AN OVERVIEW OF AN ACCOUNTING CYCLE - UNIT – I

In a business activities (whether Profit organizations such as Reliance Industries Ltd,

Birla Industries Ltd., Wipro & Infosys etc and Non-Profit organizations like,
Hospital, Libraries, Clubs, Schools, Colleges, Temples etc) which requires money and
economic resources such as Man, Machine & Capital etc accounting is required to
account for these resources. In other words, wherever money involved, accounting is
required to account for it. Accounting is often called a language of Business.

ACCOUNTING:- Meaning:- According to American Institute of Certified Public

Accountant “ Accounting is the art of Recording, Classifying, Summarizing in a
significant manner and in terms of Money, Transaction and Events which are in part
at least of a financial character and interpreting & communicating the results
thereof”.

Thus, Accounting covers the following, which is also known as accounting process or
accounting cycle
ACCOUNTING CYCLE Measured the
Identified Transaction & Event

Measuring Recording Classifying

Identification the Identified (can be done (can be done
of transaction Transaction through by through by
and Events & Event JOURNAL LEDGER
(1) (2) (3) (4)

SUMMARIZING (5)
Financial Statement Analysis 1. Trial Balance
2. Income Statement or
P& L A/c
3. Balance-Sheet
4.Funds Flow Statement
4. Fund Flow Statement

INTERPERATING &
COMMUNICATIONING
THE RESULTS

Internal users:- (6)

1. Management
End-users of 2. Employees
Financial Statement Analysis
External Users:-
1. Shareholder & Investor
2. Lender Or Creditor
3. Customers & Public
4. Govt. and other Regulating
Bodies
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(1) Identifying the Transaction & Events:- Accounting identifies the transactions and
Events of a Specific Entity or a Business Concern. A Transactions is an exchange in
which two participants involve, one participants receives other participants
gives(sacrifices), for example: Purchase of Raw Material by the Company, In this
Company receives raw material and Supplier is supplying the Raw Material.

An Event means (whether internal or external) is a happening of consequences to an

Entity, for example : Use of Raw Material for Production, in this raw material is
regularly by the Company for Production .

An entity means an Economic Unit that perform Economic Activities, for example
(Reliance Industries Ltd, Birla Industries Ltd, TISCO, TELCO, WIPRO etc)

(2) Measuring the Identified Transaction and Events: Accounting measures the
transactions and Events in terms of Common Measurement unit i.e., ruling
currency of a country. Accounting records only those transactions and events
which in terms of Money or which are of a financial character. Transaction
which are not of a financial character are not finds place in the books of accounts.
For example, if a company has got a team of dedicated and trusted & loyal
employees etc which are of important and great use to the business but since it is
not of a financial character and are capable of express in terms of money will not
be recorded in the books of business.

(3) Recording :- It is concerned with recording of identified and measured financial

transaction in an orderly manner, it is because of limitation of human memory
that cannot be remembered each and every transactions. It is therefore necessary
that the transactions are put in writing reasonably soon after its occurrence in the
books. Recording is done through Journal. Journal means Day Book or
Daily Record Book. It is the Book wherein all the transactions are first
recorded in the chronological order (as and when they take place). The
process of recording the entry in the Journal is known as “Journalising”

The Organization used two types of Accounts i.e., (1) Cash Book for recording
cash payment made to any person (2) Subsidiary book:- which records only
credit transaction . Subsidiary Book is sub-divided into:- (a) Purchase Book –
which records - Purchase made on credit (b) Sale Book – which records - Sale
made on Credit (c) Purchase Return Book - which records - Goods Returned by
Company to the Supplier of Goods due to defect (d) Sale return Books – which
records – Goods returned by the customer to Company due to defect (e) Bills
Receivables Book- which records – payment on bills to be receivable (f) Bill
Payable Book – which records – Payment to made on the Bill.

(g) Journal Proper:- This book is used to record all the transaction which cannot
be recorded or included in cash or any other above mentioned subsidiary Book .
The transaction which will be recorded in Journal Proper are :(a) Purchase or Sale
of Fixed Assets, Investment made on Credit, Adjusting Entries & Rectification
Entries etc.
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(4) Classifying : Classifying is done through preparing Ledger A/c. Ledger is

concerned with the recorded transaction same class or one Nature are recorded at
one place so that complete information regarding that particular account will be
exactly known. For example :-

All the purchases of goods whether the payment made through cash or credit are
brought to one place by preparing “ Purchasing A/C”.Similarly, if a business
person want to know the total sales for a particular period that recorded in the
Journal will have to do a great deal of searching all the transactions of cash
sales and credit sales. This task is simplify by sorting and classifying all similar
transaction relating to one particular A/c, thereby the relevant A/c will result at
glance.
Sales A/c

Ledger is a book of final entry. All the transaction are first recorded in the
Journal and finally recorded in the Ledger. The process of transferring from
Journal to the Ledger is called Posting . Ledger is also known as King of books of
Accounts.

