Introduction of Accounting

Transcription

1 Introduction of Accounting Meaning 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 financial character, and interpreting the results thereof. With greater economic development resulting in changing role of accounting, its scope, became broader. In 1966, the American Accounting Association (AAA) defined accounting as the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of information. Accounting is an Art and Science of recording, classifying, summarising, analysing and interpreting financial transactions for the particular year (Financial Year). Book keeping is an Art and Science of recording and classifying financial transactions for the particular year (Financial Year). A transaction that involves the immediate exchange of cash for an asset or anything which we buy is known as cash transaction. Credit transactions include all transactions involving the purchase of loan of goods, services or money in the present with a promise to pay or deliver in the future. Without a promise to pay or deliver in the future, there can be no transaction.

2 History and Development of Accounting Accounting enjoys a remarkable heritage. The history of accounting is as old as civilisation. The seeds of accounting were most likely first sown in Babylonia and Egypt around 4000 B.C. who recorded transactions of payment of wages and taxes on clay tablets. Historical evidences reveal that Egyptians used some form of accounting for their treasuries where gold and other valuables were kept. The in-charge of treasuries had to send day wise reports to their superiors known as Wazirs (the prime minister) and from there month wise reports were sent to kings. Babylonia, known as the city of commerce, used accounting for business to uncover losses taken place due to frauds and lack of efficiency. In Greece, accounting was used for apportioning the revenues received among treasuries, maintaining total receipts, total payments and balance of government financial transactions. Romans used memorandum or daybook where in receipts and payments were recorded and where from they were posted to ledgers on monthly basis. (700 B.C to 400 A.D). China used sophisticated form of government accounting as early as 2000 B.C. Accounting practices in India could be traced back to a period when twenty three centuries ago, Kautilya, a minister in Chandragupta s kingdom wrote a book named Arthashasthra, which also described how accounting records had to be maintained. Luca Pacioli s, a Franciscan friar (merchant class), book Summa de Arithmetica, Geometria, Proportion at Proportionality (Review of Arithmetic and Geometric proportions) in Venice (1494) is considered as the first book on double entry bookkeeping. A portion of this book contains knowledge of business and book-keeping. However, Pacioli did not claim that he was the inventor of double entry book-keeping but spread the knowledge of it. It shows that he probably relied on then current book-keeping manuals as the basis for his masterpiece. In his book, he used the present day popular terms of accounting Debit (Dr.) and Credit (Cr.). These were the concepts used in Italian terminology. Debit comes from the Italian debito which comes from the Latin debita and debeo which means owed to the proprietor. Credit comes from the Italian credito which comes from the Latin credo which means trust or belief (in the proprietor or owed by the proprietor. In explaining double entry system, Pacioli wrote that All entries have to be double entries, that is if you make one creditor, you must make some debtor. He discussed the details of memorandum, journal, ledger and specialised accounting procedures.

3 Financial Transactions Journal (Recording)- Journalizing Ledger (Classifying)- Posting Trial Balance (Summery) Financial Statements FInancial Accounting Branches of Accounting Cost Accounting Management Accounting

4 Branches of Accounting The economic development and technological improvements have resulted in an increase in the scale of operations and the advent of the company form of business organisation. This has made the management function more and more complex and increased the importance of accounting information. This gave rise to special branches of accounting. These are briefly explained below: Financial accounting: The purpose of this branch of accounting is to keep a record of all financial transactions so that: (a) The profit earned or loss sustained by the business during an accounting period can be worked out, (b) The financial position of the business as at the end of the accounting period can be ascertained, and (c) The financial information required by the management and other interested parties can be provided. Cost Accounting: The purpose of cost accounting is to analyse the expenditure so as to ascertain the cost of various products manufactured by the firm and fix the prices. It also helps in controlling the costs and providing necessary costing information to management for decision-making. Management Accounting: The purpose of management accounting is to assist the management in taking rational policy decisions and to evaluate the impact of its decisions and actions.

5 Objectives of Accounting As an information system, the basic objective of accounting is to provide useful information to the interested group of users, both external and internal. The necessary information, particularly in case of external users, is provided in the form of financial statements, viz., profit and loss account and balance sheet. Besides these, the management is provided with additional information from time to time from the accounting records of business. Thus, the primary objectives of accounting include the following: Maintenance of Records of Business Transactions Accounting is used for the maintenance of a systematic record of all financial transactions in book of accounts. Even the most brilliant executive or manager cannot accurately remember the numerous amount of varied transactions such as purchases, sales, receipts, payments, etc. that takes place in business. Hence, proper and complete records of all business transactions are kept regularly. Moreover, the recorded information enables verifiability and acts as evidence.

