Basics of Accounting | NABARD Grade A & Grade B Preparation - Bank Exams PDF Download

 Page 1


t 
UNIT 7 BASICS OF ACCOUNTING 
Structure 
7.0 Objectives 
Page 2


t 
UNIT 7 BASICS OF ACCOUNTING 
Structure 
7.0 Objectives 
Page 3


t 
UNIT 7 BASICS OF ACCOUNTING 
Structure 
7.0 Objectives 
i) Accounting Concepts Basics of Accounting 
Accounting concepts may be considered as basic assumptions or conditions upon 
which the science of accounting is based. The most commonly accepted concepts 
a) 
Business Entity Concept: According to this concept, the business enterprise 
and its owners are two separate entities. The business organization is responsible 
for the transactions and the implications there on but not the proprietor. As per 
this concept, the business affairs are free from private affairs of the proprietor. 
b) 
Money Measurement Concept: According to this concept, all business 
transactions must be recorded in terms of money only i.e. in the curreqcy of the 
country in which the business is established. The transactions which are not 
measurable in terms of money should not be recorded; e.g: Quality of the 
management or Quality of the products should not be recorded in accounting 
C) 
Going Concern Concept: This assumes that the business firm will continue to 
cany on its business at a profit for an indefinite period of rime. In simple, it 
assumes that every business entity has continuity of life and will not be dissolved 
in the near future. 
d) Dual Aspect Concepts: This concept emphasizes that every business 
transaction has two aspects. 
Receiving the benefit aspects, and 
Giving benefit aspect. 
These two aspects are measured in terms of money. The receiver of the amount 
is termed as debtor and the giver is termed as called creditor. Thus, every debit 
must have a corresponding credit and vice-versa. This dual aspect has been 
raised the whole super structure of double entry system of accounting. The 
accounting equation is based on the dual aspect concept.' 
Accounting Equation 
Assets = Equities (liabilities + capital) 
"Assets" means the resource owned by the business and the term "equities" 
denotes the claims of creditors and proprietors of the business against the assets. 
As a result of this dual aspect concept, for every debit there must be a 
corresponding and equal credit. 
e) 
Accounting Period Concept: For the purposes of calculation of profit, financial 
position, tax computation, etc., every business entity must calculate the profit or 
loss at regular intervals which are called accounting periods. Normally, 
accounting period adopted is one year. The accounting period concept requires 
that a Balance sheet and profit & loss account should be prepared at regular 
f) 
Cost Concept: This concept requires that fixed assets like building, plant & 
machinery, furniture, etc., are to be recorded in the books of accounts at a price 
paid for them. Asset is recorded at cost at the time of purchase. The market 
value is immaterial for accounting. 
g) 
Reahtion Concept: As per this concept, revenue is considered as being 
earned only when the sale is made. Realisation means the legal right to the 
receipt of money from a transaction. 
Page 4


