IQAC/ASU/F/2023-24/2.

Unit-1

Meaning of Accounting
The literal meaning of “Accounting” is - the process or work of keeping
financial accounts.

 Accounting, as an information system is a process of

identifying, measuring, and communicating the economic
information of a business to its users who need the information
for decision making.
 The systematic recording, reporting, and analysis of financial
transactions of a business. The accountant is typically required
to follow a set of rules and regulations, such as the GAAP
– Generally Accepted Accounting Principles.

Definition of Accounting
American Institute of Certified Public Accountants (AICPA) defined accounting
as

“Accounting is the art of recording, classifying and summarizing in a significant

manner and in monetary terms, transaction, and events which are in the part at
least of a financial character and interpreting the result thereof.”

In simple words,

“Financial Accounting can be defined as the recording, classifying, and

summarizing transactions, events, and adjustments in a book of accounts.”

Process of Accounting
Accounting is known as the process of identifying,
measuring, and communicating economic information to
make judgments and decisions by users of the
information.

First of all, the point to be noted here is “any economic

transaction or event of a business which can be expressed
in monetary terms should be recorded.”

The series of financial transactions of business occurs

during the accounting period and its recording is referred
to as an accounting process.

The activities under the accounting process are a

complete sequence of accounting procedures that are
repeated in the same order during each accounting period.

Traditionally, accounting is a method of collecting

(identifying and measuring), recording, classifying,
summarizing, presenting, and interpreting financial data
of the economic activity of the business.

So let’s discuss all the steps involved in the accounting

process.
 Identifying the transactions and events
 Measuring the identified transactions and events
 Recording the business transactions of financial character in
the books (preparation of the first book called ‘Journal‘)
  Classifying the recorded data of similar nature in one place
(preparation of the second book called ‘Ledger’)
 Summarising the classified data to know the result of business
operation and its financial position (preparation of Trial
balance, Income statement, and Balance sheet)
 Analysis and interprets the summarized data in such a way to
get a meaningful judgment about the operational result and
financial position of the business.
 Communicating the interpreted data to the various users such
as Owners, Investors, banks, etc.

What is accounting terminology?

Accounting terminology is the language of accounting. It is used to

describe accounting concepts and terms such as income, expenses,
assets and liabilities etc. These concepts are all essential elements in
understanding how accounting works.

The basic accounting terms include:

 Assets

An asset is one of the most important basic accounting terminologies.

They can be tangible (physical) or intangible (non-material). Examples
of assets include cash at the bank, accounts receivable (money owed to
the business by its customers), stock/inventory etc…

 Liabilities

These are obligations of accounting, such as a loan or accounts payable

(money owed to suppliers, etc…).

 Equity

This is the difference between the total assets and the total liabilities of
 a company. It represents the net worth (or worth) of the business.

 Income

This is money that has come into the business, such as sales revenue or
investment income.

 Expenses

This is money that has gone out of the business, such as salaries paid to
employees or rent for premises.

 Profits

This is the difference between income and expenses. It can be either

positive (if income exceeds expenses) or negative (if expenses are
greater than income).

 Losses

These losses represent money that the business has lost as a result of
accounting errors or other causes such as theft, embezzlement etc.

Accounting Terminologies In Detail

Now that we’ve gone over the basic accounting terms, let’s take a look
at some of these concepts in more detail.

 Assets

Assets are anything that the business owns and can use to generate
income. They can be either tangible (physical) or intangible (non-
material). Tangible assets include equipment, buildings, and
automobiles. Intangible assets include things like patents, copyrights,
trademarks (brand names), and goodwill.

 Liabilities

Liabilities are amounts that the business owes to others. They can be
either current (due within one year) or long-term (due in more than one
 year). Current liabilities include payables, notes payable, and accrued
expenses. Long-term liabilities include long-term notes payable and
mortgage loans.

 Owners’ Equity (Net Worth)

The accounting equation shows that all assets are financed by one of
two sources: liabilities or owners’ equity. Owners’ equity is the residual
interest in the assets of a business after liabilities are paid. It is
calculated by subtracting liabilities from assets. The owners’ equity
section of the balance sheet is also called the net worth or shareholder’s
equity section.

 Revenue

Revenue is the income of a business. It is generated from the sale of

products or services. Revenue can be either cash or accrual. Cash
revenue is income that is received in cash, such as payments from
customers. Accrual revenue is income that is earned but not yet
received, such as sales that have been made but the payment has not yet
been received.

