Introduction to Accounting

Introduction to Accounting

Accounting is a system meant for measuring business activities, processing information into reports, and making the findings available to decision-makers. The documents, which communicate these findings of the performance of an organization in monetary terms, are called financial statements.

Accounting is aptly called the language of business. This designation is applied to accounting because it is the method of communicating business information. The basic function of any language is to serve as a means of communication. Accounting duly serves this function. The task of learning accounting is essentially the same as the task of learning a new language. But the acceleration of change in business organizations has contributed to increasing the complexities in this language. Like other languages, it is undergoing a continuous change in an attempt to discover better means of communication. To enable the accounting language to convey the same meaning to all stakeholders, it should be made standard. To make it a standard language certain accounting principles, concepts and standards have been developed over a period of time. This video dwells upon the different dimensions of accounting, accounting concepts, accounting principles, and accounting standards.

More formally, accounting is described as the information system that measures business activities, processes the information into reports, and communicates the results to decision-makers. You can also think of it as the scorecard of business.

Evolution of Accounting

Accounting is a system of recording and summarizing business and financial transactions. For as long as civilizations have been engaging in trade or organized systems of government, methods of record-keeping, accounting, and accounting tools have been in use.

The earliest known accounting records
Accounting is as old as money itself. It has evolved, like medicine, law, and most other fields of human activity in response to the social and economic needs of society. People in all civilizations have maintained various types of records of business activities. Some of the earliest known writings discovered by archaeologists are accounts of ancient tax records on clay tablets from Egypt and Mesopotamia dating back as early as 3300 to 2000 BC. The oldest known is clay tablet records of the payment of wages in Babylonia around 600 b.c. Historians hypothesize that the primary reason for the development of writing systems came out of a need to record trade and business transactions.

Accounting Revolution
When medieval Europe moved toward a monetary economy in the 13th century, merchants depended on bookkeeping to oversee multiple simultaneous transactions financed by bank loans.

For the most part, early accounting dealt only with limited aspects of the financial operations of private or governmental enterprises. Complete accounting system for an enterprise which came to be called as “double-entry system” was developed in Italy in the 15th century. The first known description of the system was published there in 1494 by a Franciscan monk by the name Luca Pacioli.

The expanded business operations initiated by the industrial revolution required increasingly large amounts of money which in turn resulted in the development of the corporation form of organizations. As corporations became larger, an increasing number of individuals and institutions looked to accountants to provide economic information about these enterprises. For e.g. Prospective investors and creditors sought information about a corporation’s financial status. Government agencies required financial information for purposes of taxation and regulation. Thus accounting began to expand its function of meeting the needs of relatively few owners to a public role of meeting the needs of a variety of interested parties.

Accounting was practiced in India twenty-four centuries ago as is clear from Kautilya's book ‘Arthshastra’ which clearly indicates the existence and need for proper accounting and audit.

Professional Organizations for Chartered Accountants
The first professional organizations for accountants were established in Scotland in 1854, starting with the Edinburgh Society of Accountants and the Glasgow Institute of Accountants and Actuaries. The organizations were each granted a royal charter. Members of such organizations could call themselves "chartered accountants."

As companies proliferated, the demand for reliable accountancy shot up, and the profession rapidly became an integral part of the business and financial system. Organizations for chartered accountants now have been formed all over the world. In the U.S., the American Institute of Certified Public Accountants was established in 1887.

In India, (ICAI) the Institute of Chartered Accountants of India was established in 1949 as a statutory body under the Chartered Accountants Act, 1949 enacted by the Parliament for regulating the profession of Chartered Accountancy in India. The Institute of Chartered Accountants of India (ICAI) is the World's second-largest professional accounting body and largest professional accounting body of India under the ownership of the Ministry of Corporate Affairs, Government of India.

Meaning of Book-keeping and Accounting

Some people take both the terms ‘Book-keeping’ and ‘Accountancy’ as synonymous terms. Both the terms are different from each other. However, there is no universally accepted line of demarcation or division between the two.

"Book-keeping is the art of recording business transactions in a set of books of accounts".

Transaction means any dealing, expressed in terms of money. The books in which the transactions are recorded are called ‘Books of Accounts’. Book-keeping is concerned with the preparation of vouchers, recording transactions in a journal, and posting in the ledger. Book-keeper arrives at the final balances of different accounts, after totaling the accounts. The job of a bookkeeper is to the extent of preparing trial balance, duly tallied. Book-keeping is mainly of clerical nature.

Anyone who has basic knowledge of the principles of book-keeping can maintain the books of accounts. On the other hand, accountancy requires deep knowledge of the principles and their application. Though book-keeping and accountancy are different in several aspects, they are supplementary to each other.

Book-keeping and accounting are not synonymous (inter-changeable) terms. The job of an accountant commences where the work of a book-keeper ends.

Accountant guides a book-keeper and reviews the job, done by him. Normally, a book-keeper works under the supervision of an accountant.

An accountant is required to have the much higher skill and knowledge, compared to a Book-keeper. The larger the firm, the higher is the responsibility of an accountant.

Definition and explanation of Accounting

The American Institute of Certified Public Accountants, which has played a noble part in the development of Accounting, defines the concept “Accounting” as follows:

“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 thereof".

This definition is the most acceptable one because it encompasses all the functions that the modern accounting system performs.

If we break this definition for better understanding, we find the term ‘Accounting’ contains different components: like

Recording: Recording is the basic function of Accounting. Events and transactions, which are of financial character, either fully or partly, are recorded in an orderly manner in books of accounts. The transactions are recorded in a journal, as and when they happen or occur. Journal is further sub-divided into cash journal or cash-book (for recording cash transactions), Purchases Journal (for recording credit purchases), and Sales Journal (for recording credit sales). All these books are called subsidiary books. If subsidiary books are maintained, the transactions are not recorded in the journal and are recorded in these books, directly. Only those transactions that do not find a place in subsidiary books are recorded in the journal.

Classifying: All similar transactions are grouped and posted in one book, which is called a ‘Ledger’. The objective of classification is to find a summary of the entries of the same nature in one place.

This book ‘Ledger’ contains different nature of accounts. For example, there may be separate heads of accounts such as Salaries, Traveling Expenses, Repairs, Printing and Stationery, etc. We are interested to know the total amount under each head of the account for our understanding and control.

Summarizing: When posting is complete in the ledger, totals are made for debit and credit side in each head of the account and the final balance (heavier balance), be it debit or credit, is arrived. The individual accounts find a place in a summarized manner, which is called ‘Trial Balance’. Income statement (Trading and Profit and Loss account) and Balance Sheet are prepared from the Trial Balance.

Deals with Financial Transactions: Accounting transactions, which are of financial character only, are recorded in books of accounts. In other words, if a transaction cannot be expressed in terms of money, they are not recorded in accounting books.

Analysis and Interprets: This is the final and important function of accounting. A distinction is necessary to be made between the two terms — Analysis and Interpretation. Analysis refers to the methodical classification of data. If unconnected data are grouped together, understanding is not possible. All assets belonging to current assets are to be grouped together, similarly all current liabilities. If current assets and current liabilities are mixed together, data would be confusing.

Interpretation means drawing conclusions from the data and explaining the conclusions in a simple language, easy to understand, and planning further course of action. Analysis and interpretation are complementary to each other. Interpretation is not possible without analysis. The analysis is of no use unless followed by interpretation.

Communicates: Communication is the final product of accounting. Financial statements i.e. Profit and Loss account and Balance Sheet are the means of communication.

Financial Statements are vital as they are public documents, available for everyone to read if the firm is a joint-stock company.

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