CHAPTER 1

Introduction to Accounting

LEARNING OBJECTIVES

After studying this chapter, you will be able to:

state the meaning of and need for accounting;

appreciate the relevance of accounting as an information

system and its sub-systems;

identify internal and exter nal users of accounting

information;

distinguish between book keeping and accounting;

explain objectives, role and limitations of accounting.

For centuries, accounting had been

generally confined to the financial
record keeping functions of the
accountant. The role of an accountant
has gradually changed from that of the
mere recorder of transactions to that
of the member providing relevant
information to the decision-making
team. Accounting is now regarded as
an information system and forms
integral part of management
information system. As an information
system, it collects data and
communicates economic information
about a business enterprise or other
entity to a wide variety of persons
whose decisions and actions are
related to the activity. This chapter,
therefore, deals with accounting as an
information system.
1.1 Meaning of Accounting
In 1941, the American Institute of
Certified Public Accountants (AICPA)
defined 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.
With
greater
economic
development, the meaning of the term
accounting gradually became broader.
In 1966 the American Accounting
Association (AAA) defined Accounting
as: The process of identifying,
measuring and communicating
economic infor mation to per mit
informed judgments and decisions by
users of the information.

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Further, in 1970 the Accounting

Principles Board of AICPA stated that
the function of accounting is to provide
quantitative information, primarily
financial in nature, about economic
entities, that is intended to be useful
in making economic decisions.
Accounting can, therefore be defined
as: The process of identifying,
measuring, recording and communi-cating
the economic events are considered in
terms of economic and business
transactions of the organization to
interested users of the information.
The above definition contains four
essential characteristics of the
accounting:

Economic events

Identification, measurement,
recording, and communication

Organization

Interested users of information

1.1.1

Economic Events

An economic event has been defined as

a happening of consequence to a business
entity. Economic events are classified
into external and internal types.
An external event, involves the
transfer or exchange of something of
value between two or more entities. It
is called a transaction. The following
are some examples of transactions:

Sale of shoes by Allen Cooper

Shoe Company to customers.

Rendering services to customers

by Samsung Limited.

Payment of wages to employees

by Maruti Udyog Limited.

Payment of monthly rent to the

landlord.

INTRODUCTION TO ACCOUNTING

Purchase of raw materials by an

enterprise from some other
business enterprise.

Purchase of ticket from an

airline.
An internal event is an economic
event that occurs entirely within one
enterprise, e.g. supply of raw material
or equipment by the stores department
to the manufacturing department.

1.1.2 Identification, Measurement,

Recording and
Communication
Identification: It means determining
what to record, i.e., to identify events
which are to be recorded. It involves
observing activities and selecting those
events that are considered to be the
evidence of economic activity. Further,
these events should be related to a
business organization. The business
transactions and other economic
events are evaluated for considering
whether it has to be recorded as an
accounting transaction. The value of
human resources, changes in
managerial policies or change in
personnel are important but none of
these items are recorded in financial
accounts. However, when a company
makes a cash sale or purchase, it is
recorded in the books of accounts.
Measurement: It means quantification
(including estimates) of business
transactions into financial terms by
using monetary unit, i.e. rupees and
paise, as a measuring unit. If an event
cannot be quantified in monetary
ter ms, it is not considered for
recording in financial accounts. Thas
is why important items like the

appointment of a new managing

director, signing of contracts or
changes in personnel are not shown
in the books of accounts.
Recording: Once the economic events
are identified and measured in
financial terms, they are recorded in
a chronological order and systematic
manner. An item should be written in
both wor ds and numbers. The
amount should be included in the
totals of the books of account. The
accountant also clarifies by
summarizing these items.
Communication: The economic events
are classified, measured and recorded
in a order that the pertinent information is generated and communicated
in a certain form to management and
other internal and external users. The
information is communicated through
preparation and distribution of
accounting reports. The most common
reports are in the form of financial
statements (Balance Sheet and Profit
and Loss Statement).
The accounting infor mation
system should be designed in such a
way that the right information is
communicated to the right person at
the right time. Reports can be daily,
weekly, monthly, or quarterly,
depending upon the needs of the user.
An important element in the
communication process is the
accountants ability and responsibility
to interpret the reported information.
This is done by analyzing and
explaining the meaning, uses and
limitations of reported data with the
help of the ratios, percentages etc.

