Basic Online Bookkeeping & Accounting Guide » a. Accounting Concepts

Basic rules of Double Entry Bookkeeping

slang — Sat, 05 Jun 2010 11:19:31 +0000

Double entry bookkeeping is the method used to transfer our weekly or monthly totals from our books of original entry into the nominal ledger.

Basic rule to remember is that:-
EVERY FINANCAL TRANSACTION gives RISE TO TWO ACCOUNTING ENTRIES, ONE A DEBIT AND THE OTHER A CREDIT.

Also note that:
(a) An increase in an expense ( example rent) or an increase in an asset ( office furniture) is a DEBIT
(b) An increase in revenue ( example sale of goods or services) or an increase in a liability( buying goods or service on credit) is a CREDIT
(c) A decrease in an asset( example making a cash payment) is a CREDIT
(d) A decrease in liability( example paying a creditor) is a DEBIT

EXAMPLES
(a) Purchase of office equipment
DEBIT: Office Equipment ( increase in asset)
CREDIT: Cash at bank ( decrease in asset re: cash at bank decreases)

(b) Purchase of stationery on credit
CREDIT: Accounts Payable ( increase in liability )
DEBIT: Purchases ( item of expense)

© Payment received from a credit customer
CREDIT: Accounts receivable ( decrease in asset)
DEBIT : Cash at bank ( increase in asset)

Bookkeeping /Accounting Questions With Answers On Accounting Concepts/Principles/Accounting Basics ( Part 1 of 3)

slang — Thu, 15 Oct 2009 10:38:26 +0000

As explained, it is also very important for those who keep books of account to understand accounting concepts. By understanding such accounting concepts, it will then reinforce the skills of the bookkeepers.

Append below are some True Or False Questions on Accounting Concepts:-

		True	False
1.	The business entity concept does not apply to a sole proprietorship concern
2.	If economic event cannot be measured in monetary terms, it is not considered part of the accounting data
3.	As the question of sale of the business, the realizable or saleable values of its assets will not be relevant
4.	It is the desire for objectivity that explains why historical cost rather than current market value forms the basis of valuation of assets
5.	Consistency in accounting methods is observed to prevent misleading profits arising from differing accounting methods from being reported.
6.	Prudence concept explains why closing stock is always valued at the lower of cost or market value so that profits are not overrated during the current period
7.	The matching principle is base on the accrual concept of accounting
8.	Accrual concept is when revenue is recognized when it is earned and expenses when they are incurred
9.	Cash accounting recognizes revenue only when cash is received and recognizes expenses only when cash is paid
10.	Source documents are examples of objective evidence of transactions that have taken place
11.	The money measurement function eliminates important information like motivational level, inefficient management or poor working conditions

Definition Of Asset, Liability, Equity, Income And Expenses

slang — Thu, 10 Sep 2009 09:12:28 +0000

CONCEPT OF AN ASSET

Resource controlled by the enterprise
Past event
Inflow of future economic benefits (probable)

CONCEPT OF A LIABILITY

Obligation of the enterprise
Past events
Outflow of future economic benefits (probable)

CONCEPT OF EQUITY

Residual interest
Assets – Liabilities = Equity

CONCEPT OF INCOME

Increase in economic benefits, inflows and enhancements of asset values, decreases in liabilities
Corresponding recognition of increases in assets and decreases in liabilities

CONCEPT OF EXPENSE

Decrease in economic benefits, outflows and decreasement of asset values and increases in liabilities
Corresponding recognition of decreases in assets and increases in liabilities

Substance Over Form Concept-What Is It & Illustrations

slang — Tue, 06 Nov 2007 07:12:33 +0000

Earlier articles have discussed almost all concepts/ principles, however there is yet another very important one which is Substance Over Form concept which basically is to ensure that the financial statements reflects the complete, relevant and accurate picture of the transactions and events.

Append below an article which explains the meaning of this concept and given few examples to illustrate this important concept.

SUBSTANCE OVER FORM IS WHEN:

An entity endeavor to ensure that the company’s financial statements reflect the financial reality of the entity (Substance) rather than the legal form of the transactions and events(Form) which underlie them.

It really that simple in the sense that if it is a cow but was disguised in a legal form to look like a dog, Substance Over Form would prevail to reinstate that it is a cow and not a dog!

Wow- sound simple.

