Fundamental of Accounting Concept for a Non Accountant

Accounting Ki Prem Kahani

Hi friends,

To make the accountancy subject easier for the guy who is new to this field we will have discussion on accounting love story. This story is all about a boy loves to a girl where the villian is trying to break their love by putting his mind in accountancy.

                           

   (Note:- The Names and characters are fictitious)

Business Starting…………..

Once open a time two decades ago, there was an owner of a company named as Mr. Denny Droungler (Villian of this love story) having a business of various things. He was searching a guy who can handle his business entirely.

One day Mr. Dillip (Hero of this Accounting love story), handsome guy entered with his stylish Royal Enfield Thounderbird though he was searching job is joined to look after his business but he was not having any knowledge in accountancy.   

Mr. Denny Droungler feels that his business is going well rather there is not any tracking of the transaction which make away in future. So he decided to track all transaction .He asked Mr. Dillip to track all transaction happening towards his business.

As asked by his employer, Mr. Dillip started recording all the transactions relating to the business, taking only those transactions which are capable of being measured in value terms (Based on the "Money Measurement Concept"), in the accounting record .

That time there was no concept of software and computer. Hence for tracking those transactions, he has provided books to record the transactions.

Each page in the book provided by Mr. Denny Droungler that Mr. Dillip was using for recording. On an average there used to be around 50 transactions every day. Thus, recording day’s transactions resulted in a page getting filled up every day.

Love story started………….

Then one day heroine of this story named Miss. Swagatika (gorgeous, beautiful) has joined the business as an employee.

“Ussi din se Mr. Dillip ki mann mein guitar bajne laga “”Ek ladki ko dekha to esha loga jese khilta gulab jese………..””””””””””””””.

“Real love stories hit about choreography for how deep love between two people can be expressed to an audience.”
Its gone some days like this with a amusable love scene .One day what happen, Mr. Dillip was sitting and thinking of ….”” Ek ladki thi diwani si ,jo mere nind mein ati thi…………”” suddenly a loud voice came from outside with a doubtful manner.

Mr. Denny Droungler in need of information

By looking all this activity, Mr. Denny Droungler doubted that Mr. Dillip is giving more attentions to Miss. Priya which will cause his business down. So he decided to terminate Miss. Priya by thinking “” Na rahega bas na bajegi basuri……””.

One day (after the accounting recorded was filled for all the previous days), Mr. Denny Droungler, called Mr. Dillip and told him that he wanted to know whether Miss. Priya was due to them or if they had to pay anything to Miss. Priya.

Mr. Dillip derived the information to Mr. Denny Droungler !!!!!!

At the time of writing the accounting records, whenever there was a transaction involving Mrs. Priya, Mr. Dillip used to mention her name. Therefore he could derive the information needed by Mr. Denny Droungler, by locating all the transactions where Mrs. Priya name appears and analyzing them.

For deriving the needed information, Mr. Dillip noted down the amounts relating to all those transactions in which Mrs. Priya got the benefit at a place (like when she bought vegetables on credit). Simultaneously, time he noted down the amounts relating to all those transactions in which Mrs. Priya gave the benefit at another place (like when she paid the amounts due by her).

While noting down the amounts he assigned a positive sign to the amounts related to all the transactions in which Mrs. Priya took the benefit and a negative sign to the amounts related to the transactions in which Mrs. Priya gave the benefit.

The data collected by Mr. Dillip

Sales Made (+)			Amounts Received (−)
Date	S. No	Amount	Date	S. No	Amount
2012 June 10th	4	65	2012, June 11th	5	22
11th	9	12	12th	11	52
12th	2	150	14th	15	94
...	...	...	...	...	...
...	...	...	...	...	...
2012, Dec 8th	6	55	2012, Dec 6th	12	250
10th	5	95	8th	5	55
Total amount Rs. 8,000			Total amount Rs. 7,000

Adding up the two sets of amounts separately he could arrive at two sums. One a positive sum (+ Rs. 8,000) and another a negative sum (− Rs. 7,000). Positive sum representing the total benefit received by Mrs. Priya from them and the negative sum representing the total benefit given by Mrs. Priya (amounts paid by her) to them.

