Introduction to Accounting PDF

Internal Examination Introduction to Accounting  Introduction, Meaning, Objective and Scope Accounting is the systematic process of recording, classifying, summarizing, and interpreting financial information, usually pertaining to financial transactions. It allows businesses to track financi...

Internal Examination Introduction to Accounting  Introduction, Meaning, Objective and Scope Accounting is the systematic process of recording, classifying, summarizing, and interpreting financial information, usually pertaining to financial transactions. It allows businesses to track financial transactions, analyze performance, and prepare financial statements such as income statements, balance sheets, and cash flow statements. Meaning: Accounting is the process of tracking and managing financial transactions of an entity. Objective: The main objective of accounting is to provide stakeholders with accurate financial information, aiding decision-making. Scope: Accounting covers activities like bookkeeping, financial reporting, auditing, and tax preparation, applicable to organizations of all sizes.  Introduction “Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events that are, in part at least, of financial character and interpreting the results thereof.” - American Institute of Certified Accountants, 1941 “The function of accounting is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decisions. - American Institute of Certified Public Accountants, 1970  Objective Recording business transactions systematically: Maintaining systematic records is essential to track all business transactions accurately and avoid errors or omissions. Determining profit or loss: Trading and profit & loss accounts help calculate the net result at the end of an accounting period, providing insights into purchases, sales, expenses, and earnings. Deriving financial position: The balance sheet determines the firm's financial health by showing assets, liabilities, and changes in capital. This information, in various cases is more important than the accounts of transactions for investors. Assisting management: Accounting aids management in decision-making, budgeting, cash flow control, and forecasting.  Objective Analysing business progress Maintaining systematic records is essential to track all business transactions accurately and accurately analyse the business from the inside as well as monitor the external interactions of the business. Communicating financial information and accounting insights with stakeholders Financial information is communicated to concerned stakeholders like management, government, and tax authorities for better understanding and interpretation of the data, in the context of reviews or transparency. Fraud Detection and Error Prevention Systematic records help detect and rectify frauds, errors, and inefficiencies. Done to avoid wastage of finance.  Important Transactional Statements Income Statement: Definition: A financial report that summarizes revenues, expenses, and profits over a period. Uses: Assesses profitability, operational efficiency, and guides investment decisions. Features: Includes revenues, cost of goods sold (COGS), gross profit, operating income, and net income. Elements: Revenues, expenses, gross profit, operating income, taxes, and net income. Cash Flow Statement: Definition: Tracks cash inflows and outflows, showing how well a company manages cash. Uses: Evaluates liquidity, cash management, and financial stability. Features: Divided into operating, investing, and financing activities. Elements: Operating cash flows, cash from investing and financing activities, net cash increase.  Important Transactional Statements 3. Profit and Loss Statement: Definition: Similar to an income statement, showing the company’s revenues, costs, and profit/loss. Uses: Provides insight into a company's ability to generate profit. Features: Shows net income or loss. Elements: Revenues, costs, operating expenses, and net profit. 4. Balance Sheet: Definition: Provides a snapshot of a company’s assets, liabilities, and equity at a specific time. Uses: Measures financial stability and risk. Features: Shows what a company owns and owes. Elements: Assets (current and non-current), liabilities (short-term and long-term), and equity.  Types of Accounting Financial Accounting: Focuses on preparing financial statements of the company for interpretation by external stakeholders. Managerial Accounting: Provides internal reports for decision-making within the organization to the upper management. It helps understand current profitability metrics and prepare/plan for future growth. It helps forecast budgets and predict income statements. Cost Accounting: Involves tracking, recording, and analysing production costs which are undertaken by the company such as rent, power, salaries etc. These expenses influence the firms business operations. Tax Accounting: Ensures compliance with tax laws and prepares tax returns. Forensic Accounting: Investigates financial discrepancies and fraud. Advantages of Accounting Planning: Provides a clear financial picture of the present and the past. Comparative study based on this information is used to prepare business plans. Targets