Basic Records or Documents Needed for Building Your Accounts

Some fundamental records must be maintained to build any type of account, whether it is your Individual Account, Business Account, or any other field that attracts income tax. 

You cannot create or maintain an account without basic records that support your transactions. At least, you need to remember the nature and purpose of your payments and receipts. A scrap book where you note down as and when you bought something or received some money.

These basic records and documents 9for example, bills and receipts) are the most essential and important foundations for an accountant or auditor to create or maintain accounts and verify their authenticity.

Some of the essential documents are discussed below:

Purchase Bills

Bills for any purchases, whether you pay cash or credit, are to be safely maintained as your primary record. You make entries from these bills by preparing vouchers. I will discuss vouchers at a later stage. So, these bills should be kept safely either pinned to the vouchers or in separate files. 

If kept in files, you should maintain separate files according to the nature of transactions and the account head of that purchase and mark the files with their identity/nature. Or, you can simply arrange your bills and documents chronologically and mention the period on the file cover. 

In either case, you may pin the duplicate copies or xerox of the bills along with those vouchers. Keep original bills for record-keeping in their respective topic files for any urgent reference in the future.

Sales Bills

When you make sales, you should prepare sale bills to your customers.  It helps buyers understand the details of the payments made or to be made by them for those purchases. Additionally, it serves as the document for their accounting purpose. 

There may be cash and credit bills. Credit bills refer to Credit Sales. 

In either case, a copy of the bill is to be retained by you for record and for preparing your accounting entries. Cash bills may be enclosed with your sale vouchers. But credit bills are to be kept separately in files, and copies of them are to be enclosed with the voucher (you will be preparing a Debit Voucher debiting the receiver of the goods/items). 

If transactions are too many, you cannot enclose all bills with vouchers. In that case, you can give the bill number and date in your vouchers and keep the bills in files.

Asset Purchase and Sale Records:

You should maintain these bills as well to calculate the value of assets that are of significant value in your possession. If you sell any of them, keep a record of the sale value and date of sale, with supporting evidence. You can maintain an Assets Register if you are holding or selling too many assets.

Vouchers

Vouchers can be either Cash or Bank (voucher), or Journal voucher according to the nature of transactions.

• Cash vouchers are made for cash transactions when you purchase in cash or sell against cash. You can keep the cash bills enclosed with the vouchers. But if you make any big purchases, like assets or equipment, keep the bills in secured files, and only copies may be attached to vouchers.
• Bank vouchers are prepared for entering bank transactions. If you purchase by giving cheques or sell by receiving cheques or drafts, these bank vouchers are prepared. Here also, tiny payment bills may be enclosed with the vouchers, and big payment bills need to be kept in relevant files for a safe record.
• Journal vouchers are prepared for transactions other than cash or bank payments. These can be prepared for monthly total entries against sales or purchase day books or for any internal transfer accounts and adjustments or for salaries and wages sheets and depreciation accounting, etc.

Business Property Documents

Whatever property you hold in the name of your business requires proof of the holder, its authenticity, and valuation. You should be able to justify your property and its valuation and its holdings duly certified or verified by some legal authority.

Passbook

If you hold Bank or Post office accounts, you should keep the passbooks properly updated from time to time, for verification purposes and making entries in your account books. Your entries should always be tallied with the passbook entries, and keep everything updated.

Liabilities: Meaning and Classification of Liabilities

Liability is something which a person owes to another. It is an obligation that should be met by the liable party as a result of any activity or transaction entered into by the two parties.

At times, a liability can be merely a responsibility or sense of feeling shown by one person to another in place of sheer love or gratitude. For example, performing the marriage of a daughter or donating money to some social cause periodically, or even frequently, can be felt as a liability.

But, for accounting purposes, a liability is to be defined as an obligation or responsibility of a person or any business entity to the other party as a result of a transaction or contract. 

It is an unavoidable obligation to be fulfilled by the party concerned to his creditors or other parties on the maturity of a certain period, or on the occurrence of an event, or the achievement of a certain goal or target.

Liabilities, in accounts, are mostly monetary and expressed in money values. Though goods can be exchanged between parties to meet out liabilities, they should be evaluated and expressed in the books in money values.

Classification of Liabilities

Liabilities are generally classified into three major groups:

1) Current Liabilities

2) Long-Term Liabilities

3) Contingent Liabilities

Now let us take a look at the nature and identification of these three classes of liabilities.

Current Liabilities

Current liabilities are also known as short-term liabilities due to their short duration. A current liability signifies the priority involved in the clearance of the liability. Such a liability is considered to be cleared within a specific short period, say within 3 months or 6 months. You will have to clear them within that short range of period. Some of them may even become due within days, say within 3 days, 7 days, or a month like that. 

