Introduction to Accounting

Accounting is the language of business. It is the system of recording, summarizing, and

analyzing an economic entity's financial transactions. Effectively communicating this
information is key to the success of every business. Those who rely on financial information
include internal users, such as a company's managers and employees, and external users, such
as banks, investors, governmental agencies, financial analysts, and labor unions. These users
depend upon data supplied by accountants to answer the following types of questions:


Is the company profitable?
Is there enough cash to meet payroll needs?
How much debt does the company have?
How does the company's net income compare to its budget?
What is the balance owed by customers?
Has the company consistently paid cash dividends
How much income does each division generate?
Should the company invest money to expand?
Accountants must present an organization's financial information in clear, concise reports that
help make questions like these easy to answer. The most common accounting reports are
called financial statements.
Definition of Accounting
"The art of recording , classifying and summarizing , in a significant manner and in terms of money ,
transaction and events which are, in part at least, of financial character, and interpreting the result
thereof."

The three important aspects of accounts have been highlighted by the above definition.

1. Account as an Art & science.
2. Accounting is done for Business transaction.
3. Accounting is a synjj




Objectives of Accounting
To keep systematic records:
Accounting is done to keep a systematic record of financial transactions. In the absence of
accounting there would have been terrific burden on human memory which in most cases would
have been impossible to bear.

To protect business properties:
Accounting provides protection to business properties from unjustified and unwarranted us. This
is possible on account of accounting supplying the information to the manager or the proprietor.

To ascertain the operational profit or loss:
Accounting helps is ascertaining the net profit earned or loss suffered on account of carrying the
business. This is done by keeping a proper record of revenues and expenses of a particular period.
The profit and loss account is prepared at the end of a period and if the amount of revenue for the
period is more than the expenditure incurred in earning that revenue, there is said to be a profit.
In case the expenditure exceeds the revenue, there is said to be a loss.

To ascertain the financial position of business:
The profit and loss account gives the amount of profit or loss made by the business during a
particular period. However, it is not enough. The businessman must know about his financial
position i.e., where he stands; what he owes and what he owns? This objective is served by the
balance sheet or position statement.

To facilitate rational decision making:
Accounting these days has taken upon itself the task of collection, analysis and reporting of
information at the required points of time to the required levels of authority in order to facilitate
rational decision making.
Advantages
The following are the advantages of accounting to a business:
i) It helps in having complete record of business transactions.
ii) It gives information about the profit or loss made by the business at the
close of a year and its financial conditions. The basic function of
accounting is to supply meaningful information about the financial
activities of the business to the owners and the managers.
iii) It provides useful information form making economic decisions,
iv) It facilitates comparative study of current years profit, sales, expenses
etc., with those of the previous years.
v) It supplies information useful in judging the managements ability to
utilise enterprise resources effectively in achieving primary enterprise
goals.
vi) It provides users with factual and interpretive information about
transactions and other events which are useful for predicting, comparing
and evaluation the enterprises earning power.

Limitations of Accounting
i) Accounting is historical in nature: It does not reflect the current financial
position or worth of a business.
ii) Transactions of non-monetary mature do not find place in accounting.
Accounting is limited to monetary transactions only. It excludes
qualitative elements like management, reputation, employee morale,
labour strike etc.
iii) Facts recorded in financial statements are greatly influenced by
accounting conventions and personal judgements of the Accountant or
Management. Valuation of inventory, provision for doubtful debts and
assumption about useful life of an asset may, therefore, differ from one
business house to another.
iv) Accounting principles are not static or unchanging-alternative
accounting procedures are often equally acceptable. Therefore,
accounting statements do not always present comparable data
v) Cost concept is found in accounting. Price changes are not considered.
Money value is bound to change often from time to time. This is a
strong limitation of accounting.
vi) Accounting statements do not show the impact of inflation.
vii) The accounting statements do not reflect those increase in net asset
values that are not considered realized.

