History of Accounting & The first Accounting Textbook

 Every new invention and technology has its own History. 

Accounting is a science as well as an art. This beautiful and scientific method of Accounting has made the business to track its position ranging from normal grocery shop owner to the largest business tycoons like Tata's, Birla's, Reliance. 

Have you ever tried to go to the flashback, to know from where and how the Accounting system started?

This information is dedicated to all the Chartered Accountants, to all the Accountants, to all the Book-Keepers, who are engaged in this profession throughout their life. Lets dive into the History of Accounting.

History of Accounting

The Accounting system that we use today had its beginning in systems used by merchants in Venice over 500 years ago.

Generally, historians agree that the Renaissance period began in what we now call Italy during the late 1200s AD. The Renaissance was well established by 1450. It saw a huge increase in trade with some merchants becoming very wealthy. Some merchants lent money even to the Kings. This rapid increase in trade and wealth led to the development of early banking systems. The city state of Venice went even further, developing an Accounting system to record complex financial dealings.

Most common accountants today regard the Franciscan friar and mathematician Luca Pacioli (1446-1517) as the 'Father of Accounting'. Pacioli did not claimed to have invented the accounting system as such, but he did represented the system in a way that others could easily understand.

First Accounting Textbook

Pacioli's most important manuscript was the 5 section book (translated into English) The collected knowledge of arithmetic, geometry, proportion and proportionality. The book was published in 1494, about the same time when Columbus discovered America. This book by Pacioli was one of the earliest books printed on the Gutenberg press.

This is how it all started for Pacioli, Guidobaldoda Montefeltro (1472-1508), the wealthy Duke of Urbino, asked Pacioli to help him manage his financial affairs. Pacioli did so, and was the first person to codify and publish the Venetian accounting system.

For the next century, The collected knowledge of arithmetic, geometry, proportion and proportionality was the only accounting textbook available. Most of the principles, processes and concepts described in this book have been adopted by accountants till today. These processes and concepts include the:

• accounting cycle
• use of journals and ledgers
• duality of financial transactions (debit equals credits or double entry book keeping)
• formation of accounting groups: Assets, Liabilities, Owner's Equity, Income, Revenue, Expenses
• year-end closing entries
• the trial balance, which Pacioli believed should be used to prove a balance ledger

The system Pacioli described in his book has become known as ' double-entry accounting' system

The first Accounting Textbook

Accounting Concepts (Part 2)

As we have already discussed the first three accounting concepts in Part 1. We will now be discussing the remaining accounting concepts in detail.

Going Concern Concept

Accounting assumes that the business entity will continue to operate for a long time in the future unless there is good evidence to the contrary. The enterprise is viewed as a going concern, that is, as continuing in operations, at least in the foreseeable future. In other words, there is neither the intention nor the necessity to liquidate the particular business venture in the predictable future. Because of this assumption the accountant while valuing the assets does not take into account forced sale value of them. In fact, the assumption that the business is not expected to be liquidated in the foreseeable future establishes the basis for many of the valuations and allocations in accounting. For example, the accountant charges depreciation on fixed assets. It is this assumption which underlies the decision of the investors to commit capital to enterprise. Only on the basis of this assumption accounting process can remain stable and achieve the objective of correctly reporting and recording on the capital invested, the efficiency of the management, and the position of the enterprise as a going concern.

However, if the accountant has good reasons to believe that the business, or some part of it is going to be liquidated or that it will cease to operate (say within six month or a year), then the resources could be reported at their current values. If this concept is not followed, International Accounting Standard requires the disclosure of the fact in the financial statements together with reasons.

Accounting Period Concept

This concept requires that the life of the business should be divided into appropriate segments for studying the financial results shown by the enterprise after each segment. Although the results of operations of a specific enterprise can be known precisely only after the business has ceased to operate, its assets have been sold off and liabilities paid off, the knowledge of the results periodically is also necessary. Those who are interested in the operating results of the business obviously cannot wait till the end. The requirements of these parties force the businessman 'to stop' and 'see back' how things are going on. Thus, the accountant must report for the changes in the wealth of the firm for short time periods. A year is the most common interval on account of prevailing practice, tradition and government requirements. Some firms adopt financial year of the government, some other calendar year. Although a twelve month period is adopted for external reporting, a shorter span of interval, say one month or three month is applied for internal reporting purposes.

