LESSON - 1
MEANING AND OBJECTIVES OF ACCOUNTING
OBJECTIVES
After going through this chapter, you should be able to
· understand the meaning, features and limitations of accoutning
· distinguish between different concepts of accounting
· know the difference between book-keeping and accounting
· understand double entry system and preparation of journal
· understand the meaning of ledger.
STRUCTURE
1.1 Meaning of Accounting
1.2 Features and limitations
1.3 Accounting concepts
1.4 Accounting Equation
1.5 Book-keeping and Accounting
1.6 Preparation of Journal
1.7 Ledger
Unit Questions
1.1 MEANING OF ACCOUNTING
All activities of an organisation are to be recorded and documented. Irrespective of the nature of the activity wherever money is involved accounting is required to account for it. Accounting is often called the language of business as it serves as a means of communication. Accounting may be defined as the process of collecting, recording, summarizing and communicating financial information. The American Institute of Certified Public Accountants(AICPA) has defined accounting as “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”.
1.2. FEATURES AND LIMITATIONS
FEATURES OF ACCOUNTING
1. Accounting involves recording of economic activities of the business which are coupled with complexity and uncertainty. Therefore timely accounting statements estimate and professional judgements facilitate.
2. Accounting statements are prepared either on (a) cash basis of accounting, or (b) accrual basis. In cash of accounting events are recognized only when cash is received or paid. Accrual basis of accounting revenues earned and expenses incurred as transactions.
3. Accounting is historical in nature, i.e., it is the record of past happenings.
The advantages of accounting are:
1. It provides a complete, systematic and accurate record of business transactions.
2. Facilitates the organisation to know the result of its operations.
3. By studying the assets and liabilities position one can know the financial capabilities of the organisation.
4. It facilitates the organisation to know the amount payable to creditors and the amount receivable from debtors.
5. It facilitates comparison of records.
6. It minimizes the occurrence of frauds and strengthens the system of maintaining accounts.
7. It provides information for decision-making.
8. It provides useful information to investors, creditors for prediction and comparison regarding its strengths and weaknesses.
LIMITATIONS OF FINANCIAL ACCOUNTING
1. It is historical in nature. So it does not reflect current financial worth of the business.
2. They do not the impact of inflation.
3. Elaborate recording of transactions increases the volume of accounting and the cost of operation.
4. The system needs competent people who should have sound knowledge for maintenance of accounting records.
1.3 ACCOUNTING CONCEPTS
Accounting is art and science of recording business transactions in a systematic manner. Certain principles are needed to convey the accounting principle in an effective way. Otherwise confusion will prevail. Accounting concepts refer to basic accounting postulates that is the necessary assumptions and conditions on which accounting is based. Various recognized accounting concepts are:
1. Business entity concept.
2. Going concern concept
3. Cost concept
4. Dual aspect concept
5. Money measurement concept
6. Accounting period concept
7. Realisation concept
8. Matching of cost and revenue concept
9. Objectivity evidence concept
1. Business Entity Concept
For accounting it is assumed that business has separate existence and its entity is different from that of its owners. This concept ensures that accounting records reflect only the activities of the business. For enumerate the principles:
a) Business has a separate entity of its own
b) In the books of accounts only business transactions are recorded.
c) While recording and reporting, the assets of the business alone is recorded and not the personal assets of the owners or shareholders.
d) Income is the property of the business unless distributed to the owners.
2. Going Concern Concept
This concept assumes that a business entity will continue to operate indefinitely. It does not imply permanent existence but simply stability and continuity for a sufficient period to carry business plans. This is just like the living beings continue to work on the assumption that they will remain alive for a fairly long period unless they are terminally ill. The accounts are to be prepared on the assumption that the business is going to continue indefinitely.
3. Cost Concept
According to this concept, the assets are recorded at its cost in the books of accounts and gradually reduced by depreciation. Amount of depreciation can be easily calculated on cost price and its effective life. The market value of the asset cannot be taken into consideration as it poses two great problems.
4. Dual Aspect Concept
It is the basic principle of accounting. Every business transaction has a dual effect, i.e., the twofold effect of benefit giving and benefit receiving. The recording of both these is considered as the core of double-entry. This assumes that total assets are equal to total liabilities. This is called as the Balance Sheet equation or Accounting equation. It can be stated as:
Capital + Liabilities = Assets
Or
Capital = Assets – Liabilities
5. Money Measurement Concept
In accounting all transactions are expressed and interpreted in terms of money. The basic purpose of using money is to implement an element of uniformity among diversity. But this concept has two limitations:
a) This comcept does not recognize the changes in purchasing power of monetary unit.
b) It cannot keep record of such matters which cannot be expressed in terms of money.
