Principles of Accounting - Essay Example

 Principles of Accounting Accounting Accounting is the art of recording, categorizing, summarizing and reporting the transactions taken place within an organization with the aim of ensuring the financial health of an organization. This organization can be of any type like charitable firm, club or a business unit that has its own income and expenses. Accounting can be also defined as the Conventions and principles as well as established general processes for recording the financial information that are related to the entity’s resource and that utilization in meeting the goal of the organization. In simple terms accounting can be also referred to as “the language of business” because of its role that helped in recording and processing the financial information that the firm requires for management purpose (Mukherjee & Hanif, 2003; Galanza, 1995). The main purpose of accounting is to provide financial information that is required by an economic unit to enhance the efficiency of its operations. The tern economic entity not only signifies a business unit but also the entities that are operating without the purpose of profit making like the public charities, clubs, churches and government bodies. The accounting information helps in decision making in the organization. For instance decision like availability of cash while going for purchasing of new equipments or whether the business is running in profit requires the knowledge of accounting information. This accounting information for a business unit is recorded by the accountant (Nobles, et al., 2012). Book keeping Method Book-keeping is referred to as the science and arts of recording business transactions and other financial transactions that are related to any institution, firm and associations of person or company. It is recorded in certain books at regular interval following certain definite rules. It is called as science because it represents certain systemized knowledge that are based on certain set of principles, which are followed throughout the process to ensure that the reason for recording the transaction can be explained carefully. On the other hand it is called arts since it involves the human ability and skill for recording the business transaction as per the principles (Kumar & Prasad, 1999). Scope The process of Book keeping involves two significant steps. Firstly the process involves recording of all the transaction in a book called journal. Secondly transferring all the transactions that were previously recorded into another book called as ledger. In order to know the net effect of all the transactions the various accounts that are recorded into the ledger are balanced. The main theme of book keeping is to prepare and maintain the records till the stage of preparation of Trial Balance (Rao, 2005). Importance Book-keeping serves as the foundation of the entire financial reporting and accounting process. The responsibility of book-keeper is to analyze and record all the financial transaction occurring in an organization. The sum total of all the transaction forms the basis of everything that includes grant proposals, cash forecast, budget, tax return and financial reports. The employees and other staff of an organization must understand the goal and mission of a non-profitable organization, in order to perform their jobs in an effective and professional way. This is particularly true for the accounting system. Each transaction that is being recorded while book-keeping is significant for the volunteers, donors, board members, management, community and employees of the organization. Accurate information delivered in timely manner provides the stakeholders of the organization with the comment regarding the financial health of the organization. In order to make the bookkeeping more effective the organization should provide information to the book keeper in an accurate and timely manner. By understanding the reasons of better book-keeping the performance of the organization can be improved (Dropkin & Halpin, 2012). (Source: Stice, Stice & Swain, 2007) Difference Bookkeeping Accounting The main duty of the accountant is to identify and record all the financial transactions systematically in the books and subsidiary books. The main concern of book-keeping is recording financial data. Unskilled people can also prepare them. Done at a preliminary stage It is a continuous process and helps in developing the balance sheet, income statement and trial balance. The main aim of accounting is interpretation, analysis and use of information Skilled personnel are used to prepared it Begins when book-keeping ends General Ledger General ledger contains the data related to the impersonal accounts like those other than the customers and the suppliers. There are two types of impersonal accounts, nominal accounts and real accounts. Nominal accounts refers to the recording on loss or gains like for examples discount receive account, purchase accounts, rent account, wage accounts. On the other hand real account refers to the property accounts. In a business general ledger is subdivided into two sections namely nominal ledger and private ledger. Nominal ledger includes the information related to the nominal account of the business whereas private ledger contains property accounts as well as the accounts that are confidential by nature like the profit and loss account, salary account of the proprietor and capital account (Kotas & Conlan, 