accounting cycle by dr. suresh vadde

Financial and Managerial Accounting –MBA

Chapter –IIUnderstanding of financial

statements

What is Book - keeping & Accounting Book - keeping & Accounting ?

♦ Book keeping– Recording the

transactions of an organization

♦ Accounting– Analysis of the

performance of an organization

What is Book keepingBook keeping 1 ?

♦ You have £10.♦ Your mother/father/aunt

gives you £100 because today is your birthday.

♦ You go with your friends to celebrate your birthday.

♦ You have £15 left after the celebration.

♦ How much money did you spend?

♦ In businesses, all of this would be recorded !

‘Books’ would be kept of all your (financial) activities !!

What is BookkeepingBookkeeping 2 ?

♦ Record important, useful information.♦ The information must be recorded

accurately♦ It is routine♦ It is recording ♦ It is ‘accounting for’ business

transactions♦ Examples of transactions:♦ sale/purchase of goods/services,

every sale, etc., is shown in money.Accounts are kept of all the (financial) activities

Book-keeping is often known as ‘Double entry’

What is Accounting 1Accounting 1?♦ Providing financial

information in an organization – objectively– consistently– professionally– conservatively valued

♦ to enable management to perform three functions

– recording– analysis– control

What is Accounting 2Accounting 2?♦ Using financial information to analyse

the performance of management of (and inside ) an

organization – objectively– consistently

– professionally

– with reliable techniques for internal management

control– and comparing overall performance

of the organisation– with (for example) other

organizations

What is Book keepingBook keeping and and AccountingAccounting?♦ We cannot keep Accounting records

– without documents (proof of transactions)

– sales, purchases, banking (payment and receipts) documents

♦ these are source documents♦ this documentary evidence:

– tells/shows us the actual transaction

– shows what has happened

♦ Accounting records: – show the impact of these transactions on a business

– show what these transactions mean to a business

Methods of Accounting

Single Entry:

♦ It is incomplete system of recording business transactions.

♦ The business organization maintains only cash book and personal accounts of debtors and creditors.

♦ So the complete recording of transactions cannot be made and trail balance cannot be prepared.

Double Entry:

♦ It this system every business transaction is having a two fold effect of benefits giving and benefit receiving aspects.

♦ The recording is made on the basis of both these aspects.

♦ Double Entry is an accounting system that records the effects of transactions and other events in at least two accounts with equal debits and credits.

STEPS IN ACCOUNTING CYCLE

DocumentsDocumentsDocumentsSourceDocuments

Journal Ledger

Trial Balance

I - JOURNAL

♦ journal is a simple book of accounts in which all the business transactions are originally recorded in chronological order.

♦ Journaling refers to the act of recording each transaction in the journal and the form in which it is recorded, is known as a journal entry.

Advantages of Journal

♦ As all the transactions are entered in the journal chronologically, a date wise record can easily be maintained;

♦ 2. All the necessary information and the required explanations regarding all transactions can be obtained from the journal.

♦ Errors can be easily located and prevented by the use of journal or book of prime entry.

Journal Performa

Name of the journal

Date Particular L. Folio Debit Credit

Types of Accounts

♦ Business transactions have been classified into three categories:

(i) Transactions relating to persons. ( Personal Account)

(ii) Transactions relating to properties and assets ( Real Account)

(iii) Transactions relating to incomes and expenses. ( Nominal Account)

Personal Accounts:

♦ Accounts recording transactions with a person or group of persons.

♦ These accounts are necessary, in particular, to record credit transactions.

