CHAPTER 1 ACCOUNTING - AN INTRODUCTION INTRODUCTION TO ACCOUNTING
Introduction to Accounting Accounting AS AN ART In 1941 1941,, the the Ameri America can n Inst Instit itut utee of Cert Certif ifie ied d Publ Public ic Accou Account ntan ants ts (AIC (AICPA PA)) defin defined ed accounting as “The art of recording, classifying, summarising, analysing and interpreting interpreting the business transactions transactions systematically and communicating business results to interested users is accounting” AS PROCESS
The American Accounting Association defined accounting as : “It is the process of identifying, measuring, recording and communicating the required information relating to the economic events of an organisation to the interested users of such information. ACCOUNTING AS AS AN INFORMATION INFORMATION SYSTEM SYSTEM
Accounting is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decisions. ACCOUNTING Accoun Accountin ting g is the art of recordi recording, ng, classif classifyin ying g and summar summarizi izing ng in terms terms of money money
transactions and events of a financial nature and interpreting the results thereof. It is the the proc proces esss of collec collectin ting, g, record recording ing,, summar summarizin izing g and commun communicat icating ing financ financial ial
information.
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It is an information system which generates generates information information for decision decision making making used by the
interested parties. IMPORTANT ASPECTS OF DEFINATION OF ACCOUNTING ACCUNTING 1.Economic events : It is the occurring of the consequence to a business organisation which
consists of transactions that are measurable in monetary terms. Purchase of a Machinery, installing and keeping it ready for manufacturing is an economic event which consists of a number of financial transactions. These transactions are (a) buying the machine, (b) transporting the same, (c) preparing the site for its installation and (d) incurring expenditure on installing the same. Accounting identifies bunch of transactions relating to an economic event. ( External events & internal event) External events If an event involves transactions between an outsider and an organisation,
these are known as external events. The following are the examples of such transactions: • Sale of Reebok shoes to the customers. • Rendering services to the customers by Videocon Limited. • Purchase of materials from suppliers. • Payment of monthly rent to the landlord. An internal event is an economic event that occurs entirely between the internal wings of an
enterprise, e.g., supply of raw material or components by the stores department to the manufacturing department, payment of wages to the employees, etc. 2.Identification, 2.Identification, Measurement, Recording and Communication : a.)Identification implie impliess determ determini ining ng what what transact transaction ionss are to be recorde recorded d i.e. items of financial character are to be recorded.
For example, goods purchased for cash or on credit will be recorded. Items of non-financial character such as
changes in managerial policies, etc. are not recorded in the books of accounts. b.)Measurement means quantification of business transactions into financial terms by using monetary unit. If an event cannot be quantified in monetary terms , it is not considered fit for recording in
the books of the firm. That is why important items like appointment, signing of contracts, etc. are not shown in the books of accounts 2
c.)Recording : Having identified and measured the economic events in financial terms, these are recorded in the books of accounts in monetary terms and date wise.
The recording of the business transactions is done in such a manner that the necessary financial information is summarized as per well established accounting practice. d.)Communication : The economic events are identified, measured and recorded in such a
manner that the
necessary
relevant financial
information
is generated
and
communicated in a certain form to the management and other internal and external users of information.
The financial information is regularly communicated through accounting reports. An important element in the communication process is the accountant’s ability and
efficiency in presenting the relevant information. 3.Organisation : refers to a business enterprise whether for profit or not for profit motive .
Depending upon the size of activities and level of business operation, it can be a sole proprietory concern, partnership firm, cooperative society, company, local authority, municipal corporation or any other association of persons. 4. Interested users of information. Many users need financial information to make
important decisions. Since the primary function of accounting is to provide useful information for decision-making, it is a means to an end, with the end being the decision that is helped by the availability of accounting information. These users can be divided into two broad categories: internal users and external users . Internal users include: Chief Executive, Financial Officer, Vice President, Business Unit
Managers, Plant Managers, Store Managers,Line Supervisors, etc. External users include : present and potential Investors (shareholders), Creditors (Banks and
other Financial Institutions, Debentureholders and other Lenders), Tax Authorities, egulatory Agencies (Department of Company Affairs, Registrar of Companies, Securities Exchange Board of India, Labour Unions, Trade Associations, Stock Exchange and Customers,etc.
