STUDY
MATERIAL - THEORY
Accounting – Journal
, Ledger, Trial Balance, Final Accounts
Book-Keeping:
“Book-Keeping
is the art of recording business transactions in a systematic manner”.
Advantages of Book-Keeping:
1.
Reliable Record.
2.
Calculation of profit or loss
3.
Calculation of Dues.
4.
Control over borrowings.
5.
Control over assets.
6.
Ascertainment of the
growth of business.
7.
Ascertainment of the
financial position.
8.
Identifying Do’s and
Don’ts.
9.
Fixing the selling price.
10. Taxation.
Definition of Accounting:
“The
art of recording, classifying and summarising in a significant manner in terms
of money transactions and events which in part, at least of a financial
character and interpreting the results thereof”.
Objects of Accounting:
1. To ascertain whether the business
operations have been profitable or not.
Accounting helps us to know whether a business has earned profit or
suffered loss during the accounting period.
It will give us an idea of efficiency of the business. To determine profit or loss of the accounting
period, a Trading and Profit and Loss
Account or an Income Statement is prepared by matching revenues an expired
costs (i.e., revenue expenditures) incurred for earning the revenue.
2. To ascertain the financial position of
business.
Balance Sheet or Position Statement is prepared to give an idea of the
financial position of the business on a particular date. The financial position of an enterprise is
indicated by its assets on a given date and its liabilities on that date. Excess of assets over liabilities represent
the capital and is indicative of the financial soundness of an enterprise.
3. To generate such information from
accounting records which may be helpful to various persons in planning,
control, evaluation of performance and decision-making.
Functions of Accounting:
The
main functions of accounting are:
1.Systematic record of business
transaction: To keep systematic record of business transactions, post them to
the ledger and ultimately to prepare the final accounts is the first main
function of accounting.
2.Protecting the property of the business: For performing this
function the accountant is required to devise such a system of recording
information so that assets of the business are not put to wrong use and a
complete record of the assets of the concern is available without any
difficulty.
3.Communicating results to interested
parties: This function requires to supply
the meaningful information about the financial activities of the business to
the various parties i.e. owner, creditors, investors, employees, government,
public, research scholars and the managers at the right time.
4.Compliance with legal requirements: The accounting system much
be such which may be able to comply with the legal requirements. Under various enactments a businessman in
required to file various statements e.g. income tax return, return for sale tax
purpose etc.
Importance of Accounting:
The
importance of accounting is to provide meaningful information about a business
enterprise to those persons who are directly or indirectly interested in the
performance and financial position of a business enterprise. Such persons may include owners, creditors,
investors, employees, government, public, research scholars and the managers.
1.Owners: The owners of a business furnish capital to
be used for the purpose of business.
They are interested to know either the business has earned a profit or
loss during a particular period and also its financial position on a particular
date. They want accounting reports in
order to have an appraisal of past performance and also for an assessment of future prospects.
2.Creditors: The creditors include
supplier of goods and supplies, bankers and other lenders of money. They are interested in the financial
stability of the concern before making loans or granting credit. They look to the ability of the business to
pay interest and amount as and when it becomes due for payment. They also look to the trends of earnings as
it ultimately affects the solvency of a concern.
3.Investors: Investors look not only the earning capacity of business but also
its financial strength and solvency before deciding whether to subscribe or not
for the shares in a Company. They are
interested in steady and good return on their capital, the safety of their
capital and appreciation in the value of the shares.
4.Employees: Employees are interested
in earning capital of a concern as their salaries, bonus and pension schemes
are dependent on this factor. They have
a permanent stake in the business and in order to have an assurance of steady
employment they are very much interested in the stability of the organisation.
5.Government: Government is interested
in accounting statements and report in order to see the performance of a
particular unit, its cost structure and income in order to impose tax and
excise duty.
6.Public: The public as consumers is interested in
accounting statements in order to know whether control is exercised on
production, selling and distribution expenses in order to reduce the prices of
goods they buy. They can also judge
whether the economic resources of the concern are being utilised for the
benefit of the common man or not.
7.Research Scholar: Such persons are
interested in accounting statements and reports in order to get data for
proving their thesis on which they are working and hence to complete their
research projects.
