"Accounting Basic Definations"
Accounting Accounting:- Accounting means the various technical activities performed by accountants, including financial accounting, book keeping and management accounting. According to American Institute of Certificated Public Accountants (AICPA) “Accounting is the art of recording, classifying, and summarizing in a significant manner and in terms of money transactions and events which are in part at least, of a financial character and interpreting the results thereof.” Accounting is also called the eyes and ears of management, and it is often called the language of business. Objectives of Accounting:- There are following objectives of accounting. 1. To record the business transactions in a systematic manner. 2. To determine the gross profit and net profit by a firm during a period. 3. To know the financial position of a firm at the end of the year. 4. To facilitate management control. 5. To assess the taxable income and sales tax. 6. To provide needful information to different parties, i.e. owners, management employees, investors, creditors and Govt & financial Institutions etc. Functions of Accounting:- There are following functions of Accounting. 1. Recording 2. Classifying 3. Summarizing 4. Interpreting 5. Information System Branches of Accounting:- 1. Book Keeping 2. Financial Accounting 3. Cost Accounting 4. Management Accounting 5. Adamjee Coaching Centre 1st Floor, Sami Chamber Opp. D.M.C. (Campus VIII), M.A Jinnah Road, Karachi. Tel: 021-3 2218260, 32637820 The Educating Zone Institute of Management Sciences (TEZIMS) D-26, Shah Faisal Town, Block # 5, Behind Allah Wali Masjid, Karachi. Tel: 021-34576970, 0345-2419117 Father Coaching Centre Queen Centre Office # 203, 204, M. T. Khan Road Karachi. Tel: 021-35644400, 021-35644466 Email: firstname.lastname@example.org 1|Page Accounting Fundamental Accounting Equation Assets = Liabilities + Capital/Proprietorship Assets – Liabilities = Capital/Proprietorship Rules of Debit & Credit Accounts Debited Credited Assets Increase Decease Liabilities Decease Increase Income Decease Increase Capital Decease Increase Expenses Increase Decease Steps of Accounting Cycle 1. Journalizing 2. Posting 3. Trial Balance 4. Adjustments 5. Adjusted Trial Balance 6. Financial Statements 7. Closing Entries 8. Post Closing Trial Balance Assets:- Assets are economic resources that are owned by the business and are expected to provide positive future cash flows. Some resources are needed to start and run the business. So that assets are also called as resources. There are two types of assets: 1. Current assets 2. Fixed assets 2|Page Accounting Current Assets Fixed Assets Cash/Bank Land/Building/Shop Marketable Securities Furniture & Fixture Accounts Receivable Machinery/Vehicles Notes/Bills/Interest Receivable Sports Equipment Merchandise Inventory Office Equipment (Such as Office Supplies Printer, Calculator, Fax, Unexpired/ Prepaid Photostat, Telex Machine, Rent Scanner etc.) Unused Supplies Loans to Employees Salaries Good Will Insurance Patents/Trade Marks Liabilities:- Liabilities are debts that represent negative future cash flows for the enterprise. And liabilities mean the claims of the suppliers of cash or goods on account up to his balance due on the date. There are two types of liabilities: 1. Current Liabilities 2. Long Term Liabilities Current Liabilities Long Term Liabilities Accounts payable Notes/Bills payable Long term loan payable Interest payable House/Building Loan Rent payable Mortgage payable Salaries payable Debenture payable Unearned income Advance from customers Bank overdraft Account:- Account is most popular technical term, which is used by accountants or businessmen in accounting. The transactions, which are recorded in the business separately, called as Account. Such as Cash, Purchase account, Sales account etc. 3|Page Accounting Debit:- In Accounting term/language, recording some information on the left hand side of an account is known as Debit Account. Debit symbolized by capital D and small r (Dr). Credit:- In Accounting term/language, recording some information on the right hand side of an account is known as Credit Account. Credit symbolized by capital C and small r (Cr). Accounts Receivable:- Amounts which a