Basic Accounting Terms

Samir K Mahajan

Business Entity: A business entity is a commercial, corporate and/or other organisation that is formed in order to engage in business activities, usually for the sale of a product or a service.

are administered as per commercial law of the country.

take different forms sole trader, partnership, cooperatives, partnerships, private limited company, public limited company and so on.

The motive of every business is profit.

Business Entity

Samir K Mahajan

Proprietor: A person who owns a business is called its proprietor. He contributes capital to the business with the intention of

earning profit.

We distinguish between business and its proprietor. Business is assumed to have distinct identity i.e. existence other than the existence of its proprietor and other

business units. An accountant has to deal with the business entity and not with its proprietor.

Capital: Capital is the amount invested by the proprietor/s in the business.

This amount is increased by the amount of profits earned and the amount of additional capital introduced. It is decreased by the amount of losses incurred and the amounts withdrawn.

For example, if Miss X starts business with Rs.5,00,000, her capital would be Rs.5,00,000.

Samir K Mahajan

Business Transaction:

An economic event that relates to a business entity is called business transaction.

are financial interactions between businesses and its customers, vendors and others with whom it do business. involve transfer of money or goods or services between two persons or two accounts.

For example, purchase of goods, sale of goods, borrowing from bank, lending of money, salaries paid, rent paid, commission received and dividend received.

initiates the accounting process of recording it in a company's accounting system.

Samir K Mahajan

o Features of Business Transactions : Every business activity is not an accounting activity.

o Business activity which are financial in nature and have documentary proof, are capable of being presented in numerical, monetary term.

o Business transactions cause effect on assets, liabilities, capital, revenue and expenses are business or accounting transactions. Non-economic activities concerning emotions of love, patriotism, and respect do not find place in accounting.

concerned with money or money's worth of goods or services. arises out of the transfer of exchange of goods or services. brings about a change in the financial position of a business concern . has an effect on the accounting equation of any business firm . has dual aspects or sides -"receiving "(debit) and "giving "(credit ) of the benefit .

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o Type of Business Transactions:

Transactions are of two types such as: cash and credit transactions.

Cash Transaction is one where cash receipt or payment is involved in the transaction. For example, purchase of goods by cash immediately or by paying a price

Credit Transaction is one where cash is not involved immediately but will be paid or received later. For example, purchase of goods on credit

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Accounting Year: Books of accounts are closed annually. There is no legal restriction about accounting year of the sole proprietor and partnership firm. They

may adopt accounting year of their choice.

It may be between two diwalis, or 1st January to 31st December of the same year even financial year .i.e. April 1 to march 31 of next year.

The only restriction is that it must contain twelve month. Companies must adopt financial year.

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Creditor and Debtor:

A creditor is a party , the first party (e.g. person, organization, company, or government) that has a claim on the property or services of a second party.

The first party, in general, has provided some value (property or good or service or funds) to the second party under the assumption (usually enforced by contract) that the second party will return an equivalent value in some future date.

The second party is frequently called a debtor or borrower of the property, service or money.

The first party is the creditor, which is the lender of property, service or money.

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Payables:

Payables is the total of sundry creditors and bills payables. Sundry Creditor are those sellers from whom goods are purchased on credit by the firm.

Bills Payables are the bills drawn by the certain sellers or creditors to firm or promissory notes drawn by the firm to certain sellers.

Payables are shown on the liabilities of the balance sheet.

Receivables:

Receivables is the total of sundry debtors and bills receivables.

Sundry debtors are buyers of goods on credit .

Bills receivables means bills drawn by the firms to certain purchasers/buyers . Receivables are shown on the assets side of balance sheet.

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Goods: Goods are commodities in which the business deals. Goods includes articles purchased for sale at profit or processing by the business or for use in the manufacture certain other goods as raw materials. Furniture will be goods for firms dealing in furniture but it will be an assets for firm dealing stationaries.

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Purchases: Purchases refers to the amount of goods bought by a business for resale or for use in the production. Purchase are intended to mean either purchase of finished goods for sale or purchase of raw materials for

manufacture of the article, being sold by the business.

