Introduction to Accounting | ISC Class 11 Accounts Notes

This note covers the background and history of accounting, the types of accounts, the meaning and difference between book-keeping, accounting and accountancy, the accounting cycle, the basic terms used in accounting (events, transactions, vouchers, capital, assets, liabilities, trade debtors, trade creditors, purchases, sales, goods traded in, stock, profit, gain, loss, expense, revenue, income and drawings), the stakeholders of accounting information, and the specialised fields of financial, cost and management accounting.

What is the background and history of accounting?

Accounting in the ancient world

The history of accounting is as old as civilisation itself. The seeds of accounting were most likely first sown in Babylonia and Egypt around 4000 B.C., where people recorded transactions of payment of wages and taxes on clay tablets.

Egyptians used some form of accounting for their treasuries, where gold and other valuables were kept. The person in charge of a treasury sent day-wise reports to superiors called Wazirs, and month-wise reports went from there to kings.

Babylonia, known as the city of commerce, used accounting to uncover losses caused by fraud and inefficiency. In Greece, accounting was used to apportion revenues among treasuries and to keep total receipts, total payments and the balance of government transactions.

Romans used a memorandum or daybook (700 B.C. to 400 A.D.) in which receipts and payments were recorded and later posted to ledgers monthly. China used a sophisticated form of government accounting as early as 2000 B.C.

In India, accounting practices can be traced to Kautilya, a minister in Chandragupta's kingdom, who wrote Arthashasthra about twenty-three centuries ago, describing how accounting records had to be maintained.

Luca Pacioli and double entry book-keeping

The most important milestone, however, is the book Summa de Arithmetica, Geometria, Proportioni et Proportionalita, written by Luca Pacioli, a Franciscan friar, and published in Venice in 1494. It is considered the first book on double entry book-keeping.

Pacioli did not claim to have invented double entry; he probably relied on existing manuals and spread the knowledge of the system.

He used the Italian terms Debit (from debito, meaning owed to the proprietor) and Credit (from credito, meaning trust or belief), and wrote that "All entries… have to be double entries, that is if you make one creditor, you must make some debtor".

What do book-keeping, accounting and accountancy mean, and how do they differ?

In 1941, the American Institute of Certified Public Accountants (AICPA) defined accounting as "the art of recording, classifying, and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof".

In 1966, the American Accounting Association (AAA) widened this to "the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of information".

Definition: Accounting. Accounting is the process of identifying, measuring, recording and communicating the required information relating to the economic events of an organisation to the interested users of such information.

Book-keeping is the narrower, routine activity of recording business transactions in the books of account in a systematic and chronological order.

It is only the recording part of the wider accounting process; it does not by itself involve interpreting or communicating the results.

Accountancy is the broader body of knowledge and the discipline that lays down the principles, concepts and techniques that are applied in accounting, including book-keeping, the preparation of financial statements and their analysis and interpretation.

What is the accounting cycle?

The accounting cycle is the sequence of steps through which every transaction passes, from the moment it occurs to the point at which it appears in the financial statements. The process, up to the trial balance, runs as follows.

1. Identify the transactions that are to be recorded, i.e. those which can be measured in money terms.
2. Record the transactions in the journal, or in subsidiary books (such as the sales book, purchases book, returns books and cash book) for repeated transactions of the same nature, following the double entry system under which both the debit and the credit aspect of every transaction are recorded.
3. Post the entries appearing in the journal and subsidiary books to the respective accounts in the ledger.
4. Balance the ledger accounts and list them in a statement called the trial balance; if the total of the debit and credit balances agree, the accounts are taken as free from arithmetical errors.
5. Use the trial balance as the basis for preparing the financial statements, namely the trading and profit and loss account and the balance sheet.

Because accounting is "a definite process of interlinked activities" that begins with identifying transactions and ends with the preparation of financial statements, every step in this cycle generates information that is eventually communicated to the users who need it.

What are the types of accounts?

Every transaction is recorded in an account, and accounts are grouped by their nature into personal accounts and impersonal accounts. Impersonal accounts are further divided into real accounts and nominal accounts. The type of account decides the rule applied when it is debited or credited.

Personal accounts

Personal accounts are the accounts of persons and of other entities treated as persons for accounting, such as a supplier, a customer, a bank or the owner's capital account. The rule for these accounts is: debit the receiver, credit the giver.

