Accounts

ACCOUNTS FINANCIAL ACCOUNTING is an art of recording, classification & summarization of transactions of financial nature & interpretation of the results thereof. Features of financial accounting: 1. It is an art of recording the transactions. 2. It is an art of classification of the transactions. 3. It is an art of summarization of the transactions. 4. It records only monetary transactions. 5. It draws conclusions about profitability & financial position of the organization. Information generated by accounting: 1. Expenses & losses. 2. Incomes & gains. 3. Assets. 4. Liability. 5. Capital employed. 6. Net profit/loss. 7. Profitability position. 8. Financial position. Users of accounting information: 1. Management: To take the right decision. To know about profitability & financial position. 2. Shareholder: To know about the return on investment, appreciation in investment, liquidity of investment, safety of investment. 3. Loan officer: To decide the ability to repay loan, ability to pay interest regularly. Can take right decision about sanctioning loan. 4. Suppliers: Suppliers of raw materials can verify the credit worthiness of the party. 5. Trade Union Leader: can protect the interest of the workers on the basis of accounting information. 6. Government officers: Revenue from tax collection. Tax liability.

ACCOUNTING PRINCIPLE

CONCEPTS: Basic assumptions on which entire accounting is based.

CONVENTIONS: Traditions, customs & practices established by the professors.

CONCEPTS: 1. ENTITY CONCEPT: It says that the proprietor & his business are 2 separate parties i.e. entities. A proprietor becomes a creditor of the business by the amount invested in the business. Creditor is a person to whom some amount is payable for supply of goods or services. Capital is the amount invested by a proprietor in business. Capital is the liability of business. Liability is the obligation on business to repay a certain amount OR it is the claim against the property of business OR Amount payable to others is a liability. A proprietor becomes a debtor of business by the amount taken from business for personal expense. Drawing is the amount withdrawn by the proprietor from business for personal expenses. Profit earned by the business belongs to the proprietor. It increases capital. As per entity concept, the accountant should record only those monetary transactions which affect the business. The transactions of the proprietor which don’t affect business shouldn’t be recorded in accounts. Entity concept is applicable to all the organizations from accounting point of view. 2. MONETARY CONCEPT: Financial accounting records only monetary transactions i.e. the transactions which can be expressed in terms of money. Non-monetary transactions don’t find place in accounting. The transactions or events which can’t be expressed in terms of money are non-monetary transactions. E.g. loss due to death of an efficient manager. 3. COST CONCEPT: As per this concept, business transactions are recorded at cost. Cost is the sacrifice made for purchase of any goods or services. Cost is the basis of future transactions also. E.g. purchased goods worth Rs. 10,000 for Rs. 8,000. In this case, the cost of the goods is Rs. 8,000. It will be recorded at Rs. 8,000. Cost is the basis of future transactions also. Depreciation is provided on permanent assets on the basis of the cost. If the asset is sold out, the profit/loss on the sale will be calculated on the basis of cost.

4. GOING CONCERN CONCEPT: A business organization is a going concern. It has a continuous life. It continues its activities year after year. There is no intention to close down the business activities after a certain number of years. E.g. the proprietor invests huge amount in business, depreciation is provided on fixed assets for replacement, huge amount is spent on training of employees. 5. ACCOUNTING PERIOD CONCEPT: Entire life of an organization is divided into small periods for deciding the profit/loss & ascertaining the financial positioning. Each accounting period is called an Accounting year & consists of 12 months. Therefore all the organizations prepare their accounts every year. 6. MATCHING CONCEPT: The concept is employed to find out profit/loss for the year. Profit/loss is decided by matching income for the year with the expenses for the year. Profit is the excess of income over expenses for the year & loss is the excess of expenses over income for the year. Before matching expenses & income it is necessary to make adjustments about the incomes & expenses relating to the next year.

