Saturday, January 14, 2012

Bank Reconciliation Statement

Definition and Explanation:

From time to time the balance shown by the bank and cash column of the cash book required to be checked. The balance shown by the cash column of the cash book must agree with amount of cash in hand on that date. Thus reconciliation of the cash column is simple matter. If it does not agree it means that either some cash transactions have been omitted from the cash book or an amount of cash has been stolen or lost. The reason for the difference is ascertained and cash book can be corrected. So for as bank balance is concerned, its reconciliation is not so simple. The balance shown by the bank column of the cash book should always agree with the balance shown by the bank statement, because the bank statement is a copy of the customer's account in the banks ledger. But the bank balance as shown by the cash book and bank balance as shown by the bank statement seldom agree. Periodically, therefore, a statement is prepared called bank reconciliation statement to find out the reasons for disagreement between the bank statement balance and the cash book balance of the bank, and to test whether the apparently conflicting balance do really agree.


Causes of Disagreement Between Bank statement and Cash book:


Usually the reasons for the disagreement are:
1.
That the banker might have allowed interest which have not yet been entered in the cash book.
2.
That the banker might have debited the account for any such item as interest on overdraft, commission for collecting cheque, incidental charges etc., which we have not entered in the cash book.
3.
That some of the cheque which we drew and for which we credited to bank account prior to the date of closing, were not presented at the bank and therefore, not debited in the bank statement.
4.
That some cheques or drafts which the organisation have paid into bank for collection and for which debited the bank account, were not realised within the due date of closing and therefore, not credited by the bank.
5.
The banker might have credited the account with amount of a bill of exchange or any other direct payment into bank and the same may not have been entered in the cash book.
6.
That cheques dishonoured might have been debited inthe bank statement but have not been given effect to in to the books.

Cash Book

Cash book is a book of original entry in which transactions relating only to cash receipts and payments are recorded in detail. When cash is received it is entered on the debit or left hand side. Similarly, when cash is paid out the same is recorded on the credit or right hand side of the cash book.
The cash book, though it serves the purpose of a cash book of original entry viz., cash journal really it represents the cash account of the ledger separately bound for the sake of convenience. It is more a ledger than a journal. It is journal as cash transactions are chronologically recorded in it. It is a ledger as it contains a classified record of all cash transactions. The balances of the cash book are recorded in the trial balance and the balance sheet.

Vouchers:
For Every entry made in the cash book there must be a proper voucher. Vouchers are documents containing evidence of payment and receipts. When money is received generally a printed receipt is issued to the payer but counterfoil or the carbon copy of it is preserved by the cashier. The copy receipts are called debit vouchers, and they support the entries appearing on the debit side of the cash book. Similarly when payment is made a receipt is obtained from the payee. These receipts are known as credit vouchers. All the debit and credit vouchers are consecutively numbered. For ready reference the number of the vouchers are noted against the respective entries. A column is provided on either side of the cash book for this purpose.
Balancing Cash Book:

The cash book is balanced at the end of a given period by inserting the excess of the debit on the credit side as "by balance carried down" to make both sides agree. The balance is then shown on the debit side by "To balance brought down" to start the next period. As one cannot pay more than what he actually receives, the cash book recording cash only can never show a credit balance.
Types of Cash book:

1. Single column cash book – It is prepared by those companies whose all receipts and payments are made in cash only. In it receipts are shown on the left side while payments are shown on the right side of the cash book.
2. Double column cash book – This contain an additional column of bank account for recording those transaction which are affected through bank. In this there will be contra entries that are transfer of money from company to bank and from bank to company for official purpose and therefore these entries are posted on both side.
3. Petty cash book– This is used for the purpose of recording cash transactions which are small in value and of repetitive nature like conveyance, stationary etc…..This book is maintained so that huge number of transaction which are of small value can be recorded in it and therefore less pressure on person maintaining books.

Subsidiary Books

Though the principle of journalising all transactions, known as continental system of bookkeeping is quite perfect in actual business but in a large business it is found inconvenient to Journalise every transaction and sometime it becomes rather impossible for one man to Journalise numerous transactions on a business in one journal. Therefore, the journal is sub-divided into different journals knownas the subsidiary books or books of prime entry or books of original entry . These are the books in which are recorded the details of transactions as they take place from day to day, in a classified manner.
In every trading concern, the transactions, however numerous they may be, can be grouped into small number of classes. They consist chiefly of receipts and payments of cash, purchases and sales of goods, returns of goods purchased and sold, bills receivable and bills payable. The journal is divided in such a way that a separate book is used for each class of transactions.
The important subsidiary books used in modern business world are the following:-
1.
Cash Book:
It is used to record all cash receipts and payments.
2.
Purchases Book:
It is used to record all credit purchases.
3.
Sales Book:
It is used to record all credit sales
4.
Purchases returns book:
It is used to record all goods returned by business to its suppliers.
5.
Sales Returns Book:
It is used to record all goods returned to business by its customers.
6.
Bills Receivable Book:
It is used to record all accepted bills received by business.
7.
Bills payable Book: It is used to record all bill accepted by business to its creditors.
8.
Journal Proper:
It is used for recording those transactions for which there is no separate book.
All these subsidiary books are called books of original entry , as transactions in their original form are entered therein.

Advantages of Different Journals:
The advantages of having several books of original entry in place of one journal may be stated to as follows:
1.
It may be impossible to record each transaction into the ledger as it occurs. Subsidiary books record the details of the transactions and therefore, helps the ledger to become brief.
2.
As similar transactions are recorded together in the same book, future reference to any of them becomes easy.
3.
The chance of fraudulent alteration in an account is reduced as the book of original entry keeps records of the transactions in a chronological order.
4.
The work of posting can been trusted to several clerks at the same time and thus the ledger of a large business can be written up much more quickly.
5.
As each journal contains separately transactions of similar nature any desired analysis can be made conveniently.

