Tag: Amortization

The consignor, in a contract of carriage, is the person sending a shipment to be delivered whether by land, sea or air. Some carriers, such as national postal entities, use the term “sender” or “shipper” but in the event of a legal dispute the proper and technical term “consignor” will generally be used.

If Sender sends a widget to Receiver via a delivery service, Sender is the consignor and Receiver is the consignee.

In a contract of carriage, the consignee is the entity who is financially responsible (the buyer) for the receipt of a shipment. Generally, but not always, the consignee is the same as the receiver.

If a sender dispatches an item to a receiver via a delivery service, the sender is the consignor, the recipient is the consignee, and the deliverer is the carrier.

Consignor vs. Consignee

Now that the idea of consignment is clear, the matter of consignor vs. consignee can be discussed. A consignor is an individual or party that brings a good to be sold on their behalf by another party, which is called the consignee.

The consignee acts as a sort of middleman, which is the individual that buys or retains the goods and passes them along to a third party or the final buyer. Regardless of whether the item is being sold and purchased or simply transferred from one party to the other through the consignee, ownership remains in the hands of the consignor until the deal is finalized, either through payment by or delivery to the final buyer.

The consignor may also be referred to as the shipper, obtaining shipping or transfer documents for the goods they are selling to the consignee. The consignor keeps the title/ownership of the property until it is transferred to or sold to the final party.

Example of a Consignor/Consignee Relationship

To understand the consignor/consignee relationship better, consider the following example. A family is looking to sell its collection of valuable items. They make an arrangement with an auction house to sell the items. Here, the family is the consignor and the auction house is the consignee. The auction house markets the items, but the family retains ownership of them until a third party purchases the items.

Once payment’s been made from the third-party buyer to the auction house the money is turned over to the consignor, minus a fee for the consignee for hosting the items and facilitating the sale. Ownership is then transferred to the buyer.

Consignee

A consignee is the party identified on shipping documents as the recipient of goods to be delivered. This party is responsible for paying customs duties as the designated owner of the goods. The consignee does not formally take possession of the goods until it pays the consignor. The consignor is usually the party that shipped the goods.

The consignee is typically responsible for damage to the goods given into its care, even if ownership still resides with the consignor during the holding period.

An intermediate consignee is a party that receives a shipment on behalf of the ultimate consignee. The ultimate consignee is the intended final recipient of a delivery, which is forwarded to it by the intermediate consignee.

From an accounting perspective, the consignor retains ownership of consigned goods, so these inventory items remain on its balance sheet until such time as they are either sold by the consignee to a third party, or purchased outright by the consignee. The consignor does not record a sale transaction when goods are initially shipped to the consignee, since the consignor still owns the goods. A sale transaction for the consignor only occurs when goods are sold to a third party or bought outright by the consignee.

From the perspective of the consignee, goods received on consignment do not appear on its balance sheet, since it does not own the inventory. Instead, it records a commission on any sales to third parties.

Consignor

A consignor is the party who delivers goods that they own to another party to hold and sell them on their behalf. In other words, it’s the owner of a product who allows a store to take possession of it in order to sell it for him or her.

Consignment refers to an arrangement where the consignor (owner of goods) sends goods to the consignee (agent) for sale on behalf of the consignor. The consignee does not take ownership of the goods but sells them and earns a commission on the sales made.

1. Journal Entries in the Books of Consignor

The consignor records the consignment transaction using a Consignment Account to determine the profit or loss from the consignment. The following are the key entries:

2. Journal Entries in the Books of Consignee

Since the consignee acts as an agent, they do not record the consignment as their purchase. They only record the expenses incurred, commission earned, and the remittance to the consignor. The following are the key entries:

illustrative Example

Scenario:

• A consignor, XYZ Ltd., sends goods costing ₹1,00,000 to a consignee, ABC Traders.
• Expenses incurred by XYZ Ltd. on freight and insurance amount to ₹5,000.
• ABC Traders incurs unloading expenses of ₹2,000 and sells the goods for ₹1,20,000.
• ABC Traders is entitled to a commission of 10% on sales.
• ABC Traders remits the balance to XYZ Ltd. after deducting commission and expenses.

Journal Entries in the Books of Consignor (XYZ Ltd.)

Journal Entries in the Books of Consignee (ABC Traders)

Explanation

• Consignor’s Books

The consignor records the consignment transaction, including the value of goods sent, expenses incurred, sales made, and the commission paid to the consignee. The profit or loss on consignment is determined at the end by comparing the total revenue with the total expenses.

• Consignee’s Books

The consignee only records transactions related to expenses incurred, sales made on behalf of the consignor, and commission earned. Since the consignee is an agent and not the owner of the goods, no purchase or inventory entry is made.

Calculating a fire insurance claim involves several steps to ensure that the policyholder is compensated fairly for the loss or damage caused by fire. The process includes assessing the loss, verifying policy coverage, applying relevant clauses, and finally calculating the claim amount.

