1. mechanics of accounting
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The Accounting Information System
Dr Ashish Varma
Ph.D, FICWA, PGDBM
Asstt Prof.
IMT ,Gzb.
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The Accounting Cycle
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The Accounting Cycle
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1. Analyze transactions
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The Accounting Cycle
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1. Analyze transactions2. Record the effect of
transactions in a journalentry
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The Accounting Cycle
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1. Analyze transactions2. Record the effect of
transactions in a journalentry
3. Summarize the effects oftransactionsa. Post journal entries to
the ledgerb. Prepare a trial
balance
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The Accounting Cycle
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1. Analyze transactions2. Record the effect of
transactions in a journalentry
3. Summarize the effects oftransactionsa. Post journal entries to
the ledgerb. Prepare a trial
balance
4. Prepare reportsa. Make adjusting
entriesb. Prepare financial
statements
c. Close the books
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Transaction AnalysisUsing Debits and Credits
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Events and Transactions
An event is a happening of consequence to an entity.
An event could be an internal happening or external
happening.
External events that involve transfer of value ( in
monetary terms) between two entities (within or
outside) are called transactions.
Thus, a transaction is an external event that affects thefinancial position of an entity.
Financial Accounting: An introduction
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Recording of Transactions: The
Double Entry Principle
Each transaction has two aspects (or side): Debitand
Credit.
Every debit has an equal and opposite credit.
Each transaction should be recorded in such a way that
it affects two sides- debit and credit- equally.
Thus, the first and foremost step in recording a
transaction is to identify the debit and credit elements.
Financial Accounting: An introduction
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Basic Accounting Concepts
An understanding of accounting concepts is vital to
understand the process of accounting.
Accounting concepts underlying the recording of
transactions: Entity Concept
Money Measurement Concept
Accrual Concept
Cost Concept
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Transaction Analysis Using
Debits and Credits
The accounting equation
Assets = Liabilities + Owners Equity
The spreadsheet analysis format based on theaccounting equation is not practical when acompany has thousands of transactions
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Accounting Equation
The relationship among three elements of the balance
sheet can be expressed through an equation, known as
fundamental accounting equation:
Assets (A) = Liabilities (L) + Equity (E)
The unique feature of the above equation is that all
transactions will affect the equation in such a way that
the equality will always be maintained.
This happens due to double entry rule.
Financial Accounting: An introduction
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Transaction Analysis Using
Debits and Credits
All transactions relating to a specific item are
recorded in an account
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The most simple
form of an account iscalled a T- account
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The T- Account
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ACCOUNT TITLE
DEBIT CREDIT
(Left Side) (Right Side)
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A/C stands for Account.
Notice that theentry is posted on thedebitside of DebtorsAccount and simultaneously on thecreditside of Sales
Account.
JF refers to the page number of the journal where theparticular transaction is recorded.
Use of To (on thedebitside) and By (on thecreditside) iscustomary.
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Postings in the Secondary Books
Dat Particulars JF Amount Dat Particulars JF Amount
6.3.
2006
To, Sales
A/C
? 10,00,000
Dr. Debt rs cc t r.
Dat Particulars JF Dat Particulars JF Amount
6.3.
2006 A/C
?
Dat Particulars JF Amount Dat Particulars JF Amount
By, Debtors A/C ? 10,00,000
Dr. Sales cc t r.
