Introduction to Accounting--Accounting and Book-keeping

INTRODUCTION:

Accounting is the language of a business that communicates with its users. The users can be of owner, creditors, banks, shareholders etc. What business is doing can never be identified by its users if there was no proper accounting system in the world. Imagine an owner doing business, he must be curious to know how much profit his business is earning, how much expenditure is being expensed on the particular field, how much return he and accordingly he can take necessary decision; Accounting helps that owner to perform all those function, similarly, a bank, or creditor must know how the business is doing if they are giving money to that business.

From the above explanation it is clear that accounting is necessary if we want to do the business efficiently.

Definition:

In 1961 AICPA defines accounting as

“Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transaction and events which are, in part at least, of a financial character and interpreting the results thereof”.

Analyse-

let me analyse the above definition.

First, accounting is called an Art! Why?

Because the work of accounting demands practical applicability of theoretical knowledge. An accountant gets better gradually over the period as he gets an experience. Leo Tolstoy once said, if a writer makes his reader feel the same pain or joy that he/she suffered while experiencing the situation in reality, it is an art. He mean to say joining of reader with situations is an art. In same way, accountant shows the situation /performance of the business by his accounting so that the reader can understand clearly and exactly what has happened in business. So it is an art. Like an artist an accountant can glimpse the whole panorama. The pen, the ledger, the ink are his artist's brush, canvas and paint; with them he capture some phases of each dramatic moment of the scene.

Second, it is an art of recording transaction, classifying transaction, and summarizing transaction and not only transaction but also events which are financial in nature. Both transaction and events should be expressed in terms of money.

lastly, after summarizing whatever results an accountant obtained must be interpreted by him.

However this definition was criticized on the ground that it lacks the broader aspect of accounting that is, it lacks requirement of communicating and motivating informed judgment. Thus, in 1966 AICPA introduced another definition of accounting as:

“The process of identifying, measuring and communicating economic information to permit informed judgments and decision by the users”

So we can define accounting in our words as

 “The process of recording, classifying, summarizing, analyzing and interpreting the financial transaction and communicating the results thereof to the person interested in such information”.

The function of accounting included recording, classifying, summarizing, analyzing and interpreting.

Recording involves recording of transaction in the subsidiary book through journal. That is, writing journal entries.

Classifying is related to the task of grouping the transaction of similar nature in one place. It is done in one book called ledger. Classification is the most important steps in accounting because it helps owner knows the total amount given or taken from each account.

Summarizing involves preparation of trial balance, profit and loss and balance sheet.

Analyzing and interpreting- once the Balance sheet has been prepared the final task remaining in accounting is to analyze the financial position of the entity or business and interpret in such a way that can meet the user’s need.

      Communication-- Accounting information after being analysed and interpreted has to be communicated in a proper form and to the proper person. This is done through preparation of annual reports which include besides income statement and balance sheet, aditional information in the form of accounting ratios, graphs, diagrams etc. The imaginative and innovative ability of an accountant are put to test in this process.

Main aim of the makers of accounting is to create such an accounting system that can help users (shareholders, bankers, owner, creditors etc) in answering every query they need to make their decision.

The steps of the whole accounting system are like this:

      Step 1-  Journal-Recording

       Step 2- Ledger- classifying

       Step 3-Trial Balance, profit& Loss a/c, and Balance sheet-summarizing

       Step 4-Analysing and Interpreting

                step 5 communication-

The first and second steps are performed in the book keeping system. So lets start the journey of accounting-:

                                

                            Book keeping system

Look at the following example to understand about book keeping system:

“Brought cash of Rs 500000 into the business”

“Paid cash Rs 200000 to purchase raw material”

“Sold goods for Rs 300000 in cash”

“Paid wages Rs 50000”

These all above are the transactions; these are recognized in the journal book (the first book of accounts) by recording journal entries in it, like thisà

“Cash a/c…………….dr 500000

      To capital a/c                   500000”

(Being cash bought into the business)

“Purchase a/c………….dr 200000

        To cash a/c                          200000”

(Being raw material purchased in cash)

“Cash a/c……………………..dr 300000

     To sales a/c                                 300000”

(Being goods sold in cash)

“Wages a/c…………………..dr 50000

  To cash a/c                                 50000”

(Being paid wages)

The above journal entries should be posted into the ledger book, like this

   

Dr						Capital Account				cr
Date		Particular		Amount		DATE		Particular		Amount
		To  balance c/d		500000		1/1/2014		By cash a/c		500000
dr						Cash Account				cr
Date		Particular		Amount		Date		particular		Amount
1/1/2014		To Capital a/c		500000		15		By purchase a/c		200000
		TO sales ac		300000				By wages ac		50000
								By balance c/d		550000
				800000						800000
DR						Purchase Accounts				CR
Date		Particular		Amount		Date		Particular		Amount
		To cash a/c		200000				By balance c/d		200000
DR						Sales Accounts				CR
date		Particular		Amount		Date		Particular		Amount
		To balance c/d		300000				By cash a/c		300000
DR					Wages Account				CR
Date	Particular		Amount		Date		Particular		Amount
	To cash a/c		50000				By balance c/d		50000

{We will learn in detail about how this journal and ledger has been done, this illustration is just to give the basic idea of book keeping system.}

The above work is the work of book keeping system; that is, recording transaction into the journal, posting them in the ledger and balancing them.