Notification of Fire Incident

The first step after a fire occurs is for the insured to notify the insurer about the fire incident. Prompt notification is crucial as it initiates the claim process and allows the insurer to assess the damage as early as possible. Most insurance policies specify a timeline within which the fire incident must be reported.

Assessment of Loss

After the insurer has been notified, a loss assessor or surveyor is appointed to inspect the property and estimate the extent of damage caused by the fire. The surveyor assesses:

• The condition of the property before the fire.
• The extent of damage to stock, machinery, and other assets.
• The salvage value of any damaged goods or property. The assessment forms the basis of the claim, determining how much of the property has been destroyed or damaged.

Calculation of the Value of Stock or Assets Lost:

In the case of businesses, the value of the stock lost in the fire is calculated. The insured needs to provide details of the stock on hand before the fire occurred. This can be derived from:

• Stock registers or accounts.
• Invoices and purchase records.
• Valuation of finished goods and raw materials.

The valuation of assets or stock is often done at cost price or market value, depending on the terms of the policy. If the stock was insured at invoice price, any profit margin already added is also considered.

Application of Policy Coverage Limits:

Every fire insurance policy has a maximum coverage limit or sum insured, which is the maximum amount the insurer is liable to pay. If the loss exceeds this limit, the policyholder will not be compensated for the excess. In such cases, the claim amount will be restricted to the sum insured.

Deduction of Salvage Value:

Salvage value refers to the residual value of any goods, property, or assets that can still be used or sold after the fire. The insurer reduces the claim amount by the salvage value, as the policyholder can recover some amount by selling or reusing salvageable items. This is essential for fair compensation as the insured should not be paid for goods that still retain some value.

Formula:

Net Loss = Total Loss − Salvage Value

Application of the Average Clause (if applicable)

Average clause is a provision in fire insurance that applies if the insured sum is less than the actual value of the property. In such cases, the policyholder is considered to have underinsured the property, and the insurer reduces the claim payout proportionally.

Formula for Average Clause:

Claim Amount = (Sum Insured / Actual Value of Property) × Net Loss

For example, if a property worth ₹10,00,000 is insured for ₹6,00,000 and suffers a loss of ₹4,00,000, the claim is reduced as follows:

Claim Amount = (₹6,00,000 / ₹10,00,000) × ₹4,00,000 = ₹2,40,000

The policyholder will only receive ₹2,40,000, instead of the full ₹4,00,000, because of underinsurance.

Consideration of Deductibles

Fire insurance policies often include deductibles or excess clauses, which are amounts the policyholder must bear out of pocket before the insurance coverage kicks in. For example, if the deductible is ₹50,000, and the total loss is ₹3,00,000, the insurer will pay only ₹2,50,000. Deductibles encourage policyholders to avoid making small claims and to take preventive measures.

Calculation of Business Interruption Loss (if applicable)

In cases where the policy covers loss of profit due to business interruption, the insurer compensates for the reduction in gross profit caused by the fire. To calculate business interruption loss, the following factors are considered:

• Historical profit trends.
• Fixed operating expenses (e.g., rent, salaries).
• The duration of business disruption. The amount paid for business interruption is based on the financial data provided by the insured, and it helps maintain financial stability while the business recovers from the fire.

Claim Settlement by Insurer

After assessing all the factors value of the loss, salvage, deductibles, and the average clause the insurer arrives at the final claim amount. Once agreed upon, the insurer pays the policyholder the claim, restoring them to their pre-loss financial position as closely as possible.

Example: Calculation of Fire Insurance Claim

• Value of stock before the fire: ₹15,00,000
• Loss of stock due to fire: ₹5,00,000
• Salvage value of remaining stock: ₹50,000
• Sum insured: ₹12,00,000
• Deductible: ₹25,000
• Actual value of stock: ₹15,00,000

Steps:

1. Calculate the Net Loss:

Net Loss = ₹5,00,000 − ₹50,000 = ₹4,50,000

2. Apply the Average Clause:

Since the sum insured (₹12,00,000) is less than the actual value (₹15,00,000), the average clause applies:

Claim Amount = (₹12,00,000 / ₹15,00,000) × ₹4,50,000 = ₹3,60,000

3. Apply the Deductible:

The final claim amount after deducting the policy deductible (₹25,000):

Final Claim = ₹3,60,000 − ₹25,000 = ₹3,35,000

The final payout by the insurer would be ₹3,35,000.

Journal entries are systematic records of business transactions made in the journal (or book of original entry), capturing the date, accounts involved, debit, and credit amounts. They ensure that every financial event is properly documented and aligned with the double-entry system, where total debits always equal total credits. Each entry reflects the nature of the transaction, such as rent payments, royalties, sales, purchases, or adjustments.