t 
UNIT 7 BASICS OF ACCOUNTING 
Structure 
7.0 Objectives 
i) Accounting Concepts Basics of Accounting 
Accounting concepts may be considered as basic assumptions or conditions upon 
which the science of accounting is based. The most commonly accepted concepts 
a) 
Business Entity Concept: According to this concept, the business enterprise 
and its owners are two separate entities. The business organization is responsible 
for the transactions and the implications there on but not the proprietor. As per 
this concept, the business affairs are free from private affairs of the proprietor. 
b) 
Money Measurement Concept: According to this concept, all business 
transactions must be recorded in terms of money only i.e. in the curreqcy of the 
country in which the business is established. The transactions which are not 
measurable in terms of money should not be recorded; e.g: Quality of the 
management or Quality of the products should not be recorded in accounting 
C) 
Going Concern Concept: This assumes that the business firm will continue to 
cany on its business at a profit for an indefinite period of rime. In simple, it 
assumes that every business entity has continuity of life and will not be dissolved 
in the near future. 
d) Dual Aspect Concepts: This concept emphasizes that every business 
transaction has two aspects. 
Receiving the benefit aspects, and 
Giving benefit aspect. 
These two aspects are measured in terms of money. The receiver of the amount 
is termed as debtor and the giver is termed as called creditor. Thus, every debit 
must have a corresponding credit and vice-versa. This dual aspect has been 
raised the whole super structure of double entry system of accounting. The 
accounting equation is based on the dual aspect concept.' 
Accounting Equation 
Assets = Equities (liabilities + capital) 
"Assets" means the resource owned by the business and the term "equities" 
denotes the claims of creditors and proprietors of the business against the assets. 
As a result of this dual aspect concept, for every debit there must be a 
corresponding and equal credit. 
e) 
Accounting Period Concept: For the purposes of calculation of profit, financial 
position, tax computation, etc., every business entity must calculate the profit or 
loss at regular intervals which are called accounting periods. Normally, 
accounting period adopted is one year. The accounting period concept requires 
that a Balance sheet and profit & loss account should be prepared at regular 
f) 
Cost Concept: This concept requires that fixed assets like building, plant & 
machinery, furniture, etc., are to be recorded in the books of accounts at a price 
paid for them. Asset is recorded at cost at the time of purchase. The market 
value is immaterial for accounting. 
g) 
Reahtion Concept: As per this concept, revenue is considered as being 
earned only when the sale is made. Realisation means the legal right to the 
receipt of money from a transaction. 
Retail Management 
h) 
Accrual Concept: According to this concept, revenues are recognized when 
Perspectives and 
Communication 
they simply become receivable though cash is not received, and expenses are 
recognized when they simply become payable though no cash is paid immediately. 
and both are recorded in the accounting period to which they relate. 
ii) Accounting Conventions 
While preparing the accounting statements the accountant must bear in mind the 
customs or traditions of accounting which are called accounting conventions. The 
important accounting conventions are as follows: 
a) 
Consistency: This convention requires the use of same accounting methods over 
a period of time. There should not be any change in accounting rules, and 
practices. Consistency in accounting will help in making comparison between 
past and present business results. 
b) 
Disclosure: As per this convention all accounting statements shall be sincerely 
1 
prepared to disclose all significant information. This convention is gaining 
popularity in recent year\. The big business units in the form of joint stock 11 
companies, where ownership is completely different from management, require 
significant information which is of material interest to proprietors, creditors and 
investors. The accounting statements should disclose such information. 1 
C) 
Conservation (prudence): Under this concept, the working rule is "anticipate no 
gains but provide for all possible losses and if in doubt write them off. Thus the 
accountant should record not only actual losses but also those losses that are 
4 
likely to occur. For example closing stock is valued at cost or market price which 
ever is less. Thus the principle of conservation is inherent in the valuation of 
stock. 
Financial statements are usually prepared on the basis of convention of 
conservation. 
d) 
The materiality: Accord~ng to the materiality convention, only important and 
relevant information be provided in the financial statements. The general rule is 
that an item should be considered as material (i.e. significant) if the knowledge of 
that item could affect the uses of financial statements in taking some decisions 
such as to invest or not, etc. 
7.3.2 Double Entry System of Accounting 
A method of writing every transaction in two accounts is known as double entry 
# 
system of accounting. Out of these two accounts, one account is given debit and 
, 
another accoubt is given credit of an equal amount. Thus, under double entry system 
1 
for every debit there will be a corresponding credit and vice-versa. This is considered 
as the most scientific system that records both aspects of each transaction. For better 
1 
understanding of double entry system one has to bear in mind the following factors 
which are common to every business. 
i) 
Every business unit deals with a number of persons or firms. Therefore, the 
personslfirms must be recorded in separate category of accounts called personal 
accounts. 
ii) 
The business concern needs to deal with and/or maintain some assets like cash, 
stock, furniture, etc. An accountant must keep the detailed record of such 
accounts which are classified as real or property accounts. 
iii) It is common for every business to have certain resources of income and 
similarly certain expenses must be incurred to run the business. Therefore, a 
7 4 
Page 5


