CBSE Class 11 Accounting Introduction to Accounting

Accounting-Introduction to Accounting

Evolution of accounting is spread over several centuries. It is as old as money itself. The modern system of accounting based on the principles of Double Entry System owes its origin to Luco Pacioli, who first published the principles of Double Entry System in 1494 at Venice in Italy. Over centuries, accounting has remained confined to the financial record keeping functions of the accountant. But in today’s fast changing business environment, the role of an accountant has changed from that of a mere recorder of the financial transactions to that of the member providing information to the decision-making team. Accountants are now working in newer and newer areas such as financial planning, forensic accounting, e-commerce, environmental accounting etc. This has happened because of the fact that present day accounting is capable of providing information that managers and other interested persons need in order to make decisions concerning a business enterprise. Accounting now is regarded as an information system and has become an integral part of the Management Information System. As an information system, accounting collects data and communicates economic information about a business enterprise or about any other entity to a wide variety of persons whose decisions and actions are related to the performance of the business enterprise or any other entity. This introductory chapter deals with the meaning, nature, types and limitations of accounting.

1.1 Meaning of Accounting

The main purpose of accounting is to ascertain the profit or loss incurred during a specified period, generally one year, to show the financial condition of the business on a particular date and to have control over the property of the enterprise. Accounting records are required to be maintained to measure the income of the business and communicate the information so that the same may be used by the managers, owners and other parties. Accounting as a discipline records, classifies, summarizes and interprets financial information about the activities of an enterprise so that intelligent decisions can be made about the enterprise. The American Institute of Certified Public Accountants has defined financial accounting as ” the art of recording, classifying and summarizing, in a significant manner and in terms of money, transactions and events which are in part, at least, of a financial character, and interpreting the results thereof ”. American Accounting Association has defined accounting as “ the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information”.

Accounting can, therefore, be defined as the process of identifying, measuring, recording and communicating the required information relating to the economic events of an organisation to the interested users of the information. From the above, the following attributes of accounting emerge

(i) It is the art of recording and classifying business transactions and events

(ii) The transactions or events of a business must be recorded in monetary terms

(iii) It is the art of making summaries, analysis and interpretation of the business financial transactions.

(iv) The result of such analysis must be communicated to the persons who are to make decisions or form judgments.

1.2 Types of Accounting

There are three important types or branches of accounting

(i) Financial Accounting : The most important branch of accounting it is concerned with the recording, classifying, summarizing and analysing of business transactions. It is directed towards the preparation of profit and loss account, and balance sheet. With the help of these financial statements business results are communicated to the interested parties or users for decision-making.

(ii) Cost Accounting : Cost accounting is the process of accounting for costs. It is a systematic procedure for determining the unit cost of output produced or services rendered. The basic functions of cost accounting are to ascertain the cost of a product and to help the management in the control of cost. It is that branch of accounting which deals with the classification, recording, allocation, summarization and reporting of current and prospective costs. Through analysis of the expenses of operating a business, it helps in controlling the cost of products or services provided.

(iii) Management Accounting : Management accounting is concerned with the supply of information which is useful to management in decision-making for the efficient functioning of the enterprise and, thus, in maximising profits. It is the reproduction of financial statements (Profit and Loss Account and Balance Sheet) in such a way as will enable the management to take decisions and to control activities.

1.3 Basic Terms

(i) Financial Transaction: It is an event which involves the exchange or transfer of some value between two or more entities,for e.g, purchase of goods, sale of goods, amount lent to another firm, payment of expenses, receipt of commission, dividends etc. A transaction may be a credit transaction or a cash transaction. When the party does not give cash immediately on entering into a transaction but agrees to pay later, it is called a credit transaction. When the payment is received in cash immediately on entering into the transaction then it is called cash transaction.

(ii) Capital: It refers to the amount invested by the owner(s) in the enterprise. It may be brought by the owners in cash or in the from of assets. It indicates the interest of the owner(s) in the assets of the enterprise.

(iii) Assets: These are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets consist of tangible objects or intangible rights owned by the enterprise and carrying probable future benefits. Examples of tangible assets are cash, bank balance, inventories, machinery, furniture, and building. Examples of intangible assets are goodwill, patents, copyrights, trade marks. Assets can also be broadly classified into two types: fixed assets and current assets. Fixed assets are held for long use in business itself for the purpose of providing or producing goods or services and are not held for re-sale purpose in the normal course of business, for e.g., land, building, machinery, furniture and fixtures. Current assets are held on a short-term basis; normally short-term refers to an accounting year. Examples of current assets are cash, bank balance, debtors, bills receivable, investment etc. These are expected to be converted into cash or consumed in the production of goods, or rendering of services in the normal course of business.

(iv) Liability: These are the obligations or debts that the enterprise must pay in money or services at some time in the future. Liabilities are debts, for e.g, amount due to creditors, bank overdrafts, bills payable, loans etc. Like assets, liabilities can also be broadly classified into two categories: fixed or long-term liabilities and current or short-term liabilities. Long-term liabilities are those that are payable after a period of one year, for e.g, a term loan from a financial institution, debentures etc. issued by a company. Short-term liabilities are such obligations of the enterprise that are payable within a year e.g. creditors (accounts payables), bills payable (notes payable), cash credit, overdraft, short-term loans etc.

(v) Revenue: These are the amounts that the business earns by selling its products or providing services to customers. Other items of revenue common to many businesses are commission, interest, dividends, royalties, rent received etc. Revenue is also called income. It is measured by the charges made to customers, or clients, for goods supplied and services rendered to them and by the charges and records arising from the use of resources of the enterprise by them.

(vi) Debtors: They are persons and/or other entities to whom goods have been sold or services provided on credit and who thus owe certain amount to the enterprise. They are also referred to as accounts receivable or trade debtors. Debtors are assets for an enterprise and the total of debtors on the closing date is shown on the assets side of the balance sheet as “sundry debtors”.

(vii) Creditors: These are persons and/or other entities who have to be paid by an enterprise an amount for providing goods and services on credit. They are also referred to as accounts receivable or trade creditors. The total amount standing to the favour of creditors on the closing date is shown in the balance sheet as ‘sundry creditors’ on the liability side.

(viii) Goods : Articles or items purshased for sales purpose at profit or procassing by the bussiness or for use in the manufacturing process as raw material are known as goods. In other words, goods are commodities in which the business deals, for e.g., tables, chairs, desks etc are goods for a firm dealing in furniture. Americans use the term ‘merchandise’ for goods.

(ix) Expenses: These are the costs incurred by a business in the process of earning revenues. Generally, expenses are the cost of assets consumed or service used during an accounting period. Some examples of expenses are wages, salary, rent, interest, depreciation, telephone charges etc.

(x) Purchases: These are the total amount of goods procured by a business on credit or for cash for use or for resale. In a trading concern goods are purchased for resale with or without processing whereas in a manufacturing concern, raw materials are purchased, processed further into finished goods, and then sold.

(xi) Sales: Total revenues from goods sold and/or services rendered to the customers are called sales. They may be in cash or on credit.

(xii) Depreciation : It is a measure of the wearing out, consumption or other loss of value of a fixed asset arising from use, afflux of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset.

Please refer to the link below - CBSE Class 11 Accounting-Introduction to Accounting