Basic Accounting: Concepts, Techniques, Conventions. Read and Interpret The Basic Financial Statements

Chapter 1
Basic Accounting:
Concepts, Techniques, Conventions.
Read and interpret the basic financial

statements.
The Need for Accounting
Managers, investors, and other internal groups

want the answers to two important questions:
How well did the

organization perform?
Where does the
organization stand?
The Need for Accounting
Accountants answer these questions

with two major financial statements:
Income Statement
Balance Sheet
Balance Sheet
 The balance sheet (also called statement of
financial position or statement of financial
condition) is a snapshot of the financial
status of an organization at a point in time.
Balance Sheet
Assets = Equities
Assets are economic resources that are expected
to benefit future activities of the organization.
Equities are the claims against, or interests in,

the assets of the organization.
Business Transactions
A transaction is any event that affects the

financial position of an organization
and requires recording.
Accounting Concepts
 Business Entity concept
 Money Measurement concept
 Cost concept
 Going concern concept
 Dual-aspect concept
 Relisation concept
 Accrual concept
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 16 - 7
Users of Financial Statements
 Shareholders
 Investors
 Creditors
 Labour
 Government
 Researchers
King Hardware Transactions
1 Initial investment by owners, Rs 100,000
cash.
2 Acquisition of inventory for Rs 75,000 cash.
3 Acquisition of inventory for Rs 35,000 on
open account.
4 Merchandise costing Rs 100,000 was sold on
open account for Rs 120,000.
Value in the Borrowed Owners claim
company
Stockholders’
Assets = Liabilities + Equity
1) Cash + Rs100,000 + Rs100,000
2) Cash – 75,000
Inventory + 75,000
3) Inventory + 35,000 + 35,000
4) Receivable + 120,000 + 120,000
4b) Cost – 100,000 – 100,000
5 Cash collections of accounts receivable, Rs
30,000.
6 Cash payments of accounts payable, Rs
10,000.
7 On March 1, paid Rs 3,000 cash for rent for
March, April, and May. Rent is Rs 1,000
per month.
Stockholders’
Assets = Liabilities + Equity
5) Cash + 30,000
Receivable – 30,000
6) Cash – 10,000 –10,000
7) Cash – 3,000
7a) Prepaid + 3,000
7b) Expense – 1,000 – 1,000
Totals Rs 144,000 Rs 25,000 Rs 119,000
Revenues
Revenues are increases in ownership

claims arising from the delivery
of goods or services.
Revenues must be earned.
Revenues must be realized.
Expenses
Expenses are decreases in

ownership claims arising
from delivering goods or
services or using up assets.
Profits
Profits (or earnings or income) are

the excess of revenues over expenses.
Income Statement
The income statement measures

the performance of an organization
by matching its accomplishments
(revenue from customers, which
is usually called sales) and its
efforts (cost of goods sold and
other expenses).
Income Statement
Balance
Balance Sheet
Sheet Balance
Balance Sheet
Sheet Balance
Balance Sheet
Sheet
February
February 28
28 March
March 31
31 April
April 30
30
202
202 202
202 202
202
Income Income
Statement Statement
Time for March for April Time
The Analytical Power of the
Balance Sheet Equation
The balance sheet equation

can highlight the link between
the income statement and balance sheet.
Assets (A) = Liabilities (L)

+ Stockholders’ equity (SE)
The Analytical Power of the
Balance Sheet Equation
A = L + Paid-in capital + Retained income
A = L + Paid-in capital + Revenue – Expenses

Learning Objective
Distinguish between the accrual

basis of accounting and the
cash basis of accounting.
Accrual Basis versus Cash Basis
The accrual basis of accounting recognizes

revenues and expenses when they occur
instead of when cash is received or disbursed.
The cash basis of accounting recognizes

revenue and expense when cash is
received and disbursed.
Accrual Basis versus Cash Basis
The accrual basis is the principal conceptual

framework for relating accomplishments
(revenues) with efforts (expenses).
The cash basis fails to match expenses and

revenues in a manner that properly
measures financial position.
Types of Accounts
 Personal A/c .. e.g. Ram’s A/c, ISB&M’s A/c,
Jehangir Hospital’s A/c, Sita’s A/c
 Real A/c .. e.g. Cash A/c, Furniture A/c, Land
A/c, Building A/c, Plant A/c
 Nominal A/c .. e.g. Wages A/c, Discount
Allowed A/c, Discount received A/c, Purchases
A/c, Sales A/c,
 Valuation A/c .. e.g. .Provision for depreciation
A/c and provision for Doubtful debts A/c
Classify the following into Personal,
Real and Nominal and Valuation A/c
 Plant & Machinery  Land & Building
 Purchases  Carriage outward
 Investment  Capital
 Bank  Leasehold
 Provision for Bad and  Trademark
Doubtful debts  Return outward
 Tata Iron and Steel  Import duty
Co. Ltd.  Provision for
 Rent Depreciation
Answers
Real A/c Nominal A/c Personal A/c Valuation A/c

