Financial accounting

1. Financial Accounting
Professor & Lawyer
Puttu Guru Prasad Mudaliyar
VVIT - NamburVVIT - Nambur

2. Financial Accounting
Accounting is commonly referred to as the “language of
the business” as it is effectively employed to
communicate the financial performance of business to
various interested parties or stakeholders. It is
concerned with the measurement and communicating
financial data.
Meaning: Accounting is an information system, is the
process of identifying, measuring and communicating
the economic information of an organisation to its
users who need the information for decision making.

3. Definition of Accounting:
Accounting has been defined as “the art of recording,
classifying, and 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”.(AICPA)
According to American Accounting Association
“accounting is the process of identifying, measuring and
communicating information to permit judgement and
decisions by the users of accounts”.

4. Objectives of Accounting
The basic objectives of accounting are to provide financial information to the
managers, owners and the stakeholders i.e. the parties who are interested in an
organisation. To attain such objectives various financial statements are prepared.
The users of financial statements may be broadly classified in the following
groups –
(a) The investor: This group includes both existing and potential owners of
shares in companies. They are broadly interested in the performance of the entity
and the dividend declared by such entity. They also measure the social and
economic policies of the company to decide whether they will remain associated
with such entity.
(b) The lender: This group includes both secured and unsecured lenders. Such
creditors may be financing long term or short term loans. The financial
statements are analysed to determine an organisation’s ability as to
(i) Pay the interest on due date,
(ii) The growth and stability of the organisation,
(iii) Capability of repaying the loan as agreed upon, and.
(iv) The book value of assets offered as security by the organisation.

5. (c) The customers and suppliers – While customers are interested in the
ability of the organisation to provide goods/services, the suppliers are
interested in the capability of the organisation to pay their dues as and when
due.
(d) The government – This group includes various taxation authorities viz.
Income tax, Excise department, Sales tax department etc. and also various
other government authorities for statistical purposes and for framing various
economic and planning policies.
(e) The employee group – The employees are concerned with the capability
of an organisation to pay their present emoluments and future retirement
benefits. Moreover, financial statements help them to asses job security.
(f) The analyst – Advisors to the management, investors, employees or
public at large collect various data from financial statements to advise their
clients.
(g) The Management – Financial statements provide required information to
different levels of management to assist them in making decisions at each
appropriate level.

6. Users of Accounting Information :
Accounting information helps users to make better financial
decisions. Users of financial information may be both internal and
external to the organization.
Internal users (Primary Users) of accounting information include
the following:

Management: for analysing the organization's performance and
position and taking appropriate measures to improve the company
results.

Employees: for assessing company's profitability and its
consequence on their future remuneration and job security.

Owners: for analysing the viability and profitability of their
investment and determining any future course of action.
Accounting information is presented to internal users usually in the
form of management accounts, budgets, forecasts and financial
statements.

7. External users (Secondary Users) of accounting information include the following:
Creditors, banks, financial institutions, debenture holders: for evaluating the risk
of lending money to a particular business organisation on the basis of accounting
information.
Government, Tax Authorities: for determining the credibility of the tax returns
filed on behalf of the company.
Investors: for analysing the feasibility of investing in the company. Investors want
to make sure they can earn a reasonable return on their investment before they
commit any financial resources to the company.
Customers: for assessing the financial position of its suppliers which is necessary
for them to maintain a stable source of supply in the long term.
Workers: for negotiating the payment of bonus and wages is correct or not on the
size of profit earned.
Researchers: for studying the efficiency of an organisation and find reasons for
profit or losses.
External users are communicated accounting information usually in the form of
financial statements. The purpose of financial statements is to cater for the needs of
such diverse users of accounting information in order to assist them in making sound
financial decisions.

8. Accounting Cycle:
•
-- Identify business events, analyse these transactions, and record
them as journal entries
•
-- Post journal entries to applicable T-accounts or ledger accounts
•
-- Prepare an unadjusted trial balance from the general ledger

9. • -- Analyse the trial balance and make end of period adjusting
entries
• -- Post adjusting journal entries and prepare the adjusted trial
balance
• -- Use the adjusted trial balance to prepare financial statements
• -- Close all temporary income statement accounts with closing
entries
• -- Prepare the post-closing trial balance for the next accounting
period.

