Basic Accounting Level II By Sivakumar Ganesan B. Sc, ACA, ICWA, PMP, PDIM

1. Basic Accounting Level II By Sivakumar Ganesan B. Sc, ACA, ICWA, PMP, PDIM Global Technology Services LLc, UAE Email:sivakumar3009@gmail.com

2. Agenda • What is Accounting • Mode of Learning Accounting • Accounting and Finance - Difference • Accounting Concepts / Conventions • Accounting Events • Rules of Accounting • Preparation of Financial Statements • A Simple Case Study

3. Vision Enterprises Financial Statement at December 31, 1997 JOURNAL Vision Enterprises Financial Statement at December 31, 1997 Assets Cash Account Receivable Land Total Assets Liability Account Payable Notes Payable Total Liability Stockholder’s Equity Contributed Capital Retained Earnings Total Stockholder’s Equity $4,456 $5,714 $ 981 --------- $11,151 ====== $3,830 $ 416 --------- $4,246 ====== $2,365 $ 367 --------- $2,732 ====== Vision Enterprises Financial Statement at December 31, 1997 Assets Cash Account Receivable Land Total Assets Liability Account Payable Notes Payable Total Liability Stockholder’s Equity Contributed Capital Retained Earnings Total Stockholder’s Equity $4,456 $5,714 $ 981 --------- $11,151 ====== $3,830 $ 416 --------- $4,246 ====== $2,365 $ 367 --------- $2,732 ====== Assets Cash Account Receivable Land Total Assets Liability Account Payable Notes Payable Total Liability Stockholder’s Equity Contributed Capital Retained Earnings Total Stockholder’s Equity $4,456 $5,714 $ 981 --------- $11,151 ====== $3,830 $ 416 --------- $4,246 ====== $2,365 $ 367 --------- $2,732 ====== PAYMENT ? What is Accounting Accounting is defined as the art of Recording, Classifying and Summarizing transactions in monetary terms (in Money terms) for the preparation of Financial Statements

4. What is Accounting • Accounting is the art of recording, classifying and Summarizing financial transactions in the Preparation of Financial Statements • Recording refers to creating Journal entry for every financial transaction with Debit and Credit amounts. • Classifying refers to Classifying each of the Debit / Credit Transaction to Capital or Revenue and Asset, Liability, Revenue or Expense • Summarizing refers to Grouping the Transactions of Asset, Liability, Revenue and Expenses and preparing the Financial Statements (Trading, Profit and Loss Account and Balance Sheet) • In case of • Trading, Manufacturing and Customer Service oriented Organization, the sum of all income and expenses is referred to as Profit and Loss account • Social Service oriented Organization like Schools, Hospitals and Government Organizations, Banks it is referred to as Income and Expenditure account . Note:- Trial Balance is not a Financial Statement. It is only a summary of all Debit and Credit Transactions.

5. Mode of Learning Accounting • Change your mindset that accounting means only Debit and Credit • Do not blindly learn Accounting Rules and apply the rules of Debit and Credit • The Best way to Learn Accounting is • Learn the Accounting Concepts • Understand the Accounting Conventions • Classify the Accounting Event • Apply the Accounting Rules • Record, Classify and Summarize the Journal • You are Confused. Am I right? • Do not become panic and move forward, you will understand

6. Mode of Learning Accounting Learn Accounting Concepts (Ten Fundamental Accounting Concepts) Understand Accounting Conventions (Three major conventions) Classify the Accounting Events (Capital, Revenue, Deferred Revenue Expenditure) Apply the Accounting Rules (Personal, Real and Nominal Rules) Record the Transaction as a Journal (Entering the Debit and Credit Side of Transaction) Classify the Transaction (Asset, Liability, Revenue or Expense) Summarize the Transaction (Prepare Trial Balance, Trading, P&L and Balance Sheet)

7. Finance and Accounting - Difference

8. Accounting Concepts/Conventions (US GAAP/UK GAAP/IFRS/SOX) • The Concepts and conventions of accounting are developed by IASC (International Accounting Standards Committee) which is in-charge of releasing International Accounting Standards (IAS) • The IASC Decides the preferred Accounting practices worldwide and encourages the worldwide acceptance • There are 41 International Accounting Standards • Now IFRS (International Financial Reporting Standards) and SOX (Sarbanes Oxley) Act gain more importance which came up from US GAAP and UK GAAP

9. Difference between Concepts and Conventions • The Accounting Concepts / Principles evolved out of the Practice and Procedures followed by different countries and later on established by the International Statutory Accounting Bodies like The Institute of Chartered Accountants of India, The Institute of Chartered Accountants of England and Wales etc to become an Accounting Principle statutorily need to be followed while preparing the Financial Statements. In nutshell this has evolved out of standard Practice followed by several countries while preparing the Trading, Profit and Loss Account and Balance Sheet. • The Accounting Conventions / Practices are basically assumptions and expected to be followed while preparing the Financial Statements.

