Introduction To Accounting

1
Reading Materials for Accounting

Introduction to Accounting
 Accounting is a language of systematic recording, reporting, and analysis of financial
transactions of a business.
 Accounting identifies, records, and communicates relevant, reliable and comparable
information about an organization’s business activities.
O Accounting is the universal language of business and finance.
 Accounting helps to communicate financial information about a business to shareholders.
Types of Accounting
Type Details
 It includes reporting of the financial position and performance of

a firm through financial statements issued to the external users
Financial on a periodic basis.
Accounting  It includes:
o Revenues, Earnings, Assets and liabilities
o Profit and loss statement and balance sheet
 It combines accounting, finance and management with cutting-

Management edge techniques needed to drive business successfully.
Accounting  It includes:
o Costing, Budgeting, Net Present Value
Accounting is about 5 Simple Things

 Assets –Property whose value can be expressed in monetary terms is known as Asset.
O Examples: Cash, accounts receivable, inventory, notes receivable, prepaid expenses,
land, buildings, equipment, furniture, and fixtures.
 Liabilities - Obligations that an organization owes to someone else.
O Examples: Notes Payable, Accounts Payable, Accrued Liabilities, Long-Term Liabilities
(bonds).
 Expenses - The cost of doing business necessary to produce revenue.
 Revenue - Income that a company receives from its normal business activities.
 Owners’ Equity - The amount remaining after the value of all liabilities is subtracted from
the value of all assets
o Examples: Common Stock, retained earnings, revenues, and expenses.
www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

2
Assets
 Assets: Property owned by a person or a firm that is available to pay off debts.
 Liquid Assets: An asset that can be converted into cash quickly and with minimal impact
to the price received.
O Examples: Cash, cash receivables and securities.
 Current Assets: A current asset is either cash or an asset that can be sold.
O Examples: Inventories and supplies, can be turned into cash.
 Fixed Assets: Assets that are purchased for long-term use and are not likely to be
converted quickly into cash.
O Examples: Buildings, equipment, and natural resources
 Land: Fixed, but never depreciated.
 Intangible Assets: Properties other than the physical assets of a business that helps to
create operating profit.
O Examples: Patents, trademarks, and copyrights
Liabilities
 Liability: An obligation to pay debts.
 Current Liabilities: A debt to be paid with cash or with goods and services within one
year or within the entity's operating cycle if the cycle is longer than a year.
o Examples: Accounts Payable and credit card debt
 Long Term Liabilities: Liabilities with a future benefit over one year, such as notes payable
that mature longer than one year.
o Mortgage
o Note Payable
 Unearned Revenues: Payment received before a good is sold or a service is provided.
 Bonds: A fixed interest financial asset issued by governments, companies, banks, public
utilities and other large entities.
Expenses
 Expenses: The cost of doing business.
 Decrease in owners’ equity during the period by using up an asset or a portion of an asset.
 Can create additional liabilities.
Revenue
 Revenue: Income an organization has earned.

3
 An increase in owners’ equity during the period by performing a service or selling an

asset.
Owners’ Equity
 Owners’ Equity: Owners’ ownership (equity) in the business, or the amount of the business
assets owned by the business owners.
 An individual or company's net worth.
 Used in determining an individual's or company's creditworthiness, and can be used in
determining the value of a business when its owner or shareholders want to sell.
 This is calculated by taking the value of all assets and subtracting the value of all
liabilities.
O Owners’ Equity = Assets - Liabilities
 The portion of your assets that you can legally claim.
Fundamental Accounting Equation

 In the GAAP framework, there must be a continuous equilibrium between assets on the
one side and the total of liabilities and equity on the other side.
 This is represented by the fundamental equation of accounting:
o Assets = Liabilities + Owners’ Equity
 The recording of every transaction must keep this equation in balance, for which double
entry bookkeeping is employed.
Assets (owns) What the business owns
Liabilities (owes) What the business owes
Owners’ Equity (worth) What is the worth of the business
Example of Owners’ Equity

 Company A purchased a building for $500,000 with a 10% down payment ($50,000)
o Assets Amount = Sales Price = Cost of a Building = $500,000
o Liabilities: What you still owe on the building: $450,000
o Owner’s Equity or Capital (Your equity in the building)
o = $500,000 - $450,000 = $50,000

4
Ways of Money In
Payments from Customers
Operations Refunds from Suppliers
Investment by Owners
Financing Investment by Creditors (loans)
Return on Investments (interest and

dividend)
Investing Proceeds from Selling Assets
Repayment of amounts loaned to other
entities
Ways of Money Out

Payments to Suppliers
Operations Refunds to Customers
Payment of dividends or capital to
Financing Owners
Repayment of Creditors
Purchase of Assets
Investing Amounts invested in other entities (debt

or equity)
Core Components of Accounting

 Balance Sheet:
o Reports on a company's assets, liabilities, and ownership equity at a given point in
time
 Income statement or profit and loss statement (P&L):
o Reports on a company's income, expenses, and profits over a period of time
Balance Sheet
 It shows a net worth of a business.
 The amounts presented on the balance sheet are aggregated from the entity’s beginning to
the balance sheet date.
 Provides following:

5
o List of Assets
o List of Liabilities and Owners’ Equity
Income Statement
 It is a company's financial statement that indicates how the revenue is transformed into
the net income.
 Its accounts are temporary accounts.
o Matches expenses with revenues for a specific period of time
 The amounts presented in the income statement are aggregated from the beginning of the
period to the end of the period only.
o Income statement accounts are closed out at the end of the reporting period and
started over again in the next period.
 It is used to determine the net income or net loss of an individual or business for a
defined period of time.
o Used for marking progress by comparing months and years.
Sarbanes-Oxley
 The Sarbanes-Oxley act (2002) emphasizes the importance of internal control.
o Internal Control – The procedures and processes used by a company to safeguard its
assets, process information accurately, and ensure compliance with laws and regulations.
 Requires companies and their independent accountants to report on the effectiveness of
the company’s internal controls.
 The major provisions of the act established the Public Company Accounting Oversight
Board (PCAOB).
Internal Controls
 Internal control is defined as a process affected by an organization's structure, work and
authority flows, people and management information systems, designed to help the
organization accomplish specific goals or objectives.
 Policies and procedures:
o Protect assets from misuse.
o Ensure that business information is accurate.
o Ensure that laws and regulations are being followed.
Objective of Internal Controls

 Provides reasonable assurance that:

6
o Assets are safeguarded and used for business purposes.

o Business information is accurate.
Elements of Internal Controls

 Risk Assessment
 Control Procedures
 Monitoring
 Information and Communication
Double Entry Accounting
● Every business transaction causes at least two changes in the financial position of a
business concern at the same time.
● The core idea is to record the dual effects of each business transaction.
● The system under which both the changes in a transaction are recorded together:
o One change is debited, while the other change is credited with an equal amount.
● All journal entries have two “sides”:
o Debit (increase): Debits are positive numbers. Assets and expenses normally have
debit balances.
o Credit (decrease): Credits are negative numbers. Liabilities, fund balance and
revenues normally have credit balances.
● Assets are on the left (debit) side.
● Liabilities and equity are on the right (credit) side.
● For every journal entry, the total debits must equal the total credits.
● This ensures that the fundamental accounting equation (Assets = Liability + Owner's
Equity) is always in balance.
● Transaction or event occurs.

● Transaction is recorded in the journal using a journal entry (decisive step).
● Journal is posted to ledger.
● Ledger accounts are totalled.
● Financial statements are prepared. They includes:
o Income statement
o Statement of owners’ equity
7
o Balance sheet
o Statement of cash flow
T-Account for Assets
Type of Account Debit Credit
Assets Increases Decreases
T-Account for Liability
Liability Decreases Increases
T-Account for Owner’s Equity
Owner’s Equity Decreases Increases
T-Account: Always Balanced

● Assets = Liability + Owners’ Equity
Income Statement Accounts

● Net Income: The amount of money left after all costs and expenses have been
deducted.
● Net Income (Credit > Debit)
o Increases stockholder’s equity (retained earnings).
● Net Loss: The amount of additional money needed when expenses are greater than
income.

8
● Net Loss (Debit > Credit)

o Decreases Stockholder’s Equity (retained earnings).
Journal
● A list in chronological order of all the transactions for a business.
● The first book in which a transaction is recorded.
● Debit before credit.
● Indent credit information.
● Each entry gives Debit = Credit.
Journal Entry
● A journal entry, in accounting, is a log of transactions into accounting journal items.
● The journal entry can consist of several items, each of which is either a debit or a
credit.
● The total of the debits must equal the total of the credits or the journal entry is said
to be "unbalanced".
● Journal entries can record unique items or recurring items such as depreciation
● It includes the following:
o Date of the transaction
o Title of the account debited
o Title of the account credited
o Amount of the debit and credit
o Description of the transaction
Stockholder’s or Owner’s Equity

● Owner's Equity—along with liabilities—can be thought of as a source of the company's
assets.
● Owner's equity is sometimes referred to as the book value of the company, because
owner's equity is equal to the reported asset amounts minus the reported liability amounts.
● Owner's equity may also be referred to as the residual of assets minus liabilities.

9
Profit and Loss
● Profit – The positive gain from an investment or business operation after subtracting
for all expenses.
● Loss – A decrease in net income that is outside the normal operations of the business.
Profit and Loss Account

● A financial statement that summarizes the revenues, costs and expenses incurred
during a specific period of time.
o Usually a fiscal quarter or year
● These records provide information that shows the ability of a company to generate
profit by increasing revenue and reducing costs.
● Profit and Loss accounts provide information about adjustments relating to the
previous year.
Profit and Loss statement

● A summary of the financial performance of a business over time (monthly, quarterly
or annually is most common).
● The P&L statement is also known as:
o A "Statement of Profit and Loss"
o An "Income Statement"
o An "Income and Expense Statement"
Profit and Loss Appropriation Account

● Accounts which show the distribution of net profit.
o Among the shareholders, in the form of dividends, transfer of profits to various
reserves and issuance of bonus shares
● They are prepared:
o After the preparation of profit and loss account
o Before the preparation of balance sheet
● They also provide information about the appropriation of dividends out of available
profit.

