Introduction to Accounting

What is Accounting?

Accounting is the process of recording, classifying, summarizing and interpreting financial transactions and events. The purpose of accounting is to provide relevant information for decision making on a timely basis to users and their advisors. The Accounting process comprises of the following four activities:

Forms of Business Organizations

• Sole Proprietorship : A business owned by one person is generally a Proprietorship

• Partnership : A business owned by two or more persons associated as partners is a Partnership

• Corporation : A business organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock is called a corporation

The difference between three forms of Organizations are :

Accounting Principles, Concepts and Conventions

The accounting principles, concepts and conventions form the basis for how business transactions are recorded. Some of these concepts are briefly described in the following sections.

Revenue Recognition

• Recognize revenue when it is earned

• Measure revenue by cash received plus cash value of items received

Matching Concept

• Expenses are matched against revenues and recorded in the same period in which the related revenues are earned

 Accrual Basis

Revenues are recognized when earned and expenses are recognized when incurred. For example,
a seller bills the buyer at the time of sale and treats the bill amount as revenue even though
the payment may be received later

 

Cash Basis

Revenues are recognized when cash is received and expenses recorded when cash is paid

 Going Concern

• Assumes a business will continue to trade for the foreseeable future

• Provides a more realistic value of business assets

• Allows costs and revenue to be allocated to future accounting periods

• Allows fixed assets to be written of proportionally over their useful life

Accounting Period

• Accounts are finalized at the end of an identified time period

• The users of financial statements require periodical reports to ascertain the operational and the

financial position of the business concern

 Accounting Entity

Business is considered as a unit or entity apart from its owners, creditors and others

The owner is treated as a financier of business

 Money Measurement

• All events are measured in terms of money
• Only those transactions that can be expressed in terms of money are recorded

Types of Accounts

There are basically three types of accounts maintained for transactions:

Real Accounts

Real accounts are accounts relating to properties and assets, which are owned by the business concern.

Real accounts include tangible and intangible accounts. For example,

•  Land

•  Building

• Goodwill

• Purchases

• Cash

Personal Accounts

Personal accounts are accounts which relate to persons. Personal accounts include the following.

• Suppliers

• Customers

• Lenders

Nominal Accounts

Nominal accounts are accounts which relate to incomes and expenses and gains and losses of a
business concern. For example,

• Salary Account

• Dividend Account

• Sales

Rules of Accounting

All the business transactions are recorded on the basis of the following rules.

Double Entry System of Book Keeping

As per double entry system of book-keeping, all the business transactions recorded in accounts have
two aspects - Debit aspect (receiving) and Credit aspect (giving). This accounting technique records
each transaction as debit and credit, where every debit has a corresponding credit and vice versa.
The chart showing Double Entry system of Book Keeping as shown :

Mode of Accounting
Accounting process begins with identifying and recording the transactions in the books of accounts.
Accounting identifies only those transactions and events which involve money and is sorted based on
various source documents. The following are the most common source documents :

• Voucher

• Receipt / Cash memo

• Invoice or Bill

Voucher : A voucher is a document which contains the details of a transaction

 Receipt : When a trader receives cash/ cheque from a customer against goods sold by him, he issues a receipt containing the name of such customer and the details of amount received with date

Invoice or Bill : When a trader sells goods to a buyer, he prepares a sales invoice containing the details such as name and address of   buyer, name of goods, amount and terms of payment and so on

Journals : Journal means a day book or a daily record, wherein the transactions  are recorded in the chronological order

Ledger : Ledger is defined as a book of final entry containing all the accounts of a business or all the accounts of a particular type

Special Purpose Books

Most of the business transactions which are repetitive in nature can be easily recorded in special
purpose books. The Special purpose books are:

Transactions

Business transactions refer to exchange of economic consideration between parties and have twofold
effects that are recorded in at least two accounts. Source document or voucher is the document which
provides evidence of the transactions

Posting a Transaction

Posting is the process of transferring the entries recorded in the journal or subsidiary books to the
respective accounts opened in the ledger i.e., grouping of all the transactions relating to a particular
account to a single place.

Financial Statements

Financial statements is a periodic report prepared from the accounting records of a company. Some of
the financial statements are:

• Trading Account

•  Profit and Loss Account

•  Balance Sheet

Trading Account

The trading account displays the transactions pertaining to buying and selling of goods. It is prepared
to arrive at the gross profit earned by the organisation over a specified period.
The Gross Profit is expressed as:
Gross Profit = Net Sales – Cost of Sales

Profit and Loss Account

The profit and loss account helps to ascertain the net profit earned or net loss suffered during a particular period after considering all other incomes and expenses incurred over a period.
The Net Profit is expressed as:
Net Profit = (Gross Profit + Other Income) – (Selling and Administrative Expenses + Depreciation
+ Interest + Taxes + Other Expenses)

Balance Sheet

The balance sheet is a statement that summarizes the assets and liabilities of a business. The excess of assets over liabilities is the net worth of a business.

Trial Balance

A trial balance is a statement prepared for verifying the arithmetical accuracy of the ledgers. Trial Balance is the conclusion of an accounting process, facilitates locating of errors and helps in preparing the final statements.




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