Basic Principles of

Accounting
 Introduction to Bookkeeping
Bookkeeping is the activity or occupation of
keeping records of the financial affairs of a
business.
Bookkeeping refers to organization and
storage of accounting and financial documents
such as
ledgers, journals, financial statements, accounts
receivable and payable, income tax records, and a
lot more.
 There are several standard methods of bookkeeping
the single-entry bookkeeping system
the double-entry bookkeeping system,
Bookkeeping is usually performed by a bookkeeper.
He or she is usually responsible for writing the daybooks,
an accountant can then create reports from the
information concerning the financial transactions
recorded by the bookkeeper.
The bookkeeper brings the books to the trial
balance stage: an accountant may prepare the income
statement and balance sheet using the trial balance and
ledgers prepared by the bookkeeper.
 Advantages of bookkeeping
Financial Comparison
A comprehensive bookkeeping system allows a business owner
to analyze spending and revenue one item at a time.
The data can be grouped by the week, month, quarter or year to
be analyzed and compared to past years.
This is one way that business owners can discover ways to cut
back on company spending and improve profitability.
Budget Monitoring
Companies require an accurate report of current spending and
revenue to help compare actual results with projections in the
annual budget.
A bookkeeping system facilitates up-to-date company financial
information that can be cross-checked with the budget to make
sure that the company is not overspending.
Bookkeeping also identifies instances of under-spending so the
company may find new uses for the extra money to help
productivity.
 Tax Deductions
A bookkeeping system makes it easier to report revenue for tax
filings at the end of the year, but a comprehensive spending
profile can also help you find tax deductions that will lower your
tax burden.
Without a bookkeeping system, you would have no
documentation to back up your deductions.
Payroll
Bookkeeping services include checking the accuracy of each
payroll period to make sure that each employee receives the
proper amount -- an especially important function in
organizations that pay bonuses, sales commissions and
supplemental payment based on a percentage of revenue.
Confirming payroll numbers keeps employees satisfied with
their pay and prevents the company from over- or underpaying
payroll taxes as well.
 Cash Management Benefits
Certain benefits of cash management include the ability to
manage supplier and customer accounts by seeing them
on paper, create a business budget, and track deposits and
payments.
With cash management, you're able to account for every
dollar and cent your business spends.
Business Decision Benefits
Bookkeeping records offer benefits that help you make
smart business decisions.
With bookkeeping, you can identify money-making
opportunities, avoid cash-flow problems, and find ways to
increase income or decrease spending.
Good bookkeeping records also are beneficial when you're
applying for a business loan.
By keeping good and accurate records, you make it easier
for lenders to make decisions about your business.
 Compliance Benefits
Certain benefits of bookkeeping, depending upon
your situation, includes the ability to pay income
taxes, payroll taxes, workers' compensation and
sales taxes.
According to the American Institute of
Professional Bookkeepers, bookkeeping records
are valuable to have during an audit.
You'll have items such as canceled checks,
receipts, tax returns, and other papers related to
the audit.
Risk-Reducing Benefits
Two risk-reducing benefits associated with
bookkeeping are the ability to detect fraud and
embezzlement.
 Double-entry accounting

