Financial accounting

ANOOP PANDEY
NOTES ON FINANCIAL ACCOUNTING
CLASS : BCA - III
FINANCIAL ACCOUNTING
MEANING OF ACCOUNTING
According to AICPA "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 results thereof."
According to American Accounting Association "Accounting is the process
of identifying, measuring and communicating economic information to
permit informed judgments and decisions by users of the information."
In simple words, accounting is the process of collecting, recording,
summarizing and communicating financial information. Accounting is an
information system that provides accounting information to users for correct
decision-making.
The definition given by the American Accounting Association is more
appropriate in the present circumstances because many to arrive at informed
judgments and decisions use the accounting information.
ATTRIBUTES OF ACCOUNTING

The above definitions bring out the following attributes of accounting:
1. Accounting is an art as well as a Science: Art is the technique,
which helps us achieve our desired objective. Accounting is an art of
recording, classifying and summarizing financial transactions. It
helps us in achieving our objective of maintaining proper accounts,
i.e., to know the profitability and financial position of the business.
Any organized knowledge based on certain basic principles is a
'science'. Accounting is also a science. It is an organized knowledge
based on certain basic principles.
2. Accounting Records only those Events and Transactions, which
are of Financial Character: It is a serious limitation of accounting.
For example, a quarrel between the Production Manager and the Sales
Manager affects the earnings of the business but it is not recorded
because it has no financial character, no economic value and no
exchange value.
3. Accounting Records Transactions by Expressing them in Terms
of Money: This makes the transaction more meaningful. For
example, if a business has 10 machines, 20 tons of raw material, 2
buildings, 20 tables and chairs, 20 fans, etc., it is not possible to add
them together or know which one is more valuable unless they are
expressed in terms of money.
4. Functions of Accounting

Identification: Economic events are identified and measured in
terms of money.
Recording: Accounting is an art of recording business transactions
in the books of accounts. Recording is the process of entering
business transactions financial character in the book of original
entry, i.e., in Journal.
Classifying: Classification is the process of grouping transactions
or entries of one nature at one place. The transactions recorded in
the 'Journal' or the subsidiary books are classified and posted to the
main book of account known as the 'Ledger'. This book contains
the preparation of the following statements: (i) Trial Balance, (ii)
trading and individual account heads under which all financial
transactions of a similar nature are collected.
Summarizing: This involves presenting the classified data in a
manner, which is understandable and useful to internal as well as
external end-users of accounting statements. This process leads to
Profit and Loss Account, and (iii) Balance Sheet.
Interpreting: The final stage in the accounting process is analyzing
and interpreting the financial data contained in the final accounts
so that parties concerned with the business can make a meaningful
judgment about the profitability and financial business can make a
meaningful judgment about the profitability and financial position
of the business unit. This helps in planning for the future in a
better way.
5. Service Accounting

Accounting, we have discussed, is an art of recording, classifying and
summarizing the financial data and interpreting the results thereof. Thus
accounting is a wider concept than book keeping, i.e., bookkeeping is a
part of accounting.
OBJECTIVES OF ACCOUNTING
The objectives or functions of accounting are:
1. Maintain of Business Records: Accounting is the language
in which most of the business transactions (financial) and
events are expressed. Its objective is to keep a systematic
record of these financial transactions. It embraces proper
recording of transactions, classified under appropriate accounts
and summarized into financial statements- Income Statement
and the Position Statement.
2. Ascertaining Profit or Loss: Another objective of
accounting is to ascertain the net result of day-to-day
transaction for a period. In other words, to ascertain whether
during the period, the firm earned a profit or suffered a loss.
For this purpose, a statement called an Income Statement or the
Trading, Profit and Loss Account is prepared.
3. Ascertaining Financial Position: For a businessman, it is
not adequate to only ascertain the profit or loss; it is also
necessary to know the financial health of the firm. For this

purpose, a statement listing assets, liabilities and the owner's
capital is prepared. Such a statement is called a Balance Sheet.
4. Facilitating Management Control: The management often
requires financial information for decision making, effective
control, budgeting and forecasting. Accounting provides
financial information to assist the management in discharging
this function.
5. Providing accounting Information to Users: Another
objective of accounting is to provide accounting information to
users who analyse them as per their individual needs. The
American Accounting Association while defining accounting
has also identified this objective of accounting.
ADVANTAGES OF ACCOUNTING
1. Financial Information about Business: Accounting
makes available financial information, i.e., the profit
earned or loss suffered and also what are the assets and
liabilities of the enterprise.
2. Assistance to Management: The management is
responsible for the functioning of the business and has to
therefore plan, make decisions and exercise effective
control on the affairs of the business. The management
performs these functions on the basis of accounting
information.
3. Replaces Memory: No businessman can remember
everything about his business since human memory has