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1.1.3 Organization
It is an entity performing business
activities which can be for a profit or
not-for-profit motive. The activities can
be organized by choosing appropriate
form of organization to suit the level
of business operations. It can either
be sole-tradership, partnership,
company, cooperative society or board
such as Cantonment board, Municipal
board, Cricket board.
1.1.4

Interested Users of
Information

Different categories of users need

different kinds of information for
making decisions. The users can be
divided into two broad groups: internal
users, external users.
Internal users are the persons who
manage the business, i.e. management at the top, middle, and lower
levels. Their r equir ement of
information is different because they
make different types of decisions. The
top level is more concerned with
strategic planning; the middle level is
concerned equally with operational
planning and control; and the lower
level is consider ed more with
execution and controlling operations.
Information is supplied on different
aspects, e.g. cash resources, sale
estimates, result of operations,
financial position, sources and
application of funds (figure 1.1).
External users are the persons other
than internal users (officers and staff

concerned with decision-making in a

business organization) come in the
group of external users. External
users can be divided into two groups:
(a) those having direct interest; and
(b) those having indirect interest in a
business organization. The main
sources of information for external
users are annual, half-yearly, and
quarterly reports of business
organizations. These reports state the
financial position and performance,
and give the auditors reports,
directors report and other infor mation. Half-yearly and quarterly
financial reports are unaudited.
Besides these reports, the external
users can access the websites of
companies and stock exchanges to
obtain updated performance reports
and current decisions of the board
directors.

External users having direct

financial interest: Investors and
creditors-present and potentialare the external users having
direct interest. Investors
(owners), on the basis of
quantities of information, decide
about buying, holding or selling
investments in a business
entity. Creditors (banks,
financial institutions, debenture
holders and other lenders),
evaluate the risk of granting
credit or lending money to a
particular
business
organization on the basis of
accounting
and
other
information obtained about that

INTRODUCTION TO ACCOUNTING

Accounting process and its users

Identification
of
Economic events
(transactions)

Measurement
(quantity)
Rs. and paise

Recording
(record, classify, and
summarize)

Communication

(Prepare
Accounting
Reports)

Office and
other staff

Direct Interest
Present and Potential
Investors
Customers

Management at
all levels

Internal users

(Analyze and
Interpret)
External users

Indirect interest
Regulatory Agencies
Tax Authorities
Customers
Labour Unions
Trade Associations
Stock Exchanges
Public

Fig. 1.1: Accounting Process and Users of Accounting Information

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organization.
External users having indirect
financial and non-financial
interest:
T ax authorities,
regulatory agencies (such as
Department of company affairs,
Registrar of joint stock
companies,
Securities
Exchange Board of India),
customers, labour unions, trade
associa-tions, stock exchanges
and others are indirectly
interested in the companys
financial strength, its ability to
meet short-term and long-term
obligations, its future earning
power, etc. for making various
decisions.

1.2 Types of Accounting

Information
Since times immemorial, accounting
has been the primary source of
generating information about the day
to day working and future planning of
the organization. The accountant has
performed this role. Much of the
recording function in todays
organization is computerized. This has
been possible due to the advances in
the field of information technology,
which has made accounting activities
possible just in time.
From the definition of accounting,
it is clear that the social role of
accountant is that of information
scientist. Insofar as business entities
are concer ned, a distinction is

normally made between financial

accounting
and
management
accounting. Financial accounting
deals with recording and analysis of
financial results of transactions as a
means of arriving at a measure of
organizations success and financial
soundness. Financial accounting
information relates to the past period
and is essentially monetary in nature.
However, its decision-usefulness is
limited. Management accounting is
concer ned with the activity of
providing information (financial and
non-financial) to enable management
to take decisions about operations of
business. Management accounting
draws all financial infor mation
from financial accounting. Besides,
it develops other infor mation
(quantitative and qualitative, financial
and non-financial), which is futuristic
in character and relevant for decisionmaking in the organization. Thus, it
includes estimates, forecasts of sales,
cash flows, purchase requirements,
manpower needs, pollution data,
health and safety data about
employees, product and plants.
Further, financial accounting
information serves the stewardship
function
while
management
accounting aids in internal decisionmaking by management. Therefore,
financial accounting is a sub-system
of accounting information system
(AIS), which in tur n is part of
management infor mation system

INTRODUCTION TO ACCOUNTING

(MIS).

