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Agenda
What is Accounting Mode of Learning Accounting Accounting and Finance - Difference Accounting Concepts / Conventions Accounting Events Rules of Accounting Preparation of Financial Statements A Simple Case Study
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What is Accounting
JOURNAL PAYMENT
Vision Enterprises Financial Statement at December 31, 1997 Vision Enterprises Financial Statement Assets Cash $4,456 at December 31, 1997 Vision Enterprises Account Receivable $5,714 Financial Statement Land Assets $ 981 --------Cash $4,456 at December 31, 1997 Total Assets $11,151$5,714 Account Receivable ====== Land Assets $ 981 Liability --------- $4,456 Cash Account Payable Total Assets Account Receivable $3,830$11,151$5,714 Notes Payable Land $ 416====== $ 981 --------Liability --------Total Liability $4,246 $3,830$11,151 Account Payable Total Assets ====== Notes Payable $ 416====== Stockholders Equity $2,365--------Liability Contributed Capital $ 367$4,246 $3,830 Total Liability Account Payable Retained Earnings --------- ====== Notes Payable $ 416 Total Stockholders $2,732 $2,365--------Stockholders Equity Equity ====== Contributed Capital $ 367$4,246 Total Liability Retained Earnings --------- ====== Total Stockholders $2,732 $2,365 Stockholders Equity Equity ====== Contributed Capital $ 367 Retained Earnings --------Total Stockholders $2,732 Equity ======
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Accounting is defined as the art of Recording, Classifying and Summarizing transactions in monetary terms (in Money terms) for the preparation of Financial Statements
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What is Accounting
Accounting is the art of recording, classifying and Summarizing financial transactions in the Preparation of Financial Statements Recording refers to creating Journal entry for every financial transaction with Debit and Credit amounts amounts. . Classifying refers to Classifying each of the Debit / Credit Transaction to Capital or Revenue and Asset, Liability, Revenue or Expense Summarizing refers to Grouping the Transactions of Asset, Liability, Revenue and Expenses and preparing the Financial Statements (Trading, Profit and Loss Account and Balance Sheet) In case of Trading, Manufacturing and Customer Service oriented Organization, the sum of all income and expenses is referred to as Profit and Loss account Social Service oriented Organization like Schools, Hospitals and Government Organizations, Banks it is referred to as Income and Expenditure account . Note:- Trial Balance is not a Financial Statement. Note: Statement. It is only a summary of all Debit and Credit Transactions Transactions. .
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Accounts
Recording of an Accounting Event Expressed in Monetary Terms Recording , Classifying and Summarizing Transactions Preparation of Financial Statements (Trading, Profit and loss Account and Balance Sheet) Historical Compliance with Statutory Matters like Companies Act, Income Tax Act, Sales Tax Act Etc.,
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Consistency
Accrual
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Accounting Concepts
Business Entity Concept
Accounts can be kept only for Entities, which are different from the persons who are associated with these entities Ex. Ex. Sole Proprietorship, Partnership firm, Company This is one of the most Important and fundamental accounting principle with which Double entry system of accounting has evolved evolved. .
Accounts need to be maintained separate from the Owners and providers of capital. capital. If you understand the simple logic, then you can understand Accounting. Accounting.
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Types of Entities
Type of Organization
Sole Proprietary Partnership Firm Private Company
Example
Miachel & Co. Tom & Brothers Oracle India Pvt Ltd (A Private Company in which shares are not traded in Stock Exchange and members cannot exceed 50) Hindustan Unilever Ltd (A Public Company in which Shares are traded in Stock Exchange)
Public Company
Cadbury India Ltd (A Public Company in which shares are not traded but shares are held by more than 50 persons) Hutchinson Private Trust Sembur CoCo-op Society ICAI, ICWAI, ICSI, Rotary Club President of India, Governor of State A Hindu Undivided Family Jointly holding the Investment and Properties for the benefit of 12 Family members.
