INTRODUCTION

Meaning of Accounting -
• Wherever money is involved, accounting is required to account for it.
• Accounting is often called the language of business & its basic function is to serve as a
means of communication.
• It is the art of recording, classifying & summarizing in a significant manner & in terms of
money, transactions & events which are, in part of at least, of a financial character, &
interpreting the result thereof.
• The dimension of accounting is much broader. It’s the process of identifying, measuring
& communicating economic information to permit informed judgements & decisions by the
users of accounts.
• Thus accounting covers the following activities:-
• Identifying the Transaction & Events
• Measuring the Identified Transaction & Events
• Recording
• Classifying
• Summarizing
• Analyzing
• Interpreting
• Communicating

• As in information system, accounting may be viewed as-

INPUT PROCESS OUTPUT

Recording
Classifying Communicating
Economic events
Summarizing information to
measured in
Analyzing users
financial terms
Interpreting

Meaning of Accountancy -
• Refers to a systematic knowledge of accounting
• Explains ‘why to do’ & ‘how to do’ of various aspects of accounting
• Tells us why & how to prepare the books of accounts & how to summarize the
accounting information & communicating it to interested parties
Meaning of Book-Keeping -
• Is a part of accounting & is concerned with record keeping or maintenance of books of
accounting which is often routine & clerical in nature
• It covers the following 4 activities:-
• Identifying the transactions & events
• Measuring the identified transactions & events in a common measuring unit
• Recording the identified & measured transactions & events in books of accounts
• Classifying the recorded transactions & events in ledger
Relationship between Accountancy, Accounting & Book-Keeping –
• Book-Keeping is a part of Accounting
• Accounting is a part of Accountancy

Meaning of Accounting Cycle-

• After identifying & measuring the financial transactions, the accounting cycle begins.
• An accounting cycle is a complete sequence beginning with the recording of the
transactions and ending with the preparation of the final accounts
• Sequential steps involved in accounting cycle are-
• Journalising (record transactions in Journal)
• Posting (transfer the transactions recorded in journal in respective ledger accounts)
• Balancing (ascertain the difference between total debit & credit columns)
• Trial Balance (prepare list showing balance of each account, debits=credits)
• Income Statement (prepare & ascertain profit or loss for period)
• Position Statement (prepare Balance sheet at end of accounting period)
Primary Objectives of Accounting –
• To maintain Accounting records- Written records are always better than oral & can be
used by different persons for decision making & serves as evidence of transaction.
Accounting is done to keep a systematic record of Financial transactions, Assets & Liabilities
• To calculate the results of operations- To measure financial performance results are
ascertained by preparing Income statement (called as Profit & Loss account) which shows
the matching of current costs with current revenues during a particular accounting period.
Systematic recording of income & expenses facilitates preparation of Income statement
• To ascertain the Financial Position- To evaluate financial strength & weakness
financial position is ascertained by preparing Position statement (called as Balance sheet)
which shows resources (assets) owned & the sources of financing those resources. A
systematic record of various assets & liabilities facilitates the preparation of position
statement.
• To communicate the information to the users- Accounting communicates information
to internal users & external users. The internal users include all levels of management. Top
level management requires information for planning & middle level management requires
information for controlling operations. Information is in form of reports. External users do
not have access to records they are basically interested in solvency & profitability
Users of Accounting Information & their needs-
Users Uses of Information
To know profitability, assess growth & survival of Company, to decide on
INVESTORS quantum of investment
To judge profitability, assess capacity to pay interest & principal & assess
LENDERS long term survival of Company
To assure that their credit will be honored, judge credibility of form &
CREDITORS continuity of business
To ensure continuous availability of product & know credit policy &
CUSTOMERS profitability of Company
TO assess Excise/Sales Tax/Income Tax due from Company, study the
GOVT wage structure for national wage policy, know the Imports/Exports for
AGENCIES assessing net foreign exchange earned
To know the expenses on employees, ensure continuity & study
EMPLOYEES profitability of Company

