Accounting is the process of measuring and recording all the financial transactions that happened in a financial year. It includes summarizing, analyzing and recording the data. It helps in getting a clear picture of the financial position of the business by seeing the value of a company’s assets and liabilities.
Accounting is considered to be a discipline that is based on many different terms, rules, principles and standards, which are needed to be followed to obtain the required information for the decision-making process.
Accounting process consists of:
- Summarizing the data: In this step, all the financial transactions are recorded and summarized in one place.
- Analyzing the data: After summarizing the data, different specialists analyze the data.
- Interpreting the data: After the analysis of the data has been completed, the interpretation of the data is done. In this step, all the information collected from the previous steps is forwarded.
- Communicating the information: After the successful completion of the above steps, the information which is required by the different investors and other business entities is communicated to the
Basic Terms Used in Accounting:
1. Business Transaction
In accountancy, a business transaction is a financial event that involves the exchange of resources, goods, or services between two parties, where each party receives something of value. These transactions are recorded in a company's accounting system, which helps to track its financial performance and provides information for financial decision-making.
A business transaction typically involves at least two accounts - one account is debited, while another is credited. Recording business transactions accurately and in a timely manner is crucial for the proper functioning of any organization. It enables the company to monitor its financial position, make informed decisions, and comply with legal and regulatory requirements.
2. Capital
In accountancy, capital refers to the total amount of money or assets invested in a business by its owners or shareholders. It represents the long-term financial commitment of the owners to the company and is considered a liability of the business.
Capital can be either in the form of cash or assets contributed by the owners, or it can be generated by the business itself through profits or retained earnings. The amount of capital invested by the owners determines their ownership stake in the business and their entitlement to share in the profits and losses.
In the accounting system, capital is recorded as a separate account in the balance sheet, which shows the financial position of the business at a given point in time. The capital account reflects the total amount of capital invested in the business, including any additional investments made by the owners.
The capital account is also used to record the company's net income or loss for a given period. At the end of each accounting period, the net income or loss is added to or subtracted from the capital account, which results in an increase or decrease in the owners' equity in the business.
Capital is an essential aspect of any business as it provides the necessary funds for the company to operate and grow. It also serves as a measure of the owner's commitment to the business and their willingness to take risks to achieve success.
3. Drawings
In accountancy, drawings refer to the amount of money or assets withdrawn by the owner of a sole proprietorship or partnership for personal use. Drawings are recorded as a reduction in the owner's capital account and are considered a withdrawal of funds from the business.
When an owner takes money or assets from the business for personal use, it is considered a reduction in the amount of capital invested in the business. Therefore, the owner's capital account is debited or decreased by the amount of the drawings. Drawings are recorded on the balance sheet as a separate account under the owner's equity section.
In a partnership, the drawings of each partner are recorded separately to track their personal withdrawals. The total amount of drawings for all partners is then deducted from the partnership's total capital to calculate the remaining capital balance.
4. Liabilities (Current and Non-current Liability)
In accountancy, liabilities are obligations that a business owes to other parties, such as creditors or suppliers. They represent the company's debts or financial obligations and are recorded on the balance sheet.
Liabilities are of two types: Current Liabilities and Non-current Liabilities.
- Current liabilities are those that are expected to be paid within one year or the operating cycle of the business, whichever is longer. They include accounts payable, notes payable, wages payable, taxes payable, and other short-term obligations. Current liabilities are usually settled with the company's current assets, such as cash or inventory.
- Non-current liabilities are those that are not due for payment within one year or the operating cycle of the business, whichever is longer. They include long-term debts, such as bonds payable, long-term notes payable, and mortgages payable. Non-current liabilities are usually settled with the company's non-current assets, such as property, plant, and equipment.
It is important for businesses to manage their liabilities effectively to avoid default or bankruptcy. This includes monitoring payment deadlines, negotiating favourable payment terms with creditors, and maintaining adequate cash reserves to cover short-term obligations.
5. Assets (Current and Non-current Assets)
In accountancy, assets are resources that a business owns or controls, which can be used to generate revenue or provide future economic benefits. Assets are recorded on the balance sheet and are categorized as either current assets or non-current assets.
- Current Assets are those that can be converted into cash or used up within one year or the operating cycle of the business, whichever is longer. They include cash and cash equivalents, accounts receivable, inventory, and prepaid expenses. Current assets are important for the daily operations of the business and are expected to be converted into cash or used up within a short period.
- Non-current Assets are those that are not expected to be converted into cash or used up within one year or the operating cycle of the business, whichever is longer. They include long-term assets such as property, plant, and equipment, investments, and intangible assets such as patents, trademarks, and goodwill. Non-current assets are essential for the long-term growth and success of the business.
Effective management of assets is critical for the success of a business. This includes monitoring the usage and maintenance of assets, evaluating the return on investment for capital expenditures, and assessing the risk associated with different types of assets.
