ACCOUNTING RECORDS & SYSTEMS

‡ Recordkeeping Fundamentals ‡ Accounting is something best learned by doing; ‡ Debit-and-Credit Mechanism (detailing about the transactions); ‡ The Account : A device used for calculating the net changes of an item (by recording all increases and decreases of the item together for a period ± and then calculating net changes)

Recordkeeping Fundamentals«.
1. Permanent Accounts: maintained for various items of the Balance sheet ± at the end of the accounting period each account is balanced; - these balances are reported as closing balance for this accounting period & transferred as opening balance in the next accounting period.

Recordkeeping Fundamentals«.
2. Temporary Accounts: established for each revenue and expense item of an Income Statement«& these are recorded in their respective accounts as the period progress« - procedure creates a ³sort as you go´ routine for the transactions instead of allowing them to be sorted out at the end of the period« - at the end of the accounting period, all of the temporary accounts are summed up to one ³net income amount´, which is then entered into Retained Earnings Account.

Recordkeeping Fundamentals«.
‡ The Ledger: It is a group of accounts ±the accounts for balance sheet and income statement items are often referred to as µGeneral Ledger¶ accounts; ‡ a holdover from the manual system in which these accounts are recorded in a bound book called as a µLedger¶.

CLASSIFICATION OF COMMONLY USED ACCOUNTS
‡ Assets ± Fixed & Current ‡ Liabilities ± Long-term & Short-term ‡ Owners¶ Equity ± Capital, Retained earnings (Revenues & Expenses) ‡ Each of the above accounts is numbered to form the µChart of Accounts¶ Assets: Liabilities: Equipments 103 Creditors 201 Inventory 109 Expenses: Cash 113 Advertisement 509

DOUBLE ENTRY SYSTEM
‡ Every transaction must be recorded with equal debits and credits and the total of debits must be equal to total of credits. ‡ Left hand side of any account is arbitrarily called µDebit Side¶ (dr.) and the right hand side is called µCredit Side¶ (cr.). ‡ Standard form of an account: Date Explanation Ref. Dr. Cr. Bal. ‡ µT Form¶ of Account

DEBIT & CREDIT RULES
‡ Pacioli based his procedure on the fundamental equation: ‡ Assets = Liabilities + Owners¶ Equity ‡ Arbitrarily decided that asset accounts must increase on µleft hand¶ or µdebit side¶; ‡ Rules: 1. In order for debits to equal credits; 2. In order to maintain the fundamental equation, rules for liabilities and owners¶ equity accounts have to be the opposite from those for assets.

DEBIT & CREDIT RULES
‡ ‡ ‡ ‡ ‡ A = L + OE or, A = L + OE + RE Or, A = L + OE + (Rev. - Exp.) Or, A = L + OE - Drawings+ Rev. -Exp. A + D + E = L + OE + R Debit to Increase Credit to Increase (LHS) (RHS) ‡ Credit to Decrease Debit to Decrease (RHS) (LHS)

DEBIT & CREDIT RULES««..

‡ Or, A & E ‡ To increase Debit ‡ To Decrease Credit

L, OE & R Credit Debit

DEBIT & CREDIT RULES
‡ Type of Accounts ‡ Asset ‡ Liability ‡ Owner¶s Equity: Share Capital Dividend Revenue Expense Increase Recorded by Debit Credit Credit Debit Credit Debit Normal Balance Debit Credit Credit Debit Credit Debit

The Accounting Process (Accounting Cycle)
1. Analysis of transactions ± deciding which accounts to be debited & which to be credited; 2. Journalizing original entries; 3. Posting is the process of recording changes in the ledger accounts exactly as specified by the journal entries; 4. Adjusting entries at the end of accounting period ± journalized and posted in the same way as original entries; 5. Journalizing & posting of Closing entries; 6. Preparation of Financial Statements.

