Skillz

Financial statements for the uninitiated

This article is the first of a series designed to help those with no background of accounting or
finance to read financial statements. While an attempt will be made to avoid unnecessary
technicalities, these cannot be entirely eliminated.

What is book keeping?

Book keeping is the systematic recording of all

financial transactions of an organisation. For simplicity,
we shall refer to the organisation as the company. In
the paras to follow, we shall deal with Accounting, more
specifically double entry book keeping which is the
accounting system followed almost universally.
Double entry book keeping dates as far back as the
times of the Pharaohs in Egypt, whence it is presumed to
have originated. The system records every financial
transaction expressed in terms of money in two equal
and opposite parts, namely a debit and a credit.
Before we proceed further, it is necessary to acquaint
ourselves with some of the fundamental principles of
Accountancy. These are as follows:
Measurement: Accounting measures only financial
transactions or those capable of being expressed in
monetary terms. All other transactions, however
significant, are outside the scope of accounting.
Actual value: All transactions are captured at their
actual or historical cost. The market value of the
transaction is not to be considered at all.
Separation of ownership: From the accounting
perspective, the company and the owner are distinct from
each other. The owner is treated on par with an outsider.
This principle is very important for a proper
understanding of accounting.
Two facets: Every act has an equal and corresponding
aspect. This simple concept enables accountants to assure
themselves that the books are error free or balanced.
For example, if a company buys a computer for Rs.
50,000/-, it will record an increase in the assets to that
extent. At the same time, it will show a reduction of its
cash balance by Rs. 50,000/- if the computer was
purchased for cash or an increase in its liability to the
vendor.
Going Concern: There is an implicit assumption that
the company will remain in operation in the foreseeable
future. This assumption allows accountants to segregate
expenditure and income into short term or current and
long term or deferred. It must be stressed that in the
absence of this assumption, the entire method of
recording the transactions would be radically different.
Accrual Concept: All income which the company is

entitled to but has not received and expenditure which

the company has incurred but not paid should be
considered for arriving at the net surplus or profit for a
certain period.

The Golden rules of accounting

All transactions must be allocated to accounts or a

classification. Broadly speaking, there are three categories
of accounts:
Real Accounts: Items such as goods, assets such as
furniture, in fact all items which one can physically touch
would be classified as a real account. For example, Motor
car or computer.
Personal Accounts: Any person whom the company
transacts with would be classified under personal
accounts. For example, Mr. Patel or Apex & Co are
persons.
Nominal accounts: These are usually accounts, which
relate to income or expenditure. For example conveyance
expenses or Salaries would fall under this category.
The three golden rules of accounting relating to these
three types of accounts are:
Real Accounts: Debit what comes in and Credit what
goes out.
For example, if a calculator is purchased for cash, by
applying the above rule, you would debit Calculator
account and credit Cash account.
Personal accounts: Debit the receiver and credit the
giver.
For example, in the above case, if the calculator was
purchased on credit from Casio Inc., , you would debit
Calculator account and credit Casio Inc.
Nominal accounts: Debit the expense and credit the
income
For example, if you were to spend Rs. 100 on
conveyance, you would debit Conveyance account and
credit Cash account. Similarly, if you receive cash of Rs.
200/- as fees, you would debit cash account and credit
fees account.
This covers most of the technical stuff you need to
know for analysing a financial statement. Next time, we
shall begin our journey of examining the financial
statements of a company.
- Vinay Singh
Advanc'edge MBA / April 2003