Accounting Definations

Meaning of Accounting: According to American Accounting Association Accounting is “the process of identifying, measuring and communicating information to permit judgment and decisions by the users of accounts”.

Users of Accounts: Generally 2 types. 1. Internal management.

2. External users or Outsiders- Investors, Employees, Lenders, Customers,

Government and other agencies, Public. 

Sub-fields of Accounting:

ü  Book-keeping: It covers procedural aspects of accounting work and embraces record keeping function.

ü  Financial accounting: It covers the preparation and interpretation of financial statements.

ü  Management accounting: It covers the generation of accounting information for management decisions.

ü  Social responsibility accounting: It covers the accounting of social costs incurred by the enterprise.

Fundamental Accounting equation:

                                                Assets = Capital+ Liabilities.

                                           Capital = Assets - Liabilities.

Accounting elements: The elements directly related to the measurement of financial position i.e., for the preparation of balance sheet are Assets, Liabilities and Equity. The elements directly related to the measurements of performance in the profit & loss account are income and expenses.

Four phases of accounting process:

ü     Journalisation of transactions

ü     Ledger positioning and balancing

ü     Preparation of trail balance

ü     Preparation of final accounts.   

Book keeping: It is an activity, related to the recording of financial data, relating to business operations in an orderly manner. The main purpose of accounting for business is to ascertain profit or loss for the accounting period.

Accounting: It is an activity of analysis and interpretation of the book-keeping records.

Journal: Recording each transaction of the business. 

Ledger: It is a book where similar transactions relating to a person or thing are recorded.

      Types: Debtors ledger

                  Creditor’s ledger

                  General ledger

Concepts: Concepts are necessary assumptions and conditions upon which accounting is based.

ü     Business entity concept: In accounting, business is treated as separate entity from its owners. While recording the transactions in books, it should be noted that business and owners are separate entities. In the transactions of business, personal transactions of the owners should not be mixed.       For example: - Insurance premium of the owner etc...

ü     Going concern concept: Accounts are recorded and assumed that the business will continue for a long time. It is useful for assessment of goodwill.

ü     Consistency concept: It means that same accounting policies are followed from one period to another.

ü     Accrual concept: It means that financial statements are prepared on mercantile system only.

Types of Accounts: Basically accounts are three types,

ü     Personal account: Accounts which show transactions with persons are called personal account. It includes accounts in the name of persons, firms, companies.

            In this: Debit the receiver

                       Credit the giver.

            For example: - Naresh a/c, Naresh&co a/c etc…

ü     Real account: Accounts relating to assets is known as real accounts. A separate account is maintained for each asset owned by the business.

              In this: Debit what comes in

                         Credit what goes out

              For example: - Cash a/c, Machinery a/c etc…

ü     Nominal account: Accounts relating to expenses, losses, incomes and gains are known as nominal account.

              In this: Debit expenses and loses

                         Credit incomes and gains

         For example: - Wages a/c, Salaries a/c, commission received a/c, etc.

Accounting conventions: The term convention denotes customs or traditions which guide the accountant while preparing the accounting statements.

ü     Convention of consistency: Accounting rules, practices should not change from one year to another.

ü                   For example: - If Depreciation on fixed assets is provided on straight line method. It should be done year after year.

Convention of Full disclosure: All accounting statements should be honestly prepared and full disclosure of all important information should be made. All information which is important to assets, creditors, investors should be disclosed in account statements.

Trail Balance: A trail balance is a list of all the balances standing on the ledger accounts and cash book of a concern at any given date. The purpose of the trail balance is to establish accuracy of the books of accounts.

Trading a/c: The first step of the preparation of final account is the preparation of trading account. It is prepared to know the gross margin or trading results of the business.

Profit or loss a/c: It is prepared to know the net profit. The expenditure recording in this a/c is indirect nature.

Balance sheet: It is a statement prepared with a view to measure the exact financial position of the firm or business on a fixed date.

Outstanding Expenses: These expenses are related to the current year but they are not yet paid before the last date of the financial year.

Prepaid Expenses: There are several items of expenses which are paid in advance in the normal course of business operations.

Income and expenditure a/c: In this only the current period incomes and expenditures are taken into consideration while preparing this a/c.

Royalty: It is a periodical payment based on the output or sales for use of a certain asset.