Advantages of Accounting-
• Facilitates to replace memory
• Facilitates to comply with legal requirements
• Facilitates to ascertain net results of operations
• Facilitates to ascertain Financial position
• Facilitates the users to take decisions
• Facilitates a comparative study( actual vs budgeted,2 periods, inter firms)
• Assists the Management (planning, controlling & taking decisions)
• Facilitates control over Assets
• Facilitates settlement of tax liability
• Facilitates the ascertainment of value of business
• Facilitates raising of loans
• Acts as legal evidence
Limitations of Accounting-
• Ignores the qualitative elements (like quality of management, labour force)
• Not free from bias (since subjectivity is inherent in personal judgement)
• Estimated position & not real position
• Ignores the price level changes in case of Financial statements prepared on historical
costs
• Danger of window dressing

Branches of Accounting-
• Financial Accounting- Keeps systematic records & ascertain financial performance &
financial position & to communicate the accounting information to interested parties
• Cost Accounting- Is process of accounting & controlling the cost of a product, operation
or function & communicate information for decision making
 • Management Accounting- Purpose is supply information that management may need in
taking decisions & to evaluate impact of the decisions & actions. Extends beyond cost
accounting & includes Capital expenditure decisions, Capital structure decisions, Dividend
decisions etc
• Social responsibility – Accounting for environment & ecology is part of social
responsibility

Relationship between Financial Accounting, Cost Accounting & Management Accounting

Accounting

Financial Accounting Cost Accounting Management Accounting

Preparing
Financial Analyzing
Statements Cost for Assisting
for control and Management
External Maximizin for Decision
Reporting g Making
efficiency

Definitions of Management Accounting-

• Robert Anthony says - It is concerned with accounting information which is useful to
Management
• The Institute of Chartered Accountants of England & Wales has stated that any form of
accountancy which enables a business to be conducted more efficiently can be regarded as
Management Accounting
• The Institute of Cost Management Accountants London defines it as- the application of
professional knowledge & skill in presentation of accounting information in such a way to assist
management in the formation of policies & in the planning & control of operations of the
undertaking
• T.G. Rose defines it as- the adaptation & analysis of accounting information & its diagnosis &
explanation in a way to assist management
• Betty says – it is the term used to describe the accounting methods, systems & techniques which,
coupled with special knowledge & ability, assist management in its task of maximizing profits or
minimizing losses
• It is presentation of accounting information in such a way as to assist management in creation of
policy & in the day to day operations of an undertaking

Management Accounting involves:

 • Presentation of accounting information in a useful & meaningful manner to management.
• Collection , analysis & diagnosis of accounting information
• Furnishing of relevant & analytical data to management for the purpose of planning, control &
decision making
• Evaluation & Interpretation of performances
• Management reporting
Distinction between Management Accounting & Financial Accounting-
Basis of
distinction Management Accounting
Subject It relates with various departments , products of
matter other sub-division of business activity
Two main terms are planning & budgeting with
Accounting the help of which the management will be in a
method position to forecast the future possibilities
Approximation are often useful as against
Accuracy figures worked out accurately
Compulsion It is optional. It is not compulsory
Will reveal whether the plans formulated & the
decisions arrived at by the Management are
being followed rigidly & if not what part of them
Presentation are not followed.
Need not conform to the standards or rules laid
down but it can follow its own rules & principles
for the efficient achievement of objectives &
Procedure goals of an organization
Type of data Uses the data which is statistical, descriptive,
used subjective & relates to the future
Emphasizes less in respect of those qualities
which enhance the value of information. Such
Precision qualities may be flexibility & compressibility
Up to date information is required on the basis
of management action & so there is always the
emphasis for supply of information quickly,
because if the results are not informed in time,
management accounting will loose much of the
Dispatch significance
Financial Accounting
It relates to the enterprise as a whole. Balance
sheet & Income statement are drawn for entire
business activity & they report upon overall
performance of the enterprise
There is recording of business transactions in
which values of assets & liabilities are
ascertained on a specified data by the
presentation of a Balance sheet, Profit & loss
for a specified period & the results of the
trading ascertained
There is great importance to figures worked
out accurately
Is absolutely compulsory for companies & is
must for other forms of organization to satisfy
statutory provisions or for taxation purpose.
Will not reveal the plans formulated &
decisions arrived at by management
Has as one of its objectives-furnishing of
information to outsiders who have a right to get
the same under certain well defined &
accepted principles & rules
Makes use of data which is historic,
quantitative, monetary & objective
Places great stress on those policies like
objectivity, validity & absoluteness
Results are disclosed almost at the end of year
 Is related not only with the past information but
also with information about future plans. To this
extent management accounting does not end
with the analysis of what has happened in past
but it also extends to providing useful
information in good time for improving the
Nature results of the activity
Distinction between Management Accounting & Cost Accounting
Basis of distinction Management Accounting
Is the presentation of accounting
information in such a way as to assist
the management operation of an
undertaking. Functionally it involves
collecting, analyzing, interpreting &
presenting all accounting information
Definitions which is useful to the management
Will pay attention to the matters relating
Main Task to finance, productivity, profitability etc
Predicts the future on the basis of past
events, present happenings & future
Time Factor estimates
Management reports are useful only to
Utility of Reports the management & not to outsiders
Management reports are not subject to
any statutory audit. Though there is
management audit, it is voluntary & it
evaluates the managerial functions,
Statutory verification decisions etc
Has wider scope. It makes use of the
costing information, financial accounting,
statistics, economics & often non
monetary data which helps the
management to carry out their functions
Scope successfully
There are no set rules & regulations. It
can present the information to
management in the form & way which is
most appropriate & useful. Managerial
reports procedure, format can be
modified depending upon convenience &
Rules & regulations requirements
Is mainly connected with the historical records
namely what has happened. In short it is
related with the historical records
Cost Accounting
It is the technique & process of
ascertaining cost. It is the branch of
general accounting & covers the
application of accounting principles
relating to recording , classifying &
analyzing of costs within the organization
Will compare the actual results with the
standards laid down & will point out
variance, if any to the management
Lays emphasis on the past but there is
less emphasis on the future. Thus it
reports about costs that have been
incurred
Although meant for management can be
used by outsiders as well
Cost accounts & reports are subject to
cost audit hence it is necessary to prepare
reports objectively
scope is not that wide as management
accounting
There are set rules & regulations Reports
are prepared as per rules, principles,
procedures etc as specified by ICWAI

