Unit 2 accounting principles

Unit 2.

Accounting: The Languageof Business

By Moinuddin hasan

1- 2

What is accounting?

• The language of business

– Measures financial aspects of a business

– Communicates this information to decision makers

The Need for Accounting

Managers, investors, and other internal groupswant the answers to two important questions:

How well didthe organization

perform?

Where doesthe organization

stand?

The Need for Accounting

Accountants answer these questionswith three major financial statements:

Incomestatement

Balancesheet

Statement ofcash flows

Users of Accounting Information

Different categories of users need

different kinds of information for

making decisions. These users can be

divided into :

•Internal Users; and

•External Users.

ACCOUNTING PRINCIPLES

Accounting principles can be subdivided into

two categories:

· Accounting Concepts; and

· Accounting Conventions.


Accounting principles can be subdivided into

two categories:

· Accounting Concepts; and

· Accounting Conventions.


• Accounting Concepts

• Accounting Conventions

The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based. The term ‘convention’ is used to signify customs and traditions as a guide to the presentation of accounting statements.


Accounting Concepts

• Business Entity Concept

• Money Measurement Concept

• Cost Concept

• Going Concern Concept

• Dual Aspect Concept

• Realization Concept

• Accounting Period Concept


Accounting Conventions

• Convention of Consistency

• Convention of Disclosure

• Convention of Conservation


Accounting Concepts

The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based.

Business Entity Concept

Business is treated as a separate entity or unit apart from its owner and others. All the transactions of the business are recorded in the books of business from the point of view of the business as an entity and even the owner is treated as a creditor to the extent of his/her capital.

Money Measurement Concept

In accounting, we record only those

transactions which are expressed in

terms of money. In other words, a fact

which can not be expressed in

monetary terms, is not recorded in the

books of accounts.

Cost Concept

Transactions are entered in the books of accounts at the amount actually involved. Suppose a company purchases a car for Rs.1,50,000/- the real value of which is Rs.2,00,000/-, the purchase will be recorded as Rs.1,50,000/- and not any more. This is one of the most important concept and it prevents arbitrary values being put on transactions.

Going Concern Concept

It is persuaded that the business will

exists for a long time and transactions

are recorded from this point of view.

Dual Aspect Concept

Each transaction has two aspects, that

is, the receiving benefit by one party

and the giving benefit by the other.

This principle is the core of

accountancy.

Dual Aspect Concept continue…

For example, the proprietor of a business starts his business with Cash Rs.1,00,000/-, Machinery of Rs.50,000/- and Building of Rs.30,000/-, then this fact is recorded at two places. That is Assets account (Cash, Machinery & Building) and Capital accounts. The capital of the business is equal to the assets of the business.

Dual Aspect Concept continue…

Thus, the dual aspect can be expressed as under

Capital + Liabilities = Assets

or

Capital = Assets – Liabilities

Realization Concept

Accounting is a historical record of

transactions. It records what has

happened. It does not anticipate

events. This is of great important in

preventing business firms from

inflating their profits by recording

sales and income that are likely to

accrue.

Accounting Period Concept

Strictly speaking, the net income can be measured by comparing the assets of the business existing at the time of its liquidation. But as the life of the business is assumed to be infinite, the measurement of income according to the above concept is not possible. So a twelve month period is normally adopted for this purpose. This time interval is called accounting period.


Accounting Conventions

The term ‘convention’ is used to

signify customs and traditions as a

guide to the presentation of

accounting statements.

Convention of Consistency

In order to enable the management to draw important conclusions regarding the working of the company over a few years, it is essential that accounting practices and methods remain unchanged from one accounting period to another. The comparison of one accounting period with that of another is possible only when the convention of consistency is followed.

Convention of Disclosure

This principle implies that accounts must be honestly prepared and all material information must be disclosed therein. The contents of Balance Sheet and Profit and Loss Account are prescribed by law. These are designed to make disclosure of all material facts compulsory.