Plant & Purchases Bank A/c Provision for Bad
Machinery and doubtful
debts
Investment Rent Tata Iron & Steel
Land & Building Carriage Capital Provision for

Outwards depreciation
Leasehold Returns Outward
Trade Mark Import Duty
Rules for Debit and Credit
 Debit the receiver and credit the giver

 Debit what comes in and credit what goes
out
 Debit all expenses and losses and credit all
incomes and gains.
Rule No. 1: Debit the receiver and
Credit the giver
 Cash paid to Ram:
Ram’s A/c .. Dr Rs 1,000 (Personal A/c)
Cash A/c Rs 1,000 (Real A/c)
 Cash received from Debtor Shyam
Cash A/c .. Dr Rs 5,000 (Real A/c)
To Shyam’s A/c (Personal A/c)
Rule No. 2: Debit what comes in and
Credit what goes out
 Cash brought in to start business:
Cash A/c .. Rs 1,00,000
To Capital A/c Rs 1,00,000
 Cash deposited with bank:
Bank A/c .. Rs 50,000
To Cash A/c Rs 50,000
 Furniture bought for cash:
Furniture A/c .. Rs 5,000
To Cash A/c Rs 5,000
Rule No. 3: Debit all expenses and losses
and credit all incomes and gains
• Sold goods to B for Rs 6,000

B A/c .. Dr Rs 6,000 (Personal A/c)
To Sales A/c Rs 6,000 (Nominal A/c)
• Paid wages Rs 400
Wages A/c .. Dr Rs 400 (Nominal A/c)
To Cash A/c Rs 400 (Real A/c)
Rules for Debit and Credit at a
glance
Types of Account to be Account to be

Account debited credited
Personal account Receiver Giver
Real account What comes in What goes out
Nominal account Expense and losses Income And gains
Valuation account When account is to When account is to

be decreased be increased
Modern Classification of Account
ACCOUNT
ASSETS LIABILITIES CAPITAL REVENUE EXPENDITURE WITHDRAWL

A/c A/c A/c A/c A/c A/c
Problem No. 2
From the following transactions, state the nature of
accounts and state which account will be debited and
which account will be credited.
1. Mr. A started business with Rs 50,000
2. Purchased goods for cash Rs 10,000
3. Sold goods for cash Rs 15,000
4. Purchased goods from X for cash Rs 5,000
5. Sold goods to B for Rs 6,000
6. Purchased furniture for Rs 4,000
7. Purchased plant for Rs 10,000
8. Paid wages Rs 400
Answer to Problem No. 2
Sr. No. Particulars Dr (Rs) Cr (Rs)
1. Cash A/c .. Dr 50,000
To Capital A/c 50,000
(Being capital brought in by Mr. A)
2. Purchases A/c .. Dr 10,000
To Cash A/c 10,000
(Being goods purchased for Rs 10,000)
3. Cash A/c .. Dr 15,000
To Sales A/c 15,000
(Being goods sold for cash)
4. Purchases A/c .. Dr 5,000
To Cash A/c 5,000
(Being goods purchased from X for cash)
Answer to Problem No. 2
Sr. No. Particulars Dr (Rs) Cr. (Rs)
5. B’s A/c .. Dr 6,000
To Sales A/c 6,000
(Being goods sold to B for Rs 6,000)
6. Furniture A/c .. Dr 4,000
To Cash A/c 4,000
(Being furniture purchased for cash)
7. Plant A/c .. Dr 10,000
To Cash A/c 10,000
(Being plant purchased for Rs 10,000)
8. Wages A/c .. Dr 400
To Cash A/c 400
(Being wages paid for cash)
Books of Account
Journal and its Nature
 First book in which transactions of a business unit

are recorded
 Also called book of original entry
 A journal entry is an analysis of the effects of a
transaction on the accounts, along with a narration
 Hence, journal is a tool for analyzing and
describing the impact of various transactions upon
a business unit
Problem No. 3
1997, Jan 1 Mr. Peter commences business as a computer merchant, trading

under the name of “Computer Point” with a capital of Rs 4,00,000
brought in cash.
13 He buys on credit from Hindustan Computers Ltd., 10 computers
@ Rs 30,000 each.
He receives an invoice from Janta Transport Corporation for Rs
15 5,000 in respect of carriage of computers from Bangalore.
He opens a bank account by depositing Rs 3,50,000.
20
He sells 6 computers on credit to ABC Computers @ Rs 35,000
25 each.
He pays by cheque the amount for carriage.
29
He receives cash Rs 2,00,000 from ABC Computers .
31
Answer to Problem 3
In the books of Computer Point – Journal

