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MODULE - 1 Introduction to accounting, journal, ledger, trial balance

Introducing To Financial Accounting 2

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Page 1: Introducing To Financial Accounting 2

MODULE -1

Introduction to accounting,

journal, ledger, trial balance

Page 2: Introducing To Financial Accounting 2

Definitions

1. Recording, classifying, summarising business

transactions and interpreting the results thereof.

Page 3: Introducing To Financial Accounting 2

2. It is an information system whose purpose is to identify ,

collect, measure and communicate information about

economic units to those with an interest in the units

financial affairs. To permit judgment and decisions by

users of the information.

Page 4: Introducing To Financial Accounting 2

Systematic record of business transactions.

Protecting the property of the business.

Communicating results to the interested parties.

Compliance with legal requirements.

Page 5: Introducing To Financial Accounting 2

Evidence in court.

Settlement of taxation liability.

Comparative study.

Sale of business.

Assistance to various parties.

Page 6: Introducing To Financial Accounting 2

Records only monetary transactions.

Effect of price level changes not considered.

Historical in nature.

Personal bias of Accountant affects the

accounting statements.

Page 7: Introducing To Financial Accounting 2

Generally Accepted Accounting Principles

In order to make the accounting work uniform and

comparable, a set of Guidelines called as the “GAAP” have

been developed by professional bodies.

ICWAI:- Institute of cost & work Accountants of

India.

ICAI:- Institute of Charted Accountants of India.

AICPA:- American Institute of Certified Public

Accountants.

Page 8: Introducing To Financial Accounting 2

Capital:-

It means the amount (in terms of money or assets having money value) which the proprietor has invested in the firm or can claim from the firm.

For the firm Capital is a liability towards the owner. It is so because the owner is treated to be separate from the business.

Page 9: Introducing To Financial Accounting 2

Liabilities:-If an amount is due to be paid to any other

person or institution other than the owner it is called as a liability.

Liabilities can be classified into following:i) Long-term liabilities: These are those liabilities which are

payable after a long term, (generally more than one year). Example; Long-term loans, debentures etc.ii) Current liabilities: These are those liabilities which are

payable in near future ,(generally within one year). Example; creditors, bank overdrafts, bills payable, short-

term loans, etc.

Page 10: Introducing To Financial Accounting 2

Assets:- Any physical thing or right owned that has a

money value is an asset. In other words, an asset is that expenditure which results in acquiring of some property or benefit of a lasting nature.

Assets can be classified as:i) Fixed Assets: Fixed assets are those assets which are

purchased for the purpose of operating the business and not for resale. E.g. land, building, machinery, furniture, etc.

ii) Current Asset: Current assets are those assets of the business which are kept for short term for converting into cash. E.g. debtors, bills receivables, bank balance, etc.

Page 11: Introducing To Financial Accounting 2

Debtors:-

A person who owes money to the firm, generally

on account of credit sale of goods is called a debtor.

For e.g. When goods are sold to a person on credit

that person pays the price in future. He is called a debtor

because he owes the amount to the firm.

Page 12: Introducing To Financial Accounting 2

Receivables:-

The term receivables is used for the amount

that is receivable by the firm, other than the amount due

from the debtors.

Creditors:-

A person to whom the firm owes money is

called a creditor. For e.g. Mr. M is creditor of the firm when

goods are purchased on credit from him.

Page 13: Introducing To Financial Accounting 2

Payables:- The term payables is used for the amount payable

by the firm, other than the amount due to creditors.

Drawings:- It is the amount of money or the value of goods

which the proprietor takes for his domestic or personal use.

Revenue:- It means the amount which, as a result of

operations, is added to the capital. “Revenue is an inflow of assets which results in an increase in owner’s equity. E.g. sale of goods, rent income.

Page 14: Introducing To Financial Accounting 2

Expense:-

It is the amount spent in order to produce and sell the goods and services which produce the revenue. “Expenses is the cost of the use of things or services for the purpose of generating revenue”. E.g. payment of salary, wages, rent, etc.

Income:-

It is the profit earned during a period of time. In other words, the difference between revenue and expense is called income.

