ENGLISH LANGUAGE IN ACCOUNTING Unit One Accounting Profession INTRODUCTION OF ACCOUNTING. Accounting is a process of recorded, classifying, summarizing, and interpreting of those business activities that can be in expressed in monetary terms. A person who specializes in this field is known as an accountant. Accounting frequently offers the qualified person an opportunity to move ahead quickly in today s business world. Indeed, many of the heads of large corporations throughout the world have advanced to their position from the accounting department. Accounting is a basic and vital element in every modern business. It records the past growth or decline of the business. Careful analysis of these results and trends may suggest the ways in which the business may grow in future. Expansion or reorganization should not be planned without proper analysis of the accounting information; and new products and the campaign to advertise and sell them should not be launched without the help of accounting expertise. Accounting is one of the fastest growing professions in the modern business world. Every new store, school, restaurant, or filling station indeed, any new enterprise of any kind increases the demand for accountants. Consequently, the demand for competent accountants is generally much greater than the supply. Government officials often have a legal background; similarly, the men or women in management often have a background on accounting. They are usually familiar with the methodology of finance and the fundamentals of fiscal and business administration. DISTINCTION BETWEEN BOOKKEEPING AND ACCOUNTING Earlier accounting procedures were simple in comparison with modern methods. The simple bookkeeping procedures of a hundred years ago have placed in many cases by the data-processing computer. The control of the fiscal affairs of an organization must be as scientific as possible in order to be effective. In the past, a bookkeeper kept the books of accounts for an organization; the present-day accountants job developed from the bookkeepers job. Today, a sharp distinction is made between the relatively unchanged works performed by a bookkeeper and the more sophisticated duties of Page 1 of 122
the accountants. The bookkeeper simply enters data in financial records books; the accountant must understand entire system of records so that he or she can analyze and interpret business transaction. To explain the difference briefly, the accountant sets up a bookkeeping system and interprets the data in it, whereas the bookkeeper performs the routine work of recording figures in books. Because interpretation of the figures is such an important part of the accountant s function, accounting has often been described as an art. DIVISIONS OF ACCOUNTING The field of accounting is divided into three broad divisions: public, private, and governmental. A certified accountant or a CPA, as the term is usually abbreviated, must pass a series of examinations, after which he or she receives a certificate. In the United States, the certification examinations are prepared and administered by the American Institute of Certified Public Accountants. The various states or other major governmental jurisdictions set additional qualifications for residence, experience, and so on. The British equivalent for a CPA is called a charted accountant. CPA CPA CPAs can offer their services to the public on an individual consultant basis for which they receive a fee. In this respect or many others, they are similar to doctors or lawyers. Like them, CPAs may be self-employed or partners in a firm; or they may be employed by an accounting firm. Many accountants worked in government offices or for nonprofit organizations. These two areas are often joined under the term government and institutional accounting. The two are similar because of legal restrictions in the way in which they receive and spend funds. Therefore, a legal background is sometimes necessary for this type of accounting practice. All branches of governments employ accountants. In addition, government-owned corporation have accountants on their staffs. All of these accountants, like those in private industry, work on a salary basis. They tend to become specialists in limited fields like transportation or public utilities. 2 122
ENGLISH LANGUAGE IN ACCOUNTING Nonprofit organizations are, of course, in business for some purpose other than making money. They include cultural organizations like symphony orchestras or opera societies, charitable organizations, religious groups, or corporate-owned research organizations. Although they are limited in the manner in which they can raise and spend their funds, they usually benefit from special provisions in the tax laws. Private accountants, also called executive or administrative accountants, handle the financial records of a business. Like those who work for government or nonprofit organizations, they are salaried rather than paid a fee. Those who work for manufacturing concerns are sometimes called industrial accountants. Some large corporations employ hundreds of employees in their accounting offices. The chief accounting officer of a company is the controller, or comptroller, as he or she is sometimes called. Controllers are responsible for maintaining the records of the company s operations. On the basis of the data that have been recorded, they measure the company s performance; they interpret the results of the operations; and they plan and recommend future actions. This position is very close to the top of management. Indeed, a controller is often just a step away from being the executive officer of a corporation. Many people have chosen accounting as a professional because of its many advantages. Many jobs are available, primarily because the education and training for accounting careers have not kept pact with the demand for accounting services. Once on the job, private or governmental accountants have security, and they are usually given the chance to move upward in the company sometimes, as we have noted, to the top. Salaries for people with accounting training are usually good, even on the lower levels, and for those who rise to the top of the profession, they are correspondingly high. Certified public accountants now enjoy professional status similar to that of doctors or lawyers. Page 3 of 122