6. Accounting Period Concept
This refers to the span of time at the end of which financial statements are prepared to throw light on the results of operations of the business during the relevant period and financial position at the end of relevant period. Normally the accounting period is of twelve months. In India
7. Realisation Concept
This deals with the determination of the point of time when revenues are earned. Revenue is realised when goods and services produced or rendered by a business enterprise are transferred to a customer for cash or for some other asset or promise to pay cash in future.
8. Matching of Cost and Revenue Concept
This concept involves the comparison of cost of goods sold with the sales revenue during an accounting period. Expenses which are actually incurred during a specific activity period, in order to earn revenue for the said period is to be matched against the revenue which is realised in that period.
9. Objectivity Evidence Concept
All business transactions are to be recorded on the basis of documentary evidences. This is done with the object of verification and this is to substantiate the recorded event.
1.4 THE ACCOUNTING EQUATION
Financial accounting is based on accounting equation. The resources are possessed by the firm as assets. Some of the resources will have to be supplied to the firm by the owner of the business. The total amount supplied by him is known as his capital. Some of the assets of the business have been provided by someone other than the owner. The indebtedness of the firm for these resources is known as liabilities. The capital must be equal to assets minus liabilities.
So the accounting equation has two sides and they must be equal. The equity of the two sides will always be true. Capital is often called the owner’s equity or net worth. Keeping in view the two types of equities, the equation given above can be stated as below.
Assets = Liabilities + Capital
Or
Capital = Assets – Liabilities
Or
Liabilities = Assets – Capital
The following rules are to be used for accounting equation:
1. Assets – Increase in assets are debits and decrease in assets are credits.
2. Liabilities – Increase in liabilities are credits and decrease in liabilities are debits.
3. Capital – Increase in capital are credits and decrease in capital are debits.
4. Expenses – Increase in expenses are debits and decrease in expenses are credits.
5. Profits or Income – Increase in profits are credits and decrease in profits are debits.
1.5 BOOK-KEEPING AND ACCOUNTING
Book-keeping is recording of the financial transactions of the business in a methodical manner to obtain any information quickly and easily. Its features are:
a) Recording business transactions in a systematic manner
b) It is a mechanical work of a repetitive nature and performed by employees at lower levels of management.
c) Recording is done with the help of documentary evidences.
d) Preparation of ledgers and trial balance is done by the book-keepers. It lays the foundation for accounting function.
1. DOUBLE ENTRY BOOK-KEEPING
This is the orderly recording of business transactions in a systematic manner. In double entry the twofold effect of a transaction, i.e., the benefit giving and benefit receiving aspects, are to be recorded. So under double entry the total of debit entries and credit entries on various accounts must be equal. The advantages of double entry are:
a) This provides a complete and reliable record of all business transactions.
b) The arithmetical accuracy of the accounting system can be checked by preparing Trial Balance.
c) The performance can be evaluated by preparing Profit and Loss Account.
d) To ascertain financial position of the business balance sheet can be prepared
e) The accounting data provided facilitates the management to compare and to arrive at financial decisions for the future.
f) It is a scientific and reliable system of accounting and it minimizes the occurrence of frauds and errors.
1.6 PREPARATION OF JOURNAL
The transactions of a business organisation are recorded in chronological order in the Journal. It is the first book in which entries are made. It is known as the book of original entry. The journal entry analyses the effects of transaction on the accounts and they are accompanied by a narration. The recording in the journal is called Journalising.
The functions performed by a journal are
a) Analytical function. The impact of the transaction on ledgers and the debit or credit.
b) Recording function. A narration accompanies a journal entry. Ant reference can be made easily.
c) Historical function. Recording is done chronologically. It acts as a diary and serves the purpose as evidence.
The journal has five columns. They are Date, Particulars, Ledger Folio (page of the ledger where posting is made) Amount. The amount column is divided into debit and credit. As stated earlier the preparation of journal is called Journalising.
The steps in journalising are:
a) Study the business transaction.
b) Always look at the transaction from the business point of view.
c) Identity the accounts involved in the transaction.
d) Apply the rules.
e) Journalise the transaction.
