Tally Geek

Monday, 6 July 2015

Financial Statements

Financial statements are final result of accounting work done during the accounting period.
Financial statement serves a significant purpose to users of accounting information in knowing
about the profitability and financial position of the organisation.

Financial statements normally include:

‡ Trading
‡ Profit and Loss Account
‡ Balance Sheet

Trading Account

Trading refers to buying and selling of goods. The trading account displays the transactions pertaining to buying and selling of goods.

The difference between the two sides of the Trading Account indicates either Gross Profit or
Gross Loss. If the credit side total is in excess of the debit side total, the difference represents
Gross Profit. On the other hand, if the total of the debit side is in excess of the credit side total, the
difference represents Gross Loss. Such Gross Profit / Gross Loss is transferred to Profit & Loss
Account.

The Gross Profitis expressed as : Gross Profit = Net Sales – Cost of Sales

Profit and Loss Account

The profit and loss account helps to ascertain the net profit earned or net loss suffered during a
particular period. after considering all other incomes and expenses incurred over a period. This
helps the company to monitor and control the costs incurred and improve its efficiency. In other
words, the profit and loss statement shows the performance of the company in terms of profits or
losses over a specified period.

The Net Profitis expressed as :

Net Profit = (Gross Profit + Other Income) – (Selling and Administrative Expenses + Depreciation + Interest + Taxes + Other Expenses)

A key element of the Profit and Loss Account, and one that distinguishes it from a balance sheet,
is that the amounts shown on the statement represent transactions over a period of time, while
the items represented on the balance sheet show information as on a specific date.

All revenue and expense accounts are closed once the profit and loss account is prepared. The
Revenue and Expenses accounts will not have an opening balance for the next accounting
period.

Balance Sheet

The balance sheet is a statement that summarises the assets and liabilities of a business. The
excess of assets over liabilities is the net worth of a business. The balance sheet provides information that helps in assessing

‡ A company’s Long-term financial strength
‡ A company’s Efficient day-to-day working capital management
‡ A company’s Asset portfolio
‡ A company’s Sustainable long-term performance

The balances of all the real, personal and nominal(capital in nature) accounts are transferred
from trial balance to balance sheet and grouped under the major heads of assets and liabilities.
The balance sheet is complete when the net profit/ loss is transferred from the Profit and Loss
account.

Mode of Accounting

Basics of Accounting

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Accounting process begins with identifying and recording the transactions in the books of
accounts i.e., the first step in the Accounting Process is recording of transactions in the books of
accounts. Accounting identifies only those transactions and events which involves money and is
sorted based on various source documents.

The following are the most common source documents.

‡ Cash Memo
‡ Invoice or Bill
‡ Vouchers
‡ Receipt
Journals & Ledgers
‡ Debit Note
‡ Credit Note

Voucher
A voucher is a document in support of a business transaction, containing the details of such transaction.

Receipt
When a trader receives cash from a customer against goods sold by him, issues a receipt containing the name of such customer, details of amount received with date.

Invoice or Bill
When a trader sells goods to a buyer, he prepares a sales invoice containing the details of name
and address of buyer, name of goods, amount and terms of payments and so on. Similarly, when
the trader purchases goods on credit receives a Invoice/bill from the supplier of such goods.

Journals and Ledgers
A journalis a record in which all business transactions are entered in a chronological order. A
record of a single business transaction is called a journal entry. Every journal entry is supported
by a voucher, evidencing the related transaction.

What is the double entry system?

Basics of Accounting

Faizal 13:24 0

The double entry system of accounting or bookkeeping means that every business transaction will involve two accounts (or more).

Every transaction has two effects. For example, if someone transacts a purchase of a drink from a local store, he pays cash to the shopkeeper and in return, he gets a bottle of dink. This simple transaction has two effects from the perspective of both, the buyer as well as the seller. The buyer's cash balance would decrease by the amount of the cost of purchase while on the other hand he will acquire a bottle of drink. Conversely, the seller will be one drink short though his cash balance would increase by the price of the drink.

