AVANTHI INSTITUTE OF ENGINEERING& TECHNOLOGY

GUNTHAPALLY (V), HAYAT NAGAR (M), R. R (D) – 501512

Subject Name : Business Economics & Financial Analysis
Subject Code : SM504MS
Program/Course : B.Tech
Year/Semester : III-I (R-18)
Branch : CSM
Section : A
Academic Year : 2024 – 25
Subject Faculty : Dr. N. RAMANA REDDY, Associate Professor & HOD
M.Tech(CSE), MBA, Ph.D

Unit-IV: Financial Accounting

Accounting concepts and Conventions, Accounting Equation, Double-Entry system of
Accounting, Rules for maintaining Books of Accounts, Journal, Posting to Ledger,
Preparation of Trial Balance, Elements of Financial Statements, and Preparation of
Final Accounts.
Accounting: - Accounting is the science of recording and classifying business transactions
and the art of making significant, summaries, analysis and interpretations of those transactions
and communicating the results to persons who must make decisions.
According to the American Institute of Certified Public Accountants (AICPA), Accounting is
define as an art of making significant, summaries, analysis, recording and classifying business
transactions.
The following are the characteristics of Accounting;
 It is an art of recording the financial money transactions.
 It is an art of making significant, summaries, and analysis of financial transactions.
 It is an art of interpretations the result of financial transactions.
Accounting concepts and Conventions:-
Concepts are the basic ideas, the theories on how and why certain categories of transactions
should be treated in a particular manner.
Once the theories have been established and tested and proved to be acceptable, the task of the
Conventions is to set out the limit of their applications.
Accounting principles can be classified into two types ;
(1). Accounting Concepts
(2). Accounting Conventions
Accounting Concepts:-
1. Business entity concept: A business and its owner should be treated separately as far as
their financial transactions are concerned.
2. Money measurement concept: Only business transactions that can be expressed in terms
of money are recorded in accounting, though records of other types of transactions may be
kept separately.
3. Dual aspect concept: For every credit, a corresponding debit is made. The recording of a
transaction is complete only with this dual aspect.
4. Going concern concept: In accounting, a business is expected to continue for a fairly long
time and carry out its commitments and obligations. This assumes that the business will not be
forced to stop functioning and liquidate its assets at “fire-sale” prices.
5. Cost concept: The fixed assets of a business are recorded on the basis of their original cost
in the first year of accounting. Subsequently, these assets are recorded minus depreciation. No
rise or fall in market price is taken into account. The concept applies only to fixed assets.
6. Accounting year concept: Each business chooses a specific time period to complete a
cycle of the accounting process—for example, monthly, quarterly, or annually—as per a fiscal
or a calendar year.
7. Matching concept: This principle dictates that for every entry of revenue recorded in a
given accounting period, an equal expense entry has to be recorded for correctly calculating
profit or loss in a given period.
8. Realisation concept: According to this concept, profit is recognized only when it is earned.
An advance or fee paid is not considered a profit until the goods or services have been
delivered to the buyer.
Accounting Conventions:-
There are four main conventions in practice in accounting:
1. Disclosure Convention: - The revelation of all information, both favorable and
detrimental to a business enterprise, and which are of material value to creditors and debtors.
2. Consistency Convention: - Prescribes the use of the same accounting principles from one
period of an accounting cycle to the next, so that the same standards are applied to calculate
profit and loss.
3. Conservatism Convention: - The convention by which, when two values of a transaction
are available, the lower-value transaction is recorded. By this convention, profit should never
be overestimated, and there should always be a provision for losses.
4. Materiality Convention: - It means that all material facts should be recorded in
accounting. Accountants should record important data and leave out insignificant information.

Accounting Equation:-
Accounting equation describes that the total value of assets of a business is always equal to its
liabilities plus owner’s equity. This equation is the foundation of modern double entry system
of accounting being used by small proprietors to large multinational corporations.
Accounting equation is simply an expression of the relationship among assets, liabilities and
owner’s equity in a business. The general form of this equation is given below:

Assets = Liabilities + Owner’s Equity

Functions of Accounting:-
The following are the important functions of accounting ;
 Recording
 Classifying
 Summarizing
 Analyzing
 Interpretation
 Communication
 Business decision
Accounting Cycle:-
The accounting process is a continuous and it is routine cyclical activities that are applies to all
the business firms that monitoring and trace of their business operations. The cyclical process
is called as Accounting Cycle.
Accounting Cycle consist of the following steps are shown in the below figure ;
1. Identify transactions
2. Record journal entries
3. Post to general ledger
4. Prepare unadjusted trail balance
5. Make adjusted entities
6. Prepare adjusted trail balance
7. Prepare financial statements
8. Make closing entries.
 Figure: Steps of Accounting Cycle Process

Accounting Systems:-
There are two important systems of accounting, they are;
1). Single-Entry system of Accounting
2). Double-Entry system of Accounting
1). Single-Entry system of Accounting:-
The system which does not totally follow the principles of double entry system, it is called
Single-Entry system of accounting. The Single-Entry system of accounting each transaction
within a single record.
The system real and nominal accounts are not maintained. This type of transaction is
maintained only personal account. It is not proper system because it is not based any scientific
rules like double entry system.

2). Double-Entry system of Accounting:-

Accounting to this system, every transaction has two-side records that are debit and credit. It is
called Double-Entry system of Accounting. Double-Entry system of Accounting is based on
the principle ‘debit’ means we give something else in returns and ‘credit’ means receiving
something benefits.

The following are the principles of Double-Entry system of Accounting are ;

 Every transaction has two-side records (Debit & credit)

 Recording information maintain in two accounts.

 Recording data as per specific rules.

 Prepare of trail balance.

 Prepare financial statements.

Rules for maintaining Books of Accounts:-
Accounting is classified on the basis of transactions. There are separate rules of the double
entry system for maintaining the account books.
There are 3 types of accounts ;
1. Personal accounts
2. Real accounts
3. Nominal accounts.

1). Personal Accounts: - Accounts which are transactions with persons are called
“Personal Accounts”. Personal Account is these are the accounts of natural persons such as
ram account, gopal account. Artificial person such as SBI bank, syndicate bank of
representative personal accounts. The account of the person receiving benefit (receiver) is to
be debited and the account of the person giving the benefit (given) is to be credited.

Rule: “Debit----The Receiver

Credit---The Giver”

E.g.:- Krishna’s A/C, Gopal’s A/C, SBI A/C, Nagarjuna Finance Ltd.A/C, Reddys & Sons
A/C, HMT Ltd. A/C, Capital A/C, Drawings A/C etc.

2). Real Accounts: - The accounts relating to properties or assets are known as “Real
Accounts” .Every business needs assets such as machinery , furniture etc, for running its
activities .A separate account is maintained for each asset owned by the business .
When an asset is coming into the business, account of that asset is to be debited .When an
asset is going out of the business, the account of that asset is to be credited.

Rule: “Debit----What comes in

Credit---What goes out”

E.g.:- Cash A/C, furniture A/C, building A/C, machinery A/C etc.
3). Nominal Accounts: - Account dealing with expenses, losses, gains and incomes are
called nominal accounts, Eg. Salaries, wages commission account etc. Accounts relating to
expenses, losses, incomes and gains are known as “Nominal Accounts”. A separate account is
maintained for each item of expenses, losses, income or gain.
Rule: “Debit----All expenses and losses
Credit---All incomes and gains”

E.g.:- Salaries A/C, stationery A/C, wages A/C, postage A/C, commission A/C, interest A/C,
purchases A/C, rent A/C, discount A/C, commission received A/C, interest received A/C, rent
received A/C, discount received A/C.

S.No Types of Accounts Rule for Debit Rule for Credit

1 Personal Accounts The Receiver The Giver

2 Real Accounts What comes in What goes out

3 Nominal Accounts
All expenses and All incomes and
losses gains
Classifications of Accounts with Rules.
Journal:-
The word Journal is derived from the Latin word ‘journ’ means a day. Therefore, journal
means a ‘day Book’ in day-to-day business transactions are recorded in chronological order.
Journal means a daily record of business transactions. Journal being a book of original entry.
The transaction is first written in the journal from which it is posted to the ledger. The
transactions will be recorded.
Journal is treated as the book of original entry or first entry or prime entry. All the business
transactions are recorded in this book before they are posted in the ledges. The journal is a
complete and chronological (in order of dates) record of business transactions. It is recorded in
a systematic manner. The process of recording a transaction in the journal is called
“JOURNALISING”. The entries made in the book are called “Journal Entries”.
The proforma or table format of Journal is given below;
Date Particulars L.F. no Debit Credit
RS. RS.

1998 Jan 1 Purchases account to cash 10,000/- 10,000/-

account(being goods
purchased for cash)

Where: L.F means ledger folio, in this column the pages numbers on which the various
accounts appear in the ledger are entered.
 Date column is entered on which the transaction dates
 Particulars column is entered in being goods purchased.
 Debit and Credit columns are entered in the amount to be debit or credit respectively.
Posting to Ledger:-
It contains the final entry or permanent record of all the transactions. “A ledger is a book
which contains various accounts.” The process of transferring entries from journal to ledger is
called “POSTING”.
Ledger is a book in which various accounts such as personal, real and nominal accounts are
opened. Every transaction is first recorded in the journal, and from it, transferred to the
concerned account in the ledger. This process of transferring the transaction from the journal
to the ledger is called posting.
The following are the guidelines for posting transactions in the ledger;
1. After the completion of Journal entries only posting is to be made in the ledger.
2. For each item in the Journal a separate account is to be opened. Further, for each new item
a new account is to be opened.
3. Depending upon the number of transactions space for each account is to be determined in
the ledger.
4. For each account there must be a name. This should be written in the top of the table. At
the end of the name, the word “Account” is to be added.
5. The debit side of the Journal entry is to be posted on the debit side of the account, by
starting with “TO”.
6. The credit side of the Journal entry is to be posted on the debit side of the account, by
starting with “BY”.
Proforma or table format for Ledger: LEDGER BOOK
Amount Amount
Date Particulars L.F no Date Particulars L.F no
RS. RS.

Figure: Format for Ledger

 Date column is entered in date of transactions is recorded.
 Particular column is the debit side of the Journal entry is to be posted on the debit side
of the account, by starting with “TO”. The credit side of the Journal entry is to be
posted on the debit side of the account, by starting with “BY”.
 L.F means ledger folio, in this column the pages numbers is posted.
 The amount column is entered in the amount is written in the debited or credited.
Preparation of Trial Balance:-
The first step in the preparation of final accounts is the preparation of trail balance. In the
double entry system of book keeping, there will be credit for every debit and there will not be
any debit without credit. When this principle is followed in writing journal entries, the total
amount of all debits is equal to the total amount of all credits.
A trail balance is a statement of debit and credit balances. It is prepared on a particular date
with the object of checking the accuracy of the books of accounts. It indicates that all the
transactions for a particular period have been duly entered in the book, properly posted and
balanced.

Example:
Elements of Financial Statements:-
Financial statements are the important reports of the entity that provide the entity’s financial
information at a specific period of time to be used by many stakeholders such as management,
employees, the board of directors, investors, shareholders, customers, suppliers, bankers, and
other related stakeholders.
These Financial Statements contain five main elements of the entity’s financial information,
and these five elements of financial statements are as following :
1) Assets
2) Liabilities
3) Equities
4) Revenues
5) Expenses

1). Assets:-
For example, the account receivable is the Asset of the entity’s.
Here are examples of Assets:
 Land
 Building
 Property
 Computer equipment
 Cash in bank
 Cash on hand
 Cash advance
 Petty cash
 Inventories
 Account receivables
 Prepaid expenses
 Goodwill
2). Liabilities:-
Here are examples of Liabilities of the entity’s in Financial Statements:

 Bank Loan
 Overdraft
 Interest payable
 Tax payable
 Account payable
 Noted payable
 Borrowing from parent company
 Intercompany account payable
 Salary payable

3). Equity:-
Equity is officially defined by IASB’s Framework for preparation and presentation of financial
statements, is the residual interest in the assets of the entity after deducting all its liabilities.
Example: By solving the above definition, Equities = Assets – Liabilities. A good example of
Equity is Ordinary Shares Capital and Retained Earnings. That means equity increase or
decrease depending on the movement of assets and liabilities.
For example, if assets are increasing and the liabilities are stable, and then equities will
increase. However, if assets are stable and liabilities are increased, the equity will decrease.
The items that records in equity are:
 Share capital
 Retain earning or retain losses
 Revaluation gain
 Dividends payment

4). Revenues:-
The official definition of revenues defined by IASB’s Framework for preparation and
presentation of financial statement is increase in the economic benefits during the accounting
period in the form of inflows or enhancements of assets or decrease of liabilities that result in
increases in equity, other than those relating to contributions from equity participants.
The example of revenues is sales revenues from selling of goods or rendering of services,
interest incomes from banks deposits, as well as a dividend received from equity investments.

5). Expenses: Operating Expenses or Administration Expenses:-

Expenses here refer to the expenses that occur for daily operational costs. Those expenses are:
 Cost of goods sold
 Salaries expenses
 Depreciation
 Interest Expenses
 Tax expenses
 Utility expenses
  Transportation Cost
 Marketing Expenses
 Rental Expenses
 Repair and maintenance
 Internet Fee
 Telephone fee
Preparation of Final Accounts:-
Definition of Final Accounts: The trading and profit and loss accounts and the balance sheet
is prepared by the company at end of the time period is called Final Accounts.
In every business, the business man is interested in knowing whether the business has resulted
in profit or loss and what the financial position of the business is at a given time. In brief, he
wants to know (i) The profitability of the business and (ii) The soundness of the business.

The trader can ascertain this by preparing the final accounts. The final accounts are prepared
from the trial balance. Hence the trial balance is said to be the link between the ledger
accounts and the final accounts. The final accounts of a firm can be divided into two stages.
The first stage is preparing the trading and profit and loss account and the second stage is
preparing the balance sheet.

The process of preparing Final Accounts of two Stages ;

1. Trading account & Profit and loss account
2. Balance sheet.
TRADING ACCOUNT:-
Trading account is a part of profit and loss account. Trading account is prepared for
ascertaining Gross profit or gross loss. The difference between the sales and the cost of the
goods sold is gross profit. The main purpose of preparing the trading account is to ascertain
gross profit or gross loss as a result of buying and selling the goods.
Proforma of Trading Account
Trading account of Mr. --------------------- for the year ended 31 March ------------------
Particular Dr. Amount(Rs) Particular Cr. Amount(Rs)
To opening stock Xxxx By Sales xxxxx Xxxx
To Purchase xxxx Less: Sales return xxxxx
Less: purchase return xxxx Xxxx
To carriage inwards Xxx By closing stock Xxxx
To wage Xxxx
To freight , duty clearing charges Xxxx
To fuel and power Xxxx
To coal, gas, and water Xxxx
To motive power Xxxx
To factory rent Xxxx
To manufacturing expenses Xxxx
To direct expenses Xxxx
To factory lighting Xxxx
To gross profit By gross loss
(transfer to profit & loss a/c) Xxxx (transfer to profit & loss a/c) Xxxx
Xxxxxxxx Xxxxxxxx
PROFIT AND LOSS ACCOUNT:-
The business man is always interested in knowing his net income or net profit.Net profit
represents the excess of gross profit plus the other revenue incomes over administrative, sales,
Financial and other expenses. The debit side of profit and loss account shows the expenses and
the credit side the incomes. If the total of the credit side is more, it will be the net profit. And
if the debit side is more, it will be net loss.

Profit and loss account is prepared to ascertain the net profit or net loss of the business for a
particular period. All indirect expenses such as management and office expenses, financial
expenses, selling and distribution expenses are taken on the debit side. Gross profit and other
items of incomes such as interest received, discount received, etc. are taken on credit side. The
different between two sides is either net profit or net loss which is transferred to capital
account.
Proforma of Profit and Loss Account
Profit and loss of Mr. --------------------- for the year ended 31 March ------------------

Particular Dr. Amount(Rs) Particular Cr. Amount(Rs)

To Salaries xxx By gross profit
Add : outstanding salaries xxx Xxx Xxx
To Rent Xxx By Discount receive Xxx
To Discount allowed Xxx By Interest receive Xxx
To Office expenses Xxx By Commission receive Xxx
To Rate and tax Xxx By Dividend on shares Xxx
To Lighting Xxx By Miscellaneous Xxx
To Printing and stationery Xxx By Investments Xxx
To Postage and telegrams Xxx By Rent received Xxx
To Telephone charges Xxx
To Legal expenses Xxx
To Telephone charges Xxx
To Audit fee Xxx
To General expenses Xxx
To Advertisement Xxx
To Insurance xxx
To interest on capital Xxx
To deprecation on assets(machinery,
building, furniture, land.etc). Xxx
To Repairs Xxx
To carriage outward Xxx
To written off bad debts Xxx
To travelling expenses Xxx
To interest on loan Xxx
To net profit By net loss
(transferred to capital a/c) Xxx (transferred to capital a/c) Xxx

Xxxxxxxx Xxxxxxxx

Profit and Loss account is prepared in order to known whether the firm has made net profit or
net loss for a given accounting period.
BALANCE SHEET:-
The second point of final accounts is the preparation of balance sheet. It is prepared often in
the trading and profit and loss accounts have been compiled and closed. A balance sheet may
be considered as a statement of the financial position of the concern at a given date.
Definition: A balance sheet is an item wise list of assets, liabilities and proprietorship of a
business at a certain state.
According to J. R. Botliboi: A balance sheet is a statement with a view to measure exact
financial position of a business at a particular date.
Balance sheet is defined as a statement which sets out the assets and liabilities of a business
firm and which serves to ascertain the financial position of the same on any particular date.
 On the left-hand side of this statement, the liabilities and the capital are shown.
 On the right-hand side all the assets are shown.
Therefore, the two sides of the balance sheet should be equal. Otherwise, there is an error
somewhere.
PROFORMA OF BALANCE SHEET
Balance sheet of Mr. --------------------- for the year ended 31 March ------------------

Liabilities Amount(Rs) Assets Amount(Rs)

Capital Xxxx Plant and Machinery Xxxx
Add: Less: depreciation P&M xxx Xxxx
Net Profit xxxx Land & buildings Xxxx
interest on capital xxxx Less: depreciation xxx Xxxx
Less: Furniture and fittings Xxxx
Drawings xxxx Less: depreciation xxx Xxxx
Net loss xxxx Goodwill
-------------------------- Xxxxx Xxxx
Creditor Xxxxx Closing stock Xxxx
Bank overdraft Xxxxx Prepaid expenses Xxxx
Outstanding expenses / rent Xxxxx Debtors Xxxx
Bill payable Xxxxx Bills receivable Xxxx
Long term loans Xxxxx Cash at bank Xxxx
Mortgage Xxxxx Cash in hand Xxxx
Reserve fund Xxxxx Vehicle Xxxx
Investment Xxxx
Patents, copyrights Xxxx

Xxxxxxxx Xxxxxxxx

Advantages: The following are the advantages of final balance.

1. It helps in checking the arithmetical accuracy of books of accounts.
2. It helps in the preparation of financial statements.
3. It helps in detecting errors.
4. It serves as an instrument for carrying out the job of rectification of entries.
5. It is possible to find out the balances of various accounts at one place.
Final Accounts:- Examples: - 1

Solution:-
Balance Sheet:-
Examples: - 2

Examples: - 3
Examples: - 4

Important Questions
PART- A: - Give a brief description to the following:
 Journal
 Double entry system of Book-keeping.
 Accounting Equation
 Trial Balance
 Nominal account
 Conservatism
 Elements of Financial Statements
PART- B:-
1. Define Accounting. Describe briefly Accounting Concepts and Accounting Conventions?
2. Explain various types of Accounts and their Rules with examples?
3. What are accounting concepts? Discuss any three accounting concepts in detail?
4. What is “Accounting”? Explain Double entry system of Book- Keeping?
5. Explain any four accounting Concepts?
6. Outline the pros and cons of double entry system of accounting.
7. What are rule of maintaining of books of accounts? Explain.
8. Explain how a Journal account and ledger account can be maintained?
9. Explain Accounting Equation with an example?
10. What are the types of accounts and what are the rules governing them? Give two examples
for each of them.
11. Solve the different examples of Final Accounts?

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