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OVERVIEW OF ACCOUNTING

  • 1.1 Objectives of Financial Reporting.

The objective of financial reporting is to provide information about the financial position,

performance and changes in the financial position of an enterprise that is useful to a wide range of users in making economic decisions. The economic decisions that are taken by the users of financial reports require an evaluation of the ability of an enterprise to generate cash and of the timing and certainty of its generation. This can be achieved if users of financial

reports are provided with information that focuses on the enterprises‟.

  • a) Financial position which is affected by the economic resources it controls, its financial structure, its liquidity and solvency and its ability to adapt to changes in the environment in which it operates.

  • b) Performance measured by the return obtained by the enterprise on the resources it controls.

  • c) Cash flow by indicating the amounts and principle sources of its cash inflows and outflows.

The usergroups of financial reports include:

Equity investors, existing and potential;

Lenders, existing and potential;

Employees, existing, potential and past;

Analysts / Advisers including journalists, economists, Credit Rating Agencies;

Business Contacts including Customers, Suppliers, Competitors;

Government including Tax Authorities;

The Public.

The most frequently produced financial reports are known as Financial Statements. A complete set of financial statements includes the following components:

  • a) A balance sheet

  • b) Income statement

  • c) Cash flow statement

  • d) A statement showing either;

All changes in equity or;

Changes in equity other than those from capital transactions with owners and distributions to owners.

  • e) Accounting policies and explanatory notes. However, financial statements do not provide all the information that users need to make economic decisions since they largely portray the financial effects of past events and do not necessarily provide non financial information.

1.2 The Regulatory Framework of Accounting.

In order to produce financial statements that provide information that is useful to stakeholders, certain reporting principles and guidelines are necessary. These principles and guidelines are embodied in what is known as the Regulatory framework of accounting. Financial statements prepared in line of the requirements of the Regulatory Framework of

Accounting are frequently described as giving a true and fair view of or presenting fairly the financial position and performance of an enterprise. The Regulatory Framework of accounting constitutes therefore the factors which have shaped financial reporting. The following factors can be identified. The following factors can be identified:

  • 1. National / Local Legislation

  • 2. Accounting Concepts and individual judgement

  • 3. Accounting standards

  • 4. Other international influences

National / Local Legislation:

Financial reporting requirements may be stipulated in the Laws governing a particular country. For example; in Uganda, the following provide specific requirements:

Companies Act Cap 85, States that establish parastatals and other government bodies, Local Government Act, Public Finance and Accountability Act (2003).

Accounting Concepts and Individual Judgement:

Financial Statements are prepared on the basis of a number of fundamental accounting assumptions and conventions. In addition, many figures are derived from the application of

judgement in putting these assumptions into practice. However, it‟s possible that people

exercising their judgement on the same facts can arrive at very different conclusions.

Examples include: Valuation of Buildings, Accounting for inflation Valuation of intangibles. If the exercise of judgement is completely uncontrolled / any comparability between the accounts of different organizations will disappear especially where deliberate manipulation occurs in order to present accounts in the most favourable light.

Accounting Standards:

In an attempt to deal with some of the subjectivity and to achieve comparability between organizations, accounting standards have been developed. These are developed at both national and international levels.

Accounting Standards are set by an independent private sector body called National / International Accounting Standards Committee with the objective of achieving uniformity in the accounting principles which are used by businesses and other organizations for financial reporting.

In Uganda, the National Accounting Standards Board unilaterally adopted IAS except for some modification that shall be required from time to time to take account of the unique Ugandan circumstances. International Accounting Standards however, do not override local regulations on financial statements.

International Accounting Standards are produced by the International Accounting Standards

Committee (IASC) which was set up in 1973 to work for the improvement and harmonization of

financial reporting. The IASC develops IAS‟s through an international process that involves the

statements and national standard setting bodies. Therefore, IASC, has the following objectives:

  • (a) To develop, in public interest a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world‟s capital markets and other users make economic decisions.

  • (b) To promote the use and rigorous application of those standards.

  • (c) To bring about convergence of national accounting standards and International Accounting Standards to high quality solutions.

IASC is established as an independent organization composed of two main bodies: the Trustees and the Board. Other include; Standing Interpretations Committee and Standards Advisory Council.

The IASC has published 41 IASs‟ as well as revised standards.

The advantages Uganda stands to benefit from this stem from the advantages of international harmonization:

  • 1. Investors, both individual and corporate, would like to be able to compare the financial results of different companies internationally as well as nationally in making investment decisions.

  • 2. Multinational companies would benefit from harmonization for many reasons such as;

Better access would be gained to foreign investors funds.

Management control would be improved because international harmonization

would aid internal communication for financial information. Appraisal of enterprises would be more straight foreward.

It would be easier to comply with the reporting requirements of overseas stock

exchanges. A reduction in audit fees might be achieved.

Transfer of accounting staff across national borders would be easier.

  • 3. Uganda Government will save time and money and would attempt to control the activities of foreign multinational companies.

  • 4. Regional economic groups usually promote trade within a specific geographical region. This would be aided by common accounting practices within the region.

Barriers to International Harmonization:

  • 1. Different purposes of financial reporting. In some countries the purpose is solely for tax assessment while in others it is for investors‟ decision making.

  • 2. Unique circumstances. Some countries may be experiencing unusual circumstances which affect all aspects of everyday life and impinge the ability of companies to produce proper reports.

  • 3. Developing countries are obviously behind in the standard setting process and they need to develop the basic standards and principles already in place in most developed countries and the man power to interpret and apply the international standards. Other Influences These include Stock exchange regulations and EU directives.

1.3 The Qualitative Characteristics of Financial Information.

Qualitative characteristics are attributes that make the information provided in financial statements useful to others. For information to be useful, it must be:

1.

Material. Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.

  • 2. Relevant to the decision making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or by confirming or correcting their past valuations.

  • 3. Reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users. To represent faithfully in terms of valid description that which it purports to represent or could reasonably be expected to represent. Thus financial information should be neutral, prudent and complete and should present the substance of economic events.

  • 4. Useful presented to enhance comparability and understandability.

    • (a) Comparability. Users of financial information must be able to compare the financial statements of an enterprise over time to identify trends in its financial position and performance. Users must also be able to compare the financial statements of different enterprises to evaluate their relative financial position, performance and financial adaptability. Consistency is therefore required. In addition, adequate disclosure of accounting policies used in the preparation of the statements as well as the corresponding figures enhance comparability.

    • (b) Understandability. The information provided in financial statements should be presented in such a way that it is readily understandable by users. For this purpose, users are assumed to have abilities that is; reasonable knowledge of business, economic activities and accounting and a willingness to study the information with reasonable diligence.

Constraints to the Provision of Good Quality Information:

In some situations, more of one quality can only be achieved at a cost. This cost may be an

actual cost or may be a reduction in the level of another quality. It‟s therefore imperative to

observe the following:

Balance between qualitative characteristics. In practice, a balancing or a trade off between qualitative characteristics is often necessary. Generally, the aim is to achieve an appropriate balance among the characteristics in order to meet the objective of financial statements.

Timeliness. If there is undue delay in the reporting of financial information, it may

lose its relevance. Benefit and cost. The benefits derived from financial information should exceed the cost of providing it.

1.4 Traditional Historical Cost Accounting and Current Value Accounting.

The main characteristics of HCA are generally reflected as concepts or conventions. The two

main characteristics are:

  • 1. All transactions are recorded at their historical cost. Thus the Financial statements will reflect the transactions at historical cost.

  • 2. The transactions thus recorded are matched so that the income generated by the company is „matched‟ against the costs involved in getting that income. However, the strict Historical Cost Convention is sometimes modified to include the selective revaluation of non-current assets. HCA are the prevalent form of financial statements throughout the world. Criticisms of Historical Cost Accounting.

    • 1. Long Term asset values are unrealistic. The pure HC Balance sheet ignores the current value of assets and thus the amounts reports are unlikely to be realistic up-to date measures of the resources employed by the business. Assets such as Land and Buildings are usually undervalued. As no account is taken of the changing value of money over time, it is also difficult to interpret trends.

    • 2. Depreciation is inadequate to finance the replacement of fixed assets. HC depreciation does not fully reflect the value of the asset consumed during the accounting period.

    • 3. Holding Gains on inventories are included in profit. During a period of high inflation, the monetary value of inventories held may increase significantly while they are being processed. The conventions of HCA lead to the realized part of this holding gain (known as inventory appreciation) being included in profit for the year.

    • 4. Profits (Losses) on holding of net monetary items are not shown. In periods of inflation, the purchasing power of and thus the value of money falls. It follows that an investment in money will have a lower value at the end of a period of time than it did at the beginning leading to a loss. Similarly, the real value of a monetary liability will reduce over a period of time and a gain will be made.

The HCA tends to exaggerate growth.

Possible Alternatives to HCA

The deficiency of HCA is more prominent in times of severe and prolonged inflation.

Current Value Accounting is an alternative to HCA. The basic principles of this method are:

To show balance sheet items at some form of current value rather than

historical cost; To compute profits by matching the current value of costs at the date of consumption against revenue.

The current value of an item will normally be based on replacement cost, net realizable value or economic value. Other methods of accounting include; Current Purchasing Power (CPP) and a combination of Current Value and CPP.

Why Modified HCA is still Used.

Modified HC Accounts are easy to prepare, to read and to understand.

In periods of low inflation, HC accounts are seen as a reasonable reflection of

the reality of the given situation. Resistance to change.

1.5 CORPORATE GOVERNANCE AND CUURRENT ISSUES IN FINANCIAL REPORTING.

Corporate governance is the system by which companies are directed and controlled.

Following the collapse of major international companies during the 1980s‟ including

Maxwell, BCCI, Polly Peck and recently Anderson, an Audit firm issues relating to

Corporate Governance are topical. These collapses were often unexpected and dubious or even fraudulent activities were often attributed to their owners and managers. Some aspects of corporate governance has generally been developed by independent committees which have produced a series of documents on corporate governance. These include:

The Cadbury report (1992) which focused on the control functions of Boards of Directors and on the role of Auditors.

Greenbury report (1995) focused on the setting and disclosure of Directors‟

remuneration and;

Hampel report (1998) brought together all the previous recommendations and submitted a proposed code to the Stock Exchange which listed companies should comply with.

The Financial Aspects of Corporate Governance in the Cadbury Report.

The roles of those concerns with the financial statements are described as follows:

The Directors are responsible for the corporate governance of the company.

The shareholders are linked to the Directors via the financial reporting system.

The Auditors provide the shareholders with an external objective check on the

directors‟ financial statements.

Other concerned users, particularly employees (to whom the Directors owe some responsibility) are indirectly addressed by the financial statements.

