UNIT 01 Meaning and Scope of Accounting:

1.1 Definition of Accounting and Need for Accounting

1.2 Development of Accounting and Accounting as Information System, and Qualitative
characteristics of Accounting Information System
1.3 Book-Keeping and Accounting and Is Accounting a Science or an Art?
1.4 Accounting and other Disciplines: Accounting and Economics, Accounting and Statistics,
Accounting and Mathematics, and Accounting and Law
1.5 Introduction of Branches of Accounting: Financial Accounting, Cost Accounting,
Management Accounting, Human Resource Accounting, Environmental or Green Accounting,
and Inflation Accounting
1.6 Functions, Objectives, Limitations, and end Users of Financial Accounting
1.7 Meaning and Nature of Accounting Principles:
1.7.1 Accounting Concepts: Business Entity, Going Concern, Money Measurement, Cost,
Dual Aspect, Accounting Period, Period Matching of Cost and Revenue, Realization, and
Accrual
1.7.2 Accounting Conventions: Conservatism, Full Disclosure, Consistency,
and Materiality

pg. 1
Definition of Accounting

Definition by the American Institute of Certified Public Accountants (Year 1961):

“Accounting is 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 result thereof”.
Definition by the American Accounting Association (Year 1966):
“The process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by the users of accounting”.
In order to appreciate the nature of accounting it is necessary to understand the following
relevant aspects of the definition of accounting:
Economic events : It is the occurring of the consequence to a business organization which
consists of transactions that are measurable in monetary terms. Purchase of a Machinery,
installing and keeping it ready for manufacturing is an economic event which consists of a
number of financial transactions. These transactions are (a) buying the machine, (b)
transporting the same, (c) preparing the site for its installation and (d) incurring expenditure
on installing the same.
Identification implies determining what transactions are to be recorded i.e. items of financial
character are to be recorded. For example, goods purchased for cash or on credit will be
recorded. Items of non-financial character such as changes in managerial policies, etc. are not
recorded in the books of accounts.
Measurement means quantification of business transactions into financial terms by using
monetary unit. If an event cannot be quantified in monetary terms, it is not considered fit for
recording in the books of the firm. That is why important items like appointment, signing of
contracts, etc. are not shown in the books of accounts.
Recording : Having identified and measured the economic events in financial terms, these are
recorded in the books of accounts in monetary terms date wise. The recording of the business
transactions is done in such a manner that the necessary financial information is summarized
according to well established accounting practices.
Communication : The economic events are identified, measured and recorded in such a
manner that the necessary relevant information is generated and communicated in a certain

pg. 2
form to the management and other internal and external users of information. The financial
information is regularly communicated through accounting reports.
Organisation : refers to a business enterprise whether for profit or not for profit motive.
Interested users of information. Many users need financial information to make important
decisions. These users can be investors, creditors, labour unions, Trade Associations, etc.

Need for Accounting

Accounting is required for the following reasons:

Financial Record Keeping: Accounting ensures accurate recording of all financial transactions.
It provides a detailed financial history of the business.
 Decision Making: It supplies critical financial information and analyses. This aids in
making informed decisions regarding operations, investments, and strategy.
 Regulatory Compliance: Accounting helps businesses comply with legal and financial
reporting requirements. This avoids penalties and maintains a positive reputation.
 Performance Evaluation and Strategic Planning: Accounting enables the evaluation of
business performance through detailed financial analysis. It supports strategic planning
for future growth.
 Transparency and Stakeholder Trust: Accounting provides clear and accurate financial
reports. This fosters transparency, building trust among investors, creditors, and other
stakeholders.

Objectives of Accounting

(i) Providing Information to the Users for Rational Decision-making to stakeholders such as
owners, management, creditors, investors, etc. Various outcomes of business activities such as
costs, prices, sales volume, value under ownership, return of investment, etc. are measured in
the accounting process. All these accounting measurements are used by stakeholders in course
of business operation. Hence, accounting is identified as ‘language of business’.
(ii) Systematic Recording of Transactions To ensure reliability and precision for the
accounting measurements.
(iii) Ascertainment of Results of above Transactions ‘Profit/loss’ is a core accounting
measurement. It is measured by preparing profit and loss account for a particular period.

