Introduction to Accounting

By Prabhat Varma
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Thought for the day
“A pessimist sees the difficulty in
every opportunity, an optimist
sees the opportunity in every
difficulty.”
Winston Churchill
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Interesting facts about Accounts
● Luca Pacioli wrote first book on double entry in
1494. He is known as father of accounting.
● The word ‘accountant’ comes from computer
which means to count or score.
● First CPA exam was conducted in New York in
1896.
● Walter Diemer was an accountant who invented
the bubble-gum in the year 1928.
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Introduction to Accounting
Accounting is systematic process of identifying,
measuring, recording, classifying, summarizing,
analyzing, interpreting and communicating financial
information. Accounting gives information on;
❖ the resources available
❖ how available resources have been employed
❖ The results achieved by their use

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Is Accounting a science or art?
Accounting is an art of recording, classifying and
summarizing financial transaction. It helps us knowing
profitability & financial position of business.

Accounting is also a science as it is an organized

knowledge based on certain basic principles.

Hence, Accounting is Art as well as Science.

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Accounting Process

Based on the attributes of accounting, the steps of

accounting process are as follows;
✓ Identifying financial transaction
✓ Recording
✓ Classifying
✓ Summarizing
✓ Analyzing & interpreting
✓ Communicating
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Branches of Accounting

With the changing times, following specialized branches

of accounting have emerged;

● Financial Accounting
● Cost Accounting
● Management Accounting
● Social Responsibility Accounting

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Book keeping, Accounting & Accountancy
● Book keeping is a part of accounting being a process of
recording financial transactions and events.

● Accounting is a wider concept and it starts where Book

keeping ends.

● Accountancy refers to the entire body of theory and

practice of accounting.
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Objective of Accounting
The objectives of accounting are;
❖ Record of financial transactions & events
❖ Determine Profit & loss
❖ Determine financial position
❖ Assisting the Management
❖ Communicating accounting information to users
❖ Protecting business assets

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Functions of Accounting
The main functions of accounting are;

● Maintaining systematic accounting records

● Preparation of financial statements
● Meeting legal requirements
● Communicating the financial information
● Assistance to management

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 Advantages of Accounting
● Financial information about business
● Assistance to Management
● Replaces Memory
● Facilitates Comparative Study
● Facilitates Settlement of Tax Liabilities
● Facilitates Loans
● Evidence in Court
● Facilitates sale of business
● Helps in Decision Making
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Limitations of Accounting

● Not free from bias

● Accounting does not indicate the realizable value
● Accounting does not indicate qualitative elements
● Accounting ignores the effect of price level changes
● Accounting may lead to window dressing

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Type of Accounting information
Accounting information refers to the financial statement
generated through the process of bookkeeping and it
helps the users to arrive at decision;

❖ Information relating to Profit or Surplus

❖ Information relating to financial position
❖ Information about cash flow

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Users of Accounting information

Internal users;

✓ Owners
✓ Management
✓ Employees & workers

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External Users

● Banks & Financial Institutions

● Investors & Potential investors
● Creditors
● Government and its Authorities
● Researchers
● Consumers
● Public

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 Qualitative characteristics of Accounting Information

Qualitative characteristics are attributes that makes the

accounting information useful. These characteristics are;

❖ Reliability
❖ Relevance
❖ Understandability
❖ Comparability

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Double Entry System
A transaction has two aspects – Debit & Credit and at the
time of recording, it is recorded once on debit side and
again on credit side. Under double entry system of
accounting both debit and credit aspect of transactions
are recorded.

The double entry system has proved to be scientific and

complete system of accounting.
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Features of double entry system

● Maintains complete records of each transaction.

● Recognizes two fold aspect of every transaction

● It helps in establishing arithmetical accuracy.

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Stages of double entry system

● Recording the transaction.

● Classifying transaction and posting them.

● Closing the book and preparing the final accounts.