I. Internal users: Internal users are those individuals or groups who are within the organisation like owners, management, employees and trade unions. II. External users : External users are those individuals or groups who are outside the
organisation like creditors, investors, banks and other lending institutions, present and potential investors,Government, tax authorities, regulatory agencies and researchers. The users and their need for information are as follows:
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Users Need for Information Internal
i. Owners To know the profitability and financial soundness of the business. ii. Management To take prompt decisions to manage the business efficiently. iii. Employees and Trade unions To form judgement about the earning capacity of the business since their remuneration and bonus depend on it. External
i. Creditors, banks and other To determine whether the principal and lending institutions the interest thereof will be paid in when due. ii. Present investors To know the position, progress and prosperity of the business in order to ensure the safety of their investment. iii. Potential investors To decide whether to invest in the business or not. iv. Government and Tax To know the earnings in order to assess authorities the tax liabilities of the business. v. Regulatory agencies To evaluate the business operation under the regulatory legislation. vi. Researchers To use in their research work. ACCUNTING PROCESS
ACCOUNTING CYCLE
An accounting cycle is a complete sequence of accounting process, that begins with the recording of business transactions and ends with the preparation of final accounts.
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Why do the Users Want Accounting Information?
• The owners/shareholders use them to see if they are getting a satisfactory return on their investment, and to assess the financial health of their company/business. • The directors/managers use them for making both internal and external comparisons in their attempts to evaluate the performance. They may compare the financial analysis of their company with the industry figures in order to ascertain the company’s strengths and weaknesses. Management
is also concerned with ensuring that the money invested in the
company/organization is generating an adequate return and that the company/organisation is able to pay its debts and remain solvent. • The creditors (lenders) want to know if they are likely to get paid and look particularly at liquidity, which is the ability of the company/organisation to pay its debts as they become due. • The prospective investors use them to assess whether or not to invest their money in the company/organisation. • The government and regulatory agencies such as Registrar of companies, Custom departments IRDA, RBI, etc. require information for the payment of various taxes such as Value Added Tax (VAT), Income Tax (IT), Customs and Excise duties for protecting the interests of investors, creditors(lenders), and also to satisfy the legal obligations imposed by the Companies Act 1956 and SEBI from time-to time
ACCOUNTING AS AN INFORMATION SYSTEM In 1970, the Accounting Principles Board of The American Institute of certified Public Accountants (AICPA) emphasized that the function of accounting is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decisions.
Accounting is also often called the “Language of Business”. It is the common language used to communicate financial information to individuals, organisations, government agencies about various aspects of business such as financial position, operating results (i.e. Profit or loss) and cash flows. Users require financial information for the purpose of making decisions.
Users, both inside and outside the business, have to make decisions concerning the allocation of limited economic resources. In order to ensure that resources are allocated in an efficient
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and effective manner, Accounting provides information that is useful in making business and economic decisions. It is the primary means of communicating financial information to owners, lenders,
managers,.Government and its regulatory agencies ‘-and -others- who have interest in an enterprise. It helps the users in taking better decisions by providing relevant, reliable and timely information on the financial and operational position of an enterprise.
Accounting as a Source of Information Accounting is a definite processes of interlinked activities,(refer figure 1.1) that begins with the identification of transactions and ends with the preparation of financial statements. Every step in the process of accounting generates information. Generation of information is not an end in itself.It is a means to facilitate the dissemination of information among different user groups. Such information enables the interested parties to take appropriate decisions. Therefore, dissemination of information is an essential function of accounting. To be useful, the accounting information should ensure to: • provide information for making economic decisions; • serve the users who rely on financial statements as their principal source of information; • provide information useful for predicting and evaluating the amount, timing and uncertainty of potential cash-flows; • provide information for judging management’s ability to utilise resources effectively in meeting goals; • provide factual and interpretative information by disclosing underlying assumptions on matters subject to interpretation, evaluation, prediction,or estimation; and • provide information on activities affecting the society.
