We must understand some basic concepts to learn accounting which are as follow:-
Any exchange (dealing) of goods or services between two or more parties which can be expressed in money terms and must be recorded in books of account.
Any legal activity which is undertaken to earn the profit is called business.
It is an art of recording of routine business/financial transactions of the business in books of the account systematically. [ It covers only first part (Recording ) of definition of “Financial Accounting”.]
There are two methods of book-keeping.
1-Snigle entry system 2-Double entry system
1-Single Entry System:-
The system where some transactions are made orally and others are recorded or only one aspect of the transactions is recorded. Therefore this system produces incomplete information. For example shopkeepers only record credit transactions in their books and do not record cash transactions.
2-Double Entry System / Commercial Accounting:-
A system of recording of every transaction twice as debit and credit is called double entry system. It produces complete information. The account that receives the benefit is debited and the account that provides the benefit is credited..
Debit: It is left side in accounting.
Crdit: It is right side in accounting.
It is an accounting system that records transactions when cash is received or paid. It means no credit transaction is recorded in this system.
It is an accounting system in which financial events and business transactions are recorded as and when they occur. In short, both cash and credit transactions are recorded in it.
American Institute of Certified Public Accountants defines financial accounting as,” It is an art of recording, classifying, summarizing in a significant manner, in terms of money, transactions and events which are, in part at least, of financial character and interpreting results thereof.”
IMPORTANT POINTS OF THE ABOVE DEFINITION:-
Art: A skill to do any practical thing
Recording:When any transaction is written in Journal (name of a book used in accounting) is called recording.
Classifying: There are seven main classes in accounting. All the business transactions are included in its relevant class.
Summarizing: Conversion of details in few words is called summarizing like preparation of Balance sheet.
Financial Character: That can be shown in money terms.
Interpreting Results: Interpreting results mean making decisions.
It consists on theory and practice like bookkeeping, accounting, auditing etc.
Checking of work of accounting and giving opinion about the accounting system.
There are Seven pillars of accounting on which the whole accounting system is based.
Any item of economic value that is owned by anyone and that will gives future benefit.
There are 3 main points in the above definition.
Ownership, Economic value (Value in money) & future benefit.
Any transaction which fulfills three above points is our asset like we purchase a car. We become owner of the car. We can get benefit from car in future and Car has value in money.
All the payments or future payments to generate revenue and its benefit have been utilized. Like payment of salary, Electricity bill etc. We pay electricity bill of shop of June in July. Therefore, we pay bill after using its benefits and there is no future benefit is expected from it.
Loss may be suffered by following ways:-
If expenses exceed revenues, or
Normal Loss (Compulsory loss during business operation), or
Abnormal Loss (due to careless or due to natural disaster)
A liability is a financial obligation, debt, claim, or potential loss. For example loan taken from bank.
Total amount received or receivable by the company by selling goods or services like commission received or sale of any product.
A business entity may earn gain in the following ways:-
Revenue Gains (If revenue exceeds expenses), or
Capital Gains (Amount recovered greater than the cost of a fixed asset)
7-Owner’s Equity: -
(also called)Capital or Net Worth or Shareholder’s Fund or Shareholder’s Equity or Net Assets:-
The total amount invested in the business by the owner of the business or total assets minus total liabilities. For example Arshad has purchased a shop for Rs.700,000 and goods for Rs.250000. His capital is Rs.950,000.