Accounting

• Accounting is the process of recording and summarizing financial information in a useful way.
Components of Accounting
• Accounting consists of 2 parts:
1. Book-keeping
2. Analysis
• Book-keeping, which is also known as financial accounting, is the process of recording and
summarizing financial information. Book-keeping involves the recording of transactions (e.g.
sales, purchases, and expenses) which are then summarized and presented in the form of
financial statements which show the overall health of the business.
Book-keeping helps to organize the financial data which helps the effective management of the
business by providing key information such as:
• How much they owe to suppliers, tax authorities, banks, employees and others?
• How much each customer owes the business?
• How much capital is invested by the owners in the business?
• How profitable is the business?
• Bookkeeping is the backbone of an accounting system and forms the basis of analysis in
management accounting.
 Users of Accounting
• Internal Users of Accounting
• Internal users are the primary users of accounting.
• Following are the 3 types of internal users and their information needs:
• Owners
• Owners need to assess how well their business is performing.
• Financial statements provide information to owners about the profitability of the overall business as well as individual
products and geographic segments.
• Owners are also interested in knowing how risky their business is.
• Accounting information helps owners in assessing the level of stability in business over the years and to what extent have changes
in economic factors affected the bottom line of the business.
• Such information helps owners to decide if they should invest any further in the business or if they should use their financial
resources elsewhere in more promising business ventures.
• Managers
• Managers need accounting information to plan, monitor and make business decisions.
• Managers need to allocate the financial, human and capital resources towards competing needs of the business through the
budgeting process.
• Preparing and monitoring budgets effectively requires reliable accounting data relating to the various activities, processes,
products, services, segments and departments of the business.
• Management requires accounting information to monitor the performance of business by comparison against past performance,
competitor analysis, key performance indicators and industry benchmarks.
• Managers rely on accounting data to form their business decisions such as investment, financing and pricing decisions.
• In case of investment decisions for example, managers would require the return on investment calculation of a proposed project
supported by reliable estimates of the costs and revenues.
• Employees
• For the employees operating in the finance department, using
accounting information is usually part of their job description. This
includes for example preparing and reviewing various financial
reports such as financial statements.
• Employees are interested in knowing how well a company is
performing as it could have implications for their job security and
income.
• Many employees review accounting information in the annual report
just to get a better understanding of the company’s business.
• In recent years, the increase in number of shares and share options
schemes for employees particularly in startups has fostered a greater
level of interest in accounting information by employees.
• Moreover, potential employees are also interested to learn about the
financial health of the organization they aspire to join in the future.
• External Users of Accounting
• External users are the secondary users of accounting.
• Following are the 8 types of external users and their information needs:
• Investors
• Investors need to know how well their investment is performing. Investors primarily rely on the
financial statements published by companies to assess the profitability, valuation and risk of their
investment.
• Investors use accounting information to determine whether an investment is a good fit for their
portfolio and whether they should hold, increase or decrease their investment.
• Lendors
• Lenders use accounting information of borrowers to assess their credit worthiness, i.e. their
ability to pay back any loan.
• Lenders offer loans and other credit facilities on terms that are based on the assessment of
financial health of borrowers.
• Good financial health is indicated by the borrower’s ability to pay its liabilities on time, high
profitability, substantial securable assets and liquidity.
• Poor liquidity, low profitability, lack of assets that can be secured and an inability to pay liabilities
on time demonstrate poor financial health of borrowers.
• On a lighter note, borrowers can only get a loan from lenders if they can prove that they don’t
need the money.
• Suppliers
• Just like lenders, suppliers need accounting information to assess the
credit-worthiness of its customers before offering goods and services on
credit.
• Some suppliers only have a handful of customers. These customers could
be very large businesses themselves. Suppliers need accounting
information of its key customers to assess whether their business is in good
health which is necessary for sustainable business growth.
• Customers
• Most consumers don’t care about the financial information of its suppliers.
• Industrial consumers however need accounting information about its
suppliers in order to assess whether they have the required resources that
are necessary for a steady supply of goods or services in the future.
Continuity in supply of quality inputs is essential for any business.
