Chapter 2Chapter 2

Accounting Principles

Learning ObjectivesLearning ObjectivesAfter studying this chapter, you should be After studying this chapter, you should be

able to:able to: Students are able to understand the Students are able to understand the

accounting conceptsaccounting concepts Students are able to understand the concept of Students are able to understand the concept of

Book Keeping and accounting Book Keeping and accounting Students are able to understand the difference Students are able to understand the difference

between Book Keeping and Accounting between Book Keeping and Accounting Students are able to understand the Students are able to understand the

Accounting cycle.Accounting cycle. Students are able to understand the concept of Students are able to understand the concept of

Accounting equation. Accounting equation.

Accounting ConceptsAccounting ConceptsThe term Concepts includes those The term Concepts includes those basic assumptions or conditions basic assumptions or conditions upon which accounting is based.upon which accounting is based.

1. Accounting Period Assumption1. Accounting Period AssumptionThe users of financial statements need The users of financial statements need periodical reports to know the operational periodical reports to know the operational result and the financial position of the result and the financial position of the business concern.business concern.

Hence it becomes necessary to close the Hence it becomes necessary to close the accounts at regular intervals. Usually a period accounts at regular intervals. Usually a period of 365 days or 52 weeks or 1 year is of 365 days or 52 weeks or 1 year is considered as the accounting period.considered as the accounting period.

Accounting ConceptsAccounting Concepts Accounting Entity AssumptionAccounting Entity Assumption

According to this assumption, According to this assumption, business is treated as a unit or entity business is treated as a unit or entity apart from its owners, creditors and apart from its owners, creditors and others. In other words, the proprietor others. In other words, the proprietor of a business concern is always of a business concern is always considered to be separate and considered to be separate and distinct from the business which he distinct from the business which he controls. All the businesscontrols. All the business

transactions are recorded in the transactions are recorded in the books of accounts from the view point books of accounts from the view point of the business. of the business.

Accounting ConceptsAccounting Concepts

Money Measurement AssumptionMoney Measurement Assumption

In accounting, only those business In accounting, only those business transactions and events which are of transactions and events which are of financial nature are recorded. For financial nature are recorded. For example, when Sales Manager is not on example, when Sales Manager is not on good terms with Production Manager, good terms with Production Manager, the business is bound to suffer. This fact the business is bound to suffer. This fact will not be recorded, because it cannot will not be recorded, because it cannot be measuredbe measured

in terms of money.in terms of money.

Accounting ConceptsAccounting Concepts Dual Aspect ConceptDual Aspect Concept

Dual aspect principle is the basis for Dual aspect principle is the basis for Double Entry System of book-Double Entry System of book-keeping. All business transactions keeping. All business transactions recorded in accounts have two recorded in accounts have two aspects - receiving benefit and aspects - receiving benefit and giving benefit. For example, when a giving benefit. For example, when a business acquires an asset business acquires an asset (receiving of benefit) it must pay (receiving of benefit) it must pay cash (giving of benefit).cash (giving of benefit).

Accounting ConceptsAccounting Concepts

Matching Concept:Matching Concept:

The aim of every business is to earn The aim of every business is to earn profit. In order to ascertain the profit. In order to ascertain the profit the cost( expense) are profit the cost( expense) are matched to revenue. Revenue of matched to revenue. Revenue of particulars period matched against particulars period matched against expenses of the period.expenses of the period.

Accounting ConceptsAccounting Concepts

Going Concern ConceptGoing Concern Concept

As per this assumption, the As per this assumption, the business will exist for a long business will exist for a long period and transactions are period and transactions are recorded from this point of view. recorded from this point of view. There is neither the intention nor There is neither the intention nor the necessity to wind up the the necessity to wind up the business in the foreseeable future.business in the foreseeable future.

..

Book Keeping Book Keeping Vs .AccountingVs .Accounting

AccountingAccounting – is the art of recording, – is the art of recording, classifying and summarizing in classifying and summarizing in terms of money to interpreting the terms of money to interpreting the result. result.

Booking Keeping - is the art of Booking Keeping - is the art of recording business transaction in recording business transaction in the book in regular and systematic the book in regular and systematic manner.manner.

Distinction between Book-keeping and Distinction between Book-keeping and AccountingAccounting

Sr #

Basis of Distinction

Book Keeping Accounting

1 Scope Recording and maintenanceof books of accounts.

It is not only recording and maintenance of books of accounts but also includesanalysis, interpreting and Communicating the information

2 Objective To maintain systematic records of business transaction

To ascertain the net result of the business operation.

3 Nature Often routine and clerical in nature.

Analytical and executive in nature.