8.Managers:
The management of a enterprise need accounting information of planning,
control, evaluation of performance and decision-making. Their main responsibility is to operate the
business so as to obtain maximum return on capital employed without causing any
harm to the interest of the shareholders.
The manager would like to have data relating to sales. Output and expenses
etc. Relating to next year and also the
flow of cash for the purpose of planning the activities of a business. He is also faced with such a situation where
various alternatives are available and he is to decide as to what alternative
is the best. He is also required to plan
and see that the cost incurred is reasonable.
All these require relevant accounting information.
Branches of Accounting:
The
following are the main branches of accounting:
1.Financial Accounting: The main purpose of this branch of accounting is to ascertain
profit or loss during a specific period, to show financial position of the
business on a particular date and to
have control over the firm’s property.
Such accounting records are used to impart useful information to
outsides and to meet the legal requirements.
2.Cost Accounting: Its main aim is to
ascertain cost relating to the various activities of the business and to have
cost control. The cost accountant is
required to assemble and interpret cost data for the use of management in
controlling current operations and in planning for the future.
3.Management Accounting: It supplies the management
significant information in order to assist the management to discharge its
various functions such as planning, control, evaluation of performance and
decision making etc.
Advantages of Accounting:
The
following are main advantages of accounting:
1.Replacement of memory: In a large business it is
very difficult for a business-man to remember all the transactions. Accounting provides records which will
furnish information as and when desired and thus it replaces human memory.
2.Evidence in Court: Properly maintained
accounts are often treated as a good evidence in the court to settle a dispute.
3.Settlement of taxation liability: If accounts are properly
maintained, it will be of great assistance to the businessman in settling the
income tax and sale tax liability otherwise tax authorities may impose any
amount of tax which the businessman will have a pay.
4.Compararative study: It provides the facility
of comparative study with the various aspects of the business such as profits,
sales, expenses etc. which that of
previous year and helps the businessman to locate significant factor leading to
the change, if any.
5.Sale
6.Assistance to the insolvent person: If a person is maintaining
proper accounts and unfortunately he becomes insolvent ( i.e. when he is unable
to pay to his creditors), he can explain many things about the past with the
help of accounts and can start a fresh life.
7.Assistance to various parties: It provides information to
various parties, i.e., owners, creditors, investors, government, managers,
research scholars, public and employees and financial position of business
enterprise from their own view point.
Limitations of Accounting:
The
following are the main limitations of accounting:
1.Records only monetary transaction: Accounting records only those transactions which can be
measured in monetary terms. Those
transaction which cannot be measured in monetary terms as conflict between
production manager and marketing manager, efficient management etc., may be
very important for a concern but not recorded in the business books.
2.Effect of price legal changes not
considered: Accounting transaction are recorded at cost in the books. The effect of price level change is not
brought into the books with the result that comparison of the various years
becomes difficult. For example, the
sales to total assets in1998 would be much higher than in 1990 due to rising
prices, fixed assets being shown at cost and not at market price.
3.No realistic information: Accounting information may
not be realistic as accounting statements are prepared by following basic
concepts and conventions. For example,
going concern concept gives us an idea that the business will continue and
assets at to be recorded at cost but the
book value which the asset is showing may not be actually realisable. Similarly, by following the principle of
conservatism the financial statement will not reflect the true position of the
business.
4.Personal bias of Accountant affects the accounting
statements: Accounting statements are influenced by the personal judgement of
the account. He may select any method of
depreciation, valuation of stock, amortisation of fixed assets, treatment of
deferred revenue expenditure. Such
judgement based on integrity and competency of the account will definitely
affect the preparation of accounting statements.
5.Permits alternative treatments: Accounting permits
alternative treatments within generally accepted accounting concepts and
conventions. For example, method of
charging depreciation may be straight line method or diminishing balance method
or some other method. Similarly, closing
stock may be valued by FIFO (First-in-First-Out) or LIFO (Last –in-First-our)
or average price method. Application of
different methods may give different results and results may not be comparable.
6.No real test of managerial performance: Profit earned during an
accounting period is the test of managerial performance. Profit may be show in excess by manipulation
of accounts by supressing such costs as depreciation, advertisement and
research and development or taking excess value of closing stock. Consequently real idea of managerial
performance may not be available by manipulated profit.
