Accounting Notes PDF

## Accounting - **Recording of Transaction:** As soon as a transaction happens, it is first recorded in a subsidiary book. - **Journal:** The transactions are recorded in the journal chronologically. - **Ledger:** All journals are posted into the ledger chronologically and in a classified manner. -...

## Accounting - **Recording of Transaction:** As soon as a transaction happens, it is first recorded in a subsidiary book. - **Journal:** The transactions are recorded in the journal chronologically. - **Ledger:** All journals are posted into the ledger chronologically and in a classified manner. - **Trial Balance:** After taking all the ledger account closing balances, a trial balance is prepared at the end of the period for the preparation of financial statements. - **Adjustment Entries:** All the adjustments entries are to be recorded properly and adjusted accordingly before preparing financial statements. - **Adjusted Trial Balance:** An adjusted trial balance may also be prepared. - **Closing Entries:** All the nominal accounts are to be closed by the transferring to the trading account and profit and loss account. - **Financial Statements:** Financial statements can now be easily prepared, which will exhibit the true financial position and operating results. ## Accounting - Classification The various sub-fields of accounting are: | Field | Description | Accounting Type | |---|---|---| | Financial Accounting | Determining the financial results for the period and the state of affairs on the last day the accounting period. | Stewardship Accounting | | Cost Accounting | Information generation for controlling operations with a view to maximizing efficiency and profit. | Control Accounting | | Management Accounting | Accounting to assist management in planning and decision-making. | Decision Accounting| ### (a) Financial Accounting It is commonly termed as Accounting. The American Institute of Certified Public Accountants defines Accounting as "an art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are in part, at least, of a financial character, and interpreting the results thereof." ### (b) Cost Accounting According to the Chartered Institute of Management Accounts (CIMA), Cost Accountancy is defined as "application of costing and cost accounting principles, methods, and techniques to the science, art, and practice of cost control and the ascertainment of profitability as well as the presentation of information for the purpose of managerial decision-making." ### (c) Management Accounting Management Accounting is concerned with the use of Financial and Cost Accounting information to managers within organizations, to provide them with the basis in making informed business decisions that would allow them to be better-equipped in their management and control functions. ## Basis of Accounting ### Accrual Basis and Cash Basis of Accounting #### (1) Accrual Basis of Accounting Accrual Basis of Accounting is a method of recording transactions by which revenue, costs, assets, and liabilities are reflected in the accounts for the period in which they accrue. This basis includes consideration relating to deferrals, allocations, depreciation, and amortization. This basis is also referred to as the mercantile basis of accounting. #### (1) Cash Basis of Accounting Cash Basis of Accounting is a method of recording transactions by which revenues, costs, assets, and liabilities are reflected in the accounts for the period in which actual receipts or actual payments are made. ### Distinction between Accrual Basis of Accounting and Cash Basis of Accounting | Basis of Distinction | Accrual Basis of Accounting | Cash Basis of Accounting | |---|---|---| | Prepaid/Outstanding Expenses / accrued/ unaccrued Income in Balance Sheet. | Under this, there may be prepaid/ outstanding expenses and accrued/ unaccrued incomes in the Balance Sheet. | Under this, there is no prepaid/ outstanding expenses or accrued/ unaccrued incomes. | | Higher/lower Income in case of prepaid expenses and accrued income. | Income Statement will show a relatively higher income | Income Statement will show lower income. | | Higher/lower income in case of outstanding expenses and unaccrued income. | Income Statement will show a relatively lower income | Income Statement will show higher income. | | Availability of options to an accountant to manipulate the accounts by way of choosing