Definition of terms

A transaction is an exchange of value – for example, the sale of an ice-cream is a

transaction. A transaction is an exchange in which each participant receives or
sacrifices value (e.g. purchase of raw material). An event (whether internal or
external) is a happening of consequence to an entity (e.g. use of raw material for
production).
An entity means an economic unit that performs economic activities.
An account is a collection of similar records. For example, all sales for cash might be
recorded in the Cash Account.

A report is a statement that summarizes certain accounts or transactions at a certain

time or for a certain period.

Bookkeeping, in business, is the recording of financial transactions, and is part of the

process of accounting. Transactions include purchases, sales, receipts and payments
by an individual or organization. The accountant creates reports from the recorded
financial transactions recorded by the bookkeeper and files forms with government
agencies.

Book- keeping includes recording of journal, posting in ledgers and balancing

of accounts. All the records before the preparation of trail balance is the whole
subject matter of book- keeping.
Thus, book- keeping may be defined as the science and art of recording transactions
in money or money’s worth so accurately and systematically, in a certain set of
books, regularly that the true state of businessman’s affairs can be correctly
ascertained.

Objectives of Book- keeping

i) Book- keeping provides a permanent record of each transactions.
ii) Soundness of a firm can be assessed from the records of assets and abilities on a
particular date.
iii) Entries related to incomes and expenditures of a concern facilitate to know the
profit and loss for a given period.
iv) It enables to prepare a list of customers and suppliers to ascertain the amount to be
received or paid.
v) It is a method gives opportunities to review the business policies in the light of the
past records.
vi) Amendment of business laws, provision of licenses, assessment of taxes etc are
based on records.

ACCOUNTING
Meaning of Accounting
Accounting, as an information system is the process of identifying, measuring and
communicating the economic information of an organization to its users who need the
information for decision making. It identifies transactions and events of a specific
entity.

Definition of Accounting
American Institute of Certified Public Accountants (AICPA) which defines
accounting as “the art of recording, classifying and summarizing in a significant
manner and in terms of money, transactions and events, which are, in part at least, of
a financial character and interpreting the results thereof”.

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.
i) To keeping systematic record: It is very difficult to remember all the
business transactions that take place. Accounting serves this purpose of record
keeping by promptly recording all the business transactions in the books of account.
ii) To ascertain the results of the operation: Accounting helps in
ascertaining result i.e., profit earned or loss suffered in business during a particular
period. For this purpose, a business entity prepares either a Trading and Profit and
Loss account or an Income and Expenditure account which shows the profit or loss of
the business by matching the items of revenue and expenditure of the some period.
iii) To ascertain the financial position of the business: In addition to profit,
a businessman must know his financial position i.e., availability of cash, position of
assets and liabilities etc. This helps the businessman to know his financial strength.
Financial statements are barometers of health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide
information about how an enterprise obtains and spends cash, about its borrowing and
repayment of borrowing, about its capital transactions, cash dividends and other
distributions of resources by the enterprise to owners and about other factors that may
affect an enterprise’s liquidity and solvency.
v) To protect business properties: Accounting provides upto date information about
the various assets that the firm possesses and the liabilities the firm owes, so that
nobody can claim a payment which is not due to him.
vi) To facilitate rational decision – making: Accounting records and
financial statements provide financial information which help the business in making
rational decisions about the steps to be taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies,
public trusts are compulsorily required to maintain accounts as per the law governing
their operations such as the Companies Act, Societies Act, and Public Trust Act etc.
Maintenance of accounts is also compulsory under the Sales Tax Act and Income Tax
Act.

