1. Business Entity:
organizations are known as businesses. There are
three main types of businesses; those selling
services (such as dry cleaners, motor workshops,
beauty salons, airlines etc.); those selling goods
(such as food sellers, automobile dealers etc.);
those manufacturing goods (such as automobile
manufacturers, fans industries, sugar mills etc.).
A business entity
is an economic unit which enters into business
transactions that must be recorded, summarized and
reported. The entity (organization) is regarded as
separate from its owner or owners; the entity owns
its own property and has its own debts. The purpose
of accounting is to provide useful information about
an organization (an entity) to people who need such
information but not about the personal affairs of
the owner or owners. So it should be remembered that
accounting is done for business activities (what is
happening in the business organization) and it is
not concerned with the personal or private matters
of the owner. For example, the owner purchases
furniture for business use (this is a business
activity and it should be recorded in books of
accounts. But if he purchases furniture for his
domestic use, it will not be considered as a
business activity and will not be recorded in books
of accounts. In the same way, the owner may have a
personal bank account, a car, a house, and other
property, but since these things are not a part of
the business, they are not included in the record of
the business unit. So, each organization for which
accounting is done is an independent entity,
separate from its owners, managers, customers,
creditors, and all other persons and entities with
which it deals.
Forms of Business Organizations
There are three
main forms of business organization;
(a) Single or
The simplest form
of business organization "to organize and operate"
is a single or sole proprietorship. This is the most
common form of ownership and is found in business
such as small retail shops, service stations etc.
The owner is the only one in control and makes all
In a partnership,
ownership is divided between two or more persons who
agree to share their property and skills to start
and-operate a business. Like the single
proprietorship, a partnership business is simple to
(c) Joint Stock
A joint stock company has the legal right to act as person. It
may be owned by many people. A company has its own
name, in which it can buy, own, and sell property;
make contracts; borrow money; and take court action.
The persons who have made investment in the company
are known as shareholders.
2. Goods or Merchandise
In accounting the
word "Goods" has a special meaning. It refers to
something which has been purchased by a trader for
resale purposes or anything which has been
manufactured for selling purposes. For example, if a
trader purchases furniture for use in the business,
it will not be regarded as "goods", but if it is
purchased for resale, it will be regarded as
"goods". The same article may be "goods" for one
trader but may not be so to another trader. For
example, furniture is not "goods" for a book seller;
but it will be regarded as "goods" to a
Cloth will be
"goods" to a cloth dealer
Watches will be
"goods" to a Watch dealer
Books will be
"goods" to a Book - Seller
Stationery will be
"goods" to a Stationery dealer.
But watches, books
or stationery will not be considered as "goods" to a
language the word "Purchases" has a special meaning.
When saleable goods are bought in a business, it is
said that "purchases" have been made. For example,
to a cloth dealer, whenever cloth is purchased, it
will not be necessary to mention that cloth has been
purchased. simply it will be said that purchases
have been made. On the other hand, if stationery is
purchased, then it will be essential to mention that
stationery has been purchased.
4. Cash Purchases:
If goods are
purchased from, a supplier and payment is made to
him at the same time, such purchases are known as
"Cash Purchases". For example, Mr. X purchased goods
from a seller, Mr. Y, for $5000 on 1st January,
2005, and payment is made to the seller (Mr. Y) at
the same date (1.1.2005), it will be a case of cash
5. Credit Purchases or "Purchases on Account":
When goods are
purchased from a seller and payment is not made to
him at the same time, rather the payment is arranged
to be made at some future date, such purchases are
known as "credit purchases" or "Purchases on
account". For example, Mr. A purchased goods from
Mr. B for $5000 on 1st January, 2005 and Mr. A
agreed to make the payment of goods on 15th January,
2005 (payment has not been made on 1.1.2005), it
will be a case of credit purchases. On 15th January
Mr. A will pay $5000 to Mr. B.
