BASICS OF ACCOUNTING & BOOK KEEPING by : DR. T.K. JAIN AFTERSCHO ☺ OL centre for social entrepreneurship sivakamu veterinary hospital road bikaner 334001 rajasthan, india www.afterschoool.tk mobile : 91+9414430763
What is debit and credit Every transaction has two aspects – debit and credit. Basic accounting equation : assets = liabilities + equity debit denotes assets and credit denotes liability every transaction has some impact on asset / liability or on both.
How does it work? If asset will increase, liability will also increase, if assets will decrease, liability will also decrease, thus the equation is always balanced : A=L+E analyse each transaction in terms of its impact on A / L / E this is the fundamental concept in double entry system
Some examples of debit / credit If you buy building, assets will increase, thus when you make a journal entry, you have to debit building account if you borrow, liabilities will increase, thus you have to credit loan account.
Three rules to make your task easier 1. debit what comes in, credit what goes out (real accounts – regarding assets) 2. debit receiver, credit the giver (personal accounts – regarding debtors, creditors, and other such accounts) 3. debit all expenses, credit all income (nominal accounts – relating to income and expenditures)
Journalising – the first step When we prepare accounts, we start with journalising. We prepare journal entry to denote debit or credit entry and thus we are able to understand the impact of each transaction. In journalising, we classify each transaction in two parts – debit impact and credit impact
How to journalise? Look at the transaction, find its two aspects and analyse them. If you buy a building, assets will increase (building is an asset, so assets will increase), but assets will decrease also (you buy building against cash / bank balance) thus for increase in assets, you have to debit, for decrease in asset, you have to credit
Steps in accounting Journalise & preparation of day books posting to ledgers preparation of trial balance preparation of control accounts (if any) preparation of final accounts preparation of cash flow / funds flow statement analysis of accounts (ratio analysis etc.)
Example of transactions : Purchase of furniture : (increase in assets – furniture, decrease in assets – cash) purchase of goods on credit (increase of stock – assets, increase in creditors) sale of goods against cash (increase in income and increase in assets – cash)
Some important facts Equity / capital is a liability loss is an assets and profit is a liability expenditure contributes to loss, therefore it is treated like an asset revenue / income contributes to profit, therefore it is treated like a liability
Remember the basic classification.. Assets give real accounts liability create personal accounts debtors (assets) and creditors (liability) create personal accounts income and expenditure create nominal accounts
Systems of accounting Nominal accounts are closed every year and their balance is transferred to P & L account real account and personal accounts are not closed and they continue year after year and their balance is shown in balance sheet. If balance sheet doesnot tally, prepare a suspense account to ensure that balance tallies.
Trial balance In trial balance, you have to show the balance of every account on the date of preparation of trial balance. Thus it is collection of balance of all the accounts that you have. By default, it will be having equal totals of debit and credit side. Thus it will balance, if it doesnt, it means there is some error. Trace out the error and rectify it.
Examples of accounting entries Purchase of raw material against cash : purchase account debit, cash account credit (purchase is a real account, as it denotes stock, which is an asset and this account will never be closed, cash is also an assets, when you buy goods, assets increase and assets decrease thus debit and credit both affect assets, no change in liability)
example... Payment of salary out of cash salary account debit, cash account credit (salary is a nominal account, it is an expenditure, and all expenditures are treated like assets, but it is nominal account so this account will be closed at the end of the year and transferred to P & L account, cash is also an asset)
P & L account It will contain only the balance / totals of nominal accounts it will not contain balance / total of any real account or of any personal account. It has two parts – debit and credit debit part denotes only expenditure and credit denotes only income / revenue. If debit is more, we have loss, if credit is more, we have profit, which will be shown in balance sheet
Balance sheet It denotes only the balance / total of only real accounts and personal accounts. It does not show balance of nominal accounts. Some nominal accounts continue for one more year, they will be shown in balance sheet. Example : outstanding expenditure, accrued income will be shown in balance sheet (although they are nominal accounts)
Adjustment entries... At the end of the year, some adjustment entries are made, and these adjustment entries are necessary while account finalisation. Exmaple : outstanding expenditure, acrued income etc.
What is outstanding expenditure? In accounting, we generally mercantile system, in which all the income and expenditure related to this year will be recorded in this year's accounts. Thus if some expenditure has taken place, but we have not paid for it, it is outstanding expenditure. Suppose, rent of Feb. And March are outstanding, we have not paid them, but we have to treat them in P & L account and show them as outstanding expenditure.
What is accrued income ? In accounting, we generally mercantile system, in which all the income and expenditure related to this year will be recorded in this year's accounts. Thus if some income has taken place, but we have not received it it, it is accrued income. Suppose, interest receivable of Feb. And March are outstanding, we havent received them, but we have to treat them in P & L account and show them as accrued income
WHAT IS CAPITAL RECEIPT? Receipt which are of the nature of fixed capital are called capital receipt
WHAT IS REVENUE RECEIPT? Receipts which are of the nature of circulating capital are called capital receipt Circulating capital is that part of the capital which is turned over in the business and which ultimately results in profit or loss.
Machinery in the hands of a manufacturer is .... Fixed capital – it is fixed assets – it is shown in the balance sheet as an asset. When you buy it the entry is : machinary account debit, bank account credit later on you have to show depreciation every year on this. Suppose machine cost 1000, its life is 10 year, so you will show 100 every year for 10 years as depreciation in P& L account
What is trading account ? Trading accout is prepared by manufacturing companies to show their gross profit. It denotes all the expenditure till manufacturing. The debit side of trading account contains expenditures like wages, raw material purchased, carriage inward, etc. The credit side (right side) of trading account contains items like revenue, sales etc. The difference of debit and credit side is called gross profit / loss.
example... Prepare trading and profit and loss account and balance sheet from the following itmes : sales:200, purchase :50, wages :30, salary 50, rent:10, postage :5, furniture : 20, building : 50 capital: 50, loan : 100, creditors : 30, debtors : 50, cash : 20, inventory opening stock : 20, closing stock : 50, carriage outward : 20, carriage inward : 10, interest recd. : 5, interest paid : 10, Investments : 30
ADDITIONAL INFORMATION We have not provided for depreciation, which has to be provided in the annual accounts of a company, we have to follow the prescribed proforma of a company as provided in the comapnies act and we have to prepare it strictly as per that proforma.
Example... Prepare trading and profit and loss account and balance sheet from the following itmes : sales:200, purchase :50, wages 20, outstanding wages :10, salary 50 outstanding salary 10, , rent:20, prepaid rent 10, building : 50 capital: 50, loan : 100, cash : 20, inventory opening stock : 20, closing stock : 50, interest recd. : 5, interest acrued but not yet received 5, interest paid : 10, interest yet to be paid 10, Investments : 30 rate of depceciation : 10%