Once journal entries are recorded, they are posted to ledger accounts. A ledger is the principal book where transactions related to each account (like cash, sales, rent, royalties, minimum rent) are grouped, showing cumulative balances. This structured organization helps businesses track account-wise financial activities and prepare financial statements accurately.

Minimum Rent (also known as Dead Rent) is a guaranteed payment that the lessee (tenant) must make to the lessor (landlord) irrespective of the actual production or sales. If the actual royalty based on production or sales exceeds the minimum rent, the lessee will pay the higher amount. However, if the royalty is lower than the minimum rent, short workings occur, which may be recouped in future periods when the actual royalty exceeds the minimum rent.

Specifically, in royalty agreements, the Minimum Rent Account comes into play when the agreed minimum rent or dead rent is higher than the actual royalty based on production or sales. The lessee is obligated to pay this minimum amount even if actual output is low. If the royalties fall short, the shortfall is recorded as a shortworkings expense, often carried forward for recoupment in future years.

Journal entries for such cases typically include:

• Debit: Royalty Expense / Production Account

• Debit (if applicable): Shortworkings Account

• Credit: Minimum Rent Account or Landlord’s Account

Key Terms:

1. Minimum Rent (Dead Rent)

Minimum Rent, also known as Dead Rent, is the fixed minimum amount that a lessee (tenant or user) agrees to pay to the lessor (owner) under a royalty agreement, regardless of the actual level of production or sales. This concept is commonly used in mining leases, publishing contracts, or patents where the lessee uses a resource or intellectual property that generates royalties.

The idea behind minimum rent is to ensure that the lessor receives a guaranteed minimum income even if the lessee’s production or sales are low in a particular year. It acts as a safeguard for the lessor’s financial security, providing them with a fixed return for granting the lease or usage rights.

For example, if a mining company leases land to extract minerals, the owner wants assurance that even if the mining output is low, they will still receive a minimum payment. So, if the royalty based on production is less than the agreed minimum rent, the lessee must still pay the minimum rent amount.

2. Actual Royalty

Actual Royalty refers to the amount calculated and payable by the lessee (user) to the lessor (owner) based on the real quantity of production or sales during a specific period, according to the agreed royalty rate. It is the variable part of the payment in a royalty agreement and directly depends on how much the lessee produces, extracts, sells, or earns from the leased asset, property, or right.

For example, in a mining lease, the lessee agrees to pay the lessor a royalty of ₹50 per ton of coal extracted. If they extract 2,000 tons in a year, the actual royalty would be ₹100,000. Similarly, in a publishing agreement, an author may receive a royalty of 10% on book sales, so if ₹500,000 worth of books are sold, the actual royalty will be ₹50,000.

3. Short Workings

Short Workings refer to the excess amount paid by the lessee (tenant or user) to the lessor (owner) when the minimum rent (dead rent) payable under a royalty agreement exceeds the actual royalty earned during a given period. It represents the difference between the minimum rent and the actual royalty when actual production or sales fall short.

In simple terms, when a lessee is obligated to pay a guaranteed minimum amount (minimum rent) regardless of production, but their actual production or sales generate a smaller royalty, they still pay the minimum rent. This excess payment is known as short workings. Importantly, many contracts allow the lessee to recoup or recover these short workings in future years when actual royalties exceed the minimum rent.

Example

• Minimum Rent: ₹150,000

• Actual Royalty (based on production): ₹120,000

• Short Workings = ₹150,000 – ₹120,000 = ₹30,000

The lessee pays ₹150,000 to the lessor but has an excess payment of ₹30,000, recorded as short workings. This amount may be recouped in future periods if actual royalty exceeds minimum rent, subject to the contract terms.

4. Recoupment of Short Workings

Recoupment of Short Workings refers to the process where a lessee (user) recovers the excess payments (short workings) made in earlier years under a royalty agreement when actual royalties fall below the minimum rent. This recovery is done in future periods when the actual royalty exceeds the minimum rent, allowing the lessee to adjust or offset the earlier shortfall.

In a typical royalty agreement, if the lessee pays more than the actual royalty (due to minimum rent obligations), the extra amount is recorded as short workings. Many agreements give the lessee a right to recoup these short workings within a specified period (usually 2–3 years). If, during that period, the lessee’s actual royalties rise above the minimum rent, the surplus can be used to recoup the past excess payments.

Example

• Year 1: Minimum Rent ₹150,000, Actual Royalty ₹120,000 → Short Workings ₹30,000

• Year 2: Minimum Rent ₹150,000, Actual Royalty ₹180,000 → Excess Royalty ₹30,000

In Year 2, the lessee can recoup ₹30,000 of short workings from Year 1 by adjusting it against the excess royalty. The lessee now pays only the minimum rent, as the extra royalty offsets the past shortfall.

