Introduction to Accounting

Welcome Friends, you are welcome to learnvern. I am Anshu Sachan.

In the last session we saw Introduction to Fundamentals of Accounting and Bookkeeping.

Today we will be learning about Fundamentals of Accounting and Bookkeeping. But before we start let's see what fundamental accounting is. So friends, if you are ever asked about, what is accounting? What do you understand about accounting? What is the very first thing that comes to your mind when you hear the word accounting. You might think that accounting means debiting something or crediting something. It might be some recording that you do related to the journal entry. If you are a person that does not know anything about accounting, then if you ask him, as if what's the meaning of accounting? Then the probable answer would be that they constantly keep on writing some numbers. Means a businessman constantly keeps on writing something in their books. That might be accounting. For a common person, writing something business related in accounting. But that is not the case.

Accounting is also a science, and an art. Okay.

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When we learn accounting for the first time, then at that time we are told that accounting is an art, it's a science. Why is this the case? Accounting is a Science. As science is a field which runs in rules, regulations or principles. Okay.

Just like that, Accounting also has some rules and principles. Okay. We will be learning the rules, concepts and the principles of Accounting. First we will be understanding the definition of accounting. Every business has some internal talks, and for that it needs a form of communication that we call a business language. Now, if any two businesses want to talk about anything related to finance. How would they do it? They would do it through Accounting. So accounting is providing a tool for communication as a business language.

Now imagine that you have a company and you want the stakeholder to know that your company is extremely good. I have good profits and that you should consider investing in my company. To do that you would not be reaching individual shareholders for this, because your shareholder might be all over India or maybe even Overseas. So, how would you be able to communicate with your shareholder?

When you share your annual reports, which is your balance sheet, your accounts. Then at that time they would know that your company is good. What did accounting become here? It becomes a business language, through which you, an individual or a business is able to communicate with other businessmen. Okay.

Now let's divide this definition of accounting into smaller parts. What happens here is, transactions. In accounting, there is a transaction that involves a monetary amount, which means that money is involved. Then after that, it should be related to the business. The business that you have, whichever transactions that you have done, it should have an amount. Okay.

So two things happened, money should be involved in a transaction and it must be related to your business. Okay. Then the next thing is, there should be a systematic recording of it. So in this proper definition of accounting, that we are understanding, which involves a transaction, that involves some amount, that is related to your business. Now there would be a systematic recording of it in its respective ledger. Clear.

The process next to it is, the things that we have recorded. All the transactions that we will be recording in the books of accounts. We need to follow generally accepted accounting principles. Which means that, whenever someone in finance and accounting would write any books of accounting he would be following some accounting principles that are generally accepted. It would be a generally accepted principle and process that would describe what to perform in a certain given situation. Okay.

Apart from it, there are fundamental accounting rules. Like I told you earlier, accounting is a science, and just like science it has some rules. As you all know that the rules of science that are followed in India are equally followed in other countries, because those are set rules. Just like this, the rules of accounting that are applicable in India are also applicable all over the globe. Clear.

So today we will be seeing the rules of Accounting. But before that lets talk about some examples related to accounting. In accounting we only need to consider two things. The first thing is, any transaction or exchange that occurs must have some amount. And the second one is that it should be related to the business. Let's look at it through an example. Here Mr. A have placed an order to Mr. B. What does he want? He wants customised machinery. So Mr. A asked Mr. B that I want a certain customised machinery, and Mr. B agreed. So what was this? It was a purchase order. It is just a purchase order as I have not given any payment or advance for the order. Neither has he given me an invoice or machinery. So, this was a transaction, as I placed an order for customised machinery. But the one thing that is missing from this is the monetary value. Is it business related? Yes, I would be using it for my business. So it is related to my business, but as of now the monetary amount is not involved so, it’s transaction would not be booked.

Whenever I will get the machinery, or if I give him any advance. Means, if Mr B gives me the machinery or Mr A, who is me, gives the money for the machinery. Among them, whichever happens first, either I give him money or else he gives me machinery. If any one of them happens, then at that time it becomes an accounting transaction and would need to be recorded. Okay.

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Till now it was how and when the accounting transactions would be recorded.For that you need to look at business, as it should be business related and the second thing is that it should be monetary. Okay. Now we have understood this much. But we still do not know what to debit and what to credit. For that, let me explain it to you through excel.

