FUNDAMENTALS OF ACCOUNTING FOR BEGINNERS

Picture No.1 Assets

Picture No.2 Liabilities
Picture No.3 Expenses
Picture No.4 Incomes
 Lets understand the process of Accounting
Accounting Process
• Recording
• Classifying
• Summarizing
• Analyzing
• Interpreting
• Communicating
Transactions & Events in Monetary Terms
Examples of Events/Transactions
o Received Loan from Uncle of Rs.8,00,000 through Cheque
o Opened Bank Account & deposited Cheque
o Purchased Land for Rs.4,00,000
o Given Advance for purchase of Godown Building
Rs.75,000
o Bought a Motorcycle for Rs.50000
o Given loan to friend Rs.1,00,000
o Started small business by investing Rs.50000 for
Tables/Chairs/Furniture
o Purchased Goods for Rs.1,00,000
o Sold 80% of those Goods for Rs.1,20,000
o Friend repaid Rs.75,000 out of loan given by you
within 1month
o Paid Income Tax on Profit made during period
o Received Advance amount of Rs.50,000 from Customers
 towhom you promised to supply after 1 month

Recording
• Process in which the financial transactions and
events that are identified are recordedin Books
• These typically would be
– Cash Book/ Bank Book
– Purchase and Sales Books
– Bills Receivable and Bills Payable Books
– Purchase and Sales Return Books
– Journal Book (other than above)
 Classifying
• Process where transactions or entries ofone
or similar nature are grouped.
• The book containing classified informationis
called “Ledger”.
• For Example, there may be separate account
heads for Sales, Purchases, GST,Salaries,
Rent, Office Expenses, Taxes Paid,
Advertisement expenditure etc.,
 Summarizing
• Involves preparation and presentation of the
Classified Data in a manner useful to various
internal and external users.
• Leads to the preparation of the following
financial statements
o Trial Balance
o Profit and Loss Account
o Balance Sheet
o Cash-Flow Statement
 Analysis & Interpretation

• Includes analyzing and then interpreting the

financial data to make a meaningful
judgement of the profitability and financial
position of the business.
• The financial statement should explain not
only
– „what had happened‟ but also
– „why it happened‟ and also
– „what is likely to happen under specified
conditions‟
 Communicating
• It is concerned with the transmission of
analyzed and interpreted information to the
end-users to enable them to make rational
decisions
• This includes preparation and distribution of
accounting statements/Annual Reports
 Users of Financial information

INTERNAL USERS EXTERNAL USERS

• Board of Directors • Investors
• Partners • Lenders
• Managers • Suppliers
• Officers • Government
• Employees • Customers
 Functions of Accounting
Measurement Measures past performance of the business entity
and depicts its current financial position

Forecasting Helps in forecasting future performance and financial

position of the enterprise using past data

Decision-making Provides relevant information to the users of

accounts to aid rational decision making
Comparison Assesses performance achieved in relation to targets
which is important for predicting, comparing and
&Evaluation evaluating the financial results
Control Defines weaknesses of the operational system and
provides feedbacks regarding effectiveness of
measures adopted to check such weaknesses
Govt. Regulation Provides necessary information to the government to
exercise control on the entity as well as in collection
&Taxation of tax revenues
 Basis of Accounting

Cash Basis Accrual Basis

 Comparison of Methods
CASH BASIS ACCRUAL
• Recognizes revenues when cashis BASIS
received and expenses when they
are paid. • Revenues and expenses are
recorded when the are earned or
• Does not recognize accounts
Due, regardless of when the
receivable or accounts payable
money is actually is received or
• Beneficial in terms of tracking how paid
much cash the business actually has
• Gives a more realistic idea of
at any given time
income and expenses during a
• Since the transactions are not period of time, therefore
recorded until the cash is receivedor providing a long term picture of
paid, the business‟s income is not the business that cash accounting
taxed until it is in the bank can‟t provide
• Most widely followed method,
mandatory for Companies etc.,
 DOUBLE ENTRY SYSTEM
OF BOOK KEEPING
• This is the system of Keeping the Books of
Accounts world wide and now India is also
following the same
• It is based on the principle that “every business
transaction has two accounts in opposite directions
and if a complete record is to be madeof each such
transaction, it would be necessary
to Debit one account and Credit one Account.”
• So “every Debit has corresponding Credit and
every Credit has corresponding Debit with equal
amount”
 Classification
of Accounts