Purchase of assets are not the purchase in accounting terminology as these assets are not meant for sale. Goods purchased for cash are called cash purchases.

If it is purchased on credit, it is called as credit purchases. Total purchases include both cash and credit purchases.

Purchase Return or Return outwards: Purchase returns are the part of purchase of goods which are returned to the sellers by the business. This return may be due to unnecessary, excessive and defective supply of goods. It also may be result of violation of terms and conditions of the orders or agreements by the sellers.

To find net purchases, purchases return is deducted from the total purchases.

Samir K Mahajan

Sales: Sales refers to the amount of goods sold that are already bought or manufactured by the business.

In accounting sales means sale of goods and not sale of assets.

When goods are sold for cash, they are cash sales but if goods are sold and payment is not received at the time of sale, it is credit sales.

Total sales includes both cash and credit sales.

Sales Return or Returns Inward: When goods are returned from the customers to the business, it is called sales return or returns inward.

It may be due to due to defective quality or not as per the terms of sale.

To find out net sales, sales return is deducted from total sales.

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Stock: Stock includes goods unsold on a particular date. Stock may be opening and closing stock. The term opening stock means goods unsold in the beginning of the accounting period.

Whereas the term closing stock includes goods unsold at the end of the accounting period.

For example, if 4,000 units purchased @ Rs. 20 per unit remain unsold, the closing stock is Rs.80,000. This will be opening stock of the subsequent year.

Stock can be classified as under:

o Stock of raw materials o Stock of finished and semi-finished goodso Work in progress

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Expense: Expense is the amount spent or cost incurred in order to produce and sell the goods and services( in the process of earning revenue).

For example, purchase of raw materials, payment of salaries, wages, etc.

Outstanding expenses: If expenses relates to the accounting period and remain unpaid they are called outstanding payment.

Outstanding salaries, rent unpaid, wages due, repairs due but not paid are certain examples. As these expenses are still payables, these are liability of business.

Pre-paid or unexpired expenses: Pre-paid expenses are expenses paid in advance. In certain cases, expenses relating to next accounting period may be paid during the current year. Pre-paid expenses

forms part of assets of business.

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Accrued revenues ( income )/ income due but not received: Accrued revenue are revenue earned during the current accounting year but yet to be received.

These form part of assets.

Income received in advance or unearned income: Income received in advance are the income received in current accounting year although this relates to the next year.

These income form part of liability.

Profit: Excess of revenue (sale proceeds) over expense (cost of goods sold) is profit.

Income: Income is positive change in the net worth of the enterprise from business activities or other activities over a period of time.

Income is a wider term and includes profit too. Income is profit plus income from activities.

Drawings: Drawings is the amount of cash or value of goods withdrawn from the business by the proprietor for his personal use.

It is deducted from the capital.

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Assets: Assets are what firm owns.

Assets are the properties or valuable things or economic resources belonging to the business/firm/enterprise.

Cash in hand, plant and machinery, furniture and fittings, bank balance, debtors, bills receivable, stock of goods, investments, Goodwill are examples for assets.

Assets are measured in money terms.

Assets of a firm is classified as fixed asset and current asset.

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ASSETS OF A FIRM

FIXED ASSETS CURRENT ASSETS

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Fixed Assets

Fixed assets are acquired for long term use in business. They are not meant for business transaction rather are used to produce goods or service.

Fixed assets includes

o Lands, buildings

o Machines and plants,

o Furniture's, fixtures, fittings,

o Investment in shares and debentures

o Livestock

Note: Fixed stock may be intangible (patient, copy rights, good will).

ASSETS contd.

Samir K Mahajan

Current Assets

Currents assets / floating assets/circulating assets includes cash and other resources or assets which are reasonably expected to be realised in cash, sold or consumed during normal operation of business.

Current assets are most liquid assets meaning that they are either in cash or going to be converted into cash. Current assets change their value constantly.

