Accounting Principles

Table of Contents

Accounting Concepts and Introduction to GL...........................................................................2

Accounting...................................................................................................................................2
Branches of Accounting..............................................................................................................2
Book Keeping..............................................................................................................................3
Method of Book Keeping..........................................................................................................4
What is an Account?...................................................................................................................5
Principles/Concepts of Accounting..............................................................................................5
Types of Accounts in Double Entry System.................................................................................6
Some Important Accounting Documents.....................................................................................7
Journal.....................................................................................................................................7
Ledger.....................................................................................................................................7
Posting.....................................................................................................................................7
Cash Book...............................................................................................................................7
Bank Book...............................................................................................................................7
Trial Balance............................................................................................................................8
Final Accounts.........................................................................................................................8
Format of Revenue A/c, P&L A/c and Balance Sheet.................................................................9
Some Accounting Entries..........................................................................................................10
Flow of Activities in Double Entry system..................................................................................11

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Accounting Concepts and Introduction to GL

When a person starts a business his main aim is to earn profit. He receives money from certain
sources like sale of goods, Interest from bank deposits etc. He has to spend money on certain
items like purchase of goods, salary, rent etc. These activities take place during the normal
course of his business. Business transactions are numerous, that it is not possible to remember
all those transactions and recall as to how the money had been earned and spent. If he had
noted down his incomes and expenses he can get the required information easily. Hence it
becomes necessary to record activities, which have monetary effect, in a clear, and a systematic
manner to get answers for the following questions

1. What has happened to his investment?

2. What is the result of the business transactions?
3. What are the earnings and expenses?
4. How much amount is receivable from customers to whom goods have been sold on
credit?
5. How much amount is payable to suppliers on account of credit purchases?
6. What are the nature and value of assets possessed by the business concern?
7. What are the nature and value of liabilities of the business concern?

These and several other questions are answered with the help of accounting.

Accounting

Accounting is nothing but recording a set of business transaction in the books of accounts. Any
financial transaction or non-financial transaction like (cash or non cash) even depreciation,
goodwill etc has to be recorded.

The purpose of accounting is to provide the information that is needed for sound economic
decision making. The main purpose of financial accounting is to prepare financial reports that
provide information about a firm's performance during a period to external parties such as
investors, creditors, and tax authorities and the financial position of the firm as on a particular
date

Branches of Accounting

Financial Accounting is concerned with recording of business transactions in the books of

accounts in such a way that operating result of a particular period and financial position on a
particular date can be known. It deals with preparation of financial statement like profit & loss
account, balance sheet etc. which is used by all types of companies.

Cost Accounting relates to collection, classification and ascertainment of the cost of production
or job undertaken by a firm. It is used by only manufacturing companies. This deals with
preparation of various cost based statements to fix the selling price for a product, break-even
analysis, etc.

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Management Accounting relates to the use of accounting data collected with the help of
financial accounting and cost accounting for the purpose of policy formulation, planning, control
and decision making by the management. Any type of company can use management
Accounting. This deals with preparation of various reports for the management based on which
they take decisions.

Book Keeping

Book Keeping is the method of maintaining accounts. There are two methods of book keeping
namely Single Entry book keeping and Double entry book keeping.
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Method of Book Keeping

Single Entry Book Keeping

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Single entry book keeping is a method of maintaining accounts which do not conform to strict
principles of double entry book keeping. Under this system, only the personal accounts of
debtors, creditors and cashbook of the trader are maintained. The absence of two fold effect
makes it impossible to prepare Trial Balance and Final Accounts. Hence, Single Entry is
incomplete and not reliable.

This is followed by firms whose transactions are limited and where they maintain only essential
records.

Double Entry Book Keeping

Any business transaction when closely analysed reveals two aspects. One aspect will be
“Receiving aspect” or “Incoming aspect” or “expenses/Loss aspect”. This is termed as the “Debit
Aspect”. The other aspect will be “Giving aspect” or “Income/gain aspect” This is termed as the
“Credit Aspect”.

In short the basic principles of this system is, for every debit there must be a corresponding credit
of equal amount and for every credit there must be a corresponding debit of equal amount.

For example sale of furniture affects both the cash account and the furniture (asset) account.
Asset in the form of furniture goes out of business and money for that value of furniture comes
into the business. Two entries are made for each transaction, one entry as a debit in one account
and other entry as a credit in another account.