Example Scenario:

• Minimum Rent: ₹100,000
• Actual Royalty for Year 1: ₹80,000 (Short Workings: ₹20,000)
• Actual Royalty for Year 2: ₹120,000 (Recoupment of Short Workings: ₹20,000)

Journal Entries in the Books of Lessee:

Year 1: Actual Royalty is Less than Minimum Rent (Short Workings)

Year 2: Actual Royalty Exceeds Minimum Rent (Recoupment of Short Workings)

Ledger Accounts in the Books of Lessee:

1. Minimum Rent Account

2. Royalty Account

3. Short Workings Account

4. Lessor’s Account

5. Short Workings Recouped Account

6. Bank Account

Explanation of Journal Entries:

1. Year 1 (Short Workings)

• • The Royalty Account is debited with the actual royalty amount (₹80,000), and the Lessor’s Account is credited.
  • The Minimum Rent Account is debited with the guaranteed minimum rent (₹100,000), and the lessor is credited again.
  • The shortfall of ₹20,000 (short workings) is recorded by debiting the Short Workings Account and crediting the Minimum Rent Account.
  • The total amount due to the lessor is paid by debiting the Lessor’s Account and crediting the Bank Account.

2. Year 2 (Recoupment of Short Workings)

• • The actual royalty exceeds the minimum rent, so ₹120,000 is debited to the Royalty Account and credited to the Lessor’s Account.
  • The Minimum Rent Account is debited with ₹100,000, reflecting the minimum amount payable.
  • The Short Workings Recouped Account is debited with ₹20,000 (the amount of short workings recouped), and the Short Workings Account is credited.
  • Finally, the total payment of ₹120,000 is made to the lessor.

In a royalty agreement, the lessee (tenant) pays the lessor (landlord) for the use of land, property, or other resources. The lessee records journal entries for royalty payments, minimum rent (also known as dead rent), short workings, and recoupment of short workings in their books of accounts. These transactions are reflected in both the Journal Entries and Ledger Accounts.

Key Components in Lessee’s Books:

• Lease Liability

In the lessee’s books, lease liability refers to the present value of future lease payments the lessee is obligated to make under the lease contract. This liability is recorded at the inception of the lease and reflects the financial obligation over the lease term. It includes fixed payments, variable payments based on an index or rate, and amounts expected under residual guarantees. Lease liability is subsequently measured by reducing it through lease payments and increasing it by the accretion of interest expense.

• Right-of-Use (ROU) Asset

The right-of-use (ROU) asset represents the lessee’s right to control and use the leased asset for the lease term. This asset is initially measured at the amount of the lease liability, adjusted for initial direct costs, lease incentives, or advance payments. Over time, the ROU asset is depreciated systematically, typically on a straight-line basis, over the shorter of the lease term or the asset’s useful life. The ROU asset ensures the lessee properly reflects the economic benefit derived from the leased asset.

• Lease Payments

Lease payments in the lessee’s books refer to the regular periodic payments made to the lessor, covering the use of the leased asset. These payments usually include both principal and interest components. The principal portion reduces the lease liability, while the interest portion is charged as an expense to the profit and loss account. The schedule of lease payments is crucial for managing cash flow and ensuring compliance with contractual obligations over the entire lease term.

• Interest Expense

Interest expense arises from the unwinding of the discount on the lease liability over time. As lease liabilities are measured on a present value basis, each lease payment reduces the liability and incurs an interest cost. The interest expense is recognized in the profit and loss account and gradually decreases over the lease term as the liability reduces. This accounting treatment ensures the lessee’s financial statements reflect the time value of money related to future lease obligations.

• Depreciation Expense

Depreciation expense refers to the systematic allocation of the cost of the right-of-use (ROU) asset over the lease term. In the lessee’s books, depreciation is charged to the profit and loss account, usually on a straight-line basis, unless another method better reflects the asset’s consumption pattern. The depreciation period is typically the lease term, or the useful life of the underlying asset if ownership transfers. This expense ensures the gradual write-down of the asset’s value over time.

• Initial Direct Costs

Initial direct costs are the incremental costs directly attributable to negotiating and securing the lease agreement, such as legal fees or commissions. In the lessee’s books, these costs are included as part of the ROU asset’s initial measurement. Instead of expensing these costs immediately, they are capitalized and amortized over the lease term through the depreciation of the ROU asset. Proper treatment of initial direct costs ensures accurate representation of the total cost of obtaining the lease.

• Lease Modifications

Lease modifications involve changes to the lease terms, such as extending the lease, changing payment amounts, or modifying the asset’s scope. In the lessee’s books, lease modifications may require remeasurement of both the lease liability and the ROU asset, depending on whether they create a separate lease or adjust the existing agreement. Accounting standards provide specific guidance on recognizing and adjusting for modifications, ensuring that financial records remain accurate and reflect current contractual terms.

• Disclosures in Financial Statements

Lessee’s books must include detailed disclosures about leases in the financial statements, such as the nature of the leases, total lease liabilities, maturity analysis, lease expenses, and any significant assumptions or judgments used. These disclosures provide transparency to stakeholders, helping them understand the impact of leasing activities on the company’s financial position and performance. Proper disclosure ensures compliance with accounting standards like IFRS 16 or ASC 842 and improves the reliability of reported financial information.