10
Difference between P/L Accounts and P/L Appropriation Accounts
P/L Accounts P/L Appropriation Accounts
● Show only the net profit or net ● Show all non-operational adjustment, which is
loss from the operations of a needed for proper distribution of net profit
business. between shareholders and the company for
future growth.
Debit Side of P/L Appropriation Accounts

● The following items are part of debit side P/L appropriation accounts:
o Transfer to reserve /general reserve
o Transfer to dividend/interim or dividend/proposed dividend
o Debenture redemption fund account
o Dividend equalization fund account
o Dividend distribution tax
o Income tax for previous year not provided for
o Surplus transfer to balance sheet
Credit Side of P/L Appropriation Account

● The following items are part of the Credit side P/L appropriation account:
o Balance of surplus of previous year
o Net profit of this year
o Amount withdrawn from general reserve or any other reserve
o Provision such as income tax, provision no longer required or excess of provision
or refund of tax

11
Particular Amount Particular Amount
To transfer to reserve By last year’s balance b/d
To income tax for By net profit for the year b/d

previous year not
provided for
To interim dividend By provision such as income tax provision

no longer required or by excess of
provision or refund of tax
To proposed dividend
To dividend distribution-n
tax @
To surplus carried to
balance sheet (B.F.)
Represents any amount
Components of a Profit and Loss Statement

● The main components of a profit and loss statement are:
o Revenue
o Cost of goods sold
o Gross profit
o Expenses
o Net profit
Revenue
● Revenue is the total earned from ordinary business operations. Revenue includes:
o Sales of goods and services
o Interest received
o Dividends
o Rebates
o Rent received.

12
Cost of goods sold (COGS)

● Cost of goods sold (cost of sales) is the cost of merchandise sold during the period.
● COGS include all the costs directly related to getting your inventory ready for sale
such as:
o The purchase price
o Import duties
o Non-recoverable taxes
o Freight inwards
o Freight insurance
o Handling
o Direct labour
o Other costs of converting materials into finished goods.
Gross profit
● The difference between sales and the cost of producing or purchasing products or
providing services before subtracting operating expenses such as wages, rent, accounting
fees, or electricity.
● Reflects how efficiently labour and materials are used to produce goods.
Expenses
● Expenses (overhead, outgoings) are costs incurred for the purposes of earning income.
They include items such as:
o Wages
o Rent
o Accounting and legal fees
o Electricity, depreciation
o Interest paid on loans
Net profit
● Net Profit is calculated by subtracting expenses from the gross profit.
● Showing what the business has earned in a given period of time after both the cost of
goods sold and operating expenses have been taken into account.
Managerial Accounting

13
● The process of identifying, measuring, analyzing, interpreting, and communicating

information for the pursuit of an organization's goals.
● Focuses on gathering information about costs for planning and control decisions.
● The core idea is to provide useful information to decision makers.
● Used by management for:
o Conducting daily operations
o Planning
o Developing strategies
Managerial Accounting vs. Financial Accounting
Financial Managerial
KeyCustomers ● Investors, creditors, ● Managers, employees and decision

and other users. makers.
● External to the ● Internal to the organization.
organization.
Purpose of ● Assist external users ● Assist managers in making planning

Informatio in making investment, and control decisions.
n credit decisions.
Flexibility of ● Structured and often ● Relatively flexible.

Practice controlled by GAAP.
Timeliness of ● Often available only ● Available quickly without the need to

Informatio after an audit is wait for an audit.
n complete.
Focus on ● Emphasis on whole ● Emphasis on an organization’s

Informatio organization. project, and divisions.
n

14
Use of Managerial Accounting
Area Details
● Strategic planning: Developing long-range courses of

action to achieve goals.
● Operational planning: Developing short-term courses of
action to manage the day-to-day operations of a business.
Planning
● The process of monitoring decisions and evaluating an

organization’s activities and employees.
● Includes the measurement and evaluation of actions,
Controlling processes, and outcomes.
● The process by which managers are given their assigned
Directing level of responsibilities and run day-to-day operations.
Cost Accounting
● The process of comparing costs of production to output produced, and often part of a
company's decision-making for many processes, including budgeting and implementing cost
controls.
● Cost is a resource sacrificed or forgone to achieve a specific objective.
o An actual cost is the cost incurred, as distinguished from budgeted costs.
Fixed and Variable Costs

● Fixed Costs remain unchanged in total for a given time period despite wide changes in
the related level of total activity.
● Variable Cost changes in total in proportion to changes in the related level of total
activity.
Prime Costs
● A business's expenses for the materials and labor it used in production. Prime cost is a
way of measuring the total cost of the production inputs needed to create a given output.

15
● By analyzing its prime costs, a company can determine how much it must charge for
its finished product in order to make a profit.
● By lowering its prime costs, a company can increase its profit margin and/or undercut
its competitors' prices.
Prime costs = Direct materials + Direct labor
Conversion Costs
● The sum of direct labor cost and manufacturing overhead cost.
● The term is used to describe direct labor and manufacturing overhead, because these
costs are incurred to convert materials into the finished product.
Conversion costs = Direct labor cost + Manufacturing overhead cost
The Five Parts of a Cost Accounting System

● A cost accounting system requires five parts that include:
o An input measurement basis
o An inventory valuation method
o A cost accumulation method
o A cost flow assumption
o A capability of recording inventory cost flows at certain intervals
Cost Accounting System
An Input Measurement Basis

16
A Cost Accumulation Method
A Cost Flow Assumption
A Capability of Recording Inventory Cost Flows at Certain Intervals
● It is a relatively new type of procedure that can be used as an inventory valuation

method.
Introduction to Adjusting Entries
● Entries which bring certain account balances up to date at the end of the accounting
period.
● In the accounting process, there may be some transactions that do not immediately
trigger the recording of the transaction.
● These are addressed via adjusting entries, which serve to match expenses to revenues
in the accounting period in which they occur.
Types of Adjustments
● Adjusting entries are required when changes in certain accounts have not been
recorded in the accounting records.
● Adjustments are necessary for items that have either been deferred or accrued.

