Accountancy (Class-XI) CHAPTER-2
Basic Accounting Terms
- Business: Business includes any activity carried on by a person with an intention of earning profits.
- Entity : An entity in accounting language refers to an economic unit engaged in performing economic activities like Maruti Suzuki, Dabur India, DLF, etc.
- Proprietor : Proprietor is a person who makes investment in the business, manages it and is responsible for all risks connected with the business. In accounting, proprietor is considered distinct from the business entity so capital invested by him is considered as internal liability of the business.
- Transaction : Transaction is an event or a happening or an occurrence which can be expressed in terms of money for exchange of goods and services. A transaction is an exchange of money or money’s worth between two parties. It is dealing between two or more persons. It involves transfer of goods and services for money and money’s worth between two or more persons or parties.
Eg. purchases and sales of goods for cash or on credit, cash payments, purchase and sale of assets, payment of salaries and wages etc.
Barter Transaction Monetary Transaction
Cash Transaction Credit Transaction
- Business Transaction : Business transactions may be classified into two types as under :
- Barter transaction: When goods are exchanged for goods it is called as Barter Transaction. In this type of transaction, money is not used as a medium of exchange. As value of the transaction cannot be ascertained in terms of money, this type of transaction cannot be recorded in the books of accounts.
- Monetary transaction: When goods are exchanged for money or money’s worth, it is called as Monetary Transaction or Pecuniary Transaction.
Monetary transactions are further grouped on the basis of mode of payment.
They are as follows:
(i) Cash transaction: It is a business transaction in which case cash is paid or received immediately on the spot. Eg. purchases and sales of goods for cash, payment for expenses, receipts of income etc.
(ii) Credit transaction: It is a business transaction in which case cash is not paid or received immediately on spot but payment or receipt of money is postponed to agreed future date. Eg. purchases or sales of goods on credit, unpaid expenses etc.
- Account: An account is a record of all business transactions pertaining to an individual, firm or item in chronological (date wise) order. Thus we open separate account for each individual firm, asset, liability, expense, income etc. in the ledger e.g. Capital A/c, X’s A/c, Purchases A/c, Sales A/c. Furniture A/c, Bank Loan A/c, Salary A/c etc.
- Capital : The dictionary meaning of the term ‘Capital’ is Wealth. Capital is the money or money’s worth invested in business by the proprietor.
The capital of a business is the claim of the owner to the business. In the accounting sense, Capital is the excess of assets over liabilities.
- Drawings: When businessman (proprietor of the business) withdraws or takes away from the business goods / assets / cash, which belongs to the business, for his personal use or household use or domestic use, it is termed as Drawings.
- Goods: Goods means items or commodities in which a business deals regularly either manufacturing and selling or purchasing and selling.
Goods are manufactured / purchased by a business not for the purpose of using them in the business for a longer period but for the purpose of resale at a higher price and make some profit. Eg. cloth is the goods for cloth merchant, tables, chairs etc. are goods for furniture dealer, medicines are goods for medical shop, books and stationery are goods for stationery shop etc. Goods are purchased for resale either in the same form or in a different form.
- Purchases: The term ‘Purchases’ is used for the purchase of goods. Goods are the products in which the firm is dealing or producing for reselling them. In trading concerns, goods are purchased for resale while in manufacturing concerns, raw materials are purchased and processed further into finished goods for resale purposes. For example, if a dealer of furniture purchases furniture for sale purposes, it is goods. However if same dealer purchases motor vehicle say a truck for delivery purposes, it is not purchase of goods rather it is purchase of an asset.
If goods are purchased for cash, it is called ‘Cash Purchases’ but if it is purchased on credit, it is called as ‘Credit Purchases’.
Purchases Return : Goods purchased from the supplier may be returned due to manufacturing defects or due to difference in the specifications so such returned goods are known as Purchases Return or Returns Outward.
