1 introduction to financial accounting

This presentation talks about Meaning, of accounting, distinction between book keeping and accounting, Branches of accounting, Objectives of accounting, Uses and users of accounting information, Advantages of Accounting, Is accounting a science or an art, double entry system of financial accounting, limitations of financial accounting, important terms, journal entry, accounting concepts and conventions

1. INTRODUCTION TO FINANCIAL ACCOUNTING 1

2. TOPICS COVERED Meaning of Accounting Difference between Book Keeping and Accounting Is accounting an art or science Objectives of Financial Accounting Branches of Accounting Nature of Accounts with examples Double Entry System and its rules with examples Accounting Concepts Accounting Conventions Uses of Financial Accounting Users of Accounting Information Advantages of Accounting Limitations of Financial Accounting Important Terms for Reference 2

3. Meaning of Accounting Art of recording and classifying the business transactions and events which includes – receipt and payment of cash, purchase and sale of goods on credit etc The transactions must be in monetary terms Art of making summaries, analysis and interpretation of business transactions Communication to the external and internal stakeholders for decision making 3

4. Difference between Book Keeping and Accounting BASIS FOR COMPARISON BOOKKEEPING ACCOUNTING Meaning Bookkeeping is an activity of recording the financial transactions of the company in a systematic manner. Accounting is an orderly recording and reporting of the financial affairs of an organization for a particular period. What is it? It is the subset of accounting. It is regarded as the language of business. Decision Making On the basis of bookkeeping records, decisions cannot be taken. Decisions can be taken on the basis of accounting records Preparation of Financial Statements Not done in the bookkeeping process Part of Accounting Process Tools Journal and Ledgers Balance Sheet, Profit & Loss Account and Cash Flow Statement Methods / Sub-fields Single Entry System of Bookkeeping and Double Entry System of Bookkeeping Financial Accounting, Cost Accounting, Management Accounting, Human Resource Accounting, Social Responsibility Accounting. Determination of Financial Position Bookkeeping does not reflect the financial position of an organization. Accounting clearly shows the financial position of the entity. 4

5. Accounting as science and art As science An accountant finalizes the economic results by identifying, analyzing, classifying using the method of double-entry bookkeeping accounting system. So , Accounting is a science that includes comprises of rules, principles, concepts, conventions and standards in science . As Art it presents the financial findings by following and implementing a universally accepted method (GAAP) . the established rules and principles of accountingis applied in bookkeeping process of and economic entity 5

6. Objectives of Financial Accounting To know the results of business – via profit and loss account or income and expenditure account To ascertain the financial position of the business – the extent of assets and liabilities at any point of time through preparation of balance sheet To ensure control over the assets – important in prevention of frauds, misappropriation and losses To facilitate proper management of cash – surplus fund can be used in profitable ventures and deficiency of cash can be overcome by preparing for funds from bankers etc To provide requisite information – information to the govt and tax authorities with great ease, as and when needed 6

7. Branches of Accounting 7 Basis Financial Acc o un t ing Cost Accounting M a n a ge m ent Accounting Objects Record transactions & det e r m ine financial position & profit or loss. Ascertainment, allocation, accu m ulat i on and accounting for cost To assist the m ana g e m ent in decision-making & policy formulation. Nature Co n c e r n e d wi t h historical data. Concerned with both past and pres e nt recorded(historical in nature). Deals with projection of data for the future (futuristic in nature) Pr i ncip l e Follow e d Govern e d by GAAP C e rta i n pr i n c ipl e s followed for recording costs. No set principles are followed in it. Data used Q u a l i t a t i ve a s pec t s are not recorded Only quantitative aspect is recorded. Uses both q u a nt i t a t i ve a n d qualitative concepts.

8. Branches of Accounting 8 Basis Financial Acc o un t ing Cost Accounting M a n a ge m ent Accounting Rep o rting frequency Ge n e ral l y a t e n d of year As & when desired by management As & when desired by management Publication Published in case of companies NOT published NOT published I n f o r m a t i on recorded Monetary tr a nsac t i o ns ONLY Both m o n e t a ry non-monetary information. and Both m one t a ry non-monetary information and Forms Account of Accounts are prepared to meet the l egal requirements. These are generally kept Voluntarily to meet the requirements of the management. These are generally kept Voluntarily to meet the requirements of the management.

