INTRODUCTION

TO FINANCIAL
ACCOUNTING
1
TOPICS
COVERED
• Meaning of Accounting
• Difference between Book Keeping and Accounting
• Is accounting an art or science
• Objectives of Financial Accounting
• Branches of Accounting
• Nature of Accounts with examples
• Double Entry System and its rules with examples
• Accounting Concepts
• Accounting Conventions
• Uses of Financial Accounting
• Users of Accounting Information
• Advantages of Accounting
• Limitations of Financial Accounting 2
• Important Terms for Reference
Meaning of
Accounting
• Art of recording and classifying the business transactions and
events which includes – receipt and payment of cash,
purchase and sale of goods on credit etc
• The transactions must be in monetary terms
• Art of making summaries, analysis and interpretation of
business transactions
• Communication to the external and internal stakeholders for
decision making

3
Difference between
Book Keeping and
BASIS FOR COMPARISON BOOKKEEPING
Accounting Meaning Bookkeeping is an activity of recording
the financial transactions of the
company in a systematic manner.
What is it? It is the subset of accounting.
Decision Making On the basis of bookkeeping records,
decisions cannot be taken.
Preparation of Financial Statements Not done in the bookkeeping process
Tools Journal and Ledgers
Methods / Sub-fields Single Entry System of Bookkeeping
and Double Entry System of
Bookkeeping
Determination of Financial Position Bookkeeping does not reflect the
financial position of an organization.
ACCOUNTING
Accounting is an orderly recording and
reporting of the financial affairs of an
organization for a particular period.
It is regarded as the language of
business.
Decisions can be taken on the basis of
accounting records
Part of Accounting Process
Balance Sheet, Profit & Loss Account
and Cash Flow Statement
Financial Accounting, Cost Accounting,
Management Accounting, Human
Resource Accounting, Social
Responsibility Accounting. 4
Accounting clearly shows the financial
position of the entity.
Accounting as science and
art
• As science
- An accountant finalizes the economic results by identifying,
analyzing, classifying using the method of double-entry
bookkeeping accounting system.
- So, Accounting is a science that includes comprises of rules,
principles, concepts, conventions and standards in science.
• As Art
- it presents the financial findings by following and
implementing a universally accepted method (GAAP).
- the established rules and principles of accountingis
applied in
bookkeeping process of and economic entity 5
Objectives of
Financial Accounting
• To know the results of business – via profit and loss account or
income and expenditure account

• To ascertain the financial position of the business – the extent of

assets and liabilities at any point of time through preparation of
balance sheet

• To ensure control over the assets – important in prevention of

frauds, misappropriation and losses

• To facilitate proper management of cash – surplus fund can be used

in profitable ventures and deficiency of cash can be overcome by
preparing for funds from bankers etc

• To provide requisite information – information to the govt and tax

authorities with great ease, as and when needed 6
 Branches of
Accounting
Basis Financial
Accounting
Cost Accounting Management
Accounting
Objects Record transactions Ascertainment, allocation, To assist the
& accumulation and management in
determine accounting for decision-making &
financial cost policy formulation.
position & profit
Nature or Concerned with both Deals with
loss. and
past present projection of data for
Concerned recorded(historical in the future (futuristic
with historical nature). in nature)
Principle data.
Governed by Certain principles No set principles
GAAP followe for recording are followed in it.
Followed d costs.
Data Qualitative aspects Only quantitative aspect Uses
is are not recorded recorded. quantitative
both7
used qualitative
and
concepts.
 Branches of
Accounting
Basis Financial Cost Accounting Management
Accounting Accounting
Reporting Generally at end As & when desired As & when desired
by of year management by management
frequency
Publication Published in case NOT NOT
of companies published published

Information Monetary Both and Both monetary

recorded transactions monetary non- and non-monetary
ONLY monetary information
information.
Forms Accounts These are These are
of Account prepared
are to kept Voluntarily
generally kept Voluntarily
generally
the
meet meet the requirements
to to
meet the requirements8
requirements.
legal of the management. of the management.
 NATURE OF
ACCOUNTS
Personal Account Real Account Nominal Account

The elements or accounts The elements or accounts The elements or accounts

which represent persons which represent tangible or which represent expenses,
and organisations. intangible aspects or helps losses, incomes, gains.
the organisation to earn
profit
• Mrs. Vimla a/c - • Cash a/c - representing • Salaries a/c -
representing Mrs. Vimla cash which is tangible. representing
a person. • Goods/Stock a/c - expenditure on account
• M/s Bharat & Co a/c - representing Stock of salaries, an expense.
representing M/s Bharat which is tangible. • Interest received a/c -
& Co, an organisation. • Furniture a/c - representing income on
• Capital a/c - representing Furniture account of interest, an
representing the owner which is tangible. income.
of the business, a person • Goodwill • Loss on sale of Asset 9
or organisation. a/c
• Bank a/c - representing - representing the loss
Bank, an organisation. incurred on sale of
 NATURE OF ACCOUNTS
- EXAMPLES
• Started Business with a Capital of 1,00,000.

Since capital in the form of cash is being brought into the business,
capital increases by 1,00,000 and cash increases by 1,00,000

Capital a/c Cash a/c

↓ ↓
Perso Tangible Aspect (Asset)
n ↓
↓ Real a/c
Person
al a/c
10
 NATURE OF ACCOUNTS
- EXAMPLES
• Bought Furniture for cash 25,000

Since Furniture is being bought by paying cash, the value of Furniture

increases by 25,000 and the cash available with the business would
reduce by 25,000.

Furniture a/c Cash a/c

↓ ↓
Tangible Aspect (Asset) Tangible Aspect (Asset)
↓ ↓
Real a/c Real a/c

11
 NATURE OF ACCOUNTS
- EXAMPLES
• Bought Goods for cash 25,000 from M/s Roxy Brothers.
Since goods are bought by paying cash, the value of Goods increases by
25,000 and the cash available with the business would reduce by
25,000.

Goods/Stock a/c Cash a/c

↓ ↓
Tangible Aspect (Asset) Tangible Aspect (Asset)
↓ ↓
Real a/c Real a/c

*Vendor name is irrelevant in cash purchases 12

NATURE OF ACCOUNTS
- EXAMPLES
•Bought Goods from Mr. Shyam Rao on credit for 10,000.
Since goods are bought on credit, the value of Goods increases by
10,000. The liabilities of the business would increase by 10,000. This
liability is indicated by an element identified by the name of the vendor
who gave the goods on credit i.e. Mr. Shyam Rao.

Goods/Stock a/c Mr. Shyam Rao a/c

↓ ↓
Tangible Aspect (Asset) Person
↓ ↓
Real a/c Person
al a/c
13
NATURE OF ACCOUNTS
- EXAMPLES
• Sold Goods for cash 20,000 to Mr. Peter
Since goods are sold by taking cash, the value of Goods decrease by
20,000 and the cash available with the business would increase by
20,000.

Goods/Stock a/c Cash a/c

↓ ↓
Tangible Aspect (Asset) Tangible Aspect (Asset)
↓ ↓
Real a/c Real a/c

*Buyer name is irrelevant

14
 NATURE OF ACCOUNTS
- EXAMPLES
• Sold Goods on credit to M/s Bharat & Co., for 10,000.
Since goods are sold on credit, the value of Goods decreases by 10,000.
A new asset in the form of a debtor (those who owe us) is created. The
new asset is indicated by an element identified by the name of the
organisation which purchased the goods on credit i.e. M/s Bharat & Co.

Goods/Stock a/c M/s Bharat & Co. a/c

↓ ↓
Tangible Aspect (Asset) Perso
↓ n
Real a/c ↓
Person 15
al a/c
Double Entry
System
• Every transaction involves two parties or accounts – one
account gives the benefit and the other receives it. It is called
dual entity of transaction
• The process of keeping account accepting this dual entity i.e.
debiting one account for a definite amount of money and
crediting the other account for the same amount is called
double entry system.
• Therefore, for every debit there is a corresponding credit for
equal amount of money and for every credit there is a
corresponding debit for equal amount of money; i.e. for every
transaction one account is debited for the amount of
transaction and the other account is credited for the equal
16
amount of money.
Rules of Double
Entry
Type of Account Debit Credit

Personal Account Receiver Giver

Real Account What comes in What goes out

Nominal Account Expense and losses Incomes and gains

17
Rules of Double Entry
- Examples
• Commenced business with a capital of 2,00,000.

Capital a/c Cash a/c

↓ ↓
Person Tangible Aspect (Asset)
↓ ↓
Person Real a/c
al a/c ↓
↓ Coming in
Giving ↓
benefi Debit
t [Debit
↓ what
Credit comes in]
[Credit 18
the
benefi
t
Rules of Double Entry
- Examples
• Bought Furniture for cash 20,000.

Furniture a/c Cash a/c

↓ ↓
Tangible Aspect (Asset) Tangible Aspect (Asset)
↓ ↓
Real a/c Real a/c
↓ ↓
Coming in Going out
↓ ↓
Debit Credit
[Debit [Credit what goes out]
what
comes in]
19
Rules of Double Entry
- Examples
• Paid Rent to the shop owner Mr. Murugan 5,000.

Rent Paid a/c Cash a/c

↓ ↓
Expenditure Tangible Aspect (Asset)
↓ ↓
Nominal Real a/c
a/c ↓
↓ Going out
Expense ↓
↓ Credit
Debit [Credit what goes out]
[Debit
all
expense 20
s/losses
]
Rules of Double Entry
- Examples
• Paid cash into bank 1,50,000

Bank a/c Cash a/c

↓ ↓
Organisation Tangible Aspect (Asset)
↓ ↓
Personal a/c Real a/c
↓ ↓
Receiver Going out
↓ ↓
Debit Credit
[Debit [Credit what goes out]
the
benefit
receiver 21
]
Rules of Double Entry
- Examples
• Bought Goods for cash 10,000 from M/s Shamir Jain & Co.,

Goods/Stock a/c Cash a/c

↓ ↓
Tangible Aspect (Asset) Tangible Aspect (Asset)
↓ ↓
Real a/c Real a/c
↓ ↓
Coming in Going out
↓ ↓
Debit Credit
[Debi [Credi
t t 22
what what
come goes
s in] out]
Rules of Double Entry
- Examples
• Bought Goods on credit from M/s Ramdas & Bros. for 10,000.

M/s Ramdas & Bros. a/c Goods/Stock a/c

↓ ↓
Organisation Tangible Aspect (Asset)
↓ ↓
Personal a/c Real a/c
↓ ↓
Giver Coming in
↓ ↓
Credit Debit
[Credi [Debi
t the t
23
bene what
fit come
giver] s in]
Rules of Double Entry
- Examples
• Sold goods for cash 12,000 to Mr. Naryan Tiwari.

Cash a/c Goods/Stock a/c

↓ ↓
Tangible Aspect (Asset) Tangible Aspect (Asset)
↓ ↓
Real a/c Real a/c
↓ ↓
Coming in Going out
↓ ↓
Debit Credit
[Debit what comes in] [Credit what goes out]
24
Rules of Double Entry
- Examples
• Bought Machinery from M/s Boolani Machinery and paid by
cheque 25,000.

Bank a/c Machinery a/c

↓ ↓
Organisation Tangible Aspect (Asset)
↓ ↓
Personal a/c Real a/c
↓ ↓
Giver Coming in
↓ ↓
Credit Debit
[Credit the benefit giver] [Debit what comes in]
25
Rules of Double Entry
- Examples
• Sold goods on credit to Mr. Natekar for 8,000.

Mr. Natekar a/c Goods/Stock a/c

↓ ↓
Person Tangible Aspect (Asset)
↓ ↓
Personal a/c Real a/c
↓ ↓
Receiver Going out
↓ ↓
Debit Credit
[Debit the benefit reciever] [Credit what goes out]
26
Rules of Double Entry
- Examples
• Paid weekly wages to workers 5,000

Wages Paid a/c Cash a/c

↓ ↓
Expenditure Tangible Aspect (Asset)
↓ ↓
Nominal a/c Real a/c
↓ ↓
Expense Going out
↓ ↓
Debit Credit
[Debit all expenses/losses] [Credit what goes out]
27
Rules of Double Entry
- Examples
• Paid M/s Ramdas and Brothers by cheque 5,000.

M/s Ramdas & Bros. a/c Bank a/c

↓ ↓
Organisation Organisation
↓ ↓
Personal a/c Personal a/c
↓ ↓
Receiver Giver
↓ ↓
Debit Credit
[Debit the benefit reciever] [Credit the benefit giver]
28
Rules of Double Entry
- Examples
• Received from Mr. Natekar 2,000

Cash a/c Mr. Natekar a/c

↓ ↓
Tangible Aspect (Asset) Person
↓ ↓
Real a/c Personal a/c
↓ ↓
Coming in Giver
↓ ↓
Debit Credit
[Debi [Credi
t t the
29
what bene
come fit
s in] giver]
Rules of Double Entry
- Examples
• Received commission from M/s Orion Traders for giving a
trade lead 500.

Commission Received a/c Cash a/c

↓ ↓
Income Tangible Aspect (Asset)
↓ ↓
Nominal a/c Real a/c
↓ ↓
Income Coming in
↓ ↓
Credit Debit
[Credi [Debi
t all t
30
incom what
es/gai come
ns] s in]
Journal
Entry
• A daily written records of transactions

Format

31
Journal Entry -
Example

32
 Journal Entry -
Example

Journal Entry

33
Journal Entry -
Example

34
Journal Entry -
Example

35
Journal Entry -
Example

36
Journal Entry -
Example

37
Journal Entry -
Example

38
Journal Entry -
Example

39
Accounting
Concepts
• Business Entity Concept
- Business is established to achieve an economic goal
-Accounting Equation –
(Assets = Liabilities + Capital)

• Money Measuring
Concept
- All the events and transactions are recorded in the terms of
money
- Does not take care of the effects of inflation because it
assumes stable value for measuring
40
Accounting
Concepts
• Going Concern Concept
- It assumes that business will exist for a longer period of time
- It supports the concept of valuing the assets at historical cost or
replacement cost

• Dual Aspect Concept

- Every transaction has two aspects – giving certain benefits and
receiving certain benefits

• Periodicity Concept
- Business is segmented into different periods (accounting periods)
and accordingly the result of each period is ascertained e.g. Income
statement (profit and loss), balance sheet (financial position) 41
Accounting
Concepts
• Historical Cost Concept

- Transactions are recorded wrt the respective amounts

involved.
- Does not take in account the inflation rate and depreciation
rates

• Matching Concept
- All the costs should be associated to a particular period should
be compared with revenues associated with that period to
obtain net income
- It necessitates adjustments for outstanding expenses, prepaid
expenses, etc 42
Accounting
Concepts
• Realisation Concept
- Recognises revenue when sale is made

• Accrual Concept
- Revenue is recognised on its realisation
- Cost is recognised when it is incurred and not when the
payment is made

• Objective Evidence Concept

- Accounting must be based on objective evidence – every
transaction should be supported by verifiable document and 43
free from biasness
Accounting
Conventions
• Conservatism

- Revenues and profits are not anticipated. Only realized profits

with reasonable certainty are recognized in the profit and loss
account
- However, provision is made for all known expenses and losses
whether the amount is known for certain or just an estimation
- This treatment minimizes the reported profits and the
valuation of assets

44
Accounting
Conventions
• Consistency
- Companies should choose the most suitable accounting
methods and treatments, and consistently apply them in
every period
- Changes are permitted only when the new method is
considered better and can reflect the true and fair view of the
financial position of the company
- The change and its effect on profits should be disclosed in the
financial statements

45
Accounting
Conventions
• Disclosure
- Financial statements should be prepared to reflect a true and
fair view of the financial position and performance of the
enterprise
- All material and relevant information must be disclosed in the
financial statements

46
Uses of Financial
Accounting
• Ascertaining the operation profit or loss
• Ascertaining the financial position of the business
• Keeping systematic records
• Protecting and controlling business properties
• Facilitating rational decision-making
• Planning and control operations.
• Compliance with the legal requirements
• Making information available to various groups and users at a
particular time.
• Evidence in court in case of dispute
• Substitute of memory
• Settlement of taxation liability
• Comparative study
• Sale of business
• The amount ,size and causes of increase or decrease of capital 47
Users of Accounting
Information –
• Owners
Internal
- They provide funds for the operations of a business
- Interested in knowing how profitably the business operations have
been carried out and how the capital is deployed in the form of
assets and liabilities

• Management
- As the management is answerable to the owners, they need up to
date information which helps them in various facets of management
like planning, decision making and controlling

• Employees
- They need this information to analyse the which firm they are
serving and how the bonus and incentives would be paid to them 48
Users of Accounting
Information -
• Prospective Investors
External
- they are the potential investors
- By reviewing the past and present performance of the business, they
decide to invest their money
• Creditors
- Included supplier of goods and services on credit and others lending
money
- their welfare is closely related to the progress of the business as
they
can analyse the paying off capacity of the business
• Government
- Its needs information for taxation and other purposes e.g. sales tax,
•income tax, excise duty etc.
Consumers
- To analyse the exercise better control over cost of production and this
inturn improves the image and reputation of the business
• Research Scholars 49
- To analyze the financial operations
Advantages of
Accounting
1. Complete and Systematic Record:

Accounting is based on generally accepted principles and a scientific way of presentation of

business transactions in books of accounts. As such, accounting is a complete and systematic
recording of all business transactions. The limitations of humans, that they can not keep all
transactions in mind, is overcome by accounting because each and every business transaction
can be recorded and analyzed through same.

2. Determination of Selling Price:

The main function of the management is decision making. Accounting helps and guides the
management to take decisions in respect of determining selling price, deduction of cost,
increase in sales etc.

3. Valuation of the Business:

In case of sale of business or conversion of one business into another, true and fair value of
the business is calculated. Through accounting, the correct picture can be depicted in Balance
Sheet and as such the purchase price can be determined. Balance Sheet shows the value of
assets & liabilities of the business which can be used to calculate its net worth.
50
Advantages of
Accounting
4. Helps in Raising Loan:

For further expansion, business must have sufficient funds. Sometimes, due to paucity of
funds business cannot do well. In those cases further funds can be raised by taking loan from
some financial institutions like banks, IDBI, ICICI etc. These financial institutions lend money on
the basis of profitability and soundness of the business enterprise. The profitability and
soundness can be measured by the Trading and Profit & Loss Account and Balance Sheet, the
final results of books of accounts.

5. Evidence in Court of Law:

The business transactions are recorded in the books of accounts supported by authenticated
documents viz. vouchers etc. Thus, the accounts can be used as an evidence in the court of
law.

6. In Compliance of Law:

Every business has to deal with various government departments like income tax, sales tax,
custom and excise etc. Various periodic returns are to be filed with these departments.
Accounting helps in preparation and filing of such returns.
51
Advantages of
Accounting
7. Inter-Firm or Intra-Firm Comparison:

• Trading and Profit & Loss Account shows net profit earned or net loss sustained by the
business. If the accounts are maintained properly, records relating to various expenses,
sales, gross profit and net profit etc. can be compared.
• As such, accounting helps in inter- firm and intra-firm comparison. Comparison of accounts
of two different enterprises for the same year is known as inter-firm comparison and
comparison of two different periods for the same business enterprise is known as intra-firm
comparison. The performance of the business enterprise is then compared with the
predetermined goals and shortcomings, if any, can be rectified accordingly.

8. Facilitates Audit:

Depending upon the size, nature and type of business, certification of books of accounts,
known as audit, is mandatory. Audit certificate issued by the auditor on the accounts is a clean
chit to organization which proves that there are no irregularities in the organization.

9. Effective Management:

Accounting facilitates proper feed back to the management. As such, it helps the management
in planning as well as control of different activities of the business enterprise. It also helps the 52
management to evaluate the performance of the business enterprise and takes timely action
to remove the shortcomings in the management.
Limitations of
Financial Accounting
• Records only monetary transactions
• Effects of price level accounting is not considered
• No realistic information due to concepts and convention
followed
• Personal bias of accountant affects the accounting
statements
• Permits alternative treatment – Lack of uniformity in
accounting principles
• Historical in Nature – records only the past transactions and
no guidance of future
• Does not record the effect of various govt regulations
53
Important Terms for
Reference

54
Business
Transaction
• Any exchange of money or money’s worth as goods
and services between two parties is called a
business transaction
•An event which can be expressed in terms of
money May relate to purchase and sale of
goods, receipt and
• payment of cash and rendering of services by
one party to another.
• Transactions may be:
I. Cash transaction: When payment is made immediately
II. Credit transaction :When payment
is postponed to a future date 55
Assets
It is any physical thing or right owned which has
money value.
• These are resources owned by the business which
are expected to give benefits in the future.
• Assets may be fixed assets or current assets
• Assets include:
– Land - tangible
– Building - Tangible
– Equipment – Tangible
– Goodwill – Intangible 56
– Brand - Intangible
Liabilit
y• These are amounts owed by the enterprise
to the outsiders i.e. to all others except the
owner
• These are claims of outsiders on assets of
the firm.

57
Capital (Owner’s
Equity)
• It is the claim of owners on the assets of an
enterprise.
• It is the excess of assets over liabilities i.e. it
is what’s left of the assets after liabilities have
been deducted.
• Also known as networth

58
Revenu
e• They are amounts received
from customers for:
– sales of products or
– performance of services or
– in return of use of the firm’s assets by
outsiders.
• Revenues include the following
– Sales proceeds
fees for performance of services
– rent
59
– interest
Expense
• An expense is the amount incurred in the
process of earning revenue.
• They are amounts that have been paid or will
be paidlater for costs that have been incurred
to earn revenue.
• Include:
– salaries and wages
– Utilities payments
– supplies used
– advertising 60
Incom
e
• It is excess of revenue over expense

• It is the favorable change in owner’s equity which results

from operations i.e. it is an inflow of assets or decrease
in liabilities resulting in increase in capital.

61
Trade Debtor
(Account Receivable)

• A debtor is a person who owes money.

• The amount due from a debtor as per books of

account is called book debt or Accounts Receivable.

• A trade debtor is a person who owes money as a

result of purchase of goods or services on credit

62
Trade Creditor
(Accounts Payable)

• A creditor person to whom money is owing or payable.

•A trade creditor is a person who owes to whom money is
owing or payable as a result of purchase of goods or services
on credit

•Accounts Payable is a liability that results from the

purchase of goods or services on account (on credit)
63
Expenditure
• Takes place when an asset or service is acquired.

• Include both payment of a

immediately sum and a promise to pay it at a
•An expense is anfuture date. whose benefit finishes or
expenditure is
enjoyed immediately such as salaries, rent, etc.
•An expenditure which will provide benefits in the future
is considered as an asset
• A loss is an expenditure without
any benefit to the concern 64