Theory Base of Accounting (Accounting Principles, Concepts and Conventions)

According to the American Institute of Certified Public Accountants (AICPA), accounting is formally defined as:

"The art of recording, classifying, and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof."

The 7 Sequential Stages of the Accounting Cycle:

1. 1. Identification of Economic Transactions: Determining which business events have financial character and involve an exchange of economic value supported by documentary evidence (source documents: cash memos, invoices, receipts).
2. 2. Measurement in Monetary Terms: Expressing identified transactions in terms of the common national monetary unit (e.g., Indian Rupee ₹). Non-monetary events (such as employee morale or management disputes) cannot be recorded.
3. 3. Recording (Book-Keeping): Chronologically entering monetary transactions into the primary book of original entry called the Journal (or subsidiary day-books).
4. 4. Classifying: Grouping recorded transactions of similar nature into individual dedicated accounts in the principal ledger book (Ledger Posting).
5. 5. Summarising: Aggregating ledger balances into understandable summary presentations: preparing the Trial Balance, followed by the Trading and Profit & Loss Account and the Balance Sheet.
6. 6. Analyzing & Interpreting: Computing financial ratios and percentage trends to assess profitability, solvency, and operational efficiency.
7. 7. Communicating: Disseminating final audited accounting reports to internal and external stakeholders for strategic decision-making.

• Assets: Economic resources owned by a business expected to generate future cash flows or economic benefits.
  • Non-Current (Fixed) Assets: Held for long-term production, not for resale (Land, Buildings, Plant & Machinery, Patents).
  • Current Assets: Held for short-term conversion into cash within 12 months (Cash, Bank balance, Debtors, Stock/Inventory).
• Liabilities: Financial obligations or debts owed by the business to external third parties (Bank Loans, Trade Creditors, Bills Payable).
• Capital (Owner's Equity): The amount invested by the owner(s) into the business enterprise: $\text{Capital} = \text{Assets} - \text{Liabilities}$.
• Drawings: Cash or goods withdrawn by the proprietor from the business for personal or domestic use (reduces Capital).
• Debtors (Trade Receivables): Persons or enterprises who owe money to the business for goods purchased on credit.
• Creditors (Trade Payables): Persons or enterprises to whom the business owes money for goods or services purchased on credit.
• Expenditure: Spending money or incurring liability for acquiring assets, goods, or services:
  • Capital Expenditure: Incurred to acquire or enhance fixed assets; yields enduring benefits over multiple years (e.g., buying machinery). Debited to Asset account.
  • Revenue Expenditure: Incurred for routine day-to-day business operations; benefit exhausted within the current accounting year (e.g., salaries, rent, electricity). Debited to Expense account.