Chapter 1: Introduction to Accounting

1.1 Accounting

Accounting is an art of identifying, classifying, recording, summarizing, analyzing and reporting the financial transactions of a business. It enables stakeholders to make decisions, shows profitability and financial health of the organizations, and helps stay compliant with regulations.

Bookkeeping focuses on identifying, classifying and recording transactions. Accounting focuses on summarizing, analyzing and reporting financial information. Finance focuses on planning and strategy.

1.2 Accounts Department

In small businesses, the entire accounting may be outsourced to an accountancy firm or a single accountant may manage the entire bookkeeping and accounting. But as organizations grow in size and complexity, the accounting department also grows.

In mid-sized organizations you may see an Accounts Payable team, Accounts Receivable team, Payroll team managed by an Accounts Manager.

In large organizations, there is a CFO and Controller and additional specialized teams like FP&A (Financial Planning and Analysis).

1.3 Accounting Standards

Accounting standards enforce consistency and comparability enabling stakeholders to make informed decisions.

In U.S organizations comply with GAAP (Generally Accepted Accounting Standards) and in other countries organizations comply with IFRS (International Financial Reporting Standards).

Large Indian organizations are required to comply with Ind AS (Indian Accounting Standards). Ind AS is an adaptation of IFRS for India. For profit organizations in India are required to comply with Income Tax Act, 1961and Companies Act, 2013

1.4 Assets, Liabilities and Equity

Asset: Asset is what you own. Cash in hand, balance in your bank account are your assets. Assets are mainly classified into fixed assets(like furniture, machines, buildings) and current assets(cash, bank balance, stock etc).

The money that your customer owes you is also an asset.

Liability: Liability is what you owe. If you got a loan from a bank that’s a liability. Liabilities are mainly classified into Current liabilities(short term) and long term liabilities.

If you received a product or service from a supplier and you are yet to pay him, that’s a liability.

Equity: When you register a business, you and your business are recognized as two separate legal entities. When you invest $20k, the business you registered owes you that $20k. If you decide to close this business immediately after the registration the business is expected to return you the $20k you invested. (Equity is a special type of liability.)

1.5 Income and Expense

Income: In a business, you earn in many different ways. They can be mainly categorized into two groups. Direct and Indirect. When you sell your product or service to your customer, you earn direct income. The interest you earn on fixed deposit or the income earned when you sell a fixed asset like old furniture or computer is indirect income.

Expense: Your business will incur many types of expenses. They can be mainly categorized into two groups. Direct and Indirect. Let’s say you bought an item for $100 and sold it for $200, so the direct expense is $100. Money spent on your office rent, electricity etc is an indirect expense.

1.6 Stakeholders

There are many stakeholders who consume the financial statements prepared by the accounting team.

1. Management
2. Shareholders
3. Analysts and Investors
4. Creditors
5. Lenders
6. Regulators
7. Employee unions
8. Customers