ACCOUNTINGACCOUNTING

ACCOUNTINGACCOUNTING

Accounting is the language of business. Accounting is the language of business. The affairs and the results of the The affairs and the results of the business are communicated to others business are communicated to others through accounting information, which through accounting information, which has to be systematically recorded and has to be systematically recorded and presented.presented.

Accounting - Accounting - DefinitionDefinition

Accounting can be defined as the

process of identifying, measuring,

recording and communicating the

economic events of an organization to

the interested users of the

information.

Characteristics of Accounting Characteristics of Accounting

Economic eventsEconomic events Identification, measuring, recording Identification, measuring, recording

and communicationand communication OrganizationOrganization Interested users of informationInterested users of information

Economic EventsEconomic Events

An economic event has been defined

as ‘a happening of consequence’ to a

business entity. Economic events are

classified into

• External types

• Internal types.

Economic Events Economic Events Continue…Continue…

An external event which involves the

transfer or exchange of something of

value between two or more entities.

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Sale of goods to customers.

• Payment of monthly rent to the landlord.

Purchase of raw materials by an enterprise from some other business

enterprise.

Rendering of services to customers, etc.

Economic Events Economic Events Continue…Continue…

An internal event is an economic event

that occurs entirely within one

enterprise.

Eg : Supply of raw materials or

equipment by the stores department

to the manufacturing department.

OrganizationOrganization

It can be a business entity or a non-

business entity, depending upon the

profit or non-profit motive.

Users of Accounting InformationUsers of Accounting Information

Different categories of users need

different kinds of information for

making decisions. These users can be

divided into :

•Internal Users; and

•External Users.

Internal UsersInternal Users

These are the persons who manage

the business, i.e. management at the

top, middle, and lower levels. Their

requirements of information are

different because they make different

types of decisions.

Internal Users Internal Users continue…continue…

The top level is more concerned with planning; the middle level is concerned equally with planning and control; and the lower level is concerned more with controlling operations. Information is supplied on different aspects, e.g. cash resources, sales estimates, results of operations, financial position, etc.

External UsersExternal Users

All persons other than internal users come in the group of external users. External users can be divided into two groups:

       those having direct interest; and

       those having indirect interest

in a business organization.

External Users External Users continue…continue…

The main sources of information for external users are annual reports of business organizations, which state the financial position and performance and give the auditor’s report, director’s report and other information.

External Users External Users continue…continue…

Investors and creditors are the external users having direct interest. Tax authorities, regulatory agencies, customers, labour unions, trade associations, stock exchanges, investors, etc are indirectly interested in the company’s financial strength, its ability to meet short-term and long-term obligations, its future earning power, etc for making various decisions.

ASSETSASSETS

These are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets are things of value used by the business in its operations.

        Fixed Assets  

       Current Assets

ASSETS ASSETS continue…continue…

    Fixed Assets are assets held on a long-term basis.

e.g. Land, Building, Machinery, Plant, Furniture and Fixtures, etc.

ASSETS ASSETS continue…continue…

   Current Assets are assets held on a short-term basis.

e.g. Debtors, Bills receivable, Stock(Inventory), Cash and Bank balances, etc.

LIABILITIESLIABILITIES

These are obligations or debts that the

enterprise must pay in money or

services at some time in the future.

• Long-term liabilities

• Short-term liabilities

LIABILITIES LIABILITIES continue..continue..

Long-term liabilities are those that are

usually payable after a period of one

year.

e.g. A term loan from a financial institution,

debentures (bonds) issued by a company.

LIABILITIES LIABILITIES continue..continue..

Short-term liabilities are obligations

that are payable within a period of one

year.

e.g. Creditors, bills payable, overdraft

from a bank for a short period.

CAPITALCAPITAL

Investment by the owner for use in the

firm is known as capital. Owner’s

equity is the ownership claim on total

assets. It is equal to total assets minus

total liabilities.

REVENUESREVENUES

These are the amounts the business

earns by selling its products or

providing services to customers. Other

titles and sources of revenue common

to many businesses are: sales, fees,

commission, interest, dividends,

royalties, rent received, etc.

