Accounting for managers Faculty Ms Luvnica Rastogi Amity

Accounting for managers Faculty: Ms. Luvnica Rastogi Amity International Business School Imp Website: www. investorwords. com

Learning Objectives To understand the meaning of accounting To understand the scope and objectives of financial accounting To know about the branches of accounting To understand the importance and limitations of financial accounting To know more about the users of accounting information To know the basic accounting principles

Learning Objectives To understand the recording of transactions To know what are the advantages of journal To learn about the classification of accounts and its rules To learn about compound entries To learn about opening and closing entries To understand the term ledger To know how to do ledger postings To understand the rules of posting To know the meaning of trial balance

Learning Objectives To learn more about trial balance To understand the objectives of preparing trial balance To learn how errors are disclosed by trial balance To learn how errors are not disclosed by trial balance To learn about the methods of allocating errors in a trial balance To understand the meaning of capital expenditure To understand the meaning of revenue expenditure To understand the meaning of profit and loss account To understand the method of preparing the profit and loss account

Learning Objectives To understand the meaning of balance sheet To know the method of preparing a balance sheet To know the difference between profit and loss account and balance sheet To know the relationship between profit and loss account and balance sheet To know how to make various adjustments in trial balance

Introduction Accounting is the language of the business, the basic function of which is to serve as a means of communication. If you ask to whom does it communicate the results of business operations, the various interested parties are owners, creditors, investors, governments and other agencies.

Definition: The definition given by the American Institute of Certified Public Accountants clearly brings out the meaning and functions of accounting. According to it, accounting is “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 result thereof. ”

Meaning of Accounting is an Art Accounting classifies as an art as it helps in attaining the goal of ascertaining the financial results. Analysis and interpretation of the financial data is the art of accounting, requiring special knowledge, experience and judgment.

Contd. Involves Recording, Classifying and Summarizing Recording means systematically writing down the transactions and events in account books soon after their occurrence. Classifying is the process of grouping transactions or entries of similar nature at a place. This is done by opening accounts in a book called ledger. Summarizing involves the preparation of reports and statements from the classified data (ledger), understandable and useful to management and other interested parties. This involves preparation of final accounts.

Records Transaction in Terms of Money Recording business transaction in terms of money is the common measure of recording and helps in better understanding of the state of affairs of the business.

Deals with Financial Transactions Accounting records only those transactions and events which are of financial character. If a transaction has no financial character, it will not be measured in terms of money and hence will not be recorded.

Interpretation is the art of interpreting the results of operations to determine the financial position of an enterprise, the progress it has made and how well it is getting along.

Accounting involves Communication The results of analysis and interpretation are communicated to management and to other interested parties

Accounting-- A Means and Not an End Keeping accounts is not the primary objective of a person or an entity. On the contrary, the primary objective is to take decision on the basis of the financial facts given by the accounting statements. Thus, the understanding of accounts is not the basic objective. It only helps to realize a specific objective. As such, accounting is not an end in itself but a means to an end.

Objectives and Functions Provides necessary information about the financial activities to the interested parties • Provides necessary information about the efficiency or otherwise of management with regard to the proper utilization of scarce resources • Provides necessary information for making predictions (financial forecasting) • Facilitates to evaluate the earning capacity of a firm by supplying the statement of financial position, the statement of periodical earning, together with the statement of financial activities to various interested parties •

Contd… Facilitates in decision-making with regard to the changes in the manner of acquisition, utilization, preservation and distribution of scarce resources • Facilitates in decision-making with regard to the replacement of fixed assets and expansion of the firm • Provides necessary data to the government to enable it to take proper decisions concerning to duties, taxes, price control etc. • Devices remedial measures for the deviations of the actual from the budgeted performance Provides necessary data and information to managers for internal reporting and formulation of overall policies •

Branches of Accounting Financial Accounting deals with recording, classifying and summarizing the business events that have already occurred. It is, therefore, historical in nature. That is why it is called historical accounting or post-mortem accounting or more popularly financial accounting. Its aim is to collate the information about income and financial position on the basis of business events that have taken place during a particular period of time.

Cost Accounting Cost accounting deals with the detailed study of cost pertaining to cost ascertainment, cost reduction and cost control. The emphasis is on historical costs as well as future decisionmaking costs.

Management Accounting Management accounting provides information to management not only about cost but also about revenue, profits, investments etc. to enable managers to discharge their duties more efficiently and effectively. Thus, it provides required database to managers to plan and control the activities of business.

Social Responsibility Accounting Social responsibility accounting involves accounting of social costs incurred by an enterprise and reporting of social benefits created by it.

Users of Accounting Information (1) Owner(s) refers to a person or a group of persons who has provided capital for running the business. It refers to an individual in case of proprietor, partners in case of partnership firm and shareholders in case of a joint stock company. The information needs of shareholders have assumed a greater significance in the corporate business world because of the separation of ownership and management in the case of joint stock companies.

Contd. (2)Managers For managing business profitably, management requires adequate information about financial results and financial position. By providing this information, accounting helps managers in efficient and smooth running of the business. (3). Investors Prospective investors would be keen to know about the past performance of business before making investment in that concern. By analyzing historical information provided by accounting records, they can arrive at a decision about the expected return and the risk involved in investing in a particular business.

Contd. (4). Creditors and Financial Institutions Whosoever is extending credit or loan to a business enterprise would like to have information about its repaying capacity, credit worthiness etc. Analyzing and interpreting the financial statements of an enterprise can help in obtaining the required information. (5). Employees are concerned about job security and future prospects. Both of these are intimately related with the performance of business. Thus, by analyzing the financial statements, they can draw conclusions about their job security and future prospects.

Contd. (6). Government policies relating to taxation, providing subsidies etc. are guided by the relevance of industries in the economic development of the country. The policies also consider the past performance of industries. Information about past performance is provided by the accounting system. Collection of taxes is also based on accounting records. (7). Researchers need financial information for testing hypothesis and development of theories and models. The required information is provided by accounting system.