7.Historical in nature. Usually accounting
supplies information in the form of Profit and Loss Account and Balance Sheet
at the end of the year. So, the
information provided is of historical interest and only gives post-mortem
analysis of the past accounting information.
For control and planing purposes management is interested in quick and
timely information which is not provided by financial accounting.
Cash Basis of Accounting:
Under
the cash basis of accounting actual cash receipt and actual cash payments are
recorded. Credit transactions are not
recorded at all and are ignored till the cash is actually received or
paid. Income is merely the difference
between the cash receipts and cash payments.
The Receipts and Payments Account prepared in case of non-trading
concerns such as a charitable institution, a club, a school, a college etc. and
professional men like lawyer, doctor, a chartered accountant etc. can be cited
as the best example of cash basis.
Accrual Basis of Accounting:
Accrual
basis of accounting, the income whether received or not but has been earned or
accrued during the period forms past of the total income of that period e.g.,
sales made on credit will be included in the total sales of the period
irrespective of the fact when cash us actually
realised. Similarly, if the firm has taken benefit of a particular
service, but has not paid within that period, the expense will relate to the
period in which the service has been utilised and not to the period in which
the payment for it is made, e.g., rent due to the landlord but not paid will be
taken as an expense for the period when it is due and not in the period when it
is paid.
Single Entry System of Book Keeping:
This
system of recording transactions is
unscientific. Trial balance cannot be
prepared and hence accuracy of books cannot be ascertained since all accounts
are not kept. It is impossible to
prepare Profit and Loss Account and Balance Sheet from the books of single
entry. Under such condition the profit can be ascertained by valuing the assets
and liabilities at the end of each accounting period.
Double Entry System of Book keeping:
This
system was invented by an Italian named LUCO PACIOLI in 1494 A.D. According to
this system, every transaction has got a two fold aspect. One is Benefit Receiving Aspect or Incoming
aspect and the other one, Benefit giving Aspect or Outgoing aspect. The benefit receiving aspect is said to be a
Debit and the benefit giving aspect is said to be a Credit. For every transaction one account is to be
debited and another account is to be credited in order to have a complete
record of the same. Therefore every
transaction affects two accounts in opposite direction.
Few Basic Terms:
i)Business Transaction: Any
exchange of money’s worth as goods and service between two parties is called a
business transaction. It may relate to
purchase and sale of goods, receipt and payment of cash and rending of service
by one party to another. In accounting,
only business transactions are recorded.
A business transaction is an event which can be expressed in term of
money. An event which cannot be
expressed in terms of money and does not affect the financial position of a
business enterprise will not be recorded in accounting. Therefore, all business transactions are
events but all events are not business transactions.
When payment
for a business activity is made immediately, it is called a cash transaction
but when the payment is postponed to a future date, it is called a credit
transaction.
ii)Debtor: A debtor is a person who owes money. The amount due from him is called debt. The amount due from a person as per the books
of account is called a book debt.
iii)Creditor: A person to whom money is owing or payable is called a creditor.
iv)Capital: This is the owner’s financial interest or
holding in the business and is represented by the value of net assets (i.e.,
total assets less liabilities.)
v)Goods: This includes all articles, commodities or
merchandise in which the business deals.
Thus, cloth would be goods for a dealer in cloth, furniture would be
goods for a dealer in furniture and so on.
vi)Assets:
Any physical thing or right owned that
has a money value is an asset. In other
words, an asset is that expenditure which results in acquiring of some property
or benefit of a lasting nature.
vii)Equity:
A claim which can be enforced against the assets of the firm is called
equity. In other words, the rights to
properties are called equities. Equities
are of two types: the right of creditors and the right of owners. The equities of creditors represent debts of
the business and are called liabilities.
The equity of the owners is called capital, proprietorship or owner’s
equity. Thus assets must be the sum of
liabilities and capital.
viii)Income: It is the favorable change
in owner’s equity which results from business operations. In other words, income is an inflow of assets
which results in an increase in the owner’s equity.
ix)Expenditure: An expenditure takes place
when an asset or service is acquired.
