Unit-1 Accounting PDF

Unit-1- Accounting Accounting is the systematic process of recording, classifying, summarizing, and interpreting financial transactions and information to provide a clear picture of an organization’s financial health and performance. The goal of accounting is to generat...

Unit-1- Accounting Accounting is the systematic process of recording, classifying, summarizing, and interpreting financial transactions and information to provide a clear picture of an organization’s financial health and performance. The goal of accounting is to generate accurate and useful financial information that helps stakeholders make informed decisions. Transactions/Events--------Identification--------Measurement (Monetary terms)----- Recording (Journals)-----Classifying (Ledgers)-----Summarizing (Trial Bl and Final Accounts) Characteristics of Accounting: The following attributes or characteristics can be drawn from the definition of Accounting: (1) Identifying financial transactions and events  Accounting records only those transactions and events which are of financial nature.  So, first of all, such transactions and events are identified. (2) Measuring the transactions  Accounting measures the transactions and events in terms of money which are considered as a common unit. (3) Recording of transactions  Accounting involves recording the financial transactions inappropriate book of accounts such as Journal or Subsidiary Books. (4) Classifying the transactions  Transactions recorded in the books of original entry – Journal or Subsidiary books are classified and grouped according to nature and posted in separate accounts known as ‘Ledger Accounts’. (5) Summarising the transactions  It involves presenting the classified data in a manner and in the form of statements, which are understandable by the users.  It includes Trial balance, Trading Account, Profit and Loss Account and Balance Sheet. (6) Analysing and interpreting financial data  Results of the business are analyzed and interpreted so that users of financial statements can make a meaningful and sound judgment. (7) Communicating the financial data or reports to the users  Communicating the financial data to the users on time is the final step of Accounting so that they can make appropriate decisions. Accounting Principles : Accounting principles are the rules and guidelines that companies and other bodies must follow when reporting financial data. Further classified into:- 1. Accounting concepts are ideas, assumptions and conditions based on which a business entity records its financial transactions and organizes its bookkeeping. 2. Accounting conventions are guidelines used to help companies determine how to record certain business transactions. 1. Business Entity: The business and its owner(s) are two separate existence entity. Any private and personal incomes and expenses of the owner(s) should not be treated as the incomes and expenses of the business. Economic Entity - company keeps its activity separate from its owners and other businesses. – Example: Insurance premiums for the owner’s house should be excluded from the expense of the business. 2. Money Measurement: All transactions of the business are recorded in terms of money and it provides a common unit of measurement. – Example: Market conditions, technological changes and the efficiency of management would not be disclosed in the accounts. 3.Going Concern Concept: The business will continue in operational existence for the foreseeable future. Financial statements should be prepared on a going concern basis unless management either intends to liquidate the enterprise or to cease trading, or has no realistic alternative but to do so.  4.Cost Concept: Assets should be shown on the Balance sheet at the cost of purchase instead of current value. – Example: The cost of fixed assets is recorded at the date of acquisition cost. The acquisition cost includes all expenditure made to prepare the asset for its intended use. It included the invoice price of the assets, freight charges, insurance or installation costs. 5.Objectivity: The accounting information should be free from bias and capable of independent verification. The information should be based upon verifiable evidence such as invoices or contracts. – Example: The recognition of revenue should be based on verifiable evidence such as the delivery of goods or the issue of invoices. 6. Accruals/Matching: Revenues are recognized when they are earned, but not when cash is received. Expenses are recognized as they are incurred, but not when cash is paid. The net income for the period is determined by subtracting expenses incurred from revenues earned. Matching - efforts (expenses) should be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. Example: Expenses incurred but not yet paid in current period should be treated as accrual/accrued expenses under current liabilities. 7.The Realization concept: This concept holds to the view that profit can only be taken into account when realization has occurred. Generally, sales revenue arising from the sale of goods is recognized when the goods are delivered to the customers. Example: 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. 8. Periodicity: The life of an entity is divided into short economic time periods on which reporting statements are fashioned. Periodicity - company can divide its economic activities into time periods. – Example: Based on this assumption assets are classified into current and fixed Assets. Current assets have benefits within twelve months period and fixed assets have benefits beyond 12 months. 9. Dual Aspect: Transaction has two fold effect: Debit & Credit. Each and every debit aspect has equal and corresponding credit aspect and vice versa. Accounting Equation: Assets = Capital + Liability  Accounting Conventions What is Accounting Convention? Accounting Conventions are certain guidelines or principles that help organizations determine the proceedings of recording business transactions that are complicated, unclear, or not fully addressed. Although these restrictions and guidelines are not legally binding, they are generally accepted by the authorities as these principles help maintain consistency and avoid practical obstacles during the preparation of the financial statements of businesses. Accounting conventions are established practices and guidelines that accountants follow to ensure consistency, reliability, and comparability in financial reporting. These conventions help in the preparation and interpretation of financial statements. Here are some key accounting conventions with examples: 1. Convention of Consistency: Convention of consistency implies that the basis followed in different accounting period should be same. It also signifies that the accounting practices and methods should remain consistent from one accounting year to another. When once a particular method of depreciation is adopted for a particular fixed asset, the same method should be followed for that assets year after year. 2. Convention of Disclosure: Under the convention of disclosure all significant information about the business should be disclosed. This convention implies that the accounting records and statements conform to generally accepted accounting principle. As regards the investments, not only the various securities held by a concern should be disclosed, but also the mode of their valuation should be stated. Under this convention the financial statements should disclosed as much details as possible. 