Accounting and Its Types (With Examples)

What is Accounting?

Accounting is the process of recording, classifying, summarizing, analyzing, and

interpreting financial transactions of a business. It is often called the "language of
business" because it helps in communicating the financial position and performance of a
business to stakeholders such as owners, investors, creditors, and the government.

🔹 In simple words: Accounting means keeping a track of all money-related activities of a

business — like income, expenses, assets, and liabilities — and preparing reports to help in
decision-making.

Main Objectives of Accounting

1. To record financial transactions systematically.

2. To find out profit or loss for a period.

3. To know the financial position of the business (assets & liabilities).

4. To help in decision-making by providing useful financial information.

5. To ensure compliance with legal, tax, and business rules.

🔍 Types of Accounting (Explained with Examples)

1. Financial Accounting

Meaning: It deals with recording day-to-day transactions and preparing financial reports
such as Profit & Loss Account and Balance Sheet.

Purpose: To provide financial information to external users like investors, lenders, and
government authorities.

Example:
A company prepares its Income Statement to know its annual profit or loss and submits its
Balance Sheet to tax authorities.

🧾 Real-life example: Tata Motors publishes its financial reports every quarter to inform
shareholders about business performance.

2. Management Accounting
Meaning: This type of accounting provides information to internal management to help in
planning, controlling, and decision-making.

Purpose: For internal use only — helps in budgeting, cost control, and performance
evaluation.

Example:
A company prepares a monthly budget to manage expenses or uses reports to decide
whether to launch a new product.

🧾 Real-life example: Reliance Industries uses management accounting reports to control

the costs in their telecom business (Jio).

3. Cost Accounting

Meaning: It focuses on calculating the cost of producing goods or services.

Purpose: To control and reduce costs and improve profit margins.

Example:
A furniture company calculates the cost of making one chair (wood, labour, machine time)
to set a selling price.

🧾 Real-life example: Maruti Suzuki uses cost accounting to reduce production costs per car
and stay competitive.

4. Tax Accounting

Meaning: This deals with preparing tax returns and ensuring the company follows tax
rules.

Purpose: To compute tax liabilities, claim deductions, and avoid penalties.

Example:
A business files its GST returns, Income Tax Returns, and follows tax laws and due dates.

🧾 Real-life example: Infosys maintains a dedicated tax accounting team to handle domestic
and international tax obligations.

5. Forensic Accounting

Meaning: This type of accounting investigates frauds, financial crimes, or disputes.

Purpose: To uncover frauds, money laundering, or help in legal cases.

Example:
A forensic accountant investigates a case where a company manager is suspected of
embezzling funds.

🧾 Real-life example: Forensic auditors were appointed in the PNB-Nirav Modi scam to find
how fraud was conducted.

6. Government Accounting

Meaning: It is used by government departments to record and control public funds.

Purpose: To track how taxpayer money is spent and ensure accountability.

Example:
A state government prepares accounts showing how much was spent on education,
health, and roads.

🧾 Real-life example: The Comptroller and Auditor General (CAG) of India uses government
accounting to audit and report on government spending.

7. Social Responsibility Accounting

Meaning: This measures the social and environmental impact of business activities.

Purpose: To assess how responsible a business is toward society and the environment.

Example:
A company reports how much it spent on reducing carbon emissions or donating to
community welfare.

🧾 Real-life example: ITC Ltd publishes a sustainability report showing efforts in water
conservation and plastic recycling.

Summary Table

Type of Accounting Main Focus Used By Key Example

Profit, Loss, Balance Investors, Annual Financial

Financial Accounting
Sheet Government Report

Management Internal decision-

Managers Budget Report
Accounting making

Cost Accounting Production Costs Cost Controllers, Cost Sheet for

Type of Accounting Main Focus Used By Key Example

Production Dept. Manufacturing

Tax Returns, Tax Consultants, GST and Income Tax

Tax Accounting
Deductions Finance Teams Returns

Detecting fraud, Legal Experts, Fraud Investigation

Forensic Accounting
disputes Auditors Reports

Government Public Fund Government Ministry Budget

Accounting Management Departments Reports

Social Responsibility Environmental & social CSR Teams,

Sustainability Report
Accounting performance Stakeholders

Difference Between Assets and Liabilities

Assets Liabilities

✅ Meaning of Assets

Assets are the valuable resources owned or controlled by a

business or individual that provide economic benefits in the
future. In simple words, assets are what the business owns.

They can be used to generate income, run daily operations,

or can be converted into cash.

🔹 Example: Cash, buildings, land, machinery, furniture,

vehicles, inventory (stock), etc.

✅ Meaning of Liabilities

Liabilities are the financial obligations or debts that a

business owes to outsiders (creditors, banks, government,
etc.). In simple words, liabilities are what the business
owes.

These are claims against the business’s assets and must be

settled over time using money, goods, or services.

