MODULE I - FUNDAMENTALS OF FINANCIAL ACCOUNTING

• Basic Understanding of Accounting Principles, Concepts, and Conventions

• Conceptual Framework of Financial Statements,

• Preparation of Final Accounts of Companies as per Schedule III of the Companies (Amendment)
Act, 2013
Y ou’ve heard the saying that nothing happens until someone sells something. After that sale, accounting
takes over as the basic activity of business.

The Three Questions

Every business asks three key questions:
• How much money came in?
• Where did the money go?
• How much money is left?

The answer to each question can come only from the practice known as accounting.
accounting is the language of business.
• Accounting is often described as the language of business,
essential for communicating financial information across
departments and with outside organizations.

• Even if you lack a commerce or finance background, a foundational

understanding of accounting can help you make better business
and personal financial decisions, interact confidently in
professional settings, and interpret financial reports
 Why Learn Accounting?

• Decision making: Accounting informs strategic and operational

decisions in businesses, startups, and nonprofits.

• Universal application: Good financial records are essential for

securing loans, managing budgets, evaluating jobs, and investing.

• Common language: In business, financial data is the standard language

for discussions across functions like marketing, HR, and operations.
MEANING OF ACCOUNTING

The Committee on Terminology set up by the American Institute of Certified Public Accountants
formulated the following definition of accounting in 1961:

“Accounting is the art of recording, classifying, and summarising in a significant manner

and in terms of money, transactions and events which are, in part at least, of a financial
character, and interpreting the result thereof.”

Source: [Link]
Source: [Link]
 PRINCIPLES OF ACCOUNTING
• The word ‘Principle’ has been differently viewed by different schools of thought.
The American Institute of Certified Public Accountants (AICPA) has viewed the word
‘principle’ as a general law of rule adopted or professed as a guide to action; a
settled ground or basis of conduct of practice”

• Accounting principles have been defined as “those rules of conduct or procedure

which are adopted by the accountants universally while recording the
accounting transactions.”
Generally Accepted Accounting Principles (GAAP):

Accounting principles are those rules of actions on the basis of

which the transactions of the business are recorded, classified
and summarized. If the financial statements are not prepared on
the basis of these principles, there will be low acceptability and
difficulty to understand them, and the comparison will be
impossible and unreliable.
• Therefore, the accountants recommend that there should be common
concepts and conventions of accounting so that the above difficulties and
problems may not occur. These common concepts and conventions of
accounting have become the basic accounting concepts and conventions as
these are commonly accepted by the body of the professional accountants
all over the world to prepare the financial statements, therefore, they are
termed as Generally Accepted Accounting Principles (GAAP)
Classification of Accounting Principles

Accounting principles are broadly classified into three categories,

these are:

• Basic Assumptions
• Basic Principles (Concepts)
• Modifying Principles (Conventions)
Summary of Accounting Principles and concepts
Business Entity : As per this assumption, business is considered a separate
entity from its owner(s). This assumption helps in keeping the business
transactions strictly free from the effect of personal affairs of the owner.
• Going Concern : The concept of going concern assumes that a business firm
would continue to carry out its operations indefinitely (for a fairly long period
of time) and would not be liquidated in the near future.
Money Measurement : The concept of money measurement states that only those transactions
and happenings in an organisation, which can be expressed in terms of money are to be recorded
in the book of accounts. Also, the records of the transactions are to be kept not in the physical
units but in the monetary units.
• Accounting Period : Accounting period refers to the span of time at the end
of which the financial statements of an enterprise are prepared to know
whether it has earned profits or incurred losses during that period and what
exactly is the position of its assets and liabilities, at the end of that period.
• Revenue Recognition : It is also called revenue realization principle which
means profit should be considered only when realised.

• As per this principle the revenue is recorded in accounting when the sales have
taken place.

• If there is expectation that will be a particular transaction there in future, that is not
recorded in accounting.

• Revenue/sales is considered to be made when title of ownership of goods passes

from the seller to buyer and the buyer become legally liable to pay.
Cost Concept : The cost concept requires that all assets are recorded in the book of
accounts at their cost price, which includes cost of acquisition, transportation,
installation and making the asset ready for the use.
• Dual Aspect : This concept states that every transaction has a dual or two-
fold effect on various accounts and should therefore be recorded at two
places. The duality principle is commonly expressed in terms of fundamental
accounting equation, which is : Assets = Liabilities + Capital
 • For example, financial analysts who read financial
statements need to know what inventory valuation
method has been used, if there have been any significant
Full Disclosure : This concept
write-downs, how depreciation is being calculated, and
requires that all material and
other critical information for the understanding of the
relevant facts concerning financial
financial statements.
performance of an enterprise must • The full disclosure principle is crucial to ensuring that
be fully and completely disclosed in there is limited information asymmetry between the
the financial statements and their company’s management and its current shareholders,

accompanying footnotes. debtors, or other third parties.

