Basic Accounting Principles session 1 by Dino Leonandri

Language of Business
Systematic series of steps – Accounting cycle
Accounting is a service activity. It provides quantitative financial information
to different users who utilize it to make economic decisions.
OVERVIEW
Economic Entity
For Decision Making
Management Investors,
Creditors, Lenders,
Government,
Employee, Customers,
others.
Information about the
entity, profitability,
stability of operations,
ability to pay
obligations tax bases
Going Concern.
Users of Info
Financial
Information
Through
Financial
Reports

Accounting information
OVERVIEW
What Why Information
Use P&L for → 1. Results of Operations Revenue and profits in a space of
time.
Use Balance Sheet for → 2. Financial Position How much resources does the entity
currently have? How much do they
owe third parties? How much is left
over for the owners after paying all
our obligations using our resources.
→ (assets – liabilities)
Cash Flow Balance Sheet Projection for → 3. Solvency and Liquidity Refers to entity’s ability to pay
obligations when they become due.
Ability to meet short term
obligations.
Use Cash Flow reports for → 4. Cash Flows Shows the inflows and outflows of
cash.
5. Other information Any relevant information that affects
the decisions of users should be
included in the financial reports.

This is an assumption that the entity of business is
continuing to exist or will exist in the future unless
otherwise stated.
This is the reason Assets on the Balance Sheet are
generally presented at cost rather than market value
Long term assets are held in the balance sheet and fully
utilized until retired.
GOING CONCERN
BASIC ACCOUNTING PRINCIPLES

ACCRUAL BASIS
This method means revenue or income is recognized when
earned regardless of when received and expenses are
recognized when incurred regardless of when paid.
Hence:
-Income does not mean cash collections and
-expenses do not mean cash payments
-Under accrual basis income and expenses are independent of
cash collections or payments

ACCRUAL BASIS
Ex : ABC received its electricity bill for March on April 5 and paid it on April 25th.
So when is the income recognized?
QUESTION
When it is earned – Dec 9, 2016, even if it has not
been paid.
ANSWER
Ex : ABC gave repair services to a customer on Dec 9, 2016.
The Customer paid after 30 days, ie, Jan 8, 2017.
When is the expense incurred and recorded?
QUESTION
March - the electricity used was for March so must
show in that month.
ANSWER

ACCOUNTING
PRINCIPLES &
CONCEPTS

ACCOUNTING ENTITY CONCEPT
Accounting entity concept means a business is an entity,
separate from its owners, managers, and employees.
Personal transactions therefore, should not be mixed in
with transactions of the company.
Ex : 1. If ABC company, buys a vehicle for transportation
of its customers that is a business transaction.
2. If Mr A, the owner of ABC company, buys a car
for personal use with his own money, then that
transaction should not be mixed in with ABC
company transactions.
ACCOUNTING PRINCIPLES & CONCEPTS

TIME PERIOD
The time period concepts means that a business has
indefinite life unless otherwise noted and this life is
subdivided into periods of equal length for reporting
financial statements.
Accounting period is usually 1 year – More frequent
reports are done monthly or quarterly.

MATCHING PRINCIPLE
Income is matched with expenses and vice versa.
Expenses are recognized in the period the income is
earned and income is recognized in the period the
expenses are incurred. Through accrual accounting the
matching principle is achieved.
- Revenue recognition principle – accrual accounting
- Expense recognition principle – accrual accounting
Historical cost principle – items in the balance sheet are
generally presented at historical cost. Some accounts
however are revalued at fair market value or discounted
cost (Mark to Market). (usually Land, Properties)

ELEMENTS OF ACCOUNTING
3 major elements of Accounting are:
Assets
Liabilities
Capital

Before going further lets look at the word
What does it mean ?
Account is a storage unit or area used to collect and store information of a
similar nature.
Ex:
Cash
Cash is an account which stores all transactions that involve cash receipts
and cash payments. All cash receipts would be recorded as increases in
cash and all payments would be recorded as deductions in cash.
Building
If ABC company acquires a building and pays cash, the cash account would
show a deduction and the building account would show an increase.
“Account”

