Professional Documents
Culture Documents
Book-Keeping is mainly concerned with recording of financial data relating to the business operations in
a significant and orderly manner. A book keeper may be responsible for keeping all the records of a
business or only of a minor segment such as position of a customer’s accounts in a departmental store. A
substantial portion of the book keeper work is of a clerical in nature and is increasingly being
accomplished through the use of mechanical and electronical devices.
• Events and transactions of a financial nature are recorded while the events of a
non-financial nature cannot be recorded.
• The record should reflect the importance of the transactions so recorded both
individually and collectively, which includes summarization, thereby making it
amenable to analysis.
• The users of the financial statements should be able to obtain the message
encompassed in such financial statements, and it is the knowledge of
accountancy, which enables the user to understand the contents of the financial
statements.
Economic
Recording Communicatin
events
Classifying g information
measured in
Summarizing to users ( P&L
financial Analyzing A/c, B/S, CFS,
terms Interpreting etc)
Accounting Process:
Recording: Recording commences when a business transaction occurs and it has
been quantified. A record of all these transactions is maintained in the order in
which they occur in the Journal Book.
Summarizing: After the Recording and Classification phases are complete the
accounts containing relevant information in the Ledger Book are to be balanced and
the balances listed. The Statement giving names of these accounts and their
respective balances is called the Trial Balance. On the basis of the Trial Balance the
summaries are generated to provide information about the Profit / Loss and the
Position of the firm. The reporting of these summaries is done through Financial
Statements.
Financial Statements can be defined to include the Balance Sheet, the Profit
and Loss Account, Notes to the Accounts and other incidental statements and
explanatory material which are identified as part of financial statements.
• Identification—what’s relevant?
• Measurement—which yardstick?
• Classification and accumulation—how do you organize the results of
thousands of events?
• Summarization—how much information is enough, but not too much?
• Communication—how often, when, and to whom?
Qualities of Accounting Information
Information should be useful, but what does that mean? The two primary qualities
of useful information are:
S T E P 2
P r e p a r a t io n o f
B u s in e s s D o c u m e n ts
S T E P 3
R e c o r d in g o f
T r a n s a c tio n in J o u r n a l
S T E P 4
P o s tin g to L e d g e r
S T E P 5
P r e p a r a tio n o f
U n a d ju s te d T r a il B a la n c e
S T E P 6
P a s s in g o f
A d ju s t in g E n t r ie s
P r o f it & L o s s A c c o u n t
S T E P 7
P r e p a r a t io n o f A d ju s t e d
B a la n c e S h e e t
T r a il B a la n c e
F u n d F lo w S ta te m e n t
The decision maker who intends to use accounting information should have a
reasonable understanding of business and economic activities and be willing to
study the information with reasonable diligence. A sophisticated understanding of
accounting is an indispensable part of the tool-kit for most decision makers.
A c c o u n t i n g
F i n a n c i a l C o s t M a n a g e m e n t
A c c o u n t i n g A c c o u n t i n g A c c o u n t i n g
But this information, though of immense vitality does not adequately aid the
management in planning, controlling, organizing and efficiently conducting the
course of the business as a result of which Cost Accounting and Management
Accounting are in place.
V. OBJECTIVES OF ACCOUNTANCY:
It facilitates:
to replace memory.
to comply with legal requirements.
to ascertain Net results of operations.
to ascertain Financial position.
the users to take decisions.
a compliance study.
control over assets.
the settlement of tax liability.
the ascertainment of value of business.
raising of funds.
Acts as legal evidence
Investors and lenders are the most obvious users of accounting information.
Their decisions and their uses of information have been studied and described to a
much greater extent than those of other user groups. However, financial reports are
also extensively used by other individuals and groups who have to rely on them as
their major source of financial information. Potential users of accounting information
include:
Internal Users: They include Board of Directors, Partners, Managers, and
Officers.
• Auditor's Report
General Guide for Financial Accounting
• Generally
• Accepted
• Accounting
• Principles
Accounts Provide the the most useful financial information for…Decision Making
• Accounting Concepts
– Basic assumptions or conditions upon which the science of accounting
is based.
• Accounting Conventions
– Principles or theories based on which accounting is done.
• Money Measurement Concept: In financial accountancy, an event is recorded, only if it
can be expressed in monetary terms. Recording, classification and summarization of
business transactions requires a common unit of measurement, which is taken as money.
Hence, all transactions are recorded through a common denominator – money. Thus, if a
certain event, no matter how significant for the health or even existence of the business,
cannot be measured in monetary terms, that event is not recorded in accounting. Money is
expressed in terms of its value at the time an event is recorded in the accounts.
