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Accounting & Financial

An Introduction

Prof. Raman Chawla
What is accounting
Accounting is the art of identifying,
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 result thereof.
Accounting is a system in which all the
financial transaction are recorded in a
proper and system way.
Characteristics of
financial accounting
Accounting is an art- Art is that part of knowledge which helps us in
attaining our aim. Accounting helps us in attaining our aim of
ascertaining the financial results by showing the best way of
recording, classifying and summarizing the business transaction.

Recording, Classifying and summarizing- It provides information
about all the transactions of financial in nature, recorded in journal,
classifying in forms of ledgers, preparation of trial balance for
checking the accuracy of accounts.

In terms of money-Only those transaction are recorded which are in
terms of money.

Interpreting the results- It provide the tools for their analysis,
through which various parties of business obtain information related
to them.
Objectives or functions of
Knowledge of sales and purchase
Providing information of closing stock
Knowledge of financial position
Information related for working capital
Knowledge of profit & loss of the business
Provide information to various parties
Provide Information about embezzlement & frauds
Evidence in court.

Functions of Accounting
It keeps a complete record of business transactions.
It provides complete information concerning the business.
It provides a check on the arithmetical accuracy of books of
It discloses the operating results .
It makes possible a meaning full comparison of operating and
financial performance over a period of time and enable the
businessman to evaluate the progress of his business.
It also enables a business man to plan and control his
It reduces the chances of committing fraud.
Past details with regard to any account are easily and
accurately obtainable in this system.
Accounting Process


Recording of transaction (Journal entry)

Classification (Ledger Posting)

Summarizing (Trial balance)

Interpreting (Income &position statement)

Analysis of transactions
Branches of Accounting
Financial Accounting:- It is concerned
with recording and processing the
financial transactions which affect the
financial position of the business. It
leads to the preparation of income
statement & position statement of the
Cost accounting

Cost accounting is the process of
accounting for costs. It is a systematic
procedure for determining the unit
cost of output produced or services
rendered. The primary functions of
cost accounting are to ascertain the
cost of a product and to help the
management in the control of cost.
Management accounting
It is concerned with the collecting
systematically and regularly all such
information as will help to the
management in discharging its
functions of planning, control, decision
making, etc. this is also named as
accounting for management.
Users of accounting information
Internal sources




External Persons
Tax Department
Owner A person who is interested in
accounting information to know about
the profit or loss of the business,
financial position, amount of expenses,
amount of capital and its size, value of
obligations, amount to be paid to the
suppliers, details of purchase or sale.
The management needs information
from accounting for successful,
efficient and smooth running of
business operations. The management
can evaluate the progress and future
plans based on accounting
information. Shot term and long term
plans can be prepared on the basis of
financial information.
Employees are interested in
accounting information of the business
as their welfare scheme like bonus,
salaries, fringe benefits, provident
funds, Gratuity etc.
Creditors / Supplier
Creditors are those parties that
provide a firm with raw materials,
goods and services on credit way.
They are interested to know about the
credit worthiness status, financial
positions of the current year.
Government has collected sales tax,
income tax, excise duty and other
taxes from the business. For this it is
necessary that proper accounts are
made available to the government.
Investors provide risk capital to the
business. They are interested in
accounting information to know about
the survival, prosperity, profitability,
and ability to pay dividend.
The researchers are interested in
interpreting the financial statements of
the concern for a given objective.
Lenders are the persons who provide
the loan to the business. They are
interested to know about the use of
money, interest and how safe the
funds are?
Consumers are interested in buying
goods at the reasonable price.
Generally Accepted Accounting
principles (GAAP)

Business Entity Concept
Going Concern concept
Dual Aspect Concept
Cost concept
Money measurement Concept
Accounting period Concept
Matching Concept
Accrual concept
Business entity concept
Business is treated as a unit or entity
apart from its owner. The owner of an
organization is always considered to
be separate and distinct from the
business which he controls. that is
why, the capital of the owner is always
entered in liability side of balance
sheet. It is considered as the creditor
of the business.
Going concern concept
It is assumed that the business will exist
for the foreseeable future and
transactions are recorded from this point
of view. It should continue to operate at
its present scale in the foreseeable future.
Dual Aspect Concept
Financial accounting has dual aspect
of recording. Every debit has its
corresponding credit & every credit
has its corresponding debit. The
modern accounting system basically
based on dual aspect of accounting.
Cost concept
The underlying idea of cost concept is that-
Assets is recorded at the price paid to
acquire it, that is, at cost, and..
This cost is the basis for all subsequent
accounting for the asset.
The change in the real worth of an asset
with the passage of time is not ordinarily
recorded in the account books.
Money measurement
The money concept underlines the fact
that in accounting every worth
recording event, happening or
transaction is recorded in terms of
money. In other words, a fact or a
happening which cannot be expressed
in terms of money is not recorded in
the accounting books.
Accounting period
Accounts choose some shorter and
convenient time for the measurement
of income. Twelve-month period is
normally adopted for this purpose. this
time interval is called accounting
Matching concept
It is based on the determination of the
profit & loss of a particular accounting
period is the process of matching the
revenue earned during the period and
the expenses incurred during the
period to obtain such revenue.
Accrual concept

