Basics of Accounting and book keeping

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1. BOOKKEEPING & ACCOUNTING

INTRODUCTION: You have been observing since you have been a child, about how your

grandparents or parents would keep a record of their expenses in adiary. You have been receiving pocket money from your parents. Yourparents wanted an explanation from you at the end of the month,about the way in which you spent the money. Hence, you had to keepa record of the expenses. That means a record has to be kept of thedifferent transactions. The subject of 'Book-keeping & Accountancy'deals with the various aspects of keeping records for a businessorganization. Accountancy starts where Bookkeeping ends. It is an art,practice or system of keeping, analyzing and interpreting businessaccounts. Accounting communicates the results of business operationsto various parties who have some stake in the business viz.

proprietors, management, creditors, prospective investors,Government, employees, citizens and other agencies.Bookkeeping and Accountancy answer important questions like:(1) Has the business made a profit or loss?(2) What is the amount of profit or loss?(3) What are the sources of funds of the business?

NEED AND DEVELOPMENT:Accounting is as old as money itself. In India Chanakya in hisArthashastra has emphasized the existence and need of properaccounting and auditing. The advent of industrial revolution hasresulted in large-scale production, cutthroat competition and Wideningof the market. Accounting today has also grown in importance andchange in its structure with the evolution of complex and giantindustrial organizations. It has come to be recognized as a tool formastering the various economic problems, which a businessorganization may have to face.

DEFINITIONS OF BOOKKEEPING:nNorcott:'It is an art of recording in the books of accounts, the monetary aspectsof commercial or financial transactions'

nRichard E. Strahelm:“The art of analyzing & recording business transactions, reportingresults of business operations through periodic statements andinterpreting such results for purposes of effective control of futureoperations.”

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DEFINITIONS OF ACCOUNTING:* R. N. Anthony'An Accounting system is a means of collecting, summarizing,analyzing and reporting in monetary terms, information about the

business.nThe American Institute of Certified Public Accountants:Accounting is, "the art of recording, classifying and summarizing in asignificant manner and in terms of money, transactions and eventswhich are in part at least of a financial character and interpreting theresults thereof.”

DIFFERENCE BETWEEN BOOK KEEPING AND ACCOUNTING:

OBJECTIVES OF ACCOUNTING:1. To ascertain the amount of profit or loss during the accountingperiod.2. To ascertain the financial position (amount of his Capital, assets andliabilities) of the business on any particular date.3. To provide information to all the interested parties:

(a) Owners: To know about the profit or loss or financial position.(b) Creditors: To find out the creditworthiness of the business.(c) Government: To assess the tax-liability(d) Management: To keep a control on the various aspects of thebusiness.

BASIC ACCOUNTING TERMINOLOGIES

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BASIC TERMS

Business is carried on with an intention to earn profit. There arevarious factor involved to generate this profit and they also deservetheir share in profit for eg. A business has four factors i.e.

1. Land -to start the business/ a place to carry on business2. Labour - the workforce3. Outside liabilities- to provide the amount / financial help to start thebusiness.4. The entrepreneur/ the proprietor himself capital contribution fromhis own side I.e. owners own investment.

Now let us understand some basic terms.1. Transaction: A transfer of goods and/or services or cash or anyother benefit between the business and outsiders or between twoaccounts.

(i) Cash Transactions: Those transactions where one of theexchanged items is cash (including cheques and drafts) are cashtransactions.(ii) Credit transactions: When there is an exchange of goods orservices but for 'a promise to pay' on a later date, the exchange iscalled a credit transaction.

2. Goods: Goods are those tangible products, which are produced orpurchased for the purpose of sale or resale respectively.

3. Profit/Loss: Profit is the excess of Income / revenue over expenses

during the accounting year. Loss is the excess of expenses overincome / revenue.

4. Assets: They are the entire property owned by a business whichfacilitate business operations and are not meant for resale.

a) Fixed Assets: Fixed assets are required for relatively long period of time. These are used to generate income over a period of time byusing them throughout their life span. These assets are not meant forresale e.g. Land & Building, Plant and machinery. These assets arerecorded at cost i.e. acquisition / historical cost.

