Treatment of certain items

1. Treatment of trade discount.

In many cases the seller allows to the buyer deduction off the list price. Such deduction is
known as 'trade discount'. Trade discount as such is not recorded in the books. The
transaction is recorded with only the net amount i.e. (list price -trade discount).

2. Treatment- of cash discount (full settlement).

In some cases creditor may allow some concession to his debtor to prompt him to make
the payment within the period of credit allowed. Such concession is known as 'cash
discount'. It is allowed by the person receiving the payment and represents, expenditure.

3. Treatment of Bad debts (debtor becoming insolvent).

An amount due from a debtor may become irrecoverable either partially or wholly.
Reason may be that he has been declared insolvent or any other. Such irrecoverable
amount represents loss to the business and is debited to Bad debts amount.

Cash account Dr

Bad debts Dr

To customer A/c

4. Treatment of Bad debts recovered

It is evident from the above entry that whenever irrecoverable amount is written off the
personal account is credited. If after some time any paymentis received against a debt
previously written of then it represents income and as such should be credited to an
account styled as 'Bad debts recovered account'

Cash A/c Dr

To bad debts recovered account

5. Treatment of personal expenses of the owner

It is quite common for the proprietor to withdraw cash or goods from the business for
personal or domestic use. Sometimes premium on the life policy of the owner may also
be paid by the business. Similarly income tax payable by the proprietor may be paid by
business. All this represents owner's personal expenses and are debited to his personal
account viz. Drawings account.

Drawings a/c Dr

To cash account

Or

Drawings account Dr

To purchases account

6. Treatment of goods given as charity/ advertisement.

Business might distribute goods as 'free samples' to advertise its products. In some cases
it may also distribute goods as charity to boost its image. Both 'advertisement' and
'charity' are expenses of the business, hence should be debited and purchases account
should be credited.

Charity expenses/free samples/advertisement account Dr

To purchases account

9. Treatment of goods lost in accident/ fire.

Loss due to fire account Dr

To Purchases account

10. Treatment of depreciation charged on fixed assets.

Fixed assets are those properties/ possessions of the business which are used for carrying
on of business viz. plant, machinery, building etc. Depreciation is the permanent decrease
in the value of an asset due to wear and tear, passage of time and obsolescence.
Depreciation is treated as a business expenditure. Depreciation account is debited and the
respective asset account is credited.

Depreciation account Dr
 To machinery account

ACCOUNTING PRINCIPLES/CONCEPTS

1) Business Entity concept

A business enterprise is run by a group of persons with an economic objective of

maximizing the value of the organization for all the persons concerned. However they are
expected to make a distinction between the interests of the business and that of their
own. The Business Entity concept states that the enterprise is different from the
individuals running the business. This means that only the transactions that are related to
the business are accounted for and not those of the managers.

For e.g. when a manager places orders for materials needed for manufacturing a product,
it is related to the business and is thus recorded. However, if he places an order for the
interior decoration of his residence, this is not recorded as it is not concerned with the
business at all and violates the business entity concept. All the personal properties and
debts of owners and managers are totally ignored. Thus the Business entity concept
clearly defines the scope of accounting providing a clear guideline as to what must be
recorded and what must not.

2. Going concern concept

When a business is started the shareholders and owners expect to earn profits from it not
just for a short period of time but almost forever. The Going concern concept of
accounting states that any business concern will definitely exist in the future. This means
that no business has the intention or the need to wind up or close its
operations in the foreseeable future. This concept helps in determining the correct value
of properties purchased, expenses and income pertaining to different period of time.

3. Money measurement concept

The Money measurement concept states that only those transactions which can be
measured in terms of money can be recorded. If any transaction cannot be given a value
in terms of money it must not be recorded. This means that transactions such as purchase
of goods, salaries paid to employees etc can be recorded. But factors such as the
resignation or appointment of top management personnel, managerial decisions taken,
labor unions strike, efficiency of employees etc must not be recorded although these are
transactions that affect the business.

4. Accounting Period concept

The Accounting period concept actually stems from the Going concern concept. The
company is assumed to go on forever.However,for making decisions regarding growth
and related strategies, it is thus important for them to know about the organization’s
finances more frequently. The Accounting Period concept states that the life of the
business must be divided into smaller segments for which reporting is done. There is no
fixed period for reporting but it has become a normal practice to follow one year as the
accounting period.. In India, the general accounting year is from April to March.
Companies also report their results once in three months to keep the owners informed and
updated although the accounting period still remains the same one year.

5. Dual Aspect concept

Every transaction has two effects or dual aspects to it. The value of these two aspects
must be equal. This is what the dual aspect concept states.
For example, when Mr. A buys a building for Rs. 5 lakhs, the two effects are that he gets
hold of a property and also makes a payment of Rs. 5 lakhs. The dual aspects of this
transaction are 1) increase in one property (building) and 2) decrease in another property
(cash). One aspect forms the debit side of the transaction while the other forms the credit
side. The recording of all financial transactions is based on the Dual aspect concept. The
process is called the double-entry book-keeping system which has the principle of ‘Every
debit has an equal and corresponding credit’.

6. Cost concept
The cost concept states that the price paid to acquire any property or ‘asset’ must form
the basis for all subsequent accounting related to that asset. This means that only the cost
of purchasing the asset is recorded and any change in the market value of the same in
future years is not accounted for. However, a certain amount is reduced from the asset
value as depreciation which represents the reduction in value due to constant usage and
wear and tear. Thus at the end of the life of the asset, the financial statements will show
close to nil value for the asset and can be sold as scrap.

