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.

The origin of accounting is as old as money. In early days, the number of transactions were
very small, so every concerned person could keep the record of transactions during a specific
period of time. Twenty-three centuries ago, an Indian scholar named Kautilya alias
Chanakya introduced the accounting concepts in his book Arthashastra. In his book, he
described the art of proper account keeping and methods of checking accounts. Gradually, the
field of accounting has undergone remarkable changes in compliance with the changes
happening in the business scenario of the world.

A bookkeeper may record financial transactions according to certain accounting principles

and standards and as prescribed by an accountant depending upon the size, nature, volume,
and other constraints of a particular organization.

With the help of accounting process, we can determine the profit or loss of the business on a
specific date. It also helps us analyze the past performance and plan the future courses of
action.

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.”
Objectives and Scope of Accounting
Let us go through the main objectives of Accounting:

 To keep systematic records: Accounting is done to keep systematic record of

financial transactions. The primary objective of accounting is to help us collect
financial data and to record it systematically to derive correct and useful results of
financial statements.
 To ascertain profitability: With the help of accounting, we can evaluate the profits
and losses incurred during a specific accounting period. With the help of a Trading
and Profit & Loss Account, we can easily determine the profit or loss of a firm.

COMPILED FOR ORIENTATION PURPOSE AND STRICTLY FOR PRIVATE CIRCULATION 1

  To ascertain the financial position of the business: A balance sheet or a statement
of affairs indicates the financial position of a company as on a particular date. A
properly drawn balance sheet gives us an indication of the class and value of assets,
the nature and value of liability, and also the capital position of the firm. With the
help of that, we can easily ascertain the soundness of any business entity.

 To assist in decision-making: To take decisions for the future, one requires accurate
financial statements. One of the main objectives of accounting is to take right
decisions at right time. Thus, accounting gives you the platform to plan for the future
with the help of past records.

 To fulfill compliance of Law: Business entities such as companies, trusts, and

societies are being run and governed according to different legislative acts. Similarly,
different taxation laws (direct indirect tax) are also applicable to every business
house. Everyone has to keep and maintain different types of accounts and records as
prescribed by corresponding laws of the land. Accounting helps in running a business
in compliance with the law.

Accounting Process

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 following chart
shows the basic steps in an accounting cycle:

COMPILED FOR ORIENTATION PURPOSE AND STRICTLY FOR PRIVATE CIRCULATION 2

Accounting Concepts
The most important concepts of accounting are as follows:

 Business Entity Concept

 Money Measurement Concept

 Going Concern Concept

 Cost Concept

 Dual Aspects Concept

 Accounting Period Concept

 Matching Concept

 Accrual Concept

 Objective Evidence Concept

The first two accounting concepts, namely, Business Entity Concept and Money
Measurement Concept are the fundamental concepts of accounting. Let us go through each
one of them briefly:
Golden Rules of Debit and Credit under Double Entry System of Accounts

The following rules of debit and credit are called the golden rules of accounts:

Classification of
accounts Rules Effect

Debit the Receiver

Personal Accounts Credit the Giver Debit = credit
Debit What Comes In
Real Accounts Credit What Goes Out Debit = credit
Debit all Expenses and losses
Nominal Accounts Credit all Incomes and gains Debit = credit

COMPILED FOR ORIENTATION PURPOSE AND STRICTLY FOR PRIVATE CIRCULATION 3

Example:
Mr. A starts a business regarding which we have the following data:
Particulars Amount
Introduces Capital in cash Rs. 50,000
Purchases (Cash) Rs. 20,000
Purchases (Credit) from Mr. B Rs. 25,000
Freight charges paid in cash Rs. 1,000
Goods sold to Mr. C on credit Rs. 15,000
Cash Sales Rs. 30,000
Purchased computer Rs. 10,000
Income from Commission Rs. 8,000

Sl.No. Journal Entries Classification Rule

Cash A/c Dr. 50,000 Real A/c Debit what comes in;
Credit the
1 To Capital A/c 50,000 Personal A/c giver(Owner)
(Narration)
Goods Purchase A/c Dr. 20,000 Real A/c Debit what comes in;

2 To Cash A/c 20,000 Real A/c Credit what goes out

3 Goods Purchase A/c Dr. 25,000 Real A/c Debit what comes in;

COMPILED FOR ORIENTATION PURPOSE AND STRICTLY FOR PRIVATE CIRCULATION 4

 To B A/c 25,000 Personal A/c Credit the giver

Freight A/c Dr. 1,000 Nominal A/c Debit all expenses;

4 To Cash A/c 1,000 Real A/c Credit what goes out

C A/c Dr. 15,000 Personal A/c Debit the receiver;

5 To Sales A/c 15,000 Real Account Credit what goes out

Cash A/c Dr. 30,000 Real A/c Debit what comes in;

6 To Sale A/c 30,000 Real A/c Credit what goes out

Computer A/c Dr. 10,000 Real A/c Debit what comes in;

7 To Cash A/c 10,000 Real A/c Credit what goes out

Cash A/c Dr. 8,000 Real A/c Debit what comes in;

8 To Commission A/c 8,000 Nominal A/c Credit all incomes

It is very clear from the above example how the rules of debit and credit work. It is also
clear that every entry has its Dual aspect. In any case, debit will always be equal to credit in
double entry system.