4 Responsibility

A book-keeper is responsible for recording business transactions.

An accountant is also responsible for the work of a book-keeper.

5 Supervision

The book-keeper does not supervise and check the work of an Accountant.

An accountant supervises and checks the work of the book-keeper.

6 Staff involved

Work is done by the junior staff of the organization

Senior staff performs the accounting work.

Accounting CycleAccounting Cycle

MeaningMeaning

An accounting cycle is a An accounting cycle is a complete sequence of accounting complete sequence of accounting process, that begins with the process, that begins with the recording of business recording of business transactions and ends with the transactions and ends with the preparation of final accounts.preparation of final accounts.

Accounting Accounting Equation Equation

Double EntryDouble Entry

SystemSystemDR CR

Introduction of Introduction of Accounting EquationAccounting Equation

A statement which shows the equality A statement which shows the equality of business assets and liabilities is of business assets and liabilities is called accounting equation. called accounting equation.

Those who contribute assets to a Those who contribute assets to a business have legal claims on those business have legal claims on those assets. So assets of the business are assets. So assets of the business are equal to the sum of the assets equal to the sum of the assets contributed by owner and contributed contributed by owner and contributed by the creditors.by the creditors.

Accounting EquationAccounting Equation

Assets = Owner’s Equity + Liabilities

Items of value owned by the business

The funds of a business provided by its owners and the profits entitled to him

Debts owed by a business to external parties such as suppliers

Assets = Owner’s Equity + Liabilities

Building

Motor vehicle

Office Equipment

Fixtures

Stock (closing)

Cash in hand

Cash at bank

Capital

Profits

Creditors

Loan from bank

Other creditors

Introduction of Introduction of Accounting EquationAccounting Equation

The following relationship holds and The following relationship holds and referred to as the “Accounting referred to as the “Accounting Equation”. Equation”.

Assets = Assets = Liabilities+Owner’s Equity Liabilities+Owner’s Equity

Resources = Claims on Resources = Claims on ResourcesResources

Effect of Transaction upon

If a company keeps accurate records, the accounting equation will always be “in balance,” meaning the left side should always equal the right side. The balance is maintained because every business transaction affects at least two of a company’s accounts. The accounting equation will always remain in balance if double-entry accounting is followed accurately.

Introduction of Introduction of Accounting EquationAccounting Equation

For example, when a company borrows For example, when a company borrows money from a bank, the company’s money from a bank, the company’s assets will increase and its liabilities will assets will increase and its liabilities will increase by the same amount. When a increase by the same amount. When a company purchases inventory for cash, company purchases inventory for cash, one asset will increase and one asset will one asset will increase and one asset will decrease. Because there are two or more decrease. Because there are two or more accounts affected by every transaction, accounts affected by every transaction, the accounting system is referred to as the accounting system is referred to as double entry accounting

EXAMPLE-1EXAMPLE-1Transaction # 01:Transaction # 01:

Mr.A started business with cash Mr.A started business with cash Rs.70, 000 on Jan.1, 2009. Rs.70, 000 on Jan.1, 2009.

Assets = Assets = Liabilities+Owner’s EquityLiabilities+Owner’s Equity

Cash = Cash = CapitalCapital

EXAMPLE-1EXAMPLE-1

Transaction # 01:Transaction # 01:

Mr.A started business with cash Mr.A started business with cash Rs.70, 000 on Jan.1, 2009. Rs.70, 000 on Jan.1, 2009.

Assets = Assets = Liabilities+Owner’s EquityLiabilities+Owner’s Equity

Cash = Cash = CapitalCapital

Rs.70,000 = Nil +Rs.70, Rs.70,000 = Nil +Rs.70, 000000

EXAMPLE-2EXAMPLE-2 Transaction # 02:Transaction # 02:

Purchase furniture on cash Rs.5, 000.Purchase furniture on cash Rs.5, 000.

AssetsAssets = Liabilities + owner Equity= Liabilities + owner Equity

Cash +Furniture = Nil + Capital 70, Cash +Furniture = Nil + Capital 70, 000 70000 000 70000

EXAMPLE-2EXAMPLE-2 Transaction # 02:Transaction # 02:

Purchase furniture on cash Rs.5, 000.Purchase furniture on cash Rs.5, 000.

AssetsAssets = Liabilities + owner Equity= Liabilities + owner Equity

Cash +Furniture = Nil + Capital 70, Cash +Furniture = Nil + Capital 70, 000 70000 000 70000

-5,000 +5,000-5,000 +5,000

65, 000+5,000 = Nil + Rs.70,000 65, 000+5,000 = Nil + Rs.70,000

IN CLOSING…