Principle of Accounting

Principle of Accounting
“Quick refresher”

Muhammad Usman Qazi

This quick refresher is for beginners or those who need a quick refresher

Table of Contents

Introduction

o Types of business activities

o Types of business organizations

o Types of business transactions

o Types of bookkeeping systems

o Why Bookkeeping?

o Accounting Method (cash and accrual basis)

Definitions

o Introduces the terminology and definitions

Accounting Equation

o Property & Property Rights

o The Accounting Equation

o How business transactions affect the equation

The General Ledger and Journals

o General Journals

o General Ledger

o How they're used,

Recording Business Transactions

o Process of Journalizing

o Debit and Credit Rules

o Process of Posting (Transferring)

o Trial Balance

Financial Statements

o Income Statement

o Capital Statement

o Balance Sheet

o How Financial Report interlinked?

Introduction

Business

Activity and action undertaken by a trader with the objective to earn profit is known as business, First decision has to face by a trader that what kind of business needs to start, there are following kinds:

1. Trading

Purchases goods in bulk and sell them in retail in the same positions.

2. Manufacturing

Purchase goods and sell them after some modifications (changes) i.e sugarcane selling in form of sugar

3. Service

Selling service i.e Lawyer firm, Beauty saloon etc,

Business Organization

A person(s) needs to make is how the company should be structured.

Types of Business Organization

1. Sole Proprietorship

owned by one person who is normally active in running and managing the business.

2. Partnership

A partnership is two or more people who share the ownership of a single business..

3. Corporation

is made up of many owners who normally are not active in the decision making and operations of the business. These owners are called shareholders or stockholders.

Business Transaction (Give and Take)

After taking the decision of business kind and structure, there would be transactions in business which means:

An exchange of goods or services at a particular price, there is following types

1. Cash Transaction

Cash is paid or received as a result of exchange of goods / services i.e cash purchases and cash sales.

2. Credit Transaction

Payment / Receipt of cash is postponed for some future date i.e credit purchases and credit sales.

Bookkeeping

After making transactions needs to record these transactions and there is a way to record business transaction that is bookkeeping which is an art of recording the business transaction, there is following types to record business transactions.

1. Single Entry or Incomplete record

Makes only one entry to enter a business financial transaction i.e either Revenue or Expense

2. Double Entry

Since all business transactions consist of an exchange of one thing for another, double entry bookkeeping using debits and credits, is used to show this two-fold effect. Debits and credits are the device that provide the ability to record the entries twice and are explained in more detail later.

Why Bookkeeping? In order to run a business and know what, where, and when to take corrective actions, required business information. This information may get through business financial activities i.e bookkeeping.

Who need financial information and Why?

1. Internal users i.e managers, the owners and employees who actually work for the business.

2. External users i.e lenders, other creditors (suppliers), investors, customers, governmental regulatory and taxing agencies.

Users need this information

1. To make correct decisions

2. To pay back for the credit

3. To analyze financial information

4. To know the financial position of Business

Accounting Methods

An accounting method is just a set of rules used to determine when and how income and expenses are reported. There is following types:

1. Cash Method

Recognizes revenues in the period the cash is received and expenses in the period when the cash payments are made.

2. Accrual Method

Records income in the period earned and records expenses and capital expenditures such as buildings, land, equipment, and vehicles in the period incurred. The purpose of the accrual method of accounting is to properly match income and expenses in the correct period.

Definitions
Assets: Property or thing having value owned by a company are called

assets, there are of following kinds:

1. Curren Assets

Can be quickly converted into cash i.e resale, consumption i.e cash , debtor,

2. Fixed Assets

Permanent nature held for purpose of earning income (not for resale).i.e land , building ,machinery

3. Tangible Assets

In physical form i.e Land, building

4. Intangible Assets

Not in physical existence i.e Goodwill

Capital: The amount with which the trader starts his business

Sale of Products: Amounts earned from the sale of merchandise.

Trade Discount: is rebate or allowance (concession) from scheduled price granted by seller to buyer. Trade discount not recorded in books

Circumstances: selling to fellow trader, buyer is old customer, sales are made in bulk.