Example Scenario:

Consider a situation where:

• Minimum Rent (Dead Rent) = ₹100,000
• Actual Royalty (based on production) = ₹80,000 in Year 1, ₹120,000 in Year 2
• Short Workings in Year 1 = ₹20,000 (₹100,000 – ₹80,000)
• Recoupment of Short Workings in Year 2 = ₹20,000

Journal Entries in the Books of Lessee:

Ledger Accounts in the Books of Lessee:

1. Royalty Account

2. Minimum Rent Account

3. Short Workings Account

4. Lessor’s Account

5. Short Workings Recouped Account

6. Bank Account

Explanation of Journal Entries:

1. Year 1 Entries

• • The first entry records the royalty amount based on actual production.
  • The second entry records the minimum rent payable to the lessor.
  • The short workings are recorded when the actual royalty is less than the minimum rent.
  • Finally, the payment to the lessor is recorded by crediting the bank account.

2. Year 2 Entries

• • The actual royalty exceeds the minimum rent, so no short workings are created.
  • The short workings from Year 1 are recouped by reducing the royalty payment in Year 2.

Explanation of Ledger Accounts:

• Royalty Account reflects the actual royalty amounts based on production.
• Minimum Rent Account shows the minimum rent payable each year.
• Short Workings Account records the shortfall between minimum rent and actual royalty.
• Lessor’s Account tracks payments made to the lessor and any amounts owed.
• Short Workings Recouped Account tracks the amount of short workings recovered in subsequent years.
• Bank Account reflects the cash payments made to the lessor.

There are two methods for entering hire purchase transactions in the books of the hire- purchaser. The first is to enter transactions like ordinary purchases with the difference that interest is to be provided. This method recognizes the fact that the intention of the parties is to complete the purchase and to pay all the instalments. Hence, on purchase of machinery, machinery is debited and the hire vendor is credited with the cash price. When payment is made, the hire vendor is debited. At the end of each financial year, interest is credited to the hire vendor and debited to Interest Account. Depreciation is charged in the ordinary manner.

illustration 1:

Delhi Tourist Service Ltd. purchased from Maruti Udyog Ltd. a motor van on 1st April, 2009 the cash price being Rs 1,64,000. The purchase was on hire purchase basis, Rs 50,000 being paid on the signing of the contract and, thereafter, Rs 50,000 being paid annually on 31st March, for three years, Interest was charged at 15% per annum. Depreciation was written off at the rate of 25 per cent per annum on the reducing instalment system. Delhi Tourist Service Ltd. closes its books every year on 31st March. Prepare the necessary ledger accounts in the books of Delhi Tourist Service Ltd.

The other method of passing entries in the books of the hire purchaser seeks to recognize the fact that no property passes to the hire-purchaser till the final payment is made. Hence, no entry is passed when the contract is signed.

Entries are made at the time of payment of each instalment. The interest included in the instalment is debited to the interest account; the remaining amount is debited to the asset. Thus, if a payment is made down, the entry is to debit the asset and credit Bank, there being no interest when payment is made on the signing of the contract.

When the next instalment is paid, the entries will be:

1. Debit Asset Account

• Debit Interest Account
• Credit Hire Vendor; and

2. Debit Hire Vendor Credit Bank

Depreciation must be allowed on the basis of the full cash price. This is because the whole asset is being used and because ultimately the asset must be paid for wholly.

The journal entries for the illustration number 3 given above, under this method will be as under:

Entries in Interest Account, Depreciation Account and Profit & Loss Account will be the same as have been passed under the first method.

Books of Hire-Vendor:

The hire-vendor treats the hire purchase sale like an ordinary sale. He debits the hire purchaser with the full cash price and credits the Sales Account. Interest is debited to the hire purchaser when instalments become due. Cash received is, of course, credited to the hire purchaser.

In the books of the hire-vendor, the accounts pertaining to the above illustration will be as follows:

Illustration 2:

On 1st April, 2008, Ashok acquired machinery on hire purchase system from Modmac Ltd., agreeing to pay four annual instalments of Rs 60,000 each payable at the end of each year. There is no down payment. Interest is charged @ 20% per annum and is included in the annual instalments.

Because of financial difficulties, Ashok, after having paid the first and second instalments, could not pay the third yearly instalment due on 31st March, 2011, whereupon the hire vendor repossessed the machinery. Ashok provides depreciation on the Machinery @ 10% per annum according to the written down value method. He closes his books of account every year on 31st March. Show Machinery Account and the account of Modmac Ltd. for all the years in the books of Ashok. All workings should form part of your answer. [B.Com. (Hons.) Delhi, 1995 Modified]

Accounting is basically the systematic process of handling all the financial transactions and business records. In other words, Accounting is a bookkeeping process that records transactions, keeps financial records, performs auditing, etc. It is a platform that helps through many processes, for example, identifying, recording, measuring and provides other financial information.

