Introduction
Learning Objectives
Introduction and evolution of accounting. Book-keeping: meaning, need, features, process, objects and utility. Accounting: meaning, functions, objectives, advantages and limitations. Accounting Cycle. Relationship between Book-keeping, Accounting and Accountancy. Difference between Book-keeping and Accounting. Accounting whether science or art. Branches of accounting. Accounting as a source of information. Users of accounting information. Qualitative characteristics of accounting information. Transaction and events Accounting terminology Cost of goods sold and business income.
Introduction to Accounting
The development of trade, industry and commerce world over has necessitated the recording of all business transactions clearly and systematically. During the past few decades, business has witnessed a sea-change from small units to big business houses and from manual operations to highly mechanised ones. The tremendous growth of business has increased the volume of business transactions manifold.
The necessity of recording all the transactions clearly and systematically cannot be over- emphasized. Goods may be sold on credit to several persons. The buyer would pay the price of the goods to the vendor later. The vendor would like to know, from time to time that what amount is due and from whom. However strong one's memory may be, one cannot hope to remember all the details regarding all the transactions. Apart from this, the object of business is to earn profits; and every merchant likes to know at the end of a financial year that how much profit he has earned during the course of the year. For this purpose, he would need a lot of factual information which can be derived from written records of transactions, provided such records have been properly kept. As such, proper maintenance of books of accounts indispensable for a businessman. Moreover, accounting written records are also essential for the following type of information required:
(ii) The expenditure during the period on salaries, wages, lighting, rent, taxes, etc.;
(iii) The amount of profit or loss of a financial year;
(iv) The amount of capital and causes of its increase or decrease;
(v) Nature and value of assets possessed by the business;
(vi) Nature and amount of liabilities;
(vii) Customers who owe to the business and the amount in each case;
(viii) Suppliers to whom the business has to make payments and the amount in each case;
(ix) Other facts for filing various tax returns.
Limited companies, Charitable organisations and now, limited liability partnerships are compelled by law to maintain proper records of their financial transactions. Although sole traders and partnership firms are not subject to legal obligation, it is very much in their interest to keep proper financial records for the survival as well as growth of the business.
Evolution of Accounting
The history of accounting dates back to the earliest days of human agriculture and civilization when the need to maintain accurate records of the quantities and relative values of agricultural products first arose. Simple accounting is mentioned in the Christian Bible in the book of Mathew in the parable of the Talents (Matt. 25: 19). The Quran also mentions simple accounting for trade and credit arrangements (Quran 2: 282). Kautilya's famous Arthashastra not only relates to politics and economics, but also explains the art of account keeping. Written in 4th century B.C. in Shlokas or Sanskrit verses, a chapter in the book provided the details about account keeping, accountant's office, methods of supervising and checking of accounts and also about the distinction between capital and revenue, profits, expenses, etc.
The development in trade and commerce has been responsible for the growing importance of a methodical accounting work. It is in the important world trade centres of Geneva and Venice, the Italian cities that a systematic method of accounting developed between 14th and 15th centuries.
Luca Pacioli (1445-1517) also known as Friar Luca dal Borgo wrote a book, primarily on mathematics, "Summa de Arithmetica, Geometrica, Proportioni et Proportionalita" (Review of Arithmetics, Geometry and Proportions) in 1494. This book contains a brief section under the chapter heading "Particularis de computis et scripturis" (Particulars of Reckoning and their recording) on double entry system of book-keeping. Although Pacioli codified rather than invented this system, he is widely regarded as the father of modern accounting.
Pacioli was a great philospher of Italy. His book is the first printed book on double entry system. The review of literature suggests that Benedetto Cortugli completed a book on double entry system in 1458 but it was not published till 1573.
Pacioli used the term 'debito' (owed to) and 'credito' (owed by); these came from the latin words debitur and creder. The terms used today have their origin from debitur and creder. The system he published included most of the accounting cycle as we know it today. He described the use of journals and ledgers, and warned that a person should not go to sleep at night until the debits equalled the credits! He was in favour of closing accounts every year. He stressed on the measurement of profit or loss at regular interval. He also suggested the preparation of an "inventory' i.e., financial position of a business which is called 'Balance Sheet' now.