 Expenses

Expenses are the costs of doing business. They are classified into two
categories: operating expenses and non-operating expenses. Operating
expenses are costs that are necessary to generate revenue; for example,
the cost of goods sold and selling expenses. Non-operating expenses are
costs that a business incurs that do not relate to the generation of
revenue; for example, interest expenses and income taxes.

 Income Statement

The income statement is a financial report that summarises the

revenues, expenses, and net income (profit) of a business for a specified
period. It shows accounting profitability, which is an important
indicator of how well a business is doing.

 Balance Sheet
The balance sheet, also called the statement of financial position, is one
of the three key financial statements that businesses use to assess their
financial health. It shows the assets, liabilities, and owners’ equity of a
business as of a specific date. The balance sheet is used to calculate the
financial leverage ratio, which measures a business’s debt-to-equity
ratio.

In accounting, an account is a record in the accounting system used to

sort and store transactions. Accounts are organised into two categories:
balance sheet accounts and income statement accounts.

Balance sheet accounts are assets, liabilities, and owners’ equity.

Income statement accounts are revenue and expenses.

Difference between Bookkeeping and Accounting

Basis Book keeping Accounting

It refers to the
process of
identifying,
It refers to recording,
identifying and classifying,
Meaning
recording monetary summarizing,
transactions. interpreting and
communicating
financial
transactions.

Preparation of Preparing financial The accounting

Financial Statements statements does not process involves the
fall under the preparation of
purview of financial statements
 such as Trading,
bookkeeping. Profit and Loss A/c
and Balance Sheet.

It provides sufficient
It does not provide and accurate data for
Helps in Decision
sufficient data for helping in the
making
decision making. decision-making
process.

Bookkeeping does
It helps in the process
Analysis not require any
of analysis of data.
analysis of data.

It does not depict the It clearly depicts the

Financial position financial position of financial position of
the business. the business.

It requires a high
level of skills for
No high level of analyzing the
Requirement of skill
skills is needed. financial data and
using it for decision
making.
Advantages of Financial Accounting
Maintenance of business records: All financial transactions are recorded in a
systematic manner in the books of accounts so that there is no need to rely on
memory. Human memory is limited by its very nature. Accounting helps to
overcome this limitation.

Preparation of financial statements: Systematic records enables the accountants

to prepare the financial statements trading and profit & loss account to ascertain
profit or loss during a particular accounting period and balance sheet to state the
financial position of the business on a particular slate.
Comparison of results: Systematic maintenance of business records enables the
accountant to compare profit of one year with those of earlier years to know the
significant facts about the change.
Acts as Legal Evidence: Proper books of accounts maintained in systematic.
manner act as legal evidence in case of disputes.

Facilitates Raising loans: Accounting facilitates raising loans from lenders by

providing them required financial information.

Assist the Management: Accounting assists the management in taking

managerial decisions. For example, Projected Cash Flow Statement facilitates the
management to know future receipts and payment and to take decision regarding
anticipated surplus or shortage of funds.

Facilitates control over Assets: Accounting facilitates control over assets by

providing information regarding Cash Balance, Bank Balance, Stock Debtors,
Fixed Assets, etc.
Limitation of Financial Accounting
Records only monetary transactions: Financial Accounting records
only those transactions which can be measured in monetary terms. It has
no place for recording non-monetary or non-financial transactions,
though these matters also have a significant Tole in affecting the
soundness of the business. For example, efficiency of the management,
political situation, Government Policy, market competition etc. do affect
the financial results and financial position of a business, but these are
not at all recorded in accounting.
No consideration of price level changes: Accounting accepts the cost
concept and hence does not consider the change in the price level from
time to This is a very serious limitation of Financial Accounting.

No realistic information: Accounting information may not be realistic

as accounting statements are prepared by following basic concepts. For
example, Going Concern Concept gives us as idea that the business will
continue and assets are to be recorded at cost but the book value, which
the asset is showing, may not be actually realizable.

Users of Accounting Information

A large number of people, entities, and stakeholders have an interest in
the financial well-being of businesses. A list is given below of some of
the users of the information provided by accounting.

These users can be categorized under external and internal users. This is
shown in the diagram below.
Internal Users of Accounting Information
1. Owners
Owners are the people who provide capital for the business. They need
information about the financial performance and position of the
business. For this reason, they use accounting information to look into
the financial affairs of the business.

2. Management
Management is responsible for taking work from others in the most
appropriate way. Management needs accounting information to check
the efforts of subordinates, ensuring that those who are working hard
are properly motivated.

