Every subject has got its own terminology. Accounting, as a subject has got its own terms. These terms have their spe
Table of Contents
- 1 Business Transactions
- 2 Assets
- 3 Capital
- 4 Equity or Liability
- 5 Financial Statements/Final Accounts
- 6 Accounting Equation
- 7 Goods
- 8 Cost
- 9 Purchases
- 10 Sales
- 11 Purchases Return or Return Outward
- 12 Sales Return or Returns Inward
- 13 Stock
- 14 Expenses
- 15 Losses
- 16 Profit
- 17 Income
- 18 Debtors
- 19 Receivables
- 20 Payables
- 21 Proprietor
- 22 Drawings
- 23 Accounting Year
- 24 Entry
- 25 Vouchers
- 26 Insolvent
- 27 Solvent
- 28 Gain
- 29 Expenditure
The economic event that relates to a business entity is called business transaction.
Every business activity is not an accounting activity. That is why, every activity is not recorded in the books of accounting. We record only business transactions in Financial Accounting.
The first step in the accounting process is the identification of business transaction. Every activity of financial nature having documentary evidence, capable of being presented in numerical, monetary term causing effect on assets, liabilities, capital, revenue and expenses is termed business transactions.
Special features of business transactions are as under:
- Business transactions must be financial in nature.
- Business transactions must be supported by documentary evidence.
- Business transactions must be presented in numerical monetary terms.
- Business transactions must cause an effect on assets, liabilities, capital, revenue and expenses.
Business transactions as such refer to business activities involving transfer of money or goods or services between two parties or two accounts. Purchase and sale of goods, receipts of income, etc. are business transactions. Business transactions may both cash or credit.
The valuable things owned by the business are known as assets. These are the properties owned by the business. Assets are the economic resources of an enterprise which can be expressed in monetary terms.
In the words of Prof. R.N. Anthony, “Assets are valuable resources owned by a business which were acquired at a measurable money cost.” The most important assets are:
These assets are acquired for long term use in the business. They are not meant for sale. These assets increase the profit earning capacity of the business. Expenditure on these assets is not regular in nature. Land and building, plant and machinery, vehicles and furniture, etc. are some of the examples of fixed assets.
These assets, also known as circulating, fluctuating or floating assets. They change their values constantly.
Institute of Certified Public Accountants, USA, “Current assets include cash and other assets or resources, commonly identified as those which are reasonably expected to be realized in cash or sold or consumed during the normal operating circle of the business.“
It should be noted that certain assets, which are popularly known as fixed may prove to be current by virtue of their specific use such as:
- Land will be current assets in the hands of land developers and property dealers.
- Building with the builders and property dealers.
- Plant and Machinery with the manufacturers and dealers of plant and machinery.
- Furniture with the furniture dealers and furnishers.
- Shares and Debentures with the dealers in securities.
Fictitious assets are those assets, which do not have physical form. They do not have any real value. Actually, they are not the real assets but they are called assets on legal and technical ground. These assets are the revenue expenditure of capital nature which are also termed as deferred revenue expenditure.
The example of these assets are loss on issue of shares, advertising suspense and preliminary expenses, etc. Fictitious assets do not have real value, so they are written off in the future.
Traditional View: Assets having physical existence which can be seen and touched are known as tangible assets. These assets are land, building, plant, equipment, furniture, stock etc.
Alternative View: In a court testimony in USA, it was argued that tangible assets should not be allowed to mean assets having physical construction only because there are certain assets, such as cash, cash equivalent and receivables which do not have physical construction but even then treated as tangible assets. It finally emerged that all assets where revenue generation is certain should be treated as tangible assets.
The examples of these assets are building, plant, equipment, furniture, stock, receivable cash, cash equivalents such as treasury bills, commercial papers and money market funds.
On the other hand, in the case of assets like goodwill, patent or copyright the revenue generation is assumed to be uncertain. That is why they are put in the category of intangible assets.
Theses are the assets which are not normally purchased and sold in the open market such as goodwill and patents. It does not mean that these assets are never purchased and sold. They may be purchased and sold in special circumstances.
Payment for patents can be made to reputed manufacturers of the country and abroad. Payments for patents is mostly made in case of medicines. While purchasing the business of other firms payment for goodwill is made. Goodwill may also be raised in case of admission or retirement of partner. It is also preferable to write off goodwill and patents accounts and not to show in the balance sheet.
Assets, whose value goes on declining with the passage of time are known as wasting assets. Mines, patents and assets taken on lease are its examples.
