Introduction to Accounting

1.1 Basic Accounting Concepts

To understand these Accounting concepts, we will introduce you to Mr. Pule. He has enough money to start his own
business. He could choose between three kinds of businesses, namely:
• Service Business
This type of business does not sell a product that the customer can take away, but renders a specialized service, e.g., a repair
service or hairdressing salon.
• Retail Business
This type of business buys products with the intention of selling it at a higher price to customers, e.g., Friendly Grocer,
Shoprite checkers, etc.
• Manufacturer/Producer
These businesses manufacture/make their own products and sell it to their customers, e.g., Cookie Factory, Coke, KFC.

Mr. Pule did extensive market research and discovered that there is always a need for sound and music. He decided to start a business supplying music and
related sound needs to private parties, corporate functions, weddings and church functions. He named his business Pule’s Noise Box. This type of business is
called a Service Business.
Mr. Pule calculated that he needed about R800 000 to start his business. He borrowed R600 000 of the money from the local bank and R200 000 was
contributed by his family.
In order to start his business Mr. Pule had to buy a Trading License from the Mangaung Municipality.
Mr. Pule also needed to obtain the following before he could start doing business.
• A Building: He could buy a building or office, or he could rent suitable space. He decided to rent an office at the local mall;
• Vehicle/Van: He needed a vehicle for transport to the different venues where his services would be required. He decided to buy a panel van;
• Equipment: He needed modern high-tech equipment to render his service successfully. He decided to buy speakers, a turntable, mixer and
laptop, special lights and recording equipment.
Assets can be divided in two groups, namely Non-current and Current Assets.
The Building, Vehicles and Equipment are called the Non-currents of the business. Mr. Pule does not own the building.
His only Non-current Assets are the Vehicle and Equipment he bought.

The Current Assets of the business is the money in the business’s bank account, called Bank;
and the money in the cash register to give change to clients, called Cash Float.

Mr. Pule needs to pay many expenses, e.g. the trading License, to carry on with his business. Besides the Trading License, Mr. Pule must also provide for the
following expenses: Advertising, Fuel, Insurance, Rent expense, Salaries, Telephone, Panel Van Maintenance, etc.

When the business earns money for “making a noise” at functions, it is called Income.

Other examples of income accounts are:

• Money received for rendering a service
• Rent income

Pule can use money from the business for his own personal use (this is called drawings) for example:
• To pay his girlfriend’s telephone account
• To fill up his Golf (petrol) for a getaway-weekend.

Mr. Pule can now determine whether he has made a profit (or suffered a loss):

• A profit is when you sell your products/services for more than what it cost you
• A loss is suffered when your product/service cost more than the income you can generate from selling the service/product.
Make sure you understand the following:

ASSETS EQUITY

Non-Current Assets Current Assets Owner Expenses Income

- Land and Buildings - Bank - Capital - Telephone - Service fees
- Vehicles - Cash Float -Drawings - Fuel - Rent Income
- Equipment - Receivables - Insurance

Mr. Pule may also loan money from the bank if he needs further financing. This will be called a loan. A
loan is a Non-Current Liability.
Other examples of current liabilities are:

 Bank (overdraft)
 Payables (monies owing to another party)

LIABILITIES

Non-Current Liabilities Current Liabilities

-Loan - Bank (overdraft)
- Payables
Mr. Pule must be familiar with the basics of Accounting to run his business successfully. Accounting is
about accurately recording detailed information to provide figures to help the owner make decisions.
 Accounting Equation

The accounting equation forms the basis of all accounting transactions. We can compare the Accounting Equation with
scales. There are a few rules or guidelines in Accounting, for example, the double entry rule states: for every transaction,
two accounts are always involved.

The Accounting Equation works as follows:

ASSETS = OWNERS EQUITY + LIABILITIES

If you have R10 000 on the Asset side, you must also have R10 000 on the Owner’s equity and/or Liability side.

Remember that Income and Expenses also influence Equity. Income increases your equity, whilst Expenses decreases your
equity.

