WHAT IS ACCOUNTING?

It is an art (since it is a technique where there is always a scope for improvising) and a science (because it is based on some specified set of principles to be followed) of: Identifying ECONOMIC events. Measuring them in TERMS OF MONEY RECORDING in books of accounts- Journal book. CLASSIFYING them into various accounts.- posting SUMMARISING the accounts into financial statements. ANALYSISING AND INTERPRETING the financial statements COMMUNICATING the data to the users.

Accounting information thus refers to the financial statements generated through the process of BOOK KEEPING, use of which enables to arrive at the correct decision. The statements so generated are: The income statements i.e Profit and loss account. This makes available the information about the profit or loss suffered as a result of business operation or otherwise during the accounting period. Trading account, which is a part of profit and loss account that provides information about gross profit, and P&L account about the net profit. The position statement i.e Balance sheet. Which makes available the information about the financial health of the organization? It provides info about the assets owned by the organisation, amounts receivable and cash and bank balances held by it. The amounts owed are represented in liabilities as loans, creditors and amounts payable. The difference between the two is represented by Capital. Cash Flow statement which shows both inflow and outflow of cash. It is of immense use as many decisions such as payment of liabilities, doing capital expenditure, expansion of business, are based on availability of cash.

Questions: What is the basic and foremost characteristic of accounting information??UNDERSTANDABILITY.

BASIC ACCOUTING TERMS???

Assets Liabilities Creditors Purchases Stock Sale 1

Capital Expenses Income Revenue Debtor Assets: 1. Fixed assets. 2. Current assets. 3. Intangible assets.

Loss Voucher Expenditure

profit Transaction

Liabilities 1. Long term liabilities- More than a year 2. Current liabilities- within one year

ASSETS LIABILITIES= CAPITAL CURRENT ASSETS CURRENT LIABILITIES= WORKING CAPITAL Expense 1. Direct expenses 2. Indirect Expenses Income Also called revenue

REVENUE- EXPENSES= INCOME/ PROFIT EXPENSE- REVENUE=LOSS Profit is normally categorized as gross profit and net Profit. GROSS PROFIT is the difference between sales revenue of good sold over its direct cost . NET PROFIT is profit made after allowing all other expenses whether direct or Indirect. Q. What is expenditure????? What is the difference between expense and Expenditure? Expenditure is the amount spent or liability incurred for value received or to be received. e.g purchase of a machinery. It is different from Expense because latter refers to only revenue expenditure which is the amount spent to produce revenue only in the current accounting period. Hence, All revenue expenditures are shown in P&L account while all Capital Expenditure which generate benefits over a number of accounting periods are shown as part of assets in the balance sheet.

GOLDEN RULE WE FOLLOW DUAL ASPECT CONCEPT OF BOOK KEEPING WHICH MEANS WHENEVER ANY TRANSACTION IS RECORDED, TWO ACCOUNTS ARE AFFECTED. IT WILL EFFECT THE ACCOUNTS IN THE FOLLOWING MANNER: ^SE AN ASSET AND DECREASE ANOTHER ASSET. e.g machinery purchased against cash. ^SE AN ASSET AND ALSO ^SE A LIABILITY e.g machinery purchased on credit DECREASE AN ASSET AND ALSO DECREASE A LIABILITY e.g creditor has been paid off... ^SE A LIABILITY AND DECREASE ANOTHER LIABILITY e.g . loan converted into capital.

THEORIES OF ACCOUTING
WHAT IS THE NEED OF PRINCIPLES, CONCEPTS AND STANDARADS? Since there are a variety of users for the financial statements like- owners, creditors, Government, investors etc, a need was felt to follow certain rules and conceptions while drafting the financial information. Thus accounting principles, concepts and conventions have been formulated and are commonly known as GENERALLY ACCEPTED ACCOUNTING PRINCIPLES OR GAAPs Accounting principles are the rules which are adopted universally. They are the norms which are followed for treatment of various items of income, expenses, assets and Liabilities. e.g Stock should be valued at cost or market value whichever is lower. Fixed assets are recorded at depreciated value. All accounting principles are categorized into two categories: a) Accounting Concepts b) Accounting Conventions ACCOUNTING CONCEPTS These are the basic RULES or assumptions or fundamental propositions within which accounting operate. At present there are 10 basic accounting concepts. 1. Business entity concept: which means business is considered separate from its owners. The owners funds as infused into the business are shown as liability either in the form of loan or share capital, correspondingly assets of the company 3