Under this method revenue recognition
depends on its realization and not actual
receipt. Likewise costs are recognized
when they are incurred and not when
Accounting conventions
Full disclosure
The convention of consistency aims at
making the financial statements more
comparable and useful. The
convention holds that in accounting
processes, all concepts, principles and
measurement approaches should be
applied in a similar or consistent way
from one period to another period.
Full disclosure
This convention specifies that there
should be complete and
understandable reporting in the
financial statements of all significant
information relating to the economic
affairs of the entity. All information
which is of material interest to the
users of the accounting information
should be disclosed in accounting
This is the policy of playing safe.
Accounting permits for making
reserves to face the uncertainty
situations of the business.
Double entry system
It is a common system of book-keeping
whereby the two aspects of every transaction
i.e., It is based on the dual aspect concept.
This method of writing every transaction in two
different accounts on opposite sides for equal
value is known as the double entry system of
book keeping. This is the most accurate,
complete and scientific system of accounting.
Advantages of double entry
It keeps a complete record of business transactions.
It provides complete information concerning the business.
It provides a check on the arithmetical accuracy of books of
It discloses the operating results .
It makes possible a meaning full comparison of operating and
financial performance over a period of time and enable the
businessman to evaluate the progress of his business.
It also enables a business man to plan and control his operations.
It reduces the chances of committing fraud.
Past details with regard to any account are easily and accurately
obtainable in this system.
The journal records all daily transactions of a business in
the order in which they occur. It is the book in which the
transactions are recorded first of all under the double
entry system. Thus, Journal is a book of original record. A
journal does not replace but precedes the Ledger.
The process of recording transactions in a journal is
termed as journalizing Performa of journal is given below.

1. Date: The date on which the transaction was entered is
recorded here.
2. Particulars: The two aspect of transaction are recorded in
this column,i.e, the details regarding accounts which have to
be debited and credited.
L.F: It means ledger folio. The transactions entered in the
journal are later on posted to the ledger. Procedure regarding
posting the transactions in the ledger has been explained in
the succeeding chapter.
Debit. In this column, the amount to be debited is entered
Credit. In this column, The amount to be credited is shown
Golden rules of
Real account- Debit what comes
in, Credit what goes out.
Personal account- Debit the
receivers, Credit the givers.
Nominal account- Debit the
expenses & losses, Credit the
incomes & gains.
The second important part of
accounting cycle of double entry system
is the classification of transactions i.e.
posting in the ledger book.
The ledger is the main book of account,
and it is in this book that all the
business transactions would ultimately
find their place under their place under
their respective accounts in a duly
classified form.
Need and importance of
The information regarding any account can be obtained one
It saves time.
It provides information of total purchases, sales and the
status of return for a particular period.
The information of account receivables and payable can be
obtained known from it.
The information of income and expenditure can be obtained
The information of assets and liabilities of the concern can be
It helps in the preparation of trial balance and balance sheet.
Trial balance
A trial balance is a statement of debit
and credit balances extracted from all
ledgers with a view to ascertain
arithmetic accuracy of the posting of
all transactions into the respective
The first list of balances, which is added
and totaled, called a trial balance.
A trial balance is a list of all the balances
standing on the ledger accounts of the
concern at any given date.
Objectives of trial balance
Test of arithmetical accuracy of ledger
To observe the application of the rules of
double entry system
Summary of ledger account
Basis for preparing final accounts
Useful for making adjustments
Errors disclosed by trial
If books of accounts are properly
maintained according to the principles of
double entry system both the debit and
credit side of the trial balance must equal to
each other. In case both sides are not
equal, there is bound to be certain error in
accounting. The trial balance in case of
disagreement is said to be out of balance.
Following errors are responsible for
disagreement of trial balance.
Errors of additions and subtractions- these errors
make trial balance out of balance. Errors of
additions and subtractions may occur in the
subsidiary books or in the ledger account or even in
the trial balance itself. The trial balance will disclose
the errors. These errors may be enumerated as
Errors in the amount column of cash book.
Errors in the balancing of cash book
Errors in the subsidiary books
Wrong totaling and balancing of ledger accounts
Wrong totaling in trial balance.
Posting at the wrong side of an account- In
case the posting is made at the wrong side of any
specific account, the trial balance will not tally.
Entering incorrect amount- This error may
occur, when we copy wrong figures, in any type of
book of account. Ex. Writing 59 in place of 95 or
123 in place of 321.

Errors of omission- All the omissions taking place
in posting or in the trial balance will throw out the
trial balance. Following are the examples of such
1. If an item has not been posted at all from
subsidiary books to ledger.
2. If the balance of any ledger account has not
been posted to trial balance.
Wrong posting in the trial balance- If the debit
balance of an account has been posted at the credit
side of trial balance or the credit balance has been
posted at the debit side of the trial balance.

