Basics of Financial Accounting - 1

Engineers and other technical persons are responsible for the profit, revenue or cost implications of their decisions.

They need to have the ability to study the accounting information provided to them for decision making as well as for control of the functions under their supervision or management.

A brief note on the accounting system followed in business concerns is provided here.

Accounting system consists of source documents(bills, Travelling allowance bills etc.) called as vouchers in accouting jargon, a register to enter transactions serially (called a journal) and a register in which accounts are kept for various items of accounting interest (items for which the firm wants details of accounts - share capital of the firm, amount invested in buildings etc.) This register is called a ledger.

Information can be retrieved from the ledger and put in various statements to provide information relevant for various decisions and actions in the organizations.
For example, money to be received from a customer can be ascertained by preparing a statement showing the items supplied to the customers and the value of it and the amount paid by the customer so far. This information is available in the ledger of the customer in a ledger specially called customer ledger or debtors ledger. To make the job of making entries feasible, the ledger is maintained in split books called general ledger and subsidiary ledgers. Customer ledger is a subsidiary ledger.

Every year, companies have to prepare profit and loss account, balance sheet and cash flow statement and send them to their shareholders. These statements termed as financial statements are prepared using the data maintained in the ledger.

The income tax return is also an accounting statement prepared using the ledger in case of a business concern.

Thus so far we introduced the following concepts

Accounting system
Source document
Voucher
Register
Journal
Ledger
Account
Customers ledger or debtors ledger
General ledger
Subsidiary ledger
Accounting statement
Profit and loss account
Balance sheet
Cash flow statement
Financial statements


Accounting source document

When you receive payment from a cashier, you sign on say your travel bill submitted by you confirming that you received the payment claimed in the bill from cashier. This becomes the a source document for the accounting system to record the money transaction. similarly when the supplier is paid an amount through cash or through cheque he sends a receipt. If a telephone bill is paid through cash, the telephone company acknowledges the payment by stamping the receipt of the amount on bill given by them to your company. Thus source documents get generated whever there is transactions involving money.

Journal

Journal is a book or a register in which all transactions are first recorded in a chronological order (in the order of time period). You can assume that at the end of each day, all the accounting documents are passed on to an accountant and he posts the details of the transactions in the journal. In a computerised system, the journal entry is created along with the accounting source document.

The process of recording transactions in the journal is called journalising.

The journal entry indicates which account is debited and which account is credited due to the mney transaction about which the entry is being made. Accounts are maintained in the ledger, and they indicate items or revenue or expenditure, asset or liability, debtors or creditors about which or whom the firm decides to keep separate accounts.

Accounts maintained in the ledger are broadly classfied into personal accounts, real accounts and nominal accounts.

In journalising, or making entries in the journal, accounting language of debit and credit is used.

Debiting an account and crediting an account have specific meanings and they have to be understood in the relation to the category of accounts (personal, real or nominal)


Meaning of debit & credit for real accounts:
Debiting an account means there is an increase under the asset head.
The firm has acquired more of an asset category.
Crediting an account means there is a decrease under the asset head.
The firm has disposed off some portion of the asset in that category.


Popular rule for journalising real accounts

Debit what comes in
Credit what goes out

Debit-Credit Meaning – Personal Accounts

Debiting a personal account means that person has received a benefit from the firm.
He has to pay the firm in future.
Crediting a personal account means that the person has given some benefit to the firm.
The firm has to pay him in the future.

Popular rule for personal accounts

Debit the receiver
Credit the giver



Debit-credit meaning for nominal accounts

Crediting a nominal account means that revenue is earned by the firm under that account head.
Debiting a nominal account means that an expenditure is incurred by the firm under that account head.
Normally revenue accounts receive credit.
Expenditure accounts receive debit


Popular rule for nominal accounts

Debit expenses and losses
Credit incomes and profits