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Amity Business School

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Amity Business SchoolBBA, I semester

Financial Accounting -I

Nupur Agarwal


Accounting: Introduction• According to American Institute of Certified Public

Accountants (AICPA) – “accounting is the art of recording, classifying and summarizing

in a significant manner and in terms of money, transactions, and events, which are, in part at least, of a financial character,

and interpreting the results thereof.”• The language of business through which financial information

is communicated to users.• Franciscan Monk Fra Luca Pacioli (1445-1515) as the father

of modern accounting• His Summa de Arithmetica, Geometria, Proportioni et

Proportionalita, is considered as the first text on accounting2


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Accounting has two main divisions:• Financial accounting

– Primarily prepared for users external to the company.• Management accounting

– Primarily for internal purposes


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Accounting is:• Product of economic environment• Gradually evolved as a profession with the development of

economic activity• especially … Industrial Revolution• Scope and nature of accounting is closely associated with the

gradual changes in the field of organization and management of organizations

• In the modern IT era, accounting is getting integrated into software packages and constantly adapting itself


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Accounting process• Accounting is an information system which communicates

the accounting information to it’s users (internal or external) to enable them to make reasoned decisions.

Input Process Output

Economic events measured

in financial terms

RecordingClassifying

SummarizingAnalyzing

Interpreting

Communicating information to

users


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Users of Accounting Information• Stakeholders are the ones who have an interest in what

happens as a result of the entities activities• Stakeholders classified as

– Internal users viz., managers – External users viz., creditors, equity investors, government,

and society


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Accounting and Book keeping• Accounting is the academic discipline through which

knowledge of accountancy is put into practice.• Book keeping is a part of Accounting and is concerned with

record keeping or maintenance of books of accounting.Accountancy

Accounting

Book Keeping


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• Identifying transactions and events• Measuring the identified transactions and

events in common measuring units• Recording the identified transactions and

events in Books of accounts• Classifying the recorded transactions and

events in ledger• Summarizing the classified transactions and

events in the form of income and position statements

• Analyzing the summarized results• Interpreting the analyzed results• Communicating the interpreted information

to the interested parties

Book Keeping

Accounting


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Accounting as a Measurement & Valuation System • Basic orientation of financial accounting is income

determination• Oriented towards an entity- a business unit• Tries to prescribe a series of concepts, standards, postulates

and principles• Accounting theory as a doctrine is explanatory in nature and

the underlying reasoning and justifications are related to practice


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Accounting cycle

• The accounting cycle begins when accounting personnel analyze a transaction from a source document.

• A source document is a piece of paper or electronic form that records a business activity such as the purchase or sale of goods. Eg. Bills, Vouchers etc.

• Accounting personnel record transactions in a journal.• The journal is a chronological record of business events by

account.


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Accounting cycle• Journal entries recorded are then transferred to Ledger

Accounts.• The process of transferring entries from Journal to Ledger is

called Ledger posting.• Ledger accounts are balanced and the balances are

transferred to Trail balance to check the arithmetical accuracy of postings.

• Income statements are prepared to ascertain the profits and losses for the accounting period.

• Position statement is prepared to ascertain the financial position at the end of accounting period.


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Financial Statements

• Transactions are summarized into Accounts.• Accounts are summarized into Financial statements.• Financial Statements report on the financial performance of

the organization• Financial Statements are the primary means of financial

communication. Producing the statements follows a definite cycle called the Accounting Cycle.

• A complete set of financial statements usually consists of the Balance Sheet, Income Statement and Cash Flow Statement


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Objective of Accounting• Keeping systematic record: It is very difficult to remember

all the business transactions that take place. Accounting serves this purpose of record keeping by promptly recording all the business transactions in the books of account.

• To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit earned or loss suffered in business during a particular period.

• To ascertain the financial position of the business: In addition to profit, a businessman must know his financial position i.e., availability of cash, position of assets and liabilities etc. This helps the businessman to know his financial strength.


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• To portray the liquidity position: Financial reporting should provide information about firm’s current assets and liabilities so that liquidity could be ascertained.