10. GAAP (Generally Accepted Accounting Principles):
Accounting principles are the guidelines which provide a procedure to be
followed in the process of accounting. But it is very difficult to have principles
which are universally acceptable.so we have a set of principles which are general
accepted by the makers of financial statements. These principles are called as
“Generally Accepted Accounting Principles” (GAAP).
Accounting principles can be broadly divided into two categories
A. Accounting Concepts B. Accounting Conventions
1. Business Entity Concept 1. Full disclosure
2. Money Measurement Concept 2. Materiality
3. Cost Concept 3. Consistency
4. Going Concern Concept 4. Conservation
5. Dual-aspect Concept
6. Realisation Concept
7. Matching Concept
8. Accounting Period Concept
9. Objective Evident Concept

11. 1. Business Entity Concept: business is treated separated from the
proprietor. All the transactions are recorded in the books of business and
not in the books of the proprietor. The proprietor is also treated as a
creditor of business. When he contributes capital, he is treated as person
who has invested his amount in the business.
2. Money Measurement Concept: only those transactions are recorded in
accounting which can be expressed in terms of money. Therefore, in the
process of accounting only events which can be expressed and measured
in terms of money are recorded.
3. Cost Concept: according to this, an asset is recorded its cost in the
books of account i.e., the price which is paid at the time of acquiring it.
The market value or any other value of an asset is not considered. It is
therefore called as “historical cost concept”.
4. Going Concern Concept: it is assume that a business organisation will
continue to operate for a considerably long period of time. This
assumption is very important because sometimes money is spent by the
business for a future benefit.

12. 5. Dual-aspect Concept: dual mean two. It implies that every transaction will
have two aspects. These aspects are giving and receiving.
6. Realisation Concept: Every business unit spends money to purchase goods or
to manufacture goods for sale. Profit cannot be made only by manufacture sales of
goods either for cash or on credit is essential to make earning. Without realisation
of sales proceeds, there can be no profit. Unearned/unrealised revenue should not
be taken into account.
7. Matching Concept: this concept tries to match the revenue and expenditure of
an organisation pertaining to a particular period of time i.e., is one year. This will
help the users of accounting to understand the functioning of the business in a
clear manner.
8. Accounting Period Concept: business organisations are believed to have
continued existence. But the performance of the organisation should be assessed
regularly over a period of time. Normally one year is taken to assess the financial
performance of the business.
9. Objective Evident Concept: This concept relates with the verification of
accounting record with the outside evidence. Outside evidence means study of
those documents and vouchers on the basis of which accounting record has been
made.

13. Accounting conventions:-
Conventions of full disclosure: According to this convention, all
accounting statements should be honestly prepared to that and full
disclosure of all significant information to be made.
Convention of materiality: According to this convention,
accounting should consist of all the material facts. Material facts
are one those which can have an impact on the financial statements
of the organisations. Immaterial and irrelevant items should be
excluded or merged with other items.
Convention of consistency: Accounting rules, practices and
conventions should be continuously observed and applied i.e. these
should not change from one year to another.
Convention of conservation: According to this convention all
incomes or profits if anticipated should not be taken into account.
But any anticipated losses should be considered while preparing the
accounts of a business.

14. Double entry book keeping: -
This system of accounting was invented by ‘Lucas paciolio’
of Italy in 1494 in Venice but developed in England. The
object of book keeping is to keep a complete record of all
transactions that take place in business. The double entry
book keeping refers to a system of accounting in which
every transaction effects at least two accounts. In double
entry book-keeping, the amount of every transaction is
written twice, once as debit and again as credit, leading to
the conclusion that that in mathematical terms the sum of all
accounts will be zero and in terms of accounting equation,
the sum total of all assets must be equal to sum total of all
liabilities and the owners equity. This equity holds true up
to the last stage of accounting process, ending with the
preparation of the balance sheet.

