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Chapter # 1
Introduction to Accounting
Why Accounting Is Needed
• Helps answering questions like
• Am I making or losing money from my business?
• How much am I worth?
• Should I put more money in my business or sell it and go into another business?
• How much is owed to me, and how much do I owe?
• How can I change the way I operate to make more profit?

Objective of accounting

 Objective of accounting may differ from business to business depending upon their specific
requirements.
 However, the following are the general objectives of accounting. §
 Keeping systematic record.
 Determine the results of the operation.
 Find out the financial position of the business.
 Portray the liquidity position.
 To protect business properties.
 To facilitate rational decision – making.
 To satisfy the requirements of law.

Accounting Vs Economics
 accounting and economics are closely related disciplines.
 Accounting is the process of recording financial transactions.
 Economics is the study of how individuals, businesses, and governments make decisions
about the allocation of scarce resources.
 Accounting provides economists with the data they need to study economic trends and
develop economic theories.
 For example, economists use accounting data to track changes in GDP, inflation, and
employment. or study the behavior of consumers, producers, and investors.
 Economics, in turn, provides accountants with a framework for understanding and
interpreting financial data.
For example, accountants use economic principles to assess the risk of investments and to make
recommendations about how to allocate resources

 Here are some specific examples of the relationship between accounting and economics:
• Financial accounting provides information about a company's financial performance,
which can be used by economists to study the health of the economy as a whole.
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• Managerial accounting provides information about the costs and benefits of different
business activities, which can be used by economists to study the behavior of businesses.
• Tax accounting provides information about the taxes that businesses and individuals pay,
which can be used by economists to study the impact of tax policy on the economy.
• Auditing provides assurance about the reliability of financial information, which is
important for both economists and accountants.
 Overall, accounting and economics are complementary disciplines that provide insights
into the financial and economic aspects of human activity.
 In simple words, Economics requires statistical data and analysis, and accounting provides
that.

1. Accounting
The process or work of keeping financial records. Such as measurements, process, communication
of all financial activities of any person, business or corporation.

2. Accounting System

• Under cash system of accounting entries are made only when cash is received or paid
• Accrual System: This is also known as mercantile system of accounts.
• Under this system business transactions are recorded as and when it take place irrespective
of amount / cash received or paid
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3. Single Entry System:

The single-entry system appears to be time saving and economical, but it is unscientific, having
number of defects. Under single Entry system only few personal accounts are kept. This system
is followed by sole proprietor, having total control on cash as well as on goods.

4. Double-entry bookkeeping

Double-entry bookkeeping is a method of recording transactions where for every business

transaction, an entry is recorded in at least two accounts as a debit or credit. The amounts recorded
as debits must be equal to the amounts recorded as credits.

5. BRANCHES OF ACCOUNTING
Financial Accounting
It is concerned with record keeping directed towards the preparation of Trial balance, profit
and loss account and balance sheet.
Cost Accounting
Cost Accounting is the process of accounting for costs. It shows classification and analysis of
cost on the basis of functions process, products etc. It also deals with cost computation, cost
saving, cost reduction etc. In cost accounting cost per unit of output produced or services
rendered is ascertained. It helps management in the control of cost of output or services
rendered.
Management Accounting
It deals with the processing of data sentenced in financial accounting and cost accounting for
managerial decision making. It also deals with application of managerial economic concepts
for decision making for the efficient running of the business and thus in maximising profits.
Tax Accounting

