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BASICS OF FINANCIAL ACCOUNTINGDr. Makesh K.G
LEARNING
Rules of Accounting
Basic Accounting Processes
Documents in Accounting
Class Room Etiquette
Ask Doubts Carry Doubts
DO DO NOT
Very Attentive Sleep, Talk, Dream
Punctual Skip Classes
Constructive Negative
Use Resources Ignore Resources
FOUNDATION TO ACCOUNTING
Pr imary TargetStudents with NO Accounting backgroundStudents with background expected to be positive
Importance of Foundati onSemester 1: Financial AccountingSemester 2: Cost and Management AccountingSemester 3: Financial Management 1 [Common Paper]
1: May change with University Syllabus
O b j e c ti v e s o f t h e C o u r s e
● Familiarize with accounting terminologies
● Acquaint with Accounting Processes
● Appreciate the need for accounting
● Develop Expertise in Accounting activities
MEANING AND TYPES OF ACCOUNTING
Simply means recording business activitiesSystematic method
Types of Accounting● Financial Accounting● Management Accounting● Cost Accounting
N e e d fo r A c c o u n ti n g
● is the “Language of Business”
● Means of Communication of business results
● Not limited to corporate uses
● Housewives, government etc. uses it
● Probably every layman uses it, may be sub-consciously
● Part of common life
Note for Non-Commerce Students
You are Not learning a new subject, rather a new LANGUAGE
Remember how much you persevered
Commit yourself with relentless efforts
N e e d fo r A c c o u n ti n g
…be better off than this !!
● How would a typical home-maker’s accounts diary look like?
TOTAL 12,000 8,300
A c c o u n ti n g i n D a i l y L i fe
Items Receipts Payments
SalaryGroceriesElectricity BillStationeries Home repairsCash gifts from relativesClothing
10,000--------
2,000--
--500300
2,0003,000
--2,500
Balance -- 3,700TOTAL 12,000 12,000
D e fi n i ti o n o f A c c o u n ti n g
“The art of recording, classifying and summarizing the transactions in a business, in terms of money”
FUNCTIONS OF ACCOUNTINGRecording ●Classifying ●
Summarizing ●Analyzing ●
Interpreting ●Communicating ●
INTRODUCTION
Knowing 2 aspects are important for a business
● Is the business PROFITABLE ?…It may be making losses or profits
● How good is its FINANCIAL POSITION ?…It may be getting richer or poorer
I N T R O D U C T I O N
● How to know if business is Profitable?For a period, prepare
PROFIT and LOSS ACCOUNTKnown as Period Statement
● How to know if businesses’ Financial Position is good?On a date, prepare
BALANCE SHEETKnown as Position Statement
BALANCE SHEET
Shows the Financial Position of the firm2 items are included:ASSETS
Economic resources owned by businessUsed in business for productive purposes
LIABILITIESObligations owed to other partiesBurden on business
Assets and Liabilities should be Equal
S t r u c t u r e o f B a l a n c e S h e e t
LIABILITIES Rs. ASSETS Rs.
Capital --Long term Loan --Reserves --Provision --
Plant &Machinery --Land & Building --Stock --Investments --
Creditors --Bills Payable --Advance Income --Outstanding Expense --Overdraft --
Debtors --Bills Receivable --Accrued Income --Advance Expense --Cash --
TOTAL -- TOTAL --
PROFIT AND LOSS ACCOUNT
Shows Profits/Losses of business [Bottom line]2 items are included:INCOMES
Objective for which business is runGenerated from major activity
EXPENSESSuffered for generating income
Difference of Income and expense gives Profits/Losses
S t r u c t u r e o f P r o fi t a n d Lo s s A c c o u nt
EXPENSES Rs. INCOME Rs.
