Learning Objectives:

After studying this chapter, you

should be able to understand:
 Meaning of Accounting
 Accountancy, Accounting and Book-keeping
 Relationship between Accountancy, Accounting and Book-keeping
 Distinguish between Book-keeping and Accounting
 Name of Users of Accounting information
 Advantages and limitations of Accounting.
 Basic Accounting terms
 Double Entry System of Book-keeping
 Introduction
According to American Institute of Certified Public Accountants, “Accounting is
the art of recording, classifying and summarising the economic information in
a significant manner in terms of money, transactions and events which are, in
part at least, of a financial character, and interpreting the results thereof.”
 Features of Accounting

 1. Identification of Financial Transactions and events: -

Accounting records only those transactions that are
atleast financial in character and can be measured in
terms of money.
 2. Recording: - Any transaction of financial character
must be written soon after its occurrence in the books
of accounts for example-Journal cash book, sale book,
purchase book etc.
 3. Classification: - All the transactions are classified in
various books of accounts according to its nature i.e.
personal, real or nominal. This helps to know what is
due to the business from outsiders and what is due
from business to the outsiders.
 4. Summarizing: - This involves presenting
the classified data in a manner which is
understandable and useful to both internal
and external users. This process lead to
preparation of Trial balance from various
balances extracted from ledger. Trading and
profit and loss account to know the profit or
loss for a specified period and Balance Sheet
on a particular date.
 5. Analysis and interpretation :- On the basis
of balances extracted various result are
drawn by making profit and loss A/C, balance
sheet, looking out various ratio and other
statement. After preparing various
statements the decisions are made and
judgement formed. Implication of various
result are understood. This is done by
interpreting the ratios to know the progress,
prosperity and efficiency of a concern.
ACCOUNTING PROCESS
B
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A
N
C
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S
 Functions of Accounting
1. Keeping Systematic Records: - Primary function of accounting is to
keep systematic records of financial transactions to post them to ledger
A/C and ultimately prepare final statements.
2. Protecting property of the business: - The function of accounting is to
protect the property of the business. An unauthorized dissipation of assets
of the firm will bring it to the threshold of insolvency.
3. Meeting legal requirement: - A business has to file various statements
i.e. income tax returns, sales tax and so on. Accounting system aims at
fulfilling these requirement of law.
4. Communicating the result: - to communicate the result obtained from
analyzing of data to interested parties like proprietors, investors, creditors,
employees, government official and researchers.
5. Assistance to Management :- Accounting helps management in
decision making by providing essential and useful information about the
business run by them.
 Advantages of Accounting
 1. Helpful in management of business: -
Accounting helps management by providing
essential and useful information about the business
run by them.
 2. Helpful in the payment of income tax and
sales tax: -If accounts are maintained according
to the principle of accounting it Helps to Pay taxes
such as income tax, corporation tax etc.
 3. Helps in sale of business: - If the
businessman wants to sell his running business he
can realize its reasonable price only if he had
maintained proper accounts according to the
principles of accounting
 4. Aid to memory: - A businessman cannot
remember all the transactions however sharp his
memory may be therefore every transaction
should be recorded in so that there may not be any
mis-appropriation.
 5. Proof in the court of laws: - If the accounts of
the business are kept properly according to the
principles of accounting they can be presented in
6. Helpful in the realization of debts: - Accounting process is useful in
realizing of debts from other persons. As a proof of debts accounts books
can be produced in the court of law.
7. Helpful in making comparative study: - Systematic records enables
businessman to compare one year result with those of other years. Such
comparison reveals efficiencies of the concern so that necessary
connective action can be readily taken.
8. Helpful in planning: - Management has to plan its business operation
for years to come but planning cannot be done without adequate data
relating to past sales, output, expenses. The reason is that for any
forecast about the future, must be necessarily be based on the past
figures.
9. Makes decision making easy: - Management has to take literal
decisions from time to time about fixation of prices, discount to
customers, manufacturing of parts in the company’s own factory or
producing them from outside. Unless relevant Information is available to
the manufacturing it cannot take proper decisions.
10. Helpful in controlling the business: - Management should not only
plan business operation but it should also see that plans are actually
carried out and the costs are kept at minimum. Accounting helps the
management in this function (controlling) through sales budget, cost
budget etc.
 LIMITATIONS