1997). Importance The information that are hold by the general ledger are used to create the balance sheet and income statement that are used to serve several purpose in conducting the financial operations of a business. It also helps while reviewing the financial statement. Situation may arise like the accountants find fluctuation in the normal scope of operation or may discover some out-of-balance conditions in the balance sheet and external source account balance. In such cases the accountant may like to review the general ledger for more detailed information and identify the activities that are recorded in an incorrect manner. The general ledger is also used by the auditors in order to get a more detailed explanation regarding the income and expenses of the organization and also ensure the classification is done in a proper manner. Each detail of the general ledger can be selected and reviewed properly. The auditors may compare and examine the total income and expense recorded in general ledger activity and the total activity that is recorded in the income statement. At the same time the balance in the owners’ equity, asset and liability account should be also equal to the amounts shown in the balance sheet. General ledger is often referred while preparing the budget for the upcoming years. The annual budget helps the business in controlling and monitoring the financial operations. Based on the income and expenses of the current year the next year budget is planned. This requires a thorough review of the general ledger for identifying the uncommon and one time income and expenses so that the budget for the next year can be planed (Hopkins, 2012). Subsidiary Ledger Subsidiary ledger signifies recording of individual accounts that are having a common characteristics and can be grouped under a separate ledger. The subsidiary ledger is contained in the general ledger via summarizing the account called controlling account. The balance in the controlling account is equal to the sum total of all the balances mentioned in the subsidiary ledger. Thus the controlling account of the general ledger is supported by the subsidiary ledger that is considered to be secondary ledger. The subsidiary ledger is of two types the accounts payable subsidiary ledger and the accounts receivable subsidiary ledger. The accounts receivable subsidiary ledger is also referred to as customer ledger that provides an alphabetical listing of the individual creditors account. Account Receivable is the controlling account in the general ledger that is calculated by summarizing the credits and debits of the individual customers account. On the other hand the accounts payable subsidiary ledger provides an alphabetical listing of the individual creditors account. Account payable is the corresponding controlling account in the general ledger (Warren, 2012). Importance The large organizations are seen to sell their products to large number of customers and are also seen to purchase from large number of suppliers. This results into a voluminous general ledger since the company incurs extra expenses to warn additional revenue. The company should properly record each amounts resulting from each customers and suppliers. Thus to minimize error, reduce the size of general ledger, keep updated record of the credit suppliers and customer and divide the task of accounting subsidiary ledger is created. Hence subsidiary ledgers are used to keep track of various accounting departments. This type of segregation helps the organization in providing better support and control to the operations. Any event recorded incorrectly in the subsidiary ledger or journal will lead to an out-of-balance condition, which can be easily detected from the updates of the general ledger. The assessment of the accuracy and completeness of the transaction processing can be done by periodically reconciling the summary balances of the subsidiary ledger. The subsidiary ledger can be also used to track each item while purchasing equipments like cost, location and other data (Hall, 2011; Nikolai, Bazley & Jones, 2009). Control Accounts Controlling account signifies the total accounts for the stores, debtors, and creditors etc, those which are maintained through double entry account recordings. Control accounts are also used for posting the contras from the daily books by using the totals and completing the double entry. For instance the credit sales account and the debtors control accounts are debited; cash account is debited, crediting the debtor’s control account; debiting return inward accounts and debtors control account is credited; debiting the bad debt expense account etc. The control account effectively converts the individual ledger accounts on a memorandum basis. In order to construct the running balances for the control purposes the accountant are seen to use the total from the cash book, day books and independently from individual ledger accounts. This leads to the effective, speedy, economic preparation of the balance sheet and final accounts (Kimuda, 2008). The control accounts and adjustment accounts or general ledger adjustment accounts are equal and opposite of each other. Control accounts can be prepared on each of the elements of cost by classifying expenditure according to the nature. Material control account, factory overhead control account, direct labor account, selling and distribution overhead control account and administration overhead control account are some of the control