CSEET · Fundamentals of Accounting

Basic Concepts and Principles of Accounting: formula sheet

Full chapter guide

Key formulas

Accounting process chain: Identify → Record → Classify → Summarise → Analyse and Interpret → Communicate; Use this order to define accounting or to list its functions.
Basis of financial statements (Framework para 22): Accrual basis: effects of transactions are recognised when they occur, not when cash is received or paid; Write this when asked on what basis financial statements are prepared.
Materiality (Framework para 30): Information is material if its omission or misstatement could influence users' economic decisions; Materiality is a threshold or cut-off point, not a primary qualitative characteristic.
Users of accounting information: Internal: owners and management. External: investors, lenders, suppliers and trade creditors, customers, employees, government and agencies, public; The Framework lists employees among the users; in exam answers, place them in the group your study material uses, usually internal, and say why.
Book-keeping vs accounting: Book-keeping = recording only; Accounting = recording + classifying + summarising + interpreting; Book-keeping is the first stage. Accounting includes it and goes further.
Financial accounting: Purpose: profit and financial position; Users: mostly external; Time: past; Follows accounting standards and the legal format of statements.
Cost accounting: Purpose: ascertain and control cost; Users: mainly management; Deals with cost per unit, job or process.
Management accounting: Purpose: planning, decision and control; Users: internal management; Time: future-oriented; No compulsory format. Draws on financial and cost data.
Fundamental accounting assumptions (AS 1, para 10): Going Concern + Consistency + Accrual; These three are the fundamental assumptions. Others such as business entity and money measurement are commonly taught concepts but are not in this list.
Disclosure rule (AS 1, para 27): Assumption followed → no disclosure; not followed → disclose the fact; Write this whenever a question asks what happens if a fundamental assumption is violated.
Accounting equation (dual aspect): Assets = Capital + Liabilities; Holds after every transaction because each has two equal effects.
Accrual definition: Revenues and costs are recognised as earned or incurred, not as money is received or paid; Based on AS 1 para 10(c).
Going concern basis: No intention or need to liquidate or materially curtail operations; If such intention or need exists, statements may need a different basis, and that basis is disclosed (Framework para 23).
Matching: Expenses of the period are recognised along with the income they helped earn; Per Framework para 94, matching does not allow recognising items in the balance sheet that fail the definition of assets or liabilities.
Accounting equation: Assets = Liabilities + Capital; Must balance after every transaction.
Capital (rearranged): Capital = Assets − Liabilities; Also called owner's equity or net worth.
Cash basis: Income = cash received; Expense = cash paid; Ignores amounts due or outstanding.
Accrual basis income/expense: Income earned and expenses incurred are recorded in the period they relate to; Adjust for outstanding and prepaid items, and income accrued or received in advance.
Fundamental assumptions: Going concern, Consistency, Accrual; AS 1 para 27: disclose only if one is not followed.
Personal account rule: Debit the receiver; Credit the giver; Applies to persons, firms, companies, banks, and the owner's capital and drawings.
Real account rule: Debit what comes in; Credit what goes out; Applies to assets like cash, goods, building, machinery.
Nominal account rule: Debit all expenses and losses; Credit all incomes and gains; Applies to rent, wages, discount allowed, interest received, commission earned.
Accounting equation: Assets = Liabilities + Capital; Capital = Assets − Liabilities. Drawings reduce capital.
Closing capital: Closing capital = Opening capital + Additional capital + Profit − Drawings − Loss; Use profit or loss, not both.

Quick revision

Accounting records, classifies, summarises and interprets financial transactions, and communicates the results to users.
Book-keeping is only recording; accounting goes further to summarising and interpreting.
Accrual basis: transactions are recognised when they occur, not when cash is received or paid.
Going concern: the business is assumed to continue, so assets are not valued as if it will close soon.
Consistency: follow the same accounting policies from period to period unless there is a good reason to change.
Prudence: do not anticipate profits, but provide for all likely losses.
Materiality: record items that matter to users; trivial items can be treated simply.
Business entity concept: the business and its owner are separate for accounting purposes.
Money measurement: only transactions that can be expressed in money are recorded.
Personal account: debit the receiver, credit the giver. Real account: debit what comes in, credit what goes out. Nominal account: debit expenses and losses, credit incomes and gains.
Assets = Liabilities + Capital is the basic accounting equation.
AS 1 says accounting policies should give a true and fair view of the state of affairs and the profit or loss.

Common mistakes

Writing that accounting records every event of the business. Fix: State clearly that events like a change in staff morale are not recorded because they cannot be measured in rupees.
Mixing up internal and external users. Fix: Ask whether the user runs the business. Owners and management are internal. Lenders, creditors, investors, tax authorities and the public are external.
Saying book-keeping and accounting are the same thing. Fix: Remember that book-keeping only records. Accounting also summarises and interprets.
Writing that management accounting is compulsory by law in a fixed format. Fix: Management accounting has no fixed format. It is designed to meet management's own needs.
Treating the owner and the business as one when the owner withdraws money. Fix: Remember accounting treats the business as separate. The owner's withdrawal is drawings and reduces capital.
Confusing accrual with matching. Fix: Accrual decides when an item is recorded, on earning or incurring. Matching links expenses to the revenue of the same period.
Treating accrual basis as recording only cash transactions. Fix: Remember accrual records effects when they occur, not when cash is received or paid (Framework para 22).
Putting drawings or outstanding expenses on the wrong side of the equation. Fix: Drawings reduce capital. Outstanding expenses are liabilities.
Treating drawings as an expense and debiting it to the profit and loss account Fix: Drawings reduce the owner's capital. They are not an expense and do not affect profit.
Calling outstanding rent or rent received in advance a nominal account only Fix: The expense or income part is nominal. The amount owed or received in advance is a liability, so it is shown as a personal account.

Exam tips

For a 'define and explain' question, always give the process chain in the definition. It scores the definition mark quickly.
Use the internal and external split whenever users are asked. Add one need for each user group to earn full marks.
In limitations, include at least one point on money measurement and one on historical cost.
Quote Framework ideas in your own words, for example accrual basis and materiality, to show depth.
Keep one line of reasoning per point rather than a long paragraph, as examiners scan for distinct points.
Prepare a difference table in your head with the bases: meaning, purpose, users, time and format. Written answers get marks for each point.
In MCQs, look for clue words: outsiders and statements point to financial, cost per unit points to cost, budget or decision points to management.
Keep a one-line definition ready for each branch. Short questions often ask only for the meaning.