Introduction to Accounting

Purposes of accounting

Accounting records, classifies and summarises financial information so that internal users (owners, managers) and external users (banks, suppliers, investors, the government) can make decisions.

The accounting cycle: source documents → books of original entry (purchases journal, sales journal, returns journals, cash book, general journal) → ledgers → trial balance → financial statements.

The accounting equation

$\text{Assets} = \text{Liabilities} + \text{Owner's equity (Capital)}$

Expanded accounting equation:

$\text{Assets} = \text{Liabilities} + \text{Capital} + \text{Revenue} - \text{Expenses} - \text{Drawings}$

Transaction	Assets	Liabilities	Owner's equity
Owner contributes cash as capital	+		+
Buy inventory on credit	+	+ (trade payables)
Pay a trade payable in cash	−	−
Owner withdraws cash for private use (drawings)	−		−

The double-entry system

Every transaction affects at least two accounts, with equal debit and credit entries.

Type of account	Increase	Decrease
Assets, expenses, drawings	Debit	Credit
Liabilities, capital, revenue	Credit	Debit

Examples:

• Credit purchase of goods for resale: Dr Purchases, Cr Trade payables.
• Credit purchase of equipment for use: Dr Equipment, Cr Other payables.
• Credit sales: Dr Trade receivables, Cr Sales.

Trial balance

A list of ledger balances at a date. If total debits = total credits, the arithmetic accuracy of the double entry is checked. It does not reveal:

• error of omission (the whole transaction is left out),
• error of commission (posted to the wrong account of the same class),
• error of principle (posted to the wrong class of account),
• error of original entry (wrong amount in the book of original entry),
• complete reversal of entries,
• compensating errors.

Accounting assumptions, principles and conventions

	Meaning
Business entity	The business is separate from its owner; the owner's private spending is drawings
Going concern	The business will continue to operate in the foreseeable future
Historical cost	Assets are recorded at their original cost
Accrual	Revenue and expenses are recorded when earned or incurred, not when cash is received or paid
Realisation	Revenue is recognised when goods are delivered or services rendered
Matching	Expenses are matched against the revenue of the same period
Prudence	Do not overstate profit or assets; provide for anticipated losses but not anticipated gains
Consistency	Use the same accounting methods from period to period
Materiality	Insignificant items may be treated in the simplest way
Money measurement	Only items that can be measured in money are recorded