DATTA MEGHE INSTITUTE OF ENGINEERING, TECHNOLOGY AND RESEARCH, SAWANGI (MEGHE), WARDHA

Managerial Economics & Accountancy

IIIrd Sem IT
Yashwant Misale (B.E,MMS) [Faculty MBA Department]

Unit : 5
Accounting Concepts and Introduction to GL When a person starts a business his main aim is to earn profit. He receives money from certain sources like sale of goods, Interest from bank deposits etc. He has to spend money on certain items like purchase of goods, salary, rent etc. These activities take place during the normal course of his business. Business transactions are numerous, that it is not possible to remember all those transactions and recall as to how the money had been earned and spent. If he had noted down his incomes and expenses he can get the required information easily. Hence it becomes necessary to record activities, which have monetary effect, in a clear, and a systematic manner to get answers for the following questions 1. 2. 3. 4. 5. 6. 7. What has happened to his investment? What is the result of the business transactions? What are the earnings and expenses? How much amount is receivable from customers to whom goods have been sold on credit? How much amount is payable to suppliers on account of credit purchases? What are the nature and value of assets possessed by the business concern? What are the nature and value of liabilities of the business concern?

These and several other questions are answered with the help of accounting.

Accounting
Accounting is nothing but recording a set of business transaction in the books of accounts. Any financial transaction or non-financial transaction like (cash or non cash) even depreciation, goodwill etc has to be recorded. The purpose of accounting is to provide the information that is needed for sound economic decision making. The main purpose of financial accounting is to prepare financial reports that provide information about a firm's performance during a period to external parties such as investors, creditors, and tax authorities and the financial position of the firm as on a particular date

Branches of Accounting
Financial Accounting is concerned with recording of business transactions in the books of accounts in such a way that operating result of a particular period and financial position on a particular date can be known. It deals with preparation of financial statement like profit & loss account, balance sheet etc. which is used by all types of companies. Cost Accounting relates to collection, classification and ascertainment of the cost of production or job undertaken by a firm. It is used by only manufacturing companies. This deals with preparation of various cost based statements to fix the selling price for a product, break-even analysis, etc. Management Accounting relates to the use of accounting data collected with the help of financial accounting and cost accounting for the purpose of policy formulation, planning, control and decision making by the management. Any type of company can use management Accounting. This deals with preparation of various reports for the management based on which they take decisions.

Branches of Accounting

Financial Accounting

Cost Accounting

Management Accounting

Book Keeping
Book Keeping is the method of maintaining accounts. There are two methods of book keeping namely Single Entry book keeping and Double entry book keeping.

Method of Book Keeping

Single Entry Book keeping

System of Book Keeping

Double Entry Book keeping

Single Entry Book Keeping Single entry book keeping is a method of maintaining accounts which do not conform to strict principles of double entry book keeping. Under this system, only the personal accounts of debtors, creditors and cashbook of the trader are maintained. The absence of two fold effect makes it impossible to prepare Trial Balance and Final Accounts. Hence, Single Entry is incomplete and not reliable. This is followed by firms whose transactions are limited and where they maintain only essential records.

Double Entry Book Keeping Any business transaction when closely analysed reveals two aspects. One aspect will be Receiving aspect or Incoming aspect or expenses/Loss aspect. This is termed as the Debit Aspect. The other aspect will be Giving aspect or Income/gain aspect This is termed as the Credit Aspect. In short the basic principles of this system is, for every debit there must be a corresponding credit of equal amount and for every credit there must be a corresponding debit of equal amount. For example sale of furniture affects both the cash account and the furniture (asset) account. Asset in the form of furniture goes out of business and money for that value of furniture comes into the business. Two entries are made for each transaction, one entry as a debit in one account and other entry as a credit in another account. Two notable characteristics of double entry book keeping are 1. 2. Every transaction affects two accounts Each transaction has two aspects i.e., Debit and Credit.

What is an Account?
Every transaction has two aspects and each aspect has an account. An account is a summary of relevant transactions at one place relating to a particular head. In this system, the double entries take the form of debits and credits, with debits in the left column and credits in the right. For each debit there is an equal and opposite credit and the sum of all debits therefore must equal the sum of all credits. This principle is useful for identifying errors in the transaction recording process.