Trial Balance

Definition and Explanation:
Trial balance may be defined as an informal accounting schedule or statement that lists the ledger account balances at a point in time compares the total of debit balance with the total of credit balance.
The fundamental principle of double entry system is that at any stage, the total of debits must be equal to the total of credits. If entries are recorded and posted correctly, the ledger will reflect equal debits and credits, and the total credit balance will then be equal tothe total debit balances.
Every business concern prepares final accounts at the end of the year to ascertain the result of the activities of the whole year.To ensure correct result, the concern must be free from doubt that the books of accounts have been correctly recorded throughout the year. Trial balance is prepared to test the arithmetical accuracy of the books of accounts. As we know that under double entry system for each and every transaction one account is debited and other account is credited with an equal amount. If all the transactions are correctly recorded strictly according to this rule, the total amount of debit side ofall the ledger accounts mustbe equal to that of credit side of all the ledger accounts. This verification is done through trial balance.
If the trial balance agrees we may reasonably assume that the books are correct. On the other hand, if it does not agree, it indicates that the books are not correct - there are mistakes somewhere. The mistakes are to be detected and corrected otherwise correct result cannot be ascertained. There are however, a few types of errors which the trial balance cannot detect. In other words, the trial balance will agree inspite of the existence of those errors.
The trial balance is not an absolute or solid proof of the accuracy of books of accounts. Thus if trial balance agrees, there may be errors or may not be errors. But if it does not agree, certainly there are errors.

Purposes of Trial Balance:

The trial balance serves two main purposes. These are as under:
1.
To check the equality of debits and credits - an arithmetical or mathematical test of accuracy.
2.
To provide information for use in preparing final accounts.
Methods of Preparing Trial Balance:
There are three methods for the preparation of trial balance. These methods are:
1.
Total or gross trial balance
2.
Balance or net trial balance
3.
Total - cum - balance trialbalance
The method 1 and 2 are described below:

Total or Gross Trial Balance:
Under this method the two sides of all the ledger accounts are totaled up. Thereafter, a list of all the accounts is prepared in a separate sheet of paper with two "amount" columns on the right hand side. The first one for debit amounts and the second one for credit amounts. The total of debit side and credit side of each account is then placed on "debit amount" column and "credit amount" column respectively of the list. Finally the two columns are added separately to see whether they agree of not. This method is generally not followed in practice.
Balance or Net Trial Balance:
Under this method, first of all the balances of all ledger accounts are drawn. Thereafter, the debit balances and credit balances are recorded in "debit amount" and "credit amount" column respectively and the two columns are added separately to see whether they agree or not. This is the most popular method and generally followed.
The various Steps involved in the preparation of Trial Balance under this method are given below:
1.
Find out the balance of each account in the ledger.
2.
Write up the name of account in the first column.
3.
Record the account number in second column.
4.
Record the debit balance of each account in debit column and credit balance in credit column.
5.
Add up the debit and credit column and record the totals.

Ledger- Procedure for Posting

Transferring information i.e. entries from journal to ledger accounts is called posting. The procedure of posting from journal to ledger is as follows:
1.
Locate the ledger account from the first debit in the journal entry.
2.
Record the date in the date column on the debit side of the account. The date is the date of transaction rather than the date of the posting.
3.
Record the name of the opposite account (account credited in entry) in the particular (also know as reference column, description column etc) column.
4.
Record the page number of the journal in the journal reference (J.R) column from where the entry is being posted.
5.
Record the amount of the debit in the "amount column"
6.
Locate the ledger account for the first credit in the journal and follow the same procedure.

Balancing An Account:
The difference between the two sides of an account is its balance. The balance is written on the lesser side to make the two sides equal. The process of equalizing the two sides of an account is known as balancing.

Ledger- Introduction

The journal provides a complete listing of the daily transactions of a business. But it does not provide information about a specific account in one place. For example, to know how much cash balance we have, the accounting clerk would have to check all the journal entries in which cash is involved, and this is very laborious job; because there are hundreds or even thousands of cash transactions recorded on different pages of journal. To avoid this difficulty, the debit and credit of journalized transactions are transferred to ledger accounts. Thus all the changes for a single account are located in one place - in a ledger account. This makes it easy to determine the current balance of any account.
Definition and Explanation of Ledger:

The book in which accounts are maintained is called ledger . Generally, one account is opened on each page of this book, but if transactions relating to a particular account are numerous, it may extend to more than one page. All transactions relating to that account are recorded chronologically. From journal each transaction is posted to at least two concerned accounts - debit side of one account and credit side of another account. Remember that, if there are two accounts involved in a journal entry, it will be posted to two accounts in the ledger and if the journal entry consists of three accounts (compound entry) it will be posted to three different accounts in the ledger. The process of transferring information from journal to ledger accounts is known as posting. The goal of all transactions is ledger. Ledger is known as the destination of entries in journal but it must be remembered that transactions cannot be recorded directly in the ledger - they must be routed through journal. This concept is illustrated below:
1. Transaction

2. Journal

3. Ledger
So, the books in which all the transactions of a business concern are finally recorded in the concerned accounts in a summarized form is called ledger.
Characteristics of Ledger Account:
The ledger has the following main characteristics:
1.
It has two identical sides - left hand side (debit side) and right hand side (credit side).
2.
Debit aspect of all the transactions are recorded on the debit side and credit aspects of all the transactions are recorded on credit side according to date.
3.
The difference of the totals of the two sides represents balance. The excess of debit side over credit side indicates debit balance, while excess of credit side over debit side indicates the credit balance. If the two sides are equal, there will be no balance.
4.
Generally the balance is drawn at the year end and recorded on the lesser side to make the two sides equal. This balance is know as closing balance .
5.
The closing balance of thecurrent year becomes the opening balance of the next year.