limitations. It is necessary to record transactions in the
books of accounts promptly. This will obviate the
necessity of remembering various transactions, since on
need; the records will furnish the necessary information.
4. Facilitates Comparative Study: a systematic record
will enable a businessman to compare one year's results
with those of other years and locate significant factors
leading to the change, if any.
5. Facilitates Settlement of Tax Liabilities: A
systematic accounting record immensely helps settlement
of income tax, sales tax, VAT and excise duty liabilities
since it is a good evidence of the correctness of
transactions.
6. Facilitates Loans: the banks and financial institution
of basis of growth potential, which is supported by the
performance, grant Loan.
7. Evidence in Court: the Courts often treat Systematic
record of transactions as good evidence.
8. Facilitates sale of Business: If someone desires to sell
his business, the accounts maintained by him will enable
the ascertainment of the proper price.
9. Assistance in the Event of Insolvency: Insolvency
proceedings involve explaining many transactions that
have taken place in the past. Systematic accounting
records assist a great deal in such a situation.
10. Helpful in Partnership Accounts: At the time of
admission of a partner, retirement or death of a partner

and dissolution of the firm, accounting record is of vital
importance and use. It is so because it provides the basis
to reach a settlement.
ACCOUNTING PROCESS
Based on the main attributes of accounting, we may list the steps of
Accounting Process as follows:
(i) Financial Transactions,
(ii) Recording
(iii) Classifying
(iv) Summarizing
(v) Analysis and Interpretation
We have discussed in detail the above steps earlier in this Chapter. We may
now explain the accounting process with the help of a diagram:

Accounting Process
Financial Transactions or Events
Communicating to the Users
Recording
Analysis and Interpretation
Journal
1.Cash Book
2. Purchase Book
3. Sales Book
4. Purchases Returns Book
5. Sales Returns Book
6. Bills Payable Book
7. Bills Receivable Book
8. Journal Proper
Classifying
(Posting into Ledger)
Summarizing
Trial balance
Trading & Profit & loss Account
Balance-Sheet
BRANCHES OF ACCOUNTING

The changing business scenario through centuries has given rise to
specialized branches of accounting, which could cater to the changing
requirements. These branches are:
Branches of Accounting
1. FINANCIAL ACCOUNTING
2. COST ACCOUNITNG
3. MANAGEMENT ACCOUNTING
FIANCIAL ACCOUNTING
Financial Accounting is concerned with recording financial transactions,
summarizing and interpreting them and communicating the results to users.
It ascertains profit earned or loss suffered during a period (usually a year)
and the financial position on the date when the accounting period ends.
COST ACCOUNTING
The limitation of financial accounting in respect of information relating to
the cost of products or services led to the development of a specialized
branch, i.e. Cost Accounting. It ascertains the cost of products manufactured
or services rendered and helps the management in decision making (say
price fixation) and exercising controls.

MANAGEMENT ACCOUNTING
Management Accounting is the most recently developed branch of
accounting. It is concerned with generating accounting information relating
to funds, cost, profits, etc., as it enables the management in decision
making. We may say that Management Accounting addresses the needs of a
single user group, i.e. the management.
BOOK KEEPING, ACCOUNTING AND ACCOUNTANCY
Meaning of Book Keeping
Book keeping is a branch of knowledge that educates us as to how financial
records are to be maintained. Book keeping is a part of accounting and is
concerned with the recording of financial data in the books of accounts. It is
the process by which a record of financial transactions is maintained. Thus,
bookkeeping is concerned with
(i) Identifying financial transactions and events;
(ii) Measuring them in terms of money;
(iii) Recording the financial transactions and events so identified in the
books of accounts, and
(iv) Classifying recorded transactions and events, i.e. posting them into
Ledger accounts.

According to L.C. Cropper " Book keeping is the science of recording
transactions in money or money's worth in such a manner that, at any
subsequent day, the nature and effect of each transaction, and the
combined effect of the transactions may be clearly understood so that the
accounts prepared at any time from the records thus kept may show the
owner of the books his true financial position."
Accounting
Accounting, we have discussed, is an art of recording, classifying and
summarizing the financial data and interpreting the results thereof. Thus
accounting is a wider concept than book keeping, i.e., bookkeeping is a
part of accounting.
Book Keeping and Accounting Differ from each other in the following
manner:
S.No. Basis Book Keeping Accounting
1. Scope Book Keeping is
concerned with
identifying financial
transactions;
measuring them in
money terms;
recording and
classifying them.
Accounting is
concerned with
summarizing the
recorded transaction,
interpreting them and
communicating the
results.
2. Stage It is a primary stage. It is a secondary stage.
It begins where
bookkeeping ends.