are increased by way of bank balance. Therefore if the proprietor uses companys funds to meet his personal expenses, his drawings account is increased and share capital is decreased. Some more examples of business entity.. Capital contributed by the proprietor is credited to his capital account. 2. Money measurement concept: Only those events and transactions which can be measured in money terms should be recorded in the books. Therefore estimated loss of profit due to strike etc cannot be recorded. Similarly though we can record the assets by converting them into money terms, e.g 20 chairs can be recorded at a cost less depreciation , but we cannot record 20 people in the books since they do not have a realizable value. or monetary value.!!!!! Some more examples are Not only can the number of people working for the organization but also the caliber and quality of the personnel can not be expressed in the financial records. 3. Going concern concept: A very important concept whereby every business house assumes their business to run for an indefinite time rather than for a year or even less. It is for this reason that a distinction has been made into capital expenditure and revenue expenditure. Therefore the cost of the machinery is spread over the life of the asset which may be any number of years and not in just one accounting period. Some more examples are: Though a strike, a natural calamity or a threat to the future success of the company due to stiff competition may make the business difficult, still the organization is believed to be a going concern and hence all the assets are not written off. 4. Accounting period concept: It is of immense importance that the performance of the bsiness be reviewed periodically and not at the end of the life of business? Hence the life of the business is broken into various small intervals (usually one year) and accounts are made for each accounting period. 5. The cost concept: According to this concept, an asset is recorded in books at the price or compensation paid to acquire it less depreciation, if any. Hence, though market value of an asset may change but the cost price remains the same and hence the asset continues to appear at cost less depreciation. This concept assumes that in case nothing has been paid to acquire any asset, the same will not be recorded in the books as an asset. E.g Goodwill is not recorded as an asset unless it is purchased. 6. Dual aspect concept: every transaction entered into by a entity has two aspects. One being debit and other being credit of EQUAL AMOUNT. In other words,

every debit may result in credit of an equal amount in one or more accounts and vice-versa. Some examples are: Purchase of assets for a company will lead to increase in assets and decrease in cash or bank balance. Borrowing from a bank will lead to increase in bank balance and a corresponding increase in the liabilities. 7. Revenue recognition concept: Which means revenue is considered to have been realized when a transaction has been entered into and the obligation to receive the amount has been established. Therefore revenue for services is recognized in books at the time of rendering services and revenue from sale of goods is recognized when goods are furnished to the customer since an obligation for payment is automatically created on the buyer, the moment goods are delivered. 8. Matching concept: According to the matching concept, cost incurred to earn the corresponding revenue should be recognized as expense in the period when revenue is recognized as earned. Therefore: All expenses incurred (whether paid or not) should be recorded in P&L account which relates to incomes recorded in that period. All expenses incurred, against which the revenue will be earned in the next accounting period, should be carried to the balance sheet as an asset and treated as an expense in the next year. E.g Prepaid insurance premium. Any revenue received against services to be rendered in future or against goods to be sold, should be recorded in the balance sheet as liability till the time services have been rendered or goods have been sold. Some more examples.. 9. Accrual concept: A transaction is recorded at the time when it happens and not when the settlement takes place. Therefore the profit is regarded as earned, the moment goods are sold to the customer irrespective of whether money has been received or not. Therefore all liabilities whether paid or not are recorded in the books since there is a obligation to pay them. 10. Verifiable objective concept: This implies that accounting should be free from all personal bias. And each transaction should be recorded on the basis of some verifiable evidence. E.g cash memos, acknowledgement, sales bills etc.

