CHAPTER 1: BOOK-KEEPING AND ACCOUNTING.

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Definition of Accounting

Accounting can be defined as a process of reporting, recording, interpreting, and summarising economic data. The introduction of accounting helps the decision-makers of a company to make effective choices, by providing information on the financial status of the business.

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 financial character, and interpreting the results thereof”.

Objectives of Accounting

1. To keep a systematic and complete record of financial transactions in the books of accounts according to specified principles and rules to avoid the possibility of omission and fraud.

2. To ascertain the profit earned or loss incurred during a particular accounting period which further helps in knowing the financial performance of a business.

3. To ascertain the financial position of the business by the means of financial statement i.e. balance sheet which shows assets on one side and Capital & Liabilities on the other side.

4. To provide useful accounting information to users like owners, investors, creditors, banks, employees and government authorities, etc who analyze them as per their requirements.

5. To provide financial information to the management which helps in decision making, budgeting, and forecasting.

6. To prevent fraud by maintaining regular and systematic accounting records.

Advantages of Accounting

1. It provides information that is useful to management for making economic decisions.

2. It helps owners to compare one year’s results with those of other years to locate the factors which lead to changes.

3. It provides information about the financial position of the business by means of a balance sheet that shows assets on one side and Capital & Liabilities on the other side.

4. It helps in keeping a systematic and complete record of business transactions in the books of accounts according to specified principles and rules, which are accepted by the Courts as evidence.

5. It helps a firm in the assessment of its correct tax Liabilities such as income tax, sales tax, VAT, excise duty, etc.

6. Properly maintained accounts help a business entity in determining its proper purchase price.

Limitations of Accounting

1. It is historical in nature; it does not reflect the current worth of a business.

Moreover, the figures given in financial statements ignore the effects of changes in the price level.

2. It contains only those pieces of information which can be expressed in terms of money. It ignores qualitative elements such as the efficiency of management, quality of staff, customer satisfaction, etc.

3. It may be affected by window dressing i.e. manipulation in accounts to present a more favorable position of a business firm than its actual position.

4. It is not free from personal bias and the personal judgment of the people dealing with it. For example, different people have different opinions regarding the life of assets for calculating depreciation, provision for doubtful debts, etc.

5. It is based on various concepts and conventions which may hamper the disclosure of the realistic financial position of a business firm. For example assets in the balance sheet are shown at their cost and not at their market value which could be realized on their sale.

Book Keeping – The Basis of Accounting

Bookkeeping is the record-making phase of accounting which is concerned with the recording of financial transactions and events relating to business in a significant and orderly manner.

Book Keeping should not be confused with accounting. Bookkeeping is the recording phase while accounting is concerned with the summarizing phase of an accounting system. The distinction between the two areas under.

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Qualitative Characteristics of Accounting Information

Accounting information is useful for interested users only if it posses the following characteristics:

1. Reliability: Means the information must be based on facts and be verified through source documents by anyone. It must be free from bias and errors.

2. Relevance: To be relevant, information must be available in time and must influence the decisions of users by helping them to form predictions about the outcomes.

3. Understandability: The information should be presented in such a manner that users can understand it well.

4. Comparability: The information should be disclosed in such a manner that it can be compared with the previous year’s figures of the business itself and other firm’s data.

Basic accounting terms

Business Transaction

An economic activity that affects the financial position of the business and can be measured in terms of money e.g., expenses, etc.

Account: Account refers to a summarized record of relevant transactions of a particular head in one place. All accounts are divided into two sides. The left side of an account is called the debit side and the right side of an account is called the credit side.

Capital: The amount invested by the owner in the firm is known as capital. It may be brought in the form of cash or assets by the owner.

Drawings: The money or goods or both withdrawn by the owner from the business for personal use, are known as drawings. Example: Purchase of car for wife by withdrawing money from the business.

Assets: Assets are valuable and economic resources of an enterprise useful in its operations. Assets can be broadly classified as:

1. Current Assets: Current Assets are those assets that are held for short period and can be converted into cash within one year. For example Debtors, stock, etc.