Information is the processed data,

fact or any observation that adds to
the knowledge. A singular datum such
as 1000 is no information, but 1000
units of finished goods is information
because it indicates the position of
stock at hand. We can summarize the
information as follows (figure 1.2)

Stewardship
A person who manages property or
financial affair of other person(s) is
called steward. When such a person
presents his account to another
whose property or financial affairs
he manages is called stewardship
accountability. The profit and loss
account and balance sheet are part
of stewardship reporting by
managers (Board of directors) to the
shareholders and creditors.

1.3 Accounting as an Information

System
Earlier, the accounting work was

Box 1.1

Information
Consists of

Information

Non-quantitative
Quantitative
Information

Consists of

Accounting
Information

Non-Accounting
Information

Consists of

Fig. 1.2: Types of Accounting Information

Management
Accounting

Financial
Reporting

Operating
Information

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entirely manual and accounting

department used to take excessively
long time in processing the
transactions and generating the
accounting reports. The moder n
technology has enabled the accounting
department in: (i) eliminating the
redundancy, (ii) reducing the number
of people involved in processing of
transaction by removing the
unnecessary control points, and (iii)
automated posting of transaction from
electronic voucher to ledger, preparing
the trial balance, profit and loss
account and balance sheet. The
accounting information system is
divided into following sub-systems
( figure 1.3 and figure 1.4)

having the physical cash entry or exit

by using the credit cards or electronic
banking.
1.3.2
Sales and accounts
receivable sub-system
It deals with recording of sales,
maintaining of sales ledger and
receivables. It generates periodic
reports about sales, collections made,
overdue accounts and receivables
positions as also ageing schedule of
receivables/debtors.
1.3.3 Inventory sub-system
It deals with the recording of different
items purchased and issued
specifying the price, quantity and date.
It generates the inventory positions
and valuations reports.

1.3.1 Cash sub-system

1.3.4 Accounts payable sub-system

Research and
Development

Production

Inventory
Control

Administration

Accounting

Engineering

Personnel

Budget

It deals with the purchase and

payments to creditors. It provides for
ordering of goods, sorting of purchase

It deals with the receipt and payment

of cash both physical cash and
electronic fund transfer. Electronic
fund transfer takes place without

Fig. 1.3 : Interaction of Accounting Information System

Marketing

INTRODUCTION TO ACCOUNTING

Fig. 1.4 : Accounting Information System

expenses and payment to creditors. It

also generates periodic reports about
the per for mance of suppliers,
payments schedule and position of
creditors.

addition, deletion, usage of fixed assets

such as land and building, machinery
and equipment, etc. It also generates
reports about the cost, depreciation
book value of different assets.

1.3.5 Payroll accounting sub-system

1.3.7 Costing sub-system

It deals with payment of wages and

salary to employees. A typical wage
report details information about basic
pay, dearness pay, dearness allowance, other allowances and bonus
and deductions from salary and wages
on account of provident fund, loans,
advances, taxes and other charges.
The system generates reports about
wage bill, overtime payment and
payment on account of leave
encashment, etc.

It deals with the ascertainment of cost

of goods produced. It has linkages with
other accounting sub-systems for
obtaining the necessary information
about cost of material, labour and
other expenses. This system generates
information about the changes in the
cost that take place during the period
under review.

1.3.6 Fixed assets accounting

sub-system
It deals with the recording of purchase,

1.3.8 Budget sub-system

It deals with the preparation of budget
for the coming financial year as well
as comparison with the current budget
of the actual performances.
The foregoing discussion brings

10

out clearly that systems perspective

enables one to see that accounting is
one sub-system interacting with the
whole organization. The different subsystems of an organizational entity
could be operating system, financial
system, accounting system, personnel
system and marketing system.
Accounting as an integral part of
management information system,
interacts not only with all these
internal sub-systems but also with the
exter nal
environment
having
government, lenders, consumers and
other sub-systems of socio-economic
environment. This manner of viewing
the organization makes accounting
system most important for the
following reasons:

The accounting information

system is the only one, which
enables management and
external information users to
get a picture of the whole
organization.

Accounting information system

links other important information systems such as marketing,
personnel, research and
development and production in
such a manner that the
information of other sub-system
is ultimately expressed in
financial ter ms to facilitate
financial planning.

Non-financial information in
such areas as social responsibility and human resource are
integrated with accounting
information so as to permit
corporate decision-making.

