Basic fundamental of accounting word book

Basic Fundamentals of Accounting

Ricardo Earlington Kaydian Davis Kadene McKenzie Stephane Wright

Table of Content Acknowledgement ………….…………………………………………… 3

The Most Honorable Mr. Brown the Accountant


Page 1


Introduction ………………….…………………………………………… 4

Accounting Concept and Conventions ………………………………. 5

General Objectives, Specific Objectives and Overview

Key Concepts

Diagram ………………………………………………………. 6

Accrual ………………………………………………………. 7

Matching ………………………………………………………. 8

Prudence ………………………………………………………. 9

Consistency ………………….……………………………………. 10

Separate Entity ………….……………………………………. 11

Conclusion ………………….……………………………………. 12

Accounting Cycle ………………….……………………………………. 13


Steps in the cycle ………….……………………………………. 14

Diagram ………………………………………………………. 15

Content ………………………………………………………. 16 – 19

The Accounting Equation ………….……………………………………. 20


Introductory Activity ………….……………………………………. 21

Content ………………………………………………………. 22 – 25

Evaluation Exercise

Self-Test ………………………..…………………………….. 26

Reference List ………………..……………………………………… 27

Appendices ………………………………………………………. 28 – 29

Acknowledgement

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The authors would like to express deep gratitude to the following colleagues for their insight, feedback, and leadership in shaping this book and the offering of the various strategies embedded in it in an attempt to attain its objectives.

We wish to thank our lecturer Mr. Leroy Brown on matters concerning its structure, Ms. Annette Daley and Ms. Allison Mckinley for their assistance on the correctness and authenticity of the content incorporated and Mrs. Karlene Thompson for her guidance with sorting items specific to the curriculum.

Introduction

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The Basic Fundamentals of Accounting seeks to educated persons on the frame work on which the subject Principles of Accounting is built. It also seeks to reinforce the importance of the Accounting Concepts and Conventions, the Accounting Cycle and The Accounting Equation which is also referred to as the Balance Sheet Equation.

The carries a series of objectives general and specific to the area of study coupled with activities to engage the learner, diagrams for visual aids in addition to games familiar to Jamaicans and different items types representing the evaluation exercises.

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General Objective: Students will develop an appreciation for the fact that the accountingconcepts and conventions are important tool used for efficient

business management

Specific Objectives: At the end of this lesson students will be able to

1. explain the concept of accounting

2. outline the four (4) main accounting concepts and conventions that guide the accounting process

3. understand the relationship between the accounting concepts and their monthly revenue and expenditure

Introduction

Accounting concepts and conventions as used in accounting are the rules and guidelines by which the accountant lives. All accounts and accounting statements should be created, preserved and presented according to the concepts and conventions.

These generally accepted accounting principles (GAAP) are a set of rules and practices that are recognized as a general guide for financial reporting purposes; therefore, generally accepted mean that these principles must have substantial authoritative supports.

Activity

This activity can be used to induce learning by way of initiating realism. Select three (3) students to enter into two (2) separate transitions. Classified the students A, B and C. Student A can be the business, Student B the customer and Students C the creditor. First transaction will see the business selling an item valued at $1,000.00 (option to change the amount) to the customer. The second transaction will see the business buying an item from the creditor for $200.00 (again the amount can vary). Deliberately withhold the date for the transactions as the date is the essential component from which the varying concepts namely accrual and matching are derived. The date(s) should be assigned at each point of referencing to the transactions to explicitly explain the concepts.

Accounting Concepts and Conventions

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Key Accounting Concepts

Accounting concepts varies and though we have made mention of four (4) essential to the basic understanding of the practice and /or procedures of accounting, the concepts and conventions are not limited to those named.

Accruals Concept

Prudence Concept

Consistency Concept

Separate Entity

Concept

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Our Key Accounting Concepts

Accruals Concept – Revenue should be recognized in the accounting period in which it is earned.

The Accruals concept assumes that revenue and expenses are taken account of when they occur and not when the cash is received or paid out. The purpose of this concept is to make sure that all revenues and costs are recorded in the appropriate statement at the appropriate time. The accrual concept under accounting assumes that revenue is realized at the time of sale of goods or services irrespective of the fact when the cash is received. Similarly, expenses are recognized at the time of services provided, irrespective of when cash is paid.

In brief, accrual concept requires that revenue is recognized when realized, and expenses are recognized when they become due and payable without regard to the time of cash receipt or cash payment. Thus, when a profit statement is compiled, the cost of goods sold relevant to those sales should be recorded accurately and in full in that statement. Costs concerning a future period must be carried forward as a prepayment for that period and not charged in the current profit statement. For example, payments made in advance such as the prepayment of rent would be treated in this way. Similarly, expenses paid in arrears must, although paid after the period to that they relate, also be shown in the current period’s profit statement: by means of an accruals adjustment.

