A business does hundreds of things a month — buys, sells, pays, borrows, collects. At the end of the year somebody has to answer two questions: did it make a profit, and what is it worth. Accounting is the discipline of recording each transaction at the time it happens, in a form that lets both questions be answered later without relying on anyone’s memory.
The order is always the same, and every later unit of this course is one step of it:
transaction → journal → ledger → trial balance → final accounts
Unit 2 does the journal and the ledger, Unit 3 the subsidiary books that shorten the journal, Unit 4 the reconciliation that proves the bank figure, and Unit 5 the trial balance and the final accounts. Units 2, 4 and 5 use the same firm and the same rupees, so you can watch one set of numbers survive the whole cycle; Unit 3 uses small examples of its own for the subsidiary books.
These readers do not share the owner’s knowledge of the business, which is exactly why the concepts and conventions below exist: they make one firm’s accounts comparable with another’s, and with its own accounts last year.
Everything a business controls was funded by somebody — either the owner or an outsider. That is the whole of the equation:
\[ \text{Assets} \;=\; \text{Liabilities} \;+\; \text{Capital} \]Write it with the owner isolated and it says what the owner’s stake actually is:
\[ \text{Capital} \;=\; \text{Assets} \;-\; \text{Liabilities} \]and over a year the owner’s stake moves for exactly four reasons:
\[ \text{Closing capital} = \text{Opening capital} + \text{Profit} + \text{Fresh capital} - \text{Drawings} \]Take four transactions of a new firm and watch both sides after each one. Assets are listed in full so nothing hides.
| Transaction | Effect | Assets | = | Liabilities + Capital |
|---|---|---|---|---|
| Owner brings in 2,00,000 cash | Cash up, capital up | Cash 2,00,000 | = | Capital 2,00,000 |
| Buys furniture for 25,000 cash | One asset becomes another | Cash 1,75,000 + Furniture 25,000 | = | Capital 2,00,000 |
| Buys goods on credit 60,000 | Asset up, liability up | Cash 1,75,000 + Furniture 25,000 + Stock 60,000 | = | Creditors 60,000 + Capital 2,00,000 |
| Pays creditor 40,000 | Asset down, liability down | Cash 1,35,000 + Furniture 25,000 + Stock 60,000 | = | Creditors 20,000 + Capital 2,00,000 |
Check the last row: assets are 1,35,000 + 25,000 + 60,000 = 2,20,000, and the right side is 20,000 + 2,00,000 = 2,20,000. They agree, as they must. If a transaction appears to break the equation, one of its two sides has been missed — that is the whole diagnostic, and it is what double entry mechanises.
| Concept | What it assumes | What would go wrong without it |
|---|---|---|
| Business entity | The firm is separate from its owner. | The owner’s house and the firm’s godown would sit in one balance sheet and neither profit nor net worth would mean anything. |
| Money measurement | Only what can be expressed in money is recorded. | Staff skill and a good location matter, but with no price they cannot be added up — so accounts are silent about them, and a reader should know that. |
| Going concern | The firm will continue long enough to use up its assets. | Every asset would have to be shown at what it would fetch today, so depreciation over a useful life would make no sense. |
| Cost | Assets are recorded at what was paid, not what they are now worth. | Values would be re-estimated at will, and the accounts would stop being verifiable. |
| Dual aspect | Every transaction has two sides. | Double entry, and with it the arithmetic check of the trial balance, would not exist. |
| Accounting period | Life is cut into equal periods. | Profit could only be measured when the firm closed, which is too late to be useful. |
| Matching | Expenses are set against the revenue they earned, in the same period. | Buying two years of stock would look like a catastrophic year, and selling it a miraculous one. |
| Realisation | Revenue is recognised when the sale is made, not when cash arrives. | A firm could inflate this year’s profit by collecting old debts early. |
| Accrual | Income and expense belong to the period they relate to. | Rent for March paid in April would land in the wrong year. |
Conservatism and full disclosure pull against each other and examiners like that tension: conservatism understates, disclosure insists the understatement be visible.
| Type | What it covers | The rule |
|---|---|---|
| Personal | Persons and organisations — Mehta & Co., Suresh, a bank, a firm. | Debit the receiver, credit the giver. |
| Real | Assets — cash, furniture, stock, machinery. | Debit what comes in, credit what goes out. |
| Nominal | Expenses, losses, incomes and gains — rent, wages, commission. | Debit all expenses and losses, credit all incomes and gains. |
Group the five elements instead and a single sentence covers everything:
| Element | Increase | Decrease |
|---|---|---|
| Asset | Debit | Credit |
| Expense | Debit | Credit |
| Liability | Credit | Debit |
| Capital | Credit | Debit |
| Income | Credit | Debit |
Assets and expenses behave one way; liabilities, capital and income behave the other. Both systems give identical entries — use whichever you can apply without hesitating, because in an objective paper the hesitation is what costs you.
For each one: name the two accounts, classify each, apply the rule. The transactions are the opening six of the firm whose books run through Units 2 to 5.
| Transaction | Accounts involved | Type | Debit | Credit |
|---|---|---|---|---|
| Started business with cash 2,00,000 | Cash; Capital | Real; Personal | Cash (comes in) | Capital (giver) |
| Opened a bank account with 1,20,000 | Bank; Cash | Personal; Real | Bank (receiver) | Cash (goes out) |
| Bought furniture 25,000 by cheque | Furniture; Bank | Real; Personal | Furniture (comes in) | Bank (giver) |
| Bought goods on credit 60,000 | Purchases; Mehta & Co. | Nominal; Personal | Purchases (expense) | Mehta & Co. (giver) |
| Sold goods on credit 48,000 | Suresh; Sales | Personal; Nominal | Suresh (receiver) | Sales (income) |
| Paid salaries 9,000 in cash | Salaries; Cash | Nominal; Real | Salaries (expense) | Cash (goes out) |
Note the fourth row. Goods bought for resale are debited to Purchases, a nominal account, not to a “Goods” asset account. That is a convention of the trading business and it is what makes the trading account of Unit 5 work. Furniture, bought to keep and use, is an asset. The same rupees, a different account, because the intention differs.