Contd. (8). Customers The customers who have developed loyalties toward a business are those who are certainly interested in the continuance of the business. They certainly want to know about the future directions of the enterprise with which they are associating themselves. The way to information about the enterprise is through their financial statements. (9). Public at large is always interested in knowing the future directions of an enterprise and the only window to peep inside an enterprise is through their financial statements.

1. Advantages Of Accounting Facilitates to Replace Memory Accounting facilitates to replace human memory by maintaining a complete record of financial transactions. Human memory is limited by its very nature. Accounting helps to overcome this limitation. 2. Facilitates to Comply with Legal Requirements 3. Facilitates to Ascertain Net Result of Operations 4. Facilitates to Ascertain Financial Position 5. Facilitates the Users to take Decisions

Contd. 6. Facilitates a Comparative Study 7. Assist Management 8. Facilitates Control over Assets 9. Facilitates the Settlement of Tax Liability 10. Facilitates the Ascertainment of Value of Business 11. Facilitates Raising Loans

Basic Terms in Accounting 1. CAPITAL 2. ASSETS Capital generally refers to the amount invested in an enterprise by its owners. For example, paid up share capital in a corporate enterprise. Capital also refers to the interest of owners in the assets of an enterprise. Assets refer to the tangible objects or intangible rights owned by an enterprise and carrying probable future benefits.

Basic Terms in Accounting 3. LIABILITY 4. REVENUE Liability is the financial Revenue is the gross inflow obligation of an enterprise other than owners’ funds. of cash, receivables or other considerations arising in the course of ordinary activities of an enterprise’s resources yielding interest, royalties and dividends.

Basic Terms in Accounting 5. COST OF GOODS SOLD 6. PROFIT It is the cost of goods sold Profit is a general term for during an accounting period. In manufacturing operations, it includes the following: • Cost of materials • Labor and factory overheads the excess of revenue over related cost. When the result of this computation is negative, it is referred to as loss.

Basic Terms in Accounting 8. EXPENSES 9. DEFERRED EXPENDITURE Expense is the cost relating to the operation of an accounting period, or the revenue eared during the period, or the benefit of which do not extend that period. Deferred expenditure is the expenditure for which payment has been made or a liability incurred but which is carried forward on the presumption that it will be a benefit over a subsequent period or periods. This is also referred to as deferred revenue expenditure.

SUNDRY CREDITOR SUNDRY DEBTOR Sundry creditor is the Sundry debtors are persons amount owed by an enterprise on account of goods purchased or services received, or in respect of contractual obligations. It is also termed as trade creditor or account payable. from whom amounts are due for goods sold or services rendered, or in respect of contractual obligations. These are also termed as debtor, trade debtor and account receivable.

CONTINGENT ASSET CONTINGENT LIABILITY Contingent asset is an asset, Contingent liability is an the existence, ownership or value of which may be known or determined only on the occurrence or non-occurrence of one or more uncertain future events. obligation relating to an existing condition or situation which may arise in future depending on the occurrence or non-occurrence of one or more uncertain future events.

Accounting Cycle Collecting and analyzing data from transactions and events. Putting transactions into the general journal. Posting entries to the general ledger. Preparing an unadjusted trial balance. Adjusting entries appropriately. Preparing an adjusted trial balance. Organizing the accounts into the financial statements. Closing the books. Preparing a post-closing trial balance to check the accounts.

ACCOUNTING CONCEPTS The Business Entity Concept: Entity concept is an assumption that for an accounting purposes, the business is separate and different from that of its owners. The entity concept is also known as the concept of an “Enterprise” and is one of the central concepts in accounting. The entity concept may be applied to the whole organization or even to the part of the organization. Thus according to these concepts the business is treated as separate unit from that of its owners, creditors, managers, employees and others.

The Going Concern Concept According to this concepts an enterprises has an unlimited existence. Thus the concept of Going Concern Continuity can be expressed as under. “Unless & until there is evidence to the contrary, an enterprise must be considered as continuing largely in its present form and with its present purpose”

3. The Money Measurement Concept: The money measurement a concept is an assumption that any accounting transaction is to be measured in money or money’s worth. It is only when a transaction is measured that it can be recorded in the books of an enterprise and the result of the business is determined. Thus the measurement of a transaction also has to be in a common denomination (medium). Money is this common denominations in which transaction are recorded in the books of account.

4. The concept of Accounting Periodicity: The determination of the income of the enterprise cannot be postponed till the end of the enterprise. Since, according to Going-concern concept there is no limit for the life of the enterprises. Hence the economic activities of the business must be recorded periodically. These period is called as Accounting period & these Accounting period is normally called as “Accounting Year” or “Financial Year” or “Fiscal Year”. It is, within this Accounting Year, that the income & expenses (i. e. ) costs & revenues are matched with reasonable accuracy to provide significant results.

5. The Historical Cost Concept: According to Historical cost concept, all the transactions are recorded in the books at cost and not at its market value. Thus the underlying ideas of this concept are two forms. a. An asset is recorded at the price paid to acquire it i. e. at cost and b. This cost is the basis of all the subsequent treatment of the assets. e. g. depreciation, stock valuation, etc. ,

6. The Concept Of Matching Cost and Revenues Matching of Expired cost (i. e. , expenses) and revenues for the period’s determination of income, is one of the most important concept and procedures of accounting. This concept follows the accounting period concept i. e. once an accounting period is determined, within that period, the revenues and its related costs are matched. This concepts is one of the most important concept of accounting and has received major attention of accountants. Matching of costs and revenue is the ‘Test reading’ of the results and the success of the business activity. At the same time, it is one of the most difficult accounting problems.

