Introducing Accounting - Purpose, Information, Statements and Ledgers

1.0 Introduction

Our accounting class has been started one month ago. However, we have a new foreign student, who no zero accounting background, joins in our class. Since our lecturer has finished chapter one to three, he cannot catch up with the syllabus. Therefore, he seeks our assistance, to guide him. So, we have decided to provide him the knowledge that we have leant so far.

1.1 Purpose of Accounting

Accounting is the process of recording, classifying, summarizing, reporting business transactions and interpreting their effects on the affairs of a company. It serves as the language of the business, to communicate the affairs with the users. Doing proper accounts is very important for a few reasons. First of all, accounts provide financial information of a business entity in a systematic manner. It certifies the accuracy of records by preparing financial statements like trading accounts and balance sheet. The management use the information provided to measure the financial performance of the business over the accounting period. The information is also very vital for them to make economic decisions regarding the entity operation.

In addition, accounts keep track of cash inflows and outflow. Transaction recorders who are bookkeepers and decision makers like stockholders and managers have to make budgets, projections, financial reports, highlight areas of profitability or loss according to the accounts, to provide factual information about the financial position of the entity. This is done to maximize profit.

Furthermore, accounts can provide information to governments. Tax authorities need the accounts to review or evaluate tax returns. Some government departments use the accounts information to check that whether the business entity is following government rules and regulation or not.

1.2 Users of Accounting Information

There are many users of accounting information. Users of accounting information fall into two categories which are external users and internal users.

The internal users are including the managerial accounting from inside of the business. Owners use accounting information to make buy, sell or keep decisions related to shares. Owners use this accounting information to indentifies the firm is gaining or losing. They also make the decision on whether to increase or decrease their existing ownership in the firm. Managers also are the one of the users of accounting information. Managers of the business will want to know how things are going. They need financial information in order to plan for the future; they then need more up-to-date information in order to check whether actual performance is on target.

External users are including the financial accounting from outside of the business. Employees or labour union need to know if the company has the ability to pay wages and fringe benefits. Employees require information about the stability and continuing profitability of the business. They only interested in a company’s financial statements because they want the safety of their daily bread, and they also want to increase their wages and salaries. Many government agencies and departments are interested in accounting information so as to evaluate or review tax returns. They need to ensure that the business enterprises are following the government rules and regulations. Besides that, creditors require information that can help them understand and assess the short-term liquidity of a business. They need to convince that the business is liquid enough to meet with the obligation upon maturity. They are looking for information on cash flow, management of working capital and payment policy. Finally, Investors are concerned about risk and return in relation to their investments. They require information to decide whether they should continue to invest in a business. They also need to be able to assess whether a business will be able to pay dividend.

1.3 Books Used in Accounting

There are two types of accounting books that are ledger and journal. Ledger is the main accounting record of a business which uses double-entry bookkeeping and it is also known as the two column T-accounts. Ledger shows the collection of the firm’s account and all the accounting transactions are posted in the ledger using debit entry which is on the left hand side and credit entry which is on the right hand side for each transaction. It usually includes accounts for liabilities, expenses, revenue, fixed assets and current assets. Ledger allows people to check the balance and activities of each account clearly.

The sample of T-account/ledger is as shown below:

Title of account

Debits Credits

Journal is a formal and chronological record of transactions showing the date of the transaction, title of the account debited, title of account credited, amount of the debit and credit, and description of the transaction. Journal is where the information from the source document first enters the accounting system, therefore it is known as the book of original entry.

A journal takes the following format:

Format of Journal

1.4 Recording Transaction in Ledger

In double-entry system, every transaction affects at least two accounts. The changes in the account reflect the increases or decreases of the account over a given period. A T-account is the simplest form of account used in practice.

The format of T-account is as shown below:

Account name

Debit Credits

“The left side of the T-Account is called the debit side, while the right side is called the credit side.”(, 21July 2010, 10.35pm) So, if we enter the amount to the right hand side, we are crediting it, ...

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1.4 Recording Transaction in Ledger

The format of T-account is as shown below:

Account name

Debit Credits

The following is the credit and debit rules.

For example: At 1 January 2008, Ahmad started a business with RM 15,000 in cash.

