What is Transaction?

The main function of an accountant is to record properly the financial transactions of a business concern in the books of accounts and to ascertain its true result at the year end. Thus transaction is the foundation of accounting - the first and formest element of accounting. In a word, it is the life and blood of Accounting. Hence the accountant must have a fair idea about the term "transaction." In ordinary language "transaction" means exchange of something. But in Accounting it is used in a special sense. If the financial position of a business concern changes on the happening of an event which is measurable in terms of money, that event is regarded as a "transaction" in Accounting. Or A business event which can be measured in terms of money and which must be recorded in the books of accounts is called a "transaction". What is an Event? In ordinary language "Event" means anything that happens.Human life is full of events. So many events take place in the family and social life of a person. The events may be classified into two types: 1. Monetary Events: Events which are related with money, i.e. which change the financial position of a person are known as "monetary events". For example, daily shopping, marriage ceremony, birthday anniversary, marriage anniversary etc. 2. Non-Monetary Events: Events which are not related with money i.e. which do not change the financial position ofa person are known as "non-monetary events". For example, winning a game, delivering a lecture in a meeting etc. In business accounting only those events which change the financial position of the business and which call for accounting are recognized as "Events". In other words, all monetary events are regarded as "business transactions." Remember, it is not that anything which results in exchange of something will be regarded as transaction. On the other hand, something may be regarded as a transaction even though it involves no exchange. Example: For example, R sends a price-list to his customer, A. This involves exchange of price list-between R and A, yet it is not regarded as a transaction, because it is not measurable in term of money and it does not change the financial position of both the persons. Again, suppose, goods worth Rs1000 are destroyed by fire. This does not involve any exchange, yet it is regarded as a transaction, because itis measurable in terms of money and it changes the financial position of the business. It must be noted that an event, although measurable in terms of money, may not be regarded as a transaction. For example, we receive an order for supply of goods worth Rs1000. Although it is measurable in terms of money, it is not regarded as a transaction, since it has not changed the financial position. It will, however, be regard as a transaction when the goods are supplied according to the order. It appears from the above discussion that the following two conditions must be satisfied in order that an event may be regarded as a transaction in Accounting; 1. The event must be measurable in terms of money. 2. The financial position of the business must change on account ofthat event.

Accounting Conventions

The term ' accounting conventions ' includes those customs or traditions which guide the accountant while communicating the accounting information. Important accounting conventions are: 1. Conservatism convention 2. Full disclosure 3. consistency 4. Materiality These accounting conventions are explained below: 1. Conservatism: According to this convention, accounts follow the rule "anticipate no profit but provide for all possible losses ", while recording business transactions. In other words, the Accountant follows the policy of "playing safe". On account of this convention, the inventory is valued at cost or market price whichever is less! Similarly a provision is made for possible bad and doubtful debts out of current year's profits. This concept affects principally the category of current assets. The convention of conservation has been criticized these days as it goes against the convention of full disclosure. It encourages the accountant to create secret reserves (e.g. by creating excess provision for bad and doubtful debts, depreciation etc.), and the financial statements do not show a true and fair view of state of affairs of the business. 2. Full Disclosure: According to this convention the users of financial statements (proprietors, creditors and investors) are informed of any facts necessary for the proper interpretation of the statements. Full disclosure may be made either in the body of financial statements, or in notes accompanying the statements. Significant financial events occurring after the balance sheet date, but before the financial statements have been issued to outsiders require full disclosure. The practice of appending notes to the financial statements (such as about contingent liabilities or market value, of investments or law suits against the company is in pursuant to the convention of full disclosure. 3. Consistency: This convention states thatonce an entity has decided on one method, it should use the same method for all subsequent events of the same character unless it has a sound reason to change methods. If an entity made frequent changes in the manner of handling a given class of events in the accounting records, comparison of its financial statements for one period with those of another period would be difficult. Consistency, as used here, has a narrow meaning. It refers only to consistency over time, not to logical consistency at a given moment of time. For example fixed assets are recorded at cost, but inventories are recorded at the lower of their cost or market value. Some people argue that this is inconsistent. Whatever the logical merits of this argument, it does not involve the accounting concept of consistency. This convention does not mean that the treatment of different categories of transactions must be consistent with one another but only that transactions in a given category must be treated consistently from one accounting period to the next. 4. Materiality: The term materiality refers to the relative importance of an item or an event. An item is "material" if knowledge of the item might reasonably influence the decisions of users of financial statements. Accountants must be sure that all material items are properly reported in the financial statement. However, the financial reporting process should be cost-effective - that is, the value of the information should exceed the cost of its preparation. In short, the convention of materiality allows accountants to ignore other accounting principles with respect to items that are not material. An example of the materiality convention is found in the manner in which most companies account for low-cost plant assets, such as pencil sharpness or waste baskets. Although the matching concept calls for depreciating plant assets over their useful life, these low-cost items usually are charged immediately to an expense account the resulting "distortion" in the financial statement is too small to be of any importance.