Cash Discount: is deduction or allowance allowed by a creditor to a debtor if person pay his debt before due date

Expense: whose benefit finished

Expenditure: whose benefit is available for future activities of the business

Debtor: A person who owes money to another is a debtor

Creditor: To whom money is owing is a creditor

Liabilities: debts due by a business

Voucher: written evidence in support of a business transaction

Goods (Merchandise): purchased by business for selling

Stock (Inventory): in hand, that is goods remaining unsold.

Equities: Rights to properties are called equities.

» Equities are two types

» Creditors and owner

Accounting
is an art of recording, classifying, summarizing and interpreting the financial information.

Accounting-Cycle
Sequence of accounting procedures frequently is called accounting cycle, which is as under:

Source Documents

Provides the initial data about business transactions.

Journals

Use the information from the source documents to create a chronological listing of all business transactions and detailed information about each transaction.

General Ledger

Uses the information transferred from the journal(s) to summarize the data into individual accounts.

Trial Balance

Uses the information from the General Ledger to summarize the data to use for preparing the Financial Statements.

Financial Statements

Uses the summarized data contained in the Trial Balance to prepare the business's financial reports.

The Accounting Equation

(Everything business own = who provided the financing)

As we know the assets are properties owned by the business and Rights or claims to the properties of the business are Equities. In every business Assets are equal to Equities

i.e Assets = Equities

Equities are two types

1. Rights of the creditors or Liabilities (represents debt of the business)

2. Rights of the owner (represents capital or owner’s equity)

Now Equation would show like after substituting the Equities types

Assets =Liabilities + Owners' Equity

The above equation is also called “ Basic Equation” or “ Balance Sheet Equation

The Accounting Equation really is a balance scale of the business as below:

⚖

Assets=Liabilities + Owners' Equity

· Assets represents properties or things having value owned by a company= Liabilities represent borrowings and credit arrangements+ Owners' Equity represents investments by owners

· another way to think about the accounting equation

Assets =Liabilities + Owners' Equity

Everything business own = who provided the financing

· The accounting equation uses "simple math" and involves only addition and subtraction

· If no entries have ever been made, all accounts have a zero balance.

· The effect of changes in Assets, Liabilities and capital (owner’s equity) can be shown by + or - .

Accounting Equation would be balanced if

1. Increase on Asset side and similar increase on liabilities side

2. Increase in Asset and similar decrease on another Asset

3. Increase in Liability side and similar decrease in another Liability

It can be proved by the following transactions.

If Liabilities are Rs.70,000 and Owner's Equity is Rs.30,000 what is the value of the Assets?

Assets = Liabilities + Owner's Equity

Assets = 70,000 + 30,000

Assets= 100,000

If Assets are Rs.100,000 and Liabilities are Rs.70,000 what is the value of our Owner's Equity ?

Owner's Equity = Assets - Liabilities

Owner's Equity = 100,000 - 70,000

Owner's Equity = 30,000

And lastly, if Assets are Rs.100,000 and Owner's Equity is Rs.30,000 what is the value of our Liabilities ?.

Liabilities = Assets - Owner's Equity

Liabilities = 100,000 - 30,000

Liabilities = 70,000

A brief business transaction analysis effects are as follow:

Business Transactions	Assets = Left Side		Liabilities + Owner’s Equity Right Side
Business Transactions	Increase (Debit)	Decrease (Credit)	Decrease (Debit)	Increase (Credit)
1. Ali commenced business of Rs.500,000	500,000 (cash)			500,000 (owner equity)
2. Ali purchases Rs.10,000 worth of office supplies on credit. (i.e credit transaction)	10,000 (office supplies)			10,000 (Liabilities)
3. Ali purchases Land of Rs.300,000 on cash	300,000 (Land)	300,000 (cash)
4. Ali paid the liabilities of Rs.10,000		10,000 (cash)	10,000 (cash)
Totals	Rs.810,000 Increase	Rs.310,000 Decrease	Rs.10,000 Decrease	Rs.510,000 Increase
Total Net Changes (Equation Balanced)	Rs.500,000 Increase		Rs.500,000 Increase

General Journal and Ledger

General Journal

Journals are preliminary records where business transactions are first entered into the accounting system. This process is called journalizing. The journal is commonly referred to as the book of original entry. Specialized Journals-are journals used to initially record special types of transactions such as sales, cash disbursements, and cash receipts in their own journal.

