NAMI INTERNATIONAL SCHOOL (NAMI COLLEGE)

SUBJECT: - PRINCIPLES OF ACCOUNTING-I

[Santosh kuikel (SK) Sir, 9843586060]

CHAPTER-1

Definition of Accounting
Accounting can be defined as a process of reporting, recording, interpreting and
summarizing 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 summarizing 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”.

Fundamentals of Accounting

 Assets- The economic value of an item which is possessed by the enterprise

is referred to as Assets. To put it in other words, assets are those items that
can be transformed into cash or that generates income for the enterprise
shortly. It is useful in paying any expenses of the business entity or debt.
 Liabilities- The economic value of an obligation or debt that is payable by
the enterprise to other establishment or individual is referred to as liability.
To put it in other words, liabilities are the obligations that are rising out of
previous transactions, which is payable by the enterprise, through the assets
possessed by the enterprise.
 Owner’s Equity- Owner’s equity is one of the 3 vital segments of a sole
proprietorship’s balance sheet and one of the main aspects of the accounting
equation: Assets = Liabilities + Owner’s Equity. It depicts the owner’s
investment in the trade minus the owner’s withdrawal from the trade + the
net income since the business concern commenced.
Objectives of Accounting
The main objectives of accounting are:
To maintain a systematic record of business transactions

 Accounting is used to maintain a systematic record of all the financial

transactions in a book of accounts.
 For this, all the transactions are recorded in chronological order in Journal
and then posted to principle book i.e. Ledger.
To ascertain profit and loss

 Every businessman is keen to know the net results of business operations

periodically.
 To check whether the business has earned profits or incurred losses, we
prepare a “Profit & Loss Account”.
To determine the financial position

 Another important objective is to determine the financial position of the

business to check the value of assets and liabilities.
 For this purpose, we prepare a “Balance Sheet”.

To provide information to various users

 Providing information to the various interested parties or stakeholders is one

of the most important objectives of accounting.
 It helps them in making good financial decisions.
To assist the management

 By analyzing financial data and providing interpretations in the form of

reports, accounting assists management in handling business operations
effectively.
Characteristics of Accounting:
The following attributes or characteristics can be drawn from the definition of
Accounting:
(1) Identifying financial transactions and events

 Accounting records only those transactions and events which are of financial
nature.
 So, first of all, such transactions and events are identified.
(2) Measuring the transactions

 Accounting measures the transactions and events in terms of money which

are considered as a common unit.
(3) Recording of transactions

 Accounting involves recording the financial transactions inappropriate book

of accounts such as Journal or Subsidiary Books.
(4) Classifying the transactions

 Transactions recorded in the books of original entry – Journal or Subsidiary

books are classified and grouped according to nature and posted in separate
accounts known as ‘Ledger Accounts’.
(5) Summarizing the transactions

 It involves presenting the classified data in a manner and in the form of

statements, which are understandable by the users.
 It includes Trial balance, Trading Account, Profit and Loss Account
and Balance Sheet.
(6) Analyzing and interpreting financial data

 Results of the business are analyzed and interpreted so that users of financial
statements can make a meaningful and sound judgment.
(7) Communicating the financial data or reports to the users

 Communicating the financial data to the users on time is the final step of
Accounting so that they can make appropriate decisions.
What are the Different Branches of Accounting?
The following are the main branches of accounting:
(a) Financial accounting:
Financial Accounting is that branch of accounting which involves identifying,
measuring, recording, classifying, summarizing the business transactions, i.e. it
involves the steps from Identifying, Recording of transactions to Summarization,
and communicating the financial data.
(b) Cost accounting:
Cost Accounting is that branch of accounting which is concerned with the process
of ascertaining and controlling the cost of products or services.
(c) Management accounting
Management accounting refers to that branch of accounting which is concerned
with presenting the accounting information in such a way that helps the
management in planning and controlling the operations of a business and in
decision making.

Steps of the Accounting Process:

Accounting process is the process of collecting, recording, classifying,
summarizing and communicating financial information to the users for judgment
and decision-making. The following steps are involved in accounting process:
(1) Identification: It is the process of identifying and analyzing business
transactions.
(2)Recording: For recording, we use ‘Journal’ or Subsidiary Books.
(3) Classification of transactions: Classification means segregation of transactions
on the basis of nature and posting them in a format known as Ledger Account.
(4) Summarization: It includes preparation of Trial Balance and Financial
Statements.
(5) Analysis & Interpretation: It includes an assessment of the financial reports and
making some meaningful conclusions.
(6) Communicating information to the users: It includes sharing the financial
reports and interprets results to the users of financial statements.
 Define the term Bookkeeping, Accounting and Accountancy.
Bookkeeping Book Keeping is a part of Accounting and it is the process of identifying,
measuring, recording and classifying the financial transactions.

Accounting Accounting is a wider concept and actually, it begins where Book Keeping
ends. It includes summarizing, interpreting and communicating the financial
data to the users of financial statements.

Accountancy Accountancy refers to systematic knowledge of the principles and the

techniques which are applied in Accounting.

