Introduction to Accounting

Introduction to Accounting

• Accounting is as old as money
• In early commercial activities based on barter systems, record keeping was unnecessary
• The Industrial Revolution led to increased commercial activities, mass production, and credit terms, making record keeping essential
• Accounting systems have changed significantly due to technology and marketing competition

Need and Importance of Accounting

• The primary goal of a business is profit
• Businesses receive money from sales, interest, and other sources
• Businesses spend money on purchases, salaries, rent, etc.
• Recording business transactions in a clear and systematic manner allows easy and accurate answers to financial questions

Book-keeping

• Book-keeping records business transactions and is routine and clerical
• It includes recording in the journal, posting to the ledger, and balancing accounts
• Only transactions that can be expressed in terms of money are recorded

Definition of Book-keeping:

• Book-keeping is the science and art of correctly recording business transactions that result in the transfer of money or money’s worth. - R.N. Carter

Objectives of Book-keeping

• To have a permanent record of all business transactions
• To maintain records of income and expenses for net profit or loss calculation
• To maintain records of assets and liabilities for financial position assessment
• To control expenses and maximize profit

Advantages of Book-keeping

• Provides a permanent record of business transactions
• Helps in preparing a trial balance
• Facilitates the correct calculation of business profit or loss
• Helps in ascertaining the financial position of the business
• Enables comparison of financial statements to assess the progress of the business
• Helps in determining amounts due to others
• Facilitates control over assets
• Facilitates control over liabilities
• Enables intelligent analysis of business aspects like purchases and sales
• Helps focus attention on what should and should not be done to enhance profit
• Essential for determining selling prices by considering cost of production, purchases, and expenses
• Required by tax authorities for submitting accounts
• Aids planning, reviewing, revising, controlling, and decision-making
• Helps confirm claims against and for the firm in relation to outsiders as evidence in court

Accounting

• Accounting analyzes and interprets information from books of accounts
• Accounting collects and processes a business's financial information and reports it to users for decision-making

Definition of Accounting

• Accounting is the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users - American Accounting Association

Objectives of Accounting

• To maintain accounting records
• To calculate the result of operations
• To ascertain the financial position
• To communicate information to users

Process of Accounting

• Identifying business transactions from source documents
• Keeping a systematic record of all business transactions in the journal or subsidiary books
• Classifying transactions to group similar types in ledger accounts and preparing a trial balance
• Preparing profit and loss statements in a manner useful to users
• Establishing relationships between items in the profit and loss statement and the balance sheet

Interpreting

• Explains the meaning and significance of the relationship established by the analysis to enable correct decisions

Communicating

• Communicating the results obtained from the summarized, analyzed, and interpreted information to interested parties

Accountancy

• Accountancy systematically explains why and how to do various aspects of accounting
• It explains how to prepare books of accounts, summarize accounting information, and communicate to interested parties

Accounting (cont.)

• Accounting is the actual process of preparing and presenting accounts, applying accounting knowledge in practice

Book-keeping (cont.)

• Book-keeping is part of accounting, involving record keeping and maintenance of books of accounts, and is routine

Relationship between Accountancy, Accounting, and Book-keeping

• Book-keeping provides the basis and is complementary to accounting
• Accounting begins where book-keeping ends
• Accountancy includes accounting and book-keeping
• Accounting and Accountancy are used synonymously.

Users of Accounting Information

• The main objective of accounting is to provide useful information to people and groups inside and outside of the organization

Internal Users

• Owners
• Management
• Employees
• Trade unions

External Users

• Creditors
• Investors
• Banks and other lending institutions
• Potential investors
• Government
• Tax authorities
• Regulatory agencies
• Researchers

Need for Information by Different Users

• Owners need to know the profitability and financial soundness
• Management needs to make prompt decisions to manage the business efficiently
• Employees and trade unions need to form judgments about the earning capacity
• Creditors, banks, and lending institutions need to determine if payments will be made when due
• Present investors need to know the progress and prosperity to ensure the safety of their investment
• Potential investors need to decide whether to invest
• Government and tax authorities need to assess tax liabilities
• Regulatory agencies need to evaluate business operation under regulatory legislation
• Researchers need to use the information in their research work

Basic Accounting Terms

• Understanding basic accounting terms is important

Transactions

• Transactions are activities that involve money or service transfer between two parties or accounts
• Purchase of goods, sale of goods, borrowing, lending, salaries, rent, commission, and dividends are examples of transactions
• Cash and credit transactions are of two types

Cash Transaction

• Cash payment or receipt is involved in this transaction
• Buying goods with cash is an example of a cash transaction

Credit Transaction

• Cash is not involved immediately, but payment is promised later
• Buying goods on credit is an example

