ACCOUNTING MECHANISM

Learning objectives:

To understand the Accounting mechanism (Accounting Cycle)

To understand the Double Entry systemTo understand the meaning of account and

classification of accountsConceptual frame work of Financial AccountingTo know how to prepare the Final Accounts.

Double Entry System of Book Keeping

It recognizes that every transaction has a twofold effect.

The method of writing every transaction in to two accounts, of these two accounts, one A/c is given ‘Debit’ while other one is given ‘Credit’ with an equal amount so that the Accounting Equation is always in balance.

On any date

Total Debits = Total Credits

The steps in Recording Process

Transactions Documentation Journal

FinancialStatements

TrialBalance

Ledger

Conceptual frame work of Financial Accounting

Profit and Loss A/c Profit/loss tra ns fe rre d to B a la n ce S he e t

Balance Sheet(A sse ts a n d L iab ilit ie s)

O utp u t: Trial Balance

Ledger

Jounal

P rin c ip le : Double Entry System

S ub : Financial Accounting

ACCOUNTING MECHANISM

1. Recording Journalizing

2. Classifying Ledger preparation

3. Summarizing Balancing the ledger Preparation of Trial Balance Preparation of Profit and Loss A/c Preparation of Balance Sheet

4. Interpreting the results.

JOURNAL

The book containing chronological record of transactions.

Recording of entries in the journal is known as Journalizing.

Large Firms/Concerns maintain special journals also known as Subsidiary Books.

ACCOUNT - MEANING

An individual record of increases and decreases in an item that is likely to be of interest or importance.

It is “T” shaped

Debit is left side of “T” account Credit is right side of “T” account

Journalizing

Debits are always recorded first.Indent, then record the credit below the

debit.A short explanation is included on the

second line.Leave a space between journal entries.Debits must always equal credits.

Classification of Accounts

Classification of Accounts

In d ivid u a ls

P h ys ica l

F irm s ,C o m pa n ie s,

B a n ks

A rtif ic ica l

O /s E xpO /s sa la riesP re pa id E xp

R e p re se n ta tive

P e rso na l A /cs

A sse ts likeC a sh , lan d ,

B u ild in g , P la n t,P a te n ts , e tc ..

R e a l A /cs

E xp s o r L osse s,O r In co m es

o r P ro fits

N o m ina l A /cs

Im p erso n a l A /cs

A ccou n ts

Rules of Double Entry System

Personal A/c Real A/c Nominal A/c

Debit: The Receiver What comes in

All expensesand Losses

Credit: The giver What goes out

All incomesand gains

SUBSIDIARY BOOKS

1. Cash Book: Simple Two column Three column

2. Purchase Book3. Purchase returns Book4. Sales Book5. Sales returns book6. Bills Receivable book7. Bills Payable Book8. Journal Proper (other transactions)

LEDGER

It is set of all accounts.It contains a classified summary of all

transactions recorded in journal.The concerned account debited in

journal should also be debited in the ledger with a reference to the a/c which has been credited in ledger and vice versa.

Balancing of Ledger Accounts

The difference between the total debit and total credit sides of an account is called balancing.

The difference is entered in the amount column of the side showing less total .

An account is said to have a debit balance if its debit side is greater than credit .

TRIAL BALANCE

A statement of Debit and Credit totals or balances extracted from the various accounts in the Ledger.

Objectives:– To facilitate the preparation of Final Accounts.– To check the arithmetical accuracy of the

books.

Methods of preparing trial Balance

Balance Method• Prepared

with the balances of Ledger Accounts.

Total Method • The total of

the debit and credit side of every account is separately written in the debit and credit column of trial balance .

Total and Balance Method• Both the

balance and total method are presented in the trial balance

Elimination of Equal Total Method.• Accounts

whose debit totals and credit totals are equal are not incorporated in the trial balance

FINAL ACCOUNTS

Include preparation of:Trading and Profit and Loss A/c

– To know the operating performance of the business i.e.profitability.

Balance Sheet– To know the financial position of the firm on a

particular date.

Trading Account

Shows the results of buying and selling goods/services.

Ascertain Gross profit/Gross lossCalculates the cost of Goods SoldCalculates Gross profit ratio, ratio of direct

expenses to gross profit.Comparison of Actual with the desired

performance.

Items Appearing in trading Account

Debit Side

1)Purchases2)Purchase return3) Opening Stock

4)Wages5)Carriage inward

6)Custom duty7)Royalty

8) Gas, electricity etc9)Packing Material

Profit and Loss Account

Summarizes the financial results of a company during a particular period of time.

It ascertains the net profit or loss for a particular period .

It contains all the items of revenue , gains, losses and expenses pertaining to the accounting period .

