Fundamentals of Accounting

By : Karun Jha
 Fundamentals of Accounting
Introduction to Accounting
 What is Accounting?
Accounting is a language. The purpose to any language is to convey information. Thus,
in simple terms, Accounting is the language of business, which conveys financial
information.

If we look at accounting from a different perspective, it is also an art of recording,

classifying, summarizing transactions and events that are of a financial nature in a
meaningful way, and then analyzing and interpreting the results.

The results of such analysis must be communicated to various groups that are, directly
or indirectly, concerned with the business.
• Accounting Cycle
• Accounting goes through many transactions. Accounting involves gathering of financial data, recording classifying, summarizing
and provide the status of any business.

Books which needs to maintain to Recording / Classifying and Communicating the results are called as Accounting Cycle.
• Journal Entry
• Ledger Posting
• Trading Account
• Profit and Loss Account
• Balance Sheet

Journal Entry
Journal Entry is the primary format of Accounting. All daily transactions first entered in books as Journal Entry and then it’s used as
base for posting it under Ledger Accounts.

Ledger Posting
Ledger Posting is nothing it’s just used to prevent and identify any error which is been made at the time of Journal Entry.

Trading Account
Trading Account, calculates the amount of profit earned from buying and selling goods in a particular time period.

Profit and loss account

This calculates the profit what the business has earned after adjusting the cost incurred during running the business.

Balance Sheet
This explains the status of any organization in particular period.
There are seven basic categories in which all accounts are grouped:

1. Assets
2. Liability
3. Owner’s equity
4. Revenue
5. Expense
6. Gains
7. Losses
• Golden Rules of Accounting
First one should know when and how accounting concepts applies. It’s simply start on exchange but the mode/reward
should
be monetary or equivalent to monetary. As it’s said exchange so there are always two sides.
Debit
Credit

There are three golden rules for accounting which simplifies and covers all business transactions.

Golden Rules
Personal Account
Receiver is the Debit(Dr.)
Giver is the Credit(Cr.)

Real Account
What comes in Debit(Dr.)
What goes out Credit(Cr.)

Nominal Account
All Expenses and looses are Debit(Dr.)
All Income and Gains are Credit(Cr.)

So, as above shown the always accounting has two sides.

Fundamentals of Accounting
 Concepts and Conventions

 Accounting Conventions
Accounting conventions are the customs and traditions based on which accounting
statements are to be drawn. Conventions are regarded as a guide to the preparation of
accounting statements. There are four accounting conventions.

o Convention of full disclosure

o Convention of consistency
o Convention of conservatism
o Convention of materiality
 Fundamentals of Accounting
Accounting Conventions:

Convention of full disclosure:

According to this convention, accounting statements should be compete and should disclose all significant information
relating to the economic affairs of the entity. The purpose is to communicate all material and relevant facts concerning the
financial position and the results of operations to users.

Convention of consistency:
According to this convention, accounting practices, rules, and procedures should be continuously observed and applied, year after
year. This is necessary for the people in the business to compare its financial results and make decisions in conformity to past
trends. The principle of consistency does not mean that it does not allow a firm to change the accounting methods according to
the changed circumstances. Improved techniques of accounting can be introduced to replace old techniques, wherever and
whenever necessary.
Consistency eliminates personal bias and eves out personal judgment. However, this convention does not rule out complete
changes.
Fundamentals of Accounting
Accounting Conventions

Convention of conservatism:
This doctrine provides for caution or “playing it safe.” The essence is “to anticipate no profits and provide for all losses.”
Business should account for all the prospective losses but leave aside all the prospective future profits.
To summarize, uncertainties inevitably surround many business transactions. This should be recognized by exercising
prudence of financial statements. Thus, financial statements are usually drawn up on a conservative basis. Showing a
position better than what exists is not permitted.

