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Basic concept of accounting

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The document provides an overview of basic accounting concepts and the accounting cycle. It defines accounting as a process to record and communicate financial information. It explains the accounting equation that balances assets, liabilities, and owner's equity. Transactions are exchanges that affect accounts. The accounting cycle includes analyzing transactions, journalizing, posting, preparing a trial balance, adjusting entries, financial statements, and closing entries. The document also outlines users and branches of accounting.

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DEPARTMENT OF MANAGEMENTDEPARTMENT OF MANAGEMENT STUDIESSTUDIES EMBAEMBA ProgramProgram Course # E-506Course # E-506 Fundamentals of AccountingFundamentals of Accounting
BASIC CONCEPTSBASIC CONCEPTS Concept of AccountingConcept of Accounting:: Accounting is aAccounting is a service activity designed to accumulate,service activity designed to accumulate, measure, and communicate economicmeasure, and communicate economic information about organizations forinformation about organizations for decision making purposes.decision making purposes.
The American Accounting AssociationThe American Accounting Association (AAA) has defined accounting as “(AAA) has defined accounting as “thethe process of identifying, measuring, andprocess of identifying, measuring, and communicating economic information tocommunicating economic information to permit informed judgments and decisionspermit informed judgments and decisions by the users of accounting informationby the users of accounting information.”.”
THE ACCOUNTING EQUATIONTHE ACCOUNTING EQUATION ConceptConcept:: An algebraic equation thatAn algebraic equation that expresses the relationship between assetsexpresses the relationship between assets ( resources), liabilities (obligations), and( resources), liabilities (obligations), and owners’ equity. The equation is expressedowners’ equity. The equation is expressed as under:as under: Assets =Assets = LiabilitiesLiabilities ++ Owners’ Equity.Owners’ Equity.
Elements of EquationElements of Equation Assets:Assets: Economic resources that are owned orEconomic resources that are owned or controlled by an enterprise as a result of pastcontrolled by an enterprise as a result of past transactions or events, and that are expected totransactions or events, and that are expected to have future economic benefits.have future economic benefits.
Elements of Equation (continued)Elements of Equation (continued) Liabilities:Liabilities: Obligations of an enterprise to payObligations of an enterprise to pay cash or other economic resources in return forcash or other economic resources in return for past, current, or future benefits. They representpast, current, or future benefits. They represent claims against assets. In equation form it can beclaims against assets. In equation form it can be expressed as:expressed as: LiabilitiesLiabilities = Assets –= Assets – Owners’ Equity.Owners’ Equity.
Elements of Equation (continued)Elements of Equation (continued) Owners’ EquityOwners’ Equity:: The ownership interestThe ownership interest in the assets of an enterprise. It representsin the assets of an enterprise. It represents the “net equity” of the business which isthe “net equity” of the business which is the amount of net assets available after allthe amount of net assets available after all obligations are satisfied. In equation formobligations are satisfied. In equation form it can be expressed as:it can be expressed as: Owners’ EquityOwners’ Equity = Assets –= Assets – Liabilities.Liabilities.
TRANSACTIONTRANSACTION Concept of Transaction:Concept of Transaction: Exchanges of goodsExchanges of goods and services for money. Transactions affect theand services for money. Transactions affect the assets, liabilities, owner’s equity, revenues, andassets, liabilities, owner’s equity, revenues, and expenses of an organization. Transactions involve:expenses of an organization. Transactions involve:  Two partiesTwo parties  Exchange of goods and servicesExchange of goods and services  Value of exchanges is measurable in terms of moneyValue of exchanges is measurable in terms of money  Transactions cause change to financial position of anTransactions cause change to financial position of an organization.organization.
