Preparation of Journal, Ledger and Trial Balance

Unit : I [ 25 % ]

Basics of Accounting

· Definition of Accounting and its advantages & limitations, Scope of accounting, Branches of Accounting – Financial Accounting – Cost Accounting – Management Accounting, users of Accounting information, Methods of Accounting, Double Entry Accounting System, Types of Accounts and Rules for Debit and Credit. Cash and Credit Transaction, Cash discount and Trade discount.

· Preparation of Journal, Ledger and Trial Balance.

Meaning of Accounting

It is common experience of all of us that money must be spent carefully. If a person is careless in spending money, a day will come when he will be left with no money. Same is true of a business firm.

In business numerous transactions take place every day. It is humanly impossible to remember all of them. Hence, it is necessary to record them. The recording of Business transaction is the main function served by Accounting. Accounting is rightly termed as the language of business. With the help of accounting records, the business person is able to ascertain the profit or loss for the specified period and the financial position of his business on given specified date and communicate such information to all interested parties. The accounting information is useful both for the management and the outside agencies like Tax Authorities, Banks, Creditors etc. The management needs it for the purpose of planning, controlling and decision-making. The Banks and Creditors require it for assessing the credit worthiness of the business and the tax authorities use it for determining the amount of Income Tax, Sales Tax etc. In fact, accounting is necessary not only for business organization but also for non-business organizations like schools, colleges, hospitals etc.

Definition of Accounting

In the words of Committee on terminology, appointed by the American Institute of Certified Public Accountants,

“Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least, of a financial character and interpreting the results thereof.”

This is the popular definition of accounting and it outlines fully the nature and scope of accounting activity.

Recording of transactions.

This is done in the book termed as “JOURNAL”.

Classifying the transactions.

This is done in the book termed as “LEDGER”.

Summarising the transactions.

This includes preparation of Trial Balance, Profit & Loss Account and Balance Sheet of the Business.

Interpreting the results.

This involves computation of various accounting ratios etc. to know about the liquidity, solvency and profitability of business.

Scope of Accounting.

The scope of accounting can be outlined as follows.

Accounting is concerned with the transactions and events which are of a financial character. Such transactions have to be identified by the accountant. He can do so with the help of various bills and receipts.
The transactions should be measured or expressed in terms of money.
The transactions identified and measured are to be recorded in a book called “JOURNAL”.
The recorded transactions have to be classified in order to group transactions of similar nature at one place. This work is done in a separate book called “LEDGER”. In the Ledger a separate account is opened for each group of transactions of similar nature so that all transactions relating to it can be brought at one place.
To verify the arithmetical accuracy of the data, a summary of all the ledger accounts is being prepared. This is known as TRIAL BALANCE.
To make the summarised data more meaningful and to assess the performance of the business firm at the end of particular period an account known as “ PROFIT & LOSS ACCOUNT “ is being prepared. Also to ascertain the financial position of the business firm on a particular point of time, a statement of affairs known as “ BALANCE SHEET “ is being prepared.
To help the management in taking effective decisions and to help in making business more profitable, the financial statements (PROFIT & LOSS A/C AND BALANCE SHEET) are being analysed and interpreted with the statistical tools like ratios, averages, etc.

Advantages of Accounting

1. Replaces Memory.

Since all the financial events and transactions are recorded in the books, there is no need to rely on memory. The books of accounts will serve as historical records. Any information required at any time can be easily traced from these records.

2. Provides Control over Assets.

Accounting provides information regarding all the assets such as cash in hand, cash at bank, the stock of goods, the amounts receivable from various parties, the amounts invested in various other assets etc. Information about such matters help the owners and the management to have better control over the assets and also helps them to make use of the assets in the best possible way

3. Facilitates the preparation of Financial Statements.

The business person is always interested in assessing the performance of the business and in ascertaining the financial position of his business at the end of a particular period. With the help of information contained in the accounting records the profit and loss account and Balance Sheet can be easily prepared which in turn will help in assessment of the performance of a business firm.

4. Works as information Tool.

Various interested parties such as owners, lenders, creditors etc. can have necessary information at desired intervals to equip them in taking better decisions.

5. Intra Firm comparison & Inter Firm comparison.

With the help of accounting information, it becomes possible to compare the present performance of the business firm with its past performance. It also becomes possible to compare the performance of the business firm with other business firms of similar type. These comparisons assist the management and the owner to gear up the business operations for better. It also helps them in taking effective decisions in planning and controlling all business activities.

6. Works as safeguard against possible Fraud and/or Theft.

Recorded accounting transactions make it possible to verify arithmetical accuracy which in turn works as moral barries for the persons having malafied intentions of committing fraud. Thus the accounting works as safeguard against frauds and thefts. In large organisation the book-keeping work can be divided amongst many persons which minimize the chances of frauds.

7. Ascertaining value of Business.

The accounting records will help in ascertaining the correct value of business in the event of sale of the entire business.

8. Acts as Reliable Evidence.

Systematic record of business transactions is generally treated as good evidence in Court of Law in case of disputes.

9. Tax matters.

Properly maintained accounting records helps in preparation of tax statements and also helps in explaining the queries raised by the tax authorities.

Limitations of Accounting

1. The transactions and events which are not of financial character are not being recorded. Facts like quality of human resources, licences possessed, location advantages, business contacts etc. do not find place in the books of accounts. Thus accounting does not provide complete picture of the business.

2. The recorded data is always historic in nature. It always depicts historical value of all assets and liabilities for the business firm. In inflationary trend, to have better idea of the state of affairs of the business, the current values of the assets and liabilities are more relevant. Thus to this extent the accounting does not provide relevant information.