Opening Stock --Purchases --Wages --Direct Expenses --
Closing Stock --Sales --Discount Received --Interest received --
Discount Allowed --Bad-debts --Depreciation --Postage, Telegram --Provision --
TOTAL -- TOTAL --
PROFITS --
E xe rc i s e
● Prepare a Balance Sheet from the following figures
CashOverdraftMachineCreditorsBills ReceivableLoanOutstanding Expense
10060
1206040
20040
InvestmentsBuildingBills PayableCapitalStockAdvance IncomeReserve
50703040601080
E xe rc i s e
● Prepare a Profit and Loss A/c from the following figures
Opening stockBad debtsInterest receivedDepreciationDiscount allowedProvision for bad-debtsWages
30104020102050
Closing stockPurchasesSalesDirect expensesDiscount receivedPostageSalaries
50200320
40203060
PROCESS OF ACCOUNTING
Initiated by a business transactionTransaction should be:
● Financial in nature ● Supported by Documentary evidence
……like bills, invoice, cheques etc.Now recorded in books of accounts
S T E P S I N P R O C E S S O F A C C O U N T I N G
●Identify financial
transactionAuthenticate by
documents
Record in JournalPost to Ledger
Make Adjustment Entries
Prepare Trial Balance
Prepare Final Accounts
BASIS OF ACCOUNTING
2 bases of accounting ● CASH BASIS ● ACCRUAL BASIS
C A S H B A S I S O F AC C O U N T I N G
Make entries when: ● CASH is paid for Expense ● CASH is received for income
Profits will be based on cash flows
Cash inflow Less: Cash Outflow = Cash Profits
Method followed by professionals like doctors, lawyers
Cash received as Consultation FeeLess: Cash paid as staff salary
1000850
CASH PROFITS 150
A C C RUA L B A S I S O F A C C O U N T I N G
Make entries when: ● Expense is incurred – whether paid out or not ● Income is earned – whether received or not
PERIOD is very importantIncludes CASH and CREDIT transactions
Profits will NOT be based on cash flowsIncome Less: Expense = Profits
Method followed by large corporate houses
A C C RUA L B A S I S O F A C C O U N T I N G
Accounting period is Jan. 1 to Dec. 31, 2012The following transactions happened in the period:
Cash received as Fees in 2012: Rs. 10,000Fees for 2012, not yet received: Rs. 2000Fees for Jan 1- Dec. 31, 2013, received in 2012: Rs. 1500
What is the income of 2012 ?
ACCOUNTING EQUATION
Based on DUAL ASPECT principle of accountingMeans all transaction has 2 aspects
● Debit Aspect, and ● Credit Aspect
The equation is:Capital + Liabilities = Total Assets
Capital: owed to the ownerLiability: owed to others
A C C O U N T I N G EQ UAT I O N
Holds good at all times
Started business with Rs. 10,000
LIABILITIES Rs. ASSETS Rs.
CapitalLiability
10,0000
Cash 10,000
TOTAL 10,000 TOTAL 10,000
A C C O U N T I N G EQ UAT I O N
Holds good at all times
Took bank loan of Rs. 5,000
LIABILITIES Rs. ASSETS Rs.
CapitalLoan
10,0005000
Cash 15,000
TOTAL 15,000 TOTAL 15,000
A C C O U N T I N G EQ UAT I O N
Holds good at all times
Bought Building for Rs. 8,000
LIABILITIES Rs. ASSETS Rs.
CapitalLoan
10,0005000
BuildingCash
8,0007,000
TOTAL 15,000 TOTAL 15,000
A C C O U N T I N G EQ UAT I O N
Holds good at all times
Bought goods for Rs. 3000
LIABILITIES Rs. ASSETS Rs.
CapitalLoan
10,0005,000
BuildingGoodsCash
8,0003,0004,000
TOTAL 15,000 TOTAL 15,000
A C C O U N T I N G EQ UAT I O N
Holds good at all times
Bought goods for Rs. 1000 on CREDIT
LIABILITIES Rs. ASSETS Rs.
CapitalLoanCreditors
10,0005,0001,000
BuildingGoodsCash
8,0004,0004,000
TOTAL 16,000 TOTAL 16,000
A C C O U N T I N G EQ UAT I O N
Holds good at all times
Repaid Loan Rs. 2,000
LIABILITIES Rs. ASSETS Rs.