7. The Accrual Concept This concept is also called the Accrual theory of Accounting or Accrual Accounting It means a system of recording revenues and expenses of particular accounting period. Whether or not they are receive or paid in cash, at the time of accounting. It is also known as “Mercantile System of Accounting” as contrasted to “ Cash system of Accounting. In cash system of accounting, the revenues are recorded only when received, whether due or not. Payments i. e. expenses are also recorded irrespective of the fact whether they pertain to the period concerned or not. For matching of costs and revenue under accrual concept, all revenues related to current year, whenever received, and all costs of the current year, whenever paid, must be taken into account.

CONVENTIONS ASSIGNMENT: What are the conventions of accountancy ? Explain.

CONVENTIONS Consistency: This concept states that once the organisation has decided on a method, it should use the same method subsequently unless there is a valid reason for a change of method. If frequent changes are made it is not possible to carry out comparisons on an inter-period or interfirm basis. If a change is necessary it has to be highlighted. e. g. if depreciation is charged on diminishing balance method, it should be done year after year.

Disclosure All significant information should be disclosed. The disclosure concept states that all significant information should be disclosed and all insignificant information should be disregarded. However, there are no definite rules to separate the two. For recording purposes also only significant events are recorded in detail taking into consideration the cost of detailed record keeping

Materiality : The accountant should attach importance to material details and ignore insignificant details. The question what constitutes a material detail is left to the discretion of the accountant. An item is material if there is reason to believe that knowledge of it would influence the decision of the informed investor. a) Materiality of information b) Materiality of amount c ) Materiality of procedure.

Conservatism Financial statements are drawn on a conservatism basis where better evidence is required of losses. This is necessary as Management and ownership are in different hands and a cut is needed on management to show overoptimistic, favourable performance results. For example, inventories are valued at the cost or market price whichever is lower. Revenues are recognised when they are certain but expenses as soon as they are reasonably possible. e. g. it encourages the accountant to create provisions for bad and doubtful debts.

DOUBLE ENTRY SYSYTEM Double-entry accounting is a method of record-keeping that lets you track just where your money comes from and where it goes. Using double-entry means that money is never gained nor lost---it is always transferred from somewhere (a source account) to somewhere else (a destination account). This transfer is known as a transaction, and each transaction requires at least two accounts. An account is a record for keeping track of what you own, owe, spend or receive.

Contd… For example, we buy machinery for Rs. 300, 000. It has brought two changes, machinery increases by Rs 300, 000 and cash decreases by an equal amount. While recording this transaction in the books of accounts, both the changes must be recorded. In accounting language these two changes are termed "as a debit change" & "a credit change".

Contd… Thus we see that for every transaction there will be two entries, one debit entry and another credit entry. For each debit there will be a corresponding credit entry of an equal amount. Conversely, for every credit entry there will be a corresponding debit entry of an equal amount. So, the system under which both the changes in a transaction are recorded together, one change is debited, while the other change is credited with an equal amount, is known as double entry system.

ACCOUNTING EQUATION The equation that is the foundation of double entry accounting. The accounting equation displays that all assets are either financed by borrowing money or paying with the money of the company’s shareholders. Thus, the accounting equation is Assets = Liabilities + Shareholder Equity

Contd… The balance sheet is a complex display of this equation, showing that the total assets of a company are equal to the total of liabilities and shareholder equity. Any purchase or sale has an equal effect on both sides of the equation, or offsetting effects on the same side of the equation. The accounting equation is also written as Liabilities = Assets – Shareholder Equity OR Shareholder Equity = Assets – Liabilities.

Examples… Transac tion Assets Number Shareholder' s Explanation Equity Liabilities 1 + 6, 000 + 2 + 10, 00 + 0 10, 00 0 3 − 900 4 + 1, 000 + 5 + 700 6, 000 Issuing stocks for cash or other assets Buying assets by borrowing money (taking a loan from a bank or simply buying on credit) Selling assets for cash to pay off liabilities: both assets and liabilities are reduced 400 + + 600 Buying assets by paying cash by shareholder's money (600) and by borrowing money (400) 700 Earning revenues

Transac tion Assets Numbe r 6 − Liabilities 9 + − − 200 Paying expenses (e. g. rent or professional fees) or dividends 100 − 100 Recording expenses, but not paying them at the moment 200 7 8 Shareholder' s Explanation Equity 500 − 0 500 0 Paying a debt that you owe Receiving cash for sale of an asset: one 0 asset is exchanged for another; no change in assets or liabilities

Introduction: - Journal Accounting is the art of recording, classifying and summarizing the financial transactions and interpreting the results thereof. Thus, the accounting cycle involves the following four major phases: 1. Recording of transactions-- This is done in a book called journal. 2. Classifying the transactions-- This is done in a book called ledger. 3. Summarizing the transactions-- This includes preparation of trial balance, profit and loss account and balance sheet of the business. 4. Interpreting the results-- This involves computation of various accounting ratios etc. to know about the liquidity, solvency and profitability of the business.

Journal A journal records all daily transactions of a business in the order of their occurrence. A journal may, therefore, be defined as a book containing a chronological record of transactions.

is as follows:

Rules of Debit and Credit All transactions in the journal are recorded on the basis of rules of debit and credit. For this purpose, transactions have been classified into three categories: i. Transactions relating to persons ii. Transactions relating to properties and assets iii. Transactions relating to incomes and expenses

Contd. . On the basis of above rules, it is necessary to keep the accounts in respect of the following: i. Each person with whom it deals (customer, suppliers) ii. Each property or asset which it owns (building, machinery etc. ) iii. Each item of income and expense (commission, rent, salary etc. )

Classification of Accounts Personal Accounts Real Accounts Nominal Accounts

Personal Accounts Personal accounts include the accounts of persons with whom the business deals. These accounts can be further classified into three categories: a. Natural Personal Account Natural personal account means persons who are creations of God. For example, Vijay’s a/c, Hary’s a/c etc. b. Artificial Person Account Artificial person account includes accounts of corporate bodies or institutions which are recognized as persons in business dealings. For example, government, club, limited company, cooperative society etc. c. Representative Personal Account Representative personal account is the account which represents a person or a group of persons. For example, when the rent is due to landlord, an outstanding rent account represents the account of a landlord to whom the rent is payable.