3. Performance Junior staff performs
this function.
Senior staff performs
this function.
4. Nature of Job This job is clerical
and routine in nature.
This job is analytical
and dynamic in nature.
5. Objective The objective of book
keeping is to maintain
systematic records of
financial transactions.
The objective of
accounting is to
ascertain net results of
operations and
financial position and
to communicate
information to the
interest parties.
6. Relation Book keeping is the
basis for accounting
Accounting begins
where book keeping
ends.
7. Special Skills Book keeping is
mechanical in nature
and thus, does not
require special skills.
Accounting requires
special skills and
ability to analyse and
interpret.
Accountancy
Accountancy refers a systematic knowledge of accounting. It explains how
to deal with various aspects of accounting. It tells us why and how to
maintain the books of accounts and how to summarise the accounting
information and communicate it to the various users.
OBJECTIVES OF ACCOUNTING

The objectives or functions of accounting are:
1. Maintain of Business Records: Accounting is the language
in which most of the business transactions (financial) and
events are expressed. Its objective is to keep a systematic
record of these financial transactions. It embraces proper
recording of transactions, classified under appropriate accounts
and summarised into financial statements- Income Statement
and the Position Statement.
2. Ascertaining Profit or Loss: Another objective of
accounting is to ascertain the net result of day-to-day
transaction for a period. In other words, to ascertain whether
during the period, the firm earned a profit or suffered a loss.
For this purpose, a statement called an Income Statement or the
Trading, Profit and Loss Account is prepared.
3. Ascertaining Financial Position: For a businessman, it is
not adequate to only ascertain the profit or loss; it is also
necessary to know the financial health of the firm. For this
purpose, a statement listing assets, liabilities and the owner's
capital is prepared. Such a statement is called a Balance Sheet.
4. Facilitating Management Control: The management often
requires financial information for decision making, effective
control, budgeting and forecasting. Accounting provides
financial information to assist the management in discharging
this function.

5. Providing accounting Information to Users: Another
objective of accounting is to provide accounting information to
users who analyse them as per their individual needs. The
American Accounting Association while defining accounting
has also identified this objective of accounting.
1. Financial Information about Business: Accounting
makes available financial information, i.e., the profit
earned or loss suffered and also what are the assets and
liabilities of the enterprise.
information.
necessity of remembering various transaction, since on
need, the records will furnish the necessary information.
4. Facilitates Comparative Study: a systematic record
will enable a businessman to compare one year's results

with those of other years and locate significant factors
leading to the change, if any.
transactions.
6. Facilitates Loans: the banks and financial institution
of basis of growth potential, which is supported by the
performance, grant Loan.
7. Evidence in Court: the Courts often treat Systematic
record of transactions as good evidence.
8. Facilitates sale of Business: If someone desires to sell
his business, the accounts maintained by him will enable
the ascertainment of the proper price.
LIMITATIONS OF ACCOUNTING

Accounting has many advantages and that much significant information is
available from financial accounting such as profit earned or loss suffered
during a period and the financial position at its end. But it has some
limitations also.
1. Accounting is Not fully Exact: Although most of the transactions are
recorded on the basis of evidence such as sale or purchase or receipt
of cash, yet some estimates are also made for ascertaining profit or
loss.
2. Accounting Does not indicate the Realizable Value: The Balance
Sheet does not show the amount of cash which the firm may realize
by the sale of all the assets. This is because many assets are not meant
to be sole; they are meant for use and are shown at cost less
depreciation that may have been written off.
3. Accounting Ignores the Qualitative Elements: Since accounting is
confined to monetary matters only, qualitative elements like quality of
management and labour force, industrial relations and public relations
are ignored.
4. Accounting Ignores the effect of Price Level Changes: Accounting
statements are prepared at historical cost. Money, as a measurement
unit, changes in value. It does not remain stable. Unless price level
changes are considered while preparing financial statement,
accounting information will not show true financial results.
5. Accounting May Lead to Window Dressing: The term window
dressing means manipulation of accounts in a way so as to conceal
vital facts and present the financial statements in a way to show better
position than what it is actually. In this situation, income statement

