Basic Concepts of Accounting

Definition:
Accounting is a systematic process of identifying, measuring, recording, classifying,
summarizing, interpreting and communicating the financial information of the business.
Accounts are essentially required to provide information on;
 The available resources
 How the available resources utilized
 What is the end result on utilization of these resources
An account is a record in an accounting system that tracks the financial activities of a
specific;
 Asset
 Liability
 Equity
 Revenue
 Expense
These records increase and decrease as the business events occur throughout the
accounting period. Each individual account is stored in the general ledger and used to
prepare the financial statements at the end of an accounting period.
Assets are resources that the company can use to generate revenues in current and future
years.
Liabilities represent the payment obligations that the company owes to creditors & lenders.
Equity accounts represent the Owner’s Capital/ Stake in the business. Equity is often called
net assets because it shows the amount of assets that the owners actually own after all the
creditors have been paid off.
Revenue accounts track the income generated by the business.
Expense accounts, on the other hand, represent the resources used/ expenses incurred to
generate income.
 Systematic
recording
of financial
transaction

Helps decision
making Preparation
(internal & of financial
external statements
stakeholders) Function
of
Accounts

Helps
Adhering to
communicati statutory
ng financial requirements
information

Ascertaining
results of
business
operations

Provides Ascertaining
Benefits
information to financial
of
external position of
Accounts
stakeholders the business

Helps understand
utilization
available
resources (assets
& cash)
 Branches of Accounting
In order to meet the ever increasing demands made on accounting by different interested
parties such as owners, management, creditors, taxation authorities and other govt.
agencies etc. the various branches of accounting have come into existence.
These branches are as follows:
 Financial accounting
 Cost accounting
 Managerial accounting
 The main purpose of financial accounting is to ascertain the true result (Profit or
Loss) of the business operations during a accounting period and to state the financial
position of the business.
 The main object of cost accounting is to determine the cost of manufacturing or
cost of procurement by the business. It helps the management to identify key costs
and controlling the costs by indicating avoidable losses and wastes.
 The object of managerial accounting is to communicate the relevant information
periodically to the management of the business to enable it to take suitable
decisions.

Users of Accounts
Some of the Internal users of accounting include:
Owners: Responsible for the long-term survival of the business so they will use reports to
analyzing the profitability of their investment and use this information to make top-level
decisions for the future like deciding which opportunities to pursue and eliminate.
Management: Taking direction from the owners, management will use accounting
information to execute top-level decisions, monitor and report results.
Employees and Workers: Many companies provide additional incentives/ bonus etc which is
linked to the profit earned by the enterprise

.
External Users Of Account information
Lenders/ Creditors: Use financial information to make decisions whether credit will be
extended. Before extending loan, banks typically require businesses to present financial
statements to judge credit worthiness.
Tax Authorities/ Govt. regulators: Financial statement & Accounts helps Tax authorities to
determine tax liabilities and other statutory dues of the Company.
Investors & public: Investors use accounting information to determine whether a company
is a good investment.  Investors providing growth capital review financial statement to judge
the safety of their investment.
Customers: B2B customers may look to a company’s financial information to assess financial
stability and payment history to ensure consistency in their business operations.
 Accounting Principals
(GAAP)
Accounts and financial information are used by various external stakeholders. There arises a
need for an accounting framework on the basis of which the accounting transactions are
recorded and presented in a standardized format so as to make the resulting financial
statements understandable and comparable.
This need led to the framing of the Generally Accepted Accounting Principles (GAAP).
GAAP are basic accounting principles and guidelines which provide the framework for
detailed and comprehensive accounting rules, standards and other industry-specific
accounting practices. Thus GAAP encompasses:
 Basic accounting principles/guidelines
 Accounting Standards usually issued by the premier accounting body of the
country
 Industry-specific accounting practices to cover unusual scenarios

Business Entity Concept

 Treat owners of the business separate from the business. As far as accounting is
concerned the owner and the business are two separate entities. This will help the
accountant to identify the business transactions from the personal ones. All forms of
business organizations (proprietorship, partnership, company etc) must follow this
assumption. So for example, if the owner brings in additional capital into the
business, we will treat this as a liability on the balance sheet of the business.

Money Measurement Concept

 Only Financial transactions will find a place in accounting.
 So any business activities that can be expressed in monetary terms will be recorded
in accounting. So for example, if the company goes for major management
restructuring have no effect on the accounting records.

Going Concern Concept

 The going concern concept assumes that a business will continue to operate
indefinitely. So accounting works on an assumption that the business will continue
to operate for the foreseeable future and will not be winding up.
 This assumption is important because if the business entity were to liquidate in the
near future, it would have to restate its assets and liabilities in the accordance with
the actual amount that could be realized or payable as the case may be so as to
reflect the true financial position of the entity.