17
Pre-payments Accrual
(Deferral-cash paid or received (cash paid or received after
before consumption) consumption)
Expenses ● Prepaid expenses:Expenses ● Accrued expenses:Expenses

paid in cash and recorded as incurred but not yet paid in cash or
assets before they are used. recorded.
Revenues ● Unearned revenue:Revenues ● Accrued revenues:Revenues

received in cash and recorded earned but not yet recorded or
as liabilities before they are received in cash.
earned.
The Need for Adjustments

● While preparing the final accounts it, is necessary to ensure that all items of incomes
and expenses relating to the current year are fully accounted.
● The purpose of making various adjustments is to ensure that the final accounts reveal
the true profit or loss and the true financial position of the business.
● Example:
o Suppose a concern closes its books in December. The wages of its workers for the
month of December have not yet been paid.
o They are payable in January next year. It means the wages account does not
include the wages for the month of December.
o Such unpaid wages have to be brought into account and shown in the trading
account along with wages already paid.
● The items which usually need adjustment are:
o Closing stock: A business's remaining stock at the end of an accounting period.
o Outstanding expenses: The expenses that are "unpaid" at the end of the accounting
period.
o Outstanding or accrued incomes: Income which has been earned but not yet
received.
o Prepaid expenses: A current asset representing amounts paid in advance for future
expenses.
o Income received in advance or unearned income.
o Depreciation: The reduction in the value of a product arising from the passage of
time due to use,abuse, wear or tear.

18
o Interest on capital: An amount at an agreed rate of interest which is credited to a

partner based on the amount of capital contributed by the partner.
o Interest on drawing: An amount at an agreed rate of interest, based on the
drawings taken out, which is debited to the partners.
o Bad debts: The portion of a loan or portfolio of loans a lender considers to be
uncollectable. In personal finance, bad debt generally refers to high-interest consumer
debt.
o Provision for bad debts: The provision for doubtful debts is identical to the
allowance for doubtful accounts.
o Provision for discount on debtors: A provision which shows the reserve amount for
adjusting loss due to discount allowed to our debtors.
o Provision for discount on creditors: A provision which the firm may have a chance
to receive the cash discount from the creditors for prompt payment.
Adjusting Entries
● Prepaid expenses: Payment of cash that is recorded as an asset because service or
benefit will be received in the future.
Cash Payment Before Expenses Records
● Prepayments often occur in regard to:

o Insurance
o Supplies
o Advertising
o Rent
o Maintenance on equipment
o Fixed assets
● Unearned revenue: Receipt of cash that is recorded as a liability because the revenue
has not been earned.
Revenue
Cash Receipt Before
Records
● Unearned revenues often occur in regard to:

19
o Rent
o Airline tickets
o School tuition
o Magazine subscriptions
o Customer deposits
● Accrued revenue: Revenue earned but not yet received in cash or recorded.
Adjusting entry results in:

Revenue Recorded Cash
Before Receip
t
● Accrued revenue often occurs in regard to:

o Rent
o Interest
o Services performed
● Accrued Expenses: Expenses incurred but not yet paid in cash or recorded.
● Accrued expenses often occur in regard to:
o Rent
o Interest
o Taxes
o Salaries
o Bad debts
When and Why is Adjustment Entry used?

● Certain end-of-period adjustments must be made when you close your books.
● Adjusting entries are made at the end of an accounting period to account for items
that don't get recorded in your daily transactions.
o Some adjusting entries must be made, because there is a journal entry that “drives”
it.
o Some adjusting entries must be made because of the passage of time there is no
“driver.”
● Adjusting entries are used to insure that revenues are reported when earned and
expenses are reported when incurred.

20
● Adjustments are necessary because applicable things have occurred during the period
but have not been recorded.
● Any adjusting entry always increases either revenue or an expense (not both in the
same entry).
o Either revenue will be receiving a credit or an expense will be receiving a debit.
● The only question for the journal entry then becomes:
o What gets the debit (if the adjustment is to increase revenue)?
o What gets the credit (if the adjustment is to increase an expense)?
● Adjusting entries to increase revenue are required either because someone paid you
before you did any work.
o Remember:
o A prepaid expense is an asset, not an expense.
o Unearned revenue is a liability, not revenue.
Accounting for Depreciation
● The reduction in the value of a product arising from the passage of time due to use,
abuse, wear, or tear.
● Not a method of valuation but of cost allocation.
● This cost allocation can be based on a number of factors, but it is always related to
the estimated period of time the product can generate revenues for the company (economic
life).
● Depreciation expense is the amount of cost allocation within an accounting period.
● Only items that lose useful value over time can be depreciated.
● That said, land can't be depreciated because it can always be used for a purpose.
Depreciation Entry
● A computer bought for at the beginning of the year is worth only at the end of the
year.
● Below table shows depreciation accounting for the computer:

21
Account Debit Credit
Depreciation expense $200
Accumulated Depreciation – Computer $200
Depreciation Methods
● The cost of fixed assets must be charged to the income statement in a manner that
best reflects the pattern of economic use of the asset.
● Most common methods of depreciation include:
o Straight-line method
o Reducing balance method
o Units of production method
Straight Line Depreciation

● The method that depreciates cost evenly throughout the useful life of the fixed asset.
Straight line depreciation is calculated as follows:
● Cost includes the initial and any subsequent capital expenditure.
● Residual value is the estimated scrap value at the end of the useful life of the asset. As
the residual value is expected to be recovered at the end of an asset's useful life, there is no
need to charge the portion of cost equaling the residual value.
● Useful life is the estimated time period an asset is expected to be used from the time
it is available for use to the time of its disposal or termination of use. Useful life is normally
calculated in units of years but it may be calculated based on an alternative basis.
Reducing Balance Method

● The reducing balance method charges depreciation at a higher rate in the earlier years
of an asset.
●
● The amount of depreciation reduces as the life of the asset progresses receivables.
● Depreciation under reducing balance method may be calculated as follows:
o Depreciation = Book value x Depreciation rate
o Book value = Cost - Accumulated depreciation
o Depreciation Rate = Accelerator × Straight line rate
● In the above formula, accelerator is a multiplication factor which accelerates
depreciation. Book value is the difference between cost of an asset and its accumulated
depreciation.

