ACCOUNTING

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ACCOUNTING
Accounting is mainly concerned with recording of financial
transactions, summarizing them and communicating to the users.
Since accounting is the medium of communication, it is called

Accounting is an art of recording, classifying, summarising,

analysing and interpreting the business transactions and
communicating the results to the persons who are interested in
such informations.As an information system, accounting is
capable of providing information that managers and other
interested persons need in order to make better decisions. 3
Definition
According to AICPA (American Institute of Certified Public
Accountants)
“Accounting is the art of recording, classifying and summarizing
in a significant manner in terms of money, transactions and
events which are , in part at least, of a financial character and
interpreting the results there of”.

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Accounting is an information system which receives data,inputs
process the same and give its outputs.In the form of information
which usefull for the decision making.

The modern system of Accounting was orginated by Luca Pacioli.

Who first published his book on Double entry system of
Accounting in 1494.

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Functions of Accounting
Recording
This is the basic function of the accounting, its concerned with
the recording of business transactions of financial character in an
orderly manner.Its done in the book called Journal.
Classifying
It is a systematic analysis of the recorded data to bring similar
items at one place. This is done in a book called ledger.
Summarising
It is the presentation of the classified data to make it useful for
internal and external users. Eg:- Trial balance, Balance Sheet etc.
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Deals with financial transaction
It deals with transactions and events which are of financial
nature.
Analysis and interpretation
The recorded financial data are analysed and interpreted in
such a way that end users can make a meaningful judgement
about the financial position of business.
Communication
After analysis and interpretation, the accounting informations
have to be communicated in the proper form and in the proper
manner to the proper persons.
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Features /Characteristics/Nature of Accounting
- Accounting is an art.
- Accounting is a science.
- Recording of business transactions.
- Classifying business transactions.
- Summarizing the classified data
- Analysis and interpret the summarized data
- Communicating information to the interested parties.
- Records transaction and events which are financial character.
- Language of business

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Objectives /Functions of accounting
To keep systematic records.
To ascertain the operational profit or loss.
To ascertain the financial position of the business.
To make information available to various users.
To protect business properties.
To facilitate rational decision making.
To ascertain the cost of production and selling price.
To control expenditure of business.
To satisfy the requirements of law.
To calculate the amount due to and due from others.
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Users of accounting information
Accounting informations are very useful to both internal and
external users.
1. Internal users: Internal users are those who are within the
organization. Following are the internal users of accounting
information.
(a) Management- Accounting informations help the managers to
take proper decisions.
(b) Employees- Employees are interested to know the profitability
of the business based on which, they can demand increment and
other incentives.
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2. External users: External users are those who are outside the
organization. Following are the external users of accounting
information.
(a) Shareholders: Shareholders use accounting information to
understand the profitability and financial soundness of the
business.
(b) Investors: Investors require accounting information to assess
the profitability of the company. If the company is found
profitable, they will invest in it and wise versa.
(c) Creditors: They require accounting information to check the
credit worthiness of the business.
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(d) Government: Government require accounting data to
calculate corporate tax.
(e) Stock brokers-For trading in securities of the company
(f) Regulatory agencies
(g) Advisors
(h) Customers etc

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Advantages of Accounting
- Maintain business records
- Prevention and detection of fraud
- Information about profit or loss
- Present true financial position
- Helps in preparing financial statements
- Helps to assess tax liabilities
- Comparison of result
- Acts as legal evidence
- Assist the management in decision making.

