PRINCIPLES OF ACCOUNTS

Single Entry System :

In olden days businessmen used to keep the record of the transactions in a simple diary or a small book. They were unaware of the book-keeping system. This made impossible for them to find the correct financial position of the business. They were unable to find the correct profit or loss of the business. Only some personal accounts and real accounts were maintained in the books that too without applying any rules and principles. This type of system was called as single entry system.

Single entry is an unfit and incorrect form of Book-keeping. In this system only cash account and personal accounts are maintained. We cannot ascertain clear correct profit or loss under this system. So, it is an incomplete system and not in general use. Some small enterprenuers still use this system. For example : Shop-keepers, hawkers, etc.

Double Entry Book-Keeping :

Due to many drawbacks in single entry system the double entry system was introduced. Double Entry System is a system in which every business transaction has minimum two parties involved.

One is the giver and the other is the receiver. In some transactions two things are involved.

Something comes in the business while something goes out of the business.

Similarly there are some Incomes while some are expenses.

Some are profits while some are losses.

So it becomes clear that in every transaction there are at least two accounts effected.

One is debited and the other is credited. Recording 'double' or 'two-fold' effect of each transaction is known as Double entry. In double entry system, every debit has equal credit. The amount of debit is always equal to the amount of credit, no matter how many number of accounts are debited or credited.

Accountancy Concepts

Entity Concept :

The word entity means existence. In accounting sense a business is treated as separate 'entity' or a separate 'unit' from its owners. Business is an artificial person created by law. It has a separate legal entity.  In accounting sense the owner of the business is also treated as a third party i.e. a creditor of the business. So the individual transactions of the owner are not recorded in the business books of accounts. Only business transactions are recorded in the business books.  It is necessary to know the actual profit / loss of the business.

For example : If Ram is the owner of a business named by 'Ishwar Enterprises'. Then Ram is a separate entity and is a natural person account, because he is  created by nature while 'Ishwar Enterprises' is a separate entity and is an artificial personal account. 

Going concern OR Continuity Concept :

In accounting sense it is supposed that the business has a perpetual succession or a very long life. It will continue to exist for an unlimited period. Even though the businessman dies his successors will continue the business. This confirms that businessman may end but the business never ends. No businessman starts a business with the intention to close it down after a specified period. So, the financial statements of each year are prepared on this concept.

For example : Business of Tata group was started by Jamshedji Tata. His successors are still continuing the business. Similarly Bajaj Group of companies was started by Jamnalal Bajaj. Now his successors are running the business..

Realisation Concept OR Revenue Recognition Concept :

Revenue is the gross earning. It is realised when goods and services are transferred to a customer for cash or for some other asset or service or for a promise to pay cash or other asset in future. Unless revenue is treated as realised, it should not be credited in as an income earned by the business.

For example : Goods sold on credit to a customer Rs.10,000 but only Rs.9,000 have been received yet. Here the remaining Rs.1,000 is not treated as revenue as the income is not yet generated.

Accounting Period Concept :

It is assumed that the life of any business is indefinite. It is necessary for the business to know the exact financial position on a particular date. They have to know the profit & loss at the end of the year. For this purpose generally a period of twelve months is set. This period is known as Accounting Period. At the end of each financial period, final accounts are prepared to know the profit earned or loss incurred during the period. Even if the accounting period for external use is of one year, the management can fix the accounting period of much shorter interval i.e. 6 months or 3 months as required for the internal audit. In general financial statements are prepared for one year starting from 1st April of the current year and ending on 31st March of the next year.

Money Measurement Concept :

In accounting, all transactions are expressed in terms of money, not in terms of quantity. Transactions which cannot be measured in terms of money are not allowed in accounting. Transactions which have exchange value are considered may they be credit transaction, cash transaction or barter transaction.

For example : A business owns two buildings, one costs Rs.10,00,000 and the other costs Rs.5,00,000. While recording in asset side of the balance sheet the amount Rs.15,00,000 is to be written instead of writing two buildings.

