FINANCIAL ACCOUNTING

FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTINGIntroductionIntroduction Traditionally accounting was regarded as a Traditionally accounting was regarded as a

historical description of financial activities of historical description of financial activities of business.business.

Role of accountant that of a record keeperRole of accountant that of a record keeper In modern times regarded as a service activity and In modern times regarded as a service activity and

a tool in the hands of management for decision a tool in the hands of management for decision makingmaking

It is more an information system rather than a It is more an information system rather than a record keeping system.record keeping system.

FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTING

As an information system, it can be viewed as As an information system, it can be viewed as

Economiceventsmeasured infinancial terms

RecordingClassifying

Summarising

Information to

users

Input Process Output


It is a language of businessIt is a language of business Communicates the results of business Communicates the results of business

operations to various stake holdersoperations to various stake holders

MeaningMeaning

Accounting is a systematic recording of daily Accounting is a systematic recording of daily events of a business leading to presentation of events of a business leading to presentation of complete financial picturecomplete financial picture

FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTING..OriginOrigin One can say accounting is as old as money One can say accounting is as old as money

itself. itself. In India, Chanakya in his Arthashastra has In India, Chanakya in his Arthashastra has

emphasized the existence and need for proper emphasized the existence and need for proper accounting and auditing. accounting and auditing.

The modern system of accounting known as The modern system of accounting known as the “Double entry system of book keeping’ the “Double entry system of book keeping’ owes its origin to Luca De Borgo Pacioli of owes its origin to Luca De Borgo Pacioli of Italy, who published in book form ‘double Italy, who published in book form ‘double entry accounting system’ in 1494. entry accounting system’ in 1494.


DefinitionDefinitionIn 1941, AICPA (The American Institute of In 1941, AICPA (The American Institute of Certified Public Accountants) has defined Certified Public Accountants) has defined accounting as accounting as ““Accounting is the art of recording, Accounting is the art of recording, classifying and summarizing in a significant classifying and summarizing in a significant manner and in terms of money, transactions manner and in terms of money, transactions and events, which are in part at least of a and events, which are in part at least of a financial character, and interpreting the financial character, and interpreting the results thereof.”results thereof.”


Characteristic featuresCharacteristic features It is an artIt is an art Consists or recording, classifying and Consists or recording, classifying and

summarizingsummarizing Done in terms of moneyDone in terms of money Transactions having financial characterTransactions having financial character Interpretation of resultsInterpretation of results

FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTINGObjectivesObjectivesTo answer the following questionsTo answer the following questions Amount of capital invested in the businessAmount of capital invested in the business Nature and value of assetsNature and value of assets Nature and value of liabilitiesNature and value of liabilities Amount due from customers/debtorsAmount due from customers/debtors Amount due to suppliers/creditorsAmount due to suppliers/creditors Amount of stock in handAmount of stock in hand Cash and bank balances as on a particular dateCash and bank balances as on a particular date Amount of liability by way of statutory payments Amount of liability by way of statutory payments

to Governmentto Government


Objectives Objectives Amount of profit earned or loss sufferedAmount of profit earned or loss suffered To maintain a permanent record of To maintain a permanent record of

transactions for future referencetransactions for future reference Review the progress of the business from year Review the progress of the business from year

to yearto year Compare the results of the business with that Compare the results of the business with that

of the competitorsof the competitors To meet legal requirementsTo meet legal requirements


FunctionsFunctions To keep a systematic record of transactionsTo keep a systematic record of transactions To protect the properties of businessTo protect the properties of business To communicate the resultsTo communicate the results To meet legal requirementsTo meet legal requirements


ImportanceImportance Can be judged by its usefulness to various partiesCan be judged by its usefulness to various parties OwnersOwners ManagementManagement Potential investorsPotential investors Creditors/lendorsCreditors/lendors EmployeesEmployees GovernmentGovernment ResearchesResearches


Generally accepted accounting principles Generally accepted accounting principles (GAAP)(GAAP)

PrinciplesPrinciples are broad guidelines to be followed are broad guidelines to be followed to make the financial statements meaningful to to make the financial statements meaningful to all people as far as practicable. Principles all people as far as practicable. Principles consist of consist of concepts and conventionsconcepts and conventions


Concepts are underlying assumptions and Concepts are underlying assumptions and ideas which are fundamental to accounting ideas which are fundamental to accounting practice.practice.