(i.e., Profit and loss Account) fails to provide a true and fair view of
the result of operations and the Balance Sheet fails to provide a true
and fair view of the financial position of the enterprise.
MEANING AND NATURE OF ACCOUNTING PRINCIPLES
According to the AICPA "Principles of Accounting are the general law or
rule adopted or proposed as a guide to action, a settled ground or basis of
conduct or practice."
Accounting Principles may be defined as those rules of action or conduct
which are adopted by accountants universally while recording accounting

transactions. They are the norms or rules which are followed in treating
various items of assets, liabilities, expenses incomes, etc.
Principles are the basis or fundamental prepositions and are generally
accepted set of accounting principles based on which transactions are
recorded and financial statements are prepared. These principles are
classified into two categories:
(i) Accounting Concepts;
(ii) Accounting Conventions
Accounting Concepts
Accounting Concepts are the basic assumptions or fundamental propositions
concerning the economic, political and social environment within which
accounting operates. They are generally accepted set of accounting rules
based on which transactions are recorded and financial statements prepared.
It is important to follow these rules because it will enable the user to
understand the financial statements of the enterprise better, which otherwise
would become difficult if not impossible.
Accounting Conventions
Accounting Conventions are outcome of accounting practices or principles
being followed by the enterprises over a period of time. Conventions may
undergo a change with time to bring about improvement in the quality of
accounting information.

Features of Accounting Principles
1.Accounting Principles are Man-Made: Accounting
principles are man-made and, therefore, do not stand scrutiny
like principles of natural science. They are the best possible
suggestions based on practical experiences. They are
recommended for use by all enterprises to ensure uniformity
and understandability.
2. Accounting Principles are Flexible: Accounting principles
are not rigid but flexible. Whenever a situation arises that
requires solution, accountants arrive at a reasonable decision,
which gradually becomes the accepted accounting principle. It
must be remembered that accounting principles are not
permanent and change with time.
3. Accounting Principles are Generally Accepted:
Accounting principles are the bases and guide for accounting
and are generally accepted. The general acceptance of
accounting principle usually depends on how it meets the
criteria of relevance, objectivity and feasibility.
(i) Relevance: Accounting principles are relevant if they result in
information that is useful to the users of accounting information.
(ii) Objective: Accounting principles are objective if they are not
influenced by the personal bias of the persons preparing the
accounting information.
(iii) Feasible: Accounting principles are feasible if they can be
applied without undue complexity and cost.

Accounting Concepts
1. The Business Entity Concept: The Business Entity Concept holds
the business to be separate and distinct from its owners. Business
transactions, therefore, are recorded in the books of accounts from the
business point of view and not owners. Owners considered separate
from the business are considered creditors of the business to the extent
of their capital. Their account with the business is credited with the
capital introduced and profit earned during the year, etc. and debited
by the drawing made.
2. The Money Measurement Concept: The Money Measurement
Concept holds that transactions and events that can be measured in
money terms are recorded in the books of accounts of the enterprise.
In other words, money is common denominator in recording and
reporting all transactions. Consider that an enterprise has Rs. 10,000
cash, 6 tonnes of raw material, 6 trucks and 10,000 sq. yards land.
These assets cannot be added and show in the financial statements
unless their monetary value is ascertained. However, the concept
suffers from two major limitations:
(i) Transactions and events that cannot be measured in money
terms are not recorded, howsoever, important they may be to the
enterprise.
(ii) The yardstick of measurement, i.e., money is considered as
having static value as the transactions are recorded at the value on
the transaction date.

3. the Going Concern Concept: The Going Concern Concept holds that
a business shall continue for an indefinite period and there is no
intention to close the business or scale down the operations
significantly. It is because of this concept that a distinction is made
between an expenditure that will render benefit for a long period and
one whose benefit will be exhausted quickly, say, with the year. Of
course, if it is certain the business will exist only for a limited time,
accounting will keep the expected life in view. On the basis of this
concept, fixed assets are recorded a their original cost and depreciated
in a systematic manner without reference to their market value.
4. The Accounting Period Concept: The Accounting Period Concept
holds that the life of an enterprise be broken into smaller periods so
that its performance is measured at regular intervals. The accounts of
an enterprise are maintained following the Going Concern Concept
meaning the enterprise shall continue its activities in the foreseeable
future. One may argue that the financial statements of the enterprise
should be prepared at the end of its life. It is possible to do so but, a
number of users of financial statements and many of them, especially
the management and bankers, require the information from the
accounts at regular intervals so that decisions can be taken at the
appropriate time. Management requires information at regular
intervals to assess the performance, funds requirement (short term as
well as long term), bankers require accounting information
periodically because they have invested money and have to ensure its
safety and returns. Similarly, the Government has to assess the tax
dues fro the enterprise.