Current assets include

o Cash in hand and bank

o Stock of inventories of raw materials, finished and semi-finished goods

o Sundry debtors/book debt/bills payables/buyers of goods on credit that have not paid yet to the firm

o Account/ Bill receivables (bills drawn by the firm to buyers on credit and buyers have accepted.)

o Prepaid expenses

o Accrued income

ASSETS contd.

Samir K Mahajan

It should be noted that certain assets which are popularly known as fixed may prove to be goods by virtue of their use.

Such as:

o Lands will be goods in the hands of land developer and property dealers.

o Buildings will be goods in the hands of builders and property dealers.

o Machines and plants will be goods with manufacturers and dealers of plants and machineries

o Furniture's, fixtures, fittings will be goods with furniture's dealers and furnishers

o Shares and debentures will be goods with the dealers in securities

It should be taken care that assets meant for regular purchase and sale are goods.

ASSETS contd.

Samir K Mahajan

Tangible Assets: These assets are those having physical existence. It can be seen and touched. For example, plant & machinery, cash, etc.

Intangible Assets: Intangible assets are those assets having no physical existence but their possession gives rise to some rights and benefits to the owner. It cannot be seen and touched. Goodwill, patents, trademarks are some of the examples.

Liquid Assets: Liquid assets are those assets which can be converted into cash at short notice. E.g. cash in hand, cash at bank, debtors, bills receivables, etc.

ASSETS contd.

Samir K Mahajan

Liabilities:

Liabilities are the obligations payable by the enterprise/business in future in the form of money or goods or services.

Liabilities are what firm owes to others including owners.

These denote the amounts which a business owes to owners and other parties , e.g., capital invested by business, loans from banks or other persons, creditors for goods supplied, bills payable, outstanding expenses, bank overdraft etc.

Liabilities are and creditors’ claims against the assets of the business.

Samir K Mahajan

CLASSIFICATION OF LIABILITIES OF A FIRM IN TERMS

OF CLAIM

LIABILITY TO OWNERS

(OWNERS' EQUITY /CLAIM)

LIABILITY TO CREDITORS (CREDITORS'

CLAIM/EQUITY)

CREDITORS FOR GOODS

CREDITORS FOR LOANS

(LENDERS)

LIABILITIY FOR EXPENSES

CONTINGET LIABILITES

Samir K Mahajan

Liabilities to Owners /Shareholder’s Funds / Owner’s Equity/owner’s net worth = Capital + retained earnings / undistributed profits + surplus & reserves + interest in capital – drawings – expenses –losses

Liabilities to Creditors = Creditor's claim against business

o Creditors for Goods = Suppliers of goods on credit to business = Sundry Creditors

o Creditors for loans = Lenders (Banks, financial institutions or other parties) of Funds to Business

o Creditors for Expenses = Outstanding salaries+ rents due + wages unpaid

Contingent (Doubtful) Liabilities Contingent liabilities are not real liabilities future events will decide whether it is really a liability or not e.g. guarantees undertaken, cases pending in the law of court.

LIABILITIES OF A FIRM IN TERMS OF CLAIM contd.

Samir K Mahajan

CLASSIFICATION OF LIABILITIES OF A

FIRM IN DURATION OF TIME

FIXED LIABILITIES/LONG-TERM LIABILITIES

CURRENT LIABILITIES/

SHORT-TERM LIABILITIES

CLASSIFICATION OF LIABILITIES OF A FIRM IN TERMS OF INDURATION OF TIME

Samir K Mahajan

Long-Term /Fixed Liabilities

Long-Term liabilities are payable for a after a period of one year and for a long period of time. Long Term Liabilities includes

o Owners’ capitalo loanso Debentures/bondso mortgageso Others

Short-Term /Current Liabilities

Short-term Liabilities are payable within one year. Short-term liabilities change their values continuously. Short-term liabilities includes

o Creditors/sundry creditors o bills payables (bill drawn by sellers of goods on credit ,and accepted by the enterprise)o outstanding expenses

Note: Account payables includes creditors/sundry creditors and bills payables

Samir K Mahajan

Capital /share capital The company has to show the authorised, subscribed and paid up-capital under capital head.