Traditionally, the two effects of an accounting entry are known as Debit (Dr) and Credit (Cr). Accounting system is based on the principal that for every Debit entry, there will always be an equal Credit entry. This is known as the Duality Principal.

Debit entries are ones that account for the following effects:

    Increase in assets
    Increase in expense
    Decrease in liability
    Decrease in equity
    Decrease in income

Credit entries are ones that account for the following effects:

    Decrease in assets
    Decrease in expense
    Increase in liability
    Increase in equity
    Increase in income

Double Entry is recorded in a manner that the Accounting Equation is always in balance.

Assets - Liabilities = Capital

Any increase in expense (Dr) will be offset by a decrease in assets (Cr) or increase in liability or equity (Cr) and vice-versa.

Accounting Concepts and Conventions

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ACCOUNTING CONCEPT

Accounting Concept defines the assumptions on the basis of which Financial Statements of a business entity are prepared. Certain concepts are received assumed and accepted in accounting to provide a unifying structure and internal logic to accounting process. The word concept means idea or nation, which has universal application. Financial transactions are interpreted in the light of the concepts, which govern accounting methods. Concepts are those basis assumption and conditions, which form the basis upon which the accountancy has been laid. Unlike physical science, Accounting concepts are only results of broad consensus. These accounting concepts lay the foundation on the basis of which the accounting principals are formulated.

Now we shall study in detail the various concept on which accounting is based. The following are the widely accepted accounting concepts.

1.) Entity Concept:- Entity Concept says that business enterprises is a separate identity apart from its owner. Business transactions are recorded in the business books of accounts and owner’s transactions in this personal back of accounts. The concept of accounting entity for every business or what is to be excluded from the business books. Therefore, whenever business received cash from the proprietor, cash a/c is debited as business received cash and capital/c is credited. So the concept of separate entity is applicable to all forms of business organization.

2.) Money Measurement Concept:- As per this concept, only those transactions, which can be measured in terms of money are recorded. Since money in the medium of exchange and the standard of economic value, this concept requires that these transactions alone that are capable of being measured in terms of money be only to be recorded in the books of accounts. For example, health condition of the chairman of the company, working conditions of the workers, sale policy ect. do not find place in accounting because it is not measured in terms of money.

3.) Cost Concept:- By this concept, the value of assets is to be determined on the basic of historical cost. Transaction are entered in the books of accounts at the amount actually involved. For example a machine purchased for Rs. 80000 and may consider it worth Rs. 100000, But the entry in the books of account will be made with Rs. 80000 or the amount actually paid. The cost concept does not mean that the assets will always be shown at cost. The assets may be recorded at the time of purchase but it may be reduced its value be charging depreciation.

Many assets de not have acquisition cost. Human assets of an enterprises are an example. The cost concept fails to recognize such assets although it is a very important assets of any organization.

4.) Going Concern Concept:- According to this concept the financial statements are normally prepared on the assumption that an enterprises is a going concern and will continue in operation for the foreseeable future. Transaction are therefore recorded in such a manner that the benefits likely to accrue in future from money spent. It is because of this concept that fixed assets are recorded at their original cost and depreciation in a systematic manner without reference to their current realizable value.

5.) Dual aspect Concept:- This concept is the care of double entry book-keeping. Every transaction or event has two aspect. If any event occurs, it is bound to have two effect. For Rs.50000, on the other hand stock will increase by Rs.50000 and other liability will increase by Rs.50000. similarly is X starts a business with a capital of Rs. 50000, while on the other hand the business has to pay Rs. 50000 to the proprietor which is taken as proprietor’s Capital.

6.) Realization Concept: - It closely follows the cost concept any change in value of assets is to be recorded only when the business realize it. i.e. either cash has been received or a legal obligation to pay has been assumed by the customer. No Sale can be said to have taken place and no profit can be said to have arisen. It prevents business firm from inflating their profit by recording sale and income that are likely to accrue, i.e. expected income or gain are not recorded.

