Basic Understanding

of Accounting
 If given a choice
Where you want to invest ?
Which type of company ?
In a GOOD Company !
That Creates WEALTH
Which Company You call a GOOD
Company ?
How investors EVALUATE your
performance ?
 By Financial Statement Analysis ?
So …..You need to understand
the Basic Financial Statements
 To answer the three basic questions
 How much profit was generated by the business over a
particular period?
 What are the assets and liabilities of the business at the end of a
particular period?
 What were the sources and uses of cash over a particular
period?

 Financial Statements
 Profit & Loss Account
 Balance Sheet
 Staement of Changes in Equity
 Cash Flow Statement 6
 For that you will have to
Understand The Language of
Business
The Language of Business is:
Accounting
What is Accounting?
Accounting is the process of recording,
classifying, analysing & interpreting the
business transactions which can be measured
in terms of money.

Thus, accounting keeps a permanent record

of all business transactions.
What is Accounting? …cont.

 Accounting helps in knowing the true

financial position of the business.

 Accounting provides all valid financial

information to owners, banks, customers,
government and other outside parties to
make correct decisions.
 Process of Accounting

Business Transactions

Journal Entries

Ledger Accounts

Trial Balance

Final Accounts

Trading Profit & Loss Balance

Account A/c Sheet
Basic Terms of Accounting
 Assets:
 Assets are resources owned and controlled by the
business enterprise.
 Eg: land, machinery, furniture, cash, bank
balance, stock, etc

 Types of assets:
 Fixed Assets
 Current Assets
 Investments
 Basic Terms
 Fixed Assets:
 These are assets purchased for a long period i.e.
more than 1 year.

 Eg: land, building, plant and machinery, vehicles,

furniture and office equipments, etc.

 These assets form the basic infrastructure of the

company.

 These assets are not held for sale.

 Basic Terms
 Current Assets
 These assets are required to carry on the day to
day business activities.
 Eg:
 Inventories [raw material, work in progress & finished
goods]
 Cash balance
 Bank balance
 Debtors
 Receivables
Basic Terms
 Investments:
 When a business enterprise puts its surplus funds
in shares or bonds of governments, it is known as
investments.

 Investments generate income in form of interest,

dividends, etc.

 They generate gains or loss when sold.

Basic Terms
 Liabilities:
 Liabilities are obligations of the business enterprise,
payable to outsiders & to owners of the business.

 Eg:
 Owner’s capital
 Borrowings
 Creditors
 Payables
Basic Terms
 Types of liabilities;

 Long term liabilities:

 Any liability payable after a period exceeding 1
year.

 Eg: owner’s capital, bank loans for more than a

year
Basic Terms
 Current Liabilities
 Any liability payable within a year or liabilities
incurred in day to day course of business.

 Eg: creditors, payables, bank O.D or short term

credit, etc.
Balance Sheet
Liabilities Amt Assets Amt

Owner’s Capital - Fixed Assets -

- -
- -
- Current Assets -
Outside Liabilities - -
- -
- Investments -
- -
- -
Total liabilities -- Total assets --
Financial Position
 Total Assets = Total Liabilities
or
 Assets – Outside Liabilities = Owner’s Capital

 Financial position is said to be stronger if the

assets are more than outside liabilities.
Basic Terms
 Income:
 Business activities generate various types of revenues and
incomes.

 Thus income is what the firms earns

 Eg:
 Income from sales of goods,

 Fees from sale of services,

 Interest and dividends on investments,

 Cash discounts,

 Rent received,

 Gain from sale of investment

Basic Terms
 Expense:
 Many expenses are incurred in the course of
business activities.
 Eg:
 Raw material purchased,
 Wages and salaries,
 Power and fuel,
 Office rent,
 Advertisement expense,
 Loss on sale of investments
Financial Performance
 Excess of income over expenses is known as
net profit.

 Excess of expenses over income is known as

net loss.

 Every business strives to earn profits.

Financial Performance
 Net profit is added and net loss is deducted from
owner’s capital.