Code of Practice

  • 1. Directors should state whether the report and accounts comply with the code and give reasons for any non0compliance. This statement of compliance should only be published after a review by the auditors.

  • 2. Pressure should be brought by all the relevant parties on the Directors to ensure compliance with the code.

  • 3. All listed companies must establish effective audit committees with formal terms of reference dealing with their membership, authority and duties.

  • 4. Other controls and reporting requirements include:

The Directors should report on the effectiveness of their system of internal

control. The Board should ensure that an objective and professional relationship is maintained with the auditors.

It is the board‟s duty to present a balanced and understandable assessment of

their company‟s position which means that setbacks should be dealt with as well as successes. The Directors should state in their report that the business is a growing concern with supporting assumptions or qualifications as necessary.

Book-keeping Versus Accounting:

What is the difference between bookkeeping and accounting?

There is some confusion over the difference between bookkeeping and accounting. This is due to the fact that two are related and there is no universal accepted line of demarcation between them.

In general bookkeeping is the recording of business data in the prescribed manner, this is the first phase. Much of the work of bookkeeper is of the clerical in nature. Accounting is primarily concerned with the design of the system of records, the preparation of reports and the interpretation of reports. Accountants often direct and review the work of bookkeepers.

Accounting is defined as the art of recording,classifying,summarizing and classifying all businesss transactions expressed in monetary terms.it involves the preparation of reports and interpretation of reports.

Book-keeping is the art of recording business transactions in acceptable manner for future use.

Branches of Accounting:

What are the branches of accounting?

Accounting has three main forms of branches, viz, financial accounting, cost accounting, and management accounting. These forms of accounting have been developed to serve different types of objectives.

Financial Accounting:

It is the original form of accounting. It is mainly confined to the preparation of financial statements for the use of outsiders like creditors, banks and financial institutions etc. The chief purpose of financial accounting is to calculate profit or loss made by the business during the year and exhibit financial position of the business as on a particular date.

Cost Accounting:

Function of cost accounting is to ascertain the cost of the product and to help the management in the control of cost. It takes into account of all forms costs incurred during production and distribution.[direct and indirect costs].

Management Accounting or Managerial Accounting:

It is accounting for management. i.e., accounting which provides necessary information to the management for discharging its functions. It is the reproduction of financial accounts in such a way as will enable the management to take decisions and to control various business activities to achieve profit and wealth maximization of the business during the short and long term.

What are the important functions of accounting?

Accounting helps its users in the following ways.

  • 1. Assessing the tax liability of individuals and business firms [tax liability].

  • 2. Comparing the performance of firms over the period or in the industry.

  • 3. Protecting business assets from non-users and dishonest employees.

  • 4. Planning for the future financial requirements of the business.

  • 5. Simplifying credit transactions in business.

  • 6. Keeping records for future reference like solving conflict among partners.

Record Keeping Function:

  • 1. The primary function of accounting is to keep a systematic record of financial transaction - journalisation, posting and preparation of final statements. The purpose of this function is to report regularly to the interested parties by means of financial statements.

  • 2. Protect Business Property:

The second function of accounting is to protect the property of business from unjustified and unwanted use. The accountant thus has to design such a system of accounting which protect its assets from an unjustified and unwanted use.

  • 3. Legal Requirement Function:

The third function of accounting is to devise such a system as will meet the legal requirements. Under the provision of law, a business man has to file various statements e.g., income tax returns, returns for sales tax purpose etc. Accounting system aims at fulfilling the requirements of law. Accounting is a base, with the help of which various returns, documents, statements etc., are prepared.

  • 4. Communicating the Results:

Accounting is the language of business. Various transactions are communicated through accounting. There are many parties - owners, creditors, government, employees etc, who are interested in knowing the results of the firm. The fourth function of accounting is to communicate the results to interested parties. The accounting shows a real and true position of the firm of the business.

  • 1. Define and explain the term bookkeeping.

The work book or books mean books of accounts and keeping implies maintaining in proper form and order. Thus bookkeeping may be defined as the art of recording business transactions in books in a regular and systematic manner. It has been defined by different experts as:

  • 1. "The science and art of correctly recording in books of accounts all those business transactions that result in the transfer of money's worth."

  • 2. "The art and science of recording business transactions in such a systematic way as a trader may know the result of his trade at the end of a certain period and may also prove the accuracy of such record."

It should be noted from the above definitions that bookkeeping primarily deals in the art of recording transactions in books.

Important Bookkeeping Terms:

Before attempting to learn the art or science of bookkeeping it will be better to clarify some of the terms that will have to be used again and again.

Transaction:

Any dealing between two persons or things in a transaction. It may relate to purchase and sale of goods, receipt and payment of cash and rendering of services by one party to another.

Transaction is of two kinds - cash transaction and credit transaction. When cash is paid or received as a result of an exchange, the transaction is said to be a cash transaction. When the payment or receipt of cash is postponed for future date, this transaction is said to be credit transaction.

Business:

It includes any activity undertaken for the purpose of earning profit e.g., banking business, and insurance business, a merchant business etc., etc.

Proprietor:

He is the owner of a business. He invests capital in it, gives his time and attention to it. He is entitled to receive the profit or bear loss arising out of it.

Drawings:

The cash or goods taken away by the proprietor from the business for his personal use are called has drawings.

Purchases:

Goods purchased are called purchases. When the goods purchased for cash they are called cash purchases but if they are purchased for which payment will have to be made at some future date it is known as credit purchases.

Purchases Returns:

If goods purchased are found defective or unsatisfactory, they are sometimes returned to the persons from whom they were purchased or to suppliers are called purchases returns or returns outwards.

Sales:

Goods sold are called sales. When goods are sold for cash they are called cash sales, but when they are sold without having received payment, they are credit sales.

Sales Returns:

If a person to whom goods have been sold finds that they are defective or unsatisfactory and returns them, are called sales returns or returns inwards.

Trade Discount:

It is rebate or allowance from the scheduled price granted by the seller to the buyer attracting bulk purchases. Trade discount is usually granted in the following circumstances:

  • (a) When selling to a fellow trader.

  • (b) When the buyer is an old customer.

  • (c) When sales are made in bulk.

  • (d) As a custom of trade.

Cash Discount:

It is deduction or allowance allowed by creditor to a debtor for prompt payment. If a person pays his debit before the due date of payment the recipient may grant him an allowance for doing so. This allowance is known as cash discount

Commission:

It is a form of remuneration for services rendered by one person to another.

Capital Expenditure vs revenue expenditure.

Capital expenditure takes place when assets or fixed assets are purchased or capitalization of expenditure on assets while revenue expenditure refers to payment for goods and services needed or used by the business to meet its short term obligations.

Expense:

It means an expenditure whose benefit is finished or enjoyed immediately such as salaries, rent etc. Difference between expense and expenditure is that the benefit of the former is consumed by the business in present whereas in latter case benefit will be available for future activities of the business.

Account:

A summarized record of transactions relating to person or thing is called an account.

Debtor (Account Receivable):

A person who owes money to another is a debtor. When we say that we owe Mr. Rahim $200, we mean that we have received from Mr. Rahim $200 which we have to repay. We stand as debtor to Mr. Rahim for $200. It is also termed as accounts receivable.

Creditor (Accounts Payable):

A person who pays out something or to whom money is owing is a creditor. It is also termed as accounts payable.

Assets:

These are the things of value possessed by a trader such as building, land, machinery, furniture, etc.

Liabilities:

They are the debt due by a business to its proprietor and others.

Voucher:

Any written evidence in support of a business transaction is called a voucher. When a ream of paper is bought from a stationer, he gives a cash memo. The cash memo is a voucher for the payment. When wages for the month are paid to the peon, receipt is taken from him. The receipt serves as a voucher for the payment.

Goods (Merchandise):

It includes all merchandise commodities which are purchased by the business for selling.

Stock (Inventory):

Goods or merchandise on hand, that is goods remaining unsold, is called stock, stock in trade, or inventory.

Equity:

A claim which can be enforced against the assets of the firm is called equity. In other words, the rights to properties are called equities. Equities are of two types: the right of creditors and the right of owners.

Liabilities.

The equities of creditors represent debts of the business and are called liabilities. The equities of the owner is called capital, proprietorship or owner's equity.

Parties Interested in Accounting Information:

  • 1. Explain, who may be interested in accounting information of a company or firm?

There are a number of parties who are interested in the accounting information relating to business. Accounting is the language employed to communicate financial information of a concern to such parties. The following are the groups who like to make use of the accounting information.

Owners:

The owner provides funds or capital for the organization. They want to know whether their funds are being properly used or not. They need accounting information to know the profitability and

the financial position of the concern in which they have invested their funds. The financial statement prepared from time to time from accounting records tell them the profitability and the financial position.

Management:

Management is the art of getting things done through others. The management should ensure that the subordinates are doing work properly. Accounting information is an aid in this respect because it helps a manager in appraising the performance of the subordinates. Accounting information provides "the eyes and ears to management".

Creditors or service providers.

Creditors are the persons who supply goods on credit or bankers or lenders of money. They want to know the financial position of a concern before giving loans or granting credit. They want to be sure that the concern will not experience difficulty in making their payment in time i.e., liquid position of the concern in satisfactory. To know the liquid position, they need accounting information.

Employees:

Employees are interested in the financial position of a concern they serve particularly when payment of bonus depends upon the size of the profits earned. The demand for wage rise, bonus, better working conditions etc. depends upon the profitability of the concern and in turn depends upon financial position. For these reasons, this group is interested in accounting information.

Government:

The government is interested in accounting information because it wants to know earnings or sales for a particular period for the purpose of taxation. Government also needs accounting information for compiling statistics concerning which in turn helps in compiling national accounts.

Consumers:

Consumers need accounting information for establishing good accounting control so that cost of production may be reduced with the resultant reduction of the prices of goods they buy. Sometimes, prices for some goods are fixed by the government, so it needs accounting information to fix reasonable prices so that consumers are not exploited.

Accounting Cycle:

  • 1. Define and explain accounting cycle.

Accounting cycle refers to a complete sequence of accounting procedures which are required to be repeated in same order during each accounting period. Accounting cycle includes:

Recording:

First, all transactions should be recorded in the journal or books of original entry known as subsidiary books as and when they take place.

Classifying:

All entries in the journal of books of original entry should be posted to the appropriate ledger accounts to find out at a glance the total effect of all such transactions in a particular account.

Summarising:

Last stage is to prepare the trial balance and final accounts with a view to ascertaining the profit or loss made during a trading period and the financial position of the business of a particular date.