Unit Two The Conventions of Contemporary Accounting (1) 1 Accounting conventions are concepts and rules which have been accepted in performing bookkeeping and accounting. It came from a careful observation of accounting practice which revealed patterns of consistent behavior. The existence of conventions was not generally recognized by accountants until the 20 th century. They were developed to aid accountants in exercising judgment and estimation in order to limit likely differences in recording similar events by different accountants. The principal convention of contemporary accounting will be discussed. THE ENTITY CONVENTION Contemporary accounting divides the community into separate units called accounting entities. For each accounting entity a self-contained, double-entry accounting system is employed. Transactions between accounting entities are recorded in the accounts of both entities. Each accounting entity interprets transactions from its own viewpoint. For example, the same transaction may be recorded as a sale by one accounting entity and as a purchase by another. Similarly, one accounting entity may record a transaction as an investment, while the other accounting entity may record it as a capital contribution. In any particular case the identification of the accounting entity may be difficult. Consider, for example, the case of a large chain of retail stores. Is the accounting entity the whole business, a regional operation, a single store or a single department in that store? The answer can be found only by looking at the organization of the business. If a department has its own accounting system and records transactions with other departments, then it is an entity for accounting purpose. If it has no records, then it is not an accounting entity. The accounting entity is, therefore, identified as the smallest unit of activity with a self-contained accounting system. THE GOING CONCERN CONVENTION Contemporary accounting assumes the entity will remain in operation for the foreseeable future. This assumption is known as the going concern or the continuity convention. This assumption does not refer simply to its continued existence. It also assumes that it will continue in the same line of business as those in which it is cur- 4 122
ENGLISH LANGUAGE IN ACCOUNTING rently involved. The assumption of continuity is made in the absence of evidence to the contrary. In other words, when it is clear that an assumption of continued existence would result in misleading financial reports, then the assumption is not made. A major problem facing the accounting profession is in identifying the circumstances under which the continuity assumption should be abandoned. Sometimes company failures occur with the accounting reports continuing to be based upon the going concern convention. These accounting reports are subsequently as misleading. And premature abandonment of the continuity assumption by accountants may cause liquidation if it results in demands by creditors for repayment of accounts outstanding. Authoritative guidelines are needed in this area if continuity is to remain a basic assumption of contemporary accounting. THE MONETARY CONVENTION In contemporary accounting, an entity s transactions are recorded in the accounts in the monetary unit of the country in which it is operating. However, in general, financial statements are presented in the currency of the country where the reports are published. The use of money as the unit of account is accepted today without question, but that has not always been the case. For example, such commodities as cattle, salt, shells, and tobacco are said to be employed as a unit of account. The use of money as a unit of account does create some difficulties. In the first place, transactions must be expressed in money before they can be recorded in the accounts. In some cases transactions or events may not have an obvious money amount. Transactions and events of this type are either ignored or assigned a subjective or arbitrary money amount. The second difficulty associated with the monetary convention is that the value of money is not constant over time. Its purchasing power changes as a result of either inflation or deflation. Accountants conventionally choose to ignore the changes in the purchasing power of money in the accounts. And this will cause some deficiencies in accounting reports. Page 5 of 122
THE CONSISTENCY CONVENTION Contemporary accounting assumes that accountants consistently apply accounting procedures from one period to the next. As a corollary, if accounting procedures are changed, the fact of the change and its effect on reported results are supposed to be disclosed in the financial statements. The purpose of this convention is to allow meaningful inter-period comparisons of results of an entity. Without consistency in accounting procedures, management could manipulate a firm s reported results merely by changes in accounting procedures. Under these circumstances inter-period comparisons would have to be treated with skepticism. This convention differs from the others in an important respect. The others describe conventional practices actually used by accountants. The consistency convention, however, involves prescription. This convention is one that accountants ought to follow rather than that is necessary followed. The consistency convention does not mean that accounting methods cannot be changed. A change should be made if a new procedure would result in financial statements with improved truth and fairness. If a justifiable change is made, the fact and the effect of the changes should be disclosed. The convention only requires that capricious changes in procedure which can be justified by reference to a true and fair view should not be made. The convention does not require an inter-firm consistency in accounting procedures. Two similar firms in the same industry may record a similar transaction in different ways and still comply with the consistency convention. The convention applies only to the accounting practices of a particular entity from period to period. The lack of inter-firm consistency means that analyst needs to exercise a great deal of care in making inter-firm comparisons. Even, the convention does not mean that there must be an internal consistency in the use of accounting procedures. For example, the convention does not imply that a business depreciates all its assets on same basis or that all discounts allowed are treated as expense. Consistency would allow, for example, that plant and equipment be depreciated on a straight-line basis and that motor vehicles be depreciated on an accelerated basis. All that consistency implies is that the accounting procedures for a particular type of transactions are the same from period to the next. 6 122
