Chapter 1: Accounting as a Form of Communication PDF

Chapter 1 Accounting as a Form of Communication © 2019 Cengage. All rights reserved.  Module 1: The nature of Business Consists of activities necessary to provide members of society with goods and services. Certain business activities focus on providing goods or prod...

Chapter 1 Accounting as a Form of Communication © 2019 Cengage. All rights reserved.  Module 1: The nature of Business Consists of activities necessary to provide members of society with goods and services. Certain business activities focus on providing goods or products Companies can:  produce or manufacture the products  distribute the products  sell directly to the consumer Suppliers, manufacturers, wholesalers, and retailers are examples of product companies Introduction toCengage. © 2019 Cost management All rights reserved. Exhibit 1.1—Types of Businesses © 2019 Cengage. All rights reserved. Exhibit 1.2—Forms of Organization © 2019 Cengage. All rights reserved.  Business Entities Sole Proprietorships: organization with a single owner Partnerships: business owned by two or more individuals – Often used by accounting firms and law firms Corporations: entity organized under the laws of a particular state – Ownership evidenced by shares of stock Introduction toCengage. © 2019 Cost management All rights reserved.  Nonbusiness Entities Nonbusiness Entities Organization operated for some purpose other than to earn a profit Do not have an identifiable owner Introduction toCengage. © 2019 Cost management All rights reserved.  Nature of Business Activity Financing Activities – Debt/Borrowing (Bank loans, FI’s, Debentures, Bonds) – Equity/Sale of stock ( Equity shares, Preference shares, FII’s) Introduction toCengage. © 2019 Cost management All rights reserved.  Nature of Business Activity Unconventional Financing: – Venture Capital Fund (VCF) – Micro Financing/Credit (Noble Laureate Economist Professor Dr. Muhammad Yunus, Founder Grameen Bank of Bangladesh, Noble Peace Prize, 2006) *Abbasi, Ehtesham Husain. (2010). Micro Financing- A Different Perspective. Micro Finance Enabling Empowerment. Lazer, Daniel, Natarajan, P., Malabika Deo (Ed.).pp.564-570, Chennai: Vijay Nicole Imprint (P) Ltd. (ISBN- 13-97881-8209-265-5) *Abbasi, Ehtesham Husain (2009) Empowering People through Micro Financing. Journal of IPEM, Vol.3 ISSUE NO.2,31-34(ISSN:0974-8903) Introduction toCengage. © 2019 Cost management All rights reserved.  Nature of Business Activity Sustainable Finance: - *Abbasi, Ehtesham Husain, Singh, A., Constantinescu, M., Khan, A. and Naseem, M. (2017) Making Indian Companies CDM Compatible: Towards a Green Financial Strategy, International Journal of Green Economics, InderScience Publishers, Geneva, Switzerland, Vol. 11, No. 1, 62-76. (ISSN: Online: 1744-9936 ISSN print: 1744-9928) ABDC & Scopus indexed - *Abbasi, Ehtesham Husain (2018) Urban Development Backed by Clean Development Mechanism: Evolving a Green Financial Strategy for Indian Cities. Work, Employment and Labour. Kennet, Miriam (Ed.), UK: Green Economics Publishing House Seed Funding: For Start ups Crowd Funding: Introduction toCengage. © 2019 Cost management All rights reserved.  Nature of Business Activity Investing Activities – Purchase and sale of assets Operating Activities – Sale of Products/Services (Sales-Direct Exp= Gross Profit/loss) Trading, Manufacturing, factory and production expenses – Costs incurred to operate business (Gross Profit- Indirect Exp=Net Profit/Loss) Office, Administrative, General and Miscellaneous expenses) Introduction toCengage. © 2019 Cost management All rights reserved. Exhibit 1.3—A Model of Business Activities © 2019 Cengage. All rights reserved.  Organizations and Social Responsibility Business entities recognize the societal aspects of their overall mission and have established programs to meet these responsibilities Introduction toCengage. © 2019 Cost management All rights reserved.  Organizations and Social Responsibility Some of the most common examples of CSR include: Reducing carbon footprints (UN SDG 12- Responsible Consumption & Production) Improving labor policies. Participating in fairtrade. Diversity, equity and inclusion. Charitable global giving (Melinda Gates Foundation) Community and virtual volunteering. Socially and environmentally conscious investments. Introduction toCengage. © 2019 Cost management All rights reserved. Knight of the Legion of Honour July 2014 Introduction toCengage. © 2019 Cost management All rights reserved.  What is Accounting? In business numerous transactions take place every day Humanly impossible to remember all of them With the help of accounting records, the businessman is able to keep record of all business transaction and ascertain the profit or loss and financial position of the business at a given period and communicate such information to all the interested parties Introduction toCengage. © 2019 Cost management All rights reserved.  