Real Accounts Real accounts may be of the following types: a. Tangible Real Account Tangible real accounts are those which relate to such things that can be touched, felt and measured. For example, cash a/c, building a/c, furniture a/c etc. b. Intangible Real Account These accounts represent such things which cannot be touched but, however, can be measured in terms of money. For example, patent a/c, goodwill a/c etc.

Nominal Accounts Nominal accounts are opened in the books of accounts to simply explain the nature of the transactions. They do not really exist. For example, salary paid to employee, rent paid to landlord etc. Nominal accounts mainly include accounts of expense, losses, income and gains.

RULES OF ACCOUNTING

Analysis Of Business Transaction Determine the 2 accounts which are involved in the transaction. 2. Classify the above two accounts under Personal , Real and Nominal. 3. Find out the rules of debit and credit for the above two accounts. 4. Identify which account is to be debited and which account is to be credited. 1.

EXAMPLES OF JOURNAL ENTRIES

COMPOUND JOURNAL ENTRY Sometimes, there a number of transactions on the same date relating to one particular account or of one particular nature. Such entries can be passed by way of a single journal entry instead of passing individual journal entries. It may be recorded in any of the following three ways: 1. A particular account may be debited while several accounts may be credited. 2. A particular account may be credited while several accounts may be debited. 3. Several accounts might debited as well as credited.

OPENING ENTRY In the case of a running business, the assets and liabilities appearing in the pervious year’s balance sheet will have to be brought forward to the next year. This is done by the means of a journal entry which is known as “opening entry. ” All assets are debited while all liabilities are credited. The excess of assets over liabilities is the proprietor’s capital and is credited to his capital account

Example: Pass the opening entry on 1. 1. 2001 on the basis of the following information taken from the business of Mr. Shubham. 1. Cash in hand-- Rs. 20, 000 2. Sundry Debtors-- Rs. 60, 000 3. Stock in Trade-- Rs. 40, 000 4. Plant and Machinery-- Rs. 50, 000 5. Land Building-- Rs. 1, 000 6. Sundry Creditors-- Rs. 1, 000

Solution: -

Cash Discount An incentive that a seller offers to a buyer in return for paying a bill owed before the scheduled due date. The seller will usually reduce the amount owed by the buyer by a small percentage or a set dollar amount. If used properly, cash discounts improve the days-sales-outstanding aspect of a business's cash conversion cycle. For example, a typical cash discount would be if the seller offered a 2% discount on an invoice due in 30 days if the buyer were to pay within the first 10 days of receiving the invoice. Providing a small cash discount would be beneficial for the seller as it would allow him to have access to the cash sooner. The sooner a seller receives the cash, the earlier he can put the money back into the business to buy more supplies and/or grow the company further.

Trade Discount A discount on the list price granted by a manufacturer or wholesaler to buyers in the same trade. Suppose A buys from B $200 worth of goods. He is allowed a discount of 10% from the list price. Then he would have to pay only $180 to B. Suppose the terms had stipulated that he be allowed a discount of 10% and 5% off from the list price. This would not give him a deduction of 15% from the $200

Cash Discount Trade Discount Is a reduction granted by supplier from the invoice price in consideration of immediate or prompt payment Is a reduction granted by supplier from the list price of goods or services on business consideration re: buying in bulk for goods and longer period when in terms of services As an incentive in credit management to encourage prompt payment Allowed to promote the sales Not shown in the supplier bill or invoice Shown by way of deduction in the invoice itself Cash discount account is opened in the ledger Trade discount account is not opened in the ledger Allowed on payment of money Allowed on purchase of goods It may vary with the time period within which payment is received It may vary with the quantity of goods purchased or amount of purchases made

Treatment of goods given as Charity /Advertisement Ø Gave away as charity goods costing Rs. 100 and cash Rs. 50. Charity Account ……………Dr. 150 To Purchases A/C ………………. 100 To Cash Account ……………. . 50

Treatment of goods lost in Accident/ Fire Ø Goods worth Rs. 4000 were destroyed in a fire. Insurance company paid 80% of the loss. Cash Account …………… Dr. 3200 Loss by fire A/C ……………. Dr. 800 To Purchases Account ……………. . 4000

Treatment of Depreciation on Fixed Assets Ø Plant purchased for Rs. 7000. Provide Deprecation @10% P. A. for full year. Deprecation Account ……………Dr. 700 To Plant Account …………. . 700

Purchase and sale of Investment or other assets A machine is purchased for rs. 50000. Transportation expenses Rs. 2000 and Installation charges Rs. 3000 on this machine. Machine A/C ……………. Dr. 55000 To Cash Account …………. 55000

Treatment of Bad Debts. Sarkar who owed us Rs. 1000 is declared insolvent and 60 paise in a rupee is received Cash Account ……………Dr. 600 Bad Debts A/C ……………. Dr. 400 To Sarkar Account ……………. . 1000

Ledger LEDGER is the principal book of accounts which contains various accounts. An account is a summarized record of similar transactions during an accounting period relating to a particular person or thing. Therefore, all the accounts, whether real, nominal or personal, are collected in the ledger.

