INTRODUCTION TO ACCOUNTING

INTRODUCTION TO ACCOUNTING

WHAT IS ACCOUNTING?

Accounting is the process of identifying, measuring and communicating the economic/financial information of an organization for decision-making to its users.
According to the American Institute of Certificated Public Accountant (AICPA) “Accounting is the art of recording, classifying, analyzing 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.”

PRINCIPLES OF ACCOUNTING

Accounting statements disclose the profitability and solvency of the business to various parties like proprietors, investors, creditors, government and many more. It is, therefore, necessary that such statements should be prepared according to some standard language and set rules. These rules are generally called Generally Accepted Accounting Principles (GAAP).
GAAP may be defined as those rules of actions or conduct, which are derived from experience and practice and when they prove useful they become accepted as principles of accounting.
Accounting principles can be classified mainly in two categories:

I. ACCOUNTING CONCEPTS

Accounting is a business language. It speaks about business affairs.
This business language must convey the same meaning everywhere. So it has been developed around some commonly accepted ideas of assumptions. These ideas are called accounting concepts. The important accounting concepts are:

a) Business Entity Concept: This concept suggests that business is an entity in itself. It is separate from its owner. So the businessman should keep his personal or household expenses and income, separate from the business expenses or income.

b) Money Measurement Concept: This concept suggests that Accountancy records only the transactions or events, which can be measured in terms of money. The transactions or events which are not measurable in terms of money cannot be recorded.
c) Cost Concept: This concept suggests that all transactions should be recorded at the actual cost. Assets and transactions should never be overvalued or undervalued. This is necessary to make accounting reliable and accurate.
d) Going Concern Concept: This concept that we should presume, that the business will continue forever or it is a going concern. So we should create reserves for expected losses, such as depreciation and doubtful debt.
e) Dual aspect Concept: This concept suggests that every transaction has a dual aspect or two sides. Receiving of benefit & Giving of benefit. These two benefits, when measured in terms of money are equal. Benefit received = Benefit given
Whenever we purchase an asset, we pay it out of our capital or accept a Liability to pay.
The dual aspect is also expressed in another form of equation as under.
ASSET = CAPITAL + LIABILITIES
ASSETS - LIABILITIES = CAPITAL
f) Realization Concept: This concept suggests that Accountancy should record only, what is realized or achieved. It should not anticipate income. Profit should be taken for granted, only when it is realized or some party has accepted its liability to pay.

II. ACCOUNTING CONVENTIONS

Conventions mean custom or tradition. Accounting conventions are related to Accountancy records. These conventions provide useful guidance in preparing Accounts or financial statements. The important conventions are:
1. Convention of Consistency: According to this convention, the business concern should follow uniform accounts for all years. Consistency of record helps in making comparisons, between past and present business results.
2. Convention of full Disclosure: According to this convention, the accounts reveal all important financial information, necessary for business. The accountancy records should guide business management.
3. Convention of Conservatism: According to this convention, the accountant has to record the actual financial position, while recording the accounts. The accountant should not give a different picture of the business either by inflating or deleting the value of the transaction.
4. Convention of Relevant: The firm should give relevant accounting information as and when required with documentary proof like invoices, vouchers and cash, and credit memos.
5. Convention of Feasibility: The practice of comparing expenses incurred for the business transactions with that of the income received during the year by the firm is called feasibility. According to the convention, expenditure should be less than the income.

ACCOUNTING STANDARDS

Accounting is ‘Language of ‘Business’. It communicates with parties concerned through accounting statements. These statements should be based on generally accepted principles. The most important step in developing accounting standards in India has been the setting up of an Accounting Standard Board (ASB) on 21st April 1977. The main function of ASB is to formulate accounting standards that will be established by the council of the Institute of chartered accountants.

