Accounting Is The Language Of Business Accounting Essay

Category: Accounting

Just like Latin was the universal language of scholarship throughout the middle ages --scholars learned Latin as well as their own language, and thus were able to communicate with one another via writing-- accounting is the language spoken by financial and investing professionals, the capital markets, business analysts and coaches, and bankers. Every business owner will benefit from an understanding of the basic terms and concepts used in accounting, or are at a disadvantage to those who do.

As accountants prepare financial statements, we communicate the current health (balance sheet) and history (profit and loss with statement of cash flows) of the business entity. We are the messengers for the banks, investors and government reporting agencies. Our responsibility is to prepare correct financial statements in order for the users to gain an understanding of the business entity. The language is somewhat limited (assets, liabilities, equity, revenue and expenses), but can be very specific (Bond Premium Discounts, Deferred Tax Charges, etc.). There are two basic dialects (debits and credits). Of course there is often confusion that can quickly be more complicated once we try to explain book accounting (GAAP) and why it does not agree with tax accounting. EBITA is a foreign word known and understood mostly by accountants. And we are saved by the footnotes that can further communicate and add clarity (with a few exceptions…Deferred Taxes).

b) In accounting business transactions are recorded as having a dual aspect.

Dual aspect is the foundation or basic principle of accounting. It provides the very basis for recording business transactions into the book of accounts. This concept states that every transaction has a dual or two-fold effect and should therefore be recorded at two places. In other words, at least two accounts will be involved in recording a transaction.

For example Tom started business with a sum of $50000; the amount of money brought in by Tom will result in an increase in the assets (cash) of business by $ 50000. At the same time, the owner's equity or capital will also increase by an equal amount. It may be seen that the two items that got affected by this transaction are cash and capital account. In the same way suppose tom buy goods of $20000 on credit then at one hand assets will increase by $20000 and on other hand liabilities will increase by $20000

The duality principle can be expressed in terms of fundamental Accounting Equation that can be written as follows: Assets = Liabilities + Capital

In other words, above equation states that the assets of a business are always equal to the claims of owners and the outsiders. The two-fold effect of each transaction affects the above equation in such a manner that the equality of both sides of equation is maintained.

Dual aspect concept from the core of accounting and hence it is very important concept which one should always keep in mind while handling books of accounts.

c) Purchases book records all purchases.

In any organization where company buys and sells the goods on credit, at that organization, we need to divide journal into subsidiary books. One of these subsidiary books is purchase book. In purchase book, we record all transactions relating to credit purchases of goods only and these goods are trading goods. Company deals in these goods and products. In this book, accountant does not record cash purchases and purchase of assets in which company does not deal. Suppose shop of furniture's product is furniture and its credit purchase will be recorded in purchase book. Its other name is bought book, purchase journal and purchase day book. This book is maintained on the basis of invoice. Accountant records quantity of products, rate and amount from invoice. Each transaction is recorded by giving invoice no.

d) Goods taken out by proprietor from the business personal use are credited to sales account.

Drawings of stock imply the Stock/Goods taken away by the proprietor or the partner for personal purposes. These goods are to be valued at cost and not at their selling prices.

Debit » Drawings a/c

The value of goods taken away being drawings has to be debited to the "Drawings a/c" which represents the owner of the business.Â

[Drawings a/c - Personal a/c - Debit the benefit receiver.]

Credit »

The value of goods withdrawn by the proprietor represents the value of stock that has not been used for trading purposes. To reveal the cost of goods sold, the value of stock unused for trading activity is to be deducted from the total value of goods.

For this the following ledger account would be credited depending on the time of recording the transaction, what comprises the value of stock drawn and the account in which the related value exists at the time of recording the entry.

Differentiate between provision and reserves.

Ans. The points of difference between provision and reserve are stated in the tabular form:

1.

It is a possible loss so it is created by debiting profit and loss account. It is a charge against profit

1.

It is a portion of profit earned by business. It is created by debiting profit and loss appropriation account. It is an appropriation of profit.

2.

Profit and loss account will not disclose true profit/loss, unless provision is created.

2.

Profit and loss account discloses true profit/loss, even if no reserve is created.

3.

