Accounting & Auditing-1: Basics

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Basics of Accounting: Core Concepts 1. Introduction to Accounting Definition: Art of recording, classifying, summarizing transactions & events of financial character & interpreting results. Purpose: Provide financial information to stakeholders for decision-making. Key Terms: Bookkeeping: Recording financial transactions systematically. Accounting: Broader concept; includes bookkeeping + analysis, interpretation, reporting. 2. Origin & Development Ancient: Record keeping in early civilizations (e.g., Mesopotamia, Egypt). 1494: Luca Pacioli (Father of Accounting) published "Summa de Arithmetica..." detailing double-entry system. Industrial Revolution: Increased need for systematic accounting. Modern: Evolution of GAAP, IFRS, computerization, specialized accounting branches. 3. Functions & Limitations Functions: Systematic Record Keeping Ascertaining Results (Profit/Loss) Ascertaining Financial Position (Balance Sheet) Facilitating Rational Decision-Making Compliance with Legal Requirements Limitations: Historical in Nature (ignores current values) Ignores Non-Monetary Aspects (e.g., management quality) Subjectivity (estimates, judgments) Prone to Manipulation (window dressing) Affected by Personal Bias 4. Classifications of Accounting Financial Accounting: External reporting (P&L, BS). Management Accounting: Internal decision-making. Cost Accounting: Ascertaining & controlling costs. Tax Accounting: Tax compliance. Social Responsibility Accounting: Reporting social impact. Accounting Fundamentals & Process 1. Accounting Equation Core: $Assets = Liabilities + Owner's Equity$ Expanded: $Assets = Liabilities + Capital + Revenue - Expenses - Drawings$ Concept: Basis of double-entry system; every transaction affects at least two accounts, keeping the equation balanced. 2. Accounting Methods Cash Basis: Records income when cash received, expenses when cash paid. Used by: Professionals (doctors, lawyers), small businesses. Accrual Basis: Records income when earned, expenses when incurred, regardless of cash flow. Used by: Most large businesses; required by GAAP/IFRS. 3. Accounting Terminology (Key Glossary) Asset: Economic resource owned by the business (e.g., Cash, Land, Debtors). Liability: Obligation owed to external parties (e.g., Creditors, Loans Payable). Capital (Equity): Owner's claim on assets. Revenue: Income from business activities (e.g., Sales, Interest Received). Expense: Cost incurred to generate revenue (e.g., Rent, Salaries). Drawings: Cash/goods withdrawn by owner for personal use. Debtor: Person who owes money to the business. Creditor: Person to whom business owes money. Goods: Items purchased for resale. Purchases: Cost of goods bought for resale. Sales: Revenue from selling goods/services. 4. Process of Accounting Cycle Journalizing: Recording transactions chronologically in a Journal (Book of Original Entry). Journal Entry Format: Date, Particulars (Debit A/c, Credit A/c), L.F., Debit Amt, Credit Amt, Narration. Golden Rules: Personal A/c: Debit the receiver, Credit the giver. Real A/c: Debit what comes in, Credit what goes out. Nominal A/c: Debit all expenses/losses, Credit all incomes/gains. Posting: Transferring journal entries to respective Ledger accounts. Ledger: Principal book of accounts; contains all accounts (Asset, Liability, Equity, Revenue, Expense). Balancing: Calculating the difference between total debits and credits of an account to find its balance. Trial Balance: List of all ledger account balances (Debit/Credit) at a specific date. Purpose: Check arithmetical accuracy; base for final accounts. Adjusting Entries: Made at period-end to ensure revenue/expense recognition principles are followed (e.g., Accrued/Prepaid Expenses, Unearned/Accrued Revenues, Depreciation). Final Accounts: Preparing Trading A/c, Profit & Loss A/c, Balance Sheet. Closing Entries: Transferring balances of nominal accounts to Trading/P&L