Importance of Accounting
i) Owners: The owners provide funds or capital for the organization. They
possess curiosity in knowing whether the business is being conducted on sound lines
or not and whether the capital is being employed properly or not. Owners, being
businessmen, always keep an eye on the returns from the investment. Comparing the
accounts of various years helps in getting good pieces of information.
ii) Management: The management of the business is greatly interested in
knowing the position of the firm. The accounts are the basis, the management can
study the merits and demerits of the business activity. Thus, the management is
interested in financial accounting to find whether the business carried on is profitable
or not. The financial accounting is the “eyes and ears of management and facilitates
in drawing future course of action, further expansion etc.”
iii) Creditors: Creditors are the persons who supply goods on credit, or
bankers or lenders of money. It is usual that these groups are interested to know the
financial soundness before granting credit. The progress and prosperity of the firm,
two which credits are extended, are largely watched by creditors from the point of
view of security and further credit. Profit and Loss Account and Balance Sheet are
nerve centres to know the soundness of the firm.
iv) Employees: Payment of bonus depends upon the size of profit earned by
the firm. The more important point is that the workers expect regular income for the
bread. The demand for wage rise, bonus, better working conditions etc. depend upon
the profitability of the firm and in turn depends upon financial position. For these
reasons, this group is interested in accounting.
v) Investors: The prospective investors, who want to invest their money in a
firm, of course wish to see the progress and prosperity of the firm, before investing
their amount, by going through the financial statements of the firm. This is to
safeguard the investment. For this, this group is eager to go through the accounting
which enables them to know the safety of investment.
vi) Government: Government keeps a close watch on the firms which yield
good amount of profits. The state and central Governments are interested in the
financial statements to know the earnings for the purpose of taxation. To compile
national accounting is essential.
vii) Consumers: These groups are interested in getting the goods at reduced
price. Therefore, they wish to know the establishment of a proper accounting control,
which in turn will reduce to cost of production, in turn less price to be paid by the
consumers. Researchers are also interested in accounting for interpretation.
viii) Research Scholars: Accounting information, being a mirror of the
financial performance of a business organization, is of immense value to the research
scholar who wants to make a study into the financial operations of a particular firm.
To make a study into the financial operations of a particular firm, the research scholar
needs detailed accounting information relating to purchases, sales, expenses, cost of
materials used, current assets, current liabilities, fixed assets, long-term liabilities and
share-holders funds which is available in the accounting record maintained by the
firm.

Functions of Accounting
i) Record Keeping Function: The primary function of accounting relates to
recording, classification and summary of financial transactions-journalisation,
posting,
and preparation of final statements. These facilitate to know operating results and
financial positions. The purpose of this function is to report regularly to the interested
parties by means of financial statements. Thus accounting performs historical
function i.e., attention on the past performance of a business; and this facilitates
decision making programme for future activities.
ii) Managerial Function:Decision making programme is greatly assisted by
accounting. The managerial function and decision making programmes, without
accounting, may mislead. The day-to-day operations are compared with some
predetermined standard. The variations of actual operations with pre-determined
standards and their analysis is possible only with the help of accounting.
iii) Legal Requirement function: Auditing is compulsory in case o f
registered firms. Auditing is not possible without accounting. Thus accounting
becomes compulsory to comply with legal requirements. Accounting is a base and
with its help various returns, documents, statements etc., are prepared.
iv) Language of Business: Accounting is the language of business. Various
transactions are communicated through accounting. There are many parties-owners,
creditors, government, employees etc., who are interested in knowing the results of
the firm and this can be communicated only through accounting. The accounting
shows a real and true position of the firm or the business.

