ACCOUNTING: Basic Concepts

1. What is accounting

The process of recording all transactions in a business and keeping financial records of financial
information for the users who need it.

2. Accounting terminology

Starting a business
Someone who is starting a new business is called an entrepreneur. The purpose of a
trading business is to make profits. The bookkeeper or accountant keeps record of all
business transactions comprising of capital, assets, liabilities, income, and expenses.

Capital
The money or assets contributed to start the business.

Owner’s Equity
The owner’s interest in the business.
Owner’s equity = Total assets – Total liabilities (Equity is the residual interest in the asset
of the entity after deducting all its liabilities.)

Equity increase with capital investments/contributions and increases when income is

received or accrued to the business. Equity decreases when expenses occurs or accrued
and when the owner takes money or stock for his/her own use (called drawings).

Assets
Resources or items of value owned by the business. When the business purchases
assets the asset items increase in the business and vice versa.

Liabilities
Money owes to suppliers/creditors/outside parties in the form of debt. Liabilities
increases when debt increases.

Income
Money received or receivable/accrued by a business that renders a service or sells
goods. Income increases the owner’s equity of the business.

Expenses
Costs incurred continuously in operating the business. Example, wages & salaries,
telephone expenses, water & electricity, etc.
Expenses decreases the owner’s equity of the business.

Creditors & Debtors

The business might want to purchase items on credit from suppliers and owe them
money. (Creditors). The business might sell on credit to customers. (Debtors)
 NET PROFIT
Net profit consists of the income earned less the incurred expenses

Net profit = Income - Expenses

3. Accounting cycle/process
The accounting cycle is monthly process of record keeping of financial information for
an annual financial reporting period of the business.
The accounting cycle is a basic, eight-step process for completing a business
bookkeeping tasks. It provides a clear guide for the recording, analysis, and final
reporting of a business's financial activities.

1. Analyse transactions
2. Source documents
3. Journals
4. General Ledger
5. Trial Balance
6. Year-end adjustments & Closing Accounts (Final Accounts
7. Post- Adjustment Trial Balance & Post- closing Trial Balance
8. Financial statements

Accounting equation
The accounting equation basically states that: ASSETS (A) = EQUITY (OE) + LIABILITIES (L).
It is the relationship between: A= OE+L or QE= A-L or L=OE-A

A feature of this equation is that the equation remains balanced after very transaction
entry because it causes a change in two part of the equation.
For each account debited there should be another account credited.

Assets
 • An entry on the left-hand (debit) side of an asset account creates or
increases an asset value. Account will be debited.
• An entry on the right-hand (credit) side of an asset account
decreases the asset value.
Liabilities
• An entry on the credit side of a liability account creates or increases the liability.
• An entry on the debit side of a liability account decreases the liability.

Equity
• An entry on the credit side of an equity account creates or increases the equity.
• An entry on the debit side of an equity account decreases the equity. (drawings)
• A nominal account indicating a loss or expense decreases equity.
• A nominal account indicating a profit or income increases equity.

The Double - Entry principle

The double-entry principle stipulates that for every debit (left) entry there should be a
corresponding credit (right) entry for the same amount. This means that you should record
each transaction in at least TWO accounts.

The Accounting Equation and the Double-entry principles

General ledger Accounts:

DR (-) decreases Capital, Liabilities & Income acc increases CR (+)

DR (+) increases Assets, Drawings & Expense acc decreases CR (-)

What is an account:
An account is a record in the general ledger that is used to sort and store transactions.
For example, entities will have a bank account in which to record every transaction that
increases or decreases the entity's cash.