Accounting Period Concept

Every organization, according to its needs, chooses a specific period of time to complete an
accounting cycle. Generally, the time chosen is 12- Month/ a year called Accounting year.
The time period is always mentioned in the financial statements.
So the indefinite life of an organization is divided into shorter, generally equal time period.
This facilitates comparison of performances and allows stakeholders to get timely
information. Also in most cases, it is also a statutory requirement.
Cost Concept
This concept states that all assets of the firm are entered into the books of account at their
purchase price (cost of acquisition + transport + installation etc). In the subsequent years to,
the price remains the same (minus depreciation charged). The market price of the asset is
not taken into consideration while preparing financial statement.

Dual Aspect Concept

This concept is one of the golden rules of accounting –
for every credit; there must be a corresponding debit and vice- versa.
So every transaction we record must have a two-fold effect, i.e. it will be recorded in two
accounts. This is the core concept of the double entry system of accounting.
For example, the business buys an asset worth Rs 10,00,000/-. So now the Fixed Assets of
the company will increase by 10,00,000/-. But at the same time, the bank balance will
reduce by 10,00,000/-. And so the transaction will have a dual effect in accounting. And
also the Balance Sheet will stay balanced.

Realization Concept
According to the realization accounting concept, revenue is only recorded in accounts/
recognized when it is realized. Revenue is the cash inflow for a business arising from the
sale of goods or services. And we assume this revenue as realized only when it legally
arises to be received.

Matching Concept
This concept states that the revenue and the expenses of a transaction should be included
in the same accounting period. So to determine the profit of a period, all the revenues and
expenses (whether paid or not) must be included.
The matching accounting concept follows the realization concept. First, the revenue is
recognized for the accounting period and then the costs incurred during the same
accounting period are recorded to arrive at the profit or loss for the accounting period.

Full Disclosure Concept

An accounting entry may not independently be able to provide all the relevant information
relating to the transaction. So it is imperative to provide sufficient details and information
that disclose all the financial information relevant to the investor/user to assist him in
decision making. At the transactional level, this is done by recording an adequate narration
with every transaction and at the financial statement level, this is implemented by providing
notes to the accounts.

Materiality Concept
Materiality states that all material facts must be a part of the accounting process. But
immaterial facts, i.e. insignificant information should be left out. The materiality of a
transaction will depend on its nature, value and its significance to the external user. If the
information can affect a person’s investing decision then it is definitely a material fact.
Consistency Concept
Once the company decides on a certain accounting policy it should not be frequently
changed. Unless there is a statutory requirement or it allows better representation of the
accounts. Accounting policies should be consistent for long period of time.

Conservatism Concept
According to this concept, the profit should not be included until it is realized. However,
losses even those not realized but with the remote possibility of occurring should be
included in the financial statements.

Objectivity Concept
This concept states the obvious assumption that the accounting transaction recorded should
be objective, i.e. free from any bias of the person recording it. So each transaction should be
verifiable by supporting documents like vouchers, bills, invoices etc.

International Financial Reporting Standards

(IFRS)

International Financial Reporting Standards (IFRS) set common rules so that financial
statements can be consistent, transparent and comparable around the world.
IFRS are issued by the International Accounting Standards Board (IASB). They specify how
companies must
 Maintain and report their accounts,
 Defining types of transactions and other events with financial impact
IFRS were established to create a common accounting language, so that businesses and
their financial statements can be consistent and reliable from company to company and
country to country.
 Difference between GAAP & IFRS
IFRS GAAP

Developed By International Accounting Standards

Board (IASB) Institute of Chartered
Accountant of India (ICAI)

Adoption Companies in 110+ countries have Indian GAAP is only adopted by Indian
adopted IFRS. More and more companies.
countries are making the shift as well.

Disclosure A company that is complying with When a company is said to follow the
IFRS needs to disclose as a note that Indian GAAP, it’s presumed that it’s
their financial statements comply complying with it and showing a true
with the IFRS. & fair view of its financial affairs.

Consolidated Financial Statements
The companies need to prepared
consolidated financial statement
As per the Indian GAAP, the
companies should prepare individual
financial statements. There’s no
requirement of preparing
consolidated statements.

How assets and revenue shown?
Inventory valuation
As per IFRS, the revenue and assets
are shown at the fair value of the
money received or receivable.
IFRC
IFRS rules ban the use of last-in, first-
out (LIFO) inventory accounting
methods but allows first-in, first-out
method (FIFO) and the weighted
average-cost method
The money charged for the
products/services to the customers
come under revenue and assets are
shown at their cost as per Indian
GAAP.
GAAP
GAAP rules allow all the three
methods.