Personal accounts are of three kinds: natural personal accounts of individuals, such as Mr. Ravi's account; artificial personal accounts of bodies such as firms, companies and banks; and representative personal accounts, which stand for a person, such as an outstanding salaries account or a prepaid rent account.

When goods are sold on credit to a customer, the customer receives the goods, so the customer's account is debited. When the customer later pays, the customer becomes the giver of cash, so the same account is credited.

Real accounts

Real accounts are the accounts of assets and properties, such as cash, machinery, furniture, land and buildings. The rule for these accounts is: debit what comes in, credit what goes out.

When machinery is bought for cash, machinery comes into the business and is debited, while cash goes out and is credited. Cash is itself a real account, so the same rule applies to it. Real accounts may be tangible, such as machinery and cash, or intangible, such as goodwill and patents.

Nominal accounts

Nominal accounts are the accounts of expenses, losses, incomes and gains, such as rent, wages, salaries, interest and commission received. The rule for these accounts is: debit all expenses and losses, credit all incomes and gains.

Rent paid is an expense and is debited, while commission received is an income and is credited. Nominal accounts are closed at the end of the accounting period by transfer to the trading and profit and loss account.

Worked example 1. Classify each of the following accounts as personal, real or nominal, and state whether it will be debited or credited for the transaction given: (a) goods sold on credit to Mr. Ravi, (b) furniture bought for cash, (c) rent paid.

Answer: (a) Mr. Ravi's account is a personal account, and since he is the receiver of the goods it is debited. (b) Furniture account is a real account, and since furniture comes into the business it is debited; cash goes out and is credited. (c) Rent account is a nominal account, and since rent is an expense it is debited.

What are events, transactions and vouchers?

Economic events: internal and external

An economic event is a happening of consequence to a business organisation which consists of transactions that are measurable in money terms. For example, purchasing a machine, transporting it, preparing the site and installing it together make up a single event comprising a bunch of financial transactions.

If an event involves dealings between an outsider and the organisation, it is called an external event, for example sale of merchandise to customers, rendering services, purchase of materials from suppliers, or payment of monthly rent to a landlord.

An internal event occurs entirely within the internal wings of the enterprise, such as the supply of raw material by the stores department to the manufacturing department, or payment of wages to employees.

Transactions and vouchers

Definition: Transaction. An event involving some value between two or more entities, such as a purchase of goods, receipt of money, payment to a creditor or incurring of expenses. It can be a cash transaction or a credit transaction.

Definition: Voucher. The documentary evidence in support of a transaction. For example, buying goods for cash gives a cash memo, buying on credit gives an invoice, and making a payment gives a receipt.

What is capital, and what are the types of assets?

Capital and business entities

Capital is the amount invested by the owner in the firm. It may be brought in as cash or as assets. For the business entity, capital is an obligation and a claim on the assets of the business, and is therefore shown on the liabilities side of the balance sheet.

An accounting system is always devised for a specific business entity, also called an accounting entity, such as Super Bazaar, Hire Jewellers or ITC Limited, each of which is treated as a separate, identifiable business unit for accounting purposes.

Because the balance sheet lists assets on one side and capital together with liabilities on the other, with the two sides always agreeing, capital can also be expressed as a simple relationship: Capital = Assets − Liabilities. This reflects the owner's residual claim on the business once outside obligations have been met.

Definition: Assets. Assets are economic resources of an enterprise that can be usefully expressed in monetary terms; they are items of value used by the business in its operations, such as Super Bazaar's fleet of delivery trucks, which is used for delivering foodstuffs and is shown on the asset side of its balance sheet.

Types of assets

Assets are commonly classified into several types. Tangible assets have a physical, touchable existence, such as land, buildings, machinery and stock. Intangible assets have no physical existence but still have value, such as goodwill, patents and trademarks.

Fixed assets are held for long-term use in operations rather than for resale, such as furniture or plant.

Current assets are expected to be realised, sold or consumed within the normal operating cycle or within twelve months, such as debtors, stock and cash; current assets or liabilities are involved in the operating cycle, are realised or settled within twelve months, are held primarily for trading, and are cash or cash equivalent.

Liquid assets are cash or near-cash items that can be converted into cash very quickly, such as cash at bank. Wasting assets are assets that get used up or exhausted gradually over time through use, such as mines and quarries.