ACCOUNTING CONVENTIONS

Conventions are more in the nature of guidelines or behaviour that should be followed for preparation of financial accounts. They are more in the nature of principles followed over a period of time and are hence not rules but practices. In contrast to the accounting concept, conventions may undergo change with time to bring about improvement in the quality of information. GOLEDN RULE: CONVENTIONS CAN NEVER OVERRULE CONCEPTS. Accounting conventions are: 1. Full disclosure: By full disclosure, here we mean that all the RELEVANT and MATERIAL information IS DISCLOSED IN THE ACCOUNTS. If not alongwith the relevant figure , at least by way of notes to the accounts. E.g if a company has constructed a road( on which it has right to collect toll) which otherwise should be written off over 15 years , but in this case, there is an agreement that the road shall become the property of the govt. after 10 years, then the road needs to be written off in 10 years and not 15 years. This fact also needs to be disclosed by way of notes to the accounts. 2. Consistency: Just like in normal day to day life we follow certain consistency in our working, similarly while preparation of accounts, we need to follow certain methods on a consistent basis. Making changes in the same too often can lead to misleading figures. E.g a consistent method of valuation of stock-FIFO, A consistent method of depreciation- Straight line or W.D.V. etc. This can be further explained as follows: Depreciated value after 2 years by following SLM 500000 100000 400000 (-) 20% dep. 100000 300000 Depreciated value after 2 years by changing to WDV method in 2year 500000 100000 400000 (-) 20% dep on W.D.V 80000 320000 Hence we observe, how by changing from one method to another,: Our profit is overstated by 20,000 Our assets are overstated by 20,000 Our depreciation is understated by 20,000 Cost of machinery: (-) 20% dep. Cost of machinery: (-) 20% dep.

SO DOES THAT MEAN WE CANNOT CHANGE OUR POLICIES AND PRACTICES ONCE FOLLOWED???? WE CAN CHANGE THE PRACTICES PROVIDED THEY ARE A BETTER REPRESENTATION OF THE COMPANYS WORKING AND THIS ALSO NEEDS TO BE DISCLOSED BY WAY OF NOTES( HENCE FOLLOWING THE FIRST CONVENTION OF FULL DISCLOSURE.) 3. Conservatism: By the very nature of the word, it implies do not provide for a possible profit but provide for all possible losses The application of this convention ensures that financial statements are as realistic as possible and are never overstated. Conservatism does not anticipate revenues and thus always understates assets in the balance sheet. It provides for all expenses and also possible losses thus, overstating liabilities. Examples of conservatism are :

Closing stock to be valued at lower of cost or market value, so even if the stock may fetch a higher price in the market, they are still shown in accounts at cost price( hence ignoring the profit element) Providing for doubtful debts.

4. Materiality: This convention states that anything and everything which is material or of importance should be disclosed in the financial information. What is to be disclosed in the financial reports based on this concept can be, to a large extent, very subjective. However a simple rule that is followed worldwide is an item is material if there is a reason to believe that the knowledge of it would influence the decision of an informed investor. Examples of materiality are:

Rounding off figures to the nearest Rs.100/- since small amounts are immaterial. Closure of plant for whatever small or big reason is material information.

TRANSACTION ANALYSIS. Transactions are recorded in the books of accounts on the basis of an evidence e.g sales invoice, purchase bills, pay-in-slips, debit/ credit notes, cheques issued, cash receipts etc. .All such documents are popularly called as SOURCE DOCUMENT. Rules of debit and credit are then applied to each transaction and a voucher is prepared before recording in the BOOKS OF ORIGINAL ENTRY i.e journal book, Cash book, bank book. From the journal books, transactions are then transferred to the ledger accounts. This process is called posting. This process involves classifying transactions similar in