6. Purchases Returns or Returns Outwards:
purchased may subsequently be sent back to the
seller for certain reasons, i.e. goods are
defective, not according to specification, damaged
or below standard. Such return of goods to the
seller is known as "Purchases returns" or "Returns
to suppliers". For example, we purchased 100 radio
sets (goods) from Five Star Electronics for $15000.
On receiving the delivery of goods, it is found that
10 radio sets are of inferior quality. The return of
these 10 radio sets to the seller (Five Star
Electronics) will be a case of purchases returns for
7. Purchases Discount and Sales Discount:
given by the supplier to the buyer on purchases of
goods is known as "Purchases discount" to the buyer
and "Sales discount" to the seller (supplier).
customers (buyers) find that goods purchased have
minor defects. In that case, the seller may agree to
reduce the price of damaged or defective goods to
induce the buyer to keep the goods. Such reduction
in price is known as "Purchases allowance" to the
buyer and "Sales allowance" to the seller.
We know that goods
are purchased for selling purposes. When these goods
are sold to customers at a specific price, it is
said that sales have been made. For example, we
purchased goods worth $5000 (our purchases).
Suppose, these goods have been sold at a price of
$6000 - in accounting language it will be said that
sales have been made at $6000. So goods sold are
10. Cash Sales:
If goods are sold
to customers at a specific price and price of the
goods is received from them at the time of sale of
goods, such sales are known as "Cash sales". For
example, we sold goods to a customer, Mr. A for
$2000 on 10th January, 2005 and received the cash
from him on the same date, it will be a case of cash
11. Credit Sales:
If goods are sold
to a customer and he does not pay the price of goods
at the same time but agrees to make payment on some
future date, the sales are called "credit sales" or
"sales on account." For example, we sold goods to
Mr. X for $3000 on 15th January, 2005 and he agreed
to make payment on 31st January, 2005, it will be a
case of credit sales or sales on account.
12. Sales Returns or Returns Inwards:
If a customer to
whom goods have been sold finds that the goods are
defective, unsatisfactory, below standard or not
according to specification, he may return these
goods to the seller. To the seller, such return of
goods is known as "sales returns" or "returns
inwards" or "returns from customers.
13. Trade Discount:
At the time of
selling goods, the manufacturer or wholesaler allows
retailers such a discount (concession). It is
allowed at a certain percentage of the listed or
catalogue price. For example, the list price of the
goods is $30,000, and the wholesaler allows a trade
discount of 10% on the listed price to the retailer.
It means that net price of the goods is 27,000
(30,000 - 3,000). The trade discount enables the
retailer to sell goods at the listed price; and the
customer can be sure about the fair price of the
goods. It may be noted that both the buyer and
seller will record $27,000 (not $30,000) in their
books of account. In other words trade discount is
not recorded in books of account. Thus, discount
allowed by manufacturer or wholesaler at the time of
selling goods to retailer as a deduction from the
listed price or catalogue price, is called trade
14. Debtors or Accounts Receivable:
When goods are sold
to the customers on credit basis (credit sales are
made to customers), debtors come into existence.
Debtors are the persons or customers to whom goods
have been sold on credit basis and from whom the
business is to receive money in near future. The
accounts of such customers are known as "Accounts
Receivable". For example, we sold goods to A for
$3,000, to B for $2,000 and to C for $4,000 on credit
basis. The amount receivable from them (A, B and C)
is known as "Debts" and the three customers, A, B
and C are our debtors or accounts receivable.
15. Creditors or Accounts Payable:
When goods are
purchased from the suppliers (sellers) on credit
basis, creditors come into existence. Creditors are
the persons or suppliers from whom goods have been
purchased on credit basis and to whom the money is
to be paid in near future. The accounts of such
persons (suppliers) are known as "accounts payable".
Accounts payable means, the amount which a business
expects to pay to its suppliers for goods purchased
or services received from them on credit basis.
The person or business who will receive the money -
The person or business who will pay the
16. Cash Discount:
It is a deduction
or allowance given by a creditor to a debtor if the
amount due is paid by the debtor before the due
date, or it is a reduction in price (usually 2% or
less) offered by manufacturers or wholesalers
(creditors) to encourage customers (debtors) to pay
their debts within a specified discounted period.