What is the Difference between Bookkeeping and Accounting?

Parameters Bookkeeping Accounting

Scope Bookkeeping involves In addition to bookkeeping, Accounting also

identifying, measuring, recording includes summarizing, interpreting and
& classifying financial communicating the financial data to the users
transactions in the ledger of financial statements.
accounts.

Objective The main aim is to maintain The main aim is to ascertain the profitability
systematic records of financial and financial position of the business.
transactions.

Stage It is a primary stage of It is a second stage and begins where book-

accounting keeping ends.

Nature of job This job is in routine and This job is analytical in nature.
repetitive in nature.

Level of skills Bookkeeping does not require It requires specialized skill to analyze, so it is
special skills. It is performed by performed by senior staff.
Junior Staff.
What are the Advantages of Accounting?
The following are the main advantages of accounting:
1. Provide information about financial performance

 Accounting provides factual information about financial performance during

a given period of time
 Like, profit earned or loss incurred over a period and financial position at a
particular point of time.
2. Provide assistance to management

 Accounting helps management in business planning, decision making and in

exercising control.
 For this, it provides financial information in the form of reports.

3. Facilitates comparative study

 By keeping systematic records and preparation of reports at regular intervals,

accounting helps in making a comparison.
4. Helps in settlement of tax liability

 Systematic accounting records help in settlement of various tax liabilities.

Such as – Income Tax, GST, etc.
5. Helpful in raising loan

 Banks and Financial Institutions grant a loan to the firm on the basis of
appraisal of the financial statement of the firm.
6. Helpful in decision making

 Accounting provides useful information to the management for taking

decisions.
What Are the Limitations of Accounting?
 Accounting is not precise: Accounting is not completely free from personal
bias or judgment.
 Accounting is done on historic values of assets: Accounting records assets
at their historical cost less depreciation. It does not reflect their current
market value.
 Ignore the effect of price level changes: Accounting statements are
prepared at historical cost. So changes in the value of money are ignored.
 Ignore the qualitative information: Accounting records only monetary
transactions. It ignores the qualitative aspects.
 Affected by window dressing: Window dressing means manipulation in
accounting to present a more favorable position of the business than the
actual position.

Explain the Users of Accounting Information:

Users may be categorized into internal users and external users.
(A) Internal Users

 Owners: Owners contribute capital in the business and thus they are exposed to
maximum risk. So, they are always interested in the safety of their capital.
 Management: Accounting information is used by management for taking various
decisions.
 Employees: Employees are interested in the financial statements to assess the ability of
the business to pay higher wages and bonuses.
(B) External Users

 Banks and financial institutions: Banks and Financial Institutions provide loans to
business. So, they are interested in financial information to ensure the safety and recovery
of the loan.
 Investors: Investors are interested to know the earning capacity of business and safety of
the investment.
 Creditors: Creditors provide the goods on credit. So they need accounting information to
ascertain the financial soundness of the firm.
 Government: The government needs accounting information to assess the tax liability of
the business entity.
 Researchers: Researchers use accounting information in their research work.
 Consumers: They require accounting information for establishing good accounting
control, which will reduce the cost of production.
Qualitative Characteristics of Accounting Information
Qualitative characteristics are the attributes of accounting information, which
enhance its understandability and usefulness:

 Reliability: Reliability implies that the information must be free from

material error and personal bias.
 Relevance: Accounting information must be relevant to the decision-making
requirements of the users.
 Understandability: Information should be disclosed in financial statements
in such a manner that these are easily understandable.
 Comparability: Both intra-firm and inter-firm comparison must be possible
over different time periods.

Explain the System of Accounting

System of accounting

 There are following two systems of recording transactions in the books of

accounts:
 Double Entry System
 Single Entry System
Double-entry system

 The double entry system is based on the Dual Aspect Principle.

 Every transaction has two aspects, ‘a Debit’ and ‘a credit’ of an equal
amount.
 This system of accounting recognizes and records both aspects of the
transaction.
Single entry system

 Under this system, both aspects are not recorded for all the transactions.
 Either only one aspect is recorded or both the aspects are not recorded for all
the transactions.
What Are the Advantages of the Double-entry System of
Accounting?
Following are the main advantages of the double-entry system of accounting:
Scientific system

 As compared to the other systems, this system of recording transactions is

more scientific and useful to achieve the objective of accounting.
A complete record of the transaction

 Since both the aspects of transactions are considered there is a complete

recording of each and every transaction.
 Using these records we are able to compute profit or loss easily.

Checks arithmetical accuracy of accounts

 Under this system, by preparing a Trial Balance we are able to check the
arithmetical accuracy of the records.
Determination of profit/loss and depiction of financial position

 Under this system by preparing ‘Profit & Loss A/c’ we get to know about
the profit earned or loss incurred.
 By preparing the ‘Balance Sheet’ the financial position of the business can
be ascertained, i.e. position of assets and liabilities is depicted.
Helpful in decision making

 Administration and management are able to take decisions on the basis of

factual information under the double-entry system of accounting.