Classification of Accounts: Account is summarised record of all transaction relating to a person, property, income or expense.

The different types of transactions are carried on by businesses, which affect the various accounts like Rams Account, Laxmans Account, Machinery Account, Furniture Account, Salary Account, Interest Account, etc. Basically, these accounts are classified as follows: I. II. Personal Account. Impersonal Account.

I. Personal Account: Personal Accounts include the accounts of persons or parties with whom the business deals. These accounts can be classified into three categories: (1) Natural Personal Accounts: The term natural accounts means persons who are creation of God. E.g. Amits A/c., Sanjays A/c., Ajays A/c., Karans A/c. , Bank A/c., etc. (2) Artificial Personal Accounts: These accounts include accounts of corporate (i.e. registered) bodies or institutions, e.g., companies, co-operatives, clubs, accounts of government, insurance companies, charitable trust, partnership firms, legal authorities (like municipality, gram panchayat), banks, schools, colleges, etc. (3) Representative Personal Accounts: These accounts represent a certain party or party. E.g. Rent is unpaid for the last month of December Rs. 500. Other examples are Prepaid rent, prepaid insurance, etc. From personal accounts, we find out whether amount is payable or receivable. In other words, whether party is a debtor or creditor. II. Impersonal Accounts: All accounts other than Personal Accounts are Impersonal Accounts. These are further divided into(a) Real Account (b) Nominal Account.

(a) Real Account or Property Account: Real account represents assets belong to a business. Tangible Real Accounts: Means the things which we can touch, see, measure and feel. E.g. Cash account, Building Account, Land Account, Machinery Account, Furniture Account, Stock Account.

1. Intangible Real Account: These accounts represents such things which cannot be seen or touched, but can be measured in money terms. E.g. Goodwill, Patent Rights, Copyrights, Trademark Right, Design Right, etc. (b) Nominal Account or Fictitious Accounts: These accounts are opened in the books to explain the nature of the transactions. They do not really exist and thus they are fictitious. In a business, salary is paid to a clerk, rent is paid to landlord, and commission is paid to an agent. For all these transactions cash goes out of the business and cash is real, but salary, rent, commission, etc. do not exist. The accounts of these items are opened simply to explain how cash has been spent. Nominal accounts include the accounts of all expenses and gains. E.g. Rent, Rates, Insurance Premium paid, Bank

charges, Dividend, Interest, Electricity and Power, Loss by fire, Loss by theft, Profit on sale of investments.

Rules of Debit and Credit

We have seen that under Double entry system of book-keeping two accounts are involved. One account receives the benefit and the other gives the benefit, and hence one account is debited while other account is credited. Thus it is to be decided which account we should debit and which account we should credit. In Book-keeping and Accountancy, rules are formed for debit and credit. These rules are called the Golden Rules of debit and credit. Separate rules of debit and credit have been evolved for each of the three types of accounts viz., Personal, Real and Nominal.

(A) Personal Accounts:

Debit the Receiver, Credit the Giver.

The Personal Accounts, which receive the benefit, are debited while the Personal Accounts, which gave the benefit, are credited.

Real Accounts:

Debit what comes in, Credit what goes out.

When an asset is purchased, it comes in and hence that Asset Account is debited. When an asset is sold out, it goes out and hence Asset Account is credited.

Debit all expenses and losses,

(C) Nominal Accounts:

Credit all incomes and gains.

When we are paying something and not getting anything except a kind of service or we are receiving something but not paying anything except a kind of service.