1. Incomplete information’s: - Accounting records only

those transactions which are financial in nature.
Qualitative Factors such as competency of the
management, change in economic and political
situations, govt. policies, competition in the market
and change in consumer’s preference etc. are not
recorded in accounting though they affect the financial
soundness of the business.
2. In-Exactness: - Accountancy assesses profit or loss of <- DATA
the business on the basis of both the real and assumed
estimates. Accountants make the valuation of stock,
determine the method of depreciation and maintain
various reserves and provisions in any way they like.
Different firms have their own different methods so the
result of the business will change with the change in
practice.
3. Showing valueless assets: - There are certain assets which do not have
real value but they are shown in our balance sheet. These assets are
goodwill, patents, preliminary exp, discount on issue of shares etc.
Showing these assets in the books of accounts makes its result doubtful.
4. Manipulation: - Accounting results are based upon the information
supplied to it. The management may be biased and feed manipulated
Accounts can show the result of business as derive by the owners of the
business.
5. Ignorance about the present value of business: - While maintaining
books of accounts we follow going concern concept i.e. The business will
be carried on for indefinite period. With this principle in view we show the
value of our assets in the balance sheet as its book value and not at the
market value. Sometimes certain assets may be valueless in the market
but we continue to show it in the books of accounts.
 BOOK KEEPING

 According to A.H. Rozencomph : - Book-

Keeping is the art of recording business
transactions in a systematic manner.
 According to Botliboi: - Book-keeping may be
defined as the science of recording peculiary
transaction under appropriate heads.
 Accounting = Book-Keeping (recording,
classifying, summarizing) + Analysis and
interpretation
BASIS BOOK KEEPING ACCOUNTING
1.Scope BOOK Keeping involves (a) Accounting in addition to
identifying the transactions, Bookkeeping
(b) measuring the identified involves summarizing the
transactions classified Transactions,
(c) recording the measured analysing the summarized
transactions results, interpreting the
(d) classifying the recorded analysed results and
transactions. communicating the
interpreted information to
the interested parties

2 Stage Book-keeping is primary Accounting is the secondary

stage. stage. It starts
where bookkeeping ends.
3. Basic To maintain To ascertain net results of
Objective systematic records of operations and
financial financial position and to
transactions. communicate
information to the interested
parties.
4. Who Performs Performed by junior Accounting work is
staff. performed by senior staff.

5. Knowledge The book-keeper is not The accountant is required

Level required to have higher
to have higher level of level of knowledge than that
knowledge than that of of bookkeeper.
an accountant

6. Analytical The book-keeper may or An accountant is required to

Skill may possess analytical skill.
not possess analytical
skill.
7. Nature of Job Routine and clerical in The job of an accountant is
nature. analytical is nature.

8. Designing of It does not cover It covers designing of

Accounting System designing of accounts accounting system.
system.

9. Supervision & The book-keeper does An accountant supervises

Checking not and checks the work of a
supervise and check the book-keeper.
DOUBLE ENTRY SYSTEM OF BOOK-
KEEPING.
 This is a complete system of Accounting as both Debit and
Credit aspects of a transaction are recorded in the books of
accounts.
 The system is more reliable and accurate as the possibilities
of frauds and mis-appropriations are minimised.
 Arithmetic accuracies in records can mostly be checked by
preparing the trail balance.
 It is implemented by big as well as small organisations.
 Since double entry system follows specified rules of debit and
credit in recording transactions. It is more scientific as
compared to single entry system.
 LIMITATIONS

 1. Expensive system: Double entry system is quite expensive as a number

of books of original entry have to be maintained.
 2. High knowledge requirement: For maintaining books of accounts under
double entry system, person involved must have adequate and specialised
knowledge of accounting.
 3. Chances of errors: Though double entry system tries to ensure that
transactions are recorded properly through the preparation of trial balance
, it ensure that transactions recorded. Certain types of errors based on
omission, commission, principles and compensation are hard to identify.
 PRINCIPLES

 (i) Each business transaction affects at least two accounts.

