Introduction to Accounting & Basic Accounting Terms – Detailed Bullet-Point Notes

Meaning & Definitions of Accounting

• Systematic process of:

  • Identifying

  • Measuring (monetary terms)

  • Recording (Journal → Subsidiary Books)

  • Classifying (Ledger)

  • Summarising (Trial Balance → Financial Statements)

  • Analysing & Interpreting

  • Communicating to users in time & in useful form

• Communicates information on:

  • $\text{Resources available}$

  • $\text{Employment of those resources}$

  • $\text{Results of their use (profit / loss)}$

• Called the “language of business”

Attributes / Characteristics of Accounting

• Records ONLY financial transactions & events that can be measured in money.

• Measurement in common unit (national currency).

• Recording in books of original entry (Journal & Subsidiary Books).

• Classification via Ledger posting.

• Summarisation → Trial Balance, Trading A/c, Profit & Loss A/c, Balance Sheet.

• Analysis & Interpretation for meaningful judgement.

• Timely Communication to internal & external users.

Accounting Process (Cycle)

1. Identify financial transactions/events.

2. Record (Journal / Subsidiary Books).

3. Classify (Ledger).

4. Summarise (Trial Balance, Financial Statements).

5. Analyse & Interpret.

6. Communicate to users.

Objectives of Accounting

• Maintain systematic records.

• Determine profit or loss (Income Statement / Trading & P&L A/c).

• Ascertain financial position (Balance Sheet).

• Facilitate managerial decision-making, budgeting & control.

• Provide information to internal & external users.

• Protect & control business assets.

Functions of Accounting

• Maintaining systematic accounting records (rules, principles, concepts).

• Preparation of Financial Statements (Income & Position statements).

• Meeting legal requirements (Companies Act, Income-tax, GST, courts).

• Communicating financial information to diverse users.

• Assistance to management (asset protection, control, forecasting).

Advantages of Accounting

• Reveals financial performance (profit / loss) & position (assets, liabilities, equity).

• Aids management planning, decision & control.

• Replaces memory – permanent record.

• Facilitates comparative study over periods & with peers.

• Basis for tax assessment (Income-tax, GST).

• Helps in obtaining loans & investments.

• Accepted evidence in courts.

• Facilitates sale, dissolution, insolvency & partnership adjustments.

Limitations of Accounting

• Not fully exact – uses estimates (depreciation, doubtful debts, NRV).

• May present unrealistic information due to concepts (historical cost, going concern).

• Ignores qualitative factors (staff morale, management skill, IR, PR).

• Ignores price-level changes (money assumed stable).

• Possibility of window dressing (manipulation concealing vital facts).

Role of Accounting in Business

• Systematic records → ascertain profit / loss & position.

• Managerial assistance & comparative study.

• Evidence in court, facilitation of loans, tax, sale etc.

Branches of Accounting

• Financial Accounting – records, summarises & communicates financial performance & position (P&L & Balance Sheet).

• Cost Accounting – ascertain, reduce & control cost of products, processes, activities.

• Management Accounting – generate information (funds, costs, profits) exclusively for managerial decision-making.

Book-Keeping, Accounting & Accountancy

• Book-Keeping (primary stage): identify, measure, record & classify monetary transactions. Mechanical, routine, done by junior staff.

• Accounting (secondary stage): summarise, analyse, interpret & communicate. Analytical, performed by senior staff.

• Accountancy: body of knowledge – principles & techniques governing accounting practice. Accounting = application; Accountancy = theory.

Accounting Information

• Service activity providing quantitative (primarily financial) information useful for economic decisions.

• Types:

  1. Information relating to Profit / Surplus (Income Statement, Trading A/c, P&L A/c).

  2. Information relating to Financial Position (Balance Sheet – assets, liabilities, equity).

  3. Information about Cash Flows (Cash Flow Statement – inflow/outflow, liquidity planning).

Qualitative Characteristics of Accounting Information

• Reliability (verifiable, unbiased, free from error).

• Relevance (capable of influencing decisions).

• Understandability (presented clearly & logically).

• Comparability (intra-firm & inter-firm over time using consistent policies).

