Financial Accounting

Unit I Financial Accounting & Analysis
Unit I
Accounting
Accounting is the system a company uses to measure its financial performance by noting and
classifying all the transactions like sales, purchases, assets, and liabilities in a manner that
adheres to certain accepted standard formats. It helps to evaluate a Companys past performance,
present condition, and future prospects.
Definition
A more formal definition of accounting is 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 a financial character and interpreting the results thereof.
The Need for Accounting
Every organization needs to maintain good records to track how much money they have, where it
came from, and how they spend it. hese records are maintained by using an accounting system.
hese records are essential because they can answer such important !uestions as"
# Am I making or losing money from my business
# $ow much am I worth%
# &hould I put more money in my business or sell it and go into another business%
# $ow much is owed to me, and how much do I owe%
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K.Arjun Goud (Assistant Professor) Page 1
# $ow can I change the way I operate to make more profit
Even if you do not own or run a business, as an accountant you will be asked to provide the
valuable information needed to assist management in the decision making process. In addition,
these records are invaluable for filing your organizations ta' returns.
he modern method of accounting is based on the system created by an Italian monk Fra Luca
Pacioli. $e developed this system over ()) years ago. his great and scientific system was so
well designed that even modern accounting principles are based on it.
In the past, many businesses maintained their records manually in books * hence the term
+bookkeeping, came about. his method of keeping manual records was cumbersome, slow, and
prone to human errors of translation.
A faster, more organized, and easier method of maintaining books is using Computerized
Accounting -rograms. .ith the decrease in the price of computers and accounting programs, this
method of keeping books has become very popular.
What Accountants Do
.e have said that accounting consists of these functions"
# /ecording
# Classifying
# &ummarizing
# /eporting and evaluating the financial activities of a business
0efore any recording can take place, there must be something to record. In accounting, the
something consists of a transaction or event that has affected the business. Evidence of the
transaction is called a document.
1or e'ample"
# A sale is made, evidenced by a sales slip.
# A purchase is made, as evidenced by a check and other documents such as an invoice and a
purchase order.
# .ages are paid to employees with the checks and payroll records as support.
# Accountants do not record a conversation or an idea. hey must first have a document.
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Types of Accounting
he two methods of tracking your accounting records are"
# Cash 0ased Accounting
# Accrual 2ethod of Accounting
Cash Based Accounting:
2ost of us use the cash method to keep track of our personal financial activities. he cash
method recognizes revenue when payment is received, and recognizes e'penses when cash is
paid out. 1or e'ample, your personal checkbook record is based on the cash method. E'penses
are recorded when cash is paid out and revenue is recorded when cash or check deposits are
received.
Accrual Accounting:
he accrual method of accounting re!uires that revenue be recognized and assigned to the
accounting period in which it is earned. &imilarly, e'penses must be recognized and assigned to
the accounting period in which they are incurred.
A Company tracks the summary of the accounting activity in time intervals called
Accounting periods. hese periods are usually a month long. It is also common for a company to
create an annual statement of records. his annual period is also called a 1iscal or an Accounting
3ear.
he accrual method relies on the principle of matching revenues and e'penses. his
principle says that the e'penses for a period, which are the costs of doing business to earn
income, should be compared to the revenues for the period, which are the income earned as the
result of those e'penses. In other words, the e'penses for the period should accurately match up
with the costs of producing revenue for the period.
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In general, there are two types of ad4ustments that need to be made at the end of the
accounting period. he first type of ad4ustment arises when more e'pense or revenue has been
recorded than was actually incurred or earned during the accounting period.
An e'ample of this might be the pre5payment of a 65year insurance premium, say, for
76))). he actual insurance e'pense for the year would be only 78))). herefore, an ad4usting
entry at the end of the accounting period is necessary to show the correct amount of insurance
e'pense for that period.
&imilarly, there may be revenue that was received but not actually earned during the
accounting period. 1or e'ample, the business may have been paid for services that will not
actually be provided or earned until the ne't year. In this case, an ad4usting entry at the end of the
accounting period is made to defer, that is, to postpone, the recognition of revenue to the period
it is actually earned.
Although many companies use the accrual method of accounting, some small businesses
prefer the cash basis. he accrual method generates ta' obligations before the cash has been
collected. his benefits the 9overnment because the I/& gets its ta' money sooner.
Cash versus Accrual Accounting
Accounts /eceivable is an asset that is owed to you but you do not have money in the
bank or property to show you own something 5it is intangible, on paper. It grows or accumulates
as you issue invoices: therefore, Accounts /eceivable is part of an accrual accounting system.