This branch of accounting is becoming important because of complex tax laws governing
income-tax, Excise duty, value added tax etc. Tax planning is now a days is very important as
well to save tax, Account for tax deducted at sources, payment of advance tax, Filing of various
tax returns in time as well as taking Cenvat credit for various taxes whenever is available.
6. Transaction
In a simple statement, transaction means the exchange of money or moneys worth from one
account to another account Events like purchase and sale of goods, receipt and payment of
cash for services or on personal accounts, loss or profit in dealings etc., are the transactions”.
Cash transaction is one where cash receipt or payment is involved in the exchange. Credit
transaction, on the other hand, will not have cash’ either received or paid, for something given
or received respectively, but gives rise to debtor and creditor relationship. Non cash transaction
is one where the question of receipt or payment of cash does not at all arise, e.g. Depreciation,
return of goods etc.
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Important Terms
7. Goods or Merchandise
It is a general term used for the articles in which the business deals; that is, only those articles
which are bought for resale for profit are known as Goods
or
For example. If a trader purchases furniture for use in the business. it will not be regarded as "goods". but
if it is purchased for resale. it will be regarded as "goods
Thus,
• Mobile phones will be "goods" to a mobile seller.
• Cloth will be "goods" to a cloth dealer.
• Cement is goods or merchandise for a cement dealer.
• Furniture is goods or merchandise for a furniture vendor.
• Books will be "goods" to a Book - Seller
• Stationery will be "goods" to a Stationery dealer.
e.g. If Mr. A deals in cars then cars are goods for him. When he purchases Air conditioner for his
office then it will not be termed as goods.

Concepts as purchaser (you buy things for resale purpose)

8. Purchases
In accounting language, the word "purchases" has a special meaning. When saleable goods are bought in a
business, it is said that "purchases" have been made.
For example,
1. Stationery is purchased by a stationer is called “Purchases”
2. Cloth purchased by a cloth merchant is called “Purchases”
3. Cement purchased by a cement dealer is called “Purchases
There are two type of Purchase
1. Cash Purchases
2. Credit Purchases or "Purchases on Account

9. Cash Purchases
When goods are purchased for immediate (at the same time) cash payment these are called cash purchases.
For example,
If Mr. A purchased goods worth $2,000 on June 1, and payment is made by him on the same day
then this will be termed as cash purchases.
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10. Credit Purchases or "Purchases on Account

If goods are purchased but payment is postponed to a future date (not made to at the same time) is called
"credit purchases" or "Purchases on account".
For example,
If Mr. A purchases goods worth $3,000 on June 1, and promises to pay this amount one month later i.e.
July, 1 then this will be termed as credit purchases.

11. Purchases Returns or Returns Outwards

In business dealings, a return may occur when a customer returns to the seller /producer a part, or all of the
items purchased for particular reasons, i.e. goods are faulty, not according to specification, damaged or
below standard. Such return of goods is known as "Purchases returns" or "Returns to suppliers".
For example,
we purchased 10 laptops (goods) from media houses for Rs. 550,000. On the delivery of goods, it is found
that 3 Laptops are of inferior quality. The return of these 3 Laptops to the seller will be a case of purchases
returns.

12. Purchases Discount and Sales Discount

The Concession provided by the supplier to the buyer on purchases of goods is known as "Purchases
discount" to the buyer and "Sales discount" to the seller (supplier).
For example,
John Foods (Pvt) Limited announced 10% to 25% discount on its all products from 1st July to 20 July 2022.
When you will purchase some products within announced dates you will get Purchases discount.
Or
Gul Ahmed upto 70% off winter offer, J. azadi sale, Daraz 11.11 offers,

13. Allowance
If the customers or buyers find that goods purchased have minor defects. In that case, the seller may agree
to reduce the price of damaged or defective goods to encourage the buyer to keep the goods. such reduction
in price is known as "Purchases allowance" to the buyer and "Sales allowance" to the seller.
For example:
Bareeze may offer reduce price on some defected shirts

14. Account Payable

It is a liability account that represents debts owed to the creditors of a business. It is

normally a current liability. In this situation there is no formal written promise to pay.
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15. Notes Payable

It is a liability that results from purchases of goods and services or loans. Usually, a
written instrument (written promise) that includes interest. It is a form of Long-term Debt.

16. Creditors
The persons or company from whom the goods or services are purchased on credit (to
whom the money is to be paid in near future) and to whom the amount is payable are called
creditors. Creditors are also termed as Accounts Payable or not payables.

Or
A person to whom money is owing by the firm is called creditor

1. The person or business who will receive the money is - Creditor.

2. the person or business who will pay the money is -Debtor.

