Accounting Basics
1. Introduction to Accounting
1.1 Definition
“The process of identifying, measuring and communicating economic information to
permit informed judgment and decision by users of the information”.
‐ American Accounting Association
1.2 Objectives of Accounting i. to maintain accounting records. ii. to calculate the result of operations.
1. Introduction to Accounting
1.3 Debtors ‐ Definition
A company or individual who owes money. If the debt is in the form of a loan from a financial institution, the debtor is referred to as a borrower. If the debt is in the form of securities, such as bonds, the debtor is referred to as an issuer.
1.4 Creditors ‐ Definition
A creditor is an individual or institution that lends money or services to another entity under are payment agreement.
1. Introduction to Accounting
Who are creditors?
Let's look at a scenario with a real creditor, XYZ Bank, to whom you go to for a loan. If you are approved and they lend you money, XYZ Bank becomes your creditor.
2. Accounting Equation
The financial position of a company is measured by the following items:
1. Assets (what it owns)
2. Liabilities (what it owes to others)
3. Owner’s Equity (the difference between assets and liabilities)
The accounting equation (or basic accounting equation) offers us a simple way to understand how these three amounts relate to each other. The accounting equation for a sole proprietorship is:
Assets = Liabilities + Owner’s Equity
Assets Liabilities Owners
2. Accounting Equation
2.1 Assets : Assets are a company’s resources—things the company owns. Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and goodwill. From the accounting equation, we see that the amount of assets must equal the combined amount of liabilities plus owner’s (or stockholders’) equity.2.2 Liability : Liabilities are a company’s obligations—amounts the company owes.
Examples of liabilities include notes or loans payable, accounts payable, salaries and wages payable, interest payable, and income taxes payable (if the company is a regular corporation). Liabilities can be viewed in two ways:
(1) as claims by creditors against the company’s assets, and
(2) a source—along with owner or stockholder equity—of the company’s assets.
2.3 Owners Equity : Owner’s equity or stockholders’ equity is the amount left over after
liabilities are deducted from assets:
Assets – Liabilities = Owner’s (or Stockholders’) Equity.
2. Accounting Equation – Cntd.,
Terms
2.4 Double‐entry Book Keeping System
A double‐entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event changes at least two different nominal ledger accounts.
2.5 Credit
An accounting notation that increases liability, equity, and expense accounts. Credits decrease asset and expense accounts.
2.6 Debit
2. Accounting Equation – Cntd.,
2. Accounting Equation – Cntd.,
Example 1
1) Ram purchased furniture for cash = Rs 2,000 2) Outstanding wages = Rs 8,000 3) Cash in hand = Rs 12,000 4) Bank loan = Rs 15,000 5) Purchased land and equipment = Rs 14,000 6) Expenses = Rs 5,000 7) Cash received = Rs 7,000 8) Loan payable = Rs 12,000 Asset LiabilitiesTransaction Value Transaction Value
Ram purchased furniture for cash
2,000 Outstanding wages 8,000
Cash in hand 12000 Bank Loan 15,000
Purchased land and equipment
14000 Expenses 5000
Cash Received 7000 Loans Payable 7000
3. Types of Transactions
Types of Transactions Cash Transactions Credit Transactions Cash Transactions : A transaction that is settled with cash on the same day as the trade. Example : Ram bought a fridge for a cash of 3000 INRCredit Transactions : Credit transactions are dealings which you could pay later.
e.g.. pay for the goods or services at the end of the month or 30 days later. The credit
4.1 Purchases
Purchases Account : A temporary account used in the periodic inventory system to
Sales represents income or revenue for the Organization
Sales refers to the amount of goods sold that are already bought or manufactured by the business. When goods are sold for cash, they are cash sales but if goods are sold and payment is not received at the time of sale, it is credit sales. Total sales includes both cash and credit sales.
5. Types of Accounts
Real Account:‐ Real accounts are related to asset account which can be touched felt, e.g. building account, machinery account , stock, furniture etc
Personal Account:‐ Personal accounts are related to persons , institutions companies. examples : bank account, creditors a/c etc
Nominal Account:‐ Nominal accounts are related to income and expenses or losses and
gains
6. Golden Rules of Accounting
Debit The Receiver, Credit The Giver
This principle is used in the case of personal accounts. When a person gives something to the organization, it becomes an inflow and therefore the person must be credit in the books of accounts. The converse of this is also true, which is why the receiver needs to be debited.