🔹 Example: Bank loans, unpaid bills, outstanding salaries,

taxes payable, creditors, etc.
📊 Key Differences Between Assets and Liabilities

Basis of
Assets Liabilities
Comparison

Resources owned Obligations owed by the

Definition
by the business business

Help generate Represent the

Purpose income and grow money/business has to
business repay

Fixed, Current,
Types Tangible, Current and Non-Current
Intangible

Balance Sheet Shown on the left- Shown on the right-hand

Side hand side side

Effect on Increase the net Decrease the net worth

Value worth of business of business

Cash, Land, Bank Loan, Creditors,

Examples Buildings, Outstanding Expenses,
Machinery, Stock GST Payable

Business has
control or Third parties (banks,
Ownership
ownership of creditors) have claims
assets

Assets can be
Conversion to Liabilities need to be paid
converted into
Cash with cash
cash

Positive impact on Negative impact

Impact
business (financial burden)

📚 Types of Assets

A. Based on Convertibility:

1. Current Assets – Easily converted into cash within 1

year
➤ Example: Cash, Debtors, Stock, Bills Receivable
 2. Non-Current (Fixed) Assets – Used for long term, not
easily converted
➤ Example: Land, Building, Machinery, Furniture

B. Based on Physical Existence:

1. Tangible Assets – Physical form

➤ Example: Equipment, Vehicles

2. Intangible Assets – No physical form

➤ Example: Goodwill, Patents, Trademark, Copyright

📚 Types of Liabilities

A. Based on Timeframe:

1. Current Liabilities – Payable within one year

➤ Example: Creditors, Outstanding Expenses, Short-
term loans

2. Non-Current Liabilities – Payable after one year

➤ Example: Long-term loans, Bonds Payable

B. Based on Source:

1. Internal Liabilities – Owner’s capital, retained

earnings

2. External Liabilities – Loan from bank, creditors, taxes

🧾 Real-Life Examples

✅ Example 1: Grocery Shop

 Assets:
➤ ₹50,000 cash, ₹1,00,000 worth of stock, ₹2,00,000
shop building

 Liabilities:
➤ ₹75,000 loan from bank, ₹10,000 payable to
supplier

➡ This means the owner owns ₹3.5 lakh worth of assets

and owes ₹85,000 to others.

✅ Example 2: Student Personal Finance

  Assets:
➤ Laptop (₹50,000), Cash (₹5,000)

 Liabilities:
➤ Education Loan (₹2,00,000)

➡ Even individuals have assets and liabilities.

Why Is It Important to Know the Difference?

1. Helps in financial planning and investment

decisions.

2. Gives clarity about net worth (Assets – Liabilities).

3. Useful for loan approval, business valuation, and tax

filing.

4. Essential for preparing Balance Sheet and

understanding business health.

Simple Formula:

Assets = Liabilities + Owner’s Equity

Or
Owner’s Equity = Assets – Liabilities

This is called the Accounting Equation, which forms the

foundation of double-entry bookkeeping.

Basis

Resources Obligations
Meaning owned by owed by
business business

Cash, Bank Loan,

Building, Creditors,
Examples
Machinery, Outstanding
Stock Rent

Increases
Decreases
Effect on value business
business worth
worth

Positive Negative
Nature
(benefits) (burdens)
Functions of Accounting

1. Recording – Systematic entry of transactions.

2. Classifying – Grouping similar transactions.

3. Summarizing – Preparing trial balance, P&L, balance sheet.

4. Analyzing & Interpreting – Understanding financial results.

5. Communication – Reporting to stakeholders.

6. Legal Compliance – Ensuring tax and legal obligations are met.

What is Depreciation?

Depreciation is the reduction in the value of a fixed asset due to usage, wear and tear,
passage of time, or obsolescence. Businesses record depreciation to reflect the true value
of assets in their books and to match the cost of the asset with the revenue it helps
generate.

📚 Why Do We Charge Depreciation?

 To show true value of assets in the balance sheet.

 To allocate the cost of the asset over its useful life.

 To comply with the matching principle of accounting.

 For tax deduction purposes (as depreciation is a non-cash expense).

🔢 Common Methods of Charging Depreciation

1. ✅ Straight Line Method (SLM)

Also known as: Fixed Instalment Method

Meaning: Depreciation is charged equally every year during the useful life of the asset.

Formula:
Example:
A machine costing ₹1,00,000 with a life of 5 years and ₹10,000 scrap value:

1,00,000−10,0005=₹18,000 per year\frac{1,00,000 - 10,000}{5} = ₹18,000 \text{ per

year}51,00,000−10,000=₹18,000 per year

Used When: Asset is expected to give equal benefit each year, like buildings, furniture.

Advantage: Simple and easy to calculate.

2. 📉 Diminishing Balance Method (Written Down Value or WDV Method)

Meaning: A fixed percentage is charged on the reduced balance (book value) of the asset
every year.