Concepts as seller (you sell things)

17. Sales
We have studied above those goods are purchased for selling purposes. When these purchased
goods are sold to customers at a particular price are termed as sales. In simple words goods sold
are called sales.
For example
1. Cloth sold by a cloth merchant is known as “Sales”
2. Cement sold by a cement dealer is known as “Sales”
3. Cars sold by a car dealer is known as “Sales”
4. Mobile sold by mobile seller.
There two types of Sales:
• Cash Sales
• Credit Sales
18. Cash Sales
When goods are sold on cash and price is received at the time of sale of goods, such sales
are known as "Cash sales".
For example:

If Mr. B has sold goods on September 1, 2022, and he received cash at the same time then this will
be termed as cash sales.
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19. Credit Sales

When goods are sold, and cash is not received immediately (does not pay the price of goods
at the same time) but postponed/delay it to a future date then this is termed as credit sales or "Sales
on account.". This method of payment is also called deferred payment.
For example:
If July 1, 2022, Mr. C sold goods worth $1,000 and cash is not received but postponed to August
1, 2022. This will be termed as credit sales.

20. Sales Returns or Returns Inwards

When a customer to whom goods have been sold finds that the goods are defective, unsatisfactory,
below standard, or not according to specification, he/she may return these goods to the seller. To the seller,
such return of goods is known as "Sales returns" or "Returns Inwards" or "Returns from customers.

21. Trade Discount

At the time of selling goods, the manufacturer or wholesaler allows retailers such a discount
(concession). It is allowed at a certain percentage of the listed or catalogue price.
For example,
If a book has a listed price of $350 and it is sold by the bookseller for $315. Then he has given a
trade discount of $35 or a trade discount of 10%. It means the net price of the books is $315
(350-35).
It should be noted that both the buyer and seller will record the price of goods as $315 (not 350)
in their books of account. In other words, trade discount is not recorded in books of account.

22. Debtors

The persons to whom the goods or services have been sold on credit and from whom the
amount is receivable are called “Debtors”. Debtors are also termed as Accounts Receivable.
For example
John Sold goods to Harry on credit for $500, Harry is a Debtor of John.

23. Accounts Receivable

It results from the credit sales, and for many retailing firms, accounts receivable represents
a substantial portion of their current assets.

24. Note Receivable

It is an unconditional promise in writing by an individual or business to pay a definite

amount at a definite date or on demand.
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25. Cash Discount

Cash discount is a reduction or allowance given by a creditor to a debtor to encourage
the early payment. If payment is due within a specified period. It is usually 2% or less.

For example,

John Sold Books goods to Harry for $500 on credit basis. John offers an allowance of 2% to Harry,
that is if he will pay amount within 10 days, he will get 2% discount. It means, if Harry pays within
10 days, then he will pay only Rs. 490 (500-(500x (0.20)). Such a discount is known as "Cash
Discount”.

26. Capital or Owner's Equity

Capital is the amount provided/invested from its owner or owners to start or to operate a
business activity.
Now the question is: who provides funds to a business unit. Mainly there are two sources of funds:
i. Funds supplied by the owner/owners.
ii. Debt capital: Funds supplied by the external parties like bank taking loan etc.
For example:

Mr. X started a business equity (total funds) with $10,000. Out of 10,000, $ 7,000 have been
provided by the owner, Mr. X and $ 3,000 have been borrowed from a bank.

27. Assets
Any physical thing or right owned that has a money value is an asset. In other words, an asset is
that expenditure which results in acquiring of some property or benefits of a lasting nature.
For example,
cash, debtors, stock, accounts receivable, prepaid expenses, land, buildings, plant, machinery,
vehicles, furniture, fixtures, goodwill, patents, copyrights, trademarks, patterns, and deferred
costs.

28. Liabilities:
Liabilities are the present debts or obligations of a business or creditors claims against the assets
of the business arising from past events, the settlement of which is expected to result in an outflow
from the enterprise are known as "Liabilities".
Or
Liabilities mean the total amount which a business is legally bound to pay to the outsiders,
e.g. creditors, Bills payable, tax, rent Accounts payable, Bank loan etc.

29. Accounting Period

Accounting periods are time period for which a business generally prepares its financial statements
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and used to estimate the profit, loss, and financial position of a business for a that specific time
window. Mostly it is prepared for one year, but they may also be for one month or for one quarter.

30. Revenue
It is defined as the inflow of assets which result in an increase in the owner’s equity. It includes
all incomes like sales receipts, interest, commission, brokerage etc., However, receipts of capital
nature like additional capital, sale of assets etc., are not a part of revenue
For example:
Kyra sold goods to a customer for $500 and he paid $500. This amount is revenue.
Or
Mr. A rent out his building, the rent he received is revenue.