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Limitations of Accounting
- It is historical in nature.
- Transactions of non-monetary nature will not be recorded in
accounting.
- It is influenced by the personal judgment of the accountant
- In accounting valueless assets are also shown.
- In accounting price changes are not considered.
- It is not an exact science.
- Use of different accounting methods reduces the reliability of
accounts.
- Accounting records show only actual cost figures.
- Provide information about the concern as a whole. 14
Qualitative characteristics of accounting information
- Reliability
- Relevance
- Understandability
- Comparability

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Types/ forms/ branches of accounting
There are3 types of accounting. They are : -
1. Financial Accounting
2. Cost Accounting
3. Management Accounting

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1. Financial Accounting:
It is the original form of accounting. The purpose of financial
accounting is to record financial transactions in the books of
accounts, prepare the financial statements and interpreting the
results. It exhibit the true financial position of the business at the
end of every accounting period. It is historical in nature.
2. Cost Accounting:
This is a branch of accounting which deals with the ascertainment
of cost. With the help of cost accounting, the cost of product or
service can be ascertained and controlled.This is more helpful to
the management of a business.
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3. Management Accounting:
It deals with the accounting information which is useful to the
management for taking proper decisions. It uses both financial
and cost accounting informations and help the managers to take
rational decisions.

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Basic Accounting Terms
1. Asset:
Asset means any resource owned by the business with an
objective of generating future profits or income. Assets are
classified in the following ways:-
(a)Tangible assets : Assets having a physical existence. That
means those assets that we can touch and see.
Example: Plant & Machinery, Land and building, furniture etc.
(b) Intangible assets: These are the assets that can not be touched
or seen but they help the business to generate income in the
future. Example:-Goodwill, patent, copy right etc.
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(c) Fixed asset:
These are the assets which can be used for a long period of
time(above 1 year) Example: Plant & Machinery, Land and
building etc, vehicle etc.
(d) Current Assets:
These are the assets which can be converted into cash within a
short period of time. Example: Sundry debtors, cash in hand, cash
at bank etc.
(e)Fictitious assets:
These are the assets having no real value but are shown in the
books of accounts only for technical reasons. Example; Huge
advertisement expenses, Preliminary expenses 20
2. Liabilities:
These are the debt or obligations that an enterprise must pay or
fulfil in the future.This is an obligation of financial nature to be
settled in the future. Liabilities are classified as follows:-
(a)Long term liabilities:
Liabilities which are payable after a long period of time( usually
after one year) Example: long term loan.
(b)Current Liabilities:
Liabilities which are payable within a short period of time( within
one year) Example: Sundry creditors, bills payable etc.

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3. Capital:
Capital means money or money’s worth invested by the owners
into the business. It may be in the form of cash, goods or any
other things having a value.
4: Business transaction:
It means any business dealings or events which can be measured
in terms of money. It may be of 2 types:- cash transaction
(immediate settlement by cash or cheque) or credit transaction
( payment settled in future)
5. Profit : The excess of income over expense is called profit.
6. Loss: The excess of expense over income is called loss.
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7. Drawings:
It means the amount of cash or goods or any other assets
withdrawn by the owner from business for his personal use.
8. Revenue:
Amount earned by the business by selling products or rendering
services.
9. Expense:
It means the amount spent for earning revenue. It includes capital
expenditure & revenue expenditure.
(i)Capital expenditure
It is the expenditure incurred for acquiring a fixed asset which is
indented to be used for a long period of time(not for sale).
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(ii)Revenue expenditure is the routine expenditure incurred in the
normal course of business For example: maintenance of fixed
assets.
10. Trade Discount:
Trade discount is the reduction in price granted by the supplier of
goods or services.
11. Voucher:
Voucher is a documentary evidence in support of a transaction.
12. Debtor:
Debtor is a person who owes money to the business.
13. Creditor:
Creditor is a person to whom the business owes money. 24
14. Purchase:
It means buying of goods or assets by the business either for cash
or for credit. Return of purchased goods to the supplier is called
purchase return.

15. Sales:
It is process where by the business offers its products or services
to the customers for cash. Return of goods supplied is called sales
return.

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16. Stock(inventory):
Goods that are in stock with the business for sale in any date is
called stock. There are 2 types of stock. Opening stock and closing
stock.
Opening stock means the stock of goods in the beginning of an
accounting period.
Closing stock means the goods that remain unsold at the end of
an accounting period.
17. Prepaid expenses: Expenses paid in advance. Example:
prepaid rent, prepaid insurance etc.
18.Accrued income: Income due, but not yet received.
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19.Profit & Loss Account:
P/L account shows the revenue earned by the business and the
expenses incurred by the business. Usually, this is prepared for an
accounting period which could be a month, quarter, half year or a
year.
20. Balance sheet:
Balance sheet is not an account. Rather, it is a statement showing
the financial position of a business on a particular date. It shows
assets, liabilities and capital of the business.

