Theoretical concept of book-keeping & accounting

One difference: capital expenditure is incurred to acquire or improve a fixed asset and gives benefit for more than one accounting period, so it is shown in the balance sheet (for example, purchase of machinery). Revenue expenditure is incurred to run the business and gives benefit only in the current period, so it is charged to the profit and loss account (for example, rent or salary).

Accounting is the art of identifying, measuring, recording, classifying, summarizing, interpreting and communicating the financial information of a business to its users so that they can make informed decisions.

The business entity concept states that a business is a separate legal and accounting unit, distinct from its owner. The transactions of the business are recorded from the business's point of view, and the owner's private affairs are kept apart. For example, when the owner invests capital, the business shows it as a liability (capital) to the owner.

Accounting equation: $\text{Assets} = \text{Liabilities} + \text{Capital}$. Assumptions: the salary in (iii) is paid in cash and the goods in (iv) are sold for cash.

Check: Assets $= 2{,}20{,}000 + 7{,}00{,}000 + 10{,}000 = \text{Rs } 9{,}30{,}000$ and Liabilities + Capital $= 20{,}000 + 9{,}10{,}000 = \text{Rs } 9{,}30{,}000$.

Accounting equation: $\text{Assets} = \text{Liabilities} + \text{Capital}$.

Working notes: in (iii) the cost of the goods sold is not given, so it is assumed that the goods purchased in (ii), costing Rs 50,000, are sold for Rs 1,50,000, giving a profit of Rs 1,00,000 that increases capital. In (iv) wages reduce both cash and capital.

Check: Assets $= \text{Rs } 5{,}80{,}000$ and Liabilities + Capital $= 50{,}000 + 5{,}30{,}000 = \text{Rs } 5{,}80{,}000$. The equation balances.

Accounting equation: $\text{Assets} = \text{Liabilities} + \text{Capital}$. Assumption: the selling price in (iii) is not given, so the goods costing Rs 50,000 are taken as sold for Rs 50,000 cash (no profit or loss).

Check: Assets $= 1{,}48{,}000 + 2{,}90{,}000 + 50{,}000 + 50{,}000 = \text{Rs } 5{,}38{,}000$ and Liabilities + Capital $= 1{,}00{,}000 + 4{,}38{,}000 = \text{Rs } 5{,}38{,}000$.

Accounting Process

The accounting process (also called the accounting cycle) is the systematic sequence of steps followed to record, classify, summarise and communicate financial information of a business. It begins with the occurrence of a financial transaction and ends with the preparation of financial statements. The steps are:

1. Identification of transactions: First, all events are examined to find out which of them are financial transactions — that is, events that can be measured in money and that change the financial position of the business. Only such transactions are recorded; non-financial events are ignored.

2. Recording in journal (Journalising): Each transaction is recorded chronologically in the journal, with the date, accounts affected, amounts, and a brief narration. The rules of debit and credit are applied here. This is the book of original entry.

3. Posting to ledger: The journal entries are then transferred to the appropriate accounts in the ledger. The ledger is the principal book, where each account (Cash, Sales, Capital, etc.) is maintained separately. This step classifies the transactions account-wise.

4. Preparation of trial balance: At the end of the period, the debit and credit balances of all ledger accounts are listed in a statement called the trial balance. If the two totals agree, it gives reasonable assurance that the books are arithmetically accurate.

5. Preparation of final accounts: Finally, the trial balance is used to prepare the Trading Account (to find gross profit or loss), the Profit and Loss Account (to find net profit or loss), and the Balance Sheet (to show the financial position on a particular date).

6. Closing and communication: The nominal accounts are closed, the real and personal accounts are carried forward, and the results are communicated to owners, creditors, investors and the government through financial statements.

In short, the process moves from recording → classifying → summarising → communicating financial data.

Four Branches of Accounting

1. Financial Accounting: Recording business transactions and preparing Trading, Profit and Loss Account and Balance Sheet to show profit or loss and financial position.

2. Cost Accounting: Ascertaining and controlling the cost of production or services by analysing materials, labour and overhead costs.

3. Management Accounting: Providing accounting information to management for planning, decision-making and control.

4. Tax Accounting: Maintaining accounts and preparing returns relating to income tax, VAT and other taxes as required by law.

