The Hindu Business Line : Basic concepts in accounting

With the change in the ICAI’s (Institute of Chartered Accountants of India’s) exam pattern and syllabus, students with little basic knowledge of the concepts may pursue the course after passing the CPT examination.

There are certain terminologies used in accounting which have to be understood well by these youngsters.

EXPENDITURE AND LOSS

Everyone knows the rules of journalising the nominal accounts — to debit all the expense and losses and to credit all the incomes and gains. Obviously, there is an enormous difference between expenditure and a loss, which holds good for income and a gain as well.

A single isolated transaction involving outflow of cash be it immediate, earlier or later is expenditure. To constitute a loss, there should be a set of transactions. A single transaction cannot result in a loss.

For example, a pen costs, say, Rs 10. On a particular day, Student A does not have a pen to write. Student B, sitting next to A, offers a pen, but demands Rs 15. If A accepts to pay Rs 15 to B the next day and takes the pen, it is expenditure. By buying the pen for Rs 15, A has not suffered any loss.

The entire Rs 15 is expenditure. It may be observed that B might have paid Rs 10 for the pen to the shop keeper. What B did is a cash transaction and A buying it for Rs 15 is a credit transaction.

B has gained Rs 5, being the difference between cost price and selling price, which is the result of the following two transactions:

(a) bought the pen for Rs 10; and

(b) sold it for Rs 15.

If a mobile phone is stolen, the loss arises. At the time of purchase of the mobile phone it is not a loss. Any penalty paid — say, for driving without a helmet or parking in a no parking area — is not a loss. It is an item of expenditure.

PROPERTY AND ASSET

The term asset denotes a commercial use, while property indicates a personal use. The cell phone used by a student is a property but if the same is used by a businessman for the purposes of his business, it becomes an asset.

The car used by a businessman for his business purposes is his asset. But if an employee uses his own car to go to office and back, it is not his asset. It is his property.

The house in which a person lives is a property whereas the place where business is carried on is an asset because it is put to commercial use. It is important to note that only assets are subjected to depreciation and not property.

PROFIT AND GAIN

When goods are bought with the intention of selling them at a higher price, the resultant difference between the two transactions is profit.

But if the “profit motive” does not exist at the time of purchase, the resultant cannot be termed as a profit. It is a gain. In the above example, what B made in the transaction is a gain and not a profit. But the shopkeeper who originally sold the pen at Rs 10 has made a profit because of the existence of profit motive at the time of purchasing the item.

SUBSIDIARY BOOKS

Any student would reel out books of account as under:

Cash book: Used to record cash transactions;

Journal: To record opening, closing and adjusting entries;

Ledger: To maintain individual accounts;

Subsidiary books: To record credit transactions.

The term “subsidiary books” is used to denote the books used to record credit transactions. Book of prime entry is the age-old journal, which is the backbone of the accounting system. With cash book evolving, all the cash transactions are recorded in this book.

When the term “subsidiary books” is used, what about the “primary books” to which this is subsidiary? This remains an unanswered question.

These subsidiary books are not subsidiary to the ledger, since entry in the ledgers is posted based on the purchases book, sales book, etc. Then, what is it that to which these books are subsidiary? In fact, almost all transactions, be it purchases, sales, services, utilities — almost all of them are credit transactions.

Transactions are classified into two categories — cash transactions and non-cash transactions. Non-cash transactions are further classified as: (a) credit transactions; and (b) those transactions represented merely by way of book entries. (Section 227 (1A) makes a reference to such type of transactions).

Credit transactions are recorded by their nature in the respective books just as cash transactions are recorded in the cash book. Such books should be accorded the status of books of prime entry. The term “subsidiary books” should be dispensed with immediately.

TREATMENT OF CHEQUES RECEIVED

It is an age-old practice that cheques received are treated as cash and recorded in the cash book (in the cash column) as a receipt. When these cheques are deposited in the bank at a subsequent date, the bank account is debited by way of a contra entry, crediting cash.

Several textbooks as well as the study notes of various institutes follow the same mechanism. Strictly applying the principles, treating a cheque as cash is not justified.

A cheque is not cash — at best it could be termed as a cash equivalent. Cash, which is transferable freely and accepted universally, has a better position than a cheque, with limited transferability and acceptance.

There is nothing which prevents one from opening an account “cheques on hand” and debit this account when cheques are received. This could as well be supported by an underlying record such as cheques received register.

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