Financial Account Notes

Lesson 7

2009-07-08T13:16:00.001-07:00

Cash Book

• All cash transactions (receipts and payments) are recorded in the cash book.

• Cash book balance shows the amount of cash in hand at a particular time.

The balance column shows the net balance of cash available for use.

The ledger code shows the code of that head of account which contains the second effect of the cash transactions because debits and credits are always equal in financial accounting.

Bank Book

• All bank transactions are recorded in the bank book.

• The balance of bank book reflects the cash available at bank at a particular time.

• The format of bank book is same as that of cash book except the column of cheque no.

• This column is added in the format because all payments made by cheque and the number of cheque is written in that column to keep the accounting record updated.

Accounting period is any period for which a profit and loss account is prepared.

Debit & Credit Balances

• It has already been mentioned that both sides i.e. Debit and credit side of a ledger must be equal.

• If debit side of a ledger is greater that credit side. The balance will be written on the credit side and

it will be called Debit Balance. The reason being, the balance is written on the credit side because of

excessive debit balance. Therefore, it is called Debit Balance.

Similarly, if credit side is greater than debit side, the balance will be written on the debit side. This

balance is called. Credit Balance.

Trial Balance

• At the end of accounting period, a list of all ledger balances is prepared. This list is called trial

Balance.

• Both sides of trial balance i.e. Debit side and credit side must be equal. If both sides are not equal,

there are errors in the books of accounts.

RULES OF DEBIT & CREDIT

• Increase in expense is Debit (Dr.)

• Decrease in expense is credit (Cr.)

• Increase in income is credit (Cr.)

• Decrease in income is Debit (Dr.)

Lesson 6

2009-07-08T13:14:00.001-07:00

Event
Event is the happening of any thing but in accounting we discuss monetary events
Monetary Events
If the financial position of a business is change due to the happening of event that Event is called
Monetary Event
The Voucher
• Voucher is a document in a specific format that records the details of a transaction.
• It is accompanied by the evidence of transaction

The General Journal
• The Journal used to be a chronological (day-to-day) record of business transactions. All vouchers
were first recorded in books.
• It was also called the Book of Original Entry or Day Book.
• But in present day accounting and especially with the introduction of computers for accounting, this
book is not in use any more.
• We will, therefore, not study the use of Journal in detail but we should know that it is a book that
keeps day-to-day record of transactions

Lesson 5

2009-07-08T12:57:00.001-07:00

Revision of 4 Chapters +

Rules of Debit and Credit

Rules of Debit and Credit for Assets

Rules of Debit and Credit for Liabilities

Rules of Debit and Credit for Expenses

Rules of Debit and Credit for Income

Lesson 4

2009-07-08T12:53:00.001-07:00

Separate Entity Concept

‘The Business’ is treated independently from the persons who own it.

Single Entry Book-Keeping

only one aspect of transaction i.e. either cash receipt or the fact that money is receivable from someone is recorded.

Double Entry Book-Keeping

The concept of double entry is based on the fact that every transaction has two aspects i.e. receiving

a benefit and giving a benefit.

The account that receives the benefit is debited and the account that provides the benefit is credited.

The ultimate result of the system is that for every Debit (Dr) there is an equal Credit (Cr).

DEBIT

• It signifies the receiving of benefit. In simple words it is the left hand side.

CREDIT

• It signifies the providing of a benefit. In simple words it is the right hand side.

Assets

• Assets are the properties and possessions of the business.

o Tangible Assets – Furniture, Vehicle etc.

o Intangible Assets – Right to receive money, Good will etc.

Any thing that provides benefit to the business in future is called ‘Asset’. (page 14)

Any thing for which the business has to repay in any form is called ‘Liability’.

Assets = Liabilities

The liabilities of the business can be classified into two major classes i.e. the amounts payable to

‘outsiders’ and those payable to the ‘owners’. The liability of the business towards its owners is

called ‘Capital’ and amount payable to outsiders is called liability. Therefore, our accounting

equation finally becomes:

Assets = Capital + Liabilities

Cash Accounting - Lesson 3

2009-07-01T09:57:00.000-07:00

Cash Accounting

All dealing relating to cash (there is no concept of credit) It is the accounting system in which events are recorded when actual cash / cheque is received or paid.

Accrual Accounting

• It is the accounting system in which events are recorded as and when they occur.