6 Calculation of Profit and Loss The owners of business are keen to have an idea about the net results of their business operations periodically, i.e. whether the business has earned profits or incurred losses. Thus, another objective of accounting is to ascertain the profit earned or loss sustained by a business during an accounting period which can be easily workout with help of record of incomes and expenses relating to the business by preparing a profit or loss account for the period. Profit represents excess of revenue (income), over expenses. Describe Financial Position Accounting also aims at ascertaining the financial position of the business concern in the form of its assets and liabilities at the end of every accounting period. A proper record of resources owned by business organisation (Assets) and claims against such resources (Liabilities) facilitates the preparation of a statement known as balance sheet position statement. Providing Accounting Information to its Users The accounting information generated by the accounting process is communicated in the form of reports, statements, graphs and charts to the users who need it in different decision situations.

7 Internal users, mainly management, who needs timely information on cost of sales, profitability, etc. for planning, controlling and decision-making and external users who have limited authority, ability and resources to obtain the necessary information and have to rely on financial statements (Balance Sheet, Profit and Loss account). The external users are interested in the following: Investors and potential investors-information on the risks and returns on investments; Unions and employee groups-information on the stability, profitability and distribution of wealth within the business; Lenders and financial institutions-information on the creditworthiness of the company and its ability to repay loans and pay interest; Suppliers and creditors-information on whether amounts owed will be repaid when due, and on the continued existence of the business; Customers-information on the continued existence of the business and thus the probability of a continued supply of products, parts and after sales service; Government and other regulators- information on the allocation of resources and the compliance to regulations; Social responsibility groups, such as environmental groupsinformation on the impact on environment and its protection;

8 Competitors-information on the relative strengths and weaknesses of their competition and for comparative and benchmarking purposes. Whereas the above categories of users share in the wealth of the company, competitors require the information mainly for strategic purposes. Different Roles of Accounting As a language it is perceived as the language of business which is used to communicate information on enterprises; As a historical record- it is viewed as chronological record of financial transactions of an organisation at actual amounts involved; As current economic reality- it is viewed as the means of determining the true income of an entity namely the change of wealth over time; As an information system it is viewed as a process that links an information source (the accountant) to a set of receivers (external users) by means of a channel of communication; As a commodity- specialised information is viewed as a service which is in demand in society, with accountants being willing to and capable of providing it.

9 Assets Whatever a business owns is an Asset. Assets are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets can be broadly classified into following types: Fixed Assets are assets held on a long-term basis, such as land, buildings, machinery, plant, furniture and fixtures. These assets are used for the normal operations of the business. Current Assets are assets held on a short-term basis such as debtors (accounts receivable), stock (inventory), temporary marketable securities, cash and bank balances. Tangible Assets: Which h can be seen and touched. Intangible Assets: Which cannot be seen or touched. E.g. Goodwill, patent, trademark. Fictitious Assets: This is not a real asset but expenditure of big amount, benefit of which can be realised for long period. Wasting Assets:

10 Capital Amount invested by the owner in the firm is known as capital. It may be brought in the form of cash or asset by the owner for the business entity capital is an obligation and a claim on the assets of business. It is, therefore, shown as capital on the liabilities side of the balance sheet. Entity Entity means a thing that has a definite individual existence. Business entity means a specifically identifiable business enterprise like Super Bazaar, Hire Jewellers, ITC Limited, etc. An accounting system is always devised for a specific business entity (also called accounting entity). Transaction An event involving some value between two or more entities is known as transactions. It can be a purchase of goods, receipt of money, payment to a creditor, incurring expenses, etc. It can be a cash transaction or a credit transaction.

11 Contingent Liability: Liability which is payable on the occurrence of certain event is known as contingent liability. For example A Case in the court if company will lose a case then it has to pay amount. Liabilities Liabilities mean whatever amount we owe to others. Liabilities are obligations or debts that an enterprise has to pay at some time in the future. Both small and big businesses find it necessary to borrow money at one time or the other, and to purchase goods on credit. Long-term liabilities are those that are usually payable after a period of one year, for example, a term loan from a financial institution or debentures (bonds) issued by a company. Short-term liabilities are obligations that are payable within a period of one year, for example, creditors, bills payable, bank overdraft. Sales Sales are total revenues from goods or services sold or provided to customers. Sales may be cash sales or credit sales. Revenues These are the amounts of the business earned by selling its products or providing services to customers, called sales revenue. Other items of revenue common to many businesses are: commission, interest, dividends, royalties, rent received, etc. Revenue is also called income.

