdraft
etc.
 Drawings-It is the amount of cash or value of goods
withdrawn from the business by the proprietor for his
personal use. It is deducted from the capital.
 Debtors- A person (individual or firm) who receives a
benefit without giving money or money’s worth
immediately, but liable to pay in future or in due
course of time is a debtor. The debtors are shown as
an asset in the balance sheet.
 Creditors- A person who gives a benefit without
receiving money or money’s worth immediately but
to claim in future, is a creditor. The creditors are
shown as a liability in the balance sheet.
 Purchases- Purchases refers to the amount of goods
bought by a business for resale or for use in the
production. Goods purchased for cash are called cash
purchases. If it is purchased on credit, it is called as
credit purchases. Total purchases include both cash and
credit purchases.
 Purchases Return or Returns Outward- When goods are
returned to the suppliers due to defective quality or not as
per the terms of purchase, it is called as purchases return.
To find net purchases, purchases return is deducted from
the total purchases.
 Sales- Sales refers to the amount of goods sold that are
already bought or manufactured by the business. When
goods are sold for cash, they are cash sales but if goods
are sold and payment is not received at the time of sale, it
is credit sales. Total sale includes both cash and credit
sales.
 Sales Return or Returns Inward-When goods are returned
from the customers due to defective quality or not as per
the terms of sale, it is called sales return or returns
inward. To find out net sales, sales return is deducted from
total sales.
 Revenue- Revenue means the amount receivable or
realised from sale of goods and earnings from
interest, dividend, commission, etc.
 Expense- It is the amount spent in order to produce
and sell the goods and services. For example,
purchase of raw materials, payment of salaries,
wages, etc.
 Income- Income is the difference between revenue
and expense.
 Invoice- Invoice is a business document which is
prepared when one sell goods to another. The
statement is prepared by the seller of goods. It
contains the information relating to name and
address of the seller and the buyer, the date of sale
and the clear description of goods with quantity and
price.
 Receipt- Receipt is an acknowledgement for cash
received. It is issued to the party paying cash.
Receipts form the basis for entries in cash book.
 Account- Account is a summary of relevant
business transactions at one place relating to a
person, asset, expense or revenue named in the
heading. An account is a brief history of financial
transactions of a particular person or item. An
account has two sides called debit side and
credit side.
 Inventory -Inventory includes tangible property
held for sale in the ordinary course of business,
or in the process of the production for such sale,
or the consumption in the production of goods or
services for sale, including maintenance supplies
and consumables other than machinery spares.
 Book Value -Book value is the amount at which
an item appears in the books of account or
financial statement. It does not refer to any
particular basis on which the amount is
determined.
 The primary accounting standard-setting body in
the United States is the Financial Accounting
Standards Board (FASB). The Securities and
Exchange Commission (SEC) is the agency of the
U.S. government that oversees U.S. financial
markets and accounting standard-setting bodies.
The SEC relies on the FASB to develop accounting
standards, which public companies must follow.
Many countries outside of the United States have
adopted the accounting standards issued by the
International Accounting Standards Board
(IASB). These standards are called International
Financial Reporting Standards (IFRS).
 Generally accepted accounting principles
encompass the conventions, rules and
procedures necessary to define accepted
accounting practice at a particular time.
 GAAP include not only broad guidelines of
general application, but also detailed
practices and procedures
 According to ‘Dictionary of Accounting’ prepared
by Prof. P.N. Abroal, “Accounting standards refer
to accounting rules and procedures which are
relating to measurement, valuation and
disclosure prepared by such bodies as the
Accounting Standards Committee (ASC) of a
particular country”. Thus, we may define
Accounting Principles as those rules of action or
conduct which are adopted by the accountants
universally while recording accounting
transactions.
 Accounting principles are man-made. They are
accepted because they are believed to be
useful. The general acceptance of an accounting
principle usually depends on how well it meets
the following three basic norms :
a) Usefulness b) Objectiveness, and c) Feasibility
 ACCOUNTING
PRINCIPLES

ACCOUNTING ACCOUNTING
CONCEPTS CONVENTIONS
 Accounting Principles- ‘Concepts’ and
‘Conventions’.