• This means that income is recorded when it is earned and expense is recorded when incurred i.e. the organization has obtained the benefit from it.

Income

• Income is the value of goods or services that a business charges from its customers.

Expenses

• Expenses are the costs incurred to earn revenue.

• In order to earn revenue, one has to spend some money such as the cost of goods that are sold or

the money paid to the individuals who are providing services plus other costs. These costs that are incurred / spent by the business to earn the revenue are the expenses of the business.

Net Profit = Income – Expenses

In accounting the expenses that provide benefit immediately are called “Revenue Expenses” and those expenses whose benefit last for a longer period are called “Capital Expenses”.

Liabilities

• Liabilities are the debts and obligations of the business.

Commercial Accounting

2009-06-28T02:09:00.000-07:00

Commercial Accounting

aAccurate reflection of business transacted can only be obtained if both cash and credit transactions are recorded in such a manner that there is no duplication and yet the transactions are completely recorded. This is possible only under Commercial Accounting.It is done through a system that is known as Double entry book keeping.

There are two types of accounting: Single Entry and Double Entry Accounting

Single entry accounting/Cash accounting.

This system records only cash movement of transactions and that too up to the extent of recording one aspect of the transactions.
This means that only receipt or payment of cash is recorded and no separate record is maintained (about the source of receipt and payment) as to from whom the cash was received or to whom it was paid.

Double entry book keeping/Commercial accounting.

Double entry or commercial accounting system records both aspects of transaction i.e. receipt or payment and source of receipt or payment.
It also records credit transactions. Example of Electricity Bill
in cash accounting date of receipt / payment of actual cash is important
in commercial accounting the date on which the expense is caused, whether paid or not, as well as the spreading of the cost of certain items over their useful life becomes important.

Other important Concepts, you should know before finishing this lessen:
Capital ,Money Value of Time, Goodwill, Budget ,Is Cash in Hand Our Profit?
(I will explain these later, do not worry now, just read the difinitions for now.)

What is FIFO & LIFO ? Significance and Usage

2009-06-28T00:47:00.001-07:00

It's worth noting that there are other methods of inventory accounting beside LIFO and FIFO, such as the specific identification method, but those are outside the scope of this article.

Definition:

FIFO stands for First In First Out, while LIFO stands forLast In First Out.

FIFO and LIFO are two different ways to account for the cost of inventory. Remember:

FIFO and LIFO are cost flow assumptions not product flow assumptions.

Usage:

When to use LIFO?

Since prices generally rise over time because of inflation, this method records the sale of the most expensive inventory first and thereby decreases profit and reduces taxes. However, this method rarely reflects the physical flow of indistinguishable items.

LIFO valuation is permitted in the belief that an ongoing business does not realize an economic profit solely from inflation. When prices are increasing, they must replace inventory currently being sold with higher priced goods. LIFO better matches current cost against current revenue. It also defers paying taxes on phantom income arising solely from inflation. LIFO is attractive to business in that it delays a major detrimental effect of inflation, namely higher taxes. However, in a very long run, both methods converge.

When to use FIFO?

In an economy of rising prices (during inflation), it is common for beginning companies to use FIFO for reporting the value of merchandise to bolster their balance sheet. As the older and cheaper goods are sold, the newer and more expensive goods remain as assets on the company's books. Having the higher valued inventory and the lower cost of goods sold on the company's financial statements may increase the chances of getting a loan. However, as it prospers the company may switch to LIFO to reduce the amount of taxes it pays to the government.

Significance of LIFO & FIFO System:

It is important to understand the differences between the two because the COGS (cost of goods sold) line item on an income statement is affected by your choice of LIFO vs. FIFO accounting as is the valuation of inventory on the balance sheet.

As a result, a company can impact both its earnings and current assets simply through its choice of inventory cost accounting measures.

Example of LIFO System:

Think about a giant pile of coal. The coal on the bottom of the pile was the first coal to be placed there, whereas the coal on the top of the pile was the most recent (or last) coal placed there. Now, when you go to sell the coal, obviously you are going to sell the coal on the top of the pile first - you aren't going to sell the coal buried on the bottom of the pile. In fact, you may never sell the coal on the bottom of the pile.

