19c14Module 1 PPT Afm

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Amity Business School


MBA Class of 2010, Semester I

MANAGERIAL ACCOUNTING

Module I


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ACCOUNTANCY, ACCOUNTING ANDBOOK-KEEPING

Accountancy

Accounting

Book-Keeping


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ACCOUNTINGAccounting is a process of Identifying, Measuring, Recording,

Classifying, Summarizing, Analyzing, Interpreting and

Communication the economic information of an organizationto its users.

Accounting is also called the language of business

Accounting is a method to communicate financial information tointerested internal and external parties.


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BOOK-KEEPING

Book-keeping is an art of recording the financial transaction ofa business, or an individual, in terms of money, in a set of

books accurately and systematically in order to obtainnecessary information about the conduct and status of business.

Book-keeping is a part of Accounting and it starts withidentifying the transaction and ends with recording thetransaction in the books of accounts.


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ACCOUNTANCY

Accountancy is a field of knowledge concerned with theprinciples and techniques which are applied in accounting in

order to meet the specific the need of a particular concern.

For the purpose of simplicity, the accountancy can be dividedinto two parts:

(1) Book-Keeping (2) Accounting


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Activities Under

Accounting

MeasuringIdentifying Recording Classifying Summarizing

Analyzing Interpreting Communication

Transactions

Events


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ACCOUNTING CYCLEAccounting cycle is a complete sequence beginning with the

recording of the transaction and ending with preparationof the final accounts.

Steps in Accounting cycle:

1. Journalizing (Recording the Transaction)

2. Posting (Transfer of transaction in respecting a/c)3. Balancing (Calculating diff. b/w both sides of a/c)

4. Trial Balance (Preparing list of all a/c)

5. Income Statement (Preparing Trading and P&L a/c)

6. Balance sheet (Preparing Balance Sheet)


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Users of Accounting

Creditors (Short term and Long term)

Investors (Present and Potential)

Management

Employees

Tax Authorities

Customers

Government and their Agencies

Public


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Usefulness of Accounting Facilitates to replace memory

Facilitates to comply with legal requirement

Facilitates to ascertain net result of operations

Facilitates to ascertain financial position

Facilitates the users to take decisions

Facilitates a comparative study

Assists the management

Facilitates control over assets

Facilitates the settlement of tax liability

Facilitates the ascertainment of value of business

Facilitates raising loans


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Accounting Limitations

Ignores the qualitative elements

Not free from bias

Estimated position and not real position

In some cases ignores the price level changes

Window Dressing


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Branches of Accounting

Cost AccountingFinancial

AccountingManagement

Accounting

Social

Responsibility

Accounting

Financial Accounting: Process of identifying, measuring, recording,classifying, summarizing, analyzing, interpreting and communicating the financial

transactions and events.

The main purpose of this branch of accounting is to keep systematic records toascertain financial performance and financial position and to communicate the

accounting information to the interested parties.


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Cost Accounting:Process of accounting and controlling the cost of a product,operation or function.

Purpose of this branch of accounting is to ascertain the cost, to control cost and to

communicate information for decision-making.

Management Accounting: This Branch of accounting provides informationdesigned to help all levels of management in planning and controlling the activities ofbusiness enterprise and decision making.

Purpose of this branch is to supply any and all information that management may need in

taking decision and evaluate the impact of its decisions and actions.

Social Responsibility Accounting: Process of identifying, measuring, andcommunicating the social effect of business decisions to permit informed judgement and

decisions by the users of the information.

Accounting for environment and ecology is part of social responsibility accounting.


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Generally Accepted Accounting

Principles (GAAP)

Those rules of action or conduct which are derived from experience and

practice and when they prove useful, they become accepted as principles of

accounting.

General Acceptance of accounting principles or practices depends upon how

well they meet the following criteria:

Relevance : Should be relevant to the extent it results in information that is

meaningful and useful to the user of accounting information.

Objectivity : Should be objective to the extent the accounting information is

not influenced by personal bias or judgment of those who provide it.

Principles should be verifiable also.

Feasibility : Should be feasible to the extent it can be implemented without

much complexity of cost.


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Kinds of Accounting Principles Basic Concepts or Assumptions

Basic Principles

Modifying Principles

Basic Concepts or Assumptions: To make the accounting language convey the samemeaning to all people and to make it more meaningful, most of the accountants have agreed

on a number of concepts which are usually followed for preparing the financial statements.


