Sandeep Kulshrestha

Meaning, Objectives and Terminology of Accounting

To begin with• Accounting is called as the “language of business”

• Accounting is important because it makes you aware in what direction your company is going.

• It communicates with the outside world through the statements of accounts. One cannot understand the affairs of a firm unless the firm prepares financial statements in an intelligible manner.

Let us understand what book keeping and accounting is

Book Keeping• Can you estimate the number of transactions a

business undertakes?• Can a businessman remember all these transactions in

every respect?• Not at all.• So it becomes necessary to record these business

transactions in details and in a systematic manner.• Recording of business transactions in a systematic

manner in the books of account is called book-keeping.

A small definition

“Bookkeeping is the art of recording business dealings in a set of book”.

Few examples• Suppose you have started a new business and you

have taken a shop on rent for Rs 10,000 per month and you have to pay rent on 5th of every month. So, you need to write this somewhere as money has gone out of your pocket. So, on 5th of every month you will record this as “Rent paid”

• You have to record all such financial transactions somewhere or else how will you know as to how much money you have either spent or gained!

The first step to accounting

• As you know the main objective of business is to earn profits. In order to achieve this objective, mere recording of business transactions is not enough.

• As the scale of operations increased a number of questions occurred, such as:

- What is the cost of the goods produced?- What should be the selling price?- Is the cost incurred in producing goods is reasonable

or not?

Accounting…

• Accounting involves not only book keeping but also many other activities.

• Accounting refers to recording and classification of all financial transactions in a company/organisation (example sale of a product, purchase of stationary)

• Accounting refers to the process of summarizing, analyzing and reporting financial transactions. Accounting begins where book keeping ends.

Definition

• “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”.

Difference between Book keeping and Accounting

Book keeping involves

Journalising Posting to ledger

Totalling of accounts

Balancing of accounts

Accounting involves

Preparation of Trial Balance

Preparation of Trading and

Profit and Loss account

Preparation of Balance Sheet

Making of Rectification

and adjustment

entries

Difference between Book keeping and Accounting

• Book-keeping is concerned with the systematic recording of transactions in the books of original entry and their posting to the ledger.

•  Accounting refers to the process of summarizing, analyzing and reporting financial transactions.

• An accountant summarizes the results of transactions recorded by the book- keeper. An accountant’s job is analytical in nature and requires expert knowledge of accounting concepts and principles.

Objectives of Accounting

To maintain systematic record of business transactions:

- Promptly records all the business transactions- Involves identifying the transactions of financial natureAscertaining net profit or loss: - Helps in ascertaining result - a business entity prepares either a Trading and Profit

and Loss account or an Income and Expenditure account which shows the profit or loss of the business

Objectives of AccountingTo ascertain the financial position of the business:

- Helps in ascertaining the availability of cash, position of assets and liabilities

- Helps the businessman to know his financial strengthTo make information available to all interested users:

- Owners, investors, creditors, etc are the interested users

- It help owners to know the financial soundness of the business and help creditors in assessing the credit – worthiness

Accounting CycleTRADING ACCOUNT

4

PROFIT AND LOSS

ACCOUNT5

BALANCE SHEET

(CLOSING)6

TRANSACTIONS

JOURNAL 1

LEDGER2

TRIAL BALANCE

3

BALANCE SHEET (OPENING)

Journal

Ledger

Trial Balance

Trading Account

Profit and Loss Account

Balance Sheet

Accounting terminology• Transaction:- Involves exchange- Cash transaction or Credit transactionEx.: Goods purchased for Rs. 50,000Purchased machine worth Rs. 1,00,000 from Rama on creditSold Goods of worth Rs. 60,000 to Lata Gupta for cash• Capital:- Amount invested by proprietor or amount to be claimed by the

proprietor- It always equal to assets less liabilities

i.e. Capital = Assets – LiabilitiesEx.: Tarun started business with cash

Accounting terminology• Liability :- The amount which business owes to the outsiders- Owed to all others except the owner- Liability = Assets – CapitalEx.: Trade creditors – Goods worth Rs. 25,000 purchased on credit

from Anil • Asset:- Tangible objects or intangible rights owned by the enterprise- Carrying future benefits- Fixed Assets and Current AssetsEx.: Fixed Assets: Machinery purchased from Vinay for Rs. 60,000Current Assets: Goods sold on credit to Gurmeet

Accounting terminology• Revenue:- Receipt or returned received by the firm- It is added to the capital of the firm Ex.: sales receipts, commission received, interest received• Expense:- Cost incurred by a business in the process of earning revenueEx.: rent, wages, salaries, light and water, telephone, etc.• Purchases:- Buying of goods for selling them to customers- Goods bought here, are not for own use but for resale. - Does not include purchase of any asset such as machinery,

stationery, etc.

Accounting terminology• Sales:- When the goods purchased are sold out- Here, possession and the ownership rights over the

goods is transferred to the buyer• Stock:- A part of the total goods purchased which remains

unsold. - The stock at the end of the accounting year is known

as the closing stock. This closing stock at the year end will be the opening stock for the subsequent year.

Accounting terminology• Debtor:- A person who owes money to the firm mostly on

account of credit sales Ex.:Sold Goods to Ashok on credit Ashok is the

debtor of the firm• Creditor:- A person to whom the firm owes money on account of

credit purchasesEx.: Purchased goods from Kamal on credit Firm is

the creditor of Kamal

Accounting terminology• Net Profit or Income:- It is the difference between revenue and expense- It represents the result of business activities during a

particular period of time.- Income = Revenue - Expense.• Net Loss: - It means something against which the firm receives no benefit.- It is a fact that expenses lead to revenue but losses do not,

such as theft. - Net Loss means the excess of expenses over revenue.