the most suitable method out of several alternative methods of accounting e.g. FIFO/LIFO/SLM/WDV | Under this, an accountant has options. | Under this an accountant has no option to make a choice as such. | #### Hybrid or Mixed Basis Under the hybrid system of accounting, incomes are recognized as in Cash Basis Accounting i.e. when they are received in cash and expenses are recognized on accrual basis i.e. during the accounting period in which they arise irrespective of when they are paid. ## Double Entry System It was in 1494 that Luca Pacioli, the Italian mathematician, first published his comprehensive treatise on the principles of the Double Entry System. The use of principles of double entry systems made it possible to record not only cash but also all sorts of Mercantile transactions. It had created a profound impact on auditing too, because it enhanced the duties of an auditor to a considerable extent. ### Features of Double Entry System - Every transaction has two-fold aspects, i.e. one party giving the benefit and the other receiving the benefit. - Every transaction is divided into two aspects, Debit and Credit. One account is to be debited and the other account is to be credited. - Every debit must have its corresponding and equal credit. ### Advantages of Double Entry System - Since personal and impersonal accounts are maintained under the double entry system, both the effects of the transactions are recorded. - It ensures arithmetical accuracy of the books of accounts, for every debit, there is a corresponding and equal credit. This is ascertained by preparing a trial balance periodically or at the end of the financial year. - It prevents and minimizes frauds. Moreover, frauds can be detected early. - Errors can be checked and rectified easily. - The balances of receivables and payables are determined easily, since the personal accounts are maintained. - The businessman can compare the financial position of the current year with that of the past years. - The businessman can justify the standing of his business in comparison with the previous year, purchase, sales, and stocks, incomes, and expenses with that of the current year figures. - Helps in decision making. - The net operating results can be calculated by preparing the Trading and Profit and Loss A/c for the year ended, and the financial position can be ascertained by the preparation of the Balance Sheet. - It becomes easy for the Government to decide the tax. - It helps the Government to decide sickness of business units and extend help accordingly. - The other stakeholders like suppliers, banks, etc. take a proper decision regarding the grant of credit or loans. ### Limitations of Double Entry System - The system does not disclose all the errors committed in the books accounts. - The trial balance prepared under this system does not disclose certain types of errors. - It is costly as it involves the maintenance of numbers of books of accounts. ## The Concepts of 'Account', 'Debit', and 'Credit' ### The Concept of Account An account is defined as a summarized record of transactions related to a person or a thing, e.g. when the business deals with customers and suppliers, each of the customers and supplier will be a separate account. The account is also related to things - both tangible and intangible, e.g. land, building, equipment, brand value, trademarks, etc., are some of the things. When a business transaction happens, one has to identify the 'account' that will be affected by it and then apply the rules to decide the accounting treatment. Typically, an account is expressed as a statement in the form of the English letter 'T'. It has two sides. The left-hand side is called the "Debit" side, and the right-hand side is called the "Credit" side. The debit is denoted as 'Dr', and the credit by 'Cr'. The convention is to write the Dr and Cr labels on both sides as shown below. Please see the following example: | | Cash Account | | |---|---|---| | Dr. | | Cr. | **Debit side** | **Credit side** ## Types of Accounts - **Personal Account:** As the name suggests, these are accounts related to persons. - These persons could be natural persons like Suresh's A/c, Anil's A/c, Rani's A/c, etc. - The persons could also be artificial persons like companies, bodies corporate or association of persons or partnerships, etc. Accordingly, we could have Videocon Industries A/c, Infosys Technologies