Basics of Accountancy
What is Accounting ?
Accounting as an information system is the process of identifying, measuring and communicating the economic information of an organization to its users who need the information for decision making.
A Bird Eye View :
Activities of accounting
Identifying Measuring Recording Classifying
Summarising Analysing
Accountancy, Accounting and Book keeping
Accountancy : It refers to a systematic knowledge of accounting. It explains ‘why to do’ and ‘how to do’ of various aspects of accounting. It tells us why and how to prepare the books of accounts and how to summarise the accounting information and communicate it to the interested parties.
Accounting : It refers to the actual process of preparing and presenting the accounts. In other words it covers the following :
› Identifying the transactions and events
› Measuring the identified transactions and events
› Recording the identified and measured transactions and events in journal
› Classifying the recorded transactions and events in the ledger
› Summarizing the classified transactions and events in the form of income statement and position statement ( Balance Sheet)
› Analyzing the summarized data
› Interpreting the analysed data.
Book Keeping : It is a part of accounting and is concerned with record keeping or maintenance of books of accounting which is often routine and clerical in nature. It covers following activities :
› Identifying the transactions and events
› Measuring the identified transactions and events
› Recording the identified and measured transactions and events in journal
› Classifying the recorded transactions and events in the ledger
Difference between Accounting and Book keeping
S.No.
Basis
Book keeping
Accounting
1
Meaning
Define
Define
2
Stage
It is a primary stage
It is the secondary stage
3
Objective
To maintain systematic records of financial transactions
To ascertain net results of operations and financial position and to communicate.
4
Who does
It is performed by junior staff
It is performed by senior staff
5
Knowledge required
Higher level of knowledge is not required
Higher level of knowledge is required
6
Analytical skills
May or may not possess analytical skill
Required to possess analytical skills
7
Nature of job
Job is more of routine nature
It is more of analytical and not of routine nature
8
Supervision
Book keeper does not check the work of accountant
An accountant checks the work of a book keeper
What are the main objectives of accounting
Main objectives are as follows :
› To maintain accounting records
› To calculate the results of operations
› To ascertain the financial position
› To communicate the information to the users
Advantages of accounting :
Facilitates to replace memory
Facilitate to comply with the legal requirements
Facilitates to ascertain net result of operations
Facilitates to ascertain the financial position
Facilitates the users to take decisions
Facilitates a comparative study
Assists the management
Facilitates control over assets
Facilitates raising of loans
Acts as legal evidence
Limitations of Accounting :
› Ignores the qualitative elements of transactions
› Not free from bias
› Statements prepared on historical cost basis ignores the price level changes
› Possibilities of window dressing.
Branches of Accounting
Financial Cost Management
Accounting Accounting Accounting
Generally Accepted Accounting Principles
Meaning : Those rules of action which are derived from experience and practice and when they prove useful they become accepted as principles of accounting.
Basic Assumptions of Accounting
1. Accounting Entity assumption :
As per this assumption a business is treated as a different entity i.e. different from its owners. For example legally a proprietor and his business are one and the same but for the purpose of accounting they are treated as separate from each other.
2. Money Measurement Assumption :
As per this assumption only those transactions are recorded which can be expressed in terms of money. In other words the transactions which cannot be expressed in monetary terms cannot be recorded.
For example a firm is suffering financially because of inefficiency of a sales manager but this inefficiency cannot be recorded.
3. Accounting period Assumption :
As per this assumption the life of an enterprise is divided into different periods which are called as accounting periods. These periods are known as accounting periods. At the end of these periods enterprise prepare there financial statements including income and position statements.
4. Going Concern Assumption :
As per this assumption an enterprise is normally considered as going concern in other words it is assumed that there is no intention or expectation of liquidation of the firm in foreseeable future.
That is why assets are divided into current and fixed assets and liabilities are divided into short term and long term liabilities.
Basic Principles of Accounting
These are the guidelines which states that how transactions should be recorded and reported. Following are the principles :
1. Duality Principle : This principle says that every transaction has two parts one for debit and another for credit. That is the reason the book keeping is also termed as double entry book keeping.
2. Revenue recognition principle : Here the term revenue means to include total inflow of cash, receivables arising in ordinary course of business. It excludes the amount received on behalf of third parties like collection of taxes etc.
As per this principle revenue is recognized in the period in which it is earned irrespective of the fact whether it is received or not during that period.
3. Matching Principle : As per this principle only those expenses are to be recorded which are matching with the revenue of that particular period. In simple words all those expenses are to be recorded which have been incurred to achieve the sales of that particular accounting period. This principle is based on the accrual concept in which time of inflow or outflow is not considered, it consider that when a revenue or cost has been incurred.
