INTRODUCTION OF ACCOUNTING
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Accounting is a process of identifying the events of financial nature, recording them in Journal, classifying in
their respective ledgers, summarising them in Profit and Loss Account and Balance Sheet and communicating
the results to the users of such information, viz. owner/s, government, creditors, investors etc.
According to the American Institute of Certified Accountants, 1941, “Accounting is an art of recording,
classifying and summarising in a significant manner and in terms of money transactions and events that are, in
part at least, of a financial character and interpreting the results thereof.”
State what is end product of financial accounting?
Income statements (Trading and/or Profit and Loss Account)− An income statement that includes
Trading and Profit and Loss Account, ascertains the financial results of a business in terms of gross
(or net) profit or loss.
Balance Sheet− It depicts the true financial positions of a business that provides required information
like assets and liabilities of a business firm, to the users of accounting information like owners,
creditors, investors, government, etc.
Enumerate main objectives of accounting.
The main objectives of accounting are given below.
To keep a systematic record of all business transactions
To determine the profit earned or loss incurred during an accounting period by preparing profit and
3. To ascertain the financial position of the business at the end of each accounting period by preparing
To assist management for decision making, effective control, forecasting, etc.
To assess the progress and growth of business from year to year
To detect and prevent frauds and errors
To communicate information to various users
List any five users who have indirect interest in accounting.
The five users who have indirect interest in accounting are given below.
State the nature of accounting information required by long-term lenders.
Accounting information required by the long term lenders are repaying capacity of the business, profitability,
liquidity, operational efficiency, potential growth of business, etc.
Who are the external users of information?
External users of information are the individual or the organisations that have direct or indirect interest in
the business firm; however, are not a part of management. They do not have direct access to the internal
data of the firm and uses published data or reports like profit and loss accounts, balance sheets, annual
reports, press releases, etc. Some examples of external users are government, tax authorities, labour unions,
Enumerate informational needs of management.
The informational needs of management are concerned with the activities given below.
1. Assists in decision making and business planning
Preparing reports related to funds, costs and profits to ascertain the soundness of the business
Comparing current financial statements with its own historical financial statements and of other
similar firms to assess the operational efficiency of the business.
Give any three examples of revenues.
Three examples of revenue are given below.
Distinguish between debtors and creditors.
„Accounting information should be comparable‟. Do you agree with this statement? Give two reasons.
Accounting information should be comparable because of the following reasons.
Comparable accounting information helps in inter-firm comparisons. This helps in assessing viability
and advantages of various policies adopted by different firms.
It also helps in intra-firm comparisons that help in determining the changes and also to ascertain the
results of various policies and plans adopted in different time periods. This also helps to figure out the
errors, ascertain growth and assist in management planning.
If the accounting information is not clearly presented, which of the qualitative characteristic of the accounting
information is violated?
If the accounting information is not clearly presented, then the qualitative characteristics like, comparability,
reliability and understandability, are violated. This is because if the accounting information is not clearly
presented, then meaningful comparison may not be possible, as the data is not trustworthy, which may lead
to faulty conclusions.
The role of accounting has changed over the period of time”- Do you agree?
The role of accounting is ever changing. While in earlier times, accounting was merely concerned with
recording the financial events, i.e. record-keeping activity; however, now-a-days, accounting is done with the
rationale of not only maintaining records, but also providing an information system that provides important
and relevant information to various accounting users. The need of this change is brought over due to the
ever-changing and dynamic business environment, which is more competitive in nature now than it was in
earlier times. Further, there are various relevant activities like decision making, forecasting, comparison, and
evaluation that make these changes in the role of accounting, inevitable.
Giving examples, explain each of the following accounting terms:
Fixed assets− These are held for long term and increase the profit earning capacity of the business,
over various accounting periods. These assets are not meant for sale; for example, land, building,
Revenue− It refers to the amount received from day to day activities of business, viz. amount received
from sales of goods and services to customers; rent received, commission received, dividend, royalty,
interest received, etc. are items of revenue that are added to the capital.
Capital− It refers to the amount invested by the owner of a firm. It may be in form of cash or asset. It
is an obligation of the business towards the owner of the firm, since business is treated separate or
distinct from the owner.
Capital = Assets − Liabilities.
Gains− Gains are incidental to the business. They arise from irregular activities or non-recurring
transactions; for example, profit on sale of fixed assets, appreciation in value of asset, profit on sale of
Expenses− Expenses are those costs that are incurred to maintain the profitability of business,
likerent, wages, depreciation, interest, salaries, etc. These help in the production, business operations
and generating revenues.
