Chapter 1 — Introduction to Accounting

Chapter 1 covers the meaning and definition of accounting, accounting as a source of information, internal and external users of accounting information, objectives of accounting, the role of accounting, qualitative characteristics of accounting information, and basic accounting terms such as assets, liabilities, capital, debtors, creditors and voucher.

Accounting is defined as the process of identifying, measuring, recording and communicating the required information relating to the economic events of an organisation to the interested users of such information. The AAA (1966) also defined it as the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users.

The four steps are identification (determining which events of financial character are to be recorded), measurement (quantifying transactions in monetary terms), recording (entering them chronologically in books of account), and communication (reporting the information to internal and external users through accounting reports).

Internal users include the Chief Executive, Financial Officer, Vice President, Business Unit Managers, Plant Managers, Store Managers and Line Supervisors. External users include present and potential investors, creditors (banks, debenture-holders), tax authorities, regulatory agencies (SEBI, Registrar of Companies), labour unions, trade associations, stock exchanges and customers.

The four qualitative characteristics are reliability (information is free from error and bias and can be verified), relevance (information is available in time and influences decisions), understandability (decision-makers interpret it in the same sense as it is prepared), and comparability (reports use a common period, unit of measurement and format so entities can be compared).

The primary objectives are: maintenance of systematic records of business transactions, calculation of profit earned or loss sustained during an accounting period, depiction of the financial position through a balance sheet, and providing accounting information to internal and external users for planning, controlling and decision-making.

Financial accounting keeps systematic records of financial transactions and prepares financial statements to show profit/loss and financial position. Cost accounting analyses expenditure to ascertain the cost of products or services and helps fix prices and control costs. Management accounting provides information to people within the organisation for decision-making, planning and controlling business operations, drawing on both financial and cost accounting.

Profit is the excess of revenues of a period over its related expenses during an accounting year. Gain is a profit that arises from events or transactions incidental to business, such as sale of fixed assets, winning a court case, or appreciation in the value of an asset.

Trade discount is a deduction of an agreed percentage from the list price at the time of selling goods, generally offered by manufacturers to wholesalers and by wholesalers to retailers. Cash discount is a deduction given to debtors who pay the amount due within a stipulated period; it acts as an incentive for prompt payment.

Expenditure is spending money or incurring a liability for some benefit, service or property received. If the benefit of the expenditure is exhausted within a year it is treated as an expense (revenue expenditure); if the benefit lasts more than a year, it is treated as an asset (capital expenditure) such as purchase of machinery or furniture.

A voucher is documentary evidence in support of a transaction. For example, a cash memo when goods are bought for cash, an invoice when goods are bought on credit, and a receipt when a payment is made.

An economic event is a happening of consequence to a business organisation consisting of transactions measurable in monetary terms. External events involve transactions between an outsider and the organisation, such as sale of goods to customers or purchase from suppliers. Internal events occur entirely between internal wings of an enterprise, such as supply of raw materials from the stores department to the manufacturing department.

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