7.) Accrual Concept:- Under accrual concept the effect of transaction and other events are recognized on mercantile basic. When they accrue and not as cash or a cash equivalent is received or paid and they are recorded in the accounting record and reported in the financial statements of the periods to which they relate financial statement prepared on the accrual basic inform users not only of past events involving the payment and receipt of cash but also of obligation to pay cash in the future and of resources that represent cash to be received in the future. For Example:- Mr. Raj buy clothing of Rs. 50000,a paying cash Rs. 20000 and sells at Rs. 60000 of which customer paid only Rs. 40000. So his revenue is Rs. 60000, not Rs. 40000 cash received. Exp. Or Cash is Rs. 50000, not Rs. 20000 cash paid. So the accrual concept based profit is Rs. 10000 (Revenue- Exp.)

8.) Accounting Period Concept:- This is also called the concept of definite periodicity concept as per going concept on indefinite life of the entity is assumed for a business entity it causes inconvenience to measure performance achieved by the entity in the ordinary causes of business. Therefore, a small but workable fraction of time is chosen out of infinite life cycle of the business entity for measure the performance and loading at the financial position 12 months period is normally adopted for this purpose accounting to this concept accounts should be prepared after every period & not t the end of the life of the entity. Usually this period is one calendar year. In India we follow from 1^st April of a year to 31^st March of the immediately following years. Now a day because of the need of management, final accounts are prepared at shoter intervals of quarter year or in some cases a month such accounts are know a interim account.

9.) Matching Concept:- In this concept, all exp. Matched with the revenue of that period should only be taken into consideration. In the financial statements of the organization. If any revenue is recognized that exp. Related to earn that revenue should also be recognized. This concept as it considers the occurrence of exp. And income and do not concentrate on actual inflow or outflow of cash. This leads to adjustment of certain items like prepaid and outstanding expenses, unearned or accrued income.

It is not necessary that every exp. Identity every income. Some exp. Are directly related to the revenue and some are directly related to sale but rent, salaries etc. are recorded on accrual basis for a particular accounting period. In other words periodicity concept has also been followed while applying matching concept.

10.) Objective Concept:- As per this concept, all accounting must be based on objective evidence. In other words, the transactions recorded should be supported by verifiable documents. Only than auditors can verify information record as true or otherwise. The evidence should not be biased. It is for this reasons that assets are recorded at historical cost and shown thereafter at historical lass depreciation. If the assets are shown on replacement cost basis, the objectivity is lost and it become difficult for auditors to verify such value, however, in resent year replacement cost are used for specific purpose as only they represent relevant costs. For example, to find out intrinsic value of share, we need replacement cost of assets and not the historical cost of the assets.

ACCOUNTING CONVENTIONS

The term “Accounting Conventions” refers to the customs or traditions which are used as a guide in the preparation of accounting reports and statements. The conventions are derived by usage and practice. The accountancy bodies of the world may charge any of the convention to improve the quality of accounting information accounting conventions need not have universal application. Following are important accounting conventions in use:

1.) Convention of consistency:- According to this convention the accounting practices should remain unchanged from one period to another. It requires that working rules once chosen should not be changed arbitrarily and without notice of the effect of change to those who use the accounts. For example, stock should be valued in the same manner every year. Similarly depreciation is charged on fixed assets on the same method year after year. If this assumption is not followed, the fact should be disclosed together with reasons.

The principle of consistency plays its role particularly when alternative accounting methods is equally acceptable. Any change from one method to another method would result in inconsistency; they may seem to be inconsistent apparently. In case of valuation of stocks if the company applies the principle “at cost or market price whichever is less” and if this principle accordingly result in the valuation of stock in one year at cost and the market price in the other year, there is no inconsistency here. It is only an application of the principle.

An Enterprise should change its accounting policy in any of the following circumstances only.

(i) To bring the books of accounts in accordance with the issued accounting standard.

(ii) To compliance with the provision of law.

