3 Orientation in Accounting

S.S Narta

Introduction

The main aim of business is to earn profit. For earning profit, the businessman will either purchase the goods in one market at certain price and sell it in another market at higher price or will convert the raw materials into finished products and sell it to the different customers at a price which will give him some percentage of profit on cost of production. But this may not be true in all cases. Sometimes it may happen that the goods purchased or produced may go out of fashion and may be unsold simply because of depression in the market or keen competition. Moreover, in big business information is required for planning, control, evaluation of performance and decision making. This information can be provided only when business transactions are recorded, classified and summarised properly. Before recording the transactions in the books it is essential to understand the basic terms which have their special meaning in Accounting. These basic terms are called Accounting Terminology.

Accountant: – Accountant is a person who is trained to prepare and maintain financial records. An accountant with his education, training, analytical mind and experience is best qualified to provide multiple need-based services to the society. The accountant of today can do full justice not only to matters relating to taxation, costing. Management accounting but they can act in the fields relating to financial policies and even economic policies.

Accounting period: – It is referred to the period of time over which profits are calculated.

Normal accounting periods are months, quarters, and years (fiscal or calendar).

Account:- It is a statement of the various dealings which occur between a customer and the firm. It can also be expressed as a clear and concise record of the transaction relating to a person or a firm or a property (or assets) or a liability or an expense or an income.

Accrued Income: Accrued Income also known as Outstanding Income. Such incomes are accrued during the accounting period but not actually received in cash during that period.

Assets: Any physical thing or right owned that has money value is an asset. In other words, an asset is that expenditure which results in acquiring of some property or benefits of a lasting nature. Assets are properties of business which were acquired at measurable money cost. They are classified on the basis of their nature. Different types of assets are as under:

(a)   Fixed assets: Fixed assets are the assets which are acquired and held permanently and used in the business with the objective of making profits. Land and building, Plant and machinery, Furniture and Fixtures are examples of fixed assets.

(b)    Current assets: The assets of the business in the form of cash, debtors bank balances, bill receivable and stock are called current assets as they can be realised within an operating cycle of one year to discharge liabilities.

(c)    Tangible assets: Tangible assets have definite physical shape or identity and existence; they can be seen, felt and have volume such as land, cash, stock etc. Thus tangible assets can be both fixed assets and current assets.

(d)  Intangible assets: The assets which have no physical shape which cannot be seen or felt but have value are called intangible assets. Goodwill, patents, trade marks and licences are examples of intangible assets. They are usually classified under fixed assets.

(e)   Fictitious assets: Fictitious assets are not real assets. Past accumulated losses or expenses which are capitalised for the time being, expenses for promotion of organisations (preliminary expenses), discount on issue of shares, debit balance of profit and loss account etc. are the examples of fictitious assets.  

   (f)    Wasting assets: These assets are also called depleting assets. Assets such as mines, Timber forests, quarries etc. which become exhausted in value by way of excavation of the minerals, cutting of wood etc. are known as wasting assets. Such assets are usually natural resources with physical limitations.

(g)   Contingent assets: Contingent assets are assets, the existence, value possession of which is based on happening or otherwise of specific events. For example, if a business firm has filed a suit for a particular property now in possession of other persons, the firm will get the property if the suit is decided in its favour. Till the suit is decided, it is a contingent asset.

Bad debts: – Bad debts refer to those amounts owed to a company that are not going to be paid. An account receivable becomes a bad debt when it is recognized that it won’t be paid. Sometimes, bad debts are written off when recognized. This is an expense. Sometimes, a reserve is set up to provide for possible bad debts. Creating or adding to a reserve is also an expense.

Balance: – it is the sum of Debit entries minus the sum of Credit entries in an account. If it is found to be positive, the difference is called a debit balance; if found to be negative it is a credit balance.

Balance sheet: – It is a statement of the financial position of a company at a single specific time (often it is prepared at the close of business on the last day of the month, quarter, or year.) The balance sheet normally lists all assets on the left side or top while liabilities and capital are listed on the right side or bottom. The total of all numbers on the left side or top must equal or balance the total of all numbers on the right side or bottom. A balance sheet balances according to this equation: Assets = Liabilities + Capital.