Formula:

Example:
An asset costs ₹1,00,000 and the depreciation rate is 20%.

 Year 1: ₹1,00,000 × 20% = ₹20,000

 Year 2: ₹80,000 × 20% = ₹16,000

 Year 3: ₹64,000 × 20% = ₹12,800

Used When: Asset loses more value in early years — e.g., vehicles, machines.

Advantage: More realistic as it considers usage and aging.

3. 💰 Annuity Method

Meaning: This method treats the asset as an investment and charges depreciation +
interest on the asset's cost.

Concept: Each year, the same amount is charged, which includes both depreciation and a
notional interest on the capital invested in the asset.

Used For: Leaseholds or long-term assets where interest cost is significant.

Example: If an asset is ₹1,00,000 for 5 years, and interest is 10%, an annuity table is used
to find the annual amount (e.g., ₹26,379).

Advantage: Recognizes the cost of money invested in the asset.

4. 🏦 Depreciation Fund Method (Sinking Fund Method)

Meaning: In this method, the business sets aside money every year into a fund. This fund
earns interest and is used to replace the asset at the end of its useful life.

Steps:

1. Charge depreciation.

2. Invest the same amount into a separate fund.

3. At the end of the asset's life, sell the investment and buy a new asset.

Used When: Assets are expensive and need replacement after long use — like ships, large
machines.

Example: ₹20,000 is set aside every year and invested. After 5 years, the total amount
(with interest) is used to buy a new asset.

Advantage: Ensures that money is available for asset replacement.

5. ⚙️Machine Hour Method

Meaning: Depreciation is charged based on the number of hours a machine is used.

Formula:

Example:
Machine cost = ₹2,00,000; Scrap value = ₹20,000
Estimated hours = 18,000
Rate per hour = ₹10
If used for 3,000 hours in a year → Depreciation = ₹30,000

Used When: Usage of machinery varies significantly each year.

Advantage: Accurate when asset usage is uneven.

Comparison Table of Depreciation Methods

 Amount Charged Per
Method Based On Suitable For
Year

Time (equal life

Straight Line Method Same every year Furniture, buildings
span)

Diminishing Balance % on reducing

Decreases yearly Vehicles, machinery
Method balance

Annuity Method Time + Interest Same total amount Leasehold assets

Depreciation Fund Fund created Fund grows with Expensive/long-life

Method yearly interest assets

Machine Hour Method Actual usage hours Varies with use Production machines

Objectives of Trial Balance

1. To check arithmetical accuracy of ledger accounts.

2. To help in preparation of final accounts.

3. To locate errors in posting or balancing.

4. To summarize account balances.

5. To support auditing and internal reviews.

Five Accounting Concepts & Conventions

1. Business Entity Concept – Business is separate from its owner.

2. Going Concern Concept – Business will continue operating.

3. Money Measurement Concept – Only measurable transactions are recorded.

4. Cost Concept – Assets are recorded at cost, not market value.

5. Accrual Concept – Record income/expenses when they occur, not when cash is paid
or received.

Causes of Depreciation

1. Wear and Tear – Physical usage reduces value.

2. Obsolescence – Technological advancement makes assets outdated.

3. Passage of Time – Legal rights expire (e.g., patents).

4. Usage Level – Frequent use = faster depreciation.

 5. Natural Factors – Rust, decay, weather impact asset life.

Journal Entries in Ram’s Business

Date Transaction Description Journal Entry

Cash A/c Dr. ₹2,00,000

Jan 1 Started business with ₹2,00,000
To Capital A/c ₹2,00,000

Purchases A/c Dr. ₹40,000

Jan 2 Purchased goods on credit from Y ₹40,000
To Y A/c ₹40,000

Y A/c Dr. ₹20,000

Jan 8 Paid ₹20,000 to Y in cash
To Cash A/c ₹20,000

Z A/c Dr. ₹30,000

Jan 15 Sold goods to Z for ₹30,000
To Sales A/c ₹30,000

Cash A/c Dr. ₹10,000

Jan 28 Received ₹10,000 from Z in cash
To Z A/c ₹10,000

Methods of Charging Depreciation (Detailed)

1. Straight Line Method

o Same amount yearly.

o Formula: (Cost – Scrap Value) / Life

o E.g., ₹1,00,000 asset, ₹10,000 scrap, 5 years = ₹18,000/year

2. Written Down Value (WDV) Method

o Depreciation % on reducing balance.

o E.g., 10% on ₹1,00,000 → Yr 1: ₹10,000, Yr 2: ₹9,000, and so on.

3. Unit of Production Method

o Based on actual usage (units produced/hours used).

o Formula: (Cost – Scrap) / Estimated Units

4. Annuity Method

o Includes annual interest loss on capital + depreciation.

o Suitable for long-term investments.

5. Depreciation Fund Method

o Sets aside a fixed amount annually into a fund for asset replacement.

o Used when assets require large future investment for renewal.