Trust Society Association of Persons Body of Individuals (one Man Corp) Any other Legal Entity (HUF)
Accounting Concepts
Business Entity Concept
Ex 1: You are running your own Textile Showroom as a Dealer in Cloth as a Sole Proprietor/Individual Owner of the Business. Business. The entire capital amount for the Business is provided by you. you. In this case also for the purpose of accounting you need to maintain Two set of books books. . One set of books for the purpose of Textile Business in which, Business owes you equivalent to the Capital Provided (Capital + Profit earned) or (Capital Losses) In your own Books the amount of Capital invested will be shown as an Investment in Business as an Asset. This need not be maintained as a Normal Set of Books but required to know the Cash Inflow and Cash Outflow from Income Tax Perspective. Ex 2: You are working for Oracle Corporation and Oracle has a Bank Account with Bank of America and You have Bank Account with Citi Bank and the salary at end of every month is transferred from Bank of America to Citi Bank. Bank. How many accounting Entities involved in this case? If your answer is 4, then you are right (You, Oracle Corp, Bank of America, Citi Bank) Ex 3: You run your own Business in Software Consulting and your Friend has agreed to provide a Loan of 50000 USD which he goes and deposit directly into your Bank account - How many accounting Entities involved in this case? If you say 3, You are right, it is only Three. (You, Your Friend and Bank)
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Accounting Concepts
Money Measurement Concept
Record should be made only of that information which can be expressed in Monetary Terms (i.e.) Currency value (USD,GBP,INR) Ex 1. Sole Proprietor had 40 Tables & Chairs Chairs. . This cannot be recorded unless a Value of Furniture is known in monetary value Ex 2. 2. My husband loves me so much Can this be accounted? A Big NO . This is Flaw in Financial Accounting as it does not understand the human values Ex 3. My Father in Law gave his Personal Property to start my Business. Business . Can this be Accounted Yes (If the Value of the Property is provided)
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Accounting Concepts
Money Measurement Concept
A normal doubt comes to your mind in the first and last example in previous slide on how to get the value. value. We should not be taking the Purchase value, but we should take the Market value on the date of transferring the assets to Business Business. . This is an exception to cost concept only in case of transfer to another business Ex 4: Ram started his software consulting Business with his own Property (Cost Price 1 Million USD and Market Value 1.5 Million USD) and Furniture Cost price 50000 worth Market Value 30000 USD - In this case, You can record Ram Capital (1530000) and Building 1500000 and Furniture 30000 as Assets Liabilities Ram Capital Total 1530000 1530000 Building Furniture Total Assets 1500000 30000 1530000
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Accounting Concepts
Dual Aspect Concept
The Value of the Assets owned by the concern is equal to the claims on the Assets ASSETS = LIABILITIES + OWNERS EQUITY OWNERS EQUITY = ASSETS LIABILITIES LIABILITIES = ASSETS OWNERS EQUITY Ex: If Owners Equity is 600000 and Liabilities are 400000, then Total Asset = 1000000
Accounting Concepts
Cost Concept
Assets are always shown at their Cost and not at their current Market Value Ex 1. A land purchased for Rs. Rs.5 Lacs will be recorded only at Rs. Rs.5 Lacs even though Market value may be lower say Rs. Rs.4 Lacs or Higher Rs. Rs.6 Lacs than the Cost Price Ex 2. You are acquiring a Business for a Million USD and its value as per Books is 0.8 Million, then the difference of 0.2 Million is termed as Goodwill and you should record the assets and liabilities at the price you have paid for the Business (i (i. .e.) 1 Million
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Accounting Concepts
Accounting Period
Accounting measures activity for a specified interval of time, usually a year (e.g e.g) ) Calendar Year (Jan07(Jan07-Dec07) Fiscal Year (Apr07-Mar08) (Apr07Choosing the Accounting period is the entitys choice, but there are legal rules like Companies Act and Income Tax Act which prescribes the period in which the entity has to report to them them. . Off course the entities can have different accounting period for their own Internal Management Reporting A Company in India can have for Company Law Purpose (Jan(Jan-Dec) Year and Income Tax Purpose (Apr(Apr-Mar) Year and for own internal Reporting (Jul(Jul-Jun) Year Note: The Entities cannot change their accounting period without Note: getting proper approval only in case of Companies Act and 18 not possible with Income Tax Authorities Authorities. .
Accounting Concepts
Conservatism
Anticipate no Profits but provide for all possible losses. Accountants are by nature Conservative and also to protect the interest of the Shareholders and Creditors it is required to provide for all losses. losses. Ex 1. A pharmaceutical Company going to lose the case filed for Patent Right filed for a medicine Ex 2.Company is likely to Win a Major Legal Dispute or a Sales Contract Contract. . Note: Note : This rule should not be misinterpreted to provide anticipated reduction in market price of a Product and Providing Losses Ex 3: You are a Government Company and there is a possibility that Government will withdraw the subsidy for Fertilizers in the forthcoming budget, You cannot provide loss of subsidy as a loss now itself. itself. Ex 4: The Government is likely to increase the Price of petrol which is one of the essential input for your business, then you cannot provide for losses. losses. Ex 5:There is a Fire in your Factory and Goods were lost and the Goods are insured, then the claim you submitted can be booked to the satisfaction of Insurance Company and Auditors. Auditors.