JOURNAL ENTRY EXAMPLE
‡ Date 200X Jan.1 Debit Rs. Cash 2 50,000 Share Capital 1 (Cash invested in the business) Particulars Ref Credit Rs. 50,000

Jan.15 Inventory 9 11,000 Cash 2 9,000 Acct.s Payable 13 2,000 (Purchase of inventory on part payment)

Transferring Journal to Ledger
‡ Locate in the ledger the debit account in the journal entry. ‡ Enter date of the transaction in the Ledger. ‡ Enter Ref. column in the Ledger, the page no. of journal from which entry is being posted. ‡ Enter in the debit column of the ledger the amount of debit as shown in the journal. ‡ Enter in the ref. column of the journal the account no. to which the debit was posted. ‡ Repeat the above for credit side posting.

BALANCING THE LEDGER
‡ It refers to closing of the Ledger account with the difference between the total of left side and right side amounts in the account at any particular time.

TRIAL BALANCE
‡ A list of all accounts in the general ledger with their balances reflected either in µdr.¶ or in µcr.¶ column. 1. It shows whether the equality of debits and credits has been maintained; 2. It provides a convenient summary transcript of the ledger records as a basis of making the adjusting and closing entries.

ERROR IDENTIFICATION
‡ If trial balance total does not agree, following errors may be taking place: 1. A debit may be posted in an account as a credit or vice-versa; 2. An account balance may be computed incorrectly; 3. Amount of an account balance may be recorded incorrectly.

CORRECTING ERRORS
1. Identify Correct Entry; 2. Pass Correct Entry & Compare; 3. Pass an additional correcting error entry to neutralize the effect.

Example: A repair Expense was erroneously debited to equipment on July 27; error was discovered on July 31.

‡ Erroneous Entry: 27/7 Equipment ««««.500 Cash ««««««««.500 ‡ Correct Entry: 27/7 Repair Expense««500 Cash ««««««««500 ‡ Correcting Entry: 31/7 Repairing Expense««500 Equipment«««««««.500

The Adjusting & Closing Process
‡ ADJUSTING ENTRIES: End-of-period entries that assign the financial effects of implicit transactions to the appropriate time periods; ‡ Because some events that affect concerned accounts are not evidenced by documents associated with original entries.

Features of Adjusting Entries
1. Every adjusting entry affects both a balance sheet account (i.e. asset or liability) and an Income Statement (i.e. revenue or expense). 2. Adjusting entries never affect the cash account since adjustments are needed when transactions affect the revenue or expenses of more than one accounting period.

Continuous Transactions
‡ Most adjusting entries are made in connection with continuous transactions; ‡ 1st Method: ‡ Expenditure is originally recorded as an asset ± at the end of the accounting period, the inventory asset account is adjusted by subtracting the cost of inventory consumed (Expense). ‡ 2nd Method: ‡ The expenditure of inventory is originally recorded in an expense account (instead of inventory). The remaining inventory at the end is subtracted from expense and then shown as an asset.

Transactions result in Deferrals
‡ Deferrals: It is a delay of the recognition of expenditure or revenue already received ± Concerned with past cash receipts and payments. Expl: Prepaid Expenses & unearned revenue.

‡

Transactions result in Accruals
‡ Accruals: Recognition of an expense that has not been paid or of revenue that has not been received ± Concerned with future cash receipts and payments. Expl.: Salaries of employees neither billed nor paid.

‡

Types of Adjusting Entries«.. 1. PREPAID EXPENSES
‡ Recorded costs to be apportioned among two or more accounting periods. ‡ By the end of the period, the portion of these services that has been consumed during the period has become an expense and the unused portion represents an asset

PREPAID EXPENSES««.
‡ Expl.: Inventory, prepaid expenses etc. ‡ Insurance protection, originally recorded as prepaid insurance for Rs.7,200 of which Rs.3,000 becomes an expense for the current period. ‡ Analysis:Increase in Insurance expense and decrease in prepaid expense.

PREPAID EXPENSES««.
‡ Rule: Increase in expense is recorded by a debit and decrease in asset is recorded by a credit. ‡ Insurance Expense Prepaid Insurance 3,000 7,200 3,000

2. Unrecorded / Accrued / Outstanding Expenses
‡ These expenses were incurred during the period, but no record of them has yet been made (Expense Payable). ‡ Expl.: RS.5,000 of wages earned by an employee during the period, but not yet paid to the employee. ‡ Analysis: Increase in Wage Expense & Increase in the liability of Accrued/ Outstanding Wages.