CapitalLoanCreditors
10,0003,0001,000
BuildingGoodsCash
8,0004,0002,000
TOTAL 14,000 TOTAL 14,000
TYPES OF ACCOUNTS
Account : is a special statement dealing with one item
eg. Machine AccountTalks about every thing happening to machine
Traditional Classification of Accounts● PERSONAL ACCOUNT● REAL ACCOUNT● NOMINAL ACCOUNT
T Y P E S O F AC C O U N T S
● PERSONAL ACCOUNTNatural Person: Mr. X, Creditor, DebtorArtificial Person: BankRepresentative Person: Capital
● REAL ACCOUNTTangible: Machine, LandIntangible: Patent, Trademark
● NOMINAL ACCOUNTExpenses, Losses: Wages, SalariesIncomes, Gains: Interest received
T Y P E S O F AC C O U N T S
PERSONAL ACCOUNTS
Mr. X : Natural Person
Creditor : Natural Person
Debtor : Natural Person
Capital : Representative Person
Bank : Artificial Person
Drawings : Representative Person 1
1 Drawings can be of Cash [capital] or goods
T Y P E S O F AC C O U N T S
REAL ACCOUNTS
Plant, Machine : Physical Asset
Land, Building : Physical Asset
Copyright, Patent, Trademark : Intangible Asset
Cash : Physical Asset
T Y P E S O F AC C O U N T S
NOMINAL ACCOUNTS
Salaries, Wages, Rent : Expense
Carriages IN/OUT : Expense
Interest Received : Income
Interest, Dividend Paid : Income
T Y P E S O F AC C O U N T S
What type of Account is Purchases Account ?
● PurchasesGoods bought for sale in course of business
● Purchase ReturnsGoods returned to supplier due to poor quality
● SalesGoods sold in course of business
● Sales ReturnsGoods returned by customer due to poor quality
● All four related to GOODS which are Assets● All are REAL ACCOUNTS
T Y P E S O F AC C O U N T S
What type of Account is Pre-Paid Rent Account ?
Obviously RENT is a NOMINAL Account
● Outstanding ExpenseExpense Incurred, Not Yet Paid off
● Advance ExpenseExpense Not Yet Incurred, but already Paid off
● Accrued IncomeIncome Earned, Not Yet Received
● Advance IncomeIncome Not Yet Earned, but Received already
● All four are PERSONAL ACCOUNTSRule: Pre-fix Added to Nominal account: becomes Personal account
RU L E S O F D E B I T A N D C R E D I T
● PERSONAL ACCOUNTCREDIT the Giver, DEBIT the Receiver
● REAL ACCOUNTCREDIT what Goes Out, DEBIT what Comes In
● NOMINAL ACCOUNTCREDIT all Incomes/Gains, DEBIT all Expenses/Losses
RU L E S O F D E B I T A N D C R E D I T
Capital Contributed by Owner
● 2 things happen:
1. Owner gives Capital 2. Money comes In
● 2 accounts are affected:1. Owners’ Capital Account: Personal Account2. Cash Account: Real Account
● Rules of Debit/Credit:1. Owner’s Account: Personal a/c: GIVER: CREDIT the Giver
2. Cash Account: Real a/c: COMES IN: DEBIT what Comes In
RU L E S O F D E B I T A N D C R E D I T
Bought Machinery
● 2 things happen:
1. Machine Comes In 2. Cash Goes Out
● 2 accounts are affected:1. Machine Account: Real Account2. Cash Account: Real Account
● Rules of Debit/Credit:1. Machine Account: Real a/c: COMES IN: DEBIT what Comes In 2. Cash Account: Real a/c: GOES OUT: CREDIT what Goes Out
MAINTENANCE OF ACCOUNTS
Transactions are recorded as:
JOURNALBook of Original EntryChronological order – cluttered with different types
LEDGERPosted from JournalHomogenous group
JOURNAL ENTRY
JOURNAL : Book of Original Entry
Started business with capital Rs. 10,000
Bought machine for Rs. 5,000
Date Particulars Debit CreditJan. 1 Cash account Dr.
To Capital account10,000
10,000
Date Particulars Debit CreditJan. 5 Machine account Dr.
