Chapter: 1 Meaning, Objectives and Basic Accounting Terms.

What is accounting?
Accounting is the art of recording, classifying, and summarizing in a significant manner and in terms
of money, transactions and events which are, in part at least, of financial character, and interpreting the results of it. The systematic recording, classifying, and analysis of financial transactions of a business

Attributes of Accounting:
Financial transaction:
A financial transaction is an agreement, communication, or movement carried out between a buyer and a seller to exchange goods and services for payment, that effects the financial position of the business. Types of Transactions: Cash Transaction: When cash is paid or received on entering in to the transaction is called cash transaction. Credit Transaction: If one promises to pay latter is called credit transaction.

Recording of financial transaction: Recording business transaction in the books of account in a

systematic manner soon after the occurrence of it.Recording is done in the book called Journal. Transactions include sales, purchases, income, receipts and payments by an individual or organization.

Classifying: Classifying is the process of grouping of transactions or entries of one nature at on place.
This is done by opening account in the books called ledger.

Summarizing: Summarizing is the art of presenting the classified data (Ledger) in an understandable
manner and useful to management and other interested parties. This involves preparation of final accounts which includes Trading and profit and loss account and balance sheet.

Analysis and interpretation

The purpose of the data analysis and interpretation is to transform the data collected into reliable facts about the development and performance of the business.

Parties interested in Accounting Information:

Owners, Investors, Creditors, Lenders, Employees and workers, Managers, Government, Researchers

Objectives of accounting:
Maintenance of business records. Calculation of profit and loss Depiction of Financial Position Making the information available to various groups and managers

Advantages of accounting
Assistance to management Replacement of memory

Comparative study Settlement of Taxation liability Evidence in court Sale of business Assistance to an insolvent person

Disadvantages of accounting
Accounting is not fully exact Accounting will not fully include what business will realize, if sold Accounting does not tell the whole story Accounting statement may be drawn up wrongly

Accounting terminology
Capital:
Money invested (cash or asset form) in the business by the owners. Also called equity

Liabilities:
What your business have to pay to creditors or outsiders. Examples are accounts payable, loans payable.

Long Term Liabilities or current Liabilities

Liabilities those are not due within one year. An example would be a mortgage payable.

Accounts Payable
Also called A/P or Creditors, Accounts payable are the bills your business owes to suppliers.

Accounts Receivable
Also called A/R or Debtors, accounts receivable are the amounts owed to you by your customers.

Accrual Based Accounting

With the accrual method, you record income when the sale occurs, not necessarily when you receive payment. You record an expense when you receive goods or services, even though you may not pay for them until later.

Assets
Things of value held by the business, Assets are balance sheet accounts. Examples of assets are accounts receivable, furniture, fixtures and bank accounts.

Balance Sheet
Also called a statement of financial position, it is a financial "snapshot" of your business at a given point in time. It lists your assets, your liabilities, and the difference between the two, which is your equity, or net worth

Cash Based Accounting

If you use the cash method, you record income only when you receive cash from your customers. You record an expense only when you write the check to the vendor.

Cost of Goods Sold

(COGS) Cost of items or services sold to your customers.

Creditor
A company or individual whom you have to pay money

Credits
At least one component of every accounting transaction (journal entry) is a credit. Credits increase liabilities and equity and decrease assets.

Current Assets
Assets that are in the form of cash or will generally be converted to cash or used up within one year. Examples are accounts receivable and inventory.

Debits
At least one component of every accounting transaction (journal entry) is a debit. Debits increase assets and decrease liabilities and equity.

Debtor
A company or individual who has to pay money to you

Depreciation
An annual write-off of a portion of the cost of fixed assets, such as vehicles and equipment. Depreciation is listed among the expenses on the income statement.

Double Entry Accounting

In double-entry accounting, every transaction has two entries: a debit and a credit (called a journal entry). Debits must always equal credits. All General Ledger based accounting programs use double entry accounting.

Equity or capital
The net worth of your company. Also called owner's equity or capital. Equity comes from investment in the business by the owners, plus accumulated net profits of the business that have not been paid out to the owners.

Fixed Assets
Assets that are generally not converted to cash within one year. Examples are equipment and vehicles.

General Ledger
A general ledger is the collection of all balance sheet, income, and expense accounts used to keep the accounting records of a business. A general ledger works with double entry accounting and journal entries for each transaction.

Profit and loss statement or a "P&L."

It lists your income, expenses, and net profit (or loss). The net profit (or loss) is equal to your income minus your expenses.

Inventory (Stock)
Goods you hold for sale to customers. Inventory can be merchandise you buy for resale, or it can be merchandise you manufacture or process, selling the end product to the customer.

Journal
The chronological, day-to-day transactions of a business are recorded in sales, cash receipts, and cash payment journals.

