Financial Accounting-Tue (2)

8/8/2019 Financial Accounting-Tue (2)

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Financial Accounting


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Learning Objectives


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Learning Objectives


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Learning Objectives


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Learning Objectives


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Introduction


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D efinition:


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M eaning of Accounting

Accounting is an Art

Accounting classifies as an art as it helps in

attaining the goal of ascertaining the financialresults. Analysis and interpretation of the

financial data is the art of accounting,requiring special knowledge, experience and

judgment.


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Contd.

I nvolves Recording, Classifying andSummarizing

Recording means systematically writing down thetransactions and events in account books soon after their

occurrence. C lassifying is the process of groupingtransactions or entries of similar nature at a place. This is

done by opening accounts in a book called ledger.

Summarizing involves the preparation of reports andstatements from the classified data (ledger),understandable and useful to management and other

interested parties. This involves preparation of finalaccounts.


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Records Transaction in Terms of

MoneyRecording business transaction in terms

of money is the common measure of

recording and helps in betterunderstanding of the state of affairs of the business.


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D eals with Financial Transactions

Accounting records only thosetransactions and events which are of

financial character. If a transaction has

no financial character, it will not bemeasured in terms of money and hence

will not be recorded.


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I nterpretation

Interpretation is the art of interpretingthe results of operations to determinethe financial position of an enterprise,the progress it has made and how well

it is getting along.


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Accounting involves Communication

The results of analysis andinterpretation are communicated to

management and to other interestedparties


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Accounting A Means

and Not an End

Keeping accounts is not the primary objective of a person

or an entity. On the contrary, the primary objective is totake decision on the basis of the financial facts given bythe accounting statements. Thus, the understanding of

accounts is not the basic objective. It only helps to realizea specific objective. As such, accounting is not an end in

itself but a means to an end.


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Objectives and Functions

P rovides necessary information about the financialactivities to the interested partiesP rovides necessary information about the efficiency orotherwise of management with regard to the properutilization of scarce resourcesP rovides necessary information for making predictions(financial forecasting)Facilitates to evaluate the earning capacity of a firm by

supplying the statement of financial position, thestatement of periodical earning, together with thestatement of financial activities to various interestedparties


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C ontd

Facilitates in decision-making with regard to the changes inthe manner of acquisition, utilization, preservation anddistribution of scarce resources

Facilitates in decision-making with regard to thereplacement of fixed assets and expansion of the firmP rovides necessary data to the government to enable it totake proper decisions concerning to duties, taxes, pricecontrol etc.

Devices remedial measures for the deviations of the actualfrom the budgeted performanceP rovides necessary data and information to managers forinternal reporting and formulation of overall policies


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B ranches of Accounting

Financial Accounting

Accounting deals with recording, classifying andsummarizing the business events that have already

occurred. It is, therefore, historical in nature. That is whyit is called historical accounting or post-mortem

accounting or more popularly financial accounting. Itsaim is to collate the information about income and

financial position on the basis of business events thathave taken place during a particular period of time.


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Cost Accounting

Cost accounting deals with the detailed studyof cost pertaining to cost ascertainment, cost

reduction and cost control. The emphasis is onhistorical costs as well as future decision-

making costs.


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M anagementAccounting

Management accounting provides information tomanagement not only about cost but also about

revenue, profits, investments etc. to enable managers todischarge their duties more efficiently and effectively.

Thus, it provides required database to managers to planand control the activities of business.


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S ocial ResponsibilityAccounting

Social responsibility accounting involvesaccounting of social costs incurred by anenterprise and reporting of social benefits

created by it.


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U sers of Accounting

Information(1) OWNER(S)Owner(s) refers to a person or a group of persons who hasprovided capital for running the business. It refers to an

individual in case of proprietor, partners in case of partnershipfirm and shareholders in case of a joint stock company. Theinformation needs of shareholders have assumed a greatersignificance in the corporate business world because of theseparation of ownership and management in the case of jointstock companies.


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Contd.

(2)MANAGERSFor managing business profitably, management requiresadequate information about financial results and financial

position. By providing this information, accounting helpsmanagers in efficient and smooth running of the business.

(3). INVESTORSP rospective investors would be keen to know about the past

performance of business before making investment in thatconcern. By analyzing historical information provided byaccounting records, they can arrive at a decision about theexpected return and the risk involved in investing in aparticular business.