(iii) When under changed circumstances it is felt that new method will reflect more true and fair picture in the financial statement.

2.) Convention of Conservatism:- This is the policy of playing sale game. It takes into consideration all prospective losses but leaves all prospective profits financial statements are usually drawn up on a conservative basis anticipated profit are ignored but anticipated losses are taken into account while drawing the statements following are the examples of the application of the convention of conservatism.

(i) Making the provision for doubtful debts and discount on debtors.

(ii) Valuation of the stock at cost price or market price which ever is less.

(iii) Charging of small capital items, like crockery to revenue.

(iv) Showing joint life policy at surrender value as against the actual amount paid.

(v) Not providing for discount on creditors.

3.) Convention of Disclosure:- Apart from statutory requirement, good accounting practice also demands that significant information should be disclosed in financial statements. Such disclosures can also be made through footnotes. The purpose of this convention is to communicate all material and relevant facts concerning financial position and results of operations to the users. The contents of balance sheet and profit and loss account are prescribed by law. These are designed to make disclosures of all materials facts compulsory. The practice of appending notes relative to various facts and items which do not find place in accounting statements is in pursuance to the convention of full disclosure of material facts. For example;

(a) Contingent liability appearing as a note.

(b) Market value of investments appearing as a note.

The convention of disclosure also applies to events occurring after the balance sheet date and the date on which the financial statement are authorized for issue. Such events include bad debts, destruction of plant and equipment due to natural calamities’, major acquisition of another enterprises, etc. such events are likely to have a substantial influence on the earnings and financial position of the enterprises. Their not-disclosure would affect the ability of the users for evaluations and decisions.

4.) Convention of Materiality:- According to this conventions, the accountant should attach importance to material detail and ignore insignificant details in the financial statement. In materiality principle, all the items having significant economics effect on the business of the enterprises should be disclosed in the financial statement.

The term materiality is the subjective term. It is on the judgment, common sense and discretion of the accountant that which item is material and which is not. For example stationery purchased by the organization though not used fully in the concept. Similarly depreciation small items like books, calculator is taken as 100% in the year if purchase through used by company for more than one year. This is because the amount of books or calculator is very small to be shown in the balance sheet. It is the assets of the company.

What is Accounting?

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The process of identifying, measuring and communicating economic information to permit informed judgments and decision by users of the information.

Financial statements will be useful to the following parties:

Suppliers
Customers
Employees
Banks
Suppliers of equipments, buildings and other assets
Lenders
Owners

Types of Accounts

There are basically three types of Accounts maintained for transactions :

Real Accounts
Personal Accounts
Nominal Accounts

Real Accounts

Real Accounts are Accounts relating to properties and assets, which are owned by the business Concern and the balances in these accounts at the end of an accounting period will be carried over to the next period. Real accounts include tangible and intangible accounts. For example; Land& Building, Goodwill, Purchases, Cash

Rules of Accounting:Debit what comes in & Credit what goes out

Personal Accounts

Personal Accounts are Accounts which relate to persons. Personal Accounts include the following.For Ex; Suppliers,Customers, Lenders

Accounts of natural or physical persons. Ex: Rama Account, Krishna Account
Accounts of artificial or legal persons. Ex: ABC & Co.
Representative personal account. Ex: O/S Expenses Account, O/S income Account, Prepaid Expenses Account, Income Received in Advance.

Rules of Accounting:Debit the Receiver & Credit the Giver

Nominal accounts

Nominal Accounts are Accounts which relate to incomes and expenses and gains and losses of a business concern. For example: Salary Account, Dividend Account, Rent Account, Interest Account.

Rules of Accounting:Debit all expenses and losses & Credit all income and gains

Accounts can be broadly classified under the following four groups.

Assets
Liabilities
Income
Expenses

The above classification is the basis for generating various financial statements viz., Balance Sheet, Profit & Loss A/c and other MIS reports. The Assets and liabilities are taken to Balance sheet and the Income and Expenses accounts are posted to Profit and Loss Account.