However, Pacioli's book initiated an important step in keeping of records under double-entry system. In the succeeding year many improvements took place in the accounting books and methods for the convenience of different organisations. Industrial revolution of 18th century and globalised trade necessitated further improvements in accounting, such as mechanised accounts, computerised accounting statements, etc.
Meaning and Need for Book-Keeping
Book-keeping is that branch of knowledge which tells us how to keep a record of financial transactions. The need for recording such transactions arise because:
(i) it is difficult to remember the various financial payments and receipts taking place during a period of time ;
(ii) in modern forms of business organisations, the control of business rests with different persons and the results are to be reported to the owners;
(iii) the financial information is required for the purposes of costing, budgeting, forecasting and planning; and
Most of us do maintain some kind of written record of our income and expenditure. The essential idea behind maintaining such a record is to show the correct position regarding income and expenditure. Such a record should be clear and systematic so that it can be easily understood. It should show that to whom, when and what for a payment has been made. The need for maintaining a record of income and expenditure in a clear and systematic manner has given rise to the subject of book-keeping. Book-keeping can as such be defined "as an art and science of recording business transactions in a systematic and chronological order"
Accounting - Meaning and Definitions
Process of Accounting
Accounting as an information system is the process of identifying, measuring and communicating the economic information of an organisation to its users who need the information for decision making. The process of accounting contains the following steps:
Accounting Process
Accounting System
1. The balances of accounts from the balance sheet and day to day transactions of the accounting year are first of all recorded in a book known as Journal.
Accounting Cycle
3. At the end of every accounting period, these accounts are balanced and a Trial Balance is prepared.4. Then, the final accounts such as Trading and Profit & Loss Accounts are prepared in case of manufacturing and trading concerns. In case of concerns providing service only (insurance, architecture, consultancy), Trading Account is not prepared.
5. Finally, a balance sheet is prepared which indicates the financial position of the business at the end of the accounting year.
Accounting Objectives
Accounting is useful in the following respects:
"A good system of accounting is a storehouse of valuable information." Welsch and Anthony. Accounting is useful in a number of ways.
Advantages of accounting discussed above do not suggest that accounting is free from limitations. Following are the limitations of accounting:
1. Permits alternative treatments. Accounting is based on concepts and it follows "generally accepted accounting principles" but there exist more than one principle for the treatment of any one item. This permits alternative treatments within the framework of generally accepted accounting principles. For example, the closing stock of a business may be valued by any one of the following methods: FIFO (First-in- First-out); LIFO (Last-in-First- out) Average price; Standard price; etc., but the results are not comparable.
2. Influenced by personal judgements. 'Convention of objectivity' is respected in accounting but to record certain events, estimates have to be made which require personal judgement. It is very difficult to expect accuracy in future estimates, and objectivity suffers. For example, in order to determine the amount of depreciation to be charged every year for the use of fixed asset it is required to judge the useful life of the asset. Thus, estimation of the depreciation expense is charged to revenue and the income disclosed by accounting is not authenticated but 'approximation'.
3. Ignores important non-monetary information. Accounting does not consider the transactions of non-monetary in nature. For example, extent of competition faced by the business, technical innovations possessed by the business, loyalty and efficiency of the employees, changes in the value of money, etc. are the important matters in which management of the business is highly interested but accounting is not tailored to take note of such matters. Thus, any user of financial information is, naturally, deprived of vital information which is of non-monetary character.
4. Does not provide timely information. Accounting is designed to supply information in the form of statements (balance sheet and profit and loss account) for a period, normally, one year. So, the information is, at best, of historical interest and only 'post-mortem' analysis of the past can be conducted. The business requires timely information at frequent intervals to enable the management to plan and take corrective action. For example, if a business has budgeted that during current year the sales should be 12,00,000, then it requires information-whether the sales in the first month of the year amounted to 1,00,000 or less or more? Traditionally, accounting is not supposed to supply information at shorter intervals than one year.