Expenditure will include both payment of a sum immediately and a promise
to pay it at a future date.
x)Expenses: It means an expenditure whose benefit is
finished or enjoyed immediately such as salaries, rent etc. The purchase of goods is an expenditure
whereas cost of goods sold is an expense.
Similarly, if an asset is acquired during the year, it is an
expenditure, if it is consumed during the same year, it is also an expenses of
the year.
xi)Drawings: Any amount or goods
withdrawn by the owner of a business for personal use is called drawings.
xii)Loss: A loss is an expenditure without any benefit
to the concern. On the other hand,
expenses is incurred to result in some benefit in some benefit. Thus, amount spent on lighting is an expenses
but loss due to fire is loss.
xiii)Voucher: Any written document in
support of a business transaction is called a voucher. It is an objective evidence in support of a
transaction.
xiv) Turnover: It means total trading
income from cash sales and credit sales.
xv)Net worth: It means assets minus outside liabilities. Profits of business increase net worth
whereas loss reduce the net worth of a business.
JOURNAL
Journal is a book of original or prime
entry where transactions are recording in the order in which they occur, i.e.,
in chronological order. It is the basic
book of accounting in which all business transactions are recorded at the first
instance and that is why it is called the book of original entry. Journal is called the book of prime entry or
the primary book of accounts because after recording the transaction in the
journal it is finally posted in the ledger, called the book of final entry.
The process of recording or entering a
transaction in the journal is called Journalising
and the record of each transaction in the journal is called Journal Entry.
LEDGER:
All the
transactions of similar nature or relating to a particular person or thing,
entered into the books of original entry during a given period of time, must be
sorted out and consolidated at one place to ascertain their net effect. This sort of processing called classifying is
done to ascertain their net effect.
This sort of processing called classifying is done in the Ledger. In ledger, all transactions relating to a
particular person, thing, expense or income are ground or summarised under a
common head know as “Account”.
Ledger is the principal book of
accounts. It contains all the accounts
of a business whether real, personal or normal.
The transactions recorded in the journal are finally carried to the
ledger, and thus, it is also called the book of final entry.
The Old method of maintaining a ledger
is in the form of a bound book or register containing a number of pages
serially numbered. But the present
practice is to use loose leaf forms printed on paper or cards. The bound ledger is inflexible in nature as
new pages cannot be added to it. The
loose leaf ledger is flexible in nature
as the new accounts/pages can be placed at the desired place. Loose leaf ledger also helps in posting
transactions especially when mechanised system of accounting is used. In an ledger, usually, one page is allotted
to one account. If an account is very
long and it exceeds one page, a new page is allotted to it and the number of
the new page is indicated at the end of the old page.
ACCOUNTING PROCESS:
The Accounting Process, also called
Accounting Cycle involves the following stages:
1. Recording: The transactions are
primarily recorded in a book called Journal.
2. Classifying: All transactions recorded
in the journal are classified account-wise and posted in the ledger.
3.Summarising: After the preparation of
ledger, a summary of ledger accounts is prepared in the form of Trial Balance
and then Profit and Loss Account and Balance Sheet are prepared to ascertain
the net effect of business transactions on the profitability and financial
position of the business.
4. Interpreting: The financial statements
so prepared are further analysed and interpreted to determine financial
strengths and weakness of the firm. A
number of devices such as Comparative Statements, Trend Analysis, Ratio
Analysis, Fund Flow Analysis, Cash Flow Analysis etc. are used for this
purpose.
ACCOUNTING EQUATION:
The American Approach to the rule of debit and credit is based
upon the accounting equation given below: Assets
= Equities
Any physical thing or right owned that
has a money value is called an asset.
Assets of a business entity are the measurable economic resources that
are owned by the business and are expected to provide future benefits. According to the Terminology issued by the
Institute of Chartered Accounts of India, assets are “tangible objects or
intangible rights owned by an enterprise and carrying probable future
benefits’. Thus, assets may be tangible,
i.e., physical in nature such as cash, furniture, machinery, building; or they
may not exist in tangible or physical form (called intangible or nonphysical
assets) such as amount due from customers, legal claims, goodwill, patents,
copyrights etc. The tights to the
properties owned by a business enterprise are called equities or claims against
the assets. Equities may be sub-divided
into equities of creditors or outsiders representing debts owed by a firm and
equities of owners called capital or owner’s equity. Thus, accounting equation can also be expressed
as:
Assets
= Liabilities +
Capital
Or Capital
= Assets -
Liabilities
CLASSIFICATION OF ACCOUNTS:
The transactions of business can be
broadly classified into three categories:
i)
Transaction relating to
persons.
ii)
Transactions relating to
property and assets.
iii)
Transactions relating to
expenses and incomes.