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Unit Three The Conventions of Contemporary Accounting (2) 2 THE CONVENTION OF CONSERVATISM It is a characteristic of contemporary accounting that accountants act conservatism or prudently in the measurement of profit. In general, this means that accountants use reasonable pessimism in measuring revenues and expenses. Revenues are not recorded until they are reasonably certain, but expenses are recorded as soon as they are become probable. Similarly, when accountants have a choice of measurements of cost for assets and liabilities, they will, other things being equal, choose the lowest for assets and the highest for liabilities. The effect of this convention is that reported profits and net assets will be lower than under most alternative assumptions. There are several possible explanations for the convention of conservatism. One is that it is the traditional role of accountants to curb the optimism of management. Accountants are seen as a sobering influence, forcing management to assess proposals and expectations in a realistic way to minimize errors arising from over-optimism. A second explanation is that all conservatism is a natural reaction to uncertainly. As students will behave conservatively and publicly choose a modest expectation of an exam result even through they may think that they have a good chance for a high grade, accountants faced with uncertainty about futures events also behave conservatively. A third explanation is that statements users may prefer conservatism to any alternative policy. Given that profit measurement depends upon estimates, conservatism ensures that the actual profit must be at least as high as the reported profit. Conservatism allows confidence in published reports. Whatever profits and net assets may be, they will not be less than those disclosed in the published accounts. THE OBJECTIVITY CONVENTION Where an accountant has a choice of measurements the most objective will be preferred, other things equal. As far as possible, an accountant will avoid incorporating guesses or estimates in the accounting records and reports. In practical terms, objectivity means that an accountant requires evidence of the existence and the amount of a trans- 8 122
ENGLISH LANGUAGE IN ACCOUNTING action before recording in the books. For many transactions the evidence is documentary, for example, invoices, receipts, cash register type and credit notes. The documentary evidence is the stimulus for recording transactions. Accountants prefer objectivity for two reasons. First, it makes the accountant s job easier. Routine rule-following is easier than a careful examination of each transaction to determine a reasonable amount for recording purpose. Second, reliance upon documentary evidence and generally accepted accounting procedures provides accountants with some support if their professional competence is questioned. It is a more convincing defense to produce evidence to support accounting records or to argue that generally accepted procedures were used than to assert that the entries seemed reasonable at the time. THE MATERIALITY CONVENTION It is contemporary accounting practice to record and report separately only those transactions which are material. An item is judged to be material if it is important enough to influence the decisions of statement users. Some items are material because they are large. For example, a large bad-debt write-off would usually be regarded as a material event. Some items are material because they are small. For example, a very low inventory figure may be judged to be material if it reflects unfavorably on a firm s liquidity. Some items may be material if they differ significantly in amount from the same item in earlier periods. For example, a small bad-debt write-off may be judged material if it is twice as large as normal. Some items may be judged to be material solely because of their nature and regardless of their relative size. For example, the sales figure would probably be material no matter how large, how small or how variable it was. Materiality has two principal applications. One is in the processing and the other is in disclosure. In recording process, accountant must decide how much detail is necessary. Are separate ledger accounts needed for every asset or could some assets be grouped under a general heading, for example, plant and equipment? In general, ledger accounts would be maintained only if they contained material data. All not-material items would be aggregated in sundry accounts. In other Page 9 of 122
words, the decision of accounting system should be strongly influenced by considerations of materiality. The second aspect of materiality relates to disclosure. Accountants use the notion of materiality as a criterion to decide how much detail to include in financial reports. If a piece of information is not material, then it should not be disclosed separately. For example, nowadays nearly all published financial statements omit cents and most show dollar amounts rounded to the nearest thousand. Any greater detail is judged to be not material. THE ACCOUNTING PERIOD CONVENTION It is contemporary accounting practice to measure the result of an entity s operation over a relatively short period and to present a balance sheet at frequent intervals. The economic activity of a business is continuous. All transaction are recorded in the accounts and change the picture of the firm, as revealed in financial statements. The firm changes continuously as it carries out its operations. Changes cease only when the firm cease operations. In this world of continuity of operations and change, accountants are required by law to report on financial position and results at least annually. This requirement for annual reporting is a relatively modern development. Even as late as the 19 th century major businesses presented financial statements at irregular and lengthy intervals. Annual reporting probably arose from the