Unit - I Meaning and Nature of Financial Accounting

Aditya Kumar, Assistant Professor, Uttam Institute of Management Studies, Agra
UNIT –I
Meaning and Nature of Financial Accounting
The financial statements of a company reflect a true picture of its financial performances. They depict not
only profits and losses, but even assets and liabilities. It is only at the end of all accounting processes that
we can generate financial statements.
Meaning of Financial Statements
Financial statements are basically reports that depict financial and accounting information relating to
businesses. A company’s management uses it to communicate with external stakeholders. These
include shareholders, tax authorities, regulatory bodies, investors, creditors, etc.
Financial statements basically include the following reports:
1. Balance sheet
2. Profit and Loss statement
3. Cash flow statement
Nature of Financial Statements
Financial statements are prepared using facts relating to events, which are recorded chronologically. We
have to first record all these facts in monetary terms. Then, we have to process them using all applicable
rules and procedures. Finally, we can now use all this data to generate financial statements.
Based on this understanding, the nature of financial statements depends on the following points:
1. Recorded facts: We need to first record facts in monetary form to create financial statements. For
this, we need to account for figures of accounts like fixed assets, cash, trade receivables, etc.
2. Accounting conventions: Accounting Standards prescribe certain conventions applicable in the
process of accounting. We have to apply these conventions while preparing financial statements.
For example, valuation of inventory at cost price or market price, depending on whichever is lower.
3. Postulates: Apart from conventions, even postulates play a big role in the preparation of financial
statements. Postulates are basically presumptions that we must make in accounting. For example,
the going concern postulate presumes a business will exist for a long time. Hence, we have to
treat assets on a historical cost basis.
4. Personal judgments: Even personal opinions and judgments play a big role in the preparation of
financial statements. Thus, we have to rely on our own estimates while calculating things like
depreciation.
Objectives of Financial Statements
Stakeholders of a company heavily rely on financial statements to understand its functioning. They
portray the true state of affairs of the company. Here are some objectives of financial statements:
 Financial statements show an accurate state of a company’s economic assets and liabilities.
External stakeholders like investors and authorities generally do not possess this information
otherwise.
 They help in predicting the extent of a company’s capacity to earn profits. Shareholders and
investors can use this data to make their financial decisions.
 Financial statements of a company depict the effectiveness of its management. How well a
company is performing depends on its profitability, which these statements show.
 They even help readers of these statements know the accounting policies used in them. This
helps in understanding statements more comprehensively.
 These statements also provide information relating to the company’s cash flows. Investors and
creditors can use this data to predict the company’s liquidity and cash requirements.
 Finally, financial statements explain the social impact of businesses. This is because it shows how
the company’s external factors affect its functioning.
Scope of Accounting:
Accounting has got a very wide scope and area of application. Its use is not confined to the business
world alone, but spread over in all the spheres of the society and in all professions. Now-a-days, in any
social institution or professional activity, whether that is profit earning or not, financial transactions must
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take place. So there arises the need for recording and summarizing these transactions when they occur
and the necessity of finding out the net result of the same after the expiry of a certain fixed period.
Besides, the is also the need for interpretation and communication of those information to the
appropriate persons. Only accounting use can help overcome these problems.
In the modern world, accounting system is practiced no only in all the business institutions but also in
many non-trading institutions like Schools, Colleges, Hospitals, Charitable Trust Clubs, Co-operative
Society etc.and also Government and Local Self-Government in the form of Municipality, Panchayat.The
professional persons like Medical practitioners, practicing Lawyers, Chartered Accountants etc.also
adopt some suitable types of accounting methods. As a matter of fact, accounting methods are used by
all who are involved in a series of financial transactions.
The scope of accounting as it was in earlier days has undergone lots of changes in recent times. As
accounting is a dynamic subject, its scope and area of operation have been always increasing keeping
pace with the changes in socio-economic changes. As a result of continuous research in this field the
new areas of application of accounting principles and policies are emerged. National accounting, human
resources accounting and social Accounting are examples of the new areas of application of accounting
systems.
BASIS FOR
FINANCIAL ACCOUNTING MANAGEMENT ACCOUNTING
COMPARISON
Meaning Financial Accounting is an The accounting system which

accounting system that focuses on provides relevant information to the
the preparation of financial managers to make policies, plans and
statement of an organization to strategies for running the business
provide the financial information to effectively is known as Management
the interested parties. Accounting.
Is is compulsory? Yes No
Information Monetary information only. Monetary and non-monetary

information
Objective To provide financial information to To assist the management in planning

outsiders. and decision making process by
providing detailed information on
various matters.
Format Specified Not specified
Time Frame Financial Statements are prepared The reports are prepared as per the
at the end of the accounting period need and requirements of the
which is usually one year. organization.
User Internal and external parties Only internal management.
Reports Summarized Reports about the Complete and Detailed reports

financial position of the regarding various information.
organization
Publishing and Required to be published and Neither published nor audited by

auditing audited by statutory auditors statutory auditors.
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Accounting concepts & convention