• To protect business properties: This helps in deciding about the value of a firm.

• To facilitate rational decision – making: Accounting records and financial statements provide financial information which help the business in making rational decisions about the steps to be taken in respect of various aspects of business.


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• To satisfy the requirements of law: Entities such as companies, societies, public trusts are compulsorily required to maintain accounts as per the law governing their operations such as the Companies Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also compulsory under the Sales Tax Act and Income Tax Act.


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Functions of Accounting• Record Keeping Function:

The primary function of accounting relates to recording, classification and summary of financial transactions-journalization, posting, and preparation of final statements. These facilitate to know operating results and financial positions. The purpose of this function is to report regularly to the interested parties by means of financial statements. Thus accounting performs historical function i.e., attention on the past performance of a business; and this facilitates decision making programme for future activities.


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• Managerial Function:Decision making programme is greatly assisted by accounting. The managerial function and decision making programmes, without accounting, may mislead. The day-to-day operations are compared with some predetermined standard. The variations of actual operations with pre-determined standards and their analysis is possible only with the help of accounting.


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• Legal Requirement function: Auditing is compulsory in ca s e o f registered firms. Auditing is not possible without accounting. Thus accounting becomes compulsory to comply with legal requirements. Accounting is a base and with its help various returns, documents, statements etc., are prepared.

• Language of Business: Accounting is the language of business. Various transactions are communicated through accounting. There are many parties-owners, creditors, government, employees etc., who are interested in knowing the results of the firm and this can be communicated only through accounting. The accounting shows a real and true position of the firm or the business.


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• Summarising function : The next important function of accounting is summarising diverse economic data into homogeneous group or unit called account. It is most important function of accounting since just like our language system, accounting communicates economic information to its users through these accounts.


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Branches of AccountingFinancial Accounting : • The terms Accounting and Financial Accounting are very � � � �

often used interchangeably. • Financial accounting is the oldest and the forerunner of the

other branches of accounting. It is also the purveyor of raw materials for other branches of accounting.

• The emphasis of financial accounting is on the historical records of by-gone transactions with a view to fulfilling stewardship obligation by the management to the owners, creditors and other interested parties


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Cost accounting : • After the Industrial Revolution which created factory system

systematic cost accounting emerged in England. • The emphasis of cost accounting is on cost ascertainment,

cost analysis and cost control and in contrast to financial accounting, it is prospective looking.

• Cost accounting embodies the analysis and synthesis of cost in such a manner that it is possible to disclose the total cost of production of a commodity or a service, vis-a-vis the analysis of the cost elements in terms of material, labour and overhead costs.


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Management accounting : • This branch of accounting is mainly concerned with supplying

both quantitative and qualitative information to the internal management of an organisation for the purpose of day to day decisions.

• Due to its importance in today’s complex business organisations it has been described as the accounting eye that provides a way of making visible the internal functioning of an organisation.

• It is defined as a process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of financial information used by management to plan, evaluate and control with in organisation and to assure appropriate use of and accountability for its resources..


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Social accounting: • Accounting has long been recognised as a social function,

but the development of social accounting techniques is the newest of the accounting innovation.

• It is defined as .... ...The modification and application by �accountants, of the skills, techniques and discipline of conventional....accounting to the analysis and solution of problems of a social nature.


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Human Resource Accounting• Way back in 1964 the first attempt to include figures on

human capital in the balance sheet was which later came to be known as Human Resource Accounting.

• Human Resource Accounting is a branch of accounting which seeks to report and emphasis the importance of human resources (knowledgeable, trained, loyal and committed employees) in a company's earning process and total assets.

• It is concerned with "the process of identifying and measuring data about human resources and communicating this information to interested parties".


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Inflation Accounting:• Inflation Accounting is concerned with the adjustment in the

value of assets (current and fixed) and of profit in the light of changes in the price level.

• In a way, it is concerned with the overcoming of limitations that arise in financial statements on account of the cost assumption (that is recording of the assets at their historical or original cost) and the assumption of stable monetary unit.