Example

On April 28th John visits Mr. Brown’s shop to trust 2lbs of flour and 3lbs of chicken; John told Mr. Brown that he will be paid on May 5th. Though, Mr. Brown will not get the money until May he made the sale in April; therefore, the revenue is to be record at the point/time when the sale was made which is April 28th.

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Matching Concept – Expenses should be matched with revenues in the period in which the revenues are earned. (i.e. the need for prepaid expenses)

Significance:

It helps in knowing actual expenses and actual income during a particular time period.

It helps in calculating the net profit of the business.

Figure 1

Figure 1 above is shows a game of dominoes where all the respectives tile numbers are matched together for each play/turn; in essence the matching concept is liken to a game of dominoes in that all revenue earned in a particular period should be matched with the expenses incurred.

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Prudence Concept or Concept of Conservatism

It is this concept more than any other that has given rise to the idea that accountants are pessimistic boring people!! Basically the concept says that whenever there are alternative procedures or values, the accountant will choose the one that results in a lower profit, a lower asset value and a higher liability value. The concept is summarized by the well-known phrase ‘anticipate no profit and provide for all possible losses’.

Revenue and profits are included in the balance sheet only when they are realized (or there is reasonable ‘certainty’ of realizing them) but liabilities are included when there is a reasonable ‘possibility’ of incurring them.

The Prudence Concept assumes:

Assets should not be overvalued Liabilities should not be undervalued The financial statements does not reflect overstatement or understatement of

gains or losses but neutral Profit or revenue only recorded when they are realized.

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Consistency Concept

Because the methods employed in treating certain items within the accounting records may be varied from time to time, the concept of consistency has come to be applied more and more rigidly. Because of these sorts of effects, it is now accepted practice that when an entity chooses to treat items such as depreciation in a particular way in the accounts it should continue to use that method year after year. If it is NECESSARY to change the accounting method being employed then an explanation of the change and the effects it is having on the results must be shown as a note to the accounts being presented.

Example

The rules of any games are stated before the start and will remain throughout its duration and would not change during the game. With that said so too should be the methods employed to report the accounting records; in other words, the method should be consistent throughout the accounting period.

Separate Entity Concept

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The business entity concept states that a business and the owner(s) are two separate Legal Entities.

Being an artificial person, a company has an existence independent of its members. It can own property, enter into contract and conduct any lawful business in its own name. It can sue and can be sued in the court of law. A shareholder cannot be held responsible for the acts of the company.

The best example here concerns that of the sole trader or one man business: in this situation you may have the sole trader taking money by way of ‘drawings’: money for his own personal use. Despite it being his business and apparently his money, there are still two aspects to the transaction: the business is ‘giving’ money and the individual is ‘receiving’ money. So, the affairs of the individuals behind a business must be kept separate from the affairs of the business itself.

This concept restrains accountants from recording of owner’s private/ personal transactions. It also facilitates the recording and reporting of business transactions from the business point of view.

Conclusions

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These, then, are some basic concepts and conventions on which the accountant bases all of his accounting work. We can see evidence of such work in the published annual reports and accounts that all publicly quoted companies are required to prepare and publish. The concepts and conventions also apply to the millions of businesses worldwide that do not publish their accounts.

The Accounting CyclePage 12


General Objective: Students will develop an appreciation for the fundamental principles andpractices of accounting.


1. coin their own definition of the term accounting cycle

2. describe the accounting process

3. prepare diagrammatic presentation of the accounting cycle to show the sequential flow

4. discuss the source of accounting information

5. identify key concepts relative to the stages of the accounting cycle

Introduction

The Accounting Cycle is a sequence of procedures used to record, classify and summarize and processing accounting information to generate financial statements, on a regular basis. The accounting cycle during each period starts from recording individual transactions in the books of accounting and ends at the preparation of financial statements and closing processes.

Steps in the Accounting Cycle

Step 1

Collecting and analyzing raw data from source document.

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Step 2

Recording transactions in the book of prime entry.

Step 3

Posting to the ledgers.

Step 4

Preparing the trial balance.

Step 5

Making adjusting entries.

Step 6

Prepare final statements- Trading Account, Profit and Loss Account

Step 7

Preparing the post- closinial trial balance.

The Accounting Cycle

Figure 2.1

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This shows the cyclical and sequential flow of the steps within accounting process.

1. Analyze and measure transactions.

Obviously in this phase, your business collects their transactions for analysis, measurement, and recording. But here's the first hang-up: what do you have to record?

