XI- Accountancy

Introduction To Accounting (L2)

LIMITATIONS OF ACCOUNTING
1. Accounting is not Fully Exact
Accounting is not fully exact in spite of the fact that transactions are recorded on
the basis of evidence, yet some estimates are also made for ascertaining profit or
loss, for examples, estimating the useful life of an asset, providing for doubtful
debts, net realisable value of closing stock, etc.

2. Unrealistic Information
Assets are recorded in the books of accounts at historical cost and depreciated
over their estimated useful life. The fact that the assets are recorded at historical
cost and as a result, current values are not shown. Also their useful life is
estimated to provide depreciation, it makes the information unrealistic
LIMITATIONS OF ACCOUNTING
3. Accounting Ignores the Qualitative Elements
Accounting is confined to monetary matters only, therefore, qualitative elements
like quality or skills of management and staff, industrial relations and public
relations are ignored.
4. Accounting Ignores the Effect of Price Level Changes
Accounting statements are prepared at historical cost. Money, as a measurement
unit, changes in value frequently, Le.. it does not remain stable. Accounting,
however presumes that value of money remains stable. Unless price level
changes are considered accounting information will not show correct financial
results.
5. Accounting May Lead to Window Dressing
The term window dressing means manipulation of accounts in a way so as to
conceal vital facts and present the financial statements to show a better position
than what actually is. In this situation, income statement (ie., Profit and Loss
Account) does not show correct profit or loss and the Balance Sheet does not
provide a true and fair vies of the financial position of the enterprise.
Role of accounting in Business
Accounting is a process of identifying, measuring, recording, classifying,
summarizing, analyzing, interpreting and communicating the financial
information of the business. Following points highlight the role of
accounting in business:
1.Maintenance of Systematic Records :
The primary role of accounting is to maintain systematic records of
financial transactions in order to ascertain the net profit or loss for the
accounting period and financial position of the business as on a
particular date.
2. Assistance to Management :
Accounting assists the management by making available financial
information for effective functioning and rational decision making.
Role of Accounting in Business
3. Facilitates Comparative Study
A systematic record of financial transactions enables comparison of
one year's results with those of other years and identifies reasons
leading to change, if any.
4. Evidence in Court
Accounting records are often accepted by courts as good evidence.
5. Others
(1) Proper accounting records obviates the necessity to remember
business transactions.
(ii) Facilitates Raising Loans.
(iii) Facilitates sale of Business by ascertaining the proper purchase
price.
(iv) Facilitates settlement of tax liabilities.
ACCOUNTING PROCESS
ACCOUNTING PROCESS
Based on the attributes of accounting, steps of accounting process are
Identifying Financial Transactions and Events, (i) Recording, (ii)
Classifying (iii) Summarising. (iv) Analysing and Interpreting and (v)
Communicating.
BRANCHES OF ACCOUNTING
The branches of accounting are:
1. Financial Accounting;
2. Cost Accounting; and
3. Management Accounting.

