Basics of accounting01

Accounting for Managers

PurposeTo teach the basics of accounting to those

students entering the BBA program who do not have any background in accounting.

To prepare all BBA students for the course,– Managerial Accounting , by providing the fundamental concepts on which the course builds.

Intended audienceAll incoming BBA students at The GGEC.

In particular, this lecture is designed for those that have no previous education or training in accounting.

The intention is for this lecture to teach at the most basic level. To teach the “alphabet” of accounting so that

students can learn to speak in “full sentences” in the accounting (and other) courses at BBA.

Students with even minimal background may wish to skim or skip sections of the lecture.

Agenda1. Fundamental concepts2. The Accounting Cycle3. Financial statements4. Comprehensive example

Fundamental conceptsWhat is accounting?The language of business.A means to communicate financial

information.A way to convey information about a business

to users.

“Accounting is the process of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part, at least of a financial character and interpreting the results thereof.”As financial Accounting seeks to measure the financial performance and position of the business, we need to first understand the anatomy of business, then we will move over to the accounting process.

INDIA- THE PLACE OF ORIGIN OF MODERN ACCOUNTINGThe birth of double entry book keeping is

suggested to have been at the hands of a Franciscan Monk , Luca Pacioli who published a book in 1494 which includes a treatise on book keeping.

However sufficient evidence exists to lead one to believe that the art and practice of Accounting as a highly developed system was existing in India even during the time of Vedas, Sutras and the Upanishads.

Fundamental conceptsWho uses accounting information?OwnersManagersInvestors (including potential)

Analysts on their behalfCreditors (including potential)Government (tax assessment)RegulatorsCustomers

DivisionsAccounting has two main divisions:Financial accounting

Primarily prepared for users external to the company. Revenues, earnings, assets, etc.

Management accountingPrimarily for internal purposes

Costing, budgeting, net present value, etc.

We will focus only on financial accounting. We say the terms Managerial Accounting and financial Accounting interchangeably.

Fundamental conceptsThere are several ways that cash gets into a

company:Investment by ownersInvestment by creditors (loans)Payments from customers.Repayment of amounts loaned to other

entities.Return on investments (interest and

dividend)Proceeds from selling assets.

Cont..These can be organized into three categories:OperationsPayments from customersRefunds from suppliersFinancingInvestment by ownersInvestment by creditors (loans)InvestingReturn on investments (interest and dividend)Proceeds from selling assetsRepayment of amounts loaned to other entities

Fundamental conceptsSimilarly, money going out of an entity can be

categorized:OperationsPayments to suppliersRefunds to customersFinancingPayment of dividends or capital to ownersRepayment of creditorsInvestingPurchase of assetsAmounts invested in other entities (debt or equity)

Fundamental ConceptsFinancial accounting categorizes all transactions

and events based on their substance.It is very important that the substance of a

transaction be accurately reflected by financial accounting because the users of the information are using it with the assumption that these categorizations are being made accurately. If money invested by owners was reported as

revenue, this would be counter to the fundamental definition of revenue (i.e. that it results from the operations of the company).

The separation of income and capital is a fundamental concept of financial accounting.

Major Accounting BodiesAmerican Institute of Certified Public

AccountantsFinancial Accounting Standards BoardGovernment Accounting Standards BoardSecurities and Exchange Commission

Deshi Nama SystemDouble Entry SystemSingle Entry System

Financial AccountingManagement Accounting

Basic Accounting terminologiesBusiness Transactions: the economic events that

relates to a business entity is called business transaction.

Assets : the valuable thinks owned by the business are known as assets. Classification of assets-

a)Fixed assets

b)Current assets

c)Fictitious assets

d)Tangible assets

e)Intangible assets etc.

Cont…Capital: It is that part of wealth which is used

for farther production thus the capital consists of all current assets and fixed assets. Classification of Capital:

a)Fixed capitalb)Floating capitalc)Working capital

Basic Accounting terminologiesLiability: liabilities are the obligations or debts

payable by the enterprise in future in the form of money or goods. It is the proprietors or creditors claim against the assets of the business.

Financial statement: statements prepared by an business at the end of accounting year to access the status of income and assets is termed as Financial statement. It is categorized as Income statement and position statement also known as profit and loss account and Balance Sheet.

Basic Accounting terminologiesAccounting equation: Accounting rotates around

three basic terms. These terms are Assets, liabilities and capital. The true inter relationship between these terms are represented as Accounting equation. i.e

Assets = Liabilities + CapitalGoods: Articles purchased for sale at profit or

processing by the business or for use in the manufacture of certain other goods as raw material are known as goods. In simple language goods are the commodities in which the business deals.

Cont..Purchases: In its routine business the firm has to

either acquire finished goods for sale or raw material for the manufacture of the article ,being sold by the firm. The acquisition of these articles are purchases. Purchases of Assets are not purchases in Accounting terminology.

Sales: the ultimate end of the goods purchased or manufactured by the business is their sales. It includes both credit and cash sale. Sale means sale of goods never the sale of assets.

Cont…Purchase return and sales return: Purchase

return is that part of purchase of goods which is returned to the seller. In order to calculate net purchase, purchase return is deducted from the purchases.