It aims at the presentation of the cost
data to the extent required, wherever &
whenever they are required together
with other relevant information to the
Objective management for arriving at decisions
Aims at ascertaining cost of goods &
services. It lays emphasis on the stage by
stage computation of costs. It is used for
inventory valuation, determination of cost
pricing & profits, cost control budgeting
etc

Basic Accounting Terms-

Transactions: All the businessmen and professionals keep on entering into transactions with
each other. Transaction means exchange of goods, services and other things.

Transactions

Non- monetary Monetary

Cash Credit Exchange transactions

Amount is paid or
received on the spot.
Goods, services &
other things are
exchanged against
cash. In cash
Transactions cash is
received or paid and
also includes
cheques.
Amount is received or paid on
some future date. Goods, Old machinery
services & other things are exchanged against
exchanged against a promise furniture
to pay on some future date.
Due to credit transactions
amount either becomes
receivable(when we give the
benefit) or payable(when we
receive the benefit)

Thus a business transaction is an exchange in which each participant receives or sacrifices value.
It is an economic event that relates to a business entity involving transfer of money or moneys
worth.

Event- is happening of consequence e.g use of raw materials for production

Entry- is the record made in books of accounts in respect of transaction or event. An entry is
prepared on basis of vouchers
Voucher- is a document which serves as an evidence of a transaction e.g cash memo in case of
cash purchases & invoice in case of credit purchase. Thus voucher is the source document on
basis of which transaction are recorded in books

Narration- When an entry is passed it has to be followed by an explanation of the entry. This
explanation is called narration. It is written just below the entry

Account- It is summarized record of transactions relating to any particular person or thing or

income or expense

Journal – It is a book of original entry. It is the book of daily record of all transactions. The
transactions are recorded in a chronological order

Ledger – It denotes the bound volume of the accounts. The ledger is the main book of accounts.
It includes all the different accounts - assets, persons, incomes & losses.

Ledger Posting – Transactions are originally recorded in journal & are also required to be
recorded in ledger under different heads. This act of recording transactions in ledger from journal
is called posting.

Assets- refer to tangible objects or intangible rights of an enterprise which carry probable future
benefits. Is a resource controlled by the enterprise as a result of past events & from which future
economic benefits are expected to flow to the enterprise.

