Lalit Kumar

Assistant Professor in
Finance Management,
HIPA,Ggn.
Fundamentals of Accounting-Understanding five
heads

Five Elements of Accounting

The elements directly

related to financial position
(balance sheet):
Assets =

Liabilities
Equity/Capital

The elements directly

related to performance
(income statement).
Income
Expenses

Fundamentals of Accounting-Understanding five

heads

 The Basic Accounting Elements:

Asset

Liability

Expense

Revenue

Fundamentals of AccountingUnderstanding five heads

Owners
Equity

Accounting is a game
Assets

Liablitie
s

Capital
Fundamentals of Accounting-Understanding five
heads

 A financial transaction can effect five major elements of

accounting : Assets, Capital, Liabilities, Income and

Expenses.
Assets: An asset is defined as resources controlled by the
enterprise and from which economic benefits are expected
to flow to the enterprise; such as Cash, Bank balance,
Machinery, Plant, Furniture, Goods, Building and others
which can be converted into cash.

Fundamentals of Accounting-Understanding five

heads

 Liabilities: liabilities are amounts which the entity owes

other businesses or individuals; such as Bank loans,

creditors, Bills payable, Debenture and others which can
lead 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 owners
capital.

Fundamentals of Accounting-Understanding five

heads

 Income: Income is a broad term but covers all transactions

which will result in gross inflow of benefits to the

enterprise. Such as sales, commission received, Rent
received etc.
Expenses: : Expenses are gross outflow of economic
benefits arising in ordinary course of business such as
Wages, Salaries, factory rent paid etc.
Net Profit=Incomes-Expenses
Net profit added to the capital at the end of year.

Fundamentals of Accounting-Understanding five

heads

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 company

Revenue
Increase in economic resources resulting from normal

operations of the company

Expense
Decrease in economic resources resulting from normal

operations of the company

Fundamentals of AccountingUnderstanding five heads

Element structures
Assets
Current assets
Cash

Cash on hand
Bank accounts

Accounts receivable

Accounts receivable customer 1

Accounts receivable customer 2

Inventory
Raw materials
Work in process
Finished goods
Product 1
Product 2
Fundamentals of Accounting-Understanding five
heads

Element structures
Assets
Current assets
Long-term assets
Buildings
Vehicles
Cars
Trucks

Fundamentals of Accounting-Understanding five

heads

Element structures
Liabilities
Current liabilities
Accounts payable
Accrued liabilities

Long-term liabilities
Bank loans
Loan from RBI
Loan from Private banks
Notes payable
Bonds payable
Fundamentals of Accounting-Understanding five
heads

Element structures
Owners equity
Capital stock (direct investment)
Retained earnings (indirect investment)
Revenue
Expenses
(Dividends)

Fundamentals of Accounting-Understanding five

heads

Element structures
The balance sheet is a permanent statement
Its accounts accumulate information from the entitys

beginning.

The amounts presented on the balance sheet are aggregated from the
entitys 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 the
beginning of the period to the end of the period only.
Fundamentals of Accounting-Understanding five
heads

Element structures
The Closing Entry
Whenever financial statements are to be prepared, the
temporary (income statement) accounts must be closed
to zero so that they can begin tracking data for the next
period.
The amounts in the accounts at closing are transferred to

Retained Earnings (so named because it is the earnings (net

income) of the company that is retained in the company and
not distributed to the owners).

We will see an example in the comprehensive example.

Fundamentals of Accounting-Understanding five

heads

Element structures
The Closing Entry
The result of the closing entry is that all impacts on
Revenue and Expenses (the temporary accounts) are
indirectly impacts on Retained earnings (a permanent
account).
That is how A = L + OE stays in balance.

The temporary accounts are sub-pieces of OE.

Fundamentals of Accounting-Understanding five

heads

 Going back to the Fundamental Accounting Equation:

Assets = Liabilities + Owners Equity

Debit
Assets
Current assets
Long-term assets

Credit
Liabilities
Current liabilities
Long-term liabilities

Fundamentals of AccountingUnderstanding five heads

Credit
Direct investment
Capital stock
Indirect investment
Dividends (debit)
Retained earnings
Revenue (credit)
Expense (debit)

Financial Statements
There are 2 statements in a standard set of financial
statements
1.

Balance Sheet

2.

The what do we have? statement

Shows what the entity owns and owes (the difference being the
owners residual interest)

Income Statement

The what did we do? statement

Shows the activity the entity undertook in its normal course of
operations.

Fundamentals of Accounting-Understanding five

heads

Company Name
Income statement
For year ended December 31, 2003

Financial Statements
Revenue

100,000

Expenses
Salaries
Utilities
Rent
Other

45,000
13,000
30,000
8,000
-

Net Income

Company Name
Statement of Retained Earnings
For year ended December 31, 2003

Closing Retained Earnings

Assets
Current assets
Long-term assets

3,000
40,000

Total Assets

43,000

96,000
4,000

Opening Retained Earnings

Net Income (Loss)
Dividends

Company Name
Balance Steet
As at December 31, 2003

Liabilities
Current liabilities
Long-term liabilities
Owners' Equity
Capital stock
Retained Earnings

3,500
4,000
500

15,000
20,000
35,000
1,000
7,000
8,000

Total Liabilities and OE

7,000

Fundamentals of Accounting-Understanding five

heads

43,000

Company Name
Income statement
For year ended December 31, 2003

Financial Statements
Revenue

100,000

Expenses
Salaries
Utilities
Rent
Other

45,000
13,000
30,000
8,000
-

Net Income

Company Name
Statement of Retained Earnings
For year ended December 31, 2003

Closing Retained Earnings

Assets
Current assets
Long-term assets

3,000
40,000

Total Assets

43,000

96,000
4,000

Opening Retained Earnings

Net Income (Loss)
Dividends

Company Name
Balance Steet
As at December 31, 2003

Liabilities
Current liabilities
Long-term liabilities
Owners' Equity
Capital stock
Retained Earnings

3,500
4,000
500

15,000
20,000
35,000
1,000
7,000
8,000

Total Liabilities and OE

7,000

Fundamentals of Accounting-Understanding five

heads

43,000

Financial Statements
Company Name
Income statement
For year ended December 31, 2003

Company Name
Balance Steet
As at December 31, 2003

Revenue

100,000

Expenses
Salaries
Utilities
Rent
Other

45,000
13,000
30,000
8,000
-

Net Income

Company Name
Statement of Retained Earnings
For year ended December 31, 2003

Closing Retained Earnings

3,000
40,000

Total Assets

43,000

96,000
4,000

Opening Retained Earnings

Net Income (Loss)
Dividends

Assets
Current assets
Long-term assets

Liabilities
Current liabilities
Long-term liabilities
Owners' Equity
Capital stock
Retained Earnings

3,500
4,000
500

15,000
20,000
35,000
1,000
7,000
8,000

Total Liabilities and OE

7,000

Fundamentals of Accounting-Understanding five

heads

43,000

Fundamentals of Accounting-Understanding five

heads

Fundamentals of Accounting-Understanding five

heads

Fundamentals of Accounting-Understanding five

heads

Fundamentals of Accounting-Understanding five

heads

To Balance Sheet

Fundamentals of Accounting-Understanding five

heads

From Statement of
Retained Earnings