1. Basic Accounting Concepts, Conventions, Bases & Policies, Concept of Balance Sheet

Basic Accounting Concept

Definition of accounting, differences between accountancy and book-keeping, objectives of accounting, definition and classification of accounts, debits and credits, utility of accounting, features of accounting transactions, generally accepted accounting principles (GAAP), double accounting and its principle, accounting concepts & conventions.

Introduction to the concept of the balance sheet.

Concept of accounting

Accounting is a term used to describe a wide range of activities. It may be defined as the identifying, measuring, recording and communicating of financial information. Accounting may also be described as an information system designed to provide, through the medium of financial statements, relevant financial information. Usually the information provide relates to the economics resources owned by an organization.

Definition Of Accounting

According to the American Institute Of Certified Public Accountants “ 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 result thereof.”

The above definition also highlights the steps in the accounting process.

Book-keeping And Accounting

Book- keeping is essential concerned with the recording of financial transaction. Accounting goes a step further. It includes not only the recording of transaction but also summarizing these transactions and analyzing their effect on the working of the business.

Book – keeping provides the preliminary or initial record. Accounting processes this records. Actually, book keeping is a essential part of accounting.

Objective Of Accounting

Accounting must provide a record of all the business transaction in a systematic manner to prevent theft, fraud and error, and provide accurate data for interactions with outside individuals and government.

Accounting must provide information and reports for owners and mangers to assist them in making the best possible decision for the business.

Accounting Concepts, Conventions, Bases & Policies

Concepts vs Conventions

Concepts are the basic ideas, the theories on how and why certain categories of transactions should be treated in a particular manner.

Once the theories have been established and tested and proved to be acceptable, the task of the Conventions is to set out the limit of their applications.

Accounting Concepts 1. Business Entity Concept – business is a

separate entity. 2. Money Measurement Concept – money

common denominator of measurement. 3. Going Concern Concept – perpetual

succession. 4. Accounting Period Concept – pre-

determined periodicity generally an year. 5. Cost Concept – an asset’s cost is the basis

of all subsequent accounting.

Accounting Concepts 6. Realisation Concept – revenue should be

recognized “when it is earned”. 7. Matching Concept – associating the cause

and effect relationship of revenues and expenses.

8. Accrual Concept – similar to matching, period should be decided on the basis of accrual.

9. Dual Aspect Concept – 2 aspects must be examined – the giving and the receiving.

Accounting Conventions

1. Consistency – method once adopted should be followed. 2. Disclosure – all relevant facts concerning financial

position must be communicated to users. 3. Materiality – concerned with significant information. 4. Objectivity – unbiased and subject to verification by

external expert. 5. Stable Monetary Unit – the Indian Rupee. 6. Conservatism or Prudence – when in doubt, choose the

solution that is least likely to overstate net assets and net income for the current period.

Accounting Bases and Policies

Accounting bases are the methods which have been deployed for applying fundamental accounting concepts to financial transactions and items. Eg. Depreciation and Inventory.

Accounting policies are the specific accounting bases selected and consistently followed by a business enterprise.

Business Transactions

The financial position of an active business is always changing . A business day usually involves many business transactions. A business transaction may be defined as “an economic activity of the business that changes its financial position”

Types of Transactions External transaction : Involves economics events between two or more independent firms. For eg., borrow money form bank, sell goods to customer. Internal transaction : involves economics events entirely within one firm. For eg., using machines, raw material for production.

Some Important Terminology Of Accounting

Assets : The economic resources which are owned by a business and are expected to benefit future operations. Assets may have definite physical form, such as buildings, machinery or merchandise.

Equities : these are claim against the assets owned by the business. Equities or claim against the assets indicate the sources from which the assets of a building were obtained. There are two kind of equities, liabilities and net worth.

Continued…..

Liabilities : liabilities are the debts owed by a business to out side parties ( called creditors ). This includes amount owed to suppliers for goods or services purchased amount borrowed from banks or other lenders, salaries and taxes due but not paid.

Net worth : the term net worth, proprietorship, owner’s investment, or capital– all have the same meaning in accounting : namely, the owner’s equity or interest in the assets of the business. It is the difference between what the business owns and what it owes.

Continued…..

Revenue : It may be defined as the inflow of cash assets resulting from the sale of goods and services in the ordinary course of business. For eg interest received on investments, commission received, rent received etc. Revenue cause an increase in capital.

Expenses : it may be defined as the cost of the goods and services used up in the process of obtaining revenue. Example include - the cost of goods sold, wages and salaries of employees, charges for news paper, advertising etc.

Continued…..

ACCOUNT : An account is a section of the ledger in which all the transactions relating to the same activity that has taken place during a given period are summarized and accumulated .

DEBIT : when an amount is entered on the left side of the account, it is known as debit .

CREDIT : When an amount is entered on the right side of the account, it is known as credit.

Types of Entry System

There are two types of entry system:

Single entry accounting : In single entry system, both the

aspects of some transactions are recorded and only one aspect of some others, while no aspect is recorded at all for certain others. For e.g. single entry is made for purchase or sale of goods and no corresponding entry is made related with this, like depreciation of goods purchased etc.

Double entry accounting :

Double entry book-keeping is the system almost universally used in the modern business. It is simple, yet all embracing and efficient. Every transaction has two aspects, (value in) and (value out). The double entry system merely recognizes this two fold aspect of every transaction and it records both aspects from the view point of each party. It does not means doing work twice over rather it implies a record of double aspects of every transaction. Thus, every transaction twice in the ledger or account one as debit (value in ) and the other is credit (value out). The principle of double entry states that for every debit entry there will be an equal and corresponding credit entry.