BOOK KEEPING AND ACCOUNTING BOOK KEEPING Recording of business transactions in a systematic manner in the books of account is called book-keeping. “The art of keeping a permanent record of business transactions is book keeping”. Book-Keeping is concerned with recording of financial data
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R.N. Carter says, “Book-keeping is the science and art of correctly recording in the books of
account all those business transactions that result in the transfer of money or money’s worth”. From book keeping important details such as total sales, total purchases,total cash receipts, total payments, etc. may be ascertained. As you know the main objective of business is to earn profits. In order to achieve this objective, mere recording of business transactions is not enough. Accounting involves not only book keeping but also many other activities The activities of book-keeping include recording in the journal, posting to the ledger and balancing of accounts. Difference between book keeping and accounting
Book keeping and accounting can be differentiated on the basis of nature, objective, function,basis, level of knowledge, etc. Objectives of Book Keeping The objectives of book-keeping are
i. to have permanent record of all the business transactions. ii. to keep records of income and expenses in such a way that the net profit or net loss may be calculated. iii. to keep records of assets and liabilities in such a way that the financial position of the business may be ascertained. iv. to keep control on expenses with a view to minimise the same in order to maximise profit. v. to know the names of the customers and the amount due from them. vi. to know the names of suppliers and the amount due to them. vii. to have important information for legal and tax purposes Advantages of Book Keeping
From the above objectives of book-keeping, the following advantages can be noted i. Permanent and Reliable Record: Book-keeping provides permanent record for all
business transactions, replacing the memory which fails to remember everything. ii. Arithmetical Accuracy of the Accounts: With the help of book keeping trial balance can
be easily prepared. This is used to check the arithmetical accuracy of accounts. iii. Net Result of Business Operations: The result (Profit orLoss) of business can be
correctly calculated. iv. Ascertainment of Financial Position: It is not enough to know the profit or loss; the
proprietor should have a full picture of his financial position in business. Once the full picture (say for a year)is known, this helps him to plan for the next year’s business.
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v. Ascertainment of the Progress of Business: When a proprietor prepares financial
statements evey year, he will be in a position to compare the statements. This will enable him to ascertain the growth of his business. Thus book keeping enables a long range planning of business activities besides satisfying the short term objective of calculation of annual profits or losses. vi. Calculation of Dues : For certain transactions payments may be made later. Therefore,
the businessman has to know how much he has to pay others. vii. Control over Assets: In the course of business, the proprietor acquires various assets like
building, machines, furnitures, etc. He has to keep a check over them and find out their values year after year. viii. Control over Borrowings: Many businessmen borrow from banks and other sources.
These loans are repayable. Just as he must have a control over assets, he should have control over liabilities. ix. Identifying Do’s and Don’ts : Book keeping enables the proprietor to make an intelligent
and periodic analysis of various aspects of the business such as purchases, sales, expenditures and incomes. From such analysis, it will be possible to focus his attention on what should be done and what should not be done to enhance his profit earning capacity. x. Fixing the Selling Price : In fixing the selling price, the businessmen have to consider
many aspects of accounting information such as cost of production, cost of purchases and other expenses. Accounting information is essential in determining selling prices. xi. Taxation: Businessmen pay sales tax, income tax, etc. The tax authorities require them to
submit their accounts. For this purpose,they have to maintain a record of all their business transactions. xii. Management Decision-making: Planning, reviewing,revising, controlling and decision-
making functions of the management are well aided by book-keeping records and reports. xiii. Legal Requirements: Claims against and for the firm in relation to outsiders can be
confirmed and established by producing the records as evidence in the court. Table 1.1 Difference between Book Keeping and Accounting Basis of Difference
Book-keeping
Accounting
Scope
Recording and maintenance of books of accounts.