• Business Entity Concept: The business is distinctly different and separate from its
owner. A business entity or a company is an artificial company created by law, who has a
common seal, which has a perpetual existence and does not die natural death. Hence for
accounting purpose, the owner and his business should be kept separate. Accounting
records are kept from the point of view of the business unit and not the owner. So, if the
owner contributes fund to the business, it will be treated as a liability of the business –
say the business owes this much to the owner.
• Going Concern Concept: A business entity is having a perpetual existence, which does
not die a natural death. It is assumed to carry on its operations forever. It implies that the
resources of the concern would continue to be used for the purposes for which they are
meant to be used.
For instance, in a manufacturing concern, the land, buildings, machinery etc., are
primarily required for carrying out the production and selling of certain products. This
concept implies that these land, buildings, machinery etc., would continue to be used for
this purpose.
• Cost Concept: Cost Concept implies that in accounting, all transactions are generally
recorded at cost, and not at market value. For example, if a piece of land is acquired for
Rs.1 lakh, it would continue to be shown in the balance sheet at Rs.1 lakh, even when the
market value of the land rises to say Rs.10 lakhs. Why should this be so? This is because
cost concept is in fact closely related to the going concern concept.
• Duality concept: This is the fundamental accounting equation, which is the formal
expression of the dual aspect concept. To reflect the two types of equities, the equation is
more commonly expressed as
OR
The Accou
Each of the perm
affected by debits
• Period Concept: A business entity is an artificial person having a perpetual existence. To
measure income generated by the business or loss incurred by the business, the infinite
life of the business is broken into small pieces called accounting periods. End of each
such period it is ascertained what income the business generated or what loss the business
incurred and what the financial position of the business is? These small periods are
known as accounting period. Generally accounting period is one year – January 01 to
December 31 as in US and April 01 to March 31 as in India.
• Matching Concept: In order to ascertain profit or incurred some loss in an accounting
period, the expenses related to this period must be compared or matched with the
revenues generated during this period.
• Realization Concept: Realization concept deals with the point in time at which revenue may
be deemed to be realized or when a sale can be said to have taken place. Normally revenue is
recognized at the time of transfer of goods or services when a return consideration is either
obtained immediately or there exists a reasonable certainty of receiving a return consideration
in future.
For example: If a customer buys Rs 500 worth of the items at grocery stores,
paying cash, the stores realizes Rs 500 from sale. If a department stores sells a
suit for Rs 3000 the purchaser agreeing to pay within 30 days, the store realizes
Rs 3000(in receivables)from the sale, provided that the purchaser has a good
credit record so that payment is reasonably certain.
• Accrual Concept: The accrual basis of accounting recognizes revenues when sales
are made or services are preformed, regardless of when cash is received. Expenses are
recognized as incurred, that is, when goods are used or services are received, whether
or not cash has been paid out. Net profit equals the revenues earned less expenses
incurred during a period.
B) Accounting Conventions:
1. Consistency
2. Full Disclosure
3. Conservatism
4. Materiality
• Conservatism Concept: This principle emphasizes that revenues and profits should be
accounted only when there is a reasonable surety of recognizing it but any anticipated loss
or expense should be immediately accounted for.
• Materiality Concept: It states that insignificant events may be disregarded, but there
must be full disclosure of all important information.
• Consistency Concept: The consistency concept requires that once an entity has decided
on one method, it will treat all subsequent events of the same character in the same
fashion unless it has a sound reason to change the method of treatment of that transaction.
For example, if a concern is valuing its inventory by a particular method in one year it is
expected to value its inventory in the subsequent years also in the same method unless
there is a strong reason to change the same.
• Full Disclosure: According to this convention all accounting statements should be
honestly prepared and to that end full disclosure of all significant information should be
made. On the other hand, if there is no detailed disclosure in the profit and loss account
undisclosed reserves accumulated in the past periods may be used to swell the profits in
the year when the company is failing badly and the shareholders may be misled into
thinking that company is making profit.
3. Limited Company: It is a legal entity and is treated by the law like a natural
person. It must be run according to the rules laid down by the company law.
Systems of Accounting
1. Recording
Journalizing: The daily business transactions are recorded in the order of their
occurrence in a book called Journal. Recording of entries in the journal is known as
journalizing. Journals aid the recording process by
There are separate rules of the Double entry system in respect of Personal, real and
nominal accounts which are discussed below:
R u l e s o f D e b i t a n d C r e d it
P e r s o n a l A c c o u n t sR e a l A c c o u n t s N o m in a l A c c o u n t s
T h e r e c e i v e r W h a t c o m e s i n A l l e x p e n s e s a n d l o s s e s
D e b i t :
T h e g i v e r W h a t g o e s o u t A l l i n c o m e s a n d g a i n s
C r e d i t :
1. Real Account: It represents assets like plant and machinery, land and buildings
goodwill, etc. As on a particular date, this account shows the worth of the asset.