Example of FiFO System:

As an example, think about the milk in your grocer's refrigerator. As the grocer buys the milk (i.e. the inventory) he pushes it to the front of the frig and replaces newer milk behind it. In other words, the cartons of milk with the most recent dates are always the first cartons to be sold and the cartons with the later dates are only sold after the newer milk has already been sold.

Why is this seemingly meaningless difference in accounting methods important? Well, if you turnover your inventory very quickly (as is the case with milk) it is probably not that big of a deal. However, if your inventory turns over very slowly it can have a major impact. Consider again the pile of coal. Who knows how long those first pieces of coal on the bottom of the pile have been sitting there?

Impact of LIFO vs FIFO on Financial Statements:

Both these systems affects both the cost of inventory (COGS) on the income statement and the value of inventory on the balance sheet.

In an environment of rising prices (which is usually the environment in most developed economies) if you choose the LIFO method of accounting then the inventory that you sell costs more than the inventory that you have remaining.

Therefore, choosing LIFO will result in lower inventory values on your balance sheet vs. FIFO and higher COGS on the income statement than FIFO.

Choosing the FIFO method of accounting will have the opposite affect. Namely, the inventory that you sell costs you less than the inventory that you have remaining (assuming rises prices which is generally the case). Therefore, the choice of FIFO accounting results in lower COGS on the income statement vs. LIFO and a higher inventory valuation on your balance sheet vs. LIFO.

LIFO VS. FIFO AND ITS IMPACT ON TAXES:

Because FIFO results in lower COGS on the income statement, it also results in higher earnings. But when earnings are higher taxes are also higher. And when taxes are higher, after-tax earnings become lower. On the other hand, LIFO results in lower pre-tax earnings (since COGS are higher) and therefore lower taxes and therefore higher after-tax earnings.

The Use Of LIFO & FIFO and RealBusiness:

As a result of all of the above, the choice between LIFO and FIFO accounting allows a company to manipulate the cost of its inventory by choosing its method even if it is counterintuitive to the reality of their inventory purchasing situation.

most companies choose whichever method has the most favorable impact on their after-tax earnings.

It should be noted however that switching back and forth between the two methods from year to year is not a common practice. To switch from one method to another is a major hassle.
if you continuously switch back and forth then investors will view that decision quite negatively.

companies often keep two separate sets of data. One for tax purposes and one for book purposes.

companies can get the best of both worlds by using FIFO for their books and LIFO for tax purposes

OTHER APPLICATIONS OF LIFO VS. FIFO:

since this decision can affect the value of your inventory, it can also affect your current assets and other balance sheet measures. This is important to understand because many lenders use ratios involving inventory and/or current assets to assess a companies liquidity and financial stability prior to issuing credit. Therefore, the choice of LIFO vs. FIFO may also come into play for companies considering borrowing money, especially if they are concerned about the financial strength of their balance sheet. Keep in mind however, that lenders are also aware of the differences between the two accounting methods and may ask you about your choice.

2009-06-27T08:46:00.000-07:00

What is a Budget?

Budget is a plan of income, expenses & other financial operation for a future period.

Concept of Costing

A person making or producing any thing must not only know how much it costs to make but also to help in determining the selling price.It is necessary that the person not only knows the cost of what is being produced but also the cost of each component which has gone into production.All this is only possible if the costs and data relating to production is properly recorded and analysed, an exercise that the Accountant only can carry out.

Money Measurement Concept.

With the passage of time, the trading volumes and types of commodities available in the market increased and it became increasingly difficult to exchange commodity with commodity.

• That is why the concept of cash / money came in and people started valuing all goods / services in terms of a common commodity called money. Now the price of 10 kg wheat would be Rupees 60 and not 2 meters of cloth. In accounting, every transaction that is worth recording is recorded in terms of money. In other words any event or item that cannot be translated in terms of money is not recorded in books.

Cash and Credit Transactions.

• Translating every transaction in terms of money does not always mean that the money changes hands, the same time at which the transaction takes place. It may be paid before or after the goods are exchanged.

• When the money value of an item being purchased is paid, at the same time the item is exchanged.The transaction is said to be a cash transaction.

• On the other hand, if the payment is delayed to a future date, the transaction is termed as a credit transaction.

Different Types of Business Organizations:

Sole Proprietorship

A business owned and run by a single person

• Partnership

A business owned and run by more than one persons.

• Limited Company

A large organization with separate legal status.