“Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings”.– Diane Garnick
Here we are introducting you to accounting terminologies and how to manage your accounts, we will elloborate everything that you need to get started from our website.
Remember that you are learning accounting methods and tools so that you can employ your skill to manage your business so that you don’t shoot the arrow in the dark.
1.1 Introduction to Accounting
1.2 Evolution of Accounting
1.3 Meaning and Definition of Accounting
1.4 Accounting cycle
1.5 Objectives of Accounting
1.6 Functions of Accounting
1.7 Basic Accounting terminologies
1.8 Branches of Accounting
1.9 Bases of Accounting
1.10 Users of Accounting information
1.11 Role of an accountant
1.1 Introduction to Accounting
To keep a record of the financial activities of the business and other organizations and to communicate them to the responsible heads is called accounting. these must be recorded to take important decisions as to whether the activities are viable, gainful, and are to be continued or not.
Questions to ask :
- Why these activities should be recorded?
- Who needs the financial information and why?
- Why a systematic uniform approach is needed?
Financial Activity = Finance (Accounting) + Human Resource
Accountancy provides the basic theory, principles, and methods to be followed to account for all financial activities taking place in an organization.
Systematically accounting the financial activities helps in ascertaining the efficiency of the performance of these activities and provides data about the state of affairs of the organization for further analysis and planning.
Communicating the information for the running of the business is critical for the organization and that’s why you need to grasp the art of communicating the numbers in a chart to the business heads.
1.2 Evolution of Accounting
In the early days of civilisation, accounting was managed by stewards who managed the properties of wealthy people. They rendered accounts periodically to the owners of property. The stewardship accounting is said to be the root of accounting.
The history of accounting or accountancy can be traced to ancient civilizations.
The early development of accounting dates back to ancient Mesopotamia and is closely related to developments in writing, counting, and money and early auditing systems by the ancient Egyptians and Babylonians.
In India, 23 centuries ago, Chandragupta Maurya’s Minister Kautilya wrote a book named ‘Arthashastra’, wherein some references can be traced regarding the way of maintaining accounting records.
The Italian Luca Pacioli, recognized as The Father of accounting and bookkeeping was the first person to publish a work on double-entry bookkeeping and introduced the field in Italy.
From the 18th to 19th century, large-scale operations were carried by the business and other organizations due to the industrial revolution and joint-stock companies emerged as an important form of organization that required separation of ownership from management. Hence, to safeguard the interest of owners and investors, the business establishments required detailed information about the business which paved the way for the development of a comprehensive financial accounting information system.
1.3 Meaning and Definition of Accounting
Accounting is the systematic process of identifying, measuring, recording, classifying, summarising, interpreting, and communicating financial information.
Through accounting you can get information on :
- The Resources available
- Viability and how the available resources have been employed
- Profit gained by their use
- Profit earned or loss incurred in a particular accounting period
- Value and nature of assets
- liabilities and capital status etc.
Accounting requires the expertise and skill of accountants to design accounting systems and policies, to decide the accounting process in order to suit the requirements of an organization.
We record the transactions and events in monetary terms and then communicate the result to the interested persons.
Accounting is recording of business transactions in monetary terms.
Steps involved are :
- Identify the transactions and record them
- Creating Ledgers and aggregate the records
- Prepare Trial Balance
- Create Trading Report
- Prepare Balance Sheet
- Communicate the information to interested users.
We will understand these steps in detail in next step.
1.4 Accounting Cycle
Accounting cycle is the steps involved in the accounting process. In this we first identify and record the financial transactions of an organization and the final step is to prepare final accounts for the accounting year. They cycle continues for the next year as the closing balance of assets and liabilities of previous year becomes the opening balance for the next financial year.
The steps involved are :
(i) Identify the transactions and journalising :
This is the first step in accounting process where all the monetary transactions are recorded in the books of original entry called journals. Recroding the transactions in the journal is called journalising.
Entries are made in the journal on the basis of source documents in the chronological order, i.e., the order of occurence of the transactions.
(ii) Posting and Balancing :
Transferring the entries from the journal to the ledger is called posting. In the ledger, entries are made in each account after classifying them under common heads. Finding the difference between the total of the debit column and credit column of all the ledger accounts is called balancing.
(iii) Preparation of Trial Balance :
In the next step the list of ledgers balances namely trial balance is prepared. Financial statements are prepared on the basis of ledger balances.
(iv) Preparation of Trading Account :
The next step is the preparation of a trading account for a particular accounting period. All the direct revenues and direct expenses are transferred to the trading account. The balance in the trading account is the gross profit or gross loss.
(v) Preparation of profit and loss account :
The profit and loss account is prepared next for a particular accounting period. All the indirect revenues and indirect expenses along with gross profit or gross loss are transferred to the profit and loss account. The balance in the profit and loss account is the net profit or net loss.
(vi) Preparation of Balance Sheet :
A statement showing the balances of assets and liabilities namely balance sheet is prepared as the final step in the accounting process. It is prepared on a particular date, normally, on the last day of the accounting period.
The closing balances of an accounting year are taken as the opening balances for the next accounting year. The transactions identified and recorded for the next year are followed by posting and other steps.
