Accounts
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accnts...
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1. ACCOUNTING 1.1 Meaning of Accounting Accoun Accountin ting, g, as an inform informati ation on system system is the proces processs of identi identifyi fying, ng, measur measuring ing and communicating the economic information of an organization to its users who need the information for decision making. It identifies transactions and events of a specific entity. A transaction is an exchange in which each participant receives or sacrifices value (e.g. purchase of raw material). An event (whether internal or external) is a happening of consequence to an entity (e.g. use of raw material for production). An entity means an economic unit that performs economic activities. 1.2 Definition of Accounting American Institute of ertified !u"lic Accountants Accountants (AI!A) (AI!A) which defines accounting as #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 a financial character and interpreting the results thereof$. 1.3 Objective of Accounting %"&ective of accounting may differ from "usiness to "usiness depending upon their specific requirements. 'owever, 'owever, the following are the general o"&ectives of accounting. i) To kee keepin ping g !te" !te"ati aticc #eco# #eco#$% $% It is very difficult to remem"er all the "usiness transa transacti ctions ons that that take take place. place. Account ccounting ing serve servess this this purpos purposee of record record keepin keeping g "y promptly recording all the "usiness transactions transactions in the "ooks of account. ii) To ace#tain ace#tain t&e #eu't of t&e ope#ation% Accounting helps in ascertaining result i.e., profit earned or loss suffered in "usiness during a particular period. or this purpose, a "usiness entity prepares either a rading rading and !rofit and *oss account or an Income and +xpenditure account which shows the profit or loss of the "usiness "y matching the items of revenue and expenditure of the some period. iii) iii) To ace ace#t #tai ain n t&e t&e fina financ ncia ia'' poi poiti tion on of t&e buin buine e% % In addi additi tion on to prof profit it,, a "usinessman must know his financial position i.e., availa"ility of cash, position of assets and lia"ilities etc. his helps the "usinessman to know his financial strength. inancial statements are "arometers of health of a "usiness entity. entity. iv) To po#t#a! po#t#a! t&e 'i(ui$it! poition% poition% inancial reporting should provide information a"out how an enterprise o"tains and spends cash, a"out its "orrowing and repayment of "orrowing, a"out its capital transactions, transactions, cash dividends and other distri"utions of reso resour urce cess "y the the ente enterp rpri rise se to owne owners rs and and a"ou a"outt othe otherr fact factor orss that that may may affe affect ct an enterprises liquidity and solvency. v) To p#otect p#otect buine p#ope#tie% Accounting provides upto date information a"out the various assets that the firm possesses and the lia"ilities the firm owes, so that no"ody can claim a payment which is not due to him. vi) vi) To faci faci'i 'ita tate te #ati #ation ona' a' $e $eci cii ion on "akin aking% g% Accou Accounti nting ng record recordss and financ financia iall statements provide financial information which help the "usiness in making rational decisions a"out the steps to "e taken in respect of various aspects of "usiness. vii) To atif atif! ! t&e #e(ui#e"en #e(ui#e"ent t of 'a*% +ntities such as companies, societies,pu"lic trusts are compulsorily required to maintain accounts as per the law governing their operations such as the ompanies Act, -ocieties Act, and !u"lic rust Act etc.