10. Accounting Concepts / Principles • Business Entity Concept • Money Measurement Concept • Dual Aspect Concept • Cost Concept • Accounting Period • Conservatism • Realization Concept • Matching Concept • Materiality Concept • Objectivity

11. Accounting Conventions / Practices • Going Concern • Consistency • Accrual

12. Accounting Concepts • Business Entity Concept Accounts can be kept only for Entities, which are different from the persons who are associated with these entities Ex. Sole Proprietary, Partnership firm, Company This is one of the most Important and fundamental accounting principle with which Double entry system of accounting has evolved. Accounts need to be maintained separate from the Owners and providers of capital. If you understand the simple logic, then you know 30% of Accounting. Just Recall Fundamentals of Accounting from Oracle Perspective Level I Example of Siva, Oracle and Bank. See Next Slide for More Examples. If you cannot understand this Concept Please Do not Proceed Further and try to understand by reading again Level I and Level II Material

13. Types of Entities

14. Accounting Concepts • Business Entity Concept • Ex 1: You are running your own Textile Showroom as a Dealer in Cloth as a Sole Proprietor/Individual Owner of the Business. The entire capital amount for the Business is provided by you. In this case also for the purpose of accounting you need to maintain Two set of books. • One set of books for the purpose of Textile Business in which, Business owes you equivalent to the Capital Provided (Capital + Profit earned) or (Capital – Losses) • In your own Books the amount of Capital invested will be shown as an Investment in Business as an Asset. This need not be maintained as a Normal Set of Books but required to know the Cash Inflow and Cash Outflow from Income Tax Perspective. • Ex 2: You are working for Oracle Corporation and Oracle has a Bank Account with Bank of America and You have Bank Account with Citi Bank and the salary at end of every month is transferred from Bank of America to Citi Bank. How many accounting Entities involved in this case? • If your answer is 4, then you are right (You, Oracle Corp, Bank of America, Citi Bank) • Ex 3: You run your own Business in Software Consulting and your Friend has agreed to provide a Loan of 50000 USD which he goes and deposit directly into your Bank account - How many accounting Entities involved in this case? • If you say 3, You are right, it is only Three. (You, Your Friend and Bank)

15. Accounting Concepts • Money Measurement Concept Record should be made only of that information which can be expressed in Monetary Terms (i.e.) Currency value (USD,GBP,INR) Ex 1. Sole Proprietor had 40 Tables & Chairs. This cannot be recorded unless a Value of Furniture is known in monetary value Ex 2. Very Famous Indian Example – Rama Killed Ravana. Can this be Accounted? – NO Ex 3. My wife Loves me so much – Can this be accounted? – A Big NO (Hahhah). This is Flaw in Financial Accounting as it does not understand the human values Ex 4. My Father in Law gave his Personal Property to start my Business. Can this be Accounted – Yes (If the Value of the Property is provided)

16. Accounting Concepts • Money Measurement Concept A Normal Doubt comes to your mind in the first and fourth example in previous slide how to get the value. We should not be taking the Purchase value, but we should take the Market value on the date of transferring the assets to Business. This is an exception to cost concept only in case of transfer to another business Ex 5: Siva started his software consulting Business with his own Property (Cost Price 1 Million USD and Market Value 1.5 Million USD) and Furniture's Cost price 50000 worth Market Value 30000 USD - In this case, You can record Siva Capital (1530000) and Building 1500000 and Furniture 30000 as Assets

17. AccountingConcepts • Dual Aspect Concept The Value of the Assets owned by the concern is equal to the claims on the Assets ASSETS = LIABILITIES + OWNER’S EQUITY OWNER’S EQUITY = ASSETS – LIABILITIES LIABILITIES = ASSETS – OWNER’S EQUITY Ex: If Owners Equity is 600000 and Liabilities are 400000, then Total Asset = 1000000

18. Accounting Concepts • Cost Concept Assets are always shown at their Cost and not at their current Market Value Ex 1. A Land Purchased for Rs.5 Lacs will be recorded only at Rs.5 Lacs even though Market value may be lower say Rs.4 Lacs or Higher Rs.6 Lacs than the Cost Price Ex 2. You are acquiring a Business for a Million USD and its value as per Books is 0.8 Million, then the difference of 0.2 Million is termed as Goodwill and you should records the assets and liabilities at the price you have paid for the Business (i.e.) 1 Million

