Financial Accounting

P R E PA R E D B Y: M O H A M M A D AY O O B M A K H D O M
D E A N O F E C O N O M I C S FA C U LT Y
Introduction to Accounting
Introduction
The basic objective of commerce education is to produce skilled office worker for various
business concerns. As such this field includes the subjects like Economics, commerce,
banking, insurance and information technology etc. all these subjects are related with
various activities of business organizations. Accounting is one of the most important subjects
of this field. In this subject, the learner is given the education and training for preparation of
vouchers, invoices and recording them in the appropriate books, classification of the
business transactions in identical groups, making summary statement for analysis and
comparison and ascertaining results of the business after certain periods.
 Definition of Accounting
Accounting is the art of recording, classifying and summarizing the business transactions
and finally to prepare the financial statements, i.e income statement and balance sheet.

From the above definitions, we can ascertain that accounting mainly concerned with.

 Recording of business data

 Classification of recorded data

 Analyzing of summarized data

 Preparation of statements and reports

Book Keeping
Most of the people are confused that book keeping and accounting are alternative terms.
Though these are related terms but not alternate at all. The “book” means the “the books of
accounts” and keeping means “maintaining them in proper form and order” hence the book
keeping is mainly concerned with the recording of business data in proper books. Book
keeping is defined as under.

The systematic recording of financial transaction of an enterprise is known as book keeping.

 Special Fields of Accounting
With development of business activities and specialization of various fields of these activities, a number of branches
for special study in accounting have evolved. Some important branches of accounting are explained as under:

 Financial accounting: this field of accounting concerns with general accounting system. It is engaged in
recording the business transactions in books and preparation of periodical reports for managers and general
public.

 Cost accounting: the main objective of this branch of accounting is to control the cost of production and
distribution. It checks the efficiency of producing, selling and administrative department by applying actual and
pre-determined cost techniques. It also shows effects on cost with changes in the volume of production and
sales.
 managerial accounting: this field of accounting mainly concerns with the selection of
best among various alternatives. It uses the techniques of historical estimated and actual
data as a device toward positive change.

 Government accounting: it is the method of recording the financial transactions of the

central and provincial governments. It keeps the record of expenditure, taxes, revenue
and budget of various government departments. It provides information with regard to
financial aspect of public administration and activities. This is also known as “applied
accounting”.
 Basic Accounting Terminologies
In every field of study, some words are used with their specific meanings. These are called as
terms. In accounting also some terms are used. These terms and their meaning are explained as
under:

• Business: it is general term and includes any activity undertaken for the purpose of earning
profits such as buying and selling of goods. The business organizations which are engaged in
buying and selling of goods/merchandise are called as merchandising or trading concerns.
While those which are engaged in business any services are called service concerns. The
business organizations engaged in producing goods are called as manufacturing concerns.
• Proprietor: a person who invests the money or things in the business is called as owner or proprietor. In fact, he is the person
who invests capital and gives its time and attention to the business. He is entitled to receive the profit and bear the loss of the
business.

• Transactions: any dealing between two or more persons for goods or services, which effects the financial position of a business
and also can be measured in term of money is called business transaction. It is of two types, i.e. cash transaction and credit
transaction.

• Voucher: a written evidence of business transaction is called voucher. The voucher may be cash memo, bill and invoice etc.

• Cash memo: any written proof or evidence for the goods purchased from a particular seller is called cash memo. For example, if
we purchase a book from bookseller, he gives a cash memo or bill. The cash memo serves as a voucher for the payment in cash.

• Invoice: a written evidence/document given by the seller to the buyer for credit sale of goods is called invoice.
• Account: it is device which contains a systemic record of increase or decrease in an item during a
particular period of time.

• Merchandise: the things purchased by a business organization for the purpose of reselling them in same
condition are called merchandise of goods.

• Purchases: the cost of merchandise purchased is called purchases. When the price of goods purchased is
paid in cash. It is called cash purchases when it is paid on any future dates, it is called credit purchases.

• Sales: the amount earned from sales of goods is called sales. If this price is received by earned in cash, it
is called as cash sales an when is to be received on any some future dates it is called as credit sales.
• Revenue: all sorts income received or accrued are called as revenue. This revenue may be earned from sale of
merchandise or by rendering services for the customer. It is also earned in shape of commission, interest or discount
etc.

