Account
Basic Accounting terms
In business, various accounting terms are used. It is necessary to understand these terms as they are part of the standard accounting terminology.
1. Business Transaction: The term 'Business Transaction' means a financial transaction or economic event entered into by two parties that initiates the accounting process of recording it in the books of account of an enterprise. It is a financial event expressed in terms of money which brings a change in the financial position of an enterprise. Stating differently, it is an agreement between two parties involving transfer or exchange of goods or services. Examples of business transactions are sales of goods, purchases of goods, receipt from debtors, payment to creditors, purchase or sale of fixed assets, payment of interest, payment of dividend, etc.
Characteristics of a Business Transaction
1. It is concerned with money or money's worth of goods or services,
2. It arises out of the transfer or exchange of goods or services.
3. It brings about a change in the financial position (i), in Assets and Liabilities).
4. It has an effect on the accounting equation of any business firm.
5. It has dual aspects or two sides -Receiving (Debit) and Giving (Credit) of the benefit In other words, every transaction has two sides-one is 'Receiving the benefit and the other is 'Giving the benefit.
6. After each transaction, the total assets of a business must be equal to its total liabilities and capital. Therefore, the equality of the Balance Sheet cannot be disturbed by any transaction,
7. The nature of each transaction is carefully analyses since it affects the financial status of a business unit,
(i)Business Transaction (ii)Relationship with the
(iii)Accounting Unit (iv)Mode of Settlement of Value
(v)External Transaction (vi) Of Business Transaction
(vii)Cash (viii)Transaction
(ix)Internal Transaction (x)or Accounting Transaction,
(xi)a, Depreciation on (xii)Fixed Assets
(xiii)Credit (xiv)Transaction
A transaction may be a cash transaction or a credit transaction. When the amount is transacted (paid or received) immediately on entering into a transaction it is a cash may be external (between a business entity and a second party, for example, goods sold transaction and when it is promised to pay later, it is a credit transaction. Transactions on credit to z) or internal (does not involve second party, e.g., depreciation charged on machinery).
2.Account: It is a record of transactions (cash and credit) under a particular head of We Basic Accounting Terms account (say Salaries, Telephone Expenses, Electricity Expenses, etc.) or a particular
head (say asset, liability, etc.). It not only shows the amounts of transactions but also
shows their effect and direction.
3. Capital: Capital is the amount invested in an enterprise by the proprietor (in case of proprietorship) or by partners (in partnership business). It may be in the form of money or assets having a monetary value. It is a liability of the business towards the proprietor or partners which increases with further investments made in the business and the amount of profit earned. On the other hand, it decreases when it is withdrawn (drawings) or loss is incurred by the business.
In the case of Companies, contributors of capital are many and they are known as
shareholders.
It is a liability because under "Business Entity Concept", business is a separate and distinct entity from its owners. Transactions are recorded in the books of account from the point of view of business. Capital is also known as Owner's Equity or Net Worth. It is always equal to assets less liabilities. It can be expressed as:
Capital = Assets - Liabilities
4. Drawings: It is the amount withdrawn or goods taken by the proprietor or partner for personal use. Goods so taken by the proprietor or partner are valued at purchase cost. Drawings reduces the investment (or capital) of the owners. Drawings by the proprietor or partner is debited to Drawings Account. At the time of preparing Balance Sheet, it is deducted from the capital of the proprietor or partner, as the case is.
5. Liabilities: Liabilities mean amount owed (payable) by the business. Liability towards the owners (proprietor or partners) of the business is termed as internal liability. On the other hand, liability towards the outsiders, i.e., other than the owners (proprietor or partners) is termed as external liability.
External liability arises because of credit transactions or loans taken. Examples of external liability are creditors, bank overdraft, long-term borrowings, and other liabilities. Liability is further classified into:
(i) Non-current Liability: Non-current Liability is that liability which is payable after a period of more than a year from the end of the accounting period. Examples of Non-current Liability are long-term loans, debentures, etc.
(ii) Current Liability: Current Liability is that liability which is payable within 12 months from the end of the accounting period. Examples of Current Liability are creditors, bills payable, short-term loans, etc
This objective can be achieved only when accounting records are maintained on the basis of uniform rules and principles. Accounting principles, concepts and convention are known as generally accepted accounting principles (GAAP). These principles are reporting of business transactions, in order to bring uniformity and (GAAP) refers to the rules or guidelines adopted for recording and
the base of accounting. Generally accepted accounting principles consistency in the preparation and the presentation of financial statements.
These principles have evolved over a long period of time on the basis of experiences of the accountants, customs, legal decisions etc., and which are generally accepted by the accounting professionals.
Fundamental accounting assumptions
1.Going concern assumption: This concept assumes that an enterprise has an indefinite life or existence. It is assumed that the business has neither intention to liquidate nor to scale down its operations significantly.Relevance:
a) Distinction is made between capital expenditure and revenue expenditure
b)Classification of assets and liabilities into current and non-current.
c) Depreciation is charged on fixed assets, and fixed assets appear in the balance sheet at book value,
without having reference to their market value.
2.Consistency assumption: According to this assumption, accounting practices once selected and adopted, should be applied consistently year after year.This will ensure a meaningful study of the performance of the business for a number of years.
Consistency assumption does not means that particular practice, once adopted, cannot be changed. The only requirement is that when a change is desirable, it should be fully disclosed in the financial statements along with its effect on income statement and balance sheet.
Any accounting practice may be changed if the law or accounting standard requires so, to make the financial information more meaningful and transparent.
Relevance : It helps the management in decision-making by utilizing the comparable financial information.
