Introduction to Accountancy

Introduction to Accounting:

Definition: “Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in the part at least of a financial character and interpreting the results thereof”.

Characteristics of accounting:

• Economic events: Every business involves economic events, which means the business transactions can be measured in terms of money. Economic events may be internal/external accounting involves both of them.
• Identification: Identifying the transactions means the selection of transactions to be recorded. Only those transactions are to be recorded which are related to the organization and considered as financial character.
•  Measurement: The identified business transactions which can be quantified, estimated and measured in terms of monetary units viz. Rupees, Dollars and Yens, etc can be recorded in the books of accounts.
• Recording: Economic vents are recorded in a chronological order and systematic manner after having been identified and measured in financial terms.
• Communication: Identification, measurement and recording of economic events are done in order that the relevant information is generated and communicated in a prescribed format to the management and other internal and external use.
• Entity: In the whole accounting process we are concerned about the entity which does economic activities. Entity means and includes any profit making or not for profit enterprises.
• Book-keeping: Book-keeping is a primary and basic function in the process of accounting and concerned with recording and maintenance of books of accounts only. In this process the following basic activities are considered essential:

1.     Identification of the transactions from the various business transactions which have financial characters.
2.       Measurement of those transactions in terms of money. 
3.          Recording those transactions in the books of original entry.
4.      Classification of the transaction keeping in view the respective ledger accounts.

Objectives of Accounting:

The objectives of accounting are as follows:

• Systematic recording of business transactions: A systematic and complete record helps the management to receive any information easily and in time. Accounting records all business transactions in books of account in such a manner that intended to users can use the information for different decision making purpose.
• Ascertainment of results: The main purpose of any business is to earn profit. For the ascertainment of profit or loss by the business enterprise, all income and expenses are to be worked out and presented in a separate statement which is called trading and profit and loss account.
• Ascertainment of information to various users: The aim of showing financial position can be achieved by preparing balance sheet of the business enterprises. Balance sheet is a statement of assets and liabilities.
•  Communicating information to various users: There are a number of users who may be interested in knowing the information about the financial soundness and the profitability of the enterprise. Accounting information is required by different types of users (external or internal), who may need the same for decision making.

Advantages of Accounting:

The main advantages of accounting are as follows:

•  Helps in remembering: A business cannot remember all the transactions therefore these transactions should be recorded in the books so that information can be obtained whenever needed.
• Assistance of management: Accounting makes the financial information available to management i.e. profit earned or loss suffered and also what are the assets and liabilities of the enterprise. 
• Evidence in court: Systematic record of transactions is often treated as good evidence, if the accounts of the business are properly kept, then they can be presented in the court of law giving necessary documentary proof.
• Sale of business: If the businessman wants to sell his business he can realize its reasonable price only if he had maintained proper accounts.
• Comparative study: A systematic record will enable a businessman to compare one year’s result with other years and locate significant factor leading to the change.
• Helps in payment of tax: Many types of taxes i.e. income tax, sales tax one imposed upon the businessman. To make payment of these taxes it is necessary that accounts are properly maintained.

Disadvantages/Limitations of Accounting:

The main limitations of accounting are:

• Historical in nature: Accounting historical in nature and reflects the past position of business organization means postmortem.
• Records of only monetary transactions: Accounting provides incomplete information as accounting records only those transactions which can be expressed and measured in terms of money there are lot of non-financial transactions, which are important. Due to their non-financial nature, they do not get recorded in the books of accounts.
• Price level changes: The accounting statement do not show the effect of price level changes on the value of assets since it is based on historical cost. Thus, the financial position may not come true in case of inflation and deflation.
• Window dressing: Accounting principles are not static, information contained in accounting may be manipulated by the accountants. There are several methods of recording the value of unsold stock or charging depreciation, etc. Accounting is subject to window dressing and it fails to depict the true financial position of the enterprise if the accounts were not drawn properly.

Users of accounting information:

• Internal users:

1. Owners: they are those persons who contribute capital in the business and ultimately responsible to bear all risk associated with the business. They are interested in the profitability and solvency of business concerns.
2. Management: Management may consists of Board of Directors, mangers and other officers of the business enterprise. They need the accounting information on cost of sales for planning, controlling and decision making. Management is interested in assessing the capacity of the business to earn profits in future.