IFRS
Indian GAAP is also gradually converging towards IFRS. The converged accounting standards
are known as IND-AS. As of now Companies in India has two options; i.e.; either prepare
accounts on GAAP or IFRS.
But Indian GAAP (accounting standards) will continue to remain valid. So companies that
are not required to migrate to IND-AS (IFRS) will use Indian GAAP for accounting and
reporting. Companies may voluntarily adopt IND- AS (IFRS) and migrate to IFRS.

Ind AS will be mandatorily applicable to the following companies for periods beginning on or
after 1 April 2017:
 Companies whose equity and/or debt securities are listed or are in the
process of being listed on any stock exchange in India or outside India and
having net worth of less than Rs.500 Crs.
 Unlisted companies other covered above whose net worth are more than Rs.
250 Crs but less than Rs. 500 Crs .
 Holding, subsidiary, joint venture or associate companies of above
companies.
 Types of Accounts
Account (A/c), is a statement for a particular period showing all the financial transactions
relating to an individual or any other entity or the subject matter. An account essentially
exhibits the benefits being received on one side and the benefits being given on the other
side.

Accounts

Personal
(Customers, Impersonal
Creditors etc.)

Real Nominal
(Expenses,
(Assets &
Revenue, Losses
Liabilities) etc.)

• Accounts
• Asset Account
• Liability Account
• Capital
• Account
• Revenue Account
• Expenses Account

Personal Accounts
Accounts which are either directly or indirectly related to
 individuals
 companies, firms or organisations
Example of personal accounts includes: Kumar Account, XYZ Pvt. Ltd. account, Capital
account, Bank account, Creditors account, Debtors account, Suppliers account, etc.

Impersonal Accounts- Real

Assets:
Asset is an expenditure incurred to acquire resources with an economic value which has
potential to provide benefits of a lasting nature or which can be monetized or converted
into cash. Asset can be tangible asset or an intangible.
Asset accounts have a debit balance and are always presented on the Balance Sheet first.

 Tangible assets are long-term resources, such as Building, factory, plants,

equipments etc. Typically such assets are acquired to derive cash flows and are not
for resell. They are popularly known as Fixed Assets
 Intangible assets are economic resources that have no physical presence. So
Goodwill, trademark, patents and copyrights etc. are example of intangible assets.
 Accounting for intangible assets differs depending on the type of asset.
 Other type of assets: Current Assets: Such assets are in form of book debts/
receivables, stocks/ inventory, bank balance which meant to be converted in cash as
soon as possible

Liabilities
A liability means an obligation. It shows amount that business owe to outsiders. Liability
accounts have a credit balance and always presented on the Balance Sheet. Liabilities arise
during operation of business. It can be in form of
 Purchase of goods and services
 Acquiring assets on credit
 Borrowing funds for use in business

Impersonal Accounts- Nominal

Expenditure:
Expenditure means spending money to run day to day operations of the business. These are
essentially expenses whose benefits are short lived. For e.g.; paying salaries and wages,
rent, marketing and administrative expenses.
Losses:
Losses are considered or recognized when there is decrease in value of any assets. Also Loss
means excess of expenses over income of the business entity. Business can run into losses
may be due to single transaction or series of transaction for an accounting period.

Accounting Equations
Accounting Equations are a mathematical expression which shows that assets and liabilities
of the Company are equal.
Effect of transaction on accounting equation
So any financial transaction, from accounting equation viewpoint can be divided into;
 Transaction impacting two accounts
 Transaction impacting more than two accounts

Transaction impacting two accounts

Increase in Asset Increase in liability
Decrease in Asset Decrease in liability
Increase in Asset Increase in Capital
Decrease in Asset Decrease in Capital
Increase in one Asset Decrease in another Asset
Increase in liability Decrease in another liability

Transaction impacting two or more accounts

Let’s understand this with use of an example.
Particulars Amount (in Rs.)

Sales is made in cash 30,000

Cost of material 25,000

Profit 5,000

So this will have impact as follows;

 Inventory/ goods reduced by Rs.25,000
 Cash/ Bank balance increase by Rs. 30,000
 Profit/ Capital will increase by Rs. 5,000

Accounting Process
• Generation of financial transaction
• Recording of financial transaction
• Posting of entries into ledger account
• Summarising all ledger accounts into Trial Balance
• Making
• Profit & loss Account and Balance sheer
• Analysis& interpretation
• Communicating to users

Accounting process
 • Journal
• At first transactions are recorded in the primary book of accounting called
journal.
• Ledger
• In the second phase transactions are classified and recorded permanently in
the ledger in brief.
• Trial Balance
• In the third phase the arithmetical accuracy of the account is verified through
the preparation of trial balance.
• Financial Statement
• In the fourth or final stage through financial statements the results of all the
financial activities of a year are determined.

