BASIC ACCOUNTING TERMS

Account : - When all the transaction relating to a particular head are recorded at one place, it is
called an account. It resembles the English alphabet ‘T’. The left side is called the debit side and
the right side is called as the credit side.
Capital : - Capital is the amount invested by the owner into the business. It may be in the form
of cash or some assets brought in by the owner into the business.
Capital is considered as the liability of the business towards the owner. It is also known as
Owner’s Equity or Net Worth.
Capital = Assets – Liabilities
Drawings : - It is the amount withdrawn or goods taken by the proprietor for his personal use. It
reduces the capital of the owner.
Proprietor : - It is the person who has made all the investments in the business (Owner).
Business Transactions:- Any financial transaction entered into between two parties that can be
expressed in monetary terms, and which brings about a change in the financial position of the
business is called as a business transaction. For eg: - Sale of goods, purchase of goods, purchase
of fixed assets, payments of interest etc.
Liability:- Liability means amount payable by the business.
Liability towards the owner of the business is termed as internal liability and liability towards
the outsiders is termed as external liability.
Liability may be further classified into:-
1. Non- Current Liability
2. Current Liability
Non-Current Liability: - Noncurrent liability is that liability which is payable after a period of
one year from the end of the accounting year. For eg: - Long Term loans, debentures etc.
Current Liability: - Current Liability is the liability which is payable within 12 months from the
end of the accounting period. For eg- Creditors, Bills Payable, Bank Overdraft, Outstanding
expenses.
Assets:- Assets are the property owned by a business. They are the economics resources of the
business that can be measured in monetary terms. In simple words, anything that will enable a
business to get some cash or benefit in future is an asset. For eg:- Land, Building, Machinery,
Furniture, Cash in hand, Investments, Cash at Bank, Debtors, Bills Receivables, Accrued
Income, Prepaid Expenses, Stock etc.
Assets may be classified into three:-
1. Non-Current assets: - Non-Current assets are those assets which are held by a business
not with the purpose to resell, but are held either as investment or to facilitate business
operations. For eg: - Fixed assets, Non-CurrentInvestments etc.
Fixed Assets: - Fixed Assets are those assets which are held not to resell but with the
purpose to increase the earning capacity of business. They are divided into two:-
1. Tangible Assets: - Tangible Assets are those assets which have a physical existence
i.e. they can be touched and seen. For eg:- computer, furniture, building, land,
machinery etc.
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 2. Intangible Assets: - Intangible assets are those assets which do not have a physical
existence i.e. they cannot be seen or touched. For eg:- Patents, Good will, Trademark,
Computer software etc.
2. Current Assets:- Current assets are those assets which can be converted into cash
within a period of one year. For eg:- Debtors, bill receivables, cash in hand, cash at
bank, accrued income, prepaid expenses, stock (inventory) etc.
3. Fictitious Assets:- Fictitious assets are the assets which are neither tangible nor
intangible. They are the losses which are not written off in the year in which they are
incurred, but in more than one accounting period. For eg. Deferred revenue
expenditure, discount/loss on issue of debentures etc.
Trade receivables: - It is amount receivable for sale of goods or services rendered in the ordinary
course of business.
Trade Receivables = Debtors + Bills Receivables
Debtors: - Debtors are the persons who owe amount to the business against credit sale of goods or
services rendered. The amount due from debtor is known as debt.
Bill Receivable: - Bill receivable means a bill of exchange, accepted by a debtor, the amount of
which will be received in the specific date.
Trade payable: - It is amount payable for purchase of goods or services availed in the ordinary
course of business.
Trade Payables = Creditors + Bills Payables
Creditors: - Creditors are the persons to whom business owes an amount on account of credit
purchase of goods or services availed.
Bill Payable: - Bill payable means a bill of exchange accepted, the amount of which will be
payable on a specific date.
Depreciation: - Any decrease in the value of an asset because of its usage, afflux of time,
obsolescence or accident, is called as depreciation.
Bad debts: - The amount which is irrecoverable from the debtor is known as bad debt. It is a loss
for the business.
Book Value: - The amount at which an item appears in the books of accounts is known as its book
value.
(Book Value = Cost less depreciation up to date)
Balance Sheet:- Balance sheet is a statement that shows the financial position of the business. It
contains the lists of assets and liabilities of the business at a particular date. Normally it is prepared
at the end of the financial year.
Dr (Debit):- Debit is the left side of an account. If an account is to be debited, then the entry is
posted at the debit side of an account. It is derived from Italian word ‘debito’.
Cr (Credit):- Credit is the right side of an account. If an account is to be credited, then the entry is
posted to the credit side of an amount. It is derived from the Italian word ‘credito’.
Goods: - Goods refer to those products in which an enterprise deals in. For eg:- for an enterprise
dealing in home appliances, items such as TV, Fridge, AC, etc. are the goods. Similarly for a

