UNIT-4

Basic
Accounting
Principles
 Accounting

• What is a simple definition of accounting?

• In its most basic sense, accounting describes the process of
tracking an individual or company's monetary transactions.
Accountants record and analyze these transactions to
generate an overall picture of their employer's financial
health.
• What are the basics of accounting?
• Basic accounting concepts used in the business world cover
revenues, expenses, assets, and liabilities. These elements
are tracked and recorded in documents including balance
sheets, income statements, and cash flow statements.
Meaning and Scope of Accounting
• Accounting is the language of business. The
main objectives of Accounting is to safeguard
the interests of the business, its proprietors
and others connected with the business
transactions. This is done by providing suitable
information to the owners, creditors,
shareholders, Government, financial
institutions and other related agencies.
 Definition of Accounting The American
Accounting Association defines accounting
• as "the process of identifying, measuring and
communicating economic information to permit
informed judgements and decisions by the users of
the information." According to AICPA (American
Institute of Certified Public Accountants) it is
defined 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 a financial character and interpreting the
result thereof."
 Steps of Accounting The following are the
important steps to be adopted in the accounting
process:

• (1) Recording: Recording all the transactions in

subsidiary books for purpose of future record or
reference. It is referred to as "Journal."
• (2) Classifying: All recorded transactions in
subsidiary books are classified and posted to the
main book of accounts. It is known as "Ledger."
• (3) Summarizing: All recorded transactions in
main books will be summarized for the
preparation of Trail Balance, Profit and Loss
Account and Balance Sheet.
• (4) Interpreting: Interpreting refers to the
explanation of the meaning and significance of
the result of final accounts and balance sheet
so that parties concerned with business can
determine the future earnings, ability to pay
interest, liquidity and profitability of a sound
dividend policy.
Functions of Accounting From the definition
and analysis of the above the main functions
of accounting can be summarized as:

• (1) Keeping systematic record of business

transactions.
• (2) Protecting properties of the business.
• (3) Communicating the results to various parties
interested in or connected with the business.
• (4) Meeting legal requirements.
 Objectives of Accounting
• (1) Providing suitable information with an aim of
safeguarding the interest of the business and its proprietors
and others connected with it.
• (2) To emphasis on the ascertainment and exhibition of
profits earned or losses incurred in the business.
• (3) To ascertain the financial position of the business as a
whole.
• (4) To ensure accounts are prepared according to some
accepted accounting concepts and conventions.
• (5) To comply with the requirements of the Companies Act,
Income Tax Act, etc.
 Definition of Bookkeeping

• Bookkeeping may be defined as "the art of

recording the business transactions in the
books of accounts in a systematic manner." A
person who is responsible for and who
maintains and keeps a record of the business
transactions is known as Bookkeeper. His work
is primarily clerical in nature.
 On the other hand,

• Accounting is primarily concerned with the

recording, classifying, summarizing,
interpreting the financial data and
communicating the information disclosed by
the accounting records to those persons
interested in the accounting information
relating to the business.
 Limitations of Accounting
• (1) Accounting provides only limited
information because it reveals the profitability
of the concern as a whole.

• (2) Accounting considers only those

transactions which can be measured in terms of
money or quantitatively expressed. Qualitative
information is not taken into account.
• (3) Accounting provides limited information to
the management.

• (4) Accounting is only historical in nature. It

provides only a post mortem record of
business transactions.
 Branches of Accounting
• The main function of accounting is to provide the
required information for different parties who are
interested in the welfare of that enterprise
concerned. In order to serve the needs of
management and outsiders various new branches
of accounting have been developed.
The following are the main branches of accounting:
• (1) Financial Accounting.
• (2) Cost Accounting.
• (3) Management Accounting.
• (1) Financial Accounting: Financial Accounting is prepared to
determine profitability and financial position of a concern for a
specific period of time. It is the original form of accounting. It is for
preparation of financial statements for the use of outsiders like
shareholders, debenture holders, creditors, banks & financial
institutions. The financial statements i.e the profit & loss account
and balance sheet.
• (2) Cost Accounting: Cost Accounting is the formal accounting
system setup for recording costs. It is a systematic procedure for
determining the unit cost of output produced or service rendered.
• (3) Management Accounting: Management Accounting is
concerned with presentation of accounting information to the
management for effective decision making and control. Help them
to create policies and controls the information about funds, costs,
Profits etc.
 Accounting Principles
• Various accounting systems and techniques are designed to
meet the needs of the management.
• The information should be recorded and presented in such a
way that management is able to arrive at right conclusions.
The ultimate aim of the management is to increase
profitability and losses. In order to achieve the objectives of
the concern as a whole, it is essential to prepare the
accounting statements in accordance with the generally
accepted principles and procedures.
• The term principles refers to the rule of action or conduct to
be applied in accounting. Accounting principles may be
defined as "those rules of conduct or procedure which are
adopted by the accountants universally, while recording the
accounting transactions."
The accounting principles can be classified into
two categories:

I. Accounting Concepts.
II. Accounting Conventions.
 Accounting Concepts
• Accounting concepts mean and include necessary
assumptions or postulates or ideas which are used to
accounting practice and preparation of financial
statements. The following are the important accounting
concepts:
• (1) Entity Concept – Owner is a separate entity
(creditor).
• (2) Dual Aspect Concept – debit & credit
• (3) Accounting Period Concept
• (4) Going Concern Concept – Continues concept
• (5) Cost Concept- book value will not change as recorded
in accounting. Eg.5 lacs
• (6) Money Measurement Concept – Only record
measurable quantity.
• (7) Matching Concept – Revenue and expense
• (8) Realization Concept –Anticipation of profit and
statement of loss
• Materiality concept – Knowledge will change the
decision of investor.
• (9) Accrual Concept – documents should have proof of
existence.
• (10) Rupee Value Concept – today’s transaction value will
consider for today
 II. Accounting Conventions
• Accounting Convention implies that those
customs, methods and practices to be followed
as a guideline for preparation of accounting
statements. The accounting conventions can be
classified as follows:
• (1) Convention of Disclosure.
• (2) Convention of Conservatism.
• (3) Convention of Consistency.
• (4) Convention of Materiality.
 Definition of Bookkeeping

• The process of complete and systematic record

keeping of the monetary transactions of an
organization by the bookkeeper is known as
bookkeeping. It is the activity of keeping full
documentation of every single financial
transaction of the entity to form a base for the
accounting process. The purpose of bookkeeping
is to disclose the correct picture of income and
expenditure at the end of the accounting period.
Single Entry Accounting vs Double Entry Accounting System

• Recordkeeping is handled as single entry

accounting and double entry accounting. The
former deals with making a one-time entry
into an account, be it an expense or income.
On the contrary, the latter is about making
two entries simultaneously to two different
accounts and marking both the debit and
credit sides.
 Meaning
• A double entry accounting system refers to the
bookkeeping method where two entries are
made simultaneously into two different
accounts, indicating a firm’s cash inflow and
outflow. The purpose is to tally both the
accounts and balance the credit and the debit
side. This accounting system helps
organizations assess their overall performance
in a financial year.
 Journal
• A journal is a detailed record of all the transactions done by a business.
• Reconciling accounts and transferring information to other accounting
records is done using the information recorded in a journal.
• When a transaction is recorded in a company's journal, it's usually
recorded using a double-entry method, but can also be recorded using a
single-entry method of bookkeeping.
• The double-entry method reflects changes in two accounts after a
transaction has occurred; an increase in one and a decrease in the
corresponding account.
• Single-entry bookkeeping is rarely used and only notes changes in one
account.
• A journal is also used in the financial world to refer to a trading journal
that details the trades made by an investor and why.
 Journal vs Ledger Differences

• The key difference between Journal and Ledger is that a

journal is the first step of the accounting cycle where all
the accounting transactions, a ledger is the extension of
the journal where journal entries are recorded by the
company in its general ledger account based on which
the company’s financial statements are prepared.

• Both are essential concepts in financial accounting. If

you don’t know the journal and ledger, you wouldn’t be
able to decipher the real meaning of each transaction
Profit & loss account statement
• What is the capital of a firm that has total assets of
•                                                 $240,000, total liabilities of $100,000, and an income of
•                                                 $40,000 for one year?
•  
• Solution:   Capital is synonymous with owner's equity, the amount invested in
•                         the company by its proprietors.
•                             Liabilities: Are financial obligations which appear in the normal
•                                                 operation of the business. It could be short term (up to a
•                                                 year or less) or long term (over a year).
•                                 Assets:   Are anything of value that is owned by the firm.
•                         Income is the excess of sales over all expenses. From the elementary
•                         accounting equation,
•                                                 C = Capital
•                                                 L = Liabilities
•                                                 A = Assets
•                                                             C = A – L.

• Assets $240,000
• Less Liabilities $100,000

• Capital
• $140,000
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