Thus, it becomes necessary for a business to keep a separate
account of each person or firm
with whom it deals, each property or keep a
separate account of each person or firm with whom it deals, each property or
asset which it owns and each item of expenses or income. The accounts falling under the first category
are called Personal Accounts and the accounts.
The following chart shows the classification of accounts:
1.Personal Accounts: Personal accounts include
the accounts of persons, firms, institutions, organisations, companies and
corporations. The main purpose of
maintaining personal accounts is to determine the amount due from various
persons, firms etc. These accounts can
be further classified into three categories:
a)Natural Person’s
Accounts:
These are the accounts related to natural human being such as Suresh’s
A/c, Krishna ’s A/c, Sohan’s A/c etc.
b)Artificial Person’s
Account:
These are accounts related to any firms, institutions, etc. Whether
incorporated or not, e.g., M/s Mohan & Bros A/c, Shri Venkateswara Traders
A/c, TISCO Ltd. A/c, BankA/c, Insurance CompanyA/c, Lion ClubA/c, Government
CollegeA/c etc.
c)Representative Personal
Accounts:
An account which represents a certain person or a group of persons is
called a representative personal account.
For example, Rent Outstanding A/c represents the landlord to whom the
rent is due. Similarly, Salaries
Outstanding Account represents the accounts of various persons to whom the
salaries have been due and have not yet been paid. The other examples of representative personal
accounts may include: Prepaid Insurance
Account, Prepaid Rent Account, Commission Outstanding Account, Interest
Outstanding Account etc.
2.Impersonal Accounts: All accounts other than
personal accounts are termed as impersonal accounts. These accounts can be further classified into
two categories:
a)
Real Accounts b) Nominal
Accounts
a)Real Accounts: All accounts related to assets,
properties and possessions are called real accounts. For example, Land A/c, Building A/c,
Furniture A/c, Machinery A/c, Goods A/c, Cash A/c etc. Real accounts may further be classified into
two categories:
i)Tangible
Real Accounts:
Accounts which relate to tangible things which can be seen, touched,
felt and measured are called tangible real accounts, e.g., Furniture A/c, Cash
A/c, Stock A/c, Purchase A/c, Sales A/c etc.
However, it must be noted that Bank A/c is not a real A/c, it is a
personal account as it represents the account of some banking company.
ii)Intangible Real Accounts: Accounts which relate to
assets which cannot be seen or touched but have value and can be measured are
called intangible real accounts.
Examples of such accounts include Goodwill A/c, Patents A/c, Copyrights
A/c, Trade Marks A/c etc.
b)Nominal Accounts: Accounts relating to
expenses, losses, incomes, gains or profits are called nominal accounts. Examples of such accounts are Rent A/c,
Salary A/c, Interest A/c, Commission A/c, Discount Received A/c, Divided Received A/c etc.
RULES OF THE DOUBLE ENTRY SYSTEM:
Double entry system recognises that every transaction has two
aspects and it records both the aspects of a transaction. Technically speaking, it can be said that
every transaction involves two accounts out of which one account is debited and
the other is credited with the same amount.
As the accounts have been classified under three categories viz.,
Personal, Real and Nominal, there are three rules of debit and credit for
recording transactions. These rules are
as follows:
1.Rule for Personal Accounts: Whenever a personal
account is involved in a transaction, that person either receives some benefit
from the business or gives some benefit to the business. Thus, the rule is:
Debit the Receiver of the
benefit, and
Credit the Giver of the benefit.
For example, if cash is paid to Sohan is the receiver of cash and
his account shall be debited. In the
same manner if goods and thus his account shall be credited.