Classification of Assets

Current Assets Fixed Assets

Tangible Intangible

Current assets- are those which are held

i) in form of cash
ii) for their conversion into cash
iii) for their consumption in the production of goods or rendering of services
examples are Cash in hand, Cash at Bank, Stock of raw materials/work in progress/ finished
goods, Debtors, bills receivables

Fixed assets- refer to those assets which are held for the purposes of providing or producing
goods or services & those that are not held for resale in the normal course of business. Fixed
assets may be classified as follows-
i) Tangible fixed assets- refer to those which can be seen & touched like land &
building, plant & machinery, furniture & fixtures
ii) Intangible fixed assets- refer to those which cannot be seen & touched like goodwill,
patents, trademarks, copyrights

Fictitious Assets- are actually not assets but are shown as assets. They do not have any real
value. Items included in this group are losses of company, preliminary expenses & misc
expenses not written off, or loss on issue of shares/debentures

Liabilities- refer to financial obligations of an enterprise other than owners funds. Liabilities
may be classified as follows-
Current Liabilities- Refer to those liabilities which fall due for payment in a relative short
period (<12 mths from Balance sheet date) examples are Bills Payable, Trade creditors,
outstanding expenses, Bank overdraft
Long term Liabilities- Refer to those which do not fall due for payment in a relatively short
period. Examples Long term Loans, Debentures
Contingent Liabilities- Liabilities which are contingent or dependant on happening or not
happening future events which are uncertain. They are not shown in Balance sheet but appear as
foot note below balance sheet

Capital- Is the excess of assets over external liabilities. It refers to the amount invested by the
proprietor or partners. This amount is increased by the amount of profits earned & amount of
additional capital introduced & is decreased by the amount of losses incurred & the amount
withdrawn. It represents the owners claim on the assets. It is also known as owner’s equity or net
assets or net worth

Equity Capital (permanent capital)- Is capital collected by company from Public. Those who
subscribe for capital are called equity shareholders. Capital is divided in small denominations of
Rs.10 & each such denomination is called as share. Thus if company has Rs 50 crore as capital
there will be 5 crore equity shares. Equity capital has following components-
a) Authorised share capital is the capital with which company is registered. This amount is
mentioned in the memorandum of association & the company cannot collect more than this.
Example company has authorized capital of Rs 100 crores
b) Issued share capital is that part of authorized capital issued to the public for
subscription. Example issued capital is Rs.70 crores
c) Subscribed share capital is that part of issued capital which public has agreed to
subscribe. Example subscribed capital is Rs.55 crores
d) Paid up share capital is that part of subscribed capital which public has actually paid the
amount for. Example Paid up capital is Rs.50 crores this is the capital actually received
Preference Capital (Long term Capital )- This is capital subscribed by preference shareholders
which is to be repaid or redeemed by company after specific period of time. Features are-
They receive dividend ahead of equity shareholders
Dividend is at fixed rate
Upon liquidation they receive their capital ahead of equity shareholders

Debenture Capital (Long term Capital) – It is a secured loan taken by company from public at
large. It is a secured loan for specific period of time after which loan is repaid or redeemed by
company. During the period of loan the company must pay interest on debentures. If it fails to
pay interest or principal the debenture holders can bring action through court & company has to
make payment by selling the assets which are secured against the debentures.

Drawings- Refer to the total amount of cash or goods or any other assets withdrawn by partner
or proprietor for personal use

Purchases- refers to total amount of goods obtained for resale or for use in production of goods
or rendering of services. Purchases may be for cash or on credit

Sales – refers to the amount for which the goods are sold or services are rendered. Sales may be
for cash or on credit

Stock (or inventory or merchandise) – refers to tangible property held for sale in ordinary
course of business or for consumption in the production of goods or services for sale. It includes
stock of raw materials, semi finished goods & finished goods
Opening stock means goods lying unsold at beginning of accounting period & closing stock
means the goods lying unsold at end of accounting period

Trade debtors- refers to the person from whom the amounts are due for goods sold or services
rendered on credit basis

Trade Creditor- refers to the person to whom the amounts are due for goods purchased or
services rendered on credit basis

Receivables- include both the trade debtors & Bills receivable. A Bill of exchange is an
unconditional order in writing given by the creditor to the debtor to pay on demand or at a fixed
or determinable future time, a certain sum of money to or to the order of a specified person or to
the bearer. A bill of exchange is known as bills receivable for the creditor.

