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Business Organizations
1. Proprietary Business
It is a business owned and run by single person. It has no separate legal status apart from owner. Advantages Easy start-up and exit. It is flexible (can make decisions quickly). Fewer Government Regulations. No separate status apart from owner. Disadvantages Unlimited personal liability. Limited life of company depends on life of owner. Difficult to raise funds beyond a limit. Size and Efficiency constraints.
2. Partnership
The business is jointly owned by two or more persons. Profits and losses are shared among all. Business may be carried on by all persons or any one of them acting for all. Maximum partners are restricted to 20. Different types of Partnerships are: Partnership by Declaration Partnership by Will Partnership for a specific period.
2. Partnership contd.
Advantages Easy start-up (compared to Limited Companies). Relatively free from Government Regulations. It can attract financial capital easier than sole proprietorships. More efficient operations (specialized people). Disadvantages When a partner dies or leaves, it ends. It must be dissolved legally and reorganized with the remaining partners. Conflicts may arise between partners. Limited ability to raise funds. Responsible for the acts of all the other partners
4. Limited Companies
It is a legal entity. Company exists irrespective of life of shareholders. Liability of members is restricted to value of shares invested in business. Liability does not extend to private property. Companies are governed by Company Act, 1956. Different types of Limited Companies are: Private Limited Company Company Limited Shares Company Limited by Guarantees Unlimited Comapany
5. Corporation
A form of business organization that is recognized by the law as having all the legal rights of an individual. Example: Municipal Corporations, Port Trusts etc. They are entrusted by Central or State Government. They have the right to buy & sell property, enter into legal contracts, and to sue and be sued. Advantages Protection by State and unlimited life. Ability to raise funds easily by issuing bonds, selling stocks etc. Disadvantages Subject to Government Regulation, Bureaucracy. Double taxation the firms profits are taxed and also the profit that is distributed to shareholders is taxed.
Introduction to Accounting
What is Accounting?
Accounting is the language of business. Accounting is an Information System both for Insiders and Outsiders and covers information related to various activities in the entire organization/ company. Accounting provides reports to stakeholders about the economic activities and condition of a business. It refers to measurement of economic events and summarising and reporting them in the form of financial statements for use by the stakeholders i.e. bankers, creditors, shareholders, public and Govt. Reporting is the end product of Accounting.
Accounting Concepts
Accounting should be done in such a way that those who use financial statements should receive the same message as conveyed by those who prepare them. Accounting work should be carried on basis on some accounting concepts to reduce the problems and differences in accounting. Some of these concepts are: 1) Money Measurement Concept 2) Business Entity Concept 3) Going Green Concept 4) Cost Concept 5) Dual Aspect Concept 6) Accrual Concept 7) Conservative Concept 8) Materiality Concept 9) Consistency Concept
4. Cost Concept
All assets recorded should be recorded on basis of actual amounts involved. Initially assets are shown on the balance sheet at the cost of purchase instead of current value (Historical Costs). But now-days efforts are made to reconcile the concept with the rapid price fluctuations. Importance It is objective, verifiable and agreed by parties concerned. Limitations It does not show the market value of the assets which is more relevant to users. With an increase in price level, the profits may be overstated.
6. Accrual Concept
The accrual concept says that Net Income is the difference between revenues and expenses. Revenues are recognized when they earned and not when cash was received. Expenses are recognised when they incurred and not when cash was paid. Financial statements are prepared on the accrual basis of accounting. Example: Expenses incurred but not yet paid in current period should be treated as accrual/accrued expenses under current liabilities. Importance It is more accurate to show the expenses and income for the period. Actual profit is ascertained.
7. Conservative Concept
Revenues and profits are not anticipated. Only realized revenue and profits are recognized in the profit and loss account. Provision is made for all known expenses and losses whether the amount is known for certain or just an estimation. Example: Provision for doubtful debts should be deducted from debtors in balance sheet. Profit is accrued not on acquisition but on the actual sale of product and when outside party becomes legally liable to pay sale proceeds. Importance It reduces chances of users being misled by relying on the overoptimistic results. It minimizes the reported profits and the valuation of assets.
