Accounting Mnemonics Dr Cr Rules PDF

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Rules of debit and credits Debits and credits are the opposing sides of an accounting journal entry. They are used to change the ending balances in the general ledger accounts. The rules governing the use of debits and credits in a journal entry are as follows: Rule 1: All accounts that normally contain a debit balance will increase in amount when a debit (left column) is added to them, and reduced when a credit (right column) is added to them. The types of accounts to which this rule applies are expenses, assets, and dividends. Rule 2: All accounts that normally contain a credit balance will increase in amount when a credit (right column) is added to them, and reduced when a debit (left column) is added to them. The types of accounts to which this rule applies are liabilities, revenues, and equity. Rule 3: Contra accounts reduce the balances of the accounts with which they are paired. This means that (for example) a contra account paired with an asset account behaves as though it were a liability account. Rule 4: The total amount of debits must equal the total amount of credits in a transaction. Otherwise, a transaction is said to be unbalanced, and the financial statements from which a transaction is constructed will be inherently incorrect. An accounting software package will flag any journal entries that are unbalanced. By following these debit and credit rules, you will be assured of making entries in the general ledger that are technically correct, which eliminates the risk of having an unbalanced trial balance. However, just following the rules does not guarantee that the resulting entries will be correct in substance, since that also requires a knowledge of how to record transactions within the applicable accounting framework (such as Generally Accepted Accounting Principles or International Financial Reporting Standards).

Introduction to financial accounting Learning objectives: 1.

What are the different types or branches of accounting? What is the function of each branch?

Who are the users of accounting information? 3. Define and explanation accounting equation. What an accounting equation tells us? 2.

4.

What is double entry system of accounting? What are advantages and disadvantages of double entry system?

5.

What is chart of accounts? What is the purpose of preparing a chart of accounts?

6.

How do you classify accounts? Explain modern and traditional classification of accounts.

7.

What is a business transaction? What are different types of business transactions?

8.

Explain the rules of debit and credit. How the rules of debit and credit are applied to the accounts in business transaction?

Types or branches of accounting As a result of technology advancements and industrial and economic development, various types of accounting have evolved over time. Some popular types or branches of accounting are briefly discussed below: 1. Financial accounting 2. Management accounting 3. Cost accounting 4. Tax accounting 5. Project accounting 6. Not-for-profit accounting 7. International accounting 8. Government accounting 9. Social accounting 10. Forensic accounting 11. Fiduciary accounting 12. Auditing

1. Financial accounting Financial accounting is concerned with the preparation of periodic financial reports by using historical data of a business enterprise. The basic purpose of these reports is to provide useful and timely information about an entity’s financial position and its operating results to owners, managers, investors, creditors and government agencies etc. Financial position refers to the resources and obligations of a business at any given point of time and operating results means the net profit earned or net loss incurred by a business enterprise during a particular period of time.

There are certain rules known as “generally accepted accounting principles (GAAP)” that each business enterprise must follow while preparing its financial reports to ensure that the financial information published by it is useful, reliable and comparable with other companies. Financial accounting is also termed as the “general purpose accounting” because the information generated by it is published for the use of every one connected with the business enterprise.

2. Management accounting Management accounting system uses historical as well as estimated data to generate useful reports and information to be used by internal management for decision making purpose. Unlike financial accounting, the information generated by management accounting is not published for external parties but is used by managers to perform their core functions such as evaluation of various products and departments in terms of profitability, selection of the best available alternatives and making other business decisions to achieve organizational goals. As the reports generated by management accounting are not used by any external party, the business enterprises don’t need to take care of GAAP.

3. Cost accounting The cost accounting is concerned with categorizing, tracing and collecting manufacturing costs of a business enterprise. The cost data collected so is used by management in planning and control. A well established cost accounting system is essential for every business enterprise to have a proper control over costs.

4. Tax accounting Tax accounting deals with the tax related matters of a business enterprise. It includes computation of taxable income and presentation of financial or other information to tax authorities required by tax laws and regulations of a country. The reports and information generated by financial accounting system satisfy the needs of external parties to great extent. However, the rules and methods followed by a company for preparing its financial accounting reports may slightly differ from those required by tax laws. The work of a tax accountant is to adjust the net operating results and rearrange the information generated by financial accounting to conform with the tax reporting requirements of a country. Besides it, tax accountants also help companies minimize their tax obligations. Because of these functions, tax accountants need to have an updated knowledge about tax laws and regulations. Tax accounting is also important for managers because taxes usually have a significant impact on the expected outcomes of proposed decisions.

5. Project accounting Project accounting is a component of overall project management. It is a specially designed accounting system that prepares financial reports at appropriate time intervals to track the financial progress of a project. These reports provide vital information to project managers in performing their project management function. The use of project accounting is very common among companies involved in construction contracts.