CONVENTIONS 1. CONVENTION OF CONSISTENCY: As per this convention, there should be uniformity in the methods of accounting followed by the organization. Consistency means the same method of accounting should be followed year after year. The method of accounting should not be changed frequently. Consistency doesn’t mean that there can’t be a change in method. The method can be changed if there are changes in circumstances. Due to consistency, comparison between 2 accounting periods becomes meaningful. 2. CONVENTION OF CONSERVATISM: The accountant should adopt a conservative approach while preparing the financial statements. Conservatism doesn’t mean that the accountant must be pessimistic about the future of the company. Conservatism implies that the accountant should a safe approach while preparing financial statements. He should select lower values between the 2 values given. E.g. Cost of stock of goods: Rs. 2,00,000 Market value: Rs. 3,00,000 The accountant should consider Rs. 2,00,000 stock for preparing the accounts. All the anticipated losses must be provided for. Anticipated profits should not be considered while preparing the accounts. 3. OBJECTIVE EVIDENCE: Every transaction to be recorded in accounting must have a proper documentary evidence. The documentary evidence is called a voucher. E.g. Telephone charges – Telephone bill. Salary – Salary register. Cash purchase – cash memo. 4. CONVENTION OF MATERIALITY: As per this convention, only material information should be disclosed in the financial statements. Material information means significant information which has effect on decision. Whether the information is material or not depends on the personal judgment of the accountant. E.g. it is immaterial to give all the details about the salary in the income statement. Similarly fraction of the rupee should be rounded up to the nearest rupee. The breakup of the total sales is material if it affects the decision. Cash sale of Rs. 500 in a total sale of Rs. 1,00,000 is immaterial.

DOUBLE ENTRY SYSTEM OF ACCOUNTING: It is a system of accounting which records double effects of the transactions. According to this system every transaction has 2 effects & the amount of one effect is always equal to amount of another effect. It means the amount of debit is always equal to the amount of credit. An account is a summarized record of transaction relating to an asset, a liability, an expense, a loss, an income & a gain. An account is divided into 2 sections. The left hand side section is known as the debit side which is indicated by the abbreviation ‘Dr’. The right hand side is known as credit side which is indicated by the abbreviation ‘Cr’. _________________ A/C Dr Date

Particulars

J.F.

Amount

Date

Particulars

J.F.

Cr Amount

To debit the account means to record the transaction on debit side of the account. To credit the account means to record the transaction on the credit side of the account.

CLASSIFICATION OF ACCOUNTS:

Accounts

Personal A/C These are the accounts of individuals, firms, companies, association of people, body of individuals.

Impersonal A/C

Real A/C These are the accounts of assets and properties

Nominal A/C These are the accounts of expenses & losses and incomes & gains

RULES OF RECORDING TRANSACTIONS: DEBIT Debit the receiver Debit what comes in Debit expenses & losses

PERSONAL A/C REAL A/C NOMINAL A/C

CREDIT Credit the giver Credit what goes out Credit incomes & gains

ACCOUNTING EQUATION: ASSETS = CAPITAL + LIABILITIES Assets Cash Furniture Invested in business Rs. 500000 500000 Transactions

Purchased furniture for Rs. 200000

Took loan from bank Rs. 200000

-20000

20000

480000

20000

Received commission Rs. 20000

20000

20000

20000

Assets A/c Expenses & losses A/c Capital A/c Liabilities A/c Incomes & gains A/c

450000

200000

470000

200000

10000 20000

RULES OF CREDIT & DEBIT Debit + + -

200000

20000

-10000 640000

500000 -50000

20000 650000

Paid interest on loan Rs. 10000

500000 200000

-50000 630000

Liabilities

500000

200000 680000

Paid for staff salaries Rs. 50000

Capital

Credit + + +

480000

200000

RECORDING THE TRANSACTIONS: Transactions are identified on the basis of documentary evidence. The transactions are first recorded in the journal on the basis of documentary evident. A journal is a primary book of account. It is also called as a daily record of transactions. It is maintained in columnar form as given below: Date

(1) 2 007 July 1

V. No.

(2)

Particulars

(3)

L. F.

(4)

Amount Dr

Cr

(Rs.)

(Rs.)