It is created to meet specific loss or liability. But the amount of loss or liability cannot be determined exactly. So the amount of provision is an estimated amount.

3.

It is meant for meeting any unknown loss or liability. It is generally created with a portion of profit earned by business.

4.

It must be created irrespective of whether there is a profit or loss. In other words its creation is obligatory.

4.

It cannot be created unless there is a sufficient profit. Its creation is the discretion of management. In other words, it is not obligatory.

5.

Profit or loss is effected by its creation - profit decreases or loss increases.

5.

It does not effect profit or loss, since it is created after ascertaining profit.

6.

Dividend cannot be paid out of it.

6.

Dividend can be paid out of it.

7.

Its amount must be sufficient to meet the loss or liability.

7.

Its amount is generally determined by management on the basis of the amount of profit earned.

8.

It cannot increase working capital - it is utilized for meeting the specific loss or liability.

8.

It increases working capital and thereby strengthen the financial position of the business concern.

9.

The owner of the business cannot have any claim over it, since it is created for meeting a specific loss or liability.

9.

The owner can claim it, since it is created out of profit.

10.

It is shown on asset side of the balance sheet as deduction from the concerned asset, e.g., provision for doubtful debts is shown as deduction from sundry debtors.

10.

It is shown on liability side of the balance sheet as a separate item.

11.

It is used for the specific purpose for which is has been created.

11.

It can be used for the purpose whatsoever.

12.

Auditors must check its adequacy.

12.

Auditors are not required to check adequacy.

What is depreciation? State different causes of depreciation.

Ans. Depreciation refers to two very different but related concepts:

the decrease in value of assets (fair value depreciation), and

the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching principle).

The former affects values of businesses and entities. The latter affects net income. Generally the cost is allocated, as depreciation expense, among the periods in which the asset is expected to be used. Such expense is recognized by businesses for financial reporting and tax purposes. Methods of computing depreciation may vary by asset for the same business. Methods and lives may be specified in accounting and/or tax rules in a country. Several standard methods of computing depreciation expense may be used, including fixed percentage, straight line, and declining balance methods. Depreciation expense generally begins when the asset is placed in service. Example: a depreciation expense of 100 per year for 5 years may be recognized for an asset costing 500.

Here are some of the reasons or causes of depreciation:

Physical loss

Any damaging change in the physical features of the asset or  in the productivity, efficiency or effectiveness of the asset either because of the usage, perishability, or any mishap will result in the decrease in the value of asset and subsequent disposal will not fetch the same amount as was paid at the time of acquisition.

Usage

Perishability

Accident

Technological advancement

Extinction may be because of tastes and fashion or support service, spare parts not available etc. Required raw material or input is not available due to any reason or the output carry no customers in the market.

Inappropriateness

Expiry right to use has expired over time

Exhaustion in case of natural resources such as mines and wells exhaust as a result of extraction of minerals

However, following are some examples which many students might misinterpret as causes of depreciation are not. Rather these examples can be one the causes of impairment.

Market perception stolen and recovered subsequently will not have the same perceived value as the new one has or the old one with of same condition. Legal documents have been misplaced and thus ownership is not evidenced or with duplicate book where duplicate book is taken not as good as original documents.

Legality no longer legal to be used or the input required or output obtained is no longer legal.is declared hazardous. All machinery which was used to manufacture Freon gas after it

Market perception:Â due to any reason customers' perception of asset's utility has been hampered. For example, ownership documents has been misplaced.

Depreciation is a gradual decrease in the value of asset and not one off or sudden fall. That is the main difference between depreciation and impairment.

What are the different classes of errors? Which of them do not affect a Trial Balance?

Ans.

Errors of omission:

If a transaction is not recorded in books of original entry then both debit and credit effects of the transaction will be omitted and trial balance shall no be effected.

Errors of commission:Â

These errors are the result of carelessness of accounting staff and in some of the cases such errors do not effect the totals of trial balance.

Compensating errors:

Such errors neutralize the effect of the errors committed earlier. When one error is committed which affect the total of trial balance but in the mean time another error of opposite effect is committed which neutralizes the effect of earlier error.

Errors of principle:

Whenever any income or expenditure is not properly allocated between capital and revenue, the mistake so made is called a mistake of principle.