Similarly if the business owns three motor vehicles. One for Rs.50,000, second for Rs.45,000 and the third Rs.55,000, we have record in the books as 'Motor Vehicles Rs.1,50,000 and not as three vehicles.

This makes clear that every transaction is measured in terms of money no matter what the quantity is.

Conventions :

Commonly accepted rules that are used in accounting are conventions.

Conservatism :

This convention explains that expected profits are not to be considered but expected losses are to be considered. This is because we cannot judge the customers intention of paying the debts. But we are of the intention of payment of our dues.

For example : We are payable to a creditor Rs.10,000. We will pay it as and when cash is realized. We also have debtors of Rs.5,000. But we are not confident that we will realize the cash.

That is why  Reserve for doubtful debts are made but Reserve for discount on creditors is not made. Similarly closing stock is valued at cost or market price whichever is less.

Consistency :

This convention makes clear that once any system or method is applied. It should be applied for consecutive many years, so that the company can anticipate the budgets with the help of the past records. Any method or policy should not be changed, unless and otherwise the conditions allow.

For example, There are different method of depreciation such as Fixed Instalment Method, Diminishing Balance Method, Annuity Method, Sinking Fund Investment Method, etc. Once a method is applied should be followed continuously every year. If it changes it will be very difficult to compare the results of different periods. There are four methods of Stock Valuation. They are FIFO, LIFO, Simple Average and Weighted Average. Once a method is applied it should be followed for consecutive many years.

Materiality :

In a business it is not possible to record every small thing. Therefore the importance of the thing is judged and recorded if it is worth recording. Materiality means sensiblility. It means to decide what is important and what is not. Items ascertaining financial condition and the calculation of profits earned or losses incurred should be recorded and exposed in financial statements.

For example : Hundred files are bought for Rs.10 each and a dozen of pencils are bought for Rs.2 each. Amount of each file or each pencil is not recorded but the lot amount is recorded in the books of accounts. So the amount recorded as 'Stationery' is (10 X 100) + (2 X 12) = Rs.1,024.

Types of Accounts

Personal Account :

Account recording transactions which affect a person or a firm is known as Personal Account. They are again divided into  Natural, Artificial or Representative Personal Accounts.

Impersonal Account :

Account recording transactions which do not affect particular a person, but affect business in general, is known as impersonal account.  Impersonal account is again divided into two. They are Real Account or Nominal Account.

Real Account :

Account of property or possession is called Real Account. For e.g. Goods A/c., Cash A/c., Bank A/c., Furniture A/c.

Nominal OR Fictitious :

All expenses or losses, incomes or gains include nominal account. For e.g. Rent A/c, Salaries A/c., Advertisement A/c.

RULES OF ACCOUNTS

There is one rule for Personal Account no matter it is Natural, Artificial or Representative.

But for Impersonal Accounts there are two different rules for Real Account and Nominal Account

Let us see those rules

PERSONAL ACCOUNT    -     Debit the Receiver

                                                     Credit the Giver

REAL ACCOUNT              -     Debit What Comes in

                                                     Credit What Goes Out

NOMINAL ACCOUNT     -      Debit all Expenses & Losses

                                                     Credit all Incomes & Gains

IMPORTANT CONCEPTS AND DEFINITIONS IN ACCOUNTANCY

IMPORTANT CONCEPTS

AND
DEFINITIONS IN ACCOUNTANCY

Book keeping

Let us learn through an example

A customer buys some groceries from a grocer. He receives a bill against that transaction. He keeps this record for future reference.

The grocer also keeps the record of goods sold and money received on that date.

Here, we can see that both the customer as well as the shop keeper are keeping the record.

There are so many bills or invoices which are received and paid every month, such as electricity bill, water bill, petrol bill, property tax bill, salary slips, etc. which are filed and kept as a record for further references.

Thus ‘keeping of record’ is called as ‘book keeping’.