Assets- Outside Liabilities = Owner’s capital

= Capital + Net Profit

= Capital – Drawings
+ Income - Expenses
Some Critical Terms in Income Statement
 Income vs. Sales
 Capital vs. Revenue Expenditure (Capex vs. Opex)
 COGS
 Depreciation/Amortization/Depletion
 Gross Profit (EBDITA)
 Operating Profit (EBIT)
 Net Profit (PAT)
 Top Line vs Bottom Line
 Profit vs Profitability
 EPS and EPS (Diluted)
 DPS
 Other Comprehensive Income (OCI)
 Comprehensive Income
Some Critical Terms in Balance Sheet

 Share Capital
 Reserves and Surplus
 Net Worth
 Book Value vs Market Price of a share
 Market capitalization
 Capital Assets and Current Assets
 Gross block and Net block
 Inventory Value
 Deferred tax asset/liabilities
Accounting Process or Cycle

1.) Analysis of business transactions

2.) Documentation
3.) Recording
4.) Classifying
5.) Summarizing
6.) Bifurcating
 Business Transactions

Documentation &
Recording
Journal Entries

Classifying Ledger Accounts

Summarizing Trial Balance

Bifurcating Final Accounts

Trading Profit & Loss Balance

Account A/c Sheet
What is an Account?
 An account is a device to record business
transactions.

 There are various accounts prepared for

each asset, liability, income and expenses.

 An account has two sides:

Dr Cr
Particulars Amount Particulars Amount
What is an Account?
 The left side of an account is known as debit
(Dr).

 The right side of an account is known as

credit (Cr).

 In any account, on one side increase is

recorded and on other side the decrease in
the item is recorded.
 Types of Accounts
 Nominal / temporary accounts
 The accounts related to all incomes and expenses.
 Eg: Interest A/c, Rent A/c, Salary A/c, Etc.

 Personal accounts
 Accounts of natural persons like Mr. Ramesh, Mr. Suresh, etc.
 Accounts of legal persons like companies, banks, government,
etc.
 These persons are generally the buyers, sellers, lenders,
investors, etc. associated with the company.
 In short they are debtors or creditors.
Types of Accounts
 Real / Permanent accounts
 These are accounts of various assets and goods.

 Eg: Buildings A/c, Machinery A/c, debtors’ A/c,

purchase A/c, Sales A/c.
What is Debit and Credit?
 Debit is the left hand side of an A/c.

 Thus amounts written on the left side of an

account are called debits.

 Credit is the right side of an A/c.

 Thus amounts written on the right side of an

account are called credits.
Debit Balance & Credit Balance
 Every A/c has a debit balance or a credit balance.

 Debit Balance:
 An account has a debit balance when the total of debit side
is more than the total of credit side.

 All assets and expenses have a debit balance.

 For assets and expenses, an increase is written on debit

side and a decrease on credit side.
Debit Balance & Credit Balance
 Credit Balance
 When the total of credit side is more than the total
of debit side, it is known as a credit balance.

 All liabilities and incomes have a credit balance.

 For liabilities and incomes, an increase is written

on credit side and decrease is written on debit
side.
Rules of Debit and Credit
 The system of accounting is a double entry
system.

 Under double entry system of accounting,

every transaction has two effects – one debit
and one credit.

 This means for every business transaction

one A/c is debited and one A/c is credited.
The 3 main rules
 For nominal accounts i.e. incomes and
expenses:

 Rule 1:
“ Debit all expenses and losses & credit all
revenues, incomes & gains. ”
The 3 main rules
 For personal accounts

 Rule 2:
“ Debit the receiver and credit the giver.”
The 3 main rules
 For real accounts i.e. for assets and goods

 Rule 3:
“ Debit what comes in and credit what goes out.”
Method of debiting and
crediting
1. Determine accounts associated with the
transaction.

2. Determine the type of account (personal,

real or nominal)

3. Record the transaction using rules of debit

and credit.