Accounting Part1

7/31/2019 Accounting Part1

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Chapter: 1 Meaning, Objectives and Basic Accounting Terms.

What is accounting? Accounting is 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 financial character, and interpretingthe results of it.

The systematic recording, classifying, and analysis offinancial transactions of a business

Attributes of Accounting:

Financial transaction:

A financial transaction is an agreement, communication, or movement carried out between a buyer anda seller to exchange goods and services for payment, that effects the financial position of the business.

Types of Transactions:

Cash Transaction: When cash is paid or received on entering in to the transaction is calledcash transaction.

Credit Transaction: If one promises to pay latter is called credit transaction.

Recording of financial transaction: Recording business transaction in the books of account in asystematic manner soon after the occurrence of it.Recording is done in the book called Journal.Transactions include sales, purchases, income, receipts and payments by an individual ororganization.

Classifying: Classifying is the process of grouping of transactions or entries of one nature at on place.This is done by opening account in the books called ledger.

Summarizing: Summarizing is the art of presenting the classified data (Ledger) in an understandablemanner and useful to management and other interested parties. This involves preparation of final

accounts which includes Trading and profit and loss account and balance sheet.

Analysis and interpretation

The purpose of the data analysis and interpretation is to transform the data collected into reliable facts aboutthe development and performance of the business.

Parties interested in Accounting Information:

Owners, Investors, Creditors, Lenders, Employees and workers, Managers, Government, Researchers

Objectives of accounting:

Maintenance of business records.

Calculation of profit and loss

Depiction of Financial Position

Making the information available to various groups and managers

Advantages of accounting

Assistance to management

Replacement of memory
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Comparative study

Settlement of Taxation liability

Evidence in court

Sale of business

Assistance to an insolvent person

Disadvantages of accounting

Accounting is not fully exact Accounting will not fully include what business will realize, if sold

Accounting does not tell the whole story

Accounting statement may be drawn up wrongly

Accounting terminology

Capital:Money invested (cash or asset form) in the business by the owners. Also called equity

Liabilities:What your business have to pay to creditors or outsiders. Examples are accounts payable, loans payable.

Long Term Liabilities or current LiabilitiesLiabilities those are not due within one year. An example would be a mortgage payable.

Accounts PayableAlso called A/P or Creditors, Accounts payable are the bills your business owes to suppliers.

Accounts ReceivableAlso called A/R or Debtors, accounts receivable are the amounts owed to you by your customers.

Accrual Based AccountingWith the accrual method, you record income when the sale occurs, not necessarily when you receive payment.You record an expense when you receive goods or services, even though you may not pay for them until later.

AssetsThings of value held by the business, Assets are balance sheet accounts. Examples of assets are accountsreceivable, furniture, fixtures and bank accounts.

Balance SheetAlso called a statement of financial position, it is a financial "snapshot" of your business at a given point in time.It lists your assets, your liabilities, and the difference between the two, which is your equity, or net worth

Cash Based AccountingIf you use the cash method, you record income only when you receive cash from your customers. You recordan expense only when you write the check to the vendor.

Cost of Goods Sold(COGS) Cost of items or services sold to your customers.

CreditorA company or individual whom you have to pay money

CreditsAt least one component of every accounting transaction (journal entry) is a credit. Credits increase liabilitiesand equity and decrease assets.


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Current AssetsAssets that are in the form of cash or will generally be converted to cash or used up within one year. Examplesare accounts receivable and inventory.

DebitsAt least one component of every accounting transaction (journal entry) is a debit. Debits increase assets anddecrease liabilities and equity.

Debtor

A company or individual who has to pay money to you

DepreciationAn annual write-off of a portion of the cost of fixed assets, such as vehicles and equipment. Depreciation islisted among the expenses on the income statement.

Double Entry AccountingIn double-entry accounting, every transaction has two entries: a debit and a credit (called a journal entry).Debits must always equal credits. All General Ledger based accounting programs use double entry accounting.

Equity or capitalThe net worth of your company. Also called owner's equity or capital. Equity comes from investment in thebusiness by the owners, plus accumulated net profits of the business that have not been paid out to the

owners.

Fixed AssetsAssets that are generally not converted to cash within one year. Examples are equipment and vehicles.

General LedgerA general ledger is the collection of all balance sheet, income, and expense accounts used to keep theaccounting records of a business. A general ledger works with double entry accounting and journal entries foreach transaction.

Profit and loss statement or a "P&L."It lists your income, expenses, and net profit (or loss). The net profit (or loss) is equal to your income minusyour expenses.

