Accounting for Managers - The Accounting Process - Notes - Finance, Study notes of Management Accounting

Download Accounting for Managers - The Accounting Process - Notes - Finance and more Study notes Management Accounting in PDF only on Docsity! THE ACCOUNTING PROCESS ------------------------------------------------------------------------------------------------- 1.2.1 INTRODUCTION During the accounting period the accountant records transactions as and when they occur. At the end of each accounting period the accountant summarises the information recorded and prepares the Trial Balance to ensure that the double entry system has been maintained. This is often followed by certain adjusting entries which are to be made to account the changes that have taken place since the transactions were recorded. When the recording aspect has been made as complete and upto-date as possible the accountant prepares financial statements reflecting the financial position and the results of business operations. Thus the accounting process consists of three major parts: (i) the recording of business transactions during that period; (ii) the summarizing of information at the end of the period, and (iii) the reporting and interpreting of the summary information. The success of the accounting process can be judged from the responsiveness of financial reports to the needs of the users of accounting information. This lesson takes the readers into the accounting process. 1.2.2 OBJECTIVES After reading this lesson the reader should be able to: • Understand the rules of debit and credit • Pass journal entries • Prepare ledger accounts 31 • Prepare a trial balance • Make adjustment and closing entries • Get introduced to tally package 1.2.3 CONTENTS 1.2.3.1 The Account 1.2.3.2 Debit – Credit 1.2.3.3 The Ledger 1.2.3.4 Journal 1.2.3.5 The Trial Balance 1.2.3.6 Closing Entries 1.2.3.7 Adjustment Entries 1.2.3.8 Preparation of Financial Statements 1.2.3.9 Introduction to Tally Package 1.2.3.10 Summary 1.2.3.11 Key Words 1.2.3.12 Self Assessment Questions 1.2.3.13 Books for Further Reading 1.2.3.1 THE ACCOUNT The transactions that takes place in a business enterprise during a specific period may effect increases and decreases in assets, liabilities, capital, revenue and expense items. To make upto-date information available when needed and to be able to prepare timely periodic financial statements, it is necessary to maintain a separate record for each item. For e.g. it is necessary to have a separate record devoted exclusively to recording increases and decreases in cash, another one to record increases and decreases in supplies, a third one on machinery, etc. The type of record that is traditionally used for this purpose is called an account. Thus an account is a statement wherein information relating to Left side (Debit side) Right side (Credit side) 1.2.3.2 DEBIT CREDIT The left-hand side of any account is called the debit side and the right-hand side is called the credit side. Amounts entered on the left hand side of an account, regardless of the tile of the account are called debits and the amounts entered on the right hand side of an account are called credits. To debit (Dr) an account means to make an entry on the left-hand side of an account and to credit (Cr) an account means to make an entry on the right-hand side. The words debit and credit have no other meaning in accounting, though in common parlance, debit has a negative connotation, while credit has a positive connotation. Double entry system of recording business transactions is universally followed. In this system for each transaction the debit amount must equal the credit amount. If not, therecording of transactions is incorrect. The equality of debits and credits is maintained in accounting simply by specifying that the left side of asset accounts is to be used for recording increases and the right side to be used for recording decreases; the right side of a liability and capital accounts is to 33 be used to record increases and the left side to be used for recording decreases. The account balances when they are totaled, will then conform to the two equations: 1. Assets = Liabilities + Owners’ equity 2. Debits = Credits From the above arrangement we can state that the rules of debits and credits are as follows: ------------------------------------------------------------------------------------------------- Debit signifies Credit signifies ------------------------------------------------------------------------------------------------- 1. Increase in asset accounts 1. Decrease in asset accounts 2. 3. Decrease in liability accounts Decrease in owners’ equity 2. 3. Increase in liability accounts Increase in owners’ equity accounts accounts ------------------------------------------------------------------------------------------------- From the rule that credit signifies increase in owners’ equity and debit signifies decrease in it, the rules of revenue accounts and expense accounts can be derived. While explaining the dual aspect of the concept in the preceding lesson, we have seen that revenues increase the owners’ equity as they belong to the owners. Since owners’ equity accounts increase on the credit side, revenue must be credits. So, if the revenue accounts are to be increased they must be credited and if they are to be decreased they must be debited. Similarly we have seen that expenses decrease the owners’ equity. As owners’ equity account decreases on the debit side expenses must be debits. Hence to increase the expense accounts, they must be debited and to decrease it they must be credited. From the above we can arrive at the rules for revenues and expenses as follows: 34 ------------------------------------------------------------------------------------------------- Debit signifies Credit Signifies ------------------------------------------------------------------------------------------------- Increase in expenses Decrease in expenses Decrease in revenues Increase in revenues ------------------------------------------------------------------------------------------------- 1.2.3.3 THE LEDGER A ledger is a set of accounts. It contains all the accounts of a specific business enterprise. It may be kept in any of the following two forms: (i) Bound Ledger and (ii) Loose Leaf Ledger A bound ledger is kept in the form of book which contains all the accounts. These days it is common to keep the ledger in the form of loose-leaf cards. This helps in posting transactions particularly when mechanized system of accounting is used. 1.2.3.4 JOURNAL When a business transaction takes place the first record of it is done in a book called journal. The journal records all the transactions of a business in the order in which they occur. The journal may therefore be defined as a Chronological record of accounting transactions. It shows names of accounts that are to be debited or credited, the amounts of the debits and credits and any additional but useful information about the transaction. A journal does not replace but precedes the ledger. A proforma of a journal is given in Illustration 1. 35