The two sums were set off and the remainder gave an idea of whether Mrs. Priya owes them some money or they owe her some amount.

The net resultant sum on setting off the two amounts would be + Rs. 1000 (+ Rs. 8,000 − Rs. 7000). This implies that Mrs. Priya is due to the extent of Rs. 1000 to them.

What is Mr. Denny Droungler’s need.........

Mr. Denny Droungler is in need of information. The need to know how much is due from Mrs. Priya or how much is due to her. This we say is the need for (business/accounting) information relating to Mrs. Priya

Difficulty in deriving the needed information……

Accounting as understood by Mr. Denny Droungler (initially) is nothing but recording all the business transactions based on the money measurement concept i.e. all the accounting transactions.

 But after seeing Mr. Dillip conduct the exercise of deriving the small piece of information needed, Mr. Denny Droungler, understood that the method he was using for maintain the accounting record had limitations.

One major limitation being that it could not provide the information he needed at on the fly or at a glance. For finding the small information relating to Mrs. Priya, he had to get such a laborious exercise done. He understood that it would not be prudent to think in terms of deriving whatever information he wanted that way.

Therefore Mr. Denny Droungler approached a professional accountant for advice. From what the accountant told him he could understand that what he was trying to do was correct, but the format in which he was getting it recorded was not appropriate.

Mr. Denny Droungler is not able to terminate her and end their love story by putting this much effort to this.But he got a very good concept of accounting the transaction for his business. 

Before we go to learn what these are and how these are maintained, we state the basic purpose of accounting is derivation of information.

Money Measurement Concept:

State whether the following events form accounting transactions or not for the business of Mr.Denny Droungler (proprietor)

1. Mr. DJ started business with capital (brought in cash) Rs. 20,000
2. Paid salaries to staff Rs. 3,000
3. Purchased Machinery for Rs. 10,000 in cash
4. Placed an order with DJ & Co. for goods for Rs. 2,000
5. Opened a bank account by depositing Rs. 2,000
6. Received pass book from bank
7. Appointed Mr. DJ as manager on a salary of Rs.1,000 per month
8. Received interest from bank Rs.300
9. Received a price list from B

Solution:

1. Yes.   [It can be measured in terms of money. Cash is coming into the business.]
2. Yes.   [It can be measured in terms of money. It reduces the cash balance of the business.]
3. Yes.   [It can be measured in terms of money. It reduces the cash balance of the business.]
4. Yes.   [It can be measured in terms of money. It reduces the cash balance of the business.]
5. Yes.   [It can be measured in terms of money. It reduces the cash balance of the business.]
6. No.   [It cannot be measured in terms of money.]
7. No.   [It cannot be measured in terms of money.]
8. Yes.   [It can be measured in terms of money. It increases the cash balance of the business.]
9. No.   [It cannot be measured in terms of money.]

An Element in accounting

An element for the purpose of accounting is that aspect relating to which we wish to find/know information.
Each element in accounting is identified as an account or an accounting head.

Some examples of accounting elements

We wish to know

• The amount of capital invested in the business.

• Capital is an element. — We identify it as Capital a/c.

• The value of Furniture with us in the business.

• Furniture is an element. — We identify it as Furniture a/c.

• The amount of expenditure on account of salaries.

• Salaries are an element. — We identify it as Salaries a/c.

• The amount due to us from Mrs. Sudha.

• Mrs. Sudha is an element. — We identify it as Mrs. Sudha's a/c.

• The amount we owe the wholesaler Mr. Giri.

• Mr. Giri is an element. — We identify it as Mr. Giri's a/c.

• The amount available in the bank.

• Bank is an element. — We identify it as Bank a/c.

• The value of sales made by us.

• Sales is an element. — We identify it as Sales a/c.

Debit/Credit

Debit and Credit are two actions of opposing nature that are relevant to the process of accounting.

They are as fundamental to accounting as addition (+) and subtraction (−) are to mathematics.

It would not be appropriate to apply this mathematical analogy in all cases as it would give a distorted meaning. Thus, it would not be appropriate to consider debit to be an equivalent of addition and credit to be an equivalent of subtraction.

You just need to understand that debit and credit are two actions that are opposite in nature.