6. Fixed Assets (Tangible and Intangible Assets)
In accountancy, fixed assets are long-term resources that a business owns or controls and that are not expected to be converted into cash within one year or the operating cycle of the business, whichever is longer. Fixed assets include both tangible and intangible assets.
- Tangible fixed assets are physical assets that can be seen, touched, and felt. They include property, plant, and equipment (PPE) such as land, buildings, machinery, and vehicles. Tangible fixed assets are used to generate revenue for the business and are expected to last for more than one accounting period.
- Intangible fixed assets are non-physical assets that do not have a physical existence but have value to the business. They include patents, trademarks, copyrights, software, and goodwill. Intangible fixed assets are also used to generate revenue for the business and are expected to last for more than one accounting period.
- Intangible fixed assets are recorded at their historical cost or fair value, whichever is more reliable. Intangible fixed assets are not depreciated but are tested annually for impairment, which is a significant decrease in the asset's value.
7. Expenditure (Capital & Revenue Expenditure)
In accountancy, expenditures can be categorized into two types: capital expenditures and revenue expenditures.
- Capital expenditures are those expenditures that are incurred to acquire or improve a long-term asset that is expected to provide benefits over a period of more than one year. These expenditures are typically large and include the purchase or construction of buildings, machinery, and equipment, as well as the acquisition of land and patents. Capital expenditures are recorded on the balance sheet as fixed assets and are depreciated over their useful lives.
- Revenue expenditures, on the other hand, are those expenditures that are incurred to maintain or operate a business and are expected to provide benefits within the current accounting period. These expenditures are typically small and recurring and include expenses, such as rent, utilities, salaries, and supplies. Revenue expenditures are recorded on the income statement as expenses and are deducted from revenue to determine net income.
8. Expenses
In accountancy, expenses are the costs that a business incurs in order to generate revenue. Expenses can be categorized into two types: direct expenses and indirect expenses.
- Direct expenses are expenses that are directly related to the production or sale of a product or service. These expenses can be easily traced to a specific product or service and include items, such as raw materials, direct labour, and manufacturing overhead. Direct expenses are recorded as part of the cost of goods sold on the income statement.
- Indirect expenses, on the other hand, are expenses that are not directly related to the production or sale of a product or service. These expenses cannot be easily traced to a specific product or service and include items, such as rent, utilities, salaries, and advertising. Indirect expenses are recorded separately on the income statement as operating expenses.
9. Income
Income is the revenue earned by a business through its operations over a specific period of time. Income is an important metric for measuring the financial performance of a business and can be classified into two types: Operating income and Non-operating Income.
- Operating income is income that is earned from the primary business activities of the company, such as the sale of goods or services. Operating income is calculated by deducting the cost of goods sold and operating expenses from the revenue generated by the company's operations. Operating income is a key metric for measuring the profitability of a company's core business operations.
- Non-operating income is income that is earned from sources other than the primary business activities of the company, such as interest income, dividends received, or gains from the sale of investments. Non-operating income is typically reported separately from operating income in the income statement and can have a significant impact on the overall financial performance of the company.
10. Profit
In accountancy, profit is the financial gain that a company earns after deducting all expenses from the revenue generated by its operations over a specific period of time. Profit is an important metric for measuring the financial performance of a company, and it is calculated using the income statement. Profit can be classified into two types: Gross Profit and Net Profit.
- Gross profit is the profit earned by a company after deducting the cost of goods sold from its revenue. Net profit is the profit earned by a company after deducting all operating expenses, non-operating expenses, and taxes from its revenue.
- Profit is recorded on the income statement, which is a financial statement that reports revenues, expenses, and net income of a company over a specific period of time.
11. Gain
In accountancy, gain refers to an increase in the value of an asset, or a decrease in the value of a liability, which results in a financial benefit for a company. It is realised apart from the normal course of business. Gains can be realised or unrealised.
- Realized gains are those that have been actually received or realised by a company, usually through the sale of an asset or the settlement of liability. For example, a company that sells a long-term investment at a higher price than its cost basis will realize a gain. This gain will be recognized on the income statement as a realized gain.
- Unrealized gains, on the other hand, are those that have been earned but not realised by the company till date. Unrealised gains are not recognised on the income statement but instead recorded in the company's balance sheet.
12. Loss
Loss refers to a decrease in the value of an asset, or an increase in the value of a liability, which results in a financial loss for a company. Losses can be realised or unrealised and can be classified as operating or non-operating losses.
Realised losses are those that have been actually incurred by a company, usually through the sale of an asset or the settlement of liability. For example, a company that sells a long-term investment at a lower price than its cost will realise a loss. This loss will be recognised on the income statement as a realised loss.
- Unrealised losses, on the other hand, are those that have not actually occurred but exist only on paper. For example, a company that owns a long-term investment that has decreased in value, but has not been sold yet, is an unrealized loss. Unrealised losses are not recognized on the income statement but are instead recorded in the company's balance sheet.
- Operating losses are losses that are directly related to the primary business activities of the company. For example, a company that sells its products for a lower price than it paid for the raw materials used to make them will realise an operating loss.