aintenance of accounts is also compulsory under the -ales ax Act and Income ax Act. 1.+ I"po#tance of Accounting i) O*ne O*ne# #%% he owners provide funds or capital for the organization. hey possess curiosity in knowing whether the "usiness is "eing conducted on sound lines or not and whether the capital is "eing employed properly or not. %wners, "eing "usinessmen, always keep an eye on the returns from the investment. omparing the accounts of various years helps in getting good pieces of information. ii) Manage"ent% he management of the "usiness is greatly interested in knowing the position of the firm. he accounts are the "asis, "asis, the management can study the merits and demeri demerits ts of the "usine "usiness ss activi activity ty.. hus, hus, the manage managemen mentt is intere intereste sted d in finan financia ciall accounting to find whether the "usiness carried on is profita"le or not. he financial accounting is the #eyes and ears of management and facilitates in drawing future course of action, further expansion etc.$ iii) iii) C#e$i C#e$ito# to#% % reditors are the persons who supply goods on credit, or "ankers or lenders of money. It is usual that these groups are interested to know the financial soundness "efore granting credit. he progress and prosperity of the firm, two which credits are extended, are largely watched "y creditors from the point of view of security and further credit. !rofit and *oss Account and /alance -heet are nerve centres to know the soundness of the firm. iv) ,"p'o!ee% ,"p'o!ee% !ayment of "onus depends upon the size of profit earned "y the firm. he more important point is that the workers expect regular income for the "read. he demand for wage rise, "onus, "etter working conditions etc. depend upon the profita"ility of the firm and in turn depends upon financial position. or these reasons, this group is interested in accounting. v) Invet Inveto# o#%% he prospective investors, who want to invest their money in a firm, of course wish to see the progress and prosperity of the firm, "efore investing their amount, "y going through the financial statements statements of the firm. his is to safeguard the investment. investment. or this, this group is eager to go through the accounting which ena"les them to know the safety of investment. vi) vi) Gove Gove#n #n"e "ent nt%% 0overn 0overnmen mentt keeps keeps a close close watch watch on the firms which yield yield good good amount of profits. he state and central 0overnments are interested in the financial statem statement entss to know know the earni earnings ngs for the purpos purposee of taxati taxation. on. o compil compilee nation national al accounting is essential. vii) vii) Conu"e# Conu"e#%% hese groups are interested in getting the goods at reduced price. herefore, they wish to know the esta"lishment of a proper accounting control, which in turn will reduce to cost of production, in turn less price to "e paid "y the consumers. 1esearchers are also interested in accounting for interpretation. viii viii)) -ee -eea# a#c& c& c c&o &o'a 'a# #%% Accoun Accountin ting g inform informati ation, on, "eing "eing a mirror mirror of the the financ financial ial performance of a "usiness organization, organization, is of immense value to the research scholar who wants to make a study into the financial operations of a particular firm.o make a study into the financial operations of a particular firm, the research scholar needs detailed accounting information relating to purchases, sales, expenses, cost of materials used,
current assets, current lia"ilities, fixed assets, long2term lia"ilities and share2holders funds which is availa"le in the accounting record maintained "y the firm. 1./ 0unction of Accounting i) -eco#$ eeping 0unction% he primary function of accounting relates to recording, classification and summary of financial transactions2&ournalisation, posting, and preparation of final statements. hese facilitate to know operating results and financial positions. he purpose of this function is to report regularly to the interested parties "y means of financial statements. hus accounting performs historical function i.e., attention on the past performance of a "usiness3 and this facilitates decision making programme for future activities. ii) Manage#ia' 0unction% 4ecision making programme is greatly assisted "y accounting. he managerial function and decision making programmes, without accounting, may mislead. he day2to2day operations are compared with some predetermined standard. he variations of actual operations with pre2determined standards and their analysis is possi"le only with the help of accounting. iii) ega' -e(ui#e"ent function% Auditing is compulsory in case of registered firms. Auditing is not possi"le without accounting. hus accounting "ecomes compulsory to comply with legal requirements. Accounting is a "ase and with its help various returns, documents, statements etc., are prepared. iv) anguage of uine% Accounting is the language of "usiness. 5arious transactions are communicated through accounting. here are many parties2owners, creditors, government, employees etc., who are interested in knowing the results of the firm and this can "e communicated only through accounting. he accounting shows a real and true position of the firm or the "usiness. 1.4 A$vantage of Accounting
he following are the advantages of accounting to a "usiness6 i) It helps in having complete record of "usiness transactions. ii) It gives information a"out the profit or loss made "y the "usiness at theclose of a year and its financial conditions. he "asic function of accounting is to supply meaningful information a"out the financial activities of the "usiness to the owners and the managers. iii) It provides useful information form making economic decisions, iv) It facilitates comparative study of current years profit, sales, expenses etc., with those of the previous years. v) It supplies information useful in &udging the managements a"ility to utilise enterprise resources effectively in achieving primary enterprise goals. vi) It provides users with factual and interpretive information a"out transactions and other events which are useful for predicting, comparing and evaluation the enterprises earning power. vii) It helps in complying with certain legal formalities like filing of incometax and sales2 tax returns. If the accounts are properly maintained, the assessment of taxes is greatly facilitated.
