Learn basics of Accounting Target Audience: MBA Students

1. Mechanics of Accounting

2. Types of Accounts
• There are four types of accounts:
– Assets: things the business owns.
– Liabilities: debts the business owes.
– Income: the revenue generated from the sale
of goods or services.
– Expenses: the costs incurred in producing the goods
and services.
• The main difference between these categories is that
business profit is calculated as
profit = income − expenses
while the capital of the business (the owner’s investment) is
calculated as
capital = assets − liabilities

3. • Revenue expense are costs in the for day to day
running of the business for example servicing a
machine, spare parts etc. Revenue expenditure is
normally charged against profit in the Income
statement in the year it is expensed.
EXPENDITURE
Outlay as is necessary for the MAINTENANCE of
earning capacity including the upkeep of the fixed
assets in a fully efficient state.
Revenue Expenditures

4. • Capital expenditure is an item that will help
generate profits over the longer term (12 months
or more) like a purchase of a machine or
equipment etc. The item is depreciated over the
item’s useful life and each depreciable amount is
charged to the Income statement in the year the
item has helped generate profit.
CAPITAL EXPENDITURE
Outlay resulting in the increase or acquisition of an
asset or INCREASE in the earning capacity of a
business
Capital Expenditures

5. A capital expenditure is an
amount spent to acquire or
improve a long-term asset
such as equipment or
buildings. Usually the cost
is recorded in an account
classified as Property,
Plant and Equipment. The
cost (except for the cost of
land) will then be charged
to depreciation expense
over the useful life of the
asset.
A revenue expenditure is an
amount that is expensed
immediately—thereby being
matched with revenues of the
current accounting period.
Routine repairs are revenue
expenditures because they are
charged directly to an account
such as Repairs and
Maintenance Expense. Even
significant repairs that do not
extend the life of the asset or do
not improve the asset (the
repairs merely return the asset
back to its previous condition)
are revenue expenditures.
Capital v/s Revenue Expenditures

6. Capital v/s Revenue Expenditures
1. Accounting fraud occur because management choose to classify the revenue expenditure as
capital expenditure. The revenue expenditure should be taken up into the Income
Statement but instead it is deferred into the Balance Sheet. In the process, lesser expenses
are being charge into the Income Statement, hence profit is overstated to impress the
investors or outsiders
2. Strong GAAP and Accounting standards have classified what should be assets, what
should be deferred in the balance sheet so that there should be a clearer demarcation
between Capital and Revenue expenditure
3. That certain expenses are recognized as being of a capital nature, although no tangible
property may have been acquired as a result. Examples are research and development
expenditure, pre-incorporation and preliminary expenses, interest on borrowings for
building, legal expenses to acquire property, additional renovations to properties and
others
4. The classification of what is capital expenditure of a company might not applies to another
company that is not in the same industry. Say in a property based company, most land &
buildings are revenue expenditure as they are purchased with the intent for re-sale.
5. The purpose of expenditure if it is to Maintain the business it is revenue and if it is to
Improve the business it is capital.

7. • Revenue expenditure is all the sunk cost incurred
in the course of the day to day running of the
organization.
• Capital expenditure ,can be said as the transaction
cost incurred in course of installing fixed assets in
the organization
Capital v/s Revenue Expenditures

8. Types of Accounts
Accounts
Personal
(persons –
customers,
creditors)
Impersonal
Nominal
(relating to
expenses, losses,
incomes)
Real
(relating to assets)

9. Personal Accounts
 It deals with the accounts relating to persons and
takes the following forms:
– Natural person, Artificial Person or legal body
– Representative Personal Account: Outstanding
liabilities for Rent, Salary, etc. or prepaid
expenses for Insurance Premium, Rent, etc.
– The proprietor being an individual his capital
A/c and his Drawing A/c are also known as
Personal Accounts

10. Real Accounts
 It deals with the accounts relating to the
properties and assets which are possessed by the
business concern.
– Example: Cash Account, Machinery Account,
Building Account, Purchase Account, Sales
Account, etc

