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Financial Accounting-I1A.1Accountig IntroductionLESSON - 1AACCOUNTING, INTRODUCTION1A.0 Objectives : After going through this less on the student will know, what is Accountancy?what is the need for recording the business transactions in the books ? What is the differencebetween book keeping and Accountancy ? What are the things which should be bear in mind whilerecording business transaction in the books.Structure troduction to Accountancy, Scope.Definition.Need for AccountancyAccountancy FunctionsBook keeping - AccountingObjects of AccountancyAdvantages, limitations of Accountancy.Accounting process.Branches of Accounting.Concepts of Accounting.Conventions of Accounting.Summary.Self Assessment Questions.Suggested Readings1.1 Introduction to Accountancy - ScopeAccounting is as old as money itself. In the early days, the number of transactions to berecorded were so small then each business man was able to record and check for himself all histransactions. The modern system of accounting based on the principles of Double Entry systemowes its origin to luco pacio who first published the principles of Double Entry system in 1494 atVENICE in Italy.In the recent years large scale production, cut throat competition, widening of the market andchanges in the technology have brought remarkable changes in the field of accounting.A business consists of a series of transactions. These business transactions are to beidentified, classified, recorded, summarised, analysed, interpreted and communicated to interestedparties so as to serve as a basis for decision marking. In fact, modern accounting serves as the“eyes and ears” of the management.The main purpose of accounting is to ascertain profit or loss during a specified period toshow financial condition of the business on a particular date and to have control over the firmsproperty. Such accounting records are required to be maintained to measure the income of thebusiness and communicate the information so it may be used by managers, owners and otherparties.

ACHARYA NAGARJUNA UNIVERSITY1A.2CENTRE FOR DISTANCE EDUCATION1.2 Definition :Different people have defined Accountancy in deferent ways by going through these we canunderstand the nature of Accountancy.The American institute of certified public Accounting has defined financial accounting as “theart of recording, classifying and summarising in a significant manner and in terms of moneytransactions and events which in part, at least of a financial character and interpreting the resultsthere of ”American Accounting Association defines accounting as “ the process of identifying, measuringand communicating economic information to permit informed judgements and decisions by usersof the information”Accountancy is the science of recording and classifying business transactions and eventsprimarily of a financial character and the art of making significant summaries, analysis andinterpretations of those transactions and events and communication of the results to persons whomust make decisions or form judgements (Smith & Ashbuns).1.3 Need for Accounting :It is not possible to any human being to remember all business transactions which havetaken place in business - that too, over a period of time say in an year. Even if some one does reallyremember all the transactions, he would find it impossible to calculate the net effect of all suchtransactions. Hence the need for accounting is raised.What ever may be the size of organisation whether it is a sole trading concern, partnership orjoint stock company it would like to have information about1. The nature and amount of expenditure,2. The nature, source, cause and amount of earnings,3. The amount and cause of losses, if any4. The size of capital and causes for its increase or decrease,5. The nature and value of assets possessed, and6. The nature and value of liabilities.Further, the business requires various types of information for both external and internal use.For example information is required for filing sales tax, income tax and other tax returns and forpreparing statements for decisions to be taken by managers. The question is how to get thisinformation. A systematic accounting record is the only answer. Thus, the need for accountingarises on account of practical needs and sometimes legal requirements.1.4 Functions of Accounts :1.Recording : Business transactions are analysed in such a way that it may be possibleto determine profit or loss made by the business and its financial condition of a specifieddate. Business transactions may relate to the receipt and payment of cash, purchaseor sale of goods on credit, incurring an expense or receiving an income.

Financial Accounting-I2. IntroductionClassification : Classification is the second function of accountancy.The transactions recorded in journal should be classified and the transactions of onenature should be Placed at one place which we call as ledger.For example : All purchases of goods placed into purchases A/C, payment of salariesto salaries A/C etc.Summarising : The classified data should be summarised at least periodically, into asignificant form.Analysing : The summarised financial statements profit and loss account, balancesheet, statement of changes are analysed with the help of statistical tools such asaverages, percentages, ratio, rates etc.Interpreting : The information in financial statements, are interpreted in terms of setstandards and conventions. Inter preting the results of accounting information involvescommunicating and explaining the information to interested parties and decision makerslike owners, creditors, investors, government and management.1.5 Book Keeping and Accounting :It is necessary to distinguish between book - keeping and accounting Actually the two arevery closely related and there is no universally accepted line of discrimination. Generally book keeping involves the chronological recording of financial transactions in a systematic manner.According to Northcott “book Keeping is an art of recording in books of accounts the monetaryaspect of commercial or financial transaction”According to G.A. Lee the Accounting system has two branches : 1. The making of routinerecords from day - to - day in the prescribed form and according to set rules of all events whichaffect the financial state of the organisation and 2. The summarising of the information containedin the records, its presentation in significant form to interested parties and its inter pretation as anaid to decision-making by these parties. Branch 1. Is called book - keeping and branch 2. Isaccounting.Book - keeping is the record making phase of accounting. The recording of transactionstends to be routine, repetitive and mechanical. It is a part of accounting. Accounting includes, book- keeping, preparation of financial statements, audits, cost studies, preparation of budgets, income- tax and other taxation work, analysis and interpretation of accounting information; as an aid todecision making.1.6 Objects of Accounting :According to American Accounting association the objectives of accounting are to provideinformation for the following purposes.1.Making decisions concerning the use or limited resources including identification of crucialdecision areas and determination of objectives and goals.2.Effectively directing the controlling of an organisation’s human and materials resources.3.Maintaining and reporting on the custodian-ship of resources.4.Facilitating social Functions and control.