Capital Cash

RM RM RM RM

Jan 1 Cash 15,000 Jan 1 Capital 15,000

We credit the capital account to show there is an increase in capital and we debit the cash account to show there is an increase in current asset.

1.5 Uses of Trial Balance

A trial balance is a statement of ledger account balances with a ledger at a particular instance. The main purpose of the “Trial Balance” is prepared to check the mathematical/arithmetic accuracy of accounting. If the ledger entries were posted properly, the total of all of the debit balance should be equal to the credit balance. The total of the accounts on the debit and credit side is referred to as the trial balance.

The following is the sample of a trial balance.

John

Trial balance as at 31 January 2010

Debit (RM) Credit (RM)

Cash 200

Capital 1000

Bank 500

David 500

Purchase 800

1500 1500

1.6 Communicating Financial Information to Users By Means Of Financial Statement

Financial statement is the formal record of the relevant financial information of a business or an entity. The purpose of the statements is to communicate the financial performance and position with the users by providing accurate information in monetary terms. The statements have to be understandable, relevant, reliable and comparable as there are very vital in making economics decisions.

There are four major financial statements. Balance sheet is the summary of the company’s financial balances. It is used to report the company’s fixed and current assets, fixed and current liabilities, and owner equity. Assets are always listed in order of liquidity, and then followed by the liabilities. Net assets is the difference of assets and liabilities.

Income statement which is also known as profit and loss statement provides financial information on the income and expenses of the company. The gross profit or gross loss is added with all income and subtracted with the expenses to get the net profit or net loss. By using this statement, whether the company has gross profit or gross loss will be shown during the accounting period.

The third financial statement is the statement of retained earnings. It uses particular information from the income statement and provides information to the balance sheet which is located under owner’s equity. The general equation is Ending Retained Earnings= Beginning Retained Earnings- Dividends Paid + Net Income. This document is very useful in explaining the changes in a company retained earnings.

Cash flow statement is a financial statement that shows the “changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.” (, 19 July 2010). The purpose of this statement is to allow accounting personnel to know will the organization be able to cover payroll and other expenses incurred.

2.0 Introduction

We have interviewed two company of different sector. Lucky S W trading is a manufacturing company while Mega Trax Plastic (Seremban) Sdn. Bhd. is a company with service nature. In the interview, we want to get information on how the accountants of these companies do their accounts and how they apply accounting concepts and conventions in the business transactions. Furthermore, some accountings concepts and conventions are not used by them. Due to Private and Confidential, we are unable to get the financial statements of Mega Trax Plastic (Seremban) Sdn.Bhd.

2.1 Background of the Companies

2.1.1 Mega Trax Plastic (Seremban) Sdn. Bhd.

Mega Trax Plastic (Seremban) Sdn. Bhd. is a company of service nature. The main service provide by this company is to process the collected plastic, then sort them into different part and process them. The collected plastics are drinking bottles, shampoo bottles, runner from big factory and vacuum from electronic factory. After the plastics are being processed, they will either sell them off to other manufacturing company or export the material to overseas.

2.1.2 Lucky S W Trading

Lucky S.W. Trading started operation in the year 1989 which located in Senawang, Negeri Sembilan. The owner of Lucky S.W. Trading is Mr. Ng See Wah. Lucky S.W. Trading is a manufacturing factory which manufactures socks. They produce different kinds of socks such as school socks and football socks; they also produce armband. They produce the school socks with 3 types of size which have small size, medium size and free size. Lucky S.W. Trading will sell their products to the wholesaler. Wholesaler will promote their products to the other people. They will pack their products with different kind of brand before they sell to wholesalers.

2.2 Accounting Concepts and Conventions used by the Companies

2.2.1 Business Entity Concept

This concept states that unit or entity is treated different and distinct from the owner. The purpose of this concept is to make sure that personal and private transactions of owners are separated from the business.

This concept is used by Mega Trax Plastic Industry (Seremban) Sdn. Bhd. as the owner personal fixed assets like house and car are not recorded into the business accounts. In addition, goods taken out for personal use will be recorded as drawings.

The accountants of this company, Mrs Lim says the benefit of using this concept is the accounts’ profit and loss is reported very objectively.

2.2.2 Accrual Concept

The accrual concept states that when service is received, expenses are recognized instead of when payment is made.