Any type of borrowing or credit taken to meet your daily needs of business falls under this category, and they are to be cleared first. Salaries and taxes payable are such urgently payable short-term liabilities. Besides, bank overdrafts, short-term credits, like credit cards, and credit purchases are also examples of this category.

Long-Term Liabilities 

From the name itself, you are able to see that these liabilities are of long-term or for longer durations. Normally, such liabilities are cleared in many years, and the terms of repayment are set forth at the time of obtaining the funds or during execution of the contract. Bank loans for long periods, mortgages, etc. fall under this category.

Contingent Liabilities 

This category of liability depends on the occurrence of a contingency. That is, its settlement is tied to the occurrence of an event or incident. If the specified event occurs, it becomes due and payable immediately upon that happening. If the stated incident does not occur at all, it is not required to be settled.

So, a contingent liability means that it shall be met only on the occurrence of a certain incident. The time of that occurrence is neither known nor certain. 

There can be other unexpected incidents like a breach of contract, damage due to accidents, and/ or court cases which are also treated as contingent liabilities.

For accounting purposes, only current liabilities and long-term liabilities are considered in the Balance sheets. 

Contingent liabilities are merely mentioned in the notes as a supplement to the Balance Sheet for the information of the Board of Directors and Shareholders.

Definition of Assets and Types of Assets

What is an Asset?

Any goods of significant value that are durable and saleable in the market may be treated as Assets.

But sometimes, from an ordinary layman's perspective, anything considered very important to him can be treated as an asset, even though it is not saleable. 

This means that his child is his asset. Or a gift received from his sweetheart can be a great asset for him. His hands, legs, or brain can be treated as assets by him, which are of great importance for his earning and sustenance.

But, as we are currently dealing with Accounts, an asset is something with significant importance and monetary value, and lasts for a durable period and can be easily sold in a market or be exchanged for other goods.

Definition of Asset

Different definitions have been proposed describing an asset. But the essence of all definitions is more or less the same.

"So an asset may be any goods or resource or property having value for some durable period and which generates income or aids in the production of other goods and services which generate income to the holder of that asset."

So from the above definition, you can see that-

• An asset has to be of some value. 
• It should be marketable or exchangeable for other items. 
• It should be of some considerable duration. 
• And finally, it can be anything that generates income for a certain duration of the period.

Types of Assets

The above definition revealed that assets have different qualities. That means there are multiple characteristics of any asset that refer to their durability and exchangeability. Assets have been classified according to their nature and tangibility.

Classification of Assets Based on Liquidity or Convertibility:

One classification of assets is into Current Assets and Fixed Assets based on their convertibility into easy money or hard money.

• Current Assets are more easily convertible into cash or other goods within a short span of time with no legal barriers and procedures. Goods in stock or trade, cash and bank balances, and other sundry advances or deposits fall in this category of Current Assets. Current assets are mostly of a shorter time span and may become obsolete after a certain period.
• Fixed Assets are more of a fixed nature and last for many years, like Land, Roads, Building, Plant, and Machinery, etc. Further, they can not be easily sold or converted. They require adequate legal formalities and considerable time to dispose of. 

Classification of Assets Based on Usage or Utility:

Another classification based on the utility or use of the assets divides the assets into Operating and Nonoperating Assets.

• Operating Assets are those which are required for daily operations of the business, as well as for use in various production processes enabling the business to generate income. So naturally, the working capital like Cash and Bank balance, inventory in use, a stock of semi-finished and finished goods, and Plant and machinery, etc., used for running the business are all termed as operating assets.
• Non-Operating Assets are assets not of much importance for running the business but still held for future plans or disposal. The business production and activities do not get hindered by disposing of those assets. Such assets can include any excess land or buildings kept for future plans and extra cash or funds invested unnecessarily. Inventory of old and obsolete items no longer used for production and inoperative dead balances lying for long periods can also be treated as non-operating assets.

Classification of Assets Based on Tangibility or Physical Nature:

Based on their physical or non-physical existence, assets are classified into Physical and Non-physical assets.

• Physical or Tangible Assets are those which have physical quality and can be seen and felt. All fixed assets, cash, and bank balances, inventory items, debtors, are all tangible assets.
• Intangible Assets can be anything that can not be touched or felt, like a company's Brand name, patent, copyrights, logo, goodwill, and trademark, etc. Even though not physical, these are very useful and important as they promote business and help in increasing sales and profits.

Three Branches of Accounting: Costing. Financial, and Management Accounting

Any business or trade needs to maintain records for various purposes.

