Basic Concepts of Accounting

Introduction

• Channel: Saheb Academy
• Purpose: Explain basic accounting concepts, especially for science students with non-commerce backgrounds.
• Focus: What is accounting, the accounting process, and key financial elements.

Definitions

What is Accounting?

• Purpose: Record, classify, and summarize financial data.
• Reason: To create meaningful financial information for users (management, shareholders, government, creditors).
• Outcome: Creates financial statements like balance sheets and profit & loss accounts.

Accounting Process

1. Source Document: Evidence of financial transactions (bills, vouchers, invoices).
2. Journal Entry: Record transactions in the journal book.
3. Ledger Accounts: Post entries to create ledger accounts with debit/credit balances.
4. Trial Balance: Summarize ledger balances into a trial balance.
5. Financial Statements: Prepare balance sheet, profit and loss statement, cash flow statement, and statement of changes in equity.
6. Bookkeeping: Process from source document to trial balance.

Financial Statement Elements

1. Assets: Resource controlled by entity expected to bring future economic benefits (e.g., machinery, cash).
2. Expense: Costs incurred with no further benefit expected (e.g., rent, salaries).
3. Liability: Present obligation to transfer economic resources due to past events (e.g., loans).
4. Equity/Capital: Money invested by owners, also termed equity in companies (residual interest in total assets after liabilities).
5. Revenue/Income: Gross inflow of cash or receivables from business activities (e.g., sales, services, interest).

Detailed Explanation of Elements

Assets

• Definition: Resource controlled by the entity, resulting from past events, expected to provide future benefits.
• Examples: Owned or leased items like machinery with expected future utility.

Expenses

• Definition: Costs incurred to generate revenue with no future benefit expected.
• Examples: Rent, salaries, electricity bills.

Liabilities

• Definition: Present obligations to transfer economic resources due to past events.
• Examples: Loans, payables.

Equity/Capital

• Definition: Owner’s residual interest in assets after liabilities.
• Types: Partner's capital vs equity in companies.
• Example: Initial investment by an owner in the business.

Revenue

• Definition: Gross inflow from business operations.
• Examples: Sales, service revenue, interest, rent received.

Double-Entry Concept

• Principle: Every transaction affects two accounts, with one debit and one credit entry.
• Effect: Ensures balanced and accurate recording of financial transactions.
• Rule: Debit balances equal credit balances.

Balances of Financial Elements

• Debits: Represent increase in assets/expenses, decrease in liabilities/equity/revenue.
• Credits: Represent increase in liabilities/equity/revenue, decrease in assets/expenses.

Practical Example

• Initial Capital: Start business with $100,000 capital, appearing as cash (asset) and capital (equity).
• Purchase Equipment: Buy machinery for $20,000, reducing cash and adding machinery (another asset).
• Loan: Take a $40,000 loan—cash increases and liability (loan) is recorded.
• Balance Sheet Impact: Always balanced; assets equal liabilities + equity.

Modern Equation: Asset=Liability + Equity

• Debits: Asset and expense accounts
• Credits: Liability, equity, and revenue accounts
• Impact: Transaction adjustments align with debit and credit rules

Summary

• Elements & Definitions: Understand the five key financial statement elements.
• Processes: Familiarize with accounting process and double-entry bookkeeping.
• Balances: Know which accounts are debited and credited and the impact on financial statements.

Next Steps

• Upcoming Topics: Journal entries and detailed ledger posting.
• Playlist: Introduction to basics of accounting.

Stay tuned for more detailed accounting concepts!