After business transactions have been entered in journal(s), they are then periodically (usually monthly) summarized and totaled and then transferred (posted) to the General Ledger as summary entries.

What type of information is included in the Journal Record?

Entry Number
Date of each transaction
Names and/or the account numbers of the accounts to be debited or credited
Amounts of the debits and credits
Posting Reference-Account Number in the General Ledger
Explanation or description of the entry

The journals contain all the chronological (by date) information necessary to record debit and credit amounts in the accounts of the General Ledger.

Sample of A General Journal Page

General Journal

Page 1

Entry No	Date	Account Name	Post Ref.	Debit	Credit

General Ledger

A General Ledger is just a formal set Accounts. Each account that we want to track and keep up with has a separate page or pages maintained in a record book called the General Ledger. The book is organized into major sections just like the Accounting Equation that we studied in previous lesson. The general ledger's major sections are Assets, Liabilities, Owner's Equity, Revenues, Expenses and Draws.

For each item (account) in General Ledger, we record the increases and decreases for a period (usually a month) and calculate its ending balance. The ending balance of the account is easily determined by adding the increases and subtracting the decreases from the account's beginning period balance.

Simply stated a General Ledger is just a book containing the summarized financial transactions and balances of the accounts for all of a business's assets, liabilities, equity, revenue, and expense accounts.

Its chief purpose is to serve as an aid (reference) for looking up accounts and their associated account numbers.

What Information does a General Ledger Page contain?

Name of Account and Account Number
Date of Posting
Description-additional notes about the entry if needed
Posting Reference-journals name (abbreviation) , page, and entry reference
Amounts of the debits or credits transferred
Current Balance of the Account

Sample of a General Ledger Page

The Posting Reference GJ-1-1 refers to:
GJ-General Journal
1-Page 1
1-Entry Number 1

Account Name:

Account Number:

Date	Description	Post Ref.	Debit Amount	Credit Amount	Balance

Recording Business Transactions

Process of Journalizing

Before going further first of all there is need to learn the Debit / Credit rules. After applying these rules, it would be easy to journalize the entry into General Journal. Here is the summarized debit / credit rule table as under:

Summarized Debit and Credit Rules Table

Account Type	Debit	Credit	Normal Account Balance
Assets Liabilities Owner's Equity Revenue Expense Draw	Increase Decrease Decrease Decrease Increase Increase	Decrease Increase Increase Increase Decrease Decrease	Debit Balance Credit Balance Credit Balance Credit Balance Debit Balance Debit Balance

How To Use and Apply The Debit and Credit Rules:

Step1: Determine the types of accounts the transactions affect-asset, liability, revenue, or expense account.
Step2: Determine if the transaction increases or decreases the account's balance.
Step3: Apply the debit and credit rules based on the types of accounts and whether the balance of the account will increase or decrease.

Following are some business transactions for understanding Debit / Credit rule:

		Debit and Credit Rule
Business Transaction	Accounts used in business transactions	Account Type	Increase / Decrease	Debit	Credit
Business commenced	Cash is an ➨ Owner Equity	Asset ➨ Owner Equity	Increase ➡ Increase	Cash	Owner Equity
office Supplies purchased on credit	Office supplies Creditors	Asset Liabilities	Increase Increase	Office Supplies	Creditors
Land purchased on cash	Land Cash	Asset Asset	Increase Decrease	Land	Cash
paid to creditors	Creditors Cash	Liabilities Asset	Decrease Decrease	Creditors	Cash
Goods sold on cash (cash sales)	Cash Sales	Asset Revenue	Increase Increase	Cash	Sales
Electricity bill paid	Electric bill Cash	Expense Asset	Increase Decrease	Electric bill	Cash

Note: Journalizing the entries into General Journal, amount of the concerning account will be entered in the column of Debit / Credit.

