2. basic accounting terms

BASIC ACCOUNTING BASIC ACCOUNTING TERMSTERMS

By: Prof. Bhavik R. Shah

[M.Com ; M.Ed]98 98 46 21 48

BUSINESS TRANSACTIONSBUSINESS TRANSACTIONS Business Transactions means exchangeBusiness Transactions means exchange Of value for value (In Goods or Services against money)Of value for value (In Goods or Services against money) Measured in terms of moneyMeasured in terms of money Relevant to the business to the business Between to or more persons or firmsBetween to or more persons or firms For an event to be a business transactionFor an event to be a business transaction Must possess the quality of economic substanceMust possess the quality of economic substance Related to business andRelated to business and Affect the economic result andAffect the economic result and Must be capable of being measured in monetary termsMust be capable of being measured in monetary terms There are mainly TWO types of transactionsThere are mainly TWO types of transactions Cash transactions, which includes exchange of cash &Cash transactions, which includes exchange of cash & Credit transactions, in which the payment of cash is promised Credit transactions, in which the payment of cash is promised

to some future date. to some future date.

CAPITALCAPITAL Business and its owner are separate personsBusiness and its owner are separate persons The value of cash, goods or assets brought in the The value of cash, goods or assets brought in the

business by the owner is known as capital.business by the owner is known as capital. Capital shows the investment made by the owner.Capital shows the investment made by the owner. Capital means excess of business assets over Capital means excess of business assets over

liabilities.liabilities. Capital = Total Assets – Total liabilities (External)Capital = Total Assets – Total liabilities (External) Net Assets = Total Assets – Total liabilities (External)Net Assets = Total Assets – Total liabilities (External) Net Worth = Total Assets – Total liabilities (External)Net Worth = Total Assets – Total liabilities (External)

Note: In capital transaction, Owner is given of value to Note: In capital transaction, Owner is given of value to the business.the business.

DRAWINGSDRAWINGS Business and its owner are separate personsBusiness and its owner are separate persons The value of cash, goods or assets withdrawn by the The value of cash, goods or assets withdrawn by the

owner of the business is known as drawings.owner of the business is known as drawings. Drawings shows the decrease [reduction] in capital.Drawings shows the decrease [reduction] in capital.

Note: In Drawings Transactions, Owner is Note: In Drawings Transactions, Owner is Receiver of value From the business. Receiver of value From the business.

LIABILITIESLIABILITIES Any amount payable by the businessAny amount payable by the business To any outsider (other then owner) is known as To any outsider (other then owner) is known as

liability.liability.

How Created?How Created? By purchasing goods on credit, the amount becomes By purchasing goods on credit, the amount becomes

payable or liability is created.payable or liability is created. Liability is created by borrowing funds.Liability is created by borrowing funds. Liability is created by borrowing services.Liability is created by borrowing services.

There are TWO types of Liabilities:There are TWO types of Liabilities: Current liability [Amount payable within 1 Year ]Current liability [Amount payable within 1 Year ] Long-term liability [Amount payable after 1 year]Long-term liability [Amount payable after 1 year]

ASSETSASSETSAssets are Assets are ItemsItems Having realizable valueHaving realizable value Used by the business for its operations andUsed by the business for its operations and Owned by the businessOwned by the business

Examples: Examples:

Cash, land, Building, Machinery, Stock of goods, Cash, land, Building, Machinery, Stock of goods, Furniture, Goodwill, Patent, Copyright, trademark, Furniture, Goodwill, Patent, Copyright, trademark, Etc. are included in assets.Etc. are included in assets.

Assets are classified into THREE types:Assets are classified into THREE types: Fixed Assets:Fixed Assets:

Land, Building, Machinery, Furniture, Goodwill, Patent, Land, Building, Machinery, Furniture, Goodwill, Patent, Copyright, Trademark etc. which can be used for a long Copyright, Trademark etc. which can be used for a long period are known as fixed assets.period are known as fixed assets.

Current Assets:Current Assets:Stock of goods, cash balance, Bank Balance, tools etc keep on Stock of goods, cash balance, Bank Balance, tools etc keep on changing with the transactions of the business, hence, they changing with the transactions of the business, hence, they are known as current assets.are known as current assets.

Fictitious Assets:Fictitious Assets:Certain expenses, the benefit of which is available for more Certain expenses, the benefit of which is available for more then one year, are not written off in one year but are known then one year, are not written off in one year but are known as fictitious assets.as fictitious assets.