- Sales : The term is used for sale of only those goods in which the firm is dealing i.e., goods bought or produced or processed for resale purposes. The term sales is never used for sale of asset, however, it includes revenue generated from services rendered to customer. Thus a shopkeeper selling electronic item is a sale but if he sells old furniture, it is not termed as sale. Similarly, an electricity company providing electricity to consumer in the area is a sale of services.
If goods is sold for cash, it is called cash sales whereas goods sold to customer on credit basis is called credit sales. Sales is shown on the credit side of the Trading Account.
Sales Return – If the goods sold to customer is returned by the buyer, it is called as Sales Return or Returns Inward. It is shown in the Trading A/c as deduction from sales.
- Assets: Assets includes properties of every kind held (owned) by a person (business). Eg. Land & building, Plant & machinery, Furniture, Motor vehicles, Office equipments, Live-stocks, Investments in bank fixed deposits, Shares etc.
Assets also includes amount receivable from any person in future. Eg. Debtors (for credit sale of goods), loan given, balance with bank (in bank A/c) etc.
- Fixed Assets: are the items purchased by the businessman not for the purpose of resale but for the purpose of using it somewhere in the business for a longer period. It is also termed as Non-current Asset.
- Current Assets: Current assets are those assets which are likely to be converted into cash within a period of one year. They include Cash, bank balance, debtors, bills receivables, stock, short term investments, prepaid expenses etc.
- Tangible Assets: Tangible assets are those assets which have physical existence so they can be seen and touched g. land, building, machinery, furniture, computer motor vehicle, stock, cash etc.
- Intangible Assets: Assets which do not have physical existence are termed as intangible assets so they cannot be touched and seen g. goodwill, patent, trade mark, copy right etc. In real practice, intangible assets are also valuable to the business. For instance, by using technical know-how (patents), Maruti Suzuki Ltd. is producing cars in India and its goodwill helps the company to sell the cars. Thus, intangible assets also help the company in earning money. However, the value of such intangible assets to business entity depends upon the benefit likely to be derived in future.
- Liquid Assets: Liquid assets are those assets which are available to business entity either in the form of Cash or which are likely to be converted into cash within a very short period. Examples of liquid assets are cash, cash at Bank, Bills Receivable, Debtors, Short-Term Investments/Marketable Securities, etc. In short, liquid assets are current assets except stock and prepaid expenses.
- Fictitious Assets: Fictitious assets are neither tangible assets nor intangible assets. These are never realized in cash though sometimes, future benefit can be taken from these assets. They include Debit balance of Profit and Loss A/c, Deferred Revenue Expenditure (Advertisement Campaign), share Discount, Preliminary Expenses / Incorporation Expenses, Loss on Issue of Debentures, etc. These are gradually written off from Profit and Loss A/c over a period of time.
- Wasting Assets: The term is used for natural resources which are valuable but they are consumed during the process of use g. coal mine, iron-ore mine, oil wells, quarries, etc.
- Liabilities : Liabilities represents total amount payable by the business to outsiders. Eg. Creditors (for credit purchase of goods), Loans taken, Unpaid (outstanding) expenses, Salary payable, Electricity bill payable, Taxes payable to government etc.
Liabilities may be classified into two parts, namely – internal and external.
(i) Internal Liability – The amount due by business entity to proprietor or owners is called internal liability. It is represented by owners’ capital and free reserves. As per business entity concept, business firm is a separate entity and it is distinct from its owners so amount due to them is called internal liability.
(ii) External Liability – The amount due to outsiders (except proprietor or owners) by the firm is called external liability. It includes creditors, bills payable, bank loan, expenses outstanding, etc.
On the basis of tenure (period or repayment), liabilities may be classified as long term and short term liabilities.
(i) Long Term Liabilities – Long term liabilities are those liabilities which are payable after a long period of time (normally after a year). It includes Debentures, Mortgage Loan, Long term Loan etc.