(5)

(6)

Column 1: Date of the transaction is recorded systematically. First, the year is mentioned, thereafter, the name of the month & then the date. Column 2: This column mentions the serial no. of the voucher for ready reference. Every transaction is supported by a voucher. All the vouchers are properly filed & given serial numbers. Column 3: In this column names of the accounts affected are mentioned. On the first line, name of the account debited is mentioned. After the name of the account, the abbreviation ‘Dr’ is to be mentioned on the same line. On the next line small space is left & thereafter the word ‘To’ is mentioned followed by the name of the account credited. Below the 2 accounts mentioned, a brief explanation of the transaction (called as narration) is written. After the narration a line is drawn in this column to show the completion of the record of transaction. Column 4: Ledger folio is the page no. of the ledger on which the particular account appears. It is necessary to get immediate reference about a particular account. Column 5: It mentions the amount of the account debited on the same line. Column 6: It mentions the amount of the account credited on the same line.

CONCEPT OF DISCOUNT: TRADE DISCOUNT: It is the concession allowed by a seller to a buyer in order to enable him to maintain the same price & earn reasonable amount of profit. It is also called as a quantity discount because it is allowed to attract large size orders from the buyers. The amount of trade discount is deducted from the bill itself & the net amount of the bill is brought in the books of accounts. Therefore trade discount doesn’t appear in the books of account. CASH DISCOUNT: It is a concession allowed by a creditor to a debtor in order to collect the amount promptly. The debtor may make the payment in order to get discount. Cash discount is a loss to a creditor & a gain to a debtor. The creditor doesn’t mind sustaining this loss because he receives the payment from the debtor immediately. It helps him to finance the business activity. Cash discount is recorded in the books of accounts. Example: Purchased goods from A & Co. worth Rs. 20,000 on credit subject to 10% trade discount & 5% cash discount if the payment is made within 10 days. Date

2007 July 1

V. No.

Particulars

Goods A/C Dr

L. F.

Amount Dr

Cr

(Rs.)

(Rs.)

18000

To A & Co.'s A/C (Being purchased goods from A & Co. on credit) 7

A & Co.'s A/C Dr To Cash A/C To Discount A/C

18000

18000 17100 900

LEDGER After recording the transactions in the journal, they are required to be properly classified in order to get immediate reference. Therefore a separate book known as ledger is maintained. Ledger is the second book of accounts. It is a book of accounts which includes all types of accounts i.e. personal A/c, real A/c & nominal A/c. A separate page is reserved for each account. Each page of a ledger is properly numbered. The page number of the ledger is known as ledger folio which is mentioned in the journal for immediate reference. All the transactions recorded in the journal are transferred to the respective accounts in the ledger. The process of transferring the transactions from the journal to the respective account in the ledger is called posting. _________________ A/C Dr Date (1)

Particulars (2) To _______ A/c (Name of the account credited)

J.F. Amount Date (3) (4) (1)

Particulars (2) By ______ A/c (Name of the account debited)

J.F. (3)

Cr Amount (4)

Column 1: Enter the date of the transaction systematically. Column 2 (Debit side): Write the word ‘To’ & thereafter mention the name of the account credited in the journal. Column 2 (Credit side): Write the word ‘By’ & thereafter mention the name of the account debited in the journal. Column 3: Mention the page number of the journal from where the transaction has been transferred. Column 4: Write the amount of the transaction.

Journal entry: V. No.

Date

L. F.

Particulars

Amount Dr (Rs.)

2007 April 1

Cash A/c Dr To Capital A/c

Cr (Rs.)

1000000 1000000

Ledger entry: Cash A/c Dr Date 2007 April 1

Particulars

J.F.

To Capital A/c

Amount

Date

Particulars

J.F.

Cr Amount

J.F.

Cr Amount

1000000

Capital A/c Dr Date

Particulars

J.F.

Amount

Date 2007 April 1

Particulars By Cash A/c

1000000

BALANCING OF ACCOUNTS: After posting the transactions to various accounts, balancing has to be done. It is a process of finding out a balance on the account. The process of balancing involves the following steps. 1. Make a total of debit side & credit side of the account. 2. Find out the difference between the 2 totals. 3. Put the difference on the lighter side of the account as, “By Balance c/d” OR “To Balance c/d” as the case may be. 4. Make the totals of both the sides equal. 5. Bring forward the balance on the next date as, “By Balance b/d” OR “To Balance b/d” as the case may be. Debit balance: Excess of debit over credit is called as a debit balance. Credit balance: Excess of credit over debit is called as a credit balance.