The following are the 32 Accounting Standards issued by Institute of Chartered Accountants of India:

AS-1 Disclosure of Accounting Policies
AS-2® Valuation of inventories
AS-3 Cash Flow Statements
AS-4® Contingencies and Events occurring after balance sheet date
AS-5® Prior period and extraordinary items and Changes in Accounting Policies
AS-6® Depreciation Accounting
AS-7 Accounting for Construction Contracts
AS-8 Accounting for research and development
AS-9 Revenue Recognition
AS-10 Accounting for Fixed assets
AS-11® Accounting for the effects of changes in Foreign exchange rates
AS-12 Accounting for Govt. Grants
AS-13 Accounting of Investments
AS-14 Accounting for Amalgamations
AS-15 Accounting for retirement benefits in the financial statements of employees
AS-16 Borrowings costs
AS-17 Segment reporting
AS-18 Related Party Disclosures
AS-19 Leases
AS-20 Earnings per Share
AS-21 Consolidated Financial Statements
AS-22 Accounting for taxes on Income
AS-23 Accounting for Investments in Associates in Consolidated Financial Statements
AS-24 Discontinuing operations
AS-25 Interim Financial Statement
AS-26 Intangible Assets
AS-27 Financial Reporting of Interest in Joint Ventures
AS-28 Impairment of Asset
AS-29 Provisions, Contingent liabilities and contingent assets
AS-30 Financial Instruments: Recognition & measurement
AS-31 Financial Instruments: Presentation
AS-32 Financial Instruments: Disclosures

BRANCHES OF ACCOUNTING

The various branches of Accounting are as follows:
1. Financial Accounting: It is primarily concerned with providing financial information about the business enterprise to all its stakeholders. It deals with recording, classifying and summarizing business events.
2. Cost Accounting: It is concerned with the process of accounting and controlling the cost of units produced or service rendered by the business enterprise.
3. Management Accounting: It is concerned with internal reporting of information to management for planning and controlling operations, decision making and formulating long-term plans.

USERS OF ACCOUNTING INFORMATION

1. Internal users (primary users)

Internal users are the persons, who are directly involved in managing and operating the business enterprise such as managing and operating the business enterprise such as or the partners, managers, and officers. These persons need accounting information for the efficient and smooth running of business enterprises.
It includes the following:
i) Management: For analyzing the organization’s performance and position and taking appropriate measures to improve the company results.
ii) Employees: For assessing the company’s profitability and its consequence on their future remuneration and job security.
iii) Owners: For analyzing the viability and profitability of their investment and determining any future course of action.

2. External users (secondary users)

Individuals or organizations, which have present or future interest in the business enterprise, but not part of the management, are called external users of accounting.
It includes the following:
i) Creditors: For determining the creditworthiness of the organization. Terms of credit are set by creditors according to the assessment of their customer’s financial health. Creditors include suppliers as well as lenders of finance such as banks.
ii) Tax authorities: For determining the credibility of the tax returns filed on behalf of the company.
iii) Investors: For analyzing the feasibility of investing in the company. Investor wants to make sure, they can earn a reasonable return on their investment before they commit any financial resources to the company.
iv) Customers: For assessing the financial position of its suppliers, which is necessary for them to maintain a stable source of supply in the long-term.
v) Regulatory authorities: For ensuring that the company’s disclosure of accounting information is by the rules and regulations set to protect the interest of the stakeholders, who rely on such information informing their decisions.

ACCOUNTING SYSTEM

There are two systems of accounting. They are: single entry system and double entry system
1. Single entry system: This method of recording transactions is unscientific and incomplete. Some experts consider that it is not at all a system of accounting. Under this system, only one aspect of the transaction is to be recorded instead of two aspects. Hence this system is called a single entry system. Under this system, only a cash account and personal account are maintained ignoring real accounts and nominal accounts.
Limitations:
1. All transactions are not recorded.
2. Only a few accounts are maintained.
3. Trail balance cannot be prepared at the end of the year to know the arithmetical accuracy.
4. Final accounts cannot be prepared to find out the operational results and financial position of the business accurately.
2. Double-entry system: The procedure of recording both the receiving and giving aspects related to business transactions is called the Double Entry System. This means for every debit or credit there will be corresponding credit or debit respectively. Under this system, three accounts are maintained i.e., Personal account, Real Accounts, and Nominal accounts.
Advantages
The following are the advantages of the double-entry system of accounting:
1. It records all transactions of the business.
2. It gives correct and accurate information.
3. It helps to check the arithmetical accuracy by preparing a trial balance.
4. It helps in ascertainment of the financial position of the business concern.
5. It provides accounting information readily.
It helps in preventing frauds and efforts as the recording of the transactions is based on vouchers.
Disadvantages
The following are the disadvantages of the double-entry system of accounting:
1. Many numbers of accounts are to be maintained.
2. It is too expensive.
3. Its accuracy always cannot be relied upon.