Limitations of trial balance
Errors not disclosed by trial
Trial balance is taken as test of arithmetical
accuracy. If both the side of trial balance are equal
to each other, we assume that there is no mistake
in the posting of journal and subsidiary books to
ledger accounts, in carrying forward balances of
ledger accounts to trial balance and even in the
balancing of ledger accounts. This assumption is
correct but should never be taken as conclusive
proof of accuracy. It means that there are certain
errors which remain undetected by trial balance.
Both the debit and credit side of trial balance may
be equal in spite of certain mistakes of omissions
and principles. There are as.
Errors of omission in the original record-The entire
transaction is not recorded in the books of accounts, we omit
to the transaction. Ex goods returned by Mohan were taken
into the stock but the return was not entered in the books.
Errors of principle- Errors of principles may be committed,
if we debit or credit a wrong account due to our ignorance.
The accountant does not have the understanding of the
accounting concepts and commits errors. Ex- purchase of
building is capital expenditure and building account should be
debited but if the accountant debits purchases account
instead of building account, errors of principles will be there in
Compensating errors- It is just possible that the effect of
certain error is neutralized by the effect of another error. the
combined effect of the two errors will equalize the debit and
credit side of trial balance in spite of errors. Ex-sale of goods
to Mohan for Rs. 100 was debited to Mohans account with
Rs. 10 only. Rs. 100. received from Sohan was credited to
Sohans account with Rs. 10 only. In the first error, Mohans
account was debited with Rs. 10 only, whereas it should have
been debited with Rs. 100. it means that Rs. 90 was debited
short. The effect of the error in the trial balance will be that
the total of the debit side will be Rs.90 lesser. The second
error Sohans account has been credited with Rs. 10. whereas
it should have been credited with Rs. 100. it shows that Rs.
90 have been written lesser at the credit side of Sohans
account. As per the effect of this error, the total of the credit
column of trial balance will be lesser by Rs. 90..
In correct account in the original book- If the
name of wrong account are used in the journal or subsidiary
books, trial balance will not be able to direct it . Ex- sale of
goods to Amit Rs. 100. was debited in the books of amitabh.
Posting to wrong account- If the posting from the
debit side or credit side of cash book or from purchases book
or sales book or returns book is made to wrong account but
at the correct amount, both the debit and credit side of trial
balance will equal in spite of these errors.
Loss in the value and utility of assets due to
their constant use of and expiry of time is
termed as depreciation.
Depreciation is gradual and permanent
decrease in the value of assets from any
Depreciation may be defined as permanent
and continuing diminution in the quality,
quantity or the value of an asset.
Special features of
Depreciation is loss in the value of
Loss should be gradual and constant.
Depreciation is the exhaution of the
effective life of business.
Depreciation is the normal feature.
Maintenance of assets is not
It is continuing decrease in the value
of assets..
Word related with
Obsolescence Sometimes new inventions throw away the
existing machine and equipments as obsolete (useless)
although the old machines and equipments are not completely
useless. Loss due to the useless of old machine and
equipment is known as obsolescence.
Depletion the firm may possess certain minerals wealth such
as coal, oil, ore etc. The more we extract mineral wealth from
these mines the more mines are depleted. Decrease in
mineral wealth of the mines is termed as depletion.
Amortization the word amortization is used to show loss in
the value of intangible assets. These assets are goodwill ,
patents and preliminary expenses etc. these assets are written
off over certain period.
Increase and decrease in the market
value of assets is known as
Causes of depreciation
By constant use
By expiry of time
By obsolescence
By depletion
Permanent fall in price
By accidents

Need for charging
For determining of net profit or net
For showing assets at fair and true
value in the balance sheet
Provisions of funds for replacement of
Ascertaining accurate cost of
Distribution of dividend out of profit
Avoiding over payment of income tax
Methods of depreciation
Fixed installment / straight line / original
cost method it is a very simplest method of
charging depreciation. The depreciation is
calculated of on the original cost of the machine at
the specified rate, so the value of asset is fully split
over the useful life of asset.
Diminishing or reducing or written down
value method- under this method, the value of
asset upon which depreciation is to be calculated
goes on diminishing, so the amount of depreciation
to be charged every year also goes on declining.
Difference between fixed
installment and diminishing
Equal amount of depreciation is
Depreciation is charged on the
original cost of assets.
The value of assets can be written
down to zero.
The initial year of the life of the
asset bear lesser amount as
depreciation and repairs but final
years bear the same amount of
depreciation but more repairs and
maintenance charges.
This method is useful for assets of
lesser value such as patents,
furniture and fixture.

The amount of depreciation
goes on reducing year after
Depreciation is calculated on
the reducing balance of assets.
The value of assets can not be
written down to zero
Every year bears almost the
same charges. Depreciation
goes on declining, whereas
repairs and maintenance
charges go on increasing.
The method is suitable for
assets having longer life and
more value such as land and
building, plant and machinery.
Accounting bodies all over the world have
tried to achieve some uniformity in the
accounting policies by prescribing certain
accounting standards in order to narrow
the range of alternatives available to an
organization in respect of collection and
presentation of accounting information.
International accounting
Accounting bodies throughout the world are striving
to achieve a reasonable degree of uniformity in the
accounting policies by prescribing certain
accounting standards with respect to the collection
and presentation of accounting information. To
formulate the accounting standards, they have
established a committee called the International
Accounting standards committee (IASC) in
1973.Accounting bodies of most of the countries,
including the institute of chartered accountants of
India, are the members of this bodies.
Objectives of committee
i) formulating, publishing and promoting
the use of the accounting standards
ii) To work for improvement.