Lucky S W Trading has trade payable and other payable in the financial statement of balance sheet as current liabilities. (refer to Appendix) This shows that this company has accrued expenses in their business.

According to Malaysia labour law, employer should help the local employees to pay Sosco and Employee Provident Fund (EPF). The Social Security Organization (SOCSO) provides social security protection by social insurance including medical and cash benefits, provision of artificial aids, to reduce the sufferings and provide financial protection to the family. EPF is a compulsory scheme in Malaysia with aim to provide a measure of security for old age retirement to its member. These two companies have helped their local labors to register them as member of EPF. This is a accrued expenses as they always pay the EPF and SOCSO end of the month.

The reasons of why this concept is being used in the companies are to show more accurate figures in the accounts. With the figures, the managerial can analyze the financial condition of the entity and figure out what they need to do to improve the business.

2.2.3 Accounting Period Concept

Accounting period is the time interval for the measurement of income. The purpose of using this concept is to measure the net income by comparing the assets of the business existing at that time of its commencements with those existing at the time of its liquidation.

Mega Trax Plastic (Seremban) Sdn.Bhd and Lucky S.W Trading use monthly basis as accounting period. According to Mrs.Lim, accountant of the company, they will prepare the profit and loss and the balance sheet financial statement once a month.

The reason of why Mega Trax Plastic (seremban) Sdn.Bhd and Lucky S.W Trading are using monthly basis is to keep the profit and loss statement updated and to provide accuracy for the financial statement. Mrs. Lim also says that monthly basis accounting period can help them to identify the monthly expenses easily.

2.2.4 Historical Concept

Historical concept is the original price paid for the assets. This cost is the basis for all subsequent accounting for the asset.

Mega Trax Plastic (Seremban) Sdn.Bhd and Lucky S.W Trading have recorded the fixed assets in the balance sheet at cost price for the following accounting year. According to Mrs.Ng, accountant of Lucky S.W Trading, they recorded the cost of machines in its financial statement at the original price when they are purchased.

Mrs. Lim says that by using this concept they can calculate the depreciation of the fixed assets accurately so that they can include it in the Profit and Loss, to show an accurate net profit.

2.2.5 Dual Aspect Concept

This concept is the basic principle of accounting. All business transactions are regarded as having this concept that is twofold effect.

Both of the companies which are Lucky S. W. Trading and Mega Trax Plastic Sdn Bhd are using this concept in their account book. The knowledge of dual aspect helps in identifying the two aspects of a transaction which helps in applying the rules of recording the transactions in books of accounts. The implication of dual aspect concept is that every transaction has an equal impact on assets and liabilities in such a way that total assets are always equal to total liabilities.

For example, Lucky S. W. Trading purchase office equipment for cash RM 156.70 on one hand, and pay RM156.70 on the other. The transaction is recorded as debit the account of purchases and credits the account of bank in the book of account. On the other hand, Mega Trax Plastic Sdn Bhd is recording their account as journal. They purchase machinery for cash RM 3000; they receive machinery on one hand, and pay RM 3000 on the other. The transaction is recorded as debit the account of purchases and credits the account of bank in the book of account.

2.2.6 Going Concern Concept

Every enterprise is expected to continue operating their business for long time period. It means that the intention of the business is to carry for a sufficiently long period of time to carry out its existing activities and commitments.

Lucky S. W. Trading and Mega Trax Plastic Sdn Bhd are also expected their business will continue operate in the future. They want to make sure that their companies can earn income in the future.

For example, Lucky S. W. Trading and Mega Trax Plastic Sdn Bhd purchase those machines and it life time just can be few year. Therefore, Lucky S. W. Trading and Mega Trax Plastic Sdn Bhd will draw the income to buy new machines to replace old machines.

2.2.7 Monetary Concept

Every transaction is recorded in terms of money. Lucky S. W. Trading and Mega Trax Plastic Sdn Bhd are using this concept also. Transactions or events which cannot be expressed in money do not find place in the books of accounts though they may be very useful for the business.

The companies are using this concept is because all of the transaction in the account book are record in the term of money. They need to know their income and expenses when they operate the business.

For example, Lucky S.W. Trading cannot express the quality of the product into book of account. However, the company can record the sales amount which is RM 577668.10 to the book account.