ASSETS
• Assets are resources owned and controlled by the entity as a result of past actions or transactions
and from which future economic benefits are expected for the business entity.
– Assets are properties or rights owned by the business.
Assets are classified as or
A. Current Assets:
These are assets that are expected to be realized or consumed within an
accounting period or 12 months.
1. Cash and Cash Equivalents – bill, coins, funds for current use, checks, cash in bank.
2. Receivables : A/R (Receivables from customers), promissory notes, rent receivable, interest
receivable, due from employees (advances) and any other claim expected to be received in
the 12 months.
3. Allowance for Doubtful Debts. This is a valuation account which shows the potential
uncollected amount of receivable. It is also called a provision account and also called a
contra asset and presented as a deduction to its related account, Accounts receivable.
4. Inventories : Assets held for sale or for service in the normal course of business.
5. Prepaid Expense: Expenses paid in advance – prepaid rent, prepaid insurance, prepaid
office supplies, prepaid stationary, prepaid advertising.
Another way to define
current non - current

ASSETS
B. Non - Current Assets:
Assets not defined by above are Non – current assets. So they are long term in nature – or
useful for a period longer than 12 months or the normal operating cycle.
1. Long term investments: Investments for long term like stocks, bonds, properties or long
term funds.
2. Land : used for business.
3. Building : office building, factory, store.
4. Equipment : machinary, furniture and fixtures, office equipment, computer, vehicles.
Accumulated depreciation : this is a valuation account which tracks the decrease in value
of an asset from wear and tear, passage of time and obsolescence. It is a contra asset
account and presented as a deduction to the related fixed asset.
5. Intangibles : Long term assets with no physical assets.
Such as goodwill or patents, copyright, trademark, brand or proprietary technology or
customer base.
Goodwill is usually used on an acquisition – the premium paid over its tangible
identified net assets (purchase price) – (assets – liabilities).
Elements of
Accounting

LIABILITY
• Liabilities are obligations or payables of the business entity
Company assets come from 2 major sources:
- Borrowings from Lenders of creditors – Liabilities
- Contribution by Owners – Capital
• Like Assets, they are also classified as and
A. Liabilities are considered current if they are due in 12 months.
1. Trade and other payables – accounts payable, notes payable, interest payable, rent
payable, accruals.
2. Current provisions – short term liabilities that are probable and can be measured (exact timing
unknown).
3. Accruals – short term Liabilities that are known and exact timing is known.
4. Short – term borrowings – financing, short term loans or credit arrangements.
5. Current portion of a long term liability.
Ex: interest portion is a loan, or a payment due in 12 months.
6. Current tax liabilities – taxes payable for the period.
B. Non - Current Liabilities:
If they are not currently payable, then they are considered non current liabilities.
◦ Long term notes, bonds, mortgages
◦ Deferred tax liabilities
◦ Other long term obligations
Elements of
Accounting
current Non - current

CAPITAL
Also known as net assets or equity, Capital refers to whats left to the owners after all liabilities are
settled so the capital equation is
CAPITAL = ASSETS – LIABILITIES
What affects capital ?
1. Initial and additional contributions from owner.
2. Withdrawals made by owner (dividends by Corporate)
3. Income
4. Expenses
Owner contributions and Income increase Capital.
Withdrawals and Expenses decrease it.
Different definitions for Capital
↓
Sole Proprietorship → Owners equity
Partnerships → Partners equity
Corporation → Stockholders equity

INCOME
Its an increase in economic benefit during the Accounting Period by an
increase in asset or decrease in liability which results in increase in
equity. Contributions by owner would not count as income.
Income includes revenues and gains.
Revenues : come from the company’s ordinary course of business
which are fees, sales of service, etc.
Gains : come from sale of equipment, sale of short term investments,
interest income, etc.
Income is measured every period and added to the Capital Account.

EXPENSE
Its a decrease in economic benefit during the Accounting Period by a
decrease in Assets or an increase in liability which results in a decrease
in Equity. Payments to owners do not count as an expense.
Expense includes ordinary expenses and losses.
Ordinary expenses : cost of sales salaries, advertising expense, repairs,
rent expense, etc.
Losses : losses from fire, natural disasters, theft. Like income, expense
is measured every period and subtracted from capital.

