Five Heads of Accounting

8/16/2019 Five Heads of Accounting

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Lalit Kumar

Assistant Professor inFinance Management,

HIPA,Ggn.

Fundamentals of Accounting-Understanding five

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Five Elements of Accounting

The elements directly

related to financial position

a ance s ee :

Assets = Liabilities

Equity/Capital

The elements directly

related to performance

(income statement).

Income

Expenses


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Accounting is a game

Assets

Capital

Liablities


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A financial transaction can effect five major elements of

accounting : Assets, Capital, Liabilities, Income andExpenses.

Assets: An asset is defined as resources controlled by theenterprise and from which economic benefits are expectedto flow to the enterprise; such as Cash, Bank balance,

, , , ,which can be converted into cash.


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Liabilities: liabilities are amounts which the entity owes

other businesses or individuals; such as Bank loans,

creditors, Bills payable, Debenture and others which canlead to a liability on the organization.

Capital: : Capital represents the amount which owners

have invested in the business. The amount taken on credit

and then invested in business will not be a part of owner’s

capital.


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Income: Income is a broad term but covers all transactionswhich will result in gross inflow of benefits to the

enterprise. Such as sales, commission received, Rentreceived etc.

Expenses: : Expenses are gross outflow of economicbenefits arising in ordinary course of business such asWages, Salaries, factory rent paid etc.

-Net profit added to the capital at the end of year.


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The Basic Accounting Elements:

Asset

Has future benefit to the entity

Liability

Obligation to transfer assets in the future

Owners’ Equity

Owners’ interest in the com an

Revenue

Increase in economic resources resulting from normaloperations of the company

Expense

Decrease in economic resources resulting from normaloperations of the company

Fundamentals of Accounting-

Understanding five heads


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Element structuresAssets

Current assets

Cash

• Cash on hand

Bank accounts

• Accounts receivable – customer 1

• Accounts receivable – customer 2

Inventory

Raw materials

Work in process

Finished goods

• Product 1

• Product 2


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Element structuresAssets

Current assets

Long-term assets

u ngs

Vehicles

Cars

Trucks


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Element structuresLiabilities

Current liabilities

Accounts payable

Long-term liabilities

Bank loans

• Loan from RBI

• Loan from Private banks

Notes payable

Bonds payable


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Element structuresOwners’ equity

Capital stock (direct investment)

Retained earnings (indirect investment)

evenue

Expenses

(Dividends)


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Element structuresThe balance sheet is a permanent statement

Its’ accounts accumulate information from the entity’sbeginning.

The amounts presented on the balance sheet are aggregated from the entity’s beginning to the balance sheet date.

The income statement is a temporary statement

Its’ accounts are temporary accounts

They accumulate information for a period and then are reset to zero to

begin tracking information for the next period.

The amounts presented on the income statement are aggregated from thebeginning of the period to the end of the period only.


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Element structuresThe Closing Entry

Whenever financial statements are to be prepared, thetemporary (income statement) accounts must be “closed”

to zero so that the can be in trackin data for the next

period.

The amounts in the accounts at closing are transferred toRetained Earnings (so named because it is the earnings (netincome) of the company that is retained in the company andnot distributed to the owners).

We will see an example in the comprehensive example.


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Element structuresThe Closing Entry

The result of the closing entry is that all impacts on

Revenue and Expenses (the temporary accounts) are

account).

That is how A = L + OE stays in balance.

The temporary accounts are sub-pieces of OE.


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Going back to the Fundamental Accounting Equation:

Assets =Assets = Liabilities +Liabilities + Owners’ EquityOwners’ Equity

Debit Credit Credit

Assets

Current assets

Long-term assets

Liabilities

Current liabilities

Long-term liabilities

Direct investment

Capital stock

Indirect investment

Dividends (debit)

Retained earnings

Revenue (credit)

Expense (debit)

Fundamentals of Accounting-

Understanding five heads


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Financial StatementsThere are 2 statements in a standard set of financial

statements

1. Balance Sheet

The “what do we have?” statement Shows what the entity owns and owes (the difference being the

owners’ residual interest)

2. Income Statement

The “what did we do?” statement

Shows the activity the entity undertook in its normal course of

operations.


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Financial Statements

Company Name Company Name

Income statement Balance Steet

For year ended December 31, 2003 As at December 31, 2003

Revenue 100,000 Assets

Current assets 3,000

Expenses Long-term assets 40,000

Salaries 45,000

Utilities 13,000

Rent 30,000

Other 8,000 Total Assets 43,000

96,000-

Liabilities

Net Income 4,000 Current liabilities 15,000

Lon -term liabi li ties 20,000

35,000

Company Name Owners’ Equity

Statement of Retained Earnings Capital stock 1,000

For year ended December 31, 2003 Retained Earnings 7,000

Opening Retained Earnings 3,500 8,000

Net Income (Loss) 4,000

Dividends 500- Total Liabilities and OE 43,000

Closing Retained Earnings 7,000


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Financial Statements

Company Name Company Name






Salaries 45,000

Utilities 13,000

Rent 30,000


96,000-

Liabilities



35,000









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Financial StatementsCompany Name Company Name






Salaries 45,000

Utilities 13,000

Rent 30,000


96,000-

Liabilities



35,000









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heads To Balance Sheet


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headsFrom Statement of

Retained Earnings

Documents

Five Heads of Accounting