AssetsAssets 1. Cash1. Cash 2. Accounts Receivable2. Accounts Receivable 3. Notes Receivable3. Notes Receivable 4. Merchandise Inventory4. Merchandise Inventory 5. Supplies on Hand5. Supplies on Hand 6. Prepaid Expenses6. Prepaid Expenses (a)(a) Prepaid rentPrepaid rent (b)(b) Prepaid wages/ salaryPrepaid wages/ salary (c)(c) Prepaid insurancePrepaid insurance
7. Equipment7. Equipment 8. Building8. Building 9. Land9. Land
LiabilitiesLiabilities 1. Accounts Payable1. Accounts Payable 2. Notes Payable2. Notes Payable 3. Other Payables3. Other Payables (a) Rent payable(a) Rent payable (b) Wages payable(b) Wages payable (c) Salaries payable(c) Salaries payable (d) Interest payable(d) Interest payable (e) Fees payable(e) Fees payable
Owner’s EquityOwner’s Equity 1. Owner’s Initial Capital1. Owner’s Initial Capital 2. Owner’s Additional Capital2. Owner’s Additional Capital 3. Net Income from business3. Net Income from business
Reasons of Equity IncreaseReasons of Equity Increase 1. Additional Investment1. Additional Investment 2. Revenue from sales or service rendering2. Revenue from sales or service rendering 3. Net income from business3. Net income from business
Reasons of Equity DecreaseReasons of Equity Decrease 1. Withdrawals1. Withdrawals 2. Expenses2. Expenses 3. Net loss from business3. Net loss from business
Definition of an AccountDefinition of an Account An account is a tool of recording financial transactionsAn account is a tool of recording financial transactions of a business. An account has four elements. These are:of a business. An account has four elements. These are: 1.1. A title;A title; 2. A code number2. A code number 3. Two wings3. Two wings 4. A balance4. A balance
Types of AccountsTypes of Accounts Accounts Personal Accounts Real Accounts Nominal Accounts Assets Liabilities Expenses Revenues
ACCOUNTING INFORMATION The information generated through accounting system can be categorized in two parts: Accounting Information Statutory Information Non- statutory Information Routine Non-routine
Statutory Information:Statutory Information: Information requiredInformation required by law. In other words, mandatory for all registered organizations. Income Statement and Balance Sheet are statutory information. Non-statutory Information: Information that all non registered organizations are not required to provide is non-statutory information.
Routine information is generated after certain intervals. Examples of routine information are fund flow statement/cash flow statement, annual budget, performance reports, cost sheet etc. Non-routine information is need-based information generated by accounting system to help in solving specific problem, e.g., marginal cost sheet, zero-based budgeting etc.
USERS OF ACCOUNTINGUSERS OF ACCOUNTING INFORMATIONINFORMATION Different users, for making their decisions require accounting information. These users may be classified as: 1. Internal Users 2. External Users: (a) External users with direct interest (b) External users with indirect interest
Users of Accounting InformationUsers of Accounting Information Users of Accounting Information Internal Users External Users External Users with Direct Interest External Users with Indirect Interest
1. Internal users: Top, middle and bottom level of management executives are the internal users of accounting information. They need it for making decisions. These users are interested in the profitability, operational efficiency and financial soundness of the business. The top-level management is concerned with accounting information related to planning, the middle level is interested in planning and controlling and the lower level with operational affairs.
2. External users: External users may have direct interest or indirect interest and again be classified as: (a) External users with direct interest: The existing and the prospective creditors and investors have direct interest in the accounting information. The sources of information for external users are financial statements and reports of Directors and Auditors. Investors assess the financial soundness and net worth of the business so that they may decide about buying, selling or holding investment in the business. Creditors, such as banks, lenders, debenture holders and financial institutions assess the risk involved in granting loans, servicing of the existing loans to the business.
(b) External users with indirect interest: These users such as department of company affairs, registrar of joint stock companies, sales tax and income tax authorities, labor unions, prospective customers, creditors, stock exchange’s trade associations and others who are interested in the affairs of the business. They have to make their own decision on the basis of the financial reports of the business. First exam will be up to users of accounting information
BRANCHES OF ACCOUNTING On the basis of information generated by accounting system, there are three main branches of accounting: (i) Financial accounting system (ii) Cost accounting system (iii) Management accounting system.
1. Financial Accounting (FA) FA deals with preparation of Final Accounts/Financial Statements viz. (i) Income Statement to get previous year’s result of business operation i.e., Profit/Loss. Income statement is also termed as Profit & Loss Account (P & L A/c). (ii) Balance Sheet (B/S) to get previous year’s financial position i.e., picture of Assets and Liabilities.
2. Cost Accounting (CA) Cost accounting deals with present information i.e., determining unit cost at different levels (known as cost centers) of ongoing production. Cost accounting process includes: (i) Cost determination i.e. costing (ii) Cost analysis i.e. studying behavior of profit with respect to cost and volume. (iii) Cost control i.e. comparison of actual cost with predetermined cost/standard cost.
3. Management Accounting (MA) MA deals with all those information, which helps in decision-making process i.e. planning and controlling financial activities. In an organization, MA is common to both FA and CA because all those information, which are generated by FA and CA system are useful in decision-making process and comes under the preview of MA system e.g.