3.Accrual assumption: Accrual concept applies equally to revenue and expenses. As per this assumption, all revenue and cost are recognized when they are earned or incurred. It is immaterial, whether the cash is receive or paid at the time of transaction or later date e.g., if a credit sale (credit for two months) for 15,000 is made on 15th Feb .2016,then the revenue earned is to be recorded on 15th Feb.2016 not on the date of cash realized, i.e., after two months. In case of expenses, if at the end of the year the two months salary is due but not paid, than the expenses of salary will be recorded in the current year in which salary is due, not in the next year in which it will be paid.
Relevance: Earning of a revenue and expenses can be accurately matched to a particular accounting period.
Accounting Principles
1.Business Entity: An entity has a separate existence from its owner. According to this principle, business is treated as an entity, which is separate and distinct from its owner.Therefore
transaction are recorded; analyzed and financial statements are prepared from the business point of view and not of the owner.The owner is treated as a creditor (internal liability) for his investment in the business, as if the firm has borrowed from its owner instead of the outside parties. Interest on capital is treated as expense like any other business expense. His private expenses are treated as drawings leading to reduction in capital.
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2.Money measurement principle: According to this principle,only those transactions that are measured in money or can be expressed in term of money are recorded in the books of accounts of the enterprise. Non-monetary events like death of any employee/manager, strikes, disputes etc., are not recorded at all, even though these also affect the business operations significantly
Limitations:
(i) It ignores qualitative aspect e.g., efficient human resources(assets), satisfied customers (assets) and dishonest employee(liabilities).
(ii) Value of money (currency) is not stable.To make accounting records simple, relevant,understandable and homogeneous, fact are expressed in a common unit of measurement-money, which is not stable.
3. Accounting Period Principle: According to this principle, the whole indefinite life of an enterprise is divided into parts , knows accounting period.Accounting period is defined as interval of time, at the end of which the profit and loss account and balance sheet are prepared, so that the performance is measured at regular intervals and decision can be taken at the appropriate time.Accounting period is usually a period of one year.
Relevance:
1. This assumption requires showing the allocation of expenses between capital and revenue.
2. Portion of capital expenditure that is consumed during the current year is changed to income statements and rest of the portion i.e, unconsumed portion is shown as assets in the balance sheet.
3.As per income tax law,tax on income is calculated on annual basis from 1stApril to 31stMarch (financial year).
4.Timely action for corrective measures can be taken by management.
Short Question type Answer
Q1. What is meant by Cash Transaction
Ans. Cash transaction is a financial transaction or event that is settled immediately in cash
Q2. What is meant by Credit Transaction?
Ans. Credit transaction is a financial transaction or event that 1s not settled immediate
i.e., is agreed to be settled later.
Q3. Briefly explain Expenditure
Ans. Expenditure is the amount spent or liability incurred for acquiring assets, goods or serve
Q4. What are Assets?
Ans. Assets a property (land, machine, goods, premises, etc.) or legal rights (patents, copyright
etc) owned by an individual or business which can be measured n money terms
Q5. What are Fixed Assets?
Ans. Fixed Assets are the assets which are acquired not with a purpose to resell but with
purpose to increase the earning capacity of the business
Q6. What is meant by Tangible Assets?
Ans. Tangible Assets are the assets which have physical existence, 1.e, they can be seen and
touched such as Land, Building, Plant and Machinery and Computers
Q7. Briefly explain Intangible Assets.
Ans. Intangible Assets are the assets which do not have a physical existence, z.e., they cannot
be seen or touched such as Computer Software and Goodwill.
Q8. Briefly explain the term 'Goods'
Ans. Goods are the physical items of trade.
Q9. Define the term Purchase
Ans. The term Purchase is used for purchase of goods for resale or for producing the finished
products which are also to be sold. The term purchase includes both cash and credit
purchases of goods. Goods purchased for cash are termed as Cash Purchases and goods
purchased on credit are termed as Credit Purchases
Q10. What are the main classes of Liabilities?
Ans. Non-current Liabilities and Current Liabilities
Q11. Give any two examples of Current Assets.
Ans. Stock-in-Trade (Inventories) and Cash in Hand.
Q12. Name three Current Liabilities.
Ans. Creditors, Bills Payable and Outstanding Expenses.
Q13. Name two Long-term Liabilities.
Ans. Long-term loans and Debentures.
Q14. Explain Capital briefly.
Ans. Capital is the amount invested by the proprietor or the partner in the business.
Q15. Who is a Debtor?
Ans. Debtor is a person who owes amount to the business on account of credit sales of goods
and/or services in the normal course of business.
Q16. Who is a Creditor?
Ans. Creditor is the person to whom an amount is owed on account of credit purchases of
goods and/or services in the normal course of business.
Q17. What is meant by Revenue from Operations?
Ans. Revenue from Operations means revenue earned by the enterprise from its Operating.
Activities such as Net Sales (Sales -- Sales Return), services rendered, sale of scrap, etc.
Q18. What is an Income?
Ans. Income is profit earned during the accounting period, i.e., revenue minus expenses.
Q19. Define Drawings with example.
(Delhi 2012)
Ans. Drawings is the amount of money or value of goods which the proprietor or partner withdraws
for personal use. For example, withdrawal of cash by the proprietor for personal use.
Q20. Define Voucher.
Ans. Voucher is an evidence of a business transaction.
Q. 21. Define Merchandise.
Ans. Merchandise means goods for resale.
Q22. A firm earns a revenue of 21,000 and the expenses to earn this revenue are
* 15,000. Calculate its income.
(Delhi 2009)
Ans. Income = Revenue - Expense = * 21,000 - 15,000 = * 6,000.
Q23. A firm has received a large order to supply goods. Will it be recorded in the books of
account of the firm? Give reason.
Ans. No, it will not be recorded in the books of account because it is not a transaction.
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