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ACCOUNTING FOR MANAGERS UNIT-I LESSON 01 Introduction of Accounting

Definition of Accounting:"Accounting is an art of recording, classifying and summarizing in a
significant manner and in terms of money, transition and events which are of a financial character and interpreting the result there off". For recording process accounting journal and subsidiary books are maintained, for classification ledger is maintained, and for summarizing trial balance and final accounts are prepared. Accounting Principles: In Order to bring uniformity to the recording of business transactions the accountant follows certain basic procedures universally ie Generally Accepted Accounting Principles (GAAP). Accounting principles are categorized in three parts: I. II. III. Basic assumptions Concepts Conventions

I. Basic accounting assumptions: 1. Separate business entity: This principal says that the business is assumed to be a distinct entity than the person who owns the business. This concept is for business not for the person. If there is a partnership concern carrying a business name M/s XYZ Co., in which Mr. A and Mr. B are the equal partner but M/s XYZ Co., supposed to be a separate entity. 2. Going Concern Concept: This concept propose that the business organization is going to be in existence for an indefinitely longer period of time and is not likely to close down in shorter period of time. 3. Money Measurement Concept: This concept proposes that only those transaction and facts find the place in accounting which can be expressed in terms of money. For ex, morale, motivation of works, credibility on the business not finds any place in accounting. 4. Accounting Period Assumption: Even if the going concern concept proposes that the business is going to be in existence for an indefinitely longer period of time, but practically it is very difficult to wait for such a longer period. Therefore it is divided into different segment of time as one year, half yearly and quarterly, and at the end of each segment profit & loss A/C and balance sheet are prepared.

II. Concepts: 1. Revenue Reorganization Principle: This principle is also called a revenue realization principle. According to this principle revenue is recorded in books of accounts when sale has taken place and there will be no particular transaction in future, but in this principal two exemptions are there. 1. Hire purchase: in this sales are presumed to the extent of instalment received. 2. Contract account: in this total part of revenue is treated as realized 2. Cost Principle: This concept propose that the assets acquired by the organization are recorded at their cost of acquisition and this cost is considered for all the subsequent accounting (current market price being irrelevant) purpose say charging depreciation. 3. Dual aspect principle: This concept says that every business has two aspects. On the basis of this it is said that Debit = Credit. For ex: Mr. A starts a business with cash of Rs. 50000: than the entry will be, Cash A/C To Capital A/c This also called a double entry system. 4. Full Disclosure Principle: According to the Company Act 1956 financial statement should disclose true and fair view so that it provide the proper information to the users. Therefore companies have to give footnotes regarding some investment, contingent liabilities, along with the balance sheet. 5. Matching of Cost and Revenue principle: According to this principle to compute the operational profit or loss of the business in a year it is necessary to find out the expenses and revenue relating to that period, than all the revenue are matched with all the expenses. This matching is called the principle of matching of cost and revenue. (Profit = Revenue-Expenses) 6. Objectivity Principle: According to this principle transactions which are recorded in book of accounts must be based on facts and accuracy, and there should be a documentary evidence for each transaction. III Modifying Accounting Principles: 1. Conservation: This convention is usually expressed to anticipate all the future losses and profits at the time of preparing the financial statement. This principle goes against the principle of disclosure. The accountant creates a secret reserve through provision Dr. 50000 50000

for bad and doubt full debts, depreciation and valuation of stocks. 2. Consistency: This convention proposes that the accounting policies and procedures should be followed consistently on a period to period basis as to facilitate the comparison of financial statement. According Kohlar there are three types of consistency horizontal consistency, vertical consistency and dimensional consistency. 3. Timeliness: According to this principle information given in financial statement must be reliable and relevant, and this information must be supplied on time. 4. Materiality: According to this principal only those information should be considered which have material impact on profitability or financial status, and which influence the decision of shareholders, investors and creditors and other insignificant information should be ignored. For eg. Purchase of postal stamps, some of which remain unused at the time of accounting period so that should not be considered because it is negligible. 5. Cost-benefit principle: According to this principal the cost of using an accounting principal should not exceed its benefits. 6. Industry Practice: Different accounting principles are adopted in different industries. For eg. disclosing of investment, method of depreciation, and valuation of stock. Principle of Double Entry System: As per the principle of the double entry system each transaction of the business is recorded at the two places, it means each entry has effect on two sides. There are three basic rules: 1. In case of Personal Account- Debit the Receiver, Credit the Giver. For eg. Mr. kamlesh started business with cash. Entry will be: Cash A/c Dr.

To. Capital A/c 2. In case of Real Account - Debit what Comes In and Credit what Goes Out. For eg. Purchased furniture Entry will be, Furniture A/c To Cash A/c Dr.

