Basic Accounting

What is Accounting?

• Language of business – serve as a means

of communication of matters relating to
various aspects of business operations .
• Good command of grammar of language is
necessary before we study the literature –
it is necessary to learn grammar of
accounting i.e. basic accounting concepts
and conventions
 Definition of Accounting

• “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.”
 Information System

• Inputs [Business transactions and events]

• Processes [concepts, principles, standards,
Laws etc]
• Outputs [ profit loss account, balance
sheet, reports, returns]
• Users [ Internal and external]
 Users of accounting information

• Owners and shareholders

• Managers
• Employees
• Prospective Investors
• Lenders
• Security Analysts and advisers
• Suppliers
• Customers
• Government and regulatory agencies
 Financial and Management
Accounting
• Financial Accounting – preparation and
communication of financial information through
financial statements for the use of outsiders
such as shareholders, creditors, banks etc.
• Management Accounting – accounting which
provides necessary information for the
management for discharging its functions. More
timely and more detailed than information
available to external users.
 Concepts and Conventions

• Separate Entity Concept - Business is

distinct and separate from its owners.
• Going Concern – Business will continue for
a fairly long time or goes on for ever
• Periodicity – Life of the business is divided
into artificial time periods for studying the
results usually a year.
 Concepts [cont.d]

• Money Measurement – Accounting records

only monetary transactions. Events or
transactions which cannot be expressed in
terms of money will have no place in
accounting statements
• Cost concept – All transactions are
recorded at their monetary cost of
acquisition.
 Concepts [Cont.d]

• Dual Aspect – Every transaction has a dual

effect. At any given time economic
resources belonging to a business is equal
to the claims against those resources.
• Matching Concept – Expenses should be
recorded in the same accounting period in
which the revenues were earned as a
result of the expenses.
 Concepts [cont.d]

• Realization Concept – States that the

amount that is reasonably certain to be
realized- that is , the customers are
reasonably certain to pay should be
recognized as revenue.
 Conventions
• Consistency – Accounting practices to remain unchanged
from period to period; necessary for the purpose of
comparison; does not mean inflexibility.
• Conservatism – Anticipate no profits but provide for all
possible losses.
• Full Disclosure – Accounting reports should be honestly
prepared and sufficiently disclose information which is of
material interest to the users.
• Materiality – Attach importance to material details and
ignore insignificant details.
 Financial Statements

• Balance sheet – Which shows the financial

status of a company at a particular instant
in time. It summarises the resources of an
enterprise [assets] and claims against
these resources [liabilities]. Reveals what
a company owns and what it owes

• Statement of cash flows

• Profit and Loss Account – [Income
Statement] This reports the results of the
operation of an enterprise during the
accounting period. Measures the economic
performance of a company
• Statement of cash flows – Outlines where
a company gets its cash and how it
spends that cash.
 Accounting Equation

• Economic resources = Claims.

• Assets = Liabilities + Owner’s Equity.

 Terms

• Assets are resources controlled by the enterprise

as a result of past events from which future
economic benefits are expected to flow to the
enterprise.
• Liabilities are present obligations of the
enterprise arising from past events, the
settlement of which is expected to result in an
outflow of resources embodying economic
benefits
• Owner’s Equity is the residual interest in
the assets of the enterprise after
deducting all its liabilities.
• Equity = Assets – Liabilities.
• Owner’s equity consists of capital and
retained profit.
• Revenues are amounts earned from
customers for goods sold or services
rendered.
• Expenses are costs of earning revenues.
• Net profit = Revenues – Expenses.
• Retained Earnings = Net Profit – Dividend
distributions
• Retained Profits increases Owner’s equity
• Revenues increase Owner’s equity,
expenses decrease Owner’s equity,
dividends decrease Owner’s equity.
• Withdrawal by the owner equity decreases
owner’s equity and fresh capital brought
in increases the same.
Accounting equation -Problem
• Wonder Homes Ltd. Was setup on 1st April 2007
to provide architectural advice to builders of
residential apartments and commercial
complexes.
• 1st Apr’ 07 – Mr. Sai invests Rs. 100000 in cash
in WH Ltd.
• 2nd Apr’07 – Sai takes a loan of Rs.50000 from
his friend Krishna for WH Ltd.
• 5th Apr’07 – WHL purchases 2 laptops each
costing Rs.70000
• 6thApr’07 – Appointed office assistant at a
monthly salary of Rs. 5000
• 8th Apr’07- Purchased office furniture from Furni
Ltd for Rs.20000 on credit
• 15th Apr’07 – Received fees for architectural
consultation from the first client amounting to
Rs.30000
• 18th Apr’07 – Paid Furni Ltd full amount due
• 24th Apr’07 - Rendered consulting services
to another builder. Billed the client for
Rs.20000who promised to pay within
10days.
• 28th Apr’07 – Paid salary to assistant
Rs.5000 and office rent Rs.8000
• 30th Apr’07 – withdrew Rs.2000 for
personal use.
 Balance Sheet

• Liabilities • Assets
Sai Equity 100000 Cash 100000

100000 100000
 Balance Sheet

• Liabilities • Assets
Sai Equity 100000 Cash 150000
Loan 50000

150000 150000
 Balance Sheet

• Liabilities • Assets
Sai Equity 100000 Cash 10000
Loan 50000 Office Equipment 140000

150000 150000
 Balance Sheet

• Liabilities • Assets
Sai Equity 100000 Cash 10000
Loan 50000 Office Equipment 140000
Creditors 20000 Office furniture 20000

170000 170000
 Balance Sheet
• Liabilities • Assets
Sai Equity 130000 Cash 40000
Loan 50000 Office Equipment 140000
Creditors 20000 Office furniture 20000

200000 200000
 Balance Sheet

• Liabilities • Assets
Sai Equity 130000 Cash 20000
Loan 50000 Office Equipment 140000
Office furniture 20000

180000 180000
 Balance Sheet

• Liabilities • Assets
Sai Equity 150000 Cash 20000
Loan 50000 Office Equipment 140000
Office furniture 20000
Debtors 20000

200000 200000
 Balance Sheet

• Liabilities • Assets
Sai Equity 137000 Cash 7000
Loan 50000 Office Equipment 140000
Office furniture 20000
Debtors 20000

187000 187000
 Balance Sheet

• Liabilities • Assets
Sai Equity 135000 Cash 5000
Loan 50000 Office Equipment 140000
Office furniture 20000
Debtors 20000

185000 185000
 Income Statement

• Revenues
Income from Consulting 50000
Expenses
Salary 5000
Rent 8000
Total expenses 13000
Net Profit 37000
Accounting and Capital Markets

• Lemons principles - George A. Akerlof

• Market of used cars; information
asymmetry; breakdown of market
mechanism
• Micheal Spence –Signalling
• High quality financial reporting reduces
information asymmetry
• Reduces cost of raising capital