1.5 Met&o$ of Accounting /usiness transactions are recorded in two different ways. 7.8.7 -ingle +ntry 7.8.9 4ou"le +ntry 1.5.1. ing'e ,nt#!% It is incomplete system of recording "usiness transactions. he "usiness organization maintains only cash "ook and personal accounts of de"tors and creditors. -o the complete recording of transactions cannot "e made and trail "alance cannot "e prepared. 1.5.2 Doub'e ,nt#!% It this system every "usiness transaction is having a two fold effect of "enefits giving and "enefit receiving aspects. he recording is made on the "asis of "oth these aspects. 4ou"le +ntry is an accounting system that records the effects of transactions and other events in atleast two accounts with equal de"its and credits. 1.5.3 tep invo've$ in Doub'e ent#! !te" 6a) 7#epa#ation of 8ou#na'% :ournal is called the "ook of original entry. It records the effect of all transactions for the first time. 'ere the &o" of recording takes place. 6b) 7#epa#ation of e$ge#% *edger is the collection of all accounts used "y a "usiness. 'ere the grouping of accounts is performed. :ournal is posted to ledger. 6c) T#ia' a'ance p#epa#ation% -ummarizing. It is a summary of ledge "alances prepared in the form of a list. 6$) 7#epa#ation of 0ina' Account% At the end of the accounting period to know the achievements of the organization and its financial state of affairs, the final accounts are prepared. 2.1 ACCOUNTING CONC,7T AND CON9,NTION:INT-ODUCTION he word ;!rinciple has "een differently viewed "y different schools of thought. he American Institute of ertified !u"lic Accountants (AI!A) has viewed the word ;principle as a general law of rule adopted or professed as a guide to action3 a settled ground or "asis of conduct of practice$ Accounting principles refer, to certain rules, procedures and conventions which represent a consensus view "y those indulging in good accounting practices and procedures. 1ules governing the formation of accounting axioms and the principles derived from them have arisen from common experiences, historical precedent, statements "y individuals and professional "odies and regulations of 0overnmental agencies$. o "e more relia"le, accounting statements are prepared in conformity with these principles. If not, chaotic conditions would result. /ut in reality as all the "usinesses are not alike, each one has its own method of accounting. 'owever, to "e more accepta"le, the accounting principles should satisfy the following three "asic qualities, viz., relevance, o"&ectivity and feasi"ility. he accounting principle is considered to "e relevant and useful to the extent that it increases the utility of the records to its readers. It is said to "e o"&ective to the extent that it is supported "y the facts and free from personal "ias. It is considered to "e feasi"le to the extent that it is practica"le with the least complication or cost. hough accounting principles are denoted "y various terms such as concepts, conventions, doctrines, tenets,
assumptions, axioms, postulates, etc., it can "e classified into two groups, viz., accounting concepts and accounting conventions. 2.2 ACCOUNTING CONC,7T AND CON9,NTION 2.2.1 Accounting concept% he term ;concept is used to denote accounting postulates, i.e., "asic assumptions or conditions upon the edifice of which the accounting super2structure is "ased. he following are the common accounting concepts adopted "y many "usiness concerns. 7. /usiness +ntity oncept 9. oney easurement oncept . 'istorical ost oncept ?. atching oncept @. 1ealisation oncept . Accrual oncept 7B. %"&ective +vidence oncept i) uine ,ntit! Concept% A "usiness unit is an organization of persons esta"lished to accomplish an economic goal. /usiness entity concept implies that the "usiness unit is separate and distinct from the persons who provide the required capital to it. his concept can "e expressed through an accounting equation, viz., Assets C *ia"ilities D apital. he equation clearly shows that the "usiness itself owns the assets and in turn owes to various claimants. It is worth mentioning here that the "usiness entity concept as applied in accounting for sole trading units is different from the legal concept. he expenses, income, assets and lia"ilities not related to the sole proprietorship "usiness are excluded from accounting. 'owever, a sole proprietor is personally lia"le and required to utilize non2"usiness assets or private assets also to settle the "usiness creditors as per law. hus, in the case of sole proprietorship, "usiness and non2"usiness assets and lia"ilities are treated alike in the eyes of law. In the case of a partnership, firm, for paying the "usiness lia"ilities the "usiness assets are used first and it any surplus remains thereafter, it can "e used for paying off the private lia"ilities of each partner. -imilarly, the private assets are first used to pay off the private lia"ilities of partners and if any surplus remains, it is treated as part of the firms property and is used for paying the firms lia"ilities. In the case of a company, its existence does not depend on the life span of any shareholder. ii) Mone! Meau#e"ent Concept% In accounting all events and transactions are recode in terms of money. oney is considered as a common denominator, "y means of which various facts, events and transactions a"out a "usiness can "e expressed in terms of num"ers. In other words, facts, events and transactions which cannot "e expressed in monetary terms are not recorded in accounting. 