Fundamentals of Accounting

ACCOUNTING FOR MANAGERS

For I Semester, MBA-Pondicherry University

Outline of the Course…

• Unit I – Financial Accounting

• Unit II – Depreciation Accounting & Ratio Analysis

• Unit III – Fund Flow and Cash Flow Analysis

• Unit IV – Marginal Costing

• Unit V – Cost Accounting

• Problems vs. Theory – 60: 40

Concept of Accounting• Accounting is a process of Identifying,

Measuring, Classifying, Recording and

communicating Financial Information.

Book Keeping is

the art of recording

business

transactions in a

systematic manner.

Element Description

Identifying Determining business transaction

Measuring Expressing business transaction in terms of

money

Recording Entering money transactions in books

Classifying Grouping of entries according to nature

Summarizing Presentation of accounting information

Communicating Interpretation of results

Transaction Vs.Event

• Capital introduced by proprietor in business

• Amount withdrawn by proprietor for personal

use.

• Appointed a salesman for business

• Private income earned and retained by the

proprietor with himself.

• Promise to give loan to a friend

• Received gift from mother-in-law

• Purchase return

• Discount allowed to a customer

• An expense incurred, but not paid.

• Sale of good on credit

• Loss of goods by theft

What is the

difference?

Every financial

change that occurs

in your business is a

transaction.

Event is not

measurable in terms

of money, but

transaction is

measurable in terms

of money.

Users of Accounting Information

• Owners or Shareholders

• Potential investors

• Lenders

• Creditors

• Customers

• Creditors

• Management

• Employees

• Government

• Stock exchanges

The various parties

who are interested

in accounting

information..

Need and Importance of Accounting

• Results of operations

• Solvency and liquidity

• Financial position

• Cash flows

Types of transactions

1. Cash Transactions

2. Credit transaction

3. Barter transaction

4. Paper transaction

Criteria: Settlement

and Time

1. Antony commenced business with cash

2. Took loan from a bank

3. Salaries yet to paid to employees

4. Returned goods to supplier Mr. Akbar

5. Cash stone from office

6. Sale of goods on credit to Mr. Amar

7. Withdrew from bank account for personal use

8. Sold goods to employee in settlement of his salary

Test your Progress?

Basic Accounting Terms

• Business Entity

• Proprietor or Owner

• Equity

• Capital

• Net worth

• Drawings

• Assets

• Liabilities

• Debtors

• Creditors

• Inventory

• Sales and Purchases

• Debit & Credit

• Turnover

• Bills payable and Receivables

1. Accounting Concepts 2. Accounting Convention

• Business Entity Concept

• Business and owner are separate entities

• Accounting view

• Capital and drawings

• Accurate financial position

Accounting Principles

“A general law or rule adopted or professed as

a guide to action; a settled ground on basis of

conduct on practice”

• Money Measurement Concept

• Records only monetary transactions

• Helps to know the value of business

Accounting Concepts These concepts provide a foundation for accounting process. No enterprise can prepare its financial statements without considering these concepts.

Accounting

Concepts

Accounting Concepts

• Going Concern Concept• Permanent continuity

• Preparation of Financial statements

• Distinction between capital and revenue items

• Entering into long term contracts

• Classification of assets

• Accounting period concept

• Knowing the performance of business

• Convenient short periods

• Calendar period and financial period

• Cost or Historical Concept

• Fixed assets at cost

• Current assets at cost price or market price which ever is less

• Valuation of fixed assets every year becomes difficult

Accounting

convention refers

to custom tradition

or practice, which

has been in

practice for a long

time, which

becomes the basis

of preparing

financial

statements.

Accounting Concepts and Convention

• Objective Evidence Concept

• Entries based on source documents

• Reduces scope of manipulations

• Revenue recognition concept

• Revenue is earned from sale of goods

• Goods or services are transferred when legally liable to pay

• No unrealized profits

• Prevents inflated profits

• Gives objectivity

• Accrual Concept• Transactions are recorded whether they are settled in

cash or not

• Outstanding, Prepaid, Accrued, Incomes received in advance

• Dual Aspect concept/ Accounting Equation

Concept

• Assets= Liabilities + Capital

Accounting Concepts• Accounting convention refers to custom tradition or practice, which has been in practice for a

long time, which becomes the basis of preparing financial statements.

Accounting Concept Description

Going Concern

Concept

Business unit will have a perpetual existence and will not be sold or liquidated

Accounting period

concept

Prepare financial statements at periodic intervals for taking timely corrective action

Cost or Historical

Concept

Assets should be shown on the balance sheet at the cost of purchase instead of

current valueObjective Evidence

Concept

Accounting records will initiate from a source document and that the information

recorded is based on fact and not personal opinion.

Revenue recognition

concept

Realization is assumed to occur when the seller receives cash or a claim to cash

(receivable) in exchange for goods or services.

Accrual Concept Transactions are recorded even though actual receipts or payments of money may

not have taken place.

Dual aspect Concept This concept ensures that transaction are recorded in books at least in two accounts

Accounting Conventions

Accounting

convention refers

to custom tradition

or practice, which

has been in

practice for a long

time, which

becomes the basis

of preparing

financial

statements.

• Convention of Materiality• According to American Accounting Association, “An item

should be regarded as material if there is reason to believe that knowledge of it would influence decision of informed investor.”

• Convention of Conservatism• All anticipated losses should be recorded but all

anticipated gains should be ignored.

• It is a policy of playing safe

• Convention of consistency• Accounting method should remain consistent year by year.

• This facilitates comparison in both directions i.e. intra firm & inter firm.

• Convention of Full disclosure

• Information relating to the economic affairs of the enterprise should be completely disclosed which are of material interest to the users.

• Proforma & contents of balance sheet & P&L a/c are prescribed by Companies Act.

• It does not mean that leaking out the secrets of the business.

ACCOUNTING EQUIVALENCE

Assets = Owner’s Equity +

Outside Liabilities

A = OE + OL

14

DEFINITION: BS

•Balance Sheet is defined as•a statement of the financial position•of an enterprise•as at a given date, which exhibits•assets, liabilities, capital, etc.

HORIZONTAL FORM OF BS

LIABILITIESAmount

(Rs)ASSETS

Amount

(Rs)

Capital XXFixed Assets-Land,

Bldg,XX

Loan taken XX Current Assets

Current Liabilities •Cash / Bank B/s XX

•Outstanding Expenses XX•Accounts Receivable

(Debtors)XX

•Bank Overdraft XX •Bills Receivable) XX

•Accounts Payable

(Creditors)XX •Inventories (Stock) XX

XYZ XYZ

VERTICAL FORM OF BSSOURCES OF FUNDS Amount (Rs.) py Amount (Rs) cy

Share Capital AA XX

Reserves & Surplus AA

Secured Loans AA XX

Unsecured Loans AA XX

ABC XYZ

APPLICATION OF FUNDS Amount (Rs.) py Amount (Rs) cy

Fixed Assets Gross Block

- DepreciationAA XX

Investment AA XX

Current Assets – Current Liabilities AA XX

Loans & Advances AA XX

Miscellaneous Expenditure AA XX

ABC XYZ

17

A = OE + OLAssets are properties or economic

resources owned by a business. They are

expected to provide future benefits to the

business.

Liabilities are

obligations of the

business. They

are claims

against the

assets of the

business.

Equity is the

owner’s claim on

the assets of the

business. It is the

residual interest in

the assets after

deducting

liabilities.

18

A = OE + OL

LIABILITIESAmount

ASSETSAmount

Capital XX Fixed Assets-Land, Bldg, XX

Loan taken XX Current Assets

Current Liabilities Cash / Bank B/s XX

Outstanding Expenses XXAccounts Receivable

(Debtors)XX

Bank Overdraft XX Bills Receivable) XX

Accounts Payable (Creditors) XX Inventories (Stock) XX

XYZ XYZ

A = OE + OL

SOURCES OF FUNDSAmount

py

Amount

cy

Share Capital AA XX

Reserves & Surplus AA

Secured Loans XX

Unsecured Loans XX

XX

APPLICATION OF FUNDSAmount

(Rs) py

Amount

(Rs) cy

Fixed Assets Gross Block

- Depreciation

Investment

Current Assets – Current Liabilities

Loans & Advances

Miscellaneous Expenditure

20

The accounts involved are:

(1) Cash (asset)

(2) Owner’s Equity (equity)

Owners of Scox Company contributed

Rs. 20,000 cash to start the business.

PROOF: A = OE + OL

21

Assets = Liabilities +

Owners'

Equity

Cash Supplies Equipment

Accounts

Payable

Notes

Payable

Owners'

Capital

(1) 20000 20000

20000 0 0 0 0 20000

20000 = 20000

Owners of Scox Company contributed

Rs. 20,000 cash to start the business.

Transaction Analysis

22


(1) Cash (asset)

(2) Supplies (asset)


Purchased supplies paying Rs. 1,000 cash.

23


Owners'

Equity


Accounts

Payable

Notes

Payable

Owner's'

Capital

(1) 20000 20000

(2) -1000 1000

19000 1000 0 0 0 20000

20000 = 20000


Purchased supplies paying Rs. 1,000

cash.

24


(1) Cash (asset)

(2) Equipment (asset)


Purchased equipment for Rs.15,000

cash.

25


Owners'

Equity


Accounts

Payable

Notes

Payable

Owners'

Capital

(1) 20000 20000

(2) -1000 1000

(3) -15000 15000

4000 1000 15000 0 0 20000

20000 = 20000


Purchased equipment for Rs. 15,000

cash.

26


(1) Supplies (asset)

(2) Equipment (asset)

(3) Accounts Payable (liability)


Purchased Supplies of Rs. 200 and

Equipment of Rs. 1,000 on account.

27


Owners'

Equity


Accounts

Payable

Notes

Payable

Owners'

Capital

(1) 20000 20000

(2) -1000 1000

(3) -15000 15000

(4) 200 1000 1200

4000 1200 16000 1200 0 20000

21200 = 21200

Purchased Supplies of Rs. 200 and

Equipment of Rs. 1,000 on account.


28


Owners'

Equity


Accounts

Payable

Notes

Payable

Owners'

Capital

Bal. 4000 1200 16000 1200 20000

4000 1200 16000 1200 0 20000

21200 = 21200


The balances so far appear below. Note that the

Balance Sheet Equation is still in balance.

Now let’s look at transactions

involving revenues and expenses.

29


(1) Cash (asset)

(2) Revenues (equity)


Rendered consulting services receiving Rs. 3,000 cash.

30


Owner's

Equity


Accounts

Payable

Notes

Payable

Owner's

Capital

Bal. 4000 1200 16000 1200 20000

(5) 3000 3000

7000 1200 16000 1200 0 23000

24200 = 24200

Rendered consulting services

receiving Rs. 3,000 cash.


31


(1) Cash (asset)

(2) Salaries expense (equity)


Paid salaries to employees, Rs. 800

cash.

32


Owner's

Equity


Accounts

Payable

Notes

Payable

Owner's

Capital

Bal. 4000 1200 16000 1200 20000

(5) 3000 3000

(6) -800 -800

6200 1200 16000 1200 0 22200

23400 = 23400

Paid salaries to employees, Rs. 800 cash.


33


(1) Cash (asset)

(2) Notes payable (liability)


Borrowed Rs. 4,000 from SBI

34


Owner's

Equity


Accounts

payable

Notes

Payable

Owner's

capital

Bal. 4000 1200 16000 1200 20000

(5) 3000 3000

(6) -800 -800

(7) 4000 4000

10200 1200 16000 1200 4000 22200

27400 = 27400

Borrowed Rs. 4,000 from SBI


35

Financial StatementsPrepare the Financial Statements reflecting the transactions we

have recorded.

36

Scox’s net

income is the

difference

between

Revenues and

Expenses.

The net income

of Rs. 2,200

increases

Scox’s equity

by Rs. 2,200.

Revenues:

Consulting revenue 3000

Expenses:

Salaries expense 800

Net income 2200

Scox Company

Income Statement

For Month Ended March 31, 2001

Income Statement

Owners' equity, 1st April 2000 0

Plus: Investment by owners 20000

Net income 2200

Owners' equity, 31st March 2002 22200

Scox Company

Statement of Changes in Owners' Equity

For Month Ended March 31, 2001

37

Accounts payable 1200 Cash 10200

Notes payable 4000 Supplies 1200

Total liabilities 5200 Equipment 16000

Owners' equity 22200

Total liabilities

and owners'

equity 27400 Total assets 27400

AssetsLiabilities & Owners' Equity

Scox Company

Balance Sheet

March 31, 2001

Balance Sheet

Owners' equity 0

Investment by owners 20000

Net income 2200

Owners' equity, March 31 2001 22200

Scox Company

Statement of Changes in Owners' Equity

For Month Ended March 31, 2001The balance sheet reflects

Scox’s financial position at

March 31 2001

Classification of Accounts

1.English Approach

2.American Approach

English Approach

Accounts

Personal Asset Nominal

Every Business

concern deals with

other persons.

A business concern

has certain

properties or assets

It may incur certain

expenses and may

earn certain

incomes

Personal Accounts

• Natural personal account

• Accounts of physical and naturally born person

• Artificial personal account

• A person created by law

• Representative personal account

• They represent certain person behind them

Persons with whom

a business is carried

out.

Asset AccountAn account of

things owned by a

concern and in and

with which the

business is carried

on.

• Accounts of Tangible assets

• Physical evidence

• Accounts of Intangible assets

• Do of have physical existence

NominalAccount

Account of incomes and losses and expenses

and gains

ActivityTest your Progress

Furniture account

Outstanding wages account

Stationary account

Capital Account

Salaries account

National Trading Co; account

Prepaid insurance account

Interest account

Sales account

Repair on machinery

Debtors account

Bills receivable account

Provision for depreciation

Rent account

Asset or Nominal a/c

Nominal a/c

Representative

personal a/c

Natural personal

account a/c

Nominal account a/c

Artificial personal account

a/cRepresentative

personal a/c

Nominal account a/c

Asset a/c

Nominal account a/c

Personal account

a/cAsset

a/c

Asset a/c

Nominal a/c

43

DOUBLE ENTRY SYSTEM

A = OE + OL

In the double-entry accounting system,

every transaction is recorded by equal

amounts of debits and credits.

Debit = Credit

44

ACCOUNTANT’S LIFE

A = OE + OL

ASSETS

Debit

for

Increase

Credit

for

Decrease

EQUITIES

Debit

for

Decrease

Credit

for

Increase

LIABILITIES

Debit

for

Decrease

Credit

for

Increase

Debit Credit

ASSETS

+ -

LIABILITIES

- +

Debit Credit

EQUITIES

- +

Debit Credit

RULES OF DOUBLE ENTRY SYSTEM

Real Account

• Rules of Accounting:

•Debit what comes in

•Credit what goes out

These are asset

accounts that

appear in the

Balance Sheet.

They are referred to

as Real Account (or

Permanent

Accounts) as these

are owned by

businesses and the

balances in these

accounts at the

end of an

accounting period

will be carried over

to the next period.

Ex: Cash Account,

Land Account,

Building Account

etc.

PERSONAL Account


•Debit the Receiver

•Credit the Giver

These are accounts

of parties with

whom the business

is a carried on.

Nominal Account


•Debit all expenses and

losses

•Credit all income and

gains

These are accounts

of expenses and

losses which a

business incurs and

income & gains

which a business

earn in the course

of business. Ex: Rent

Account, Interest

Account.

Activity• Mr. Ajay started business with Cash Rs. 100,000. • Test your progress

Two accounts

Involved

Types of

accounts

Rule of Debit and Credit Account to

debited

Account to be

credited

Cash a/c

Capital a/c

Real a/c

Personal a/c

Debit what comes in

Credit giver of benefit

Cash Capital

• Brought Goods from Vijay for Cash Rs. 1000

Two accounts

Involved

Types of

accounts


debited

Account to be

credited

Cash a/c

Goods purchased

a/c

Real a/c

Real a/c

Credit what goes out

Debit what comes in

Goods

purchased

Cash

• Purchased Goods from Sujay for credit Rs. 300

Two accounts

Involved

Types of

accounts


debited

Account to be

credited

Raghu a/c

Goods purchased

a/c

Personal a/c

Real a/c

Credit giver of benefit

Debit what comes in

Goods

purchased

Raghu

50

ACCOUNTING CYCLE

1. Business Transaction2. Transaction is recorded in

document (Voucher / Receipt)3. Analyze the transaction 4. Journal Entry5. Ledger Accounts (or ‘T’ account)6. Trial Balance7. Balance Sheet, P&L A/c, Cash Flow

Statement

51

Balance Sheet

P & L A/c

Cash Flow

Prepare a trial

balance

Post to the

ledgerJournal Entry

Source

documentsTransaction Analyze

ACCOUNTANT’S ROUTINE

Thank You Now, was that debits to

the left or credits to the

left?

I sure wish I had paid

more attention in class!

Fundamentals of Accounting

Business

accounting process

financial information

financial accountingunit

financial change

employeesreturned goods

officesale of goods

creditloss of goods

personal usesold goods