Accounting is the language of finance. It conveys the financial position of the firm or business to anyone who wants to know. It helps to translate the workings of a firm into tangible reports that can be compared.

Accounting is all about the process that helps to record, summarize, analyze, and report data that concerns financial transactions.

Accounting is all about the term ALOE. Do not confuse it with the plant! ALOE is a term that has an important role to play in the accounting world and the understanding of the meaning of accounting. Here is what the acronym, “A-L-O-E” means.

• A: Assets
• L: Liabilities
• E: Owner’s Equity

This is one of the basic concepts of accounting. The equation for the same goes like this:

Assets = Liabilities + Owner’s Equity

Here is the meaning of every term that ALOE stands for.

(i) Assets: Assets are the items that belong to you and you are the owner of it. These items correspond to a “value” and can serve you cash in exchange for it.  Examples of Assets are Car, House, etc.

(ii) Liabilities: Whatever you own is a liability. Even a loan that you take from a bank to buy any sort of asset is a liability.

(ii) Owner’s Equity: The total amount of cash someone (anyone) invests in an organization is Owner’s Equity. The investment done is not necessarily money always. It can be in the form of stocks too.

Scope of Accounting

Accounting has got a very wide scope and area of application. Its use is not confined to the business world alone, but spread over in all the spheres of the society and in all professions. Now-a-days, in any social institution or professional activity, whether that is profit earning or not, financial transactions must take place. So there arises the need for recording and summarizing these transactions when they occur and the necessity of finding out the net result of the same after the expiry of a certain fixed period. Besides, the is also the need for interpretation and communication of those information to the appropriate persons. Only accounting use can help overcome these problems.

In the modern world, accounting system is practiced no only in all the business institutions but also in many non-trading institutions like Schools, Colleges, Hospitals, Charitable Trust Clubs, Co-operative Society etc.and also Government and Local Self-Government in the form of Municipality, Panchayat.The professional persons like Medical practitioners, practicing Lawyers, Chartered Accountants etc.also adopt some suitable types of accounting methods. As a matter of fact, accounting methods are used by all who are involved in a series of financial transactions.

The scope of accounting as it was in earlier days has undergone lots of changes in recent times. As accounting is a dynamic subject, its scope and area of operation have been always increasing keeping pace with the changes in socio-economic changes. As a result of continuous research in this field the new areas of application of accounting principles and policies are emerged. National accounting, human resources accounting and social Accounting are examples of the new areas of application of accounting systems.

Journal is the first book of original entry in the accounting process, where all business transactions are recorded chronologically and systematically for the first time. Each transaction is entered using the double-entry system, which means every transaction affects at least two accounts — one is debited, and the other is credited. A journal entry includes the date, accounts involved, amounts, and a brief description or narration. It serves as the base for posting entries into the ledger. The journal helps ensure accuracy, maintains a complete record of all financial events, and supports audit trails. Types of journals include the general journal and special journals like the sales journal and purchase journal. It is essential for tracking and analyzing financial activities.

Nature of a Journal:

Journal is often referred to as the “book of original entry,” where transactions are initially recorded in chronological order. This means that transactions are recorded in the order they occur, providing a comprehensive timeline of the financial activities of the business. Journals help ensure that all transactions are accounted for and provide a basis for future financial reporting. Each entry in a journal is accompanied by relevant source documents, such as invoices, receipts, or contracts, which serve as evidence of the transaction.

Structure of a Journal

A typical journal entry consists of several key components:

1. Date: The date when the transaction occurred.
2. Account Titles: The names of the accounts affected by the transaction, with the debited account listed first and the credited account listed second.
3. Debit Amount: The amount being debited to the first account.
4. Credit Amount: The amount being credited to the second account.
5. Description: A brief explanation of the transaction.

The standard format for a journal entry looks like this:

Types of Journals:

1. General Journal:

This is the most common type of journal where all types of transactions are recorded that do not fit into specialized journals. It is used for recording adjusting entries, closing entries, and transactions that involve multiple accounts.

2. Special Journals:

These are used to record specific types of transactions to streamline the recording process. Common types of special journals:

• Sales Journal: Records all sales transactions made on credit.
• Purchases Journal: Records all purchases made on credit.
• Cash Receipts Journal: Records all cash received by the business.
• Cash Disbursements Journal: Records all cash payments made by the business.

Using special journals allows businesses to summarize similar transactions and reduces the time spent on posting to the general ledger.

Journalizing Process:

Journalizing is the process of recording transactions in the journal. Here’s how it typically works:

1. Identifying the Transaction: Determine the nature of the transaction and which accounts are affected.
2. Analyzing the Transaction: Assess whether each account is being debited or credited. This is guided by the double-entry accounting system, which states that every transaction must affect at least two accounts and that total debits must equal total credits.
3. Recording the Entry: Create a journal entry with the appropriate date, account titles, debit and credit amounts, and description.
4. Reviewing the Entry: Verify the accuracy of the journal entry to ensure that it reflects the transaction correctly.