Accounting Cycle

Classifying: All entries in the journal of books of original entry should be posted to the

Equation:

Definition and Explanation:

Accounting is the language of business. Affairs of a business unit are made understood to others as well as to those who own or manage it through accounting information which has to be suitably recorded, classified, summarized and presented.

In order to make this language to convey the same meaning to all people, it is necessary that it should be based on certain uniform scientifically laid down standards. These standards are termed as accounting principles. Accounting principles may be defined as those rules of action or conduct which are adopted by the accountants universally while recording accounting transactions. In the absence of common principles there will be a chaotic situation and every accountant will have his own principles. Not only the utility of accounts will be less but these

will not be comparable even in the same business. Therefore, it become essential that common principles should be followed for measuring business revenues and expenses.

Essential Features of Accounting Principles:

Accounting principles are accepted if they satisfy the following norms:

Usefulness:

A principle will be relevant only if it satisfies the needs of those who use it. The accounting principles should be able to provide useful information to its users otherwise it will not serve the purpose.

Objectivity:

A principle will be said to be objective if it is based on facts and figures. There should not be a scope for personal bias. If the principle can be influenced by the personal bias of users, it will not be objective and its usefulness will be limited.

Feasibility:

The accounting principle should be practicable. The principles should be easy to use otherwise their utility will be limited.

Classification of Accounting principles:

Accounting principles can be classified into two kinds:

  • 1. Accounting Concepts: The term concepts includes those basic assumptions or conditions upon which accounting is based

Explain important accounting principles.

The term concepts includes those basic assumptions or conditions upon which accounting is based. The following are the important accounting concepts:

  • 1. Business Entity Concept

  • 2. Going Concern Concept

  • 3. Money Measurement Concept

  • 4. Cost Concept

  • 5. Duel Aspect Concept

  • 6. Accounting Period Concept

  • 7. Matching Concept

  • 8. Realisation / Realization Concepts

The explanation of these concepts are as follows:

Business Entity Concept:

In accounting, business is treated as separate entity from its owners. Accounts are prepare to give information about the business and not about those who own it. a distinction is made between business transactions and personal transactions. Without such a distinction, the affairs of the business will be mixed up with the private affairs of the proprietor and the true picture of the firm will not be available. The 'Business' and 'owner' are taken as two separate entities. The accountant is interested to record transactions relating to business only. The private transactions of the owner will be recorded separately and will have no bearing on the business transactions. All the transactions of the business are recorded in the books of the business from the point of view of the business as an entity and even the proprietor is treated as a creditor to the extent of his capital.

The concept of separate entity is applicable to all of business organizations. For example, in case of a sole proprietorship business or partnership business, though the sole proprietor or partners are not considered as separate entities in the eyes of law, but for accounting purposes they will be considered as separate entities. In the case of joint stock company, the business has a separate legal entity than the shareholders. The coming and going shareholders don not affect the entity of the business. Thus, the distinction between owner and the business unit has helped accounting in reporting profitability more objectively and fairly. It has also led to the development of 'responsibility accounting' which enables us to find out the profitability of even the different sub- units of the main business.

Going Concern Concept:

According to going concern concept it is assumed that the business will exist for a long time to come. Transactions are recorded in the books keeping in view the going concern aspect of the business unit. A firm is said to be going concern when there is neither the intention nor necessary to wind up its affairs. In other words, it should continue to operate at its present scale in the future. On account of this concept the fixed assets are shown in the balance sheet at a diminishing balance method i.e., going concern value. There is no need to show assets at market value because these have been purchased for use in future and earn revenues and for sale purpose. If the business is not to continue then market value will have significance. Since business is to continue, fixed assets will be shown at cost less depreciation basis. It is due to the concept that the fixed assets are depreciated on the basis of their expected life than on the basis of market value. The concept also necessitates distinction between expenditure that will render benefit over a long period and that whose benefit will be exhausted quickly, say within one year. The going concern concept also implies that existing liabilities will be paid at maturity.

Money Measurement Concept:

Accounting to records only those transactions which can be expressed in terms of money. Transactions or events which cannot be expressed in money do not find place in the books of accounts though they may be very useful for the business. For example, if a business has got a team of dedicated and trusted employees, it is definitely an asset to the business, but since their monetary measurement is not possible, they are not shown in the books of business. It should be remembered that money enables various things of diverse nature to be added up together and dealt with. The use of a building and the use of clerical service can be aggregated only through money values and not otherwise.

Cost Concept:

This concept is closely related to the going concern concept. According to this concept, an asset in ordinarily recorded in the books at the price at which it was acquired i.e., at its cost price. This cost serves the basis for the accounting of this asset during the subsequent period. The 'cost'

should not be confused with 'value'. It must be remembered that as the real worth of the assets changes from time to time, it does not mean that the value of such an asset is wrongly recorded in the books. The book values of the assets as recorded do not reflect their real value. They do not signify that values noted therein are the values for which they can be sold. Though the assets are recorded in the books at cost, in course of time, they are reduced in value on account of depreciation charges. The idea that the transactions should be recorded at cost rather than at a subjective or arbitrary value is known as cost concept. With the passage of time, the market value of fixed assets like land and buildings vary greatly from their cost. These changes in the value are generally ignored by the accountants and they continue to value them in the balance sheet at historical cost. The principle of valuing the fixed assets at cost and not at market value is the underlying principle in cost concept. According to them the current values alone will fairly represent the cost to the entity. The cost principle is based on the principle of objectivity. There is no room for personal assessment in showing the figures in accounting records. If subjectivity is flowed in records the same assets will be valued at different figures by different individual. Every body will have his own views about various assets. The cost concept is helpful in making truthful records. The records becomes more reliable and comparable.

Dual Aspect Concept:

This is the basic concept of accounting. Modern accounting system is based on dual aspect concept. Dual concept may be stated as "for every debit, there is a credit". Every transaction should have two sided effect to the extent of same amount. For example, if A starts a business with a capital of $10,000. There are two aspects of the transaction. On the one hand the business has assets of $10,000 while on the other hand the business has to pay to the proprietor a sum of $10,000 which is taken as proprietor's capital. This expression can be shown in the form of following equation:

Capital (Equities)

=

Costs (Assets)

10,000

=

10,000

The term 'assets' denotes the resources owned by a business while the term 'equities' denotes the claims of various parties against the assets. Equities are of two types. They are owners equity and outsiders equity. Owner's equity (or capital) is the claim of the owner's against the assets of the business while outsiders equity (liabilities) is the claim of outside parties against the assets of the business. Since all assets of the business are claimed by someone (either owners or outsiders), the total of assets will be equal to total of liabilities. Thus:

 

Equities

=

Assets

OR

Liabilities

+

Capital

=

Assets

Suppose if the business borrows $5000 from a bank, dual aspect of this transaction will be

Capital + Liabilities A Loan

=

Assets

10,000

=

15,000

Thus the accounting Equation states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of owner's equity and outsider's liabilities. As a mater of fact the entire system of double entry accounting is based on this concept.

Accounting period concept:

According to this concept, the life of the business is divided into appropriate segments for studying the results shown by the business after each segment. Since the life of the business is considered to be indefinite (according to going concern concept) the measurement of income and studying financial position of the business according to the above concept, after a very long period would not be helpful in taking proper corrective steps at the appropriate time. It is, therefore, absolutely necessary that after each segment or time interval the businessman must stop and see, how things are going on. In accounting such a segment or time interval is called accounting period. It is usually of a year.

At the end of each accounting period and income statement/profit & loss Account and a Balance Sheet are prepared. The income statement discloses the profit or loss made by the business during the accounting period while Balance Sheet discloses the financial position of the business as on the last day of the accounting period. While preparing these statements a proper distinction has to be made between capital and revenue expenditure.

Matching concept:

The aim of business is to earn profit. In order to ascertain the profit the costs (expenses) are matched to revenue. The difference between income from sales and costs of producing the goods will be the profit. When business is taken as a going concern then it becomes necessary to evaluate the performance periodically. A correct statement of income requires a distinction between past, present and future expenditures. A distinction between capital and revenue expenditure is also necessary. The revenues and costs of same period are matched. In other words, income made by the business during a period can be measured only when the revenue earned during a period is compared with the expenditure incurred for earning that revenue. The question when the payment was received or made is irrelevant.

Realization Concept:

This concept emphasises that profit should be considered only when realised. The question is at what stage profit should be deemed to have accrued? Whether at the time of receiving the order or at the time of execution of the order or at the time of receiving the cash? For answering this question the accounting is in conformity with the law and Recognises the principle of law i.e., the revenue is earned only when the goods are transferred. It means that profit is deemed to have accrued when property i goods passes to the buyer, viz., when sales are made.

The term "conventions" includes those customs or traditions which guide the accountants while preparing the accounting statements. The following are the important accounting conventions.

Convention of Disclosure:

The disclosure of all significant information is one of the important accounting conventions. It implies that accounts should be prepared in such a way that all material information is clearly

disclosed to the reader. The term disclosure does not imply that all information that any one

could desire is to be included in accounting

statements. .

The idea behind this convention is that

any body who want to study the financial statements should not be mislead. He should be able to make a free judgment. The disclosures can be in the way of foot notes. Within the body of financial statements, in the minutes of meeting of directors etc.

Convention of Materiality:

It refers to the relative importance of an item or even. According to this convention only those events or items should be recorded which have a significant bearing and insignificant things should be ignored. This is because otherwise accounting will be unnecessarily over burden with minute details. There is no formula in making a distinction between material and immaterial events. It is a matter of judgment and it is left to the accountant for taking a decision. It should be noted that an item material for one concern may be immaterial for another. Similarly, an item material in one year may not be material in the next year.

Convention of Consistency:

This convention means that accounting practices should remain uncharged from one period to another. For example, if stock is valued at cost or market price whichever is less; this principle should be followed year after year. Similarly, if depreciation is charged on fixed assets according to diminishing balance method, it should be done year after year. This is necessary for the purpose of comparison. However, consistency does not mean inflexibility. It does not forbid introduction of improved accounting techniques. If a change becomes necessary, the change and its effect should be stated clearly.

Convention of Conservatism:

This convention means a caution approach or policy of "play safe". This convention ensures that uncertainties and risks inherent in business transactions should be given a proper consideration. If there is a possibility of loss, it should be taken into account at the earliest. On the other hand, a prospect of profit should be ignored up to the time it does not materialise. On account of this reason, the accountants follow the rule 'anticipate no profit but provide for all possible losses'. On account of this convention, the inventory is valued 'at cost or market price whichever is less.' The effect of the above is that in case market price has gone down then provide for the 'anticipated loss' but if the market price has gone up then ignore the 'anticipated profits.' Similarly a provision is made for possible bad and doubtful debt out of current year's profits.

