Basics of Accounting

Mahmudur RahmanBBA-SUST

Mobile-+88017141180401. Define accounting?

Answer to the Question no. 1

Definition of Accounting:

“Accounting is an information system that identifies, records and communicates the

economic events of an organization to interested users.”

—Kieso, Weygandt, Kimmel-Accounting Principles.

“Accounting refers to the process of identifying, measuring, and communicating

economic information to permit informed judgments and decisions by users of the

information.” —The American Accounting Association.

“Accountancy may be defined as the collection, compilation and systematic recording

of business transactions of money, the preparation of financial reports, the analysis

and interpretation of these reports and the use of these reports for the information

and guidance of management.” —A. W. Johnson.

“Accounting is the art of recording, classifying and summarizing in 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.”

—American Institute of Certified Public Accounts (AICPA).

After discussing the above definitions we can say that Accounting is concerned with the

processes of recording, sorting and summarizing data resulting from the business operations

and events.

Or in other words accounting means-

1. Systematic classification of business transactions for recording them in books of

account.

2. Recording of events and transactions in books of account - called Bookkeeping.

3. Summarizing of the recorded events i.e., Preparation of a trial balance from a ledger

and subsequently preparation of balance sheet and profit and loss account from the

trial balance.

4. Interpreting the financial transactions from the recorded data and financial statement.

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Mobile-+88017141180402. What are the objectives of accounting?


Objective

The main objective of accounting is to provide information to the users to make relevant decisions and form judgment.

Let us now elaborate a little on the Primary Objectives.

The main objectives of accounting are as follows:

Figure: Objectives of accounting

Let us now discuss these objectives one by one:

1. To maintain accounting records:

Written records are always better than oral records. Different persons can use written records for different decision-making purpose. It also serves as evidence of transactions. Human memory cannot absorb each and every transaction.

2. To calculate the results of operations:

To measure the financial performance of an enterprise, i.e. preparing the Income statement.

3. To ascertain the financial position:

To evaluate the financial strength and weaknesses of an enterprise, the financial position is ascertained by preparing the position statement or the balance sheet.

4. To communicate the information to the users:

Accounting communicates information to internal users and the external users.

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Primary Objectives of Accounting

Maintaining accounting records

Calculating the results of operations

Ascertaining the financial position

Communicating the information to the users


Mobile-+88017141180403. Discuss the importance of accounting.


Importance of Accounting: In the competitive world, Accounting has become an integral part of the business world. It guides and advises the business on a day-to-day basis. The importance of Accounting are given below:

1. 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:

Accounting facilitates to comply with legal requirements of an enterprise to maintain books of accounts.

3. Facilitates to Ascertain Net Result of Operations:

Accounting facilitates to ascertain net results of operations by preparing income statement.

4. Facilitates to Ascertain Financial Position:

Accounting facilitates to ascertain financial position by preparing the position statement.

5. Facilitates the Users to take Decisions:

Accounting facilitates the users to take decisions by communicating accounting information to them. The users include the following:

Short-term creditors Long-term creditors Present investors Potential investors Employees’ groups Management General public Tax authorities

6. Assist Management:

Accounting assists management in planning and controlling business activities and in taking decisions. For example, projected cash flow statement facilitates management to know future receipts and payments and to take decision regarding anticipated surplus or shortage of funds.

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7. Facilitates a Comparative Study:

Accounting facilitates a comparative study in the following four ways:

(a)Comparison of actual figures with standard or budgeted

figures for the same period and for the same firm.

(b)Comparison of actual figures of a period with those of another

period for the same firm, i.e., intra-firm comparison.

(c) Comparison of actual figures of a firm with those of another

standard firm belonging to the same industry, i.e., inter-firm

comparison.

(d)Comparison of actual figures of a firm with those of industry to

which the firm belongs, i.e., pattern comparison.

8. Facilitates Control over Assets:

Accounting facilitates control over assets by providing information regarding cash balance, bank balance, debtors, fixed assets, stock etc.

