Unit 1 Introduction to Accounting

Contents

1.1

Importance, Objectives - Nature and Scope

1.1.1 History of Accounting

1.1.2 Definition of Accounting
1.1.3 Importance of Accounting
1.1.4 Objective of Accounting
1.2

Management Process and Accounting

1.3

Accounting Concepts and conventions

1.3.1 Users of Accounting Information and its Implications

1.3.2 Accounting Information System:
1.4

Financial accounting

1.4.1 Objectives of Financial Accounting

1.4.2 Nature of Financial Accounting
1.4.3 Scope of Financial Accounting
1.4.4 Types of Accounting and difference between Financial Accounting Vs Cost Accounting
Vs Accounting for Management
1.5

Role of accounting in modern organization

1.6

Classification of Accounts

Chapter I
Chapter Objectives:
1. To make the students understand origin and growth of accounting as a
profession in India
2. To make them well versed with important terminologies that are often used in
accounting.
3. To equip the students with different type of accounts and its rule regarding
debit and credit.
4. To give students a broader understanding of the type of accounting and the
difference between each type of accounting.
Introduction:
Reliance Industries, Wipro, Tata Group etc. etc. what for these names stand? These
are all the giants in business. What do we mean by business? Is it manufacturing? Is
it selling the finished product? or is there anything that is involved beyond these two
points? Is there any component of money involved in the answers of all these
questions?
Definitely we will get the answer as yes. Then we can say that every business
enterprise incurs expenditure in order to run the business. The next point what
strikes our mind is only investment is important or business enterprise will also be
interested in knowing as to whether the investment fetches any returns? If so what
to call these returns? Is it profit? What type of profit? How to find out the profit? Is
there any procedure for finding out profit? To answer all these questions read the
following chapters carefully.

Chapter 1.1
Introduction to Accounting
Accounting is part of every individuals life. Human beings have been adopting
accounting since the time immemorial. Accounting has been considered as the
important component of ones life. People have been following the double entry
system of accounting, centuries ago it started as a barter system, and gradually it
has evolved into exchange of money with kind or moneys worth. But it was without
proper methodology or any form of theory. It was during nineteenth century that a
move from book keeping to accounting- a move which helped every one in following
accounting as a system , it paved way for designing of a comprehensive accounting
system.
Accounting gained recognition only after the separation of forms of business
organization, from a conventional single ownership it has shifted to partnership form
of business organization and in turn the ownership and control got diversified,
gradually the volume of stake holders also increased, which necesseciated the
preparation and presentation of accounts in a systematic manner.
Earlier profit calculation has only two components one is the inflow of cash and the
other used to be outflow of cash, of late because of the complexities in the tax
calculation, growing importance of valuations and complex set of allocations arriving
at profits itself has become a daunting task.
If we look back, we can say that accounting has gone through many phases- started
as a simple double entry system of book keeping enterprise accounting
Government Accounting and now a days social accounting . with changing phases
of accounting , over the year new concepts and techniques have also evolved to
meet the increasing needs

for financial information

. Without such information ,

many complex economic developments and social and economic programmes would
not have been undertaken.

1.1.1 History of Accounting

Accounting has existed for many centuries ; the exact period during which
accounting practice was started is unknown , but symbols recording transactions
between tribes have been found to date back 5000 BC. The Sumerian civilization in
Mesopotamia kept such records on clay tablets beginning bout 3200 BC, and more
than 3,000 years ago scribes in Babylonia and Egypt actually received what in effect
was formal accounting training in schools. Perisa under Drius (521 -486 BC) ahs
government scribes who performed surprise audits of the accounts of the provinces,
and similar audits were made in the Hebrew civilization in which the chief scribe was
the second highest position in the government. However, in the ancient Greece (1400
BC) it became customary to use slaves as scribe and auditors.
In Greece, accounting became prestigious , the records of construction costs of the
government buildings were carved on the structures. In the Roman Empire, about
200 BC , quaestors in the territories were responsible for supervising the local
government accounts. The quaestors report to Roman Empire were given person and
heard by an examiner, a practice that gives us our modern day term auditor.
In the Byzantine Empire, Constantine founded a public administration school in which
accounting was taught. Full blown double entry book keeping appears in Genoese
records of 1340 , and the office of exchequer developed in England. In the 15 th
Century, branches of the Medici Bank were required to submit annual balance sheets
to the main office in Florence. In 1631 , an accountant was sent from Holland by the
financial backers of the settlement at Plymouth, Massachusetts, to investigate the
colonys increasing debt, the new Americans thus experienced their first audit.
1.1.2 Definition of Accounting
What is accounting?
The basic definition of accounting is yet to get its precise form; many contributors
gave the definition of accounting in many ways. Let us look into the definition of
accounting , but before discussing as to what is accounting it is important for a lay
man to understand the exact definition of account:

Account: Is a summarized record of all transactions relating to persons or things or

subjects taken place in a given period. An account has two sides, left hand side is
known as Debit side and right hand side is known as Credit Side. Thus you can ask
as to what is debit and credit?
Debit: Debit in general is considered as whatever the business receives or comes
into the business enterprise.
Credit: Credit stands for whatever goes out of the enterprise and also what ever the
enterprise pays.
Friends you might doubt as to how to understand the importance of accounting---it is
referred in the definition of accountancy
Accountancy- Accountancy gives systematic details about why to prepare the
accounts, how to prepare the accounts, when to prepare and what to consider while
preparing accounts.
Once we are able to answer these questions, we should be able to prepare accounts.
We can define Accounting:
Preparation of accounts in a procedural manner is known as Accounting.
The actual procedure of preparing and presenting accounts is known as
Accounting.
In 1996, The American Accounting Association (AAA), in order to emphasis the
broader perspectives of accounting provided the following definition of accounting1

Accounting is the process of identifying, measuring and communicating

economic information to permit informed judgments and decisions by users

of the information
The committee on Terminology of the American Institute of Certified Public
Accountant (AICPA) framed a comprehensive definition of accounting , which covers
almost all the pre-requisites of accounting.
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 results
thereof2

Let us look into other important terminologies of accounting:

Book Keeping: It is the record keeping of books of accounts
Entity: An entity means an economic unit that performs activities.
Event: An event is a happening of consequence to an entity. That means in an
economic unit there are various activities in an event.
Transaction: is an exchange in which each participant scarifies or receives value.
Voucher: Is a document which serves as an evidence of a transaction.
Entry: Is the record made in the books of accounts in respect of transaction or
event.
Asset: Refers to tangible object or intangible rights of an enterprise which carry a
future probable benefit.
Assets can be divided into tangible and intangible
Tangible assets are those which can seen and felt e.g Chair , Machinery , Motor Car
etc.
Intangible Assets are those which can not be seen or felt e.g. Patent rights,
Trademark. etc.
Liabilities: Any financial obligation of the business enterprise, it may be short term
or long term obligation.
Capital: Is an excess of assets over external liabilities or it is an amount invested by
its proprietor or enterprise.
Drawings: Refers to the total amount of cash or goods or any other asset
withdrawn by the proprietor for personal use.
Purchases: Refers to the total amount of the goods obtained by an enterprise for
resale or for use in the production of goods or rendering of services.
Sales: Refers to the amount for which the goods are sold or services are rendered
Stock or Inventory: Refers to the tangible property held for sale in the ordinary
course of business or for consumption or the production of goods and services.
Trade Debtors: Refers to the person form whom the amount are due to the
company- generally trade debtors arise due to credit sales of the company
Trade Creditors:

Refers to the person to whom the amount are due by the

company- generally trade creditors arise due to credit purchases.

Receivables: Includes trade debtors and also bills receivables.
Payables: Includes trade creditor and also bills payables.

Expenditure: Are the costs incurred in acquiring asset or receive service in the form
of outflow or depletion of assets or incurrence of liability.
In other words it refers to the amount invested for one time and which generates
returns on year on year basis.
Or a liability borrowed for one time on which the enterprise need to pay interest at
regular intervals.
Income:

An increase in economic benefits during an accounting period on the

inflow of assets or decrease in liabilities.