Page 15: Introducing To Financial Accounting 2

Gross Profit:- Gross profit is the difference between sales

revenue or the proceeds of goods sold and services rendered over its direct cost.

Net Profit:-Net Profit is the profit made after allowing for

all expenses. In case, expenses are more than revenue, it is Net Loss.

Cost of goods sold:- It is the direct cost of the goods or

services sold.

Page 16: Introducing To Financial Accounting 2

Expenditure:- Expenditure is the amount spent or liability

incurred for the value received. Expenditure may be classified into:

i) Revenue Expenditure: It is the amount that is incurred in current activities to purchase goods and services which are consumed during the period.

ii) Capital Expenditure: It is the amount that is incurred in purchasing assets which will give benefit extending over a number of accounting periods.

Page 17: Introducing To Financial Accounting 2

Discount:-

When customers are allowed any type of

reduction in the prices of goods by the businessman, that is

called discount.

Gain:-

It is a term used to describe profit of an irregular

nature, e.g. capital gains.

Page 18: Introducing To Financial Accounting 2

Cash Transaction:-

Transactions involving immediate

receipt or payment of cash.

Credit Transaction:-

Transactions in which the

receipt/payment of cash is postponed to a future date is

called as a credit transaction.

Page 19: Introducing To Financial Accounting 2

Net worth:-It means assets minus outside liabilities.Profits of a business increase net worth where

as losses reduce the net worth of a business.

Turn over:-It means total trading income from cash sales

and credit sales.

Voucher:- Any written document in support of a business

transaction is called a voucher. It is an objective evidence in support of a transaction.

Page 20: Introducing To Financial Accounting 2

Basis of Accounting

a) Cash Basis

b) Accrual / Mercantile Basis

Page 21: Introducing To Financial Accounting 2

Cash Basis:- Under this basis, actual cash

receipts & actual cash payments are recorded. Credit transactions are not recorded until the cash is actually received or paid.

Limitation: Does not show actual profits nor does it show the financial position of a firm.

Page 22: Introducing To Financial Accounting 2

Mercantile or Accrual Basis:-

In the accrual basis of accounting, the income,

whether received or not, but has been earned or accrued

during the period forms part of the total income of that

period.

Similarly, if the firm has taken benefit of a particular

service, but has not paid within that period, the expenses will

relate to the period in which the service has been utilised.

Page 23: Introducing To Financial Accounting 2

Accounting concepts

1. Entity 2. Money measurement

6. Accruals

4. Cost 3. Going-concern

5. Réalisation

7. Matching 8. Periodicity 9. Consistency 10. Conservatisme

Page 24: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. realization

7. Matching 8. Periodicity 9. Consistency 10. conservatism

The affairs of the business are distinct from the personal affairs of its owner. The business is an independent ENTITY.

Page 25: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. realization

7. Matching 8. Periodicity 9. Consistency 10. conservatism

Records are kept in monetary terms, and only matters capable of being expressed in monetary terms are reflected in the books.

Page 26: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. realization

7. Matching 8. Periodicity 9. Consistency 10. conservatism

The business is assumed to have a continuing and indefinite life. The business IS NOT on the verge of extinction.

Page 27: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. realization

7. Matching 8. Periodicity 9. Consistency 10. conservatism

Accountants compute the value of an asset by reference to its acquisition cost, AND NOT by reference to its expected future benefits.

Page 28: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. réalisation

7. Matching 8. Periodicity 9. Consistency 10. conservatism

Any change in the value of an asset may only be recognized at the moment the firm REALIZES it, or disposes of that asset.

Page 29: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. realization

7. Matching 8. Periodicity 9. Consistency 10. conservatism

The recognition of an expense (or revenue) and the related liability (or asset) results from an accounting EVENT, and is not necessarily signaled by a cash transaction.

SFAC #1: Accrual accounting attempts to record the financial effects on an enterprise of transactions and other events and circumstances that have cash consequences for the enterprise in the periods in which these transactions, etc… occur rather than only in the periods when cash is received or paid.

Page 30: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. realization

7. Matching 8. Periodicity 9. Consistency 10. conservatism

Expenses should be recognized in the same accounting period during which the firm has recognized the associated revenues.

Revenues and expenses resulting from the same transactions (or events, circumstances, etc…) should be recognized simultaneously.

