Introduction to Financial Accounting Prof.

Rahul K Kavishwar Faculty KLES IMSR, Hubli

Scheme of my presentation
Introduction of Accounting. Accounting as a Information Meaning of Accounting. Classification of Accounting. Meaning of Financial Accounting. Distinction between Bookkeeping and Accounting Accounting as a information system.

Introduction to Accounting
Accounting is as old as money itself. Chankaya in his Arthshastra had emphasized the existence and need of proper accounting and auditing in the society. The role of accounting has been changing with the economic and social developments.
Historical description of financial accounting. Modern description of financial accounting - GAAP

SAP, Tally, Profit and in-house accounting software's.

Accounting as an Information System

Business Activities

Operating activities create revenues, expenses, gains, and losses. Investing activities increase and decrease long-term assets. Financing activities obtain cash from investors and creditors.

Financing Activities
Activities associated with obtaining adequate funds to begin and continue operations
Issuing stock Paying dividends to stockholders Obtaining loans from creditors Repaying amounts to creditors, plus interest

Payments of dividends and interest are associated with financing activities, even though they involve cash outflows, because they are necessary to obtain funding.

Investing Activities
Activities associated with spending funds to begin and continue operations
Buying resources such as land, buildings, and equipment needed in the operation of the business. Selling these resources when no longer needed

Selling land, buildings, and equipment is associated with investing activities, even though it results in a cash inflow, because it involves resources used to begin and continue operations

Operating Activities
Involve activities associated with the course of running a business
Selling goods and services Employing managers and workers Buying goods and services Paying taxes

Meaning Accounting
Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and event which are in part at least of a financial character and interpreting the results thereof.
According to American Institute of Certified Public Accountants (AICPA) Transactions which are measurable in monetary terms. Rupees. Rupees. Financial character Rs. 10,000. Rs. 10,000. Interpretation of financial data Ratio Analysis

Classification Accounting
The word Accounting can be classified into 3 main categories.

Classification Accounting .
Government Accounting:
Specifically addresses issues of measurement and valuation in the context of Government enterprises. For Example:
Electricity. Water supply P & T and etc.

Enterprise Accounting
Specifically addresses issues of measurement and valuation in the context of business enterprises. Has evolved into three disciplines.

Classification Accounting .
Social Accounting:
Relates to social activities of the society. How much money spend on the social activities or society. For Example: Construction of Hospital in village Social cost benefit analysis.

Cost Accounting
Cost Costing Cost Accounting Cost Accountancy

Cost
Cost is the amount of expenditure incurred. It is price paid for something. Cost is an expenditure incurred on production of goods and services.
For Example: Rs. 135 is cost of Khan & Jain Book. Rs. 45,000 is a cost of Hero Honda

Costing
Costing refers to cost ascertainment
Cost finding Cost calculation of a product or services It does not includes accounting part.

It is a technique and process of ascertaining costs of a product. For Example: Example

Rs. 45,000 is a cost of Hero Honda. How?????

Cost Accounting
Cost accounting is the process of accounting for cost from point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centers and cost units.
It is accounting for the cost.

And beings with the recording of all income and expenditure, and ends with the presentation of statistical data.

Cost Accountancy
Application of costing and cost accounting principles, methods and techniques. It also includes cost control and ascertainment of profitability.

Costing

Cost Accounting

Cost Accountancy

Book Keeping
Book keeping is a part of accounting. It concerned with record-keeping or maintenance of books of accounting which is often routine and clerical in nature. It covers
Identifying the transactions and events Measuring the identified transactions and events Recording the identified and measured transactions and events in proper books of accounts Classifying the recorded business transactions and post them in to ledger.

Accounting
Accounting referees to the actual process of preparing and presenting the accounts of an enterprises.
Summarizing Analyzing and interpreting and summarized results. Communicating the results to interested parties.