I have prepared this excel. You can see this right now. If you look at accounting in a very broad way then you would find only four things. Income, expense, assets and liabilities. Getting me? It means the transaction would be an income, that is you have earned that money. Or it can be an expense that you have paid to someone. It can also be an asset, that is you might have purchased something, that is considered as an asset, it’s usually your property. Or finally it can be your liability, as you have to give some money to someone.

So the whole of accounting can be divided in a broader way into four things. That is income, expenses, assets and liabilities. What happens generally is, I’m using the word generally here.

Generally what happens is that Income is usually credited. Expenses are usually debited. Assets are also usually debited and liabilities are also credited. Now what you need to do is. If there is a transaction that is related to your business then, you need to find out whether it is my income or expense, or it is my asset or liability. So you would automatically know what to debit and what to credit. If it is an asset then you need to debit it. If it is you income then you need to credit it. If in case it is your liability then you need to credit it, and if it is your expense then you need to debit it. Understanding me?

Now, who will get to decide the income, asset, expense or liability? You would be the one deciding it, as you are the one running a business. Okay. You would know whether this is an income of my business and this is the expense of my business. Getting me?

Here I have given an example. Mr A has made a sale, to whom? To Mr B. That means that Mr A is the supplier and Mr B is the customer. So Mr A sold the product to Mr B. As the product is sold, that means the sales have happened and that is the income of Mr A. That means for Mr A it would be credit. Whereas for Mr B. He has purchased the product and materials, so it would be the expense. So it would be a debit for him. Okay.

Again on the other side. Mr A has sold the products to Mr B, but he also said that Mr B can make the payment within 30 days. 30 days here is the credit term. Now what is this credit term? Listen friends, wherever we enter the practical market, then there are day to day transactions and also there are day to day suppliers, and also there are many customers from which we transact daily. They have become trustworthy and they generally follow a credit term. It is like, if you sold a product today then you need to pay the supplier after 30 days. Then these 30 days are known as credit terms. As you can give the money after the 30 days. These 30 days would not be there at every place. It depends on the business and the type of supplier, and also on the relation between you and the supplier. If you know that the customer is not trustworthy then you would not lend him any of the product on credit. As you might also say that you do not give credit.

There are credit terms of 30 days or 60 days. As to when the product is sold, you can make the payment in 30 days. It is called credit terms. Understood. When Mr A sold the product today, he might be getting the payment after 30 days or maybe 10 days. So for today, it becomes receivable, it becomes trust, as he needs to accept the money. Hence it becomes the asset of the company. As we want to receive the money. So Mr A will be debiting Mr B from his account. Understood? It will become an asset for Mr A, as he wants to receive the money, so it will be debit. While Mr B has to pay money so it will be his liabilities, he has to pay the money in 10 days, so it's Mr B’s liabilities and he has to pay that sum of money to Mr A. Hence it will become credit.

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The asset here falls in debit and the income on the other hand falls in credit. Similarly, the liabilities comes in credit and the expense comes in debit. The whole of the accounting works on these principles. Whenever there is a transaction in your business and you do not understand what entry it should have, then you should do is. You only need to find that, from all of the transaction, what is it to you. Its not like that the transaction would always be of income and expense or of asset and liabilities. Sometimes it can be a combination of all four. A part of it can be an asset and liability and also be a source of income and also some expense. It not like that the transaction would always be based on the income and expense or asset and liability. Sometimes it can be a combination of all four of them. The thing that you need to keep on your mind is that income is credit and liability is also credit, whereas assets are debit and the expenses are also debit.

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Furthermore we will understand the importance of accounting in a business. If we do accounting then what would be the importance of accounting for a business.

When we learn anything, as I would be explaining accounting to you, then, what is the requirement of accounting. Why accounting? So we would be first discussing the importance of accounting in today's world.

The first one is, real time information of the business, which means the business that you are doing, you would get to know the real time data of the business. As to what the sales of the business are, how much of the things that I have purchased. How much I am in the loss and how much I am in the profit. Whether I am able to perform the business as I thought I would be able to? Do I need to do something new in the business? Okay.

The second thing is, you can do the performance evaluation. Which means since the last 6 months or 8 months of 1 year, that you have been doing the business. So you need to look at the performance as to the efforts that you are putting in the business, you are working from 9 in the morning till 8 in the evening. Then the things that I want, the money or the financial return that I should be getting. Am I able to achieve it? This is called performance evaluation. How my business is giving me the performance. If I talk in layman terms then this is the marksheet of my business. Right. What are the results of my business, the efforts that I am puting, I have been working the whole day, so what kind of performance is my business giving? Okay.