2.2.8 Matching Concept

Matching concept is income that determination or measurement of Income is a matter of matching the revenues earned during the accounting period with the expenses that were incurred in the process of earning these Revenues.

Lucky S.W. Trading and Mega Trax Plastic Sdn Bhd using this concept is because they want to know their companies are gain or loss profit for every month or even in the future.

Lucky S.W. Trading and Mega Trax Plastic Sdn Bhd are using this concept. Mega Trax Plastic will record the net profit into the book of account. Lucky S. W. Trading are also using this concept which can refer the profit and loss account in the appendix.

2.2.9 Convention of Conservatism

Convention of conservatism will tend to understate the revenue, profits and assets and also overstate the expenses, losses and liabilities.

This convention is being used by Mega Trax Plastic (Seremban) Sdn.Shd and Lucky S.W Trading. Both of the company makes provision for depreciation and provision for doubtful debts (refer to Appendix) which show that they are overstating their expenses and understating their profits.

The reason of using this convention is to record possible loss before it actually occurs. Mrs. Ng says that this is a useful tool in situations of uncertainty and doubt.

2.2.10 Convention of Materiality

This convention states that unimportant items are either left out or merged together with other items. Immaterial items will not have any significant effect on the results.

Mega Trax Plastic Industry (Seremban) Sdn. Bhd. has also used this convention when they have purchased on some small items. According to Mrs. Lim, sometimes they will buy a few big screws which only cost few ringgits; these items will be merged into either expenses of toiletry or printing.

This convention is used to leave out unnecessary accounts so that it does not look so messy and complicated. As what Mrs Lim says, since the small amounts have no effects on the profit and loss of the business, therefore the small items are combined with other related accounts.

2.2.11 Convention of Consistency

Accountants who stick to only one valuation or transaction method, is following the convention of consistency. Once a particular accounting policy is adopted, it should be followed in all accounting years.

Mega Trax Plastic Industry (Seremban) Sdn. Bhd. and Lucky S.W trading are using this convention as the percentage of provision on depreciation has already been fixed. Every fixed assets in Lucky S W Trading are compulsory to be depreciated for 10%. In Mega Trax Plastic Industry (Seremban) Sdn. Bhd., the provision for depreciation for office equipment is 10% every accounting period, while computer will be depreciated 20% every accounting period. Furthermore, from the four depreciation methods: straight line method, reducing balance method, sum of years digit method and consumption method, both companies have chosen straight line method to do their depreciation.

By applying this convention into the accounts, Mrs. Ng, the accountants of Lucky S W Trading can make more meaningful comparisons of financial performance from year to year. In addition, the convention of consistency helps them to get more accurate figures.

2.3 Accounting Concepts and Conventions that are not used by the Companies

2.3.1 Convention of disclosure

This convention states that all accounts have to be honestly prepared and all material facts have to be disclosed. Financial statement needs to include all their related foot notes and other disclosures.

Mega Trax Plastic (Seremban) Sdn.Shd and Lucky S.W Trading are not using this convention. This can be seen in the balance sheet provided by the Lucky S.W Trading in the Appendix. There is no footnote or disclosure in the balance sheet. Accountant of Mega Trax Plastic (seremban) Sdn.Bhd, Mrs.Lim also says that they do not disclose material facts in the balance sheet.

2.4 Recommendation

The companies are being recommended to use the convention of disclosure as it is very important in preparing accounts. If there is a change in accounting method of provision for depreciation or provision for doubtful debts, all the important facts should be disclosed, as all the relevant data is essential to user’s understanding of the entity’s financial status. Otherwise, the financial statements would be incomplete, unreliable and misleading. Therefore, any changes in the accounting policies, method and procedures need to be fully presented in the accounts in order to achieve the purpose of accounting.

2.5 Conclusion

This assignment has given us the opportunity to gain more knowledge in accounting. It helps us to understand better on the basic knowledge of accounting such as the users of accounting, recording of journal and ledger, preparing the profit and loss and balance sheet and the accounting concepts and conventions. From the interviews, our group members have learnt that how a company uses the accounting concepts and accounting conventions in preparing the accounts and the reasons of using it. We were surprised that a company can actually practice almost all of the accounting concepts and conventions in the accounts. Besides, we also have learnt that the important of using the accounting concepts and conventions so as to prepare a reliable and understandable accounts which fulfill the purpose of accounting.