Fundamentals of Accounting:

Meaning, Principles, Categories,

and Statements
Fundamentals of Accounting
Accounting is the procedure of data entry, recording, summarizing,
analyzing, and then reporting the data related to financial
transactions of businesses and corporations. Fundamentals of
accounting are guiding principles to perform such tasks. Operations
of a business entity over an accounting period, generally a year, are
keys to prepare financial statements. A company uses accounts to
measure where it stands in the economic sense. They help in
decision-making as well as cost planning and assessment. Above all,
accounting reports are of utmost importance to outside entities as
well, viz., the investors, creditors, and regulatory bodies.
Professionals across the world use a set of standards- “GAAP–
Generally Accepted Accounting Principles” for preparing these
reports.

Fundamentals of Accounting Principles

There are five basic accounting principles:

Revenue Recognition Principle

According to this principle, revenue recognition happens at the time
of execution of the transaction—irrespective of receipt of payment
or cash. More importantly, the sale of goods or services should be
complete, and payment should be due for it. Also, the associated
costs are booked during the same period.

Historical Cost Principle

This principle directs that all assets will be reported at the actual
cost of acquisition and not at their current market value. There is an
exception to this rule for highly marketable securities. They are
valued at their fair market value. Intangible assets with
impairments are also shown at their appropriate market values.
Thus, this principle ensures a reasonable value/cost of the assets
reported.

Further, depreciation is provided for all the assets in

every accounting period to take care of their wear and tear. Thus
depreciation is deducted from the historical value of the asset. This
results in reduced net asset value every year.

Matching Principle
The matching principle directs that income earned during an
accounting period is compared with corresponding expenditure.
Similarly, all the costs related to the sale or revenue reported in a
particular period be taken into account in that period only.

Full Disclosure Principle

The full disclosure principle states that an entity’s books of accounts
should fully disclose all the relevant information to its users. Also,
there should be no deliberate concealment of information. The idea
and objective are that concerned people should be able to make
proper and well-informed decisions based on the reports.

Objectivity Principle
This principle states that all the information in the books of accounts
should be objective, reliable, and accurate. Also, they should be free
from the personal bias of the reporting persons. Above all, every
transaction should be backed with adequate evidence, such as
vouchers, receipts, invoices, etc., as support.

Read Accounting Principles for a more detailed article.

Accounting Categories
There are five types of accounts category in this system:
Assets
Assets are tangible and intangible items that a business entity owns.
Tangible or physical assets are those which can be touched or felt,
like land, machinery, building, etc. Intangible assets are goodwill,
patents, and trademarks, which are abstract ones.

Liabilities
Liabilities are whatever the entity owes to outsiders. So, it includes
loans, the amount payable to creditors, etc.

Owner’s Equity
It denotes the net worth of the entity. Most important, it is a
measure at any particular point in time and not over some time.

Owner’s Equity = Assets – Liabilities

Expenses
Anything the business entity purchases for its daily activities is an
expense and can be in the form of salaries, rents, utility bills, etc.
As per the accrual basis of accounting, costs are recorded in the
books of accounts when they are incurred/due. However, actual
payment can be made at a later date or sometimes in advance.

Income
Income is what the entity earns by selling its goods or services or
by way of interest or dividends. Notably, it is also recorded in
accounts when made and not when it is realized, as per the accrual
basis of accounting.

Journal and Ledger in Accounting

A journal entry is the basis of all accounts for any business entity. It
consists of a debit and a credit for each transaction. And the total of
all debits should always equal the sum of all credits. If there is a
difference between the two, that means journal entries will not
balance. It will result in a discrepancy in the accounts.

Subsequently, all journal entries get their way to their respective

ledger accounts. Every ledger will usually have an opening balance
unless it is the first time created one. Previous year balances are
taken here. At the end of the accounting period, each ledger
account will have a closing balance, considering the transactions in
the current accounting period. Making financial statements of an
entity is the next step. Therefore, proper ledgers are very important
to anybody.
Double Entry System
As per GAAP, accounting entries have to be done using the double-
entry bookkeeping system. Thereby each transaction will have:

 two sides for every financial transaction;

 the entries will be under any of the five categories of accounts;
 every account “debited” shall have a corresponding “credit”
entry in other reports.
That’s how the sum of all debits will always be equal to the amount
of all credits.