Convention of materiality:
Materiality refers to the relative importance of an event or item. According to the American Accounting Association, “an
item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of an
informed Investor .” thus, deciding what is material in accounting is a matter of exercising judgment, not of applying
specific rules.
Materiality requires that accounting statements should not be made unwieldy or unintelligible due to a strict adherence
to
accounting principles.
Fundamentals of Accounting
• Concepts and Conventions

Accounting Concepts
Accounting concepts are the necessary assumptions or conditions on which the principles of accounting are based. They are the
foundations of systematic and proper accounting. They form the necessary condition or assumptions that should be followed
while recording transactions. The eight Accounting concepts generally followed are shown below.

Concepts
o Dual Aspect Concept
o Entity Concept
o Cost Concept
o Money Measurement Concept
o Matching Concept
o Revenue Recognition Concept
o Going Concern Concept
o Period Concept
Fundamentals of Accounting
Concepts and Conventions

Dual Aspect Concept

According to the Dual Aspect concept, every transaction entered into by a firm or an institution will have two Accounting
Equation is based on this concept.
Capital + Liabilities = Assets

Entity Concept
The Entity Concept stipulates that an Accounting entity is held to be ‘separate and distinct from its owners.’ therefore, the
transactions of the business are recorded from the point of view of the business and not from the point of view of the
proprietor. Without such a distinction, the affairs of the business and the private affairs of the proprietor will get mixed and
the true position of the firm will never be reflected.

Matching Concept
Once revenues for an accounting period are recognized, expenses incurred in generating these revenues are matched against
them. This is called the Matching Concept of Accounting. This ensures that the sale and cost of goods that appear in the Financial
Statements refer to the same products. In other words:
o Cost relates to goods and services that are delivered in the accounting period and whose revenues are recognized in that period
o Costs are associated with activities of the period
Fundamentals of Accounting
Concepts

Revenue Recognition Concept:

The Revenue Recognition Concept stipulates that revenue is deemed to be earned only when it is realized. This
means that revenue is earned only when goods and services are delivered to the customer and not when the
contract is signed or goods are manufactured. Revenue may be recognized before, during, or after the period in
which the cash from the sale is received.

Going Concern Concept:

According to the Going Concern Concept, it is assumed that a business will continue its operations for an
indefinite period of time. There is not intention or willingness to liquidate the business immediately.
The Going Concern Concept also rests on the assumption that a business would continue its operations over a
long period of time. On this assumption, fixed assets are recorded at there original cost and depreciated over a
period of time in a systematic manner.

Period Concept:
In order to ascertain the results of business operations and financial position of the firm periodically, time is divided into segments
referred to as Accounting Periods. Income is measured for these periods and the financial position is assessed at the end of an
Accounting Period. The Accounting Period can be a calendar year (January to December) or a financial year ( April to March).
Fundamentals of Accounting
Introduction to Accounting

Accounting Terminology
In order to understand the significance of accounting, it is important to know the meaning of various
terms used in a business environment. Given below are the basic terms used in Accounting.

Event
An event refers to an occurrence or happening, which may or may not have financial effects. An event with
financial effects triggers the accounting process.

Two examples of events are:

• The Olympic Games
• A rock concert
The buying and selling of tickets for such events will have a financial effect (as cash is changing hands) and will
alter the financial position of the organization.
Fundamentals of Accounting
Transaction
Transaction refers to an economic activity or a financial event that affects the financial position and/or
Earnings of a business.

For example, buying and selling tickets for a rock concert is a transaction. In this situation, cash changes hands and
will thus affect the financial position of the organization arranging the rock concert.

Accounting Period
Accounting period refers to the length of time covered by a financial statement. The length of time can be a quarter
covering three months, a calendar year, or a fiscal year.

Revenue
Revenue refers to the increase in the Owner’s Equity resulting from an organization’s operating activities over a period of time,
usually from the sale of goods or rendering services.

Expense
An expense refers to the cost of the use of products or services for generating revenue. These costs are incurred during the
production and sale of the goods and services that produce the revenue. An example is payment of salaries.

Capital Receipts
Capital receipts refer to the increase in the Owner’s Equity resulting from an organization’s operating activities over a period of
time, usually from the sale of goods or rendering services.