Personal Real Nominal

 Personal Accounts
• Natural personal accounts: The elements or accounts
which represent persons. E.g. Kumar‟s A/c,Asha A/c etc.
• Artificial personal accounts: Personal accounts which are
created artificially by law, such as corporatebodies and
institutions, are called Artificial personal accounts. Ex.
Private Ltd Companies, LLPs, Clubs, Societies/Schools
etc.
• Representative personal accounts: Accounts which
represent a certain person or a group directly or indirectly.
E.g. Outstanding expense a/c, Prepaid expense a/c
Golden Rule for “Personal Accounts”

Debit the Receiver

Credit the Giver

Example :
Paid M/s Mitra Agencies Rs.25,000 by Cheque

Accounts
Debit/Credit Rule Applied
Involved
• Mitra Agencies • Debit • Personal a/c-
A/c Debit the
Receiver
• To Bank a/c • Personal a/c-
• Credit Credit the
Giver
 Real Accounts
• All assets of a firm, which are tangible or intangible,fall
under the category “Real Accounts“.

• Tangible real accounts are related to things that can be

touched and felt physically. Few examples of tangible real
accounts are Building, Machinery, Stock, Land etc.

• Intangible real accounts are related to things that can’t

be touched and felt physically.
Few examples of such real accounts are Goodwill,
Patents (new Invention), Trademarks (Brand Name such
as Chutneys, Chermas, Bata, Titan etc.)
Golden Rule for “Real Accounts”

Debit what comes in

Credit what goes out

Example :Purchased Furniture for Rs.10,000 in cash

Accounts Debit/Credit Rule Applied

Involved
• Furniture a/c • Debit • Real a/c-Debit
what comes in
• Credit • Real a/c-Credit
• To Cash a/c what goes out
 Nominal Accounts
• Accounts which are related to expenses, losses,
incomes or gains are called Nominal accounts.

• Nominal accounts do not really exist in physical form,but

behind every nominal account money is involved.
E.g. Purchase A/c, Salary A/c, Sales A/c, Commissionpaid
A/c, Commission received A/c

• The final result of all nominal accounts is either profit or

loss which is then transferred to the capital account.
Golden Rule for “Nominal Accounts”

Debit all expenses and losses

Credit all incomes and gains

 Example : Paid Salaries of Rs.20,000 in cash

Accounts
Debit/Credit Rule Applied
Involved
• Salaries a/c • Debit • Nominal a/c-
Debit all
expenses
• To Cash a/c • Credit
• Real a/c-
Credit what
goes out
 Basic Accounting Rules
 Credit  Debit

Expenditure
Income

 Liability  Asset

25
 Rules of Accounting
Type of Account Debit Credit

Personal The Receiver The Giver

Real What Comes In What goes out

Nominal All Expenses & All Incomes &

Losses Gains
26
 Flow of Accounting
Understanding the Transaction

Voucher Entry

Posting

Balancing

Trial Balance

P & L Account Balance Sheet

27
 Financial Statements
Financial Statements are Summary-level reports
about an organization's financial results, financial
position and cash flows.
Useful for:
• Determine the ability of a business to generate cash,and
the sources and uses of that cash.
• Determine whether a business has the capability topay
back its debts.
• Track financial results on a trend line to spot any
profitability issues.
• Investigate the details of certain business transactions
Standard contents of a set of financial statements:

• Balance Sheet : Shows the entity's assets, liabilities, and

shareholders' equity as of the report date.
• Income Statement : Shows the results of the entity's
operations and financial activities for the reporting period.
It includes revenues, expenses, gains, and losses.
• Statement of Cash Flows : Shows changes in the entity's
cash flows during the reporting period.

• Supplementary Notes : Includes explanations of various

activities, additional detail on some accounts, and other
items as mandated by the applicable accounting framework,
worldwide
 Structure of Accounting
Ledger Accounts

Credit Debit

Liability Income Expenditure Asset

P & L Account

Balance Sheet 30
 Ledger Grouping
Income Expenditure
Groups Groups

Asset Group
Liability
Group
 Profit and Loss Account(P&L)

• Financial statement that summarizes the revenues,costs,

and expenses incurred during a specified period, usually
a year or even Quarterly (for Stock Exchange Listed
Companies).

