ELEMENTARY FINANCE
- 0N LINE
Lesson 1, Chapter 1(c) - Basic Accounting Procedures
Introduction of the Host
Mrs.Geetha Dasaraty is a commerce graduate with a Masters in Business Administration specialising in finance. Her stint with a Coimbatore based company and later with a consulting firm in Chennai has provided her with a decade of experience in project finance and appraisals, accounting and tax laws. She is a freelance writer and money matters are her forte. She is currently pursuing her final course in Company Secretaryship and is doing a course on Vaishnavism. She has a passion for literature and Carnatic music. She is also a violinist.
About the classWe bring you an online class titled 'Elementary Finance'. This will have 12 lessons - one a month. Each lesson is further subdivided into 4 chapters. And we will give you one new chapter every week.
In the previous lesson, we saw the types and ground rules for accounting, these ground rules form the basis for recording business transactions. In chapter 1(c ) we move on to the basic accounting procedures..
Chapter1(c) - Basic Accounting Procedures
In this chapter we will acquaint ourselves with the following:
- Accounting Equation
- Rules for accounting Equation
- The Accounting Cycle
- Journal
- Subsidiary Books
- Ledger
At any given point of time, the total assets of a firm will be equal to the total claims. The total claims of the firm will be
- The owners capital or equity
- Liabilities due to outsiders.
Capital + Liabilities =Assets
Rules For Accounting Equation
Capital: When capital is increased, it is credited, and when capital is withdrawn, it is debited.
Outsiders' Liabilities: When liabilities increase, outsider's accounts are credited and when liabilities decrease their accounts are debited.
Revenue Income: Capital is increased by the amount of revenue income.
Revenue Expense: The capital is decreased by the amount of revenue expenses.
Assets: When there is an increase in assets, the assets accounts are debited and in case of a decrease, the assets accounts are credited.
In certain cases, as a result of a transaction, one asset increases and another asset decreases. Similarly one liability increases and another decreases. In such cases there will be no change in the accounting equation.
All business transactions are recorded on the basis of the accounting equation. The Balance Sheet, which is the final statement of the accounting process, conforms to the accounting equation.
Let us take an example.
Ram starts a business with Rs.30,000 as his capital. The accounting equation will be:
Assets = Liabilities + Capital
Rs.30,000 = 0 + Rs.30,000
The business purchases equipment for Rs.5000. Now, although the cash in hand will reduce by Rs.5000, there is an increase in the asset by way of purchase of equipment to the extent of Rs.5000. Hence, the total of the assets remains the same. The accounting equation will be
Assets = Liabilities + Capital.
Cash + Equipment
Old Balance 30,000 + 0 0 + 30,000
New transaction -5,000 + 5,000 - -
New balance 25,000 + 5,000 0 + 30,000
The Accounting Cycle
The various stages in an accounting cycle are recording,classifying,summarising,and finalising all business transactions.
- Recording: Recording of transactions is done through the Journal or subsidiary books.
- Classification: This is done through the ledger.
- Summarising: This is done by preparing the Trial Balance.
- Finalising: This is done through the preparation of trading account, Profit and Loss account and Balance Sheet.
A journal is a daily record of business transactions and is the book of original entry. A voucher is a documentary evidence for the transaction and has to be preserved till audit and tax assessments are over. Based on these vouchers, journal entries are passed.
Specimen of a journal.
Date Particulars LF Debit Credit
Amount(Rs) Amount (Rs)
The entries are recorded in a chronological order.
Particulars column refers to the accounts to be debited or credited.
LF is Ledger Folio which refers to the page number in the ledger where the journal is posted.
Debit or credit amount refers to the amount to be debited or credited to the respective accounts.
Every journal entry is followed by a narration in brackets which gives details of the transaction for which the entry is passed.