Advantages of Double entry

It enables a business to have a complete record of transaction.

It provide correct and ready information.

It facilitates reference.

It enable a trader to prove the arithmetical accuracy of the book of account.

Advantages of Double entry It facilitates the preparation of

final accounts.

It facilitates necessary information to the management for decision making.

Disadvantage Of Double Entry.

The volume of accounting work is more in comparison with single entry accounting.

Accounting principles has to be strictly adhered.

Golden rule of Double Entry

Debit the account receiving the benefit, and

Credit the account yielding the benefit

RULES OF DOUBLE ENTRYThere are two methods of double entry: Method 1

Debit .. The receiver Personal Account :

Credit .. The giver

Debit .. What goes in Real account :

Credit ..What goes out

Debit .. Expenses and lossesNominal account :

Credit .. Revenue and gain

RULES OF DOUBLE ENTRY

Method 2

Debit Increase Assets Credit decrease

Debit increase

Expenses Credit decrease

Note : in this case debit represents increase and credit represents decrease.

CLASSIFICATION OF ACCOUNTS

Accounts

Personal Impersonal

Debtors Real or property NominalCreditors

ExpensesOr Loss

Revenue Or Gains

Personal accounts

It records transaction with person and firm with whom we deal. It take in the form of.

1. Natural person.2. Artificial person.3. Representative person.

Impersonal Accounts

Account which do not relates with any person are know as impersonal account.

Real or property account Nominal account.

Difference between real accounts and nominal account

Real Account These are the

account which relate to assets and properties.

These account represents something which are usually tangible and have existence.

Nominal Account These are the account

which relates to the expenses, losses gains or revenue.

These account usually do not represent anything which have existence or which are tangible.

Difference between real accounts and nominal account: continued…

Real Accounts These account continue

year after year until the assets are sold off or completely written off by way of depreciation.

At the end of the year, the real account are not closed but the balanced and these balances are shown on the assets side of the balance sheet.

Nominal Accounts These are only

temporary accounts for the year in which the expenses are incurred. They do not continue year after year.

At the end of the

year, all nominal accounts are closed by transfer to the profit and loss account.

GAAP – given by ICAI

The Generally Accepted Accounting Principles that companies registered in India under the Companies Act, 1956, are given to us by the Institute of Chartered Accountants of India.

Characteristics of Companies under the Companies Act, 1956

Separate legal entity, artificial person, perpetual succession, to name a few.

BALANCE SHEET

Introduction : A balance sheet is a classified

summary of the balances remaining open in a set of books after the preparation of the trading and profit & loss account. It shows the financial position of a business at a particular moment in time. It is a snapshot of the financial condition of the business and hence it is also known as the ‘mirror’ of the business.

The Accounting Equation

ASSETS= LIABILITIES +CAPITAL

Or CAPITAL = ASSETS -

LIABILITIES

TRIAL BALANCE A trial balance is a list of the balances

on all the accounts in the books , prepared as a document ancillary to the ledger after all the transactions of a period have been entered. It is not a account and is not appear in the books of account. It is prepared to check the arithmetical accuracy of the ledgers.

Features of a balance sheet Statement of a financial position.

Prepared at a given date.

In balance sheet total assets equal total liabilities.

Assets are listed on the right side of the balance sheet and liabilities are on the left side.

OBJECTIVE OF PREPARING A BALANCE SHEET

To disclose the financial condition of a business.

Examine the worth of a company and the profitability of the company.

PRINCIPLES TO BE OBSERVED IN PREPARING A BALANCE SHEET

The first principle to be observed in the preparation of a balance sheet is that the balance of similar significance should be grouped together, and that the balances of dissimilar significance should be stated under separate heads.

Eg: plants & machinery, building, sundry debtors, land & building should be grouped in a same group.

Continued…..

The second principle of accounting relates to “marshalling” . The assets and liability should be arranged in a specific order. This arrangement is called a marshalling.

There are three methods for marshalling.

Continued…..

The first method is to arrange the assets according to their availability to pay off the liabilities i.e those assets which are represented by cash or easily convertible into cash would take the first place while those which are not immediately available for the payment of the liability will take the second place.

Continued…..The second method of arranging the

item is almost the reverse of the first method.

Immovable property should be taken at first place.

Moveable assets should be taken on second place.

Liquid assets should be taken on third place .

Continued…..

The third method is a mixture of the first and second methods, assets are arranged in the first method and the liability in the second method.

Trial balance Balance sheet

A trial balance is extracted before the final accounts are prepared.

A trial balance contains the balances of all accounts.

A balance sheet is constructed after the preparation of final account.

A balance sheet contains only those account left open in the ledger.

Trial balance Balance sheet

It is prepared in view to prove the arithmetical accuracy.

A trial balance contains a debit and a credit column just like a journal.

A balance sheet is prepared to portray the financial position of a business at a given date.

It contain two side one for assets and one for liability side.

Profit & Loss Balance Sheet It is an account.

It is prepared to know the final result of the business.

It include only revenue receipts and revenue expenses.

It is an statement not an account.

It shows the financial position of the business.

It includes assets and liability.

Profit & loss Balance sheet It is prepared for

the particular period.

The left side of the account is known as debit side and the right side is known as the credit side.

It is prepared on the particular date.

Left side is known as the liability side and right side is known as the assets side.

Classification of Assets

Fixed assets. (tangible assets, intangible assets)

Wasting assets. (depreciable assets)

Current assets. (floating assets, circulating assets)

Liquid assets . (cash in hand, cash at bank)

Fictitious assets. (not real assets)

Classification of Liabilities

Capital .

Sundry creditor. (payment to the supplier)