The IASC has so far issued forty one
accounting standard
Indian accounting
Recognizing the need to harmonized the diverse
accounting policies and practices prevalent in India.
The institute of chartered accountants of India
constituted an accounting standard board (ASB) on
april,1977.The main function of ASB is to frame
accounting standards which would be formally issued
under the authority of the council of the institute of
chartered accountants.
Importance of accounting
The role of mandatory accounting standards
in presenting clear-cut account on a uniform
basis can not overemphasized. The standards
represent the ideal practice of accounting and
ensure comparability of accounts because of
uniformity in the presentation. Hence, such
accounts are bound to show the clear
position of the state of affairs.
Accounting standards
issued by ASB of ICAI
The ASB of the institute of chartered
accountants of India, has in line with
the international standards, issued
twenty nine standards to be followed
by its members while auditing the
accounts of companies. These are
(AS 1) Disclosure of accounting policies
(AS 2) Valuation of Inventories ( revised )
(AS 3) Cash flow statements
(AS 4) Contingencies and events occurring after the balance sheet
(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 contract
(AS 8) Accounting for research and development
(AS 9) Revenue recognition
(AS 10) Accounting for fixed assets
(AS 11) (Revised 2003) The effects of changes in foreign exchange
(AS 12) Accounting for government grants
(AS13) Accounting for Investments.
(AS14) Accounting for Amalgamations.
(AS15) Accounting for retirements benefits in the financial
statement of employers.
(AS16) borrowing costs
(AS17) Segment Reporting
(AS18) Related party Disclosures
(AS19) Leases
(AS20) Earning per share
(AS21) Consolidated financial Statements
(AS22) Accounting for taxes on Income
(AS23) Accounting for investments in associates in
consolidated financial Statements.

(AS24) Discontinuing Operations
(AS25) Interim financial Reporting
(AS26) Intangible Assets
(AS27) Financial Reporting of Interests in joint ventures
(AS28) Impairment of assets
(AS29) Provisions, Contingent Liabilities and contingent
(AS30) Financial instruments: Recognition and Measurement
(AS31) Financial Instruments: Presentation
(AS32) Financial Instructions: Disclosures
Disclosure of accounting
policies(AS 1)
This standard deals with the disclosure of
significant accounting policies followed in
preparing and presenting financial
statements. The purpose of this statement
is to promote better understanding of
financial statements by establishing an
accounting standard and the manner in
which accounting policies are disclosed in
the financial statements.
Different accounting
Methods of depreciation, depletion and amortization
Treatment of expenditure during construction
Valuation of inventories
Treatment of goodwill
Valuation of investments
Treatment of retirement benefits
Recognition of profits on long term contracts
Valuation of fixed assets.
Treatment of contingent liabilities, etc.
As-2 valuation of inventories
The object of this standard is to determine
the value at which inventories are carried in
financial statements until the related
revenue recognized. Inventories includes all
those which are held for sale in the ordinary
course of business, used in the process of
production for such sale or in the form of
materials or supplies to consumed in
production process or in the rendering of
As-3 Cash flow statements
In this accounting standard the cash flow statement
should report cash flows during the period classified
by operating, investing and financial activities and
cash and cash equivalents. Which are explained as
Cash comprises of cash and demand deposit with
Cash equivalents are short term, highly liquid
investments are readily convertible into cash
Cash flows are inflows and outflows of cash and
cash equivalents.
As-4 contingencies and events occurring
after the balance sheet
This standard deals with the treatment of a) contingencies
and b) events occurring after the balance sheet dare, where-
a) a contingency is a condition or situation, the ultimate
outcome of which, gain or loss, will be known or determined
only on the occurrence, or non occurrence, of one or more
uncertain future events. It is restricted to conditions or
situations at the balance sheet , the financial
effects of which is to be determined by future
events which may or may not occur

As-5 Net profit or loss for the
The object of this standard is to prescribe
the classification and disclosure of certain
items in the statement of profit and loss so
that all enterprises prepare and present
such a statement on a uniform basis. This
enhances the comparability of the financial
statements of an enterprise over time and
with the financial statements of other
As-6 Depreciation accounting
Depreciation is a measure of the wearing out,
consumption or other loss of the value of a
depreciable asset arising from use or obsolescence
through technology and market changes. The
standard deals with depreciation accounting and
applies to all depreciable assets, expect the following
items to which special considerations apply:- forests,
plantations and similar regenerative natural
resources, expenditure on research and
development, goodwill, live stock, land unless
it has a limited useful life the enterprise.
As-7 accounting for construction
The standard deals with accounting for
construction contract in the financial
statements of contracts in the financial
statements of contractors. The
principal problem relating to
accounting for construction contracts
is the allocation of revenues and
related costs to accounting periods
over the duration of the contract.
AS-8 Accounting for Research and
This standard has been withdrawn and
included is AS-26.
AS-9 Revenue Recognition
This standard deals with the bases for
recognition of revenue in the
statement of profit and loss of an
enterprise. It is concerned with the
recognition of revenue arising in the
course of ordinary activities of the
enterprise from sale of goods and the
rendering of services, the use of other
AS-10 Accounting for Fixed
This standard in the financial
statements and providing information
with regard to cost, life span,
depreciation, revaluation and carrying
amount (w.d.v) of such assets.
AS-11 (Revised)
the effect of changes in foreign
exchange rates
The objective of this standard is to
show the effects of changes in foreign
branches. Foreign currency
transactions should be expressed in
the enterprises reporting currency and
the financial statements of foreign
branches should be translated into the
enterprises reporting currency in
order to include them in the financial
statements of the enterprise.
AS-12: Accounting for
Government Grants
AS-12 deals with accounting for
government grants, subsidies, cash
incentives and duty drawbacks etc.
however, this standard does not deals
with government assistance other than
in the form of government grants and
government participation.
AS-13 Accounting for
It deals with the accounting treatment of
investments in respect of its classification,
cost, carry amount, disposal and disclosure.
However, this standard does not deal with:-
Investments by way of operating or financial
Investments of life insurance enterprises
Mutual funds and public financial institution
and banks.

