UNIT 1

INTRODUCTION
 THE ACCOUNTING SYSTEM
► Accounting is an ancient art, certainly as old money itself which conveys the language of
business by recording, classifying and summarizing money transactions & events in a
significant manner and interpreting the results thereof.
► In modern age the scope of business has been widen. The production and the sales are made at
large scale due to division of labor, specialization and scientific management.
► The customers of a seller are spread over throughout the country. Usually the seller sells their
goods for cash but to increase their sales the number of credit transactions increases.
► The memory of human being is limited. Therefore, it is not possible to remember all the
transactions of a business. To overcome this problem, the work of recording the business
transactions started which develops.
► Different methods of bookkeeping were used in different periods. Today we can say that the
bookkeeping is a foundation on which the whole structure of modern business is based.
 Need for Accounting
► Accounting has rightly been termed as the language of business. It communicates the business
operations to various parties who have some stake in the business viz., the proprietor, creditors,
investors, Government and other agencies.
► The need for accounting is mainly for a person who is running a business.
► He should know:
(i) what he owns?
(ii) What he owes?
(iii) Whether he has earned a profit or suffered a loss on account of running a business?
(iv) What is his financial position?
i.e. whether he will be in a position to meet all his commitments in the near future or he is in the process
of becoming a bankrupt.
MEANING, OBJECTIVES & SCOPE OF ACCOUNTING
► “Accounting is the process of identifying, measuring and communicating economic information to
permit informed judgments and decisions by the users of information”
► In the beginning the main objective of accounting was to ascertain the result of the business (whether
profit has been earned or loss has been suffered) during a year and to show the financial position of the
business as on a particular date.
► But which the lapse of time more and more being expected from accounting. At present accounting has
to meet the requirements of taxation authorities, investors, government regulations, management and
owners. This has resulted in widening to scope of accounting and may be defined as follows:
► With greater economic development resulting in changing role of accounting, its scope became
broader. In 1966 the American Accounting Association (AAA) defined accounting as “the process of
identifying, measuring and communicating economic information to permit informed judgments and
decisions by users of information.”
► In 1970 the, Accounting Principles Board of AICPA also emphasized that the function of accounting
is to provide quantitative information, primarily financial in nature, about economic entities, that is
intended to be useful in making economic decisions.
MEANING, OBJECTIVES & SCOPE OF ACCOUNTING
► Accounting can therefore be defined as the process of identifying, measuring,
recording and communicating the required information relating to the economic
events of an organization to the interested users of such information. In order to
appreciate the exact nature of accounting, we must understand the following
relevant aspect of the definition:
∙ Economic events
∙ Identification, Measurement, Recording and communication
∙ Organization
∙ Interested users of information.
 Definition of Accounting
► In 1941, the American Institute of Certified Public Accountant (AICPA) defined accounting
as follows:
► “Accounting is the art of recording, classifying and summarizing in 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.”
► Thus accounting cycle involves the following stages:
1. Recording of Transactions. This is done in the book termed as ‘Journal’.
2. Classifying the Transactions. This is done in the book termed as ‘Ledger’.
3. Summarizing the Transactions. This includes preparation of the trial balance, profit and loss
account and balance sheet of the business.
4. Interpreting the Result. This involves computation of various accounting ratios, etc., to
know about the liquidity, solvency and profitability of business.
An analysis of the definition brings out the following functions of accounting
 Functions of Accounting
Recording
► This is the basic function of accounting. Recording is done in the book “Journal”.
► This book may be further subdivided into various subsidiary books such as Cash Journal (for recording cash
transactions), Purchase Journal (for recording credit purchase of goods), Sales Journal (for recording credit sales of
goods), etc. the number of subsidiary books to be maintained will be according to the nature and size of the business.
Classifying
► Classification is concerned with the systematic analysis of the recorded data, with a view to group transactions or
entries of one nature at one place.
► The work of classification is done in the book termed as “Ledger”.
Summarising
► This involves presenting the classified data in a manner which is understandable and useful to the internal as well
as external end-users of accounting statements.
► This process leads to the preparation of the following statements:
(i) Trial Balance, (ii) Income Statement, and (iii) Balance Sheet
 Functions of Accounting
Dealing with Financial Transactions
► Accounting records only those transactions and even in terms of money which are of a financial character.
► Transactions which are of a financial character are not recorded in the books of accounts.
Analysing and Interpreting
► The recorded financial data is analysed and interpreted in a manner that the end-users can make a meaningful
judgement about the financial condition and profitability of the business operations.
► The term ‘Analysis’ refers to the methodical classification of the data given in the financial statements.
► The term ‘Interpretation’ means, explaining the meaning and significance of the data simplified.
 Functions of Accounting