The owner of a business wants to know how much profit is being made and what the assets and liabilities are at any time. 

The government requires proper record-keeping and tax payments. 

The manager is concerned about how to control costs and increase the company's profit. 

Therefore, accounting principles must provide accurate information to satisfy all these people. 

To meet the above-stated needs of different groups of people, multiple branches of accounting have developed according to their basic purposes. 

The three most important branches of accounting are Cost Accounting, Financial Accounting, and Management Accounting.

Let us now discuss these branches one by one.

Cost Accounting

Cost accounting deals with the segregation of costs. It analyses the cost of the finished product through various intermediary and final output stages. 

For example, it deals with the cost of the raw material, semi-finished goods, and finished goods one-by-one and side-by-side. Finished product cost includes other costs also, like administrative, marketing costs, and selling expenses, and elements like interest and depreciation. So all the required information needs to be kept accurately to determine the cost at each stage. This is possible through cost accounting records.

The total costs incurred, like salaries, wages, and administrative expenses, are maintained product-wise and stage-wise for each process and product. This facilitates calculating costs at different stages and for each product individually. Only then can their management control the costs at each level and determine the price for selling their products.

Financial Accounting

This branch is responsible for maintaining accounting records such as the Cash Book, Bank Book, Main Ledger (General Ledger), Customer and Sales Books, Purchase Ledger, etc. These records must be maintained accurately to prepare the company's Profit & Loss Account and Balance Sheets, which enable the Taxman to verify whether the tax is being properly calculated and deposited. It also enables the management and Board of Directors to understand the company's financial position.

Management Accounting

This is also an important accounting branch. This branch deals with the preparation of various monthly, weekly, and yearly reports, like Cash Flow, Funds Flow, and Budget. They are compared with actual expenses. These reports provide information to management regarding the progress of the company, its financial status, and enable them to take important decisions for the efficient running of the business.

Other Branches of Accounting:

Besides these main branches of accounting, there are other branches like Government accounting, Tax accounting, Audit accounting, Fiduciary accounting (dealing with accounts on behalf of minors), and Fund accounting, and other branches

Meaning of Finance: Its Objectives and Scope

Introduction to Finance as a Subject

Finance as a subject deals with money matters. It helps plan the financial growth of institutions and economies. It examines the creation and circulation of money and its efficient management. It studies the financial conditions of a country, region, business entity, or even individuals. It examines how people and countries behave in financial matters, including how they collect and create funds and make financial decisions. Based on such scientific studies, it formulates principles and provides guidelines for solving financial problems and helps create and maximize funds through efficient management. It includes the management of money, funds, and capital.

Objectives of Finance

Here are the two important objectives of finance: Profit Maximization and Wealth Maximization

1) How to Manage Money Efficiently

This is aimed at profit maximization. 

Any financier who invests his funds in business aims at maximising the returns on the money invested. So efficient management of money is necessary to earn profits. This goal is achieved through proper planning, streamlining available resources, and eliminating waste and unnecessary expenditure.

2) How to Create and Arrange Funds

This is aimed at wealth creation and wealth maximization. 

If it is public finance, you are concerned with accumulating money and providing funds for the various projects and activities of a country. 

If it is a business entity, the finance personnel are concerned with creating funds through profit maximization as well as efficient control of money by locating wastages. 

They are further concerned with various options available for creating funds like debt management, loan financing, share dealings, etc.

We shall discuss these functions in detail later on.

Scope of Finance

Finance plays an important role in almost every field of public and private activities. So its scope is much broader than initially purported to be. We can assess the scope of finance in two distinct ways.

1) One is based on the nature of organisations or institutions it deals with: public or government, corporate, private, institutional, personal and international types.

2) The other is based on the nature of functions. Modern financial activities are directly linked with many functional departments like public administration, personnel, marketing, accounting, and production.

Let us have a look at these horizons of finance.

1. Public Finance

Public finance is associated with the study of government spending- the way they raise large amounts of funds and spend them through planned budgets for different schemes. Public spending is different from corporate and institutional spending as it is not profit-oriented. It concentrates only on raising funds and spending them prudently for public welfare works through efficient management. The finance departments of central and state governments, with their Finance Ministers and staff, fall under this scope.

2. Corporate/ Business Finance

Corporate Finance and Business Finance deal with the capital structure and activities of various business establishments and corporate bodies. Here, all activities are profit-oriented. So financial decisions and activities are aimed at profit maximization. It is concerned with how to invest, save money, and increase profits through efficient financial management. All business firms and corporations appoint Finance Managers for this function.