The following steps must be followed for the Accounting Equation:

• Name the two accounts involved
• Illustrate the effect on the accounting equation.
The following situations illustrate the principle of the Accounting Equation.
Situation 1: Capital contribution of owner
If Mr. Pule invests R800 000 in the business, there are two accounts involved, namely, Bank (Asset) and Capital (Equity). The Assets
will increase with R800 000 (business receives money) and the Equity of the business will also increase with R800 000.
ASSETS = OWNERS EQUITY + LIABILITIES
+ 800 000 +800 000 0
Situation 2: Pay an expense
If Mr. Pule must pay the rent of his office in the mall that cost R5 000 per month, the two accounts involved are Bank and Rent
Expense. Bank is an Asset and Rent Expense is an Expense. The Bank account will decrease the Assets and the Rent Expense will
decrease the Equity. ASSETS = OWNERS EQUITY + LIABILITIES
-5 000 -5 000 0
Situation 3: Receive an Income
Mr. Pule recently supplied the music for a wedding ceremony and received R2 000 from his client. The two accounts involved are
Bank and Service Fee. Bank is an asset and Service Fee is an Income. The Bank will increase, and the Equity will also increase.
ASSETS = OWNERS EQUITY + LIABILITIES

+2 000 +2 000 0
Situation 4: Buy an Asset on credit.
New sound equipment was needed, but Mr. Pule decided not to pay cash, but rather buy on credit from Hifi Suppliers to the value of R3 500. The two
accounts involved are Equipment and Payables (NOT BANK!). The Equipment will increase and the Liabilities (Payables) will increase.
ASSETS = OWNERS EQUITY + LIABILITIES
+3 500 0 +3 500
Situation 5: Buy an Asset and pay for it with cash.
New sound equipment was needed, but Mr. Pule decided to pay cash, to the value of R3 500. The two accounts involved are Equipment and BANK. The
Equipment will increase, and the Bank will decrease.
Both are ASSETS!! ASSETS = OWNERS EQUITY + LIABILITIES
+3 500/-3 500 = 0 0 0

Situation 6: Owner paid his personal fuel account from business funds.
Mr. Pule decided to take a week-end off and filled his car with fuel using business funds, R850. The two accounts involved are Bank and Drawings. The
money in the Bank will decrease and the increase in the Drawings will make the Equity less.

ASSETS = OWNERS EQUITY + LIABILITIES

-850 -850 0
 Situation 7: Receiving cash from customers for services rendered to them.
Mr. Pule was fully booked over the Valentine period. Some of his customers paid in cash for the service rendered to the value of R4 000. The two accounts
involved are Bank and Service Fees (income). The money in the bank will increase the Assets and the generating of an income will increase your Owner’s
Equity. ASSETS = OWNERS EQUITY + LIABILITIES
+4 000 +4 000 0

Situation 8: Services rendered to customers on credit, R6 700.

Some of Mr. Pule’s customers spent all their money on Valentine gifts, and had no money left to pay for the music. Mr. Pule agreed to render the service to
them on the agreement of paying him later. These customers are called Debtors/Receivables (current asset). They will be charged with the service on the
date that it was rendered but they will only pay their debt later (at a date agreed upon). The two accounts involved are Receivables/Debtors and Service
fees. The Receivables owe us money, this will increase the Assets and the generating of an income will increase the Equity.
ASSETS = OWNERS EQUITY + LIABILITIES
+6 700 +6 700 0

Situation 9: Receive money from Receivables for paying their outstanding accounts, R2 300.
After a certain period (30 days) Receivables will pay their outstanding balances, either in full or partly. The two accounts involved are Bank and
Receivables. The money received will increase the Bank (asset) and the Receivables will decrease (they owe you less). Yes!! Both are assets.
ASSETS = OWNERS EQUITY + LIAILITIES
+2 300 / -2 300 = 0 0 0
 Summary of the Basic Concepts
 What is accounting?
The process of recording all transactions in a business and keeping financial records of financial information for the users who need it.
 
Accounting terminology:
Starting a business:
Someone who is starting a new business is called an entrepreneur. The purpose of a trading business is to make profits. The accountant
keeps record of all business transactions comprising of capital, assets, liabilities, income, and expenses.
Capital
The money or assets contributed by the owner to start the business.
Owner’s Equity
The owner’s interest in the business.
Owner’s equity = Total assets – Total liabilities (Equity is the residual interest in the asset of the entity after deducting all its liabilities.)
Equity increase with capital investments/contributions and increases when income is received to the business. Equity decreases when expenses
occur. Equity also decreases and when the owner takes money or stock for his/her own use (called Drawings).
Assets
Resources or items of value owned by the business. When the business purchases assets the asset items increase in the business and vice
versa.
Liabilities
Money owes to suppliers/creditors/outside parties in the form of debt. Liabilities increases when debt increases.
Income
Money received or receivable by a business that renders a service or sells goods. Income increases the owner’s equity of the business.
Expenses
Costs incurred continuously in operating of the business. Example, wages & salaries, telephone expenses, water & electricity, etc.
Expenses decreases the owner’s equity of the business.