INTRODUCTI0N TO ACCOUNTING -- 1 -

INTRODUCTI0N TO ACCOUNTING AND BASIC CONCEPTS

Definition of the term Accounting
The American Institute of Certified Public Accountants(AICPA) has defined
accounting as “the art of recording, classifying and summarizing, in a significant
manner and in terms of money, transactions and events which are, in part at least,
of a financial character and interpreting the results thereof.”
Functions of Accounting
Based on the above definition the functions of accounting can be discussed
as follows:
1. Identifying
It is the first step in the process of accounting is identifying or determining the
business transactions that are the transactions of financial character that are
required to be recorded in the books of accounting.
2. Measuring
The second step in the process of accounting is measuring the business
transactions. Measuring the business transactions means expressing the value of
the business transactions in terms of money.
3. Recording
Recording means entering the business transactions in terms of money, as and
when they occur, date-wise, in a systematic manner, in the books of original entry.
(either journal or subsidiary books)
4. Classifying (Posting)
Classifying means grouping of the entries of like nature found in the book or
books of original entry into appropriate heads periodically by positing or
transferring the entries in the book or books of original entry to appropriate
accounts in the ledger.
5. Summarizing
Summarizing means summarizing or condensing the effects of the
transactions grouped or classified in the form of accounts in the ledger, upon the
profit and the financial position of the business into meaningful figures, and
presenting them in the form of financial statements like the profit and loss account
and the balance sheet. In short, it means the preparation and presentation of
financial statements like the profit and loss account and the balance sheet.

6. Analyzing and interpreting

Analyzing and interpreting means re-arranging the summarized data in the
financial statements and explaining the significance of those data in a manner that

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the end user of the financial information can make meaningful judgments about
the profitability and the financial positions of the business.
Users of accounting Information
Shareholders
Debentureholders
Banks and other Financial Institutions
Creditors
Prospective Investors
Employees
Government
Customers
Consumers
Stock exchanges
Security or investment analysts
Economists and researchers
General public

Principals of Accounting
Accounting is the language used by a concern for communicating financial
information about itself to all those who are interested in knowing them. As such,
the language of business, the accounting should be clear to the persons to whom
the communication is made. To make the language of business or accounting
clear to the different groups of persons, a number of rules or principles have been
agreed upon and followed by accountants in the writing up of accounts and in the
presentation of financial statements. The general rules or principles adopted in
accounting are called accounting standards or accounting principles.
1. Money measurement concept or common denominator concept or
monetary unit assumption
The money measurement concept means that, in accounting, a record is made
only of those transactions or events, which can be measured and expressed in
terms of money. Non monetary events like the retirement of the managing director
of a concern, the good quality of the products produced by the production
manager of the concern, etc. are not recorded, though they are also material
events, as they cannot be measured and expressed in terms of money.
Another important feature of this assumption is that business transactions are
recorded in books of accounts in terms of the values of money at the transactions
are recorded. The money measurement concept has one great advantage. It
helps a concern to express items of diverse nature, such as bank balance, stock-
in-trade, furniture, machinery, buildings and so on in terms of a common
denominator, money and add them up for the purpose of knowing the total worth
of assets at any particular time.

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However, the money measurement concept has one serious limitation. As only
monetary transactions are recorded in account books, and no record is kept of
non-monetary events, accounting records do not give a complete picture of all the
happenings in a concern.
2. Accounting entity concept, economic entity assumption, business entity
concept or separate entity concept
Legally only a joint stock company is a distinct entity apart from the
shareholders owning it. But, in accounting, every business undertaking, whether it
is a sole-trading concern or a partnership firm or a joint stock company is
considered a distinct entity from the persons who own it.
The Significance of this concept is:
a. All the transactionsof a business are recorded in the books of the business,
& not in the personal boos of the proprietor of the business.
b. All the transaction of a business are recorded from the point of view of the
business, and not from the point of view of the owner of the business.
c. Only the transactions of the business are recorded. The personal affairs or
transactions of the owner of the business are not recorded in the books of
the business.
The benefits of this concept are:
a. As the business is regarded as a separate entity, the transactions between
the proprietor of the business & the business are recorded in the books of
the business. It is on account of this concept that the capital invested by the
proprietor of the business is regarded as money borrowed by the business
from the proprietor.
b. The affairs of a business account can be kept separate from the private
affairs of the owners of the business.
c. The profit or loss of the business can be easily ascertained.
3. Going concern concept, concept of continuity or continuity assumption
The going-concern concept means that, in accounting, an enterprise is
considered as a going concern (i.e. a concern that will continue to operate fro a
fairly long time), & it is from this point of view, its transactions are recorded in its
books.
It should be noted that this concept does not mean permanent continuance of
a business. What it really means is that a business will continue to operate for a
fairly long period of time.
The benefits of this assumption or concept are as follows:
a. It makes a distinction between revenue expenditure & capital expenditure
possible & meaningful.
b. Imparted (i.e. given) significance to cost concept.