8. Materiality Concept
There are set of guidelines for accounting and disclosure of transactions. Financial statement should separately disclose significant items as they influence decisions of users. Each material item should be presented separately in the financial statements. Materiality depends on the size and nature of the item. Immaterial amounts may be aggregated with the amounts of a similar nature or function and need not be presented separately. Example: Small payments such as postage, stationery and cleaning expenses should not be disclosed separately. They should be grouped together as sundry expenses.
9. Consistency Concept
It states that when a firm has chosen a method for the accounting treatment of an item, all similar items should be treated in the same way. Changes can be made if they provide a better way of presenting the accounting data. The change and its effect on profits should be disclosed in the financial statements. Example: Change of Depreciation policy from one period to another (Straight line to Double Declining Method). Importance It is more reliable for comparison of the results of different periods.
Branches of Accounting
Accounting mainly has three branches: 1) Financial Accounting - preparation and communication of financial information mainly for those outside the organisation. 2) Management Accounting - preparation and communication of financial and other information for the internal use of management. 3) Cost Accounting - collation of data for inventory valuation.
Financial Statements
Financial Statements are used to provide information about the financial position, performance and cash flow of the enterprise. Financial position includes Economic Resources, Financial Structure and Liquidity and Solvency. Financial statements are used by many users such as: Present and Potential Investors Employees, Management Lenders Security Analysts and Advisers Suppliers and Creditors Customers and Public Governments and Regulatory agencies
Income Statement
Importance
It is also called as Profit and Loss Account. It shows the results of companys operations over a period of time. It provides summary of: Revenues goods sold or services performed by company Expenses costs incurred in normal operations to generate revenues Net Income profit/ loss made by the company It highlights the business performance during the period. Valuable guide in anticipating how a company performs in future.
Gross Profit = Net Sales Cost of Goods Sold 4) Operating Expenses includes general administrative expenses,
selling and distribution expenses and depreciation. Examples of operating expenses are: Sales agents salaries and commissions Advertising and promotion Travel and entertainment Executives salaries Office payroll and expenses
Operating Profit = Gross Profit Operating Expenses 6) Non-Operating surplus/ deficit represents gains/ losses arising
from sources other than normal operations of company. Examples of Non-operating surplus/ deficit includes: Investments in stocks and bonds Gain and losses on sale of equipment
PBT = PBIT - Interest 10) Profit after Tax is the difference between PBT and Tax for the
period.
Importance
Indicates how Net Income and Dividends affect Financial position of the company during the period. Identifies changes in Retained Earnings from one accounting period to the next.
Dividends results in: Decrease in Net Assets Decrease in Retained Earnings Decrease in Owners Equity
Balance Sheet
Importance
It is the Summary of the financial position of a company at a particular date. It indicates the following: What are the Resources of the company What are the companys existing obligations What are the companys Net Assets The Balance Sheet is Divided into two halves: Assets Liabilities and Shareholders equity The standard Balance Sheet Equation is:
Assets
The Assets section includes all the goods and property owned by the company, and uncollected amounts due (receivables) to the company from others. Assets are acquired at specific monetary value by the company to conduct its operations. They have potential to contribute (directly or indirectly) to the flow of cash or cash equivalents to the company. Physical form is not essential to the existence of the asset. Legal right of ownership not essential in establishing the existence of asset. Assets are listed in order of liquidity. Examples of Assets are Land, Vehicles, Buildings, Plant and Machinery etc.
Liabilities
The Liabilities section includes all debts and amounts owed (payables) to outside parties. These are the obligations of the company at present to be settled in future. Obligations may be due to a binding contract or statutory requirement. Present obligations and future commitments differ from each other. Liabilities are listed in order of maturity. Examples of Liabilities are Accounts payable, Bonds payable.
