FINANCIAL

ACCOUNTING
 Accounting
• The art of
• Recording
• Classifying
• Summarizing

in a significant manner and in terms of money transactions and events

which are, in part at least, of financial character, and interpreting the
results thereof.

•
The Accounting Process
 Importance of Accounting

is a
Accounting
Accounting Identifies
Identifies
system that

Records
Records

information
Relevant
Relevant Communicates
Communicates
that is

Reliable
Reliable
about
aboutan
an
organization’s
organization’s
Comparable
Comparable business
businessactivities.
activities.
1-4
 Use fullness of Accounting
• Tool for Measuring and comparing of
performance.
• To handle your own finances.
• Helps in creation of Budgets.
• Felicitate decision making process.
• It helps in Investment decision.
 Users of Accounting Information

External Users Internal Users

•Lenders •Consumer Groups •Managers •Sales Staff

•Shareholders •External Auditors •Officers •Budget Officers
•Governments •Customers •Internal Auditors •Controllers
 Financial and Management
Accounting
• The major distinction between financial
and management accounting is the users
of the information.
– Financial accounting serves external users.
– Management accounting serves internal
users, such as top executives, management,
and administrators
within organizations.
 Objectives of book keeping
• To keep systematic record
• To ascertain the results of operation
• To ascertain the financial position of the
business
• To portray the liquidity position
• To facilitate rational decision making
• To satisfy the requirements of law
 Functions of accounting
• Record keeping function

• Managerial function

• Legal requirement function

• Language of business
 Branches of Accounting

• Financial Accounting

• Management Accounting
 Financial accounting

• It is mainly confined to preparation of

financial statements for the use of
outsiders like shareholders, debenture
holders, creditors, banks and financial
institutions.
 Management accounting
• It is accounting for management

• It provides information to the management

for discharging its functions.
•
It assist management in the formation of
policies and in the planning and control of
operations of the undertaking
 MEANING OF AN ACCOUNTING EQUATION

• An Accounting Equation is a mathematical

expression which shows that the assets
and liabilities of a firm are equal.
• An Accounting Equation is based on the
dual aspect concept of accounting i.e.,
every transaction has two aspects-debit
and credit.
• It holds that for every debit there is a credit
of equal amount and vice versa.
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 The Accounting Equation

Assets = Liabilities + Owner’s Equity

Assets – Liabilities = Owner’s Equity

 The Accounting Equation

• The equation must be in balance.

• If there is an increase to the left side the

right side must increase as well.

• Or an increase to the left side could cause

a decrease in another account on the left
side.
MEANING OF AN ACCOUNTING EQUATION

Transactions from the Accounting

Equation viewpoint, can be
divided into two, i.e.,

1. Transactions Affecting Two

Items and

2. Transactions Affecting More

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Than Two Items.
 Transactions Affecting Two Items

Transactions affecting opposite sides are:

(i) Increase in Asset, Increase in Liability: Transaction such

as credit purchases increase asset (stock) and also
increase liability (creditor). Similarly, loans from bank
increase asset (cash) and also increase liability (loan).

(ii) Decrease in Liability, Decrease in Asset: Transaction of

payment to a creditor decreases liability (creditor) and also
reduces asset (cash or bank).
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 Transactions Affecting Two Items

(iii) Increase in Asset, Increase in Owner's

Equity: Introduction of capital by the
proprietor increases asset (cash or bank)
and also liability (capital).
(iv) Decrease in Owner's Capital, Decrease
in Asset: Drawings by the proprietor
decreases liability (capital) and also asset
(cash or bank). 18
 Transactions Affecting Two Items
Transactions affecting same side but in opposite
direction are:
(i) Increase in Asset, Decrease in Another Asset:
Transactions such as cash purchases or receipt
from debtors increase one asset (goods and cash or
bank, respectively) and decrease another asset
(cash or bank and debtors).
(ii) Decrease in Liability, Increase in Another Liability:
Settlement of creditor by issue of Bill of Exchange
decreases a liability (creditor) and increases another
liability (Bill of Exchange).