Example. Cash received from Raj on 1st Jan 2001, Rs. 10,000 will be recorded as follows:
Date Particulars LF Debit Credit
2001
Jan 1 Cash a/c Dr 10000
To Raj's a/c 10000
(Being cash received from Raj)
Ledger accounts are prepared on the basis of the journal.
In the case of small business houses a single journal can be maintained for all the transactions. But, when the business expands maintaining a single journal book becomes cumbersome. Similar transactions are then grouped and recorded in specialised journal called subsidiary books.
Subsidiary Books.
Subsidiary books not only reduce the work but also ensure accuracy of accounts. The following are the various subsidiary books .
- Purchases Book: Purchase book also known as purchase day book or bought book is used to record all credit purchases of goods. The inward invoices from suppliers are the basic documentary evidence for entries in these books.
- Sales Book: Sales book also known as sales day book or sold book is used to record all the credit sales of goods .The outward invoices will be the documentary evidence for these books.
- Purchase Returns Book: It is also known as the Returns Outwards Book or Purchase Returns Journal.When goods purchased on credit are returned to the supplier they are entered in the Purchase Returns Book.Debit notes sent by the firm to the suppliers are the basis of these entries.
- Sales Returns Book: This is also known as the Returns Inward Book or Sales Returns Journal.When goods sold on credit are returned by the customers an entry is made in the Sales Returns Book.Credit notes sent to the customers are the basis of these entries.
- Cash Book: All the transactions of the firm relating to cash or bank are recorded in the Cash Book.It is a book of original entry. All the receipts and payments are recorded in these books and then posted to the ledger.
- Petty Cash Book: A Petty Cash Book is a cashbook, which records cash transactions of small amounts. Generally in big business houses a petty cashier is in charge of these small payments.
- Bills Receivable Book: Also known as the Bills Receivable Journal, it is used to record details of the bills received by the firm.
- Bills Payable Book: Also known as the Bills Payable Journal it is used to record details of the bills payable accepted by the firm.
- General Ledger or Jounal Proper: The General Ledger is the Residual Book and all transactions that cannot find a place in the other subsidiary books are entered here. Transactions like credit purchase of assets and credit sale of assets are recorded in this book.
Ledger is considered to be the main book of accounts in a business. It is the second stage in the accounting cycle. Here all the accounts are classified and grouped under various headings. The ledger provides a summary of all the transactions pertaining to an asset or expense or person in a specified period.
Ledger Account: Preparation of ledger accounts is also known as posting of entries from the journal. A ledger account takes the form of a T, where the left-hand side is the debit side and the right hand side is the credit side.
Let us take an example.
A firm sells goods on credit to B on 1st Jan 2001 for Rs. 2000
The journal entry will be
Date Particulars Debit Credit
1.1.2001 B's a/c Dr 2000
To Sales 2000
(Being Credit sales made)
The ledger posting will be
B's Account
Dr. Cr
Date Particulars Rs Date Particulars Rs
1.1.2001 To Sales A/c 2000
Sales account
Dr Cr
Date Particulars Rs. Date Particulars Rs.
1.1.2001 By B's A/c 2000
At the end of the month all the books are totalled and the total amount is posted to the ledger. While totalling a ledger account, both the sides are totalled and the difference is entered on the side where the total is short.
If the left hand side is more, it is called a debit balance & is written on the right hand side as 'By balance c/d'.
If the right hand side is more, then it is called a credit balance and is written on the left hand side as 'To balance c/d'
These balances are the basis for finalisation of accounts.
Questions on Lesson 1, Chapter 1(b)
1. Classify the following under the three types of accounts.
(Real ,Nominal, Personal Accounts).
(a). Cash (b). Outstanding Salary (c). Depreciation (d). Rent
(e). Drawings (f). Fixed Deposits (g). Loan
2. In the following, state which account will be debited and which will be credited.
(a). Goods purchased (b). Machinery sold (c). Goods Sold (d). Rent paid
(e). Commission received (f). Discount allowed.
Answers to these questions will be given at the end of Lesson 1