Convention of Conservation

Financial statements are always drawn up on rather a conservative basis. That is, showing a position better than what it is, not permitted. It is also not proper to show a position worse than what it is. In other words, secret reserves are not permitted.

FUNCTIONS OF ACCOUNTING

• Keeping systematic records

• Protecting properties of the business

• Communicating the results

• Meeting legal requirements

Keeping systematic records

The first function of accounting is to

keep a systematic record of financial

transactions, to post them to the

ledger accounts and ultimately

prepare final statements.

Protecting properties of the business

The second important function is to

protect the property of the business.

The system accounting is designed in

such a way that it protects its assets

from an unjustified and unwarranted

use.

Meeting legal requirements

The fourth and the last function of

accounting is to meet the legal

requirements under the Companies

Act, Income Tax Act, Sales Tax Act and

so on.

THE ACCOUNTING CYCLE

Recording transactions in subsidiary books.

Classifying data by posting from subsidiary books to the accounts.

Closing the books and preparation of final accounts.

CLASSIFICATION OF ACCOUNTS

• Accounts in the names of persons are known as “Personal Accounts”

• Accounts in the names of assets are known as “Real Accounts”

• Accounts in respect of expenses and incomes are known as “Nominal Accounts”

CLASSIFICATION OF ACCOUNTS

ACCOUNTS

PERSONALACCOUNTS

IMPERSONALACCOUNTS

REALACCOUNTS

NOMINALACCOUNTS

PERSONAL ACCOUNTS

Accounts in the name of persons are known as personal accounts.

Eg: Babu A/C,

Babu & Co. A/C,

Outstanding Salaries A/C, etc.

REAL ACCOUNTS

These are accounts of assets or properties. Assets may be tangible or intangible. Real accounts are impersonal which are tangible or intangible in nature.

Eg:- Cash a/c, Building a/c, etc are Real Accounts related to things which we

can feel, see and touch.

Goodwill a/c, Patent a/c, etc Real Accounts which are of intangible in nature.

NOMINAL ACCOUNTS

These accounts are impersonal, but invisible and intangible. Nominal accounts are related to those things which we can feel, but can not see and touch. All “expenses and losses” and all “incomes and gains” fall in this category.

Eg:- Salaries A/C, Rent A/C, Wages A/C, Interest Received A/C, Commission Received A/C, Discount A/C, etc.

DEBIT AND CREDIT

Each accounts have two sides – the left side

and the right side. In accounting, the left

side of an account is called the “Debit Side”

and the right side of an account is called the

“Credit Side”. The entries made on the left

side of an account is called a “Debit Entry”

and the entries made on the right side of an

account is called a “Credit Entry”.

RULES FOR DEBIT AND CREDIT

Personal Account

Debit the Receiver

Credit the Giver

Real Accounts Debit what comes in

Credit what goes out

Nominal Accounts

Debit all Expenses and Losses

Credit all Incomes and Gains

Steps for finding the debit and credit aspects of a particular transaction

• Find out the two accounts involved in the

transaction.

• Check whether it belongs to Personal,

Real or Nominal account.

• Apply the debit and credit rules for the

two accounts.

Exercise

• Purchased a Building for Rs.20,000/-.

• Paid Cash Rs.1,000/- to Satheesh.

• Paid Salary Rs.1000/-.

• Received Commission Rs.250/-.

• Sold goods for Cash Rs.3500/-.

Journal

Journal is the prime or original book of entry in which all transactions are recorded in the form of entries. Journalising is an act of recording or entering transactions in a Journal in the order of date.Date Particulars LF Debit

AmountCredit

Amount

Journal Entry

Jan 1, 2013 Prakash Started a business Rs. 50,000/-Date Particulars LF Debit

AmountCredit

Amount

2013Jan 1

Cash a/c Dr. To Prakash’s Capital a/c(Being cash invetsed to business)

50,00050,000