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Chapter 1 Accounting information for decision making Definition of accounting: The American Institute of Certified Public Accountants (AICPA) has defined the financial accounting as, the art of recording, classifying, and summarizing in the significant manner in term of money transaction and event which is part, at least of financial character and interpreting the result thereof. American accounting association (AAA) defines accounting as, the process of identifying, measuring and communicating economic information to permit informed judgment and by user of the information" Thus account may be defined as the process of recording. classifying. summarizing, analyzing and interpreting the financial transaction and communicating the result thereof to the persons interested in such information An analysis of the definition brings out the following functions of accounting: Recording:- This is the basic function of accounting. It is essentially concerned with not only insuring that all business transaction of financial character are in fact recorded but also that they are recorded in the orderly manner. Recording is done in the book 'Journal Classifying - Classification is concerned with the systematic analysis of the recorded data, with a view to group transaction or entries of one nature at one place. The work of classification is done in the book of 'Ledger". This book contains on different pages individual account heads under which all financial transaction of similar nature are collected. For example, all expenses under these heads for travelling expenses, printing and stationary, advertising etc. Summarizing: This involves presenting the financial data in a manner which is understandable and useful to the internal as well as external end-users of accounting statements. This process leads to the preparation of the following statement; Trial Balance, (i) Income statement and (ii) Balance Sheet. Dealing with financial transaction:- Accounting records only those transactions and events in term of money which are of a financial character. Transactions which are not a financial character are not recorded in the book of account. For example, Company has got a team of dedicated and trusted employees, it is of great use to the business but since it is not of a financial character and not capable of being expressed in term of money, it will not be recorded in the book of account Analyzing and interpreting- This is the final function of accounting. The recorded financial data is analyzed and interpreted in a manner that the end-users can make a meaningful judgment about the financial condition and profitability of the business operations. Communicating: - The accounting information after being meaningfully analyzed and interpreted has to be communicated in a proper form and manner to the proper person. This is done through preparation and distribution of accounting report, which include beside the usual Income Statement and the Balance Sheet. Basic Terms of accounting Basic Accounting Terms: - Every subject has gor its own terminology. Account also, as a subject has got its own terms. These terms have their specific meaning in accounting and use to express financial nature of the business, Special feature of Business transaction are:- Business transaction must be financial in nature. Business transaction must be supported by documentary evidence Business transaction must be presented in numerical monetary terms. Business: It is an activity which involves exchange of goods and services with the intention of earning profit. 2. Transaction: Transaction is a financial event of a nature that is entered in to by the parties and is recorded in the book of accounts 1. Assets: Assets refers to any properties or things owned by the business concern including the amount due to it form others. Examples: Cash, Furniture, Machines, Buildings, Money owned by the debtors, Stock of goods etc. Assets can be classified as follows: Fixed Assets: Land and building, Plant and Machinery, Furniture and Equipments. i. Current Assets: Stock (Inventory), Debtors, Cash, Prepaid Expanses etc. Intangible Assets: Goodwill, Trade Mark, Patents. Liabilities: It means the amount which the business owes to outsiders. Liabilities can be classified as follows: Long term Liabilities: Long term loans, Debentures etc. ii. Current Liabilities: Creditors, Bank overdraft, Bills payables, Short term loans, uneared revenue. $ Capital or Owners Equity: Capital means the amount which the proprietor has invested in the business towards the owner and can claim for it. For form, it is a liability. 6 Expenses: It is the amount spent in order to produce and sell the goods and services which produce the revenue. (Payment of salaries, wages, rent, insurance, depreciations, bad debts ) 7. Revenue: It is refer to the earning of the business. (Receipts from sale of goods, rent receive, commissions receive, discounts receive etc.) Some other terms: Debtor: A person who owes money to the firm generally on account of credit sale of goods is called debtors. In other words "The term "debtors' represents the persons or parties who have purchased goods on credit from us and have not paid for the goods sold to them. They still owe to the business. For example, if goods worth $ 20,000 have been call to Ali he will of the Some other terms: Debtor: A person who owes money to the firm generally on account of credit sale of goods is called debtors. In other words "The term "debtors' represents the persons or parties who have purchased goods on credit from us and have not paid for the goods sold to them. They still owe to the business. For example, if goods worth $ 20,000 have been sold to Ali, he will continue to remain the debtors of the business so for he does not make the full payment. In case, he makes a payment of S 16,000, he will remain to be debtor for $ 20,000- 16,000 - 4,000 Creditors: A person to whom a firm owes money is involved on account of credit purchase of goods is called creditor. In addition to cash purchases the firm has to make credit purchase also. The sellers of goods on credit to the firm are known as its creditors for goods. Creditors for liability of the business. They will continue to remain the creditors of the firm so for the full payment is not made to them. Liability to creditors will reduce with the payment made to them. Stock: The goods available with the business for sale on a particular date is termed as stock. In the case of manufacturing enterprises stock is classified as :- Stock of raw material. Raw material required for manufacturing of product in which the business deals is known as stock of raw material. Cotton in the case of cotton mill is its example, Stock of work in progress. It is the stock of partly finished and partly manufactured goods just as price of thread and unfinished cloth in the case of cotton mill. Stock of finished goods. Manufactured and ready goods for sale are known as finished goods. Finished cloth is its example. - Goods: This is the products in which a business unit is dealing Purchase: When the goods are bought for resale or for the producing Finished product (new product) Sale: This term is used for the sale of only those goods deal by the firm. Profit: It is a surplus of revenues over its expenses. Profit is normally categorized inte; . Gross profit: It is a difference between sale revenue and cost of goods sold. Net Profit: Net profit is the profit made after allowing all expenses (also other than business) Loss: It means expenses are excess than revenue. Drawing: It is the amount of money or the value of goods which the proprietor takes for his personal use. - Proprietor: The owner of the business is called proprietor. Assignment: (Explain in your own words) 1. What information should be included in the heading of each of the financial statements? 2. Briefly explain the difference between net income and net loss. 3. What are the purposes of (a) the balances sheet, (b) the income statement, (c) the statement of retained earnings. (d) the statement of cash flows? 4. Show the income statement equation define each element. 5. Distinguish between financial accounting and managerial accounting