2.Rule for Real Accounts: Whenever a real account is
involved in a transaction, that thing either comes into the business or goes out of the
business. This the rule for real
accounts is:
Debit
What Comes In
Credit
What Goes Out
For example, if furniture is purchased
for cash, the two accounts involved in the transaction are Furniture A/c and
Cash A/c; Furniture comes into the business and cash goes out of the
business. Hence, Furniture A/c should be
debited and Cash A/c should be credited.
3.Rule For Nominal Account: Nominal accounts are
related to either expenses and losses or incomes, gains and profits. Thus, the rule for nominal accounts is:
Debit
All Expenses And Losses
Credit
All Incomes, Gains or Profits.
For example, when rent is paid, Rent
A/c should be debited as it is an expenses for the business. Similarly, if interest is received, Interest
A/c should be credited since it is an income.
TRAIL BALANCE
According to Pickles, “the statement
prepared with the help of ledger balances, at the end of financial year or at
any other date to find out whether debit total agrees with credit total is
called trial balance.”
FEATURES OF TRAIL BALANCE:
The
following are the features of trail balance:
1.
Trail balance is statement
or a schedule.
2.
It contains the debit and
credit balances of various accounts.
3.
It may also be prepared by
taking the totals of debit and credit sides of all the ledger accounts before
these have been balanced.
4.
It is usually prepared at
the end of the accounting year, but it can also be prepared at any other date,
say at the end of a week, month or quarter, if so desired.
5.
It can be prepared only
after balancing all the accounts in the ledger.
However, if it is prepared on total basis, accounts have to be simply
totalled up and not necessarily balanced.
6.
It is prepared to check
the arithmetical accuracy of books of accounts.
If the totals of debit and credit columns of a trial balance agree, i.e.
if they are equal, it is presumed that accounts are arithmetically correct.
7.
If the trial balance does
not agree, it points out that there are some errors.
8.
Trial balance is not a
conclusive proof of the accuracy of books of accounts. One cannot assume that because the trial
balance agrees, the accounts are positively correct. There may still exist certain errors which are not disclosed through the
trial balance.
OBJECTIVES OF PREPARING TRIAL BALANCE:
A trial
balance is prepared with the following objectives:
1.To provide check on the arithmetical
accuracy of books of accounts: The principal objecting of preparing a trial
balance is to check the debit and credit columns of a trial balance agree, it
can be concluded that:
i)
For each transaction, both
the aspects have been recorded and the debits and credits have been recorded in
equal amounts.
ii)
The balance (debit or
credit) for each account has been correctly calculated.
iii)
The balances of various
accounts have been correctly totalled to arrive at the equality of debits and
credits.
If the trail balance does not agree, it is certain that some
errors do exist and the efforts have
to be
made to locate the errors.
2.To provide a basis for the preparation of
final accounts: Trial balance forms the basis for preparing
final accounts, i.e. Trading and Profit and Loss Account, and the Balance
Sheet.
3.To provide a summary of ledger accounts: Trial balance, by
bringing together the balances of all the accounts at one place, provides the
entire ledger in a summarised form. The
net balance or position of a particular account can be found by merely looking
at the trial balance.
LIMITATIONS OF TRIAL BALANCE:
The
following are the main limitations of trial balance:
1.
The agreement of a trial
balance is not a conclusive proof of the accuracy of books of accounts. There may be certain errors which are not
disclosed by a trial balance.
2.
Trial balance does not
provide detailed information about ledger accounts. It contains only balances or totals of debit
and credit sides of each account. Thus,
one has to refer to the ledger for details.
3.
It is not a substitute of
financial statements, i.e. profit and loss account and the balance sheet. Trial balance does not provide information
about the profit made or loss incurred by the business in the accounting period
or the financial position of the business on a particular date.
CAPITAL AND REVENUE
It consists of expenditure the benefit
of which is not fully consumed in one period but spread over several
periods. Such expenses are taken to
Balance Sheet and are determined by the fact whether.
1. The expenditure made is for the purpose of acquiring fixed assets
and in placing the business in a position in which it can commence or continue
operation.
2. The expenditure results in some more or less long term benefit to
the business
3. Expenditure increases the earning capacity of the business or
reduces working expenses.
E.g.
1.Purchase
of land, building, plant and machinery, furniture, vehicles and any other fixed
asset.