natureor relating to obe party at one place called an Account. The book in which accounts are maintained is known as LEDGER. The last step In the accounting process is striking a balance in each ledger account and preparing a Trial Balance by placing a debit balance and a credit balance in ach account in the debit and credit column of the trial balance. The total of two columns should agree since accounts are prepared on dual aspect concept. Financial statements are prepared from the trial balance. RULES OF DEBIT AND CREDIT What is debit or credit? In simple terminology, debt refers to left side of the account while credit refers to right side of an account. A debit entry means value has flowed to the account and hence account has been debited. The balance resting on this side is said to be a debit balance. And vice versa. In other words if debit side is larger than the credit side, it is called as having a debit balance and vice-versa. To understand the rules of debit and credit, we need to know the types of accounts. There are three types of accounts for the purpose of debit and credit classification. 1. Personal account: Accounts which relates to persons, including company, society etc is a personal account. Even a capital account or a drawing account is also personal account since it relates to a person RULE: DEBIT THE RECEIVER, CREDIT THE GIVER 2. Real account: Real accounts are the accounts which relate to tangible or intangible assets of the firm.( EXCLUDING DEBTORS) E.g plant and machinery, cash, Goodwill, patents etc. All Debtors are Personal account. Bank is also a personal account though it is an asset since it is a person/ entity. RULE: DEBIT WHAT COMES IN , CREDIT WHAT GOES OUT. 3. Nominal account: Accounts which relate to expenses, losses, gains, revenue, are called Nominal accounts. The net result of all the nominal accounts is called net profit which is transferred to the capital account. RULE: DEBIT ALL EXPENSES AND LOSSES AND CREDIT ALL GAINS AND INCOMES GOLDEN RULE: The rules of Debit and credit can also be summarized as follows:

Account Assets Liabilities Capital Revenue Expenses

Account to be debited Increase Decrease Decrease Decrease Increase

Account to be credited Decrease Increase Increase Increase Decrease

ALSO, WE ARRIVE AT THE CONCLUSION THAT ALL DEBIT BALANCES IS EITHER AN ASSET OR AN EXPENSE AND ALL CREDIT BALANCES ARE EITHER INCOME EARNED OR LIABLITY OR THE AMOUNT INVETSED BY THE PROPRIETOR. The Recording of a transaction alongwith the impact of debit and credit can be studied as follows: TRANSACTION (amount in Rs.) 1. A started business( 50,000) 2. Borrowed from B (20,000) 3.purchased furniture from C ( 10,000) 4. Purchased machinery with cash(10,000) 5.Purchased goods for cash(5000) 6.Sold goods for cash(10,000) 7. Sold goods to D on credit(5000) 8.Purchased goods from E(5000) 9. Paid cash to E (5000) 10. Cash received from D(1000) 11.Deposited cash in bank(1000) 12.Withdrew cash for personal use. (500) 13. Withdrew cash for staff ACCOUNTS INVOLVED Cash Capital Cash Loan Furniture C Furniture Cash Purchases Cash Cash Sales D Sales Purchases E E Cash Cash D Cash Bank Drawings Cash Cash Bank NATURE OF ACCOUNT Asset Capial Asset Liability Asset Liability Asset Asset Expenses Assets Assets Revenue Assets Revenue Expenses Liability Liability Assets Assets Assets Assets Assets capital Assets Assets Assets HOW AFFECTED Increase Increase Increase Increase Increase Increase Increase Decrease Increase Decrease Increase Increase Increase Increase Increase Increase Decrease Decrease Increase Decrease Decrease Increase Decrease Increase Increase Decrease 9

salary(20000) 14. Paid salary to F (5000) 15.Received cheque from D(2000) 16. Deposited Ds cheque in bank(2000) 17.Paid rent to G by cheque(4000) 18.Paid interest on loan(2000) 19. Goods returned by D(2000)

Salary Cash Cash D Bank Cash Rent Bank Interest on loan Cash/bank Sales return D

Expense Assets Assets Assets Assets Assets Expense Assets Expense Assets Expense/ Loss Assets

Increase Decrease Increase Decrease Increase Decrease Increase Decrease Increase Decrease Increase Decrease

