Five Elements of Accounting: Basic Rules of Financial Accounting

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World’s Most Difficult Subjects

Every subject has its merits and demerits.

World’s most difficult numerical subjects are mathematics, physics, chemistry and accounting.

World’s most difficult theoretical subjects are English grammar and Economics.

Above subjects need more times to practice.

Very old saying ‘practice makes man perfect.’

As well as a learner makes practice and understands concept of chapter, above subject will be interesting.

  

Accounting

Accounting is the process or work to keep recording financial transactions.

It is broader than bookkeeping.

It starts when bookkeeping ends.

Accounting is the language of business.

It is an analysis and interpretation of book keeping records.

It is an art of measuring, recording and communicating of financial information.

It includes maintenance of accounting records as well as preparation of financial and economic information.

 

Accounting is an information system.

It measures, processes and communicates financial information for decision makers.

Business activities are identified and measured in terms of money.

Then processed and finally communicated to the various groups of users.

Without accounting, the financial transactions are only data.

They are converted to information by the accounting processing system.

 

In simple meaning, accounting is a story of value or money.

From where the money come, how much the money worth, how much the money cost, how much value for money exchange and how much of money is in hand at any given time.

  

Five Elements of Accounting

Entire financial accounting is based on five elements.

These accounting elements are presented as:

 

 

Keep in Mind

Some writers write seven elements of accounting in place of five elements.

They are capital, incomes, profits, liabilities, assets, expenses, losses.

Accounting equation is:

Assets = Capital + Liabilities

 

(1) CAPITAL

Capital is the first element of accounting.

Without investing capital in the business, no one business can be started.

When a businessperson starts his business, he must invest cash.

He can start business with cash, inventory (business goods and merchandise) and fixed assets.

 

Generally, there are four types of business; sole proprietorship, partnership, private limited company and limited company.

It is basic journal entry; so we are going to study according to sole proprietorship and limited company.

 

Owner’s equity

Owner’s equity is also known as capital or shareholders’ equity.

Owner’s equity is the capital amount of sole proprietor and partners invested in the business.

Shareholders’ equity is the capital amount of private limited company and limited company.

 

Expenses, income, profit or loss is the part of owner’s equity; they are adjusted with capital.

Income and profit are added with capital (owner’s equity).

Expense and loss are deducted from capital (owner’s equity).

 

Journal Entry of Business Started of Sole Proprietorship

Cash account	Dr	Cash introduction	Increase asset
Bank account	Dr	Account open (bank balance)	Increase asset
Stock (Inventory) account	Dr	Value of business goods	Increase asset
Plant and machinery account	Dr	Value of assets	Increase asset
Land and building account	Dr	Value of assets	Increase asset
Furniture and fitting account	Dr	Value of assets	Increase asset
Computer and equipment account	Dr	Value of assets	Increase asset
Other assets account …………………	Dr	Value of assets	Increase asset
To Owner’s equity or Capital account		Total capital	Increase liability
(Being- business started with ………………

 

Journal Entry of Additional Capital

Cash account	Dr	Additional capital introduction	Increase asset
Bank account	Dr	Additional capital introduction	Increase asset
To Owner’s equity or Capital account		Total capital	Increase liability
(Being- additional capital brought by owner)

 

 

Business Commenced of Private Limited and Limited Company

Private Limited Company, Limited Liabilities Company (LLC), Limited Company or Joint Stock Company starts its business by issuing common stock (equity shares, ordinary share).

These companies first issue equity shares to the public; then they collect money from public.

After collecting cash, they purchase land, building, machinery, equipment, materials, inventory etc according to their need.

Journal Entry of Business Started of Limited Company   

Cash account	Dr	Cash introduction	Increase asset
Bank account	Dr	Account open (bank balance)	Increase asset
To Equity shares capital account		Total capital	Increase liability
(Being- business commenced with cash/bank and converted into xxxx common stock  of $/₹/Rs … each)

 

 

Keep in Mind

Sometimes owner or proprietor of the business takes (withdrawal) money or goods from business his personal, private or domestic use; it is known as drawings or withdrawals.

The uses of business assets for domestic purposes are also considered as drawings.

If cash is taken, it is deducted from cash as well as capital.

If goods are taken, it is deducted from cash and purchase (inventory).

For accounting purposes, drawings and withdrawals are different.

Drawings are made out of business profits and withdrawals are made out of proprietor’s capital contribution.