ACHARYA NAGARJUNA UNIVERSITY1A.4CENTRE FOR DISTANCE EDUCATION1.7 Advantages and limitations of Accounting :The following are the advantages of a properly maintained accounting system1. The operating results i.e. profit or loss and the financial state of affairs of an organisationcan be known.2. Any information required at any time can readily be had from the books of account.3. With the help of financial statements an organization can evaluate its present performancewith that in the past, and compare it with that of other organisations4. Accounts form the basis for the settlement of tax liability such as income tax, sales taxetc.5. In the events of the business being sold, the accounts are helpful in ascertaining thevalue of the business.6. Accounting is an aid to the management. It is possible to find out exact reasons for theloss incurred or profit earned. The identification of reasons help the management intaking necessary steps to avoid losses or to further increase profits.7. The financial information provided by the accounting system is needed to help themanagement in planning and controlling the activities with the help of budgets.Limitations :The following are the main limitations of accounting.1.Accounting records only those transactions which can be measured in monetary terms.2.Accounting transactions are recorded at cost in the books. The effect of price levelchanges is not brought into the books, with the result that comparison of the variousyears becomes difficult. For example the sale price of total assets in 2007 would bemuch higher than in 1980 due to rising prices, fixed assets being shown to cost and notat market price.3.Accounting information may not be realist i.e. as accounting statements are prepared byfollowing basic concepts and conventions.4.Accounting statements are influenced by the personal judgement of the accountant. Themethod of depreciation, valuation of stock, treatment of deferred revenue expenditure isdecided by the accountant. Such judgement if based on integrity will definitely affect thepreparation of accounting statements.1.8 Accounting process :The accounting process begins when a financial transaction takes place. Transaction isrecorded first in a book called ‘Journal’ and later posted in separate accounts maintained for thepurpose in a ledger. At the end of the accounting year whether actual figures are entered accuratelyor not in the accounts is tested by preparing a ‘trail balance’ with the help of this trial balance andother information ‘final accounts’ are prepared to find out the financial result of the operations whetherprofit or loss and the financial position, assets and liabilities. In the subsequent year the accountingbooks are opened with the previous year’s closing balances. The process thus repeats itself like acycle.

Financial Accounting-I1A.5Accountig Introduction1.9 Branches of Accounting :The accounting can be classified into the following categories.1. Financial Accounting2. Cost Accounting3. Management Accounting4. Inflation Accounting5. Human resources Development Accounting1.10. Concepts of Accounting :Accounting is the language of business. To make the language convey the same meaning toall people, accountants all over the world have developed certain rules, procedure and conventions.Accounting concepts may be considered as basic assumptions or conditions upon whichthe science of accounting is based. They are as follows.1. Business Entity Concept : This concept implies that a business unit is separate anddistinct from the persons who supply capital to it. Accounting system gives the information aboutbusiness only. The entity concept regards the proprietor of the business as just a creditor having aclaim over the assets of the business. The accounting equation i.e, Assets liabilities capital isan expression of the entity concept. In case this concept is not followed affairs of the business willbe mixed up with the private affairs of the proprietor and the true picture of the business will not beavailable.2. Going concern concept : According to this concept it is assumed that business entitywill go on for ever. Transactions are recorded in the books keeping inview the going concernaspect of the business unit. This assumption provides much of the justification for recording fixedassets at original cost without reference to their current realisable value. Similarly the going concernconcept supports the treatment of prepaid expenses as assets even though they may be unsaleable.Prepaid expenses are made assets on the assumption that the business entity will continue infuture and the benefit of prepaid expenses will be utilised in future.3. Money measurement concept : Money is the only practical unit of measurement thatcan be employed to achieve homogenity of financial data. The advantage of expressing businesstransactions in terms of money is that money serves a common denominator by means of whichheterogeneous facts about a business can be expressed in terms of numbers, i.e. money, whichare capable of additions and subtractions.The money measurement concept restricts the scope of accounting because it is notcapable of recording transactions which cannot be expressed in terms of money. For example :if there is a strike in the factory or the production manager is not in good terms with the salesmanager, as these can not be measured in money terms. Accounting therefore can not recordthem. Similarly it does not take care of the effects of inflation because it assumes a stability ofthe money measurement unit.Cost Concept : All assets are recorded in the books at the price paid to acquire it. Its value

