FINANCIAL ACCOUNTING

M-1(A)
 Objectives

The objectives of this lecture are to:

• Define book-keeping, and accounting
• Describe the accounting process
• Explain the objectives of accounting
• Distinguish between book-keeping and accounting
• Analyse the informational requirements of various users of
accounting information and also the limitations of accounting.
• Explain the basic terminologies used in this subject
 Book-keeping

• It is defined as the science and art of recording business

transactions in a systematic manner in certain set of books known as
books of accounts. The following are the functions of book-keeping:
– To identify the transactions and events

– To measure the identified transactions and events in a common measuring unit

– To record them in suitable books of accounts

– To classify them in a book called the ledger

 ACCOUNTING
Accounting is a process of three activities:
1 Identifying
2 Recording
3 Communicating
 ACCOUNTING PROCESS
Communication

Accounting
Reports
Identification Recording

Prepare accounting
reports

SOFTBYTE
Select economic events Record, classify Annual Report

(transactions) and summarize

Analyze and interpret

for users
 Objectives of Accounting

Accounting involves the following :

• Accounting supports systematic recording of all business events or
transactions.
• Accounting measures the financial performance of an enterprise.
• Accounting facilitates reporting of results to both internal and
external users.
• Accounting is required to fulfil the statutory requirements of various
regulatory bodies such as:
• Registrar of Companies
• Securities Exchange Board of India (SEBI)
• income tax authorities
• Government
• Accounting helps in internal control by holding the concerned
persons responsible for any errors, lapses, or under performances.
 Users of Accounting Information

• Accounting reports are designed to meet the common information

needs of most decision makers. These decision makers are broadly
classified into the following eight groups.
• Investors
• Lenders
• Regulators, Rating Agencies and Security Analyst
• Management
• Employees, Trade Unions and Tax Authorities
• Customers
• Government and Regulatory Agencies
• Public
 Limitations of Accounting

Accounting has certain limitations, they are as follows:

• Accounting measures only such transactions that can be
measured in terms of money.
• Accounting is not free from bias.
• The accountants have some leeway or freedom on the methods
of depreciation charged, inventory valuation, etc. through
which profit or financial performance can be manipulated.
• Accounting ignores the price level changes when financial
statements are prepared on historical cost.
• Fixed assets are shown in the balance sheet at historical cost
less accumulated depreciation and not at their original cost.
 Basic Terminologies
Transaction:
It is transfer of money, goods, or service from one person or account to
another person or account.
– Cash transactions: cash is paid or received immediately
– Credit transactions: Promise to pay or receive cash at a future date
– Paper transactions: No cash inflow or outflow, but adjustment is
made only in the records
Capital: Funds brought in to start a business, by the owner or owners. In
the case of a company, capital is collected by issue of shares.
Assets: Held for use in the production or supply of goods and services and
not for resale in the normal course of business.
Current assets: Held or receivable within a year or within the operating
cycle of the business.
 Basic Terminologies.........

• Liquid assets: These can be easily converted into cash.

• Fictitious assets: These cannot be written off during the period of
their incidence.
• Liability: It is a financial obligation of an enterprise that arises from
a past event, the settlement of which is expected to result in an
outflow of resources embodying economic benefit.
• Current liability: It is an obligation which has to be satisfied within
a year.
• Equity: It is the residual interest in the asset of the enterprise after
deducting all its liabilities.
• Entity: It is an economic unit that performs economic activities.
• Sole trader: A single individual carrying on business with or
without the help of kith and kin is called a sole trader.
 Basic Terminologies...........

• Partnership: It is a relationship between partners to contribute

capital to start a business with an agreement to distribute profits and
losses in an agreed proportion.
• Joint stock Company: It is an organisation, for which the capital is
contributed by shareholders to carry on business.
• Goods: Refers to merchandise, commodities, products, articles, or
things in which a trader deals. Six types are there:
• Purchases: Goods purchased by a business are called purchases.
• Sales: Goods sold by a business are called sales.
• Purchases return or returns outward: Goods returned by a business to its
suppliers out of the purchases already made from them are called purchase
returns.
 Basic Terminologies......

• Sales returns or returns inward: Goods returned to a business by its

customers out of the sales already made to them are called sales returns.
• Opening stock: Unsold goods lying in a business at the beginning of a year
are called opening stock.
• Closing stock: Unsold goods lying in a business at the end of a year are
called closing stock.
• Inventory: Refers to goods held by a business for sale in the ordinary
course of business or for consumption in the production of goods or service
for sale.
• Drawings: It refers to cash, goods, or any other asset withdrawn by the
proprietor from his or her business for his or her personal or domestic use.
 Basic Terminologies.......

• Debtor: A debtor is a person who owes money to the business. A debtor

may be of four types: Trade debtor, loan debtor, debtor for assets and
debtor for service rendered.
Debt: The amount due from a debtor to the business is called a “Debt”.
Debt may be of three types: Good, bad and doubtful.
• Creditors: A creditor is a person to whom the business owes money. It can
be of four types. Such as Trade creditor, Loan creditor, Expenses creditor
and Creditor for asset purchased.
• Loss: It refers to money or the worth of money given up without any
benefit in return.
• Profit: It is a situation where the revenue of a business exceeds its
expenses.
• Journal: A journal is a daily record of business transactions.
 Basic Terminologies......

• Ledger: A ledger is an account book in which all the accounts are

maintained.
• Entry: It is the record of a transaction made in any book of account, either
in the book of original entry or in the books of final entry.
• Narration: It is a brief explanation of a journal entry. It is given below the
journal entry, within brackets.
• Posting: It is a process of transferring balances from book-keeping records
called journals to a final book-keeping record called the general ledger.
• Voucher: A document which serves as an evidence for transactions.
• Trial balance: A list of all ledger account balances on a given day.
• Balance sheet: It is also known as a Statement of Financial Position or a
Statement of Financial Condition.
 Basic Terminologies......

• Carried Forward (c/f) or Carried Down (c/d): It is used to transfer a

total or a balance figure from one period to the next or from one page to the
next.
• Brought Forward (b/f) or Brought Down (b/d): It is used to bring an
amount (balance or total) from a previous period to the current period or
from a previous page to the current page.
• Bill of exchange: It is a written documentary evidence that contains an
unconditional order signed by the maker, directing a certain person to pay a
certain sum of money only to, or to the order of, a certain person or the
bearer of the instrument.
• Bills payable: It is a bill of exchange stating an obligation to pay a certain
sum of money at a specified date.
• Bills receivable: It is a bill of exchange containing an acceptance from the
drawee (or payee) for a certain sum of money at a specified date.