Proprietor

• A proprietor owns a business and contributes capital to earn a profit

Capital

• Capital refers to the amount invested by the owner(s)
• Increased by profits and additional capital
• Decreased by losses and withdrawals

Assets

• Assets are properties belonging to the business, including cash, machinery, furniture, bank balance, debtors, stock, investments and goodwill
• Can be classified as tangible and intangible

Tangible Assets

• Tangible assets have a physical existence, such as plant, machinery, and cash

Intangible Assets

• Intangible assets lack physical existence but give rights and benefits, like goodwill, patents, and trademarks

Current Asset

• Current assets can be converted to cash within a year
• Examples include cash, marketable securities, short-term investments, accounts receivable, prepaid expenses, and inventory

Liabilities

• Liabilities are financial obligations, like loans, creditors, bills payable, and outstanding expenses

Drawings

• Drawings are cash or goods withdrawn by the owner for personal use
• Deducted from the capital

Income

• Income is the difference between revenue and expense

Debtors

• Debtors are people who receive a benefit without immediate payment but are liable to pay in the future, shown as an asset

Creditors

• Creditors are people who give a benefit without immediate payment but have a claim in the future, shown as a liability

Purchases

• Purchases are goods bought for resale or production
• Purchases made in cash are cash purchases, and those on credit are credit purchases

Purchase Returns

• The total includes both cash and credit purchases
• Purchase returns occur when goods are returned to suppliers due to defects
• Purchase returns are deducted from total purchases to find net purchases

Sales

• Sales are goods sold that are already bought or manufactured
• Goods sold for cash are cash sales and if payment is not received it is credit sales

Sales Returns

• Total includes both cash and credit sales
• Sales returns occur when goods are returned by customers due to defects
• Sales returns are deducted from total sales to find net sales

Stock/Inventory

• Stock includes unsold goods on a particular date
• Opening stock is goods unsold at the start of the accounting period
• Closing stock is goods unsold at the end of the accounting period

Revenue

• Revenue is the amount receivable or realized from sales and earnings

Expense

• Expense is the amount spent to produce and sell goods and services

Voucher

• A voucher is a written document that serves as proof of a transaction and is necessary to audit the accounts

Invoice

• An invoice is a business document used when selling goods to another party

Receipt

• A receipt is an acknowledgement for cash received and forms the basis for entries in the cashbook

Account

• An account summarizes relevant business transactions at one place related to a person, asset, expense or revenue with two sides called debit and credit

Branches of Accounting

Financial Accounting

• Based on systematically recording business transactions according to accounting principles
• Its purpose is calculating profit or loss and providing a clear picture of the financial position
• Used by creditors, banks, and financial institutions to assess financial status

Financial Statements

• Trial Balance
• Profit and Loss
• Balance Sheets

Cost Accounting

• Deals with determining the cost of a product or service
• Calculates the cost by considering all contributing factors
• Helps in fixing prices, controlling costs, and pinpointing waste

Management Accounting

• Provides information to improve business administration
• Aids in making decisions and controlling activities
• Utilizes budgets, cash flow projections, variance analysis reports, and break-even-point analysis

Financial Accounting vs Management Accounting

• Not to be confused
• Management aims to serve management in decision making regarding minimizing costs and enhancing profits
• Financial aims to provide for financial institutions in ascertaining the financial position
• Management records are kept secret for management eyes only

Language of Business

• Accounting can be though of as the language of business, where it communicates the result of business transactions in the form of accounts

Basic Accounting Assumptions, Concepts, and Principles

Accounting Entity Assumption

• Business is treated separately from its owners, creditors, etc

Money Measurement Assumption

• Only business transactions that are of financial nature are recorded

Accounting Period Assumption

• Financial statements are prepared at regular intervals. Usually 365 days or one year

Going Concern Assumption

• Business will exist for a long period of time and winddown is not to be considered

Concepts

Revenue Realization Concept

• Revenue is recorded when it is earned, avoids possibility of inflating profits and incomes

Historical Cost Concept

• Assets are recorded at their original purchase price
• Used as the basis for all subsequent accounting

Matching Concept

• Revenues match the costs during a period to ascertain the business concern

Full Disclosure Concept

• All significant information should be fully disclosed on the accounting statements

Verifiable and Objective Evidence Concept

• Business transactions should have evidence to support it

Principles

Cost Benefit Principle

• The cost of applying a principle should never overcome the benefit

Materiality Principle

• All relevant information should be disclosed on the statements. All immaterial should be left out

Consistency Principle

• The aim is to preserve the comparability of all financial statements

Conservatism Principle

• All perspective losses should be accounted for, but leaves out all prospective profits. Anticipate no profit and provide for all possible losses