Communicating
► The accounting information after being meaningfully analysed and interpreted
done through preparation and distribution of accounting reports, which includes
besides the usual income statement and the balance sheet, additional information
in the form of accounting ratios, graphs, diagrams, funds flow statements, etc. the
initiative, imagination and innovative ability of the accountant are put to test in
this process.
 OBJECTIVES OF ACCOUNTING
❑ To keep systematic record of business transactions
❑ To calculate profit or loss of the business
❑ To depict the financial position of the business
❑ To provide information’s to various parties
❑ Other objectives: Accounting functions also fulfill the following objectives:
❖ To keep systematic and permanent record of all financial transactions
❖ To use accounting records for future reference
❖ To fulfill the legal requirements
❖ To provide information about various tax liabilities
❖ To check the accounting errors, frauds, and misappropriations of funds
❖ To know the requirements of the business
❖ To help in fulfilling tenders and quotations
❖ To provide information about profitability of various products
❖ To facilitate rational decision-making.
❖ To control over expenditures to minimize them.
 LIMITATIONS OF ACCOUNTING
❖ Incomplete information
❖ Influenced the by personal judgments
❖ Realizable value of business is not shown
❖ Complete control on frauds is impossible
❖ Manipulation in accounts
❖ Does not provide timely information
 ACCOUNTING SYSTEM
► Business transactions may be recorded in any system, which will enable the ascertainment of the profit
or loss of a business and its financial position. The following are the main systems adopted by business
people:
► Cash System of Accounting: Under this system, only actual cash receipts and payment transactions will
be entered into the books of accounts. No entry will be made for credit transactions
► Government system of accounting is mostly on cash basis. Certain professional organisations also
record their income on cash basis, but while recording expenses they take into account the outstanding
expenses also and prepare Income and Expenditure Account instead of Profit and Loss Account.
► Merchantile System of Accounting: This system is based on Double Entry Principle. This Book Profit
System of Accounting” takes into consideration all the aspects of business transactions (Both Credit and
Cash transactions).
► This system is followed by most of the industrial and commercial firm. This system owes its origin to an
Italian Merchant Luco Pacioli who wrote the book entitled “De Computis et Scripturis” on Double Entry
Accounting in the year 1494.
 ACCOUNTING SYSTEM
► SYSTEM OF BOOK KEEPING
► The art and technique of recording the business transactions in a set of books is called as Bookkeeping. It is the
process of analyzing, classifying and recording transactions in accordance with a preconceived plan.
► This recording may be done according to two ways:
1) Single Entry System: which is an incomplete maintenance of books of accounts without following the Double
Entry Concepts and Conventions, where some business houses maintains for their convenience keeping only some
of the essential Books of Records. Thus it is referred as incomplete double entry recording of business
transactions.
2) Double Entry System: Where the transactions are recorded according to the Golden Rules of Accounting taking
into consideration both the aspects of a transaction (Debit and Credit) and following the Accounting Concepts and
Conventions. This system maintains both Book of Original Entry (Journal / Subsidiary Books) and Book of Final
Entry (Ledger) according to the classification of Accounts into Real, Personal & Nominal, in order to know the
state of affairs of the business by preparing the Profit and Loss Account and Balance Sheet from the Trial
Balance.
 BRANCHES/STREAMS OF ACCOUNTING
► The subject of accountancy has become important for all the business organization in the present time. Its subject
matter has been increased and it has taken the form of accounting. Accounting subject has the following branches:
FINANCIAL ACCOUNTING
1. Journal
2. Ledger
3. Trial Balance
4. Final Accounts
COST ACCOUNTING
1. Cost sheet
2. Job and contract costing
3. Process costing
4. Operating costing
 BRANCHES/STREAMS OF ACCOUNTING
MANAGEMENT ACCOUNTING
1. Ratio Analysis
2. Break event Point Analysis
3. Standard costing
4. Analysis Of Financial Statements