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The integration of accounting

with other sub-systems leads to
greater accuracy and higher
speed in the delivery of
information to the users.

1.4 Qualitative Characteristics of

Accounting Information System
The objective of accounting is to
provide infor mation about the
financial position, performance and
changes in financial position of an
enterprise that is useful to wide range
of users in making economic decisions.
To be useful the accounting
infor mation must possess the
characteristic of reliability, relevance,
understand-ability and comparability.
1.4.1 Reliability
Information is said to be reliable if it
is free from err or and bias and
faithfully represents what it seeks to
repr esent. Infor mation must be
believed and depended upon by the
users for a given purpose. To ensure
that infor mation is r eliable, it
must be verifiable, neutral and
faithful in representing the economic
condition.
1.4.2 Relevance
Information is said to be relevant if it
influences the decisions. To be
relevant, infor mation must be
available in time, must help in
prediction, and help in feedback.
1.4.3 Understandability
The accounting information must

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INTRODUCTION TO ACCOUNTING

possess the quality of economic

significance to the user, i.e. to
understand the content and significance of financial statements and
reports. The qualities that distinguish
between good and bad communication
in a message are fundamental to the
understandability of the message. A
message is said to be communicated
when it is interpreted by the receiver
of the message in the same sense in
which the sender has sent.
1.4.4 Comparability
The quality of information that enables
users to identify changes in the economic
phenomena over a period of time,
between two or more entities. Accounting
reports should be comparable across the
firms to identify similarities and
differences. To be comparable,
accounting reports must belong to a
period, use common unit of measurement and common format of reporting.
1.5 Difference between Book
Keeping and Accounting
Book keeping usually involves only the
recording of business transactions
(transactions) and is therefore, just
one part of the accounting process.
Accounting on the other hand, involves
the entire accounting process, i.e.
identification, measurement, recording, and communication. Now-adays, much of the book keeping
function is performed by the computer
and other machines.
1.6 Objectives of Accounting
The basic objective of accounting is to
provide information to the interested

users to enable them to make business

decisions. The necessary information,
particularly in the case of external
users, is provided in the basic financial
statements: Profit and loss statement
and Balance sheet
Besides the above sources of
infor mation, the inter nal users,
officers and staff of the enterprise, can
obtain additional information from the
records of business. Thus the primary
objectives of accounting can be stated
as :

Maintenance of Records of
Business transactions.

Calculation of Profit or Loss

Depiction of Financial Position.

Provide Information to the Users

1.6.1 Maintenance of Records of
Business
First record, then pay; if there is an
error, trace it from the records.
Human memory is short. Even the
most brilliant executive or manager
cannot accurately remember what
he might have observed regarding
the daily operations. He need not
strain his memory unnecessarily, if
proper and complete records of all
business transactions ar e kept
regularly. More-over, records can be
used by different officials for
dif ferent
decision-making
purposes.
1.6.2 Calculation of Profit or Loss
Earning profit is the main purpose for
which a business is carried on. This
information is available from the profit
and loss statement. Profit is calculated
by deducting expenses from the

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associated revenues. Profit is a

measure of the performance of the
enterprise.

1.6.3 Depiction of Financial

Position
A balance sheet depicts the financial
position of an enterprise. It is a
statement of assets and liabilities. It
shows the resources(assets) owned by
an enterprise and depicts the claims
(liabilities) against the resources. The
balance of assets minus the external
liabilities shows the capital (owners
equity).
1.6.4 Provide Information to the
Users
Generation of information is not an
end in itself. It is a means to facilitate
the dissemination of infor mation
among dif ferent user gr oups.
Therefore, communication of information is the essential function of
accounting. Accounting information is
communicated in the form of reports,
statements, graphs and charts to the
internal and external users who need
it in different decision situations.
Internal users: The officers and staff
of an enterprise need useful and timely
information for making different types
of business decisions. A major
objective of accounting is to provide
management with relevant and reliable
information. For example, some of the
questions a manager might ask are:

How much profit did the

company make during the last
accounting period?

Is the return to share holders

adequate? How can it be
improved?
Does the company have enough
cash on hands to pay debts
when they fall due? What are
the projected cash needs in the
next quarter?
Which are the most profitable
products?
What is the cost of manufacturing each product?
Which costs exceed the budget?
How much money should
be borrowed to expand the
business?

