K.

H GOVERNMENT DEGREE COLLEGE, DHARMAVARAM

DEPARTMENT OF COMMERCE
Financial Accounting-II Semester
M. Pushpavathi
M.Com (Ph.D.)

UNIT-I
Introduction
At some point, you may have visited a grocery or pharmacy and wondered how the shopkeeper
keeps track of all the transactions over the course of the year. You might have also thought about why it's
important to maintain records, whether it's mandatory, and how it benefits the business. Now, consider a
larger business organization, which could range from selling everyday items like safety pins to complex
products like fighter aircraft. Service businesses, on the other hand, offer services like transportation,
hospitality, or even developing software programs.

To make informed decisions, businesses need accounting information. This information is also
essential for government agencies, regulators, analysts, and individuals who rely on it at various levels.

Accounting is one of the oldest and most structured forms of management information. It has evolved
over time to meet the social and economic needs of society. As an information system, accounting helps
identify, measure, and communicate financial data about an organization to users who rely on it to make
rational decisions. The accounting system provides relevant and reliable financial information to all
interested parties.

In today's world, everyone, whether an individual or an organization, needs to keep track of their
financial activities. Whether it’s managing wealth, income, or expenses, accounting plays a crucial role.
Without proper records, businesses cannot determine if they are making a profit or loss, nor can they
understand their financial position at any given time.

History of Accounting: -

Accounting has a long history that dates back to ancient times. Some believe writing was originally
created to help record accounting information, which highlights the importance of accounting throughout
history. Early accounting records have been found in ancient civilizations like China, Babylon, Greece,
and Egypt, where it was used to track the costs of labour and materials for major construction projects,
like the Pyramids.

In the 1400s, accounting developed further due to the growing demand for information from
merchants in Venice, Italy. The first known description of double-entry bookkeeping was published in
1494 by Luca Pacioli, a mathematician and friend of Leonardo da Vinci.
 The Industrial Revolution in the 18th and 19th centuries led to the need for more advanced
accounting systems. Businesses could no longer rely on rough estimates of costs, as competition and mass
production increased. Accounting became more structured and formal as it became a recognized field of
study.

As the corporate world grew, particularly in industries like railroads, steel, and communications,
the need for clear accounting systems grew as well. With the rise of corporations, ownership and
management became separate, and businesses needed reliable accounting systems to report their
performance to their owners.

Governments also played a key role in the development of accounting, particularly through the
introduction of income tax, which brought the concept of "income." Governments needed accurate
financial information for decisions related to education, healthcare, and economic planning. As a result,
stricter accountability and formal accounting practices became necessary in the corporate sector.

Meaning of Accounting: -

Accounting is the process of recording, classifying, and summarizing financial transactions to provide
useful information for decision-making. It involves tracking the income, expenses, assets, and liabilities
of a business or individual. The goal of accounting is to produce financial statements that accurately
reflect the financial position and performance of an entity, helping stakeholders such as managers,
investors, and government authorities make informed decisions. In simple terms, accounting is the
language of business that helps in understanding how money flows within an organization.

Definitions

American Accounting Association (AAA): AAA defines "Accounting refers to the process of
identifying, measuring and communicating economic information to permit informed judgment and
decisions by users of the information."

A.W. Johnson: "Accounting may be defined as the collection, compilation and systematic recording of
business transactions in terms of money, the preparation of financial reports, the analysis and
interpretation of these reports and the use of these reports for the information and guidance of
management."