EXPENSES EXPENSES

These are costs incurred by a business in the process of earning revenue. Generally, expenses are measured by the cost of assets consumed or services used during an accounting period. The usual titles of expenses are: depreciation, rent, wages, salaries, interest, costs of heat, light and water, telephone, etc.

PURCHASESPURCHASESPurchases are total amount of goods procured by a business on credit and for cash, for use or sale. In a trading concern, purchases are made of merchandise for resale with or without processing.

In a manufacturing concern, raw materials are purchased, processed further into finished goods and then sold. Purchases may be cash purchase or credit purchase.

SALES SALES

Sales are total revenues from goods or

services sold or provided to

customers. Sales may be cash sales or

credit sales.

STOCKSTOCK

Stock (Inventory) is a measure of

something on hand – goods, spares

and other items – in a business.

It is called stock on hand.

STOCK: STOCK: continue…continue…

In a trading concern, the stock on

hand is the amount of goods which

have not been sold on the date on

which the balance sheet is prepared.

This is also called closing stock.

STOCK STOCK continue…continue… In a manufacturing concern, closing

stock comprises raw materials, semi-

finished goods and finished goods on

hand on the closing date.

Similarly, opening stock is the amount

of stock at the beginning of the

accounting year.

DEBTORSDEBTORS

Debtors are persons and/or other entities

who owe to an enterprise an amount for

receiving goods and services on credit.

The total amount standing against such

persons and/or entities on the closing date,

is shown in the Balance Sheet as Sundry

Debtors on the asset side.

CREDITORSCREDITORS

Creditors are persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit.

The total amount standing to the favour of such persons and/or entities on the closing date, is shown in the Balance Sheet as Sundry Creditors on the liability side.

ACCOUNTING PRINCIPLESACCOUNTING PRINCIPLES

Accounting principles can be subdivided into

two categories:

        Accounting Concepts; and

        Accounting Conventions.

ACCOUNTING PRINCIPLESACCOUNTING PRINCIPLES

        Accounting Concepts

        Accounting Conventions

The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based. The term ‘convention’ is used to signify customs and traditions as a guide to the presentation of accounting statements.

ACCOUNTING PRINCIPLESACCOUNTING PRINCIPLES

Accounting Concepts

• Business Entity Concept

• Money Measurement Concept

• Cost Concept

• Going Concern Concept

• Dual Aspect Concept

• Realization Concept

• Accounting Period Concept

ACCOUNTING PRINCIPLESACCOUNTING PRINCIPLES

Accounting Conventions

• Convention of Consistency

• Convention of Disclosure

• Convention of Conservation

ACCOUNTING PRINCIPLESACCOUNTING PRINCIPLES

Accounting Concepts

The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based.

Business Entity ConceptBusiness Entity Concept

Business is treated as a separate entity or unit apart from its owner and others. All the transactions of the business are recorded in the books of business from the point of view of the business as an entity and even the owner is treated as a creditor to the extent of his/her capital.

Money Measurement ConceptMoney Measurement Concept

In accounting, we record only those

transactions which are expressed in

terms of money. In other words, a fact

which can not be expressed in

monetary terms, is not recorded in the

books of accounts.

Cost ConceptCost Concept

Transactions are entered in the books of accounts at the amount actually involved. Suppose a company purchases a car for Rs.1,50,000/- the real value of which is Rs.2,00,000/-, the purchase will be recorded as Rs.1,50,000/- and not any more. This is one of the most important concept and it prevents arbitrary values being put on transactions.

Going Concern ConceptGoing Concern Concept

It is persuaded that the business will

exists for a long time and transactions

are recorded from this point of view.

Dual Aspect ConceptDual Aspect Concept

Each transaction has two aspects, that

is, the receiving benefit by one party

and the giving benefit by the other.

This principle is the core of

accountancy.

Dual Aspect Concept Dual Aspect Concept continue…continue…

For example, the proprietor of a business starts his business with Cash Rs.1,00,000/-, Machinery of Rs.50,000/- and Building of Rs.30,000/-, then this fact is recorded at two places. That is Assets account (Cash, Machinery & Building) and Capital accounts. The capital of the business is equal to the assets of the business.