6. Not-for-profit accounting Not-for-profit accounting is concerned with recording events, preparing reports, and planning operations of not-for-profit organizations such as charities, churches, educational institutions, and government agencies etc.

7. International accounting Intentional accounting deals with the issues and complications involved in doing trade in world markets. Many companies have expanded their business internationally. Such companies employ accountants who possess detailed knowledge about custom and taxation laws of various countries. 8. Government accounting Government accounting is concerned with the allocation and utilization of government budgets. It ensures that the central or state government funds released for various purposes are being utilized efficiently. The proper record keeping makes the audit of completed projects possible. 9. Social accounting Social accounting is concerned with analyzing and evaluating organizational impact on society and its environment. It measures the social costs and benefits of various organizational activities. For example, accountants in this area might analyze and evaluate the use of federal and state land or the use of welfare funds in a large city. Other accountants might analyze and evaluate the environmental impact of acid rain. 10. Forensic accounting Forensic accounting deals with legal issues faced by business enterprises. Accountants in this area uses their knowledge, skills and techniques to deal with legal matters such as dispute resolution, claim settlement, fraud investigation, court and litigation cases etc.

11. Fiduciary accounting Fiduciary accounting refers to the management of financial records by a person to whom the custody and management of some property has been entrusted for the benefit of another person. Estate accounting, trust accounting, and receivership are some examples of fiduciary accounting. 12. Auditing The term auditing generally refers to review, examination, verification, evaluation or inspection of historical data, records or events belonging to an entity. The person who performs the work of audit is known as auditor. In accounting and business, there are two types of auditing – external auditing and internal auditing. External auditing refers to the independent examination of an entity’s financial statements and other accounting records that an entity publishes for the use of external parties. The auditor gives his opinion about the fairness of all accounting information examined by him. An important element of “fairness” is the compliance of financial statements with the generally accepted accounting principles (GAAP). Internal auditing is performed to determine whether or not the policies and procedures set by management are being followed. An important purpose of internal auditing is to evaluate whether the activities performed by the employees at various levels are in line with the goals set by management. Internal auditing may be performed by the existing accountants, however many companies employ special staff for this purpose.

Users of accounting information Accounting information of a business enterprise is used by a number of parties. Different parties use accounting information for different purposes depending on their needs. Therefore, the accounting information system of a business enterprise must be designed in a way that should generate reports to satisfy the needs of everyone interested in accounting information. We can broadly divide the users of accounting information into two groups – internal users and external users. Internal users include managers and owners of the business whereas external users include investors, creditors of funds, suppliers of goods, government agencies, general public, customers and employees.

Internal users Internal users use a mix of management and financial accounting information. Some internal users of accounting information and their needs are briefly discussed below:

1. Management Management uses accounting information for evaluating and analyzing organization’s financial performance and position, to take important decisions and appropriate actions to improve the business performance in terms of profitability, financial position and cash flows. One of the major roles of management is to set rules and procedures to achieve organizational goals. For this purpose, management uses information generated by financial as well as managerial accounting system of the organization.

2. Owners Owners invest capital to start and run business with the primary objective to earn profit. They need accurate financial information to know what they have earned or lost during a particular period of time. On the basis of this information they decide their future course of actions such as expansion or contraction of business. In small businesses (like sole proprietorship and partnership) owners themselves perform the function of management.

External users External users normally use only financial accounting information. Some external users of accounting information and their needs are briefly discussed below:

1. Investors In corporate form of business, the ownership is often separated from the management. Normally investors provide capital and management runs the business. The accounting information is used by both actual and potential investors. Actual investors use this information to know how their funds are used by the management and what is the expected performance of business in future in terms of profitability and growth. On the basis of this information, they decide whether to increase or decrease investment in corporation in future. Potential investors use accounting information to decide whether or not a particular corporation is suitable for their investment needs.

2. Lenders Lenders are individuals or financial institutions that normally lend money to businesses and earn interest income on it. They need accounting information to assess the financial performance and position and to have a reasonable assurance that the business to whom they are going to lend money would be able to return the principal amount as well as pay interest there on.

3. Suppliers Suppliers are business individuals or organizations that normally sell merchandise or raw materials to other businesses on credit. They use accounting information to have an idea about the future creditworthiness of the business and to decide whether or not to continue providing goods on credit.

4. Government agencies Government agencies use financial information of businesses for the purpose of imposing taxes and regulations.

5. General public General public also uses accounting information of business organizations. For example, accounting information is:



a source of education for students of accounting and finance. a source of valuable data for those researching on organizational impacts on individuals and economy as a whole.

