Tuesday, September 04, 2012

Introduction to Accounting

Book keeping
Book keeping is an activity concerned with the recording of financial data relating to business operation in a significant and orderly manner.
According to the R.N carton: - “Book – keeping is the science and arts of correctly recording in the book of accounts all those business transactions that result in the transfer of money or moneys worth “.
“North coot” has defined it as “Book – keeping is the art of recording in the books of accounts the monitory aspects to commercial or financial transaction “.
Thus we can say that it is an art of recording business transaction in a systematic manner in the book of business.

Objectives of Book- keeping:
A businessman record the transaction in a set of book in order to ascertain the following objects:-
a)      To have a permanent records of each transaction of the business.
b)      To show the financial effect on the entity of each transaction recorded.
c)       To know the financial position of the business on a particular data.
d)      To disclose factors responsible for earning profit or suffering loss in a given period.
e)      Determination of the tax liability of the business.
f)       For prevention of frauds and errors.
g)      Protection of assets.             

Accounting is the analysis and interpretation of book-keeping records. It includes not only maintains of accounting records but also the preparation of financial and economic information. Which involves the measurement of transaction and other events pertaining to a business?
“Accounting system is a measure of collecting summarizing, analyzing and reporting in monetary terms the information of the business”.
According to the American institute of certified public accounts” The arts of recordings, classifying and summarizing in a significant manner and in terms of money transaction and events which in parts, at least of a financial charter and interpreting the result there of”.

The mean objectives of accounting are as follow:-
a)      To keep systematic and authentic records: - The accounting provides as authentic and permanent records of all the financial transaction of a business.
b)      To protect business properties: - It keeps full records of all assets and liabilities and provides information to the proprietor as regards the utilization and preservation of funds.
c)       To determine tax liability: - Accounting supplies some important and relevant information on the basis of which tax liability can be discharged.
d)      To ascertain the apparitional profit or loss: - Accounting helps in ascertaining the net profit or loss suffered on account of carrying the business.
e)      To ascertain the financial position of business: - the profit and loss account gives the amount of profit or loss made by the business during a particular period.

Advantages and limitations of Accounting
The main advantages of accounting are mentioned below:
a)      Accounting information is used by the management in taking various menageries at decision.
b)      It shows the financial position of business on a particular data.
c)       Accounting data are accepted by the tax authorities as authentic and reliable. Hence they can be used as the basis for discharging tax liabilities.
d)      Accounting supplies financial data which are accepted by the insurance company as reliable figure for settlement of insurance claim.

Following are the limitations of accounting:
a)      Records transaction measurable in monitory term: - According to records only those transactions which can be measured in monetary terms. There may be certain important non-monitory transaction but are not recorded.
b)      Permits alternative treatment: - The similar treated with different alternative approach or method and as a consequent correct result may not be attained.
c)       Effect of price level changes not considered: - Accounting transaction is recorded at cash in the book .The effect of price level changes is not brought into the book .It lead to the difficulties in.
d)      Personal bias of accountant affect the accounting statement: - Accounting statement is influenced by the personal judgment of the accountant. He may select any methods of depreciation, valuation of stock etc. Such judgment it based on antiquity and compliancy of the accountant with definitely affects the preparation of accounting statement.

Difference Between book keeping and accountancy
The difference between Book – keeping and accounting summarized below:-
a)      Objective: - The objectives of book –keeping is too limited up to recording of business transaction. Where as the object of accounting is not only maintaining business records but also calculating income, depiction of financial position and communication of business result.
b)      Function: - The function of book – keeping is to record business transaction. The function of accounting is the recording, classifying, summarizing, interpreting business transaction and communicating result.
c)       Basis: - Business transaction vouchers and other supporting documents are the basis of book – keeping for recording. Where as book - keeping serves as the basic for accounting information.
d)      Nature: - Book – keeping is mostly of decrial nature. Accounting is comprehensive in nature and requires specialized knowledge.
e)      Usefulness: - Book keeping is not of much help to the management for their decision making. Accounting helps management in forming and executing management policy.