Advantages of Accounting
The following are the advantages of accounting to a business:
i) It helps in having complete record of business transactions.
ii) It gives information about the profit or loss made by the business at the close of a
year and its financial conditions. The basic function of accounting is to supply
meaningful information about the financial activities of the business to the owners
and the managers.
iii) It provides useful information form making economic decisions,
iv) It facilitates comparative study of current year’s profit, sales, expenses etc., with
those of the previous years.
v) It supplies information useful in judging the management’s ability to utilise
enterprise resources effectively in achieving primary enterprise goals.
vi) It provides users with factual and interpretive information about transactions and
other events which are useful for predicting, comparing and evaluation the
enterprise’s earning power.
vii) It helps in complying with certain legal formalities like filing of income tax
and sales-tax returns. If the accounts are properly maintained, the assessment of taxes
is greatly facilitated.
1.3.7 Limitations of Accounting
i) Accounting is historical in nature: It does not reflect the current financial
position or worth of a business.
ii) Transactions of non-monetary mature do not find place in accounting.
Accounting is limited to monetary transactions only. It excludes qualitative elements
like management, reputation, employee morale, labour strike etc.
iii) Facts recorded in financial statements are greatly influenced by accounting
conventions and personal judgements of the Accountant or Management. Valuation
of inventory, provision for doubtful debts and assumption about useful life of an asset
may, therefore, differ from one business house to another.
iv) Accounting principles are not static or unchanging-alternative accounting
procedures are often equally acceptable. Therefore, accounting statements do not
always present comparable data
v) Cost concept is found in accounting. Price changes are not considered. Money
value is bound to change often from time to time. This is a strong limitation of
accounting.
vi) Accounting statements do not show the impact of inflation.
vii) The accounting statements do not reflect those increase in net asset
values that are not considered realized.

1.4 Methods of Accounting

Business transactions are recorded in two different ways.
 Single Entry
 Double Entry

Single Entry: It is incomplete system of recording business transactions. The

business organization maintains only cash book and personal accounts of debtors and
creditors. So the complete recording of transactions cannot be made and trail balance
cannot be prepared.

Double Entry: It this system every business transaction is having a two fold
effect of benefits giving and benefit receiving aspects. The recording is made on the
basis of both these aspects. Double Entry is an accounting system that records the
effects of transactions and other events in atleast two accounts with equal debits and
credits.

Steps involved in Double entry system

(a) Preparation of Journal: Journal is called the book of original entry. It
records the effect of all transactions for the first time. Here the job of recording takes
place.
(b) Preparation of Ledger: Ledger is the collection of all accounts used by a
business. Here the grouping of accounts is performed. Journal is posted to ledger.
(c) Trial Balance preparation: Summarizing. It is a summary of ledge
balances prepared in the form of a list.
(d) Preparation of Final Account: At the end of the accounting period to
know the achievements of the organization and its financial state of affairs, the final
accounts are prepared.

Advantages of Double Entry System

i) Scientific system: This system is the only scientific system of recording
business transactions in a set of accounting records. It helps to attain the objectives of
accounting.
ii) Complete record of transactions: This system maintains a complete
record of all business transactions.
iii) A check on the accuracy of accounts: By use of this system the accuracy
of accounting book can be established through the device called a Trail balance.
iv) Ascertainment of profit or loss: The profit earned or loss suffered during
a period can be ascertained together with details by the preparation of Profit and Loss
Account.
v) Knowledge of the financial position of the business: The financial
position of the firm can be ascertained at the end of each period, through the
preparation of balance sheet.
vi) Full details for purposes of control: This system permits accounts to be
prepared or kept in as much detail as necessary and, therefore, affords significant
information for purposes of control etc.
vii) Comparative study is possible: Results of one year may be compared
with those of the precious year and reasons for the change may be ascertained.
viii) Helps management in decision making: The management may be also
to obtain good information for its work, specially for making decisions.
ix) No scope for fraud: The firm is saved from frauds and misappropriations
since full information about all assets and liabilities will be available.

1.5 Meaning of Debit and Credit

The term ‘debit’ is supposed to have derived from ‘debit’ and the term ‘credit’ from
‘creditable’. For convenience ‘Dr’ is used for debit and ‘Cr’ is used for credit.
Recording of transactions require a thorough understanding of the rules of debit and
credit relating to accounts. Both debit and credit may represent either increase or
decrease, depending upon the nature of account.

