Basic concepts of Financial Accounting {Part-3}

The article explains the basic concepts of financial accounting. The accounting can be understood only after understanding its base.

Basic concepts of Financial Accounting {Part-3}

-Dr. Lalit Kumar Setia*

Previous.....

Balancing financial transactions:

A basic understanding of accounting principles may be necessary to identify transactions and enter them in the correct accounts. The double entry system balances all the accounts on the basis of specific transactions. Every accounting system whether it is kept manually or in computerized form; operates on the basic rule of the double entry system. It does not matter which system you are using. If it is a hand system, transactions are recorded by pen into physical books, or if it is a computerised accounting system (such as Tally), the transactions are captured or entered into the computerised accounting system. The accounting principles will be the same. For each transaction you will have debit and credit entries, which will be of equal value[1].

Any business activity, which has a financial implication, constitutes a transaction. When a transaction is entered or processed in the accounting system a credit is entered for each debit of equal value, and visa versa. Double entry system balances all the accounts on the basis of accounting equation.

Elements of financial transactions:

The financial transaction affects a business in various ways. The financial implications can be seen on five major elements of accounting. These elements are: Assets, Capital, Liabilities, Income and Expenses. These elements can be detailed as below[2]:

1. Assets: 

An asset is defined as resources controlled by the enterprise as a result of past events and from which economic benefits are expected to flow to the enterprise. In simple terms an asset is defined as something valuable owned by the business. Assets are further subdivided into current and non current. Non current assets are those which are used in conducting business and are held for more than one accounting year with no intention of resale. Examples include Land and Buildings, Vehicles and Machinery. On the other hand current assets are those assets held in form of cash or those which can easily be turned into cash. Examples here include stocks, debtors and cash.

2. Liabilities: 

Liabilities are defined as “entity’s obligation to transfer economic benefits to another enterprise or individual as a result of past transactions or events”. Thus liabilities are amounts which the entity owes other businesses or individuals. Liabilities are classified into current and non-current liabilities. Current liabilities are those amounts which are repayable within a period of less than 12 months while non-current liabilities are those which should be repaid after more than 12 months.

3. Capital: 

Capital represents the amount which owners have invested in the business. Capital will always equal to assets less the liabilities. It should be remembered that the amount of the resources supplied by the owner are called capital while resources that are then in business are called assets. Capital is also referred to as owner’s equity or net worth. It comprises the funds invested in the business by the owner plus any profits retained for use in business less any drawings distributed to the owners.

4. Income: 

Income is a broad term but covers all transactions which will result in gross inflow of benefits to the enterprise. Income is subdivided into revenues and gains. Revenue is the gross inflow in economic benefits in ordinary activities of an enterprise like sales, dividends ,interest, royalties or rent while gains represents other items that meet the definition of income and may, or may not arise in the ordinary course of an enterprise. For example: profit made on the disposal of non current assets. 

5. Expenses: 

Expenses are gross outflow of economic benefits arising in ordinary course of business. Expenses are incurred in order to generate revenue for the enterprise. Any expense to acquire a new asset or enhance the capacity of an existing asset is called capital expenditure and should be included as part of the value of such asset.

Continued....

*Copyright © 2018 Dr. Lalit Kumar. All rights reserved. Dr. Lalit Kumar is a free-lance writer with publication of research papers in various esteemed and reputed journals. Presently he is working as Assistant Professor (Faculty of Financial Management), HIPA, Gurugram (Delhi-NCR), India (Asia).

You Might Also Be Interested In Reading:1. Basic concepts of Financial Accounting2. Skills for Earning Money3. Tips for Effective Content Writing4. Amazing Tools for Editing Written Content5. Current Affairs Content - Free to prepare for Competitive Examinations6. Wanna to write an eBook for Free