ACCOUNTING

ACCOUNTING
Accounting is the language of business. The
affairs and the results of the business are
communicated to others through accounting
information, which has to be systematically
recorded and presented.
 Accounting - Definition

Accounting can be defined as the

process of identifying, measuring,
recording and communicating the
economic events of an organization to
the interested users of the
information.
 Characteristics of Accounting

 Economic events
 Identification, measuring, recording and

communication
 Organization

 Interested users of information

 Economic Events

An economic event has been defined

as ‘a happening of consequence’ to a
business entity. Economic events are
classified into

• External types
 Economic Events Continue…

An external event which involves the

transfer or exchange of something of
value between two or more entities.
 Economic Events Continue…

• Sale of goods to customers.

• Payment of monthly rent to the
landlord.
• Purchase of raw materials by an
enterprise from some other business
enterprise.
• Rendering of services to
customers, etc.
 Economic Events Continue…

An internal event is an economic event

that occurs entirely within one
enterprise.

Eg : Supply of raw materials or

equipment by the stores department
to the manufacturing department.
 Identification

It means determining what to record,

i.e. to identify recordable events. It
involves observing activities and
selecting those events that are
considered to be evidence of economic
activity.
 Identification continue …

The value of human resources,

changes in managerial policies or
changes in personnel are important
but none of these items is recorded in
financial accounts. However, when a
company makes a cash sale or
purchase, even if the item is small, it
is recorded in the books of account.
 Measurement

It means quantification, including

estimates of business transactions into
financial terms, i.e. rupees and paise.
If an event cannot be quantified in
monetary terms, it is not considered
for recording in financial accounts.
 Recording

Once the economic events are

identified and measured in financial
terms, they are recorded, i.e. a
chronological diary of these measured
events is kept in an orderly and
systematic manner.
 Communication

The economic events are identified,

measured and recorded is
communicated in some form to
management and others for internal
and external uses. The information is
communicated through the
preparation and distribution of
accounting reports. The most common
reports are in the form of financial
 Organization

It can be a business entity or a non-

business entity, depending upon the
profit or non-profit motive.
Users of Accounting Information

Different categories of users need

different kinds of information for
making decisions. These users can be
divided into :

•Internal Users; and

 Internal Users

These are the persons who manage

the business, i.e. management at the
top, middle, and lower levels. Their
requirements of information are
different because they make different
types of decisions.
 Internal Users continue…

The top level is more concerned with

planning; the middle level is
concerned equally with planning and
control; and the lower level is
concerned more with controlling
operations. Information is supplied on
different aspects, e.g. cash resources,
sales estimates, results of operations,
financial position, etc.
 External Users

All persons other than internal users

come in the group of external users.
External users can be divided into two
groups:
• those having direct interest; and
• those having indirect interest
in a business organization.
 External Users continue…

The main sources of information for

external users are annual reports of
business organizations, which state
the financial position and performance
and give the auditor’s report,
director’s report and other
information.
 External Users continue…

Investors and creditors are the

external users having direct interest.
Tax authorities, regulatory agencies,
customers, labour unions, trade
associations, stock exchanges,
investors, etc are indirectly interested
in the company’s financial strength, its
ability to meet short-term and long-
term obligations, its future earning
 ASSETS

These are economic resources of an

enterprise that can be usefully
expressed in monetary terms. Assets
are things of value used by the
business in its operations.
• Fixed Assets  
• Current Assets
 ASSETS continue…

• Fixed Assets are assets held on a

long-term basis.
e.g. Land, Building, Machinery, Plant,
Furniture and Fixtures, etc.
 ASSETS continue…

• Current Assets are assets held on a

short-term basis.
e.g. Debtors, Bills receivable,
Stock(Inventory), Cash and Bank
balances, etc.
 LIABILITIES

These are obligations or debts that the

enterprise must pay in money or
services at some time in the future.

• Long-term liabilities

• Short-term liabilities
 LIABILITIES continue..