A/c, Charitable Trust A/c, Ali and Sons trading A/c, ABC Bank A/c, etc. - There could be representative personal accounts as well. Although the individual identity of persons related to these is known, the convention is to reflect them as collective accounts, e.g., when salary is payable to employees, we know how much is payable to each of them, but collectively the account is called as 'Salary Payable A/c'. Similar examples, are rent payable, Insurance prepaid, commission pre-received, etc. The students should be careful to have clarity on this type and the chances of error are more here. - **Real Accounts:** These are accounts related to assets or properties or possessions. Depending on their physical existence, or otherwise, they are further classified as follows:- - Tangible Real Account - Assets that have physical existence and can be seen, and touched. e.g. Machinery A/c, Stock A/c, Cash A/c, Vehicle A/c, and the like. - Intangible Real Account - These represent possession of properties that have no physical existence but can be measured in terms of money and have value attached to them, e.g. Goodwill A/c, Trade Mark A/c, Patents & Copy Rights A/c, Intellectual Property Rights A/c, and the like. - **Nominal Account:** These accounts are related to expenses or losses and incomes or gains, e.g. Salary and Wages A/c, Rent of Rates A/c, Travelling Expenses A/c, Commission Received A/c, Loss by fire A/c etc. ## The Concepts of Debit and Credit - In double entry book-keeping, debits and credits (abbreviated Dr and Cr, respectively) are entries made in account ledgers to record changes in value due to business transactions. - Debit is derived from the latin word "debitum", which means 'what we will receive'. It is the destination, who enjoys the benefit. - Credit is derived from the Latin word "credre" which means "what we will have to pay." It is the source, who sacrifices for the benefit. - The source account for the transaction is credited (an entry is made on the right side of the account's ledger) and the destination account is debited (an entry is made on the left). - Each transaction's debit entries must equal its credit entries. - The difference between the total debits and total credits in a single account is the account's balance. If debits exceed credits, the account has a debit balance; If credits exceed debits, the account has a credit balance. ## Accounting Equation ### Illustration: 3 Prepare an Accounting Equation from the following transactions in the books of Mr. X for January, 2015:- **Transactions** | Date | Transaction | |---|---| | Jan. 1 | Invested Capital in the firm ₹20,000 | | 2 | Purchased goods on credit from Das & Co. for ₹2,000 | | 4 | Bought plant for cash ₹ 8,000 | | 8 | Purchased goods for cash ₹ 4,000 | | 12 | Sold goods for cash (Cost ₹ 4,000 + Profit ₹ 2,000) ₹ 6,000 | | 18 | Paid to Das & Co. in cash ₹ 1,000 | | 22 | Received from B. Banerjee ₹ 300 | | 25 | Paid salary ₹ 6,000 | | 30 | Received interest ₹ 5,000 | | 31 | Paid wages ₹ 3,000 | **Solution:** **Effect of transaction on Assets, Liabilities and Capital** | Date | Transaction | Assets= | Liabilities+ | Capital | |---|---|---|---|---| | 2015 | | | | | | Jan.1 | Invested Capital in the firm ₹ 20,000 | ₹ 20,000 | | ₹ 20,000 | | 2 | Purchased goods on credit from Das & Co. ₹2000 | +₹ 2,000 | +₹ 2,000 | | | **Revised Equation** | | ₹ 22,000 = | ₹ 2,000 + | ₹ 20,000 | | 4 | Bought Plant for cash ₹ 8,000 | +₹ 8,000 | | -₹ 8,000 | | **Revised Equation** | | ₹ 30,000 = | ₹ 2,000 + | ₹ 28,000 | | 8 | Purchased goods for cash ₹ 4,000 | +₹ 4,000 | | -₹ 4,000 | | **Revised Equation** | | ₹ 34,000 = | ₹ 2,000 + | ₹ 32,000 | | 12 | Sold Goods for cash (Cost ₹ 4,000 + Profit ₹ 2,000) | +₹ 6,000 | +₹ 2,000 | -₹ 4,000 | | **Revised Equation** | | ₹ 40,000 = | ₹ 4,000 + | ₹ 36,000 | | 18 | Paid to Das & Co. for ₹ 1,000 | -₹ 1,000 | -₹ 1,000 | | | **Revised Equation** | | ₹ 39,000 = | ₹ 3,000 + | ₹ 36,000 | | 22 | Received from B. Banerjee for 300 | +₹ 300 | | -₹ 300 | | **Revised Equation** | | ₹ 39,300 = | ₹ 3,000 + | ₹ 36,300 | | 25 | Paid salary for ₹ 6,000 | -₹ 6,000 | | -₹ 6,000 | | **Revised Equation** | |₹ 33,300 = | ₹ 3,000 + | ₹ 30,300 | | 30 | Received Interest for ₹ 5,000 | +₹ 5,000 | | +₹ 5,000 | | **Revised Equation** | | ₹ 38,300 = | ₹ 3,000 + | ₹ 35,300 | | 31 | Paid Wages for ₹ 3,000 | -₹ 3,000 | | -₹ 3,000 | | **Revised Equation** | | ₹ 35,300 = | ₹ 3,000 + | ₹ 32,300 |