demands of investors, owners, creditors and taxation authorities who were not prepared to wait until the end of a firm s life before the success of its operation was measured. The accounting period convention does, however, lead to difficulties. First, it should be realized that the shorter the reporting period the greater the need for estimates and judgment. Over a short period, few transactions will be completed and there will be more accruals and deferrals than for longer period. Incorporating accruals and deferrals into the accounts increase the subjectivity of financial statements. In addition, financial reports for short periods may provide misleading impressions of the long-run prospects for the firm. A balance sheet represents a snapshot of the entity s financial position at an instant of time. Immediately before and after the date of the balance sheet, the financial position is different. Bye the time the balance sheet is published the financial position of the firm may have changed dramatically. As a result, the balance sheet is out of date the day after the end of the accounting period, and by the time it is published; it is of histori- 10 122
ENGLISH LANGUAGE IN ACCOUNTING cal interest only. Page 11 of 122
Unit Four Accounting Equation and Double Entry The financial condition or position of a business enterprise is represented by the relationship of assets to liabilities and capital. Assets are properties that are owned and have monetary value; for instance, cash, inventory, buildings, equipments. Liabilities are amounts owned to outsiders, such as notes payable, accounts payable, bonds payable. Liabilities may also include certain deferred items, such as income taxes to be allocated. Capital is the interest of the owner in an enterprise. Also known as owner s equity. These three basic elements are connected by fundamental relationship called balance-sheet equation, sometimes called simply the accounting equation. This equation expresses the equality of the assets on one side with the claims of the creditors and owners on the other side: Assets = Liability + Capital. = + According to the accounting equation, a firm is assumed to possess its assets subject to the rights of the creditors and owners. The equilibrium which the bookkeeping record achieves through the accounting equation is an essential feature of double entry. The creation of assets within an enterprise is always accompanied by the incurring of identical financial obligations, either to the properties of the enterprise (owner s equity) or to outside creditors (liabilities). The derivation of profit is always accompanied by an identical increase in the net assets (i.e. assets minus liabilities) of the enterprise. It is now possible to see how double-entry bookkeeping produces this equilibrium of results by ensuring that the equation holds well at all times. Examplev1: Assume that a business owned assets $100 000, owed the creditors $80 000, and owed the owner $20 000. The accounting equation would be: Assets = Liabilities + Capital $100 000 $80 000 $20 000 12 122
ENGLISH LANGUAGE IN ACCOUNTING 1 10 8 2 = + 100 000 = 80 000 + 20 000 If over a certain period of time, the firm had a net income of $10 000, representing an increase of net assets; the change may be reflected as increased cash, increased inventory or other assets, or decreased liabilities. Suppose that $6 000 was used to reduce liabilities and the balance remained in assets. The equation would then be: Assets = Liabilities + Capital $104 000 $74 000 $30 000 6 000 = + 104 000 = 74 000 + 30 000 Example 2: The selected events of January of Water Dentists are as following: (1) Invest $4 000 to practice. (2) Bought supplies for cash $300. (3) Bought office furniture from Brown Furniture company on account $2 000. The accounting equation after each transaction will appear as follows: (1) Assets = Liabilities + Capital Cash Water Capital + $4 000 +$4 000 (2) Assets = Liabilities + Capital Cash Supplies Water Capital $4 000 $4 000 - $300 + $300 $3 700 $300 $4 000 (3) Assets = Liabilities + Capital Cash Supplies Furniture Accounts Payable Water Capital $3 700 $300 $4 000 +$2 000 +$2 000 $3 700 $300 $2000 $2000 $4000 2 1. 4 000 2. 3 00 3. 2 000 1. = + +4 000 +4 000 Page 13 of 122
2. = + 4 000 4 000-300 + 300 3 700 300 4 000 3. = + 3700 300 4 000 +2 000 +2 000 3 700 300 2 000 2 000 4 000 We shall call any business event which alters the amount of assets, liabilities, or capital a transaction. In example 1, the net changes in asset groups were discussed; in example 2, we show how the accountant makes a meaningful record of a series of transactions, reconciling them step by step with the accounting equation. 1 2 However, preparing a new equation A=L+C after each transaction would be cumbersome and costly; especially there are a great many transactions in an accounting period. Also, information for a specific item such as cash would be lost as successive transactions were recorded. This information could be obtained by going back and summarizing the transactions, but that would be very time-consuming. A=L+C A much more efficient way is to classify the transaction according to items on the balances sheet and income statement. The increases and decreases are then recorded according to type of item by means of a summary called account. An account may be defined as a record of the increases, decreases, and balances in an individual item of asset, liability, capital, revenue, or expense. The simplest form of the account is known as the T account because it resembles the letter T. The account has three parts: (1) the name of the account and the account number, (2) the debit side (left side), and (3) the credit side (right side). The increases are entered on one side, and the decreases on the other. The balance (the excess of the total of one side over the total of the other) is inserted near the last figure on the side with the larger amount. Account Title Left side or debit side Right side or credit side T T 1 2 3 14 122