The results are communicated to the users of accounting information for the purpose of analysis and decision making.
1.5 Objective of Accounting
Following are the objectives of accounting:
- To keep a systematic record of financial transactions and events
- To ascertain the profit or loss of the business enterprise
- To ascertain the financial position or status of the enterprise
- To provide information to various stakeholders for their requirements
- To protect the properties of an enterprise and
- To ascertain the solvency and liquidity position of an enterprise
1.6 Functions of Accounting
The main functions of accounting are as follows:
(i) Decision Making :
Accounting provides relevant information to the management for planning, evaluation of performance and control. This will help them to take various decisions concerning cost, price, sales, level of activity, etc.
(ii) Calculation :
The main objective of accounting is to keep systematic record of transactions, post them to the ledger and finally prepare the final accounts for the decision making purpose. Accounting works as a tool for measuring the performance of the business enterprises. It also shows the financial position of the business enterprises.
(ii) Forecasting :
With the help of the various tools of accounting, future performance and financial position of the business enterprises can be forecasted.
(iii) Comparison :
With accounting information you can compare the actual performance with the planned performance projection. It is also possible to compare with the accounting policies. You can find relevant information by comparison and can take effective measures that can enchance the efficiency of various operations.
(iv) SWOT Analysis :
With accounting you can take control of your business, you can find the strengths, weaknesses, opportunities, and analyze threats to your business, so that you can take adequate measures. It serves as a tool for evaluating compliance of business policies and programs.
(iv) GST and Taxation :
The government needs full information on the financial aspects of the business for various purposes such as taxation, the grant of subsidy, etc. Accounting provides relevant information about the business to exercise government control on business enterprises.
1.7 Basic Accounting Terminologies
|Transaction||An activity which involves transfer of money or money’s worth (goods, services, ideas) from one person to another.|
|Cash transaction||It is a transaction that involves immediate cash receipts or immediate cash payments.|
|Credit transaction||It is a transaction in which cash is not received or paid immediately, but will be received or paid later.|
|Account||It is the basic unit for measurement in accounting. It is used for identifying a person, or an item in accounting. An account is opened individually for a person, asset, expense, income, etc. In the ledger, an account is a summary of transactions under a head.|
|Capital||It is the amount invested by the owner or proprietor in an organization.|
|Drawings||It is the amount of cash or value of goods, assets, etc., withdrawn from the business by the owner for the personal use of the owner.|
|Voucher||Any written or printed document in support of a business transaction is called a voucher. Examples: cash receipt, invoice, cash memo, bank pay-in-slip, etc.|
|Invoice||It is a statement prepared by a seller of goods to be sent to the buyer. It shows details of quantity, price, value, etc. of the goods and any discount given, finally showing the net amount payable by the buyer.|
|Goods||It includes articles, things, or commodities in which a business is dealing with. Example: Furniture will be goods for those who deal in furniture.|
|Purchases||Buying goods with the intention of resale is called purchase.|
|Purchases returns or returns outward||When goods bought are returned to the suppliers, it is known as purchase returns or returns outward.|
|Sales||When goods meant for resale are sold, it is called sales.|
|Sales returns or returns inward||When goods sold are returned by the customers, it is called as sales returns or returns inward.|
|Stock||Unsold goods lying in a business on a particular date are known as stock.|
|Income||It is the amount receivable or realized from the sale of goods and earnings from interest, dividend, commission, etc.|
|Expense||It is the amount incurred in order to produce and sell goods and services.|
|Solvency||Solvency is the capability of a person or an enterprise to pay the debts.|
|Insolvency||Insolvency is the incapability of a person or an enterprise to pay the debts.|
|Asset||Any physical thing or right owned that has a monetary value is called an asset.|
|Liability||It refers to the financial obligation of the business.|
|Debtor||A person who receives a benefit without giving money or money’s worth immediately, but liable to pay in the future or in due course of time.|
|Creditor||A person who gives a benefit without receiving money or money’s worth immediately but to claim in the future.|
|Depreciation||It refers to the gradual reduction in the value of fixed assets due to usage and passage of time.|
|Bad debt||It is a loss to the business arising out of the failure of a debtor to pay the dues. It is irrecoverable debt.|
1.8 Branches of Accounting
It depends upon the type of information that you need from your financial data, several branches of subfields of accounting have been developed to aggregate the information to appropriate users.
The various branches of accounting are:
(i) Financial Accounting :
In involves recording financial transactions and events. It is historical in nature and records are maintained for transactions and events which have already occurred. It provides financial information to the users for taking decisions. It is concerned with the identification, recording, classifying, and summarising of financial transactions and events and ends up with the preparation of financial statements, such as trading and profit and loss account or income statement and balance sheet, and communicating this information to interested users.
(ii) Cost Accounting :
Collection, recording, classification, and allocation of expenditure for the determination of the costs of products or services and for the presentation of data for the purposes of cost control and managerial decision making.
(iii) Management Accounting :
Management accounting is concerned with the presentation of accounting information in such a way as to assist the management in decision making and in the day-to-day operations. We collect the information from financial accounting, cost accounting, etc., so they are grouped, modified and presented as per the requirements of management for discharging their functions and for decision making.