It is not only recording and maintenance of books of accounts but also includes analysis, interpreting and communicating the information. Secondary stage. Accounting begins
Stage
Primary stage. Book-keeping is the
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Objective Nature Responsibility Supervision
Staff involved
first step to where bookkeeping accounting. ends. To maintain systematic records of To ascertain the net result of the business transactions. business operation. Analytical and executive in nature.. Often routine and clerical in nature. A book-keeper is responsible for recording business transactions. The b ook-keeper does n ot s upervise and check the work of an Accountant.
An accountant is also responsible for the work of a book-keeper. An accountant supervises and checks the work of the book-keeper. Work is done by the junior staff of the Senior staff performs the accounting work. organisation
Accountancy, Accounting and Book-keeping Accountancy refers to a systematic knowledge of accounting. It explains “why to do” and
“how to do” of various aspects of accounting. It tells us why and how to prepare the books of accounts and how to summarize the accounting information and communicate it to the interested parties. Accounting refers to the actual process of preparing and presenting the accounts. In other
words, it is the art of putting the academic knowledge of accountancy into practice. Book-keeping is a part of accounting and is concerned with record keeping or maintenance
of books of accounts. It is often routine and clerical in nature.
Relationship between Accountancy, Accounting and Book-keeping Book-keeping provides the basis for accounting and it is complementary to accounting process. Accounting begins where book-keeping ends. Accountancy
includes accounting and book-keeping.
The
terms
Accounting and
Accountancy are used synonymously. BRANCHES AND OBJECTIVES OF ACCOUNTING Branches of accounting
The changing requirements of the business over the centuries have given rise to specialized branches of accounting and these are : Financial accounting
It is concerned with recording the transactions of financial character, summarising and interpreting them and communicating the results to the users. It ascertains profit earned or loss incurred during a period (usually one year as accounting year) and the financial position as on the date when the accounting period ends. It can provide financial information required by the management and other parties. The word accounting and financial accounting are used interchangeably. At present we are concerned with financial accounting only.
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Cost accounting
It analyses the expenditure so as to ascertain the cost of various products manufactured by the firm and fix the prices. It also helps in controlling the costs and providing necessary costing information to management for decision making. Management accounting
It is concerned with generating information relating to funds, cost and profits etc. This enables the management in decision making. Basically, it is meant to assist the management in taking rational policy decisions and to evaluate the impact of its decisions and actions and the performance of various departments.. As a result, the scope of accounting has become so vast, that new areas like human resource accounting, social accounting, responsibility accounting have also gained prominance.
Branches of Accounting The economic development and technological improvements have resulted in an increase in the scale of operations and the advent of the company form of business organisation. This has made the management function more and more complex and increased the importance of accounting information. This gave rise to special branches of accounting. These are briefly explained below : Financial accounting : The purpose of this branch of accounting is to keep a record of all
financial transactions so that: (a) the profit earned or loss sustained by the business during an accounting period can be worked out, (b) the financial position of the business as at the end of the accounting period can be ascertained, and (c) the financial information required by the management and other interested parties can be provided. Cost Accounting : The purpose of cost accounting is to analyse the expenditure so as to
ascertain the cost of various products manufactured by the firm and fix the prices. It also helps in controlling the costs and providing necessary costing information to management for decision-making.
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Management Accounting : The purpose of management accounting is to assist the
management in taking rational policy decisions and to evaluate the impact of its decisons and actions.
Objectives of financial accounting The main objectives of financial accounting are as under : 1 )Finding out various balances
Systematic recording of business transactions provides vital information about various balances like cash balance, bank balance, etc. 2)Providing knowledge of transactions Systematic maintenance of books provides the details of every transactions.Ascertaining net profit or loss 3) Summarisation in form of Profit and Loss Account provides business income over a period of time. 4)Depicting financial position Balance sheet is prepared to depict financial position of business means what the business owns and what owes to others. 5) Information to all interested users After analysis and interpretation, business performance and position are communicated to the interested users. 6) Fulfilling legal obligations Vital accounting information helps in fulfilling legal obligations e.g. sales tax, income tax etc.
