Principles of Accounts

This course provides a basic insight into the Principles of Accounts and lays the foundation for candidates opting for higher studies in Accounting.

Introduction to Accounting

DEFINITION OF ACCOUNTING

As buyers or consumers, every time we buy goods or pay for services, we incur a transaction. Whilst some people might not do it, but it is good practice to note down or record whatever we have spent on our purchases or expenses so that we could control our budget. Even students obtaining weekly or monthly pocket money could do so. The overall benefit of this practice is to have a follow-up on our expenses so that we could calculate at any point in time how much money we have left till the end of the month and as a result, take important decisions such as whether to spend more on cyber cafe LAN gaming or save that amount so that we could buy trendy t-shirts at a shopping mall. The concept of Accounting works in the same way, enabling businesses to take critical decisions within the required time frame.

ACCOUNTING CAN, THEREFORE, BE DEFINED AS THE SYSTEMATIC PROCESS OF IDENTIFYING, VERIFYING, MEASURING, RECORDING, CLASSIFYING, SUMMARISING, INTERPRETING AND COMMUNICATING CRUCIAL INFORMATION PERTAINING TO AN ORGANISATION.

The highlighted terms shall be clearly explained through numerical and theoretical illustrations as we proceed through the chapters and the definition of Accounting shall be much clearer by then.


DEFINITION OF BOOKKEEPING

Bookkeeping is defined as the factual recording of financial economic events (known as transactions) of an organisation in its books of account. 

For example, Clara, a housewife, bought some groceries at the nearby supermarket. Upon payment at the counter, she was given a receipt which listed whatever she had bought along with the unit prices and the total amount paid. Upon reaching home, she noted down in a personal diary the amount she spent for the day on groceries, the details of which she extracted from the supermarket receipt. This is a very simple but useful example of bookkeeping.



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Before moving on, it would be useful to have a clearer perception of the definition of Accounting in relation to Bookkeeping.

ACCOUNTING CAN, THEREFORE, BE DEFINED AS THE SYSTEMATIC PROCESS OF IDENTIFYING, VERIFYING, MEASURING, RECORDING, CLASSIFYING, SUMMARISING, INTERPRETING AND COMMUNICATING CRUCIAL INFORMATION PERTAINING TO AN ORGANISATION.

As we can see from the above definition of Accounting, the Bookkeeping process satisfies the first four procedures namely:

  • IDENTIFYING
  • VERIFYING
  • MEASURING
  • RECORDING

Referring back to the example of Clara, she IDENTIFIED and VERIFIED the items she has purchased by referring to the receipt and she MEASURED the transactions through their unit prices printed on the receipt before RECORDING in her personal notebook.


DIFFERENCE BETWEEN BOOKKEEPING AND ACCOUNTING

Bookkeeping is just a part of an otherwise wider system of Accounting.

While Bookkeeping is only concerned with the systematic recording of economic events, Accounting goes a step further into analysing these events and communicating them to the relevant section of users to enable decisions to be made bearing in mind the benefit of the business.

As depicted in the above diagram, the Accounting function occupies the entire green area while the Bookkeeping function is just one part of the entire spectrum.

Referring back to the example of Clara, it would not be enough if she just noted down details of her purchases in her notebook. After having done her recordings, she should maybe ask the following questions:

  1. What is the use of recording these transactions?
  2. Can she analyse her purchases over the past 3 months?
  3. Has she been shopping economically?
  4. Is she getting the best prices for good quality?

The bottom line is that Clara should be able to make future decisions based on the analysis of her past purchases (ACCOUNTING) and that should be based on the figures recorded in her notebook (BOOKKEEPING).

ROLE OF ACCOUNTING IN A BUSINESS

The main role of Accounting is to track and monitor the on-going operational activities of the business. Just recording numerical data is not enough to know whether the business is profitable or not and whether it is going to sustain in the long run. 

In this optic, the following details might be relevant:

  1. The value of purchases
  2. The value of sales
  3. The value of expenses
  4. The amount of cash in hand or amount of cash at bank
  5. The amount owing by the business to its suppliers and lenders
  6. The amount owing to the business by its customers
  7. The recorded value of the property and other possessions of the business
  8. The profit or loss made during a particular period
  9. The financial position of the business on any given day

However, the numerical data of the above list would only be fully meaningful upon analysis of the figures within the same period or over a relevant string of periods. Also, the data has to be communicated to different groups of users so that they can draw meaningful conclusions as per their respective requirements.

We shall elaborate on this in the coming sections.

FINANCIAL REPORTS TO BE PREPARED BY BUSINESSES AT YEAR-END

Financial reports are statements prepared by businesses on regular intervals that give an overview of the financial health of the business. Different users of these reports would draw their respective inferences based on the figures provided in those reports. Such reports are prepared using the following formats.

The first report is called the Income Statement (formerly known as the Trading and Profit and Loss Account) and it computes the Trading Profit or Loss for the period.

The second report, the Statement of Financial Position (formerly called the Balance Sheet), most simply details the belongings and possessions of the business and also its obligations to external parties. The format is as follows:

The above two statements form the basis of decision-making by many parties who have an interest in the activities of the business. We shall explore each and every element of these two reports in further detail throughout this course.

Please note that the above two statements shall be used as reference with the same figures.

ACCOUNTING FLOW

Finally, to conclude our introduction to Accounting, we shall have a look at the entire process of Accounting in a summarised form. Each element of the process shall be further elaborated in subsequent chapters. The Accounting flow shown below is a very basic but useful graphical representation of the entire Accounting process.

The Accounting process is followed in the given order.

  1. Source Documents
  2. Journal Entry
  3. Ledger Entry
  4. Trial Balance
  5. Year-end Adjustments
  6. Accounts Closure
  7. Financial Statements

Throughout this course, we shall be following the same order to have a complete understanding of the Accounting process.