Accounting is the process of recording, classifying, and summarizing financial transactions to provide information that is useful in making business decisions. It involves the systematic collection, recording, and analysis of financial data, such as income, expenses, and assets, in order to produce financial statements, such as balance sheets, income statements, and cash flow statements. These statements provide information on a company's financial performance, liquidity, and solvency. Accounting also includes the development and use of internal controls to ensure the accuracy and reliability of financial information, as well as compliance with legal and regulatory requirements.
Importance of accounting
Accounting is important for a variety of reasons, including:
- Decision Making: Accounting provides financial information that is essential for making informed business decisions. By analyzing financial statements, managers and investors can identify areas of strength and weakness, and make informed decisions about how to allocate resources and manage risks.
- Compliance: Accounting helps organizations comply with legal and regulatory requirements, such as filing tax returns and financial statements with government agencies.
- Planning and Budgeting: Accounting is an essential tool for planning and budgeting. By analyzing past financial performance and projecting future results, organizations can create budgets and financial plans that align with their strategic goals.
- Performance Evaluation: Accounting provides a means of evaluating the performance of a business or organization. Financial statements such as income statement and balance sheet are used to measure a company's financial performance over a period of time.
- Communication: Accounting is also a means of communication between the organization and its stakeholders. Financial statements are used to communicate an organization's financial position and performance to investors, creditors, and other interested parties.
- Risk Management: Accounting information can be used to identify and manage financial risks. Organizations can use financial statements to identify potential problem areas and take steps to mitigate risks.
- Cost Control: Accounting helps organizations control costs by providing information on income and expenses. This information can be used to identify areas where costs can be reduced, and to develop strategies for controlling costs.
What are the important rules of accounting
The important rules of accounting are generally referred to as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) depending on the country or region. These rules provide a framework for the preparation of financial statements and ensure that they are comparable, consistent, and reliable. Some of the important rules of accounting include:
- The accrual principle, which states that financial transactions should be recorded when they occur, not when payment is made or received.
- The consistency principle, which states that a company should use the same accounting methods from period to period, in order to provide accurate and comparable financial statements.
- The prudence principle, which states that when there is doubt about the treatment of a transaction, it should be recorded in a way that is conservative and does not overstate assets or income.
- The going concern principle, which states that a company should continue to operate for the foreseeable future, and that its financial statements should be prepared on that assumption.
- The materiality principle, which states that information that is not significant to the overall financial statements should not be included.
- The cost principle, which states that assets should be recorded at their original cost, and not at their current market value.
- The revenue recognition principle, which states that revenue should be recognized when it is earned, regardless of when payment is received.
- The matching principle, which states that expenses should be matched with the related revenue in the same period.
- The full disclosure principle, which requires that all material information relevant to the financial statements should be disclosed in the notes to the financial statements.
- The objectivity principle, which requires that accounting information should be based on objective evidence, rather than subjective judgment.
Types of Accounting
There are three types of accounts:
1. Personal Accounts
Personal accounts are accounts that are related to individuals, such as customers, suppliers, and employees. These accounts track transactions between the organization and the individual, such as sales, purchases, and wages. Personal accounts are classified as either debit or credit depending on the nature of the transactions.
Golden Rule of Personal Accounts: Debit the receiver and Credit the giver
Example:
Mr. Shyam took cash of Rs.20,000/- from bank for personal use
Drawing A/c Debit the receiver
To Cash A/c Credit what goes out.
Narration: Being cash withdrawn from bank.
2. Real Accounts
Real accounts are accounts that represent assets, liabilities and equity of a business. Real accounts are also known as permanent accounts because their balances are carried forward to the next accounting period. Examples of real accounts are Cash, Accounts Receivable, Accounts Payable, Buildings, Equipment, etc.
Golden Rule of Real Accounts: Debit what’s come in and Credit what goes out.
Examples
Mr. A purchased furniture of Rs.15,000/- for cash.
Furniture A/c Debit what’s come in
To Cash A/c Credit what goes out
Narration: Furniture purchase for cash.
3. Nominal Accounts
Nominal accounts are accounts that represent income, expenses, and gains or losses of a business. Nominal accounts are also known as temporary accounts because their balances are closed at the end of each accounting period. Examples of nominal accounts are Sales, Purchases, Rent, Salaries, etc.
Golden Rule of Nominal Accounts: Debit all expenses & losses and Credit all income’s & gain’s.
Examples
Salary amounting Rs.8,000/- was paid to Mr. B in cash.
Salary A/c Debit all expenses & losses.
To Cash A/c Credit what goes out.
Narration: Being salary paid in cash.
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