11. Nominal Accounts
 It relates to the items which exist in name only.
Expenses, Incomes, etc. are there in business
activities
– Example: Rent Account, Salary Account,
Dividend Account, etc

12. Classify ………P , R / N
A. Rent a/c
B. Buildings a/c
C. Machinery a/c
D. Furniture a/c
E. Mohan a/c
F. Salaries a/c
G. Interest a/c
H. Sham a/c
I. Ali a/c
J. Capital a/c
K. Bank loan a/c
L. Cash a/c

13. Classify ………P , R / N
A. Rent a/c……………..n
B. Buildings a/c ……………..r
C. Machinery a/c ……………..r
D. Furniture a/c ……………..r
E. Mohan ……………..p
F. Salaries a/c ……………..n
G. Interest a/c ……………..n
H. Sham ……………..p
I. Alii ……………..p
J. Capital a/c ……………..p
K. Bank loan a/c ……………..p
L. Cash a/c ……………..r

14. Asset
• It results in acquiring some property or benefit of
a lasting nature or something that can be
converted into cash or any benefit can be derived
out of it later on as well
– Fixed asset
– Current asset / floating asset
– Liquid asset
– Intangible assets
– Fictitious assets – useless trademarks, preliminary
expenses

15. Classify ……….which assets
A. Leasehold premises
B. Accounting machines
C. Goodwill
D. Stock of raw materials
E. Motor vehicles
F. Cash in hand
G. Govt. securities
H. Copyright of book
I. Amounts due from customers
J. Lose tools
K. Cost of floating a company

16. Classify ……….which assets
A. Leasehold premises Fixed
B. Accounting machines Fixed
C. Goodwill Intangible
D. Stock of raw materials Current
E. Motor vehicles Fixed
F. Cash in hand Liquid
G. Govt. securities Liquid
H. Copyright of book Intangible
I. Amounts due from customers Current
J. Lose tools Fixed
K. Cost of floating a company Fictitious

17. Forms of Transactions
• Transactions may take place in one of two forms:
– Cash: If the business sells goods/services for cash, the double entry
is an increase in income and an increase in the bank account (an
asset). If the business buys goods/services for cash, either an asset
or an expense will increase (depending on what is bought) and the
bank account will decrease
– Credit: If the business sells goods/services on credit, the double
entry is an increase in debts owed to the business (called debtors,
an asset) and an increase in income. If the business buys
goods/services on credit, either an asset or an expense will increase
(depending on what is bought) and the debts owed by the business
will increase (called creditors, a liability)

18. Forms of Transactions
When goods are bought, they become an asset called
inventory (or stock). When the same goods are sold,
there are two transactions:
1. The sale, either by cash or credit; and
2. The transfer of the cost of those goods, now sold, from
inventory to an expense, called cost of sales.

19. ** HOW TO RECORD A TRANSACTION
• To record transactions, we need to decide:
– what type of account is affected (asset,
liability, income or expense) or P, R, N ;
and
– whether the transaction increases or
decreases that account.

20. Table 1: Business Transactions and the Double Entry

21. GOLDEN RULES OF ACCOUNTING
• REAL ACCOUNTS:
– DEBIT WHAT COMES IN
– CREDIT WHAT GOES OUT
• NOMINAL ACCOUNTS:
– DEBIT ALL EXPENSES AND LOSSES
– CREDIT ALL INCOMES AND REVENUES
• PERSONAL ACCOUNTS:
– DEBIT THE RECEIVER
– CREDIT THE GIVER

22. Types of Accounts
Accounts
Personal
(persons –
customers,
creditors)
Impersonal
Nominal
(relating to
expenses, losses,
incomes)
Real
(relating to assets)
Dr – Receiver
Cr – Giver
Dr – expenses/loss
Cr – incomes/gains
Dr – Comes In
Cr – Goes out