ENGLISH LANGUAGE IN ACCOUNTING When an amount is entered on the left side of an account, it is a debit, and the account is said to be debited. When an amount is entered on the right side, it is a credit, and the account is said to be credited. The abbreviations for debit and credit are Dr. and Cr., respectively. Dr. Cr. Whether an increase in a given item is credited or debited depends on the category of the item. By convention, asset and expense increases are recorded as debits while liability, capital and income increases are recorded as credits. Assets and expense decreases are recorded as credits, while liability, capital, income decreases are recorded as debits. The following tables summarize the rule. Assets and Expenses Liabilities, Capital and Income Dr. Cr. Dr. Cr. + - - + (Increases) (Decreases) (Decreases) (Increases) Dr Cr. Dr. Cr. + - - + ( ) ( ) ( ) ( ) Example 3: T&T Co. LTD bought furniture from ABC Co. on account, $2 000. In this event, the company is receiving an asset (furniture) and therefore, debits Furniture to show the increases. They are not paying cash but creating a new liability, thereby increasing the liability account (Accounts Payable). Furniture Accounts Payable Dr. Cr. Dr. Cr. $2 000 $2 000 3 ABC Dr Cr. Dr. Cr. 2,000 2,000 An account has a debit balance when the sum of its debits exceeds the sum of its credits; it Page 15 of 122
has a credit balance when the sum of creditors is the greater. In double-entry accounting, which is in almost universal use, there are equal debit and credit entries for every transaction. Where there are only two accounts affected, the debit and credit amounts are equal. If more than two accounts are affected, the total of the debit entries must equal the total of the credit entries. 16 122
ENGLISH LANGUAGE IN ACCOUNTING Unit Five Ledgers As was mentioned earlier, an account is a record of the changes and balances in the value of an individual item of an organization. It is understandable that an enterprise may use a member of accounts. The complete set of accounts for a business entity is called a ledger. It is the reference book of the accounting system and is used to classify and summarize transactions and to prepare data for financial statements. It is also a valuable source of information for managerial purposes, giving, for example, amount of sales for the period or the cash balance at the end of the period. GENERAL LEDGER The general ledger is the book used to list all the accounts established by an organization. It is desirable to establish a systematic method of identifying and locating each account in the ledger. The chart of accounts, sometimes called the code of accounts, is a listing of the accounts by title and numerical designation. In some companies, the chart of accounts may run to hundreds of items. It serves both as an index to the ledger and a description of the accounting system and also a link between financial statements and the ledger. Generally, blocks of numbers are assigned to various groups of accounts. A simple chart structure is to have the first digit represent the major group in which the account is located. Thus, account which have numbers beginning with 1 are assets; 2, liabilities; 3, capital; 4, income; and 5, expenses. The second or the third digit designates the position of the account in the group. 1 2 3 4 5 In the two-digit system, assets are assigned the block of numbers 10-19, and the liabilities 20-29. In larger firms, a three digit (or higher) system may be used, with assets assigned 100-199, and liabilities 200-299. Example 1: Numerical designations for the account groups under two-digit and three-digit methods: Account Group Two-digit Three-digit 1. Assets 10-19 100-199 2. Liabilities 20-29 200-299 3. Capital 30-39 300-399 4. Income 40-49 400-499 5. Expenses 50-59 500-599 Page 17 of 122
2 3 2 3 1. 10-19 100-199 2. 20-29 200-299 3. 30-39 300-399 4. 40-49 400-499 5. 50-59 500-599 Thus, cash may be account 11 under the first system and 101 under the second system. The cash may be further broken down as 101, Cash-First National Bank; 102, Cash-Second National Bank; and so on. 11 101 101 102 In designing a numbering structure for the accounts, it is important to provide adequate flexibility to permit expansion without having to revise the basic system. There are various systems of coding, depending on the needs and desires of the company. SUBSIDARY LEDGER Further simplification of the general ledger is brought about by the use of subsidiary ledger. In particular, for those businesses which sell goods on credit and which find it necessary to maintain a separate account with each customer and eliminates the need to make multiple entries in the general ledger. The advantages of subsidiary ledgers are as following: (1) Reduces ledger detail. Most of information will be in the subsidiary ledger, and the general ledger will be reserved chiefly for summary or total figures. Therefore, it will be easier to prepare the financial statements. 1. (2) Permits better division of labor. Here, each special or subsidiary will be handed by a different person. Therefore, one person may work on the general ledger accounts while another person may work simultaneously on the subsidiary ledger. 2. (3) Permits a different sequence of accounts. In the general ledger, it is desirable to have the accounts in the same sequence as in the balance sheet and income statement. As a further said, it is desirable to use numbers to locate and refer to the accounts. However, in connection with accounts receivable, which involves names of customers or companies, it is preferable to have the accounts alphabetical sequence. 18 122
ENGLISH LANGUAGE IN ACCOUNTING 3. (4) Permits better internal control. Better control is maintained if a person other than the person responsible for the general ledger is responsible for the subsidiary ledger. For example, the subsidiary accounts receivable ledger trial balance should agree with the balance of the accounts receivable accounts in the general ledger. The general ledger account acts as a controlling account, and the subsidiary ledger must agree with the control. 4. The idea of control accounts introduced above is an important one in accounting. Any group of similar accounts may be removed from the general ledger and a controlling account substituted for it. Not only is another level of error-protection thereby provided, but the time needed to prepare the general ledger trial balance and the financial statements becomes further reduced. In order to be capable of supplying information concerning the businesses accounts receivable, a firm needs a separate account for each customer. These customer s accounts are grouped together in a subsidiary ledger known as the accounts receivable ledger. Each time the accounts receivable (control account) is increased or decreased, a customer s account in the accounts receivable ledger must also be increased or decreased by the same amount. The subsidiary ledger and control account technique may be applied similarly to transactions with creditors and other groups of related accounts, detailed information which in not required in the general ledger. It is particularly useful, for example, in accounting for inventories, fixed assets or expenses and it has general application to the accounts of manufacturing enterprises and organizations consisting of a head office and one or more branches. It enables the general ledger to be confined to the basic information necessary for a broad understanding of operating results and financial position of a business. Page 19 of 122