Functions of Accounting The function of accounting is To provide quantitative information primarily financial in nature about economic entities, which is intended to be useful in making economic decisions. Financial accounting
performs the following major functions: 1)Maintaining systematic records Business transactions are properly recorded, classified under appropriate accounts and summarized into financial statements. 2) Communicating the financial results It is used to communicate financial information in respect of net profits (or loss), assets, liabilities etc. to the interested parties.
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3) Meeting Legal Requirements The provisions of various Laws such as Companies Act, 1956 Income Tax and Sales/VAT Tax Acts, require the submission of various statements i.e. Annual accounts, Income Tax returns, Returns for VAT etc. 4) Fixing responsibility It helps in computation of profits of different departments of an enterprise.This facilitates the fixing of the responsibility of departmental heads. 5) Decision making It provides the users the relevant data to enable them make appropriate decisions in respect of investment in the capital of the business enterprise or to supply goods on credit or lend money etc.
Limitations of Accounting 1. Accounting information is expressed in terms of Money : Non monetary events or transactions are completely omitted. 2. Fixed assets are recorded in the accounting records at the original cost : Actual amount spent on the assets like building, machinery, plus all incidental charges is recorded. In this way the effect of rise in prices not taken into consideration. As a result the Balance Sheet does not represent the true financial position of the business. 3. Accounting information is sometimes based on estimates: Estimates are often
inaccurate. For example, it is not possible to predict the actual life of an asset for the purpose of depreciation. 4. Accounting information cannot be used as the only test of managerial performance on the basis of mere profits : Profit for a period of one year can readily be manipulated by
omitting certain expenses such as advertisement, research and development, depreciation etc. i.e. window dressing is possible. 5. Accounting information is not neutral or unbiased : Accountants ascertain income as excess of revenue over expenses. But they consider selected revenue and expenses for calculating profit of the concern. They also do not include cost of such items as water, noise or air pollution i.e. social cost they may use different methods of valuation of stock or depreciations.
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Role of an Accountant in Society The accountant with his specialized knowledge, extensive training and experience is not merely suitable for making accounts. Rather he/she is the best equipped to provide other related services normally required by the management. This helps the management to discharge their duties more effectively thereby providing for efficient utilization of resources. The accountants’ role in the society includes the following
l )To maintain the proper books of accounts which portray the true and fair view of the results of the business. 2) To provide information and reports to management to enable them to discharge their duties more effectively. 3)To act as auditor for attestation of accounts as per the requirement of law. 4) To act as an internal auditor to assist and strengthen the hands of the management. 5)To act as tax consultant to handle the tax matters of the business. 6) To act as management consultant to provide services regarding financial planning of the business to their clients.
Qualitative Characteristics/ (Attributes) of Accounting Information Qualitative characteristics are the attributes of accounting information which tend to enhance its understandability and usefulness. In order to assess whether accounting information is decision useful, it must possess the characteristics of reliability, relevance, understandability and comparability . 1) Reliability Reliability means the users must be able to depend on the information. The reliability of accounting information is determined by the degree of correspondence
between what the information conveys about the transactions or events that have occurred, measured and displayed. A reliable information should be free from error and bias and faithfully represents what
it is meant to represent. To ensure reliability, the information disclosed must be credible, verifiable by independent parties use the same method of measuring, and be neutral and faithful (refer figure 1.3). 2)Relevance To be relevant, information must be available in time, must help in prediction and feedback,
and must influence the decisions of users by : (a) helping them form prediction about the outcomes of past, present or future events; and/or
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(b) confirming or correcting their past evaluations. 3) Understandability
Understandability means decision-makers must interpret accounting information in the same sense as it is prepared and conveyed to them. The qualities that distinguish between good and bad communication in a message are fundamental to the understandability of the message. A message is said to be effectively communicated when it is interpreted by the receiver of the message in the same sense in which the sender has sent. Accountants should present the comparable information in the most intenlligible manner without sacrificing relevance and reliability. 4.Comparability
It is not sufficient that the financial information is relevant and reliable at a particular time, in a particular circumstance or for a particular reporting entity. But it is equally important that the users of the general purpose financial reports are able to compare various aspects of an entity over different time period and with other entities. To be comparable, accounting reports must belong to a common period and use common unit of measurement and format of reporting.
