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Accounting for Management
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CHAPTER - 1
INTRODUTION TO
ACCOUNTING
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Learning Objectives:• To understand the working of business organizations.• To understand the Importance and Objectives of
Accounting• To identify the major users of Accounting information.• To explain the role of Accounting in making economic and
business decisions• To identify the branches of Accounting.• To describe the common forms of business orgn.• To understand the concept of Accounting Equation.• To understand the Accounting Cycle• To understand the meaning and Classification of Indian
GAAP.
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UNDERSTANDING BUSINESS ORGANIZATIONS
• Business orgns provide goods and services in order to earn profit.
• Business orgns that provide goods are of three kinds:
Merchandising (Trading) Orgns Manufacturing Orgns Service Orgns
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What is Accounting?
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Accounting is the information system that...Accounting is the information system that...
measures business activities,measures business activities,
processes data into reports, andprocesses data into reports, and
communicates results to decision makers.communicates results to decision makers.
Accounting –The Language of Business
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What is Accounting?
• Accounting is often called the language of Business.
• Accounting, as an information system, is the process of identifying, measuring, and communicating the economic information of an organization to its users who need the information for decision making.
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INPUT PROCESS OUTPUT
•Recording•Classifying •Summarizing•Analyzing•Interpreting
Communicating information to users ( P&L A/c, B/S, CFS, etc)
Economic events measured in financial terms
The Accounting Information System
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Definition of Accounting
• The American Institute of Certified Public Accountants (AICPA) defines accounting as “the art of recording, classifying and summarizing in a significant manner and in terms of money transactions and events which are, in part at least, of a financial character, and interpreting the results thereof”.
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OBJECTIVES OF ACCOUNTING
To maintain accounting records.To calculate the results of operationsTo ascertain the financial positionTo communicate the information to the
users
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USERS OF ACCOUNTING INFORMATION
Internal Users:
Management group: Board of Directors Partners Managers Officers
External Users: Financing group: Investors (present and potential)
Lenders Suppliers Public Group: Govt and Regulatory
Authorities Employees and Trade Unions Customers Rating Agencies Others:
Security AnalystsAcademiciansResearchers
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ACCOUNTING INFORMATION AND ECONOMIC DECISIONS
1. Decide when to buy, hold or sell an equity investment.
2. Assess the stewardship or accountability of mgt.
3. Assess the ability of the enterprise to pay and provide other benefits to its employees.
4. Assess the security for amounts lent to the enterprise.
5. Determine distributable profits and dividends.
6. Determine taxation policies.
7. Prepare and use national income statistics.
8. Regulate the activities of enterprises.
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Branches /Classification of Accounting
F in a n c ia l A cco u n ting
C o s tA cco u n ting
M a na ge m e ntA cco u n ting
H u m anR e so u rce
A /c ing
R e sp o n s ib ilityA /c ing
In fla tionA /c ing
O th er E m erg ingB ra nch es
Accounting
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Forms of Business Organization Sole Proprietorship
Single individual Unlimited Liability
Partnership Firms A few individuals Unlimited Liability
Limited company Numerous individuals, often strangers Large business Limited liability
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Financial Statements
Profit and Loss A/c Statement of financial performance
Balance sheet Statement of financial position
Statement of cash flows Statement of cash receipts and cash
payments
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Assets What a business “owns” Probable future economic benefits Examples
CashInvestmentsBuildingsPlant and MachineryPatents and Copyrights
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Liabilities What a business “owes” Probable future sacrifices of economic
benefits Examples
Loans payableWarranty obligationsPensions payableIncome tax payable
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Revenues• They are amounts received or to be received
from customers for sales of products or services.– sales– performance of services– rent– interest
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• They are amounts that have been paid or will be paid later for costs that have been incurred to earn revenue.– salaries and wages– utilities– supplies used– advertising
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Owner’s Equity• It is what’s left of the assets after liabilities have been
deducted (Residual interest of owners)– the same as net assets– the owner’s claim on the entity’s assets
Examples Share capital Share premium Revenues Retained profit
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EconomicResources
Claims toEconomicResources
The Accounting Equation
Assets = Liabilities + Owner’s Equity
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Transactions that AffectOwner’s Equity
OWNER’S EQUITYINCREASES
OWNER’S EQUITYDECREASES
Owner Investmentsin the Business
Revenues Expenses
Owner Withdrawalsfrom the Business
Owner’s Equity
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Analysing the Effects of Business Transactions
• On April 1, Suresh starts Softomation for developing customer-specific computer software. The transactions of Softomation during April are now described.
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Analysing the Effects of Business Transactions
Investment by Owner:• On April 1, Suresh invests Rs 5,00,000 in cash in
Softomation. The first Balance Sheet of the new business will be:
Softomation : Balance Sheet as on April 1
Liabilities and Owners’ Equity Amount Rs.
Assets Amount Rs
Suresh, Equity 5,00,000 Cash 5,00,000
Total 5,00,000 Total 5,00,000
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Analysing the Effects of Business Transactions
Receipt of Loan:• On April 2, Suresh takes a loan of Rs 2,00,000 from
Manish for Softomation. The effect of the transaction will be:
Softomation : Balance Sheet as on April 2
Liabilities and Owners’ Equity Amount Rs.
Assets Amount Rs
Suresh, Equity 5,00,000 Cash (5,00,000 + 2,00,000)
7,00,000
Liabilities ( Loan from Manish) 2,00,000
Total 7,00,000 Total 7,00,000
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Analysing the Effects of Business Transactions
Purchase of Assets for Cash:• On April 3, Softomation purchases for cash two computers
each costing Rs 2,90,000. The effect of the transaction will be:
Softomation : Balance Sheet as on April 3
Liabilities and Owners’ Equity
Amount Rs.
Assets Amount Rs
Suresh, Equity 5,00,000 Cash (7,00,000 –5,80,000)
1,20,000
Liabilities ( Loan from Manish) 2,00,000 Office Equipment 5,80,000
Total 7,00,000 Total 7,00,000
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Analysing the Effects of Business Transactions
Purchase of Assets on Credit:• On April 4, Softomation purchases supplies of CD, DVD
Disks and stationery for Rs 60,000 on credit. The effect of the transaction will be:
Softomation : Balance Sheet as on April 4
Liabilities and Owners’ Equity
Amount Rs.