22
Units of Production Method

● The method that provides for depreciation by means of a fixed rate per unit of
production.
● Under this method, one must first determine the cost per one production unit and
then multiply that cost per unit with the total number of units the company produced
within an accounting period to determine its depreciation expense.
o Depreciation expense = Total acquisition cost - Residual value / Estimated total
units
o Depreciation expense = Depreciation per unit × Number of units produced during an
accounting period
Accounting for Receivables

● It is money owed to a business by its clients and shown on its balance sheet as an
asset.
● Accounts receivable, also known as debtors.
● One of a series of accounting transactions dealing with the billing of a customer for
goods and services that the customer has ordered.
Receivables
● Includes all money claims against other entities, including people, business firms, and
other organization.
● Usually, a significant portion of the total current assets.
Accounts Receivable
● Accounts receivable is money owed to a business by its clients (customers or debtors)
and shown on its balance sheet as an asset.
● Results from the sale of merchandise on credit and expected to be collected within a
relatively short period, such as 30 or 60 days.
Notes Receivable
● Amounts that customers owe, for which a formal written instrument of credit has
been issued.
● Usually used for credit periods of more than sixty days.
● Promissory Note: A written promise to pay a sum of money on demand of the payee
or at a definite time.

23
o Payee: The person to whom the note is payable.

o Maker: The one making the note and owing the money.
o Due date: The date when the note is due.
o Maturity value = Principal + Interest
Uncollectible Receivables
● When allowing customers to purchase on credit, businesses run the risk of non-
payments.
● A part of the credit sales that will not be collectible.
o Bad debts expenses – operating expenses recorded from the uncollectible
receivables.
Accounting for Uncollectible Receivables

Allowance Method:
● Allowance account:
o Records the estimated uncollectible
o Credit to increase
● Required by Generally Accepted Accounting Principles
(GAAP)
o Estimates the accounts receivable that will not be collected and records bad debt
expenses for this estimate at the end of each accounting period.
Direct Write-off Method:
● The method in which the company does not anticipate bad debt expense.
● Rather, it waits until an account is actually written-off as uncollectible before
recording bad debt expense.
● No estimate of uncollectible.
Allowance Method Entry

● Accounts receivable have a balance of and it is estimated that will go bad.

24
Bad Debts Expense $1,000
Allowance for Bad Debts $1,000
Net Realizable Value

● A technique used to calculate the worth of an asset while in inventory.
● To define the net realizable value in a proper way, it can be stated as the value of an
asset which can be realized by a business entity or company upon the sale of asset, minus a
logical prediction of the costs associated with either the ultimate sale or the disposal of the
asset in question.
● What is really expected to be collected?
●
Write-Off to the Allowance Account

● Once we determine that a particular customer will be not collectible, we write-off the
account.
● The write-off consists of reducing the allowance account by the amount of the write-
off and removing the uncollectible account from accounts receivable.
● Example: A balance of $1,000 is uncollectible.
Allowance for Bad Debts $1,000
Accounts Receivable $1,000
Estimating Uncollectible
● When it is highly probable that some accounts will prove uncollectible and the dollar
amount can be reasonably estimated, estimates of bad debt expense should be made and
recorded in the period in which the sale takes place.
● Estimates are based on past experience and forecasts of the future.
● Two methods:
o Estimation based on percentage of sales

25
o Analysis of accounts receivable

● At the end of the year when an allowance account has a:
o Debit balance: We underestimated the bad debts.
o Credit balance: We overestimated the bad debts.
Example: Direct Write-Off Method

● Mary’s account goes bad with a balance of $10,000.
Bad Debts Expense $10,000
Accounts Receivable $10,000
Example of Notes Receivable

● Jack’s account is past due. Jack converts the receivable to a note for 30 days at 10% on
April 1. The balance is $3,000.
Date Account PR Debit Credit
April 1 Notes Receivable
Accounts Receivable
● Jack pays the amount on the due date of May 1.
Date Account Debit Credit
May 1 Cash $3,300
Notes Receivable $3,000
Interest Revenue $300
Dishonored Notes
● When the maker does not pay the maturity value on the due date, the note is said to
be dishonored.
● At this time, the note ceases to exist, and the maturity value of the note is reported
again as an accounts receivable.