Capital: – It is the part of the wealth which is used for further production and thus capital consists of all current assets and fixed assets. Cash in hand, Cash at bank, Building, plant & machinery, etc are the capital of the business. Capital should not necessarily be in cash, as it may be in kind also. Capital can be classified as : Fixed Capital, Floating Capital and Working capital.

Closing stock:- Closing stock is the value of goods remaining at the end of the accounting period. It includes closing stock of raw materials, work progress (where manufacturing account is not separately prepared) and finished stock.

Cost of sales, cost of goods sold: – It is the expense or cost of all items sold during an accounting period. Each unit sold has a cost of sales or cost of the goods sold. In businesses there are many items flowing through, the cost of sales or cost of goods sold is often computed by this formula: Cost of Sales = Beginning Inventory + Purchases During the Period ‐ Ending Inventory.

Creditor: – A person to whom money is owing by the firm is called creditor. These creditors may be creditors for goods and creditors for expenses.

Credit: – In simplest terms the right side of an account is arbitrarily or traditionally called Credit side.

Cast and Carry Forward: When journal entries extend to several pages of the journal, the totals is cast (done) at the end of each page. At the end of each page the words Total C/F are written in the particulars column against the debit and credit totals. On the next page, in the beginning the words Total b/f is written in the column against the debit and credit totals.

Compound Journal Entry: If there are two or more transaction of a similar nature are occurring on the same day and either Dr. or Cr. Account is common, such transactions can be conveniently recorded in the form of one journal entry instead of making a separate entry for each transaction. Such entry is known as compound Journal entry.

Cash Discount: This discount is allowed by a creditor to a debtor when the latter pays the amount of goods purchased by him either immediately or within a specified period. It is an incentive given to a debtor for making an early payment.

Debtor: – A person who owes money to the firm mostly on account 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.

Drawings: – It is the amount of money or the value of goods which the proprietor takes for his domestic or personal use. It is usually subtracted from capital as it is an expense for a company.

Discount: – When customers are allowed any type of deduction in the prices of goods by the businessman that is called discount. When some discount is allowed in prices of goods on the basis of sales of the items, that is termed as trade discount, but when debtors are allowed some discount in prices of the goods for quick payment, that is termed as cash discount.

Depreciation: The term depreciation refers to loss on account of reduced value of assets due to wear and tear, obsolescence, damaged with time or accident. Depreciation is treated as the cost or loss arises.

Debit: – In simplest terms the left side of an account is arbitrarily or traditionally called Debit side. Usually an increase in assets or a reduction in liabilities. Every debit has a balancing credit.

Double Entry: – It is a system of accounting in which every transaction is recorded twice, as a debit and as a credit. Each credit has a balancing debit.

Expense: – The terms „expense‟ refers to the amount incurred in the process of earning revenue. If the benefit of an expenditure is limited to one year, it is treated as an expense (also know is as revenue expenditure) such as payment of salaries and rent.

Goods: – It is a general term used for the articles in which the business deals; that is, only those articles which are bought for resale for profit are known as Goods.

Gross Profit: – If the sales revenue is higher than the cost of goods sold the difference is known as Gross Profit.

Gross Loss: – If the sales revenue is less than the cost of goods sold the difference is known as Gross Loss.

Invoice: –While making a sale, the seller prepares a statement giving the particulars such as the quantity, price per unit, the total amount payable, any deductions made and shows the net amount payable by the buyer. Such a statement is called an invoice.

Liability: -A liability is an amount which a business firm is „liable to pay‟ legally. All the amounts which are claims by outsiders on the assets of the business are known as liabilities. It means the amount which the firm owes to outsiders that is, excepting the proprietors. In simple terms, debts repayable to outsiders by the business are known as liabilities. They are credit balances in the ledger.