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Contd.

(4). CREDITORS AND FINANCIAL INSTITUTIONSWhosoever is extending credit or loan to a business enterprisewould like to have information about its repaying capacity,

credit worthiness etc. Analyzing and interpreting the financialstatements of an enterprise can help in obtaining the requiredinformation.

(5). EMPLOYEES

Employees are concerned about job security and futureprospects. Both of these are intimately related with theperformance of business. Thus, by analyzing the financialstatements, they can draw conclusions about their jobsecurity and future prospects.


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Contd.

(6). GOVERNMENT Government policies relating to taxation, providing subsidiesetc. are guided by the relevance of industries in the economicdevelopment of the country. The policies also consider the

past performance of industries.Information about pastperformance is provided by the accounting system. Collection

of taxes is also based on accounting records.

(7).RESEARCHERS

Researchers need financial information for testing hypothesisand development of theories and models. The requiredinformation is provided by accounting system.


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Contd.

(8). CUSTOMERSThe customers who have developed loyalties toward abusiness are those who are certainly interested in thecontinuance of the business. They certainly want to knowabout the future directions of the enterprise with which theyare associating themselves. The way to information about theenterprise is through their financial statements.

(9).PUBLICP ublic at large is always interested in knowing the futuredirections of an enterprise and the only window to peepinside an enterprise is through their financial statements.


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Advantages Of Accounting

1. Facilitates to Replace MemoryAccounting facilitates to replace human memory bymaintaining a complete record of financial transactions.Human memory is limited by its very nature. Accounting helps

to overcome this limitation.2 . Facilitates to Comply with Legal

Requirements3 . Facilitates to Ascertain Net Result

of Operations4 . Facilitates to Ascertain Financial

Position. F ili h r k


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Contd.

6 . Facilitates a Comparative Study7 . Assist Management

8 . Facilitates Control over Assets9 . Facilitates the Settlement of Tax

Liability10.

Facilitates the Ascertainment ofValue of Business11. Facilitates Raising Loans


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B asic Terms in Accounting

1. CAPITAL

C apital generally refers tothe amount invested in an

enterprise by its owners.For example, paid up sharecapital in a corporateenterprise. Capital alsorefers to the interest of owners in the assets of anenterprise.

2. ASSETS

Assets refer to the tangibleobjects or intangible rights

owned by an enterpriseand carrying probablefuture benefits.


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3. LIABILITY

Liability is the financialobligation of an enterprise

other than owners funds.

4. REVENUE

Revenue is the gross inflowof cash, receivables or

other considerationsarising in the course of ordinary activities of anenterprise s resourcesyielding interest, royaltiesand dividends.


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8. EXPENSES

Expense is the cost relatingto the operation of an

accounting period, or therevenue eared during theperiod, or the benefit of which do not extend thatperiod.

9. DEFERREDEXPENDITURE

Deferred expenditure is theexpenditure for which

payment has been made ora liability incurred but whichis carried forward on thepresumption that it will be abenefit over a subsequentperiod or periods. This isalso referred to as deferredrevenue expenditure.


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SUNDRY CREDITOR

S undry creditor is theamount owed by an

enterprise on account of goods purchased orservices received, or inrespect of contractualobligations. It is alsotermed as trade creditor oraccount payable.

SUNDRY DEBTOR

S undry debtors are personsfrom whom amounts are

due for goods sold orservices rendered, or inrespect of contractualobligations. These are alsotermed as debtor, tradedebtor and accountreceivable.


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M odule- II


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JournalIntroduction:-Accounting is the art of recording, classifying andsummarizing the financial transactions and interpreting theresults thereof. Thus, the accounting cycle involves thefollowing four major phases:

1. Recording of transactions-- This is done in a book called journal.

2. C lassifying the transactions-- This is done in a book called ledger.

3. S ummarizing the transactions-- This includes preparation of trial balance,profit and loss account and balance sheet of the business.

4. Interpreting the results-- This involves computation of various accountingratios etc. to know about the liquidity, solvency and profitability of thebusiness.


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A journal records all daily transactions ofa business in the order of theiroccurrence . A journal may, therefore, bedefined as a book containing achronological record of transactions .