Net Income
Also called profit or net profit, it is equal to income minus expenses. Net income is the bottom line of the income statement (also called the profit and loss statement).

Retained Earnings
Profits of the business that have not been paid to the owners; profits that have been "retained" in the business.

Trial Balance
A list of the categories (or general ledger accounts) and their totals

Revenue:
Revenue means the amount which, as a result of operations, is added to the capital.

Expense:

Expense is the cost of the use of things or services for the purpose of generating the revenue.

Purchase:
The term purchase is used for the purchase of goods meant for resale or for producing the finished goods. The term includes both cash and credit purchase

Sales:
This term is used for the sale of goods only. Sale includes both cash and credit sales.

Stock:
The term stock includes the goods lying unsold on a particular date, to ascertain the value of closing stock, it is necessary to make a complete list of all the items in the godown together with quantities. The stock is valued on the basis of stock or market prices which ever is less principle. The stock may be opening and closing stock.

Opening Stock:
The term opening stock means goods lying unsold in the beginning of the accounting year

Closing Stock:
The term closing stock means goods lying unsold at the end of the accounting year

Losses:
Losses really mean something against which the firm receives no benefit. It may be noted that expenses lead to revenue but loses do not, such as theft. Some time the expenses exceeds the revenue, this shows that the extra expenses does not contribute anything to generate the revenue hence they are also loses.

Proprietor:
The person who makes the investment and bears all the risks connected with the business is called the proprietor.

Drawings:
It is the amount of money or value of goods which the proprietor takes for his domestic or personal use.

Discount:
When customer are allowed any type of reduction in the prices of goods by the businessman, that is called discount.

Trade discount:
When some discount is allowed in prices of goods on the basis of sales of the items, that is called trade discount.

Cash discount:
When debtors are allowed some discount in prices of the goods for quick payment, it is called cash discount.

Chapter: 2 Theory Base of Accounting

Basic accounting principles and assumptions
Accounting principles and assumptions are the essential guidelines under which businesses prepare their financial statements. These principles guide the methods and decisions for a business over a short and long term. For both internal and external reporting purposes, it is important to understand the concepts presented below because they serve as a guideline to the analysis of financial reporting issues.

Revenue Recognition Principle

Under this principle revenue is to be recorded when it is realized (or realizable), and when it is earned and not when it is received. Revenue is realized when goods or services are exchanged, is realizable when assets received can be converted to cash, and is earned when all necessary requirements are met entitling the company to the benefits represented by the revenue (e.g. services performed). For example, suppose a neighborhood coffee house orders 100 coffee mugs from a coffee wholesaler in June. The coffee house takes delivery of the new mugs in July and pays for the order in August. The wholesaler does not recognize the revenue from this sale in June, when the order was placed, or in August, when the cash was received. For recording purposes, the revenue is recognized by the wholesaler in July, when the coffee mugs were delivered to the coffeehouse. This principle is used for the recognition of revenue for both goods and services. For example, if an attorney is hired with an agreed upon retainer fee of Rs.2,500 in May, and the services are not performed until July, the attorney does not recognize the revenue until July. The attorney must earn the income before it can be recorded as such, even though he/she received cash for the service at an earlier date.

Historical Cost Principle

The historical cost principle deals with the valuation of both assets and liabilities. The value at the time of acquisition is used to value most assets and liabilities. For example, say the coffee wholesaler purchased an office building in 1990 for Rs.1.2 crore. Over time this asset has most likely appreciated in value. However, in accordance with the cost principle, the original (historical) price of the building is what is recorded as the cost of the building in the books of the business.

Matching Principle
This principle mandates that the expenses of a business need to line up with its revenue. The expense or cost of doing business is recorded in the same period as the revenue that has been generated as the result of incurring that cost. In the case of the coffee wholesaler, when the 100 coffee mugs were delivered in July they changed from being a part of inventory (asset) to a cost of goods sold entry (expense) in the month that the revenue from the sale was recognized. At this point, the difference between the revenue and expense is determined as the gross profit from the sale.

Full Disclosure Principle

This principle states that all past, present and future information that may have had an impact on the financial performance of the company needs to be fully disclosed. The historical performance of a company is readily available, but examining the numbers does not always provide the entire financial picture of a company. Sometimes there are alternative situations that need to be reported. Pending or current lawsuits are one example of a transaction that could severely impact a companys bottom line. In addition, incomplete financial transactions or any other conditions that could impact the companys performance must also be disclosed. Most of these transactions are disclosed in the footnotes to the financial statements.

