An Introduction to Accounting (Grade 11 NSC Matric Accounting): Revision Notes

An Introduction to Accounting

Basic principles of accounting

Every business operates with the primary goal of generating profit. To achieve this, the business needs to acquire resources (called assets) that will help it earn income through its operations. The money needed to purchase these assets comes from two main sources: the owners themselves (known as owner's equity) or from external sources such as loans (known as liabilities).

This relationship between what the business owns and where the money came from is expressed in the accounting equation:

$\text{ASSETS} = \text{OWNER'S EQUITY} + \text{LIABILITIES}$

Or simply: $A = OE + L$

Business owners and managers need a way to track whether their operations are generating profit or loss during a specific period. This is where accounting becomes essential. Accounting organises and presents financial information in a structured, standardised format. This standardisation is crucial because it ensures that every business presents its information in the same way, making it easier to understand, analyse, and compare results across different periods. This consistency helps owners make informed decisions about their business.

GAAP concepts

The Generally Accepted Accounting Principles (GAAP) provide guidelines that ensure accounting information is recorded in a consistent and reliable manner. These principles help accountants decide how to handle different situations. Six key concepts form the foundation of accounting practice:

Historical cost concept

When a business purchases an asset, it records that asset at its purchase price and maintains this value in the records. Even if the market value of the asset increases or decreases over time, the recorded value remains at the original cost. This provides consistency and reliability in financial records.

Prudence concept

Sometimes a transaction can be recorded in more than one way. The prudence concept guides accountants to choose the more conservative option - the one that is less likely to overstate profits or assets. This prevents businesses from appearing more successful than they actually are.

Materiality concept

Not every small detail needs to follow strict accounting rules. If an amount or transaction is so small that it would make no meaningful difference to the financial statements, accountants can ignore certain principles. This concept helps accountants focus on what truly matters.

Business entity concept

The business is treated as a separate entity from its owner. This means the business's financial transactions must be kept completely separate from the owner's personal transactions. For example, if the owner buys groceries for their family, this should not appear in the business records.

Going concern concept

When recording transactions, accountants assume that the business will continue operating into the future. The business is expected to continue pursuing its goals rather than closing down. This affects how assets and liabilities are valued.

Matching concept

Expenses incurred to generate income must be recorded in the same period as the income they helped to earn. For example, if you sell goods in March, the cost of those goods should also be recorded in March, even if you paid for them in February. This gives a true picture of profit for each period.

Additional GAAP concepts

Two other important concepts complement these six principles:

Consistency concept: A business should use the same accounting methods from one period to the next. This allows for meaningful comparisons over time.

Accrual basis: Income and expenses are recorded based on when they are earned or incurred, not when cash actually changes hands. This means revenue is recorded when earned, and expenses are recorded when used, regardless of payment timing.

Accounting cycle

The accounting cycle represents the journey of financial information from when a transaction occurs to when it appears in the final financial statements. Every business, regardless of size, follows this same cycle:

$\text{Transactions} \rightarrow \text{Source documents} \rightarrow \text{Subsidiary journals} \rightarrow \text{Posting to ledgers} \rightarrow \text{Trial Balance} \rightarrow \text{Final accounts and financial statements}$

Source documents

Source documents provide evidence that a transaction actually occurred. They contain all the necessary details about each transaction. Without source documents, there would be no proof of business activities. The business collects similar types of transactions and records them in specific journals, making it easier to transfer information to the ledger accounts later.

Here are the common transactions, their source documents, and the journals used:

Transaction	Source document	Subsidiary journal
All money received	Duplicate receipt, Cash register roll, Duplicate deposit slip, EFT/Direct deposit, Credits on bank statement	Cash Receipts Journal (CRJ)
All payments made	Cheque counterfoil (Cheques issued), EFT (Electronic funds transfer), Debits on bank statement	Cash Payments Journal (CPJ)
All payments from petty cash	Petty cash voucher	Petty Cash Journal (PCJ)
Credit sales of merchandise	Duplicate invoice (Invoices issued)	Debtors Journal (DJ)
Returns by debtors or allowances to debtors	Original credit note (Credit note issued)	Debtors Allowances Journal (DAJ)
Credit purchases of merchandise and other assets and services rendered to us on credit	Original invoice (Invoices received)	Creditors Journal (CJ)
Returns to creditors or allowances received	Original debit note (Debit note issued)	Creditors Allowances Journal (CAJ)
Transactions that do not belong in other journals	Journal narration or Journal voucher	General Journal (GJ)
Calculation of salaries and wages	Staff register and contracts	Salaries Journal (SJ), Wages Journal (WJ)

Subsidiary journals and ledger accounts

The subsidiary journals on their own don't provide enough information to calculate profit or loss. The information needs to be transferred (posted) to ledger accounts. Ledger accounts track all changes in the value of assets, liabilities, owner's equity, income, and expenses.