• The principle helps foster transparency in financial
markets and limits the opportunities for potentially
fraudulent activities
• Full disclosure principle refers to the concept that suggests that a
business should report all the necessary information in their
financial statements, so that the users who are able to read the
financial information are in a better position to make important
decisions regarding the company.
• Matching Concept: The concept of matching emphasises that expenses incurred in
an accounting period should be matched with revenues during that period. It follows
from this that the revenue and expenses incurred to earn these revenue must belong
to the same accounting period.
• Objectivity : It is also known as objective evidence
concept. As per this principle the transactions which are
recorded in accounting must be on the objective and
factual basis.

• There should be a voucher or documentary evidence

behind each entry in the accounting.

• The entry must be free from personal bias and based on

the rational approach. If the entries are made without
evidence, it will lose the confidence of the several users
of the financial statements about their reliability. For the
auditing of the financial statements, there is also a need
of objective evidence.
Conservatism or Prudence: As per the law of conservatism, at the time of
preparing the financial statements, all the possible losses must be kept in mind
and all anticipated profits/gains should be left out. In other words the
accounts must follow the policy of playing safe.
• Consistency : This concepts states that accounting policies and practices followed by
enterprises should be uniform and consistent one the period of time so that
results are comparable. Comparability results when the same accounting principles
are consistently being applied by different enterprises for the period under
comparison, or the same firm for a number of periods.
Timeliness: Accounting information given in the
financial statements must be reliable and
relevant. In order to be relevant, this
information must be supplied in time. If late
and obsolete information is provided, it will
hamper the management and the users of the
financial statements to take appropriate, timely
and rational decision.
• Materiality or Relevance : Herewith, the materiality means that only that
information should be disclosed and attached with financial statements which
influence the decisions of shareholders, investors and creditors, etc. and the other
insignificant details must be ignored.
Preparation of Financial Statements
• The Board of Directors of the Company shall lay financial statements at
every annual general meeting of a company.

• As per Section 129 of Companies Act 2013 the financial statement shall give a
true and fair view of the state of affairs of the company.

• It shall comply with notified accounting standards and it shall be in the form
as prescribed in the Schedule III of the companies Act 2013.

• Part I of Schedule III is Balance Sheet and Part II is the Profit and Loss
Account
Financial Statement Includes

• Financial Statement include:

• 1) A Balance sheet as at the end of the financial year

• 2) A profit and Loss account for the financial year

• 3) Cash flow statement for the financial year

• 4) A statement of changes in equity, if applicable

• 5) Any explanatory notes related to point 1 to 4

Roles of various financial statements

• Balance Sheet:
• The balance sheet (also known as the statement of financial position or
statement of financial condition) reports the firm’s financial position at
a point in time.
• The balance sheet consists of three elements:
• 1. Assets are the resources controlled by the firm.
• 2. Liabilities are amounts owed to lenders and other creditors.
• [Link]’ equity is the residual interest in the net assets of an entity
that remains after deducting its liabilities.
• Transactions are measured so that the fundamental accounting equation
holds:
• Assets = Liabilities + Owners’ equity
Roles of various financial statements
• Profit and Loss Statement:
• The income statement (also known as the statement of operations or the profit and loss
statement) reports on the financial performance of the firm over a period of time.

• The elements of the income statement include revenues, expenses, and gains and losses.

• Revenues are inflows from delivering or producing goods, rendering services, or other
activities that constitute the entity’s ongoing major or central operations.

• Expenses are outflows from delivering or producing goods or services that constitute the
entity’s ongoing major or central operations.

• Other income includes gains that may or may not arise in the ordinary course of business.
Roles of various financial statements

• Cash flow statement for the financial year

• The statement of cash flows reports the company’s cash receipts and payments.

• These cash flows are classified as follows:

• Operating cash flows include the cash effects of transactions that involve the normal
business of the firm.

• Investing cash flows are those resulting from the acquisition or sale of property, plant, and
equipment; of a subsidiary or segment; of securities; and of investments in other firms.

• Financing cash flows :which shows the net flows of cash that are used to fund the company.
Financing activities include transactions involving debt, equity, and dividends.
Roles of various financial statements

• Statement of Changes in Equity is the reconciliation between the opening balance

and closing balance of shareholder’s equity.