Economic Entity Assumption

Under the economic entity assumption, an economic activity can be identified to a separate entity accountable for that activity. In other words, this assumption states that businesses must keep their transactions separate from their owners, business units or other businesses transactions. For example, the business activities of the neighborhood coffee house are to be kept separate from the financial activities of its owners or managers. The financial statements for the coffee house will only reflect the revenue and expenses for the coffee house. Thus,

it is possible to compare the financial statements of this coffeehouse with its competitors reports, since these statements should be reported separately under the economic entity assumption. Important to note, a separate entity does not necessary mean a legal entity. For example, financial statements for a parent company and its subsidiaries (i.e. separate legal entities) can be presented together (i.e. consolidated financial statements).

Going Concern Assumption

For accounting purposes, the going concern assumption states that the financial activities of a business are assumed to be in operation for an indefinite period of time. This allows a business to operate with a view towards a long term. This is a very critical assumption as it provides that there is no short term end point in which all assets need to be sold and all debt must be paid off. Thus, the going concern assumption makes it possible to depreciate or amortize assets because we assume that businesses will have a long life. For example, if the coffee house was going to be sold, its assets would be valued at their disposal or liquidation value (sales price less expense of disposal). Under the going concern assumption, the coffee house values its assets at their original cost. As we can see, the going concern assumption is only inapplicable when business liquidation is imminent, and it should be used in all other business situations.

Monetary Unit Assumption

This assumption states that information in the financial statements must be expressed in monetary units. The reason is that economic activity is expressed in monetary unit, and thus, it makes sense to apply the same basis for accounting purposes. Monetary units are relevant, universally available, and understandable. Using the neighborhood coffeehouse as an example, the intrinsic value of the best coffee server cannot be valued in the financial statements, regardless of how many customers frequent the coffeehouse due to this individual. The inherent value of this person cannot be quantified in the financial statements as an asset. The monetary unit assumption also states that a stable unit of currency is to be used as the unit of record. In India, the Indian Rupee is typically the currency of choice. Important to note, accounting ignores inflation or deflation and assumes that Indian Rupee remains reasonably stable. For instance, no adjustments are necessary when adding 1990 Rupees to 2010 Rupees, unless economic conditions change dramatically (e.g. hyperinflation).

Time Period Assumption

This assumption allows for the division of businesses operational activities into artificial time periods for reporting purposes as determined by the business owners. The coffeehouse can record information on a daily, weekly, monthly, quarterly and yearly basis during a time frame they deem relevant. However, there is a tradeoff between the accuracy (reliability) and relevancy in preparing financial statements: the more quickly a company presents financial data, the more likely such data contains errors (i.e. less reliable information).

Chapter: 3 Accounting Equations & Accounting Formats

The 'basic accounting equation' is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits.

Assets = Liabilities + Owner's Equity

What a company owns must always equal (=) What it owes to its creditors Plus (+) what it owes to the owner or owners

What is Asset?
An asset is something of value the company owns. Assets can be tangible or intangible.

Tangible assets:

are generally divided into three major categories:

Current assets (including cash, marketable securities, accounts receivable, inventory, and prepaid expenses) Property, plant, and equipment Long-term investments

Current

assets typically include cash and assets the company reasonably expects to use, sell, or collect within one year. Current assets appear on the balance sheet (and in the numbered list below) in order, from most liquid to least liquid. Liquid assets are readily convertible into cash or other assets, and they are generally accepted as payment for liabilities.

1.

Cash includes cash on hand (petty cash), bank balances (checking, savings, or

money-market accounts), and cash equivalents. Cash equivalents are highly liquid investments, such as certificates of deposit and U.S. treasury bills, with maturities of ninety days or less at the time of purchase. 2. Marketable securities include short-term investments in stocks, bonds (debt), certificates of deposit, or other securities. These items are classified as marketable securities rather than long-term investmentsonly if the company has both the ability and the desire to sell them within one year. 3. Accounts receivable are amounts owed to the company by customers who have received products or services but have not yet paid for them. 4. Inventory is the cost to acquire or manufacture merchandise for sale to customers. Although service enterprises that never provide customers with merchandise do not use this

category for current assets, inventory usually represents a significant portion of assets in merchandising and manufacturing companies. 5. Prepaid expenses are amounts paid by the company to purchase items or services that represent future costs of doing business. Examples include office supplies, insurance premiums, and advance payments for rent. These assets become expenses as they expire or get used up.

Property, plant, and equipment is

the title given to long-lived assets the business uses to help generate revenue. This category is sometimes called fixed assets. Examples include land, natural resources such as timber or mineral reserves, buildings, production equipment, vehicles, and office furniture. With the exception of land, the cost of an asset in this category is allocated to expense over the asset's estimated useful life.

Long-term investments include purchases of debt or stock issued by other companies

and investments with other companies in joint ventures. Long-term investments differ from marketable securities because the company intends to hold long-term investments for more than one year or the securities are not marketable.