TAX ACCOUNTING
1. Sales Tax
2. Income Tax
3. Wealth Tax
4. Excise Duty
 BRANCHES/STREAMS OF ACCOUNTING
GOVERNMENT ACCOUNTING
1. Budget
2. Consolidated Fund
3. Contingency Fund
4. Public Accounting
SOCIAL RESPONSIBILITY ACCOUNTING
1. Social Fund
2. TQM
3. Environmental Accounting
HUMAN RESOURCES ACCOUNTING
1. Employee Inventory Management
2. HRD Operational & Administrative Aspects
3. Profitability and Work Measurement
 Financial Accounting
❖ “Financial Accounting is the art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions and events which are at least
in part, of a financial character, and interpreting the results thereof.”
❖ In financial accounting we record the business transactions in the books of accounts.
❖ Its object is to ascertain the profit or loss and to know the financial position of the
business.
❖ In this, Journal, Subsidiary books, Ledger, Trial balance, trading account, Profit &
loss account and Balance sheet are prepared.
 LIMITATIONS OF FINANCIAL ACCOUNTING
❖ Financial accounting gives only limited information to the management. It is inadequate for
management in the task of decision making.
❖ Managerial decisions relate to future. Hence they are made on the basis of estimates and
projections. Financial accounting is inadequate for making future projections because it provides
only historical information.
❖ The present day management is of three tier system. Different levels of management needs
different information. Financial accounting fails to meet the information needs of different levels
of management.
❖ Financial accounting considers only quantifiable information. Nowadays business decisions are
influenced by a number of social factors. For this many of them are ignored in financial
accounting.
❖ The rapid change in technology and fast growth of business units have made the task of modern
management highly complicated. Financial accounting with its simple structure is not in a position
to cater the needs of modern management.
 Management Accounting

❖ This branch of accounting supplies necessary information to the

managers.
❖ On the basis of these information the evaluation of policies is done and
decisions for future are taken. It includes Ratio Analysis, Analysis of
financial statements, Fund flow Analysis, Cash flow Analysis etc.
 OBJECTIVES OF MANAGEMENT ACCOUNTING
• To assist in decision making process
• To formulate Planning and Policy
• To assist in controlling business operations (A
comparison is made between the actual performance of
each unit and the predetermined objectives to identify
deviations and take corrective actions to improve the
performance)
• To organize the data
• To Understand financial data
• To Identify business problem areas
• Interpretation (graphical representation) of financial
documents
 LIMITATIONS OF MANAGEMENT ACCOUNTING
1. Based on Financial and Cost Records
2. Personal Bias
3. Lack of Knowledge and Understanding of the Related Subjects
4. Provides only Data
5. Preference to Intuitive Decision Making
6. Management Accounting is only a Tool
7. Continuity and Participation
8. Broad Based Scope
9. Costly Installation
10. Resistance to Change
11. Evolutionary State
12. Unquantifiable Variables
 FINANCIAL ACCOUNTING V/S MANAGEMENT
ACCOUNTING
Financial Accounting Management Accounting

❑ The primary objective is recording business ❑ The objective of is to provide necessary

transactions in a systematic way and ascertains information to the management for the efficient
the business results and financial position of a discharging of its functions
business concern.
❑ It is an external accounting because it presents ❑ It is an internal accounting because it presents
information to the external parties like information to the management.
shareholders, creditors, bank etc.
❑ It is concerned with historical records relating to ❑ It is mainly concerned with future plans and
the past policies
❑ It is compulsory ❑ It is optional

❑ It relates to the business as a whole ❑ It deals with reports about a particular

department or division of an enterprise.
❑ More emphasis on precise data ❑ Less emphasis on precision. Estimates and future
data are mostly used
 FINANCIAL ACCOUNTING V/S MANAGEMENT
ACCOUNTING
Financial Accounting Management Accounting
❑ It is prepared in accordance with the GAAP ❑ It is prepared according to the internal requirements
of the management.
❑ It presents annual reports ❑ Its reports are of both shorter and longer durations.

