# Introduction to accounting

Concept of accounting
Accounting is a term used to describe a wide range of activities. It may be defined as the identifying, measuring, recording and communicating of financial information. Accounting may also be described as an information system designed to provide, through the medium of financial statements, relevant financial information. Usually the information provide relates to the economics resources owned by an organization.

Definition Of Accounting
According to the American Institute Of Certified Public Accountants 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 financial character and interpreting the result thereof.
The above definition also highlights the steps in the accounting process.

Objective Of Accounting

To keep systematic records To protect business properties To ascertain the operational profit or loss To ascertain the financial position of business To facilitate rational decision making

Users of financial Accounting information

Investors
Employees
Lenders

Public

Accounting Information

Managers

Government

Suppliers and other trade creditors

Customers

Accounting Concepts, Conventions, Bases & Policies

Concepts vs Conventions Concepts are the basic ideas, the theories on how and why certain categories of transactions should be treated in a particular manner. Once the theories have been established and tested and proved to be acceptable, the task of the Conventions is to set out the limit of their applications.

Accounting Concepts

1. Business Entity Concept business is a separate entity. 2. Money Measurement Concept money common denominator of measurement. 3. Going Concern Concept perpetual succession. 4. Accounting Period Concept pre-determined periodicity generally an year. 5. Cost Concept an assets cost is the basis of all subsequent accounting.

Accounting Concepts

6. Realisation Concept revenue should be recognized when it is earned. 7. Matching Concept associating the cause and effect relationship of revenues and expenses. 8. Accrual Concept similar to matching, period should be decided on the basis of accrual. 9. Dual Aspect Concept 2 aspects must be examined the giving and the receiving.

Accounting Conventions

1. Consistency method once adopted should be followed. 2. Full Disclosure all relevant facts concerning financial position must be communicated to users. 3. Materiality concerned with significant information. 4. Conservatism or Prudence when in doubt, choose the solution that is least likely to overstate net assets and net income for the current period.

Some Important Terminology Of Accounting

Transactions Goods Liabilities Assets Capital Drawings Debtors Creditors

Profit Loss Net worth Contingent liabilities Expenses Discounts Solvent Insolvent

Some Important Terminology Of Accounting (Cont)

Capital Expenditure Revenue Expenditure Accounting year Goodwill Income Bad debts

# CLASSIFICATION OF ACCOUNTS
Accounts

Personal

Impersonal

Debtors

Creditors

Real or property

Nominal

Expenses Or Loss

Revenue Or Gains

Real : all the assets except Debtors Nominal : all the expenses , incomes , losses, gains. Personal : all the accounts of persons, company or firms. these are further classified into three types

Natural: all the accounts of persons. E.g. debtors, Creditors Artificial: all the accounts of a company, a firm,or any other business organization. E.g. Bank, Sharma Traders etc. Representative: all the expense O/S or prepaid, revenue in advance or accrued.

Golden rules
REAL ACCOUNTS DEBIT WHAT COMES IN CREDIT WHAT GOES OUT DEBIT THE RECEIVER CREDIT THE GIVER

PERSONAL ACCOUNTS

NOMINAL ACCOUNTS

DEBIT ALL EXPENSES AND LOSSES CREDIT ALL INCOMES AND REVENUES

Journal Meaning And Format Of Journal

A Journal is a book in which transactions are recorded in chronological order. A Journal is a book of prime entry (original entry) because all the transactions are first recorded in this book. The word journal comes from the French word 'Jour' meaning 'day'. It is written up from the various source documents. The entry passed in the journal is called 'Journal Entry'. The process of writing up the book of Journal is called 'Journalizing'.

The format of a Journal is shown as below:

Journal of for the period Date Particulars L.F. Debit Amount (Rs.) Credit Amount (Rs.)

Q1) From the following transactions of Juneja, find out the nature of accounts and also state which account should be debited and to be credited.
1. 2. 3. 4.

5.
6. 7.

8.
9. 10.

Started business with cash Purchased Machinery Purchased goods on credit from 'Shyam' Sold goods for cash Purchased goods for cash Deposited into bank Purchased goods from Sudhir Withdrew cash for personal use Sold goods to Ram Paid Rent

Cont..
11. 12. 13. 14.

15.
16. 17.

18.
19. 20.

Received commission Sold goods to Surekha Received cash from Ram Borrowed money from XYZ Paid interest on loan Outstanding Salary Amount paid to Sudhir Received cash from Surekha Goods withdrawn for personal use Interest allowed by bank.