23. Transaction recording …..
Sl.
No.
Transaction Total assets Owing to
outsiders
Capital /Owner’s
Equity
1 Commenced business
with Rs. 100,000 100,000 100,000
2 Borrowed Rs. 50,000 50,000 50,000
150,000 50,000 100,000
3 Paid Expenses Rs.
10,000
-10,000 -10,000
140,000 50,000 90,000
4 Returned Rs 20,000 to
the lender
-20,000 -20,000
120,000 30,000 90,000
5 Made a profit of Rs
25,000
25,000 25,000
145,000 30,000 115,000

24. Journal Entries ……..
• Chronological order of entries
• Account to be debited to be written first
• A full explanation of the entry is given – why this
entry is made is given just below called as
narration – a journal entry without narration is
not meaningful.

25. Journal Entry
Date Particulars L.F Debit Credit
Rs. P. Rs. P.
2010 July 1 Cash A/c Dr
To Loans Payable
(Received proceeds from Bank
ABC Loan)
5
61
250,000 00
250,000 00

26. Journal Entries ……..
1. I start business with Rs 150,000 as my capital
2. Out of Rs 150,000 I deposit Rs 100,000 with the bank account
3. Goods are purchased on credit basis from M/s Ram Lal for Rs 60,000
4. A computer is purchased for cash for Rs 54,500
5. Goods are sold on credit to M/s Ali Brothers for RS 10,000
6. Goods are purchased for cash Rs5000
7. Cash is received for sale of goods to M/s Rao Brothers Rs 7000
8. Rent is paid to the landlord Rs 2000
9. A machinery is received & payment is made by cheque Rs 240,000
10. Borrowed Rs 50,0000 from a friend Mr K.Lal
11. Interest paid to Mr K.Lal Rs 600
12. Interest of Rs 600, is due to Mr K.Lal but not yet paid
13. There is fire & certain goods are destroyed; the value is Rs 10,000
14. Paid insurance premium Rs 4500 by cheque

27. Ans ……(narration + amount has to be there ………)
1. Cash a/c Dr
To Capital A/c
(…….. Narration …..)
2. Bank a/c Dr
To Cash A/c
3. Goods A/c Dr
To M/s Ram Lal
4. Computer A/c Dr
To Cash a/c
5. Ali Brothers a/c Dr
To Goods A/c
6. Goods A/c Dr
To Cash A/c
7. Cash A/c Dr
To Goods A/c
8. Rent a/c Dr
To Cash A/c
9. Machinery a/c Dr
To Bank A/c
10. Cash A/c Dr
To Loan from K.Lal a/c
11. Interest A/c Dr
To Cash a/c
12. Interst a/c Dr
To K.Lal A/c
13. Loss by fire A/c Dr
To Goods A/c
14. Insurance Premium A/c Dr
To Bank A/c

28. Make the entries for the CASE given
Mr. Raj starts his business with Rs 200,000. He opens
a bank account & deposits Rs 180,000. He purchases
furniture for Rs 8000 & makes payment by cheque.
He purchased goods from M/s Jyothi on credit Rs
56000. He also purchased goods worth Rs 11000
from M/s Khan & made cash payment. He sold goods
on credit to M/s Mohanlal worth 15,000. Paid for
office stationary Rs 2500. Paid rent of Rs 2000 to Mr
Satish by cash. Received cash from M/s Mohanlal
Rs14,700 & allowed them a discount of Rs 300.

29. Ledger
• The accounts are all contained within a ledger,
which is simply a collection of all the different
accounts for the business.
• The ledger would summarize the transactions for
each account, as shown in Table 2

30. Table 2: Summarizing Business Transactions in a Ledger

31. Ledger
• The ledger is the source of the financial reports that
present the performance of the business.
• The ledger would also contain the balance of each account
brought forward from the previous period.
In our simple example, assume that the business
commenced with £50,000 in the bank account that had
been contributed by the owner (the owner’s capital). Table
3 shows the effect of the opening balances.