Two notable characteristics of double entry book keeping are

1. Every transaction affects two accounts

2. Each transaction has two aspects i.e., Debit and Credit.

What is an Account?
Every transaction has two aspects and each aspect has an account. An account is a summary of
relevant transactions at one place relating to a particular head.

In this system, the double entries take the form of debits and credits, with debits in the left column
and credits in the right. For each debit there is an equal and opposite credit and the sum of all
debits therefore must equal the sum of all credits. This principle is useful for identifying errors in
the transaction recording process.

Principles/Concepts of Accounting
Accounting entries are made keeping the following principles in mind.

Conservatism
According to this principle all known expected expenses are provided for whereas expected
income is not recorded.

Double Entry System

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For every debit entry there is a corresponding credit entry for the same amount. Dual aspects of
transaction are recorded and accounts for all the account types viz. Personal, Real and Nominal
are maintained.

Cut Off Date

Profit & Loss account is to show the performance of the business for a given period ending on a
date known as cut off date
Balance Sheet is to show the financial position of the business as on that date.

Basis of Accounting
Every transaction should not be qualified and the monetary value should be recorded. Items that
can be quantified in monetary terms alone will be accounted. Items like Employees Moral, skill
set or a company’s brand image, quality of management are not accounted (unless someone is
prepared to pay something for them)

Revenue Recognition
Revenue is both revenue income and revenue expenditure.
Eg. Claim provision is made on intimation date itself. Similarly for revenue income, premium has
to be recognised on the date on which the coverage commences. Only at that time the revenue
should be recognized in the books of accounts. If policy issue date is 15, March 2005 and
premium is collected on 15, March 2003 and if the policy effective date is April 1, 2005 then this is
the date on which the revenue has to be recognised in the books of account.

Historical Data
Transaction should be recorded after it has happened.

Going Concern Concept

Assumed that the business will go on forever.

Ownership & Control Segregation

Owner and business are separate. Types of ownership are sole proprietor, partnership, private
limited company, public limited company, and co-operative society.
Any household or personal expenses paid from the business should not be debited as business
expense, but it should be debited to the personal account

Types of Accounts in Double Entry System

There are 3 types of Accounts in the double entry system of book keeping. They are
1. Personal Account
2. Real Accounts
3. Nominal Accounts

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Personal Account
Account maintained in the names of person or concern or companies.
Eg: Ram’s A/c, Ramesh & co. ABC Insurance Company, XYZ Brokers & Co etc

The Rule for Personal Account is

Debit the Receiver

Credit the Giver

Real Account
Asset Account (other than Personal Accounts) is classified as Real accounts.
Eg. Cash A/c, Bank A/c, Furniture A/c, Building & Machinery A/c

The Rule for Real Account

Debit what comes in

Credit what goes out

Nominal Account
Accounts maintained for Incomes, Expenses, Profits and Losses are classified as Nominal
Accounts.
Eg. Salary A/c, Premium A/c, Dividend Account, Rent Account etc.

The Rule for Nominal Account

Debit all expenses and losses

Credit all incomes and gains

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Some Important Accounting Documents

Journal
A Journal is a chronological listing of the firm’s transaction including the amounts, accounts that
are affected and whether the affected account is to be debited or credited. Journal is the primary
book of accounts from which the different accounts are debited or credited.

Ledger
Ledger is a principal or main book which contains all the accounts to which the transactions
recorded in the Journal are transferred / posted.

In Journal each transaction is recorded separately and it is not possible to know the net result of
many transactions pertaining to a particular account at a glance. A ledger is a book which
contains all the accounts whether personal, real or nominal. It is an account wise collection of
transaction. So that tracking of individual account balances becomes easier. After recording a
transaction in the Journal it is then transferred to the ledger. The process of transferring the
debits and credits to the Ledger is called Posting.

Each Ledger Account will have Debit and Credit columns. Based on each transaction in journal,
the ledger account can have debit or credit or both entries. Both debit and credit columns will be
totalled to find out the net balance of the account.

Posting
The process of transferring the entries recorded in the journal or subsidiary books to the
respective accounts opened in the ledger is called posting. In other words, posting refers to
grouping of all the transactions relating to a particular account at one place.
It is necessary to post all the transactions into various accounts in the ledger because posting
helps us to know the net effect of various transactions during a given period on a particular
account.

Cash Book
This is a ledger for cash transactions where the cash receipt are recorded on the debit side and
cash payments are recorded on the credit side.