Financial Statements
The three main types of financial statements in accounting are:

Statement of Profit and Loss

This statement shows the profit or loss made by the entity during a
particular period. The total income of an entity minus total expenses
gives us the “Net Profit” or “Net Loss” of the business entity.

Net Profit or Loss = Income – Expenditure

Balance Sheet
A balance sheet denotes an entity’s financial position at a particular
point in time. Again, as per the principle of matching, both sides of
the balance sheet should always match. On the one hand, we have
assets, whereas the other side comprises liabilities and owner’s or
stockholder’s equity.

Assets = Liabilities + Owner’s/Stockholders’ Equity

Statement of Cash Flows

This statement shows how and where cash has been earned.
Subsequently, it shows how it has been spent or utilized during a
specific period. Cash may have come from its operating activities or
financial and investing activities.
Fields of Accounting
There are three main areas or fields of Accounting.

Financial Accounting
It comes into play for preparing the above three types of financial
statements, namely income and expenditure statement, balance
sheet, and statement of cash flows. These statements are useful for
ascertaining and reporting the financial information and standing of
the entity periodically, usually a year. This information is also of
interest to stakeholders. Such as suppliers, creditors, investors,
owners, board of directors, and regulatory bodies like the Securities
and Exchange Commission (SEC), etc.

Furthermore, financial statements are of use to calculate financial

ratios, which are vital indicators of a firm’s financial performance
and standing.

Managerial Accounting
The financial ratios and analysis are essential to making important
decisions by the management. Above all, managers decide on the
future course of action of the organization regarding products,
pricing, inventory, marketing, etc. Managerial accounting is useful
for preparing reports for internal use and hence is critical for
decision making and control.

Cost Accounting
It measures the performance of the production resources of an
entity in economic terms. Cost accounting considers direct and
indirect costs incurred in the production and distribution of goods.
Thereby, it helps to make decisions such as product pricing,
production performance, and improvement.

Types of Accounts and Three Golden

Rules
Real Accounts
All tangible and intangible assets of an entity come under the
purview of real accounts. Physical assets are land, machinery, etc.,
whereas intangible assets are those that we cannot touch, like
goodwill or patents.

The golden rule for creating real accounts is:

Debit what comes in, Credit what goes out.

For example, suppose an entity purchases a computer for US $800,

paid in cash. Here, both assets are real accounts: computers and
cash. Accounting entry for the same will be:

Journal Entry Amt. ($) Rule

Computer A/c Dr. 800 Debit what comes in

To Cash A/c 800 Credit what goes out

Personal Accounts
Accounts that relate to individuals or represent a group, entity,
corporation, and bank comprise this category. Therefore, accounts
like Sundry Creditors, Bank A/c, etc., fall under this category.

The golden rule for personal accounts is:

Debit the receiver and Credit the giver.

For example, an entity makes a payment of US $500 to one of its

suppliers, XYZ, through the bank. Both the accounts are personal,
and entry will be:
 Journal Entry Amt. ($) Rule

XYZ A/c Dr. 500 Debit the receiver

To Bank A/c 500 Credit the giver

Nominal Accounts
These accounts are related to income, expenditure, gains, and
losses and do not exist in physical form. Examples of such accounts
are salary A/c, purchase A/c, rent A/c, etc.

The golden rule for treating nominal accounts is:

Debit the expenditure and losses and Credit the income and gains.

For example, suppose an entity sells a product for the US $200 in

cash. Here, the entry for the same will be-

Journal Entry Amt. ($) Rule

Cash A/c Dr. 200 Debit what comes in: Real Account

To Sales A/c 200 Credit the income: Nominal Account

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