3. In case of Nominal account- Debit all the Expenses, Credit all the Incomes. For eg. Paid for travelling expenses. Entry will be. Travelling expenses A/c Dr. To Cash A/c. Types of Accounts The accounts are classified on the basis of two approaches: American approach English approach. American Approach: In American approach account are classified in four parts: 1. Assets Account: In this account business related transaction are considered. For eg plant and machinery, furniture, land, building etc. 2. Liabilities Account: Under this account those transaction are kept which are related to credit purchase, loans, capital etc. 3. Revenue Account: This account includes the transaction related to income, commission, interest, dividend, etc. 4. Expenses Account: This account include the transaction related to expenses of business as repair, rent, advertising, salary, etc. English Approach: In English approach accounts are classified in three parts: 1. Personal Account: In this those terms are included which are related to person, firm, organization, bank, etc. 2. Real Account: In this account of assets and liabilities are included for eg. Land, building, machinery, plant, etc. It also consist intangible assets as goodwill, trademark, etc. 3. Nominal Account: In this account income and expenses are included. For eg. Salary, wages, stationery, insurance, etc.

Journal
Journal is a primary book of original entries, the process of recording business transaction in the journal is called journalizing. Performa of journal: Date Particular L.F. Dr.(Rs.) Cr.(Rs.)

Journal is being subdivided in five columns: 1. Date: It refers the date on which transaction has taken place. 2. Particular: It refers to titles of the account to be credited and debited. In the same column on the next line, brief description of the transaction is written which is referred to as Narration. 3. L.F: This is the abbreviation of the ledger folio. This column refers to the page number of the ledger. 4. Amount Debited: The amount to be debited is stated in this column. 5. Amount Credited: The amount to be credited is stated in this column. Compound Journal Entry: When two or more transaction takes place in the business relating to same account on the same date is called compound entry. Opening Journal Entry: The closing balance of last year becomes the opening balance of next year. To record the opening balance, journal entry is passed which is called opening entry. For eg. In a business closing balance Cash 10000, Machinery 25000, Building 50000 and Capital 85000. Entry will be: Cash A/c Machinery A/c Building A/c To. Capital Dr. Dr. Dr. 10000 25000 50000 85000

Illustration: Journalizing the following transaction in the books of Mr. Amit Sen. a. Mr. Amit Sen commenced business with Cash Rs. 10000, Machinery Rs. 10000, Building Rs. 30000 and Furniture Rs. 15000. b. Paid salaries of Rs. 12000. c. Received cash from cash sales Rs. 250000. d. Wages paid Rs. 4000. e. Additional Capital brought by Mr. Amit Sen of Rs. 50000 f. Mr. Sen purchased good worth Rs. 10000 from Mr. Rao on cash @ 2% cash discount. g. A personal table fan worth Rs. 450 brought in the office for office use. h. Sold goods to Mr. Ram worth Rs. 15000 cash after allowing 5% trade discount. i. j. Sent a cheque of Rs. 1000 to charity as Mr. Sen personal contribution. Good purchased for Mr Kamlesh on credit Rs. 25000.

Solution: In the books of Mr. Amit Sen Date Particular Cash A/c Dr. Machinery A/c Dr. Building A/c Dr. Furniture A/c Dr. To, Capital (Being business started with cash, machinery, building and furniture.) Salaries A/c Dr. To, Cash (Being salaries paid by cash) Cash A/c Dr. To, Sales (Being good sold for cash) Wages A/c Dr. To, Cash (Being wages paid by cash) Cash A/c Dr. To, Capital (Being additional capital introduced in business) L.F. Dr. Rs 10000 10000 30000 15000 Cr. Rs.

65000

12000 250000 4000 50000

12000 250000 4000 50000

Purchase A/c Dr. To, Cash To, Discount Received (Purchased goods purchased worth Rs 10000 and received discount of 2%) Furniture A/c Dr. To, Capital (Being personal table fan purchased for office use.) Cash A/c Dr. To, Sales (Being goods sold for Rs 15000 at trade discount of 5%.) Drawings A/c Dr. To. Bank (Being donation (personal contribution) paid by cheque) Purchase A/c Dr. To, Mr. Kamlesh (Being goods purchased on credit by Mr. Kamlesh)

