ACCOUNTING – CLASSIFICATION

The various sub-fields of the accounting are:

FINANCIAL ACCOUNTING
it is commonly termed as Accounting. The American Institute of Certified Public Accountants
defines Accounting as “an art of recoding, 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.”

COST ACCOUNTING
According to the Chartered Institute of Management Accountants (CIMA), Cost
Accountancy is defined as “application of costing and cost accounting principles, methods
and techniques to the science, art and practice of cost control and the ascertainment of
profitability as well as the presentation of information for the purpose of managerial decision-
making.”

MANAGEMENT ACCOUNTING
Management Accounting is concerned with the use of Financial and Cost Accounting
information to managers within organizations, to provide them with the basis in making
informed business decisions that would allow them to be better equipped in their
management and control functions.

BASIS OF ACCOUNTING - ACCRUAL BASIS AND CASH BASIS OF ACCOUNTING

Accrual Basis of Accounting

Accrual Basis of Accounting is a method of recording transactions by which revenue, costs,

assets and liabilities are reflected in the accounts for the period in which they accrue. This
basis includes consideration relating to deferrals, allocations, depreciation and amortization.
This basis is also referred to as mercantile basis of accounting.

Cash Basis of Accounting

Cash Basis of Accounting is a method of recording transactions by which revenues,

costs, assets and liabilities are reflected in the accounts for the period in which
actual receipts or actual payments are made.
ACCOUNTING PRINCIPLES

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

A widely accepted set of rules, conventions, standards, and procedures for reporting financial
information, as established by the Financial Accounting Standards Board are called Generally
Accepted Accounting Principles (GAAP).

These are the common set of accounting principles, standards and procedures that companies use to
compile their financial statements. GAAP are a combination of standards (set by policy and simply the
commonly accepted ways of recording and reporting accounting information.

ACCOUNTING CONCEPTS AND CONVENTIONS

As seen earlier, the accounting information is published in the form of financial statements. The three
basic financial statements are

 The Profit & Loss Account that shows net business result i.e. profit or loss for a certain periods
 The Balance Sheet that exhibits the financial strength of the business as on a particular dates
 The Cash Flow Statement that describes the movement of cash from one date to the other.

As these statements are meant to be used by different stakeholders, it is necessary that the information
contained therein is based on definite principles, concrete concepts and well accepted convention.

Accounting principles are basic guidelines that provide standards for scientific accounting practices and
procedures. They guide as to how the transactions are to be recorded and reported.

Business Entity Concept

This concept explains that the business is distinct from the proprietor. Thus, the transactions of business
only are to be recorded in the books of business.
Going Concern Concept
This concept assumes that the business has a perpetual succession or continued existence.
Money Measurement Concept
According to this concept only those transactions which are expressed in money terms are to be
recorded in accounting books.
THE ACCOUNTING PERIOD CONCEPT
Businesses are living, continuous organisms. The splitting of the continuous stream of business events into
time periods is thus somewhat arbitrary. There is no significant change just because one accounting
period ends and a new one begins, normally an accounting period is one year

THE ACCRUAL CONCEPT

The accrual concept is based on recognition of both cash and credit transactions. In case of a cash
transaction, owner’s equity is instantly affected as cash either is received or paid. In a credit
transaction, however, a mere obligation towards or by the business is created. When credit transactions
exist (which is generally the case), revenues are not the same as cash receipts and expenses are not
same as cash paid during the period.
Today’s accounting systems based on accrual concept are called as Accrual system or mercantile
system of accounting.

REALIZATION CONCEPT
This concept speaks about recording of only those transactions which are actually realized. For
example Sale or Profit on sales will be taken into account only when money is realized i.e. either cash is
received or legal ownership is transferred.

MATCHING CONCEPT
It is referred to as matching of expenses against incomes. It means that all incomes and expenses
relating to the financial period to which the accounts relate should be taken in to account without
regard to the date of receipts or payment.

FULL DISCLOSURE CONCEPT

As per this concept, all significant information must be disclosed. Accounting data should properly be
clarified, summarized, aggregated and explained for the purpose of presenting the financial
statements which are useful for the users of accounting information. Practically, this principle
emphasizes on the materiality, objectivity and consistency of accounting data which should disclose
the true and fair view of the state of affairs of a firm.

DUALITY CONCEPT
According to this concept every transaction has two aspects i.e. the benefit receiving aspect and
benefit giving aspect. These two aspects are to be recorded in the books of accounts.

Verifiable Objective Evidence Concept

Under this principle, accounting data must be verified. In other words, documentary evidence of
transactions must be made which are capable of verification by an independent respect. In the
absence of such verification, the data which will be available will neither be reliable nor be
dependable, i.e., these should be biased data. Verifiability and objectivity express dependability,
reliability and trustworthiness that are very useful for the purpose of displaying the accounting data and
information to the users.

Historical Cost Concept

Business transactions are always recorded at the actual cost at which they are actually undertaken.
The basic advantage is that it avoids an arbitrary value being attached to the transactions. Whenever
an asset is bought, it is recorded at its actual cost and the same is used as the basis for all subsequent
accounting purposes such as charging depreciation on the use of asset, e.g. if a production
equipment is bought for ` 1.50 crores, the asset will be shown at the same value in all future periods
when disclosing the original cost.
 DOUBLE ENTRY SYSTEM
Features of Double Entry System

Every transaction has two fold aspects, i.e., one party giving the benefit and the other receiving the
benefit.

Every transaction is divided into two aspects, Debit and Credit. One account is to be debited and the
other account is to be credited.