Items of Profit and loss account

Debit Side

Balance Sheet

Balance sheet is an item wise list of assets ,liabilities and proprietorship of a business at a certain date.

To ascertain the financial position of a business. It gives protection against uncertaintyHelps ascertain proprietary ratio

Items of Balance Sheet

Assets Side

Items of Balance sheet

Non curre

nt Asset

s

Items of Balance sheet

Current

Assets

Inventories

Trade Receivab

lesCash and

Cash Equivale

nts

Other Current Assets

Short Term Loans and

Advances

Current Investme

nts

Items of Balance sheet

Owner’s Equity

Share Capital

Reserves and

SurplusMoney receive

d against share

warrants

Share applicat

ion money pendin

g Allotm

ent

Items of Balance sheetLong Term Provisions

Non Curren

t Liabilit

ies

Items of Balance sheetCurren

t Liabilit

ies Trade Payables

Short Term

Provisions

Other Current

Liabilities

Short Term

Borrowings

Adjustments

Adjusting journal entries are required to be passed for errors,ommissions not yet recorded in the books .The main adjustments are

Relating to expensesRelating to incomeRelating to provisionsOther adjustments.

Adjustments Adjustments Journal Entry Adjustment in

trading p/l a/cBalance Sheet

Closing Stock Closing stock To Trading a/c

Credit Side of Trading

Asset Side

Depreciation Depreciation To Asset

Dr of P&l a/c Deducted from concerned asset

Appreciation Asset To Appreciation

Cr of P&l/ac Added to concerned asset

Outstanding Expenses

Expenses To O/s Expenses

Added to concerned expense of debit side of p& l a/c

Liabilities side

Prepaid Expenses Prepaid Exp To Expense

Ded from concerned expense of debit side of p& l a/c

Asset Side

Adjustments

Adjustments Journal ENTRY Trading and P&l a/c

Balance Sheet

Accrued Income Accrued Income To Income

Added to concerned income of credit side of p& l a/c

Liabilities side

Unearned Income Income to Unearned

Deducted to concerned income of credit side of p& l a/c

Asset Side

Interest on capital Interest on capital To capital

Dr of p&l a/c Added to capital

Interest on Drawings

Drawing To interest on drawing

Cr of P/l ac Deducted from capital

Adjustments

Adjustments Journal ENTRY Trading and P&l a/c

Balance Sheet

Interest on investments

Investment To interest

Dr side of p & l a/c

Added to investment

Interest on loans(borrow)

Interest on loan To loan

Cr side of P&l a/c Added to loan on liabilities

Interest on loans(advance)

Loan To Interest

Dr side of p&l a/c Added to loan to asset side

Bad Debts Bad DebtTo Debtor

Cr side of p& l a/c Deducted from debtors

Provision for Bad debts

P/L A/C To Provision for bad debts

Dr side of p&l a/c Deducted from debtors

Adjustments

Adjustments Journal ENTRY Trading and P&l a/c Balance Sheet

Provision on discount on debtors

P&l a/c To prov. for discount on debtors

Dr. side of P/L a/c Deducted from debtors

Provision for discount on creditors

Prov. for discount on debtors To p&l a/c

Cr. Side of P/L A/C Deducted from creditors

Accidental loss of stock

Loss of stock To trading a/c orTo Purchases a/c

Ded from purchases or posted at the cr side of trading a/c and dr of p/l a/c

No effect

Loss of assets by fire(if not insured)

Loss by fire a/c To assets a/c

Dr to p/l a/c Ded from the asset

Adjustments

Adjustments Journal ENTRY Trading and P&l a/c

Balance Sheet

Accidental loss of assets if insured

Insurance co.a/c orLoss by fire a/c to assets a/c

Dr side of p/l a/c (loss by fire a/c)

Insurance co.a/c shown on asset side , loss by fire deducted from asset

O/S manager’s commission

p/l a/c To o/c manager’s commission

Dr. side of p/l a/c Liabilities side

Goods taken by proprietor for personal use

Drawings a/c To purchases a/c

Amt of goods deducted from purchases

Deducted from capital

Goods given as charity

Charity a/c To Purchases a/c

Deducted from purchases

Deducted from capital

Adjustments

Adjustments Journal ENTRY Trading and P&l a/c

Balance Sheet

Goods distributed as free samples

Advertising a/c Or Free samples a/c To purchases a/c

Dr .side of p/l a/c No effect.

Goods sent on approval

1) Sale price of goods

Sale a/c To debtors a/c2) Cost price of

goodsClosing stock To trading a/c

Deducted from sales on cr side of trading a/cAdded to closing stock on the cr . Side of trading a/c

Deducted from debtorsAdded to closing stock