19. Accounting Concepts • Accounting Period Accounting measures activity for a specified interval of time, usually a year (e.g) Calendar Year (Jan’07-Dec’07) Fiscal Year (Apr’07-Mar’08) Choosing the Accounting period is the entities choice, but there are legal rules like Companies Act and Income Tax Act which prescribes the period in which the entity has to report to them. Remember still Entities can have different accounting period for their own Internal Management Reporting A Company in India can have for Company Law Purpose (Jan-Dec) Year and Income Tax Purpose (Apr-Mar) Year and for own internal Reporting (Jul-Jun) Year Note: The Entities cannot change their accounting period without getting proper approval only in case of Companies Act and not possible with Income Tax Authorities.

20. Accounting Concepts • Conservatism Anticipate no Profits but provide for all possible losses. Accountants are by nature Conservative and also to protect the interest of the Shareholders and Creditors it is required to provide for all losses. Ex 1. A pharmaceutical Company going to Loose the case filed for Patent Right filed for a medicine Ex 2.Company is likely to Win a Major Legal Dispute or a Sales Contract. Note: This rule should not be misinterpreted to provide anticipated reduction in market price of a Product and Providing Losses Ex 3: You are a Government Company and there is a possibility that Government will withdraw the subsidy for Fertilizers in the forthcoming budget, You cannot provide loss of subsidy as a loss now itself. Ex 4: The Government is likely to increase the Price of petrol which is one of the essential input for your business, then you cannot provide for losses. Ex 5:There is a Fire in your Factory and Goods were lost and the Goods are insured, then the claim you submitted can be booked to the satisfaction of Insurance Company and Auditors.

21. Accounting Concepts • Realization Concept The Sales is considered to have taken place only when either the cash is received or some third party becomes legally liable to pay the amount. Revenues are recognized when they are earned or realized.  Realization is assumed to occur when the seller receives cash or a claim to cash (receivable) in exchange for goods or services Ex 1: A Sales invoice for Rs.1 Million Credit Note for Rs.15000 received Ex 2: For instance, if a company is awarded a contract to build an office building the revenue from that project would not be recorded in one lump sum but rather it would be divided over time according to the work that is actually being done. 

22. Accounting Concepts • Matching Concept When an Event affects both the revenues and expenses, the effect on each should be recognized in the same accounting period Ex 1: Generally Employees Salaries are paid for the previous month at the beginning of the next month. But they have rendered their services to produce goods and sold and Sales revenue is recognized in previous month. So to match the cost with the revenue earned, we need to make provision for Salaries in previous month itself. (i.e.) March Salary paid in April, but a Salary Payable provision will be made in March itself EX 2: Insurance Premium paid for Jan- Dec whereas your accounting period closes on March. In this case only three months premium need to be treated as Expense and balance 9 months treated as advance premium paid as an asset

23. Accounting Concepts • Materiality concept Insignificant events would not be recorded, if the benefit of recording them does not signify the cost Ex: A calculator worth Rs.500 not recorded asset rather than charged off as an Expense even though the benefit is enduring in nature. This concept need to read in conjunction with accounting events which signifies the transaction into Capital, Revenue and deferred revenue expenditure.

24. Accounting Concepts • Objectivity Concept An Evidence of the happening of the Transaction should support every Transaction in the form of paper. External Evidence is considered to be more authenticated proof than Internal Evidence. This rule is more important from Audit perspective as Auditors always consider and bound to get more external evidences than internal Evidences. Ex 1: Third Party Evidence (Credit Note from Supplier) Ex 2: Auditors Collect Statements from Customer and Suppliers for the amount showing as Outstanding from Customers and amounts Payable to Suppliers. Ex 3: The Sales Invoices alone is not considered as an objective evidence unless it is not supported by Delivery challan and acknowledgement of Goods Received by Customer.

25. Accounting Conventions • Going Concern Accounting Records , Events and Transactions on the assumption that the entity will continue to operate for an indefinitely Long period of time Ex. An Entity will not be started with an intention to close within the specified time period. Business is always not started with an intention to close and it is expected to continue forever.

26. Accounting Conventions • Consistency The Accounting Policies and methods followed by the company should be the same every year Ex 1. Period should not be changed frequently from Jan-Dec to Apr-Mar Ex 2. Inventory Valuation change from FIFO to LIFO or Weighted Average not permitted frequently Ex 3. Changing Depreciation Policy from Straight Line to Reducing Balance Method frequently Note: If any Company decides to change the policy, then that Company has to report on the effect of Profit/Loss due to the change for past 5 Years.