 (ii) Each account is divided into two parts, i.e., Debit Side and Credit Side.
 (iii) Division of amount column of journal into Debit and Credit.
 (iv) Based upon accounting concepts and conventions.
 (v) Helps in preparing Trial Balance which is a test of arithmetical
accuracy in accounting. In a Trial Balance total of all debit is always equal
to the total of all credits.
 (vi) Preparation of final accounts with the help of Trial Balance.
 USER OF ACCOUNTING INFORMATION
AND THEIR NEEDS
 INTERNAL USERS
 1.Owners Owners are directly concerned with the financial performance
of the organisation. They need information related to profit or loss and
financial position of the organisation for safety of their capital Investment.
 2. Management Management needs accounting information for planning
and controlling purpose. They need to determine cost of product, selling
price, investment into new projects etc.
 3. Employees & Workers Employees and workers are interested in
financial statements to get salary increment, bonus which is determined on
the basis of financial performance and profit of the organisation.
 EXTERNAL USERS
 Banks Financial Institutions- They watch the
performance of business to ensure safety and
recovery of loan and payment of interest on their
loan.
 Investors- Investors need accounting information
to know earning capacity of enterprise for safety
of their investment and payment of dividend.
 Creditor Creditor are interested in knowing credit
worthiness of the organisation before allowing
credit sales of significant amount.
 Government Government needs accounting
information from different business organisations
for making policy and decision. Further, tax
authorities of various concerned governments
need financial information to evaluate whether the
taxes have been paid correctly by the
organisations.
 Public Public is interested in knowing whether the
organisations are running properly or not because
such organisations contribute to public welfare in
several forms like providing employment, making
goods available, undertaking projects meant for
 Industry Association An industry association keeps relevant records of
business operations including financial performance of its members for
analysis and providing suggestions to improve working of the industry.
 Stock Exchange Stock exchange keep financial records of those
companies whose shares are listed in stock exchange for trading. Existing
and prospective investors invest in shares of these companies.
 Researcher Researchers need information about financial performance
and financial position of the organisations for their research work.
 Consumer Association Consumer association are the not-for-profit
organisations established by consumers to protect their interest. These
associations need accounting information to assess whether the
organisation are making exorbitant profit at the cost of consumer’s
interest.
 QUALITATIVE CHARACTERISTICS OF
ACCOUNTING
(i).Reliability: Accounting information is meaningful only when it is reliable.
Accounting information has reliability when it
(a) has true representation of relevant transactions, (b) is verifiable by any one
and (c) is complete in all respects.
(ii).Relevance: In order to became effective tool for decision making, accounting
information should be relevant to its users. Accounting information has
relevance when it(a) influences decision of the users by helping them to
evaluate past, present or future events and (b) is received timely.
(iii).Understandability : Accounting information should have understandability
from the view point of users. Accounting information has understandability
when it is (a) presented in such a form which can be easily understood by the
users and (b) devoid of very critical accounting terms and jargons.
(iv). Comparability: To be useful, accounting information should have quality of
comparability. Accounting information should have quality of comparability.
Accounting information has quality of comparability when (a) information
belongs to similar period of time and (b) common unit of measurement and
formats of presenting information are used.
 SOME
IMPORTAN
T TERMS
 Business Transaction:-An economic activity that affects financial
position of the business and can be measured in terms of money. e.g., sale
of goods, paying for expenses etc.
 CAPITAL :- Amount invested by the owner in the firm is known as capital.
It may be brought in the form of cash or assets by the owner.
 FIXED CAPITAL: - The amount invested in acquiring fixed assets is called
fixed capital. The money is blocked in fixed assets and not available to
meet the current liabilities. The amount spent on purchase or addition to
the fixed asset is fixed capital, plant & machinery, vehicle, furniture and
building etc are some of the example of fixed capital.
 FLOATING CAPITAL: - Assets purchased with the intention of sales such
as stock and investment
 WORKING CAPITAL:- The part of capital available with the firm in day to
day working of the business in known as working capital.
Working Capital = Current Assets – Current Liabilities
 PROPRIETOR :- An individual or group of persons who undertake the risk
of the business are known as proprietor. They invest their funds into the
business as capital.
 Drawings:- The money or goods or both withdrawn by owner from
business for personal use, is known as drawings.
 ASSETS :- The valuable things owned by the business are known as assets.
Assets are the economic resources of an enterprise which can be expressed in
monetary terms. It help in generating the revenue in a business are called Assets.
There Assets are classified as :
 CURRENT ASSETS :- Current Assets are those assets which are held for short
period and can be converted into cash within one year. For example: Debtors,
stock etc.
 LIQUID ASSETS :- Liquidity refers to convertibility in cash. Liquid Assets are
those Assets which can be counted into cash at short notice. The example of
Liquid Assets are cash in hand , cash at bank , debtors , B/R etc.
 Liquid Assets = Current Assets – (Stock + Prepaid exp.)
 NON-CURRENT ASSETS /FIXED ASSETS:- Non-Current Assets are those assets
which are hold for long period and used for normal business operation. For