• It aims at correcting the distortions in the reported results caused by price level changes.


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Advantages of Accounting• It helps in having complete record of business transactions.• It gives information about the profit or loss made by the

business at the close of a year and its financial conditions. The basic function of accounting is to supply meaningful information about the financial activities of the business to the owners and the managers.

• It facilitates comparative study of current year’s profit, sales, expenses etc., with those of the previous years.

• It supplies information useful in judging the management’s ability to utilise enterprise resources effectively in achieving primary enterprise goals.


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• It provides users with factual and interpretive information about transactions and other events which are useful for predicting, comparing and evaluation the enterprise’s earning power.

• It helps in complying with certain legal formalities like filing of income tax and sales-tax returns. If the accounts are properly maintained, the assessment of taxes is greatly facilitated.


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Limitations of Accounting• Accounting is historical in nature. It does not reflect the

current financial position or worth of a business.• Transactions of non-monetary mature do not find place in

accounting. Accounting is limited to monetary transactions only. It excludes qualitative elements like management, reputation, employee morale, labour strike etc.

• Facts recorded in financial statements are greatly influenced by accounting conventions and personal judgements of the Accountant or Management. Valuation of inventory, provision for doubtful debts and assumption about useful life of an asset may, therefore, differ from one business house to another.

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• Accounting principles are not static or unchanging- alternative accounting procedures are often equally acceptable. Therefore, accounting statements do not always present comparable data

• Cost concept is found in accounting. Price changes are not considered. Money value is bound to change often from time to time.

• Accounting statements do not show the impact of inflation.• The accounting statements do not reflect those increase in

net asset values that are not considered realized.


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Nature of Accounting• Accounting as a process : Accounting is a process which

involves gathering, compacting, interpreting and disseminating economic information in a systematic way.

• Stewardship function : Accounting is a stewardship function. Its basic goal is to report on the resources and obligation of the entity to the owners. Through the medium of financial statements it communicates to the interested parties of the contributions and relative rights of the economy segments the shareholders/owners, creditors and �others.


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• Concepts and conventions : Since accounting is a process that aims at communicating economic information, it must rely on a set of previously agreed concepts, conventions and rules.

• Accounting as a means to an end : Although accounting system is characterised by a host of rules, procedures and conventions, they are not the end by themselves. The ultimate end of accounting is to provide external information-communication system by gathering, compacting, interpreting and disseminating economic data which gives a financial representation of the relative economic rights and interests of the economy segments, in order to facilitate judgement formulation and action taking by its users.


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• Accounting as an art : Accounting is more of an art than a science, its logical foundation is not deeply embedded in scientific or natural law. It is essentially and fundamentally utilitarian in nature, therefore, its methodologies are primarily based on expediency and upon actual day to day needs of the business community.


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Concepts of Financial Accounting• Financial accounting is based on several principles known

as Generally Accepted Accounting Principles (GAAP) These include:


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Business Entity Concept: • A business unit is an organization of persons established to

accomplish an economic goal. Business entity concept implies that the business unit is separate and distinct from the persons who provide the required capital to it.

• In the case of a company, its existence does not depend on the life span of any shareholder. Members may come and go but companies continue to survive.


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Money Measurement Concept: • In accounting all events and transactions are recode in terms

of money. Money is considered as a common denominator, by means of which various facts, events and transactions about a business can be expressed in terms of numbers.

Going Concern Concept: • Under this concept, the transactions are recorded assuming

that the business will exist for a longer period of time, i.e., a• business unit is considered to be a going concern and not a

liquidated one. • Keeping this in view, the suppliers and other companies

enter into business transactions with the business unit. unsalable.


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Dual Aspect Concept: • Every transaction has a two-fold aspect, Viz., 1.giving

certain benefits and 2. Receiving certain benefits. • The basic principle of double entry system is that every

debit has a corresponding and equal amount of credit.


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Periodicity Concept: • Under this concept, the life of the business is segmented into

different periods and accordingly the result of each period is ascertained.

