Unit 1: Introduction to Book keeping and Accounting

Introduction to Book-keeping

Bookkeeping, at its core, is the systematic recording of financial transactions. It’s a

fundamental aspect of both business and personal finance management. Without proper
bookkeeping, one can easily lose track of money coming in and going out, leading to
potential financial pitfalls.

History of Bookkeeping

The art of bookkeeping has been around for centuries, evolving from simple tally sticks to
intricate ledger books. With the rise of the digital age, manual bookkeeping has largely been
replaced by software solutions, streamlining the process and increasing accuracy.

Basics of book keeping

To understand bookkeeping, one must familiarise themselves with its foundational concepts

1. Debits and Credits: Every financial transaction has a debit and credit entry, ensuring
the books always balance
2. Journals and Ledgers: Journals are the initial entry point for transactions, while
ledgers categorise these entries
3. Double-entry system: A method where every transaction affects at least two
accounts, ensuring the accounting equation remains balanced

Principles of Bookkeeping

1. Accuracy: It’s paramount to record all financial transactions correctly

2. Consistency: It’s vital to use the same accounting methods consistently from one
financial period to the next
3. Completeness: Every financial transaction must be recorded without any omissions
4. Transparency: Financial records should be clear and straightforward to understand

Types of Book-keeping System

1. Single-Entry System: A straightforward system where only one entry is made for
each transaction. It’s suitable for small businesses or personal finances but has its
limitations.
2. Double-Entry System: This system is the industry standard, with every transaction
recorded twice (as a debit and credit). It provides a clearer financial picture and is
used by most businesses.

Advantages of Book-keeping

Efficient bookkeeping provides a clear financial picture, aiding in

1. Improved financial analysis and management
2. Streamlined tax preparation and compliance
 3. Informed decision-making based on accurate financial data
4. Building confidence among investors and lenders

Objectives of Bookkeeping

The objectives of bookkeeping are as follows:

1. The primary objective of bookkeeping is recording the financial transactions in

an orderly or systematic manner.
2. To summarise the transactions in a chronological order.
3. To provide financial information to both internal and external users, which will
be beneficial in making future plans.
4. To detect potential errors in recording of information

Need / Importance of Bookkeeping

Proper bookkeeping gives companies a reliable measure of their performance. It also

provides information to make general strategic decisions and a benchmark for its revenue and
income goals. In short, once a business is up and running, spending extra time and money on
maintaining proper records is critical.

Many small companies don’t actually hire full-time accountants to work for them because of
the cost. Instead, small companies generally hire a bookkeeper or outsource the job to a
professional firm. One important thing to note here is that many people who intend to start a
new business sometimes overlook the importance of matters such as keeping records of every
penny spent.

Accounting

As an accountant, you may have to crunch numbers, but those are not the only skills needed.
It is important to possess sharp logic skills and big-picture problem-solving abilities, as well.
While bookkeepers make sure the small pieces fit properly into place, accountants use those
small pieces to draw much more significant and broader conclusions .

Need for Accounting

 Recording of transactions: Accounting is needed to record all the transactions of the

business and maintain proper books to show assets, liabilities, capital and profit and

loss. Up-to-date records help businessmen to compare current financial information to

past data.
  Profit and loss: Businesses are some to earn profits, and to know whether a business is

earning profits, one must prepare a profit and loss account, which ultimately will

show the results of transactions done.

 Tax Filing: One of the major reasons for accounting is the preparation of files of tax

returns on income tax, sales tax, wealth tax, exercise duty, tax on dividends, value-

added tax, import and export duties, and many more.

 Knowing the financial position: A businessman should always be aware of his

business's financial position in the market. A statement called a balance sheet has all

the information of the assets and liabilities of the company and thus helps in knowing

the business's financial position.

 Necessary Information for financial Institution: When a business wants investment

from financial institutions, they have to show the necessary information like sales,

profitability, and financial position, which are there in accounts.

 Payroll accounting: accounting helps maintain the records of all the employees

through the payroll accounting management system.

