UNIT-2

Mechanics of Accounting: The double entry system, Trading Account, .


Mechanics of Accounting: Double entry system of accounting, journalizing of transactions;preparation of final accounts, Trading Account, Manufacturing Accounts, Profit & Loss Account,Profit & Loss Appropriation account and Balance Sheet, Policies related with depreciation, inventory and intangible assets like copyright, trademark, patents and goodwill.

The double entry system

The double entry system of accounting or bookkeeping means that every business transaction will involve two accounts (or more). For example, when a company borrows money from its bank, the company's Cash account will increase and its liability account Loans Payable will increase. If a company pays $200 for an advertisement, its Cash account will decrease and its account Advertising Expense will increase.

Double entry also allows for the accounting equation (assets = liabilities + owner's equity) to always be in balance. In our example involving Advertising Expense, the accounting equation remained in balance because expenses cause owner's equity to decrease. In that example, the asset Cash decreased and the owner's capital account within owner's equity also decreased. A third aspect of double entry is that the amounts entered into the general ledger accounts as debits must be equal to the amounts entered as credits.

Trading Account:

Definition and Explanation:

The account which is prepared to determine the gross profit or gross loss of a business concern is called trading account.

It should be noted that the result of the business determined through trading account is not true result. The true result is the net profit or the net loss which is determined through profit and loss account. The trading accounting has the following features:


It is the first stage of final accounts of a trading concern.
It is prepared on the last day of an accounting period.
Only direct revenue and direct expenses are considered in it.
Direct expenses are recorded on its debit side and direct revenue on its credit side.
All items of direct expenses and direct revenue concerning current year are taken into account but no item relating to past or next year is considered in it.
If its credit side exceeds it represents gross profit and if debit side exceeds it shows gross loss.

Purpose of Preparing Trading Account:

The profit or loss determined by a trading account is the gross result of the business but not the net result. If so, then a question arises - what is the use of preparing a trading account? This account is necessary because of the following advantages.
Gross profit of a business is very important data, since all business expenses are met out of it. So the amount of gross profit should be adequate to meet the indirect expenses of a business concern.
The amount of net sales can be determined through this account. Gross sales can be ascertained from sales account in the ledger, but net sales cannot be so obtained. The true sales of a business is net sales - not gross sales. Net sales are determined by deducting sales returns from gross sales in trading account.
The success or failure of a business can be ascertained by comparing net sales of the current year with that of the last year. It should be noted that an increase in the amount of net sales of the current year over the last year may not be regarded as a sign of success, since sales may increase because of rise in price level.
Percentage of gross profit on net sales (gross profit ratio) can be easily determined from trading account. This percentage is very important yardstick for measuring the success or failure of a business. Compared to last year, if the rate increases, it indicates success; on the other hand if the rate decreases, it is an indication of failure.
.Percentage of different items of buying expenses (direct expenses) on gross profit can be easily determined and by comparing the percentage of the current year with that of the previous year the variations can be ascertained. An analysis of variances will disclose their cause which will help in controlling the amount of expenses.
Inventory or stock turnover ratio can be determined from trading account. The success or failure of a business can be measured by this rate. Higher rate indicates a favorable sign i.e. goods are sold soon after their purchase. On the other hand, low rate signifies deterioration, i.e. goods are sold long after their purchase.

The American Accounting Association defines accounting as “the process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information”. This definition highlights the following aspects :

(a) Identifying the Business Transactions. Identification of transactions are useful for proper recording of them in books of accounting without missing any of the transactions.

(b) Measurement of Business Performance. Measurement or evaluation of business performance is necessary to know the progress of business.

(c) Communication of Information. Communication of information relates to reporting the results of business to all those interested in the business. This enables them to judge the efficiency of the business and to take suitable decisions to improve the business.

DOUBLE ENTRY SYSTEM OF ACCOUNTING

The double entry system of accounting or bookkeeping means that every business transaction will involve two accounts (or more). For example, when a company borrows money from its bank, the company's Cash account will increase and its liability account Loans Payable will increase.

JOURNALIZING OF TRANSACTIONS

Journalizing is the process of recording a business transaction in the accounting records. This activity only applies to the double-entry bookkeeping system. The steps involved in journalizing are as follows: Examine each business transaction to determine the nature of the transaction.

PREPARATION OF FINAL ACCOUNTS

Image result for preparation of final accountswww.youtube.com Trading Account is the first stage in the process of preparing final accounts. Trading account shows the gross profit or gross loss during an accounting year. Its main components are sales, services rendered in the credit side of such sales or services rendered in the debit side.

TRADING ACCOUNTS

Trading Account is the first stage in the process of preparing final accounts. Trading account shows the gross profit or gross loss during an accounting year. Its main components are sales, services rendered in the credit side of such sales or services rendered in the debit side.

MANUFACTURING ACCOUNTS

From this, the chapter looks at the construction of manufacturing, trading and profit and loss accounts and the drawing up of a balance sheet. Ratio analysis is a particularly powerful technique aimed at helping marketers to compare sets of figures over time and between companies.

PROFIT AND LOSS ACCOUNTS

The account through which annual net profit or loss of a business is ascertained, is called profit and loss account. Gross profit or loss of a business is ascertained through trading account and net profit is determined by deducting all indirect expenses (business operating expenses) from the gross profit through profit and loss account. Thus profit and loss account starts with the result provided by trading account. The particulars required for the preparation of profit and loss account are available from the trial balance. Only indirect expenses and indirect revenues are considered in it. This account starts from the result of trading account (gross profit or gross loss). Gross profit is shown on the credit side of the profit and loss account and gross loss is shown on the debit side of this account. All indirect expenses are transferred on the debit side of this account and all indirect revenues on credit side. If the total of the credit side exceeds the debit side, the result is "net profit" and if the total of the debit side exceeds the total of the credit side, the result is net loss. As the net profit or net loss of a certain accounting period is determined through profit and loss account, so its heading is:

POLICIES PLATED WITH DEPRECIATION

The depreciation methods used, the total depreciation for the period for each class of assets, the gross amount of each class of depreciable assets and the related accumulated depreciation are disclosed in the financial statements alongwith the disclosure of other accounting policies.

TRADEMARK

A trademark, trade mark, or trade-mark is a recognizable sign, design, or expression which identifies products or services of a particular source from those of others, although trademarks used to identify services are usually called service marks.