Preliminary expenses, discount on debentures, Preliminary expenses, discount on debentures, advertisement campaign expenses, etc. are examples of advertisement campaign expenses, etc. are examples of fictitious assets.fictitious assets.

Other classification of Assets is:Other classification of Assets is: Tangible assets Tangible assets

land, Building, Machinery, Furniture, etc. which can land, Building, Machinery, Furniture, etc. which can be seen, touched, are known as tangible assets.be seen, touched, are known as tangible assets.

Intangible assetsIntangible assets

Assets like goodwill, patent, copyright, trademark Assets like goodwill, patent, copyright, trademark are valuable but cannot be seen or touched, are valuable but cannot be seen or touched, therefore, they are known as intangible assets.therefore, they are known as intangible assets.

REVENUEREVENUE Revenue is the amount that business earnsRevenue is the amount that business earns By selling its products.By selling its products. By providing services to customers.By providing services to customers. Revenues are the titled as Revenues are the titled as Sales RevenueSales Revenue FeesFees CommissionCommission InterestInterest DividendsDividends Royalties ReceivedRoyalties Received Rent ReceivedRent Received Revenue is recognizedRevenue is recognized When the goods or services are sold to the customer for cashWhen the goods or services are sold to the customer for cash

* In credit sales also, though the amount is yet to be received revenue is * In credit sales also, though the amount is yet to be received revenue is recognized.recognized.

For interest, Discount, Royalties, Rent, Commission Etc.For interest, Discount, Royalties, Rent, Commission Etc.* When they are due or accrued.* When they are due or accrued.

EXPENDITUREEXPENDITURE Expenditure is the amount ofExpenditure is the amount of

Resources ConsumedResources ConsumedFor any benefit or servicesFor any benefit or services

Resources are consumedResources are consumedAmount spent or paid orAmount spent or paid orWhen the liability is createdWhen the liability is created

Examples:Examples:Machinery PurchasedMachinery PurchasedSalary PaidSalary PaidWages PaidWages PaidFurniture PurchasedFurniture Purchased

EXPENSESEXPENSES These are the cost incurred by a business in the These are the cost incurred by a business in the

process of earning revenues.process of earning revenues. Generally expenses are measured byGenerally expenses are measured by

• The cost of assets consumed ORThe cost of assets consumed OR• The cost of goods consumedThe cost of goods consumed• Services usedServices used• During the accounting periodDuring the accounting period

Examples:Examples:Depreciation, Rent paid, Wages, Salary, Interest, Cost Depreciation, Rent paid, Wages, Salary, Interest, Cost of Heat, Light, Telephone Etc.of Heat, Light, Telephone Etc.

If the benefit of Expenses is available to the business If the benefit of Expenses is available to the business for more than one year is known as prepaid for more than one year is known as prepaid expenses.expenses.

INCOMEINCOME Income is the increase in the net worth of the organization Income is the increase in the net worth of the organization

either from business activity or other activities.either from business activity or other activities. Income is a comprehensive term, which includes profit also.Income is a comprehensive term, which includes profit also. Profit occurs:Profit occurs:

On sale of Goods and ServicesOn sale of Goods and Services On sale of Business AssetsOn sale of Business Assets

Income is classified intoIncome is classified into Revenue Income:Revenue Income:

Income received from the day to day transaction of the business is known Income received from the day to day transaction of the business is known as revenue income.as revenue income.

Capital Income:Capital Income:The income received on sale of any assets or on receipt of any long-term The income received on sale of any assets or on receipt of any long-term debt is known as capital income.debt is known as capital income.

In accounting, income is the positive change in the wealth of In accounting, income is the positive change in the wealth of the firm over a period of time.the firm over a period of time.

LOSS & GAINLOSS & GAIN LOSS:LOSS:

Amount lost without getting any benefit is known as loss. Amount lost without getting any benefit is known as loss. For Example: Loss due to fire is a loss.For Example: Loss due to fire is a loss.

Excess of revenue expenses over revenue income is known Excess of revenue expenses over revenue income is known as loss.as loss.

Results in decrease in owner’s capital or net assets or net Results in decrease in owner’s capital or net assets or net worth over a period of 1 year is known as loss.worth over a period of 1 year is known as loss.