pg. 3
Various other accounting measurements such as different types of revenue expenses and
revenue incomes are considered for preparing this profit and loss account. Difference between
these revenue incomes and revenue expenses is known as result of business transactions
identified as profit/loss. As this measure is used very frequently by stockholders for rational
decision making, it has become the objective of accounting. For example, Income Tax Act
requires that every business should have an accounting system that can measure taxable
income of business and also explain nature and source of every item reported in Income Tax
Return.
(iv) Ascertain the Financial Position of Business ‘Financial position’ is another core
accounting measurement. Financial position is identified by preparing a statement of
ownership i.e., Assets and Owings i.e., liabilities of the business as on a certain date. This
statement is popularly known as balance sheet. Various other accounting measurements such
as different types of assets and different types of liabilities as existed at a particular date are
considered for preparing the balance sheet. This statement may be used by various
stakeholders for financing and investment decision.
(v) To Know the Solvency Position Balance sheet and profit and loss account prepared as
above give useful information to stockholders regarding concerns potential to meet its
obligations in the short run as well as in the long run.
(vi) Maintenance of Records of Business Transactions Accounting is used for the maintenance
of a systematic record of all financial transactions in book of accounts. Even the most brilliant
executive or manager cannot accurately remember the numerous amount of varied
transactions such as purchases, sales, receipts, payments, etc. that takes place in business
everyday. Hence, a proper and complete records of all business transactions are kept regularly.
Moreover, the recorded information enables verifiability and acts as an evidence.
(vii) Calculation of Profit and Loss The owners of business are keen to have an idea about the
net results of their business operations periodically, i.e. whether the business has earned
profits or incurred losses. Thus, another objective of accounting is to ascertain the profit
earned or loss sustained by a business during an accounting period which can be easily
workout with help of record of incomes and expenses relating to the business by preparing a
profit or loss account for the period. Profit represents excess of revenue (income), over
expenses. If the total revenue of a given period is ` 6,00,000 and total expenses are ` 5,40,000
the profit will be equal to ` 60,000(` 6,00,000 – ` 5,40,000). If however, the total expenses
exceed the total revenue, the difference reflects the loss

pg. 4
Scope of accounting

1. Accounting is concerned with financial transactions and events which bring' about a change
in the resources (or wealth) position of the business firm. Such transactions have to be
identified first, as and when they occur. It is not difficult because. there will be proof in the
form of a bill or receipt (called vouchers). With the help of these bills and receipts
identification of a transaction is easy. For example, when you purchase something you get a
bill, when you make payment you get a receipt.
2. These transactions are to be measured or expressed in terms of money, if not done already.
Generally, this problem will not arise, because the statement of proof expresses the
transaction in terms of money. For example, if ten books are purchased at the rate of Rs. 20
each, then the bill is prepared for Rs. 200. But, if an event cannot be expressed in monetary
terms, it will not come under the scope of accounting.
3. The transactions which are identified and measured are to be recorded in a book called
journal or in one of its sub-divisions.
4. The recorded transactions are to be classified with a view to group transactions of similar
nature at one place. The work of classification is done in a separate book called ledger. In the
ledger, a separate account is opened for each item so that all transactions relating to it can be
brought to one place. For example, all payments of salaries are brought to salaries account.
5. The recording and classification of many transactions will result in a mass of financial data. It
is, therefore, necessary to summarise such data periodically (at least once a year), in a
significant and meaningful form. The summarisation is done in the form of profit and loss
account which reveals the profit made or loss incurred, and the balance sheet which reveals
the financial position
6 The summary results will have to be analysed, interpreted (critically explained) and
communicated to interested parties. Accounting information is generally communicated in the
form of a 'report'. Big organisations generally present printed reports, called published
account.

Development of Accounting and Accounting as Information System, and Qualitative

characteristics of Accounting Information System

pg. 5
Accounting as Information System
Accounting is a definite processes of interlinked activities, that begins with the identification of
transactions and ends with the preparation of financial statements.
Every step in the process of accounting generates information. Generation of information is
not an end in itself.
It is a means to facilitate the dissemination of information among different user groups. Such
information enables the interested parties to take appropriate decisions. Therefore,
dissemination of information is an essential function of accounting.
To be useful, the accounting information should ensure to:
• provide information for making economic decisions;
• serve the users who rely on financial statements as their principal source of information;
• provide information useful for predicting and evaluating the amount, timing and uncertainty
of potential cash-flows;
• provide information for judging management’s ability to utilise resources effectively in
meeting goals;
• provide factual and interpretative information by disclosing underlying assumptions on
matters subject to interpretation, evaluation, prediction, or estimation; and
• provide information on activities affecting the society.

The role of an accountant in generating accounting information is to observe, screen and

recognise events and transactions to measure and process them, and thereby compile reports
comprising accounting information that are communicated to the users. These are then
interpreted, decoded and used by management and other user groups. It must be ensured that
the information provided is relevant, adequate and reliable for decision-making. The
apparently divergent needs of internal and external users of accounting information have
resulted in the development of sub-disciplines within the accounting discipline namely,
financial accounting, cost accounting and management accounting (refer box 3).
Financial accounting assists keeping a systematic record of financial transactions the
preparation and presentation of financial reports in order to arrive at a measure of
organisational success and financial soundness. It relates to the past period, serves the