Ledger What is a ledger? It is a digest of all accounts utilized by an entity during an accounting period. Loose leaf pages Computer printout Bound books Cards 79

Ledger Accounts Ledger - a group of related accounts kept current in a systematic manner Think of a ledger as a book with each account. one page for Ledger 80

Ledger Cash Accts. Receivable Supplies Accts. Payable 81

Ledger Cash Customer Accounts Accts. Receivable A B C D Supplies Accts. Payable 82

Ledger Cash Customer Accounts Accts. Receivable A B C D Supplies Creditor Accounts Accts. Payable A B C D 83

LEDGER ACCOUNTS A simplified version of a ledger account is called the T- account. They allow us to capture the essence of the accounting process without having to worry about too many details. The account is divided into two sides for recording increases and decreases in the accounts. Account Title Left Side Right Side 84

DEBITS AND CREDITS Debit (dr. ) - an entry or balance on the left side of an account Credit (cr. ) - an entry or balance on the right side of an account Remember: Debit is always the left side! Credit is always the right side! 85

Post from the journal to the ledger. 86

POSTING What is posting? It is the transfer of information from the journal to the appropriate accounts in the ledger. 87

POSTING TO THE LEDGER POSTING REFERS TO TRANSFERRING THE INFORMATION IN A JOURNAL ENTRY TO THE APPROPRIATE LEDGER ACCOUNT ENTER DATE ENTER AMOUNT IN PROPER DEBIT OR CREDIT COLUMN ENTER JOURNAL SOURCE INFO 88

PROFORMA FOR ACCOUNT Debit Date Particulars J. f Credit Amt. Date Particulars J. f Amt. 89

THE ACCOUNT Account Title Debit Credit LEFT SIDE 90

THE ACCOUNT Account Title Debit Credit RIGHT SIDE 91

LEDGER ACCOUNTS Balance - difference between total left-side amounts and total right-side amounts at any particular time Assets have left-side balances. Increased by entries to the left side Decreased by entries to the right side Liabilities and Owners’ Equity have right-side balances. Decreased by entries to the left side Increased by entries to the right side 92

DETAILS OF JOURNALS AND LEDGERS Journal Page Credit 1 Particulars Debit Date April 2 Cash 30, 000 Garge Capital 30, 000 (Received initial investment from owner) 93

POSTING Debit Credit Date April 2 Cash Account Ref. Particulars 1 To G. Cap Amount Date Ref Particulars Amoun 30, 000 Insert the number of the journal page. 94

RECORDING AND POSTING AN ENTRY Journal Page 1 L. F. Date Description Debit 12/1 Prepaid Insurance Cash 2, 400 Credit 2, 400 1. Analyze and record the transaction as shown. 2. Post the debit side of the transaction. 3. Post the credit side of the transaction. 95

Recording and Posting an Entry Journal Page 1 L. f Date Description 12/1 Prepaid Insurance Cash Debit 15 Credit 2, 400 Ledger Prepaid Insurance Account Dr. Cr. Date Particulars Fol. Amt. Date 12/1 To Cash 1 Particulars Fol. Amt. 2400 96

Recording and Posting an Entry Journal Page 1 Date Description L. f. Debit Credit 12/1 1 Prepaid Insurance Cash 15 11 2, 400 3 4 Ledger 2 Page No. 15 Prepaid insurance Account Dr. Cr. Date Particulars Fol. Amt. Date 12/1 To Cash 1 Particulars Fol. Amt. 2400 97

Balancing of Ledger Account The totals of the debit side and credit side of an account are taken to ascertain the difference between the two sides. This difference is known as the balance on the account. The total of the heavier side is entered on the lighter side for arriving at the balance. When the total of the debit side exceeds the total of the credit side, the balance is said to be in debit, i. e. known debit balance. When the total of the credit side exceeds the total of the debit side, it means that the account has a credit balance. The balancing of the account is necessary to ascertain the net effect whether debit or credit on the account.

TRIAL BALANCE Trial balance is a list of debit and credit balances extracted from the ledger on a particular date. Since for every debit entry there is a corresponding credit entry of the equivalent amount, the total of the debit and credit balances should agree in equal amount. A trial balance essentially proves the arithmetical accuracy of the entries passed in the books of account and is derived from ledger where all accounts find a place. Trial balance is prepared after striking the balance of various accounts in the ledger.

OBJECTIVES OF PREPARING TRIAL BALANCE 1. It forms the very basis on which final accounts are prepared. 2. It helps in knowing the balance on any particular account in the ledger. 3. It is a test of arithmetical accuracy. Note: - A trial balance is not a conclusive proof of the absolute accuracy of the account. It does not indicate the absence of an error. So, a non-tailed trial balance indicates the presence of book keeping error.

PREPARING THE TRIAL BALANCE The purposes of the trial balance: To help check on accuracy of posting by proving whether the total debits equal the total credits To establish a convenient summary of balances in all accounts for the preparation of formal financial statements 101

ERRORS DISCLOSED BY THE TRIAL BALANCE • Wrong posting of entries, e. g. , a debit entry of Rs. 500 for purchase of furniture wrongly posted as Rs. 50 in the account • Omission of posting, e. g. , when a debit entry of Rs. 500 for purchase of furniture has not been posted at all • Duplication of posting, e. g. , when a debit entry of Rs. 500 for purchase of furniture has been posted twice to the account • Wrong side of posting, e. g. , when debit entry is posted on the credit side or credit entry is posted on the debit side. That is, when debit entry of Rs. 500 is posted on the credit side and vice-versa

Contd. . • Errors in casting the totals of debit or credit side of the trial balance • Wrong transfer of balances to the trial balance • Omission of entering the balance of account in the trial balance • Balance of cash book omitted to be recorded in the trial balance • Wrong balancing of account

ERRORS NOT DISCLOSED BY THE TRIAL BALANCE (a) Errors of omission to record any transaction. (b) Posting of wrong amount to both debit and credit side of the account. (c) Error made in the posting of debit or credit entry is compensated by an identical error of equal amount. These errors are known as errors of compensation. (d) Errors made in posting a transaction on the correct side of wrong account. (e) Erroneously recording a transaction twice. These are known as errors of duplication. (f) Errors of principle when the accounting principle is disregarded. For example, a capital item treated as revenue item and vice versa. That is, purchase of furniture posted to purchase a/c.