Critics point out that conservatism to an excess degree will result in the creation of secrets reserves. This will be quite contrary to the doctrine of disclosure.

Accounting Equation:

Dual aspect may be stated as "for every debit, there is a credit." Every transaction should have twofold effect to the extent of the same amount. This concept has resulted in accounting equation which states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of equities.

Accounting Equation:

Learning Objective:

  • 1. Define and explain accounting equation.

  • 2. Give an example of accounting equation.

Definition and Explanation of Accounting Equation:

Dual aspect may be stated as "for every debit, there is a credit." Every transaction should have twofold effect to the extent of the same amount. This concept has resulted in accounting equation which states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of equities. In other words, for every business enterprise, the sum of the rights to the properties is equal to the sum of the properties owned. The properties of the business are called "assets". The rights to the properties are called "equities". Equities may be sub-divided into two principle types: The rights of the creditors and the rights of the owners. The equity of the creditors represents debts of the the business and are called liabilities. The equity of the owner is called capital, or proprietorship or owner's equity.

The formula know as the accounting equation, thus arrived at is as follows:

Assets = Equities

OR

Assets = Liabilities + Proprietorship

Another method of demonstrating the mathematical relationship involves a simple variation in the form of equation. Again it begins with the position that every business owns or has interest in certain assets. It also owes certain amounts to its creditors. The difference between what it owns and what it owes represents the owner's capital or proprietorship. Thus the original equation is changed into:

Assets - Liabilities = Proprietorship

Effects of Transactions on the Accounting Equation:

Each and every business transaction affects the elements of accounting equation. The effect is shown by the use of (+) or (-) placed against the elements affected. Note particularly that the equation remains in balance after each transaction. The accounting equation can be understood with the help of the following example:

Example:

Mr. Riaz commences his business with cash $50,000. This is an example of investment of asset in the business by the owner. The effect of this transaction on the accounting equation is that cash asset is increased by $50,000 and the proprietorship (Riaz's capital) is also increased by the same amount such as:

Assets

=

Liabilities

+

Proprietorship

Cash

Riaz, Capital

+ 50,000

=

----

+ 50,000

Note that assets and equities increased by equal amounts

Transaction 2:

Purchased furniture on cash $10,000. This transaction effected accounting equation as the increase in one new asset furniture and decreases in assets cash with the same amount. Thus

Assets

=

Liabilities

+

Proprietorship

Cash

Furniture

Riaz, Capital

+ 50,000

=

----

+ 50,000

- 10,000

+ 10,000

40,000

+ 10,000

=

50,000

 

Note that this transaction has affected assets side only and no change is made in equities side of the equation.

Transaction 3:

Purchased merchandise for cash $10,000. This transaction will introduce a new element (merchandise) on the assets side and decrease the cash by $10,000.

Assets

=

Liabilities

+

Proprietorship

Cash

Furniture

Merchandise

Riaz, Capital

+ 40,000

+ 10,000

=

----

+ 50,000

-10,000

--

+ 10,000

30,000

+ 10,000

=

50,000

 

Note that this transaction has affected assets side only and no change is made in equities side of the equation.

Transaction 4:

Purchased merchandise on account (on credit) $5,000.

Assets

=

Liabilities

+

Proprietorship

Cash

Furniture

Merchandise

Creditors

Riaz, Capital

+ 30,000

+ 10,000

+ 10,000

=

+ 50,000

 

+ 5,000

+ 5,000

30,000

+10,000

+ 15,000

=

+ 5,000

+ 50,000

 

Note that this transaction has affected assets side and liabilities. Both the sides of equation has increased with the same amount.

Transaction 5:

Sold merchandise for cash $2,000 cost of these merchandise were $1,500.

Assets

=

Liabilities

+

Proprietorship

Cash

Furniture

Merchandise

Creditors

Riaz, Capital

+ 30,000

+ 10,000

+ 15,000

=

+ 5,000

+ 50,000

+ 2,000

- 1,500

+ 500 (Profit)

+ 32,000

+10,000

+ 13,500

=

+ 5,000

+ 50,500

 

Note that this transaction has affected assets side and also the proprietorship. Difference between sales price and cost price is treated as profit and has been added to capital.

Transaction 6:

Sold merchandise on credit for $4,000 costing $3,000.

Assets

=

Liabilities

+

Proprietorship

Cash

Furniture

Merchandise Debtors

 

Creditors

Riaz, Capital

+ 32,000

+ 10,000

+ 13,500

=

+ 5,000

+ 50,500

 

- 3,000

+ 4,000

+ 1,000

32,000

+10,000

+ 10,500

+ 4000

=

+ 5,000

+ 51,500

 

Note that this transaction has affected assets side and also the proprietorship. Anew element "debtors" has been introduced. Difference between sales price and cost price is treated as profit and has been added to capital.

Transaction 7:

Paid $1,000 to creditors for merchandise purchased.

Assets

=

Liabilities

+

Proprietorship

Cash

Furniture

Merchandise Debtors

 

Creditors

Riaz, Capital

+ 32,000

+ 10,000

+ 10,500

+ 4,000

=

+ 5,000

+ 51,500

- 1,000

- 1,000

31,000

+10,000

+ 10,500

+ 4000

=

+ 4,000

+ 51,500

Transaction 8:

 

Received cash from a debtor $ 1,000 whom a sale on credit was made earlier. This is an example of collection from debtors. This transaction is an exchange of one asset for another. the effect is on one side of the equation, i.e., asset side. Thus:

Assets

=

Liabilities

+

Proprietorship

Cash

Furniture

Merchandise Debtors

 

Creditors

Riaz, Capital

+ 31,000

+ 10,000

+ 10,500

+ 4,000

=

+ 4,000

+ 51,500

+ 1,000

- 1,000

32,000

+10,000

+ 10,500

+ 3000

=

+ 4,000

+ 51,500

Transaction 9:

 

Paid salaries $1,000 in cash. This transaction affected the equation by decrease in a cash asset

and decrease in proprietorship (i.e., capital). Thus:

Assets

=

Liabilities

+

Proprietorship

Cash

Furniture

Merchandise Debtors

 

Creditors

Riaz, Capital

+ 32,000

+ 10,000

+ 10,500

+ 4,000

=

+ 4,000

+ 51,500

- 1,000

- 1,000

31,000

+10,000

+ 10,500

+ 3000

=

+ 4,000

+ 50,500

 

Effects of all the transactions explained above are presented in the following table:

Assets

 

= Liabilities

+ Proprietorship

 
 

Cash

+ Furniture Merchandise + + Debtors

Creditors

+ Riaz, Capital

1

+ 50,000

 

+50,000

 

50,000

 

=

+ 50,000

2

-

10,000

+ 10,000

   

40,000

10,000

=

+ 50,000

3

-

10,000

+ 10,000

 
   

30,000

10,000

10,000

=

+ 50,000

4

 

+ 5,000

+ 5,000

   
   

30,000

10,000

15,000

= 5,000

+ 50,000

5

+ 2,000

- 1,500

+ 500 (Profit)

 
 

32,000

10,000

13,500

= 5,000

+ 50,500

6

 

- 3,000

+ 4,000

+ 1,000 (Profit)

 

32,000

10,000

10,500

4,000

= 5,000

+ 51,500

7

-

1,000

- 1,000

 

31,000

10,000

10,500

4,000

= 4,000

+ 51,500

8

+1,000

 

1,000

 

32,000

+ 10,000

+ 10,500

+ 3,000

4,000

+ 51,500

9

1,000

 

1,000

 

31,000

10,000

10,500

3,000

= 4,000

+ 50,500

The elements of the equation of Mr. Riaz that is,

 

Cash

 

+ Furniture

+ Merchandise

+ Debtors

=

Creditors

+

Capital

31,000

+ 10,000

+ 10,500

+

3,000

=

4,000

+

50,500

This may also be stated in vertical form as shown below:

EQUITIES

ASSETS

Creditors

$4,000

Cash

$31,000

Capital

$50,500

Debtors

3,000

 

Merchandise

10,500

Furniture

10,000

 

$54,500

$54,500

The presentation of the effects of transactions in tabular form is only a device which helps

beginners to understand the analysis of different types of transactions. It is not practically

feasible to record the effects of transactions in this form. The increases and decreases in the

various elements are recorded in the journal in a special technical form.

ACCOUNTING.

MEANING OF BOOK KEEPINNG.

Accounting refers to the science and art of recording, classifying and summarizing of business

transactions in an accurate and systematic way in business.

Importance of accounting.

  • 1. Book keeping helps an entrepreneur to ascertain whether the business has realized a profit or it has incurred a loss.

  • 2. Helps an entrepreneur in credit transactions. Most business transactions are carried out on credit basis i.e. buying or selling on credit. It would therefore be difficult for

the entrepreneur to remember all the purchases or sales made on credit without proper

book keeping.

  • 3. It acts as a tool of control book keeping enables the business to keep record of all the properties of the business which help to eliminate the possibility of theft and misappropriation.

  • 4. It helps in tax assessment. Types like income tax, excise duty, customs duty etc. are imposed by the government depending on the records. To ensure accurate assessment of tax, book keeping records must be maintained properly to avoid under or over taxation of the business by the government.

  • 5. Book keeping records help an entrepreneur to acquire loans. This is because financial institutions e.g. banks usually require looking at the financial records of the business to determine whether to extend credit or not.

  • 6. Book keeping acts as a tool for planning. This is because most entrepreneurs base their financial decisions according to sales, purchases, profits, investments of he past and the present.

  • 7. Book keeping act as a proof for financial position of the business. Knowing the assets (properties of the business) and liabilities (debts of the business) the entrepreneur can easily establish.

  • 8. acts as a centre for reference whenever information about business is required.

  • 9. it helps to solve disputes among business members e.g. partnerships, companies, co- operatives etc. this is because it acts as evidence of the events which took place in the business.

Users of Accounting Information.

There are many users of accounting information who will use them and make

judgments and to influence decisions related to the business.

i)

Owners will use the information in order to determine the performance of the

business. Also it will help them to improve on the way they manage their business

and make decisions that affect the future.

ii)

Lenders Such as banks will need accounting information in order to assess the

financial capacity of the business to determine whether to give out the loan or not.

iii)

Customers These will want to be sure that the business can meet their supply

requirements such that the supplies will be sustained in future.

iv)

Creditors The creditors are interested to know whether the business is credit

worthy such that it can meet their payments. They will also want to know more about

how long they will expect to unit for payment.

v)

Employers They want to know about the financial strength of the business and also

they require information in relation to profit sharing, for better pay, job security and

whether the business is still strong enough to continue existing.

vi)

Government departments These may include Revenue Authority and may use

accounting information to determine the tax liability of the business.

vii)

Share holders (in case of companies) will want to know that their investment in the

business is secure and what the returns are likely to be.

viii)

Local community The public tries to know the extent to which the business is

concerned about their welfare, possibility of providing employment, pricing of

products to decide whether there is need to get involved and if so how.

ix)

Donors Before donors continue or stop the donations they will first have to check

in the books of account.

