Introduction to Accounting

Introduction to Accounting

• Accounting is the systematic process of identifying, recording, classifying, summarizing, and interpreting financial transactions.
• It aids in decision-making by providing information on business performance and position.
• Accounting ensures accuracy and transparency in financial reporting.
• It acts as a communication tool between a business and its stakeholders (investors, creditors, regulatory bodies).
• It plays a crucial role in maintaining legal compliance and guides managerial decisions.

Salient Features of Accounting

• Art and Science: It combines practical application of knowledge to record financial data systematically and the principles and methods to ensure accuracy and consistency.
• Financial Transactions Only: Only monetary transactions (quantifiable in monetary terms) are recorded. Non-financial aspects, like employee satisfaction, are excluded unless quantifiable.
• Chronological Recording: Financial transactions are recorded in chronological order, typically in journals. Accuracy in recording is fundamental.
• Classification: Similar transactions are grouped into specific accounts for clarity and accessibility. This occurs in ledgers, which organize entries under appropriate account heads.
• Summarization: Financial statements (Profit & Loss Account, Balance Sheet) provide an overview of a business's financial health by condensing detailed transactions.
• Analysis and Interpretation: Accounting goes beyond numbers; it offers insights into financial trends, performance, and future prospects.

Meaning of Bookkeeping

• Bookkeeping is the systematic process of recording all financial transactions of a business in a detailed and chronological order.
• It forms the foundation for all accounting processes because it provides the raw financial data.
• It focuses solely on recording transactions, unlike accounting which involves analysis and interpretation.
• It ensures financial transparency, aids in audits, and supports legal compliance, maintaining control over a business's finances.

Distinction Between Accounting and Bookkeeping

• Scope: Bookkeeping is limited to recording transactions, while accounting is broader, encompassing recording, classifying, summarizing, and decision-making.
• Objective: Bookkeeping is aimed at maintaining accurate records, whereas accounting is geared towards providing informative financial data for decision-making.
• Process: Bookkeeping involves journalizing and posting transactions, while accounting involves preparation of financial statements, analysis, and interpretation.
• Skill Requirements: Bookkeeping requires basic understanding of financial transactions, but accounting requires more analytical skills and knowledge of accounting principles.
• Stage: Bookkeeping is an initial stage; accounting builds upon it.
• Results: Bookkeeping produces raw data, and accounting produces summaries like profit and loss accounts.
• Authority Level: Bookkeeping is typically handled by junior staff, while accounting is usually the domain of accountants, auditors, or financial managers.

Objective of Accounting

• Maintain Records: Ensures a systematic record of all business transactions, maintaining a historical record.
• Calculate Profit/Loss: Determines a business's profitability by preparing a Profit & Loss Account.
• Depict Financial Position: Presents a financial snapshot through the Balance Sheet, showing assets, liabilities, and capital.
• Inform Various Groups: Provides vital financial information to all stakeholders for informed decision-making.

Types of Accounts in Accounting

• Personal Accounts: Relate to individuals, organizations, and entities with whom a business has dealings.
• Real Accounts: Relate to tangible and intangible assets of the business. The balance remains in the next period.
• Nominal Accounts: These relate to incomes, gains, expenses, and losses. Their balance is transferred at the end of the accounting period.

Golden Rule

• Debit the receiver, Credit the giver (Personal Accounts)
• Debit what comes in, Credit what goes out (Real Accounts)
• Debit all expenses and losses, Credit all incomes and gains (Nominal Accounts)

Difference Between Cash and Mercantile Accounting Systems

• Recording: Cash accounting records transactions only when cash is received or paid; mercantile records transactions when they occur.
• Revenue Recognition: Cash accounting recognizes revenue only when cash is received, mercantile recognizes revenue when earned, regardless of payment.
• Expense Recognition: Cash accounting recognizes expenses only when paid, mercantile recognizes expenses when incurred, regardless of payment.

Single Entry System

• Meaning: A simplified method where only selected transactions (primarily cash and personal accounts of debtors/creditors) are recorded.
• Features: Incomplete record-keeping; lacks standardization; straightforward; suitable for small-scale businesses with limited transactions.
• Advantages: Simple to maintain; cost-effective; saves time; useful for small businesses with limited dealings.
• Disadvantages: Incomplete records; inaccurate profit/loss calculations; no checks on errors or fraud; lack of financial statements.

Double Entry System

• Meaning: Comprehensive method of accounting where every transaction affects at least two accounts with equal and opposite effects (debit and credit).
• Features: Dual aspect principle; systematic recording; accurate; comprehensive records; error detection; suitable for all types of businesses, including those requiring detailed financial reports.
• Advantages: Scientific system; complete record; high accuracy; profit/loss calculation; financial position clarity; decision-making aid; effective financial control.
• Disadvantages: Complex; costly to maintain; time-consuming; limitations in detecting certain errors.

Computerized Accounting System

• Components: Accounting software; electronic spreadsheets; database management systems; word processors, used for processing, recording, storage, analysis, and report generation of financial data.

Accounting Cycle

• Steps of Accounting Cycle: Identifying transactions; recording in journals; posting in ledgers; preparing trial balance; adjusting entries; preparing financial statements; closing accounts.

Basic Accounting Terminology

• Capital: Owner's investment in the business.
• Liability: Debts owed by the business.
• Asset: Resources owned by the business.
  • Fixed Asset: Long-term assets.
  • Current Asset: Short-term assets.
  • Liquid Asset: Assets easily converted to cash.
  • Wasting Asset: Assets that lose value over time (like mines or oil fields).
  • Tangible Asset: Physical assets.
  • Intangible Asset: Non-physical assets (patents, trademarks, goodwill).
• Revenue: Income from core business operations.
• Expenses: Costs incurred in generating revenue.
• Purchases: Acquisition of goods or materials.
• Sales: Income from selling goods or services.
• Stock: Inventory of goods or products.
• Debtors: Individuals or entities owing money to the business.
• Creditors: Individuals or entities to whom the business owes money.
• Drawings: Withdrawals of funds from the business by the owner.
• Debit: An accounting entry that increases assets or expenses, or decreases liabilities or revenues.
• Credit: An accounting entry that increases liabilities or revenues, or decreases assets or expenses.
• Discount: Reduction in price of goods or services, often for early payment.
• Net Profit/Loss: Difference between total revenue and total expenses.