3. Convention of Conservation: Convention of conservation refers to the accounting records and in the financial statements of business, all the prospective losses, risks, and uncertainties should be taken note of and provided but prospective profits should be ignored. Such transactions related to provision for doubtful debts, provision for discount on Debtors etc. The importance of this convention is that the financial statements should indicate the actual position. 4.Convention of Materiality: Convention of Materiality implies that transactions which are more important to the business are recorded and which do not affect the result of the business drastically should be ignored as the cost of ascertaining such insignificant expenses is more than such a trivial expense incurred. A new pencil purchased and supplied to the office is, no doubt, an asset for the concern. Every day when someone in the office writes with the pencil, a portion of the pencil is used up, and as such the value of the pencil decreases. The pencil is taken as used up at the time it is purchased or at the time it is issued to the office. Final Accounts: Trading Account, Profit and Loss Account and Balance Sheet 1. Trading Account: Trading account is the outcome of Trial Balance. The debit balances of Trial Balance would represent either Assets or Losses, and the credit balances either Liabilities or Gains. Trading account is prepared to know the trading results, how much Gross Profit or Gross Loss derived in business concern for a given particular period. The trading account shows the results of buying and selling of goods. In preparing this account, the general establishment charges are ignored and only the transactions in goods are included. Trading account includes only such transactions which are related with goods, such as opening stock, closing stock, purchase of goods, sales of goods, purchase returns, sales returns, manufacturing expenses, and other direct expenses. Finally trading account is merely the result of trading i.e, involve purchasing and selling of goods 2. Profit and Loss Account Profit and loss account is the outcome of both trial balance and trading account. Profit and loss account is prepared to know the business results, how much net profit or net loss derived in the business concern for a given financial year. After ascertaining gross profit or gross loss from trading account it would be transferred to the profit and loss account on the credit side and debit side respectively. Profit and loss account includes only such transactions which are miscellaneous incomes like; interest, commission, dividend, discount, profit on exchange, rent received etc., on the credit side of profit and loss account also includes all the expenses incidental to the carrying on the business such as office rent, salaries, insurance, stationary and printing, telephone expenses, audit fees, advertising, carriage outwards, sales tax, repairs and renewals, entertainment expenses, legal charges, Ö etc. on the debit side. Profit and Loss account is an account into which all gains and losses are collected in order to ascertain, the excess of gains over the loses or vice-versa.  Balance Sheet Balance Sheet is a statement which reflects the true position of assets and liabilities on a particular period. It is also known as financial statement. In view of the fact that the assets and liabilities changes from day to day as a result of business transactions, the trader must necessarily feel anxious to find out what his true financial position is at the end of each trading period. In the first place, he would like to know whether the net profit as is disclosed by the profit and loss account is correctly arrived at, for, if so, his capital at the end of the period must necessarily increase by that amount. He is equally anxious to see for himself as to how such capital is made up, i.e., what the component assets and Liabilities of the business are. In order, therefore, to obtain this information at the end of the trading period, he has to set out his several assets and liabilities as at that date in the shape of a statement and this statement is called the Balance Sheet. Balance sheet is prepared from the Trial balance, after all the balances on nominal account are transferred to the trading and profit and loss account and corresponding account in the ledger are closed. The balances now left in the trial balance and remaining one in the ledger represent either personal or real account. All assets and liabilities are set out in the balance sheet in a systematic manner. In the right side are shown the assets and on the left-hand side are shown the various liabilities. Finally, Balance Sheet shows the true financial position of the business on a specific date i.e., at the end of an accounting period the total assets and total liabilities must be equal.  Adjustments (a) Outstanding Expenses - Outstanding expenses are those expenses which are still to be paid these are the expenses which are treated as liabilities (Current Liability) and add to the concerned expenditure in Profit and Loss Account. (b) Prepaid Expenses - Prepaid expenses are those expenses which have been paid in advance for the next financial year, these are the expenses which are treated as Assets (Current Assets) and deducted from the concerned expenses in the current financial year. (c) Unearned Income/ Income Received in Advance - These are the income which we have not earned but received in advance for the next financial year they are treated as liability till the work is done in this regard and deducted from the concerned income in Profit and Loss Account and shown as a liability in Balance Sheet of current financial year. (d) Accrued Income - This is the income which we have earned in the current financial year but still not received the same. It is treated as assets and added to the concerned income in the current year to get the actual profit figure for the current year.