Journal- Journalising and Rules of journalising

Journalising and rules of journalising: Journalising Journalising is a systematic process of recording financial transaction. Such recording are made in terms of debit and credit. In it, financial transactions are recorded in the original book. Rules of journalising: Every financial transaction of a business organization has dual effect.It means that every financial transaction of a business involves at least two accounts. One account is debited and the other account is credited. Before journalising a transaction, following three steps must be borne in mind. 1. Firstly, we need to find outthe two aspects or two fold effects of a transaction. 2. Secondly, we need to identify the accounts whether they are personal, real or nominal accounts. 3. Finally, we need to use the rules of debit and credit. whether it may be traditional approach rules or modern approach rules.

Journal- Introduction

According to double entry system of bookkeeping , transactions are recorded in the books of accounts in two stages:
First stage -
Journal
Second stage -
Ledger
The flow of accounting information from the time a transaction takes place to its recording in the ledger may be illustrated as follows:
1. Business Transaction
2.Business Document Prepared
3.Entry Recorded in Journal
4.Entry Posted to Ledger.
The initial record of each transaction is evidenced by a business document such as invoice, cash, voucher etc. Transactions are first recorded in journal and there after posted to two or three concerned accounts in the ledger.
Definition and Explanation of Journal :

The word journal has been derived from the French word "Jour" Jour means day. So, journal means daily. Transactions are recorded daily in journal and hence it has named so. As soon as a transaction takes place its debit and credit aspects are analyzed and first of all recorded chronologically (in the orderof their occurrence) in a book together with its short description. This book is known as journal. Thus we see that the most important function of journal is to show the relationship between the two accounts connected with a transaction. This facilitates writing of ledger. Since transactions are first of all recorded in journal, so it is called book of original entry or prime entry or primary entry or preliminary entry, or first entry.
Entry:
Recording a transaction in the appropriate place of the concerned book of account is called entry. Entry may be of the following two types:
Journal Entry:
Recording a transaction in a journal is called journal entry or journalizing .
Ledger Entry:
Recording a transaction from journal to the concerned account in the ledger is called ledger entry.
It is also known as ledger posting .
Narration:
A short explanation of eachtransaction is written under each entry which is called narration. The subject matter of the transaction can be ascertained through narration. Besides this, if there be any mistake in determining debit or credit aspect of a transaction, it can be easily detected from narration.
"A journal entry is not complete without narration".
Characteristics:

Journal has the following features:
1.
Journal is the first successful step of the double entry system. A transaction is recorded first of all in the journal. So, journal is called the book of original entry .
2.
A transaction is recorded on the same day it takes place. So, journal is also called a day book .
3.
Transactions are recorded chronologically. So, journal is called chronological book.
4.
For each transaction the names of the two concerned accounts indicating which is debited and which is credited, are clearly written into consecutive lines. This makes ledger - posting easy. That is why journal is called "assistant to ledger" or "subsidiarybook" .
5.
Narration is written beloweach entry.
6.
The amount is written in the last two columns - debit amount in debit column and credit amount in credit column.
Advantages of Journal:

The following are the advantages of journal:
1.
Each transaction is recorded as soon as it takes place. So there is no possibility of any transaction being omitted from the books of account.
2.
Since the transactions arekept recorded in journal chronologically with narration, it can be easily ascertained when and why a transaction has taken place.
3.
For each and every transaction which of the two concerned accounts will be debited and which account credited, are clearly written in journal. So, there is no possibility of committing any mistake in writing the ledger.
4.
Since all the details of transactions are recorded in journal, it is not necessary to repeat them in ledger. As a result ledger is kept tidy and brief.
5.
Journal shows the complete story of a transaction in one entry.
6.
Any mistake in ledger can be easily detected with the help of journal.

Friday, January 13, 2012

Rules of Debits and Credits

Rules of Debit and Credit When Accounts are Classified According to Traditional Classification of Accounts: Debit and credit are simply additions to or subtraction from an account. In accounting, debit refers to the left hand side of any account and credit refers to the right hand side. Asset, expenses and losses accounts normally have debit balances; liability, income and capital accounts normally have credit balances. The term debit is derived from the latin base debere (to owe) which contracts to the "Dr" used in journal entries to refer to debits. Credit comes from the word credere (that which one believes in, including persons, like a creditor), which contracts to the "Cr." used in journal entries for a credit. Personal Accounts: Debit the account of the person who receives something and credit the account of the person who gives something. Real Accounts: Debit the account of the asset/property which comes into the business or addition to an asset, and credit the account which goes out of the business. When furniture is purchased for cash, furniture account is debited (which comes into the business) and cash accountis credited (which goes out of the business). Nominal Accounts: Debit the accounts of expenses and losses, and credit the accounts of incomes and gains. When wages are paid, wages account is debited (expense) and cash accountis credited (asset goes out). Valuation Account: Debit the account when the account is to be reduced and credit the account when the account is to be increased. Rules of Debit and Credit When Accounts are Classified According to Modern Classification of Accounts: 1. Assets account: Debit Increases Credit Decreases 2. Liabilities account: Debit Decreases Credit Increases 3. Capital account: Debit Decreases Credit Increases 4. Revenue account: Debit Decreases Credit Increases 5. Expenditure account: Debit Increases Credit Decreases.