Conventions mean customs or traditions as a Conventions mean customs or traditions as a guide to the preparation of accounting guide to the preparation of accounting statementsstatements


ConceptsConcepts Business entity/Separate entityBusiness entity/Separate entity Going concernGoing concern Money measurementMoney measurement CostCost Accounting periodAccounting period Matching of cost and revenuesMatching of cost and revenues Dual aspectDual aspect AccrualAccrual


ConventionsConventions ConservatismConservatism ConsistencyConsistency Full disclosure Full disclosure MaterialityMateriality Objectively verifiable evidenceObjectively verifiable evidence

Indian Accounting StandardsIndian Accounting Standards In order to bring about uniformity in terminology, In order to bring about uniformity in terminology,

approach and presentation of accounting results, the ICAI approach and presentation of accounting results, the ICAI established an Accounting Standards Board (ASB) in established an Accounting Standards Board (ASB) in April 1977. The main function of the ASB is to formulate April 1977. The main function of the ASB is to formulate Accounting Standards.Accounting Standards.

Accounting standards are the regulatory framework within Accounting standards are the regulatory framework within which financial statements are to be prepared. They which financial statements are to be prepared. They describe accounting principles, valuation techniques and describe accounting principles, valuation techniques and various aspects of measurement, treatment, presentation various aspects of measurement, treatment, presentation and disclosure of accounting transactions and events. and disclosure of accounting transactions and events.

The purpose of Accounting Standards is to eliminate as far The purpose of Accounting Standards is to eliminate as far as possible, incomparability of financial statements and as possible, incomparability of financial statements and discourage pursuance of accounting policies which are not discourage pursuance of accounting policies which are not in conformity with GAAPin conformity with GAAP

Fundamental Accounting Fundamental Accounting AssumptionsAssumptions

There are three fundamental accounting There are three fundamental accounting assumptions: assumptions:

(i) Going Concern (i) Going Concern

(ii) Consistency (ii) Consistency

(iii) Accrual (iii) Accrual

Components of financial statementsComponents of financial statements

A complete set of financial statements A complete set of financial statements normally consists of normally consists of

a Balance Sheet, a Balance Sheet, a Profit & Loss A/c and a Profit & Loss A/c and a Cash Flow Statement together with a Cash Flow Statement together with notes, statements and other explanatory notes, statements and other explanatory

materials that form integral parts of the materials that form integral parts of the financial statements. financial statements.

Components of financial statementsComponents of financial statementsInformation contents of different components of Information contents of different components of financial statements financial statements

Balance Sheet portrays value of economic Balance Sheet portrays value of economic resources controlled by an enterprise and the way resources controlled by an enterprise and the way they are financed. they are financed.

Profit & Loss A/c presents the result of operations Profit & Loss A/c presents the result of operations of an enterprise for an accounting period. of an enterprise for an accounting period.

Cash Flow Statement shows the way an enterprise Cash Flow Statement shows the way an enterprise has generated cash and the way they have been has generated cash and the way they have been used in an accounting period. used in an accounting period.

Notes and Schedules present supplementary Notes and Schedules present supplementary information explaining different items of financial information explaining different items of financial statements. statements.

Elements of financial statements Elements of financial statements

The items of financial statements can be The items of financial statements can be classified in five broad groups depending on classified in five broad groups depending on their economic characteristics. These five their economic characteristics. These five financial elements are financial elements are

assets assets liabilities liabilities equity equity Income/gains and Income/gains and expenses/ losses. expenses/ losses.

AssetsAssets

An asset is a resource owned/controlled by the An asset is a resource owned/controlled by the enterprise from which future economic enterprise from which future economic benefits are expected to flow to the enterprise. benefits are expected to flow to the enterprise.