Conventions
The term 'convention' includes those customs and traditions which guide the accountant while
preparing the accounting statements. Conventions have their origin in the various accounting
practices followed by the accountant. It is very difficult to trace the origin of the conventions and
establish their authenticity as accounting principles. But by usage they have attained the status of
accounting principles.
In this study the basic principles on which accounting is based are proposed to be classified into
'Accounting Concepts ' and 'Accounting Conventions'. All those basic assumptions or conditions upon
which the science of accounting is based are grouped under accounting concepts .Those customs or
traditions which guide the accountant while preparing the accounting statements are included under
the head accounting conventions.
Accounting Concepts
a. Separate Entity Concept
b. Going Concern Concept
c. Money Measurement Concept
d. Cost Concept
e. Dual Aspect Concept
f. Periodic Matching of Cost and Revenue Concept
g. Realization Concept
Accounting Conventions
a. Convention of Conservatism
b. Convention of Full Disclosure
c. Convention of Consistency
d. Convention of Materiality.
Separate Entity Concept
In separate entity concept the business is treated as a separate entity from the owner event though
statutes recognise no such distinct entity. In accounting the concept of separate entity is applicable in
the case of all organisations. This concept is very much relevant in the case of sole proprietorship
entities and partnerships. In the case of a company it is recognised as a separate entity by statutes
as well as from the accounting point of view.The separate entity concept helps to keep the affairs of
the business separate from the private affairs of the proprietor.
Going Concern Concept
This concept assumes that the business will continue for a fairly long period of time in future. There is
no need of forced sale of the assets of the entity. Otherwise every time the annual financial
statements are prepared the probable losses on account of the possible sale of assets should be
accounted. This would distort the operating result as revealed by the profit and loss account and the
financial position depicted in the balance sheet. On the basis of this principle depreciation is charged
on fixed assets on the basis of expected life rather than its market value and intangible assets are
amortized over a period of time .The annual financial statements are considered to be interrelated
series of statements.
Money Measurement Concept
Money is the unit in which economic events affecting a business entity are measured. The money
measurement concept implies that accounting could measure and report only those transactions and
events which could be measured in terms of money. It cannot account for qualitative aspects like
employee relations, competitive market, advantages of the entity over others etc. This concept
imposes a restriction on the ability of the financial statements to present a correct picture of the entity
as those events which are unable to be quantified in money terms are left out. Further the money as a
unit of measurement is not stable. The variations in the value of money fails to present a correct
picture of the operating results and financial position of the entity. Over a period of time the value of
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money fluctuates and even when we are employing the same unit of money the values represented
by them are not equal. Thus money as a unit of measurement fails.
Cost Concept
The basis on which assets are recorded in the books of accounts is the cost- that is the price paid to
acquire them. Cost will form the basis of which further accounting will be done as regards the asset.
No adjustment is made in the cost to reflect the market value of the asset. The cost concept does not
imply that asset will always appear at cost in the balance sheet. It only means that cost will be the
basis for further accounting treatment. The cost of the asset may be reduced gradually by the process
of charging depreciation.
Further the cost concept means that if nothing is paid for the acquisition of an asset it cannot be
shown as an asset in the books of account. Cost concept brings objectivity in the preparation and
presentation of financial statements. The assets appearing in the books should be based on objective
evidence and not on the subjective view of the person who makes such statements or of some other
person.
Paul Grady has observed the cost concept in the following words.
" Value as used in accounts signifies the amount at which an item is stated in accordance with the
accounting principles related to that item. Using the word value in this sense, it may be said that
balance sheet values generally represent cost to the accounting unit or some modifications there of;
but sometimes they are determined in other ways, as for instance on the basis of market values or
cost of replacement, in which cases the basis should be indicated in financial statements. The word
value should seldom if ever, be used in accounting statement with out a qualifying objective."
Dual Aspect Concept
The basic equation of accounting is
Assets = Equities
Or
Assets = Outsiders' Equity + Owners' Equity
Or
Assets = Liabilities + Capital
Every transaction affecting an entity has dual aspect on the accounting records. Both aspects are
recorded in the books of accounts. Hence accounting is called ' double entry system'. The two
aspects are expressed as 'debit' and 'credit '.In other words ' for every debit there is an equivalent
credit'.
The term 'assets' denotes the resources owned by a business while equities denote the claims of
various parties against the assets. Equities are two types
i) Owners' Equity and
ii) Outsiders' Equity
Owners' equity otherwise called 'capital' denotes the claims of the owners against the assets of the
entity where as outsiders' equity denotes the claims of creditors, debenture holders ,lenders etc
against the assets of the entity.
The dual aspect of transaction may result in change in the assets and equities of the organization and
make them equal.
Accounting standards in India
Indian Accounting Standards
Accounting Standards (AS) are basic policy documents. Their main aim is to ensure transparency,
reliability, consistency, and comparability of the financial statements. They do so by standardizing
accounting policies and principles of a nation/economy. So the transactions of all companies will be
recorded in a similar manner if they follow these accounting standards.
These Accounting Standards (AS) are issued by an accounting body or a regulatory board or sometimes
by the government directly. In India, the Indian Accounting Standards are issued by the Institute of
Chartered Accountants of India (ICAI).
Accounting Standards mainly deal with four major issues of accounting, namely
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i. Recognition of financial events

ii. Measurement of financial transactions
iii. Presentation of financial statements in a fair manner
iv. Disclosure requirement of companies to ensure stakeholders are not misinformed
Ministry of Corporate Affairs has notified phase-wise adoption of Ind AS. Specific classes of companies
based on their Net worth and listing status helps in this notification.
Phase I
From 1st April 2016, Indian AS became mandatorily applicable to all companies provided:
 It is a listed or unlisted company
 Its Net worth is ≥ ₹ 500 crores
Calculate Net worth using figures for the previous three Financial Years (31.03.2014, 31.03.2015 and
31.03.2016).
Phase II
From 1st April 2017, Indian AS mandatorily applicable to all companies provided:
 It is a listed company or is in the process.
 Its Net worth is ≥ ₹ 250 crores but ≤ ₹ 500 crores (on any of the above dates).
Calculate Net worth using figures for the previous four Financial Years (31.03.2014, 31.03.2015,
31.03.2016 and 31.03.2017).
Phase III
Indian AS became mandatorily applicable to all Banks, NBFCs and Insurance companies with effect
from 1st April 2018, provided:
 Net worth is ≥ ₹ 500 crores with effect from 1st April 2018.
IRDA has notified a separate set of Ind AS for Banking and Insurance Companies with effect from
1st April 2018. Core investment companies, stockbrokers, venture capitalists, etc. are all included in
NBFCS.
Calculate Net worth using figures for the previous three Financial Years (31.03.2016, 31.03.2017 and
31.03.2018)
Phase IV
From 1st April 2019, Indian AS mandatorily applicable to all NBFCs provided:
 Net worth is ≥ ₹ 250 crores but ≤ ₹ 500 crores
Companies can follow Ind AS either voluntarily or mandatorily. But, once a company starts following Ind
AS, it cannot revert back to its old method of Accounting.
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UNIT –II
Capital and Revenue Items
Introduction – Capital and Revenue Items:

In order to know the fair performance and financial standing of a business; the nature of business
transactions taking place during the year has to be analyzed. The accounting transactions may be
divided into two categories:
(1) Capital transactions (relating to capital items)
(2) Revenue transactions (relating to revenue items)
Definition of Capital Items:
Capital items are those items which have long term effects on business, (normally more than one
year). There are two main types of of capital items; (i) capital expenditure and (ii) capital receipt. For
example, fixed assets; tangible or intangible assets; (land, building, machinery, legal rights, etc)
are capital items.
Definition Revenue Items:
Revenue items are those items having short term effects on business, (normally less than one year).
There are two main types of revenue items; (i) revenue expenditure and (ii) revenue receipts. For
example, repairs, wages, salaries, fuel, etc., are revenue items.
Role of Computers in Accounting

Role of Computers in Accounting:
The manual system of recording accounting transactions requires maintaining books of accounts
such as journal, cash book, special purpose books, and ledger and so on. From these books
summary of transactions and financial statements are prepared manually.
The advanced technology involves various machines, which can perform different accounting
functions, for example a billing machine. This machine is capable of computing discount, adding net
total and posting the requisite data to the relevant accounts.
With substantial increase in the number of transactions, a new machine was developed to store and
process accounting data with greater speed and accuracy. A computer, to which it was connected,
operated this machine.
As a result, the maintenance of accounting data on a real-time basis became almost essential. Now
maintaining accounting records become more convenient with the computerized accounting.
Objects of Introduction of Computers in Accounting:
Labor Saving:
Labor saving is the main aim of introduction of computers in accounting. It refers to annual savings in
labor cost or increase in the volume of work handled by the existing staff.
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Time Saving:
Savings in time is another object of computerization. Computers should be used whenever it is
important to save time. It is important that jobs should be completed in a specified time such as the
preparation of pay rolls and statement of accounts. Time so saved by using computers may be used
for other jobs.
Accuracy:
Accuracy in accounting statements and books of accounts is the most important in business. This can
be done without any errors or mistakes with the help of computers. It also helps to locate the errors
and frauds very easily.
Double Entry System
Double Entry System of accounting deals with either two or more accounts for every business
transaction. For instance, a person enters a transaction of borrowing money from the bank. So, this will
increase the assets for cash balance account and simultaneously the liability for loan payable account
will also increase.
It’s a fundamental concept encompassing accounting and book-keeping in present times. Every financial
transaction has an equal and opposite effect in at least two different accounts.
Equation can be: ASSETS = LIABILITIES + EQUITY
Recording System
Double entry system records the transactions by understanding them as a DEBIT ITEM or CREDIT
ITEM. A debit entry in one account gives the opposite effect in another account by credit entry. This
means that the sum of all Debit accounts must be equal to the sum of Credit accounts. This method of
accounting and book-keeping results in the accurate depiction of financial statements. Thus, it also
lowers the rate of errors by detecting them on a timely basis.
Types of Accounts
The accounting and book-keeping process measures, records and communicates day to day financial
activities. A transaction is an event taking place between two economic entities, such as customers or
vendors and businesses. Accounting and book-keeping record this event.
Under a systematic accounting process, the activities are recorded into various accounts to keep the
data bifurcated and classified under account heads. There are majorly seven types of accounts wherein
all the business accounting entries and transactions are classified. These are:
 Assets
 Liabilities
 Equity
 Gains
 Losses
 Expenses
 Revenues
The accounting and book-keeping is a continuous process of tracking changes in each account as the
company continues to do its operations.
Debit and Credit
Debits and Credits are essentials to enter data in a double entry system of accounting and book-
keeping. While posting an accounting entry, an entry on the left side of the account ledger is a debit
entry and right side entry is a credit entry.
Finally, to complete an entry the total of the Debit side and the Credit side should be equal. All debits do
not always equate to increase the account nor do all credits equate to decrease the accounts. A debit
entry might increase one account and at the same time decrease another account.
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Introduction to Journal
An accounting journal is just what it sounds like—it's a place to record the details of all the financial
transactions of your business. And it keeps a record as to which of your accounts these transactions
affect. In accounting terms, a journal refers to a financial record kept in the form of a book,
spreadsheet, or accounting software. It contains all the recorded financial transaction information
about a business. It's also known as a book of first entry.
Keeping an accounting journal can prevent your business from overspending in some areas while
under spending in others. It can also prevent you (and your executives) from overdrawing funds, and
it can help you spot any irregularities before they get out of hand. In short, although it's just a simple
book or a computer spreadsheet, an accounting journal can prevent a potential crisis from starting; or
spreading.
Before computers, an accounting journal was a physical log book with multiple columns to record
financial transactions for a company. Today, most businesses use some type of financial accounting
software to record and manage their business transactions. These transactions are then assigned to
a specific ledger class using a "chart of accounts" number to prepare profit and loss statements,
financial statements, and other important financial reports.
Ledger Account:
An account is a summary of business transactions affecting a person or property or an income or an
expense. An account is a brief history of financial dealings of a particular man or a particular item.
An account has two sides—Debit and Credit. The left side is known as DEBIT and the right side is
known as CREDIT. Double entry book-keeping, means recording of both the receiving and giving
aspects of every transaction.
When an account receives a benefit, the account is debited. When an account gives a benefit, the
account is credited. These two aspects are denoted by the symbols Debtor (Dr) and Creditor (Cr.)
respectively. So, for every debit there will be a corresponding credit. The rules for Debit and Credit
are formulated according to the types of accounts.
The accounts can be divided into three types:
1. Personal,
2. Real and
3. Nominal.
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1. Personal Account:
These are accounts of persons, firms, and other associations with which we have business dealings.
The rule is to debit the account of the person, who receives something and credit the account of the
person, who gives something. That is, Debit the receiver and Credit the giver.
2. Real or Property Account:
Real accounts are the accounts of things, i.e., lifeless things. It is an account relating to properties or
assets such as Land, Machinery etc. Debit the account of the things which come in and credit the
account of the things which go out. That is, Debit what comes in and Credit what goes out.
3. Nominal or Fictitious Account:
This type of accounts relate to the accounts of income, expenses, profit and losses. Many items of
expenses like, salary, wages, rent etc. are incurred in the business. Similarly, many items of income,
discount, commission etc. are earned in the business. The rule is that Debit all losses and expenses
and Credit all gains and incomes.