32. Table 3: Summarizing Business Transactions with Opening
Balances in a Ledger

33. Ledgers
• While journals are chronologically listings of accounting
transactions (debits/credits), those transactions’ effects will
not be reflected in the financial statements until they are
posted to the general ledger.
• The general ledger contains all the accounts and their
balances, regardless of which financial statement the
accounts affect.
– Posting is the process of transferring the debits and credits from
the journals to the ledgers.
• So an entry that increases cash (via a debit) has not
actually increased the cash general ledger account until the
journal entry has been posted to the general ledger.

34. Trial Balances
• Trial balances are listings of all the general ledger accounts and their
respective balances.
• The purposes of the trial balance are to:
1. prove that debits equal credits and
2. review the accounts and their balances to see if any obvious errors exist.
• Besides checking for balance between debits and credits, the trial balance
can be used to prepare adjusting entries or even to prepare financial
statements once the balances are properly adjusted.
• A trial balance can be prepared at any point in the accounting cycle or
fiscal year.
• It is an internal tool and is not a financial statement.
• The accounts are grouped by financial statement, with balance sheet
accounts listed first, and then in the order they would appear on the
respective financial statement.

35. Closing Entries
• While all general ledger accounts have running balances (net of all
debits and credits), some accounts should be set back to zero at the
start of each major accounting period (usually annually).
• This is called closing the accounts and is accomplished by closing
entries.
• Accounts that should be closed are called “temporary” or
“nominal” accounts and include the accounts that report results of
operation. This would be all accounts reflected on the income
statement, as well as the dividends account.
• Balance sheet accounts are never closed.
• After closing entries, the balance in the retained earnings account
will reflect all past periods’ impacts (revenues, expenses, and
dividends).

36. Basics of Financial Accounting
Format of Trading Account
Dr. Trading Account for the year ending…. Cr.
Particulars Amt. Particulars Amt.
To Opening Stock xxx By Sales xxx
To Purchases xxx By Closing Stock xxx
To Direct expenses xxx By Profit & Loss Account xxx
To Profit & Loss Account xxx (Balancing figure being
(Balancing figure being Gross Loss)
Gross Profit)
xxx xxx

37. Basics of Financial Accounting
Format of Profit & Loss Account
Dr. P/L a/c for the year ending…. Cr.
Particulars Amt. Particulars Amt.
To Gross Loss b/d xxx By Gross Profit b/d xxx
To Admn. Expenses xxx By Discount received xxx
To Depreciation xxx By Net Loss transferred to xxx
To Interest xxx Capital A/c
To Bad debts xxx
To Discount
To Provision for Tax xxx
To Net Profit transferred to
Capital A/c xxx

38. Basics of Financial Accounting
Format of Balance Sheet (Horizontal)
Balance Sheet as on….
LIABILITIES Amt. ASSETS Amt.
Share Capital xxx Fixed Assets xxx
Reserves & Surpluses xxx Investments xxx
Secured Loans xxx Current Assets, Loans & xxx
Advances
Unsecured Loans xxx Miscellaneous Expenditure xxx
& Losses
Current Liabilities &
Provisions xxx
xxx xxx

39. Basics of Financial Accounting
Format of Balance Sheet (Vertical)
Balance Sheet as on……..
I. Sources of funds
1. Shareholders funds
Share capital
Reserves & Surplus
2. Loan Fund
Secured loans
Unsecured loans
II. Application of funds
1. Fixed Assets
2. Investments
3. Current assets , loans and advances
LESS: Current liabilities and provisions
4. Miscellaneous expenditure

40. Financial Reports
• To produce financial reports we need to separate the
accounts for income and expenses from those for assets
and liabilities.
• In this example, we would produce a Profit and Loss
account based on the income and expenses:

41. Balance Sheet
• The Balance Sheet lists the assets and liabilities of
the business, as shown in Table 4
• The Balance Sheet must balance, i.e. assets are
equal to liabilities.
• Although shown separately, capital is a type of
liability as it is owed by the business to its owners

42. Table 4: Balance Sheet

43. Vertical Format of Presenting A Balance Sheet