External users: The outside users have

limited authority, ability or resources
to obtain information. Unlike internal
users, they have to rely on financial
statements (Balance sheet, Profit and
Loss statement) as their principal
source of infor mation about an
enterprises economic activity.
Primarily the exter nal users are
interested in the following:

The amount and the time when

they are likely to receive cash
in the future from dividend,
interest etc.
Reliable infor mation about
economic resources (assets) and
obligations (liabilities) of a
business enterprise in order to
evaluate its strengths and
weaknesses, and its financial
position in general.
Information about the performance and the earning power
of the business enterprise.

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INTRODUCTION TO ACCOUNTING

Any other information relevant

to the users needs.

1.7 Role of Accounting

Accounting is not an end in itself; it is
a means to an end. It performs the
service activity by providing
quantitative financial information that
helps the users in making better
business decisions. Accounting also
describes and analyses the mass of
data of an enterprise through
measurement, classification, and
summarization, and reduces that data
into reports and statements, which
show the financial condition and
results of operations of that enterprise.
Accounting as an information system
collects, processes and communicates
information about an enterprise to a
wide variety of interested parties.
1.8 Limitations of Accounting
Accounting records relate to the past
transactions, which provide fairly good
account of the economic activity of the
business enterprise. However, from
decision-making viewpoint we need
information, which relates not only to
past but also about present and
future. Financial accounting makes
provision for financial information but
it does not provide non-financial
information such as behavioural and
socio-economic. If the objective of
accounting reports is to influence the
behaviour through decision-making
then it must provide the data
concer ning the behaviour and
outcome of human activity to facilitate
performance evaluation. Therefore, the

accounting information does not fully

meet different types of informationrequirements of varied decision
making situations. Accounting
provides stewardship information and
not decisional information.
1.9 Basic Terms in Accounting
1.9.1 Financial Statements
There are two basic financial
statements which are prepared by an
enterprise: (1) Profit & Loss Statement,
and (2) Balance Sheet.
1.9.2 Accounting Equation
The three components of a balance
sheet can be stated in the form of
following basic accounting equation
Assets = Liabilities + Capital (owners
equity)
Rs.50,000=Rs.10,000+Rs.40,000

This equation tells at a glance that

the resources of this enterprise total
Rs. 50,000 and these assets are
financed by two sources Rs.10,000
by the creditors(liabilities), also known
as outsiders claims, and Rs.40,000 by
the owner (capital), also known as
owner equity.
1.9.3 Business Transactions
It is an economic event that relates to
a business entity. It can be a purchase
of goods, collection of money, payment
to creditors for goods and expenses.
An event to be a transaction must
possess the quality of economic
substance, relate to business and
affect the economic results. In other
words, an event must be capable of

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ACCOUNTANCY

being measured in monetary terms

and related to business enterprise in
terms of economic consequence.
1.9.4 Assets
These are economic resources of an
enterprise that can be usefully
expressed in monetary terms. Assets
are things of value used by the
business in its operations. For
example, Departmental Store owns a
fleet of trucks, which is used by it for
delivering food stuff; the trucks, thus,
provides economic benefits to the
enterprise. This item will be shown of
the asset side of the balance sheet of
Departmental Store. Assets can be
broadly classified into two types : Fixed
Assets and Current Assets.

Fixed Assets are assets held on

a long term basis, such as land,
buildings, machinery, plant,
furniture and fixtures. These
assets are used for doing
business and not for re-sale in
normal course of operation.
Current Assets are assets held
on a short term basis such as
debtors (account receivable),
bills receivable (notes receivable),
stock (inventory),temporary
investment in securities, cash
and bank balances. Normally
the short term refers to an
accounting year.

1.9.5 Liabilities
These are the obligations or debts that
the enterprise must pay in money or
services at sometime in the future.

They, therefore, represent creditors,

claims against assets of the firms. Both
small and big businesses find it
necessary to borrow money at some
time or the other, and to purchase
goods on credit. Super Bazaar, for
example, purchases goods for
Rs.10,000 on credit for a month from
Fast Foods Products Company on 25
December 2001. If the balance sheet
of Departmental stores is prepared as
at 31 December 2001, Fast Food
Products Company will be shown as
creditors (accounts payable) on the
liabilities side of the balance sheet. If
the departmental store also takes a
loan for a period of three years from
Delhi State Cooperative Bank Ltd., this
will be shown as a liability in the
balance sheet of the Departmental
Stores.