But, to really substantiate or differentiate Substance Over Form, one need to be vigilant, have very good inner knowledge of the company’s operation and takes a more investigative in-depth approach so as to seek further evidence or proof. This is because normally these types of events or transactions are often quite complex. These events or transactions happen just around the accounting year ended. (balance sheet date)

We have seen many cases whereby many accounting fraud/ scams/ business fraud occur as a result of this lack of Substance Over Form. Typical cases are the Enron and Computer Associate which are described below:

EXAMPLE NO 1 OF SUBSTANCE OVER FORM

Exchanging revenue/revenue swap:

In the Computer Associate case, the CEO of the company swap or exchange revenue with another company. What it did was CSA purchased a certain software/service from the company A and in turn company A also purchased from CSA. Its look like a sale and it being recognized as revenues in the Income Statement

EXAMPLE NO 2 OF SUBSTANCE OVER FORM

In the Enron’s case we have:

Enron group’s use of over 3000 Special Purpose Entities (SPEs) structured in such a way as to enable the company to avoid including extensive debt in the consolidated financial statements of the group

EXAMPLE NO 3 OF SUBSTANCE OVER FORM

Company itself fund its own revenue

Let say in a Group of companies, Company A has recorded one transaction as a sale to a customer. Another transaction records a loan to the same customer for a similar amount. In this case, when the transactions are considered together, the sale may be without substance as it has actually been funded by the same group of company.

EXAMPLE NO 4 OF SUBSTANCE OVER FORM

Transaction should be lease instead of outright purchase

An outright purchase of capital equipment, whereas in fact the substance of the transactions is a lease of (or perhaps an option to purchase) the equipment.

Contra Account

slang — Sun, 04 Nov 2007 03:45:27 +0000

Along the way, when we keep the books of account, there is a certain bookkeeping term called Contra account. Do we know what is this? In simple term, contra account is actually an opposite account to another account.

The following are some of the examples of using a contra account:

EXAMPLE NO.1 OF CONTRA A/C

· When a customer of a company is also a supplier, he or she may be a debtor as well as a creditor of the company.Instead of physically making payment vide cheque/draft or cash, his accounts by mutual consent can be settled by setting off/contra the amount owing by him to the company and amount due by the company to him.

[ Note that:The contra or setting off needs to be reflected in the Total or Control Account to ensure the Control accounts for both debtors and creditors balances with the sum of all the individual debtors and creditors account. ]

EXAMPLE NO.2 OF CONTRA A/C

In the case of bank, say money of $10,000 came into the bank but immediately being paid out say for petty cash account hence this is a typical contra account.

EXAMPLE NO.3 OF CONTRA A/C

A company say has a gross sales(credit entry) of $100,000 but has opposite account which are sales return (debit entry)-$15,000 and sales allowances(debit entry)- $25,000 these are contra accounts to get the net sales figure of $100,000-15,000-25,000=$60,000.

EXAMPLE NO.4 OF CONTRA A/C

We have a gross cost of fixed assets(debit) of $100,000 but there is accumulated depreciation of $55,000 (credit) here again we have a contra account involved.

EXAMPLE NO.5 OF CONTRA A/C

Lastly, we have a gross account receivable(debit) of $200,000 but there is another opposite account of $30,000 of provision for doubtful debt(contra account). By netting the gross versus the contra account we then get a net account receivabe of $170,000

Accounting Treatment of CONTRA Account

ILLUSTRATION USING EXAMPLE 1

Contra account/entries between a debtor Mr. A owing to the Company and at the same time, the company is owing Mr. A

Question:

Assuming Mr A is our debtor and he owed the company for $4,000 being goods supplied by the company to him.

However, the company also purchase goods from Mr A where the company now owed him for $5,000

How do we effect the contra entries/account:

Solution:

We transfer $4,000 by debiting Mr. A’s account in the Purchase ledger and crediting Mr. A in the Sales Ledger.

The transfer will then appear on the debit side of the Purchase ledger Control Account and on the credit side of the Sales Ledger Control Account.

Accounting entries:

Debit: Mr. A ( Purchase Ledger a/c) $4,000

Credit: Mr. A ( Sales Ledger a/c ) $4,000

( The above is also being transferred to the respective control account)

Being offset of account

Accounting Assumptions, Principles/Concepts And Constraints

slang — Wed, 31 Oct 2007 12:36:03 +0000

As bookkeepers, we need to at least understand the following:

ACCOUNTING ASSUMPTIONS:

Economic Entity concept:- also known as Separate Business Entity Principle where a business is accounted SEPARATELY from other business entities, including its owner. The business records should be separated and distinct from personal records of business owner.
For example, Mr A is the owner of a limited company XYZ Co. Mr X owned many personal assets like bungalows, exotic cars,etc. Assuming the limited company XYZ Co is being liquidated by the creditors, the personal assets of Mr X will not be touched by the creditors. Due to this business entity principle/concept, only the company is being affected.

