ACCOUNTING Accounting is the language of business. The affairs and the results of the business are communicated to others through accounting information, which has to be systematically recorded and presented.
Accounting - Definition Accounting can be defined as the process of identifying, measuring, recording and communicating the economic events of an organization to the interested users of the information.
Characteristics of Accounting • Economic events • Identification, measuring, recording and communication • Organization • Interested users of information
Economic Events • An economic event has been defined as ‘a happening of consequence’ to a business entity. Economic events are classified into • External types • Internal types.
Economic Events Continue… An external event which involves the transfer or exchange of something of value between two or more entities.
Economic Events Continue… • · Sale of goods to customers. • Payment of monthly rent to the landlord. • · Purchase of raw materials by an enterprise from some other business enterprise. • · Rendering of services to customers, etc.
Economic Events Continue… An internal event is an economic event that occurs entirely within one enterprise. Eg : Supply of raw materials or equipment by the stores department to the manufacturing department.
Identification It means determining what to record, i.e. to identify recordable events. It involves observing activities and selecting those events that are considered to be evidence of economic activity.
Identification continue … The value of human resources, changes in managerial policies or changes in personnel are important but none of these items is recorded in financial accounts. However, when a company makes a cash sale or purchase, even if the item is small, it is recorded in the books of account.
Measurement It means quantification, including estimates of business transactions into financial terms, i.e. rupees and paise. If an event cannot be quantified in monetary terms, it is not considered for recording in financial accounts.
Recording Once the economic events are identified and measured in financial terms, they are recorded, i.e. a chronological diary of these measured events is kept in an orderly and systematic manner.
Communication The economic events are identified, measured and recorded is communicated in some form to management and others for internal and external uses. The information is communicated through the preparation and distribution of accounting reports. The most common reports are in the form of financial statements (Balance Sheet and Profit and Loss Statement).
Organization It can be a business entity or a non-business entity, depending upon the profit or non-profit motive.
Users of Accounting Information • Different categories of users need different kinds of information for making decisions. These users can be divided into : • Internal Users; and • External Users.
Internal Users These are the persons who manage the business, i.e. management at the top, middle, and lower levels. Their requirements of information are different because they make different types of decisions.
Internal Users continue… The top level is more concerned with planning; the middle level is concerned equally with planning and control; and the lower level is concerned more with controlling operations. Information is supplied on different aspects, e.g. cash resources, sales estimates, results of operations, financial position, etc.
External Users All persons other than internal users come in the group of external users. External users can be divided into two groups: ·those having direct interest; and ·those having indirect interest in a business organization.
External Users continue… The main sources of information for external users are annual reports of business organizations, which state the financial position and performance and give the auditor’s report, director’s report and other information.
External Users continue… Investors and creditors are the external users having direct interest. Tax authorities, regulatory agencies, customers, labour unions, trade associations, stock exchanges, investors, etc are indirectly interested in the company’s financial strength, its ability to meet short-term and long-term obligations, its future earning power, etc for making various decisions.
ASSETS These are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets are things of value used by the business in its operations. ·Fixed Assets ·Current Assets
ASSETS continue… ·Fixed Assetsare assets held on a long-term basis. e.g. Land, Building, Machinery, Plant, Furniture and Fixtures, etc.
ASSETS continue… ·Current Assets are assets held on a short-term basis. e.g. Debtors, Bills receivable, Stock(Inventory), Cash and Bank balances, etc.
LIABILITIES • These are obligations or debts that the enterprise must pay in money or services at some time in the future. • Long-term liabilities • Short-term liabilities
LIABILITIES continue.. · Long-term liabilities are those that are usually payable after a period of one year. e.g. A term loan from a financial institution, debentures (bonds) issued by a company.
LIABILITIES continue.. · Short-term liabilities are obligations that are payable within a period of one year. e.g. Creditors, bills payable, overdraft from a bank for a short period.
CAPITAL Investment by the owner for use in the firm is known as capital. Owner’s equity is the ownership claim on total assets. It is equal to total assets minus total liabilities.
REVENUES These are the amounts the business earns by selling its products or providing services to customers. Other titles and sources of revenue common to many businesses are: sales, fees, commission, interest, dividends, royalties, rent received, etc.
