Meaning of Accounting

1.1 Introduction
A Commercial Professional or Industrial activity, driven by an individual or a group of individuals
engaging in producing and selling goods and services for profit is known as Business.

An organization that is formed to operate some type of service or commercial activities for profit or
for non-profit.

For Example: Proprietorship, Partnership, Limited Liability Partnership, Private Limited Company,
Public Limited Company, Co-operative societies, NGO etc.

Types of Business Sector

 Producing raw materials: These are the business sectors which are involved in the
production and extraction of the raw materials.

 Trading: The business of buying and selling commodities & products.

 Manufacturing: The process of converting raw materials, components, or parts into finished
goods that meet a customer's expectations

 Service: An enterprise of professional or team of experts that deliver work or aid in

completing a task for the benefit of its customers. A type of economic activity that is
intangible. Examples of a service business are consultancy and profession services rendered
by Chartered Accountants, Tax Consultants, Doctors, Engineers, Recreation, Health care,
Transportation etc.

It becomes essential for a business owner to keep a record of the business income and expenditure,
to find answers to numerous questions, a few of which are:

 What is the total value of business assets?

 Whether the business is earning profits or incurring a loss?

 How much do third parties owe the business?

 How much does the business owe to third parties?

 Should a specific operation be withdrawn?

 Can the business be expanded?

These answers can be occurred by, studying the financial information of the business operations.
Therefore, accounting is an integral part of the business.

Accounting is the practice of maintaining precise records of the financial dealings of a business. It
involves identifying business transactions, recording them, and summarising the same in such a way
that important financial information can be communicated to the stakeholders of the business.
Accounting is also called the language of business/finance.

The Common Stakeholders of typical business concern are,

 Owners: The stakeholders are the owners of an organization.

 Employees: These people are employed for wages or salary.

  Investors (existing and potential): These investors can be owners or outside vendors who
typically have a right to know the accurate and timely information such as regular financial
statements.

 Suppliers: These are the people or businesses who sell goods to your business and rely on
you for revenue from the sale of those goods.

 Customers: These are the people who buy business products.

 Communities: These are stakeholders which are considered as business function by another
set of stakeholders( Suppliers, customer employees).

 Government authorities: These are the authorities which collect taxes from the company
and its employees.

1.1.1 Meaning of Accounting

Accounting is a process of identifying, systematic recording, summarizing, analyzing, and
interpretation of financial reports of a business.

Phases of the Accounting Cycle

The following chart will depict the different phases/process of the accounting cycle as shown in Chart
1.1.

Explanation of the Chart

 1. Understanding the transaction: The details of transaction like date, debit and credit amount
etc.

2. Journal Entry: In this process, we will record the business transaction by debiting and
crediting the different account.

3. Ledger Posting: In this process, we will transfer the transactions which were recorded in
the journal to its corresponding ledger accounts.

4. Trial Balance: In this process, we will determine the list of all the general ledger accounts
into debit and credit account column totals that are equally contained in the ledger of a
business. The purpose of producing a Trial Balance is to ensure the entries in the company’s
book keeping system are mathematically correct.

5. Profit & Loss Account: In this process, we will determine the net profit/loss of a business
that occurs during the accounting period.

6. Balance Sheet: In this process, we will determine the summary of the financial balances of
a business or an organization.

In the case of manual accounting, all seven activities are carried out manually by accountants. But in
case of accounting software, out of these above given seven activities, only two activities are
performed manually. i.e.

 Understanding the Transactions

 Voucher Entry

Remaining five activities, i.e. Ledger Posting, Trial Balance, Profit & Loss Account & Balance Sheet are
performed by the accounting software automatically.

1.2 Terminologies used in Accounting

Basic accounting terms are most important for Accounting beginners or an individual. The commonly
used accounting terms in the business are :

1. Capital.
The amount of money or money’s worth introduced into the business by owner is called capital.

2. Transaction
A Transaction is a business activity that involves the transfer of money or money’s worth between
two accounts. A transaction can be of two types :

 Cash transaction: A cash transaction is one where the money is immediately received or paid
in the form of cash.

 Credit transaction: A credit transaction is one where the money is paid later, but the benefits
are enjoyed immediately.

3. Assets
Any item of economic value owned by an individual or corporation especially, which could be
converted into cash.
4. Liability
The Liabilities are whatever the entity owes to outsiders. So, it includes loans, the amount payable to
creditors, etc.

5. Drawings
Money or money worth, which is withdrawn by an individual (business owner) or corporation from a
business for his personal use.

6. Bad debts
When a debtor becomes insolvent the trader will not be able to realize in part or full amount due
from the customer. Part or full amount will remain unrealized. The unrealized amount is called bad
debts. Bad debts are irrecoverable receivable.

7. Purchases
A purchase is the number of goods bought by a business for further use or for reselling. Goods
purchased with immediate payment of cash are called cash purchases. Goods purchased on credit
are called credit purchases.

8. Purchase returns
Goods that have been purchased but are returned to the seller before consumption due to reasons
like poor quality and damage are called purchase returns.

9. Sales
Sales refer to the number of goods sold by businesses. Sales made against immediate payment of
cash are called cash sales. Sales on credit are called credit sales.

10. Sales returns

The goods that are sold but returned by the buyer before consumption due to poor quality and
damage, are called sales returns.

11. Debtor
A Debtor is a person who receives benefits from the business immediately but is obligated to pay for
the same in future.

12. Creditor
A person who provides benefit without receiving immediate payment for the same, and who will
claim the payment in future, is called a creditor.