5. The Cost Concept: The Cost Concept holds that an asset is recorded
in the books of account at the price paid to ac1quire it and the cost is
the basis for all subsequent accounting of the asset. Asset is recorded
at the cost at the time of its purchase but is systematically reduced in
value by charging depreciation. The market value of an asset may
change with the passage of time, but for accounting purposes it
continues to be shown in the books of accounts at its book value (i.e.,
cost at which it was purchased minus depreciation provided up-to-
date).
According to the cost principle, if an asset is acquired and nothing is paid
for it, it is usually not recorded as an asset.
The cost principle has the advantage of bringing objectivity into the
accounts, information given in the financial statements is not influenced
by the personal bias or judgments of those who furnish such statements.
In the absence of this principle, the amount shown in the accounting
records would depend on the objective views of a person.
6. The Dual Aspect Concept: This is the basic concept of accounting.
According to this concept, every transaction entered into by an
enterprise has two aspects. If a transaction has taken place or an event
has occurred, it is bound to have a two sided effect. This two sided
effect can be better understood, it we recollect the business entity
concept under which the enterprise is considered to be separate from
its proprietor. When the proprietor starts the business and invests
money, the enterprise will have that much money but, also, the
enterprise shall owe that much amount to the proprietor. One may,

therefore, say that the assets (cash in hand in this case) are equal to the
owner's equity or capital.
7. The Revenue Recognition Concept: The Revenue Recognition
Concept holds that revenue is considered to have been realized when a
transaction has been entered into and the obligation to receive the
amount has been established. It is to be noted that recognizing
revenue and receipt of an amount are two separate aspects. Let us
take an example to understand it. An enterprise sells goods in
February 2006 and receives the amount in April 2006. Revenue of
this sale should be recognized in February 2006, i.e., when the goods
are sold. It is so because the legal obligation has been established
(upon sale) in February 2006. Let us take another example. Suppose
an enterprise has received an advance in February 2006 for the sale to
be made in May 2006, revenue shall be recognized in May 2006, upon
sale having been made because the legal obligation to receive the
amount has been established in May 2006.
8. The Matching Concept: The Matching Concept is based on the
accrual concept of accounting and related to the revenue concept. It
holds that the cost incurred to earn the revenue should be set out
against the revenue in the period during which it is recognized as
earned. For matching expenses with revenue, first revenue is
recognized and then costs associated with those revenue are
recognized.

1. Financial Information about Business:
Accounting makes available financial information, i.e.,
the profit earned or loss suffered and also what are the
assets and liabilities of the enterprise.
information.
necessity of remembering various transaction, since on
need, the records will furnish the necessary information.
4. Facilitates Comparative Study: a systematic
record will enable a businessman to compare one year's
results with those of other years and locate significant
factors leading to the change, if any.
transactions.

6. Facilitates Loans: Loan is granted by the banks
and financial institution of basis of growth potential
which is supported by the performance.
7. Evidence in Court: Systematic record of
transactions is often treated by the Courts as good
evidence.
8. Facilitates sale of Business: If someone desires to
sell his business, the accounts maintained by him will
enable the ascertainment of the proper price.
LIMITATIONS OF ACCOUNTING
Accounting has many advantages and that much significant information is
available from financial accounting such as profit earned or loss suffered
during a period and the financial position at its end. But it has some
limitations also.

1. Accounting is Not fully Exact: Although most of the transactions are
recorded on the basis of evidence such as sale or purchase or receipt
of cash, yet some estimates are also made for ascertaining profit or
loss.
2. Accounting Does not indicate the Realisable Value: The Balance
Sheet does not show the amount of cash which the firm may realize
by the sale of all the assets. This is because many assets are not meant
to be sole; they are meant for use and are shown at cost less
depreciation that may have been written off.
3. Accounting Ignores the Qualitative Elements: Since accounting is
confined to monetary matters only, qualitative elements like quality of
management and labour force, industrial relations and public relations
are ignored.
4. Accounting Ignores the effect of Price Level Changes: Accounting
statements are prepared at historical cost. Money, as a measurement
unit, changes in value. It does not remain stable. Unless price level
changes are considered while preparing financial statement,
accounting information will not show true financial results.
5. Accounting May Lead to Window Dressing: The term window
dressing means manipulation of accounts in a way so as to conceal
vital facts and present the financial statements in a way to show better
position than what it is actually. In this situation, income statement
(i.e., Profit and loss Account) fails to provide a true and fair view of
the result of operations and the Balance Sheet fails to provide a true
and fair view of the financial position of the enterprise.

