Introduction to Accounting Class 11 Notes

Accounting is the process of identifying, measuring, recording, classifying, summarising and communicating economic information so that users can make decisions. It is called the language of business because every business transaction, reduced to debit and credit, is expressed through it.Its role in business is threefold: to show the firm's financial position at a point in time, to show profit or loss over a period, and to disclose the full picture honestly so that no user is misled.

• Recording: every transaction entered in chronological order as a debit and a credit.
• Classifying: entries grouped into assets, liabilities, capital, revenue, expense and the rest.
• Summarising: totals compiled into a trial balance, a trading account and a balance sheet.
• Reporting: the final statements handed to users to support a decision.

The advantages are replacement of memory and arithmetic, a legal record for taxation and a defence in court, a ready means of knowing the exact position, comparison of profit with past years, and a basis for planning. The limitations follow directly from the cost involved.

• Only financial information is recorded — the efficient manager, the honest clerk and the loyal worker never appear in the books.
• The figures are historical, not predictive; they describe what happened, never what will happen.
• Accounting is expensive, so small firms may keep only a partial set of books.
• It is based on the cost principle, so assets are shown at cost less depreciation rather than at current market value.
• It assumes the going concern, so a firm about to close shows its books as though it continues.

Users are classified by the standing they have in relation to the business, and each group wants a different thing from the same set of books. Naming the group and its need is a reliable 2-mark question.

• Internal users — owners or managers: profitability, liquidity, solvency and the value of the business.
• External users — lenders and creditors: the firm's ability to repay interest and principal when due.
• External users — the government: tax liability, licensing and national income accounting.
• External users — investors and shareholders: earnings per share, growth, liquidity and the management's stewardship.
• External users — employees, suppliers and customers: job security, continuity of supply and the stability of the business.
• External users — creditors: additional security when the firm wants to raise loans.

Every transaction in the life of a business leaves the accounting equation in balance. This single identity, built from the terms defined below, is the reason a balanced trial balance is possible and it is the backbone of Chapters 3 and 4.

• Entity: the business is separate from its owner, so the owner's personal drawings are not a business expense.
• Business transaction: an event that changes the firm's assets, liabilities, capital or income, and therefore the equation.
• Capital: the owner's residual interest in the assets after deducting liabilities.
• Drawings: goods or cash withdrawn by the owner for personal use. They reduce capital and are never an expense.
• Asset: a resource controlled by the business from which future economic benefit is expected.
• Non-current assets: held for more than one year, used in producing goods or services, or of lasting use — plant, machinery, land, buildings, patents, goodwill.
• Current assets: held for sale or consumed in the operating cycle, typically convertible into cash within a year — cash, debtors, stock, prepaid expenses, accrued income.
• Liability: an obligation owed to outsiders. Non-current liabilities fall due after more than a year; current liabilities fall due within one year.
• Current liability examples: creditors, bills payable, bank overdraft, outstanding expenses, income received in advance and short-term loans.

The terms that decide where a cost is placed are the most heavily examined part of this chapter. Capital expenditure gives a benefit beyond the current year; revenue expenditure does not. The rule is about the benefit period, never about the amount.

• Expenditure: a payment made for an asset or service. It is capital when the benefit lasts beyond one accounting year, and revenue when the benefit is confined to the current year.
• Revenue: income earned from the main operations of the business — sales of goods and rendering of services.
• Income: anything that increases capital. Revenue is a subset of income, so a gain on the sale of an asset is income but not revenue.
• Expense: any cost incurred to earn revenue in the current period.
• Profit: the excess of revenue over expenses for a period. Loss is the reverse.
• Gain: income from a source other than the main operations, such as profit on the sale of a fixed asset.
• Purchase: buying goods for resale. Sales: the quantity of goods sold, not the cash received. Purchase returns and sales returns reduce them respectively.
• Goods and stock: goods bought for resale, and the unsold portion held at the closing date.
• Debtor: a person from whom goods or services have been sold on credit. Creditor: a person to whom goods or services have been bought on credit.
• Voucher: the document prepared from the source document that authorises and records an entry in the books.
• Trade discount: a discount allowed on the list price, recorded only in the memorandum column, so neither the purchase nor the sale is recorded. The ledger is entered net of the discount.
• Cash discount: a discount allowed for prompt payment. It is an expense of the seller and income of the buyer.