Debit	Credit
Dr	Cr
+	-
No Brackets	< >
No Parentheses	( )

⤣

For Info!

Symbols are used mostly to indicate Debi⥆ts and Credits.

Example:

Journalize the following business transactions:

Date Business Transactions

Feb 5, xxxx Business commenced with amounting Rs.500,000/-

Feb 8, xxxx Office Supplies purchased of Rs. 10,000/- on credit

Feb 10, xxxx Land purchased on cash Rs. 300,000/-

Feb 20, xxxx Paid to creditors amounting Rs. 10,000/-

Feb 27, xxxx Cash sales of Rs. 150,000/-

Feb 30, xxxx Electricity bill paid of Rs. 50,000/-

Journalizing:

General Journal

Page 1

Entry No	Date	Account Name	Post Ref(GL).	Debit	Credit
Record Business commenced amounting Rs.500,000/-
GJ-1-1	Feb 5, xxxx	Cash	100	500,000
		Owern Equity (Capital)	200		500,000
Record office Supplies purchased of Rs. 10,000/- on credit
GJ-1-2	Feb 8, xxxx	Office supplies	300	10,000
		Creditors (Liabilities)	400		10,000
Record Land purchased on cash Rs. 300,000/-
GJ-1-3	Feb 10, xxxx	Land	500	300,000
		Cash	100		300,000
Record paid to creditors amounting Rs. 10,000/-
GJ-1-4	Feb 20, xxxx	Creditors (Liabilities)	400	10,000
		Cash	100		10,000
Record cash sales of Rs. 150,000/-
GJ-1-5	Feb 27, xxxx	Cash	100	150,000
		Sales (Revenue)	700		150,000
Record paid Electricity bill Rs. 50,000/-
GJ-1-6	Feb 30, xxxx	Electric bill (Expense)	800	50,000
		Cash	100		50,000

Process of posting (transferring)

After business transactions entering in the above journal, they are then transferred (posted) to the General Ledger as summary entries.

For each item (account) in General Ledger, record the increases and decreases for a period (usually a month) and calculate its ending balance i.e debit balance or credit balance. The ending balance (debit / credit balance) of the account is easily determined by adding the increases and subtracting the decreases from the account's beginning period balance or through running balance account in which ending balance determined after every transaction.

Following are the running balance accounts in which individual account entries have been transferred (posted) from the above journal and ending balance is being determined after every transaction:

Account Name: Cash

Account Number:100

Date

Description

Post Ref(GJ).

Debit Amount

Credit Amount

Balance

Feb 5, xxxx

Business commenced (business start)

GJ-1-1

➨➨➨➨ 500,000

⇙

500,000 Dr

Feb 10, xxxx

Land purchased

GJ-1-3

300,000➡

200,000 Dr

Feb 20, xxxx

Paid to creditors

GJ-1-4

10,000

190,000 Dr

Feb 27 xxxx

Cash Sale

GJ-1-5

150,000

340,000 Dr

Feb 30, xxxx

Electric bill paid

GJ-1-6

50,000

290,000 Dr

Note: Rs. 290,000/- is ending balance i. e debit balance (Dr) because Debit amounts are greater than Credit amounts.

Account Name: Owner Equity

Account Number:200

Date	Description	Post Ref.	Debit Amount	Credit Amount	Balance
Jan 5, xxxx	Business commenced	GJ-1-1		500,000	500,000 Cr

Note: The above table shows credit balance (Cr) because credit amount is greater than debit amount which is nil.

