Accounting for managers

Financial Accounting

Accounting for managersFaculty: Ms. Luvnica RastogiAmity International Business SchoolImp Website: www.investorwords.com

Learning Objectives Learning Objectives Learning Objectives Learning Objectives IntroductionDefinition:

Meaning of Accounting 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

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 partiesAccounting-- A Means and Not an EndKeeping 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 FunctionsProvides 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

ContdFacilitates 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 AccountingAccounting 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 decision-making 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) 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 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 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 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 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.

Advantages Of AccountingFacilitates 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 Business11. Facilitates Raising Loans

Basic Terms in Accounting1. Capital

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. 2. Assets

Assets refer to the tangible objects or intangible rights owned by an enterprise and carrying probable future benefits. Basic Terms in Accounting3. Liability

Liability is the financial obligation of an enterprise other than owners funds. 4. Revenue

Revenue is the gross inflow of cash, receivables or other considerations arising in the course of ordinary activities of an enterprises resources yielding interest, royalties and dividends. Basic Terms in Accounting5. Cost of Goods Sold

It is the cost of goods sold during an accounting period. In manufacturing operations, it includes the following:

Cost of materials

Labor and factory overheads

6. Profit

Profit is a general term for the excess of revenue over related cost. When the result of this computation is negative, it is referred to as loss. Basic Terms in Accounting8. Expenses

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. 9. Deferred Expenditure

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 creditor is the 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. Sundry Debtor

Sundry debtors are persons 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 asset is an asset, 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. Contingent Liability

Contingent liability is an 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 CycleACCOUNTING CONCEPTSThe 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, anenterprise must be considered as continuing largely in itspresent 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 moneys 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. atcost andb. This cost is the basis of all the subsequent treatment ofthe assets. e.g. depreciation, stock valuation, etc.,

6. The Concept Of Matching Cost and RevenuesMatching of Expired cost (i.e., expenses) and revenues for the periods 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.

CONVENTIONSASSIGNMENT:What are the conventions of accountancy ?Explain.CONVENTIONSConsistency: 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.DisclosureAll 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 keepingMateriality :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 amountc ) 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 SYSYTEMDouble-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.

ContdFor 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".

ContdThus 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 EQUATIONThe 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 companys shareholders. Thus, the accounting equation is

Assets = Liabilities + Shareholder EquityContdThe 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 ORShareholder Equity = Assets Liabilities.

ExamplesTransactionNumberAssetsLiabilitiesShareholder'sEquityExplanation1+6,000+6,000Issuing stocks for cash or other assets2+10,000+10,000Buying assets by borrowing money (taking a loan from a bank or simply buying on credit)3900900Selling assets for cash to pay off liabilities: both assets and liabilities are reduced4+1,000+400+600Buying assets by paying cash by shareholder's money (600) and by borrowing money (400)5+700+700Earning revenues6200200Paying expenses (e.g. rent or professional fees) or dividends7+100100Recording expenses, but not paying them at the moment8500500Paying a debt that you owe9000Receiving cash for sale of an asset: one asset is exchanged for another; no change in assets or liabilitiesTransactionNumberAssetsLiabilitiesShareholder'sEquityExplanationJournalIntroduction:- 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.

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. Journal

The Performa of a journal 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 assetsiii. 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.)

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, Vijays a/c, Harys 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 TransactionDetermine the 2 accounts which are involved in the transaction.Classify the above two accounts under Personal , Real and Nominal.Find out the rules of debit and credit for the above two accounts.Identify which account is to be debited and which account is to be credited.

EXAMPLES OF JOURNAL ENTRIES

COMPOUND JOURNAL ENTRY Sometimes, there are 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 years 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 proprietors 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 and Building-- Rs. 1,00,000 6. Sundry Creditors-- Rs. 1,00,000 Solution:-

DiscountAn incentive that a seller offers to abuyerin return forpaying a bill owed before the scheduled due date. The seller will usually reduce the amount owed by the buyer by a smallpercentage 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 cashdiscountwould be beneficial for the seller as it would allow him tohave access to the cashsooner.The sooner a seller receives the cash, the earlier he can put the money back into the business to buy more supplies and/orgrow the company further.