This concept poses difficulty for the process of allocation of long term costs. All the revenues and all the cost relating to the year in operation have to be taken into account while matching the earnings and the cost of those earnings for the any accounting period. This holds good irrespective of whether or not they have been received in cash or paid in cash. Despite the difficulties which stem from this concept, short term reports are of vital importance to owners, management, creditors and other interested parties. Hence, the accountants have no option but to resolve such difficulties.

Cost Concept

The term 'assets' denotes the resources land building, machinery etc. owned by a business. The money values that are assigned to assets are derived from the cost concept. According to this concept an asset is ordinarily entered on the accounting records at the price paid to acquire it. For example, if a business buys a plant for Rs. 5 lakh the asset would be recorded in the books at Rs. 5 lakh, even if its market value at that time happens to be Rs 6 lakh. Thus, assets are recorded at their original purchase price and this cost is the basis for all subsequent accounting for the business. The assets shown in the financial statements do not necessarily indicate their present market values. The term 'book value' is used for amount shown in the accounting records.

The cost concept does not mean that all the assets remain on accounting records at their original cost for all times to come. The asset may systematically be reduced in its value by charging 'depreciation'. Depreciation has the effect of reducing profit of each period. The prime purpose of depreciation is to allocate the cost of an asset over its useful life and not to adjust its cost. However, a balance sheet based on this concept can be very misleading as it shows assets at cost even when there are wide differences between their cost and market values. Despite these limitations cost concept will meet the three basic norms of relevance, objectivity and feasibility.

The Matching Concept

This concept is based on the accounting period concept. In reality we match revenues and expenses during the accounting periods. Matching is the entire process of periodic earning measurement, often described as a process of matching expenses with revenues. In other words, income made by the enterprise during a period can be measured only when a revenue earned during a period is compared with the expenditure incurred for earning that revenue. Broadly speaking revenue is the total amount realised from the sale of goods or provision of services together with earnings from interest, dividend and other items of income. Expenses are cost incurred in connection with the earnings of revenues. Costs incurred do not become expenses until the goods or services in question are exchanged. Cost is not synonymous with expense since expense is sacrifice made, resources consumed in relation to revenues earned during an accounting period. Only costs that have been expired during the accounting period are considered as expenses. For example, if a commission is paid in January 2020 for services enjoyed in November, 2019, that commission should be taken as the cost for services rendered in November 2019. On account of this concept, adjustments are made for all prepaid expenses, outstanding expenses, accrued income etc while preparing periodic reports.

Accrual Concept

It is generally accepted in accounting that the basis of reporting income is accrual. Accrual concept makes a distinction between the receipt of cash and the right to receive it, and the payment of cash and the legal obligation to pay it. This concept provides a guidelines to the accountant as to how he should treat the cash receipts and the related thereto. Accrual principles tries to evaluate every transaction in terms of its impact on the owner's equity. The essence of the accrual concept is that net income arises from events that change the owner's equity in a specified period and that these are not necessarily the same as change in the cash position of the business. Thus, it helps in proper measurement of income.

Realisation Concept

Realisation is actually understood as the process of converting non-cash resources and rights into money. As accounting principle, it is used to identify precisely the amount of revenue to be recognised and the amount of expenses to be matched to such revenue for the purpose of income measurement. According to realisation concept, revenue is recognised when sale is made. Sale is considered to be made at the point when the property in goods passes to the buyer and he becomes legally liable to pay. This implies that revenue is generally realised when goods are delivered or services are rendered. The rationale is that delivery validates a claim against the customer. However, in case of long run construction contracts revenue is often recognised on the basis of a proportionate or partial completion method. Similarly, in case of long run installment sales contacts, revenue is regarded as realised only in proprtion to the actual cash collection. In fact, both these cases are the exceptions to the notion that an exhange is needed to justify the realisation of revenue. 