Q4) From the following transactions, prepare journal entries in the books of ABC
2005 Jan. 1 "1 "2 "3 "5 "8 10 12 "15 18 "21 "25 "28 "30 Started business with cash Paid into bank Goods purchased for cash Purchase of furniture and payment by cheque Sold goods for cash Sold goods to Arvind Walia Goods purchased from Amrit Lai Goods returned to Amrit Lai Goods returned by Aravind Walia Cash received from Arvind Walia Ra. 3,760 and discount allowed to him Withdrew from bank for private use Withdrew from bank for use in the business Paid telephone rent for one year Cash paid to Amrit Lai in full settlement of his account Paid for: Stationery Rent Salaries to staff 45,000 25,000 15,000 5,000 8,500 4,000 7,000 1,000 200 40 1,000 5,000 400 5,940 200 1,000 2,500

Journalize the following transactions.

2006 January 1 " 3 " 4 " 5 " 7 " 8 " 10 " 11 " " " " " " 12 14 16 25 26 31 31 31 Started business with Rs.10, 000, paid into bank Rs.5, 000. Bought furniture for Rs.900. Purchased goods from Mohan & Co. for Rs.4, 000 for cash Sold goods for Rs. 1,700 Paid telephone rent for the year Rs.400. Purchased goods for Rs. 1, 000 from Bir & Co Paid Rs. 100 for advertisement by cheque Bought one Typewriter for Rs.750 from Universal Typewriter Co. on credit Sold goods to Bedi & Co. for Rs.2, 900 Withdrew Rs.350 from the Bank for private use Sold goods to Omega & Co. for Rs.650 cash Received cash from Bedi & Co. Rs.2, 850, discount allowed Rs.50. Paid into bank Rs.2, 500 Issued cheque for Rs.300 in favour of the landlord for rent for January Paid salaries to staff Rs.600 Paid cash Rs.950 Bir & Co. in full settlement of their account.

Ledger

A summary of all business transactions relating to a person, asset, expense or income, which have taken, place during a given period of time and show their net effect. It is the compilation of all corresponding entries with reference to a particular account. This compilation is prepared in an accounting format which is known as Ledger.

Specimen format of a ledger a/c

Dr Date Particulars J.F. Amount Date Particulars J. F. Cr Amount

LEDGER

When all accounts of the ledger are in balance, a Trial Balance is prepared. A Trial Balance is a listing of all accounts and their respective balances . Trial Balance is the statement of debit balances and credit balanced from ledger accounts on a particular date. A Trial Balance is, thus, a summary of all the Ledger Balances outstanding as on particular date.

Performa of Trial Balance

Sr. No. Name of the account Debit Rs. Credit Rs.

It must be stated here that total of debit balance column must be equal to total of credit balances column. This is so because under double entry system , for each item of debit there is corresponding credit and secondly all the transactions recorded in the books of original entry are transferred to ledger.

# Capital and Revenue

Classification of Expenses

Expenses are classified as revenue expenses, capital expenses, and deferred revenue expenses.
Expenditure Revenue expenses Capital expenses Deferred revenue exp.

Illustration 1

State whether the following items are of capital or revenue in nature.

1. 2. 3. 4.

5.

Machinery purchased for Rs. 100000. Salary paid Rs. 5000. Preliminary expenses paid Rs. 23000. Freight and insurance paid Rs. 5000 on purchase of new machinery. Expenses on foreign tour Rs. 40000 for purchase of new machinery.

Illustration 2

State with reason whether the following items are of capital or revenue in nature.
1. 2. 3.

4.

5.

Customs duty paid Rs.5000 on import of machinery. Wages paid for erection of the plant Rs. 3000. Repairing expenses Rs. 5000 before putting to use a second hand car purchased. Rs. 4300 paid for replacing a worn out part of a machine with the new part. Amount of Rs. 500 paid for repairs of existing plant.

Illustration 3

State with reason whether the following items are of capital or revenue in nature.
1.

2.

3.

4.
5.

An amount of Rs. 15000 paid for replacing petrol driven engine with diesel engine. Rs. 800000 paid for the advertisement for launching a new product into the market. The benefit of such advertisement will be accrued for 4 to 5 years. White washing of a factory Rs. 10000. Expenses for providing uniform to the factory workers Rs. 25000. Heavy amount of Rs. 100000 paid for preparing a project report for implementing a new project.

Illustration 4

State with reason whether the following items are of capital or revenue in nature.
1.

2.

3.

4.

5.