Journal
Journal is a book that is maintained on a daily basis for recording all the financial entries of
the day. Passing the entries is called journal entry. Journal entries are passed according to
rules of debit and credit of double entry system.
Format of a Journal Entry

Debit Credit
Date Particulars L.F. (Rs.) (Rs.)
1 2 3 4 5
DD/MM/
YYYY ******************A/c Dr. xx xxxx

To ************A/c xx Xxxx
(Brief Narration)

Column 1: It represents the date of transaction.

Column 2: Line 1 (******) represents the name of account to be debited.

Line 2 (******) represents the name of account to be credited.
Line 3 for narration of transaction.
Column 3: Ledger Folio (L.F.) represents the page number of ledger account on which
we post these entries.
Column 4: Amount(s) to be debited.
Column 5: Amount(s) to be credited.

Notes:
1. If there are multiple transactions in a day, the total amount of all the transaction through
a single journal entry may pass with total amount.

2. If debit or credit entry is same and the corresponding entry is different, we may post a
combined entry for the same. It is called ‘compound entry’ regardless of how many
debit or credit entries are contained in compound journal entry. For example,

Debit Credit
Date Particulars L.F. (Rs.) (Rs.)
DD/MM/YYYY *************A/C Dr. XXXX
*************A/C Dr. XXXX
To ********** A/C XXXX
(Brief Narration)

Problems on Identification of transactions and journalizing:

1. Classify the following into Real, Nominal and Personal Accounts:
a. Drawings Account
b. Bank Account
c. Cash Account
d. Discount Account
e. Patent Account
f. Arihant Industries Ltd., Account
g. Goodwill Account
h. Salaries Account
i. Bad Debts Account
j. Capital Account
k. Machinery Account
l. Salary outstanding Account
m. Prepaid Insurance Account
n. Inventories Account
o. Bank Overdraft
p. Purchases Account
q. Bills receivables Account
r. Reserve for Discount on creditors

2. Identify the following Transactions and classify accordingly

January 2019
1st Started Business with cash 40, 00,000
2nd Purchased machinery Rs. 20, 00,000
10th Bought furniture from Suresh Rs. 50,000
12th Sold furniture Rs. 10,000
15th Purchased goods from Srinivas on account Rs. 40,000
18th Sold goods to Sridhar Rs. 20,000
25th Returned damaged goods to Srinivas Rs. 5,000
27th Received Cheque from Sridhar Rs. 10,000

3. Identify the following Transactions in the books of Ravi and classify accordingly
January 2018
1st Started Business with Cash Rs. 10, 00,000
1st Paid into Bank Rs. 5, 00,000
2nd Goods purchased for cash 3, 00,000
3rd Purchased furniture and paid by Cheque Rs. 1, 00,000
10th Withdrawn from bank for personal use 20,000
11th Withdrawn from bank for official purpose 1, 20,000
31st Paid for stationery Rs. 5,000, Rent Rs. 20,000 and Salaries to Staff Rs. 1, 00,000
31st Purchased Infosys Equity Shares amounted to Rs. 10, 000

4. Journalise the following transactions:

a) Goods worth of Rs. 50,000 given as a charity.
b) Received Rs. 97,500 from Krishnan in full settlement of his account amounted
 to Rs. 1, 00,000
c) Received a first and final dividend of 60 paise in the rupee from the official
receiver of Mr. Rajesh, who owed in Rs. 10,000
d) Sold to Mr. Mohan goods worth Rs. 10,000 less 3% cash discount and
received Rs. 9,700 net on account by Cheque.
e) Bought from M/s. Raman & co. goods worth Rs. 50,000 at 10% trade discount
and 2% cash discount terms, and paid them half the amount in cash.
f) Paid Rs.5, 000 in cash as wages on installation of machine
g) Supplied goods costing RS. 10,000 to Mr. Mohan issued invoice at 20% above
cost less 5% trade discount.
h) Goods worth Rs. 20,000 were used by the Proprietor for his personal use.
i) Uninsured goods worth Rs. 80,000 were destroyed by fire.