'ence, the accounting does not give a complete picture of all the transactions of a "usiness unit. his concept does not also take care of the effects of inflation "ecause it assumes a sta"le value for measuring. iii) Going Conce#n Concept% Ender this concept, the transactions are recorded assuming that the "usiness will exist for a longer period of time, i.e., a "usiness unit is considered to "e a going concern and not a liquidated one. Feeping this in view, the suppliers and other companies enter into "usiness transactions with the "usiness unit. his assumption
supports the concept of valuing the assets at historical cost or replacement cost. his concept also supports the treatment of prepaid expenses as assets, although they may "e practically unsalea"le. iv) Dua' Apect Concept% According to this "asic concept of accounting, every transaction has a two2fold aspect, 5iz., 7.giving certain "enefits and 9. 1eceiving certain "enefits. he "asic principle of dou"le entry system is that every de"it has a corresponding and equal amount of credit. his is the underlying assumption of this concept. he accounting equation viz., Assets C apital D *ia"ilities or apital C Assets G *ia"ilities, will further clarify this concept, i.e., at any point of time the total assets of the "usiness unit are equal to its total lia"ilities. *ia"ilities here relate "oth to the outsiders and the owners. *ia"ilities to the owners are considered as capital. 9) 7e#io$icit! Concept% Ender this concept, the life of the "usiness is segmented into different periods and accordingly the result of each period is ascertained. hough the "usiness is assumed to "e continuing in future (as per going concern concept), the measurement of income and studying the financial position of the "uisness for a shorter and definite period will help in taking corrective steps at the appropriate time. +ach segmented period is called #accounting period$ and the same is normally a year. he "usinessman has to analyse and evaluate the results ascertained periodically. At the end of an accounting period, an Income -tatement is prepared to ascertain the profit or loss made during that accounting period and /alance -heet is prepared which depicts the financial position of the "usiness as on the last day of that period. 4uring the course of preparation of these statements capital revenue items are to "e necessarily distinguished. vi) ;ito#ica' Cot Concept% According to this concept, the transactions are recorded in the "ooks of account with the respective amounts involved. or example, if an asset is purchases, it is entered in the accounting record at the price paid to acquire the same and that cost is considered to "e the "ase for all future accounting. It means that the asset is recorded at cost at the time of purchase "ut it may "e methodically reduced in its value "y way of charging depreciation. 'owever, in the light of inflationary conditions, the application of this concept is considered highly irrelevant for &udging the financial position of the "usiness. vii) Matc&ing Concept% he essence of the matching concept lies in the view that all costs which are associated to a particular period should "e compared with the revenues associated to the same period to o"tain the net income of the "usiness. Ender this concept, the accounting period concept is relevant and it is this concept (matching concept) which necessitated the provisions of different ad&ustments for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in advance, etc., during the course of preparing the financial statements at the end of the accounting period. viii) -ea'iation Concept% his concept assumes or recognizes revenue when a sale is made. -ale is considered to "e complete when the ownership and property are transferred from the seller to the "uyer and the consideration is paid in full. 'owever, there are two exceptions to this concept, viz., 7. 'ire purchase system where the ownership is
transferred to the "uyer when the last instalment is paid and 9. ontract accounts, in which the contractor is lia"le to pay only when the whole contract is completed, the profit is calculated on the "asis of work certified each year. i "y prescri"ing formats for the preparation of financial statements. 'owever, the term disclosure does not mean all information that one desires to get should "e included in accounting statements. It is enough if sufficient information, which is of material interest to the users, is included. iii) Cone#vati"% In the prevailing present day uncertainties, the convention of conservatism has its own importance. his convention follows the policy of caution or playing safe. It takes into account all possi"le losses "ut not the possi"le profits or gains. A view opposed to this convention is that there is the possi"ility of creation of secret reserves when conservatism is excessively applied, which is directly opposed to the convention of full disclosure. hus, the convention of conservatism should "e applied very cautiously.