Cash DiscountTrade DiscountA 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 $200Cash DiscountTrade DiscountIs a reduction granted by supplier from the invoice price in consideration of immediate or prompt paymentIs 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 servicesAs an incentive in credit management to encourage prompt paymentAllowed to promote the salesNot shown in the supplier bill or invoiceShown by way of deduction in the invoice itselfCash discountaccountis opened in the ledgerTradediscount account is not opened in the ledgerAllowed on payment ofmoneyAllowed on purchase of goodsIt may vary with the time period within which payment is receivedIt may vary with the quantity of goods purchased or amount of purchases madeTreatment of goods given as Charity /AdvertisementGave away as charity goods costing Rs. 100 and cash Rs.50.

Charity Account Dr. 150 To Purchases A/C . 100 To Cash Account .. 5073Treatment of goods lost in Accident/ FireGoods 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 .. 400074Treatment of Depreciation on Fixed AssetsPlant purchased for Rs. 7000. Provide Deprecation @10% P.A. for full year.

Deprecation Account Dr. 700 To Plant Account .. 70075 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 .5500076Treatment 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 .. 100077 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 LedgerWhat is a ledger?It is a digest of all accounts utilized by an entity during an accounting period.79BoundbooksComputerprintoutCardsLoose leafpagesLedger AccountsLedger - a group of related accounts kept current in a systematic manner

Think of a ledger as a book with one page for each account.

80

Ledger81CashAccts. Payable Ledger Accts. ReceivableSupplies Ledger 82CashAccts. Payable Ledger ABCDCustomer AccountsAccts. ReceivableSupplies Ledger 83Cash LedgerSuppliesAccts. PayableLedger ABCDCustomer AccountsAccts. ReceivableABCDCreditor AccountsLEDGER ACCOUNTSA 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.84Account TitleLeft SideRight SideDEBITS AND CREDITSDebit (dr.) - an entry or balance on the left side of an accountCredit (cr.) - an entry or balance on the right side of an accountRemember:Debit is always the left side!Credit is always the right side!85

86Post from the journalto the ledger.POSTINGWhat is posting?It is the transfer of information from the journal to the appropriate accounts in the ledger.87POSTING TO THE LEDGERPOSTING REFERS TO TRANSFERRING THE INFORMATION IN A JOURNAL ENTRY TO THE APPROPRIATE LEDGER ACCOUNTENTER DATEENTER AMOUNT IN PROPER DEBIT OR CREDIT COLUMNENTER JOURNAL SOURCE INFO8889DateParticularsJ.fAmt.DateParticularsJ.fAmt.Debit CreditPROFORMA FOR ACCOUNTTHE ACCOUNT90Account TitleDebitCreditLEFT SIDETHE ACCOUNT91Account TitleDebitCreditRIGHT SIDELEDGER ACCOUNTSBalance - difference between total left-side amounts and total right-side amounts at any particular timeAssets have left-side balances.Increased by entries to the left sideDecreased by entries to the right sideLiabilities and Owners Equity have right-side balances.Decreased by entries to the left sideIncreased by entries to the right side92DETAILS OF JOURNALS AND LEDGERS93DateJournalPage 1Particulars Debit CreditApril 2Cash 30,000Garge Capital 30,000(Received initialinvestment from owner)