Posting in a Ledger

Now let us try to understand how a journal works. With the help of journal entries, we record
each and every financial transaction of the organization chronically without considering how
many times the same type of entry has been repeated in that particular accounting year or
period.
 Journal entries in any organization may vary from hundreds to millions depending upon the
size and structure of the organization. With the help of a journal, each of the transactions
might be recorded; however, we can conclude nothing from a journal. Let us consider the
following cases. Suppose we want to know:
 the total sale value or purchase value
 the total of any particular income or expenses
 the total of amount payable to any particular creditor or receivable from a debtor
In such cases, it might be a tedious job for any bookkeeper or accountant. Hence, the next
step is ledger accounts.

The ledger helps us in summarizing journal entries of same nature at single ledger.
For example: if we pass 100 times a journal entry for sale, we can create a Sales account
only once and post all the sales transaction in that ledger account date-wise. Hence, an
unlimited number of journal entries can be summarized in a few ledger accounts.
Transferring journal entries into a ledger account is called ‘posting’.

Ruling of Account in Ledger Account

In the books of M/s. ABC Company

Ledger account of M/s XYZ LTD.

Dr. Cr.
Date Particulars J/ Amt. Date Particulars J/ Amt.
F F
DD/MM/ To name of the A/C xxx DD/MM/ By name of the A/C xxx
YYYY YYYY

DD/MM/ By, Balance C/D xxx

YYYY
DD/MM/ To, Balance B/D xxx
YYYY
Total xxx Total xxx

Important Points Regarding Ledger

 Each side of a journal entry is posted in the same side of the ledger. It means the debit
entry of a journal is posted in the debit side and vice-a-versa.
 Balance C/D refers to the balance carried down and balance b/d refers to the balance
brought down.
 After posting in ledger, balancing of ledger is done. In the column named
Total, the figure comes on the basis of ‘whichever is higher’. Means, if the total of
debit side is Rs 10,000 and the total of credit is Rs 5,000, we write Rs 10,000 in the
column named Total of both, the debit and the credit side.
 The difference of both sides (in this case, it is Rs 5,000) is written in the last row of
the credit side as ‘balance C/D’. This balance is called the debit balance of account or
vice-a-versa.
 All expenses and assets represent debit balance.

 All the income and liabilities represent credit balance including capital account.

 Debit balance of personal account represents ‘Amount Receivable’. This comes

under the category of assets. For example debtors.
 Credit balance of personal accounts signifies ‘Amount Payable’. This comes under
liabilities side and represents that we need to pay this amount which is credited due to
goods, service, loan, or advance received.

 Debit side of real account means stock in hand or any kind of assets. Credit balance of
Real account is not possible.

 Debit balance of nominal account means expenses of organization.

 Credit balance of nominal accounts means income earned.

 Debit balance of cash book means cash in hand.

 Debit side of Bank book means balance at bank.

 Credit balance of Bank book indicates ‘Bank Overdraft’.

 Debit and credit balances of nominal account; Expenses and income will be nil,
because these balances get transferred to trading, and profit & loss account to arrive at
profit and loss of the company.

 Balances of real and personal account appear in balance sheet of the company and to
be carried forward to next accounting years.
Cash Book

Cash book is a record of all the transactions related to cash. Examples include: expenses paid
in cash, revenue collected in cash, payments made to creditors, payments received from
debtors, cash deposited in bank, withdrawn of cash for office use, etc.

In double column cash book, a discount column is included on both debit and credit sides to
record the discount allowed to customers and the discount received from Creditors (suppliers)
respectively.

In triple column cash book, one more column of bank is included to record all the transactions
relating to bank.

Note: In modern accounting, simple cash book is the most popular way to record cash
transactions. The double column cash book or three column cash book is practically for
academic purpose. A separate bank book is used to record all the banking transactions as they
are more than cash transactions. These days, cash is used just to meet petty and routine
expenditures of an organization. In most of the organizations, the salaries of employees are
paid through bank.

Note: Cash book always shows debit balance; cash in hand, and a part of current assets.

Single Column Cash Book

Cash book is just like a ledger account. There is no need to open a separate cash account in
the ledger. The balance of cash book is directly posted to the trial balance. Since cash account
is a real account, ruling is followed, i.e. what comes in – debit, and what goes out – credit. All
the received cash is posted in the debit side and all payments and expenses are posted in the
credit side of the cash book.
Format:

CASH BOOK (Single Column)

Dr Cr
Date Particulars L.F. Amt Date Particulars L.F. Amt

Triple Column Cash Book

When one more column of Bank is added in both sides of the double column cash book to
post all banking transactions, it is called triple column cash book. All banking transactions
are routed through this cash book and there is no need to open a separate bank account in
ledger.
Bank Reconciliation

On a particular date, reconciliation of our bank balance with the balance of bank passbook is
called bank reconciliation. The bank reconciliation is a statement that consists of:
 Balance as per our cash book/bank book
 Balance as per pass book
 Reason for difference in both of above

This statement may be prepared at any time as per suitability and requirement of the firm, which
depends upon the volume and number of transaction of the bank.

