Introduction to Accounting (CIT)

Definition, Purpose and Terminology


Introduction to Accounting

Accounting deals with communicating the business activities of a firm to individuals and various sections within the firm and also to outsiders. We can say that technique of recording, process of identifying, method of measuring and language of communicating business transaction is accounting. From the above definition we ascertain that Accounting is:
1: Recording of data All business and other organization cannot keep all details in their mind so they have  to keep record of it.  They will not only record cash receive and paid also record good bought and sold. It is called recording of data.
2: Classifying and Summarizing When data is recorded it has to be sorted out so as to be most important and useful to business. This is called classifying and summarizing data. By classifying we can work out how much profit or loss is made, also show what resources owed by business.
3: Communicating information From the sorted data, someone skilled in accounting should be able to tell whether or not business is performing well financially. He should be able to ascertain strengths and weakness of business. Finally he should be able to tell or communicate his result to owners of business or to others allowed to receive this information.

Objective of Accounting The information communicated by accounting is needed for following purposes:
1: Owners of business wants to know their result of activities i.e. profit or loss suffered and financial strength of business.
2: Prospective investor and creditors are interested to know profitability and financial status of business.
3: Employees want to know the stability and future prospects and scope of business.
4: Management needs various kind of classified informations for decision-making techniques.
5: Various Government agencies are also interested in firm activities and incomes.

Basic Terminology
In every field of life some words are used with their specific meanings. These are called terms. In accounting, also some basic term are used. These term and their meaning are:

Business: Any activity undertaken for purpose of earning profit such as buying and selling of merchandise called merchandise concern, rendering services called service concern and manufacturing goods called manufacturing concerns.

 Transaction: Any dealing between two people, which can be measured in terms of money, is called transaction. Like buying some item, selling some item , receive money from someone, pay  to someone.

Voucher: Documentary evidence of business transaction is called voucher. It can be cash memo ,bill, invoice, etc.

Merchandise: Things bought by firm for purpose of reselling them in same condition is called merchandise or goods.

Purchases: Cost of merchandise bought is called purchases. When price of goods purchase is paid in cash it is called cash purchase and when it is paid in future date it is credit purchase.

Sales: The selling price of goods sold is called sales. If this price is received in cash it is called cash sales and when receive on any future date it is called credit sales.

Revenue: All sort of income received or accrued is called as Revenue. This revenue may earn from sale of merchandise or by rendering services for customers. It is also earned in shape of commission, interest, discount, etc.

Expenses: To achieve objective of business certain payments or obligations are created. These payments are expenses of business, examples of such expenses are freight, cartage, salaries, rent, advertisement etc.

Assets:
Anything valuable possess by a firm with following three characteristics qualifies as asset:
·         Legal title of ownership
·         Right to use
·         Right to dispose
Examples of assets are cash, building, furniture and fixtures, machinery and plant, account receivables, notes receivables, investments, inventories, etc.  Asset can be subdivided into following groups:

·         Current Assets:
Which are either cash or easily convertible into cash. They are created with a view to convert or sell them for cash. Examples of such assets are cash in hand, cash at bank, account receivables, notes receivables, merchandise inventories, etc.
·         Non current Assets:
 These are assets which are acquired with a view to hold them and earn income other than business income. Example is investment, shares of other companies, Government securities, etc.


·         Fixed Assets:
 These assets are acquired to retain and use in business operations e.g. land, building, machinery and plant, motor vehicles, etc.

·         Intangible Assets:
 These assets though not physically touchable but still valuable for business enterprise, e.g. preliminary expenses, trademark, goodwill etc.

Equities:
 The right possessed by owners or outsiders against the assets of firm are called equities. These are divided into two categories:
Owner Equity:
 It is capital invested by proprietors/owners of business. It is claim of owner on assets of enterprise.
Liabilities:
It is claim of outsiders against assets of enterprise. It can be of following two types:
Short term liability
Liability which are payable in near future are called short-term liabilities. For e.g. account payable, notes payable, bills payable, bank overdrafts.
Long term Liabilities
These are loans which are raised for permanent finance of firm. These are payable after number of years. Examples are long period bank loans, securities, mortgage loans, etc.

Drawing
Cash or commodities withdrawn by owner for his personal use from business are known as drawings.



















Questions

1: Tick the correct Answer:
a.    Capital refer to equity of owner in a firm                                T/F
b.    Liabilities are claim of outsiders in a business.                    T/F
c.    Merchandise are current assets.                                             T/F
d.    Revenue means income.                                                         T/F
e.    Commission receive is an income.                                         T/F
f.     Building purchase for office will be included in purchase.           T/F

2. Fill in the blanks:
a.    Any action undertaken for purpose of earning profit is called --------------
b.    Art of measuring, communicating, interpreting financial activities is called ------
c.    Any dealing between two persons in term of money is called --------------
d.    Goods sold in course of trading is called  --------------
e.    Any documentary evidence in support of business transaction is called as -----
f.     Amount of cash and goods which owner of business invest is called ------------.

3: Classify following as Assets, liabilities and Owners equity.
Account Receivable                        Account Payable                 Loan from Bank
Capital                                   Building                                 Machinery
Expenses Payable              Net Income

4: Classify as Expenses and Revenue
Commission received         Discount Paid           Salaries paid         Rent Received
Advertisement bill                Custom duties          Sale of good        Purchase of goods.

