Accounting

Accounting can be explained as a process of providing information required by the

interested parties of a business for their decision making. Financial information is very
important in decision making in a business. Accounting that mainly provides financial
information is called as Financial Accounting.

Objectives and need of Accounting

As mentioned above, Accounting is needed to provide useful information to interested
parties of a business for their decision making. Further, the business activities also impact
various other parties. All these parties including owners and debt holders are named as
interested parties (stakeholders) of a business. Owners, debt holders, investors, customers,
suppliers, employees and the government are usually considered as key interested parties
among other parties. Each party takes decisions in various nature and for that they require
information. Accordingly, providing information for decesion making is the main objective of
accounting. Based on this main objective, there are various other objectives and few of such
objectives are given below.

● To know whether the business has earned an adequate profit

● To know whether the financial position of the business is sound
● To fulfill legal requirements (presentation of financial reports is a mandatory
requirement by law for some organisations)
● To minimize disadvantages arising through ommission and commission of
transactions, and to organize financial activities
In order to fulfill above objectives, accounting provides various types of reports to the
interested parties. These reports are generally termed as Financial Statements. These
financial statements are based on business transactions

Business transactions
A transaction can be identified as an exchange of resources between a business and other
parties. In a business, there can be various types of transactions. Among those transactions,
the transactions of which their value can be measured in terms of money, are considered in
accounting.
Eg - Sales of goods for Rs 100 000
In addition, to the exchange of resources mentioned above, some events that had occurred in
businesses are also considered in accounting.
Eg - Damage of trade stocks - Rs. 10 000
These events are also considered as transactions in a broader sense in accounting. Most of
the transactions that occur in a business are associated with purchases and sales of goods
and providing services. Such transactions could be made either on cash or credit basis. If the
value of the transaction is settled at the point of the transaction, it will be considered as a
transaction on cash basis. On the other hand, if the settlement is made later, it will be
considered as a transaction on credit basis.

Pradeep Perera BBA(Int. Bus.)sp - Colombo Business & Accounting Studies 2023 1
Assets, liabilities, equity, income and expenses,
that arise from various transactions
As a result of transactions following accounting elements arise.

● Assets
● Equity
● Liabilities
● Income and Expenses

Assets
The resources that are generated as a result of a past transaction are simply called assets.
Examples :- Purchase of a machine by a business Purchase of a motor vehicle by a business In
order to recognize an asset in accounting reports, its cost/value should be able to be
measured reliably. Assets generate future economic benefits to the business. Examples :- If a
machine that had been purchased by a business is used to manufacture and sell goods, the
cash that flows to the business in future from that machine. The profits that are generated by
the future sale of purchased stocks. If any item does not generate future economic benefits,
that item cannot be considered as an asset. Further, the item should be controlled by the
business. This means, the business should be able to use that asset according to the
discretion of the business and to take decisions on the asset. For example, the above
mentioned machine and the stock should be able to be used by the business according to the
discretion of the business. A building on a rental basis cannot be considered as an asset as it
is not controllable by the business.
The following characteristics are observed of an asset.

● Arose as a result of a past transaction

● Controlled by the business
● Inflow of future economic benefit to the business
Accordingly, an asset could be defined as follows.

An asset is a resource controlled by the business as a result of a past transaction and from
which future economic benefits are expected to flow to the business.
Eg Land and buildings, machinery, furniture, equipment, stocks, debtors including
receivables, cash at bank, cash in hand.
The assets of a business can be categorised into two types as follows.

● Current Assets
● Non-current Assets

Current Assets
The assets that are expected to be used, sold or converted into cash within a short time period
as 12 months in the ordinary activities of a business are classified as current assets.
Examples :- Stocks to be resold, Trade receivable that needs to be recovered within 12
months.

Pradeep Perera BBA(Int. Bus.)sp - Colombo Business & Accounting Studies 2023 2
Non-current Assets
All the assets that cannot be considered as current assets are considered as non-current
assets.
Examples :- Land and buildings, machinery, furniture, equipment, motor vehicles.

