Ms.K.

GOWRI, Associate Professor in Management studies, Excel Business School

Need of Accounting
What he owns? What he owes? Whether he has earned a profit or Loss? What is the financial position of the company?

The Need for Accounting

Managers, investors, and other internal groups want the answers to two important questions:

How well did the organization perform?

Where does the organization stand?

The Need for Accounting

Accountants answer these questions with three major financial statements: Income statement Statement of cash flows

Balance sheet

The Need for Accounting

A transaction is any event that affects the financial position of an organization and requires recording.

Fundamental concepts
What is accounting? The language of business. A means to communicate financial information. A way to convey information about a business to users.
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Fundamental concepts
1.Cash basis = Cash Receipts and cash payments are recorded. 2.Accrual basis = Credit Transactions are recorded. 3.Mixed system = Both the combination of two.

Definition Of Accounting
(a) Accounting is the art (b) Of recording ,classifying and summarizing (c) In terms of money and (d) Interpreting the results

Definition of Accounting Accounting is the art

Art is that part of knowledge which helps us in attaining our aim of ascertaining the financial result

Definition of Accounting Accounting is the art

Of recording ,classifying and summarizing
Recording Recording is done through a book called Journal Classification Is the process of grouping of transactions in the subsidiary Summarizing Is the art of making (i) Trial balance (ii) Trading and profit and loss account (iii) balance Sheet (iv) Cash flow

Definition of accounting
(a) Accounting is an art
(b) Of recording, classifying and summarizing

In terms of money. Transaction of financial character

Definition of accounting
(a) Accounting

is an art (b) Of recording, classifying and summarising (c) In terms of money

Interpreting the results

Process of explaining the meaning and significance of relationship as established by analysis of accounting data

Objectives of accounting
1) Systematic recording of the business transactions 2) Calculation of profit or loss 3) Depiction of financial position 4) To make information available to various group and users at a particular time. 5) To know the solvency position

Advantages of Accounting
1) 2) 3) 4) 5) 6) 7) 8) 9) 10) Maintenance of business records. Preparation of financial statements Comparison of results. Decision-making Good evidence in courts Planning and control operations Provides information to interested groups Taxation problems Valuation of business Helps in planning for expansion

Bookkeeping Vs. Accounting Bookkeeping

1) Recording of transaction 2) Base for accounting 3) Decision cannot be taken 4) No sub-field 5) Financial position cannot be ascertained

Accounting
1) Summarizing transactions. 2) Language of the business. 3) Decisions can be taken 4) Several sub-fields 5)Financial position can be ascertained

User of accounting information

Customers Owners

Government

Managers

Employees Creditors and Financial Institution

Investor

Different categories of users

Need different kinds of information for making decisions. These users can be divided into : 1.Internal Users; and 2.External Users.

1.Internal Users
These are the persons who manage the business, i.e. management at the top, middle, and lower levels. Their requirements of information are different because they make different types of decisions.

Internal Users

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The top level is more concerned with planning;

the middle level is concerned equally with planning and control;

and the lower level is concerned more with controlling operations. Information is supplied on different aspects, e.g. cash resources, sales estimates, results of operations, financial position, etc.

External Users
All persons other than internal users come in the group of external users. External users can be divided into two groups:

those having direct interest; and

those having indirect interest

in a business organization.

External Users continue

The main sources of information for external users are annual reports of business organizations, which state the financial position and performance and give the auditors report, directors report and other information.

External Users
having direct interest.
Tax authorities,
regulatory agencies, customers,

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Investors and creditors are the external users

labour unions,
trade associations, stock exchanges,

investors, etc are indirectly interested in the companys financial strength, its ability to meet short-term and long-term obligations, its future earning power, etc for making various decisions.

The Fundamental Accounting Equation

Assets = Liabilities + Owners Equity

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Sub fields of accounting

Management accounting

Financial accounting

Cost accounting

Financial Accounting
Accounting for revenues, expenses, assets and liabilities that is carried on the general offices on the business is known as Financial Accounting.
Primarily prepared for users external to the company.

Cost Accounting
It determines cost, profit and loss of each product. Detailed system of control for Material, Labour and overhead.

