Identification of Accounting Elements

After reading this article you will learn about identification of accounting elements.

Accounting elements are identified in transaction analysis process. Always two accounting elements are involved in each transaction or event.

An event is a happening of consequence to an entity. It may be an internal or external event that causes evaluation of existing resources. An entity carries out stock- taking at the year end and found value of inventories to be Rs.100 million – it is example of an event. An entity carries out a survey and financial analysis and establish that value of plant and machinery is impaired (means eroded) because of emergence of new technology. This is an event.

Transaction means an external or internal event by which an entity exchange resource with another entity, or a division of an entity exchange resource with another division. X Ltd. sold goods to Y Ltd. – this is an example of exchange of resource between two entities. Fertiliser division of X Ltd. purchases material from its chemical division – this internal transaction that signifies exchange resource between two arms of the same entity.

All transaction and events have dual aspects meaning that they involve two distinct accounting elements (out of five) or two sub-items of the same account­ing element.

Example 1:

Analyse the following transactions and events, and identify debit – credit giving reasons:

i. X Ltd., raised equity share capital of Rs.500 million.

ii. It purchased plant and machinery for Rs.400 million.

iii. It took bank loans Rs.200 million @ 10% interest p.a.

iv. It purchased raw materials for Rs.500 million, spent Rs.100 million wages and salaries, Rs.40 million factory expenses.

v. It produced 10,000 units generator sets.

vi. It sold them @ Rs.80,000 per set.

vii. It paid interest at the year end.

viii. It spent Rs.30 million on account of general, administrative and marketing expenses.

Solution:

Check:

Sum of debits equal sum of credits – it is obvious as all transactions are analysed into debit and credit. The double entry principle sets out that debits are equal to credits.

Summary:

Example 2:

Apply your knowledge of accounting equation and set out final accounting equation taking into account all eight items discussed in Example 1.

Solution:

Cash In Hand = Rs. 500 – Rs. 400 + Rs. 200 – Rs. 640 + Rs. 800 – Rs. 30 – Rs. 20 = Rs. 410.

Cash debit means cash increased, cash credit means cash decreased.

Example 3:

A company has sold goods in cash Rs.600,000 and met expenses of Rs.4,00,000 in cash. So it has earned profit of Rs.2,00,000. Show debit and credit.

Solution:

Debit-credit analysis in 3 & 4 are closure entries. All income and expenses are transferred to income Statement (Profit and Loss Account) for profit or loss measurement.

Now you will check that debit and credit amount of Profit and Loss Account tallies to each other.

Finally, net profit is transferred to Retained Earning this is also called (Reserves and Surplus).