• Though the business is assumed to be continuing in future (as per going concern concept), the measurement of income and studying the financial position of the business for a shorter and definite period will help in taking corrective steps at the appropriate time.

• Each segmented period is called “accounting period” and the same is normally a year. The businessman has to analyse and evaluate the results ascertained periodically.


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Historical Cost Concept: • The transactions are recorded in the books of account with

the respective amounts involved. For example, if an asset is purchases, it is entered in the accounting record at the price paid to acquire the same and that cost is considered to be the base for all future accounting.

• It means that the asset is recorded at cost at the time of purchase but it may be methodically reduced in its value by way of charging depreciation.


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Matching Concept: • The essence of the matching concept lies in the view that all

costs which are associated to a particular period should be compared with the revenues associated to the same period to obtain the net income of the business.

• Under this concept, the accounting period concept is relevant and it is this concept (matching concept) which necessitated the provisions of different adjustments for recording outstanding expenses, prepaid expenses, outstanding incomes, incomes received in advance, etc., during the course of preparing the financial statements at the end of the accounting period.


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Realisation Concept: • This concept assumes or recognizes revenue when a sale is

made. Sale is considered to be complete when the ownership and property are transferred from the seller to the buyer and the consideration is paid in full.

• There are two exceptions to this concept, viz., 1. Hire purchase system where the ownership is transferred to the buyer when the last instalment is paid 2. Contract accounts, in which the contractor is liable to pay only when the whole contract is completed, the profit is calculated on the basis of work certified each year


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Accrual Concept: • The revenue is recognized on its realization and not on its

actual receipt. Similarly the costs are recognized when they are incurred and not when payment is made.

• This assumption makes it necessary to give certain adjustments in the preparation of income statement regarding revenues and costs.

• Under cash accounting system, the revenues and costs are recognized only when they are actually received or paid.


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Objective Evidence Concept: • All accounting must be based on objective evidence, i.e.,

every transaction recorded in the books of account must have a verifiable document in support of its, existence. Only then, the transactions can be verified by the auditors and declared as true or otherwise.

• The verifiable evidence for the transactions should be free from the personal bias, i.e., it should be objective in nature and not subjective. However, in reality the subjectivity cannot be avoided in the aspects like provision for bad and doubtful debts, provision for depreciation, valuation of inventory, etc., and the accountants are required to disclose the regulations followed.


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Accounting conventionsConsistency: • The convention of consistency refers to the state of

accounting rules, concepts, principles, practices and conventions being observed and applied constantly, i.e., from one year to another there should not be any change.

• If consistency is there, the results and performance of one period can he compared easily and meaningfully with the other.

• It does not ignore changes. It admits changes wherever indispensable and adds to the improved and modern techniques of accounting.


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Disclosure: • It states that accurate, full and reliable information and data

in the financial statements which is of material interest to the users and readers of such statements should be disclosed.

• This convention is given due legal emphasis by the Companies Act, 1956 by prescribing formats for the preparation of financial statements.


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Relevance• The convention of relevance emphasises the fact that only

such information should be made available by accounting that is pertinent and helpful for achieving its objectives.

• The relevance of the items to be recorded depends on its nature and the amount involved. It includes information, which will influence the decision of its client.

• This is also known as convention of materiality. For example, business is interested in knowing as to what has been the total labour cost. It is neither interested in knowing the amount employees spend nor what they save.


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Conservatism: • This concept accentuates that profits should never be

overstated or anticipated. However, if the business anticipates any loss in the near future, provision should be made for it in the books of accounts, for the same. For example, creating provision for doubtful debts, discount on debtors, writing off intangible assets like goodwill, patent and so on should be taken in to consideration

• Traditionally, accounting follows the rule 'anticipate no profit and provide for all possible losses.' For example, the closing stock is valued at cost price or market price, whichever is lower.


ACCOUNTING STANDARDSNeed for Standards: • The information contained in published financial statements is of

particular importance to external users, such as shareholders and investors.

• Without such information they would not be able to take right decisions about their investments.