Management Accounting
Which is meant exclusively for managerial decision making. Management accounting is concerned with accounting information that is useful to management.
Primarily for internal purposes
Costing, budgeting, net present value, etc.

1) Permanent record 2) Control on expenses 3) For operational profit\loss 4) Show financial position 5) For forecasting

Important terms of Accounting

ASSETS
These are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets are things of value used by the business in its operations.
Fixed Assets

Current Assets

Classification of Assets
Assets
Short term assets (current assets) Cash Tangible Long term assets (fixed assets)

Short-term investments
Receivables Inventory Accruals & defferrals, etc.

Intangible
Financial (Investment)

ASSETS

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Fixed Assets are assets held on a longterm basis.

e.g. Land, Building, Machinery, Plant, Furniture and Fixtures, etc.

ASSETS

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Current Assets are assets held on a short-term basis.

e.g. Debtors, Bills receivable, Stock(Inventory), Cash and Bank balances, etc.

LIABILITIES
These are obligations or debts that the enterprise must pay in money or services at some time in the future. Long-term liabilities

Short-term liabilities

Classification of Liabilities
Liabilities
Current liabilities (Short-term liabilities) Accounts payable Loans payable Deferred taxes Accrued expenses Long-term debt Provisions Capitalised lease obligations Long-term liabilities

Note: on purpose this terminology is an annoying combination of British-English and American-English

LIABILITIES

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Long-term liabilities are those that are

usually payable after a period of one year.

e.g. A term loan from a financial institution,

debentures (bonds) issued by a company.

LIABILITIES

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Short-term liabilities are obligations that

are payable within a period of one year.

e.g. Creditors, bills payable, overdraft from

a bank for a short period.

CAPITAL
Investment by the owner for use in the
firm is known as capital. Owners equity is

the ownership claim on total assets. It is

equal to total assets minus total liabilities.

REVENUES
These are the amounts the business

earns by selling its products or providing

services to customers.

Other titles and sources of revenue

common to many businesses are: sales,

fees, commission, interest, dividends,

royalties, rent received, etc.

EXPENSES
These are costs incurred by a business in the process of earning revenue. Generally, expenses are measured by the cost of assets consumed or services used during an accounting period.

The usual titles of expenses are: depreciation, rent, wages, salaries, interest, costs of heat, light and water, telephone, etc.

PURCHASES
Purchases are total amount of goods procured by a business on credit and for cash, for use or sale. In a trading concern, purchases are made of merchandise for resale with or without processing. In a manufacturing concern, raw materials are purchased, processed further into finished goods and then sold. Purchases may be cash purchase or credit purchase.

SALES
Sales are total revenues from goods
or services sold or provided to

customers. Sales may be cash sales or

credit sales.

STOCK
Stock (Inventory) is a measure of
something on hand goods, spares

and other items in a business.

It is called stock on hand.

STOCK: continue
In a trading concern, the stock on hand is the amount of goods which have not been sold on the date on which the balance sheet is prepared. This is also called closing stock.

STOCK
comprises raw

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In a manufacturing concern, closing stock materials, semi-finished goods and finished goods on hand on the closing date. Similarly, opening stock is the amount of stock at the beginning of the accounting year.

DEBTORS
Debtors are persons and/or other entities

who owe to an enterprise an amount for

receiving goods and services on credit. The total amount standing against such persons and/or entities on the closing date, is shown in the Balance Sheet as Sundry

Debtors on the asset side.

CREDITORS
Creditors are persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit.

The total amount standing to the favour of such persons and/or entities on the closing date, is shown in the Balance Sheet as Sundry Creditors on the liability side.

ACCOUNTING PRINCIPLES
Accounting principles can be subdivided into two categories:

Accounting Concepts; and

Accounting Conventions.

Accounting Principles concepts and conventions

ACCOUNTING PRINCIPLES
Accounting Concepts
The term concept is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based.

Concepts and Conventions

1) Cost concept 2) Money measurement concept 3) Business entity concept 4) Realisation concept 5) Accounting period concept 6) Going concern concept 7) Dual aspect concept 8) Matching concept 9) Disclosure concept 10) Materiality concept 11) Conservatism concept 12) Consistency concept

1.COST CONCEPT
Transactions are entered in the books of accounts at the amount actually involved. Suppose a company purchases a car for Rs.1,50,000/- the real value of which is Rs.2,00,000/-, the purchase will be recorded as Rs.1,50,000/- and not any more. This is one of the most important concept and it prevents arbitrary values being put on transactions.

