Advanc'edge MBA / April 2003

What is book keeping?Book keeping is the systematic recording of all

financial transactions of an organisation. For simplicity,we shall refer to the organisation as “the company”. Inthe paras to follow, we shall deal with Accounting, morespecifically “double entry book keeping” which is theaccounting system followed almost universally.

Double entry book keeping dates as far back as thetimes of the Pharaohs in Egypt, whence it is presumed tohave originated. The system records every financialtransaction expressed in terms of money in two equaland opposite parts, namely a debit and a credit.

Before we proceed further, it is necessary to acquaintourselves with some of the fundamental principles ofAccountancy. These are as follows:

Measurement: Accounting measures only financialtransactions or those capable of being expressed inmonetary terms. All other transactions, howeversignificant, are outside the scope of accounting.

Actual value: All transactions are captured at theiractual or “historical” cost. The market value of thetransaction is not to be considered at all.

Separation of ownership: From the accountingperspective, the company and the owner are distinct fromeach other. The owner is treated on par with an outsider.This principle is very important for a properunderstanding of accounting.

Two facets: Every act has an equal and correspondingaspect. This simple concept enables accountants to assurethemselves that the books are error free or “balanced”.For example, if a company buys a computer for Rs.50,000/-, it will record an increase in the assets to thatextent. At the same time, it will show a reduction of it’scash balance by Rs. 50,000/- if the computer waspurchased for cash or an increase in it’s liability to thevendor.

Going Concern: There is an implicit assumption thatthe company will remain in operation in the foreseeablefuture. This assumption allows accountants to segregateexpenditure and income into short term or current andlong term or deferred. It must be stressed that in theabsence of this assumption, the entire method ofrecording the transactions would be radically different.

Accrual Concept: All income which the company is

Financial statements for the uninitiated

entitled to but has not received and expenditure whichthe company has incurred but not paid should beconsidered for arriving at the net surplus or profit for acertain period.

The Golden rules of accountingAll transactions must be allocated to ‘accounts’ or a

classification. Broadly speaking, there are three categoriesof accounts:

Real Accounts: Items such as goods, assets such asfurniture, in fact all items which one can physically touchwould be classified as a real account. For example, Motorcar or computer.

Personal Accounts: Any person whom the companytransacts with would be classified under personalaccounts. For example, Mr. Patel or Apex & Co arepersons.

Nominal accounts: These are usually accounts, whichrelate to income or expenditure. For example conveyanceexpenses or Salaries would fall under this category. The three golden rules of accounting relating to thesethree types of accounts are:

Real Accounts: Debit what comes in and Credit whatgoes out.

For example, if a calculator is purchased for cash, byapplying the above rule, you would debit Calculatoraccount and credit Cash account.

Personal accounts: Debit the receiver and credit thegiver.

For example, in the above case, if the calculator waspurchased on credit from Casio Inc., , you would debitCalculator account and credit Casio Inc.

Nominal accounts: Debit the expense and credit theincome

For example, if you were to spend Rs. 100 onconveyance, you would debit Conveyance account andcredit Cash account. Similarly, if you receive cash of Rs.200/- as fees, you would debit cash account and creditfees account.

This covers most of the technical stuff you need toknow for analysing a financial statement. Next time, weshall begin our journey of examining the financialstatements of a company.

- Vinay Singh

This article is the first of a series designed to help those with no background of accounting orfinance to read financial statements. While an attempt will be made to avoid unnecessary

technicalities, these cannot be entirely eliminated.

Skillz