• Parliament in India has specified in the Companies Act, the type and minimum level of information which companies should disclose in financial statements.

• It is the responsibility of the accounting profession to ensure that the required information is properly presented.

• There should not be too much discretion to companies and their accountants to present financial information the 'way they like. In other words, the information contained in financial statements should conform to carefully considered standards.


• Public confidence in accounting information contained in financial statements will grow if they are satisfied as to the logic, consistency and fairness of the figures shown therein. For instance, a company could incur a loss and still "pay dividends by manipulating the loss into a profit. In the long run this course may have a disastrous effect on the company and its investors.

• Such information should make it possible for investors to evaluate the investment opportunities offered by different firms and allocate scarce resource to the most efficient ones.

• Unless there are reasonably appropriate standards, neither the purpose of the individual investor nor that of the nation as a whole can be served. The purpose is likely to be served if the accounting methods used by different firms for presenting information to investors allow correct comparisons to be made.

• If companies were free to choose their accounting methods, the consequences might be that deliberate distortions are introduced, leading eventually to misapplication of resources in the economy.


CHANGING NATURE OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) • Generally accepted accounting principles are usually developed by professional accounting

bodies like American Institute of Certified Public Accountants (AICPA) and Institute of Chartered Accountants of India(ICAI).

• In developing such principles, however, the accounting profession has to reflect the realities of social, economic, legal and political environment in which it operates.

• Besides academic research, regulatory and tax laws of the government e.g., Companies Act, 1956, income Tax Act, 1961 etc., in a large measure, influence the formulation of acceptable accounting principles.

• Stock exchanges and other regulatory agencies like Controller of Capital Issues (CCI) have laid down rules for disclosure and extent of accounting information.

• Since the environment in which business operates, undergoes constant changes as a result of changes in economic and financial policies of the Government and changes in the structure of business, continued evaluation of the relevance of generally accepted accounting principles is required.

• In this sense, the principles of accounting are not ever-lasting truths. It is the development of relevant accounting principles in tune with the present day needs of the society that would make it possible for the business enterprises to develop financial statements which would be acceptable and of value to the end users.


Accounting Standards Board • Institute of Chartered Accountants of India (ICAI) has so far issued

twenty eight standards: • Framework for the Preparation and Presentation of Financial Statements • (AS 1) Disclosure of Accounting Policies • (AS 2) Valuation of Inventories • (AS 3) Cash Flow Statements • (AS 4) Contingencies and Events Occurring after the Balance Sheet Date • (AS 5) Net Profit or Loss for the period, Prior Period and Extraordinary

Items and Changes in Accounting Policies • (AS 6) Depreciation Accounting • (AS 7) Accounting for Construction Contracts • (AS 8) Accounting for Research and Development • (AS 9) Revenue Recognition • (AS 10) Accounting for Fixed Assets


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• (AS 11) Accounting for the Effects and Changes in Foreign Exchange Rates • (AS 11) (Revised 2003). The Effects of Changes in Foreign Exchange Rate 21-02-

200• (AS 12) Accounting for Government Grants • (AS 13) Accounting for Investments • (AS 14) Accounting for Amalgamations • (AS 15) Accounting for Retirement Benefits in the Financial Statement of

Employers• (AS 16) on Borrowing Costs • (AS 17) Segment Reporting • (AS 18) Related Party Disclosures • (AS 19) Leases • (AS 20) Earnings Per Share • (AS 21) Consolidated Financial Statements • (AS 22) Accounting for Taxes on Income


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• Clarification on Accounting Standards (AS) 22, Accounting for Taxes on Income

• (AS 23) Accounting for Investments in Associates in Consolidated Financial Statements

• (AS 24) Discontinuing Operations• (AS 25) Interim Financial Reporting • (AS 26) Intangible Assets • (AS 27) Financial Reporting of Interests in Joint Ventures • (AS 28) Impairment of Assets 30-05-2002


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Types of Accounts

• The object of accounting is to keep a complete record of all the transactions that place in the business. To achieve this object, business transactions have been classified into three categories:

(i) Transactions relating to persons.(ii) Transactions relating to properties and assets(iii) Transactions relating to incomes and expenses.