CVP analysis and variance analysis of CA system also form part of MA system. Fund Flow Statement (FFS) of FA system also form part of MA system. Because it presents the flow of fund through business organization during financial year and is of great help in assessing fund position. Apart from above information which are common to both FA system and CA system, there are some information exclusively generated by management accountants e.g.
(i) Projected statements like: A- Projected income statement to estimate coming year’s target profit. B- Projected balance sheet to estimate coming year’s target financial position. (i.e. assets and liabilities). C-Projected FFS/CFS to estimate coming year’s target fund/cash position. (ii) Developing budget and budgetary control system for the purpose of budgeting. (iii) Marginal costing techniques for short-term decision- making purposes.
Need for Accounting Accounting helps in knowing: 1.What is the result of business operation after a certain interval i.e., profit/loss? 2. Financial health: Will the organization be able to meet commitments/obligations in the near future?
3. What is fund/cash position? 4. What the organization owns i.e., assets to the organization. 5. What the organization owes i.e., liabilities of the organization. and many more things, which help in decision-making process. This creates need for accounting.
Accounting CycleAccounting Cycle The sequential and related steps that are requiredThe sequential and related steps that are required to perform to complete the accounting processto perform to complete the accounting process is known as accounting cycle. The steps include:is known as accounting cycle. The steps include: 1. Analyze transaction by examining source1. Analyze transaction by examining source documents.documents. 2. Journalize transactions in the Journal2. Journalize transactions in the Journal 3. Post journal entries to the accounts in the3. Post journal entries to the accounts in the Ledger.Ledger.
4. Take a trial balance of the accounts to measure4. Take a trial balance of the accounts to measure arithmetic accuracyarithmetic accuracy 5. Prepare a Work Sheet.5. Prepare a Work Sheet. 6. Prepare financial statements:6. Prepare financial statements: (a) Income Statement; and(a) Income Statement; and (b) Balance Sheet(b) Balance Sheet 7. Journalize and post adjusting entries.7. Journalize and post adjusting entries. 8. Journalize and post closing entries.8. Journalize and post closing entries. 9. Take a post-closing trial balance.9. Take a post-closing trial balance.

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Basic concept of accounting

  • 1. DEPARTMENT OF MANAGEMENTDEPARTMENT OF MANAGEMENT STUDIESSTUDIES EMBAEMBA ProgramProgram Course # E-506Course # E-506 Fundamentals of AccountingFundamentals of Accounting
  • 2. BASIC CONCEPTSBASIC CONCEPTS Concept of AccountingConcept of Accounting:: Accounting is aAccounting is a service activity designed to accumulate,service activity designed to accumulate, measure, and communicate economicmeasure, and communicate economic information about organizations forinformation about organizations for decision making purposes.decision making purposes.
  • 3. The American Accounting AssociationThe American Accounting Association (AAA) has defined accounting as “(AAA) has defined accounting as “thethe process of identifying, measuring, andprocess of identifying, measuring, and communicating economic information tocommunicating economic information to permit informed judgments and decisionspermit informed judgments and decisions by the users of accounting informationby the users of accounting information.”.”
  • 4. THE ACCOUNTING EQUATIONTHE ACCOUNTING EQUATION ConceptConcept:: An algebraic equation thatAn algebraic equation that expresses the relationship between assetsexpresses the relationship between assets ( resources), liabilities (obligations), and( resources), liabilities (obligations), and owners’ equity. The equation is expressedowners’ equity. The equation is expressed as under:as under: Assets =Assets = LiabilitiesLiabilities ++ Owners’ Equity.Owners’ Equity.
  • 5. Elements of EquationElements of Equation Assets:Assets: Economic resources that are owned orEconomic resources that are owned or controlled by an enterprise as a result of pastcontrolled by an enterprise as a result of past transactions or events, and that are expected totransactions or events, and that are expected to have future economic benefits.have future economic benefits.
  • 6. Elements of Equation (continued)Elements of Equation (continued) Liabilities:Liabilities: Obligations of an enterprise to payObligations of an enterprise to pay cash or other economic resources in return forcash or other economic resources in return for past, current, or future benefits. They representpast, current, or future benefits. They represent claims against assets. In equation form it can beclaims against assets. In equation form it can be expressed as:expressed as: LiabilitiesLiabilities = Assets –= Assets – Owners’ Equity.Owners’ Equity.