Classification of Accounts

We can classify accounts in two different ways. These are: 1. Traditional classification of accounts 2. Modern classification of accounts Traditional Classification of Accounts: This is very old method of classifying accounts and is not used in most of the advanced countries. Under this method, accounts are classified into four types. These are: 1. Personal accounts 2. Real accounts 3. Nominal accounts 4. Valuation accounts These four types of accounts are briefly explained below: Personal Accounts: These accounts show the transactions with the customers, suppliers, money lenders, the bank and the owner. A business may have many credit transactions with the above persons or organizations. A separate account is to be prepared for each of them. Persons or organizations with whom the business has credit transactions are either debtors or creditors. If they have to give some money to the firm, they are called debtors. Conversely, if the firm is to pay them some money they are known as creditors. The main purpose of preparing personal accounts is to ascertain the balances due to or due from persons or organizations. Real Accounts: These accounts are accounts of assets and properties such as land, building, plant, machinery, patent, cash, investment, inventory, etc. When a machinery is purchased for cash, the two accounts involved are machinery and cash - both are real accounts. But if the same machine is purchased from Z & Co. on credit, the two accounts involved will be those of machinery and Z &Co., the former being a real account and the later being a personal account. Nominal Accounts: These are the accounts of incomes, expenses, gains and losses. Examples of nominal accounts are wagespaid, discount allowed or received, purchases, sales,etc. These accounts generally accumulate the data required for the preparation of income statement or trading and profit and loss account. Valuation Accounts: These are the accounts of provision for depreciation and provision for doubtful debts. Where fixed assets are maintained in the books of accounts at original cost,to reflect the actual book value of the assets, a provision for depreciation account on the credit is maintained. In the balance sheet, it is shown as deduction from the original cost of the asset. Similarly, if the debtors' personal accounts are retained at total amount due, a valuation account on the credit - provision for doubtful debts is required. In the balance sheet, it is shown as a reduction from sundry debtors account to reflect estimated realizable value. Example: Classify the following into real, nominal, personal and valuation accounts: 1. Plant and machinery 2. Purchases 3. Investment 4. Bank 5. Provision for bad and doubtful debt 6. Tata Iron & steel Co. 7. Rent 8. Land and Building 9. Carriage outward 10. Capital 11. Leasehold 12. Trademark 13. Return outwards 14. Import duty 15. Provision for depreciation Solution: 1. Real account 2. Nominal account 3. Real account 4. Personal account 5. Valuation account 6. Personal account 7. Nominal account 8. Real account 9. Nominal account 10. Personal account 11. Real account 12. Real account 13. Nominal account 14. Nominal account 15. Valuation account Modern Classification of Accounts: According to Modern approach Accounts are classified into five groups: 1. Asset Account 2. Expense Account 3. Revenue Account 4. Liability Account 5. Capital Account.

What is Account?

Numerous transactions takeplace in business concerns every day. For example, goods are sold to various customers every day, purchases are made from suppliers, cash is paid to creditors and is received from debtors, expenses are paid etc. All these transactions should be properly analyzed and recorded. Again, the concept of double change in a business transaction is important to keep in mind. To record these changes different accounts are maintained in the ledger. Definition and Explanation of Account: Account is the individual record of an asset, a liability, a revenue, an expense or capital, in a summarized manner. For example, the individual record of sales is 'sales account'. In the same way there are so many accounts which are opened in the ledger like salary account, machinery account, furniture account etc. How many accounts there should be in the ledger of a business? It depends upon the nature and size of the business. Generally one full page is fixed in the ledger for each account. But it depends, how many times the changes take place in that particular account. Some accounts are very busy accounts like cash account, bank account and sales account. Obviously for such accounts one page for each will not be enough and so, they need more pages in the ledger to be fixed. In some accounts, changes take place only once or twice in a year, so only one page will be enough. e.g. machinery account, capital account, loan account etc. There are two types of changes that may take place in an account, e.g. either there will be increase or there will be decrease. Take the example of cash (an asset), either there is inflow of cash or there is outflow of cash. To record these two types of changes, every account (a page) is divided in two sides. Increase is recorded on one side and decrease is recorded on the other side. When a change takes place in an account, either it will be recorded on the left side(debit side) or on the right side (credit side). Amounts recorded on the left side of an account, regardless of the account title, are called debits, and the account is said to be debited. Amounts recorded on the right side of an account are called credits, and the account is said to be credited. Now keeping in mind the concept of double change in every business transactions, we can say that every business transaction affects a minimum of two accounts and every change(in a particular transaction) is recorded in a separate account.

Single Entry System

Definition and Explanation: From the very name of the system it apparently seems that a system in which only one aspect of the transaction is recorded, is called single entry system . But in fact it is not so. This system does not observe any systematic rule. Under single entry system, some transactions are recorded on both the sides like double entry system , some are recorded on one side only, while some others are not recorded. According to Arthur Fieldhouse, "single entry is faulty, incomplete, inaccurate, unscientific and unsystematic style of account keeping". For this reason many persons call the single entry system as accounting from incomplete records. Single entry system is a misnomer. So it is very difficult to give a proper definition of the system. On the whole, "single entry is that which which is not double entry". It can be said that this system is nothing but a mixture of double entry, single entry and no entry.