10000

9800 200

450 14250 1000

450 14250 1000

25000

25000

Ledger: Ledger is the book where transactions of similar nature are pooled together under one
ledger account. Posting: The process of transferring the entries from journal to ledger is called posting. Rules of posting in ledger are: 1. In the debit side of ledger word To is used while on credit side word By is used. 2. All those account which are in journal will be opened in ledger. 3. All the debit item of journal account is posted on debit in ledger and all the credit will be posted on credit side in ledger. 4. The name of the account in which posting is being made is not written. But the posting is done by the name of other account given in the opposite side of that entry in journal. 5. At the item of posting if page is full than it should be carried forward to next page for remaining entries and total. Balancing of ledger account: 1. Take the total of the both side of the ledger account. 2. Calculate the difference between total of both the sides. 3. If the total of debit side is heavier place the difference on credit side by writing By Balance c/d,. And if the balance of credit side is heavier than place the difference on

debit side by writing To Balance b/d. 4. After balance is placed, ensure that the total of both sides match each other. Illustration: Machinery Account Dr. Date 2008 March 1 March 31 Particular To balance b/d To Bank L.F. Rs. 25000 70000 Date 2008 March 10 March 31 Particular By depreciation By Balance c/d L.F. Cr. Rs. 10000 85000

2008 April 1

To Balance b/d

95000 85000

95000

Trial balance: Trial balance is the summary of all the balance in all account listed in the
Journal, Ledger and Cash book of an organization at any given date. Trial balance is the evidence of the fact that all transactions have been properly posted in the ledger. Trial balance generally is the arithmetical accuracy. Performa of trial balance Particular Dr. Cr.

Methods of trial balance There are three methods: 1. Balance method: In this the balance of all accounts are recorded, if an account has debit balance than this comes on debit side of trail balance and if credit than on credit side, and if any account has no balance than it does not appears in trial balance. 2. Total method: In this to check the arithmetical accuracy the amount of both side are totalled and if its mismatches than it is corrected. However this is not the sole proof of accuracy of the book of ledger.

3. Balance and total method: This is the method in which both the method is going to be used Balance method and Total method. According to balance method the accounts are recorded according to their balance and at last to see the accuracy the total of both debit side and credit side will be checked. Types of Errors: There are two types of errors: 1. Errors which cannot be located by trial balance: i. Error of omission: While recording in the books when any business transaction is completely or partially omitted it is known as Error of Omission. For eg. good purchased by cash, if it is not entered in the book. Error of commission: These types of error occur when one account is debited or credited in the place of another account. For eg. Furniture purchased, and if it is wrongly entered in the plant account. Error of principle: This is an error when there is a wrong classification between the capital and revenue nature incomes or expenditure. For eg. Purchase of furniture Rs 5000, are entered in the books of purchase wrongly, instead of entering in furniture account. Compensating error: When two errors of the same account occur and the effect of one error is compensated by the effect of other is called compensating error. For eg. Good sold to Ram of Rs 10000/- is debited by only Rs 1000 while the sales from Shyam for Rs 1000, is credited by 10000. 2. Error which can be located by trial balance: I. Total of the ledger accounts or subsidiary books. II. Wrong posting of any amount in any account. III. Posting of any amount may be in the wrong side of the account. IV. Balance of any account may be omitted in writing in the trial balance. V. Wrong total of the trial balance. Capital and Revenue - Expenditure and Receipts Expenditure is classified in three categories: 1. Capital expenditure: Capital Expenditure indicate the amount of fund is incurred in the business to get the benefit for a long period, whether that fund is to purchase new assets, or it is incurred in addition or improvement of old assets. For eg. Purchase of furniture, building or any assets, expenditure done on improvement of building, expenditure to acquire license,

ii.

iii.

iv.

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patent, etc. 2. Revenue Expenditure: The expenditure which is done for a short period (less than one year) for the day to day operation of business comes under this head. For eg. Giving salary, fuel and electricity charges, repair of machinery etc 3. Deferred Revenue Expenditure: Deferred Revenue Expenditure is done for the benefit of two or three years. For eg expenditure on advertisement, research and development, preliminary expenses, this type of expenditure are divided by a company for a number of years. Therefore the amount is not completely transferred to profit and loss account, it is entered over the period of time, Written off amount is reflected in profit and loss account and the unwritten off is reflected on assets side of balance sheet as factious assets. Classification of Receipts: This is of two types: 1. Capital receipt: Sale of fixed assets, loan raised, long term investment comes in capital receipt. Capital receipt is different from capital profit/loss. For eg entire amount of sale of assets is capital receipt, but the difference of sales proceeds and the cost of asset is the capital loss/profit.
2. Revenue receipt: The receipt which is obtained by the normal course of business. For eg sale

of goods. Revenue receipt is different from revenue profit/loss. For eg. Goods are of Rs 7000 and sold at Rs 5000. So the entire sale is revenue receipt and revenue loss is of Rs 2000.

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