3. Facts recorded in the financial statements are greatly influenced by accounting conventions and personal judgments. Decisions taken on the basis of such information may not prove to be as effective as it should be.

Methods & Systems of Book-keeping.

Generally, one of the following three methods of book-keeping is being followed.

Deshi-Nama System

It is one of the methods of Book-keeping followed in India. About 90 % of the businesses are using this method for preparing their books of accounts. This method is very simple less expensive and suitable to all business entities. Under this method two important books are maintained. i.e. (a) Rojmel and (b) Khatavahi.

Double Entry System of Book-keeping

It is a method which has its origin in Europe. Though it is costlier compared to Deshi Nama System and requires skilled man-power, because it is a scientific and complete method, more and more business firms are now a days following this method.

In this method, the transactions are recorded as per the "RULES OF DEBIT AND CREDIT". In Double Entry Accounting system every business transaction has a two fold effect. The receiving aspect and the giving aspect. Thus, in commercial context it is a famous dictum that

“Every receiver is also a giver and every giver is also a receiver.”

Single Entry System

It is an incomplete form of double entry system of book-keeping. Under this method only one aspect of the transactions is being recorded and so it is known as “ SINGLE ENTRY SYSTEM “. It is in fact a defective and incomplete method because it does not provide all the information of the business. If one who is following this system wants to prepare final accounts, first of all he will have to find out missing information, then only he can proceed further.

Branches of Accounting

Accounting has three main branches, viz., Financial Accounting, Cost Accounting, Management Accounting. These branches of accounting have been developed to serve different objectives.

Financial Accounting

In the words of Committee on terminology, appointed by the American Institute of Certified Public Accountants,

Financial Accounting is primarily concerned with record keeping directed towards the preparation of Profit and Loss Account and Balance Sheet. The main purposes of financial accounting are:

1. Recording of the transactions concerning and affecting the business;

2. Preparation of necessary accounts and balance sheet as required by statutes;

3. Apprising the owners of the business about the results of the business over a period of time.

Financial accounting is the accounting for revenues, expenses, assets and liabilities that is commonly carried on in the general office of a business. It is a term often limited to the accounting concerned with published financial reports in contrast to internal aspects of accounting such as cost accounting.

Cost Accounting

Cost Accounting is the process of ascertaining cost from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centre and cost units. It is the process of accounting for costs. It is a systematic procedure for determining the unit cost of output produced or services rendered. Its Primary functions are to ascertain the cost of product and to help the management in the control of cost. So, this branch deals with the classification, recording, allocation, summarization and reporting of current and prospective costs.

Management Accounting

“Such of its techniques and procedures by which accounting mainly seeks toaid the management collectively have come to be known as Management Accounting.”

- The Institute of Chartered Accountants of India

Management is primarily concerned with the supply of information which is useful to management in decision making for the efficient running of the business and, thus, in maximizing profit. Management Accounting is the reproduction final accounts in such a way as will enable the management to take decisions and to control activities.

Management Accounting is the term used to describe the accounting methods, systems and techniques which coupled with special knowledge and ability, assist management in its task of maximizing profit or minimizing losses.

So, it is the blending together into a coherent whole, Financial Accounting, Cost Accounting and all aspects of financial management.

MEANING OF JOURNAL AND JOURNALISING.

A Journal is a book in which the transactions are recorded in the order in which they occur, i.e. in chronological order. It is called a book of prime entry (also original entry) because all business transactions are entered first in this book. The process of recording a transaction in the Journal is called “Journalising”. An entry made in the Journal is called a ‘Journal Entry’. A format of a Journal is shown below.

JOURNAL

CLASSIFICATION OF ACCOUNTS AND RULES OF DEBIT AND CREDIT

An account is a summary of relevant transactions at one place relating to a particular head. It records not only the amount of transaction but also their effect and direction. The transactions in the journal are recorded on the basis of the rules of debit and credit. For this purpose business transactions have been classified into three categories.

Transactions relating to persons.
Transactions relating to properties and assets.
Transactions relating to incomes and expenses.

The classification of accounts can be given as under.

Types of account Meaning

1. Personal Accounts These accounts relate to natural persons, artificial persons and representative persons.

2. Real Accounts These accounts relate to the tangible or intangible real assets.

3. Nominal Accounts These accounts relate to expenses, losses, profit & gains.

Thus, three classes of accounts are maintained for recording all business transactions. They are (1) Personal accounts, (2) Real accounts and (3) Nominal accounts.

Basically, debit means to enter an amount on the left side of an account and credit means to enter an amount on the right side of an account. In the abbreviated form Dr. stands for Debit and Cr. stands for Credit. Both debit and credit may represent either increase or decrease depending upon the nature of an account.

The Rules for Debit and Credit are given below.

Types of Account

Rules for Debit

Rules for Credit

1. For Personal Accounts / Debit the receiver / Credit the giver
2. For Real Accounts / Debit what comes in / Credit what goes out
3. For Nominal Accounts / Debit all expenses & losses /

Credit all gains & profit

MEANING OF LEDGER

A Ledger is a principal book which contains all the accounts (Assets Accounts, Liabilities Accounts, Capital Account, Revenue Accounts, Expenses Accounts) to which the transactions recorded in the books of original entry are transferred. As the Ledger is the ultimate destination of all transactions, it is called the “BOOK OF FINAL ENTRY”. It is considered as a permanent record and is frequently referred to. It may be noted that an account is a formal record of all transactions relating to change in particular item. A Ledger may be kept in form of bound books, loose leaf sheets, floppy diskettes (in case computer is used) or any other like device.