Dat Particulars JF Dat Particulars JF Amount
6.3. ? 10,00,000
2006
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Debits and Credits:
Balance Sheet Accounts
Increase Decrease
Assets Debit
Liabilities Credit
Equity Credit
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Debits and Credits:
Balance Sheet Accounts
Increase Decrease
Assets Debit Credit
Liabilities Credit Debit
Equity Credit Debit
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Debits and Credits:
Balance Sheet Accounts
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ASSET LIABILITY EQUITY
DEBITDEBIT CREDITCREDIT DEBITDEBIT DEBITDEBITCREDITCREDIT CREDITCREDIT
++ ++ ++-- -- --
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Debits and Credits:
Revenues, Expenses, and Dividends
Increase Decrease
Revenues Credit
Expenses Debit
Dividends Debit
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Debits and Credits:
Revenues, Expenses, and Dividends
Increase Decrease
Revenues Credit Debit
Expenses Debit Credit
Dividends Debit Credit
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Debits and Credits:
Revenues, Expenses, and Dividends
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REVENUE EX ENSE DIVIDEND
DEBITDEBIT CREDITCREDIT DEBITDEBIT DEBITDEBITCREDITCREDIT CREDITCREDIT
++ ++ ++-- -- --
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Debits and Credits All Accounts
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Assets LiabilitiesOw ersEq ity
Dr.Dr. Dr.Dr. Dr.Dr.Cr.Cr. Cr.Cr. Cr.Cr.
++ ++ ++-- -- --
aid-iCapital
Retai edEarnings
Dr.Dr. Dr.Dr.Cr.Cr. Cr.Cr.
++ ++-- --
Expenses Revenues
Dividends
Dr.Dr. Dr.Dr.
Dr.Dr.
Cr.Cr. Cr.Cr.
Cr.Cr.
++ ++
++
-- --
--
= +
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RecordingJournal Entries
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Recording the Effects
of Transactions
Thejournal is a book
in which all
transactions arerecorded in
chronological order
Each journal entryhas its debit
amounts equal to
its credit amounts
to ensure that theaccounting
equation remains
in balanceFinancial Accounting/ DR ASHISH /IMT / 2010 25
DR = CRDR = CR
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Recording the Effects
of Transactions
Journalizing involves a three-step process:
1. Identify which accounts are involved
2. For each account, determine if it is increased or
decreased
3. For each account, determine by how much it
changed
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Recording the Effects
of Transactions
The account debited is always listed first,
followed by the account credited
The credit entry is indented
Some selectedtransactions from Veda
Landscape Solutions are presented next as
examples
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Transaction 1
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Investment of$700,000 cash intothe business.
Tx # Account Titles Ref Debit Credit 1 Cash 700,000
Paid-In Capital 700,000
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Transaction 2
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Borrowed $300,000cash from the bank.
2 Cash 300,000Bank Loan ayable 300,000
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Transaction 3
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Purchased land costing $50,000and buildings costing $400,000.Paid $100,000 in cash andsigned a mortgage for thebalance.
3 Land 50,000Buildings 400,000
Cash 100,000
Mortage ayable 350,000
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Transaction 4
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Purchased equipmentfor $650,000 in cash.
4 Equi ment 650,000Cash 650,000
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Transaction 7
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Purchased inventorycosting $90,000 for $10,000in cash and the remaining$80,000 on account.
7 Inventory 90,000Cash 10,000
Accounts ayable 80,000
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Transaction 8
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Paid $15,000 cash for aninsurance policy.
8 re ai Insurance 15,000Cash 15,000
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Transaction
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Performed landscapingconsulting services andbilled clients $200,000for these services.
11 Accounts Receivable 200,000Consulting 200,000
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Transaction
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Collected $820,000 cashfrom customers aspayment on theiraccounts.
14 Cash 820,000Accounts Receivable 820,000
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Transaction
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Paid $1,200,000 in cashto suppliers as paymenton account.
15 Accounts ayable 1,200,000Cash 1,200,000
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Transaction
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Paid cash of $150,000 foradvertising, utilities, andoffice supplies.
18 SG&AExpense 150,000Cash 150,000
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Transaction
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Paid cashdividends of$5,000.
