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UROPEAN INTERNATIONAL COLLE

Introduction to Accounting
Dr. Luvnica Verma

Week 1- Lecture 2
Outline
The accounting procedure and system
Meaning of Some terms
assumption of Business Entity
Historical cost
Objectivity
Continuity
Measuring Units
Matching Principal
Form of Business and their Business

Learning Outcomes

Will a clear concept accounting procedure

Will have idea about some important terms of


Accounting

Understand different types of Business

Learning objective
Understanding Some accounting terms
assumption of Business Entity
Historical cost
Objectivity
Continuity
Measuring Units
Matching Principal

Basic Accounting Terms


Transactions: Transactions are those activities of a business, which involve
transfer of money or goods or services between two persons or two
accounts. For example, purchase of goods, sale of goods, borrowing from
bank, lending of money, salaries paid, rent paid, commission received and
dividend received.
Transactions are of two types, namely,
Cash Transaction is one where cash receipt or payment is involved in the
transaction.
For example, When Ram buys goods from Kanha paying the price of goods by
cash immediately, it is a cash transaction.
Credit Transaction is one where cash is not involved immediately but will be
paid or received later.
In the above example, if Ram, does not pay cash immediately but promises to
pay later, it is credit transaction.

Basic Accounting Terms


Proprietor
A person who owns a business is called its proprietor. He
contributes
capital to the business with the intention of earning profit.
Capital: It is the amount invested by the proprietor/s in the
business.
This amount is increased by the amount of profits earned and the
amount of additional capital introduced.
It is decreased by the amount of losses incurred and the amounts
withdrawn.
For example, if Mr.Anand starts business with Rs.5,00,000, his
capital would be Rs.5,00,000.

Basic Accounting Terms


Assets: Assets are the properties of every description
belonging to the
business. Cash in hand, plant and machinery, furniture
and fittings, bank balance, debtors, bills receivable,
stock of goods, investments, Goodwill.
Assets can be classified into:
1. Tangible Assets: These assets are those having
physical
existence. It can be seen and touched. For example,
plant & machinery, cash, etc.
2. Intangible Assets: Intangible assets are those
assets having no
physical existence but their possession gives rise to
IPMORTA
some rights and
NT
benefits to the owner. It cannot be seen and touched.

IPMORTA
NT

Basic Accounting Terms

Debtors
A person (individual or firm) who
receives a benefit without giving
money or moneys worth
immediately, but liable to pay in
future or in due course of time is a
debtor.
The debtors are shown as an asset in
the balance sheet.
For example, Mr. Arun bought
goods on credit from Mr.Babu for
Rs.10,000.
Mr. Arun is a debtor to Mr.Babu
till he pays the value of the goods.

IPMORTA
NT

Creditors

A person who gives a benefit


without receiving money or
moneys worth immediately
but to claim in future, is a
creditor.
The creditors are shown as a
liability in the balance sheet.
In the above example Mr.Babu
is a creditor to Mr.Arun till he
receive the value of the goods.

Basic Accounting Terms


Liabilities
Liabilities refer to the
financial obligations of a
business.
These denote the amounts
which a business owes to
others,
e.g., loans from banks or
other persons, creditors for
goods supplied, bills payable,
outstanding expenses, bank
overdraft etc.

Drawings
It is the amount of cash
or value of goods
withdrawn from the
business
by
the
proprietor
for
his
personal use.
It is deducted from the
capital.

Basic Accounting Terms


Purchases
Purchases refers to the
amount of goods bought by a
business for resale or for use
in the production.
Goods purchased for cash are
called cash purchases.
If it is purchased on credit, it
is called as credit purchases.
Total purchases include both
cash and credit purchases.

Purchases Return or
Returns Outward
When goods are returned to
the suppliers due to
defective quality or not as
per the terms of purchase, it
is called as purchases
return.
To find net purchases,
purchases return is deducted
from the total purchases.

Basic Accounting Terms


Sales
Sales refers to the amount of
goods sold that are already
bought or manufactured by
the business.
When goods are sold for cash,
they are cash sales
But if goods are sold and
payment is not received at the
time of sale, it is credit sales.
Total sales includes both cash
and credit sales.