;ouble5entry accounting is the most accurate and best way to keep your financial
records. .ith a computer, you dont have to fully understand all the accounting details. 0asically,
in double entry accounting each transaction affects two or more categories or accounts, so
everything stays in balance. herefore, if you change an asset balance by issuing an invoice some
other category balance changes as well. In this case, when you issue an invoice, the category that
balances the asset called Accounts /eceivable is an income or a sales account.
.hen you bill your client, there is an increase in income <on paper= and hence an
increase in Accounts /eceivable. .hen you are paid, the paper asset turns into money you put in
the bank * a tangible asset. hrough a process of recording the payment and the deposit,
Accounts /eceivable decreases and the bank balance increases. his accounting program takes
care of all the accounting details.
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his paper income can be confusing if you dont understand that it is the total of all
invoiced work, both paid and unpaid. If you have invoiced clients for a total of 78),))) but only
76,))) has been paid, your income will be 78),))) and your Accounts /eceivable balance will
be 7>,))), and your bank account has increased by the 76,))) you received. An accountant
would call this an accrual accounting method.
A cash accounting method only counts income when money is received, and it does not
keep track of Accounts /eceivable. $owever, in real life, small businesses tend to use both
methods without realizing the difference until income ta' time.
his program can handle both accrual and cash based accounting. 3ou can use the G/L
Setup option in the G/L module to select either Cash or Accrual based accounting. .e
recommended that you consult with your accountant to determine which system will work best
for you.
Classification of Accounting
In order to satisfy needs of different people interested in the accounting information,
different branches of accounting have developed.
Accounting is generally classified into three different disciplines as shown in 1igure.
inancial Accounting"
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Accounting involves recording, classifying and summarizing of past events and thus is
historical in nature. It is $istorical accounting which is better known as financial accounting
whose primary intention is to prepare the &tatements revealing the Income ? @oss and financial
position of the business on the basis of events, which have happened in the period being
reckoned.
0ut this information, though of immense vitality does not ade!uately aid the
management in planning, controlling, organizing and efficiently conducting the
course of the business as a result of which Cost Accounting and 2anagement
Accounting are in place.
Cost Accounting"
It shows classification and analysis of costs on the basis of functions, processes, products,
centers etc. It also deals with cost computation, cost saving, cost reduction, etc.
!anage"ent Accounting"
2anagement Accounting begins where 1inancial accounting and Cost Accounting ends.
It deals with the processing of data generated in financial accounting and cost accounting for
managerial decision5making. It also deals with application of managerial economics concepts for
decision5making.
The Accounting #$uation
Aow let us discuss the accounting e!uation, which keeps all the business accounts in
balance. .e will create this e!uation in steps to clarify your understanding of this concept. In
order to start a business, the owner usually has to put some money down to finance the business
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operations. &ince the owner provides this money, it is called %&ner's e$uity. In addition, this
money is an Asset for the company. his can be represented by the e!uation"
ASS#TS ( %WN#)'S #*+,T-
If the owner of the business were to close down this business, he would receive all its
assets. @ets say that owner decides to accept a loan from the bank. .hen the business decides to
accept the loan, their Assets would increase by the amount of the loan. In addition, this loan is
also a @iability for the company. his can be represented by the e!uation"
Assets ( Lia.ilities / %&ner's #$uity
Aow the Assets of the company consist of the money invested by the owner, <i.e. %&ner's
#$uity01 and the loan taken from the bank, <i.e. a Lia.ility0. he companys liabilities are placed
before the owners e!uity because creditors have first claim on assets.
If the business were to close down, after the liabilities are paid off, anything left over <assets=
would belong to the owner
Accounting 2rinciple
!eaning of Accounting 2rinciples
Accounting principles refer to the rules and actions adopted by the accountants globally for
recording accounting transactions.
hese are classified into two categories"
1. Accounting concepts
2. Accounting conventions
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Accounting Concepts
Accounting concepts include the assumptions and conditions on which the science of accounting
is based. hese are also known as accounting standards. Important accounting concepts are"
8. &eparate entity concept
6. 9oing concern concept
B. 2oney measurement concept
C. Cost concept
(. ;ual aspect concept
D. Accounting period concept
E. /ealization concept
Business Entity Concept or Separate entity concept
he concept of business entity assumes that business has a distinct and separate entity
from its owners. It means that for the purposes of accounting, the business and its owners are to
be treated as two separate entities. Feeping this in view, when a person brings in some money as
capital into his business, in accounting records, it is treated as liability of the business to the
owner.