Assets Amount Rs
Suresh, Equity 5,00,000 Cash 1,20,000
Creditors ( office Supplies) 60,000 Supplies (Inventory) 60,000
Liabilities ( Loan from Manish) 2,00,000 Office Equipment 5,80,000
Total 7,60,000 Total 7,60,000
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Analysing the Effects of Business Transactions
Receipt of Revenues:• On April 19, Softomation completes its maiden software
for a retail store and receives a price of Rs 1,20,000. The effect of the transaction will be:
Softomation : Balance Sheet as on April 19
Liabilities and Owners’ Equity
Amount Rs.
Assets Amount Rs
Suresh, Equity (5,00,000 + 1,20,000)
6,20,000 Cash (1,20,000 + 1,20,000)
2,40,000
Creditors ( office Supplies) 60,000 Supplies (Inventory) 60,000
Liabilities ( Loan from Manish) 2,00,000 Office Equipment 5,80,000
Total 8,80,000 Total 8,80,000
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Analysing the Effects of Business Transactions
Payment of a Liability:• On April 21, Softomation pays its creditor for supplies, Rs
20,000. The effect of the transaction will be:
Softomation : Balance Sheet as on April 21
Liabilities and Owners’ Equity
Amount Rs.
Assets Amount Rs
Suresh, Equity 6,20,000 Cash (2,40,000 - 20,000)
2,20,000
Creditors ( office Supplies)(60,000 – 20,000)
40,000 Supplies (Inventory) 60,000
Liabilities ( Loan from Manish) 2,00,000 Office Equipment 5,80,000
Total 8,60,000 Total 8,60,000
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Analysing the Effects of Business Transactions
Payment of Expenses:• On April 29, Softomation pays salaries to employees, Rs
40,000 and office rent Rs 12,000. The effect of the transactions will be:
Softomation : Balance Sheet as on April 29
Liabilities and Owners’ Equity Amount Rs.
Assets Amount Rs
Suresh, Equity (6,20,000 – 40,000 – 12,000)
5,68,000 Cash (2,20,000 – 40,000 – 12,000)
1,68,000
Creditors ( office Supplies) 40,000 Supplies (Inventory) 60,000
Liabilities ( Loan from Manish) 2,00,000 Office Equipment 5,80,000
Total 8,08,000 Total 8,08,000
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Analysing the Effects of Business Transactions
Revenues Receivable:• On April 30, Softomation completes a software package for a
shoe shop. The customer agrees to pay the price of Rs 80,000 a week later. In this case, the revenues has been earned but cash has not been received. The effect of the transactions will be: Softomation : Balance Sheet as on April 30
Liabilities and Owners’ Equity Amount Rs.
Assets Amount Rs
Suresh, Equity (5,68,000 + 80,000)
6,48,000 Cash 1,68,000
Creditors ( office Supplies) 40,000 Supplies (Inventory) 60,000
Debtors ( Shoe Shop) 80,000
Liabilities ( Loan from Manish) 2,00,000 Office Equipment 5,80,000
Total 8,88,000 Total 8,88,000
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Analysing the Effects of Business Transactions
Withdrawal by Owner:• On April 30, Suresh withdraws Rs 35,000 for his personal use.
In accordance with the accounting entity assumption, it should not as a business expense but treated as a withdrawal of capital by the owner. The effect of the transactions will be:
Softomation : Balance Sheet as on April 30
Liabilities and Owners’ Equity Amount Rs.
Assets Amount Rs
Suresh, Equity (6,48,000 – 35,000) 6,13,000 Cash (1,68,000 – 35,000) 1,33,000
Creditors ( office Supplies) 40,000 Supplies (Inventory) 60,000
Debtors ( Shoe Shop) 80,000
Liabilities ( Loan from Manish) 2,00,000 Office Equipment 5,80,000
Total 8,53,000 Total 8,53,000
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Generally Accepted Accounting Principles - Meaning
• Accounting principles may be defined as the set of conventions, rules, and procedures necessary to define universally accepted accounting practice at a particular time.
• These principles enable to a certain extent standardization in recording and reporting of information.
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Classification of Accounting Principles
Accounting Concepts:• Postulates i.e. basic assumptions or
conditions upon which the science of accounting is based.
Accounting Conventions:• Circumstances or traditions which guide
the accountant while preparing the accounting statements.
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ACCOUNTING PRINCIPLES A/CING CONCEPTS1. Business entity concept2. Money measurement
concept3. Going concern concept4. Cost concept5. Dual aspect concept6. Accounting period
concept7. Matching concept8. Realization concept9. Objective evidence
concept10. Accrual concept
A/CING CONVENTIONS
1. Consistency
2. Full disclosure
3. Conservatism
4. Materiality
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Generally Accepted Accounting Principles and Basic Concepts
The Entity Concept
• An accounting entity is an organization that stands apart from other organizations and individuals as a separate economic unit.• The entity concept helps relate events to a
clearly defined area of accountability.
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The Entity Concept
An accounting entity is anorganization that stands apartas a separate economic unit.
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The Entity Concept Example
• Assume that John decides to open up a gas station and coffee shop.
• The gas station made Rs 250,000 in profits, while the coffee shop lost Rs 50,000.
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The Entity Concept Example
• How much money did John make?• At a first glance, we would assume that
John made Rs 200,000.• However, by applying the entity concept we
realize that the gas station made Rs 250,000 while the coffee shop lost Rs 50,000.
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The entity will continueto operate in the future.The entity will continueto operate in the future.
Generally Accepted Accounting Principles and Basic Concepts
The Going Concern Concept
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Generally Accepted Accounting Principles and Basic Concepts
Going Concern Convention
• The assumption that in all ordinary situations an entity persists indefinitely• This notion implies that a company’s existing resources
will be used to fulfill the business needs of the company rather than be sold.
• If the continuity of an entity is in doubt, a liquidation approach to the balance sheet is taken, and the assets and liabilities are valued as if the entity were to be liquidated in the near future.
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• Record fixed assets at original cost and depreciate over a period of time.
• Take prepaid expenses as assets.
• Business is concerned with net income or earning capacity as compared to market values.