firm/person expects to collect from its customers for goods and services sold to them on credit/on account is called as Accounts Receivable. It is also called debtors; each customer who owes money to the firm is a debtor of the firm. Merchandise Inventory:- The commodities bought in a business/firm for the purpose of reselling at a profit is called Merchandise such as in case of bookseller, books, copies, pens, pencils, erasers, registers, etc. are the Merchandise of a shop. Prepaid Expense:- The prepaid expenses are expenses, which have been paid in advance of their use/consumption. Accounts Payable:- The amount which a firm/person owes its creditors for assets and services on credit is called as Accounts Payable. Unearned Income:- An unearned income results when payment is received for goods or services in advance of their delivery are called as Unearned Income. Unearned income also may be called deferred income. 4|Page Accounting Net Income:- Net income is an increase in owner’s equity resulting from the profitable operation of the business. Net income does not consist of any cash or any other specific assets. Rather, net income is a computation of the overall effects of many business transactions on owner’s equity. Owner’s Equity:- The amount invested by the owner in the business is called as Capital of the owner. The rights of owner on the business properties called capital/owner’s equity. Owner’s equity represents the owner’s claim to the assets of the business; it is equal to the total assets minus liabilities. Changes in owner‘s equity. Owner’s Investments Business Earnings Owner’s Withdrawals Business Losses Drawing:- Whenever the proprietor of the business draws any amount or any asset from his business for personal use is called Drawing. Expense:- Expenses are the cost of goods and services used up in the process of earning revenue. Examples include cost of employees’ salaries, bank interest and rent of the office building, etc. are expenses of the business. Expenses are often called the “Cost of doing business,” that is the cost of various activities necessary to carry on a business. Some expenses may be paid at the time when they become due or some expenses may be deferred to future date according to agreement. Purchases The term ‘Purchase’ means the acquisition of goods for the purpose of re-sale either in the same form or after taking some required benefit or after performing some activity. That is, if a furniture dealer purchases furniture for re-sale, furniture in this case, it will be treated as ‘goods/merchandise’ but when the same dealer purchases furniture for office decoration, the same will not appear in Purchase Account since the furniture is not used for re-sale purpose. In other words, the commodities, which are purchased for normal buying and selling transactions, are known as ‘goods/merchandise’. 5|Page Accounting Credit Term & Cash Discount:- Manufacturers and wholesalers normally sell their products to merchandisers on account. The credit terms are stated in the seller’s bill, or invoice. Perhaps the most common credit terms offered by manufacturers and wholesalers are 2/10, n/30. This expression is read “2, 10, net 30,” and means that full payment is due in 30 days, but that the buyer may take a 2% discount if payment is made within 10 days. The period during which the discount is available is termed the discount period. Sales Revenue The revenue earned in a sales transaction is equal to the sales price of the merchandise and is created to a revenue account entitled Sales. Sales revenue is considered realized when merchandise is delivered to the customer, even if the sale is made on account. Sales Return and Allowance:- Sales return and allowance is a contra-revenue account, it is deducted from gross sales revenue as a step in determining net sales. Most merchandise companies allow customers to obtain a refund by returning any merchandise considered to be unsatisfactory. If the merchandise has only a minor defects, customers sometimes agree to keep the merchandise if an allowance (reduction) is made in the sales price. Sales Discount:- Sales discount is another contra-revenue account. In computing net sales, sales discounts are deducted from gross sales with any sales returns and allowance. (If the customer has returned part of the merchandise, a discount may be taken only on the gross amount owed after the return). Sales Taxes:- Sales are levied by many states & cities on retail sales. Sales taxes actually are imposed on the consumer, not on the seller. However, the seller must collect the tax, file tax returns at the times specified by law, and remit to governmental agencies the taxes collected. For cash sales, the sales tax is collected from the customer at the time of sales transaction. For credit sales, sales tax is included in the amount charged to the customer’s account. 