(Other accepted branches: Government Accounting, Social Accounting, Human Resource Accounting, Inflation Accounting.)

Book-keeping is the art and science of identifying, measuring and recording the financial transactions of a business in a systematic and chronological manner in the books of account, such as the journal and the ledger. It is the first and basic stage of accounting.

The money measurement concept states that only those transactions and events that can be expressed in terms of money are recorded in the books of account. For example, a purchase of furniture for Rs 50,000 is recorded, but the skill of the manager or the loyalty of employees is not, because it cannot be measured in money.

The accounting equation is $\text{Assets} = \text{Liabilities} + \text{Capital}$.

Working notes: in (b) goods are bought for Rs 80,000 cash and Rs 70,000 on credit; in (c) rent reduces both cash and capital; in (d) goods costing Rs 20,000 are sold for Rs 25,000, so stock falls by Rs 20,000, cash rises by Rs 25,000 and capital rises by the profit of Rs 5,000.

Check: Assets $= 55{,}000 + 1{,}30{,}000 + 5{,}00{,}000 = \text{Rs } 6{,}85{,}000$ and Liabilities + Capital $= 70{,}000 + 6{,}15{,}000 = \text{Rs } 6{,}85{,}000$. The equation balances.

Accounting equation: $\text{Assets} = \text{Liabilities} + \text{Capital}$. Assumptions: the goods in (iii) are sold for cash and the salary in (iv) is paid in cash.

Check: assets $= 47{,}000 + 50{,}000 + 10{,}000 = \text{Rs } 1{,}07{,}000$ and liabilities + capital $= 20{,}000 + 87{,}000 = \text{Rs } 1{,}07{,}000$.

Objectives of Accounting

Accounting is the process of identifying, recording, classifying and summarising financial transactions, and communicating the results to users. Its main objectives are:

1. To keep a systematic record of transactions Accounting keeps a complete, orderly and permanent record of all financial transactions of a business in the books of account (journal, ledger, etc.). This record can be used at any time to know what the business did on a particular date. Without such a record, transactions would be forgotten and business could not be managed properly.

2. To ascertain profit or loss Accounting helps to find out the net result of business operations for a given period. A Trading and Profit and Loss Account is prepared to compare revenues with expenses. If revenue exceeds expenses, there is profit; if expenses exceed revenue, there is loss. This helps the owner to judge the efficiency of the business.

3. To ascertain the financial position Accounting shows the financial position of the business on a particular date through the Balance Sheet. It lists assets, liabilities and capital, and thus reveals what the business owns and what it owes. This helps in judging the solvency and stability of the business.

4. To provide information to various users Accounting supplies useful financial information to different parties — owners, managers, creditors, banks, investors, employees and the government. Each user takes decisions on the basis of this information, such as granting loans, investing money, or fixing tax liability.

5. To assist management in planning and decision-making Accounting provides cost and revenue data that help management in planning, budgeting, controlling operations and taking important decisions like expansion, price fixation or discontinuing a product. It also helps in comparing actual performance with plans and taking corrective action.

Other objectives (any of these may also be mentioned):

• To help in the settlement of tax liability.
• To prevent errors and frauds through proper recording and internal check.
• To help in the valuation of the business at the time of sale or purchase.

Three objectives of book-keeping are:

1. To keep a systematic and permanent record. All financial transactions are recorded in the books in an orderly, chronological way. This removes dependence on memory and gives a permanent record for future reference.

2. To know the profit or loss. Complete records of income and expenses allow the business to prepare a profit and loss account and find the result of operations for a period.

3. To know the financial position. Records of assets, liabilities and capital make it possible to prepare a balance sheet that shows what the business owns and owes on a given date.

Other objectives include providing information to owners, creditors, banks and the tax authority, and helping in the detection and prevention of errors and fraud.

Business entity concept: The business is treated as a separate unit, distinct from its owner. Only the transactions of the business are recorded in its books, and the owner's personal affairs are kept out. The capital put in by the owner is treated as a liability of the business to the owner, and anything he takes out is recorded as drawings.