Sales Return or Returns


Inward
When goods are returned
from the customers due to
defective quality or not as
per the terms of sale, it is
called sales return or
returns inward.
To find out net sales, sales
return is deducted from
total sales.

Basic Accounting Terms


Revenue means the amount receivable or realized
from sale of goods and earnings from interest,
dividend, commission, etc.
Expense
It is the amount spent in order to produce and sell
the goods and services.
For example, purchase of raw materials, payment of
salaries, wages, etc.
Income
Income is the difference between revenue and
expense.

Basic Accounting Terms


Voucher
It is a written document in
support of a transaction.
It is a proof that a
particular transaction has
taken place for the value
stated in the voucher.
It may be in the form of
cash receipt, invoice, cash
memo, bank pay-in-slip
etc.
Voucher is necessary to
audit the accounts.

Invoice
Invoice
is
a
business
document which is prepared
when one sell goods to
another.
The statement is prepared
by the seller of goods.
It contains the information
relating
to
name
and
address of the seller and the
buyer, the date of sale and
the clear description of
goods
with quantity and price.

Basic Accounting Terms


Receipt

Receipt is an
acknowledgement for
cash received.
It is issued to the party
paying cash.
Receipts form the basis
for entries in cash book.

Account
Account is a summary of
relevant business transactions
at one place relating to a
person, asset, expense or
revenue named in the heading.
An account is a brief history
of financial transactions of a
particular person or item.
An account has two sides
called debit side and credit
side.

GAAP

Generally Accepted Accounting


Principles
Professionals in the field of accounting have worked
hard to develop and consistently follow generally
accepted accounting principles (GAAP), in order to
describe the best method of recording any financial
transaction and to ensure that readers of financial
statements can immediately depend upon their
accuracy.

16

Generally Accepted
Accounting Principles
Eleven of the most critical generally accepted
accounting principles all managers simply must
recognize include:

17

Distinct business entity principle


Going concern principle
Monetary unit principle
Time period principle
Cost principle
Consistency principle
Matching principle
Materiality principle
Objectivity principle
Conservatism principle
Full disclosure principle

IMPORTA
NT

The Distinct Business Entity


Principle
The distinct business entity principle
states that a businesss financial
transactions should be kept completely
separate from those of its owners.
There are three basic types of business
ownership in the United States.
Corporation
Partnership
Proprietorship
18

The Going Concern


Principle
The going concern principle means that
accountants make the assumption that the
business will be ongoing (continue to exist)
indefinitely and that there is no intention to
liquidate (sell) all of the assets of the business.
The going concern principle clearly directs
accountants to record the value of a businesss
assets only at the price paid for them, so that
readers of a financial statement know that asset
values represent a businesss true cost, and not
the cost of liquidation or replacement.
19

The Monetary Unit


Principle
The monetary unit principle means that financial
statements must be prepared in a specific
currency denomination. In the United States, the
U.S. dollar is the monetary unit used for preparing
financial statements.
Fulfilling the monetary unit principle can be quite
complicated, since companies often operate in
more than one country, and use more than one
currency in their operating transactions.

20

The Time Period


Principle

The time period principle requires a business to


identify the time period for which its financial
transactions are reported.
A fiscal year consists of 12 consecutive months (but
not necessarily beginning in January and ending in
December like a calendar year).
The amount of time included in any summary of
financial information is called an accounting period.
The managers of a business may be most
interested in monthly, weekly, or even daily
financial summary reports.

21

The Cost Principle


The cost principle requires accountants to record
all business transactions at their cash cost.
For example, if a piece of land is purchased for Rs.5,00,000
and its market value is Rs.8,00,000 at the time of preparing
final accounts the land value is recorded only for Rs.5,00,000.
Thus, the balance sheet does not indicate the price at which the
asset could be sold for.

22

The Consistency
Principle
The consistency principle of accounting states
that a business must select and consistently
report financial information under the rules of the
specific reporting system it elects to use.
In an accrual accounting system, revenue is
recorded when it is earned, regardless of when it
is collected, and expenses are recorded when
they are incurred, regardless of when they are
paid.
A cash accounting system records revenue as
being earned when it is actually received and
records expenditures when they are actually paid,
regardless of when they were incurred.
23

The Matching Principle


The matching principle is designed to closely
match expenses incurred to the actual revenue
those expenses helped generate.
This principle applies to those organizations that
elect to use an accrual system of accounting.