6|Page Accounting Transaction:- Any exchange of values is called Transaction; there are two types of transactions such as: 1. Cash transaction:- Purchasing of assets like merchandise, land, building, furniture etc, on cash. 2. Credit transaction:- Purchasing of assets like merchandise, land, building, furniture etc, on account. The Journal:- The term journal originated from the French word ‘Jour’, which means a ‘Day’. In an actual accounting system, however the information about each business transaction is initially recorded in an accounting record called journal. The simplest type of journal is called a general journal. General journal is a subsidiary book, which provides chronological (day by day) records of the business transactions, while the ledger is a main book which provides analytical records. Each transaction is posted in the sequence of date and happening of the transaction with debit and credit rules. It is further divided in two types; 1. Standard form 2. Skeleton form Posting:- The process of the transferring the debits and credits from the general journal to the ledger accounts is called posting. Each amount in the debit column of the journal is posted by entering it on the debit side of an account in the ledger, and each amount listed in the credit column of the journal is posted to the credit side of a ledger account. Ledger Account:- The ledger is called the king of all books of account because all the entries from the books of original entry must be posted to the various accounts into ledger. Journal contains a chronological record while ledger contains a classified record of all transactions. In other ways, we can say that ledger account means of accumulating information needed by management in directing the business. There are three forms of accounts. 1. Standard form 2. Skeleton form 3. Self Balancing form 7|Page Accounting Trail Balance:- In order to test the arithmetical accuracy of our ledger we should prepare a statement called the Trial Balance. A Trial balance is a 2 column schedule listing the names and balances are listed in the accounts in the order in which they appear in the ledger. Debit balances are listed in the left-hand column and the credit balances in the right-hand column. The main purposes of a Trial Balance are; 1. It proves the equality of debit and credit in ledger account. 2. To summarize the information of ledger for preparation of financial statements. Special Journal:- A special journal is an accounting record or device designed to record a specific type of routine transaction quickly and efficiently. Special journals are highly specialized in terms of the transactions they can record. Some special journals are maintained by hand. An example is the cheque register in your personal cheque book. If maintained, this special journal provides an efficient record of all cash disbursements made by cheque. Subsidiary Ledger :- (Source of Needed Detail) A subsidiary ledger contains a separate account for each of the items included in the balance of a general account. For example an accounts receivable subsidiary ledger contains a separate account for each credit customer. An accounts receivable subsidiary ledger provides the information used in billing credit customers and in reviewing their credit worthiness. The account includes information on the dates and amounts of past charges and payments. In fact, each account provides a complete history of the credit transaction between the company and the individual customer. Petty Cash:- In almost all businesses, it is found necessary to keep small sum of ready money with the cashier for the purpose of meeting