3. Institutional Finance

Institutional finance deals with some public service-oriented institutions that also work for profit, like Banks, Insurance Companies, educational institutions, etc. They deal in savings and capital formation by way of serving the public.

4. Personal Finance

Personal finance is concerned with the individual financial activities of people. Preparation of personal budgets, providing guidelines for saving and spending, financing of loans, etc are studied here.

5. International Finance

International finance deals with international activities of finance. Financial transactions between nations, matters related to compliance with international financial laws and regulations are covered in this area. It also deals with the transactions between individuals and corporate bodies that have multinational and international activities with regard to the flow of money and financial problems across international markets.

Further, based on the activities of functional departments, the purview of finance includes the following branches of study:

1. Finance and Accounts

2. Finance and Costs

3. Finance and Economics

4. Production Finance

5. Marketing Finance

6. Personnel Finance

We may discuss these things in later chapters.

Production Possibility Frontier, Opportunity Cost and Specialisation

Economics deals with the problem of optimizing the use of scarce resources to achieve the best possible returns from them. To achieve the best possible results, it analyses various alternative methods of using the resources. During this study, we come across various terms like Production Possibility Frontier (PPF), Comparative Advantage, Opportunity Cost, Economic Efficiency, Specialization, and Absolute Advantage, etc.

Let us study these economic concepts one by one.

Production Possibility Frontier (PPF)

Any country or region must produce and provide a number of products and goods to meet the needs of its people. But normally the resources of any given place or country do not allow it to produce all its requirements in abundance. Some items may be produced in larger quantities, whereas other items may be produced in smaller quantities and at higher costs. All this depends on the availability of resources and the costs involved in turning those resources into end products.

For example, let us suppose two items produced by a country, say steel and petroleum. Steel is easily produced in large quantities due to the availability of vast reserves of iron ore. But petroleum is being produced in smaller quantities and, that too, at high cost, due to shortage of resources and drilling problems at deep levels.

If the country has to produce both items, with the help of its other fixed resources remaining the same, like manpower, technology, and working capital, it becomes necessary for the country to figure out how much quantity of these products can be produced so that it may use the available resources to their optimum possible benefits.

Suppose the country in our study can invest an equal amount of money in the production of steel and petroleum products. As a result, it can produce 1 million MT of steel and half a million kiloliters of petrol (when equally invested and other factors are completely utilised). Now, if the steel production is surplus, the country may want to divert the investment in steel to petroleum products to meet the shortage of petrol. 

Suppose the cost of production per MT of steel is $800 and that of petrol is $1000. So when diverting funds to producing petrol, you need an additional $200 for each KL of extra petrol.

If you can reduce 5lac MT of steel, you will be able to produce another 4lac KL of petrol. Or, if you forego 2.5lac MT of steel, then you get 2lac KL petrol approximately.

If represented in a graph, the picture will be like this.

Category 1 is steel, and Category 2 is petrol.

• Series 1 line shows that if steel is produced 10 lac MT, Petrol production is 5 lac KL.
• Series 2 line shows Steel production as 5 lac MT and petrol as 9 lac KL.
• Series 3 line shows Steel as 7.5 lac MT and Petrol as 7 lac KL.

All three lines are intersecting at a point of 7.2 (approx), which may be the production possibility frontier for these two products. 

This is the best possible combination for producing the two goods economically by using the available resources to their optimal maximum advantage. So, you can produce 7.2 LMT of steel and 7.2 LKL of petrol approximately to reach PPF.

This is when you are contemplating only two products. 

But in actuality, there will be a lot of goods produced, and decision-making will be much more tedious and require much more prudence than a simple chart.

Thus, the applications of the Production Possibility Frontier determine the production structure for any country or firm.

Comparative Advantage

Comparative advantage refers to the process of adapting to the production of those goods and services which can be economically beneficial and feasible compared to other items, both in terms of available resources and the cost factor. In this approach, you will be analysing the various factors related to production among available options. Any country or business can produce only certain goods and services beneficially with its available resources. If it indulges in producing all items, its economy will dwindle. In the above example of steel and petroleum, we can see that concentrating on steel production is more beneficial than producing both items. Petroleum or petrol can be more beneficially imported from another country where it is available cheaper by exchanging with steel than producing it at high costs domestically and wasting the resources. So it is comparatively advantageous to produce more steel in this case.

