Learning Basic Financial Accounting

Basic Terms in Accounting

It is necessary to understand some basic accounting terms, which are, used daily in business world. These terms are

financial accounting

Basic Terms in Accounting

It is necessary to understand some basic accounting terms, which are, used daily in business world. These terms are called accounting terminology.

Capital

In accounting language Capital means the amount (in terms of money or assets having money value) which the proprietor has invested in the firm. For the firm, it is a liability towards the owner. It is so because the owner is treated as separate entity from the business. Capital is also known as Owner’s Equity. It will always be equal to assets less liability. This can be expressed as:

Capital = Assets – Liabilities

Liabilities

In Accounting terms Liabilities mean the amount, which the firm owes to outsiders, except the proprietor.

Liabilities = Assets – capital

A liability arises because of credit transactions. Most goods and services may be purchased by a business on credit. Funds may be borrowed form commercial bank for working capital purposes.

Liabilities can be classified into following:

Long- Term Liabilities:- These are those liabilities which are payable after a long term, (generally more than one year). –Long Term Liabilities are Long- Term Loans, Debentures, etc.

Current Liabilities:- Those liabilities which are payable in near future like:- Balance payable to sundry creditors, bank overdrafts, bills payable, etc.

Assets

In Accounting Terms Assets are those resources that is owned by the business. In other words, anything, which will enable the firm to get Cash or a benefit in future. Like:- money owned by debtors, stock of goods, Cash, furniture, machines and building, etc.

Assets can be classified into:-

Fixed Assets

Accounting defines those assets which are purchased for operating the business and not for resale. Examples of these are land, building, machinery, furniture, etc.

Current Assets

Those assets of the business, which are kept for short term for converting into Cash or for resale debtors, bank balance, etc., are some of the examples of current assets.

Sundry Debtors

Accounting language defines A person who owes money to the firm because of credit sales of goods is called a debtor. For example, when goods are sold to a person on credit that person pays the price in future. He is called a debtor because he owes the amount to the firm, commonly customers of goods/ services are known as debtors.

Sundry Creditors

In accounting terms A person to whom the firm owes money is called a creditor, when goods are purchased on credit from supplier, commonly suppliers of goods/ services are known as creditors.

Proprietor

Accounts defines proprietor as person who owns the business by making investment and bears all the risks connected with the business is called the proprietor.

Drawings

It is the amount of money or the value of goods which the proprietor takes for his personal use.

Expense

Expense is the amount spent in order to produce and sale of goods and services. Expenses is the cost of the use of things or services for the purpose of generating revenue like:- purchase expense, printing & stationery expenses, conveyance expenses etc.

Income

Income is the profit earned during a period of time. In other words, the difference between revenue and expense is called income.

income = Revenue – expense

Accounting transaction meaning & examples

Bad Debts

When a debtor is unable to pay debts, the entire amount due from him is not realized. The unrealized amount is a loss to the business, the same is called Bad Debts. Entry of bad debts is:

Bad debts A/c …. Dr.

To Debtor’s Personal A/c Cr.

Banking Transactions  

Payment by cheque, cheque received, withdrawal of Cash from bank, deposited into bank, Cash withdrawn from bank for personal use, interest credited or debited by bank, bank charges charged by bank are examples of bank transactions.

Cash deposited into bank

Bank A/c … Dr.

To Cash A/c Cr.

Cash withdrawn from bank

Cash A/c …. Dr

To Bank A/c Cr.

Payment by cheque to supplier

Creditor’s Personal A/c… Dr

To Bank A/c Cr.

Withdrawn from Bank for personal use

Drawings A/c… Dr

To bank A/c Cr.

For interest credited by Bank

Bank A/c … Dr

To interest A/c Cr.

For commission charged by Bank

Commission A/c …. Dr

To bank A/c Cr.

Cash withdrawn or goods taken by proprietor for personal Use

Drawings A/c… Dr

To Cash A/c Cr. (if Cash is withdrawn)

In many states, VAT is paid on purchases which is adjusted against VAT collected on sales and balance is the liability payable to the Government. Journal entries passed are:

Outstanding or payable expenses

Outstanding expenses are the expenses that relate to the current year but have not been paid till the year end.

Salary A/c…. Dr.

To Outstanding salary A/c Cr.

Prepaid Expenses

Normally payment of certain expenses like-Insurance, rent of shop, etc. is paid in advance. Such expenses are termed as advance or prepaid expenses.

Prepaid expenses A/c. Dr

To Insurance Expenses Cr.

Depreciation

Due to continuous use of fixed assets, value of these assets keeps on decreasing every year. This diminution in value is called the depreciation. This is a trading loss. Following journal entry is passed for recording depreciation:

Depreciation A/c … Dr

To Assets A/c Cr.

Voucher

Voucher is a document in accounting containing the details of a financial transaction. Examples include sales invoice, purchase invoice, pay-slip, rent receipt & so on. In a journal, several entries are recorded, each of which is unrelated to the other. To know the total effect of all the transactions, each journal entry must be moved transferred to the account it relates to.

Account

It is a statement of transactions affecting any particular asset, liability, expense or income. A ledger is the book in which all the accounts are maintained. A chart of accounts is a list of all account titles used by an organization. The chart of accounts of the business shows the categorization & grouping of its accounts.

Meaning of Voucher Posting in Accounting

 Posting is the process by which information about transactions is transferred or moved to an account.

Financial Accounting Period

 A regular period of time, such as a quarter or a year, for which a financial statement is generated is called an accounting period.