• Expenses: to achieve the objectives of business certain payments are made. These are the expenses of business.
The examples of such expenses are carriage, freight, cartage, salaries, rent and advertisement etc.

• Profit: the amount earned by a business organization after deducting the cost of the product form the revenues. In
simple words the excess amount over the expenses is called profit.

• Loss: if the expenses or the cost of the product or goods is higher then the revenue, the differences is called as loss.
• Stock (inventory): goods or merchandise on hand at any time is called as stock, inventory or stock in trade.
The value of goods at the beginning of the period is called opening inventory and value of goods remained
unsold at the end of period is called as ending inventory.

• Balance: the difference between the total debits and total credits of any account is called as balance.
When the debit is more, it is called as debit balance and when the credit is more it is called as credit
balance.

• Account receivable/debtor: a person to whom goods are sold on credit is called account receivable or
debtor. It is treated as current asset and recorded on the assets side of the balance sheet.
• Account payable/creditor: a person from whom goods are purchased on credit is called as account payable
or creditor. It is treated as short term liability for the business and recorded on the liabilities side of
balance sheet.

• Note payable: any instrument in writing payable by the firm on certain future date is called as note payable
is bill payable. These are the bills or notes accepted by the firm.

• Note receivable: any instrument in writing receivable by the firm on certain future date is as note
receivable or bill receivable. These are the bills or notes received by the firm.

• Cash book: a book of original entries in which all cash receipts and payments are recorded is called
cashbook. It has three types.
• bad debts/un-collectable: the amount which is finally written off as un-collectable is called as bad debts. It is
treated as loss of business.

• Outstanding expenses: it means those expense which have been incurred but not actually paid. These are called
as accrued expenses or unpaid expenses.

• prepaid expenses: it means the expense which have been paid in advance, but not yet expired. It is also called as
unexpired expenses or expenses paid in advance.

• Unearned income: any income which has been received in advance but not earned in current year is called
unearned income.

• Assets: anything valuable possessed by a firm with the following three features qualifies as assets.
 according to the feature of their liquidity and purpose of their holding the assets can be sub-divided in
following four groups:

• Current assets: which are either cash or easily convertible into cash. In fact they are acquired or created
with a view to convert or sell them for cash. The example of such assets are cash in hand, bank balance,
account receivable, note receivable and stock etc.

• Fixed assets: which are not easily convertible into cash, these are acquired to retain and use in business
operation e.g. land, building, plant and machinery, furniture and motor vehicles etc.

• Intangible assets: the assets, which are not physically touched, but still valuable for business enterprise
e.g. preliminary expenditure, trade mark, goodwill and patent right etc.
 Equities: the rights possessed by owners or outsiders against the assets of the firm are called as equities. The equities are further divided into two categories.

• Owner’s equity: it is the capital invested by the proprietor/owners of the business. It is the claim of the owners on the business assets. It is also called as internal
equities or capital funds.

• Liabilities: it is the claim of the outsiders against the assets of the enterprise. The liabilities are also called external equities. It may be following types.

1. Short term/current liabilities: the liabilities which are payable in near future (within one year) are called as short term or current liabilities. The example are
account payable, notes payable, expenses payable and bank overdraft etc.

2. Long term liabilities: these are the loans which are raised for permanent finance of the firm. These are payable after number of years. The examples of
long term liabilities are long period bank loans, securities and debentures issued, mortgage loans etc.

Drawings: the cash or commondities withdrawn by the owner for his personal use from business are known as drawings.
 Financial statement: the statement which are prepared by the accountants to show the results of the business at the end of particular period.
These are income statement, cash flow statement and balance sheet.

• Income statement: one the major objectives of accounting is to know the results of the business. This means that the profit earned or loss
suffered is calculated at the end of accounting period. For this purpose a statement is prepared where all incomes of the period are added
and all the expense of the that period are deducted. This statement is called as income statement.

• cash flow statement: the basic purpose of a statement of cash flow is to provide information about the cash receipts and cash payments of a
business entity during the accounting period. (The term cash flow includes both cash receipts and cash payments).

