Learning Accounting through an example
A poor unemployed person (we shall call him Oberoi) thought of making his livelihood by selling vegetables going around houses in a locality. He could only garner a small amount say Rs. 200/- with which he could start the business.
In a very simple sense, business implies something that is carried on with a motive to earn profit/income. Profit motive is inherent in business. Not that every business generates profits, but the motive behind every act/transaction in a business would be making profit.
The amounts and other resources with which a business is started or carried on is called Capital.
Oberoi's Capital = Rs. 200/-
Oberoi's daily routineHe used to go to the wholesale market early in the morning to buy fresh vegetables which are generally available during that time. He bought vegetables from wholesale vendors. He then roamed around a locality selling the vegetables to various households. To make a profit he sold the vegetables at a price arrived at by adding a certain amount over his purchase price.
• Profit and Loss
Profit = Selling price — Cost price and
Loss = Cost price — Selling price
Profit is a numerical figure. It can either be positive (when there is a profit), negative (when there is a loss) or zero when there is neither profit nor loss. A loss is also expressed as a negative profit.
In a similar way, loss is also a numerical figure. It can either be positive (when there is a loss), negative (when there is a profit) or zero when there is neither profit nor loss. A profit can also be as a negative loss, but is seldom done.
At the beginning and during the course of Day OneOberoi, went to the wholesale market, bought vegetables with the Rs. 200 (his capital) and then set out on his trip around the locality selling vegetables. Since the Rs. 200 he invested enabled him to buy a small quantity of vegetables, he could remember the prices at which he bought the various varieties. He was selling his stock by adding certain amount over the cost at which he purchased them.
• Price and Value
End of day OneBy evening, Oberoi, sold all the vegetables he purchased in the morning. He counted the cash with him at the end of the day. It was Rs. 280. Where did the extra Rs. 80 (280 − 200) come from? It is on account of the profit he made by selling vegetables.
Beginning of day twoWhat is the capital Oberoi has? Since he has Rs. 280 at the end of day one, he can use all that for purchasing vegetables on day two. Therefore his capital is Rs. 280.
What happened to his capital? Why? How?His capital has increased from day one to day two by Rs. 80. The reason for this increase is the profit he made on day one.
From this we learn one of the fundamental understandings in accounting/business.
• Profit increases Capital
During the course of Day TwoOberoi, went to the wholesale market, bought vegetables with the Rs. 280 (his capital for day two) and then set out on his trip around the locality selling vegetables. Even on day two he was selling his stock by adding certain amount over the cost at which he purchased them.
Towards the end of the day he noticed that there was certain stock left over which if he is unable to sell would get spoilt and he would get nothing out of it. Therefore he sold them by reducing the price. This price at which he sold the vegetables was far less than the price at which he bought them.
End of day TwoOberoi, counted the cash with him at the end of the day. It was Rs. 260. Why a shortage, what happened to his Rs. 280/-. The shortage of Rs. 20/- (280 - 260) is on account of the loss he incurred in selling the vegetables.
Beginning of day threeWhat is the capital Oberoi has? Since he has Rs. 260 at the end of day two, he can use all that for purchasing vegetables on day three. Therefore his capital is Rs. 260.
What happened to his capital? Why? How?
From this we learn one another fundamental understanding in accounting/business.
• Losses decrease Capital
As we incur losses our capital decreases.
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