set in the previous quarter are measured and compared with actual results. Aids in decision-making, whether it is with respect to reducing costs, removing liabilities, exploring new assets and improving financial health. Helps in legal compliance. Accounting records of business transactions are treated as satisfactory evidence in the court of law and are used to settle disputes between parties. They also help prove the tax payments made by the business. Facilitates business performance evaluation. Accounting provides necessary information to various stakeholders like owners, creditors, management, employees, government, consumers, debtors to evaluate the business. Limitations of Accounting Historical in nature, does not Does not account for qualitative Can be subject to human error. inherently directly predict future factors like employee morale. manipulation or bias. trends. No standard practice globally. In India, we follow Accounting Some values can be estimated as Considers historical costs, not Standards, in the US – GAAP is it is difficult to establish exact current factors like inflation etc. followed. Other standards such as amounts IFRS are also followed. Applications of Accounting Accounting has many everyday applications for both businesses and individuals. Common areas include bookkeeping, financial statement analysis, auditing, and taxation. Business: Companies use accounting to monitor financial health, make strategic decisions, and assess assets, liabilities, and equity through financial statements. Individuals: Personal accounting helps manage budgets, track net worth, and plan for future savings. Auditing: Auditors review financial statements for accuracy and regulatory compliance, identifying irregularities or fraud. Taxation: Accounting is key to filing tax returns, calculating liabilities, and navigating complex tax laws. Basic Terminology Assets: Resources owned by the company (e.g., cash, property). Liabilities: Obligations the company owes (e.g., loans, accounts payable). Equity: Owner’s claim after liabilities are deducted from assets. Revenue: Income earned from business activities. Expenses: Costs incurred by the business in generating revenue. Ledger: A book containing accounts to record financial transactions.  Relationship Between 3 Important Terms Book-keeping: Book-keeping involves identifying, measuring, and recording, financial transactions. Management can't take a decision based on the data provided by bookkeeping as financial statements are not prepared as part of this process. Doesn't require specific analysis and therefore, skills. Accounting: The broader process of summarizing, interpreting, and reporting financial data based on book-keeping entries. Used by the management to make decisions as the purpose of accounting is to analyse the current situation of the firm and communicate it to stakeholders. Requires a specific skillset to perform. Accountancy: The profession or practice of accounting, which includes both accounting and book-keeping activities.  Accounting Equation The accounting equation forms the foundation of double-entry bookkeeping. It states that: Assets = Liabilities + Equity This equation ensures that the balance sheet remains balanced. Every transaction affects at least two accounts and maintains this equation. Examples: Example 1: A company buys office supplies for $100 using cash. Asset (Supplies) increases by $100, Asset (Cash) decreases by $100, so the equation remains balanced. Example 2: A business takes a loan of $5,000. Assets (Cash) increase by $5,000, and Liabilities (Loan Payable) increase by $5,000.  Double Entry System of Book-keeping The double-entry system requires every financial transaction to be recorded in at least two accounts: one as a debit and the other as a credit. This maintains the accounting equation (Assets = Liabilities + Equity). Examples: Example 1: A company purchases a computer for $500. Debit Equipment (Asset) $500, Credit Cash (Asset) $500. Example 2: A company receives a loan of $1,000. Debit Cash (Asset) $1,000, Credit Loan Payable (Liability) $1,000. Event Definition: An event is any occurrence or happening that has some impact on the financial status of a business. Events in accounting are broader than transactions and can be monetary (with measurable value) or non-monetary (not involving any immediate exchange of money). Example: Monetary Event: A business purchases equipment for $10,000. This impacts both cash and asset accounts, so it’s a recorded event. Non-Monetary Event: A company’s CEO announces plans to expand into new markets. This event might affect future finances, but there is no immediate financial transaction to record. Transaction Definition: A transaction is any business activity that involves an exchange of goods, services, or funds and has a quantifiable financial impact on the company's accounts. Transactions are always monetary events and are recorded in the books of accounts. Example: Revenue Transaction: Selling 100 shares of a listed stock to an investor for $5,000, where cash or bank accounts are credited, and sales or revenue accounts are debited. Expense Transaction: Paying $500 for office supplies. Here, the supplies account increases while cash or