DEFINITION OF ACCOUNTING
“ Accounting is an art of recording, classifying, summarizing, analyzing and interpretation of financial or economics information to permits judgement to various uses.”
In the above definition
Recording means record the transaction. Recording refers to Journal.
Classifying refers to Ledger.
Summarizing refers to Trial Balance.
Analyzing and interpretation refers to comparison of various items given in the Financial Statements.
Financial Statements refer to Income Statement and Balance Sheet.
JOURNAL
It is a book of original entry to record in order of date and indetail the various transactions of a trader. It is also known as “ Day Book”.
LEDGER
It is the book, which contains classified record of all transactions, generally transfer from book original entry. It is also known as book of second entry.
TRIAL BALANCE
A statement, which is prepared by taking out debit and credit balance of all, accounts appearing in the Ledger.
INCOME STATEMENT
A statement, which is prepared to determine the net result (Profit or Loss) of business, is called Income Statement.
BALANCE SHEET
A statement, which is prepared to show the financial position of the business at the end of trading period, is called Balance Sheet.
BASIC TERMINOLOGY
TRANSACTION
Any dealing, buying and selling between two persons and business enterpriser is called transaction. There are two types of transaction.
• Cash Transaction
When cash is paid or received as a result of exchange, called cash transactions.
• Credit transaction
When the payment or receipt of cash is postponed for future date, called credit transaction.
BUSINESS
Any activity undertaken for the purpose of earning profit such as buying and selling of merchandise/goods called merchandise concern, rendering services called service concern.
MERCHANDISE / GOODS
Things bought by a firm for the purpose of reselling are called merchandise. For example, bookseller sells the books, a textile mill produces cloth, the books and cloths are merchandise.
PURCHASES
The cost of merchandise/goods bought is called purchases. Purchases may be of two types.
• Cash Purchases
When the goods/merchandise are purchased for cash, it is called cash purchases.
• Credit Purchases
When the goods/merchandise are bought on credit it is called credit purchases.
PURCHASE RETURNS AND ALLOWANCE
If the goods are not according to sample, and return to supplier is known as purchase return, or if the purchaser informs the supplier about the defect and not according to sample and the supplier agreed to reduce the price of such goods are called as purchases allowances.
SALES
When the goods/merchandise are sold out, they are called sales. Sales may be two types.
• Cash Sales
When merchandise/goods are sold at cash, it is called cash sales.
• Credit Sales
When merchandise/goods are sold at credit, it is called credit sales.
SALES RETURN AND ALLOWANCE
If the goods return back by purchaser to the seller. It is called sales returns, or if the seller gets the information about defect, damage supply etc and the seller agrees to allow some rebate in price of the merchandise it is called as sale allowance.
DISCOUNT
It is a deduction, reduction, grant or an allowance from the price of goods or any other asset purchased, sold or from the amount payable or receivable. Discount may be two types.
1. Trade Discount. 2. Cash Discount.
TRADE DISCOUNT
This is an allowance or deduction made from the list price of a merchandise / asset at the time when it is being purchased or sold.
The trade discount, being the deduction from the original cost, is deducted from the list price of the asset / merchandise, before the cost is entered into the books. No entry is passed for trade discount.
Trade Discount = list-price * % / 100
Example
500*10/100 = 50
500-50 = 450
450 amount will be recorded in the account.
CASH DISCOUNT
When a person pays his debt before date, the receiver of cash may allow him certain amount as concession for prompt payment. This deduction is called as cash discount. This discount will in the form of percentage (e.g. 2%), or in the form of net amount (e.g. 200).
There is two type of cash discount.
1. Discount Allowed
2. Discount Received
DISCOUNT ALLOWED
When discount is granted / gave to other, it is called discount allowed. This knew as expense.
DISCOUNT RECEIVED
When discount is earned, it is called discount received. This knew as income.
NOTE
Discount in the form of: -
2 / 10 – n / 30
Where
2 means 2 percent discount
10 means, when payment in 10-days then 2 percent discount will gain.
N/30 means, payment will due in the 30- days. And no discount will gain.
POSTING
The classified information recorded in the form of debit and credit in journal are transferred into ledger account. It is called ledger.
VOUCHER
Documentary evidence of business transaction is called voucher. It can be cash memo, bill invoice, etc.
ASSETS
The things and properties possessed by the business are called assets, such as Cash, Account Receivable, Furniture, Supplies, Equipment, Building, Machinery etc.
OFFICE SUPPLIES
Office supplies means various articles bought for consumption in office like letterheads, envelops, pencils, carbon papers, typewriters ribbon, paper pins, etc. etc.
ACCOUNT RECEIVABLE
When we sell merchandise or any other asset with a promise to receive money at some future date, it is called as credit sale. All the persons whom credit sale is made are collectively known as Debtors or Account Receivable.
NOTES RECEIVABLE
When we sell some goods or asset with promise notes to receive the money at future date called Notes Receivable.
MERCHANDISE INVENTORY
The merchandise, which are not used and remained unsold, is called merchandise inventory.
LIABILITIES
They are the debts due by a business to its proprietor and others are called liabilities. Or it is claim of the outsiders against the assets of business.
ACCOUNT PAYABLE
These are the claim of the outsiders for services or merchandise received or any other asset purchased on credit. This is called Account Payable.
NOTES PAYABLE
When we purchase some goods, asset with promise notes to pay at future date called Notes Payable.
OWNER EQUITY
It is the capital invested by the owner of the business. This is an important financial right of the owner in the assets of the business. This right of the owner is called owner equity.
DRAWINGS
The Owner withdraws the cash or commodities for his personal use from business is known as drawings.