A c c o u n t s
P e r s o n a l A c c o u n t s I m p e r s o n a l A c c o u n t s
E g . I n d i v i d u a l s , F i r m s , N o m i n a l
R e a l A c c o u n t s
C o m p a n i e s , B a n k s , e t c . A c c o u n t s
A s s e t s l i k e c a s h ,R l ea ln a d t e, t o e x p e n s e s
b u i l d i n g s , p l a n t ao n r d l o s s e s o r
m a c h i n e r y , p a t i n
e n t s , c o m e s o r p r o f i t s .
g o o d w i l l m , e t c .
Figure 2.2 Types of Accounts
Opening Entry
All previous year’s assets and liabilities of B/S are brought forward to the current
year as an opening entry. All asset a/c’s are debited All liability a/c’s are
credited. The excess of assets over liabilities are credited to capital account.
A list of all the accounts and their balances at a given time. It serves to prove the
mathematical equality of debits and credits after posting. It aids in the preparation
of financial statements.
FINANCIAL STATEMENTS:
3. Statement of Cash Flows: It reflects the major sources of cash receipts and
cash payments of an enterprise. It reports the cash effects during a period of not
only the enterprise’s operations but also its investing and financing activities.
Capital Expenditure:
• The benefit of which is not fully derived in one year but spread over several
periods.
• Eg: Acquisition of assets, additions to fixed assets
Revenue Expenditure:
• The benefit of which is derived in the year in which the expenditure was
incurred.
• Eg: Raw material, Rent, wages and salaries.
FINAL ACCOUNTS OF MANUFACTURING FIRMS
• Receipts and Payments A/c: To know the Cash and Bank balances
• Income and Expenditure A/c: To know the Surplus made / Deficit incurred
• Balance Sheet: To know the financial position
• Profit and Loss A/c: To know the operating performance of the business
i.e. Net
profit / Net Loss
Trading Account
• Opening Stock
• Closing Stock – valuation
• Purchases
• Sales
• Direct Expenses –Wages,Customs & Import Duty,Freight, carriage and
cartage inwards,Royalty
– Gas, electricity, water, fuel,Packing materials
Closing Entries – Trading Account
1. Trading a/c Dr
To Opening stock a/c
To Purchases a/c
To Carriage a/c
2. Sales A/c Dr
To Trading a/c
•
Net profit/Net loss is an index of profitability of business
•
Comparison of profit over periods helps in assessing the business efficiency
•
Analysis of expenses over periods help in effective control of expenses
•
Profit and expense analysis helps in planning and forecasting the future
course of action.
Manufacturing Account
• Cost of production
• Stock
– Raw Materials
– Work in progress
• Raw Materials consumed
• Carriage inwards
• Direct wages
• Factory overheads
– Factory power
– Depreciation on factory machines
• Sale of scrap
Final Accounts – Adjustment Entries
Sometimes the accountant will come to know that he had not taken some
significant information into the books of accounts. This apart it not too uncommon
that certain transactions take place during or after the preparation of trial balance.
In the above cases the transactions were not recorded in the books and hence they
need to be adjusted in the books. This is done by passing some adjustment entries.
Following the double entry system every adjustment will have a two-fold effect. Put
in other words, the adjustment has to be carried out at two places. Normally the
adjustment takes palace at any two of the following three places
1. Closing Stock
2. Outstanding expenses
3. Prepaid Expenses
4. Accrued Income
5. Income received in advance or unearned income
6. Depreciation
7. Bad debts
8. Provision for bad debts
9. Provision for discount on debtors
Closing Stock
• Adjustment
– Taken on credit side of trading account
Closing stock a/c Dr
To Trading a/c
Outstanding expenses
• Outstanding expenses are those expenses which are due during the
accounting period but have not yet been paid
• Appears as adjustment
– Expense a/c Dr
To Outstanding expense a/c
• Prepaid expenses are those expenses which have been paid in advance
during the accounting period
• Appears as adjustment
– Prepaid Expense a/c Dr
To expense a/c
• Outstanding income is that income which is due during the accounting period
but has not yet been received
• Outstanding income & Accrued income
• Appears as adjustment
– Outstanding Income a/c Dr
To Income a/c
• Depreciation denotes the decrease in the value of an asset due to the wear
and tear, lapse of time, obsolescence, exhaustion etc.,
• As an adjustment
Depreciation A/c Dr
• As an adjustment
Bad debts A/c Dr
To Debtors a/c
All balance sheets are built up from 3 main categories, namely assets, liabilities and
shareholders funds. The relationship between them can be looked at either from the
point of view of shareholders (a proprietary approach) or from the point of view of
the company as a whole (an entity approach). Two forms of the fundamental
balance sheet identity can thus be derived:
A proprietary approach balance sheet will look like the following (vertical balance
sheet).