Accountancy
It is a systematic knowledge of accounting. It explains the method of preparing the books of accounts, and summarizing and communicating accounting information. GAAP
Bookkeeping Accounting

Accountancy

Distinction Between Book Keeping & Accounting

Basis of Distinction
Scope

Book Keeping
Bookkeeping involves the following functions: Identifying the transactions Measuring the identified transactions Recording the measured transactions Classifying the recorded transactions

Accounting
Accounting, in addition to bookkeeping, involves the following functions: Summarizing the classified transactions Analyzing the summarized results Interpreting the analyzed results Communicating the interpreted information to the interested parties.

Stage

Bookkeeping is a primary stage. The basic objective of bookkeeping is to maintain systematic records of financial transactions.

Accounting is the secondary stage. It starts where bookkeeping ends. The basic objectives of accounting are as follows: To ascertain the net results of operations and financial position To communicate information to the interested parties.

Basic

Who Junior staff perfor performs bookkeeping ms work.

Senior staff performs accounting work.

Knowledge level

A bookkeeper is not required to have a higher level of knowledge than that of an accountant.

An accountant is required to have a higher level of knowledge than that of a bookkeeper.

Analytical skills Nature of job

A bookkeeper may or may An accountant should not possess analytical skills. possess analytical skills. job of an The job of a bookkeeper is The often routine and clerical in accountant is nature. analytical in nature.

Designing of Bookkeeping does not cover Accounting covers accounting designing of accounts designing of system system. accounting system.

Supervision and checking

A bookkeeper does not supervise and check the work of an accountant.

An accountant supervises and checks the work of a bookkeeper.

Meaning Financial Accounting

It is defined as the science and art of recording and classifying business transaction and preparing summaries of the same for determining year end profit or loss and the financial position of the concern.
Profitability Provide information about the financial position of the concern. Principal statement of financial accounting Income and expenditure statement Balance sheet.

Who Needs Accounting Information?

Internal Users
Employees Managers

External Users
Stockholders Creditors Government regulators

Management Accounting Information about past performance and what can be expected in the future

Financial Accounting Financial statements report on profitability and liquidity to evaluate the success of a business

Who Uses Accounting Information?

Management
 Finance  Investment  Operations & Production  Marketing  Human Relations  Accounting

Those With Indirect Financial Interests

    

Those With Direct Financial Interests

 Investors  Creditors  Banks

Tax Authorities Regulators Labor Unions Customers Economic Planners

Users with Direct Financial Interests

 Investors

 Creditors
Require financial data to assess whether a company will have the cash to repay debt before making a loan.

Require financial information to analyze the past success and potential earnings of a business

Users with Indirect Financial Interests

 Tax Authorities require special tax returns and recordkeeping
 Regulatory Agencies publicly traded companies must report periodically to the SEC  Labor Unions, Consumer Groups, Customers, and Other Groups the financial performance and prospects of businesses affect the economy, environment, and public policy.

Components of Accounting
System Design

Record Transactions: Bookkeeping

Processing can be done: Manually, By computer, or Using a management information system

Accounting

Analyze & Interpret Information

Communicate Information

Accounting Principles
It refers to the rules of action or conduct to be applied in accounting. Those rules of conduct or procedure which are adopted by the accountants universally, while recording the accounting transactions. Accounting principles can be classified into two categories
1. Accounting concepts 2. Accounting conventions.

Accounting Principles
Accounting Concepts Entity concept Dual Aspect concept Accounting period concept Going concern concept Cost concept Money measurement concept Matching concept Accounting Conventions Convention of disclosure Convention of conservatism Convention of consistency Convention of materiality.

Accounting Concepts
Accounting concepts means
Necessary assumptions Ideas postulates Which are used to accounting practice and preparation of financial statements

Entity Concepts
The entity is separate and distinct from the owners and
the entity is liable to the owner. Hence, in a limited liability company, the enterprise is liable to the owner (shareholder) based on the proportion of the capital investment (share capital) made by the latter. A business is considered distinct from its creditors and customers as well as its owners. For Example:

Concept of Separate Entity in the business

A business is considered distinct from its creditors and customers as well as its owners.