Rs. 100000 paid to the employee as compensation as he was retrenched. Interest on a term loan for purchase of machinery. The commercial production has not begun till the last date of a year. Interest on a term loan for purchase of machinery. The commercial production has already begun. Compensation paid Rs.1000 for breach of contract for acquiring stock-in-trade. Amount of Rs.140000 paid for renovating a cinema hall which will increase its sitting capacity.

# Depreciation

DEPRECIATION EXPENSES

The Institute of Chartered Accountants of India defines depreciation as follows in accounting standard AS-6 on Depreciation Accounting. Depreciation is a measure of wearing out, consumption or other loss of value of depreciable asset arising from use, time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortization of assets whose useful life is pre-determined.

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DEPRECIATION EXPENSES

In short, depreciation is the allocated cost of services given up by a tangible long-term operating asset (other than land) during a period of time. It can be said that amount of depreciation recorded in books of account is only an estimate.
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CAUSES OF DEPRECIATION

Wear and Tear Obsolescence Time Accidents

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OBJECTIVES OF DEPRECIATION

Correct income measurement True position statements Funds for replacement

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EFFECTS OF NOT PROVIDING FOR DEPRECIATION

Periodic expenses will be understated, Profits will be overstated; Asset valuation will be overstated; Capital depletion will take place; Cost of production will be understated; Price determination will be in appropriate; and Net worth will be overstated.
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The following are the important factors which cause some reduction in the value of fixed asset. The difference between the original value and reduced value is called depreciation.

Physical depreciation

Depreciation is caused mainly from wear and tear when the asset is in use and from erosion rust, rot and decay from being exposed to wind, rain, sun and other elements of nature.

Economic factor

These may be said to be those that cause the asset to be put out of use even though it is in good physical condition. These arise due to obsolescence and inadequacy.

Time factors

There are certain assets with a fixed period of legal life such as lease, patents and rights. Provision for the consumption of these assets is called amortization rather than depreciation.

Depletion

Some assets are of a wasting character perhaps due to the extraction of raw materials from them Natural resources such as mines, quarries and oil wells come under this heading. To provide for the consumption of an asset of a wasting character is called provision for depletion.

Accident

An asset may reduce in value because of meeting an accident, obsolescence, etc.

Method of Providing Depreciation

Straight Line Method Machine Hour rate method Diminishing Value Method

Sum of Digits Method

Asset Disposal Method

Methods of Depreciation
Depletion Method

Change of Depreciation Method

Revaluation Method

Annuity Method

Insurance Policy Method

Depreciatio n Fund Method

Example 1:

A company purchased a second hand plant for Rs 60000. It immediately spent on it Rs 10000. The plant was put to use on 1-1-02. After having used it for 6 years, it was sold for Rs 30000. You are requested to prepare the plant a/c for all the six years providing depreciation at 10 % p.a on original cost.

Example 2

On 1st January 2004 Machinery was purchased by X for Rs.50, 000. On 1st July 2005 additions were made to the extent of Rs. 10,000. On 1st April 2006, further additions were made to the extent c Rs.6,400. On 30th June 2007 Machinery the original value of which was Rs.8,000-on 1st January 2004 was sold for Rs.6,000,'X closes his books on 31st December each year. Show the machinery account for four years from 2004 to 2007 in the books of X if depreciation is charged at 10% s original cost method

Example 3

On 1s" January 2004 Machinery was purchased by X for Rs.50, 000, On 1st July 2005 additions made to the extent of Rs. 10,000. On 1st April 2006, further additions were made to the extent of is 6, 400. On 30th June 2007 Machinery the original value of which was Rs.8, 000 on 1st January 2004 was sold for Rs.6, 000. X closes his books on 31s1 December each year. Show the machinery account for four years from 2004 to 2007 in the books of X if depreciation is charged at 10% at diminishing balance method.

Example 4

On 1.1.2006 machinery was purchased for Rs.80,000. On 1.1.2007 additions were made to the amount of Rs.40, 000. On 31.3.08 machinery purchased on 1.1.07, costing Rs.12, 000 was sold for Rs 11,000 and on 30.6.08 machinery purchased on 1.1.06 costing Rs.32, 000 was sold for Rs.26, 700. On 1.10.08 additions were made to the amount of Rs.20,000. Depreciation was provided at 10% p.a. on the diminishing balance method. Show the machinery account for the three years 2006 to 2008 (year ended on December 31.)

Final Accounts

Ratio Analysis

Questions:

Convert balance sheet into vertical form. Calculate the following ratios

Current ratio, Quick ratio, Debt to equity ratio, Propriety ratio, and Capital gearing ratio.

Operating net profit ratio, Net profit ratio, Stock turnover ratio and Gross profit ratio.