The Objectives of Accounting

The primary objectives of accounting include systematic maintenance of records of
transactions summarising and analysing business reports to assess the financial standing of
the business entity. The following are the various objectives of accounting –
Maintaining systematic financial records
One of the most important accounting objectives is that accounting helps the business
organisation keep a systematic and accurate record of the day-to-day transactions, which
helps to understand the working of the business, payments made, income received, etc.
To estimate and ascertain profits or losses
Recording transactions concerning revenues and expenditures helps us ascertain the profit/
loss at the end of the financial year. Ascertaining profits or losses is important to make
payments, making it one of the important objectives of accounting.
Preparing financial reports to assess the financial position
Accounting involves the preparation of a balance sheet which is a record of the assets and
liabilities of a business entity. This helps in the analysis of the financial position of the
business organisation. Ascertaining profitability can help us understand the strengths and
weaknesses of the business organisation and formulate various policies and strategies to
correct the weaknesses and improve the organisation’s strengths.
Auditing of financial reports
Another objective of accounting is that it helps in understanding the financial position of a
company in the form of assets, debts, profits and losses, etc. These records are made available
to the auditor, who can then analyse the reports to find any discrepancies and suggest the
required corrective reforms. These reports also help the higher authorities formulate plans
and make rational decisions.
To forecast future payments, expenditures and budgets
Accounting helps to predict the future profitability of a business entity. This helps plan future
payments, debts, expenditures and budgets accordingly. It also helps in distributing funds
among different departments of the business organisation based on past allocations and
profitability.
These are a few of the most important objectives of accounting. Once we understand the
objectives of accounting, it becomes easier to understand the role of accounting.
Function of Accounting
Accounting functions involve the identification, recording, summarising of transactions,
analysing and ascertaining the profit/losses and communication of the necessary information.
Here are a few functions of accounting –
Preparation of budget and cash control
The most important role of accounting, which also helps explain the objectives of accounting,
is the record of transactions to facilitate the budget and cash control preparation. Cash control
is estimating a standard cost beforehand. Evaluating and comparing the standard and actual
costs incurred can help us analyse and understand the efficiency of the work undertaken and
the corrective measures to be applied to improve efficiency.
Prevention of errors and fraud
Accounting helps in estimating and ascertaining the profits or losses through a systematic
record of all transactions. This helps prevent errors and fraud like all the transactions,
including the employee reports, are recorded systematically and accurately.
Basis of evaluation of performance
Accounting acts as a basis for the evaluation of performance. It helps us ascertain whether the
pre-planned goals are achieved and provides information regarding the assets and liability
situation of the business, which can be beneficial to evaluate the financial position of the
business organisation.
Control of fiscal policies of the business
Another important function of accounting is to provide a detailed summary of reports which
ensures strong vigilance, thereby preventing mismanagement of funds and helps in the
control and regulation of the fiscal policies of the business via proper allocation of the funds.

Advantages of Accounting

 Maintenance of business records

 Preparation of financial statements

 Comparison of results

 Decision making

 Evidence in legal matters

 Provides information to related parties

 Helps in taxation matters

 Valuation of business

 Replacement of memory
Maintenance of business records
It records all the financial transaction pertaining to the respective year systematically in the
books of accounts. It is not possible for management to remember each and every transaction for
a long time due to their size and complexities.

Preparation of financial statements

Financial statements like Trading and profit and loss account, Balance Sheet can be prepared
easily if there is a proper recording of transactions. Proper recording of all the financial
transactions is very important for the preparation of financial statements of the entity.

Comparison of results
It facilitates the comparison of the financial results of one year with another year easily. Also,
the management can analyze the systematic recording of all the financial transactions according
to the policies of the entity.
Decision making
Decision making becomes easier for management if there is a proper recording of financial
transactions. Accounting information enables management to plan its future activities, make
budgets and coordination of various activities in various departments.

Evidence in legal matters

The proper and systematic records of the financial transactions act as evidence in the court of
law.

Provides information to related parties

It makes the financial information of the organization available to stakeholders like owners,
creditors, employees, customers, government etc. easily.

Helps in taxation matters

Various tax authorities like income tax, indirect taxes depends on the accounts maintained by
the management for settlement of taxation matters.

Valuation of business
For proper valuation of an entity’s business accounting information can be utilized. Thus, it
helps in measuring the value of the entity by using the accounting information in the case of sale
of the entity.

Replacement of memory
Proper recording of accounting transactions replaces the need to remember transactions.