Parties interested in accounting information:
a)      Owners: The owners provide funds or capital for the organization. Owners, being businessmen, always keep an eye on the returns from the investment.
b)      Management: The management of the business is greatly interested in knowing the position of the firm. The accounts are the basis with the help of which the management can study the merits and demerits of the business activity.
c)       Creditors: Creditors are the persons who supply goods on credit, or bankers or lenders of money. It is usual that these groups are interested to know the financial soundness before granting credit.
d)      Employees: Payment of bonus depends upon the size of profit earned by the firm. The more important point is that the workers expect regular income for living. The increase in wages, Bonus, better working conditions etc. depend upon the profitability of the firm.
e)      Investors: The prospective investors, who want to invest their money in a firm, wish to see the progress and prosperity of the firm, before investing their amount, by going through the financial statements of the firm. This is to safeguard the investment.
f)       Government: Government keeps a close watch on the firms which yield good amount of profits. The state and central Governments are interested in the financial statements to know the earnings for the purpose of taxation.
g)      Consumers: These groups are interested in getting the goods at reduced price. Therefore, they wish to know the establishment of a proper accounting control, which in turn will reduce to cost of production, in turn fewer prices to be paid by the consumers.
h)      Research Scholars: Accounting information, being a mirror of the financial performance of a business organization, is of immense value to the research scholar who wants to make a study into the financial operations of a particular firm.

Functions (Process) of accounting:
a)      Record Keeping Function: The primary function of accounting relates to recording, classification and summary of financial transactions-journalisation, posting, and preparation of final statements. These facilitate to know operating results and financial positions.
b)      Managerial Function: Decision making programme is greatly assisted by accounting. The managerial function and decision making programmes, without accounting, may mislead.
c)       Legal Requirement function: Auditing is compulsory in case of registered firms. Auditing is not possible without accounting. Thus accounting becomes compulsory to comply with legal requirements.
d)      Language of Business: Accounting is the language of business. Various transactions are communicated through accounting. There are many parties-owners, creditors, government, employees etc., who are interested in knowing the results of the firm and this can be communicated only through accounting.

BRANCHES OF ACCOUNTING: The branches of accounting are;
a)      Financial accounting;
b)      Cost accounting; and
c)       Management accounting.
a)      Financial Accounting: It is the original form of accounting. It is mainly concerned with the preparation of financial statements for the use of outsiders like creditors, debenture holders, investors and financial institutions. The financial statements i.e., the profit and loss account and the balance sheet, show them the operating results and financial position of the business.
b)      Cost Accounting: It is that branch of accounting which is concerned with the accumulation and assignment of historical costs to units of product and department, primarily for the purpose of valuation of stock and measurement of profits. Cost accounting seeks to ascertain the cost of unit produced and sold or the services rendered by the business unit with a view to exercising control over these costs to assess profitability and efficiency of the enterprise.
c)       Management Accounting: It is an accounting for the management i.e., accounting which provides necessary information to the management for discharging its functions.

Accounting cycle
The sequence of accounting procedures used to record, classify, and summarize accounting information is often termed the accounting cycle. At this point, we have illustrated a complete accounting cycle as it relates to the preparation of a balance sheet for a service-type business with a manual accounting system. The accounting procedures discussed to this point may be summarized as follows.
a)      Recording transaction in the journal: As each business transaction occurs, it is entered in the journal, thus creating a chronological record of events. This procedure completes the recording step in the accounting cycle.
b)      Post to ledger accounts: The debit and credit changes in account balances are posted from the journal to the ledger. This procedure classifies the effects of the business transactions in terms of specific asset, liability, and owner’s equity.
c)       Prepare a trial balance: A trial balance proves the equality of the debit and credit entries in the ledger. The purpose of this procedure is to verify the accuracy of the posting process and the computation of ledger account balances.
d)      Prepare financial statements: At this point, we have discussed only one financial statement – the balance sheet. This statement shows the financial position of the business at a specific date.
The preparation of financial statements summarizes the effects of business transaction occurring through the date of the statements and completes the accounting cycle.

