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Module 1: Introduction to Accounting Standards and Principles

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Namaste. In our earlier modules we have discussed about financial statements, then we have discussedvarious conceptual aspects like corporate governance like evolution of accounting. Todaywe are going to go back to the very first step of accounting, if you remember the accountinghas three steps, one is recoding of transactions, summarizing and preparation of financial statements.Normally, the students are first taught about recording and then they go to financial statements;we have followed a reverse path. We have first understood what is a final output in the formof balance sheet, then P and L then cash flow and now we are going to understand what isa recording part of it The main purpose of changing this sequencebecause this course is mainly for non-accounting students like engineers or management studentswho are less interested in recording they are more interested in reading and analysingthe statements. So, we have tried to understand the balance sheet P and L and cash flow. Now,we will discuss what are the basic transactions using those transactions you get a summaryand from that summary you have made the P and L and balance sheet.So, this is popularly known as journal entries or ledger entries, we will not go into toomuch of details of it, I will just give an overview as to what is journal, what is ledgerand so on. And in the next PPT of this module, we will see how basic P and L and balancesheet is prepared, so that in next sessions we can talk about preparation of corporateP and L and balance sheet ok. To first begin with the Recording of Financial Transactions.So, we are going to discuss about journal, ledger and subsidiary books, these are themajor books of accounts, these are not final accounts, but from here the recording aspectstarts.Now, first one is journal now this is called as a book of original entry because all thetransactions are first recorded in journal and the effects are decided here in journal.Recording of transaction is many times called as journalizing of entries.Entries are recorded normally in a chronological manner; these are very important in earlierdays we used to have physical books where people will actually write the journal entries,now most of the accounting is computerized. So, journal entries happen within the system,within the system ledgers are created and within the computer system the final accountsare created, but keep in mind the correctness of journal entries has not gone down in fact,it has increased. If there is a any kind of mistake in the journalentry it is going to be carried in the ledger and it is going to be carried in the finalaccount. So, either an entry in the amount or entry a mistake in the very conceptualunderstanding of the entry is going to distort the final accounts completely. So, keep inmind that journal entries have not lost relevance, only thing is instead of from the book todaythey are made in some, so computer software, but understanding of this entries is veryimportant.Now, this is a specimen of traditional journal where you write date, particular, ledger folio,debit amount and credit amount. Even in computerized system a similar type of entry is to be madeNow, here what we have tried to do is give a list of simple transactions and the entriesfor those transactions. So, that you understand that for a particular transaction how an entryis passed, so goods sold for cash 5000, cash deposited in bank 3000.Now, if you take these two simple entries, the journal entries for them is like thisthe goods are sold for cash. So, cash comes in we get more cash that is why cash accountis debited and our sales are increasing, so sales account is credited. Keep in mind thatcash is an asset, so by debiting it the cash increases sales is an income, so by creditingit the sales increases. So, cash account to sales account this ishow the entries written the debit amount for cash is 5000, the credit amount for salesis 5000. It is necessary that total of debit and credit should match for every entry, thenonly the final balance sheet will be tallied. Are you getting it, for those who do not haveany commerce or such type of accounting background this maybe very new, but this forms the basisof all other entry of various entries or various accounting which is done in futureThe next entry was cash deposited in bank. So, remember here what is done is the bankbalance is increasing and the cash balance is decreasing, so we say bank account debit3000 to cash account 3000; that means, the cash account is credited by 3000 and herethe date is written, are you getting me. Now, we can take hundreds of transactions and goon writing more and more entries as I told you we are not going into too much detailsthis is just to make you understand what a journal is I hope that much is clear to you.The next one is ledger.Now, from the journal the entries are classified and grouped for a particular account and theyare written under a particular account in what is known as a ledger. In the old daysphysically the ledgers used to be written and they were called as principle books ofentries, journal is a primary book where the entries first made from there it is transferredto ledger and ledger is a main book that is why is called as a principle book of accounts.This is a specimen of ledger, you can see here this side is for debit, this side isfor credit, date particular J F; J F is a journal folio and the amount same way date,particular, J F and amount; we will write here D r for debit, C r for credit and ABCaccount is the heading of a particular account. So, getting it has two sides and for everyaccount a separate ledger account is required to be opened in the ledger book. Normally,to and by is written on debit and credit side. Now, a simple case is given, so that we canprepare ledger accounts for the given transactions.Prepare ledger accounts for Ram and Company, opening balances are given cash, debtors,creditors and capital.And some simple transactions are given purchase of goods