Methods of Accounting
learning Objectives
After completing the chapter, you will be able to:
=> Describe divisions of accounting
=> Explain the types of accounts
=> Apply methods of accounting
Accounting is a dynamic profession which has evolved over a period of time. It helps business organisations to keep a track of their financial performance and make necessary decisions on time. For this, records of financial transactions are maintained. In accounting, mainly two types of accounts are maintained namely, real and impersonal. Areal account is maintained in a name of an individual and does not get closed by the end of a specific period. On the other hand, impersonal accounts are not maintained in the name of person.
In accounting, two methods are used for recording financial transactions, namely single entry and double entry. However, the most commonly used method is double entry as it provides a clearer picture of the financial health of a business organisation by showing detailed information of all the financial activities in an organisation.
In this chapter, we will discuss division of accounting. we will also describe the types of accounts. We will also discuss the methods of recording transactions.
Divisions of Accounting
Due to constant changes in the business scenario from the ancient times, different divisions of accounting have emerged. There are three most important divisions of accounting namely, financial accounting, cost accounting and management accounting. Let us understand the three divisions in detail.
Cost Accounting
Cost accounting is associated with ascertaining the costs incurred by an organisation to perform activities for accomplishment of a purpose. The aim of applying cost accounting is to provide comprehensive cost information to the management of an organisation and enable it to control existing operations and make future jplans. The inputs for cost accounting are provided by information from financial accounting.
Management accounting
According to Aglo-American Council on productivity, "Management accounting is the presentation of accounting information in such a way as to assist management in the creation of policy and the day to day operation of an undertaking." Thus, Management Accounting encompasses all the information required by chief executive of an organisation to control his/her business and make necessary financial decisions. for example, information about profits. costs and funds are used by the management of and organisation to make decisions related to growth, expansion, investment, capital, dividend etc.
Types of Accounting
The objective of the of the book keeping is to keep a complete records of each and every transaction, normally any kind of business transactions are classified in following categories:
Transactions which are related to persons.
Transaction which are related to properties and persons.
Transactions which are related to the expenses and income of the organisation
The accounts are mainly of two types as shown in the Figure:
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| Create by dhiraj kumar |
Personal Accounts
it records the transactions related to the person or a group of persons; the personal accounts are of following types:
a. Natural person: It records the transactions related to the natural persons, for, example Rahul's A/C etc.
b. Artificial or legal person: these relate to the accounts related to the artificial persons, which include the cooperative society accounts, education society accounts, etc.
c. Representative personal account: it represents the group of accounts representing the person or persons, like prepaid insurance, rent payable and so on.
Impersonal Accounts
Impersonal accounts can be classified into two types namely, real accounts and nominal accounts. These are explained as follow.
Real Accounts
Real accounts are the accounts which record the transactions related to the properties and assets, such as machinery, and building. For these assets, separated accounts are maintained which can be either of the following types:
a. Tangible Real Accounts: These represent the assets which can be touched and felt. Examples of tangible real accounts are machinery, furniture, etc.
b. Intangible Real Accounts: These represent the assets class which cannot be touched or felt. Examples of intangible real accounts include goodwill, trademark, patent, copyright, etc.
Nominal Accounts
The nominal accounts are the accounts, which record the transactions related to the expense and income. The nominal accounts record the transactions of all the income, revenue, gains, expenses and losses of an organisation.
Let us now discuss the different methods of recording transactions in the accounting system.
Recording Transactions
Accounting transactions have a significant impact on monetary conditions of a business organisation. Therefore, it is important for organisations to maintain a record of their transactions. There are two types of methods in accounting to record transactions as shown in the Figure.
Let us discuss these methods in subsequent sections.
In single entry method, only a cashbook and personal accounts of creditors and are maintained by an organisation. therefore, complete transactions are not recorded. As a result, trial balance cannot be prepared. The method 'Incomplete Book-Keeping System.
Single entry method of transaction recording is suitable for small business organisations due to the following advantages.