Types of Accounts
The object of book-keeping is to keep a complete record of all the transactions
that place in the business. To achieve this object, business transactions have been
classified into three categories:
 Transactions relating to persons.
 Transactions relating to properties and assets
 Transactions relating to incomes and expenses.
The accounts falling under the first heading are known as ‘personal Accounts’.
The accounts falling under the second heading are known as ‘Real Accounts’, The
accounts falling under the third heading are called ‘Nominal Accounts’. The accounts
can also be classified as personal and impersonal. The following chart will show the
various types of accounts:
Personal Accounts:
Accounts recording transactions with a person or group of persons are known as
personal accounts. These accounts are necessary, in particular, to record credit
transactions. Personal accounts are of the following types:

(a) Natural persons: An account recording transactions with an individual human

being is termed as a natural persons’ personal account. eg., Kamal’s account, Mala’s
account, Sharma’s accounts. Both males and females are included in it
(b) Artificial or legal persons: An account recording financial transactions
with an artificial person created by law or otherwise is termed as an artificial person,
personal account, e.g. Firms’ accounts, limited companies’ accounts, educational
institutions’ accounts, Co-operative society account.
(c) Groups/Representative personal Accounts: An account indirectly representing a
person or persons is known as representative personal account. When accounts are of
a similar nature and their number is large, it is better tot group them under one head
and open a representative personal accounts. e.g., prepaid insurance, outstanding
salaries, rent, wages etc.

When a person starts a business, he is known as proprietor. This proprietor is

represented by capital account for all that he invests in business and by drawings
accounts for all that which he withdraws from business. So, capital accounts and
drawings account are also personal accounts.
The rule for personal accounts is: Debit the receiver
Credit the giver
Real Accounts
Accounts relating to properties or assets are known as ‘Real Accounts’, A separate
account is maintained for each asset e.g., Cash Machinery, Building, etc., Real
accounts can be further classified into tangible and intangible.
(a) Tangible Real Accounts: These accounts represent assets and properties
which can be seen, touched, felt, measured, purchased and sold. e.g. Machinery
account Cash account, Furniture account, stock account etc.
(b) Intangible Real Accounts: These accounts represent assets and properties
which cannot be seen, touched or felt but they can be measured in terms of money.
e.g., Goodwill accounts, patents account, Trademarks account, Copyrights account,
etc.
The rule for Real accounts is: Debit what comes in
Credit what goes out
Nominal Accounts
Accounts relating to income, revenue, gain expenses and losses are termed as
nominal accounts. These accounts are also known as fictitious accounts as they do not
represent any tangible asset. A separate account is maintained for each head or
expense or loss and gain or income. Wages account, Rent account Commission
account, Interest received account are some examples of nominal account
The rule for Nominal accounts is: Debit all expenses and losses
Credit all incomes and gains

DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING

The difference between book-keeping and accounting can be summarized in a
tabular from as under:
 A good bookkeeper will:

1. Make use of an appropriate bookkeeping package such as Express Accounts.

2. Understand transactions and know how they should be entered.

3. Enter transactions on a regular basis.

4. Reconcile statements as they are received. The most important of these statements are
the bank statements.

5. Prepare reports as and when they are required.

6. Retain original documentation (invoices, etc.) in a systematic way.

7. Understand the big picture and recognize problem areas.

Process

The bookkeeping process primarily records the financial effects of transactions only.
The variation between manual and any electronic accounting system stems from the
latency between the recording of the financial transaction and its posting in the
relevant account. This delay, although absent in electronic accounting systems due to
instantaneous posting into relevant accounts, is a basic characteristic of manual
systems, thus giving rise to primary books of accounts such as Cash Book, Bank
Book, Purchase Book, and Sales Book for manually recording the immediate effect of
the financial transaction.

In the normal course of business, a document is produced each time a transaction

occurs. Sales and purchases usually have invoices or receipts. Deposit slips are
produced when lodgements (deposits) are made to a bank account.