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As a general rule of thumb, a business should minimally record:

1. All cash sales.2. All purchases (no matter how small).3. Anything that's measurable, relevant, or reliable.4. Source of accounting information:

-Sales invoice- reflect cash and credit sale-Purchase invoice- reflect cash and credit purchase-Cash bill- given to customers and received from suppliers as proof of purchase -Credit note- given to customers and receive from suppliers when good are returned.-Debit note-given to customers to show increase indebtedness.-Stock card- records of material, etc. purchased

In short, a company records as many transactions as possible that affect its financial position.

2. Record transactions in the journal.

This is also known as journalizing. A journal chronologically lists transactions and other events in terms of debits and credits to accounts. Each journal entry consists of four parts:

1. The accounts and amounts to be debited.

2. The accounts and amounts to be credited.

3. The date of transaction.

4. A transaction explanation.

3. Post Types of Ledgers

Accounting entries are made in books called Ledgers. Most businesses use the following ledgers:

-Sales Ledger: This book contains the personal accounts for customers or debtors.

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-Purchases Ledger: This book contains the personal accounts for suppliers or creditors.

-General Ledger: The remaining double-entry accounts such as those related to capital, fixed assets, expenses and revenues (except for cash account and bank account) are entered in the general ledger.

This is the act of transferring information from the journal to the ledger. Posting is needed in order to have a complete record of all accounting transactions in the general ledger, which is used to create a company's financial statements.

4. Prepare an adjusted trial balance.

After journalizing and posting all adjusting entries, many businesses prepare another trial balance from their ledger and accounts. This is called the adjusted trial balance. It shows the balance of all accounts, including those adjusted, at the end of the accounting period. Therefore, the end result of this adjusted trial balance demonstrates the effects of all financial events that occurred during that particular reporting period.

5. Preparing adjusting entries.

Adjusting entries are journal entries recorded at the end of an accounting period that alter the final balances of various general ledger accounts. These adjustments are made in order to more closely align the reported results and the actual financial position of a business. Adjusting entries follow the principles of revenue recognition and matching.

6. Prepare financial statements.

Financial statements can be prepared directly from the adjusted trial balance. A financial statement is an organization's financial results, condition, and cash flow

7. Prepare a post-closing trial balance.

The post-closing balance consists only of assets, liabilities, and owners' equity, also known as real or permanent accounts. This balance provides evidence that the company has properly

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Chapter Round –UP Notes

1 The accounting cycle outlined the steps in the accounting process, which is repeatedduring each accounting period.

2 Two type of accounting transactions are cash and credit transactions

3 The main users of accounting information are the owners, bank, employees, governmentand competitors.

4 In order for accounting information to be useful, it must be easily understood, relevant,accurate and comparable.

5 Source documents provide evidence of transaction and are used to record information in the book of accounts.

Exercises – Self-test

1. distinguish between accounting process and accounting cycle 2. What is an account?3. Name and defined two types of accounting transactions.

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4. List four categories of users of accounting information.

Multiple choices

1 The accounting process is complete when

a. all financial information has been gatheredb. financial information has been communicatedc. financial information has been analyzedd. financial information has been recorded

2 the process of transferring information from prime entry to books of ledger is calleda. postingb. journalizingc. accountingd. analyzing

Match

3. Match the terms on the left with the description on the right

a. Invoice

b. Debit note

c. Stock card

d. Cash bill

e. Credit note

1. given to customers when goods are returned

2. describe items bought and sold

3. proof of cash purchase

4. record of stock movement

5. shows additional indebtedness of customer

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General Objective: Students will realize that being able to identify and interpret financial data is an important skill required for effective business management.


1. with the use of examples and/or non-examples explain the meaning of the term assets, liabilities and capital

2. interchange the variables of the accounting equation without compromising its’ authenticity

3. correctly solve for missing variable

4. classify the items listed in an activity under the correct variable

Introduction

It is recommended to incorporate a good activity to tap into the leaner’s prior knowledge and by extension get them lesson ready; hence, the activity stated below is included to satisfy the preceding statement.

The Accounting Equation

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Introductory Activity

1

2 3

4 5

6 7

8

Across

3. money owed

4. 5 y = y + 2 x

6. Required for riding a bike

8. A word that start with C that mean the here and now

Down

1. not common but ........

2. a bedding fabric or paper

5. Honey? it's .....d, not moving at all.

7. valuables owned by a business

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The Accounting Equation

We have often heard the expression “the books are in balance” in reference to the accounting records of a business. This relates to the use of the double-entry system of accounting, which says that every transaction will affect two accounts. Because the monetary values are equal we say the transaction is “in balance.” Accounting is based on a simple rule, called the accounting equation.

Using a two pan scale as illustration, the Accounting Equation is really:

The accounting Equation describes above by way of the two pan scale, shows that in the acquisition of assets, a business must use funds from external parties which

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are liabilities (such as loans and good taken on credit) and its owner’s equity namely in the form of capital invested.

Table 1.2 below shows the effects of transactions on the accounting equation.

