Introduction to Accounting

Basics of Accounting and Book Keeping

"Accounting is the language of business"

Accounting - Accounting is a systematic process of recording, classifying, summarising, analysing and interpreting the financial transactions and communicating the results to the users thereof.

In short, Accounting can be defined as - Accounting is the process of recording and summarizing financial information in a useful way.

Accounting is also known as 'Language of business', since it acts as the medium of communication among different stakeholders of the business.

American Institute of Certified Public Accountants defined it as - 'Accounting is the art of recording, classifying and summarising 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.' 

In 1970, the Accounting Principles Board (APB) of American Institute Certified Public Accounts (AICPA) enumerated the functions of accounting as follows:

"The function of accounting is to provide quantitative information, primarily of financial in nature, about economic entities, that is needed to be useful in making economic decisions."

Note - Luca Bartoloeo de Pacioli, an Italian Mathematician is known as the 'Father of Accounting'.

Characterstics of Accounting 

1. Identifying
2. Measuring the identified transactions
3. Recording
4. Classifying
5. Summarising
6. Analysing and interpreting
7. Communicating

Identifying - Accounting records only those transactions and events which can be measured in terms of money.

Measuring the identifying transactions - Financial transactions and events are measured in terms of money. Events which cannot be measured in terms of money are not recorded in the books of account.

Recording - Recording is the process of recording business transactions of financial character.

Note - The process of Accounting starts by first identifying the events and transactions which are of financial character and then be recorded in the books of account. This recording is done in Journal or Subsidiary Books, also known as Primary book of accounting.

Classifying - Classifying is the process of grouping transactions or entries of one nature at one place.

Summarising - This involves presenting the classified data in a manner which is understandable and useful for internal as well as external users.

Note - After the events and transactions are recorded, they are transferred to the Secondary books of account known as Ledger. In ledger, transactions and events are classified in terms of income, expense, assets and liabilities.

Analysing and Interpretation - It is carried out so that the users of financial data can make meaningful judgement.

Communicating - It involves communicating financial statement to users (internal as well as external users).

Objective of Accounting 

1. Maintaining systematic Accounting records (or transactions)
2. Determining profit or loss
3. Determining financial position of the business
4. Facilitating management
5. Providing accounting information to the users
6. Protecting business assets
7. Meeting legal requirement

Advantages of Accounting 

1. It helps to know the financial position of the business.
2. It helps the management to make business plan, take decisions and exercise control over the cost of goods.
3. It eliminates the necessity of remembering the transaction.
4. It helps in comparing one year's result with those of other year's.
5. It helps in facilitating/taking loans from banks or other financial institutions.
6. It acts as an evidence in court of law.
7. It facilitates sale of business.
8. It helps in resolving disputes in case of partnership firms and insolvency.

Limitation of Accounting 

1. Accounting is not fully exact - Although transactions are recorded on the basis of evidences, yet at few places estimates are made on the basis of personal estimation, such as provisions for doubtful debts, method of depreciation adopted, etc.
2. Assets are recorded in the books of account at Historical Cost (neglecting depreciation over the time) and as a result current values are not shown in the book of account.
3. Accounting ignores the qualitative elements like skill of management, public relations, etc.
4. Accounting ignores the effect of price level change - Accounting presumes that the value of money remains stable.
5. Accounting may lead to window dressing, i.e., manipulating accounts in a way so as to conceal vital facts and present the financial statement to show better position than what actually is.

Branches of Accounting 

1. Financial Accounting
2. Cost Accounting
3. Management Accounting
4. Human Resource Accounting

Financial Accounting - It deals with the maintenance of books of accounts to determine the financial performance and financial position of the business.

It deals with ascertaining profit earned or loss suffered.

Cost Accounting - It deals with recording costs with the objective of ascertaining, reducing and controlling costs, i.e., it deals with ascertaining the cost of product manufactured or service rendered.