Need for Accounting: -

1. Financial Record Keeping: Accounting ensures all financial transactions are accurately recorded,
creating a comprehensive and detailed history of a business's financial activities. This allows
businesses to track their financial performance over time.
2. Informed Decision Making: By providing critical financial data and analysis, accounting enables
business owners and managers to make well-informed decisions. This can influence key areas
such as operations, investment strategies, and overall business direction.
3. Regulatory Compliance: Accounting ensures that businesses adhere to legal and financial
reporting requirements. Accurate financial records help avoid potential penalties, legal issues, and
safeguard the company's reputation by ensuring compliance with regulations.
 4. Performance Evaluation & Strategic Planning: Accounting offers in-depth financial analysis
that helps assess business performance. This analysis is crucial for strategic planning and setting
goals, helping businesses identify opportunities for growth and areas that require improvement.
5. Transparency & Trust with Stakeholders: Clear, accurate, and transparent financial reports are
essential for building trust with investors, creditors, and other stakeholders. Consistent and reliable
accounting practices promote transparency, enhancing the business’s credibility and reputation.

Objectives of Accounting: -

The principal object of accounting is to keep permanent record of all monetary transactions effected by a
person or enterprise during a definite period and ascertainment of results of those transactions at the end
of the period. The main objects of accounting are enumerated below:

1. Providing Information for Decision-Making

Accounting provides important financial data that helps stakeholders (owners, investors, creditors) make
informed decisions about the business, such as costs, sales, profits, and investment returns. It’s often
called the "language of business."

2. Systematic Recording of Transactions

Accurate financial records are kept through bookkeeping, ensuring reliable and precise accounting
information for stakeholders. These records are then summarized and presented in reports.

3. Measuring Profit or Loss

Accounting calculates a business’s profit or loss by comparing revenues and expenses over a period,
typically through a profit and loss statement. This helps stakeholders understand business performance
and also meets tax reporting requirements.

4. Determining Financial Position

The balance sheet shows a business’s financial position by listing its assets (what it owns) and liabilities
(what it owes) at a specific point in time, helping stakeholders make investment and financing decisions.

5. Assessing Solvency
The balance sheet and profit and loss account provide insights into a business’s ability to meet short-term
and long-term obligations, informing stakeholders about the business’s financial stability.

Functions of Accounting: -
1.Historical Functions

The historical functioning of accounting involves keeping accurate records of all the past transactions made
in the business. This type of functioning of accounting includes:

1. Recording the financial transactions and maintain a journal to keep them all.
2. It is important to classify and separate the records and the ledger.
3. Preparation of brief summary takes place for quick reviews.
4. This type of accounting gives the net result other than just keeping the records.
 5. The preparation of the balance sheet takes place to determine the financial position of the
business.
6. The analysed data and records are then used for other purposes.
7. The last step is to communicate the obtained financial information to the interested sectors, for
instance, owners, suppliers, government, researchers, etc.

2.Managerial Functions

In an organization, the management committee looks for all kinds of decision making. To ensure that the
decisions are smooth and beneficial for everyone, they do an evaluation of the past records provided by
accounting. These are managerial functions. The five managerial functions of accounting are:

1. Formation of plans in addition to controlling the financial policies.

2. Besides that, a budget is prepared to estimate the total expenditure for future activities.
3. Also, cost control is made possible by comparing the cost with the efficiency of the work.
4. The accounting also provides the necessary information during the evaluation of employee’s
performance.
5. To check for fraud and errors is what the workability of the whole procedure depends on.

Accounting Concepts and Conventions: -

1.Business Entity Concept:-

The business entity concept treats the business and its owner as separate entities. This means the
business's financial transactions are distinct from the owner's personal transactions. For example, when
the owner invests money into the business, it is recorded as a liability owed by the business to the owner.
Similarly, if the owner withdraws cash or goods for personal use, it is not treated as a business expense
but as "drawings." All transactions are recorded from the business's perspective, not the owners.

Example: - Example: If Mr. Birla invests ₹1,00,000 in his business, it is recorded as the business's
liability to him. If he withdraws ₹5,000 for personal use, it is called Drawings, not a business expense.

2.Accounting Cost Concept:

The accounting cost concept states all the business assets should be written down in the book of accounts
at the price assets are purchased, including the cost of acquisition, and installation. The assets are not
recorded at their market price. It implies that the fixed assets like plant and machinery, building, furniture,
etc are recorded at their purchase price

Example: A machine bought for ₹10,00,000 with ₹4,000 spent on transport and installation will be
recorded as ₹10,04,000 in the accounts.