Profit− This refers to the excess of revenue over the expense. It is normally categorised into gross
profit or net profit. Net profit is added to the capital of the owner, which increases the owner‟s capital.
For example, goods sold above its cost
Short term liabilities− Those liabilities that are incurred with an intention to be paid or are payable
within a year; for example, bank overdraft creditors, bills payable, outstanding wages, short-term
How will you define revenues and expenses?
Revenues− Revenues refer to the amount received from day to day activities of the business, likesale proceeds
of goods and rendering services to the customers. Rent received, commission received, royalties and interest
received are considered as revenue, as they are regular in nature and concerned with day to day activities. It is
shown in the credit side of the profit and loss account or trading account.
Expenses− Expenses refer to those costs that are incurred to earn revenue for the business. It is incurred for
maintaining profitability of the business. It indicates the amount spent to meet short-term needs of the
business. It is shown in the debit side of the profit and loss account or trading account. For example, wages,
rent paid, salaries paid, outstanding wages, etc.
What is the primary reason for the business students and others to familiarise themselves with the accounting
Every monetary transaction must be recorded in such a manner that various accounting users must understand
and interpret these results in the same manner without any ambiguity. The reasons for why business students
and others should familiarise themselves with the accounting discipline are given below.
It helps in learning the various aspects of accounting.
It helps in learning how to maintain books of accounts.
It helps in learning how to summarise accounting information.
It helps in learning how to interpret the accounting information with relative accuracy.
Explain the factors, which necessitated systematic accounting.
The factors that necessitated systematic accounting are given below.
1. Only financial transactions are recorded− Those events that are financial in nature are only
recorded in the books of accounts. For example, salary of an employee is recorded in the books but
his/her educational qualification is not recorded.
2. Transactions are recorded in monetary terms− Only those transactions which can be expressed in
monetary terms are recorded in the books. For example, if a business has two buildings and four
machines, then their monetary values is recorded in the books, i.e. two buildings costing Rs 2,00,000,
four machines costing Rs 8,00,000. Thus the total value of assets is Rs 10,00,000.
Art of recording− Transactions are recorded in the order of their occurrence.
Classification of transaction− Business transactions of similar nature are classified and posted under
their respective accounts. For example, all the transactions relating to machinery will be posted in the
Summarising of data− All business transactions are summarised in the form of Trial Balance,
Trading Account, Profit and Loss Account and Balance Sheet that provides necessary information to
Analysing and interpreting data− Systematic accounting records enable users to analyse and
interpret the accounting data in a proper and appropriate manner. These accounting data and
information are presented in form of graphs, statements, charts that leads to easy communication and
understandability by various users. Moreover, these facilitates in decision making and future
Describe the brief history of accounting.
The history of accounting can be traced long back in civilisation. Around 4000 B.C., in Babylonia and Egypt,
payment of wages and taxes were recorded on clay tablets. As history claims that Egyptians kept the record
of gold and valuables deposits and withdrawal from the treasuries. These records were reported on daily
basis by the incharge of treasuries to the wazir, who used to forward the monthly reports to the king.
Babylonia and Egypt used this method to rectify and remove errors, frauds and inefficiency from the records.
Around 2000 B.C., China used sophisticated form of accounting. In Greece, accounting was used to maintain
total receipts and total payments and to balance government accounts. In Rome, around 700 B.C., receipts
and payments were recorded in daybook and were posted in the ledger at the end of the month. In India,
around twenty three centuries ago, Kautilya wrote the book Arthshastra, which describes how accounting
records have to be maintained. In 1494, Luca Pacioli wrote the book Summa de Arithmetica Geometria
Proportioni et Proportionalita. In this, he explained the term debit and credit, which are used in accounting
Explain the development of and role of accounting.
Development of accounting
In ancient times, around 4000 B.C., accounting was used for recording wages and salaries, deposits and
withdrawals of valuable goods (such as gold and silver) from the treasures of the king. Afterwards, it was used
to record the receipts and payments and balancing of government financial transactions. During 1500 A.D.,
accounting was used by business firms for recording transactions related to business. In 1800 A.D., accounting
was used to record transactions and also to provide information to various users of financial data.
Role of accounting− While in the earlier times accounting was merely concerned with recording the financial
events (i.e. record-keeping activity); however, now-a-days, accounting is done with the rationale of not only
maintaining records, but also providing an information system that provides important and relevant
information to various accounting users.