❑ Financial accounting is based on measurements. ❑ Management accounting is based on judgment. Thus

Thus it is more objective it is more subjective
❑ It records only those transactions which can be ❑ It records not only monetary transactions but also
expressed in terms of money. non-monetary events like technical changes,
government policies etc
❑ The scope of financial accounting is not vast as ❑ The scope of management accounting is most wide
compared to management accounting. It does not because financial accounting, cost accounting,
include the techniques like costing, statistics, statistics and other techniques are used in it.
management accounting etc. It is a part of
management accounting
 Cost Accounting
❖ This branch of accounting has attained good importance in recent days.
❖ Under it, the raw materials, labors and other expenses incurred in the
industrial production and business activities are recorded regularly so that
production cost and per unit cost can be ascertained and the unnecessary
expenses can be checked out to control the cost.
❖ Cost accounting helps in maintaining a desirable margin between cost and
price so that business can earn profit. It also include job and contract costing,
process costing, operating costing and cost sheet preparation.
 Cost Accounting & its Importance

► Wheldon defines cost accounting as “classifying, recording and appropriate

allocation of expenditure for determination of costs of products or services and
for the presentation of suitably arranged data for purposes of control and
guidance of management”.
► Cost accounting aids price fixation
► Cost accounting eliminates wastages
► Cost accounting makes comparisons possible
► Cost accounting helps in determining and enhancing efficiency
► Cost Ascertainment
► Control of Costs
► Proper matching of cost with revenue
► Aids to Management Decision-making
 FINANCIAL ACCOUNTING V/S COST ACCOUNTING

Financial Accounting Cost Accounting

• It aims at safeguarding the interests of the business • It renders information for the guidance of the
and its proprietors and others connected with it. This management for proper planning, operation, control
is done by providing suitable information to various and decision making.
parties, such as shareholders or partners, present or
prospective creditors etc
• Financial accounts are kept in such a way as to meet • Cost accounts are generally kept voluntarily to meet
the requirements of the Companies Act, Income-tax the requirements of management. But now the
Act and other statues Companies Act has made it obligatory to keep cost
records in some manufacturing industries.
• It emphasizes the measurement of profitability • It aims at ascertainment of costs and accumulates
data for this very purpose.
• Financial accounts disclose the net profit and loss of • Cost accounts disclose profit or loss of each product,
the business as a whole job or service. This enables the management to
eliminate less profitable product lines and maximise
the profits by concentrating on more profitable ones.
 FINANCIAL ACCOUNTING V/S COST ACCOUNTING
Financial Accounting Cost Accounting

• Financial accounts deal mainly with actual facts and • Cost accounts deal partly with facts and figures and
figures partly with estimates.

• In case of financial accounts, stress is on the • In cost accounts the emphasis is more on aspects of
ascertainment and exhibition of profits earned or planning and control.
losses incurred in the business.
• Financial accounting is concerned with historical • Cost accounting is concerned with historical cost but
records also with pre-determined cost
• Financial accounts are concerned with external • Cost accounts are concerned with internal
transactions i.e. transactions between the business transactions which do not form the basis of payment
concern on one side and third parties on the other. or receipt of cash
These transactions form the basis for payment or
receipt of cash
• The costs are reported in aggregate in financial • Costs are broken into unit basis in cost accounts.
accounts
• Financial reports (profit and loss account and balance • Cost reporting is a continuous process and may be
sheet) are prepared periodically – quarterly, half daily, weekly, monthly etc
yearly or annual basis.