Management Accounting - It deals with providing necessary information to the management for discharging their functions.

It usually concerned with generating accounting information relating to funds, costs, profits, etc. as it enables the management in decision making.

Human Resource Accounting - It deals with the optimal use of human resource in a business.

Book Keeping, Accounting and Accountancy 

Book Keeping - It is a process of recording financial transactions and events in the books of account.

In other word, it can be defined as - An art of recording business transactions in a systematic way.

Accounting - Accounting is a systematic process of recording, classifying, summarising, analysing and interpreting the financial transactions and communicating the results to the users thereof.

Accounting is wider term than Book Keeping. It starts where Book Keeping ends.

Accounting begins with the identification of transactions of financial nature and ends with the preparation of financial statement.

Accountancy - Accounting refers to the entire body of the theory and practice of accounting. It is a systematic knowledge of accounting.

Accountancy is the knowledge whereas accounting is the action or process. Accounting process is carried out on the basis of the rules and principles framed by accountancy.

Difference between Accounting and Book Keeping 

Qualitative characterstics of Accounting information (Accounting) 

1. Reliability - Information should be reliable, i.e., it must be free from bias and material error.
2. Relevance - Information provided should be relevant, i.e., it meets the needs of users in decision making.
3. Understandability - The information should be presented in such a way that users are able to understand it.
4. Comparability - The information should be presented in such a way that the users can easily made intra-firm or inter-firm comparison.

Users of Accounting Information 

Internal users 

• Owner
• Management
• Employees*

External users 

• Employees* and workers
• Banks and Financial institutions
• Investors
• Creditors
• Government and its institutions
• Regulatory agencies such as IRDAI, SEBI
• Public
• Researchers

*Employee can be external as well as internal users.

(as per Google and other websites, employee is Internal user whereas as per T.S. Grewal, Employee is external user)

System of Accounting - The system of recording transactions in the books of account are two namely -

1. Double entry system
2. Single entry system

Double entry system - Double entry system means a system of accounting which recognises and records both aspects - debit and credit of a financial transaction. 

A Debit in one account and a Credit in another.

This system is based on the 'Dual Aspect Concept' and is universally applied in accounting.

Advantages of Double entry system 

1. It is a scientific system of accounting. It helps in attaining the objectives of Accounting.
2. It provides complete record of each transactions.
3. It helps in establishing arithmetic accuracy by preparing the trial balance (the sum of all debits should always equals to the sum of all credits).
4. It helps in determining profit or loss during a period by preparing profit and loss account.
5. It helps in ascertaining the financial position at the end of each period by preparing the Balance sheet.
6. It facilitates comparative study.
7. It helps management in decision making.
8. It helps in detecting frauds and misappropriations.

Single Entry System - In this system, all the transactions are not recorded on double entry basis. In some transactions, both the aspects of the transactions are recorded, while in others, either one aspect is recorded or not recorded at all.

Since all transactions are not recorded under this system on double entry basis, it is not possible to prepare a trial balance. As a result, the Profit & Loss account and the balance sheet cannot be prepared.

Method of Accounting 

1. Cash Basis Accounting - As per cash basis of accounting, we record revenues on receipt of cash, and expenses on their payment. Cash basis of accounting does not recognize accounts receivable or accounts payable. All transactions related to revenues, costs, assets, and liabilities are reflected in the accounts for the period in which actual receipts or actual payments are made. 
2. Accrual Basis Accounting - As per accrual basis, we record revenues and expenses when they accrue (or occur), regardless of the actual receipt or payment of the amount. This basis is more commonly in use than the cash basis. The accrual basis provides a more realistic idea of income and expenses during a period of time. This method provides a long-term picture of the business that cash accounting cannot provide

Next Article - Basic Accounting Terms

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Note - This is my Vision IAS Notes (Vision IAS Class Notes) and Ashutosh Pandey Sir's Public Administration Class notes. I've also added some of the information on my own. 

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