AS-14 Accounting for
It aims to provide accounting
treatment on amalgamation and the
treatment of goodwill or reserves
arising there. As per AS 14 there are
two types of amalgamations:-
Amalgamation in the nature of merger
Amalgamation in the nature of
AS-15 Accounting for retirement
benefits in the financial statements
of employers
This standard deals with the
accounting treatment of retirement
benefits such as provident fund,
superannuation dun, pension benefits,
Gratuity, encashment of earned leave
and other retirement benefits.
AS-16 Borrowing Costs
It deals with the treatment of
borrowing costs such as interests and
other costs incurred in connection with
the borrowing of funds.
AS-17 Segment Reporting
AS-17 seeks to establish guidelines
and to prescribe rules for financial
information about the different types
of products and services in which the
firms deals in, called Business
Segment and covering various
geographical areas called Geographical
AS-18 Related Party
AS-18 prescribes guidelines regarding
disclosure requirements of related
transactions, related party includes:
Holding companies, Subsidiaries and
fellow subsidiaries
Associates and Joint ventures

AS-19 Leases
It deals with the accounting treatment
of lease transactions in the books of
both parties. As per the standard the
leases have classified in two
categories:- Financial Leases
Operating Leases
AS-20 Earning Per Share
The objective of this standard is to
prescribe principles for the
determination and presentation of
earning per share which will improve
the comparison of performance among
different enterprises.
AS-21 Consolidated
Financial Statement
AS 21 Prescribes guidelines, rules and
procedure to prepare consolidated
financial statements for group of
enterprises under the control of a
AS-22 Accounting For
Taxes on Income
AS-22 deals with the accounting
treatment of taxes on income. It
prescribes guidelines and principles for
determination of an amount of tax
expense or tax savings on the total
profits of an enterprise in respect of
an accounting period and disclosure of
such amount in the financial
AS-23 Accounting for Investments in
Associates in Consolidated Financial
This standard deals with the
investments in associates in the
preparation and presentation of
consolidated financial statements of an
AS-24 Discontinuing
This standard prescribes guidelines for
reporting information about discontinuing
operations thereby enhancing the ability of
users of financial statements to make
projections of an enterprises cash flows,
earning-generating capacity and financial
position by segregating information about
discontinuing from information about
continuing operations.
AS-25 Interim financial
AS-25 aims to prescribe minimum
contents of an interim financial report
and to prescribe principles for
recognition and measurement in a
complete financial statements for an
interim period.
AS-26 Intangible Assets
The main objectives of AS-26 is to
prescribe the accounting treatment for
intangible assets that are not dealt
with specifically in another accounting
AS-27 Financial Reporting of
Interests in joint ventures
The objective of this standard is to set
out principles and procedures for
accounting for interests in joint
ventures and reporting of joint
ventures assets, liabilities, incomes
and expenses in the financial
statements of investors.
AS-28 Impairment of
AS 28 aims to prescribe principles to
ensure that assets are shown at an
amount which is not more than the
recoverable amount. The excess of
carrying amount( Book Value) over the
recoverable amount from sale or use
of asset is known as impairment loss.
AS-29 Provisions, contingent
Liabilities and Assets
The main objective of this standard is
to ensure appropriate recognition and
measurement criteria for provisions
and contingent liabilities by providing
sufficient information in the financial
AS-30 Financial Instruments
Recognition and Measurements
An enterprise recognizes a financial
assets or a financial assets or a
financial liability on its balance sheet
when the enterprise became a party to
the contractual provisions of
AS-31 Financial Instruments -
This standard has been set out broadly
in line of IAS-32 establishes various
For presenting financial instruments as
liabilities or equity.

Inventory Valuation
Inventories are the stock of product a
company is manufacturing for sale or
buying for resale including the parts,
components or materials that make
the product.
Classification of
1) Raw Materials: these are the basis
inputs that are converted into finished
product through production process.
2) Work in Progress: this part of
inventories comprises semi produced
of incomplete units of product. it
includes cost such as material, direct
labour and factory overheads etc.
3) Finished Goods: Goods produced
and completed and ready for sale.

Objectives of inventories
Determination of inventory valuation.
Determination of financial position.
Estimating working capital requirements.
To maintain an ideal balance b/w production
and sales.

Methods of taking
Periodic inventory method:- under this
method value of inventory is ascertained by
physical counting and checking of all items
of inventory at the year end and the same is
verified from the book entry.
Perpetual inventory method:-this method
involves continues recording of addition to
or reduction in material, work in progress
and finished goods on the day to day basis.
Methods of valuation
First in First out FIFO
Last in First out LIFO
Highest in First out HIFO
Base Stock Method
Simple Average Cost Method
Weighted average cost Method
Standard cost method
Specific identification cost methods
Replacement cost
Lower cost method
Retail Inventory method