Disadvantages of Accounting

 Expresses Accounting information in terms of money

 Accounting information is based on estimates

 Accounting information may be biased

 Recording of Fixed assets at the original cost

 Manipulation of Accounts

 Money as a measurement unit changes in value

Expresses Accounting information in terms of money
Non-financial transactions cannot be given effect to in books of accounts. Only transactions of
financial nature are measurable by the accountant. In fact, financial transactions are expressed in
terms of money.

Accounting information is based on estimates

There are some accounting data which are based on estimates. Thus, inaccuracy in estimates is
possible.

Accounting information may be biased

Accountants personal influence affects the accounting information of the entity. Different
methods of inventory valuation, depreciation methods, treatment of revenue and capital
expenses etc can be adopted by the accountant for measurement of income of the entity.
Unit 2: Accounting Equation Effects

Introduction

Accounting Equation

The accounting equation states that a companies total assets are equal to the sum of its
liabilities and its shareholder’s equity this straightforward relationship between assets,
liabilities, and equity is considered to be foundation of the double – entry accounting system.

Types of Accounting Concepts

Along with dual aspect accounting, there are quite a few types of accounting concepts which
are vital for a better understanding of the subject. Some of these crucial concepts are
explained below.
1. Accrual Concept: This concept suggests that revenue should be recognised and recorded
on its realisation rather than that of its actual receipt. Additionally related costs are not left till
payment, but recorded when it is incurred. This concept requires proper adjustment and
citation while preparing income statements of revenue and costs.
2. Business Entity Concept: The main idea behind this concept is that a business in itself is
separate from all its stakeholders or capital investors. It stresses the importance of
maintaining proper transactional records of a firm. Here a proprietor is considered to be the
creditor.
3. Cost Concept: This concept directs recording of fixed assets at their original cost when
they were acquired. This price which is paid to acquire an asset is the relevant cost. This
forms the basis of every accounting of this asset that is to follow.
4. Going Concern Concept: A vital concept dealing with the longevity of a business
venture, this focuses on profitability of a firm. Consequently, any business enterprise which is
making profit can continue with their venture and are known as going concerns. Here,
accounting reports are recorded as going concerns, similar to that against liquidation.
5. Money Measurement Concept: A simple accounting concept, it suggests that every
transaction which involves liquid cash should be recorded while bookkeeping. Vitally, this
concept requires every transaction to be recorded only in monetary terms.
The business entity concept
The business entity concept states that the business is separate from the owner(s) of the
business. Therefore the accounting records for even the simplest business, the sole trader,
must be kept separate from the personal affairs of the owner or owners.
There are basically three types of business entity:
 sole trader
 partnership
 limited company.
The principles of double-entry accounting apply to all forms of business organisation, as well
as not-for-profit organisations.
As you learned in Week 1, any business starts with no money. It needs resources to be able to
operate and those resources have to be financed. Right from the start it often also needs to
incur debts or liabilities to buy assets such as equipment and inventory that it will use for
future financial benefit. Assets, capital and liabilities are the elements of the accounting
equation, which expresses the relation between these elements.
Entity Concept

The Business Entity Concept is essential for maintaining clarity and

integrity in financial reporting. Here are some key points that highlight the
importance of the Business Entity Concept:

Clarity in Financial Reporting: This Concept ensures that financial

statements provide a clear and accurate picture of a company’s financial
health.

Transparency for Stakeholders: Investors, creditors, and regulators

rely on financial reports to make informed decisions.

Protecting Investor Interests: Shareholders and investors often

entrust their capital to a business entity.

Legal and Tax Compliance: From a legal and tax perspective, treating
the business as a distinct entity is essential.

Accurate Performance Assessment: The Business Entity Concept

allows for the accurate assessment of a business’s profitability and
financial stability.

Comparative Analysis: Businesses often need to benchmark their

performance against industry peers.

Maintaining Accountability: The concept promotes accountability

within a business. When financial activities are clearly attributed to the
entity rather than individuals, it becomes easier to hold responsible
parties.

Enhancing Credibility: A company that adheres to this concept

enhances its credibility in the eyes of stakeholders.

Risk Mitigation: By maintaining a clear separation between business

and personal finances, the Business Entity Concept helps mitigate risks
associated with legal disputes or financial crises.
Business Entity Concept Examples

Example 1:

Separate Bank Accounts for a Partnership: In a partnership, two or more

individuals join to run a business. To comply with the Business Entity
Concept, the partners should maintain a separate business bank account
distinct from their personal accounts. This separation allows for the
transparent tracking of funds flowing in and out of the partnership,
preventing financial confusion.