26
Example of Dishonored Notes

● Jack’s account is past due. Jack converts the receivable to a note for 30 days at 10% on
April 1. The balance is $3,000.
● On the due date, May 1, the note becomes dishonored.
Date Account PR Debit Credit
May 1 Accounts Receivable $3,300
Notes Receivable $3,000
Interest Revenue $300
Financial Ratios
● Useful indicators of a firm's performance and financial situation.
● Financial ratios give information about some activities of a company:
o Such as the ratio between the company's:
o Current assets and its current liabilities.
o And debtors and its turnover.
● Measure relationships between resources and financial flows.
● Show ways in which a firm’s situation deviates from its own past situation, other
firms, and the industry.
Liquidity Ratios
● Liquidity Ratios provide information about a firm's ability to meet its short term
financial obligations.
● Assess ability to cover current obligations.
● The current ratio is the ratio of current assets to current liabilities:
●
● The acid test ratio/quick ratio is an alternative measure of liquidity that does not
include inventory in the current assets:
●
● The cash ratio is the most conservative liquidity ratio.
o It excludes all current assets except the most liquid: Cash and Cash Equivalents.
o Cash ratio is calculated by dividing absolute liquid assets by current liabilities:

27
● Net Working Capital is more a measure of cash flow than a ratio.

o It is an indication of short-term financial health of a business.
Financial Leverage Ratios

● These ratios provide an indication of the long-term solvency of the firm.
● Assess ability to cover long-term debt obligations.
o The debt ratio is defined as total liabilities divided by total assets:
o The debt-to-equity ratio is total debt (long-term debt + value of leases)
divided by total equity:
Operating Ratios
● A ratio that shows the efficiency of a company's management by comparing operating
expense to net sale.
Profitability Ratios
● Ratios that offer several different measures of the success of the firm at generating
profits.
o The gross profit margin is a measure of the gross profit earned on sales.
o Gross margin is calculated as gross profit divided by total sales (revenue).
o Assess profits relative to amount of resources used.

o Returns on assets: A measure of how effectively the firm's assets are being used to
generate profits.
o Return on equity: The bottom line measure for the shareholders, measuring the
profits earned for each currency (dollar) invested in the firm's stock.
o The profit margin: How much profit a company makes for every $1 it generates in
revenue or sales.
o A ratio of profitability calculated as after-tax net income (net profits) divided by
sales (revenue).
o Net profit margin is displayed as a percentage. It shows the amount of each sales
dollar left over after all expenses have been paid.
o EBIT Means “Earnings Before Interests and Taxes”.

28
o Gross profit: total revenue variable (direct) costs.

o The gross profit margin is a measure of the gross profit earned on sales. It
considers the firm's cost of goods sold, but does not include other costs.
o
o Net profit =Total revenue – total costs
o Total cost=
o VC = Variable cost
o FC = Fixed costs
Investment Ratios
● The average profit earned per ordinary share.
● The average dividend received per ordinary share.
Dividend Policy Ratios

● Ratios that provide insight into the dividend policy of the firm and the prospects for
future growth
● Two commonly used ratios are the dividend yield and payout ratio:
Activity Analysis Ratios

● Activity Ratios help investors evaluate a firm’s ability to effectively and efficiently
manage its operations and assets.
● Assess amount of activity relative to amount of resources used.
● The asset turnover indicates how effectively a company utilizes its investment in
assets.
● It is the cost of goods sold in a time period divided by the average inventory level
during that period.

29
Accounting Equation and Cycle
The below flow chart explain steps in the accounting cycle.
Step 1: Business Documents Analyzed

● Analyze the transaction source documents and decide:
o What accounts are involved?
o What account(s) needs to be increased?
o What account(s) needs to be decreased?
o What account needs to be debited?
o What account needs to be credited?
● Example of source documents:
o Checks
o Receipts
o Invoices
o Deposit Slips
o Contracts
● Source documents are kept on file for 3 years for tax and auditing purposes.
Step 2: Transactions Recorded in Journals

● Enter source data in a chronological order in a journal.
● The journal is called a book of original entry. It gives:
o The date of the transaction.
o The record of the accounts debited and credited in the transaction.
o The accounts increased or decreased.
o The post reference number of the ledger accounts involved.
o Occurs after the transaction has been posted to the ledger accounts
Step 3: Transactions Posted to Ledgers

● The “Ledger Accounts” are the individual records of all assets, liabilities, and owners’
equity accounts.
● Each Ledger Account is updated daily or weekly and keeps an ongoing record of
activity in the account and balance of the account.
● All data that goes into the ledger accounts must first be put into the journal and then
posted from the journal to the ledger account on the day the information is journalized.

30
● The ledger is divided up into these different accounts:

o Assets (100 accounts)
o Liabilities (200 accounts)
o Capital/Owners’ Equity (300 accounts)
o Revenues (400 accounts)
o Cost of Goods Sold (Expense) – (500 accounts)
o General Expenses (600 accounts)
Step 4: Trial Balance

● A proof of the equality of debits and credits in a general ledger.
● A statement of all debits and credits in a double-entry account book, with any
disagreement indicating an error.
● Before preparing your statements, make sure that all of your accounts have the
correct balance.
o List of all accounts with debit and credit balances.
o Debits must equal credits.
o If the account is not in balance, you must go back in your audit trail and find your
errors.
Step 5: Adjustments
● Adjustments are made at the end of an “accounting period.”
● Adjust the necessary accounts to bring them up to date.
o Requires internal transactions.
o Requires journal entries & posting as well.
● Example: Depreciation of Equipment, Use of Supplies and Materials, Unearned
Revenues.
Step 6: Financial Statement

● A formal record of the financial activities of a business, person, or other entity.
● The Financial Statements are prepared as follows:
o Income Statement
o Statement of Changes in Owners’ Equity
o Balance Sheet
● Main product of the accounting system that outsiders, investors, and/or creditors etc.
will look at to see the financial health of your business.