  • 7. Elements of Equation (continued)Elements of Equation (continued) Owners’ EquityOwners’ Equity:: The ownership interestThe ownership interest in the assets of an enterprise. It representsin the assets of an enterprise. It represents the “net equity” of the business which isthe “net equity” of the business which is the amount of net assets available after allthe amount of net assets available after all obligations are satisfied. In equation formobligations are satisfied. In equation form it can be expressed as:it can be expressed as: Owners’ EquityOwners’ Equity = Assets –= Assets – Liabilities.Liabilities.
  • 8. TRANSACTIONTRANSACTION Concept of Transaction:Concept of Transaction: Exchanges of goodsExchanges of goods and services for money. Transactions affect theand services for money. Transactions affect the assets, liabilities, owner’s equity, revenues, andassets, liabilities, owner’s equity, revenues, and expenses of an organization. Transactions involve:expenses of an organization. Transactions involve:  Two partiesTwo parties  Exchange of goods and servicesExchange of goods and services  Value of exchanges is measurable in terms of moneyValue of exchanges is measurable in terms of money  Transactions cause change to financial position of anTransactions cause change to financial position of an organization.organization.
  • 9. AssetsAssets 1. Cash1. Cash 2. Accounts Receivable2. Accounts Receivable 3. Notes Receivable3. Notes Receivable 4. Merchandise Inventory4. Merchandise Inventory 5. Supplies on Hand5. Supplies on Hand 6. Prepaid Expenses6. Prepaid Expenses (a)(a) Prepaid rentPrepaid rent (b)(b) Prepaid wages/ salaryPrepaid wages/ salary (c)(c) Prepaid insurancePrepaid insurance
  • 10. 7. Equipment7. Equipment 8. Building8. Building 9. Land9. Land
  • 11. LiabilitiesLiabilities 1. Accounts Payable1. Accounts Payable 2. Notes Payable2. Notes Payable 3. Other Payables3. Other Payables (a) Rent payable(a) Rent payable (b) Wages payable(b) Wages payable (c) Salaries payable(c) Salaries payable (d) Interest payable(d) Interest payable (e) Fees payable(e) Fees payable
  • 12. Owner’s EquityOwner’s Equity 1. Owner’s Initial Capital1. Owner’s Initial Capital 2. Owner’s Additional Capital2. Owner’s Additional Capital 3. Net Income from business3. Net Income from business
  • 13. Reasons of Equity IncreaseReasons of Equity Increase 1. Additional Investment1. Additional Investment 2. Revenue from sales or service rendering2. Revenue from sales or service rendering 3. Net income from business3. Net income from business
  • 14. Reasons of Equity DecreaseReasons of Equity Decrease 1. Withdrawals1. Withdrawals 2. Expenses2. Expenses 3. Net loss from business3. Net loss from business
  • 15. Definition of an AccountDefinition of an Account An account is a tool of recording financial transactionsAn account is a tool of recording financial transactions of a business. An account has four elements. These are:of a business. An account has four elements. These are: 1.1. A title;A title; 2. A code number2. A code number 3. Two wings3. Two wings 4. A balance4. A balance
  • 16. Types of AccountsTypes of Accounts Accounts Personal Accounts Real Accounts Nominal Accounts Assets Liabilities Expenses Revenues
  • 17. ACCOUNTING INFORMATION The information generated through accounting system can be categorized in two parts: Accounting Information Statutory Information Non- statutory Information Routine Non-routine
  • 18. Statutory Information:Statutory Information: Information requiredInformation required by law. In other words, mandatory for all registered organizations. Income Statement and Balance Sheet are statutory information. Non-statutory Information: Information that all non registered organizations are not required to provide is non-statutory information.
  • 19. Routine information is generated after certain intervals. Examples of routine information are fund flow statement/cash flow statement, annual budget, performance reports, cost sheet etc. Non-routine information is need-based information generated by accounting system to help in solving specific problem, e.g., marginal cost sheet, zero-based budgeting etc.
  • 20. USERS OF ACCOUNTINGUSERS OF ACCOUNTING INFORMATIONINFORMATION Different users, for making their decisions require accounting information. These users may be classified as: 1. Internal Users 2. External Users: (a) External users with direct interest (b) External users with indirect interest
  • 21. Users of Accounting InformationUsers of Accounting Information Users of Accounting Information Internal Users External Users External Users with Direct Interest External Users with Indirect Interest
  • 22. 1. Internal users: Top, middle and bottom level of management executives are the internal users of accounting information. They need it for making decisions. These users are interested in the profitability, operational efficiency and financial soundness of the business. The top-level management is concerned with accounting information related to planning, the middle level is interested in planning and controlling and the lower level with operational affairs.