• Long-term liabilities are those that are

usually payable after a period of one
year.

e.g. A term loan from a financial institution,

debentures (bonds) issued by a company.
 LIABILITIES continue..

• Short-term liabilities are obligations

that are payable within a period of one
year.

e.g. Creditors, bills payable, overdraft

from a bank for a short period.
 CAPITAL

Investment by the owner for use in the

firm is known as capital. Owner’s
equity is the ownership claim on total
assets. It is equal to total assets minus
total liabilities.
 REVENUES

These are the amounts the business

earns by selling its products or
providing services to customers. Other
titles and sources of revenue common
to many businesses are: sales, fees,
commission, interest, dividends,
 EXPENSES

These are costs incurred by a business

in the process of earning revenue.
Generally, expenses are measured by
the cost of assets consumed or
services used during an accounting
period. The usual titles of expenses
are: depreciation, rent, wages,
salaries, interest, costs of heat, light
and water, telephone, etc.
 PURCHASES
Purchases are total amount of goods
procured by a business on credit and
for cash, for use or sale. In a trading
concern, purchases are made of
merchandise for resale with or without
processing.
In a manufacturing concern, raw
materials are purchased, processed
further into finished goods and then
sold. Purchases may be cash purchase
 SALES

Sales are total revenues from goods or

services sold or provided to
customers. Sales may be cash sales or
credit sales.
 STOCK

Stock (Inventory) is a measure of

something on hand – goods, spares
and other items – in a business.

It is called stock on hand.

 STOCK: continue…

In a trading concern, the stock on

hand is the amount of goods which
have not been sold on the date on
which the balance sheet is prepared.
This is also called closing stock.
 STOCK continue…

In a manufacturing concern, closing

stock comprises raw materials, semi-
finished goods and finished goods on
hand on the closing date.

Similarly, opening stock is the amount

of stock at the beginning of the
accounting year.
 DEBTORS

Debtors are persons and/or other entities

who owe to an enterprise an amount for
receiving goods and services on credit.

The total amount standing against such

persons and/or entities on the closing date,
is shown in the Balance Sheet as Sundry
Debtors on the asset side.
 CREDITORS

Creditors are persons and/or other entities

who have to be paid by an enterprise an
amount for providing the enterprise goods
and services on credit.

The total amount standing to the favour of

such persons and/or entities on the closing
date, is shown in the Balance Sheet as
Sundry Creditors on the liability side.
ACCOUNTING PRINCIPLES

Accounting principles can be subdivided into

two categories:

• Accounting Concepts; and

• Accounting Conventions.
 ACCOUNTING PRINCIPLES
• Accounting Concepts
• Accounting Conventions
The term ‘concept’ is used to connote
accounting postulates, that is
necessary assumptions and conditions
upon which accounting is based. The
term ‘convention’ is used to signify
customs and traditions as a guide to
the presentation of accounting
 ACCOUNTING PRINCIPLES

Accounting Concepts
• Business Entity Concept
• Money Measurement Concept
• Cost Concept
• Going Concern Concept
• Dual Aspect Concept
• Realization Concept
• Accounting Period Concept
 ACCOUNTING PRINCIPLES

Accounting Conventions
• Convention of Consistency
• Convention of Disclosure
• Convention of Conservation
 ACCOUNTING PRINCIPLES

Accounting Concepts
The term ‘concept’ is used to connote
accounting postulates, that is
necessary assumptions and conditions
upon which accounting is based.
 Business Entity Concept

Business is treated as a separate

entity or unit apart from its owner and
others. All the transactions of the
business are recorded in the books of
business from the point of view of the
business as an entity and even the
owner is treated as a creditor to the
extent of his/her capital.
 Money Measurement Concept

In accounting, we record only those

transactions which are expressed in
terms of money. In other words, a fact
which can not be expressed in
monetary terms, is not recorded in the
books of accounts.
 Cost Concept