Now if I’m to define book keeping, I will say “Book keeping is a work of recording transaction into the journal, posting them into the ledger and balancing them so that the accurate position of the business can be known”.

R.N. Carter defines Book keeping as “Book-keeping is the science and art of correctly recording in books of account all those business transaction that result in the transfer or money or money’s worth.”

A.H.Rosenkamph defines Book-Keeping as” Book- Keeping is the art of recording business transaction in a systematic manner.”

From the above two definitions it is clear that:

·        Book-keeping means recording of transaction accurately.

·        Recording must be in a systematic manner, I,e, transaction should be recorded in the journal and then posted in the ledger.

It should be noted that the work of book keeper is to take the transactional information up to ledger level and from trial balance the work of accountant starts.

                   Book keeping—Art and Science

Now Book keeping has been called an art and science by these famous writers? It is because the recording of transaction and posting it into the ledger requires efficient and experience professional. Like painting is an art, you and me can also paint it but we can’t paint it accurately and can’t give it a professional touch as a real artist can give to that painting, it is because he has an experience and talent, in the same way inexperience person can also record transaction (easier one) but they can’t do it (harder one) so efficiently as a professional experience accountant can do it. In one word, recording of transaction is the talent that arises gradually with years of experience that is why it is called an art.

Book keeping is a science because like every scientific theory it is based on many rules, concepts, convention and assumptions.

Book keeping and Accounting:

The way I’ve stated above, I bet readers are not confused between accounting and book keeping because they have understood very clearly that Accounting is the broad concept whereas book-keeping is a narrow concept. If Accounting is imagined as tree with four branches the two of them are the book keeping. 

Introduction to Accounting--Transaction and Events

This is the topic studied by the number of students confronting first time with the concepts of accounting, here is my little try to help them understand this basic and root concepts of accounting.

Event:

If accounting were a big tree with lots of branches, an event would be its seed on which the whole tree stands. No accounting is possible without an event.

Now, what is an event? Event is nothing but all the happenings.

“India has won the match” is the happenings that’s why it’s an event, “Ram get married yesterday” is an event-- but business doesn’t care about these events because its financial situation remains unaffected whether or not India won the match, whether or not Ram get married. Business cares only about the events which is expressed in terms of money and which change its financial position; those events are called Financial Events. “Taken a loan of Rs10000 from Ram for business purpose” is a happening express in term of money that’s why it is called financial event because the financial position of the business is affected by the inflow of money into the business as loan. Now we understand that a business cares only about the financial events and it is this financial event on which the accounting stands, it is the seed and at last this financial event in other way, is called Transaction in a business.

If I talk about the proper definition, Transaction is a financial or economic event that affects a change in the financial position of an enterprise.

Now look at the following examples:

“Purchase of goods worth Rs 100000 on credit” is also a transaction though we are not paying money instantly but the inflow of goods in business increases its value by 100000 and thus, its financial position get affected by this, so it’s  transaction.

“Proprietor received a gift of diamond ring worth 1 million” is not a transaction although it has money value of 1 million. It is because it is not related with business of the proprietor and thus, doesn’t affect its financial position.

From the above explanation and examples it is clear that All the events are not transactions but all the transactions are events that is, every transaction is a financial events but every event can’t be a transaction if it does not have financial value and if it’s not related with the business.

Transaction can be of different types:

Transaction can be reciprocal—“sale of goods worth Rs 10000” in this transaction buyer received the goods worth 10000 and seller received the cash of 10000. Thus, economic value has been exchanged directly between two parties equally that’s why it’s reciprocal.

Transaction can be non reciprocal—“payment of tax for Rs 3000 to the government” here there is no mutual benefit between the two parties, govt. is not paying directly anything in return, thus, it is reciprocal.

Transaction can be external:

 Purchasing and selling goods is the external transaction as there is a link between business and outside party.

Transaction can be internal:

Charging depreciation is an example of internal transaction.

Up to this point, it is clear that to call any event a transaction

·       It should be expressed in terms of money.

·       It should change the financial position of an enterprise, entity or company whatever case may be.

Let’s see some more examples:

“Placing an order worth Rs 50000” is not a transaction it doesn’t affect the financial position of an entity; it will affect when the entity will receive the goods and will paid the cash in return. Similarly “appointing an employee for 50000 per month” or “receiving a free samples for 100” are not transactions because they don’t change the financial position of business though they are expressed in terms of money.