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Accounting Concepts
Matching Concept
When an Event affects both the revenues and expenses, the effect on each should be recognized in the same accounting period Ex 1: Generally Employees Salaries are paid for the previous month at the beginning of the next month month. . But they have rendered their services to produce goods and sold and Sales revenue is recognized in previous month month. . So to match the cost with the revenue earned, we need to make provision for Salaries in previous month itself. itself. (i (i. .e.) March Salary paid in April, but a Salary Payable provision will be made in March itself EX 2: Insurance Premium paid for JanJan- Dec whereas your accounting period closes on March. March. In this case only three months premium need to be treated as Expense and balance 9 months treated as advance premium paid as an asset
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Accounting Concepts
Materiality concept
Insignificant events would not be recorded, if the benefit of recording them does not signify the cost Ex: Ex: A calculator worth Rs. Rs.500 not recorded asset rather than charged off as an Expense even though the benefit is enduring in nature. nature. This concept need to read in conjunction with accounting events which signifies the transaction into Capital, Revenue and deferred revenue expenditure. expenditure . 22
Accounting Concepts
Objectivity Concept
An Evidence of the happening of the Transaction should support every Transaction in the form of paper. paper. External Evidence is considered to be more authenticated proof than Internal Evidence. Evidence. This rule is more important from Audit perspective as Auditors always consider and bound to get more external evidences than internal Evidences. Evidences. Ex 1: 1: Third Party Evidence (Credit Note from Supplier) Ex 2: Auditors Collect Statements from Customer and Suppliers for the amount showing as Outstanding from Customers and amounts Payable to Suppliers. Suppliers. Ex 3: The Sales Invoices alone is not considered as an objective evidence unless it is supported by Delivery challan and acknowledgement of Goods Received by Customer Customer. .
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Accounting Conventions
Going Concern
Accounting Records , Events and Transactions on the assumption that the entity will continue to operate for an indefinitely Long period of time Ex. Ex. An Entity will not be started with an intention to close within the specified time period period. . Business is always not started with an intention to close and it is expected to continue forever. forever.
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Accounting Conventions
Consistency
The Accounting Policies and methods followed by the company should be the same every year Ex 1. 1. Period should not be changed frequently from JanJanDec to AprApr-Mar Ex 2. 2. Inventory Valuation change from FIFO to LIFO or Weighted Average not permitted frequently Ex 3. 3. Changing Depreciation Policy from Straight Line to Reducing Balance Method frequently Note: Note : If any Company decides to change the policy, then that Company has to report on the effect of Profit/Loss due to the change for past 5 Years Years. .
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Accounting Conventions
Accrual
In General it is assumed that Accounts are always prepared based on Accrual basis basis. . However there are entities which follow Cash Basis of Accounting Also Ex: Ex: Salary Payable to employees (March salary paid in April), Interest Receivable on Investments (NSC interest), Dividend Receivable on shares, Tax Payable to Government (March sales Tax and Annual Income Tax) The Company Law / Income Tax Act Prescribes all Companies to follow Accrual Basis of Accounting except for Professional Firms and Government Organizations which are allowed to follow Cash Basis of Accounting Accounting. .
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Rules of Accounting
Accounts
Personal
Debit the Receiver Credit the Giver Ex: Sole Prop, Company
Impersonal
Real
ominal
Debit Expenses and Losses Credit Revenue and Income Ex: Sales, Power, Rent
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Debit what comes in Credit what goes out Ex: Cash, Bank, Building,Inv
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Combination of Rules
Dr Personal A/c Cr Real A/c
Ex:Drawings or Advance to Employee, Payment to Supplier
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Combination Personal
Credit
Personal X
Real
Nominal
Real
Nominal
X
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Cash A/c Dr Ram A/c Cr In Ram set of Books Ajay A/c Dr Cash A/c Cr
1000 1000
1000 1000
Similarly Both Debit and Credit cannot be Nominal Accounts Note: Remember this important aspect and therefore You will not commit any mistake in Debit and Credit
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Accounting Concepts
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Case Study
Ram started Business in dealer in Computer Spare parts and Computer Stationery on 0101-APRAPR-2007 and following events occurred in the month of April. Ram invested USD 50000 Cash and USD 50000 worth of furniture Ram purchased USD 75000 worth of goods on credit Rams friend Ajay promised him to give a loan of USD 25000 Ram sold USD 50000 worth of good for USD 100000 Ram paid rent USD 2000 for two months Ram paid Salary to Staff USD 5000 Ram incurred USD 5000 on interior decoration which will last for two years. Ram sold USD 10000 worth of goods on credit for USD 18000 Ram has a Bank account with Citi Bank which credited USD 5000 wrongly of John account Purchased Vehicle for USD 25000 paid through Bank Cash Deposited by Ram into Bank 50000 USD