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Generally Accepted Accounting Principles(GAAP)
In order to maintain uniformity and consistency in accounting
records, certain rules or principles have been developed which
are generally accepted by the accounting profession. These rules
are called by different names such as principles, concepts,
conventions, postulates, assumptions and modifying principles.
Thus, GAAP refers to the rules or guidelines adopted for recording
and reporting of business transactions, in order to bring
uniformity, comparability and consistency in the preparation and
the presentation of financial statements.

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From the practical view point, it is observed that the various
terms such as principles, postulates, conventions, modifying
principles, assumptions, etc. have been used inter- changeably
and are referred to as Basic Accounting Concepts.

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Basic Accounting Concepts
Following are the basic accounting concepts:-
1. Accounting/Business Entity Concept: According to this concept,
a business has a seperate legal entity apart from its owners. So it
is highly essential to keep the business transactions separately
from personal transactions of owners.
2. Money measurement concept: According to this concept,
transactions involving money or money’s worth will be recorded
in the books of accounts. The transactions or events which
cannot be expressed in monitory terms (like Dedication, Loyalty
etc. of the worker cannot be recorded in the books of accounts.
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3. Going concern concept:
According to this concept, the business shall continue for a long
period of time. There is no intention to liquidate the business.
4. Accounting period concept:
According to this concept, there should be a period for which
accounts are to be prepared and presented for ascertaining the
financial position. This period is called accounting period. Usually,
this period is for 1 year like 1st April to 31st march.

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5. Cost concept:
According to this concept, assets are to be recorded in the books
of accounts at their purchase price and not at their market price.
6. Duel aspect concept:
This is the basic principle of accounting. According to this concept,
every business transaction has two aspects- giving aspect(debit)
and receiving aspect(credit).
This principle is commonly expressed in terms of fundamental
accounting equation.(Assets =Capital +Liabilities)

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7. Revenue recognition or realization concept: According to this
concept, revenue is to be recognized whenever a sale is made or
service is rendered regardless when the cash is received. It may
be cash sale or credit sale or instalment sale. Anyway, there
should be a revenue.
8. Matching concept: According to this concept, the expenses
incurred during the accounting period are matched with revenues
earned during the same period. That is, if revenue is recognized
on goods sold during the period, cost of goods sold also be
charged to that period.
Determination of profit and loss can be done by matching
revenue and expenditure of the appropriate accounting period. 33
9. Objectivity or verifiability concept:
According to this concept, accounting transactions should be
recorded in the books of accounts in an objective manner that is,
the recorded transactions must have proper documentary
evidences like vouchers, receipts, invoices etc.
10. Full disclosure concept:
According to this concept, all significant facts figures regarding
the financial performance of the enterprise must be fully and
completely disclosed in the financial statements. In other words,
all the informations furnished in the financial statements should
be true and honest.
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11. Consistency concept: According to this concept, accounting
methods or practices adopted in the organization should be
constantly applied year after year. This facilitates inter-firm
and intra-firm comparison.
12. Conservatism concept(Prudence principle):
According to this principle, an accountant should not anticipate
profits or income but he has to make provision for all possible
losses.
This is a convention of playing safe, which is followed while
preparing the financial statements. The idea of this convention is
to consider all possible losses and to ignore all probable profits.
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13. Materiality concept:
According to this principle, only the material or important facts
about the business are to be disclosed through the financial
statements. All other unimportant facts should be either ignored
or recorded in footnotes.
14. Timeliness concept:
According to this concept, accounting informations in the form of
financial statements must be made available to the end users on
time. If it is late or obsolete, rational decisions cannot be taken
using that information.

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Types of accounts
There are 3 types of accounts.
1. Real Account
2. Personal Account
3. Nominal Account.

