Introduction
This chapter lays the foundation for understanding the essential role accounting plays in the success of any business. We'll delve into the very definition and purpose of accounting, exploring why it's considered the "language of business."
This chapter carries a weightage of 6%, highlighting its significance in your overall understanding of accounting. So, buckle up and get ready to unlock the secrets behind the scenes of any successful business venture!
This chapter lays the foundation for understanding the essential role accounting plays in the success of any business. We'll delve into the very definition and purpose of accounting, exploring why it's considered the "language of business."
LEARNING OBJECTIVES After studying this chapter you will be able to: - state the meaning and need of accounting;
- discuss accounting as a source of information
- identify the internal and external users of accounting information
- explain the objectives of accounting
- describe the role of accounting
- explain the basic terms used in accounting.
Chapter Weightage
CA: 06 Score
AFS: 08 Score
What is
Accounting?
Accounting is a
systematic way of identifying, recording, classifying, summarizing,
interpreting, and communicating financial information to people who need it.
Think of it as the "language of business."
According to
the American Institute of Certified Public Accountants (AICPA), accounting
is an art of recording, classifying, and summarizing financial transactions and
events in terms of money, and then interpreting the results.
Who is the
Father of Accounting?: Luca Pacioli is known as the Father of Accounting.
NATURE OF
ACCOUNTING:
- Economic Event: These are transactions that
can be measured in money.
·
Internal event: Transactions happening inside
the organization (e.g., raw materials used in production).
·
External event: Transactions between the
organization and an outsider (e.g., selling goods to a customer).
- Identification: Deciding which events are
financial and relate to the organization, so they can be recorded.
- Recording: Writing down financial
transactions in books in money terms and in date order.
- Classifying: Grouping similar transactions
together in one place (e.g., all sales transactions).
- Summarizing: Presenting the classified
information in an understandable way that is useful for users. This
includes preparing reports like the Trading Account, Profit and Loss
Account, and Balance Sheet.
- Organization: This refers to the business
entity itself, which can be for profit or not-for-profit. It can be a sole
proprietorship, partnership, or company.
- Interested Users of Information:
·
Internal Users: Owners, Shareholders,
Employees, Management.
·
External Users: Creditors, Suppliers, Tax
Authority, Stock Exchange, Business Analyst, Bank, Investors, Government.
BRANCHES OF
ACCOUNTING:
- Financial Accounting: Helps to find out the
profit and loss of a business by keeping systematic records of
transactions. It usually deals with past events.
- Cost Accounting: Focuses on finding out the
cost of a product or service. It helps in setting the price of products.
- Management Accounting: Provides information
to the management for making important decisions. It uses information from
both financial and cost accounting.
QUALITATIVE
CHARACTERISTICS OF ACCOUNTING INFORMATION:
- Reliability: Accounting information must be
trustworthy, free from errors, and unbiased.
- Relevance: The information should be
available on time, accurate, and complete to be useful for
decision-making.
- Understandability: Accounting information
should be easy for all users to understand.
- Comparability: Financial reports should be
comparable over different periods and between different businesses.
OBJECTIVES OF
ACCOUNTING:
- Maintenance of Business Records: Keeping a
systematic record of all financial transactions.
- Calculation of Profit and Loss: Determining
if the business made a profit or loss by comparing income and expenses.
- Profit = Income - Expense
- Loss = Expense - Income
- To Find Financial Position: Preparing a
Balance Sheet to show the financial health of the business.
- Providing Accounting Information to Users:
Presenting accounting information in various forms like reports,
statements, charts, and graphs.
BASIC TERMS IN
ACCOUNTING:
- Entity: Refers to a business unit that has
its own individual existence.
- Business Entity: A specifically identifiable
business unit.
- Transactions: All economic events in a
business. Examples include purchasing goods, receiving cash, or paying
creditors. Transactions can be cash transactions or credit transactions.
- Assets: These are properties or things of
value owned by the business, which are used for generating profit.
·
Fixed Assets/Non-Current Assets: Assets
used for a long period (more than one year), like machinery, land, building,
furniture.
o Tangible
Assets: Assets with a physical shape and existence (e.g., building,
machinery).
o Intangible
Assets: Assets that have no physical existence but are represented by
rights (e.g., goodwill, trademark, patent, copyright).
o Wasting
Assets: Natural resources that reduce in value as they are used (e.g., oil
wells, mines).
- Current Assets: Assets that can be
converted into cash within a short period (usually one year). Examples
include cash, bank balance, stock, bills receivables, debtors.
- Liabilities: These are obligations or debts
that the business has to pay in the future.
·
Long-Term/Non-Current Liabilities:
Obligations payable after a period of one year (e.g., long-term loans,
debentures).