GAIN:GAIN: Gain or Profit is the excess of revenues over expenses Gain or Profit is the excess of revenues over expenses

during an accounting year.during an accounting year. Results in increase in Owner’s capital or net assets or net Results in increase in Owner’s capital or net assets or net

worth over a period of 1 year is known as Gain Or Profit.worth over a period of 1 year is known as Gain Or Profit.

PURCHASESPURCHASES The items, in which the trader is trading are The items, in which the trader is trading are

called goods.called goods.

Goods received by the trader for cash or on Goods received by the trader for cash or on credit are known as purchases.credit are known as purchases.

In a trading concern, purchases are made for In a trading concern, purchases are made for resale with or without processing.resale with or without processing.

In a manufacturing concern, Raw materials In a manufacturing concern, Raw materials are purchased, processed further into are purchased, processed further into finished goods and then sold. finished goods and then sold.

SALES:SALES: Goods given by the trader for cash or on credit to the Goods given by the trader for cash or on credit to the

customer are known as sales.customer are known as sales.

STOCK:STOCK: Goods;Goods;

• Remaining unsoldRemaining unsold• On handOn hand• At the end of the accounting periodAt the end of the accounting period• Is known as STOCK OF GOODSIs known as STOCK OF GOODS

Stock is,Stock is,• Cost of Goods Purchased LESSCost of Goods Purchased LESS• Cost of Sold out of the PurchasesCost of Sold out of the Purchases• This stock is known as closing stockThis stock is known as closing stock• Which becomes opening stock in the next year.Which becomes opening stock in the next year.

DEBTORS:DEBTORS:Are Persons and other entitiesAre Persons and other entities Known as debtors or customers of the business.Known as debtors or customers of the business. To whom the goods or services are sold on credit To whom the goods or services are sold on credit

andand The amount receivable.The amount receivable.

RECEIVABLES:RECEIVABLES: Amount receivable from any person other than the Amount receivable from any person other than the

debtors are known as receivables.debtors are known as receivables.For Examples:For Examples:

• Pre-paid expensesPre-paid expenses• Income due but not receivedIncome due but not received• Outstanding income are known as receivables.Outstanding income are known as receivables.

CREDITORS:CREDITORS:Are Persons and other entitiesAre Persons and other entities Known as creditors or suppliers of the business.Known as creditors or suppliers of the business. From whom the goods or services are purchased on From whom the goods or services are purchased on

credit andcredit and The amount is payable.The amount is payable.

PAYABLE:PAYABLE: Amount payable to any person other than the Amount payable to any person other than the

creditors are known as payables.creditors are known as payables.For Examples:For Examples:

• Outstanding expensesOutstanding expenses• Income received in advance are known as Income received in advance are known as

payables.payables.

DEBIT:DEBIT:To debit means recording an amount on the debit To debit means recording an amount on the debit side (Left-hand side) of a ledger account. side (Left-hand side) of a ledger account.

The name of account credited should be written in The name of account credited should be written in the column of particulars.the column of particulars.

CREDIT:CREDIT:To credit means recording an amount on the credit To credit means recording an amount on the credit side (Right hand side) of a ledger account.side (Right hand side) of a ledger account.

The name of account debited should be written in The name of account debited should be written in the column of particulars.the column of particulars.

Methods or Systems of AccountingMethods or Systems of AccountingThere are TWO methods of accounting:There are TWO methods of accounting:1.1. Double Entry Accounting SystemDouble Entry Accounting System

As the name suggests, in book-keeping, each As the name suggests, in book-keeping, each transaction is given 2 (Double) effects (i) Debit Effects & (ii) transaction is given 2 (Double) effects (i) Debit Effects & (ii) Credit Effect. The amount debited is equal to the amount Credit Effect. The amount debited is equal to the amount credited. This method is used in many countries of the credited. This method is used in many countries of the world including India, as it is the scientific method of world including India, as it is the scientific method of accounting.accounting.

2.2. Deshi Nama Accounting SystemDeshi Nama Accounting SystemThis book-keeping system, which was used in This book-keeping system, which was used in

the ancient times is still prevalent. This is similar to, double the ancient times is still prevalent. This is similar to, double entry system but it is structurally different from double entry system but it is structurally different from double entry system. In this system, one book is Rojmel, which entry system. In this system, one book is Rojmel, which satisfies the requirement of cash book and journal and the satisfies the requirement of cash book and journal and the other book is khatabahi (Ledger). This system is also other book is khatabahi (Ledger). This system is also known as "Bahi Khata“ system.known as "Bahi Khata“ system.