Liquidity refers to convertibility in cash. Liquid assets, therefore are those assets, which can be converted into cash at short notice. The examples of liquid assets are cash in hand, cash at bank, debtors, bills receivable, etc. In other words, liquid assets are current assets less stock i.e.,
Liquid Assets = Current Assets – (Stock + prepaid expenses)
It is that part of wealth which is used for further production and thus capital consists of all current assets and fixed assets. Cash in hand, ash at bank, building, plant and furniture, etc. are the capital of business. Capital need not necessarily be in cash. It may be in kind also. Capital may be classified as follows.
The amount invested in acquiring fixed assets is called fixed capital. The money is blocked in fixed assets and not available to meet the current liabilities. The amount spent on purchase or extension or addition to the fixed assets is fixed capital. Plant and machinery, vehicle, furniture and building, etc. are some of the examples of fixed capital.
Assets purchased with the intention of sales, such as stock and investments are termed as floating capital.
The part of capital available with the firm for day-to-day working of the business is known as working capital. Sufficient funds are required for purchasing goods and incurring direct and indirect expenses. Operational expenses are met with working capital. Current assets and current liabilities constitute working capital.
Current assets consist of cash in hand, cash at bank, bills receivable, debtors, stock in hand, etc. and creditors, bills payable, short term loan, income received in advance and outstanding expenses are the current liabilities. Working capital can also be expressed as under :
Working Capital = Current Assets – Current Liabilities
Equity or Liability
Liabilities are the obligations or debts payable by the enterprise in future in the form of money or goods. It is the proprietors’ and creditors’ claim against the assets of the business. Creditor may be classified as creditors for goods and creditors for expenses.
The business should have sufficient current assets to meet its current liabilities and reasonable amount of fixed assets to meet its fixed liability. Liabilities can be classified as under:
Liability to owners
It is the owner’s claim against the assets of the business, generally known as capital. It is technically known as internal equity or shareholder’s funds.
It is creditors’ claim against the assets of the business. These creditors may be creditors for goods and creditors for expenses:
- Creditors for goods: Business has to purchase goods on credit, so the suppliers of goods to the business on credit are known as creditors for goods. They may be called as creditors and bills payable.
- Creditors for loan: These creditors are the parties, banks and other financial institutions. The liability is named as Bank loan, Bank overdraft, Loan from Industrial Finance Corporation, Industrial Development Bank of India and World Bank.
- Creditors for expenses: Certain expenses may concern the accounting period but may remain unpaid. These expenses may be outstanding salaries, rent due and wages unpaid. It is the current liability of the business.
Liabilities can also be classified and fixed, current and contingent liabilities.
- Fixed liability: These liabilities are paid after a long period. Capital, loans, debentures, mortgage, etc. are its examples. These are not current liabilities.
- Current liabilities: Liabilities payable within a year are termed as current liabilities. The value of these liabilities goes on changing. Creditors, bills payable and outstanding expenses, etc. are current liabilities.
- Contingent liabilities: These are not the real liabilities. Future events can only decide whether it is really a liability or not. Due to their uncertainty, these liabilities are termed as contingent (doubtful) liabilities. Important examples of contingent liabilities are as under:
- Value of bills discounted
- Cases pending in the court of law
- Guarantees undertaken.
The value of contingent liabilities is not shown in the amount column at the liabilities side of balance sheet. It is clearly mentioned as a note inside/outside the balance sheet.
Liabilities are also classified as long term liabilities and short term liabilities
- Long term liabilities: Liabilities payable after a period of one year such as term loans and debentures are long term liabilities.
- Short term liabilities: Obligations payable within a period of one year, such as creditors, bills payable and overdraft, etc., are short term liabilities.
Financial Statements/Final Accounts
Statements prepared by an enterprise at the end of accounting year to assess the status of income and assets is termed as Financial Statement/Final Accounts. It is categorised as Income Statement and Position Statement traditionally known as Profit and Loss Account and Balance Sheet.
Accounting rotate around three basic terms. These terms are Assets, Liabilities and Capital. The true inter-relationship between these terms is represented as Accounting Equations i.e..
Assets = Liabilities + Capital
Articles purchased for sale at profit or processing by the business or for use in the manufacture of certain other goods as raw material are known as goods. In other words, goods are the commodities, in which the business deals. Furniture will be goods for the firm dealing in furniture but it will be an asset for the firm dealing in stationery. Americans use the term ‘merchandise’ for goods.
Expenditure incurred in acquiring, manufacturing and processing goods to make it sale worthy are termed as cost of goods. It includes purchases of tradeable goods, raw materials and direct expenses incurred in acquiring and manufacturing goods.
In its routine business, the firm has to either purchase finished goods for sale or purchase of raw material for the manufacture of the article, being sold by the firm. The acquisition of these articles are purchases. The purchase of 10,000 metres of silk by Naro, a cloth merchant is termed as purchases in the business.