pg. 6
stewardship function and is monetary in nature. It is primarily concerned with the provision of
financial information to all stakeholders.
Cost accounting assists in analysing the expenditure for ascertaining the cost of various
products manufactured or services rendered by the firm and fixation of prices thereof. It also
helps in controlling the costs and providing necessary costing information to management for
decision-making.
Management accounting deals with the provision of necessary accounting information to
people within the organisation to enable them in decision-making, planning and controlling
business operations. Management accounting draws the relevant information mainly from
financial accounting and cost accounting which helps the management in budgeting, assessing
profitability, taking pricing decisions, capital expenditure decisions and so on. Besides, it
generates other information (quantitative and qualitative, financial and non-financial) which
relates to the future and is relevant for decision-making in the organisation. Such information
includes: sales forecast, cash flows, purchase requirement, manpower needs, environmental
data about effects on air, water, land, natural resources, flora, fauna, human health, social
responsibilities, etc. As a result, the scope of accounting has become so vast, that new areas
like human resource accounting, social accounting, responsibility accounting have also gained
prominance.

Qualitative Characteristics of Accounting Information

Qualitative characteristics are the attributes of accounting information which tend to enhance
its understandability and usefulness. In order to assess whether accounting information is
decision useful, it must possess the characteristics of reliability, relevance, understandability
and comparability.
Reliability Reliability means the users must be able to depend on the information. The
reliability of accounting information is determined by the degree of correspondence between
what the information conveys about the transactions or events that have occurred, measured
and displayed. A reliable information should be free from error and bias and faithfully
represents what it is meant to represent. To ensure reliability, the information disclosed must
be credible, verifiable by independent parties use the same method of measuring, and be
neutral and faithful (refer figure 1.3).
Relevance To be relevant, information must be available in time, must help in prediction and
feedback, and must influence the decisions of users by :
pg. 7
(a) helping them form prediction about the outcomes of past, present or future events; and/or
(b) confirming or correcting their past evaluations.
Understandability Understandability means decision-makers must interpret accounting
information in the same sense as it is prepared and conveyed to them. The qualities that
distinguish between good and bad communication in a message are fundamental to the
understandability of the message. A message is said to be effectively communicated when it is
interpreted by the receiver of the message in the same sense in which the sender has sent.
Accountants should present the comparable information in the most intenlligible manner
without sacrificing relevance and reliability.
Comparability It is not sufficient that the financial information is relevant and reliable at a
particular time, in a particular circumstance or for a particular reporting entity. But it is equally
important that the users of the general purpose financial reports are able to compare various
aspects of an entity over different time period and with other entities. To be comparable,
accounting reports must belong to a common period and use common unit of measurement
and format of reporting.

Book-Keeping and Accounting and Is Accounting a Science or an Art?

A business undertakes number of transactions. Can you estimate the number of transactions a
business undertakes? It depends upon the size of a business entity. Every day business
transactions may be around hundreds/thousands. Can a businessman remember all these
transactions in every respect? Not at all. So it becomes necessary to record these business
transactions in details and in a systematic manner. Recording of business transactions in a
systematic manner in the books of account is called bookkeeping.
Book-Keeping is concerned with recording of financial data. This may be defined as. “The art of
keeping a permanent record of business transactions is book-keeping”.
From books of accounts important details such as total sales, total purchases, total cash
receipts, total payments, etc. may be ascertained. As you know the main objective of business
is to earn profits. In order to ascertain the profit earned during a period, mere recording of
business transactions is not enough. Accounting involves not only book keeping but also many
other activities.
Difference between book keeping and accounting : Book keeping and accounting can be
differentiated on the basis of nature, objective, function, basis, level of knowledge, etc.

pg. 8
 Difference Book-keeping Accounting
It is concerned with identifying
financial transactions; measuring It is concerned with summarizing the
them in monetary terms; recorded transactions, interpreting
Nature recording and classifying them. them and communicating the results

It aims at ascertaining business

income and financial position by
It is to maintain systematic maintaining records of business
Objective records of financial transactions transactions.
It is the recording, classifying,
It is to record business summarizing, interpreting business
transactions. So its transactions and communicating the
Function scope is limited. results. Thus its scope is quite wide.
Vouchers and other supporting
documents are necessary as
evidence to record the business Book-keeping works as the basis for
Basis transactions. accounting information
It is enough to have elementary For accounting, advanced and
Level of knowledge of accounting to do indepth knowledge and
Knowledge bookkeeping. understanding is required.
Book-keeping is the first step to Accounting begins where
Relation accounting bookkeeping ends.