24

The Materiality Principle


The consistency and matching principles require
accountants to expense the cost of certain longlife assets like furniture and equipment over the
time period in which they will help a business
generate revenue.
The
materiality
principle,
however,
allows
accountants, under very strict circumstances, to
vary from these two important principles.
The materiality principle means that if the value of
an item is deemed to be not significant, then other
accounting principles may be ignored if it is not
practical to use them.
25

The Objectivity Principle


The objectivity principle states that financial
transactions must have a confirmable (objective)
basis in fact.
Sales should have substantiating evidence to
prove that they actually occurred, such as guest
checks, bank card statements, or various sales
records maintained in an electronic cash register
or computer.
Before they can be recorded as having been
incurred or paid, expenses must be verified with
evidence such as delivery slips or original
invoices supplied by vendors, cancelled checks,
26
or documented electronic funds transfers (EFTs).

The Conservatism Principle


The
conservatism
principle
requires
the
accountants of a business to be conservative
when reporting its revenue (and thus not to
report it until it is actually earned) and realistic
when reporting its expenses and other liabilities.

27

The Full Disclosure


Principle
The full disclosure principle requires that any past or
even future event which could materially affect the
financial standing of the business and that cannot be
easily discerned from reading the businesss
financial statements must be separately reported.
These reports, prepared in the form of footnotes,
must be attached to the financial statements
prepared by the businesss accountants.
Examples of such events include significant lawsuits,
changing from a cash to an accrual accounting
system,
significant
tax
disputes,
modifying
depreciation schedules, or unusual events.

28

Learning objective

Understanding different Forms of


Business and their Business

Form of Business
Sole Proprietor/Sole Trader
Partnership
Companies

Short Assignment
1.Briefly explain for all stated form of
business.

Sole Proprietor or Sole


Trader
Business ownership is a single business carried
on by individuals and owned by individual full.
Business owner have a power to control the
business operations.
Owners and business is referred to as one of the
same entity. No separation between them.
Owners will received all the profits and bear for
all losses from business.
Unlimited liabilities

Advantages
Easy to set up.
The owner has absolute power to control the
business.
Fast decision make by the owner of the business.
Individual Tax.
No need the complex financial reports.

Disadvantages
Difficult to grow because of the limited capacity
of capital
Difficult to get capital financing from the financial
institution because they need a strong assurance
from the business.
Liability is unlimited.
Business will disband itself if the owner died.

Partnerships
A partnership is defined as the relationship that
exist between person carrying on business.
These person agree to combine some or all their
property, labor and skill. This relationship is
based on contract.
Business owned by minimum of two persons and
maximum of 20 persons.
Professional service partnerships consist of
maximum 50 persons.
There are two types of partnerships:
-Active partner
-Sleeping partner

Partnerships
Strictly follow the Partnerships Act 1961 and
partnerships contract of agreement for profit and
loss distribution.
Liability for partnerships is unlimited except for
the limited partnerships.
General partners have unlimited liability for
partnerships debts, and the partnerships
terminates when a general partner wishes to sell
out or dies.

Advantages
Partnerships allow for a greater amount of
money, skill and other resources to be pooled.
They are relatively easy to organize.
They are subject to limited government
regulations and do not face high tax rates.

Disadvantages
Partnerships have a limited life.
Each partner is subject to unlimited liability. This
means that if the company fails, creditors can
take action against both the partnership and the
persons who are in it.
Partners have mutual agency. This means that
one partner can make decisions without
consulting to other(s).

Corporation
A business created as a distinct legal entity
composed of one or more individuals or entities.
In Malaysia, corporations are follow strictly under
Company Act 1965.
Corporation are divide into two
-Private Limited
-Public Limited

Corporation
Private limited can be held by minimum of 2 and
maximum of 50 shareholders.
There is no maximum shareholders for Public
limited company.
Shareholders will received their profit in the form
of dividend.
Corporation managed by Board of Director that
appointed by shareholders in AGM.
Liability of shareholders is limited base on the
paid up capital.
Tax is paid, base on company profit.
Eg: Tenaga Nasional Berhad, Safeguard Securicor
Sdn Bhd.