Let's take another example -  A business or a  firm buys raw material, assets and incurs various expenses. It also sells the finished goods. For all the transactions separate bills or invoices are generated. These bills are kept as a record. Similarly the amount paid or received is also recorded in some books. This way of keeping a record is called as ‘book keeping’. The recording is done in a systematic way.

Therefore we can conclude as :

'Book-keeping is a system of recording business transactions having money value, in the books of accounts'.

According to R.N. Carter, "Book-keeping is the science and art of correctly recording in the books of accounts, all those business transactions that result in the transfer of money or money's worth.

Thus we can say that -

Book keeping is a systematic record.

It contains only monetary transactions.

It has a system of recording which means there is a scientific method. 

It is recorded in a set of books.

In book-keeping there are some rules and principles to be followed which are universal, so it is called as a science.

Similarly there is an efficient and attractive way of maintaining records, so it is also called as an art. 

 

Objectives of book keeping are :

1. To know the profit or loss of the business annually. 

2. To know the financial position of the business on a particular date.

3. To know the solvency of the business to the creditors and money lenders of the business.

4. To act as a proof in the court of law in case of dispute with third parties.

5. To help management in future planning. 

6. To know the liquidity of the business.

 

Accounting :

Accounting is identifying, measuring, recording, classifying, summarising, analysing, interpreting and communicating the financial data of the business through financial statements to it’s end users.

 

Accountancy :

It is the subject in which one learns the procedure of accounting by applying some principles and rules of accounts.

 

Account

An Account is summary of business transaction relating to person, thing, goods, or services. 

An account has two sides viz debit side and credit side. The left hand side is called debit side and the right hand side is called credit side.

An account refers to the recording of assets, liabilities, incomes, gains, expenditures and losses.

Format of an account

ACCOUNT

Date	Particulars	LF	Amount	Date	Particulars	LF	Amount

 

 

Goods

Any article produced or bought for selling purpose is called goods.

An article or product in which the trader deals is called goods.

 

For example : A manufacturer buys raw materials and produces some finished product to sell.

Here, both the raw material as well as the finished product are called as goods.

 

Goods are divided into 4 types

 

1) Purchases - When raw materials are bought in a company either in cash or on credit is called as 'Purchase'

 

2) Sales - When finished goods are sold by the company either on cash or credit basis it is called as 'Sales'

 

3) Purchase Return - When raw material are returned to the suppliers it is called as Purchase Return. The other word used for 'Purchase Return' is 'Return Outward' 

 

4) Sales Return - When finished goods are returned by the customers it is called as Sales Return. The other word used for 'Sales Return' is 'Return Inward' 

 

Asset

Anything bought for the business but is not for sale, is called as an asset. In other words asset is the property of the business.

 

For example : Machinery, Building, Cash, Furniture, Stock of goods, etc.

'All goods are assets but not all assets are goods.'

 

Income

Any amount received in cash or kind is called an income. In other words, cost of anything when received is called an income.

For example : Sales of goods, Commission received, Rent received, interest received, etc.

 

Gain / Profit

Suppose goods are bought at Rs.500 and sold for Rs.700. Here the selling price is more than the buying price. It is said to be profit.

 

'When the selling price is more than the cost of any product or service, it is called as profit or gain.'

 

Expense

Payment made in cash or kind is called an expense. In other words, cost of a thing when paid is called an expense.

For example : Salaries paid, Wages paid, Travelling expenses paid, raw material purchased, coal & fuel, rent paid, interest paid etc.

 

Loss

Suppose goods are bought at Rs.1,000 and sold for Rs.900. Here the buying price is more than the selling price. It is said to be loss.

 

'When the cost is more than the selling price of any product or service, it is called as a loss.

  

Types of Expenditure

a) Capital Expenditure

Capital Expenditure is the expenditure made for buying a fixed asset. Or in other words when any asset is bought to increase the productivity or the income of the business, it is called capital expenditure. In simple words, all the fixed assets are capital expenditures.