23 Divi ends 5,000Cash 5,000
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Postingand the Trial Balance
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Posting
Posting involves transferring the the debits
and credits from the journal entries to the
individual accounts
Posting is purely mechanical in nature and
requires no analysis
The collection of all of a companys accounts
is called a ledger
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Example:
Posting Transaction 1
Cash 700,000
Paid-in Capital 700,000
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Cash aid-in Capital
700,000 700,000
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Trial Balance
A trial balance is a listing of all of the ledger
accounts and their balances
The total of the debit balance accounts should
equal the total of the credit balance accounts
The equality of the debits and credits providessome assurance that the posting process has
been completed correctly
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DR = CRDR = CR
Veda Landscape Solutions
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Financial Accounting/ DR ASHISH /IMT / 2010 43
Debit edit
ash $130,400
ccounts ecei able 120,
In entory 490,
Prepaidinsurance
Land 50,uildings 38 ,
Equipment 5 ,
ccountspayable $18 ,
Wagespayable 40,
Unearned franchiserevenue 5 ,Interest payable 58,
ankloanpayable 300,
Mortgagepayable 35 ,
Paid-incapital 700,000
Retainedearnings (beginningof year) 0
Salesrevenue 1,100,000
Consultingrevenue 200,000
Landscapingrevenue 500,000Cost ofgoodssold 800,000
Landscapingsuppliesexpense 100,000
Wagesexpense 500,000
Selling, general, andadministrativeexpens 174,600
Interest expense 58,000
Depreciationexpense 150,000
D
ividends 5,000
otals $3,478,000 $3,478,000
VedaLandscapeSolutionsTrial alance
December31, 2006
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Permanent Accounts
= real accounts = balance sheet accounts.
Reported on balance sheet.
Carried forward into next period: In this sense, they are permanent.
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Temporary Accounts
Revenue and expense accounts.
Details of income statement and changes in
retained earnings (RE).
Helps summarize operating activity.
Avoids cluttering RE account.
At end of accounting period, amounts are totaled,
combined and transferred to RE. Balances at beginning of each period are 0.
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Adjusting andClosing Entries
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Adjusting Entries
Adjusting entries are made at the end of the
accounting period
to properly reflect the balances of all asset,
liability, and owners equity accounts
to recognize all revenues and expenses on an
accrual basis
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Adjusting Entries
New information
requires an
adjustment to a
transaction thathas already been
recorded
A transaction has
not yet been
recorded even
though a businessevent has occurred
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Adjustments result from one of twosequences of events:
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An Event Already Recorded
Assume a company purchases a one-yearinsurance policy paying $1,200 on October
1, 2006, resulting in the following journalentry
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Prepaid Insurance 1,200Cash 1,200
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An Event Already Recorded
At December 31, 2006, the followingadjusting journal entry is required:
Insurance Expense 300
Prepaid Insurance 300
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$1,2 (12 mont s $100 rmont )
ctober1 eptember30
|-----------------------||-------------------------------------------|
December31
3 mont s used up 9mont sstill an asset
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An Event Not Yet Recorded
Assume that a chemical spill during November 2006
at a factory will require a cleanup costing $23,000.
The cleanup will take place in 2007, and nothing yethas been recorded. The following adjustment is
necessary at December 31, 2006:
Chemical Cleanup Expense 23,000 Chemical Cleanup Liability 23,000
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Closing Entries
Closing entries
Transfer the amounts in the revenue, expense,
and dividend accounts to Retained Earnings
Zero-out these temporary accounts for the start
of the next accounting period
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Closing Entries
Comprised of three journal entries:
1. Close the revenue accounts to RetainedEarnings
2. Close the expense accounts to Retained
Earnings
3. Close the dividends account to Retained
Earnings
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Computers and Accounting
The time spent performing routine tasks within theaccounting cycle has been greatly reduced as a resultof using computers
Personal computers are being used for financial analysis
accounting functions
word processing
database management inventory control
credit analysis of customers
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Computers and Accounting
Through networking (Internet and intranet),
personal computers are speeding up the
exchange of information among users
It is still important, however, to be familiar
with the accounting cycle in order to
understand the flow of information withinan organization
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Basic Accounting Concepts
Accounting concepts underlying financial reporting:
Going Concern Concept
Periodicity Concept
Matching Concept Prudence
Substance over form
Consistency
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Accounting Concepts: Entity and
Money Measurement
Entity Concept:
A business entity is an economic unit distinct from its
owner(s). Such entity owns its assets and has its own
obligations. Only those transactions and events which affectthe financial position of the business entity will be recorded
in its books of accounts.