1.1.3 Importance
Accounting is said to be as old as the hills and money, however with the changing times the
role of accounting has also been changing. Such a change can be attributed to the changing
business patterns, and social, economic, and technological developments. The notion that
accounting is historical in nature does not hold good in view of the changing patterns.
Accounting as has been defined as an art of recording , classifying and summarizing
transactions and events , accounting has come to known as a , Process of identifying ,
measuring and communicating economic information, In the present scenario it is
considered as a service activity whose function is to provide quantitative information about
the financial performance of the company.
This definition brings out the following attributes of accounting:
a. Events and transactions of financial nature are recorded while events of a non
financial nature cannot be recorded.

b. The record should reflect the importance of the transactions recorded both
individually and collectively, which included summarization, thereby making it
amenable to analysis.

c. The users of the financial statements should be able to obtain the messages
encompassed in such financial statements and it is the knowledge of accountancy
which enables the user to understand the contents of the financial statements.
1.1.4 Objective of Accounting
a. To Maintain a Systematic Record:
Accounting is done to maintain a systematic record of the monetary transactions of the firm
which is the initial step leading to the creation of financial statements. Once the recording
is complete, the records are classified and summarized to depict the financial performance
of the enterprise.

b. To Ascertain The Performance of The Business:

The income statement, also known as the Profit and Loss Account , is prepared to reflect the
profits earned or losses incurred. All the expenses incurred in the course of conducting the
business are found out and deducted from the total revenue to arrive at the profit earned or
loss suffered during the relevant period.
c. To Evaluate The Financial Strength of the Business:
The information about the asset and liabilities provided by accounting gives information
about how much the business has to pay to others and how much the business has to
recover from others. In a Balance Sheet on its right hand side are the assets and on the left
hand side are the liabilities. The owners portion is the capital and is to be distinguished
from that of the other liabilities such as loan and creditors. All of them are grouped under
the head liabilities.
d. To Facilitate Financial reporting:
Accounting is the precursor to financial reporting. It helps in conveying information in a
systematic manner to the users of accounting information.
e. To Facilitate Decision Making:
Accounting facilitates decision making through financial reporting. Financial reports such as
cash budgets, production budgets etc. are used for integral decision making while financial
statements are used for external purpose.
1.2

Management Process and Accounting

The process of management consist of

a. Planning
Planning is the primary phase and most creative element of the management
process which includes: defining business objectives, ways and means for achieving
the objectives, determining possible alternatives and selecting the best one for
achieving the set objectives. Accounting planning, in accordance with this phase of
management process, enables the preparation of information and a special costbenefit analysis of setting business alternatives with the purpose to help in the
decision-making process, as well as of certain periodical plans.
b. Organizing
Organizing, as the phase of management process, solves the problem of an internal
organizational structure of enterprise, managerial authority and responsibility
division, as well as of selecting people and ways of performing business activities.

Concerning the organizing, as the phase of management process, the task of

accounting is to structure internal accounting reporting in accordance with the
organizational structure of an enterprise, indicate possibilities for improving the
organizational structure, and determine the basis and measures for estimating
efficiency of delegated authorities accomplishment.
c. Communicating
Communicating, as the phase of management process, means transferring
instructions and information through the enterprise's management. This phase is
supported by the phase of accounting communication, which provides a quantitative
expression of instructions and information, creating a scheme of their transferring,
and eliminating any interruption of instruction and information flows.
d. Directing:
Directing refers to the proper way out of any activity. Directing goes hand in hand with
organizing , in the similar manner accounting also gives a direction for the proper
performance of the business enterprise.
e. Coordinating
Coordinating is defined as coordinating of the each and every steps and process in
the business enterprise. In this function managers tries to seek the coordination from
all the subordinates in order to achieve the goal of the organization. In the same way
accounting provides information in order to seek coordination among all the
functional areas in the business enterprise.
f.

Motivating

Motivating is the phase of management process which determines an individual

behavior so that the organizational parts and individuals are identified with the global
objective and that they should behave accordingly. In that sense, it is important to
respect individual objectives of the employees in the way to motivate them to
achieve objectives and development of enterprise. This phase of management
process provides the information support through the motivation aspect of
management accounting which provides an information basis for estimating success
of parts according to the current motivation and compensation system, defines the
basis and measures of stimulation, and affirms rewards.
g. Controlling
Controlling, as the phase of management process, includes comparison of planned

and achieved results, for reacting to possible deviations and taking eventual
corrective actions. In connection with this, the accounting control provides the
preparation of report about realization, comparison of achieved and planned values,
and an analysis of possible deviations, their locations, and reasons for their
occurrence.
h. Budgeting
The final stage in the process of management is budgeting, based on the financial
information provided in the form of accounting , management prepares a budget which
is more to do with the identification and allocation of the financial support of each
department in the enterprise.