Trial Balance as on 30 th April 2009

PREPARING THE TRIAL BALANCE The trial balance is usually prepared with the balance sheet accounts first, followed by the income statement accounts. An example of a Account Number 100 130 202 300 trial balance: Account Title Cash Merchandise inventory Note payable Paid-in capital 500, 000 ========== (Rs) Debit Credit 3, 50, 000 150, 000 100, 000 400, 000 500, 000 ========= 106

LOCATING TRIAL BALANCE ERRORS Note that a trial balance may balance even when errors were made in recording or posting. A transaction may be recorded as different amounts in two different accounts. A transaction may be recorded in a wrong account. In both situations, the total debits will still equal total credits on the trial balance. Dr. = Cr. 107

Correcting Errors Three Types of Errors Journal Entry 1. incorrect Ledger Posting not posted 108

Correcting Errors Three Types of Errors Journal Entry 1. incorrect 2. correct Ledger Posting not posted incorrectly posted 109

Correcting Errors Three Types of Errors Journal Entry 1. incorrect 2. correct incorrect Ledger Posting not posted incorrectly posted 110

LOCATING TRIAL BALANCE ERRORS What if it doesn’t balance ? Is the addition correct? Are all accounts listed? Are the balances listed correctly? DEBITS CREDITS 111

LOCATING TRIAL BALANCE ERRORS Divide the difference by two. Is there a debit/credit balance for this amount posted in the wrong column? Check journal postings. Review accounts for reasonableness. 112

Basic Principles of Preparing Final Account (Capital and Revenue) CAPITAL EXPENDITURE 1. Capital expenditure is that expenditure the benefits of which are not fully consumed in a year but spread over several years. 2. It is the expenditure which results in the purchase or acquisition of asset or property. 3. It is the expenditure incurred in connection with the purchase of asset. 4. It is the expenditure incurred to bring an old asset into working condition. 5. It is the expenditure incurred for extending or improving an existing asset to increase its productivity or to increase the earning capacity of business or to decrease working expenditure.

REVENUE EXPENDITURE 1. Revenue expenditure is the expenditure which benefits in the current accounting year. It is not carried forward to the next year or years. 2. It is the expenditure which is incurred in the normal course of business to run the business and to maintain the fixed assets of business. 3. It is the expenditure which is incurred on purchase of goods meant for resale or to purchase materials which will be used to convert them into final product. Therefore, revenue expenditure is a recurring expenditure made to maintain the business. The amount spent is generally small and the benefit is for a short period which is not more than a year. All revenue expenditure are charged to trading and profit and loss account.

DEFERRED REVENUE EXPENDITURE Deferred revenue expenditure is the expenditure which is originally revenue in nature but the amount spent is so large that the benefit is received for not a year but for many years. A proportionate amount is charged to profit and loss account of each year and balance is carried forward to subsequent years as deferred revenue expenditure. It is shown as an asset in the balance sheet, e. g. , heavy expenditure incurred on advertisements.

CAPITAL RECEIPTS Capital receipts are the receipts which are not received in the ordinary course of business. These are non-recurring receipts. Money obtained from the sale of fixed assets or investments, issue of shares or debentures, loans taken are some of the examples of capital receipts. Capital receipts are shown as liability reduced from assets appearing in the balance sheet.

REVENUE RECEIPTS Revenue receipts are receipts obtained in the normal course of business. It is a receipt against supply of goods or services. The money obtained from sales, interest, dividend, transfer fees etc. are examples of revenue receipts. Revenue receipts are credited to profit and loss account.

CAPITAL PROFIT Those profits which are not earned during the regular course of business and which are not earned on account of the day-today trading activities of the business are capital profits. For example, profit on sale of asset and premium received on issue of shares. These types of profits are normally not taken to profit and loss account but are shown in the liabilities side of the balance sheet.

CAPITAL LOSSES The losses which are not suffered during the regular course of business are called capital losses. For example, discount on issue of shares.

The Financial Statements The financial statements are a picture of the company in financial terms. Each financial statement relates to a specific date or covers a particular period. 120

Information Reported on the Financial Statements Question Answer 1. How well did the company perform (or operate) during the period? Revenues – Direct Expenses Gross income (Gross loss) 1. How well did the company perform (or operate) during the period? Gross Profit – Indirect Expenses Net income (Net loss) 121 Financial Statement Trading Account Profit and Loss Account

Information Reported on the Financial Statements Question 3. What is the company’s financial position at the end of the period? 4. How much cash did the company generate and spend during the period? 122 Answer Assets = Liabilities + Owners’ equity Operating cash flows ± Investing cash flows ± Financing cash flows Increase or decrease in cash Financial Statement Balance sheet Statement of cash flows

Income Statement The income statement, reports the company’s revenues, expenses, and net income or net loss for the period. 123

Introduction to the Income Statement The income statement is a financial tool that provides information about a company’s past performance. 124

The Income Statement Revenues – 125 Expenses = Net income (or Net loss)

Income Statement Format Sales revenues Selling and – Cost of goods sold– administrative = Gross profit expenses Operating income Add: Other revenues and gains Less: Other expenses and losses 126

Income Statement Revenue - the proceeds that come from sales to customers Cost of Goods Sold - an expense that reflects the cost of the product or good that generates revenue. . Gross Margin - also called gross profit, this is revenue minus COGS Operating Expenses - any expense that doesn't fit under COGS such as administration and marketing expenses. Net Income before Interest and Tax - net income before taking interest and income tax expenses into account. Interest Expense outstanding debt. - the payments made on the company's Income Tax Expense - the amount payable to government. Net Income 127 - the final profit after deducting all expenses from revenue.