Principles/Concepts of Accounting
Accounting entries are made keeping the following principles in mind. Conservatism According to this principle all known expected expenses are provided for whereas expected income is not recorded. Double Entry System For every debit entry there is a corresponding credit entry for the same amount. Dual aspects of transaction are recorded and accounts for all the account types viz. Personal, Real and Nominal are maintained.

Cut Off Date Profit & Loss account is to show the performance of the business for a given period ending on a date known as cut off date Balance Sheet is to show the financial position of the business as on that date. Basis of Accounting Every transaction should not be qualified and the monetary value should be recorded. Items that can be quantified in monetary terms alone will be accounted. Items like Employees Moral, skill set or a

companys brand image, quality of management are not accounted (unless someone is prepared to pay something for them) Revenue Recognition Revenue is both revenue income and revenue expenditure. Eg. Claim provision is made on intimation date itself. Similarly for revenue income, premium has to be recognised on the date on which the coverage commences. Only at that time the revenue should be recognized in the books of accounts. If policy issue date is 15, March 2005 and premium is collected on 15, March 2003 and if the policy effective date is April 1, 2005 then this is the date on which the revenue has to be recognised in the books of account. Historical Data Transaction should be recorded after it has happened. Going Concern Concept Assumed that the business will go on forever. Ownership & Control Segregation Owner and business are separate. Types of ownership are sole proprietor, partnership, private limited company, public limited company, and co-operative society. Any household or personal expenses paid from the business should not be debited as business expense, but it should be debited to the personal account

Types of Accounts in Double Entry System

There are 3 types of Accounts in the double entry system of book keeping. They are 1. Personal Account 2. Real Accounts 3. Nominal Accounts
Account Types

Personal Accounts

Real Accounts

Nominal Accounts

Personal Account Account maintained in the names of person or concern or companies. Eg: Rams A/c, Ramesh & co. ABC Insurance Company, XYZ Brokers & Co etc The Rule for Personal Account is

Debit the Receiver Credit the Giver Real Account Asset Account (other than Personal Accounts) is classified as Real accounts. Eg. Cash A/c, Bank A/c, Furniture A/c, Building & Machinery A/c The Rule for Real Account Debit what comes in Credit what goes out Nominal Account Accounts maintained for Incomes, Expenses, Profits and Losses are classified as Nominal Accounts. Eg. Salary A/c, Premium A/c, Dividend Account, Rent Account etc. The Rule for Nominal Account Debit all expenses and losses Credit all incomes and gains

Some Important Accounting Documents Journal

A Journal is a chronological listing of the firms transaction including the amounts, accounts that are affected and whether the affected account is to be debited or credited. Journal is the primary book of accounts from which the different accounts are debited or credited.

Ledger
Ledger is a principal or main book which contains all the accounts to which the transactions recorded in the Journal are transferred / posted. In Journal each transaction is recorded separately and it is not possible to know the net result of many transactions pertaining to a particular account at a glance. A ledger is a book which contains all the accounts whether personal, real or nominal. It is an account wise collection of transaction. So that tracking of individual account balances becomes easier. After recording a transaction in the Journal it is then transferred to the ledger. The process of transferring the debits and credits to the Ledger is called Posting. Each Ledger Account will have Debit and Credit columns. Based on each transaction in journal, the ledger account can have debit or credit or both entries. Both debit and credit columns will be totalled to find out the net balance of the account.

Posting
The process of transferring the entries recorded in the journal or subsidiary books to the respective accounts opened in the ledger is called posting. In other words, posting refers to grouping of all the transactions relating to a particular account at one place. It is necessary to post all the transactions into various accounts in the ledger because posting helps us to know the net effect of various transactions during a given period on a particular account.

Cash Book
This is a ledger for cash transactions where the cash receipt are recorded on the debit side and cash payments are recorded on the credit side.

Bank Book
This is a ledger where bank related transactions are posted. All the bank receipts are posted on the debit the side and bank payments are posted on the credit side. Bank receipt refers to income by way of cheque and Bank payment refers to any payment by way of cheque.

Trial Balance
The Trial balance is a listing of all Leger Account Balances, which can be a Debit or Credit Balance. The total of all debit Balances should tally with the total of Credit balances. If it does not tally then there is mistake in posting/totalling/balancing the accounts Such errors will come to light by preparing this trial balance.