Journal


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The P erforma of a journalis as follows:


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Rules of D ebit and C redit

All transactions in the journal arerecorded on the basis of rules of debitand credit . For this purpose, transactionshave been classified into three categories:

i. Transactions relating to persons

ii . Transactions relating to properties andassets

iii . Transactions relating to incomes andexpenses


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Contd..

On the basis of above rules, it isnecessary to keep the accounts in respectof the following:

i . Each person with whom it deals(customer, suppliers)

ii . Each property or asset which it owns(building, machinery etc . )

iii.

Each item of income and expense


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C lassification of

Accounts

P ersonal

Accounts

Real

Accounts

Nominal

Accounts


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P ersonal AccountsP ersonal accounts include the accounts of persons with whom the business

deals. These accounts can be further classified into three categories:

a. Natural P ersonal AccountN atural personal account means persons who are creations of God. For

example, Vijay s a/c, Hary s a/c etc.

b. Artificial P erson AccountArtificial person account includes accounts of corporate bodies or institutions

which are recognized as persons in business dealings. For example,government, club, limited company, cooperative society etc.

c. Representative P ersonal AccountRepresentative personal account is the account which represents a person or

a group of persons. For example, when the rent is due to landlord, anoutstanding rent account represents the account of a landlord to whomthe rent is payable.


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Real AccountsReal accounts may be of the following types:

a. Tangible Real Account

Tangible real accounts are those which relate to such things that can betouched, felt and measured. For example, cash a/c, building a/c, furniturea/c etc.

b. Intangible Real Account

These accounts represent such things which cannot be touched but, however,can be measured in terms of money. For example, patent a/c, goodwill a/cetc.


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Nominal Accounts

Nominal accounts are opened in the books of accounts tosimply explain the nature of the transactions. They do notreally exist. For example, salary paid to employee, rent paidto landlord etc. Nominal accounts mainly include accounts of expense, losses, income and gains.


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RU LES OF ACC OU NTING


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EXAMP LES OF JOU RNAL ENTRIES


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COMP OU ND JOU RNAL ENTRYSometimes, there are a number of transactions on the samedate relating to one particular account or of one particularnature. Such entries can be passed by way of a single journalentry instead of passing individual journal entries. It may berecorded in any of the following three ways:

1. A particular account may be debited while several accountsmay be credited.

2. A particular account may be credited while several accountsmay be debited.

3. Several accounts might debited as well as credited.


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COMP OU ND JOU RNAL ENTRY

Example 1

P ass a compound journal entry in each of the following cases:

1. P ayment made to S (supplier) Rs. 10,000 and he allowed cashdiscount of Rs. 1,0002. A going concern was purchased having following assets and

liabilities: Cash-- Rs. 5,000 Land-- Rs. 50,000 Furniture-- Rs. 10,000 Stock-- Rs. 20,000 Trade C reditors-- Rs. 10,000 Bank Overdraft-- Rs. 10,000


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S OLU TION


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OP ENING ENTRY

In the case of a running business, the assets and liabilitiesappearing in the pervious year s balance sheet will have to bebrought forward to the next year. This is done by the means of a journal entry which is known as opening entry. All assetsare debited while all liabilities are credited. The excess of assets over liabilities is the proprietor s capital and is creditedto his capital account


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Example:-

Pass the opening entry on 1.1.2001 on the basis of the followinginformation taken from the business of Mr. Shubham.1. Cash in hand-- Rs. 20,0002. Sundry Debtors-- Rs. 60,0003. Stock in Trade-- Rs. 40,0004. Plant and Machinery-- Rs. 50,0005. Land and Building-- Rs. 1,00,0006. Sundry Creditors-- Rs. 1,00,000


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S olution:-


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LEDGER is the principal book of accounts whichcontains various accounts. An account is asummarized record of similar transactions during anaccounting period relating to a particular person or thing. Therefore, all the accounts, whether real,nominal or personal, are collected in the ledger.

L g r


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FORM AT

Dr. Title of the Account C r


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P OS TING

P osting means the process of transferring all the debit andcredit items from the journal onto the accounts maintained inthe ledger. Each amount entered in the debit column of the

journal is posted by entering it on the debit side of theaccount in the ledger with relevant details. Similarly, eachamount entered in the credit column is posted by entering iton the credit side of the account in the ledger with relevantdetails.