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c. That the fixed assets are valued for the purpose of balance sheet at their
cost prices.
d. The working life of the fixed assets is taken into consideration.
e. The outstanding expenses & outstanding incomes, & prepaid expenses &
pre-received incomes (i.e. incomes received in advance) are taken into
account, while preparing the final accounts.
f. They give long-term-loans to the business, invest money on the debentures
of the company, etc.
g. This concept has given birth to the accounting period concept.
4. Cost concept or historical cost concept
An asset acquired by a concern is recorded in the books of account at cost
(i.e. at the price actually paid for acquiring the asset).

The Significance of this concept is:

a. Recorded in its books of accounts at their cost prices (i.e. the prices paid
for their acquisition).
b. If a concern has not paid anything fro an item, i.e. an asset, which it has,
then, that item is, usually, not recorded in its books i.e. goodwill.
c. It is only the fixed assets that are shown in the balance sheet at cost.
Balance sheet at a cost or market price, whichever is lower, though they
are acquired at cost.

The benefits of accost concept are as follows:

a. The fixed assets of a business have to be valued, taking into consideration
their market values, every year when financial statements are prepared.
b. The estimation of depreciation on fixed assets easy, in the sense that, for
the estimation of depreciation of an asset.
c. Depreciation is a process of allocation.

5. Dual aspect concept, equation concept or accounting equation concept

Every business transaction always results in receiving of some benefit of
some value & giving of some other benefit of equal value. When a business
purchases goods for cash or sells goods for cash, it receives cash of some
value & gives goods of equal value.
Each transaction of a concern has dual or double effects, namely –
a. An increase in the assets & a corresponding increase in the liabilities or the
proprietor’s capital.
b. A decrease in the assets & a corresponding decrease in the liabilities or the
proprietor’s capital.
c. A decrease in some asset or assets & a corresponding increase in some
other asset or assets without any change in the liabilities.
d. A decrease in some other liability or liabilities & a corresponding increase in
some other liability or liabilities without any change in the assets.

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At any moment of time,

Assets = liabilities + proprietor’s capital
The benefits of this concept are:
a. The dual aspect concept or the accounting equation concept is very useful
in accounting. It forms the very basis fro recording every business
transaction in the books of a concern.
b. The accounting equation, assets – liabilities = capital, helps a concern to
determine its profit or loss.
6. Accounting period concept or periodicity of accounts
The accounting period concept comes from the going concern concept.
Accounting to the going concern concept, a business is likely long period of time.
As such, the financial results of the business operations (i.e., the profit or loss and
the financial position of the business) can be ascertained only after the liquidation
of the business. It is true that such results (i.e., the financial results ascertained on
liquidation of business) are accurate.

7. Objective evidence concept

That all entries should be evidenced & supported by business documents,
such as invoices, vouchers, etc. This concept also implies that the evidences must
be completely objective (i.e. must state the facts ads they are without bias or
fraud), & must be subject to verification by auditors.

The benefits of this concept are:

a. Objective & true accounting records & financial statements.
b. The accounting records & the financial statements of business concerns
will be accepted by various groups of people interested in accounting
information with confidence.

8. Matching concept or periodical matching concept

Every businessman invests money in the business with the main objective of
earning profit. So, naturally he would like to know the amount of profit earned from
his business. With mere information about the net profit or net loss of the
business. It wants the details of all revenues (which increase the profit) & all
expenses (which reduce the profit). Detailed information about all the items of
revenue & all the items of expenses & losses is necessary.
The process of matching revenues & costs involves the following steps:
a. Identification & measurement of revenues for the accounting period.
b. Identification & measurement of the expenses incurred during the
accounting period for earning the revenues.
c. Matching or comparing of total revenues & total expenses.

The benefits of this concept are as follows:

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a. It ensures proper recognition of revenues & expenses required for the

matching of expenses with revenues.
b. Matching concept is of great significance for the ascertainment of net profit
or loss of a concern periodically, i.e. every year
c. It provides a sound basis, viz. the accrual basis, for the ascertainment of
the correct profit or loss of the business.

