In this earth, every resource is scarce. The scarcity of resources gave birth to the needs that resources must be kept in safe custody and properly accounted for. Accounting came in the picture when the business community understood the requirement of an accounting framework to cater to the above need.
Accounting is an art of recording, classifying, summarizing and presenting financial transaction in a formal manner to serve the needs of the user of the accounting information. Over the time GAAP (Generally accepted accounting principle) was formed and accounting standards like IFRS, IND AS, IAS etc. were issued to develop a solid accounting framework. Accounting is focused on recording a business transaction with a view to prepare financial statements in accordance with the applicable financial reporting framework and regulatory framework. A financial statement prepared in accordance with GAAP shows the profit or loss during a period and the situation of assets and liabilities at a certain date.
Basic understanding of Accountancy
To gain the basic understanding of Accountancy, we must look around and notice that on a daily basis, multiple incidents are happening. These incidents are called events. Events can be classified into two segments namely financial events and non-financial events. In financial events, money is involved and on the other hand, non-financial events are those in which money is not involved. Financial events are also known as a transaction.
In accounting, an accountant only focuses on transactions. Financial transaction means the transaction of financial instruments, other assets, goods, services which can be measured in money. In other words, any transactions which cannot be measured in money will not come under the consideration of an accountant.
The accountant initially records financial transactions in a systematic form knows as the journal entry. Journal entries are recorded by the accountant for a specified duration, for example, one year. A journal entry comprises two accounts. One account is debited and another account is credited with the transaction value. Which account will be debited and which one will be credited depends upon the nature of the accounts involved in the transaction and the nature of the transaction as well. For better understanding, we will need to know the classifications of accounts. As per American approach, Accounts are broadly classified into three categories,
First three class of accounts have credit nature. It means that when any transaction occurs which increases capital or liabilities or income then the accounts of these classes will be credited. If any transaction leads to a decrease in the capital or income or liabilities then the accounts in those classes will be debited. On the other hand, assets and expenses have debit nature which means an increase in those accounts will be debited and decrease will be credited.
A journal entry is recorded in the following format-
X A/C…………..Dr. ****
To Y A/C ****
(Narration for the journal entry.)
After recording the journals as per above format, it is posted into ledgers of various accounts like the ledger of X A/C and Y A/C. After posting journal entries to appropriate ledgers, ledgers are closed and balance of the ledger accounts are calculated. Ledger balance pertaining to Income and expenses are transferred to profit and loss accounts to find out profit or loss. On the other hand, balances of the asset account, liability account, capital account, and profit or loss arrived in profit & loss account are transferred to the Balance Sheet.
Before transferring closing balances of the various ledger to Profit & Loss account and Balance Sheet, an accountant prepares a Trial Balance to verify the arithmetical accuracy of the transactions recorded. It may be noted that an agreed Trial Balance does not guarantee that accounting is completely free from errors. Many errors, for example, an omission of an entry, also produce an agreed Trial Balance.
Financial statements of an Entity are largely used by stakeholders like Owner, shareholder, creditors, Government, Management of the entity etc. for numerous purposes. A complete set of financial statement generally comprises of following items,
- Profit & Loss Account
- Balance Sheet
- Cash Flow
- Notes to accounts
- Statement of changes in equity
In India, financial statements are prepared in accordance with Accounting standards and Indian accounting standards (Indian version of IFRS) mandated by Central Government in consultation with Institute of Chartered Accountants Of India.
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