(ii) Short Term Liabilities or Current Liabilities – Short term liabilities or current liabilities are those liabilities which are payable within a year. It includes creditors, bills payable, bank overdraft, short-term loan, outstanding expenses, etc.
- Bills Receivable : A Bill of exchange is written by the seller of goods on the buyer of goods directing to pay the specified amount at a future date. A bill of exchange becomes bill receivable for the seller of goods or services (drawer) after getting the acceptance of the buyer of good (drawee). Bill Receivables are shown on the asset side of the Balance Sheet under the head, “Current Assets”.
- Bills Payables : The buyer of goods or services who accepts the bill of exchange drawn by seller of goods, become drawee of the bill. On the acceptance of the bill of exchange, it becomes bills payable for the buyer (drawee) of goods or services. Bills Payable are shown on the liabilities side of the Balance Sheet under the hand, “Current Liabilities”.
- Debtor: is a person who owes us something i.e. debtor is a person from whom money is receivable at some future date i.e. a debtor is a person who has to pay to other person namely the creditor. So buyer of goods on credit is a debtor.
- Creditor: is a person to whom we owe something i.e. creditor is a person to whom money is payable at some future date i.e. a creditor is a person who has to receive from other person namely the debtor. So, if we purchase goods on credit from a supplier than such supplier is a creditor.
- Bad debts : The amount which is receivable (due) from a debtor which is now irrecoverable from a debtor is called Bad debts. Bad debts are the debts which are irrecoverable.
- Solvent: A business / businessman is said to be solvent when its / his assets are greater than or equal to its / his liabilities.
- Insolvent: A business / businessman is said to be insolvent when its / his assets are less than its / his liabilities or liabilities are greater than its / his assets, and such liabilities cannot be paid through expected earnings in the immediate future.
- Cost : Cost is the amount of the expenditure incurred on or chargeable to a specified product or activity.
- Expenses : All payments made to carry out business smoothly are known as Expenses. Expenses is the amount spent by the businessman to earn Revenue or Income. Expenses are incurred / spent on manufacturing (producing) and selling of goods & services. Eg. salary, wages, electricity expenses, interest, rent, travelling expenses etc.
- Income: is gain which is received in return of the services rendered. eg. rent received, interest received etc.
- Gain: Gains are profit that arises from those transactions which are incidental to business. For example, profit earned on sale of investment or sale of fixed assets. The profits in the nature of gain are of irregular or of non-recurring nature.
- Profit : It is the excess of income for a particular period over expenses of such period.
Such profit can be either withdrawn by the proprietor for meeting his personal expenses or can be retained in the business in the form of reserves.
Such undrawn profits retained in the business as reserves increases Net Worth of the proprietor.
Net Profit = Incomes (and gains) – Expenses (and losses)
- Loss: It is the excess of expenses for a particular period over incomes of such period.
Net Loss = Expenses (and losses) – Incomes (and gains)
- Capital Expenditure
(i) These either bring into existence any new asset to the business ( which has saleable value) or it adds to the value of an existing asset ( by increasing profit earning capacity of the asset ).
(ii) These also includes all the expenses incurred either at the time of purchase of any Fixed Asset / Investment or at the time of construction of such Fixed Asset.
(iii) Any expense incurred on Fixed Asset (after such fixed asset is put to use ) can also be capitalized if such expense is not just to maintain such asset in the present working condition but to improve such condition either by increasing profit earning capacity of such asset or by reducing operating cost of the business, thereby, increasing overall profitability of the business.
- Revenue Expenditure:
(i) These includes all the day-to-day expenses of the business whose benefit is restricted only to the year in which such expense is incurred.
(ii) These also includes certain expenses like repairs, maintenance, insurance premium etc. incurred on fixed assets after such asset is put to use.
These expenses are generally to maintain such asset in the present working condition.
(iii) These also includes any expense incurred for employees or on employees of the business.
- Deferred Revenue Expenditure:
(i) These are generally non – recurring in nature.