Unrecorded / Accrued / Outstanding Expenses«««.
‡ Rule: Increase in expense has to be debited& Increase in liability has to be created. ‡ Wages Expense 5,000 Accrued Wages 5,000

3. Unearned Revenue/ Revenue Received in Advances
‡ Recorded revenues to be apportioned among two or more accounting periods. ‡ These amounts were initially recorded in one account, and at the end of the accounting period must be properly divided between a revenue and a liability account.

Unearned Revenue«««
‡ Expl.: Rent collected during the period and recorded as rent revenue ± Rs.7,500 of which, Rs.6,000 is applicable to the next period and hence is a liability at the end of the current period. ‡ Analysis: Liability (Unearned rent revenue) decreased. Revenues (Rent revenue earned) increased.

Unearned Revenue«««
‡ Rule: Decrease in liability is recorded by a debit and increase in revenue is recorded by a credit. ‡ Rent Rev. Earned 1,500 Unearned Rent Rev 1,500 7,500

4. UNRECORDED/ACCRUED REVENUES
‡ These revenues were earned during the period but no record of them has yet been made. ‡ Expl.:Rs.1,200 of interest earned by the entity during the period but not yet received. ‡ Analysis: Increase in asset (Interest Receivable) and increase in revenue (Interest Revenue).

ACCRUED REVENUES«««
‡ Rule: Increase in asset is recorded by a debit and increase in revenue is recorded by a credit. ‡ Interest Receivable 1,200 Interest Revenue 1,200

5. Depreciation
‡ Portion of long-lived asset costs that has become expense during an accounting period. ‡ Factors: 1.Service life of asset, 2. Residual Value, 3. Cost of the asset along with additional maintenance expenses.

Depreciation Methods
1. Straight Line Method (SLM) Original Cost ± Estimated Scrap Estimated useful life (Amount of Depreciation is fixed) 2. Written Down Value Method 1 - n Estimated Scrap Value Original Cost (Depreciation Rate is fixed)

Depreciation Methods««
‡ Sum of the Year Digit method (SYD) ‡ Rate of Depreciation = (n/SYD) = for the first year {(n-1)/SYD} = for the second year {(n-2)/SYD} = for the third year ‡ SYD = 1+2+3+«««.+n ‡ Rate is applied to the net cost.

Example
‡ A Construction company purchased an earthmoving equipment for Rs.20,00,000, expected to have an useful life of 6 years, or 15,000 hours with an estimated residual value of Rs.2,00,000 at the end of the time. The equipment logged 2,000 hours in the first year. ‡ Compute depreciation expenses under various methods.

Amortization
‡ Business acquires intangible assets viz. patents, copyright, trademark, goodwill by paying large sums of money ± Unexpired cost. ‡ Expiration of these costs (similar to depreciation) is known as Amortization. ‡ Amortization is always on straight line basis. ‡ Intangible assets are amortized over a reasonably short period (as it is difficult to determine the useful life precisely).

Accounting Treatment of Depreciation
1. Amount of depreciation is debited to Depreciation Expense. 2. A separate account called µAccumulated Depreciation¶ is credited for the amount allocated to the period instead of making a direct credit to the asset account. 3. The µAccumulated Depreciation¶ is a contra asset account (this is reported as a deduction from related asset account in the balance sheet.

Example
‡ Rs.3,500 is the depreciation expense for furniture. ‡ Analysis: Depreciation expense increased, concerned asset decreased through accumulated depreciation. ‡ Entry: Increase in expense is recorded by a debit and decrease in asset is recorded by a credit to contra-asset account ± accumulated Depreciation, concerned asset.

Example«««
‡ Depn. Expense 3,500 Acc.Depn.,Furniture 3,500

‡ Depreciation is recorded in the Income Statement as expense. ‡ Furniture will be shown in the B/S as: Furniture««««.. 35,000 31,500 Less, Accumulated Depn« 3,500

Reasons«««
‡ GAAP requires separate disclosure of:

1. Original cost of entity¶s depreciable assets; 1. Depreciation that has been accumulated on these assets from the time they were required until the date of Balance sheet.