The steps in journalising are to be explained. The first two steps are the general instructions to be kept in mind. In the third step identification of accounts is given. All accounts are classified into two groups known as personal and impersonal accounts. Personal Accounts means recording transactions with a person or group of persons, i.e., individuals and institutions. The personnel accounts are classified (a) Natural parsons, (b) Artificial persons, and (c) Representative persons. Example:Ram’s Capital A/c, Nehru’s Capital Account, Reliance Industries Limited Account, Punjab National Bank Account. Impersonal accounts are those which are not personal accounts. It is further classified as Real and Nominal accounts. Real Accounts relate to properties of business enterprise which may be tangible or intangible. Tangible real accounts mean accounts of properties which have physical existence like cash, building, stock, furniture, etc. Intangible Real accounts cannot be physically felt or touched but are capable monetary measurement. Example: Goodwill, Patent Rights, Trade Mark, Copyright. Nominal Accounts relating to income, revenue, gain, expenses and losses are called as nominal accounts. Example:Commission Account, Rent Account, Discount Account. The fourth step in journalizing is the application of rules. The rules are:
Personal Accounts – Debit the receiver, Credit the giver.
Real Accounts – Debit what comes in, Credit what goes out.
Nominal Accounts – Debit Expenses and Losses, Credit Incomes and Gains.
Example 1:
Journalise the following transactions of M/s Arun and Co. for the month of March,2007.
Balances on March 1 Rs.
Cash 14,000
Bank 40,000
Stock 30,000
Furniture 10,000
Building 80,000
Debtors: Mrs. A 6,000
Mr. B 10,000
Bank Loan 14,000
Creditors: X 14,000
Creditors: Y 16,000
March 2 Received cash from Mrs. A Rs. 5,800 in full and final settlement.
March 6 Purchased goods at the list price Rs.10,000 at 10% discount on credit from Mr. Z
March 8 Sold goods to C on credit Rs. 8,000.
March 11 C pays Rs. 7,200 after getting 10% discount for prompt payment.
March 15 Salaries paid in cash Rs. 2,000
March 18 Interest on Bank loan Rs. 700 debited.
March 20 Goods costing Rs. 1,000 distributed as samples.
March 25 Ramanujam withdrew cash for personal use Rs. 2,000
March 30 Paid Rs. 13,500 to X in full settlement of his account.
March 31 Cash sales at list price Rs.5,000. Trade discount allowed Rs.500.
Solution.
In the Books of M/s Ramanujam and Co.
JOURNAL ENTRIES
Date | Particulars | L.F. | Debit Rs. | Credit Rs. |
2004 March 1 | Cash A/c Dr. Bank A/c Dr. Debtors Stock A/c Dr. Furniture A/c Dr. Building To Creditors A/c To Bank Loan A/c To Capital A/c (Balancing figure) (Being the record for opening balances of Asses and Liabilities and balance as capital) | 14,000 40,000 16,000 30,000 10,000 80,000 | 30,000 14,000 1,46,000 | |
2 | Cash A/c Dr. Discount Allowed A/c To A’s A/c (Being the entry for cash received from Mrs. A in full settlement) | 5,800 200 | 6,000 | |
6 | Purchases To Z’s A/c (Being the entry for credit purchase from Z) (10,000 – 10%) | 9,000 | 9,000 | |
8 | C’s A/c Dr. To Sales A/c (Being the entry for credit sales) | 8,000 | 8,000 | |
11 | Cash A/c Dr. Discount Allowed To C’s A/c (Being the entry for the receipt of cash from and allowing him discount) | 7,200 800 | 8,000 | |
15 | Salaries To Cash A/c (Being the entry for paying salaries) | 2,000 | 2,000 | |
18 | Interest on To Bank A/c (Being the entry for charging interest on Bank loan) | 700 | 700 | |
20 | Sales Promotion To Purchases A/c (Being the cost free samples distributed) | 1,000 | 1,000 | |
25 | Drawings To Cash A/c (Being the entry for money drawn for personal use) | 2,000 | 2,000 | |
30 | X’s A/c Dr. To Cash A/c To Discount Received A/c (Being the entry for paying cash to X in full settlement) | 14,000 | 13,500 500 | |
31 | Cash A/c Dr. To Sales A/c (Being the entry for cash sales at list price less 10%) | 4,500 | 4,500 |
1.7 LEDGER
The next step in the accounting process is known as classifying the transactions. This is done by preparing the ledgers. A group of accounts is called as ledger. This includes all basic accounts needed for the preparation of financial statements. It is the principal book of accounts. It is a collection of all accounts debited and credited in the journal and subsidiary books.