12 Expenses Costs incurred by a business in the process of earning revenue are known as expenses. Generally, expenses are measured by the cost of assets consumed or services used during an accounting period. The usual items of expenses are: depreciation, rent, wages, salaries, interest, cost of heater, light and water, telephone, etc. Purchases Purchases are total amount of goods procured by a business on credit and on cash, for use or sale. In a trading concern, purchases are made of merchandise for resale with or without processing. In a manufacturing concern, raw materials are purchased, processed further into finished goods and then sold. Purchases may be cash purchases or credit purchases. Drawings Withdrawal of money and/or goods by the owner from the business for personal use is known as drawings. Drawing reduces the investment of the owners. Stock Stock (inventory) is a measure of something on hand-goods, spares and other items in a business. It is called Stock in hand. In a trading concern, the stock on hand is the amount of goods which are lying unsold as at the end of an accounting period is called closing stock (ending inventory). In a manufacturing company, closing stock comprises raw materials, semi-finished goods and finished goods on hand on the closing date.

13 Debtors Debtors are persons and/or other entities who owe to an enterprise an amount for buying goods and services on credit. The total amount standing against such persons and/or entities on the closing date, is shown in the balance sheet as sundry debtors on the asset side. Creditors Creditors are persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit. The total amount standing to the favour of such persons and/or entities on the closing date, is shown in the Balance Sheet as sundry creditors on the liabilities side. Features of Accounting: 1. Art as well as Science : It is an Art of correctly recording the day-to-day business transactions. It is a science of maintaining business record in regular and proper way. Certain accounting conventions and principles have to be following while writing accounts hence we can conclude that Accounting is an Art and Science. 2. Financial Transaction:

14 Accounting only record transactions and events of financial nature only, if the transaction cannot be measured in the terms of money it cannot be recorded in the books of Account. E.g. Skill of manager certainly effect the profitability of the business but it will not be recorded in the book of accounts. 3. Recording: Accounting involves recording business transaction in a systematic manner. These recording is done by various subsidiary books such as Purchase book, Sales book, Purchase return book, Sales return book, Cash Book, Petty cash book, General Journal etc The number of these subsidiary books to be kept depends on the size and nature of the business. 4. Classifying: Classifying means process of grouping the entries or transactions of one nature at one place. This is done opening accounts in a book called Ledger which contains all the accounts of the firm. Ledgers are available in printed format in the market. Page numbers are given to ledgers. 5. Summarising: It means the process of presenting the classified data in a manner useful to the user of the accounts. This involves preparing Trial Balance and Final Accounts (Trading A/c, Profit and Loss A/c, Balance Sheet). 6. Analysis and Interpretation: The accounting statements are analysed and interpreted with the help of ratios. Such analysis helps management and other to judge the performance of the business.

15 Book Keeping Book keeping is the art and science of recording business transactions in the different set of books Bookkeeping and Accountancy are complementary to each other, as Bookkeeping provides the basis for accountancy because analysis and interpretation are not possible until transactions are recorded. But without Accountancy, book keeping is meaningless because mere recording does not show the result of the business. Difference between Accounting and Book keeping : Basis Difference of Book keeping Accountancy

16 Accounting Systems: 1. Single Entry Bookkeeping System: It is difficult to define single entry system because, in fact, there exists no system like single entry system. Broadly speaking, it is a defective double entry system. Any system that falls short of complete double entry method is called single entry system. Under this method, sometimes both the aspects of transactions are recorded, sometimes only one aspect is recorded or sometime no aspects of transactions is recorded in the books. As a general rule under the single entry practice only the personal aspects of the transactions are recorded and the nominal and real aspects are omitted altogether. As the name implies, the single entry system does not take into account the double effect of every transaction. Desi Nama System: It is traditional accounting system followed and discovered in India. It follows Indian calendar year from Kartak to Aso into the consideration. The Concept of Godess laxmi puja on the day of Diwali came from this system as Aso Vad Amas is the last day of Indian calendarand next day new year will begin. Double Entry Bookkeeping System: The double entry theory of bookkeeping can be defined as the system of recording transactions having two fundamental aspects - one involving the receiving of a benefit and the other to giving the benefit - in the same set of books. In this theory, as the two fold aspects of each transaction are recorded, the name "double entry" has been given to this system.