Business reports & accounts Personal reports & accounts

Forms of Business
Sole Proprietorship
One owner Owner takes all profits and losses Owner is liable for all business obligations

Partnership
Two or more owners Partners share in profits and losses One partner can obligate the business to another party Must be dissolved if ownership changes

Corporation
 Business unit chartered by the state with articles of incorporation; legally separate from owners (stockholders)  Stockholders enjoy limited liability  Life of corporation is unlimited

Dual Aspect concept

According to this concept, every business transaction involves two aspects, namely for every receiving of benefit and there is a corresponding giving of benefits. Every debit there is an equal and corresponding credit. Capital + Liabilities = Assets or Assets = Equities (Capital)

Accounting Equation

Assets are the economic resources of a business that are expected to produce a benefit in the future. Liabilities are outsider claims, or economic obligations payable to outsiders. Owners equity represents the insider claims of a business.

Building the Accounting Equation

Economic Resources = Creditors Equities + Stockholders Equity
In accounting terms

Assets = Liabilities + Stockholders Equity

The two sides of the equation must always be in balance.

Accounting Equation.

Assets
 Economic resources expected to benefit the companys future operations  Inventory, land, equipment, buildings (physical items)  Cash, accounts receivable (monetary items)  Patents, trademarks, copyrights (nonphysical)

Liabilities
 Obligations to pay cash, transfer assets, or provide services to other entities in the future  May take the form of accounts payable, taxes payable, loans, or wages owed to employees  Liabilities are claims recognized by law

Stockholders Equity
Claims of the owners of a corporation to the assets of the business
Stockholders Equity Contributed Capital Amount that stockholders invest in the business
Share Capital Par value Addl paid-in capital

Retained Earnings (RE) Generated by business operations and kept for use in the business
Expenses and dividends decrease RE Revenues increase RE

In all Accounting Equation.

Assets

Liabilities

Owners Equity

Assets = Liabilities + Owners Equity

Expansion of the Accounting Equation.

+ Equity shares + Retained Earnings Dividends + Revenues Expenses

Assets

Liabilities

Owners Equity

Accounting Period Concept

Assigns revenue and expenses to a specific time period. Time periods are of equal length. Financial statements may be prepared for any time period. The 12-month accounting period is called a fiscal year (does not have to correspond with the calendar year). Monthly or quarterly periods are called interim periods.

Accounting Period Concept

Suitable accounting period In India accounting period starts on
1st April 2005 to 31st march 2006

In USA accounting period start on

1st Jan 2005 to 31st December 2005

All the statements are prepared at the end of the accounting period.

Going concern Concept

Continue of Activity concept. Business concern will continue for a long period to exist. Entities have a life of infinite duration, unless facts are known that indicate otherwise. The basis of valuation of resources is influenced more by their future utility to the business entity than by their current market valuation. Organisation accountant feel that.

Going concern Concept

Unless there is evidence to the contrary, the accountant assumes that the business will continue to operate indefinitely.

Balance Sheet The cost of certain assets may be held until a future year

Income Statement Rs. when it will become an expense.

Cost Concept
It implies that assets acquired are recorded in the accounting books at the cost or price paid to acquire it. For Example: Example
Plant & Machinery @ Rs. 2 crores So Accountant has to enter Rs. 2 crores in the books of accounts.

Money measurement Concept

Accounting transactions are measured, expressed and recorded in terms of money. Only money terms are used. Concept excludes those transactions or events which cannot be expressed in terms of money For Example: Skill of the supervisor, product policies, employeremployee relationship.

Matching Concept
Business concern is to ascertain the profit periodically. Expenses must be assigned to the accounting period in which they are used to produce revenue. To measure the profit for a particular period it is essential to match accurately the cost associated with the revenue.
If cause and effect relationship exists Recognize expenses and related revenues in same period. Allocate costs in a systematic way to accounting periods that benefit from the costs.