• Balance sheet: balance sheet represents the financial position of the firm on the certain fixed date, usually at the close of the financial
period. All the assets possessed by the firms are written on one side and equities on the other side. Both the assets and the equities are
grouped under various classifications. Both the sides are equal.
 Accounting Cycle
When a business transaction occurs, it is recorded in various books in proper sequence. The order
of recording these transactions is called as “Accounting cycle”. Every step of recording is called a
phase of accounting cycle.
Journal

Financial
Statement Ledger
Accounting
Cycle

Adjusting
Trail
Entries
Balance
 Chapter 2

Accounting Equation
Assets = Equities

Assets = Liabilities + Capital

 Transaction & Accounting Equitation
When a transaction takes place, it effects in terms of increasing/decreasing three basic components of
accounting equation.

1. Mr. Irfan started business of printing by introducing 200000 Afg in the name of Irfan Printing Services.

Assets Equities
Cash 200000 Af = Irfan’s Capital 200000 Af

2. Irfan Purchased Building for 100000 Af and Paid Cash for the seller.

Assets Equities
Cash 100000 Af = Irfan’s Capital 200000 Af
Building 100000 Af
3. Irfan purchased Machinary worth 150000 Af From Ali and Paid 50000 Af in cash.
Assets Equities
Cash 50000 Af = Irfan’s Capital 200000 Af
Building 100000 Af Account Payable 100000 Af
Machinery 150000 Af

4. Irfan purchased raw material of 30000 Af for cash.

Assets Equities
Cash 20000 Af = Irfan’s Capital 200000 Af
Building 100000 Af Account Payable 100000 Af
Machinery 150000 Af
Raw material 30000 Af
5. Irfan received and order of printing work from Ahmad who paid 35000 Af in cash and promised
to pay 15000 Af later. .
Assets Equities
Cash 55000 Af = Irfan’s Capital 250000 Af
Building 100000 Af Account Payable 100000 Af
Machinery 150000 Af
Raw material 30000 Af
Account receivable 15000 Af

6. Irfan paid 50000 Af to Ali on Account.

Assets Equities
Cash 5000 Af = Irfan’s Capital 250000 Af
Building 100000 Af Account Payable 50000 Af
Machinery 150000 Af
Raw material 30000
Raw material 15000 Af
7. following expenses were paid for the month. Salaries 500Af, Tax 200Af, Carriage 100Af and
General Expenses 200Af
Assets Equities
Cash 4000 Af = Irfan’s Capital 249000 Af
Building 100000 Af Account Payable 100000 Af
Machinery 150000 Af
Raw material 30000 Af
Account receivable 15000 Af

8. Material used out of inventory was valued at 25000Af.

Assets Equities
Cash 4000 Af = Irfan’s Capital 224000 Af
Building 100000 Af Account Payable 50000 Af
Machinery 150000 Af
Raw material 5000
Raw material 15000 Af
 Summary of Illustration
Assets = Equities
No Cash Building Machinery Material Account/R Liabilities Capital
1 + 200000 Af + 200000 Af
2 - 100000 Af + 100000 Af + 200000 Af
3 100000 Af + 100000 Af + 150000 Af + 100000 Af + 200000 Af
- 50000 Af
4 + 50000 Af + 100000 Af + 150000 Af + 30000 Af + 100000 Af + 200000 Af
- 30000 Af
5 + 20000 Af + 100000 Af + 150000 Af + 30000 Af + 15000 Af + 100000 Af + 200000 Af
+ 35000 Af +50000 Af
6 + 55000 Af + 100000 Af + 150000 Af + 30000 Af + 15000 Af + 100000 Af + 250000 Af
- 50000 Af - 50000 Af
7 + 5000 Af + 100000 Af + 150000 Af + 30000 Af + 15000 Af + 50000 Af + 250000 Af
- 1000 Af - 1000 Af
8 + 4000 Af + 100000 Af + 150000 Af + 30000 Af + 15000 Af + 50000 Af 249000 Af
- 25000 Af - 25000 Af
Balance + 4000 Af + 100000 Af + 150000 Af + 5000 Af + 15000 Af + 50000 Af + 224000 Af

Total Assets = 274000 Af = Total Equities = 274000 Af

 Accounting Transactions
Record these transactions properly in accounting book.
1. Ali started a business by investing 30000 Af

2. Purchased supplies for cash 500 Af

3. Purchased furniture on account 1000 Af

4. Paid office rent 200 Af

5. Earned 2000 Af by performing service.

6. Paid salary to a part time workers 300 Af

7. Supplies used during the week 200 Af.