Corporation
Acorporation(sometimes referred to as a C
corporation) is an independent legal entity owned
by shareholders. This means that the
corporationitself, not the shareholders that own
it, is held legally liable for the actions and debts
the business incurs.
Advantages

Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital

Disadvantages

Double taxation
Cost of set-up
and report filing

Suggestion
Accounting Cycle
GAAP
Forms of Business

QUESTION?

Week 1 Lecture 2 Outline

Basic Accounting equation


Asset
Liabilities
Owners equity
Revenue and expenses
Business Transaction
Analysis the effect of business
transaction on the basic accounting
equation

Learning Outcomes
After completing this chapter you will be
able to
Understand the accounting equation
Get an idea about the components of
accounting system
Interpret the effect of business
transaction on the basic accounting
equation

Learning objective

Basic Accounting equation

The Accounting equation


Accounting as a whole is based
on a single equation:

ASSETS = EQUITY +
LIABILITIES

DOUBLE-ENTRY SYSTEM
In a double-entry system, equal
debits and credits are made in
the accounts for each
transaction.
Thus, the total debits will always
equal the total credits and the
accounting equation will always
stay in balance.

Assets

Liabilities

Equity

So what does the


accounting equation mean?
Well, in order to answer that question
we need to look at what each of the
terms in the equation mean
1. Assets
2. Liabilities
3. Owners Equity

What is an asset?
Official Definition: A resource
controlled by the enterprise as a
result of past events and from which
future economic benefits are
expected to flow to the enterprise.

examples

Land
Computer
Vehicle
Cash

So the full test of whether


something is an asset is:
1.DOES YOUR BUSINESS
OWN/CONTROL IT?
2.WILL IT BRING YOUR BUSINESS
BENEFITS IN THE FUTURE?
3.CAN YOU VALUE IT ACCURATELY?

Changes in assets
Decrease Assets

Increase Assets

Purchasing Supplies (The asset


account Cash decreases)

Purchasing Supplies (The asset


account Supplies increases)

Owner Draws

Owner Contributions

Repaying bank loans

Receiving bank loans


Credit purchases

The accounting equation


ASSETS = EQUITY + LIABILITIES
The accounting equation indicates
how much of the assets of a business
belong to, or are owned, by whom.
Assets can only belong to two types of
people:
people outside the business who are owed
money (liabilities)
the owner himself (owners equity).

Changes in owners equity


Decrease Owners Equity

Increase Owners Equity

Expenses

Revenues

Losses

Gains

Owner withdraws

Owner investments
Beginning Capital

Revenues
Income
Example: a service company earns
revenue when it provides services to
its clients
Recorded as an increases in owners
equity and an increase in assets

Expenses
The costs the company incurs in
carrying on operations in its effort to
create revenue
Decrease owners equity
Can be paid for with cash (decreases
assets)
Or charged (increase liabilities)

owners equity

Beginning
Capital
PLUS
Additional
Investment

Net Income*

Revenues
-- Expenses

Withdraws

If expenses are greater than revenues, then a net loss would result.
This loss would be subtracted from capital because it would be a
negative number.

EQUITY is the OWNERS CLAIM ON


ASSETS
In a business EQUITY is composed of
four parts that EQUITY
either increase or
decrease equity:
CAPITAL:
What the
owner
puts into
the
business

INCREASE
DECREASE

WITHDRAW
ALS:
What the
owner
takes out of
the
business

DECREASE

REVENUE
S:
What the
company
receives
for sales

INCREASE
58

EXPENSE
S:
What the
company
pays to
operate
the
business.

Sometimes we expand the


Accounting Equation to show all
the Equity components. This is
called the
EXPANDED ACCOUNTING
EQUATION.

This equation
must ALWAYS BE
IN BALANCE
59

P1

Transaction Analysis
Business activities can be described in
terms of transactions and events. External
transactions are exchanges of value
between two entities, which yield changes
in the accounting equation. Internal
transactions are exchanges within any
entity; they can also affect the accounting
equation. Events refer to happenings that
affect an entitys accounting equation and
can be reliably measured. Transaction
analysis is defined as the process used to
analyze transactions and events.