Assets may further be classified asTangible assets & Intangible Assets

(i) Tangible Assets: These assets are properties, which can be seen,touched felt, measured eg. Plant and Machinery.(ii) Intangible assets: These assets consist of properties, which cannot be seen touched, or felt but they are capable of measurement in

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terms of money. For eg. Goodwill - the name & fame of the business,patents copyrights, Trademarks.b) Current Assets: They are acquired for relatively longer period of time and are generally not meant for resale.

5. Liabilities: The amount that the business owes to outsiders.

6. Net Worth/ Capital: Total Assets of the business (-) Total Liabilitiesof the business

7. Drawings: Amount withdrawn by the proprietor from the businessin cash or goods for personal use.

8. Sundry Debtors: They represent amount outstanding and duefrom customers against credit sales.

9. Sundry Creditors: They represent amount payable to suppliersagainst credit purchases.

10. Contingent Liability: There may be certain items, which are notliabilities at the time of assessing the financial position of the business.It becomes a liability on a particular event happening. A contingentliability is therefore, one that may or may not become a liability.

11. Capital Expenditure: A substantial expenditure made by thebusiness organization may be for the purchase of an asset. This wouldresult in increasing the earning capacity of the business and the

benefits from the asset will also be received throughout its workinglife. This expenditure is known as Capital Expenditure.

12. Revenue Expenditure: Expenditure that is incurred on the day-to-day running of the business and chargeable to the revenue earnedfrom the business is called revenue expenditure. The benefits receivedfrom these expenses are received during the current accounting yearitself.

13. Deferred Revenue Expenditure: Some expenses are essentiallyrevenue in nature but the benefits received there from extend beyond

one accounting period.

14. Insolvent: A person or a business who/which is not in a position topayoff its liabilities is said to be insolvent or bankrupt.

15. Accounting Year: The year for which accounts are kept by aproprietor.

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3 . ACCOUNTING CONCEPTS AND ACCOUNTING CONVENTIONS

Accounting Concepts:Accounting concepts are the necessary assumptions or conditions

upon which accounting is based.

Business Entity concept.For accounting purposes, the 'business' is treated as a separate entityfrom the proprietor.

Going concern concept.It is assumed that a business is a 'going concern' and that it willcontinue to operate for an indefinite period of time.

Money measurement concept.

Only transactions or events that can be recorded in terms of moneyare recorded in the books of accounts.

Cost concept.An asset is recorded in the books at cost i.e. the price paid to acquireit.

Dual aspect concept.Every transaction that takes place in an organization, has two effectson the balance sheet equation (Total Assets = Owners' Capital +Liabilities to outsiders) such that at any point of time the equation is

always maintained.

Accounting period concept. The entire life of the business is divided into smaller periods at the endof which the performance is reviewed and reported. The period forwhich the final accounts of a company are prepared may be a year andis known as an accounting period.

Realisation concept. The realization concept states that the amount recognized as revenueis the amount that is reasonably certain to be realized.

Accrual concept. The costs and the revenues, which are recorded in the financialstatements, should relate to the accounting period of the financialstatements to which they relate. The cash may or may not be receivedor paid in the same accounting period.

Conservatism

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It refers to the policy of 'playing safe'. As per this convention, allprospective losses are taken into consideration but not all prospectiveprofits.

4. MEANING OF AN ACCOUNT

ACCOUNT:An account may be defined as a systematic and summarised record of transaction pertaining to one person, one property or one head of expense /loss or gain. An account is given a suitable heading, whichmay be of the person, property or an expense or a gain. An account isalways divided into two sides. The left hand side is known as the Debitside and the right hand side is known as the Credit side. To debit andaccount means to enter the amount of transaction on the debit side i.e.left side and the credit an account means to enter the amount to thetransaction on the credit side i.e. right side. An account is a ledger

account opened in the ledger on separate pages.

