Accounting Principles

1. Book Keeping : Book Keeping is an art of recording the business

transactions in a systematic manner.

2. Accounting : Accounting refers to the process of indentifying,

measuring and communicating the economic information of an organization
to its users who need the information for decision making.

3. Accounting Cycle : Journalizing - Ledger posting – Ledger balancing –

Trial Balance – Trading or Profit or Loss a/c – Balance sheet.

4. Accounting Equation : Accounting equation is a statement of equality

between resources and sources of finance and expressed as under

Assets = Capital +Laibilities

Capital = Assets – Liabilities

Liabilities = Assets – Capital

5. Classification of Accounting: Accounting is classified into three types

1. Financial Accounting

2. Cost Accounting

3. Management Accounting

6. Golden Rules of Accounting:

a. Personal a/c : These are accounts of individuals firms, companies, Banks

etc. The proprietor being individual his capital a/c and Drawing a/c are
also known as personal a/c.

Rule: Debit the Receiver

Credit the Giver

b. Real a/c: A business concern has certain possessions. It possesses goods

in which it trades. It also possesses certain properties with which it trades.
All of them are real accounts.

Rule: Debit what comes in

Credit what goes out

 c. Nominal a/c: While a business is carried on many types of expenses are
met ex. Salaries, Rent etc. Similarly certain income received ex.
Commission, Interests etc. These accounts are called Nominal a/c.

Rule: Debit all Expenses and Losses

Credit all Incomes and Gains

7. Journal: When ever a transaction takes place it has to be recorded. The

transactions are recorded in above called Journal

8. Journalizing : The process of recording the transaction in a journal is

called Journalizing

9. Ledger: It is the main or principle book of account which contains

all the accounts to which the transactions recorded in the journal are
transferred. It is called the book of final entry because it is the destination of
all transactions.

Working Capital: Current assets – Current liabilities Working capital is that

Capital which we use in day to day running of business. That’s way we use
Current Assets and Current liabilities to calculate working capital.

Bills Receivable/Bills Payable:

Business transactions not only includes cash transactions but also includes credit
transactions.

Credit sales are nothing but Bills Receivable. Credit Purchases are nothing but
Bill Payable. We show Bills Receivable under the Head Current Liabilities.

RATIO ANALYSIS

Gross Profit Ratio: This is most common Ratio used in Financial analysis .

GROSS PROFIT X 100

SALES

Since Gross profit is equal to sales – Cost of goods sold it can also be stated
as follows:

Sales – Cost of the Goods sold X 100

 SALES

In the trading concern Gross Profit is Rs.50,000, Sales Rs.2,00,000 then the Gross
Profit Ratio is

50,000 X 100 = 25%

2,00,000

Net Profit Ratio:

This ratio is also known as “Profit Margin”. This measures the relationship
between net profits and sales of a firm. It reveals the overall profitability of the
concern. This ratio is calculated as follows:

Net Profit(After Tax) X 100

Sales

Operating Ratio:

This ratio expresses the relationship between total cost of the goods sold and
sales. It is calculated as follows.

Cost of Goods sold + Operating Expenses X 100

Sales

Here, Cost of Goods Sold = Opening Stock + Purchases + Manufacturing

Expenses - Closing Stock

Operating Expenses = Office + Administrative Expenses + Selling and

Distribution Expenses

But it does not include financial expenses like interest, taxes, and losses due to
theft of goods, goods destroyed by fire etc.

Operating Profit Ratio:

Return on Capital Employed

Debt-Equity Ratio

Fixed Assets Ratio

Total Assets Turnover Ratio

Current Ratio:
 Current ratio is the ratio of total current assets to total current liabilities. It
is calculated by dividing total current assets by total current liabilities. This ratio
is called “Working Capital Ratio” because it is related to the working capital of
the firm.

Current Ratio shows the Company’s financial ability to fulfill the short term
obligations. Generally, the ideal Current Ratio must be 2.

Current Ratio = Current Assets/Current Liabilities.

Current Assets Current Liabilities

1. Cash/Bank 1. Creditors
2. Debtors 2. Bills Payable
3. Stock 3. Out Standing
4. Bills Receivable
5. Prepaid Expenses

Quick Ratio:

This ratio measures the relationship between Quick or Liquid Assets and
Current Liabilities. An Asset is considered liquid if it can be converted into cash
without loss of time or value. Stock and Prepaid Expenses are excluded from the
liquid assets because they are not easily convertible into cash.

Therefore Quick Asset = Current Assets – (Stock + Prepaid Expenses)

Quick Ratio = Quick Assets/Quick Liabilities (or) Current

Liabilities

Rectification of Errors
Error is a mistake committed in book keeping.

1. Errors of Principle: Errors are committed when a transaction is not

recorded according to accounting Principles. For ex:- Capital expenses treated
as revenue business expenses as personal expenses etc.

2. Clerical Errors: Those errors which are generally committed by the

clerical staff while recording the transactions in the account books. Such
errors may be.

3. Errors of Omission: When a transaction is either completely or partially

omitted from the books it is called error of omission. Purchase of goods on
credit may be omitted to be entered in the purchase books.
 4. Errors of Commission: Such errors arise when any transaction is
incorrectly recorded either wholly or partially. Ex: Posting wrong amount to an
Account.

5. Compensating Errors: In case of such Errors one Error is compensated by

other.

Suspense Account:

When Trial Balance does not tally, the excess Debit or Credit is put
against an unidentified account until the errors are properly located and rectified -
this account is called Suspense Account.

BANK RECONCILIATION STATEMENT

Generally the bank balance in cash book does not tally with Pass Book.

Bank Reconciliation Statement which states the reasons for those different
balances.

Causes for the difference between cash book Balance and Pass Book
Balance.

The items which cause the difference between the two balances are: (1)
Entries have been made in Cash Book, but not in the pass book 2) Entries have
been made in pass book , but not in cash book. If as on a particular date entries
have been made both in cash book and pass book or not made in any of the books
then there will not any difference in the balances shown by the two books.

The causes for the difference in the balance shown cash book and pas book
are discuses below.

1. Cheques issued, but not presented for payment

2. Cheques deposited but not yet collected by the bank.

3. Interest on investments, dividends, interest on deposits etc. credited in Pass

Book, but not entered in Cash Book.

4. Bank Charges, interest on overdrafts, insurance Premium etc.

5. Amount directly deposited by the customers of the trader in his bank

account.
 6. Cheques deposited but not entered in Cash Book.

7. Cheques debited in Cash Book but omitted to be sent to bank.

8. Errors in Cash Book or Pass Book.

DEPRECIATION

The fall in the value of an Asset is called as Depreciation. It also defined as

the permanent and continuous decrease in the quality, quantity or value of an
Asset.

Reasons for calculating Depreciation:

1. To allocate depreciable cost

2. To ascertain true and fair Profit or Loss

3. To show the correct Financial position

4. To provide funds for replacement

5. To compute Tax Liability.

Methods of providing Deprecation:

There are different methods of providing depreciation. The main methods are:

1. Fixed Installment Method:

It is also called as Straight Line Method or Original Cost or Equal

Installment or Fixed Percentage Method.

Cost –Estimated Scrap Value

Estimated life of the Asset

While calculating depreciation for a particular year the period for which the asset is
used in the year concerned should also be taken into account.

For example an asset is purchased for Rs.1,10,000 it has an estimated life of 10

years and its estimated scrap value after 10 years is Rs.10,000, then annual
depreciation will be

1,10,000 -10,000/10 = Rs.10,000.

2. Diminishing method or Written Down Value Method:

It is also called Reducing Installment method. Under this method depreciation is
charged at a fixed rate of the reducing balance of the asset every year. For
example, if the cost of an asset is Rs.1,00,000 and if the rate of depreciation is
10% per annum, then in the first year the depreciation will be 10% in
Rs.1,00,000, i.e, Rs.10,000. In the second year 10% on Rs.90,000, i.e Rs.9000.
Though the percentage at which depreciation is charged remains fixed, the
amount of depreciation goes on decreasing year after year.

Formula for calculating the rate of depreciation is as follows.

___________________

Rate of Depreciation = 1-n ∫Residual Value/Cost of Assets X 100

Where n = number of years of Asset’s life.