1-60

Accounting Transactions...

are economic events


that must be recorded
in the financial
statements because
they affect
assets
liabilities
and/or stockholders
equity

Transaction Analysis
The process of identifying the
specific effects of economic
events on the accounting
equation.
Each transaction has a dual
(double-sided) effect on the
accounting equation.

Steps in transaction analysis


Step 1: Identify the name of accounts
Step 2: Classify the Accounts
Step 3: Analyze the impacts on
accounting equation

Steps in transaction analysis


Step 1: Identify the name of accounts
Jims Lemonade
Chart of Accounts

101
105
110
150
201
210
305
320
401
410
501
505
510

Cash
Accts Receivable
Office Supplies
Equipment
Accounts Payable
Wages Payable
Common Stock
Retained Earnings
Sales - Lemonade
Sales Catering
Lemon Expense
Insurance Expense
Office Expense

P1

Transaction Analysis
The balances so far appear below. Note that the
Balance Sheet Equation is still in balance.

1-65

P1

Transaction Analysis

Now, lets look at transactions


involving revenue, expenses
and dividends.

1-66

P1

Transaction Analysis

Provided consulting services receiving


$3,000 cash.

1-67

P1

Transaction Analysis
Paid salaries of $800 to employees.

Remember that expenses decrease equity.


1-68

P1

Transaction Analysis

Dividends of $500 are paid to shareholders.

Remember that dividends decrease equity.


1-69

Every Account has:


An Increase Side,
and
A Decrease Side
But, Some
Accounts Increase
on the Debit Side
And, Some
Accounts Increase
on the Credit Side

Effects
Effects of
of Transactions
Transactions on
on Owners
Owners Equity
Equity
OWNERS EQUITY

71

Effects
Effects of
of Transactions
Transactions on
on Owners
Owners Equity
Equity
OWNERS EQUITY
decreased by

72

Effects
Effects of
of Transactions
Transactions on
on Owners
Owners Equity
Equity
OWNERS EQUITY
decreased by

Owners withdrawals
Expenses

73

Effects
Effects of
of Transactions
Transactions on
on Owners
Owners Equity
Equity
OWNERS EQUITY
increased by

74

Effects
Effects of
of Transactions
Transactions on
on Owners
Owners Equity
Equity
OWNERS EQUITY
increased by

Owners investments
Revenues

75

Effects
Effects of
of Transactions
Transactions on
on Owners
Owners Equity
Equity
OWNERS EQUITY
decreased by

76

increased by

Owners withdrawals

Owners investments

Expenses

Revenues

The Accounting Equation

77

The Accounting Equation


Assets

Economic
Resources

78

= Liabilities + Owners Equity

Claims to
Economic
Resources

The Accounting Equation


Resources

What are an organizations resources called?

79

The Accounting Equation


Resources

Sources

Assets

Resources used
in the business

80

What are the


sources of the
assets?

The Accounting Equation


Resources

Sources
Liabilities

Assets
Owners
Equity

Resources used
in the business

81

Resources
supplied by
creditors and
owners

Business
Business Transactions
Transactions
a. Sachin deposits $ 25,000 in a bank account
ABC Ltd
LIABILITIES

ASSETS

82

for

OWNERS EQUITY

Business
Business Transactions
Transactions
a. Sachin deposits $ 25,000 in a bank account
ABC Ltd.
LIABILITIES

ASSETS

Cash
25,000

83

for

OWNERS EQUITY

Business
Business Transactions
Transactions
a. Sachin deposits $ 25,000 in a bank account
ABC Ltd.
LIABILITIES

ASSETS

Cash
25,000

for

OWNERS EQUITY
Sachin, Capital
25,000

84

Business
Business Transactions
Transactions
b. ABC Ltd. buys land for $ 20,000.

LIABILITIES

ASSETS

85

OWNERS EQUITY

Business
Business Transactions
Transactions
b. ABC Ltd. buys land for $ 20,000.

LIABILITIES

ASSETS
Cash
(20,000)

86

OWNERS EQUITY

Business
Business Transactions
Transactions
b. ABC Ltd buys land for $ 20,000.

