A story for relating to accounting basics

accounting basics

Accounts are the pillars of any business. For a business to run money is needed. In order to manage money all the transactions needs to be recorded. Only when everything is recorded we can evaluate whether the business is worth doing or not.

Let’s explain it through an example.

 Mohan, a sole trader is going to start a textile business. For this, he has to invest some money to take stock of textiles. The money that he invests is the capital of the business. From this money he will buy textiles by getting several quotations from retailers. Since he will be buying in bulk he will be getting trade discount. He will do business for one month and depending upon the demand sometimes he have to make purchases again. Let’s take what all basic accounts he has to manage. It’s not an exhaustive list but inclusive one.

  1. Rent: For a business to start he will have to take a place for rent. Rental expenses are accounted in Profit and Loss statement.
  2. Salary: He will have to hire services of a person to do trading. Salary includes DA, TA and all other amenities required for employees are taken into account. The purchases of textiles from retailer amount to direct expenditure whereas salary and rent amounts to indirect expenditure
  3. Miscellaneous Expenses: Any expense which are of small amount shall be clubbed under this head.
  4. Fixed Assets: There will be purchase of machinery and other equipment .Since these types of assets can be capitalised for more than one year they should be classified under Fixed Assets. Fixed assets are subject to wear and tear due to usage. So depreciation should be taken into account and it shall be debited to Profit and Loss account.
  5. Cash and bank accounts: Cash that a person will bring to business is considered as capital. Day today expenses are managed through petty cash account. Sometimes he will receive money from debtors via bank account. So he has to start a bank account in business name and shall be accounted separately with personal expenses.
  6. Debtors and creditors: For smooth running of business debtors shall be given proper collection period. Creditors will also allow deferring the payment. There shall be proper management of these two to maintain liquidity of cash. Debtors shall be paid within the period to avail discount.
  7. Bank Accounts: A bank account shall be started for the company and transactions shall be routed through this. Periodically reconciliation statement is to be prepared to confirm balances.

For all business whether small or big these accounting heads are inevitable. An accountant’s duty is to provide correct information to management and assist them in decision making.

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