5. Does not provide detailed analysis. The information supplied by the accounting, in reality, aggregates of the financial transactions during the course of the year. Of course, it enables to study the overall results of the business. The information is required regarding the cost, revenue and profit of each product but accounting does not provide such detailed information product-wise. For example, if business has earned a total profit of, say, 5,00,000 during the accounting year and it sells three products namely petrol, diesel and mobil oil and wants to know profit earned by each product, accounting is not likely to help him.
6. Does not disclose the present value of the business. In accounting, the position of the business as on a particular date is shown by a statement known as 'Balance sheet'. In balance sheet, the assets are shown on the basis of "Continuing entity concept." Thus, it that business has relatively longer life and will continue to exist indefinitely, hence the asset values are 'going concern values.' The 'realisable value' of each asset, if sold today can not be known by studying the balance sheet.
Accounting is still in the process of evolution. Accounting has grown with the rapid growth of business. To meet the changing requirements of the business world, accountants have also discovered various specialised branches of accounting. The important branches of accountancy are given below:
1. Financial Accounting. It is concerned with the recording of transactions in financial books in order to find out the trading results in terms of profit or loss and financial position of the business, for a given period of time. The accounting which leads to the preparation of final accounts is called financial accounting. It is used by the proprietor, creditors, investors, employees, management, government, etc.
2. Cost Accounting. It is concerned with classification, recording, allocation and summarisation of current and budgeted cost. The object of cost accounting is to find out the cost of goods produced or services rendered by a business. It also helps the business in controlling the costs by indicating available losses and wastes.
3. Management Accounting. It is the presentation of accounting information in such a way so as to assist the management in creation of policy and day-to-day operation of an undertaking. Thus, it relates to the use of accounting data collected with the help of financial accounting and cost accounting for the purpose of policy formulation, planning, control and decision making by the management.
Besides the above, there are Government Accounting, Tax Accounting, Human Resource Accounting. Social Accounting and Inflation Accounting in use. In this book, we are concerned with financial accounting.
Accounting provides information of the business. It is the language of the business. Various parties are interested to collect information about the profitability and state of affairs of the business.
The various users of accounting information and their specific needs are described below:
1. Internal users. Top, middle and lower level executives in the organisations are the internal users of accounting information. Management needs accounting information in (a) selecting out of alternative proposals; (b) controlling, acquisition and maintenance of inventories, cash receipts and payments; (c) planning or budgeting for the future (d) appraising the performance, and (e) devising remedial measures for the deviations of the actual results from the budgeted targets. Top level management is concerned with accounting information for planning and policy making, the middle level is concerned with planning and controlling and bottom level management requires it for operational affairs.
2. External users. External users may have direct or indirect interest in accounting information.
(a) Creditors. The users may be short term creditors (i.e. suppliers of raw materials or finished goods, lenders of temporary advance) or long term creditors (i.e. mortgages, debenture holders etc). Although, both are interested in the stability and earnings of the debtor firm, yet the short term creditors look to its short-term solvency i.e. liquidity position whereas the long term creditors are interested in the long term solvency of the firm.
(b) Investors. The users of accounting information may be present or potential investors. Present investors (owners/equity shareholders) need accounting information to judge prospects of their investment and to determine whether they should buy more shares, hold or sell the earlier shares in hand. Potential investors (i.e. those who want to invest) want to be sure before investment that their capital will be safe and periodic return will be received from the company. The accounting information makes it possible.
(c) Employees. They are interested in the account books due to bonus schemes and security of their employment. Account books provide information to the employees regarding the profits earned by the business. On the basis of profits, employees demand bonus from their employer. They are also eager to assess the ability of the enterprise to pay salary and retirement benefits. A sound and stable organisation means that their future career is safe in the organisation.
(d) Tax authorities. Tax authorities whether income tax, value added tax, wealth tax or any other tax, they need information to assess the tax liability of the enterprise.
(e) Consumers. Price increase is disfavoured in almost all the quarters. Accordingly, a producer endeavours to reduce his product cost as also its selling price. Consumers are interested in the accounting information with which an idea of price structure can be made. Recently, consumer protection associations have been formed to exercise control on the business and industry and also to make them aware of the 'social responsibility' towards society for which they require accounting information.
(f) Foreign entrepreneurs. Fast means of communication and transport have made the whole world as one market. Foreigners are interested in the accounting information for export, import and collaborations with companies of other countries.