1.3 Accounting Concepts and conventions

In the beginning of the chapter we asked few questions as to how to define profit is there
any procedure etc. to answer those questions we have Generally Accepted Accounting
Principles in short known as GAAP which gives us a clear cut understanding of the
preparation and presentation of accounts. It is a combination of authoritative standards (set
by policy boards) and the accepted ways of accounting. These are the rules that the
business enterprises are expected to follow while preparing their financial statements.
It is in this context that fundamental concepts in accounting have become crucial to
the process of measurement and valuation. It is a given fact that in the presentation
of the financial position and income of an enterprise, we come across several
alternatives. These fundamentals help us to select from among the many attributes.
In the absence of a unified theory of accounting, its fundamentals are evolved over a
period of time. It is a continuous process, because subject matter of accounting
operates in a continuously changing environment. If we look into the evolution of
accounting fundamentals we can segregate it into four stages. Namely- concepts,
standards, postulates and principles. Let us have a look at each other in brief.
a. Concepts- it is an idea, a general notion, thought or assumption.

b. Standards- are something established for use as a rule, intended to act as a

basis of comparison and reference in measuring quantity or quality and
assigning value to it.
c. Postulates- are assumptions; they are taken to be true and real. They are
restored as a basis for an argument or as a prerequisite.
d. Principles- refers to a law, or a rule of conduct.

Accounting Concepts:
Accounting concepts are formed primarily by observation and are established
through agreement. Most of the concepts, evolved over the years, have been
generally accepted as postulates. and some concepts over a period have been
accepted as principles.
1. Business Entity Concept:
This concept explains that the business enterprise is separate form it owner and
hence liable to the owner. e.g. when we look at the Balance Sheet we see capital
as a liability. In the beginning we have defined capital as the amount invested by
the proprietor, hence when we are showing capital as a liability it indicates that
the owner has lent the capital to the business enterprise. The concept therefore,
enables

the

accountant

to

distinguish

between

personal

and

business

transactions. The concept applies to all types and all sizes of business
enterprises.
e.g. When the proprietor invests Rs. 50,000 into a business it is assumed that the
proprietor has

given the amount to the business enterprise and it will treated

as a liability under the head capital from the business enterprises point of view.
When he withdraws any amount from it will deducted form the capital and
accordingly liability will come down to that extent.
2. Going Concern Concept:
The business enterprise has a life of infinite duration. It means that the business
enterprises have a long lasting life. Because of the relative permanence of the
enterprise, financial accounting is formulated assuming that the business will
continue to operate for an indefinitely long period in the future. Hence, individual
financial statements carry interrelationship between the past financial statement

and also on the future statements. The information provided in one years
statements may help individuals to understand the performance of the business
enterprise in comparison with past period.
3. Accounting Period Concept:
In sync with the going concern concept we can say that measuring profit in case
of going concern is relatively difficult, as we can not define profit for five year or
ten years , nor we can say that we will measure profit at the end of the life of an
enterprise, hence this concept says that the enterprise should define its
accounting period which should be of twelve months, it may be a calendar year
starting from 1st January and ending on 12th December, every year or it can be a
financial year starting form 1st April and ending on 31st march, every year. Some
companies also issue quarterly or half yearly statements to shareholders. They
are considered to be interim, and essentially different form annual statements.

It helps in defining the financial performance of a business enterprise concretely

at the end of one year and based on which further decisions can be taken for
next years to follow.

4. Matching Concept:
The matching concept is useful in determining the profitability of business
operations during a particular period. It means determining profits after charging
the expenses of a period with the revenues. In short matching concept explains
that whatever expenses have been incurred in one accounting period should be
able to generate revenues in that year only. Alternatively we can say that we use
only those costs that resulted in revenue generation in a particular period, as the
expenditure for a particular year.
The most important feature of this concept is that there should be positive
correlation between respective revenues and costs.