5. Summarizing:- This is concerned or presenting the Classified Data in a

manner which is understandable and useful to the internal as well as external
users. This process involves preparation of

(a) Trial Balance

(b) Income Statement or Profit & Loss A/c
(c) Balance-Sheet
(d) Funds Flow Statement .

(a) TRIAL BALANCE : The main objective of Trial Balance is to Check the
arithmetic accuracy of Ledger Account
(b) To help in locating error in the total of Debit & Credit Balance of Ledger A/c.
(c) To facilitate the preparation of Financial Statement Analysis.

(b) INCOME STATEMENT OR PROFIT & LOSS A/C:- Profit & Loss A/c is
prepared with a view to ascertain the profit or loss of a business activities during an
accounting period. All the items of indirect revenue expenses such as
Administrative, Office or Management Expenses, Selling & Distribution Expenses
and other Financial Expenses such as Depreciation, Provision etc are to be taken on
Debit Side which is left side of P & L A/c. All the Indirect revenue income such
as Interest received, Discount received etc are to be taken on Credit side which is
right hand side of P & L A/c. If the expenses exceeds the income, it result in Net
Loss or If Income exceeds expenses, it results in Net Profit.

The Net Profit or Net Loss thereafter transferred to the Capital A/c in the Balance-
Sheet, thereby closing the P & L A/c.

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 (c) BALANCE-SHEET OR POSITION STATEMENT: Balance-sheet is in a fact a
“ Statement of Assets and Liabilities of Business which is prepared on the last day
of the accounting year” i.e., 31st March of year.

The left hand sides indicates Liabilities, Capital and the sources through which
Money have been obtained which is due to outsider. (Note:- Capital refers to the
amount invested by the owner and the Liabilities are the financial obligations
other than owners funds).

The right hand sides indicates Assets where the money has been applied or invest,
it is owned by the company.

In other words Balance –sheet shows what business owes(due) and what
business(Owns). All the liabilities or Capital of proprietor and all Assets or
Property recorded in the Balance-sheet must be tally or agree i.e., the assets and
property must be equal to Liabilities and Capital.

(d) FUND FLOW STATEMENT:- Every company prepares its Balance-sheet at the
end of its accounting year. It reveals the financial position of the company at the
end of the year. It does not present any analysis which is sharply focus those
transaction which is behind the Balance-sheet. Funds flow statement provides the
summary of funds or movement of funds that take place between two accounting
period. For example, if the fixed assets worth Rs. 2,00,00,000 such as Land &
Building are purchased during the current year by raising the Share Capital of
Rs.2,00,00,000, the Balance-sheet will simply show a higher share capital of Rs.
2,00,00,000 in the liabilities sides and also shows higher fixed assets of Rs.
2,00,00,000 on the Assets sides. In this case if one compares the current year
Balance-sheet with the previous year Balance-sheet then one can draw inference
that fixed assets were acquired by raising share capital of Rs.2,00,00,000.

Similarly, certain important transactions which might occur during the course of
accounting year that might not find any place in the Balance-sheet. For example, if a
loan was taken of Rs.50,00,000 in the month of September and the same was paid
(say) in the month of January i.e., before the end of the accounting year, Then the
Balance-sheet does not show these transactions. However, an financial analysist must
know the purpose for which the loan was taken and utilized. This will help him in
making a better estimation about Company’s Financial position & policies.

A fund flow statement is a report of financial operation, changes, flow or movement of

funds taken place between two accounting periods. It shows from source the funds are
procured(obtained) and how these are utilized (Applied in or Uses) during the year.

(5) Interpreting and Communicating :- The importance of accounting is to provide

meaningful information about business enterprise to those who are directly or
indirectly (end users) interested in the performance & financial position of
Business Enterprise. The end users of financial statement may be (a) Internal
parties (b) External Parties.
 -5-
Internal Parties or Users:

(a) Management or Owners: The owners of a business invested their

capital in the business. They are interested to know whether the business
has earned a profit or loss during particular period and also its financial
position on a particular date. They want to have accounting reports in
order to haven an appraisal the past performance and also for an
assessment of future prospects. By seeing the past performance. They
can carry out the functions of Planning, Controlling, and Decision
making.

