ACCOUNTING CONCEPTS

Accounting Concepts are the rules which we have to follow while preparing the financial
statements. Concept means idea. Basically these concepts are divided into 12 types. The
total Accounting rotates around these twelve concepts. Let us discuss those concepts in
detail.

1.Business Entity Concept

According to this concept business is separate from owner. Means while preparing the
accounts we must treat the owner as a outside person. This leads to keeping away the
personal factors which influences business factors.

Why this concept introduced

Because if we keep the business records along with our personal records, there may
arise the problems of vague profit/loss. Because there is no concept like this, we will
record our personal expenses and incomes in the business books only. So, we can't
arrive at our real profit.

Example :-Expenses related to son's marriage, LIC premium paid for family etc.,

2. Dual Aspect Concept

According to this concept, every transaction has two aspects. Those are Debit and
Credit. Every debit has a credit and every credit has a debit. So, a change in debit results
in change in credit.

For Example, You purchases a car of Rs.10,00,000 by paying cash immediately. Then
there is a decrease in asset of Rs.10,00,000 in form of cash and increase in another asset
of Rs.10,00,000 in the form of Car.

We will take another example, assume you have creditors of Rs.10000. You paid cash to
them Rs.10,000. So, here there is a decrease in asset in the form of cash and decrease in
liability in the form of creditors.

Finally, in both the cases Balance Sheet will tally because of this Dual Aspect Concept.
3. Money Measurement Concept
As per this concept, we will record only those transactions which will be measured in
terms of money. Because generally financial transactions will be prepared for the
ascertainment of profit. That profit must be in monetary terms. So, it is impossible to
record non monetary transactions. Even if you record what value you will show for that
entry in books ? Measuring unit for money is taken as the currency of ruling country,
means if you are preparing accounts in India then record transactions and events in
terms of rupees.

Examples for Non Monetary Transactions :- Employee dismissed from job, Riots and
Strikes etc.,

4. Periodicity Concept
The period for which we prepare accounts is called a Accounting Period. Then, if a
person started a business. After five years he want to close it. So, he decided to prepare
accounts at the end of 5 years. Is it acceptable ? The answer is obviously no. Then there
arises a question why ? The answer is "periodicity concept". Periodicity concept
describes a period in which we have to prepare accounts. Generally this period may be
6months or 9months or 1 year.

Why this concept ?

Because of this concept we will know about our product demand and sales, we can
make decisions to introduce a new product or not, decision on business
expansions, comparing financial statements of different periods etc., This results in a
huge profit. Think, if you prepare accounts after 5 years, you may not be to access all
these features.

In India, the period we follow is 1 April to 31 March.

5. Accrual Concept
This concept says, record the transactions and events on mercantile basis i.e., when
they occur. As per accrual concept: Revenue - Expenses = Profit. Here, revenue includes
received and yet to be received and expense include paid and yet to be paid. For
example, if you have to pay salary to your employee in February, because of losses you
promised him that you will pay it in March. So, here you have to record February
month's salary in February only as outstanding salary as per this concept.
Why this concept ?

Assume there is no Accrual Concept. Then you will record the transaction whenever
actual payment/receipt was done. For Example, you promised your business premises
owner that you will pay rent Rs.5,00,000 of year 2016 in year 2017. So, then you will get
a high profit in 2016 because you didn't recorded the expense and low profit or even
loss in 2017 because you recorded the expense in this year.

So, finally we can conclude that without accrual concept we cannot arrive at real profit .

6. Matching Concept
As per this concept, all expenses matched with the revenue of that period should only
taken into consideration. According to this concept, Periodic profit = Periodic Revenue -
Matched Expenses. We should deduct the expenses of a period from the revenue of
that period only. This concept will reflect while preparing the Trading and Profit and
Loss account and Balance Sheet.

7. Going Concern Concept :

Basically it is an assumption. Generally, we will prepare financial statements on the
assumption that the business will continue for a far long period. So, this concept makes
an assumption that business doesn't have an intention to liquidate. For Example, if a
person purchases a machinery with a life of 5 years. I he purchased that machine to sale
? No, because he purchased that machine to generate revenue. Means, here we can
assume that he has an intention to continue business for coming 5 years (because he
purchased machinery with a life of 5 years). Generally going concern ignores the change
in value of asset in short run.

