Basics of accounting in financial accounting

basics of accounting

1. Basics of accounting-ii By: anup nautiyal

2. BRANCHES OF ACCOUNTING 1. Financial Accounting- it is concerned with the recording, summarizing, and reporting of financial transactions of an organization. It involves the preparation of financial statements such as the balance sheet, income statement, and cash flow statement. Financial accounting is used by external stakeholders such as investors, creditors, and regulators to make decisions about the organization. 2. Management Accounting- it is concerned with the provision of financial information to internal stakeholders such as managers and employees to make decisions about the organization's operations. Management accountants prepare reports such as budget reports, cost analysis reports, and variance analysis reports, which help managers in making informed decisions. 3. Cost Accounting- is concerned with the analysis of costs incurred in the production of goods and services. It involves the calculation of costs such as direct material costs, direct labor costs, and manufacturing overhead costs. Cost accountants provide information to managers to help them in making decisions about pricing, product mix, and cost reduction strategies.

3. TYPES OF ACCOUNTS Classification of Accounts in Accounting Personal Account- These accounts types are related to persons. These persons may be natural persons like Raj’s account, Rajesh’s account, Ramesh’s account, Suresh’s account, etc. Real Account- These account types are related to assets or properties. They are further classified as Tangible real account and Intangible real accounts. Nominal Account- These accounts types are related to income or gains and expenses or losses. For example: – Rent A/c, commission received A/c, salary A/c, wages A/c, conveyance A/c, etc.

4. Golden rules of accounting The golden rules of accounting are: Personal Account- Debit the receiver, Credit the Giver. For Example   – Goods sold to Suresh. In this transaction, Suresh is a personal account as being a natural person. His account will be debited in the entry as the receiver. Real Account- Debit what comes in, Credit what goes out For Example  – Furniture purchased by an entity in cash. Debit furniture A/c  and credit cash A/c. Nominal Account- Debit all the expenses and losses, Credit the incomes and gains For Example   – Salary paid to employees of the entity. Salary A/c will be debited when the expenses are incurred. Whereas, when an entity receives any interest, discount, etc these are credited whenever these are received by the entity.

5. Basis of accounting The basis of accounting relates to the timing when transactions get recorded. The two bases businesses can choose from are either  cash basis or accrual basis accounting . Cash and accrual accounting make similar  journal entries , but the key difference between the two lays in the timing of recording. Cash accounting recognizes money only when it is received or paid. While accrual, recognizes revenue the second it gets earned, and expenses right when they get billed.

6. System of accounting Single Entry System - This system is also known as pure entry system. It does not follow the traditional dual recording format. Instead, in a single entry system, only a  Cash Book  will be maintained. All cash transactions will be recorded in the Cash Book. No other Ledgers find a place in this system. Double Entry System - This is the more traditional and conventional system for recording transactions in financial accounting. This is a scientific method which has some rules and principles which must be followed. The basic essence of the double entry system is that every transaction will affect two accounts. This is known as the debit and credit rule – every credit entry, there must be a corresponding debit entry.

7. Single entry system This system is also known as pure entry system. It does not follow the traditional dual recording format. Instead, in a single entry system, only a  Cash Book  will be maintained. All cash transactions will be recorded in the Cash Book. No other Ledgers find a place in this system. All  transactions  of personal  nature  are simply recorded in a rough book. Some other salient features of the single entry system are, Since only one cash book is kept, personal and business transactions will be recorded together Real and Nominal accounts will be ignored by this system Profit or Loss can be ascertained but we cannot represent the financial position of the organization No trial balance is prepared, so arithmetical accuracy of accounts cannot be verified

8. Double entry system This is the more traditional and conventional system for recording transactions in financial accounting. This is a scientific method which has some rules and principles which must be followed. The basic essence of the double entry system is that every transaction will affect two accounts. This is known as the debit and credit rule – every credit entry, there must be a corresponding debit entry. The double entry system is the one widely used and recognized in the  accounting  world. Some salient features of this system are, All three types of accounts are maintained in this system – real, nominal and personal The arithmetic accuracy of the financial records are verified by preparing the trial balance The system does not have many modifications. 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

9. Accounting equation The accounting equation summarizes the essential nature of double-entry system of accounting. Under which, the debit always equal to credit, and assets always equal to the sum of equities and liabilities. Accounting equation can be simply defined as a relationship between assets, liabilities and owner’s equity in the business. The accounting equation connotes two equations that are basic and core to  accrual accounting  and double-entry accounting system. The following are two basic rules of accounting equation that distinguishes the accrual system of accounting from  cash basis accounting , and single-entry system from the double-entry system: The first among them is the basic accounting equation which written as Assets = Liabilities + Equities. The second one is termed as ‘Expanded Accounting Equation’ which is a combination of the basic equation and secondary equation i.e. Debit = Credit. It derives its status only from the accrual system of accounting and thereby, it does not apply in a cash-based, single-entry accounting system. Assets = Liabilities + Owners Equities

10. Solved Example on Accounting Equation Analyze the following transactions under the Accounting Equation Approach. Commenced business with cash ₹500000 Purchased goods ₹25000 Paid salary ₹10000 Sold goods costing ₹20000 at a profit of 25% on the cost Paid salary in advance ₹2000 Introduced additional capital ₹10000 Purchased computer ₹ 15000 on credit Deposited ₹50000 into the bank 

11. Assets Capital + Liabilities Cash Stock Computer Pre-paid Salary Bank Capital Creditors 500000 500000 -25000 [phone] 25000 500000 -10000 -10000 465000 25000 490000 [phone] [phone] 495000 -2000 [phone] 2000 495000 +10000 [phone] 2000 505000 +15000 [phone] 15000 2000 505000 15000 -50000 [phone] 15000 2000 50000 505000 15000 520000 520000