13. Stock
Unsold goods, raw material, etc., that lie with the business are collectively known as stock.

14. Revenue
The earnings of a business through its business activities and operations is called revenue.

1.3 Concepts of Accounting

Accounting Concepts are those basic assumptions and conditions on which accounting is based.

1. Business Entity Concept

The business concept is also known as the separate entity concept. It is assumed that business has a
separate and distinct entity from its owner who owns it. Thus, the transactions related to business
needs to be recorded in the books of Accounts.

The types of Business Entities are:

 Sole Proprietorship: A sole proprietorship, is also known as the sole trader or simply a
proprietorship, is a type of business entity that is owned and run by an individual.

 Partnership: A business organization in which two or more individuals manage and operate
the business. Both owners are equally and personally liable for the debts from the business.

 Private Limited Company: It is a type of privately held small/medium business entity, in

which owner liability is limited to their shares, the firm is limited to having 200 or fewer
shareholders, and shares are prohibited from being publicly traded.

 Public Limited Company: The standard legal designation of a company which has offered
shares to the general public and has limited liability. A Public limited company’s stock can be
acquired by anyone and holders are only limited to potentially lose the amount paid for the
share

 Corporation: It is a type of legal entity which is separate and distinct from its owners.

 Limited Liability Partnership (LLP): A hybrid legal entity that has both the characteristics of a
corporation and a partnership. An LLP provides its owners with corporate-like protection
against personal liability. It is, however, usually treated as a non-corporate business
organization for tax purposes.

2. Going Concern Concept

The going concern concept is also known as continuity concept. In this concept, the assumption is
made that every business is carried on continuing for an indefinite period. It will not be dissolved in
near future.

3. Money Measurement Concept (Monetary Expression)

It implies in accounting entries to record is made of only those transactions or events, which can be
measured and expressed in terms of money.

4. Cost Concept

The cost concept is also called a Historical cost concept. According to this concept the assets which
are acquired by a concern are recorded in the books of accounts at cost price. The cost of acquisition
is related to the past; hence it is known as the historical cost concept.

5. Dual Aspect Concept

This concept states that every financial transaction has two aspects: one where the business receives
a benefit, and the other where it provides a benefit. Therefore, every transaction should be recorded
in such a way that its effect is reflected in two places in a business’ books of accounts. This concept
forms the basis for the Double Entry System of Accounting.
6. Accounting Period Concept

The Accounting period concept can also be called a Periodicity concept. Life of the business is
indefinite, thus indefinite period is divided into periodic intervals each interval is known as the
accounting period. At the end of each accounting period, financial statements i.e, Balance sheet and
Profit and Loss account are prepared to know the financial position of the business.

7. Revenue Realisation Concept

According to this concept, revenue is considered as the income earned on the date when it is
received. As per this concept, unearned or unrealised revenue is not considered. This concept is vital
for determining income pertaining to an accounting period. It reduces the possibilities of inflating
incomes and profits.

8. Accrual Concept

This concept requires that income or expenditure are recorded when they become receivable or
payable rather than when they are collected or paid i.e., transactions are recorded based on income
earned or expense incurred irrespective of actual receipt or payment.

9. Matching Concept

As per this concept, the revenue earned and the cost incurred to earn such revenue, need to belong
to the same period, and hence they need to be ‘matched’. This will help ascertain the result of the
business operations. This concept serves as the basis for calculating accurate profit earned during a
period.

10. Verifiable and Objective Evidence Concept

This concept requires that all financial transactions be supported by documentary evidence. Such
evidence should be easy to verify and provide unbiased proof of transaction.

Note: The cash basis of accounting is a method wherein revenue is recognised when it is received,
rather than when it is earned. Expenses are booked when they are actually paid, rather than when
incurred. This method is usually not used by businesses and is, therefore, used only in selected
situations such as for micro-businesses.

1.4 Double Entry System of Accounting

Every business transaction has a two-fold effect, wherein two accounts are affected in opposite
directions. Thus, if a complete record were to be made of each such transaction, it is necessary to
debit one account and credit another account. Recording of this twofold effect of every transaction is
called the Double Entry System of Accounting.

As explained in the Dual Aspect Concept, every financial transaction has two aspects: one where the
business receives a benefit, and the other where it provides benefit. Therefore, every transaction
should be recorded in such a way that its effect is reflected in two places in a business’ Books of
Accounts. The receiving aspect is termed the ‘Debit’ aspect. The giving aspect is termed the ‘Credit’
aspect. Therefore, every business transaction will influence two accounts; one will be debited,
whereas the other will be credited.

The double entry mode format is shown in Table 1.1.

1.4.1 Uses of Debit and Credit

Every transaction involves two aspects – give and take. In the double entry system of accounting,
every transaction is recorded in at least two accounts. While recording transactions, the total amount
debited and credited must be equal. In accounting, the terms debit (abbreviated as Dr.) and credit
(abbreviated as Cr.) indicate whether the transactions are to be recorded on the left or right of the
account.

1.4.2 Rules of Debit and Credit

The following table summarises the rules applicable to different kinds of accounts is shown in Table
1.2.

The 5 Elements of Financial Statement

Illustration 1: Application of Rules of Debit and Credit

Objective: Recording transactions using debit and credit rules for the business

As on 1st April 2020, Suman commenced the business with ₹15,00,000 by Cheque of Citi Bank vide
cheque number 540102.
This transaction increases the capital as well as the Bank balance. Increase in assets is debited and
the Increase in capital is credited. Therefore, record the transaction with a debit to Bank account and
credit to Suman’s capital account.

Akash Mahakur