Ledger Posting:
As soon as a transaction takes place, the same is recorded in the journal in the form of a journal
entry. This entry is posted again in the respective ledger accounts under the double entry principle
from the journal. This is called ledger posting.

Process of Ledger Posting:
The following procedures are followed for posting:
First part of the Account:
1. Locate in the ledger, the first Account named in the journal.
2. Write the date of the transaction, in the date column, in debit-side of that account.
3. Enter in the debit-side of the ledger, in particulars column, the name of the Account credited with
prefix “To”.
4. Write in folio column on the debit-side of the account, the page number of journal from which the
entry is being posted.
5. Enter the amount, on the debit column of the ledger as per journal.
6. Similarly, write the ledger page number in the folio column of the Journal.
Second part of the other Account:
1. Locate in the ledger, the second Account named in the Journal.
2. Write the date of the transaction, in the date column on credit side of that Account.
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3. Enter in the credit-side of the ledger, in particulars column, the name of the Account debited with
prefix “By”.
4. Write in the folio column of the ledger, the page number of the journal from which the entry is being
posted.
5. Enter the amount on the credit side of the ledger as per the journal.
6. Similarly, write the ledger page number in the folio column of the journal.
Example: Record the following transaction and post them into ledgers:
On 1st Dec. 2004, Ram started business with a capital of Rs. 50,000.
Introduction to Trail Balance