• This Statement provide information about a

company's ability or inability to generate profit by
increasing revenue, reducing costs, or both.

• P&L Management refers to how a company handlesits

Profit or Loss through revenue and cost management, by
taking suitable decisions.
 Profit & Loss Account Group

Incom Expenditure
e

Direct Income Direct Expenses

Indirect Indirect Expenses
Income
Purchase
Sales Accounts
Accounts
 Balance Sheet
• A balance sheet is a financial statement that reports a
company's assets, liabilities and shareholders' equity at
a specific point in time, and provides a basis for
computing rates of returnand evaluating its capital
structure.
• It is a financial statement that provides a snapshot of
what a company owns and owes, as well as the amount
invested by shareholders.
 Balance Sheet
Liabilities :
Capital
Reserves & SurplusLoans (Liability)
• Secured Loans
• Unsecured LoansCurrent Liabilities
• Bank OCC/Bank OD
• Provisions
• Sundry Creditors
Assets :
Fixed Assets Investments Current Assets
– Bank Accounts
– Cash in Hand
– Sundry Debtors
– Deposit (Assets)
– Loans & Advances(Asset)
Computerization of Accounts
• Like all functions which are being automated now,
Accounting is also automated through
Computerization & Specific Accounting Softwares
• Computerized Accounting System is Accounting
Information System which processes financial
transactions and events as per Generally Accepted
Accounting Principles (which we saw earlier) to
produce Reports as per User Requirement
• Based on the size of organization, there may be
„Single User‟ software or there may be a „Serverhaving
Software‟ with number of users
• „Tally‟ and „Focus‟ are most widely used Softwaresin
India
 Manual Accounting Computerized Accounting

• It is a system of accounting • It is a system of accounting that

that uses physical account uses an accounting software for
books for keeping financial recording financial transactions
records. electronically

• All the calculation is • Only data input is required, the

performed manually. calculations are performed by
computer system.

• Entries are made in Book of • Entries are recorded in software

Original Entry. like Tally, Focus, Quick Books
etc.
• The final result is to provide
the Financial Statements at • The final result is to provide
the end of the year. Financial Statements at any time
given in a year.
 Cash Flow Statement

• Cash Flow Statement summarizes the amountof

cash and cash equivalents entering and leaving a
company during a particular period of time

• The cash flow statement (CFS) measures how well a

company generates cash to pay its debt obligations
and fund its operating expenses.
 Annual Report
• An annual report is a publication that public corporations
must provide annually to shareholders to describe their
operations and financial conditions and contains detailed
financial and operational information.

• The intent of the required annual report is to provide

public disclosure of a company's corporate activities over
the past year.

• The report is typically issued to shareholders and other

stakeholders who use it to evaluate the firm's financial
performance.
 Some Conceptual Understandings

Meaning of Debits and Credits

Debit and credit are related to the terms used in Italy 500 years ago to record business transactions using the double-
entry system of accounting. Today, you should memorize the following meanings:

• Debit means left or left side of an account

• Credit means right or right side of an account

An amount recorded on the left side of an account is said to have been debited to the account, or that the amount
was a debit (or debit entry) in the account. An amount recorded on the right side of an account is said to be a
credit entry, a credit, or that the account was credited.

It is important that you do not think that a debit is “good” or “bad”. Similarly, you should not think of a credit as
being “good” or “bad”.
Account

An account is a record in which the amounts from a company’s transactions are posted (or recorded) in order to
sort and store similar amounts. The following are common account titles: Cash, Accounts Receivable, Accounts
Payable, Loans Payable, Sales, Advertising Expense, Rent Expense, Interest Expense, and perhaps hundreds more.

When we use the term accounts, we are referring to the general ledger accounts. In the past, the general ledger
was a ledger book with paper pages, but today it is likely to be a computer file ordatabase.

A simple listing of the general ledger account titles and account numbers that are available for use is the chart of
accounts.