5. Money Measurement Concept:

Money measurement concept says that we should consider components which
can be measured in terms money or moneys worth for the purpose of
accounting. The component which does not carry any monetary value should not
included in accounting. Alternatively the common denominator in accounting
should be money.
6. Cost Concept:
The cost principle requires that assets be recorded at their exchange price i.e.
acquisition cost , or historical cost. The historical cost concept implies that since
the business is not going to sell its assets as such, thee is little point in
revaluating assets to reflect current values. In addition, for practical reasons the
accountant prefers reporting of actual costs to market values which are difficult to
verify. Thus, the cost concept provides greater objectivity and greater feasibility
to the financial statements.
7. Dual Aspect Concept:
This concept is the central point of accounting, through which all the transactions
of a business enterprise , have to pass through. The accountant records events
affecting the entity as per the business entity concept. The question here arises
as to how to identify the source form where the transaction has begun or how to
identify the destination where the transaction has reached?
This concept explains that every transaction has two effects one is known as
debit and other is credit. We have seen

the definition of transaction, for the

purpose of transaction to take place, there should be two parties, out of which if
one is sacrificing the other will benefit, in turn both the parties will be part of the
transaction.
Hence, dual aspect concept says that in accounting one has to reveal the impact
on both parties.

8. Realization Concept:
The concept of realization determines the point of time when revenue, and hence
returns can be recognized objectively, without bias and with certainty. It is very
important that the recognition of revenue has nothing to do with the receipt of
cash.
In case of sale of goods cash may be received before the sale, at the time of sale,
or after the sale, but the revenue and in turn profits are recognized only at the
point of sale. For example, if goods are sold in the month of December, for which
the payment will be received in the month of January, revenue and hence profits
will be considered to have been earned or realized in the month of December and
not in the month of January.
Conversely, if an advance is received in the month of March, for sales to be made
in the month of April, revenue is required to be considered to be earned or
recognized in the-month of April, not in March.
Conventions:
1. Convention of Disclosure:
The convention of disclosure indicates that the business enterprise has to
invariably disclose their financial performance and financial position at the end of
each accounting period to the stake holders in its true form.
The question here arises as to who are the stakeholders. Stakeholders are the
parties who might be interested on knowing about the performance of the
business enterprise with direct purpose or indirect objective. These stakeholders
can be divided into two , namely internal and external
The broad classification can be split in the following manner.
Internal Stakeholders
Management
Employees

External Stakeholders
Customers
Suppliers
Providers of Funds
Government
Society as a whole
Share holders
Research Scholars
Regulatory Bodies

2. Convention of Consistency:
This convention takes care of the consistency in preparing the accounts. This is
basically applicable valuing the inventory or while valuing the depreciation of an

asset. This business enterprise requires to follow the same method of valuation
with which it would have made a beginning.
The basic objective of this convention is to see that because of the consistency in
valuation pattern profits can also be projected without much variation.
3. Convention of Conservatism:
To be conservative, is to prefer the familiar to the un known, to prefer the actual
to the possible, the limited to the unbounded, the convenient to the perfect.
Alternatively conservatism mean selecting the method of measurement, which
yields the gloomiest immediate results. The bottom line of this convention is,
anticipate no gains , but provide for all possible losses and if in doubt write it
off.
Thus this convention requires the accountant to not to eye on profits but to
minimize the losses.

1.3.1
Users of Accounting Information and its Implications
Following are some of the groups of people who would like to make use of the
accounting information.
a. Owners:
The primary objective of accounting is to provide necessary information to the
owners relating to their business. E.g the shareholders of a company are interested
in the accounting information with a view to ascertaining the profitability and
financial strength of the company.
b. Management:
in large business organizations there is a separation of the ownership and
management functions. The management of such concerns are more concerned with
the accounting information because of their accountability to the owners for better
performance of their concerns.
c. Creditors:
Trade creditors, debenture holders, bankers, and other lending institutions are
interested in knowing about the short term as well as long term position of the