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stationery shop, stationery items are the goods. But for a cloth merchant, AC is a fixed asset and
stationery is an expense.
Receipts: - Receipts is the amount received or receivable from selling assets, goods or services.
Receipts are further divided into two:-
1. Revenue receipts:- It is the amount received or receivable in the normal course of
business say against sale of goods or rendering of services. For eg:- sale of goods.
2. Capital receipts:- It is the amount received or receivable against transaction which are
not revenue in nature. For eg:- sale of asset, loan taken, additional capital introduced by
owner.
Expenditure: - It is the amount spent for value received. For eg - payment of salaries, rent,
purchase of furniture, computer etc. It may be categorized into three:-
1. Capital Expenditure: - It is the amount spent in purchasing assets which will give
benefit over a number of accounting periods. For eg:- Purchase of furniture, machinery
etc. It is shown on the assets side of balance sheet.
2. Revenue Expenditure: - If the benefit derived from an expenditure gets exhausted
within one financial year, it is treated as revenue expenditure. For eg:- rent paid, salaries
paid, electricity, expenses etc. It is shown on the debit side of Trading & Profit/Loss
A/c.
3. Deferred Revenue Expenditure:- It is a revenue expenditure in nature but is written off
in more than one accounting periods. For eg:- large advertisement expenditure that will
give benefits over a no. of accounting periods is called as Deferred Revenue
Expenditure.
Purchase: - Purchase refers to buying the goods meant for resale or for producing the finished
products which are to be sold.
Purchase Return: - Sometimes goods purchased may not be as per the specifications or may be
defective. Such goods returned to the seller are known as Purchase Return or Return Outward.
Sale: - ‘Sale’ is used for the sale of only those goods dealt by the firm.
Sales Return: - Goods sold when returned by the customers are termed as sales return. Sales return
is also known as Return Inwards.
Stock/Inventory: - It is the tangible property held by an enterprise for the purpose of sale or for
using it in the production of goods meant for sale or services to be rendered. Stock may be of two
types:-
1. Opening Stock: - It is the amount of goods lying unsold at the beginning of the
accounting period.
2. Closing Stock: - It is the amount of goods lying unsold at the end of the accounting
period.
Note: - In case of a manufacturing concerns, closing stock includes raw materials, work-
in-progress and finished goods.
Voucher: - Voucher is the evidence of a business transaction. For eg: - cash memo, invoice or bill,
debit note, credit note etc.
Cost: - Cost is the amount of expenditure incurred on or attributable to a specific product.
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Discount:- When customers are allowed rebate in the price of goods by the business or from the
amount paid by customers it is known as discount. It may be of two types:-
1. Trade Discount: - It is a rebate allowed by the seller on the basis of sales. It is not recorded in
the books of accounts as sales are recorded at net value i.e. sales less trade discount.
2. Cash Discount: - Cash discount is the rebate allowed for getting timely payment of due
amount. It is recorded in the books of accounts of both the parties.
Expense: - Expense is the cost incurred for generating revenue. It may include cost of goods sold,
salaries paid, depreciation, rent paid etc.
Prepaid Expense: - The expenses that have been paid in advance.
Outstanding Expense: - The expenses which are due but not paid yet.
Revenue: - It is the amount of money earned by selling goods, or providing services to customers.
It may also include other items like commission received, rent received, interests received etc.
Profit/Income: - Income is the profit earned during a period.
Income = Revenue Expense
For eg: - Goods costing Rs. 10,000 are sold for Rs. 17,000. Hence sale of Rs. 17000 is revenue, cost
of goods gold’s Rs. 10,000 is expense and difference of Rs 7000 is income.
Gain: - Gain is a profit of irregular or non-recurrent nature. For eg:- Gain on sale of fixed assets or
investments.
Loss: - Loss is the excess of expenses of a period over its revenue. It decreases the owner’s equity.

FUNDAMENTAL ACCOUNTING ASSUMPTIONS

1. Going concern assumption:- According to this concept, it is assumed that business shall
continue for an indefinite period of time and there is no intention to close the business or
scale down its operations significantly.
It is because of this concept that a distinction is made between capital expenditure and
revenue expenditure while recording accounting transactions.
2. Consistency assumption:- According to this assumption, accounting practices once
selected and adopted should be applied consistently year after year. This eliminates personal
bias and helps in achieving results that are comparable. For example:- among the two
methods available for charging depreciation i:e W.D.V (Written down value) method and
straight line method, the method once adopted should be applied consistently year after year.
But that does not mean that practices once adopted cannot be changed. The accounting
practices may be changed if law requires it, or if the change will result in more
meaningful presentation.
3. Accrual Assumption:- According to this assumption a transaction is recorded in the books
of accounts at the time when it is entered into and not when the settlement takes place. Thus
revenue is recognized when it is realised i.e. when sale is complete or services are rendered,
it is immaterial whether cash is received or not. Similarly, expenses are recognized as

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expenses in the accounting period in which the revenue relating to it is recognized, it does
not matter whether cash is paid or not.
For eg:- XYZ Limited purchased a computer worth Rs. 50,000 in Jan 2016 to be paid on
April 2016. This transaction will be recorded in the books of accounts in Jan 2016 only,
thus, books will show that business owns a computer worth 50,000 and also owes an equal
amount to the supplier.