Trial balance may be defined as an informal accounting schedule or statement that lists the ledger
account balances at a point in time compares the total of debit balance with the total of credit
balance.
The fundamental principle of double entry system is that at any stage, the total of debits must be
equal to the total of credits. If entries are recorded and posted correctly, the ledger will reflect equal
debits and credits, and the total credit balance will then be equal to the total debit balances.
Every business concern prepares final accounts at the end of the year to ascertain the result of the
activities of the whole year. To ensure correct result, the concern must be free from doubt that the
books of accounts have been correctly recorded throughout the year. Trial balance is prepared to test
the arithmetical accuracy of the books of accounts. As we know that under double entry system for
each and every transaction one account is debited and other account is credited with an equal
amount. If all the transactions are correctly recorded strictly according to this rule, the total amount of
debit side of all the ledger accounts must be equal to that of credit side of all the ledger accounts.
This verification is done through trial balance.
If the trial balance agrees we may reasonably assume that the books are correct. On the other hand,
if it does not agree, it indicates that the books are not correct - there are mistakes somewhere. The
mistakes are to be detected and corrected otherwise correct result cannot be ascertained. There are
however, a few types of errors which the trial balance cannot detect. In other words, the trial balance
will agree in spite of the existence of those errors.
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The trial balance is not an absolute or solid proof of the accuracy of books of accounts. Thus if trial
balance agrees, there may be errors or may not be errors. But if it does not agree, certainly there are
errors.
Purposes of Trial Balance:
The trial balance serves two main purposes. These are as under:
1. To check the equality of debits and credits - an arithmetical or mathematical test of accuracy.
2. To provide information for use in preparing final accounts.
Methods of Preparing Trial Balance:
There are three methods for the preparation of trial balance. These methods are:
1. Total or gross trial balance
2. Balance or net trial balance
3. Total - cum - balance trial balance
The method 1 and 2 are described below:
Total or Gross Trial Balance:
Under this method the two sides of all the ledger accounts are totaled up. Thereafter, a list of all the
accounts is prepared in a separate sheet of paper with two "amount" columns on the right hand side.
The first one for debit amounts and the second one for credit amounts. The total of debit side and
credit side of each account is then placed on "debit amount" column and "credit amount" column
respectively of the list. Finally the two columns are added separately to see whether they agree of
not. This method is generally not followed in practice.
Balance or Net Trial Balance:
Under this method, first of all the balances of all ledger accounts are drawn. Thereafter, the debit
balances and credit balances are recorded in "debit amount" and "credit amount" column respectively
and the two columns are added separately to see whether they agree or not. This is the most popular
method and generally followed.
The various Steps involved in the preparation of Trial Balance under this method are given below:
1. Find out the balance of each account in the ledger.
2. Write up the name of account in the first column.
3. Record the account number in second column.
4. Record the debit balance of each account in debit column and credit balance in credit column.
5. Add up the debit and credit column and record the totals.
Example:
Enter the following transactions in journal and post them into the ledger and also prepare a trial
balance.
2005
Jan. 1 Mr. X started business with cash $80,000 and furniture $20,000.
Jan. 2 Purchased goods on credit worth $30,000 from Y.
Jan. 3 Sold goods for cash $16,000.
Jan. 4 Sold goods on credit to S for $10,000
Jan. 8 Cash received from S $9,800 in full settlement of his account.
Solution:
Journal
Date Particulars L.F DR. Cr.
2005 Amount ($) Amount ($)
Jan.
Cash A/C 5 80,000
1
Furniture A/C 7 20,000
Capital A/C 9 1,00,000
11
(Owner invested cash and furniture)
Jan.
Purchases Account 11 30,000
2
Y 13 30,000
(Bought goods on credit)
Jan.
Cash A/C 5 16,000
3
Sales A/C 15 16,000
(Sold goods for cash)
Jan.
S A/C 17 10,000
4
Sales A/C 15 10,000
(Sold goods on credit)
Jan.
Cash A/C 5 9,800
8
Discount A/C 19 200
S A/C 17 10,000
(Cash received and discount allowed)
Ledger
Cash Account (No.5)
Date references J.R Debit Credit Balance
2005 Dr. Cr.
Jan. 1 Capital A/C 5 80,000 80,000
Jan. 3 Sales A/C 5 16,000 96,000
Jan. 8 S A/C 5 9,800 105,800
Furniture Account (No.7)
2005 Dr. Cr.
Jan. 1 Capital A/C 5 20,000 20,000
Capital Account (No.9)
2005 Dr. Cr.
Jan. 1 Cash A/C 5 80,000 80,000
Jan. 1 Furniture A/C 5 20,000 1,00,000
Purchases Account (No.11)
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2005 Dr. Cr.
Jan. 2 Y A/C 5 30,000 30,000
Y Account (No.13)
2005 Dr. Cr.
Jan. 2 Purchases A/C 5 30,000 30,000
Sales Account (No.15)
2005 Dr. Cr.
Jan. 3 Cash A/C 5 16,000 16,000
Jan. 4 S A/C 5 10,000 26,000
S Account (No.17)
2005 Dr. Cr.
Jan. 4 Sales A/C 5 10,000 10,000
Jan. 8 Cash A/C 5 9,800
Jan. 8 Discount A/C 5 200 Nil
Discount Account (No.19)
2005 Dr. Cr.
Jan. 8 S A/C 5 200 200
Trial Balance
A/C
S. No. Account Name Debit Credit
No.
1 Cash Account 5 105,800
2 Furniture Account 7 20,000
3 Capital Account 9 -- 100,000
4 Purchases Account 11 30,000
5 Y Account 13 -- 30,000
6 Sales Account 15 -- 26,000
7 S Account 17 -- --
8 Discount Account 19 200 --
Total 156,000 1,56,000
Note: If an account shows zero balance, it is not necessary to record it in trial balance.
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Final Accounts
Final Accounts are the accounts, which are prepared at the end of a fiscal year. It gives a precise
idea of the financial position of the business/organization to the owners, management, or other
interested parties. Financial statements are primarily recorded in a journal; then transferred to a
ledger; and thereafter, the final account is prepared (as shown in the illustration).
Usually, a final account includes the following components −
 Trading Account
 Manufacturing Account
 Profit and Loss Account
 Balance Sheet
Now, let us discuss each of them in detail −
Trading Account
Trading accounts represents the Gross Profit/Gross Loss of the concern out of sale and purchase for
the particular accounting period.
Study of Debit side of Trading Account
 Opening Stock − Unsold closing stock of the last financial year is appeared in debit side of
the Trading Account as “To Opening Stock“ of the current financial year.
 Purchases − Total purchases (net of purchase return) including cash purchase and credit
purchase of traded goods during the current financial year appeared as “To Purchases” in the
debit side of Trading Account.
 Direct Expenses − Expenses incurred to bring traded goods at business premises/warehouse
called direct expenses. Freight charges, cartage or carriage charges, custom and import duty
in case of import, gas, electricity fuel, water, packing material, wages, and any other
expenses incurred in this regards comes under the debit side of Trading Account and
appeared as “To Particular Name of the Expenses”.
 Sales Account − Total Sale of the traded goods including cash and credit sales will appear at
outer column of the credit side of Trading Account as “By Sales.” Sales should be on net
releasable value excluding Central Sales Tax, Vat, Custom, and Excise Duty.
 Closing Stock − Total Value of unsold stock of the current financial year is called as closing
stock and will appear at the credit side of Trading Account.
closing Stock = Opening Stock + Net Purchases - Net Sale
 Gross Profit − Gross profit is the difference of revenue and the cost of providing services or
making products. However, it is calculated before deducting payroll, taxation, overhead, and
other interest payments. Gross Margin is used in the US English and carries same meaning
as the Gross Profit.
Gross Profit = Sales - Cost of Goods Sold
 Operating Profit − Operating profit is the difference of revenue and the costs generated by
ordinary operations. However, it is calculated before deducting taxes, interest payments,
investment gains/losses, and many other non-recurring items.
14
Operating Profit = Gross Profit - Total Operating Expenses

 Net Profit − Net profit is the difference of total revenue and the total expenses of the
company. It is also known as net income or net earnings.
Net Profit = Operating Profit - (Taxes + Interest)
Format of Trading Account
Trading Account of M/s ABC Limited

