Accounting

What is accounting?

Accounting is the process of identifying, recording, classifying and summarising of financial transactions in the form of financial report or statement (Profit& Loss and Balance Sheet) in a systematic manner for the purpose of providing financial information for decision making. Basically, accounting is a financial support system that

Records transactions

Classifies transactions and events

Expresses transactions in monetary terms

Helps to monitor the financial performance and condition of the business

Helps to evaluate the business

Helps to establish control for the business

Accounting helps to arrive at the financial position of an organisation at any given point of time. The organisation’s financial status, as on particular date, is reflected in the balance sheet, while financial performance for the year is stated in the Profit and Loss Account.

Accounting Principal, concept and conventions

The accounting principles, concepts and conventions form the basis for how business transactions are recorded. A number of principles, concepts and conventions are developed to ensure that accounting information is presented accurately and consistently. Some of these concepts are briefly described in the following sections-

Historical Cost Principle

All accounting transactions relating to purchase of an asset should always be recorded at cost price, that is, the price at which it was acquired. This figure would be used as a basis for all future accounting procedures related to this asset.

Revenue realisation concept

According to the revenue realisation concept, revenue is considered as the income earned on the date, when it is realised. As per this concept, unearned or unrealised revenue is not taken into account.

This concept is vital for determining income pertaining to an accounting period. It reduces the possibilities of inflating incomes and profits.

Matching Concept

As per this concept, matching of the revenues earned during an accounting period with the cost associated with the respective period to ascertain the result of the business concern is carried out. This concept serves as basis for the finding accurate profit for a period which can be distributed to the owners.

Full Disclosure Principle  

.Financial statements should be a true and fair representative of the company’s financial activities during the year. The financial statements should neither conceal nor mislead the users of accounting information. All materials information has to be disclosed either in the financial statement or in the note to the financial statement.

 Accrual Principle

Under accrual method of accounting, the transactions are recorded when earned or incurred rather when collected or paid i.e. transactions are recorded on the basis of income earned or expense incurred irrespective of the actual receipt or payment. For example, a seller bills the buyer at the time of sale and treats the bill amount as the revenue, even though the payment may be received later.

Cash Basis of accounting is a method wherein revenue is recognised when it is actually received rather than when it is earned. Expenses are booked when they are actually paid rather than incurred.

This method is usually not considered  to be in conformity with  accounting  principles and is therefore , used only in selected situations such as for very small businesses.

Going Concern

As per this assumption, the business will exist for long period and transactions are recorded from this point of view

Accounting Period

The user of financial statements required periodical reports to ascertain the operation and the financial position of the business concern. Thus, it is essential to close the accounts at regular intervals. Viz.. 365 days or one year is considered as the accounting year.

Business Entity Concept

According to this concept, it is assumed that a business is separate from its owners, creditors and others .  For example, in case of a sole proprietor concern, the proprietor is treated to be separate and distinct from the business, which he controls. The proprietor is treated as a creditor to the extent of his capital and all the business transactions are recorded in the books of accounts from the business stand point.

Money Measurement

In accounting, only business transactions and events of financial nature are recorded. Only transactions that can be expressed in terms of money are recorded.

Double Entry System of Book Keeping

As per Double Entry System book-keeping, all the business transactions recorded in accounts have two aspects- Debit aspect (receiving) and Credit aspect (giving). For example, when a business acquires an asset (receiving) and pays cash (giving) for it. This accounting technique records each transaction as debit and credit. Where every debit has a corresponding credit and vice versa.

Features of Double Entry System of Book Keeping:

The Double entry system of book comprises of the following features:

• Every business transaction affects two accounts
• Each transaction has two aspects, i.e., debit and credit
• It maintains a complete record of all business transactions
• It helps to check the accuracy of the accounting transactions by preparation of trial balance
• It helps ascertaining profit earned or loss occurred during a period by preparation of Profit &Loss Account
• It helps ascertaining financial position of the business at the end of each period by preparation of Balance Sheet
• It helps for timely decision making based on sufficient information
• It minimises the possibilities of fraud due to its systematic and scientific recording of business transactions

Types of Accounts

There are basically three types of Account maintained for transactions:

• Personal Accounts
• Real Accounts
• Nominal Accounts

 Personal Accounts

Personal Accounts are Accounts which relate to persons. Personal Accounts include the following.

• Suppliers
• Customers
• Lenders

Real Accounts

Real Accounts are Accounts relating to properties and assets which are owned by the business concern. Real accounts include tangible and intangible accounts. For example,

• Land
• Building
• Goodwill
• Purchases
• Cash
• Furniture

Nominal Accounts

Nominal Accounts are Accounts which relate to income and expenses and gains and losses of a business concern. For example,

• Salary Accounts
• Dividend Accounts
• Sales

Accounts can be broadly classified under the following four groups.Assets

Liabilities

Income

Expenses

The above classification is the basic for generating various financial statement viz.,

Balance Sheet, Profit & Loss A/c and other MIS reports. The Assets and liabilities are taken to Balance sheet and the Income and Expenses accounts are posted to Profit and Loss Accounts.

Golden Rules of Accounting

All the business transactions are recorded on the basis of the following rules.