Planning:- It involves the establishment of goals, mission of the

organization i.e, should the new product introduce in the market, Shoud,
Production facilities be expanded, should the present production and sales
be terminated ( if incurring loss) etc.

Controlling:- It involves decisions results from implementing plans and

monitoring the actual results are being achieved as per the plan or not. If
goals are not achieved, either corrective steps may be taken or plan may
be revised to attainable level..

Decision making:- It involves choosing the decision among several

alternatives(Plans ) and selecting the best among the available alternative.

(b) Employees: They are interested in the good running of the business,
because their bread & butter depends on the soundness of the Business.
If the firm does well their remuneration, the bonus, Pension Scheme will
be assured. If the firm does not does not do well their might be feared
that, their salaries, bonus & pension scheme will be at stake.

External parties or Users:-

(a) Shareholders Or Investors: Share holders and investors are interested

in knowing how profitable the business is and its ability to pay
dividends. All the investors need information to help them whether to
buy, hold or sell the Stock(Shares, Debentures etc). They are
interested in good return and the safety of their capital and also
appreciation in the value of share.

(b) Lenders Or Creditors:- Lenders are Bank and Financial Institution

who grant loan and Creditor are Supplier of raw material to the
company on Credit. Therefore Lenders or Creditors are interested in
knowing the working ability of the enterprise before they grant loan
or supply of raw material. In case of Lenders, they look to the ability
of the business to pay interest and amount as and when became due
for payment. In case of Creditor, they want to know whether the
credit to be grant for shorter period or longer period. Thus, by
assessing the financial statement the Lender or Creditor take their
decision.
 -6-

(c) Customer or General Public: The product of the company is

established long-term relationship between a business and customer.
The customer will judge whether the product is being utilized or
satisfied for the benefit of common man or not. They are interested
in the quality of goods and services of the firm and the legal
obligations attached with it such as guarantees, warranties etc.

(d) Govt. & Regulatory Bodies:- They are interested in accounting

statement and report in order to see the performance of a particular
business organization so as to enable them to impose tax and excise duty.
In addition to this, the Govt. can use the information in estimating the
nation income of the Country & economic development, plus the Govt.
will also asses whether the Industry is becoming sick unit or not.

Regulatory Bodies such as Income Tax Authorities are interested in

assessing the feasible profit generated in business thereby the income
tax has been paid or not..

In addition to above, Diverse persons such as Scholar, Researcher &

Academician are interested in order to get the data for proving their
thesis on which they are working and hence to complete their research
project.

Thus, utility of accounting information is greatly increase when it

is complied, prepare and presented in a systematic manner.

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ACCOUNTING CONCEPTS & CONVENTIONS

 OR GENERALLY ACCOUTING ACCEPTED PRINCIPLE (GAAP)

Accounting Concepts: refer to the Accounting postulates i.e., necessary

assumption or the conditions based upon which the financial transactions or events are
recorded, classified and summarized.

1. Business Entity Concept: According to this concept, business is treated as a

separate entry from its owners, creditors, managers and others. In other words, the
proprietor of an enterprise is always considered to be a separate and distinct from the
business from which he controls. All the transactions of the business are recorded in the
books of the business from the point of view of the business. Thus, even the amount of
money invested by the owner(s) in the money, called "capital" which will be treated as
a liability of the business. The name of the owner should not be written in the books of
accounts of the business, instead two accounts will be maintained called "capital
account" to show the amount due to him at a pint of time and "drawing A/c" to show
the amount, which he has already withdrawn from the business for this personal
purposes.

2. Going Concern Concept: According to this concept, the business is treated as an

artificial person and viewed as having indefinite or unlimited life(established for
longer period.). It is so important a concept that it is on the basis of the common
assumption that business shall continue to exists until it is liquidated. The accountant of
the business does not make un-necessary assumption regarding the forced sale values of
goods and assets. Assets will be depreciated on the basis of expected life rather than on
the basis of market value. Credit sale and purchase transactions take place assuming that
the business will be existing in future to settle them.

The International Accounting Standard has recognized "Going concern Concept" as a

fundamental accounting assumption. According to it, the enterprise is normally viewed
as a going concern, that is as continuing in operation for the foreseeable future. It is
assumed that the enterprise has neither the intention nor the necessity of liquidation or of
curtailing materially the sale of its operations.