In the same way, the purchases of ten fans by Kevi, a dealer in electrical appliances for use in the cooler being assembled in his factory will also be the purchases. It is immaterial whether goods have been purchased for cash or on credit. They may be purchased within the country or imported from abroad.
Purchases of assets, are not the purchases in accounting terminology as these assets are not meant for sale. Proper, complete and systematic record of the purchases is essential as the cost price of goods is based upon it. Purchases must be made at competitive rates.
The ultimate end of the goods purchased or manufactured by the business is their sales. It includes both cash and credit sales. In accounting terminology, sales means the sale of goods, never the sale of assets, sales should have a regular feature. The sales of ten sofa sets by Amenla, a furniture is sales but sale of old furniture by Akho, a stationery dealer will not be a sale. Sales may be effected within the country or exported abroad.
The maintenance of proper and complete record of sales is necessary, because the profit or loss is associated with the amount of sales. It should be the sincere effort of every business to purchase goods at competitive rates and make sales at reasonably higher rates to earn more profit.
Purchases Return or Return Outward
It is that part of the purchases of goods, which is returned to the seller. This return may be due to unnecessary, excessive and defective supply of goods. It may also result, if the supplier violates the terms and conditions of the order and agreement.
IN order to calculate net purchases, purchases return is deducted from purchases. Purchases returns are also known as returns outward, because it is the return of goods outside the business.
Sales Return or Returns Inward
It is that part of sales of goods which is actually returned to us by purchasers. This return may also be due to excessive, unnecessary and defective supply of goods or violation of terms of agreement. Sales return, also known as returns inward is deducted from sales, in order to calculate net sales.
The goods available with the business for sale on a particular date is termed as stock. It varies i.e., increases or decreases and goes on changing. In accounting, we use the term stock widely as opening and closing stock. In case of business which is being carried on for the last so many years, the value of goods on the opening day of the accounting year is known as opening stock. In the same way, the value of goods on the closing day of the accounting year will be closing stock.
In case of manufacturing enterprises stock is classified as under:
- Stock of raw material. Raw material required for manufacturing of the product in which the business deals is known as stock of raw material. Cotton in case of cotton mill is its example.
- Work in progress. It is the stock of partly finished or partly manufactured goods just as price of thread and unfinished cloth in case of cotton mill.
- Stock of finished goods. Manufactured and finished goods ready for sale are known as stock of finished goods. Finished cloth is its example.
Expenses are cost incurred by the business in the process of earning revenues. Generating income is the foremost objective of every business. The firm has to use certain goods and services to produce articles, sold by it. Payment for these goods and services are called expenses.
Cost of raw material for the manufacture of goods or the cost of goods purchased for sale, expenses incurred in manufacturing or acquiring goods, such as wages, carriage, freight and amount spent for selling and distributing goods such as salaries, rent, advertising and insurance, etc. are known as expenses in accounting terminology.
According to Finney and Miller, “Expense is the cost of use of things or services for the purpose of generating revenue. Expenses are voluntarily incurred to generate income”.
Losses are unwanted burden which the business is forced to bear. Loss of goods due to theft or fire, or flood or storm or accidents are termed as losses in accounting. Losses are different from expenses in the sense that expenses are voluntarily incurred to generate income where losses are forced to bear.
Losses may be classified as normal and abnormal. Normal loss is due to the inherent weakness in the commodities i.e., coal, cement, oil, ghee, ice, petrol. There will be shortage in their weight due to leakage, meltage, evaporation, spoilage and wastage during the journey. Abnormal loss on the other hand, is an extra ordinary loss due to earthquake, fir, flood, storm, theft and accidents.
Losses adversely affect the profit of the business, so it should be the sincere effort of every firm to adopt preventive measures to minimize losses.
Excess of revenue over expense is termed as profit. In other words excess of sale proceeds over cost of goods sold is income. Here, sales means net sales i.e., sales less sales return. Cost of goods sold, also known as cost of sales is opening stock plus net purchases plus direct expenses less closing stock.
Income must be regular in nature. It must concern routine activities of the business. It is always the part of revenue receipt. It must relate to the business of the current year. It is shown at the credit side of profit and loss A/c. Profit is generated through business activities.
Increase in the net worth of the enterprise either from business activities or other activities is termed as income. Income is a wider term, which includes profit also. From accounting point of view, income is the positive change in the wealth of the enterprise over a period of time.
The term ‘debtors’ represents the persons or parties who have purchased goods on credit from us and have not paid for the goods sold to them. They still owe to the business.
