Financial

Accounting
Meaning of Accounting

 Accounting is an art of recording,

classifying, summering in a significant
manner in terms of money transaction and
events which in part at least of a financial
character and interpreting the result there
of.
 Accounting refers to systematic recording,
classifying and summarizing of financial
transactions and interpreting the results thereof.
Thus, accounting encompasses financial
reporting.
 Accounting starts with recording and ends with
presentation of financial information in a manner
that facilitates informed judgments and
decisions by users.
 In modern days accounting is not merely
concern with recording keeping but also
with a whole range of activities involving
planning, controlling, decision-making,
problem solving, performance
measurement & evaluating, coordinating &
directing, tax designing and planning cost &
management accounting.
Nature of Accounting

• Accounting is a book keeping

• Accounting as an Information System
• Accounting as a language
Accounting is a book keeping
Book keeping is a process of accounting
concern merely with recording transaction
and keeping records. Bookkeeping should
be small and simple part of accounting. It is
a mechanical repetitive while dealing with
financial transactions.
Accounting as an Information System
Accounting involves a series of linked
activities begins with observing, collecting,
recording, analyzing and pass information
or communicating information to users.
 System- it is the sets of elements together
in order to attain a goal. It contains (a)
Input, (b) Processing of Input and (c)
Output.
Accounting as a language

Accounting is called as language of

business. It is the communicating
information about a business.
Functions of Accounting System
 Internal routine reporting to managers for
cost planning and cost control of
operations, and performance evaluation of
people and activities.
 Internal routine reporting to managers on
the profitability of products, brand
categories, customers etc.
 Internal non-routine reporting to managers
for strategic and tactical decisions.
 External reporting through financial
statements to different users.
Users of Accounting
 Management and Managers- Promoters,
Directors, Officers of company, Managers,
Department Heads etc.
 Users with direct financial interest-
Shareholders, Creditors, Employees, and
Suppliers.
 Users with indirect financial interest-
Customers, Taxation Authority, Financial
Analysts, Advisors, General Public.
Accounting Trail / Cycle

Identify a transaction
and make Voucher
Recording
Record in Primary
Books

Record in Secondary
Books

Prepare Trial
Balance

Prepare Financial
Reporting
Statements
1-5

Events and Transactions

 An event is a happening of consequence to
an entity.
 An event could be an internal happening or
external happening.
 External events that involve transfer of value (
in monetary terms) between two entities
(within or outside) are called transactions.
 Thus, a transaction is an external event that
affects the financial position of an entity.

Financial Accounting: An introduction

Branches of Accounting

 There are three main branches of

accounting they are
(a) Financial Accounting
(b) Cost Accounting
(c) Management Accounting
(d) Social Responsibility Accounting
Financial Accounting
 Its largely concern with financial statements for
external use by investors, creditors, financial
analysts, government Agencies and other interest
groups. It deals with historical data. It involves
recording, classifying, and analysis of financial
transaction in a subjective manner according to
nature of expenditure so as to facilitate preparation
of financial statements for showing the performance
and position of the business operation as a whole. It
is the published financial statement, which are
generally the best for the investment decision by the
shareholders, lending decision by the banks & FIs
and credit decision by the vendors.
Cost Accounting
 It is defined as the process of accounting
for costs from the point of which
expenditure is incurred or committed. It
involves classification, allocation,
absorption, and control of costs. It also
ascertaining or evaluating of total costs and
cost per unit of a product, service and
operation.
Management Accounting
 It means provision or provide of information
for management activities such as decision
making, planning and controlling. It is a
system of accounting which is concern with
internal reporting of information to
management for (a) planning, controlling,
operating (b) Decision making in special
matter. (c) Formulating long range planning.
Social responsibility Accounting
 It is the process of identifying, measuring and
communicating the social effects of business
to permit informed judgment and decision by
the users of information’s. It is accounting for
social responsibility aspect of a business
management is hold responsible for what is
contribution to the social well being and
progress accounting for environment and
ecology as part of social responsibility
Double Entry Book Keeping
 Each business transaction used to record in
minimum of two accounts, so that the
accounting equation is always in balance.
In the double entry system, every
transaction must be recorded with equal
debits and credits. As a result the total of all
debits must equals to total of all credits.
 Recording of Transactions: The
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Double Entry Principle