DOUBLE ENTRY BOOK-KEEPING SYSTEMS.Double entry book keeping system denotes that every businesstransaction has two-fold effect. There cannot be business transactionunless it has effect at least on two account or two parties. So mainprinciples of Double entry book-keeping system are:(I) Every business transaction is split up into two aspects viz. debitaspect and credit aspect(ii) Minimum two parties are required to complete a businesstransaction

(iii) One party is a receiver of the benefit while the other is the giver of the benefit.(Iv) Every debit has a corresponding credit of an equal amount.

5. TYPES OF ACCOUNTS

INTRODUCTION: The transactions are recorded on the basis of the rules of debit andcredit. For this purpose business transactions have been classified intothree categories:1) Transactions relating to persons.2) Transactions relating to properties and assets.3) Transactions relating to incomes and expenses.?The accounts falling under the first heading are called as "PersonalAccounts."?Accounts falling under the second heading are called as "RealAccounts" and?The accounts falling under the third heading are termed as "Nominal

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Accounts."

Let us now understand each type of account.A) PERSONAL ACCOUNTS:Personal Accounts include the accounts of persons with whom the

business deals. These accounts can be classified into three categories:-1. Natural Personal Accounts: - The term Natural Persons meanspersons accounts of individual human beings for e.g. Jassi's Account,Mr. Bhatia'sA/c. etc.

B) REAL ACCOUNTS: These are the accounts of properties, assets or possessions of thebusinessman. These accounts represent the belongings of thebusinessman. A separate account is maintained for each class of property or asset.

C) NOMINAL ACCOUNTS:Nominal Accounts include accounts of all expenses, losses, incomesand gains. The examples of such accounts are Rent A/c., Salaries A/c. InsuranceCharges A/c., Loss by Fire A/c. These accounts of these items are opened to explain how cash hasbeen spent.

CHART FOR RULES OF DEBIT & CREDITFollowing are the fundamental rules for recording businesstransactions in a journal:

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Now let us consider these rules with the help of transactions:

(1)X started business by investing Rs 1, 00,000 in 'X & Co'.

(2) 'X & Co' purchases a machine by investing cash Rs 20,000

6. BOOKS OF ACCOUNTS

INTRODUCTION:Accounting is an art of recording, classifying and summarizing thefinancial transactions and interpreting the results thereof. There are

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specific books of accounts which are used to record and classify thebusiness transactions.

STAGES OF ACCOUNTING:

The accounting cycle involves the following stages

1. Recording of transactions This is done in the book termed as “Journal”2. Classifying the transactions: This is done in the book termed as “Ledger”3. Preparing Trial Balance This is a schedule which shows a list of all debit balance and creditbalances of ledger accounts, which match each other.4. Preparing “Final Accounts” This involves preparation of “Profit &Loss A/C” and “balance

Sheet”

JOURNALA journal is book of or original entry or primary entry. It is book of daily

record first of all the transactions are recorded in the Journal andsubsequently they are posted in the ledger. To journalize thetransactions means to record in two- fold effects of a transaction interms of debit and credit. This has to be done by observing the rules of debit and credit. Also a brief explanation of the entry done istransaction executed is given in the bracket just below the entry. It iscalled “Narration”.

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HOW TO JOURNALIZE THE TRANSACTIONS:

1. First find out the two accounts involved in the transactions i.e.Parties involved, properties transacted, amounts expressed2. Ascertain the types of these accounts (i.e. Real, nominal and

personal accounts) then decide by applying rules of debit and credit asto which account is to be debited ad which account is to be credited.

FORMAT OF JOURNAL

JOURNAL

SUBSIDIARY BOOKS (SUB_DIVISIONS OF JOURNAL)With the growth of business the number of transaction also increases

and there is a need to have a better method of recording businesstransactions. Also a big business recording of all transactions in one Journal will not only be inconvenient but also cause delay in collectinginformation required. The journal is therefore sub divided into manysubsidiary books. This subdivision results in many advantages namelyconvenience division of labor, classified information.

