accounting demistified for everyone

8/14/2019 Accounting Demistified for Everyone

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5 DECEMBER 09 AFTERSCHOOOL centre for socialentrepreneurship

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ACCOUNTING DEMISTIFIED FOR EVERYONE

by :DR. T.K. JAIN

AFTERSCHO OLcentre for social entrepreneurshipsivakamu veterinary hospital road

bikaner 334001 rajasthan, [email protected]

mobile : 91+9414430763


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5 DECEMBER 09 AFTERSCHOOOL centre for socialentrepreneurship 2

What is accounting, accountancy

and bookkeeping?Accountancy is science which gives principlesof accounting. Accounting means recording,

analysing and presenting information abouttransactions involving money. Book keeping isa part of accounting, where you undertakerecording of the day to day transactions.

Accounting has further many parts : financialaccounting, management accounting and cost

accounting etc.


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What is a day book and ledger?We keep day book for recording day to daytransactions. Generally we have 4 types of

transactions : purchase, sale, other expenditure, other income. These can be

against cash or credit.Thus we keep purchase book and sale book as

our day books for recording credit purchase /sale. All the cash transactions are recorded incash book. For other income and and other

expenditure, we make record in journal proper


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How to prepare journal entry?

Whenever you are trying to prepare an entry, just try to visualise its impact on assets or liabilities. Each transaction has two aspects.

Bot these aspects must be analysed in terms of

impact on assets or liabilities. Remember the basic accounting equation :Assets = liabilities + capital


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transaction????

Transaction means any dealing which has a bearing on either assets or on liabilities or on both.

Thus when you purchase raw material, your inventory (assets) will go up and your cash

(assets) will reduce.


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Principles of posting.....

When assets increase, debit that transactionsand when liabilities increase, credit thattransaction. Thus any transaction that

increases assets must be debited. Remember,

your loss is treated as an asset and profit istreated as liability (because profit belongs toowner who is external to the organisation)


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posting....

When you increase income, it is credited andwhen you increase expenditure, it is debited.


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Types of accounts...

Nominal : income or expenditure nothingreal must be closed down at the end of the

year, unless it is related to next year (like prepaid expenditure)

real : assets personal: debtors, creditors, owner (capital)

etc.


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Prepare accounts from the followngsummary of totals of various accounts

in all the ledgers that the companyhas ?

Capital 10, building 4, wages 2, sales 100, interest paid 2, purchase 30, salary 10, repairs 1, postage 1, commissionreceived 1, interest received 1, bad debt 1, debtors 10,

creditors 3, cash 10, investments 4, depreciation 1, plant20, provision for bad debt 1, furniture 10, loan 20.

Provision for bad debt must be 20% of debtors. Openingstock 10, closing stock 10


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Step 1 trial balanceWhich accounts will have debit balance ?

building 4, interest paid 2, purchase 30, salary 10, repairs 1, postage1 , wages 2, bad debt 1, debtors 10,furniture 10 cash 10, investments

4, depreciation 1, plant 20

total : 106Which accounts will have credit balance ?

Capital 10, sales 100, , commission received 1, interest received 1,creditors 3, provision for bad debt 1, loan 20.

total 136trial balance dont tally, so put 30 more in debit side till you find the

reason for diference.


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What should be the next step?

guess.....


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steps....

1. prepare a trial balance2. prepare p& l account

3. prepare balance sheet


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Trading accout (first part of P & L

account)Trading account shows purchase, sale, manufacturing and

other direct expendtireu and gross profit.

Credit side : (sales + closing stock)sales 100, closing stock 10 total 110

Debit : (purchase+ opening stock+direct exp.)opening stock 10, purchase 30, wages 2, total : 42

gross profit : 68 total :110


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Profit and loss account ...

Credit side : (income other than sales)gross profit : 68, interest received 1

commission received 1total 70debit side : (all expenditure)

interest paid 2, salary 10, repairs 1, postage 1 , bad debt 1,depreciation 1, provision for bad debt 1

total : 17

net profit : (70 17= 53) total 70


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Working notes....