Double entry system

Businesses use the double entry system to record information in ledger accounts. This system is fundamental to accounting. Every transaction affects at least two accounts: if you debit one account, you must credit another account. This keeps the accounting equation in balance.

Entries are made in T-accounts, which look like the letter T:

                Account name
    Debit side  |  Credit side
       (Dr)     |     (Cr)

Debit entries are made on the left side of the T-account, while credit entries are made on the right side.

Accounting equation and debit/credit rules

The accounting equation helps you determine which side of an account to use when recording a transaction. Understanding this is crucial for accurate bookkeeping.

$\text{ASSETS} = \text{OWNER'S EQUITY} + \text{LIABILITIES}$

Each component of the equation has natural positions:

Assets:

• Increase on the Debit side (left)
• Decrease on the Credit side (right)

Owner's Equity:

• Decrease on the Debit side (left)
• Increase on the Credit side (right)

Liabilities:

• Decrease on the Debit side (left)
• Increase on the Credit side (right)

Understanding owner's equity

Owner's equity represents the owner's interest or stake in the business - essentially, what the business owes to the owner. Since the main goal of any business is to generate profit, and owners typically provide most of the funding and take the risk, they are entitled to the profits earned. The business calculates profit in two stages:

$\text{Gross profit} = (\text{Sales} - \text{Debtors allowances}) - \text{Cost of sales}$

$\text{Net profit} = \text{Gross profit} + \text{Income} - \text{Expenses}$

Effect on owner's equity

Income and expenses don't directly appear in the owner's equity account, but they affect it through profit:

• Sales and Income increase profit, which increases owner's equity
• Cost of sales and Expenses decrease profit, which decreases owner's equity

Summary of ledger entries

This table shows which side to use when recording increases or decreases:

Account type	Account to debit	Account to credit
Assets	Increase	Decrease
Owner's equity	Decrease	Increase
Income/Sales/Profit	Decrease	Increase
Expenses/Cost of sales/Loss	Increase	Decrease
Liabilities	Decrease	Increase

General ledger sections

The General Ledger organises accounts into two main sections, each serving a specific purpose:

Section	Accounts	Purpose
Balance Sheet accounts section	Capital, Drawings, Assets, Liabilities	To determine the financial position of the business in the financial statements (Balance Sheet)
Nominal accounts section	Sales, Cost of sales, Income, Expenses	To determine the result of operations (profit or loss) in the financial statements (Income Statement)

Trial balance

A Trial Balance is a list of all General Ledger accounts showing their balances at a specific point in time. It proves that the total of all debit balances equals the total of all credit balances. When you prepare the Trial Balance, the accounts appear in the same sections and order as in the General Ledger.

The Trial Balance serves as a checkpoint at the end of an accounting period. After making certain adjustments to the figures, accountants use the Trial Balance information to prepare the financial statements. These statements show two critical pieces of information: the results of operations (profit or loss in the Income Statement) and the financial position of the business (shown in the Balance Sheet).

Forms of ownership

The accounting cycle, accounting equation, and basic principles apply to all businesses regardless of their ownership structure. Whether a business is a sole trader, partnership, or company, the fundamental accounting processes remain the same. Owners are always entitled to the profit, and owner's equity always represents the business's obligation to the owner(s).

The main differences between ownership forms lie in how profit is distributed and how owner's equity is structured:

Form of ownership	Structure of owner's equity
Sole trader	Capital + Net profit - Drawings
Partnership	Capital, Current accounts of partners (Earnings - Drawings)

Financial statements

Businesses need to organise the information from their many transactions in a way that makes sense to different users - owners, managers, potential investors, banks, and suppliers. Financial statements present the transactions for a specific financial year (usually 12 months) in a standardised, meaningful format.

The financial statements tell the 'story' of the business for that year. They enable owners and other stakeholders to analyse the performance of the business and make informed decisions. For example, a bank might use financial statements to decide whether to grant a loan, while an owner might use them to decide whether to expand the business or reduce expenses.

The two main financial statements work together to provide a complete picture:

• The Income Statement shows whether the business made a profit or loss during the period
• The Balance Sheet shows what the business owns and owes at a specific point in time

Together, these statements help answer critical questions: Is the business profitable? Can it pay its debts? Is it growing? These insights are essential for sound business decisions.