Page 31: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. realization

7. Matching 8. Periodicity 9. Consistency 10. conservatism

Accounting reports must be prepared for fixed, and relatively short, periods of time.

Page 32: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. realization

7. Matching 8. Periodicity 9. Consistency 10. conservatism

Like transactions should be treated the same way in consecutive periods.

Page 33: Introducing To Financial Accounting 2

• Accounting concepts 1. Entity 2. money measurement

6. Accruals

4. Cost 3. Going-concern

5. realization

7. Matching 8. Periodicity 9. Consistency 10. Conservatisme

(1) The accountant should not anticipate profit, and should provide for all possible losses;(2) Faced with several methods of valuing an asset, the accountant should choose that which leads to the lesser value.

Page 34: Introducing To Financial Accounting 2

Business Transactions:-

Any event which involves

exchange of money or money’s worth between the firm and

any other person is known as a Business Transaction.

In other words any event which affects the

business and involves money is a Business Transaction.

Page 35: Introducing To Financial Accounting 2

ILLUSTRATIONS:-

a) Capital introduced into the business by the proprietor [BT]

b) Sending of price list [NBT]

c) Purchase of goods for cash [BT]

d) Receiving of a price list [NBT]

e) Purchase of goods on credit [BT]

f) Placing of an order [NBT]

g) Sale of goods on credit [BT]

h) Receipt of an order [NBT]

Page 36: Introducing To Financial Accounting 2

Accounting Equation

The equation is based on the principle that accounting deals

with property & rights to property & the sum of the

properties owned is equal to the sum of the rights to the

properties. The properties owned by a business are called

assets & the rights to properties are known as liabilities or

equities of the business.

Assets = Liabilities + Capital

Page 37: Introducing To Financial Accounting 2

The Double-Entry System

The double-entry book-keeping system is based on the

principle that for every business transaction that takes place

two entries must be made in the accounts: a debit entry,

showing goods or value coming into the business, & a

corresponding credit entry, showing goods or value going

out of the business.

Page 38: Introducing To Financial Accounting 2

Rules of the Double Entry System

1) Personal Account:-

These accounts record a business dealings with

persons or firm.

The person receiving something is given debit

and the person giving something is given credit.

Page 39: Introducing To Financial Accounting 2

2) Real Account:-

These are the accounts of assets. Assets

entering the business is given debit and assets leaving the

business is given credit.

Page 40: Introducing To Financial Accounting 2

3) Nominal Account:-

These accounts deal with expenses, incomes,

profits and losses. Accounts of expenses and losses are

debited and accounts of incomes and gains are credited.

Page 41: Introducing To Financial Accounting 2

Debit Receiver

Personal AccountCredit Giver

Debit What comes in

Real Account Credit What goes out

Debit Expenses & Losses

Nominal Account Credit Incomes & Gains

Page 42: Introducing To Financial Accounting 2

Advantages of Double Entry System

a) Complete record of the financial transactions is maintained.

b) It gives accurate information of amount due to & due by the

business unit at any time.

c) It is helpful in preventing frauds & errors.

d) Arithmetical accuracy of the account books can be tested.

e) It is helpful in preparing profit & loss account and Balance

sheet of a firm.

Page 43: Introducing To Financial Accounting 2

Accounting Cycle

a) Recording:-

First, all transactions should be recorded in

the Journal or Books of original entry known as subsidiary

books.

b) Classifying:-

All entries in the Journal should be posted to

the appropriate ledger accounts to find out at a glance the

total effect of all such transactions in a particular account.

Page 44: Introducing To Financial Accounting 2

c) Summarising:-

Last stage is to prepare the trial balance

and final accounts with a view to ascertaining the profit or

loss made during a trading period and the financial position

of the business on a particular date.

Page 45: Introducing To Financial Accounting 2

JournalJournal means a daily record of business transactions.

Journal is a book of original entry because transaction is first

written in the Journal from which it is posted to the ledger.

Page 46: Introducing To Financial Accounting 2

Date Particular LF Debit Rs [Dr]

Credit Rs [Cr]

YearMonthDate

Name of account to be debited. To, Name of account to be credited.[Narration]

The ruling of the journal is as follows:-

Journal

Page 47: Introducing To Financial Accounting 2

L.F:- It stands for Ledger Folio which means page of the

ledger. This column is used to record the page numbers on

which the various accounts appear in the ledger.