Intangible assets:
Intangible assets lack physical substance, but they may, nevertheless, provide substantial value to the company that owns them. Examples of intangible assets include patents, copyrights, trademarks, and franchise licenses. A brief description of some tangible assets follows.

What is Liabilities?
Liabilities are the company's existing debts and obligations owed to third parties. Examples include amounts owed to suppliers for goods or services received (accounts payable), to employees for work performed (wages payable), to banks for principal and interest on loans (notes payable and interest payable). Liabilities are generally classified as Short-term (current) if they are due in one year or less. Long-term liabilities are not due for at least one year. What is owners Capital/Equity? Owner's equity represents the amount owed to the owner or owners by the company. Algebraically, this amount is calculated by subtracting liabilities from each side of the accounting equation. Owner's equity also represents the net assets of the company.

In a sole proprietorship or partnership, owner's equity equals the total net investment in the business plus the net income or loss generated during the business's life. Net investment equals

the sum of all investment in the business by the owner or owners minus withdrawals made by the owner or owners. The owner's investment is recorded in the owner's capital account, and any withdrawals are recorded in a separate owner's drawing account. For example, if a business owner contributes Rs.10,000 to start a company but later withdraws Rs.1,000 for personal expenses, the owner's net investment equals Rs.9,000. Net income or net lossequals the company's revenues less its expenses. Revenues are inflows of money or other assets received from customers in exchange for goods or services.Expenses are the costs incurred to generate those revenues.

Capital investments and revenues increase owner's equity, while expenses and owner withdrawals (drawings) decrease owner's equity. In a partnership, there are separate capital and drawing accounts for each partner.

Sample Problem:
Transaction Assets Liabilities Shareholder's Number Equity Explanation

+ 6,000

6,000

Issuing stocks for cash or other assets

+ 10,000 + 10,000

Buying assets by borrowing money (taking a loan from a bank or simply buying on credit)

900

900

Selling assets for cash to pay off liabilities: both assets and liabilities are reduced

+ 1,000

+ 400

600

Buying assets by paying cash by shareholder's money (600) and by borrowing money (400)

+ 700

700

Earning revenues

200

200

Paying expenses (e.g. rent or professional fees) or dividends

+ 100

100

Recording expenses, but not paying them at the moment

500

500

Paying a debt that you owe

Receiving cash for sale of an asset: one asset is exchanged for another; no change in assets or liabilities

These are some simple examples, but even the most complicated transactions can be recorded in a similar way. This equation is behind debits, credits, and journal entries.

The DEBIT - CREDIT Rule Each of the accounts in a Ledger will have a Debit Column and a Credit Column. Debits and Credits increase or decrease amounts on a ledger page account without having to use a plus (+) or minus (-) sign. No matter what - always DEBIT on the LEFT and CREDIT on the RIGHT. This basic rule never changes.

"T" Accounts Notice in this graphic that DEBIT is on the LEFT and

that CREDIT is on the RIGHT in each of the "T" s. Again, always DEBIT LEFT and CREDIT RIGHT

"T" Accounts Expanded Now that we know that we always debit on the left and credit on the right we can begin to discuss how we INCREASE and DECREASE the balances in accounts. The ( + ) sign means INCREASE and the ( - ) sign means DECREASE. Note that when you cross over the ( = )sign you reverse the way accounts increase and decrease.

Assets: To INCREASE ( + ) the balance in Asset Accounts you DEBIT To DECREASE ( - ) the balance you CREDIT Liabilities: To INCREASE the balance in Liability Accounts you CREDIT To DECREASE the balance you DEBIT Owner's Capital: To INCREASE the balance in Owner's Equity Accounts you CREDIT To DECREASE the balance you DEBIT

T's within Ts

Note: In Balance Sheet, Assets will be on right hand side (RHS) and liabilities on left hand side (LHS)

For Single Proprietor and Partnerships

Dhfghgfjhgfh fghfjg

Note: In Balance Sheet, Assets will be on right hand side (RHS) and liabilities on left hand side (LHS)

The next step is to fill in these Ledger pages using the amounts in the General Journal and show how Posting to Ledger pages is done.

Next we will make a Trial Balance to be sure that all the different accounts are in balance.

Trading and Profit & Loss Account example

Trading and Profit & Loss Account example

Rs Debit Revenues GROSS REVENUES (including INTEREST income) Expenses: ADVERTISING BANK & CREDIT CARD FEES BOOKKEEPING SUBCONTRACTORS ENTERTAINMENT INSURANCE LEGAL & PROFESSIONAL SERVICES LICENSES PRINTING, POSTAGE & STATIONERY RENT 6,300 144 2,350 88,000 5,550 750 1,575 632 320 13,000 296,397 -------Rs Credit

MATERIALS TELEPHONE UTILITIES TOTAL EXPENSES NET INCOME

74,400 1,000 1,491 -------(195,512) -------100,885