Fixed assets
+ Current assets
- Current liabilities
=Net assets or capital employed
LIABILITIES = ASSETS
Assets
Assets are something of value to the business, which can either be turned into
cash or used to produce revenue.
Fixed assets
Those assets which are intended for use on a continuing basis in an undertakings
activities.
Examples are buildings, equipment, vehicles. Stocks, for example, are not
regarded as fixed assets since they are acquired either for immediate resale (for
example cigarettes as sold by a tobacconist) or as raw materials for use in
manufacturing operations.
Plant and vehicles, for example, are the current assets of a company whose
business it is to manufacture them for sale.
Investments
Shares, loans, bonds and debentures held either as fixed tangible assets or
current assets. These are usually valued at cost.
Goodwill
A company is not just a collection of tangible assets. It is, or should be, a going
concern whose total value, by reason of its proven ability to earn profits, is
greater than the sum of its parts. It is the difference between the total value and
the sum of the parts which constitutes goodwill. It should not be regarded as in
any way a fictitious asset: to be valuable, an asset does not have to be tangible.
Goodwill is, however, very difficult to value objectively and company law does
not permit it to be appear in the balance sheet unless it has been purchased,
and even then it is usually written off immediately or quite quickly. In some
group balance sheets an item appears entitled “goodwill arising on
consolidation” or “goodwill on acquisition”. This represents the excess of the
cost of shares in subsidiary companies over the book value of their net tangible
assets at the date of acquisition; that is, the parent company was willing to pay
more to purchase a company than the sum of its tangible and net current assets.
Current assets
Comprise those assets which are not intended for continuing use in the business.
Expected to be turned into cash or used in course of trading which can normally
be expected to be turned into cash within one year from the date of the balance
sheet.
Stocks are another example of matching concept - just how far to take it
depends upon the materiality concept.
Liabilities
Current liabilities
Long term liabilities represent the extent to which the firm, not wishing to
borrow further long term funds from shareholders, has borrowed from outsiders.
The major parts consist of both long term loans (not wholly repayable within 5
years) and medium term loans (repayable within 5 years).
Banks are an obvious source of outside finance and many firms long term
liabilities are in the form of bank loans. These are not the only form of
borrowings. There are also debentures and debenture stocks which may be
secured by fixed or floating charges or may alternatively be unsecured
debentures.
Shareholders funds
The shareholders funds section of the group balance sheet is subdivided into
Share Capital and Reserves.
Shareholders differ from debenture holders in three important ways; they are
owners of the company, not lenders; they receive dividends (a share of the
profits), not interest; and, except in special circumstances, the cost of their
shares will not be repaid (redeemed) to them by the company.
Shares can be either ordinary or preference. The latter is usually entitled only to
a dividend at a fixed rate, but has priority of repayment in the event of the
company being wound up. Preference shares may be cumulative or non-
cumulative.
Every share has a par value but this is not necessarily the same as the issue
price of the shares or their market price. Shares can be issued at more than their
par value: this gives rise to a share premium reserve. Once a share has been
issued, its market price fluctuates from day to day, but this has no effect on the
firms balance sheet.
A company does not have to issue all its shares at once, nor does it have to
request full payment on the shares immediately. Companies normally have
authority to issue (i.e. have authorised capital of) shares even though they have
not issued them. Also shares can be partly paid. For example, a 25p share could
be payable 5p on application for the shares, a further 5p on allotment, when the
directors decide to whom the shares are going to be issued (or allotted), and the
remaining 15p in calls. Thus, in summary, one can distinguish authorised, issued,
called up and paid-up share capital.
Reserves
Reserves consist of the retained profit (or loss), the share premium account and
other reserves such as a revaluation reserve. This is created as a result of the
revaluation of fixed assets on the other side of the balance sheet.
It is very important not to confuse reserves with cash. To say that a company
has large reserves is not the same thing as saying that it has plenty of cash. If a
company has reserves it must have net assets of equal amount, but these assets
may be of any kind (e.g. machinery, stock in trade). Thus it is perfectly possible
for a company to have both large reserves and a large bank overdraft.
CURRENT LIABILITIES
Creditors 50
TOTAL ASSETS LESS CURRENT LIABILITIES 175
It is clear that the only ways to increase the assets are to increase the liabilities
(to borrow) or to increase the shareholders funds. How can a company increase
the latter? There are two possibilities: it can issue more shares or it can plough
back profits (assuming of course that it is making some). Ploughing back profits
is the simplest but not necessarily the cheapest source of long term finance for a
company. Also the more a company ploughs back the less, in the short run at
least, there will be available for paying dividends.