 

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Click on link for YouTube videos
Share (Accounting for Share)	http://tiny.cc/889jkz
Share in Nepali	http://tiny.cc/k99jkz
Debentures	http://tiny.cc/yeakkz
Final Account: Class 12	http://tiny.cc/e89jkz
Final Account in Nepali	http://tiny.cc/w89jkz
Work Sheet	http://tiny.cc/579jkz
Ratio Analysis (Accounting Ratio)	http://tiny.cc/4fakkz
Fund Flow Statement	http://tiny.cc/wiakkz
Cash Flow Statement	http://tiny.cc/8gakkz
Theory Accounting Xii	http://tiny.cc/nfakkz
Theory: Cost Accounting	http://tiny.cc/tfakkz
Cost Accounting	http://tiny.cc/p29jkz
LIFO−FIFO	http://tiny.cc/dgakkz
Cost Sheet, Unit Costing	http://tiny.cc/w49jkz
Cost Reconciliation Statement	http://tiny.cc/829jkz

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(2) INCOME

There are two types of the business on the basis of revenues.

First is goods selling organization and second is service providing organization.

 

Trading firms purchase readymade goods and sell at profit.

Assembling firms purchase ready-made components; them make new product and sell.

Manufacturing firms purchase raw materials and semi-famished goods; then make new product and sell.

 

Goods selling organizations sell goods and receive sales revenues.

Service providing organizations sell services and receive service revenues.

 

Sales revenues or service revenues are major incomes for any business organization.

Besides this, organizations receive or earn some other incomes; these incomes are:

Discount received

Interest received

Commission received

Dividend received

Rent received

Other income  

 

Journal Entry of Sundry Income

Cash account	Dr	Income received  in cash	Increase in assets
Bank account	Dr	Income received  by cheque	Increase in assets
Income receivable account	Dr	Income earned but not received	Increase in assets
Accrued income account	Dr	Income earned but not received	Increase in assets
To Income account (by name)		Name of income head	Increase in income
(Being- income received or receivable)

 

 

(3) LIABILITIES

Liabilities are obligation of a person or an organization; they are recorded in liabilities side of balance sheet.

Liabilities are known as current liabilities or non-current liabilities.

Current liabilities are for 12 months or one year.

Non-current liabilities or long-term liabilities are for more than one year.

This time limit may be upto 30 years.

 

Sometimes one transaction heading may be short-term or long-term.

Mortgage loan and notes payable payments due during the current year is recorded as current liability.

Mortgage loan and notes payable payments due in more than one year is recorded as non-current liability.

 

Long-term liabilities (Non-current liabilities)	Current liabilities (Short-term liabilities)
Debentures or bonds	Creditors and suppliers
Mortgage loan	Bills payable, account payable
Notes payable	Notes payable
Long-term loan	Short-term loan
Bank loan	Bank overdraft
Deferred tax	Provision for tax
	Outstanding expenses (expenses payable or due)
	Advance income

 

Journal Entry of Short-term Liabilities

Cash account	Dr	Cash received as loan	Increase asset
Bank account	Dr	Loan received through bank	Increase asset
Purchase account	Dr	Inventory purchased on credit	Increase inventory
To Short-term loan		Short-term loan took	Increase liability
To Creditor or supplier		Inventory purchased on credit	Increase liability
To Expenses payable		Expense occurred but not paid	Increase liability
(Being: ………………….

 

Journal Entry of Long-term Liabilities

Bank account	Dr	Loan received through bank	Increase asset
To Debentures or Bonds		Debentures or bond issue	Increase liability
To Mortgage loan or Long-term loan		Mortgage loan took	Increase liability
To Bank loan		Bank loan took	Increase liability
(Being: ………………….

 

#####

Click on link for YouTube videos
Share (Accounting for Share)	http://tiny.cc/889jkz
Share in Nepali	http://tiny.cc/k99jkz
Debentures	http://tiny.cc/yeakkz
Final Account: Class 12	http://tiny.cc/e89jkz
Final Account in Nepali	http://tiny.cc/w89jkz
Work Sheet	http://tiny.cc/579jkz
Ratio Analysis (Accounting Ratio)	http://tiny.cc/4fakkz
Fund Flow Statement	http://tiny.cc/wiakkz
Cash Flow Statement	http://tiny.cc/8gakkz
Theory Accounting Xii	http://tiny.cc/nfakkz
Theory: Cost Accounting	http://tiny.cc/tfakkz
Cost Accounting	http://tiny.cc/p29jkz
LIFO−FIFO	http://tiny.cc/dgakkz
Cost Sheet, Unit Costing	http://tiny.cc/w49jkz
Cost Reconciliation Statement	http://tiny.cc/829jkz

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(4) ASSETS

Assets are the economic resources; they are recorded in assets side of balance sheet.

Assets represent probable future economic benefits.

Tangible assets have their physical substance.

Tangible assets are also known as fixed assets.

Intangible assets do not have physical substance.

Intangible assets are also known as fictitious assets.

 

Tangible assets	Intangible assets	Current assets
Land and building	Goodwill	Cash in hand
Plant and machinery	Trade mark and copy rights*	Cash at bank
Equipment	Preliminary expenses	Stock, inventory or merchandise
Furniture and fitting	Loss on issue of debentures	Debtors or customers
Vehicle etc.	Discount on issue of shares	Bills receivable
	P&L account (Dr) or Deficit	Account receivable
		Prepaid expenses etc.