Qualitative Characteristics of Accounting Information
Qualitative characteristics are the attributes of accounting information which tend to enhance its understandability and usefulness. In order to assess whether accounting information is decision useful, it must possess the characteristics of reliability, relevance, understandability and comparability.
a)      Reliability: Reliability means the users must be able to depend on the information. The reliability of accounting information is determined by the degree of correspondence between what the information conveys about the transactions or events that have occurred, measured and displayed.
b)      Relevance: To be relevant, information must be available in time, must help in prediction and feedback, and must influence the decisions of users by:
(a) Helping them form prediction about the outcomes of past, present or future events; and/or
(b) Confirming or correcting their past evaluations.
c)       Understandability: Understandability means decision-makers must interpret accounting information in the same sense as it is prepared and conveyed to them. Accountants should present the comparable information in the most intelligible manner without sacrificing relevance and reliability.
d)      Comparability: It is not sufficient that the financial information is relevant and reliable at a particular time, in a particular circumstance or for a particular reporting entity. But it is equally important that the users of the general purpose financial reports are able to compare various aspects of an entity over different time period and with other entities. To be comparable, accounting reports must belong to a common period and use common unit of measurement and format of reporting.

Transaction means the exchange of money or money’s worth from one account to another account. Events like purchase and sale of goods, receipt and payment of cash for services or on personal accounts, loss or profit in dealings etc., are the transactions”. It is an economic activity of the business that causes a change in an organization’s financial position or net worth, resulting from normal business activity.
The following are the characteristics of transaction.
a)      There must be two parties in a transaction.
b)      The events must be measurable in terms of money.
c)       The event involves the transfer of property or service.
d)      The event must charge the financial position of a person or an institution.
e)      Change may be qualitative or quantitative.

Types of transaction:
Transactions may be classified on the following basis:
a)      On the basis of payment
b)      On the basis of exchange
c)       On the basis of entity involved

a)      On the basis of mode of payment:
1.       Cash transaction: Cash transactions are those for which cash is paid as received immediately and those for and are classified as receipts or payment.
2.       Credit transaction: A transaction for which payment is not made instantly is reoffered to as credit transaction.
3.       Paper transaction: It is a transaction which is not conducted either in cash or in credit, but has to be recorded on paper or books of account for accounting treatment example - Depreciation, outstanding, expenses etc.

b)      On the basis of exchange:
1.       Exchange transaction: When a transaction involves any exchange of value between two parties is called exchange transaction.
2.       Non-Exchange transaction: When a transaction does not involve any exchange of value between two parties, it is called a non-exchange transaction.

c)       On the basis of entity involved:
1.       External transaction: A transaction which takes place between two different parties is called an external transaction. For example, cash paid to a supplier for supplying goods to business.
2.       Internal transaction: An internal transaction is one that takes place within the business entity itself. For example, charging of depreciation on fixed assets used in the business.

An event is a happening indicating a business transaction requiring a journal entry has occurred. There are occasions which cause changes in the value due to time element such as depreciation, accrued interest etc. Only monetary events are regarded as transactions. So, all transactions are events though all events are not transactions.
Difference between Transactions and events
1.       It is the consequence of exchange.
2.       It can be internal as well as external.
3.       It is an economic activity.
4.       It can involve more than one account.
5.       Both qualitative as well as quantitative changes.
6.       All transactions are events.
1.       It is a consequence of occasion.
2.       It is always internal activity.
3.       It is a historical activity.
4.       Only one party is involved.
5.       It involves only qualitative changes.
6.       All events are not transactions.

Types of accounts
The object of book-keeping is to keep a complete record of all the transactions that place in the business. To achieve this object, business transactions have been classified into three categories:
                (i) Transactions relating to persons.
                (ii) Transactions relating to properties and assets
                (iii) Transactions relating to incomes and expenses.

The accounts falling under the first heading are known as ‘personal Accounts’. The accounts falling under the second heading are known as ‘Real Accounts’, the accounts falling under the third heading are called ‘Nominal Accounts’.