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Sub division of journals (Subsidiary/Day Book)

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JOURNAL PROPER:It records those transactions that do not find place in any of theprimary books in the table. It records1. Credit purchase and sale asset (i.e. No cash payment)2. Opening entries-At the beginning of an accounting period, the

balances of elements appearing the immediately proceeding periodare carried forwards with the help of journal entry that is passed in journal proper.

7. SECONDARY BOOKS OF ACCOUNTS

INTRODUCTION: The main disadvantage of a primary book is that transactions arerecorded date wise and not as per their nature.Eg: if you wish to find out the amount spent on salaries in anorganization in a particular year, you would have to go through every

page of cash book. This would be a time consuming and cumbersomeprocedure. The basic purpose of accounting is to generate meaningful informationin a systematic, properly classified manner. This cannot be achievedwith only primary books. This calls for:i) Identifying the nature of various transactions recorded in the primarybooks.ii) Giving an appropriate name to an identical class of transactionsiii) Re-recording the transactions in another set of books according tothe defined class.

The second book is also called as Ledger.If there are several transactions relating to one account, these appearin different pages in journal as per the dates.However, they will appear in a classified form under that particularaccount in the Ledger. A Ledger contains a set of accounts as per therequirement of the organization.

Specimen of a Ledger:A Ledger is typically written in a 'T' format as follows:

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8. RECORDING TRANSACTIONS IN A JOURNAL

INTRODUCTION:We have already seen the rules to be followed for debiting andcrediting accounts, while passing journal entries.

In journal entries, the word Debit is abbreviated as “Dr” and the wordcredit is abbreviated as “Cr” The account which is to be debited islisted first and the Dr amount entered in the first of the two moneycolumns. Then, the account which is to be credited is listed and theamount entered in second money column. A narration should bewritten after each journal entry.

We will now see how journal entries are to be passed for differenttransactions1) Salary to be paid to Mr.Joshi by ABC ltd. Rs 5000/- Two accounts are involved

a) Salary A/C which is nominal account.Rule for nominal account is:1. Debit all expenses and losses2. Credit all gains and incomesSalary is an expense for business, so debit it.Salary A/C …..Dr.

b) Cash A/c which is real account.Rule for real account1. Debit what comes in2. Credit what goes outCash has gone out so credit it

Cash A/c…..Cr.So the journal entry is:Salary A/c Dr.5000

To cash A/c 5000

Pass journal entries for the following( without narrations)1) Nikhil starts business with a Rs 50000 out of which he deposits Rs35000in the bank..

Bank A/C Dr.35000Cash A/C Dr.15000

To capital A/c 50000

9. LEDGER POSTINGSINTRODUCTION: The process of transferring journal entries to the ledger is known asposting to the ledger.

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Ledger Posting:It involves the following steps:a) In case of simple journal entry, every transaction would affect twoaccountsb) One account is debited, while the other is credited

c) It is possible for multiple accounts to be debited or creditedd) The amount of debit and credit must be the same.

10. TRIAL BALANCEINTRODUCTIONOnce the ledger postings have been completed the balances of variousaccounts are calculated at the end of accounting period. Then, the trialbalance is prepared. The trial balance is a statement prepared to testthe accuracy of the ledger balances. The Trial Balance is a summary of the balances of every single accounton a particular date. As the primary and secondary books are

maintained on the double entry book keeping concept, the debit andthe credit balances from the trial balance must tally. If the two sides donot match, this means that there is some arithmetical inaccuracy inthe books of accounts. The purpose of a trail balance is not only to check arithmeticalaccuracy of ledger balances, but also to have an overview of theoperations of the business as on particular date. A trial balance is notpart of the books of accounts. It is drawn up as a separate statementand this becomes the source document for preparing external financialstatements like “Profit and LossA/c” and the “Balance Sheet”

TRIAL BALANCE AS on_____________

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Basics of Accounting and book keeping