ACCOUNTING PRINCIPLES
1. Business Entity / Accounting Entity: - This concept states that business is separate and
distinct from its owner. Business transactions are recorded in the books of accounts from the
business point of view and not from that of the owner. That is why even the money invested
by the owner i.e. capital is treated as a liability of business towards the owner.
2. Money Measurement Principles:- According to this concept, only those transactions
and entries that can be measured in terms of money are recorded on the books of accounts.
All such items which cannot be expressed in monetary terms, say, the skilled human
resources or creativity of research department cannot be shown in the accounting records.
This principles suffers from two limitations.
1. Transactions that cannot be expressed in terms of money are not recorded in the
books of accounts, howsoever important they may be to the business.
2. The value of money is considered to have static value, as transactions are
recorded at value on the transaction date.
3. Accounting Period Concept:- This concept states that life of an enterprise must be
broken into small periods, called as accounting periods, so that its performance can be
measured at regular intervals. Generally, the business houses prepare their financial
statements annually and their financial year begins on 1st April and ends on 31st March.
4. Full Disclosure Principle: - This convention states that all material and relevant facts
concerning financial performance of an enterprise must be fully disclosed in the
financial statements. This is to enable the users to make correct assessment about the
financial soundness of the enterprise and help them to make informed decisions. For eg,
the reasons for low turnovers should be disclosed.
5. Materiality Principle:- This principle states that accounting should focus on material
facts only. Any fact would be considered as material if its knowledge would influence
the decision of the users of the financial statements. The materiality of a fact depends
upon its nature and the amount involved. For ex:- amount spent on repairs say Rs. 2000
is material for a business having a turnover of 2 lakhs but it is not material for an
enterprise having a turnover of 2 crores.
6. Prudence or Conservatism Principle:- This principle says “Do not anticipate profits
but provide for all possible losses”. In simple words, the profits should not be recorded
until realized but all losses, even the probable ones should be provided in the books of
accounts. For eg, provision for doubtful debts is created in anticipation of bad debts.

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 The application of this concept ensures that financial statements present a realistic
picture of the state of affairs of an enterprise and do not paint a better picture than
what it actually is.
7. Cost Concept / Historical Cost Principle:- This concept states that all assets should
be recorded in the books of accounts at their purchase price which includes cost of
acquisition, transportation and other expenses incurred for making asset ready to use.
The market value of an asset may change with the passage of time but for accounting
purposes, it continues to be shown in the books of accounts at its book value i.e. (cost of
acquisition – depreciation upto date). For ex:- an asset is purchased for Rs 5 lakhs and if
at the time of preparing financial accounts, even if its market value is say, 4 lakhs or 7
lakhs, yet asset shall be recorded at its purchase price of Rs 5 lakhs.
8. Matching Concept:- According to this concept cost incurred to earn the revenue
should be recognized as an expense in the period when revenue is recognized as earned.
Thus, the expenses incurred in an accounting period should be matched with the
revenues earned during that period to arrive at the correct profit or loss. For eg:-
expenses such as salaries, rent, insurance etc. are recognized on the basis of period to
which they relate to and not when they are paid.
9. Dual aspect or duality principle:- According to this concept, every transaction
entered into by an enterprise has two aspects, a debit and a credit of an equal account.
Simply stated for every debit there is a credit of equal amount in one or more accounts.
For eg:- Rahul started a business with capital of Rs. 100,000. These are two aspects of
this transaction – 1st is that business has an asset of Rs 100000 and 2 nd is that it has a
liability of Rs 100000 towards Rahul (Capital).

CASH BASIS OF ACCOUNTING

Under this system transaction are recorded in the books of accounts only when cash is received or
paid and not when the receipt or payment becomes due. For ex:- if rent for the month of March
2016 in paid in April 2016, it would be recorded in the books of accounts as an expense in April
2016 only. Though simple, this method is not appropriate for most organizations as it is not
compatible with the matching principle.
ACCRURAL BASIS OF ACCOUNTING
Under this system the monetary effects of a transaction is taken into account in the period in which
it happens rather than the period in which cash is actually incurred or paid. This is a more
appropriate method for calculation of profits as expenses are matched against revenue earned. For
ex:- credit sales are included in the total sales of a period irrespective of the fact whether cash is
received or not.