DISCUSS VARIOUS ACCOUNTING CONCEPTS THAT UNDER LIE

PREPARATION AND

PRESATATION OF ACCOUNTS IN ORDER TO IMPROVE

THE QUALITY OF ACCOUNTING INFORMATION.

INTRODUCTION

Accounting is the process of recording, reporting and analyzing the financial and other

information for management and the external users, to enable them make relevant decisions

regarding the enterprise.

The accounting information generated and used can be categorized into branches of

accounting which are aimed at solving specific problems of the entity. These include

financial accounting, management accounting, financial management and auditing. Each

branch of accounting has specific users of accounting information.

The underlying purpose of accounting is to provide financial information about an

organization that will help decision makers to make good decisions.

THE USES OF ACCOUNTING INFORMATION

Organizations are set up to achieve defined objectives the commonest which relates to

entities in business is to make profit for the users (owners). Consequently the entity should

produce information which shows whether this aim has been fulfilled or not and to show

whether this aim has been fulfilled or not and to show the state of its assets and financial

obligations.

The “corporate report” a paper produced under government support in the UK explains the

purpose of reports by organization (which includes accounts) as: is to communicate

economic measurement of and information about the resource and performance of the

reporting entity useful to those having reasonable rights to such information.

Therefore the information to be reported should have all the requisite economic information

to be useful.

The information is also required to the performance of the entity which in business means

profit communicated in such a way as to reveal to cause underlying the results

Information is also required a bout the resources of the entity. This is usually shown in the

balance shelf; contains information regarding the assets owned by the entity and its liabilities.

Together with other non-financial information the users can be able to make informed

economic decisions about the entity.

USERS OF FINANCIAL INFFORMATION

Depending on the size of the entity and the persons interested in its affairs, the persons

interested in the financial information produced by the entity may include:

1.0 Management the information to enable them plan and control future activities of the

entity.

  • 1.1 Ownership (shareholder) they need to know whether management is efficient and effective .This will enable them decide whether to change management/maintain/increase or dispose of their investment.

  • 1.2 Trading contacts-suppliers of an enterprise need to know whether they will be paid

within a reasonable time, while the customer need to know whether the enterprise is

capable of giving the required services or goods

  • 1.3 Tax authorities- need to be able to access the tax liability of the entity and whether all

due taxes have been settled.

  • 1.4 Financial the provider of loan capital to the enterprise want to know whether their loans are secure and whether the enterprise is capable of repaying on schedule.

  • 1.5 Government and its Agencies need to know the nature and scale of operation for

planning national development and to provide national statistics.

  • 1.6 Employees- they need to decide on their future careers depending on the prospects of the entity and for bargaining their future benefits.

  • 1.7 Financial analysts and Advisors need to advise their clients for example, whether

to invest or disinvest in the company, whether to provide credit and general knowledge

of the public.

  • 1.8 The general public- they need to know whether the activities of the enterprise are

beneficial or destructive to their communities. They may also need to know of

employment opportunities, use of local materials and the effect on their environments,

HOW INFORMATION REACH THE USERS .

Most information of organization is kept private and is not available to all the users except

management. In order to make such information available to the needy users, the following

forces prevail upon management

  • a) The Law. Company Act requires all companies to public such reports.

  • b) Taxation Acts authorizes tax to receive such information to make assessments.

  • c) Financiers often request such information before or after proving loans as a pre- condition.

  • d) Professional accountancy bodies compel their members to follow accounting standards which require minimum level of disclosure in the financial statements.

  • e) For some organizations, it may be to their interest to provide certain information to some groups like employees or to the general public.

Elements of Useful Accounting Information.

Accounting information which is availed to the external users should posses a minimum of

qualities so as to enable users to make informed decisions.

  • 1.0 Relevancy- the contents of the report should be what is required to fulfill the needs of the users.

  • 1.1 Reliability- the information should be accurate and not misleading. This is improved through an independent audit.

  • 1.2 Comprehensibility the reports should be such as can be easily understood. Incomplete

information, too much detail or use much jargon may impair comprehensiveness

  • 1.3 Objectivity- Information must contain facts and should avoid as far as possible

subjective judgment or basis towards of desires view.

  • 1.4 Completeness- all relevant information should be given to give around picture of the

entity.

  • 1.5 Turneries information gained long after it is required is of no value. The information

should be given in reasonable interval and not too long after it is produced.

  • 1.6 Comparability consistent bears should be used to prepare and present information so

as to enable valid comparison to be made with other periods and similar entities.

  • 1.7 Understand ability- information about complex matter should be included in the

financial analyst where as other categories is user like employee need non complex

information.

DEFINITION OF ACCOUNTING PRINCIPLES/CONCEPTS/CONVENTION.

1.Financial accounting principles are also known as accounting concepts, accounting

conventions or postulates of accounting. The Nomenclature varies from author to

author.

They are defined as basic ground rules which must be followed when financial

accounts are being prepared and presented. They are also referred to as

assumptions or a preposition that underlies the preparation and presentation of

financial statements.

To make accounting information convey the same meaning to all

people, as far as

practicable, and to make it full of meaning,

accountants here agreed on a number

of concept which they try to

follow in order to disclose any intentions of

doctoring accountings for misstatements.

This concept requires recognition and recording of transactions relating to the entity

(organization) in question and excludes private transactions of the owners or those running it.

Record is only made for what the entity owes the owner (capital) and what the owner owes

the entity (drawings)

There is likelihood that accountants will increase expenses in order to declare lower profits

and there by minimize fax liability. This might involve increasing expenses by including

those of a private nature or not declaring all incomes of the entity. This would lead to

misleading information to tax assessors. Such actions are deemed illegal and outlawed thus

implementing its business entity concept.

The limitation of this concept can be appreciated from the perspective of a humble business

man/woman like a sole trader or a family run business. The owner and the business are

actually inseparable. For instance if a sole trader sells but also swells in the same premises,

rent and utilities paid on those premises will be difficult to apportion between the owner and

the business especially if there are no clear apportionment bases.

  • 2. MONETARY /MONEY MEASUREMENT:

According to this concept all transactions to be recorded must be quantified in monetary

terms or language of money. Money is a common denomination for all transactions.

Where no paper unit of measurement, unit of account and store of value is attached to a

transaction, it will be easier for accountant to manipulate information because such

information about a transaction will be biased. The monetary concept was not employed; it

would have been very easy for accountants to give under estimations or over estimated

information about a particular transaction thus giving irreverent information to users.

The limitation of this concept is that it assumes that money has stable value over time and yet

it is common knowledge that money losses value with time, a phenomenon referred to as

inflation. Under inflationary circumstances money ceases to be an objective measure of

value.

Also, there are certain events or things that can not be expressed in monetary terms thus not

recorded and yet they materially impede or enhance business operations. For instance if a

supervisor is granted leave, business will not flow smoothly.

Further more, there are some intangible assets like good will, patent, brand name etc which

lead to increased turn over and profits but cannot be recorded as assets because they are

difficult to quantify in financial term. Attempts are being made to value intangible assets for

inclusion in the balance sheet.

  • 3. GOING CONCERN:

This concept states that the business entity is assumed to continue is operational existence in

the foreseeable future. The business is not on the verge of collapse unless there are

indications to suggest so.

This concept makes it possible for accountants to project or prepare estimates for a long

period into the future for example preparation of budget estimates for many years into the

future. The budget are useful for trend analysis and comparison profits, the accountant will

not be able to underestimate the profit for a particular financial year to which the budget

relate, because this will act as evidence that will raise questions on the trend of profit got by

the company.

This concept also enables the business to apportion the value of an asset over its useful life.

Without this concept, the asset would only be used for a particular financial year and its

residue value taken over by an accountant or any other member who would hence require

purchase of fixed assets for every financial year.

There is almost no challenge against the going concern assumption and has been embraced

and estimated in accounting standard of many countries as a fundamental assumption or

concept.

This concept requires accountants to record assets and liabilities at historical cost of their

acquisition. Assets are recorded at the acquisition (invoice) cost even if the value today is

more than the historical cost. Likewise liabilities are recorded at amounts they were incurred

though the true value of the liability might have changed due to foreign exchange

fluctuations and other macro economic issues such as inflation.

Without the historical cost convention in recording of assets, there is more temptation of over

valuing assets in the balance sheet in order to portray a sound financial stand. This balance

sheet will thus carry misleading information to users.

Also without the cost concept is that during inflation, historical cost will not reflect the value

of the asset to the business. The true value is not reflected. For instance if an asset was

bought for shs 1900,000. The historical cost concept will require 1000,000 and not 1900,000

to be recorded.

  • 5. REALIZATION:

This concept demands that accountants recognize income as earned only when a sale has

been made and the goals have been accepted by the customer or services have been offered

and enjoyed by customers or where value has been created by a transaction and legal right

and obligation have resulted.

Without this concept, accountants would be able to use money from operational gains and

compensate it with that value calculated from holding gains. This can show misleading

information in the financial statements.

Also without its realization concepts, assets in the balance sheet would be under estimated.

For instance accrued income will not be included under the current assets, and it would be

improper to include it in the profit and loss account. This reduces its accountant‟s possibility

of doctoring accountants to present misleading information.

There is no major problem with this concept, however questions debate is at which in time

income should be recognized as earned. The majority argue that income should be

reorganized when the goods have been shipped to the customer and she/he has been invoiced

and there is a strong likelihood of amount being collected i.e. absence of bad debts.

  • 6. ACCRUAL:

According to this concept, income is recorded as earned even though it might have been

received cash provided there is right to income (see realization concepts). Accrual basis

accounting recognizes both income and expenses without necessarily changing hands.

Without the accrual concept the scope of accounting would be narrowed to preparation of its

cash book. This would mean, where debtors accounts are not kept, all payments from debtors

would be exploited by accountants.

Also, without accrual concept, it be would be possible for accountants to include accrued

items in preparation of cash flow statements which show actual or expected cash flow

position of the enterprise.

There is no major criticism of this concept just like the reduction concept, however when

preparing a cash flow position of the enterprise, accrued items should be eliminated.

Investment decisions are based on the available or expected cash, accrued items will falsify

the actual cash position.

  • 7. MATCHING:

This concept requires accurate matching of expenses against incomers by writing off only

those costs or expenses that were incurred in generating specific income for the period ended.