Example 2:

Corporate Shareholders and Dividends: When a corporation issues shares

to investors, the Business Entity Concept suggests that the corporation’s
financial statements must clearly distinguish between the company’s
earnings and the dividends paid to shareholders. This separation helps
investors assess the corporation’s profitability and the returns on their
investments without conflating personal income with corporate earnings.

Need for Applying Business Entity Concept

 The application of the Business Entity Concept is crucial for several

compelling reasons. Here are the key points illustrating the need for
applying the Business Entity Concept:
 The Business Entity Concept is essential to provide clarity in
financial statements
 Investors, creditors, and regulatory authorities rely on transparent
financial reporting to make informed decisions.
 The Concept safeguards Investor’s/Shareholder’s interests by
preventing the mingling of personal and business finances, reducing
the risk of misappropriation or misuse of funds.
 Compliance with tax regulations and legal requirements is essential
for any business.
 To make informed decisions about expansion, investment, or
strategic planning, accurate assessments of a business’s
profitability and financial stability are essential which is effectively
done by applying the Business Entity concept.
 Auditors rely on this Concept to conduct thorough examinations of a
company’s financial records.
Limitations to Business Entity Concept

The Business Entity Concept has certain limitations that should be

considered. These limitations arise due to the inherent simplifications and
assumptions involved in applying this concept. Here are the key
limitations of the Business Entity Concept:
 1. Complex Business Structures: In modern business environments,
entities can have complex ownership structures involving multiple
subsidiaries, joint ventures, and affiliates.
2. Consolidation Challenges: The Concept may not fully capture the
financial performance and position of the entire group, as it focuses
on individual entities rather than the group as a whole.
3. Intangible Assets: The concept may not adequately account for
intangible assets such as intellectual property, brands, or goodwill,
which can have a significant impact on a company’s value and
financial performance.
4. Intercompany Transactions: In cases where entities within the
same corporate group engage in transactions with each other, the
Business Entity Concept may not fully address the potential for
conflicts of interest or transfer pricing issues.
5. Economic Substance vs. Legal Form: The concept primarily
focuses on the legal structure of a business entity. In some
instances, the legal form may not align with the economic
substance of a transaction or arrangement.
6. Lack of Transparency: While it aims to enhance transparency, it
may not always achieve this goal.
7. Personal Liabilities: In certain business structures like sole
proprietorships and partnerships, the owner’s personal assets may
still be at risk in the event of business liabilities or debts.
8. Inadequate for Nonprofits: Nonprofit organizations may find
limitations due to their unique funding sources and mission-driven
activities.
9. Historical Cost Accounting: The concept often aligns with
historical cost accounting, which records assets at their original
purchase cost.
10. Evolution of Business Models: New business models and
financing methods emerge regularly in a rapidly evolving business
landscape. This Concept may lag behind in adapting to these
changes.
The accounting equation
The financial position of a business is expressed in the statement of financial position, which
is more commonly called the balance sheet. The financial position of a business is
represented by:
 assets (what the business owns)
 liabilities (what the business owes)
 owner’s capital (the monetary value of the owner’s investment in the business).
As you may remember from Week 2, the accounting equation (also called balance sheet
equation), for any business, says:

The accounting equation

Assets = Capital + Liabilities

below demonstrates the accounting equation.

Examples of Dual Aspect Accounting

As a practical field of study, it is vital for students to understand accounting concepts with
examples since it offers enhanced clarity. A few examples are given below to clearly explain
this concept.
1. Issuing An Invoice To A Customer: The first entry appears in its income statement
indicating increase in sales. Additionally, its accounts receivable asset in the balance sheet is
also increased, while change in income due to increase in sales are recorded in retained
earnings. This is a part of the section of equity in a balance sheet.
2. Receiving An Invoice From A Supplier: First portion of this entry records increase of
expense or asset account. This can appear either in the income statement for an expense or in
the balance sheet for assets. Second portion of this entry increases accounts payable liability.
Furthermore, this change in income recorded due to an expense appears in retained earnings
as a part of the equity section in a balance sheet.
While these examples demonstrate a scenario, to explain accounting concepts to students
illustrative examples must also be presented.
Consider a startup by Mr. X which has a financial asset of Rs.1 lakh. In this situation, double-
entry accounting shows the following.
Assets = Liabilities Owner’s equity