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Accounting Terminologies
Before creating Accounting Transactions let us recall and learn few accounting terminologies
ASSETS: Any property or Investment which can be convertible into cash LIABILITIES: Amount Payable to providers of goods and Services (Creditors) and Providers of Capital (Owners) REVENUE: Amount earned out of the Sale Proceeds and the amount earned on Investments EXPENSES: Amount incurred or expended to earn the revenue PROFIT: TOTAL REVENUE TOTAL EXPENSES LOSS: If the Total Expenses is more than Total Revenue it is termed as Loss FIXED ASSETS: Amount Invested in Long Term Assets which is not intended to be sold within a Year (Ex. Machinery, Land) CURRENT ASSETS: Amount invested in Short Term Assets which is intended and rotated to earn Revenue (Ex. Inventory) NOTE: The Fixed Asset and Current asset vary from Person to Person Ex: For a Dealer in Refrigerator it is a Current asset which becomes Fixed Asset for you when you buy. CREDITORS: Person who provide Money or Goods on Credit to the Business (Supplier) DEBTORS: Goods or Money Provided / sold on Credit by the Business (Customers)
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Accounting Terminologies
You should also understand the same accounting terminology is referred or used by different people in different context
Receivables also known as Trade Debtors, Debtors, Account Receivables, Sundry Debtors, Trade Receivables, Amount Receivables Liability is also known as Trade Creditors, Account Payable, Sundry Creditors, Amount Payable, Trade Liabilities, Creditors Cost of Goods Sold: Sold: It varies with Company to Company the way they do set up and use it it. . The Cost of Goods Sold comprise of Material Cost, Resource Cost (Labor and Machinery) and Overheads. Overheads . There are few companies which will have only Material Cost and will not add up Resource Cost and Overheads. Overheads. You Should talk to client and understand their requirement
Lets See Each of this in a Formula Model
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(-) Less Cash Received 2000 (-) Less Credit Memo (Sales Return) 125 (-) Negative Adjustments 50 Closing Receivables 650
(-) Less Cash Paid 1500 (-) Less Credit Memo (Purc. Return) 125 (-) Negative Adjustments 50 Closing Payables 750
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(-) Less Issued to Production (-) Less Purchase Return Closing Purchased Inventory
Closing FG Inventory
800
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(+) Add Cash Receipts 2500 (Cash Sales, Cash Recd from Receivables, Cash with drawl from Bank) (-) Less Cash Payments 2000 (Cash Purchases, Expenses paid By Cash, Cash Deposited into Bank) Closing Cash Balance 600
(-) Less Payments from Bank (Paid to Creditors by Cheque, Expenses paid by cheque, Cash With drawl from bank) Closing Bank Balance
1500
700
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Personal (Also using the Business Entity Concept Ram being owner is also treated as a Creditor for the purpose of Business. If the Business is wind up Business has to pay back Ram) Real 75000
Inventory A/c Dr (Real Tangible Asset) To Creditors A/c (Person be an Individual or Company gives the goods on Credit)
Personal
75000
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Real A/c 100000 Nominal A/c 100000 Nominal A/c 50000 Real A/c 50000
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Real A/c
5000
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Real
25000
25000
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Real 50000
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T Accounts
Ram Capital Account
Dr To Bal USD 100000 Cr USD Dr
Furniture Account
USD Cr By Bal Total USD 50000 50000 To Ram Cap 50000 Total 50000
Total
100000
Cash Account
Dr USD Cr By Rent By Rent Adv By Salary By Advt Adv By Advt exp By Bank By Balance Total USD 1000 1000 5000 2500 2500 50000 88000 150000 Dr
Inventory Account
USD Cr USD
To Creditors 75000
Total
75000
Total
75000
Total
150000
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T Accounts
Creditors Account
Dr To Bal USD 75000 Cr By Invent USD 75000 Dr To Cash Total
Rent Account
USD 1000 1000 Cr By Bal Total USD 1000 1000
Total
75000
Total
75000
Total
1000
Total
1000
Total
118000
Salary Account
Dr To Cash USD 5000 Cr By Bal USD 5000 Dr To Cash
Total
5000
Total
5000
Total
2500
Total
2500 53
T Accounts
Advt Exp Advance Account
Dr To Cash USD 2500 Cr By Bal USD 2500 Dr To sales Total
Receivables Account
USD 18000 18000 Cr By Bal Total USD 18000 18000
Total
2500
Total
2500
Vehicle Account
USD 25000 Cr By Bal USD 25000
Total
60000
Total
25000
Total
25000
Bank Account
Dr To Cash USD 50000 Cr By Vehicle By Bal Total USD 25000 25000 50000
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Total
50000
Trial Balance
Trial Balance for the Month of APRIL 2007
A Asset, L Liability, R Revenue, E - Expense
Debit
USD
Furniture (A) 50000 Cash (A) 88000 Bank (A) 25000 COGS (E) 60000 Salary (E) 5000 Rent (E) 1000 Rent Advance (A) 1000 Advertisement Exp (E) 2500 Advt Exp Advance (A) 2500 Inventory (A) 15000 Vehicle (A) 25000 Receivable (A) 18000 Total 293000
Total
293000
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Total
118000
Total
118000
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Total
224500
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By Cash 50000
Total
50000
Total
25000
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