Accounting Basics

A small primer to get you up to speed on the concepts of accounting.

Let's understand the concept of accounting with the example of an imaginary business that is just starting out.

Let’s say we’re starting a Home Interior business and we have ₹5,00,000 of capital to start our business. Now the business has ₹5,00,000 in its bank.

Now we will need an operating place where we can work and meet clients. We rent out a co-working space for ₹40,000 per month. This is our first expense. Our bank balance will be ₹5,00,000 - ₹40,000 = ₹4,60,000 at this point.

We have invested some cash, we have a working place and now we have our first sale. We earned ₹30,000 from our first customer. This is our first income. Our bank balance at this point will be ₹4,60,000 + ₹30,000 = ₹4,90,000.

Let’s say we decided to hire a Web Agency to build a website for us, they charge ₹50,000 which will be paid after 2 months from current date. At this point we haven’t paid them any money, but we are liable to pay them in the future. This is a liability and will be recorded under Accounts Payable.

Let’s list these down in a table:

Owner Investment ₹5,00,000
Rent - ₹40,000
Sales + ₹30,000
Accounts Payable - ₹50,000
Total ₹4,40,000

Now, let's categorize these into the five types of Accounts:

  • Asset (Bank): ₹4,90,000

  • Liabilities (Accounts Payable): ₹50,000

  • Equity (Owner Investment): ₹5,00,000

  • Income (Sales): ₹30,000

  • Expense (Rent): ₹40,000

Impact of accounting on accounts

Let’s take a look at each transaction and understand which accounts will get affected, from an accounting point-of-view:

1. Cash Investment

Since you, the owner, invested money into the business, it is a liability. So, Account Payables, which is a Liability account, is increased by ₹5,00,000.

Also, the money in the Bank Account, which is an Asset account, is increased by ₹5,00,000.

2. Rent

Rent is an immediate expense, so it is recorded in the Rent Account, which is an Expense account, it is increased by ₹40,000.

Also, the money is spent from the Bank Account, which is an Asset account, it is decreased by ₹40,000.

3. First Sale

We got an immediate payment, it is recorded in Sales Account, which is an Income account, the balance is increased by ₹30,000.

Also, we received the money in our Bank Account directly, so it’s balance increases by ₹30,000.

4. Hiring a Web Agency

We hired a Web Agency for some work, and we are liable to pay them in the future. This is recorded in Accounts Payable by increasing the amount by ₹50,000.

Since this is an expense for us, we also increase the balance in the Vendor Expense Account by ₹50,000.

As you might have noticed, every transaction we do in our business affects two accounts. This is the basis of double-entry bookkeeping system.

You can test this out by creating a Sales Invoice in Frappe Books, and then check the General Ledger Report to see which accounts were affected.