Meaning of Trial Balance in Accounting

 After posting the accounts in the Ledger, a statement is prepared to show separately the debit and credit balances. Such a statement is known as Trial Balance. It may also be prepared by listing each and every accounts and entering in separate columns the totals of the debit and credit sides. Whichever way it is prepared, the totals of the two columns should agree. An agreement indicates reasonable arithmetical acoustical of the accounting work. If the two sides do not agree, there is definitely some error. We should remember that equalizing the two sides of a Trial Balance is not the sole and conclusive proof of the complete correctness of accounting work.

Objects of a Trial Balance

A Trail Balance is a list of accounts showing debits balances and credit balances. If the Trial Balance agrees it proves:

  • That the accounts are arithmetically accurate,
  • That both aspects of all the transactions have been correctly recorded
  • Both the debit and credit entries are passed in the ledger.

A Trial Balance facilitates the preparation of final accounts, i.e., the Trading Account, the Profit and Loss Account and the Balance Sheet.

Methods of Preparing the Trial Balance

There are two methods of preparing a Trail Balance:

  • Total Method. In this method, the total of debit and credit sides of the ledger accounts, excluding the closing balances are shown in the Trial Balance.
  • Balance Method. Only the closing balances of the ledger accounts are shown in the Trial Balance.
  • Account name                             Debit balance                    Credit balance

Meaning of Invoice or Bill Receipt Pay-in-Slip Cheque Debit Notes and Credit Notes

Invoice

Accounting language define that a Invoice or bill is prepared by the seller of goods when the goods are sold on credit. It has details with respect to the name of the party to whom goods are sold the description of the goods sold and the total amount of sale, the original Copy of the sales invoice is sent to the purchaser and a duplicate copy is retained as an evidence of the sale for recording in books of account and also for future reference. From the purchaser’s point of view, purchases are evidenced by credit bills received from the supplier. One makes out an invoice but receives a bill, thought the two terms are interchangeable and mean the same thing.

Receipt

As per accounting terms When Cash or cheque is received from a customer, a receipt is issued as an acknowledgement for having received the Cash. Receipt is also prepared in duplicate. The original copy is handed over to the party tendering the payment and the duplicate copy is kept for record. This source document contains the details regarding date, amount, name of the party and the nature of the payment.

Pay-in-Slip

As per accounting term, this source document relates to the bank transactions. Pay-in-Slip is a form available from a bank for depositing money in a bank account. It has a counterfoil, which is returned to the depositor with signature of the Cashier, as receipt. The counterfoil of the pay-in-Slip gives the details regarding the date, the amount (in Cash or cheque) deposited.

Cheque

As per accounting definition A cheque is a document in writing drawn upon a specified banker and payable on demand. The bank supplies the cheque book having folios. The name of the party to whom payment is to be made is written after the words ‘Pay To’. Then the amount has to be written-both in words and figures. A cheque must be dated and signed by the drawer. Each cheque has a counterfoil. The same details are entered on the counterfoil, which remains with the account holder for his future reference. The counterfoil forms the source document for entries to be recorded in the account books.

Debit and Credit Notes

The term ‘Debit Note’ is reserved for a document evidencing a debit to be raised against a party for other reasons, for example, when goods are returned to a supplier or when an additional amount is recoverable from a customer, however a credit note is raised against customers for sale return.

 

Accounting Principles, Concepts and Conventions

 

In an accounting period, the income displayed must be set off against the expenses incurred to generate that profits. This gives a true & fair view of the profit earned in that period.

Accrual

Under accrual, method of accounting revenue is recognised when it is earned rather than when received, similarly expenses are recorded when incurred than actually paid. Thus, under accrual systems of accounting transactions are recorded on the basis of income earned or expense incurred, irrespective of actual receipt or payment.

Periodicity

Financial statements are generated for one year, so that performance of the period can be viewed.

Entity

 The business entity principle is laid on the principle that Business and its owner are two separate entities views the business as an entity separate from its owner(s). When the owner of the business takes money from the business for his personal use, through the business & its assets belong to him, the transaction is recorded as the owner receiving money from the business.

Money Measurement

In accounting, all transactions are measured using a common unit of measurement, which is money. Only transactions that can be expressed in terms of money are recorded.

Classification of Accounts

Assets Accounts- These accounts are accounts of assets and properties such as land and building, plant, furniture, etc.

Liability Accounts- These accounts are accounts of lenders, creditors, for goods and services.

Capital Accounts- These accounts refer to the accounts of proprietor who has invested in the business.

Revenue Accounts- These are accounts of income and gains e.g:- sales/ interest income.

Expenses Accounts- The accounts which show the amount spent on the operation of business like: – purchases, wages paid.

Types of Accounts

 

Nominal Accounts

  1. Expense Accounts Income Accounts Rule
  2. Purchase Account Sales Account Dr. All Expenses
  3. Conveyance Account Interest Income Cr. All Incomes
  4. Salary Account Dividend Account
  5. Rent Account
  6. Printing Stationery Account

 Personal Accounts

 

Suppliers Account Customers Accounts Rule

 

  • M/s Sony India Ltd M/s N N Jain & Co Dr. The Receiver
  • M/s Voltas India Ltd M/s Rahul & Sons Cr. The Giver
  • M/s Videocon India Ltd

Real Accounts

Assets Loans & Liabilities Rule

 

Car Account Dr What Comes in

Cash Account Cr. What Goes out

 

Bank Account

Building Account

Stock

Goodwill

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