Fundamentals of Accounting Accounting Process of Accounting/Steps of Accounting

Bank of Baroda Accounting and Financial Management
Fundamentals of Accounting
Accounting
Accounting is a process of systematic way of recording business transactions.
Process of Accounting/Steps of Accounting
Step 1: Recording (Preparation of Journal Entries)
Recording refers to recording (i.e., entering) of business transactions as and when
they
occur.
Step 2: Classifying (Preparation of Ledger Accounts)
Classification refers to the grouping/classifying the business transactions (which are
recorded in journal book) which are similar in nature.
Step 3: Summarizing (Preparation of P&L and Balance Sheet)
Summarization refers to presentation of classified business transactions through
financial
statements like Profit & Loss account and Balance Sheet.
Step 4: Analysis & Interpretation
It refers to drawing conclusions from the data found in the financial statements about
the
profitability and the financial position of the business.
Accounting Principles:
Accounting Principles can be divided into –
a) Accounting Concepts
b) Accounting Conventions
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I Accounting Concepts
Accounting concepts refers to “general assumptions’ on which accounts are prepared. These
assumptions (concepts) give clarity on the transactions.
Example 1
Apollo tyres sold goods (tyres) to Toyota Ltd. on 1 st Dec 2012 worth Rs. 5, 00,000 and
amount will be received on 1st Feb 2013.
What is the transaction date?
Example 2
ICICI Bank purchased a land in M.G.Road for Rs. 5, 00,000 on 1 st Jan 2006 and the value of
the land as of now is Rs. 9, 00,000.
What should be the value to be recorded? Whether is it Rs. 5, 00,000 or Rs. 9, 00,000?
Example 3
Mr. Girish appointed as a Managing Director in Toyota Ltd.
Should the transaction be entered or not?
In the above three examples, there is an ambiguity. So accounting concepts (assumptions) are
made to get clarity on the transactions.
There are 11 concepts –
1) Money Measurement Concept
2) Going Concern Concept
3) Cost Concept
4) Dual Aspect Concept/Accounting Equation Concept
5) Accounting Period Concept
6) Objective Evidence concept
7) Matching Concept
8) Business Entity/Separate Entity Concept
9) Accrual Concept
10) Realization Concept
11) Legal Aspect Concept
1) Money Measurement concept
 Only those transactions that can be expressed in money terms (financial transactions)
are recorded in the books.
e.g. Toyota Ltd purchased goods from Apollo Tyres Ltd. worth Rs. 1,00,000
 Non-monetary transactions (i.e., events which cannot be expressed in terms of money)
will not be recorded.
e.g. a) Retirement of a managing director
b) Appointment of an employee.
2) Business/Separate Entity Concept

 The owner and the business are considered as two different persons, distinct from
each other.
 Transactions are recorded from the point of view of the business and not the owner.
As such any amount invested by the owner in the business is considered as a liability
by the business towards owner.
 Only those transactions which are related to business are recorded.
 Personal transactions and private property of the owner are not recorded in the books.
3) Going Concern Concept

 It is assumed that the business will continue to operate for a fairly long time/indefinite
period.
4) Cost Concept
 Assets acquired (purchases) are recorded at cost price. (i.e., at the price actually paid
for acquiring the asset)
 The market price of the asset is ignored.
5) Dual-aspect Concept/Equation Concept/Accounting Equation Concept:

 Every business transaction always results in receiving of some benefit of some value
and giving of some other benefit of equal value.
 E.g. L & T limited purchased goods worth Rs. 1,00,000
o L & T received goods – receiving benefit
o L & T giving money to other party – giving benefit.
 Thus, every business transaction involves dual or double aspects of equal value
(which is also called as double entry or two-fold effect)
6) Accounting Period Concept:

 According to this concept, the life span of a business is divided into fixed period of
time (monthly, quarterly, half yearly, yearly) for which accounts are prepared.
 Accounts of the business are closed at a specific date every year and final accounts
(P&L a/c and Balance Sheet) are prepared to ascertain the results.
7) Objective Evidence Concept:

 As per this concept, all accounting transactions should be evidenced and supported by
documents such as invoices, receipts etc.
8) Accrual Concept:
 As per this concept, the business transactions are recorded when they occur (and not
as when the cash is paid or received).
 E.g. BHEL Ltd sold goods to HAL on credit basis worth Rs. 1,00,000 on 1 st Dec 2012,
and the amount will be paid on 2nd Feb 2012.