Unit Six Journals In a western accounting system, the information about each business transaction is initially recorded in an accounting recorded called a Journal. Afterward, the data is transferred or posted to the ledger, the book of subsequent or secondary entry. The various transactions are evidenced by sales tickets, purchase invoices, check stubs, and so on. Since the journal is the accounting recorded which transactions are first recorded, it is sometimes called the book of original entry. It is also called the day book because the journal is a chronological (day-by-day) record of all business transactions. The information about each transaction that should be recorded includes the date of transaction, the debit and credit figures in specific ledger accounts, and a brief explanation of the transaction. At convenient intervals, the debit and credit amounts recorded in the journals are transferred to the accounts in the ledger. The process of recording a transaction in a journal is called journalizing the transaction and the one of transferring information from the journal to the ledger is called posting and usually done monthly. The updated ledger accounts, in turn, serve as the basis for preparing the balance sheet and other financial statements. ADVANTAGES OF USING JOURNALS. Technically speaking, it is possible to record transactions indirectly in the ledgers, then why bother to maintain a journal? The answer is that the unit of organization for the journal is the transaction, whereas the unit of organization for ledger is the account. By having both a journal and a ledger, we achieve several advantages which would not be possible if transactions were recorded indirectly in ledger accounts. (1) The journal shows all information about a transaction in one place and also provides an explanation of the transaction. In a journal entry, the debits and credits for a given transaction are recorded together, but when the transaction is recorded in the ledger, the debits and credits are entered in different accounts. Since a ledger may contain hundreds of accounts, it would be very difficult to locate all the facts about a particular transaction by looking in the ledger. The journal is the record which shows the complete story of a transaction in one entry. 1. 20 122
ENGLISH LANGUAGE IN ACCOUNTING (2) The journal provides a chronological record of all the events in the life of a business. If we want to look up the facts about a transaction of some months or years back, all we need is in the date of the transaction in order to locate it in the journal. 2. (3) The use of a journal helps to prevent errors. If the transactions were recorded directly in the ledger, it would be very easy to make errors such as omitting the debit or the credit, or entering the debit twice or the credit twice. Such errors are not likely to be made in the journal, since the offsetting debits and credits appear together for each transaction. 3. TYPES OF JOURNALS. Many businesses maintain several types of journal. The nature of operation and the volume of transactions in the particular business determine the number and types of journals needed. Journals are designed to recorded information about different transactions, including sales, purchases, cash receipts and cash disbursements, and many others. Journal have two or more columns to record increases or decreases in the accounts affected by the transaction, and they often have space for the a date and an explanation of the transaction. They may be grouped into (1) general journals and (2) specialized journals. 1 2 The simplest type of journal is called a general journal. It has only two money columns, one for debits and the other for credits; it may be used for all the types of transaction. To illustrate journalizing, we present the standard form of general journal as below: General Journal Date Account Titles and Description P.R Debit Credit (1) (2) (3) (4) (5) 19 1 Cash 11 5 500 Sept. Accounts Receivable 13 5 500 Collected receivable from ABC CO. 3 Land 17 150 000 Cash 11 150 000 Purchased land for office site Page 21 of 122
(1) (2) (3) (4) (5) 19 1 11 5 500 9. 13 5 500 ABC. 3 17 150 000 11 150 000 We describe the entries in the general journal according to the numbering in the table above. (1) Date. The year, month, and day of the first entry are written in the date column. The year and month do not have to be repeated for the additional entries until a new month occurs or a new page is needed. 1. (2) Description. The account title to be debited is entered on the first line, next to the date column. The name of the account to be credited is entered on the line below and indented. A brief explanation of the transaction is usually made on the ling below the credit. Generally, a blank line is left between the explanation and the next entry. 2. (3) P.R. (Posting Reference). Nothing is entered in the column until the particular entry is posted; that is, until the amounts are transferred to the related ledger accounts. 3. (4) Debit. The debit amount for each account is entered in this column. Generally, there is only one item, but there could be two or more separate item. 4. (5) Credit. The amount of each account is entered in this column. Here again, there is generally only one account, but there could be two or more accounts involved with different amounts. 5. SPECIAL JOURNALS. In the modern world, a business of any size enters into so many transactions that the use of a single journal would impose intolerable restrictions on its ability to maintain adequate records. It is, therefore, usual to break down or subdivide the journal into a number of specialized journals, each being used to record transactions of certain kind. It is much simpler and more efficient to group together those transactions which are repetitive such as sales, purchases, cash receipts and cash payments and place each of them in a special journal. In par- 22 122