Debit What Comes In, Credit What Goes Out
This principle is applied in case of real accounts. Real accounts involve machinery, land and building etc. They have a debit balance by default. Thus when you debit what comes in, you are adding to the existing account balance. This is exactly what needs to be done. Similarly when you credit what goes out, you are reducing the account balance when a tangible asset goes out of the organization.
Debit All Expenses And Losses, Credit All Incomes And Gains
This rule is applied when the account in question is a nominal account. The capital of the company is a liability. Therefore it has a default credit balance. When you credit all incomes and gains, you increase the capital and by debiting expenses and losses, you decrease the capital. This is exactly what needs to be done for the system to stay in balance.
S NO Debit Credit
1 The Receiver The Giver
2 What comes in What comes out
7 . Introduction of Journal
Journal is a date‐wise record of all the transactions with details of the accounts debited
and credited and the amount of each transaction.
7. Introduction of Journal – Cntd.,
Step No. Process
1 Determine the two accounts which are involved in the transaction 2 Classify the above two accounts under Personal, Real or Nominal 3 Find out the rules of debit and credit for the above two accounts
4 Identify which account is to be debited and which account is to be credited
5 Record the date of transaction in the date column. The year and month is written once, till they change. The sequence of the dates and months should be strictly maintained 6 Enter the name of the account to be debited in the particulars column very close to the
left hand side of the particulars column followed by the abbreviation Dr. in the same line. Against this, the amount to be debited is written in the debit amount column in the same line
7 Write the name of the account to be credited in the second line starts with the word ‘To’ a few space away from the margin in the particulars column. Against this, the amount to be credited is written in the credit amount column in the same line.
8 Write the narration within brackets in the next line in the particulars column.
7 . Introduction of Journal – Cntd.,
Illustration
January 1, 2004 – Saravanan started business with Rs. 1,00,000 8.1 Analysis of Transaction
8 . Introduction of Ledger
‘The book which contains a classified and permanent record of all the transactions of a business is called the Ledger’.
8 . Posting in Ledger
Procedure of posting for an Account which has been debited in the journal entry.
S No. Particulars
1 Locate in the ledger, the account to be debited and enter the date of the transaction in the date column on the debit side.
2 Record the name of the account credited in the Journal in the particular columns of the debit side as “To... (name of the account credited)”.
3 Record the page number of the Journal in the J.F column on the debit side and in the Journal, write the page number of the ledger on which a particular account appears in the L.F. column.
4 Enter the relevant amount in the amount column on the debit side
Procedure of posting for an Account which has been credited in the journal entry
1 Locate in the ledger the account to be credited and enter the date of the transaction in the date column on the credit side.
2 Record the name of the account debited in the Journal in the particulars column on the credit side as “By... (name of the account debited)”
3 Record the page number of the Journal in the J.F column on the credit side and in the Journal, write the page number of the ledger on which a particular account appears in the L.F. column
8. Introduction of Ledger– Cntd.,
Illustration
Mr. Ram started business with cash Rs. 5,00,000 on 1stJune 2003.
9 Trail Balance ‐ Illustration
9 . Trail Balance – Illustration
10. Final Accounts
Final Accounts Trading, Profit and Loss Account Balance Sheet Parts of Final Accounts10.1 Trading Account
Trading means buying and selling. The trading account shows the result of buying and selling of goods.
9.1 FORMAT 9.2 ILLUSTRATION
Prepare a Trading Account from the following information of a trader.
10.2 Profit and Loss A/C
After calculating the gross profit or gross loss the next step is to prepare the profit and loss account. To earn net profit a trader has to incur many expenses apart from those spent for purchases and manufacturing of goods. If such expenses are less than gross profit, the result will be net profit. When total of all these expenses are more than gross profit the result will be net loss.
Need
Format
10.2 Profit and Loss A/C
Illustration
10.3 Balance Sheet
Definition
‘A statement which sets out the assets and liabilities of a business firm and which serves to ascertain the financial position of the same on any particular date’
10.3 Balance Sheet
Illustration
Question