To Cash account5,000
5,000
J O U R N A L E N T RY
Started business with capital Rs. 20,000Bought Goods for Rs. 10,000Deposited into Bank Rs. 5,000Sold Goods for Rs. 12,000Bought furniture for Rs. 2,000 paid by chequePaid telephone charges Rs. 200Withdrew cash for personal use Rs. 500Withdrew goods for personal use Rs. 1,000
COMPOUND JOURNAL ENTRY
One transaction affects more than 2 accounts
eg. Paid to Ram Rs. 1000, and he allowed a discount Rs. 100
3 accounts are affected:1. Cash Account: Goes Out – CREDIT2. Ram’s Account: Recipient – DEBIT3. Discount Received Account: Income – CREDIT
Date Particulars Debit Credit
Jan. 5 Ram’s a/c Dr. To Cash a/c
To Discount Received a/c
1,000900100
C O M P O U N D J O U R N A L E N T RY
Prepare compound journal entry
1. Customer owing Rs. 1000 offered payment; on payment allowed discount of Rs. 150
2. Paid for Salaries [Rs. 500] and Telephone charges [Rs. 200]
POSTING TO LEDGER
LEDGER : homogeneous Set of items
All causes of cash coming in and going out are recorded hereDebit Side: cash coming inCredit Side: cash going out
Debit Cash Account CreditDate Item Rs. Date Item Rs.
To… By…
P O S T I N G TO L E D G E R
Debit Cash Account CreditDate Item Rs. Date Item Rs.Jan 1 To Capital 1000 By…
Date Particulars Debit CreditJan. 1 Cash account Dr.
To Capital account1000
1000
Debit Capital Account CreditDate Item Rs. Date Item Rs.
To.. Jan 1 By Cash 1000
P O S T I N G TO L E D G E R
Prepare a Cash Account and find the cash balance
Jan.1: Started business Rs. 10,000Jan.9: Bought goods Rs. 5,000Jan.17: Deposited into bank Rs. 2,000Jan.22: Paid to Mr. X Rs. 500Jan.31: Received from Mr. Y Rs. 1,000
B A L A N C I N G A L E D G E R
Balancing figure equates Debit and Credit columnsShows how much Cash is at hand
Debit Cash Account CreditDate Item Rs. Date Item Rs.Jan. 1Jan. 31
To CapitalTo Mr. Y
10,0001,000
Jan. 9Jan. 17Jan. 22
By PurchasesBy BankBy Mr. X
5,0002,000
500
TOTAL 11,000 TOTAL 11,000
Feb. 1--
To Balance b/d--
3,500--
-- -- --
Debit Cash Account CreditDate Item Rs. Date Item Rs.Jan. 1Jan. 31
To CapitalTo Mr. Y
10,0001,000
Jan. 9Jan. 17Jan. 22Jan. 31
By PurchasesBy BankBy Mr. XBy Balance c/d
5,0002,000
5003,500
TOTAL 11,000 TOTAL 11,000
TRIAL BALANCE
Made of balances drawn out from ledger accountsTo check arithmetical accuracy of accountsPrepared towards end of a periodPrepared before P&L and B/S
TRIAL BALANCEParticulars Debit Credit
CashCapitalMachinePurchasesSales
6,000--
5,0003,000
--
10,000----
4,000TOTAL 14,000 14,000
T R I A L B A L A N C E
Prepare a Trial Balance
Statement of Ledger balancesParticulars Rs. Particulars Rs.
CashCapitalMachinePurchases
4,00010,000
6,00012,000
DebtorsCreditorsBankSales
3,0006,0005,000
14,000
T R I A L B A L A N C E
Prepare Journal, Ledgers, Trial Balance, and final accounts as on Jan 31.
1 Jan. Started business with Rs. 25,0005 Jan. Bought Building for Rs. 12,00010 Jan. Bought goods for Rs. 10,00020 Jan. Paid wages for Rs. 5,00025 Jan. Sold entire goods for Rs. 20,000
T R I A L B A L A N C E
Prepare Journal, Ledgers, Trial Balance, and final accounts as on Jan 31.
1 Jan. Started business with Rs. 50,0005 Jan. Bought Machine for Rs. 25,00010 Jan. Bought Goods for Rs. 20,000 on credit20 Jan. Paid wages for Rs. 5,00025 Jan. Sold Goods [costing Rs. 15,000] Rs. for Rs. 30,000 on
creditDEBTORS A/C DRTO SALES
ADJUSTMENT ENTRIES
Needed due to peculiar itemsAdjustments to accounts to make it more realistic
Why……?Some items are known only after preparing Trial BalanceMeans……………Some items NOT included in Trial BalanceMake entries, Modify Trial BalanceThen prepare Final accounts
A D J U S T M E N T E N T R I E S
• Closing Stock• Outstanding Expense• Prepaid Expenses• Accrued Income• Advance Income• Depreciation• Bad debts• Provision for bad debts• Provision for Discount on Debtors• Reserve for discount on Creditors• Interest on Capital• Interest on Drawings
A D J U S T M E N T E N T R I E S
● CLOSING STOCKRemember:Opening stock given INSIDE the Trial BalanceClosing stock given OUTSIDE the Trial BalanceBoth Opening and Closing Stock will NEVER be inside Trial
Balance together…………………………….If one is in, the other is out
Date Particulars Debit CreditDec. 31 Closing stock Dr.