Double Entry System

Definition and Explanation of Double Entry System: Every business transaction causes at least two changes in the financial position of a business concern at the same time - hence, both the changes must be recorded in the books of accounts. Otherwise, the books of accounts will remain incomplete and the result ascertained therefore will be inaccurate. For example, we buy machinery for Rs100,000. Obviously, it is a business transaction. It has brought two changes - machinery increases by Rs100,000 and cash decreases by an equal amount. While recording this transaction in the books of accounts, both the changes must be recorded. In accounting language these two changes are termed as "a debit change" and "a credit change" The detail about these terms is given under the topic account . Thus we see that for every transaction there will be two entries - one debit entry and another credit entry. For each debit there will be a corresponding credit entry of an equal amount. Conversely, for every credit entry there will be a corresponding debit entry of an equal amount. So, the system under which both the changes in a transaction are recorded together - one change is debited, while the other change is credited with an equal amount - is known as double entry system . Locus Pacioli, an Italian wrote a first book on double entry system in 1494. It is regarded as the best and the only scientific method of accounting system universally accepted throughout the world. It has been built on well defined rules and principles which is the foundation of modern accountancy. The fundamental principle of double entry system lies in analyzing the two changes (parties) involved in business transactions and properly recording of both the changes in the books of accounts. There isno exception to this principle. If a complete picture of the transactions is to be reflected through books of accounts, the double entry system must be duly observed. Otherwise the books of accounts will fail to provided complete information and the very objective of accounting will be defeated. Successive Processes of the Double Entry System: Following are the successive processes of the double entry system: Journal: First of all, transactions are recorded in a book known as journal. Ledger: In the second process, the transactions are classified in a suitable manner and recorded in another book known as ledger. Trial Balance: In the third process, the arithmetical accuracy of the books of account is tested by means of trial balance. Final Accounts: In the fourth and final process the result of the full year's working is determined through final accounts. Advantages: Double entry system is acknowledged as the best method of accounting in the modern world. Following are the main advantages of double entry system : 1. Under this method both the aspects of each and every transaction are recorded. So it is possible to keep complete account. 2. Since both the aspects of a transaction are recorded, for each debit there must be a corresponding credit of an equal amount. Therefore, total debits must be equal to total credits. In fact, it is possible to verify the arithmetical accuracy of the books of accounts by ascertaining whether the two sides become equal or not through a process known as trial balance . 3. Under this system profit and loss account can be prepared easily by taking together all the accounts relating to income or revenue and expenses or losses and thereby the result of the business can be ascertained. 4. A balance sheet can be prepared by taking together all the accounts relating to assets and liabilities and thereby the financial position of the business can be assessed. 5. Under this system mistakes and deflections can be detected - this exerts a moral pressure on the accountant and his staff. 6. Under this system necessary statistics are easily available so that the management can take appropriate decision and run the business efficiently. Disadvantages: Despite so may advantagesof the system, double entrysystem has some disadvantages which are as follows: 1. Under this method each transaction is recorded in books in two stages (journal and ledger) and two sides (debit and credit). This results in increase of number and size of books of account and creation of complications. 2. It involves time, labor and money. So it is not possible for small concerns to keep accounts under this system. 3. It requires expert knowledge to keep accounts under this system. 4. As the system is complex,there is greater possibility of committing errors and mistakes. It is clear from the above discussion that the advantages of double entry system far outweigh its disadvantages. So, it is regarded as the best system in the modern world.

Sunday, January 8, 2012

Accounting Equation

The equation that is the foundation of double entry accounting.The accounting equation displays that all assets are either financed by borrowing money or paying with the money of the company’s shareholders. Thus, the accounting equation is: Assets = Liabilities + Shareholder Equity. The balance sheet is a complex display of this equation, showing that the total assets of a company are equal to the total of liabilities and shareholder equity. Any purchase or sale by an accounting equity has an equal effect on both sides of the equation, or offsetting effects on the same side of the equation. The accounting equation is also written as Liabilities = Assets – Shareholder Equity and Shareholder Equity = Assets – Liabilities.

Classification of Transaction

Transactions may be divided into three groups: 1. Cash Transaction: If the value of a transaction met is cash immediately, itis called cash transaction. For example we buy furniture for Rs 2000 from A and immediately pay him in cash. It is a cash transaction. 2. Credit Transaction: If the value of the transaction is not met in cash immediately, it is called credit transaction. In that above example, if we do not pay A Rs 2000 immediately, it will be credit transaction. 3. Paper Transaction: When there is no question of meeting the value of a transaction, it is regarded as a paper transaction. For example, I have lost Rs 500. This changes my financial position-my properties decrease in value by Rs 500. But there is no question of meeting the value of such a transaction. This is a paper transaction. Transactions may also be divided into the following two classes: 1. External Transaction: A transaction taking place with an outside person or organization, is called an external transaction. For example, a machine is purchased for Rs 20,000 from K Bros. This is an external transaction. 2. Internal Transaction: A transaction with which no outside person or institution is involved, is called internal transaction. For example, loss of furniture by fire, decrease in the value of assets on account of use (depreciation) etc.

Characteristics of Transaction

Transaction is an event. All events are not accounting transactions. An event must have the following features to become a transaction: 1. There must be two parties: No transaction is possible without two parties. Just as it takes two hands to clap, so it takes two parties for a transaction to take place. There cannot be a giver unless there is a receiver. Suppose, X borrows Rs10,000 from a bank. This is a transaction, since there are two parties here - X and bank. 2. The event must be measurable in terms of money: An event will not be regarded as a transaction, unless it is capable of being measured in terms of money. 3. The event must result in transfer of property or service: Suppose, we buy a motor-car from S for Rs 40000. This results in transfer of property from S to us, so it is a transaction. Again suppose, we pay salary to our employee Rs 2000. This results in transfer of service - the employee renders service and we receive it. So it is a transaction. 4. The event must change the financial position of the business: Transaction takes place only when there is a change in the financial position of the business. The change in financial position may be of two kinds: 1. Quantitative change: This changes the total value of assets and liabilities of a business concern. Suppose, machinery of Rs 50,000 is destroyed. This reduces the total value of the assets of the business. As a result, the financial position changes and hence it is a transaction. 2. Qualitative change: This causes increase or decrease in the different elements of assets or liabilities, but the value of total assets and total liabilities remains unchanged. Suppose, we buy machinery worth Rs 50,000. This results in exchange of properties - cash Rs 50,000 goes out of our possession and at the same time machinery of an equal value comes into our possession. This does not change the total value of our assets, but this causes a qualitative change in our financial position, hence it is a transaction.