31
Step 7: Adjustment (Close All Temporary Accounts and Start Over)

● Close Temporary Accounts:
o All Expense Accounts
o All Revenue Accounts
o All Drawing or Dividend Accounts
● Transfer the net increases or decreases of these temporary accounts into the
permanent owners’ equity account of capital or retained earnings.
o This makes it possible for the company to start a new set of reports to compare
with the old
Step 8: Closing Financial Statement

● Closing entries are journal entries made at the end of an accounting cycle to set the
balance of temporary accounts to zero to begin the next accounting period.
● The accounts that are closed are revenue, expense, and drawing accounts.
● The assets, liabilities, and owner's equity accounts are not closed because their ending
balances are the beginning balances for the next accounting period.
Classification of Accounts
● Personal Accounts: A personal account is an account for use by an individual for that
person's own needs.
o Natural Persons
o Artificial Person
o Representative personal accounts
● Real Accounts: Accounts relating to properties or assets.
o Tangible real account: Tangible accounts are any assets that can be physically
identified such as cash, equipment, and real estate.
o Intangible real account: Intangible Account are usually classified as noncurrent
(long-term) assets because they produce benefits over several years, such as trademarks,
copyrights, patents, franchises, customer lists, and goodwill.
● Nominal Account: An account recording the financial transactions of a business in a
particular category, rather than with a person or other organization.
o Income & Gains
o Expenses & Losses
Recording of Transactions
● Rule for Personal Accounts:

32
o Debit the receiver

o Credit the giver
● Rule for Real Accounts:
o Debit what comes in
o Credit what goes out
● Rule for Nominal Account:
o Debit all expenses & losses
o Credit all incomes & gains
Debit and Credits

Debits Credit
● Debits are positive numbers. ● Credits are negative numbers.
● Assets and expenses normally ● Liabilities, fund balance and revenues normally
have debit balances. have credit balances.
The Accounting Equations

● The resources controlled by a business are referred to as its assets. For a new business,
those assets originate from two possible sources:
o Investors who buy ownership in the business.
o Creditors who extend loans to the business.
● Those who contribute assets to a business have legal claims on those assets.
● Since the total assets of the business are equal to the sum of the assets contributed by
investors and the assets contributed by creditors, the following relationship holds and is
referred to as the accounting equation.
● The 'basic accounting equation' is the foundation for the double-entry bookkeeping
system. For each transaction, the total debits equal the total credits.
Assets = Liabilities + Owner’s Equity
o Assets (what it owns)
o Liabilities (what it owes to others)
o Owner’s Equity (the difference between assets and liabilities)
Note: Owner’s Equity is also known as Shareholders and Capital.

● Owner equity is affected by capital contributions such as the issuance of stock.

33
● Once business operations commence, there will be income (revenues minus expenses,
and gains minus losses) and perhaps additional capital contributions and withdrawals such as
dividends.
● At the end of a reporting period, these items will impact the owners' equity as follows:
● Expanded Accounting Equation:
o Assets = Liabilities + Stockholders' Equity.
o Assets = Liabilities + Common Stock + Retained Earnings.
o Assets = Liabilities + Common Stock + Net Income – Dividends.
o Assets = Liabilities + Common Stock + Income – Expenses – Dividends.
● These are some simple examples, but even the most complicated transactions can be
recorded in a similar way. This equation is behind debits, credits, and journal entries.
● Owners’ equity = Contributed Capital + Retained Earnings.
o Retained Earnings = Net Income – Dividends.
o 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.
● The following table shows how a number of typical accounting transactions are
recorded within the framework of the accounting equation:

34
Transaction Type Assets Liabilities + Equity
Buy fixed assets Fixed assets Accounts payable (liability) increases

on credit increase
Buy inventory on Inventory Accounts payable (liability) increases

credit increases
Pay dividends Cash decreases Retained earnings (equity) decreases
Pay rent Cash decreases Income (equity) decreases
Pay supplier Cash decreases Accounts payable (liability) decreases

invoices
Sell goods on Inventory Income (equity) decreases

credit (part decreases
1)
Sell goods on Accounts Income (equity) increases

credit (part receivable
2) increases
Sell services on Accounts Income (equity) increases

credit receivable
increases
Sell stock. Cash increases Equity increases
Accounting for Cash, Accrual and Inventory
● Accrual Basis:
o An accounting method in which transactions are recorded when revenues are
earned or expenses are incurred.
o Revenues are reported in the income statement in the period they are earned.
o Revenue recognition concept: The revenue recognition principle is a cornerstone of
accrual accounting together with matching principle.
o Matching concept: It is a culmination of accrual accounting and the revenue
recognition principle. They both determine the accounting period, in which revenues and
expenses are recognized.

35
● Cash Basis:
o An accounting method in which transactions are recorded when cash is paid or
cash is received.
A Simple Transaction
● A national insurance company sells a 3-year policy to a small business for all of its 20
employees.
o The national insurance company wants a payment of in advance.
o The insurance company incurs yearly expenses of on the policy.
● How will you record the above activity via accrual and cash accounting?
Note: The financial year starts from 2011.
Accrual accounting for the above transaction:
2011 2012 2013
Revenues $40,000 $40,000 $40,000
Expenses $25,000 $25,000 $25,000
Net Income (Loss) $15,000 $15,000 $15,000
Cash accounting for the above transaction:
2011 2012 2013
Revenues $120,000 $0 $0
Expenses $25,000 $25,000 $25,000
Net Income (Loss) $95,000 ($25,000) ($25,000)
Accounting Period
● A period of time covered by an accounting report.
● Accounting period can be one of the following:
o Monthly
o Quarterly
o Semi-annually

