INTERNATIONAL BUSINESS AND ACCOUNTING BA 1540

(CHAPTER 1)
ACCOUNTING BASICS AND DEFINITIONS
Business

It is any activity undertaken with a view to make profit.

Types of Business

By Ownership

1) Sole Trader-ship

One man controls and operates the business.

2) Partnership

Business is controlled and operated by 2 to 20 persons (2 to 10 in banking business)

3) Company

Controlled and operated by many persons.

By Nature

1) Manufacturing

These organizations manufacture goods and then sell them at a profit e.g. Honda, Toyota, Bata etc.

Trading

These organizations buy already manufactured goods and resell them at a profit e.g. super stores, car
dealers, cloth stores etc.

2) Services

These organizations provide services at a profit e.g. colleges, hospitals, restaurants etc.

Transaction

Whenever goods or property changes hands it is called transaction e.g. sale and purchase of goods/
property, payment of expenses etc. It can be either of the following.

Cash Transaction

Here buyer pay cash to the seller at the time of exchange of goods/services.

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Credit Transaction

Here buyer pays cash to the seller at a later date, not at the time of exchange of goods/services.

Users of Accounting Information

♣ Owners (concerned about profits)

♣ Employees (concerned about wages and salaries and job security)
♣ Lenders/Banks (concerned about when my client will pay money back)
♣ Tax Authorities (concerned about tax payments)
♣ Suppliers (concerned if they will be paid and when?)
♣ Customers (concerned if company will continue to supply them goods in future?)
♣ Government (Is company performing to increase economic development?)
♣ Competitors (concerned with company performance )

Accounting Definitions

1) Book Keeping

Recording part of a transaction is called book keeping.

2) Accounting

It is an art of recording, classifying, summarizing and reporting (i.e. interpretation) of financial information.

3) Financial Accounting

Classification and recording of financial transactions in accordance with established concepts, principles,
accounting standards and legal requirements and their presentation by means of Income Statements,
Balance Sheets and Statement of cash flows during and at the end of an accounting period.

4) Management Accounting

It is the application of the principles of accounting and financial management to create value for the
stakeholders for profit and not for profit enterprises in the public and private sectors.

5) Assets

Resources owned by a business which are expected to benefit in the future operations of a business.

Types of Assets

Non-Current Assets

Assets which have a long life and are expected to benefit for more than one accounting period are called
fixed assets. They are not for resale purposes. For example Plant and Machinery, Land and Building,
Moto Vehicles, Furniture and fixtures, Office Equipments, Properties, Premises, Long Term Investments
etc.

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Current Assets

Assets which have a short life and which can converted into cash quickly to meet short term obligations
are called current assets. Their benefit is for one accounting period only. For example Cash, Bank,
Stocks, Debtors, Bills Receivables, Prepaid Expenses, Accrued Incomes, Short Term Investments etc.

Intangible Assets

Assets which have no physical existence and which cannot be seen, touched and felt are intangible
assets. For example Goodwill, Trade Mark, Copy Rights Software, Brands Licenses, Patents etc.

6) Liabilities

Liabilities are the debts or obligations of the business. The business is legally bound to pay this amount to
the outsiders.

Types of Liabilities

Long Term/Non-Current Liabilities

These are payable after one year (i.e. after one accounting period). For example long term loans,
Debentures, Mortgages, Redeemable Preference Shares etc.

Current Liabilities

These are payable within one year e.g. Bank Overdraft, Creditors, Bills Payable, Accrued Expenses,
Prepaid Incomes, etc.

7) Capital/Owner’s Equity

These are the funds supplied by the owner. It is the internal liability of a business.

8) Expenses

It is the cost of goods and services used up in process of obtaining revenue.

Types of Expenses

Direct Expenses

Expenses related with the purchase or manufacturing of goods are all direct expenses. For example
Purchase Price, Wages, Carriage in, Freight in, Taxes on Purchases etc.

Indirect Expenses

These expenses are not related to the purchase of goods but are mainly incurred for administration for
purpose or selling and distribution purpose. For example Rent, Salaries, Telephone charges, printing and
Stationery, Advertisement, Insurance, Discounts Allowed, Bad Debts, Audit Fees, Director Remuneration,
Carriage Outwards, Depreciation, etc.

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9) Income/Revenue

It is the amount that business charges from its customers on providing them goods and services or the
value generated by business through its business activities

Types of Income

Direct Income

It is the revenue earned through business related activities. For example sale proceeds from goods and
services.

Indirect Revenue

It is the revenue earned through sources other than normal business activities. For example Commission
Received, Interest Received, Rent Received, Discounts Received, Investment income etc.

10) Accounting Equation

Resources of the Business = Sources of funds (or)

Assets = Capital + Liabilities

11) Accounting Cycle

It is the movement of an accounting transaction.

Journal Ledger
Trial Balance
Financial Statements

12) Journal

Journal is a book where the first entry of a transaction is made. It is also called Books of Original/Principal
Entry.

13) Ledger

The book in which T-accounts are maintained is called ledger. It is also known as books of double entry.

14) Trial Balance

It is a list of account titles and their balances in the books on a specific date, shown in debit and credit
columns.

15) Financial Statements

These are as follows.

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a) Income Statement

Income Statement is a statement which shows the financial performance of a business over a particular
accounting period. It contains two accounts:

a. Trading Account
b. Profit & Loss Account

In Trading Account Gross Profit/Gross Loss is calculated

In Profit & Loss Account Net Profit/Net Loss is calculated

Where:

Gross Profit = Net Sales – Cost of Sales

Where: Cost Of Sales = Opening inventory + Net Purchases – Closing inventory

Net Profit = Gross Profit + Indirect Incomes – Indirect Expenses

b) Statement of Financial position

Statement of Financial position is a statement which shows the financial position of a business, on a
particular day.

Assets = Liabilities + Owner’s Equity

c) Statement of cash flows

Cash flow statement is a single document to analyze the cash and cash equivalents movements of a
business.

16) Balancing the T-account

Finding and entering the difference between the two sides of an account at the lesser side, so as to
equalize the two sides of an account.

17) Sales

Value generated in business by selling goods to customers.

18) Purchases

Goods bought by the business for the purpose of selling them again.

19) Sales Return/Returns In

Goods returned to the business by its customers.

20 Purchases Return/Returns Out

Goods returned by the business to its suppliers.

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21) Drawings

Cash or goods taken out of the business by the owner for his private/personal use.

22) Carriage Inwards

Cost of transport of goods into the business.

23) Carriage Outwards

Cost of transport of good out to the customers of a business.

24) Final Accounts

Term that includes Income Statement and Statement of Financial Position.

25) Trade Discounts

A reduction given to a customer when calculating the selling prices of goods. Invoice is prepared after
deducting trade discount. So they are not a part of double entry system.

26) Settlement discounts

These discounts are generated upon settlement and these are a part of double entry system.
These include:

a) Discounts Allowed

A reduction given to customers who pay their accounts within the time allowed.

b) Discounts Received

A reduction given to us by suppliers when we pay suppliers before the time allowed has elapsed.

27) Posting

The act of using one book as a mean of entering the transaction.

28) Duality concept

Every accounting transaction has got two effects.

i. Debit effect
ii. Credit effect

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Classes Debit Credit

Expenses

Incomes

Assets

Liabilities

Capital

29) Debit

The Left Hand Side of an account in double entry.

30) Credit

The Right Hand Side of an account in double entry.

31) Double Entry Book Keeping

A system where each transaction is entered twice. Once on the debit side and once on the credit side of
the account.

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