bank account decreases by the same amount. Journal Definition: The journal is the initial book of entry in which every financial transaction is recorded in chronological order. Each entry consists of a debit and a credit to different accounts based on double-entry principles. Example: Journal Entry for Purchase: If a company buys office equipment for $1,000 on credit, the journal entry would be: Debit: Equipment $1,000 Credit: Accounts Payable $1,000 Ledger Definition: A ledger is a collection of all the accounts in which journal entries are posted to show changes in financial position. The ledger categorizes transactions by account type, making it easier to prepare a trial balance and financial statements. Example: If a company has multiple transactions involving "Cash," these will be consolidated under the Cash Ledger account to provide a clear view of all cash inflows and outflows. Trial Balance Definition: The trial balance is a statement that lists all ledger accounts and their balances at a particular point in time. It checks the arithmetical accuracy of ledger entries by ensuring that the total debits equal total credits. Example: If the company has $10,000 in cash (debit) and $5,000 in accounts payable (credit), along with other entries, the trial balance will aggregate all debits and credits. The goal is to have both sides match, confirming accurate ledger postings. Cash Book Definition: A cashbook is a specialized ledger used solely to record all cash transactions, including both cash receipts and cash payments. It serves as both a journal and ledger for cash transactions, ensuring that all cash flows are accurately documented. Example: If a business receives $2,000 in cash for consulting services, the entry in the cashbook would increase the cash balance by $2,000. Types of Cashbook 1. Single Column Cash Book Definition: The single column cash book records only cash transactions and contains one column each for cash receipts and payments. Features: Only records cash transactions. Contains a Debit column for cash receipts and a Credit column for cash payments. Example: If the company receives $500 cash from a customer, it is recorded on the debit side. If the company pays $200 for office supplies, it is recorded on the credit side. 2. Double Column Cash Book Definition: The double column cash book, also known as a two-column cash book, records both cash and bank transactions. This format is helpful for companies that frequently deposit or withdraw money from the bank. Features: Has two columns on each side: one for Cash and one for Bank. Tracks both cash and bank transactions in one place. Example: If the business receives $1,000 cash, it is recorded in the Cash Debit column. If $500 is deposited in the bank, it is recorded in the Bank Debit column. If the company writes a check for $300, it is recorded in the Bank Credit column. 3. Triple Column Cash Book Definition: A triple column cash book includes three columns on each side for Cash, Bank, and Discounts. It’s used by companies that frequently offer or receive discounts, enabling them to capture all necessary details in one book. Features: Includes Cash, Bank, and Discount columns on both debit and credit sides. Helps track cash, bank transactions, and discounts given or received simultaneously. Example: If a customer pays $500 in cash with a $50 discount, the transaction is recorded with: $500 in Cash Debit $50 in Discount Allowed (debit). If the company deposits $400 in the bank, it goes in the Bank Debit column. 4. Petty Cash Book Definition: A petty cash book is a separate cash book maintained for recording small, routine expenses such as postage, office supplies, and refreshments. It is usually managed under an imprest system, where a fixed amount is replenished regularly. Features: Used for tracking small cash expenditures. Helps avoid overcrowding the main cash book. Contains columns for different expense types like postage, travel, and office supplies. Example: The petty cashier receives an imprest amount of $200. Expenditures such as $10 for stationery and $15 for refreshments are recorded under their respective columns. Summary of Cash Book Subsidiary Books Definition: Subsidiary books are used for the preliminary recording of different types of transactions to avoid overcrowding the journal. Each subsidiary book serves a specific purpose and is designed to handle particular types of transactions. Types and Examples: Sales Book: Records all credit sales. If a company sells $1,500 worth of goods on credit to a customer, it would be entered in the sales book. Purchase Book: Records all credit purchases. If the business buys office supplies worth $200 on credit, it’s noted in the purchase book. Cash Book: Specifically for cash transactions as detailed earlier. Sales Return Book: Records returns of sold goods from customers. General Guidelines Refer Class Notes Practice the questions taught in class Refer TS Grewal or Basu & Dutta (for practicing) Indian Accounting Standards notes were already given in class, please refer those for theory questions Everything that has been covered in class thus far, will be part of the internal examinations. For any additional question, please write to ‘[email protected]’