Accounting Entries/ Journal Entries

What is Journal/ Accounting Entries

Journal entries are the first step in the accounting cycle and are used to record all business
transactions and events in the accounting system.
As business events occur throughout the accounting period, journal entries are recorded in
the general journal to show how the event changed in the accounting equation.
For example, when the company spends cash to purchase a new vehicle, the cash account
is decreased or credited and the vehicle account is increased or debited.
 How to make Journal Entries
Identify Transactions
Identify the financial transaction . For e.g.; the transaction may
be related to sell or purchase of inventory or sale or purchase of
any asset or it can be related to payment of money or receipt of
money.

Analyze/ Interpret the Transactions

Once you identify the transaction, try to understand or interpret that
particular transaction. Understand how this transaction will impact the
accounting equation. For e.g.; purchase of any fixed asset will result in
addition to fixed asset and reduction in bank balance.

Journalizing Transactions
Once you understand the transaction, you can record the same with help
of journal entry. Journal entries use debits and credits to record the
changes of the accounting equation Each journal entry is also accompanied
by the transaction date, title, and description of the event.

What is Debit and Credit?

Debits and credits are equal but opposite entries in books of accounts. If a debit increases
an account, you will decrease the opposite account with a credit.
A debit is an entry made on the left side of an account. For example, you would debit the
purchase of a new car by entering the asset gained on the left side of your asset account.
A credit is an entry made on the right side of an account. Record the corresponding credit
for the purchase of a new computer by crediting your bank account from which payment
is made.

Business transactions are events that have a monetary impact on the financial statements of
an organization. When accounting for these transactions, we record numbers in two
accounts, where the debit column is on the left and the credit column is on the right.
 A debit is an accounting entry that either increases an asset or expense
account, or decreases a liability or equity account. It is positioned to the left
in an accounting entry.
  A credit is an accounting entry that either increases a liability or equity
account, or decreases an asset or expense account. It is positioned to the
right in an accounting entry.

The rules governing the use of debits and credits are as follows:
All accounts that normally contain a
 debit balance will increase in amount when a debit (left column) is added to
them, and
 reduced when a credit (right column) is added to them.
The types of accounts to which this rule applies are expenses, assets, and dividends.

All accounts that normally contain a

 credit balance will increase in amount when a credit (right column) is added
to them, and
 reduced when a debit (left column) is added to them.
The types of accounts to which this rule applies are liabilities, revenues, and equity.
The total amount of debits must equal the total amount of credits in a transaction.
Otherwise, an accounting transaction is said to be unbalanced, and that will result in mis-
match in assets and liabilities in the Balance Sheet.

Debit Credit
Definition Is a use of value for a Is a source of value for a
transaction transaction
Application Used to express increase/ Used to express increase/
decrease in assets & decrease in liabilities &
expenses or liabilities and income or assets and
income expense
Journal Is the first account that is Is recorded after debit
recorded account followed by “To”
Placement in “T Always placed on right side Always placed on left side
format” Balance
sheet

Type of Account Accounts to be Debited Accounts to be

Credited
Personal Account Receiver Giver

Real Account What comes in What goes out

Nominal Account Expenses and Losses Income and Gain

Golden Rules of Debit & Credit

Type of Account Accounts to be Accounts to be

Debited credited
Assets Increase Decrease

Liabilities Decrease Increase

Capital Decrease Increase

Revenue Decrease Increase

Expenses Increase Decrease

Common transaction involving debit & credit

Sale for cash:

Debit the cash account | Credit the revenue account
Sale on credit:
Debit the Debtor/ Account receivable account | Credit the revenue account
Receive cash in payment from Debtor:
Debit the bank/ cash account | Credit the accounts receivable account
Purchase inventory from supplier for cash:
Debit the inventory account | Credit the cash account
Pay employees:
Debit the wages and salaries accounts | Credit the cash account
Take out a loan:
Debit cash account | Credit loan payable/ lender/ banker account
Repay a loan:
Debit loans payable account | Credit cash account

Example of Journal entries

 Jan 1. Capital introduced into the business Rs. 100,000
 Jan 2. Rent paid for the month Rs. 36,000
 Jan 3. Equipment purchased from ABC Ltd on payment of Rs.
60,000. Balance Rs. 20,000 to be paid after one month.
 Jan 4. Inventory purchased from XY ltd. on two month credit for
Rs. 17,600
 Debit Credit
Date Account Amount (in Amount (in
Rs.) Rs.)
Bank A/c
Jan 1 100,000  
Dr.
  To Capital A/c   100,000
Rent A/c
Jan 2 36,000  
Dr.
  To Cash A/c   36,000
Equipment A/c
Jan 3 80,000  
Dr.
  To Bank A/c   60,000
To ABC Ltd.
    20,000
A/c
Inventory A/c
Jan 4 17,600  
Dr.
  To XYZ Ltd. A/c   17,600