Monetary Unit concept:- transactions and events can only be expressed in monetary or money, units for example in USD or other currencies.
Due to this monetary unit concept, annual reports has it limitation of not able to express events like appointment of CEO or other top management in quantifable terms like in USD currency,etc. Other examples like the factory productivity,etc

Going Concern concept:-the business is assumed to continue operating instead of being closed/liquidated or sold or we can say that the business will continue its operation to the foreseeable future.
Using this concept, ironically at times that we can see some ailing or unhealthy companies which show visible signs of deteriorating financial health but auditors or accountants still hold on to this going concern viewpoint.

Time Period:-a business operation can be divided into specific period of time such as a month, a quarter or a year (accounting period).
This time period concept/principle enables the financial statements to be reported timely and systematically as both internal and external users will know when to expect the financial statements.
Also using this time period concept/principle, the accountant and other users can compare like-to-like over the same period of time say comparing Q2′ 2006 results with Q2’2007 results,etc.

ACCOUNTING PRINCIPLES/CONCEPT:

Historical cost principle/concept:basically business should report its activities or economic events at their actual cost.
For example, Company A has a piece of property bought twenty years ago which cost only $100,000. But the property’s present value is worth say $100 million but due to this historical cost principle/concept, the Company A can only record the historical actual cost of $100,000 into the company’s book.

Revenue Recognition principle/concept: recognize revenue when it is earned, not too early and not too late.
Hence, based on this revenue recognition concept, company record the revenue services/products is actually received by the customers and not when cash is only received.

Matching or Accrual principle/concept: expenses are matched against revenues and recorded in the same period which revenue are earned.
This matching principle/concept is so crucial as the company’s profit is recognized by matcing the income of the period with all the expenses incurred in earning such income.
Imagine that this matching or the accrual concept is not followed- profits of companies will be reported irresponsibly resulting in the public investors buying their shares due to wrong perception of the company’s profitability!

Full disclosure principle/concept: enough information must be reported to help users make knowledgeable decisions.
Under this full disclosure principle, the financial statements should provide sufficient/relevant information to influence users’ decision making
Let’s say a UK public listed conglomerate which own substantial properties in Argentina did not report truthfully and accurately the financial impact(s) of a major earthquake which destroyed a substantial part of the company’s assets. This can actually tantamount to fraudulent intention to cheat their shareholders!

CONSTRAINTS:

Conservatism or Prudent Concept: requires that income and assets be recorded at the lowest reasonable amount
This prudent or conservatism concept or principle assist to guide all financial expertise whether accountants/controllers/bookkeepers to choose option that minimize the possibilityof overstating an asset or income.

Materiality Concept: significant items must be accurately measured.
When we apply this materiality concept/principle, we must bear in mind the size of the company operation versus the items that we want to record in the books of account. Say the company is a billion dollar operation, stationery costing $500 or less obviously will not be significant.
However, also imagine a company which is supposed to report a small profit of $15,000 before tax but has omitted to take up certain expenses amounting to $35,000- this is deemed material as this will change the profit into a loss situation.

Cash Basis Accounting Versus The Accrual Method/Concept (Part 2of2)

slang — Sun, 14 Oct 2007 17:36:03 +0000

Earlier, the accrual concept has been illustrated in details. It is very vital that in order to keep proper books of accounts, we need to know how to differentiate between the cash basis accounting method and the accrual method.

Append below, in tabulated form, the characteristic of both methods and some salient points to understand the importance of the different methods.