small expenses such as telegrams, postage, stationary, transportation & conveyance, supplies, entertainment and Miscellaneous etc. The sum of money so kept in hand is generally termed as the Petty Cash and the book in which petty cash expenditures are recorded is called as Petty Cash Book. 8|Page Accounting Cash Book:- In a medium size business the main object of maintaining a cash book is to record date wise all cash daily business transactions. There are three amount columns are maintained in cash book, debit and credit side for cash, bank and discount both side after date, explanation and reference columns. A business can see and check the most important item of the business in one book that how much cash balance is in hand and cash at bank and total discount allowed or received in a day or at the end of the month. It also saves the time of posting journal entries and their postings to ledger. Cash Short & over:- It means balance of cash book not in the safe; either short or over. Financial Statement:- Financial statement is a Lens to View Business. There are three basic statements that summarize information about a firm. 1. Balance Sheet 2. Income Statement 3. Statement of Cash Flows Balance Sheet:- Balance sheet summaries the assets owned by a firm, the value of these assets, and the mix of financing debt, and equity used to finance these assets at a point in time. Income Statement:- Income Statement provides information on the revenues and the expenses of the firm, and the resulting income made by the firm during a particular period. The period can be a quarter (if it is a quarterly income statement) or a year (if it is an annual report). Statement of Cash Flows:- Cash flow statement specifies the sources of cash to the firm from both operational and new financing, and the uses of this cash, during a period. The statement of cash flows can be viewed as an attempt to explain how much the cash flows were during a period and why the cash balance changed during the period. 9|Page Accounting Mubeen & Co Balance Sheet As on Dec-31-2011 Assets Equities Current Assets Current Liabilities Cash/Bank Rs. 110000 Accounts payable Rs. 28000 Marketing Securities Rs. 10000 Notes payable Rs. 10000 Accounts Receivable Rs.25000 Bills payable Rs. 5000 Less: Allow Bad Debts Rs.(5000) Rs. 20000 Interest payable Rs. 12000 Bill /Notes Receivable Rs. 5000 Tax Payable Rs. 1000 Commission Receivable Rs. 5000 Rent payable Rs. 10000 Interest Receivable Rs. 5000 Salaries payable Rs. 15000 Merchandise Inventory (Ending) Rs. 20000 Unearned commission Rs. 10000 Office Supplies Rs. 2000 Advance from customers Rs. 10000 Unexpired Insurance/Rent Rs. 1500 Bank overdraft Rs. 2000 Prepaid Expenses Rs. 1500 Long Term Liabilities Fixed Assets Long term loan payable Rs. 100000 Land Rs.170000 House/Building Loan Rs. 120000 Building/Shop Rs.55000 Mortgage payable Rs. 45000 Less: Accumulated Dep Rs. (5000) Rs. 50000 10% Debenture payable Rs. 45000 Furniture & Fixture Rs.30000 Less: Accumulated Dep Rs. (3000) Rs. 27000 Owner’s Equity Machinery/Vehicles Rs.40000 Less: Accumulated Dep Rs. (8000) Rs. 32000 Capital at start Rs. 100000 Sports Equipment Rs. 6000 Add: Further investments Rs 00000 Office Equipment Rs.60000 Rs. 100000 Less: Accumulated Dep Rs (5000) Rs. 55000 Add: Net Income Rs. 50000 Loans to Employees Rs. 10000 Less: Net Loss Rs. (0000) Good Will Rs. 15000 Less: Drawing Rs. (5000) Patents / Trade Marks Rs. 15000 Adjusted Capital Rs. 145000 Total Assets Rs. 560000 Total Equities Rs. 560000 10 | P a g e Accounting Mubeen & Co Income Statement As on Dec-31-2011 Sales Rs. 260000 Sales return & allowance Rs. (5000) Sales discount & allowance Rs. (5000) Net sale Rs. 250000 Less: Cost of Goods Sold Merchandise inventory (Opening) Rs. 100000 Add: Net Purchases Purchases Rs. 85000 Less: Merchandise drawn by Owner Rs. (5000) Add: Wages expense Rs. 1000 Add: Packing charges Rs. 1000 Add: Import / Excise duty Rs.1000 Add: Fright/Transportation/Carriage in Rs. 2000 Delivered cost Rs. 85000 Less: Purchase return & allowance Rs. (2500) Less: Purchase discount Rs. (2000) Net purchases Rs. 80000 Cost of Goods available for sale Rs. 180000 Less: Merchandise inventory (Ending) Rs. (20000) Cost of Goods Sold Rs. (160000) Gross Profit Rs. 90000 Less: Operating & Non Operating Expenses Bad debts expenses Rs. 5000 Depreciation expenses Rs. 5000 Rent expenses Rs. 9000 Office supplies expenses Rs. 2000 Salaries expenses Rs. 3000 CDGK Tax Expenses Rs. 3000 Utilities Expenses Rs. 1000 Interest expenses Rs. 6000 Insurance expenses Rs. 6000 Rs.