Account Name: Office Supplies

Account Number:300

Date	Description	Post Ref.	Debit Amount	Credit Amount	Balance
Feb 8, xxxx	Purchase office supplies	GJ-1-2	10,000		10,000 Dr

Account Name: Creditors (Liabilities)

Account Number:400

Date	Description	Post Ref.	Debit Amount	Credit Amount	Balance
Feb 8, xxxx	Supplies purchase on credit	GJ-1-2		10,000	10,000 Cr
Feb 20, xxxx	Paid to creditors	GJ-1-4	10,000		0 (Zero Balance)

Note: The above creditors account shows ending balance is zero because credit amount (Cr) is equal to debit amount (Dr).

Account Name: Land

Account Number:500

Date	Description	Post Ref.	Debit Amount	Credit Amount	Balance
Feb 10, xxxx	Supplies purchase on credit	GJ-1-3	300,000		300,000 Dr

Account Name: Sales

Account Number:700

Date	Description	Post Ref.	Debit Amount	Credit Amount	Balance
Feb 27, xxxx	Goods sold (cash sale)	GJ-1-5		150,000	150,000 Cr

Account Name: Electric bill

Account Number:800

Date	Description	Post Ref.	Debit Amount	Credit Amount	Balance
Feb 30, xxxx	Electric bill paid	GJ-1-6	50,000		50,000 Dr

Trial Balance

A Trial Balance is a listing of all the accounts appearing in the general ledger with the amount of the debit or credit balance of each. It is used to make sure the books are "in balance" -total debits and credits are equal.

Trial Balance is used at the end to check our postings. In other words trial balance is just a worksheet that bookkeeper's and accountants prepare from the General Ledger to check that the books (General Ledger) are in balance (Debit Account Balances = Credit Account Balances).

Below is the Trial Balance for XYZ Company at the end of Month. in which ending balances have been taken from the above General Ledger:-

Trial Balance

XYZ

For the month ------

Account	Debit Balances	Credit Balances
Asset Accounts
Cash	290,000
Land	300,000
Inventory-Office Supplies	10,000

Liability Accounts
Creditors		0

Equity Accounts
Owner's Equity		500,000

Revenue Accounts
Sales( Revenue)		150,000

Expense Accounts
Electric bill (Expense)	50,000

Totals	650,000	650,000

Financial Statements

Financial Statements: are accounting reports prepared periodically to inform the owner, creditors, and other interested parties as to the financial condition and operating results of the business. As they need this information to make important and knowledgeable decisions and for making important decisions, financial statements are used.

Note: Entries have been taken for preparation of Financial Statements from above Trial Balance.

There are three basic financial statements or reports are as under:

Financial Statements

⍖ ⇙ ⇘

Income Statement/ Capital Statement/ Balance Sheet

Profit and Loss Account Retained Earning

Income Statement- Income statement shows the company profit or Loss for the specific period after matching the Revenue and Expenses.

Hopefully a business earns a profit called net income (revenues are larger than expenses). If however, expenses are larger than revenues a net loss results.

There are major sections of an income statement are as follow:

· The heading, (should contain the name of the company, the title of the statement, and the period covered by the statement)

· The revenue section

· The expense section

· And the final calculation of a profit or loss.

XYZ Company

Income Statement

For The Period Ending ---------

Sales (Revenue)

Rs. 150,000

Expenses

Electric bill Expense

Rs.50,000

Total Expenses

Rs.50,000

Net Income

Rs.100,000

Capital Statement- that summarizes all the changes in owner's equity that occurred during a specific period.

XYZ Company
Capital Statement
For The Period Ending -----------

Capital Beginning		Rs.500,000
Capital Contributed	0
Net Income	100,000
Increase in capital		100,000
Ending Capital		Rs.600,000

Balance Sheet-.Balance sheet shows the financial position of the company having information / balances of Assets, Liabilities, and Owner Equity / Capital on a particular date.

The balance sheet is derived from accounting equation as discussed earlier i.e Assets = Liabilities + Owner's Equity

XYZ Company
Balance Sheet
As on ----------
Assets
Cash	Rs. 290,000
Land	300,000
Inventory-Office Supplies	10,000
Total Assets		Rs.600,000

Liabilities
Creditors	0
Total Liabilities		0

Owner's Equity
XYZ Capital		Rs.600,000
Total Liabilities & Equity		Rs.600,000