EXPENSES These are costs incurred by a business in the process of earning revenue. Generally, expenses are measured by the cost of assets consumed or services used during an accounting period. The usual titles of expenses are: depreciation, rent, wages, salaries, interest, costs of heat, light and water, telephone, etc.
PURCHASES Purchases are total amount of goods procured by a business on credit and for cash, for use or sale. In a trading concern, purchases are made of merchandise for resale with or without processing. In a manufacturing concern, raw materials are purchased, processed further into finished goods and then sold. Purchases may be cash purchase or credit purchase.
SALES Sales are total revenues from goods or services sold or provided to customers. Sales may be cash sales or credit sales.
STOCK Stock (Inventory) is a measure of something on hand – goods, spares and other items – in a business. It is called stock on hand.
STOCK: continue… In a trading concern, the stock on hand is the amount of goods which have not been sold on the date on which the balance sheet is prepared. This is also called closing stock.
STOCK continue… In a manufacturing concern, closing stock comprises raw materials, semi-finished goods and finished goods on hand on the closing date. Similarly, opening stock is the amount of stock at the beginning of the accounting year.
DEBTORS Debtors are persons and/or other entities who owe to an enterprise an amount for receiving goods and services on credit. The total amount standing against such persons and/or entities on the closing date, is shown in the Balance Sheet as Sundry Debtors on the asset side.
CREDITORS Creditors are persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit. The total amount standing to the favour of such persons and/or entities on the closing date, is shown in the Balance Sheet as Sundry Creditors on the liability side.
ACCOUNTING PRINCIPLES Accounting principles can be subdivided into two categories: ·Accounting Concepts; and ·Accounting Conventions.
ACCOUNTING PRINCIPLES ·Accounting Concepts ·Accounting Conventions The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based. The term ‘convention’ is used to signify customs and traditions as a guide to the presentation of accounting statements.
ACCOUNTING PRINCIPLES • Accounting Concepts • Business Entity Concept • Money Measurement Concept • Cost Concept • Going Concern Concept • Dual Aspect Concept • Realization Concept • Accounting Period Concept
ACCOUNTING PRINCIPLES • Accounting Conventions • Convention of Consistency • Convention of Disclosure • Convention of Conservation
ACCOUNTING PRINCIPLES Accounting Concepts The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based.
Business Entity Concept Business is treated as a separate entity or unit apart from its owner and others. All the transactions of the business are recorded in the books of business from the point of view of the business as an entity and even the owner is treated as a creditor to the extent of his/her capital.
Money Measurement Concept In accounting, we record only those transactions which are expressed in terms of money. In other words, a fact which can not be expressed in monetary terms, is not recorded in the books of accounts.
Cost Concept Transactions are entered in the books of accounts at the amount actually involved. Suppose a company purchases a car for Rs.1,50,000/- the real value of which is Rs.2,00,000/-, the purchase will be recorded as Rs.1,50,000/- and not any more. This is one of the most important concept and it prevents arbitrary values being put on transactions.
Going Concern Concept It is persuaded that the business will exists for a long time and transactions are recorded from this point of view.
Dual Aspect Concept Each transaction has two aspects, that is, the receiving benefit by one party and the giving benefit by the other. This principle is the core of accountancy.
Dual Aspect Concept continue… For example, the proprietor of a business starts his business with Cash Rs.1,00,000/-, Machinery of Rs.50,000/- and Building of Rs.30,000/-, then this fact is recorded at two places. That is Assets account (Cash, Machinery & Building) and Capital accounts. The capital of the business is equal to the assets of the business.
Dual Aspect Concept continue… Thus, the dual aspect can be expressed as under Capital + Liabilities = Assets or Capital = Assets – Liabilities
Realization Concept Accounting is a historical record of transactions. It records what has happened. It does not anticipate events. This is of great important in preventing business firms from inflating their profits by recording sales and income that are likely to accrue.
Accounting Period Concept Strictly speaking, the net income can be measured by comparing the assets of the business existing at the time of its liquidation. But as the life of the business is assumed to be infinite, the measurement of income according to the above concept is not possible. So a twelve month period is normally adopted for this purpose. This time interval is called accounting period.