=> It is a simple to use and understand as no principles are required to recode transactions.
=> It does not require the hiring of any trained accounting personnel to maintain records. Small scale businessmen can maintain records on their own.
=> it is easy to calculate profits by comparing opening and closing capital under single entry method. However, single entry method has some disadvantages which are as follows:
=> The arithmetical accuracy cannot be tested under the method. Thus, there are greater chances of occurrence of frauds and errors.
=> As there is no maintenance of asset and liability accounts, it is difficult to control and avoid misappropriation of assets.
=> Due to incomplete information about business transactions, financial position of a company can not be determined.
Due to all these disadvantages, single entry is not suitable for large scale organisation. they apply the other methods of recording transaction,
Double Entry
A double entry system is a system every transaction is being recorded in two different ledger accounts. These two different leger accounts are Debit (Dr and Credit (Cr). According to William pickles "The double entry system seeks to record every transaction in money or money's worth in a double aspect the receipt of a benefit by one account and the surrender of a like benefit by another account".
Debit entries are ones that account for the following effects:
=> Increase in assets
=> Increase in expense
=> Decrease in Liability
=> Decrease in equity
=> Decrease in income
Credit entries are ones that account for the following effects:
=> Decrease in assets
=> Decrease in expense
=> Increase in Liability
=> Increase in equity
=> Increase in income
For example, in double entry, if a company makes some purchases against cash, two accounts shall get affected:
-> Purchase Account
-> Cash Account
since the company has made some purchases, hence purchase
account shall be debited and cash account shall be credited.
Double Entry Book Keeping process
The accounting process is a process which begins with the recording of transactions and ends up once the books are closed . This process is repeated in each reporting period; hence it is referred to as accounting cycle. The accounting cycle can be depicted as shown in the below:
It involves:
=> Identification of the transactions which are to be recorded in the books of accounts.
=> In order to prepare and crosscheck the sources document of the transaction means that if the sales are to be booked then the invoice should be the supporting for the same.
=> When the transaction is being analysed and classified and once the analysis is carried out one account is debited and other is credited. in detail, accounting process consists of following steps:
1. Passing the journal entries: Journal is an original book of accounting. It records the effect of all the transactions. Whenever a journal entry is being passed two accounts are affected, one account is debited and other is credited.
2.Preparation of ledgers: Once the Journal entries have been passed, the next step involves preparing the ledger. It is a collection of the accounts of similar nature. Ledger helps in performing the grouping of accounts. Once all the entries in a journal are posted into ledgers, balances can be ascertained with ease. For instance, by transferring all the debits and credits related to cash into cash account in the ledger, one can easily ascertain the inflow and outflow of cash.
3. Preparation of Unadjusted Trial Balance: This step involves preparation of trial balance to check if debits and credits are equal. trial balance is prepared based on the account balances of ledger. If total debit is not equal to credit, then there are errors in the report.
4. Adjustment of entries: In this step, adjusting entries are prepared to update the accounts at the end of an accounting period. These are the entries of expenses and revenues but not mentioned in any journal. Such entries mainly include accrual of income, prepayments. accrual of expenses, depreciation, deferrals and allowances.
5. Preparation of adjusted trial balance: Once all the entries are adjusted, the next step is to make an of debit and the sum value of credits is equal after adjusting entries.
6. Preparation of Financial Statements: This step involves the preparation of financial statements to show the financial condition of an organisation. The financial statements prepared include income statement, balance sheet, statement of changes in equity, statement of cash flow, and notes of financial statements.
7. Closure of Entries: In this step, all the nominal accounts are closed to prepare for the new accounting period. Such accounts include income account, expenses account and withdrawal account.
8. Passing of reverse journal entries: If required, the reverse journal entries are passed. The reverse journal entries are passed when there is a deferral or the accrued amount.
Rule of Debit and Credit
Personal Account: Debit the Receiver and Credit the Giver
Real Account: Debit What come in and Credit What Goes Out.
Nominal Account: Debit all Expenses & Losses and Credit all Incomes & Gain
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