  • 23. 2. External users: External users may have direct interest or indirect interest and again be classified as: (a) External users with direct interest: The existing and the prospective creditors and investors have direct interest in the accounting information. The sources of information for external users are financial statements and reports of Directors and Auditors. Investors assess the financial soundness and net worth of the business so that they may decide about buying, selling or holding investment in the business. Creditors, such as banks, lenders, debenture holders and financial institutions assess the risk involved in granting loans, servicing of the existing loans to the business.
  • 24. (b) External users with indirect interest: These users such as department of company affairs, registrar of joint stock companies, sales tax and income tax authorities, labor unions, prospective customers, creditors, stock exchange’s trade associations and others who are interested in the affairs of the business. They have to make their own decision on the basis of the financial reports of the business. First exam will be up to users of accounting information
  • 25. BRANCHES OF ACCOUNTING On the basis of information generated by accounting system, there are three main branches of accounting: (i) Financial accounting system (ii) Cost accounting system (iii) Management accounting system.
  • 26. 1. Financial Accounting (FA) FA deals with preparation of Final Accounts/Financial Statements viz. (i) Income Statement to get previous year’s result of business operation i.e., Profit/Loss. Income statement is also termed as Profit & Loss Account (P & L A/c). (ii) Balance Sheet (B/S) to get previous year’s financial position i.e., picture of Assets and Liabilities.
  • 27. 2. Cost Accounting (CA) Cost accounting deals with present information i.e., determining unit cost at different levels (known as cost centers) of ongoing production. Cost accounting process includes: (i) Cost determination i.e. costing (ii) Cost analysis i.e. studying behavior of profit with respect to cost and volume. (iii) Cost control i.e. comparison of actual cost with predetermined cost/standard cost.
  • 28. 3. Management Accounting (MA) MA deals with all those information, which helps in decision-making process i.e. planning and controlling financial activities. In an organization, MA is common to both FA and CA because all those information, which are generated by FA and CA system are useful in decision-making process and comes under the preview of MA system e.g.
  • 29. CVP analysis and variance analysis of CA system also form part of MA system. Fund Flow Statement (FFS) of FA system also form part of MA system. Because it presents the flow of fund through business organization during financial year and is of great help in assessing fund position. Apart from above information which are common to both FA system and CA system, there are some information exclusively generated by management accountants e.g.
  • 30. (i) Projected statements like: A- Projected income statement to estimate coming year’s target profit. B- Projected balance sheet to estimate coming year’s target financial position. (i.e. assets and liabilities). C-Projected FFS/CFS to estimate coming year’s target fund/cash position. (ii) Developing budget and budgetary control system for the purpose of budgeting. (iii) Marginal costing techniques for short-term decision- making purposes.
  • 31. Need for Accounting Accounting helps in knowing: 1.What is the result of business operation after a certain interval i.e., profit/loss? 2. Financial health: Will the organization be able to meet commitments/obligations in the near future?
  • 32. 3. What is fund/cash position? 4. What the organization owns i.e., assets to the organization. 5. What the organization owes i.e., liabilities of the organization. and many more things, which help in decision-making process. This creates need for accounting.
  • 33. Accounting CycleAccounting Cycle The sequential and related steps that are requiredThe sequential and related steps that are required to perform to complete the accounting processto perform to complete the accounting process is known as accounting cycle. The steps include:is known as accounting cycle. The steps include: 1. Analyze transaction by examining source1. Analyze transaction by examining source documents.documents. 2. Journalize transactions in the Journal2. Journalize transactions in the Journal 3. Post journal entries to the accounts in the3. Post journal entries to the accounts in the Ledger.Ledger.
  • 34. 4. Take a trial balance of the accounts to measure4. Take a trial balance of the accounts to measure arithmetic accuracyarithmetic accuracy 5. Prepare a Work Sheet.5. Prepare a Work Sheet. 6. Prepare financial statements:6. Prepare financial statements: (a) Income Statement; and(a) Income Statement; and (b) Balance Sheet(b) Balance Sheet 7. Journalize and post adjusting entries.7. Journalize and post adjusting entries. 8. Journalize and post closing entries.8. Journalize and post closing entries. 9. Take a post-closing trial balance.9. Take a post-closing trial balance.