Double entry accounting, also called double entry

bookkeeping, is the accounting system that requires
every business transaction or event to be recorded in
at least two accounts.
It is used to satisfy the equation Assets = Liabilities +
Equity, in which each entry is recorded to maintain the
relationship.
Every debit that is recorded must be matched with a
credit.
 Traditionally, the two effects of an accounting entry are known as Debit
(Dr) and Credit (Cr).
Accounting system is based on the principal that for every Debit entry,
there will always be an equal Credit entry. This is known as the Duality
Principal.
Debit entries are ones that account for the following effects:
Increase in assets
Increase in expense
Decrease in liability
Decrease in equity
Decrease in income
Credit entries are ones that account for the following effects:
Decrease in assets
Decrease in expense
Increase in liability
Increase in equity
Increase in income
Double Entry is recorded in a manner that the Accounting Equation is
always in balance.
Assets - Liabilities = Capital
Any increase in expense (Dr) will be offset by a decrease in assets (Cr) or
increase in liability or equity (Cr) and vice-versa. Hence, the accounting
equation will still be in equilibrium.
 Basic books of accounting
Journal, cash book and other subsidiary books
are the basic books of account ledgers.
All the accounts in the ledger book are made
from journal, cash book and subsidiary books
by posting the entry.
 What is a journal?
is a record of financial transactions in order by date.
A journal is often defined as the book of original entry.
business transactions are first recorded in a journal
A manual journal entry will consist of the following:
the appropriate date
the amount(s) and account(s) that will be debited
the amount(s) and account(s) that will be credited
a short description/memo
a reference such as a check number
These journalized amounts (which will appear in the journal
in order by date) are then posted to the accounts in
the general ledger.
 Cash books
The book in which all cash transactions (either cash is received or
paid) are primarily recorded according to dates, is called 'Cash
Book'.
Features:
It plays a dual role. It is both a book of original entry as well as a book
of final entry. All cash transactions are primarily recorded in it as soon
as they take place; so it is a journal (a book of original entry). On the
other hand, the cash aspect of all cash transactions is finally recorded
in the Cash Book (no posting in Ledger); so a Cash Book is also a
Ledger (a book of final entry).
It has two identical sides-left hand side, the debit side and right hand
side, the credit side.
All the items of cash receipts are recorded on the left hand side and all
items of cash payments on the right hand side in order of date.
The difference between the total of two sides shows cash in hand.
It always shows debit balance. It can never show credit balance.
 Advantages:
Daily cash receipts and cash payments are easily
ascertained.
Cash in hand at any time can easily be ascertained
through Cash Book balance.
Any mistake in the book can be easily detected at the
time of verification of cash.
Any defalcation of money can be detected while
verifying cash.
Since cash is verified daily, Cash Book is always kept
up-to-date.
Cash Book
It is a separate book in
which cash transactions are
directly recorded.
It serves the purpose of
both journal and ledger and
hence cash transactions
need not be primarily
recorded in Journal.
Narration is required.
Cash Account
It is an account in a Ledger
in which posting is made
from journal.
It serves the purpose of a
Ledger only. If Cash A/C is
opened in the Ledger, all
cash transactions are first
recorded in journal.
Narration is not required.
 Subsidiary books
Subsidiary book is the sub division of Journal.
These are known as books of prime entry or books of original entry as all the
transactions are recorded in their original form.
In these books the details of the transactions are recorded as they take place from
day to day in a classified manner.
The important subsidiary books used are as following:-
Cash Book : Used to record all the cash receipts and payments.
Purchase Book : Used to record all the credit purchases.
Sales Book : Used to record all the credit sales
Purchase Return Book : Used to record all goods returned by business to the supplier
Sales Return Book : Used to record all good returned by the customer to the business.
Bills Receivable Book : Used to record all accepted bills received by business.
Bills Payable Book : Used to record all bill accepted by us to our creditors.
Journal Proper : Used to record those transactions for which there is no separate book.
These subsidiary books are maintained because it may be impossible to record
each transaction into the ledger as it occurs.
And these books record the details of the transactions and therefore help the
ledger to become brief.
Future reference and any desired analysis becomes easy as transactions of similar
nature are recorded together
 Ledger
A ledger is an accounting book that facilitates
the transfer of all journal entries in a
chronological sequence to individual accounts.
The process of recording journal entries into
the ledger is called posting.
Type of Ledger Collect information from

The general ledger accumulates information from

journals.
Each month all journals are totalled and posted
General Ledger to the General Ledger.
The purpose of the General Ledger is therefore to
organise and summarise the individual
transactions listed in all the journals.

The Debtors Ledger accumulates information

from the sales journal.
Debtors Ledger The purpose of the Debtors Ledger is to provide
knowledge about which customers owe money to
the business, and how much.

The Creditors Ledger accumulates information

from the purchases journal.
Creditors Ledger The purpose of the Creditors Ledger is to provide
knowledge about which suppliers the business
owes money, and how much.
 Trial Balance
When the transactions are recorded under double entry system
there is a credit for every debit.
When one account is debited, another account is credited with
equal amount.
Therefore, it is quite evident that the total of debit balances of the
ledger accounts of given transactions will be equal to the total of
the credit balances.
If a statement is prepared with debit balances in one side/column
and credit balances on the other side/column, the totals of the two
sides/columns will be equal.
Such a statement is called as Trial Balance.
Or simply a trial balance may be defined as a list of balances
standing on the ledger accounts and cashbook of a concern.
 Features:
It is a tabular statement having separate
sides/columns for debit balances and credit
balances.
Closing balances of the various ledger accounts
are brought to this statement.
It can be prepared at any date on which accounts
are closed and balanced. But it is usually
prepared at the end of the accounting year.
Trial balance is not an account. It is only a
statement.
 Advantages of a Trial balance:

It presents to the businessman a consolidated list of all

ledger balances.
It is the shortest method of verifying the arithmetical
accuracy of entries made in the ledger.
If the total of debit side/column is equal to the total of
credit side/column, the trial balance is said to agree.
Otherwise, it is implied that some errors have been
committed in the preparation of accounts.
It helps in the preparation of the final accounts i.e.,
Trading a/c. Profit and loss a/c and Balance Sheet.
 'Balance Sheet'
A balance sheet is a financial statement that
summarizes a company's assets, liabilities and
shareholders' equity at a specific point in time.
These three balance sheet segments give
investors an idea as to what the company owns
and owes, as well as the amount invested by
shareholders.
The balance sheet adheres to the following
formula:
Assets = Liabilities + Shareholders' Equity
 BREAKING DOWN 'Balance Sheet'

Assets, liabilities and shareholders' equity are

each comprised of several smaller accounts that
break down the specifics of a company's finances.
These accounts vary widely by industry, and the
same terms can have different implications
depending on the nature of the business.
Broadly, however, there are a few common
components investors are likely to come across.
 Assets
Within the assets segment, accounts are listed from top to bottom in
order of their liquidity, that is, the ease with which they can be converted
into cash.
They are divided into current assets, those which can be converted to cash
in one year or less; and non-current or long-term assets, which cannot.
Cash and cash equivalents: the most liquid assets, these can include Treasury
bills and short-term certificates of deposit, as well as hard currency
Marketable securities: equity and debt securities for which there is a liquid
market
Accounts receivable: money which customers owe the company,since a
certain proportion of customers can be expected not to pay
Inventory: goods available for sale, valued at the lower of the cost or market
price
Prepaid expenses: representing value that has already been paid for, such as
insurance, advertising contracts or rent
Long-term assets include the following:
Long-term investments: securities that will not or cannot be liquidated in the next year
Fixed assets: these include land, machinery, equipment, buildings and other durable,
generally capital-intensive assets
Intangible assets: these include non-physical, but still valuable, assets such as intellectual
property and goodwill; in general, intangible assets are only listed on the balance sheet if
they are acquired, rather than developed in-house; their value may therefore be wildly
understatedby not including a globally recognized logo, for exampleor just as wildly
overstated
 Liabilities
Liabilities are the money that a company owes to outside parties, from
bills it has to pay to suppliers to interest on bonds it has issued to creditors
to rent, utilities and salaries.
Current liabilities are those that are due within one year and are listed in
order of their due date. Long-term liabilities are due at any point after one
year.
Current liabilities accounts might include:
Current portion of long-term debt
Bank indebtedness
Interest payable
Rent, tax, utilities
Wages payable
Customer prepayments
Dividends payable and others
Long-term liabilities can include:
Long-term debt: interest and principle on bonds issued
Pension fund liability: the money a company is required to pay into its employees'
retirement accounts
Deferred tax liability: taxes that have been accrued but will not be paid for another year;
besides timing, this figure reconciles differences between requirements for financial
reporting and the way tax is assessed, such as depreciation calculations
Some liabilities are off-balance sheet, meaning that they will not appear on the balance
sheet. Operating leases are an example of this kind of liability.
 Shareholders' equity
Shareholders' equity is the money attributable to a
business' owners, meaning its shareholders.
It is also known as "net assets," since it is equivalent to
the total assets of a company minus its liabilities, that
is, the debt it owes to non-shareholders.
Retained earnings are the net earnings a company either
reinvests in the business or uses to pay off debt; the rest is
distributed to shareholders in the form of dividends.
Treasury stock is the stock a company has
either repurchased or never issued in the first place. It can
be sold at a later date to raise cash or reserved to repel
a hostile takeover, etc
 Profit & Loss (P&L) Statement
The profit & loss (P&L) statement is one of the three primary financial
statements used to assess a companys performance and financial position
the two others being the balance sheet and the cash flow statement
The profit & loss statement summarizes the revenues and expenses
generated by the company over the entire reporting period.
The profit & loss statement is also known as the income statement,
statement of earnings, statement of operations, or statement of income.
The basic equation on which a profit & loss statement is based is Revenues
Expenses = Profit.
All companies need to generate revenue to stay in business.
Revenues are used to pay expenses, interest payments on debt,
and taxes owed to the government.
After the costs of doing business are paid, the amount left over is
called net income.
Net income is theoretically available to shareholders, though instead of
paying out dividends, the firms management often chooses to retain
earnings for future investment in the business.