Module-1: Accounting: An Introduction PDF

# Module-1: Accounting: An Introduction ## Objective The objective of this module is to introduce concepts of financial accounting such as basics of accounting rules, branched of accounting, accounting equation and knowledge of Generally Accepted Accounting Principles. ## Outcome At the end of t...

# Module-1: Accounting: An Introduction ## Objective The objective of this module is to introduce concepts of financial accounting such as basics of accounting rules, branched of accounting, accounting equation and knowledge of Generally Accepted Accounting Principles. ## Outcome At the end of this module, learner will be able to- 1. Understand the meaning and significance of accounting. 2. Explain sub-fields of accounting. 3. Grasp the basic accounting concepts, principles and conventions and observe their implications while recording transactions and events. 4. Understand the qualitative characteristics that will help to develop the skill in course of time to prepare financial statements. "The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of accounting" According to American Accounting Association (Year 1966)- ## 1.1 Introduction Business is an economic activity conducted to earn profits and increase the wealth of the owner. Business rules are based on general principles of trade social values and the national or international boundaries legal framework. While these variables the vary for different companies and regions, the basic goal is to add value to the product or service in order to satisfy customer demand. Through reporting all transactions related to the development of monetary inflows of sales revenue and monetary outflows of operating expenses, a business accounting system ensures an accountability. The accounting system provides the financial information needed to assess the efficacy of both current and past activities. The accounting system also provides the data required to file reports that show the status of a business entity's borrower liabilities, ownership equities and asset capital. ## 1.2 What is Accounting? All of us do some accounting, often without realizing it. It is a part of out life. Let us say you realize suddenly, one morning, that you need to buy a book urgently. You ask your parents for the money. “But” the parent asks, as to “What happened to the money you were given last week?” You either recollect how you spent it or if you believe in being systematic and have noted it in your diary you explain as to how the money was spent. ## Notes →primary goal of a business ## 1.3 Definition of Accounting - **Definition by the American Institute of Certified Public Accountants (Year 1961):** "Accounting is the art of recording, classifying and summarizing 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 result thereof". - **Definition by the "The Accounting Principles Board" (APB) of the AICPA (Year 1970):** “Accounting is a service activity. Its function is to provide information primarily financial in nature about economic entities that is intended to be useful in making economic decisions.” With the help of above definitions, we can draw out following attributes of accounting:- - **Recording:** Involves the reporting of financial transactions in an orderly manner, immediately after their occurrence in the proper account books. - **Classifying:** Involves systematic analysis of data recorded, in order to collect transactions of a similar type at one place. This role is accomplished by managing the ledger in which different accounts are opened to which relevant transactions are reported. - **Summarising:** Involves the planning and delivery of the classified data in a way that would be helpful to users. The function includes preparing financial statements, like income statement, balance sheet, financial position adjustment statement, cash flow statement, value added statement, etc. - **Interpreting:** Technology advancement helps the electronic data processing tools to perform three tasks that are being recorded, categorized and summarized. One of the key goals of maintaining accounts periodically is to view data that is subjective and can differ from person to person. The accounts clarify not only what has occurred but also as to why it has happened and a future forecast as well. ## Notes raging is not attribute of counting. ## 1.4 Nature of Accounting Accounting is the systematic recording of financial transactions and presentation of the related information of the appropriate persons. The basic features of accounting are as follows: 1. **Accounting is a Process:** A process refers to the step-by-step method of performing any specific job according to the goals or target. Accounting is identified as a process performing specific task of collecting, processing and communicating the financial data. This is accompanied by certain steps such as the data tracking compilation, description summarization, finalisation, and publishing. 2. **Accounting is an Art:** Accounting is art of recording, classifying, summarizing and finalizing the financial data. The word -art refers to the way something is performed. It is knowledge of behaviour involving certain skills and creativity that can help attain specific goals. ## 1.5 Objectives and Scope of Accounting Accounting has a very broad scope and area of operation. It is not limited only to the business world but is distributed throughout all facets of society and all occupations. Nowadays, financial transactions must take place in any social institution or professional practice, whether that is income generating or not. Therefore the need to record and summarize these transactions as they occur emerges and there is a need to figure out the net result of the same after the expiry of a certain fixed period. - To keep systematic records: Accounting is performed to keep a systematic record of financial transactions. The primary objective of accounting is to help collect financial data and to record it systematically for the derivation of correct and useful results of financial statements. - To ascertain profitability: With the help of accounting, the profits and losses incurred during a specific accounting period can be evaluated. With the help of a Trading and Profit& Loss Account, the profit or loss of a firm can be easily determined. - To ascertain the financial position of the business: A balance sheet or a statement indicates the financial position of the Company as on a particular date. A properly drawn balance sheet gives us an indication of the value of assets, the nature and value of a liability, and also the capital position of the firm. Thus, the soundness of any business entity can be easily ascertained. - To assist in decision-making: To take decisions for the future, there is a need for accurate financial statements. One of the main objectives of accounting is to take the right decisions at the right time. Thus, accounting gives the platform to plan for the future with the help of past records. - To fulfill law compliance: Business entities like organizations, trusts, and societies are being run and governed according to different legislative acts. Similarly, different