(For the period ending 31-03-2014)
Particulars Amount Particulars Amount
To Opening Stock XX By Sales XX
To Purchases XX By Closing Stock XX
To Direct Expenses XX By Gross Loss c/d XXX
To Gross Profit c/d XXX
Total XXXX Total XXXX
Manufacturing Account
Manufacturing account prepared in a case where goods are manufactured by the firm itself.
Manufacturing accounts represent cost of production. Cost of production then transferred to Trading
account where other traded goods also treated in a same manner as Trading account.
Important Point Related to Manufacturing Account
Apart from the points discussed under the section of Trading account, there are a few additional
important points that need to be discuss here −
 Raw Material − Raw material is used to produce products and there may be opening stock,
purchases, and closing stock of Raw material. Raw material is the main and basic material to
produce items.
 Work-in-Progress − Work-in-progress means the products, which are still partially finished,
but they are important parts of the opening and closing stock. To know the correct value of the
cost of production, it is necessary to calculate the correct cost of it.
 Finished Product − Finished product is the final product, which is manufactured by the
concerned business and transferred to trading account for sale.
 Raw Material Consumed (RMC) − It is calculated as.
RMC = Opening Stock of Raw Material + Purchases - Closing Stock
 Cost of Production − Cost of production is the balancing figure of Manufacturing account as
per the format given below.
15
Manufacturing Account
(For the year ending……….)
To Opening Stock of Work-in- By Closing Stock of Work-in-

XX XX
Progress Progress
To Raw Material Consumed XX By Scrap Sale XX
To Wages XXX By Cost of Production XXX
To Factory overheadxx (Balancing figure)
Power or fuelxx
Dep. Of Plantxx
Rent- Factoryxx
Other Factory Exp.xx xxx
Profit and Loss Account

Profit & Loss account represents the Gross profit as transferred from Trading Account on the credit
side of it along with any other income received by the firm like interest, Commission, etc.
Debit side of profit and loss account is a summary of all the indirect expenses as incurred by the firm
during that particular accounting year. For example, Administrative Expenses, Personal Expenses,
Financial Expenses, Selling, and Distribution Expenses, Depreciation, Bad Debts, Interest, Discount,
etc. Balancing figure of profit and loss accounts represents the true and net profit as earned at the
end of the accounting period and transferred to the Balance Sheet.
Profit & Loss Account of M/s ………

(For the period ending ………..)
To Salaries XX By Gross Profit b/d XX
To Rent XX
To Office Expenses XX By Bank Interest received XX
To Bank charges XX By Discount XX
16
To Bank Interest XX By Commission Income XX
By Net Loss transfer to Balance

To Electricity Expenses XX XX
sheet
To Staff Welfare Expenses XX
To Audit Fees XX
To Repair & Renewal XX
To Commission XX
To Sundry Expenses XX
To Depreciation XX
To Net Profit transfer to Balance

XX
sheet
Balance Sheet
A balance sheet reflects the financial position of a business for the specific period of time. The
balance sheet is prepared by tabulating the assets (fixed assets + current assets) and the liabilities
(long term liability + current liability) on a specific date.
Assets
Assets are the economic resources for the businesses. It can be categorized as −
 Fixed Assets − Fixed assets are the purchased/constructed assets, used to earn profit not
only in current year, but also in next coming years. However, it also depends upon the life and
utility of the assets. Fixed assets may be tangible or intangible. Plant & machinery, land &
building, furniture, and fixture are the examples of a few Fixed Assets.
 Current Assets − The assets, which are easily available to discharge current liabilities of the
firm called as Current Assets. Cash at bank, stock, and sundry debtors are the examples of
current assets.
 Fictitious Assets − Accumulated losses and expenses, which are not actually any virtual
assets called as Fictitious Assets. Discount on issue of shares, Profit & Loss account, and
capitalized expenditure for time being are the main examples of fictitious assets.
 Cash & Cash Equivalents − Cash balance, cash at bank, and securities which are
redeemable in next three months are called as Cash & Cash equivalents.
 Wasting Assets − The assets, which are reduce or exhausted in value because of their use
are called as Wasting Assets. For example, mines, queries, etc.
 Tangible Assets − The assets, which can be touched, seen, and have volume such as cash,
stock, building, etc. are called as Tangible Assets.
17
 Intangible Assets − The assets, which are valuable in nature, but cannot be seen, touched,
and not have any volume such as patents, goodwill, and trademarks are the important
examples of intangible assets.
 Accounts Receivables − The bills receivables and sundry debtors come under the category
of Accounts Receivables.
 Working Capital − Difference between the Current Assets and the Current Liabilities are
called as Working Capital.
Liability
A liability is the obligation of a business/firm/company arises because of the past
transactions/events. Its settlement/repayments is expected to result in an outflow from the resources
of respective firm.
There are two major types of Liability −
 Current Liabilities − The liabilities which are expected to be liquidated by the end of current
year are called as Current Liabilities. For example, taxes, accounts payable, wages, partial
payments of long term loans, etc.
 Long-term Liabilities − The liabilities which are expected to be liquidated in more than a year
are called as Long-term Liabilities. For example, mortgages, long-term loan, long-term bonds,
pension obligations, etc.
Grouping of Assets and Liabilities
There may be two types of Marshalling and grouping of the assets and liabilities −
 In order of Liquidity − In this case, assets and liabilities are arranged according to their
liquidity.
 In order of Permanence − In this case, order of the arrangement of assets and liabilities are
reversed as followed in order of liquidity.
Financial Statements with Adjustments Entries and their Accounting Treatment

In order to prepare a true and fair financial statement, there are some very important adjustments
those have to be done before finalization of the accounts (as shown in the following illustration) –
18
Sr.No. Adjustments Accounting Treatments
1 First Treatment
Where an opening and
closing stock adjusted
through a purchase
account and the value of
Closing Stock Closing Stock given in
Unsold stock at the end of Financial year called Closing Trial Balance −
stock and valued at “Cost or market value whichever is Closing stock will be
less” shown as adjusted
purchase account on the
debit side of Trading
account and will appear in
the Balance Sheet under
current Assets.
2 Accounting Treatment
Outstanding expenses will
be added in Trading or
Outstanding Expenses
Profit & Loss account in
Expenses which are due or not paid called as outstanding
particular expense account
expenses.
and will appear in liabilities
side of the Balance Sheet
under the current liabilities.
Prepaid Expenses will be
deducted from the
Prepaid Expenses particular expenses as
Expenses which are paid in advance are called as Prepaid appear in Trading & Profit
Expenses. & Loss account and will be
shown in the Balance
Sheet under the current
assets.
4 Accrued Income Accounting Treatment