business enterprise. The financial statements provide the required information for
ascertaining such positions.
d. Regulatory Agencies:
Various governments and other agencies use accounting reports not only as a basis
for tax assessment but also in evaluating how well various business concerns are
operating under regulatory framework.
e. Government:
Government all over the world are using financial statements for compiling statistics
concerning business unit, which, in turn help in compiling national accounts.
f. Potential Investors:
Investors use the information in accounting reports to a greater extent in order to
determine the relative merits of various investment opportunities.
g. Employees:
Employees are interested in the earnings of the enterprise because their pay hike
and payment of bonus is depend on the size of profits earned.
h. Researchers:
The researchers in their research in accounting theory as well as business affairs and
practice also use accounting data.

1.3.2 Accounting Information System:

An accounting information system (AIS) is the system of records a business
keeps to maintain its Accounting system. This includes the purchase, sales, and
other financial processes of the business. The purpose of an AIS is to accumulate
data and provide decision makers (investors, creditors, and managers) with
information. Accounting refers to the discipline of recording and classifying the
monetary effects of business transactions and events of an enterprise for the
purpose of analyzing, and finally reporting the results to variety of interested parties.
If the transactions are mostly financial in nature, the accounting system will be
termed as financial accounting. On the other hand , if they are of costing in nature

the system will be known as cost accounting. On the other hand, accounting , which
is primarily concerned with providing information relating to the conduct of the
various aspects of business like cost or profit associated with some portions of
business operations, is called management accounting . All financial and cost
information generated by accountants is some interest to the management. But in
practice management accounting differs form other accounting systems it its
emphasis upon purpose rather than techniques .
While this was previously a paper-based process, most businesses now use
accounting software. In an electronic financial accounting system, the steps in the
accounting cycle are dependent upon the system itself. For example, some systems
allow direct journal posting to the various ledgers and others do not.
1.4

Financial accounting

Financial Accounting involves recording, classifying and summarizing of past event and thus
it is considered as historical accounting , whose primary intention is to prepare statements
revealing the income and the financial position of the business on the basis of the events
which have happened in the period reckoned.
1.4.1 Objectives of Financial Accounting
From the definition of accounting, the following may be listed out as the main objectives of
financial accounting.
a. To ascertain the operating results of the enterprise
b. To reveal the financial position of the business and
c. To enable control over the operation as well as the resources of the business.
1.4.2 Nature and Scope of Financial Accounting
When we look into the definition of financial accounting
a. Records and stores large data:
In big enterprises it is very difficult to remember all the transactions. Accounting
provides records which will furnish information as and when desired and thus it replaces
human memory which cannot remember large accounting data.
b. Provides evidence:
In case of disputes, the accounting records function as a good evidence for the
settlement of disputes. For verification of the correctness of the performance of the
business enterprise it provides a strong base for comparing with the past data.
c. Payment of Taxes:

Financial Accounting will be of great assistance to the businessman in the income tax
issues, without which the tax authorities can impose any amount of taxes which the
businessman has to pay.
d. For sale of Business:
In case the businessman is interested in the sale of the business enterprise, if accounts
are properly maintained then it is helpful in fixing the value of the business easily.
e. Fulfills the information needs of various parties:
Financial Accounting provides reliable and useful information to different parties. i.e.
creditor, managers, research scholars, investors, and employees.
1.4.3 Scope of Financial Accounting:
The scope of financial accounting spreads across many fields , it has been discussed
widely that accounting can not be considered in isolation without understanding its
relationship with other disciplines.

As finance is the life blood of every business

enterprise so is the importance of Financial Accounting, financial accounting is Omni

present, it can be found every where in the business enterprise, for that matter any
transaction which involves money or moneys worth takes a birth in the financial
accounting, hence it is said that financial accounting will be present in all spheres of life
of the enterprise. The following point discusses the scope of Financial Accounting in
relation to other disciplines.
a. Accounting and Statistics:
Both accounting and statistics have certain common features such as collection,
classification, summarizing, analyzing, and interpretation of data. Statistical tools can be
used for the purpose of comparison between past and present accounting results.
Statistics considers both types of data which may be defined in terms of money or
otherwise. It facilitates to forecast future plans with a fair degree of accuracy. The
business cycle can forecasted with the help of statistical data related with the accounting
information.