The transaction date is 1st Dec 2012.
9) Realization Concept:
The realization concept determines the exact period when revenue is recognized/realized.
e.g. A business receives an order in the month of March to supply goods in the month of May.
The revenue will only be realized once the actual transaction takes place in the month of
May.
10) Matching Concept:

As per this concept, a business organization needs to match expenses with related revenues in
order to report a company’s profitability during a specified time interval.
II Accounting Conventions
1) Convention of Materiality
2) Convention of Conservatism (convention of caution, prudence)
3) Convention of Consistency
Convention of Materiality:
A detailed record is made only of those business transactions which are material (i.e.,
important)
Insignificant transactions are not recorded.
Convention of Conservatism
“Provide for all possible losses, but anticipate no profits”. Company can show expected
losses (e.g. provision for bad debts, doubtful debts) but should not show projected/expected
profits/or revenues)
Convention of Consistency:
Accounting practices and methods should remain consistent (i.e., unchanged) from one
accounting year to another.
e.g. Once a particular method adopted for depreciation, the same method should continue for
next year.
Technical Terms
Goods
 Goods refer to merchandise, commodities, products, articles or things in which a
trader deals. In other words, they refer to commodities or things meant for re-sale.
 Anything you purchase for the purpose of trading.
 E.g. Furniture dealer purchases chairs, tables benches etc.
Assets
 Anything purchased for the purpose of use for the business.
 Anything purchased not for the purpose of re-sale.
 E.g. Cash, machinery, land & building etc
I: Types
a) Tangible Asset: Cash, machinery, land etc.
b) Intangible Asset: Patents, copy rights, trade mark, goodwill etc.
II: Types
a) Fixed Asset : Held for long-term
e.g. Machinery, land & building etc
b) Current Asset : Held for short-term ( generally < 12 months)
e.g. Debtors, Cash, bills receivables etc.
Debt:
 Borrowed money
 E.g. Bank loan, etc.
Liability:
 Amount due from a business to others either for money borrowed or for goods
purchased on credit (i.e., goods purchased without making immediate payment)
 E.g. Loan taken form banks, creditors (amount owed to suppliers), BOD (Bank
Overdraft)
Types
a) Short-term Liability: < 12 months
e.g. Creditors (amount due to suppliers) etc.
b) Long-term Liability : > 12 months
e.g. Loan taken from the bank, debentures etc.
Capital
 Amount invested in the business (usually at start up, but may include additional funds
raised)
 Money (i.e., cash) or money’s worth (i.e., goods, furniture, buildings) introduced or
invested by the proprietor or owner in the business.
Expenses
 These are general costs of doing business.
 It includes all expenses ( other than cost involved for purchase of asset) such as rent
paid, purchase of goods, salaries etc
Revenue
The mechanism where income enters the company (note that revenue & income are not the
same thing – they are used here to describe each other in basic terms only)
Creditor
 Amount owed to a supplier from the business for credit purchase.
 Amount due by business to the suppliers of goods.
Debtors
 Amount owed to the business from a customer for credit sales.
Equity
 Represents the ownership. It is the ownership value of a company.
 e.g. common stock, retained earnings.
Depreciation
 Depreciated value of an asset
Drawings
 Amount withdrawn from the business by the owner for his personal use.
Bad Debt
 A debt (loan) which is irrecoverable is called a bad debt.
Doubtful Debt
 A debt whose recovery is doubtful is called a doubtful debt.
Journal
 A journal is a daily record of business transactions.
Outstanding Expenses
 Cash such as rent, interest and insurance premium etc that are due (yet to be paid)
Prepaid Expenses
 Costs such as rent, interest, insurance premium etc that are paid in advance.
Bills Receivables
 Bills receivables/Account receivables represent money owed by entities to the firm on
the sale of products on credit.
Bills Payables
 Bills payables represents money owed to suppliers of goods purchased on credit.
Accounting Equation
 Accounting equation represents Assets are equal to Liabilities.
 Liabilities can be further categorize as External Liabilities and Capital
 Assets = Liability + Capital
Debits & Credits

