ACCOUNTING

Theory
https://www.youtube.com/watch?v=4c0fB0IwIqs
MEANING

● Language of business
Concerned with;
● recording of financial transactions
● Summarizing them
● Communicating the financial info to
users
DEFINITION (AICPA)
● Art of recording, classifying &
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.
ATTRIBUTES (CHARACTERISTICS)

● Identification of financial transactions &

events
● Measuring the identified transactions
● Recording
● Classifying
● Summarizing
● Analysis & interpretation
● communicating
BRANCHES OF ACCOUNTING

● Financial accounting

● Cost accounting

● Management accounting
BOOK KEEPING, ACCOUNTING,
ACCOUNTANCY
● BK - part of accounting, recording of financial
transactions in the books of accounts

● A/Cing - recording, classifying, summarizing &

interpreting

● A/Cancy – area of systematic knowledge

OBJECTIVES
● Maintaining systematic records of
transactions
● Ascertaining profit or loss
● Ascertaining financial position
● Assisting the management
● Communicating accounting information
to users
FUNCTIONS

● Maintaining systematic records

● Communicating the financial results
● Meeting legal requirements
● Protecting business assets
● Assistance to management
● stewardship
ADVANTAGES
● Financial information about business
● Assistance to management
● Replaces memory
● Facilitates comparative study
● Facilitates settlement of tax liabilities
● Facilitates loans
● Evidence in court
● Facilitates sale of business
● Assistance in the event of insolvency
● Helpful in partnership accounts
LIMITATIONS
● Accounting is not fully exact (estimates)
● Accounting does not indicate the realisable
value of assets
● Accounting ignores the qualitative elements
● Accounting ignores the effect of price level
changes
● Accounting may lead to window dressing
ACCOUNTING INFORMATION
● Types

● Information relating to profit/ surplus

● Information relating to financial position

● Information about cash flow

USERS

•INTERNAL
● Owners
● Management
● Employees & Workers
•EXTERNAL
● Banks & Financial Institutions
● Investors & potential investors
● creditors
● Government & its authorities
● Researchers
● Consumers
● Public
QUALITATIVE CHARACTERISTICS
● Reliability
❑ Should be verifiable, free from bias and material error

● Relevance

● Understandability

● Comparability – intra – firm & inter-firm

SYSTEMS OF ACCOUNTING

● Double entry system

● – Lucas Pacioli
● - every transaction has two aspects, both are recorded

● Single entry system – only personal accounts & cash

book is prepared.
BASIC ACCOUNTING
TERMS
1. BUSINESS TRANSACTION
● Financial transactions or events entered into by
parties
● recorded in books of accounts
● Can be expressed in terms of money
● Brings change in the financial position of the firm
● Concerned with 2 parties

● Examples:
● Dual aspect :
● receiving (debit)
● Giving (credit) of the benefit

•Transaction
• Relationship with Accounting unit
○ Internal(accounting) transaction
○ External(business) transaction

• Mode of settlement of Value

○ cash
○ credit
2. ACCOUNT
● Summarized record of transactions
● Relating to a particular head
● At one place

● …it records…
● Amount
● Effect
● Direction
● …..of transactions
3. CAPITAL
● Amount invested by proprietor or partner
● Money or assets having money value
● Liability of business towards proprietor or partner

● Owner`s equity
● Net worth

● Equals assets less liabilities

4. DRAWINGS
● Amount withdrawn or goods
● taken by the proprietor
● for his personal use

● Goods so taken are valued at purchase cost

● Reduce investment/ capital of the owners

5. LIABILITIES
● Amount owed (payable) by the business

● To outsiders (external) : from credit transactions or loans

raised. Creditors, bank overdraft, bills payable, ….

● To the proprietor (internal) : represented in the balance

sheet as capital & free reserves
FURTHER…
● Long term : payable after a long period (more than 1 year) ;
long term loans, debentures,…

● Current : payable within a year ; creditors, bills payable, short

term loans

● Contingent : may or may not arise in future depending on the

happening of an event ; bills receivable discounted (if
dishonoured) ; shown as footnote in balance sheet.
6. ASSETS
● Property or legal rights owned by a business to which money
value can be attached

● Anything which will enable the firm to get cash or a benefit in

future

● Land, building, machinery, furniture, stock, debtors, cash, bank

balance, ….