27. Accounting Conventions • Accrual In General it is assumed that Accounts are always prepared based on Accrual basis. However there are entities which follow Cash Basis of Accounting Also Ex: Salary Payable to employees (March salary paid in April), Interest Receivable on Investments (NSC interest), Dividend Receivable on shares, Tax Payable to Government (March sales Tax and Annual Income Tax) The Company Law / Income Tax Act Prescribes all Companies to follow Accrual Basis of Accounting except for Professional Firms and Government Organizations which are allowed to follow Cash Basis of Accounting.

28. Classification of Accounting Event • Capital Item:Any expenditure that creates an asset, for example: • Purchase of plant or machinery • Improvements to assets that increase their usefulness or extend their effective useful life of the asset • Expenditure incurred in transporting an asset to its site and preparing it for use.

29. Classification of Accounting Event • Revenue Item: An Income or Expenditure and the benefit of which will be exhausted within a year (i.e.) The Calendar Year or the Financial Year whichever is set up for the Set of Books • Ex: Salary and wages, Printing and Stationery, Sales Revenue, Interest Income, Salary Payable, Bonus Payable, Tax Payable etc., • In Simple terms this is an event which generates revenue and the related cost to earn the revenue are accounted as expense.

30. Classification of Accounting Event • Deferred Revenue Expenditure: It is neither a Capital nor Revenue and the benefit of which will be realized for more than a year (Exceeding beyond the Calendar year for the set of books) and does not result in creation of an asset. • Ex 1: Advertisement Expenditure the benefit of which is likely to be obtained over a period more than one year (E.g.) PepsiCo Pays USD 2 Million to Sachin Tendulkar for an Advertisement Contract for two Years and benefit of which is expected to be for four years • Ex 2: Royalty paid to the author of the book for five years

31. Rules of Accounting Accounts Personal Impersonal Debit the Receiver Credit the Giver Ex: Sole Prop, Company Real Nominal Debit what comes in Credit what goes out Debit Expenses and Losses Credit Revenue and Income Ex: Cash, Bank, Building,Inv Ex: Sales, Power, Rent

32. Application of Accounting Rule • Check whether is there a Money Transaction Involved? • Does that transaction affect your set of books? • Check whether does the transaction fall under which accounting period. • Does the transaction involve a personal account (i.e.) Siva as a Person or a Company or any other entity as mentioned in Business entity concept • Is that person receiver or giver in the transaction and accordingly debit or credit the person account. • Does the transaction involve any Cash inflow or Cash outflow? (i.e.) Cash or Bank involved • If there is no cash involvement then the choices are as follows • Both can be real ( Debit and credit both real accounts) • One real and one nominal (Either Debit/Credit for Real or Credit/ Debit for Nominal accounts)

33. Accounting Rule of Thumb

34. Combination of Rules Dr Personal A/c Cr Real A/c Ex:Drawings or Advance to Employee, Payment to Supplier Dr Real A/c Cr Personal A/c Ex:Capital invested, Payment Received from Customer Dr Real A/c Cr Real A/c Ex: Cash withdrawal or Deposit Dr Real A/c Cr Real A/c Ex:Purchase of Inventory by Cash Dr Real A/c Cr Nominal A/c Ex: Interest Recd by Cash, Cash Sales Dr Nominal A/c Cr Real A/c Ex: Rent Paid by Cash Dr Personal A/c Cr Nominal A/c Ex: Interest Accrued on Investment, Dividend accrued on Investment Dr Nominal A/c Cr Personal A/c Ex: Hire Purchase Charges accrued, Interest Payable, Salary Payable

35. Combination of Accounting Rules Debit Credit

36. Combination of Accounting Rules • Both Debit and Creditcannot be Personal Accounts • EX 1: Siva paid Cash to Ajay. The Entry Cannot be • Ajay A/c Dr • Siva A/c Cr • The Correct entries are as follows. In Ajay set of Books In Siva set of Books Similarly Both Debit and Credit cannot be Nominal Accounts Note: Remember this important aspect and therefore You will not commit any mistake in Debit and Credit

37. Recording of Accounting Transactions • Recording of an Accounting event is known as Journal entry • Recording is made in Primary and Secondary Books in Manual Accounting system • Primary Books • General Ledger • Cash Book Secondary Books • Purchase Register • Sales Register • Fixed Assets Register • Returns (Purchase return/Sales Return) • Journal Register • In Oracle ERP System GL is called Main Ledger and the Transactions emanating from Modules are referred to as Sub Ledger