Going concern concept: The business is assumed to continue for an indefinite period in the future, with no intention or need to close down or reduce its scale significantly. Because of this, assets are recorded at cost and depreciated over their useful lives instead of being valued at their sale value, and prepaid and outstanding items are carried forward to later periods.

Accounting is the process of identifying, measuring, recording, classifying, summarizing and communicating the financial information of an organization to its users so that they can make informed decisions. One function of accounting is to keep a systematic record of all financial transactions, so that the profit or loss and the financial position of the business can be known.

Two purposes of keeping accounting records are:

1. To find the profit or loss of the business for a period, by preparing the trading and profit and loss accounts.
2. To know the financial position of the business, that is, its assets, liabilities and capital, through the balance sheet.

A liability is a present obligation of a business arising from past transactions or events, the settlement of which is expected to result in an outflow of economic resources (money or other benefits) from the business. Examples are creditors, bank loan and outstanding expenses.

From the accounting equation:

$\text{Assets} = \text{Liabilities} + \text{Capital}$

$\text{Liabilities} = 5{,}00{,}000 - 3{,}50{,}000 = \text{Rs } 1{,}50{,}000$

One feature of accounting is that it records only those transactions and events that can be expressed in terms of money. Other features include that it is a systematic process, and that it provides financial information to users for decision making.

Cash basis accounting is a method in which incomes and expenses are recorded only when cash is actually received or paid, regardless of the period to which they relate. Credit transactions, outstanding and prepaid items are not recognised until cash is settled.

GAAP stands for Generally Accepted Accounting Principles.

Meaning of GAAP

GAAP (Generally Accepted Accounting Principles) is the set of rules, concepts, conventions and standards that accountants follow while recording transactions and preparing financial statements. These rules are accepted by the accounting profession and by law, so that financial statements are uniform, reliable and comparable.

Features of GAAP

1. Generally accepted: GAAP is accepted by accountants, professional bodies, regulators and users of accounts.
2. Uniformity: the same rules are applied by all businesses, so statements follow a common standard.
3. Comparability: because of uniform rules, the accounts of different firms, or of the same firm in different years, can be compared.
4. Reliability and objectivity: records are based on documents and verifiable evidence, which reduces personal bias.
5. Transparency and full disclosure: all material information is disclosed so that users get a true and fair view.
6. Consistency: the same accounting policies are followed from one period to the next.
7. Based on concepts, conventions and standards: GAAP includes concepts such as going concern, accrual, matching and money measurement, along with accounting standards.
8. Evolving in nature: GAAP changes with law, business practice and the issue of new accounting standards.

Accounting is divided into branches according to the purpose it serves.

1. Financial accounting: records business transactions in the books of account and prepares the final accounts (trading account, profit and loss account and balance sheet) to show the profit or loss and financial position. It serves owners, creditors, banks, tax authorities and other external users.
2. Cost accounting: records, classifies and analyses the cost of producing goods or providing services. It helps to find the cost per unit, control costs and fix selling prices.
3. Management accounting: supplies financial and non-financial information, such as budgets, forecasts and variance reports, to the management for planning, controlling and decision making.
4. Auditing: the independent examination of the books and accounts by a qualified auditor, to check that the statements show a true and fair view.
5. Tax accounting: deals with computing income and preparing returns according to tax laws such as income tax and VAT.
6. Social responsibility accounting: measures and reports the social and environmental effects of business activities, such as pollution and employment.

Of these, financial, cost and management accounting are the three main branches.

Accounting equation: $\text{Assets} = \text{Liabilities} + \text{Capital}$. Assumptions: the balance of the machinery price is payable on credit, and the salary is paid in cash.

Check: Assets $= 80{,}000 + 80{,}000 = \text{Rs } 1{,}60{,}000$ and Liabilities + Capital $= 30{,}000 + 1{,}30{,}000 = \text{Rs } 1{,}60{,}000$.

(b) The art of recording financial transactions in a systematic manner in the books of accounts

Book-keeping is limited to the recording of financial transactions in a systematic manner in the books of accounts. Classifying and summarizing, interpreting results (option a) and preparing final accounts (option d) belong to accounting, while auditing (option c) is a separate function.

Distinction between Book-keeping and Accounting

(Any five bases may be written.)