15. Every business transaction having two aspects, one will be treated as
debit and other will be treated as credit. This debit and credit will be
decided on the basis of nature of aspect. Each aspect comes under
personal, real or nominal accounts.
Every business organisation deals with people, assets, pays expenses and
receives incomes. Therefore, it is necessary to keep the following
accounts in order to keep a complete record of all the transactions.
1.Personal accounts (PA)
2. Real accounts (RA)
3. Nominal accounts(NA)
Transaction
Aspect 1
Dr
Aspect 2
Cr

16. Characteristics of Double entry system:
1.Every business transaction affects two or more accounts
2.Every account is divided in two parts
3.Division of amount column as debit and credit
4.Dual aspect of every transaction
5.Based upon accounting concepts and conventions
6.Preparing trial balance
7.Preparation final accounts

17. Advantages of double entry system:
1.Scientific system: It is scientific system compared to single
entry system.
2.Full information
3. Assessment of profit and loss
4. Knowledge of creditors
5.Arithmetical accuracy
6.Assessment of financial position
7.Comparison of results
8.Maintenance according to incoming tax rules
9.Detection of frauds

18. Limitations:
1.Errors of omission: in case the entire transaction is not recorded in the
books of accounting.
2.Errors of principle: Debiting Ram’s a/c instead of Rao’s a/c
3.Compensating errors: If rahim’s a/c is by mistake debited with Rs. 15/-
lesser and mohan’s a/c is also by mistake credited with Rs 15/- lesser.
Single entry book keeping:
It is a crude and unscientific method of maintaining accounts. Under
this system all the transactions are not recorded. Similarly all the account
books are not maintained. Sometimes two aspects of a transaction are
recorded and are not recorded completely. Under this system it is
incomplete and unsystematic. So, it is not reliable. It is not possible to
prepare proper trial balance and it is difficult to prepare the correct P&L
a/c to know the profit or loss.

19. Definition
According to Kohler, “Single entry system is a
system of bookkeeping in which as the rules, only records of
cash and personal accounts are maintained. It is always an
incomplete double entry varying with circumstances.”
Explanation
•Single entry system is a system of art of bookkeeping. All
business transactions are recorded in the books of accounts.
• In single entry system, only cash and personal accounts are
maintained and real and nominal accounts are not
maintained.
This system is a n incomplete double entry system which is
variable in nature.

20. Feathers of single entry system
1) It is applicable for sole proprietor and partnership
Single entry system is unscientific system and incomplete double entry system.
It cannot be applied to corporate sectors. It is applicable to small level business
which has small level of transactions comparing to corporate sectors.
2) Cash and Personal Accounts
Under single entry system, all transactions are recorded and grouped under two
accounts only. They are named as personal accounts and cash accounts. Real
account and nominal accounts are not existed in this system but they are existed
in double entry system. Only the cash transactions and the credit transactions
which are dealing with persons are recorded in this system.
3) Transactions are not recorded completely
Under single entry system, transactions are recorded in diaries, similar notes as
single line. As they are keeping these style of bookkeeping, some transactions
can be omitted and missed because insufficient method of recording.

21. 4) No Uniformity
As like double entry system, Single entry system records all
transactions in the books of accounts but it does not follow
uniformity in recording and classifying the transactions. No proper
Journal or subsidiary books are kept and no ledger accounts are
maintained separately for every class of accounts.
5) Dependent on source document
The transactions recorded in the books of accounts in single entry
system are not accurate and reliable. No proper books of accounts
are maintained. To check the reliability of transactions recorded in
the books of accounts, source documents of such transactions are to
be verified. The recorded data in books of accounts cannot be relied
for accuracy of transactions.

22. Limitations of Single Entry System
1) Incomplete Records
Transactions are not recorded in dual aspect concept. There is no
equal amount of credit to every debit. Debit and Credit are not
existed in the system. The recording of transactions in this system
is incomplete, no equal debit to equal credit.
2) Financial position is not ascertained
Statement of Affairs is prepared to find out the closing balance
of capital in the final accounts of single entry system. The
balancing figure obtained by comparing the all liabilities except
capital with all assets of a business is treated as closing capital of
the business. Financial position is not revealed accurately in this
statement of affairs. Under double entry system, Balance sheet is
prepared in the final accounts. Balance sheet tallies all assets with
all liabilities exactly. The exact financial position can be
ascertained.

