Accounting Basics for Beginners

In this article, we’ll cover the Accounting Basics for Beginners. We’ll start by looking at the meaning of accounting and how it works as a source of information. Then, we’ll look at some of the different objectives of accounting. Finally, we’ll take a look at the basic terms in accounting. By the end of this article, you’ll be able to understand the basics of accounting and apply them to your own business.

Accounting is one of the most important aspects of running a business. It helps businesses keep track of their finances and make decisions based on accurate data. Without accounting, there would be no way to accurately measure the performance of a company. Read on to discover more.

---

---

Also Read: Management FAQs Part IV

Meaning of Accounting

As defined by The American Institute of Certified Public Accountants (AICPA) in 1941, accounting is the art of recording, classifying, and summarizing money, transactions, and events with a financial character, as well as interpreting the results thereof. In response to economic development, accounting’s role changed, and its scope expanded.  According to the American Accounting Association (AAA), accounting is the process of identifying, measuring, and communicating economic information for users to make informed judgments and decisions.

Accounting as a Source of Information

Accounting is a definite process of interlinked activities that starts with the identification of transactions and ends with the preparation of financial statements. Information is generated at every step of the accounting process. It facilitates the dissemination of information among different user groups. Having access to such information allows interested parties to make informed decisions. Thus, accounting plays a crucial role in disseminating information.

Accounting information must ensure the following to be useful:

1. provide information for making economic decisions;
2. serve the users who rely on financial statements as their principal source of information;
3. provide information useful for predicting and evaluating the amount, timing, and uncertainty of potential cash flows;
4. provide information regarding management’s ability to utilize resources effectively in meeting goals;
5. provide factual and interpretative information by disclosing underlying assumptions on matters subject to interpretation, evaluation, prediction, or estimation; and
6. provide information on activities affecting society.

Objectives of Accounting

As an information system, the basic objective of accounting is to provide useful information to the interested group of users, both external and internal. The necessary information, particularly in the case of external users, is provided in the form of financial statements, viz., profit and loss accounts, and balance sheets. Besides these, the management is provided with additional information from time to time from the accounting records of the business. Thus, the primary objectives of accounting include the following:

1. Maintenance of Records of Business Transactions
2. Calculation of Profit and Loss
3. Providing Accounting Information to its Users
4. Depiction of Financial Position

Role of Accounting

1. As a language – it is perceived as the language of business which is used to communicate information on enterprises;
2. As a historical record- it is viewed as a chronological record of financial transactions of an organization at actual amounts involved;
3. As current economic reality- it is viewed as the means of determining the true income of an entity named the change of wealth over time;
4. As an information system – it is viewed as a process that links an information source (the accountant) to a set of receivers (external users) utilizing a channel of communication;
5. As a commodity- specialized information is viewed as a service that is in demand in society, with accountants being willing to and capable of providing it.

You might also like: How to Meditate for Concentration?

Basic Terms in Accounting

Entity

Entity means a reality that has a definite individual existence. Business entity means a specifically identifiable business enterprise like Super Bazaar, Hire Jewellers, ITC Limited, etc. An accounting system is always devised for a specific business entity (also called an accounting entity).

Transaction

An event involving some value between two or more entities. It can be a purchase of goods, receipt of money, payment to a creditor, incurring expenses, etc. It can be a cash transaction or a credit transaction.

Assets

Assets are economic resources of an enterprise that can be usefully expressed in monetary terms. They are items of value used by the business in its operations. For example, Super Bazar owns a fleet of trucks, which is used by it for delivering foodstuffs; the trucks, thus, provide economic benefit to the enterprise. This item will be shown on the asset side of the balance sheet of Super Bazaar. Assets can be broadly classified into two types: current and Non-current.

Liabilities

Liabilities are obligations or debts that an enterprise has to pay at some time in the future. They represent creditors’ claims on the firm’s assets. Both small and big businesses find it necessary to borrow money at one time or the other and to purchase goods on credit. Super Bazar, for example, purchased goods for ` 10,000 on credit for a month from Fast Food Products on March 25, 2005. If the balance sheet of Super Bazaar is prepared as of March 31, 2005, Fast Food Products will be shown as creditors on the liabilities side of the balance sheet. If Super Bazaar takes a loan for three years from Delhi State Co-operative Bank, this will also be shown as a liability on the balance sheet of Super Bazaar. Liabilities are classified as current and non-current.

The distinction between current and non-current items:

1. Current assets or liabilities are involved in the operating cycle.

2. Current assets or liabilities are realized/settled within 12 months.

3. Current items are primarily for trading.

4. Current items are cash or cash equivalent.

Capital

Amount invested by the owner in the firm is known as capital. It may be brought in the form of cash or assets by the owner of the business entity capital is an obligation and a claim on the assets of the business. It is, therefore, shown as capital on the liabilities side of the balance sheet.

Sales

Sales are total revenues from goods or services sold or provided to customers. It may be cash sales or credit sales.

Revenues

These are the amounts of the business earned by selling its products or providing services to customers, called sales revenue. Other items of revenue common to many businesses are commission, interest, dividends, royalties, rent received, etc. Revenue is also called income.