"Any enterprise which is expected to continue operating indefinitely in the future, hence
its collective assets, liabilities, revenues, operating costs, personnel, policies and
prospects a basic axiom of accounting"

3. Accounting Period Concept: The result of the business i.e., profit or loss, can be
measured by comparing the assets of the business existing at the time of its
commencement with those existing at the time of liquidation. Since life of business is
assumed to be indefinite as per the going concern concept, the measurement of income
will not be possible till the liquidation of the business. The owner of the business cannot
wait for such a long period as it will be too late to take corrective steps at that time if it
is disclosed that the business had all the time been running at a loss on account of certain
reasons or business had not been using its full capacity to make more profits. Thus, he
needs to know at frequent intervals "how things are going". Therefore, accountants
choose some shorter and convenient time for the measurement of income. 12 month
period is normally adopted for this purpose. Under the Companies Act and
Banking Companies Act accounts are to be prepared for 12 month period. The
time-interval is called "accounting period". In other words, according to this concept,
the business is assumed to close its business operations at the end of an accounting
period, normally of twelve months, to know the results of the transactions during the
same period by closing the books of accounts and resume the business operations by
opening a new set of accounts from the next day onwards.

4 Money measurement Concept: The money measurement concept underlines the

facts that in the books of accounts all the transactions are recorded only in terms money.
In other words, all the transactions, which can be measured and recorded in terms of
money only, can only be recorded in the books of accounts. The information which
cannot expressed in terms of money is not included in accounting records.

5. Cost concept: The underlying idea of cost concept is that, an asset is recorded in the
books of accounts at the price paid to acquire it at the time of its acquisition and
that cost becomes the basis for the subsequent accounting period for that asset.
Accordingly, if nothing is paid to acquire an assets, the same will not be usually recorded
as an assets, For Example:- a favorable location of the company will remain
unrecorded though these are valuable assets.

6. Dual aspect concept: This is the core principle of double entry book-keeping. All
the business transactions are assumed to be having two corresponding effects,
namely, giving effect and receiving effect, later these two effects will be known as
debit and credit effect. In other words, every debit effect will have corresponding credit
effect as every inflow of cash will have an equivalent outflow in the form of goods or
services or an outflow of cash will have an equivalent out flow of services.

This concept give the basic accounting equation. i. e.,

Assets = Capital + Liabilities OR

Assets – Liabilities = Capital

ACCOUNTING CONVENTIONS: The accounting conventions signifies the customs,

or traditional a guide to the preparation of accounting statements.

1. Convention of Full Disclosure: The accounting convention of disclosure implies that

the accounts must be honestly prepared and all material information must be
disclosed therein. The term "disclosure" does not imply that all information that anyone
could conceivably desire is to be included in accounting statements. The term only
implies that there is to be a sufficient disclosure of information of Financial
Statement(P&L A/C & B/S), which is of material interest to Internal as well External
Users such as proprietors, present and potential creditors and investors. The
disclosure should be full , fair and adequate so that the Users of the Financial Statement
can make correct decisions about the financial performance of the Company.

2. Convention of Materiality:- This principle is basically an exception to the Full

Disclosure Principle. The above Full disclosure principle states that all the facts
necessary to ensure that the financial statement are not misleading, must be disclosed.
Whereas the Materiality Principle requires that the items or events having an
insignificant economic effect or not being relevant to the Users need not to be
disclosed.

1. Convention of consistency: In order to enable the management of a company to

draw important conclusions regarding the working of a company over a number of
 years, it is essential that accounting policies, practices and methods remain
unchanged from one accounting period to another. The comparison of one
accounting period with that in the past is possible only when the convention of
consistency principle is followed to. But the idea of consistency does not imply
non-flexibility as not to permit the introduction of improved technique of
accounting. According to Accounting Standard - I consistency is a fundamental
assumption and it is assumed that accounting policies are consistent from one period
to another. Where this assumption is not followed, the fact should be disclosed
together with reasons.

2. Convention of Conservatism: This is the policy of "playing safe". This takes into
consideration that anticipate no profits but provide for all probable losses. This
accounting principle is given recognition that "In view of the uncertainty attached
to future events, profits are not anticipated but recognized only when realized
though not necessarily in cash. Provision is made for all known liabilities and
losses even though the amount cannot be determined with certainty and represents
only a best estimate in the light of available information".

The Principle of conservatism is applied:-

a) When there is an uncertainty inherent in the activity, e.g., uncertainty as to the

useful life of an asset, occurrence of loss, realization of income, remaining utility
of an asset, estimated liability;
b) When there are two equally acceptable methods then the one, which is more
conservative, will be accepted;
c) When there is judgement based on estimates and doubt exists as to which of the
general estimates is correct, the most conservative would be selected; and
d) When there is a possibility of occurrence of a loss or profit; losses will be
considered and profits will be overlooked. In other words, "expect no profit but
make all provision for all the possible losses".