Users of Accounting Information

• Internal:

  • Owners/Shareholders

  • Management

  • Employees & Workers (bonus, PF/ESI compliance)

• External:

  • Banks & Financial Institutions (solvency, repayment ability)

  • Investors / Potential investors (risk & return)

  • Creditors / Suppliers (credit-worthiness)

  • Government & Authorities (policy, taxation, national income)

  • Researchers

  • Consumers (cost control, fair pricing)

  • Public / Society (employment, economic contribution)

Accounting – Art or Science?

• Art: technique of recording, classifying & summarising.

• Science: organised body of knowledge based on principles & concepts (GAAP).

Systems of Accounting

1. Double Entry System (scientific & complete)

   • Records both aspects (Debit & Credit) of every transaction.

   • Features: complete record, duality, equality of debits & credits → Trial Balance accuracy.

   • Stages: Journal → Ledger → Trial Balance → Final Accounts.

   • Advantages: scientific, complete, accuracy, profit/loss ascertainment, financial position, detailed control, comparison, decision support, fraud detection.

2. Single Entry / Incomplete Records

   • Partial recording: usually only Cash Book + Personal A/cs.

   • Cannot prepare Trial Balance; P&L & Balance Sheet difficult → information unreliable.

Higher Order Thinking Examples (from text)

• Only monetary items recorded → advantage (common yardstick) + limitation (ignores qualitative events e.g., labour strike).

• Manager resignation not recorded → no monetary measurement.

Basic Accounting Terms (Comprehensive Glossary)

Business Transaction

• Financial event measurable in money, changes financial position; dual effect (Debit ↔ Credit). Types: Cash vs Credit, External vs Internal.

Account

• Formal record under a particular heading showing transactions & their effects (e.g., Salary A/c, Furniture A/c).

Capital

• Owner’s investment; liability of business towards owners.

• $\text{Capital} = \text{Assets} - \text{Liabilities}$

Drawings

• Withdrawal of cash or goods by proprietor/partner for personal use. Deducted from capital.

Liabilities

• Obligations payable by business.

  • Internal (towards owners) vs External (towards outsiders).

  • Non-current Liability: payable after >12 months (long-term loans, debentures).

  • Current Liability: payable within 12 months (creditors, bills payable, bank O/D, outstanding expenses).

  • Schedule-III criteria: normal operating cycle, held for trading, due within 12 months, no unconditional deferral right.

Assets

• Economic resources owned/control with future benefits.

  • Non-current Assets (fixed assets, long-term investments, etc.)

  • Tangible (land, building, machinery)

  • Intangible (goodwill, patents, software)

  • Current Assets (inventory, trade receivables, cash, prepaid expenses) – realisable within 12 months.

  • Fictitious Assets: deferred losses not representing real assets (discount on issue of debentures, heavy advertisement expenditure).

• Schedule-III classification uses same 12-month / operating-cycle test.

Receipts

• Inflows of cash/asset:

  • Revenue Receipts (normal operations: sales, service income, interest).

  • Capital Receipts (non-operational: sale of fixed assets, capital introduced, loans).

Expenditure

• Outflows or obligations incurred:

  • Capital Expenditure (acquisition/improvement of non-current assets; enduring benefit).

  • Revenue Expenditure (benefit consumed within current period; cost of goods sold, wages).

  • Deferred Revenue Expenditure (revenue in nature but benefit >1 year; large advertising spend).

Expense

• Cost incurred to earn revenue (salaries, depreciation, bad debts).

  • Prepaid Expense – paid in advance, benefit next period (Current Asset).

  • Outstanding Expense – incurred but unpaid (Current Liability).

Income

• $\text{Income} = \text{Revenue} - \text{Expenses}$

• Broader than “profit”; includes non-operating gains.

Profit

• Income from operating activities.

  • Gross Profit: $\text{Net Sales} - \text{Cost of Goods Sold}$

  • Net Profit: $\text{Total Revenue} - \text{Total Expenses}$

Gain & Loss

• Gain: increase in equity from incidental, non-operating events (e.g., profit on sale of machinery).

• Loss: excess of expenses over revenue, or money’s worth lost without benefit (e.g., theft, abnormal loss).

Purchases / Purchase Return

• Purchases: acquisition of goods for resale/production (cash + credit).

• Purchases Return (Returns Outward): goods sent back to supplier.

Sales / Sales Return

• Sales: revenue from goods sold/services rendered (cash + credit).

• Sales Return (Returns Inward): goods returned by customers.