Accounting Concepts (Part 1)

Accounting is often called as the language of the business. Accounting to become intelligible and commonly understood language, if it is based on certain Accounting Principles, Concepts and Conventions.

Let us study the Accounting Concepts:

Separate Business Entity Concept:

In Accounting we make a distinction between business and the owner. All the books of accounts records day to day business transactions from the view point of the business rather than from that of the owner. The proprietor is considered a creditor to the extent of the capital bought in the business by him. For instance, when a person invests Rs. 10 lakh into a business, it will be treated that the business has borrowed that much money from the owner and it will shown as a 'liability' in the books of accounts of the business. Similarly, if the owner of the shop were to take cash from the cash box for meeting certain personal expenditure, the accounts would show that cash had been reduced even though it does not make any difference to the owner himself. Thus, in recording a transaction the important question is how does it affects the business? For example, if the owner puts cash into the business, he has a claim against the business for capital brought in.

In so-far as a limited company is concerned, this distinction can be easily maintained because a company has a legal entity like a natural person it can engage itself on economic activities of buying, selling, producing, lending, borrowing and consuming goods and services. However, it is difficult to show this distinction in the case of sole proprietorship and partnership. Nevertheless, accounting still maintains separation of business and owner. It may be noted that it is only for the accounting purpose that partnership and sole proprietorship are treated as separate from the owner, though law does not make such distinction. In fact, the business entity concept is applied to make it possible for the owners to assess the performance of their business and performance of those who manage the enterprise. 

Money Measurement Concept:

In Accounting, only those business transactions are recorded which can be expressed in terms of money. In other words, a fact or transaction or happening which cannot be expressed in terms of money is not recorded in the accounting books. As money is accepted not only as a medium of exchange but also as a store of value. It has a very important advantage since a number of assets and equities, which are otherwise different, can be measured and expressed in terms of common denominator.

We must understand that this concept imposes two severe limitations. Firstly, there are several facts which are very important to the business, cannot be recorded in the books of accounts because they cannot be expressed in terms of money. For example, general health condition of the Managing Director of the company, working conditions in which a worker has to work, sales policy pursued by the enterprise, quality of product introduced by the enterprise, all these factors exert a great influence on the productivity and profitability of the enterprise. You will agree that all this reasons have a bearing on the future profitability of the business.

Secondly, use of money implies that we assume stable or constant value of rupee. Taking the assumptions means that the changes in the money value in future dates are conveniently ignored. For example, a piece of land purchased in 1990 for Rs. 2 lakh and another bought for the same amount in 1998 are recorded at the same price, although the first purchased in 1990 may be worth 2 times higher than the value recorded in the books because of rise in land prices. In fact, most accountants knows fully well that purchasing power of rupee does change but very few recognize this fact in accounting books and make allowance for changing price level.

Dual Aspect Concept:

Financial Accounting records all the transactions and events involving financial element. Each of such transactions requires two aspects to be recorded. The recognition of these two aspects of every transaction is known as a dual aspect analysis. According to this concept every business transactions has dual effect. For example, if a firm sells goods of Rs. 5000 this transaction involves two aspects. One aspect is the delivery of goods and the other aspect is immediate receipt of cash (in case of cash sales). In fact, the term 'double entry' book keeping has come into vogue and in this system the total amount debited always equals the total amount credited. It follows from 'dual aspect concept' that at any point of time owners' equity and liabilities for any accounting entity will be equal to assets owned by that entity. This idea is fundamental to accounting and could be expressed as the following: 

Assets= Liabilities+ Owners equity

Owners equity= Assets- Liabilities 

The above relationship is known as "Accounting Equation".  The term 'owners equity' denotes the resources supplied by the owners of the entity, while the term 'liabilities' denotes the claim of the outside parties such as creditors, debenture-holders, bank against the assets of the business. 'Assets' are the resources owned by a business. The total of the assets will be equal to the total of the liabilities plus owners capital because all assets of the business are claimed by either owners or outsiders.

Types of Accounting

The financial literature classifies accounting into two broad categories, viz, Financial Accounting and Management Accounting. Financial Accounting is primarily concerned with the preparation of financial statements whereas Management Accounting covers areas such as interpretation of financial statements, cost accounting, etc. Both these types of Accounting are studied in detail in the following paragraphs.