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The procedure of posting is as follows:

1. Enter the debit aspect of the transaction entered in journal on the debit side of the account in the ledger with all the relevant details in the respective column.

2. In the folio column of the journal, the page number of the ledger in which postingis done is entered.

3. Now enter the credit aspect of the transaction in the journal on the credit side of the account in the ledger with all the relevant details in the respective column.

4. The entering of the folio number on the corresponding page, as explained in thepoint number two above, is to be repeated in the case of credit item.

5. It is customary to prefix the name of the account credited and entered on thedebit side of the account in the ledger with word To.

6. S imilarly, the name of the account debited and entered on the credit side of theaccount in the ledger is prefixed with B y.


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B alancing of Ledger AccountThe totals of the debit side and credit side of an account aretaken to ascertain the difference between the two sides.This difference is known as the balance on the account. Thetotal of the heavier side is entered on the lighter side forarriving at the balance.

When the total of the debit side exceeds the total of thecredit side, the balance is said to be in debit, i.e. known debitbalance.When the total of the credit side exceeds the total of thedebit side, it means that the account has a credit balance.The balancing of the account is necessary to ascertain the neteffect whether debit or credit on the account.


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TRIALB ALANCE

Trial balance is a list of debit and credit balances extractedfrom the ledger on a particular date. S ince for every debitentry there is a corresponding credit entry of the equivalentamount, the total of the debit and credit balances shouldagree in equal amount.A trial balance essentially proves the arithmetical accuracyof the entries passed in the books of account and is derivedfrom ledger where all accounts find a place .

Trial balance is prepared after striking the balance of variousaccounts in the ledger.

OBJ ECTIVES OF P REP ARING TRIAL


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OBJ ECTIVES OF P REP ARING TRIALB ALANCE

1. It forms the very basis on which final accounts are prepared.

2. It helps in knowing the balance on any particular account inthe ledger.

3. It is a test of arithmetical accuracy.

N ote:- A trial balance is not a conclusive proof of the absolute

accuracy of the account. It does not indicate the absence of an error. So, a non-tailed trial balance indicates the presenceof book keeping error.

ERRORS D ISC LOS ED BY THE TRIAL


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ERRORS D ISC LOS ED BY THE TRIALB ALANCE

Wrong posting of entries, e.g., a debit entry of Rs. 500 forpurchase of furniture wrongly posted as Rs. 50 in the account

Omission of posting, e.g., when a debit entry of Rs. 500 forpurchase of furniture has not been posted at all

Duplication of posting, e.g., when a debit entry of Rs. 500 forpurchase of furniture has been posted twice to the account

Wrong side of posting, e.g., when debit entry is posted on thecredit side or credit entry is posted on the debit side. That is,

when debit entry of Rs. 500 is posted on the credit side andvice-versa


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Contd..

Errors in casting the totals of debit or credit side of the trialbalance

Wrong transfer of balances to the trial balanceOmission of entering the balance of account in the trialbalanceBalance of cash book omitted to be recorded in the trialbalance

Wrong balancing of account


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ERRORS NOT D ISC LOS ED BY THE TRIALB ALANCE

(a) Errors of omission to record any transaction.(b) P osting of wrong amount to both debit and credit side of the account.(c) Error made in the posting of debit or credit entry is compensated by an

identical error of equal amount. These errors are known as errors of compensation.

(d) Errors made in posting a transaction on the correct side of wrongaccount.

(e) Erroneously recording a transaction twice. These are known as errors of duplication.

(f) Errors of principle when the accounting principle is disregarded. Forexample, a capital item treated as revenue item and vice versa. That is,purchase of furniture posted to purchase a/c.


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Trial Balance ason 30 th April 2009

B asic P rinciples of P reparing Final


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B asic P rinciples of P reparing FinalAccount ( Capital and Revenue)

CAP ITAL EXP END ITU RE1. C apital expenditure is that expenditure the benefits of which are not fully

consumed in a year but spread over several years.2. It is the expenditure which results in the purchase or acquisition of asset or

property.3. It is the expenditure incurred in connection with the purchase of asset.4. It is the expenditure incurred to bring an old asset into working condition.5. It is the expenditure incurred for extending or improving an existing asset

to increase its productivity or to increase the earning capacity of businessor to decrease working expenditure.