Give the rules of debit and credit and explain them with imaginary examples.

Ans. Debits & Credits

In each and every accounting transaction, there are at least two elements (accounts) involved. These accounts are either debited or credited, with the amount that is reflected in the transaction, depending on the nature of the account (Real/Personal/Nominal) and the rule applicable to it.

Golden universal rules of Debits & Credits

Accounting elements are categorized into three groups;

Real - examples are cash, equipment, furniture etc.

Personal - Proprietor's Capital, Accounts Payable, Accounts Receivables etc.

Nominal - All expenses & gains

1.Real Account

Debit what comes In

Credit what goes out

Example: Paid for equipment purchase $10,500. In this accounting transaction, cash and equipment accounts are involved. They belong to real account. Now applying golden rule for real accounts we know debit what comes in, So equipment would be debited and cash goes out, so cash would be credited.

2.Personal Account

Debit the receiver

Credit the giver

Example: Purchased raw materials (GI Sheets) for $125,125 from Sheets Supplier Company on credit. We have Raw Materials Inventory (Real Account) and Sheets Supplier Company (Personal Account). Golden Rule for Personal account Credit the giver. So entry would be :

Raw Materials(Sheets) Inventory Debit $125,125

Sheets Supplier Company Credit $125,125

3.Nominal Account

All expenses & Losses should be Debited

All income & gains should be Credited

Example : Used Sheets for $50,100 for the repairing work In this transaction we have expense for the period and applying the golden rule, We need to debit Work In Progress(expense account for raw materials usage viz. all expenses should be debited) as follows :

Work In Process Debit $50,100

Raw Materials(Sheets) Inventory Credit $50,100

a journal entry that would be recorded that impacts the balance sheet.

Equipment $10,500 (Assets on Balance Sheet)

Cash $10,500 (assets on Balance Sheet)

a) What are prepaid expenses? Explain with the help of examples.

Ans. Prepaid expense is expense paid in advance but which has not yet been incurred.

Expense must be recorded in the accounting period in which it is incurred. Therefore, prepaid expense must be not be shown as expense in the accounting period in which it is paid but instead it must be presented as such in the subsequent accounting periods in which the services in respect of the prepaid expense have been performed.

Entity should therefore recognize an asset in respect of expense it has paid in advance until such time as the services that are due in relation to the prepaid expense have been performed by the suppliers/contractors. Following accounting entry is required to account for the prepaid expense:

Debit

Prepaid Expense (Asset)

Credit

Cash

Example

ABC LTD pays advance rent to its landowner of $10,000 on 31st December 2010 in respect of office rent for the following year. ABC LTD has an accounting year end of 31st December 2010.

ABC LTD will recognize an asset of $10,000 in the financial statements of year 2010 in respect of the prepaid expense to recognize its right to use office space in the following year. Following accounting entry will be recorded in the books of ABC LTD in the year 2010:

$

$

Debit

Prepaid Rent

10,000

Credit

Cash

10,000

The prepaid expense will be recognized as expense in the next accounting period to which the rental expense relates. Following accounting entry will be recorded in the year 2011:

$

$

Debit

Rent Expense (Income Statement)

10,000

Credit

Cash/Bank

10,000

b) What is meant by the provision for discount on debtors? Explain with the help of examples

Ans. In accounting, provision for discount on debtors shows the reserve amount for adjusting loss due to discount allowed to our debtors. Every businessman wants to get money faster from their customer. So, businessman accepts less money than actual from those customers who will pay before maturity of debt. So, at the end of year, we make provision for next year losses due to discount allowed. So, these provisions will be called provision for discount on debtors. This provision is made on the basis of past experience with customers. We will not use this money which has been kept out of profit and will use for purchasing new material in case our loss of discount allowed will happen. This provision may be 1 % to 10% of net debtors.Â

We will show provision for discount on debtors in profit and loss account and balance sheet. Many students are still confused which amount of provision for discount on debtor will be shown in profit and loss account and balance sheet. According to question, there may be different situation but best procedure is to make provision for discount on debtors account and new provision of this year will be deducted out of gross debtors in balance sheet and balancing figure of provision for discount on debtors account will be shown in the debit side of profit and loss account.Â