•  External users:

1.      Investors and potential investors: Investors and potential investors of an enterprise are interested to know the earning capacity of the entity investors and not always involved in the day to day working of the enterprise, they get the information through financial statements.
2.     Lenders and financial institutions: They includes banks and financial companies are interested to know the short-term as well as the long-term solvency position of the entity.
3.    Suppliers and creditors: Suppliers and trade creditors are interested in the financial strength of an entity, so that they can extend credit for goods accordingly.
4.     Customers: On the basis of accounting information, customers can know the continued existence of the enterprise and continued supply of the products and services rendered by it.
5.    Government and other regulations: On the basis of financial statement government authorized and determine the progress of business.
6.     Taxation authority: Various taxes and excise duties are levied by the government after analyzing the financial statements.

Three Golden Rules of Accountancy

Creating journal entries requires some rules, such rule is named as Three Golden Rules of Accounting standards. There are 3 kinds of account as Personal Account, Real Account and Nominal Account.

1.   Personal Account         

         Personal Account relates to person with whom a business keeps dealings. A person called a natural person or a legal person. If a person receives anything from the business, he is called receiver and his account is to be debited in the books of the business. If person gives anything to business, he is called as a giver and his account is to be credited in the books of the business.

The golden rule for personal account is, “debit the receiver and credit the giver”.

Example: Goods worth 1000 bucks sold to Mr. Smith from Mr. John. In this transaction, Mr. Smith is the receiver of goods, he is called receiver and his account is to be debited in the books of business. John is the giver of goods, he is called giver and his account is to be credited in the books of business.

2.   Real Account        

            Real Account relates to property which may either come into the business or go from business. If any property or goods comes into the business, account of that property or goods is to be debited in the books of business. If any property or goods goes out from the business, account of that property or goods is to be credited in the books of business.

The golden rule for real account is, “debit what comes in and credit what goes out”.

Example:  Goods sold on cash for 1500 bucks. In this transaction, cash, an asset for business comes into the business on sales of goods, and therefore cash account is to be debited in the books of business. On the other side, goods, an asset of business goes out of the business on sale and therefore goods account is to be credited in the books of business.

3.  Nominal Account

      Nominal Account is an account that relates to business expenses, income and gains. If business incurs expense of manage and run business, account of that expense is to be debited in the books of business. When a business earns income by rending services or hiring business assets, an account of that income is to created in the book of business.

On the other hand, if in the case transaction of sale or purchase of goods or assets, of any loss is incurred by the business, account of that loss is to be debited in the books or assets. If in the transaction of sale or purchase of goods or assets any profit is earned by the business, then account of that profit is to be credited in the books of business.

The golden rule for nominal account is, “debit all Expenses or Loss and Credit all Income Gains or Profit”.

 Example:  i. Paid 50 bucks as a commission to our agent, here commission which is paid to an agent is business expense and it is to be debited in the books of business.

ii. Received Rs.100 bucks as interest on our fixed deposit, here interest which is received is business income and therefore it is to be credited in the books of business.    

BASIC ACCOUNTING TERMS

• Proprietor: A person who owns the business is called proprietor.
• Capital: The amount with which business is started is called capital. This amount will be      increased by profit and additional capital introduced and it will be decreased by the amount of loss and the amount of drawing.
• Assets :  An assets is that expenditure with result in purchasing of some property or benefit of lasting nature or something that can be converted into cash. Example: building, cash, bank, livestock, debtor, furniture, etc.
• Tangible Assets:  Those assets which have physical existance.ie. they can be seen and touched. Examples: building, cash, furniture, etc.
• Intangible Assets:  Those assets which do not have physical existence. i.e. they can't be seen and touched. Example: trademark, patent, copyright, goodwill.
• Fixed Assets:  The assets which are acquired for use and not for resale. Example: building, patent, land etc.
• Current Assets:  The assets which are acquired for resale not for use or some assets that can be converted into cash as soon as possible. Example: cash, bank, stock, debtor etc.
• Liabilities:  In accounting terms, a liability is a debt or obligation that a company must pay. Example: loan, loan from other, creditor etc.
• Long-term liabilities: They are those which will be paid after one year. Example: loans, debentures, etc.
• Short-term liabilities:  are those which will be paid into one year. Example: loan from others, bank loans, creditors, etc.
• Drawing:  The amount of cash or value of goods withdrawn from the business by the owner for his personal/domestic use. It is deducted from the capital.
• Debtor :  The term 'debtor' represents those      persons to whom goods have been sold on credit and payment has not received from them.
• Creditor:  The term creditor represents those persons from whom goods have been purchase on credit and payment has not been made to them. Some money is still owing to them.
• Expense:  The term expenses means that the amount incurred in the process of earning revenue. If the benefits of an expenditure is limited to one year it is treated an expense. Example: rent paid, salary paid, telephone bill paid.
• Revenue:  The amount received or receivable from the sale of goods and services. Example: salary received, rent received etc.
• Income:  The difference between revenue and expense is called income. Income is the profit earning during a period of time. Example: goods purchase for Rs 10,000/- and sold it for Rs 15,000/- so the profit is 5,000.