Accounting Concepts Part-2

4. Cost Concept: The concept is closely related to going concern concept. According to this concept. "An asset is ordinarily entered on the accounting record at the price paid to acquire it, and this cost is the basis for all subsequent accounting for the asset". If business buys a building for Rs 5,00,000, the assets would be recorded in the books at Rs 500,000, even if its market value at that time may be Rs 550,000. In case a year later the market value of this asset comes down to Rs 450,000 it will ordinarily continue to be shown at Rs 500,000 and not at Rs 450,000. The cost concept does not mean that the asset will always be shown at cost. It has also been stated above that cost becomes the basis for all future accounting for the asset. It means that asset is recorded at cost at the time of purchase but it may systematically be reduced in its value by charging depreciation. 5. Dual Aspect Concept: The economic resources of an entity are called 'assets'.The claims of various parties against these assets are called 'equities'. There are two types of equities: 1. Liabilities, which are the claims of creditors (that is, everyone other than the owners of business) and 2. Owner's Equity, which is the claim of the owners ofthe business. Since all of the assets of a business are claimed by someone (either by its owners or by its creditors) so we can say that Assets = Equities This is the fundamental accounting equation, which is the formal expression of the dual - aspect concept. As we shall see all accounting procedures are derived from this equation. To reflect the two type of equities, the equation is more commonly expressed as: Assets = Liabilities + Owner's Equity Every transaction has a dual impact on the accounting records. Accounting systems are set up so as to record both of these aspects of a transaction; this is why accounting is called a double-entry system. To illustrate the dual-aspect concept, suppose that Mr. A starts a business with a capital of Rs 30,000. There are two changes, first the business has cash (asset) of Rs 30,000 and second, the business has to pay to the proprietor a sum of Rs10,000 which is taken as proprietor's capital. This expression can be shown inthe form of following equation: Cash (Assets) = Capital (Equities) Rs 30,000 =Rs 30,000. Subsequently if the business borrows Rs15,000 from a bank, the new position would be as follows: Assets = Equities Cash Rs 30,000 + Bank Rs 15,000 = Bank loan Rs15,000 + Capital Rs30,000. The term 'accounting equation' is also used to denote the relationship of equities to assets. The equation can be technically, stated as "for every debit, there is an equivalent credit". 6. Accounting Period Concept: The users of financial statements need information that is reasonably current. Therefore, for financial reporting purposes, the life of a business is divided into a series of relatively short accounting periods of equal length. It is, therefore, absolutely necessary that after each accounting period the business must 'stop' and 'see back', how things are going. In accounting such accounting period is usually of a year. At the end of each accounting period an income statement and a balance sheet is prepared the income statement discloses the profit or loss made by business during the year while balance sheet shows the financial position of business as on the last day of the accounting period. 7. The Matching Concept: A significant relationship exists between revenue and expenses. Expenses are incurred for the purpose of producing revenue. In measuring net income for a period, revenue should be offset by all the expenses incurred in producing that revenue. This concept of offsetting expenses against revenue on the basis of "cause and effect" is called the Matching Concept. The term 'matching' means appropriate association of related revenues and expenses. In matching expenses against revenue the question when the payment was made or received is 'irrelevant'. For example if a salesman is paid commission in January,2005, for sales made by him in December, 2004. According to this concept commission expense should be offset against sales of December 2004 because this expense is incurred for producing revenue in December 2004. On account of this concept, adjustments are made for all outstanding expenses, accrued revenues, prepaid expenses and unearned revenues, etc., while preparing the final accounts at the end of accounting period. 8. Realization Concept: Accounting to this concept revenue should be recognized at the time when services are rendered. Sale is considered to be made at the point when the property in goods passes to the buyer and he becomes legally liable to pay.