ACHARYA NAGARJUNA UNIVERSITY1A.6CENTRE FOR DISTANCE EDUCATIONis systematically reduced by charging depreciation. The market value of an asset may change withthe passage of time but for accounting purpose it continues to be shown in the books at its bookvalue i.e. the cost at which it was purchased minus depreciation provided up to date. The costconcept has the advantage of bringing objectivity in the accounts. Information given in the financialstatements is not influenced by the personal bias or judgement of those who furnish such statements.Dual Aspect Concept :This is the basic concept of accounting. According to this concept every financial transactioninvolves a two - fold aspect. 1) Yielding of a benefit and 2) Giving of that benefit. For example, if abusiness has acquired as asset, it must have given up some other asset such as cash. Theremust be a double entry to have a complete record of each business transaction, an entry beingmade in the receiving account and an entry of the same amount in the giving account. The receivingaccount is termed as debtor and the giving account is called creditor. Thus every debit must havea corresponding credit and vice versa and upon this dual aspect has been raised the whosesuperstructure of Double Entry System of Accounting. The Accounting Equation is based on dualaspect concept.Assets Liabilities CapitalAccounting equation demonstrates the fact that for every debit there is an equivalent credit.Accounting period Concept : Even though it is assumed that the business will continue fora long period, almost indefinitely; the businessman cannot postpone the ascertainment of its profitand financial position indefinitely. So it is reasonable to devide the life of the business into accountingperiods so as to be able to know the profit or loss of each such period and the financial position atthe end of such a period. Normally accounting period adopted is one year. However for internalpurposes accounts can be prepared even for shorter periods.The principal of segregating capital expenditure from revenue expenditure is based on theaccounting period concept. The revenue expenditure for a particular period is transferred to theP & L A/c of that period whereas capital expenditure is carried forward to the extent to which itsbenefit extents in future accounting periods.Realisation Concept : According to this concept, revenue is considered as being earned onthe date at which it is realised, Take into account realised profit but donot take into account unrealisedprofit is the summary of this concept1.11. Conventions of Accounting :The terms conventions denotes customs or traditions which guide the accountant whilepreparing the accounting statements the following are the important accounting conventions.1. Convention of Consistency2. Convention of full disclosure3. Convention of conservation4. Convention of Materiality.Convention of Consistency : Accounting rules, practices and conventions should be

Financial Accounting-I1A.7Accountig Introductioncontinuously observed. The results of different years will be comparable only when accountingrules are continuously adhered from year to year. For example the principle of “valuing stock atcost or market price which ever is lower should be followed year after year to get comparableresults.Convention of full Disclosure : According of this convention all accounting statementsshould be honestly prepared and all significant information should be made. All information which isof material interest to proprietors, creditors and investors should be disclosed in accountingstatements. The convention is becoming popular these days because most of big business unitsare in the form of joint stock companies here ownership is diverse from management. The companiesAct 1956 makes simple provisions for the disclosure of essential information that there is no changeof any material information being left out.Convention of conservatism : Conservatism means taking the gloomy view of a situation.It compels the business man to take all precautions for risks of future. It says anticipate no profitsbut provide for all possible losses. For ex. closing stock is valued at cost or market price whicheveris lower. If market price is higher than the cost the higher amount is ignored in accounts and closingstock will be valued at cost which is lower than the market price and vice versa.Thus the principle of conservation is inherent in the valuation of stock.Convention of Materiality : Whether something should be disclosed or not in the financialstatements will depend on whether it is material or not Materiality depends on the amount involvedin the transaction. For ex. Minor expenditure of Rs 10 for the purchase of a waste basket may betreated as an expense of the period rather than an asset.The term materiality is a subjective term. The accountant should record an item as materialeven though it is of small amount if its knowledge seems to influence the decision of the proprietorsor auditors or investors.Parties interested in Accounting information :Accounting information is useful to various parties. They are :1. Owners : Owners assume the primary risk of business by investing their funds in it.Naturally they are interested in obtaining information about the operations of their business howmuch profit it earned and what is the position of their capital. They also use the accounting toevaluate the managements performance and to compare their enterprise with others.Managers : Accounting reports are important to manager for basing their decisions or forevaluation, the result of their decisions or for controlling the activities of the business. In addition toexternal financial statements managers need detailed internal reports, production wise, sales wiseetc. Accounting reports for managers are prepared much more frequency than external reportsand are usually available only for internal purposes.Creditors and Bankers : Creditors and Bankers want to know the solvency of the concernso as to satisfy themselves that their money will be safe and that they can expect repayment intime.Prospective Investors : Prospective investors who wants to invest their money in the firmwants to make a careful analysis of the financial statements of that business so as to know howsafe and rewarding the proposed investments will be.

ACHARYA NAGARJUNA UNIVERSITY1A.8CENTRE FOR DISTANCE EDUCATIONEmployees : The employees of large organisation are interested in the results of theirorganisation operations. They use the accounting data to know whether they are getting a fairshape of the resources distributed by the organisation.Governments : Numerous governmental agencies, both state and central are in

1.1 Introduction to Accountancy, Scope. 1.2 Definition. 1.3 Need for Accountancy 1.4 Accountancy Functions 1.5 Book keeping - Accounting 1.6 Objects of Accountancy 1.7 Advantages, limitations of Accountancy. 1.8 Accounting process. 1.9 Branches of Accounting. 1.10 Concepts of Accounting. 1.11

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