Dual Aspect Concept Dual Aspect Concept continue…continue…

Thus, the dual aspect can be expressed as under

 

Capital + Liabilities = Assets

or

Capital = Assets – Liabilities

Realization ConceptRealization Concept

Accounting is a historical record of

transactions. It records what has

happened. It does not anticipate

events. This is of great important in

preventing business firms from

inflating their profits by recording

sales and income that are likely to

accrue.

Accounting Period ConceptAccounting Period Concept

Strictly speaking, the net income can be measured by comparing the assets of the business existing at the time of its liquidation. But as the life of the business is assumed to be infinite, the measurement of income according to the above concept is not possible. So a twelve month period is normally adopted for this purpose. This time interval is called accounting period.

ACCOUNTING PRINCIPLESACCOUNTING PRINCIPLES

Accounting Conventions

The term ‘convention’ is used to

signify customs and traditions as a

guide to the presentation of

accounting statements.

Convention of ConsistencyConvention of Consistency

In order to enable the management to draw important conclusions regarding the working of the company over a few years, it is essential that accounting practices and methods remain unchanged from one accounting period to another. The comparison of one accounting period with that of another is possible only when the convention of consistency is followed.

Convention of DisclosureConvention of Disclosure

This principle implies that accounts must be honestly prepared and all material information must be disclosed therein. The contents of Balance Sheet and Profit and Loss Account are prescribed by law. These are designed to make disclosure of all material facts compulsory.

Convention of ConservationConvention of Conservation

Financial statements are always drawn up on rather a conservative basis. That is, showing a position better than what it is, not permitted. It is also not proper to show a position worse than what it is. In other words, secret reserves are not permitted.

FUNCTIONS OF FUNCTIONS OF ACCOUNTINGACCOUNTING

• Keeping systematic records

• Protecting properties of the business

• Communicating the results

• Meeting legal requirements

Keeping systematic recordsKeeping systematic records

The first function of accounting is to

keep a systematic record of financial

transactions, to post them to the

ledger accounts and ultimately

prepare final statements.

Protecting properties of the Protecting properties of the businessbusiness

The second important function is to

protect the property of the business.

The system accounting is designed in

such a way that it protects its assets

from an unjustified and unwarranted

use.

Meeting legal requirementsMeeting legal requirements

The fourth and the last function of

accounting is to meet the legal

requirements under the Companies

Act, Income Tax Act, Sales Tax Act and

so on.

THE ACCOUNTING CYCLETHE ACCOUNTING CYCLE

Recording transactions in subsidiary books.

Classifying data by posting from subsidiary books to the accounts.

Closing the books and preparation of final accounts.

SYSTEMS OF ACCOUNINGSYSTEMS OF ACCOUNING

• Cash System

• Single Entry System

• Double Entry System

Cash SystemCash System

This system takes into account only cash receipts and payments on the assumption that there are no credit transactions. Even if there are any, they will not be recorded. This system may be suitable for charitable institutions like schools, colleges, social clubs, etc.

Single Entry SystemSingle Entry System

As the name itself implies, it deals with only one aspect of transaction. This system recognizes cash and personal items of the transactions and it ignores the impersonal items. So it is incomplete, inaccurate and unscientific.

Double Entry SystemDouble Entry System

This is the most scientific system that recognizes both the aspects of each transaction and also records each aspect. This system takes into account every business transaction in its double aspect, i.e., receiving benefit by one party and giving the like benefit by another. So it records the two-fold aspect of every business transaction.

Double Entry System Double Entry System continue…continue…

Example: When ‘A’ purchases a car, he receives the benefit in the form of a car and gives the benefit in the form of money. Similarly, the car seller receives the benefit in the form of money and gives the benefit in the form of a car.

Double Entry System Double Entry System continue…continue…

Definition

The process by which the dual aspects of business transactions are recorded is known as the double entry book-keeping. It is a complete book-keeping in the sense that it records all the two aspects, debit and credit in each business transaction, in equal value.