Accounting and other Disciplines: Accounting and Economics, Accounting and Statistics,
Accounting and Mathematics, and Accounting and Law

Relationship of Accounting with other discipline:

(1) Accounting and Economics:-
Economics tells how scarce resources are utilized effectively. For that it is required to analysis
the data of resources. Accounting provides major data base for same purpose.
Economics is a view as a science of demand and supply, and accounting is the business’s
language, where economics talks about satisfying human wants by efficiently using scarce
resources.

pg. 9
Accounting overlaps economics in many aspects. It contributed to improving the decision-
making process of management.
Accountants have ideas about income, capital, and value from economists, applying it in
practical circumstances.
(2) Accounting and statistics :-
In accounts all individual transactions or events are important but in statistics behaviour (i.e.
trend analysis, degree of variation over a period). So here statistics methods help accounting
to collect data in systematic manner. Statistic techniques like time series, cross-sectional
comparison etc. are used for better presentation of accounting data.
The Accounting information is precise to the point and exact to the last paisa. For decision-
making, such precision is not necessary, so a statistical approach comes to the sought.
Statistical presentation by graphs, pie-charts, etc. of the accounting information make is to
ascertain the enterprise’s growth. A lot of figures from books of accounts can generalize to a
single graph or pie-chart.
Statistics also help in formulating prices, ratios that are to be calculated using statistical tools.
Accounting and financial calculations are based on analytical formulae.
Therefore the study of statistics provides an extra edge to accounting.

(3) Accounting and Mathematics:-

Mathematics helps accounting in numbers of ways like calculation of interest, annuity to find
out installments etc.
Double-entry book-keeping can convert in an algebraic form; in fact, the first book on this
subject was part of a treatise on algebra.
Knowledge of algebra and arithmetic is an essential requirement for accounting computations
and measurements. Calculations of interests, annuity, etc. are examples of such uses.
Presently, graphs and charts extensively used for communicating accounting information. In
addition to statistical knowledge in geometry and learning in trigonometry, it seems essential
to have a better understanding of the accounting.
(4) Accounting and law:-

pg. 10
Business enterprises require complying so many laws and making its accounting to comply
their requirement. Partnership firms require to comply partnership act 1932, A company
require to comply requirement of company act 2013, and so many other laws like labour laws,
MRTP Act, Contract Act, Negotiable Instrument Act, The sale of good Act. Thus transaction and
events of accounting are guided by law.
An economic entity operates within a legal environment. All transactions with government,
suppliers, and customers governed by the contract act, the sales of goods act and the
negotiable instruments act, etc.
The entity itself created and operated by-laws and acts. For example, a partnership governed
by the Indian Partnership Act. A company created by the Companies Act and also controlled by
the law.
Laws guide every transaction and event. Every country has a set of economic policies, fiscal,
and labor rules. Very often, the accounting system used has been prescribed by the law. For
example, the financial statements made by the company are to be made under the norms,
rules, regulations, and standards given by the Companies Act.
(5) Accounting and Management--
Accounting helps management in decision making process. Accounting data are used by
management as basic source documents. Large portion of accounting information are
prepared for management decision making.
Management is a wide-ranging occupational field that incorporates many functions and
encompasses many areas or branches of learning. Accountants are well placed in the
management and play a vital role in the administration. A large portion of accounting is done
to make managerial decisions. Although management relies on other data sources, accounting
data are used as essential source documents.

Introduction of Branches of Accounting: Financial Accounting, Cost Accounting, Management

Accounting, Human Resource Accounting, Environmental or Green Accounting, and Inflation
Accounting

The changing requirements of the business over the centuries have given rise to specialized
branches of accounting and these are :
pg. 11
Financial Accounting
It is concerned with recording the transactions of financial character, summarising and
interpreting them and communicating the results to the users. It ascertains profit earned or
loss incurred during a period (usually one year as accounting year) and the financial position as
on the date when the accounting period ends. It can provide financial information required by
the management and other parties. The word accounting and financial accounting are used
interchangeably. At present we are concerned with financial accounting only.
Cost Accounting
It analyses the expenditure so as to ascertain the cost of various products manufactured by the
firm and fix the prices. It also helps in controlling the costs and providing necessary costing
information to management for decision making.
Management Accounting
It is concerned with generating information relating to funds, cost and profits etc. This enables
the management in decision making. Basically, it is meant to assist the management in taking
rational policy decisions and to evaluate the impact of its decisions and actions and the
performance of various departments.
Tax Accounting
This branch of accounting has grown in response to the difficult tax laws such as relating to
income tax, sales tax etc. An accountant is required to be fully aware of various tax legislations.
Social Accounting
This branch of accounting is also known as social reporting or social responsibility accounting.
It discloses the social benefits created and the costs incurred by the enterprise. Social benefits
include such facilities as medical, housing, education, canteen, provident fund and so on while
the social costs may include such matters as exploitation of employees, industrial interest,
environment pollution, unreasonable terminations, social evils resulting from setting up
industries etc.