9. Facilitates the Settlement of Tax Liability:

Accounting facilitates the settlement of tax liability with the authorities by maintaining proper books of accounts in a systematic manner.

10. Facilitates the Ascertainment of Value of Business:

Accounting facilitates the ascertainment of value of business in case of transfer of business to another entity.

11. Facilitates Raising Loans:

Accounting facilitates raising loans from lenders by proving them historical and projected financial statements.

12. Acts as Legal Evidence:

Proper books of accounts maintained in a systematic manner act as legal evidence in case of disputes.

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4. What are the functions of accounting?


Functions of Accounting:

The functions of accounting are as follows:

1. Provides necessary information about the financial activities to the

interested parties

2. Provides necessary information about the efficiency or otherwise of

management with regard to the proper utilization of scarce

resources

3. Provides necessary information for making predictions (financial

forecasting)

4. 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

5. Facilitates in decision-making with regard to the changes in the

manner of acquisition, utilization, preservation and distribution of

scarce resources

6. Facilitates in decision-making with regard to the replacement of

fixed assets and expansion of the firm

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Mobile-+88017141180407. Provides necessary data to the government to enable it to take

proper decisions concerning to duties, taxes, price control etc.

8. Devices remedial measures for the deviations of the actual from the

budgeted performance

9. Provides necessary data and information to managers for internal

reporting and formulation of overall policies

5. What are the principles of accounting?


The Principles of Accounting:

The basic principles of accounting are essentially the general decision rules, which govern the development of accounting technique. On the basis of these assumptions of accounting, the following basic principles of accounting have been developed:

1. Accounting Entity Principle:

Accountants treat a business as distinct from the persons who own it. Then, it becomes possible to record the transactions of the business without the proprietor also. The concept of separate business entity is applicable for all types of organizations like sole proprietorship, partnership etc. where the business affairs are free from the private affairs of the proprietor or partner.

2. Going Concern Principle:

It is assumed that the business will exist for a long time and transactions are recorded from this point of view. Based on this concept, the accountants, while valuing assets, will not consider the forced sale value of assets (market value), but the assets, normally, will be reflected at the cost of acquisition minus depreciation. Similarly, depreciation is provided based on the expected life of the assets. The concept, however, does not imply the permanent continuance of the business. The underlying presumption is that the business will continue in operations long enough to charge against income the cost of fixed assets over their economic lives and to pay the liabilities when they fall due. This concept is applicable to the business as a whole and not for a particular division or branch. Merely closing of a branch or division may not adversely affect the ability of the enterprise to continue other businesses normally. Once the business goes in to liquidation or becomes insolvent, this concept does not

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Mobile-+8801714118040apply. In other words, the going concern status of the concern will stand terminated from the date of appointment of a receiver.

3. Accounting Period Principle:

According to this concept, the life of a business is divided into appropriate segments of time, say 12 months, for studying the results. While the life of a business is considered to be indefinite, according to the going concern concept, the measurement of income and studying the financial position of the business after a very long time would not be helpful in taking corrective steps at the appropriate time. Therefore, it is necessary that after each segment of time interval the management should review the performance. The segment of time interval is called accounting period, which is usually a year. At the end of each accounting period, an income statement and a balance sheet is prepared. The income statement discloses the profit or loss made by the business during an accounting period. The balance sheet discloses the state of affairs of the business as on the last date of the accounting period. The term “conventions” includes those customs or traditions, which guide the accountants while preparing the accounting statements.

4. Cost Principle:

Transactions are entered in the books of account at the amounts actually involved. An asset is ordinarily recorded at a price at which it has been acquired. For example, a plot of land purchased by a firm for Tk. 5,00,000 would be recorded at this value irrespective of its current market price. Cost concept has the advantage of bringing objectivity in the presentation of the financial statements. In the absence of this concept, the figures shown in the accounting records would have to depend on the subjective view of a person.