Cost or expenses paid should be adjusted for any part-period that does not relate to the

overall period.

Without the matching concept, it would be possible for accountants to write off all the part of

the income set aside for an expense e.g. rent) including the pre payment that has been part of

the total expense. The prepaid rent will also be written off it one financial year. It will not be

carried forward to cater for the part of/the following financial year.

Example: rent paid for one and half years

End of year adjustment

1800,000

= 100,000 monthly rent

18 (month)

1800, 000=

Therefore rent expense= 12x 100,000=1200, 000=

Prepaid rent expense=

600,000=

Therefore the rent to write off out of the income earned in the financial will be 1200, 000=

There is no major critism with this concept as far as accounting preparations are concerned.

According to this concept, during valuation, estimation and measurement is preparation of

account; the accountant should follow a procedure that tends to understate things.

Since the valuation and preparation of estimates is subjective, without the conservation

concepts, accountants would be able to value asset at high value (overstatement) and

understate another asset, or over state a liability in order to use the different (overstatement)

for personal issues. (Fraud)

Also the prudence concept requires that accountants should not anticipate revenue and profits

until realized but should provide for all possible losses. Provisions for bad debts are created

and written off from profits for this reason. Provision is also made for all known contingent

liabilities in order to be prudent. This will deter the accountant from presenting a higher

figure for net profit that is misleading to users, for example creditors who are required to give

loan to the company.

The limitation of this concept is that, other than being inconsistent with the historical cost

concept, prudence concept has been criticized for discourages optimism, ambition, creativity

and innovation because it requires accountants to behave in a conservative manner.

This concept has been criticized for discouraging ambitions and challenging of existing

literature and has undermined evolution of concepts that would respond to contemporary

business environment.

The prudence concept is also at fault because it gives the impression that while

overstatements are not bad and may be a positive virtue. Deliberate misstatement in either

direction i.e. on the higher or lower side should be condoned. Un warranted conservatism in

financial reporting is as bad as overstatement and contravenes objectivity concept.

9.

CONSISTENCE.

This states that once a particular accounting method or base has been selected and has

become accounting policy, it must be applied continuously or consistently from year to year.

Changes in accounting methods or policies are permitted only if there are justifiable reasons

for doing so for instance of the old one have become inappropriate for the present

circumstances. When a change is made, the effect of the change on the reported net profit and

balance shall position if material must be disclosed as foot notes in the accounts.

Without the consistency concept it would be possible for accountants to employ different

accounting bases of their interest for example in calculating depreciation which would make

financial statements incomparable over a given trend. Changes from one method to another

will cause distortion in financial reporing.This will prevent accurate analysis of a company‟s

accounts over time.

Inter period comparison and inter company comparison will be difficult of some companies

keep changing their accounting policies.

Also, using different methods for calculating depreciation may give misleading information

to final users. For instance one who use reducing balance method for calculating deprecation

will have a higher value for total asset as compared to that accountant whose uses straight-

line method (depreciation cost). This wills portray information to the potential lender to the

firm that business has enough assets to operate as a going concern. So they will be intending

to offer loans to such an assurance.

The consistency concept is one of the most fundamental concepts required by UK and

international accounting standards. There is no serious challenge of this concept.

  • 10. PERIODICITY AND DISCLOSURE

. This concept makes financial reporting mandatory as enshrined in the companies Act of

Uganda and many other countries. At the end on an accounting year, accompany must

prepare and disclose financial statements. Publishing annual accounts is made an obligation

by this concept.Disclousure can be made more that once a year if the accountant so wishes. If

interim accounts are to be published, it is not discouraging.

Section 147 of the companies Act requires every company to keep proper books of account

in English in respect of incomes and expenditure, sales and purchase of goods and assets and

liabilities of the company. There fore without the periodicity and disclosure concept it would

be possible for accounts to conceal some of the information regarding items which are

required by statute to be disclosed. This would mean giving misleading information to

shareholders and other users of accounting information in respect of their individual

requirements for financial information.

There is no serious challenge of the periodicity concept.

  • 11. MATERIALITY CONCEPT

: This requires recognition of only material items and excluding immaterial or trivial items or

matters. Information is material if it is able to influence the decision (Economic decision) For

instance if the cost of recording certain items is not justifiable, then they should be left out.

For instance it is immaterial to record buying a bloom of 100/= in its cash book or as an

asset. Some assets like good will and some low value assets are written off in the profit and

loss account rather than being included as assets in the balance sheet because of materiality .

12. CONSIDERATIONS.

Without materiality concept accountants would record and report too much transaction which

would portray a misleading picture of the overall nature of operation of the business. There

those transaction though immaterial which would seem very risky to the business in the eyes

of the users (lenders). For instance the clerk may like 500/= out of petty cash of the creditor,

it will bring a picture of improper use of the company funds.

The concept of materiality has to be applied with some caution because there is no threshold

or quantities guideline for judging materiality of a transaction or an asset. Materiality is a

matter of opinion and judgement, abuses should be guarded against.

Also caution should be taken regarding the level at which views materiality. Some value may

be immaterial at the overall value (as percentage of profit) but may be material at the

transaction level.

Objectivity Concept: This states that whatever figure is recorded in accounting books and

financial statements must have a clear criteria or yardstick for its measurement. Figure must

have a basis for arriving at them but not simply planted into financial statements.

Accountants must be able to defend figures in financial statements using objective evidence,

empirical or other will.

Without the objectivity concept, accountants would have a lot of subjectivity and biased

accounting information in preparation of accounts for the firm. This would with no question

present misleading information to users whose interest do not match with those of the

accountants in charge of preparing financial statements.

The preparation of accounting statements however involves a considerable amount of

individual discretion especially on judging the materiality of amounts or issues.

While personal discretion cannot be done a way with completely, accounts should be

prepared with minimum amount of personal bias and the maximum amount of over all

objectivity.

13.

DUALITY CONCEPTS: This requires a transaction to be recorded twice (dual

recording) the dual aspect rule is a recognition that every transaction involves giving

and receiving effects. When some body gives something another must receive it. This

is in effect a requirement for double entry book keeping.

.

Without the duality concept, accountants would doctor accounts the way they wish hence

presenting incomplete records. Incomplete records are not easy to understand by users. They

do not give a true picture of the performance and operations of the business. Incomplete

records carry little information to financial users of accounts, like it is not easy to ascertain

opening capital of the business where all transactions are not balanced. Assets-liabilities

=capital

Therefore any information where double entry system is not used may not be very useful to

decision makers.

There is no particular challenger to the dual aspects concept. It has been employed almost

every where in preparation of accounts.

  • 14. SUBSTANCE OVER FORM.

This states that transactions and other events should be accounted for and presented in

accordance with their legal form.

Lawyer say on purchase of an asset the title passes on fully paying up for that particular

asset. This is not the case with accounting. The substance and reality is that one is using the

asset he bought in his business, so it‟s a business asset and should be recorded in its books

and statements.

Without the substance over form concept it would be possible for accountants to over

estimate the value of a fixed asset at cost which has been for a long time in operation at the

date it is fully paid for. In other words the recorded value of the asset in such a circumstance

(i.e. at cost) does not exist, the asset has depreciated already already, and it is overstated.

Overstatement under such a scenario will mean the value of the assets might have been

exploited by the accountant or other member to the extent of it. Net book value, but a

purchased item is a recorded at cost. So there is a gap for exploitation. Such an item

presented in the financial statement for users (shareholders, employee, lenders) will actually

be misleading in any case.

There is no proper ground on which the convention has been criticized as far as accounting is

concerned. However this concept conflicts with other forms of disciplines which are used

hand in hand with accounting, for example law.

Relevancy: Accounting to this concept the over all messages that accounts are trying to relay

may be obscured if too much information is presented. Accounts statements should contain

only information that complete strictly with the specific requirement of the user. This concept

is at times combined with

15. MATERIALITY CONCEPT.

Without the tolerance concept it would be easy for accountants to present information that is

irrelevant and un reliable to user a hide that information that will influence an economic

decision. In other words it would be very possible to disclose part of the information which is

material but likely to raise tension on the reliability of the accountant‟s information.

There is no too much challenge as far as this convention is concerned where the accounting

statements contain only information that complies strictly with the specific requirement of

the user. Financial analysts will require information which is more sophisticated than that

employees require for decision making.

BALANCE SHEET EQUATION. [ACCOUNTING EQUATION].

A=L+E

Balance sheet is defined as the financial statement prepared to show the financial position of a

business stating assets and liabilities for the period.

An elaborate form of this equation is presented in a balance sheet which lists all assets, liabilities,

and equity, as well as totals to ensure that it balances.

Assets ------------------

Liab-----------------

The formula can be rewritten:

Assets − Liabilities = (Shareholders or Owners equity or Capital.

Now it shows owner's interest is equal to property (assets) minus debts (liabilities). Since in a

company owners are shareholders, owner's interest is called shareholder's equity. Every

accounting transaction affects at least one element of the equation, but always balances. Simplest

transactions also include:

Transaction

Number

1

+

2

+

3

4

+

5

+

6

7

8

9

.

 

Shareholder's

Assets

Liabilities

Equity

Explanation

6,000

+

6,000 Issuing stocks for cash or other assets

10,000 +

10,000

Buying assets by borrowing money (taking a

 

loan from a bank or simply buying on credit)

900

900

Selling assets for cash to pay off liabilities:

 

both assets and liabilities are reduced

1,000 +

400 +

600 Buying assets by paying cash by shareholder's

 

money (600) and by borrowing money (400)

700

+

700 Earning revenues

200

200 Paying expenses (e.g. rent or professional

 

fees) or dividends

 

+

100

100 Recording expenses, but not paying them at

 

the moment

500

500

Paying a debt that you owe

 

Receiving cash for sale of an asset: one asset

0

0

0 is exchanged for another; no change in assets

or liabilities

This equation is part of the transaction analysis model for which we also write

Owners equity = Contributed Capital + Retained Earnings

Retained Earnings = Net Income Dividends

And Net Income = Income − Expenses

The equation resulting from making these substitutions in the accounting equation may be

referred to as the expanded accounting equation, because it yields the breakdown of the equity

component of the equation.

Expanded Accounting Equation

The Basic Accounting Formula

The accounting formula essentially shows what the firm owns (its assets) are purchased by

either what it owes (its liabilities) or by what its owners invest (its shareholders equity or

capital). This relationship is expressed in the form of an equation:

Assets = Liabilities + Owner's Capital

This equation has to balance because everything the firm owns (assets) has to be purchased with

something, either a liability or owner's capital. Assets refer to items like inventory or accounts

receivable. Examples of liabilities are bank loans or accounts payable. Owner's capital or equity

is the investment or capital the owner has in the firm. Another example is business profit.

