The Fundamental Concept

Whenever, we would wish to account for any item in the subject of accounting the first step is to identify the nature of the element. Is the item an asset, liability, income, expense, or capital. The treatment of the item depends on this identification.

However, for beginners I think we better distinguish between the above mentioned items.

• ASSETS are expenditures which are incurred by an entity which benefit the organization for more than one accounting period. Such items are called Capital expenditures because the benefit exceeds the normal accounting period being followed by the company. Such expenditures are non-recurring in nature i.e. these are relatively rare. For example, if a company purchases a truck for usage in business, then this transaction will be a capital expenditure and the item should be classified as an asset. Why? The benefits from the truck are expected to flow to the entity over a long period of time, which would definitely exceed the normal accounting period. Such items are BALANCE SHEET ITEMS.

• The mirror image of an asset is a LIABILITY. Liability is an obligation of the company which might have accrued against any expenditure. For example, when a certain transaction takes place like the purchasing of the truck mentioned above, it should be against the payment of its sales price. But businesses don't run on cash payments all the time. Suppliers allow their customers to purchase items on credit i.e. the payment is made at a later time. Any item which results in a future obligation like this is classified as a liability which is also a BALANCE SHEET ITEM.

• EXPENSES, on the other hand are expenditures just like asset are, but these are mostly recurring in nature and the benefits of these are not expected to flow to the entity beyond the normal accounting period. Such items are INCOME STATEMENT ITEMS.

• INCOME as the name suggests is revenue generated by the entity's normal trading operations. There might not necessarily be an inflow of cash, because remember we also allow credit to certain customers of ours. The revenue generated is the primary source of survival of the company. This is also an INCOME STATEMENT ITEM.

• Finally, CAPITAL refers to the investment made or drawings by the owner of the business. This is the intial source of funds which the owner used to get the business up and running. Later on the person may invest more depending on the requirements of the business. In addition to it, he may withdraw part of his investment.