Cash + = 0 Capital

Rs.1,00,000 0 10,000

This entry changes when Mr. X purchases goods of worth Rs. 20,000 from another firm on
credit. After this purchase, this accounting looks as follows.
Assets = Liabilities Owner’s equity

Cash + Purchases = Creditors + Capital

Rs.1,00,000 = 0 Rs.20,000
 Rs1,00,000 + Rs.20,000 = Rs.20,000 + Rs.1,00,000

Accounting Transactions - Effect on the Fundamental Accounting Equation

Every accounting transaction effects the Fundamental Accounting

Equation

Every Business transaction which is to be considered for accounting i.e. every Accounting
transaction, has its effect on the fundamental accounting equation.

Each transaction alters the expressions forming the equation in such a way that the
accounting equation is satisfied after every such alteration.

The values forming the various terms of the expressions within the equation are altered in
such a way that the basic fact, rule or equation, Capital + Liabilities = Assets is always
satisfied.

Illustration

Go through the explanation to the following few transactions which have occurred towards
the beginning of a newly started business.

1. A business is proposed to be started by Mr. Oberoi.

Since the business has only been proposed and not yet started it has neither assets nor
liabilities.

Capital + Liabilities = Assets

0 + 0 = 0

The equation is satisfied.

2. He brought in a cash of 1,00,000 as his capital contribution for the business.

This transaction in accounting books is read and interpreted as

Started business with a capital of 1,00,000 in cash.

Since capital in the form of cash is being brought into the business,

 The value of capital has increased from zero to 1,00,000 and

  The cash available with the business has also increased from zero to 1,00,000.

Cash, since it is capable of being liquidated, is an asset.

Capital + Liabilities = Assets

1,00,00 + 0 = 1,00,000 (Cash)

0

The equation is satisfied.

3. He then purchased some furniture for 25,000.

Accounting interpretation of the transaction

Bought Furniture for cash 25,000.

Since Furniture is being bought by paying cash,

 The value of Furniture has increased from zero to 25,000.

Furniture, since it is capable of being liquidated, is an asset.

 The cash available with the business would reduce by 25,000 to 75,000.

This transaction does not have any effect on either capital or liabilities.

Capital + Liabilities = Assets

1,00,000 + 0 = 75,000 (Cash)

+ 25,000 (Furniture)

The equation is satisfied.

4. He then purchased some goods for cash for 25,000 from M/s Roxy Brothers.

Accounting interpretation of the transaction

Bought Goods for cash 25,000.

Importance of Dual Aspect Concept in Accounting

Maintaining Balance:
The Dual Aspect Concept ensures that every financial transaction has equal and opposite
effects on the two fundamental aspects of accounting – assets and equities. This principle
guarantees that the fundamental accounting equation (Assets = Liabilities + Equity) is always
in equilibrium. It prevents errors and discrepancies in financial records, providing a
dependable basis for decision-making.
Accuracy and Reliability:
By requiring every transaction to be recorded with both a debit and a credit, this concept
enhances the accuracy and reliability of financial statements. It leaves no room for omissions
or double counting, ensuring that all financial activities are systematically accounted for.
Detection of Errors and Fraud:
The dual recording system creates a natural check and balance within financial records. This
makes it easier to detect errors or discrepancies and helps in the early detection of fraudulent
activities. It enhances the internal control mechanisms of a business, safeguarding its
financial integrity.
Complete Financial Picture:
The Dual Aspect Concept compels businesses to record all financial activities, whether they
involve cash, credit, assets, or liabilities. This comprehensive approach provides a complete
and detailed financial picture, enabling stakeholders to make informed decisions and
accurately assess an entity's financial health.
Uniformity and Compliance:
Adherence to the Dual Aspect Concept ensures compliance with standard accounting
principles such as Generally Accepted Accounting Principles (GAAP) and International
Financial Reporting Standards (IFRS). This uniformity is crucial for maintaining consistency
and comparability in national and international financial reporting.
Decision-Making:
Businesses rely on accurate financial information for decision-making. The Dual Aspect
Concept ensures that financial statements accurately reflect the economic reality of
transactions. This, in turn, assists managers, investors, creditors, and other stakeholders make
sound decisions.