94 Date Ref. Particulars Amount Date Ref Particulars Amount

April 2 1 To G. Cap 30,000 Debit Cash Account CreditInsert the number of the journal page.POSTING95L.F. DateDescriptionDebitCredit12/1Prepaid Insurance 2,400 Cash 2,400 JournalPage 1RECORDING AND POSTING AN ENTRY1. Analyze and record the transaction as shown.2. Post the debit side of the transaction.3. Post the credit side of the transaction.96L.f DateDescriptionDebitCredit12/1Prepaid Insurance152,400 Cash 2,400Journal Ledger Prepaid Insurance Account Dr. Cr.Page 1Recording and Posting an EntryDateParticularsFol.Amt.DateParticularsFol.Amt.12/1To Cash1240097Recording and Posting an Entry DateDescriptionL.f.DebitCredit12/1Prepaid Insurance152,400 Cash112,400 Journal Ledger Page No.15 Prepaid insurance Account Dr. Cr.Page 11324DateParticularsFol.Amt.DateParticularsFol.Amt.12/1To Cash12400Balancing of Ledger AccountThe 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 BALANCETrial 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 BALANCE1. 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 BALANCEThe purposes of the trial balance:To help check on accuracy of posting by proving whether the total debits equal the total creditsTo establish a convenient summary of balances in all accounts for the preparation of formal financial statements101

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 30th April 2009

PREPARING THE TRIAL BALANCEThe trial balance is usually prepared with the balance sheet accounts first, followed by the income statement accounts.

An example of a trial balance:

Account (Rs)NumberAccount Title Debit Credit

100Cash 3,50,000 3,50,000 130Merchandise inventory 150,000 150,000 202Note payable 100,000 100,000 300Paid-in capital 400,000 400,000 500,000500,000 =====================================106LOCATING TRIAL BALANCE ERRORSNote 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.107108Correcting ErrorsThree Types of ErrorsJournal EntryLedger Posting1.incorrect not posted109Correcting ErrorsThree Types of ErrorsJournal EntryLedger Posting1.incorrect not posted2.correct incorrectly posted110Correcting Errors Three Types of ErrorsJournal EntryLedger Posting1.incorrect not posted

2.correct incorrectly postedincorrect LOCATING TRIAL BALANCE ERRORSWhat if it doesnt balance ?Is the addition correct?Are all accounts listed?Are the balances listed correctly?111

DEBITS CREDITSLOCATING TRIAL BALANCE ERRORSDivide 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.112Basic 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-to-day 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 Statements120The financial statements are a pictureof the company in financial terms.Each financial statement relates to a specificdate or covers a particular period.

Information Reported on the Financial Statements1211. How well did the company perform (or operate) during the period? Revenues Direct Expenses Gross income (Gross loss)TradingAccountQuestionAnswerFinancialStatement1. How well did the company perform (or operate) during the period? Gross Profit Indirect Expenses Net income (Net loss)Profit and Loss AccountInformation Reported on the Financial Statements1223. What is the companys financial position at the end of the period? Assets= Liabilities+ Owners equityBalancesheetQuestionAnswerFinancialStatement4. How much cash did the company generate and spend during the period? Operating cash flows Investing cash flows Financing cash flowsIncrease or decrease in cashStatementofcashflowsIncome Statement123The income statement, reports the companys revenues,expenses, and net incomeor net loss for the period.Introduction to theIncome Statement124The income statement is a financialtool that provides information abouta companys past performance.The Income Statement125RevenuesExpenses=Net income(or Net loss)Income Statement Format126 Sales revenues Cost of goods sold Gross profitOperatingincomeSelling andadministrativeexpenses=Add: Other revenues and gainsLess:Other expenses and losses127 Income StatementRevenue - 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 COGSOperating 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 - the payments made on the company's outstanding debt. Income Tax Expense - the amount payable to government.Net Income - the final profit after deducting all expenses from revenue.128The Income Statement can be divided into: Trading Account Profit and Loss AccountThe Accounting Terms129Revenues are inflows or otherenhancements of assets to an entity.RevenuesThey result from delivering orproducing goods, rendering services,or other activities that constitute theentitys major or central operations.The Accounting Terms130Expenses are outflows orother using up of assets.ExpensesThey result from delivering orproducing goods, rendering services,or other activities that constitute theentitys major or central operations.The Accounting TermsGross profit (gross margin) - excess of sales revenue over the cost of inventory that was soldOperating expenses - a group of recurring expenses that pertain to a firms routine operationsOperating income (operating profit) - gross profit less all operating expensesOther revenues and expenses - items not directly related to the main operations of a firm131The Accounting TermsNet income - the remainder after all expenses (including income taxes) have been deducted from revenueOften seen as the bottom line