           For example: - Mines, Copyrights, Patent.

Hire purchase: It is an agreement between two parties. The buyer acquires possession of the goods immediately and agrees to pay the total hire purchase price in installments.

                Hire purchase price = Cash price + Interest.

Lease: A contractual arrangement whereby the lessor grants the lessee the right to use an asset in return for periodic lease rental payments.

Double entry: Every transaction consists of two aspects

                                                 1. The receiving aspect

                                                 2. The giving aspect

The recording of two aspect effort of each transaction is called ‘double entry’.

The principle of double entry is, for every debit there must be an equal and a corresponding credit and vice versa.

BRS: When the cash book and the passbook are compared, some times we found that the balances are not matching. BRS is prepared to explain these differences.

Capital Transactions: The transactions which provide benefits to the business unit for more than one year is known as “capital Transactions”.

Revenue Transactions: The transactions which provide benefits to a business unit for one accounting period only are known as “Revenue Transactions”.

Deferred Revenue Expenditure:  The expenditure which is of revenue nature but its benefit will be for a very long period is called deferred revenue expenditure.

Ex: Advertisement expenses

A part of such expenditure is shown in P&L a/c and remaining amount is shown on the assests side of B/S.

Capital Receipts: The receipts which rise not from the regular course of business are called “Capital receipts”.

Revenue Receipts: All recurring incomes which a business earns during normal course of its activities.

Ex: Sale of good, Discount Received, Commission Received.

Reserve Capital: It refers to that portion of uncalled share capital which shall not be able to call up except for the purpose of company being wound up.

Fixed Assets: Fixed assets, also called noncurrent assets, are assets that are expected to produce benefits for more than one year. These assets may be tangible or intangible. Tangible fixed assets include items such as land, buildings, plant, machinery, etc… Intangible fixed assets include items such as patents, copyrights, trademarks, and goodwill.

Current Assets: Assets which normally get converted into cash during the operating cycle of the firm. Ex: Cash, inventory, receivables.

Fictitious assets: They are not represented by anything tangible or concrete.

Ex: Goodwill, deferred revenue expenditure, etc…

Contingent Assets: It is an existence whose value, ownership and existence will depend on occurance or non-occurance of specific act.

Fixed Liabilities: These are those liabilities which are payable only on the termination of the business such as capital which is liability to the owner.

Longterm Liabilities: These liabilities which are not payable with in the next accounting period but will be payable with in next 5 to 10 years are called long term liabilities. Ex: Debentures.

Current Liabilities: These liabilities which are payable out of current assets with in the accounting period. Ex: Creditors, bills payable, etc…

Contingent Liabilities: A contingent liability is one, which is not an actual liability but which will become an actual one on the happening of some event which is uncertain. These are staded on balance sheet by way of a note.

Ex: Claims against company, Liability of a case pending in the court.

Bad Debts: Some of the debtors do not pay their debts. Such debt if unrecoverable is called bad debt. Bad debt is a business expense and it is debited to P&L account.

Capital Gains/losses: Gains/losses arising from the sale of assets.

Fixed Cost: These are the costs which remains constant at all levels of production. They do not tend to increase or decrease with the changes in volume of production.

Variable Cost: These costs tend to vary with the volume of output. Any increase in the volume of production results in an increase in the variable cost and vice-versa.

Semi-Variable Cost: These costs are partly fixed and partly variable in relation to output.

Absorption Costing: It is the practice of charging all costs, both variable and fixed to operations, processess or products. This differs from marginal costing where fixed costs are excluded.

Operating Costing: It is used in the case of concerns rendering services like transport. Ex: Supply of water, retail trade, etc...

Costing: Cost accounting is the recording, classifying the expenditure for the determination of the costs of products for the purpose of control of the costs.

Rectification of Errors: Errors that occur while preparing accounting statements are rectified by replacing it by the correct one.

  Errors like: Errors of posting, Errors of accounting etc…

Absorbtion: When a company purchases the business of another existing company that is called absorbtion.

Mergers: A merger refers to a combination of two or more companies into one company.

Variance Analasys: The deviations between standard costs, profits or sales and actual costs are known as variances.

 Types of variances :

                                    1: Material Variances

                                    2: Labour Variances

                                    3: Cost Variances

                                    4: Sales or Profit Variances