Date Particulars Dr (Rs) Cr (Rs)
1997, Jan 1 Cash A/c .. Dr 4,00,000

To Capital A/c 4,00,000
(Being business started with capital
brought in cash)
3 Purchases A/c .. Dr 3,00,000
To Hindustan Computers Ltd. A/c 3,00,000
(Being the purchase of 10 computers @
Rs 30,000 each on credit)
15 Carriage Inward A/c .. Dr 5,000
To Janata Transport Corporation A/c 5,000
(Being carriage charges payable)
Answer to Problem 3

Jan 20 Bank A/c .. Dr 3,50,000
To Cash A/c 3,50,000
(Being the opening of a Bank Account)
25 ABC Computers A/c .. Dr 2,10,000
To Sales A/c 2,10,000
(Being the sale of 6 computers @ Rs 35,000
each on credit)
29 Janta Transport Corporation A/c .. Dr 5,000
To Bank A/c 5,000
(Being paid by cheque)
Answer to Problem 3

Jan 31 Cash A/c .. Dr 2,00,000
To ABC Computers A/c 2,00,000
(Being cash received from ABC Computers)
31 Hindustan Computers A/c .. Dr 3,00,000
To Bank A/c 3,00,000
(Being paid by cheque)
The Ledger
 Ledger represents a detailed record of changes that have

occurred in a particular asset, liability, expense, loss, gain
or capital during an accounting period
 Debtor’s Ledger: contain the accounts of all the
customers to whom goods have been sold on credit
 Creditor’s Ledger: contain the accounts of all the
suppliers from whom goods have been purchased on credit
 General Ledger: may contain all residual accounts,
mainly real and nominal accounts
Posting of Ledgers
Process of transferring of debits and credits from the journal to the ledger accounts is
called posting.
Cash A/c .. Dr. Rs 10,000

To Capital A/c Rs 10,000
Ledger- Cash Account Cr

Dr
Date Particulars Amt Date Particulars Amt
( Rs) ( Rs)
To Capital A/c 10,000
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
Posting of Ledgers
Cash A/c .. Dr. Rs 10,000

To Capital A/c Rs 10,000
Ledger – Capital A/c
Date Particulars Amt Date Particulars Amt

(Rs) (Rs)
By Cash A/c 10,000
Balancing Ledger Accounts
 The balance is an accounting term which means the difference
between the two sides of an account
 Where the total of the debit side exceeds the total of the credit side, the
account is said to have a debit balance
 Where the total of the credit side exceeds the total of the debit side, the
account is said to have a credit balance
 Method of balancing- take the total of the two sides of the account
concerned. Compute the difference of the two sides
 If the debit side total is more, put the difference on the credit side
amount column, by writing the words in particulars column ‘By
balance c/d’
 If the credit side total is more, put the difference on the debit side
amount column by writing the words in particulars column ‘To
balance c/d’
Bank Account
Date Particulars (Rs) Date Particulars (Rs)

01/06/09 To Capital A/c 30,000 05/06/09 By Purchases A/c 10,000
10/01/97 To Sales A/c 15,000 20/06/09 By Wages A/c 5,000
25/06/09 By Freight A/c 2,000
30/06/09 By Balance c/d 28,000
TOTAL 45,000 TOTAL 45,000
01/07/09 To Bal b/d 28,000
Learning Objective
Relate the measurement of

expenses to the expiration
of assets.
Adjustments
 Under the accrual basis of accounting,
adjustments are used to record implicit
transactions, in contrast to the explicit
transactions that trigger nearly all day-to-
day routine entries.
 Adjustments are generally prepared by the
accountant at month or year end.
Types of Adjustments
Expiration of unexpired costs
Recognition (earning) of unearned revenues
Accrual of unrecorded expenses
Accrual of unrecorded revenues

Depreciation
Accountants usually…
predict the residual value.
predict the length of the useful life.
allocate the cost to the years of its useful life.

Learning Objective
Explain the nature of dividends

and retained income.
Dividends
Dividends are distributions of assets to

stockholders that reduce retained income.
Cash dividends are distributions of assets
that liquidate a portion of the ownership claim.
The distribution is made possible by profitable
operations.
Retained Income
Retained income is a result of profitable

operations, it is not a pot of cash awaiting
distribution to stockholders.
The retained income is, in effect, invested

in the assets and liabilities of the entity.
Learning Objective
Select relevant items from a set

of data and assemble them into
a balance sheet, an income
statement, and a statement
of retained income.
King Hardware Company
Income Statement for the Month Ended April 30, 20x1
Sales Rs 85,000
Cost of goods sold 70,000
Gross profit Rs 15,000
Operating expenses:
Rent Rs1,000
Wages 6,600 7,600
Net income Rs 7,400
Statement of Retained Income
for the Month Ended April 30, 20x1
Retained income, March 31, 20X1 Rs19,000
Add: Net income for April 7,400
Total 26,400
Deduct: Dividends 18,000
Retained income, April 30, 19X1 Rs 8,400
Balance Sheet as of April 30, 20x1
Assets
Cash Rs 85,000
Accounts receivable 87,000
Inventory 20,000
Prepaid rent 1,000
Total assets Rs193,000