Here one point is to be noted that every expense cannot be perfectly correlated to the revenue in that case the accounting period of occurrence of that revenue of expense has to taken care of.
4. Full Disclosure Principle : Every financial statement which is prepared is prepared with a main purpose of conveying information to all those who are interested in that enterprise or in other words for all those stake holders who have some interest in the organization. As per this principle the financial statements should disclose and not hide the information. The disclosure should be full and adequate enough so that whosoever using it can take right decisions and can draw appropriate.
5. Historical Principle : As per this principle any asset which is recorded in the books of accounts has to be recorded on the price on which it was acquired. This cost becomes basis for recording the value of asset in the books of accounts. That means if an asset is acquired by paying nothing than it will not be recorded in the books.
One point here is to note that an asset will always not be recorded on cost it will be proportionately reduced by the amount of depreciation throughout its life.
Modifying Principles of Accounting
Till now we have discussed the assumptions and basic principles of accounting, in order to provide more useful information these have been modified and following principles have been derived :
1. Materiality Principle : As per this principle any item which has an insignificant effect need not to be recorded or disclosed, in a way it is an exception to the principle of disclosure. According to American Accounting Association “ An item should be regarded as material if there is any reason to believe that knowledge of it would affect the decision of informed investors.”
In other words according to this principle there is no need to record immaterial items because their recording wastes time and money.
2. Principle of Consistency : In every business organization some methods are adopted to record the business transactions, as per this principle same method of accounting should be adopted year after year, in other words the change of principles or methods should be avoided by every enterprise because in case methods get changed the comparison would not be possible in two accounting periods.
3. Principle of timeliness : As per this principle the business transactions should be recorded at proper time so that the complete information can be prepared in time and can be supplied to the managers at the earliest possible, so that their usefulness can be maintained.
Even the final accounts should be prepared as early as possible after the end of every accounting period.
4. Conservatism Principle : This principle is to ‘provide for all probable losses an but not to anticipate any gains’. Provision for bad debts is created to meet any loss which may occur because of any sort of bad debt in future. Another example can be taken of investment fluctuation fund which is created against investments.
In other words profits should not be recorded even if they are expected but provision for all losses should be made in advance so that they are not underestimated.
What is Accounting ?
Accounting as an information system is the process of identifying, measuring and communicating the economic information of an organization to its users who need the information for decision making.
A Bird Eye View :
Activities of accounting
Identifying Measuring Recording Classifying
Summarising Analysing
Accountancy, Accounting and Book keeping
Accountancy : It refers to a systematic knowledge of accounting. It explains ‘why to do’ and ‘how to do’ of various aspects of accounting. It tells us why and how to prepare the books of accounts and how to summarise the accounting information and communicate it to the interested parties.
Accounting : It refers to the actual process of preparing and presenting the accounts. In other words it covers the following :
› Identifying the transactions and events
› Measuring the identified transactions and events
› Recording the identified and measured transactions and events in journal
› Classifying the recorded transactions and events in the ledger
› Summarizing the classified transactions and events in the form of income statement and position statement ( Balance Sheet)
› Analyzing the summarized data
› Interpreting the analysed data.
Book Keeping : It is a part of accounting and is concerned with record keeping or maintenance of books of accounting which is often routine and clerical in nature. It covers following activities :
› Identifying the transactions and events
› Measuring the identified transactions and events
› Recording the identified and measured transactions and events in journal
› Classifying the recorded transactions and events in the ledger
Difference between Accounting and Book keeping
S.No.
Basis
Book keeping
Accounting
1
Meaning
Define
Define
2
Stage
It is a primary stage
It is the secondary stage
3
Objective
To maintain systematic records of financial transactions
To ascertain net results of operations and financial position and to communicate.
4
Who does
It is performed by junior staff
It is performed by senior staff
5
Knowledge required
Higher level of knowledge is not required
Higher level of knowledge is required
6
Analytical skills
May or may not possess analytical skill
Required to possess analytical skills
7
Nature of job
Job is more of routine nature
It is more of analytical and not of routine nature
8
Supervision
Book keeper does not check the work of accountant
An accountant checks the work of a book keeper
What are the main objectives of accounting
Main objectives are as follows :
› To maintain accounting records
› To calculate the results of operations
› To ascertain the financial position
› To communicate the information to the users
Advantages of accounting :
Facilitates to replace memory
Facilitate to comply with the legal requirements
Facilitates to ascertain net result of operations
Facilitates to ascertain the financial position
Facilitates the users to take decisions
Facilitates a comparative study
Assists the management
Facilitates control over assets
Facilitates raising of loans
Acts as legal evidence
Limitations of Accounting :
› Ignores the qualitative elements of transactions
› Not free from bias
› Statements prepared on historical cost basis ignores the price level changes
› Possibilities of window dressing.
