Finance Basics Introduction to Accounting Need for Accounting Meaning of Accounting Attributes of...

Finance Basics

Finance Basics

• Introduction to Accounting• Need for Accounting• Meaning of Accounting• Attributes of Accounting• Branches of Accounting• Users of Accounting Information• Accounting Cycle

• Accounting Equation• Introduction and Meaning• Effects of Business Transactions on Accounting Equation• Purchase of an asset of credit• Rules of Accounting Equation

Finance Basics

• Double Entry System• Types of Accounting• Rules of the Double Entry System (Debit and Credit)• Advantage of Double Entry System

• Journal• Meaning of Journal• Objectives of Journal• Rules of Journalizing• Miscellaneous Journal Entries

Finance Basics

• Ledger• Meaning of Ledger• Rules of the Double Entry System (Debit and Credit)• Advantage of Double Entry System

• Journal• Trial Balance• Cash Book

Finance Basics

• Journal• Meaning of Journal

• Journal is a book of original or prime entry. In this book, transactions are recorded in the order in which they happen. i.e. in the chronological order. It is the basic book of accounts in which the transactions are recorded for the first time and hence is called the book of original entry.

• After recording the transactions in the journal, it is finally posted to the LEDGER. The process of recording a transaction in the journal is called Journalizing and the record of each transaction in the journal is called journal entry

Finance Basics

• Journal• Objectives of Journal

1. Correct Knowledge: While passing entries in the journal, every transaction is recorded at two places – debit and credit. This gives the correct knowledge about the transactions as every transaction has tow-fold aspects.

2. Complete record: The main objective of the journal is to provide a complete record of each and every transaction together with the date by giving narration of each transaction.

3. Proof: A journal is the proof of every business transaction as it is used to remove any misunderstanding between business parties

Finance Basics

• Journal• Objectives of Journal

4. Helpful in Auditing: The completer record of every business transaction makes the auditing and verification of the books of accounts very easy .

5. Helpful in location error: In journal, the transactions are recorded datewise y minimizing the chances of errors. Even if errors are committed, they can be easily checked.

6. To fulfill the requirement of ledger: The main objective of a journal is to provide the completer record of each and every transaction to prepare ledger.

Finance Basics

• Journal• Steps of Journalizing

1. Proper Proforma: The journal entries should always be passed in proper proforma.

2. Name of Journal: The name of the owner should always be written on the top of the journal before passing any entry in it.

3. Sorting of two accounts: Firs of all two effected accounts of every transaction must be ascertained. The nature of the accounts and the rules of debit and credit to be applicable are analyzed properly.

Finance Basics

• Journal• Steps of Journalizing

4. Uses of ‘Dr’ and ‘To’: The word ‘Dr’ must be used after the name of the account which is to be debited and word ‘To’ must e used before the account which is to be credited. There is no need to write credit after the account which is to be credited.

5. On personal accounts: The word ‘Account’ (a/c) is not required in the personal accounts

6. Write narration: Write a narration within brackets after the account to be credited.

7. Totaling of amount: After making the necessary entries in the journal there must be a total of debit and credit columns in a straight line. The total of one page is carried forward to the next page by putting “c/f” (carried forward).

Finance Basics

• Journal• Miscellaneous Journal Entries

• Different types of transactions along with their journal entries are given in the following:

1. Hamad started business with a capital of SAR 50,000: The two accounts involved in this transaction are (a) cash a/c and (b) Hamad’s Capital a/c. Cash a/c is a real account and cash comes into the business, hence the Cash a/c shall be debited. Hamad’s Capital a/c is a personal account and Hamad is the giver of the benefit, hence Hamad’s Capital a/c shall be credited. The transaction will be recorded in the journal as follows:

JOURNALDate Particulars L.F.