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Generally Accepted Accounting Principles and Basic Concepts
Materiality Convention
• A financial statement item is material if its omission or misstatement would tend to mislead the reader of the financial statements under consideration• Materiality often depends on the size of the
organization – what is material to one company might not be material to another company.
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• AAA defines
“An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investor”
• Disclose only material information.• No overburdening with minute details• Material information differs organization to
organization year to year (change in depreciation method)
• Materiality may depend upon amount or may not
be.
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Generally Accepted Accounting Principles and Basic Concepts
Convention of Conservatism:-• “ Anticipate no profits but provide for all possible
losses”
• Policy of ‘caution’ & ‘playing safe’
• Policy of safeguarding against possible losses in world of uncertainty
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Kobler defines :-
‘Conservatism’ as a guideline which chooses between
acceptable accounting alternatives for recording
events or transactions so that the least favorable
immediate effect on assets , income and owner’s
equity is reported.
Example:-
Making the provision for doubtful debts and discounts
on debtors in anticipation of actual bad debts and
discount
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Generally Accepted Accounting Principles and Basic Concepts
Cost-Benefit Criterion
• A system should be changed when the expected additional benefits of the change exceed its expected additional costs• The benefits of information should exceed the
cost of providing that information.
Benefits > Costs
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The purchasingpower is
stable.
The purchasingpower is
stable.
Generally Accepted Accounting Principles and Basic Concepts
The Stable-Monetary-Unit Concept
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Generally Accepted Accounting Principles and Basic Concepts
Stable Monetary Unit
• The monetary unit is the principle means for measuring assets and equities.• It is the common denominator for quantifying
the effects of transactions.• A stable monetary unit is one that
is not expected to significantly change in value over time.
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Assets and servicesacquired
should be recordedat their actual cost.
Assets and servicesacquired
should be recordedat their actual cost.
Generally Accepted Accounting Principles and Basic Concepts
The Cost Principle
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• Record assets at price paid to acquire and take it as base for subsequent years.
• Makes financial statements more objective.
Limitations
• Financial statements become irrelevant in case of inflation
• Remove cost of fixed assets by writing off their cost while asset may be in good condition
• Don’t show as asset for which no payment has been made for e.g knowledge ,skill of Human Resources.
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TWO METHODS
Reporting Revenue and Expense
Cash Basis of Accounting
Accrual Basis of Accounting
Accrual Basis
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Cash Basis of Accounting
Revenue reported when cash is received
Expense reported when cash is paid
Does not properly match revenues and
expenses
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Accrual Basis of Accounting
Revenue reported when earned
Expense reported when incurred
Properly matches revenues and expenses
in determining net income
Requires adjusting entries at end of period
It just sounds mean – it really isn’t
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ACCRUAL VS CASH ACCOUNTING
• ACCRUAL ACCOUNTING - FOCUSES ON THE ECONOMIC IMPACT OF TRANSACTIONS
• FIRM MAXIMIZES ASSETS
• CASH ACCOUNTING - FOCUSES ON WHEN CASH IS RECEIVED AND PAID OUT
• FIRM MAXIMIZES CASH
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Full Disclosure Principle
Illustration 1-14
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Revenue Principle
• When is revenue recognized?• When it is deemed earned.• Recognition of revenue and cash receipts
do not necessarily occur at the same time.
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Revenue Principle
The revenue principle governs two things:
When to record revenue and…
the amount of revenue to record.
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Revenue Principle
photos
Disney
World
Situation 2The client has taken a trip arranged by
Air & Sea Travel. – Record Revenue
Situation 2The client has taken a trip arranged by
Air & Sea Travel. – Record Revenue
Air & SeaTravel, Inc.
April 2
Air & SeaTravel, Inc.
Situation 1No transaction has occurred.
– Do Not Record Revenue
Situation 1No transaction has occurred.
– Do Not Record Revenue
March 12I plan to have youmake my travelarrangements.
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Recognition of Revenues• Recognition - a test to determine whether
revenues should be recorded in the financial statements for a given period
• To be recognized, revenue must be:• Earned - goods are delivered or a service is
performed• Realized - cash or a claim to cash (credit) is
received in exchange for goods or services
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The Matching Principle
• What is the matching principle?• It is the basis for recording expenses.• Expenses are the costs of assets and the
increase in liabilities incurred in the earning of revenues.
• Expenses are recognized when the benefit from the expense is received.
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The Matching Principle
It is the basis for recordingexpenses and includes two steps:
Identify all the expenses incurredduring the accounting period.
Measure the expenses and matchexpenses against revenues earned.
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The Matching Principle
RevenueRevenue – ExpenseExpense = Net incomeNet income
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The Matching Principle
RevenueRevenue – ExpenseExpense = (Net loss)(Net loss)
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Revenues Rs 15,000Cost of goods sold 8,000Net income Rs 7,000
May
Example Matching Expenses with Revenues
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Managers adopt anartificial period of time
to evaluate performance.
Managers adopt anartificial period of time
to evaluate performance.
Accounting Period concept
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Interacts with the revenue principle and the matching principle
Interacts with the revenue principle and the matching principle
Requires that income be measured
accurately each period
Requires that income be measured
accurately each period
Accounting Period concept
• It requires that accounting information be reported at regular intervals.
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Accounting Period concept The Time-Period Concept
Businesses need regular progress reports,so accountants prepare financial statementsfor specific periods and at regular intervals.
Monthly
Quarterly
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Dual concept
• Accounting information is based on the double entry system.
• Under this system, the two-sided effect of a transaction is recorded in the appropriate accounts.
• The recording is done by means of a “debit-credit” convention (set of rules) applying to all accounts.
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The Accounting Equation
Assets are the economic resourcesof a business that are expected toproduce a benefit in the future.
Liabilities are “outsider claims,”or economic obligations
payable to outsiders.
Owners’ equity represents the“insider claims” of a business.
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The Reliability Concept
The quality of information that assures decision makers that the information captures the conditions or events it
purports to represent• Reliable data are supported by convincing
evidence that can be verified by independent parties.
• The impact of events should be measured in a systematic, reliable manner.
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Information mustbe reasonably
accurate.
Information mustbe reasonably
accurate.
