Fundamentals of Financial

Accounting
Nature of Accounting:
Accounting is a language of business. It records business
transactions taking place during the accounting period and at the end
of the period (the year); it shows the result of the transactions in the
form of final Accounts (consisting of at least P&L A/C and Balance
sheet.
Definition of Accounting:
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”.
Functions of Accounting:
1) Keeping systematic records.
2) Protecting properties of the business.
3) Communicating the results.
4) Meeting legal requirements.
5) Depiction of the financial position.
6) Providing effective control over business.
Limitation of Accounting:
1) Incomplete information.
2) In exactness.
3) Showing valueless Assets.
4) Manipulation.
5) Ignorance about the present value of Business.
6) Making information available to various group.
Book-Keeping:
Book Keeping is the proper and systematic keeping of books of
Accounts. Book keeping starts from the identification of business
transactions. These transactions must be supported by the documents
and they must be financial in nature.
Double Entry Book-Keeping:
Business transactions are recorded in the books of Account on
the basis of double entry system. The system is based upon the fact
that there are two aspects of every business transaction. Every
transaction involves at least two persons, parties or accounts.
Advantages: 1) Complete records of every transaction.
2) Reliable information at a glance.

1
 3) Scrutinising and verification of information.
4) Knowledge of gross profit/loss.
5) Knowledge of net profit/loss.
6) Knowledge of assets and liabilities of the business.
7) Comparative studies.
8) Detection of fraud.
Disadvantage: 1) Error of commission.
2) Error of principle.
3) Compensating Errors.
Basic Terms of Accounting:
1) Assets: The valuable things owned by the business are known
as assets. In other words, these are the properties owned by the
business.
Classification of Asset
a) Fixed Assets.
b) Floating Assets.
c) Fictitious Assets.
d) Intangible Assets.
e) Liquid Assets.

2) Capital: It is that part of wealth which is used for further

production and thus capital consists of all current assets and fixed
Assets. Capital need not necessarily be in cash. It may be in kind
also.
Kinds of capital
a) Fixed capital.
b) Working capital.

3) Liability of equity: It is the properties and creditors claim against

the assets of the business.
Classification of Liability:
a) Owners liability:
• Capital.
• Profit earned.
• Retained earning.
• Undistributed profit.
• Interest on capital.
b) Liability to creditor’s:
• Creditors for goods.
• Creditors for loan.
• Creditors for expenses.

2
 4) Goods: Articles purchased for sale by the business or for use in
the manufacture of certain other goods as raw material are known
as Goods. Goods are the Commodities, in which the business deals.

5) Purchase: In its routine business, the firm has to either

purchase finished goods for sale or purchase raw material for the
manufacture of the article being sold by the firm. The acquisition of
these articles is purchases.

6) Sales: The ultimate end of the goods purchased or

manufactured by the business in their sales. It includes both cash
and credit sales.

7) Stock: The goods available with the business for sale on a

particular date are termed as stock.

8) Revenue: Revenue in accounting means the amount realized or

receivable from the sale of goods.

9) Expenses: Generating income is foremost objective of every

business. The firm has to use certain goods and services to produce
articles, sold by it payment for these goods and services is called
“Expenses”.

10) Debtors: The term “Debtors” represents the persons or parties

who have purchased goods on credit from us and have not paid for
the goods sold to them. They still owe to the business.

11) Creditors: In addition to cash purchase the firm has to make

credit purchases also. The sellers of goods on credit to the firm are
known as its creditors for goods. Creditors are the liability of the
business.
Accounting Concept:
1) Entity concept
2) Dual aspect concept
3) Going concern concept
4) Accounting period concept
5) Money measurement concept
6) Cost concept
The concept of Debit and Credit:
Every accounting transaction has got two sides the “Debit” and a
“Credit”. These are the two signs used in accounting to present and
report the financial effect of every transaction. Debit means decrease
in proprietor’s equity and credit means increase in proprietor’s equity.

3
Type of accounts:
1) Personal Accounts
2) Real Accounts
3) Nominal Accounts

4
Rules of Accounts:
1) Personal Accounts : “Debit the receiver
Credit the giver”.
2) Real Accounts : “Debit what comes in
Credit what goes out”
3) Nominal Accounts : “Debit all expenses or losses
Credit all income or gain”.

Journal: Journal is a book of prime record for small firms.

Ledger: A ledger is a set of accounts. In other words, ledger is a book

in which various accounts (personal, real and nominal) are opened. Eq
Cash book, purchase Books, Sales books, B/R books, B/P books etc.

Posting: Posting is the process of entering in the ledger the

information given in the journals (both special and general) posting
from the journal or book is done periodically, may be weekly or
fortnightly or monthly as per the convenience of the business.
Trial Balance: Trial Balance is a statement, prepared with the debit
and credit balances of ledger accounts to test the arithmetical
accuracy of the books. It may also be prepared with debit and credit
totals of ledger account and also with the balances and totals of ledger
accounts.
Final Accounts: There are three following stages of preparing final
Accounts of a Trading concern. - 1) Trading Account
2) Profit & loss account
3) Balance sheet.