• It is a financial statement which summarises the transactions related to the

shareholder’s equity over an accounting period.

• Movement in retained earnings, other reserves and changes in share capital such as

the issue of new shares and payment of dividends are recorded in this report..
Roles of various financial statements

• Financial statement notes ( footnotes) include disclosures that provide further details about the
information summarized in the financial statements.

• Footnotes allow users to improve their assessments of the amount, timing, and uncertainty of the
estimates reported in the financial statements.

• Discuss the basis of presentation such as the fiscal period covered by the statements and the
inclusion of consolidated entities.

• Provide information about accounting methods, assumptions, and estimates used by management.

• Provide additional information on items such as business acquisitions or disposals, legal actions,
employee benefit plans, contingencies and commitments, significant customers, sales to related
parties, and segments of the firm.
Schedule III of Companies Act 2013
• Schedule III to the Companies Act, 2013 (2013 Act) provides general instructions for
presentation of financial statements of a company under both Accounting Standards (AS) and
Indian Accounting Standards (Ind AS).

• Schedule III has three parts and they are as follows:

• Division I is applicable to a company whose financial statements are prepared in

accordance with AS

• Division II is applicable to a company whose financial statements are prepared in

accordance with Ind AS (other than Non-Banking Financial Companies (NBFCs))

• Division III is applicable only to NBFCs which are required to prepare financial
statements in accordance with Ind AS.
AS and Ind AS
• AS are the original Indian accounting rules issued by the Institute of Chartered
Accountants of India (ICAI) before India converged with global standards.

• Ind AS are updated Indian accounting standards, prepared in line with International
Financial Reporting Standards (IFRS), tailored for Indian conditions

• AS = traditional, Indian-specific, simpler.

• Ind AS = modern, globally aligned, more complex and detailed.

EQUITY AND LIABILITIES
• 1. Shareholders’ funds
• a. Share capital : The amount invested by the company's owners (shareholders) in the form of
equity shares or preference shares.

Example: The company issues 10,000 shares of ₹10 each, raising ₹1,00,000.

• b. Reserves and Surplus : Profits retained in the business and other reserves like general
reserve, capital reserve, etc.
• Example: Company made a profit of ₹25,000, chooses not to distribute as dividend. (retained earnings)

• c. Money received against share warrants: Funds received for share warrants, yet to be
converted into shares.
• 2. Share application money pending allotment

• Money received from investors for shares to be issued in the future;

shares are not yet allotted

• Money collected from investors for shares that are about to be allotted
(but not yet allotted) is called "Share application money pending
allotment." It is like a “waiting room” for investor money until shares
are formally issued!
• 3. Non-current liabilities

• a. Long-term borrowings: Loans and borrowings due for repayment after more than 12 months
(e.g., term loans).
• Example: A company takes a 5-year loan of ₹5,00,000 from a bank to buy machinery.

• b. Deferred tax liabilities (Net): Taxes payable in the future due to timing differences between
account and tax figures.
• Example: Due to different methods of calculating depreciation for tax and for accounting, the company has to
pay ₹15,000 of tax in the future.

• c. Other long-term liabilities: Other obligations due beyond 12 months (e.g., lease obligations).
• Example: Lease obligations for equipment extend beyond one year (e.g., ₹25,000 due over 3 years).

• d. Long-term provisions: Provisions for liabilities to be settled after 12 months (e.g., gratuity, leave
encashment).
• Example: Setting aside ₹10,000 for employees’ gratuity payable upon retirement.
• 4. Current liabilities
• a. Short-term borrowings: Loans and borrowings payable within 12 months.
• Example: A company takes a working capital loan of ₹50,000, repayable in 6 months.

• b. Trade payables: Amounts owed to suppliers for goods or services received.

• Example: The business owes ₹30,000 to suppliers for inventory bought on credit.

• c. Other current liabilities: Other short-term obligations, such as taxes payable,

interest accrued.
• Example: ₹5,000 in unpaid electricity bills and ₹12,000 in accrued salary.

• d. Short-term provisions: Provisions for short-term liabilities, payable within

the same fiscal year.
• Example: Provision for income tax expected to be paid within the year—₹7,000.
Assets

• 1. Non-current assets
• a. Property, Plant and Equipment: Physical assets like buildings,
machinery, furniture—used for over one year.
• i. Tangible assets: Physical assets, touchable (e.g., machinery).

• ii. Intangible assets: Non-physical assets (e.g., patents, copyrights).

• iii. Capital work-in-progress: Cost spent on assets under construction.