What is Accounting? Accounting helps the management of an organisation to have control over its performance The success of a business entity depends on the combined effects of 4 factors » Land » Labour » Capital » Management Contribution of each factor has to be measured then only the resultant performance of business entity can be evaluated e.g. an outsider does not consider how many engineers, chartered accountants & MBA’s an organisation possess, to judge its performance he may be interested only in the bottom line (i.e. profits of the organisation) Introduction toCengage. © 2019 Cost management All rights reserved.  What is Accounting? Without accounting, a business entity cannot communicate with the outside world Accounting is the language of business Introduction toCengage. © 2019 Cost management All rights reserved.  What is Accounting?  Meaning and Definition: According to the Committee on Terminology of American Institute of Certified Public Accountants (AICPA), “Accounting is the 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 ”.  Definition continues…. Eric L. Kohlen(A dictionary for Accountants) defines accounting as the “ the procedure of analysing, classifying and recording transactions in accordance with a preconceived plan for the benefit of (a) providing means by which an enterprise can be conducted in orderly fashion, and (b) establishing a basis reporting the financial condition of enterprise and results of its operations.” Introduction toCengage. © 2019 Cost management All rights reserved.  What is Accounting? The American Accounting Association (AAA) defines accounting as “ the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of information.” Smith and Ashburne defines accounting as “the science of recording and classifying business transactions and events, primarily of a financial character, and the art of making significant summaries, analysis and interpretations of those transactions and events and communicating the results to persons who must make decisions or form judgments.’’ Introduction toCengage. © 2019 Cost management All rights reserved.  Historical Background Principles of the Double Entry Accounting were first explained in print by » Luca Fra Pacioli, an Italian Mathematician » In his book ‘Summa de Arithmatica, Geometria Proportioniet Proportionalita’, in 1494 Introduction toCengage. © 2019 Cost management All rights reserved.  Historical Background….. 300 years later Johan Von Goethe, perhaps the most influential writer of the late 18th century Described Pacioli’s system as something of timeless beauty and simplicity It may sound strange that even in today’s advanced age of computers and IT, Pacioli’s simple principles still apply Introduction toCengage. © 2019 Cost management All rights reserved.  Financial Accounting Process Identifying Financial Transactions Recording of Financial Transactions - The Accounting process begins with the basic function of recording all the Fin. Transactions in the book of original entry - This book is called ‘Journal’ - Journal is the daily record of transactions chronologically - Journal entries are made with the help of various vouchers such as cash memos, cash receipts, Invoices, etc. called journalising Introduction toCengage. © 2019 Cost management All rights reserved.  Financial Accounting Process Classifying the Transactions – Ledger - The journal is just a chronological record of all business transactions - It does not provide all information regarding a particular item at one place - This difficulty has been solved by another book called ‘Ledger’ - It contains different pages of individual account heads under which all financial transactions of similar nature are collected - e.g. all transactions of cash are posted to cash account Introduction toCengage. © 2019 Cost management All rights reserved.  Financial Accounting Process - The objective of classifying the transaction in this manner is to ascertain the combined effect of all transactions of a given period in respect of each account Summarising the Transactions – Trial Balance, Income statements, Balance Sheets - Presenting the classified data in a manner which is understandable and useful to internal as well as external end users of accounting info. - Preparation of a statement called ‘Trial Balance’ to check the arithmetical accuracy of the books of accounts Introduction toCengage. © 2019 Cost management All rights reserved.  Financial Accounting Process - If the Trial Balance tallies, more or less it means that transactions have been accurately recorded and posted into ledger - The preparation of a year end summary known as ‘Final Accounts’ - To know the net operating results of the business - To ascertain the financial position of the business at a particular date Introduction toCengage. © 2019 Cost management All rights reserved.  