Information mustbe free from bias.Information mustbe free from bias.
Information must report what
actually happened.
Information must report what
actually happened.
Individuals wouldarrive at similar
conclusions usingsame data.
Individuals wouldarrive at similar
conclusions usingsame data.
The Reliability (Objectivity) concept
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The Double Entry System
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Double-Entry AccountingDouble-Entry Accounting
“ Double-entry accounting is based on a
simple concept: each party in a business
transaction will receive something and give
something in return. In bookkeeping terms,
what is received is a debit and what is given
is a credit. The T account is a representation
of a scale or balance.”
Scale or Balance
ReceiveDEBIT
GiveCREDIT
T account
Left SideReceiveDEBIT
Right SideGive
CREDITLuca PacioliDeveloper ofDouble-EntryAccounting
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One debit One credit
Each transaction is recorded with at least:
Total debits must equal total credits.
The Double-Entry SystemThe Double Entry System
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The Double-Entry System
• Each transaction must still be analyzed to determine which accounts are involved, whether the accounts increase or decrease, and how much the balance will change.
The Double Entry System
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The Double-Entry system• Some businesses enter into thousands of
transactions daily or even hourly.• Accountants must carefully keep track of and
record these transactions in a systematic manner.
• Accountants use a double-entry accounting system in which at least two accounts are always affected by each transaction.
The Double Entry System
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Classification of Accounts
• There are some asset accounts?– Cash– Notes Receivable– Accounts Receivable– Prepaid Expenses– Land– Building– Equipment
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Classification of Accounts
• There are some liability accounts?– Notes Payable– Accounts Payable– Accrued Liabilities (for expenses incurred
but not paid)– Long-term Liabilities (bonds)
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Classification of Accounts
• There are some owner’s equity accounts?– Capital or owner’s interest in the business– Withdrawals– Revenues– Expenses
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Classification of Accounts
• Real Account = Debit –What comes in
Credit- what goes out• Personal Account = Debit –Receiver
Credit - Giver • Nominal Account =Debit –Expenses/Losses
Credit- Incomes/Gains
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The system records the two-sided effect of transactions
Transaction Two-sided effect
Bought furniture for cash Decrease in one asset Increase in another asset
Took a loan in cash Increase in an asset Increase in a liability
The Double-Entry systemThe Double Entry System
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Note that the accounting equation equality is maintained after recording
each transaction.
The Double Entry System
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XYZ Ltd.A Sole Proprietorship
XYZ Ltd.A Sole Proprietorship
“ On November 1, 2002, A started a sole
proprietorship called XYZ Ltd. The following
double-entry transactions show how amounts
received (debits) always equal amounts given
(credits).”
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Amit deposits Rs25,000 in a bank account for XYZ Ltd..
Business Transactions
Journal
receiveDebit
giveCredit
XYZ Ltd(investee)
Amit (investor)
giveCredit
Entry A.
Date Description Debit Credit
11/1
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Amit deposits Rs25,000 in a bank account for XYZ Ltd..
Business Transactions
l Journal
receiveDebit
giveCredit
XYZ Ltd.(investee)
Cash
Amit (investor)
giveCredit
Entry A.
Date Description Debit Credit
11/1 Cash 25,000
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Amit deposits Rs 25,000 in a bank account for XYZ Ltd..
Business Transactions
Journal
Date Description Debit Credit
11/1 Cash 25,000 Amit, Capital 25,000
receiveDebit
giveCredit
XYZ Ltd.(investee)
Cash A promiseto the owner
Amit (investor)
giveCredit
Entry A.
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XYZ Ltd. buys land for Rs20,000.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd(buyer)
Land Owner (seller)
giveCredit
Entry B.
Journal
Date Description Debit Credit
11/5
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XYZ Ltd. buys land for Rs20,000.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd(buyer)
Land
Land Owner (seller)
giveCredit
Entry B.
General Journal
Date Description Debit Credit
11/5 Land 20,000
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XYZ Ltd. buys land for Rs 20,000.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd(buyer)
Land Cash
Land Owner (seller)
giveCredit
Entry B.
Journal
Date Description Debit Credit
11/5 Land 20,000 Cash 20,000
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XYZ Ltd. buys supplies for Rs1,350, agreeing to pay in the near future.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd(buyer)
Supplier (seller)
giveCredit
Entry C.
Journal
Date Description Debit Credit
11/10
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XYZ Ltd. buys goods for Rs1,350, agreeing to pay in the near future.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(buyer)
Supplies
Supplier (seller)
giveCredit
Entry C.
General Journal
Date Description Debit Credit
11/10 Purchases 1,350
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XYZ Ltd. buys goods for Rs1,350, agreeing to pay in the near future.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(buyer)
Supplies
Supplier (seller)
giveCredit
Entry C.
A promiseto pay later
Journal
Date Description Debit Credit
11/10 purchases 1,350 Accounts Payable 1,350
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XYZ Ltd. earns fees of Rs7,500, receiving cash.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(seller)
Customer (buyer)
giveCredit
Entry D.
Journal
Date Description Debit Credit
11/18
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XYZ Ltd. earns fees of Rs7,500, receiving cash.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(seller)
Cash
Customer (buyer)
giveCredit
Entry D.
Journal
Date Description Debit Credit
11/18 Cash 7,500
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XYZ Ltd. earns fees of Rs7,500, receiving cash.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(seller)
Cash
Customer (buyer)
giveCredit
Entry D.
Services
Journal
Date Description Debit Credit
11/18 Cash 7,500 Fees Earned 7,500
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Date Description Debit Credit
XYZ Ltd. paid: wages, Rs 2,125; rent, Rs 800; commissions, Rs450; and misc, Rs275.
Business Transactions
Journal
receiveDebit
giveCredit
XYZ Ltd.(buyer)
Various suppliers
giveCredit
Entry E.
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Date Description Debit Credit
11/18 Wages Expense 2,125Rent Expense 800Commission 450Misc. Expense 275
XYZ Ltd. paid: wages, Rs 2,125; rent, Rs 800; commissions, Rs450; and miscellaneous, Rs275.
Business Transactions
Journal
receiveDebit
giveCredit
XYZ Ltd.(buyer)
Services,benefits
Various suppliers
giveCredit
Entry E.