7. Matching concept
The main objective of any business is to make profits. To determine the amount of profit
one has to match the revenues earned during a particular period with the expenses
incurred during the same period. This process is called the Matching concept. This
concept involves the entire process of identifying all revenues and then adjusting for
expenses of current, previous and future years. Generally, all the direct expenses related
to manufacture a product such as purchase of raw materials, payment of wages to factory
workers, expenses incurred exclusively for the factory etc are matched with the sales
revenue to get what is called ‘Gross Profit’. This is then matched with indirect costs such
as administrative expenses, employees’ salary, office rent etc and the ‘Net Profit’ is
arrived at.
8. Revenue Recognition or Realisation concept
This concept states that revenue has to be recorded or treated as earned when it is
realized. This means that when a legal obligation or commitment to pay for the sales has
arisen, the revenue has to be recorded as earned. The realization concept says that as soon
as the buyer acknowledges the delivery of goods and indicates his acceptance to pay for
the goods, the seller has to record the amount as sales for the period. Thus the actual date
of receipt of the amount is not the date of realizing the revenue.

9. Accrual concept
Today accountants all over the world prefer the accrual system of accounting as opposed
to the cash system. The accrual system says that any revenue or expense is to be
accounted for when it becomes due and not when it is actually received or paid. For e.g.
salary for an employee for a particular month becomes due for payment as soon as
he completes his work for that month. However the amount might be paid to him after a
month. As per the accrual concept the expense is to be accounted for when the amount
becomes due and not in the next month when the payment is made. The accrual concept
ensures that all transactions for a particular period alone are recorded and thus a fair and
true amount of profit or loss is known at the end of the period.

10. Objective evidence concept

As per the objective evidence concept all transactions recorded must have objective
evidence that can be verified by professionals. This is because an accounting statement is
accepted as true and fair representation of the financial position of the business only
when these are verified and declared as true by auditors. The auditors will have to verify
all transactions to give such a declaration.

It is thus important that all business transactions recorded must have an

evidence to support it. These evidences can be in the form of invoices,
bills, sales agreements, bank statements and challans etc.

Accounting Conventions
1. Convention of complete disclosure

The disclosure convention indicates that all the relevant and material information
necessary must be revealed when an accounting statement is prepared. This also involves
appropriate classification, summarization and also a valid explanation of various business
transactions. This convention ensures that the owners and investors of a business get all
facts and figures related to the business. It is not necessary to reveal business secrets and
strategies but only those facts needed for understanding the financial
position must be revealed.

2. Convention of consistency
Financial statements have to be used for comparison and analysis for reasonably long
periods. Therefore it becomes necessary that uniformity is maintained in recording and
classifying transactions.. For instance the amount of depreciation of asset can be
calculated using various methods like Straight Line method, Written down value method
etc. Although a company has the flexibility to adopt any of these methods, the
consistency convention requires that the same method is followed for a reasonably long
period of time so that value of assets over a long period of time can be
correctly compared.

3. Convention of conservatism
In accounting parlance, conservatism is nothing but ‘playing safe’. The policy considers
all possible losses and makes provisions for it but does not consider all possible profits
expected. For e.g. value of the stock of unsold goods is recorded at the lower of cost or
market price due to the consistency convention. Any discount expected to be given
by suppliers is not to be accounted for but discounts expected to be given to customers
can be provided for.

4. Convention of materiality
When a business is run, there might be loads of information available to an accountant. If
all these are recorded in a statement, it might just be an overdose of an ocean of
information. Therefore the materiality convention laid down by the American Accounting
Association states that “any item should be regarded as material if there is reason to
believe that knowledge of it would influence the decision of informed
investor”. For instance, if there has been any change in the method of evaluation
stock of goods, this must be disclosed as per the convention of materiality. However, if a
profit amount of Rs.50,310.64 is rounded off to the nearest rupee and is reported as Rs.
50,311, this may not be too important for an investor and need not be disclosed.
A fact might look unimportant to one while it may be quite important for another.
Thus the accounting principles and conventions must always be
remembered at every stage of recording transactions.

Types of Accounts

Every asset or a liability

is recorded as a separate account in the company’s books. For example
machinery is a separate account while a loan forms another account. Each
of these accounts can be categorized into the following three types to
facilitate the process of recording.

• Personal accounts
• Real accounts
• Nominal accounts
1. Personal Accounts: A business usually deals with a number of persons
and organizations during the course of its operations. The details of
transactions with these individuals are maintained as separate accounts.
These accounts belong to the category of personal accounts. Examples of
personal accounts are suppliers, employees, banks etc.

2. Real Accounts: A real account represents all ‘real things’ owned by a

business enterprise. In other words, all assets of an organization such as
building and machinery are classified as real accounts. These include both
tangible things such as cash and building as well as intangible things such
as goodwill or patents which are also assets for the business.

3. Nominal Accounts: Nominal accounts are those accounts related to

items which do not actually exist in the form of persons or assets but
represent money paid or received for various purposes. In other words,
income and expenses such as salaries, interest on deposits etc belong to
the category of nominal accounts. These accounts are created to know the
purpose for which money is received or paid. For instance when salary is
paid to en employee, the cash paid is a real account and the purpose for
which the cash is paid i.e. salary is a nominal account.