Final Accounts
The businessman is interested in knowing whether the business has resulted in profit or loss and what is the financial position of the business at a given date. In short he wants to know the profitability and the financial soundness of the business. This could be ascertained by preparing the final accounts. Final accounts are prepared at the end of the year from the trial balance. The parts of final accounts are 1. Trading account 2. Manufacturing account 3. Revenue account in case of Insurance Companies 4. Profit and Loss account 5. Balance sheet Trading Account Trading means buying and selling. This account shows the results of buying and selling of goods. Gross profit or Gross loss is ascertained by preparing Trading account. This is prepared by trading companies to find out the trading profit/loss. Expenses include purchase, wages, etc. Income includes sales, closing stock etc. Manufacturing Account (For Manufacturing Concerns) This is a statement prepared by manufacturing firms to find out at the end of the financial year whether they have made a profit or loss. This is prepared taking into account only the income and expenses, which are directly related to the manufacturing operations. It does not include income like interest from investment and expenses like salary to permanent staff. It is prepared taking expenses like wages, materials, manufacturing expenses like power, water etc and income include closing stock.

Revenue Account Insurance companies do not prepare Trading account or manufacturing account since they dont deal with purchasing and selling of goods or manufacture of goods. So they prepare Revenue accounts where premium received is treated as an income and the claims paid is treated as an expenses with other management expenses like salaries paid, rent paid, commission paid etc. This is prepared for each class of business separately. Profit and Loss Account Profit and Loss account is prepared to compute the Net profit or Net loss. Management Expenses and Administrative expenses, Investment income and income from other sources are entered in P& L account. Expenses relating to purchasing and selling of goods are not entered in this account. Balance Sheet This is a statement prepared at the end of a financial year where the Assets and Liabilities are stated along with their values. It shows the financial position of a business at a given date. The Capital and Liabilities are shown on the left hand side and Assets and other debit balances are shown on the right hand side. The total value of Assets and total value of Liabilities should be equal. Balance Sheet is prepared with a view to measure the correct financial position of a business on a certain date. It is a snap shot of the financial condition of the business. An important thing to note about the Balance Sheet is that it is always balances i.e., total value of asset is always equal to the total value of liabilities

Format of Revenue A/c, P&L A/c and Balance Sheet

Dr Revenue Account Cr Premium (Less RI) Commission Received Salvage / Recovery

Claim Paid (Less RI) Commission Paid Claim expenses Management expenses (Salary etc)* Reserve for Unexpired Risk Revenue Surplus /Deficit (Balancing Figure)

If the total of credit items is higher than the debit items then it results in surplus and if it is the other way around it results in deficit. * These expenses are apportioned to the various classes of business based on some proportion. The revenue account is prepared separately for Marin, Fire and Miscellaneous. Dr Revenue Deficit Non-Operating Expenses Revenue Surplus Non-Operating Income

Depreciation Etc. Net profit /Loss* (Balancing Figure)

(Eg. Interest on Investment)

* This amount is taken to the Reserves & Surplus in the Balance Sheet. Balance Sheet Share Capital P & L Account (Net profit) Reserves & Surplus Secured Borrowings Unsecured Borrowings xxxxxx xxxxxx xxxxxx xxxxxx xxxxxx Investments Loans Fixed Assets Current Assets & Liabilities Cash Debtors Stock ---------------------Less: Salary Payable P.F payable P& L A/c (Loss to be written Off) xxxxxx xxxxxx xxxxxx xxxxxx

xxxxx xxxx

xxxxxx

xxxxxxx

Flow of Activities in Double Entry system

Identify the accounts involved Identify the Transaction to be recorded
Identify the type of account and the amount

Analyse the Transaction.

Aplly the rule for the type of account and record the transaction The transaction in recorded primarily in the Jounal debiting one account and crediting another account

Recording the transaction

Ledger is a summary of transaction related to a particular account

Debits are entered in the Left hand side and Credits are entered in the Right hand side

Posting to Ledger

All the debit/credit balances in the ledger for various accounts are transferred to Trial balance

Trial Balance is prepared to check the arithmetical accuracy of the transactions recorded.

Trial Balance

Financial Statements

Trading Account To find the Gross profit/ Loss

Manufacturing Account. Followed by manufacturing units to find the Gross profit/ Loss.

Revenue Account Followed by Insurance Cos to find the UW profit/ Loss(GI) and Life Fund(Life)

Profit & Loss Account To find the Net profit/Loss

Profit & Loss Appropriation Account

Balance Sheet