Financial Accounting:

As mentioned earlier, financial accounting deals with the preparation of the financial statements for the basic purpose of providing information to various interested groups like creditors, banks, shareholders, financial institutions, government, consumers etc. Financial statements, i.e. the income statement and the balance sheet indicate the way in which the activities of the business have been conducted during a given period of time.

Financial Accounting is charged with the primary responsibility of external reporting. The users of information generated by financial accounting, like bankers, financial institutions, regulatory authorities, government, investors, etc. want the accounting information to be consistent so as to facilitate comparison. Therefore, financial accounting is based on certain concepts and conventions.

The significance of financial accounting lies in the fact that it aids the management in directing and controlling the activities of the firm and to frame relevant managerial policies related to areas like production, sales, financing, etc. However, it results from certain drawbacks which are:

• The information provided by financial accounting is consolidated in nature. It does not include break-up for different departments, processes, products and jobs. As such, it becomes difficult to evaluate the performance of different sub-units of the organisation.

• Financial Accounting does not help in knowing the cost behavior as it does not distinguish between fixed cost and variable cost.

• The information provided by financial accounting is historical in nature and as such the predictability of such information is limited.

The management of a company has to solve certain ticklish questions like expansion of business, making or buying a component, adding or deleting a product line, deciding on alternative methods of production, etc. The financial accounting information is of little help in answering these questions.

The limitations of financial accounting, however, should not lead one to believe that it is of no use. It is the basic foundation on which other branches and tools of accounting analysis are based. It is the source of information, which can be further analysed and interpreted according to the tailor-made requirements of the decision makers.

Management Accounting:

Management Accounting is tailor made accounting. It facilitates the management by providing accounting information in such a way so that it is conducive for policy making and running the day to day operations of the business. Its basic purpose is to communicate the facts according to the specific needs of decision makers by presenting the information in a systematic manner. Management Accounting, therefore specifically helps in planning and control. It helps in setting standards and in case of variances between planned and actual performances, it helps in deciding the corrective actions.

An important characteristic of Management Accounting is that it is forward looking. Its basic focus is one future activity to be performed and not what has already happened in the past.

Since Management Accounting caters to the specific decision needs, it does not rest upon well defined and set principles. The reports generated by the management accountant can be of any duration short or long, depending on the purpose. Further, the reports can be prepared for the organization as a whole as well as its segments.

Cost Accounting:

One important variant of management accounting is the cost analysis. Cost accounting makes elaborate cost records regarding various products, operations and functions. It is the process of determining and accumulating the cost of a particular product or activity. Any product, function, job or process for which costs are determined and interpreted are called Cost Centres.

 The basic purpose of cost accounting is to provide detailed break up of cost of different departments, processes, jobs, products, sales, territories etc, so that the effective cost control can be exercised.

Cost accounting also helps in making revenue decisions such as those related to pricing, product-mix, profit volume decisions, expansion of business, replacement decisions, etc.

The objectives of cost accounting can therefore be summarized in the form of 3 important statements, viz., to determine costs, to facilitate planning and control of business activities and to supply information for short and long term decision. Cost accounting has certain distinct advantages over financial accounting. The cost accounting system provides data about profitable and non-profitable products and activities, thus prompting corrective measures. It is easier to segregate and analyse individual cost items and to minimize losses and wastage arising from the manufacturing process. Production method can be varied so as to minimize the cost and increase profits. Cost accounting help in making realistic pricing decisions in times of low demand, competitive conditions, technology changes etc.

Various alternative courses of action can be properly evaluated with the help of data generated by cost accounting. It would not be an exaggeration if it is said that cost accounting system ensures maximum utilization of physical and human resources. It checks frauds and manipulation and directs the employer and employees towards achieving the organization goal.

Introduction to Accounting- Characteristics Accounting

Accounting is also known as the financial language of the business.

Accounting is a process of identifying, measuring, recording, classifying, summarizing and analyzing the financial transaction of the business.