(ii) These are primarily Revenue Expenses since they do not have saleable value.
(iii) Although they do not have saleable value, their benefit is expected to be enjoyed over no. of years. For example heavy advertising incurred towards the end of an accounting year.
- Trade Discount : It is the allowance allowed by a manufacturer or wholesaler to the retailer. The purpose is to enable the retailers to sell the goods at list price and earn profits. The amount of trade discount is deducted from the list price. It is shown in the invoice.
It is not recorded in the books of accounts.
- Cash Discount : It is the concession allowed by the seller to the buyer to encourage him to make the payment promptly. It is allowed when the buyer pays the amount within a stipulated period. Cash discount is charged on the amount arising after deduction of trade discount from the list price. It is recorded in the books of accounts.
The condition regarding cash discount is mentioned in the invoice. Cash discount is a loss to the seller and a gain to the buyer.
For example :
Mr. Vishal sold goods to Ms. Jigna ` 20,000 less 10% trade discount and 5% cash discount terms if payment is made within one week.
In this case the amount of trade discount will be:
List Price 20,000
Less : Trade discount 10% (2,000)
Invoice Value 18,000
Less : Cash discount 5% (900)
- Reserves: Reserves are undistributed profits belonging to the proprietor.
Reserves are created for two purposes:
- To meet unforeseen losses that might arise in future.
- For expansion of business in future.
- Net Worth: It is also called as proprietor’s fund. It is the amount of fund provided by the proprietors. It is also known as own fund. It is calculated by the following equation.
Net worth = Capital + Reserves
It is also known as owner’s equity or shareholder’s Equity
- Contingent Liabilities: These are the liabilities which are uncertain at present. These may become our liability in future, depending upon outcome of a specific event, which is uncertain at present.
If outcome of such specific event is favourable, it may not become our liability in future. However, if outcome of such specific event is unfavourable for us, it may become our liability in future.
Such liabilities are not recorded in the books of accounts since existence of such liabilities is uncertain at present.
Eg. Claim for damages pending in court etc.
- Voucher : A voucher is a written document prepared by the accountant providing the evidence of a business transaction. The evidence of a business transaction is called as source document viz., cash memo, purchase bill, sales bill, pay-in-slip, etc. Vouchers are also in the printed forms and they specify the accounts to be debited or credited. On the basis of vouchers, transactions are recorded for the first time in the books of original entry i.e. in journal or in the subsidiary books. As accounting entries are passed on the basis of vouchers so they are usually called as accounting vouchers and source documents of each transactions is attached with the vouchers. All the vouchers are numbered and signed by its maker.
- Books of Accounts: The term books of accounts refer to journal and ledger of a business entity in which all the financial transactions are recorded for an accounting period. In large scale business houses where volume of transactions is very large. Journal is further sub-divided into various subsidiary books or books of original entries. These are
- Cash Book Purchases Book
- Sales Book 4. Purchases Return book
- Sales Return Book 6. Bills Receivable Book
- Bills Payable Book 8. Journal Proper
- Accounting Year : It is the year for which accounts are kept by a proprietor. It may be financial year, calendar year, or any other year. For taxation purpose, everybody has to follow financial year as accounting year. It begins on 1st April and ends on 31st March. At the end of the accounting year every business has to prepare Profit and Loss Account and Balance Sheet.
- Trading Concern : It is an organization which is concerned with buying and selling of goods. Its objective is to buy and sell goods to earn profit. It is also called as a commercial organization.
- Not for Profit Concerns : It is an organization which is established not for making profit but for rendering services to the society as a whole or a particular segment of a society. The objective of such an organization is not to earn profit but to render services.
For example, schools, colleges, universities, clubs, trusts, hospitals and religious institutions etc.
- Goodwill : It is an intangible fixed asset having realizable value. It is the cost of reputation of a business organization. It is also known as cost of business connections. It is the present value of future expected earnings. It is the name established in the market.