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Basic Accounting Concepts.ppt

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Basic Accounting Concepts.ppt

  1. 1. 1/31/2023 3:27:45 AM 5864_ER_RED 1 Basic Accounting Concepts Maruti Pratapa
  2. 2. Agenda • What is Accounting • What's an Account? • Debit and Credit • Accounting Terminology • Some Basic Information • Accounting Equation • Double Entry system • What is Debit and Credit • Accounting vs. Finance • Advantages of Accounting • Accounting Method • Accounting Concepts and Conventions • Generally Accepted Acct. principles • Thumb Rules of Accounting • Financial Statements • Usage of Accounting • Preparation of Reports • In ERP Perspective
  3. 3. What is Accounting • A Business Language • A set of Rules to record business transactions in a consistent Manner • The Basis of Business Operations • Constantly changing In a layman’s language accounting is  Keeping track of the Financials activities  recording them in a specific order  keeping them for reference of future use.
  4. 4. What is Accounting Accounting is a difficult term to define. However, it is formally defined by the American Accounting Association as “The classification and recording of monetary transactions, the presentation and interpretation of the results of those transactions in order to assess performance over a period and the financial position at a given date, and the monetary projection of future activities arising from alternative planned courses of action”. Using this definition, accounting can be seen to be about the identification and recording of business transactions as a way of assisting the management and planning of a business. Definition: Accounting is defined as Recording, Classifying and Summarizing the transactions in monetary terms for preparation of Financial Statements. Ex: Profit & Loss account, Balance Sheet
  5. 5. What's an Account? An account is a summarized record of business transactions that effect a particular type of asset, liability or capital The System Of Double Entry Every Business Transaction involving money or money’s worth gives rise to two aspects 1) The receiving of value on one hand 2) The giving of the same value on the other hand Giving & receiving aspects takes place between accounts Rules: Debit Expenses and losses Credit income and gains
  6. 6. Accounting Terminology Accountants use the terms debit and credit to describe whether money is being transferred to or from an account. Money is recorded in the debit column, which is always the left column, when it is being transferred to an account. Money is recorded in the credit column, which is always the right column, when it is being transferred from an account. Money always flows from the right column of one account to the left column of another account. The main rule of accounting is this: For every transaction, total debits must equal total credits. This is the way of double entry rule, that for each transaction, the amount of money transferred from accounts must equal the amount transferred to other accounts
  7. 7. Some Basic information Basic accounting rules group all finance related things into fundamental types of “accounts”. That is, everything that accounting deals with can be placed into one of these 5 accounts 1. Assets - things you own. 2. Liabilities - things you owe. 3. Equity - overall net worth. (Capital-in case of a Sole Trader & Partnerships) 4. Income - increases the value of your accounts. 5. Expenses - decreases the value of your accounts. It is clear that it is possible to categorize financial world into these 5 groups. For example, the cash in bank account is an asset, Housing Loan is a liability, salary is income, and the cost of dinner last night is an expense for an Individual.
  8. 8. The Accounting Equation The relationship between 5 basic accounts and How they affect the others? Your net worth is calculated by subtracting your liabilities from your assets Assets - Liabilities = Equity Furthermore, you can increase your equity through income, and decrease equity through expenses. This makes sense of course, when you receive a paycheck you become "richer" and when you pay for dinner you become "poorer". This is expressed mathematically in what is known as the Accounting Equation: Assets - Liabilities = Equity + (Income - Expenses)
  9. 9. Double Entry Double entry accounting has been around since the late 15th century, when it was described by an Italian friar, Luca Pacioli. • Double entry accounting is recording transactions in a book called a ledger. • Copying each part of the transaction to separate books called journals. • This method is used to avoid entry errors and to track source of errors. • This Book-keeping lets to track where money comes from and where it goes. • Double entry means value for money is never gained nor lost - an equal amount is always transferred from one place to another. Example: When you purchase any thing from grocery store, money is transferring from your pocket to the grocery store. And you are receiving the equivalent groceries from the store.