● It can be in tangible or intangible form

CLASSIFICATION…

❖ Tangible : have physical existence; can be seen &

touched.
● Land, building, furniture, goods,…

❖ Intangible : do not have physical existence; cannot be

seen & touched.
● Patents, goodwill, trademark,..
❖ Fixed : acquired not with the purpose to resell but to employ
them in business
● Facilitates business operations
● Increases earning capacity
● Land, building,…

❖ Current : retained with the purpose to convert them into cash

within a short period (one year)
● Goods, debtors, bills receivable,…
● Prepaid expenses(though cannot be converted into
cash)…classified as current assets….as benefit from such
expenses are not fully exhausted …it will be available in the
next accounting year also
❖ Liquid assets : assets in the form of cash or can be
converted into cash within a very short period.
● Eg: cash, bank, bills receivable, debtors,…

❖ Fictitious Assets :
● Neither tangible nor intangible
● Represents loss or expenses yet to be written off
● Eg: Debit balance of P& L A/c (loss),
Deferred revenue expenditure…
7. RECEIPTS
● Amount received or receivable for selling assets,
goods or services

❖ Capital receipts: amount received or receivable for

selling assets
● Eg: sale of machinery, building, furniture, etc…

❖ Revenue receipts : amount received or receivable

against sale of goods or services.
● Receipts on account of business transactions
8. EXPENDITURE
● Amount spent or liability incurred for acquiring assets,
goods or services

❖ Capital expenditure :
● expenditure incurred to acquire assets or improving
the existing assets
● Will increase the earning capacity of the business
● Will give benefit in more than one accounting year
● Purchase of machinery, furniture, computers,…to
carry on business
● Shown on the `Asset side` of `Balance sheet`
❖ Revenue Expenditure :
● amount spent to purchase goods and services that are
consumed during the accounting period.
● Does not increase earning capacity but maintains it in the
current year.
● Shown on the `Debit side` of `P&L A/c`

❖ Deferred Revenue expenditure :

● Revenue expenditure in nature
● But written off (charged) to P&L A/c in more than one
accounting period
● Eg: Large advertising expenditure that will give benefit for
more than one accounting period.
REVENUE…
● Inflow of assets which results in an increase in owner`s
equity

● Amount (as a result of operations; i.e.; sale of goods or

services) added to capital.

● E.g.; receipts from sale of goods, rent received,

commission received,…

● Income = revenue – expense

(sale of goods) (cost of sale of goods)
9. EXPENSE
● Value expired during the accounting period
…may be..
1. Cash payment…salaries, wages, rent,…
2. Writing off a part of fixed assets (depreciation)
3. Writing off from a current asset (bad debt)
4. Decline in the value of assets (eg; investments)
5. Cost of goods sold

● Charged (debited) to P&L A/c

PREPAID EXPENSE

● Expense paid in advance

● Benefit available in the following year/years

● Shown under ‘current assets’ in Balance sheet

● Transferred to P&L A/c in the next year
OUTSTANDING EXPENSE
● Expense that has not been paid for
● Benefit has already been availed

● Debited to P&L A/c

● Shown under ‘current liabilities’ in the Balance sheet
10. INCOME

● Profit earned during a period of time

● Difference between revenue & expense

● income = Revenue - Expense

11. PROFIT
● Excess of revenue over cost

● Gross profit : difference between sales revenue and

direct cost

● Net profit : profit made after allowing for all expenses

…if expenses are more than the revenue…it is Net loss
12. GAIN

● Profit of irregular or non-recurrent nature

● Example:
Profit on sale of fixed assets or investment
13. LOSS
● Excess of expenses of a period over its related revenues
● Decreases owner`s equity

● Money/money`s worth lost(or cost incurred) against which

the firm receives no benefit
● E.g.; cash or goods lost in theft

● Also from events of non-recurring nature

● E.g.; loss on sale of fixed assets
14. PURCHASES
❑ sed for ‘purchases of goods’
U

● Goods ; articles purchased

for resale
for producing finished goods which are to be
sold

❑ Includes both cash and credit purchases of goods

❑ Purchase returns : goods returned (defective, not as

per specification); Returns outward
15. SALES

● Sale of goods that are dealt with by the firm

● Includes both cash & credit sales

● Sales return : goods sold when returned by the

purchaser (customer); Returns inward
 BASES OF
ACCOUNTING
CASH BASIS OF ACCOUNTING
● Transactions are recorded only when cash is received
or paid
● o/s & prepaid expenses, accrued income, income
received in advance,.. Are not considered

● E.g.:, Receipts and Payments A/c in Not-for –profit

organisations

● Simple…no adjustment entries

ACCRUAL/ MERCANTILE BASIS OF
ACCOUNTING
● Transactions are recorded when
● income is earned or accrued
● expense is incurred

● Based on revenue recognition and matching principle

ACCOUNTING EQUATION
● http://www.youtube.com/watch?v=YK4FJ7QrFY0

● http://www.accountancy.tv/videos-the-accounting-equation-conceptual-analogy-[YK4FJ7QrFY0].cfm