TYPES OF REVENUE:

a. Sales: The total price of goods sold

b. Interest earned
c. Fees earned
d. Rent earned
e. Commission earned

22. Expenses
The amount or cost paid for obtaining revenues (goods or services) provided by a business.
Or
Expenses are the cost of producing revenue in a particular accounting period.
For example,
salaries for employees, telephone charges, rent of the building, insurance and
transportation etc. All these costs are necessary to attract and serve the customers and thereby to
obtain revenue. Expenses are sometimes also referred to as the "cost of doing business" or "expired
costs".

23. Net Income or Net Profit

Net income shows how much money a company is making after subtracting all expenses. It can
also be referred to as “net profit” or “the bottom line.” Net Income is usually found at the bottom
of a company’s income statement.
Net income or net profit = Revenue- Expenses

24. Balance Sheet

Balance sheet is a financial document that shows the relationship between a company’s assets,
liabilities, and shareholder equity at a particular point in time.
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25. Drawings
Cash or goods taken out of the business by owner for his personal use.
31. Losses
Loss really means something against which the firm receives no benefit. It represents
money given up without any return. It may be noted that expense leads to revenue but
losses do not. (e.g.) loss due to fire, theft and damages payable to others.
32. Stock
The goods purchased are for selling, if the goods are not sold out fully, a partof the total
goods purchased is kept with the trader unlit it is sold out, it is said to be a stock. If there
is stock at the end of the accounting year, it is said to be a closing stock. This closing stock
at the yearend will be the opening stock for the subsequent year.
33. Stocks/shares
A share is one unit of ownership interest in a corporation. A share entitles its owner to a portion
of the dividends and residual value of the issuing entity. A shareholder is also entitled to vote on
certain issues at periodic shareholder meetings.
34. Accounting equation
Assets = Liabilities + Capital
(Or)
Capital = Assets – Liabilities
(Or)
Liabilities = Assets – Capital.
35. Rules for accounting equation:
Following rules help in making the accounting equation:
i. Assets:
If there is increase in assets, this increase is debited in assets account. If there is decrease
in assets, this decrease credited in assets account.
ii. Liabilities:
When liabilities are increase, outsider’ s equities are credited and when liabilities are
decreased, outsider’s equities are debited.
iii. Capital:
When capital is increased, it is credited and when capital is withdrawn, it is debited.
iv. Expenses:
Owner’s equity is decreased by the amount of revenue expenses.
v. Income or profits:
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Owner’s equity is increased by the amount of revenue income

36. Dual Aspect Concept
This concept based on double Entry book-keeping which means that Accounting system is
set up in such a way that a record is made of the two aspects of each transaction that affects
the record. The recognition of the two aspects of every transaction is known as dual aspects
concept. Modern Financial Accounting considers both aspects of every transaction.

History of accounting

• Accounting is as old as civilization. It was initiated in Babylonia and Egypt around 4000 BC.
Clay tablets was used to record the transaction. Egyptians used account to record the safe
keeping of gold and the valuables in treasures. Babylonia was known as the city of commerce.
• Accounts was used for business to discover losses due to fraud and inefficiency.
• In Greece accounts was used to distribute the revenue received maintaining total
receipts/payments and equalize/balance of government financial transaction.
• Coined money was introduced in about 600 B.C.

Luco Pacioli is the father of accounting. He introduced Double Entry System of account in 1494
at Venice in Italy. If the total of left side and right side does not tally Pacioli says: “that would
indicate a mistake in your ledger.