♦ The rule for personal accounts is: • Debit the receiver• Credit the giver

Real Accounts

♦ Accounts relating to properties or assets♦ A separate account is maintained for each

asset e.g., Cash Machinery, Building, etc.,♦ The rule for Real accounts is:

• Debit what comes in• Credit what goes out

Nominal Accounts♦ It is relating to income, revenue, gain

expenses and losses.♦ A separate account is maintained for each

expense or loss and gain or income.♦ Ex:-Wages account, Rent account

Commission account, Interest received account etc.,

♦ The rule for Nominal accounts is: • Debit all expenses and losses• Credit all incomes and gains

The Rules of Debit and Credit

Debit Account Credit

Increase in Assets Decrease in Assets

Decrease in Liabilities Increase in Liabilities

Decrease in Owner’s Equity Increase in Owner’s Equity

Decrease in Revenue Increase in Revenue

Increase in Expenses Decrease in Expenses

Expansion of Basic Equation

Assets = Liabilities + Owner’s Equity

AssetsLiabilities Capital Drawings

Revenue Expenses

Recording Transaction

Transaction Debit Credit

Started business with cash. CapitalCash

Bought office equipment on creditfrom Syarikat Emas.

OfficeEquipment

Account Payable

Received loan from Bank Intanin cash.

Cash BankLoan


Bought motor van by cash Motor Vehicle

Cash

Paid rental expenses by cash RentalExpenses

Cash

Bought office supplies by credit OfficeSupplies

Account Payable


Paid utility bills with cash UtilityExpenses

Cash

Received cash from Abu, a debtor. Cash AccountReceivable

A check on supplies showedthat $120 supplies has been used.

SuppliesExpenses

OfficeSupplies


Owner brought in his own car to be used in business.

MotorVehicle

Capital

Sold motor van for cash CashMotor Vehicle

Owner took cash for his own use. Drawings Cash

Journal Entries

Siti Malaysia, the owner of Tadika Malaysia started her businesson 1 January 2002 with cash M25,000. The followings are transactions related to the business for the month of January:

Illustration : Tadika Malaysia

Tadika Malaysia

General Journal

Date Particulars Debit Credit

Jan. 1 Cash 25,000

Capital 25,000

( Cash invested by owner )

Tadika Malaysia- General Journal

Jan. 5 Bought office equipment with cash, RM500.

Jan. 5 Office Equipment 500

Cash 500

(Bought office equipment with cash)


Jan.10 Bought furnitures amounting to RM4,700 withcash from Syarikat Perabot Kita.

Jan. 10 Furnitures 4,700

Cash 4,700

( Bought furnitures withcash )



Jan. 11 35,000

35,000



Jan.11 Bought motor van for business use by creditfrom Syarikat Kenderaan amounting to RM35,000.

Motor vehicles

Account Payable

( bought motor van by credit )

Jan.15 Paid advertising expense RM2,000 with cash.

Jan. 15 Advertising expense 2,000

Cash 2,000

( Paid advertising expense with cash )



Jan.18 Paid utility bills with cash amounting to RM325.

Jan. 18 Utilities Expense 325

Cash 325

( Paid utility bills with cash )



Jan.23 Paid salaries by cash RM700 per person for5 workers.

Jan. 23 Salary expense 3,500

Cash 3,500

( Paid salary by cash )



Jan 24 Received cash RM7,500 for the fees of the month.

Jan. 24 Cash 7,500

Revenue : Fees 7,500

( received fees or the month )



Jan.27 Bought two units of computers on credit , amountingto RM4,000 per unit.

Jan. 27 Office Equipment 8,000

Account Payables 8,000

( Bought computers on credit )



Jan.30 Siti Malaysia took cash RM1,200 for her own use.

Jan. 30 Drawings 1,200

Cash 1,200

( Cash withdrawals by the owner )



II - LEDGER

♦ In journal, as all the business transactions are recorded chronologically, it is very difficult to obtain all the transactions pertaining to one head of account together at one place.

♦ But, the preparation of different ledger accounts helps to get a consolidated picture of the transactions pertaining to one ledger account at a time.

♦ Thus, a ledger account may be defined as a summary statement of all the transactions relating to a person, asset, expense, or income or gain or loss which have taken place during a specified period and shows their net effect ultimately.