23. 3) Performance of business is not found
Under single entry system, statement of profit or loss is prepared to know
the profit or loss of a business. In statement of profit, the profits are
derived as a balancing figure resulted by subtracting the opening capital
from the closing capital and the drawings are added with and additional
capitals are subtracted from closing capital. The profit is estimation but it
is not exact result of the business. Under double entry system, Trading
and profit and loss account is prepared. All accrued incomes are matched
with the accrued expenses and the result is treated as profit or loss of the
business. The profit is ascertained more exactly.
4) No accuracy of accounts
Trial Balance cannot be prepared in single entry system as it is not
following dual aspect concept. No debit and credit is treated in this
accounts. So all debit accounts cannot be matched with all credit accounts
while preparing Trial Balance. The accuracy of accounts cannot be found
because trial balance is not prepared.

24. 5) No comparison between two accounting periods
Transactions recorded in single entry system is inaccurate so it cannot be
compared the transactions recorded between two accounting periods. All
transactions are not recorded genuinely so it is not acceptable to compare the
transactions between two accounting periods.
6) Unacceptable by tax authorities
One cannot file his return of accounts by following single entry system to the
tax authorities. It is a unscientific method of bookkeeping so it is not
acceptable by tax authorizes.
7) Insufficient to detect frauds
If any frauds are committed in the books of accounts, it cannot be found. An
incomplete record of account does not provide a platform to detect the frauds
in the books of accounts. It is unscientific, inaccurate so it is no possible to
find the frauds by following some systematic rules or practices.

25. Book keeping and accounting:
Book keeping usually involves only the recording of economic
events and is therefore, just one part of accounting process.
Accounting involves the entire accounting process i.e.
identification, measurement, recording analysis and
communication of financial information.
Now-a-days much of the book-keeping function is performed by
computers.

26. Rules for debiting and crediting:-
The rules of debit and credit depend on the nature of an account. If aspect
related to persons, personal account rules, if assets real account rule and if
expenses or incomes nominal account rules are applicable.
Personal accounts: Personal accounts deal with persons. These include
natural persons such as Rama Rao, Latha etc., artificial persons or legal
persons such as Tata Company Ltd, Andhra Bank etc and representative
personal accounts.
Rule: Debit ((Dr)  The receiver
Credit (Cr) the giver
E.g.:1. Cash received from Raju is Rs 5000/- . Here Raju is personal
a/c and he is Cr (giver).
2. Goods sold to Chandra is Rs 7000/- . Here Chandra is personal a/c
and he is Dr (receiver).

27. Real accounts: Real a/c deals with assets. These include tangible assets
like land, buildings, machinery etc which can be seen touched and
intangible assets like goodwill, trademarks etc which cannot be seen but
can be measured.
Rule: Dr what comes in?
Cr what goes out?
E.g. goods purchased for cash RS 8000/-. Here goods and cash are real
a/c. Goods is Dr(coming) while cash is Cr(going).
Nominal accounts: Nominal accounts are deals with expenses like rent,
wages, salary, transport etc and incomes like discount received, rent
received, commissions received etc.
Rule: Dr the expenses and losses
Cr the incomes and gains
E.g. 1. Salary paid by cash Rs 5000/- . Salary is nominal a/c and is Dr
(expenditure)
2. Interest received Rs 5000/- .interest is nominal a/c and is Dr
(income)

28. Journal: The term journal means a daily record of events or transactions.
Every transaction relating to a business is recorded in chronological order
as every transaction is first recorded in a journal. It is also called as a
book of original entry or first entry or prime entry.
The process of entering the transactions in a journal is called
as “JOURNALISING”. So transactions which are recorded in a journal
are called as a “JOURNAL ENTRY”.
Pro-forma of Journal
Advantages of journal:
1.It shows all necessary information about transaction
2.It provides an explanation of the transaction.
3.It provides a data wise record of all the transactions.
4.It helps to locate and prevent errors.
Date particulars L
F
Debit credit