 Debit is on the left or payments, Credit are on the right or receipts.
 How are debit and credit rules applied to different types of accounts?
Debit ……………… Nature of Accounts……………… Credit

Increase…………………....Assets……………………..Decrease
Decrease…………………Liabilities…………...………..Increase
Decrease……….…………Revenue……………………..Increase
Decrease……………..…….Equity……………….……..Increase
Increase………………...…Expenses…………...……….Decrease
Classification of Accounts / Golden Rules of Accounting

1) Real Account
2) Personal Account
3) Nominal Account
REAL ACCOUNT
Business activities require tangible things like furniture, land, building, vehicle, plant and
machinery etc. for operation. Cash need to be paid to acquire these items. They are known
as real account.
DEBIT WHAT COMES IN

CREDIT WHAT GOES OUT
PERSONAL ACCOUNT
This accounts relates to a person, or institution (firm) in which the business concern either
‘receives’ something from the individual or institution or ‘pays’ something to the individual
or institution by which a ‘future relationship is established’/
DEBIT THE RECEIVER

CREDIT THE GIVER
E.g. Individuals (ram’s a/c, Janaki’s a/c), firm (apollo tyres, xyz ltd.), drawings, debtors,
creditors etc.
NOMINAL ACCOUNT (FICTITIOUS ACCOUNT)
Nominal accounts are accounts of the expenses & losses which a firm incurs, and incomes &
gains which a firm earns in the course of its business.
E.g. rent paid, salary paid, commission received, interest earned etc.
DEBIT ALL EXPENSES AND LOSSES

CREDIT ALL INCOMES AND GAINS
DISCUSSION ON DEBITS AND CREDITS
Debit ……………… Nature of Accounts……………… Credit

Increase…………………....Assets……………………..Decrease
Decrease…………………Liabilities…………...………..Increase
Decrease……….…………Revenue……………………..Increase
Decrease……………..…….Equity……………….……..Increase
Increase………………...…Expenses…………...……….Decrease
Assets & Expenses Liability & Revenue
Debit
Credit
Liability & Revenue Assets & Expenses
Steps to Classify the Accounts/Application of Golden Rules of Accounting

Step 1: Find out the two aspects/accounts of the transactions
Step 2: Identify those two aspects/accounts as expense, income, asset, individual etc.
Step 3: Classify those identified two accounts/aspects under 3 heads such as a) Real a/c, b)
Personal a/c, c) Personal a/c
Steps of Accounting Cycle

1) Journal
2) Leger Accounts
3) Trial Balance
4) Trading & Profit & Loss Account (T & P & L account)
5) Balance Sheet
I JOURNAL ENTRY
Journal Book: It is called as book of original entry recorded manually under the conventional
method of accounting.
Format of Journal Book
Date Particulars LF Debit Credit
II LEDGER
It is the book where transactions of the same nature are classified and grouped together in one
place in the form of an account, through a process called “posting” (i.e., transferring of
entries from the journal to the ledger), to know the position of that account.
Format of Ledger Account
Dt
Ct
Date Particulars Amount Date Particulars Amount
III TRIAL BALANCE

 A Trial Balance is a statement of Debit(Payment) and Credit(Receipt) balances
extracted from all the ledgers.
 The purpose is to find out the arithmetical accuracy of posting all accounts in the
respective ledgers.
Hints for the preparation of a Trial Balance