What is the nature of service tax, sales tax, VAT collected during the course of business? What is the treatment in accounts at the time of collection and deposition? What is the nature of interest on capital and interest on drawings? RECORDING/ POSTING OF ENTRIES IN THE LEDGER Once we are through with the creation of various entries in the journal book, we proceed to post these entries into the ledger accounts. The first and foremost step in preparation of accounts is posting of opening entries. The entry passed to record the closing balances of the previous year Is called the opening entry. The balance sheet prepared at the end of the year reflects the closing balances of each asset and liability and forms the basis for this opening entry. While passing an opening entry all assets are debited by opening the relevant asset account and writing to balance b/d on the debit side . Similarly all liabilities are credited by opening the relevant liability account and writing by balance b/d on the credit side. After the same is done, entries from the journal book are posted to the ledger by debiting or crediting the relevant account. We can study the impact of the above entries on the ledger accounts and hence the trial balances of a company and see how the net effect is BALANCING OF BOTH THE SIDES by equal amount. i.e Debits are equal to credits after posting all the above entries. This can also be illustrated. Prepare ledger accounts of the account heads as given above and post each and every entry in the same. Also carry the entries to the trial balance and show the net impact. Lets try to prepare a trial balance from the extracts as given below. The balancing figure can be entered as capital.

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Purchases Stock(opening) Sales 528000 Sundry debtors Discount Rcd. Carriage outward Cash in hand Machinery Prov. For dep Prov. For doubtful debts

170000 24000 105000 23800 3500 700 3500 124500 24200 2380

Drawings Returns inward Premises sundry creditors Discount allowed carriage inward Cash at bank General Expenses bad debts written off

7700 3500 16100 2800 1400 17500 2100 2450

Solution: Capial ( balancing fig. 760770) Debit Credit 170000 24000 105000 23800 3500 700 3500 124500 24200 7700 3500 528000 16100 2800 1400 17500 2100 2450 2380 760770 911950 911950

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UNDERSTANDING OF CORPORATE ACCOUNTS Format of a trading accounts Dr. Particulars Rs To openeing stock To Purchases Less Returns o/w To direct expenses To Wages To freight inward To carriage inward To cartage inward To gross profit tfd. To P&L a/c Particulars By sales Less return i/w By closing stock By abnormal loss of stock By gross loss transferred to P&L a/c Cr. Rs.

Note:1.) Sales tax is always deducted from sales account. i.e entry passes is : Sales a/c.Dr. To Sales tax a/c (Liability to be paid) 2.) all cartage/freight etc. inwards are on purchases and not on assets. 3.)Direct expenses include power and fuel for manufacturing., rent of factory, duty on purchases, factory lighting, royalties to use patents, consumable stores. 4.) freight and cartage outward are indirect costs and hence not debited to trading account.
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Profit and Loss account Dr. Profit and loss account for the period ending Cr. Particulars Rs. Particulars Rs. To Gross profit tfd. From By gross profit tfd. From trading a/c trading a/c To salaries By rent To rect, rates and taxes By discount recd. To stationery & printing By commission recd. To Postage and telegram By interest To Audit fees By bad debt recovered To legal charges By income from T telephine expenses investment To Insurance premium By dividend on shares To business promotion By misc gains To repairs and renewals By income from other To depreciation sources To interest By net loss To sundry trade expenses ( tfd. To capital a/c) To conveyance To charity To Bank charges To office expenses To establishment expenses To general expenses To loss in exchange To license fees To brokerage To car running & maint. To office lighting To loss by fire ,theft To commission To advertisement
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To freight and cartage outward To discount allowed To packing charges To traveling expenses To distribution expenses To bad debts To net profit trd. To capital account

Some important points to know before reading a balance sheet: Operating profit= net sales-(cost of goods sold+ administrative and office expenses + selling and distribution expenses) OR Operating profit= net sales+ non-operating expenses- Non operating incomes Non operating expenses- interest on loan, loss due to theft, loss on revaluation of assets, charity and donations, loss on sale of assets etc. Non operating incomes= interest, rent, dividend, profit on sale of assets. Etc, Balance sheet Balance sheets can be prepared in two forms: 1. Vertical form 2. Horizontal form

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Handouts for the two formats given to students and items can be briefly explained. Special reference to: 1. calls in arrears account: to be shown as reduction from subscribed and paid up capital 2. calls in advance: to be added 3. Forfeited shares: amount already recd. On shares forfeited- to be added to share capital account.

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