TERMS USED IN ACCOUNTING

1. Proprietor: The proprietor is the person, who owns the business. He gets profit and bears the loss.
2. Transaction: Any sale or purchase of goods or services is called the transaction. It also includes receipt and payment of money.
3. Cash transaction: When payment for business activity is made immediately, it is called a cash transaction.
4. Credit transaction: When payment is postponed to a future date it is called credit transaction.
5. Non - cash transaction: A non- cash transaction is a business transaction where there is no payment or receipt of cash either immediately or at a future date. Example: depreciation, bad debts, etc.
6. Capital: Capital is the amount of money, which the proprietor/businessman invests in business, to earn profit.
7. Drawings: Drawings are the amount drawn from the business by the proprietor, for his personal or household use.
8. Goods: Goods are articles, commodities or things in which the trader deals. There are Different goods for different trades.
9. Debtor: A debtor is a person, from whom the business will receive money in the future.
10. Creditor: A creditor is a person, to whom the business has to pay money in the future.
11. Assets: Assets are properties or possessions. They include cash, machines, furniture, building, debtors and other things.
12. Liabilities: Liabilities are responsibilities; these represent amounts of money, which one has to pay to others.
13. Book debt or debt: The amount due from a debtor is called book debt or debt.
14. Good debt: It is a debt that is fully recoverable.
15. Bad debt: An irrecoverable debt is called bad debt.
16. Revenue: Revenue refers to the earnings of a business.
17. Expenses: It is the amount spent on conducting business activities. It is the expenditure, in return for some benefit. Ex: salaries paid to the staff for their service etc.
18. Loss: Loss refers to money or money’s worth given up without any benefit in return. It is an expenditure in return for which no benefit is received.
19. Debit and credit: To debit the account means to enter the transaction on the debit side of that account and the debit side means the left-hand side of an account. To credit the account means to enter the transaction on the credit side of that account and the credit side means the right-hand side of an account.
20. Entry: The record of a transaction in a journal/any book of account is called entry.
21. Posting: Posting is the process of entering in the ledger the information already recorded in journal or subsidiary books.
22. Brought down (b/d): This term is written in the ledger to show the opening balance in any account. It suggests that the account has been brought down from the previous period.
23. Carried down (c/d): This is written in the ledger account at the time of closing the account.

TYPES OF ACCOUNTS

An Account is a record of a transaction relating to a particular person's property or a Head of an Income or expenditure. Accounts are broadly classified into three. They are as follows:

1. Personal Account: It is an account of a person. It may be natural, artificial or representative person
Ex: Arun, bank, outstanding salaries, etc
2. Real Account: It is an account for assets. It may be tangible or intangible.
Ex: building, cash, goodwill, etc.

3. Nominal Account: It is an account for expenses and incomes of business

Ex: salary, rent, commission, etc.

ACCOUNTING METHODS

The following are the rules for debiting and crediting various types of accounts

1. TRADITIONAL METHOD

2. MODERN METHOD

Note: I think the traditional method is best to start understanding account as you have to learn only three account rules. But if you understand the modern method then go for it.

ACCOUNTING CYCLE

The accounting cycle refers to a sequence of accounting procedures that are required to be repeated in the same order during each accounting period. Accounting cycle includes:

1. Recording in Journal: First, all the transactions should be recorded in the journal or subsidiary books as and when they take place. That means entries are recorded daily.
2. Posting into ledger: Then all the entries in the Journal or subsidiary books should be posted to appropriate ledger accounts and balanced. Usually, it is posted once in a month as we close the ledger every month ending and brought down the balance to the next month.
3. Preparation of Trial Balance and Financial statements: The next step is the preparation of trial balance. This should lead to the preparation of Trading and profit and loss account and balance sheet. These are prepared once a year.

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