1. Financial Accounting
• Financial Accounting is that branch of accounting which records financial
transactions and events, summarises and interprets them before
communicating the results to the users.
BRANCHES OF ACCOUNTING
1. Cost Accounting
This branch of accounting is concerned with ascertaining cost of
products, operations, processes or activities. It is that branch of
accounting which deals with recording costs with the objective of
ascertaining, reducing and controlling costs.
2. Management Accounting
Management Accounting is that branch of accounting which is
concerned with generating accounting information relating to
funds, costs, profits, etc., as it enables the management in decision-
making. We may say that Management Accounting addresses the
needs of a single user group, i.e., the management.
Book keeping, Accounting and Accountancy
Definitions of Book Keeping
Book Keeping is an art of recording in the books of account the
monetary aspect of commercial and financial transactions.“
-Northcott
Accounting
Accounting is a wider term than Book Keeping. It starts where Book
Keeping ends. In other words, Book Keeping is a part of accounting.
Accountancy
Accountancy is a systematic knowledge of accounting. It explains
how to deal with various aspects of accounting. It educates us how
to maintain the books of account and how to summarise the
accounting information and communicate it to the users. In the
words of Kohler, accountancy refers to the entire body of the theory
and practice of accounting.
Difference between Book keeping and Accounting
Basis Book keeping Accounting
1. Scope Book Keeping involves identifying financial Accounting involves summarising the
transactions and events; measuring them in recorded transactions and events,
money terms; recording them in the books of interpreting them and communicating
account and classifying them. the results there of.
2. Stage It is a primary stage. It is the basis for It is a secondary stage. It begins where
accounting. Book Keeping ends.
3. Objective The objective of Book Keeping is to maintain The objective of Accounting is to
systematic records of financial transactions. ascertain net results of operations and
financial position and to communicate
information to the interested parties.
4. Nature of This job is routine in nature. This job is analytical and dynamic in
Job nature.
5. It being a routine work can be performed by It being a specialised function is
Performance not so trained staff. performed by a trained staff.
6. Special Skill Book Keeping is mechanical in nature and, Accounting requires special skills and
thus, does not require special skills. ability to analyse and interpret.
QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION
Qualitative characteristics are attributes that make the accounting
information useful to users. The qualitative characteristics are of
cash.
1. Reliability
Accounting information must be reliable. Reliability of information
means it is verifiable, free from bias and material error.
2. Relevance
Accounting information must be relevant to the user. Information is
relevant if it meets the needs of the users in decision-making.
QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION
3. Understandability
Understandability means that the information provided through the
financial statements must be presented in a manner that the users are
able to understand it.
4. Comparability
Comparability means that the users should be able to compare the
accounting information of an enterprise of the period either with that of
other periods, known as intra-firm comparison or with the accounting
information of other enterprises, known as inter-firm comparison.
 USERS OF ACCOUNTING INFORMATION
USERS OF ACCOUNTING INFORMATION
Users of Accounting Information may be Internal Users or External Users.
Internal Users
Internal Users are the users who have access to information that can be
taken from the accounting records.
(i) Owners
Owners contribute capital in the business and thus are exposed to
maximum risk. Naturally, they are interested in knowing the profit earned
or loss incurred by the business besides the safety of their capital. The
financial statements give the information about profit or loss and financial
position of the business.
USERS OF ACCOUNTING INFORMATION
(ii) Management
The management makes extensive use of accounting information to
arrive at informed decisions such as determination of selling price, cost
controls and reduction, investment into new projects, etc.
External Users
External Users are the users who do not have access to accounting
records and have to base their decision on financial statements.
USERS OF ACCOUNTING INFORMATION
(i) Employees and Workers
Employees and workers are entitled to bonus at the year-end, which is
linked to the profit earned by an enterprise. Therefore, the employees
and workers are interested in financial statements. Besides, the
financial statements also reflect whether the enterprise has deposited
its dues towards Employees' Provident Fund and Employees, State
Insurance, etc., or not with the appropriate authorities.
(ii) Banks and Financial Institutions
Banks and financial institutions are an essential part of any business as
they provide loans to businesses. Naturally, they watch the
performance of the business to know whether it is making progress as
projected to ensure the safety and recovery of the loan advanced and
payment of interest. They assess it by analysing the accounting
information.
USERS OF ACCOUNTING INFORMATION
(iii) Investors and Potential Investors
Investment involves risk and also the investors do not have direct
control over the business affairs. Therefore, they rely on the
accounting information available to them and seek answers to
questions such as-what is the earning capacity of the enterprise
and how safe is their investment?
(iv) Creditors
Creditors are those parties who supply goods and/or services on
credit. It is a common business practice that a large number of
suppliers remain invested in credit sales. Before granting credit,
creditors satisfy themselves about the credit-worthiness of the
business. The financial statements help them immensely in
making such an assessment.
USERS OF ACCOUNTING INFORMATION
v) Government and its Authorities
The government makes use of financial statements to compile national income
accounts and other information. The information available to it enables it to take
policy decisions. Government levies various taxes such as custom duty, GST and
income tax. These government authorities assess correct tax dues after analysis of
the financial statements.
(vi) Public
They want to see the business running since it makes substantial contribution to
the economy in many ways, e.g., employment of people, patronage to suppliers,
etc. They also want to see the concern of the business for environment, amount
spent as Corporate Social Responsibility. Thus, financial accounting provides useful
financial information to various user groups for decision-making.
(vii) Researchers
Researchers use accounting information in their research work.
SYSTEMS OF ACCOUNTING
The systems of recording transactions in the books of account are
two namely:
1. Double Entry System, and
Double Entry System means a system of accounting which recognizes
and records both aspects-Debit and Credit of a financial transaction.
At the time of recording a transaction, one aspect is recorded on the
debit side and other aspect is recorded on the credit side. For
example, when goods are purchased for cash, goods are acquired
and in return cash is paid. In this transaction, two aspects are
involved, i.e., receiving goods and paying cash. Under the Double
Entry System, both these aspects are recorded. This system is based
on the 'Dual Aspect Concept' and is universally applied in
accounting.
 Advantages of the Double Entry System
Advantages of the Double Entry System
The advantages of Double Entry System are:
(i) Scientific System Double Entry System is a scientific system of recording
business transactions compared to Single Entry system. It helps attain the
objectives of accounting.as
(ii) Complete Record of Transactions Under the system, both sides of a
transaction are recorded. It is a complete record as it results in showing
correct income or loss, assets and liabilities.
(iii) Arithmetical Accuracy of Accounts is Ensured By the use of this system,
arithmetical accuracy of the accounting work can be established through
the Trial Balance.
 Advantages of the Double Entry System
(iv) Determining Profit or Loss Profit earned or loss incurred during a
period can be determined by preparing Profit and Loss Account.
(v) Ascertaining Financial Position:
Financial position of the firm or the institution can be ascertained at
the end of each period by preparing the Balance Sheet.
(vi) Details for Purposes of Control
The system permits accounts to be maintained in as much detail as
necessary and therefore, provides significant information for purposes
of control, etc.
(vii) Comparative Study is PossibleResults of one year may be
compared with those of previous years and reasons for the change can
be identified.
Advantages of the Double Entry System
(viii) Helps Management in Decision-making Management is able to
obtain good information for its work, especially in making decisions.

(ix) Detection of Frauds and Misappropriations Frauds and

misappropriations are minimized since complete information about
all assets and liabilities is available, It is because of these
advantages that the Double Entry System is extensively used.
2. Accounts from Incomplete Records or Single Entry System
2. Accounts from Incomplete Records or Single Entry System
Account from Incomplete Records or Single Entry System of recording
transactions in the books of account may be defined as an incomplete
Double Entry System. In this system, all transactions are not recorded on
double entry basis. In some transactions, both aspects of the transactions
are recorded, while in others, either one aspect is recorded or not
recorded at all. Instead of maintaining all the accounts, only Personal
Accounts and Cash Book are maintained under this system. The accounts
maintained under this system are incomplete and unsystematic and,
therefore, not reliable.. Since all transactions are not recorded under this
system on double entry basis, it is not possible to prepare a Trial Balance.
As a result, the Profit and Loss Account and the Balance Sheet cannot be
prepared.