To Trading and P&L a/c--
--
A D J U S T M E N T E N T R I E S
● OUTSTANDING EXPENSEExpense Incurred, Not yet paid in Cash
Wages paid Rs. 5,000
Accountant comes to know that Wages of Rs. 1000 is NOT yet paid
Extract of Trial BalanceParticulars Debit Credit
CashWages
--5,000
5,000--
TOTAL 5,000 5,000
A D J U S T M E N T E N T R I E S
● OUTSTANDING EXPENSE ……………. continuedPass Adjustment entry
Date Particulars Debit CreditDec. 31 Wages a/c Dr.
To Outstanding Wages a/c1000
1000
Extract of Trial BalanceParticulars Debit Credit
CashWagesOutstanding Wages
--6,000
5,000--
1000TOTAL 6,000 6,000
A D J U S T M E N T E N T R I E S
● OUTSTANDING EXPENSE ……………. continuedImpact on Final Accounts
Dr. Profit and Loss Account Cr.Expense Rs. Income Rs.
Wages paidAdd: O/S wage
50001000 6000
Balance SheetLiability Rs. Asset Rs.
Outstanding Wages 1000
A D J U S T M E N T E N T R I E S
● PROVISION FOR BAD-DEBTSThe following points are important:
1. Provision is a PREPAREDENESS to meet FUTURE bad debts
2. Is done at year-end, taking from P & L
3. Is created by DEBIT-ing the current year’s P & L Account
4. Taken to Liability side of current year’s Balance Sheet
5. Available to meet NEXT YEAR’S bad debts
6. NOT available for current year’s bad debts
7. Current year’s Bad debt is charged to P & L as usual
8. Next year’s bad debt is charged to Provision for Bad Debts
9. Replenishment to Provision happens from P&L year on
A D J U S T M E N T E N T R I E S
● Provision for Bad-Debts……CREATION in current year
Dr. Profit and Loss Account [Current Year] Cr.Expense Rs. Income Rs.
To Bad debtsTo Provision for B/D
xxxxxx
Balance Sheet [Current Year] Liability Rs. Asset Rs.
Provision for B/D xxx Debtors xxx
A D J U S T M E N T E N T R I E S
● Provision for Bad-Debts…CHARGE of BAD DEBTS next year
Dr Provision for B/D [Next Year] Cr.Expense Rs. Income Rs.
To Bad DebtsTo Closing balance
xxxxxx
By Opening balanceBy P & L
xxxxxx
Balance Sheet [Next Year] Liability Rs. Asset Rs.
Provision for B/D xxx Debtors xxx
CLOSING ENTRIES
Trial balance is prepared from ledger balances
All ledgers are closed: ● At year-end ● After preparing Trial Balance
Balances in ledgers taken either to: ● Profit and Loss account, or ● Balance Sheet
C LO S I N G E N T R I E S
● Ledgers taken to PROFIT AND LOSS ACCOUNT
Following ledgers are closed by transferring balances to P&L: ● All NOMINAL Accounts ● All GOODS Accounts [6 types]
Dr. Expense Account Cr.Item Rs. Item Rs.
To Cash 1000 By Balance 1000
TOTAL 1000 TOTAL 1000
Taken to Trial Balance
C LO S I N G E N T R I E S
● Ledgers taken to PROFIT AND LOSS ACCOUNT
Following ledgers are closed by transferring balances to P&L: ● All NOMINAL Accounts ● All GOODS Accounts [6 types]
Dr. Expense Account Cr.Item Rs. Item Rs.
To Cash 1000 By P and L 1000
TOTAL 1000 TOTAL 1000
C LO S I N G E N T R I E S
● Ledgers taken to BALANCE SHEET
Following ledgers are CARRIED to next year by transferring balances to Balance Sheet ● All REAL Accounts ● All PERSONAL Accounts
Dr. Machine Account Cr.