Authorised capital/registered is the total of the share capital which a limited company is allowed (authorised) to issue.

o Issued capital is the total of the share capital issued (allocated) to shareholders. This may be less or equal to the authorised capital.

o Subscribed capital is the portion of the issued capital, which has been subscribed by all the investors including the public. This may be less than or more than the issued capital.

o Called up capital is the total amount of subscribed capital for which the shareholders are required to pay. This may be less than the subscribed capital as the company may ask shareholders to pay by instalments.

o Paid up capital is the amount of share capital paid by the shareholders. This may be less than the called up capital as payments may be in instalments ("calls-in-arrears"). Some of the shareholders might have defaulted in paying the called up money.

Reserve Capital :It is that part of uncalled capital of a company which can be called only in the event of its winding up

Liabilities contd

Samir K Mahajan

Capital /share capital : An Illustration

Liabilities contd.

Capital Requirement (long run) = Rs. 1,00,000 Authorized Capital = Rs. 1,000,000

Current Requirement = Rs. 50,000Issued Capital = Rs. 50,000 (5000 share @Rs.10 per share)

Subscribed capital= Rs. 40,000 (4000 shares @ Rs. 10 per share)

If 4,000 shares of Rs. 10 each have been subscribed by the public, and of which Rs. 5 per share has been called up.

Called up capital= Rs. 20,000

Hence Reserve capital = Rs 20000

If some of the shareholders have defaulted in paying the called up money, say: Paid Up capital = Rs. 10000 (2000 share @ Rs 5 per share).

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Reserve and surpluses :Typically the company have to hold Statutory reserves, Capital Reserves, Share Premium Revenue and other reserves under this head.

o Under statutory reserves, any company has to create a reserve fund out of profit each year as disclosed in the profit and loss account.

o Capital Reserves are reserve created for long-term capital investment projects or any other large and anticipated expenses (such as inflation, recession ) that will be incurred in the future. This type of reserve fund is set aside to ensure that the company has adequate funding to at least partially finance the project. Normally Capital reserve cannot be used for distribution of dividend.

o Revenue Reserve are the reserves created out of profit from trading activities. e.g. retained earnings, and profit and loss account under liabilities side etc. This can be distributed as dividend and also as bonus shares normally.

o Share premium is the amount received by a company over and above the face value of its shares. This difference between the selling price and the face value of a share is known as share premium.

Retained earnings refers to the portion of net income of a corporation that is retained by the corporation rather than distributed to shareholders as dividends.

Bank Liabilities contd.

Samir K Mahajan

Insolvent: All business firms who have been suffering from losses for the last many years and are not even capable of meeting their liabilities out of their asset are financially unsound. Only court can declare the business firm as insolvent it is satisfied that the continuation of the firm will be against the public or creditors.

Solvent: Solvent firms capable of meeting their liabilities out of their own resources. Solvent firms Solvent have sufficient funds and assets to meet proprietor’s and creditor’s claim.

Expenditure: Expenditure is the amount of resources consumed. Expenditure are incurred to acquire assets of the business.

Investment: The firm may invest in other firms’ share and equities and earn dividend and income.

Samir K Mahajan

Entry: Any entry is a systematic record of business transaction. While passing entries, the principle 'every debit has got its corresponding credit’ is adopted. Different accounts are debited and credited in the entry with the same amount.

Account: An account is a brief history of financial transactions of a particular person or item such as asset, capital, liabilities, expense or revenue named in the heading. An account has two sides called debit side and credit side.

Voucher: Voucher is a written document in support of a transaction. It is a proof that a particular transaction has taken place for the value stated in the voucher. It may be in the form of cash receipt or cash memo, invoice, bank pay-in-slip etc. Voucher is necessary to audit the accounts.

Receipt: Receipt is an acknowledgement for cash received. It is issued to the party paying cash. Receipts form the basis for entries in cash book.

Invoice/Bill: Invoice is a business document which is prepared when one sell goods to another on credit. The statement is prepared by the seller of goods. It contains the information relating to name and address of the seller and the buyer, the date of sale and the clear description of goods with quantity and price.

Samir K Mahajan