Debit (SAR)

Credit (SAR)

2010April 1

Cash a/c Dr.To Hamad’s capital a/c

(Being business started with SAR 50,000)

50,000 50,000

Finance Basics


2. He purchased furniture for SAR 1,500 : The two accounts involved in this transaction are (a) Furniture a/c and (b) Cash a/c. Both Furniture and Cash accounts are real accounts. Furniture comes into the business. Therefore, it shall be debited. Cash goes out of the business, hence it shall be credited. The transaction shall be recorded in the journal as follows:

JOURNAL

Date Particulars L.F.

Debit (SAR)

Credit (SAR)

2010April 3

Furniture a/c Dr. To cash a/c

(Being furniture purchased)

15,000 15,000

Finance Basics


3. He opened an account with a bank depositing SAR 5,000: The two accounts involved in this transaction are (a) Bank a/c and (b) Cash a/c. Bank a/c is a personal account and Cash a/c is a real account. Bank receives the money, and therefore, Bank a/c should be debited. Cash goes out of business, and hence, Cash a/c should be credited. The journal entry should be as follows:

JOURNAL


Debit (SAR)

Credit (SAR)

2010April 3

Bank a/c Dr. To cash a/c

(Being amount deposited into bank)

5,000 5,000

Finance Basics


4. He purchased goods from SAR 20,000: The two accounts involved in this transaction are (a) Purchase a/c and (b) Cash a/c. Both purchase (goods) and cash are real accounts. Goods are coming into the business and cash is going out. Therefore, Purchase a/c shall be debited and Cash a/c shall be credited.

JOURNAL


Debit (SAR)

Credit (SAR)

2010April 4

Purchase a/c Dr. To cash a/c

(Being goods purchased for cash)

20,000 20,000

Finance Basics


5. He sold goods for SAR 8,000: The two accounts involved in this transaction are (a) Sales a/c and (b) Cash a/c. Both Sales and Cash are real accounts. The effect of this transaction is that cash comes into the business and goods go out of the business. Therefore, Cash a/c shall be debited and Sales a/c shall be credited.

JOURNAL


Debit (SAR)

Credit (SAR)

2010April 5

Cash a/c Dr. To cash a/c

(Being goods sold for cash)

8,000 8,000

Finance Basics


6. Purchased goods from Saleh on credit for SAR 12,000: The two accounts involved in this transaction are (a) Purchase a/c and (b) Saleh’s a/c. Purchase a/c is a real account and the goods are coming into the business, and therefore, should be debited. Saleh’s a/c is a personal account and Saleh is the giver of the benefit, therefore, his account should be credited.

JOURNAL


Debit (SAR)

Credit (SAR)

2010April 12

Purchase a/c Dr. To Saleh’s a/c

(Being goods Purchased from Saleh)

12,000 12,000

Finance Basics


7. Paid SAR 7000 to Saleh on account: The two accounts involved in this transaction are (a) Saleh’s a/c and (b) Cash a/c. Saleh’s a/c is a personal account and he is the receiver of the benefit, therefore his account shall be debited. Cash a/c is a real account and cash goes out, and therefore, it should be credited.

JOURNAL


Debit (SAR)

Credit (SAR)

2010April 18

Saleh’s a/c Dr. To Cash a/c

(Being amount paid to Saleh)

7,000 7,000

Finance Basics


8. Paid rent for the shop SAR 800: The two accounts involved in this transaction are (a) Rent a/c and (b) Cash a/c. Rent a/c is a nominal account, it is an expense, and therefore, should be debited. Cash a/c is a real account. It goes out of the business, and therefore, should be credited.

JOURNALDate Particulars

L.F.Debit (SAR)

Credit (SAR)

2010April 25

Rent a/c Dr. To Cash a/c

(Being rent paid)

800 800

Finance Basics


9. Paid salary SAR 500: The two accounts involved in this transaction are (a) Salary a/c and (b) Cash a/c. Salary a/c is a nominal account, it is an expense, and therefore, should be debited. Cash a/c is a real account. It goes out of the business, and therefore, should be credited.

