Accounting is the essential part of business, as it keeps the proper records of business transactions.
After studying the chapter, you will be able to: Explain the Accounting alongwith its objectives.
Explain the advantages & limitations of accounting.
Explain the users of accounting information and their needs.
Explain the basic accounting terms.
Suggested Teaching Method:
Meaning of Accounting
Accounting is an information system that provides accounting information to the users for correct decision-making.
“Accounting is the art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof..” Objectives of Accounting
1. To maintain systematic and complete record of business transactions.
2. To know profitabilities of business by calculating profit or loss.
3. To ascertain the Financial position of business.
4. To provide useful information to various users.
Interested users/parties of Accountings informations and their Needs There are number of users interested in knowing about the financial soundness and the profitability of the business.
Users Classification Information the user want Internal
1. Owner Return on their investment, financial health of their company/business.
2. Management To evaluate the performance to take various decisions.
External 1. Investors and Safety and growth of their investments, potential investors future of the business.
2. Creditors Assessing the financial capability, ability of the business to pay its debts.
3. Lenders Repaying capacity, credit worthiness.
4. Tax Authorities Assessment of due taxes, true and fair disclosure of accounting information,
5. Employees Profitability to claim higher wages and bonus, whether their dues (PF, ESI, etc.) deposited regularly.
6. Others Customers, Researchers etc., may seek different information for different
Qualitative Characteristics of Accounting Information Accounting information is useful for interested users only if it posses the following characteristics:
1. Realiability : Means the information must be based on facts and be verified through source documents by anyone. It must be free from bias.
2. Relevance : To be relevant, information must be available in time and must influence the decisions of users by helping them form prediction about the outcomes.
3. Understandability: The information should be presented in such a manner that users can understand it well.
4. Comparability: The information should be disclosed in such a manner that it can be compared with previous years figures of business itself and other firm’s data.
Limitations of Accounting
The accounting information suffers from the following limitations: 1. Based on historical data
2. Not free from bias
3. Qualitative information not shown
4. Ignores price level changes
5. Window Dressing
BASIC ACCOUNTING TERMS
An economic activity that affects financial position of the business and can be measured in terms of money e.g., sale of goods, paying for expenses etc.
The documentary evidence in support of a transaction is known as voucher.
For example, if we buy goods for cash we get cash memo, if we buy on credit, we get an invoice, when we make a payment, we get a receipt and so on.
Amount invested by the owner in the firm is known as capital. It may be brought in the form of cash or assets by the owner.
The money or goods or both withdrawn by owner from business for personal use, is known as drawings. Example: Purchase of car for wife by withdrawing money from business.
Assets are valuable and economic resources of an enterprise useful in its operations. Assets can be broadly classified as :
1. Current Assets : Current Assets are those assets which are held for short period and can be converted into cash within one year. For example: Debtors, stock etc.
2. Non-Current Assets : Non-Current Assets are those assets which are hold for long period and used for normal business operation. For example: Land, Building, Machinery etc.
3. Tangible Assets : Tangible Assets are those assets which have physical existence and can be seen and touched. For Example: Furniture, Machinery etc.
4. Intangible Assets : Intangible Assets are those assets which have no physical existence and can be feel by operation. For example: Goodwill, Patent, Trade mark etc.
Liabilities are obligations or debts that an enterprise has to pay after some time in the future.
Liabilities can be classified as :
1. Current Liabilities : Current Liabilities are obligations or debts that are payable within a period of one year. For Example: Creditors, Bill Payable etc.
2. Non-Current Liabilities : Non-Current Liabilities are those obligations or debts that are payable after a period of one year. Example: Bank Loan, Debentures etc.
1. Revenue Receipts : Revenue Receipts are those receipts which are occurred by normal operation of business like money received by sale of business products.
2. Capital Receipts : Capital Receipts are those receipts which are occurred by other than business operations like money received by sale of fixed assets.
Costs incurred by a business for earning revenue are known as expenses.
For example: Rent, Wages, Salaries, Interest etc.
Spending money or incurring a liability for acquiring assets, goods or services is called expenditure. The expenditure is classified as :
1. Revenue Expenditure : If the benefit of expenditure is received within a year, it is called revenue expenditure. For Example: Rent, Interest etc.
2. Capital Expenditure : If benefit of expenditure is received for more than one year, it is called capital expenditure. Example: Purchase of Machinery.
3. Deferred Revenue Expenditure : There are certain expenditures which are revenue in nature but benefit of which is derived over number of years. For Example: Huge Advertisement Expenditure.
The excess of revenues over its related expenses during an accounting year is profit.
Profit = Revenue – Expenses
A non-recurring profit from events or transactions incidental to business such as sale of fixed assets, appreciation in the value of an asset etc.
The excess of expenses of a period over its related revenues is termed as loss.
Loss = Expenses – Revenue
The products in which the business deal in. The items that are purchased for the purpose of resale and not for use in the business are called goods.
The term purchases is used only for the goods procured by a business for resale. In case of trading concerns it is purchase of final goods and in manufacturing concern it is purchase of raw materials. Purchases may be cash purchases or credit purchases.
When purchased goods are returned to the suppliers, these are known as purchase return.
Sales are total revenues from goods sold or services provided to customers.
Sales may be cash sales or credit sales.
When sold goods are returned from customer due to any reason is known as sales return.
Debtors are persons and/or other entities to whom business has sold goods and services on credit and amount has not received yet. These are assets of the business.
If the business buys goods/services on credit and amount is still to be paid to the persons and/or other entities, these are called creditors. These are liabilities for the business.
Bill Receivable is an accounting term of Bill of Exchange. A Bill of Exchange is Bill Receivable for seller at time of credit sale.
Bill Payable is also an accounting term of Bill of Exchange. A Bill of Exchange is Bill Payable for purchaser at time of credit purchase.
Discount is the rebate given by the seller to the buyer. It can be classified as :
1. Trade Discount : The purpose of this discount is to persuade the buyer to buy more goods. It is offered at an agreed percentage of list price at the time of selling goods. This discount is not recorded in the accounting books as it is deducted in the invoice/cash memo.
2. Cash Discount : The objective of providing cash discount is to encourage the debtors to pay the dues promptly. This discount is recorded in the accounting books.
Account refers to a summarised record of relevant transactions of particular head at one place.
Income is a wider term, which includes profit also. Income means increase in the wealth of the enterprise over a period of time.
The goods available with the business for sale on a particular date is known as stock.
Cost refers to expenditures incurred in acquiring manufacturing and processing goods to make it saleable.