 For example : When any furniture, machinery, building, etc. is bought in the business it becomes capital expenditure. 

 

b) Revenue Expenditure

Revenue Expenditure is the expenditure which is made daily, weekly, fortnightly, monthly or yearly. Revenue expenses are of recurring nature.  These expenditures are not for buying an asset. They are made to satisfy the daily needs of the organisations. 

 For example : Purchase of goods, wages, salaries, postage and telegram, printing and stationery, etc.

 

c) Deferred Revenue Expenditure

Deferred Revenue Expenditure is an expenditure which is made once for all in the business, but is used for the life time of the business. It is not like fixed asset. So as to levy the expenditure for life time of the asset or for a longer period, it is partially written of every year. 

For example : Preliminary expenses, formation expenses, research and development expenses, discount on issue of shares, debentures, etc.

 

Transaction :

 An exchange of goods and services against goods and services or against money is called a transaction.

 In other words exchange of money or money's worth is called a transaction.

 

Transactions are of three types :

a) Cash Transaction : In this type of transaction cash is received paid immediately during the transaction.

For example : If we go to a grocer and buy a chocolate, we pay him cash immediately. Such a transaction is called as a cash transaction.

b) Credit Transaction : When cash is not received or paid instantly during the transaction, it is said to be credit transaction. In such transactions, cash remains accrued.

For example : We go to grocer and buy some groceries and do not pay him cash immediately and tell him that we will pay the amount next month. This becomes a credit transaction.

c) Barter Transaction : When goods and services are exchanged for goods and services, then such transaction is called a barter transaction.

For example : A second hand car is exchanged for a new bike becomes a barter transaction.

 

Capital

An amount invested by the owner of the business in the business is called as capital. The investment may be in cash or in the form of asset.

Suppose a businessman starts the business with cash Rs.1,00,000, brings in the business machinery worth Rs.20,000 and Furniture Rs.5,000 and has a building of Rs.2,00,000. So the total of all these amounts will be the capital. This means that his capital is Rs.3,25,000.

To find out the capital a simple formula is applied :

Capital = Assets minus Liabilities.

 

Drawings

An amount or goods withdrawn by the owner of the business for his personal use is called as drawings.  Drawings is always deducted from capital.

For example : If a businessman uses goods from the business of Rs.10,000 for his household and withdraws cash Rs.5,000 for private purpose. So the total of all these amounts will be drawings. This means that his drawings is Rs.15,000.

 

Liability

Any amount owed to others is called a liability. In other words we can say that, the amount due to others is a liability. 

For example : Capital, Bank Loan, Creditors, Bills Payable, Outstanding Expenses, etc.

 

Reserve

The amount kept aside from the profit of the business, to meet the business needs when the funds are not available is called as a 'Reserve'.

In other words we can say that when unexpected losses occur, the amount used to mitigate those losses is called as a 'Reserve'

For example : Reserve Fund, General Reserve, Depreciation Fund, Building Fund, etc.

 

Discount

The reduction in the selling price of goods to increase the sale of goods is called as 'discount'.

Discount is given on marked price of the goods by the retailer to the customer.

There are two types of discount

Trade Discount

A Ltd. buys the goods on credit from B Ltd. of Rs.1,00,000. B Ltd.  offers A Ltd., a discount of 20% if the goods are bought in bulk quantity. This type of discount is called trade discount.

When a discount is given by a manufacturer to the distributor or from a wholesaler to the retailer is called as 'trade discount'.

This discount is not shown in the books of accounts.

Cash Discount

A customer buys the goods on credit from the supplier of Rs.10,000. If the supplier needs money instantly, he offers the customer a discount of Rs.500. Thus the customer will pay only Rs.9,500 to settle his account. This type of discount is called cash discount.

When a discount is given to the debtor/customer to receive immediate cash from him is called as 'cash discount'.

This discount is shown in the books of accounts. This discount is mainly given by the retailer to the end customer.