UNIT 11: BASIC ACCOUNTING CONCEPTS, SYSTEMS, AND TERMINOLOGIES

Learning Objectives

After completing this unit, students will be able to:

Explain the two Systems of Bookkeeping: Single Entry System and Double Entry System, along with their features, advantages, disadvantages, and differences.
Distinguish between the two Bases of Accounting: Cash Basis and Accrual Basis.
Explain the core Accounting Concepts / Assumptions (GAAP): Business Entity, Money Measurement, Going Concern, Historical Cost, Dual Aspect (and the Accounting Equation), Accounting Period, Matching, and Realization Concepts.
Define and apply 18 essential Basic Accounting Terminologies in the context of Nepal.

11.1 Accounting Systems: Single Entry vs. Double Entry System

There are two systems of recording financial transactions in the books of accounts:

The Single Entry System is an incomplete, unscientific, and traditional method of bookkeeping in which the dual aspect of every transaction is ignored. Under this system, normally only Cash Book and Personal Accounts (of Debtors and Creditors) are maintained, while Real Accounts (other than cash) and Nominal Accounts (expenses and incomes) are not opened.

“Single entry system is not any particular system of bookkeeping, but rather the double entry system in an incomplete and disjointed form.” — J.R. Batliboi

Merits: Simple to understand; economical (no need to hire a qualified accountant); requires fewer books; suitable for tiny roadside stalls or micro-retailers.
Disadvantages: Incomplete and unscientific; Trial Balance cannot be prepared to check arithmetical accuracy; Trading and Profit & Loss Account cannot be prepared to find exact net profit; Balance Sheet cannot be prepared to show true financial position; high risk of undetected fraud; not accepted by tax authorities (IRD) or courts of law.

2. Double Entry System

The Double Entry System—propounded by Luca Pacioli in 1494 A.D.—is the modern, scientific, complete, and universally accepted system of bookkeeping which recognizes that every financial transaction has two equal and opposite aspects: a Receiving Aspect (Debit / Dr.) and a Giving Aspect (Credit / Cr.). Under this system, for every debit there must be a corresponding credit of an equal amount, and vice versa.

“Every business transaction has a two-fold effect and that affects two accounts in opposite directions, and if a complete record were to be made of each such transaction, it would be necessary to debit one account and credit another account. It is this recording of the two-fold effect of every transaction that has given rise to the term Double Entry System.” — J.R. Batliboi

Comparison Between Single Entry System and Double Entry System

Basis of Comparison	Single Entry System	Double Entry System
1. Dual Aspect Recording	Records only one aspect of a transaction (or omits both aspects for non-cash real/nominal items)	Records both aspects (Debit and Credit) of every financial transaction
2. Accounts Maintained	Maintains only Personal Accounts (debtors/creditors) and Cash Book; ignores Real and Nominal accounts	Maintains all three classes of accounts: Personal, Real, and Nominal Accounts (or Assets, Liabilities, Equity, Revenue, Expenses)
3. Arithmetical Accuracy (Trial Balance)	Trial Balance cannot be prepared; arithmetical accuracy of books cannot be verified	Trial Balance is prepared regularly to verify that Total Debits equal Total Credits
4. Ascertainment of Profit or Loss	Only an estimated profit/loss can be guessed by comparing opening and closing capital	Exact Gross Profit/Loss and Net Profit/Loss are ascertained by preparing Trading and Profit & Loss Accounts
5. True Financial Position (Balance Sheet)	A true Balance Sheet cannot be prepared in the absence of real asset accounts	A true Balance Sheet is prepared showing exact Assets, Liabilities, and Capital
6. Legal & Tax Recognition	Not accepted by the Inland Revenue Department (tax office), banks, or courts of law	Universally accepted as authentic evidence by tax authorities, auditors, banks, and courts
7. Suitability	Suitable only for very small petty traders with mostly cash dealings	Suitable for all small, medium, and large enterprises, companies, banks, and governments

11.2 Bases of Accounting: Cash Basis vs. Accrual Basis

Cash Basis of Accounting: Revenues are recorded only when actual cash is received, and expenses are recorded only when actual cash is paid, regardless of the accounting period to which they belong. Credit sales, credit purchases, outstanding expenses, and accrued incomes are ignored until cash changes hands. (Used in Nepal’s Government Accounting System and by some professional firms).
Accrual / Mercantile Basis of Accounting: Revenues are recognized and recorded when they are earned (whether received in cash or sold on credit), and expenses are recorded when they are incurred (whether paid in cash or still outstanding/unpaid) during the accounting period to which they relate. (Mandatory for all commercial businesses and companies under NFRS/GAAP).

11.3 Basic Accounting Concepts / Assumptions

Accounting concepts are the fundamental assumptions and rules (Generally Accepted Accounting Principles — GAAP) upon which financial statements are prepared:

Accounting Concept	Core Principle & Practical Application in Nepal
1. Business Entity Concept	The business is treated as a separate and distinct unit from its owner(s). Therefore, when the proprietor invests Rs. 5,00,000 into the business, the business treats it as a liability (Capital) owed to the owner; if the owner withdraws Rs. 10,000 for domestic expenses, it is recorded separately as Drawings, not business expense.
2. Money Measurement Concept	Only those transactions and events that can be expressed in monetary terms (e.g., Nepalese Rupees — Rs.) are recorded in the books of accounts. Non-monetary events (such as a quarrel between two managers or the high skill of a worker) are not recorded.
3. Going Concern Concept	It is assumed that the business will continue to operate indefinitely in the foreseeable future and has no intention of closing down. Because of this assumption, fixed assets are recorded at historical cost and depreciated over their useful life rather than valued at immediate liquidation price.
4. Cost (Historical Cost) Concept	An asset acquired by a business is recorded in the books of accounts at the actual price paid to acquire it (historical cost)—including transport and installation costs—rather than its fluctuating market price. For example, land bought 5 years ago for Rs. 20,00,000 is recorded at Rs. 20,00,000 even if its market value today is Rs. 45,00,000.
5. Dual Aspect Concept & Accounting Equation	Every business transaction has two equal aspects (Debit and Credit), so the resources owned by a business (Assets) are always equal to the claims against those resources (Capital + Liabilities): Assets = Capital + Liabilities
6. Accounting Period Concept	Although a business is a going concern with an indefinite life, its life is divided into uniform 12-month intervals called Accounting Periods (Fiscal Years) to measure profit/loss and financial position regularly. In Nepal, the official fiscal year runs for 12 continuous months from Shrawan 1 to the end of Ashadh (Fiscal Year).
7. Matching Concept	To determine the true net profit or loss of an accounting period, the total revenues earned during that period must be matched against all expenses incurred (whether paid or outstanding) to earn that revenue.
8. Realization (Revenue Recognition) Concept	Revenue is considered earned only when goods are actually transferred or services are rendered to the customer creating a legal right to receive payment—not merely when a customer places an order or pays an advance.

Illustration of the Accounting Equation (`Assets = Capital + Liabilities`)

Let us verify how every transaction maintains the Accounting Equation:

Ramesh started business with cash Rs. 2,00,000: Assets (Cash Rs. 2,00,000) = Capital (Rs. 2,00,000) + Liabilities (Rs. 0)
Purchased furniture on credit from Koshi Furniture for Rs. 40,000: Assets (Cash 2,00,000 + Furniture 40,000 = Rs. 2,40,000) = Capital (Rs. 2,00,000) + Liabilities (Creditor Rs. 40,000)
Sold goods costing Rs. 30,000 (purchased out of cash) for Rs. 38,000 in cash (Profit Rs. 8,000 adds to Capital): Assets (Cash 2,08,000 + Furniture 40,000 = Rs. 2,48,000) = Capital (Rs. 2,08,000) + Liabilities (Rs. 40,000)

11.4 Basic Accounting Terminologies

Mastery of the following 18 accounting terms is essential for every student:

Capital: The total amount of cash, goods, or fixed assets invested by the proprietor or shareholders to start and run a business. It represents the owner’s claim on the business (Capital = Assets - Liabilities).
Drawings: Any amount of cash or value of goods withdrawn by the proprietor from the business for personal, family, or domestic use (e.g., paying the owner’s house rent, life insurance premium, or children’s school fees from business cash). Drawings reduce Capital.
Assets: All properties, economic resources, and receivables owned by a business that have monetary value and help generate future income:
- Fixed / Non-Current Assets: Acquired for long-term use (more than 1 year) and not for resale (e.g., Land & Building, Plant & Machinery, Furniture, Vehicles).
- Current / Floating Assets: Cash and assets expected to be converted into cash within one accounting year (e.g., Cash in hand, Cash at bank, Sundry Debtors, Bills Receivable, Closing Stock, Prepaid Expenses).
- Tangible Assets: Assets having physical existence that can be seen and touched (e.g., Building, Machinery, Cash, Stock).
- Intangible Assets: Assets lacking physical shape that cannot be touched but possess valuable legal/commercial rights (e.g., Goodwill, Patents, Trademarks, Copyrights, Software Licenses).
- Fictitious / Nominal Assets: Heavy deferred revenue expenditures or accumulated losses temporarily shown on the asset side of the Balance Sheet until written off against future profits, having zero resale value (e.g., Preliminary Expenses, Discount/Loss on Issue of Shares or Debentures).
Liabilities: All financial debts and obligations payable by the business to outsiders:
- Long-Term / Fixed Liabilities: Payable after more than one year (e.g., Long-term Bank Loan, Debentures, Mortgage Loan).
- Current / Short-Term Liabilities: Payable within one year (e.g., Sundry Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses, Advance/Unearned Income).
Goods: Commodities or articles purchased or manufactured by a trader specifically for the purpose of resale at a profit. For a stationery dealer, books and pens are Goods (recorded under Purchases A/c and Sales A/c), whereas a table bought for office use is an Asset (recorded under Furniture A/c).
Purchases and Purchase Return: Purchases refer to the buying of goods for resale (Cash Purchases + Credit Purchases). When defective or damaged goods are returned to the supplier, it is called Purchase Return or Return Outward.
Sales and Sales Return: Sales refer to selling goods to customers for cash or on credit. When a customer returns goods back to the business, it is called Sales Return or Return Inward.
Stock / Inventory: The value of unsold goods lying in the warehouse or shop at a particular date:
- Opening Stock: Unsold goods on hand at the beginning of the fiscal year (Shrawan 1).
- Closing Stock: Unsold goods remaining at the end of the fiscal year (end of Ashadh).
Debtor / Accounts Receivable: A person or firm to whom the business has sold goods on credit and from whom money is receivable. Debtors are a Current Asset.
Creditor / Accounts Payable: A person or supplier from whom the business has purchased goods on credit and to whom money is payable. Creditors are a Current Liability.
Revenue / Income: The inflow of funds earned by selling goods or rendering services, plus secondary receipts such as commission received, rent received, interest received, and discount received.
Expenses: The cost incurred in producing and selling goods and running the office (e.g., wages, salaries, rent, electricity, stationery, carriage, depreciation).
Profit and Loss: Profit is the excess of total revenue over total expenses (Revenue > Expenses), which increases Capital; Loss is the excess of total expenses over total revenue (Expenses > Revenue), which reduces Capital.
Discount: A rebate or deduction in price allowed by a seller to a buyer. It is of two distinct types:

Basis of Comparison	Trade Discount	Cash Discount
1. Meaning & Purpose	A deduction allowed by a manufacturer or wholesaler on the catalogue/list price to encourage bulk purchasing	A deduction allowed by a creditor to a debtor to encourage prompt or early payment of cash within a stipulated time
2. When Allowed	Allowed at the time of purchasing or selling goods (both cash and credit)	Allowed only at the time of making or receiving cash/cheque payment
3. Deduction in Invoice	Deducted directly on the face of the Invoice/Bill; entries are recorded at the net amount after deducting Trade Discount	Not deducted in the Invoice; calculated at the time of settlement
4. Recording in Journal / Ledger	Never recorded separately in the Journal or Ledger accounts	Always recorded separately in the Journal and Cash Book as Discount Allowed A/c (Dr. — Expense) or Discount Received A/c (Cr. — Income)

Depreciation: The gradual and permanent decrease in the book value of a fixed tangible asset (except land) due to continuous use, wear and tear, passage of time, or technological obsolescence. It is a non-cash expense.
Bad Debts and Bad Debts Recovered: When a debtor becomes insolvent or dishonest and fails to pay the amount due, the irrecoverable amount written off is a loss called Bad Debts. If a previously written-off bad debt is unexpectedly recovered in a later period, it is an income called Bad Debts Recovered.
Solvent and Insolvent: A person or firm whose assets are equal to or greater than their liabilities (Assets ≥ Liabilities) and who can pay all debts in full is Solvent; a person whose liabilities exceed their assets (Liabilities > Assets) and who cannot pay debts in full is Insolvent.
Fiscal / Financial Year: A continuous 12-month period adopted for closing accounts and preparing financial statements. In Nepal, it runs for 12 months from Shrawan 1 to the end of Ashadh (roughly mid-July to mid-July).

Things to Remember (Unit 11 Summary)

The Accounting Equation states that Assets = Capital + Liabilities, derived from the Dual Aspect Concept.
Trade Discount is deducted directly from the invoice price and is not shown in the Journal, whereas Cash Discount is allowed for prompt payment and must be recorded in the Journal/Cash Book.
Debtors (credit customers) are Current Assets; Creditors (credit suppliers) are Current Liabilities.

Exercises (Unit 11)

A. Very Short Answer Questions (1 Mark Each)

State the Accounting Equation.
Under which accounting concept is the proprietor treated as a creditor of the business for their capital?
What is meant by a Fiscal Year?
Define Fictitious Assets with two examples.
What is Bad Debt?

B. Short Answer Questions (4 Marks Each)

Differentiate between Single Entry System and Double Entry System on any four bases.
Explain the Business Entity Concept, Money Measurement Concept, Going Concern Concept, and Matching Concept.
Differentiate between Trade Discount and Cash Discount.
Distinguish between: (a) Fixed Assets and Current Assets, and (b) Debtors and Creditors.

C. Long Analytical Questions (8 Marks Each)

What is the Double Entry System of bookkeeping? Explain its features, objectives, and advantages in detail.

Worked answers to these exercises are in Unit 11 Solutions.

Accounting for All: Grade 9