Liabilities
Payables of a business that had arisen as a result of past transactions could be simply
considered as liabilities.
Examples :- A loan obtained from a bank
The business is bound to repay these liabilities in future. Therefore, these are considered as
current obligations. When these liabilities are settled, the resources which generate future
economic benefits (assets) will flow out from the business. Further, in order to show a
liability in the accounts, its amount should be able to be measured reliably.
Example :- In settling a bank loan, it requires to pay cash and cash outflows from the
business.
Accordingly, following characteristics are observed of a liability

● Arose as a result of a past transaction

● Outflow of economic resources when settlement is made
● Having a current obligation
Examples :- Bank loans, Trade creditors
Liabilities also can be categorized into two types as follows.

● Current Liabilities
● Non-current Liabilities

Current Liabilities
The liabilities that should be settled within a short period of time as within 12 months are
classified as current liabilities. These are also termed as short-term liabilities.
Examples :- Trade creditors that arise when goods are purchased on credit for resale,
accrued electricity expense.

Non-current Liabilities
All of the liabilities that cannot be considered as current liabilities are classified as
non-current liabilities.
Example :- The portion of a bank loan that needs to be settled after one year.

Equity
If the business has liabilities, a part of its assets has to be used to settle those liabilities. After
the settlement of such liabilities the assets that remain belongs to the owners of the business.
The value of assets that belongs to owners of the business is termed as equity.

Pradeep Perera BBA(Int. Bus.)sp - Colombo Business & Accounting Studies 2023 3
Example :- Let us assume that a business has Rs. 500 000 worth of assets and a bank loan
amounting to Rs. 200 000. Rs. 200 000 out of Rs. 500 000 of assets has to be used to settle the
bank loan and therefore, the remaining of assets worth of Rs. 300 000 belongs to the owners.
Equity = Assets - Liabilities
= Rs 500 000 - Rs 200 000
= Rs 300 000
In a sole proprietorship, the capital invested represents the equity.

Income and Expenses

Profit of a business is the difference between income and expenses. Accordingly,
Profit = Income - Expenses
Profit belongs to the owners of the business. Therefore, profit must be added to the equity.
Profit can be calculated separately and thereby it can be added to the equity. Alternatively,
income could be added to the equity and expenses could be deducted from the equity. In
other words, equity is increased by income and decreased by expenses.
As mentioned above, income belongs to the owners. Therefore, it should be added to the
equity. As a result, equity increase. However, an increase of equity does not occur only from
receipt of income. When owners bring additional capital to the business it causes to increase
the equity. This increase in equity is not considered as income.
Therefore, income can be defined as an increase in equity except due to the increases from
capital introductions by owners.
Examples :- Sales
Interest received
Rent received
Commission received

As income belongs to the owners, expenses should also be born by the owners. Therefore,
expenses should be deducted from the equity and it causes to reduce the equity. However, a
decrease of equity does not occur only from expenses. When owners take goods or cash out of
the business for their private use (which is termed as drawings), equity decreases.
Therefore, expenses can be defined as a reduction in equity except due to drawings.
Examples :- Salaries and wages
Insurance expenses
Cost of goods sold
Interest expenses

The difference between income and expenses is identified as the profit or loss. If it is a profit,
it belongs to owners and if it is a loss, owners have to bear that as well. Therefore, profit or
loss should be ultimately adjusted to the equity. Then, what remain are assets, liabilities and
equity. The relationship among these assets, liabilities and equity could be shown in an
equation. This equation is named as the Accounting Equation.

Pradeep Perera BBA(Int. Bus.)sp - Colombo Business & Accounting Studies 2023 4
Notes
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Pradeep Perera
BBA(Int. Bus.)sp - Colombo

Contact - 0757157174(Whatsapp)
0702896420
kpcperera88gmail.com
https://web.facebook.com/profile.php?id=61550022347412

Pradeep Perera BBA(Int. Bus.)sp - Colombo Business & Accounting Studies 2023 5