Fictitious assets are not real assets at all; they are unwritten-off expenses or losses, such as preliminary expenses, which are carried forward and shown on the assets side only until they are written off.

What are liabilities, and how are they classified?

Meaning of liabilities

Definition: Liabilities. Liabilities are obligations or debts that an enterprise has to pay at some time in the future; they represent creditors' claims on the firm's assets.

If a business purchases goods on credit, for example from a supplier, the amount owed will be shown as a creditor on the liabilities side of the balance sheet; a loan taken from a bank for a period of years is likewise shown as a liability.

Current, long-term, internal and external liabilities

Liabilities are broadly classified as current and long-term. Long-term liabilities include long-term borrowings, deferred tax liabilities and long-term provisions, while current liabilities include short-term borrowings, trade payables, other current liabilities and short-term provisions.

Liabilities can also be grouped as internal liabilities, which are the obligations a firm owes to its own owners, chiefly the owner's capital, and external liabilities, which are obligations owed to outsiders such as creditors, lenders and the government.

External liabilities are further classified as current liabilities (payable within a short period, generally twelve months), long-term liabilities (payable over a longer period, such as a bank loan) and contingent liabilities, which are possible obligations that may or may not arise depending on the outcome of a future uncertain event, such as a pending court case, and which are disclosed only as a note rather than shown among the actual liabilities until they become certain.

Worked example 2. Super Bazaar purchases goods worth ₹10,000 on credit for a month from Fast Food Products on 25 March. Super Bazaar also takes a loan for a period of three years from Delhi State Co-operative Bank. If the balance sheet of Super Bazaar is prepared as at 31 March, show how these two items will appear in it.

Answer: Fast Food Products will be shown as a creditor of ₹10,000 on the liabilities side of the balance sheet, because the amount is owed to an outside party for goods bought on credit. The loan from Delhi State Co-operative Bank will also be shown as a liability on the liabilities side, because it is a debt the business must repay over the three-year period.

What are trade debtors, trade creditors, purchases, sales, goods traded in and stock?

Trade debtors and trade creditors

Definition: Trade debtors. Trade debtors are persons or entities who owe an enterprise an amount for buying goods and services on credit; the total due from them on the closing date is shown as sundry debtors on the asset side of the balance sheet.

Definition: Trade creditors. Trade creditors are persons or entities to whom an enterprise owes an amount for goods or services bought on credit; the total owed to them is shown as sundry creditors on the liabilities side of the balance sheet.

Purchases, sales and goods traded in

Purchases are the total amount of goods procured by a business, on credit or for cash, for use or resale; in a trading concern these are merchandise bought for resale, while in a manufacturing concern raw materials are purchased and processed into finished goods.

Sales are the total revenues from goods or services sold or provided to customers, and may be cash sales or credit sales.

Goods traded in refers specifically to the products in which the business unit deals, that is, the items it buys and sells or produces and sells.

For a furniture dealer, chairs and tables purchased for resale are goods traded in, while for most other businesses furniture bought for office use is an asset, not goods traded in.

Stock: raw material, work in progress and finished goods

Definition: Stock. Stock (inventory) is a measure of what is on hand: goods, spares and other items in the business. The amount of unsold goods at the end of an accounting period is called closing stock, and the amount at the beginning of the period is the opening stock.

In a manufacturing concern, closing stock comprises three categories: raw material not yet put into production, work in progress (goods that are partly processed), and finished goods that are ready for sale.

What are profit, gain, loss, expense, revenue, income and drawings?

Profit and loss

Profit is the excess of revenues of a period over its related expenses during an accounting year; profit increases the investment of the owners. This relationship is written as: Profit = Revenue − Expenses.

If the total revenue of a given period is ₹6,00,000 and total expenses are ₹5,40,000, the profit will be equal to ₹60,000 (₹6,00,000 minus ₹5,40,000); if expenses exceed revenue instead, the difference reflects a loss, written as: Loss = Expenses − Revenue.

Worked example 3. A firm's total revenue for a period is ₹6,00,000 and its total expenses are ₹5,40,000. Find the profit for the period.

Answer: Profit = Revenue − Expenses = ₹6,00,000 − ₹5,40,000 = ₹60,000. The firm has earned a profit of ₹60,000 for the period.