The owners and managers of businesses use accounting information for

the following purposes:
  To understand the financial health of their business units

 To set organizational goals

 To evaluate progress toward organizational goals

 To take corrective action where needed

Decisions that are based on accounting information are more likely to

be correct compared to those based on pure intuition.

3. Employees
Employees are the people who serve in the business. Employees are
interested in accounting information because their salary appraisals,
bonuses, and other monetary and non-monetary benefits are attached to
the company’s financial position.

4. Individuals
Individuals make use of accounting information in the day-to-day
affairs of managing their cash and bank balances, making investments,
or deciding on whether to buy or lease a car or home.

External Users of Accounting Information

1. Investors
Investors are the people who are ready to invest their money in
a business. Investors who are looking for business opportunities can
only make correct decisions based on high-quality accounting
information.

An investor is interested in knowing about the financial position of the

business. This kind of information is supplied in financial statements.

Accounting information shows the future potential of the business in

terms of future profits for investors.
2. Creditors
Creditors give loans to businesses. Creditors use accounting information
to evaluate creditworthiness and other factors since this helps to
guarantee that the loan will be repaid in the future.

Accounting information also helps creditors to make decisions about

whether to offer loans to a business in the future.

3. Government Agencies
Government agencies such as CBR and the Income Tax Department
need accounting information from businesses in order to levy tax
effectively and accurately.

Without accounting information, these agencies may miscalculate

the revenues generated for the government.

4. Customers
Customers are divided into four categories:

 Producers

 Wholesalers

 Retailers

 Final consumers

Producers must have assurance about the continuous supply of materials

needed to make products. Similarly, wholesalers, retailers, and final
consumers are interested in the fluent supply of materials.

For example, if any party (e.g., a wholesaler) believes that a product

may be unavailable in the future, they will shift their choice to another
product. To help make all these decisions effectively, accounting
information is necessary.
5. Public
The public is interested in accounting information because this informs
them about the financial health of individual businesses. In turn, it is
possible to determine the overall impact on the country’s economy.

6. Non-Profit Organizations
Even non-profit making organizations, including clubs, non-
governmental organizations (NGOs), and welfare societies, require
accounting information to manage their affairs properly.

In the absence of proper accounting records, non-profit organizations

cannot satisfy their members and other stakeholders regarding the ways
in which their financial affairs are conducted.

BASIC ACCOUNTING CONCEPTS

Various accounting concepts help to frame financial statements
accurately. Some of the accounting concepts are as follows:

Business entity concept: This concept implies that a business and its
proprietor should be treated distinctly for the financial transactions of
the business.

Money measurement concept: This concept shows that only business

dealings that can be expressed in monetary terms are documented in
accounting, and the records of other types of events may be disclosed
separately in the books.

Dual aspect concept: This concept implies that for every account
credit, a matching account shall be debited. Therefore, the dual aspect
concept completes the recording of the transactions.

Going concern concept: This concept means that a business is

anticipated to last for a reasonably long time and carry out its activities
and obligations. This predicts that the business will not be required to
rest working and discharge its assets at unreasonable prices.
Cost concept: This concept requires that the fixed assets of a business
are documented based on their initial cost in the first year of accounting.
Eventually, these assets are recorded deducting the amount of
depreciation. A rise or fall in the market price of the assets is not
considered. This concept is only applicable to fixed assets.

Accounting year concept: This concept implies that each business

indicates a particular period to complete an accounting cycle process,
for example, monthly, quarterly, or annually as per a fiscal or a calendar
year.

Matching concept: This concept implies that for every transaction of

revenue recorded in a particular accounting period, a corresponding
expense transaction has to be recorded for accurately calculating profit
or loss in a given accounting period.

Realization concept: As per this concept, profit is identified in the

books only when it is earned. An advance or fee paid is not identified as
a profit till the goods or services have been transported to the buyer.

BASIC ACCOUNTING CONVENTIONS

Conservatism

It is the convention by which the transaction with a lower amount is

recorded when two transactions of different amounts are provided. By
this convention, profits are not recorded for an overestimated amount,
and losses or expenses are provided as provisions in the books.

Consistency

This convention implies the usage of the same principles of accounting

from one period to the other period of an accounting cycle so that the
same methods are functional to calculate profit and loss earned during a
period.
Materiality

This convention shows that all significant facts should be recorded and
disclosed in the books of accounts. Accountants should record
important data and can ignore information that is not significant.

Disclosure

This convention implies the disclosure of all information, both

advantageous and disadvantageous to a business enterprise, and which
are of significant value to creditors and debtors.

Faculty Name- Mr. Pankaj Lalwani – Department of business

administration