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Introduction to the basics of accounting

The most fundamental rule of accounting is that every debit has an equal and corresponding credit. Therefore, every transaction has a debit and credit component, which are equal. When all the accounts of a business are presented together (i.e. debit balances and credit balances are independently aggregated, the net balance will be nil (because aggregate of debit balances will be equal to aggregate of credit balances. This is also called the double-entry method of accounting which forms the core of record keeping.

Fundamentally, the golden rules of accounting are as follows:


Nature of Account


Personal: representing persons or organizations

Ravindra Shah A/c

Real: representing assets /liabilities

Furniture A/c, Cash A/C, Bank A/C

Nominal: representing expenses/losses/gains/incomes

Salaries A/c, Electricity A/C, Interest A/C


In India, the rules of accounting are laid down by the Institute of Chartered Accountants of India in collaboration with Ministry of Corporate Affairs, Government of India. To make Indian companies at par with the globalized accounting environment, the Ministry has adopted the accounting standards prevalent in other countries which are known as Indian Accounting Standards. Presently, there are about 35 Indian Accounting Standards which are applicable to different types of companies. These Accounting Standards are recognized by the Companies Act, 1956 under Section 211 (3A).


Meaning of accounting and record keeping

Accounting is a method of recording activities of business and the transactions that take place in business operations. Accounting presents the financial state and health of a business in a nutshell. Entrepreneurs do not need to possess detailed knowledge of accounting, though it can be a significant advantage to know basics of the accounting process and their legal responsibilities with respect to accounting statements prepared for their business. They should also develop a basic ability to read and understand financial statements. Of course, the way in which an entrepreneur should understand or use financial statements of his business is very different from the way in which a financial analyst or a Chartered Accountant interprets or uses them.

This module will introduce business accounting as a process to beginners. Teaching how to comprehend financial statements is outside the scope of this module. Those of you who want to learn about those topics are encouraged to read an accounting textbook for the same.


In this section, we would begin with why accounting is crucial for business persons and decision makers in the corporate world. Please note that some of you may have knowledge about some of these topics already if you have studied accounting in school or college, in which case feel free to skip the parts that you already know. There would be certain legal aspects which you would still need to learn, so do not give this a complete miss.

Need and use of accounting

Accounting is useful for the following purposes:

1.Record of business transactions: Due to the multiplicity and complexity of most business transactions, keeping a record of them is very important. Accounting is useful in keeping such records of business transactions.

2.Attracting capital and loans:

Accounting is useful for a business to attract capital (from investors - venture capitalists, private equity investors, etc.). Investors and banks/ financial institutions rely on the financial statements of a business to determine value of a business and before investing or giving a loan they would want to be sure that you have proper accounting procedures. Further, businesses are often required to provide financial projections to investors periodically which requires an understanding of accounting.

3. Providing Information:

Accounting helps in providing financial information about the business to various stakeholders – such as managers, shareholders, customers and even regulators.

4. Making internal decisions:

Accounting helps the management to make decisions related to costs, inventories, work-force, etc.

5. Knowledge of cash flows:

Knowledge of cash flows is important for a business for two reasons – (i) every business must have a revenue model, and cash flows are extremely important in assessing the viability of a revenue model, (ii) every business must have sufficient cash flows to make its short term payments and liabilities, else it will be suffering from a liquidity crunch. Note that under Indian law, non-payment of debts and liabilities is also a ground for winding up (in other words, shutting down of a business due to bankruptcy) of a limited liability partnership (LLP) or a company, if they exceed Rs. 1 lakh and are due and unpaid for a minimum of three weeks. Businesses must have a clear understanding of their actual and projected cash flows, so that they do not face such a situation.

Setting targets and performance evaluation: Accounting helps in ascribing hard numbers to the targets of a business, and in comparing the actual performance of the business against those targets.


7. Comparison of performance:  

Accounting helps ascertain the present and future cash flows of a business, to evaluate targets, and to: (i) compare the financial performance of a business across different financial periods (ii) compare performance of similar businesses (that is, competitors and related businesses in the same industry sector) (iii) compare the financial parameters of other industries, and (iv) compare the financial performance of different units of the same business.

8. Regulatory & Tax Requirement:

Businesses are required to maintain accounts pursuant to various laws. For example, companies must comply with the Companies Act, 1956 while preparing their accounts. Banks also need to follow any applicable directions of the Reserve Bank of India. The Income Tax Act, 1961 also lays down certain requirements to be followed for maintaining books of accounts. Failure to comply to these rules and regulations have serious consequences, including imprisonment. Specific legal provisions will be discussed in another document.

Note: Accounting information can be useful only if it is presented in a systematic manner which is standardized across businesses and industries. Therefore, there are rules to account and record information in pre-set formats so that the user of the information is able to understand the information in the intended manner. These rules are called Generally Acceptable Accounting Principles or GAAP



Financial accounting vs. Managerial Accounting

Financial Accounting provides information to people outside the company primarily with the aim to attract capital and for auditing for taxation purposes. The information is presented in such a manner that all the major activities of the company are recorded and shown so that the investors get a picture of the company and are able to decide whether to invest in the company.

Managerial Accounting is aimed at company’s internal usage to make investment decisions and to evaluate the company’s performance.

It is an analysis of business information for the purposes of calculation of costs and planning in order to achieve efficiency in business operations. The main users of this type of business information are the owners and enterprise managers of an organization. Managerial accounting or management accounting confines itself to intra-company executives who are decision-making authorities in the company. They are concerned with the present and projected cash-flows, cost of production, cost of the finished product and its sale price, inventory management, achieving the targets and goals set out for different business units and their performance evaluation

Components of Managerial Accounting

There are no strict rules for management accounting. An enterprise or the manager may choose any method of accounting the information available as long as it suits the needs of the enterprise.

The various components of managerial accounting are:

1. Cost accounting and evaluation of the enterprise goods and services – The various components of this aspect are:

  •  Cost accounting
  •  Determination of cost of production of goods/ rendering services
  •  Setting of selling price of the goods and/or services
  •  Estimation of value of the stocks

2. Management accounting also helps in managerial decision making, by helping managers in setting goals and objectives for the business, and in budgetary control and planning (say, planning organizational expenditure on employees) for employees or different units of an organization

The mindmap can be accessed here.

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