2.Cost
of replacing a petrol driven engine to a diesel driven engine.
3.Expenditure
incurred for increasing the sitting accommodation in a cinema hall or
restaurant.
4.Amount
spent or erection of plant and machinery.
5.Expenditure
incurred for acquiring some right to carry on business, e.g., copyright,
goodwill, trade mark, patent rights etc.
6.Expenditure
incurred for reconditioning an old fixed asset.
7.Expenditure
incurred on major repairs and replacement of plant and machinery or any other
fixed asset which results in increased efficiency.
Revenue Expenditure
It consists of expenditure incurred in one period of account, the
full benefit of which is consumed in that period. In includes purchasing assets required for
resale at a profit or for being made into saleable goods, maintaining fixed
assets in good working order, meeting the day-to-day expenses of carrying on
business. Cost of goods, raw materials
and stores, replacements, renewals, repairs, depreciation of the fixed assets,
rent, rates, and taxes, wages and salaries, carriage, insurance and other trade
expenses are few examples of such expenditures.
DIFFERENCE BETWEEN CAPITAL EXPENDITURE AND
REVENUE EXPENDITURE
Sl.No Capital
Expenditure Revenue
Expenditure
1. It results in
acquisition of fixed assets It
does not result in acquisition of any fixed
which are
meant for use and not for resale. asset.
This expenditure is incurred for
the assets
acquired are used for earning meeting
the day-to-day expenses of
profit as long
as they can serve the purpose carrying
on operation of business.
of the business
and sold only when they
become unfit
or obsolete for business.
2. It results in improving the earning
capacity It results in maintenance of
business assets such
of the fixed assets, e.g., overhauling the as repairs and maintenance of
machinery. It is
machinery for improving the business by helpful in maintaining the existing
capacity of
increasing the earning capacity of the the asset.
machinery.
3. It represents unexpired cost i.e., cost of It represents expired cost i.e.,
benefit of cost has
benefit to be taken in future. been taken.
4. It is a non-recurring expenditure. It is a recurring
expenditure.
5. The benefit of such expenditure will be The benefit of such expenditure
expires during
for more then one year. Only a portion of the
year and the amount is charged to Revenue
such expenditure known as depreciation
is Account, (i.e., Trading and
Profit and Loss
charged to Profit and Loss Account and Account) of the same year.
balance amount of such expenditure
unless
it is Balance Sheet as an asset.
6. All items of capital expenditure which are All items of revenue expenditure
the benefit of
not written off are shown in the Balance which has exhaused during the year
are
Sheet as assets and are carried forward
to transferred to Trading and Profit
and Loss S
the next year. Account and
the accounts representing such
items
are closed by transferring them to
Trading
and Profit and Loss. Such items arenot
Carried
forward to the next year because their
Benefit
has been taken during the year. Only a
Portion
of the deferred revenue expenditure,
(i.e.,
heavy advertisement) the benefit of which
has
not expired during the year is carried
forward
to the next year.
TRADING
ACCOUNT:
This Account is prepared to know the trading
results of the business i.e. how much gross profit the business has earned from
buying and selling during a particular period. The difference between the sales
and cost of goods sold is gross profit. For the purpose of calculating cost of
goods sold, we take in to consideration opening stock, purchases, and direct
expenses on purchasing or manufacturing the goods and closing stock. The
balance of this account represents gross profit or loss and is transferred to
the profit and loss account.
PROFIT
AND LOSS ACCOUNT:
This account is prepared to calculate
the net profit of the business. There are certain items of expenses of the
business, which must be taken into consideration for calculating the net profit
of the business. These are of indirect nature i.e. concerning the whole
business and relating to various activities which are done by the business for
the purpose of making the goods available to the consumers. Indirect expenses
may be selling and distribution expenses, management expenses, financial
expenses, extraordinary losses and expenses to maintain the assets into working
order. This account is prepared from nominal accounts and its balance is
transferred to capital account as the whole profit or loss will be that of the
owner and it will increase or decrease his capital.