5. Realization Principle:

Accounting is a historical record of transactions. It only records what has happened. It does not anticipate events, though anticipated adverse effects of events that have already occurred are usually recorded. For example, A places an order on B for supply of certain goods. Upon receipt of the order, B procures raw material, employs labor, and produces and delivers the goods to A. In this case, the sale transaction will be recorded in the books of B only when the goods are delivered and not upon the receipt of an enforceable purchase order from A. There are certain exceptions to this concept, which are as follows:

i. In the case of hire-purchase transaction, the ownership of the goods passes on to the buyer only when the last installment is paid, but sales presume to have been made to the extent of installments received and installments outstanding (installments due but not received).

ii. In the case of contract accounts, though the contractor is liable to pay only when the whole of contract is completed as per terms of the contract, the profit at the end of accounting year is calculated on the basis of the work completed and certified by a competent authority.

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Mobile-+88017141180406. Expenses Recognition Principle:

Cost is the total outlay or expenditure on acquiring resources required for the production of goods or rendering of services. Cost of resources utilized and lost during a particular period is termed as the expired cost or expense and is charged to the revenue of the period to obtain information about income. Costs of the resources remaining unutilized or un-expired at the end of the period are carried forward to the next accounting period and are termed as assets.

7. Dual Aspect Principle:

Each transaction has two aspects. With every increase in the money owned to others, there should be an increase in assets or loss. Thus, at any time the accounting equations is as follows:

Assets = Liabilities + Capital, or alternatively, Capital = Assets - Liabilities

For example, a proprietor brings in Tk. 1,00,000 in cash as capital to start a small business. Tk. 1,00,000 is the capital and corresponding amount of Tk. 1,00,000 will appear as cash in hand (assets).

8. The Matching Principle:

In determining the net income, it is necessary to match related costs and expenses to revenue for the reporting period. The cost of a product sold and all expenses incurred in generating the sale should be matched against the respective revenue.

This concept is basically an accrual concept since it disregards the timings and the amount of actual cash inflow or cash outflow and concentrates on the occurrence of revenue and expenses.

This concept calls for adjustments to be made in respect of prepaid expenses, outstanding expenses, accrued revenue and un-accrued revenue. Thus, appropriate costs have to be matched against the appropriate revenue for the accounting period.

9. Objectivity Principle:

According to this principle, the accounting data should be definite, verifiable and free from personal bias of an accountant. In other words, this principle requires that each recorded transaction/events in the books of accounts should have an adequate evidence to support it.

In historical cost accounting, the accounting data are verifiable since the transactions are recorded on the basis of source documents such as vouchers, receipts, cash memos, invoices and the like. The supporting documents form the basis of their verification by auditors afterwards.

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Mobile-+8801714118040For items like depreciation and the provisions for doubtful debts where no documentary evidence is available, the policy statement made by the management is treated as the necessary evidence.

10. Materiality Principle:

According to this convention, the accountant should attach importance to material details and ignore insignificant details. This is because otherwise accounting will be unnecessarily overburdened with minute details. The question “what constitutes material details” is left to the discretion of the accountant. Moreover, an item may be material for one purpose while immaterial for another. The term materiality is a subjective term. The accountant should regard an item as material if there is a reason to believe that knowledge of it would influence decision of the informed investor. According to Kohler, “Materiality means characteristic attaching to a statement, fact or item whereby its disclosure or method of giving it expression would be likely to influence the judgment of a reasonable person”.

11. Full Disclosure Principle:

According to this principle, the financial statements should act as a means of conveying and not concealing. It means that the financial statements should disclose all the relevant and reliable information, which they purport to represent, so that the information may be useful for the users.

The practice of appending notes to the financial statements has developed as a result of the principle of full disclosure. The disclosure should be full, fair and adequate so that the users of the financial statements can make correct assessments about the financial performance and position of the enterprise.

The changes, which have a significant impact on the accounts, should be disclosed. For accurate interpretation, the accounting reports should include financial statements and accompanying notes. Accompanying notes should be included to call attention toward events and circumstances that may have significant effect on potential future earnings and/or a company’s position, e.g., future take over or merger taking place.