Posting from journal to ledger

Journal Ledger

General Ledger

Cash

Jan 1 Capital 25,000 Jan 5 Office Equipt 500

24 Fees Rec. 7,500 10 Furnitures 4,700

18 Utilities 325

15 Advertising 2,000

30 Drawings 1,200

23 Salary 3,500

Balance c/f

32,500 32,500

20,275

General Ledger

Capital

Jan 1 Cash 25,000

25,00025,000

Jan 31 Bal c/f 25,000

General Ledger

Office Equipment

Jan 31 Bal c/f 8,500

Jan 5 Cash 500

27 A/c Payable8,000

8,500 8,500

General Ledger

Furnitures

Jan 31 Bal c/f 4,700Jan 10 Cash 4,700

4,700 4,700

Motor Vehicles

Jan 11 A/c Payable 35,000 Jan 31 Bal c/f 4,700

35,000 35,000

General Ledger

Account Payable

Jan 31 Bal c/f 43,000 Jan 11 M. Vehicles 35,000

27 O. Equipmt 8,000

43,000 43,000

General Ledger

Advertising


2,000 2,000

Utility

Jan 18 Cash 325 Jan 31 Bal c/f 325

325 325

General Ledger

Salaries


3,500 3,500

Fees Received

Jan 24 Cash 7,500Jan 31 Bal c/f 7,500

7,500 7,500

General Ledger

Drawings

Jan 30 Cash 1,200

1,2001,200

Jan 31 Bal c/f 1,200

Practice Question:-Journalise the following transactions, post the same in relevant ledger

account and balance the same.

III - TRIAL BALANCE♦ Trial balance is a statement prepared with the

balances or total of debits and credits of all the accounts in the ledger to test the arithmetical accuracy of the ledger accounts.

♦ As the name indicates it is prepared to check the ledger balances.

♦ If the total of the debit and credit amount columns of the trail balance are equal, it is assumed that the posting to the ledger is accurate.

♦ If not, it is a sign of error that occurs during journalizing and posting.

Tadika MalaysiaTrial Balance as at 31 January 2002

Accounts Debit Credit

Cash 20,275

Capital 25,000

Office Equipment 8,500Furniture 4,700Motor Vehicles 35,000Account Payables 43,000

Advertising 2,000Utility 325Salaries 3,500

Fees Received 7,500Drawings 1,200

75,500 75,500

IV – FINANCIAL STATEMENTS(FINAL ACCOUNTS)

♦ A. Trading Account♦ B. Profit and Loss Account♦ C. Balance Sheet

A. Trading Account♦ Trading account is prepared for an accounting period to

find the trading results i.e., the amount of gross profit/loss of the concern.

♦ It has made from buying and selling during the accounting period.

♦ The difference between the sales and cost of sales is gross profit.

♦ For the purpose of computing cost of sales, value of opening stock, purchases, direct expenses on purchasing and manufacturing are added up and closing stock of finished goods is reduced.

♦ The balance of this account shows gross profit or loss which is transferred to the profit and loss account.

Example:-

Solution

B. Profit And Loss Account

♦ Profit and loss account starts with gross profit brought down from trading account on the credit side. (If gross loss, on the debit side).

♦ All the indirect expenses are debited and all the revenue incomes are credited to the profit and loss account

♦ If incomes or credit is more, than the expenses or debit, the difference is net profit.

♦ On the other hand if the expenses or debit side is more, the difference is net loss.

The Specimen of Profit and Loss Account

Example:- From the following Trial balance of Mr.Gandhi prepare profit and loss account for the year ended 31-3-2001.

Solution

C. Balance Sheet ♦ “Balance sheet is a screen picture of the financial position of a going

business concern at a certain moment” - Francis.♦ It comprises of lists of assets, liabilities and capital fund on a given

date.♦ It presents the financial position of a concern as revealed by the

accounting records. ♦ It reflects the assets owned by the concern and the sources of funds

used in the acquisition of those assets. ♦ In simple language it is prepared in such a way that true financial

position is revealed in a form easily readable and more rapidly understood.

Proforma of Balance Sheet

Example:- From the following adjustment Trial Balance, Prepare Balance Sheet of Saravanan Traders as at 31st December 2004.

Solution

Individual AssignmentFrom the following data, prepare a profit and loss a/c and a balance sheet

as on 31-3-1996.

Any QuestionsQuestions ?

ByDr. Suresh Vadde

Associate ProfessorDepartment of Management

Samara University, Ethiopia.