Accounting Concepts Part-1

The term ' accounting concepts ' includes those basic assumptions or conditions on which the science of accounting is based. These concepts are used by accountants and bookkeepers all over the world. Following are the most important accounting concepts: 1. Separate entity concept. 2. Going concern concept. 3. Money measurement concept. 4. Cost concept. 5. Dual aspect concept. 6. Accounting period concept. 7. Matching concept. 8. realization concept. These accounting concepts are explained below: 1. Separate Entity Concept: Accounts are kept for entities, as distinguished from the persons who are associated with these entities. In recording events in accounting, the important question is: "How do these events affect the entity?" How they affect the persons who own, operate, or otherwise are associated with the entity is irrelevant.For example, when a person invests Rs 200,000 into business it will be deemed that the owner has given that money to the business which will be shown as a 'liability' in the books of the business. In case the owner withdraws Rs 30,000 from the business, it will change the position and the net amount payable by the business to the owner will be shown only as Rs170,000. The concept of separate entity is applicable to all forms of business organizations. For example, in case of a sole proprietorship or partnership business, though the sole proprietor or partners are not considered as separate entities in the eyes of law, but for accounting purposes they will be considered as separate entities. 2. Going ConcernConcept: According to this concept it is assumed that an entity is a going concern - that it will continue to operate for an indefinite time period there is no intention to liquidate the particular business venture in the foreseeable future. On account of this concept, the accountant while valuing the asset does not take into account the sale value of assets. Moreover, he charges depreciation on fixed assets on the basis of their expected life rather than on their market values. For example, suppose that a company has just purchased a three-year insurance policy for Rs 45,000. If we assume that the business will continue inoperation for three years or more. We will consider the Rs 45,000 cost of insurance as an asset which provides services to the business over a three-year period. On the other hand, if we assume that the business is likely to terminate in the near future, the insurance policy should be reported at its cancellation value i.e. the amount refundable upon cancellation. Moreover, the concept applies to the business as a whole. When an enterprise liquidates a branch or one segment of its operations, the ability ofthe enterprise to continue as a going-concern is not impaired normally. The enterprise will not be considered as a going-concern when it has gone into liquidation. 3. Money Measurement Concept: In financial accounting, a record is made only of those information that can be expressed in monetary terms. In other words, no accounting is possible for an event or transaction which is not measurable in terms of money, e.g. passing an examination, delivering lecture in a meeting, winning a prize etc.These are events no doubt, but since these are not measurable in terms of money, there is no question of their accounting. Measurement of business events in money helps in understanding the state of affairs of business in a much better way. For example, If a business owns. 1,500kg of stock, one car, 1,500 square feet of building space etc. these amounts cannot be added to produce a meaningful total of what the business owns. However, if these items are expressed in monetary terms such as stock Rs 24,000, car Rs 300,000 and building Rs 500,000, all such items can be added in better way and precise estimate about the assets of the business will be available.

Accounting Principles

Accounting is the language of business through which economic information is communicated to all the parties concerned. In order to make this language easily understandable all over the world, it is necessary to frame or make certain uniform standards which are acceptable universally. These standards are termed as "Accounting Principles ". Accounting principles may be defined as those rules of action or conduct which are adopted by the accountants universally while recording accounting transactions. They are a body of doctrines commonly associated with the theory and procedures of accounting. They are serving as an explanation of current practices and as a guide for selection of conventions or procedures where alternatives exist. These principles can be classified into two groups. 1. Accounting concepts 2. Accounting conventions. Accounting Concepts: The term 'concepts' includes those basic assumptions or conditions on which the science of accounting is based. The following are the important accounting concepts: 1. Separate entity concept 2. Going concern concept 3. Money measurement concept 4. Cost concept 5. Dual aspect concept 6. Accounting period concept 7. Matching concept 8. Realization concept. Accounting Conventions: The term 'conventions' includes those customs or traditions which guide the accountant while communicating the accounting information. The following are the important accounting conventions; 1. Convention of conservatism 2. Convention of full disclosure 3. Convention of consistency 4. Convention of materiality.