8. Cost Concept
This concept says that, the value of an asset should be determined on the basis of
historical cost or acquisition cost. Means record the record the assets at cost at which
you have purchased. For Example, if you purchased a machinery for Rs.5,00,000 then
record the machinery at Rs.5,00,000 only till the end of it's life. Traditionally we
followed cost concept in order to maintain objectivity. But cost concept have lot of
distortions.

For Example, if you purchased a land before 20 years for Rs.5,000. But now the value of
land is Rs.50,00,000. Will you record that land at Rs.5,000 only. Absolutely No. Because
if you record that land at Rs.5,000 the Balance Sheet will not reflect true figure. So, cost
concept creates such type of controversies. Hence now a days, in many circumstances,
cost concept is not followed.

9. Realisation Concept
As per the realization concept, recognize income only when actually realized. Means any
change in value of an asset shall be recorded only when business realizes it. For
Example, if you received any advance for service offered by customer, then recognize
that income only when you rendered the service. It follows some what conservative
principle, because it covers all the possible losses but doesn't cover any gains. This
concept doesn't applies to Revaluation Reserve. This is the most significant concept now
a days.

10. Conservatism
This concept states that accountant should anticipate only losses but not gains/incomes.
This concept is also called as prudence concept. Then there arises a question how
should we anticipate losses. For Example, think you have a debtor of Rs.10,000. He is
incapable to pay us money. So, you may record him as bad debts. But if you anticipate
that your gains next year will be Rs.6,000. Can you record it as upcoming gains. The
answer is No. Because of this conservatism concept. It says that record only anticipated
expenses but not anticipated incomes.

11. Consistency Concept

As per this concept, we have to prepare financial statements, as per the same
accounting policies which we are followed first. It is basically an assumption. For
Example, if you used straight line method for calculating depreciation in the first year
then this concept will assume that you will use this method only for
depreciation consistently for the coming financial years also. This leads to the
comparison and decision making. But in some cases we may change the accounting
policies which we are followed. You can change the policies in accordance with
Accounting Standards and Law.

12. Materiality
As per this concept, we will consider only significant items while preparing the financial
statements. This principle is an exception for Disclosure policies. Why will consider here
only significant items? For example, if the business purchased a calculator, Note Books,
Calendars etc., can you record those as transactions? No, because the amount of books
and calculators are very small. It creates a negative impression to the users on the
financial statements and it's also an extra work to the accountants. Because the users
doesn't want this type of information.
 JOURNAL
What is Journal ?
So, now after knowing what is accounts, we may have a doubt that how to prepare
accounts? As I discussed earlier Accounting starts with the phase "Recording". So, how
we will record the transactions and events in the books of accounts ? The best answer is
with the help of Journal.

Now you got the point that we will do recording with help of Journal. Then there will
arise a question that what is Journal. Journal is a book where record the financial data in
a systematic and chronological order. The financial data is first recorded in this book
only. So, it is also called as Primary Book of Entry.

If we found any mistakes while preparing financial statements, it is difficult to

check where we have done it. So, with the help of journal we can easily find the mistake
and rectify that. And it also makes easy to post these entries in ledger.

Now, there arise another question that how will we do this Journalizing. Before going to
learn this we must have to know about classification of accounts. Accounts are generally
classified into three types those are :

1.Personal Account

As the name includes person means, here, anything which has an identity. This personal
account includes debtors, creditors and other persons. This personal account again
classified into three types :

a. Natural Persons :-Natural persons includes human beings like you, me, Ram, Shyam
etc.,

b. Artificial Person :- Artificial persons are those persons who are recognized as persons
under law. These persons include business entities, financial institutions, companies
etc.,
c. Representative Personal Account :- These are not persons actually but represented as
persons. It includes drawings, capital, outstanding and prepaid etc.,

2. Real Account

These accounts only relates to the assets of the firm. It includes all the assets like
machinery, cash, investments, furniture etc.,

3. Nominal Account

These accounts relates the expense and incomes, profits and losses. The result of
nominal account is treated as profit/loss. It includes salary, commission, rent etc.,

Golden Rules of Accounting

Accounting provided us three Golden Rules with which we can record the transactions
and events in Journal. Those are :