CLASSIFICATION OF ACCOUNTSCLASSIFICATION OF ACCOUNTS

Every business deal with other “Person”, possesses “Assets”, pay “Expenses” and receive “Income”.

So from the above, we can see every business has to keep

• An account for each person

• An account for each asset and

• An account for each expense or income.

CLASSIFICATION OF ACCOUNTSCLASSIFICATION OF ACCOUNTS

• Accounts in the names of persons are known as “Personal Accounts”

• Accounts in the names of assets are known as “Real Accounts”

• Accounts in respect of expenses and incomes are known as “Nominal Accounts”

CLASSIFICATION OF ACCOUNTSCLASSIFICATION OF ACCOUNTS

ACCOUNTS

PERSONALACCOUNTS

IMPERSONALACCOUNTS

REALACCOUNTS

NOMINALACCOUNTS

PERSONAL ACCOUNTSPERSONAL ACCOUNTS

Accounts in the name of persons are known as personal accounts.

Eg: Babu A/C,

Babu & Co. A/C,

Outstanding Salaries A/C, etc.

REAL ACCOUNTSREAL ACCOUNTS

These are accounts of assets or properties. Assets may be tangible or intangible. Real accounts are impersonal which are tangible or intangible in nature.

Eg:- Cash a/c, Building a/c, etc are Real Accounts related to things which we

can feel, see and touch.

Goodwill a/c, Patent a/c, etc Real Accounts which are of intangible in nature.

NOMINAL ACCOUNTSNOMINAL ACCOUNTS

These accounts are impersonal, but invisible and intangible. Nominal accounts are related to those things which we can feel, but can not see and touch. All “expenses and losses” and all “incomes and gains” fall in this category.

Eg:- Salaries A/C, Rent A/C, Wages A/C, Interest Received A/C, Commission Received A/C, Discount A/C, etc.

DEBIT AND CREDITDEBIT AND CREDIT

Each accounts have two sides – the left side

and the right side. In accounting, the left

side of an account is called the “Debit Side”

and the right side of an account is called the

“Credit Side”. The entries made on the left

side of an account is called a “Debit Entry”

and the entries made on the right side of an

account is called a “Credit Entry”.

RULES FOR DEBIT AND CREDITRULES FOR DEBIT AND CREDIT

Personal Personal AccountAccount

Debit the ReceiverDebit the Receiver

Credit the GiverCredit the Giver

Real AccountsReal Accounts Debit what comes inDebit what comes in

Credit what goes Credit what goes outout

Nominal Nominal AccountsAccounts

Debit all Expenses Debit all Expenses and Lossesand Losses

Credit all Incomes Credit all Incomes and Gainsand Gains

Steps for finding the debit and credit aspects Steps for finding the debit and credit aspects

of a particular transactionof a particular transaction

• Find out the two accounts involved in the

transaction.

• Check whether it belongs to Personal,

Real or Nominal account.

• Apply the debit and credit rules for the

two accounts.

ExerciseExercise

• Purchased a Building for Rs.20,000/-.

• Paid Cash Rs.1,000/- to Satheesh.

• Paid Salary Rs.1000/-.

• Received Commission Rs.250/-.

• Sold goods for Cash Rs.3500/-.

Subsidiary BooksSubsidiary Books

• General Journal• Special Journals

• Purchase Book• Sales Book• Purchase Return Book• Sales Return Book• Bills Receivable Book• Bills Payable Book• Cash Book• Petty Cash Book

JournalJournal

Journal is the prime or original book of entry in which all transactions are recorded in the form of entries. Journalising is an act of recording or entering transactions in a Journal in the order of date.DateDate ParticularsParticulars LFLF DebitDebit

AmountAmountCredit Credit

AmountAmount

Journal EntryJournal Entry

Jan 1, 1981 Prakash Started a business Rs. 15,000/-DateDate ParticularsParticulars LFLF DebitDebit

AmountAmountCredit Credit

AmountAmount

19811981

Jan 1Jan 1Cash a/c Cash a/c Dr.Dr.

To Prakash’s Capital To Prakash’s Capital a/ca/c

(Being cash invetsed to (Being cash invetsed to business)business)

15,00015,000

15,00015,000