An element (account) that is effected by an accounting transaction is either debited or credited (with an amount that is reflected in the transaction) depending on the nature of the account and the rule applicable to it.

Accounting Head in Accounting System

There are three types of accounts i.e. Real a/c's, Nominal a/c's and Personal a/c's.

• Where the information needed by the organization is very minimal, it can account for the transactions relating to its business with a minimum of four accounting heads.

Family Accounting Story

As we discussed the love story between Dillip and Priya earlier to find a new concept in accounting.Their love story had got succeed and they got married.Now they had a small family consisting of parents, one son, two daughter and wife.

Now Dillip wants to define his family in terms of accounting elements i.e...........

Here I am providing hints to understand the accounting head concept by this family story.

Parents = Asset

Wife = Liability

Son = Income

Daughter = Expense
                                                "WHY !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"

Profit and Loss Acccount for the year end 2013
Expenses	Amount	Income	Amount
Daughter 1	500000	Son	2000000
Daughter 2	700000
Profit	800000
Total	2000000	Total	2000000

Balance sheet as on 31-March-2013
Liabilities	Amount	Asset	Amount
Wife		Parents
Total	0	Total	0

• Assets and Liabilities

1. Assets a/c

Why parents are Asset account I considered because the parents always wants us to be happy wherever we are. We will always get sacrifice and dedication from our parents. We always liable to get something from our parents till end of life, it may be grace or something else.  

• All the assets whatever considered under a single head named Assets a/c
• It ascertain liable to get.

2. Liabilities a/c

Why wife is liability account I considered because the wife always wants something from us whatever it may be until ….. We will always get sacrifice and dedication from wife but with some repayment. We always liable to pay something to wife till end of life; it may be lipstick or something else.  

• All liabilities shall be considered under a single head Liabilities a/c (which includes capital).
• It ascertain liable to pay.

 Incomes/Gains and Expenses/Losses

• Every organization has to deal with incomes/gains and expenses/losses.

3. Expenses/Losses a/c

Why daughter is Expense account I considered because we have to spent money for her marriage which now a days is very expensive.  

• All the expenses/losses whatever they may be are considered under a single head Expenses/Losses a/c.

4. Incomes/Gains a/c

Why Son is Income account I considered because Son will do job and earn money for his family.  

• All the incomes/gains whatever they may be are considered under a single head Incomes/Gains a/c.

5. Minimum Five Account Heads

• The liabilities are acquired from two sources owners and others. The capital acquired from the owners takes the total risk in the business and is different in characteristic from the capital acquired from others.
• Thus to have a clear and better understanding/information regarding liabilities, the Liabilities a/c is replaced by two accounts: Capital a/c and Liabilities a/c.
• Therefore, the minimum accounting heads to be maintained would be 5 i.e. Capital a/c, Liabilities a/c, Assets a/c, Expenses/Losses a/c, Incomes/Gains a/c.

Diamond Rule of Accounting

Particulars	Increase	Decrease
Asset	Debit	Credit
Liability	Credit	Debit
Income/Revenue	Credit	Debit
Expense	Debit	Credit
Equity/Capital	Credit	Debit

OR

ACCOUNT TYPE	DEBIT	CREDIT
Asset	+	−
Liability	−	+
Income	−	+
Expense	+	−
Equity	−	+

Types of Accounts

All the accounting heads used in an organizational accounting system are divided into three kinds/types.

• Personal Accounts

The elements or accounts which represent persons and organizations.

• Real Accounts

The elements or accounts which represent assets

In the initial stages of learning accounting, we can assume real accounts to be those related to tangible aspects.

» Tangible/Touchable

Capable of being perceived by the senses or the mind; especially capable of being handled or touched or felt.

There are assets which are intangible like the organizations Goodwill.

• Nominal Accounts

The elements or accounts which represent expenses, losses, incomes, gains.

• An Account should be one of the three

Any element or account used in an organizational accounting system should be one of these.

Thus, we can say that if an account is not real or personal it should be a nominal account.

Therefore we may also interpret

• Nominal accounts as, the accounts other than Personal and Real accounts
• Real accounts as, the accounts other than Personal and Nominal accounts
• Personal accounts as, the accounts other than Real and Nominal accounts

The total process of accounting is driven by

• The dual entity concept
• The nature of the accounts and
• The rules/principles of debit and credit.