(a) Regulatory agencies. Governments and their agencies regulate the functioning of various forms of business. Company Law Board, Registrar of Companies, Ministry of Labour, Ministry of Industries, Central Statistical Organisation, SEBI, etc. play different roles directly or indirectly in the performance of various activities. They need information about the business from different point of view.
(b) Public. Public may be interested in the financial information of the institutions with which they come in contact in their routine life e.g. bank, public utilities such as gas, electricity, transport companies, profit making or non-profit enterprises may make a substantial contribution to the local economy in many ways including the number of people, they employ. Accounting information indicates the trends and recent developments in the prosperity of the enterprise and its impact on the general public.
(c) Researchers. The financial statements, being a mirror of business conditions, are of immense value for research into business affars. These statements are, therefore, of great interest to scholars undertaking research in accounting theory as well as business affairs and practices.
(d) Print and electronic media. The newspapers and various T.V. channels related to economics and finance need information for publishing/telecast the achievements, performance, and problems of companies. Accounting provides the required information to such newspapers.
In every discipline, there are certain basic terms commonly used to understand a particular subject. In accounting also, there are certain basic accounting terms to understand and record the items in books of accounts. These terms have specific meaning in accounting. The basic terms used are called accounting terminology.
1. Business Transaction
Any exchange (dealing) of goods or services for cash or on credit by the business with any other person is a business transaction. Transaction is an economic activity of the business that changes the values of some assets, liabilities or capital.
The important features of a business transaction are:
(i) Economic activity. e.g. purchase of goods; receiving cash or cheque from debtors, etc. whereas inviting a friend on dinner is not economic but social activity.
(ii) External or internal. External transactions involve exchange or transfer of values between two parties whereas internal transaction like depreciation of the asset does not involve two parties.
(iii) Quantitative or qualitative. Purchase of goods or assets for cash is a quantitative change whereas depreciation of asset is a qualitative change.
(iv) Financial in nature. Death of a debtor and consequent loss due to non recovery of debt is financial change and hence a business transaction but death of an efficient employee is non- monetary loss, thus, not a financial transaction.
Account is a date-wise summary of transactions relating to persons, property or expenses and incomes. It has two sides. Left hand side of the account is called debit side and right hand side is called credit side. The transactions of similar nature are recorded at one place which is called an 'account'.
An 'account' is abbreviated as A/c. This abbreviation may be used any where in place of its full form except at the top of the account.
It may be classified as follows:
(A) Personal Accounts. The accounts of the persons with whom various transactions are entered into, such as credit sale, credit purchase, sales return, purchases return, cash or cheques received and issued are known as personal accounts. The personal accounts are further classified as:
(i) Natural personal accounts. The accounts of the persons made of flesh and bones are called as natural person's account e.g. Malika's Account, Abhishek's account, Khushwant's account. etc.
(ii) Artificial personal accounts. The persons are not made of flesh and bones but treated as persons in the eyes of law. They can sue and be sued for their omissions and commissions e.g. companies, banks, co-operative society, trust, etc.
(iii) Representative personal accounts. The accounts prepared to represent natural or artificial persons are called representative personal accounts. These are prepared for the convenience of recording of the transactions. One particular account may represent hundred or thousands of persons e.g. any expense outstanding, expense prepaid, income accrued (due but not received), income received in advance account. Salary due account will represent the salary amount still payable to the staff members.
(B) Impersonal Accounts. The accounts which do not relate to the persons are called impersonal accounts. They are further classified as:
(i) Real accounts. The accounts relating to the property of the business are called real accounts. The real account may be sub-divided as:
(a) Tangible real accounts. These are the accounts of the properties which can be touched and seen e.g. land, building, plant, furniture, vehicles, etc.
(b) Intangible real accounts. The accounts of the properties which cannot be touched or seen but can be felt or used as a right e.g. Goodwill (reputation of the business), Patent right (right of invention), Copyright (right of publications or music compositions), etc.
(ii) Nominal accounts. The accounts of expenses, losses, incomes or gains are known as nominal accounts e.g. rent account, loss by theft account, interest received account, profit on sales account, etc.