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Date Description Debit Credit
11/18 Wages Expense 2,125Rent Expense 800Commission 450Misc. Expense 275 Cash 3,650
XYZ Ltd. paid: wages, Rs 2,125; rent, Rs 800; commissions, Rs 450; and misc Rs 275.
Business Transactions
Journal
receiveDebit
giveCredit
XYZ Ltd.(buyer)
Services,benefits
Various suppliers
giveCredit
Entry E.
Cash
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XYZ Ltd. pays Rs950 to creditors on account.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(payor)
Supplier (payee)
giveCredit
Entry F.
Journal
Date Description Debit Credit
11/30
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XYZ Ltd. pays Rs950 to creditors on account.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(payor)
Reduction in obligation
Supplier (payee)
giveCredit
Entry F.
Journal
Date Description Debit Credit
11/30 Accounts Payable 950
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XYZ Ltd. pays Rs950 to creditors on account.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(payor)
Reduction in obligation
Supplier (payee)
giveCredit
Entry F.
Cash
Journal
Date Description Debit Credit
11/30 Accounts Payable 950 Cash 950
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Amit withdraws Rs 2,000 in cash.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(payor)
Amit (payee)
giveCredit
Entry H.
Journal
Date Description Debit Credit
11/30
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Amit withdraws Rs 2,000 in cash.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(payor)
Reduction in obligation
Amit (payee)
giveCredit
Entry H.
Journal
Date Description Debit Credit
11/30 Amit, Drawing 2,000
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Amit withdraws Rs 2,000 in cash.
Business Transactions
receiveDebit
giveCredit
XYZ Ltd.(payor)
Reduction in obligation
Amit (payee)
giveCredit
Entry H.
Cash
Journal
Date Description Debit Credit
11/30 Amit, Drawing 2,000 Cash 2,000
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The Accounting Cycle
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1. Analyze the transaction2. Journalize the transaction3. Post the transaction to accounts in ledger4. Prepare the trial balance5. Prepare financial statements
The Accounting Cycle: Steps
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The Recording Process
• The sequence of steps in recording transactions:
Transactions Documentation Journal
FinancialStatements
TrialBalance
Ledger
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The Recording Process
• The process starts with source documents, which are the supporting original records of any transaction.• Examples are sales slips or invoices, check
stubs, purchase orders, receiving reports, and cash receipt slips.
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The Recording Process
• In the second step, an analysis of the transaction is placed in the book of original entry, which is a chronological record of how the transactions affect the balances of applicable accounts.• The most common example is the
general journal - a diary of all events (transactions) in an entity’s life.
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The Recording Process
• In the third step, transactions are entered into the ledger.• Remember that a transaction is not entered in
just one place; it must be entered in each account that it affects.
• Depending on the nature of the organization, analysis of the transactions could occur continuously or periodically.
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The Recording Process
• The fourth step includes the preparation of the trial balance, which is a simple listing of all accounts from the ledger with their balances.• Aids in verifying accuracy and
in preparing the financial statements• Prepared periodically as necessary
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The Recording Process
• In the final step, the financial statements are prepared.• Financial statements may be prepared after each
quarter of the year.• the companies may prepare
financial statements at various other intervals to meet the needs of their users.
December 2002
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1. Transactions are analyzed and recorded in journal.
DocumentsJournal
Journal, Ledger, Trial Balance
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1. Transactions are analyzed and recorded in journal.
DocumentsJournal
2. Transactions are posted from journal to ledger.
Journal Ledger
Journal, Ledger, Trial Balance
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1. Transactions are analyzed and recorded in journal.
DocumentsJournal
2. Transactions are posted from journal to ledger.
Journal Ledger
3. Trial balance is prepared.
Journal, Ledger, Trial Balance
Trial Balance
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Manual Accounting Cycle
1. Transactions are analyzed and recorded in journal.
Documents Journal
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Manual Accounting Cycle
1. Transactions are analyzed and recorded in journal.
Documents Journal
2. Transactions are posted from journal to ledger.
Journal Ledger
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Manual Accounting Cycle
1. Transactions are analyzed and recorded in journal.
Documents Journal
2. Transactions are posted from journal to ledger.
Journal Ledger
3. Trial balance is prepared,
Trial balance
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Manual Accounting Cycle
1. Transactions are analyzed and recorded in journal.
Documents Journal
2. Transactions are posted from journal to ledger.
Journal Ledger
3. Trial balance is prepared,
4. Financial statements areprepared and distributed.
Financial Statements
IS SOE BS
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Computerized Accounting Cycle
1. Transactions are analyzed and entered in the computer.
DocumentsComputer
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Computerized Accounting Cycle
1. Transactions are analyzed and entered in the computer.
DocumentsComputer
2. Preliminary reports are analyzed, adjustments areprepared and entered in thecomputer.
ComputerReports Computer
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Computerized Accounting Cycle
1. Transactions are analyzed and entered in the computer.
DocumentsComputer
2. Preliminary reports are analyzed, adjustments areprepared and entered in thecomputer.
ComputerReports
3. Financial statements areprinted and distributed.
Computer
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Computerized Accounting Cycle
1. Transactions are analyzed and entered in the computer.
DocumentsComputer
2. Preliminary reports are analyzed, adjustments areprepared and entered in thecomputer.
ComputerReports
3. Financial statements areprinted and distributed.
Financial Statements
IS SOE BS SCF
Computer
4. Reports are analyzed andinterpreted for decision-making purposes.
?
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JOURNAL
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Journal
• What is a journal?• It is a list in chronological order of all the
transactions for a business.1 Identify transaction from source documents.2 Specify accounts affected.3 Apply debit/credit rules.4 Record transaction with description.
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Journal entry• Journal entry - an analysis of the effects of a transaction on the accounts, usually accompanied by an explanation of the transaction–This analysis identifies the accounts to be
debited and credited.
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Journal entry• What does a journal entry include?– date of the transaction– title of the account debited– title of the account credited– amount of the debit and credit– description of the transaction (narration)
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Record transactions
in the journal.
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Journalizing
• Journalizing –
It is the process of entering transactions into the journal
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JOURNALIZING TRANSACTIONS
• THE JOURNAL IS A CHRONOLOGICAL LISTING OF TRANSACTIONS.