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Basic Assumptions ofAccounting

Money

Measurement

Assumption

Accounting Entity

Assumption

Accounting Period

Assumption

Going Concern

Assumption

Accounting Entity Assumption:Business is a separate entity that is distinct from itsowner(s), and all other economic proprietors. E.g. in case of proprietary concern, though the

legal entity of the business and its proprietor is the same, for the purpose of accounting, they

are to be treated as separate.

MoneyMeasurement Assumption:Only those transactions which are capable ofbeing expressed in terms of money are included in the accounting records. E.g. If the sales

director is not on speaking terms with the production director, the enterprise is bound to

suffer. Since monetary measurement of this information is not possible, this fact is not

recorded in accounting records.

Verifiable

Objective

Evidence

Assumption


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Accounting Period Assumption:Also known as Periodicity assumption or Timeperiod assumption. The economic life of an enterprise is artificially split into periodic

intervals which are known as accounting periods, at the end of which an income

statement and position statement are prepared to show the performance and

financial position.

Going Concern Assumption:Also known as Continuity assumption. Enterpriseis normally viewed as going concern, that is, continuing in operation for the

foreseeable future. It is assumed that the enterprise has neither the intention nor the

necessity of liquidation or of curtailing materially the scale of operation.

Verifiable Objective Evidence Assumption:All accounting transaction thatare recorded in the books of accounts should be evidenced and supported by

business documents.


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Basic Principles of

Accounting

Principle of

Expense

Revenue

Recognition

Principle

Dual Aspect

Principle

Matching

Principle

Fill Disclosure

Principle

Basic Principles of Accounting:On the basis of the concepts of accounting discussedabove, certain principles have been developed that guide how transactions should be

recorded and reported. These basic principles are as follow:

Principle of Revenue Recognition:Revenue is earned by sale of goods or byproviding a service. This principle determines or the particular period in which the revenue is

realized. The basis that may be used for determining the period in which revenue is realized

are: On the basis of Sales, On the basis of Cash, On the basis of Production.

Principle of Expenses:According to this principle of expenses, expenses are notrecognized when cash is paid for them but only when they are actually used to generate

revenue


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Principle ofMatching Cost and Revenue:In determining the net profit frombusiness operation, all costs which are applicable to revenue period should becharged against that revenue. Accordingly, for matching costs with revenue, first

revenue should be recognized and then costs incurred for generating that revenue

should be recognized.

Principle of full disclosure:All significant information relating to the economic

affair of the enterprise should be completely disclosed. In other words, there shouldbe sufficient disclosure of information which is of material interest to the users of the

financial statements such as proprietors, present and potential creditors, investors

and others. Thats why we are showing Contingent liabilities as a footnote in financial

statements.

Dual Aspect Principles

:Every business transaction is recorded as having a dualaspect. In other words, every transaction affects at least two accounts. If one account

is debited, any other account must be credited. This system of recording transactions

based on this principle is called as Double Entry System. Thats why the two sides

of the balance sheet are always equal and the following accounting equation will

always hold good at any point of time:

Assets = Liabilities + Capital orCapital = Assets - Liabilities


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Modifying Principles

Principle of

Consistency

Principle of

Materiality

Principle of Conservatism

Or Prudence

Principle of

Timeliness

Principle of

Accounting Practice

Modifying Principles: There are certain accounting principles which can be slightlymodified by different accountants according to the situations and requirements of the business.

This is done in order to make the financial statements more relevant and reliable. These

principles are:

Principle of Materiality: This principle is an exception to the principle of full disclosure.According to this principle, items having an insignificant effect or being irrelevant to the user

need not be disclosed. These unimportant items are either left out or merged with other items,otherwise accounting statements will be unnecessarily overburdened. It should be noted what

may be material for one concern may be immaterial for another. E.g. the cost of small tools

may be material for a small repair workshop, but the same figure may be immaterial for

Escorts Ltd. Similarly the nature of transaction should also be taken into consideration. A

difference of Rs. 5,000 in valuation of stock may be regarded as immaterial, but a difference of

Rs. 5,000 in cash could be termed material.


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Principle of Consistency: Accounting principles and methods should remain

consistent from one year to another. These should not be changed from year to year, inorder to enable the management to compare profit & loss A/c and Balance sheet of different

periods and draw important conclusion about the working of the enterprise.

But this principle of consistency should not be taken to mean that it does not allow a firm to

change the accounting methods according to changed circumstances of the business.

Otherwise, the accounting will become non-flexible and the improved techniques of

accounting will not be used.Principle of Conservatism or Prudence: All anticipated losses should be recordedin the books of accounts, but all anticipated or unrealized gain should be ignored. In other

words, it is a policy of playing safe. Provision is made for all known liabilities and losses

even though the amount can not be determined with certainty.