Money Measurement Concept:
Only transactions and events which are measurable in
monetary terms should be recorded.
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Accounting Concepts: Accrual and
Cost
Accrual Concept: Income and expenses should be recognised as and when they
are earned and incurred, irrespective of whether money is
received or paid in connection thereof. An alternative of
accrual basis of accounting is cash basis where transactionsare recorded only when cash is received or paid.
Cost Concept:
Assets and liabilities should be recorded at historical cost. The
recent trends in accounting show that policy makers favour
fair value accounting in place of historical cost accounting.
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Accounting Concepts: Going Concern
and Periodicity
Going Concern Concept:
An entity is said to be a going concern if it has neither the
intention nor the necessity of liquidation or of curtailing
materially the scale of the operations. The valuation
principles of assets and liabilities depend on this concept.
Periodicity Concept:
Accounts are prepared for a defined accounting period. Such
period could be a quarter, half year, a year or, in exceptional
circumstances, more than one year. This concept is essentialto measure financial performance.
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Accounting Concepts: Matching and
Prudence
Matching Concept:
While measuring periodic financial results, revenue earnedduring an accounting period is matched with expensesincurred (to earn the revenue) in the same accounting
period. Thus, expenditure incurred during construction phaseshould be withheld till the business starts commercial activityand earns revenue.
Prudence Concept:
This concept suggests that all possible expenses and losses
should be estimated and recorded, but anticipated gainsshould be ignored. This concept is also called the concept ofconservatism.
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Accounting Concepts: Substance overform and Consistency
Substance over form: While recording transactions more emphasis needs to be given
to the substance of the transactions and not merely to their legalform. A transaction may appear to be an expense when lookedat from legal angle (e.g., construction of road by a business
entity on land owned by the municipality), but the substance ofthe matter may demand such expense be shown as asset (e.g., ifsuch road is primarily used by the business entity for its businesspurposes).
Consistency:
A business entity frames accounting policies that lay down rulesfor presentation of financial statements. Accounting policies,once framed, should be consistently followed. However, suchpolicies may be changed if circumstances so warrant.
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Financial tatements: O jective
To provide information about thefinancial
position,performance and cash flows of an
enterprise that is useful to a wide range of users
in makingeconomic decisions.
Financial statements do not necessarily provide
non-financial information.
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Financial tatements: QualitativeCharacteristics
Understandability
Relevance
Reliability
Faithful representation
Substance over form
Prudence
Neutrality
Comparability
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Financial Elements: Definition
Assets are economic resources controlled by theenterprise as a result ofpast events from which
future economic benefits are expected to flow to
the enterprise.
Liabilities are present obligations of the enterprisearising from past events, the settlement of which
is expected to result in an outflow from the
enterprise of resources embodying economic
benefits.
Equityis the residual interest in the assets of the
enterprise after deducting all its liabilities.
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Financial Elements: Definition
Income is increase in economic benefits during theaccounting period in the form of inflows or enhancement
of assets or decreases of liabilities that result in increases
in equity, other than those relating to contributions from
equity participants. Expenses are decreases in economic benefits during the
accounting period in the form of outflows or depletion of
assets or incurrence of liabilities that result in decreases
in equity, other than those relating to distributions to
equity participants.
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Corporate Financial Statements
What are the corporate financial statements?
Balance Sheet
Shows the financial position (position of assets,
liabilities and equity) as on the reporting date. Profit & Loss Account
Shows the financial results (profit or loss) for an
accounting period.
Cash Flow Statement Shows the net increase /decrease in cash and cash
equivalents during the accounting period.
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Fundamental AccountingAssumptions
What are the fundamental accountingassumptions?
Accrual
Going concern Consistency.
Why are they called Fundamental?
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Internal Accounting Controls
Basic Principle: make it as difficult as is
practical for people to be dishonest or
careless.
Activities that reduce possibility of theft, or
intentional or unintentional mistakes.
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