 Each transaction has two aspects (or side):
Debit and Credit.
 Every debit has an equal and opposite
credit.
 Each transaction should be recorded in such
a way that it affects two sides- debit and
credit- equally.
 Thus, the first and foremost step in
recording a transaction is to identify the
debit and credit elements.
Financial Accounting: An introduction
Some Important terms in
Accounting
 Entity- it is an economic/business Unit that
performs the economic/business activities.
 Events- it is the happening of consequences in
the entity.
 Transaction- it is an exchange in which each
participant receives or sacrifices value and
also the recording of events.
 Voucher- it is a document, which is, serves as
an evidence of a transaction.
 Entry- it is the record made in the books of
accounts in respect of a transaction or events.
 Assets- it refers to the tangible object or intangible right
of a company. It is the company of it’s owns.
 Liabilities- It is the company of it’s owes.
 Capital- it refers to the amount invested in the enterprise
by the proprietor or partners or Promoters. It is the
assets over the liabilities.
 Drawings- it refers to the total amount of cash or goods
or any other assets withdraw by the proprietor.
 Purchases- the total amount of goods obtains for resale
or production or service render.
 Sales- The total amount of goods is sold or service
render.
 Stock or Inventory- It refers to the tangible property held
for consumption in the production of products.
 Trade Debtors- It refers to the person from whom the
amounts are due for goods sold or services rendered on
credit basis.
 Trade Creditors- It refers to the person from whom the
amounts are due for goods purchased or services
rendered on credit basis
 Receivables- It involves the bills of exchange, trade
debtor and bills receivables.
 Payables- it involves the bills of exchange, trade creditor
and bills payables.
 Expenditure- these are the cost in acquisition of an asset
or service it the terms of outflow or decrease of assets or
increase in liabilities.
 Expenses- it is the decrease in economic benefit during
the accounting period in the form of outflow of assets or
increase in liabilities.
 Losses- it is decrease in Equity.
 Income- it is the increase in economic benefit during the
accounting period in the form of inflow of assets or
decrease in liabilities.
 Revenue- it refers to the amount charged for goods sold
or services rendered.
 Gains- it is increase in Equity
Generally Accepted Accounting
Principles (GAAP
 Generally Accepted Accounting Principles
and the Accounting Environment- The set of
conversions, rules and procedures are
necessary to defined accepted accounting
practice at a particular time is referred to as
Generally Accepted Accounting Principles
(GAAP). GAAP represents the fundamental
positions that have been generally agreed
for making accounts. GAAP involves
Postulates, Concepts and Principles.
 Accounting Postulates- These are basic
assumptions, which are generally accepted as
self-evident truth in accounting. These are
basic assumption used in accounting practice.
 Accounting Concepts- These are self-evident
statements of truths. This is use to accept by
the people without questioning. It provides
conceptual guidelines for application in the
financial accounting process.
 Accounting Principles- These are generally
the decisions rules derived from the
accounting concept. Principle means a
general law or rules adopted or preferred as a
guide to action a settled ground or basis of
conduct practice. These are characterized as
how to apply concepts.
 Entity Concept:- A business entity is
an economic unit distinct from its
owner(s). Such entity owns its assets
and has its own obligations. Only
those transactions and events which
affect the financial position of the
business entity will be recorded in its
books of accounts.
 Money Measurement Concepts- a unit of
exchange or measurement is necessary to
account for the transaction of business
enterprise in uniform manner. The common
denominator chosen in accounting is the
monetary unit.
 Going Concern Concept- Financial
accounting is formulated assuming that the
business will continue to operate for an
indefinite time.
 Cost Concept:- Assets and liabilities
should be recorded at historical cost. The
recent trends in accounting show that
policy makers favour fair value accounting
in place of historical cost accounting.

 Accounting Period Concept- Financial accounting

provide information about the economic activities
about the business activities of an enterprises for
that are shorter than the life of the enterprise.
Normally the time periods are of equal length to
facilitate comparison.
 Conservatism Concept- This concept
modifies the cost concept in the case of
current assets (It is normally not apply to
non current assets the valuation of which is
governed by the cost concept). This concept
is usually stated as – Anticipated no profit
by provide for all possible losses. It
represents the current assets used to record
the marker value or cost which ever is lower.
Dual Aspect Concept- this may be regarded
as most distinctive and fundamental concept
of accounting. It provides the conceptual
basis for accounting mechanics and there is
a universal agreement among accountant
over this concept.
Here Assets = Liabilities
Assets = Equities
Assets = Capital + Liabilities
Capital = Assets - Liabilities
 Realization Concept- According to this
revenue, which is derived, to be earned only
when it is realized. It realized when goods
are shipped or delivered to the customer and
not when a sale order is received or a
contract signed or goods manufactured.
This concept implies that profit should be
recognized when there is objective evidence
for it.
 Matching Concept:- While measuring
periodic financial results, revenue earned
during an accounting period is matched
with expenses incurred (to earn the
revenue) in the same accounting period.
Thus, expenditure incurred during
construction phase should be withheld till
the business starts commercial activity
and earns revenue.
 Accrual Concept:- Income and expenses should be
recognised as and when they are earned and
incurred, irrespective of whether money is received
or paid in connection thereof. An alternative of
accrual basis of accounting is cash basis where
transactions are recorded only when cash is
received or paid.
 Materiality Concept- maintaining the accounting
records involve time and expenses, the accountant
is usually concern with events, which are material.
 Full Discloser Principle- It require that a business
enterprise should provide all relevant information to
external users for the purpose of sound economic
decision.
Accounting Standard
 GAAP is the collection of conventions and
rules. These rules and procedures help in
preparing and providing financial statements.
An accounting standard specifies the
acceptable accounting method.
 In India the Accounting Standard Board (ASB)
of the ICAI formulates accounting standards.
The ASB’s member consists of membership
companies, auditors of financial statement,
representative of government and regulatory
agencies & academics. The council of ICAI
issues the final standard.
 Accounting Standard is a selected set of
accounting policies or board guidelines
regarding the principle and methods to be
chosen out of several alternatives.
Standard conform to applicable laws,
customs, usages and business
environment. So there is no universal
acceptable set of standards.
6-2

 Accounting standards are established guidelines

which are to be complied with to ensure that
financial statements are prepared in accordance with
generally accepted accounting principles.
 The Institute of Chartered Accountants of India
(ICAI) sets accounting standards in India.
 Most of the accounting standards are mandatory in
nature.
 The National Advisory Committee on Accounting
Standards (NACAS) identifies accounting standards
of the ICAI for adoption by companies.
 Section 211(3A) of the Companies Act, 1956 states
that every profit and loss account and balance sheet
of a company shall comply with the accounting
standards.

Accounting Standards in India: A brief outline of each standard

6-3

List of Accounting Standards (AS)

 So far (May 2006), twenty nine (29) accounting
standards have been issued by the ICAI.
 Disclosure of Accounting Policies (AS 1)
 Valuation of Inventories (AS 2)
 Cash Flow Statement (AS 3)
 Contingencies and Events occurring after the Balance
Sheet date (AS 4)
 Net Profit or Loss for the periods, Prior Period items
and Changes in Accounting Policies (AS 5)
 Depreciation Accounting (AS 6)
 Construction Contracts (AS 7)
 Accounting for Research and Development (AS 8)

Accounting Standards in India: A brief outline of each standard

6-4

List of Accounting Standards (contd.)

 Revenue Recognition (AS 9)
 Accounting for Fixed Assets (AS 10)
 The Effects of Changes in Foreign Exchange
Rates (AS 11)
 Accounting for Government Grants (AS 12)
 Accounting for Investments (AS 13)
 Accounting for Amalgamations (AS 14)
 Accounting for Retirement Benefits in the
Financial Statements of Employers (AS 15)
 Borrowing Costs (AS 16)
 Segment Reporting (AS 17)
 Related Party Disclosures (AS 18)
 Leases (AS 19)

Accounting Standards in India: A brief outline of each standard

6-5

List of Accounting Standards (Contd.)

 Earning Per Share (AS 20)
 Consolidated Financial Statements (AS 21)
 Accounting for Taxes on Income (AS 22)
 Accounting for Investments in Associates in
Consolidated Financial Statements (AS 23)
 Discontinuing Operations (AS 24)
 Interim Financial Reporting (AS 25)
 Intangible Assets (AS 26)
 Financial Reporting of Interests in Joint Ventures (AS
27)
 Impairment of Assets (AS 28)
 Provisions, Contingent Liabilities and Contingent
Assets (AS 29)

Accounting Standards in India: A brief outline of each standard

International Harmonisation of
Accounting Standards
 Recognising the need for international harmonisation of
accounting standards, in 1973, the International
Accounting Standards Committee (IASC) was
established. It may be mentioned here that the IASC has
been reconstituted as the International Accounting
Standards Board (IASB). The objectives of IASC included
promotion of the International Accounting Standards for
worldwide acceptance and observance so that the
accounting standards in different countries are
harmonised. In recent years, need for international
harmonisation of Accounting Standards followed in
different countries has grown considerably as the cross-
border transfers of capital are becoming increasingly
common.
Account
 An account is a summary of transaction at one
place relating to a particular head. It records
not only the amount of transaction but also
effect and direction. The accounts can be
divided Assets, Liabilities, Capital, Expenses
and Revenue. There are three types of
accounts.
 Personal accounts
 Real Account
 Nominal Accounting
 Personal accounts- these account relate to
natural persons, artificial persons, and
representative persons. eg: - Natural Person-
Ram, Artificial Person- Ram & Co.,
Representative Person- Outstanding Salaries.
 Real accounts- these account related to the
tangible or intangible real assets. eg: -
tangible- land & building, intangible- goodwill
 Nominal accounts- these accounts related to
al expenses, losses, profits and gains.
Meaning of debit and credit

 Debit- it means to enter an amount of

transaction on the left hand side of an
account.
 Credit- it means to enter an amount of
transaction on the right hand side of an
account
Rules of debit and credit

 Personal accounts
 Debit the receiver
 Credit the giver
 Real accounts
 Debit what comes in
 Credit what goes out
 Nominal accounts
 Debit all expenses and losses
 Credit all profit and gains
 Assets accounts- Debit the increase
Credit the decrease
 Expenses accounts- Debit the increase
Credit the decrease
 Liabilities accounts- Debit the decrease
Credit the increase
 Capital accounts- Debit the decrease
Credit the increase
 Revenue accounts-. Debit the decrease
Credit the increase
 2-2

Primary Books

 Books of accounts consist of two broad sets of

books: Primary Books and Secondary Books.
 A primary Book (also called Journal) is a book of
prime (first) entry of transactions.
 Any transaction which is not recorded in primary
book does not get reflected in books of accounts.

Recording in the Primary Books

 2-3

Ground Rules for Recording in

Primary Books
 Recollect the accounting equation:
 A(Asset)= L(Liabilities)+ E(Equity)
 Ground Rules:
 Increase in assets and decrease in liabilities and
equity: Debit.
 Decrease in assets and increase in liabilities and
equity: Credit.
 Expenses and losses: Debit
 Income and gains: Credit

Recording in the Primary Books

 2-4

Application of Ground Rules

 Example 1:
ABC Ltd bought an equipment for Rs. 500,000 in
cash.
 Is it a transaction?
 There are two elements: Equipment (Asset) and Cash
(Asset).
 One asset (Equipment) increases and the other asset
(Cash) decreases.
 Applying ground rules:
 Equipment Debit Rs.500,000
 Cash Credit Rs. 500,000

Recording in the Primary Books

 2-5

Application of Ground Rules

ABC Ltd. purchased raw materials for immediate
consumption worth Rs. 200,000 paying 50% in cash
and balance payable after one month.
 Three elements: Purchase of raw materials
(Expenses), Cash (Asset), Payables to suppliers
(Liability)
 Expenses are incurred, cash (Asset) depletes, and
Suppliers’ Credit (Liabilities) increases.
 Applying ground rules:
 Purchases Debit Rs. 200,000
 Cash Credit Rs. 100,000
 Creditors Credit Rs. 100,000

Recording in the Primary Books

 2-6

Application of Ground Rules

 Example 3:
Cash sales of Rs. 100,000
 Two elements- Cash (Asset) and Sales (Income)
 Cash (Asset) increases and Sales (Income) increases.
 Applying ground rules:
 Cash Debit Rs. 100,000
 Sales Credit Rs. 100,000

Recording in the Primary Books

 2-7

Application of Ground Rules

 Example 4:
Repayment of Loan of Rs. 150,000
 The two elements are: Loan (Liability) and Cash
(Asset)
 Loan (Liability) has decreased and Cash (Asset) has
also decreased.
 Applying ground rules:
 Loan Debit Rs. 150,000
 Cash Credit Rs. 150,000

Recording in the Primary Books

 2-8

Application of Ground Rules

 Example 5:
Sold goods worth Rs. 10,00,000 on credit.
 The two elements are sales (income) and receivables
from customer (Asset).
 Income (sales) increases and Asset (Debtors) also
increases.
 Applying ground rules:
 Debtors Debit Rs. 10,00,000
 Sales Credit Rs. 10,00,000

Recording in the Primary Books

2-9

Application of Ground Rules

 Example 6:
Continuing with Example 5,the customer has paid
Rs. 9,90,000 in full and final settlement of her dues.
 The elements are receivables from customer (Asset),
cash (Asset), discount allowed (expense)
 One asset (receivables from customer) decreases,
another asset (cash) increases and an expense
(discount allowed) has been incurred.
 Applying ground rules:
 Cash Debit Rs. 9,90,000
 Discount Allowed Debit Rs. 10,000
 Debtors Credit Rs. 10,00,000
Journalize the following:

 Started business with cash Rs. 50, 000, Furniture Rs.

40,000 and equipment worth Rs. 50,000.
 Rented a premise at a monthly rent of Rs. 10,000
 Purchased goods on credit from Ram Rs. 1,75,000.
 Sold goods on credit to Shyam Rs. 1,50,000
inclusive of sales tax @8%
 Cash sales Rs. 20,000 inclusive of 8% sales tax.
 Received cash from Shyam Rs. 1,45000 in full
settlement of his dues.
 Paid Rs. 170,000 to Ram and availed discount of Rs.
5,000.
 Paid monthly rent of Rs. 10,000.
 Deposited sales tax with sales tax authority
 Withdrawn money for personal use by the owner
Rs.10,000.
2-10

Types of Journal
 There are many primary books (i.e., Journal
Books). The transactions are categorized as
per their nature and, for each type of
transaction, a separate journal is used for
recording the transaction. It is also called
subsidiary books of journal in accounting.
 Since transactions are recorded in journal
chronologically as these occur, journal books
are generally called day books.
 Types of Journal
2-11

 There are eight types of journal books:

 Purchases Day Book
 It records credit purchase of raw
materials, and traded goods
 Sales Day Book
 It records credit sale of goods.
 Return Outward (also called Purchases
Return) Book
 It records goods returned to the supplier
(s) of raw materials and traded goods.
 Return Inward (also called Sales Return) Book
 It records goods returned by customers.
2-12

Types of Journal
 Bills Receivable Book
It records bills (of exchange) accepted by
customers.
 Bills Payable Book
It records bills (of exchange) raised by suppliers.
 Cash Book
It records all cash (and bank) transactions:
receipts and payments.
 Journal Proper
It records all residual transactions i.e.,
transactions which do not find place in any of the
other journal books.
 2-13

Journal Book Identification

 Identify the appropriate journal for the following
transactions:
1. Credit purchase of machinery.
2. Cash sales
3. Loan raised
4. Credit sale of goods.
5. Cash purchase
6. Credit purchase of goods
7. Cash deposited to Bank
8. Goods returned by customers.
9. Goods returned to suppliers.
10. Depreciation on assets

Recording in the Primary Books