The accounting formula or balance sheet equation can be expressed in two other ways:

Liabilities = Assets - Owner's Equity

Owner's Equity = Assets Liabilities

A=FA + CA

L= LTL + E

E= C + NP- D

EXPANDED EQUATION

FA + CA =

LTL + CL +C + NP-D

WC= CA- CL

CE= FA + WC [FA +CA-CL].

If you know any two of the three components of the accounting equation, you can calculate the

third component. If you look at a balance sheet, you can also see that the balance sheet is just an

extended form of the accounting equation.

Keeping the Accounting Formula Balanced

When you start up a new company, your accounting formula will be the following:

Assets = Liabilities + Owner's Equity

Shs 0 = shs 0 + shs 0

If this start-up is a very small business, the owner may deposit shs 1,000 in the business's

checking account. If the business is using double-entry bookkeeping, then the accounting

equation will now look like this:

Assets = Liabilities + Owner's Equity

Shs 1,000 = shs 0 + shs 1,000

Next, this small business may purchase office supplies, using cash, in the amount of shs 150.

Suddenly, the accounting equation looks like this:

Assets = Liabilities + Owner's Equity

Shs 1000 = shs 150 + shs 850

because expenses decrease owner's equity

This means that the asset account "Office Supplies" was increased by shs 150 and the cash

account was decreased by shs 150. Regardless of the type of transaction, the accounting equation

must stay balanced.

The Expanded Accounting Formula

The expanded accounting equation shows the relationship between the income statement and the

balance sheet. The Owner's Equity component of the accounting equation can be broken down

into two parts - revenue and expenses. So far, the accounting equation has focused on the

components of the balance sheet. Now, breaking the owner's equity part of the accounting

equation into revenues and expenses shows the relationship between the balance sheet and the

income statement since revenue and expenses are the key components of the firm's income

statement.

Revenues, also called sales revenues, are what the business earns for providing its product or

service to customers. Expenses are what it costs the business to provide the product or service to

the customers. The relationship between revenues and expenses is simple. If revenues are greater

than expenses, then the business generates a profit. If revenues are less than expenses, then the

business sustains a loss.

The owner or owners of the company can also withdraw a salary or equity from the business. If

the company is incorporated, then that salary may be in the form of dividends paid by the

corporation. However, if the company is small and a sole proprietorship, partnership, or limited

liability company, then the owner or owners will take a draw from the business as their salaries.

The expanded accounting equation, after you consider sales revenue and expenses, is:

Assets = Liabilities + Owner's Equity + Revenue - Expenses - Draws

where: Revenues increase Owner's Equity

Expenses decrease Owner's Equity

Draws or Dividends decrease Owner's Equity

It's important that your accounting equation balance because, if it does not, your financial reports

will not make sense or enable you to keep track of your financial transactions.

For you to do.

  • a) With 3 examples in each case, explain the three elements of the accounting equation

  • b) On 1 st January 2010, Edward started a business of selling ladies‟ Garments around the small kampala. He started with cash of UGX 5,000,000 at hand and cash at bank of UGX 10,000,000

Jan 2. Purchased stock for UGX 3,000,000, paying 60% cash and 40% on credit. Sold 2/3 of

the goods at UGX 2,500,000 on credit

Jan 3. Paid rent UGX 100,000 cash

Jan 10. Received cash payment of UGX 2,000,000 from debtors and paid UGX 1,000,000

cash to suppliers.

Jan 15. Bought motor vehicle for UGX 6,000,000, paid UGX 2,000,000 by cheque, UGX

1,000,000 cash and promised to pay the balance later.

Jan 20. Sold ½ of the remaining stock of goods for UGX 700,000 collecting cash of

UGX 200,000 immediately and the balance to be received later.

Jan 25. Paid electricity UGX 200,000 by cheque

Jan29. Used business cash of UGX 200,000 to buy a trouser for her husband

Jan 31. Acquired a loan of UGX 4,000,000 from a cousin brother to be repaid in two year‟s

time. It was deposited on the business

bank account.

Required

Construct accounting equations for each of the above transactions and at the end, come up

with an elementary balance sheet.

Two financial statements are used by financial institutions to evaluate a company's loan

application, the Income Statement and the Balance Sheet.

The Income Statement shows the sales (incoming revenues) and expenses over a set period of

time. This statement is a good indicator of the profitability of a business during a particular

period, as it shows the net result when the sales of the business are put against its expenses. The

Balance Sheet, on the other hand, shows the business assets, liabilities and shareholder capital on

a specific date, and as a result gives a good picture of a company's financial position.

In this article, we take a closer look at the balance sheet and what the numbers represent.

Assets

Liabilities

The Intangibles

Equity

Assets

Assets are anything with commercial value that your business owns. They are divided into three

categories: current assets, fixed assets, and other assets.

Current assets are cash, accounts receivable, inventory, and other assets that will likely be turned

into cash, bartered, exchanged, or converted into an expense within a year during the normal

course of business. Included in the “other current assets” category are loans to shareholders, also

known as due to shareholders.

Some business owners will not pay themselves a salary, preferring to take drawings, which they

must deal with at year-end. In the current assets section, due to shareholder amounts may

artificially inflate current assets if you plan to convert them to bonuses, dividends or

management fees at year-end, at which time they become expenses of the business.

Fixed assets have commercial value but are not expected to be consumed or converted into cash

in the normal course of business. They are long-term, more permanent or "fixed" items, such as

land, building, equipment, fixtures, furniture, and leasehold improvements.

Fixed assets often decrease in value (depreciate) over time due to wear and tear from use. The

federal government allows businesses to depreciate items for tax purposes, and it has defined

specific depreciation rates for different categories of fixed assets. On your balance sheet,

therefore, you will see the initial value of the asset, the amount of accumulated depreciation, and

finally the net depreciated value of the asset.

Example of a fixed asset on the balance sheet:

Vehicle

$ 28,000

Accum Deprec - Vehicle

$ -8,500

Total Vehicle

$ 19,500*

* Net depreciated value of the vehicle.

Other assets are things that don't fit into either of the above two categories, yet still belong on the

balance sheet. They include things like prepaid expenses, which have value but are not fixed or

necessarily to be converted into cash value during the current business year.

Liabilities

Liabilities are company debts or obligations to outside parties as a result of goods or services that

were transferred to your company on a specific date that has already passed. Current liabilities

are the portion of those obligations that are to be paid out during the course of the year, while

long-term liabilities are the portion of your company's obligations that extend beyond that

timeframe.

Current liabilities include accounts payable, accumulated taxes and payroll liabilities, and the

current amount owing on business loans and/or leases.

Long-term liabilities, meanwhile, include the balance of your loans, leases, and other liabilities

beyond the current calendar year.

The Intangibles

While Intangible Assets do not appear directly on your balance sheet, they can be a significant

factor when one looks to buy or sell a business or part of the business. Intangible assets include

things like good will; intellectual property such as copyrights, trademarks, patents; leases;

franchises; permits and so on.

While you do not list these assets on your balance sheet, they are reflected in the sense that they

enable you to maintain profit margins and market share, so in turn they show up on the current

assets section of your balance sheet through the revenue and profits they create.

Equity

Something that is often difficult for new entrepreneurs to grasp is the way equity is calculated on

the balance sheet, where the total assets always equal the total liabilities plus equity.

In other words, your company's equity is equal to the value of its total assets minus its total

liabilities. If the business assets are greater than the liabilities, which is hopefully the case, then

the equity of the business is the positive difference between the two numbers.

The Intangibles While Intangible Assets do not appear directly on your balance sheet, they can be

Sample equity calculation:

On Company ABC's Balance Sheet, the Total Assets are $100,000, while the Total Liabilities are

$40,000. In this case, the difference between the assets and liabilities is $60,000. Since equity is

equal to this difference, the equity of Company ABC at that time is $60,000.

If Company ABC had Total Liabilities of $50,000, with its Total Assets staying at $100,000,

then the equity of Company ABC at that time would be $50,000. The increase in the total

liabilities of the company in comparison to its total assets causes the equity of the business to

drop.

SOURCE DOCUMENTS AND BOOKS OF ACCCOUNTS KEPT BY THE BUSINESS.

In order that the entries made in the books of account are trusted they should be supported by

documentary evidence. Source documents are documents which provide the accounting

information where required. They include the following:-

i)

Cash sale ship

This is used for cash transactions. It is prepared by the seller and issued to the

customer who has paid for the goods on spot.

ii)

Cash Receipt

Is issued when a debtor pays for the goods already delivered or service already

rendered. It acknowledges the receipt of cash.

iii)

Cash payment voucher

This is prepared for internal use. It is prepared/approved by top management to

authorize payment of cash for goods or services.

iv)

Bank deposit slip

This is a document issued by the bank to its client as evidence that cash or cheque has

been deposited into the bank account.

v)

Bank statement

This is a document issued by the bank to its customer showing the transactions that

have taken place during a given period of time. It shows deposits made, with draws

and the balance as at a given date.

vi)

Invoice

Is a document which gives the quantity, quality, unit price, total value of the goods

sold on credit

vii)

Delivery note

This is a document showing the list of goods, without showing their prices which is

sent to the buyer. It is used for checking the goods. When the goods are delivered to

the buyer, he is supposed to retain one copy and return the other copy to the seller,

duly signed by him. It proves that the goods have been delivered.

viii)

Credit note

This document shows a decrease on the claim of money. It is issued when part of the

goods sold or purchased are returned or price overcharged is reduced at a later stage.

ix)

Debit note

This document is sent by the seller to correct for an undercharge on the original

invoice. It is issued because it is considered to issue another document rather than to

do the alterations on the original invoice.

DOUBLE ENTRY SYSTEM AND PREPARATION OF BOOKS OF ACCOUNTS

DOUBLE ENTRY SYSTEM.

This is a book keeping system where there is dual recording of transactions that is; it should be

recorded twice in 2 books of Accounts.

In the Double entry system, the Debit (DR) entry must have a Corresponding Credit (CR) entry

and vice versa.

To every transaction, the totals must be the same that is; DR and CR totals. Debit and Credit are

means of increasing and decreasing an account‟s balance depending on the nature of account.

A Debit entry may increase or decrease or vice versa.

AN ACCOUNT

An account is a means of bringing together records or it‟s a means of bringing together records

of all transactions which took place in a business in chorological order that is; recorded in order

of time.

Accounts include; “IMPERSONAL” and „PERSONAL ACCOUNTS”. Personal accounts

include; Debtors and Creditors Accounts and Impersonal accounts are subdivided into „Real‟ and

„Nominal‟ Accounts. Real Accounts are accounts of tangible things. For example; Furniture

whereas Nominal Accounts are accounts of intangible things that is; services like; advertising.