12. Consistency Principle:

The accounting practices should remain the same from one year to another. For example, consistency in valuation of stock, in trade or in method of charging depreciation. If the stock has been valued by adopting the principle of cost or market value, whichever is less, the same principle has to be consistently followed year after year. Similarly, the method of charging depreciation, either straight line or written down value method, has to be consistently followed. This is necessary for the comparison of results. However, consistency does not mean inflexibility. In the case of change in law or from the point of view of improved reporting, this convention is broken and then adequate disclosure, as to the impact on the profit due to such change, has to be mentioned in the notes appended to the accounts.

13. Conservatism Principle:

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Mobile-+8801714118040Financial statements are usually drawn up on a conservative basis, especially in the initial stages when the anticipated profits, which were accounted, did not materialize. This results in less acceptability of accounting figures by the end-users. Therefore, accountants follow the rule “anticipate no profits but provide for all possible losses.” Similarly, based on this convention, the inventory is valued at cost or market price whichever is less. Necessary provision for bad and doubtful debts is made in the books of account. Window-dressing, i.e. showing a position better than what it is, is not permitted. It is also not proper to show a position substantially worse than what it is. In other words, secret reserves are not permitted. Therefore, this convention has to be applied with reasonable caution and care.

14. Stable Money Measurement Principle:

Accounting records normally those transactions, which are being expressed in monetary terms. Measurement of business events in monetary terms helps in understanding the state of affairs of the business in a much better way. For example, if a business owns two factory buildings, five lathe machines and Tk. 1,00,000 as cash at bank, we cannot add these numbers so as to produce a meaningful result. However, if we say the value of two factory buildings is Tk. 10,00,000, the value of five lathe machines is Tk. 5,00,000 and cash of Tk. 1,00,000, we can add these values and say that the value of assets owned by the business is Tk. 16,00,000. This is definitely informative and useful.

6. Describe the branches of accounting.


Branches of Accounting: The followings are the branches of accounting-

1. Financial Accounting:

“Financial accounting is the field of accounting that provides economic and financial information for investors, creditors, and other external users.”

—Donald E. Kieso-Accounting Principles.

It is the process of identifying, measuring, recording, classifying, summarizing, analyzing, interpreting and communicating the financial transactions and events. The purpose of this branch of accounting is to keep systematic records to ascertain financial performance and financial position and to communicate the accounting information to the interested parties. It deals with the preparation of trial balance, profit and loss account and balance sheet. It shows the amount of profit earned or loss incurred during a period.

2. Management Accounting:

“Management accounting includes the methods and concepts necessary for effective planning, for choosing among alternative business actions, and for control through the evaluation and interpretation of performances”. -- The American Accounting Association.

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It is the application of accounting techniques for providing information designed to help all levels of management in planning and controlling the activities of business enterprises and in decision making. The purpose of this branch of accounting is to supply any and all information that management may need in taking decision and to evaluate the impact of its decisions and actions.

Management accounting is not only confined to the area of cost accounting, but also covers other areas such as

Capital Expenditure Decisions Capital Structure decisions Dividend decisions.

In short, it deals with the processing of data generated in financial accounting and cost accounting for managerial decision making. It also deals with application of managerial economic concepts for decision-making.

3. Social Responsibility Accounting:

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

4. Cost Accounting:

According to Charles T. Horngren, cost accounting is a quantitative method that accumulates, classifies, summarizes and interprets information for the following three major purposes:

1. Operational planning and control 2. Special decisions 3. Product decisions

According to the Chartered Institute of Management Accountants, London, “cost accounting is the process of accounting for costs from the point at which its expenditure is incurred or committed to the establishment of the ultimate relationship with cost units”. The purpose of Cost accounting is to ascertain the cost, to control the cost and to communicate information for decision-making. It shows classification and analysis of costs on the basis of functions, processes, products, centers etc. It also deals with cost computation, cost saving, cost reduction etc.

