Chapter 1

Basic Understanding

of Accounting

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Accounting

• Accounting is the language of business.

• Luca Pacioli, a Franciscan monk, is considered

to be the father of the modern system of

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to be the father of the modern system of

accounting known as the double-entry system

of bookkeeping and accounting.

Accounting

• Accounting is a service-based discipline.

• Accounting is a measurement discipline.

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• Accounting is the process of preparing and

presenting the accounts.

Definition

• 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

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which are, in part, at least, of a financial

character, and interpreting the results thereof.’

- AICPA

Book-keeping

• Bookkeeping is the record-making phase of

accounting.

• Bookkeeping is the systematic recording of

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• Bookkeeping is the systematic recording of

financial and economic transactions,

accounting is the analysis and interpretation

of bookkeeping records.

Function of Accounting

• Ascertaining the claims and interest in the said entity;

• measuring the resources and changes in these resources;

assigning the changes to specified period of times

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• assigning the changes to specified period of times in terms of money;

• communicating information about an entity; and

• fulfilling the statutory requirements, particularly in respect of income tax, sales tax, etc.

Limitations of Accounting

• Financial Nature

• Historical costs

• Measurement unit

• Personal Judgment

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• Personal Judgment

• Estimates

• Inexact informations

Users of Accounting

• Outside Users

• Inside Users

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Kind of Accounting Activities

• Financial Accounting

• Cost Accounting

• Taxation Accounting

• Management Accounting

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• Management Accounting

Basic Terminology

• Capital

• Equity

• Liability

• Drawings

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• Drawings

• Assets

• Goods or Merchandise

Basic Terminology

• Revenue, Income or Turnover

• Expenses

• Discounts

• Debtors

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• Debtors

• Creditors

Basic Terminology

• Loss

• Profits

• Cost of Goods Sold

• Expenditures

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• Expenditures

Cyclical Nature of Business

• receiving assets from owners and creditors;

• purchasing assets (including traded items for

resale) or materials to produce saleable goods

and/or services;

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and/or services;

• selling goods or services;

• collecting cash or assets equivalent to cash-in-

kind from customers; and

• repaying creditors their dues.

Cyclical Nature of Business

• Financial Cycle

• Operating Cycle

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Accounting Equation

• Assets = Claims

• Assets = Liabilities + Equity

• Equity = Assets – Liabilities

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Accounting Equation

• Owners’ Equity = Capital + Retained Earnings

• Retained Earnings = Income − Expenses −

Drawings by Owners

• Owners’ Equity = Capital + (Income − Expenses

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• Owners’ Equity = Capital + (Income − Expenses

− Drawings)

• Assets = Liabilities + Capital + Retained

Earnings

Accounting Events and Transactions

• A transaction is a particular kind of economic

event that involves the transfer of something

between two enterprises.

• An accounting event is an economic

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• An accounting event is an economic

transaction that has an impact on the

organization’s assets, liabilities, and/or equity.

The transactions may be internal, or external,

Accounting Basics

• Effects of transactions on Accounting Equation

• Personal Accounts and Impersonal Accounts

• Accounting Methods

– Cash Basis

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– Cash Basis

– Accrual Basis

Classification of Accounts

• Traditional Approach

– Personal Account

– Impersonal Account

• Real account

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• Real account

• Nominal account

Classification of Accounts

• Modern Approach

– Assets Account

– Liability Account

– Capital Account

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– Capital Account

– Revenue Account

– Expense Account

Role And Activities of an Accountant

• Primary Role

• Decision-Maker

• Tax Planner

• External Verifier

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• External Verifier

• Conscience Keeper

• Manager of Information

Accounting Personnel

• Auditor

• Controller

• Treasurer

• Finance Director

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• Finance Director