38. Recording of Accounting Transactions • First the transactions are entered as Journal • Then Second step is they are posted to individual account as ‘T’ Accounts – In Oracle or any other ERP system this happens immediately when a transaction is created • Prior to ERP system except for Non cash charges, Journals are directly posted in Primary and secondary ledger with supporting Document reference Number (like Invoice Number), date, amount and a cross reference ledger folio number (Page Number) of respective Debit and Credit Entries in Ledger. • Journals are entered only for year end Provision Entries. • Then the balance from each T account is taken and which becomes a Trial Balance with Sum of Debits and Sum of Credit which should be equal. • Trial Balance forms the basis for preparation of Financial Statements and in ERP systems including Oracle Applications Debit is shown as Positive and Credit is shown as Negative • In ERP systems the chance of Trial Balance not matching or not tallying issue is very minimal. In case of manual Accounting this will happen most of the time and unless it is corrected and balanced, the accountant should not proceed to prepare Financial Statements

39. Preparation of Financial Statements • Preparation of Trial Balance • Balances Extracted from General Ledger • Sum of debit and credit balances = 0 • Preparation of Trading, Profit & Loss Account or Income & Expenditure Account and Balance sheet • Trial Balance is the base for preparing Financial Statements • Adjustment entries are made in adjustment period and passed as Journal Vouchers before making the financial statements • Trading and Profit and Loss Account is Always for a period say for an Year (Jan - Dec or Apr - Mar), Quarterly for 3 months or Half yearly for 6 months • Balance Sheet is always as on Date (As on 31-12-2007 or 31-03-2008)

40. Accounting Concepts A Simple Case Study

41. Case Study • Siva started Business as dealer in Computer Spare parts and Computer Stationery on 01-APR-2007 and following events occurred in the month of April. • Siva invested USD 50000 Cash and USD 50000 worth of furniture • Siva purchased USD 75000 worth of goods on credit • Siva’s friend Ajay promised him to give a loan of USD 25000 • Siva sold USD 50000 worth of good for USD 100000 • Siva paid rent USD 2000 for two months • Siva paid Salary to Staff USD 5000 • Siva incurred USD 5000 on interior decoration which will last for two years. • Siva sold USD 10000 worth of goods on credit for USD 18000 • Siva has a Bank account with Citi Bank which credited USD 5000 wrongly of John account • Purchased Vehicle for USD 25000 paid through Bank • Cash Deposited by Siva into Bank 50000 USD

42. ARE YOU READY FOR THE GAME Accounting is very simple

43. Accounting Terminologies • Before creating Accounting Transactions let us recall and learn few accounting terminologies • ASSETS: Any property or Investment which can be convertible into cash • LIABILITIES: Amount Payable to providers of goods and Services (Creditors) and Providers of Capital (Owners) • REVENUE: Amount earned out of the Sale Proceeds and the amount earned on Investments • EXPENSES: Amount incurred or expended to earn the revenue • PROFIT: TOTAL REVENUE – TOTAL EXPENSES • LOSS: If the Total Expenses is more than Total Revenue it is termed as Loss • FIXED ASSETS: Amount Invested in Long Term Assets which is not intended to be sold within a Year (Ex. Machinery, Land) • CURRENT ASSETS: Amount invested in Short Term Assets which is intended and rotated to earn Revenue (Ex. Inventory) • NOTE: The Fixed Asset and Current asset vary from Person to Person • Ex: For a Dealer in Refrigerator it is a Current asset which becomes Fixed Asset for you when you buy. • CREDITORS: Person who provide Money or Goods on Credit to the Business (Supplier) • DEBTORS: Goods or Money Provided / sold on Credit by the Business (Customers)

44. Accounting Terminologies • You should also understand the same accounting terminology is referred or used by different people in different context • Receivables also known as Trade Debtors, Debtors, Account Receivables, Sundry Debtors, Trade Receivables, Amount Receivables • Liability is also known as Trade Creditors, Account Payable, Sundry Creditors, Amount Payable, Trade Liabilities, Creditors • Cost of Goods Sold: It varies with Company to Company the way they do set up and use it. The Cost of Goods Sold comprise of Material Cost, Resource Cost (Labor and Machinery) and Overheads. There are few companies which will have only Material Cost and will not add up Resource Cost and Overheads. You Should talk to client and understand their requirement • Let’s See Each of this in a Formula Model

45. Accounting Calculation and Formula

46. Accounting Calculations and Formula

47. Accounting Calculations and Formula

48. Accounting Entries for the Case Study

49. Accounting Entries for the Case Study

50. Accounting Entries for the Case Study