• ENTER DATE IN FIRST COLUMN• IDENTIFY APPROPRIATE ACCOUNTS• ENTER THE TITLE OF THE ACCOUNT DEBITED• ENTER THE TITLE OF THE ACCOUNT TO BE
CREDITED• INSERT APPROPRIATE AMOUNTS IN DEBIT AND
CREDIT COLUMN• INSERT A BRIEF DESCRIPTION OF
TRANSACTION
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Recording Transactions
• On April 2, Garge invested Rs 30,000 in Gay GillenTravel.
• What is the journal entry?
Date Particulars Debit Credit
April Rs
2 Cash Account Dr 30,000 To Garge Capital 30,000 (Received initial investment from owner)
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Types of journal entries:
• Types of journal entries:• Simple entry - an entry for a transaction that
affects only two accounts• Compound entry - an entry for a transaction
that affects more than two accounts
• Remember: whether the entry is simple or compound, the debits (left side) and credits (right side) must always equal.
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Ledger
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Boundbooks
Computerprintout
Cards
Loose leafpages
Ledger
• What is a ledger?• It is a digest of all accounts utilized by an
entity during an accounting period.
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Ledger Accounts
• Ledger - a group of related accounts kept current in a systematic manner
• Think of a ledger as a book with one page for each account.
Ledger
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Cash
Accts. Payable
Ledger
Accts. Receivable
Supplies
Ledger
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Cash
Accts. Payable
Ledger
A B C D
Customer AccountsAccts. Receivable
Supplies
Ledger
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Cash
Ledger
Supplies
Accts. Payable
Ledger
A B C D
Customer AccountsAccts. Receivable
A B C D
Creditor Accounts
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Ledger Accounts• A simplified version of a ledger account is called the T-account.• They allow us to capture the essence of the accounting
process without having to worry about too many details.
• The account is divided into two sides for recording increases and decreases in the accounts.
Account Title
Left Side Right Side
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Debits and Credits• Debit (dr.) - an entry or balance on the left
side of an account
• Credit (cr.) - an entry or balance on the right side of an account
• Remember:• Debit is always the left side!• Credit is always the right side!
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Post from the journal
to the ledger.
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Posting
• What is posting?• It is the transfer of information from the
journal to the appropriate accounts in the ledger.
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POSTING TO THE LEDGER
• POSTING REFERS TO TRANSFERRING THE INFORMATION IN A JOURNAL ENTRY TO THE APPROPRIATE LEDGER ACCOUNT
• ENTER DATE• ENTER AMOUNT IN PROPER DEBIT OR
CREDIT COLUMN• ENTER JOURNAL SOURCE INFO
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Date Particulars L.f Amt. Date Particulars L.f Amt.
Debit Credit
Proforma for Account
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The Account
Account Title
Debit Credit
LEFT SIDE
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The Account
Account Title
Debit Credit
RIGHT SIDE
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Ledger Accounts• Balance - difference between total left-side
amounts and total right-side amounts at any particular time• Assets have left-side balances.
• Increased by entries to the left side• Decreased by entries to the right side
• Liabilities and Owners’ Equity have right-side balances.• Decreased by entries to the left side• Increased by entries to the right side
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Details of Journals and Ledgers
Date Particulars Debit CreditApril 2 Cash 30,000
Garge Capital 30,000(Received initialinvestment from owner)
JournalPage 1
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Date Ref. Particulars Amount Date Ref Particulars Amount
April 2 1 To G. Cap 30,000
Debit Cash Account Credit
Insert the number of the journal page.
Posting
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L.F. Date Description Debit Credit
12/1 Prepaid Insurance 2,400 Cash 2,400
Journal Page 1
Recording and Posting an Entry
1. Analyze and record the transaction as shown.
2. Post the debit side of the transaction.
3. Post the credit side of the transaction.
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L.f Date Description Debit Credit
12/1 Prepaid Insurance 15 2,400 Cash 2,400
Journal
Ledger Prepaid Insurance Account Dr. Cr.
Page 1
Recording and Posting an Entry
Date Particulars Fol.
Amt. Date Particulars Fol.
Amt.
12/1 To Cash 1 2400
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Recording and Posting an Entry
Date Description L.f.Debit Credit
12/1 Prepaid Insurance 15 2,400 Cash 11 2,400
Journal
Ledger Page No.15 Prepaid insurance Account Dr. Cr.
Page 1
13 24
Date Particulars Fol. Amt. Date Particulars Fol. Amt.
12/1 To Cash 1 2400
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TRIAL BALANCE
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TRIAL BALANCE
What is a Trial balance?• It is an internal document.• It is a listing of all the accounts with their
related balances.• It provide a check on accuracy by showing
whether total debits equal total credits.
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TRIAL BALANCE
• A listing of all accounts with balances at the end of the accounting period after all transactions have journalized and posted
• Purpose• to determine that debits = credits• to identify accounts to be adjusted
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TRIAL BALANCE
• A listing of all accounts with balances at the end of the accounting period after all transactions have journalized and posted
• To determine that debits = credits
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Preparing the Trial Balance• The purposes of the trial balance:
• To help check on accuracy of posting by proving whether the total debits equal the total credits
• To establish a convenient summary of balances in all accounts for the preparation of formal
financial statements
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Preparing the Trial Balance• The trial balance is usually prepared with
the balance sheet accounts first, followed by the income statement accounts.
• An example of a trial balance:Account (Rs)Number Account Title Debit Credit
100 Cash 3,50,000 3,50,000
130 Merchandise inventory 150,000 150,000 202 Note payable 100,000
100,000 300 Paid-in capital 400,000
400,000 500,000 500,000 ==================
===================
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Locating Trial Balance Errors• Note that a trial balance may balance even when
errors were made in recording or posting.• A transaction may be recorded as different
amounts in two different accounts.• A transaction may be recorded in a wrong
account.
• In both situations, the total debits will still equal total credits on the trial balance.
Dr. = Cr.
