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Introduction To Fundamentals of Accounting

This document provides an introduction to fundamentals of accounting. It discusses that accounting is a systematic process of identifying, recording, measuring, and communicating financial information, which provides feedback to management regarding an organization's financial results and status. It may be handled by bookkeepers or accountants. The document then briefly discusses the history of accounting and Luca Pacioli's contributions, defines three major types of businesses (service, merchandising, manufacturing), and describes double entry bookkeeping and basic accounting principles such as accrual, conservatism, cost, and matching.

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Queen Valle
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95 views

Introduction To Fundamentals of Accounting

This document provides an introduction to fundamentals of accounting. It discusses that accounting is a systematic process of identifying, recording, measuring, and communicating financial information, which provides feedback to management regarding an organization's financial results and status. It may be handled by bookkeepers or accountants. The document then briefly discusses the history of accounting and Luca Pacioli's contributions, defines three major types of businesses (service, merchandising, manufacturing), and describes double entry bookkeeping and basic accounting principles such as accrual, conservatism, cost, and matching.

Uploaded by

Queen Valle
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Introduction to Fundamentals of Accounting

Accounting is a systematic process of identifying, recording, measuring, classifying,


verifying, summarizing, interpreting and communicating financial information. It provides
feedback to management regarding the financial results and status of an organization. It
may be handled by a bookkeeper or an accountant at small firms or by sizable finance
departments.

Brief History of Accounting


Luca Pacioli, a Franciscan friar in Medieval Venice, wrote the ―Summa de arithmetica,
geometria, proportioni et proportionalità‖ in 1494. In it, he detailed a system of financial
recordkeeping in which every debit (Latin for ―he owes‖) was matched to a credit (―he
trusts‖). In his system, Pacioli included asset, liability, capital, income, and expense
accounts: exactly those categories you would find on your own balance sheet and
income statement. Although he is not credited with having invented the system (that
designation goes to the Venetian merchants who used it), he is nonetheless known as
the ―Father of Accounting‖ for having put it to paper. Although modern accounting
revolves around double-entry bookkeeping, accounting as a technical craft existed long
before Pacioli. Financial records of goods sold and money exchanged stretch back to
ancient Mesopotamia, Assyria, Babylon, and Sumeria, where it likely functioned as an
expedient to taxation and the operation of temples. There is even record of a state
official in Egypt holding the title of―comptroller.

Types of Business Organizations


A business entity is an organization that uses economic resources or inputs to provide
goods or services to customers in exchange for money or other goods and services.
Business organizations come in different types and different forms of ownership.

Three major types of businesses:


1. Service Business
A service type of business provides intangible products (no physical form). Service type
firms offers professional skills, expertise, advice, and other similar products.
Examples: salon, repair shops, schools, banks, accounting and law firms

2. Merchandising Business
This type of business buys products at wholesale price and sells the same at retail
price. They are known as “buy and sell” businesses. They make profit by selling the
products at prices higher than their purchase costs. A merchandising business sells a
product without changing its form.
Examples: grocery stores, convenience stores, distributors, and other resellers
3. Manufacturing Business
Unlike a merchandising business, a manufacturing business buys products with the
intention of using them as materials in making a new product. Thus, there is a
transformation of the products purchased. A manufacturing business combines raw
materials, labor, and factory overhead in its production process. The manufactured
goods will then be sold to customers.
Examples: furniture shops, gardenia, car dealers
Hybrid Business
Hybrid businesses are companies that may be classified in more than one type of
business. A restaurant, for example, combines ingredients in making a fine meal
(manufacturing), sells a cold bottle of wine (merchandising), and fills customer orders
(service). Nonetheless, these companies may be classified according to their major
business interest. In that case, restaurants are more of the service type – they provide
dining services.

Double Entry Bookkeeping


Double entry is the fundamental concept underlying present-day bookkeeping and
accounting. Double-entry accounting is based on the fact that every financial transaction
has equal and opposite effects in at least two different accounts. in which each entry is
recorded to maintain the relationship.
The fundamental concept of double entry derives from the use of debit and credit to
record business transactions. The total debits always equal the total credits.
Customarily, in bookkeeping and accounting, the asset, expense and loss accounts are
listed on the left side of a bookkeeping sheet, and the liability, equity, revenue and gain
accounts are listed on the right side, with the two sides maintaining the same total
balance. A debit to one or more accounts must be accompanied by a credit to at least
one account, equally increasing or decreasing the balance on each side. Other times, a
debit to either side is balanced out by an equal credit to the same side.

Basic Accounting Principles


A number of basic accounting principles have been developed through common usage.
They form the basis upon which modern accounting is based. The best-known of these
principles are as follows:

1. Accrual principle. This is the concept that accounting transactions should be


recorded in the accounting periods when they actually occur, rather than in the periods
when there are cash flows associated with them. This is the foundation of the accrual
basis of accounting. It is important for the construction of financial statements that show
what actually happened in an accounting period, rather than being artificially delayed or
accelerated by the associated cash flows.

2. Conservatism principle. This is the concept that you should record expenses


and liabilities as soon as possible, but to record revenues and assets only when you are
sure that they will occur. This introduces a conservative slant to the financial statements
that may yield lower reported profits, since revenue and asset recognition may be
delayed for some time. Conversely, this principle tends to encourage the recordation of
losses earlier, rather than later.

3. Cost principle. This is the concept that a business should only record its assets,
liabilities, and equity investments at their original purchase costs. This principle is
becoming less valid, as a host of accounting standards are heading in the direction of
adjusting assets and liabilities to their fair values.

4. Economic entity principle. This is the concept that the transactions of a


business should be kept separate from those of its owners and other businesses. This
prevents intermingling of assets and liabilities among multiple entities, which can cause
considerable difficulties when t he financial statements of a fledgling business are first
audited.

5. Full disclosure principle. This is the concept that you should include in or


alongside the financial statements of a business all of the information that may impact a
reader's understanding of those financial statements. The accounting standards have
greatly amplified upon this concept in specifying an enormous number of informational
disclosures.

6. Going concern principle. This is the concept that a business will remain in


operation for the foreseeable future. This means that you would be justified in def erring
the recognition of some expenses, such as depreciation, until later periods. Otherwise,
you would have to recognize all expenses at once and not defer any of them.

7. Matching principle. This is the concept that, when you record revenue, you
should record all related expenses at the same time. Thus, you charge inventory to the
cost of goods sold at the same time that you record revenue from the sale of those
inventory items. This is a cornerstone of the accrual basis of accounting. The cash basis
of accounting does not use the matching the principle.

8. Materiality principle. This is the concept that you should record a transaction in


the accounting records if not doing so might have altered the decision making process
of someone reading the company's financial statements. This is quite a vague concept
that is difficult to quantify, which has led some of the more picayune controllers to
record even the smallest transactions.

9. Monetary unit principle. This is the concept that a business should only record
transactions that can be stated in terms of a unit of currency. Thus, it is easy enough to
record the purchase of a fixed asset, since it was bought for a specific price, whereas
the value of the quality control system of a business is not recorded. This concept keeps
a business from engaging in an excessive level of estimation in deriving the value of its
assets and liabilities.

10. Time period principle. This is the concept that a business should report the
results of its operations over a standard period of time. This may qualify as the most
glaringly obvious of all accounting principles but is intended to create a standard set of
comparable periods, which is useful for trend analysis.

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