ACCOUNTING MECHANISM

Learning objectives:  To understand the Accounting mechanism (Accounting Cycle)  To understand the Double Entry system  To understand the meaning of account and classification of accounts  Conceptual frame work of Financial Accounting  To know how to prepare the Final Accounts.

Double Entry System of Book Keeping  It recognizes that every transaction has a twofold effect.  The method of writing every transaction in to two accounts, of these two accounts, one A/c is given ‘Debit’ while other one is given ‘Credit’ with an equal amount so that the Accounting Equation is always in balance.  On any date Total Debits = Total Credits

The steps in Recording Process TransactionsDocumentationJournal Financial Statements Trial Balance Ledger

Conceptual frame work of Financial Accounting

ACCOUNTING MECHANISM 1. Recording  Journalizing 2. Classifying  Ledger preparation 3. Summarizing  Balancing the ledger  Preparation of Trial Balance  Preparation of Profit and Loss A/c  Preparation of Balance Sheet 4. Interpreting the results.

JOURNAL  The book containing chronological record of transactions.  Recording of entries in the journal is known as Journalizing.  Large Firms/Concerns maintain special journals also known as Subsidiary Books.

ACCOUNT - MEANING  An individual record of increases and decreases in an item that is likely to be of interest or importance.  It is “T” shaped Debit is left side of “T” account Credit is right side of “T” account

Journalizing  Debits are always recorded first.  Indent, then record the credit below the debit.  A short explanation is included on the second line.  Leave a space between journal entries.  Debits must always equal credits.

Classification of Accounts

Rules of Double Entry System Personal A/cReal A/cNominal A/c Debit:The ReceiverWhat comes in All expenses and Losses Credit:The giverWhat goes out All incomes and gains

SUBSIDIARY BOOKS 1. Cash Book:  Simple  Two column  Three column 2. Purchase Book 3. Purchase returns Book 4. Sales Book 5. Sales returns book 6. Bills Receivable book 7. Bills Payable Book 8. Journal Proper (other transactions)

LEDGER  It is set of all accounts.  It contains a classified summary of all transactions recorded in journal.  The concerned account debited in journal should also be debited in the ledger with a reference to the a/c which has been credited in ledger and vice versa.

Balancing of Ledger Accounts  The difference between the total debit and total credit sides of an account is called balancing.  The difference is entered in the amount column of the side showing less total.  An account is said to have a debit balance if its debit side is greater than credit.

TRIAL BALANCE  A statement of Debit and Credit totals or balances extracted from the various accounts in the Ledger.  Objectives: –To facilitate the preparation of Final Accounts. –To check the arithmetical accuracy of the books.

Methods of preparing trial Balance Balance Method Prepared with the balances of Ledger Accounts. Total Method The total of the debit and credit side of every account is separately written in the debit and credit column of trial balance. Total and Balance Method Both the balance and total method are presented in the trial balance Elimination of Equal Total Method. Accounts whose debit totals and credit totals are equal are not incorporated in the trial balance

FINAL ACCOUNTS  Include preparation of:  Trading and Profit and Loss A/c –To know the operating performance of the business i.e.profitability.  Balance Sheet –To know the financial position of the firm on a particular date.

Trading Account  Shows the results of buying and selling goods/services.  Ascertain Gross profit/Gross loss  Calculates the cost of Goods Sold  Calculates Gross profit ratio, ratio of direct expenses to gross profit.  Comparison of Actual with the desired performance.

Items Appearing in trading Account Debit Side 1)Purchases 2)Purchase return 3) Opening Stock 4)Wages 5)Carriage inward 6)Custom duty 7)Royalty 8) Gas, electricity etc 9)Packing Material Credit Side 1)Sales 2)Sales Return 3) Closing Stock

Profit and Loss Account  Summarizes the financial results of a company during a particular period of time.  It ascertains the net profit or loss for a particular period.  It contains all the items of revenue, gains, losses and expenses pertaining to the accounting period.