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Correcting Errors
Three Types of ErrorsJournal Entry Ledger Posting
1. incorrect not posted
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Correcting Errors
Three Types of ErrorsJournal Entry Ledger Posting
1. incorrect not posted2. correct incorrectly posted
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Correcting Errors
Three Types of ErrorsJournal Entry Ledger Posting
1. incorrect not posted
2. correct incorrectly postedincorrect
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DEBITS CREDITS
Locating Trial Balance Errors
• What if it doesn’t balance ?• Is the addition correct?• Are all accounts listed?• Are the balances listed correctly?
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Locating Trial Balance Errors
• Divide the difference by two.• Is there a debit/credit balance for this
amount posted in the wrong column?• Check journal postings.• Review accounts for reasonableness.• Computerized accounting programs usually
prohibit out-of-balance entries.
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Cash
AccountsPayable
Purchase Book
Ledger
All subsidiary books
combinedmake up
the ledger.
Cash transactions
liability accounts
Credit purchases
Subsidiary Books
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SELLING
BUYING
Special Journals
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Rendering of services on account
SELLING
Sales Book recorded in
BUYING
Special Journals
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Rendering of services on account
SELLING
Sales Book
Cash Book
Receipt of cash from any source
recorded in
recorded in
BUYING
Special Journals
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Rendering of services on account
SELLING
Sales Book
Cash Book
Purchases Book
Receipt of cash from any source
Purchase of items on account
recorded in
recorded in
recorded in
BUYING
Special Journals
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Special Journals
Rendering of services or selling of product on account
SELLING
Sales Book
Cash Book
Purchases Book
Cash Book
Receipt of cash from any source
Purchase of items on account
Payment of cash for any purpose
recorded in
recorded in
recorded in
recorded in
BUYING
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3/2 615 MyMusicClub.com 2,2003/6 616 RapZone.com 1,7503/18 617 Web Cantina 2,6503/27 618 MyMusicClub.com 3,000
Totals 9,600
Sales Journal InvoiceDate No. Particulars Details Amount
Page 35
The Sales Journal
All sales on credit are recorded in this journal. Each sales invoice is listed in numerical order. This journal is often referred to as an invoice register.
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3/3 Howard Supplies 600 3/7 Donnelly Supplies 420 3/19 Donnelly Supplies 1,450 3/27 Howard Supplies 960
Totals 3,430
Purchases Journal Page 11
The Purchases Journal
All purchases on account are recorded in this journal.
Date Particulars Details Amount
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Cash journals
• Single column Cash Book
= Simple cash Book• Double column Cash Book
= Cash Book with bank column• Triple column Cash Book
=Cash Book with Bank & Discount Column• Petty Cash Book
= Record small cash payouts
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The Financial Statements
The financial statements are a pictureof the company in financial terms.
Each financial statement relates to a specificdate or covers a particular period.
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Information Reported on the Financial Statements
1. How well did the company perform (or operate) during the period?
Revenues– Direct Expenses Gross income (Gross loss)
TradingAccount
Question AnswerFinancialStatement
1. How well did the company perform (or operate) during the period?
Gross Profit– Indirect Expenses Net income (Net loss)
Profit and Loss
Account
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Information Reported on the Financial Statements
3. What is the company’s financial position at the end of the period?
Assets= Liabilities
+ Owners’ equity
Balancesheet
Question AnswerFinancialStatement
4. How much cash did the company generate and spend during the period?
Operating cash flows± Investing cash flows± Financing cash flowsIncrease or decrease in cash
Statementof
cashflows
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Income Statement
The income statement, reports the company’s revenues,
expenses, and net incomeor net loss for the period.
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Introduction to theIncome Statement
The income statement is a financialtool that provides information about
a company’s past performance.
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The Income Statement
Revenues
–Expenses
= Net income(or Net loss)
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Sales revenues– Cost of goods sold Gross profit
Operatingincome
Selling andadministrative
expenses– =
Income Statement Format
Add: Other revenues and gainsLess: Other expenses and losses
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Income Statement
Revenue - the proceeds that come from sales to customers
Cost of Goods Sold - an expense that reflects the cost of the product or good that generates revenue. .
Gross Margin - also called gross profit, this is revenue minus
COGS
Operating Expenses - any expense that doesn't fit under COGS
such as administration and marketing expenses.
Net Income before Interest and Tax - net income before taking interest
and income tax expenses into account.
Interest Expense - the payments made on the company's outstanding debt.
Income Tax Expense - the amount payable to government.
Net Income - the final profit after deducting all expenses from revenue.
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The Income Statement can be divided into:
• Trading Account
• Profit and Loss Account
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The Accounting Terms
Revenues are inflows or otherenhancements of assets to an entity.
They result from delivering orproducing goods, rendering services,or other activities that constitute theentity’s major or central operations.
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The Accounting Terms
Expenses are outflows orother using up of assets.
They result from delivering orproducing goods, rendering services,or other activities that constitute theentity’s major or central operations.
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The Accounting Terms• Gross profit (gross margin) - excess of sales
revenue over the cost of inventory that was sold• Operating expenses - a group of recurring
expenses that pertain to a firm’s routine operations
• Operating income (operating profit) - gross profit less all operating expenses
• Other revenues and expenses - items not directly related to the main operations of a firm
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The Accounting Terms
• Net income - the remainder after all expenses (including income taxes) have been deducted from revenue• Often seen as the “bottom line”
• Net loss - the excess of expenses over revenues
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The Income StatementDANIELS COMPANY
Income Statement
for the Year Ended June 30, 2002
Sales Rs98,600
Expenses:
Wages expense Rs45,800
Rent expense 12,000
Carriage 6,500
Depreciation expense 5,000
Total expenses 69,300
Net Income Rs29,300==============
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Proforma for the Trading Account for the year ending on
31.12.2005
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Particulars Amount Particulars Amount
Opening stockPurchasesLess:- Returns :-DrawingsDirect Expenses:-• Carriage inward• Wages• Fuel & Power• Manf. Expenses• Coal, water & gas• Foreman/Works• Manager’s salary• Royalty on manf. Goods• Gross profit c/d(bal)
SalesLess: Returns Closing stockGoods Lost by fire(Gross Loss c/d)
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Proforma for the Profit and Loss Account for the year
ending on 31.12.2005
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Profit and Loss Account for the period ending on -----Debit Credit
Particulars Amount Particulars Amount
Gross loss b/dSelling & Dist Exp :-• Advertisement• Traveller’s Salary, exp. & commission• Bad DebtsAdministration Expenses• Rent, Rates & Taxes• Office salaries• Printing & Stationary
Net Profit c/d (bal)
Gross Profit b/dInterest Received Discount ReceivedComm. ReceivedNet Loss c/d
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Introduction to theBalance Sheet
The balance sheet is the financialtool that focuses on the present
condition of a business.