If no cause and effect relationship exists

Assumptions and the Matching Rule

Accounting Conventions
Are the traditions, usage and customs which are in the use in preparation of accounting.
Methods
Methods of depreciation Valuation of inventories Treatment of retirement benefits Conversion of foreign currency items

Practices Guidelines for preparation of accounting statements

GAAP

Convention of Disclosure
All the accounting statements should be honestly prepared and all the facts and figures must be disclosed. For Example: Global Trust Bank Example:
Now Merged with Oriental Bank of Commerce

Disclosure of all the information is one of the important accounting conventions.

Convention of Conservatism
Policy of playing safe or cautious approach. Company can make provision for possible loss, it should be taken into account.
For Example: Reserves and surplus or Retained earnings For distribution of dividends or interest payment Bad debts provisions Inventory valuation cost price or market price whichever is lower.

Convention of Consistency
Accounting policies and methods should remain unchanged for preparation of financial statements from one period to another period. For Example: Example:
Straight line method of depreciation to Reducing Balance of Depreciation.

Meaningful comparison in the performance of different periods.

Current year profit and last year profit Current year growth and last year growth

Convention of Materiality
Only those events should be recorded which have a significant bearing and insignificant things should be ignored while preparing the profit and loss account and balance sheet. For Example: Example:
Leakage of oil in the oil factory Loss of raw material due to bad handling Wastage of raw material due to bad handling

Usually accountant will take the decision in this regards. He/she should follow some steps in this regard.for example

Measuring Business Transactions

Economic Event

When to record? Recognition

What value to record? Valuation

How to categorize? Classification

Affects the financial position of an entity

System of Accounting
There are two systems of accounting 1) Single entry system
All transactions relating to a personal aspect are recorded in the books of account. It is incomplete and inaccurate system of accounting.

2) Double entry system

Every transactions has two aspects and according to this system, both the aspects are recorded in the books of account.

DoubleDouble-Entry Accounting

Double-entry bookkeeping means to record the dual effects of each business transaction.

System of Accounting for recording 1) Cash system of accounting 2) Mercantile or Accrual system of Accounting 3) Mixed system of Accounting

Cash system of accounting

Only actual cash receipts and cash payments are recorded.
No credit transactions is made Receipts and Payment account is prepared

For Example:
Government Organizations Pan shops Kirana shops and etc

Mercantile system of accounting

All the business transactions are recorded in the books of accounts for a particular period inclusive of cash receipts and cash payments or any amount having become due for payment or receipt. Cash and credit transaction are recorded. For Example: Example:
Big Business organisation or corporates. Pan shops Kirana shops and etc

Mixed system of accounting

It is a combination of Cash system and Mercantile system. All the cash payments and receipts are recorded All the credit and cash transaction are recorded in the books. For Example: Example:
Whole sale shops Big Business organisation or corporates. Retail shops and etc

Main element of accounting Income Assets Expenses Liabilities

1) Personal account 2) Real account 3) Nominal account

Types of Accounts
Types Accounts Personal Account Natural persons A/c Impersonal Account Artificial Persons A/c Representative Personal A/c

Real Account

Nominal Accounts

Tangible Real Account

Intangible Real Account

Types of Accounts.
Personal account
This account relates to a person or a group of persons or a firm in which the business concern either receives something from the individual or institutions or pay something to the individual or institutions. Personal accounts involve future relationship. Personal accounts appears in the Balance sheet of the concern. Rule for recording Personal Account are

Personal Accounts

Debit the receiver & Credit the giver

Personal Accounts.
The personal account further divided into 3 types.
Natural Persons Account: Recording transactions of business deals with individual person. For Example: Ram Account, Krishna Account, Sita account and Radha Account

Personal Accounts.
Artificial Persons or legal bodies:
An artificial person or legal bodies created by law. Transaction related to business entity For Example: Reliance Industries Ltd Account ABC company ltd account Societys account