	Personal Accounts	Real Accounts	Nominal Accounts
Debit	The receiver	What comes in	All expenses and Losses
Credit	The giver	What goes out	All Income and Gains

Mode of Accounting

Accounting process begins  with identifying and recording the transaction  in the books of accounts i.e the first step in the Accounting  process is the recording of transactions in the books of accounts, Accounting identifies  only those transactions and events which involves money and is sorted based on various source documents.

The following are the most common source documents.

Cash Memo

Invoice or Bill

Voucher

Receipt

Debit Note

Credit Note

Voucher

Voucher is a document which contains the details of a transaction.

Receipt

When a trader receives Cash / Cheque from a customer against goods sold by him issues a receipt containing the name of such customer, details o amount received with date

Invoice or Bill

When a trader sells goods to a buyer, he prepares a sales invoice containing the details of a name and address of buyer, name of goods , amount and terms of payments  and so on . Similarly, when the trader purchases goods on credit receives a invoice/bill from supplier of such goods

Journal and Ledgers

A Journal is a record in which of all transactions are entered in a chronological order. A record of a single business transaction is called a journal entry. Every journal entry is supported by a voucher evidencing the related transaction.

Account

An account is a statement of transactions affecting any particular asset, liability, expenses or income.

Ledger

A ledger is a book which contains all the accounts whether personal, real or nominal which are entered in journal or subsidiary books.

Chart of Accounts

A chart of accounts is a list of all accounts used by an organisation. The chart of accounting also displays the categorisation and grouping of its accounts.

Posting

Posting is the process of transferring the entries recorded in the journal or subsidiary books to the respective accounts opened in the ledger i.e grouping of all the transactions relating to particular accounts to a single place.

Accounting Period

Generally, the financial statement is generated for a regular period such as a quarter or a year, for timely and accurate ascertainment of opening and financial position of the organisation.

Trial Balance

Trial Balance is a statement which shows debit balance and credit balances of all Ledger accounts. As per the rules of double entry system, every debit should have a corresponding credit, the total of the debit balances and credit, the total of the debit balances and credit balances should agree. A detailed trial balance has column for

Account name

Debit balance

Credit balance

Financial Statement

Financial statements are final result of accounting work done during the accounting period. Financial statement serves a significant purpose to users of accounting information in the knowing about the profitability and financial position of the organisation.

Financial statements normally include-

Trading

Profit and Loss Account

Balance Sheet

Trading Account-

Trading refers to buying and selling of goods. The trading, account displays the transactions pertaining to buying and selling of goods

The difference between the two sides of the Trading Account indicates either Gross Profit or Gross Loss. If the credit side total is in excess of the debit side total, the difference represents Gross Profit. On the other hand, if the total of the debit side is in the excess of the credit side total, the difference represents Gross Loss. Such Gross Profit/Loss is transferred to profit & Loss Account. The Gross Profit is expressed as –

Gross Profit= Net Sales –Cost of Sales

Profit and Loss Account

The profit and loss account helps to ascertain the net profit earned or net loss suffered during a particular period. After considering all other incomes and expenses incurred over a period. This helps the company to monitor and control the costs incurred and its efficiency. In other words, the profit and loss statement shows the performance of the company in terms of the profits or losses over a specified period.

The net profit is expressed as

Net profit= (Gross Profit + other Income) – (Selling and Administrative expenses+ Depreciation+ Interest+ Taxes+ Other Expenses)

A key element of the Profit and Loss Account, and one that distinguishes if from a balance sheet, is that the amounts shown on the statement represent transactions over a period of time, while the items represented on the balance sheet show information as on a specific date.

All revenue and expenses accounts are closed once the profit and loss account is prepared. The Revenue and Expenses accounts will not have an opening balance for the next accounting period.

Balance Sheet

The Balance Sheet is a statement that summarises the assets and liabilities of a business. The excess of assets over liabilities is the net worth of a business. The balance sheet provides information that helps in assessing –

A company’s long term- term financial strength

A company’s efficient day-to-day working capital management

A company’s Asset portfolio

A company’s Sustainable long term performance

The balances of all the real, personal and nominal (capital in nature) accounts are transferred from trial balance to balance sheet and grouped under the major heads of assets and liabilities. The balance sheet is complete when the net profit/loss is transferred from the Profit and Loss account.

Transactions

A transaction is a financial event that takes places in the course of furtherance of business and effects the financial position of the company. For example, when you deposit cash in the bank , your cash balance increases and your stock reduces.

Transactions can be classified as follows-

• Receipts- Cash or Bank
• Payment-Cash or Bank
• Purchases
• Sales

Recording Transactions –

The important aspect of accounting is to record transaction promptly and correctly to ascertain the financial status of a company as on particular date.

Generally, the business transactions may be of the following nature-

• Purchase of goods either as raw materials for processing or as finished goods for re-sales
• Payment of expenses incurred towards business
• Sale of goods or services
• Receipts ( in Cash or by cheques )
• Payments (in Cash or cheques)

 Users of Financial Statement

The Accounting information is useful to various interested parties, both internal and external viz.,

• Suppliers, who supplies goods and services for cash or on credit
• Customers, who buy goods or services for cash or on credit
• Employees, who provides services in exchange of salaries and wages.
• Banks, with whom accounts are maintained
• Suppliers of equipment, buildings and other assets needed to carry on the business.
• Lenders, from whom you borrow money to finance your business
• Owners, who hold a share in the capital of your business.