NET INCOME
NET INCOME =
INCOME - EXPENSES
or
P&L
Also called Profit and
Loss Statement
Income Statement

TEST
ITEM
1. Tool and equipment
2. Salaries payable
3. Additional cash from owner
4. Cash on hand
5. Cash deposit in bank
6. Vehicle purchase
7. Invoice from supplies
8. Loan from bank (5 years)
9. Prepaid Insurance
10.Trademark
11.Withdrawals by owner
12.Food Inventory
13.Accounts Receivable
14.Additional Building for rent
1
Asset
Liability
Capital
Asset
Asset
Asset
Liability
Liability
Asset
Asset
Capital
Asset
Asset
Asset
2
Non current
Current
N/A
Current
Current
Non current
Current
Non current
Current
Non current
N/A
Current
Current
Non current
A. For each item in column 1 note whether it is an Asset or Liability or
Capital then in column 2 indicate whether it is current or non -
current if the item is capital put N/A

TEST
1. Rent expense
2. Rent payable
3. Employee salaries
4. Room sales
5. Electric, water, gas
6. Flood damage
7. Depreciation
8. Prepaid Advertising
9. Delivery cost
10.Bank Interest
Expense
Liability
Expense
Income
Expense
Loss
Contra - asset
Asset
Expense
Income
B. For each item below indicate in column if it is Income, Expense,
Asset or Liability.

TEST
1. Chemical inventory
2. Accounts payable
3. Utilities expenses
4. Service charge
5. Computer equipment
6. Office supplies
7. Cash
8. Furniture & fixtures
9. Tax payable
10.Loan payable
Asset
Liability
Expense
Liability
Asset
Expense
Asset
Asset
Liability
Liability
C.For each item below indicate in column 1 if it is Income, Expense,
Asset or Liability. If asset is liability note if it current or non current.
Current
Current
-
Current
Non Current
-
Current
Non Current
Current
Current

ACCOUNTING EQUATION
How does it stay in balance ?
The accounting equation is the underlying concept that shows the relationship
between the elements : asset, liabilities, capital.
When a business starts up, its assets come from two sources:
1. Contributions from owners (capital)
2. Loans from lenders or creditors
As business transactions take place, the value of each of the elements change.
The accounting equation always stay in balance.
For every transaction at least 2 accounts are affected.
Total Assets = Total Liabilities + Capital
ACCOUNTING EQUATION

ACCOUNTING EQUATION
Ex:
1. Mr A invested $ 20,000 to start a coffee shop
2. He got a loan from a bank for $ 30,000
3. The business purchased equipment worth $ 1,000
Here is how the transactions affect the Accounting equation.
The company assets grew by the amount of the equipment however it decreased
cash which is an asset.
Assets = Liabilities + Capital
Owners Investment 20,000 = + 20,000
Loan from Bank 30,000 = 30,000 + ---
Equipment purchase
Cash
1,000
(1,000)
=
Total 50,000 = 30,000 + 20,000
The Accounting equation is (and should always) be in balance
ACCOUNTING EQUATION

ACCOUNTING EQUATION
Capital is affected by withdrawals, income, expense & contributions, therefore you can rewrite the equation as
Ex:
1. Mr A invested $ 20,000 to start a coffee shop
2. He got loan from a bank for $ 30,000
3. The business purchased stock and equipment for $1,000
4. Sold coffee and received $ 500
5. Purchased supplies for $100 on credit
6. Repaired equipment for $400
7. Made sales of $1,000
Assets = Liabilities + Capital - With drawals + Income - Expenses
1. 20,000 = + 20,000 - + -
2. 30,000 = 30,000 + - + -
3. 1,000 = + - + -
4. (1,000) = + - + -
5. 500 = + - + 500 -
6. 200 = 200 + - + -
7. - = 400 + - + - 400
8. 1,000 = + - + 1,000 -
51,700 = 30,600 + 20,000 - 0 + 1,500 - 400
ACCOUNTING EQUATION

This is the foundation on which the Accounting Cycle and concepts of Accounting are
based.
In earlier times accounts were simple lists or a single entry system.
After the industrial revolution as business became more complex, bookkeeping developed
to capture more aspects of business and Thus developed into what is today known as
Double Entry Bookkeeping or Double Entry Accounting. The basic premise of Double Entry
is that in business transactions, there is a two fold effect - a value is given and a value is
received.
Double entry captures both sides of this concept.
Let us examine both Single Entry & Double Entry Method
THE DOUBLE ENTRY ACCOUNTING SYSTEM

This method does not capture the two fold effect of business transactions.
Separate books are maintained for some basic accounts like cash, receivables and
payables. Therefore the Accounting records are incomplete.
Ex:
On May 1st, 2017 Mr. B invested $ 30,000 to start a Marketing consultancy business
On May 5th, 2017 the company purchased a computer for the office for $1,000
On May 8th, 2017 the company provided services to a client and received $ 500
Under a single entry system, the company uses a cash book to record all its
transactions.
It looks like this:
SINGLE ENTRY
Date Item Amount Balance
1-5-16 Beginning Balance 0
1-5-16 Invesment of owner 30,000 30,000
5-5-16 Purchase of Computer (1,000) 29,000
8-5-16 Cash from Customer 500 29,500

