BASIC ACCOUNTING CONCEPTS
Accounting is a system of recording information about a business. Accounting is a
process that has developed over many centuries. The modern system was developed by
an Italian Lucas Pacioli in 1494.
The information that is collected is primarily numerical. This information is then presented
to various people to help them make decisions.
Activity 1: List who you think make use of this information.
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The accounting system is used to maintain records for all businesses, whether a
multinational corporation or a small business.
To account for something means to keep a record of something in your business by
using the accounting system.
An accountant (or bookkeeper) collects documentation and records this information,
categorizes it (i.e. organizes the different bits of information under certain categories), and
presents it in specific formats.
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Bookkeepers are usually involved more in data collection and entry.
Accountants can fulfil this role too, but more often these days are involved in
preparing and presenting financial statements, and fulfilling an advisory or
consulting role. Accountants have even become business strategists, intimately
involved in guiding the operations of a business.
Accounting information is finally presented in the form of financial statements – the key
reports of a business
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A balance sheet, also referred to as a statement of financial position, reports on
a company's assets, liabilities, and owners’ equity at a given point in time.
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An income statement, also known as a P&L or profit and loss report, reports on a
company's income, expenses, and profits over a period of time. An income
statement provides information on the operation of the enterprise. These include
sales and the various expenses incurred during the stated period.
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A statement of cash flows reports on a company's cash flow activities, particularly
its operating, investing and financing activities.
The Accounting Equation:
The single most important equation in accounting, the foundation on which everything else
rests is called the Accounting Equation
OWNERS’ EQUITY = ASSETS - LIABILITIES
Or, as it is more commonly used in accounting:
ASSETS = OWNERS’ EQUITY + LIABILITIES
So what does the accounting equation mean? Well, in order to answer that question we
need to look at what each of the terms in the equation mean...
An ASSET is officially defined as:
A resource controlled by the enterprise as a result of past events and from which future
economic benefits are expected to flow to the enterprise.
To put it more simply... an asset is a possession of a business that will bring the
business benefits in the future.
An asset is anything that will add future value to your business.
Let’s look at a couple of examples:
If you owned land, would it be an asset for your business? Not sure? Well, do you expect
to receive benefits for your business in the future from the land? Of course. So what are
the benefits it will bring? Well, you can construct a building on it that you can use for
business. Even selling it would bring benefits, in the form of cash.
Land = asset
How about a computer that you own – is this an asset? Will it bring you benefits in the
future? Well, amongst other things, you can store and retrieve large amounts of
information and use it to communicate with suppliers and customers.
So yes, a computer is certainly an asset.
What about a motor vehicle – is this an asset? Does it have benefits for your business,
and if so, what are they? Answer: Yes, there are benefits for your business... You can use
the motor vehicle to pick up and deliver goods. So yes, this is also an asset.
Now let’s take something more tricky – what about cash? Is cash an asset? Answer: cash
is certainly an asset. What are the benefits of having cash? Simple: you can pay for things!
That is certainly useful (and indeed essential) for a business.
Have you ever heard of debtors? Debtors are people that owe your business money and
the value of these debts as a whole.
Another name for debtors is accounts receivable. The word receivable simply means
capable of being received, or will be received. Would debtors or accounts receivable be an
asset for your business?
Answer: Even though you cannot own a debtor, you will get benefits in future from having
money owed to your business.
The benefits are simple – you will get paid! So if you have R3,000 owed to you by Mr.
Smith, you have a debtor, an asset, worth R3,000.
An additional requirement for an asset is that you have to be able to measure its value
somehow and you have to be able to measure this accurately. This is usually quite simple:
the value is equal to how much you paid for it.
So the full test of whether something is an asset is:
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DOES A BUSINESS OWN/CONTROL IT?
WILL IT BRING A BUSINESS BENEFITS IN THE FUTURE?
CAN YOU VALUE IT ACCURATELY?
If these three criteria are met, then you have an asset according to the accounting system.
A LIABILITY is officially defined as:
A present obligation of the enterprise arising from past events, the settlement of which is
expected to result in an outflow from the enterprise of resources embodying economic
benefits.
In other words, a liability is simply... A debt of the business.
The debt will result in assets (usually cash) leaving the business in the future.
The most common liability is a loan. Another common liability is called creditors. A creditor,
also known as a payable, is any business or person (apart from the bank) that you owe.
Suppliers (who you owe for products purchased on credit) would fall under creditors. When
you pay a loan back, or you pay off your creditors, some of your assets (most often cash)
will leave your business.
OWNERS’ EQUITY is officially defined as:
The residual interest in the assets of the enterprise after deducting all its liabilities.
That's a slightly complicated definition. Here's a simpler one:
The owner’s equity is THE VALUE OF THE BUSINESS TO THE OWNER(S)
In other words, it's the value of all the assets after deducting the liabilities - the value of the
assets that the owner really owns.
