Basics of Accounting

Let’s Start Basics of
Accounting

Accounting is a business language. We can use this
language to communicate financial transactions and
their results. Accounting is a comprehensive system
to collect, analyze, and communicate financial
information.
ACCOUNTING

DEFINITION OF ACCOUNTING
The American Institute of Certified Public
Accountant has defined Financial Accounting
as:
“the art of recording, classifying and summarizing in
a significant manner and in terms of money,
transactions and events which in part at least of a
financial character and interpreting the results
thereof.”

THE MAIN OBJECTIVES OF ACCOUNTING:
1.To keep systematic records
2.To ascertain profitability
3.To ascertain the financial position of the business
4.To assist in decision-making
5.To fulfill compliance of Law

The following are the major functions of
accounting:
(a)Keeping Systematic Records.
(b)Communicating the Results.
(c)Meeting the Legal Requirements.
(d)Protecting the Properties of the Business.
(e) Planning and Controlling the Business activities.
FUNCTIONS OF ACCOUNTING:

ATTRIBUTES OF ACCOUNTING:
1. Accounting is both an art and science.
2. It involves recording, classifying, and
summarizing.
3. It records transactions in terms of money.
4. It records only those transactions and
events,which are financial in character.
5. It is the art of interpreting the results of
operations.
6. It involves communication.

1. The items expressed in monetary terms are
recorded in the accountings where as the items
which are nonmonetary nature not recorded.
2. Sometimes accounting data are recorded on the
basis of estimates and which could be inaccurate.
3. Fixed assets are recorded as the original cost.
4. Value of money does not remain stable so
accounting value does not show true financial
results.
5. Accounting can be manipulated and biased.
LIMITATIONS OF ACCOUNTING

ACCOUNTING CYCLE
Accounting cycle refers to the specific tasks
involved in completing an accounting process.
The length of an accounting cycle can be
monthly, quarterly, half-yearly, or annually. It
may vary from organization to organization
but the process remains the same.

The classification of accounts and their
treatment in double entry system of
accounts. Broadly, the accounts are
classified into three categories:
•Personal accounts
•Real accounts
• Tangible accounts
• Intangible accounts
• Nominal accounts
CLASSIFICATION OF ACCOUNTS

Personal Account
A personal account is an account for use by an individual
for that person's own needs. It is a relative term to
differentiate them from those accounts for corporate or
business use.

Personal accounts may be further
classified into three categories:
1.Natural Personal Account
2.Artificial Personal Account
3.Representative Personal Account
Categories Of Personal Accounts

Representative personal account represents a group of
account. If there are a number of accounts of similar
nature, it is better to group them like salary payable
account, rent payable account, insurance prepaid account,
interest receivable account, capital account and drawing
account, etc.
Natural Personal Account
An account related to any individual like David, George,
Ram, or Shyam is called as a Natural Personal Account.
Artificial Personal Account
An account related to any artificial person like M/s ABC Ltd, M/s
General Trading, M/s Reliance Industries, etc., is called as
an Artificial Personal Account.
Representative Personal Account

Every Business has some assets and every
asset has an account. Thus, asset account is
called a real account. There are two type of
assets:
Tangible assets are touchable assets such
as plant, machinery, furniture, stock, cash,
etc.
Intangible assets are non-touchable assets
such as goodwill, patent, copyrights, etc.
Accounting treatment for both type of assets
is same.
Real Accounts

This account does not represent any tangible
asset, it is called nominal or fictitious account.
All kinds of expense account, loss account,
gain account or income accounts come under
the category of nominal account. For example,
rent account, salary account, electricity
expenses account, interest income account,
etc.
Nominal Accounts

Basic terms of Accounting
Accounts Payable - money owed to creditors, vendors, etc.
Accounts Receivable - money owed to a business, i.e. credit sales
Accruals - a list of expenses that have been incurred and expensed,
but not paid or a list of sales that have been completed, but not yet
billed
Amortization - gradual reduction of amounts in an account over
time, either assets or liabilities
Asset - property with a cash value that is owned by a business or
individual
Audit Trail - a record of every transaction, when it was done, by
whom and where, used by auditors when validating the financial
statement

Auditors - third party accountants who review an entity’s financial
statements for accuracy and provide a statement to that effect.
Balance Sheet - summary of a company's financial status, including assets, liabilities,
and equity
Bookkeeping - recording financial information
Budgeting - the process of assigning forecasted income and expenses to accounts,
which amounts will be compared to actual income and expense for analysis of
variances
Capital Stock - found in the equity portion of the balance sheet describing the number
of shares sold to shareholders at a predetermined value per share, also called
“common stock” or “preferred stock”
Capital Surplus - found in the equity portion of the balance sheet accounting for the
amount shareholders paid that is greater or lesser than the “capital stock” amount
Capitalized Expense - expenses that are accumulated, not expensed as incurred, to be
amortized over a period of time; i.e. the development cost of a new product

Cash-Basis Accounting - a method in which income and expenses are recorded
when they are paid.
Cash Flow - a summary of cash received and disbursed showing the beginning
and ending amounts
Closing the Books/Year End Closing - the process of reversing the income and
expense for a fiscal or calendar year and netting the amount into “retained
earnings”
Cost Accounting - a type of accounting that focuses on recording, defining, and
reporting costs associated with specific operating functions
Cost of Goods Sold - expenses incurred in producing inventory; this may
include materials, labors, storage costs, depreciation, and overhead.
Credit - an account entry with a negative value for assets, and positive value
for liabilities and equity.

