BCA - II (ACCOUNTING AND FINANCIAL MANAGEMENT) Unit - II
Systems of Accounting
Systems of accounting refer to the two systems of recording the financial transactions in the books of accounts. These two systems are the single entry system and the double or dual entry system. Let us learn about both in brief.
- It allows for the preparation of the balance sheet which will reflect the financial position of the organization
- Easy to detect frauds and errors in this double entry system
Basis of Accounting
This deals with the timing of the revenue recognition, i.e. when should the revenue be recognized in the books of accounts. There are two approaches to this dilemma – cash basis of accounting and accrual basis of accounting. Let us take a brief look at both.
Cash Basis of Accounting
This is the simpler, uncomplicated approach. Under the cash system of accounting an income will only be recorded when it comes in. So an income will be earned when it is received in cash by the organization. And similarly, the expenses will also be recorded only when they are actually made.
So take for example the organization pays the salary of its employees for the month of June on the 3rd of July. This salary expense will thus be recorded in July, although the expense is for the period of June. Similarly, say the organization made a credit sale on 5th August. They received the payment on 11th October, so this sale will be recorded on this date.
Accrual Basis of Accounting
Accrual basis is the more logical and scientific approach to accounting. This is the method most organizations chose to adopt, as it gives a more fair representation of the financial position of the company.
In the accrual system, the revenues and expenses are recognized in the time period in which they occur, not when the money actually comes in. So the income will be recorded if it is earned irrespective of whether the payment has come in or not. And the expense is recorded when it becomes due, irrespective of whether it has been paid.
So in accrual system, all incomes and expenses – cash items and non-cash items (like prepaid/outstanding expenses and accrued/advance income) will be taken into account. And the final accounts will be a true representation of the organization’s financial position.
Introduction to Accounting
According to American Institute of Certified Public Accountants, “Accounting is the art of recording, classifying and summarising 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.”
Accounting Principles Board (APB) of AICPA(U.S.A) defined accounting as “Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.”
Objectives of Accounting
1. To keep systematic and complete record of financial transactions in the books of accounts according to specified principles and rules to avoid the possibility of omission and fraud.
2. To ascertain the profit earned or loss incurred during a particular accounting period which further help in knowing the financial performance of a business.
3. To ascertain the financial position of the business by the means of financial statement i.e. balance sheet which shows assets on one side and Capital & Liabilities on the other side.
4. To provide useful accounting information to users like owners, investors, creditors, banks, employees and government authorities etc who analyze them as per their requirements.
5. To provide financial information to the management which help in decision making, budgeting and forecasting.
6. To prevent frauds by maintaining regular and systematic accounting records.
Advantages of Accounting
1. It provides information which is useful to management for making economic decisions.
2. It help owners to compare one year’s results with those of other years to locate the factors which leads to changes.
3. It provide information about the financial position of the business by means of balance sheet which shows assets on one side and Capital & Liabilities on the other side.
4. It help in keeping systematic and complete record of business transactions in the books of accounts according to specified principles and rules, which is accepted by the Courts as evidence.
5. It help a firm in the assessment of its correct tax Liabilities such as income tax, sales tax, VAT, excise duty etc.
6. Properly maintained accounts help a business entity in determining its proper purchase price.
Limitations of Accounting
1. It is historical in nature; it does not reflect the current worth of a business.
Moreover, the figures given in financial statements ignore the effects of changes in price level.
2. It contain only those informations which can be expressed in terms of money. It ignore qualitative elements such as efficiency of management, quality of staff, customers satisfactions etc.
3. It may be affected by window dressing i.e. manipulation in accounts to present a more favorable position of a business firm than its actual position.
4. It is not free from personal bias and personal judgment of the people dealing with it. For example different people have different opinions regarding life of asset for calculating depreciation, provision for doubtful debts etc.
5. It is based on various concepts and conventions which may hamper the disclosure of realistic financial position of a business firm. For example assets in balance sheet are shown at their cost and not at their market value which could be realised on their sale.
