Basics of Accounting
Introduction
Accounting is often called the "Language of Business". It communicates the result of business operations to various stakeholders.
Definition (AICPA): "Accounting is the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof."
Process of Accounting (IMRC-SAC)
- Identification: Identifying financial transactions.
- Measurement: Measuring them in monetary terms.
- Recording: Entering them in Journal/subsidiary books.
- Classifying: Grouping similar transactions in Ledger.
- Summarizing: Preparing Trial Balance, P&L A/c, and Balance Sheet.
- Analysis & Interpretation: Deriving meaning from data.
- Communicating: Reporting to users.
Branches of Accounting
- Financial Accounting: Ascertaining Profit/Loss and Financial Position. (Main focus for us).
- Cost Accounting: Ascertaining cost of production and controlling cost.
- Management Accounting: Generating info for internal management decision making.
Book-keeping vs Accounting
| Basis | Book-keeping | Accounting |
|---|---|---|
| Scope | Recording & Classifying | Summarizing & Interpreting |
| Stage | Primary Stage | Secondary Stage |
| Nature | Routine/Clerical | Analytical |
| Staff | Junior Staff | Senior Staff |
Systems of Accounting
1. Double Entry System
Every transaction has two aspects - Debit and Credit. Accounts are maintained for all types of transactions (Assets, Liabilities, Capital, Expenses, Income).
2. Single Entry System
Only Personal accounts and Cash Book are maintained. It is an "Incomplete Record" system. Used by small shopkeepers.
Basic Accounting Terms
- Capital (Owner's Equity): Amount invested by the owner. Claim of owner against
assets.
Capital = Assets - Liabilities - Assets: Economic resources owned by business (e.g., Cash, Machinery, Goodwill).
- Non-Current (Fixed): Held for long term use (Tangible & Intangible).
- Current: Held for conversion into cash within a year.
- Fictitious: Accumulated losses/Deferred Expenses (e.g., P&L Dr. Balance).
- Liabilities: Obligations to pay. (Non-Current & Current).
- Drawings: Withdrawal of cash/goods by owner for personal use.
- Expenditure: Spending money or incurring liability.
- Capital Exp: Benefit > 1 year (Asset acquisition).
- Revenue Exp: Benefit < 1 year (Day-to-day expenses).
- Deferred Revenue Exp: Revenue nature but benefit over multiple years (e.g., Heavy Ad campaign).
- Debtor: Person who owes money to the business (Asset).
- Creditor: Person to whom business owes money (Liability).
Numericals & PYQs
Part A: Numericals (10 Questions)
(a) Capital Expenditure (Increases earning capacity/asset value).
(b) Revenue Expenditure (Maintenance).
(a) Intangible Asset.
(b) Fictitious Asset (Accumulated loss/deferred expense to be written off).
Capital = Total Assets invested by Owner.
Capital = 1,00,000 + 50,000 = ₹1,50,000
Gross Profit = Sales - COGS
GP = 2,00,000 - 1,50,000 = ₹50,000
Remaining Debtors = 50,000 - 2,000 = ₹48,000.
Provision = 5% of 48,000 = ₹2,400.
Net Debtors = 48,000 - 2,400 = ₹45,600
Deferred Revenue Expenditure. Benefit will accrue over several years.
Total Purchases = Cash Purchases + Credit Purchases.
Total = 10,000 + 5,000 = ₹15,000
Depreciation per year = 10,000.
After 2 years total dep = 20,000.
Book Value = 1,00,000 - 20,000 = ₹80,000
Total Drawings = Cash + Goods.
Total = 2,000 + 1,000 = ₹3,000
Expense (Accrual Basis) = Paid + Outstanding.
Total = 10,000 + 2,000 = ₹12,000
Part B: Previous Year Questions (PYQs) (10 Questions)
Luca Pacioli (Published 'Summa de Arithmetica...' in 1494).
Italy (Venice).
Recording of financial data.
Goodwill, Patents, Trademarks, Copyrights.
Petty Cash Book.
Fictitious Assets.
Debtors (for prompt payment).
Sale/Purchase of goods (Does not appear in books).
Machinery Account (Capital Expenditure).
Original Entry (or Prime Entry).