on credit, cash sales, goods soldon credit and paid cash for expenses.Further cash received from debtors, cash paid to creditors. Now, I will request you to takeprint out of this particular case, the case has been shared with you and now try to look,try to solve it and then check with the solution ok.Now, this is how in the books of Ram and Company the ledger will appear. First account preparedis cash account it follows like this, to balance brought down 1500 you can see here the openingbalance of cash was given, it was not given whether it is debit or credit. But since youknow that cash is an asset it is going to have a debit balance of 1500, then there wasa cash transaction on 4th April cash sales of 2400. So, we have sold goods and we havegot cash, so this will go on debit side in the ledger.On f15th April again there is a cash transaction paid cash for rupees 250 for expenses. So,you have paid cash; cash will go down it will appear as a credit transaction you can justsee this transactions here are you getting me. So, opening balance 1500 on this is adebit side, on 4th April to sales 2400, on 15th April by expenses 250 we will go backagain. Next cash transaction 18th April cash received from debtors 1200 and on 22 Aprilpaid cash to creditors 800. You can see here, cash received from debtors willappear on debit side because the money has come in. So, to debtors 1200 and amount paidto creditors is by creditors on 22nd April 800.So, we have recorded all the transactions in the period related to cash and the lastday that is on 30th of April we will calculate the balance; are you getting it. So, we willtake total here which is 5100 and deduct this two amounts we get a balance of 4050; thatmeans, the cash in hand at the end of the month that is on 30th April is 4050, are yougetting it. So, what you would have realized is we havesummarized, we have categorized and summarized the transactions, we were given the raw transactionssince we want to prepare a cash account we have classified only those transactions whichare related to cash. So, first one was opening balance of cash, then cash sales, then cashexpenses, cash received from debtor and cash paid to creditor. Only those items or thoseentries related to cash will come in the ledger account known as cash account this is verymuch of commonsense, but I am just repeating it for those who are perhaps doing it forthe first time are you getting it. This is how a separate ledger account is createdfor every asset or a liability or a income or expense and transactions related to thataccount are recorded in the ledger. So, this is cash account, the balance will be carriedhere so that in the next month that is from May, 1st May it says two balance brought downnow below this we can make the account for May.So, you can see accounting period concept the accounts are being closed at the end ofa particular month. So, at the end of April we get the balance it becomes the openingbalance for the next month.Now, similarly we have prepared purchase account; purchase account there was only one entryto creditors there was a cash purchase of goods for 3000 and that much is balance carrieddown. For sales; sales are on credit side there were two sales, one for cash sale theother one was credit sale, this is the total sales for the month balance brought down is3650, are you getting it.Next is debtors; debtors are the customer balances or receivables from customers, thereis only one transaction of sale, on 7th April 12500 the amount is received by cash 1200and the balance is 1250. So, if you see carefully you will realizethat the opening balance of 1200 is received on 18th April and a fresh sale the amountof 1250 is yet to be received till 1st May, getting it; perhaps they were credit periodof 1 month. So, last month’s balance is received this month’s balance is due itis carried to the next month. Creditors there was only one credit purchaseon 2nd April for 3000, the balance is still pending we have already paid the opening balanceof 800 on 22nd of April. So, these are the accounts of receivables and payables thisis a very small company very less number of transactions, but that will give you one ideaas to how a particular account can be prepared for even for a larger company.Then the expense account there was only one entry for expense for cash expense this 250rupees is a balance of expenses. Capital account there is no entry, normally the capital willnot change every month, so opening balance of 1900 is carried as a closing balance, soare you getting me. Now, there is one more topic known as subsidiarybooks we have just seen that journal entries are passed then ledger accounts are prepared,but what happens is in most of the businesses similar type of entries come in very largenumber like purchases, sales and cash. So, there is no point in making journal entryevery time instead of that we will prepare a register and record all the purchases inone register, all the sales in one register, all cash transactions are recorded in a specialbook known as cash book where the cashier will record only the cash transactions.So, in subsidiary books instead of having one journal for a similar type of transactionnumber of books are prepared which are called as subsidiary books these are the books oforiginal entry from there the transactions are transferred to ledgerare you getting it.So, this easiest procedure in the olden days, physical maintenance was required. So, differentbooks could be maintained at different point of time like in sales depot there will besales book, in the hands of cashier there will be cash book etcetera. Nowadays everythingis done by computer system, but even in computer system subsidiary books are maintained andauthority of making certain type of transactions will lie in certain type of people.So, typical subsidiary books are cash book for all cash transactions, purchase book forpurchases, sales book for credit sales, purchase return books sales return book then bill receivablebook for recording transactions of promissory notes and so on. Bills payable book and thereis one journal proper.Now, all the similar transactions will go