2.Money measurement concept

In
accounting, we record only those transactions which are expressed in terms of money.

In other words, a fact which can not be expressed in monetary terms, is not recorded in the books of accounts. Accounting doesnt tell how good the quality of employees skills are although this is important for the success of a business.

3.Business Entity Concept

Business is treated as a separate entity or unit apart from its owner and others. All the transactions of the business are recorded in the books of business from the point of view of the business as an entity and even the owner is treated as a creditor to the extent of his/her capital. This concept implies that the affairs of a business are to be treated as being quite separate from the non-business activities of its owners. Personal transactions of the owner should not be included. E.g - A directors private car should not be included in the fixed assets of the company.

4.Realisation concepts (or) Revenue recognition concept

Accounting is a historical record of transactions. It records what has happened. It does not anticipate events. This is of great important in preventing business firms from inflating their profits by recording sales and income that are likely to accrue. This concept holds to the view that profit can only be taken into account when realisation has occurred. Generally, sales revenue arising from the sale of goods is recognised when the goods are delivered to the customers. e.g. Profit is earned when goods or services are provided to customers. Thus it is incorrect to record profit when order is received, or when the customer pays for the goods.

5.Accounting period concept

A twelve month period is normally adopted for this purpose. This time interval is called accounting period.

1. Financial year (1st April to 31st March)

2. Calendar year(1st Jan to 31st Dec)

It is persuaded that the business will exists for a long time and transactions are recorded from this point of view. This concept implies that the business will continue to operate for the foreseeable future. This is why we use the historical cost concept and ignore the current market value in asset valuation. e.g.Fixed assets are shown at cost less accumulated depreciation.

7.Dual Aspect Concept

Each transaction has two aspects, that is, the receiving benefit by one party and the giving benefit by the other. This principle is the core of accountancy. For example, the proprietor of a business starts his business with Cash Rs.1,00,000/-, Machinery of Rs.50,000/- and Building of Rs.30,000/-, then this fact is recorded at two places. That is Assets account (Cash, Machinery & Building) and Capital accounts. The capital of the business is equal to the assets of the business. Thus, the dual aspect can be expressed as under Capital + Liabilities = Assets orCapital = Assets Liabilities

8.Matching Concept.
All the revenue of a particular period Match of income will be matched with the cost of that period for determining the net profits of that period. Net income=Revenues-Expenses

9.Disclosure Concept
Full disclosure concept Since financial statements contain information which is used by different groups of people such as investors, lenders, supplier, government and others in taking various financial decisions regarding the company. Hence the principle of full disclosure requires that all material and relevant facts concerning financial performance of an enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes. This is to enable the users to make correct assessment about the profitability and financial soundness of the enterprise and help them to take informed decisions.

10.Materiality Concept
Financial statement should separately disclose significant items for they would influence decisions of users. Accounting does not serve a useful purpose if the effort of recording a transaction in a certain way is not worthwhile. In other words do not waste your time in the elaborate recording of trivial items. e.g. A stock of stationery worths $10 should be treated as an expense when it was bought.

11.Conservatism Concept
1) All possible losses must be considered 2) Anticipated profit ignored 3) Principle of prudence.

12.Consistency Concept
Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts can, therefore, make more meaningful comparisons of financial performance from year to year. Consistency is a concept used when applying accounting methods to a business, the business must continue to use that particular method. The consistency concept: that the same principles for constructing accounts will be maintained from one set of accounts to the next. For an example if a company is charging depreciation using the straight line method, they must stick with the straight line method.

ACCOUNTING PRINCIPLES
Accounting Conventions
The term convention is used to signify

customs and traditions as a guide to the

presentation of accounting statements.

ACCOUNTING CONVENTIONS
1.Convention of full disclosure - Completion of proper statements 2.Convention of consistency -vertical, horizontal and dimensional. 3.Convention of Materiality -information about the material conversion 4.Convention of conservation - Policy of cause/playing safe

1.Convention of Disclosure
This principle implies that accounts must be honestly prepared and all material information must be disclosed therein. The contents of Balance Sheet and Profit and Loss Account are prescribed by law. These are designed to make disclosure of all material facts compulsory.