Gain is a profit that arises from events or transactions incidental to the business, such as sale of a fixed asset, winning a court case, or appreciation in the value of an asset, rather than from the ordinary trading activity itself. Where a fixed asset is sold, this is written as: Gain = Sale proceeds − Cost.

Loss is the excess of expenses of a period over its related revenues, decreasing owner's equity; it also refers to money or money's worth lost without receiving any benefit, such as goods lost by theft or fire, or a loss on the sale of a fixed asset.

Worked example 4. Mr. Sunrise's business owned machinery that originally cost ₹40,000. This machinery was sold for ₹45,000. In the same month, stationery worth ₹30,000 was destroyed in a fire accident. Identify the gain and the loss.

Answer: Gain = Sale proceeds − Cost of asset = ₹45,000 − ₹40,000 = ₹5,000, because it arises incidentally from sale of a fixed asset. Loss = ₹30,000, being the value of stationery destroyed by fire, for which no benefit was received in return.

Expense, revenue, income and drawings

Expense is a cost incurred by a business in the process of earning revenue, measured by the cost of assets consumed or services used during an accounting period, such as depreciation, rent, wages, salaries and interest.

Revenue consists of the amounts the business earns by selling its products or providing services, called sales revenue, plus other items such as commission, interest, dividends, royalties and rent received.

Income is the amount of money or money's worth that a business receives or earns during an accounting period, whether from its ordinary operations or from other sources. Revenue is the income earned from the sale of goods or services and from other regular receipts such as commission, interest and rent received, while income is the wider figure that also includes gains, such as profit on the sale of a fixed asset, which arise from events incidental to the business.

Revenue is therefore the income of the ordinary trading activity, and a gain is income of an incidental kind; together they make up the total income of the period. The net result of the period, the excess of revenue and gains over expenses and losses, is called net income or net profit.

Drawings is the withdrawal of money or goods by the owner from the business for personal use; drawings reduce the investment of the owners.

Worked example 5. Mr. Sunrise started a stationery business with ₹5,00,000 as initial investment, of which he paid ₹1,00,000 for furniture and ₹2,00,000 for buying stationery items. He later bought stationery items worth ₹1,50,000 from Mr. Peace on credit. He also sold stationery worth ₹1,00,000 on credit to Mr. Ravi. Identify his capital, his fixed asset, his total purchases, his creditor with the amount owed, and his debtor with the amount receivable.

Answer: Capital = ₹5,00,000, the amount invested by the owner. Fixed asset = Furniture of ₹1,00,000, bought for long-term use, not resale. Total purchases = ₹2,00,000 + ₹1,50,000 = ₹3,50,000, because purchases include goods bought for resale both for cash and on credit. Creditor = Mr. Peace, ₹1,50,000 owed for stationery bought on credit. Debtor = Mr. Ravi, ₹1,00,000 receivable for stationery sold on credit.

Who are the stakeholders of accounting information?

Internal and external users

Accounting is a means by which necessary financial information about a business enterprise is communicated, and is also called the language of business.

Users of this information fall into two broad categories: internal users, including the chief executive, financial officer, vice president, business unit managers, plant managers, store managers and line supervisors; and external users, including present and potential investors (shareholders), creditors (banks and other financial institutions, debenture-holders and other lenders), tax authorities, regulatory agencies, labour unions, trade associations, stock exchanges and customers.

Why each stakeholder wants accounting information

Different stakeholders want different things from the same set of figures. Owners and shareholders use accounting information to see whether they are getting a satisfactory return on their investment and to assess the financial health of the business.

Directors and managers use it for internal and external comparisons to evaluate performance and to compare their company with industry figures.

Creditors (lenders) look particularly at liquidity, the ability of the business to pay its debts as they become due, to see if they are likely to get paid. Prospective investors use the information to decide whether or not to invest.

The government and regulatory agencies require information for levying taxes such as Goods and Services Tax (GST) and Income Tax, and to protect the interests of investors and creditors and satisfy legal obligations imposed by the Companies Act, 2013. In India this regulatory role is shared by the Registrar of Companies, customs departments, the Insurance Regulatory and Development Authority of India (IRDAI), the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI), each of which draws on a firm's accounting information for its own regulatory purpose.

Customers want to know about the continued existence of the business and the likely continuity of supply of products and after-sales service.