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REVENU E EXP END ITU RE1. Revenue expenditure is the expenditure which benefits in the

current accounting year. It is not carried forward to the nextyear or years.

2. It is the expenditure which is incurred in the normal course of business to run the business and to maintain the fixed assets

of business.3. It is the expenditure which is incurred on purchase of goods

meant for resale or to purchase materials which will be usedto convert them into final product.

Therefore, revenue expenditure is a recurring expenditure made tomaintain the business. The amount spent is generally small and the benefit is for a short period which is not more than a year. All revenue expenditureare charged to trading and profit and loss account.


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D EFERRED REVENU E EXP END ITU RE

Deferred revenue expenditure is the expenditure which isoriginally revenue in nature but the amount spent is so largethat the benefit is received for not a year but for many years.A proportionate amount is charged to profit and loss accountof each year and balance is carried forward to subsequentyears as deferred revenue expenditure.It is shown as an asset in the balance sheet, e.g., heavy expenditure incurred on advertisements.


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CAP ITAL RECEIP TS

C apital receipts are the receipts which are notreceived in the ordinary course of business. Theseare non-recurring receipts.

M oney obtained from the sale of fixed assets orinvestments, issue of shares or debentures, loanstaken are some of the examples of capital receipts.C apital receipts are shown as liability reduced fromassets appearing in the balance sheet.


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REVENU E RECEIP TS

Revenue receipts are receipts obtained in the normalcourse of business. It is a receipt against supply of goods or services.

The money obtained from sales, interest, dividend,transfer fees etc . are examples of revenue receipts.Revenue receipts are credited to profit and lossaccount.


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CAP ITALP ROFIT

Those profits which are not earned during the regular courseof business and which are not earned on account of the day-to-day trading activities of the business are capital profits. F or example, profit on sale of asset and premium received onissue of shares.These types of profits are normally not taken to profit and lossaccount but are shown in the liabilities side of the balancesheet.


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CAP ITAL LOSS ES

The losses which are not suffered during the regularcourse of business are called capital losses. F or example, discount on issue of shares.


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INCOM E S TATEM ENTS

IntroductionAfter the agreement of trial balance, a trader closesledger accounts with a view to ascertain thefollowing aspects:

Gross profitN et profit

Financial position of the firm


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TRAD ING ACC OU NT

The goods account is split up and separate accounts are opened as follows:

Opening stock account, i.e. stock at commencementP urchase account including both cash and credit purchases Sales account including both cash and credit sales Returns inwards account, i.e. total goods returned by

customers Returns outwards account, i.e. total goods returned to vendorsC losing stock account, i.e. stock of goods at the end

These separate accounts, in total, are ultimately transferred toa common heading called trading account.


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Contd..

In order to find out the gross profit or gross loss of abusiness, a trading account is prepared.This account gives the overall profit of the business

relating to an accounting period which is subject todeduction of general administrative, selling andother expenses.Gross profit is the difference between sale proceedsof a particular period and the cost of the goodsactually sold during that period.


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The format of tradingaccount is as follows:


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P ROFIT AND LOSS ACC OU NTP rofit and loss account is prepared with a view to ascertain

the profit or loss on account of business activity during anaccounting period.P rofit and loss account is also an account like other accountsin the ledger which discloses the net effect in the form of

profit or loss resulting from settling off the expenses incurredagainst the revenue earned during the accounting period.

The difference between total revenue and total expensesrepresents net income or net loss according to whether thedifference is positive or negative.In this regard, it is pertinent to note that all the expensesincurred for the period are to be debited to this account,whether paid or not. Likewise, all revenue earned, whetherreceived or not, are to be credited to this account.


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C ontdThe balance of a trading account showing gross profit or gross loss

becomes the opening transfer entry of this account on the credit or debitside respectively.All the revenue expenses appear on the debit side including thoseexpenses which do not find a place in the trading account.The losses on sale of capital asset or any abnormal loss also appear on

the debit side. The credit side of the account shows the revenue earnedincluding the non-trading income like interest on bank deposit orsecurities, dividend on shares, rent of let-out property, profit arisingfrom sale of fixed assets etc. after transfer of all the nominal accountsfrom the trial balance to the profit and loss account.

The net result of the profit and loss account is ascertained by balancingit. If the credit side is more than the debit side, it indicates net profit forthe period.Conversely, if the debit side is more than the credit side, it indicates netloss for the period.