Personal Accounts: Accounts recording transactions with a person or group of persons are known as personal accounts. These accounts are necessary, in particular, to record credit transactions. Personal accounts are of the following types:
                (a) Natural persons: An account recording transactions with an individual human being is termed as a natural persons’ personal account. e.g., Kamal’s account, Mala’s account, Sharma’s accounts. Both males and females are included in it
                (b) Artificial or legal persons: An account recording financial transactions with an artificial person created by law or otherwise is termed as an artificial person, personal account, e.g. Firms’ accounts, limited companies’ accounts, educational institutions’ accounts, Co-operative society account.
                (c) Groups/Representative personal Accounts: An account indirectly representing a person or persons is known as representative personal account. When accounts are of a similar nature and their number is large, it is better to group them under one head and open a representative personal account. e.g., prepaid insurance, outstanding salaries, rent, wages etc.
                                The rule for personal accounts is: Debit the receiver
                                                                                                   Credit the giver

Real Accounts: Accounts relating to properties or assets are known as ‘Real Accounts’, A separate account is maintained for each asset e.g., Cash Machinery, Building, etc., Real accounts can be further classified into tangible and intangible.
                (a) Tangible Real Accounts: These accounts represent assets and properties which can be seen, touched, felt, measured, purchased and sold. E.g. Machinery account Cash account, Furniture account, stock account etc.
                (b) Intangible Real Accounts: These accounts represent assets and properties which cannot be seen, touched or felt but they can be measured in terms of money. e.g., Goodwill accounts, patents account, Trademarks account, Copyrights account, etc.
                                The rule for Real accounts is: Debit what comes in
                                                                                           Credit what goes out
Nominal Accounts: Accounts relating to income, revenue, gain expenses and losses are termed as nominal accounts. These accounts are also known as fictitious accounts as they do not represent any tangible asset. Wages account, Rent account Commission account, Interest received account are some examples of nominal account
                                The rule for Nominal accounts is: Debit all expenses and losses
                                                                             Credit all incomes and gains
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 benefits of a lasting nature. Assets are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets can be broadly classified into three types:
a)      Fixed Assets
b)      Current Assets
c)       Fictitious Assets
a)      Fixed Assets are assets held on a long-term basis, such as land, buildings, machinery, plant, furniture and fixtures. These assets are used for the normal operations of the business. Fixed assets are further classified into two parts
Tangible assets: It refers to those assets which can be touched and seen. For example, vehicle, plant and machinery, equipments, wasting assets like oil well, coal mines etc.
Intangible assets: It refers to those assets which cannot be touched and seen. For example, goodwill, trademark, patents, copyright etc.
b)      Current Assets are assets held on a short-term basis such as debtors (accounts receivable), bills receivable (notes receivable), stock (inventory), temporary marketable securities, cash and bank balances.
c)       Fictitious assets: It refers to those assets which do not have any physical form and realisable value such as preliminary expenses, discount on issue of shares etc.

It means the amount which the firm owes to outsiders except the proprietors. In the words of Finny and Miller, “Liabilities are debts; they are amounts owed to creditors; thus the claims of those who ate not owners are called liabilities”. In simple terms, debts repayable to outsiders by the business are known as liabilities. Liabilities are classified as
a)      long-term liabilities or Fixed liabilities
b)      Short-term liabilities or current liabilities
c)       Contingent liabilities.
a)      Long-term liabilities are those that are usually payable after a period of one year, for example, a term loan from a financial institution or debentures (bonds) issued by a company.
b)      Short-term liabilities are obligations that are payable within a period of one year, for example, creditors, bills payable, bank overdraft.
c)       Contingent Liabilities are those which may or may not become payable in future. For example, financial cases pending, guarantee given, bills discounted from bank etc.

Basic accounting terms:
 Transaction: Transaction means the exchange of money or money’s worth from one account to another account. Events like purchase and sale of goods, receipt and payment of cash for services or on personal accounts, loss or profit in dealings etc., are the transactions”. Transactions are of three types: (a) Cash (b) Credit and (c) non cash transaction.
Cash transaction is one where cash receipt or payment is involved.
 Credit transaction, on the other hand, will not have ‘cash’ either received or paid, but gives rise to debtor and creditor relationship.
 Non-cash transaction is one where the question of receipt or payment of cash does not arise at all, e.g. Depreciation, return of goods etc.