Debit - an account entry with a positive value for assets, and negative valu
for liabilities and equity.
Depreciation - recognizing the decrease in the value of an asset due to age
and use.
Dividends - amounts paid to shareholders out of current or retained
earnings.
Double-Entry Bookkeeping - system of accounting in which every
transaction has a corresponding positive and negative entry (debits and
credits).
Equity - money owed to the owner or owners of a company, also known as
"owner's equity“.
Financial Accounting - accounting focused on reporting an entity's activities
to an external party; i.e: shareholders.
Financial Statement - a record containing the balance sheet and the income
statement.

Fixed Asset - long-term tangible property; building, land, computers, etc.
General Ledger - a record of all financial transactions within an entity
Goodwill - an intangible asset reflecting the value of an entity in excess of
its tangible assets
Income Statement - a summary of income and expenses
Inventory - merchandise purchased for resale at a profit
Invoice - the original billing from the seller to the buyer, outlining what was
purchased and the terms of sale, payment, etc.
Job Costing - system of tracking costs associated with a job or project
(labor, equipment, etc) and comparing with forecasted costs
Journal - a record where transactions are recorded, also known as an
"account"
Liability - money owed to creditors, vendors, etc
Liquid Asset - cash or other property that can be easily converted to cash

Loan - money borrowed from a lender and usually repaid with interest
Master Account - an account on the general ledger that subtotals the
“subsidiary accounts” assigned to it; i.e. Cash might be the master account for
a list of depository accounts at banks
Net Income - money remaining after all expenses and taxes have been paid
Non Cash Expense - recognizing the decrease in the value of an asset; i.e.
depreciation and amortization
Non-operating Income - income generated from non-recurring transactions; ie:
sale of an old building
Note - a written agreement to repay borrowed money; sometimes used in place
of "loan"
Operating Expense (opex) - money used in the process of selling inventory (as
opposed to developing inventory)

Operating Income - income generated from regular business operations
Other Income - income generated from other than regular business operations,
i.e. interest, rents, etc.
Payroll - a list of employees and their wages
Posting - the process of entering then permanently saving or “archiving”
accounting data
Profit - see "net income”
Profit/Loss Statement - see "income statement"
Reconciliation - the process of matching one set of data to another; i.e. the
bank statement to the check register, the accounts payable journal to the
general ledger, etc.
Retained Earnings - the amount of net profit retained and not paid out to
shareholders over the life of the business

Revenue - total income before expenses.
Shareholder Equity - the capital and retained earnings in an entity
attributed to the shareholders
Single-Entry Bookkeeping - system of accounting in which
transactions are entered into one account
Statement of Account - a summary of amounts owed to a vendor,
lender, etc.
Subsidiary Accounts - the subaccounts that are totaled on the
financial statement under “master accounts;” i.e. “Cash-ABC Bank”
might be one of several subsidiary accounts that are subtotaled
under “Cash”
Supplies - assets purchased to be consumed by the entity
Treasury Stock - shares purchased by the entity from shareholders,

Write-down/Write-off - an accounting entry that reduces the value of an
asset due to an impairment of that asset; i.e. the account receivable from
the bankrupt customer

This principle is applied in case of real accounts. Real accounts
involve machinery, land and building etc. They have a debit balance by
default. Thus when you debit what comes in, you are adding to the
existing account balance. This is exactly what needs to be done.
Similarly when you credit what goes out, you are reducing the account
balance when a tangible asset goes out of the organization.
The Golden Rules of Accounting
1.Debit The Receiver, Credit The Giver
This principle is used in the case of personal accounts. When
a person gives something to the organization, it becomes an
inflow and therefore the person must be credit in the books of
accounts. The converse of this is also true, which is why the
receiver needs to be debited.
2.Debit What Comes In, Credit What Goes Out

This rule is applied when the account in question is a nominal
account. The capital of the company is a liability. Therefore it has a
default credit balance. When you credit all incomes and gains, you
increase the capital and by debiting expenses and losses, you
decrease the capital. This is exactly what needs to be done for the
system to stay in balance
3.Debit All Expenses And Losses, Credit All Incomes And Gains

Basics of Accounting

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