A/c. Post-Closing Trial Balance: Contains only real & personal accounts. ⭐ Exam Smart Tip: Journal Entries Always identify the two accounts affected. Determine their type (Personal, Real, Nominal). Apply Golden Rules of Debit/Credit. Write a clear narration. Specialized Aspects & Statements 1. Books of Subsidiary Records (Special Purpose Books) Purpose: Record specific types of transactions frequently to reduce ledger work. Types: Cash Book: Records all cash & bank transactions. Purchases Book: Credit purchases of goods. Sales Book: Credit sales of goods. Purchases Return Book: Goods returned to suppliers. Sales Return Book: Goods returned by customers. Bills Receivable Book: Bills accepted by debtors. Bills Payable Book: Bills accepted by business (owed to creditors). Journal Proper: For transactions not recorded in other subsidiary books (e.g., opening entries, adjustment entries, rectification entries). 2. Vouching Definition: Examination of documentary evidence (vouchers) supporting accounting entries. Importance: Ensures authenticity, validity, and accuracy of transactions. Vouchers: Invoices, receipts, bank statements, salary slips, etc. 3. Rectification of Errors Errors: Errors of Omission: Transaction completely or partially omitted. Errors of Commission: Wrong amount, wrong account, wrong side. Errors of Principle: Violation of accounting principles (e.g., treating capital expenditure as revenue). Compensating Errors: Two or more errors cancel each other out. Rectification: Journal entries made to correct errors, ensuring Trial Balance agrees. 4. Bills of Exchange Definition: Unconditional order in writing by drawer to drawee to pay a certain sum of money to payee. Parties: Drawer (maker), Drawee (acceptor), Payee (receiver). Types: Trade Bills, Accommodation Bills. Key Concepts: Discounting, Endorsement, Renewal, Dishonour. 5. Bank Reconciliation Statement (BRS) Purpose: Reconcile differences between Bank Balance as per Cash Book and Bank Pass Book. Reasons for Difference: Cheques issued but not presented. Cheques deposited but not cleared. Bank charges/interest not recorded in Cash Book. Direct deposits/payments by bank. Errors in Cash Book or Pass Book. Method: Start with one balance, add/subtract items to arrive at the other balance. 6. Capital and Revenue Items Feature Capital Expenditure Revenue Expenditure Benefit Period Long-term (>$1$ year) Short-term ($\le 1$ year) Purpose Acquire/improve assets, increase earning capacity Maintain existing assets, day-to-day operations Impact on P&L Not charged directly (depreciated) Charged to P&L A/c Balance Sheet Appears as an asset Does not appear Example Purchase of machinery, building extension Salaries, rent, repairs 7. Depreciation Accounts Definition: Systematic allocation of the depreciable amount of an asset over its useful life. Causes: Wear & tear, obsolescence, efflux of time, depletion. Methods: Straight Line Method: $\frac{\text{Cost - Salvage Value}}{\text{Useful Life}}$ (Constant amount) Written Down Value (Diminishing Balance): Fixed percentage on reducing balance. Units of Production, Sum of Years Digits, etc. Impact: Reduces asset value, charged to P&L. 8. Accounts of Non-Profit Organisations (NPO) Purpose: Service, not profit. Key Statements: Receipts & Payments A/c: Summary of cash transactions (like Cash Book). Income & Expenditure A/c: Like P&L A/c, shows Surplus/Deficit (accrual basis). Balance Sheet: Shows financial position. Key Terms: Subscriptions, Donations, Legacies, Endowment Fund, Capital Fund. Accounting Framework: Principles & Standards 1. Accounting Concepts (Assumptions) Business Entity: Business is separate from owner. Money Measurement: Only monetary transactions recorded. Going Concern: Business will continue indefinitely. Accounting Period: Life of business divided into periods for reporting. Cost Concept: Assets recorded at acquisition cost. Dual Aspect: Every transaction has two-fold effect (Debit & Credit). Revenue Recognition: Revenue recognized when earned, not when cash received. Matching Concept: Expenses matched with revenues they generate. Accrual Concept: Revenue/expenses recognized when earned/incurred. 