In these days, where most of the banking transactions are done electronically, the customer gets
alerts for every transaction. Time to reconcile the bank is reduced.
Format:

Credit Bank
Debit Bank Balance as
Balance as per Bank Book
PARTICULARS per Bank Book (overdraft)
Balance as per Bank Book 50,000 -50,000
Add: Cheque issued to parties but not
1. presented in bank 3,25,000 3,25,000
Less: Cheque deposited in bank but
2. not cleared yet -50,000 -50,000
Less: Bank Charges debited by bank
but not entered in our books of
3. accounts -1,200 -1,200
Less: Bank interest charged by bank
but not entered in our books of
4. accounts -10,000 -10,000
Add: Payment direct deposited by
5. party without intimation to us 1,75,000 1,75,000
Balance as per Bank Pass Book/
Statement 4,88,800 3,88,800
Trial Balance

Trial balance is a summary of all the debit and credit balances of ledger accounts. The total of
debit side and credit side of trial balance should be matched. Trial balance is prepared on the last
day of the accounting cycle.

Trial balance provides us a comprehensive list of balances. With the help of that, we can draw
financial reports of an organization. For example, the trading account can be analyzed to
ascertain the gross profit, the profit and loss account is analyzed to ascertain the profit or Loss of
that particular accounting year, and finally, the balance sheet of the concern is prepared to
conclude the financial position of the firm.

Format:
TRIAL BALANCE of M/s ABC Limited

SL.NO DEBIT Credit

. Ledger Accounts L.F. (Rs) (Rs.)
1 Advance from customers XX
2 Advance to staff XX
3 Audit fees XX
4 Balance at bank XX
5 Bank borrowings XX
6 Bank interest paid XX
7 Capital XX
8 Cash in hand XX
9 Commission on sale XX
10 Electricity expenses XX
11 Fixed assets XX
12 Freight outward XX
13 Interest received XX
14 Inward freight charges XX
15 Office expenses XX
16 Outstanding rent XX
17 Prepaid insurance XX
18 Purchases XX
19 Rent XX
20 Repair and renewals XX
21 Salary XX
22 Salary payable XX
23 Sales XX
24 Staff welfare expenses XX
25 Stock XX
26 Sundry creditors XX
 27 Sundry debtors XX
TOTAL XXXXX XXXXX

Financial Statements
Financial statements are prepared to ascertain the profit or loss of the business, and to know the
financial position of the company.

Trading, profit & Loss accounts ascertain the Net profit for an accounting period and balance
sheet reflects the position of the business.

All the above has almost a fixed format, just record all the balances of ledger accounts into the
format given below with the help of the trial balance. With that, we may derive desired results in
the form of financial equation.

Trading & Profit & Loss Account of……………………………………

(For the period ending 31-03-2014)
Particulars Amount Particulars Amount
To Opening Stock XX By Sales XX
To Purchases XX By Closing Stock XX
To Freight charges XX By Gross Loss c/d XXX
To Direct Expenses XX
To Gross Profit c/d XXX
Total XXXX Total XXXX
To Gross Loss c/d XXX
To Salaries XX By Gross Profit b/d XXX
To Rent XX
To Office Expenses XX By Bank Interest received XX
To Bank charges XX By Discount XX
To Bank Interest XX By Commission Income XX
By Net Loss transfer to
To Electricity Exp XX Balance sheet XXXX
To Staff Welfare
EXP. XX
T
oTo Audit Fees XX
T
oTo Repair & Renewals XX
T
oTo Commission XX
T
oTo Sundry Expenses XX
To Depreciation XX
 To Net Profit transfer to
Balance sheet XXXX
Total XXXX Total XXXX

Balance sheet of M/s ABC Limited as on

31-03-2019

Liabilities Amount Assets Amount

Capital XX Fixed Assets XXXX

X
Add: Net Profit XX XXLess: Depreciation X XXX
Bank
Borrowings XXCurrent Assets XX
Long Term Borrowing XXStock XX
Current Liabilities: XXDebtors XX
Advance From Cash In hand XX
Customers XX Cash at Bank XX
Sundry Creditors XXXBills receivables XX
Bills payable XX
Expenses Payable XXX
Total XXXX Total XXXX

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