Payables- include both the trade creditors & bills payable. The bill of exchange is known as
Bills payable for the debtors

Expenditure- are the costs incurred in acquiring an asset or service in the form of outflow or
depletion of assets or incurrence of liability. Cost is the measure of expenditure. It may be
expired (revenue expenses) or unexpired (capital expenses).
a) Expired Cost (or Expense) – Is that portion of expenditure which has been consumed
during the accounting period. It decreases equity. Expired costs is of following 2 types
 i) Utilized cost – is that portion of expired cost which benefits the enterprise in producing
revenue & includes cost of merchandise sold or services rendered for example
commission on sales, advertisement expenses
ii) Lost cost – is that portion of expired cost which does not contribute to revenue & is
regarded as loss for example loss on uninsured assets due to fire
b) Unexpired Cost (or Asset) – is that portion of expenditure which has not been consumed till
end of accounting period. It does not reduce equity. Usually the present unexpired cost
becomes future expired cost over a long period
c) Deferred Revenue expenditure- is revenue expenditure by nature but its matching with
revenue may be deferred considering the benefits to be accrued in future for example heavy
expenditure on advertisement. So long as deferred revenue expenditure is not written off it is
shown on asset side as fictitious assets.

Types of Profits- Profit is excess of revenue over the expenses to earn that revenue.
Profit = Revenue – Expenses
a) Gross profit – Excess of proceeds of goods & services sold during certain period over
their cost before considering administrative, selling & financing expenses
GP = Sales – Cost of goods sold
COGS = (Opening stock + Purchases – Closing stock) + Direct manufacturing expenses

b) Operating Profit (EBIT / PBIT) – Net profit arising from normal operations & non
operating activities but without considering interest expenses. It is also referred as Profit or
Earnings before Interest & Tax
PBIT = Sales + Other Income – (COGS + Admin + Selling + Depreciation)

c) Net Profit (NP / PBT) – Excess of revenue over expenses. Income tax is payable on this
profit

d) Capital profit- Profits realized from sale, transfer or exchange of assets of business is usually
considered as non-operating gains

e) Profit after tax (PAT) – Profits left after paying income tax. From this amount
Dividend on Preference shares is paid
Dividend on equity shares is paid
Remaining amount (retained earnings) is kept as reserve of company

General Accounting Terms-

Trade Discount – Reduction granted by supplier from its list price of goods on business
consideration other than for prompt payment. It is not shown in books of accounts. It is allowed
at time of sale & is calculated on sale value

Cash Discount – Reduction granted to our company by suppliers or by or company to customers

from invoice price in consideration of immediate payment or payment within stipulated period. It
is shown in books of accounts. It is allowed at time of receipt of cash/ cheque & is calculated on
basis of amount settled

Debit Note – is a document sent by our company to supplier which indicates that balance in
suppliers account is being reduced by amount of purchase returns or purchase allowance

Credit Note – is a document sent by our company to customer which indicates that balance in
customers account is being reduced by amount of sales returns or sales allowance

Prepaid expenses – Payment for expenses in an accounting period the benefit of which will
accrue in the next accounting period. It is current asset.

Outstanding expenses - Payment for expenses not made in an accounting period the benefit of
which accrues in same accounting period. It is current Liability.

Advance Received – It is an amount received by company from customers for which goods or
services have not been provided. It is current liability

Bad Debts – Debts owed to company which are considered to be irrecoverable. It is a loss to the
company & shown under selling & distribution expenses

Bank Overdraft – It is a limit specified by bank upto which company can have negative
balance. Bank charges interest on negative balance on day basis

Provision – An amount written off or retained by way of providing for:

a) Depreciation or
b) Diminution in value of asset or
c) Known liability amount of which cannot be determined with substantial accuracy

Double Entry Book keeping System –

• Every business transaction has a two fold effect & therefore in each transaction
there are 2 parties or accounts
• Following are main principles of Double entry book keeping system:
• Every account has 2 sides
• One account is receiver of benefit
• Other is giver of benefit
• Both personal & impersonal aspects of a transaction are recorded
• One aspect is debited & other aspect is credited. Hence the debits in total are
equal to credits in total
• Helps in checking arithmetical accuracy of books maintained as every debit has a
credit of equal amount
• Errors & frauds can be detected
• Comparison between the accounts (head of account) of any years can be made