Accounting treatment of
intangible assets
AS per accounting standard 26 an
intangible assets is an identifiable non
monetary asset without physical
substance held for use in the
production or sale of goods or services
or for rental to other or for
Enterprise frequently pay for
acquisition and development of
intangible assets. These may relate to
scientific or technical knowledge,
design and system. Licenses, market
knowledge, trade marks, brand name
and computer software, patents, copy
rights, marketing rights and goodwill
Salient features
As item may be recognized as an intangible asset if
following three conditions are satisfied.
Identifiability :- an asset is identifiable if it separate
or arises from contractual or other legal rights.
Control over an asset :- control provides to enjoy
economic benefits of an asset.
Future economic benefits :- the future economic
benefits flowing from an intangible asset may
include revenue from the sale of products or
services resulting from the use of the asset by the
Final Accounts
Final accounts refers to the final statements
of accounts prepared in order to ascertain
and report the results of the financial
activities of a business. Having prepared the
trial balance, which establishes the accuracy
of books of accounts, the next step is to
ascertain the operating result and financial
position of the business. For this purpose,
the final accounts are prepared, which
include mainly the trading and profit and
loss account, also called as income
statement and balance sheet
Objectives of preparing final accounts
To calculate profit or loss at the end of
accounting year.
To ascertain financial position of the
business at the end of the year.
To make a comparative study of changes
taken place in assets and liabilities.
To calculate or decide capital employed .
Legal compulsion of preparing final
Trading account
Trading account is an account through
which it is ascertained as to how much
profit has been earned or losses have
been sustained through purchase and
sale of goods within specified period.
The result of trading account is named
as gross profit or gross loss.
Profit and loss account
Profit and loss account is an account, which is
prepared to calculate the final profit and loss of the
business. All operating expenses and other non
operating income and expenditure and losses are
charged to P&L account to find out the net profit.
Operating expenses such as office and
administration expenses, selling and distribution
expenses and financial charges are in direct in
nature and incurred to carry on business profitably.
Non operating income such as a dividends received
and interest received etc. and non operating
expenses such as donation paid are also charged to
P/L account
Balance sheet
A balance sheet may be defined as a
statement drawn upon a given date,
generally at the end of each accounting
year, to measure the exact financial position
of the business, setting forth the various
assets and liabilities of the concern at this
date. On the other hand The balance sheet
is a statement at a particular date showing
on one side the traders property and
possessions and on the other hand
Difference b/w balance
sheet and trial balance
Trial balances
It is a list of
balances of all
Its object is to
check the
accuracy of the
Balance sheet
It is a statement of
assets and
Its object is to
reveal at a glance
the financial
position of the
business concerns.
It includes the opening
It is prepared whenever

It does not give information
about the net profit or net
It is not necessary to
prepare the trial balance.
It includes the closing stock
It is usually prepared at the
end of a trading period or
accounting year.
It gives information about
the profits and the capital
balance includes the profit.
Preparation of balance
sheet is necessary to
complete the accounting
It is generally
prepared without
giving effect to any
It contains the
heading debit and
It can not be
prepared without
It contains the
headings liabilities
and assets.
Closing stock As the value of closing
inventories is ascertained at the accounting
year, it appears as an adjustment. It should
be credited to trading a/c and shown in the
assets side of the B/S.
Outstanding these are the expenses
incurred within the accounting year but the
payment has not been made or expenses
just payable but not paid. Outstanding or
unpaid expenses should be added to the
concerned item in trading and profit and
loss a/c and will be shown in liability side of
balance sheet.
Prepaid expenses
These are the expenses, which have
been paid in advance extends to the
next year. It is also called as Un
expired expenses. Advanced amount
paid should be deducted from the
concerned expenses and be shown as
a current assets in the Assets side of
Accrued Income
It is the income that has already been
earned (the service has already been
rendered) but the money has not
received. This type of income should
be added in the concerned item in the
credit side of P/L a/c and also will
shown in the assets side of balance
Unaccrued income
The income which are received in
advance relates to the next year is
named as un accrued or un earned
income. Such amount must be
deducted from the concerned item in
the credit side of P/L a/c and also will
show in the liability side of balance
Depreciation on Assets
Depreciation means diminution or fall in
value of an asset due to its constant use. It
may also arise on account of wear and tear,
lapse of time, and obsolescence. It is a loss
of business. It is usually calculated at a
certain % on the value of asset and the
amount so obtained is first shown on the
debit side of the P/L a/c and then deducted
from the original value of asset in the asset
side of balance sheet.
Bad debts.
Bed debts represent money due from
debtors ( i.e., uncollected portion of
the credit sales ) when debts become
irrecoverable, it becomes bad debts
and treated as a loss. The amount of
bad debts is debited to P/L a/c and is
deducted from sundry debtors in the
Provisions for bad debts
doubtful debts
Every business has a lot of dealings by way
of credit transactions. This gives rise to a
sizable amount of book debts or debtors.
But it is seldom that 100% of these debts
will be recovered. The object of making
bad debts provisions is to bring down the
balance of debtors to its true position, the
usual practice is to calculate as provision or
reserve for doubtful debts.
Provision for discount on
Cash discounts are allowed to debtors
in order to encourage them to make
prompt payments. After providing for
bad and doubtful debts, the balance of
debtors represents debts due from
sound parties. They may try to pay
their dues on time and avail
themselves of the cash discounts
Provision for discount on
Creditors represents the amount owed by the
business to suppliers for goods on credit. Sound
business concerns make it a practice to settle
accounts with creditors in time to earn goodwill of
the creditors and also the discount allowed by
them. In that case the liability in respect of sundry
creditors can be reduced to the extent of discounts
anticipated. A certain % on creditors is calculated
and should be entered in the credit side of P/L a/c
and then after reduced from the creditors in liability
side of balance sheet
Interest on capital
Interest on a normal rate is allowed on
the capital of the proprietor employed
in the business. It is treated as
business expenditure. Such expense is
debited in P/L a/c and also added to
the capital in the balance sheet.
Interest on Drawing
Drawing are money withdrawn by the
proprietor from his capital. It charges
interest on drawings. It is treated as
business incomes. So that the amount
of interest is entered in the credit side
of P/L a/c and then added in drawing
Drawing of goods by the
proprietor for personal use
When the proprietor withdraws or
takes away some goods from the
business for his personal use or
consumption, the goods so taken are
deducted from purchases on the debit
side of the trading account and
included in proprietors drawing
account or deducted from capital on
the liability side of the balance sheet.
Managers commission on
net profit
In some cases, the manager of a business
may be given a commission based on a
fixed % of the net profits earned by the
business. In such a case, the total net
profits are calculated and then the % of
the commission is applied. Outstanding
managers commission will be shown on
the debit side of profit and loss account
and as a liability on the liabilities side of
the balance sheet.
Analysis of financial
statement ( unit III)
The number given in financial statement (
profit and loss a/c and balance sheet ) are
not of much use to the decision maker.
These number are to be analyzed over a
period of time or in relation to other
numbers so that significant conclusions
could be drawn regarding the strengths and
weakness of a business enterprise. The tools
of financial analysis help in this regards