Debit The Receiver

Credit The Giver

Debit What comes in

Credit What goes out

Debit All expenses

Credit All incomes
Proforma

Date Particulars LF Debit Credit

 LEDGER
What is Ledger?
In the previous post we discussed about Journal. So, we completed the recording phase
in Accounting Procedure. Now, the second phase of Accounting cycle is Classifying.
What is this means ? Here we will classify the recorded data under different heads as
per their nature. We will do this classification in ledger. From this we can define ledger
as “the book where we classify the recorded entries in a chronological manner and
grouped them into by preparation of accounts and the book which contains all set of
accounts viz., personal, real, nominal.” This book is also called as Principle book of
accounts and Secondary book of Entry. By this we can classify the entries into Personal,
Real, Nominal. It helps to find out the closing balance of all the heads.

PROFORMA :-

Date Particulars JF Debit Date Particulars JF Credit

The way of transferring the financial data from Journal to Ledger is called ‘Posting’. The
systematic segregation of that posted data is called ‘classifying’.

Rules :

1. Separate Account should be prepared for each account.

2. The word ‘To’ must be used while writing accounts in debit side and word ‘by’
must be used while writing accounts in credit side.
3. It follows the rule that Every debit has a credit and Every credit has a debit
4. It leads to the preparation of trail balance.
5. All the accounts are balanced except nominal accounts.
6. The balance of nominal accounts were transferred to Profit and Loss account.
 SUBSIDIARY BOOKS
What are Subsidiary Books :
In the previous post we discussed about Ledger. So, now we will discuss another
procedure of Accounting cycle i.e., Subsidiary Books. So, now a question arises that
what are these subsidiary books. A separate register maintained for recording each class
of transactions is called a subsidiary book. So, generally after reading this definition you
may get a doubt that what is the use of these Subsidiary books. Now we will discuss
about that. Simply saying about the usage of these books is they will summarize the
same category of transactions. For example assume you have purchases from Mr.A
Rs.10000, purchases from Mr.B Rs.5,000 and purchases from Mr.C Rs.15,000. So, it is
not possible to record these individual transactions in final accounts. So, subsidiary
books will group above three transactions into a single transaction i.e., Purchases
Rs.30,000(Rs.10000+Rs.5,000+Rs.15,000) By this way it helps us to minimize work.

WHY SUBSIDARY BOOKS ?

While checking the errors relating to an individual class of transactions like Purchases,
Sales etc., it is difficult to revise all the transactions and find the error. So these
Subsidiary Books made easy to solve such type of problems . By these we can find the
mistakes with the help the registers that we have maintained for each class of
transactions.

TYPES OF SUBSIDARY BOOKS :-

1) Purchase Book
2) Sales Book
3) Purchase Returns Book
4) Sales Returns Book
5) Bills Receivable Book
6) Bills Payable Book
7) Journal Proper
8) Cash Book
Here we will record only credit purchases of goods. Cash purchases and Purchase of
assets and will not be recorded in this Purchase Book. Here we will record suppliers
name with their respective quantities of goods,. After that just we will total the amount
of that Purchase Book.

Proforma

Date Particulars L.F Details Amount

Example : If you have purchases of 2000 kg @ Rs.10000 from Mr.A, 1000 kg @ Rs.5,000
from Mr.B, 3000 kg @ Rs.15,000 from Mr.C. Then you will record these transactions in
Subsidiary books as

Date Particulars L.F Details Amount

Mr.A 2000 kg 10,000

Mr.B 1000 kg 5,000

Mr. C 3000 kg 15,000

TOTAL 6000 kg 30000

Here we will record only credit sales of goods. Cash sales and sales of other things like
assets, stationery will not be recorded in this Sales book. Here we will record customers
name, quantity and amount in their respective columns. After that we will total it and
add packing charges, Sales Tax and deduct trade discount and record the amount in
outer column.
Proforma

Date Particulars L.F Details Amount

Example :- If you have sales of Rs.10,000 from Mr.A with packing charges Rs.500 and
trade discount Rs.1000, you will record this in subsidiary books as :

Date Particulars L.F Details Amount

Mr.A

(+) Packing Charges 10,000

(-) Trade Discount 500

1000

TOTAL 10,500

It is also called as Returns Inward Book. If customers frequently returns the goods, then
it is better to keep a book separately for Sales returns. The issue of credit note will be
used to prepare sales returns book. The credit note is a statement which is issued by the
customers to us specifying the details of goods and their quantities of which they are
going to return.