Book Keeping – The Basis of Accounting
Book keeping is the record-making phase of accounting which is concerned with the recording of financial transactions and events relating to business in a significant and orderly manner.
Book Keeping should not be confused with accounting. Book keeping is the recording phase while accounting is concerned with the summarizing phase of an accounting system. The distinction between the two are as under.
Qualitative Characteristics of Accounting Information
Accounting information is useful for interested users only if it posses the following characteristics:
1. Reliability: Means the information must be based on facts and be verified through source documents by anyone. It must be free from bias and errors.
2. Relevance: To be relevant, information must be available in time and must influence the decisions of users by helping them to form prediction about the outcomes.
3. Understandability: The information should be presented in such a manner that users can understand it well.
4. Comparability: The information should be disclosed in such a manner that it can be compared with previous year’s figures of business itself and other firm’s data.
Types of Journal Entries
A journal is a detailed account that records all of a company's financial activities. There are 6 types of journal entries.
Types of Journal Entries
A journal is a detailed account that records all of a company's financial activities. There are 6 types of journal entries.
TABLE OF CONTENT
Meaning of Journal
A journal is a detailed account that records all of a company’s financial activities and is used for future reconciliations and information transfer to other formal accounting records, such as the general ledger. In a double-entry bookkeeping system, a journal records the date of a transaction, which accounts were affected, and the balances.
Types of Journal Entries
There are six different types of journal entries, or seven if you include the archaic, imprecise, and seldom used single entry. Standard accounting, which is based on double-entry, does not employ a single journal entry. It’s better at checkbook balancing than for company accounting, which has a lot of accounts.
Each of the six basic entry types has a different purpose in accounting. They give a balanced, accurate, and unbiased financial account of the organization as a whole. They are as follows:
Opening entries
These entries carry over the previous accounting period’s ending balance as the current accounting period’s beginning balance. Consider the following scenario: After all liabilities for the preceding accounting period were settled, the closing balance of the Cash account on the balance sheet was Rs. 11000. The opening entry for the current accounting period is that balance of Rs. 11000.
Transfer entries
To move or allocate an expense or income from one account to another transfer entries are used. For example, Reliance Ltd. transfers cash from its primary account to a subsidiary account. A transfer journal entry accounts for the transfer must be made. There is no involvement of a third party in these transactions, and hence all transfers must be net zero.
Closing entries
These entries indicate the completion of an accounting period with a balance that can be moved from a temporary to a permanent account, or from one accounting period to the next. The closing entry in the case of temporary accounts zeros out the account, and any amount remaining is transferred to a more permanent account. After that, the temporary account is closed. Expense and loss accounts, revenue, income, and gain accounts, income summary accounts, and dividend or withdrawal accounts are all examples of temporary accounts. When it comes to accounting periods, the closing entry indicates the account’s final balance at the close of that period. The value is subsequently moved to the next accounting period’s starting entry. It is the accounting period for that account that is closed in this case.
Adjusting entries
Adjusting entries are entries that, in accordance with the accrual method of accounting, reflect changes to accounts that are not otherwise accounted for in the journal. According to matching and revenue recognition principles, these entries are entered in the general ledger at the ending of an accounting period. Accruals, deferrals, and estimations are all common examples. An expense accrual is an expense that is reported in an accounting period but not yet paid. Electricity used by a plant in the month prior to the utility issuing a bill for the firm to pay is an example.
Work that has been completed or products that have been delivered but for which the customer has not been billed is referred to as a revenue accrual. When a payment is made in an accounting period before the item is actually incurred, this is known as an expense deferral. A payment made now for insurance that covers the next six months is an example. When a corporation gets money in advance for services or products that will be provided in the future, this is referred to as deferred revenue.
Compound entries
These entries record various accounts that will be debited or credited. The total of debits and credits must be equal, but the number of credits and debits does not have to be equal, according to the rule of journal entry. There might be one debit but two or more credits, one credit but two or more debits, or even two or more credits and debits. Payroll, for example, may involve a huge number of journal entries that may be summarized in compounded form.