9. NATURE OF ACCOUNTS 9 Personal Account Real Account Nominal Account The elements or accounts which represent persons and organisations . The elements or accounts which represent tangible or intangible aspects or helps the organisation to earn profit The elements or accounts which represent expenses, losses, incomes, gains. Mrs. Vimla a/c - representing Mrs. Vimla a person. M/s Bharat & Co a/c - representing M/s Bharat & Co, an organisation . Capital a/c - representing the owner of the business, a person or organisation . Bank a/c - representing Bank, an organisation . Cash a/c - representing cash which is tangible. Goods/Stock a/c - representing Stock which is tangible. Furniture a/c - representing Furniture which is tangible. Goodwill Salaries a/c - representing expenditure on account of salaries, an expense. Interest received a/c - representing income on account of interest, an income. Loss on sale of Asset a/c - representing the loss incurred on sale of assets, a loss.

10. NATURE OF ACCOUNTS - EXAMPLES Started Business with a Capital of 1,00,000 . Since capital in the form of cash is being brought into the business, capital increases by 1,00,000 and cash increases by 1,00,000 10 Capital a/c ↓ Person ↓ Personal a/c Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c

11. NATURE OF ACCOUNTS - EXAMPLES Bought Furniture for cash 25,000 Since Furniture is being bought by paying cash, the value of Furniture increases by 25,000 and the cash available with the business would reduce by 25,000. 11 Furniture a/c ↓ Tangible Aspect (Asset) ↓ Real a/c Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c

12. NATURE OF ACCOUNTS - EXAMPLES Bought Goods for cash 25,000 from M/s Roxy Brothers. Since goods are bought by paying cash, the value of Goods increases by 25,000 and the cash available with the business would reduce by 25,000. 12 Goods/Stock a/c ↓ Tangible Aspect (Asset) ↓ Real a/c Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c *Vendor name is irrelevant in cash purchases

13. NATURE OF ACCOUNTS - EXAMPLES Bought Goods from Mr. Shyam Rao on credit for 10,000 . Since goods are bought on credit, the value of Goods increases by 10,000. The liabilities of the business would increase by 10,000. This liability is indicated by an element identified by the name of the vendor who gave the goods on credit i.e. Mr. Shyam Rao . 13 Goods/Stock a/c ↓ Tangible Aspect (Asset) ↓ Real a/c Mr. Shyam Rao a/c ↓ Person ↓ Personal a/c

14. NATURE OF ACCOUNTS - EXAMPLES Sold Goods for cash 20,000 to Mr. Peter Since goods are sold by taking cash, the value of Goods decrease by 20,000 and the cash available with the business would increase by 20,000. 14 Goods/Stock a/c ↓ Tangible Aspect (Asset) ↓ Real a/c Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c *Buyer name is irrelevant

15. NATURE OF ACCOUNTS - EXAMPLES Sold Goods on credit to M/s Bharat & Co., for 10,000. Since goods are sold on credit, the value of Goods decreases by 10,000. A new asset in the form of a debtor (those who owe us) is created. The new asset is indicated by an element identified by the name of the organisation which purchased the goods on credit i.e. M/s Bharat & Co. 15 Goods/Stock a/c ↓ Tangible Aspect (Asset) ↓ Real a/c M/s Bharat & Co. a/c ↓ Person ↓ Personal a/c

16. Double Entry System Every transaction involves two parties or accounts – one account gives the benefit and the other receives it. It is called dual entity of transaction The process of keeping account accepting this dual entity i.e. debiting one account for a definite amount of money and crediting the other account for the same amount is called double entry system . Therefore, for every debit there is a corresponding credit for equal amount of money and for every credit there is a corresponding debit for equal amount of money; i.e. for every transaction one account is debited for the amount of transaction and the other account is credited for the equal amount of money . 16

17. Rules of Double Entry Type of Account Debit Credit Personal Account Receiver Giver Real Account What comes in What goes out Nominal Account Expense and losses Incomes and gains 17

18. Rules of Double Entry - Examples Commenced business with a capital of 2,00,000. 18 Capital a/c ↓ Person ↓ Personal a/c ↓ Giving benefit ↓ Credit [Credit the benefit giver] Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Coming in ↓ Debit [Debit what comes in]

19. Rules of Double Entry - Examples Bought Furniture for cash 20,000. 19 Furniture a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Coming in ↓ Debit [Debit what comes in] Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Going out ↓ Credit [Credit what goes out]

20. Rules of Double Entry - Examples Paid Rent to the shop owner Mr. Murugan 5,000. 20 Rent Paid a/c ↓ Expenditure ↓ Nominal a/c ↓ Expense ↓ Debit [Debit all expenses/losses] Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Going out ↓ Credit [Credit what goes out]

21. Rules of Double Entry - Examples Paid cash into bank 1,50,000 21 Bank a/c ↓ Organisation ↓ Personal a/c ↓ Receiver ↓ Debit [Debit the benefit receiver] Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Going out ↓ Credit [Credit what goes out]

22. Rules of Double Entry - Examples Bought Goods for cash 10,000 from M/s Shamir Jain & Co., 22 Goods/Stock a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Coming in ↓ Debit [Debit what comes in] Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Going out ↓ Credit [Credit what goes out]

23. Rules of Double Entry - Examples Bought Goods on credit from M/s Ramdas & Bros. for 10,000. 23 M/s Ramdas & Bros. a/c ↓ Organisation ↓ Personal a/c ↓ Giver ↓ Credit [Credit the benefit giver] Goods/Stock a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Coming in ↓ Debit [Debit what comes in]

24. Rules of Double Entry - Examples Sold goods for cash 12,000 to Mr. Naryan Tiwari . 24 Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Coming in ↓ Debit [Debit what comes in] Goods/Stock a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Going out ↓ Credit [Credit what goes out]

25. Rules of Double Entry - Examples Bought Machinery from M/s Boolani Machinery and paid by cheque 25,000. 25 Bank a/c ↓ Organisation ↓ Personal a/c ↓ Giver ↓ Credit [Credit the benefit giver] Machinery a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Coming in ↓ Debit [Debit what comes in]

26. Rules of Double Entry - Examples Sold goods on credit to Mr. Natekar for 8,000. 26 Mr. Natekar a/c ↓ Person ↓ Personal a/c ↓ Receiver ↓ Debit [Debit the benefit reciever ] Goods/Stock a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Going out ↓ Credit [Credit what goes out]

27. Rules of Double Entry - Examples Paid weekly wages to workers 5,000 27 Wages Paid a/c ↓ Expenditure ↓ Nominal a/c ↓ Expense ↓ Debit [Debit all expenses/losses] Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Going out ↓ Credit [Credit what goes out]

28. Rules of Double Entry - Examples Paid M/s Ramdas and Brothers by cheque 5,000. 28 M/s Ramdas & Bros. a/c ↓ Organisation ↓ Personal a/c ↓ Receiver ↓ Debit [Debit the benefit reciever ] Bank a/c ↓ Organisation ↓ Personal a/c ↓ Giver ↓ Credit [Credit the benefit giver]

29. Rules of Double Entry - Examples Received from Mr. Natekar 2,000 29 Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Coming in ↓ Debit [Debit what comes in] Mr. Natekar a/c ↓ Person ↓ Personal a/c ↓ Giver ↓ Credit [Credit the benefit giver]

30. Rules of Double Entry - Examples Received commission from M/s Orion Traders for giving a trade lead 500. 30 Commission Received a/c ↓ Income ↓ Nominal a/c ↓ Income ↓ Credit [Credit all incomes/gains] Cash a/c ↓ Tangible Aspect (Asset) ↓ Real a/c ↓ Coming in ↓ Debit [Debit what comes in]

31. Journal Entry A daily written records of transactions Format 31

32. Journal Entry - Example 32

33. Journal Entry - Example 33 Journal Entry

34. Journal Entry - Example 34

35. Journal Entry - Example 35

36. Journal Entry - Example 36

37. Journal Entry - Example 37

38. Journal Entry - Example 38

39. Journal Entry - Example 39

40. Accounting Concepts Business Entity Concept Business is established to achieve an economic goal Accounting Equation – (Assets = Liabilities + Capital ) Money Measuring Concept All the events and transactions are recorded in the terms of money Does not take care of the effects of inflation because it assumes stable value for measuring 40

41. Accounting Concepts Going Concern Concept It assumes that business will exist for a longer period of time It supports the concept of valuing the assets at historical cost or replacement cost Dual Aspect Concept Every transaction has two aspects – giving certain benefits and receiving certain benefits Periodicity Concept Business is segmented into different periods (accounting periods) and accordingly the result of each period is ascertained e.g. Income statement (profit and loss), balance sheet (financial position ) 41

42. Accounting Concepts Historical Cost Concept Transactions are recorded wrt the respective amounts involved. Does not take in account the inflation rate and depreciation rates Matching Concept All the costs should be associated to a particular period should be compared with revenues associated with that period to obtain net income It necessitates adjustments for outstanding expenses, prepaid expenses, etc 42

43. Accounting Concepts Realisation Concept Recognises revenue when sale is made Accrual Concept Revenue is recognised on its realisation Cost is recognised when it is incurred and not when the payment is made Objective Evidence Concept Accounting must be based on objective evidence – every transaction should be supported by verifiable document and free from biasness 43

44. Accounting Conventions Conservatism Revenues and profits are not anticipated. Only realized profits with reasonable certainty are recognized in the profit and loss account However , provision is made for all known expenses and losses whether the amount is known for certain or just an estimation This treatment minimizes the reported profits and the valuation of assets 44

45. Accounting Conventions Consistency Companies should choose the most suitable accounting methods and treatments, and consistently apply them in every period Changes are permitted only when the new method is considered better and can reflect the true and fair view of the financial position of the company The change and its effect on profits should be disclosed in the financial statements 45

46. Accounting Conventions Disclosure Financial statements should be prepared to reflect a true and fair view of the financial position and performance of the enterprise All material and relevant information must be disclosed in the financial statements 46

47. Uses of Financial Accounting Ascertaining the operation profit or loss Ascertaining the financial position of the business Keeping systematic records Protecting and controlling business properties Facilitating rational decision- making Planning and control operations . Compliance with the legal requirements Making information available to various groups and users at a particular time . Evidence in court in case of dispute Substitute of memory Settlement of taxation liability Comparative study Sale of business The amount ,size and causes of increase or decrease of capital 47

48. Users of Accounting Information – Internal Owners They provide funds for the operations of a business Interested in knowing how profitably the business operations have been carried out and how the capital is deployed in the form of assets and liabilities Management As the management is answerable to the owners, they need up to date information which helps them in various facets of management like planning, decision making and controlling Employees They need this information to analyse the which firm they are serving and how the bonus and incentives would be paid to them 48

49. Users of Accounting Information - External Prospective Investors they are the potential investors By reviewing the past and present performance of the business, they decide to invest their money Creditors Included supplier of goods and services on credit and others lending money their welfare is closely related to the progress of the business as they can analyse the paying off capacity of the business Government - Its needs information for taxation and other purposes e.g. sales tax, income tax, excise duty etc. Consumers To analyse the exercise better control over cost of production and this inturn improves the image and reputation of the business Research Scholars To analyze the financial operations 49

50. Advantages of Accounting 1. Complete and Systematic Record: Accounting is based on generally accepted principles and a scientific way of presentation of business transactions in books of accounts. As such, accounting is a complete and systematic recording of all business transactions. The limitations of humans, that they can not keep all transactions in mind, is overcome by accounting because each and every business transaction can be recorded and analyzed through same. 2 . Determination of Selling Price : The main function of the management is decision making. Accounting helps and guides the management to take decisions in respect of determining selling price, deduction of cost, increase in sales etc. 3 . Valuation of the Business: In case of sale of business or conversion of one business into another, true and fair value of the business is calculated. Through accounting, the correct picture can be depicted in Balance Sheet and as such the purchase price can be determined. Balance Sheet shows the value of assets & liabilities of the business which can be used to calculate its net worth . 50

51. Advantages of Accounting 4. Helps in Raising Loan : For further expansion, business must have sufficient funds. Sometimes, due to paucity of funds business cannot do well. In those cases further funds can be raised by taking loan from some financial institutions like banks, IDBI, ICICI etc. These financial institutions lend money on the basis of profitability and soundness of the business enterprise. The profitability and soundness can be measured by the Trading and Profit & Loss Account and Balance Sheet, the final results of books of accounts. 5 . Evidence in Court of Law: The business transactions are recorded in the books of accounts supported by authenticated documents viz. vouchers etc. Thus, the accounts can be used as an evidence in the court of law. 6 . In Compliance of Law: Every business has to deal with various government departments like income tax, sales tax, custom and excise etc. Various periodic returns are to be filed with these departments. Accounting helps in preparation and filing of such returns. 51

52. Advantages of Accounting 7. Inter-Firm or Intra-Firm Comparison: Trading and Profit & Loss Account shows net profit earned or net loss sustained by the business. If the accounts are maintained properly, records relating to various expenses, sales, gross profit and net profit etc. can be compared. As such, accounting helps in inter- firm and intra-firm comparison. Comparison of accounts of two different enterprises for the same year is known as inter-firm comparison and comparison of two different periods for the same business enterprise is known as intra-firm comparison. The performance of the business enterprise is then compared with the predetermined goals and shortcomings, if any, can be rectified accordingly . 8. Facilitates Audit: Depending upon the size, nature and type of business, certification of books of accounts, known as audit, is mandatory. Audit certificate issued by the auditor on the accounts is a clean chit to organization which proves that there are no irregularities in the organization. 9 . Effective Management: Accounting facilitates proper feed back to the management. As such, it helps the management in planning as well as control of different activities of the business enterprise. It also helps the management to evaluate the performance of the business enterprise and takes timely action to remove the shortcomings in the management . 52

53. Limitations of Financial Accounting Records only monetary transactions Effects of price level accounting is not considered No realistic information due to concepts and convention followed Personal bias of accountant affects the accounting statements Permits alternative treatment – Lack of uniformity in accounting principles Historical in Nature – records only the past transactions and no guidance of future Does not record the effect of various govt regulations 53

54. Important Terms for Reference 54

55. Business Transaction Any exchange of money or money’s worth as goods and services between two parties is called a business transaction An event which can be expressed in terms of money May relate to purchase and sale of goods, receipt and payment of cash and rendering of services by one party to another. Transactions may be: Cash transaction: When payment is made immediately Cr e dit t r a n s a ction : When pay m ent is p o stpo n e d to a future date 55

56. Assets It is any physical thing or right owned which has money value. 56 These are resources owned by the business which are expected to give benefits in the future. Assets may be fixed assets or current assets Assets include: Land - tangible Building - Tangible Equipment – Tangible Goodwill – Intangible Brand - Intangible

57. Liability These are amounts owed by the enterprise to the outsiders i.e. to all others except the owner These are claims of outsiders on assets of the firm. 57

58. Capital (Owner’s Equity) It is the claim of owners on the assets of an enterprise. It is the excess of assets over liabilities i.e. it is what’s left of the assets after liabilities have been deducted. Also known as networth 58

59. Revenue 59 They a r e a m ounts receiv e d from customers for : sales of products or performance of services or – in return of use of the firm’s assets by outsiders. Revenues include the following Sales proceeds fees for performance of services rent interest

60. Expense An expense is the amount incurred in the process of earning revenue. They are amounts that have been paid or will be paid later for costs that have been incurred to earn revenue. Include : salaries and wages Utilities payments supplies used advertising 60

61. Income It is excess of revenue over expense It is the favorable change in owner’s equity which results from operations i.e. it is an inflow of assets or decrease in liabilities resulting in increase in capital. 61

62. Trade Debtor (Account Receivable) A debtor is a person who owes money. The amount due from a debtor as per books of account is called book debt or Accounts Receivable . A trade debtor is a person who owes money as a result of purchase of goods or services on credit 62

63. Trade Creditor (Accounts Payable) A creditor person to whom money is owing or payable. A trade creditor is a person who owes to whom money is owing or payable as a result of purchase of goods or services on credit Accounts Payable is a liability that results from the purchase of goods or services on account (on credit) 63

64. Expenditure Takes place when an asset or service is acquired. Include both payment of a sum immediately and a promise to pay it at a future date. An expense is an expenditure whose benefit finishes or is enjoyed immediately such as salaries, rent, etc. An expenditure which will provide benefits in the future is considered as an asset A loss is an expenditure without any benefit to the concern 64