Importance of Journals:

• Chronological Record:

Journals provide a chronological record of all transactions, making it easier to track and verify financial activities over time.

• Audit Trail:

A well-maintained journal serves as a valuable audit trail for both internal and external audits. Auditors can trace back transactions from the financial statements to the original journal entries.

• Error Detection:

By reviewing journal entries, accountants can identify errors or discrepancies early in the accounting process, facilitating timely corrections.

• Data Summary for Ledgers:

Journal entries serve as the source for postings to the general ledger, providing a summarized view of financial activity.

• Facilitating Financial Reporting:

Accurate journal entries are crucial for preparing reliable financial statements. They ensure that all transactions are accounted for, allowing for accurate revenue and expense recognition.

• Compliance and Accountability:

Maintaining a proper journal is essential for compliance with accounting standards and regulations. It helps businesses demonstrate transparency and accountability to stakeholders.

Accounting is basically the systematic process of handling all the financial transactions and business records. In other words, Accounting is a bookkeeping process that records transactions, keeps financial records, performs auditing, etc. It is a platform that helps through many processes, for example, identifying, recording, measuring and provides other financial information.

Accounting is the language of finance. It conveys the financial position of the firm or business to anyone who wants to know. It helps to translate the workings of a firm into tangible reports that can be compared.

Accounting is all about the process that helps to record, summarize, analyze, and report data that concerns financial transactions.

Accounting is all about the term ALOE. Do not confuse it with the plant! ALOE is a term that has an important role to play in the accounting world and the understanding of the meaning of accounting. Here is what the acronym, “A-L-O-E” means.

• A – Assets
• L – Liabilities
• E- Owner’s Equity

This is one of the basic concepts of accounting. The equation for the same goes like this:

Assets = Liabilities + Owner’s Equity

Here is the meaning of every term that ALOE stands for.

(i) Assets: Assets are the items that belong to you and you are the owner of it. These items correspond to a “value” and can serve you cash in exchange for it.  Examples of Assets are Car, House, etc.

(ii) Liabilities: Whatever you own is a liability. Even a loan that you take from a bank to buy any sort of asset is a liability.

(ii) Owner’s Equity: The total amount of cash someone (anyone) invests in an organization is Owner’s Equity. The investment done is not necessarily money always. It can be in the form of stocks too.

Scope of Accounting

Accounting has got a very wide scope and area of application. Its use is not confined to the business world alone, but spread over in all the spheres of the society and in all professions. Now-a-days, in any social institution or professional activity, whether that is profit earning or not, financial transactions must take place. So there arises the need for recording and summarizing these transactions when they occur and the necessity of finding out the net result of the same after the expiry of a certain fixed period. Besides, the is also the need for interpretation and communication of those information to the appropriate persons. Only accounting use can help overcome these problems.

In the modern world, accounting system is practiced no only in all the business institutions but also in many non-trading institutions like Schools, Colleges, Hospitals, Charitable Trust Clubs, Co-operative Society etc.and also Government and Local Self-Government in the form of Municipality, Panchayat.The professional persons like Medical practitioners, practicing Lawyers, Chartered Accountants etc.also adopt some suitable types of accounting methods. As a matter of fact, accounting methods are used by all who are involved in a series of financial transactions.

The scope of accounting as it was in earlier days has undergone lots of changes in recent times. As accounting is a dynamic subject, its scope and area of operation have been always increasing keeping pace with the changes in socio-economic changes. As a result of continuous research in this field the new areas of application of accounting principles and policies are emerged. National accounting, human resources accounting and social Accounting are examples of the new areas of application of accounting systems.

The following is a list of the ten main accounting principles and guidelines together with a highly condensed explanation of each.

• Economic Entity Assumption

The accountant keeps all of the business transactions of a sole proprietorship separate from the business owner’s personal transactions. For legal purposes, a sole proprietorship and its owner are considered to be one entity, but for accounting purposes they are considered to be two separate entities.

2. Monetary Unit Assumption

Economic activity is measured in U.S. dollars, and only transactions that can be expressed in U.S. dollars are recorded.

Because of this basic accounting principle, it is assumed that the dollar’s purchasing power has not changed over time. As a result accountants ignore the effect of inflation on recorded amounts. For example, dollars from a 1960 transaction are combined (or shown) with dollars from a 2018 transaction.

3. Time Period Assumption

This accounting principle assumes that it is possible to report the complex and ongoing activities of a business in relatively short, distinct time intervals such as the five months ended May 31, 2018, or the 5 weeks ended May 1, 2018. The shorter the time interval, the more likely the need for the accountant to estimate amounts relevant to that period. For example, the property tax bill is received on December 15 of each year. On the income statement for the year ended December 31, 2017, the amount is known; but for the income statement for the three months ended March 31, 2018, the amount was not known and an estimate had to be used.