taxation laws (direct-indirect tax) are also applicable to every business house. It is requires to keep and maintain various types of accounts and records as prescribed by corresponding laws of the land. Accounting helps in running a business in compliance with the law. ## Notes It's a scope not an objective. ## To avoid legal penalties. ## 1.6 Branches of Accounting Accounting is an old science that aims at keeping records of various transactions. Accounting is considered essential for record-keeping of all the receipts and payments as well as the income and expenditures. Accounting can be broadly classified into three categories: 1. **Financial Accounting** (Financial accounting is aimed at identifying an accounting year's results in terms of profits or losses and assets and liabilities) To do this it is important that numerous transactions are documented systematically. Financial accounting is characterized as an art and science of systematically classifying, analyzing and reporting business transactions in order to prepare a report at the end of the year to assess the details of the related year. - Financial accounting involves the following terms - - **Business Transactions:** A business transaction is any activity that creates a kind of legal relationship. For example, the purchase and sale of goods, appointing an employee and paying salary, payment of various expenses, purchase of assets, etc. - **Classification of Transactions:** Before recording any transaction, it is essential to classify it. A transaction can be classified as a cash and credit transaction. Similarly, transactions of receiving income and expenditure payment can be segregated. to make recording easier. - **Recording of Transactions:** The essence of financial accounting is the recording of transactions. In accounting terms, recording of the transaction is known as entry, and there are specific rules for recording various transactions in books of accounts. 2. **Cost Accounting** Cost accounting is intended to capture a Company's production costs by assessing the input costs for each production phase, as well as fixed costs such as depreciation of an equipment. Cost accounting must analyze and record these costs independently first, and then compare the results with expected or measurable outcomes to help the Company assess financial performance. Cost accounting is often used within a Company to facilitate decision-making, and financial management is typically seen by the investor's external community. Cost accounting can also be useful in budgeting and setting up cost control systems as a method for management, which can increase the Company's net profits in the long run. ## Notes It focuses on “future projections” not a charactershy. 3. **Management Accounting** Management accounting is the application of professional knowledge and skills for the preparation and presentation of accounting information in such way that assists the management in the formulation of policies and also in planning and controlling the operations of the organization. The main purpose of management accounting is to provide information to the management team at all levels within the organization for the following purposes: To make informed decisions at all level ## Notes A ## 1.7.1 Difference between Book keeping and Accounting | S.n | Book Keeping | Accounting | |---|---|---| | 1 | Purpose of book-keeping is to keep systematic record of transactions and events of financial character in order of its occurrence | Purpose of accounting is to find results of operating activity of business and to report financial strength of business. | | 2 | Output of book-keeping is an input for accounting. | Output of accounting permit informed judgments and decisions by the user of accounting information | | 3 | Book-keeping is a foundation of accounting. | Accounting is considered as a language of business. | | 4 | Book-keeping is carried out by junior staff | Accounting is done by senior staff with skill of analysis and interpretation. | | 5 | Objects of book-keeping is to summarize the cumulative effect of all economic transactions of business for a given period by maintaining permanent record of each business transaction with its evidence and financial effects on accounting variable. | Object of accounting is not only bookkeeping but also analyzing and interpreting reported financial information for informed decisions. | ## 1.8 Generally Accepted Accounting Principles GAAP A widely accepted set of rules, conventions, standards, and procedures for reporting financial information, as established by the Financial Accounting Standards Board are known as Generally Accepted Accounting Principles (GAAP). These are the common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP is a mix of standards set by the government bodies and essentially the commonly accepted methods of collecting and presenting information on accounting. Organizations are to follow GAAP so that investors have an optimal level of consistency in the financial statements they use when evaluating firms for investment purposes. GAAP covers the aspects like revenue recognition, balance sheet items classification and outstanding share measurements. ## Notes - Financial accounting is based on monetary transactions of the Company. - Reports prepared in Management Accounting are meant for management as well as for shareholders and creditors of the concern. - Its main focus is on recording and classifying monetary transactions in the books of accounts and preparation of financial statements at the end of every accounting period. - Reports should always be supported by relevant figures and it emphasizes on the objectivity of data. - Reports are always subject to statutory audit. - It evaluates the sectional as well as the financial strength of the whole business. - Financial accounting 15 based on monetary transactions & accounting is based on data available from financial acc - Management accounting objective is based on data available from management acc. - Financial accounting objective is subjective. - Financial accounting is based on monetary transactions white management accounting is based on data available from financial acc ## 1.7 Book Keeping As defined by Carter, 'Book-keeping is a science and art of correctly recording in books of accounts, all the business transactions resulting in the transfer of money or money's worth'. Book-keeping is an activity concerned with recording and classifying financial data related to business operation as per the order of its occurrence. Book-keeping is a mechanical task that involves - - The collection of basic financial information. - Identification of events and transactions with a financial character i.e., economic transactions. - Measurement of economic transactions in terms of money. - Classifying the effects of economic transactions. - Recording financial effects of economic transactions as per its order of occurrence. - Preparing organized statement known as trial balance. ## Notes - Acc - tran - sta - anc - pro - The - time - A - (a) - (b) - (c) - (d) - (e) - 1 - 2 - 1 - 2 - 3 - 4 - 5 - 6 - S.n - ( - 1 - F - S - 2 - a - tl - p - is - -