Transactions are entered in the books

of accounts at the amount actually
involved. Suppose a company
purchases a car for Rs.1,50,000/- the
real value of which is Rs.2,00,000/-,
the purchase will be recorded as
Rs.1,50,000/- and not any more. This
is one of the most important concept
and it prevents arbitrary values being
 Going Concern Concept

It is persuaded that the business will

exists for a long time and transactions
are recorded from this point of view.
 Dual Aspect Concept

Each transaction has two aspects, that

is, the receiving benefit by one party
and the giving benefit by the other.
This principle is the core of
accountancy.
 Dual Aspect Concept continue…

For example, the proprietor of a

business starts his business with Cash
Rs.1,00,000/-, Machinery of
Rs.50,000/- and Building of
Rs.30,000/-, then this fact is recorded
at two places. That is Assets account
(Cash, Machinery & Building) and
Capital accounts. The capital of the
business is equal to the assets of the
 Dual Aspect Concept continue…

Thus, the dual aspect can be

expressed as under
 
Capital + Liabilities = Assets
or
Capital = Assets – Liabilities
 Realization Concept

Accounting is a historical record of

transactions. It records what has
happened. It does not anticipate
events. This is of great important in
preventing business firms from
inflating their profits by recording
 Accounting Period Concept

Strictly speaking, the net income can

be measured by comparing the assets
of the business existing at the time of
its liquidation. But as the life of the
business is assumed to be infinite, the
measurement of income according to
the above concept is not possible. So a
twelve month period is normally
adopted for this purpose. This time
 ACCOUNTING PRINCIPLES

Accounting Conventions

The term ‘convention’ is used to

signify customs and traditions as a
guide to the presentation of
accounting statements.
 Convention of Consistency

In order to enable the management to

draw important conclusions regarding
the working of the company over a few
years, it is essential that accounting
practices and methods remain
unchanged from one accounting
period to another. The comparison of
one accounting period with that of
another is possible only when the
 Convention of Disclosure

This principle implies that accounts

must be honestly prepared and all
material information must be disclosed
therein. The contents of Balance Sheet
and Profit and Loss Account are
prescribed by law. These are designed
to make disclosure of all material facts
compulsory.
 Convention of Conservation

Financial statements are always drawn

up on rather a conservative basis. That
is, showing a position better than what
it is, not permitted. It is also not
proper to show a position worse than
what it is. In other words, secret
reserves are not permitted.
 FUNCTIONS OF
ACCOUNTING
• Keeping systematic records
• Protecting properties of the
business
• Communicating the results
• Meeting legal requirements
 Keeping systematic records

The first function of accounting is to

keep a systematic record of financial
transactions, to post them to the
ledger accounts and ultimately
prepare final statements.
 Protecting properties of the
business

The second important function is to

protect the property of the business.
The system accounting is designed in
such a way that it protects its assets
from an unjustified and unwarranted
use.
 Meeting legal requirements

The fourth and the last function of

accounting is to meet the legal
requirements under the Companies
Act, Income Tax Act, Sales Tax Act and
so on.
THE ACCOUNTING CYCLE

Recording transactions in subsidiary

books.
Classifying data by posting from
subsidiary books to the accounts.
Closing the books and preparation of
final accounts.
 SYSTEMS OF ACCOUNING

• Cash System

• Single Entry System

• Double Entry System

 Cash System

This system takes into account only

cash receipts and payments on the
assumption that there are no credit
transactions. Even if there are any,
they will not be recorded. This system
may be suitable for charitable
institutions like schools, colleges,
social clubs, etc.
 Single Entry System

As the name itself implies, it deals with

only one aspect of transaction. This
system recognizes cash and personal
items of the transactions and it
ignores the impersonal items. So it is
incomplete, inaccurate and
unscientific.
 Double Entry System

This is the most scientific system that

recognizes both the aspects of each
transaction and also records each
aspect. This system takes into account
every business transaction in its
double aspect, i.e., receiving benefit
by one party and giving the like
benefit by another. So it records the
two-fold aspect of every business
 Double Entry System continue…