Long term liabilities are those

that are usually payable after a
period of one year, for example,
a ter m loan from financial
institution or debentures
(bonds) issued by the company.
Short ter m liabilities are
obligations that are payable
within a period of one year,
for example, creditors (accounts
payable), bills payable (notes
payable), cash credit overdraft
from a bank for a short period.

1.9.6 Capital
Investment by the owners for the use
in the firm is known as capital. From
the accounting equation given earlier,
it can easily be found that the capital

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INTRODUCTION TO ACCOUNTING

is Rs.40,000. Owners equity is the

ownership claim on total assets. It is
equal to total assets minus total
external liabilities: E=A-L This is also
called residual interest. Owners equity
is equal to capital.

1.9.11 Loss

Sales are total revenues from goods

sold and/or services sold or provided
to customers. Sales may be cash sales
or credit sales.

Loss is the gross decreases in the

assets or gross increases in the
liabilities. It is the excess of expenses
over revenues. It represents reduction
in owners equity due to inability of the
firm to recover the assets used in the
business. For example, a firm spends
Rs. 70,000 and generates a revenue
of Rs. 60,000, there is a loss of Rs.
10,000 which represents non-recovery
of assets consumed in doing business.

1.9.8 Revenues

1.9.12 Income

These are the amounts the business

ear ns by selling it products or
providing services to customers. These
are called sales revenues. Other items
and sources of revenues common to
many businesses are: sales, fees,
commission, interest, dividends,
royalties, rent received, etc.

Income is the increase in the net worth

of the organization either from
business activity or other activities.
Income is a comprehensive term,
which includes profit also. In
accounting income is the positive
change in the wealth of the firm over a
period of time.

1.9.9 Expenses

1.9.13 Profit

These are costs incurred by a business

in the process of earning revenues.
Generally, expenses are measured by
the cost of assets consumed or services
used during an accounting period. The
usual items of expenses are: depreciation, rent, wages, salary, interest,
costs of heat, light and water,
telephone, etc.

Profit is the excess of revenues over

expenses during an accounting year.
It increases the owners equity.

1.9.7 Sales

1.9.14 Gains

1.9.10 Expenditure

Gain is the change in the equity (net

worth) arising from change in the form
and place of goods and holding of assets
over a period of time whether realized or
unrealized. It may either be of capital
nature or revenue nature or both.

Expenditure is the amount of

resources consumed. Usually, it is of
long term in nature. Therefore, its
benefit is to be derived in future. For
example, capital expenditure.

1.9.15 Drawings
It is the amount of cash or other assets
withdrawn by the owner for his
personal use.

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ACCOUNTANCY

1.9.16 Purchases
Purchases are total amounts of goods
procured by a business on credit and
for cash, for use or sale. In a trading
concer n, purchases are made of
merchandise for resale with or without
processing. In a manufacturing
concern, raw materials are purchased,
processed further into finished goods
and then sold. Purchases may be cash
purchases or credit purchases.
1.9.17 Stock
Stock (inventory) is a measure of
something on hand-goods, spares and
other items-in a business. It is called
stock on hand.
In a trading concern, the stock on
hand is the amount of goods which
have not been sold on the date on which
the balance sheet is prepared. This is
also called closing stock (ending
inventory). In a manufacturing
company, closing stock comprises raw
materials, semi-finished goods and
finished goods on hand on the closing

date.
Similarly,
opening
stock
(beginning inventory) is the amount
of stock at the beginning of the
accounting year.
1.9.18 Debtors/ Accounts Receivable
Debtors (accounts receivable) are
persons and/or other entities who owe
to an enterprise an amount for
receiving goods and services on the
credit. The total amount due from such
persons and/or entities on the closing
date is shown in the balance sheet
as the sundry debtors (account
receivables) on the asset side.
1.9.19 Creditors/ Accounts Payable
Creditors (accounts payable) are
persons and/or other entities who have
to be paid by an enterprise an amount
for providing the enterprise goods and/
or services on credit. The total amount
standing due to such persons and/or
entities on the closing date, is shown
on the balance sheet as sundry creditors
(accounts payable) on the liability side.