  10. 10. Double Entry The accounting equation is the very heart of a double entry accounting system. For every change in value of one account in the Accounting Equation, there must be a balancing change in another. This concept is known as the Principle of Balance, and is of fundamental importance for double entry accounting systems. Double entry accounting serves two purposes. The first is to create an accounting trail, money always has to come from somewhere and go to somewhere. Additionally, double entry accounting historically served to double check the math of an accountant. Because the numbers are entered into multiple accounts simultaneously, there are multiple places to check to make sure the totals match. Of course, with the advent of computers, the chances of a mathematical problem are low, but it is good to know that the concept still exists!
  11. 11. Accounting and Finance • Sourcing and Application of Funds • Means for Investment Decisions • Financing Decisions (Application) • Always Futuristic (Forecast) • Cost of Capital • Cash Flow / Funds Flow • Project Appraisal • Ratio Analysis • Recording of an Financial event • Always Expressed in Monetary Terms • Record, Classify, Summarize the Transactions • Preparation of Financial Statements (Trading, P&L and Balance Sheet) • Historical (Post Mortem) • Compliance with Statutory Matters of Companies Act, Income Tax Act,Sales Tax etc Finance Accounts
  12. 12. Advantages of Accounting •Provides a vision for the Business •Provides the sources and application of the funds in correct way •Before and after effects can be managed in Finance •Accounting is a record of all financial activities » Allows to manage the financial activities » Financial Control and integration •Provides a complete understanding about the business for all.
  13. 13. There are some accounting methods by which we can practice the Accounting Ex: Cash Method, Accrual Method and Mixed (Hybrid) Method Cash Basis Cash-basis accounting is a method of bookkeeping that records financial events based on cash flows and cash position. Revenue is recognized when cash is received and expense is recognized when cash is paid. In cash-basis accounting, revenues and expenses are also called cash receipts and cash payments. Accrual-basis Accrual-basis accounting records financial events based on events that change your net worth (the amount owed to you minus the amount you owe others). Standard practice is to record and recognize revenues in the period in which they incur and to match them with related expenses in a process known as matching or expense matching. Even though cash is not received or paid in a credit transaction, they are recorded because they are consequential in the future income and cash flow of the company. Accrual-basis is GAAP compliant. Accounting Method
  14. 14. Accounting Concepts/Conventions • Accounting Principles were historically developed through common acceptance and Usage • In General they satisfy the following – Usefulness – Objectivity – Feasibility
  15. 15. Generally Accepted Accounting Principles (GAAP) 1. There are some principles that govern the double entry book-keeping, they are called GAAP 2. These GAAP are defined by the statutory bodies
  16. 16. Accounting Concepts/Conventions (US GAAP/UK GAAP) • The Concepts and conventions of accounting are developed by IASC (International Accounting Standards Committee) which is in-charge of releasing International Accounting Standards(IAS) • The IASC Decides the preferred Accounting practices worldwide and encourages the worldwide acceptance • There are 41 International Accounting Standards and 29 Indian Accounting Standards
  17. 17. Accounting Concepts / Principles • Business Entity Concept • Money Measurement Concept • Dual Aspect Concept • Cost Concept • Accounting Period • Conservatism • Realization Concept • Matching Concept • Materiality Concept • Objectivity
  18. 18. Accounting Conventions / Practices • Going Concern • Consistency • Accrual
  19. 19. Accounting Concepts • Business Entity Concept Accounts can only be kept for Entities, which are different from the persons who are associated with these entities (e.g) Sole Proprietary, Partnership firm, Company • Money Measurement Concept Record should be made only of that information which can be expressed in Monetary Terms (e.g) Sole Proprietor had 40 Tables & Chairs
  20. 20. Accounting Concepts • Dual Aspect Concept The Value of the Assets owned by the concern is equal to the claims on the Assets ASSETS = LIABILITIES + OWNER’S EQUITY EQUITY = ASSETS – LIABILITIES • Cost Concept Assets are always shown at their Cost and not at their current Market Value (e.g) A Land Purchased for Rs.5 Lacs will be recorded only at Rs.5 Lacs even though Market value may be lower say Rs.4 Lacs or Higher Rs.6 Lacs than the Cost Price