1. The traditional classification of accounts into personal, real and nominal is rigid to some extent. Some accounts may be treated as both real and personal e.g. Prepaid Rent Account, Interest Accrued (due but not received) Account or Bank Account. Similarly, some accounts may be treated as both real and nominal e.g. stationery, postage, purchase etc. Purchases of stationery is a real account, consumption of stationery is a nominal account. Purchase of postal stamps is a real account, consumption of stamps is a nominal account. Even the purchases account is a unique account. In a perpetual system of accounting, purchases account is not opened. It is stock account. Purchase of goods increases the stock and sale of goods decreases the stock.
In a periodic system of accounting, purchases account is opened through out the year but at the end of the year, it has to be segregated into two parts i.e. part of goods sold and part of goods unsold. Part of goods sold (i.e. cost of goods sold) is a nominal account and part of goods unsold (i.e. closing stock) is a real account.
2. The classification of accounts into personal, real and nominal makes the treatement of some of the accounts inconvenient. The 'valuation accounts' or 'contra accounts' can not be conveniently put under any of three categories. A valuation account is always accompanied with an asset account. It is opened to depict the time value of the asset account without reducing it e.g. provision for bad debts, provision for discount on debtors or provision for depreciation. In order to retain the original value of the debtors for true amount due, provision for doubtful debts or provision for discount on debtors are maintained to show the estimated realizable value of debtors in the balance sheet. Similarly, in order to record the fixed asset at its original cost, the provision for depreciation account may be maintained to show the book value of the asset.
Provision for bad debts, provision for discount on debtors, provision for depreciation accounts are also called contra accounts. Other contra accounts are purchases return account and sales return account. Purchases return account is contra to purchases account and sales return account is contra to sales account.
3. Capital
It is the amount invested by the proprietor into business. It may be in cash or in kind. Capital is increased with the amount of profits and is decreased with the amount of losses and drawings.
It can also be calculated by deducting the outside liabilities from the total assets.
It is the amount or benefit withdrawn by the owner from the business for personal or domestic use. It may be in the form of cash, goods or assets. Any personal payment out of the business assets is also called drawings.
Example. Sukhmani started business with cash 50,000 and own furniture 10,000. After some time, she withdrew 3,000 from business for her personal use.
In this case, Sukhmani is the proprietor of business. Cash 50,000 and furniture 10,000 introduced by the owner in the business represents capital, so capital in this case is 60,000. Withdrawl of 3,000 made from the business for personal use is the drawings.
5. Liability
It refers to an amount owing by one person to another payable in money, goods or services. In general, liabilities are financial obligations to outside parties arising from events that have already happened.
"An amount owing by one person (a debtor) to another (a creditor), payable in money, or in goods or services." -Eric. L. Kohler
"In general, liabilities are obligations to outside parties arising from events that have already happened." -R.N. Anthony & J.S. Reece
Thus, liability is the amount which arises as a result of purchase of goods or services from others on credit and through cash borrowings to finance the business.
Out of the total property of the business, the finance raised from the source other than the owner is called liability.
(i) Internal Liabilities. In accounting, business man and business enterprise are treated as separate entities. The amount owed by the business enterprise to the owners are internal liabilities, such as capital and profits.
Liabilities may further by classified as follows:
(i) Long term liabilities. The liabilities which are payable in a relatively longer period (normally, after a period of one year) are called long term liabilities. These are also known as fixed liabilities. For example, long term loans, public deposits, debentures etc.
(ii) Short term liabilities. It refers to those liabilities which fall due for payment in a relatively short period (normally, within one year). These are also known as current liabilities. For example, creditors, short term loans, outstanding expenses etc.
(iii) Contingent liabilities. It refers to the amounts which may or may not become payable in future. Future events may decide whether it is really a liability or not. Due to their known as contingent liabilities. For example, financial cases pending uncertainty, these are against the business in the court of law; guarantees given on behalf of others, etc. The expected value of contingent liabilities is either shown as a foot note (i.e. outside the balance sheet) or in the inner column only the liability side of the balance sheet. The accounting convention of 'full disclosure' requires this liability to be shown like this.
