Accounting is the language of business. It took me some time to absorb this line. Lets just say that accounting is the official language of conveying the nut bolts of business transactions. Its therefore also the process of understanding, measuring and finally communicating any financial information. Why do we need such a language. Well, we shall know in some time. But my limited view says that we cant keep writing transactions in its micro way - took 1500 rs, gave 1000 rs, so saved 500 rs. Therefore earned 500 rs.
You see somebody decided to put a structure to all this (Business guys love structure to everything) and put a top down kind of structure to it. Its easier to follow a top down structure. But what does somebody do with this information.Obviously they take certain informed calls about any business basis these transactions and form an understanding that can be taken places and conveyed in a structure. Long story short - you cant convey the financial results of business if you don't know accounting.
For achieving all the above there are four assumptions that are basic:
1) Economic Entity Assumption: Put very simply it says what we keep saying very often to each other- keep your personal life separate from your professional (business) life. For accounting your life is your transaction(s). Keep the financial activities of my business separate from the financial activities of the owner. Makes sense right ? why would your business pay for your movie ticket of your friends.
2) Time Period Assumption: Again very simple and basic.Business people would want to understanding business performance regularly and may be periodically. All this assumption says is you can do so for short periods of time- month, quarter. I am sure we all have heard of quarterly and annual reports of companies.
3) Monetary Unit Assumption: Tell me everything in Rupee. If you cant convey an economic activity in Rs then it is recordable. But one thing it also assumes that I am personally not ok with is it assumes Rupee is stable.So 100 rs of 1984 = 100 rs of 2014.
4) Going Concern Assumption: says that company of today will continue to operate in foreseeable future. And most of the companies are assumed to be going concern firms. What about those that are not ? They are selling their assets and paying their dues to say good bye to business.
Income Statement: Ok...so lets say all of the above are happening ( all assumptions) and the accountant is making right entries. But is the business running successfully. Any business, one must not forget, has only one aim. To be profitable while delivering customer value. Either of the things not happening may cause you to not becoming going concern. Income statement is accounting way of answering the question - Is the business profitable ? Income statement contains any business's revenue and expenses. An Income statement looks like the following:
What is Revenue and Expenses: I think this is generally known to everybody but let me state it. Revenue is what you earn when somebody buys your services. Note that services may be in any form - goods, software, advice and at times mere presence. What you spend for making your service market ready is your expense. Company's employee's salary is their expense. Similarly raw material for making a cloth piece ready is an expense. There are two principles one must keep in mind keywords when we discuss revenue and expenses. Revenue Recognition Principle and Matching Principle. Both principles are important basis of accrual accounting and determine the accounting period. Revenue Recognition principle states that revenue is recognised or recorded when it is realized or earned. Not when the actual cash comes. Similarly. Matching principle states that expense should be recorded when the resources are used to generate revenue. For example: an interest on say , a loan used for generating business revenue for Jan-Feb would be recorded will be included as expense for the same months
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