Reversing entries
Reversing entries are created at the start of a new accounting period to reverse, or undo, an adjusting entry made at the completion of the previous period. This option reduces accounting mistakes caused by double-counting expenses or income while also improving the efficiency of processing actual invoices in the next accounting period. To put it another way, they’re utilized to make bookkeeping easier.
Conclusion
A journal is a book of accounts that records every transaction that occurs in a business with precise explanation for it. It is maintained day to day.
What do you mean by Ledger?
Answer:
Ledger is the collection of different accounts of assets, liabilities, capital, revenue and expenses. When transactions are recorded in the Journal (Book of Original Entry), these are transferred or posted to their respective accounts in Ledgers. These are called Book of Secondary or Final Entry. Ledger contains all accounts of a business enterprise, irrespective of whether they are personal, real or nominal.
- Sheet.
- A Trial Balance helps in summarising the financial transactions done while running a business. It is a consolidated summary of the financial transactions that have taken place within a financial year. It can help the management in making business decisions as well.
Limitations of a Trial Balance
The main limitations of a Trial Balance are as follows:
- It may hide errors of omission. Some transactions are not journalised at all. Even a correctly balanced Trial Balance cannot reveal this mistake.
- If a journal entry with an incorrect amount gets recorded in both accounts, the Trial Balance will not detect that error.
- A journal entry may have the right amount, but the accountant may have entered it under the wrong accounting heads. The Trial Balance cannot identify such mistakes.
- If a journal entry is missing in the ledger, it will not reflect in the Trial Balance.
Conclusion
Trial Balance is an essential part of the accounting process. It is beneficial in providing a summary of the financial activities of a company, and it also helps in preparing financial statements.
Final Accounts Meaning
Final accounts are those accounts that are prepared by a joint stock company at the end of a fiscal year. The purpose of creating final accounts is to provide a clear picture of the financial position of the organisation to its management, owners, or any other users of such accounting information.
Final account preparation involves preparing a set of accounts and statements at the end of an accounting year. The final account consists of the following accounts:
- Trading and Profit and Loss Account
- Balance Sheet
- Profit and Loss Appropriation account
Objectives of Final Account preparation
Final accounts are prepared with the following objectives:
- To determine profit or loss incurred by a company in a given financial period
- To determine the financial position of the company
- To act as a source of information to convey the users of accounting information (owners, creditors, investors and other stakeholders) about the solvency of the company.
The format of a final account is represented as follows:
| Particulars | Amount | Particulars | Amount |
| Sales | 2,05,000 | ||
| Sales returns | 15,000 | ||
| Purchases | 49,000 | ||
| Purchases returns | 3000 | ||
| Opening inventory | 8000 | ||
| Closing inventory | 30,000 | ||
| Trading Account | 1,500 |
The format of trading account after passing the closing entry is as follows:
| Dr. Trading Account for the year ended Cr. | ||||
| Sales returns | 15,000 | Sales | 205,000 | |
| Purchases | 49,000 | Purchase returns | 3,000 | |
| Beginning inventory | 8,000 | Ending inventory | 9,000 | |
| Balance c/d | 145,000 | |||
| Total | 217,000 | Total | 217,000 | |
| Balance b/d | 145,000 | |||
In this example, all accounts are closed and transferred to the trading account. The credit entry of 1,45,000 is the gross profit for the period.
Format for Profit and Loss Account
What is a Balance Sheet?
A financial statement that showcases the net worth of an organization by listing the assets and liabilities of the organization, along with shareholder’s equity for a particular period, usually a year, is what a Balance Sheet means.
Importance and Purpose of Balance Sheet
A Balance Sheet shows the financial position of an organization during a particular time frame
The growth of a company is evaluated by comparing the balance sheet of the previous years.
iii) A Balance Sheet displays what an organization owns and what the organization owes.
With the help of the Balance Sheet, potential shareholders and investors can get an insight into an entity’s liquidity position before buying any shares or before investing.
Balance Sheet helps the shareholders and investors to check whether the company will be able to pay dividends.
The following is a typical balance sheet sample –
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