Data is presented in visual manner using, graphs, charts, bars and projections.
(iv) Social Responsibility Accounting :
To provide the business information and present the business activity to the costumers and audiences, the social responsibility accounting method is applied. It is concerned from the viewpoint of the society by showing the social costs incurred such as environmental pollution by the enterprise and social benefits such as infrastructure development and employment opportunities created by them. It arises because of corporate social responsibility.
(v) Human Resources Accounting :
It is concerned with the identification, quantification, and reporting of investments made in the human resources of an enterprise.
1.9 Bases of Accounting
There are three bases of accounting in common usage :
- Cash basis
- Accrual or mercantile basis
- Mixed or hybrid basis.
(i) Cash basis
Under the cash basis of accounting, actual cash receipts, and actual cash payments are recorded. On this basis, revenue is recognized when cash is received and expenses are recognized when cash is paid. Credit transactions are not recorded till cash is actually received or paid. Under this basis :
- Any income received
- Any expenditure paid
- Any asset purchased for which cash is paid
- Any liability paid during the accounting period whether related to the past, present, or future is taken into account.
(ii) Accrual or mercantile basis
Under the accrual basis of accounting, the revenue whether received or not, but has been earned or accrued during the accounting period, and expenses incurred whether paid or not being recorded. In other words, revenue is recognized when it is earned or accrued and expenses are recognized when these are incurred. Under this basis :
- Any income earned whether received or not
- Any expenditure incurred whether paid or not
- Any asset purchased whether cash is paid or not
- Any liability incurred whether paid or not during the accounting period is recorded.
(iii) Hybrid or mixed basis
This basis is a combination of cash basis and accrual basis of accounting. Under a mixed basis of accounting, both cash basis and accrual basis are followed. Revenues and assets are generally recorded on a cash basis whereas expenses and liabilities are generally taken on an accrual basis.
1.10 Users of Accounting Information
There are several persons who need the accounting information for various purposes. They can be classified into two:
(A) Internal users
(B) External users
The people within the organization such as owners, management, and employees arer called internal users.
(A) Internal users :
The owners of an organization provides the capital to be used in the business. So they are interested to know whether the business has earned profit or not during a particular period. They want to know the financial status of their business so they want accounting reports in order to have an overview of performance and also for an assessment of future prospects to ensure that they will get their expected returns from the business and get back their capital safely.
Every decision that an organization makes is based on the financial information of the enterprise. The trends in sales and purchase, relationship of expenses to the sales, efficiency of employees, comparative profitability of different departments, capital structure, and solvency position are some of the vital data required by management for planning and controlling the business operations. Financial and other types of financing methods provide this information to the management.
The employees are interested in the profit-earning capacity of the business which will affect their remuneration, working conditions, and retirement benefits and stability and growth of the enterprise.
(B) External users :
External users are the persons who are outside the organisation but make use of accounting information for their purposes.
- Tax authorities and other regulatory bodies
- General public
Creditors such as suppliers of goods and services, commercial banks, public deposit holders and debet holders are included in this category, who are interested in knowing the liquidity position and repaying capacity of the business to ensure the safety of getting the amount due to them or interest and the principal amount.
Persons who are interested in investing their funds in an organisation should know about the financial condition of a business unit while making their investment decisions.
They are more concerned about future earnings and risk-bearing capacity of the organization which will affect the return to the investors.
Customers who buy and use the products and services of business enterprises are interested in knowing the details of the products and the prices charged to them.
They are interested in knowing the stability and profitability of an enterprise to ensure the continued supply of the products or services by the enterprise.
(iv) Tax authorities and other regulatory bodies
Tax authorities can use the accounting information to compute income tax and taxes on goods and services and other taxes to be collected form business units. Other regulatory bodies also require information about revenues, expenses, and other financial aspects of the business to ensure that the enterprises comply with statutory requirements.
Information about the performance of business units in different industries helps the government in policy formulation for the development of trade and industry, allocation of scarce resources, the grant of subsidy, etc. The government also administers the prices of certain commodities. In such cases, government agencies have to ensure that the guidelines for pricing are followed.
(vii) General public
The general public is interested in viewing the earning capacity and stability of the enterprise as well as the social responsibility measures undertaken by the enterprise particularly in its area of operation and also the employment opportunities provided to the people.
1.11 Role of an accountant
An accountat is responsible for creating financial information for the organization, The accountant assists the management by providing financial information required for decision making and for exercising control.
The accountant maintains a systematic record of financial transactions and prepares the financial statement and other financial reports.
The accountant maintains records of assets and liabilities of the business which enables the management team to decide on the next step on the action.
The accountant has to analyze the financial information and should advise the business managers regarding investment opportunities, strategies for cost savings, capital budgeting, provision for future growth and development, expansion of the enterprise, etc.
The accountant ensures that tax returns are prepared and filed correctly on time and payment of tax is made on time. The accountant can advise the managers regarding tax management, reducing tax burden, availing tax exemptions, etc.
The accountant provides accounting information to various interested users for analysis as per their requirements.
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