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• The accounts falling under the first heading are known as ‘personal Accounts’.

• The accounts falling under the second heading are known as ‘Real Accounts’.

• The accounts falling under the third heading are called ‘Nominal Accounts’.


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Types of Accounts


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Personal Accounts

• Accounts recording transactions with a person or group of persons are known as personal accounts.

• Personal accounts are of the following types:(a) Natural persons: An account recording transactions with

an individual human being is termed as a natural persons’ personal account. eg., Kamal’s account, Mala’s account, Sharma’s accounts.


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(b) Artificial or legal persons: An account recording financial transactions with an artificial person created by law or otherwise is termed as an artificial person, personal account, e.g. Firms’ accounts, limited companies’ accounts, educational institutions’ accounts, Co-operative society account.

(c) Groups/Representative personal Accounts: An account indirectly representing a person or persons is known as representative personal account. When accounts are of a similar nature and their number is large, it is better tot group them under one head and open a representative personal accounts. e.g., prepaid insurance, outstanding salaries, rent, wages etc.


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• When a person starts a business, he is known as proprietor. This proprietor is represented by capital account for all that he invests in business and by drawings accounts for all that which he withdraws from business. So, capital accounts and drawings account are also personal accounts.

• The rule for personal accounts is: Debit the receiver and Credit the giver


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Real Accounts

• Accounts relating to properties or assets are known as ‘Real Accounts’.

• Separate account is maintained for each asset e.g., Cash Machinery, Building, etc.

• Real accounts can be further classified into tangible and intangible.(a) Tangible Real Accounts: These accounts represent

assets and properties which can be seen, touched, felt, measured, purchased and sold. e.g. Machinery account Cash account, Furniture account, stock account etc.


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(b) Intangible Real Accounts: These accounts represent assets and properties which cannot be seen, touched or felt but they can be measured in terms of money. E.g., Goodwill accounts, patents account, Trademarks account, Copyrights account etc.

• The rule for Real accounts is: Debit what comes in and Credit what goes out


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Nominal Accounts• Accounts relating to income, revenue, gain expenses and

losses are termed as nominal accounts. These accounts are also known as fictitious accounts as they do not represent any tangible asset.

• A separate account is maintained for each head or expense or loss and gain or income. Wages account, Rent account Commission account, Interest received account are some examples of nominal account

• The rule for Nominal accounts is: Debit all expenses and losses Credit all incomes and gains.


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INTRODUCTION• When the business transactions take place, the first step is to

record the same in the books of original entry or subsidiary books or books of prime or journal.

• Journal is a simple book of accounts in which all the business transactions are originally recorded in chronological order and from which they are posted to the ledger accounts at any convenient time.

• Journalising refers to the act of recording each transaction in the journal and the form in which it is recorded, is known as a journal entry.


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Journal


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• The journal has five columns, viz. (1) Date; (2) Particulars; (3) Ledger Folio; (4) Amount (Debit); and (5) Amount (Credit) and a brief explanation of the transaction by way of narration is given after passing the journal entry.

• Date: In each page of the journal at the top of the date column, the year is written and in the next line, month and date of the first entry are written. The year and month need not be repeated until a new page is begun or the month or the year changes.


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• Particulars: In this column, the details regarding account titles and description are recorded. The name of the account to be debited is entered first at the extreme left of the particulars column next to the date and the abbreviation ‘Dr.’ is written at the right extreme of the same column in the same line. The name of the account to be credited is entered in the next line preceded by the word “To” leaving a few spaces away from the extreme left of the particulars column.


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• Ledger Folio: The page number of the ledger in which the accounts are appearing is indicated in this column.

• Amount (Debit): The amount to be debited along with its unit of measurement at the top of this column on each page is written against the account debited.

• Amount (Credit): The amount to be credited along with its unit of measurement at the top of this column on each page is written against the account credited.

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