The resource must have a cost or value that The resource must have a cost or value that can be measured reliablycan be measured reliably

It need not have a physical substance. It need not have a physical substance. It should generate future economic benefit. It should generate future economic benefit.

Classification of assetsClassification of assets

Assets

Non-current assetsCurrent assets

Fixed assets Monetary assets Non-monetary assetsinvestments

Tangible assets

Intangible assets

Fixed AssetsFixed Assets Assets owned by the enterprise and held to enable Assets owned by the enterprise and held to enable

production of goods and to carry on the business production of goods and to carry on the business operations, which are NOT held for resale in the operations, which are NOT held for resale in the normal course of businessnormal course of business

Can be further classified as tangible assets and Can be further classified as tangible assets and intangible assetsintangible assetsTangible assets are those which have a physical Tangible assets are those which have a physical substance eg. Plant and machinery, building, furniture substance eg. Plant and machinery, building, furniture etcetcIntangible assets are those which do not have a Intangible assets are those which do not have a physical existence but which provide rights or physical existence but which provide rights or privileges to the owner eg. Goodwill, Patents, privileges to the owner eg. Goodwill, Patents, trademarks etc.trademarks etc.

InvestmentsInvestments Investments include cash invested in long term Investments include cash invested in long term

securities, with an intention of earning income securities, with an intention of earning income or other benefitsor other benefits

If a firm has surplus funds, it may invest the If a firm has surplus funds, it may invest the surplus in securities issued by other entities.surplus in securities issued by other entities.

It may invest in equity securities issued by It may invest in equity securities issued by other firms to obtain trade benefits.other firms to obtain trade benefits.

Surplus can also be invested in property with a Surplus can also be invested in property with a view to earn rentals or for capital appreciationview to earn rentals or for capital appreciation

Current assetsCurrent assets

These are assets held These are assets held

(i)(i) In the form of cashIn the form of cash

(ii)(ii) For their conversion into cashFor their conversion into cash

(iii)(iii) For their consumption in the production of For their consumption in the production of goods.goods.

Eg. Cash in hand, cash at bank, debtors, bills Eg. Cash in hand, cash at bank, debtors, bills receivable, stock of raw materials, stock of receivable, stock of raw materials, stock of finished goodsfinished goods

Current assetsCurrent assets

Current assets can be classified intoCurrent assets can be classified into Monetary assets: These are moneys held and Monetary assets: These are moneys held and

financial assets to be received in fixed or financial assets to be received in fixed or determinable amounts of money. Eg. Accounts determinable amounts of money. Eg. Accounts receivables, loans and advances receivable, receivables, loans and advances receivable, short term deposits.short term deposits.

Non-monetary assets: Assets which are Non-monetary assets: Assets which are represented by goods or services. Eg. represented by goods or services. Eg. Inventories, prepaid expensesInventories, prepaid expenses

LiabilitiesLiabilities

Liabilities

Non-current liabilities Current liabilities

Secured liabilities Unsecured liabilities

LiabilitiesLiabilities

A liability is a present obligation of the A liability is a present obligation of the enterprise arising from past events, the enterprise arising from past events, the settlement of which is expected to result in an settlement of which is expected to result in an outflow of a resource embodying economic outflow of a resource embodying economic benefits benefits

Liabilities can be classified as Liabilities can be classified as

long term liabilitieslong term liabilities

current liabilitiescurrent liabilities

Long term liabilitiesLong term liabilities

These are financial obligations for repayment of These are financial obligations for repayment of money obtained for a relatively longer period of time, money obtained for a relatively longer period of time, generally more than a yeargenerally more than a year

These liabilities can be either These liabilities can be either Secured: Those liabilities for which the enterprise Secured: Those liabilities for which the enterprise

has provided some collateral, usually in the form has provided some collateral, usually in the form of mortgage or hypothecation. Eg. debenturesof mortgage or hypothecation. Eg. debentures

Unsecured: Those liabilities for which no security Unsecured: Those liabilities for which no security has been provided. Eg. public deposits, loans from has been provided. Eg. public deposits, loans from friends and relativesfriends and relatives

Current liabilitiesCurrent liabilities

These represent obligations maturing within a These represent obligations maturing within a relatively short period not exceeding one year relatively short period not exceeding one year or the normal operating cycle of the business.or the normal operating cycle of the business.