SOLVED EXAMPLE: “Pizza & burger huts” is a retail chain having retail outlets in almost all the major cities in India. It has opened one more branch in Navi Mumbai 3 months ago. The manager of this branch provides you with the following information for the month of April 2007. you are required to prepare Journal & Ledger on the basis of the following transactions: Balances as on 1/4/2007: Fixed assets Rs. 18,00,000 Stocks of materials Rs. 1,50,000 Debtors Rs. 3,50,000 Capital Rs. 15,00,000 Security deposit Rs. 5,00,000 Bank A/c Rs. 1,00,000 Bank loan Rs. 7,50,000 Creditors Rs. 7,50,000 Local taxes payable Rs. 1,00,000 Cash Rs. 2,00,000 Transactions during April 2007: April 1 : Paid creditors Rs 1,50,000 by cheque no. 468523. April 2 : Received cheque no. 124650 from Mr. Mahesh to whom goods were supplied in the last year Rs. 2,50,000. April 5 : Received cash from debtors Rs. 1,00,000. April 10 : Paid local taxes by cheque no. 468524. April 11: Purchased raw materials from “pizza products ltd.” on credit Rs. 500000 April 25 : Paid wages Rs 2,50,000 in cash. Electricity bill Rs. 50,000. Credit sales Rs. 1,00,000. Cash sales Rs. 7,00,000. Interest on loan paid Rs. 20,000. Miscellaneous expenses Rs. 50,000.

JOURNAL V. No.

Date

2007 April 1

2

5

10

11

25

Particulars

L. F.

Amount Dr

Cr

(Rs.)

(Rs.)

Fixed assets A/c Dr

18,00,000

Stock of materials A/c Dr Debtor's A/c Dr Security deposit A/c Dr Bank A/c Dr Cash A/c Dr

1,50,000 3,50,000 5,00,000 1,00,000 2,00,000

To Capital A/c To Bank Loan A/c To Creditor’s A/c To Local taxes payable A/c (Being brought forward the assets & liabilities) Creditor's A/c Dr To Bank A/c (being paid to creditors by cheque no. 468523) Bank A/c Dr To Debtor's A/c (Being received cheque from Mahesh, a debtor by cheque no 124650) Cash A/c Dr To Debtor's A/c (Being received cash from debtors) Local taxes A/c Dr To Bank A/c (Being paid local taxes by cheque no. 468524) Purchase A/c Dr To Pizza products ltd. (Being purchased raw material on credit) Wages A/c Dr To cash A/c (Being paid for wages) Electric Charges A/c Dr To Cash A/c (Being paid for electricity bill) Debtor's A/c Dr To Sales A/c (Being sold goods on credit) Cash A/c Dr To Sales A/c (Being sold goods for cash) Interest on loan A/c Dr

15,00,000 7,50,000 7,50,000 1,00,000 1,50,000 1,50,000 2,50,000 2,50,000 1,00,000 1,00,000 1,00,000 1,00,000 5,00,000 5,00,000 2,50,000 2,50,000 50,000 50,000 1,00,000 1,00,000 7,00,000 7,00,000

20,000

To Cash A/c (Being paid for interest on loan) Miscellaneous A/c Dr To Cash A/c (Being paid for miscellaneous expenses)

20,000

50,000 50,000

LEDGER Fixed Asset A/c Dr Date 2007 April 1 May 1

Particulars

J.F.

Amount

To bal. b/d

1800000 1800000 1800000

To bal. b/d

Date 2007 April 30

Particulars

J.F.

By bal c/d

Cr Amount 1800000 1800000

Stock of Material A/c Dr Date 2007 April 1 May 1

Particulars

J.F.

Amount

To bal. b/d

150000 150000 150000

To bal. b/d

Date 2007 April 30

Particulars

J.F.