Methods of Accounting
Business transactions are recorded in two different ways.
1. Single Entry
2.Double Entry
Single Entry: It is incomplete system of recording business transactions. The
business organization maintains only cash book and personal accounts of debtors and
creditors. So the complete recording of transactions cannot be made and trail balance
cannot be prepared.
Double Entry: It this system every business transaction is having a two fold
effect of benefits giving and benefit receiving aspects. The recording is made on the
basis of both these aspects. Double Entry is an accounting system that records the
effects of transactions and other events in atleast two accounts with equal debits and
credits.
Types of Accounts
The object of book-keeping is to keep a complete record of all the transactions
that place in the business. To achieve this object, business transactions have been
classified into three categories:
(i) Transactions relating to persons.
(ii) Transactions relating to properties and assets
(iii) Transactions relating to incomes and expenses.

Personal Accounts: Accounts recording transactions with a person or group of
persons are known as personal accounts. These accounts are necessary, in particular,
to record credit transactions. Personal accounts are of the following types:
(a) Natural persons: An account recording transactions with an individual
human being is termed as a natural persons personal account. eg., Kamals account,
Malas account, Sharmas accounts. Both males and females are included in it
(b) Artificial or legal persons: An account recording financial transactions
with an artificial person created by law or otherwise is termed as an artificial person,
personal account, e.g. Firms accounts, limited companies accounts, educational
institutions accounts, Co-operative society account.
(c) Groups/Representative personal Accounts: An account indirectly
representing a person or persons is known as representative personal account. When
accounts are of a similar nature and their number is large, it is better tot group them
under one head and open a representative personal accounts. e.g., prepaid insurance,
outstanding salaries, rent, wages etc.
When a person starts a business, he is known as proprietor. This proprietor is
represented by capital account for all that he invests in business and by drawings
accounts for all that which he withdraws from business. So, capital accounts and
drawings account are also personal accounts.
The rule for personal accounts is: Debit the receiver Credit the giver

Real Accounts
Accounts relating to properties or assets are known as Real Accounts, A
separate account is maintained for each asset e.g., Cash Machinery, Building, etc.,
Real accounts can be further classified into tangible and intangible.
(a) Tangible Real Accounts: These accounts represent assets and properties
which can be seen, touched, felt, measured, purchased and sold. e.g. Machinery
account Cash account, Furniture account, stock account etc.
(b) Intangible Real Accounts: These accounts represent assets and properties
which cannot be seen, touched or felt but they can be measured in terms of money.
e.g., Goodwill accounts, patents account, Trademarks account, Copyrights account,
etc.
The rule for Real accounts is: Debit what comes in
Credit what goes out

Nominal Accounts
Accounts relating to income, revenue, gain expenses and losses are termed as
nominal accounts. These accounts are also known as fictitious accounts as they do not
represent any tangible asset. A separate account is maintained for each head or
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expense or loss and gain or income. Wages account, Rent account Commission
account, Interest received account are some examples of nominal account
The rule for Nominal accounts is: Debit all expenses and losses
Credit all incomes and gains



BRANCHES OF ACCOUNTING
The changing business scenario over the centuries gave rise to specialized
branches of accounting which could cater to the changing requirements. The branches
of accounting are;
Financial Accounting
The accounting system concerned only with the financial state of affairs and
financial results of operations is known as Financial Accounting. It is the original
from of accounting. It is mainly concerned with the preparation of financial
statements for the use of outsiders like creditors, debenture holders, investors and
financial institutions. The financial statements i.e., the profit and loss account and the
balance sheet, show them the manner in which operations of the business have been
conducted during a specified period.
Cost Accounting
In view of the limitations of financial accounting in respect of information
relating to the cost of individual products, cost accounting was developed. It is that
branch of accounting which is concerned with the accumulation and assignment of
historical costs to units of product and department, primarily for the purpose of
valuation of stock and measurement of profits. Cost accounting seeks to ascertain the
cost of unit produced and sold or the services rendered by the business unit with a
view to exercising control over these costs to assess profitability and efficiency of the
enterprise. It generally relates to the future and involves an estimation of future costs
to be incurred. The process of cost accounting based on the data provided by the
financial accounting.
Management Accounting
It is an accounting for the management i.e., accounting which provides
necessary information to the management for discharging its functions. According to
the Anglo-American Council on productivity, Management accounting is the
presentation of accounting information is such a way as to assist management in the
creation of policy and the day-to-day operation of an undertaking. It covers all
arrangements and combinations or adjustments of the orthodox information to provide
the Chief Executive with the information from which he can control the business e.g.
Information about funds, costs, profits etc. Management accounting is not only
confined to the area of cost accounting but also covers other areas (such as capital
expenditure decisions, capital structure decisions, and dividend decisions) as well.