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a source of information for the people looking for job opportunities.

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a source of information about the future of a particular enterprise.

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6. Customers Accounting information provides important information to customers about current position of a business organization and to make a judgment about its future. Customers can be divided into three groups – manufactures or producers at various stages of production, wholesalers and retailers and end users or final consumers. Manufacturers or producers at every stage of processing need assurance that the organization in question will continue providing inputs such as raw materials, parts, components and support etc. The wholesalers and retailers must be assured of consistent supply of products. The end users or final consumers are interested in continuous availability of products and related accessories. Because of these reasons, the accounting information is of significant importance for all three types of customers.

7. Employees Employees who do not have a hand in core management of the business are considered external users of accounting information. They are interested in financial information because their present and future is tied up with the success or failure of the business. The success and

profitability of business ensures job security, better remuneration, job promotion and retirement benefits.

Accounting equation Accounting equation describes that the total value of assets of a business is always equal to its liabilities plus owner’s equity. This equation is the foundation of modern double entry system of accounting being used by small proprietors to large multinational corporations. Other names used for accounting equation are balance sheet equation and fundamental or basic accounting equation.

Definition and explanation We know that every business owns some properties known as assets. The claims to the assets owned by a business entity are primarily divided into two types – the claims of creditors and the claims of owner. In accounting, the claims of creditors are referred to as liabilities and the claims of owner are referred to as owner’s equity. Accounting equation is simply an expression of the relationship among assets, liabilities and owner’s equity in a business. The general form of this equation is given below: Assets = Liabilities + Owner’s Equity Notice that the left hand side (also known as assets side) of the equation shows the resources owned by the business and the right hand side (also known as equity side) shows the sources of funds used to acquire the resources. All assets owned by a business are acquired with the funds supplied either by creditors or by owner. In other words, we can say that the value of assets in a business is always equal to the sum of the value of liabilities and owner’s equity. The total dollar amounts of two sides of accounting equation are always equal because they represent two different views of the same thing. In accounting equation, the liabilities are normally placed before owner’s equity because the rights of creditors are always given a priority over the rights of owners. Because of this preference, the liabilities are sometime transposed to the left side which results in the following form of accounting equation: Assets – Liabilities = Owner’s Equity If dollar amounts of any two of the three elements are known, we can solve the equation to find the third one. For example, if a business has total assets amounting to $200,000 and total liabilities amounting to $60,000, the owners’ equity must be equal to $140,000 as computed below: Assets – Liabilities = Owner’s Equity

$200,000 – $60,000 = $140,000 Example 1: Using the concept of accounting equation, compute missing figures from the following: 1. Assets = $50,000, Liabilities = $20,000, Owner’s equity = ? 2. Assets = ?, Liabilities = $10,000, Owner’s equity = $15,000 3. Assets = $60,000, Liabilities = ?, Owner’s equity = $40,000 4. Assets = ?, Liabilities + Owner’s equity = $150,000 Solution 1. Owner’s = = $30,000 2. Assets = = $$25,000 3. Liabilities = = $20,000

equity $50,000 =

=

Assets –

Liabilities $10,000

+

Assets

–

= $60,000

–

Owner’s

equity $15,000

Owner’s

equity $40,000

+

–

Liabilities $20,000

4. The basic accounting equation is: Assets = Liabilities + Owner’s equity. If liabilities plus owner’s equity is equal to $150,000, the assets must also be equal to $150,000.

Accounting equation and business transactions Every business transaction impacts accounting equation in terms of dollar amounts but the equation as a whole always remains in balance. Any increase in one side is balanced either by a corresponding decrease in the same side or by a corresponding increase in the other side and any decrease is balanced either by a corresponding increase in the same side or by a corresponding decrease in the other side. For better explanation, consider the impact of twelve transactions included in the following example:

Example 2: Mr. John started a T-shirts business to be known as “John T-shirts”. He performed following transactions during the first month of operations: 1. Mr. John invested a capital of $15,000 into his business. 2. He purchased a building for $5,000 cash for business use.

3. He purchased furniture for $1,500 cash for business use. 4. He purchased T-shirts from a manufacturer for $3,000 cash. 5. He sold T- shirts for $1,000 cash, the cost of those T-shirts were $700. 6. He purchased T-shirts for $2,000 on credit. 7. He sold T-shirts for $800 on credit, the cost of those shirts were $550. 8. He paid $1,000 cash to his payables. 9. He collected $800 cash from his receivables. 10. The shirts costing $100 were stolen by someone. 11. Mr. John paid $150 cash for telephone bill. 12. He borrowed money amounting to $5,000 from City Bank for business purpose.

Required: Explain how each of th...