Debtor: A person who owes money to the firm mostly on account of credit sales of goods is called a debtor. For example, 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.
Creditor:  A person to whom money owes by the firm is called creditor. For example, Madan is a creditor of the firm when goods are purchased on credit from him
 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. It is also known as owner’s equity, Proprietor’s claim or net worth. Owner’s equity means owner’s claim against the assets. It will always be equal to assets less liabilities, say: Capital = Assets - Liabilities.

Liability: It means the amount which the firm owes to outsiders except the proprietors. In the words of Finny and Miller, “Liabilities are debts; they are amounts owed to creditors; thus the claims of those who ate not owners are called liabilities”. In simple terms, debts repayable to outsiders by the business are known as liabilities.
Asset: Any physical thing or right owned that has money value is an asset. In other words, an asset is that expenditure which results in acquiring of some property or benefits of a lasting nature.
 Goods: It is a general term used for the articles in which the business deals; that is, only those articles which are bought for resale for profit are known as Goods.
 Revenue: It is defined as the inflow of assets form business operations which result in an increase in the owner’s equity. It includes all incomes like sales receipts, interest, commission, brokerage etc.  However, receipts of capital nature like additional capital, sale of assets etc., are not a part of revenue.
Expense: The terms ‘expense’ refers to the amount incurred in the process of earning revenue. If the benefit of an expenditure is limited to one year, it is treated as an expense (also know is as revenue expenditure) such as payment of salaries and rent.
Expenditure: Expenditure takes place when an asset or service is acquired. The purchase of goods is expenditure, where as cost of goods sold is an expense. Similarly, if an asset is acquired during the year, it is expenditure, if it is consumed during the same year; it is also an expense of the year.
Purchases: Buying of goods by the trader for selling them to his customers is known as purchases. Purchases can be of two types. Viz, cash purchases and credit purchases. If cash is paid immediately for the purchase, it is cash purchases, if the payment is postponed, it is credit purchases.
Sales: When the goods purchased are sold out, it is known as sales. Here, the possession and the ownership right over the goods are transferred to the buyer. It is known as. 'Business Turnover’ or sales proceeds. It can be of two types, viz., cash sales and credit sales. If the sale is for immediate cash payment, it is cash sales. If payment for sales is postponed, it is credit sales.
Stock: The goods purchased are for selling, if the goods are not sold out fully, the remaining unsold part said to be a stock. If there is stock at the end of the accounting year, it is said to be a closing stock. This closing stock at the end of the year will be the opening stock for the next year.
Drawings:  It is the amount of money or the value of goods which the proprietor takes for his domestic or personal use. It is usually subtracted from capital.
Losses: Loss really means something against which the firm receives no benefit. It represents money given up without any return. It may be noted that expense leads to revenue but losses do not. (e.g.) loss due to fire, theft and damages payable to others,
Account: It is a statement of the various dealings which occur between a customer and the firm. It can also be expressed as a clear and concise record of the transaction relating to a person or a firm or a property (or assets) or a liability or an expense or an income.
Invoice: While making a sale, the seller prepares a statement giving the particulars such as the quantity, price per unit, the total amount payable, any deductions made and shows the net amount payable by the buyer. Such a statement is called an invoice.
Voucher: A voucher is a written document in support of a transaction. It is a proof that a particular transaction has taken place for the value stated in the voucher. Voucher is necessary to audit the accounts.
Proprietor: The person who makes the investment and bears all the risks connected with the business is known as proprietor.
Discount: When customers are allowed any type of deduction in the prices of goods by the businessman that is called discount. When some discount is allowed in prices of goods on the basis of sales of the items, that is termed as trade discount, but when debtors are allowed some discount in prices of the goods for quick payment, that is termed as cash discount.
Solvent: A person who has assets with realizable values which exceeds his liabilities is insolvent.
Insolvent: A person whose liabilities are more than the realizable values of his assets is called an insolvent.