Financial Accounting Process Interpretation of Results - Final stage of Accounting is analysing and interpreting the results shown by the final accounts - Recorded financial data is analysed and interpreted in a manner that the end users can make a meaningful judgment about the financial position and profitability of the business operations - Computation of various accounting ratios to assess the liquidity, solvency and profitability of the business - Balances appearing in balance sheet will then be transferred to the new books of accounts for the new year Introduction toCengage. © 2019 Cost management All rights reserved.  Financial Accounting Process - Thereafter the process of recording transactions for the next year starts again Communication to Interested Parties - Accounting information after being meaningfully analysed and interpreted has to be communicated in the proper form and manner to the proper person - Through preparation & distribution of accounting reports which includes besides the final accounts, in the form of ratios, graphs, diagrams, fund flow statement, etc. Introduction toCengage. © 2019 Cost management All rights reserved. Exhibit 1.4—Users of Accounting Information © 2019 Cengage. All rights reserved.  Users of Accounting Information - Study the present financial position of business - Compare its present performance with that of past years - Compare its performance with similar enterprises Owners/ Shareholders - Shareholders are the real owners of the company -They contribute the required capital and take the risk of business - Interested to know the result of operations and financial position of the company - Evaluate the performance of the managers because in company type of organisation management of business is vested in the hands of paid managers Introduction toCengage. © 2019 Cost management All rights reserved.  Users of Accounting Information Prospective Investors - Persons who are interested in buying shares of a company or want to advance money to the company - How safe & rewarding the investments already made or proposed investments would be -Lenders - Initially the required funds of the business are provided by the owners - When business is going on it requires more funds - Additional funds are provided by FI’s, banks and other money lenders - Lenders would like to know about the solvency of the enterprise Introduction toCengage. © 2019 Cost management All rights reserved.  Users of Accounting Information Creditors - Supply goods & services on credit - Credit worthiness of the business concern Managers - To plan, control and evaluate all business activities Government -Taxation/ Tax liability -Labour laws -Corporate laws Introduction toCengage. © 2019 Cost management All rights reserved.  Users of Accounting Information Employees - Interested in knowing the state of affairs of the organisation in which they are working - To know how safe their interests are in the organisation - Knowledge of accounting information helps in conducting negotiations with management Researchers - Accounting theory and practices Citizens - As a voter & tax payer- PSU, public utility Introduction toCengage. © 2019 Cost management All rights reserved.  Need of Accounting in Business Decisions To keep systematic records of the Business To ascertain profit and loss of the Business -Proper record of all incomes and expenses helps in preparing P/L A/C and Ascertaining net operating results of a business during a particular period To ascertain the financial position of Business -Businessman – always interested to know the financial position of his business. -Apart from operating results: -He wants to know how much he owns & how much he owes to others. Introduction toCengage. © 2019 Cost management All rights reserved.  Need of Accounting in Business Decisions- Conts….. - He would also like to know what happened to his capital, whether it has increased or decreased or remained constant - A systematic record of Assets and Liabilities facilitates the preparation of a position statement called Balance Sheet. - Balance Sheet serves as barometer for ascertaining Financial Solvency of the business To provide accounting information to interested parties - Bankers, Creditors, Tax Authorities, Prospective Investors etc. Introduction toCengage. © 2019 Cost management All rights reserved. Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods 1- Concepts Observed at the recording stage i.e. while recording the transactions 2- Concepts Observed at the reporting stage i.e. at the time of preparing final accounts It must be remembered that some of them are overlapping and even contradictory Introduction toCengage. © 2019 Cost management All rights reserved.  Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods….. 1- Concepts Observed at the recording stage a- Business Entity Concept b- Money Measurement Concept c- Objective Evidence Concept d- Historical Record Concept e- Cost Concept f- Dual Aspect Concept Introduction toCengage. © 2019 Cost management All rights reserved.  Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods….. 2- Concepts Observed at the reporting stage a- Going Concern Concept b- Accounting Period Concept c- Matching Concept d- Conservation Concept e- Consistency Concept f- Full Disclosure Concept g- Materiality Concept Introduction toCengage. © 2019 Cost management All rights reserved. Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods 1- Concepts Observed at the recording stage a- Business Entity Concept - capital contributed by the owner is regarded as liability to the firm & owner is regarded as (internal) creditor of the firm - personal expenditure of the owner is met from business funds it shall be recorded in the business books as drawings by the owner and not business expenditure - profit –liability - loss - asset - this concept is applicable to all forms of business organisation, easily in ltd. Company but in case of sole proprietorship or partnership it is difficult - because in the eyes of law sole proprietor or partners are not considered separate entities, but for accounting purpose they are treated as separate entities Introduction toCengage. © 2019 Cost management All rights reserved. Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods b- Money measurement concept Usually business deals in physical units such as kilograms, quintals, tons, meters, liters etc. Only those transactions and events are recorded in the books of accounts which can be expressed in terms of money such purchases, sales, salaries etc. Non- monetary happenings like labour management relations, sales policy, labour unrest, effectiveness of competition, a team of dedicated & trusted employees etc. are not recorded Limitation: this concept is based on the assumption that the money value is constant which is not true. The value of money however tends to change with passage of time Introduction toCengage. © 2019 Cost management All rights reserved. Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods c- Objective Evidence Concept It refers to being free from bias or free from subjectivity For this purpose all accounting transactions should be evidenced and supported by documents (vouchers) such as invoices, receipts, cash memos etc. These supporting documents (vouchers) becomes the basis for making entry and their verification by auditors As per the items like depreciation and the provision for DD where no documentary evidence is available the policy statement made by the management are treated as the necessary evidence Introduction toCengage. © 2019 Cost management All rights reserved. Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods d- Historical Record Concept e- Cost Concept - the price paid (or agreed to be paid in case of a credit transaction) at the time of purchase is called cost Introduction toCengage. © 2019 Cost management All rights reserved. Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods f- Dual Aspect Concept ‘Every receiver is also a giver and every giver is also a receiver’ e.g. if you purchase a machine for USD 8,000, you receive machinery on the one hand and give USD 8,000 on the other Two fold effect: i) Increase in one asset ii) Decrease in one asset e.g. if you buy goods worth USD 500 on credit i) It will increase an asset (stock of goods) ii) Increase a liability (creditors) Every business transaction involves two aspects i) The receiving aspect Ii) The giving aspect Introduction toCengage. © 2019 Cost management All rights reserved.  Dual Aspect Concept In case of example (i) receiving aspect is machinery and giving aspect is cash In case of example (ii) receiving aspect is goods and giving aspect is creditor It is necessary to record both the aspects in books of accounts This principle is the core of double entry book keeping i.e. why it is called Double Entry system of book keeping Let us understand another accounting implication of the dual aspect concept To start the business initial funds (capital) required by the business are contributed by the owner Additional funds are provided by the outsiders (creditors) Introduction toCengage. © 2019 Cost management All rights reserved.  Dual Aspect Concept As per the dual aspect concept all these receipts create corresponding obligations for their repayment In other words a contribution to the business, either in cash or kind not only increases its resources (assets) but also its obligations (liabilities and equities) correspondingly This equation is called ‘ Balance Sheet Equation’ or Accounting Equation’ Introduction toCengage. © 2019 Cost management All rights reserved.  Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods….. 2- Concepts to be observed at the reporting stage a- Going Concern Concept Keeping this in view, the investors lend money and the creditors supply goods and services to the concern For all practical purpose the business is normally treated as a going concern unless there is a strong evidence to the contrary Recording of transactions in accounting is judged whether the benefits from expenses are immediate (short period, i.e. less than one year) or a long term e.g. revenue expenditure or capital expenditure Introduction toCengage. © 2019 Cost management All rights reserved.  Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods….. e.g. short term benefits expenses like rent, repairs etc. such expenses are fully debited to P/L A/C If capital expenditure is available for a long period It must be spread over a number of years Only a portion of such expenditure will be debited to P/L A/C and balance shown as an asset in the Balance Sheet Business purchased a van for Rs. 1,00,000/- expected life is 10 years, 10,000 or 1 , will be charged as depreciation every year to P/L A/C 10th and show the balance in the balance sheet as an asset - While preparing final accounts a record will also be made for O/S expenses and prepaid expenses on the assumption that the business will continue for an indefinite period and the assets will be used for its expected life Introduction toCengage. © 2019 Cost management All rights reserved.  Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods….. b- Accounting Period Concept Going concern concept assumes that life of the business is indefinite and the preparation of income & positional statements after a long period would not be helpful in taking appropriate steps at the right time It is necessary to prepare the financial statements periodically to find out the profit or loss and financial position of the business It also helps the interested parties to make periodical assessment of its performance 1st January to 31st December, 1st April to 31st March, Diwali to Diwali or Dushehra to Dushehra, 1st Muharram to last Dhu’l Hajj Final Accounts are prepared at the end of each accounting period and the financial reports thus, prepared facilitate to make good decision, corrective measures, business expansion etc. Introduction toCengage. © 2019 Cost management All rights reserved.  Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods….. c- Matching Concept Matching of cost against revenue to ascertain profit d- Conservation Concept or Prudent Concept Overstatement of liabilities or costs Understatement of assets or revenue Anticipate no profit but provide for all possible losses Provision for Doubtful Debts, provision of discount on debtors, stock price are valued at cost price or market value, which ever is less principle This reflects generally pessimistic attitude of the accountant, but it is regarded as the best way of dealing with uncertainty and protecting creditors Criticism: against the convention of full disclosure, it encourages creation of secret reserves and financial statement do not reflect true and fair view of the affairs of the business Introduction toCengage. © 2019 Cost management All rights reserved.  Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods….. e- Consistency Concept Same accounting principle should be used f- Full Disclosure Concept Introduction toCengage. © 2019 Cost management All rights reserved.  Framework of Accounting Postulates, Principles, Conventions, Concepts, Procedures and methods….. g- Materiality Concept Only relevant and material information must be disclosed e.g. commission paid to selling agent or change in the method of depreciation Non-material , petty or items of little importance e.g. erasers, pencils, stapler, pins, scales etc. are used for a long period but they are not treated as assets, they are treated as expenditure Rs. 1,45, 923.28 or 1,45,923.00 Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Capital -Amount which proprietor has invested in firm or can claim from the firm Capital = Assets- Liabilities Liabilities -The amount which the firm owes to outsiders that is excepting the proprietors (capital) Liabilities = Assets- Capital -Long term liabilities- Payable after more than one year, e.g. long term loans, debentures, etc. -Current Liabilities- Payable with in one year, e.g. creditors, bank overdrafts, bills payable, short term loans, etc. Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Assets Those resources that the business owns e.g. debtors, stock of goods, cash, furniture, machines, building, etc. Fixed Assets- purchased for the purpose of operating the business and not for resale, e.g. land, building, machinery, furniture etc. Current Assets- kept for short term for converting into cash or for resale, e.g. unsold goods, debtors, B/R, bank & cash balance, marketable securities, etc. Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Debtors Person who owes money to the firm generally on account of credit sales of goods and services Creditors Person to whom the firm owes money on account of credit purchase Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Receivables O/S amount due from others, e.g. trade debtors, B/R, notes receivables (promissory notes) Payables Includes the amount due to others, e.g. trade creditors, B/P, notes payable Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Stock Goods lying unsold on a particular date To ascertain the value of closing stock, it is necessary to make a complete list of items in the godown together with quantities The stock is valued on the basis of cost or market price which ever is less principle Opening stock- goods lying unsold in the beginning of accounting year Closing stock- goods lying unsold at the end of the accounting period Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Proprietor Who makes the investment and bears all the risks connected with business Drawings Amount of money or the value of goods which the proprietor takes for his domestic or personal use Revenue Amount which as a result of operations, is added to the capital Revenue is an inflow of assets which results in an increase in the owners equity e.g. receipts from sale of goods, rent, income, etc. Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Income Profit earned during a period of time Difference between revenue, income and expenses e.g. goods costing Rs. 20,000 are sold for Rs. 25,000, the cost of goods sold i.e. Rs. 20,000 is expense, the sale of goods, i.e. Rs. 25,000 is revenue and difference i.e. 5,000 is income Income = Revenue - Expense Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Gain Term used to describe profit of an irregular nature, e.g. capital gains Loss Against which the firm receives no benefit Purchase The term purchase is used only for the purchase of goods It includes both cash and credit purchase of goods Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Sale Sale of goods only & it includes both cash and credit sales Goods Physical items of trade Cost Expenditure required in order to produce some specified output or benefit Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Voucher Voucher is an evidence of a business transaction e.g. Cash memo, invoice, bill, receipts, Dr. and Cr. Notes Profit A surplus of revenues of a business over its costs Profit is categorized into gross profit and net profit Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Gross Profit/ Loss Difference between sales revenue or the proceeds of goods sold and / or services rendered over its direct cost Net Profit/ Loss Profit made after allowing for all expenses In case expenses are more than the revenue, it is net loss Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Expense Expense is a value which has expired during the accounting period It may be: Cash payment such as salaries, wages, rent, etc. Writing off a part of fixed assets (depreciation) An amount written off out of a current asset (bad debts) Decline in the value of assets (investments) Cost of goods sold An expense is charged (debited) to P/L A/C Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Prepaid Expenses Expense paid in advance and benefit thereof will arise in the next year It is shown under the head current assets in the balance sheet and In the next year it is transferred to P/L A/C O/S Expenses That has not been paid but the benefit thereof has already been availed It is debited to the P/L A/C and also shown under the head current liabilities in the balance sheet Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Expenditure Amount spent or liability incurred for acquiring assets, goods or services Capital expenditure Expenditure incurred to acquire assets which will increase the earning capacity of the business, i.e. will give benefit to the business in more than one accounting year It means expenditure incurred to acquire fixed asset or for its improvement e.g. purchase of machinery to manufacture goods, purchase of furniture or computers to carry on business Capital expenditure is shown on the assets side of the balance sheet Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Revenue expenditure Amount spent to purchase goods and services that are consumed during the accounting period Revenue expenditure does not increase the earning capacity but it maintains the earning capacity in the current year Shown on the debit side of the P/L A/C Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Debit An account has two parts, i.e. debit and credit The left side is the debit side while right side is credit side If an account is to be debited then the entry is posted to the debit side of the account. In such an event, it is said that the account is debited It has been derived from an Italian word ‘Debito’ Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Terminology Credit Credit is the right side of the account It has been derived from an Italian word ‘Credito’ Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Equation Recording of business transactions in the books of accounts is based on accounting equation Each transaction has double effect on the financial profit of a concern Accounting equation is a formula expressing equivalence of the two expressions of assets and liabilities Thus the total claims will equal to the total assets of the firm, total claims may be to outsiders and the proprietor In the beginning the owner of the firm provides funds to the business in the form of capital, known as ‘owners equity’ Initially the capital contributed by the owner to the business will be In the form of cash and this cash is treated as an asset of the firm At the same time a liability will be created in the form of owners’ equity according to business entity concept Thus the asset (cash) is balanced against liability (capital) Introduction toCengage. © 2019 Cost management All rights reserved.  