FINANCIAL ACCOUNTING Account • It is a unit of information that represents business records • There are five types of accounts: asset, liability, equity, revenue and expense. Accounting • It is concerned with the use of which the records are put, their analysis and interpretation • It is the process of recording business activities that make changes to accounts, Attributes of accounting • It is the art of recording business transactions • It is the art of classifying business transactions • The transactions or events of a business must be recorded in monetary terms • It is the art of summarizing financial transactions • The results should be communicated to users Branches of Accounting • Financial Accounting (Record keeping) • Cost Accounting (Price fixation & Operating efficiency) • Management Accounting (Analysis for decision making) Advantages • Replacement of Memory • Evidence in court • Tax purpose • Comparative study • Sale of business • Assistance to the insolvent (unable to pay money) Limitations • Records only monetary transactions • Effect of price level changes not considered • Personal bias of accountant affects the accounting statements • Permits alternative treatments (LIFO, FIFO) • No real test for managerial performance • Historical in nature Basis of Accounting • Cash basis –Actual cash receipts and payments are recorded. –Credit transactions are not recorded. • Accrual basis – The income whether received or not but has been earned or accrued during the period forms part of the total income of the period. • Mixed basis – Combination of cash and accrual basis Accounting has been defined by the American accounting association committee as: “The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information”. FINANCIAL ACCOUNTING We can define financial accounting as a process of recording, summarizing, and reporting various transactions that occur over a period of time during the course of business. We gather and convert all the daily transactions into financial statements, balance sheet, income statements, and cash flow statements. ACCOUNTING TERMINOLOGY • Business: An organization created with the objective of making a profit from the sale of goods or services. • Book keeping: The act of systematically recording the financial transactions affecting a business. • Book Value: The net amount (original value plus or minus any adjustments such as depreciation) showed in the accounts for an asset, liability, or owners' equity item. • Calendar Year:
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FINANCIAL ACCOUNTING
Account
• It is a unit of information that represents business records
• There are five types of accounts: asset, liability, equity, revenue and expense.
Accounting
• It is concerned with the use of which the records are put, their analysis and interpretation
• It is the process of recording business activities that make changes to accounts,
Attributes of accounting
• It is the art of recording business transactions
• It is the art of classifying business transactions
• The transactions or events of a business must be recorded in monetary terms
• It is the art of summarizing financial transactions
• Management Accounting (Analysis for decision making)
Advantages • Replacement of Memory • Evidence in court • Tax purpose • Comparative study • Sale of business • Assistance to the insolvent (unable to pay money)
Limitations • Records only monetary transactions • Effect of price level changes not considered • Personal bias of accountant affects the accounting statements • Permits alternative treatments (LIFO, FIFO) • No real test for managerial performance • Historical in nature
Basis of Accounting • Cash basis
–Actual cash receipts and payments are recorded. –Credit transactions are not recorded.
• Accrual basis – The income whether received or not but has been earned or accrued during the period forms part of the total income of the period.
• Mixed basis – Combination of cash and accrual basis
Accounting has been defined by the American accounting association committee as: “The process of identifying, measuring and communicating economic information to permit informed
judgments and decisions by users of the information”.
FINANCIAL ACCOUNTING
We can define financial accounting as a process of recording, summarizing, and reporting various transactions that
occur over a period of time during the course of business. We gather and convert all the daily transactions into
financial statements, balance sheet, income statements, and cash flow statements.
ACCOUNTING TERMINOLOGY
• Business:
An organization created with the objective of making a profit from the sale of goods or services.
• Book keeping:
The act of systematically recording the financial transactions affecting a business.
• Book Value:
The net amount (original value plus or minus any adjustments such as depreciation) showed in the accounts for an asset,
liability, or owners' equity item.
• Calendar Year:
An entity's reporting year, covering 12 months.
• Transactions:
Exchange of goods or services between businesses or individuals. Can also be other events having an economic impact
on a business.
• Journal:
A book or original entry in a double-entry bookkeeping system. The journal lists all transactions and indicates the
accounts to which they are posted.
• Journal Entry:
A recording of a transaction where debits equal credits.
• Ledger:
A summary statement of all the transactions relating to a person, asset, expense or income which have taken place during
a given period of time and show their net effect.
• Trial Balance:
A listing of all account balances that provides a test of whether total debits equals total credits.
• Revenues:
Increases in a company's resources from the sale of goods or services.
• Goods:
This includes all articles, commodities or merchandise in which the business deals. Thus, cloth would be goods for a
dealer in cloth; furniture would be goods for a dealer in furniture and so on.
• Assets:
Economic resources owned or controlled by a person or company.
• Net Assets:
The difference between assets and liabilities.
• Liquidity:
The availability of cash or ability to obtain it quickly. Also used to determine debt repayment ability.
• Goodwill:
An intangible asset that exists when a business is valued at more than the fair market value of its net assets.
• Interest:
The cost of the use of money
• Cheque:
It is a document in writing drawn upon a specified banker and payable on demand.
• Debit Notes:
For the party from whom the money is recoverable this document becomes debit note.
• Credit Note:
For the party who is to recover the amount the document becomes credit note. When goods returned from the customer, a
proper credit note should be sent to him.
KINDS OF ACCOUNTS
• Personal Account
• Real Account
o Tangible Real Account
o Intangible Real Account
• Nominal Account
[1] Personal Account
These accounts types are related to persons.
for example salary paid to ram
Rule for this Account
Debit the receiver.
Credit the Giver.
For Example – Goods sold to Suresh. In this transaction, Suresh is a personal account as being a natural
person. His account will be debited in the entry as the receiver.
[2] Real Accounts
These account types are related to assets or properties. They are further classified as Tangible real account and Intangible
real accounts.
Tangible Real Accounts
These include assets that have a physical existence and can be touched. For example – Building A/c, cash A/c,
stationery A/c, inventory A/c, etc.
Intangible Real Accounts
These assets do not have any physical existence and cannot be touched. However, these can be measured in terms of
money and have value. For Example – Goodwill, Patent, Copyright, Trademark, etc.
Real Account Rules
Debit what comes into the business.
Credit what goes out of business.
For Example – Furniture purchased by an entity in cash. Debit furniture A/c and credit cash A/c.
[3] Nominal Account
These accounts types are related to income or gains and expenses or losses. For example: – Rent A/c, commission
received A/c, salary A/c, wages A/c, conveyance A/c, etc.
Nominal Account Rules
Debit all the expenses and losses of the business.
Credit the incomes and gains of business.
For Example – Salary paid to employees of the entity. Salary A/c will be debited when the expenses are incurred.
Whereas, when an entity receives any interest, discount, etc these are credited whenever these are received by the
entity.
DOUBLE ENTRY
What do you know about double entry book keeping?
Luca De Pacioli is the "Father of Accounting" in Italy in 1494
Main Principle:
“Every debit has corresponding credit and every credit has corresponding debit with equal amount”.
Definition of double entry book keeping
“Every business transaction has a two fold effect and that it effects two accounts in opposite directions and if a
complete record is to be made of each such transaction it would been necessary to debit one account and credit another
account. It is this recording of two fold effect of every transaction that has given rise to the term Double Entry.” - By J.R.
Batluboi
What are the advantages of double entry book keeping?
Advantages of double entry book keeping:
1. Accuracy
2. Business result
3. Complete record
4. Comparative study
5. Common acceptance
Features of Double Entry Accounting system
• A transaction has two-fold aspects i.e. one giving the benefit and the other receiving the benefit.
• A transaction is divided into two aspects, Debit and Credit. One account needs to be debited and the other is to
be credited.
• Every debit must have its corresponding and equal credit.
JOURNAL
• The word journal is derived from the Latin word ‘Journ’ which means a day.
• Journal means a day book where in day-to-day business transactions are recorded in a chronological order.
• The process of recording a transaction in the journal is called Journalisation.
• The entries made in the book are called journal entries.
Advantages of Journal
• It provides a chronological (date wise) order of all transactions and hence provides permanent
record.
• It provides the information of debit and credit in an entry and an explanation to make it
understandable properly.
• It reduces the possibility of error as both aspects of a business transaction are written side by side.
LEDGER
• It is a book which contains various accounts. It is in ‘T’ form.
• It is a summary statement of all the transactions relating to a person, asset, expense or income
which have taken place during a given period of time and shows their net effect.
• It is designed to accommodate the various accounts maintained by a trader.
• The process of transferring the entries from the journal into the ledger is called posting.
PROCESS OF ACCOUNTING
Identification of Transaction
Recording process Preparation of Business Transactions
Recording of Transactions in Journal
Posting in Ledgers Grouping process
Preparation of Unadjusted Trial Balance Summarizing process
Pass of Adjustment Entries
Preparation Process
Preparation of Adjusted Trial Balance
Trading
P&L A/c
Balance Sheet
DEFINE TRIAL BALANCE
A trial balance is a statement showing the balances, or total of debits and credits, of all the accounts in the ledger
with a view to verify the arithmetical accuracy of posting into the ledger accounts. Trial balance is an important
statement in the accounting process. Which shows final position of all accounts and helps in preparing the final
statements? The task of preparing the statements is simplified because the accountant can take the account
balances from the trial balance instead of looking them up in the ledger. It is normally prepared at the end of an
accounting year. However, an organization may prepare a trial balance at the end of any chosen period, which may be
monthly, quarterly, half yearly or annually depending upon its requirements
SUBSIDIARY BOOKS
Subsidiary Books are books of Original Entry. They are also known as Day Book or special journals. We record
transactions of similar nature are in Subsidiary Books. They are helpful in overcoming the limitations of
journal book or journal entries.
Subsidiary books are books of original entry. In the normal course of business, a majority of transactions are either relate to
sales, purchases or cash. So we record transactions of the same or similar nature in one place, i.e. the subsidiary book. And we
record these transactions in chronological order.
This actually saves a lot of man-hours and tiresome clerical work. Instead of journalizing each entry, they are recorded into
various subsidiary books. Think of your subsidiary book as sub-journals that record only one type of transaction.
There is no separate entry for these transactions in the general ledger. The posting to the Ledger Accounts is done from the
subsidiary book itself. This method of recording is known as the Practical System of Accounting or sometimes the English
System.
Subsidiary book system does not violate the rules of Double Entry System. We have still recorded the transactions according
to this system.
Only instead of a journal, we are using subsidiary books as the books of original entry.
TYPES OF SUBSIDIARY BOOKS
The following are the subsidiary books a company will generally maintain while writing their accounts,
• Cash Book- It is a book which records the receipts and payment of cashtransaction.
• Purchase Book- It is a book which records all the credit purchases of goods of the company.
• Purchase Return Book- It is a book which records all the return of credit purchases of goods of the company.
• Sales Book- It is a book which records all the credit sales of goods of the company.
• Sales Return Book- It is a book which records all the return of credit sales of goods of the company.
• Bills Receivable Book- It is a book which records all the bills receivable.
• Bills Payable Book- It is a book which records all the bills payable.
• Journal Proper- All the transactions which are not recorded in the above books are recorded here
ADVANTAGES
Let us now take a look at some of the advantages these subsidiary books provide in the process of accounting
i. Saving Labour Hours: Recording in a subsidiary book saves a lot of time and clerical hours. Firstly there is no need
to journalize and/or give narrations for every transaction. This helps reduce the time it takes to completely record a
transaction. Also since we use a number of subsidiary books, various accounting process can be undertaken
simultaneously. This will save the time of the clerks/accountants.
ii. Division of Work: In place of one general journal, we have several subsidiary books, So the resulting work may be
divided among several members of the staff. This will save time, improve efficiency and result in fewer errors as well.
iii. Specialization of Work: If one person maintains the same subsidiary book over many years he acquires full
knowledge and understanding of the work. We can say he becomes a specialist in one type of transaction (say
purchases for example). He becomes very efficient in handling such transactions and hardly any error gets made.
iv. Easy for Reference: When transactions of all types are in the same subsidiary book it becomes easy to search for
them. Whenever any information is needed we directly refer the subsidiary book to get said information.
v. Easier for Checking: If the Trial Balance does not match, it will be much easier to locate the error thanks to the
existence of separate books i.e. a subsidiary book. Same goes if you want to detect fraud.
vi. Minimizes Frauds: These books make possible the introduction of internal check system under which the system of
rotation of writing up books can be adopted. This helps minimizing errors and detecting frauds.