Principle of Timeliness: Financial statements should be prepared quickly at the end of

accounting period and made available to management and other external users at theearliest possible time. If they are delayed, they will be of little or no use.

Principle of Industry Practice: Some time the unique characteristics or the peculiarnature of industry requires the departure from accounting principles to report the true

results of the business. E.g. if a particular method of providing depreciation and valuing

stock is prevailing in an industry, it becomes the industry practice. An accountant must

follow the accounting practices prevailing in the industry which preparing financialtatement .


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Introduction to Accounting Standards Accounting standards deal with the system of financial measurement and disclosure

used to prepare fairly presented financial statements.

These standards draw boundaries within which acceptable conduct should lie. In

other words, they provide Generally Accepted Accounting Principles (GAAP) and

procedures as pronounced by professionally competent organizations. These

standards suggest rules and criteria of accounting measurement.

Accounting Standards in India:On 27thApril 1977, The institute of CharteredAccountants of India constitute Accounting Standards Board (known as A.S.B.) with a

view to harmonize accounting policies and practices used in India. The main function

of A.S.B. is to formulate the standards after taking into consideration the applicable

laws, customs, usages and business environment.

Types of Standards:The Standards are of two types: Recommendatory andMandatory. Initially the standards are recommendatory in nature. Certain period is

allowed for smooth transition to conform to the Standards from existing practices.

This period is decided by Institute of Chartered Accountant of India. Mandatory

standards imply that compulsory adherence to the standards by all enterprises

covered by standards, is to be ensured.


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Accounting Equation means the total of assets will be equal to the total of liabilities. The basic idea behind this equation is that the business does not have

anything of its own. All assets of the business are claimed by someone (either owner of

outsiders). It follows, therefore that, whenever an asset comes into business, and equal

claims arises or an equal value of other asset goes away. As no asset can drop from

heaven, it must be accompanied by a claim. This expression can be shown in the form

of following equation:Assets = Equities*

or

Assets = Liabilities + Capital

*Claims of various parties against the assets

Example:

Govind commenced business with capital of Rs. 60, 000.


Cash = Liabilities + Capital

60, 000 = Nil + 60, 000


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Govind purchased goods from Gopal on credit for Rs. 20, 000


Cash + Goods = Creditors + Capital

Old Equation 60, 000 + 0 = 0 + 60, 000

Transaction 0 + 20, 000 = 20, 000 + 0

New Equation 60, 000 + 20,000 = 20, 000 + 60, 000

Govind purchased furniture for cash Rs. 2, 000.

Govind purchased goods for cash Rs. 30, 000.

Goods costing Rs. 15, 000 sold on credit for Rs. 18, 000. Paid Rent Rs. 600.


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S.N.

Transactions Accounts AffectedAssets Liabilities and Capital

1 Capital brought in Cash increases Capital increase

2 Purchased goods for cash Stock increases

Cash Decreases

3 Purchased goods on credit Stock Increases Creditors increases4 Purchased furniture for cash Cash decreases

Furniture increases

5 Paid rent Cash decreases Rent = Expenses Therefore,

Capital decreases

6 Received Commission Cash increases Commission = IncomeTherefore, Capital Increases

7 Withdrew cash for private use Cash decreases Capital decreases

8 Paid to creditors Cash decreases Creditors decreases


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Meaning of Debit and Credit

In actual practice, the individual transactions of like nature are recorded, added and

subtracted at one place. Such place is customarily termed as an Account . Prior to

understanding the meaning of debit and credit, it is essential to understand the

meaning and form of an account.

An account is a ledger record in a summarized form, of all the transactions thathave taken place with the particular person of things specified

- Carter

All accounts are divided into two sides. The left side of an account is arbitrarily or

traditionally called Debit side and the right side of an account is called Credit side.

In the abbreviated form, Debit is written as Dr. and Credit is known as Cr.

Debit (Dr.) Cash Account Credit (Cr.)

The above account is often called T shape account. An account is abbreviated as A/c.


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Rules of Debit and Credit In order to decide when to write on the debit side of an account and when to write on the

credit side of an account. There are two approaches:

a) Modern approach and

b) Traditional approach

Modern Approach:

Debit means decrease in proprietor equity and credit means increase in proprietors

equity

The rules of debit and credit depends on the nature of an account. For this purpose, all the

accounts are classified into the following five categories:

I. Assets Accounts

II. Liabilities Accounts

III. Capital Account or Owners Equity Account

IV. Revenue or Income Accounts

V. Losses or Expenses Accounts

Assets Accounts: Increase in assets will be recorded on debit side and Decrease in assets will

be recorded on credit side.

