Accounting is a finance support system that:
- Records transaction.
- Classifies transaction and events.
- Expresses transactions in monetary terms.
- Helps to monitor the financial performance and condition of the business.
- Helps to evaluate the business.
- Helps to establish controls for the business.
Accounting helps to arrive at the financial position of an organisation at any point of time. The organisation’s financial status, as on a particular date, is captured in the balance sheet, while financial performance for the year is summarized in a profit and loss statement.
A transaction is an event that changes the organisation’s financial position and/or its earnings. For example, when you deposit cash in the bank, your cash balance reduces and bank balance increases; when you sell goods for cash, your cash balance increases and your stock reduces. Transactions can be classified as follows;
- Receipts – cash or bank
- Payments – cash or bank
Mercantile Method is a method of accounting that recognizes revenue when earned rather than when due or collected and expenses when incurred rather than when paid. Thus, under the Mercantile Method, transactions are recorded on the basis of income earned or expense incurred, irrespective of actual receipt or payment. For example, a seller bills the buyer at the time of sale and treats the bill amount as revenue, even though the payment may be received later.
Double Entry Accounting is a system of recording transactions in a manner that maintains the equality of the accounting equation. This accounting technique records each transaction as a debit and a credit, where every debit has a corresponding credit and vice versa.
Credit refers to money loaned or the ability of an individual or company to borrow money. Credit is also used to mean positive cash entries in a bank account. For instance, an account may be credited with interest.
In accounting, an entry on the left-hand side of an account record in which amounts are recorded in a double-entry system of bookkeeping. Debit is a charge to a customer’s access account or deposit account.
A journal is a book in which business transactions and entered in chronological order. A record of a single business transaction is called a journal entry. Every journal entry is supported by a voucher, evidencing the related transaction.
A voucher is a document containing the details of a financial transaction. Examples include sales invoice, purchase invoice, payslip, rent receipts and so on.
An account is a statement of transactions affecting any particular asset, liability, expense or income. A ledger is a book in which all the accounts are maintained. A chart of accounts is a list of all account titles used by an organisation. The chart of accounts of the business shows the categorisation and grouping of its accounts.
Posting is the process by which information about transactions is transferred or moved to an account.
A trial balance is a list of the balances of all ledger accounts. It is prepared after all the transactions are entered in a journal, journal entries posted to the ledger and ledger accounts balanced. It is the sum of balances of all real, personal and nominal accounts of the organisation. A detail trial balance has a column for:
- Account name
- Debit Balance
- Credit Balance
A financial Balance is a periodic report prepared from the accounting records of a company. Financial statements include the profit and loss statement (or income statement), the balance sheet and the cash flow statement. Financial statements are usually compiled on a quarterly basis or an annual basis. For reporting convenience the Profit and Loss statement is divided into Trading Account and Profit and Loss Account.
Gross Profit is arrived at, after considering the core activities of the company. It is expressed as Gross Profit = Net Sales – Cost of Sales
Net profit is arrived at after considering the other administrative costs uncured for the period. It is expressed as Net Profit = (Gross Profit + Other Income) – (Selling and Administrative Expenses + Depreciation + Interest + Taxes + Other Expenses)
The trading account is prepared so as to arrive at the gross profit earned by an organisation over a specified period. This helps the organisation to arrive at the cost of its core activity and calculate the direct profit from its operation.
The profit and loss account gives the net profit earned by a company, after considering all other incomes and expenses incurred over a period. This helps the company to monitor and control the costs incurred and improve its efficiency. In other words, the profit and loss statement shows the performance of the company in terms of profits or losses over a specified period. A key element of Profit and Loss Account and one that distinguishes it from a balance sheet is that the amounts shown on the statement represent transactions over a period of time, while the items represented on the balance sheet show information as on a specific date.
The balance sheet is a statement that summarizes the assets and liabilities of a business. The excess of assets over liabilities is the net worth of a business. The balance sheet provides information that helps in assessing;
- A company’s Long-term financial strength.
- A company’s efficient day-to-day working capital management.
- A company’s Asset portfolio.
- A company’s sustainable long-term performance.
Service is defined as work done for others in lieu of a payment or price. Services do not have a physical form or substance.
An organisation providing services is called as Service organisation.
Maintaining “Books of Accounts” in software is Computerized Accounting. The software should meet the basic needs of accounting such as Journals, Vouchers, Ledgers and Trial Balance.
Cash Method is a method of accounting that recognizes revenue when collected rather than when earned/billed and expenses when paid rather than when incurred. Thus, under Cash Method, transactions are recorded on the basis of actual receipt or payment, irrespective of income earned or expense incurred. For example, a seller receives the payment from the buyer and treats the receipt amount as revenue, even though the Bill might have been done earlier.