b. Accounting and Economics:

Economics can be defined as the mother of finance; it is a science which studies human
behavior as a relationship of unlimited wants and limited resources which have
alternative uses. As economics studies human behavior in terms of consumption,
production,

exchange

and

distribution

of

wealth

aiming

at

maximizing

human

satisfaction. Accounting helps in identifying cost behind each and every components and
in turn provides a scope to reduce down on these costs. Thus we can say that
accounting takes into account transactions which are economic in nature.
c. Accounting and Engineering:
Engineers depend on accounting to make estimates of the cost of projects. In view of
the limited availability of funds all projects which require capital expenditure cannot be
started. Hence, the engineers have to select among the alternatives available. This
where an accountant comes to the rescue of an engineer. The accountant provides the
information on the costs , benefits and profits of the various alternatives. Therefore,
accounting and engineering can give a sound judgment on the financial feasibility of the
project.
d. Accounting and Law
Financial statements recorded are sometimes affected by law. i.e. in some cases, the
accounting data must comply with the legal requirements. In case of companies in India
there is statutory requirement to comply with section 210 of the Companies Act:

It

gives a detailed regulation in terms of preparation of the financial statements. E.g. each
financial statement details should be provided in the form of schedules explaining
detailed components of the item in the profit and loss account or balance sheet as the
case may be.
e. Accounting and Sociology
The term sociology is derived from the Latin Word socio meaning society. The main
objective of sociology is to find out pattern of relationship between human beings in
order to pave way for the betterment of individuals in a society. Individual enter into
transactions in order to meet their bare requirements, and tries to make use of the
resources that are available so that living standards can be improved. Accounting
provides the information about the availability of resources and also ways and means to
improve the standards of living of the society at large.
1.4.4 Types of Accounting:
Accounting is broadly classified into Financial Accounting, Cost Accounting and Management
Accounting. We have already discussed about the definition of Financial Accounting , let us

discuss in furtherance Cost Accounting and its comparison with Financial Accounting and
also Management Accounting and it comparison with Financial Accounting.
Cost Accounting:
Cost accounting is not merely a tool for cost ascertainment and cost recording: it is also a
tool for cost control and ascertainment of profitability and for management decision making.
Generally in terms of Cost Accounting , the costs incurred for each element of production is
identified and based on which the decisions for further reducing costs are taken. It said that
in the entire gamut of accounting Financial Accounting acquires a prominent position
followed by cost accounting and then management accounting , which means financial
accounting provides a base to identify the costs incurred with respect to the elements of
production.
Management Accounting:
Deals with the processing of data generated in financial and cost accounting for managerial
decision making. the main concern of management accounting is to provide necessary
qualitative and quantitative information to the management for planning and control.
Difference between Financial Accounting
And
Cost Accounting

Basis

Financial Accounting

Cost Accounting

Objective

To supply information to

To ascertain cost and control.

external parties
Subject Matter Deals with overall

Deals with specific costs and

performance/position of the classification and analysis of cost on

business.
Normally year end
Reporting period

the basis of functions.

Continuous process depending

( 12 months)

upon the size and nature of

business.

Differences Between Financial Accounting & Management Accounting

Basis

Financial Accounting

Management Accounting

Objective

To supply information to

To

external parties

internal use by the mgmt.

with

provide

information

for

Subject

Deals

overall

Deals with the details of the

Matter

performance/position of

various divisions/dept./ products

the business.

etc. of the entity.

Reporting

Normally year end

More Frequent

period

( 12 months)

Compulsion

As per law more or less

Compulsory

for

Not compulsory as per law

all

businesses
Nature

of

Data Used

It is concerned with the

It

monetary

information.

records

of

is

concerned

with

future

past events .
Flexibility

It is not flexible

It is highly flexible

Difference Between Cost Accounting and Management Accounting

Objective

Elements
Subject Matter

Cost Accounting
It is concerned with cost

Management Accounting
It is concerned with all such matters in

ascertainment

cost

a wider perspective, which assist the

control
It deals with cost data
It takes part of the

management in formulation of policies.

It deals with cost and revenue
It is an all inclusive accounting

accounting

information system.

and

information

system.