  21. 21. Accounting Concepts • Accounting Period Accounting measures activity for a specified interval of time, usually a year (e.g) Calendar Year (Jan’04-Dec’04), Financial Year (Apr’04-Mar’05) • Conservatism Anticipate no Profits but provide for all possible losses (e.g) A pharmaceutical Company going to Loose the case filed for Patent Right filed for a medicine Company is likely to Win a Major Legal Dispute or a Sales Contract
  22. 22. Accounting Concepts • Realization Concept The Sales is considered to have taken place only when either the cash is received or some third party becomes legally liable to pay the amount (e.g) A Sales invoice for Rs.10 Lacs Credit Note for Rs.15000 received • Matching Concept When an Event affects both the revenues and expenses, the effect on each should be recognized in the same accounting period (e.g) March Salary paid in April
  23. 23. Accounting Concepts • Materiality concept Insignificant events would not be recorded, if the benefit of recording them does not signify the cost (e.g) A calculator worth Rs.500 not recorded asset rather than charged off as Expenses even though the benefit is enduring in nature • Objectivity Concept An Evidence of the happening of the Transaction should support every Transaction (e.g) Third Party Evidence (Cr.Note from Supplier)
  24. 24. Accounting Conventions • Going Concern Accounting Records , Events and Transactions on the assumption that the entity will continue to operate for an indefinitely Long period of time (e.g) An Entity will not be started with an intention to close within the specified time period • Consistency The Accounting Policies and methods followed by the company should be the same every year (e.g) Period should not be changed frequently from Jan-Dec to Apr- Mar
  25. 25. Accounting Conventions • Accrual In General it is assumed that Accounts are always prepared based on Accrual basis. However there are entities which follow Cash Basis of Accounting Also (e.g) Salary Payable to employees(March salary paid in April), Interest Receivable on Investments (NSC interest), Dividend Receivable on shares, Tax Payable to Govt (March sales Tax and Annual Income Tax)
  26. 26. Thumb Rules for Accounting Accounts Nominal Real Personal 1. Debit the Receiver and Credit the giver 2. Debit What comes in and Credit what Goes out 3. Debit all Expenses and losses and Credit all Incomes and Gains
  27. 27. Combination of Rules Dr Personal A/c Cr Real A/c Ex:Drawings or Advance to Emp Dr Real A/c Cr Personal A/c Ex:Capital invested Dr Real A/c Cr Nominal A/c Ex: Interest Recd by Cash Dr Nominal A/c Cr Real A/c Ex: Rent Paid by Cash Dr Personal A/c Cr Nominal A/c Ex: Interest Accrued on Invst Dr Nominal A/c Cr Personal A/c Ex: Hire Purchase Charges accrued Dr Real A/c Cr Real A/c Ex:Purchase of Inv by Cash Dr Real A/c Cr Real A/c Ex: Cash withdraw or Deposit
  28. 28. Combination of Accounting Rules Combination Personal Real Nominal Personal X   Real    Nominal   X Debit Credit
  29. 29. Recording of Accounting Transactions • Recording of an Accounting event is known as Journal entry • Recording is made in Primary and Secondary Books • Primary Books – General Ledger – Cash Book Secondary Books – Purchase Register – Sales Register – Fixed Assets Register – Returns (Purchase return/Sales Return) – Journal Register
  30. 30. Classification of Accounting Event Capital Item: Any expenditure that creates an asset, for example: • Purchase of plant or machinery • Improvements to assets that increase their usefulness or extend their useful life • Expenditure incurred in transporting an asset to its site and preparing it for use.
  31. 31. Classification of Accounting Event • Revenue Item: An Income or Expenditure and the benefit of which will be exhausted within a year – (e.g) Salary and wages, Printing and Stationery, Sales Revenue, Interest Income
  32. 32. Classification of Accounting Event • Deferred Revenue Expenditure: It is neither a Capital nor Revenue and the benefit of which will be realized for more than a year and does not result in creation of an asset – Advertisement Expenditure the benefit of which is likely to be obtained over a period more than one year
  33. 33. Preparation of Financial Statements • Preparation of Trial Balance – Balances Extracted from General Ledger – Sum of debit and credit balances = 0 • Preparation of Trading, Profit & Loss Account and Balance sheet – Trial Balance is the base for preparing Financial Statements – Adjustment entries are made in adjustment period and passed as Journal Vouchers before making the financial statements – Trading and Profit and Loss Account is Always for a period say for an Year (Jan - Dec or Apr - Mar) – Balance Sheet is always as on Date (As on 31-12-2006 or 31-03-2007)
  34. 34. 1/31/2023 3:27:47 AM 5864_ER_RED 34 The End