6. Asset
An asset is any owned physical object (tangible) or right (intangible), having a money value. In other words, assets are economic resources which are owned by a business and from which future economic benefits are expected to flow to the enterprise.
"Assets are economic resources which are owned by a business and expected to benefit future operations." -W.B. Meigs and R.F.Meigs
"An asset is any physical object (tangible) or right (intangible) having a money value...." -Eric. L. Kohler
"Assets are things of value to be included in its balance sheet, the business must have acquired the right to use or control the asset for the benefit of business." -Finnery and Miller
Cash, Debtors, Investments, Stock of goods, Plant and Machinery, Land & Building, Computers, Vehicles, Goodwill, etc. are the examples of assets.
These assets may have the value for the business for several reasons; for instance:
These assets may broadly be classified as follows:
(b) Current Assets. Current assets are those assets which are held :
(i) in the form of cash;
(ii) for their conversion into cash, as early as possible (usually within one year), and
(iii) for their consumption in the production of goods.
For Example. Cash in hand, Cash at bank, Short term Investments, Short term Advances. The difference of the liquid assets from the current assets can be judged from the following line:
All liquid assets are current assets but all current assets may not be liquid.
(c) Fictitious Assets. It refers to those assets which do not have any physical form and have no realisable value. Such assets can not be converted into cash. These are shown as assets because of their non-recurring nature. All non-recurring payments are shown as assets.
For example, expenses incurred before the formation of company (called preliminary expenses), 'expenses on issue of shares or debentures' by the companies, discount on shares or debentures, etc.
For example, Cash in hand, Cash at bank, Stock of finished goods, Debtors, Bills Receivable, Stock of raw materials, etc.
Liquid assets is a varied form of current assets. Liquid assets are those assets which are in cash form or can be easily convertible into cash in a very short period.
The business enterprise may have financial inflows in the business from different sources. These sources may be recurring or non-recurring. There is a need to make proper distinction between such inflows. These are classified into two parts:
(i) Capital Receipts. Capital receipts consist of non-recurring receipts into the business which are shown on the liability side of the balance sheet or as a reduction in the value of assets. These receipts may arise in the business on account of :
Expenditure is the amount incurred for recurring or non-recurring business transactions. Any payment made for the receipt of the benefit is called expenditure. The non-recurring payment may be for the purchase of assets or for improving the quality of fixed assets. The recurring payment may be for acquiring the goods or services or other routine expenses. Expenditure may be classified into three categories: (i) Capital expenditure (ii) Revenue expenditure and (iii) Deferred revenue expenditure.
(i) Capital Expenditure. The payment made for the purchase of assets from which the benefit will be derived in future is called capital expenditure. It is a non-recurring payment for the purchase of land and building, machinery, vehicles, computers, etc. for the business. Capital expenditure increases the earning capacity of the business.
"Capital expenditure may be described as outlay resulting in the increases or acquisition of asset or increase in the earning capacity of a business." -William Pickles
(ii) Revenue Expenditure. The amount incurred for the purchase of goods or services which are consumed during the current period is called revenue expenditure. This is the expense incurred for meeting day to day expenses. All the payments of recurring nature, such as salaries, rent, insurance, carriage, freight, advertisement etc. are known as expense or revenue expenditure.
"Revenue expenditure is the expenditure on purchasing items which are used, directly or indirectly, to produce revenue in the current accounting period."
(iii) Deferred Revenue Expenditure. A heavy expenditure of revenue nature incurred, having the effect of generating income over a number of years is classified as deferred revenue expenditure. This expenditure is temporarily capitalised and spread equally over the number of years for which the benefit is anticipated. For instance, a heavy expenditure on advertisement may be incurred at the time of launching a new product in the market or for boosting the sales level. Such expenditure may be deferred for the next four or five years.
"Deferred Revenue Expenditures are those non-recurring expenses which are expected to be of financial nature distributed to several accounting periods of indeterminate total length". -Johnson, A.W.
Expense is that portion of the expenditure which has been consumed during the current accounting period to earn revenue. Since expenses are the cost of goods and services used up. they are also called expired cost. Examples include salaries paid, postage, advertisement, depreciation on assets.