Accounting Process
The accounting process is actually three separate types of transactions that are intended to
record business transactions into the accounting records and then aggregate this information
into financial statements. The transaction types are:

The first transaction type is to ensure that reversing entries from the previous period
have, in fact, been reversed.
The second group is comprised of the steps needed to record individual business
transactions in the accounting records.
The third group is the period-end processing required to close the books and produce
financial statements.
We will address these three parts of the accounting process below.
Beginning of Period Processing

Verify that all transactions designated as reversing entries in preceding periods have actually been
reversed. These transactions are usually flagged as being reversing entries in the accounting software,
so the reversal should be automatic. Nonetheless, examine the accounts at the beginning of the period
to verify the reversals. It is quite possible that a reversing flag was not set, and so an entry must be
reversed manually, with a new journal entry.

Individual Transactions

The steps required for individual transactions in the accounting process are:

1. Identify the transaction. First, determine what kind of transaction it may be. Examples are
buying goods from suppliers, selling products to customers, paying employees, and recording
the receipt of cash from customers.
2. Prepare document. There is frequently a business document to be prepared or recognized to
initiate the transaction, such as an invoice to a customer or an invoice from a supplier.
3. Identify accounts. Every business transaction is recorded in an account in the accounting
database, such as a revenue, expense, asset, liability, or stockholders' equity account. Identify
which accounts are to be used to record the transaction.
4. Record the transaction. Enter the transaction in the accounting system. This is done either
with a journal entry or an on-line standard transaction form (such as is used to record cash
receipts against open accounts receivable). In the latter case, the transaction forms record
information in a pre-determined set of accounts (which can be overridden).
These four steps are the part of the accounting process used to record individual business transactions
in the accounting records.


Period-End Processing

The remaining steps in the accounting process are used to aggregate all of the information created in
the preceding steps, and present it in the format of financial statements. The steps are:

1. Prepare trial balance. The trial balance is simply a listing of the ending balances in every
account. The total of all the debits in the trial balance should equal the total of all the credits;
if not, there was an error in the entry of the original transactions that must be researched and
corrected.
2. Adjust the trial balance. It may be necessary to adjust the trial balance, either to correct errors
or to create allowances of various kinds, or to accrue for revenues or expenses in the period.
3. Prepare adjusted trial balance. This is the original trial balance, plus or minus all adjustments
subsequently made.
4. Prepare financial statements. Create the financial statements from the adjusted trial balance.
The asset, liability, and shareholders' equity line items form the balance sheet, while the
revenue expense line items form the income statement.
5. Close the period. This involves shifting the balances in the revenue and expense accounts into
the retained earnings account, leaving them empty and ready to receive transactions for the
next accounting period.
6. Prepare a post-closing trial balance. This version of the trial balance should have zero account
balances for all revenue and expense accounts.
In reality, any accounting software package will automatically create all versions of the trial
balance and the financial statements, so the actual steps in the accounting process may be
considerably reduced. Instead, the steps used in a computerized environment are likely to be:

Prepare financial statements. This information is automatically compiled from the general
ledger by the accounting software.
Close the period. The accounting staff closes the accounting period that has just been
completed, and opens the new accounting period. Doing so prevents current-period
transactions from being inadvertently entered into the prior accounting period. In a multi-
division company, it may be necessary to complete this period closing step in the software for
each subsidiary.