FINANCIAL

ACCOUNTING
 Commerce
• Commerce is defined as the exchange of goods
and services between two or more entities.
 Accounting
• Accounting has rightly been termed as the
language of the business.
• The basic function of a language is to serve as
a means of communication.
• It communicates the results of business
operations to various parties who have some
stake in the business viz. the proprietor,
creditors, investors, government and other
agencies.
• For example, a housewife has to keep a record
of the money received and spent by her during
a particular period. She can record her receipts
of money on one page of her household diary
while payments for different items such as
milk, food, clothing, house, education etc. on
some other page or pages of her diary in a
chronological order.
 FINANCIAL ACCOUNTING
• Financial accounting is a specific branch of
accounting involving a process of recording,
summarizing, and reporting the myriad of
transactions resulting from business
operations over a period of time.
• We know accounting is the systematic
recording of financial transactions and
presentation of the related information of the
appropriate persons.
• Financial accounting is concerned with the
recording, classification, summarizing,
analysis, interpretation and communication of
business transaction information through
accounts and financial statements.

branches OF ACCOUNTING
1. Financial accounting
2. Cost accounting
3. Management accounting
• According to American Institute of
Certified Public Accountants (AICPA),
“Accounting is an art of recording, classifying
and summarizing in a significant manner and
in terms of money, of transactions and events
which are, in part at least of a financial
character and interpreting the result thereof.”
• The American Accounting Association
termed as, “Accounting is the process of
identifying, measuring and communicating
economic information to permit informed
judgements and decision by users of the
information.”
 NATURE AND SCOPE OF
FINANCIAL ACCOUNTING
• Financial accounting is a useful tool to
management and to external users such as
shareholders, owners, creditors, customers,
employees and government. It provides
information regarding the results of its
operations and the financial status of the
business.
• The following are the functional areas of
financial accounting:-
• Dealing with financial transactions: Accounting
as a process deals only with those transactions
which are measurable in terms of money. Anything
which cannot be expressed in monetary terms does
not form part of financial accounting however
significant it is.
• Recording of information: Accounting is an art of
recording financial transactions of a business
concern. There is a limitation for human memory. It
is not possible to remember all transactions of the
business. Therefore, the information is recorded in a
set of books called Journal and other subsidiary
books and it is useful for management in its
decision making process.
• Classification of Data: The recorded data is
arranged in a manner so as to group the
transactions of similar nature at one place so that
full information of these items may be collected
under different heads. This is done in the book
called „Ledger‟. For example, we may have
accounts called „Salaries‟, „Rent‟, „Interest‟,
Advertisement‟, etc. To verify the arithmetical
accuracy of such accounts, trial balance is
prepared.
• Making Summaries: The classified information of
the trial balance is used to prepare profit and loss
account and balance sheet in a manner useful to the
users of accounting information. The final accounts
are prepared to find out operational efficiency
and financial strength of the business.
• Analyzing: It is the process of establishing the
relationship between the items of the profit and loss
account and the balance sheet. The purpose is to
identify the financial strength and weakness of the
business. It also provides a basis for interpretation.
• Interpreting the financial information: It is
concerned with explaining the meaning and
significance of the relationship established by the
analysis. It should be useful to the users, so as to
enable them to take correct decisions.
• Communicating the results: The profitability
and financial position of the business as interpreted
above are communicated to the interested parties at
regular intervals so as to assist them to make their
own conclusions.
 USERS OF ACCOUNTING
• Internal users of accounting
• Internal users are that individual who runs, manages
and operates the daily activities of the inside area of an
organization.
• Owners and stockholders.
• Directors.
• Managers.
• Officers.
• Internal departments.
• Employees.
• Internal auditor.
 EXTERNAL USERS OF
ACCOUNTING
• Creditors
• Investors
• Government
• Trading partners
• Regulatory agencies.
• International standardization agencies.
 OWNERS
• The primary objective of accounting is to
provide necessary information to the owners
relating to their business. For example, the
shareholders of a company are interested in the
accounting information with a view to
ascertaining the profitability and financial
strength of the company.
 MANAGEMENT
• In large business organizations there is a
separation of the ownership and management
functions. The managements of such concerns
are more concerned with the accounting
information because of their accountability to
the owners for better performance of their
concerns.
 REGULATORY AGENCIES
• Various government and other agencies use
accounting reports not only as a basis for tax
assessment but also in evaluating how well
various business concerns are operating under
regulatory framework.