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 Transactions Affecting More Than Two Items

• Some transactions affect more than two items of

the accounting equation or a Balance Sheet.
• For example, when a sale is made in cash for Rs.
30,000, it is made at cost (Rs. 25,000) plus profit
(Rs. 5,000).
• Cost of goods (Rs. 25,000) reduces asset (stock
of goods), cash increases by Rs. 30,000 and the
owner's capital increases by the profit Rs. 5,000).
• It should be noted that profit increases the
owner's capital and loss decreases it.
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 Effect of Transactions on Accounting Equation

• The procedure to workout an Accounting

Equation is:
1. Analyse the transaction in terms of such
variables as assets, liabilities, capital. revenues
and expenses.
2. Decide the effect of the transactions in terms of
increase or decrease on variables mentioned in
1.
3. Record the effect on the relevant side of the
equation.
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 Effect of Transactions on Accounting Equation

• Suppose, Rakesh starts business and the following successive

transactions are entered into:
(1) He commences his business with Rs. 20,000 as Capital.

• Effect: It means that the firm has assets totalling Rs. 20,000 in the
form of cash and claims against the firm are also Rs. 20.000 in the
form of capital. The equation stands as follows:

Assets = Liabilities + Capital

Cash
Capital Introduced 20,000 = 0 + 20,000
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 (2) Purchases furniture for Rs. 500 in cash.
• Effect: It means cash in hand is reduced by Rs. 500 but
a new asset (furniture) of the same amount has been
purchased. Thus, total of assets remains unchanged.
The equation will now appear as follows:

Assets = Liabilities Capital

+
Cash + Furniture Rakesh's
Old Balance 20,000 + 0 = 0 + 20,000
New
- 500 + 500 = 0 + 0
Transaction
New Balance 19,500 + 500 = 0 + 20,000
 Effect of Transactions on Accounting Equation

• (3) Purchases goods for Rs. 1,000 in cash.

• Effect: It means cash in hand is reduced by Rs. 1,000
and another asset, i.e., stock has come into existence
but the total of assets remains unchanged. The equation
now will be as follows:
Assets = Liabilities Capital
+
Cash + Furniture + Stock Rakesh's

Old Balance 19,500 + 500 + 0 0+ 20,000

=
New -1,000 + 0 + 1,000 0+ 0
Transaction
=
New Balance 18,500 + 500 + 1,000 0+ 20,000
= 24
 Effect of Transactions on Accounting Equation

• (4) Purchases goods for Rs. 2,000 on credit.

• Effect: It means the stock has increased by Rs. 2,000
making the total assets Rs. 22,000. A liability of Rs.
2.000 to the supplier of the goods (creditor) has arisen.
The equation now will be as follows:

Assets = Liabilities +Capital

Cash + Furniture + Stock Creditor + Rakesh's
s
Old Balance 18,500 + 500 + 1,000 = 0 + 20,000
New 0+ 0 + 2,000 = 2,000 + 0
Transaction
New Balance 18,500 + 500 + 3,000 = 2,000 + 20,000
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 Effect of Transactions on Accounting Equation

• (5) Sold goods costing Rs. 2,500 on credit for Rs. 4,000.
• Effect: It means a debtor has come into existence to the extent of
Rs. 4,000. The stock will be reduced only by Rs. 2.500, being the
cost of goods sold. The net increase in assets. Rs. 1,500. i.e. Rs.
4,000 - Rs. 2,500 (profit) will be added to the capital. The position
now will be shown as
Assets = Liabilities + Capital

Cash + Furniture + Stock + Debtors = Creditors + Rakesh's

Old Balance 18,500 + 500 + 3000 + = 2,000 + 20000

New Transaction + 0 + -2500 + +4000 = 0 -

1500
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New Balance 18,500 + 500 + 500 + 4,000 = 2,000 +
21500
 Effect of Transactions on Accounting Equation

• (7) Rakesh withdraws Rs. 2,000 for personal use.

• Effect: Cash in hand is reduced by Rs. 2.000 and capital
will also reduced by the same amount. The new
Accounting Equation will be as follows:

Assets = Liabilitie + Capital

s
Cash + Furnitur + Stock + Debtor = Creditor + Rakesh’
e s s s
Old Balance 18,500 + 5,00 + 500 + 4,000 = 2,000 + 21500
New -2,000 + 0 + 0 + 0 = 0 - 2,000
Transaction
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New 16,500 + 500 + 500 + 4,000 = 2,000 + 19500
 Effect of Transactions on Accounting Equation

• It will be observed from above that the total of assets will

always be equal to the total of liabilities and the capital.
• The last equation stated above can also be presented in
the form of a statement i.e.
• Balance Sheet

Liabilities Rs. Assets Rs.