Page 48: Introducing To Financial Accounting 2

Trade Discount:-

It is a deduction allowed by the

manufacturer to the wholesaler or retailer on the gross value

or list price of goods to enable the buyer to sell the goods

further (at list price) and yet make a profit for himself.

Trade discount is not recorded in any

account as it is deducted in the invoice itself from the gross

value of goods.

Page 49: Introducing To Financial Accounting 2

Cash Discount:-

It is allowed by the creditor to the debtor as

an incentive to the latter to make an early payment.

Cash discount is calculated on net value of

goods, after deducting trade discount.

Cash discount being a nominal account, it

is debited with the loss on discount allowed and credited

with the gain on discount received.

Page 50: Introducing To Financial Accounting 2

Example – 1

Sale of food & drink as meals in a restaurant

amounted to Rs. 1,500 cash.

In this case the sales account would be credited

with the value of the food & drink leaving the restaurant as

meals, and the cash account would be debited with Rs. 1,500

cash coming into the business from the sale.

Page 51: Introducing To Financial Accounting 2

Example – 2

A hotelier sent a cheque for Rs. 20,000 as

payment of her electricity bill.

In this case the bank account would be credited

with Rs. 20,000 going out of the business and electricity

account would be debited with Rs. 20,000 being the cost of

the electricity used in the business.

Page 52: Introducing To Financial Accounting 2

Debit1.Increase in asset accounts2.Increase in expense accounts 3.Decrease in liability accounts4.Decrease in equity accounts5.Decrease in revenue accounts

Credit1.Decrease in asset accounts2.Decrease in expense accounts 3.Increase in liability accounts4.Increase in equity accounts5.Increase in revenue accounts

Page 53: Introducing To Financial Accounting 2

LEDGER

A ledger account may be defined as a summary statement of

all the transactions relating to a person, asset, expense or

income which have taken place during a given period of

time and shows their net effect.

Page 54: Introducing To Financial Accounting 2

Date Particular F Amount

Date Particular F Amount

To, Name of credit A/c

Rs By, Name of debit A/c

Rs

Ledger Format

Page 55: Introducing To Financial Accounting 2

Each account in the ledger is divided into two

equal parts by a vertical line. The left hand side of the

account is known as debit side and the right hand side is

called credit side.

‘F’ stands for folio (page number) of the

journal or subsidiary book.

Page 56: Introducing To Financial Accounting 2

Ledger Posting of Journal

Every transaction is first recorded in the

journal in the form of a journal entry.

From the journal it is transferred to the

concerned accounts in the ledger. This process of

transferring the transaction from the journal to the ledger is

known as Posting.

Page 57: Introducing To Financial Accounting 2

Balancing of Accounts

Various accounts in the ledger are balanced

with a view to preparing the final accounts.

1) Take the totals of the two sides of the account concerned.

2) Ascertain the difference between the totals of two sides.

Page 58: Introducing To Financial Accounting 2

3) Enter the difference in the amount column of the side

showing less total writing against the difference in the

particular column “To, balance c / d” [ c/d means carried

down] on the debit side of the account and “By, Balance

c/d” on the credit side of the account. In this way, the totals

of two sides will agree.

Page 59: Introducing To Financial Accounting 2

4) The balance is brought forward at the beginning of the next

period. If “To, Balance C/d” is written on the debit side

before balancing, it is brought forward on the credit side and

“By, Balance b/d” [b/d means brought down] is written

against the balance in the particulars column and vice versa.

Page 60: Introducing To Financial Accounting 2

An account is said to have a debit balance if the

total of its debit side is more than the total of its credit side.

On the other hand, an account is considered to

have a credit balance if the total of its credit side is more

than the total of its debit side.

Page 61: Introducing To Financial Accounting 2

1] Journalise the following transactions & post them to ledger.

