What is Accounting?

Accounting a process of identifying, analyzing, recording, summarizing, and reporting economic information to decision makers in the form of financial statements. It is an information system that identifies what information is to be included or excluded from the system, records that information and communicates that information to the users who are interested. Accounting is a system that provides information on:

Amount of resources How resources were financed How were these resources invested. Results achieved by using these resources

A widely accepted definition of accounting has been provided by the American Accounting Association. According to this definition accounting is the process of identifying, measuring and communicating information to permit judgement and decisions by the users of accounts. This definition implies that (1) there should be users of accounts who need relevant information, (2) the information should enable the users to make judgement and decisions, and (3) transactions and events are measured and the data are processed and then communicated to the users through accounting.

Financial accounting focuses on the specific needs of decision makers external to the organization (e.g. stockholders, suppliers, banks, and government agencies). Financial Accounting is based on double entry system of accounting which comprises of (i) recording of business transactions in the books of prime entry, (ii) posting into respective ledger accounts, (iii) striking balance, and (iv) preparing the performance statement (profit and loss statement) and position statement (balance sheet). Financial Accounting is concerned with the collection, recording, classification and presentation of financial data to serve the purposes of the management, shareholders and stakeholders, such as, creditors, bankers, Government, etc. Who Cares? Accounting information is useful to anyone who needs to make a decision based upon the companys performance and potential. For example:

Investors Owners Managers Creditors Legislators

Etc.

Aim of Accounting: The basic aim of accounting in a business entity is to provide financial information for making decisions on its activities. Managers of an economic entity at various levels require analyzed financial information for planning and programming, for controlling expenditure, for ascertaining the extent of profitability or otherwise of a department even of each production item for undertaking new jobs, etc. To provide sufficient information for users to make informed business decisions. Accounting helps in decision making by showing where and when money has been spent, by evaluating performance, and by showing the implications of choosing one plan instead of another. From Pure Accounting Viewpoint : the fundamental accounting equation is:

Debit = Credit And, Assets = Liabilities And, Assets = Internal Liabilities + External Liabilities And finally, Assets = Capital + Liabilities; or A = C + L Capital = Assets Liabilities Assets = Liabilities + Owners equity. Assets = Liabilities + Capital Withdrawals + Revenue - Expenses

Jargons: Assets :

Are probable future economic benefit obtained or controlled by a particular entity as a results of past transactions or event. A resource owned or controlled by an entity that is expected to provide benefits to business in the future. Owned (owner has a legal title to asset) Provide benefit now and in future Examples of assets:

Cash Accounts Receivable Office Supplies Equipment Building Machinery Stationery Other assets

Liabilities:

Are probable future sacrifices of economic benefits, arising from a present obligation. Something that the business currently owes to another party

Examples of Liabilities

Accounts payable Bank Loan Loan payable

Equity:

Is the residual interest in the assets of an entity that remains after deducting its liability Represents the value of the assets of the business that the owner can claim Assets Liabilities In business enterprises the equity is the ownership interest Ownership of the assets

Capital :

Contributions that the owners invest into the business.

Capital Employed :

Own + Loan capital

Revenues :

Amounts earned by a firm in the ordinary course of business Commonly earned by providing goods or services to customers Any increase in owners equity

Expenses:

Costs incurred by the firm to earn revenues Incurred in the ordinary course of business

Process of Accounting :

Creating necessary accounting heads Assets Liabilities Equity Income and Expense Double entry system Accounting equation Yield financial statements

Transaction Analysis Two rules to apply

Each transaction has at least two entries : Double entry system The accounting equation must always remain in balance ( A= L + E)

Elements measuring financial position are:

Assets Liabilities Equity These result in Balance sheet

Elements measuring performance are:

Revenue Expenses These result in Profit and Loss statement

Four Financial statements: IRBC 1) Income statement 2) Retained Earning statement 3) Balance Sheet 4) Cash flow statements Six Account types: DEALOR 1) 1. 2) 1. 3) 1. Dividends Retained earnings statement Expenses Income statement Assets Balance sheet

These three are recorded as Debit 4) 1. 5) 1. 2. 6) Liabilities Balance sheet Owners equity Common stock -> Balance sheet Retained earnings -> Retained earnings statement Revenue

1.

Income statement

These three are recorded as Credit Three transaction types: 1) Operating 2) Investing 3) Financing Used to complete cash flow statements.