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1ByProf. Harvinder S. Chawla

Introduction to Accounting1History of Accounting Accounting was born before writing or numbers existed, some 10,000 years ago in Mesopotamia later know as Persia (Iran and Iraq). This area contains the Tigris river valley, fertile area with a large population and active trading being done between towns and cities up and down the river valley.

And what happens next will directly lead to the invention of both writing and number systems.

A short history of accounting: Accounting was born before writing or numbers existed, some 10,000 years ago, in the area known as Mesopotamia, later Persia, and today the countries of Iran and Iraq. This area contains the Tigris Euphrates river valley, a large fertile area 10,000 years ago with a large thriving population and active trading between towns and cities up and down the two rivers. Writing and numbers would be not be invented for about another 5,000 years. And what happens next will directly lead to the invention of both writing and number systems. At that time, merchants faced many of the same problems businesses face today. They had to ship their merchandise up and down the rivers, and that meant trusting a boatman with their goods. Unfortunately, not all boatmen were honest, and disagreements often arose about how much was shipped versus what was received at the other end. It is hard for us today to imagine a world without writing and numbers. Try to imagine yourself in their position.... what would you do? To deal with the problem, merchants came up with an ingenious plan. They made small clay tokens, in various shapes and with various markings, to indicate different products. One would mean a basket of grain, another would mean a pot of oil, etc. They had over 200 such tokens to indicate a large variety of common goods, including food, leather, clothing, utensils, tools, jewelry, etc.

2Before shipping their goods, a merchant would take one token for each item in the shipment, and encase the tokens in a ball of clay, called a "BOLLAE" (pronounced "bowl-eye") - meaning ball. This ball would be dried in the sun, given to the boatman, and then broken by the buyer on the other end of the transaction. The buyer would match the tokens with the items, to verify that everything sent was accounted for. This is the function of protection of assets, and is a major function of all modern accounting systems. It was important 10,000 years ago and is just as important now.

This is the function of protection of assets, and is a major function of all modern accounting systems. It was important 10,000 years ago and is just as important now. Today we see merchants doing the same thing as their counterparts 10 millennia ago - today they get a bill of lading a listing of the merchandise entrusted to a shipper. The system of using bollae continued for almost 5,000 years, all before the invention of writing or numbers. One day, probably by accident, a wet clay bollae was rolled over a loose token, laying on the ground. The impression of the token was left in the wet clay. Merchants began pressing the tokens on the outside of the bollae, in addition to putting the tokens inside the ball. Eventually they would press tokens into a flat piece of clay, leaving an impression for each item. Remember, they didn't have numbers yet, so they would press a token into the clay for each individual item. Probably by accident one day the right token couldn't be found, and someone used a stick or other object to make the right marks in the soft clay tablet. And writing was born... New symbols were soon created representing multiple items, and suddenly both writing and number systems were invented. The last phase of this remarkable process took about 500 years, but once writing was invented, it caught on like wildfire, and was the most popular thing anyone had ever seen.

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Written accounting records are some of the oldest writings that have been excavated across the world. These early records were simple single-entry listings of wages paid, temple assets, taxes and tributes to the king or Pharaoh.

Picture in the Tomb of Chnemhotep, pharaoh of Egypt dated 1950 BC.

Minute care is not only taken in the case of large amounts, but even the smallest quantities of corn or dates are conscientiously entered." In ancient Egypt, the accountants literally counted food, beer, clothing and everything else. Ancient Egyptians were paid in kind as the concept of money was not invented till then.

Marble tablet: Account of Disbursements of the Athenian State c. 418-415 BCBy the time Christopher Columbus was trying to sail west, a new form of accounting was in use by merchants in Venice . Luca Pacioli set down in writing for the first time a description of the double-entry system of accounting, which we still use today in the same form. Although he didn't actually invent the system he is called "The Father Of Accounting" for his contributions and for documenting the system in his fifth book on mathematics Summa de Arithmetica, Geometria, Proportioni et Proportionalita (Everything About Arithmetic, Geometry and Proportion).