5: Classify as Current asset, Non current asset, Fixed asset, Intangible asset:
Cash,                         Account receivable,             Building,        Investments,
Goodwill,       Inventories,                           Copyright,      Prize bonds, 
Furniture,      Electric fans,                         Sports Material.










Accounting Equation

Accounting Equation
Whole of financial accounting is based upon accounting equation. For e.g. If a firm is to setup and start trading than it needs resources. Let us assume that in first place it is owner of business who has supplied all resources, This is
            Resources in business = Resources supplied by owner
Amount of resources supplied by owner is called capital. Actual resources that are than in business are called assets of business. So accounting equation can be:   Assets = Capital
However, people other than owner have supplied some of the asset. Liabilities are name given to amount owing to these peoples for these assets. Equation now will be:      Assets = Capital + Liabilities
It can be seem that two sides of equation will have same total so:
            Resources what they are = Resources who supplied them
            Assets   =  Capital + Liabilities

Transaction and Accounting Equation
When a transaction take place it effects in term of increase or decrease of three components of accounting equation. Consider following illustrations:

1: Mr Irfan started business of printing by introducing Rs: 2,00,000 in name of Irfan Printing press.
Effect of these transaction is that cash increase 2,00,000 and capital also increase 2,00,000.
            Asset             =          Equities
 Cash                         =          Capital
+2,00,000                  =          +2,00,000

2: Irfan purchase building Rs:1,00,000 and paid cash for same.
Now  Cash will decrease 1,00,000 and building will increase by 1,00,000.
                        Asset                         =          Equities
Cash              Building        =          Capital
1:         2,00,000                                 =          2,00,000
2:      -1,00,000          1,00,000         =         


           
Bal:     1,00,000        1,00,000         =          2,00,000









3: Irfan Purchase Machinery worth Rs: 1,50,000 from Liaqat and paid Rs: 50,000 in cash
Now Machinery(asset) will increase by 1,50,000 A/P(Account Payable) to liaqat will be 1,00,000 increase and cash will decrease 50,000
                       
Asset                                                 =          Equities

Cash                          Building        Machinery                =          Capital           A/P
1:         2,00,000                                                                     =          2,00,000
2:      -1,00,000          1,00,000                                             =         
3:      -50,000                                     +1,50,000                  =                           +1,00,000

Bal:  50,000              1,00,000         1,50,000                     =          2,00,000    1,00,000


Example:1
 Given effect of following transaction of trader incurred during month of May, 1998 by means of Accounting Equation:
·         Ali started business by introducing capital of Rs:25,000.
·         Purchase building Rs:10,000.
·         Purchase furniture Rs:14,000 on account from Qureshi Furniture.
·         Earn Rs:1,39,000 receive the amount in cash.
·         Following expenses were paid:
·         Wages :1125
·         Utilities: 250
·         Tax paid: 130
·         Ali withdraw from business 1200 in cash for personal use.






















Example 2:
·         Salman start business with Rs:50,000.
·         Purchase merchandise for cash Rs:10,000.
·         Purchase furniture for cash Rs:8,000.
·         Merchandise costing Rs:8000 were sold for Rs:10,000 on account
·         Purchase merchandise for cash 14,000.
·         Merchandise costing Rs:6,000 were sold 8,000 on credit
·         Payment receive against the account receivable Rs:10,000
·         Rent of shop for month was paid 500.
Record above transactions in an accounting equation

Example 3:
·         Abasin start business with cash 50,000 on Jan 1986.
·         Purchase office furniture for cash 2000.
·         Purchase merchandise for cash 9,000
·         Paid carriage on purchase of merchandise Rs:250
·         Purchase merchandise from Saleem/Co Rs:7,000.
·         Sold merchandise for cash Rs:1200, cost Rs:1,000.
·         Sold merchandise to Rehman/sons Rs:15,000 costing 13,000
·         Received cash from Rehman/Sons Rs:13,000.
·         Paid cash to Salman/Co Rs:3,000
·         Paid salaries for month 2500








Exercise

Q 1: Identify By putting tick mark where following statement are true or false
1st Revenue has effect of increasing capital                             T/F
2nd       Liabilities = Asset – Capital                                                            T/F
3rd Liabilities are claim of outsider against of firm                     T/F
4th Equities means liabilities of business                                   T/F
5th Account Receivable is a current asset                                  T/F

Q 2: Encircle the answer which is correct.
1st Liabilities arising from purchase of goods on credit is called
l   Loan                     l Account Payable             l Bank overdraft

2nd       Asset must be equal to
l Capital                   l Liabilities                           l Capital+Liabilities

3rd Expenses paid by business decreases
l Cash                      l Capital                               l Cash & Capital

4th When cash is receive from Account Receivable it increases
l Cash                      l Account Receivable        l Capital

5th The difference between Sale price and Purchase price of merchandise is added in
l Assets                    l Liabilities                           l Capital

Q 3: Show the effect of following transaction in an Accounting Equation:
1.    Introduce cash as capital Rs: 20,000
2.    Purchase merchandise for cash Rs:5000
3.    Purchase typewriter for cash Rs:1000
4.    Merchandise costing Rs;1400 were sold to Ahmad for Rs:1800 on account.
5.    Purchase merchandise from Aftab for Rs:500
6.    Receive Rs:1000 from Ahmad
7.    Sold merchandise for cash Rs:800 which cost 750

8.    Paid salaries in cash Rs:400

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