• Example: Spent ₹90,000 on machinery still under installation.

• iv. Intangible assets under development: Cost for intangibles not ready for use.
• b. Non-current investments: Investments meant to be held for more
than a year (e.g., long-term bonds, investments in subsidiaries).
• Example: Investments in bonds maturing after 3 years, ₹40,000.

• c. Deferred tax assets (Net): Income taxes recoverable in future periods.

• Example: Company can claim back ₹6,000 in future taxes due to past losses.

• d. Long-term loans and advances: Money given out, recoverable after

more than a year.
• e. Other non-current assets: Any other assets not expected to be
converted to cash within a year.
• Example: Given an advance of ₹20,000 to a supplier, recoverable next year.
• 2. Current assets
• a. Current investments: Investments that can be easily liquidated
within 12 months.
• Example: Mutual funds worth ₹25,000 that can be readily sold.
• b. Inventories: Stock of raw materials, work-in-progress, finished
goods.
• Example: Raw materials worth ₹18,000 and finished goods worth ₹22,000.
• c. Trade receivables: Amounts owed to the company by its
customers.
• Example: Customers owe ₹45,000 for credit sales.
• d. Cash and cash equivalents: Physical cash, bank balances, short-term
investments.
• Example: ₹12,000 in hand, ₹28,000 in bank.

• e. Short-term loans and advances: Loans recoverable in less than a year.

• Example: Employee advances of ₹5,000 to be settled next month.

• f. Other current assets: Any other assets recoverable in the short term.
• Example: ₹3,000 prepaid for insurance, benefit available within the year.
 Item/Heading Explanation

Money earned from the company’s main business

I. Revenue from Operations activities (e.g., sales of products or services). This is
the core income generated by the company.
Income earned from other sources not related to
II. Other Income primary business (e.g., interest income, rent
received).

Sum of revenue from operations and other income;

III. Total Revenue (I+II)
total income earned during the period.
 Costs incurred to run the business. These are sub-divided
IV. Expenses: into:
- Cost of Materials Consumed Cost of raw materials used to produce goods.
- Purchases of Stock-In-Trade Cost of goods bought for resale (trading inventory).

- Changes in Inventories of Finished Goods / Adjustment for increase/decrease in inventory quantities;

Work-in-progress and Stock-In-Trade reflects goods produced but not sold yet.
- Employee Benefits Expense Salaries, wages, and benefits paid to employees.

- Finance Costs Interest and other borrowing costs (e.g., loan interest).
Allocation of the cost of tangible and intangible fixed assets
- Depreciation and Amortization Expense over their useful life.

- Other Expenses All other operating expenses (e.g., rent, utilities, advertising).
Total Expenses Sum of all expenses incurred during the period.
V. Profit before Exceptional & Extraordinary The profit earned before considering any exceptional or
Items and Tax (III - IV) extraordinary items, and taxes; also called Operating Profit.

Items that are unusual or infrequent but related to normal

VI. Exceptional Items
business activities (e.g., gains or losses from sale of assets).

VII. Profit before Extraordinary Items and Tax Profit after adjusting for exceptional items but before
(V - VI) extraordinary items and tax.

Income or expenses that are both unusual and infrequent,

VIII. Extraordinary Items
e.g., losses from natural disasters or legal settlements.

Profit earned before paying income tax (after all

IX. Profit before Tax (VII - VIII)
exceptional and extraordinary adjustments).
X. Tax Expenses: Taxes related to the profits earned:

- Current Tax Tax payable on the current year’s taxable income.

Tax related to timing differences between accounting

- Deferred Tax income and taxable income (tax to be paid or saved in
future periods).
XI. Profit/(Loss) from Continuing
Net profit or loss from ongoing business operations after tax.
Operations (IX - X)

XII. Profit/(Loss) from Discontinuing Profit or loss from any part of the business that has been
Operations discontinued or is to be sold.

XIII. Tax Expense of Discontinuing

Taxes related to the profit or loss from discontinuing operations.
Operations

XIV. Profit/(Loss) from Discontinuing

Net profit or loss from discontinued operations after tax.
Operations (After Tax) (XII - XIII)

Overall profit or loss combining continuing and discontinued

XV. Profit/(Loss) for the Period (XI + XIV)
operations. This is the “bottom line” figure.
XVI. Earnings per Profit allocable to each share of the company, indicating the
Equity Share: profitability from a shareholder’s perspective:

Earnings per share calculated without considering diluted potential

- Basic shares.

Earnings per share considering all convertible securities, options,

- Diluted etc. that could dilute earnings per share.