It is imperative that the time interval (or period of time) be shown in the heading of each income statement, statement of stockholders’ equity, and statement of cash flows. Labeling one of these financial statements with “December 31” is not good enough–the reader needs to know if the statement covers the one week ended December 31, 2018 the month ended December 31, 2018 the three months ended December 31, 2018 or the year ended December 31, 2018.

4. Cost Principle

From an accountant’s point of view, the term “cost” refers to the amount spent (cash or the cash equivalent) when an item was originally obtained, whether that purchase happened last year or thirty years ago. For this reason, the amounts shown on financial statements are referred to as historical cost amounts.

Because of this accounting principle asset amounts are not adjusted upward for inflation. In fact, as a general rule, asset amounts are not adjusted to reflect any type of increase in value. Hence, an asset amount does not reflect the amount of money a company would receive if it were to sell the asset at today’s market value. (An exception is certain investments in stocks and bonds that are actively traded on a stock exchange.) If you want to know the current value of a company’s long-term assets, you will not get this information from a company’s financial statements–you need to look elsewhere, perhaps to a third-party appraiser.

5. Full Disclosure Principle

If certain information is important to an investor or lender using the financial statements, that information should be disclosed within the statement or in the notes to the statement. It is because of this basic accounting principle that numerous pages of “footnotes” are often attached to financial statements.

As an example, let’s say a company is named in a lawsuit that demands a significant amount of money. When the financial statements are prepared it is not clear whether the company will be able to defend itself or whether it might lose the lawsuit. As a result of these conditions and because of the full disclosure principle the lawsuit will be described in the notes to the financial statements.

A company usually lists its significant accounting policies as the first note to its financial statements.

6. Going Concern Principle

This accounting principle assumes that a company will continue to exist long enough to carry out its objectives and commitments and will not liquidate in the foreseeable future. If the company’s financial situation is such that the accountant believes the company will not be able to continue on, the accountant is required to disclose this assessment.

The going concern principle allows the company to defer some of its prepaid expenses until future accounting periods.

7. Matching Principle

This accounting principle requires companies to use the accrual basis of accounting. The matching principle requires that expenses be matched with revenues. For example, sales commissions expense should be reported in the period when the sales were made (and not reported in the period when the commissions were paid). Wages to employees are reported as an expense in the week when the employees worked and not in the week when the employees are paid. If a company agrees to give its employees 1% of its 2018 revenues as a bonus on January 15, 2019, the company should report the bonus as an expense in 2018 and the amount unpaid at December 31, 2018 as a liability. (The expense is occurring as the sales are occurring.)

Because we cannot measure the future economic benefit of things such as advertisements (and thereby we cannot match the ad expense with related future revenues), the accountant charges the ad amount to expense in the period that the ad is run.

8. Revenue Recognition Principle

Under the accrual basis of accounting (as opposed to the cash basis of accounting), revenues are recognized as soon as a product has been sold or a service has been performed, regardless of when the money is actually received. Under this basic accounting principle, a company could earn and report $20,000 of revenue in its first month of operation but receive $0 in actual cash in that month.

For example, if ABC Consulting completes its service at an agreed price of $1,000, ABC should recognize $1,000 of revenue as soon as its work is done—it does not matter whether the client pays the $1,000 immediately or in 30 days. Do not confuse revenue with a cash receipt.

9. Materiality

Because of this basic accounting principle or guideline, an accountant might be allowed to violate another accounting principle if an amount is insignificant. Professional judgement is needed to decide whether an amount is insignificant or immaterial.

An example of an obviously immaterial item is the purchase of a $150 printer by a highly profitable multi-million dollar company. Because the printer will be used for five years, the matching principle directs the accountant to expense the cost over the five-year period. The materiality guideline allows this company to violate the matching principle and to expense the entire cost of $150 in the year it is purchased. The justification is that no one would consider it misleading if $150 is expensed in the first year instead of $30 being expensed in each of the five years that it is used.

Because of materiality, financial statements usually show amounts rounded to the nearest dollar, to the nearest thousand, or to the nearest million dollars depending on the size of the company.

10. Conservatism

If a situation arises where there are two acceptable alternatives for reporting an item, conservatism directs the accountant to choose the alternative that will result in less net income and/or less asset amount. Conservatism helps the accountant to “break a tie.” It does not direct accountants to be conservative. Accountants are expected to be unbiased and objective.

The basic accounting principle of conservatism leads accountants to anticipate or disclose losses, but it does not allow a similar action for gains. For example, potential losses from lawsuits will be reported on the financial statements or in the notes, but potential gains will not be reported. Also, an accountant may write inventory down to an amount that is lower than the original cost, but will not write inventory up to an amount higher than the original cost.