CHAPTER 1
BASIC CONCEPTS OF ACCOUNTING
DEFINITION OF ACCOUNTING
In 1941, The American Institute of Certified Public Accountants (AICPA) had defined
accounting as the art of recording, classifying, and summarising in a significant manner and in
terms of money, transactions and events which are, in part at least, of fina ncial character, and
interpreting the results thereof’.
Functions of Accountind
Recording: Recording of economic information which is of financial character is the primary
function of financial accounting. It involves analyzing individual business transaction as and
when it occurs, such as, what has taken place? Identifying the nature of account that involves.
Ascertaining the rules of debits and credits etc.After the business transactions being analyzed,
they are to be recorded systematically in a book called the book or original entry. The whole
process of recording a business transaction is called Journalizing. When used separated journals,
they are referred as subsidiary journals.
Classifying: Classifying of financial information is concerned with systematic analysis of the
recorded data. It involves posting of journalized transactions in the concerning ledger accounts
by grouping them into the accounts that are of similar nature and balancing thereof. It is worth
mentioning here, the advent of computers has aided this process significantly. Ledger accounts
are balanced automatically when using a particular program developed for financial accounting
purpose.
Summarizing: The transactions, having been posted and classified in accordance with the
concerning ledgers, are then summarized in a particular manner in order to prepare the following
statements. Trial Balance, Income Statement and Balance sheet.
Interpreting: This function involves analysis and interpretation of financial data. Since
accounting is regarded as a business language, it provides necessary and the required information
to its users through which the profitability and the financial position of a business may be
ascertained, which in turn will be very much useful for planning and establishing various
policies.
Communicating: After having been analyzed and well interpreted,the financial information is
communicated to the intended users. The process undertakes preparing various reports including
chief financial statements, such as, cash flow, funds flow, ratio analysis and presentations with
graphs etc.
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Objectives of Accounting:
1. Recording business transactions systematically− It is necessary to maintain systematic
records of every business transaction, as it is beyond human capacities to remember such
large number of transactions. Skipping the record of any one of the transactions may lead
to erroneous and faulty results.
2. Determining profit earned or loss incurred− In order to determine the net result at the end
of an accounting period, we need to calculate profit or loss. For this purpose trading and
profit and loss account are prepared. It gives information regarding how much of goods
have been purchased and sold, expenses incurred and amount earned during a year.
3. Ascertaining financial position of the firm− Ascertaining profit earned or loss incurred is
not enough; proprietor also interested in knowing the financial position of his/her firm,
i.e. the value of the assets, amount of liabilities owed, net increase or decrease in his/her
capital. This purpose is served by preparing the balance sheet that facilitates in
ascertaining the true financial position of the business.
4. To make information available to various groups or users—The accounting information
obtained from records should be communicated to interested parties like owners,
creditors, bankers, government, employees etc..Each group is provided with information
for their requirements.
Qualitative Characteristics of Accounting
Reliability
Reliability means the users must be able to depend on the information. The reliability of
accounting information is determined by the degree of correspondence between what the
information conveys about the transactions or events that have occurred, measured and
displayed
Relevance
Information to be relevant, it must be available in time and ought to be help in prediction
and feedback
Understanding
It must be understood by those to whome it is communicated
Comparability
Accounting information should have the characteristics of comparability. This means that
the accounting reports should be comparable with other firms to identify similarities or
differences.
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Advantages
Helps in ascertaining financial position of the business
Systematic recording of data is possible
Provide quantitative information
Act as an information
Disadvantage
It records only transactions which can be recorded in monetory terms. Qualitative aspects
like management skills, services of experts etc are not recorded.
Uses of different accounting methods reduces the reliability of accounts
Manipulation of profit or loss by the accounts of the business
Records may be biased
Book keeping
Bookkeeping is a process of recording and organizing all the business transactions that have
occurred in the course of the business. Bookkeeping is an integral part of accounting and largely
focuses on recording day-to-day financial transaction of the business.
Difference between Book keeping and Accounting
Book keeping Accounting
Definition Bookkeeping deals with Accounting refers to the process
identifying and recording of summarising, interpreting and
financial transactions only communicating the financial
data of an organisation.
Decision making Data provided by Management can take important
bookkeeping is not decisions based on the data
sufficient for decision obtained from accounting
making
Preparation of Financial Not done in the case of Financial statements are a part
Statement bookkeeping of the accounting process
Analysis No analysis is required in Accounting analyses the data
the bookkeeping and creates insights for the
business
Persons Involved The person concerned with The person concerned with
bookkeeping is known as a accounting is known as an
bookkeeper accountant
Determining Financial Bookkeeping does not show Accounting helps in showing a
Position the financial position of a clear picture of the financial
business position of a business
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