What is Transaction?

The main function of an accountant is to record properly the financial transactions of a business concern in the books of accounts and to ascertain its true result at the year end. Thus transaction is the foundation of accounting - the first and formest element of accounting. In a word, it is the life and blood of Accounting. Hence the accountant must have a fair idea about the term "transaction." In ordinary language "transaction" means exchange of something. But in Accounting it is used in a special sense. If the financial position of a business concern changes on the happening of an event which is measurable in terms of money, that event is regarded as a "transaction" in Accounting. Or A business event which can be measured in terms of money and which must be recorded in the books of accounts is called a "transaction". What is an Event? In ordinary language "Event" means anything that happens.Human life is full of events. So many events take place in the family and social life of a person. The events may be classified into two types: 1. Monetary Events: Events which are related with money, i.e. which change the financial position of a person are known as "monetary events". For example, daily shopping, marriage ceremony, birthday anniversary, marriage anniversary etc. 2. Non-Monetary Events: Events which are not related with money i.e. which do not change the financial position ofa person are known as "non-monetary events". For example, winning a game, delivering a lecture in a meeting etc. In business accounting only those events which change the financial position of the business and which call for accounting are recognized as "Events". In other words, all monetary events are regarded as "business transactions." Remember, it is not that anything which results in exchange of something will be regarded as transaction. On the other hand, something may be regarded as a transaction even though it involves no exchange. Example: For example, R sends a price-list to his customer, A. This involves exchange of price list-between R and A, yet it is not regarded as a transaction, because it is not measurable in term of money and it does not change the financial position of both the persons. Again, suppose, goods worth Rs1000 are destroyed by fire. This does not involve any exchange, yet it is regarded as a transaction, because itis measurable in terms of money and it changes the financial position of the business. It must be noted that an event, although measurable in terms of money, may not be regarded as a transaction. For example, we receive an order for supply of goods worth Rs1000. Although it is measurable in terms of money, it is not regarded as a transaction, since it has not changed the financial position. It will, however, be regard as a transaction when the goods are supplied according to the order. It appears from the above discussion that the following two conditions must be satisfied in order that an event may be regarded as a transaction in Accounting; 1. The event must be measurable in terms of money. 2. The financial position of the business must change on account ofthat event.

Accounting Conventions

The term ' accounting conventions ' includes those customs or traditions which guide the accountant while communicating the accounting information. Important accounting conventions are: 1. Conservatism convention 2. Full disclosure 3. consistency 4. Materiality These accounting conventions are explained below: 1. Conservatism: According to this convention, accounts follow the rule "anticipate no profit but provide for all possible losses ", while recording business transactions. In other words, the Accountant follows the policy of "playing safe". On account of this convention, the inventory is valued at cost or market price whichever is less! Similarly a provision is made for possible bad and doubtful debts out of current year's profits. This concept affects principally the category of current assets. The convention of conservation has been criticized these days as it goes against the convention of full disclosure. It encourages the accountant to create secret reserves (e.g. by creating excess provision for bad and doubtful debts, depreciation etc.), and the financial statements do not show a true and fair view of state of affairs of the business. 2. Full Disclosure: According to this convention the users of financial statements (proprietors, creditors and investors) are informed of any facts necessary for the proper interpretation of the statements. Full disclosure may be made either in the body of financial statements, or in notes accompanying the statements. Significant financial events occurring after the balance sheet date, but before the financial statements have been issued to outsiders require full disclosure. The practice of appending notes to the financial statements (such as about contingent liabilities or market value, of investments or law suits against the company is in pursuant to the convention of full disclosure. 3. Consistency: This convention states thatonce an entity has decided on one method, it should use the same method for all subsequent events of the same character unless it has a sound reason to change methods. If an entity made frequent changes in the manner of handling a given class of events in the accounting records, comparison of its financial statements for one period with those of another period would be difficult. Consistency, as used here, has a narrow meaning. It refers only to consistency over time, not to logical consistency at a given moment of time. For example fixed assets are recorded at cost, but inventories are recorded at the lower of their cost or market value. Some people argue that this is inconsistent. Whatever the logical merits of this argument, it does not involve the accounting concept of consistency. This convention does not mean that the treatment of different categories of transactions must be consistent with one another but only that transactions in a given category must be treated consistently from one accounting period to the next. 4. Materiality: The term materiality refers to the relative importance of an item or an event. An item is "material" if knowledge of the item might reasonably influence the decisions of users of financial statements. Accountants must be sure that all material items are properly reported in the financial statement. However, the financial reporting process should be cost-effective - that is, the value of the information should exceed the cost of its preparation. In short, the convention of materiality allows accountants to ignore other accounting principles with respect to items that are not material. An example of the materiality convention is found in the manner in which most companies account for low-cost plant assets, such as pencil sharpness or waste baskets. Although the matching concept calls for depreciating plant assets over their useful life, these low-cost items usually are charged immediately to an expense account the resulting "distortion" in the financial statement is too small to be of any importance.