17 Every transaction involves two fold aspects e.g., an aspect of receiving and an aspect of giving. One who receives is a debtor (Dr) and one who gives is a creditor (Cr). Under the double entry system, both the aspects of giving and receiving are recorded in terms of accounts. The account which receives the benefit is debited and the account which gives the benefit is credited. It is the ultimate result of this system that every debit must have corresponding credit and vice versa and on any particular day the total of the debit entries and the credit entries on the various accounts must be equal. It was invented by an Italian Monk Luca Di Pacioli, in his book called mathematics in Difference between Double entry and single entry book keeping system Basis Double Entry System Single Entry System Nature It is a scientific system It is unscientific of accounting and method and does not provides complete provide complete and and detailed records detailed records of business Recording Both aspects (Dr and Both aspects (Dr and Both Cr)of Every Cr)of Every aspects transactions are transactions are not recorded in it. recorded in it Types of All the types Only Personal A/c and A/c (Personal, Real, Cash book are Nominal) are maintained recorded Trial TB can be prepared to TB cannot be Balance check arithmetical prepared to check accuracy arithmetical accuracy P/L Account Trading and P/L account can be prepared to ascertain true profitability of the business Trading and P/L account cannot be prepared to ascertain true profitability of the business

18 Balance Sheet Legal Proof Reliability Balance sheet is prepared to ascertain true financial position Books prepared in this system are accepted as an evidence in the court Books are completely liable under this system as these are based on scientific principles Cost Relatively more Expensive Rules Strict rules are to be followed Suitability This system is suitable for all types of business, large or small Balance sheet is not prepared only a statement of affairs is prepared on the basis of Incomplete records and estimates. Books prepared in this system are not accepted as an evidence in the court Not liable as these is prepared from estimates.. There is Greater chance of errors and frauds.. Relatively Less Expensive No rules are to be followed Suitable only for small business Tax Dept. Accepts this system Does not Accept

19 Computerised Accounting System: Accounting work requires considerable repetition and routine work. Computers are widely used in accounting work due to fast, speedy and accuracy of works. Large size firms prefer it due to greater storage facility, better performance and low cost. All the business transaction can be analyses, classified and summarised with the help of Computers. Following type of accounting work can be done with the help of Computers: 1. Recording business transactions 2. Preparation of individual records 3. Maintenance of stock records 4. Payroll accounting 5. Drawing of Bills and Invoices 6. Maintenance of Purchase and sales ledgers 7. Analysing and summarisation of Transactions 8. Reporting of performance through financial statement. Please visit the following page to check the history of Accounting -of-accountancy Visit the following page for Accounting Terminology

20 Questions: For 2 marks 1. What is accounting? 2. What is bookkeeping? 3. Accounting is an Art and Science Comment. 4. Bookkeeping is only an Art not a science Comment. 5. Name the branches of Accounting. 6. What is Cost Accounting? 7. What is Managerial accounting? 8. What is Single Entry Bookkeeping System? 9. What is Desi Nama System? 10. Mention two features of Single entry book keeping. 11. Mention two features of Double entry book keeping. 12. What is the main difference between Accounting and Bookkeeping? 13. Name subsidiary books used in place of Journal. 14. Show accounting cycle for a year. 15. Mention 4 uses of computer in accounting. 16. Define: Capital and Drawing. 17. Define: Assets and Liabilities. 18. Define: Debtors and Creditors. 19. Define: Purchase and Sales. 20. In which circumstances goods have to be returned? 21. What is Fictitious Asset? Give one example. 22. What is Wasting Asset? Give one example. 23. Differentiate Tangible and Intangible Assets. For 5 marks 1. Differentiate Accounting and Book keeping 2. Differentiate Single entry and Double entry book keeping. 3. What is accounting? Explain any 4 features of it. 4. What is bookkeeping? Explain any 4 features of it. 5. Explain the branches of Accounting. 6. Write a brief note on: Single Entry and Desi Nama System. 7. Write a note on Computerised Accounting System. 8. Write a note on: Types of Assets. 9. Write a note on: Types of Liabilities.

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