I can explain you with a very simple example

suppose your trial balance showing Rs.5 as provision for discount on debtors account in the credit side. Your trial balance also showing bad debts of Rs.15 and discount allowed of Rs.10 and debtors Rs.100. Outside of trial balance there are following adjustments.Â

a) Provision for bad debts 10%

b) bad debts Rs.10

c) provision for discount on debtors.Â

Make provision for discount on debtor account and show these adjustments in final accounts.Â

Provision for discount on debtors accountÂ

Credit sideÂ

1. Provision for discount on debtor account Rs.5

2. Difference of Debit side and credit side will go to profit and loss account Rs.9

Debit sideÂ

1. Discount allowed Rs.10

2. New provision for discount on debtors Rs.4

working noteÂ

debtors 100

less new bad debts 10

----------------------------

balance 90

less new provision for bad debts 10% on 90 = 9

-------------------------------------------------------

balance 81

------------------------------------------------------

new provision of 5% on 81 = 4

Adjustment in Profit and loss accountÂ

In profit and loss account's debit side, we will show only provision for discount account with Rs.9

( Note, we will not show discount allowed )

Adjustment in balance sheetÂ

In balance sheet's asset side, we show only net debtors amountÂ

Balance debtors Rs.81Â

minus new provision for discount on debtors Rs.4

---------------------------------------------------------

Net debtors = Rs.77

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c) What is accrued income? Explain with the help of examples.

Ans. Accrued income is an amount that has been 1) earned, 2) there is a right to receive the amount, and 3) it has not yet been recorded in the general ledger accounts. One example of accrued income is the interest earned on a bond investment.

To illustrate, let's assume that a company invested $100,000 on December 1 in a 6% $100,000 bond that pays $3,000 of interest on each June 1 and December 1. On December 31, the company will have earned one month's interest amounting to $500 ($100,000 x 6% per year x 1/12 of a year, or 1/6 of the semiannual $3,000). No interest will be received in December since it will be part of the $3,000 to be received on June 1. The $500 of interest earned during December, but not yet received or recorded as of December 31 is known as accrued income.

Under the accrual basis of accounting, accrued income is recorded with an adjusting entry prior to issuing the financial statements. In our example, there will need to be an adjusting entry dated December 31 that debits Interest Receivable (a balance sheet account) for $500, and credits Interest Income (an income statement account) for $500.

Accrued income is an amount that has been 1) earned, 2) there is a right to receive the amount, and 3) it has not yet been recorded in the general ledger accounts. One example of accrued income is the interest earned on a bond investment.

To illustrate, let's assume that a company invested $100,000 on December 1 in a 6% $100,000 bond that pays $3,000 of interest on each June 1 and December 1. On December 31, the company will have earned one month's interest amounting to $500 ($100,000 x 6% per year x 1/12 of a year, or 1/6 of the semiannual $3,000). No interest will be received in December since it will be part of the $3,000 to be received on June 1. The $500 of interest earned during December, but not yet received or recorded as of December 31 is known as accrued income.

Under the accrual basis of accounting, accrued income is recorded with an adjusting entry prior to issuing the financial statements. In our example, there will need to be an adjusting entry dated December 31 that debits Interest Receivable (a balance sheet account) for $500, and credits Interest Income (an income statement account) for $500.

Differentiate between capital expenditure and revenue expenditure.

Ans. Following is the difference between capital and revenue expenditures.

Capital Expenditures

Revenue Expenditures

1

Its effect is long term i.e., it is not exhausted within the current account year. Its benefit is enjoyed in future year or years also. In a word, its effect is reduces gradually.

1

Its effect is temporary, i.e., it is exhausted within the current accounting year.

2

An asset is acquired or the value of an asset is increased as a result of this expenditure.

2

Neither an asset is acquired nor is the value of an asset increased.

3

It does not occur again and again - it is non-recurring and irregular.

3

It occurs repeatedly - It is recurring and regular.

4

Generally, it has physical existence i.e., it can be seen with eyes.

4

It has no physical existence, i.e., it cannot be seen with eyes.

5

This expenditure improves the position of the concern

5

This expenditure helps to maintain the concern

6

A portion of this expenditure is shown in the trading and profit and loss account or income and expenditure account as depreciation.