5. Tax Accounting:

Tax accounting is related to the tax liabilities of an organization. Based upon the projected profit and loss statements, the tax consultants arrive at the likely tax liabilities. This helps the management in tax planning (saving of tax liabilities by appropriate investments/taking advantage of tax exemption provisions).

6. Auditing:

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Auditing is the examination of financial statements by a certified public accountant in order to express an opinion as to the fairness of presentation.

7. Public Accounting or Government Accounting:

Public Accounting is an area of accounting in which the accountant offers expert service to the general public.

8. Human Resource Accounting:

Human beings are considered central to achievement of productivity, well above equipment, technology and money. Human Resource Accounting (HRA) is an attempt to identify, quantify and report investment made in human resources of an organization that are not presently accounted for under conventional accounting practice. The committee of HRA of the American Accounting Association defined HRA as the process of identifying and measuring data about human resources and communicating this information to interested parties. However resources are not yet recognized as ‘assets’ in the Balance Sheet. The measures of the net income, which are provided in the conventional financial statement, do not accurately reflect the level of business performance. Expenses relating to the human organization are charged to current revenue instead of being treated as investments to be amortized over the economic service life, with the result that the magnitude of net income is significantly distorted.

7. Distinguish between Financial Accounting and Cost Accounting.


The main differences between financial and cost accounting are given as follows:

Point of Distinction

Financial Accounting Cost Accounting

1.Purpose It provides information about the business in a general way. It tells about the profit and financial position of the business to owners and other outside parties.

It provides information to the management for proper planning, operation, control and decision-making.

2.Form of accounts

These accounts are kept in such a way as to meet the requirements of Companies Act and Income Tax Act.

These accounts are generally kept voluntarily to meet the requirements of the management. But now Companies Act has made it obligatory to keep cost records in some manufacturing industries.

3.Recording It classifies, records and analyses the transactions in a subjective manner i.e. according to the nature of expenses.

It records the expenditure in an objective manner i.e. according to the purposes for which the costs are incurred.

4.Control It lays emphasis on the recording It provides a detailed system of

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Mobile-+8801714118040aspect without attaching any importance to control.

control for materials, labor and overhead costs with the help of standard costing and budgetary control.

5.Periodicity of reporting

It reports operating results and financial position usually at the end of the year.

It gives information through cost reports to management as and when desired.

6.Analysis of profit

Financial accounts are the accounts of the whole business. They are independent in nature and disclose the net profit or loss of the business as a whole.

Cost Accounting is only a part of the financial accounts and discloses profit or loss of each product, job or service.

7.Reporting of costs

The costs are reported in aggregate in financial accounts.

The costs are broken down on a unit basis in cost accounts.

8.Nature of transactions

Financial accounts relate to commercial transactions of the business and include all expenses viz., manufacturing, office, selling and distribution etc. Financial accounts are concerned with external transactions i.e. transactions between the business concern on one side and third parties on the other. These transactions form the basis for payment or receipt of cash.

Cost Accounts relate to transactions connected with the manufacture of goods and services and include only those expenses, which enter into the production. Cost Accounts are concerned with internal transactions, which do not form the basis of payment or receipt of cash.

Point of Distinction

Financial Accounting Cost Accounting

9.Information Monetary information is only used (i.e. only monetary transactions are recorded).

Non-monetary information like units is also used (i.e. it deals with monetary as well as non-monetary information).

10.Fixation of selling Price

Financial accounts are not maintained with the object of fixing selling prices.

Cost accounting provides sufficient data for fixation of selling prices.

11.Figures Financial accounts deal mainly with actual facts and figures.

Cost Accounts deal partly with facts and figures and partly with estimates.

12.Reference In devising or operating a system of financial accounting reference can be made in case of difficulty to the company law, case decisions and to the canons of sound professional practice.

No such reference is possible. Guidance can be had only from a body of conventions followed by cost accountants.

13.Relative efficiency

Financial accounts do not provide information on the relative efficiencies of various workers, plants and machinery.