Creditors 2,000 Cash 16.500
Capital 21,500 Furniture 500
Less: Drawings 2,000 19,500 Stock 500
Debtors 4,000
21,500 21,500
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 Example
1. Assets of ABC LTD are Rs. 10,000 while
its Liabilities and Equity are Rs 5,000 each.

2. 2. ABC LTD purchases a machine costing

Rs. 1000 for cash.
3.
ABC ltd receives Rs. 500 cash from a debtor
DEF ltd. In respect of goods sold on credit.
4. ABC ltd receives Rs 2500 bank loan in
cash.
5. ABC ltd pays Rs. 500 cash to XYZ ltd for
the goods purchased on credit.
6. ABC ltd issues share capital for Rs. 2500
in cash
[Link] pay the dividend of Rs. 500 in cash
 Methods of Accounting
• Single entry:-

• Double entry
 Single entry
• It is incomplete system of recording
business transactions.
• The business organization maintains only
cash book and personal accounts of
debtors and creditors.
• So the complete recording of transactions
cannot be made and trail balance cannot
be prepared.
 Double entry
• It this system every business transaction
is having a two fold effect of benefits
giving and benefit receiving aspects.

• Double Entry is an accounting system that

records the effects of transactions and
other events in at least two accounts with
equal debits and credits.
 Steps involved in double entry
system
1. Preparation of journal

2. Preparation of ledger

3. Trial balance preparation

4. Preparation of final accounts

 Types of accounts
• Transactions relating to persons.
(PERSONAL ACCOUNT)

• Transactions relating to properties and

assets (REAL ACCOUNT)

• Transactions relating to incomes and

expenses.(NOMINAL ACCOUNT)
 GAAP

• Materiality concept
• Money measurement concept
• Cost concept
• Time period concept
• Conservatism concept
 GAAP

• Consistency concept
• Business entity concept
• Going concern concept
• Dual aspect concept/accounting equivalence
concept
• Accounting period concept/Time period
concept
• Realization concept
• Matching concept
Difference between US GAAP &
Indian GAAP

1. Underlying assumptions: Under Indian

GAAP, Financial statements are prepared
in accordance with the principle of
conservatism which basically means
"Anticipate no profits and provide for all
possible losses". Under US GAAP
conservatism is not considered.
Difference between US GAAP &
Indian GAAP
2. Format/ Presentation of financial
statements: Under Indian GAAP, financial
statements are prepared in accordance with
the presentation requirements of Schedule VI
to the Companies Act, 1956. On the other
hand , financial statements prepared as per
US GAAP are not required to be prepared
under any specific format as long as they
comply with the disclosure requirements of
US GAAP.
Difference between US GAAP &
Indian GAAP
3. Cash flow statement: Under Indian GAAP (AS 3) ,
inclusion of Cash Flow statement in financial statements
is mandatory only for companies whose share are listed
on recognized stock exchanges and Certain enterprises
whose turnover for the accounting period exceeds Rs.
50 crore. Thus , unlisted companies escape the burden
of providing cash flow statements as part of their
financial statements. On the other hand, US GAAP
(SFAS 95) mandates furnishing of cash flow statements
for 3 years - current year and 2 immediate preceding
years irrespective of whether the company is listed or not
.
Difference between US GAAP &
Indian GAAP
4. Depreciation: Under the Indian GAAP,
depreciation is provided based on rates
prescribed by the Companies Act, 1956.
US GAAP , depreciation has to be
provided over the estimated useful life of
the asset,
Difference between US GAAP &
Indian GAAP
5. Long term Debts: Under US GAAP , the current portion
of long term debt is classified as current liability, whereas
under the Indian GAAP, there is no such requirement
and hence the interest accrued on such long term debt in
not taken as current liability.

6. Consolidation of subsidiary accounts: Under the

Indian GAAP, consolidation of accounts of subsidiary
companies is not mandatory. Under US GAAP (SFAS
94),Consolidation of results of Subsidiary Companies is
mandatory.