Different Roles of Accounting 1 As a language – it is perceived as the language of business which is used to communicate information on enterprises; 2 As a historical record- it is viewed as chronological record of financial transactions of an organisation at actual amounts involved; 3 As current economic reality- it is viewed as the means of determining the true income of an entity namely the change of wealth over time; 4.As an information system – it is viewed as a process that links an information source (the accountant) to a set of receivers (external users) by means of a channel of communication; 5. As a commodity- specialised information is viewed as a service which is in demand in society, with accountants being willing to and capable of providing it.
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BASIC TERMS IN ACCOUNTING 1)Business Entity/ Entity/Accounting entity Entity means a thing that has a definite individual existence. Business entity means a
specific identifiable business enterprise like Big bazaar, Super Bazaar, Your father’s shop, Transport limited, etc. An accounting system is always devised for specific business entity (may be called an accounting entity).
Proprietor A person who owns a business is called its proprietor. He contributes capital to the business with the intention of earning profit. 2)Transaction An economic activity that affects financial position of the business and can be measured in terms of money e.g. sale of goods, paying for expenses etc. A event involving some value between two or more entities. It can be
a purchase of goods, receipt of money, payment to a creditor, incurring expenses, etc. It can be a cash transaction or a credit transaction. Cash Transaction is one where cash receipt or payment is involved in the transaction. For
example, When Ram buys goods from Kannan paying the price of goods by cash immediately, it is a cash transaction. Credit Transaction is one where cash is not involved immediately but will be paid or
received later. In the above example, if Ram, does not pay cash immediately but promises to pay later, it is credit transaction. 3)Voucher
The documentary evidence in support of a transaction is known as voucher. It is a written document in support of a transaction . It is a proof that a particular transaction has taken place for the value stated in the voucher. Voucher is necessary to audit the accounts
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For example, if we buy goods for cash we get cash memo , if we buy on credit we get an invoice,
when we make a payment we get a receipt and so on. Invoice :Invoice is a business document which is prepared when one sell goods to another.
The statement is prepared by the seller of goods. It contains the information relating to name and address of the seller and the buyer, the date of sale and the clear description of goods with quantity and price.. Receipt
Receipt is an acknowledgement for cash received. It is issued to the party paying cash. Receipts form the basis for entries in cash book. 4 Liabilities
Liabilities are obligations or debts that an enterprise has to pay at some time in the future. Liabilities can be classified as : 1. Long-term liabilities are those that are usually payable after a period of one Year e.g. a
long term loan from a financial institution. 2. Short-term liabilities are obligations that are payable within a period of one year , for
example, creditors, bills payable, bank overdraft etc. 5.Capital
Amount invested by the owner in the firm is known as capital. It may be brought in the form of cash or assets by the owner It is the amount invested in an enterprise by its owners e.g. paid up share capital in a corporate enterprise.
It also refers to the interest of owners in the assets of an enterprise Capital is an obligation and a claim on the assets of business. It is, therefore,shown as
capital on the liabilities side of the balance sheet Any amount contributed by the owner towards the business unit is a liability for the business enterprise.This liability is also termed as capital which may be brought in the form of cash or assets by the owner. 6.Drawings
Withdrawal of money and/or goods by the owner from the business for personal use is known as drawings. Drawings reduces the investment of the owners. 7. Assets
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Assets are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets are items of value used by the business in its operations. Assets are purchased for business use and are not for sale. They raise the profit earning capacity of the business enterprise. Tangible Assets : These are tangible objects or rights owned by the enterprise and carrying
probable future benefits. Tangible items are those which can be touched and their physical presence can be noted/felt e.g. furniture, machine etc. Intangible Assets Intangible assets/ rights are those rights which one possesses but cannot
see or intangible rights owned by the enterprise and carrying probable future benefits. e.g. patent rights, copyrights, goodwill etc. Assets can further be broadly classified into two types : 1. Fixed Assets/ Non-current assets are assets used for normal operations and held on a long-term basis, such as land, buildings, machinery, plant, furniture and fixtures etc.