EXPENSES
To achieve the objective of business certain payments are created. These payments are expenses of business. For example, salary expense rent expense, wages expense, electricity charges, telephone bills etc.
REVENUES
All sorts of income receive or outstanding is called revenues. These revenues may be earned from sales of merchandise or by rending services for the customers.
ACCOUNTING CYCLE
All the process of recording business transaction from Journal to Balance Sheet is known as accounting cycle.
The accounting cycle is as under
Transaction
Financial statements Journal
Income statement
& Balance Sheet
Trial Balance Ledger
BASIC ELEMENT OF ACCOUNTING
ASSETS
The things and properties possessed by the business are called assets, such as Cash, Account Receivable, Furniture, Supplies, Equipment, Building, Machinery etc.
Assets can be subdivided into following groups:
• Current Assets
Which are either cash or easily convertible into cash. For example, cash in hand; cash at Bank, Account Receivable, Notes Receivable, Merchandise etc.
• Non-Current Assets
These are assets that are acquired with a view to hold them and earn income other than business income. For example, investments, shares of other companies, Government Securities etc.
• Fixed/Plant Assets
These assets are acquired to retain and use in business operation, e.g. land, Building, Machinery and Plant, Motor Vehicles, etc.
• Intangible Assets
These assets though not physically touchable but still valuable for business enterprise, e.g., goodwill etc.
LIABILITIES
They are the debts due by a business to its proprietor and others are called liabilities. Or it is the claims of the outsiders against the assets of the business. It may be of the following type: -
• Short Term Liabilities
The liabilities which are payable in near future date (with in one year) are called short-term liabilities.
E.g. A/C Payable, Notes Payable etc.
• Long Term Liabilities
These are the loans, which are raised for permanent finance of the business. These are payable after number of years. E.g. bank loans etc.
OWNER EQUITY
It is the capital invested by the owner of the business. This is an important financial right of the owner in the assets of the business. This right of the owner is called owner equity.
EXPENSES
To achieve the objective of business certain payments are created. These payments are expenses of business. For example, salary expense rent expense, wages expense, electricity charges, telephone bills etc.
REVENUES
All sorts of income receive or outstanding is called revenues. These revenues may be earned from sales of merchandise or by rending services for the customers.
ACCOUNTING AND BOOK-KEEPING
ACCOUNTING
Accounting is concerned with the design of the system of records, policy making, data analysis, preparation of report and interpretation.
BOOK-KEEPING
There is two system of bookkeeping.
“Single entry System”
It is an incomplete record of the business transaction. There is no definite method and principles of this system. The small traders use this system.
“Double entry System”
As there are two aspects in every transaction. So if we record both the aspect of a transaction, it is called double entry system.
Advantages of double entry system
• This system provides complete record.
• This system provides up to date information.
• It is a complete record of all business transaction.
• The financial position of the business can be ascertained.
• This system provides an opportunity for analysis of the accounting record.
NATURE OF ACCOUNTING
Accounting plays an important role in our economics and social system. It is concerned with the process of recording, sorting, classifying and summarizing data related to business transactions. Accounting is also concerned with the preparation of reports analysis and interpretation of the recorded data.
OBJECTIVE OF ACCOUNTING
• The purpose of accounting to organize the financial details of a business.
• To identify the financial transaction.
• To organize the financial data into useful information.
• To measure the value of these information in term of money.
• To analyze, interpret and communicate the information to persons or groups both inside and outside the business.
FIELDS OF ACCOUNTING
Some special fields of accounting are as under: -
1. Financial Accounting
It is concerned with general Accounting System. In this field we record the business transaction and prepare various periodic reports from such records. These reports provide useful information for owner, manger, creditor, government agencies and general public.
2. Cost Accounting
This field of accounting is concerned with the determination and controls the cost of production and distribution, i.e. the cost of manufacturing process and of manufactured products.
3. Management Accounting
This field of accounting mainly concerns with the selection of best among various alternations. It uses all the techniques of historical, estimate and actual data as device toward positive change.
4. Auditing
It is the examination of accounting record. The purpose of examination is to check the fairness and accuracy, its reconciliation with prescribed policies and procedure.
ACCOUNT
It a device, which contains a systematic record of, increase or decrease in an item during a particular period.
CLASSIFICATION OF ACCOUNTS
Real accounts
These are the accounts of assets, liabilities and owner equity. As these accounts have their existence even after the close of a year. They are classed as real accounts. Those are also called as balance sheet accounts as they are recorded in balance sheet prepared at the end of period.
Nominal accounts
These are the accounts of expenses and revenue. At the end of accounting year. These accounts are closed to expenses and income summary. All the nominal accounts are either incomes or expenses.
USER / CONSUMER OF ACCOUNTING
Owner
The owner of the business wants to know the financial status of the business and income earned or suffered loss.
Managerial Personnel
The manager of the business needs the information for decision-making techniques.
Employees
These are also interested in the stability of the business.
Government Agencies
These are also keenly interested in incomes and other business activities.
Others
For example, customer and client, labor, unions, trade, association and journalists etc are also interested with the business world.
RULES FOR DEBIT AND CREDIT
The rules of debit and credit in relation to the kinds of accounts are started as under.
1. For Assets Accounts
Increase in assets is recorded as debit.
Decrease in assets is recorded as credit.
2. For Expenses Accounts
Increase in an expense is recorded as debit.
Decrease in an expense is recorded as credit.
3. For Liabilities Accounts
Increase in liabilities is recorded as credit.
Decrease in liabilities is recorded as debit.
4. For Revenue Accounts
Increase in revenues is recorded as credit.
Decrease in revenues is recorded as debit.
5. For Capital Accounts
Increase in capital is recorded as credit.
Decrease in capital is recorded as debit.
