Accounting Basics. Prepared for First Year MBA

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1 Accounting Basics Prepared for First Year MBA

2 Overview S No Particulars 01 Introduction to Accounting 02 Accounting Equation 03 Types of Transactions 04 Purchase and Sales 05 Types of Accounts 06 Golden Rules of Accounting 07 Journal ;Step by Step Procedure of Writing a Journal 08 Ledger ; Procedure for Posting a Ledger 09 Trail Balance along with illustration 10 Introduction to Trading account, P&L A/C and Balance Sheets 11 References

3 1. Introduction to Accounting 1.1 Definition The process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information. American Accounting Association 1.2 Objectives of Accounting i. to maintain accounting records. ii. to calculate the result of operations. iii. to ascertain the financial position. iv. to communicate the information to users.

4 1. Introduction to Accounting 1.3 Debtors Definition A company or individual who owes money. If the debt is in the form of a loan from a financial institution, the debtor is referred to as a borrower. If the debt is in the form of securities, such as bonds, the debtor is referred to as an issuer. Debtors can be entities, companies or people of a legal nature that owe money to someone else such as your business for example.

5 1. Introduction to Accounting Who are creditors? 1.4 Creditors Definition A creditor is an individual or institution that lends money or services to another entity under are payment agreement. Understanding Let's look at a scenario with a real creditor, XYZ Bank, to whom yougotoforaloan.ifyouareapprovedandtheylendyou money, XYZ Bank becomes your creditor.

6 Relationship between Debtors and Creditors

7 2. Accounting Equation The financial position of a company is measured by the following items: 1. Assets (what it owns) 2. Liabilities (what it owes to others) 3. Owner s Equity (the difference between assets and liabilities) The accounting equation (or basic accounting equation) offers us a simple way to understand how these three amounts relate to each other. The accounting equation for a sole proprietorship is: Assets = Liabilities + Owner s Equity Assets Liabilities Owners Equity

8 2. Accounting Equation 2.1 Assets : Assets are a company s resources things the company owns. Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and goodwill. From the accounting equation, we see that the amount of assets must equal the combined amount of liabilities plus owner s (or stockholders ) equity. 2.2 Liability : Liabilities are a company s obligations amounts the company owes. Examples of liabilities include notes or loans payable, accounts payable, salaries and wages payable, interest payable, and income taxes payable (if the company is a regular corporation). Liabilities can be viewed in two ways: (1) as claims by creditors against the company s assets, and (2) a source along with owner or stockholder equity of the company s assets. 2.3 Owners Equity : Owner s equity or stockholders equity is the amount left over after liabilities are deducted from assets: Assets Liabilities = Owner s (or Stockholders ) Equity. Owner s or stockholders equity also reports the amounts invested into the company by the owners plus the cumulative net income of the company that has not been withdrawn or distributed to the owners.

9 2. Accounting Equation Cntd., Assets and Liabilities

10 2. Accounting Equation Cntd., Terms 2.4 Double entry Book Keeping System A double entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event changes at least two different nominal ledger accounts. 2.5 Credit An accounting notation that increases liability, equity, and expense accounts. Credits decrease asset and expense accounts. 2.6 Debit In bookkeeping, an entry in the left hand column of an account to record a debt. Debits increase asset and expense accounts. Debits decrease liability, income, and equity accounts.

11 2. Accounting Equation Cntd., Assets = Liability + Owner s Equity

12 2. Accounting Equation Cntd., Example 1 1) Ram purchased furniture for cash = Rs 2,000 2) Outstanding wages = Rs 8,000 3) Cash in hand = Rs 12,000 4) Bank loan = Rs 15,000 5) Purchased land and equipment = Rs 14,000 6) Expenses = Rs 5,000 7) Cash received = Rs 7,000 8) Loan payable = Rs 12,000 Asset Liabilities Transaction Value Transaction Value Ram purchased furniture for cash 2,000 Outstanding wages 8,000 Cash in hand Bank Loan 15,000 Purchased land and equipment Expenses 5000 Cash Received 7000 Loans Payable 7000 Total Total 35,000