6

The whole amount of this expenditure is shown in trading and profit and loss account or income and expense account. But deferred revenue expenditures and prepaid expenses are not shown.

7

It appears in balance sheet until its benefit is fully exhausted.

7

It does not appear in balance sheet. Deferred revenue expenditure, outstanding expenditure, outstanding expenses and prepaid expenses, however, temporarily shown in the balance sheet.

8

It does not reduce the revenue of the concern. Purchase of fixed assets does not affect revenue.

8

It reduces revenue. Payment of salaries to employees decreases revenue.

Journalize the following transactions:

(a)Â Â Â Mr.Gopal commences business with: Cash-Rs.200000, Furniture-Rs.100000, Building-Rs.700000 and Machinery-Rs.150000.

(b)Â Â Withdrawn cash from bank for personal expenses Rs.250

(c)Â Â Â Goods worth Rs.1000 were given as charity out of business.

(d)Â Â Ram sold goods to Kapil for Rs.700 against a cheque.

(e)Â Â Â Goods costing Rs.660 issues as samples.

(f)Â Â Â Goods sold costing Rs. 5000 to aakash at invoice price 20% above cost less 10% trade discount.

ABC ltd. purchased on Jan1, 1997, certain machinery for Rs.1,94,000 and spent Rs.6000 on its eretion. On July1, 1997 additional machinery costing Rs.1,00,000 was purchased. On July1, 1999 the machinery purchased on Jan1, 1997 has been auctioned for Rs.1,00,000 and on the same date , new machinery was purchased at a cost of Rs.1,50,000. Depreciation was provided annually on Dec31 @ 10% p.a. on original cost. No depreciation need to be charged during the year of sale of machinery for that part of the year when the machine was used. In 2001, however the company has changed the method of depreciation to written down value @ 15% p.a. from the straight line method. Show the machinery account for the period from 1997 to 2001 with retrospective effect.

The book value of plant and machinery on 1-1-2004 was Rs.200000. New machinery for Rs.10000 was purchased on 1-10-2004 and for Rs.20000 on 1-7-2005. On 1-4-2006, a machinery whose book value had been Rs.30000 on 1-1-2004 was sold for Rs.16000. Depreciation had been charged at 10% p.a. since 2004 on SLM. It was decided in 2006 that depreciation @ 20% p.a. on WDV method should be charged with retrospective effect since 1-1-2004.Show plant and machinery A/C up to 31-12-2006.

Differentiate between cash and mercantile systems of accounting.

Ans. The mercantile system is better known in the US as the accrual system. The difference between the accrual and cash system is when a transaction is recognized: the cash system recognizes (records) the transaction when the money is paid or received, while the accrual system recognizes the transaction when it occurs, regardless of whether or not the money is received.

For example, let's take a company that sold computers to another company, with payment to be made in 30 days. Under the cash system, the revenue from this transaction is recorded in 30 days, while under the accrual system the revenue is recorded the day the computers were transferred to the other company.

State the objectives of preparing Trial balance.

Ans. 1. To check the mathematical accuracyÂ

with the help of trial balance, we can simply track if any mathematical fault is done by accountant or it's assistant because at that time, trial balance will not match. We will understand that either one account is shown with fewer amounts or write incorrect amount in any side of any account. After finding that account, we can correct it. So, trial balance has become most important financial report which secures our accounts from all mathematical errors.Â

2. To Make Final Account of Company

it is also objective of trial balance because after making trial balance, we can know which items we have already recorded and which we have to record. If we do not make trial balance and just start profit and loss account, it may possible that we forget to record some adjustment. List of balance in trial balance is also helpful to do proper change specially adjustment of provisions.Â

3. Comparative study of each accountÂ

Trial balance is good source of telling the position of each account and compares it with past balance of same account. By making trial balance, we can decide whether closing balance of accounts will increase or decrease within two accounting period. It can also be used as the tool to decide whether there is need to decrease rate of depreciation for showing improved profit position or not.Â

4. To make financial budgetÂ

previous year trial balance figures are also helpful to estimate the future amount. In other words, we can make financial budget with the help of trial balance and compare with its worth.