There is a great deal of similarity in accounting practices around the world because they all have a common origin. 56ByProf. Harvinder S. Chawla

Important Concepts & Necessity of Accounting6Why should managers and other decision-makers know accounting?If Finance is the language of business, then Accounting is its grammar.Accounting is an information systemAccounting provides information for making decisionsAccounting and economic decisionsWhat is Accounting?Process of Accounting

Users of Accounting Information9Accounting entityBusiness is distinct from ownerGoing concernBusiness is a continuing enterprisePeriodicityBusiness activities divided into periodsMoney measurementMoney is a stable measurement unitAccrual ConceptRecord business transaction when they occur not when the cash is receivedAccounting AssumptionsImportance of GAAP

What is GAAP?

Institutions that influence GAAPGovernmentAccounting professionSecurities regulatorsOther regulatorsInternational organizationsAccounting PrinciplesAccounting standards

Accounting policies

Why does accounting practice differ?

Need for accounting standards

Principle-based and rule-based standards

Standard-setting mechanism in IndiaAccounting Standards and Policies131415ByProf. Harvinder S. Chawla

Overview of Income Statement & Balance Sheet15Objective of Accounting

CA Book

16Measurement: Past & Current Performance

Forecasting: Future Financial Position

Decision Making: Relevant information to users

Comparison & Evaluation: Targets vs. Actual

Control: Identify Weakness & offer Feedback

Government Regulation & TaxationFunctions of AccountingCA Book17Profit and loss accountStatement of financial performanceRevenues; Expenses (Profitability)Balance sheetStatement of financial positionAssets; Liabilities; Equity (Solvency)Cash flow statement Statement of cash receipts and cash paymentsActivities: Operating;Investing;Financing (Changes in Financial Position)Financial Statements18Sources of Funds = Uses of Funds

Equities = Asset

Assets=Liabilities + Equity

Capital+ RevenuesExpensesDrawingsDividends

Can be rewritten as (Assets + Expenses + Drawings + Dividends = Liabilities + Capital + RevenuesThe Accounting Equation19Probable future economic benefits (Cash or something that can generate cash for business)Assets = what a business ownsExamplesCash, Cash at Bank, Bills Receivables, Prepaid Expenses, Debtors or Account Receivable, Stock (of Raw Material, Work in Progress, Finished Goods, etc.)Land, Buildings, Plant & Machinery, Patents, Copyrights, Loose Tools, Goodwill, etc.AssetsProbable future sacrifices of economic benefitsLiabilities = what a business owes (Contractual, statutory, or constructive)Examples

Bank Overdraft, Outstanding Expenses, Bills Payable, Creditors on accounts, Loan short term as well as long term, Debentures, etc.LiabilitiesEquity represent the claims of those who supplied or invested the money to start the business.Difference between Asset Liabilities. Equity is the residual interest in the asset of the business after deducting all its liabilities.ExampleMoney supplied by the Proprietor for business or seed money (less withdrawals)Reserve & surplus of profit (accumulated profit)Proprietorship EquityIncrease in one AssetDecrease in another AssetIncrease in one LiabilityDecrease in another LiabilityIncrease in one item of Proprietor's EquityDecrease in one item of Proprietor's EquityIncrease in Proprietor's EquityDecrease in LiabilityIncrease in LiabilityDecrease in Proprietor's EquityDecrease in AssetDecrease in Proprietor's EquityIncrease in AssetIncrease in Proprietor's EquityIncrease in AssetIncrease in LiabilityDecrease in AssetDecrease in LiabilityAssets + Expenses + Drawings + Dividends = Liabilities + Capital + Revenues(Effects of Financial Transaction on Accounting Equation)23The account is the basic building block of any accounting system. An accounting system classifies transactions into meaningful categories to prepare financial statements & reports.Accounts facilitates easy & quick retrieval of companys financial data. An account is used to record increase & decrease in these item (assets, liabilities, capital, revenue, drawings, dividends & expenses) resulting from business transactions.No matter whether a company uses either a manual or electronic accounting system, it is essential to have a proper system of classification of transaction into various accounts.

AccountsThe Double Entry SystemThe T account

We need to record each transaction in two accounts so that the accounting equation is always in balance. Double Entry System records every transaction with equal debits & credits. As a result, the total of all Debits must equal total of all Credits

Credit = RightDebit = LeftDebits = CreditsThe terms Debit (Dr.) & Credit (Cr.) are used to describe the left hand side & right hand side of an account.To debit means to make an entry in the left hand side of an account & to credit means to make an entry on the right hand side.

