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