Double-Entry Accounting or Bookkeeping

The double-entry system requires that the amount(s) in a transaction must be entered in the general ledger
accounts as a debit and as a credit in another account(s). In other words, every transaction will involve:

• A minimum of two accounts

• One or more of the accounts must have an amount entered as a debit, and
• One or more of the accounts must have an amount entered as a credit
• The total amount entered as a debit must be equal to the amount entered as a credit
Example #1.
When a company borrows $5,000 from its bank, the company will record a debit of $5,000 in the account entitled
Cash and a credit of $5,000 in the account Loans Payable or Notes Payable.

Example #2.
When a company pays $1,000 for a loan payment consisting of $100 of interest and $900 of principal the company
will record a debit of $100 in the account Interest Expense, a debit of $900 to Loans Payable, and a credit of
$1,000 in the account Cash.

It is common for inexpensive, yet sophisticated accounting software to use the double-entry system, however, it
may prompt you for only one account name or number. For example, if the software prepares a check, it will
automatically credit the account Cash when the check is written. Therefore, the software requires that you enter
only the account or accounts to be debited.

Accounting Equation May Help YouUnderstand Debits and Credits

The accounting equation is:

Assets = Liabilities + Stockholders’ (or Owner’s)

Equity
Asset accounts, which are on the left side of the equation, will usually have their balances on the left side of the
general ledger account. Since debit means left side, an asset account will normally have a debit balance.
Liability accounts, which appear on the right side of the accounting equation, will usually have their balances on
the right side of the general ledger account. Since credit means right side, a liability account will normally have a
credit balance.

Stockholders’ equity accounts, which also appear on the right side of the accounting equation, will usually have their
account balances on the right side.

Asset Accounts Will Likely Have DebitBalances

Examples of asset accounts are:

• Cash
• Accounts Receivable
• Inventory
• Prepaid Expenses
• Investments
• Land
 • Buildings
• Furniture and Fixtures
• Vehicles, and more

Generally, asset accounts will have debit balances and their account balances will be increased with a debit entry.
Therefore, a credit entry will decrease the asset’s normal debit balance.

There are a few asset accounts that are expected to have credit balances. These are known as contra-asset
accounts. Two examples of contra-asset accounts include:

• Allowance for Doubtful Accounts (which relates to the debit balance in Accounts Receivable)

• Accumulated Depreciation (which relates to the debit balances in the accounts Buildings, Equipment,
Vehicles, etc.)

These contra-asset accounts will be credited instead of crediting the related asset accounts.
Liability Accounts Will Likely Have CreditBalances

Some examples of liability accounts include:

• Accounts Payable
• Loans Payable (or Notes Payable)
• Interest Payable
 • Wages Payable
• Income Taxes Payable
• Accrued Expenses Payable (or Accrued Liabilities)
• Deferred Revenues, and others

Generally, liability accounts are expected to have credit balances and their account balances will be increased with a
credit entry. To decrease a liability account’s balance a debit entry is needed.

Stockholders’ (or Owner’s) Equity AccountsWill Have Credit Balances

Some examples of stockholders’ (or owner’s) equity accounts include:

• Common Stock
• Paid-in Capital in Excess of Par
• Retained Earnings
• Accumulated Other Comprehensive Income
• Mary Smith, Capital

Generally, these accounts are expected to have credit balances and their account balances will be increased with a
credit entry. To decrease one of these accounts a debit entry is needed.
 Note: Treasury Stock and Mary Smith, Drawing are two contra-equity accounts that are expected to
have debit balances.

Revenue Accounts Will Have Credit Balances

Examples of revenue accounts include:

• Sales
• Service Fees Earned
• Fee Revenues
• Interest Income

Revenue accounts will have credit balances and their account balances will be increased with a credit entry. Revenue
accounts have credit balances because revenues increase stockholders’ (or owner’s) equity.

There are a few revenue accounts that will have debit balances. Two examples are:

• Sales Discounts
• Sales Returns and Allowances

Revenue accounts that are expected to have debit balances are know as contra-revenue accounts. These accounts
are debited because they cause a decrease in the expected credit balances of the stockholders’ (or owner’s) equity
accounts.

Expense Accounts Will Have Debit Balances

The following are just a few of the many general ledger accounts for expenses:

• Salaries Expense
• Rent Expense
• Utilities Expense
• Repairs and Maintenance Expense
• Advertising Expense
• Depreciation Expense
• Interest Expense
• Income Tax Expense
The accounts for expenses will have debit balances and will almost always be debited. Expenses have debit balances
because they decrease the normal credit balances of stockholders’ (owner’s) equity.