The term debit & credit has no other meaning in accounting.All accounts show entries recording increase & decrease. In some accounts increase are recorded on the left side & decrease on right side whereas in other accounts the reverse is true. It means debits & credits by themselves do not indicate increase & decrease unless reference is made to a specific account to determine the debits & credits represent increases & decreases.DEBITS & CREDITS(Any type of Account)DebitCreditAlways the left sideAlways the right sideDebit and Credit Rules

Asset AccountsDebit SideCredit SideShows IncreasesShows DecreasesNormal Balance - DebitExpenses AccountDebit SideCredit SideShows IncreasesShows DecreasesNormal Balance - DebitLiabilities AccountDebit SideCredit SideShows DecreasesShows IncreasesNormal Balance - CreditOwners' Equity AccountDebit SideCredit SideShows DecreasesShows IncreasesNormal Balance - CreditRevenue AccountDebit SideCredit SideShows DecreasesShows IncreaseNormal Balance - CreditDrawings AccountDebit SideCredit SideShows IncreasesShows DecreasesNormal Balance - DebitThe accounts maintained by the business organization can be classified into three types.Personal Account: It deals with accounts of individuals like Creditors, Debtors, Bank etc. It give you an idea about the balance due to these individuals or due from them on a particular date. Real Account: It relates to assets of the firm but not debts. Eg: Machinery, Land, Buildings, Fixed Deposits Goodwill etc. This account shows the worth of an asset on a particular date.Nominal Account: It consists of different types of expenses or losses and income or profit. The account shows the amount of income earned or expenses incurred for a particular period.Types of AccountsPERSONAL ACCOUNT Debit the receiver, Credit the giver.REAL ACCOUNT Debit what comes in, Credit what goes out.NOMINAL ACCOUNT Debit all expenses & losses, Credit all incomes & gains.3 GOLDEN RULES

EXAMPLESSr. No Title of Account 1BUILDING2STOCK3SALES4BANK DEPOSIT5RENT6CASH7DEBTORS8LOAN9DRAWINGS10FURNITUREEquation Approach Traditional ApproachASSETASSETREVENUEASSETEXPENSESASSETASSETLIABILITYDRAWINGSASSETREALREALNOMINALPERSONALNOMINALREALPERSONALPERSONALPERSONALREALThe Journal is a chronological record of transaction entered into by the business. It is called the Book of Original entry or primary book because we record all the business transaction first in this book.

The process of recording transaction in Journal is called Journalizing.

JournalThe procedure for recording transactions in the journal is as follows:Enter the year, month & date of the transaction on the Date ColumnWrite the account titles under the Description Column Enter the account to debit on the first line. Enter the account to credit under the debited account & indent it to set the account apart from the debited account. If there are several accounts enter them one after another.JOURNALDateDescriptionPost. RefDebit (Dr.)Credit (Cr.)(1)(2)(3)(4)(5)NARRATION (6)Enter the amount of the debit in the Debit Column alongside the account to debit & the amount of the credit in the Credit Column alongside the account to credit.Write a brief explanation of the transactionThe Post. Ref. (Posting Reference) is left blank at the time of making the journal entry.

After recording transaction in the Journals, all entries are classified & grouped into set of accounts. Transferring information from Journal to Ledger is called Posting.A ledger account has two sides debit side & credit side. Each of this sides has four columns: Date, Particulars, Journal Folio, Amount.

LedgerDr.ACCOUNT NAMECr.DateParticularsJ.F.AmountDateParticularsJ.F.Amount1/6/10To Vijays A\c1,00010/6/10By Machinery A\c500Separate account is opened in ledger book for each account & entries from ledger posted to respective account accordingly.It is a practice to use words TO & BY while posting debit & credit entries respectively.To ascertain the balance, total both the sides and find out the difference. Cr. > Dr.The account has a credit balance.Dr. > Cr.The account has a debit balance.Posting information into LedgerDr.CASH ACCOUNTCr.DateParticularsJ.F.AmountDateParticularsJ.F.Amount1/6/10To Vijays A\c1,00010/6/10By Machinery A\c50031/6/10By Balance5001,0001,0001/7/10To Balance b\d500Required

EffectAssets, Expenses, Drawings,DividendsLiabilities, Equity, Revenues

DebitCredit

CreditDebit

Required

EffectAssets, Expenses, Drawings,DividendsLiabilities, Equity, Revenues

DebitCredit

CreditDebit