The excess of revenue over expenses is called income. If goods costing 80,000 are sold for 1,00,000, the sale proceeds of 1,00,000 is the revenue; cost of goods sold 80,000 is the expense and revenue minus cost of goods sold 20,000 is the income. The income is expressed as:
11. Profit
The excess of total revenues over total expenses of a business enterprise for an accounting period is called profit. Profit Increases the owner's equity.
12. Gain
It is a profit of irregular nature resulting from the transactions or events incidental to the business such as sale of fixed assets or investments. The gain may be classified as short term or long term depending upon the period for which an asset or investment is held in the business. For example, if a machinery costing 45,000, is sold for 60,000 there is gain of Rs 15,000 on the sale of machinery.
13. Loss
Loss is an unwanted burden on the business, which does not generate any revenue for the business. It may be classified as normal loss and abnormal loss. Normal loss arises due to inherent nature of the product, such as evaporation, leakage, shrinkage, loss of weight, etc. On the other hand, abnormal loss is the result of some mishappening, such as fire, theft, earthquake, flood, storm, etc. The excess of expenses or revenues is also termed as loss. Loss always decreases owner's equity.
14. Goods
It implies all those articles which have been purchased by the enterprise for sale in the usual course of business. It also includes raw material purchased for further processing. For example, furniture purchased is goods for furniture dealer; cars purchased are goods for car dealer but furniture or cars purchased by cloth merchant or fan manufacturer are assets for them because these items are not meant for resale in the ordinary course of business.
15. Purchases
The purchase of raw materials for production or purchase of finished goods for sale is called as "purchases". The term 'purchase' is used for the purchase of goods and not for the purchase of assets. When asset is purchased, asset account is opened.
16. Sales
For the sale of finished of goods, the term 'sales' is used. It may be cash sales or credit sales. When an asset is sold, the asset account is credited and not the sales account. When goods are sold at a discount, sales is credited with net amount i.e. after deducting trade discount.
17. Purchases Return or Returns Outward
It is that part of the goods purchased, which is returned to the seller. The reason of return may be supply of defective goods, goods not as per specifications or any other reason. In order to calculate net purchases of business, purchase return is deducted from purchases. Purchases return is also known as 'Returns Outward' because the goods are going out from the business to the suppliers.
18. Sales Return or Returns Inward
It is that part of the goods sold, which is returned by the customer to us. The reason of return may be excessive, unspecified or supply of defective goods, etc. In order to calculate net sales of the business, sales return is deducted from sales. Sales return is also known as 'Returns Inward' because the goods are coming back in the business from the customers.
Example. Malika sold goods to Isha for 60,000, of which the latter returned goods to former for 8,000. For Malika, sales is of 60,000; sales return is 8,000 and net sales 52,000 (i.e. 760,000 8,000). For Isha, purchase is of 60,000; purchases return 8,000 and net purchases 52,000.
19. Stock
The goods left unsold at the end of the accounting period is called closing stock. The stock may be of raw material, work-in-progress or finished goods. The closing stock of one accounting period will become the opening stock of the next accounting period.
20. Debtor
The person from whom amounts are due for goods sold or services rendered or in respect of contractual obligations is called debtor. The debtors are collectively called 'Sundry Debtors' or Total Debtors'. The total amount due from sundry debtors is called 'Book Debts'.
21. Creditor
The person to whom amount is owed by the enterprise on account of goods purchased or services rendered or in respect of contractual obligations is called creditor. The creditors are collectively called 'Sundry Creditors' or Total Creditors' or Trade Creditors'.
Example. Reddy sold goods to Chatterjee for 40,000 on two months' credit.
It is a credit transaction. For the business of Reddy, Chatterjee is a debtor because he owes * 40,000 to Reddy on account of goods sold to him. For the business of Chatterjee, Reddy is a creditor because Chatterjee owes 40,000 to him on account of goods purchased.
22. Receivables
It means the amount which outsiders owe to the business on revenue accounts. When goods are sold on credit to customers, they may accept bills drawn by the seller (creditor). These bills of exchange for a creditor is known as Bills Receivable. These are realisable within a year and are part of current assets. The total of debtors and bills receivable is known as 'Accounts Receivables.'