Liabilities = Assets – Capital

Liabilities are classified into further categories as given below:

(a)     Owner’s capital: Capital is the amount contributed by the owners of the business. In addition to initial capital introduced, proprietors may introduce additional capital and withdraw some amounts from business over a period of time. Owner‟s capital is also called „net worth‟. Net worth is the total fund of proprietors on a particulars date. It consists of capital, profits and interest on capital subject to reduction of drawings and interest on drawings.

In case of limited companies, capital refers to capital subscribed by shareholders. Net worth refers to paid up equity capital plus reserves and profits, minus losses.

(b)    Long term Liabilities: Liabilities repayable after specific duration of long period of time are called long term liabilities. They do not become due for payment in the ordinary „operating cycle‟ of business or within a short period of lime. Examples are long term loans and debentures

(c)    Current liabilities: Liabilities which are repayable during the operating cycle of business, usually within a year, are called short term liabilities or current liabilities. They are paid out of current assets or by the creation of other current liabilities. Examples of current liabilities are trade creditors, bills payable, outstanding expenses, bank overdraft, taxes payable and dividends payable.

(d)   Contingent liabilities: Contingent liabilities will result into liabilities only if certain events happen. Examples are: Bills discounted and endorsed which may be dishonoured, unpaid calls on investments.

Losses: Loss in simplest terms means something against which the firm receives no benefit. It represents money given up without any return. It may be noted that expense leads to revenue but losses do not, e.g. loss due to fire, theft and damages payable to others.

Purchases: – Buying of goods by the trader for selling them to his customers is known as purchases. As the trade is buying and selling of commodities purchase is the main function of a trade. Here, the trader gets possession of the goods which are not for own use but for resale. Purchases can be of two types; viz, cash purchases and credit purchases. If cash is paid immediately for the purchase, it is cash purchases. If the payment is postponed, it is credit purchases.

Purchase Returns: – When purchased goods are returned to the suppliers these are known as purchase returns. Such returns are also termed as „returns outwards‟.

 Proprietor: –The person who makes the investment and bears all the risks connected with the business is known as proprietor.

Revenue: – It means the amount which, as a result of operations, is added to the capital. It is defined as the inflow of assets which result in an increase in the owner‟s equity. It includes all incomes like sales receipts, interest, commission, brokerage etc., However, receipts of capital nature like additional capital, sale of assets etc., are not a part of revenue. Revenue is different from „Income‟. Amount received from sale of goods is called „Revenue‟. The Cost of goods sold is called „Expense‟. Surplus of revenue over expenses is called „Income‟. For example, the goods costing Rs. 4, 00,000 are sold for Rs. 5, 00,000. The sale amounting to Rs. 5,00,000 is the revenue, the cost amounting to Rs. 4,00,000 is the expense and the difference between the two i.e., Rs. 1,00,000 is the income.

Sales: – When the goods purchased are sold out, it is known as sales. Here, the possession and the ownership right over the goods are transferred to the buyer. It is known as ‘Business Turnover‟ or sales proceeds. It can be of two types, viz.,, cash sales and credit sales. If the sale is for immediate cash payment, it is cash sales. If payment for sales is postponed, it is credit sales.

Stock: – The goods purchased are for selling, if the goods are not sold out fully, a part of the total goods purchased is kept with the trader unlit it is sold out, it is said to be a stock. If there is stock at the end of the accounting year, it is said to be a closing stock. This closing stock at the yearend will be the opening stock for the subsequent year.

Solvent: – A person who has assets with realizable values which exceeds his liabilities is insolvent.

Sale of Shares: If shares or security are sold, the entry should be passed at market value less brokerage, if any, paid on such shares.

Transaction: – “An event the recognition of which gives rise to an entry in accounting records. It is an event which results in change in the balance sheet equation and changes the value of assets and equity. In simple terms, transaction means the exchange of money or money‟s worth from one account to another account. Events like purchase and sale of goods, receipt and payment of cash for services or on personal accounts, loss or profit in dealings etc., are the transactions”. Cash transaction is one where cash receipt or payment is involved in the exchange. Credit transaction, on the other hand, will not have „cash‟ either received or paid, for something given or received respectively, but gives rise to debtor and creditor relationship. Non-cash transaction is one where the question of receipt or payment of cash does not at all arise, e.g. Depreciation, return of goods etc. Transactions are of four kinds:

   (a)    Cash transaction: Cash transactions are those transactions in which cash is involved in the exchange.