All the account heads used in the accounting system of an organisation are classified under three heads Real, Personal and Nominal.

Each account type has a pair of principles or rules of debit and credit relevant to it. One for debit and another for Credit.

Principles of Debit and Credit (Golden Rule of Accounting)

ACCOUNT TYPE	Rule
Real Accounts	Debit what comes in
	Credit what goes out
Personal Accounts	Debit the benefit receiver
	Credit the benefit giver
Nominal Accounts	Debit all Expenses and Losses
	Credit all Incomes and Gains

1. Real Accounts

 Debit what comes in

Consider the following Transaction: Bought Furniture for Credit from M/s Big Bazar

The two elements affected by the transaction are

1. Furniture a/c (Real account) and
2. M/s Big bazaar a/c (Personal account).

Since furniture is being bought, we can say that it is coming in.
Thus we say that Furniture a/c is to be debited based on the principle "Debit what comes in".

Credit what goes out

Consider the following Transaction: Sold Goods to Mr. Rajsekar on credit

The two elements affected by the transaction are

1. Goods a/c (Real account) and
2. Mr. Rajsekar a/c (Personal account).

Since we are selling goods, we can say that it is going out.
Thus we say that Goods a/c is to be credited based on the principle "Credit what goes out".

» Thought to be applied: Is it Coming in (Or) Is it Going out

To decide whether a particular Real Account (element) effected by an accounting transaction is to be debited or credited; we need to identify whether the element is coming into the organization or going out of it.

2.Personal Accounts

» Debit the benefit receiver

Consider the following Transaction: Paid Cash to Mr. Kotes

The two elements effected by the transaction are

1. Cash a/c (Real account) and
2. Mr. Kotes a/c (Personal account).

Since cash is being paid, we can say that Mr. Kotes is receiving (benefit) from the organization.
Thus we say that Mr. Kotes a/c is to be debited based on the principle "Debit the benefit receiver".

[Please ignore the effect relating to the other element]

» Credit the benefit giver

Consider the following Transaction: Bought Goods on Credit from M/s DJ & Co

The two elements effected by the transaction are

1. Goods a/c (Real account) and
2. M/s DJ & Co a/c (Personal account).

Since the goods are being bought on credit, we can say that M/s DJ & Co is giving (benefit) to the organization.
Thus we say that M/s DJ & Co a/c is to be credited based on the principle "Credit the benefit giver".

» Thought to be applied » Is he/she/it Giving (Or) Is he/she/it Taking

To decide whether a particular personal account (element) effected by an accounting transaction is to be debited or credited; we need to identify whether the element is giving the benefit to the organization or taking the benefit from the organization.

3. Nominal Accounts

In dealing with nominal accounts in a transaction we generally come across situations where the element is related to either an expenditure/loss or income/gain to the organization.

» Debit all Expenses and Losses

Consider the following Transaction: Paid Wages to Workers

The two elements affected by the transaction are

1. Cash a/c (Real account) and
2. Wages a/c (Nominal account).

Since wages are being paid, it amounts to expenditure for the organization.
Thus we say that Wages a/c is to be debited based on the principle "Debit all expenses and losses"

[Please ignore the effect relating to the other element]

» Credit all Incomes and Gains

Consider the following Transaction: Received Commission from M/s Baji & Co by Cheque

The two elements effected by the transaction are

1. Bank a/c (Personal account) and
2. M/s Commission a/c (Nominal account).

Since commission is being received, it amounts to an income for the organization.
Thus we say that Commission a/c is to be credited based on the principle "Credit all incomes and gains".

ACCOUNT TYPE	Debit	Credit
Real (assets)	Increase	Decrease
Personal	Increase	Decrease
Personal (owner's equity)	Decrease	Increase
Nominal (revenue)	Decrease	Increase
Nominal (expenses)	Increase	Decrease
Nominal (gain)	Decrease	Increase
Nominal (loss)	Increase	Decrease

Transaction

After identifying the two elements affected by the transaction we identify the nature/type of the two elements i.e. whether the elements affected are real, personal or nominal accounts.