Eg. Sundry creditors, provision for taxation, Eg. Sundry creditors, provision for taxation, outstanding expenses, advances from outstanding expenses, advances from customerscustomers

EquityEquity

It is the residual interest in the assets of an It is the residual interest in the assets of an enterprise after deducting all its liabilities.enterprise after deducting all its liabilities.

Equity is the excess of aggregate assets of an Equity is the excess of aggregate assets of an enterprise over its aggregate liabilities. enterprise over its aggregate liabilities.

Equity represents owners’ claim consisting of Equity represents owners’ claim consisting of items like capital and reserves, which are items like capital and reserves, which are clearly distinct from liabilities, which are clearly distinct from liabilities, which are claims of parties other than owners. claims of parties other than owners.

Incomes and gainsIncomes and gains Income is the revenue that arises in the ordinary Income is the revenue that arises in the ordinary

course of activities of the enterprise, e.g. sales by course of activities of the enterprise, e.g. sales by a trader. a trader.

It includes interest, dividend or royalties It includes interest, dividend or royalties received by permitting others to use enterprise’s received by permitting others to use enterprise’s resources.resources.

Gains are income, which may or may not arise in Gains are income, which may or may not arise in the ordinary course of activity of the enterprise, the ordinary course of activity of the enterprise, e.g. profit on disposal of fixed assets. e.g. profit on disposal of fixed assets.

Expenses and lossesExpenses and losses

Expense refers to the amount incurred in the Expense refers to the amount incurred in the process of earning revenuesprocess of earning revenues

It includes expenses that arise in the ordinary It includes expenses that arise in the ordinary course of activities of the enterprise, e.g. course of activities of the enterprise, e.g. wages paid, salary paid, cost of goods soldwages paid, salary paid, cost of goods sold

Losses may or may not arise in the ordinary Losses may or may not arise in the ordinary course of activity of the enterprise, e.g. loss on course of activity of the enterprise, e.g. loss on disposal of fixed assets. disposal of fixed assets.

Fundamental accounting equationFundamental accounting equationAssets = Liabilities + capital (equity)Assets = Liabilities + capital (equity) The equation signifies that assets of a business The equation signifies that assets of a business

are always equal to the total of outside are always equal to the total of outside liabilities and proprietor’s equity.liabilities and proprietor’s equity.

This is because whatever funds are raised by This is because whatever funds are raised by the business, either through capital or from the business, either through capital or from outsiders or business operations, will be tied outsiders or business operations, will be tied up in one or the other form of uses (assets)up in one or the other form of uses (assets)

This equation emphasises the duality conceptThis equation emphasises the duality concept

Effect of business transactions on Effect of business transactions on accounting equationaccounting equation

Every business transaction can be Every business transaction can be analysed by or expressed in terms of its analysed by or expressed in terms of its effect on the balance sheet equation.effect on the balance sheet equation.

Different types of business transactions Different types of business transactions may result into a maximum of nine may result into a maximum of nine possible effect combinations on the possible effect combinations on the components of the accounting equationcomponents of the accounting equation

Effect of business transactions on Effect of business transactions on accounting equationaccounting equation

The NINE possible combination of effects are:The NINE possible combination of effects are: Increase in one asset; decrease in another assetIncrease in one asset; decrease in another asset Increase in asset; increase in liabilityIncrease in asset; increase in liability Increase in asset; increase in capitalIncrease in asset; increase in capital Decrease in asset; decrease in liabilityDecrease in asset; decrease in liability Decrease in asset; decrease in capitalDecrease in asset; decrease in capital Increase in one liability; decrease in another liabilityIncrease in one liability; decrease in another liability Increase in a liability; decrease in capitalIncrease in a liability; decrease in capital Increase in one item of capital; decrease in liabilityIncrease in one item of capital; decrease in liability Increase in one item of capital; decrease in another Increase in one item of capital; decrease in another

item of capitalitem of capital