Functions, Objectives, Limitations, and end Users of Financial Accounting

Objectives of Financial Accounting

pg. 12
As an information system, the basic objective of accounting is to provide useful information to
the interested group of users, both external and internal. The necessary information,
particularly in case of external users, is provided in the form of financial statements, viz., profit
and loss account and balance sheet. Besides these, the management is provided with
additional information from time to time from the accounting records of business. Thus, the
primary objectives of accounting include the following:
1. Finding out Various Balances Systematic recording of business transactions provides
vital information about various balances like cash balance, bank balance, etc.
2. Providing Knowledge of Transactions Systematic maintenance of books provides the
details of every transactions.
3. Ascertaining Net Profit or Loss Summarisation in form of Profit and Loss Account
provides business income over a period of time.
4. Depicting Financial Position Balance sheet is prepared to depict financial position of
business means what the business owns and what it owes to others.
5. Information to All Interested Users After analysis and interpretation, business
performance and position are communicated to the interested users.
6. Fulfilling Legal Obligations Vital accounting information helps in fulfilling legal
obligations e.g. sales tax, income tax etc.
7. Maintenance of Records of Business Transactions Accounting is used for the
maintenance of a systematic record of all financial transactions in book of accounts.
Even the most brilliant executive or manager cannot accurately remember the numerous
amount of varied transactions such as purchases, sales, receipts, payments, etc. that
takes place in business everyday. Hence, a proper and complete records of all business
transactions are kept regularly. Moreover, the recorded information enables verifiability
and acts as an evidence.
8. Providing Accounting Information to its Users
The accounting information generated by the accounting process is communicated in the form
of reports, statements, graphs and charts to the users who need it in different decision
situations. As already stated, there are two main user groups, viz. internal users, mainly
management, who needs timely information on cost of sales, profitability, etc. for planning,
controlling and decision-making and external users who have limited authority, ability and
resources to obtain the necessary information and have to rely on financial statements
(Balance Sheet, Profit and Loss account). Primarily, the external users are interested in the
following:

pg. 13
 a. Investors and potential investors-information on the risks and return on
investment;
b. Unions and employee groups-information on the stability, profitability and
distribution of wealth within the business;
c. Lenders and financial institutions-information on the creditworthiness of the
company and its ability to repay loans and pay interest;
d. Suppliers and creditors-information on whether amounts owed will be repaid
when due, and on the continued existence of the business;
e. Customers-information on the continued existence of the business and thus the
probability of a continued supply of products, parts and after sales service;
f. Government and other regulators- information on the allocation of resources and
the compliance to regulations;
g. Social responsibility groups, such as environmental groups-information on the
impact on environment and its protection;
h. Competitors-information on the relative strengths and weaknesses of their
competition and for comparative and benchmarking purposes. Whereas the
above categories of users share in the wealth of the company, competitors require
the information mainly for strategic purposes.

Functions of Accounting
The function of accounting is to provide quantitative information primarily financial in nature
about economic entities, which is intended to be useful in making economic decisions.
Financial accounting performs the following major functions:
1. Maintaining Systematic Rrecords Business transactions are properly recorded, classified
under appropriate accounts and summarized into financial statements.
2. Communicating the financial results It is used to communicate financial information in
respect of net profits (or loss), assets, liabilities etc. to the interested parties.
3. Meeting Legal Requirements The provisions of various Laws such as Companies Act,
1956 Income Tax and Sales/ VAT Tax Acts, require the submission of various statements
i.e. Annual accounts, Income Tax returns, Returns for VAT etc.
4. Fixing responsibility It helps in computation of profits of different departments of an
enterprise. This facilitates the fixing of the responsibility of departmental heads.