Revenue Receipts
Revenue receipts refer to all the recurring incomes that a business receives in the normal course of its operations, mainly by the
sale of goods and services. They do not create any interest income or liability and comprise the sale proceeds of merchandise. All
revenue receipts are treated as income.
Fundamentals of Accounting
Introduction to Accounting

Accounting Terminology
You may have the term Capital and Equity used by shareholders with regard to businesses. Expenditure is another
common
Term used commonly in life as well as in Accounting.

Capital/Equity

• Paid in Capital
• Earnings

Paid in Capital
Refers to an amount supplied by investors in the form of cash or assets.
Examples of capital are as follows:

• Share capital invested by the owner of an enterprise

• Money raised from the public
Fundamentals of Accounting
Expenditure

• Capital Expenditure
• Revenue Expenditure

Capital Expenditure
Refers to the expenditure, the benefit of which is not fully consumed in one accounting period, but is spread over several
Periods. This expenditure may or may not recur in the future. The amount spent in erecting a cement plant is a Capital
Expenditure since the benefit of such expenditure will be available over a number of accounting cycles.

Revenue Expenditure
Refers to the expenditure incurred in one accounting period, the full benefit of which is consumed in the same period in
which it has been incurred.
Examples of Revenue expenditure are as follows:
• Expenses such as rent and salaries incurred in the day-to-day running of a business
• Expenses incurred in the upkeep of Fixed Assets
Fundamentals of Accounting
Balance Sheet

Final Accounts with adjustments

Adjustment are made to Final Accounts for the following reasons:

• To include all expenses, losses, and incomes relating to the accounting period
• To exclude such expenses, losses, and incomes from the Final Accounts

The objective of adjustments is listed below:

• Ascertain the true profit and loss of the business
• Ascertain the true financial picture of the business
• Make a record of the transactions earlier omitted in the business
• Rectify errors in the books
• Complete all the incomplete transactions
• Record incomes that have been accrued, but have not been received
• Make a record of expenditures due, but not paid
• Adjust incomes or any expenditure paid in advance
• Provide for other reserves, provisions, or depreciations among others
Fundamentals of Accounting
Important Adjustments

Adjustments are made for the continuous assessment of the final affairs of a firm. It is necessary that for the year for
which
accounts are being prepared, all expenses and incomes for the year should be taken. Thus, it is necessary that:

 Expenditure whether paid or not, be included

 Income whether received or not, be included
 Expenditure relating to the succeeding years be excluded
 Incomes relating to the succeeding years also to be excluded

For example, Amba Furnishers has paid insurance premium for 12 months beginning September 1, 2011. If the company
closes its Books on March 31, 2011, insurance protection will be available for six months this year and for six months next
year. Therefore, half of the premium should be treated as the expenses of the next year.
Fundamentals of Accounting
The important adjustments with regards to Final Accounts are listed below.
Closing Stock
Often, all goods purchased or produced during an accounting year are not completely sold out at the end of the year. The
goods remaining unsold are called closing stock. Since the closing stock is known only at the end of the year, it is not
included in the Trial Balance.

Outstanding Expenses
Expenses incurred during a year, whose benefit has been derived during the year, but the payment for which is yet to be
made, are called outstanding or accrued expenses.

Prepaid Expenses
In some cases, the benefit of the amount already spent will be available in the next accounting year too.
Prepaid expenses are treated in the accounts as follows:
 They will be subtracted from the insurance premium in the income Statement.
 This will be shown on the Assets side of the Balance Sheet as a separate item under Current Assets.

Accrued Incomes
The income that have been earned during the accounting period, but have not been received till the end of the
accounting
period are called accrued incomes.
Fundamentals of Accounting
Provision of Bad Debts
Bad debts often occur and they are a loss. When it is certain that a debt will not be recovered, the amount is credited to
the
debtor’s account to close it, and debited to the Bad Debts account. A provision may be created to meet any possible loss
That is likely to occur in the future.

Interest on Capital
The funds provided by a proprietor to the business become a liability in terms of capital for the business. Like other
borrowings,
the company can pay to the proprietor funds too.

Interest on Drawing
The proprietor may also realize that when he draws money for private use, the firm loses interest. Therefore, the
proprietor may
debited with the interest on the money drawn by him.