·
Short-Term/Current Liabilities:
Obligations payable within one year (e.g., creditors, bank overdraft, bills
payable, short-term loans, tax payable).
- Capital: The amount of money or assets
invested in the business by its owners. It is also called owner's equity
or net worth.
- Sales: The total revenue earned from selling
goods or providing services to customers. This can be cash sales or credit
sales.
- Revenues: Amounts earned by selling products
or through other means. Also called income. Examples include sales
revenue, commission received, interest received, dividend received, rent
received.
- Expenses: Amounts spent by a business to
earn revenue. Examples include depreciation, rent, wages, salaries,
interest, cost of light and water, telephone.
- Profit: When revenue is more than expenses
during an accounting period. Profit increases the owner's capital.
- Loss: When expenses are more than revenue
during an accounting period. Loss decreases the owner's capital. It can
also include money or goods lost without earning benefits (e.g., theft,
fire).
- Gain: A profit that comes from events or
transactions that are not part of the main business activities (e.g.,
profit from selling a fixed asset, winning a court case).
- Voucher (Source Document): The documentary
evidence that supports a transaction (e.g., cash memo, invoice, receipt).
- Goods: The products in which a business
trades. Items purchased for use in the business (like machinery for
production) are generally not called goods.
- Drawings: When the owner takes money or
goods from the business for their personal use. Drawings reduce the amount
of capital.
- Purchases: The total amount of goods bought
by a business, either for cash or on credit, that are meant for resale.
·
Purchase Return: Returning goods that
were previously purchased to the suppliers.
- Stock (Inventory): The value of unsold goods
lying with a business on a particular date.
·
Closing Stock: Stock at the end of the
accounting period.
·
Opening Stock: Stock at the beginning of
the accounting period.
- Debtor: A person who owes money to the
business. The total amount owed by various debtors is called sundry
debtors. Sundry debtors are an asset.
- Creditor: A person to whom the business owes
money. The total amount owed to various creditors is called sundry
creditors. Sundry creditors are a liability.
- Discount: A reduction in the price of goods
sold.
·
Trade Discount: A reduction given at the
time of selling goods to increase sales. It is not recorded in the books
of account.
·
Cash Discount: A reduction allowed by the
creditor to the debtor for making prompt payment. It is a loss for the creditor
and a gain for the debtor, and it is recorded in the books of account.
- Expenditure: Spending money or incurring a
liability to receive some benefit, service, or property.
·
Revenue Expenditure/Expense: Small
amounts that are repetitive and benefit only the current period (e.g., purchase
of goods for sale, salaries, rent).
·
Capital Expenditure: Large amounts that
are not repetitive and provide benefits for more than one year, typically for
acquiring fixed assets (e.g., purchase of buildings, machinery, furniture).
- state the meaning and need of accounting;
- discuss accounting as a source of information
- identify the internal and external users of accounting information
- explain the objectives of accounting
- describe the role of accounting
- explain the basic terms used in accounting.
Chapter Weightage
CA: 06 Score
AFS: 08 Score
What is
Accounting?
Accounting is a
systematic way of identifying, recording, classifying, summarizing,
interpreting, and communicating financial information to people who need it.
Think of it as the "language of business."
According to
the American Institute of Certified Public Accountants (AICPA), accounting
is an art of recording, classifying, and summarizing financial transactions and
events in terms of money, and then interpreting the results.
Who is the Father of Accounting?: Luca Pacioli is known as the Father of Accounting.
NATURE OF
ACCOUNTING:
- Economic Event: These are transactions that
can be measured in money.
·
Internal event: Transactions happening inside
the organization (e.g., raw materials used in production).
·
External event: Transactions between the
organization and an outsider (e.g., selling goods to a customer).
- Identification: Deciding which events are
financial and relate to the organization, so they can be recorded.
- Recording: Writing down financial
transactions in books in money terms and in date order.
- Classifying: Grouping similar transactions
together in one place (e.g., all sales transactions).
- Summarizing: Presenting the classified
information in an understandable way that is useful for users. This
includes preparing reports like the Trading Account, Profit and Loss
Account, and Balance Sheet.
- Organization: This refers to the business
entity itself, which can be for profit or not-for-profit. It can be a sole
proprietorship, partnership, or company.
- Interested Users of Information:
·
Internal Users: Owners, Shareholders,
Employees, Management.
·
External Users: Creditors, Suppliers, Tax
Authority, Stock Exchange, Business Analyst, Bank, Investors, Government.
BRANCHES OF
ACCOUNTING:
- Financial Accounting: Helps to find out the
profit and loss of a business by keeping systematic records of
transactions. It usually deals with past events.
- Cost Accounting: Focuses on finding out the
cost of a product or service. It helps in setting the price of products.
- Management Accounting: Provides information
to the management for making important decisions. It uses information from
both financial and cost accounting.
