Chapter 1

Accounting: The Language of Business

Introduction to Accounting

Key Points to Remember

Difference between Accounting and Book keeping.
Financial Reporting & Financial Statements

GAAP-Generally Accepted Accounting Principles

What is a Balance Sheet

Components of Balance Sheet

The Accounting Equation
Introduction to Accounting 2

What is Accounting
It is the art of interpreting, measuring and communicating the results of economic activities. Like for e.g.: paying for the phone bill etc It is also called as the language of business which includes terms as assets, liabilities, net income and cash flow. The basic purpose is to provide decision makers with information useful in making economic decisions. Making such decisions means allocating scarce resources in an efficient manner. Types of accounting are: Financial Accounting, Management Accounting and Tax Accounting. FA is to assist investors by describing them the financial position of a company; MA is specifically for management to help them in setting goals; TA helps in preparation of income tax returns.
Introduction to Accounting 3

Distinction between Accounting & Book keeping

Book keeping refers to the daily operation of an accounting system that is recording and classifying routine transactions. An individual might learn this within a few weeks time

It is performed efficiently through the use of computer.

Accounting however, is more than a skill. Accountants must have complete understanding of financial reporting requirements, tax regulations, regulatory requirements. They design systems for internal control, record complex transactions and asisst managers to interpret all this accounting information.
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The Financial Reporting Process

Supplying financial information about a business to people outside the organization is termed as Financial Reporting. Why is it needed? Large corporates especially are required to make general purpose information public to everyone. How is this information passed on to the general public? It is through the Financial Statements. Financial Statement is simple defined as an accounting report. They include the Balance Sheet, Income Statement, Statement of owners equity and Statement of Cash Flow
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The Components of Financial Statements

A BALANCE SHEET shows financial position of the company at a specific date. An INCOME STATEMENT indicates profitability of the business over a period of time.

A STATEMENT OF OWNERS EQUITY explains changes in the amount of owners investment in the business.
A STATEMENT OF CASH FLOW explain cash receipts (inflows) and cash payments (outflows) over a period of time. NOTES- which contains additional information/details about the above statements
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GAAP-Generally Accepted Accounting Principles

All Financial Statements are prepared in conformity with a set of ground rules which are called the GAAP. GAAP are necessary so that when investors are studying financial statements of different companies, comparison can be made on same grounds. GAAP identifies what information is included in financial statements and how this information is to be presented.

Some of the concepts included in GAAP include: 1. comparability (among different companies) 2. reliability 3. entity principle 4. cost principle 5. going concern assumption 6. objectivity principle 7. adequate disclosure
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 ENTITY PRINCIPLE: financial statements describe the affairs of a specific business entity. The business entity is regarded as separate from the personal affairs of its owners.
COST PRINCIPLE: assets are recorded at their cost, meaning that the dollar amount originally paid to acquire the asset is shown in the balance sheet. GOING CONCERN: business is a continuing enterprise, a going concern OBJECTIVITY PRINCIPLE: we need definite factual basis for valuation of assets and this is the reason why assets are valued at cost. Estimated market values are not factual and objective.

Introduction to Accounting

The Balance Sheet

Balance Sheet shows the financial position of a business entity at a specific date. Starts with Company Name and then the Balance Sheet Date Three distinct sections are: Liabilities and Owners Equity Assets,

Introduction to Accounting

ASSETS
ASSETS: are economic resources owned by business and are expected to benefit future operations. Examples: building, machinery, inventory of merchandise, legal claims, patent rights. Assets are taken on their cost or face value and not on the market values, as per the GAAP, in the balance sheet. Current /Liquid assets are reported first followed by Fixed/Permanent assets.
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LIABILITIES
Liabilities are debts. This means when you are buying your merchandise on credit, rather than paying cash at the time of each purchase. The liability which arises from purchase of good on credit is called as :Accounts payable and the person to whom the money is owed is called creditor. Note payable- a written promise to pay money at a future date. Introduction to Accounting

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OWNERS EQUITY
Money invested by the owner. It is a residual claim because the claims of the creditors legally come first. If you are the owner of a business, you are entitled to whatever remains after the claims of the creditors are fully satisfied. Therefore: OE=TA-TL Increase in OE comes from: 1. Owner himself 2. retained earnings.(ploughed back earnings) Decrease in OE comes from: 1. withdrawals by owner 2. losses Introduction to Accounting 12

The Accounting Equation

TOTAL ASSETS =TOTAL LIABILITIES+TOTAL EQUITY
The above relationship always exists; equality of these totals is one reason why this financial statement is called a balance sheet. The dollar /rupee total om the two sides of the balance sheet are always equal because these two sides are merely two views if the same business. Assets shows what resources the business owns and Liabilities /OE shows who supplied these resources. Effects of business transactions upon the balance sheet- a transaction which increases total assets MUST also increase either total liabilities or owners equity.
Introduction to Accounting

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