LIABILITIES

ASSETS
Cash
(20,000)
Land
20,000

87

OWNERS EQUITY

Business
Business Transactions
Transactions
c. ABC Ltd buys goods for $1,350, agreeing to
the supplier in the near future.
LIABILITIES

ASSETS

88

pay

OWNERS EQUITY

Business
Business Transactions
Transactions
c. ABC Ltd buys goods for $1,350, agreeing to
the supplier in the near future.

pay

LIABILITIES

ASSETS

Accounts Payable
1,350
Purchases
1,350

89

OWNERS EQUITY

Business
Business Transactions
Transactions
e. ABC Ltd paid: wages $ 2,125; rent, $ 800;
utilities, $ 450; and miscellaneous, $ 275.
LIABILITIES

ASSETS

90

OWNERS EQUITY

Business
Business Transactions
Transactions
e. ABC Ltd paid: wages $ 2,125; rent, $ 800;
utilities, $ 450; and miscellaneous, $ 275.
LIABILITIES

ASSETS

Cash
(3,650)

91

OWNERS EQUITY

Business
Business Transactions
Transactions
e. ABC Ltd paid: wages $ 2,125; rent, $ 800;
utilities, $ 450; and miscellaneous, $ 275.
LIABILITIES

ASSETS

Cash
(3,650)

OWNERS EQUITY
Expenses
(3,650)

92

Business
Business Transactions
Transactions
f. ABC Ltd pays $ 950 to creditors on account.
LIABILITIES

ASSETS

93

OWNERS EQUITY

Business
Business Transactions
Transactions
f. ABC Ltd pays $ 950 to creditors on account.
LIABILITIES

ASSETS

Cash
(950)

94

OWNERS EQUITY

Business
Business Transactions
Transactions
f. ABC Ltd pays $ 950 to creditors on account.
LIABILITIES

ASSETS

Accounts Payable
(950)
Cash
(950)

95

OWNERS EQUITY

Business
Business Transactions
Transactions
h. Sachin withdraws $ 2,000 in cash.
LIABILITIES

ASSETS

96

OWNERS EQUITY

Business
Business Transactions
Transactions
h. Sachin withdraws $ 2,000 in cash.
LIABILITIES

ASSETS

Cash
(2,000)

97

OWNERS EQUITY

Business
Business Transactions
Transactions
h. Sachin withdraws $ 2,000 in cash.
LIABILITIES

ASSETS

Cash
(2,000)

OWNERS EQUITY
Sachins, Drawing
(2,000)

98

Transaction
Transaction Summary
Summary
LIABILITIES

ASSETS
Cash
Purchases
Land

99

6,700
550
20,000

OWNERS EQUITY

Transaction
Transaction Summary
Summary
LIABILITIES
Accts. Payable 400

ASSETS
Cash
Purchases
Land

100

6,700
550
20,000

OWNERS EQUITY

Transaction
Transaction Summary
Summary
LIABILITIES
Accts. Payable 400

ASSETS
Cash
Purchases
Land

101

6,700
550
20,000

OWNERS EQUITY
Sachin, Capital
Sachin, Drawing
Fees Earned
Wages Expense
Rent Expense
Commission
Misc. Expense

25,000
(2,000)
7,500
(2,125)
(800)
(450)
(275)

EXAMPLE
Issuing stocks for cash or other assets $6000
Buying assets by borrowing money (taking a
loan from a bank or simply buying on credit)
$10000
Selling assets for cash to pay off liabilities:
both assets and liabilities are reduced $900
Buying assets by paying cash by shareholder's
money (600) and by borrowing money (400)
Earning revenues $700

102

Examples
Transac
tion
Assets
Number
1

Liabilities

6,000

10,00
+
0

10,00
0

900

900

1,000 +

700

Shareholder'
s
Equity
+

6,000

400 +

600

700

Some more Examples


Paying expenses (e.g. rent or
professional fees) or dividends $200
Recording expenses, but not paying
them at the moment $100
Paying a debt that you owe $500
Receiving cash for sale of an asset:
one asset is exchanged for another;
no change in assets or liabilities
104

Solutions
Transa
ction
Assets
Numb
er
6

Liabilities

200

7
8

Sharehold
er's
Equity

500

200

100

100

500

EIC Abu
Dhabi

European International
College-AbuDhabi

Thank you!

@EICabudh
abi