Cost accounts provide valuable information on the relative efficiencies of various plants and machinery.

14.Stock valuation

Stocks are valued at cost or market price whichever is less.

Stocks are valued at cost.

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15.Type of science

Financial accounting is a positive science because it is subject to legal rigidity with regard to the preparation of the financial statements.

Cost accounting is not only a positive science but also a normative science because it includes techniques of budgetary control and standard costing. Costing is an empirical science, that is to science, the rules which govern it are largely conditioned by the operations, personnel and policy of the undertaking with respect to which is its techniques are to be applied.

8. Distinguish between Financial Accounting and Management Accounting.


Distinction Between Financial Accounting and Management Accounting:

Serial No.

Factor Financial Accounting Management Accounting

1. Objective External reporting Internal reporting

2. Nature of data used

Historical, quantitative, monetary and objective

Descriptive, statistical, subjective and future

3. Subject matter Business as a whole Departments, divisions and units

4. Flexibility Principles and rules-rigid Flexible in approach

5. Legal compulsion Statutory Voluntary

6. Periodicity of reports

Longer with lapse of time Shorter, prompt and immediate

7. Precision Accurate and precise Approximate

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Mobile-+88017141180408. Unit of account Whole business concern Whole or departments.

9. Coverage Entire range of business Only money transactions Static in nature

Parts of activities Non-monetary events also Dynamic in nature

10. Publication and audit

Compulsory Not compulsory

11. Accounting principles

Generally Accepted Accounting Principles (GAAP)

No standard principles

12. Methodology Records of income, expenses, personal and assets accounts

Costs and revenue are reported by cost/profit centers

9. What is Accounting Information System?


Accounting Information System:

“The system that collects and processes transaction data and disseminates financial information to interested parties is known as the accounting information system”.

—Donald E. Kieso-Accounting Principles.

Principles of Accounting Information Systems:

Efficient and effective accounting information systems are based on certain basic principles. These principles are:

Cost Effectiveness:

The accounting system must be cost effective. Benefits of information must outweigh the cost of providing it.

Useful Output:

To be useful, information must be understandable, relevant, reliable, timely, and accurate. Designers of accounting systems must consider the needs and knowledge of various users.

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Flexibility:

The accounting system should accommodate a variety of users and changing information needs. The system should be sufficiently flexible to meet the resulting changes in the demands made upon it.

If the accounting system is cost effective, provides useful output, and has the flexibility to meet future needs, it can contribute to both individual and organizational goals.

10. Who are the users of Accounting Information?


Users of Accounting Information: Accounting provides information to a variety of users. The major user groups for a business organization are shown below:

1. Owners

Owners are referred to as 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. Usually, an owner is interested in the financial information to know about the safety of amount invested and the return on investment.

2. Managers

For managing business profitably, management requires adequate information about financial results and financial position. By

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Mobile-+8801714118040providing 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. There are two types of investors involved in using accounting information-

Present Investor: Present investors need information to judge prospects for their investments and to determine whether they should buy, hold or sell the shares.

Potential Investor: Potential Investor needs information to judge prospects of an enterprise and to determine whether they should buy the shares.

4. 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.

5. 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.

6. Researchers

Researchers need financial information for testing hypothesis and development of theories and models. The required information is provided by accounting system.

7. 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. There are two types of creditors involved in using accounting information-

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Mobile-+8801714118040 Short-term creditors: Short-term creditors need information to determine

whether the amount owing to them will be paid when due and whether they should extend, maintain or restrict the flow of credit to an individual enterprise.

Long-term creditors: Long-term creditors need information to determine whether their principals and the interest thereof will be paid when due and whether they should extend, maintain or restrict the flow of credit to an enterprise.

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

An enterprise affects the public at large in many ways as it acts as a provider of employment to a number of persons, a customer to many suppliers, a provider of amenities in the locality or a cause of concern to the public due to pollution. Hence, 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. The above-mentioned list of group of users of accounting information is not exhaustive. Anyone having interest in an enterprise can use the information for decision-making.