Accounting Cycle

After taking decisions such as selecting a business, selecting the form of organization of business, making decision about the amount of capital to be invested, selecting suitable site, acquiring equipment, supplies etc., selecting staff, getting customers and selling the goods etc., business man finally resorts to record keeping. For all types of business organizations, transactions such as purchases, sales, manufacturing and selling expenses, collections from customers and payments to suppliers do take place. These business transactions are recorded in a set of ruled books, such as journal, ledger, cash book etc; In modern times all the records are maintained on a computer using computer software; unless these transactions are recorded properly, he will not be in a position to know where exactly he stands. Therefore, for any business record keeping is of foremost importance. Following is the complete cycle of accounting :- (1) The balances of accounting; from opening balance sheet and day-to-day business transactions of the accounting year are first recorded in a book known as Journal. (2) Periodically these transactions are transferred to concerned accounts, known as ledger accounts. (3) At the end of every accounting year these accounts are balanced and a trial balance is prepared. (4) Then the final accounts such as Trading and profit & loss accounts are prepared. (5) Finally a Balance Sheet is made which gives the financial position of the business at the end of the period.

Important Accounting terms

Assets An asset may be defined as anything of use to future operations of the enterprise and belonging to the enterprise. For example, building, land, machinery, cash, debtors (amount due from customers) goodwill etc. Equity In broad sense the term equity refers to total claims against the enterprise. It is further divided into two categories: (1) Owners claim-capital and (2) Outsiders' claim-liability (3) Liability: Amounts owed by the enterprise to the outsiders i.e. to all others except the owner. For example, trade creditors, bank overdraft etc. (4) Capital: The excess of assets over liabilities of the enterprise. It is the difference between the total assets and the total liabilities of the enterprise. For example, if on a particular date the assets of the business amount to Rs 1,00,000 and liabilities to Rs 30,000 then the capital on the date would be Rs 70,000. It is also known as net worth. Revenue It is the monetary value of the products or services sold to the customers during the period. It results from sales, services and sources like interest, dividend and commission, etc. Expenses/ Costs Expenditure incurred by the enterprise to earn revenue is termed as expenses or costs. Distinction between expense and asset is that the benefit of the former is consumed by the business in present whereas in latter case benefit will be available for future activities of the business. Examples of expenses are raw materials consumed, salaries etc. . Loss The term is used to convey, at least, two different meanings. First it refers to the result of the business for a period when expense exceed the revenue. For example, if sales are Rs 10,000 and expenses are Rs 11,000 the loss will be Rs 1,000. Second- It describes those efforts which fail to earn revenue. For example-un saleable stock, loss due to fire, theft, accident etc. Proprietor/ Owner The person who investshis money or money's worth and bears the risk of the business. Drawings Money or value of goods belonging to business used by the proprietor for his personal use. Goods Includes all merchandise commodities which are purchased by the business for selling. Trade Debtor Person who owes money to the business. It happens when goods are sold on credit. Trade Creditor Person to whom the business owe money. It happens when goods or materials are purchased by the business on credit. Transaction Any exchange (dealing) of goods or services, for cash or on credit by the business with any other business. Events There are the occasions which cause changes in the value due to time element. Outsiders are not directly concerned. For example, interest accrued, depreciation in the value of assets etc. Entry The record of a transaction or event in the books of accounts is known as entry. Entity All elements of financial statements are in relation to a particular entity which may be business enterprise, an educational or charitable organization, a government unit, a natural person or the like. An entity may comprise two or more affiliated entities and may not necessarily correspond, with 'legal entity'. Thus, the accounting information is recorded, compiled and presented with reference to identifiable entity. The term 'other entity' refers to a subsidiary company that is a part of the same entity as its parent company in consolidated financial statements but is an 'other entity' in the separate financial statements of its parent. Net worth Is also known as "ownership equity" or"stockholders', equity" or "capital". It is the difference between total assets minus outside liabilities. Alternatively net worth is the sum of capital plus retained earnings.