example: Land, Building, Machinery etc .
 TANGIBLE ASSETS :- Tangible Assets are those assets which have physical
existence and can be seen and touched. Tangible Assets can be fixed Assets as
well as current Assets. Example :- cash , Building , Plant & Machinery , Stock etc.
 INTAGIBLE ASSETS:- Intangible Assets are those assets which have no physical
existence and can not be seen or touched. e.g. Goodwill, Software, Trademark,
Patents etc.
 FICTITIOUS ASSETS :- Fictitious Assets are those Assets that don’t have physical
from. They don’t have any real value. They are not the real Assets but they are
called assets on legal and technical grounds. These assets are the revenue
expenditure of capital nature which are also termed as. deferred revenue
LIABLITY TO OWNERS :- It is the owners claim against the assets of the business , generally known as capital. It is also
known as internal equity or shareholders funds.
Owners Equity Or Capital + Profit earned + Retained Earning OR Undistributed Profit
Internal Equity + Interest on Capital – Drawings – Expenses
 CREDITORS EQUITY: - It is creditors claim against the assets of the business. There creditors may be creditors for goods
and creditors for expenses.
 CREDITORS IN GOODS :- Business has to purchase goods on credit so the supplies of goods to the business on credit are
known as creditors for goods. They maybe called creditors and bills payables.
 CREDITORS :- The persons from whom goods are purchased on credit are called creditors. The sellers of goods on credit
to the firm are known as its creditors. They will continue to remain the creditors of the firm so far the full payment is made
to them.
 BILLS PAYABLE :-In case of bills payable the business man accepts a written order from others. It happens in case of
credit purchases. In this case if business man puts his signatures on the written order then it is said that bill has been
accepted by the business man and becomes bills payable in him.
 CREDITORS FOR LOAN :- There creditors are the parties , bank and other financial institutions. The liability is named as
bank loan , bank overdraft , loan from industrial finance corporation etc.
 CREDITORS FOR EXPENSES :- Any expenses which has become due in payment but payment is not made is called
outstanding expenses. Any persons to whom such payment is to be made is called creditors for expenses. e.g. O/S salaries
, O/S cash , O/S rent.
 LIABILITIES :-Liabilities are obligations or debts that an enterprise has to pay after some time in the future.
 Liabilities can be classified as:
 FIXED LAIBLITIES/NON-CURRENT LIABILITIES :- The liabilities against which payment are to be made after a long time
are called long term liabilities. e.g. capital , loan , debentures , mortgage , etc.
 CURRENT LIABLITY :-The liabilities against which payment are to be made in a shorter period , usually less than are year
are called current or short term liabilities creditor, bills Payable, o/s expenses etc.
 CONTINGENT LIABLITY :-These are not the real liabilities. Future events can only decide whether it is really a liability or
not. Due to their uncertainty, these liabilities are termed as contingent (doubtful ) Liabilities.
 EG- - Value of bills discounted
- Cases pending in the court of law
 RECEIPTS:-
 1. REVENUE RECEIPITS :- Revenue Receipts are those receipts which are occurred by normal
operation of business like money received by sale of business products.
 2. CAPITAL RECEIPTS:-Capital Receipts are those receipts which are occurred by other than
business operation like money received by sale of fixed assets.
 EXPENSES:- Generating income is the foremost objective of every business. The firm has to use
certain goods and services to produce articles sold by it, payment for these goods and services
is called expenses. Costs incurred by a business for earning revenue are known as expenses. For
example: Rent, Wages, Salaries, Interest etc,
 EXPENDITURE:-Spending money or incurring a liability for acqur4ing assets, goods or services
is called expenditure. The expenditure is classified as:
 1. REVENUE EXPENDITURE :-If the benefit of expenditure is received within a year, it is called
revenue expenditure, For Example : Rent, Interest etc.
 2. CAPITAL EXPENDITURE:- If benefit of expenditure is received for more than one year, it is
called capital
 expenditure, Example: Purchase of Machinery.
 DEFERRED REVENUE EXPENDITURE :- There are certain expenditures which are revenue in
nature but benefit of which is derived over number of years. For Examples: Huge Advertisement
Expenditure.
 PROFIT:-The excess of revenues over its related expenses during an accounting year is profit.
 Profit = Revenue─ Expenses
 GAIN:- A non-recurring profit from events or transactions incidental to business such as sale of
fixed assets, appreciation in the value of an asset etc.
 LOSS:-The excess of expenses of a period over its related revenues it termed as loss.
 Loss = Expenses ─ Revenue
 GOODS:-The products in which the business deal in. The items that are
purchased for the purpose of resale and not for use in the business are called
goods.
 PURCHASES:- The term purchase is used only for the goods procured by a
business for resale. In case of trading concerns it is purchase of final goods and
in manufacturing concern it is purchase of raw materials. Purchases may be
cash purchases or credit purchases. Purchase of goods (not of property or
assets) either for cash or credit are termed as purchases.
 Total Purchases = Cash Purchases + Credit Purchases
 Net Purchases/ Net Total Purchases = Total Purchases – Purchases Returns
 PURCHASE RETURN OR RETURN OUTWORD OR RETURN (CR) :- It is that
part of purchases of goods, which is returned to seller. This return may be due
to unnecessary , excessive and defective supply of goods.
 SALE:- Sales are total revenues from goods sold or services provided to
customers. May be cash sales or credit sales.
 Total Sales = Cash Sales + Credit Sales
 Net Sales/ Net Total Sales = Total Sales – Sales Return
 SALES RETURN OR RETURN INWORD OR RETURN (DR) :- It is that pant of
sales of goods which is actually returned to us by purchases. This return may
also be due to excessive , unnecessary and defective supply of goods.
 GOO
D