 

(A) Assets Purchased

Tangible assets are used to generate sales or service revenues.

Tangible assets represent probable future economic benefits.

They are not purchased for resale.

After using these assets their life will be decreased; and their value also will be decreased.

This decreased value is known as depreciation.

 

Journal Entry of Tangible Assets Purchased

Plant and machinery account	Dr	Value of assets	Increase assets
Land and building account	Dr	Value of assets	Increase assets
Furniture and fitting account	Dr	Value of assets	Increase assets
Equipment account	Dr	Value of asset	Increase assets
Vehicle account	Dr	Value of asset	Increase assets
Computer/laptop account	Dr	Value of asset	Increase assets
To Cash account		Cash given	Decrease in assets
To Bank account		Cheque given	Decrease in assets
To XYZ Suppliers account		Credit purchased from firm	Increase in liabilities
To Bills payable account		Credit purchased and bill accepted	Increase in liabilities
(Being- assets purchased …………….

 

(B) Assets Sold

After using fixed asset, it becomes old.

Sometime it may be useless or outdated.

After using for long time, these tangible assets become useless or outdated; then they are sold.

At the time of asset selling, there may be capitalized profit or capitalized loss.

Loss is debited but profit is credited in journal entry.

 

Accumulated depreciation   = Original value – Book salvage value

Profit = Cash salvage value − Book salvage value

Loss = Book salvage value − Cash salvage value

 

Journal Entry of Tangible Assets Sold

Cash account	Dr	Cash received	Increase in assets
Bank account	Dr	Cheque received	Increase in assets
Customer or debtors	Dr	Credit sold to person  or firm	Increase in assets
XYZ Trader account	Dr	Credit sold to firm	Increase in assets
Profit and loss (loss) account	Dr	If assets sold at loss	Increase of loss
To Asset account (name of asset)		Value of assets	Decrease in assets
To Profit and loss (profit)		If assets sold at profit	Increase of profit
(Being- assets sold at …………

 

(5) EXPENSES

Every business firm has to do expenses to operate business.

These expenses maybe daily, weekly, monthly, quarterly, half yearly and yearly on regular basis.

There are three types of operating expenses; they are:

(a) Trading or manufacturing expenses

(b) Office and administration expenses

(c) Selling and distribution expenses

 

Trading Account	Office or Administrative Expenses:	Selling and Distribution Expenses:
Purchase expenses:	Salary and wages	Carriage or freight outward
Carriage or carriage inward	Director’s fees	Carriage or freight on sales
Freight or freight inward	Office rent, rates and tax	Travelling expenses
Carriage on purchase	Printing and stationery	Advertisement and publicity
Purchase expenses	Postage expenses	Free sample
Octoi	Insurance	Sales expenses
Import duty or custom duty	Phone, mobile, internet expenses	Packing expenses
Clearing charge	Bank charge	Salary to sales agent
Dock charge (dock dues)	Legal charge	Commission to sales agent
Coolie and cartage	License fees	Rent of warehouse or godown
Packing on purchase	Audit fee	Stationery, postage expenses
Factory expenses:	Interest on loan	Phone, mobile, internet expenses
Wages and salary	Staff benefits	Insurance of warehouse
Productive wages	Bonus to staff	Trade or trading expenses
Store keeper’s salary	Office lighting and power	Delivery expenses
Fuel and power	Entertainment expenses	Bad debts
Motive power	General expenses	Provision for bade debts
Store consumed*	Establishment expenses	Discount allowed
Coal, gas, stem and water	Commission paid	Sales tax or VAT  or GST
Heating and power	Manager’s commission
Excise duty	Interest on capital	Non-cash expenses:
Royalty (for manufacturing)	Non-cash expenses:	Depreciation on warehouse
Factory insurance	Depreciation on equipment	Depreciation on delivery van
Factory rent, rates and taxes	Depreciation on furniture
Estimate expenses	Depreciation on land building  etc.	Other expenses and losses:
Benefit to workers etc.		Loss by fire or theft etc.

 

Journal Entry of Operating Expenses

Salary account	Dr	salary paid to person	Increase in expenses
Wages account	Dr	wages paid to person	Increase in expenses
Rent account	Dr	rent paid to house owner	Increase in expenses
Telephone and internet bill account	Dr	telephone and internet bill paid	Increase in expenses
Stationery account	Dr	stationery purchased	Increase in expenses
Electricity and water bill account	Dr	electricity and water bill paid	Increase in expenses
Interest and commission	Dr	interest and commission paid	Increase in expenses
Other expenses account	Dr	other expenses paid	Increase in expenses
To Cash account		paid in cash	Decrease in assets
To Bank account		paid by cheque	Decrease in assets
To Expenses payable		Expenses incurred but not paid	Increase liabilities
(Being- ….expenses paid by)