Every debit must have its corresponding and equal credit

TYPES OF ACCOUNTS

Let us see what each type of account means:

Personal Account: As the name suggests these are accounts related to persons. These persons could be
natural persons like Suresh’s A/c, Anil’s a/c, Rani’s A/c etc.

The persons could also be artificial persons like companies, bodies corporate or association of persons
or partnerships etc. Accordingly, we could have Videocon Industries A/c, Infosys Technologies A/c,
Charitable Trust A/c, Ali and Sons trading A/c, ABC Bank A/c, etc.

There could be representative personal accounts as well. Although the individual identity of persons
related to these is known, the convention is to reflect them as collective accounts. e.g. when salary is
payable to employees, we know how much is payable to each of them, but collectively the account is
called as ‘Salary Payable A/c’. Similar examples are rent payable, Insurance prepaid, commission
pre-received etc. The students should be careful to have clarity on this type and the chances of error
are more here.

Real Accounts: These are accounts related to assets or properties or possessions. Depending on their
physical existence or otherwise, they are further classified as follows:-

Tangible Real Account – Assets that have physical existence and can be seen, and touched. e.g.
Machinery A/c, Stock A/c, Cash A/c, Vehicle A/c, and the like.

Intangible Real Account – These represent possession of properties that have no physical existence but
can be measured in terms of money and have value attached to them. e.g. Goodwill A/c, Trade mark
A/c, Patents & Copy Rights A/c, Intellectual Property Rights A/c and the like.

Nominal Account: These accounts are related to expenses or losses and incomes or gains e.g. Salary
and Wages A/c, Rent of Rates A/c, Travelling Expenses A/c, Commission received A/c, Loss by fire
A/c etc.
Double Entry System

Features of Double Entry System

Every transaction has two fold aspects, i.e., one party giving the benefit and the other receiving the
benefit.

Every transaction is divided into two aspects, Debit and Credit. One account is to be debited and the
other account is to be credited.

Every debit must have its corresponding and equal credit.

For Assets Increase in Assets Dr.

Decrease in Assets Cr.
For Liabilities Decrease in Liabilities Dr.
Increase in Liabilities Cr.
For Capital Decrease in Capital Dr.
Increase in Capital Cr.
For Incomes Decrease in Income Dr.
Increase in Income Cr.
For Expense Increase in Expense Dr.
Decrease in Expense Cr.

Illustration 1.

Ascertain the debit and credit from the following particulars under Modern Approach.

a. Started business with capital.

b. Bought goods for cash.
c. Sold goods for cash.
d. Paid salary.
e. Received Interest on Investment.
f. Bought goods on credit from Mr. Y
g. Paid Rent out of Personal cash.
Solution:

Effect of Transaction Account To be debited/Credited

(a) Increase in Cash Cash A/c Debit

Increase in Capital Capital A/c Credit
(b) Increase in Stock Purchase A/c Debit
Decrease in Cash Cash A/c Credit
(c) Increase in Cash Cash A/c Debit
Decrease in Stock Sale A/c Credit
(d) Increase in Expense Salary A/c Debit
Decrease in Cash Cash A/c Credit
(e) Increase in Cash Cash A/c Debit
Increase in Income Interest A/c Credit
(f) Increase in Stock Purchase A/c Debit
Increase in Liability Y A/c Credit
(g) Increase in Expense Rent A/c Debit
Increase in Liability Capital A/c Credit
ACCOUNTING EQUATION

The whole Financial Accounting depends on Accounting Equation which is also known as
Balance Sheet Equation.
01. The basic Accounting Equation is:

ASSETS = LIABILITIES + OWNER’S EQUITY

02. From the basic equation we extract the following Equation s

a. Non-Current Assets +Current Assets = Non-Current Liabilities+ Current Liabilities +

OWNER’S EQUITY

b. NCA +CA = NCL+ CL +Income - Expenditure OWNER’S EQUITY

Note :While trying to do this correlation, please note that incomes or gains will increase
owner’s equity and expenses or losses will reduce it.

Example - 01
Prepare an Accounting Equation from the following transactions in the books of Mr. SARANGAN for
January, 2020 :-

01 Invested Capital in the firm ` 20,000

02 Purchased goods on credit from Das & Co. for ` 2,000
Bought plant for cash ` 8,000
8 Purchased goods for cash ` 4,000
12 Sold goods for cash (Cost ` 4,000 + Profit ` 2,000) ` 6,000.
18 Paid to Das & Co. in cash ` 1,000
22 Received from B. Banerjee ` 300
25 Paid salary ` 6,000
30 Received interest ` 5,000
31 Paid wages ` 3,000

Date Transaction Assets= Liabilities+ Capital

2020 Invested Capital in the firm ` 20,000 20,000 - 20,000
Jan.1
2 Purchased goods on credit from Das & Co. `2000 +2,000 +2,000 -
4 Bought Plant for cash ` 8,000 +8,000 - -
-8,000
8 Purchased goods for cash ` 4,000 +4,000 -- --
-4,000
12 Sold Goods for cash (Cost ` 4,000 + Profit ` 2,000) +6,000 +2,000
-4,000
18 Paid to Das & Co. for ` 1,000 -1,000 -1,000 -
+300
22 Received from B. Banerjee for ` 300 -300
5 Paid Salary -6000 -6000
30 Received Interest +5000 +5000
31 Paid Wages -3000 -3000
+19000 +1000 +18000

Total Assets as at 31st January is 19000

Total Liability as at 31st January is 1000+18000
So
Here Assets = Liabilities as at 31st January