JOURNALDate Particulars

L.F.Debit (SAR)

Credit (SAR)

2010April 25

Salary a/c Dr. To Cash a/c

(Being rent paid)

500 500

Finance Basics


10.Capital account and drawings account: These are two personal accounts which are opened in the books of the proprietor of a business. Anything which the proprietor brings to the business is credited to the capital account, while anything which is taken by the proprietor from the business for personal use or any expense made by the business on account of the proprietor are debited to the drawings account. The following transactions will make the things clear:

a) Withdrew cash SAR 300 and goods worth SAR 400 for personal use.

b) Paid life insurance premium SAR 600c) Paid income tax SAR 1000

Finance Basics


10.Capital account and drawings account:

a)

b)

c)

Drawings a/c Dr. To Cash a/c To Purchase a/c(Being withdrew cash and goods for personal use)

Drawings a/c Dr. To Cash a/c(Being paid life insurance premium of the proprietor)

Drawings a/c Dr. To Cash a/c (Being paid income tax of the proprietor)

700

600

1,000

300400

600

1,000

Finance Basics


11. Goods given away as charity: When goods are given as charity, then it is not called sales. The amount of such goods is withdrawn or deducted from the purchase account. Therefore the purchase account is credited. The charity account is an expense for the business, hence, is debited.

Charity a/c Dr. To Purchase a/c (Being goods given away as charity)

500500

Finance Basics


12.Goods distributed as free sample: Goods are sometimes distributed as free sample for the advertisement purpose. Hence the advertisement account is debited, and as it is not a sale, the cost of goods are adjusted through the purchase account. Therefore, the purchase account is debited.

Example: Goods costing SAR 2000 were distributed as free sample.

Advertisement a/c Dr. To Purchase a/c (Being goods distributed as free sample)

20002000

Finance Basics• Journal

• Miscellaneous Journal Entries13.Bad Debts: When a debtor of the trader is declared

insolvent, or due to any other reason the chances of realization of debt is almost nil, then such unrecovered debt is transferred to the bad debts account and treated as business loss.

Example: Ali who owes SAR 500 becomes insolvent. Only SAR 200 is realized from his estate.

Cash a/c Dr.Bad debts Dr. To Ali a/c (Being received SAR 200 from Ali)

200300

500


• Miscellaneous Journal Entries14.Bad debts recovered: When amount already written off as

bad debts is unexpectedly recovered, then the amount is not credited to the party account as that is already credited. The amount is written off as bad debts. Such amount is credited to bad debts recovered account.

Example: SAR 300 were written off as bad debts last year but this year SAR 150 out of that were received from Ali.

Cash a/c Dr. To bad debts recovered a/c (Being bad debts recovered)

150 150


• Miscellaneous Journal Entries15.Expenses incurred on purchase of asset: When an asset

is purchased for business, all expenses related to its purchase and installation are charged to asset account. If second hand asset is purchased and expenses on immediate repairs are spent, then such expenses are also charged to the asset account. Further repairs and maintenance shall not be charged to the asset a/c but to the repairs a/c.

Example: (1) Bought a machinery for SAR 5000 and spent SAR 2000 on its repair, (2) paid installation charges of the machinery SAR 3000..

1

2

Machinery a/c Dr. To cash a/c (Being bought machinery)Machinery a/c Dr. To cash a/c (Being paid installation charges of machinery)

7,000

3,000

7,000

3,000


• Miscellaneous Journal Entries16.Purchase and sale of investment: When shares,

debentures, bonds or other types of securities are purchased, then such purchases are recorded through the investment account. Generally, the price of such securities and bonds is either more or less than its face value, and if such sale or purchase of shares is done through brokers, then the transaction is recorded with the actual price paid or received.

Example: (1) 50 Shares of AB & Co. are purchased at the rate SAR 40 per share and SAR 50 paid for brokerage; (2) Sold 30 Shares of AB & Co. at SAR 80 per share and SAR 30 paid as brokerage.