Unit-3 Analysis of
financial statement
Following are the techniques of analysis of
financial statement-
1) Common size statement
2) Comparative statement
3) Trend analysis
4) Ratio analysis
5) Fund Flow Statement
6) Cash Flow statement
It is not necessary that all the above
mentioned tools are at one stretch.
Selection of an appropriate tool depends on
the objective of investigation .
Common size statements
Common size statements express all
items of a financial statement as a
percentage of some measure of size of
the enterprise.
For example total assets may be
chosen as a measure size for balance
sheet and sales act as a measure of
profit and loss a/c.
Thus, the determination of trends and
the comparison of amounts are
facilitated by the use of %age of
figures instead of rupee amount.
These statement is known as common
size statements, because all figures
are converted into a common size ,
%age and related to one column
figure i.e., 100.
An analysis of common size statement
will help better understand the
important changes which have
occurred in the enterprise over a
period of time
Comparative statement
Comparative statement are financial
statements that cover a different time
frame, but are formatted in a manner
that makes comparing line items from
one period to other. It makes a
process of comparative analysis.
To provide information about nature of
changes affecting the financial position
and performances of an enterprises.
To assess the position of the
enterprises in comparative way
To ascertain profitability, liquidity and
solvency position.
The analysis basis on-
Comparative income statement
Comparative financial position

Trend Analysis
It is the analysis of trend over a period. It
does not required comparison of actual
ratios with bench mark ratio. Trend analysis
shows that general tendency of the
variables through presentation of facts and
figure in such a way that indicates a definite
direction of financial variables forming part
of income and financial position statements.
Trend analysis covers the period of
more than two years. The trend %age
can be calculated as
Current year figures
Trend %age=----------------------- X100
Base year figure