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The Balance Sheet• The Balance sheet shows the financial
position of a company at a particular point in time.• The balance sheet is also referred to as the
statement of financial position or the statement of financial condition.
• The left side lists assets – the right side lists liabilities and owners’ equity
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The Accounting Elements
Probable future economic benefitsobtained or controlled by aparticular entity as a resultof past transactions events.
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The Accounting Elements
Probable future sacrifices of economicbenefits arising from present obligationsof a particular entity to transfer assets
or provide services to other entitiesin the future as a result of past
transactions or events.
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The Accounting Elements
The residual interest in the assetsof an entity that remains after
deducting its liabilities.
Investmentby owners
Earnedequity
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Formats of Balance Sheets• Balance sheet formats:
• Report format - a classified balance sheet with assets at the top and liabilities and equity below
• Account format - a classified balance sheet with assets at the left and liabilities and equity at the right
• Regardless of format, balance sheets always contain the same basic information.
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Balance Sheet Transactions
• The balance sheet is affected by every
transaction that an entity encounters.
• Each transaction has counterbalancing entries that keep total assets equal to total liabilities and owners’ equity.
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BALANCE SHEET
• RESOURCES AVAILABLE FOR USE BY THE FIRM (ENTITY)
• ASSETS - PROBABLE FUTURE ECONOMIC BENEFITS
• HOW RESOURCES ARE FINANCED• LIABILITIES - DEBT OWED TO
OTHERS• OWNERS’ EQUITY - INVESTMENT BY
OWNERS• DIRECT• INDIRECT
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The Balance SheetSTEVENS COMPANY
Balance Sheet as on June 30, 2005
Liabilities Assets
Owner’s Equity
Hamilton, capitalReservesSecured LoansUnsecured Loans
Current liabilities:
Wages payable Tax payableBills Payable
Bank balance Cash balance
Fixed Assets: Land
Plant Equipment
Total Fixed Asset
Current assets:
Bills Receivable
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LIABILITIES ASSETS
SHARE CAPITAL Authorised Issued Subscribed Less:- Calls unpaid Add:- Forfeited shares RESERVES AND SURPLUS SECURED LOANS UNSECURED LOANS: CURRENT LIABILITIES AND PROVISIONS: A. CURRENT LIABILITIES: a) Acceptances. b) Sundry Creditors c) Subsidiary companies. d) Advance Payments e) Unclaimed dividends f) Other liabilities (if any) g) Interest accrued but not due on loans. B. PROVISIONS a) Provision for taxation. b) Proposed dividends. c) For contingencies.
FIXED ASSETS a) Land , b) Buildings, c) Goodwill, d) Plant and Machinery e) Furniture and fittings f) Patents, trade marks and designs. INVESTMENTS: a) Investments in Government or Trust Securities, in shares, debentures or bonds, b) Immovable Properties. CURRENT ASSETS, LOANS AND ADVANCES: (A) Current Assets: a) Interest accrued on Investments. b) Stores and Spare Parts,c) Loose Tools d) Stock in trade, e) Works in progress. f) Sundry Debtors, g) Cash balance on hand h) Bank balances (B) LOANS AND ADVANCES: a) Advances and loans to subsidiaries. b) Bills of Exchange. c) Advances recoverable in cash or in kind MISCELLANEOUS EXPENDITURE: a) Preliminary expenses. b) Expenses including commission or brokerage on underwriting or subscription of shares or debentures. c) Discount allowed on the issue of shares or debentures.
PROFORMA BALANCE SHEET
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The Balance Sheet
• Elements of the balance sheet:• Assets - resources of the firm that are expected to
increase or cause future cash flows (everything the firm owns)
• Liabilities - obligations of the firm to outsiders or claims against its assets by outsiders (debts of the firm)
• Owners’ Equity - the residual interest in, or remaining claims against, the firm’s assets after deducting liabilities (rights of the owners)
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Classifying Assets and Liabilities
Current assets
Long-term assets
Current liabilities
Long-term liabilities
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XYZ Ltd.Trial Balance
November 30, 2002
Cash 5,900Purchases 550Land 20,000Accounts Payable 400Amit, Capital 25,000Amit, Drawing 2,000Fees Earned 7,500Wages Expense 2,125Rent Expense 800Commission 450Supplies Expense 800Miscellaneous Expense 275
32,900 32,900
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XYZ Ltd.Trial Balance
November 30, 2002
Cash 5,900Purchases 550Land 20,000Accounts Payable 400Amit, Capital 25,000Amit, Drawing 2,000Fees Earned 7,500Wages Expense 2,125Rent Expense 800Commission 450Supplies Expense 800Miscellaneous Expense 275
32,900 32,900
BalanceSheet
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IncomeStatement
XYZ Ltd.Trial Balance
November 30, 2002
Cash 5,900Purchases 550Land 20,000Accounts Payable 400Amit, Capital 25,000Amit, Drawing 2,000Fees Earned 7,500Wages Expense 2,125Rent Expense 800Commission 450Supplies Expense 800Miscellaneous Expense 275
32,900 32,900
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XYZ Ltd.
Balance Sheet Income Statement
1. Assets11 Cash12 Accounts Receivable14 purchases15 Prepaid Insurance17 Land18 Office Equipment
2. Liabilities21 Accounts Payable23 Unearned Rent
3. Owner’s Equity31 Amit, Capital32 Amit, Drawing
4. Revenue41 Sales5. Expenses51 Wages Expense52 Rent Expense54 Commission55 Supplies Expense59 Miscellaneous
Expense
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SummaryOriginal evidence
recordsAccounting
recordsFinancial
Statements
Sourcedocuments
Journals
Ledger
Trial Balance
Statement of cash flows
Balance Sheet
Profit and LossStatement
ClosingEntries