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

Definitions

1. Recording, classifying, summarising business transactions and interpreting the results thereof.

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.

Systematic record of business transactions.Protecting the property of the business.Communicating results to the interested parties.Compliance with legal requirements.

Evidence in court.Settlement of taxation liability.Comparative study.Sale of business.Assistance to various parties.

Records only monetary transactions.Effect of price level changes not considered.Historical in nature.Personal bias of Accountant affects the accounting statements.

Generally Accepted Accounting PrinciplesIn 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.

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.

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.

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.

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.

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.

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 owners equity. E.g. sale of goods, rent income.

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.

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.

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.

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.

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.

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.

Basis of Accounting

a) Cash Basis

b) Accrual / Mercantile Basis

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.

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.

Accounting concepts

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

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

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

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

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

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.

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.

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

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

(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.

Business Transactions:-Any event which involves exchange of money or moneys 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.

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]

Accounting EquationThe 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

The Double-Entry SystemThe 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.

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.

2) Real Account:-These are the accounts of assets. Assets entering the business is given debit and assets leaving the business is given credit.

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.

DebitReceiverPersonal AccountCreditGiver

DebitWhat comes inReal Account CreditWhat goes out

DebitExpenses & Losses

Nominal Account CreditIncomes & Gains

Advantages of Double Entry Systema) 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.

Accounting Cyclea) 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.

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.

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.

The ruling of the journal is as follows:-

Journal

DateParticularLFDebit Rs [Dr]Credit Rs [Cr]YearMonthDateName of account to be debited. To, Name of account to be credited.[Narration]

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.

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.

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.

Example 1Sale 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.

Example 2A 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.

DebitIncrease in asset accountsIncrease in expense accountsDecrease in liability accountsDecrease in equity accountsDecrease in revenue accounts

CreditDecrease in asset accountsDecrease in expense accountsIncrease in liability accountsIncrease in equity accountsIncrease in revenue accounts

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.

Ledger Format

DateParticularFAmountDateParticularFAmountTo, Name of credit A/cRsBy, Name of debit A/cRs

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.

Ledger Posting of JournalEvery 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.

Balancing of AccountsVarious 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.

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.

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.

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.

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.

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.

Uses of Trial Balances1) 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) Postingb) Totalingc) Balancing.

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.

Sl NoParticularsLFDebit Balance Rs Credit Balance Rs

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.

Procedures for locating Errors in the Trial Balancea) 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.

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.

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.

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.

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.

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.

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.

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.

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