BALANCE
SHEET:
A balance sheet is a statement
prepared with a view to measure the financial position of a business on a
certain fixed date. The financial position of a concern is indicated by its assets
on a given date and its liabilities on that date. Excess of assets over
liabilities represent the capital and is indicative of the financial soundness
of a company. A balance sheet is also described as “a statement showing sources and application
of capital’. It is a statement and not an account and prepared from real and
personal accounts. The left hand side of the balance sheet may be viewed as a
description of sources from which the business has obtained the capital with
which it currently operates sand the right hand side as a description of the
form in which that capital is invested on a specified date.
A properly drawn up balance sheet
gives information relating to (i) the nature and value of assets, (ii) the
nature and extent of liabilities, (iii) whether firm is solvent, (iv)whether
the firm is over trading.
If assets exceed the liabilities, the
firm is solvent, i.e. able to pay it's debts in full. A business is therefore
solvent by the amount of ownership
capital in it, as it is the excess of assets over liabilities (iv) concernbs
the stability of the business.
CLASSIFICATION
OF ASSETS AND LIABILITIES
ASSETS
Assets are property and
possession of a business. Stock, land and buildings, book debts, cash, bills
receivable are some examples of assets. The classification of assets depends on
their nature. The various types of assets are:
FIXED
ASSETS:
Those assets, which are acquired and
held permanently in the business and are used for the purpose of earning
profits are called fixed assets. Land and building, machinery, furniture and
fixtures are some examples of these assets.
CURRENT
ASSETS:
Those assets such as cash, debtors and
stock that can be realised and readily available to discharge liabilities are
current assets.
TANGIBLE
ASSETS:
These are definite assets which can be
seen touched and have volume such as machinery, stock, cash etc.
FICTITIOUS
ASSETS:
These assets are fictitious in nature,
i.e. they are virtually not assets. These are either the past accumulated
losses or expenses which are incurred once in the life of a business and are
capitalized for the time-being. Profit and loss account (debit balance,
organisation expenses, discount on the issue of shares, advertisement expenses
capitalized for the time being are examples of such assets.
INTANGIBLE
ASSETS:
Those assets which cannot be seen
touched and have no volume but have value are called intangible assets.
Goodwill, patents trademarks are examples of such assets but quite valuable to
undertaking.
WASTING
ASSETS:
Those assets as mines quaries etc.
that become exhausted or reduce in value by their working are called wasting
assets.
LIQUID
ASSETS:
These are cash are such items as
marketable securities, which can be converted in to cash quickly.
CONTINGENT
ASSETS:
It is an asset the existence, value
and ownership of which is dependent on the occurrence or non-occurrence of a
specified act. Suppose a firm has filed a suit for some specified property now
in possession of someone else. If the suit is decided in firm’s favour, the
firm will get the property. At the moment it is a contingent asset. Similar
would be the position of a patent
applied for arising of a firm’s own
research effort.
LIABILITIES:
A liability is an amount, which a
business is legally bound to pay. It is claim by an outsider on the assets of a
business. Liabilities may be classified into four categories.
FIXED
LIABILITIES:
These are those liabilities which are
payable only on the termination of the business such as capital which is a
liability to owner.
LONG
TERM LIABILITIES:
These liabilities which are not
payable within the next accounting period but will be payable within next five
to ten years are called long term liabilities such as debentures.
CURRENT
LIABILITIES:
Those liabilities which are payable
out of current assets, within the next accounting period usually year or
already due are called current liabilities. Sundry creditors, bills payable,
short term bank overdraft are examples of such liabilities.
CONTINGENT
LIABILITIES:
A contingent liability is one which is
not an actual liability but which will become an actual one on the happening of
some event which is uncertain. Thus such liabilities have tweo characteristics:
(a) Uncertainty
as to whether the amount will be poayable at all, and
(b) Uncertainty
about the amount involved
It
is sufficient if the amount of such liability is stated on the face of the
Balance sheet by way of a note unless there is a probability that aloss will
materialize. In that event it is no more a contingent liability and a specific provision should be made
therefore. Examples of such liabilities are:
a. Claims
against the companies not acknowledged as debts.
b. Uncalled
liability on partly paid up shares
c. Arrears
of fixed cumulative dividend.
d. Estimated
amount of contracts remaining to be excluded on capital account and not
provided for.
e. Liability
of a case pending in a court.
f. Bills
of exchange, guarantees given against a particular firm or person.
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