 If a ledger account shows a debit balance, it should appear on the debit side of the trial
balance.
o The balances of a) assets accounts b) Expenses accounts are placed in the
debit column of the trial balance
 If a ledger account shows a credit balance, it should appear on the credit side of the
trial balance.
o The balances of a) Liabilities accounts b) capital are placed in the credit
column of the trial balance
Format of Trial Balance

Sl Debit Credit
Heads (i.e., Names of Accounts) LF
No. Balances Balances
1 Assets ( cash a/c, debtors a/c, machinery a/c, Loan a/c xxx ---
2 etc) --- xxx
3 Liabilities (capital a/c, SB a/c, FD a/c etc) xxx ---
4 Expenses(Courier Charges a/c, Int paid a/c, rent a/c --- xxx
etc) _________ ________
Incomes ( Int received a/c, commission received a/c, xxx xxx
etc)
IV PREPARATION OF PROFIT & LOSS A/C

 The profit and loss account shows the net profit or net loss (i.e., ultimate profit or
loss) of a business for a particular period. It considers all the income and expenses
incurred in running the business.
Appendix 8: Banking Company Financial Statements

Profit and Loss Account for the period ending March 31, XXXX
Income
 Interest Earned S-13 XXXXXX

 Other Income
S-14 XXXXXX
Expenditure XXXXXX
 Interest Expended
 Operating Expenses
S-15 XXXXXX
 provisions
S-16 XXXXXX
Profit/Loss
S-17 XXXXXX
XXXXXX
XXXXXX
Balance carried over to Balance Sheet
V PREPARATION OF BALANCE SHEET

 A balance sheet, also referred to as Statement of Financial Position, is a statement that
exhibits the assets and liabilities of a business enterprise prepared at a particular date.
 A balance sheet comprises of three parts viz., Assets, Liabilities and Capital
Balance sheet as on March 31, XXXX

Capital & Current Liabilities
S-1 XXXXXX
 Share Capital
S-2 XXXXXX
 Reserves and Surplus S-3 XXXXXX
 Deposits S-4 XXXXXX
 Borrowings S-5 XXXXXX
 Other liabilities and provisions XXXXXX
Assets
 Cash and balance with RBI

 Balances with banks and money at call and short notice S-6 XXXXXX
 Investments S-7 XXXXXX
 Advances S-8 XXXXXX
 Fixed assets S-9 XXXXXX
 Other assets S-10 XXXXXX
S-11 XXXXXX
XXXXXX

Fundamentals of Accounting Accounting Process of Accounting/Steps of Accounting

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Bank of Baroda Accounting and Financial Management

2) Business/Separate Entity Concept

3) Going Concern Concept

5) Dual-aspect Concept/Equation Concept/Accounting Equation Concept:

6) Accounting Period Concept:

7) Objective Evidence Concept:

and the amount will be paid on 2nd Feb 2012.

10) Matching Concept:

 e.g. common stock, retained earnings.

Debits & Credits

Debit ……………… Nature of Accounts……………… Credit

Classification of Accounts / Golden Rules of Accounting

DEBIT WHAT COMES IN

DEBIT THE RECEIVER

DEBIT ALL EXPENSES AND LOSSES

DISCUSSION ON DEBITS AND CREDITS

Debit ……………… Nature of Accounts……………… Credit

Assets & Expenses Liability & Revenue

Liability & Revenue Assets & Expenses

Steps to Classify the Accounts/Application of Golden Rules of Accounting

Steps of Accounting Cycle

Format of Journal Book

Date Particulars LF Debit Credit

III TRIAL BALANCE

Hints for the preparation of a Trial Balance

Format of Trial Balance

IV PREPARATION OF PROFIT & LOSS A/C

Appendix 8: Banking Company Financial Statements

 Interest Earned S-13 XXXXXX

V PREPARATION OF BALANCE SHEET

Balance sheet as on March 31, XXXX

 Cash and balance with RBI

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