13 2. Accounting Equation Cntd., Example

14 3. Types of Transactions Types of Transactions Cash Transactions Credit Transactions Cash Transactions : A transaction that is settled with cash on the same day as the trade. Example : Ram bought a fridge for a cash of 3000 INR Credit Transactions : Credit transactions are dealings which you could pay later. e.g.. pay for the goods or services at the end of the month or 30 days later. The credit terms are the time you are allowed to delay payment, eg. 30 days, 7 days.

15 4.1 Purchases Purchases Account : A temporary account used in the periodic inventory system to record the purchases of merchandise for resale. (Purchases of equipment or supplies are not recorded in the purchases account.) This account reports the gross amount of purchases of merchandise. Net purchases is the amount of purchases minus purchases returns, purchases allowances, and purchases discounts.

16 4.2 Sales Sales represents income or revenue for the Organization Sales refers to the amount of goods sold that are already bought or manufactured by the business. When goods are sold for cash, they are cash sales but if goods are sold andpaymentisnotreceivedatthetimeofsale,itiscredit sales. Total sales includes both cash and credit sales.

17 5. Types of Accounts Real Account: Real accounts are related to asset account which can be touched felt, e.g. building account, machinery account, stock, furniture etc Personal Account: Personal accounts are related to persons, institutions companies. examples : bank account, creditors a/c etc Nominal Account: Nominal accounts are related to income and expenses or losses and gains examples are rent, commission, salary etc

18 6. Golden Rules of Accounting Debit The Receiver, Credit The Giver This principle is used in the case of personal accounts. When a person gives something to the organization, it becomes an inflow and therefore the person must be credit in the books of accounts. The converse of this is also true, which is why the receiver needs to be debited. Debit What Comes In, Credit What Goes Out This principle is applied in case of real accounts. Real accounts involve machinery, land and building etc. They have a debit balance by default. Thus when you debit what comes in, you are adding to the existing account balance. This is exactly what needs to be done. Similarly when you credit what goes out, you are reducing the account balance when a tangible asset goes out of the organization. Debit All Expenses And Losses, Credit All Incomes And Gains This rule is applied when the account in question is a nominal account. The capital of the company is a liability. Therefore it has a default credit balance. When you credit all incomes and gains, you increase the capital and by debiting expenses and losses, you decrease the capital. This is exactly what needs to be done for the system to stay in balance. S NO Debit Credit 1 The Receiver The Giver 2 What comes in What comes out 3 All expenses and losses All incomes and gains

19 7. Introduction of Journal Journal is a date wise record of all the transactions with details of the accounts debited and credited and the amount of each transaction. 8.1 FORMAT

20 7. Introduction of Journal Cntd., Step No. Process 1 Determine the two accounts which are involved in the transaction 2 Classify the above two accounts under Personal, Real or Nominal 3 Find out the rules of debit and credit for the above two accounts 4 Identify which account is to be debited and which account is to be credited 5 Record the date of transaction in the date column. The year and month is written once, till they change. The sequence of the dates and months should be strictly maintained 6 Enter the name of the account to be debited in the particulars column very close to the left hand side of the particulars column followed by the abbreviation Dr. in the same line. Against this, the amount to be debited is written in the debit amount column in the same line 7 Write the name of the account to be credited in the second line starts with the word To a few space away from the margin in the particulars column. Against this, the amount to be credited is written in the credit amount column in the same line. 8 Write the narration within brackets in the next line in the particulars column. 9 Draw a line across the entire particulars column to separate one journal entry from the other.