2. Accounting Conventions Consistency: Same accounting methods applied year after year. Conservatism (Prudence): Anticipate no profits, provide for all losses. Materiality: Only material items are disclosed. Full Disclosure: All significant information should be disclosed. 3. Accounting Policies Specific accounting principles & methods adopted by an entity in preparing & presenting financial statements. Choice where alternatives exist (e.g., depreciation method, inventory valuation). 4. Accounting Principles & GAAP GAAP (Generally Accepted Accounting Principles): Common set of accounting principles, standards, and procedures. Provides framework for financial reporting. Ensures comparability, consistency, and reliability. Source: Accounting Concepts, Conventions, Pronouncements by regulatory bodies. 5. Accounting Standards (AS) & Indian AS (Ind AS) Accounting Standards: Written policy documents issued by expert accounting bodies/govt. Cover specific accounting treatments (e.g., AS 10 for Fixed Assets). Ensure uniformity & better understanding. Indian Accounting Standards (Ind AS): Indian GAAP converged with IFRS. Not identical to IFRS but substantially harmonized. Mandatory for certain classes of companies. 6. International Accounting Standards (IAS) & IFRS IAS (International Accounting Standards): Older standards issued by IASC. IFRS (International Financial Reporting Standards): New standards issued by IASB. Aims for a single set of high-quality, understandable, enforceable, and globally accepted financial reporting standards. Used in many countries worldwide to enhance comparability. 7. Role of Computer in Accounting & Tally Benefits: Speed, Accuracy, Efficiency, Timely Information, Reduced Manual Effort, Enhanced Reporting. Functions: Data entry, Ledger posting, Trial Balance generation, Final Accounts, Payroll, Inventory Management. Tally: Popular accounting software in India. Used by SMEs for financial accounting, inventory, payroll, taxation (GST). Automates many accounting processes. ⭐ Exam Smart Tip: Answer Structure for 10-Mark Questions Introduction (1-2 lines): Define the term concisely. Body (6-8 points): Explain features, types, advantages/disadvantages, process, or components. Use bullet points or short, clear sentences. Provide relevant examples. If applicable, include a small table/diagram. Conclusion (1-2 lines): Summarize importance or impact. Example: "What is Depreciation? Explain its methods." Intro: Define depreciation. Body: Causes, objectives, Straight Line Method (formula, example), WDV Method (formula, example), impact on financials. Conclusion: Importance for true & fair view. ONE-DAY BEFORE EXAM QUICK REVISION PAGE Key Concepts & Mnemonics Accounting Equation: $A = L + OE$ (Always Balanced) Golden Rules: P ersonal: DR Receiver, CR Giver R eal: DR What Comes In, CR What Goes Out N ominal: DR Exp/Losses, CR Inc/Gains Accounting Process: J L T A F C (Journal, Ledger, Trial Balance, Adjustments, Final A/c, Closing) GAAP: Consistency, Going Concern, Accrual, Entity, Materiality, Prudence, Full Disclosure. Capital vs Revenue: Long-term/Asset vs Short-term/P&L. Depreciation: Allocation of cost, not valuation. SLM vs WDV. NPO Accounts: Receipts & Payments (cash), Income & Expenditure (accrual P&L). BRS: Reconcile Cash Book vs Pass Book differences. Errors: Omission, Commission, Principle, Compensating. Important Formulas (Quick Glance) Accounting Eq: $A = L + C + R - E - D$ Straight Line Dep: $\frac{\text{Cost - Salvage}}{\text{Useful Life}}$ P&L A/c: Revenue - Expenses = Profit/Loss Balance Sheet: Assets = Liabilities + Capital Last-Minute Checks Are all adjustments considered in final accounts? Is the Trial Balance balanced? Have all nominal accounts been closed? Are ratios and financial statements clearly presented?