• Tax Authorities
• Tax authorities determine whether a business declared the correct amount of tax in its tax returns.
• Occasionally, tax authorities conduct audits of the tax returns filed by businesses in order to verify the
information with the underlying accounting records.
• Tax authorities also cross reference accounting information of suppliers and consumers in order to identify
potential tax evaders.
• Government
• Government ensures that a company's disclosure of accounting information is in accordance with the
regulations that are in place to protect the interest of various stakeholders who rely on such information in
forming their decisions.
• Government defines and monitors accounting thresholds such as sales revenue and net profit to determine
the size of each business for the purpose of ensuring that it complies with the relevant employee, consumer
and safety regulations.
• Auditors
• External auditors examine the financial statements and the underlying accounting record of businesses in
order to form an audit opinion.
• Investors and other stakeholders rely on the independent opinion of external auditors on the accuracy of
financial statements.
• Public
• General public may also be interested in accounting information of a company. These could include
journalists, analysts, academics, activists and individuals with an interest in economic developments.
 What are Financial Statements?
• Financial Statements represent a formal record of the financial activities of an entity. These are written reports that quantify the
financial strength, performance and liquidity of a company. Financial Statements reflect the financial effects of business
transactions and events on the entity. The four main types of financial statements are:
Statement of Financial Position
• Statement of Financial Position, also known as the Balance Sheet, presents the financial position of an entity at a given date. It is
comprised of the following three elements:
• Assets: Something a business owns or controls (e.g. cash, inventory, plant and machinery, etc)
• Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)
• Equity: What the business owes to its owners. This represents the amount of capital that remains in the business after its assets
are used to pay off its outstanding liabilities. Equity therefore represents the difference between the assets and liabilities.

Income Statement
• Income Statement, also known as the Profit and Loss Statement, reports the company's financial performance in terms of net
profit or loss over a specified period. Income Statement is composed of the following two elements:
• Income: What the business has earned over a period (e.g. sales revenue, dividend income, etc)
• Expense: The cost incurred by the business over a period (e.g. salaries and wages, depreciation, rental charges, etc)
• Net profit or loss is arrived by deducting expenses from income.
 Cash Flow Statement
• Cash Flow Statement, presents the movement in cash and bank balances over a period.
The movement in cash flows is classified into the following segments:
• Operating Activities: Represents the cash flow from primary activities of a business.
• Investing Activities: Represents cash flow from the purchase and sale of assets other
than inventories (e.g. purchase of a factory plant)
• Financing Activities: Represents cash flow generated or spent on raising and repaying
share capital and debt together with the payments of interest and dividends.
Statement of Changes in Equity
• Statement of Changes in Equity, also known as the Statement of Retained Earnings,
details the movement in owners' equity over a period. The movement in owners' equity
is derived from the following components:
• Net Profit or loss during the period as reported in the income statement
• Share capital issued or repaid during the period
• Dividend payments
• Gains or losses recognized directly in equity (e.g. revaluation surpluses)
• Effects of a change in accounting policy or correction of accounting error
• Transaction: An accounting transaction is a business event having a
monetary impact on the financial statements of a business.
• Journal: In accounting and bookkeeping, a journal is a record of financial
transactions in order by date. A journal is often defined as the book of
original entry.
• Ledger: A ledger account contains a record of business transactions. It is a
separate record within the general ledger that is assigned to a specific
asset, liability, equity item, revenue type, or expense type. Information is
stored in a ledger account with beginning and ending balances, which are
adjusted during an accounting period with debits and credits.
• Trail Balance: Trial Balance is a list of closing balances of ledger
accounts on a certain date and is the first step towards the preparation of
financial statements. It is usually prepared at the end of
an accounting period to assist in the drafting of financial statements.
• Purpose of a Trial Balance
• Trial Balance acts as the first step in the preparation of financial
statements. It is a working paper that accountants use as a basis while
preparing financial statements.
• Trial balance ensures that for every debit entry recorded, a
corresponding credit entry has been recorded in the books in
accordance with the double entry concept of accounting. If the totals
of the trial balance do not agree, the differences may be investigated
and resolved before financial statements are prepared. Rectifying
basic accounting errors can be a much lengthy task after the financial
statements have been prepared because of the changes that would
be required to correct the financial statements.