Creditors In addition, to cash purchases the firm has to make credit purchases also. The sellers of goods on credit to the firm are known as its creditors for goods. Creditors are the liability of the business. They will continue to remain the creditors of the firm so far the full payment is not made to them.
Liability to creditors will reduce with the payment made to them. Creditors may also be known as creditors for expenses. In case, certain expenses such as salaries, rent, repairs, etc. remain unpaid during the accounting period, it will be termed as outstanding expenses. Parties rendering these services will be our creditors. Creditors are current liability so the firm should have sufficient current assets to make their timely payment.
Receivable means, what business has to receive from outside parties on revenue account. When we sell goods on credit, purchasers are known as debtors. Certain debtors accept bills drawn by us and become part of bills receivables. The total of Debtors and Bills Receivable is known as Receivables. These are current assets and realized within a year. Receivables are shown at the assets side of the Balance Sheet
Payable means, what the business has to pay to outside parties. When we purchase goods on credit, sellers are known as creditors. We accept bills drawn by certain creditors, which becomes a part of Bills Payable. The total of Creditors and Bills Payable is termed as Payables. It is shown at the liabilities side of the Balance Sheet.
An individual or group of persons who undertake the risk of the business are known as proprietor. They invest their funds into the business as capital. Proprietors are adventurous persons who make arrangement of land, labour, capital and organisation. They pay wages to labour, rent to land, interest to capital and salary to organisation. After meeting all the expenses of business. If there remains any surplus. It is known as profit. The proprietor is rewarded with profit for the risk undertaken by him if expenses exceed revenue the deficit is a loss to be borne by the proprietor. In case of profit, proprietor’s capital increases and in case of loss the capital decreases. Proprietor is an individual in case of sole trade, partners in case of partner ship firms and shareholders in case of company.
Amount or goods withdrawn by the proprietor for his private or personal use is termed as drawing. The cost of using business assets for private of domestic use is also drawing. Use of business car for domestic use or use of business premises for residential purpose is also drawing. Acquiring personal assets with business funds is also drawing. Certain examples of drawings are as under:
- Amount withdrawn by proprietor for personal use.
- Goods taken by the proprietor for domestic use.
- Purchasing pocket transistor for proprietor’s son.
- Using business vehicles for domestic use.
- Using business premises for residential purpose.
Books of accounts are closed annually. From the balances of different ledger accounts we prepare income statement and position statement. Income statement shows gross and net income of the business. Position statement, traditionally known as Balance Sheet is a mirror, which reflects the true value of assets and liabilities on a particular date.
There is no legal restriction about the accounting year of sole proprietorship and partnership firm. They may adopt the accounting year of their choice. It may be between January 1st to December 31st of the same year of July 1st of the year of June 30th of the next year or between two Diwalis or even financial year, i.e., April 1st to March 31st of the next year. The only restriction is that the accounting period must consist of 12 months. Companies must adopt financial year as their accounting year.
An entry is the systematic record of business transactions in the books of accounts. While passing entries, the principle ‘every debit has got its corresponding credit’ is adopted. Different accounts are debited and credited in the entry with the same amount.
Accounting transactions must be supported by documents. These documentary proofs in support of the transactions are termed as vouchers. It may be a receipt, cash memo, invoice, wages bill, salaries bill, deeds or any document as an evidence of transaction having taken place.
The contents of vouchers are date, amount paid, purpose of the payment, payment passed by competent authority, payment made and cancelled. Vouchers are the basis of accounting records. They facilitate accounting. Vouchers are also used for verification and auditing of business records. Vouchers may also be used for detecting embezzlement and frauds.
All business firms who have been suffering losses for the last many years and are not even capable of meeting their liabilities out of their assets are financially unsound. Only the court can declare the business firm as insolvent if it is satisfied that the continuation of the firm will be against the interest of the public or creditors. No firm can declare itself as insolvent. In case of solvency, the assets of the business are sold and liabilities paid with the funds realised from the sale of assets. If the fuds realised fall short of the liabilities creditors are paid proportionately.
Solvent are those persons and firms who are capable of meeting their liabilities out of their own resources. Solvent firms have sufficient funds and assets to meet proprietors’ and creditors’ claim. Solvency shows the financial soundness of the business.
Change in the net worth (equity) due to change in the form and place of goods and holding of assets for a long period, whether realised or unrealised is termed as gain. It may either be of capital nature or revenue nature or both.
Expenditure is the amount of resources consumed. It is long term in nature. It is the benefit to be derived in future. It is the amount spent for the purchase of assets. Expenditures can be made through cash, or exchanged for other assets or commodities or a promise to make the payment is made. Expenditures increase the profit earning capacity of the business and profit is expected from them in future. Expenditures are incurred to acquire assets of the business.