Such assets raise the profit earning capacity of the business enterprise. Expenditure on such assets is of non-recurring and of capital nature. Expenses incurred on acquiring these assets are added to the value of the assets. 2. Current Assets are assets held for a short-term and converted into cash within one year such as such as debtors(accounts receivable), bills receivable (notes receivable), stock
(inventory), temporary marketable securities, cash and bank balances. Etc The balance of such items goes on fluctuating i.e. it keeps on changing throughout the year The balance of cash in hand may change so many times in a day 3.Liquid Assets− Assets that are kept either in cash or cash equivalents are regarded as
liquid assets. These can be converted into cash in a very short period of time; for example, cash, bank, bills receivable, etc. 4Fictitious Assets− These are the heavy revenue expenditures, the benefit of whose can be
derived in more than one year. They represent loss or expense that are written off over a period of time, for example, if advertisement expenditure is Rs 1,00,000 for 5 years, then each year Rs 2,00,000 will be written off. 8.Goods
The products in which the business deal in. The items that are purchased for the purpose of resale not for use in the business are called goods.
9. Purchases The term Purchases is used only for the goods procured by a business for resale. 17
Purchases are total amount of goods procured by a business on credit and on cash, for use or sale. OR Purchase of goods is the sum of cash purchases and credit purchases. In a trading concern , purchases are made of merchandise for resale with or without
processing. In a manufacturing concern , raw materials are purchased, processed further into finished
goods and then sold. Purchases may be cash purchases or credit purchases. Purchases Return or Returns Outward
When goods are returned to the suppliers due to defective quality or not as per the terms of purchase, it is called as purchases return. To find net purchases, purchases return is deducted from the total purchases. 10.Expenditure Spending money or incurring a liability for some benefit, service or property received is called expenditure. Payment of rent, salary, purchase of goods, purchase of machinery, purchase of furniture, etc. are examples of expenditure. Expenditure can be classified into Revenue expenditure If the benefit of expenditure is exhausted within a year, it is treated as
an expense called revenue expenditure Capital Ependiture If the benefit of an expenditure lasts for more than a year, it is treated
as an asset also called capital expenditure such as purchase of machinery, furniture, etc.10. 11.Expenses Costs incurred by a business in the process of earning revenue are known as expenses. Generally, expenses are measured by the cost of assets consumed or services used during an accounting period.
The usual items of expenses are: depreciation, rent, wages, salaries, interest, cost of heater, light and water,telephone, etc.
12 Revenue/ Income Revenues Revenue means the income from any source. It should be of regular nature. These are the amounts of the business earned by selling its products or providing services to customers, called sales revenue. Other items of revenue common to many businesses are: commission, interest, dividends, royalities,rent received, etc. Revenue is also called income.
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Income The difference between revenue and expense is called income. For example,goods costing
Rs.25000 are sold for Rs.35000, the cost of goods sold, i.e.Rs.25000 is expense, the sale of goods, i.e. Rs.35000 is revenue and the difference. i.e. Rs.10000 is income. In other words, we can state that income = Revenue - Expense
13 Sales Sales revenue is the amount by selling its products or providing services to customers. Sales
are total revenues from goods sold or services provided to customers.Sales may be cash sales or credit sales Sales Return or Returns Inward
When goods are returned from the customers due to defective quality or not as per the terms of sale, it is called sales return or returns inward. To find out net sales, sales return is deducted from total sales. 14.Profit
The excess of revenues of a period over its related expenses during an accounting year profit. Profit = Revenue- Expenses Profit increases the investment of the owners. It is the excess of revenue of a business over its costs. Profit can further be classified into Gross profit.: Gross profit is the difference between sales revenue or the proceeds of goods
sold and/or services provided over its direct cost of the goods sold. Net profit : Net Profit is the profit made after allowing for all types of expenses. 15.Gain A non-recurring profit from events or transactions incidental to business such as sale of
fixed assets, appreciation in the value of an asset etc.. Usually this term is used for profit of an irregular nature , for example, capital gain. 16.Loss
The excess of expenses of a period over its related revenues its termed as loss. e.g., cash or goods lost by theft of fire etc. Loss = Expenses- Revenue It decreases in owner’s equity.