1

2

Investment in shares a/c Dr. To cash a/c (Being brought 50 shares of AB & Co.)Cash a/c Dr. To Investment in shares a/c (Being sold 30 shares of AB & Co.)

2,050

2,370

2,050

2,370


• Miscellaneous Journal Entries17.Trade Discount: Trade discount is generally allowed by

manufacturer to wholesaler and by wholesaler to retailer for purchasing goods in bulk quantity. This is generally calculated on the list price of the goods. This item of trade discount is used for calculation of the price (real) of goods. Hence, for passing the journal entry, no such account is recorded in the books but used for fixation of price only.

Example: Bought goods of list price of SAR 5000 at 20%. Trade discount from Global.

Purchase a/c Dr. To Global a/c (Being brought goods of list price of SAR 5000 at 20% trade discount from Global)

4000 4000


• Miscellaneous Journal Entries18.Cash Discount: Cash discount is allowed by the trader to

encourage buyers to make early cash payment. It is a nominal account and is debited in the books if allowed by the trader.

Example: Paid to Global the bill for SAR 4000 after deducting 5% cash discount.

Global a/c Dr. To Cash a/c To discount a/c (Being paid to Global his bill of SAR 4000 after deducting 5% cash discount)

4000 3800

200


• Miscellaneous Journal Entries18.Cash Discount: Example: Sold goods of list price of SAR 2000 at 15%, trade discount

and 2% cash discount to Fahad for cash.

Cash a/c Dr.Discount a/c Dr. To Sales a/c (Being sold goods of lit price of SAR 3000 at 15% T.D. and 2% C.D.)

249951

2550


• Miscellaneous Journal Entries18.Cash Discount: Example: Bought goods of list price of SAR 5000 at 20% trade discount

and 5% cash discount From Abdullah. Half the payment was made in cash immediately.

. Purchase a/c Dr.

To Cash a/c To Discount a/c To Abdullah a/c (Being bought goods of lit price of SAR 5000 at 20% T.D. and 5% C.D. from Abdullah and half payment made in cash immediately)

4,000

1,900 100

2,000


• Miscellaneous Journal Entries19.Payment of expenses to some persons: When payment

of an expense like rent or salary is made to some person, the particular expense amount should be debited but not the personal account. For example, if salary is paid to Ali, salary account shall be debited but not Ali’s account.

20.Receipt of income from a person: When an amount is received from a person which is an income of the business, the particular income account should be credited but not the personal account of the giver. For example, if interest is received from Ali, interest account should be credited but not Ali’s account.


• Miscellaneous Journal Entries21.Payment/receipt on behalf of another: When

payment is made on behalf of another person, the account of the person on whose behalf the payment is made, should be debited but not the person to whom payment is made. For example, if payment is made to Ali on behalf of Fahad, then Fahad’s account should be debited. Similarly, if freight is paid on behalf of the customer, then customer’s account should be debited but not the freight account.


• Miscellaneous Journal Entries22.Transfer entries: There are some accounts which are

generally transferred to the main account. The entry passed for this purpose is called transfer entry.

Example: Drawings of SAR 500 of proprietor transferred to capital account.

Capital a/c Dr. To Drawings a/c (Being drawings account transferred to capital a/c)

500

500


• Miscellaneous Journal Entries23.Compound Journal Entry: Compound journal entry refers

to a single journal entry passed for two or more than two transactions taking place on the same date. When two or more entries are combined to form one journal entry, it is called a composite or compound journal entry. Compound entry is passed if:A. Two or more transactions are of similar nature.B. The transactions have taken place on the same date.C. At least one of the accounts involved in various

transactions is common.Thus, a compound entry may take the form of one or several accounts may be debited and one or several accounts may be credited.


• Miscellaneous Journal Entries24.Depreciation on fixed assets: Depreciation is

the decrease in the value of an asset due to wear and tear and passage of time. It is an expense/loss for business. So, depreciation account should be debited and fixed asset account should be credited.