5
 Specimen ( final accounts)
Trading, Profit & Loss account for the year ending 31.3.2007

To Opening Stock XXX By Sales XXX

To Purchase XXX Less; Return XXX XXX
Less Return XXX XXX By Goods Destroyed
To Material consumed XXX ( by Fire/theft ) XXX
To Finished goods XXX By Closing Stock XXX
To Wages XXX
Add-Out standing XXX XXX
To Fuel XXX
To Carriage Inward XXX
To Freight XXX
To Gas and water XXX
To Lighting XXX
To Royalties XXX
To Gross profit C/D XXX

XXX XXX
To Salary XXX By Gross profit b/d XXX
Add : Out standing XXX XXX By Discount received XXX
To Insurance XXX By Interest received XXX
Less : Prepaid XXX XXX By Transfer fees XXX
To Advertisement XXX By Profit on sale of Assets XXX
To General expenses XXX By Dividend received XXX
To Discount allowed XXX By Provision on discount
To Rent & Taxes XXX (Creditors) XXX
To Carriage outward XXX Any other income received XXX
To Administrative expenses XXX
To Selling expenses XXX
To Distribution expenses XXX
To Traveling expenses XXX
To Directors fees XXX
To Auditors fees XXX
To Preliminary expenses XXX
To Sundry expenses XXX
To Bad debts XXX
To Reserve for bad debts XXX
To Miscellaneous expenses XXX
To Deprecation XXX
To Net profit (Transfer B/S) XXX

6
 Balance sheet as on 31.03.2007

Liabilities Assets

A) Share Capital: A) Fixed assets:

1)Authorized capital XXX Goodwill XXX
2)Issued & subs capital XXX Land and building XXX
3)Called up and paid Furniture XXX
up share capital XXX Less : Depreciation XXX XXX
Add : Forfeited XXX Motor van XXX
Less calls in arrears XXX XXX Less : Depreciation XXX XXX
Trademarks XXX
B) Reserve & Surplus: Patents XXX
General reserve XXX
Capital Reserve XXX B) Investment at cost:
Sinking fund XXX Government securities XXX
Share premium XXX Bonds XXX
Profit & loss account XXX
C) Current assets,
C) Secured loan: loans & advances:
5% Debenture XXX 1)Current assets-
Add : Interest O/S XXX XXX Cash in hand XXX
Cash at bank XXX
D) Unsecured loan: Closing stock XXX
Public deposit XXX Prepaid insurance XXX
Other unsecured loan XXX Loose tools XXX
Work in progress XXX
E) Current liabilities & Sundry Debtors XXX XXX
provisions: Less : RDB XXX XXX
1)Current liabilities 2)Loans advance-
Sundry creditors XXX Bills Receivable XXX
Bank O/D XXX Fixed deposit XXX
Bills payable XXX
Outstanding expenses XXX D)Miscellaneous
Unclaimed dividend XXX expenditure:
Unexpired discount XXX Preliminary expenses XXX
2)Provisions- Underwriting commission XXX
Provision for taxation XXX Subscription of shares XXX
Proposed dividend XXX

Total XXX Total XXX

7
 Important adjustment:

Items Particulars First place Second place

1. Wages outstanding Trading A/C B/S – C.L
Add - wages
2. Salary outstanding P&L A/C B/S – C.L
Add-salary
3. Insurance prepaid P&L – A/C B/S – C.A
Less-insurance
4. Depreciation P&L – Debit side B/S – Less from
Assets
5. Reserve for bad doubtful debts P&L – Debit side B/S – Less from
Drs
6. Bad debts “ “
7. Discount on Debtors “ “
8. Closing stock Trading A/C B/S – C.A
credit side
9. Income accru but not received P&L – Income B/S – C.A
side
10. Discount on creditors P&L – Income B/S –less from
side Cr’s
11. Interest on capital P&L – debit side B/S – liability
side
12. Interest on drawing P&L – Income B/S – less from
side capital
13. Proposed dividend P&L – debit side B/S - provision
14. Provision for taxation P&L – debit side B/S – provision
15. Debenture interest out P&L – debit side B/S – secured
standing loan

8
Problems in Final Accounts
1. The following is the Trial balance of Sun light Ltd as on
31.03.2007.Prepare Trading & Profit and loss account, Balance sheet.
Debit Credit
Share capital 100000
Land 10000
Calls in arrears 6400
Building 25000
Machinery 15000
Furniture 3200
Carriage 2300
Wages 21400
Salaries 4600
Bad debts reserve 1400
Sales 80000
Sales return 1700
Bank charges 100
Coal gas water 700
Rent Rates 800
Purchases 50000
Purchase return 3400
Bills Receivable 1200
Gen expenses 1900
Debtors 42800
Creditors 13200
Stocks 25000
Insurance 400
Cash at bank 13000
Cash in hand 2500
Share premium 6000
General reserve 24000

228000 228000
Adjustments
1. Depreciation on Building 2%, Machinary 10%, Furniture 10%
2. Reserve for bad and doubtful debts 5%. Prepaid insurance Rs120
3, outstanding liability. Wages Rs 3200, salaries Rs500, Rent Rs200
4. Closing stock Rs 30000.

9
2Following is the Trial balance of Sri Krishna company ltd Bangalore as on
31.03.2007
.
Debit Credit
Share capital 80000
Stock 51000
Purchase 220000
Sales 330000
Sales return 3800
General expenses 1800
Wages 12000
Salaries 18700
Traveling expenses 3200
Advertising 1550
Rent &taxes 4900
Discount received 2200
Bank interest 850
Bad debts 2500
Building 95000
Plant & Machinery 98000
Debtors 45000
Creditors 55500
Loan 75000
Cash in hand 1400
Reserve fund 23000
Preliminary expenses 11000
P&L (Credit) 5000
570700 570700

Adjustments;-

1. Provision for taxation Rs25000

2. Proposed dividend 15%
3. Transfer Rs 10000 to Reserve fund.
4. Closing stock Rs 32000.

Prepare Final Accounts

10