accounts. Depending upon the circumstances some of these control accounts are segregated into variable and fixed (Lal & Srivastava, 2009). Importance If control accounts are maintained as memorandum records then the double entry system may not function fully. The control account has the following roles to be performed in the organization: Any mistake in the ledger can lead to an obvious imbalance in the control account. This helps in saving time to identify and locate the error. If the financial record is dependent on the trial balance only then any mistake may lead to checking the cashbook and all the three main ledgers. Any person can maintain the control accounts who may not be a person who is responsible for maintaining the personal accounts of the creditors and the debtors. This leads to elimination of chances of fraud. While constructing the trial balance the figures related to creditors and debtors can be ascertained more quickly than off balancing the individual personal accounts in purchase and sales ledger. Errors can be stopped affecting the trial balance. For the various entries that are made in the ledger account, mistakes are an obvious thing that can happen anytime. Most of the companies those who are using computerized system are also seen to commit such mistakes. Control account is an effective way to check these types of mistakes. Special Ledger The areas that are not clearly answered by the general ledger are answered by the special purpose ledger. In simple terms special ledger provides the methods of evaluation for these areas. There are several reports and analysis present in the special ledger processing that provides supplement to the application of traditional accounting. This process reveals various ways through which the accounts assignments based on company codes can be relocated to special ledger for reporting and analysis. Special ledger can be formed based on time like month, year etc; type like region, cost centre, accounts etc; specific comparison like budget, total values, actual values etc or external and internal requirements like consolidation and local ledger. The key areas responsible for the functionality of special ledger are reporting, capabilities, planning and integration. The different information from the various business areas, third party data or application can create the business value for the special ledger. Special ledgers can be derived from various business processes and areas like “invoicing, asset transfers, receivables, cash receipts/disbursement, individual account closing and statistical activities” (Curran & Ladd, 2000, p. 158). The specific data can be either transferred periodically or immediately to the special ledger and can be updated automatically. These data can come from posting from financial accounting or from the process of procurement. By using standard interface, special ledger can be derived from the third-party system (Curran & Ladd, 2000). Importance Special purpose ledger is the component that helps in controlling and planning. The information that is required for the purpose of comparison is personal cost versus total sales, which is stored in the business objects with attributes of planning. The parameters of planning are based on general data like quantities and transaction are used for the purpose of compilation of information over a certain period of time. The processing of special ledger is also important for understanding which report or requirement should be done specific to an area. The special ledger compiles various transactions related to certain specific areas and generates reports through various information systems (Curran & Ladd, 2000). Differences General ledger contains the data related to the impersonal accounts like those other than the customers and the suppliers. The information that are hold by the general ledger are used to create the balance sheet and income statement that are used to serve several purpose in conducting the financial operations of a business. However a general ledger does not contain details about all the accounts that are required for summarizing the financial information of a company. In order to become more efficient control account is used in general ledger. At the same time subsidiary ledger is used to keep the details of the customer’s account. The sum total that is present in the subsidiary ledger must be equal to the control account present in the control account (the balance present in general ledger). On the other hand the areas which are not addressed by the general ledger are addressed by the special ledger. Reference Curran, T.A. & Ladd, A. (2000). Sap R/3 business blueprint: Understanding enterprise supply chain management. New Delhi: Pearson Education India. Dropkin, M. & Halpin, J. (2012). Bookkeeping for nonprofits: A step-by-step guide to nonprofit accounting. New Jersey: John Wiley & Sons. Galanza, R.M. (1995). Accounting principles and procedures for a sole proprietorship. Quezon City: Rex Bookstore, Inc. Hall, J.A. (2011). Accounting information systems. 8th Ed. Connecticut: Cengage Learning. Hopkins, B.R. (2012). Nonprofit law & finance essentials e-book set: Tools to manage money and mission. New Jersey: John Wiley & Sons. Kimuda, D.M. (2008). Foundations of accounting. Nairobi: East African Publishers. Kotas, R. & Conlan, M. (1997). Hospitality accounting. Connecticut: Cengage Learning EMEA. Kumar, A. & Prasad, S. (1999). 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