Opportunity Cost

By opportunity, it is meant that you are given an opportunity to select among two or more items to satisfy an immediate need with your available resources. For example, you have, say, Rs.1000/- with you and you are in need of both shoes and a branded shirt. But when you enquire at the stores, you may realize that you can procure only one item with your money. So you will have to decide which is more important for you, purchase that item, and postpone the other item until next shopping. So, in this instance, if you opt for the shoes by foregoing the shirt, the opportunity cost of the shoes is the shirt. Economists study these statistics and the driving reasons behind these decisions of consumers to set guidelines for markets.

Economic Efficiency

Economic efficiency is a situation where the economy has attained its best results. If a country could produce all its requirements with its available resources without leaving any bad effects on the economy, it is said to have attained economic efficiency. It is a situation where the country can meet all the needs of its society and people at affordable costs and without any loss to the exchequer. This kind of efficiency is possible when the country is rich in all kinds of resources and technology, etc.

Specialization

Specialization implies reaping the benefits of specialized skills by producing certain goods more abundantly and at lower cost than other countries. Normally, no country or business can produce all goods and services equally well. It may produce some goods very efficiently and in abundance, whereas producing other goods or services may require more resources and effort, with much smaller output. So it will be advantageous for that country to specialize in those goods and services it can produce in greater abundance, and to do so easily and at lower cost. This is possible because it has vast resources and advanced technology for producing certain items. It can concentrate on those items only and reap the advantage of specialization by producing more goods and exporting them to other countries, from which it can import other requirements at cheaper rates than it could have produced them. So specialization improves trading relations between countries and boosts the economy.

Absolute Advantage

Sometimes, a country may be so positioned that it will be rich in all kinds of resources and technology skills by default. In such cases, the country is said to be in absolute advantage as compared to others in the production of any type of goods and services. It may be a rare case.

To sum up, a country's economy will generally benefit if it focuses on specific products and services, using the PPF, comparative advantage, and specialization. In this way, it can use its resources efficiently to achieve optimal outcomes at comparatively low costs and maintain sufficient stock levels. It can export excess goods and services and import other essential goods and services at affordable rates through trade. In this way, it can improve its economy.

Notion of Scarcity and Effects on Economy

Scarcity is a state of the economy where the available goods, services, or resources are unable to meet all the needs and requirements of the public. It is a case of insufficiency. 

People's requirements are larger than the available resources of the country, or that particular economy.

It is a condition of insufficient stock, insufficient production, and insufficient availability of all resources or funds.

Factors Contributing to Scarcity

• It is geographically situated in a way that it is resourceless by default.
• Lack of technology and mining facilities to unearth the resources and produce the end products.
• Ever-increasing population, with no corresponding improvement in production and services.
• Impact of natural calamities destroying resources and production.
• Lack of efficient planning and management.

So you can see that scarcity of resources is both geographical and man-made. 

It is either a natural element or weakness of that country and may also be due to chaos in their administration.

Solutions to the Problem of Scarcity

If the problem is due to natural elements such as being destined by default to be poor in natural resources, then we may not be able to solve it easily.

The available options are either to import raw materials and resources from other countries and produce finished goods in your country, or to import finished goods directly from there.

You should consider the cost factor to be economical. If the cost of production from importing raw materials and turning them into finished goods is lower or equal to the cost of imported finished goods, then you can opt for importing the raw materials and producing them at your end, as it has the benefit of giving employment to your workforce. 

If, on the other hand, you realize that the cost of importing finished goods is much lower, then you should import the finished goods to tackle the situation.

In case the scarcity is due to reasons other than natural elements:

Given the country's scarce resources, there are many factors that require deep understanding and analysis before identifying and formulating solutions.

• In case of floods, rains, and droughts that destroy stocks and resources, you must consider solutions to tackle the problem. Collecting statistics on the frequency and periodicity of these calamities can help you formulate preventive measures, such as constructing dams and reservoirs, adopting rainwater harvesting and irrigation canal techniques, and building water reservoirs and ponds to store water for off-season use. These measures can help address scarcity to a significant extent.
• If the problem is man-made, such as population growth or congestion in certain areas, scarcity can be addressed by controlling population growth or by increasing the production and supply of goods through transportation and transhipment from other places.
• Inefficiency in management and administration can be resolved through proper training programs and active participation by workers and management to remove bottlenecks.
• Proper cost control studies and analysis can reduce funding problems that may contribute to scarcity if left uncontrolled.

From the above analysis, you can realise that the notion of scarcity is both natural and artificial. Artificial in the sense that it is created due to improper planning and administration and lack of knowledge. 

In some cases, scarcity may be intentionally created through corrupt methods to create black marketeering. 

But normally scarcity can be resolved through better planning and administration. 

Better planning is possible through an in-depth review of all the economic factors prevailing in the relevant environments and through formulating suitable principles and norms for application under particular conditions and situations.