(b)   Credit transaction: Credit transactions are those in which cash is not paid immediately. The settlement is postponed to a later date.

(c)    Barter transactions: Barter transactions are those transactions where, no doubt, there is an exchange of goods, but the exchange of benefit is not in terms of money.

(d)   Paper transaction: Paper transactions are those transactions where there is no question of meeting the value of transaction.

Trading Account: – It is an account prepared for an accounting period to find the trading results or gross margin of the business i.e., the amount of gross profit the concern has made from buying and selling during the accounting period.

Opening Stock: The stock at the beginning of an accounting period is called opening stock.

Opening Entry: The balances of the previous year are brought forward in the beginning of the year by means of an entry in a going concern. Such entry is made on the basis of accounting equation i.e. by debiting all assets and crediting liabilities and capital account.

Interest on Drawings: – Any amount charged as interest on drawings made by the proprietors for his personal use during the particular period is treated as interest on drawings. Interest on drawings should be taken as an income for ascertaining the true profit for a period.

Non-Operating Income: Non-Operating incomes refer to other than operating income. For example, interest on investment of outside business, profit on sale of fixed assets and dividend received etc.

Provision for Doubtful Debts: those bad debts of which recovery is doubtful. Thus doubtful debts should not be written off from the books of accounts. Doubtful debts are treated as anticipated loss therefore making suitable provisions for these is required to be made in the books of accounts.

Interest on Capital: In order to ascertain true profitability of the business concern, it is essential that profit is determined after deducting interest on the capital provided by proprietor.

Income Received in Advance: It is any income received in advance which is not earned during the accounting period. Therefore, if any income received in advance, it should be treated as income for the subsequent year.

Outstanding Expenses: Outstanding expenses refer to those expenses incurred and remain unpaid during the accounting period. For example, salary, rent, interest etc. are expenses which are incurred but remain unpaid during the accounting period. In order to ascertain the correct profit and loss made during the year, it is essential that such related expenses are treated as Salary Outstanding, Interest Outstanding and Rent Outstanding etc.

Operating Income: It refers to the income earned from the operation of the business excluding Gross Profit and Non-Operating incomes.

Voucher: –A voucher is a written document in support of a transaction. It is a proof that a particular transaction has taken place for the value stated in the voucher. Voucher is necessary to audit the accounts.

Summary:

• Ø Accounting is both a science as well as an art.
• Ø The three main branches of accountancy are: Finished accounting; cost accounting and management accounting.
• Ø The assets are broadly classified as: fixed assets, current assets and fictitious assets.
• Ø The liabilities are broadly classified as: Fixed liabilities and current liabilities.
• Ø Accounting is both a science as well as an art.
• Ø The accounts relating to the property of the business are called real accounts.
• Ø Any exchange of goods or services for cash or on credit by the business with any other business or customer is called transaction.

Suggested Readings:

• Ø Shashi K Gupta,R.K,Sharma(2005), “Management Accounting”, Kalyani Publishers,New Delhi
• Ø Tulsian . P.C (2014) “Financial Accounting” Pearson Education India.
• Ø Lal, Jawahar and Seema Srivastava (2004) “Financial Accounting” S.Chand (G/L) &

Company Ltd.

• Ø Goyal, V.K. and Ruchi Goyal (2012) “Financial Accounting” PHI.
• Ø Maheshwari, S.N., Suneel K Maheshwari and Sharad K Maheshwari(2012) “Financial Accounting” Vikas Publishing House Pvt Ltd.
• Ø Monga, J.R. “Avanced Financial Accounting” Mayoor Paperbacks.
• Ø Bhattacharyya Asish K., (2012)” Essentials of Financial Accounting” PHI.
• Ø A Students Guide to IFRS (2012), Kaplan Publishing.