In the previous example, we have createdsuspense account of 30, which must be tracedout. Accouting is like mathematics, it will notmatch, if trial balance totals dont match. We

have created additional provision for bad debitof 1, because it has to be 20% of debtors (wealready had provision of 1).


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BALANCE SHEET

LIABILITIES:Capital 10, Profit : 53, creditors 3 loan 20. Provision for

bad debt 2 total : 98ASSETS :

building 4, debtors 10, cash 10, investments 4, plant 20,

furniture 10, closing stock 10 suspense 30 total : 98


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How to judge the health of a

company ???

Look at its balance sheet and try to find out the

following aspects :1. can it meet its liabilities

2. can it meet urgent requirements and have

cash whenever required.3. is it able to earn sufficient profit and is it

able to use its assets properly.


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Find the health of the following

company:LIABILITIES : equity 500, preference 150, reserves 70,

Profit :;; 125, debenture 150, bank loan 100, overdraft 45,

creditors 55, tax payable 100, dividend payable 60,security premium 30 total : 1385

ASSETS : land 530, plant 110, furniture 20, investment90, stock 95, debtors 175, BR 25, cash 80, prepaid exp.

15, securities 20, preliminary exp. 40, goodwill 110, patents 75 total 1385sales was 1300


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solution....

In the example the total of liabilities andassets are equal, that has to be there otherwise,

we have to create a suspense account to matchthem and find the reasons for difference(remember, the totals of assets and liabilites isequal, and totals of debit and credit side of trial

balance is also equal). Arrange these inliquidity order or permance order. Now look at

their financial health.


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liquidity???

Do the company has ability to meet short term liabilitiesand to encash opportunities that come to the company. For

this let us judge liquidity. Compare current assets andcurrent liabilities.

Current assets: (175+25+80+15+20+95)=410current liability : (45+55+100+60) =260

current assets are 1.6 times current liabilities it musthave been at least 2 times current liabilitie.s


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Liquidity acit test ratioLook at those current assets which are quick assets, - they may be used any time to encash

and pay the liabilities : (remove inventory and

prepaid exp. From current assets)Quick assets: (175+25+80+20)=300

current liability : (45+55+100+60) =260Quick assets are more than current liabilities this is

good, the quick assets should always be more than curentliabilties. Do find the quality of the quick assets- are the

debtors good enough etc.


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Find solvency of the company...

Can the company remain solvent in the long term. For findingsolvency, we have to look at the overall ability of the company

to meet its liabilities in the long term.Total long term debt / fixed interest bearing capital :

(150+150+100) = 400equity + reserves+profit = (500+70+125) = 695

we have treated preference shares also as debt. The company iscomfortable as Debt can be upto two times equity + reserves.


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Find profitability of the

company...Find fixed assets turnover ratio :

total fixed assets : (110+75+530+110+90)

= 915sales was 1300, so

fixed turnover ratio is : 1300/915 = 1.4, which is not avery good one. But we have to compare these ratio to

other companies in the same industry. It is possible that itis a capital intensive industry so require huge investment

in fixed assets.


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ROI / ROCE

Ultimate measure of returns is ROI and ROCE.ROI means return on investment how much

returns are the shareholders getting for their money. ROCE means return on capital

employed, how much return are you able to

generate on total investment.Divide profit by money invested and find

overall profitability...


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ROI

Profit = 125

equity : 500 (you can take reserves also with equity, if you wish).so ROI = 125/500*100 = 25% which is good. If we look at total capital employed, we can take preference shares,

and debt also to find our ROCE, then we have to take profit before interest and taxes, but that data is notavailable to us.


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Remember the basics....

DO Anticipate all losses if there can be a loss make a provision for that, if there can besome expenditure, make a provision for that

DONT anticipate your income let the incomeactually come

adopt the principles of conservatism, prudence.


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What are provisions & reserves ?

We prepare provisions for some uncertainsituation and for a particular situation.Reserves are general and can be used for any purpose. We make provisions for things like bad debts etc. Thus provisions are for those

situations which may take place in future.


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What are nominal / real / personal

accounts?Expenditures and incomes are nominal accounts and

must be closed at the end of the year by transferring to

P&L accountassets and provisions are real accounts and will

continue for ever, so they will appear in balance sheetevery year

personal accounts include debtors, creditors, capitalaccount, loan account etc. And will appear in balance

sheet every year.