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Advantages of double entry system

● Scientific system
● Complete records of transaction
● Arithmetical accuracy of accounts is ensured
● Determining profit and loss
● Knowledge of financial position
● Full details for purposes of control

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Continued……….
● Comparative study is possible
● Helps management in decision making
● Detection of frauds and misappropriation

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Generally Accepted Accounting Principles (GAAP)
GAAP may be defined as those rules of action or conduct
which are derived from experience and practice and
when they prove useful , they become as principles of
accounting. The acceptance of accounting principles or
practices depends upon how well they meet the
following criteria;
✓ Relevance
✓ Objectivity
✓ Feasibility
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Basic Assumption of Accounting
The following are the basic assumption of accounting
and are like foundation pillars on which the structure of
accounting is based ;
➢ Accounting Entity Assumption

➢ Money Measurement Assumption

➢ Accounting Period Assumption

➢ Going Concern Assumption

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Basic principles of accounting
Basic principle of accounting are essentially, the general
decision rules, which govern the development of
accounting technique;

❖Duality Principle
❖Revenue Recognition Principle

❖Historical Cost Principle

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Continued……….
❖Matching Principle
❖Full Disclosure Principle

❖Objectivity Principle

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 Modifying Principles of accounting
To make the information useful, the basic
assumptions and principles have to be modified.
These modifying principles are as follows;

➢ Cost benefit principal

➢ Materiality principle
➢ Consistency principle

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Continued……….

➢ Prudence (or Conservatism) Principle

➢ Timeliness Principle
➢ Substance over form
➢ Industry practice

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Accounting Standards

➢ An accounting standard is a selected set of accounting

policies or broad guidelines regarding the principles
and methods to be chosen out of several alternatives.

➢ Standards conform to applicable laws, customs, usages

and business environment.

➢ The objective is to harmonize the diverse accounting

policies and practices.

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Accounting Policies
● Accounting policies refers to specific accounting
principles and methods of applying those principles
adopted by the enterprise in the preparation &
presentation of financial statements.
● There is no single list of accounting policies applicable
to all enterprises in all circumstances.
● The management of each enterprise has to select
appropriate accounting policies.

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Example of Accounting Policies
● Methods of depreciation, depletion, and amortization
● Treatment of expenditure during construction
● Valuation of investments
● Valuation of fixed assets
● Treatment of contingent liabilities

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Consideration in selection of Accounting Policies
● Prudence
● Substance over form
● Materiality

According to AS – 1, all significant accounting policies

adopted in preparation & presentation of financial
statements should be disclosed.

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Change in Accounting Policy
The change in Accounting Policy is recommended only in
following circumstances;

● If required by statute for compliance with an

accounting standard.
● If it is considered that change would result in more
appropriate presentation of the financial statements of
an enterprise.

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Disclosure in case of Change in Accounting Policy
Case Disclosure Requirement

Have material effect in current The amount of change should be

period & effect of change is disclosed.
ascertainable
Have material effect in current The fact should be disclosed.
period & effect of change is not
ascertainable, wholly or in part.

Have no material effect in current The fact of such change should be

period but expected to have material appropriately disclosed.
effect in later periods.
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Basic Accounting Terminology
● Entity : An economic unit that performs economic
activity.

● Transaction : An exchange in which each participants

receives or sacrifices value. It involves exchange of
goods & services on cash or credit basis.

● Entry : The record made in books of accounts in respect

of transaction. An entry is passed on the basis of 34
Continued………..

● Assets : refers to tangible objects and intangible rights

of an enterprise which carry probable future value. The
Assets are broadly classified as ‘Current Asset’ & ‘Fixed
/ long term Assets’.

● Liabilities : refers to financial obligation of an

enterprise other than owner’s fund. Liabilities may be
classified as ‘Current Liabilities’ and ‘ Long term
liabilities’
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 Continued………..

● Capital : It refers to the amount invested in an

enterprise by proprietor / partner / promoter /
shareholders.

● Drawing : It refers to the amount of cash or goods or

any other assets withdrawn by the proprietor / partner.

● Expenditure : The expenditure may be for the purchase

of an asset, a reduction of a liability, a distribution to
the owners, or it could be an expense. 
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Continued………………
● Expenses : is a cost that has expired, was used up, or
was necessary in order to earn the revenues .