Accounting terminology• Drawings:- Amount of money or the value of goods which the

proprietor takes for his domestic or personal use. - It is usually subtracted from capital.Ex.: Withdrew cash for domestic use - Rs. 2,500• Entry:- It means the record made in the books of account in

respect of a transaction.• Voucher:-A voucher is a written document in support of a transaction.

Accounting terminology• Debit :- It means ‘to owe’- Entries are shown on left side of the account• Credit:- It refers to the benefit or gain or expecting payment in the

future- Entries are shown on the right side of the account • Discount:- When customers are allowed any type of deduction in the

prices of goods by the businessman

Accounting Principles and Concept

• In order to maintain uniformity and consistency in preparing and maintaining books of accounts, certain rules or principles have been evolved.

• These rules/principles are classified as concepts and conventions.

• These are foundations of preparing and maintaining accounting records.

Meaning• Accounting concept refers to the basic assumptions

and rules and principles which work as the basis of recording of business transactions and preparing accounts.

The Business Entity Concept:

• The business enterprise and its owners are two separate independent entities.

• The accounting records are made from the point of view of the business unit and not the person owning the business.

• Thus, the owners’ capital is recorded as the liability of the business to the owner

Liability of the firmOwners’ Capital

Owner

Example• Suppose Mr. Sahoo started business investing Rs1,00,000. He

purchased goods for Rs40,000, Furniture for Rs20,000 and plant and machinery of Rs30,000. Rs10,000 remains in hand. These are the assets of the business and not of the owner. According to the business entity concept Rs100000 will be treated by business as capital i.e. a liability of business towards the owner of the business.

• ASSET OF THE FIRM LIABILITY OF THE FIRM

Goods 40,000 Capital 1,00,000

Furniture 20,000Plant & Mach. 30,000Cash 10,000

• Now suppose, he takes away Rs5000 cash or goods worth Rs5000 for his domestic purposes. This withdrawal of cash/goods by the owner from the business is his private expense and not an expense of the business.

• It is termed as Drawings

Going concern concept

• A business firm will continue to carry on its activities for an indefinite period of time.

• This concept provides a basis for showing the value of assets in the balance sheet.

• Thus, fixed assets are recorded at their original cost less depreciation.

• Market value of fixed assets is not recorded.

• A company purchases a plant and machinery of Rs.1,00,000 and its life span is 10 years.

• According to this concept every year some amount will be shown as expenses and the balance amount as an asset.

Example

Money Measurement Concept

• All business transactions must be in terms of money• The records of the transactions are to be kept not in

the physical units but in the monetary unit

Sale of goods worth Rs.20,0000 Purchase of raw materials Rs.1,00,000Rent Paid Rs.10,000 These are expressed in terms of money, and so they

are recorded in the books of accounts. Sincerity, loyalty, honesty of employees are not recorded in books of accounts because these cannot be measured in terms of money although they do affect the profits and losses of the business concern.

Example

• At the end of the year 2013, an organisation may have:

A factory on a piece of land - 10 acres Office building - 50 roomsPersonal computers – 50 units Office chairs and tables – 50 unitsRaw materials – 100 kgThese are expressed in different units. But for

accounting purposes they are to be recorded in money terms i.e. in rupees.

Accounting Period Concept

• All the transactions are recorded in the books of accounts on the assumption that profits on these transactions are to be ascertained for a specified period.

• Year that begins from 1st of January and ends on 31st of December, is known as Calendar Year. The year that begins from 1st of April and ends on 31st of March of the following year, is known as financial year.

Dual aspect principle

• Every transaction has a dual effect• It affects two accounts in their respective opposite

sides.• The duality concept is commonly expressed in terms

of fundamental accounting equation:• Assets = Liabilities + Capital• The above accounting equation states that the assets

of a business are always equal to the claims of owner/owners and the outsiders.

• This claim is also termed as capital and that of outsiders, as liabilities.

Example• Goods purchased for cash has two aspects: (i) Giving of cash(ii) Receiving of goods. • Capital brought in by the owner of the businessThe two aspects in this transaction are:(i) Receipt of cash(ii) Increase in Capital (owners’ equity)• Purchase of machinery by chequeThe two aspects in the transaction are(i) Reduction in Bank Balance(ii) Owning of Machinery

Realisation principle• This concept states that revenue from any business

transaction should be included in the accounting records only when it is realised.

• The term realisation means creation of legal right to receive money.

• Revenue is said to have been realised when cash has been received or right to receive cash on the sale of goods or services or both has been created.

• The concept of realisation states that revenue is realized at the time when goods or services are actually delivered.

• N.P. Jewellers received an order to supply gold ornaments worth Rs.500000. They supplied ornaments worth Rs.200000 up to the year ending 31st December 2005 and rest of the ornaments were supplied in January 2006.

• The revenue for the year 2005 for N.P. Jewellers is Rs.200000. Mere getting an order is not considered as revenue until the goods have been delivered.

• Akshay sold goods on credit for Rs.50,000 during the year ending 31st December 2005. The goods have been delivered in 2005 but the payment was received in March 2006.

• Akshay’s revenue for the year 2005 is Rs.50,000, because the goods have been delivered to the customer in the year 2005. Revenue became due in the year 2005 itself.

Matching principle• This concept states that the revenue and the expenses incurred

to earn the revenues must belong to the same accounting period.

• It is in the view that all costs which are associated to a particular period should be compared with the revenues associated to the same period to obtain the net income of the business.

• It implies - revenues earned during an accounting year, whether received/not received during that year and all cost incurred, whether paid/not paid during the year should be taken into account while ascertaining profit or loss for that year.

•

The Full Disclosure Principle

• It stresses upon providing accurate, full and reliable information and data in the financial statements

• Accounts should be prepared in such a way that all material information required by the users of financial statements is clearly disclosed.

Thank You