Inventory (Stock)Goods you hold for sale to customers. Inventory can be merchandise you buy for resale, or it can bemerchandise you manufacture or process, selling the end product to the customer.

JournalThe chronological, day-to-day transactions of a business are recorded in sales, cash receipts, and cashpayment journals.

Net IncomeAlso called profit or net profit, it is equal to income minus expenses. Net income is the bottom line of theincome statement (also called the profit and loss statement).

Retained EarningsProfits of the business that have not been paid to the owners; profits that have been "retained" in the business.

Trial BalanceA list of the categories (or general ledger accounts) and their totals

Revenue:Revenue means the amount which, as a result of operations, is added to the capital.

Expense:


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Expense is the cost of the use of things or services for the purpose of generating the revenue.

Purchase:The term purchase is used for the purchase of goods meant for resale or for producing the finished goods. Theterm includes both cash and credit purchase

Sales:This term is used for the sale of goods only. Sale includes both cash and credit sales.

Stock:The term stock includes the goods lying unsold on a particular date, to ascertain the value of closing stock, itis necessary to make a complete list of all the items in the godown together with quantities. The stock isvalued on the basis of stock or market prices which ever is less principle. The stock may be openingand closing stock.

Opening Stock:The term opening stock means goods lying unsold in the beginning of the accounting year

Closing Stock:The term closing stock means goods lying unsold at the end of the accounting year

Losses:Losses really mean something against which the firm receives no benefit. It may be noted that expenses leadto revenue but loses do not, such as theft. Some time the expenses exceeds the revenue, this shows that theextra expenses does not contribute anything to generate the revenue hence they are also loses.

Proprietor:The person who makes the investment and bears all the risks connected with the business is called theproprietor.

Drawings:It is the amount of money or value of goods which the proprietor takes for his domestic or personal use.

Discount:When customer are allowed any type of reduction in the prices of goods by the businessman, that is calleddiscount.

Trade discount:When some discount is allowed in prices of goods on the basis of sales of the items, that is called tradediscount.

Cash discount:When debtors are allowed some discount in prices of the goods for quick payment, it is called cash discount.


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Chapter: 2 Theory Base of Accounting

Basic accounting principles and assumptions

Accounting principles and assumptions are the essential guidelines under which businesses prepare theirfinancial statements. These principles guide the methods and decisions for a business over a short and long

term. For both internal and external reporting purposes, it is important to understand the concepts presentedbelow because they serve as a guideline to the analysis of financial reporting issues.

Revenue Recognition PrincipleUnder this principle revenue is to be recorded when it is realized (or realizable), and when it is earned and notwhen it is received. Revenue is realized when goods or services are exchanged, is realizable when assetsreceived can be converted to cash, and is earned when all necessary requirements are met entitling thecompany to the benefits represented by the revenue (e.g. services performed).

For example, suppose a neighborhood coffee house orders 100 coffee mugs from a coffee wholesaler in June.The coffee house takes delivery of the new mugs in July and pays for the order in August. The wholesaler doesnot recognize the revenue from this sale in June, when the order was placed, or in August, when the cash wasreceived. For recording purposes, the revenue is recognized by the wholesaler in July, when the coffee mugs

were delivered to the coffeehouse.

This principle is used for the recognition of revenue for both goods and services. For example, if an attorney ishired with an agreed upon retainer fee of Rs.2,500 in May, and the services are not performed until July, theattorney does not recognize the revenue until July. The attorney must earn the income before it can berecorded as such, even though he/she received cash for the service at an earlier date.

Historical Cost PrincipleThe historical cost principle deals with the valuation of both assets and liabilities. The value at the time ofacquisition is used to value most assets and liabilities. For example, say the coffee wholesaler purchased anoffice building in 1990 for Rs.1.2 crore. Over time this asset has most likely appreciated in value. However, inaccordance with the cost principle, the original (historical) price of the building is what is recorded as the cost ofthe building in the books of the business.

Matching PrincipleThis principle mandates that the expenses of a business need to line up with its revenue. The expense or costof doing business is recorded in the same period as the revenue that has been generated as the result ofincurring that cost. In the case of the coffee wholesaler, when the 100 coffee mugs were delivered in July theychanged from being a part of inventory (asset) to a cost of goods sold entry (expense) in the month that therevenue from the sale was recognized. At this point, the difference between the revenue and expense isdetermined as the gross profit from the sale.