Item Rs. Item Rs.To Cash 1000 By Closing Balance 1000
TOTAL 1000 TOTAL 1000To Opening Balance 1000
A d j u s t m e nt E nt r i e s
1. Bought machine Rs. 50,000, and incurred installation charges Rs. 5,000
2. Bought goods from Mr X, Rs. 50,000, returned goods worth RS. 2,000 being poor in quality
3. Sold goods Rs. 60,000, customer returns goods worth Rs. 1,000 being poor in quality
4. Incurred wages Rs. 15,000, paid only Rs. 12,000
5. Paid insurance premium for next year Rs. 2,500
6. Commission payable to agents is Rs. 2000
7. Create Provision for Bad debts Rs. 5,000
8. Charge bad debts Rs. 1,000 to Provision for bad debts
F i n a l A c c o u n t s
Prepare a Manufacturing Account for year ended 31-12-08
Stock on 1-1-08: Raw Material Work-in-Progress
10,0005,000
Stock on 31-12-08: Raw Material Work-in-Progress
5,00015,000
Purchase of Raw MaterialDirect WagesCarriagesFactory PowerFactory DepreciationFactory Repairs
50,00010,000
2,5002,000
10,0001,500
F i n a l A c c o u n t s
Prepare Manufacturing & Trading Account
Raw Materials purchased in the year Rs. 50,000Sale of finished goods Rs. 1,00,000
Stock on 1-1-08: Raw Material W-in-P Finished Goods
3,5002,000
18,000
Carriage InwardsWagesFactory PowerPacking of Finished GoodsCartage of Finished Goods
1,10027,000
2,0003,0001,000Stock on 31-12-08
Raw Material W-in-P Finished Goods
4,0004,500
28,000
F i n a l A c c o u n t s w i t h A d j u s t m e nt
Pass Journal Entries and create Debtors accountOpening balance of Debtors Rs. 25,000. Following transactions happened in the year:1. Sold goods on credit Rs. 30,0002. Received from Debtors Rs. 18,0003. Debtors worth Rs. 10,000 make payment, and firm allows
them a discount of Rs. 2,0004. Bad debts incurred Rs. 2,5005. Create Provision for Bad debts @ 10% of closing balance of
debtors
Also show the impact of these transactions on P&L Account and Balance Sheet
F i n a l A c c o u n t s w i t h A d j u s t m e nt
Closing stock is Rs. 6,000; Wages unpaid is Rs. 2,000; Depreciate machine by 10 %. Prepare final accounts
Particulars Debit CreditCapitalCashWagesOpening stockPurchase and SalesReturnsSalaryMachineDebtors and CreditorsLoan
--10,000
5,0004,000
50,0002,000
15,00015,00020,000
--
20,000------
80,0001,000
----
15,0005,000
TOTAL 1,21,000 1,21,000
F i n a l A c c o u n t s w i t h A d j u s t m e nt
a. Closing Stock Rs. 3,000b. Additional Bad Debts Rs. 500
c. Owner withdrew Rs. 5,000 from business
d. Interest on Drawings 10 %e. Interest on Capital 10 %
f. Create Provision for Bad debts at 10 % of debtors
Item Dr. Cr.CapitalDebtorsMachineryPurchasesSalesOpening StockCashSalariesBad-DebtsInterest
--20,00010,00025,000
--3,0009,0002,0001,000
--
30,000------
38,000------
2,000TOTAL 70,000 70,000
Also called Accounting standardsRules universally followed in accountingGoverns the Theory and Procedures in accounting
2 categories of Principles:● ACCOUNTING CONCEPTS● ACCOUNTING CONVENTIONS
ACCOUNTING PRINCIPLES
A C C O U N T I N G P R I N C I P L E S
AC CO U N TI N G CO N C E PTS
1. Separate Entity2. Going Concern3. Money Measurement4. Cost5. Dual Aspect6. Accounting Period7. Matching of Revenue and Cost8. Realization
AC CO U N TI N G CO N V E N TI O N S
1. Conservatism2. Full Disclosure3. Consistency4. Materiality
A C C O U N T I N G P R I N C I P L E S
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