9. Realization concepts or recognition concept

It is true that revenue results from the sale of goods or from the service
rendered. But the question is as to when the revenue results from the sale of
goods or the service rendered. The realization concept gives the answer to this
question. Revenue is recognized or is considered as being earned on the date on
which it is realized. Revenue is considered as being realized, not when goods are
manufactured or order is received or contract is signed, but on the date on which
goods or services are transferred to the customer & the customer becomes legally
liable to pay for them.

The benefits of this concept are as follows:

a. The revenue recognition concept is of much significance for the preparation
of financial statements, particularly the profit & loss account.
b. This concept has contributed to the accrual basis of accounting.
c. This concept gives objectivity & definiteness to revenue recognition.

10. Accrual concept

While the realization concept is mainly concerned with the recognition of
revenues, the accrual concept is concerned with recognition of both revenues &
expenses. In short, the accrual concept emphasizes the realization concept in
regard to both revenues & expenses.
The benefits of the accrual concept are as follows:
a. Great help for the preparation of financial statements.
b. This concept has led to the introduction of accrual system of accounting as
opposed to cash system of accounting.
c. This concept has given sound accounting principle in respect of recognition
of revenues & expenses.

11. Legal aspect concept

The accounting records & books should reflect the legal position. For example,
if goods are sold by a concern on approval basis, in accounting, the customers to
whom goods are sold on approval basis should not be shown as debtors unless
the goods are approved by them.
The benefits of this concept are:
a. It ensures that the accounting records reflect the legal position.

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b. It satisfies the requirement of law.

Branches of accounting
There are four branches of accounting
1. Financial accounting: It is the process of identifying, measuring,
recording, classifying, summarizing, analyzing, interpreting and
communicating the financial transaction and events. The purpose of this
branch of accounting is to keep systematic records to ascertain financial
performance and financial position and to communicate the accounting
information to the interested parties.
2. Cost accounting: It is the process of accounting and controlling the cost
of a product, operation or function. The purpose of this branch of
accounting is to ascertain the cost, to control the cost and to communicate
information for decision-making.
3. Management accounting: It is the application of accounting techniques
for providing information designed to help all levels of management in
planning and controlling the activities of business enterprise and in decision
making. The purpose of this branch of accounting is to supply any and all
information that management may need in taking decision and to evaluate
the impact of its decisions and actions. Management accounting is not only
confined to the area of cost accounting but also covers other areas (such
as capital expenditure decisions, capital structure decisions, divided
decision) as well.
4. Social responsibility accounting: It is the process of identifying,
measuring and communicating the social effects of business decisions to
permit informed judgment and decisions by the users of information’s. It is
accounting for social responsibility aspects of a business. Management is
held responsible for what it contributes to the social well being and
progress. Accounting for environment and ecology is part of the social
responsibility accounting.

TERMINOLOGY
1. Business Transaction
Financial accounting is concerned with the recording of the transactions
of a business in its books of account so as to ascertain their results(i.e, the profit
and loss and the financial position of the business) at the end of every accounting
year. So, it is necessary to have some idea about the term ‘transaction’, ‘business
transaction’ or ‘financial transactions’.

Definition and Meaning of Transaction:

In the words of Field house, “Every financial change which occurs in your
business is a transaction”.

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According to Noble and Niwonger, “ Any happening which brings change

in the pattern of assets or liabilities or proprietorship of a business concern
is a financial transaction to it”.
From these definitions, it is clear that, in accounting, the term ‘transaction’
refers to any event, which changes the financial position of the business concern.
In other words, business transaction refers to any event, happening, dealing or
activity which is measurable in terms of money, which, generally, involves
exchange (i.e some value or benefit) between the business and any other person
including the proprietor of the business, and which results in a change in the
financial position of the business. In short, a transaction refers to any monetary or
financial event or activity (i.e. an activity having value measurable in terms of
money), which changes the financial position of the business.
Types of transactions or Business Transactions
Business transactions can be classified into four types, they are:
a. Cash transactions
b. Credit transactions
c. Barter transactions
d. Paper transactions
a. Cash Transactions
A cash transaction refers to any business transactions where the value of the
transactions is met (i.e. received or paid) in cash immediately or readily.
b. Credit transactions
A credit transaction is a business transaction where the value of the
transaction is not met (i.e. not received or not paid) immediately, but is postponed
to a future date.
c. Barter transactions
A barter transaction is a business transaction where, no doubt, there is an
exchange (i.e. receiving of some benefit & giving of some benefit) simultaneously,
but the exchange of benefit is not in terms of money (i.e. not in terms of cash), but
in terms of money’s worth (i.e. in kind).
d. Paper transactions
A paper transaction is a business transaction where there is no question of
meeting (i.e. receiving or paying) the value of the transaction.
2. Goods
Goods refer to merchandise, commodities, products, articles or things in which
a trader deals. In other words, they refer to commodities or things meant for
resale. For example, for a stationery articles like books, pens, pencils, etc. are his
goods; for a furniture dealer, furniture, such as tables, chairs, benches, etc., are
his goods or a cloth merchant, cloths are his goods.
Sub-divisions of goods or accounts related to goods.
a. Purchases