3.Dual Aspect Concept: -

The dual aspect is the basic principle of accounting. It provides the basis for recording business
transactions in the books of accounts. This concept assumes that every transaction recorded in the books
of accountants is based on dual concepts. This implies that the transaction that is recorded affects two
accounts on their respective opposite sides. Hence, the transaction should be recorded at dual places. It
implies that both aspects of the transaction should be recorded in the books of account.

Example: Buying goods for cash reduces cash (asset) but increases inventory (asset).
Formula: Assets = Liabilities + Capital.

4.Going Concern Concept: -

The going concern concept assumes that a business will continue its operations indefinitely and will not
be closed or liquidated in the near future. This assumption allows assets to be valued and reported in the
balance sheet based on their long-term use rather than their immediate sale value .

Example: A machine costing ₹10,00,000 with a 10-year life is partially charged as an expense each
year, while the remaining value is treated as an asset.

5.Money Measurement Concept:

The money measurement concept assumes that the business transactions are made in terms of money i.e.
in the currency of a country. In India, such transactions are made in terms of the rupee. Hence, as per the
money measurement concept, transactions that can be expressed in terms of money should be recorded in
books of accounts.
Example: Sales worth ₹10,000 or rent paid ₹2,000 can be recorded, but employee skills or goodwill
cannot be.

6.Accounting Period Concepts

The accounting period concept states that a business's financial performance is measured over specific
intervals, called accounting periods, such as a month, quarter, or year. This helps in calculating profit or
loss, taxes, and understanding the financial position regularly. Typically, one year is used as the
accounting period, which can either follow the calendar year (January 1 to December 31) or the financial
year (April 1 to March 31).
Example: A balance sheet is prepared every year, typically on March 31 (financial year).

7.Realization Concept
The realization concept states that revenue should be recorded in the accounting records only when it is
earned and there is a legal right to receive payment. For example, selling goods is considered realized
revenue, but merely receiving an order is not. Revenue is recognized either when cash is received or when
the right to receive cash is established through a sale.
Example: Selling goods is recorded as revenue when the sale happens, not when the payment is
received.

8.Matching Concepts

The matching concept ensures that revenue and the expenses incurred to earn that revenue are recorded in
the same accounting period. For example, if a commission is paid for a sale recorded in March, the
commission expense should also be recorded in March. This ensures accurate determination of profit or
loss for the period, helping investors and stakeholders understand the business's true financial
performance.
Example: If a salesperson earns a commission for March sales, it is recorded as an expense in March,
not later.

9.Accrual Concept

The accrual concept means that transactions are recorded when they occur, regardless of when cash is
received or paid. Revenue is recognized when goods or services are sold, even if payment is received
later. Similarly, expenses are recorded when they become payable, even if payment is made later. This
ensures that all transactions are recorded in the accounting period to which they relate.

Example: If goods are sold on March 5, 2021, for ₹55,000 but payment is received on April 5, it is
included as March revenue. Similarly, if services are received but payment is pending, it is recorded as an
expense in the current period.
Accounting conventions: -

Accounting conventions are guidelines used to handle complex or unclear business transactions. While
not legally binding, they help maintain consistency in financial statements. These conventions ensure
financial reports are standardized, comparable, relevant, and provide full disclosure of transactions.
Four important types of accounting conventions are:

1. Conservatism:
It tells the accountants to err on the side of caution when providing the estimates for the assets and
liabilities, which means that when there are two values of a transaction available, then the always
lower one should be referred to.
2. Consistency: A company is forced to apply the similar accounting principles across the different
accounting cycles. Once this chooses a method it is urged to stick with it in the future also, unless
it finds a good reason to perform it in another way. In the absence of these accounting
conventions, the ability of investors to compare and assess how the company performs becomes
more challenging.
3. Full Disclosure: Information that is considered potentially significant and relevant is to be
completely disclosed, regardless of whether it is detrimental to the company.
4. Materiality: Similar to full disclosure, this convention also bound organizations to put down their
cards on the table, meaning they need to totally disclose all the material facts about the company.
The aim behind this materiality convention is that any information that could influence the
person’s decision by considering the financial statement must be included.