Cheques are written to pay money out of the account. Bookkeeping involves, first of
all, recording the details of all of these source documents into multi-column journals
(also known as a books of first entry or daybooks). For example, all credit sales are
recorded in the sales journal, all cash payments are recorded in the cash payments
journal.

Each column in a journal normally corresponds to an account. In the single entry

system, each transaction is recorded only once. Most individuals who balance their
cheque-book each month are using such a system, and most personal finance software
follows this approach.

Using the rules of double entry, these journal summaries are then transferred to their
respective accounts in the ledger, or book of accounts. For example the entries in the
Sales Journal are taken and a debit entry is made in each customer's account (showing
that the customer now owes us money) and a credit entry might be made in the
account for "Sale of class 2 widgets" (showing that this activity has generated
revenue for us). This process of transferring summaries or individual transactions to
the ledger is called posting. Once the posting process is complete, accounts kept using
 the "T" format undergo balancing, which is simply a process to arrive at the balance
of the account.

Once the accounts balance, the accountant makes a number of adjustments and
changes the balance amounts of some of the accounts. These adjustments must still
obey the double-entry rule.

Finally financial statements are drawn from the trial balance, which may include:

 the income statement, also known as the statement of financial results, profit and loss
account, or P&L
 the balance sheet, also known as the statement of financial position
 the cash flow statement
 the statement of retained earnings, also known as the statement of total recognised
gains and losses or statement of changes in equity

Entry systems

Two common bookkeeping systems used by businesses and other organizations are
the single-entry bookkeeping system and the double-entry bookkeeping system.
Single-entry bookkeeping uses only income and expense accounts, recorded primarily
in a revenue and expense journal. Single-entry bookkeeping is adequate for many
small businesses. Double-entry bookkeeping requires posting (recording) each
transaction twice, using debits and credits.

Single-entry system

The primary bookkeeping record in single-entry bookkeeping is the cash book, which
is similar to a checking (cheque) account register but allocates the income and
expenses to various income and expense accounts. Separate account records are
maintained for petty cash, accounts payable and receivable, and other relevant
transactions such as inventory and travel expenses. These days, single entry
 bookkeeping can be done with DIY bookkeeping software to speed up manual
calculations.

Double-entry system

A double-entry bookkeeping system is a set of rules for recording financial

information in a financial accounting system in which every transaction or event
changes at least two different nominal ledger accounts.

Sources of information

DAYBOOK

A daybook is a descriptive and chronological (diary-like) record of day-to-day

financial transactions also called a book of original entry. The daybook's details must
be entered formally into journals to enable posting to ledgers. Daybooks include:

 Sales daybook, for recording all the sales invoices.

 Sales credits daybook, for recording all the sales credit notes.
 Purchases daybook, for recording all the purchase invoices.
 Purchases credits daybook, for recording all the purchase credit notes.
 Cash daybook, usually known as the cash book, for recording all money received as
well as money paid out. It may be split into two daybooks: receipts daybook for
money received in, and payments daybook for money paid out.
 General Journal daybook, for recording journals.

Petty cash book

A petty cash book is a record of small value purchases before they are later
transferred to the ledger and final accounts, it is maintained by a petty or junior
cashier. This type of cash book usually uses the imprest system: a certain amount of
money is provided to the petty cashier by the senior cashier. This money is to cater
for minor expenditures (hospitality, minor stationery, casual postage and so on) and is
reimbursed periodically on satisfactory explanation of how it was spent.
 Journals

Journals are recorded in the general journal daybook. A journal is a formal and
chronological record of financial transactions before their values are accounted for in
the general ledger as debits and credits. A company can maintain one journal for all
transactions, or keep several journals based on similar activity (i.e. sales, cash
receipts, revenue, etc.) making transactions easier to summarize and reference later.
For every debit journal entry recorded there must be an equivalent credit journal entry
to maintain a balanced accounting equation.