Income = Revenue - Expense

• Sale:  The amount of goods sold that are already bought or manufactured by the business. When goods are sold for cash-cash sale and when goods are sold for credit-credit sales.
• Purchase:  Amount of goods purchase by the business for resale or for use in the production is called purchase. When it is purchased for cash-cash purchase and when it is purchase for credit-credit purchase.

Total purchase = Cash purchase – Credit purchase

* Outstanding – creditor <liability>

   - Unpaid, due but not paid, arier, not paid.

* Prepaid- debtor<assets>

   - Advance, paid for future.

• Stock: Goods unsold on a particular date is called stock. It may be opening or closing stock. Opening stock means goods unsold in the beginning of the accounting period. Closing stock means goods unsold at the end of accounting period.
• Voucher: It is a written document in support of a transaction. It is a period that a      particular transaction has taken place for the value displayed in the voucher.
• Accounting equation: Assets = Capital + Liabilities.
• Depreciation: It simply means, the fall the in the value of assets due to its uses, efflux of time, wear and tear. 

Journal: Journal is the primary books of accounts in which transactions are first recorded in a chronological order i.e. as they entered into. Transactions are recorded in the Journal Books from the accounting voucher that is prepared on the basis of source documents i.e. cash memo, invoices, purchase bill, etc.   

Format and some Journal entries for specific transactions:

Date	Particulars	L.F.	Amount (Dr.)	Amount (Cr.)
1	Drawing a/c                                ...Dr.    To cash a/c (being cash withdraw for personal use)
2	Drawing a/c                                ...Dr.    To Purchases a/c (being goods withdraw for personal use)
3	Advertisement a/c                           ...Dr.                      To purchase a/c (being goods distributed as free sample)
4	Charity/Donation a/c                         ...Dr.                      To purchases a/c (being goods given as charity/donation)
5	Assets a/c                                          ...Dr.     To Purchases a/c (being goods used to make (contract) and assets)
6	Closing stock a/c                            ...Dr.     To Trading a/c (being entered closing stock at the end) Note: In case of opening stock entry will be reversed.
7	Wages a/c                                 ...Dr.     To Outstanding wages a/c (being wages outstanding/due/unpaid)
8	Prepaid wages a/c                           ...Dr.     To wages a/c (being prepaid/paid in advance)
9	Depreciation a/c                            ...Dr.      To Assets a/c (being depreciation charge on assets)
10	Machine a/c                                ...Dr.     To Cash a/c (being wages paid on installation of machine)
11	Interest on capital a/c                        ...Dr.      To Capital a/c (being interest charge on capital)
12	Drawings a/c                               ...Dr.      To Interest on drawings a/c (being interest charge on drawings)
13	Cash a/c                                   ...Dr.      To Bad debt recovered a/c (being bad debt recovered)
14	Drawings a/c                                     ...Dr.      To Cash a/c (being income tax paid)
15	Interest/Bank charges a/c                     ...Dr.      To Bank a/c (being interest charge by bank)
16	Bank a/c                                   ...Dr.       To Interest a/c (being interest allowed/credited by bank)
17	Rent a/c                                   ...Dr.      To Advance Rent a/c (Being rent received in advance)
18	Bank a/c                                   ...Dr.      To Mr. X (being cheque received from Mr. X)
19	Bank a/c                                   ...Dr.      To Cash a/c (being open a bank account)

*Ram declared insolvent and recovered from his official receiver a divided of 60 paise in the rupee on a debt of Rs.1000. Pass the Journal entry.

Cash a/c            ...Dr.               600

Bad debt a/c     ...Dr.                400      

     To Ram a/c                                1000

 (being declared insolvent for payment of debt)

*Cheque received from Mr. X deposited into bank and dishonored/return unpaid:

 Mr. X a/c         ...Dr.                          

      To Bank a/c

 (being cheque received dishonored/return unpaid)

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