The Income Statement can be divided into: • Trading Account • Profit and Loss Account 128

The Accounting Terms Revenues are inflows or other enhancements of assets to an entity. They result from delivering or producing goods, rendering services, or other activities that constitute the entity’s major or central operations. 129

The Accounting Terms Expenses are outflows or other using up of assets. They result from delivering or producing goods, rendering services, or other activities that constitute the entity’s major or central operations. 130

The Accounting Terms Gross profit (gross margin) - excess of sales revenue over the cost of inventory that was sold Operating expenses - a group of recurring expenses that pertain to a firm’s routine operations Operating income (operating profit) - gross profit less all operating expenses Other revenues and expenses - items not directly related to the main operations of a firm 131

The Accounting Terms Net income - the remainder after all expenses (including income taxes) have been deducted from revenue Often seen as the “bottom line” Net loss - the excess of expenses over revenues 132

INCOME STATEMENTS Introduction After the agreement of trial balance, a trader closes ledger accounts with a view to ascertain the following aspects: • Gross profit • Net profit • Financial position of the firm

TRADING ACCOUNT The goods account is split up and separate accounts are opened as follows: • Opening stock account, i. e. stock at commencement • Purchase account including both cash and credit purchases • Sales account including both cash and credit sales • Returns inwards account, i. e. total goods returned by customers • Returns outwards account, i. e. total goods returned to vendors • Closing stock account, i. e. stock of goods at the end These separate accounts, in total, are ultimately transferred to a common heading called trading account.

Net Sales =Cash Sales+Credit sales. Sales Return Cost Of Goods Sold=Opening Stock +Net Purchases-closing stock(stock at the end)+Direct Expenses Net Purchases=Cash Purchases+Credit Purchases Return Gross Profit=Net Sales Revenue. Cost Of Goods Sold

Trading Account The balances of accounts of all related items have to be transferred to the trading account by way of passing entries. The entries needed for such transfers are termed as closing entries. The closing entries are as follows:

FOR CLOSING OF DEBIT ACCOUNTS Trading A/c Dr. To opening stock To Purchases A/c To Sales Return A/c To Wages A/c To Direct Expenses A/c

FOR CLOSING OF CREDIT ACCOUNTS Sales A/c Dr. Purchases Return A/c Dr. To Trading A/c

FOR CLOSING OF TRADING ACCOUNT (a) For gross Profit: Trading A/c Dr. To profit and Loss A/c (b) For Gross Loss Profit and Loss A/c Dr. To Trading A/c

Contd. . In order to find out the gross profit or gross loss of a business, a trading account is prepared. This account gives the overall profit of the business relating to an accounting period which is subject to deduction of general administrative, selling and other expenses. Gross profit is the difference between sale proceeds of a particular period and the cost of the goods actually sold during that period.

The format of trading account is as follows:

PROFIT AND LOSS ACCOUNT Profit and loss account is prepared with a view to ascertain the profit or loss on account of business activity during an accounting period. Profit and loss account is also an account like other accounts in the ledger which discloses the net effect in the form of profit or loss resulting from settling off the expenses incurred against the revenue earned during the accounting period. The difference between total revenue and total expenses represents net income or net loss according to whether the difference is positive or negative. In this regard, it is pertinent to note that all the expenses incurred for the period are to be debited to this account, whether paid or not. Likewise, all revenue earned, whether received or not, are to be credited to this account.

Contd… The balance of a trading account showing gross profit or gross loss becomes the opening transfer entry of this account on the credit or debit side respectively. All the revenue expenses appear on the debit side including those expenses which do not find a place in the trading account. The losses on sale of capital asset or any abnormal loss also appear on the debit side. The credit side of the account shows the revenue earned including the non-trading income like interest on bank deposit or securities, dividend on shares, rent of let-out property, profit arising from sale of fixed assets etc. after transfer of all the nominal accounts from the trial balance to the profit and loss account. The net result of the profit and loss account is ascertained by balancing it. If the credit side is more than the debit side, it indicates net profit for the period. Conversely, if the debit side is more than the credit side, it indicates net loss for the period.

PROFIT AND LOSS ACCOUNT

Introduction to the Balance Sheet The balance sheet is the financial tool that focuses on the present condition of a business. 145

BALANCE SHEET The American Institute of Certified Public Accountants defines balance sheet as “a tabular statement of summary of balances (debits and credits) carried forward after an actual and constructive closing of books of account and kept according to the principles of accounting. ”

Contd… The balance sheet is one of the important statements depicting the financial strength of the company. On one hand, it shows the properties which were utilized and on the other, the sources of those properties. The balance sheet shows all the assets owned by the company and all the liabilities and claims it owes to owners and outsiders. The balance sheet is prepared on a particular date. The right hand side shows properties and assets. Usually, there is no particular sequence for showing various assets and liabilities.

The Balance Sheet The Balance sheet shows the financial position of a company at a particular point in time. The balance sheet is also referred to as the statement of financial position or the statement of financial condition. The left side lists assets – the right side lists liabilities and owners’ equity 148

The Accounting Elements Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions events. 149

The Accounting Elements Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. 150

The Accounting Elements The residual interest in the assets of an entity that remains after deducting its liabilities. Investment by owners 151 Earned equity

Formats of Balance Sheets Balance sheet formats: Report format - a classified balance sheet with assets at the top and liabilities and equity below Account format - a classified balance sheet with assets at the left and liabilities and equity at the right Regardless of format, balance sheets always contain the same basic information. 152

Balance Sheet Transactions The balance sheet is affected by every transaction that an entity encounters. Each transaction has counterbalancing keep total assets equal to owners’ equity. 153 entries that total liabilities and

BALANCE SHEET RESOURCES ARE FINANCED AVAILABLE FOR USE BY THE FIRM (ENTITY) LIABILITIES - DEBT OWED TO OTHERS ASSETS OWNERS’ EQUITY PROBABLE FUTURE INVESTMENT BY ECONOMIC BENEFITS OWNERS RESOURCES HOW DIRECT INDIRECT 154

EXPLANATION OF BALANCE SHEET ITEMS 1. Share Capital Share capital is the first item on the liabilities side of a balance sheet. Authorized and issued capital is shown giving the number of shares and their amount. The number of shares for which public has applied (subscribed capital) are mentioned along with the type of capital, i. e. preference share capital and equity share capital. If the capital is issued for other than cash, the amount of such capital is mentioned.