Personal Accounts.
Representative Personal Account:
An account, indirectly representing a person or persons. Records all the transaction related to outstanding expense, prepaid expenses and accrued expenses. For Example: Salaries outstanding Wages outstanding Rent outstanding Prepaid Insurance and etc

Real Accounts
Transactions which are connected with Assets is known as Real Accounts. The real account may be tangible or intangible Tangible: Assets which can be touched, felt and measured.
For Example:
Land and Building Goods Furniture Plant and Machinery

Real Accounts
Intangible: Asset which cannot be touched and measured physically.
For Example: Trade mark Goodwill Patent, Copy Rights and etc

Rule for recording Real Account are

Real Accounts

Debit what comes in & Credit what goes out

Nominal Accounts
Transaction related to business connected with expenses, incomes, profit or losses. Payment made / Income received do not acquire any Asset or create any Future Relationship. For Example:
Rent Salaries Interest Taxi fair & Stationary and etc

Rule for recording Nominal Account are

Nominal Accounts

Debit all expenses and losses & Credit all incomes and gains

Journal
Book of original entry or prime entry or First entry. All the business transactions are recorded in chronological order. In simple meaning Journal is a daily record. The transactions are not written directly in the accounts. They are, first of all recorded in the journal. Then they are transferred to ledger.

Format of Journal
Journal of Mr. Khan & Jain as on 31st Jan 2006

Date

Particulars Accounts and Explanation or ( narration )

L.F Debit Credit

Recording Transactions in the Journal

Identify the transaction and specify each account affected.

Use the rules of debits and credits.

Enter the transaction in the journal, including a brief explanation for the entry.

Ledger
Book of a final entry. Second state in the accounting cycle. Summary statement of all transactions relating to a person, asset, expenses or income which have taken place during a given period of time and showing their net effect. All the recorded transactions which are classified and grouped into different heads of accounts.

Format of Ledger
Capital Account Dr. Date Particulars JF Amount Date Particulars Cr. JF Amount

To

By

The T-Account T-

Account Title Debit Credit

LEFT SIDE

RIGHT SIDE

The T-Account. TThree parts 1. A title that describes the account 2. A left side, called the debit side 3. A right side, called the credit side
Title of Account

Debit (left) side

Credit (right) side

Increases and Decreases in the Accounts

Assets Rules of Debit and Credit:

Liabilities

Expenses

Debit Credit +

Debit Credit +

Debit Credit + -

Posting from Journal to Ledger

The journal is a chronological record of all transactions listed by date. The ledger is a grouping of all the accounts; it shows their balances. Data must be copied to the ledger a process called posting.

Posting from Journal to Ledger

Cash asset accounts All accounts combined make up the ledger. Ledger liability accounts

Accounts Payable Capital

Share capital accounts

Trial Balance
A trial balance lists all accounts with their balances assets first, followed by liabilities, and then share capital.

DEBITS

CREDITS

Trial Balance
Trail Balance is the list of all debit and credit balances of accounts taken out from the ledger at any given date. Helps in preparation of final accounts
Trading Account Profit & Loss account Balance sheet

Format of Trial Balance

Trial Balance of Khan & Jain as on 31st Jan 2006

Sl. No

Name of accounts

Debit

Credit

Trial Balance
For every amount debited, an equal amount must be credited
Result: The total of debits and credits for all the T accounts must be equal

Trial balance is prepared to test this

Usually prepared at the end of a month or an accounting period Can be prepared anytime

Subsidiary Books
For practical convenience the journal is maintained by using a number of books called the subsidiary books. Also called as Special Journals Suitable for big organisation Totally 7 subsidiary books, namely

Subsidiary Books.
Subsidiary Books

Sales Book

Sales return Book

BP Book

BR Book Cash Book

Purchase Book

Purchase Return Book

Simple cash Book

Cash with D/S book

Cash with Bank & D/s Column

Petty cash book

Final Accounts
Final accounts include
Trading account Profit & Loss account Balance sheet.

Adjustment entries Financial soundness of a concern as a whole during the particular period.

Trading Account
It shows the results of the purchasing and selling of goods. It determines Gross profit or Gross Loss. It records all Direct Expenses. Helps in calculation of Cost of Goods Sold
COGS = Opening stock + Purchases Purchases return + direct expenses Closing stock stock.

Trading Account.
Dr. Cr.

Particulars
To Opening stock

Amount

Particulars
By Gross Sales Less: Returns Net Sales By Closing stock By Gross Loss C/d ( Transfer to P & L Account)

Amount

To Purchases To Direct Expenses To Gross Profit C/d ( transfer to P & Account )

Trading Account.
Important Elements of Trading Accounts
Opening stock Purchases & Purchases Return Direct Expenses Gross Profit is the excess value of sales over the cost of sales. Sales & Sales return Closing stock Gross Loss is the excess of cost of sales over the sales revenue.

Profit & Loss Account

Was it a good year or bad year? What was the volume of operations? What was the margin available on sales realization? The answer

Profit & Loss Account

Profit & Loss Account

It records all indirect Expenses. Helps in determining Net Profit or Net Loss of the firm. A profit & Loss Account shows a company's earnings and expenses over a given period of time. It exclusively summarizes revenue and expenses of the period and shows the net difference i.e., profit or loss of the period.

Profit & Loss Account

Dr. Cr.

Particulars To Gross Loss B/d To All Indirect Expenses To Net Profit c/d

Amount

Particulars By Gross Profit B/d By Nonoperating Incomes By Net Loss C/d

Amount

Balance sheet
Balance sheet is a statement of assets and liabilities prepared with a view to ascertain the financial position of a business on a certain fixed date. It is a statement not an account. Helps in knowing the financial position of the firm. Reports value of assets, liabilities and owners equity at a particular point in time.

Balance sheet.
Liabilities Capital / Fixed Liabilities Non- current liabilities Current liabilities Amount Assets Fixed Assets Current Assets Factious Assets Amount

Liabilities
It is an economic obligations of an enterprise. Business enterprise has to pay in case of discontinuation of business.
Repayment of capital invested by the owner or investor.

For Example: Example:

Capital / Equity shares Preference shares

NonNon-current Liabilities
Payable after a certain number of years. Liabilities which are become due for payment beyond period of one year. For Example: Example:
Long term debt Debenture Long term loan from Bank Long term loan from Financial Institutions Long term loan raised by Issue of Public deposits Long term debt raised by issue of securities.

Current Liabilities
Are obligations due within one year or Any amount owing by the business which are currently due for payment. For Example:
Bills payable Sundry Creditors Short term loans Dividend payable Provision for Taxes payable Short term bank Overdraft Outstanding expenses

Assets
have a useful life of more than one year. are acquired for use in the business. are not intended for resale to customers. Assets which are acquired for permanent use in the business. Information about long-term acquisitions can be found under investing activities in the statement of cash flows. For Example: Example:

Assets.

Current Assets
It is also called as floating Assets. Assets which can be easily realised or converted in to cash. Shorter period say, less than one year For Example:
Cash or cash at Bank Inventories Debtors Bill Receivable Short term investment Prepaid Expanses

Fictitious Assets
They are useful because of the special rights that they carry. Do not have a physical form. For Example:
Patents Copyrights Trademarks Preliminary Expenses Share issue expenses

Adjustment entries
1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) Closing stock Outstanding expenses Prepaid Expenses Accrued Income Income received in Advance Depreciation Interest on Capital Interest on Drawings Bad Debts Provision for Doubtful debts Provisions for Discount on debtors Provision for Discount on creditors.

Accounting Cycle

Accounting Cycle
Describe the accounting cycle, and explain the purposes of closing entries.

Class is open for the discussion

Thank u