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Introduction to Accounting
By S Bhardwaj
Definition of Accounting:
"It is the Art of recording, classifying and summarizing in a significant manner & in terms of money,
transactions & events which are, i part at least, of a financial character, and interpreting the results
thereof".
Steps/Process/Attributes of accounting:
1. Identification of financial transaction: First, a business transaction has to be identified and any
non-business transaction has to be ignored. Like purchase of goods, is a business transaction where
as payment of electric bill of the owners house is a non-business transaction.
2. Measuring the Identified Transaction: second step is to measure the above business transaction
in terms of money. the monetary value is to be ascertained.
3. Recording: once the value is ascertained, the next step is to record it in the books for the first
time, recording is always done in JOURNAL, where transactions are recorded for the first time in a
chronological order.
4. Classifying: recorded transactions are many & difficult to comprehend. so these transaction has to
be classified on smaller groups with same feature, rather same account transactions are classified in
LEDGER. it is the process of grouping of similar items in one account. the process of putting
transaction from JOURNAL to ledger is called POSTING.
5. Summarizing: in this step we find out the total of each classified account. summarizing is done
using the following three statements:
i) Trial balance: ascertains Arithmetical Accuracy of accounts.
ii) Profit & Loss Account: ascertains profits or loss for a period.
iii) Balance Sheet: ascertains the position of assets and liabilities on a particular date.
6. Analyzing & Interpreting: all summarizing, the next step is to analyse the summarized statements
and interpret it to find out the performance of the business,i.e, the profits or loss of the business for
the accounting period.
7: Communication to User: the last step of accounting is to communicate the result of the business
to its various users. users may be internal and external. eg, management, employees, shareholders,
government, tax authorities, etc.
Mnemonic Code of Accounting may be: I M R C S A C
Accounting concepts:
In order to maintain Uniformity and consistency in accounting records, certain rules or principles
have been developed which are generally accepted by accounting profession. Thee rules are called
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by different names such as PRINCIPLES, CONCEPTS, CONVENTIONS, POSTULATES, ASSUMPTIONS &
MODIFYING PRINCIPLES. From practical point of view, we will refer them as Basic Accounting
Concepts.
A PRINCIPLE is a general law or rule adopted or professed as a guide to action, a settled ground or
basis of conduct or practice.
GAAP: Generally Accepted Accounting Principles: It refers to rules or guidelines adopted for
recording and reporting of business transactions, in order to bring uniformity in preparation &
presentation of Financial statements.
BASIC ACCOUNTING PRINCIPLES:
1. BUSINESS ENTITY CONCEPT: the concept assumes that the business has a distinct and
separate entity from its owners. For all accounting purpose, owners and the business are
two separate entity. EXAMPLE: Mr X starts a business with rs 10000. Here, Mr X has given
money to the Business, so the business is liable to pay back rs 10000 to Mr X. all the
accounting is done from the business point of view, and not from the owners point of view.
2. MONEM MEASUREMENT CONCEPT: this concept states that only those transaction which
can be recorded in monetary terms should be recorded in the books of accounts. EXAMPLE,
purchase or sale of goods, expenses paid, income received, etc are all recorded in books as
these can be measured in terms of money, whereas skills of a manager, or quality of a
worker can’t be recorded in the books as they cant be measured in monetary terms.
3. GOING CONCERN CONCEPT: this concept assumes that a business would continue to carry
out its operations indefinitely for a fairly long period of time and would not be liquidated in
the near future. A business goes on for ever.
4. ACCOUNTING PERIOD CONCEPT: this concept defines the span of time at the end of which
the financial statement are to be prepared to know the performance of the business, usually
a 12 month period is accounting period starting from 1st
January to 31st
December OR from
1st
April to 31st
march of the next year.
5. COST CONCEPT: This concept state that all assets should be recorded I n the books at their
cost price or historical cost, which includes cost of transportation, installation, acquisition
and making the asset ready for use.
COST OF ASSET=Price + transportation cost + installation cost + etc.
6. DUAL ASPECT CONCEPT: this concept states that for every transaction, there is a double fold
effect on various accounts and should therefore be recorded at two places. The duality
principle is commonly expressed in terms of fundamental accounting equation which is:
ASSETS= LIABILITY +CAPITAL
Example: X sold Goods to Y. here, for X, his goods will decrease and Cash will Increase.
7. REVENUE RECOGNITION CONCEPT: Revenue is the gross inflow of cash arising from the sale
of goods & services by the enterprise and it also includes Interest, commission, dividend, etc.
this concept states that the revenue should be recognised when a legal right to receive it
arises, not when the cash is received. EXAMPLE: X sold goods on 1-1-2018, but received the
payment on 10-1-2018, here the revenue is recognised on 1-1-2018, not on 10-1-2018.