Accounting Equation » Cash (Assets) = Capital (Liabilities) » Total Assets = Total Liabilities (Capital + Liabilities) OR Fixed Assets+ Current Assets = Internal liabilities+ External Liabilities OR Capital = Assets – Liabilities OR Liabilities = Assets- Capital Introduction toCengage. © 2019 Cost management All rights reserved.  Types of Accounts Personal Accounts: Which relates to persons Examples: Individuals, firms, companies or an institution are called personal accounts Account of Azeem, Account of Ram Chander Krishen Chander, Debtors, Creditors, Account of L&T Ltd., Account of Aligarh Muslim University, bank account, bank overdraft account, capital Account of the proprietor, Drawings Account of the proprietor Main purpose: To ascertain as to how much amount a personal account owes to the business, i.e. how much amount is due to be received from him How much amount is owed to a personal account from the business, i.e. how much amount is payable Introduction toCengage. © 2019 Cost management All rights reserved.  Personal Accounts Rule - Debit the receiver and Credit the giver In other words - - debit that person’s account who receives something from the business and credit that person’s account who gives something to business Example 1- Paid Rs. 1,000 to Harry – In this case, two A/c affected are Hari’s A/c and Cash A/c, According to the rule of “Debit the receiver”, Hari’s A/c will be debited in the entry as he is the receiver of cash. Simultaneously, the account of cash will be credited, as cash has gone out, the entry will be Hari (Debit the receiver) Dr. 1,000 To Cash A/c 1,000 Introduction toCengage. © 2019 Cost management All rights reserved.  Personal Accounts Example 2 – Received Rs. 500 from Mohan In this case, cash account will be debited as cash has been received and Mohan’s A/c will be credited according to the rule “ Credit the Giver”. The entry will be – Cash A/c Dr. 500 To Mohan (Credit the Giver) 500 Introduction toCengage. © 2019 Cost management All rights reserved.  Types of Accounts  Impersonal Account:  Accounts which are not personal such as machinery accounts, cash a/c, rent a/c etc.  Further sub- divided as:  Real Accounts:  The accounts of all those things whose value can be measured in terms of money and which are properties of the business  Real accounts such as cash account, stock account, furniture account, machinery account, building account, goodwill account, patents account, trade marks account etc. Introduction toCengage. © 2019 Cost management All rights reserved.  Real Accounts Rule- “Debit what comes in and credit what goes out” Whenever any property comes into the business, it is debited and when it goes outside the business, it is credited Example 1- if furniture for Rs. 5,000 has been purchased for cash, furniture account should be debited according to the rule of “debit what comes in” , while cash account should be credited according to the rule of “credit what goes out”. Entry will be Furniture A/c (Debit what comes in) Dr. 5,000 To Cash A/c 5,000 Objects- These accounts represents the value of various properties owned by a business in terms of money and indicate the final position of the business Introduction toCengage. © 2019 Cost management All rights reserved.  Real Accounts Types of Real Accounts Tangible Real Accounts Accounts of those things which can be touched, felt, measured, purchased, sold etc. Cash account, stock account, furniture account, land account, building account etc. Introduction toCengage. © 2019 Cost management All rights reserved.  Real Accounts Intangible Real Accounts- Accounts which represents such things which cannot be touched, but their value can be measured in terms of money Goodwill account, Patents account, Trademarks account, copyrights accounts Introduction toCengage. © 2019 Cost management All rights reserved.  Nominal Accounts These accounts include the accounts of all expenses and incomes Purchases, salaries paid, rent paid, Discount allowed, bad debts etc. Rule- “Debit the expenses and losses and credit incomes and gains” Example 1- Paid Rs. 5,000 for salaries. In this case the two accounts being affected are salaries account and cash account. Salaries represent expenses and as such, salaries a/c will be debited according to the rule debit the expenses. On the other hand, cash account will be credited according to the rule of credit what goes out, Salary a/c (debit the expenses) Dr. 5,000 To cash a/c 5,000 Introduction toCengage. © 2019 Cost management All rights reserved.  