Going Concern Concept
he concept of going concern assumes that a business firm would continue to carry out
its operations indefinitely, i.e. for a fairly long period of time and would not be li!uidated in the
foreseeable future.
oney easurement Concept
he concept of money measurement states that only those transactions and happenings in
an organisation which can be e'pressed in terms of money such as sale of goods or payment of
e'penses or receipt of income, etc. are to be recorded in the book of accounts. All such
transactions or happenings which cannot be e'pressed in monetary terms,
1or e'ample, the appointment of a manager, capabilities of its human resources or creativity of
its research department
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Cost Concept
he cost concept re!uires that all assets are recorded in the book of accounts at their
purchase price, which includes cost of ac!uisition, transportation, installation and making the
asset ready to use
(
!ccounting Period Concept
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 e'actly is the position of its assets and liabilities at the end of that period. &uch
information is re!uired by different user at regular interval for various purposes, as no firm can
wait for long to know it financial results as various decisions are to be taken at regular intervals
on the basis of such information.
"ual !spect Concept
;ual aspect is the foundation or basic principle of accounting. It provides the very basis
for recording business transactions into the book of accounts. his concept states that every
transaction has a dual or two5fold effect and should therefore be recorded at two places.
#evenue #ecognition $#ealisation% Concept
he concept of revenue recognition requires that the revenue for a business transaction
should be included in the accounting records only when it is realized.
atching Concept
he process of ascertaining the amount of profit earned or the loss incurred during a
particular period involves deduction of related e'penses from the revenue earned during that
period. he matching concept emphasizes e'actly on this aspect.
It states that e'penses incurred in an accounting period should be matched with revenues
during that period.
&'(ectivity Concept
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he concept of ob4ectivity re!uires that accounting transaction should be recorded in an
ob4ective manner, free from the bias of accountants and others
his can be possible when each of the transaction is supported by verifiably documents or
vouchers. 1or e'ample, the transaction for the purchase of materials may be supported by the
cash receipt for the money paid
Accounting Conventions
Accounting conventions include the customs and traditions that assist the accountants in
preparing accounting statements. Important accounting conventions are"
8. Convention of conservatism
6. Convention of full disclosure
B. Convention of consistency
C. Convention of materiality
Conservatism Concept
he concept of conservatism <also called Gprudence= provides guidance for recording
transactions in the book of accounts and is based on the policy of playing safe
Full "isclosure Concept
he financial statement makes a full, fair and ade!uate disclosure of all information
which is relevant for taking financial decisions
he principle of full disclosure re!uires that all material and relevant facts concerning
financial performance of an enterprise must be fully and completely disclosed in the financial
statements and their accompanying footnotes
Consistency Concept
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he accounting information provided by the financial statements would be useful in
drawing conclusions regarding the working of an enterprise only when it allows comparisons
over a period of time as well as with the working of other enterprises.
ateriality Concept
he concept of materiality re!uires that accounting should focus on material facts
In certain cases, when the amount involved is very small, strict adherence to accounting
principles is not re!uired. 1or e'ample, stock of erasers, pencils, scales, etc. are not shown as
assets, whatever amount of stationery is bought in an accounting period is treated as the e'pense
of that period, whether consumed or not.
Accounting process
he se!uence of activities beginning with the occurrence of a transaction is known as the
accounting cycle. his process is shown in the following diagram"
Steps in the Accounting 2rocess
,dentify the Transaction
Identify the event as a transaction
and generate the source document.
Analy3e the Transaction
;etermine the transaction amount,
which accounts are affected,
and in which direction.
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4ournal #ntries
he transaction is recorded in
the 4ournal as a debit and a credit.
2ost to Ledger
he 4ournal entries are transferred
to the appropriate 5accounts
in the ledger.
Trial Balance
A trial balance is calculated
to verify that the sum of the debits
is e!ual to the sum of the credits.
Ad5usting #ntries
Ad4usting entries are made for
accrued and deferred items.
he entries are 4ournalized and
posted to the 5accounts
in the ledger.
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Ad5usted
Trial Balance
A new trial balance is calculated
after making the ad4usting entries.
inancial State"ents
he financial statements
are prepared.
Closing #ntries
ransfer the balances of the
temporary accounts
<e.g. revenues and e'penses=
to ownerHs e!uity.
After6Closing
Trial Balance
A final trial balance is
calculated after the closing
entries are made.
he above diagram shows the financial statements as being prepared after the ad4usting
entries and ad4usted trial balance. he financial statements also can be prepared before the
ad4usting entries with the help of a worksheet that calculates the impact of the ad4usting entries
before they actually are posted.