What are the specialised fields of accounting?

Why specialised branches developed

The economic development and technological advancement that followed the growth of the company form of business made management functions more complex and gave rise to specialised branches of accounting.

Financial, cost and management accounting

Definition: Financial accounting. This branch keeps a record of all financial transactions so that the profit or loss for an accounting period can be worked out, the financial position at the end of the period can be ascertained, and the financial information needed by management and other interested parties can be provided.

Definition: Cost accounting. This branch analyses expenditure to ascertain the cost of various products manufactured or services rendered by the firm, to fix prices, to control costs and to provide costing information to management for decision-making.

Definition: Management accounting. This branch provides necessary accounting information to people within the organisation to help them in decision-making, planning and controlling business operations, drawing mainly on financial accounting and cost accounting.

Financial accounting relates to the past period, serves a stewardship function and is monetary in nature, being concerned primarily with providing financial information to all stakeholders.

Management accounting, in contrast, also generates information relating to the future, such as sales forecasts, cash flows, purchase requirements, manpower needs and environmental data, which is relevant for decisions such as budgeting, assessing profitability, pricing and capital expenditure.

The widening scope of accounting has also given rise to newer areas such as human resource accounting, social accounting and responsibility accounting.

Going beyond the syllabus

These ideas extend the unit and are not needed for the questions on it.

What are the advantages and limitations of accounting?

Accounting serves several primary objectives for a business. It maintains a systematic record of all financial transactions in the books of account, since even the most brilliant manager cannot accurately remember the numerous varied transactions that take place every day.

The recorded information also enables verifiability and acts as evidence. Accounting helps calculate profit or loss for a period, by preparing a profit or loss account from the record of incomes and expenses.

It depicts the financial position of the business in the form of its assets and liabilities at the end of every accounting period, through the balance sheet.

Finally, it provides accounting information to its various users, both internal (mainly management, who need timely information on cost of sales and profitability for planning, controlling and decision-making) and external (who have limited authority and resources and must rely on the financial statements).

Accounting information relates to past transactions and is quantitative and financial in nature; it does not provide qualitative and non-financial information, such as the value of human resources, changes in managerial policies, or the quality of staff morale, since these cannot be quantified in money terms.

These limitations of accounting must be kept in view while making use of accounting information.

What new areas do accountants work in today?

Modern accountants increasingly work outside traditional record-keeping, in growth areas such as forensic accounting (investigating crimes like computer hacking and large-scale internet theft of money), e-commerce (designing web-based payment systems), financial planning and environmental accounting.

What makes accounting information decision-useful?

Accounting information is also expected to possess certain qualitative characteristics to be decision-useful: reliability (free from error and bias, verifiable and faithful), relevance (timely, and able to help predict or confirm past evaluations), understandability (interpreted by the receiver in the same sense the sender intended) and comparability (using a common period, unit of measurement and reporting format so that an entity can be compared over time and with other entities).

How can profit and liquidity be shown on a graph?

Draw a line graph with successive accounting periods along the horizontal axis and profit in rupees along the vertical axis. Plot one point for each period's profit and join the points to show whether profit is rising, falling or steady. A rising line shows improving trading results, a falling line shows declining results, and a line that dips below the horizontal axis shows a loss for that period.

Draw a line graph with successive balance sheet dates along the horizontal axis and the amount of liquid assets (cash and near-cash items such as cash at bank) along the vertical axis. Plot the liquid assets held at each date and join the points. If the debts falling due at each date are plotted on the same axes, a liquid assets line that stays well above them shows a comfortable liquidity position, while a falling line warns that the business may find it hard to pay its debts as they become due.

Glossary

• Accounting — the process of identifying, measuring, recording and communicating economic information about an organisation to interested users.
• Book-keeping — the routine, clerical activity of recording business transactions in the books of account in a systematic order.
• Accountancy — the systematic body of knowledge and principles that governs how book-keeping and accounting are carried out.
• Accounting cycle — the sequence from identifying a transaction, through journalising, ledger posting and the trial balance, to the financial statements.
• Transaction — an event involving some value between two or more entities, such as a purchase, receipt or payment.
• Voucher — the documentary evidence, such as a cash memo, invoice or receipt, that supports a transaction.
• Capital — the amount invested by the owner in the firm, shown as a liability towards the owner.
• Fictitious assets — unwritten-off expenses or losses carried forward on the assets side, such as preliminary expenses.
• Contingent liability — a possible obligation that may or may not arise depending on a future uncertain event.
• Stock — goods, spares and other items on hand, including opening stock and closing stock.
• Revenue — the amounts earned by selling goods or providing services, together with other regular receipts such as commission, interest and rent received.
• Income — the money or money's worth received or earned in a period, including revenue and gains.
• Drawings — withdrawal of money or goods by the owner from the business for personal use.
• Personal account — the account of a person or entity treated as a person, debited with the receiver and credited with the giver.
• Nominal account — the account of an expense, loss, income or gain, debited for expenses and losses and credited for incomes and gains.