Classification of Goods Account Goods include articles purchased by business for resale Goods purchased may be returned back to supplier – Purchases Returns/ Return outward Goods sold to customers may be returned by the customers to the business due to certain reasons – Sales Return/ Return Inward In business, it is desired that a separate record to be kept for all purchases, sale and return of goods Introduction toCengage. © 2019 Cost management All rights reserved.  Classification of Goods Account Goods account can be classified into the following categories Purchases Account: This A/c is maintained for recording all purchases of goods Goods comes in on purchase of goods so Purchase Account is debited on purchase of goods Purchases A/C Dr. (Goods Come in) Introduction toCengage. © 2019 Cost management All rights reserved.  Classification of Goods Account Sales Account Maintained for recording sale of goods, goods are delivered on sale and therefore sales A/c is credited on sale of goods To Sales A/c (Goods go out) Introduction toCengage. © 2019 Cost management All rights reserved.  Classification of Goods Account Purchases Returns A/c For recording return of goods Purchased The goods delivered on return of goods to the supplier and therefore, purchases return A/c is credited To Purchases Return A/c (Goods go out) Introduction toCengage. © 2019 Cost management All rights reserved.  Classification of Goods Account Sales Return Account Goods are received and therefore Sales Return Account is debited on return of goods Sales Return A/C Dr. (Goods come in ) Introduction toCengage. © 2019 Cost management All rights reserved.  The Income Statement Summarizes the revenues and expenses of a company for a period of time Introduction toCengage. © 2019 Cost management All rights reserved. Example 1.5—Preparing an Income Statement © 2019 Cengage. All rights reserved.  The Balance Sheet Financial statement that summarizes the assets, liabilities, and owners’ equity of a company At any point in time, assets must equal liabilities and owners’ equity Introduction toCengage. © 2019 Cost management All rights reserved. Example 1.4—Preparing a Balance Sheet © 2019 Cengage. All rights reserved.  The Statement of Retained Earnings Summarizes the income earned and dividends paid over the life of a business Dividends: Distribution of the net income of a business to its owners Introduction toCengage. © 2019 Cost management All rights reserved. Example 1.6—Preparing a Statement of Retained Earnings © 2019 Cengage. All rights reserved.  The Statement of Cash Flows Summarizes a company’s cash receipts and cash payments during the period from operating, investing, and financing activities Introduction toCengage. © 2019 Cost management All rights reserved. Example 1.7—Preparing a Statement of Cash Flows © 2019 Cengage. All rights reserved. Exhibit 1.6—Relationships Among the Financial Statements © 2019 Cengage. All rights reserved.  Setting Accounting Standards (1 of 2) Generally accepted accounting principles (GAAP) – Various methods, rules, practices, and other procedures —preparing financial statements Securities and Exchange Commission (SEC) – Federal agency with ultimate authority to determine the rules for preparing statements Financial Accounting Standards Board (FASB) – Authority to set accounting standards Introduction toCengage. © 2019 Cost management All rights reserved.  Setting Accounting Standards (2 of 2) American Institute of Certified Public Accountants (AICPA) – Professional organization of Certified Public Accountants (CPA) Public Company Accounting Oversight Board (PCAOB) The Sarbanes Oxley Act of 2002 – Five-member body created by an act of Congress in 2002 to set auditing standards International Accounting Standards Board (IASB) – Develop worldwide accounting standards Introduction toCengage. © 2019 Cost management All rights reserved.  Audit of Financial Statements Most stockholders are not actively involved in the daily affairs of the business Auditing: examining whether financial statements are fairly presented – External auditor performs various tests and procedures and render his opinion  Auditors’ report is an opinion, not a statement of fact Introduction toCengage. © 2019 Cost management All rights reserved.  Ethics in Accounting Ethics plays a critical role in providing useful financial information Investors and other users must have confidence in a company, its accountants, and its outside auditors that the information presented in financial statements is relevant, complete, neutral, and free from error Moral and social ethical behavior must be considered while decision making Introduction toCengage. © 2019 Cost management All rights reserved. Exhibit 1.9—Ethics and Accounting: A Decision-Making Model © 2019 Cengage. All rights reserved.