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b. Sales
c. Purchases Returns (also known as Returns Outwards, Returns to suppliers)
d. Sales Returns ( also know as Returns Inwards, Returns from customers)
e. Opening stock
f. Closing stock

3. Liabilities
Liabilities mean debts or amounts due from a business to others either for
money borrowed
or for goods or assets purchased on credit or for services received on credit
(i.e. services received without making immediate payment for
the same) loans borrowed, bank o/d, creditors, bills payable, outstanding
expenses, etc. are examples of liabilities.

4. Drawings
Drawings refer to cash, goods or any other assets withdrawn (i.e. taken
away) by the proprietor from his business for his personal or domestic use. It
also includes the personal or domestic expenses of the proprietor paid by the
business (i.e. paid out of business money).

5 Debtor
A Debtor is a person who owes money to the business. He owes money to
the business because he has received some benefit from the business. A
debtor contributes an asset for the business.
A debtor may be (a) a trade debtor, (b) a loan debtor, (c)a debtor for an asset
sold on credit or (d) a for debtor for the service rendered on credit.

6 Debt
The amount due from a debtor to the business is called a debt.

7 Book debt
Book debt is nothing but debt. It is called book debt, as it is the amount due
from the debtor as per the books of account.

8 Good debt
Good debt refers to full recoverable debt.

9 Bad Debt
Bad debt is irrecoverable is called a bad debt.

10 Doubtful Debt
A debt whose recover is doubtful is called a doubtful debt.

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11 Creditors
A creditor is a person to whom the business owes money. The business
owes to him, because he has given some benefit to the business. A creditor
constitutes a liability for the business.
A creditor may be
i. Trade creditor
ii. A loan creditor
iii. A creditor for an asset purchased on the credit
iv. Expenses.

12 Solvent
A businessman is said to be solvent, when he is able to pa his liabilities in
full (i.e., when his assets exceed his liabilities).

13 Insolvent
A businessman is considered to be insolvent, when he is not able to pay his
liabilities in full, i.e. when his assets are less then his liabilities.

14 Revenue or Income
Revenue or income refers to the earnings of a business. It includes the sale
proceeds the sale proceeds of goods, receipts for services rendered and
earnings from interest, dividend, rent, commission, discount etc.

15 Expenses
An expense refers to an expenditure in return for which some benefit is
received, and the benefit received is enjoyed and exhausted immediately. Cost
of goods sold, salaries, printing and stationary, postage and telegram, rent,
interest, commission, etc are examples of expenses.

16 Loss
Loss refers to money or money’s worth given up without any benefits in
return. It refers to any expenditure in return for which no benefit is received.
Loss of goods by fire, loss of cash by theft, damages paid to others, etc are
examples of losses

17 Debit
It means the benefit received by that account.
18 Credit
It means the benefit given by an account.

19 Account

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Account refers to a summarized record of all the transactions relating to

particular person, thing, (i.e. an account) or a service (an expense or an
income), which have taken place during a given period of time.

20 Books of accounts
Books of accounts refers to suitably ruled account books in which business
transactions are recorded. There are two types of books of accounts
maintained by a business concern. They are:
i. Journal or subsidiary books
ii. Ledger

21 Journal
A journal is a daily record of business transactions. It is a book of original,
prime or first entry in which all the business transactions are first entered in the
specified manner in the order of dates. It is maintained under the theoretical
system of book-keeping.

22 Ledger
A ledger is an account book in which all the accounts are maintained. It
contains all the accounts of a business in a well-arranged form. It is a book of
final entry, in the sense that all the transactions are finally recorded in the
ledger. It is the principal, chief or main book of accounts in the sense that it is
from this book that a businessman can obtain the final information relating to
his business.