Accounting and global business

Globalization occurs as managers become aware of and involve in cross-border trade and
operations. Think of globalization as a continuous process where at the most basic level a
purely domestic company’s managers become aware that changes in foreign exchange rates,

Globalization typically progresses through a series of stages that include

• Exporting is selling a good or service to a foreign customer. Which is created by that local
country.
• Licensing gives up some control for a monetary return. contractual agreement between a
company and a foreign party allowing the use of trademarks, patents, technology, designs,
processes, intellectual property, or other proprietary advantage. Most major multinational
food manufacturing companies are involved in some form of international product
licensing. Honda, Toyota.
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• international joint venture is a company owned by two or more companies from different
countries.
• wholly owned international subsidiary is created when a company uses its own funds to
construct or purchase 100 percent equity control of a foreign subsidiary.
• global sourcing is the close coordination of R&D, manufacturing, and marketing across
national boundaries and typically includes exporting, licensing, joint ventures, and wholly
owned subsidiaries in cross-border operations.

harmonization of global financial reporting standards

Cross-border differences in accounting and reporting create analysis and comparability

problems between and among companies. The need for comparable information has led to the
demand for harmonization. The International Accounting Standards Board
(IASB) is particularly interested in synchronizing and is charged with the responsibility of
establishing and gaining acceptance of international financial reporting standards (IFRSs).
This committee represents over 150 professional organizations from more than 120 countries
and over 2 million accounting professionals worldwide. While the IASB has no regulatory
authority in any country, it uses its influence to move the reporting standards of all countries
closer together in hopes of better harmonizing those standards. For countries that do not have
well-developed capital markets.

ACCOUNTING FOR TRANSACTIONS WITH FOREIGN COMPANIES

When a Pakistani company buys or sells merchandise in a transaction with a foreign company, the
transaction price may be stipulated either in PKR or in units of the foreign currency. If the price is
stated in PKR the company encounters no special accounting problems. The transaction may be
recorded in the same manner as are similar transactions with domestic suppliers or customers.

If the transaction price is stated in terms of the foreign currency, the company encounters
two accounting problems.
1. the company’s accounting records are maintained in local currency the transaction price must
be translated into dollars before the transaction can be recorded.
2. problem arises when (1) the purchase or sale is made on account (deferred payment) and (2)
the exchange rate changes between the date of the transaction and the date that the account is
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paid. This fluctuation in the exchange rate will cause the company to experience either a gain
or a loss in the settlement of the transaction. For this purpose, Hedging is used. It is offsetting
the probability of loss from fluctuations in the exchange rate fluctuations. It can be
accomplished by having offsetting/ adjusting receivables and payables in the foreign currency
or by buying or selling foreign currency future contracts.

SOLE Proprietorships
 A sole proprietorship is an independent business owned by one person. Often the owner
also acts as the manager.
 Proprietorships are the most common form of business organization because they are so
easy to start.
 From an accounting viewpoint, a sole proprietorship is regarded as a business entity
separate from the other financial activities of its owner.
 The owner is personally liable for the debts of the business. If the business encounters
financial difficulties, creditors(lender) can force the owner to sell his or her personal assets
to pay the business debts.

Partnership
 Partnership is a form of business organization in which two or more persons willingly join
for purposes of carrying out business activities.
 Partnerships, like sole proprietorships, are widely used for small businesses.
 Examples some large professional practices, law firms, are organized as partnerships.
 From an accounting standpoint, a partnership is viewed as a business entity separate from
the personal affairs of its owners.

Corporation
 A corporation is a type of business organization which issues share.
 Share holder are the owners of a corporation. They are not personally liable for the debts
of the business.
 The stockholders are generally free to sell some or all of these shares to other investors at
any time.

Difference between
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 Corporation big companies owned by shareholders. Shareholders have the rights to profits
but nor responsible for obligations.
 Partnership owned by two or more people. Share profits and are responsible for
obligations.

Users Of Accounting Information

 Every employee of the firm/enterprise uses internal accounting information. From basic
labor categories to the chief executive officer (CEO).
 The amount of use and, the involvement in the design of accounting information systems
vary considerably.
 Examples of internal users of accounting information systems are as follows:
• Board of directors • Business unit managers
• Chief executive officer (CEO) • Plant managers
• Chief financial officer (CFO) • Store managers
• Vice-presidents (information services, • Line supervisors
human resources, ethics, and so forth)

External Users Of Accounting Inform

 External users of accounting information are individuals and other enterprises that have a
financial interest in the company, but
 They are not involved in the day-to-day operations of that company.
 External users of financial information may include the following:

• Owners • Suppliers
• Creditors • Customers
• Potential investors • Trade associations
• Labor unions • General public
• Governmental agencies
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Career Paths
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