29. Ledger:
Journal is the record of all the transactions that take place in organization, in a
chronological order. But, Ledger is the book which contains various accounts.
In other words ledger is a set of accounts. It contains all the accounts of business
whether real, nominal and personal thus, “a Ledger account may be defined as a
summary statement of all the transactions relating to a person, asset, expense or
income which have taken place during given period of time and shows their net
effect”.
Advantages or Features:-
It provides complete information about all accounts in one book.
It is permanent record of business transactions.
It enables to ascertain what are the main items of revenue & Expenses
It enables to ascertain what are the assets and amount & what are the liabilities
and amount.
It facilitates the preparation of final accounts.

30. Pro-forma of Ledger
Name of the Account
Date Particulars JF Amount Date Particulars JF Amount
1
2
3
4
Journal Ledger
It is a book of origin
entry.
It is a book of final entry.
Transactions recorded in
chronological order.
Transactions recorded in
particular order.
It is a subsidiary Book. It is a principal book.
The process of recording
financial transaction in
the journal is called
Journaling.
The process of recording
transaction in the ledger
is called posting.
Difference between Journal & Ledger

31. Trial Balance:-
After posting the journal entries into the respective
ledger accounts and balancing them, the next step is preparation of
“trial balance”. It is a statement prepared, after completion of
ledger accounts to check the arithmetical accuracy of the books of
accounting.
According to double entry system every
transaction should have debit and credit effect therefore the total of
debit balances of all the accounts should equal to credit balances.

32. Pro-forma of Trial Balance
Trial Balance of……As on……
Name of the account Debit(Rs) Credit(Rs)
Capital A/c Xxx
Drawings A/c Xxx
Asset A/c Xxx
Liabilities A/c Xxx
Purchases A/c Xxx
Purchase returns A/c Xxx
Sales A/c Xxx
Sales returns A/c Xxx
Reserves and provisions A/c Xxx
Exp & Losses A/c Xxx
Outstanding Exp xxx
Incomes & gains A/c Xxx
Prepaid Expenses A/c (Un expired expenses) Xxx
Income Receivable A/c (Accrued Income A/c) Xxx
Income Received in advance Xxx

33. Subsidiary books:-
Journal is called as the book of first entry, where all transaction
recorded before in the respective ledger. But in a big organization one
journal and one ledger for each transaction and may not be easy to
prepare and update. Therefore, in order to overcome this difficulty, a
journal is sub divided into different books.
These books are called as “subsidiary books”
The following are the various subsidiary books being maintained by
organization.
Purchase book: this book is records all credit purchases only. Purchase
of goods for cash and purchase of assets for cash or credit will not be
recorded in this book. Purchase book is otherwise called purchases day
book, purchases journal or purchases register.
Purchase returns book: this book is used to record the particulars of
goods returned to the suppliers. This book is otherwise called returns
outward book.

34.  Sales book: this book is records all credit sales only. Goods are
sold for cash and sale of assets for cash or credit will not be
recorded in this book. This book is otherwise called sales day
book, sales journal or sales register.
 Sales returns book: this book is used to record the particulars of
goods returned by the customers. This book is otherwise called
returns inward book.
 Cash book: all cash transactions, receipts and payments are
recorded in this book. Cash includes cheques, money orders etc.
Types of cash book
Simple column cash book
Two column cash book
Three column cash book
Petty cash book

35.  Simple or single column cash book: this simple cash book
is record of only cash transactions.
 Two column cash book: two column cash book is one
which consists of two separate columns on the debit side
as well as credit side for recording cash and discount.
 Three column cash book: treble column cash book is one
in which there are three columns on each side - debit and
credit side. One is used to record cash transactions, the
second is used to record bank transactions and third is
used to record discount received and paid.