For example, X sold goods to Y (a customer) for
$1,000 on credit basis. It means, X is creditor and Y
is debtor. X offers an allowance of 2% to Y, if he
will pay his debts within 15 days. It means, if Y
pays his debts within 15 days, then he will pay only
$980 (1,000 - 20) to X. Such a discount is known as
17. Capital or Owner's Equity:
To understand this
term, recall that business is an entity
(organization) separate from its owner or owners.
Equities mean the sources of funds provided to start
or to operate a business entity. Now the question
is: who provides funds to a business unit. Mainly
there are two sources of funds:
- Funds supplied
by the owner/owners.
- Funds supplied
by the external parties like bank etc.
So, the amount of
cash or goods invested (supplied) by the
owner/owners in a business unit is known as
"capital" or owner's equity.
Capital is the
money or moneys worth borrowed by a business unit
from its owner or owners.
It is the claim or
right of the owner/owners against the assets
(properties etc. possessed by business) of the
It is the source of
funds provided by the owner/owners of the business.
It is a part of the
total equity which is supplied by the owner/owners.
For example, Mr. X
started a business with $100,000. Out of $100,000,
$70000 have been provided by, the owner, X and
$30,000 have been borrowed from a bank. Now, the
equity (total funds) of the business is $100,000 but
owner's equity (capital) of the business is $70,000
(1,00,000 - 30,000).
Assets are the
economic resources (having certain value) owned by a
business on a particular date and which are expected
to benefit the future operation of the business.
Assets are the
properties and possessions of a business both
tangible (have physical existence) and intangible
(have no physical existence).
Assets are the
things having certain value possessed by a business
and receivable by a business on a particular date.
For example, cash, furniture, building, land,
machinery, stock of goods, Debtors or Accounts
receivable, Bank balance, Goodwill etc.
Liabilities are the
debts or obligations of a business.
(creditors etc.) claims against the assets of the
business are known as "Liabilities". There are two
main parties who have claims against the assets of a
- (a) Owner's claim
- (b) Outsiders' claims.
The owner's claim against the assets of a business
is known as owner's equity and outsider's claims
against the assets of the business are known as
the total amount which a business is legally bound
to pay to the outsiders, e.g. creditors, Bills
payable, Accounts payable, Bank loan etc.
20. Accounting Period:
It is a span of
time for which a business generally prepares its
financial statements (the statement prepared to know
the profit or loss of a business and to know its
financial position). Mostly the financial reports
are prepared for one year but they may also be
prepared for one month or for one quarter.
organizations are engaged in providing goods or
services to their customers. The amount which a
business charges its customers for these goods or
services, measures the revenue of the business.
It is the price of
goods sold or services provided by a business to its
Revenue is the
inflow of assets (cash or debtors) in return for
services performed or goods delivered (sold) during
an accounting period.
It is inflow of
cash and debtors (receivable) in exchange for goods
sold or services rendered during an accounting
For example, we
sold goods to a customer for $1,000 and he paid cash
to us $1,000. The revenue will be equal to inflow of
cash $1,000. But if the customer has paid only $500
and he agreed to pay the remaining amounts at some
future date, again in that case the revenue will be
equal to $1,000 (inflow of cash $500 + $500
Revenue has the following types.
1. Sales: The total
price of goods sold
2. Interest earned
3. Fees earned
4. Rent earned
5. Commission earned
Expenses are the
costs of the goods and services used up in the
process of obtaining revenue.
Expenses are the
cost of producing revenue in a particular accounting
An expense is a
sacrifice, or cost incurred to generate revenue.
salaries for employees, telephone charges, rent of
the building, insurance and transportation etc. All
these costs are necessary to attract and serve the
customers and thereby to obtain revenue. Expenses
are sometimes also referred to as the "cost of doing
business" or "expired costs".
23. Net Income or Profit:
Net income or net
profit is simply the amount by which the "revenue"
for a particular period of time exceeds the
"expenses" incurred to generate them.
income or net profit = Revenue - Expenses