Bank Book
This is a ledger where bank related transactions are posted. All the bank receipts are posted on
the debit the side and bank payments are posted on the credit side. Bank receipt refers to
income by way of cheque and Bank payment refers to any payment by way of cheque.

Trial Balance
The Trial balance is a listing of all Leger Account Balances, which can be a Debit or Credit
Balance. The total of all debit Balances should tally with the total of Credit balances. If it does not
tally then there is mistake in posting/totalling/balancing the accounts
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Such errors will come to light by preparing this trial balance.

Final Accounts
The businessman is interested in knowing whether the business has resulted in profit or loss and
what is the financial position of the business at a given date. In short he wants to know the
profitability and the financial soundness of the business. This could be ascertained by preparing
the final accounts.

Final accounts are prepared at the end of the year from the trial balance. The parts of final
accounts are
1. Trading account
2. Manufacturing account
3. Revenue account in case of Insurance Companies
4. Profit and Loss account
5. Balance sheet

Trading Account
Trading means buying and selling. This account shows the results of buying and selling of
goods. Gross profit or Gross loss is ascertained by preparing Trading account. This is prepared
by trading companies to find out the trading profit/loss. Expenses include purchase, wages, etc.
Income includes sales, closing stock etc.

Manufacturing Account (For Manufacturing Concerns)

This is a statement prepared by manufacturing firms to find out at the end of the financial year
whether they have made a profit or loss. This is prepared taking into account only the income and
expenses, which are directly related to the manufacturing operations. It does not include income
like interest from investment and expenses like salary to permanent staff. It is prepared taking
expenses like wages, materials, manufacturing expenses like power, water etc and income
include closing stock.

Revenue Account
Insurance companies do not prepare Trading account or manufacturing account since they don’t
deal with purchasing and selling of goods or manufacture of goods. So they prepare Revenue
accounts where premium received is treated as an income and the claims paid is treated as an
expenses with other management expenses like salaries paid, rent paid, commission paid etc.
This is prepared for each class of business separately.

Profit and Loss Account

Profit and Loss account is prepared to compute the Net profit or Net loss. Management
Expenses and Administrative expenses, Investment income and income from other sources are
entered in P& L account. Expenses relating to purchasing and selling of goods are not entered in
this account.

Balance Sheet
This is a statement prepared at the end of a financial year where the Assets and Liabilities are
stated along with their values. It shows the financial position of a business at a given date. The
Capital and Liabilities are shown on the left hand side and Assets and other debit balances are

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shown on the right hand side. The total value of Assets and total value of Liabilities should be
equal.

Balance Sheet is prepared with a view to measure the correct financial position of a business on
a certain date. It is a snap shot of the financial condition of the business.

An important thing to note about the Balance Sheet is that it is always balances i.e., total value of
asset is always equal to the total value of liabilities

Format of Revenue A/c, P&L A/c and Balance Sheet

Dr Revenue Account Cr

Claim Paid (Less RI) Premium (Less RI)

Commission Paid Commission Received
Claim expenses Salvage / Recovery
Management expenses (Salary etc)*
Reserve for Unexpired Risk
Revenue Surplus /Deficit

(Balancing Figure)

If the total of credit items is higher than the debit items then it results in surplus and if it is the
other way around it results in deficit.

* These expenses are apportioned to the various classes of business based on some proportion.

The revenue account is prepared separately for Marin, Fire and Miscellaneous.

Dr

Profit & Loss Account

Cr

Revenue Deficit Revenue Surplus

Non-Operating Expenses Non-Operating Income
Depreciation Etc. (Eg. Interest on Investment)
Net profit /Loss*
(Balancing Figure)

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* This amount is taken to the Reserves & Surplus in the Balance Sheet.
Balance Sheet

Share Capital xxxxxx Investments xxxxxx

P & L Account (Net profit) xxxxxx
Reserves & Surplus xxxxxx Loans xxxxxx
Secured Borrowings xxxxxx Fixed Assets xxxxxx
Unsecured Borrowings xxxxxx Current Assets & Liabilities xxxxxx
Cash
Debtors
Stock
----------------------
Less: Salary Payable
P.F payable xxxxx
P& L A/c (Loss to be written xxxx
Off)

xxxxxx xxxxxxx

(The format for preparing the balance sheet is prescribed in Schedule 6 to the Companies Act).

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Flow of Activities in Double Entry system

Identify the accou

involved

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account and record t
transaction