PURCHASING
SELLING
 DEBTORS:- Debtors are persons and/or other entities to whom business has
sold goods and services on credit and amount has not received yet. These are
assets of the business.
 CREDITORS:- If the business buys goods/services on credit and amount is still
to be paid to the persons and /or other entities, these are called creditors.
These are liabilities for the business.
 BILL RECEIVABLE:-Bill Receivable is an accounting term of Bill of Exchange. A
Bill of Exchange is Bill Receivable for seller at time of credit sale.
 BILL PAYABLE:-Bill payable is also an accounting term of Bill of Exchange, A
Bill of Exchange is Bill Payable for purchaser at time of credit purchase.
 DISCOUNT:-It is the rebate given by the seller to the buyer. It can be classified
as:
 1. TRADE DISCOUNT :- The purpose of this discount is to persuade the buyer to
buy more goods. It is offered at an agreed percentage of list price at the time
of selling goods. The discount is not recorded in the accounting books as it is
deducted in the invoice/cash memo.
 2. CASH DISCOUNT:- The objective of providing cash discount is to encourage
the debtors to pay the dues promptly. This discount is recorded in the
accounting books.
 3. QUANTITY DISCOUNT :- As the name implies this type of discount is given to
customer to encourage them to purchase in large quantities.
 ACCOUNT:- Account refers to a summarized record of relevant transactions of
particular head at one place.
 STOCK:- The goods available with the business for sale on a particular date is
known as stock. The goods available with the business in sale on a particular
date is termed as stock. It varies i.e. increase or decrease and goes on
changing. In accounting there are two terms in stock.
 1. Opening Stock :- Stock in the beginning of the financial year.
 2. Closing Stock :- Stock at the end of the year is called closing stock.
 COST:- Cost refers to expenditures incurred in acquiring manufacturing and
processing goods to make it saleable.
 LOSSES :- Losses are unwanted burden which is business is forced to bears.
Losses are different from expenses in the sense that expenses are voluntarily
incurred to generate income where losses are forced to bear.
 There are two types of losses.
 1. NORMAL LOSSES :-It is due to inherent weakness in the commodities. E.g.
coal , cement , oil , ghee , ice , petrol. There will be shortage in their weight due
to leakage , evaporation , spoilage and wastage during the journey.
 2. ABNORMAL LOSS :- Loss due to earthquake , fire , flood , storm , theft and
accident.
 EVENTS :- Any happening of the business, monetary or non-monetary i.e. use
of raw material in production.
 ENTITY :- An entity means an economic units that perform economic activities
 TRANSACTION :-An event the recognition of which gives rise to an entry in
accounting records or a business activity or event which has taken place.
 VOUCHER :- The documentary evidence in support of a transaction is known as
voucher. For example, if we buy goods for cash we get cash memo, if we buy
on credit, we get an invoice, when we make a payment, we get receipt and so
on.
 ENTRY:- The record of a transaction or event in the books of account is known
as entry.
 ACCOUNTING YEAR :- Period containing 12 months and books are closed
annually is known as accounting year.
 OUTSTANDING INCOME OR ACCRUED INCOME :- Income due but not
received is called o/S income.
 PREPAID EXPENSES OR UNEXPIRED EXPENSES :-If expense paid in
advance is called prepaid expenses.
 RECEIVED IN ADVANCE OR UNEARNED INCOME :- If any things received in
advance is called received in advance.
 OUTSTANDING EXPENSES:-Expenses due but not paid is called outstanding
expenses.
 ACCOUNT :- An account is a register of a particular class of money transaction.
 BROUGHT FORWORD(b/d) :- Used to open an A/C in current year by posting
the closing balance of previous year.
 CARIED DOWN(c/d) :- The term is used to balance an account.