CASH ACCOUNTING METHOD
1. All financial transactions events are based on cash basis. This applies to all incoming receipts or outgoing payments or outflows of an enterprise.
2. Based on this accounting method, revenue of the enterprise is not been properly taken up nor expenses in relation to earning the revenue are accounted for. In other words, we can say that Cash-basis accounting does not recognize promises to pay or expectations to receive money or service in the future, such as payables, receivables, and prepaid expenses
3. Normally, cash basis accounting applies to very small concern where the recording of transaction are simple and does not need to conform to any generally acceptable accounting principles. Also, cash basis accounting applies when the accounting process is very short for example, the supplier invoices needs to be paid very early or billings and collections involves a very short span of time.
ACCRUAL ACCOUNTING METHOD
1. Unlike the cash basis accounting method, accrual method is based on the matching and prudence concept. It also consider the proper way of recognizing revenue.
2. Without this accrual accounting method, the entity is not able to reflect the true obligations to its suppliers or the correct amount owing by its customers.
3. Normally, accrual accounting is practiced during the accounting close so as to take up all expenses and revenue not yet taken in the books of accounts. This normally form part of the accounting routine of the accounting month end adjustments.
SALIENT POINTS TO NOTE
1. Some sole proprietors practice cash basis accounting with the intention to reduce their profit so as to deceive the Inland Revenue. By doing cash basis, both revenue and profit before tax will be understated. If modified cash method for taking up the cash outflow namely taking up the bills from suppliers and instead of basing on cash payment basis so as to increase the expenses incurred, this will further understate the profit. Hence, taxes payable will then be lower.
2. On the contrary, Inland Revenue will require enterprise to prepare their financial statement based on an accrual accounting basis so that both revenues and expenses are properly stated and profit is more accurate.
3. Needless to say, as cash basis accounting does not conform to generally acceptable accounting practice (GAAP), this methodology is not acceptable amongst Certified Accountants Associations

Accruals Concept-Its Importance(Part 1 of 2)

slang — Sun, 14 Oct 2007 17:31:09 +0000

Earlier, the accounting period has been mentioned. Besides this concept, there is yet another equally important concept which is called the:

ACCRUALS CONCEPT

The effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.

ILLUSTRATION NO.1

Company A has received cash of $40,000 from his customers. However, the company actually has done all work satisfactorily and the customers have acknowledged the work done which the company can billed for another $20,000. Furthermore, the expenses for the $20,000 work-done has been taken up into the books of account.

Question: Should the company just close their accounting book by presently its income as $40,000 for the cash received or should it be $40,000+$20,000 =$60,000

Answer: Based on this concept, the company has actually completed all work done, also, the work done have being acknowledged by the customers, hence income of $60,000 should be taken up and not just the cash received.

ILLUSTRATION NO.2

Company A has billed customers for $100,000. Total supplier bills paid was $50,000 but there are some suppliers bills not paid amounting to another $15,000

Question: The company’s income is undisputed by $100,000 but what should its book show for expenses- is it only $50,000 being invoices paid or is it all inclusive of the other $15,000

Answer: As the total supplier bills should be $50,000+$15,000=$65,000, the company should based on this concept to accrue for the balance of the bills not being paid.

Accounting Cycle

slang — Sun, 14 Oct 2007 12:42:22 +0000

Accounting cycle is the basically the processes where the bookkeepers will strive to complete within each accounting period’s deadline/timeline. Hence, what’s in the accounting cycle must be fully grasped and executed.
Append below is what we usually called the usual steps involved in the Accounting Cycle. This Accounting cycle is always repeating itself. When we closed an accounting cycle, another cycle is repeating.

WHAT IS AN ACCOUNTING CYCLE?

Accounting Cycle is a series of accounting process which

begins with :

The identification of an economic activity or transaction,

Recording of the economic activity and

ends with:

The preparation of the financial statements.

THE STEPS INVOLVE IN AN ACCOUNTING CYCLE ARE:

Analyse source documents like invoices, receipts, payment vouchers, etc

Record transactions in Journals ( sales journal, purchase journals,etc)

Post to ledger accounts

Prepare Unadjusted Trial Balance

Journalize adjusting entries

Post adjusting entries

Prepare Adjusted Trial Balance

Journalize closing entries

Post closing entries

Prepare post-closing Trial Balance

Prepare financial statements like the Income Statement and the Balance Sheet

Accounting Period

slang — Sun, 14 Oct 2007 12:41:13 +0000

There are some major accounting convention/principles. However, one extremely crucial convention is the Accounting Period Concept. Bookkeepers need to adhere to this accounting period otherwise penalty or fine might be imposed by authorities ( particularly in public listed companies where the books of accounts need to be properly kept and closed consistently and then financial statements are prepared and submitted)

ACCOUNTING PERIOD CONCEPT

A fixed equal period of time ascertained to report the financial performance of an enterprise. If this fixed equal period of time is not ascertained, the business based on the going concern concept can last a quite a long period of time which will render the analysis of the financial statement impractical. Normally, these fixed equal period may be of any length of time but periods of one year in length are the most commonly used.

We can say that accounting period is a convenient way of dividing up the life of the business into smaller units of time to enable investors and other users of the financial statement to assess the financial performance.

The normal twelve months accounting period is also to coincide with the taxation period ( twelve months )

Illustration:

Company A has just been incorporated. It decides to put up its accounting period for twelve months ending every 31^st December.