Accounting Concepts Part-2

4. Cost Concept: The concept is closely related to going concern concept. According to this concept. "An asset is ordinarily entered on the accounting record at the price paid to acquire it, and this cost is the basis for all subsequent accounting for the asset". If business buys a building for Rs 5,00,000, the assets would be recorded in the books at Rs 500,000, even if its market value at that time may be Rs 550,000. In case a year later the market value of this asset comes down to Rs 450,000 it will ordinarily continue to be shown at Rs 500,000 and not at Rs 450,000. The cost concept does not mean that the asset will always be shown at cost. It has also been stated above that cost becomes the basis for all future accounting for the asset. It means that asset is recorded at cost at the time of purchase but it may systematically be reduced in its value by charging depreciation. 5. Dual Aspect Concept: The economic resources of an entity are called 'assets'.The claims of various parties against these assets are called 'equities'. There are two types of equities: 1. Liabilities, which are the claims of creditors (that is, everyone other than the owners of business) and 2. Owner's Equity, which is the claim of the owners ofthe business. Since all of the assets of a business are claimed by someone (either by its owners or by its creditors) so we can say that Assets = Equities This is the fundamental accounting equation, which is the formal expression of the dual - aspect concept. As we shall see all accounting procedures are derived from this equation. To reflect the two type of equities, the equation is more commonly expressed as: Assets = Liabilities + Owner's Equity Every transaction has a dual impact on the accounting records. Accounting systems are set up so as to record both of these aspects of a transaction; this is why accounting is called a double-entry system. To illustrate the dual-aspect concept, suppose that Mr. A starts a business with a capital of Rs 30,000. There are two changes, first the business has cash (asset) of Rs 30,000 and second, the business has to pay to the proprietor a sum of Rs10,000 which is taken as proprietor's capital. This expression can be shown inthe form of following equation: Cash (Assets) = Capital (Equities) Rs 30,000 =Rs 30,000. Subsequently if the business borrows Rs15,000 from a bank, the new position would be as follows: Assets = Equities Cash Rs 30,000 + Bank Rs 15,000 = Bank loan Rs15,000 + Capital Rs30,000. The term 'accounting equation' is also used to denote the relationship of equities to assets. The equation can be technically, stated as "for every debit, there is an equivalent credit". 6. Accounting Period Concept: The users of financial statements need information that is reasonably current. Therefore, for financial reporting purposes, the life of a business is divided into a series of relatively short accounting periods of equal length. It is, therefore, absolutely necessary that after each accounting period the business must 'stop' and 'see back', how things are going. In accounting such accounting period is usually of a year. At the end of each accounting period an income statement and a balance sheet is prepared the income statement discloses the profit or loss made by business during the year while balance sheet shows the financial position of business as on the last day of the accounting period. 7. The Matching Concept: A significant relationship exists between revenue and expenses. Expenses are incurred for the purpose of producing revenue. In measuring net income for a period, revenue should be offset by all the expenses incurred in producing that revenue. This concept of offsetting expenses against revenue on the basis of "cause and effect" is called the Matching Concept. The term 'matching' means appropriate association of related revenues and expenses. In matching expenses against revenue the question when the payment was made or received is 'irrelevant'. For example if a salesman is paid commission in January,2005, for sales made by him in December, 2004. According to this concept commission expense should be offset against sales of December 2004 because this expense is incurred for producing revenue in December 2004. On account of this concept, adjustments are made for all outstanding expenses, accrued revenues, prepaid expenses and unearned revenues, etc., while preparing the final accounts at the end of accounting period. 8. Realization Concept: Accounting to this concept revenue should be recognized at the time when services are rendered. Sale is considered to be made at the point when the property in goods passes to the buyer and he becomes legally liable to pay.

Accounting Concepts Part-1

The term ' accounting concepts ' includes those basic assumptions or conditions on which the science of accounting is based. These concepts are used by accountants and bookkeepers all over the world. Following are the most important accounting concepts: 1. Separate entity concept. 2. Going concern concept. 3. Money measurement concept. 4. Cost concept. 5. Dual aspect concept. 6. Accounting period concept. 7. Matching concept. 8. realization concept. These accounting concepts are explained below: 1. Separate Entity Concept: Accounts are kept for entities, as distinguished from the persons who are associated with these entities. In recording events in accounting, the important question is: "How do these events affect the entity?" How they affect the persons who own, operate, or otherwise are associated with the entity is irrelevant.For example, when a person invests Rs 200,000 into business it will be deemed that the owner has given that money to the business which will be shown as a 'liability' in the books of the business. In case the owner withdraws Rs 30,000 from the business, it will change the position and the net amount payable by the business to the owner will be shown only as Rs170,000. The concept of separate entity is applicable to all forms of business organizations. For example, in case of a sole proprietorship or partnership business, though the sole proprietor or partners are not considered as separate entities in the eyes of law, but for accounting purposes they will be considered as separate entities. 2. Going ConcernConcept: According to this concept it is assumed that an entity is a going concern - that it will continue to operate for an indefinite time period there is no intention to liquidate the particular business venture in the foreseeable future. On account of this concept, the accountant while valuing the asset does not take into account the sale value of assets. Moreover, he charges depreciation on fixed assets on the basis of their expected life rather than on their market values. For example, suppose that a company has just purchased a three-year insurance policy for Rs 45,000. If we assume that the business will continue inoperation for three years or more. We will consider the Rs 45,000 cost of insurance as an asset which provides services to the business over a three-year period. On the other hand, if we assume that the business is likely to terminate in the near future, the insurance policy should be reported at its cancellation value i.e. the amount refundable upon cancellation. Moreover, the concept applies to the business as a whole. When an enterprise liquidates a branch or one segment of its operations, the ability ofthe enterprise to continue as a going-concern is not impaired normally. The enterprise will not be considered as a going-concern when it has gone into liquidation. 3. Money Measurement Concept: In financial accounting, a record is made only of those information that can be expressed in monetary terms. In other words, no accounting is possible for an event or transaction which is not measurable in terms of money, e.g. passing an examination, delivering lecture in a meeting, winning a prize etc.These are events no doubt, but since these are not measurable in terms of money, there is no question of their accounting. Measurement of business events in money helps in understanding the state of affairs of business in a much better way. For example, If a business owns. 1,500kg of stock, one car, 1,500 square feet of building space etc. these amounts cannot be added to produce a meaningful total of what the business owns. However, if these items are expressed in monetary terms such as stock Rs 24,000, car Rs 300,000 and building Rs 500,000, all such items can be added in better way and precise estimate about the assets of the business will be available.