36
o Annually
Adjusting Process
● The updating of accounts prior to the preparation of financial statements.
● Affects income statement accounts and at least one balance sheet account.
Accounts Requiring Adjusting

● Prepaid Expenses:
o Items that have been initially recorded as assets but are expected to become
expenses over time or through the normal operations of the business are known as
prepaid expenses.
o Supplies and prepaid insurance.
● Unearned revenue:
o Unearned rent
o Deferred revenue
o Items initially recorded as liabilities but are expected to become revenues over
time.
o Deposits by customers for work to be done in the future.
● Accrued revenue:
o Some revenues are only recorded when cash is received.
o At the end of the accounting period, there may be items of revenue that have
been earned but have not been
o recorded.
● Accrued expenses:
o Expenses that have been incurred but have not been recorded in the accounts.
● Wages payable: This account is used to record employee compensation that has not yet
been received by the employee.
● Depreciation: The gradual conversion of the cost of a tangible capital asset or fixed
asset into an operational expense.
Accounting for Inventory

● Inventory is used to indicate:
o Merchandise held for sale in the normal course of business.
o Materials in the process of production or held for production.
● Any errors in the inventory count will affect both the balance sheet and the income
statement.

37
o Inventory could be overstated or understated.
Inventory Cost Flow

● First In, First Out method:
o Cost flow is in the order in which the costs were incurred.
● Last In, First Out method:
o Cost flow is in the reverse order in which the costs are incurred.
● Average Cost:
o Cost flow is an average of the costs.
First in, First out Method (FIFO)

● The method in which the oldest goods sold first.
● The ending inventory consists of the newer purchases.
● During times of rising prices, FIFO will result in a higher ending inventory value and a
lower cost of goods sold.
● Most businesses dispose of goods in the order in which the goods are purchased.
● Especially true of perishables and goods whose styles or models often change.
● The FIFO method is often consistent with the physical flow or movement of
merchandise.
Last In, First Out Method (LIFO)

● The LIFO method considers the most recent purchases as being sold first.
● The ending inventory consists of the older purchases.
● During times of rising prices, LIFO will result in a lower ending inventory and a higher
cost of goods sold
● The cost of units sold is the cost of the most recent purchases.
Example of Inventory Accounting

38
Date Activity Units CostperUnit
Jan 1 Inventory 100 $50
Jan 10 Sale 70
Jan 20 Purchase 50 $45
Jan 22 Sale 40
Jan 28 Sale 20
Jan 30 Purchase 100 $55
● Cost of merchandise sold under FIFO

Date Units Cost per unit Total Cost
Jan 10 70 $50 $3500
Jan 22 30 $50 $1500

10 $45 $450
Jan 28 20 $45 $900
Total Cost $6350
● Value of inventory remaining under FIFO

o 20 units @ $45 = $900
o 100 units @ $55 = $5,500
o Total inventory = $6,400
● Cost of merchandise sold under LIFO

Date Units Cost per unit Total Cost
Jan 10 70 $50 $3,500
Jan 22 40 $45 $1,800
Jan 28 10 $45 $450

10 $50 $500
Total Cost $6,250

39
● Value of Inventory remaining under LIFO

o 20 units @ $50 = $1,000
o 100 units @ $55 = $5,500
o Total inventory = $6,500
● Comparison of LIFO and FIFO

FIFO LIFO
Cost of goods sold $6,350 $6,250
Value of Inventory $6,400 $6,500
Total $12,750 $12,750
Average Cost Method

● An average unit cost for each type of item is computed, each time a purchase is made.
All are collected from online.

Introduction To Accounting

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Introduction To Accounting

Uploaded by

Copyright:

Available Formats

1

Reading Materials for Accounting

 It includes reporting of the financial position and performance of

 It combines accounting, finance and management with cutting-

Accounting is about 5 Simple Things

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

 An increase in owners’ equity during the period by performing a service or selling an

Fundamental Accounting Equation

Assets (owns) What the business owns

Liabilities (owes) What the business owes

Owners’ Equity (worth) What is the worth of the business

Example of Owners’ Equity

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

Operations Refunds from Suppliers

Financing Investment by Creditors (loans)

Return on Investments (interest and

Ways of Money Out

Operations Refunds to Customers

Payment of dividends or capital to

Investing Amounts invested in other entities (debt

Core Components of Accounting

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

Objective of Internal Controls

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

o Assets are safeguarded and used for business purposes.

Elements of Internal Controls

Double Entry Accounting

● Transaction or event occurs.

T-Account for Assets

Type of Account Debit Credit

Assets Increases Decreases

T-Account for Liability

Type of Account Debit Credit

Liability Decreases Increases

T-Account for Owner’s Equity

Type of Account Debit Credit

Owner’s Equity Decreases Increases

T-Account: Always Balanced

Income Statement Accounts

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

● Net Loss (Debit > Credit)

Stockholder’s or Owner’s Equity

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

Profit and Loss

Profit and Loss Account

Profit and Loss statement

Profit and Loss Appropriation Account

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

Difference between P/L Accounts and P/L Appropriation Accounts

P/L Accounts P/L Appropriation Accounts

Debit Side of P/L Appropriation Accounts

Credit Side of P/L Appropriation Account

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

Particular Amount Particular Amount

To transfer to reserve By last year’s balance b/d

To income tax for By net profit for the year b/d

To interim dividend By provision such as income tax provision

Represents any amount

Components of a Profit and Loss Statement

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com

Cost of goods sold (COGS)

www.bankingnewsbd.com, Email: bankingnewsbd@gmail.com