 GOVERNMENT
• Government all over the world are using
financial statements for compiling statistics
concerning business units, which, in turn help
in compiling national accounts.
 INVESTORS
• Investors use the information in accounting
reports to a greater extent in order to determine
the relative merits of various investment
opportunities.
 EMPLOYEES
• Employees are interested in the earnings of the
enterprise because their pay hike and payment
of bonus depend on the size of profits earned.
 SINGLE ENTRY AND DOUBLE
ENTRY SYSTEM
• A single Entry System is a bookkeeping
system in which only one part of a transaction
is recorded, such as debit or credit.
• A double entry system is a method of
recording transactions in which both sides of a
transaction are recorded. This sort of
bookkeeping is not for tax purposes
SINGLE ENTRY SYSTEM
DOUBLE ENTRY SYSTEM
 Golden rules of commerce
• Debit what comes in, credit what goes out.
• Debit all expenses and losses, credit all
incomes and gains.
• Debit the receiver, credit the giver.
 ACCOUNTING PRINCIPLES
• Accounting principles are the rules and
guidelines that companies and other bodies
must follow when reporting financial data.
These rules make it easier to examine financial
data by standardizing the terms and methods
that accountants must use.
• The set rules which defined the way account
should be prepared are known as accounting
principles.
• Generally Accepted Accounting
Principles (GAAP).
Necessity of accounting principles
• Accounting information is better understood if
it is prepared following the set of Accounting
Principles uniformly.
• It means same accounting principles are
followed by all entities in preparing their final
account.
• Accounting information become meaningful
and useful for users accounting information if
the accounting records and financial
statements are prepared following generally
accepted accounting principles.
 Features of accounting
principles
• Accounting principles are man-made.
• Accounting principles are flexible.
• Accounting principles are generally accepted.
Meaning and nature of
accounting principles &
ACCOUNTING ASSUMPTIONS
Accounting Assumptions
• Going concern:- Business will continuous for a
long period of time.
• Consistency concept:- Accounting principles/
method & policies will remain consistent from
years.
• Accrual concept:- Revenue is recorded when
sales are made.
• Expenses are recorded in the year in which they
assist to earn revenue.
Accounting entity or business
entity principle
• Business is considered to be a separate entity
from its owners.
• Business transactions are recorded in the
books of account from the business point of
view and not from that of the owners.
• Owners being regarded as separate from
business are considered as creditors of the
business to the extent of their capital.
Money measurement principle
• Transactions and events that can be measured
in money terms are recorded in the books of
accounts of the enterprise.
 Accounting period principle
• Life of an enterprise is broken into smaller
periods (known as accounting period) so that
its performance is measured at regular
intervals i.e. with the help of income statement
and position statement.
• Calendar year.
• Financial year.
Cost concept/ Historical cost
principle
• An asset is recorded in the books of account at
the price paid to acquire it i.e. at cost or
purchase price.
 Matching concept/ Matching
principle
• An important objective of business is to
determine profit periodically.
• So it is necessary to match revenue of the
period with the expenses of that period to
determine correct profit/loss for the accounting
period.
 Dual aspect/ duality
principle
• Every transaction entered into by an enterprise
has two aspects - a debit and a credit.
• Eg. Rahul starts a business with a capital of
Rs. 1,00,000. there are two aspects of the
transaction. On one hand the business has an
assets of Rs. 1,00,000 (cash) while on the other
hand, it has a liability.
 Full disclosure principle
• All the significant information relating to
economic affairs of the entity should be fully
disclosed in the financial statements.
• Eg. Contingent liability is shown as footnote to
the Balance sheet, the reasons for low turnover
should be disclosed.
 Debit & Credit - Meaning
• Debit refers to the left side of an account Dr.
• Credit refers to Right side of an account Cr.
• Both debit and credit may represent either
increase or decrease depending upon the nature
of an account.
 Account
• Account is a record of transaction under a
particular head. It records not only the amount
of transaction but also their effect and
direction.
 Classification of Account
1. Traditional Approach (English Approach)
2. Modern Approach (Accounting Equation
Approach/ American Approach)
 Traditional Approach
Traditional Classification of Accounts
1. Personal Accounts
a) Natural personal accounts
b) Artificial personal accounts
c) Representative personal accounts
2. Impersonal Accounts
a) Real accounts
b) Nominal accounts
 Personal Accounts
• Accounts relate to persons i.e. individuals,
firms, companies, debtors or creditor etc.
• Examples- Ram & Co. customer (Debtor),
Supplier (Creditor), Capital A/C and Drawing
A/C or proprietor.
• Purpose- To determine the balance due to or
due from persons or organizations.
 Natural personal accounts
• Persons who are creation of God. Means
accounts in individual name.
• Ex. Ram‟s A/C, Shyam A/C.
Artificial Personal Accounts
• Account of corporate Body or Institutions
which are recognized as persons in business
dealing.
• Ex. A/C of limited company, A/C
Club/Cooperative.
 Representative Personal
Accounts
• Accounts which represent a certain
person/group of persons.
• Ex. If rent is due to landlord- outstanding rent
A/C.
 Impersonal Account
Real Account- Which are related to tangible and
intangible assets of firm (Excluding Debtors).
• Ex. Land, Building, Investment, Goodwill, Patent,
trademark etc.
Nominal Account- which are related to expense, loses,
gains, revenue etc. are treated as Nominal Account.
• Sales A/C, Purchase A/C, Interest paid A/C etc.
Main three types of Accounts
• Personal accounts
• Real accounts
• Nominal accounts
 If a Prefix/Suffix (Outstanding,
Prepaid Accrued) is added to a
Nominal Account it becomes a
Personal Account
Nominal Account Personal Account
Interest A/C Outstanding Interest A/C, Interest
Received in Advance A/C, prepaid
Interest A/C
Rent A/C Outstanding Rent A/C, Prepaid Rent A/C
Salary A/C Outstanding Salaries A/C, Prepaid
Salaries A/C
Commission A/C Outstanding Commission A/C, Prepaid
Commission A/C.
 Golden Rule of DebiT and
Credit
Personal Account
• Debit the receiver
• Credit the giver
Real Account
• What comes in is debited
• What goes out is credited
Nominal account
• Debit all expenses & losses
• Credit all income & gains
 Modern Classification of
Accounts
1. Asset accounts.
2. Liability accounts.
3. Capital accounts.
4. Revenue accounts.
5. Expense accounts.
 Bases of accounting
• Cash basis of accounting.
• Accrual basis of accounting.
 Cash basis of accounting
• Is a system in which transactions are recorded
when cash is received/paid.
• Total income (received) – total expenses (paid) =
profit/loss
• Outstanding & prepaid Expenses, Income
received in advance or accrued incomes are not
considered.
• Ex. Receipts & payment account prepared for
NPO (non profit org.) such as charitable institutes,
clubs and schools.
 Advantages
• Simple basis of accounting, as adjustment is
not made.
• More objective as very few estimates and
judgment is required.
• Suitable for those enterprise where most of
transaction are on cash basis.
 Disadvantages
• Does not give true and fair view of profit and
loss ignore outstanding, prepaid items.
• Does not follow the matching principles of
accounting.
 Accrual basis of accounting
• Income is recorded as income when it is earned or
accrued.
• Ex. Credit sale/Purchase is recognized as sale
irrespective of fact whether amount has been
received or not.
• Similarly, if an expense has been incurred but
payment has not been made, it will recorded as an
expenses.
• Adjustment are made- prepaid & outstanding
Expenses, accrued & advance income.
 Advantages
• More scientific method.
• Discloses correct/true profit or loss.
• Reflect true financial position by adjusting all
items.
Disadvantages
• Not simple as cash basis.
• Accounting process too elaborate.
• Adjustment is required.
 Accounting standards & IFRS
• As are a set of guidelines, i.e. Generally Accepted
Accounting Principles, that are followed for preparation
and presentation of financial statements.
IASC- IFRB (International Financial Reporting
Board) – 1973
ICAI – Institute Of Chartered Accountant Of India.
ICWAI – Institute Of Cost & Work Accountant Of India.
ASB – Accounting Standard Board -1977
• They are accounting rules and procedures relating to
measurement, recognition, treatment, presentation and
disclosure of accounting transaction in the financial
statement issued by the council of the Institute of
Chartered Accountant of India.
 Nature
• Guideline so that reliable financial statement
can be prepared.
• To bring uniformity in accounting practices
and to ensure transparency, consistency and
comparability.
• Are prepared keeping in view the business
Environment and law of the country.
• AS mandatory in nature.
• AS are flexible.
 objective
• Minimize the diverse accounting policies and
practices.
• Promote better understanding of financial
statement.
• Facilitating meaningful comparison of
financial statements of two or more entities.
• Enhancing reliability of financial statements.
 List Of iCAi’s MANdAtOry ACCOuNtiNg
Standards (AS-1 to AS-29)
• ICAI’s AS-1: Disclosure of Accounting Policies
• ICAI’s AS-2: Valuation of Inventories
• ICAI’s AS-3: Cash Flow Statements
• ICAI’s AS-4: Contingencies and Events Occurring After Balance Sheet Date
• ICAI’s AS-5: Net profit or Loss for the period, Prior Period Items and Changes in Accounting Policies
• ICAI’s AS-7: Construction Contracts
• ICAI’s AS-9: Revenue Recognition
• ICAI’s AS-10: Property, Plant and Equipment
• ICAI’s AS-11: The Effects of Changes in Foreign Exchange Rates
• ICAI’s AS-12: Government Grants
• ICAI’s AS-13: Accounting for Investments
• ICAI’s AS-14: Accounting for Amalgamations
• ICAI’s AS-15: Employee Benefits
• ICAI’s AS-16: Borrowing Costs
• ICAI’s AS-17: Segment Reporting
• ICAI’s AS-18: Related Party Disclosures
• ICAI’s AS-19: Leases
• ICAI’s AS-20: Earnings Per Share
• ICAI’s AS-21: Consolidated Financial Statements
• ICAI’s AS-22: Accounting for Taxes on Income
• ICAI’s AS-23: Accounting for Investments in Associates
• ICAI’s AS-24: Discontinuing Operations
• ICAI’s AS-25: Interim Financial Reporting
• ICAI’s AS-26: Intangible Assets
• ICAI’s AS-27: Financial Reporting of Interests in Joint Ventures
• ICAI’s AS-28: Impairment of Assets
• ICAI’s AS-29: Provisions, Contingent Liabilities and Contingent Assets
 International Financial
Reporting Standards (IFRS)
• A set of Accounting Standards developed by
International Accounting Standard Board
(IASB) – IAS setting body.
• Are based on sound and clearly stated
principles. Therefore IFRS are referred to as
principle – Based Accounting Standard.
 Journal
• Journal is a historical record of business transaction or
events.
• Journal is primary book for recording the day to day
transactions in a chronological order i.e. the order in
which they occur.
• This is called the book of first entry. (primary book)
• Journal entry means recording the business transactions in
the journal.
• Transactions are recorded in the journal book from the
accounting vouchers that are prepared on the basis of
source documents i.e. cash memo, invoice, purchase bill
etc.
• The transaction is analyzed to determine which account is
to be debited and which account is to be credited.
 Important point
• Provide accounting data in chronological
order.
• Possibility of error reduce.
• Explanation of transaction.
• Ledger posting of transaction.
• Location of error.
• Date:- The date of transaction on which it takes place.
• Particulars:- The name of the accounts to the
debited is written first, then the names of the accounts
to be credited, and lastly the narration are entered.
• L.F. (Ledger Folio):- In it entered the page numbers
on which the various accounts appear in the ledger.
• Debit (Amount):- The amount to be debited against
the Dr. Account is written along with the nature of
currency.
• Credit (Amount):- The amount to be credited
against the Cr. Account is written along with the nature
of currency.
 journalizing
• Journalism is the process of recording journal
entries in the journal.
• It is a systematic act of entering the transaction
in a day book in order of their event i.e. Date
wise.
• At the time of journalizing of the transactions,
when an account is debited it is denoted by Dr.
and crediting of an account by To.
 Journalizing steps
• Find out what accounts are involved in
business transaction.
• Ascertain what is the nature of accounts
involved.
• Ascertain the golden rule of debit and credit is
applicable for each of the accounts involved.
• Find out what account is to be debited which is
to be credited.
• Record the date of transaction in the Date
Column.
• In the “Particulars Column” along with the
word “Dr.” on the same line against the name
of the account, the amount to be debited in the
“Debit Amount column”.
• Record the name of the account to be credited
in the next line preceded by the word “To” at a
few space towards right in the “Particulars
Column” and the amount to be credited in the
“Credit Amount Column” in front of the name
of the account.
• Record narration (i.e. a brief explanation of the
transaction) within brackets in the following
line in “Particular Column”.
• A thin line is drawn all through the particulars
column to separate one journal entry from the
other and it shows that the entry of a
transaction has been completed.
• After it ledger posting would be posted.
 ledger
• A ledger is called the book of final entry, since all
transactions recorded in books of original entry
(i.e. journal) are transferred (posted) in the ledger.
• A book which contains, in a summarized and
classified form, a permanent record of all
transactions.
• It is the most important book of account, since the
trial balance is drawn from it and from the trial
balance, financial statements are prepared. Hence,
ledger is called the principal book of account.
 Ledger features
• Ledger is a master record of all the accounts of
business.
• It is prepared from journal.
• Ledger accounts show the current balance in all
account.
• Trail balance and final accounts are prepared from
ledger accounts.
• Ledger accounts summarise the effect of
transactions upon assets, liabilities, capital,
income and expenditures.
 Ledger utility
• Provides complete information of a particular
account. (Example- Cash A/C, bank A/C etc.)
• Information of income and expenses.
• Preparation of trial balance.
• Helpful in preparing final Accounts.
Format of ledger Account
 Posting the entries
• The process of transferring the transaction
written in the journal to a ledger is called
posting.
 Use of words To and By
• It is customary to use the word-
• To with accounts which appear on Debit Side
of ledger Account.
• By is used with account which appear on
Credit Side of ledger Account.
• The words To and By do not have any specific
meaning.
• Modern accountant therefore do not use these
words.
Balancing of ledger account
• Balancing an account means that two sides of
an account are totaled and the difference in
total of two sides are written on side whose
total is smaller. (So that Dr. = Cr.)
• For Example-
• If the total of credit side > Total of Debit side.
• Then the difference of amount will be recorded
as To Balance c/d on Debit side.
• If the total of debit side > Total of Credit side.
• Then the difference of amount will be recorded
as By Balance c/d on Credit side.
 Debit Balance & Credit
Balance
• If the total of Debit Side > Total of Credit Side
• Means Account has Debit Balance
• If the Total of Credit Side > Total of Debit Side
• Means Account has Credit Balance
• Debit & Credit Balance – written on the Debit
Side/ Credit Side as “ To Balance brought
down” or “To Balance b/d” which is the
opening balance for the new period.
 Trial Balance
• Is a statement prepared with the debit and
credit balances of the ledger Account and Cash
Book balance to test the Arithmetical Accuracy
of Books.
• It is list of debit and credit balances, taken out
from the ledger. It also includes the balances of
cash and bank taken from the cash book.
 Trial Balance Features
• It is a list of balance of Ledger Accounts and Cash
Book.
• It is not a part of Double Entry System of Book
keeping. It is a result of Double Entry System of
Book Keeping.
• It can be prepared on any date if the accounts are
balanced.
• Adv.- It verifies the Arithmetical Correctness of
posting of entries from journal to ledger.
• It is not a conclusive proof of accuracy of books of
accounts since some errors are not disclosed by Trial
Balance.
• Adv.- It is helpful in preparation of Trading Account,
Profit and Loss Accounts and Balance Sheet.
 Limitation
• It is not a conclusive proof of absolute
accuracy of the books of accounts.
Format of Trial Balance
 Preparing Trail Balance
(Balance Methods)
• By taking the debit or credit balance of all
ledger accounts (including Cash & Bank
Accounts). These balances are entered
separately in two columns.
• Debit Balance are placed in Debit Column.
• Credit Balance are placed in Credit Column.
Example
 Imp. Point to remember for
preparing Trail Balance
• Trial balance is prepared with help of ledger
and cash book.
• If an account does not have balance, it is
ignored, it is not written in Trial Balance.
• Ledger Account showing Debit Balance are
shown on debit column of Trial Balance.
• And ledger Accounts showing credit balance
are shown in the credit column of Trail
Balance.
• Purchase account always has a debit balance-
shown on debit column of a Trial Balance.
• Sales Account always has credit Balance-
shown in Credit Column of Trail Balance.
• Return inward Account/ Sales Return Account-
always Debit Balance Shown on debit column
of at Trial Balance.
• Return Outward Account/ Purchase Return
Account
Always Credit Balance
Shown on credit column of a Trail Balance.
• Opening stock account has debit balance – shown
in column of a Trial Balance.
• Accounts of assets such as plant & Machinery,
Furniture, land & Building, Motor Car Bill
Receivable, Goodwill, Trade mark, Patent,
Copyright, Cash in hand etc. have debit balance
and are shown in Debit Column of Trial Balance.
• Bank balance may be debit/Credit.
• Accounts of income & gains have credit balance –
shown in credit column of a Trial Balance.
• Accounts of expenses & Losses have Debit
Balance – are shown in Debit Column of Trail
Balance.
• Debit Balance – Assets, Drawings, Debtors,
Expenses & Losses.
• Credit Balance – liabilities, Capital, Creditors,
Income & Gain.
Example
 Trial Balance
as on 30th November, 2017