Users of accounting information
The primary aim of financial accounting is to make accounting information
available to the users to enable them top arrive at informed decisions. It is
unlikely that users will have common interests and it is not possible to meet
their individual requirements. Therefore, general purpose of financial
statements that includes Profit and Loss Account. Balance Sheet, schedules
and notes to accounts forming part of financial statements are prepared and
communicated to the users.
Users of accounting information may be categorized into Internal Users and
External Users.
INTERNAL USERS
1. Owners: Owners contribute capital in the business and thus are
always exposed to risk. In view of the risk involved, the owners are
always interested in knowing the profit earned or loss suffered by the
business besides the safety of the capital invested by them. In small
and medium sized enterprises, owners generally exercise direct
control on the affairs and thus, always possess the information as to
profit and financial position. But, in large sized enterprises, owners
do not exercise direct control and are dependent on the mangers for
financial information.

2. Management: We have discussed above that in large sized
enterprises, ownership and management are separate. Businesses are
managed by professional managers who are in direct control.
Management has the responsibility to not only safeguard the owner's
investment but also to increase its value by managing the business
efficiently so that it earns the maximum profit. The management
makes extensive use of accounting information to arrive at informed
decisions such as determination of selling price, cost controls and
reduction, investment into new projects, etc.
EXTERNAL USERS
3. Banks and Financial Institutions: Bankers and Financial Institutions
are an essential part of any business as they provide loans to the
businesses. It is natural that the Banks and Financial Institutions will
watch the performance of the business to know, whether it is making
progress as projected to ensure the safety and recovery of the loan
advanced.
4. Investors and Potential Investors: Investment involves risk and also
the investors do not have direct control over the business affairs.
Therefore, they rely on the accounting information available to them
and seek answers to the questions such as- what is the earning
capacity of the enterprise and how safe is their investment?
5. Creditors: Creditors are those parties who supply goods or services
on credit. It is a common business practice that a large amount of
suppliers remains invested in credit sales. Before granting credit,

creditors satisfy themselves about the credit worthiness of the
business.
6. Government and its Authorities: The Government makes use of
financial statements to compile national income accounts and other
informations. The information so available to it enables them to take
policy decisions.
Government levies varied taxes such as Excise Duty, VAT, Service
Tax and Income Tax. These government aurthorities assess the correct
tax dues from an analysis of financial statements.
7. Employees and Workers: Employees and Workers are entitled to
bonus at the year end besides the salary and wages taken every
month. Bonus is directly linked to the profit earned by an enterprise.
Therefore, the employees and workers are interested in financial
statements. Besides, the financial statements also reflect whether the
enterprise has deposited its dues into the provident fund and
employees state insurance, etc. or not.
8. Researchers: Financial statements are of immense use to the
Researchers undertaking research in topical areas like accounting
theory and business practices. Stock brokers also carry out research on
financial statements to assess the future profitability and a result
assess what should be the value of the share
9. Society: Enterprises have a social responsibility towards the Society
and thus, both directly and indirectly, contribute to its welfare with
respect to economic betterment, protecting environment, providing
educational facilities, etc. Indirect contribution is not reflected in the

financial statements but is visible through increased business activity,
better infrastructure, better educational facilities and so on. Direct
contributions are reflected in the financial statements.
Users of accounting information
The primary aim of financial accounting is to make accounting information
available to the users to enable them top arrive at informed decisions. It is
unlikely that users will have common interests and it is not possible to meet
their individual requirements. Therefore, general purpose of financial
statements that includes Profit and Loss Account. Balance Sheet, schedules
and notes to accounts forming part of financial statements are prepared and
communicated to the users.
Users of accounting information may be categorized into Internal Users and
External Users.
INTERNAL USERS
1. Owners: Owners contribute capital in the business and thus are
always exposed to risk. In view of the risk involved, the owners are
always interested in knowing the profit earned or loss suffered by the
business besides the safety of the capital invested by them. In small
and medium sized enterprises, owners generally exercise direct
control on the affairs and thus, always possess the information as to
profit and financial position. But, in large sized enterprises, owners