ENGLISH LANGUAGE IN ACCOUNTING ticular, it is likely that all the transactions involving credit sales will be recorded in a separate journal known as the sales journal; all transactions involving credit purchases of goods in a purchase journal; receipts of cash in a cash receipts journal; and cash payments in a cash payments journal. Special journal may also be maintained for other groups of transactions which occur frequently, such as returns or allowances in respect of goods bought or sold, bills of exchange receivable or payable journal, leaving the general journal to record only those transactions not included elsewhere. Example 1: Sales on account are made during the months as follows: On February 1 to A. Anderson for $200, on February 2 to B. Butler for $350, on February 12 to C. Chase for $125. These can be journalized in the sales journal. Sales Journal Date Account Debited P.R Amount 19 Feb. 1 2 12 A. Anderson B. Butler C. Chase $ 200 350 125 1 2 1 A. 200 2 2 B. 350 2 12 C. 125 19 1 A. $ 200 2. 2 B. 350 12 C. 125 Special journal have several advantages: (1) Reduce detail recording. Each sales transaction is recorded on a single line with all details included on that line: date, customer s name, and amount. 1. Page 23 of 122
(2) Reduce posting. There is only one posting made to Accounts Receivable and one posting to Sales, regardless of the number of transactions. 2. (3) Permit better division of labor. If there are several journals, it makes it possible for more than one bookkeeper to work on the books at the same time. 3. 24 122
ENGLISH LANGUAGE IN ACCOUNTING Unit Seven The Trial Balance Since equal dollar amounts of debits and credits are entered in the accounts for every transaction recorded, the sum of all the debits in the ledger must be equal to the sum of all the credits. If the computation of account balances has been accurate, it follows that the total of the accounts with debit balances must be equal to the total of the accounts with credit balances. PREPAIRING A TRIAL BALANCE. Before using the account balances to prepare financial statements, it is desirable to prove that the total of accounts with debit balances is in fact equal to the total of accounts with credit balances. This proof of equality of debit and credit balances is called a trial balance. A trial balance is a two-column schedule listing the name and balances of all the accounts in the order in which they appear in the ledger. The debit balances are listed in the left-hand column and the credit balances in the right-hand column. The totals of the columns should agree. The procedure is as follows: (1) List account titles in numerical order. (2) Record balances of each account, entering the debit balances in the left column and the credit balances in the right column. (3) Add the columns and record the totals. (4) Compare the totals. 1. 2. 3. 4. Asset and expenses accounts are debited for increases and would normally have debit balances. Liabilities, capital, and income accounts are credited for increases and would normally have credit balances. If the totals of debits and credits agree, the trial balance is in balance, indicating that debits and credits are equal for the hundreds or thousands of transactions entered in the ledger. Example 1: The summary of the transactions for ABC Co. LTD and their effect on the accounts is shown Page 25 of 122
below. The trial balance is then taken. (Omitted) ABC Co. LTD. Trial Balance September 30, 19 Dr. Cr. Cash $ 5 800 Furniture 2 000 Accounts Payable $ 2 000 Capital 4 000 Income 2 500 Rent Expense 500 Salaries Expense 200 $ 8500 $ 8 500 1: ABC ( ) ABC. 19 9 30 $ 5 800 2 000 $ 2 000 4 000 2 500 500 200 $ 8500 $ 8 500 USES AND LITMITATIONS OF THE TRIAL BALANCE. The trial balance provide proof that the ledger is in balance. The agreement of the debit and credit totals of the trial balance gives assurance that: (1) Equal debits and credits have been recorded for all transaction. (2) The debit and credit of each account has been correctly computed. (3) The additional of the account balances in the trial balance has been correctly performed. 1. 2. 3. Suppose that the debit and credit totals of the trial balance do not agree. This situation indi- 26 122
ENGLISH LANGUAGE IN ACCOUNTING cates that one or more errors have been made. Typical of such errors are: (1) The entering of a debit as a credit or vice versa; (2) Arithmetical mistakes in balancing account; (3) Clerical errors in copying account balances into the trial balance; (4) Listing a debit balance in the credit column of the trial balance, or vice versa; and (5) Errors in addition of the trial balance. 1. 2. 3. 4. 5. The preparation of a trial balance does not prove that transactions have been correctly analyzed and recorded in the proper accounts. If, for example, the purchase of a machine was incorrectly charged to expense, the trial balance would still balance, but theoretically the accounts would be wrong, as Expense would overstated and Machinery understated. Also, if a transaction were complete omitted from the ledger, the error would not be disclosed by the trial balance. In brief, the trial balance proves only one aspect of the ledger, and that is the equality of debits and credits. Despite the limitations, the trial balance is a useful device. It not only provides assurance that the ledger is in balance, but it also serves as a convenient stepping-stone for the preparation of financial statements showing the financial position of the business, intended for distribution to managers, owners, banker, and various outsiders. The trial balance, on the other hand, is merely a working paper, useful to the accountant but not intended for distribution to others. The balance sheet and other financial statements can be prepared more conveniently from the trial balance than directly from the ledger, especially if there are a great many ledger accounts. Page 27 of 122