1. Substitute of memory− As, it is beyond human capabilities to remember each and every business
transaction, so accounting plays an important role in recording these transactions in the book of
Assistance to management− Management uses accounting information for short term and long term
planning of business activities and to control various costs and budgets.
Comparative study− In order to ascertain the performance of the business, accounting enables
comparison of current year‟s profit with that of previous years (intra-firm comparison)and also with
other firms in the same business (inter-firm comparison).
4. Evidence in court− It acts as evidence that can be used or presented in the court, if any discrepancy
arises in the future.
Define accounting and state its objectives.
Accounting is a process of identifying the events of financial nature, recording them in the journal, classifying
in their respective accounts and summarising them in profit and loss account and balance sheet and
communicating results to users of such information, viz. owner, government, creditor, investors, etc.
According to American Institute of Certified Accountants, 1941, “Accounting is the art of recording,
classifying and summarising in a significant manner and in terms of money, transactions and events that are, in
part at least, of financial character and interpreting the results thereof.”
In 1970, American Institute of Certified Public Accountants changed the definition and stated, “The function of
accounting is to provide quantitative information, primarily financial in nature, about economic entities, that is
intended to be useful in making economic decisions.”
Objectives of Accounting:
Recording business transactions systematically− It is necessary to maintain systematic records of
every business transaction, as it is beyond human capacities to remember such large number of
transactions. Skipping the record of any one of the transactions may lead to erroneous and faulty
Determining profit earned or loss incurred− In order to determine the net result at the end of an
accounting period, we need to calculate profit or loss. For this purpose trading and profit and loss
account are prepared. It gives information regarding how much of goods have been purchased and
sold, expenses incurred and amount earned during a year.
Ascertaining financial position of the firm− Ascertaining profit earned or loss incurred
is not enough; proprietor also interested in knowing the financial position of his/her firm, i.e. the value
of the assets, amount of liabilities owed, net increase or decrease in his/her capital. This purpose is
served by preparing the balance sheet that facilitates in ascertaining the true financial position of the
Assisting management− Systematic accounting helps the management in effective decision making,
efficient control on cash management policies, preparing budget and forecasting, etc.
Assessing the progress of the business− Accounting helps in assessing the progress of business from
year to year, as accounting facilitates the comparison both inter-firm as well as intra-firm.
Detecting and preventing frauds and errors− It is necessary to detect and prevent fraud and errors,
mismanagement and wastage of the finance. Systematic recording helps in the easy detection and
rectification of frauds, errors and inefficiencies, if any.
Communicating accounting information to various users− The important step in the accounting
process is to communicate financial and accounting information to various users including both
internal and external users like owners, management, government, labour, tax authorities, etc. This
assists the users to understand and interpret the accounting data in a meaningful and appropriate
manner without any ambiguity.
Describe the informational needs of external users.
There are various external users of accounting who need accounting information for decision making,
investment planning and to assess the financial position of the business. The various external users are given
Banks and other financial institutions− Banks provide finance in form of loans and advances to
various businesses. Thus, they need information regarding liquidity, creditworthiness, solvency and
profitability to advance loans.
Creditors− These are those individuals and organisations to whom a business owes money on account
of credit purchases of goods and receiving services; hence, the creditors require information about
credit worthiness of the business.
Investors and potential investors− They invest or plan to invest in the business. Hence, in order to
assess the viability and prospectus of their investment, creditors need information about profitability
and solvency of the business.
Tax authorities− They need information about sales, revenues, profit and taxable income in order to
determine the levy various types of tax on the business.
Government− It needs information to determine national income, GDP, industrial growth, etc. The
accounting information assist the government in the formulation of various policies measures and to
address various economic problems like employment, poverty etc.
Researcher− Various research institutes like NGOs and other independent research institutions like
CRISIL, stock exchanges, etc. undertake various research projects and the accounting information
facilitates their research work.
Consumer− Every business tries to build up reputation in the eyes of consumers, which can be
created by the supply of better quality products and post-sale services at reasonable and affordable
prices. Business that has transparent financial records, assists the customers to know the correct cost
of production and accordingly assess the degree of reasonability of the price charged by the business
for its products and thus helps in repo building of the business.
8. Public− Public is keenly interested to know the proportion of the profit that the business spends on
various public welfare schemes; for example, charitable hospitals, funding schools, etc. This
information is also revealed by the profit and loss account and balance sheet of the business.