Accounting Notes – Key Topics
1. Basic Accounting Concepts
● Accounting: The systematic recording, reporting, and analysis of financial transactions.
● Business Entity Concept: The business is separate from its owner.
● Money Measurement Concept: Only transactions measurable in money are recorded.
● Going Concern: Assumes the business will continue to operate in the foreseeable
future.
● Accruals Concept: Income and expenses are recorded when earned or incurred, not
when cash changes hands.
● Consistency: The same accounting methods should be used over time for
comparability.
2. Accounting Terms
● Asset: Resources owned by the business (e.g., cash, machinery).
● Liability: Amounts owed to outsiders (e.g., loans, creditors).
● Capital: Owner’s investment in the business.
● Revenue: Income from sales or services.
● Expense: Cost incurred to earn revenue.
● Profit: Revenue – Expenses.
● Loss: Expenses > Revenue.
3. Types of Accounts
● Personal Account: Related to people (e.g., creditors, debtors).
● Real Account: Related to assets (e.g., cash, machinery).
● Nominal Account: Related to expenses, losses, income, and gains.
Golden Rules of Accounting:
1. Personal Account: Debit the receiver, Credit the giver.
2. Real Account: Debit what comes in, Credit what goes out.
3. Nominal Account: Debit all expenses & losses, Credit all incomes & gains.
4. Double Entry System
● Every transaction affects two accounts.
● Debit = Credit ensures the accounting equation:
Assets = Liabilities + Capital
Example:
● Bought machinery for cash:
○ Debit Machinery (Asset increases)
○ Credit Cash (Asset decreases)
5. Books of Original Entry
● Cash Book: Records cash and bank transactions.
● Sales Day Book: Records credit sales.
● Purchases Day Book: Records credit purchases.
● Journal: Records transactions not in day books (e.g., depreciation, errors).
6. Ledger Accounts
● Transfer transactions from journals/day books to individual accounts.
● Shows balances for each account.
● Used to prepare trial balance and financial statements.
7. Trial Balance
● Lists all ledger balances.
● Purpose: Ensure debits = credits.
● Helps detect errors.
8. Final Accounts
For a Sole Trader:
1. Trading Account – Calculates Gross Profit
○ Sales – Cost of Goods Sold = Gross Profit
2. Profit & Loss Account – Calculates Net Profit
○ Gross Profit – Expenses + Other Income = Net Profit
3. Balance Sheet – Shows financial position
○ Assets = Liabilities + Capital
9. Depreciation
● Allocation of the cost of a fixed asset over its useful life.
● Methods:
1. Straight-Line: Equal charge each year
■ Formula: (Cost – Residual Value) ÷ Useful Life
2. Reducing Balance: Fixed percentage of book value each year
■ Formula: Book Value × Depreciation Rate
10. Adjustments
● Accruals: Expenses incurred but not yet paid / Income earned but not yet received.
● Prepayments: Expenses paid in advance.
● Bad Debts: Debts unlikely to be collected; reduce accounts receivable.
● Provision for Doubtful Debts: Estimate of future bad debts.
11. Capital vs Revenue Expenditure
● Capital Expenditure: Long-term, increases assets (e.g., buying machinery).
● Revenue Expenditure: Short-term, day-to-day costs (e.g., salaries, rent).
12. Financial Ratios
● Liquidity Ratios: Ability to meet short-term obligations
○ Current Ratio = Current Assets ÷ Current Liabilities
○ Quick Ratio = (Current Assets – Stock) ÷ Current Liabilities
● Profitability Ratios: Measure profit performance
○ Gross Profit Margin = (Gross Profit ÷ Sales) × 100
○ Net Profit Margin = (Net Profit ÷ Sales) × 100