» Illustration :

Considering the same example (as in the previous page) of business transactions relating to the business of Mr. Oberoi .

1. The business is proposed to be started.

There are no elements affected by this transaction since it is not a transaction to be taken into account based on the "Money Measurement Concept".

2. Started Business with a Capital of Rs. 1,00,000.

Capital and Cash are the two elements affected by this transaction. Since capital is being brought into the business in cash, the value of Capital increases by Rs. 1,00,000 and the value of cash also increases by Rs. 1,00,000.

Capital a/c ↓ Person ↓ Personal a/c

Cash a/c ↓ Tangible aspect/Asset ↓ Real a/c

3. Bought Furniture for cash Rs. 25,000.

Since Furniture is being bought by paying cash, the value of Furniture increases by Rs. 25,000 and the cash available with the business would reduce by Rs. 25,000.

Furniture a/c ↓ Tangible aspect/Asset ↓ Real a/c

Cash a/c ↓ Tangible aspect/Asset ↓ Real a/c

4. Bought Goods for cash Rs. 25,000 from M/s DJ Brothers.

Since goods are bought by paying cash, the value of Goods increases by Rs. 25,000 and the cash available with the business would reduce by Rs. 25,000.

Goods/Stock a/c ↓ Tangible aspect/Asset ↓ Real a/c

Cash a/c ↓ Tangible aspect/Asset ↓ Real a/c

5. Bought Goods from Mr. DJ on credit for Rs. 10,000.

Since goods are bought on credit, the value of Goods increases by Rs. 10,000. The liabilities of the business would increase by Rs. 10,000. This liability is identified by the name of the vendor who gave the goods on credit i.e. Mr. DJ.

Goods/Stock a/c ↓ Tangible aspect/Asset ↓ Real a/c

Mr. DJ a/c ↓ Person ↓ Personal a/c

6. Sold Goods for cash Rs. 20,000 to Mr. Kotes.

Since goods are sold by taking cash, the value of Goods has decreased by Rs. 20,000. The cash available with the business would increase from Rs. 50,000 to Rs. 70,000.

Goods/Stock a/c ↓ Tangible aspect/Asset ↓ Real a/c

Cash a/c ↓ Tangible aspect/Asset ↓ Real a/c

7. Sold Goods on credit to M/s Baji & Co., for Rs. 10,000.

Since goods are sold on credit, the value of Goods decreases by 10,000. A new asset in the form of a debtor (those who owe us) is created. The new asset is identified by the name of the organization which purchased the goods on credit i.e. M/s Baji & Co.

Goods/Stock a/c ↓ Tangible aspect/Asset ↓ Real a/c

M/s Baji & Co. a/c ↓ Organization ↓ Personal a/c

8. Paid Cash into Bank Rs. 60,000.

Since cash is paid into bank, the available cash reduces by Rs. 60,000 and the amount of balance in the bank increases by Rs. 60,000. The amount paid into the bank is held by the bank on our behalf. The bank has to pay us the same whenever we ask for it. The bank therefore stands in the position of a debtor to us (those who owe us money).

The new asset is identified as "Bank" if there is only one bank account. Where there are more than one bank account, each bank is identified by its name.

Cash a/c ↓ Tangible aspect/Asset ↓ Real a/c

Bank a/c ↓ Organization ↓ Personal a/c

9. Paid Cash to Mr. Ajay, Rs. 5,000.

Since cash is paid to Mr. Ajay, the available cash reduces by Rs. 5,000 and the liability in the name of Mr. Shyam Rao (the amount due to him) also reduces by Rs. 5,000.

Cash a/c ↓ Tangible aspect/Asset ↓ Real a/c

Mr. Ajay a/c ↓ Person ↓ Personal a/c

10. Received cash from M/s DJ & Co., on account, Rs. 8,000.

Since cash is received from M/s DJ & Co., the available cash increases by Rs. 8,000 and the asset in the name of M/s. DJ & Co (the amount receivable from them) also reduces by Rs. 8,000.

Cash a/c ↓ Tangible aspect/Asset ↓ Real a/c

M/s Dj & Co. a/c ↓ Organisation ↓ Personal a/c