Accounting Fundamentals
Why This Chapter Matters
Accounting is the language of business. Whether you are preparing for CA Foundation, B.Com exams, finance roles, or just want to understand business — these fundamentals are essential and surprisingly logical.
Core Concepts
1. Basic Accounting Terms
Assets: What a business OWNS. Resources.
Fixed assets: long-term (land, building, machinery, vehicles)
Current assets: short-term (cash, debtors, inventory, prepaid expenses)
Liabilities: What a business OWES. Obligations.
Long-term liabilities: loans, debentures
Current liabilities: creditors, bank overdraft, outstanding expenses
Capital/Owner's Equity: Owner's investment. Assets - Liabilities = Capital.
Increases: profits, additional investment. Decreases: losses, drawings.
Revenue: Income earned from business activities (sales, fees, interest received).
Expenses: Costs incurred to earn revenue (rent, salaries, cost of goods sold).
Profit: Revenue - Expenses. Gross profit (before overheads) vs Net profit (after all expenses).
2. Accounting Equation
Assets = Liabilities + Capital (Owner's Equity)
This equation must ALWAYS balance.
Every transaction affects at least two accounts (double-entry system).
3. Double Entry System
Every transaction has two sides: DEBIT and CREDIT.
Total debits always equal total credits.
Rules:
Real accounts (assets): Debit what comes IN, Credit what goes OUT.
Nominal accounts (income/expenses): Debit all expenses/losses, Credit all incomes/gains.
Personal accounts (people/companies): Debit the receiver, Credit the giver.
4. Journal, Ledger, Trial Balance
Journal: Book of original entry. Records transactions chronologically.
Format: Date | Particulars | Debit (Rs) | Credit (Rs)
Each entry: Dr account name [Debit amount] / Cr account name [Credit amount] / Narration.
Ledger: Book of final entry. Each account has its own page/T-account.
Left side: Debit | Right side: Credit
Balancing: Dr total > Cr total = Debit balance (asset/expense account)
Trial Balance: Lists all ledger accounts with their balances.
Sum of all debits = Sum of all credits (if no errors).
Doesn't guarantee all errors are caught (errors of omission, principle, commission).
5. Financial Statements
Trading Account: Gross Profit calculation.
Net Sales - Cost of Goods Sold = Gross Profit.
COGS = Opening stock + Purchases - Closing stock.
Profit and Loss Account: Net Profit calculation.
Gross Profit + Other Income - Operating expenses = Net Profit.
Balance Sheet: Snapshot of financial position at a date.
Assets side = Liabilities + Capital side (must balance).
6. Key Accounting Concepts
Going Concern: Business will continue indefinitely.
Accrual Concept: Record revenue when earned, expenses when incurred (not when cash received/paid).
Matching Concept: Match expenses to the revenue they help generate.
Consistency: Use same accounting methods year to year.
Conservatism/Prudence: Record losses when probable, gains only when certain.
Materiality: Report items significant enough to affect decisions.
Worked Example
Transaction: Business buys furniture for Rs 50,000 cash.
Journal entry:
Furniture A/c Dr 50,000 (asset increases → debit)
To Cash A/c Cr 50,000 (asset decreases → credit)
Equation: Assets unchanged (cash-50k, furniture+50k), Liabilities=0, Capital=0.
Transaction: Business sells goods worth Rs 20,000 on credit (debtor owes us).
Debtors A/c Dr 20,000
To Sales A/c Cr 20,000
Assets: Debtors +20,000. Capital: Revenue +20,000 (profit increases capital).