Expenses

Costs incurred by a business in the process of earning revenue are known as expenses. Generally, expenses are measured by the cost of assets consumed or services used during an accounting period. The usual items of expenses are depreciation, rent, wages, salaries, interest, cost of heater, light, water, telephone, etc.

Expenditure

Spending money or incurring liability for some benefit, service, or property received is called expenditure. Purchase of goods, purchase of machinery, purchase of furniture, etc. are examples of expenditure. If the benefit of expenditure is exhausted within a year, it is treated as an expense (also called revenue expenditure). On the other hand, the benefit of an expenditure lasts for more than a year, it is treated as an asset (also called capital expenditure) such as the purchase of machinery, furniture, etc.

Profit

The excess of revenues of a period over its related expenses during an accounting year is profit. Profit increases the investment of the owners.

Gain

A profit that arises from events or transactions which are incidental to business such as the sale of fixed assets, winning a court case, or appreciation in the value of an asset.

Loss

The excess of expenses of a period over its related revenues is termed a loss. It decreases the owner’s equity. It also refers to money or money’s worth lost (or cost incurred) without receiving any benefit in return, e.g., cash or goods lost by theft or a fire accident, etc. As well includes a loss on the sale of fixed assets.

Discount

Discount is the deduction in the price of the goods sold. It is offered in two ways. Offering a deduction of an agreed percentage of the list price at the time of selling goods is one way of giving a discount. Such a discount is called a ‘trade discount’. It is generally offered by manufacturers to whole sellers and by whole sellers to retailers.

After selling the goods on a credit basis the debtors may be given a certain deduction in the amount due in case they pay the amount within the stipulated period or earlier. This deduction is given at the time of payment on the amount payable. Hence, it is called a cash discount. Cash discount acts as an incentive that encourages prompt payment by the debtors.

Voucher

The documentary evidence in support of a transaction is known as a voucher. For example, if we buy goods for cash, we get a cash memo, if we buy on credit, we get an invoice; when we make a payment we get a receipt, and so on.

Goods

It refers to the products in which the business unit is dealing, i.e. in terms of which it is buying and selling or producing and selling. The items that are purchased for use in the business are not called goods. For example, for a furniture dealer purchase of chairs and tables is termed as goods, while for others it is furniture and is treated as an asset. Similarly, for a stationery merchant, stationery is goods, whereas for others it is an item of expense (not purchases)

Drawings

Drawings Withdrawal of money and/or goods by the owner of the business for personal use is known as drawings. They are often known to reduce the investment of the owners.

Purchases

Purchases are the total amount of goods procured by a business on credit and cash, for use or sale. In a trading concern, purchases are made of merchandise for resale with or without processing. In a manufacturing concern, raw materials are purchased, processed further into finished goods, and then sold. Purchases may be cash purchases or credit purchases.

Stock

Stock (inventory) is a measure of something on hand goods, spares, and other items in a business. It is called Stock in hand. In a trading concern, the stock on hand is the amount of goods that are lying unsold as at the end of an accounting period is called closing stock (ending inventory). In a manufacturing company, closing stock comprises raw materials, semi-finished goods, and finished goods on hand on the closing date. Similarly, opening stock (beginning inventory) is the amount of stock at the beginning of the accounting period.

Debtors

Debtors are persons and/or other entities who owe to an enterprise an amount for buying goods and services on credit. The total amount standing against such persons and/or entities on the closing date are shown in the balance sheet as sundry debtors on the asset side.

Creditors

Creditors are persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit. The total amount standing in the favour of such persons and/or entities on the closing date is shown in the Balance Sheet as sundry creditors on the liabilities side.

Types of Accounting Systems.

There are two main types of accounting systems used by companies today: cash basis and accrual basis. Cash basis means that when a transaction occurs, the money changes hands immediately. Accrual basis means that transactions occur at the end of each period.

1. In addition to understanding how to use these different methods, you also need to understand what the numbers mean. This includes knowing how to read financial statements and balance sheets.
2. You should also learn how to interpret financial statements and balance sheets so you can make informed decisions about your business.
3. To understand what goes into making a profit, you must first understand what goes into making losses. This includes understanding the difference between income and expenses, as well as how to calculate profits and losses.

Conclusion/ Summary

Meaning of Accounting:

It is a process of identifying, measuring, recording business transactions and communicating thereof the required information to interested users.

Accounting as a source of information:

Accounting as a source of information system is the process of identifying, measuring, recording, and communicating the economic events of an organization to interested users of the information.

Users of accounting information:

Accounting plays a significant role in society by providing information to management at all levels and those having a direct financial interest in the enterprise, such as present and potential investors and creditors.  Accounting information is also important to those having an indirect financial interest, such as regulatory agencies, tax authorities, customers, labor unions, trade associations, stock exchanges, and others.

Qualitative characteristics of Accounting:

To make accounting information decisions useful, it should possess the following qualitative characteristics.

• Reliability
• Understandability
• Relevance
• Comparability

The objective of accounting:

The primary objectives of accounting are to:

• maintain records of business;
• calculate profit or loss;
• depict the financial position; and
• make information available to various groups and users.

Role of accounting:

Accounting is not an end in itself. It is a means to an end. It plays the role of a:

• Language of a business
• Historical record
• Current economic reality
• Information system
• Service to users

---

---

Related: Management FAQs Part III