Unit Eight Cash Basis and Accrual Basis of Accounting Because an income statement pertains to a definite period of time, it becomes necessary to determine just when an item of revenue or expenses is to be accounted for. Two systems can be used in dealing with this problem: cash basis and accrual basis. DISTINCTIONS BETWEEN CASH BASIS AND ACCRUAL BASIS. Under the cash basis, revenue is recorded when received in cash and expenses are recorded in the period in which cash payment is made. The cash basis of accounting does not give a good picture of profitability because it fails to match revenue and related expenses and therefore does not lead to a logical measurement of income. For example, it ignores uncollected revenue which has been earned and expenses which have been incurred but not paid. The use of it is limited mostly to individual income tax returns and to accounting records of physicians and other professional people. Most business firms use the accrual basis of accounting and it will be discussed in more details. The accrual basis differs significantly from cash basis of accounting. Under the accrual basis it needs to record revenue in the period in which it is earned and to record expenses in the period in which they are incurred. The effect of events on the business is recognized as service are rendered or consumed rather than when cash is received or paid. Essential to the accrual basis is the matching of expenses with the revenue that they helped produce. Most revenue is earned when goods or services are delivered. At this time, title to goods or services is transferred, and there is legal obligation created to pay for such goods and services. Some revenue is recognized on a time basis, such as rental income, and is earned when the specified period of time has passed. The accrual concept demands that expenses be kept in step with revenue, so that each month sees only that month s expense applied against the revenue for that month. Therefore, under the accrual system, the accounts are adjusted at the end of the accounting period to properly reflect the revenue earned and the cost and expenses applicable to period. The entries to be made on the balance day are called adjusting entries. 28 122
ENGLISH LANGUAGE IN ACCOUNTING ADJUSTMENTS UNDER ACCRUAL BASIS. Balance-day adjustments are of four main kinds: (1) Transactions which have been recorded in the books of account during the current period, but which relate wholly or partly to subsequent accounting periods; (2) Transactions which have occurred during the current period, but which for some reason have not been recorded in the books of account prior to balance day; (3) Allocations to the current period of its share of the original cost of fixed capital assets depreciation; (4) Provision for anticipated revenue, costs or losses arising out of the current period s operations, the exact amounts of which can not be determined at balance-day. 1. 2. 3. 4. The following examples will show how the adjusting entries are made for the four types of adjustments. Example 1: Prepaid Expenses Assume that a business paid a $1 200 premium on April 1 for one year s assurance in advance. This represents an increase in one asset (prepaid expense) and a decrease in another asset (cash). Thus, the entry would be: Dr. Prepaid Insurance $ 1 200 Cr. Cash $ 1200 1 4 1 1 200 1 200 1 200 At the end of April, 1/12 of the $1 200 or $100 had expired or been used up. Therefore, an adjustment has to be made, decreasing or crediting Prepaid Insurance and Increasing or debiting Insurance Expense. The entry would be: Dr. Insurance Expense $ 100 Cr. Prepaid Insurance $100 4 1 200 1/12 100 Page 29 of 122
100 100 Example 2: Accrued Salaries Assume that April 30 falls on the Tuesday for the last weekly payroll period. Then, two days of that week will apply to April, three days to May. The payroll for the week amounted to $2 500, of which $1 000 applied to April and $1 500 to May. The entries would be as follows: April 30 Dr. Salaries Expense $ 1 000 Cr. Salaries Payable $ 1 000 2 4 30 4 4 3 5 2 500 1 000 4 1 500 5 4 30 1 000 1 000 When the payment of the payroll is made, say, on May 3, the entry would be as follows: May 3. Dr. Salaries Expense $ 1 500 Salaries Payable $ 1 000 Cr. Cash $ 2500 5 3 5 3 1 000 1 500 2 500 As can be seen above, $1 000 was charged to expense in April and $1 500 in May. The debit to Salaries Payable of $1 000 in May is merely canceled the credit entry made in April, when the liability was set up for the April salaries expense. 1 000 4 1 500 5 5 1 000 4 4 Example 3: Accumulated Depreciation This is a valuation of offset account, which means that the balance is offset against the related asset account. In the case of property, plant and equipment, it is desirable to know the original cost as well as the value after depreciation. Assume the machinery costing $15 000 was purchased on February 1 of the current year and was expected to 10 years. With the straight-line method of accounting, the depreciation would be $1 500 a year, or $125 a month. The adjusting entry would be as follows: 30 122
ENGLISH LANGUAGE IN ACCOUNTING Dr. Depreciation Expense $ 125 Cr. Accumulated Depreciation $ 125 3 15 000 2 1 10 1 500 125 1 200 1 200 At the end of April, Accumulated Depreciation would have a balance of $375, representing three months accumulated depreciation. The account would be shown in the balance sheet as follows: Machinery $ 15000 Less: Accumulated Depreciation 375 $ 14 625 375 3 15 000 375 14 625 Example 4: Allowance for Uncollected Accounts A business with many accounts receivables will reasonably expect to have losses from uncollectible accounts. It will be not known which specific accounts will not be collect, but past experience furnishes an estimate of the total uncollectible amount. 4 Assume that a business estimates that 1 percent of sales on account will be uncollectible. Then, if such sales $10 000 for April, it is estimated that $100 will be uncollectible. The actual loss may not definitely be determined for a year or more, but the loss attributed to April sales would call for an adjusting entry. Dr. Uncollectible Accounts expense $ 100 Cr. Allowance for Uncollectible Accounts $ 100 1% 4 10 000 100 4 1 200 1 200 If the balance in Accounts Receivable at April 30 was $9 500 and the previous month s balance in Allowance for Uncollectible Accounts was $300, the balance sheet at April 30 would show Page 31 of 122