Based on the size of the organisation and the volume of transactions, the ledgers are designed to meet their requirements. Normally business enterprises will maintain three ledgers known as (a) Debtors’ Ledger, (b) Creditor’s Ledger, (c) General Ledger.
Debtors’ Ledger: It contains the accounts of all customers to whom goods have been sold on credit. Entries are made from Sales Day Book, Sales Returns Book and Cash Book. Other names: Sales Ledger or Customers’ Ledger.
Creditors’ Ledger: Other names are Purchase Ledger or Suppliers’ Ledger. It includes the accounts of all suppliers from whom goods have been purchased on credit. Entries are made from Purchases Book, Purchases Returns Book and Cash Book.
General Ledger: It is otherwise known as Nominal Ledger. It contains all residual accounts, mainly real and nominal accounts.
Form of Ledger
Accounts are simplified representation of ledger accounts widely used. It is dividend into two sides. The left-hand side represents debit side and the right-hand side the credit side. Each side of the ledger has the following columns. (a) Date, (b) Particulars, (c) Folio, (d) Amount.
Date - Shows the date of the transaction
Particulars - This is used for writing the account debited or credited.
Folio - The page of the Journal where the recording has been made.
Amount - Debiting/Crediting Amount of the account.
The preparation of ledger is technically called as posting. The posting is made from the Journal. The steps for posting are:
1. Locate in the ledger the first account named in the Journal.
2. On the Debit enter the credit aspect of Journal with prefix ‘To’.
3. Enter the date, amount and folio number.
4. Locate in the ledger the second account named in the journal.
5. In the Particulars column of credit side enter the name of the account debited in the Journal with a prefix ‘By’.
6. Enter the date, amount and Journal Folio.
7. After completing postings the accounts are balanced.
Balance is an accounting term which means the difference between the two sides of an account. The totals of both sides are calculated and from the greater total lesser is more than that of the credit side. If the total of the amount column on the debit side is balance is termed as Credit balance if the total of the credit side is more than the debit make the total of the both sides to be equal.
Example 2:
Prepare Ledger Accounts on the basis of Journal entries recorded for example 1.
Solution:
For students to solve problems of this type it is advisable to prepare a list of accounts to be prepared to plan your approach.
The accounts to be opened for this problem are:
(a) Cash account (b) Bank account
(c) Mrs. A’s account (d) B’s account
(e) Stock account (f) Furniture account
(g) Building account (h) Bank Loan A/c
(i) X’s account (j) Y’s account
(k) Discount Allowed A/c (l) Purchases account
(m) C’s account (n) Sales account
(o) Salaries account (p) Interest on Loan account
(q) Sales Promotion Expenses account (r) Drawings account
(s) Discount Received A/c
CASH A/C
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 1 | To Balance | Rs. 14,000 | 2004 March 15 | By Salaries A/c | Rs. 2,000 | ||
2 | To Mrs. A’s A/c | 5,800 | 25 | By Drawings A/c | 2,000 | ||
11 | To C’s A/c | 7,200 | 30 | By X’s A/c | 6,000 | ||
31 | To Sales A/c | 4,500 | 31 | By Balance c/d | 21,500 | ||
31,500 | 31,500 |
BANK A/C
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 1 | To Balance b/d | Rs. 4,000 | 2004 March 18 | By Interest on Loan | Rs. 700 | ||
March 31 | By Balance c/d | 3,300 | |||||
4,000 | 4,000 |
Mr. A’s ACCOUNT
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 1 | To Balance | Rs. 6,000 | 2004 March 2 | By Cash By Discount allowed | Rs. 5,800 200 | ||
6,000 | 6,000 |
Mr. B’s A/c
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 1 | To Balance | Rs. 2,000 | 2004 March 31 | By Balance c/d | Rs. 2,000 | ||
2,000 | 2,000 |
STOCK A/c
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 1 | To Balance | Rs. 30,000 | 2004 March 31 | By Balance c/d | Rs. 30,000 | ||
30,000 | 30,000 |
FURNITURE A/C
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 1 | To Balance | Rs. 10,000 | 2004 March 31 | By Balance c/d | Rs. 10,000 | ||
10,000 | 10,000 |
BUILDING A/c