6. BAD DEBTS
‡ Arises because of credit sales. ‡ Such a state initially is recorded as: Debit Accounts Receivable, Credit Sales Revenue. ‡ But when bad debts occur, another entry must be made to show that: ‡ Amount debited to A/R does not represent the amount of the additional asset and that O.E. has not in fact increased by the amount of sale.

Accounting Treatment
1. Direct Write-Off Method: Amounts that are believed to be bad are subtracted from A/R and same accounts are shown as expenses in Income Statement. ‡ Entry: Debit Bad Debt Expense Credit Accounts Receivable This method, however, requires that specific uncollectible accounts be identified, which is not usually possible.

‡

Accounting Treatment«««
2. Allowance Method: Here, the total amount of uncollectible accounts is first estimated to be shown under µBad Debts Expense A/c¶ in the Income statement. ‡ Then, the estimate is shown as a Contra Asset in the B/S in the form of µAllowance for Doubtful Debts Account¶. ‡ Entry: Debit Bad Debts Expense Credit Allowance for Doubtful Debts A/C

Accounting Treatment«««
‡ Bad Debts Exp. 300 Allow. for Doubtful Debt 300

‡ In the Balance sheet: Accounts Receivable-10,000 Less, Allow. for Doubtful Debts- 300 Accounts Receivable Net - 9,700

Accounting Treatment«««
‡ Now, if a company decides a specific customer is never going to pay the amount owed, then: ‡ Entry: Debit Allowance for doubtful debts«50 Credit Accounts Receivable «««..50 ‡ This entry does not have any effect on Bad Debt Expense or on income of the period in which account is written off.

CLOSING ENTRIES
‡ Journal entries designed to transfer the balances in revenue and expense accounts at the end of an accounting period to a balance sheet equity account. ‡ Temporary accounts are closed now by transferring their balances to Income Summary or Profit & Loss account. ‡ Permanent accounts are also closed to extract their balances to prepare B/S.

Closing Revenue & Expenses (Temporary Accounts)
1. Transferring Revenue Accounts Debit All revenue accounts Credit Profit & Loss A/c or Income Summary 2. Transferring Expenses Accounts Debit Profit & Loss A/c or Income Summary Credit All expenses accounts

Closing Revenue & Expenses (Temporary Accounts)««.
3. Balance of Profit & Loss a/c transferred to Retained Earnings or Profit & Loss Appropriation Account. (i) If net profit: Debit Profit & Loss Account Credit Retained Earnings Account (ii) If net loss: Reverse entry

Closing Revenue & Expenses (Temporary Accounts)«««
4. Closing Dividend Account ( Having Debit Balance) Debit Retained Earnings Account Credit Dividend Account 5. Now all temporary accounts relating to revenue expenses, dividend have zero balance & ready to be used for next accounting period.

Accounts after closing
‡ All temporary accounts have now zero balances & balances of permanent accounts are carried forward to next period. ‡ Post-Closing Trial Balance: Accuracy check for all permanent accounts and temporary accounts to be reflected in the balance sheet.

Steps in formation of accounting records
‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Identify transactions Analyze & record them in journals Ledger posting Trial Balance Preparing Adjusting & Closing entries Worksheet Income Summary & Balance sheet Transfer entries

Completion of Accounting cycle
‡ After passing the adjusting and closing entries, accountants accommodate them through Work Sheet. ‡ Proforma Worksheet
‡ Accounts Trial balance Adjustments Adjusted TB P&L A/c B/S
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Steps to prepare Worksheet
1. Enter the A/c balances in Trial balance column, in adjustments column & in Adjusted Trial balance column. Enter each account in the Adjusted T.B. column to either P&L or B/S column. Total P&L A/c and B/S columns & enter the Net profit or loss as a balancing figure in both pairs of columns. Total the four columns with the balancing figure included.

2.

3.

PREPARING FINANCIAL STATEMENTS
1. After preparing the work sheet, the adjusting entries must be entered in the general journal & posted to the ledger accounts. 2. Next, closing entries should be designed to transfer the balances in revenue and expenses accounts to P&L account. 3. Balancing P&L A/c to identify Net profit or loss for the accounting period.

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