Accounting Principles

Accounting is the language of business through which economic information is communicated to all the parties concerned. In order to make this language easily understandable all over the world, it is necessary to frame or make certain uniform standards which are acceptable universally. These standards are termed as "Accounting Principles ". Accounting principles may be defined as those rules of action or conduct which are adopted by the accountants universally while recording accounting transactions. They are a body of doctrines commonly associated with the theory and procedures of accounting. They are serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternatives exist. These principles can be classified into two groups. 1. Accounting concepts 2. Accounting conventions. Accounting Concepts: The term 'concepts' includes those basic assumptions or conditions on which the science of accounting is based. The following are the important accounting concepts: 1. Separate entity concept 2. Going concern concept 3. Money measurement concept 4. Cost concept 5. Dual aspect concept 6. Accounting period concept 7. Matching concept 8. Realization concept. Accounting Conventions: The term 'conventions' includes those customs or traditions which guide the accountant while communicating the accounting information. The following are the important accounting conventions; 1. Convention of conservatism 2. Convention of full disclosure 3. Convention of consistency 4. Convention of materiality.

Accounting Cycle

After taking decisions such as selecting a business, selecting the form of organization of business, making decision about the amount of capital to be invested, selecting suitable site, acquiring equipment, supplies etc., selecting staff, getting customers and selling the goods etc., business man finally resorts to record keeping. For all types of business organizations, transactions such as purchases, sales, manufacturing and selling expenses, collections from customers and payments to suppliers do take place. These business transactions are recorded in a set of ruled books, such as journal, ledger, cash book etc; In modern times all the records are maintained on a computer using computer software; unless these transactions are recorded properly, he will not be in a position to know where exactly he stands. Therefore, for any business record keeping is of foremost importance. Following is the complete cycle of accounting :- (1) The balances of accounting; from opening balance sheet and day-to-day business transactions of the accounting year are first recorded in a book known as Journal. (2) Periodically these transactions are transferred to concerned accounts, known as ledger accounts. (3) At the end of every accounting year these accounts are balanced and a trial balance is prepared. (4) Then the final accounts such as Trading and profit & loss accounts are prepared. (5) Finally a Balance Sheet is made which gives the financial position of the business at the end of the period.

Important Accounting terms

Assets An asset may be defined as anything of use to future operations of the enterprise and belonging to the enterprise. For example, building, land, machinery, cash, debtors (amount due from customers) goodwill etc. Equity In broad sense the term equity refers to total claims against the enterprise. It is further divided into two categories: (1) Owners claim-capital and (2) Outsiders' claim-liability (3) Liability: Amounts owed by the enterprise to the outsiders i.e. to all others except the owner. For example, trade creditors, bank overdraft etc. (4) Capital: The excess of assets over liabilities of the enterprise. It is the difference between the total assets and the total liabilities of the enterprise. For example, if on a particular date the assets of the business amount to Rs 1,00,000 and liabilities to Rs 30,000 then the capital on the date would be Rs 70,000. It is also known as net worth. Revenue It is the monetary value of the products or services sold to the customers during the period. It results from sales, services and sources like interest, dividend and commission, etc. Expenses/ Costs Expenditure incurred by the enterprise to earn revenue is termed as expenses or costs. Distinction between expense and asset is that the benefit of the former is consumed by the business in present whereas in latter case benefit will be available for future activities of the business. Examples of expenses are raw materials consumed, salaries etc. . Loss The term is used to convey, at least, two different meanings. First it refers to the result of the business for a period when expense exceed the revenue. For example, if sales are Rs 10,000 and expenses are Rs 11,000 the loss will be Rs 1,000. Second- It describes those efforts which fail to earn revenue. For example-un saleable stock, loss due to fire, theft, accident etc. Proprietor/ Owner The person who investshis money or money's worth and bears the risk of the business. Drawings Money or value of goods belonging to business used by the proprietor for his personal use. Goods Includes all merchandise commodities which are purchased by the business for selling. Trade Debtor Person who owes money to the business. It happens when goods are sold on credit. Trade Creditor Person to whom the business owe money. It happens when goods or materials are purchased by the business on credit. Transaction Any exchange (dealing) of goods or services, for cash or on credit by the business with any other business. Events There are the occasions which cause changes in the value due to time element. Outsiders are not directly concerned. For example, interest accrued, depreciation in the value of assets etc. Entry The record of a transaction or event in the books of accounts is known as entry. Entity All elements of financial statements are in relation to a particular entity which may be business enterprise, an educational or charitable organization, a government unit, a natural person or the like. An entity may comprise two or more affiliated entities and may not necessarily correspond, with 'legal entity'. Thus, the accounting information is recorded, compiled and presented with reference to identifiable entity. The term 'other entity' refers to a subsidiary company that is a part of the same entity as its parent company in consolidated financial statements but is an 'other entity' in the separate financial statements of its parent. Net worth Is also known as "ownership equity" or"stockholders', equity" or "capital". It is the difference between total assets minus outside liabilities. Alternatively net worth is the sum of capital plus retained earnings.