Ledgers

A ledger is a record of accounts. These accounts are recorded separately showing

their beginning/ending balance. A journal lists financial transactions in chronological
order without showing their balance but showing how much is going to be charged in
each account. A ledger takes each financial transactions from the journal and records
them into the corresponding account for every transaction listed. The ledger also
sums up the total of every account which is transferred into the balance sheet and
income statement. There are 3 different kinds of ledgers that deal with book-keeping.
Ledgers include:

 Sales ledger, which deals mostly with the accounts receivable account. This ledger
consists of the financial transactions made by customers to the business.
 Purchase ledger is a ledger that goes hand and hand with the Accounts Payable
account. This is the purchasing transaction a company does.
 General ledger representing the original 5 main accounts: assets, liabilities, equity,
income, and expenses

Computerized bookkeeping

Computerized bookkeeping removes many of the paper "books" that are used to
record the financial transactions of an entity. Instead, relational databases take their
 place, but still typically enforce the double entry bookkeeping system and
methodology.

FINANCIAL STATEMENTS

A financial statement (or financial report) is a formal record of the financial

activities of a business, person, or other entity.

Relevant financial information is presented in a structured manner and in a form easy

to understand. They include:-

1. A balance sheet, also referred to as a statement of financial position, reports on a

company's assets, liabilities, and ownership equity at a given point in time.
2. An income statement, also known as a statement of comprehensive income,
statement of revenue & expense, P&L or profit and loss report, reports on a
company's income, expenses, and profits over a period of time. A profit and loss
statement provides information on the operation of the enterprise. These include sales
and the various expenses incurred during the stated period.
3. A statement of cash flows reports on a company's cash flow activities, particularly
its operating, investing and financing activities.

Purpose of financial statements by business entities

"The objective of financial statements is to provide information about the financial

position, performance and changes in financial position of an enterprise that is useful
to a wide range of users in making economic decisions.

Financial statements should be understandab le, relevant, reliable and comparable.

Reported assets, liabilities, equity, income and expenses are directly related to an
organization's financial position.

Financial statements are intended to be understandable by readers who have "a

reasonable knowledge of business and economic activities and accounting and who
 are willing to study the information diligently. Financial statements may be used by
users for different purposes:

 Owners and managers require financial statements to make important business

decisions that affect its continued operations. Financial analysis is then performed on
these statements to provide management with a more detailed understanding of the
figures. These statements are also used as part of management's annual report to the
stockholders.

 Employees also need these reports in making collective bargaining agreements (CBA)
with the management, in the case of labor unions or for individuals in discussing their
compensation, promotion and rankings.

 Prospective investors make use of financial statements to assess the viability of

investing in a business. Financial analyses are often used by investors and are
prepared by professionals (financial analysts), thus providing them with the basis for
making investment decisions.

 Financial institutions (banks and other lending companies) use them to decide
whether to grant a company with fresh working capital or extend debt securities (such
as a long-term bank loan or debentures) to finance expansion and other significant
expenditures.

Moving to electronic financial statements

Financial statements have been created on paper for hundreds of years. The growth of
the Web has seen more and more financial statements created in an electronic form
which is exchangeable over the Web. Common forms of electronic financial
statements are PDF and HTML. These types of electronic financial statements have
their drawbacks in that it still takes a human to read the information in order to reuse
the information contained in a financial statement.
More recently a market driven global standard, XBRL (Extensible Business
Reporting Language), which can be used for creating financial statements in a
structured and computer readable format, has become more popular as a format for
creating financial statements. Many regulators around the world such as the U.S.
Securities and Exchange Commission have mandated XBRL for the submission of
financial information.

The UN/CEFACT created, with respect to Generally Accepted Accounting

Principles, (GAAP), internal or external financial reporting XML messages to be used
between enterprises and their partners, such as private interested parties (e.g. bank)
and public collecting bodies (e.g. taxation authorities). Many regulators use such
messages to collect financial and economic information.