Effect of transaction

Transactions Assets Liabilities CapitalOwner bring in additional funds Increase(+) No effect Increase (+)Owner pay business debts out of private funds

No effect Decrease(-) Increase(+)

Business paid for stock bought on credit Decrease(-) Decrease(-) No effectThe owner introduce capital to pay off business loan

No effect Decrease(-) Increase (+)

See below transactions that only affects one side of the equationBusiness buys goods for cash Increase

asset(+)

Decrease asset(-)

No effect No effect

Withdrew cash from bank Increase asset(+)

Decrease asset(-)

No effect No effect

The owner accesses a bank loan (payable in 6 months) to invest in the business.

Increase(+) Increase(+)

Asset - liabilities = capital

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Table 1.3 below shows the various types of accounts

Types of Accounts

Types Description ExamplesAssets: current These assets are classified as

current assets because they can be turned into disposable form easily

1 Cash in hand 2 cash at bank

1 Trade debtors are individuals and firms to whom goods and service are supplied on credit

2 Expense debtors are individual and firm who have been paid beforehand to supply service to the firm

3 Stock describe all kind of goods which businesses need to operate

Asset: fixed These are purchased because they help the firm to produce profits over several accounting periods

Land, buildings, factory buildings (called plant), machinery, equipment, furniture, fixtures (shelves, lighting), motor vehicles.

Liability: long-term A long term liability represent a debt or amount owed to a firm or individual but the period for repayment longer than on year

Bank loans, loan from individual, debentures, mortgage

Income/revenue Inflow of assets, such as cash, debtor arising from the firm’s delivery of goods to others

Sales of stocks, earning from rent, commission

Capital These are inflow of assets from the owners to finance the firm operation

Cash, stock, land, buildings etc.

Expense These are outflow of assets, such as cash

Rent, wages, salaries

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Rules of Entry for general Accounts

Take note that there are rules of entry for general accounts and that an account is divided into two sides, a left side called the Debit side (DR) and a right side called the Credit side (CR).

All accounts may be grouped in two broad categories or classifications. These are personal and impersonal.

Personal Accounts: These are the accounts that have the names of debtors (customers) or creditors (suppliers). They are therefore personal to this extent.

Impersonal Accounts: These non-personal accounts may be divided into Real Accounts and Nominal Accounts.

-Real Accounts - These accounts are tangible in nature and represent accounts that records possession such as machinery, furniture, premises and stock.

-Nominal Accounts – These accounts are intangible in nature and represent accounts that in which expenses, revenues and capital are recorded.

CLASSIFICATION OF ACCOUNTS

Classification of Accounts

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Self-test

1. Define the term Accounting.

2. Explain the nature and scope of accounting.

3. What are the important functions of accounting?

4. What are the objectives of accounting?

5. Briefly explain the basic accounting concept and conventions.

6. What are the important classification of accounting concepts? Explain them briefly.

(a) Consistency Concept

(b) Convention of Conservatism.

7. What do you understand by Dual Aspect Concept?

8. Explain the prudence Concept

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9. Write short notes on:

(a) Separate Entity Concept

(b) Convention of Consistency.

10. Differentiate between

(a) Prudence concept and Conservatism

(b) Accounting Period Concept and Accruals Concept

Reference

Frank Wood’s (2011) Business Accounting Volume 1Financial Times Press

Frank Wood, Sheila I. RobinsonPearson Education, Limited, 2000 - Accounting

Frank Wood, Alan SangsterFT Prentice Hall Financial Times, 2005 - Business & Economics

Frank Wood, Alan SangsterPearson Education, Limited, 3 Sep 2015 - Accounting

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About the Book

In concluded it is imperative to note that Accounting deals primarily with information that is

intended to be used in making economic decision and resolved choices among alternative

courses of action.

This book is designed to presents the authors’ position with respect to dealing with the basic

fundamental of accounting and it takes into consideration the importance of the elements

contained in concepts, cycle and the simple balancing equation of accounting in guiding

management decision.

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It will take the students through a series of topics with a view to aid their development and

improve their understanding of the critical factors that influences management decision while

maintaining the objectives of the business for continuity.

About the Authors

Our main area of study deals in accounting and though the subject is theory based it demands

continuous practice of the principles to attain excellence. If a challenge is experienced for which

a resolve has to be determined, once the solution have been reach then the principles involves in

solving the problem is transferable to future similar situations. Therefore, our philosophical

statement is “Learning is the process whereby knowledge is created through the transference of

experiences”.

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We believe that a collaboration of both teacher and students center approach to learning is the

best way to aid students to be open minded, become critical thinkers and thus knowledge would

be created through the transference of experiences.

BASIC FUNDAMENTALSOF ACCOUNTING

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Kaydian Davis Ricardo Earlington Stephane Wright Kadene McKenzie

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Basic fundamental of accounting word book