Revenue from Operations

• Net inflow from core activities (net sales, service income, interest/dividend for financial enterprises).

Goods

• Items held for resale or manufacture for sale; differ by business nature (TVs for appliance dealer, stationery for bookseller).

Stock / Inventory

• Goods held for sale or use in production.

  • Opening Stock: at start of period.

  • Closing Stock: at end of period – valued at $\min(\text{Cost},\text{NRV})$.

  • Types: Raw Material, Work-in-Progress, Finished Goods.

Trade Receivables & Payables

• Trade Receivables = Debtors + Bills Receivable → amounts receivable from customers.

• Trade Payables = Creditors + Bills Payable → amounts payable to suppliers.

Cost

• Expenditure incurred / attributable to an article, product or activity.

Voucher

• Documentary evidence of a transaction (Cash Memo, Invoice, Receipt, Debit/Credit Note).

Discount

• Trade Discount: reduction in list price for bulk/wholesale; not recorded separately (record at net).

• Cash Discount: incentive for prompt payment; recorded as expense (allowing) or income (receiving).

Other Important Terms

• Bad Debts (irrecoverable receivable → loss).

• Balance Sheet (financial position statement on a given date).

• Book Value (carrying amount in books).

• Books of Account (journals, ledgers, Cash Book, etc.).

• Cost of Goods Sold (direct cost of inventory sold).

• Debit / Credit (left / right side of account; dual aspect recording).

• Depreciation (systematic allocation of depreciable amount of asset over useful life).

• Entity (separate economic unit – Business Entity concept).

• Entry (record of a transaction in books).

• Insolvent (inability to pay debts) vs Solvent (ability to pay).

• Proprietor (owner bearing risk & reward).

• Rebate (post-sale reduction in price for defects, quality issues etc.).

• Financial Statements / Final Accounts (Trading, P&L / Statement of P&L, Balance Sheet; Cash Flow).

Illustrative Numerical Highlights (from text)

• Capital formula $\text{Capital} = \text{Assets} - \text{Liabilities}$.

• Operating-cycle rule: if not identifiable, assumed 12 months.

• Inventory valuation rule: $\text{Value} = \min(\text{Cost},\text{Net Realisable Value})$.

• Example computation (Prem’s case):

  • Capital introduced $=₹20,00,000$.

  • Net purchases $=₹17,80,000$ (after returns).

  • Closing Stock $=₹7,75,000$ (derived via inventory equation).

  • Income / Profit $=₹1,75,000$.

Ethical & Practical Implications Discussed

• Reliability & window-dressing: ethical obligation to present true & fair view; manipulation undermines trust.

• Limitation of ignoring qualitative factors – need for integrated reporting (social, environmental).

• Price-level changes – importance of inflation accounting for fair presentation.

Connections & Real-World Relevance

• Comparative analysis assists investors, lenders & management in performance benchmarking.

• Tax authorities rely on systematic records for GST & Income-tax assessments.

• Courts accept properly kept books as legal evidence.

• Bank loan covenants often require compliance with recognised accounting principles (GAAP / Ind AS).

Key Formulae & Equations

• $\text{Capital} = \text{Assets} - \text{Liabilities}$

• $\text{Income} = \text{Revenue} - \text{Expense}$

• $\text{Gross Profit} = \text{Net Sales} - \text{Cost of Goods Sold}$

• $\text{Net Profit} = \text{Total Revenue} - \text{Total Expenses}$

• Inventory Valuation $= \min(\text{Cost},\text{NRV})$

Quick Comparison: Book-Keeping vs Accounting

Systems of Recording: Double vs Single Entry (Snapshot)

Memory Aids

• DEALER rule (Debits: Dividends, Expenses, Assets — Credits: Liabilities, Equity, Revenue).

• CASH mnemonic for Qualitative Characteristics:
  C – Comparability
  A – UnderstandAbility
  S – Relevance (Significance)
  H – Reliability (Honesty)

Typical Questions for Self-Check (HOTS & MCQs)

• Why are non-monetary events excluded? Discuss advantage vs limitation.

• Differentiate between Capital & Revenue items with examples.

• Identify users of accounting information & specify their needs.

• Classify given items into Assets, Liabilities, Capital, Revenue, Expense.

• Multiple-choice practice (sample answers provided in text).