10. Tax Authorities:

Tax Authorities need information to assess the tax liabilities of an enterprise.

11. What is the ‘Accounting Equation’?


The Accounting Equation:

The accounting equation indicates a company’s financial position at any point in time.

On its framework rests the entire accounting process. According to the accounting equation, a

company’s assets equal its liabilities plus owner’s equity, thus:

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Assets = Liabilities + Owners’ Equity

Any recorded business transaction can be analyzed in terms of its effect on the

accounting equation. Also, business transactions must be recorded to maintain the equality of

this equation. This equality is reflected in the balance sheet, one of the financial statements a

firm is required to prepare.

Assets:

Anything of value owned by the business and used in conducting its operations are

called assets. Examples include cash, investments, inventory, accounts receivable, and

furniture and fixtures.

Liabilities:

The amounts owed by the business to its creditors, including obligations to perform

services in the future are called liabilities. Liabilities include accounts payable and

notes payable (for example, when a firm uses credit to purchase machinery or

inventory), wages payable to employees, and taxes payable.

Owners’ Equity:

Owners’ equity represents the claims of the owners, partners, and shareholders against

the firm’s assets. It is the owners’ claim on the firm’s assets, or the excess of assets

over all liabilities.

12. Describe the ‘Accounting Cycle’.


The Accounting Cycle: An accounting cycle is a complete sequence. It begins with the recording of the transactions and ending with the preparation of the final accounts.

Various Steps in an Accounting Cycle

Step 1: Identification of the transaction:

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In this step we identify the events of organization, which are included with money.

Step 2: Journalizing:

Record the transactions and events in the Journal.

Step 3: Posting:

Transfer the transactions (recorded in the Journal), in the respective accounts opened in the Ledger.

Step 4: Balancing:

Ascertain the difference between the total of debit amount column and the total of credit amount column of the ledger account.

Step 5: Trial Balance:

Prepare a list showing the balances of each and every account to verify whether the sum of the debit balances is equal to the sum of the credit balances.

Step 6: Income Statement:

Prepare Trading and Profit & Loss Account to ascertain the profit or loss for the accounting period.

Step 7: Position Statement (i.e. Balance Sheet):

Prepare a Balance Sheet to ascertain the financial position as at the end of the accounting period.

Step 8: Rectification:

If there occur any error we correct this error by this step.

Step 9: Analysis:

In this step we analyze the financial statement of organizations.The illustration below shows the steps in the accounting cycle:

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1.Identification

of the transaction

9.Analysis


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Figure: Accounting Cycle

PROBLEMS: SET A

P1-1A On April 1, Holly Palmer established Matrix Travel Agency. The following transactions were completed during the month.

1. Invested $10,000 cash to start the agency.

2. Paid $400 cash for April office rent.

3. Purchased office equipment for $2,500 cash.

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AccountingCycle

2.Journalizing

3.Posting

4.Balancing

5.Trial Balance

6.Income

Statement

7.Position

Statement

8.Rectification


Mobile-+88017141180404. Incurred $300 of advertising costs in the Chicago Tribune, on account.

5. Paid $600 cash for office supplies.

6. Earned $7,500 for services rendered: $1,000 cash is received from customers, and the

balance of $6,500 is billed to customers on account.

7. Withdrew $200 cash for personal use.

8. Paid Chicago Tribune amount due in transaction (4).

9. Paid employees’ salaries $2,200.

10. Received $5,000 in cash from customers who have previously been in transaction (6).

Instructions:

(a) Prepare a tabular analysis of the transactions using the following column headings: Cash,

Accounts Receivable, Supplies, Office Equipment, Accounts Payable, and Holly Palmer’s

Capital.

(b) From an analysis of the column Holly Palmer’s Capital, compute the net income or net

loss for April.

22

Basics of Accounting

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accounting records

importance of accounting

definition of accounting

main objectives of accounting

accounting assists management

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