By bal c/d

Cr Amount 150000 150000

Debtor's A/c Dr Date 2007 April 1 25

May 1

Particulars

J.F.

Amount

To bal. b/d To Sales A/c

350000 100000

To bal. b/d

450000 100000

Date 2007 April 2 5 30

Particulars

J.F.

By Bank A/c By Cash A/c By bal. c/d

Cr Amount 250000 100000 100000 450000

Security deposit A/c Dr Date 2007 April 1 May 1

Particulars

J.F.

To bal. b/d

Amount 500000 500000 500000

To bal. b/d

Date 2007 April 30

Particulars

J.F.

By bal. c/d

Cr Amount 500000 500000

Bank A/c Dr Date 2007 April 1

May 1

Particulars

J.F.

Amount

To bal. b/d

100000

To bal. b/d

350000 100000

Date 2007 April 1 10 30

Particulars By Creditor's A/c By Local taxes A/c By bal c/d

J.F.

Cr Amount 150000 100000 100000 350000

Capital A/c Dr Date 2007 April 30

Particulars

J.F.

To bal. c/d

Amount 1500000 1500000

Date 2207 April 1

Particulars

May 1

By bal. b/d

J.F.

By bal. b/d

Cr Amount 1500000 1500000 1500000

Cash A/c Dr Date 2007 April 1

Particulars

J.F.

Amount

To bal b/d

200000

5

To Debtor's A/c

100000

25

To Sales A/c

700000

Date 2007 April 25

Particulars By wages A/c By electric charges A/c By Interest on loan A/c By miscellaneous expenses A/c By bal. c/d

30 May 1

J.F.

250000 50000 20000 50000 630000 1000000

1000000 630000

To bal. b/d

Cr Amount

Bank Loan A/c Dr Date 2007 April 30

Particulars

J.F.

To bal. c/d

Amount 750000 750000

Date 2007 April 1

Particulars

May 1

By bal. b/d

J.F.

By bal. b/d

Cr Amount 750000 750000 750000

Creditor's A/c Dr Date 2007 April 1 April 30

Particulars

J.F.

To Bank A/c To bal. c/d

Amount

Date 2007 April 1 11

150000 1100000 1250000

Particulars

J.F.

By bal. b/d By Purchases A/c

May 1

Cr Amount 750000 500000 1250000 1100000

By bal. b/d

Local taxes payable A/c Dr Date 2007 April 10

Particulars To Bank A/c

J.F.

Amount 100000 100000

Date 2007 April 1

Particulars By bal. b/d

J.F.

Cr Amount 100000 100000

Purchases A/c Dr Date 2007 April 11 May 1

Particulars

J.F.

To Creditor's A/c

Amount

Date 2007 April 30

500000 500000 500000

To bal. b/d

Particulars

J.F.

By bal. c/d

Cr Amount 500000 500000

Wages A/c Dr Date 2007 April 25 May 1

Particulars

J.F.

To Cash A/c

Amount 250000 250000 250000

To bal. c/d

Date 2007 April 30

Particulars

J.F.

By bal. c/d

Cr Amount 250000 250000

Electric charges A/c Dr Date 2007 April 25

Particulars

May 1

To bal. b/d

J.F.

Amount

To cash A/c

50000 50000 50000

Date 2007 April 30

Particulars

J.F.

By bal. c/d

50000 50000

Dr Date 2007 April 30

Particulars

J.F.

Amount

To bal. c/d

800000

Date 2007 April 25

Particulars

J.F.

By Debtor's A/c

Cr Amount 100000 700000 800000 800000

800000 May 1

Cr Amount

To bal. b/d

Interest on Loan A/c Dr Date 2007 April 25 May1

Particulars

J.F.

To Cash A/c

Amount 20000 20000 20000

To bal b/d

Date 2007 April 30

Particulars

J.F.

By bal. c/d

Cr Amount 20000 20000

Miscellaneous expenses A/c Dr Date 2007 April 25 May 1

Particulars To cash A/c To bal b/d

J.F.

Amount 50000 50000 50000

Date 2007 April 30

Particulars By bal. c/d

J.F.

Cr Amount 50000 50000