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If you are able to maintain the accounting of the transaction, on a day to day basis. Then there would be very less chances that any of the transactions would be missed by you. It is possible that you do not have a systematic or organised way for accounting, or that you do not have a proper individual for the maintenance of the accounts. In that case, there is a chance that you have made a transaction but the accounting of that has not been done. It means that a particular transaction is unaccounted for and we have forgotten about why and how we did the transaction, after maybe 3 to 4 or 5 to 6 months. And you also do not remember where the money went, and what happened to it. So if you follow a proper systematic way for the process of account management in your business then what would happen is. There would be a very small chance of the transaction that you did and you would not remember it. Right. Because you are maintaining it from day to day.

Imagine, there is a raid of income tax in your business. I would not want it to happen, but suppose it happened. The first thing that they will say might be. You have such a big business or shop and you have a huge market base, you are earning so much and also have a big house. So where did this money come from? Show me the money.

So you say that I have a business and the money comes from that. Then he might ask for proof for the earnings. To show the records of the previous 4 to 5 years, to know the profits of the business and to show how much you earn and what not other things. Now, if you have not maintained the accounting of the business then what would you show to the individual. Are you getting me? So this might be the proof of all your earnings. You can show that this is the proof of earning my business for the last 4 to 5 years. You can see the profit and the loss account. How much is the profit and the loss? You can show that every year since the last 4 to 5 years my profit has been increasing around 20 to 25 and 50 percent per year. So did this become? It became the proof for you to show to the income tax. Not only for the income tax but also for the other places that I have been earning the money from these different places. Okay.

Second thing, I have been doing the business for the last 5 to 6 years and the growth of my business has stagnated. I am not able to grow it further. Since the last 5 years, I earned good money but the work has been slowing down gradually. My profit margin has been decreasing. I am still putting the same amount of effort into my business but the profits have been reducing. So should I add something new in the business, or what is the place that I am making a mistake? Or else If I am not making any mistake then what is the area where my spending has increased. Or In future what products would I be selling more than others. So it is also important for future forecasting. As when I have the accounts and the track record, then I would be able to know.

Thirdly, I need to make a decision. Whether I should buy another shop or not. How would I know about it? I will have to evaluate it first, that the current shop that I am running, would I be able to earn enough for the expense. If I decide to open another shop, the expenses for the rent and electricity or any other activity that happens regularly. Do I have the money or the working capital, the money required to open another shop, do I have it with me right now? If I have that money then only I would be able to start the business, in other words, I will open that shop.

What happens with this is, whatever decision that you will make, you will have proof for that decision. Then, I can do the business, I can open another shop. If I have the data for this shop that I currently have from the last 5 years.

This means that accounting helps you in strengthening the decision making. If you are making the decision based on the statistics, then there are very low chances that the decision will go wrong.

The last point is, smooth working. It is related to the day to day working. One importance of accounting is that it enables you to understand how much you have in your hand. If I am maintaining a bank book and cash book daily. Then I would be able to know what amount of money I have in my hands. Will I be able to give money to everyone easily? I would know that this is the amount of money that I have so I can also promise the suppliers that I will be paying them the money in 20 days or 30 days. When will it be possible? When you know how much money you will be having, and which customer will be paying money on which day, how much money is left to be received from a customer. Because of the work that we are doing today, some of it will be done by cash while some of it will be done on a credit basis. It is a business, some of the work can be done in credit and some through cash. A mix of everything would be there. So if we are giving credit to someone, which is usually for 30 days. That you can take the product as of now and pay the money later after 30 days. It usually happens more in the retail business. So, if we are able to maintain the accounting on a daily basis, only then it will be possible that I would know, from whom I need to take the money, and to whom I need to pay.

So, for the smooth functioning of the business, accounting is required. Okay.

Now we have seen what accounting is and also the systematic definition of accounting and the importance of accounting in my business. Now we will be learning about the various concepts in accounting.

Accounting is a subject that is not easy to understand for everyone. That is, if I want to do accounting, as I have seen that there are lots of benefits, I will start learning business accounting. Now, I will start writing the account of my business on a daily basis. But for that I first need to understand some concepts. Things related to debit, journal entries, credit, what are the things there. What needs to be debited and credited. We will be learning all that in the next session. We will understand what accounting concepts and accounting principles are. And also about the accounting rules. Okay.

If you have any queries and comments……

In the next topic we will learn about different accounting concepts.

Until then Thank You.