23. Payables
It means the amount which business owes to outsiders on revenue accounts. When goods are purchased on credit from suppliers, the customer may accept bills drawn by the seller. These bills of exchange for a customer is known as Bills Payable. These are payable within a year and are part of current liabilities. The total of creditors and bills payable is known as 'Accounts Payable'.
Example. Sharma sold goods on credit to Khan. Sharma draws a bill on Khan for the amount due, which was duly accepted by Khan. Sharma will record this bill of exchange as 'Bills Receivable' in his books and Khan as 'Bills Payable'. For Sharma, it is an asset and for Khan, it is a liability to be paid in a specified short period.
24. Cost
The amount spent for the purchase of goods or services is called cost. The amount spent may be actual or notional. The amount incurred to purchase the raw material or finished goods is the actual cost. In order to calculate the real cost of production, the rent of own building is also included which is notional cost.
25. Voucher
The document prepared for the purpose of recording business transactions in the books of accounts are known as vouchers. Source documents are the basis for recording on vouchers. Source document is an evidence of the transaction where as voucher is a document of correct recording of a transaction in the books of original entry.
26. Discount
The reduction in the price or payment of goods allowed by business enterprise to its customers is called discount. Discount is classified as :
(i) Trade Discount. The reduction in the list or catalogue price allowed by a seller to a customer is called trade discount. It is deducted in the invoice or cash memo from the gross sale proceeds. The trade discount is not recorded in the books of buyer or seller as the transaction is recorded with net sale proceeds i.e. Gross sale proceeds less trade discount.
(ii) Cash discount. The reduction allowed by a creditor to his debtor for making the quick payment of the amount due is called cash discount. Cash discount is recorded in the books of creditor and debtor. It is an expense for the creditor and income for the debtor.
Other Important Accounting Terms
27. Proprietor
The proprietor who takes the initiative to start the business, invests his money or money's worth and bears the risk of the business is called proprietor.
28. Debit and Credit
The left-hand side of any account is arbitrarily called debit side, and the right-hand side is called credit side. The words debit and credit have no other meaning in accounting.
Debit is abbreviated as Dr. and Credit as Cr. in accounting. The word debit is derived from the latin word debitur which means debtor. Credit is derived from the latin word creder which means lender. Apparently, the abbreviations Dr. and Cr. are taken from the first and last letters of these latin words. In accounting, debit and credit do not mean debtor and creditor.
29. Equity
In broad sense, the term equity refers to all claims or rights against the assets of the enterprise. For every asset of the business, some one has paid for it or the amount is payable to someone for this. The amount payable to such persons is called equity. It is further divided into two categories: (i) Owners' equity and (ii) Outsiders' equity.
Owners' equity is called capital and outsiders'/creditors' equity is called liabilities.
The dictionary meaning of word merchandise is the commodities or goods that are bought and sold in business. The merchandising cost (cost of goods sold) in a trading business is arrived at as follows:
Gross profit or gross income may be described as the excess of amount of sales over cost of goods sold. Every business enterprise adds the profit margin while selling the goods. If in an item purchased for 3.000, the profit added is 500 to sell the product at 3,500, this addition of 500 is a gross profit. Thus, in the above case:
Rs
Sales 1,30,000
Less: Cost of Goods Sold 1.00.000
Gross prof 30.000
While ascertaining cost of goods sold, only those expenses are considered which are incurred on the purchase and production of goods. There are number of other expenses like rent, salaries. stationery, electricity, telephone and so on which are required to carry on the business. Such expenses which are needed to conduct business are known as 'indirect expenses'. These may be grouped under (i) Selling and distribution expenses (e.g., salesmen's salary, commission ; carriage on sales, packing expenses etc.); (ii) Administrative expenses (e.g., salaries of office staff. insurance, legal expenses, audit fee etc.); (iii) Financial expenses (e.g., discount, interest etc.) and (iv) Maintenance expenses (e.g., repairs, depreciation etc).
1. Luca Pacioli of Italy also known as Friar Luca dal Borgo published a book in 1494 containing a chapter on double entry system of book-keeping.
.jpg)