pg. 14
 5. Decision making It provides the users the relevant data to enable them make
appropriate decisions in respect of investment in the capital of the business enterprise
or to supply goods on credit or lend money etc.
Advantages of Accounting
1. Financial Information about Business : Financial performance during the accounting period,
i.e., profit or loss and also the financial position at the end of the accounting period is known
through accounting.
2. Assistance of Management : The management makes business plans, takes decision and
exercise control on affairs on the basis of accounting information.
3. Replace Memory : A systematic and timely recording of transactions obviates the necessity
to remember the transactions. The accounting record provides this necessary information.
4. Facilitates Comparative Study : A systematic record enables a businessman to compare one
year’s results with those of other years and locate significant factors leading to the change, if
any.
5. Facilitates Settlement of Tax Liabilities : A systematic accounting record immensely helps
settlement of income tax, sales tax, VAT and excise duty liabilities since it is a good evidence of
the correctness of transactions.
6. Facilitates Loans : Loan is granted by the banks and financial institutions on the basis of
growth potential which is supported by the performance. Accounting makes available the
information with respect to performance.
7. Evidence in Court : Systematic record of transactions is often accepted by the Courts as
good evidence.
8. Facilitates Sale of Business : If someone desires to sell his business, the accounts maintained
by him will enable the ascertainment of the proper purchase price.
9. Assistance in the Event of Insolvency : Insolvency proceedings involve explaining many
transactions that have taken place in the past. Systematic accounting records assist a great deal
in such a situation.
10. Helpful in Partnership Accounts : At the time of admission of a partner, retirement or
death of a partner and dissolution of the firm, accounting records are of vital importance and
use. It is so because such records provide the basis to reach a settlement.
Limitations of Accounting
pg. 15
1. Accounting information is expressed in terms of Money : Non-monetary events or
transactions are completely omitted.
2. Fixed assets are recorded in the accounting records at the original cost :
Actual amount spent on the assets like building, machinery, plus all incidental charges is
recorded. In this way the effect of rise in prices is not taken into consideration. As a result the
Balance Sheet does not represent the true financial position of the business.
3. Accounting information is sometimes based on estimates: Estimates are often inaccurate.
For example, it is not possible to predict the actual life of an asset for the purpose of
depreciation.
4. Accounting information cannot be used as the only test of managerial performance on the
basis of mere profits : Profit for a period of one year can readily be manipulated by omitting
certain expenses such as advertisement, research and development, depreciation etc. i.e.
window dressing is possible.
5. Accounting information is not neutral or unbiased : Accountants ascertain income as excess
of revenue over expenses. But they consider selected revenue and expenses for calculating
profit of the concern. They also do not include cost of such items as water, noise or air
pollution i.e. social cost, they may also use different methods of valuation of stock or
depreciations.
Users of Accounting Information
Users of Accounting Information may be categorised into Internal Users and External
Users.
Internal Users
i. Owners : Owners contribute capital in the business and thus, are exposed to maximum risk.
Naturally, they are interested in knowing the profit earned or loss suffered by the business
besides the safety of their capital. The financial statements give the information about profit or
loss and financial position of the business.
ii. Management : The management makes extensive use of accounting information to arrive at
informed decisions such as determination of selling price, cost controls and reduction,
investment into new projects, etc.
iii. Employees and Workers : Employees and workers are entitled to bonus at the year end,
which is linked to the profit earned by an enterprise. Therefore, the employees and workers
pg. 16
are interested in financial statements. Besides, the financial statements also reflect whether
the enterprise has deposited its dues into the provident fund and employees state insurance
accounts, etc., or not.
External Users
i. Banks and Financial Institutions : Banks and financial institutions are an essential part of any
business as they provide loans to the businesses. Naturally, they watch the performance of the
business to know, whether it is making progress as projected to ensure the safety and recovery
of the loan advanced. They assess it by analysing the accounting information.
ii. Investors and Potential Investors : Investment involves risk and also the investors do not
have direct control over the business affairs. Therefore, they rely on the accounting
information available to them and seek answers to the questions such as - what is the earning
capacity of the enterprise and how safe is their investment?
iii. Creditors : Creditors are those parties who supply goods or services on credit. Before
granting credit, creditors satisfy themselves about the credit worthiness of the business. The
financial statements help them immensely in making such an assessment.
iv. Government and Its Authorities : The government makes use of financial statements to
compile national income accounts and other informations. The information so available to it
enables them to take policy decisions. Government levies varied taxes such as Excise Duty, VAT,
Service Tax and Income Tax. These government authorities assess the correct tax dues from an
analysis of financial statements.
v. Researchers : Researchers use accounting information in their research work.
vi. Consumers : Consumers require accounting information for establishing good accounting
control so that cost of production may be reduced with the resultant reduction of the prices of
products they buy. Sometimes, prices of some products are fixed by the government, so it
needs accounting information to fix fair prices so that consumers and producers are not
exploited.
vii. Public : They want to see the business running since it makes substantial contribution to
the economy in many ways, e.g., employment of people, patronage to suppliers, etc. Thus,
financial accounting provides useful financial information to various user groups for decision-
making.

pg. 17
Meaning and Nature of Accounting Principles:

Accounting Concepts
1. Business Entity,
This concept explains that the business is distinct from the proprieto Thus, the
transactions of business only are to be recorded in the books of business.
2. Going Concern,
This concept assumes that the business has a perpetual succession or continued
existence.
3. Money Measurement,
According to this concept only those transactions which are expressed in money terms
are to be recorded in accounting books.
4. Cost,
5. Dual Aspect,

The dual aspect concept forms the basis of the double-entry accounting method. This
requires that each business transaction be recorded in two separate accounts.
According to the dual aspect concept, every transaction impacts the business in two
ways which must be equal and opposite. When something (like cash or inventory) is
given, someone (like the buyer or seller) will receive it. In financial accounts, this is
represented with a system of equal but opposite matching credits and debits. For each
debit recorded, there is a corresponding credit of the same amount.

6. Accounting Period,
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. This results into
the most difficult problem of accounting of how to measure the net income for an
accounting period. One has to be careful in recognizing revenue and expenses for a

pg. 18
 particular accounting period. Subsequent section on accounting procedures will explain
how one goes about it in practice.
7. Period Matching of Cost and Revenue,
Matching 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.
8. Realization
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.
9. Accrual
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.