Liabilities Accounts: Decrease in liability will be recorded on debit side and increase in

liability will be recorded on credit side.


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Capital Account: Decrease in capital will be recorded on debit side and increase in capital

will be recorded on credit side.

Revenue or Income Accounts: Decrease in gains and incomes will be recorded on debit

side and increase in gains and incomes will be recorded on credit side.

Losses or Expenses Accounts: Increase in losses and expenses will be recorded on debit

side and Decrease in losses and expenses will be recorded on credit side.

English Approach: English approach is also known as Double Entry System. According

to this system every business transaction affects at least two accounts in opposite directions.

For example, if the furniture is purchased in the business, furniture is increased whereas the

cash is decreased. There can be no transaction in the business which affects only one account

or which has only one aspect. As such, both the aspects of every transaction are recorded

under this system. It may, however, be noted that the double entry does not mean that atransaction is recorded twice. But it means that at least two accounts are affected by a

transaction one account receiving a benefit and the other account yielding a benefit. The

person or the account receiving a benefit is debited and the person or the account who gives

something to the business is credited. The amount of every transaction is written twice, once

as a debit and again as a credit. E.g. We received Rs. 5,000 from Mohan. Here cash account is

receiving, hence debited whereas Mohan is yielding, hence credited.


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Every business transaction has a two-fold effect and that it affects two accounts in

opposite directions and if a complete record were to be made of each suchtransaction, it would be necessary to debit one account and credit another account. It

is this recording of the two-fold effect of every transaction that has given rise to the

term Double Entry System

-J. R. Batliboi

Characteristics ofDouble Entry System

Every business transaction affects two accounts

Recording of both personal and impersonal aspects

Recording is made according to certain specified rules

Preparation of Trial Balance


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Classification ofAccounts

Impersonal AccountPersonal Account

Natural Artificial Representative Real Accounts Nominal Account

Tangible Intangible

Personal Account:The accounts which relates to an individual, firm, company or an

institution are called personal account. Account of Mohan, account ofRam Chander, KrishanChander, Account of D.C.M. Ltd, Account of Delhi University, Bank Account, Capital Account

of the proprietor, Drawing account of the proprietor etc.

Rule:Debit the receiver andCredit the giver

In other words, Debit that persons account who receives something from the business and

Credit that persons account who gives something to the business"


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Example 1: Paid Rs. 1,000 to Hari:

In this case two accounts affected are Haris A/c and Cash A/c. Haris account will be

debited as he is the receiver of cash, the account of cash will be credited, as cash

has gone out and the entry will be:

Hari (Debit the receiver) Dr. 1, 000

To Cash A/c 1, 000

Example 2: Received Rs. 500 from Mohan:

In this case, cash account will be debited as cash has been received, and Mohans

account will be credited according to the rule of Credit the Giver. And the entry willbe:

Cash A/c Dr. 500

To Mohan (Credit the Giver) 500


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Types or Classification of Accounts

1) Natural Personal Account:Accounts of Natural Persons means the accountsof human beings. For example, Mohans A/c, Sohans A/c, Proprietors Capital A/c,

Proprietors Drawings A/c, Debtors A/c, Creditors A/c etc.

2) Artificial Personal Account:These accounts do not have physical existence ashuman beings but they work as personal accounts. For example, any Firms account,

any limited companys account, any institutions account and any other banksaccount. These are treated as artificial persons for the recording of business

transactions. These transactions also include the accounts of Clubs, Insurance

Companies and the accounts of Government departments which are recognized as

persons in the business dealings.

3) Representative Personal Accounts:

When an account represents a particularperson or group of persons, it is termed as a representative personal account. For

example, if the salaries for the month of December are not paid to the employees, the

amount payable to these employees will be added and put under one common title

Salaries Outstanding Account. This account represents the accounts of all the

persons to whom salaries have to be paid. This is therefore termed as

Representative Personal Account.


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Real Accounts:The accounts of all those things whose value can be measured in

terms of money and which are the properties of the business are termed as RealAccount. Such as Cash Account, Furniture Account, Machinery Account, Building

Accounts, Goodwill Accounts etc.

Rule:Debit what comes in andCredit what goes out

In other words, whenever any property comes into the business, it is debited and

when it goes outside the business, it is credited.