There are various characteristics of Accounting:

• Identifying various business transaction:  Accounting is a process of identifying various business transactions. Every business has variety of business transactions daily. For example: purchases, sales, other expenses, income from other investments etc. Each business has to identify such financial transactions.

• Measuring the transactions: Every financial transactions has to be measured in terms of money. "Money" in accounting is considered as the common unit and also the common medium of exchange. In India, Rupees is the currency used by every person.

• Recording the transactions: In-order to find out the financial status of the business it is important to record each and every transaction that takes place in business. Therefore, business maintains proper books of accounts known as book keeping. Business has to maintain purchase book for purchases, sales book for sales, cash and bank book for bank and cash related activities, also creditor and debtors book for credit related transactions and journal proper for other transactions. 

• Classifying the transactions: After posting the transactions of business in Journal, all the transactions are then classified into their respective ledgers. For example: if a business is selling mobile phone to a customer in cash, first of all a journal entry will be recorded in Journal and then the ledger posting will be done in cash account and sales account. 

• Summarizing the transactions: After posting the transactions to the respective ledger accounts, it is important to make the accounting information presentable to the users and the owner. This is called summarizing. It involves presenting the classified data in such a manner which can be understandable by the users. It includes Trial Balance, Trading Account, Profit & Loss Account and Balance Sheet.

• Analyzing and Interpreting the Financial data: It is important to analyze the financial data so that the users of financial statements can make sound decisions and proper judgement regarding the investment decisions and other sound decisions.

• Communicating the Financial data and report to the users: If you own a business or a company, it is important to communicate about the financial data or statements of the business, so that the users can take sound decisions regarding the investment in business. Every user is communicated regarding the financial information through the "Annual Report" at the end of the year.

Introduction to Accounting- Meaning & Objectives

Have you ever thought of how large companies like Reliance or Tata interpret their financial position at the end of the year? Do the employees have special power to check the profits or losses of the business?

The answer is big: NO

Definition of Accounts:

Accounts is a process of reporting, recording, interpreting, summarizing, analyzing the economic and financial data of the business or a company. 

Accounting helps the managers or the owners of the company to know the financial status or position of the business. Now-a-days, Accounting is useful for every business and beneficial to all. Many aspects of our lives are dependent on accounts like, personal financial planning, investments, income tax law etc. We have different roles to perform in life- the role of a student,of a family head, of a manager, of an investor etc. The knowledge of accounting is an added advantage to perform these roles. However, we shall limit our scope of discussion to a business organisation and various financial aspects of such an organisation.

Aspects of Accounting:

• Economic Events:  Every business organisation has to go through number of economic events like purchasing the products or selling the products along with transportation or advertising costs, employee salary and other miscellaneous expenses.

• Identification, Measurement, Recording and Communication: The accounting information should be outlined in such a way that right information is identified, measured, recorded and communicated to the right individual at the right time.

• Organization: It refers to the size of the business along with the number of employees and level of business operation.

• Interested users of Information: Customers are the most interested users of information about the business or the companies financial position because accordingly they will take the decision regarding investment in the business or the company.

Objectives of Accounting:

• To maintain a systematic record of business transactions: A normal business conducts various transaction daily. Any human being cannot remember each and every transaction that has taken place in day to day business. Accounting is a process where each and every transaction related to business is recorded first in Journal and posted to ledger followed by preparation of trial balance and then preparing the financial statements.

• To ascertain profits and losses of the business: Any person or any company carrying a business is interested to know the position of the business at the end of the year. Every business has the objective to maximize the profits. Whether the business earned profits or loss is ascertained by preparing profits and loss account or Income statement. A comparison of Income & Expenditure gives either Profits or Losses.

• To depict financial position of the business: A businessman is also interested in ascertaining his financial position at the end of a given period. For this purpose, a position statement called Balance Sheet is prepared in which assets and liabilities are shown. 

• To provide accounting information to the interested users: Apart from owner of the business, there are some other parties like bankers, creditors, tax authorities, investors, researchers etc. who are interested in getting the accounting information of the business. Hence, one of the objectives is to make the accounting information available to the interested users to enable them to take sound and effective decisions. The accounting information is available in the form of "Annual Report".

Accounting is also called as the Financial Language of  the Business.