FORMATS OF ACCOUNTS

  • 1. T Account Format. This is the Debit and Credit format in a T form that is;

DR CASH A/C CR
DR
CASH A/C
CR
  • 2. Running Balance Format. This is a format where a balance is shown every after the recording of a transaction.

CASH ACCOUNT

 

Date

Details

Folio

Debt

Credit

Balance

 
           

Type of Account

   

Increase

 

Decrease

   

Normal Balance

   

Asset Account

Debit (DR)

 

Credit (CR)

 

Debit (DR)

Liabilities Account

Credit (CR)

 

Debit (DR)

 

Credit (CR)

Incomes Account

Credit (CR)

 

Debit (DR)

 

Credit (CR)

Owners‟ Equity

Credit (CR)

 

Debit (DR)

 

Credit (CR)

Capital & reserves

     

Expenditures

Debit (DR)

 

Credit (CR)

 

Debit (DR)

Account

   
  • - Liabilities are obligations you have to pay in a business.

  • - Things or goods which are not for resale are not purchases.

Examples;

 

i)

Sold goods for cash 8 million

 

DR

CASH A/C

CR

DR

SALES

A/C

Sales

8m

Cash

1m

CASH

ii)

Bought furniture for 5 million and paid by cheque

 
 

BANK A/C

 

FURNITURE A/C

 
 

Furniture

5m

BANK

5m

 

iii)

Bought goods for 3 million on credit

 
 

PURCHASES

 

CREDITOR A/C

 
 

Creditor

3m

 

Cash

1m

Purchases

iv)

Made part payment 1 million cash on credit

 

Definition and Explanation of Cash Book:

Learning Objectives:

  • 1. Define and explain cash book.

3.

Prepare a format of the simple cash book.

Cash book is a book of original entry in which cash transactions relating only to cash receipts

and payments are recorded in detail. When cash is received it is entered on the debit or left hand

side. Similarly, when cash is paid out the same is recorded on the credit or right hand side of the

cash book.

The cash book, though it serves the purpose of a cash book of original entry viz., cash journal

really it represents the cash account of the ledger separately bound for the sake of convenience.

Types of cash books.

  • a) Single column cash book.

  • b) Two/double column cash book.

  • c) Triple or three column cash book

  • d) Analytical petty cashbook.

Vouchers:

For Every entry made in the cash book there must be a proper voucher. Vouchers are documents

containing evidence of payment and receipts. When money is received generally a printed receipt

is issued to the payer but counterfoil or the carbon copy of it is preserved by the cashier.

The copy receipts are called debit vouchers, and they support the entries appearing on the debit

side of the cash book. Similarly when payment is made a receipt is obtained from the payee.

These receipts are known as credit vouchers. All the debit and credit vouchers are consecutively

numbered. For

Balancing Cash Book:

The cash book is balanced at the end of a given period by inserting the excess of the debit on the

credit side as "by balance carried down" to make both sides agree. The balance is then shown on

the debit side by "To balance brought down" to start the next period. As one cannot pay more

than what he actually receives, the cash book recording cash only can never show a credit

balance.

Format:

The following is the simple format of a cash book:

Date

Particulars

L.F.

Amount

Date

Particulars

L.F.

Amount

               

Single Column Cash Book:

Learning Objectives:

  • 1. Define and explain single column cash book.

Definition and Explanation:

Single column cash book records only cash receipts and payments. It has only one money

column on each of the debit and credit sides of the cash book. All the cash receipts are entered on

the debit side and the cash payments on the credit side.

While writing a single column cash book the following points should be kept in mind:

  • 1. The pages of the cash book are vertically divided into two equal parts. The left hand side is for recording receipts and the right hand side is for recording payments.

  • 2. Being the cash book with the balance brought forward from the preceding period or with what we start. It appears at the top of the left side as "To Balance" or "To Capital" in case of a new business.

  • 3. Record the transactions in order of date.

  • 4. If any amount of cash is received on an account, the name of that account is entered in the particulars column by the word "To" on the left hand side of the cash book.

  • 5. If any amount is paid on account, the name of the account is written in the particulars column by the word "By" on the right hand side of the cash book.

  • 6. It should be balanced at the end of a given period.

Posting:

The balance at the beginning of the period is not posted but other entries appearing on the debit

side of the cash book are posted to the credit of the respective accounts in the ledger, and the

entries appearing on the credit side of the cash book are posted to the debit of the proper

accounts in the ledger.

Format of the Single Column Cash Book:

Following is the format of the single column cash book:

Date

Particulars

L.F.

Amount

Date

Particulars

L.F.

Amount

               
               

Example:

Write the following transactions in the simple cash book and post into the ledger:

1991

Jan. 1

Cash in hand

15,000

"

6

Purchased goods for cash

2,000

"

16

Received from Akbar

3,000

"

18

Paid to Babar

1,000

"

20

Cash sales

4,000

"

25

Paid for stationary

60

"

30

Paid for salaries

1,000

"

31

Purchased office furniture

2,000

Solution:

 

Cash Book

 

Date

 

Particulars

L.F.

 

Amount

Date

 

Particulars

L.F.

Amount

1991

             

Jan. 1

To Balance b/d

 

15,000

Jan. 6

By Purchases a/c

2,000

16

To Akbar

3,000

18

By Babar

1,000

20

To sales a/c

4,000

25

By stationary

60

 

30

By Salaries a/c

1,000

 

31

By Furniture a/c

By Balance c/d

2,000

 

22,000

15,940

 

15,940

 

22,000

To Balance b/d

   
 

Akbar

     

1991

   

$

 

Jan. 16

By Cash

3,000

 

Sales Account

 
     

1991

   

$

 

Jan. 2

By Cash

4,000

 

Purchases Account

 

1991

 

$

     

Jan. 6

To Cash

2,000

 

Babar Account

 

1991

 

$

     

Jan. 18

To Cash

1,000

 

Stationary Account

 

1991

 

$

     

Jan. 25

To Cash

60

 

Salaries Account

 

1991

 

$

     

Jan. 30

To Cash

1,000

Furniture Account

1991

 

$

     

Jan. 31

To Cash

2,000

Two Column Cash Book/Double Column Cash Book:

Learning Objectives:

  • 1. Define and explain a two/double column cash book.

  • 2. Prepare a two column cash book.

  • 3. What is the difference between a single column cash book and a double column cash book?

Definition and Explanation:

A double column cash book or two column cash book is one which consists of two separate

columns on the debit side as well as credit side for recording cash and discount. In many

concerns it is customary for the trader to allow or to receive small allowance off or against the

dues. These allowances are made for prompt settlement of accounts. In certain business almost

all receipts or payments are accompanied by such discounts and in order to avoid unnecessary

postings separate columns in the cash book are introduced to record the discounts received or

allowed. These discount columns are memorandum columns only. They do not form the discount

account. The discount column on the debit side of the cash book will record discounts allowed

and that on the credit side discounts received.

Posting:

The cash columns will be posted in the same way as single column cash book. But as regards

discount column, each item of discount allowed (Dr. side of the cash book) will be posted to the

credit of the respective personal accounts. Similarly each item of discount received will be

posted to the debit of the respective personal account. Total of the discount column on the debit

side of the cash book will be posted to the debit side of the discount account in the ledger and the

total of discount column on the credit side of the cash book on the credit side of the discount

account. The discount columns are not balanced like cash column of the tow column cash book.

Format of the Double Column Cash Book:

 

Debit Side

 

Credit Side

 

Date

Particulars

V.N.

L.F.

Discount

Cash

Date

Particulars

V.N.

L.F.

Discount

Cash

                       

Example of Two Column Cash Book:

From the following transactions write up a two column cash book and post into ledger:

1991

Jan. 1 Cash in hand $2,000 " 7 Received from Riaz & Co. $200; discount allowed
Jan. 1
Cash in hand $2,000
"
7
Received from Riaz & Co. $200; discount allowed $10
"
12
Cash sales $1,000
"
15
Paid Zahoor Sons $500; discount received $15
"
20
Purchased goods for cash $300
"
25
Received from Salman $500; discount allowed $15
"
27
Paid Hussan & Sons $300.
"
28
Bought furniture for cash $100
"
31
Paid rent $100
Solution:
Cash Book
Debit Side
Credit Side
Date
Particulars V.N. L.F. Discount
Cash
Date
Particulars
V.N. L.F. Discount
Cash
1991
1991
Jan.1 To Balance
2,000
Jan.5 By Zahoor &
15
500
"
7
b/d
10
200
"
20 Sons
300
"
12 To Riaz &
1,000
" 27 By purchase a/c
300
"
25 Co.
15
500
"
28 By
100
To Sales a/c
"
31
Hussan&Sons
100
To Salman
By Furniture
2,400
25
3,700
a/c
15
3,700
By Rent a/c
1991
2,400
By Balance c/d
Feb1
To Balance
b/d
Riaz & Co.
1991
$
Jan. 7
By Cash
200
By Discount
10
 

Sales Account

 
     

1991

 

$

Jan. 12

By Cash

1,000

 

Salman Account

 
     

1991

 

$

Jan. 25

By Cash

500

By Discount

15

 

Babar Account

 

1991

 

$

     

Jan. 18

To Cash

1,000

 

Zahoor Account

 

1991

 

$

     

Jan. 15

To Cash

500

Discount

15

 

Purchases Account

 

1991

 

$

     

Jan. 20

To Cash

300

 

Hussan & Sons

 

1991

 

$

     

Jan. 27

To Cash

300

 

Furniture Account

 

1991

 

$

     

Jan. 28

To Cash

100

 

Rent Account

 

1991

 

$

     

Jan. 31

To Cash

100

Discount Account

1991

 

$

1991

   

Jan. 31

To Sundries as per Cash

Jan. 31

By Sundries as per cash

book

25

book

15

Three Column Cash Book:

Learning Objectives:

  • 1. Define and explain a three column cash book/treble column cash book.

  • 2. Prepare a three column cash book.

  • 3. What is the difference between a single column cash book, a double column cash book and a three column cash book?

Definition and Explanation:

A three column cash book or treble column cash book is one in which there are three columns

on each side - debit and credit side. One is used to record cash transactions, the second is used to

record bank transactions and third is used to record discount received and paid.

When a trader keeps a bank account it becomes necessary to record the amounts deposited into

bank and withdrawals from it. Fir this purpose one additional column is added on each side of

the cash book. One of the main advantages of a three column cash book is that it is very

helpful to businessmen, since it reveals the cash and bank deposits at a glance

Writing a Three column Cash Book:

Opening Balance:

Put the opening balance (if any) on cash in hand and cash at bank on the debit side in the cash