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8. MATCHING CONCEPT: this concept states that expenses incurred in an accounting year
should be matched with the revenue received during that period. It states that revenue and
expenses incurred to earn this revenue must belong to the same period.
9. FULL DISCLOUSER CONCEPT: this concept states that all material and relevant facts
concerning financial performance of an enterprise must be fully disclosed in the financial
statement and their accompanying footnotes. This is to enable the users to make correct
assumptions about the profitability and financial soundness of enterprise and help them to
take informed decisions.
10. CONSISTENCY CONCEPT: It states that the accounting policies and practices followed by the
enterprise should be uniform and consistent over the period of time, so as to facilitate inter
firm and intra firm comparisons.
11. CONSERVATISM CONCEPT: this concept states that a firm should not overstate its profits. All
anticipated losses should be recorded but all unrealised profits must be IGNORED.
12. MATERIALITY CONCEPT: this concept states that accounting must focus on material facts.
Efforts should not be wasted on facts which are not material. If the fact is liable to change
the decision of an informed user, the fact is MATERIAL FACT.
13. OBJECTIVE CONCEPT: this concept states that accounting transactions should be recorded in
an objective manner, free from bias of the accountant and others and must be supported by
verifiable documents or vouchers.
COMMON TERMS OF ACCOUNTING:
ASSET: Valuable things owned by the firm. These are acquired for the future use. Assets are
acquired to increase the profit earning capacity of the firm. Eg, cash, bank, debtors, bills
receivable, investment, stock, Land & Building, Plant & Machinery, Equipment, Fixtures&
furniture, Patents, trademark, copyright, goodwill, prepaid expenses, accrued income, etc.
Something that an entity has acquired or purchased, and that has money value. Something
physical, such as cash, machinery, inventory, land and building, an enforceable claim against
others, such as accounts receivable, a right, such as copyright, patent, trademark, or an
assumption, such as goodwill.
LIABILITY: Creditors or proprietors claim against the assets of the business is called capital.
Proprietors claim is called capital and the claim of outsiders is called a liability. This is the
account for which the business is indebted. Eg, creditors, bills payable, outstanding expenses,
loan, advance income, bank overdraft, debenture, etc.
what a firm owes is a liability. Accounts and wages payable, accrued rent and taxes, trade debt,
and short and long-term loans. Owners' equity is also termed a liability because it is an
obligation of the company to its owners.
DEBTORS: a person or organisation who owes money to the firm.
CREDITORS: a person or organisation to whom the firm owes money.
ACCOUNT?
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Meaning: an account is a summarised record of all the transaction retaling to a
particularperson, thing or an item of income or expense. It is vertically divided into two halves
and resembles the shape of letter T as under.
Types of Account
Accounts can be classified into two major heads:
1. Personal Account: it can be further grouped as:
i) Natural person: like Ram, Rahim, Ralf, etc
ii) Artificial Person: Like ABC ltd, reliance ltd, etc
iii) Representative personal account: like Outstanding expenses, etc
2 Impersonal Accounts
a) Real Account: It includes all the assets including cash, building, furniture, patents,
goodwill, copyright, etc.
b) Nominal Account: it includes all the revenue and expenses of temporary nature like
expenses paid for salary, wages, etc and income received as commission, dividend, etc.
RULES OF DEBIT & CREDIT:
i) PERSONAL ACCOUNT: Debit the receiver
Credit the giver
ii) REAL ACCOUNT: Debit what comes in
Credit what goes out
iii)NOMINAL ACCOUNT: Debit all expenses & Losses
Credit all Incomes & gains
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Examples:
1. Paid cash to john Rs 5000.
Here there are two accounts being affected. I) John (personal Account) and ii) Cash ( Real Account).
John has received benefit from the business and as per the rule of personal account his name should
be debited, as “debit the receiver”. On the other hand cash being real account, is going out of the
business, so we will credit the cash account, as “Credit what goes out” says the real account rule.
2. Received Rs6000 from Neelam.
Two accounts being affected are, i) Neelam (personal), and ii) Cash ( Real).
Neelam is giving benefit to the business and as per the rule of personal account her name should be
credited, as “credit the receiver”. On the other hand cash being real account, is coming in to the
business, so we will debit the cash account, as “debit what comes in” says the real account rule.
3. Salary paid Rs5500.
Here, the two account being affected are, i) salary (Nominal) and ii) Cash. Salary, being a nominal
account, is an expense to the business, so it will be debited, as the rule says “Debit all expenses and
losses”. On the other hand cash being real account, is going out of the business, so we will credit the
cash account, as “Credit what goes out” says the real account rule.
Journal:
A journal is the daily record of the business. It is also called a Day book & is used for recording all day
to day transactions in the order in which they occur. It is the book of prime entry or original entry as
all the transactions are recorded first in this book. The process of recording is called JOURNALISING
and entries in this book is called a JOURNAL Entry. Format is given below: