Professional Documents
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LESSON
1
FINANCIAL ACCOUNTING
CONTENTS
1.0 Aims and Objectives
1.1 Introduction
1.2 Process of Accounting
1.2.1 What is Cash System?
1.2.2 What is Accrual System?
1.2.3 Value at Which it is to be Recorded ?
1.3 Utility of the Financial Statements
1.3.1 To Management
1.3.2 To Shareholders, Security Analysts and Investors
1.3.3 To Lenders
1.3.4 To Suppliers
1.3.5 To Customers
1.3.6 To Govt. and Regulatory Authorities
1.3.7 To Promote Research and Development
1.4 Accounting Principles
1.5 Accounting Concepts
1.5.1 Money Measurement Concept
1.5.2 Business Entity Concept
1.5.3 Going Concern Concept
1.5.4 Matching Concept
1.5.5 Accounting Period Concept
1.5.6 Duality or Double Entry Accounting Concept
1.5.7 Cost Concept
1.6 Accounting Conventions
1.6.1 Convention of Consistency
1.6.2 Convention of Conservatism
1.6.3 Convention of Disclosure
1.6.4 Persons of Nature
1.6.5 Persons of Artificial Relationship
1.6.6 Persons of Representations
1.6.7 Receiver of the Benefits
1.6.8 Giver of the Benefits
1.7 Real Accounts
1.8 Nominal Accounts
1.9 Transactions in between the Real A/c
1.9.1 What is Movement-In?
1.9.2 What is Movement-Out?
1.10 Journal entries in between the accounts of two different categories
1.10.1 What is meant by Ledger?
1.10.2 Ledgering
1.11 Case Let
1.12 Let us Sum up
1.13 Lesson-end Activity
1.14 Keywords
1.15 Questions for Discussion
1.16 Suggested Readings
Accounting and Finance
for Managers 1.0 AIMS AND OBJECTIVES
In this less we shall discuss about financial accounting. After going through this lesson
you will be able to:
(i) analyse process of accounting and accounting concepts.
(ii) discuss accounting conventions.
1.1 INTRODUCTION
Accounting is a business language which elucidates the various kinds of transactions
during the given period of time. Accounting is defined as either recording or recounting
the information of the business enterprise, transpired during the specific period in the
summarized form.
What is meant by accounting?
Accounting is broadly classified into three different functions viz
Recording
Classifying and Transactions of Financial Nature
Summarizing
Is accounting an equivalent function to book keeping ?
No, accounting is broader in scope than the book keeping., the earlier cannot be
equated to the later. Accounting is a combination of various functions viz
Accounting
Recording of Transactions
Classification
Sum m arisation
Interpretation
American Institute of Certified Public Accountants Association defines the term accounting
as follows "Accounting is the process of recording, classifying, summarizing in a
significant manner of transactions which are in financial character and finally results
are interpreted."
Qualities of Accounting:
l In accounting, transactions which are non- financial in character can not be recorded.
l Transactions are recorded either individually or collectively according to their groups.
l Users should be able to make use of information.
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Financial Accounting
1.2 PROCESS OF ACCOUNTING
Step 1
Identification of Transaction
Recording
Step 2
Preparation of Business Transactions
Step 3
Recording of Transactions in Journal
Grouping
Step 4
Posting In Ledgers
Summarizing
Step 5
Preparation of Unadjusted Trial Balance
Step 6
Pass of Adjustment Entries
Step 7
Preparation
Financial Accounting is described as origin for the creation of information and the
continuous utility of information
After the creation of information, the developed information should be appropriately
recorded. Are there any scales/guide available for the recording of information? Yes,
What are they?
They are as follows
l What to record: Financial Transaction is only to be recorded
l When to record: Time relevance of the transaction at the moment of recording
l How to record: Methodology of recording - It contains two different systems of
accounting viz cash system and accrual system
1.3.3 To Lenders
The lenders do study about the business enterprise through the available information of
its financial statements normally before lending. The aim of the study is to analyse the
status of the firm for the worthiness of lending with reference to the payment of interest
periodicals and the repayment of the principal.
1.3.4 To Suppliers
The suppliers are in need of information about the business fleeces before sale of goods
on credit. The Suppliers are very cautious in supplying the goods to the business houses
based on the various capacities of themselves. The most important capacity required as
well as expected from the buyer firms is that prompt repayment of dues of the credit
purchase from the suppliers. This quality of prompt payment could be known through
culling out the information from the balance sheet.
It mainly plays pivotal role in answering the status inquiries about the buyer
1.3.5 To Customers
The legal relationship of the transferability of ownership of the products is obviously
understood through financial information available in the statements. The agreement of
warranty and guarantee is tested through the financial status of the enterprise.
(b) Classifying
(c) Summarising
Accounting Concepts
Accounting Conventions
Accounting Principles
12
1.5.1 Money Measurement Concept Financial Accounting
This is the concept tunes the system of accounting as fruitful in recording the transactions
and events of the enterprise only in terms of money. The money is used as well as
expressed as a denominator of the business events and transactions. The transactions
which are not in the expression of monetary terms cannot be registered in the book of
accounts as transactions.
For e.g. 5 machines, 1 ton of raw materials, 6 fork lift trucks, 10 lorries and so on. The
early mentioned items are not expressed in terms of money instead they are illustrated
only in numbers. The worth of the items are getting differed from one to another. To
record the above enlisted items in the book of accounts, all the assets should be converted
in to money. For e.g. 5 lathe machines worth Rs 1,00,000; 1 ton of raw materials worth
amounted Rs. 15,00,000 and so on.
The transactions which are not in financial in character cannot be entered in the book of
accounts.
Type of Capital
Liabilities Assets
Share capital Plant and Machinery
Preference Share Capital Land and Buildings
Debentures/Long Term Borrowings Fixtures and Tools
Retained Earnings Delivery vehicles
Commercial Paper Furniture – Industry and office
Public Deposits Office administrative devices
Bank Loan Marketable securities
Overdraft Short-term investments
Pre received Income Closing stock
Outstanding Expenses Pre paid expenses
Sundry Creditors Outstanding Income
Bills Payable Sundry debtors
Provision for Taxation Bill Receivable
Cash at Bank
Cash in Hand
15
Accounting and Finance
for Managers Concept of mutual agreement and sharing of benefits
According to this convention, the entire status of the firm should be highlighted / presented
in detail without hiding anything; which has to furnish the required information to various
parties involved in the process of the firm.
Next stage is to classify the accounts into various categories.
Classification of Accounts: The entire process of accounting brought under three major
segments ; which are broadly grouped into two categories.
Accounts
Personal Impersonal
Accounts Accounts
The entire accounts of the enterprise is broadly classified into two categories viz Personal
Accounts and Impersonal Accounts. The Impersonal accounts is further classified into
two categories viz Real accounts and Nominal accounts.
What is personal accounts?
It is an account which deals with a due balance either to or from these individuals on
a particular period. It is an account normally reveals the outstanding balance of the firm
to individuals e.g. suppliers or outstanding balance from individuals e.g. customers. This 17
Accounting and Finance is the only account which emphasizes the future relationship in between the business
for Managers
firm and the individuals.
The personal accounts can be classified into three categories.
are coming into the firm and the assets which are going out of the firm.
Whenever any movement of the assets taking place with reference to any transactions
either coming into the firm or going out of the firm should be recorded in accordance
with the set golden rules of this account.
Journalising the entries are different from one transaction to another The difference is
only due to nature and characteristics of the transactions. To journalise as easy as possible,
the systematic approach to be adopted to post the transactions without any ambiguity.
Journalising can be generally categorized into following various categories.
l Taking place within the same natured accounts
l Taking part in between accounts of two different in categories
First, we will discuss the journalizing of entries of the same natured accounts. This can
be classified into various segments
l Transactions only in between the personal accounts
l Transactions only in between the real accounts
Under the category of transactions which affect only the personal accounts are as follows:
19
l Between the persons of the nature
Accounting and Finance l Between the persons of the artificial relationship
for Managers
l Between the persons of Representations
What are the points to observed at the moment of journalizing ?
l The nature of the accounts to be identified
l The accounts to be correlated to the golden rules
l Once the accounts are finalized, the next stage is to pass the entry through proper
debiting and crediting of the accounts respectively.
The meaning of the transaction should be made explicit for easier understanding through
brief and catchy narration to follow as well as evade the ambiguity in near future.
Mr Sundar is a debtor who has paid Rs 1,500, in the bank A/c
Personal A/cs
Persons of Nature
Giver Receiver
Business Supplier
Enterprise
Rent paid Expense - Office Rent paid Nominal A/c - Debit All expenses and losses
Movement - out Cash – moving out of the firm Real A/c - Credit what goes out
(c) Personal A/c and Personal A/c (d) Real A/c and Real A/c
(3) Identify nature of the transactions: Sundar has purchased goods on credit
from M/s Melvin & Co Rs.15,000. The portion of the goods were found to
damaged which worth of Rs 5,000. Sundar immediately returned the damaged
goods to Melvin & Co.
(a) Identify the various types of accounts involved in the above illustrated
transactions.
(b) Pass the journal entries with regards to the nature of accounts involved.
Illustration 1
Pass the following various journal entries.
(i) Jan 1, 2006 Mr. Sundar has started business with a capital of Rs 50,000
(ii) Jan 2,2006 Goods purchased Rs 10,000
(iii) Jan 5, 2006 Goods sold Rs 5,000
(iv) Jan 10, 2006 Goods purchased from Mittal & Co Rs 10,000
(v) Jan 11, 2006 Goods sold to Ganesh & Co Rs 10,000
(vi) Jan 12,2006 Goods returned to Mittal & Co Rs 1,500
(vii) Jan 20,2006 Goods returned from Ganesh Rs 2,000
(viii) Jan 31,2006 Office Rent paid Rs 500
(ix) Feb 2,2006 Interim Cash Dividend paid Rs 3000
(x) Feb 8, 2006 Cash withdrawn from bank Rs 2,000
(i) Jan 1, 2006 Mr. Sundar has started business with a capital of Rs 50,000
Rs Rs
Jan 1, 2006 Cash A/c Dr 50,000
To Sundar’s capital A/c Cr 50,000
Being capital brought by sundar as cash
(iv) Jan 10, 2006 Goods purchased from Mittal & Co Rs 10,000
Rs Rs
Jan 10, 2006 Purchase A/c Dr 10,000
To Mittal A/c Cr 10,000
Being credit purchase from Mittal
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Accounting and Finance (v) Jan 11, 2006 Goods sold to Ganesh & Co Rs. 10,000
for Managers
Rs Rs
Jan 11, 2006 Ganesh A/c Dr 10,000
To SaleA/c Cr 10,000
Being credit sale made to Ganesh
(vi) Jan, 12, 2006 Goods returned to Mittal & Co Rs. 1,500
Rs Rs
Jan 12, 2006 Mittal &Co A/c Dr 1,500
To Purchase Return A/c Cr 1,500
(Being the goods returned to supplier Mittal &Co)
(vii) Jan 20, 2006 Goods returned from Ganesh Rs. 2,000
Rs Rs
Jan 20, 2006 Sales ReturnA/c Dr 2,000
To Ganesh&co Cr 2,000
Being sales return made by Ganesh & Co
(viii) Jan 31, 2006 Office Rent paid Rs. 500
Rs Rs
Jan 31, 2006 Office Rent A/c Dr 500
To Cash A/c Cr 500
Being office rent paid
Classification of transactions is being done only on the basis of preparing the ledger
accounts. The accounts are classified on the basis of nature and characteristics.
How the account transactions are classified ?
The accounts are classified through the preparation of ledger.
1.10.1 What is meant by Ledger?
Ledger is nothing but preliminary book of accounting transactions at which, each account
is separately maintained through the allotment of various pages for exclusive recording.
The exclusive allotment of pages for every account to finalize their balances. Finally,
ledger can be understood that is a document of grouping the transactions under one
heading .
It is a fundamental book of accounts which mainly highlights the status of the accounts.
Example: Plant & Machinery’s ledger A/c should reveal the transactions of the sale &
purchase of the plant and machinery.
How the transactions are recorded in the ledger ?
The journal entries which are recorded nothing but posting of the entries in the ledger
book of accounts. Posting / entering the journal entries are routinely carried out
immediately after the transactions.
Prior to discuss the posting of journal entries into the ledger accounts, every body should
24 know the contents of the ledger. The ledger is segmented into two different categories.
Proforma of the Ledger Account Financial Accounting
Credit item of the journal transaction Debit item of the journal transaction
“Krishna capital A/c” to be recorded in “Cash A/c” to be recorded in the
the debit side of the A/c i.e. Cash A/c credit side of the remaining A/c i.e
Krishna capital A/c debited into cash A/c Cash A/c credited into Krishna capital A/c 25
Accounting and Finance Next step is to Balance the individual Ledger A/c:
for Managers
How to balance the ledger A/c?
The individual ledger A/c may have more than two transactions during the specified period.
l The first step is to find out the totals of debit and credit side of the ledger account.
l The second step is to compare the totals of the two different sides
l The third step is to find out the total of which side is greater over the other
l The fourth step is to identify the difference among the two different side balances
i.e., debit and credit side totals.
l The fifth step is most important step which balances the difference on the total of
the side which bears lesser total over the greater.
l If the balance of the debit side of the ledger is more than the credit side of the
ledger is called as Debit balance ledger and vice versa in the case of Credit balance
ledger
l The closing balance of one ledger account will become automatically a opening
balance of the same ledger account for next accounting period.
Post the journal entries into respective ledger accounts. And list out their accounting
balances.
(i) Jan 1, 2006 Mr. Sundar has started business with a capital of Rs. 50,000
Rs Rs
Jan 1, 2006 Cash A/c Dr 50,000
To Sundar’s capital A/c Cr 50,000
Being capital brought by Sundar as cash
(ii) Jan 2, 2006 Goods purchased Rs 10,000
Rs Rs
Jan 2, 2006 Purchase A/c Dr 10,000
To Cash A/c Cr 10,000
Being cash purchase is made
Rs Rs
Jan 20, 2006 Sales ReturnA/c Dr 2,000
To Ganesh& co Cr 2,000
Being sales return made by Ganesh & Co
List out the various accounts which are involved in the enterprise during the year?
I. Cash Account
II. Sundar Capital Account
III. Purchase Account
IV. Sales Account
V. Mittal & Co Account
VI. Ganesh & Co Account
VII. Sales Return Account
VIII. Purchase Return Account
IX. Office Rent Account
X. Interim Dividend Account
XI. Bank Account
Dr Cash Account Cr
Date Particular Rs Date Particulars Rs
Jan 1 To Sundar Capital 50,000 Jan 2 By Purchase 10,000
Jan 5 To Sale 5,000 Jan 31 By Office Rent 500
Feb 2 To Interim Dividend 3,000 By Balance c/d 49,500
Feb 8 To Bank 2,000
60,000 60,000
50,000 50,000
` By Balance B/d 50,000
Note: Sundar capital account is having the greater credit balance over the debit balance
account which led to credit balance account.
Dr Purchase Account Cr
Date Particular Rs Date Particulars Rs
Jan 2 To Cash 10,000 By Balance c/d 20,000
Jan 10 To Mittal & Co 10,000
20,000 20,000
To Balance B/d 20,000
Note: Purchase account is bearing the debit balance account
Dr Sale Account Cr
Date Particulars Rs Date Particulars Rs
To Balance c/d 15,000 Jan 5 By Cash 5,000
Jan 11 By Ganesh 10,000
15,000 15,000
By Balance B/d 15,000
Note: Sale account is bearing the credit balance account
Dr Sales Return Account Cr
Date Particulars Rs Date Particulars Rs
Jan 20 To Ganesh 2000 By Balance c/d 2000
2000 2000
1,500
10,000 10,000
By Balance B/d 8,500
Note: Mittal & Co account is having the greater total in the credit side than the debit
side led to credit balance at the closing
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Dr Ganesh & Co Account Cr Financial Accounting
10,000 10,000
To Balance B/d 8,000
Note: Ganesh & Co account is bearing a greater debit side total than the credit side total
which led to have debit balance account
Dr Office Rent Account Cr
Date Particulars Rs Date Particulars Rs
Jan 31 To Cash 500 By Balance c/d 500
500 500
To Balance B/d 500
Note: Office rent account is bearing debit balance
Dr Interim Dividend Account Cr
Date Particular Rs Date Particulars Rs
To Balance c/d 3,000 Feb 2 By Cash 3,000
3,000 3,000
2,000 2,000
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Accounting and Finance Balance sheet as on dated 31st Mar, 2006
for Managers
Liabilities Assets
Capital(A.Pandit) 1,00,000 Building 80,0000
(+) Commission 4,925 Depreciation 2.5% 2,000
1,04,925 78,000
(+)Net profit 11,869 Furniture 23,000
1,16,794 Depreciation 10% 2,050
(-)Drawings 16,000 20,950
1,00,794 Closing stock 1,14,500
Capital( B.Pandit) 1,00,000 Sundry Debtors 25,000
(+)Commission 1,187 Cash in hand 400
1,01,187
(+) Net profit 11,869
1,13,056
(-)Drawings 16,000 97,056
Bank overdraft 29,000
Sundry creditors 12,000
2,38,850 2,38,850
List out the various accounting concepts dealt in the above balance sheet.
Explain the treatment of accounting concepts
1.14 KEYWORDS
Record
Accounting
Revenues
Personal Account
Normal Account
Real Account
Classifying
Summarizing
Business Entity Concept
Money Measurement Concept
Going Concern Concept
Matching Concept
Duality Concept
Ledger
32