(40000) Operating Income Rs. 50000 Add: Other income Commission income Rs. 5000 Rent income Rs. 7000 Interest income Rs. 3000 Total operating income Rs. 15000 Net Income Rs. 65000 11 | P a g e Accounting Zaheer & Co Ltd Balance Sheet As on Dec-31-2011 Equities Assets Shareholder’s Equity Fixed Assets Authorized capital Land Rs. 170000 100000shares @10 Rs. 1000000 Building/Shop Rs.55000 Less: Accumulated Dep Rs (5000) Rs. 50000 Issued & Paid-up Capital Furniture & Fixture Rs.30000 Shares capital Rs. 200000 Less: Accumulated Dep Rs. (3000) Rs. 27000 Retained earning Rs. 50000 Machinery/Vehicles Rs. 40000 Add: Net income Rs. 25000 Less: Accumulated Dep Rs. (8000) Rs. 32000 Less: Net loss Rs. (0000) Rs. 75000 Sports Equipment Rs. 6000 Office Equipment Rs.60000 Shares premium Rs. 15000 Less: Accumulated Dep Rs (5000) Rs. 55000 Less: Shares discount Rs.(10000) Rs. 5000 Loans to Employees Rs. 10000 Good Will Rs. 15000 Long Term Liabilities Patents / Trade Marks Rs. 15000 Long term loan payable Rs. 50000 Debenture payable Rs. 100000 Preliminary expenses Rs. 10000 Mortgage/bonds payable Rs. 90000 Premium on redemption Rs. 25000 Loss on debenture Rs. 10000 Debenture discount Rs. 10000 Current Liabilities Accounts payable Rs. 25000 Current Assets Notes/Bills payable Rs. 10000 Cash Rs. 70000 Interest payable Rs. 10000 Bank Rs. 200000 Advance from customers Rs. 2000 Marketing Securities Rs. 10000 Rent payable Rs. 12000 Accounts Receivable Rs.90000 CDGK Tax Rs. 1000 Less: Allow Bad Debts Rs.(2000) Rs. 70000 Salaries payable Rs. 15000 Bills Receivable Rs. 25000 Stock/cash dividend Rs. 25000 Notes Receivable Rs. 30000 Unearned commission Rs. 8000 Commission Receivable Rs. 55000 Bank overdraft Rs. 2000 Interest Receivable Rs. 55000 Merchandise Inventory (Ending) Rs. 20000 Reserves & Funds Unused/On hand Office Supplies Rs. 12000 Reserve for contingencies Rs. 25000 Unexpired/Prepaid Rent/Salaries Rs. 13000 Reserve for plant extension Rs. 50000 Reserve for building expansion Rs. 50000 Reserve for income tax Rs. 20000 Total Assets Rs. 800000 Total Equities Rs. 800000 12 | P a g e Accounting Mubeen & Co Computation of Cost of Goods Sold For the period ended Dec-31-2011 Cost of Goods Sold Merchandise inventory (Opening) Rs.100000 Add: Net Purchases Purchases Rs.85000 Less: Merchandise drawn by Owner Rs. (5000) Add: Wages expense Rs. 1000 Add: Packing charges Rs. 1000 Add: Import duty Rs. 1000 Add: Fright/Transportation-in Rs. 2000 Delivered cost Rs.85000 Less: Purchase return & allowance Rs. (2500) Less: Purchase discount Rs. (2000) Net Purchases Rs. 80000 Cost of Goods available for sale Rs.180000 Less: Merchandise inventory (Ending ) Rs. (20000) Cost of Goods Sold Rs. 160000 Mubeen & Co Computation of Statement of Retained Earning For the period ended Dec-31-2011 Retained Earning at start Rs.100000 Add: Income for the period Rs. 50000 Unadjusted Retained Earning Rs.150000 Less: All Reserves Reserve for plant extension Rs.15000 Reserve for building extension Rs.20000 Reserve for income tax Rs.10000 Reserve for contingencies Rs.15000 Rs. (60000) Retained Earning at end Rs. 90000 13 | P a g e Accounting For Bank Reconciliation Statement Always To Be Added In Bank Statement Unclear cheques/not yet credited by bank Late deposit (In last 2 or 3 days of the month) Bank deposit Deposit in transit Wrongly debit by banker Always To Be Deducted From Bank Statement Balances ( Overdraft/Debit ) Outstanding/unpresented/unpaid cheques Wrongly credited by banker Not yet paid by bank Always To Be Added In Cash Book Direct deposit by a customer Profit/interest/credited/given by bank Notes/interest/dividend collected by bank Borrowed from bank or Loan granted by bank Always To Be Deducted From Cash Book Balances (Overdraft/Credit ) Dishonored/returned cheques/N.S.F Marked by bank Zakat Deduction/ Tax Deduction Service/collection/mark up/repair charges debited by bank Notes/interest/dividend/insurance premium paid by bank Cash withdraw from bank 14 | P a g e