Branches of Accounting
Financial Cost Management
Accounting Accounting Accounting
Generally Accepted Accounting Principles
Meaning : Those rules of action which are derived from experience and practice and when they prove useful they become accepted as principles of accounting.
Basic Assumptions of Accounting
1. Accounting Entity assumption :
As per this assumption a business is treated as a different entity i.e. different from its owners. For example legally a proprietor and his business are one and the same but for the purpose of accounting they are treated as separate from each other.
2. Money Measurement Assumption :
As per this assumption only those transactions are recorded which can be expressed in terms of money. In other words the transactions which cannot be expressed in monetary terms cannot be recorded.
For example a firm is suffering financially because of inefficiency of a sales manager but this inefficiency cannot be recorded.
3. Accounting period Assumption :
As per this assumption the life of an enterprise is divided into different periods which are called as accounting periods. These periods are known as accounting periods. At the end of these periods enterprise prepare there financial statements including income and position statements.
4. Going Concern Assumption :
As per this assumption an enterprise is normally considered as going concern in other words it is assumed that there is no intention or expectation of liquidation of the firm in foreseeable future.
That is why assets are divided into current and fixed assets and liabilities are divided into short term and long term liabilities.
Basic Principles of Accounting
These are the guidelines which states that how transactions should be recorded and reported. Following are the principles :
1. Duality Principle : This principle says that every transaction has two parts one for debit and another for credit. That is the reason the book keeping is also termed as double entry book keeping.
2. Revenue recognition principle : Here the term revenue means to include total inflow of cash, receivables arising in ordinary course of business. It excludes the amount received on behalf of third parties like collection of taxes etc.
As per this principle revenue is recognized in the period in which it is earned irrespective of the fact whether it is received or not during that period.
3. Matching Principle : As per this principle only those expenses are to be recorded which are matching with the revenue of that particular period. In simple words all those expenses are to be recorded which have been incurred to achieve the sales of that particular accounting period. This principle is based on the accrual concept in which time of inflow or outflow is not considered, it consider that when a revenue or cost has been incurred.
Here one point is to be noted that every expense cannot be perfectly correlated to the revenue in that case the accounting period of occurrence of that revenue of expense has to taken care of.
4. Full Disclosure Principle : Every financial statement which is prepared is prepared with a main purpose of conveying information to all those who are interested in that enterprise or in other words for all those stake holders who have some interest in the organization. As per this principle the financial statements should disclose and not hide the information. The disclosure should be full and adequate enough so that whosoever using it can take right decisions and can draw appropriate.
5. Historical Principle : As per this principle any asset which is recorded in the books of accounts has to be recorded on the price on which it was acquired. This cost becomes basis for recording the value of asset in the books of accounts. That means if an asset is acquired by paying nothing than it will not be recorded in the books.
One point here is to note that an asset will always not be recorded on cost it will be proportionately reduced by the amount of depreciation throughout its life.
Modifying Principles of Accounting
Till now we have discussed the assumptions and basic principles of accounting, in order to provide more useful information these have been modified and following principles have been derived :
1. Materiality Principle : As per this principle any item which has an insignificant effect need not to be recorded or disclosed, in a way it is an exception to the principle of disclosure. According to American Accounting Association “ An item should be regarded as material if there is any reason to believe that knowledge of it would affect the decision of informed investors.”
In other words according to this principle there is no need to record immaterial items because their recording wastes time and money.
2. Principle of Consistency : In every business organization some methods are adopted to record the business transactions, as per this principle same method of accounting should be adopted year after year, in other words the change of principles or methods should be avoided by every enterprise because in case methods get changed the comparison would not be possible in two accounting periods.
3. Principle of timeliness : As per this principle the business transactions should be recorded at proper time so that the complete information can be prepared in time and can be supplied to the managers at the earliest possible, so that their usefulness can be maintained.
Even the final accounts should be prepared as early as possible after the end of every accounting period.
4. Conservatism Principle : This principle is to ‘provide for all probable losses an but not to anticipate any gains’. Provision for bad debts is created to meet any loss which may occur because of any sort of bad debt in future. Another example can be taken of investment fluctuation fund which is created against investments.
In other words profits should not be recorded even if they are expected but provision for all losses should be made in advance so that they are not underestimated.
Student of Rai Business School-New Delhi
Sanjeev Kumar Singh
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