Wednesday, September 10, 2014

Cash flow Statement

contd. from Accounting Basics

1.4 Cash flow Statement

You should also have idea about cash flow statement. This shows how TOD's cash has changed during the time interval shown in the heading of the statement. This statement shows the cash generated and used by your company's operating activities, investing activities, and financing activities. Much of the information to this statement comes from balance sheet and income statement. We shall learn more about it in a chapter separately.

1.5 Double Entry System of Accounting 

For ages, accountants have been using accounting procedure termed as double entry system of accounting for recording transactions. In double entry system, each amount is recorded in at least TWO accounts.
For each transaction, there are two aspects. One is “receiving aspect” or “incoming aspect” or “expenses/loss aspect”. This is “Debit aspect”. The other is “giving aspect” or “outgoing aspect” or “income/gain aspect”. This is “Credit aspect”. These aspects “Debit aspect” and “Credit aspect” form the basis of Double Entry System. For every debit, there must be a corresponding credit of equal amount and vice versa.
Recording of transactions can be done by following given approaches:
I. Accounting Equation Approach
II. Traditional Approach

Accounting Equation Approach

This is called American approach wherein transactions are recorded based on accounting equation
Assets=Liabilities+ Stockholders' (or Owner's) Equity

Traditional Approach

This is British Approach. Transactions are recorded on the basis of existence of two aspects of each transaction i.e. debit and credit. Books of accounts are used to record transactions under double entry system.
For your company first you should find out all the relevant and useful list of accounts for recording transactions. This list is referred to as Chart of Accounts.
TOD might use following accounts

From Balance Sheet

  • Asset accounts (e.g. Cash, Accounts Receivable, Supplies, and Equipment) 
  • Liability accounts (e.g. Loan Payable, Accounts Payable, and Wages Payable) 
  • Stockholders' Equity accounts (e.g. Common Stock, Retained Earnings)

From Income Statement: 

  • Revenue accounts (e.g. Service Revenues, Investment Revenues) 
  • Expense accounts (e.g. Wages Expense, Rent Expense, Depreciation Expense) 

1.6 Illustrations for Double Entry System of Accounting (American Approach) 

 Suppose on July 1, on the first day of your business, first transaction is investment of your money (Rs. 500,000) for 50,000 shares of TOD of common stock then TOD's accounting system will show addition to CASH account of Rs. 500,000 and stockholder’s equity account will show increase of Rs. 500,000. CASH and STOCKHOLDER’S EQUITY are balance sheet accounts. Nothing will appear on income statement because there is no revenue or expenses as on July 1.

When you record these transactions, TOD's balance sheet will look as shown below as per American approach:

Balance-sheet always balances as shown above. From above table an equation may be derived which is given below.

                            Assets = Liabilities+ Stockholders' (or Owner's) Equity
                         500,000 = 0                + 500,000

As we learnt about double entry system of accounting, in this case two accounts i.e. Cash and Common stock accounts are affected by the transaction.

As per double entry system, an amount for transaction should be entered on left side of one account and on the right side of another account. Entry on left is DEBIT and entry on right is CREDIT. Amount is entered is same on both sides.
But how accountants know which account he should debit and which account he should credit. For that we shall have to know about types of accounts. Account is a summary of relevant transactions at one place relating to a particular head. Account may be classified based on kind of transactions.

Transactions can be divided into three categories

• Transactions relating to individuals and firms
• Transactions relating to properties, goods or cash
• Transactions relating to expenses or losses and incomes or gains.

Therefore accounts may be classified as follows

Personal Accounts: The accounts which relate to persons. Personal accounts include the following.

i. Natural Persons: Accounts which relate to individuals. For example Ram's A/c, Daksh’s A/c, etc. ii. Artificial persons: Accounts which relate to a group of persons or firms or institutions. For example, XYZ Ltd., Indian Bank, GIC Limited Country club etc.
iii. Representative Persons: Accounts which represent a particular person or group of persons. For example, outstanding salary account, prepaid insurance account, etc.

The company may keep business relations with all the above personal accounts, because of buying goods from them or selling goods to them or borrowing from them or lending to them. Thus they become either Debtors or Creditors.
The proprietor being an individual his capital account and his drawings account are also personal accounts.

Impersonal Accounts: All those accounts which are not personal accounts. This is further divided into two types viz. Real and Nominal accounts.
i. Real Accounts: Accounts relating to properties and assets which are owned by the business concern. Real accounts include tangible and intangible accounts. For example, Land, Building, Goodwill, Purchases, etc.
ii. Nominal Accounts: These accounts do not have any existence, form or shape. They relate to incomes and expenses and gains and losses of a business concern. For example, Salary Account, Dividend Account, etc.
Business transactions are recorded based on following golden rules of accounting

Sr.No Name of Account Debit aspect Credit Aspect
1Personal The receiver The Giver
2Real What comes in What goes out
3NominalAll Expenses and LossesAll income and Gains