Sales return is that part of sales of goods which is actually returned to us by purchasers. Sales return is deducted from sales in order to calculate net sales.

Cont..Stock : the goods available for sale with the business

on a particular date is termed as stock. In accounts we use the terms opening and closing stock.

There can be three types of stock- Stock of raw material Stock of work in progress Stock of finished goods Revenue: Revenue in Accounting means the amount

realized or receivable from the sale of goods. Amount received from sale of assets and borrowing loan is not revenue.

Basic Accounting terminologiesRevenue can also mean receipt of rent,

commission and discount also.Expenses: Expenses are costs incurred by the

business in the process of earning revenues. Generating income is the foremost objective of every business. The firm has to use certain goods and services to produce these goods. Payment for these goods and services are called expenses.

Basic Accounting terminologiesExpenditure: Expenditure is the amount of

resources consumed. It is long term in nature. Expenditures increases the profit earning capacities of the business. They are incurred to acquire assets of the business.

Losses: losses are unwanted burden the business is forced to bear. Loss of goods due to theft, fire, flood or accident is termed as loss in accounting.

Losses can be classified as normal and abnormal . It inversely affect the profit of the business.

Basic Accounting terminologiesProfit: excess of revenue over expense is termed

as profit. In the other words excess of sell proceeds over the cost of goods sold is profit. Here, sales means net sale and cost of goods sold= opening stock+ net purchase+ direct expenses- closing stock. It is always a part of the revenue receipt. Profit is generated through regular activities of the business.

Income: Increase in the net worth of the enterprise either from business activity or any other activity is termed as income. Income is a wider term which includes Profit also. It is the positive change in the wealth of the enterprize.

Cont..Gain: Changes in the net worth ( equity) due

to change in the form and place of goods and holding assets for a long period, whether realized or unrealized is termed as gain. It may either be of capital nature or revenue nature or both.

Cont..Debtors: the term debtor represents the persons

or parties who have purchased goods on credit from us and have not paid for the goods.

Creditors: the seller of the goods on credit to the firm are known as its creditor for goods. Creditors are liability of the business. Creditors may be also known as creditors for expenses.

Receivables: Receivables means what business has to receive from outside parties on revenue account. Certain debtors accept a bill drawn by us and becomes

Cont.. Our bills receivable account. The total of bills

receivable and debtors is known as Receivables.

Payables: Payable means what the business has to pay to outside parties. When we purchase goods on credit, sellers are known as creditors. When we accept bills drawn by certain creditor, it becomes a par of Bills payable. The total of bills payable and creditors is known as Payables.

Cont..Proprietor: An individual or group of people who

undertake the risk of the business are known as Proprietor. The proprietor is rewarded by profit for the risk undertaken by him.

Drawings: amount or goods withdrawn by the proprietor for his personal use is termed as drawings.

Solvent: Solvent are those persons or firms who are capable of meeting their liabilities out of their own resources. They have sufficient funds and assets to meet proprietors and creditors claim.

Cont..Insolvent: All business firm who have been

suffering losses for the last many years and are not even capable of meeting their liabilities out of their own assets are financially unsound. Only the court can declare the business firm as insolvent.

Vouchers: Accounting transactions must be supported by documents. These documentary proofs in support of the transactions are termed as vouchers.

Accounting year: books of accounts are closed annually. From the different ledger accounts we

Cont.. prepare Income Statement and position

statement. Accounting period has to be of 12 months.

Entry: an entry is the systematic record of business transactions in the books of accounts. While passing the entries the principle ‘ every debit has got its corresponding credit’ is adopted.

Accounting ConceptsSeparate entity conceptMoney measurement conceptGoing concern conceptPeriodicity conceptCost conceptDual entry conceptRevenue recognition conceptAccrual concept Matching conceptFull disclosure conceptConsistency conceptConservatism conceptMateriality conceptObjectivity concept

Assets = Capital + Liabilities

1. Increase in assets with corresponding increase in capital.

2. Increase in asset with corresponding increase in liabilities.

3. Increase and decrease in asset.4. Decrease in assets with corresponding decrease in

liabilities. 5. Decrease in asset with corresponding decrease in

capital.6. Increase and decrease in liability.7. Increase and decrease in capital8. Increase in liability and decrease in capital9. Increase in capital and decrease in liability.

Example:Commenced business with cash $.20000Good purchased on credit $7000Furniture purchase on cash $3000Paid to creditors $ 2000Amount withdraw by the proprietor $4000Creditors accepted a bill for $1500Change in ownership for $1000Transfer from capital to loan $5000Allotted shares to creditors worth $1000

Anwar started business with:Cash $20000Goods $12000Machine $8000

Purchase of goods $5000 in cashSold goods costing $ 2000 for $2500Purchase goods on credit$7000Payment made to creditors in full settlement $6900Sold goods on credit $6000 costing $5400Payment received $5800 with discount allowed $ 200Salary paid $4000: Wages outstanding $400: Prepaid Insurance $100:

Rent received $300Amount withdrawn $3000Interest on drawings $200Depreciation on machinery $800Purchase goods on credit $17000