2008 Jan 1. Started business with cash Rs. 1,00,000

2. Cash paid into bank Rs. 40,000

3. Purchased goods Rs. 6,000

7. Cash sales Rs. 10,000

9. Goods sold to Mr. Raj Rs. 15,000

12. Purchased goods from Mr. Nanda Rs. 20,000

19. Returned goods to Mr. Nanda Rs. 2,500

25. Received from Mr. Raj Rs. 15,000

27. Paid Mr. Nanda Rs. 17,500 by cheque.

Page 62: Introducing To Financial Accounting 2

Trial Balance

Trial Balance is a list of balances

extracted from the ledger accounts at the end of an

accounting period. Since the balances in ledger accounts are

effects of double entries, the total of debit balances should

be equal to total of credit balances.

Page 63: Introducing To Financial Accounting 2

Uses of Trial Balances

1) It is the basis of preparation of Final Accounts.

2) It helps in verifying the arithmetical accuracy of ledger

accounts.

The two sides of the trial balance will not tally if a mistakes

has taken place in the following.

a) Posting

b) Totaling

c) Balancing.

Page 64: Introducing To Financial Accounting 2

Nature of Balances:

In the normal circumstances,

i) All assets accounts & also dues from persons will show

debit balances.

ii) All liabilities accounts will show credit balances.

iii) All expenses account will show debit balances.

iv) All income accounts will show credit balances.

Page 65: Introducing To Financial Accounting 2

Sl No Particulars LF Debit Balance Rs

Credit Balance Rs

Page 66: Introducing To Financial Accounting 2

Errors Revealed by the Trial Balance:-

1) Incorrect balances of the cash book.

2) Incorrect totals in purchases, purchase returns, allowances or sales day books.

3) Entries posted to the wrong side of an account.

4) Omission of a debit or a credit in posting from the journals to the ledger.

5) Incorrect figures posted from a journal to the ledger account.

6) Discounts transferred incorrectly.

Page 67: Introducing To Financial Accounting 2

Procedures for locating Errors in the Trial Balance

a) Check the cash balance in the cash book against the actual

cash in hand.

b) Check and reconcile the bank balance in the cash book

against the balance in the bank statement.

c) Prove the purchases and purchases returns figures against

the purchases control account.

Page 68: Introducing To Financial Accounting 2

Errors not revealed by the Trial Balance:-

1) Errors of omission:

This type of errors occurs when an

accounting document, e.g. an invoice or a credit note, is lost

or mislaid, the result being that there is no debit or credit

entry in either the book of first entry or the ledger account.

Page 69: Introducing To Financial Accounting 2

2) Errors of original entry:

This type of error occurs when an

amount on an invoice, e.g. Rs. 600, is entered wrongly in the

book of first entry, e.g. Rs. 666, and then is posted wrongly

to the ledger account, as Rs. 666.

As there has been a debit entry and a

credit entry for the same amount, the totals of the trial

balance will still be in agreement.

Page 70: Introducing To Financial Accounting 2

3) Errors of principle:

This type of error occurs when a

transaction has a debit entry and a credit entry but the item is

posted in principle to the wrong classification of account.

E.g. Motor expenses of Rs. 300 has been debited to motor

vehicles account.

Page 71: Introducing To Financial Accounting 2

4) Errors of commission:

When a wrong amount is entered

either in the subsidiary books or in the ledger accounts or

when amount is posted on the wrong side, it is a case of

errors of commission.

For example, if fuel costs are incorrectly debited to the

postage account (both expense accounts). This will not

affect the totals.

Page 72: Introducing To Financial Accounting 2

5) Compensating errors:

An example of this type of errors is

where the wages account has been over-added by Rs. 5,000

& by coincidence the sales account has been over added by

Rs. 5,000. So an error on debit side is compensated by an

error on the credit side.

Page 73: Introducing To Financial Accounting 2

6) Errors of duplication:

An example of this type of error is

when the same invoice is entered into the purchases day

book twice and posted from there to the ledger account

twice.

Page 74: Introducing To Financial Accounting 2

The Suspense Account:-

When trial balance does not tally , the

difference is put into a newly opened account named

suspense account and the trial balance is thus made to tally.

In case , the debit side exceeds the credit

side the difference is put on the credit side of suspense

account . Likewise , if the credit side of the trial balance

exceeds the debit side , the difference is put on the debit side

of suspense account.