 Accounting Concepts- are broad general

assumptions which underline the periodic
financial statements of business enterprises. The
reason why some of the these terms should be
called concepts is that they are basic
assumptions and have a direct bearing on the
quality of financial accounting information.
 Accounting Conventions- signify customs
or tradition as a guide to the preparation of
accounting Statements.
 The business is treated as a distinct (and
separate) entity from the individuals who
own it and accordingly accountants record
transactions. For example, a company the
distinction is easier as legally the company is
a distinct entity from the persons who own
it. Therefore, an entity is a business
organisation or activity in relation to which
accounting reports are compiled. It may
include universities, voluntary organisations,
government and non-business units.
A record is made only of the information that
can be expressed in monetary terms for
accounting purposes. If we look at financial
accounting purely from the point of view of
Fundamental Accounting
 The cost concept and the money measurement
concept go hand in hand. Transactions are recorded
in the books at the price paid that is the cost.
Therefore, the recording of the assets is at cost
figures and this may not reflect the current market
value especially in the case of the older assets. The
value of an asset in the accounting records does not
remain at the original cost because it is diminished
systematically by virtue of its use called expired cost
and then shown at its depreciated value e.g. an asset
of Rs. 1,00,000 is depreciated at 10%. Therefore,
closing value will be Rs. 90,000 in the Balance Sheet.
An expired cost is an expenditure of money, the
economic value of which has been made use of during
a particular year
 Accounting assumes that the business will
exist indefinitely into future and accordingly
transactions are recorded.
 Dualaspect principle is the basis for Double
Entry System of book-keeping. All business
transactions recorded in accounts have two
aspects - receiving benefit and giving
benefit. For example, when a business
acquires an asset (receiving of benefit) it
must pay cash (giving of benefit).
 According to this concept, revenue is
considered as the income earned on the date
when it is realised. Unearned or unrealised
revenue should not be taken into account.
The realisation concept is vital for
determining income pertaining to an
accounting period. It avoids the possibility of
inflating incomes and profits
 Acquiring the legal right to claim the
consideration for goods/services is called accrual
of revenue, which usually precedes collection.
However, in case of cash transactions, under the
accrual method P/L A/c and Balance Sheet are
prepared on the accrual basis, in the absence of
any uncertainty about collection. In the other
words- The accrual concept in accounting means
that expenses and revenues are recorded in the
period they occur, whether or not cash is
involved. The benefit of the accrual approach is
that financial statements reflect all the
expenses associated with the reported revenues
for an accounting period.
 The accounting reports measure activities for a
specified interval of time called the accounting
period, which is usually one year and therefore
termed as annual reports. Interim reports in
between may be compiled especially for internal
users. Except for those ventures which are
predetermined to end on the completion of a
specific task or a specific time-frame, every
enterprise, profit-oriented or not, desires to
enjoy perpetual existence as a going (running)
concern, making profits, grow and distribute
profits judiciously. This calls for recognition and
measurement of incomes and expenses and to
match them to ascertain profit. But, the concept
of profit is time-related.
 Conservatism: Financial statements are
drawn on a conservatism basis where better
evidence is required of losses. This is
necessary as Management and ownership are
in different hands and a cut is needed on
management to show overoptimistic,
favourable performance results.
 Consistency: This concept states that once
the organisation has decided on a method, it
should use the same method subsequently
unless there is a valid reason for a change of
method.
 Matching: When an event affects revenues
and expenses, the effect on each period
should be recognised in the same accounting
period.
 Disclosure: Apart from legal requirements all
significant information should be disclosed.
 Materiality: The accountant should attach
importance to material details and ignore
insignificant details.
Accounting equation is based on dual aspect
concept (Debit and Credit). It emphasizes on the
fact that every transaction has a two sided
effect i.e., on the assets and claims on assets.
Always the total claims (those of outsiders and
of the proprietors) will be equal to the total
assets of the business concern. The claims are
also known as equities, are of two types: i.)
Owners equity (Capital); ii.) Outsider’s equity
(Liabilities).
 Assets = Equities
 Assets = Capital + Liabilities (A = C+L)
 Capital = Assets – Liabilities (C = A–L)
 Liabilities = Assets – Capital (L = A–C)
 Ifthe capital of a business is Rs.3,00,000 and
other liabilities are Rs.2,00,000, calculate
the total assets of the business.

 If the total assets of a business are

Rs.3,60,000 and capital is Rs.2,00,000,
calculate liabilities.

 If the total assets of a business are

Rs.4,50,000 and outside liabilities are
Rs.2,50,000, calculate the capital.
 Show the Accounting Equation on the basis of the following
transactions
1. Maharajan commenced business with cash 1,00,000
2. Purchased goods for cash 70,000
3. Purchased goods on credit 80,000
4. Purchased furniture for cash 3,000
5. Paid rent 2,000
6. Sold goods for cash costing Rs.45,000 60,000
7. Paid to creditors 20,000
8. Withdrew cash for private use 10,000
9. Paid salaries 5,000
10. Sold goods on credit (cost price Rs.60,000) 80,000
 Assets Capital + Liability Transaction Assets Liabilities
affected affected

1 100000 100000 Capital brought in Cash increase Capital increase

2 -70000 + 70000 Cash purchases Stock increase

Cash decreases
3 80000 80000 Credit purchases Stock increases Creditors increase

4 -3000 +3000 Furniture bought Cash decreases ––

Furniture
increases
(comes in)
5 -2000 -2000 Rent paid Cash decreases Capital decreases
(Rent is an expenses
it results in a loss)
6 60000 -45000 15000 Cash Sales Cash increases ––
Stock decreases
7 -20000 -20000 Payment to Cash decreases Creditors decrease
creditors
8 -10000 -10000 Withdrawal of Cash decreases Capital decreases
cash for private
use (Drawings)
9 -5000 -5000 Salaries paid Cash decreases Capital decreases
(Salary is an
expense
- Loss)
Credit Sales Stock decreases ––