do not exercise direct control and are dependent on the mangers for
financial information.
2. Management: We have discussed above that in large sized
enterprises, ownership and management are separate. Businesses are
managed by professional managers who are in direct control.
Management has the responsibility to not only safeguard the owner's
investment but also to increase its value by managing the business
efficiently so that it earns the maximum profit. The management
makes extensive use of accounting information to arrive at informed
decisions such as determination of selling price, cost controls and
reduction, investment into new projects, etc.
EXTERNAL USERS
3. Banks and Financial Institutions: Bankers and Financial Institutions
are an essential part of any business as they provide loans to the
businesses. It is natural that the Banks and Financial Institutions will
watch the performance of the business to know, whether it is making
progress as projected to ensure the safety and recovery of the loan
advanced.
4. Investors and Potential Investors: Investment involves risk and also
the investors do not have direct control over the business affairs.
Therefore, they rely on the accounting information available to them
and seek answers to the questions such as- what is the earning
capacity of the enterprise and how safe is their investment?
5. Creditors: Creditors are those parties who supply goods or services
on credit. It is a common business practice that a large amount of
suppliers remains invested in credit sales. Before granting credit,

financial statements but is visible through increased business activity,
better infrastructure, better educational facilities and so on. Direct
contributions are reflected in the financial statements.
BASIC ACCOUNTING TERMS
It is necessary to understand the basic accounting terms which are used in
the business. These terms are a part of the standa5rd accounting
terminology.
1. Assets: Assets are property or legal rights owned by an individual or
business to which money value can be attached. In other words,
anything which will enable the firm to get cash or a benefit in the
future, is an asset.
Assets can be classified to be:
(i) Fixed Assets: Fixed Assets are those assets which are
purchased for the purpose of operating the business and not for resale.
Examples of fixed assets are land, building, machinery, furniture etc.
(ii) Current Assets: Current Assets are those assets of a
business which are kept for short term with a purpose to convert
them into cash or for resale. Examples of current assets are unsold
goods, debtors, bills receivables, bank balance etc.
(iii) Tangible Assets: Tangible Assets are those assets
which have physical existence, i.e. they can be seen and touched.

(iv) Intangible Assets: Intangible Assets are those assets
which do not have any physical form, i.e., they cannot be seen and
touched.
(v) Wasting Assets: Wasting Assets are those assets
which are natural resources consumed during the process of use.
2. Liabilities: Liabilities mean the amount which the business owes to
outsiders, that is, excepting the proprietors. In the words of Finny
and Miller, " Liablilities are debts, they are amounts owed to
creditors."
3. Capital: Capital means the amount (in terms of money or assets
having money value) which the proprietor has invested in the business
and can claim from it. For the firm, it is a liablility towards the owner.
It is so because the owner is treated separate from the business.
Capital is also known as Owner's Equity, Proprietorship and net
worth. Owner's Equity means owner's claim against the assets of the
business.
4. Expense: Expense is the amount spent in order to produce and sell the
goods and services which produce the revenue. "Expense is the cost of
the use of things or services for the purpose of generating revenue.
5. Income: Income is the profit earned during a period of time. In other
words, the difference between revenue and expense is called income.
6. Expenditure: Expenditure is the amount spent or liability incurred for
the vlue received. An expenditure is a payment for a benefit
received. Expenditure may be categorized into:
(i) Capital Expenditure: Capital Expenditure is the
amount spent in purchasing assets which will give benefits over a

number of accounting periods. It means expenditure incurred to
acquire fixed assets or its improvement.
(ii) Revenue Expenditure: Revenue Expenditure is the
amount spent to purchase goods and services that are consumed
during the accounting period. Revenue expenditure does not
increase the earning capacity but it maintains the earning capacity
in the current year. Revenue expenditure is shown on the debit
side of the Profit and Loss Account.
7. Revenue: Revenue means the amount, which as a result of operations,
is added to the capital. "Revenue is an inflow of assets, which results
in an increase in the owner's equity."
8. Debtor: A person who owes money to the firm generally on account
of credit sales of goods is called a Debtor.
9. Creditor: A person to whom a firm owes money is called a Creditor.
10.Goods: They refer to items forming part of the stock-in-trade of a
business firm, which are purchased and are to be resold. In other
words, they refer to the products in which a business unit is dealing.
For a firm dealing in home appliances such as TV, Fridge, AC etc.
these are goods.
11.Cost: It is the amount of expenditure incurred on or attributable to a
specified article, product or activity.
12.Gain: It is a profit that arises from transactions which are incidental to
business such as sale of investments or fixed assets ate more than their
book values. The term gain is used to indicate increase in capital from
incidental transactions. Gain may be operating gain or non-operating
gain.