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P ROFIT AND LOSS ACC OU NT


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B ALANCE S HEET

The American Institute of C ertified P ublic Accountants definesbalance sheet as a tabular statement of summary of balances (debits and credits) carried forward after an actual and constructive closing of books of account and kept

according to the principles of accounting.


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C ontd

The balance sheet is one of the important statementsdepicting the financial strength of the company. On one hand,it shows the properties which were utilized and on the other,the sources of those properties.

The balance sheet shows all the assets owned by thecompany and all the liabilities and claims it owes to ownersand outsiders.

The balance sheet is prepared on a particular date. The right

hand side shows properties and assets. Usually, there is noparticular sequence for showing various assets and liabilities.


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FORM AND CONTENTS OF B ALANCE S HEET

The balance sheet is generally divided into parts, i.e. assets, liabilities andcapital. It is usually prepared in the horizontal form. The assets are shownon the right hand side and capital and liabilities on the left hand side.The order of assets and liabilities is either on liquidity basis or onpermanency basis. When balance sheet is prepared on liquidity bas is,large liquid assets like cash in hand, cast at bank, investments etc. areshown first and small liquid assets later. On liabilities side, the liabilities tobe paid in the short period are shown first, long-term liabilities next andcapital in the last.The liquidity form is suitable for banking and other financial companies.When balance sheet prepared on permanency basis , on assets side, fixedassets are shown first and liquid assets later. On liabilities side, the capitalis shown first, long-term liabilities next, and short-term and currentliabilities in the last.


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EXP LANATION OFB ALANCE S HEET ITEMS

1. S hare Capital

Share capital is the first item on the liabilities side of abalance sheet. Authorized and issued capital is shown givingthe number of shares and their amount. The number of shares for which public has applied (subscribed capital) arementioned along with the type of capital, i.e. preferenceshare capital and equity share capital. If the capital is issuedfor other than cash, the amount of such capital ismentioned.


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S ECU RED LOANS

All those loans against which securities are given are shown under thiscategory. Debentures are shown under this heading. Loans and advancesfrom bank, subsidiary companies etc. should be shown separately and the

nature of securities should also be mentioned.

U NS ECU RED LOANS These are the loans and advances against which the company has notgiven any security. The items included here are deposits, loans andadvances from subsidiary companies and loans and advances from other

sources. Short-term loans from banks and other sources are also shown inthis category. Short-term loans include those which are due for not morethan one year on the balance sheet.


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CU RRENT LIAB ILITIES AND P ROVIS IONS

(a) C urrent liabilities includethe following:

Acceptances Sundry creditors Subsidiary companies Advance payments and unexpired

discounts Unclaimed dividends Other liabilities, if anyInterest accrued but not paid on

loans

(b) Following items areincluded under provisions:

P rovision for taxationP roposed dividendsP rovision for contingenciesP rovision for provident fund

schemeP rovision for insurance, pension

and similar staff benefits schemes Other provisions


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ASS ETS S ID E1. Fixed Assets

Fixed assets are those which arepurchased for use over a longperiod. These assets are meant toincrease production capacity of the business.They are not acquired for sale butare used for a considerableperiod of time.The balance sheet is prepared toshow the financial position of theconcern. These assets should beshown in such a way that balancesheet depicts true financialposition of the business.

2. InvestmentsInvestments are shown by givingtheir nature and mode of valuation. Investments undervarious sub-heads such asinvestments in government ortrust securities, in shares,debentures and bonds, and inimmovable properties are givenseparately in the inner column of the balance sheet.


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3. Current Assets

Current assets are such assets asin the ordinary and natural courseof business move onward through

the various processes of production, distribution andpayment of goods, until theybecome cash or its equivalent bywhich debts may be readily andimmediately paid.

4. M iscellaneous ExpenditureDeferred expenditure is shownunder this heading.M iscellaneous expenditure arethe expenses which are not

debited fully to the profit and lossaccount of the year in which theyhave been incurred. Theseexpenses are spread over anumber of years and unwrittenbalance is shown in the balancesheet. The items under thisheading are preliminaryexpenses, discount allowed onissue of shares or debentures,interest paid out of capital during

construction


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C ontd


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THANK YOU

Documents

Financial Accounting-Tue (2)