This book is also called as Returns outward book. If we return the goods which we have
purchased earlier, then it would be better to keep a separate book called purchase
returns book. The issue of debit note will be used to prepare purchase returns book. The
debit note is a statement which is issued by the us to suppliers specifying the details of
goods and their quantities which we are returning.
ADVANTAGES OF SUBSIDARY BOOKS:-

1) Work would be divided and will be distributed according to their specifications.

2) Easy checking of mistakes and rectify them

3) It saves time as work is distributed

4) Since we kept separate books for separate transactions, all the information will be
available at one place.
 CASH BOOK
What is Cash Book?
Cash book is one of the type of subsidiary books. It is a part of ledger also. So, it is thus
both a Subsidiary book and Principle book. We will record only cash transactions in the
cash book. So, there is no chance of recording outstanding and prepaid balances.

KINDS OF CASH BOOK:-

It is also called single column cash book as that it looks like an ordinary cash ledger. So,
in this simply we record receipts on the debit side and payments on the credit side. The
cash book will always show debit balance that it never shows credit balance. The
balancing figure should be written as “Balance c/d” on the debit side of cash book.

Why it always shows debit balance?

If a cash book shows credit balance, it means payments are higher than receipts. It will
never happen. Because without receipt of money how will a person make payments.

PROFORMA :-

Date Particulars JF Debit Date Particulars JF Credit

2) DOUBLE COLUMN CASH BOOK :-

Along with the cash column, Double column cash book includes discount column. So, it
includes both cash and discount column. Discount allowed to the customers is entered
in the debit side and discount received from suppliers should be entered in the credit
side of cash book.
Here, only cash columns are balanced and discount columns are merely totaled and
transferred to the profit and loss account as discount allowed on debit side and discount
received on the credit side.

PROFORMA :-

Date Particulars JF Disc. Amt. Date Particulars JF Disc. Amt.

allowed received

3) THREE COLUMN CASH BOOK :-

This is the mostly used and acceptable method of preparing cash book. Because now a
days there is an increase in bank transactions. So, it is better to draw bank column
separately for banking transactions. Write deposits on the debit side and payments on
the credit side of this book. Discount column is as usual as mentioned in above.

Write cash receipts or payments in cash column and cheque/draft receipt or payments
in bank column.

CONTRA ENTRIES :-

1) CASH DEPOSITED INTO BANK:

Entry:- Bank A/c Dr.

To Cash A/c

2) CASH WITHDRAWN FROM BANK:

Entry:- Cash A/c Dr.

To Bank A/c

How will you record these transactions ?

These type of entries are called Contra Entries. We will record these transactions as
follows :
CASH DEPOSITED INTO BANK :

Amount is entered on the receipts side in the bank column as “To Cash” and on the
payment side in cash column as “By Bank”

LF LF
Date Particulars Bank Cash Date Particulars Bank Cash
No. No.
To Cash C XXXX By Bank C XXXX

CASH WITHDRAWN FROM BANK :

Amount is entered on the payments side in the bank column as “By Cash” and on the
receipt side in cash column as “To Bank”

LF LF
Date Particulars Bank Cash Date Particulars Bank Cash
No. No.
To Bank C XXXX By Cash C XXXX

CHEQUE DISHONOUR CASE :-

If some cheque sent to bank is dishonored

ENTRY: Debtors A/c Dr.

To Bank A/c

Enter Debtor’s name in the bank column on credit side.

LF LF
Date Particulars Bank Cash Date Particulars Bank Cash
No. No.
By Debtor XXXX
BALANCING :-

In three column cash book, both cash and bank columns are balanced. Cash column
must shows debit balance. Bank column may show either debit balance or credit
balance. Debit balance represents cash at bank and credit balance represents Bank
Overdraft.

ACCOUNTING FOR CREDIT/DEBIT CARD SALE :-

Now a days there is an increase in credit/debit card sale. Bank charges some
commission on such transactions.

ENTRIES:

1) FOR SALE THROUGH CREDIT/DEBIT CARD

Bank A/c Dr.

To Sales A/c

2) COMMISSION CHARGED BY BANK

Commission A/c Dr.

To Bank A/c