QUALITATIVE
CHARACTERISTICS OF ACCOUNTING INFORMATION:
- Reliability: Accounting information must be
trustworthy, free from errors, and unbiased.
- Relevance: The information should be
available on time, accurate, and complete to be useful for
decision-making.
- Understandability: Accounting information
should be easy for all users to understand.
- Comparability: Financial reports should be
comparable over different periods and between different businesses.
OBJECTIVES OF
ACCOUNTING:
- Maintenance of Business Records: Keeping a
systematic record of all financial transactions.
- Calculation of Profit and Loss: Determining
if the business made a profit or loss by comparing income and expenses.
- Profit = Income - Expense
- Loss = Expense - Income
- To Find Financial Position: Preparing a
Balance Sheet to show the financial health of the business.
- Providing Accounting Information to Users:
Presenting accounting information in various forms like reports,
statements, charts, and graphs.
BASIC TERMS IN
ACCOUNTING:
- Entity: Refers to a business unit that has
its own individual existence.
- Business Entity: A specifically identifiable
business unit.
- Transactions: All economic events in a
business. Examples include purchasing goods, receiving cash, or paying
creditors. Transactions can be cash transactions or credit transactions.
- Assets: These are properties or things of
value owned by the business, which are used for generating profit.
·
Fixed Assets/Non-Current Assets: Assets
used for a long period (more than one year), like machinery, land, building,
furniture.
o Tangible
Assets: Assets with a physical shape and existence (e.g., building,
machinery).
o Intangible
Assets: Assets that have no physical existence but are represented by
rights (e.g., goodwill, trademark, patent, copyright).
o Wasting
Assets: Natural resources that reduce in value as they are used (e.g., oil
wells, mines).
- Current Assets: Assets that can be
converted into cash within a short period (usually one year). Examples
include cash, bank balance, stock, bills receivables, debtors.
- Liabilities: These are obligations or debts
that the business has to pay in the future.
·
Long-Term/Non-Current Liabilities:
Obligations payable after a period of one year (e.g., long-term loans,
debentures).
·
Short-Term/Current Liabilities:
Obligations payable within one year (e.g., creditors, bank overdraft, bills
payable, short-term loans, tax payable).
- Capital: The amount of money or assets
invested in the business by its owners. It is also called owner's equity
or net worth.
- Sales: The total revenue earned from selling
goods or providing services to customers. This can be cash sales or credit
sales.
- Revenues: Amounts earned by selling products
or through other means. Also called income. Examples include sales
revenue, commission received, interest received, dividend received, rent
received.
- Expenses: Amounts spent by a business to
earn revenue. Examples include depreciation, rent, wages, salaries,
interest, cost of light and water, telephone.
- Profit: When revenue is more than expenses
during an accounting period. Profit increases the owner's capital.
- Loss: When expenses are more than revenue
during an accounting period. Loss decreases the owner's capital. It can
also include money or goods lost without earning benefits (e.g., theft,
fire).
- Gain: A profit that comes from events or
transactions that are not part of the main business activities (e.g.,
profit from selling a fixed asset, winning a court case).
- Voucher (Source Document): The documentary
evidence that supports a transaction (e.g., cash memo, invoice, receipt).
- Goods: The products in which a business
trades. Items purchased for use in the business (like machinery for
production) are generally not called goods.
- Drawings: When the owner takes money or
goods from the business for their personal use. Drawings reduce the amount
of capital.
- Purchases: The total amount of goods bought
by a business, either for cash or on credit, that are meant for resale.
·
Purchase Return: Returning goods that
were previously purchased to the suppliers.
- Stock (Inventory): The value of unsold goods
lying with a business on a particular date.
·
Closing Stock: Stock at the end of the
accounting period.
·
Opening Stock: Stock at the beginning of
the accounting period.
- Debtor: A person who owes money to the
business. The total amount owed by various debtors is called sundry
debtors. Sundry debtors are an asset.
- Creditor: A person to whom the business owes
money. The total amount owed to various creditors is called sundry
creditors. Sundry creditors are a liability.
- Discount: A reduction in the price of goods
sold.
·
Trade Discount: A reduction given at the
time of selling goods to increase sales. It is not recorded in the books
of account.
·
Cash Discount: A reduction allowed by the
creditor to the debtor for making prompt payment. It is a loss for the creditor
and a gain for the debtor, and it is recorded in the books of account.
- Expenditure: Spending money or incurring a
liability to receive some benefit, service, or property.
·
Revenue Expenditure/Expense: Small
amounts that are repetitive and benefit only the current period (e.g., purchase
of goods for sale, salaries, rent).
· Capital Expenditure: Large amounts that are not repetitive and provide benefits for more than one year, typically for acquiring fixed assets (e.g., purchase of buildings, machinery, furniture).
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