Common errors and misconceptions

• Misconception: Book-keeping and accounting mean the same thing. Correct: Book-keeping is only the recording stage; accounting also measures, classifies, summarises and communicates the results.
• Misconception: Every item bought for a business is goods traded in. Correct: Only items the business deals in for resale or production are goods traded in; items like furniture bought for office use are assets.
• Misconception: Profit and gain are the same thing. Correct: Profit arises from ordinary trading activity (revenue minus expenses), while gain arises from an incidental event, such as sale of a fixed asset.
• Misconception: All liabilities are owed to outsiders. Correct: Internal liabilities, chiefly the owner's capital, are owed to the owner, while external liabilities are owed to outsiders.
• Misconception: A contingent liability is already a definite debt. Correct: It is only a possible obligation depending on a future uncertain event, so it is disclosed as a note, not shown as an actual liability.
• Misconception: Fixed assets and current assets mean the same thing as tangible and intangible assets. Correct: Fixed/current describes how long the asset is held, while tangible/intangible describes whether the asset has physical existence.
• Misconception: Revenue and income are two names for exactly the same figure. Correct: Revenue is the income from sales and other regular receipts, while income is the wider figure that also includes gains from incidental events.
• Misconception: Every account is debited for the same reason. Correct: Personal accounts are debited with the receiver, real accounts with what comes in, and nominal accounts with expenses and losses.

Exam-style questions with model answers

Q1. Choose the correct option. Which of the following is a nominal account? (Recall) [1 mark]

1. (a) Machinery account
2. (b) Rent account
3. (c) Bank account
4. (d) Capital account
5. Option (b): rent is an expense, and the accounts of expenses, losses, incomes and gains are nominal accounts.

Q2. State the meaning of drawings. [2 marks]

1. Drawings is the withdrawal of money or goods by the owner from the business for personal use.
2. Drawings reduce the investment of the owners in the business.

Q3. Distinguish between revenue and income, giving one example of each. [3 marks]

1. Revenue is the amount earned by selling goods or providing services, together with other regular receipts such as commission, interest and rent received; an example is ₹80,000 earned from sales.
2. Income is the wider amount of money or money's worth received or earned in a period, and it includes revenue as well as gains.
3. A gain, such as ₹5,000 profit on the sale of an old machine, is income but not revenue, because it arises from an event incidental to the business.

Q4. Explain the meaning of book-keeping, accounting and accountancy, and state one difference between book-keeping and accounting. [4 marks]

1. Book-keeping is the routine activity of recording business transactions in the books of account in a systematic and chronological order.
2. Accounting is the wider process of identifying, measuring, recording, classifying, summarising and communicating economic information to users.
3. Accountancy is the body of knowledge and principles that lays down the rules and techniques applied in book-keeping and accounting.
4. Book-keeping is only the recording stage, whereas accounting also interprets and communicates the results to interested users.

Q5. A firm earned revenue of ₹7,00,000 during a year. Its expenses were ₹5,20,000, and it also sold an old machine for ₹60,000 which had cost ₹45,000. Calculate the profit from its ordinary trading activity and the gain on the sale, and state the total income of the period. (Application) [4 marks]

1. Profit from ordinary trading = Revenue − Expenses = ₹7,00,000 − ₹5,20,000 = ₹1,80,000.
2. Gain = Sale proceeds − Cost = ₹60,000 − ₹45,000 = ₹15,000, because the sale of a fixed asset is incidental to the business.
3. Total income of the period = Revenue + Gain = ₹7,00,000 + ₹15,000 = ₹7,15,000.
4. The gain of ₹15,000 is income of an incidental kind and not revenue from sales; together with the trading profit it raises the owner's investment by ₹1,80,000 + ₹15,000 = ₹1,95,000.