Items of Profit and loss account Debit Side 1)Salaries 2)Rent 3) Discounts 4)Bad Debts 5)Carriage outward 6)Drawing 7)Income Tax 8) Loss by fire,theft 9)Loss or gain on sale of fixed assets. Credit Side 1)Discount earned 2)Interest earned 3) Commission earned 4)Rent earned

Balance Sheet  Balance sheet is an item wise list of assets,liabilities and proprietorship of a business at a certain date.  To ascertain the financial position of a business.  It gives protection against uncertainty  Helps ascertain proprietary ratio

Items of Balance Sheet Assets Side 1 ) Non Current Assets 2) Current Assets Liabilities Side 1) Owner’s Equity 2)Long term Liabilities 3)Current Liabilities

Items of Balance sheet Non current Assets Fixed Assets 1)Tangible Assets 2)Intangible Assets Deferred tax assets Other Non Current Assets Intangible Assets under Development Non Current Investments

Items of Balance sheet Current Assets Inventories Trade Receivables Cash and Cash Equivalents Other Current Assets Short Term Loans and Advances Current Investments

Items of Balance sheet Owner’s Equity Share Capital Reserves and Surplus Money received against share warrants Share application money pending Allotment

Items of Balance sheet Long Term Provisions Other Long Term Liabilities Deferred Tax Liabilities Long Term Borrowings Non Current Liabilities

Items of Balance sheet Current Liabilities Trade Payables Short Term Provisions Other Current Liabilities Short Term Borrowings

Adjustments  Adjusting journal entries are required to be passed for errors,ommissions not yet recorded in the books.The main adjustments are  Relating to expenses  Relating to income  Relating to provisions  Other adjustments.

Adjustments Journal EntryAdjustment in trading p/l a/c Balance Sheet Closing StockClosing stock To Trading a/c Credit Side of Trading Asset Side Depreciation To Asset Dr of P&l a/cDeducted from concerned asset AppreciationAsset To Appreciation Cr of P&l/acAdded to concerned asset Outstanding Expenses Expenses To O/s Expenses Added to concerned expense of debit side of p& l a/c Liabilities side Prepaid ExpensesPrepaid Exp To Expense Ded from concerned expense of debit side of p& l a/c Asset Side

Adjustments Journal ENTRYTrading and P&l a/c Balance Sheet Accrued Income To Income Added to concerned income of credit side of p& l a/c Liabilities side Unearned IncomeIncome to Unearned Deducted to concerned income of credit side of p& l a/c Asset Side Interest on capital To capital Dr of p&l a/cAdded to capital Interest on Drawings Drawing To interest on drawing Cr of P/l acDeducted from capital

Adjustments Journal ENTRYTrading and P&l a/c Balance Sheet Interest on investments Investment To interest Dr side of p & l a/c Added to investment Interest on loans(borrow) Interest on loan To loan Cr side of P&l a/cAdded to loan on liabilities Interest on loans(advance) Loan To Interest Dr side of p&l a/cAdded to loan to asset side Bad DebtsBad Debt To Debtor Cr side of p& l a/cDeducted from debtors Provision for Bad debts P/L A/C To Provision for bad debts Dr side of p&l a/cDeducted from debtors

Adjustments Journal ENTRYTrading and P&l a/cBalance Sheet Provision on discount on debtors P&l a/c To prov. for discount on debtors Dr. side of P/L a/cDeducted from debtors Provision for discount on creditors Prov. for discount on debtors To p&l a/c Cr. Side of P/L A/CDeducted from creditors Accidental loss of stock Loss of stock To trading a/c or To Purchases a/c Ded from purchases or posted at the cr side of trading a/c and dr of p/l a/c No effect Loss of assets by fire(if not insured) Loss by fire a/c To assets a/c Dr to p/l a/cDed from the asset

Adjustments Journal ENTRYTrading and P&l a/c Balance Sheet Accidental loss of assets if insured Insurance co.a/c or Loss by fire a/c to assets a/c Dr side of p/l a/c (loss by fire a/c) Insurance co.a/c shown on asset side, loss by fire deducted from asset O/S manager’s commission p/l a/c To o/c manager’s commission Dr. side of p/l a/cLiabilities side Goods taken by proprietor for personal use Drawings a/c To purchases a/c Amt of goods deducted from purchases Deducted from capital Goods given as charity Charity a/c To Purchases a/c Deducted from purchases Deducted from capital

Adjustments Journal ENTRYTrading and P&l a/c Balance Sheet Goods distributed as free samples Advertising a/c Or Free samples a/c To purchases a/c Dr.side of p/l a/cNo effect. Goods sent on approval 1)Sale price of goods Sale a/c To debtors a/c 2) Cost price of goods Closing stock To trading a/c Deducted from sales on cr side of trading a/c Added to closing stock on the cr. Side of trading a/c Deducted from debtors Added to closing stock