• Trial balance ensures that the account balances are accurately
extracted from accounting ledgers.
• Trail balance assists in the identification and rectification of errors.
• Adjusting Entries: An adjusting journal entry is an adjustment recorded at
the end of an accounting period to an asset or liability account and related
expense or income accounts to record business events that occurred in the
period but were not recorded.
• Adjusted Trail Balance: An adjusted trial balance is a listing of all the
account titles and balances contained in the general ledger after
the adjusting entries for an accounting period have been posted to
the accounts. The adjusted trial balance is an internal document and is not
a financial statement. The purpose of the adjusted trial balance is to be
certain that the total amount of debit balances in the general ledger equals
the total amount of credit balances.
• Owner’s Equity Statement: A Statement of Owner's Equity (SOE) shows the
owner's capital at the start of the period, the changes that affect capital,
and the resulting capital at the end of the period. It is also known as
"Statement of Changes in Owner's Equity". The amount of owner's equity is
increased by income and owner contributions. The balance is decreased by
losses and owner draws.
• Closing Entries: Closing entries, also called closing journal entries, are
entries made at the end of an accounting period to zero out all
temporary accounts and transfer their balances to permanent
accounts.
• After Closing Trial balance: The post closing trial balance is a list of
all accounts and their balances after the closing entries have been
journalized and posted to the ledger. In other words, the post closing
trial balance is a list of accounts or permanent accounts that still
have balances after the closing entries have been made.
• Bank Reconciliation: A bank reconciliation is the process of matching
the balances in an entity's accounting records for a cash account to
the corresponding information on a bank statement. The goal of this
process is to determine the differences between the two, and to book
changes to the accounting records as appropriate.
• Worksheet: An accounting worksheet is a spreadsheet used to
prepare accounting information and reports. Accounting
worksheets are most often used in the accounting cycle process to
draft an unadjusted trial balance, adjusting journal entries, adjusted
trial balance, and financial statements.
 Accounting Concepts
Business Entity Concept: The business and its owner(s) are two separate existence
entity. Any private and personal incomes and expenses of the owner(s) should not
be treated as the incomes and expenses of the business.
Going Concern Concept: It is assumed that the entity is a going concern, i.e., it will
continue to operate for an indefinitely long period in future and transactions are
recorded from this point of view.
Money Measurement Concept: In accounting, a record is made only of those
transactions or events which can be measured and expressed in terms of money.
Accounting Period Concept: For measuring the financial results of a business
periodically, the working life of an enterprise is split into suitable short periods
called accounting period.
Cost Concept: An asset acquired by a concern is recorded in the books of account
sat historical cost (i.e., at the price actually paid for acquiring the asset). The market
price of the asset is ignored.
Dual Aspect Concept: For Every Debit, there is a Credit. Every transaction should
have a two- sided effect to the level of same amount. This Concept has resulted in
the accounting equation.
 Accounting Concepts
Realization Concept: Profit is earned when goods or services are
provided/transferred to customers. Thus it is incorrect to record profit when
order is received, or when the customer pays for the goods.
Matching Concept: The matching principle ensures that revenues and all
their associated expenses are recorded in the same accounting period. The
matching principle is the basis on which the accrual accounting method of
book- keeping is built.
Accounting Conventions: Accounting Conventions are the common practices
which are universally followed in recording and presenting accounting
information of business. It helps in comparing accounting data of different
business or of same units for different periods.
Materiality: Only those transactions, important facts and items are shown
which are useful and material for the business. The firm need not record
immaterial and insignificant items.
Full Disclourse: Financial Statements and their notes should present all
information that is relevant and material to the user’s understanding of the
statements.
 Accounting Concepts
Conservatism: Anticipate No Profits but Provide for all Losses.
Accountant should always be on side of safety.
Consistency: The accounting practices and methods should remain
consistent from one accounting period to another. Whatever
accounting practice is followed by the business enterprise, should be
followed on a consistent basis from year to year.