The Accounts for Revenues and Expenses areTemporary Accounts

At the end of each accounting year, the income statement accounts (revenues, expenses, gains, losses) are closed to
a stockholders’ (owner’s) equity account. As a result, the income statement accounts will begin each accounting
year with zero balances. This is the reason that the income statement accounts are known as temporary accounts.
(The balance sheet accounts are known as permanent accounts, since their balances are not closed at the end of an
accounting year. Instead, balances in the balance sheet accounts are carried forward to the next accounting year.)

Learning Which Accounts to Debit and Credit

Since many business transactions involve cash, a good place to begin learning debits and credits is with the general
ledger account Cash. Since Cash is an asset account:

• Cash will be debited when cash is received. (Recall that a debit will increase an asset account’s balance.)
• Cash will be credited when cash is paid out. (Recall that a credit will decrease an asset account’s balance.)

In our earlier examples, a company borrowed money from its bank. The account Cash has to be debited because
the company is receiving Rs. 5,000 of cash from its bank. Because of double-entry accounting, another account will
be credited for Rs. 5,000. In this case, the company should credit Loans Payable or Notes Payable. This credit
makes sense because the balance in a liability account needs to be increased.

In our other example, when a company pays a bill, the asset account Cash needs to be credited for
Rs. 1,000 in order to reduce this asset’s normal debit balance. Therefore, one or more accounts will need to be
debited. Since Rs. 100 of the payment was for interest, the account Interest Expense will be debited. The Rs. 900
principal repayment will be debited to the liability account Loans Payable. (Recall that liability accounts are
decreased with a debit entry.)
If a company makes a cash sale of Rs. 500, the company will debit Cash for Rs. 500 because the company is
receiving cash and needs to increase the balance in the asset account Cash. The double-entry system requires that
another account be credited. In this situation, the account to be credited is Sales. (Recall that revenue accounts
are almost always credited. Also recall that revenue accounts are credited since they increase the normal credit
balance in the equity accounts.)

If a company buys a new machine at a cost of Rs. 20,000 by writing a check for Rs. 12,000 and promising to pay
Rs. 8,000 in six months, the company will debit the asset Machinery for Rs. 20,000; credit Cash for
Rs. 12,000; and credit Loans Payable or Notes Payable for Rs. 8,000.

Additional Tips for Accounts to be Debitedand Credited

You might think of the acronym DEAL when learning which accounts will be increased with a debit
entry. Use the first letter from the following four types of accounts to spell D-E-A-L:

DividendsExpensesAssets Losses

You could think of the acronym GIRLS when learning which accounts will be increased with a credit
entry. Use the first letter from the following five types of accounts to spell G-I-R-L-S:

Gains
Income
Revenues
Liabilities
Stockholders’ (or owner’s Equity)

Trial Balance

If each transaction is recorded with debits equal to credits, and there are no math errors in calculating the account
balances, then the accounts will be in balance. A trial balance is an internal report that lists all of the account
balances in the respective debit or credit column. The amounts in each column should sum to the same total.
(Today’s popular accounting software is programmed
to require debits to be equal to credits and the account balances will be computed without error.
Therefore, the trial balance should never indicate a difference.)
However, a balanced trial balance does not guarantee that the records are free of errors. For example, an entry
could be completely omitted or could be entered twice and the trial balance will be in balance. Also, the monthly
rent payment could be coded incorrectly as a debit to an asset account instead of a debit to Rent Expense and the
trial balance will be in balance.
One revision of Golden rules
 Accounting animations and video links

S. Topics Link for video or animaton

No.
Intro Accounting Overview - Basic
1 https://www.youtube.com/watch?v=dbhZSrTdFlU
Accounting (Animation)

Why do we need accounting?

2 https://www.youtube.com/watch?v=weCXE2wIl90

What is Accounting and Bookkeeping ?

3 https://www.youtube.com/watch?v=hwJby9ztwvE

What does an accountant do and why is it

4 https://www.youtube.com/watch?v=WR2oftI_urg
so important?

Modern Rules of Accounting - Explained

5 https://www.youtube.com/watch?v=7O7sadsZrtA
with Animated Examples
( Hindi Video)

Best wishes and Happy Learnings.

Do More and Be More