Unit 3
Ratio Analysis
Ratio analysis is an important
technique of meaningful analysis of
financial statements. It implies
financial analysis of a business by
establishing relationship between
items or group of items of the same
financial statements.
Ratio analysis is a process of determining
and presenting the relationship of items and
group of items in the statements. It involves
calculations, comparisons and interpretation
of ratios between two or more items of
financial statements for some specified
purpose. As compared to other tools of
financial analysis, the ratio analysis
highlights more useful facts about various
aspects of the working (financial position,
solvency, stability, liquidity and profitability)
Uses or advantages of
Ratio analysis
Aid in business forecasting - ratio analysis assists in
business forecasting. Trend in relation to financial
statements can be ascertained on the basis of
figures of past years, they assists in forecasting.
Aid in the management Ratio analysis has great
relevance for management. It assists management
in formulation of policies and budgets. On the basis
of ratio analysis manager establishes co
ordination between various activities and achieves
the targets.
Aid in cost control waste expenditure and
losses can be controlled through ratio
analysis, which reduces cost. This is helpful
in establishing control on costs in period of
To know efficiency operating profitability
and efficiency can be measured on the basis
of various results, obtained through ratio
To know liquidity and solvency
positionThrough ratio analysis,
important information related to
liquidity and solvency position of an
organization is obtained. Working
capital is determined on the basis of
liquidity and on the basis of solvency
proper utilization of capital is ensured.
Useful for decision making Ratio analysis is
immense help, in reaching to a conclusion through
evaluations of various data's.
Investment decision Ratio analysis provides
various in formations to investors in relation to
maximum rate of return and security of their
Aid in comparison Inter firm comparison becomes
becomes possible through ratio analysis. It is useful
for managers in comparing departmental working
performance, as a result, efficiency of departments
can be measured easily.
Aid in trend analysis Trends of figures are
interpreted on the basis of various past
records, thereafter corrective measures are
taken after interpretation of trends.
Better utilization of resources through
ratio analysis various information, dates and
facts are collected and better utilization of
physical and natural resources is ensured.
Limitations of Ratio Analysis
Though ratio analysis is a precious
technique of financial analysis but it is
not a full proof technique. Its utilities
depends upon its proper use.
Mishandling of ratios and using them
without proper context may mislead
the analyst and wrong conclusions
may be drawn. Hence, its users must
know its limitations. Some main
limitations are given as under.
Limited use of a single Ratio
A single ratio has limited value in ratio
analysis because trend is more
significant in the analysis. A change in
a particular ratio is meaningful only
when it is interpreted with reference
to other related ratio.
Lack of qualitative analysis
of the problem
Ratio analysis is an instrument of
quantitative analysis. It overlooks
qualitative factors of the problem even
if they are more important than
quantitative factors.
Effect of inherent limitations
of the accounting
As ratio are calculated from figures
obtained from historical accounting
records, hence, they will posses all
those weaknesses and errors which
the accounting record possess.
Arithmetical window
In ratio analysis arithmetical window
dressing is possible. During this course
of action, actual facts are concealed
and with the help of figures
Accounting limitations
As ratio analysis is calculated on the
basis of figures and sometimes actual
datas and figures are not available due
to limitations of accounting, this has a
adverse affects on decision making
and interpretation.
Changing conditions
As ratio analysis is done on the basis
of past figures and facts, during
constantly changing conditions it is not
possible to practically accommodate
affects in accounting, which has a
adverse effects on results.
Ignoring the backgrounds
During inter firm evaluation in ratio
analysis, at times background of firms
is ignored, as a result true conditions
are not ascertained.
Bios of the analyst
Ratio analysis can be affected through
bias of the analyst also. In this case,
analyst can collect and interpret data
for his own interest and use,
consequently results are affected.
Limited use
Ratio analysis is used only for
interpretation of financial statements it
is not used for any other purpose of
accounting, thus it has a limited scope.
Price level effect
In comparative study of financial
statements change in price level are
ignored due to which utility of
comparative ratio for various periods is
adversely affected.
fund flow statement
Fund flow statement is a statement in
the summary form that indicates the
changes in items of financial position
between two different balance sheet
dates showing clearly the sources and
application of funds.
A statement of sources and applications of
funds is a technical device designed to
analyse the changes in the financial
condition of a business enterprise between
two dates.
A funds flow statement is prepaid in
summary form indicate changes occurring in
the items of financial conditions between
two different balance sheet dates.
Concept -
The term funds as cash and they
concern themselves with the
movements in cash account. The
statement showing the changes in
cash balances is termed as cash flow
statement. In other word the term
fund refers to working capital i.e.,
excess of current assets over current
The term flow refers to change or
transfer, and therefore, the flow of
funds means transfer of economic
values from one assets to another, or
the utilizations of funds.
Objectives of fund flow
From what sources finance has been
provided for increase in working capital.
From what sources cash has been obtained
for payment of loan and redemption of
In what manner, amount received from sale
of fixed assets has been utilized.
In what manner fixed assets have been
How and where the amount of net
profit has been utilized.
What are the other sources of funds
and how they are utilized.

Importance of fund flow
Helpful in financial analysis this
statement is an important tool for
financial analysis. The statement
provides information to finance
manager about the sources and
utilizations of working capital in past
accounting years.
Comparative study is possible - With the
help of fund flow statement it becomes
possible to compare the balance sheet and
P/L account for the past years along with
Helpful in future planning with the
analysis of fund flow statement, finance
manager is able to collect information about
various facts which helpful in preparing
future financial plans.
Effective use and management of
working capital it provides the
information of the use of working
Helpful in borrowing operations.
Source and uses of fund
Sources of funds all items related to
business transactions of organizations which
increase working capital are known as
sources of funds. These are as under-
Profit from operation, loan taken from bank,
sale of fixed assets, issue of shares and
debentures, income from the receipt of
interest etc.
Applications or uses of
Transaction which result in decrease in
working capital are known as
application of funds. these are as
Operating losses, purchases of fixed
assets, repayment of loan,
redemptions of shares and
debentures, payment of interest, taxes
and dividends.
Preparation of funds flow
Mainly two comparative balance sheet at
the beginning and at the end of a period are
used for preparing a funds flow statement.
This analysis is classified into three
categories. These are as
Schedule of change in working capital
Calculation of operating profit
Fund flow statement
Schedule of changes in
working capital
The schedule prepared to depict
changes, in current assets and current
liabilities which, arise due to flow of
fund is known as schedule of changes
in working capital. This schedule
depicts the changes taking place in
individual items of current assets and
current liabilities between balance
sheet of two accounting periods.
Fund from operations or
operating profit
Operating profit refers to the profit
from business activities. In general
practice the profit provided in profit
and loss account having so many
items of non operating incomes and
expenditures. the calculation of
operating profit we have the following
Calculation of fund from
Profit and loss from current year
- Profit and loss from current year
Profit for the year -----------------------
+ non operating items or expenses
A) current year depreciation .
B) transfer to general reserve
C) loss on sale of fixed assets ..
D) good will, discount on shares and debenture preliminary expenses
written off .
E) provisions for taxations and
proposed dividend .
Less profit on sale of fixed assets
Fund from operations -------------------
Fund flow statement
Sources of fund
Issue of shares and debenture.
Loan taken from bank
Sale of fixed assets
profit from operations
Other receipts

Applications of fund
Redemption of shares and
Repayment of loans
Purchase of fixed assts
Loss from operation
Other payments
Cash flow statement
Cash flow statement is the statement
which shows the inflow and flow of
cash and cash equa