The income, which is earned during the year, but not yet Accrued income will be
received at the end of the Financial Year is called as added to a particular
19
Accrued Income. income under the Profit &

Loss account and will be
shown in the Balance
Sheet as current assets.
An income to be reduced
Income Received in Advance by the amount of advance
An income received in advance, but not earned like income in profit & loss
advance rent etc. account and will appear as
current liabilities in the
Balance Sheet.
 Debit Side of Profit
Interest on Capital
& Loss account
Where an interest paid on the capital introduced by the
 Add to capital
proprietor or partner of the firm.
account (Credit side
of Capital account).
 Credit Side of Profit
Interest on Drawing & Loss account
Where an interest paid on the capital introduced by the  Reduced from
proprietor or partner of the firm. capital account
(Debit side of
Drawing account).
& Loss Account
 In a Balance Sheet,
Provision for Doubtful Debts
provision for the
If there is any doubt on the recovery from Sundry Debtors.
Doubtful will be
deducted from the
Sundry Debtors’
Account.
9 Provision for Discount on Debtors Accounting Treatment

If there is any offer of discount to pay the debtors within  Debit Side of Profit
20
certain period. & Loss Account

 In a Balance Sheet,
provision for the
Discount on
Debtors will be
deducted from the
Sundry Debtors
Account.
& Loss Account
Bad Debts  In a Balance Sheet,
Unrecovered debts or irrecoverable debts Sundry debtors will
be shown after
deducting the Bad
Debts.
 Credit Side of Profit
& Loss Account
Reserve for Discount on Creditors  In a Balance Sheet,
If there is any chance to get discount on the payment of Sundry Creditors
sundry creditors within certain period. will be shown after
deducting the
Reserve for
Discount.
1. If Stock is fully
insured
 Credit Side of
Trading Account
Loss of Stock by fire
 Assets side of
There may be three conditions in this case
Balance Sheet
 (With full value of
loss)
2. If Stock is partially
insured
21
 Credit side of
Trading Account
(With Total value of
Loss)
 Debit side of Profit &
Loss a/c
(With value of loss
unrecoverable)
 Asset Side of
Balance Sheet
( With value
recoverable)
3. If Stock is not insured
 Credit Side of
Trading Account
Loss Account
Reserve Fund Loss Account
 Liabilities side of
Balance Sheet
 Credit side of
Free Sample to Customers Trading Account
& Loss Account
Loss Account
Managerial Commission  Liabilities side of
Balance Sheet as
commission
payable
16 Goods on Sale or Approval Basis Accounting Treatment

If there is any un-approved stock lying with the customers  Sales AccountDr
22
at the end of financial year. To Debtors A/c

(With Sale Price)
 Stock AccountDr
To Trading Account
(with cost price)
Profit and Loss Statement (P&L)

The profit and loss (P&L) statement is a financial statement that summarizes the revenues, costs and
expenses incurred during a specified period, usually a fiscal quarter or year. The P&L statement is
synonymous with the income statement. These records provide information about a company's
ability or inability to generate profit by increasing revenue, reducing costs or both. Some refer to the
P&L statement as a statement of profit and loss, income statement, statement of
operations, statement of financial results or income, earnings statement or expense statement.
 The P&L statement is a financial statement that summarizes the revenues, costs and
expenses incurred during a specified period.
 The P&L statement is one of three financial statements every public company issues quarterly
and annually, along with the balance sheet and the cash flow statement.
 It is important to compare P&L statements from different accounting periods, as the changes in
revenues, operating costs, R&D spending and net earnings over time are more meaningful
than the numbers themselves.
 Together with the balance sheet and cash flow statement, the P&L statement provides an in-
depth look at a company's financial performance.
Balance Sheet
A balance sheet is a statement of the financial position of a business which states the assets,
liabilities and owner's equity at a particular point in time. In other words, the balance sheet illustrates
your business's net worth.
The balance sheet may also have details from previous years so you can do a back-to-back
comparison of two consecutive years. This data will help you track your performance, and will
identify ways in which you can build up your finances and see where you need to improve.
The balance sheet may also have details from previous years so you can do a back-to-back
comparison of two consecutive years. This data will help you track your performance, and will
identify ways in which you can build up your finances and see where you need to improve.
The balance sheet is the most important of the three main financial statements used to illustrate the
financial health of a business. The other two are:
 The Income Statement which shows net income for a specific period of time, such as a month,
quarter, or year. Net income equals revenue minus expenses for the period.
 The Cash Flow Statement which shows the movements of cash and cash equivalents in and
out of the business. Chronic negative cash flows are symptomatic of troubled businesses.
23
 Incorporated businesses are required to include balance sheets, income statements, and cash
flow statements in financial reports to shareholders and tax and regulatory authorities.
Preparing balance sheets is optional for sole proprietorships and partnerships, but is useful for
monitoring the health of the business.
 An up-to-date and accurate balance sheet is essential for a business owner looking for
additional debt or equity financing, or who wishes to sell the business and needs to determine
its net worth.
 All accounts in your general ledger are categorized as an asset, a liability or equity. The
relationship between them is expressed in this equation:
Assets = Liabilities + Equity
The items listed on balance sheets vary from business to business depending on the industry, but in
general, the balance sheet is divided into the following three sections:
Assets
As in the balance sheet example shown below, assets are typically organized into liquid assets —
those that are cash or can be easily converted into cash, and non-liquid assets that cannot quickly be
converted to cash such as land, buildings, and equipment.
The list of assets may also include intangible assets, which are much more difficult to value.
Generally accepted accounting principles (GAAP) guidelines only allow intangible assets to be listed
on a balance sheet if they are acquired assets with a lifespan and a clearly identifiable fair market
value (the probable price at which a willing buyer would buy the asset from a willing seller) that can
be amortized. These are reported on the balance sheet at the original cost minus depreciation. This
includes items such as:
 Franchise agreements
 Copyrights
 Patents
Liabilities
Liabilities are funds owed by the business and are broken down into current and long-term
categories. Current liabilities are those due within one year and include items such as:
 Accounts payable (supplier invoices)