Net loss - the excess of expenses over revenues132INCOME 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 ACCOUNTThe 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. Trading AccountThe 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 ACCOUNTSTrading A/c Dr. To opening stockTo Purchases A/cTo Sales Return A/cTo Wages A/cTo Direct Expenses A/c

FOR CLOSING OF CREDIT ACCOUNTSSales A/c Dr.Purchases Return A/cDr. To Trading A/cFOR CLOSING OF TRADING ACCOUNTFor 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/cContd..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. ContdThe 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 theBalance Sheet 145The balance sheet is the financialtool that focuses on the presentcondition of a business.

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.

ContdThe 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 SheetThe 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 equity148The Accounting Elements149Probable future economic benefitsobtained or controlled by aparticular entity as a resultof past transactions events.AssetsThe Accounting Elements150Probable future sacrifices of economicbenefits arising from present obligationsof a particular entity to transfer assetsor provide services to other entitiesin the future as a result of pasttransactions or events.LiabilitiesThe Accounting Elements151The residual interest in the assetsof an entity that remains afterdeducting its liabilities.EquityInvestmentby ownersEarnedequityFormats of Balance SheetsBalance sheet formats:Report format - a classified balance sheet with assets at the top and liabilities and equity belowAccount 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.152Balance Sheet TransactionsThe balance sheet is affected by every transaction that an entity encounters.

Each transaction has counterbalancing entries that keep total assets equal to total liabilities and owners equity.153

BALANCE SHEETRESOURCES AVAILABLE FOR USE BY THE FIRM (ENTITY)ASSETS - PROBABLE FUTURE ECONOMIC BENEFITSHOW RESOURCES ARE FINANCEDLIABILITIES - DEBT OWED TO OTHERSOWNERS EQUITY - INVESTMENT BY OWNERSDIRECTINDIRECT154EXPLANATION OF BALANCE SHEET ITEMS 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 sub-heads 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 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. 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

Contd

The Balance SheetElements 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 firms assets after deducting liabilities (rights of the owners)163Classifying Assets and Liabilities164Current assetsLong-term assetsCurrent liabilitiesLong-term liabilities165XYZ Ltd.Trial BalanceNovember 30, 2002 Cash5,900Purchases550Land20,000Accounts Payable400Amit, Capital25,000Amit, Drawing2,000Fees Earned7,500Wages Expense2,125Rent Expense800Commission450Supplies Expense800Miscellaneous Expense27532,90032,900

166XYZ Ltd.Trial BalanceNovember 30, 2002 Cash5,900Purchases550Land20,000Accounts Payable400Amit, Capital25,000Amit, Drawing2,000Fees Earned7,500Wages Expense2,125Rent Expense800Commission450Supplies Expense800Miscellaneous Expense27532,90032,900BalanceSheet167IncomeStatementXYZ Ltd.Trial BalanceNovember 30, 2002 Cash5,900Purchases550Land20,000Accounts Payable400Amit, Capital25,000Amit, Drawing2,000Fees Earned7,500Wages Expense2,125Rent Expense800Commission450Supplies Expense800Miscellaneous Expense27532,90032,900168XYZ Ltd.

Balance SheetIncome Statement1.Assets11Cash12Accounts Receivable14purchases15Prepaid Insurance17Land18Office Equipment

2.Liabilities21Accounts Payable23Unearned Rent

3.Owners Equity31Amit, Capital32Amit, Drawing4.RevenueSales5.Expenses51Wages Expense52Rent Expense54Commission55Supplies Expense59Miscellaneous ExpenseSummary169Original evidencerecordsAccountingrecordsFinancialStatementsSourcedocumentsJournalsLedgerTrial BalanceStatement of cash flowsBalance SheetProfit and LossStatementClosingEntriesFORM 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