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1. Real account:
The assets of a company which are either tangible or intangible
are coming under the category of “Real Account”.
Example: Land, building, machinery, goodwill etc.

Example: Purchased Furniture for cash 10000

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2. Personal Account
These are the accounts related to individuals, firms, companies
etc.
Example: Debtors, creditors, Bank etc.

Example: Paid an amount of Rs. 20000 to ABC Ltd. (our creditor)

by cheque.

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3. Nominal Account.
These are the accounts related to income, expenses, losses or
gains.Example: Purchase, Sales, Salary, Commission etc.

1. Salary Paid 10000

Salary A/c Dr 10000
To Cash A/c 10000
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1 Plant and Machinery a/c Asset
2 Rent a/c Expense
3 Indian Bank a/c Person
4 Raju’s a/c Person
5 Stationary a/c Expense
6 Debtors a/c Person
7 Wages a/c Expense
8 Depreciation a/c Expense
9 Drawings a/c Person
10 Cash a/c Asset
11 Stock a/c Asset
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12 Loan a/c Person
14 Discount received a/c Income
16 Building a/c Asset
17 Bills receivable a/c Person

18 Bank overdraft a/c Artificial Person

19 Capital a/c Person
20 Purchase a/c Expense
21 Sales a/c Income
22 Goodwill a/c Asset
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Accounting equation
Asset = Equity
Asset = owners equity + Outsiders equity
Asset = Capital + Liabilities

Liabilities = Assets - Capital

Capital = Assets - Liabilities

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Double Entry System
For every transaction, two parties are required.Between these
parties there is the exchange of equal values.Accordingly, every
transaction has two aspects.One is receiving aspect and the other
is giving aspect.The receiving aspect of a transaction is known as
debit and the giving aspect of the transaction is known as credit.
In order to record a transaction completely, it is necessary to
record both aspects of the transaction.This method of recording
the two fold aspects of every transaction is called double entry
system.Thus every debit has an equal and corresponding credit.

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In short,
Double entry system is the system of recording both aspects of
every transaction in order to maintain the equality between debit
and credit.

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Item/Accounts Debit Credit

Asset Increase Decrease

Liabilities Decrease Increase

Capital Decrease Increase

Income Decrease Increase

Expenses/Loss Increase Decrease

Stock Increase Decrease

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Qn. State the debit and credit of the following transactions

1. Rohit started business with cash Rs. 2,50,000/-

Cash A/c Dr (Asset increases)
To Capital A/c (Capital increases)

2. Purchased goods for cash Rs. 3000

Purchase A/c Dr (Expense increases)
To Cash A/c (Asset decreases)

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3. Purchased furniture & issued cheque for the same Rs. 5000
Furniture A/c Dr ( Asset increases)
To Bank A/c ( Asset i.e., cash at bank decreases)

4. Bought machinery from Sumit Traders Rs. 10000

Machinery A/c Dr ( Asset increases)
To Sumit Traders A/c (Liabilities increases)

5. Opened a bank account with with an amount of Rs. 150000

Bank A/c Dr (Asset increases)
To Cash A/c (Asset decreases)
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6. Sold goods for cash Rs. 4500
Cash A/c Dr (Asset increases)
To Sales A/c (Income Increases)

7. Sold machinery for cash Rs. 5000

Cash A/c Dr (Asset increases)
To Machinery A/c ( Asset decreases)

8. Sold goods on credit to Mr. Naresh Rs. 12000

Naresh A/c Dr (Asset i.e., debtors increases)
To Sales A/c (Income increases)
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9. Paid salary to staff Rs. 10000
Salary A/c Dr (Expense increases)
To Cash A/c (Asset decreases)

10. Received commission Rs. 3000

Cash A/c Dr (Asset increases)
To Commission A/c (Income increases)

11. Withdraw cash for personal use Rs. 2500

Drawings A/c Dr (Expense increases)
To Cash A/c (Asset decreases)
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 Assistant Professor
Department of Islamic Finance
SAFI Institute of Advanced Study

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