21 7. Introduction of Journal Cntd., Illustration January 1, 2004 Saravanan started business with Rs. 1,00, Analysis of Transaction 8.1 Analysis of Transaction

22 8. Introduction of Ledger The book which contains a classified and permanent record of all the transactions of a business is called the Ledger. 9.1 FORMAT L.C. Cropper

23 8. Posting in Ledger Procedure of posting for an Account which has been debited in the journal entry. S No. Particulars 1 Locate in the ledger, the account to be debited and enter the date of the transaction in the date column on the debit side. 2 Record the name of the account credited in the Journal in the particular columns of the debit side as To... (name of the account credited). 3 Record the page number of the Journal in the J.F column on the debit side and in the Journal, write the page number of the ledger on which a particular account appears in the L.F. column. 4 Enter the relevant amount in the amount column on the debit side Procedure of posting for an Account which has been credited in the journal entry 1 Locateintheledgertheaccounttobecreditedandenterthedateofthetransactionin the date column on the credit side. 2 Record the name of the account debited in the Journal in the particulars column on the credit side as By... (name of the account debited) 3 Record the page number of the Journal in the J.F column on the credit side and in the Journal, write the page number of the ledger on which a particular account appears in the L.F. column 4 Enter the relevant amount in the amount column on the credit side.

24 8. Introduction of Ledger Cntd., Illustration Mr. Ram started business with cash Rs. 5,00,000 on 1stJune Solution : The above transaction will appear in Journal and Ledger as under

25 9. Trail Balance Trial balance is a statement, prepared with the debit and credit balances of ledger accounts to test the arithmetical accuracy of the books 10.1 FORMAT J.R. Batliboi Points to be noted : i. Date on which trial balance is prepared should be mentioned at the top. ii. Name of Account column contains the list of all ledger accounts. iii. Ledger folio of the respective account is entered in the next column. iv. In the debit column, debit balance of the respective account is entered. v. Credit balance of the respective account is written in the credit column. vi. The last two columns are totaled at the end.

26 9 Trail Balance Illustration The following balances were extracted from the ledger of Rahul on 31st March, You are requested to prepare a trial balance as on that date in the proper form.

27 9. Trail Balance Illustration Solution

28 10. Final Accounts Final Accounts Trading, Profit and Loss Account Balance Sheet Parts of Final Accounts The first part is Trading and Profit and Loss Account. This is prepared to find out the net result of the business. The second part is Balance Sheet which is prepared to know the financial position of the business.

29 10.1 Trading Account Trading means buying and selling. The trading account shows the result of buying and selling of goods. 9.1 FORMAT 9.2 ILLUSTRATION Prepare a Trading Account from the following information of a trader. Total purchases made during the year 2003 Rs.2,00,000.

30 10.2 Profit and Loss A/C After calculating the gross profit or gross loss the next step is to prepare the profit and loss account. To earn net profit a trader has to incur many expenses apart from those spent for purchases and manufacturing of goods. If such expenses are less than gross profit, the result will be net profit. When total of all these expenses are more than gross profit the result will be net loss. Format Need The aim of profit and loss account is to ascertain the net profit earned or net loss suffered during a particular period

31 10.2 Profit and Loss A/C Illustration Prepare Profit and Loss Account, from the following balances of Mr. Kandan for the year ending

32 10.2 Profit and Loss A/C Illustration Solution

33 10.3 Balance Sheet Definition A statement which sets out the assets and liabilities of a business firm and which serves to ascertain the financial position of the same on any particular date Format

34 Question 10.3 Balance Sheet Illustration From the following Trial Balance of M/s. Ram & Sons, prepare trading and profit and loss account for the year ending on 31st March 2002 and the balance sheet as on the date

35 10.3 Balance Sheet Illustration Solution

36 11.References 1. Higher Secondary Accountancy book published by Tamil Nadu Text Book Corporation 2. T.S.Grewal Double Entry Book Keeping. 3. R.L.Gupta, Radha Swamy Financial Accounting. 4. Institute of Company Secretaries of India Principle of Accountancy. 5. P.C.Tulsian, S.D.Tulsian ISC Accountancy for Class XI 6. Accounting Text and Cases Robert Anthony, Tata McGraw Hill Publications Education.svtution.org

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