For expenses like Salary, Wages, Insurance Premium, Interest, Commission, Rent, Conveyance, Electricity charges, Telephone charges etc. accounts should be debited. For incomes like interest received, rent received, commission received, etc. Discounts: Discount can be defined as a concession or allowance allowed for bulk purchase of goods or for prompt payment. Commercial discounts are of two types, viz., (a) Trade Discount, (b) Cash Discount. Trade Discount: A wholesaler usually allows this discount to a retailer, when goods are purchased in bulk or in large quantity. Trade discount is allowed as a deduction from the invoice; hence, no record is made in the books of trade discount while recording the transaction. Cash Discount: Cash Discount is an allowance given for making prompt or immediate payment. To encourage payment within the specific time, seller usually allows the buyer a deduction from the amount owed. Cash discount is recorded in the books. Two different accounts are operated for cash discount, namely, Discount Received A/c and Discount Allowed A/c. This discount is not actually paid or received but it is a mere adjustment made in the accounts. Discount Tree: Gross Value of goods (i.e. value from transaction) Less: Trade Discount (Calculated as % of Gross Value) Net Value of goods sold

---------------------. X

. Cash Transaction Amount Less: Cash Discount (% of Cash Transaction Amount) Amount Payable/ Receivable in Cash Credit Transaction Amount . . ---------

Cash Amount

Amount of cheque

Some important points to remember:

Proprietors personal transaction is not recorded in books, e.g., sal e of private property (land, building, car etc.) 2) Placing of an order is not a transaction hence no entry is passed. 3) Paid, received, borrowed, lent means Cash. 4) Purchase of Investments: Entry is passed at Market Price for which it is purchased and not at Face Value/ Nominal Value. If any brokerage or commission paid, the same should be added to the cost of investment. Commission or brokerage A/c is not debited, instead the amount is added to Investment Cost and Investment A/c. is debited. 5) Sale of Investments: Investment A/c is credited with net amount of sale proceeds less brokerage. For e.g., 1)

Sold 50 shares for Rs.85/- having Face Value Rs.10/-. 2% brokerage was allowed to broker.

Types of Accounts:
Saving A/c: Banks to boost saving habits in public operate this account. Salaried people generally open it. Saving account is not common with businessmen, of its following features: 1) Restriction is imposed on number of withdrawals from saving account. An accountholder is allowed to withdraw only twice in a week from his account. Since businessman needs to withdraw frequently saving account is uncommon with businessman. th 2) An interest of 4% p.a. is allowed half yearly computed on the minimum balance within 10 of every month. 3) A minimum balance of Rs.250/- is required to be maintained to avail cheque book facility. 4) Overdraft facility is not allowed to the saving accountholder for long periods. Current A/c: This account is specifically meant for businessman. The following are its main features: 1) No restriction is imposed for amount and number of times deposits and withdrawal made by the accountholder. 2) No interest is provided on the balance held in the account. But ranging Rates of interest is charged on overdrawn balance. 3) Overdraft facility is provided to accountholder for enduring periods. 4) A minimum balance of Rs.500/- is required to be maintained to avail chequebook facility. Bank account column provided in the cashbook is a Current Account. Fixed Deposit A/c: This account is meant for investing ideal money for long periods. This type of account is not a running account. It is not useful to business people for its following features: 1) Money remains blocked for long period. Fixed deposit is removed for minimum for 46 days. Hence money cannot be received on demand. 2) The bank on amount deposited in this account gives high rate of interest. The interest rate ranges from minimum 6.5% to maximum 40.5%. 3) Deposits are made in figures of Rs.100/-, minimum being Rs.500/-. 4) Cheque Book facility is not given to the accountholder. Fixed Deposit A/c is suitable for those people who wish to earn regular income on their investment.

Cheques: A cheque is a negotiable instrument signed by the maker, directing the drawee (i.e. Bank) to pay a certain sum of money to the order or to the bearer of the instrument. It is a written unconditional order by the accountholder to his banker to pay to the person mentioned in it or to self a certain sum of money.

Types of Cheques:
a) Bearer Cheque: It is a type of cheque where the holder of the cheque is paid the amount mentioned therein, across the counter of Bank. This cheque is used for immediate payments. It runs a risk of losing money if the Cheque goes into hands of unwanted persons. b) Order Cheque: In this type of cheque bank makes payment across its counter to the person whose name

appears on the cheque. To make a cheque order cheque the word bearer printed on the cheque is cancelled and word order is retained. c) Cross Cheque: When two parallel transverse lines are drawn on the face of the cheque with or without words A/c payee, on the left hand top corner it becomes a crossed cheque. This cheque cannot

be encashed across the counter of the bank. The payee of the cheque is required to deposit the cheque in his account to get the amount of cheque credited to his account.

DEPRECIATION

Meaning: Depreciation is the gradual and permanent decrease in the value of Fixed Assets due to its use and or non-use. Continuous and permanent reduction in the value of fixed asset due to its wear & tear is known as Depreciation. The depreciation is provided on Fixed Asset to arrive at a correct Profit and loss and to show the proper value of the asset. Factors to be considered in measurement of depreciation. (a) Cost of Asset - Purchase price plus installation charges. (b) Life of the Asset - The number of years an asset is expected to last and serve is known as life of asset. (c) Residual/Break up/Scrap Value - Amount realised on sale of asset after its useful life. Formula for Calculating Depreciation. Depreciation = Cost of Asset + Installation charges - Scrap Value Life of Asset

Methods of Charging Depreciation 1. Fixed Installment / Straight Line / Original Cost / Equal Installment Method: - Amount of depreciation remains constant every year during lifetime of asset. - Depreciation is calculated on the cost of the asset. 2. Reducing Balance Method/Written Down Value Method/Diminishing Balance Method: - Under this method amount of depreciation goes on diminishing year after year.

Depreciation is calculated on the diminishing debit balance of the Asset Account.

Change in Method of Depreciation Some times business change methods of depreciation. Such change may be (a) Prospective - Applicable from the date of taking decision, no adjustment is required for the past. (b) Retrospective Effect - means that is effective from date of purchase of asset. The difference between the depreciation as per two methods is adjusted in Profit and Loss A/c.of the current year.

What is Ratio Analysis? Ratio Analysis is one of the most important tools of financial management. Ratio analysis means the process of computing, determining and presenting the relationships between items and/or groups of items in the financial statements through accounting ratios. Since the analysis is normally undertaken for the purpose of projecting financial position or profitability, knowledge of trends is usually more significant than knowledge of present status only. An analysis of trends through ratio analysis helps in appraisal of financial conditions, efficiency and profitability of a business. An analyst of ratios studies the results of business operations as reflected in the relationships among the items of balance sheet and operating statement. He asks the following questions and tries to get the answer from the financial statements on 1. 2. 3. 4. 5. 6. The extent and character of the liabilities of the business. The net worth of the business. The ability of the business to meet its obligations as and when they arise. The ability of the business to earn a fair return on its investments in the business. The ability of the business to withstand possible setbacks from external and internal forces. The resourcefulness and the ability of the business to raise new funds as and when required.

What is Ratio? Ratio is an arithmetical or numerical relating one number to another. For example, if the relationship between two numbers say, 8 and 4 is to be expressed, it will be expressed in the form of a ratio 2:1 Different modes of expressing accounting ratios 1. Pure ratio 2. Percentage 3. Rate (3:2, 2:5) (25%, 20%) (10 times)

Classification of accounting ratios 1. Balance sheet ratios, also known as Static Ratios or Financial ratios 2. Income statement ratios are also known as Dynamic Ratios or Operational Ratios. 3. Inter statement ratios are also known as Inter-related ratios or Combined Ratios. Preparation of Financial Statements from Accounting Ratios

In order to prepare Profit & Loss A/c and Balance Sheet from the given ratios, it is necessary to have an idea of relationship which exists between different terms used to compute ratios. The following equations may be used to prepare final accounts: Trading and Profit & Loss A/c. Gross Profit = Sales Cost of goods sold (1) Hence Cost of goods sold = Sales Gross Profit Sales = Cost of goods sold + Gross Profit Cost of Goods sold = Opening Stock + Materials consumed + Manufacturing Expenses Closing Stock Operating Profit = Gross Profit Operating Expenses Operating Expenses = Administrative Expenses + Selling and Distribution Expenses + Finance Expenses Operating Profit = Sales Operating Cost (2) Operating Cost = Sales Opening Profit Sales = Operating Cost + Operating Profit Operating Cost = Cost of goods sold + Operating Expenses Net Profit after Interest but before Tax = Operating Profit + Non- Operating Income Non - Operating Expenses Net Profit after Interest and Tax = N.P.BIT I Net Profit after Interest and Tax = NPBT T Balance Sheet Capital Employed Fixed Assets Working Capital Working Capital Current Assets = Fixed Assets + Working Capital (1) = Capital Employed Working Capital = Capital Employed Fixed Assets = Current Assets Current Liabilities (2) = Working Capital Current Liabilities OR Current Liabilities Current Assets Liquid Assets Stock Liquid Assets Debtors = Current Assets Working Capital = Liquid Assets + Stock = Current Assets Stock = Current Assets Liquid Assets = Debtors + Cash and Bank = Liquid Assets Debtors

Capital Employed (Liability Side) Capital Employed = Net Worth + Long Term Loans Net Worth/ Proprietors Fund = Capital Employed Long Term Long Term Loans = Capital Employed Net Worth Net Worth = Share Capital + Reserves and Surplus Equity Share Capital = Equity Net Worth Reserves and Surplus Reserves and Surplus = Equity Net Worth Equity Share Capital Stock Turnover Ratio Connects Sales, Cost of Sales, Operating Profits and Stock. Debtors Turnover Ratio Connects Sales, Cost of Sales, Operating Profits and Debtors. Stock to working Capital Ratio helps to ascertain composition of Working Capital or between Current and Quick Assets.

Definition: A Funds Flow Statement may be defined as: a statement which summarises, for the period covered, the changes in the amount of the Funds of a concern, indicating the sources from which Funds were obtained by the concern and the specific uses to which the Funds were put Funds Flow Statement is a financial statement which shows as to how business entity has obtained its funds and how it has applied or employed its funds between the opening and closing balance sheet dates (during the particular year/ period) Types: The term Funds may denote working capital or cash. (a) Working Capital: A statement of inflow and outflow of Working Capital (Current Assets and Current Liabilities) is known as a Fund Flow Statement. (b) Cash: A statement of inflow and outflow of cash is called Cash Flow Statement Procedure: 1. Find out the effect of the transaction on the Current items. 2. If the transaction increases current assets or reduces current liability, it is a source of fund. 3. If the transaction decreases current asset or increases current liability it is an application of fund. Procedure Followed: 1. Enter current assets in particular column. 2. Enter current assets for previous year in previous year column. 3. Enter current assets for current year in current year column. 4. Enter increase in Current Assets in Increases column and decrease in Current Assets on Decrease column. 5. Total up previous year and current year columns. 6. Enter current liabilities of previous year in previous year column. 7. Enter current liabilities of current year in current year column 8. Enter the Decrease in current liabilities in Increase column 9. Enter the Increase in current liabilities in Decrease column 10. Total up previous year and current year columns for current liabilities. 11. Calculate working capital for previous year and current year. 12. Calculate the difference between working capital and find out the net change. The net change may be either net increase or net decrease in working capital. Note: Working Capital = Current Assets Current Liabilities Increase in current assets means increase in working capital Decrease in current assets means decrease in working capital Increase in current liabilities means decrease in working capital Decrease in current liabilities means increase in working capital

Key Points: Cash Flow Statement is prepared on the basis of balance sheets of the two years, profitability statement and some additional information.

Preparation of Cash Flow Statement is mandatory as per AS 3 for companies listed on the stock exchange. Cash Flow Statement is prepared by classifying Cash Flows in three activities: 1) Operating Activities 2) Investing Activities 3) Financing Activities Cash Flow Statement highlights the change in cash and cash equivalents during the course of the year due to various cash flows. Cash Flow Statement preparation is substantially similar to that used for preparation of Fund Flow Statement. Only difference is that in Cash Flow Statement focus is on cash and cash equivalent as against working capital in the case of Fund Flow Statement.

Cash Flow: Cash Flows are inflow or outflow of cash and cash equivalents. Major cash flows are listed below: Cash Inflows: 1) Issue of new shares for cash. 2) Receipt of long-term loans from banks, financial institutions etc. 3) Receipt of short-term loans from banks, financial institutions and other entities. 4) Sale of assets and investments. 5) Dividend and interest received. 6) Cash generated from operations. Cash Outflows: 1) Redemption of preference shares. 2) Purchase of fixed assets or investments. 3) Repayment of long term and short term borrowings. 4) Decrease in deferred payment liabilities. 5) Loss from operations. 6) Payment of tax, dividend etc. Classification of Activities: As per AS 3 the Cash Flow Statement should report cash flows during the period classified by Operating, Investing and Financing activities. Cash Flow from Operating activities: The cash flows generated from major revenue producing activities of the entities are covered under this head. Cash Flow from operating activities is the indicator of the extent to which the operations of the enterprise have generated sufficient cash to maintain the Operating Capability to pay dividend, repay loans and make new investments. Examples of cash flows from operating activities are as follows: 1) 2) 3) 4) Cash receipts from sale of goods & services. Cash receipts from royalties, fees, commission etc. Cash payments to employees. Cash payments or refunds of income tax (except when such payments or refunds relate to investing or financing activities). Cash receipts and payments relating to future contracts, forward contract etc. Cash receipts and payment arising from purchase and sale of trading securities.

5) 6)

Cash flows from investing activities:

These are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. This represents the extent to which the expenditures have been made for resources intended to generate future incomes and cash flows. Examples of cash flows from investing activities are as follows: 1) Cash payments for purchase of fixed assets. 2) Cash receipts from sale of fixed assets. 3) Cash payments for purchase of shares/ debentures etc. in other entities. 4) Repayments of loans given.

Cash flows from financing activities: Financing activities are the activities that result in changes in the size and composition of the owners capital and borrowings of the enterprise. Separate disclosure is important because it is useful in predicting claims on future cash flows by providers of funds. Examples of cash flows from financing activities are as follows: 1) Cash receipts from issue of share capital. 2) Cash receipts from issue of debentures, loans (short & long term). 3) Cash repayments of amounts borrowed. 4) Cash payment to redeem preference shares. Note: Investing and financing activities that do not require the use of cash or cash equivalents should be excluded from a cash flow statement. Examples of non-cash transactions are: 1) 2) 3) Acquisition of assets by assuming directly related liabilities. Acquisition of business by means of issue of shares. Conversion of debt into equity.

Methods of calculation of Cash Flows from Operating Activities:

1) Direct Method: Under this method, major classes of gross cash receipts and gross cash payments are obtained from the records for determination of cash flow from operating activities. Following are the examples of usual cash receipts and cash payments resulting from operating activities: i) Cash sale of goods and services. ii) Collection from customers. iii) Receipt of royalties, fees, commissions and other revenues. iv) Cash payment for purchase of inventories. v) Cash payment for various operating expenses. vi) Cash payment of salaries and wages of employees. vii) Cash payment of income tax. The procedure of computation of cash from operating activities also known as Income Statement method. Profit and Loss A/c records all the items on accrual basis. Various items in the Profit and Loss A/c are adjusted for changes in related items in current assets and current liabilities in order to decide Profit and Loss A/c on cash basis. The balancing figure in Profit and Loss A/c reveals cash from operating activities. 2) Indirect method: Under this method, cash from operating activities is calculated by adjusting net profit and loss instead of individual items, disclosed in the Profit & Loss A/c. Net Profit and Loss is adjusted in the light of changes during the period. Following formula should be kept in mind for determination of cash from operating activities: Procedure of Preparation of Cash Flow Statement: The procedure of preparation of Cash Flow Statement is similar to that of Fund Flow Statement except the treatment of current assets and current liabilities.

Following steps are involved in the procedure: Step 1. Calculate Cash Flows from operating activities 2. Analyse non current assets: Non operating current assets, non current liabilities, non operating current liabilities and capital to ascertain the cash inflows and cash outflows which is not related to operating activities of the organisation. 3. Fund out cash inflows from investing activities and financing activities. 4. Prepare a cash flow statement as per AS.3.