TERMINOLOGY
Assets
ACCOUNTING TERMINIOLOGY
DEFINITION
Has value and owned by the business
Liabilities
That which is owing by the business – money or items
Expenses
Paid for on a continuous / regular basis, enabling the firm to
operate effectively e.g. Insurance, stationery, wages and
salaries, rent, interest and discounts allowed + cost of sales
Profit
Income minus expenses
Solvent
Assets exceed liabilities
Liquid
Accounting equation
Owners Equity
Capital
Drawings
Entrepreneur
Sole Proprietor
Current assets exceed current liabilities
Assets = Owner’s Equity + Liabilities (A = OE + L)
Value of business to owner
Owner’s Equity = Capital + Net profit - Drawings
The amount of money or items of value (tangible assets)
contributed to the business by the owner
The amount of money or items of value withdrawn by the owner
for his personal use
An individual combining the other factors of production (Capital,
Land and Labour) with a view to making a profit in a business
venture
The owner responsible for a one person business
Accountant
Person with specialized knowledge of commerce and finance
Accounting
System of recording the monetary value of business dealings
Non-current asset
(Fixed Asset)
Current assets
Non-current liabilities
Current liabilities
Debtor
Creditor
Bought for use in the business and expected to last in excess of
12 months (land and buildings, vehicles and equipment)
Of value to the firm which may or may not change on a daily
basis e.g. trading stock (inventory), debtors (accounts
receivable) and cash (bank, petty cash, cash float)
Owed by the business over a period in excess of 12 months
e.g. loan and mortgage bond
Amount owed that may or may not change daily as goods are
bought on credit and accounts paid e.g. creditors (accounts
payable), bank overdraft
Someone who owes the business money
Someone to whom the business owes money
THE DIVISION OF ACCOUNTS WITHIN THE THREE KEY CATEGORIES:
ASSETS
Fixed (non-current) assets
Current assets
 Land and buildings
 Trading stock
 Equipment
 Debtors
 Vehicles
 Bank
 Cash float
 Petty cash
Non-current liabilities
 Loan
Capital
Drawings
LIABILITIES
Current liabilities
 Creditors
 Bank overdraft
OWNERS EQUITY
Income
 Sales
 Current income
 Rent income
 Commission received
 Interest on bank account
 Donations
 Interest on fixed deposit
Expenses
 Rent expense
 Salaries and wages
 Stationery
 Cost of sales
 Rates
 Insurance
 Water and electricity
 Advertising
 Bank charges
 Telephone
 Repairs
 Packing material
 Interest on bank overdraft
 Donations
 Interest on loan
There are 6 categories of accounts – (or 3 pairs of accounts):
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Assets (what the business owns) and Liabilities (what the business owes)
Capital (what the owner(s) contribute to the business) and Drawings (what the
owner(s) take from the business)
Income (money earned by the business doing business) Expenses (the costs
incurred by the business doing business)
Activity 2: Write the correct letter in the box next to the concept:
CONCEPT
CORRECT
ANSWER
OPTIONS
Asset
A
Book of first entry where information is recorded
from the source document.
Source
document
B
Amount due to another person or business
Accounting
C
Someone to whom the business owes money
Journal
D
When income exceed expenses
Ledger
E
A business that renders a service
Liability
F
Business owned by one person
Debtor
G
The evidence of a transaction
Profit
H
Creditor
I
Owners’ Equity
J
Event between two or more parties
K
Possessions of the business
L
A collection of accounts of a business
Transaction
M
Someone who owes the business money
Sole trader
N
The interest of the owner in the business
Expenses
O
Income
P
Trading
concern
Service
undertaking
A business that buys and sells merchandise for
profit
Amounts that generate money for the business
e.g. sales
Recording, reporting and interpretation of
information of a business
Amounts directly or indirectly involved in operating
the business, e.g. telephone, stationery
Activity 3: Indicate a type of account for each of the options
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E.g
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Account:
Telephone
Wages
Rent Income
Bank
Insurance
Advertising
Creditor
Current Income
Stationery
Cash Float
Packing material
Vehicle
Donations received
Debtor
Equipment
Loan
Asset
Expense
X
Income
Liability
Activity 4: Complete the following:
1
The money which the owner provides is called his _________________
2.
This gives the owner an interest in the business, known as _________________
3.
All money received by a business and deposited in the bank account of a business
is called _________________
4.
All money paid by a business and deposited in the bank account of a business is
called _________________
5.
What is relationship between the value of the assets of the business and the
owner's equity?
________________________________________________________________________
________________________________________________________________________
6.
Indicate the type of asset in each of the following examples:
Motorcycle for delivery purposes _________________
Shelves, tables and chairs _________________
Computers, cash registers _________________
Desks _________________
Money in the current bank account _________________
6.
Write definitions of the following concepts:
assets: __________________________________________________________________
________________________________________________________________________
capital contribution ________________________________________________________
________________________________________________________________________
transaction ______________________________________________________________
________________________________________________________________________
profit ___________________________________________________________________
________________________________________________________________________
owner's equity ____________________________________________________________
________________________________________________________________________
payments _______________________________________________________________
________________________________________________________________________
receipts _________________________________________________________________
________________________________________________________________________
accounting ______________________________________________________________
________________________________________________________________________