25.Bank Charges: These are expenses charged by bank from its customers for its services. It is a business expense, and so, bank charges account should be debited and bank account should be credited.


• Miscellaneous Journal Entries26. Interest on capital/drawings: Interest on

capital is an expense of the business and should be debited but the capital account of the proprietor should be credited. Similarly, interest on drawings is an income of a business. Interest on drawings account should be credited and drawings account should be debited.


• Miscellaneous Journal Entries27.Goods lost by fire: Sometimes goods may

be lost by fire, theft, etc. It is a loss to the business as stock of goods decreases. So loss by fire account should be debited and purchased account should be credited. If the amount of loss is recoverable form the insurance company, either fully or partially, then insurance claim company account should be debited and loss by fire, etc. should be credited.

Finance Basics• Illustration #1: Journalize the following transactions:

Jan 1 Started business with SAR 10,000, paid into the bank SAR 5000Jan 1 Bought furniture for SAR 900Jan 3 Purchased goods from Ali form SAR 4000 for cashJan 4 Sold goods for SAR 1700Jan 5 Paid telephone rent for SAR 400Jan 7 Purchased goods for SAR 1000 from Fahad & Co.Jan 8 Paid SAR 100 for advertisement by chequeJan 10 Bought one printer for SAR 750 from Universal Co. on credit.Jan 11 Sold goods to Ali & Co. for 2,900Jan 12 Withdrew SAR 350 from the bank for private useJan 14 Sold goods to Omega & Co. SAR 650 for cashJan 16 Received cash from Ali & Co. for 2850, discount allowed SAR 50Jan 25 Paid into bank SAR 2,500Jan 26 Issued cheque for SAR 300 for rent Jan 31 Paid salaries to staff SAR 600Jan 31 Issued cheque for SAR 950 in favor of Fahad & Co. in full settlement of their

account.

Finance Basics• Solution:

Jan 1

Jan 1

Jan 1

Jan 3

Jan 4

Cash a/c Dr. To Capital a/c (Being cash brought in as capital)

Bank a/c Dr. To cash a/c(Being cash deposited in the bank)

Furniture a/c Dr. To cash a/c(Being furniture purchased)

Purchase a/c Dr. To cash a/c(Being gods purchased for cash)

Cash a/c Dr. To Sales a/c(Being goods sold for cash)

10,000

5,000

900

4,000

1,700

10,000

5,000

900

4,000

1,700


Jan 5

Jan 7

Jan 8

Jan 10

Jan 11

Telephone rent a/c Dr. To Cash a/c (Being paid telephone rent)

Purchase a/c Dr. To Fahad & Co. a/c(Being goods purchased on credit)

Advertisement a/c Dr. To Bank a/c(Being payment of advertisement made by cheque)Printers or office equipment a/c Dr. To Universal Co. a/c(Being purchased one printer on credit)

Ali & Co. a/c Dr. To Sales a/c(Being goods sold on credit)

400

1,000

100

750

2900

400

1,000

100

750

2900


Jan 12

Jan 14

Jan 16

Jan 25

Jan 31

Drawings a/c Dr. To Bank a/c (Being amount withdrawn for personal use)

Cash a/c Dr. To Sales a/c(Being goods sold for cash)

Cash a/c Dr.Discount allowed a/c Dr. To Ali & Co. a/c(Being cash received and discount allowed)

Rent a/c Dr. To Bank a/c(Being cheque paid for rent)

Salaries a/c Dr. To Cash a/c(Being Salaries paid)

350

650

2,85050

300

600

350

650

2,900

300

600


Jan 31 Fahad & Co. a/c Dr. To Cash a/c To discount received a/c (Being cash paid in full settlement)

1000

950

50

Total 30,050 30,050

Finance Basics Introduction to Accounting Need for Accounting Meaning of Accounting Attributes of...

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