3.1T!pe of Accounting 3.1.1T!pe of Account he o"&ect of "ook2keeping is to keep a complete record of all the transactions that place in the "usiness. o achieve this o"&ect, "usiness transactions have "een classified into three categories6 (i) ransactions relating to persons. (ii) ransactions relating to properties and assets (iii) ransactions relating to incomes and expenses. he accounts falling under the first heading are known as ;personal Accounts.he accounts falling under the second heading are known as ;1eal Accounts, he accounts falling under the third heading are called ;Hominal Accounts. he accounts can also "e classified as personal and impersonal. he following chart will show the various types of accounts6 Accounts !ersonal
Impersonal Hatural 0roups 1epresentative 1eal Hominal angi"le Intangi"le 1evenue, Income and 0ain +xpense and loss Artificial or *egal 3.1.2 7e#ona' Account% Accounts recording transactions with a person or group of persons are known as personal accounts. hese accounts are necessary, in particular, to record credit transactions. !ersonal accounts are of the following types6 6a) Natu#a' pe#on% An account recording transactions with an individual human "eing is termed as a natural persons personal account. eg., Famals account, alas account, -harmas accounts. /oth males and females are included in it 6b) A#tificia' o# 'ega' pe#on% An account recording financial transactions with an artificial person created "y law or otherwise is termed as an artificial person, personal account, e.g. irms accounts, limited companies accounts, educational institutions accounts, o2operative society account. 6c) G#oup=-ep#eentative pe#ona' Account% An account indirectly representing a person or persons is known as representative personal account. Jhen accounts are of a similar nature and their num"er is large, it is "etter tot group them under one head and open a representative personal accounts. e.g., prepaid insurance, outstanding salaries, rent, wages etc. Jhen a person starts a "usiness, he is known as proprietor. his proprietor is represented "y capital account for all that he invests in "usiness and "y
drawings accounts for all that which he withdraws from "usiness. -o, capital accounts and drawings account are also personal accounts. he rule for personal accounts is6 Debit t&e #eceive# C#e$it t&e give# 3.1.3 -ea' Account Accounts relating to properties or assets are known as ;1eal Accounts, A separate account is maintained for each asset e.g., ash achinery, /uilding, etc.,1eal accounts can "e further classified into tangi"le and intangi"le. 6a) Tangib'e -ea' Account% hese accounts represent assets and properties which can "e seen, touched, felt, measured, purchased and sold. e.g. achinery account ash account, urniture account, stock account etc. 6b) Intangib'e -ea' Account% hese accounts represent assets and properties which cannot "e seen, touched or felt "ut they can "e measured in terms of money. e.g., 0oodwill accounts, patents account, rademarks account, opyrights account, etc. Debit *&at co"e in he rule for 1eal accounts is6 C#e$it *&at goe out 3.1.+ No"ina' Account Accounts relating to income, revenue, gain expenses and losses are termed as nominal accounts. hese accounts are also known as fictitious accounts as they do not represent any tangi"le asset. A separate account is maintained for each head or expense or loss and gain or income. Jages account, 1ent account ommission account, Interest received account are some examples of nominal account he rule for Hominal accounts is6
Debit a'' e
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