Balance Sheet as of April 30, 20x1
Liabilities and Stockholders’ Equity
Liabilities
Accounts payable Rs 81,000
Accrued wages payable 600
Unearned sales revenue 3,000 Rs 84,600
Stockholders’ equity
Paid-in capital Rs100,000
Retained income 8,400 108,400
Total equities Rs193,000
Learning Objective
Distinguish between the

reporting of corporate owners’
equity and the reporting of
owners’ equity for partnerships
and sole proprietorships.
Sole Proprietorship/
Partnership
A sole proprietorship is a business entity with

a single owner.
A partnership is an organization that joins two

or more individuals together as co-owners.
Comparison of
Owners’ Equity Reporting
Owners’ Equity for a Corporation
Stockholders’ equity
Capital stock (paid-in capital) Rs100,000
Retained income 8,400
Total stockholders’ equity Rs 108,400
Comparison of
Owner’s Equity for a Sole Proprietorship
Alice Walsh, capital Rs 108,400

Comparison of
Owners’ Equity for a Partnership
Susan Zingler, capital Rs 54,200

John Martin, capital 54,200
Total partners’ equity Rs 108,400
Generally Accepted
Accounting Principles (GAAP)
Årsregnskabslov (ÅL)
International Accounting
Standards Committee (IASC)
Accounting is based on a set of principles on which

there is general agreement, not on rules that can be
“proved.”
Audit
An audit is an examination or in-depth

inspection of financial statements and
companies’ records that is made in
accordance with generally accepted
auditing standards.
Learning Objective
Understand how managers and

investors can learn about the
financial position and prospects
of an organization from its
financial statements.
Financial Statements
Managers and investors
can learn about the
financial position
and prospects of an
organization from its
financial statements.
Financial statements describe the financial results of an organi-

zation in a consistent way that allows comparison to historical
results of the organization and to the results of other organizations.
Exercises
 16-A1
 16-A2
 16-B1
 16-B2
 16-B3
 16-22 to 16-25
 16-27 to 16-33
 16-35 to 16-36

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Chapter 1

Read and interpret the basic financial

Managers, investors, and other internal groups

How well did the

Accountants answer these questions

Equities are the claims against, or interests in,

A transaction is any event that affects the

Revenues are increases in ownership

Expenses are decreases in

Profits (or earnings or income) are

The income statement measures

The balance sheet equation

Assets (A) = Liabilities (L)

A = L + Paid-in capital + Retained income

A = L + Paid-in capital + Revenue – Expenses

Distinguish between the accrual

The accrual basis of accounting recognizes

The cash basis of accounting recognizes

The accrual basis is the principal conceptual

The cash basis fails to match expenses and

Real A/c Nominal A/c Personal A/c Valuation A/c

Land & Building Carriage Capital Provision for

Trade Mark Import Duty

 Debit the receiver and credit the giver

• Sold goods to B for Rs 6,000

Types of Account to be Account to be

Real account What comes in What goes out

Nominal account Expense and losses Income And gains

Valuation account When account is to When account is to

ASSETS LIABILITIES CAPITAL REVENUE EXPENDITURE WITHDRAWL

 First book in which transactions of a business unit

1997, Jan 1 Mr. Peter commences business as a computer merchant, trading

In the books of Computer Point – Journal

1997, Jan 1 Cash A/c .. Dr 4,00,000

In the books of Computer Point – Journal

Date Particulars Dr (Rs) Cr (Rs)

In the books of Computer Point – Journal

 Ledger represents a detailed record of changes that have

Cash A/c .. Dr. Rs 10,000

Ledger- Cash Account Cr

Cash A/c .. Dr. Rs 10,000

Ledger – Capital A/c

Date Particulars Amt Date Particulars Amt

Date Particulars (Rs) Date Particulars (Rs)

10/01/97 To Sales A/c 15,000 20/06/09 By Wages A/c 5,000

25/06/09 By Freight A/c 2,000

30/06/09 By Balance c/d 28,000

TOTAL 45,000 TOTAL 45,000

01/07/09 To Bal b/d 28,000

Relate the measurement of

Expiration of unexpired costs

Recognition (earning) of unearned revenues

Accrual of unrecorded expenses

Accrual of unrecorded revenues

predict the residual value.

predict the length of the useful life.

allocate the cost to the years of its useful life.

Explain the nature of dividends

Dividends are distributions of assets to

Retained income is a result of profitable

The retained income is, in effect, invested

Select relevant items from a set

Total assets Rs193,000