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Journalized the following transactions.

2005, April 1. Shree Vijay commenced business with a cash of Rs. 50,000, Stock
Rs. 40,000 and Furniture worth Rs. 10,000.

2005,April 2. Borrow from X Rs. 40,000.

2005, April 4. Opened a bank account with Rs. 20,000
2005, April 6. Bought goods of Rs. 30,000 from X, paid Rs. 10,000 by cheque
and Rs. 10,000 in cash.
2005, April 8. Sold goods of Rs. 50,000 and received Rs. 30,000 by
cheque.
2005, April 10. The above cheque deposited into bank Rs. 20,000
2005, April 12. Sold goods to kashave Rs. 15,000
2005, April 15. Bank charged Rs. 5 as collection charges.
2005, April 18. Cash received from kashave Rs. 10,000
2005, April 19. Settled X’s account and the allowed cash discount of 5%.
2005, April 20. Purchased goods of Rs. 10,000 From Naveen and he allowed
at discount on 10%.
2005, April 21. Kashave become insolvent and 0.40 piece in a rupee was
recovered.
2005, April 24. Sold goods on Rs. 20,000 to Sunil at trade discount of Rs.
10% and 5% cash
2005, April 25. Interest credited by the bank of Rs. 50 and branch charges
office debited there in Rs. 15
2005,April 26. Bought a second hand scooter for his son Rs. 6,000. Paid Rs.
2,000 in cash, Rs.1,000 by cheque and the balancing goods.
2005,April 27. Purchased a second hand machinery of Rs. 40,000. From
HNT limited and spent Rs. 15,000 on the repairs, transportation and
installation.
2005,April 28. Bought fixture of Rs. 10,000 and issued a cheque.
2005, April 29. Bought goods on Rs. 5,000 from Manohar and issued a
cheque.
2005,April 30. Rent outstanding Rs. 1,000
2005,April 30. Depreciation charged on Furniture Rs. 500

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JOURNAL ENTRIES

Date Particulars LF Debit Credit

(Rs) (Rs)
2004 Cash A/c Dr 50,000 -
April 1 Furniture A/c Dr 10,000 -
Stock A/c Dr 40,000 -
To Capital A/c Cr - 1,00,000

April 2 Cash A/c Dr 40,000 -

To X’s A/c Cr - 40,000

April 4 Bank A/c Dr 20,000 -

To Cash A/c Cr - 20,000

April 6 30,000 -
Purchases A/c Dr
- 10,000
To Cash A/c Cr
- 10,000
To Bank A/c Cr
- 10,000
To X’s A/c Cr

April 8 30,000 -
Cash A/c Dr
20,000 -
Debtors A/c Dr
- 50,000
To Sales A/c Cr
April 10 30,000 -
Bank A/c Dr - 30,000
To Cash A/c Cr
April 12 15,000 -
Keshav’s A/c Dr - 15,000
To Sales A/c Cr
5 -
April 15 Bank Charges A/c Dr - 5
To Bank A/c Cr

April 18 Keshav’s A/c Dr 10,000 -

To Cash A/c Cr - 10,000

April 19 10,000 -
X’s A/c Dr
- 9,500

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To Cash A/c Cr - 500

To Discount A/c Cr

9,000 -
April 20 Purchases A/c Dr - 9,000
To Cash A/c Cr

April 21 Cash A/c Dr 2,000 -

Bad debts A/c Dr 3,000 -
To Keshav A/c Cr - 5,000

April 24 Cash A/c Dr 17,100 -

Discount A/c Dr 900 -
To Sales A/c Cr - 18,000

April 25 Bank A/c Dr 50 -

To Bank Interest A/c Cr - 50

April 25 -
Bank Interest A/c Dr
15 15
To Bank A/c Cr
-

Drawing A/c Dr
April 26 6,000 -
To Cash A/c Cr
- 2,000
To Bank A/c Cr
- 1,000
To Sales A/c Cr
- 3,000

April 26 Machinery A/c Dr 55,000 -

To HMT Ltd A/c Cr - 40,000
To Cash A/c Cr - 15,000

April 28 Fixtures A/c Dr 10,000 -

To Bank A/c Cr - 10,000

April 29 Purchases A/c Dr 5,000 -

To Bank A/c Cr - 5,000

April 30 Rent A/c Dr 1,000 -

To Outstanding A/c Cr - 1,000

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April 30 Depreciation A/c Dr 500 -

To Furniture A/c Cr - 500

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