Accounting Conventions:

1. Conservatism,
Conservatism concept states that when alternative valuations are possible, One should
select the alternative which fairly represents economic substance of transactions but
when such choice is not clear select the alternative that is least likely to overstate net
assets and net income. It provides for all known expenses and losses by best estimates if
amount is not known with certainty, but does not recognizes revenues and gains on the
basis of anticipation.
pg. 19
 2. Full Disclosure,
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.
3. Consistency,
This Concept says that the Accounting practices should not change or must remain
unchanged over a period of several years.
4. Materiality
The materiality could be related to information, amount, procedure and nature. Error in
description of an asset or wrong classification between capital and revenue would lead
to materiality of information. Say, If postal stamps of ` 500 remain unused at the end of
accounting period, the same may not be considered for recognizing as inventory on
account of materiality of amount. Certain accounting treatments depend upon
procedures laid down by accounting standards. Some transactions are by nature
material irrespective of the amount involved. e.g. audit fees, loan to directors. It is an
event which involves exchange of some value between two or more entities. It can be
purchase of stationery, receipt of money, payment to a supplier, incurring expenses, etc.
It can be a cash transaction or a credit transaction.

EXTRA NOTES

Purchases
This term is used for goods to be dealt-in i.e. goods are purchased for resale or for producing
the finished products which are meant for sale. Goods purchased may be Cash Purchases or
Credit Purchases. Thus, Purchase of goods is the sum of cash purchases and credit purchases.

pg. 20
Sundry Creditors
Creditors are persons who have to be paid by an enterprise an amount for providing goods and
services on credit.
Sales
Sales are total revenues from goods or services provided to customers. Sales may be in cash or
in credit.
Sundry Debtors
Persons who have to pay for goods sold or services rendered or in respect of contractual
obligations. It is also termed as debtor, trade debtor, and accounts receivable.
Revenue (Sales)
Sales revenue is the amount by selling products or providing services to customers. Other
items of revenue common to many businesses are: Commission, Interest, Dividends, Royalties,
and Rent received, etc.
Expenses
Costs incurred by a business in the process of earning revenue are called expenses. In general,
expenses are measured by the cost of assets consumed or services used during the accounting
period. The common items of expenses are: Depreciation, Rent, Wages, Salaries, Interest, Cost
of Heating, Light and water and Telephone, etc.
Income
The difference between revenue and expense is called income. For example, goods costing `
25000 are sold for ` 35000, the cost of goods sold, i.e. ` 25000 is expense, the sale of goods, i.e.
` 35000 is revenue and the difference. i.e. `10000 is income. In other words, we can state that
Income = Revenue – Expense
Gain
Usually this term is used for profit of an irregular nature, for example, capital gain.
Loss
It means something against which the firm receives no benefit. It is a fact that expenses lead to
revenue but losses do not, such as theft.
Profit
pg. 21
It is the excess of revenue of a business over its costs. It may be gross profit and net profit.
Gross profit is the difference between sales revenue or the proceeds of goods sold and/or
services provided over its direct cost of the goods sold. Net profit is the profit made after
allowing for all types of expenses. There may be a net loss if the expenses exceed the revenue.
Expenditure
Spending money or incurring a liability for some benefit, service or property received is called
expenditure. Payment of rent, salary, purchase of goods, purchase of machinery, etc. are some
examples of expenditure. If the benefit of expenditure is exhausted within a year, it is treated
as revenue expenditure. In case the benefit of expenditure lasts for more than one year, it is
treated as an asset and also known as capital expenditure.
Expenditure is usually the amount spent for the purchase of assets. It increases the profit
earning capacity of the business. Expense, on the other hand, is an amount to earn revenue.
Expenditure is considered as capital expenditure unless it is qualified with words like revenue
expenditure on rent, salaries etc., while expense is always considered as a revenue expense
because it is always incurred to earn revenue.
Drawings
It is the amount of money or the value of goods which the proprietor takes away from business
for his/her household or private use.
Capital
It is the amount invested in an enterprise by its owners e.g. paid up share capital in a corporate
enterprise. It also refers to the interest of owners in the assets of an enterprise.
It is the claim against the assets of the business. Any amount contributed by the owner
towards the business unit is a liability for the business enterprise. This liability is also termed as
capital which may be brought in the form of cash or assets by the owner.
Assets
These are tangible objects or intangible rights owned by the enterprise and carrying probable
future benefits. Tangible items are those which can be touched and their physical presence can
be noted/felt e.g. furniture, machine etc. Intangible rights are those rights which one
possesses but cannot see e.g. patent rights, copyrights, goodwill etc. Assets are purchased for
business use and are not for sale. They raise the profit earning capacity of the business
enterprise.