Example: When ‘A’ purchases a car, he

receives the benefit in the form of a
car and gives the benefit in the form of
money. Similarly, the car seller
receives the benefit in the form of
money and gives the benefit in the
form of a car.
 Double Entry System continue…

Definition
The process by which the dual aspects
of business transactions are recorded
is known as the double entry book-
keeping. It is a complete book-keeping
in the sense that it records all the two
aspects, debit and credit in each
business transaction, in equal value.
 CLASSIFICATION OF
ACCOUNTS

Every business deal with other “Person”,

possesses “Assets”, pay “Expenses” and
receive “Income”.
So from the above, we can see every
business has to keep
• An account for each person
• An account for each asset and
• An account for each expense or income.
 CLASSIFICATION OF
ACCOUNTS

• Accounts in the names of persons are

known as “Personal Accounts”
• Accounts in the names of assets are
known as “Real Accounts”
• Accounts in respect of expenses and
incomes are known as “Nominal
Accounts”
 CLASSIFICATION OF
ACCOUNTS

ACCOUNTS

PERSONAL IMPERSONAL
ACCOUNTS ACCOUNTS

REAL NOMINAL
ACCOUNTS ACCOUNTS
 PERSONAL ACCOUNTS

Accounts in the name of persons are known

as personal accounts.
Eg: Babu A/C,
Babu & Co. A/C,
Outstanding Salaries A/C, etc.
 REAL ACCOUNTS

These are accounts of assets or properties.

Assets may be tangible or intangible. Real
accounts are impersonal which are tangible
or intangible in nature.
Eg:- Cash a/c, Building a/c, etc are Real
Accounts related to things which we
can feel, see and touch.
Goodwill a/c, Patent a/c, etc Real
Accounts which are of intangible in nature.
 NOMINAL ACCOUNTS

These accounts are impersonal, but invisible

and intangible. Nominal accounts are
related to those things which we can feel,
but can not see and touch. All “expenses
and losses” and all “incomes and gains” fall
in this category.
Eg:- Salaries A/C, Rent A/C, Wages A/C,
Interest Received A/C, Commission
Received A/C, Discount A/C, etc.
 DEBIT AND CREDIT

Each accounts have two sides – the left side

and the right side. In accounting, the left
side of an account is called the “Debit Side”
and the right side of an account is called the
“Credit Side”. The entries made on the left
side of an account is called a “Debit Entry”
and the entries made on the right side of an
account is called a “Credit Entry”.
RULES FOR DEBIT AND CREDIT

Personal Account Debit the Receiver

Credit the Giver

Real Accounts Debit what comes in

Credit what goes out

Nominal Accounts Debit all Expenses and

Losses
Credit all Incomes and
Gains
Steps for finding the debit and credit aspects
of a particular transaction

• Find out the two accounts involved in the

transaction.

• Check whether it belongs to Personal,

Real or Nominal account.

• Apply the debit and credit rules for the

two accounts.
 Exercise

• Purchased a Building for Rs.20,000/-.

• Paid Cash Rs.1,000/- to Satheesh.

• Paid Salary Rs.1000/-.

• Received Commission Rs.250/-.

• Sold goods for Cash Rs.3500/-.

 Subsidiary Books

• General Journal
• Special Journals
• Purchase Book
• Sales Book
• Purchase Return Book
• Sales Return Book
• Bills Receivable Book
• Bills Payable Book
• Cash Book
• Petty Cash Book
 Journal

Journal is the prime or original book of entry

in which all transactions are recorded in the
form of entries. Journalising is an act of
recording or entering transactions in a
Journal in the order of date.
Date Particulars LF Debit Credit Amount
Amount
 Journal Entry

Jan 1, 1981 Prakash Started a business Rs.

15,000/-
Date Particulars LF Debit Credit
Amount Amount
1981 Cash a/c Dr. 15,000
Jan 1 To Prakash’s Capital a/c 15,000
(Being cash invetsed to
business)