- Non-operating losses, on the other hand, are losses that are not related to the primary business activities of the company. For example, a company that incurs a loss on the sale of an office building will realise a non-operating loss.
13. Purchase
In accounting, a purchase refers to the acquisition of goods or services by a company for the purpose of using them in its operations, reselling them, or holding them as an investment. A purchase can be made for cash or on credit and is typically recorded in a company's books of accounts.
Goods are those items in which a business deals. In other words, goods are the commodities that are purchased and sold in a business on a daily basis. When goods are purchased in cash or credit, donated, lost, or withdrawn for personal use, in all these cases, Goods are denoted as Purchases A/c.
14. Sales
In accounting, a sale refers to the transfer of goods or services by a company to a customer in exchange for payment. A sale can be made for cash or on credit and is typically recorded in a company's books of accounts.
15. Goods
In accounting, goods typically refer to tangible products that a company buys or sells as part of its normal operations. Goods are usually classified as assets on a company's balance sheet until they are sold, at which point they become revenue.
Goods can include any tangible item that a company produces or sells, such as inventory, raw materials, finished products, or supplies. In order to account for goods, a company must keep accurate records of all purchases and sales, as well as any changes in the value of its inventory.
16. Stock
Stock refers to the inventory of products or materials that a company holds for sale or production. This can include raw materials, work-in-progress items, and finished goods. Stock is classified as an asset on a company's balance sheet.
Stock is recorded in a company's accounting records using the perpetual inventory system, which involves continuously updating inventory balances based on purchases, sales, and any adjustments for shrinkage or damage. This allows a company to track the quantity and value of its stock in real time and ensure that it has sufficient levels of stock on hand to meet customer demand.
The cost of stock is typically determined using one of several methods, such as First-In-First-Out (FIFO), Last-In-First-Out (LIFO), or Weighted Average Cost (WAC). These methods help a company to determine the value of its stock on hand, as well as the cost of goods sold (COGS) when stock is sold.
17. Debtor
In accounting, a debtor is an individual or entity that owes money to the firm. This typically refers to a customer or client who has purchased goods or services on credit but has not yet paid for them. Debtor is classified as an asset on a company's balance sheet.
When a company extends credit to a customer, it records the transaction in its books of accounts by debiting the accounts receivable account and crediting the revenue account. This creates a balance owed by the customer, which is recorded as a debtor on the company's balance sheet.
18. Creditor
In accounting, a creditor is an individual or entity to whom the firm owes money. This typically refers to a supplier or vendor from whom a company has purchased goods or services on credit but has not yet paid for them. Creditors are classified as a liability on a company's balance sheet.
When a company purchases goods or services on credit, it records the transaction in its books of accounts by debiting the relevant expense or asset account and crediting the accounts payable account. This creates a balance owed to the supplier or vendor, which is recorded as a creditor on the company's balance sheet.
19. Voucher
In accounting, a voucher is a document that serves as evidence of a financial transaction. It is typically used to authorize a payment or to record a receipt of funds. Vouchers are important for maintaining accurate financial records and for ensuring that all transactions are properly authorized and documented.
A voucher typically contains the following information:
A. Date: The date on which the transaction occurred.
B. Amount: The amount of money involved in the transaction.
C. Description: A brief description of the transaction, including the purpose and any relevant details.
D. Account Codes: The account codes that should be used to record the transaction in the general ledger.
E. Approval: The name and signature of the person who authorized the transaction.
Vouchers can be used for a wide range of financial transactions, including purchases, reimbursements, and payments to employees or suppliers. When a voucher is used to authorize a payment, it serves as a form of internal control, ensuring that the payment is made only for legitimate expenses and that all necessary approvals have been obtained.
20. Discount
In accounting, discounts are reductions in the price of goods or services that are offered to customers. There are two main types of discounts: trade discounts and cash discounts.
- A trade discount is a reduction in the list price of goods or services that is offered to customers based on the quantity of the product or the volume of the order. It is usually expressed as a percentage of the list price and is not recorded as a separate transaction. Instead, the discounted price is simply recorded as the new selling price.
- Trade discounts are used to encourage larger purchases and to reward customers who purchase in bulk. They are also used to simplify pricing structures and to maintain consistent pricing across different customers and markets.
- A cash discount is a reduction in the price of goods or services that is offered to customers who pay their dues within a specified period of time. It is usually expressed as a percentage of the selling price and is recorded as a separate transaction.
- Cash discounts are used to encourage prompt payment and to reduce the risk of bad debts. They are also used to improve cash flow by accelerating the collection of accounts receivable.
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Chapter 5: Depreciation, Provisions, and Reserves
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Chapter 6: Trial Balance and Rectification of Errors
Chapter 7: Bills of Exchange
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Accounting Treatment of Bills of ExchangeWhat is a Bill of Exchange?A bill of exchange is a written order that one party receives from another requiring them to pay the other a specific amount of money, either immediately or at a later date. It is important that such an order of payment should be unconditional and be accepted by both parti
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Part B