pg. 22
Assets are broadly categorized as current assets and non-current assets/fixed assets.
Current assets are those assets which are held for a short period generally one year’s time. The
balance of such items goes on fluctuating i.e. it keeps on changing throughout the year. The
balance of cash in hand may change so many times in a day. Various current assets are cash in
hand/at bank, debtors, bills receivable, stock, pre-paid expenses.
Non-current assets : Those assets are acquired for long term use in the business. Such assets
raise the profit earning capacity of the business enterprise. Expenditure on such assets is non-
recurring and of capital nature. Expenses incurred on acquiring these assets are added to the
value of the assets.
Liability
It is the financial obligation of an enterprise other than owners’ funds.
Liabilities : Liabilities mean the amount which the business owes to outsiders, that is, except
the proprietors. In the words of Finny and Miller, “Liabilities are debts, they are amounts owed
to creditors.” Thus, the claims of those who are not owners are called Liabilities. This can be
expressed as :
Liabilities = Assets – Capital
In business, transactions are recorded taking business to be an entity distinct from its owners.
Thus, capital invested by the proprietors is a liability but an internal liability. On the other hand,
external liability is a liability that is payable to outsiders, i.e., other than the proprietors.
External liability arises because of credit transactions or loans raised. Examples of
external liabilities are creditors, bank overdraft, bills payable, outstanding liabilities.
Liabilities can be classified into the following :
i. Long-Term Liabilities : These are those liabilities which are payable after a longterm,
(generally more than a year). Examples of Long-Term Liabilities are longterm loans,
debentures, etc.
ii. Short-Term/Current Liabilities : These are liabilities which are payable in the near future
(generally within a year). Examples of Current Liabilities are creditors, bank overdrafts, bills
payable, short-term loans, etc.

pg. 23
Account : Account is a summarised record of relevant transactions at one place relating to a
particular head. It records not only the amount of transactions but also their effect and
direction.
Stock or Inventory : Stock is the tangible property held by an enterprise for the purpose of sale
in the ordinary course of business or for the purpose of using it in the production of goods
meant for sale or services to be rendered. Stock may be opening stock or closing stock. In case
of a manufacturing concern, Closing Stock comprises raw materials, Work-in-Progress (i.e.,
semi-finished goods) and finished goods in hand on the closing date. Similarly, Opening Stock
(beginning inventory) is the amount of stock at the beginning of the accounting period.
Goods : They refer to items forming part of the Stock-in-Trade of an enterprise, which are
purchased or manufactured with a purpose of selling. In other words, they refer to the
products in which an enterprise is dealing. For an enterprise dealing in home appliances such
as T.V., fridge, A.C., etc., these are goods. Similarly, for a stationer, stationery is goods, whereas
for others, it is an item of expense (not purchases). An enterprise may purchase assets for use
in furtherance of business or stationery for use in the business, but they are not purchases of
‘goods’ but fixed asset and expense respectively.
Receivables : The term ‘Receivables’ includes the outstanding amount due from others.
Sometimes, a debtor may accept a Bill of Exchange, which is payable after a certain period.
Such a bill is known as Bill Receivable. Sometimes, a debtor promises to pay the specific
amount in writing after a specified period. Such a promise is known as a Promissory Note and
is recorded as note receivable. The term – accounts receivable includes trade debtors as well as
bills receivable and promissory notes receivable. The term receivable includes all the amounts
due from others.
Payables : The term ‘Payables’ include the amounts due to other. Accounts Payable includes
trade creditors as well as bills payable and promissory notes payable. The term payable
includes all the amounts due to others.
Bill Receivable : Bill Receivable means a Bill of Exchange accepted by a debtor the amount of
which will be received on the specified date.
Bill Payable : Bill Payable means a Bill of Exchange, the amount of which will be payable on the
specified date.
Event : Any transactions in an organisation can be called as an event. Transactions in an
organisation have documentary evidence and will create a change in revenue, expense,

pg. 24
assets, liabilities and capital.
Cost : It is the amount of expenditure incurred on or is attributed to a specified article; product
or activity.
Voucher : It is proof of a business transaction. Cash Memo, Bill/Invoice, Credit/Debit notes etc.
are examples of voucher.
Discount : Some customers are allowed reduction in the price of goods by the business. It is
called a Discount.
Trade Discount : It is the reduction allowed by the seller to the buyer at the time of sale on the
list price of goods. Trade discount is allowed on bulk purchases. Normally, trade discount is
deducted from the list price and only the balance is accounted for. Therefore, trade discount
will not be shown in the books of accounts.
Cash Discount : It is the deduction allowed by the creditor to the debtor on the amount due by
the latter. This concession is given only to those who settle their accounts within a stipulated
period. Therefore, cash discount encourage prompt settlement of accounts. For the debtor
who pays the amount, it is an income. For creditor, cash discount is an expense.
Debtors
Debtors are persons and/or other entities who owe to an enterprise an amount for buying
goods and services on credit. The total amount standing against such persons and/or entities
on the closing date, is shown in the balance sheet as sundry debtors on the asset side.
Creditors
Creditors are persons and/or other entities who have to be paid by an enterprise an amount
for providing the enterprise goods and services on credit. The total amount standing to the
favour of such persons and/or entities on the closing date, is shown in the Balance Sheet as
sundry creditors on the liabilities side.

pg. 25