The above will quickly give you the cash balance. However if you need to find the
balances of revenues and expenses you will need to maintain separate books for
them as well.
The whole financial picture of the company is incomplete.
Under a Double Entry System each transaction is recorded in at least two accounts.
All Accounts have a credit side and a debit side.
Due to the effect of having at least two sides to a transaction debit always equal
credit.
Rules
To increase an Asset you debit it; to decrease credit it.
To increase Liability or Capital you credit it; to decrease debit it.
When you incur expenses debit it.
When you earn income credit it.
DEBITS AND CREDITS

DOUBLE ENTRY
Accounting Element To increase To decrease
1. Asset Debit Credit
2. Liability Credit Debit
3. Capital investment Credit Debit
4. Capital withdrawal Debit Credit
5. Income Credit Debit
6. Expenses Debit Credit
Table

DOUBLE ENTRY
Using the above business transaction example, the recording would look like this:
Date Description Debit Credit
1-5-16 Cash
Capital
To record initial Investment
30,000
30,000
5-5-16 Computer equipment
Cash
To record purchase of computer equipment
1,000
1,000
8-5-16 Cash
Revenue
To record revenue received
500 500

DOUBLE ENTRY
Debit Credit
1-5-16 30,000
Balance 30,000
Debit Credit
1-5-16 30,000
5-5-16 1,000
8-5-16 500
30,500 1,000
Balance 29,500
Debit Credit
5-5-16 1,000
Balance 1,000
Capital Account Cash Account Computer (Asset)

READING YOUR FINANCIAL STATEMENTS
Going through in detail over financial statements may be not be very appealing. However spending some
time on the details will help you make better business decisions.
P&L
Generally you look at Profit and Loss to see how much income and profit you make.
But it also tells you your strengths and weakness.
It tells you what works and what doesn’t for your bottom line
Balance Sheet
P&L’s always gets the headlines. It is a good measure of how a business is functioning.
However looking at a balance sheet will give you a closer look at day to day realities.
Balance sheets have assets, debts, liabilities, cash and as such are health checks for the stability or the
vulnerability of the business.
When you interpret the figures, you should always focus on there being a sustainable balance between
Assets and Liabilities.
Cash
The importance of maintaining positive cash flows or access to credit can not be emphazized enough for the
business.
Cash flows can turn into major headaches if you cannot meet current obligations and even a profitable
business might end up struggling to remain viable.

1. If business is struggling to be profitable or if there is no clear path to profit, then this is a
business at risk.
2. If margins are slipping → It is a measure of how it manages its costs.
3. Stagnant sales or rate of growth:
Your sales may be increasing but your rate of growth may be decreasing or stagnant
from year to year or month to month.
4. Profitable but no positive cash flow
Liquidity is important. Maybe your profits are tied up excessively in inventories of
receivables.
5. Know your metrics
Market share, Revenue, Profit margins, EBITDA
P&L WARNING SIGNS

Current Assets
Know what is in them and how quickly they can be converted into Cash.
Pay close attention to Receivable. What are the issues slowing collection? Understand the process of billing,
collection.
Current Liabilities
Know what is in creditors payable (A/P). Are there vendors older than 6 months? Is this cleaned up periodically?
Know what is in accruals , provisions. How old are they? Is there anything older than 3 months?
Use ratios
1. Working Capital Ratio
This measures the liquidity of a company.
It shows how easily the company can use its assets to pay short term obligations.
Divide Current Assets / Current Liabilities.
Ex: If ABC had Current Assets of $ 8 mil and Current Liabilities of $ 4 mil then the ratio is 2:1 which looks good
but same example if a company had more cash among its current assets then it is in much better shape.
2. Quick ratio
Subtract inventories from Current Assets and divide by Liabilities. This is a measure of how current Liabilities are
covered by Cash and Liquid Assets. Inventories are excluded because they are not easily converted into cash.
Balance Sheet reviews

Days on hand
This measures an optimal level of Inventory based on your business volume and purchasing practice. This
indicates if you have too much cash tied up in Inventories.
Food →
Beverage →
Guest Supplies →
Engineering →
Any other →
Balance Sheet reviews
Average Inventory for the month
Cost of sales for the month
Cost of sales for the month
Monthly expense
Monthly expense
Monthly expense

Basic Accounting Principles session 1 by Dino Leonandri

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Basic Accounting Principles session 1 by Dino Leonandri