2. Non-Current Assets: Non-Current Assets are those assets that are held for long period and used for normal business operation. For example Land, Building, Machinery, etc. They are further classified into:

(a) Tangible Assets: Tangible Assets are those assets that have physical existence and can be seen and touched. For Example Furniture, Machinery, etc.

(b) Intangible Assets: Intangible Assets are those assets that have no physical existence and can be felt by operation. For example Goodwill, Patent, Trademark, etc.

Liabilities: Liabilities are obligations or debts that an enterprise has to pay after some time in the future.

Liabilities can be classified as:

1. Current Liabilities: Current Liabilities are obligations or debts that are payable within a period of one year. For Example Creditors, Bill Payable, etc.

2. Non-Current Liabilities: Non-Current Liabilities are those obligations or debts that are payable after a period of one year. Example: Bank Loan, Debentures, etc.

RECEIPTS

1. Revenue Receipts: Revenue Receipts are those receipts which are occurred by the normal operation of a business like money received by the sale of business products.

2. Capital Receipts: Capital Receipts are those receipts that are occurred by other than business operations like money received by the sale of fixed assets.

Expenses: Costs incurred by a business for earning revenue are known as expenses. For example Rent, Wages, Salaries, Interest, etc.

Expenditure: Spending money or incurring liability for acquiring assets, goods or services is called expenditure. The expenditure is classified as :

1. Revenue Expenditure: It is the amount spent to purchase goods and services that are used during an accounting period is called revenue expenditure. For Example Rent, Interest, etc.

2. Capital Expenditure: If the benefit of expenditure is received for more than one year, it is called capital expenditure. Example: Purchase of Machinery.

3. Deferred Revenue Expenditure: There are certain expenditures that are revenue in nature but the benefit of which is derived over a number of years. For Example Huge Advertisement Expenditure.

Profit: The excess of revenues over its related expenses during an accounting year is profit.

Profit = Revenue – Expenses

Gain: A non-recurring profit from events or transactions incidental to business such as the sale of fixed assets, appreciation in the value of an asset, etc.

Loss: The excess of expenses of a period over its related revenues is termed as a loss. Loss = Expenses – Revenue

Goods: The products in which the business deal. The items that are purchased for the purpose of resale and not for use in the business are called goods.

Purchases: The term purchases are used only for the goods procured by a business for resale. In the case of trading concerns, it is the purchase of final goods and in manufacturing concerns, it is the purchase of raw materials. Purchases may be cash purchases or credit purchases.

Purchase Return: When purchased goods are returned to the suppliers, these are known as purchase returns.

Sales: Sales are total revenues from goods sold or services provided to customers. Sales may be cash sales or credit sales.

Sales Return: When sold goods are returned from the customer due to any reason is known as sales return.

Debtors: Debtors are persons and/or other entities to whom the business has sold goods and services on credit and the amount has not received yet. These are assets of the business.

Creditors: If the business buys goods/services on credit and the amount is still to be paid to the persons and/or other entities, these are called creditors. These are liabilities for the business.

Bill Receivable: Bill Receivable is an accounting term of the Bill of Exchange. A Bill of Exchange is Bill Receivable for the seller at the time of credit sale.

Bill Payable: Bill Payable is also an accounting term of Bill of Exchange. A Bill of Exchange is Bill Payable for the purchaser at the time of credit purchase.

Discount: Discount is the rebate given by the seller to the buyer. It can be classified as :

1. Trade Discount: The purpose of this discount is to persuade the buyer to buy more goods. It is offered at an agreed percentage of the list price at the time of selling goods. This discount is not recorded in the accounting books as it is deducted in the invoice/cash memo.

2. Cash Discount: The objective of providing a cash discount is to encourage the debtors to pay the dues promptly. This discount is recorded in the accounting books.

Income: Income is a wider term, which includes profit also. Income means an increase in the wealth of the enterprise over a period of time.

Stock: The goods available with the business for sale on a particular date is known as stock.

Cost: Cost refers to expenditures incurred in acquiring manufacturing and processing goods to make it saleable.

Voucher: The documentary evidence in support of a transaction is known as a voucher. For example, if we buy goods for cash we get a cash memo, if we buy goods on credit, we get an invoice, when we make a payment we get a receipt.

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