Shareholders Equity
The Shareholders Equity section represents the shareholders ownership interest in the company. It indicates what the companys assets would be worth after all claims upon those assets were paid. It consists of Contributed Capital (cash raised from issuance of shares) and Earned Capital (Retained Earnings). Shareholders Equity is the Book Value of the Company. It is equal to excess of Assets over Liabilities. Change in Net Assets results in Change in Equity.
Types of Assets
Assets can be either Current Assets or Non-Current Assets. Current Assets are the assets that are used or turned into cash in short term (usually within an year of the balance sheet). Examples of Current Assets are cash, accounts receivables, short term investments, supplies etc. Non-Current Assets comprise the remaining. Examples of Non-Current Assets are land, buildings, long term investments etc. Assets are basically classified into three types: 1) Fixed Assets 2) Investments 3) Current Assets, Loans and Advances
1. Fixed Assets
Fixed Assets are the assets that acquired for longer periods of time.
They are not intended for resale. The category includes: a) b) c) d) e) Land Building Machinery, Equipment Automobiles Furniture
Fixed assets are reported as Cost minus depreciation accumulated through the date of Balance Sheet. The cost of acquired fixed assets is allocated over the useful life of assets. Depreciation is accumulated over the period of time and is shown as Accumulated Depreciation.
2. Investments
Investments are the financial securities owned by the company.
This category includes: a) Investment in government securities b) Investment in shares, debentures and bonds c) Investment in immovable properties d) Investment in the capital of partnership firms
Types of Liabilities
Liabilities can be either Current Liabilities or Long Term Assets. Current Liabilities are the obligations that are due or payable within short term (usually within an year of the balance sheet). These may be paid in cash or satisfied by providing service. Examples of Current Liabilities are Accounts payable, Taxes payable etc. Long Term Liabilities are the obligations which are not paid or satisfied within one year. Examples of Long Term Liabilities Bonds payable, mortgage payable.
1. Current Liabilities
Current Liabilities are classified into five types:
a) Accounts Payable b) Notes Payable c) Accrued Expenses d) Income Taxes Payable e) Other Current Liabilities (Advance Payments, Unpaid Dividends) Creditors/ Accounts payable are the liabilities on account of goods/ services purchased on credit. These are amounts owed by the company to its regular business creditors for routine purchases. Notes payable is the money owed to a bank, individual, corporation or other lender under a promissory note. Borrower named in the note is responsible for repaying the loan principal plus any interest charges.
1. Share Capital
Share Capital is also referred to as Capital Stock which represents
shares in the ownership of the company. It is two common types: a) Equity Capital b) Preference Capital Equity Capital Equity Capital represents the contribution of equity shareholders who are owners of the firm. It carries no fixed rate of interest. It is also termed as Common Stock and has no limit on dividends payable each year.
The balance profits is retained in the Profit and loss account as Retained Earnings. These are reinvested or retained in the company. Retained earnings increase by the amount of profits earned, less dividends declared to shareholders.
Statement of Retained Earnings Beginning Retained Earnings (+) () = Net income Dividends paid Ending Retained Earnings
Balance Sheet
Additional Paid in 20,000 Capital Supplies Expense Accounts Receivable Retained Earnings 3,000 10,000 5,000
Additional Paid in 20,000 Capital Supplies Expense Accounts Receivable Retained Earnings 3,000 10,000 5,000
Additional Paid in 20,000 Capital Supplies Expense Accounts Receivable Retained Earnings 3,000 10,000 5,000
Additional Paid in 20,000 Capital Supplies Expense Accounts Receivable Retained Earnings 3,000 10,000 5,000
Additional Paid in 20,000 Capital Supplies Expense Accounts Receivable Retained Earnings 3,000 10,000 5,000
Additional Paid in 20,000 Capital Supplies Expense Accounts Receivable Retained Earnings 3,000 10,000 5,000