 Wages
 Income tax deductions
 Pension plan contributions
 Medical plan payments
 Building and equipment rents
 Customer deposits (advance payments for goods or services to be delivered)
 Utilities
 Temporary loans, lines of credit or overdrafts
 Interest
 Maturing debt
 Sales tax and/or goods and services tax charged on purchases
24
Long-term liabilities are any that are due after a one-year period. These may include deferred tax
liabilities, any long-term debt such as interest and principal on bonds, and any pension fund
liabilities.
Equity/Earnings
Equity, also known as shareholders' equity, is that which remains after subtracting the liabilities from
the assets. Retained earnings are earnings retained by the corporation — that is, not paid
to shareholders in the form of dividends.
Retained earnings are used to pay down debt or are otherwise reinvested in the business to take
advantage of growth opportunities. While a business is in a growth phase, retained earnings are
typically used to fund expansion rather than paid out as dividends to shareholders.
Sample Balance Sheet
COMPANY NAME
BALANCE SHEET as at __________ (Date)
ASSETS $ LIABILITIES $
Current Assets: Current Liabilities:
Cash in Bank $18,500.00 Accounts Payable $4,800.00
Petty Cash $500.00 Wages Payable $14,300.00
Net Cash $19,000.00 Office Rent —
Inventory $25,400.00 Utilities $430.00
Accounts Receivable $5,300.00 Federal Income Tax Payable $2,600.00
Prepaid Insurance $5,500.00 Overdrafts —
Total Current Assets $55,200.00 Customer Deposits $900.00
Pension Payable $720.00
Fixed Assets: Union Dues Payable —
Land $150,000.00 Medical Payable $1,200.00
Buildings $330,000.00 Sales Tax Payable
Less Depreciation $50,000.00 Total Current Liabilities $24,950.00
Net Land & Buildings $430,000.00
Long-Term Liabilities:
25
Equipment $68,000.00 Long-Term Loans $40,000.00
Less Depreciation $35,000.00 Mortgage $155,000.00
Net Equipment $33,000.00 Total Long-Term Liabilities $195,000.00
TOTAL LIABILITIES $219,950.00
Owners' Equity:
Common Stock $120,000.00
Owner - Draws $50,000.00
Retained Earnings $128,250.00
Total Owners' Equity: $298,250.00
TOTAL ASSETS $518,200.00 LIABILITIES AND EQUITY $518,200.00
26

Unit - I Meaning and Nature of Financial Accounting

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Unit - I Meaning and Nature of Financial Accounting

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Aditya Kumar, Assistant Professor, Uttam Institute of Management Studies, Agra

Meaning Financial Accounting is an The accounting system which

Information Monetary information only. Monetary and non-monetary

Objective To provide financial information to To assist the management in planning

Format Specified Not specified

User Internal and external parties Only internal management.

Reports Summarized Reports about the Complete and Detailed reports

Publishing and Required to be published and Neither published nor audited by

Accounting concepts & convention

i. Recognition of financial events

Introduction – Capital and Revenue Items:

Role of Computers in Accounting

summary of transactions and financial statements are prepared manually.

total and posting the requisite data to the relevant accounts.

operated this machine.

Savings in time is another object of computerization. Computers should be used whenever it is

for other jobs.

An account is a summary of business transactions affecting a person or property or an income or an

are formulated according to the types of accounts.

The accounts can be divided into three types:

and Credit all gains and incomes.

from the journal. This is called ledger posting.

The following procedures are followed for posting:

First part of the Account:

1. Locate in the ledger, the first Account named in the journal.

entry is being posted.

1. Locate in the ledger, the second Account named in the Journal.

Introduction to Trail Balance

(Owner invested cash and furniture)

Date references J.R Debit Credit Balance

Operating Profit = Gross Profit - Total Operating Expenses

Trading Account of M/s ABC Limited

Particulars Amount Particulars Amount

To Opening Stock XX By Sales XX

To Purchases XX By Closing Stock XX

To Direct Expenses XX By Gross Loss c/d XXX

To Gross Profit c/d XXX

Total XXXX Total XXXX

Particulars Amount Particulars Amount

To Opening Stock of Work-in- By Closing Stock of Work-in-

To Raw Material Consumed XX By Scrap Sale XX

To Wages XXX By Cost of Production XXX

To Factory overheadxx (Balancing figure)

Other Factory Exp.xx xxx

Total XXXX Total XXXX

Profit and Loss Account

Profit & Loss Account of M/s ………

Particulars Amount Particulars Amount

To Salaries XX By Gross Profit b/d XX

To Office Expenses XX By Bank Interest received XX

To Bank charges XX By Discount XX

To Bank Interest XX By Commission Income XX

By Net Loss transfer to Balance

To Staff Welfare Expenses XX

To Repair & Renewal XX

To Net Profit transfer to Balance

Total XXXX Total XXXX

Financial Statements with Adjustments Entries and their Accounting Treatment

Sr.No. Adjustments Accounting Treatments

4 Accrued Income Accounting Treatment

Accrued Income. income under the Profit &

9 Provision for Discount on Debtors Accounting Treatment

certain period. & Loss Account