● Income : refers to increase in economic benefits during

an accounting period in the form of (a) inflow of assets
(b) decrease in liabilities.

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Accounting Equation

An accounting equation is a statement of equality

between ‘resources’ and the sources which finance the
resources and is expressed as follows;
Resources = Sources of finance
Resources means Assets like land & building, Plant &
machinery, Debtors, Bank balance etc
Sources of finance includes equities (Capital) and
liabilities.
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Continued……….

Total Assets = Total Equities

Or
Assets = Capital + liability
Or
Capital = Assets – liability

The above entries gives the foundation to the double

entry book keeping.

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Procedure for developing an accounting equation
➢ Ascertain the variables ( i.e. Assets, Liability & Capital)
of an equation is affected by a transaction.

➢ Find out the effect (in terms of increase or decrease) of

a transaction on the variables of an equation.

➢ Show the effect on appropriate side of an equation and

ensure that the total of right hand side is equal to left
hand side.
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 Type of Accounts
Traditional approach
Type of Accounts Meaning Examples
Personal Accounts These accounts relates to Natural – Human
natural persons, artificial Artificial - Company’s name
person and representative Representative -
person. Outstanding salary
Real Accounts These accounts relate to Tangible – Land A/c
tangible or intangible real Intangible – Goodwill A/c
assets.

Nominal Accounts These accounts relates to Purchases, loss by fire, Sales,

losses, profit & gain. discounts
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Classification of Accounts according Accounting
equation
Type of Accounts Meaning Examples
Assets Accounts These accounts relate to Land a/c, Building a/c,
tangible or intangible real cash a/c, goodwill a/c
assets.

Liability Accounts These accounts relates to Trade Creditors,

financial obligations of an
enterprise towards
outsiders.
Capital Accounts These accounts relates to
owners of an enterprise.
outstanding expenses,
Term loans
Capital a/c, Drawing a/c
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Classification of Accounts according Accounting
equation
Type of Accounts Meaning Examples
Revenue Accounts These accounts relates to the Sales a/c, Discount
amount charged for goods sold or received a/c, Dividend
services rendered or permitting received a/c, Interest
others to use enterprise resources received a/c
yielding interest, royalty or
dividend.
Expenses Accounts These accounts relates to the Purchase a/c, Discount
amount incurred or lost in the allowed a/c, Royalty
process of earning revenue. paid a/c
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Meaning of Debit and Credit

● Debit means to enter an amount of transaction on the

left side of an account and credit means to enter an
amount of transaction on the right side of an account.

● Dr. stands for debit and Cr. stands for credit.

● Both debit & credit represents either increase or

decrease depending upon the nature of an account.
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Rules for Dr. & Cr. (Traditional Classification)

Type of Accounts Rules for Dr. Rules for Cr.

For Personal Accounts Debit the receiver Credit the giver

For Real Accounts Debit what comes in Credit what goes out

For Nominal Accounts Debit all expenses & losses Credit all gains & profits

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Classification of Accounts according Accounting equation
Type of Accounts Rules for Dr. Rules for Cr.
Assets Accounts Debit the increase Credit the decrease
Credit the increase
Liability Accounts Debit the decrease

Capital Accounts Debit the decrease Credit the increase

Revenue Accounts Debit the decrease Credit the increase

Debit the increase
Expenses Accounts Credit the decrease

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Accounting Methods
● Accrual basis of Accounting
Accrual basis of Accounting is a method of recording
transactions by which revenue, cash, assets and
liabilities are reflected in the accounts for the period in
which they accrue.
The basis includes consideration relating to deferrals,
allocations, depreciation and amortization. This is also
refers to as mercantile basis of accounting.
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Under the Companies Act 1956, all companies are
required to maintain the books of accounts according to
accrual basis of accounting.

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Cash Basis of Accounting
● Cash basis of Accounting is a method of recording
transactions by which revenues, costs, assets and
liabilities are reflected in the accounts for the period in
which actual receipts or actual payments are made.

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Thanks

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