t 
UNIT 7 BASICS OF ACCOUNTING 
Structure 
7.0 Objectives 
i) Accounting Concepts Basics of Accounting 
Accounting concepts may be considered as basic assumptions or conditions upon 
which the science of accounting is based. The most commonly accepted concepts 
a) 
Business Entity Concept: According to this concept, the business enterprise 
and its owners are two separate entities. The business organization is responsible 
for the transactions and the implications there on but not the proprietor. As per 
this concept, the business affairs are free from private affairs of the proprietor. 
b) 
Money Measurement Concept: According to this concept, all business 
transactions must be recorded in terms of money only i.e. in the curreqcy of the 
country in which the business is established. The transactions which are not 
measurable in terms of money should not be recorded; e.g: Quality of the 
management or Quality of the products should not be recorded in accounting 
C) 
Going Concern Concept: This assumes that the business firm will continue to 
cany on its business at a profit for an indefinite period of rime. In simple, it 
assumes that every business entity has continuity of life and will not be dissolved 
in the near future. 
d) Dual Aspect Concepts: This concept emphasizes that every business 
transaction has two aspects. 
Receiving the benefit aspects, and 
Giving benefit aspect. 
These two aspects are measured in terms of money. The receiver of the amount 
is termed as debtor and the giver is termed as called creditor. Thus, every debit 
must have a corresponding credit and vice-versa. This dual aspect has been 
raised the whole super structure of double entry system of accounting. The 
accounting equation is based on the dual aspect concept.' 
Accounting Equation 
Assets = Equities (liabilities + capital) 
"Assets" means the resource owned by the business and the term "equities" 
denotes the claims of creditors and proprietors of the business against the assets. 
As a result of this dual aspect concept, for every debit there must be a 
corresponding and equal credit. 
e) 
Accounting Period Concept: For the purposes of calculation of profit, financial 
position, tax computation, etc., every business entity must calculate the profit or 
loss at regular intervals which are called accounting periods. Normally, 
accounting period adopted is one year. The accounting period concept requires 
that a Balance sheet and profit & loss account should be prepared at regular 
f) 
Cost Concept: This concept requires that fixed assets like building, plant & 
machinery, furniture, etc., are to be recorded in the books of accounts at a price 
paid for them. Asset is recorded at cost at the time of purchase. The market 
value is immaterial for accounting. 
g) 
Reahtion Concept: As per this concept, revenue is considered as being 
earned only when the sale is made. Realisation means the legal right to the 
receipt of money from a transaction. 
Retail Management 
h) 
Accrual Concept: According to this concept, revenues are recognized when 
Perspectives and 
Communication 
they simply become receivable though cash is not received, and expenses are 
recognized when they simply become payable though no cash is paid immediately. 
and both are recorded in the accounting period to which they relate. 
ii) Accounting Conventions 
While preparing the accounting statements the accountant must bear in mind the 
customs or traditions of accounting which are called accounting conventions. The 
important accounting conventions are as follows: 
a) 
Consistency: This convention requires the use of same accounting methods over 
a period of time. There should not be any change in accounting rules, and 
practices. Consistency in accounting will help in making comparison between 
past and present business results. 
b) 
Disclosure: As per this convention all accounting statements shall be sincerely 
1 
prepared to disclose all significant information. This convention is gaining 
popularity in recent year\. The big business units in the form of joint stock 11 
companies, where ownership is completely different from management, require 
significant information which is of material interest to proprietors, creditors and 
investors. The accounting statements should disclose such information. 1 
C) 
Conservation (prudence): Under this concept, the working rule is "anticipate no 
gains but provide for all possible losses and if in doubt write them off. Thus the 
accountant should record not only actual losses but also those losses that are 
4 
likely to occur. For example closing stock is valued at cost or market price which 
ever is less. Thus the principle of conservation is inherent in the valuation of 
stock. 
Financial statements are usually prepared on the basis of convention of 
conservation. 
d) 
The materiality: Accord~ng to the materiality convention, only important and 
relevant information be provided in the financial statements. The general rule is 
that an item should be considered as material (i.e. significant) if the knowledge of 
that item could affect the uses of financial statements in taking some decisions 
such as to invest or not, etc. 
7.3.2 Double Entry System of Accounting 
A method of writing every transaction in two accounts is known as double entry 
# 
system of accounting. Out of these two accounts, one account is given debit and 
, 
another accoubt is given credit of an equal amount. Thus, under double entry system 
1 
for every debit there will be a corresponding credit and vice-versa. This is considered 
as the most scientific system that records both aspects of each transaction. For better 
1 
understanding of double entry system one has to bear in mind the following factors 
which are common to every business. 
i) 
Every business unit deals with a number of persons or firms. Therefore, the 
personslfirms must be recorded in separate category of accounts called personal 
accounts. 
ii) 
The business concern needs to deal with and/or maintain some assets like cash, 
stock, furniture, etc. An accountant must keep the detailed record of such 
accounts which are classified as real or property accounts. 
iii) It is common for every business to have certain resources of income and 
similarly certain expenses must be incurred to run the business. Therefore, a 
7 4 
account. Such accounts are known as nominal orfictitious accounts. 
An account is a summarized record of transactions relating to a person, asset, 
expense or gain. It will be maintained in 'T' form. The left side of the account is 
called debit side and the right side of the account is called credit side. In other 
words, an account is a statement in the ledger which records, transactions 
relevant to a person or an asset or income. Figure 7.1 Illustrates the 
classification of accounts. 
Accounts 
1 
4 
Personal Accounts Impersonal Accounts 
Nominal/Personal Accounts Accounts of Institutions 
(or) firms ril 
Real Accounts Nominal Accounts 
4- 
Tangible Real Accounts Intangible Real Accounts 
Figure 7.1: Classification of accounts 
The accounts are divided into the following three types. They are Personal accounts, 
Real accounts and Nominal accounts. In these three categories of accounts all 
business transactions relating to finance will be recorded. 
Personal Accounts: Accounts of persons, partnership firms, companies or co- 
operative institutions will be treated as personal accounts. Eg: Capital amount of the 
proprietor 
Drawings amount of the proprietor 
Debtors amounts 
Creditors accounts. ' 
I * 
Bank accounts etc., 
I 
Real Accounts: Any business transaction relating to property, asset or possessions 
are recorded in separate categories of amounts known as real accounts. Real 
accounts are the accounts relating to either tangible things (cash, building, furniture, 
etc) or intangible (non-visible) assets like good will, patents etc., 
I 
Nominal Accounts: It relates to expenses, incomes, losses and gains of business 
1 
organization; eg: Salaries, Rent, Interest, Commission, Discount received etc., 
I 
7.3.3 Rules of Double Entry System 
Double entry system means ensures recording of receiving of values and giving the 
values of each transaction. 'Dr' is the symbol for debit and 'Cr' is the symbol for 
credit. When an account receives the benefit or value of the transaction it is debited 
when it gives or foregoes the benefit or value it is credited. 7 5