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It also refers to money or money’s worth lost (or cost incurred) without receiving any benefit in return, e.g., cash or goods lost by theft or a fire accident, etc. It also includes loss on sale of fixed assets It means something against which the firm receives no benefit. 17. Discount
Discount is the rebate given by the seller to the buyer. Discount is the deduction in the price of the goods sold. It can be classified as : 1. Trade discount : The purpose of this discount is to persuade the buyer to buy more goods.
It is offered at an agreed percentage of list price at the time of selling goods. This discount is not recorded in the account books as it is deducted in the invoice/cash memo. It is generally offered by manufactures to wholesellers and by wholesellers to retailers. 2. Cash discount : After selling the goods on credit basis the debtors may be given certain deduction in amount due in case if they pay the amount within the stipulated period or earlier This deduction is given at the time of payment on the amount payable. Hence, it is
called as cash discount The objective of providing cash discount is to encourage the debtors to pay the dues promptly. This discount is recorded in the account books. 17.Closing Stock/(inventory)
It is the value of the goods lying unsold at the end of accounting year. Stock (inventory) is a measure of something on hand-goods, spares and other items in a business. It is called Stock in hand. In a trading concern, the stock on hand is the amount of goods which are lying unsold as at
the end of an accounting period is called closing stock (ending inventory). In a manufacturing company , closing stock comprises raw materials, semi-finished goods
and finished goods on hand on the closing date. Similarly, opening stock (beginning inventory) is the amount of stock at the beginning of
the accounting period. Closing stock of one year becomes the opening stock of next year. 18..Debtors/ Sundry Debtors
Debtors are persons and/or other entities who owe to an enterprise an amount for buying goods and services on credit. 20
Persons who are to pay for goods sold or services rendered or in respect of contractual obligations.. The total amount standing against such persons and/or entities on the closing date, is shown in the balance sheet as sundry debtors on the asset side. It is also termed as debtor, trade debtor, and accounts receivable 19.Sundry creditors Creditors are persons and/or other entities
who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit. The total amount standing to the favour of such persons and/or entities on the closing date, is shown in the Balance Sheet as sundry creditors on the liabilities side.. 20.Depreciation : It is a measure of the wearing out, consumption or other loss of value of a
fixed asset arising from use, afflux of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. 21.Account
Account is a summary of relevant business transactions at one place relating to a person, asset, expense or revenue named in the heading. An account is a brief history of financial transactions of a particular person or item. An account has two sides called debit side and credit side.
Need and Importance of Accounting When a person starts a business, whether large or small, his main aim is to earn profit. He receives money from certain sources like sale of goods, interest on bank deposits etc. He has to spend money on certain items like purchase of goods, salary, rent, etc. These activities take place during the normal course of his business. He would naturally be anxious at the year end, to know the progress of his business. Business transactions are numerous, that it is not possible to recall his memory as to how the money had been earned and spent. At the same time, if he had noted down his incomes and expenditures, he can readily get the required information. Hence, the details of the business transactions have to be recorded in a
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clear and systematic manner to get answers easily and accurately for the following questions at any time he likes.
i. What has happened to his investment? ii. What is the result of the business transactions? iii. What are the earnings and expenses? iv. How much amount is receivable from customers to whom goods have been sold on credit? v. How much amount is payable to suppliers on account of credit purchases? vi. What are the nature and value of assets possessed by the business concern? vii. What are the nature and value of liabilities of the business concern? These and several other questions are answered with the help of accounting. The need for recording business transactions in a clear and systematic manner is the basis which gives rise to Book-keeping.
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