Full Disclosure PrincipleThis principle states that all past, present and future information that may have had an impact on the financialperformance of the company needs to be fully disclosed. The historical performance of a company is readily

available, but examining the numbers does not always provide the entire financial picture of a company.Sometimes there are alternative situations that need to be reported. Pending or current lawsuits are oneexample of a transaction that could severely impact a companys bottom line. In addition, incomplete financialtransactions or any other conditions that could impact the companys performance must also be disclosed.Most of these transactions are disclosed in the footnotes to the financial statements.

Economic Entity AssumptionUnder the economic entity assumption, an economic activity can be identified to a separate entity accountablefor that activity. In other words, this assumption states that businesses must keep their transactions separatefrom their owners, business units or other businesses transactions. For example, the business activities of theneighborhood coffee house are to be kept separate from the financial activities of its owners or managers. Thefinancial statements for the coffee house will only reflect the revenue and expenses for the coffee house. Thus,


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it is possible to compare the financial statements of this coffeehouse with its competitors reports, since thesestatements should be reported separately under the economic entity assumption. Important to note, a separateentity does not necessary mean a legal entity. For example, financial statements for a parent company and itssubsidiaries (i.e. separate legal entities) can be presented together (i.e. consolidated financial statements).

Going Concern AssumptionFor accounting purposes, the going concern assumption states that the financial activities of a business areassumed to be in operation for an indefinite period of time. This allows a business to operate with a viewtowards a long term. This is a very critical assumption as it provides that there is no short term end point inwhich all assets need to be sold and all debt must be paid off. Thus, the going concern assumption makes itpossible to depreciate or amortize assets because we assume that businesses will have a long life. Forexample, if the coffee house was going to be sold, its assets would be valued at their disposal or liquidationvalue (sales price less expense of disposal). Under the going concern assumption, the coffee house values itsassets at their original cost. As we can see, the going concern assumption is only inapplicable when businessliquidation is imminent, and it should be used in all other business situations.

Monetary Unit AssumptionThis assumption states that information in the financial statements must be expressed in monetary units. Thereason is that economic activity is expressed in monetary unit, and thus, it makes sense to apply the samebasis for accounting purposes. Monetary units are relevant, universally available, and understandable. Usingthe neighborhood coffeehouse as an example, the intrinsic value of the best coffee server cannot be valued inthe financial statements, regardless of how many customers frequent the coffeehouse due to this individual.The inherent value of this person cannot be quantified in the financial statements as an asset.

The monetary unit assumption also states that a stable unit of currency is to be used as the unit of record. InIndia, the Indian Rupee is typically the currency of choice. Important to note, accounting ignores inflation ordeflation and assumes that Indian Rupee remains reasonably stable. For instance, no adjustments arenecessary when adding 1990 Rupees to 2010 Rupees, unless economic conditions change dramatically (e.g.hyperinflation).

Time Period AssumptionThis assumption allows for the division of businesses operational activities into artificial time periods forreporting purposes as determined by the business owners. The coffeehouse can record information on a daily,weekly, monthly, quarterly and yearly basis during a time frame they deem relevant. However, there is a trade-

off between the accuracy (reliability) and relevancy in preparing financial statements: the more quickly acompany presents financial data, the more likely such data contains errors (i.e. less reliable information).


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Chapter: 3 Accounting Equations & Accounting Formats

The 'basicaccounting equation'is the foundation for the double-entry bookkeepingsystem. For each transaction, the total debits equal the total credits.

Assets = Liabilities + Owner's Equity

What a company owns must always equal (=)

What it owes to its creditors

Plus (+) what it owes to the owner or owners

What is Asset?An asset is something of value the company owns. Assets can be tangible or intangible.

Tangible assets: are generally divided into three majorcategories:

Current assets (including cash, marketable securities, accounts receivable,inventory, and prepaid expenses)

Property, plant, and equipment

Long-term investments

Current assets typically include cash and assets the company reasonably expects to use,sell, or collect within one year. Current assets appear on the balance sheet (and in the

numbered list below) in order, from most liquid to least liquid. Liquid assets are readily

convertible into cash or other assets, and they are generally accepted as payment for

liabilities.

1. Cash includes cash on hand (petty cash), bank balances (checking, savings, or

money-market accounts), and cash equivalents. Cash equivalents are highly liquid

investments, such as certificates of deposit and U.S. treasury bills, with maturities of ninety

days or less at the time of purchase.

2. Marketable securities include short-term investments in stocks, bonds (debt),certificates of deposit, or other securities. These items are classified as marketable securities

rather than long-term investmentsonly if the company has both the ability and the desire

to sell them within one year.