For Example, if furniture forRs. 5, 000 has been purchased for cash, furniture

account should be debited according to the rule of Debit what comes in, while cash

account should be credited according to the rule of Credit what goes out. And the

entry should be:

Furniture A/c (Debit what comes in) Dr. 5, 000

To Cash A/c (Credit what goes out) 5, 000

Types of Real Accounts:

a) Tangible Real Account:Accounts of the things which can be touched, felt,

measured, purchased and sold etc. E.g. Cash A/c, Furniture A/c, Land A/c etc.

b) Intangible Real Account:Accounts of things which can not be touched but, of

course, their value can be measured in term of money. E.g. Goodwill A/c, Trade Mark

A/c, Patent A/c, Copyright A/c etc.


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Nominal Accounts:These accounts include the accounts of all expenses and

incomes. E.g. Salaries paid, Rent paid, Discount Allowed and Bed Debts etc.

Rule: Debit the expenses and losses andCredit the incomes and gains

Example 1: Paid Rs. 5, 000 for Salaries.

In this case two accounts being affected are Salaries A/c and Cash A/c. Salaries

represents expenses and as such, Salaries account will be debited according to therule ofDebit the expenses. On the other hand, Cash A/c will be Credited according

to the rule ofCredit what goes outand the entry will be:

Salaries A/c (Debit the Expenses) Dr. 5, 000

To Cash A/c (Credit what goes out) 5, 000

Example 2:

Received Rs. 1, 000 for Commission.Commission A/c is a nominal account and represents an income. As such,

Commission A/c will be credited according to the rule ofCredit the incomes. Cash

A/c is a real account and cash is coming in, therefore Cash A/c will be debited

according to the rule ofDebit what comes in.And the entry will be:

Cash A/c (Debit what comes in) Dr. 1, 000

To Commission A/c (Credit the incomes) 1, 000


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Advantages ofDouble Entry System

Scientific System

Complete record of every transaction

Preparation of Trial Balance

Preparation of Trading and Profit & Loss A/c

Knowledge of financial position of the business

Knowledge of various information

Lesser possibility of fraud

Legal Approval

Comparative Study

Expensive system

Difficult to apply rules of debit and Credit

Only arithmetical accuracy of accounts is checked by preparing a trial balance under

the double entry system. Following types of errors are not disclosed:

Errors ofOmission, Errors of Commission, Errors of Principle, and Compensating

Errors.

Disadvantages ofDouble Entry System


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Stages/ Parts ofDouble Entry System

Original Record:All the transactions are first recorded in a primary book calledJournal. When a business is a big one and the number of transactions is large,

journal is divided into various books which are called Sub-division of Journalor

Subsidiary Books. Thus recording in Journal or in its subsidiary books is the first

stage of double entry system. This stage is also known as Original record stage.

Classification:In this stage, all the transactions recorded in the Journal or itssubsidiary books are transferred (posted) in a classified form to another book which is

called Ledger. This book contains, on different pages, individual account heads

under which all financial transactions of similar nature are collected at one place, so

that the combined effect of all the transactions relating to a particular account may be

ascertained. Posting in ledger is also known as Classification Stage.

Summary:In this stage, all the ledger are balanced off and are put in a list, debitbalances on one side and credit balances on other side. The list so prepared is called

a Trial Balance. With the help of Trial Balance a Trading and Profit & Loss A/c is

prepared to ascertain the profit earned of loss suffered during a particular period and

a Balance Sheet is prepared to show the financial position of the business.


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Books of Original Entry - Journal

The books in which a transaction is recorded for the first time from a sourcedocument are called Books ofOriginal Entry. Journal is one of the basic books of

original entry in which transactions are originally recorded in a chronological (day-to-

day) order according to the principles of double entry system. When the size of the

business is a small one, then it is possible to enter each and every transaction in the

journal. But when the size of the business grows, it becomes no longer possible to

record each and every transaction in the journal. As such, the Journal is sub-divided

into a number of Sub-Journals known as special purpose subsidiary books orbooks

of original entrysuch as: Cash Book, Purchase Book, Sales Book, Sales Return

Book, Purchase Return Book, Bills Receivable Book, Bills Payable Book, Journal

Proper.

Documents on the basis of which entries are recorded in the books of accounts are

named as source documents. The following are the most common source

documents:a) Cash Memo b) Invoice and Bill

c) Receipt d) Debit Note

e) Credit Note f) Pay-in-Slip

g) Cheque

Vouchers

19c14Module 1 PPT Afm

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