Book-Keeping and Accounting

Meaning of Book-Keeping: -"Book' means 'Book of Accounts' and 'Keeping' means 'maintaining' the
books of accounts. Thus, the writing of business transactions in the books of accounts for future use is a
simple meaning of book-keeping.

Definitions of Book-Keeping: -We can define book-keeping as a systematic record of all the business
transactions to know the financial position of a business.

Meaning and Definition of Accountancy:

Book-keeping is a part of accounting. It is the primary stage in accounting. It is the process of recording
transactions in the books of accounts. Accounting is part of Accountancy. Accountancy is the practice of
recording, classifying, and reporting of business transactions for a business. Accounting principles are the
basic norms and assumptions developed and established as the basis for accounting system. These
principles are adopted by the accountants universally.

Definitions:
1) “Accountancy refers to the entire body of the theory and process of accounting.” By Kohler.
2) Prof. Robert N. Anthony has defined accounting as “Nearly every business enterprise has an
accounting system. It is a means of collecting, summarizing, analysing and reporting in monetary
terms information about the business transactions.”
Book-Keeping Vs Accounting
Sl. Basis of Book-Keeping Accounting
No Difference
1 Object The Object of book-keeping is to prepare The object of accounting record classify,
original books of Accounts Trail balance Summarise, analysis and interpret the
and final accounts and to maintain business transactions and to as-Certain
Systematic records of financial results. operating results Financial position and to
communicate to various users.
2 Scope It has limited scope and is Concerned with It has a wide Scope and Covers book
recording, classifying and summarising of keeping plus analysis and interpretation
business transactions.
3 Level of Work It is restricted to clerical work and is done It is concerned with all levels of
by lower levels of management management lower-level clerks pre-pare
the accounts, medium level report it and
top level interpret it
4 Mutual It has to depend on accounting for making It has to depend on book keeping for
dependence the accounting records more useful. getting the required information form
accounting records and for making them
useful for planning , Control and decision
making
5 Results of the It shows the Net result and financial It analysis the operating results and
business position of the business as the Scope financial position of the business
extends to the pre-preparation of final
accounts.

6 Stages book Keeping is a primary stage. Accounting is the Secondary stage. It

begins where book keeping ends

7 Nature of Job The job of book Keeper often routine and the job of an accountant analytical in
clerical-is Cal in nature nature

8 Knowledge The book keeper is not required to have the accountant must have higher level of
required higher level of Know ledge then that of an knowledge then that of book keeper
accountant
9 Staff for Book keeping work is for formed by Accounting work is performed by Staff.
Performing Junior staff Senior
work

Accounting Rules:-
1. Personal Accounts (Natural person or Company)
 Debit the receiver
 Credit the giver
2. Real Accounts (cash, property or asset)
 Debit what comes in
 Credit what goes out
3. Nominal Accounts (Business expenses or losses and income or gains)
 Debit all expenses and losses
 Credit all income and gains
Note:-
1.Purchases is always Debit
2.Sales is always Credit
3.Purchase returns is always Credit
4.Sales returns is always Debit
Explanation

1. Purchases are always recorded as a debit: When a business acquires goods or inventory, it is
considered an increase in assets, so the purchase is recorded on the debit side.
2. Sales are always recorded as a credit: When a business sells goods, it generates revenue, which
increases the business's income, so the sale is recorded on the credit side.
3. Purchase returns are always recorded as a credit: When goods purchased are returned to the
supplier, it reduces the inventory and the purchase expense, so the return is recorded on the credit
side.
4. Sales returns are always recorded as a debit: When customers return goods, it reduces the
revenue from sales, so the sales return is recorded on the debit side to decrease the sales account.