SECURED LOANS All those loans against which securities are given are shown under this category. Debentures are shown under this heading. Loans and advances from bank, subsidiary companies etc. should be shown separately and the nature of securities should also be mentioned. UNSECURED LOANS These are the loans and advances against which the company has not given any security. The items included here are deposits, loans and advances from subsidiary companies and loans and advances from other sources. Short-term loans from banks and other sources are also shown in this category. Short-term loans include those which are due for not more than one year on the balance sheet.

CURRENT LIABILITIES AND PROVISIONS (A) CURRENT LIABILITIES INCLUDE THE FOLLOWING: • Acceptances • Sundry creditors • Subsidiary companies • Advance payments and unexpired discounts • Unclaimed dividends • Other liabilities, if any • Interest accrued but not paid on loans (B) FOLLOWING ITEMS ARE INCLUDED UNDER PROVISIONS: • Provision for taxation • Proposed dividends • Provision for contingencies • Provision for provident fund scheme • Provision for insurance, pension and similar staff benefits schemes • Other provisions

ASSETS SIDE 1. FIXED ASSETS Fixed assets are those which are purchased for use over a long period. These assets are meant to increase production capacity of the business. They are not acquired for sale but are used for a considerable period of time. The balance sheet is prepared to show the financial position of the concern. These assets should be shown in such a way that balance sheet depicts true financial position of the business. 2. INVESTMENTS Investments are shown by giving their nature and mode of valuation. Investments under various subheads such as investments in government or trust securities, in shares, debentures and bonds, and in immovable properties are given separately in the inner column of the balance sheet.

3. CURRENT ASSETS 4. MISCELLANEOUS EXPENDITURE Deferred expenditure is shown under this heading. Miscellaneous expenditure are the expenses which are not debited fully to the profit and loss account of the year in which they have been incurred. These expenses are spread over a number of years and unwritten balance is shown in the balance sheet. The items under this heading are preliminary expenses, discount allowed on issue of shares or debentures, interest paid out of capital during construction Current assets are such assets as in the ordinary and natural course of business move onward through the various processes of production, distribution and payment of goods, until they become cash or its equivalent by which debts may be readily and immediately paid.

Contd…

The Balance Sheet Elements of the balance sheet: Assets - resources of the firm that are expected to increase or cause future cash flows (everything the firm owns) Liabilities - obligations of the firm to outsiders or claims against its assets by outsiders (debts of the firm) Owners’ Equity - the residual interest in, or remaining claims against, the firm’s assets after deducting liabilities (rights of the owners) 163

Classifying Assets and Liabilities Current assets Long-term assets Current liabilities Long-term liabilities 164

XYZ Ltd. Trial Balance November 30, 2002 Cash Purchases Land Accounts Payable Amit, Capital 25, 000 Amit, Drawing Fees Earned 7, 500 Wages Expense Rent Expense Commission Supplies Expense Miscellaneous Expense 32, 900 165 5, 900 550 20, 000 400 2, 000 2, 125 800 450 800 275 32, 900

XYZ Ltd. Trial Balance November 30, 2002 Balance Sheet Cash Purchases Land Accounts Payable Amit, Capital 25, 000 Amit, Drawing Fees Earned 7, 500 Wages Expense Rent Expense Commission Supplies Expense Miscellaneous Expense 32, 900 166 5, 900 550 20, 000 400 2, 000 2, 125 800 450 800 275 32, 900

XYZ Ltd. Trial Balance November 30, 2002 Income Statement Cash Purchases Land Accounts Payable Amit, Capital 25, 000 Amit, Drawing Fees Earned 7, 500 Wages Expense Rent Expense Commission Supplies Expense Miscellaneous Expense 32, 900 167 5, 900 550 20, 000 400 2, 000 2, 125 800 450 800 275 32, 900

XYZ Ltd. Balance Sheet 168 1. 11 12 14 15 17 18 Assets Cash Accounts Receivable purchases Prepaid Insurance Land Office Equipment 2. 21 23 Liabilities Accounts Payable Unearned Rent 3. 31 32 Owner’s Equity Amit, Capital Amit, Drawing Income Statement 4. 41 5. 51 52 54 55 59 Revenue Sales Expenses Wages Expense Rent Expense Commission Supplies Expense Miscellaneous Expe

Summary Original evidence records Accounting records Source documents Journals Ledger Trial Balance Closing Entries 169 Financial Statements Profit and Loss Statement Balance Sheet Statement of cash flows

FORM AND CONTENTS OF BALANCE SHEET The balance sheet is generally divided into parts, i. e. assets, liabilities and capital. It is usually prepared in the horizontal form. The assets are shown on the right hand side and capital and liabilities on the left hand side. The order of assets and liabilities is either on liquidity basis or on permanency basis. When balance sheet is prepared on liquidity basis, large liquid assets like cash in hand, cast at bank, investments etc. are shown first and small liquid assets later. On liabilities side, the liabilities to be paid in the short period are shown first, long-term liabilities next and capital in the last. The liquidity form is suitable for banking and other financial companies. When balance sheet prepared on permanency basis, on assets side, fixed assets are shown first and liquid assets later. On liabilities side, the capital is shown first, long-term liabilities next, and short-term and current liabilities in the last.

Thank You