3. Accounts receivable are amounts owed to the company by customers who have

received products or services but have not yet paid for them.

4. Inventoryis the cost to acquire or manufacture merchandise for sale to customers.

Although service enterprises that never provide customers with merchandise do not use this
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the sum of all investment in the business by the owner or owners minus withdrawals made by the

owner or owners. The owner's investment is recorded in the owner's capital account, and any

withdrawals are recorded in a separate owner's drawing account. For example, if a business owner

contributes Rs.10,000 to start a company but later withdraws Rs.1,000 for personal expenses, the

owner's net investment equals Rs.9,000. Net income ornet lossequals the company's revenues

less its expenses. Revenues are inflows of money or other assets received from customers in

exchange for goods or services.Expenses are the costs incurred to generate those revenues.

Capital investments and revenues increase owner's equity, while expenses and owner withdrawals

(drawings) decrease owner's equity. In a partnership, there are separate capital and drawing

accounts for each partner.

Sample Problem:

Transaction

Number

Assets Liabilities Shareholder's

Equity

Explanation

1 + 6,000 + 6,000 Issuing stocks for cash or other assets

2 + 10,000 + 10,000 Buying assets by borrowing money (taking a loan from a

bank or simply buying on credit)

3 900 900 Selling assets for cash to pay off liabilities: both assets and

liabilities are reduced

4 + 1,000 + 400 + 600 Buying assets by paying cash by shareholder's money

(600) and by borrowing money (400)

5 + 700 + 700 Earning revenues
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6 200 200 Paying expenses (e.g. rent or professional fees) or

dividends

7 + 100 100 Recording expenses, but not paying them at the moment

8 500 500 Paying a debt that you owe

9 0 0 0 Receiving cash for sale of an asset: one asset is

exchanged for another; no change in assets or liabilities

These are some simple examples, but even the most complicated transactions can be recorded in

a similar way. This equation is behind debits, credits, and journal entries.

The DEBIT - CREDIT Rule

Each of the accounts in a Ledger will have a Debit Column and a CreditColumn. Debits and Credits increase or decrease amounts on a ledger pageaccount without having to use a plus (+) or minus (-) sign.

No matter what - alwaysDEBIT on the LEFT and CREDIT on the RIGHT.

This basic rule never changes.

"T" Accounts

Notice in this graphic that DEBIT is on the LEFT and
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that CREDIT is on the RIGHT in each of the "T" s.

Again, always DEBIT LEFT and CREDIT RIGHT

"T" Accounts Expanded

Now that we know that we always debit on the left and credit on the right we canbegin to discuss how we INCREASE and DECREASE the balances in accounts.The ( + ) sign means INCREASE and the ( - ) sign means DECREASE. Note thatwhen you cross over the ( = )sign you reverse the way accounts increase anddecrease.

Assets: To INCREASE ( + ) the balance in Asset Accounts you DEBIT To DECREASE ( - ) the balance you CREDIT

Liabilities:

To INCREASE the balance in Liability Accounts you CREDIT

To DECREASE the balance you DEBIT

Owner's Capital:

To INCREASE the balance in Owner's Equity Accounts you CREDIT

To DECREASE the balance you DEBIT


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T's within Ts


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Note: In Balance Sheet, Assets will be on right hand side (RHS) and liabilities on left hand side (LHS)

For Single Proprietor and Partnerships


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Note: In Balance Sheet, Assets will be on right hand side (RHS) and liabilities on left hand side (LHS)


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The next step is to fill in theseLedgerpages using the amounts in the

General Journal a nd show how Posting to Ledger pages is done.


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Next we will make a Trial Balance to be sure that all the different

accounts are in balance.


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Trading and Profit & Loss Account example


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Trading and Profit & Loss Account example

Rs Rs

Debit Credit

Revenues

GROSS REVENUES (including INTEREST income) 296,397

--------

Expenses:

ADVERTISING 6,300

BANK & CREDIT CARD FEES 144

BOOKKEEPING 2,350

SUBCONTRACTORS 88,000

ENTERTAINMENT 5,550

INSURANCE 750

LEGAL & PROFESSIONAL SERVICES 1,575

LICENSES 632

PRINTING, POSTAGE & STATIONERY 320

RENT 13,000


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MATERIALS 74,400

TELEPHONE 1,000

UTILITIES 1,491

--------

TOTAL EXPENSES (195,512)

--------

NET INCOME 100,885

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Accounting Part1

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