36.  Petty cash book: In almost all businesses, it is found
necessary to keep small sums of ready money with the
cashier or petty cashier for the purpose of meeting
small expenses such as postage, telegrams, stationary and
office sundries etc. The sum of money so kept in hand
generally termed as petty cash and book in which the petty
cash expenditures are recorded is termed as petty cash book.
Bills receivable book: this book is used to record all the
bills and promissory notes are received from the customers.
Bills Payable book: this book is used to record all the bills
and promissory notes accepted to the suppliers.
Journal Proper: The transaction which are not recorded in
the above seven books is recorded in this book.

37. Pro-forma of purchase book
Pro-forma of purchase returns book
Pro-forma of sales book
Pro-forma of sales returns book
Date Particulars LF Inward invoice no Amount (Rs)
Date Particulars LF Debit note no Amount (Rs)
Date Particulars LF Outward invoice no Amount (Rs)
Date Particulars LF Credit note no Amount (Rs)

38. Pro-forma of simple cash book
Pro-forma of Two Column cash book
Pro-forma of Three column cash book
Date Particulars Amount Date Particulars Amount
Date Particulars Discount Amount Date Particulars Discount Amount
Date Particulars LF Disc. Cash Bank Date Particulars LF Disc. Cash Bank

39. Pro-forma of petty cash book
Pro-forma of Bills Receivable book
Pro-forma of Bills Payable book
Receipts Date Particulars Total Conveyance Cartage Stationary Postage
S
n
o
Date
received
From
whom
received
Drawer Accepter Where
payable
Date
of bill
term Due
date
F Amount Remark
S.
no
Date
given
To whom
given
Name of
payee
Where
payable
Date
of bill
Term due
date
LF Amount Remarks

40. Final Accounts:
Final accounts are prepared by an organization at end of the
financial years to know the operational efficiency and
financial position of the business. Financial account for a
trading firm refers to
Trading and profit loss A/c.
Balance sheet.
Trading Account:
This account is prepared to ascertain the profit or loss
earned by the business from buying and selling of goods
manufactured during a particular period of time. Normally
the period is financial year. The profit earned in this account
is called “GROSS PROFIT” and the profit or loss earned
from this account is transferred to profit or loss A/c.

41. Pro-forma or Trading A/c
Trading A/c of……for the year ended…….
particulars Amount
(Rs)
Amount
(Rs)
particulars Amount
(Rs)
Amount
(Rs)
To opening stock Xxx By sales
Loss: Sales returns
xxx
xxxTo purchases
Less: purchase returns
xxx
xxx
xx
xx
To carriage inwards xxx By closing stock xxx
To fuel and power xxx By gross loss c/d xxx
To manufacturing exp xxx
To coal, water and gas xxx
To motive power xxx
To octroi xxx
To import duty xxx
To custom duty xxx
To consumable stores xxx
To salary to foreman/
works manager
xxx
To royally on mfg goods xxx
To gross profit c/d xxx
XXX XXX

42. Profit & Loss A/C:
It is an account meant for showing net financial result of the
business i.e., Net profit or Net loss.
The profit or loss is arrived at by carrying forward gross profit or gross loss
from trading account credit or debit side respectively.
Apart from this all expenses, other than showing in trading account
and debited to profit or loss A/c. these expenses could be all office and
administration and selling or distribution etc. any income is credited to this
account like commissions received, rent received, dividends received,
discount received etc.
If the total of the credit side is greater than debit side, the difference is net
profit. This is written on debit side as “TO NET PROFIT transferred to
capital account”
If the total of debit side greater than credit side, the difference is net loss.
This is shown on credit side as “BY NET LOSS transferred to capital
account”.

43. Pro-forma of Profit & Loss A/c

44. Balance sheet:
After preparing the trading account and profit and loss A/c. a
business organization prepares a statement called “BALANCE
SHEET” By the preparation of this statement, the financial
position of the business can be derived.
This statement called balance sheet is in a tabular
form. The left side is called LIABILITIES and the right side is
called ASSETS. It is known fact that the assets of a business
should be equal to the sum of capital and liabilities
Capital + liabilities=Assets.
Thus the liabilities side and assets side of the balance sheet
tally i.e., the total of liabilities should be equal to the assets.

45. Pro-forma of Balance sheet

46. Prepared by
Puttu Guru Prasad MudaliyarPuttu Guru Prasad Mudaliyar