in sale, purchase, cash book etcetera, butthe transactions which do not get recorded in any of the subsidiary books will be recordedin the journal proper. If there are any rectification of mistakes to be done they will also be recordedin journal proper. So, this was a very short summary of important books like journal, ledgerand subsidiary books as I told we are not going into details of it, but those who aremore interested in the topic perhaps can go to some book of accounting and go for moredetails about the books of accounts. Now, we will continue this discussion andtry to prepare take a very simple case and prepare P and L and balance sheet from trialbalance.Now, first we will discuss about cash system and mercantile system, we have already discussedabout one of the concepts known as accrual concept.In cash system of accounting what happens is only those transactions which are relatedto cash are recorded. So, suppose you have a very small let us say a small-time shopkeeperwhenever sale happens the person records it as a cash sale, if there is a purchase theperson records it as a cash purchase. Suppose any sales are made on credit, it willbe recorded in a separate diary, but if the sales will be recorded only when the cashis received this is called as a cash system of accounting, earlier government system usedto be mostly on cash basis.Example is this, suppose the December salary is paid on 5th of January, then in the cashsystem it is recorded in January because the payment has made in January though it is aexpense of December it is not recorded in December, this is called a cash system.Now, in general cash system has lot of lacunae it is not a full proof system. So, we needa mercantile system where all entries are made irrespective of cash received or notas and when a particular transaction is due it needs to be recorded and afterwards itspayment or receipt is recorded.So, transaction occurs when a particular contract is entered when a understanding is reachedabout sale or purchase or about incurring expense it needs to be recorded, that is alsocalled as a accrual system. That is why I told you that in our concepts you have readabout the accrual concept, using the accrual concept the system of accounting which isfollowed is called as a mercantile system. Cash basis of accounting has lot of lacunaethat is why most of the businesses have converted their accounting system to mercantile system,except for very small businesses now the cash system is not much in use, are you gettingit.Now, let us go to a small case where perhaps you will understand how to make a small Pand L and balance sheet this is not for a company, so not in a particular format justto understand from the trial balance how to make P and L and balance sheet. First of allwhat do you understand by trial balance? We have just discussed what is a ledger; in ledgerthere are various accounts and at the end of the period the balances are calculatedfor each account. Now, those balances are listed in a list whichis called as a trial balance. Now, trial balance has many advantages because it gives you thelist of all the accounts it also helps us to ensure to find out if there are any mistakes,if there are any errors in the ledger the trial balance will not tally. So, that thetotal of debit should match with total of credit in a trial balance which gives a initiallywe feel that most of the things are correct of course, it’s not a full proof methodthere could be still some errors, but largely it helps us in finding out many of the errors.Now, a small trial balance is given, you can see here and using this trial balance youare required to make P and L account and balance sheet. This is not for in the company formatyou can use any format, but just try to make a P and L and balance sheet. So, first ofall read the items of the trial balance, mark whether a particular item is a P and L itemor a balance sheet item and then take them to P and L or balance sheet.I hope you have got the print out if you are not you can stop the video here take the printout and then go for the next step. So, we will discuss a few of them first is cash.Now, cash is what type of item? It is a asset right, so it should go under the assets. Tradedebtors again asset in the balance sheet, rent is a expense in P and L salary, expensein P and L please note this items. Trade creditors liabilities in balance sheet, insurance expensein P and L; in the same manner try to note all other items in the trial balance I thinkit is very simple, opening stock this goes in P and L account as a expense, is it done.So, please complete the exercise and then I will show you the solution So, P and L accountis now to be made in two parts, the first part is known as trading account.So, we have recorded sales, opening stock, purchases the balance is called as gross profitwhich is 65000. Since, there is no closing stock you do not find here closing stock,if there would have been closing stock it would have come here.Then there is a listing of all other expenses, so gross profit is 65000, you list out allthe expenses and you get net profit of 30300. As the name suggest as I told you it is notfor any company, so it’s not in a particular format, but it is just given for you to understandhow to make a simple P and L.Then we go to balance sheet; balance sheet you know has to two side’s assets and liabilities.On asset side we have recorded motor vehicle, machinery, debtors and cash, capital and tradecreditors. The net profit 30300 from P and L is to be carried in the balance sheet, wehave already discussed that profit represents the owners funds, this amount belongs to theowners that is why it is shown below the capital. I hope it is now clear to you how to preparea very starting point; a simple P and L and balance sheet, in coming sessions we are goingto make P and L and balance sheet for various types of companies taking the actual datafrom the balance sheets of companies. This was basically a starting point for you tounderstand how a simple P and L and balance sheet can be made from the trial balance.I hope it is clear to you, so we will stop here. Namaste. Thank you.