Analysing Transactions

Before you can analyse the accounting equation (OA=OE=L) you first need to understand the
following process:

Transaction: example
ABC Traders paid weekly wages to his employees:

Steps in answer the question

STEPS
Name the two Determine the type of Decide whether the Should the account
accounts accounts, whether its an account increase or be either debited or
involve in the assets, liability, capital, decrease credited?
transaction income & expense
ANSWERS
Bank is affected Bank is decreasing
because money Bank is an asset because money is been Credit bank because
is been paid paid assets are increasing
Wages is Wages decrease owners Debit wages because
affected equity because its an owner's equity is
because Wages is an expense expense decreasing
employees are
receiving money

Analysis of transactions: Other format

Cash Receipts Journal
Receipt or capital contribution from owner
Source document: Duplicate receipt
Journal: CRJ
Analysis: Cash in bank (an asset) increases
Or Bank overdraft (liability) decreases
Capital (equity) is created – increases
Double entry: Dr. Bank A+ (or L – overdraft)
Cr. Capital E+
TRANSACTIONS, SOURCE DOCUMENTS AND SUBSIDIARY JOURNALS
The next step in the accounting process is to keep book of all the daily transactions
which involves the business. A transaction can be described as any trade action which
involves money. When a transaction incurs a source document is completed that
provides information regarding the transaction. Each transaction is then recorded from
the information as it appears on the source document in the specific subsidiary journal,
also called the book of first entry.
Bookkeeping of the following transactions should be known to you:
Transaction Subsidiary journal Source document

1. Any cash received by the Cash Receipts Journal Duplicate receipt

business. (DREC) or Cash
(CRJ)
register roll
2. Any payments made out from Cash Payments (CRR)
Cheque counterfoil
the current bank account. Journal (CPJ) (CC)

3. Small cash amounts paid out of Petty Cash Journal (PCJ) Petty cash voucher
Petty cash. (PCR)

4. Goods sold on credit. Debtors Journal (DJ) Duplicate sales invoice

(DCSI)
5. Any item bought on credit. Creditors Journal Original
(CJ) renumbered
credit purchases
6. Items with which debtors Debtors Allowance invoice credit
Duplicate (CPI) note
are unsatisfied with, Journal(DAJ) (DC/N)
returned to us.
7. Items with which we are Creditors Allowance Duplicate debit note
unsatisfied, returned to creditors. Journal (CAJ) (DD/N)

DEBTORS, CREDITORS AND GENERAL LEDGER

Debtor & Creditor ledger;
For each debtor and creditor a personal account is created in, what we call a “subsidiary
ledger”. Each transaction involving a debtor or creditor must be posted the same day
that it happens, to the creditor or the debtor’s personal account and the balance
immediately adapted. This is done to determine at any given time the amount that a
debtor owes us, or the amount that we owe a specific creditor.
Each transaction is posted separately to the personal account of debtors or creditors.
In the General Ledger a debtors control account and creditors control account is
composed which is a summary of all the separate transactions that appeared during the
month in the different personal accounts. At the end of the month a list of all the
outstanding balances of debtors and creditors, up as it appears in the subsidiary ledgers,
are drawn up. The total of the debtors list must correspond with the balance of the
debtors control account and the total of the creditors list with the balance of the creditors
control account.
The General Ledger is divided in two main sections, namely the Balance sheet accounts
section and Nominal accounts section.

Balance sheet accounts-section consists of all accounts employed to prepare the

Balance sheet at the end of the year;
1) The two direct owner’s equity accounts: Capital and Drawings.
2) All assets: Land and buildings, Vehicles, Equipment, Fixed deposit, Trading stock,
Debtors control, Savings account, Bank, Petty cash and Cash float.
3) All liabilities: Loans and Creditors control.
Nominal accounts-section consists of all incomes and expenses employed to prepare
the;
Income statement and calculate the net profit.
1) Incomes, e.g. Sales, Rent income, etc.
2) Expenses, e.g. Cost of sales, Debtors allowance, Telephone, Stationery, wages, etc.
At the end of the month all subsidiary journals are posted to the General Ledger. It is
very important that the double entry principle is always applied when posting to the
General Ledger. The double entry principle determines that for every debit entry a credit
entry must be made in another account and that the accounts must refer to each other.
All ledger accounts must be balanced at the end of the month.
Trial balance;
Drawn up to control whether the double entry principle was applied correctly. All debit
account balances must equal all credit account balances at month end/financial year-
end.