Q6. Explain the meaning of financial accounting, cost accounting and management accounting. [6 marks]

1. Financial accounting keeps a systematic record of financial transactions and prepares financial reports to measure organisational success and financial soundness.
2. It relates to the past period, serves the stewardship function and is monetary in nature, providing information to all stakeholders.
3. Cost accounting analyses expenditure to ascertain the cost of products manufactured or services rendered by the firm.
4. It also helps in fixing prices, controlling costs and providing costing information to management for decision-making.
5. Management accounting provides necessary accounting information to people within the organisation for decision-making, planning and controlling business operations.
6. It draws mainly on financial accounting and cost accounting, and also generates future-oriented information such as sales forecasts and cash flows.

Q7. Explain the information needs of any four stakeholders of accounting information. [4 marks]

1. Owners and shareholders use accounting information to see whether they are getting a satisfactory return on their investment and to assess the financial health of the business.
2. Creditors and lenders look particularly at liquidity, the ability of the business to pay its debts as they become due, to judge whether they are likely to be paid.
3. Prospective investors use the information to assess whether or not to invest their money in the business.
4. Customers want information about the continued existence of the business, as an indicator of the likely continuity of supply of products and after-sales service.

Q8. Assertion: A contingent liability is not shown among the actual liabilities in the balance sheet. Reason: It is a possible obligation that depends on the outcome of a future uncertain event. Which option is correct? (Understanding) [1 mark]

1. (a) Both Assertion and Reason are true and Reason is the correct explanation for Assertion.
2. (b) Both Assertion and Reason are true but Reason is not the correct explanation for Assertion.
3. (c) Assertion is true and Reason is false.
4. (d) Both Assertion and Reason are false.
5. Option (a): a contingent liability, such as a pending court case, becomes a definite liability only if the uncertain future event occurs, so until then it is disclosed only as a note.

Key takeaways

• Accounting developed from simple record-keeping in ancient Babylonia, Egypt, Greece, Rome, China and India into today's information system, with Luca Pacioli's 1494 book spreading knowledge of double entry.
• Book-keeping is the clerical recording of transactions; accounting also measures, classifies, summarises and communicates the results; accountancy is the body of principles that governs both.
• The accounting cycle runs from identifying transactions, through journalising and ledger posting, to the trial balance and the financial statements.
• Accounts are personal, real or nominal; personal accounts are debited with the receiver, real accounts with what comes in, and nominal accounts with expenses and losses.
• Assets can be tangible, intangible, fixed, current, liquid, wasting or fictitious; liabilities can be internal or external, and external liabilities can be current, long-term or contingent.
• Profit is revenue less expenses from ordinary trading; gain arises from incidental events; loss is the opposite of profit or money lost without benefit.
• Revenue is the income earned from sales and other regular receipts, while income is the wider figure that also includes gains from incidental events.
• Internal users include management and staff; external users include investors, creditors, the government, regulators and customers, each needing different information.
• Financial accounting records the past and reports to all stakeholders; cost accounting ascertains and controls costs; management accounting supports internal planning and decisions.

Test yourself

Who is credited with the first printed description of double entry book-keeping, and in which book?

Luca Pacioli, a Franciscan friar, in his 1494 Venice book Summa de Arithmetica, Geometria, Proportioni et Proportionalita.

What is the main difference between book-keeping and accounting?

Book-keeping is the routine recording of transactions, while accounting also measures, classifies, summarises and communicates the resulting information to users.

Give one example each of an internal event and an external event.

Internal: supply of raw material by the stores department to the manufacturing department. External: sale of merchandise to customers.

What type of asset is goodwill, and why?

Goodwill is an intangible asset, because it has value to the business but no physical existence that can be seen or touched.

How is a contingent liability shown in the accounts?

It is disclosed only as a note to the balance sheet, not shown among the actual liabilities, since it depends on an uncertain future event.

Name the three sub-categories of stock in a manufacturing concern.

Raw material, work in progress and finished goods.

State the rule applied to a real account.

Debit what comes in and credit what goes out, because real accounts are the accounts of assets and properties such as cash, machinery and furniture.

Name the three main specialised fields of accounting.

Financial accounting, cost accounting and management accounting.