13.Stock or Inventory: Stock is the tangible property held by an
enterprise for the purpose of sale in the ordinary course of business or
for the purpose of using it in the production of goods meant for sale or
services to be rendered. Stock may be opening stock or closing
stock. In case of a trading concern it comprises of closing stock in
hand or the amount of goods which are lying unsold at the end of an
accounting period.
14.Purchase: The term purchase is used only for purchase of goods.
Goods are those things which are purchased for resale or for
producing the finished products which are also to be sold. The term
'Purchases' includes both cash and credit purchases of goods. Goods
purchased for cash are called cash purchases but if goods are
purchased on credit, it is referred to as credit purchases.
Purchases Returns: Goods purchased may be returned due to any
reason, say, they are not as per specifications or are defective. Goods
returned are known as Purchases Returns or Returns Outward.
15.Sale: This term is used for the sale of only those goods dealt by the
firm. The term 'sales' includes both cash and credit sales. When
goods are sold for cash, they are cash sales but if goods are sold and
payment is not received at the time of sale, it is referred to as credit
sales.
Sales Returns: Goods sold when returned by the purchaser are
termed as Sales Returns or Return Inwards.
16.Loss: A loss is an excess of expenses of a period over its related
revenues which may arise from normal business activities. It

decreases the owner's equity. It also refers to money or money's
worth lost (or cost incurred) against which the firm receives no
benefit, e.g. cash or goods lost in theft.
17.Profit: It is the surplus of revenues of a business over its costs. Profit
is normally categorized into gross profit and net profit.
Gross Profit: Gross Profit is the difference between sales revenue or
the proceeds of goods sold and /or services rendered over its direct
cost.
Net Profit: Net Profit is the profit made after allowing for all
expenses. In case expenses are more than the revenue, it is Net Loss.
18.Voucher: Voucher is an evidence of a business transaction. Examples
of voucher are: Cash Memo, Invoice or Bill, Receipt Debit/Credit
Notes, etc.
19.Discount: When customers are allowed any type of reduction in the
prices of goods by the business, it is called a Discount.
20.Transaction: Transaction is a financial event of a nature that is
entered into by the parties and is recorded in the books of accounts. A
transaction is a particular kind of external event that involves transfer
of something valuable between two entities. It changes the financial
position of the enterprise.
21.Drawings: It is the amount of money or the value of goods which the
proprietor takes for his domestic or personal use. Drawing reduces the
investment of the owners.
22.Account: Account is a summarised record of relevant transactions at
one place relating to a particular head. It records not only the amount
of transactions but also their effect and direction.

23.Books of Accounts: Books of accounts refer to Journal and Ledgers
in which transactions are recorded.
24.Entry: A transaction and event when recorded in the books of
accounts is known as an entry.
25.Debit: An account has two parts, i.e., debit and credit. The left side is
the debit side while the right side is the credit side. If an account is to
be debited, then the entry is posted to the debit side of the account.
26.Credit: Credit is the right side of an account. If n account is to be
credited, then the entry is posted to the credit side of the account.
27.Proprietor: The person who makes the investment and bears all the
risks connected with the business is called the proprietor.
28.Receivables: The term 'Receivables' includes the outstanding amount
due from others. Sometimes, a debtor may accept a Bill of Exchange,
which is payable after a given period. Such a bill is known as bill
receivable.
29.Payables: The term 'Payables' include the amounts due to others.
Accounts Payable includes trade creditors as well as bills payable and
promissory notes payable. The term payable includes all the amounts
due to others.
30.Bill Receivable: Bill Receivable means a bill of exchange accepted
by a debtor the amount of which will be received on the specified
date.
31.Bill Payable: Bill Payable means a bill of exchange, the amount of
which will be payable on the specified date.
32.Depreciation: Depreciation is a fall in the value of an asset because
of usage or with passage of time or obsolescence or accident.

33.Cost of Goods Sold: Cost of Goods Sold is the direct costs of the
goods or services sold.
34.Bad Debts: Bad Debts is the amount that has become irrecoverable.
It is a business loss and is debited to Profit and Loss Account.
35.Insolvent: Insolvent is a person or enterprise which is not in a
position to pay its debts.
36.Solvent: Solvent is a person or enterprise which is in a position to pay
its debts.
37.Book Value: This is the amount at which an item appears in the
books of accounts or financial statements.
38.Balance Sheet: It is a statement of the financial position of an
individual or enterprise as at a given date, which exhibits its assets,
liabilities, capital, reserves and other account balances at their
respective book values.
39.Entity: An entity means an economic unit which performs economic
activities (e.g. Reliance industries, Bajaj Auto, Maruti, TISCO).
Business entity means a specifically identifiable business enterprise
like ITC Ltd., An accounting system is always devised for a specific
business entity.
THANK YOU

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