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 1 | To Balance | Rs. 80,000 | 2004 March 31 | By Balance c/d | Rs. 80,000 | ||
80,000 | 80,000 |
BANK LOAN’S A/c
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 31 | To Balance | Rs. 14,000 | 2004 March 1 | By Balance c/d | Rs. 14,000 | ||
14,000 | 14,000 |
X’s A/c
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 31 | To Balance | Rs. 14,000 | 2004 March 1 | By Balance c/d | Rs. 14,000 | ||
14,000 | 14,000 |
Y’s A/c
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 31 | To Balance | Rs. 16,000 | 2004 March 1 | By Balance c/d | Rs. 16,000 | ||
16,000 | 16,000 |
Discount allowed Account
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 2 11 | To A’s A/c To C’s A/c | Rs. 200 800 | 2004 March 31 | By Balance c/d | Rs. 1,000 | ||
1,000 | 1,000 |
Purchases Account
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 6 | To Z’s A/c | Rs. 9,000 | 2004 March 20 | By Sales Promotion Expenses A/c By Balance c/d | Rs. 1,000 8,000 | ||
9,000 | 9,000 |
C’s Account
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 8 | To Sales A/c | Rs. 8,000 | 2004 March 31 | By Balance c/d | Rs. 8,000 | ||
8,000 | 8,000 |
Sales account
Dr. | Cr. | ||||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 31 | To Balance | Rs. 11,500 | 2004 March 8 | By C’s A/c By Cash A/c | Rs. 8,000 4,500 | ||
12,500 | 12,500 |
Dr. | SALARIES ACCOUNT | Cr. | |||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 15 | To Cash A/c | Rs. 2,000 | 2004 March 31 | By Balance c/d | Rs. 2,000 | ||
2,000 | 2,000 | ||||||
Dr. | SALES PROMOTION A/c | Cr. | |||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 20 | To Purchase A/c | Rs. 1,000 | 2004 March 31 | By Balance c/d | Rs. 1,000 | ||
1,000 | 1,000 | ||||||
Dr. | INTEREST ON LOAN A/c | Cr. | |||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 18 | To Bank A/c | Rs. 700 | 2004 March 31 | By Balance c/d | Rs. 700 | ||
700 | 700 | ||||||
Dr. | DRAWINGS ACCOUNT | Cr. | |||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 15 | To Cash A/c | Rs. 2,000 | 2004 March 31 | By Balance c/d | Rs. 2,000 | ||
2,000 | 2,000 | ||||||
Dr. | DISCOUNT RECEIVED A/c | Cr. | |||||
Date | Particulars | J.F. | Amount | Date | Particulars | J.F. | Amount |
2004 March 31 | To Balance c/d | Rs. 1,000 | 2004 March 30 | By X’s A/c | Rs. 1,000 | ||
1,000 | 1,000 | ||||||
Unit Questions.
1. What do you mean by ‘Accounting Concepts’? Why are they used in accounting? Explain the significance of any two of them.
2. What is the basic accounting equation?
3. Classify accounts. Explain each one of them by giving two examples.
4. Explain the rules of double entry by giving suitable examples for each one of them.
5. Record the following transactions in general journal
a) Commenced business with cash of Rs.50,000
b) Purchased supplies on account Rs.16,000
c) Paid rent for the month Rs.2,000
d) Purchased equipment for cash Rs.6,000
e) Paid miscellaneous expenses Rs.2,600
f) Paid creditors on account Rs.11,000
g) Received Rs.1,200 as commission
h) Received from cash sales Rs.12,000
6. On April 1, 1998, Ashok established an enterprise under the name Ashoksons, Transaction completed during the month were as follows:
a) Started business with cash Rs.60,000
b) Opened a business bank account with a deposit of Rs.20,000
c) Purchased sundry equipment for Rs.22,000 paying cash of Rs.15,000 and the balance on account.
d) Purchased supplies for the office for cash Rs.1,500
e) Paid creditors on account Rs.3,000
f) Paid office rent for the month Rs.1,150
g) Earned commission (in cash) Rs.9,000
h) Paid miscellaneous expenses Rs.250
i) Withdrew cash rs.2,700 from bank.
You are required to give entries in the general journal and post them to ledger.
7. Journalise the following transactions and post them to ledger:
a) Cash sales Rs.10,000
b) Paid income tax Rs.1,900
c) Paid for cartage and freight Rs.350
d) Cash purchases from Ram Sahai Rs.800
e) Paid Salary to Jeewan Rs.300
f) Received interest from Naresh Rs.100
g) Cash sales to Ram Nath Rs.1,300
h) Credit sales to Ramsons Rs.5,800
[Hint: Parties names in transactions d, e, f and g are matters of detail only. They are not to be considered in the journal entries. For example, journal entry for transaction (e) would be:
Salary Dr. Rs.300
To Cash Rs.300]
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