2.Convention of Consistency
In order to enable the management to draw important conclusions regarding the working of the company over a few years, it is essential that accounting practices and methods remain unchanged from one accounting period to another. The comparison of one accounting period with that of another is possible only when the convention of consistency is followed.

3.Convention of Materiality
It refers to the relative importance of an item or even. According to this convention only those events or items should be recorded which have a significant bearing and insignificant things should be ignored. This is because otherwise accounting will be unnecessarily over burden with minute details. There is no formula in making a distinction between material and immaterial events. It is a matter of judgment and it is left to the accountant for taking a decision. It should be noted that an item material for one concern may be immaterial for another. Similarly, an item material in one year may not be material in the next year.

4.Convention of Conservation
Financial statements are always drawn up on rather a conservative basis.
That is, showing a position better than what it is, not permitted. It is also not proper to show a position worse than what it is. In other words, secret reserves are not permitted.

CLASSIFICATION OF ACCOUNTS
Accounts in the names of persons are known as Personal Accounts
Accounts in the names of assets are known as Real Accounts Accounts in respect of expenses and incomes are known as Nominal Accounts

CLASSIFICATION OF ACCOUNTS
ACCOUNTS

PERSONAL ACCOUNTS

IMPERSONAL ACCOUNTS

REAL ACCOUNTS

NOMINAL ACCOUNTS

Golden Rules of Accounting

1.Personal accounts - Debit the receiver
Credit the giver

2.Real accounts

- Debit what comes in - Credit what goes out 3.Nominal accounts -Debit all expenses and losses Credit all incomes and gains

PERSONAL ACCOUNTS
Accounts in the name of persons are known as personal accounts.
Eg: Babu A/C, Babu & Co. A/C, Outstanding Salaries A/C, etc.

REAL ACCOUNTS
These are accounts of assets or properties. Assets may be tangible or intangible. Real accounts are impersonal which are tangible or intangible in nature.

Eg:- Cash a/c, Building a/c, etc are Real Accounts related to things which we can feel, see and touch. Goodwill a/c, Patent a/c, etc Real Accounts which are of intangible in nature.

NOMINAL ACCOUNTS
These accounts are impersonal, but invisible and intangible. Nominal accounts are related to those things which we can feel, but can not see and touch. All expenses and losses and all incomes and gains fall in this category.
Eg:- Salaries A/C, Rent A/C, Wages A/C, Interest Received A/C, Commission Received A/C, Discount A/C, etc.

DEBIT AND CREDIT

Each accounts have two sides the left side and

the right side.

In accounting, the left side of an account is called the Debit Side and the right side of an account is called the Credit Side. The entries made on the left side of an account

is called a Debit Entry and the entries made on

the right side of an account is called a Credit Entry.

RULES FOR DEBIT AND CREDIT

Debit the Receiver Personal Account Credit the Giver Debit what comes in Real Accounts Credit what goes out

Nominal Accounts

Debit all Expenses and Losses Credit all Incomes and Gains

Steps for finding the debit and credit aspects of a particular transaction
Find out the two accounts involved in the
transaction. Check whether it belongs to Personal, Real or Nominal account. Apply the debit and credit rules for the two accounts.

Exercise
Purchased a Building for Rs.20,000/-.
Paid Cash Rs.1,000/- to Satheesh.

Paid Salary Rs.1000/-.

Received Commission Rs.250/-.

Sold goods for Cash Rs.3500/-.

Subsidiary Books
General Journal Special Journals Purchase Book Sales Book Purchase Return Book Sales Return Book Bills Receivable Book Bills Payable Book Cash Book Petty Cash Book

Journal
Journal is the prime or original book of entry which all transactions are recorded in the form entries. Journalising is an act of recording entering transactions in a Journal in the order date.
Date Particulars LF Debit Amount

in of or of

Credit Amount

Journal Entry
Jan 1, 1981 Prakash Started a business Rs. 15,000/Date 1981 Jan 1 Particulars Cash a/c Dr. To Prakashs Capital a/c (Being cash invetsed to business) LF Debit Amount 15,000 15,000 Credit Amount