SUMMARY WITH REFERENCE TO LEARNING OBJECTIVES

1. Meaning of accounting as an information system
Accounting as an information system is the process of identifying, measuring,
recording and communicating the economic events of the organization to interested
users of the information.
2. Users of accounting information
Accounting plays a significant role in society by providing information to
management at all levels and to those having direct financial interest in the
enterprise, such as present and potential investors and creditors. Accounting
information is also important to external users such as regulatory agencies, tax
authorities, customers, labour unions, trade associations, stock exchanges and
others.

INTRODUCTION TO ACCOUNTING

3. Difference between book keeping and accounting

Book keeping involves only the recording of business transactions, while accounting
involves identifying, measuring, recording, processing and communication of
financial information.
4. Objectives of accounting
The primary objective of accounting is to:

5.

maintain records of business;

calculate profit or loss;
depict the financial position; and
make information available to various groups and users.
Role of accounting

Accounting is not an end in itself. It is a means to an end. It plays the role of:

providing service to the users;

describing, analyzing and reducing a mass of data into reports statement that
show the finan-cial status and performance results of an enterprise; and
an accounting information system.

6. Basic terms in accounting

Assets are the economic resources of an enterprise that can be expressed

in monetary terms.
Liabilities are obligations or debts that an enterprise must pay in money or
services at sometime in the future.
Capital is investment by the owners for use in the firm. It is equal to total
assets minus total liabilities.
Revenues are the amount a business earns by selling its products or
providing services to the customers.
Expenses are the costs incurred by a business in the process of earning
revenue.
Purchases are the total amount of goods procured by business on credit
and for cash, for use, or sale.
Sales are total revenues from goods sold and/or services provided to
customers.
Stock is the measure of something on hand-goods, spares and other items
in a business.
Debtors (account receivables) are persons or entities who owe to an enterprise
an amount for receiving goods and services on credit.
Creditors (accounts payables) are persons or entities who have to be paid by
an enterprise an amount for providing the enterprise goods and services on
credit.

17

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ACCOUNTANCY

EXERCISES
Objective Type Questions
1.

Determine whether the following are assets, liabilities, revenue, or expenses

or none of them:
(i)
(ii)
(iii)
(iv)

2.

Sales
Debtors (accounts receivable)
Creditors (accounts payable)
Salary paid to manager

Which of the following statements is not an objective of accounting?

(i)

To provide information about the enterprises assets, liabilities and

capital.
(ii) To provide information on the personal assets and liabilities of the
owner of enterprise.
(iii) To maintain records of business.
(iv) To provide information about the performance of the enterprise.
3.

The information provided in the annual financial statement of an enterprise

pertains to :
(i)
(ii)
(iii)
(iv)

4.

Individual business enterprise

Business industries
The economy as whole
None of the above

Do the following events represent business transactions? (State True or False)

(i)
(ii)

An employee dismissed from the job.

The owner of the business withdraws cash from the business for his
personal use Rs. 500.
(iii) Goods are purchased on credit Rs. 1,000 from Y.
(iv) A perspective employee is interviewed.
(v) Goods ordered for delivery next month.
(vi) The owner of the firm dies.
(vii) Land is purchased for cash Rs. 5,00,000.
Short Answer Questions
5.
6.
7.
8.

Explain the meaning of accounting?

Distinguish between book keeping and accounting?
List the main objectives of accounting.
What is primary reason for the business students and others to familiarize
themselves with the accounting discipline?
9. Which decision makers use accounting information?
10. What information do the users need?
11. Define assets, liabilities and capital?
12. How will you define revenues and expenses?

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INTRODUCTION TO ACCOUNTING

13. Describe the role of accounting?

14. What accounting information system will be needed by the following:
(i)
A newspaper vendor.
(ii) A newspaper distributor.
(iii) A newspaper publisher.
Essay Type Questions
15. Define accounting and explain its features.
16. What is accounting information system? What are the qualitative
characteristics of accounting information?
17. Explain the objectives of accounting? What are the limitations of accounting
information?
18. Explain the sub-systems of the accounting information system?
19. Distinguish between the scope and objectives of the following accounting
information sub-systems?
(i)
(ii)

Financial accounting information sub-system.

Managerial accounting information sub-system.

20. Explain the following sub-systems of an accounting information system:

(i)
(ii)

Budget sub-system.
Payables and Receivables sub-system.

Check-list of Key Letters/Words

1.

(i)
(ii)
(iii)
(iv)

2.

(ii)

3.

(i)

4.

(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)

Revenue
Debtors
Liability
Expenses

No
Yes
Yes
No
No
No
Yes