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What is provision for bad debt?

On the basis of your past experience, if youknow that 5% debtors dont make payments,

then you can make a provision for bad /doubtful debt @5% of outstanding debtors.

Thus at the end of the year you have to pass a journal entry for this purpose. Later you haveto maintain it at 5% level of debtors.


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Example : your debtors are 1 lakhand bad debts are 5000 and make

a provision for 5% for future.Your trial balance shows a baddebt of 15000. what entry willyou make and for how much ?


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Solution ...continued...

When you find that you have 5000 more of bad

debt, just pass an entry for this : bad debt debit and debtors credit : 5000

to make a provision for bad debt, pass another

entry :P & L account debit and provision for bad debt

a/c credit (5% of 95000)


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Impact on balance sheet

Bad debt account is a nominal account, so it willdisappear at the end of the accounting year andwill be closed by transferring to P & L account.

Provision of bad debt will not close and will appearin balance sheet. We have made only one entry of this account, thus it will show credit balance andwill appear in both P & L account and balancesheet and will continue in the next year also.


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Balances for year 2009

Capital : 25, Plant19, Depreciation 1, repairs 1,wages 1, salares 2, income tax 1, Cash 1,

building 38, depreciation on building 1, purchase 61, sales 125, bank overdraft 2,acrued income 1, salaries outstanding 1, BR 5,

BP 1, Provision for bad debt 3, bad debts 1,Discount on purchase 2, debtors 17, creditors

11, opening stock 18, closing stock 15.


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continued...write off bad debts 2, maintain provisions of

5% on debtors, goods costing 2 sent tocustomer on sale or returned basis on 1/3/9

recorded as actual sales. Rate of gross profitwas 16.67% of sales. Rent of office 1 debited

to landlord's account and were included in

debtors, manager gets 10% commission on net profit after charging commission of work manager and his own. Work manager gets 5%

on gross profit


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Steps

Prepare trial balance, find out adjustments to be made, make necessary adjustment for

account finalisation and then prepare P & Laccounts, balance sheet


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Important rules.

Income will have credit balance, expenditure willhave debit balances. Assets will have debit

balances and liabilities will have credit balances,based on these try to prepare trial balance.Remember, all the income and expenditure

accounts are closed at the end of the year, for thistransfer their balance to trading account or P & L

account, assets and liabilities acccounts andpersonal account are not closed therefore their

balances are shown in balance sheet.


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Trial balance

CREDIT SIDE : Capital : 25,bank overdraft 2, BP 1,Provision for bad debt 3 creditors 11 Discount on

purchase 2, sales 125, salaries outstanding 1, TOTAL =169

DEBIT SIDE : Plant 19, repairs 1, Depreciation 1,depreciation on building 1, wages 1, salares 2, income tax

1, Cash 1, building 38, purchase 61, acrued income 1,BR 5, , bad debts 1, debtors 19, opening stock 18,TOTAL=169


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TRADING ACCOUNT

CREDIT SIDE :sales : (125-2)=123, closing stock : (15 +1.67)

total :139.67DEBIT SIDE :

Purchase (61-2)=59, wages 14, total : 73gross profit : 66.67


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Profit and Loss account

Credit side :

gross profit 66.67, income acrued 1, Prov. For bad debt (excess) 1.25 total : 67.92

Debit side :

salaries (2+1), Depreciation 1, Depreciation on building 1, Repairs 1, rent 1, baddebts 1, income tax 1

total : 9

outstanding commission

works manager : 3.5 Manager 5

net profit : 49.16


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Balance sheet

Liabilities :capital 25, profit 49.16 creditors 11, bank overdraft 2 , BP 1 outstanding salary 1,outstanding commission 8.38 total :97.5

Assets :

building (38-1) 37, plant (18-1) 17, Debtors 15,BR 5, Cash 1, Stock 16.67 , Acrued income 1

suspense account 5 total : 97.5


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Provision for bad debt

Opening balance : 3less bad debt 1

closing balance 2 but we have to keep it only .75, so remaining

amount will be transferred back to P & Laccount = 1.25


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accounting demistified for everyone

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