1.5

Role of accounting in modern organization

Responsible for the installation, development & efficient functioning of the

mgt. accounting system.

Plays an important role in gathering, compiling, reporting & interpreting

internal accounting information.

Designs the framework of the financial & cost reports in order to satisfy the
information needs of different levels of mgt. but actual decision making
responsibility lies with the mgt.

1.6

Classification of accounts.

Accounts can be broadly classified under three heads , the following chart explains
the classification with suitable examples.
Classification of Accounts

Personal
Account

Natural
Persons
Personal
Account

Artificial
Persons
Personal
Account

1. Personal Account:

Nominal
Account

Real
Account

Tangible
Real

Intangible Real

Personal Account is the account of an individuals account , which is divided into

two. Natural Persons personal Account e.g. Harish Account, Pavan Account and
Artificial Persons Personal Account, which belongs to the entities. E.g Harish &
Sons Account, Reliance Industries Account etc.
Rule of Debit and Credit:
Dr. (Debit) the Receiver
Cr. (Credit) the Giver
2. Real Account:
Real Account is the account of non living things on which business enterprise
invests in the form of expenditure. Real account can be divided into two,
Tangible Real Account , which means the existence of the component of the
account can touched , felt and seen. E.g. Cash, Chair, Motor Car, Machinery etc.
Intangible Real Account: The existence of which can not be seen or felt is known
as intangible real account.
e.g. Patents, Trade Marks, Copyright, Goodwill etc.
Rule of Debit and Credit
Dr. (Debit) what comes in
Cr. (Credit) what goes out
3. Nominal Account :
Nominal account is the account in which the enterprise spends in the form of
expenses, which is of recurring nature.
Rule of Debit and Credit
Dr. (Debit) all Expenses and Losses
Cr. (Credit) all Incomes and Gains

Exercise:
Classify the following items under the types of accounts which ever is applicable.
1. Cash A/c
2. Capital A/c

3. loan from Mahesh A/c

4. Furniture A/c
5. Purchases A/c
6. Rams A/c
7. Bank A/c
8. Salary A/c
9. Machinery A/c
10. Sales A/c
11. Sales Return A/c
12. Printing and Stationery A/c
13. Telephone charges A/c
14. Carriage A/c
15. Wages A/c
16. Buildings A/c
17. Suresh A/c
18. Drawings A/c
19. Prepaid Expenses A/c

20. Goodwill A/c

References:
1. American Accounting Association , A statement 0f Basic Accounting Theory,
1966. p.1
2. Accounting Terminology Bulletin No 1: Review and Resume , AICPA, 1953,
Para 9

Questions:

1. Explain the importance of accounting in everyday life, give your own

examples
2. What do you mean by GAAP. Explain the concepts and conventions with
suitable examples wherever necessary
3. Differentiate between Financial Accounting, Cost Accounting and Management
Accounting. Gather as much information as possible to answer this question
4. Who are the stakeholders, explain the importance of stakeholders , giving the
reason as to why each stakeholder will be interested in knowing about the
performance of the business enterprise. Use your own thought to answer
these questions.
Project: Take any company of your choice and study the organization set
up to relate the flow of accounting data and information for taking
decisions at various levels.
Hint: You are required to study the link between each and every branch
of accounting.
Questions:
1. Identify the types of accounts involved in the transaction and mention
which on should be debited and which one should be credited.
a. Started business with cash
b. Deposited into bank
c. Borrowed from Mahesh
d. Purchased furniture
e. Withdrew form bank
f.

Withdrew amount for personal use

g. Sold good to Bindu on credit

h. Sold goods for cash
i.

Purchased goods from Ram on credit

j.

Purchased furniture form Mohan on credit

k. Received a cheque from a customer

l.

Deposited the same the next day

m. Bank intimated that the cheque was dishonored

n. Paid installment of loan
o. Paid an advance to suppliers of goods
p. Paid salary

q. Paid rent by cheque

r.

Goods withdrawn for personal use

s. Paid interest on loan

t.

Purchase machinery for cash

Project:
From the above transactions classify them under the broader categories of types
of accounts and try to apply the rule of debit and credit.
Try to answer the following questions: