Accounting

Terminology
• Understand the different accounting terminologies that would be used
and applied in making accounting transactions
• Capital
• Equity
• Liabilities
• Drawings
• Assets
• Goods or Merchandise
• Revenue, Income, Turnover
• Expenses
• Discount
• Account
• Debtors
• Creditors
• Profit
• Cost of Goods Sold
• Expenditure

Learning Objectives 2
• It means the amount (in terms of
money or assets having money
value) which the proprietor has
invested in the firm or can claim
from the firm.
• It is also known as owner’s equity
or net worth.
• Owner’s equity means owner’s
claim against the assets.
• It will always be equal to assets less
liabilities, say:
• Capital = Assets - Liabilities.

Capital 3
Equity Capital 4
• It means the amount
which the firm owes to
outsiders that is,
excepting the proprietors.
• Liabilities are debts; they
are amounts owed to
creditors; thus the claims
of those who are not
owners are called
liabilities.
• In simple terms, debts
repayable to outsiders by
the business are known as
liabilities
Examples
• Notes payable - a written
promise.
• Accounts Payable - an
oral promise.
• Interests Payable.
• Sales Payable.
• Salaries payable.
• Unclaimed dividend.
• Wages
• Taxes

Liabilities 5
• Amount of money or the value of goods which the proprietor /owner takes
for his domestic or personal use.
• Subtracted from capital in the balance sheet to record the transactions taken
place of money removed from the company by the owners
• It is a reduction in the assets and a reduction in the owners equity as an
accounting record needs to be maintained to track money withdrawn from
the business by its owners from their personal finances.
• These are not to be confused with expenses or wages for the owners as these
will be recorded in the company profit and loss account separately.
• It is particularly relevant in partnerships, where partners may wish to
monitor withdrawals to ensure that a partner is not taking too much money
out of the business.
• A drawing account is closed to the owners' equity account each year, and is
not recorded as a business expense.
• Owner of sole proprietorship or partner in partnership can withdraw cash
from business but shareholders of company cannot withdraw except when
company pays dividends

Drawings 6
• ABC Partnership distributes a Rs. 5,000 per month to
each of its two partners
• Records this transaction with
• A credit to the cash account of Rs. 10,000
• A debit to the drawing account of Rs. 10,000.
• By the end of the year, this has resulted in a total draw of
Rs. 120,000 from the partnership.
• The accountant transfers this balance to the owners'
equity account with
• A credit to the drawing account of Rs. 120,000
• A debit to the owners' equity account of Rs. 120,000

Example of the Drawing Account7

• Any physical thing or right owned that has a money value
is an asset.
• An asset is that expenditure which results in acquiring of
some property or benefits of a lasting nature.
• Example: cash, computer systems, patents

Assets 8
 Current Assets Fixed Assets
• Assets which are expected • Assets used within your
to be used up and replaced business and not acquired
within a year are referred to for the purposes of resale,
as Current or Short Term used for more than one year,
are referred to as Fixed
Assets. Assets.
• Liquid in nature • Typically not very liquid.
• Examples: stock, bank and • Examples: Land and
cash balance and debtors, buildings, plant &
amounts owed to the machinery, fixtures and
business from its fittings and motor vehicles.
customers.
Assets grouped according to either their life span or liquidity - the speed at which they can be converted into cash.

Assets 9
 Tangible assets Intangible assets
• Tangible assets are • Intangible assets are
physical entities that the things that represent
business owns such as money or value
• Examples: Land, • Example: copyrights,
buildings, vehicles, goodwill, patents.
equipment, and
inventory.

Assets grouped according to either their physical existence

Assets 10
• Money deposited with a bank becomes a liability of the
bank, because the bank has an obligation to pay the
depositor the money deposited; usually on demand.
• The money deposited is an asset for the depositor.
• The bank will record an ASSET when money is
deposited, and their double-entry accounting
correspondingly records an equal LIABILITY since the
bank doesn't own the ASSET.

Example 11
Accounting Equation 12
• The articles in which the business deals; that is, only those
articles which are bought for resale for profit are known as
Goods.
• Merchandise refers to the aggregate of items, commodities or
goods that are either sold in same form or converted into
saleable products by firm
• Goods are expected to be sold within a year during the course
of one business cycle
• Example: If XYZ Ltd furniture purchases chairs for sale to its
customers , the chairs constitute goods.
• Example: If chairs are purchased by Kiran Glossary stores ,
they would be referred as firms; fixed assets.
• Example: If Galaxy Furniture purchases wooden pieces
manufacture dinning tables, these wooden pieces will be
referred to as goods of firm.

Goods or Merchandise 13
• Revenue refers to cash or cash equivalents received or receivable for
goods and commodities sold or services rendered or right given to
firm for utilisation of assets.
• It is amount which, as a result of operations, is added to the capital.
• The inflow of assets which result in an increase in the owner’s equity.
• Example: All incomes like sales receipts, interest, commission,
brokerage etc.
• Receipts of capital nature are not a pant of revenue. Example:
additional capital, sale of assets.
• The revenue generated by a firm for regular operating activities is
known as business income
• The amount received on sale of goods is known as sales income
• Revenue is also known as turnover

Revenue, Income, Turnover 14

• Example: A grocery shopkeeper earns revenue by sale of
consumable items such as food, soaps and detergents and
cosmetics

Example 15
• The terms ‘expense’ refers to the amount incurred in the
process of earning revenue.
• If the benefit of an expenditure is limited to one year, it is
treated as an expense (also know is as revenue
expenditure) Examples: payment of salaries and rent.
• Example: The peon of SPM Auto has paid Rs. 50 as auto
fare for going to and returning from bank for official
work. This Rs. 50 will be considered as conveyance
expense because no future benefit will be available from
auto fare.

Expenses 16
• Expenditure takes place when an asset or service is
acquired.
• Similarly, if an asset is acquired during the year, it is
expenditure, if it is consumed during the same year, it is
also an expense of the year.
• The expenditure is the cost beared for the purchase of
assets into the business. The benefits of this expenditure
can be for longer period of time.
• While the amount spent on the repair and maintenance of
the car comes under expense. The benefits of expense can
be for limited period.

Expenditure 17

• Assets, goods, or commodities
purchased by a firm considering
the long term benefits that they
provide to firm are long term
assets or fixed assets.
• The amount expended in future in
addition to expense incurred to
make the asset workable is
referred to as capital expenditure
• Example: Purchase of land &
Building, Machinery
Expenditure
• When the amount expended or
agreed to be expended in future is
not concerned with value addition
of fixed assets, but supports the
firm’s business activities on day to
day basis, it is termed as revenue
expenditure.
• Example: Depreciation on P&M,
Salaries & Wages, Insurance
Premium
18
• When customers are allowed any type of deduction in the
prices of goods by the businessman that is called
discount.
• When some discount is allowed in prices of goods on the
basis of sales of the items, that is termed as trade
discount.
• When debtors are allowed some discount in prices of the
goods for quick payment, that is termed as cash discount.
• Example: It is better to receive e.g. 95% of an invoice
with a couple of days than wait 30 or more days to
receive the full amount, some suppliers offer a cash
discount for early payment.

Discount 19
A trade discount is the reduction in price a manufacturer or wholesaler gives a
wholesaler or retail when they buy a product or group of products 20
 A cash discount is a deduction allowed by the seller of
goods or by the provider of services in order to motivate the
customer to pay within a specified time. 21
• It is a statement of the
various dealings which occur
between a customer and the
firm.
• It can also be expressed as a
clear and concise record of
the transaction relating to a
person or a firm or a property
(or assets) or a liability or an
expense or an income.
• Example: Sales a/c , Salaries
A/c, Sandhya a/c, Raw
material a/c, closing stock
a/c, bills payable a/c

Account 22
• Land a/c :
• Land account records Land owned by enterprise and kept for use in its business
• Building a/c :
• Building account records Acquisition of buildings used by an enterprise to carry out its operations:
Examples: Factory buildings, warehouses and office buildings
• Equipment a/c
• Examples: office equipments like photocopiers, fax machines, computers; Furniture & fittings a/c like chairs,
tables, cupboards
• Prepaid Expenses a/c:
• Sometimes business pays for services before they have been received or used. This records all such accounts
to the extent related benefits are expired. Example: Prepaid phone services
• Cash a/c:
• Records receipts and payments of cash. It includes coins, currency, cheques and amount deposited in bank.
• Bills Receivable a/c:
• A legal document containing acceptance of bills by customers of firm to pay a certain sum of money
(amounts due) at specified date as a means to extend credit .
• Debtors a/c:
• Records goods and services sold on credit so that customers can pay after specified period on credit. Separate
accounts are created for individual debtors

Example of Account in Asset Side 23

• Short Term Liabilities a/c :
• Wages payable, income tax payable, interest payable, dividends payable
• Long Term Liabilities a/c :
• Debentures, loans from banks and other financial institutions and long term deposits
• Secured and Unsecured Liabilities a/c
• Secured liabilities are backed by assets of business such as land, buildings, investments or debtors. If secured
loan is not paid , the creditor may force the sale of assets to recover loan
• Unearned Revenue a/c:
• Amount received from customers for services yet to be provided. It represents liabilities because the supplier
has an obligation to provide the services. Example: advances from customers account
• Bills Payable a/c:
• A legal document signifying an obligation to pay a certain sum of money (amounts due) at specified date . It
contains amounts due to a firm’s suppliers on bills accepted by the firm. Its opposite of bills receivable.
• Creditors a/c:
• Also known as accounts payable. It shows increases and decreases in amounts owned to outsiders for
purchase of goods and services on credit. Separate accounts are created for individual creditors

Example of Account in Liabilities Side

24
 • Share Capital a/c
• Retained Earnings
• The percentage of net earnings not paid out as dividends, but retained by the company to
be reinvested in its core business or to pay debt. It is recorded under shareholders' equity
on the balance sheet.
• The formula calculates retained earnings by adding net income to (or subtracting any net
losses from) beginning retained earnings and subtracting any dividends paid to
shareholders:
• Also known as the "retention ratio" or "retained surplus".
• Revenues & Expenses
• Revenue from services or sales, Commission income, interest income , professional fees
• Salaries, rent, insurance, consumables and supplies
• Drawings
• Records all withdrawals
• Dividends
• Dividends are distributions of assets that reduce the retained profits of a company
• BOD recommends dividend and the shareholders declare them as payable
• Dividends are not an expense in P/L account.
• In India , dividends must be paid in cash

Examples of Accounts affecting Equity

25
• A person who owes
money to the firm mostly
on account of credit sales
of goods is called a
debtor.
• Example: when goods
are sold to a person on
credit that person pays
the price in future, he is
called a debtor because
he owes the amount to
the firm.

Debtors 26
• A person to whom money
is owing by the firm is
called creditor.
• Example: Madan is a
creditor of the firm when
goods are purchased on
credit from him

Creditors 27
• While making a sale, the
seller prepares a
statement giving the
particulars such as
• Quantity
• Price per unit
• Total amount payable,
• Deductions made
• Net amount payable by the
buyer.
• Such a statement is called
an invoice.

Invoice 28
• The direct costs attributable to the production of the goods sold
by a company.
• This amount includes the cost of the materials used in creating
the good along with the direct labor costs used to produce the
good.
• It excludes indirect expenses such as distribution costs and sales
force costs.
• COGS appears on the income statement and can be deducted
from revenue to calculate a company's gross margin.
• Also referred to as cost of sales.

Cost of Goods Sold 29

• Loss really means something against which the firm
receives no benefit.
• It represents money given up without any return.
• Expense leads to revenue but losses do not. (e.g.) loss due
to fire, theft and damages payable to others
• When the sales revenue is lesser than the cost of goods
sold, the difference is called as Gross Loss
• When the sum of revenue is lower than the sum of cost of
goods sold and other administrative, selling, and
distribution expenses, it is called as net loss.

Loss 30
• A financial benefit that is realized
when the amount of revenue gained
from a business activity exceeds the
expenses, costs and taxes needed to
sustain the activity.
• Any profit that is gained goes to the
business's owners, who may or may
not decide to spend it on the business.
• Another term for net income.
• Calculated as: Total Revenue-Total
Expenses = Profit
• When sales revenue is greater than the
cost of goods sold

Profit 31
• An event the recognition of which gives rise to an entry
in accounting records.
• It is an event which results in change in the balance sheet
equation.
• That is, which changes the value of assets and equity.
• Transaction means the exchange of money or moneys
W
worth from one account to another account
• Examples: Purchase and sale of goods, receipt and
payment of cash for services or on personal accounts, loss
or profit in dealings.

Transaction 32
• Cash transaction: Where cash receipt or payment is
involved in the exchange.
• Credit transaction: Do not have ‘cash’ either received or
paid, for something given or received respectively, but
gives rise to debtor and creditor relationship.
• Non-cash transaction: Where W the question of receipt or
payment of cash does not at all arise, e.g. Depreciation,
return of goods etc.,

Transaction 33
• Buying of goods by the trader for selling them to his
customers is known as purchases.
• As the trade is buying and selling of commodities
purchase is the main function of a trade.
• Here, the trader gets possession of the goods which are
not for own use but for resale.
• Purchases can be of two types. viz, cash purchases and
W
credit purchases.
• If cash is paid immediately for the purchase, it is cash
purchases, If the payment is postponed, it is credit
purchases.

Purchase 34
• When the goods purchased are sold out,
it is known as sales.
• Here, the possession and the ownership
right over the goods are transferred to
the buyer.
• It is known as. 'Business Turnover’ or
sales proceeds.
• It can be of two types, viz., cash sales
and credit sales.
• If the sale is for immediate cash
payment, it is cash sales. If payment for
sales is postponed, it is credit sales

Sales 35
• A person who has assets
with realizable values
which exceeds his
liabilities is solvent.
• A person whose liabilities
are more than the
realizable values of his
assets is called an
insolvent

Solvent/Insolvent 36
• An accounting year is a
twelve (to eighteen) month
period over which a
company's accounts are
calculated. accounting
year, or accounting period,
is a company’s annual
reporting period.

Accounting Year 37