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he above stages are repeated in accounting process, as previous years closing balances
are taken as opening balances for current year. As this process is repeated, this is also called as
accounting cycle. his can be represented in the following way
The Accounting Cycle
he following stages are in accounting cycle"
8= All the business transactions are systematically entered in 4ournal by way of 4ournal
entries
6= 1rom the 4ournal, they are recorded in various accounts in the book called ledger
B= .ith the help of the balances in various accounts, trial balance is prepared to know the
arithmetical accuracy
C= 1inally, preparing final accounts with the help of the balance. rading I -rofit I @oss
Account is prepared to ascertain the profit or loss made during a particular period,
balance sheet is prepared to know the e'act financial position
Syste"s of Boo768eeping
wo types of systems of book5keeping are"
8. Single entry syste"" It is used to record only cash and personal accounts.
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6. Dou.le entry syste"" It is used to record each transaction under two different accounts.
It is more reliable and efficient than the single entry system.
Difference .et&een Dou.le #ntry and Single #ntry Syste"s
eatures Dou.le #ntry Syste" Single #ntry Syste"
/ecording of transactions
;ual aspect is followed for all
transactions
;ual aspects is not followed
for all transactions
2aintenance of books
&ubsidiary books such as cash,
sales, purchases are
maintained
Jnly cash book is maintained
2aintenance of books of
accounts
All real, personal, nominal
accounts are maintained
Jnly personal account is
maintained
-reparation of trail balance I
final statements
rail balance I 1inal
statements can be accurately
maintained
rail balance cannot be
prepared I 1inal statements
does not provide accurate
results
D%+BL# ACC%+NT,NG S-ST#!
;ouble entry system of 0ook5keeping is simple and universal in its application. It has the
test of four hundred years continuous use. It may be claimed that it is the only system worthy of
adoption by the practical businessman. o understand the system of double entry system of book5
keeping all that we need to remember is the fundamental rule"
)"e'it * the account which receives the 'enefit+,
)Credit * the account which gives the 'enefit,
ypes of account
8= -ersonal Account
6= /eal Account
B= Aominal Account
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)+L#S %) D#B,T 9 C)#D,T+
8= 2ersonal Account" 5 his account deals with the individuals of the organization these includes
accounts of natural persons in varied capacities likes suppliers and buyers of goods, lenders and
borrowers of loans etc.
)"e'it * the receiver,
)Credit * the giver,
6= )eal Account" 5 his account deals with the group of individuals of the organization these
include combinations of the properties or assets are known as real account.
)"e'it * what comes in,
)Credit * what goes out,
B= No"inal Account" 5 Aominal accounts relate to such items which e'ist in name only. hese
items pertain to e'penses and gains like interest, rent, commission, discount, salary etc,
)"e'it * all e-penses and losses, )Credit *
all incomes and gains,
4ournal #ntries
A 4ournal entry is an entry into an accounting 4ournal. An accounting 4ournal records
accounting transactions as they occur. A 4ournal entry converts accounting transactions into the
language of accounting by using debits and credits.
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)e$uire"ents for 5ournal entries
All 4ournal entries should satisfy the following re!uirements"
<8= At least one entry on the debit side
<6= At least one entry on the credit side
<B= &um of debit side amounts K sum of credit side amounts
4ournals :2reparation of 4ournal #ntries0
he word HLournalH is derived from the 1rench word M4ourM meaning Ha dayH. Lournal,
therefore, means a Hdaily recordH. ransactions are first entered in a book called HLournalH to show
which accounts should be debited and which credited along with an e'planation of the entry
<called HnarrationH=. Lournal entry is any transaction that is recorded in the 4ournal. he process of
recording the transactions in the 4ournal is termed as 4ournalizing the entries.
All transactions are first recorded in the 4ournal as they occur in a chronological order. his is the
first step in the accounting process. he 4ournal is called H0ook of original entryH as all
transactions that occur are first recorded here.
he form of the 4ournal is given below"
4%+)NAL
;ate -articulars @.1 ;ebit amount
Credit
amount
Date is the date of the transaction
2articulars: $ere the names of the account involved are written. 1irst the account to be debited
is written and on the ne't line the account to be credited is written preceded by the word MoM.
hen in the ne't line the e'planation for the entry together with necessary details is given <called
HnarrationH=
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;L<; indicates M@edger 1olioM where in the page number in the ledger on which the account is
written up is recorded.
Preparation of (ournal entries.
All the accounting transactions must be first recorded in Lournal. he recording of
transactions in the 4ournal is called 4ournal entry. -reparation of 4ournal entries involves certain
steps that are e'plained below"
Analyze the transactions and identify the accounts that are affected by the transaction
Ascertain the nature of the accounts involved as real, personal or nominal.
;etermine the rule of debit or credit applicable to each of the accounts involved.
Ascertain the account to be debited and the account to be credited.
Aow, write the date of transaction in the H;ateH column
.rite the name of the account to be debited and the amount to be debited in debit amount
column against the name of the account.
.rite the name of the account to be credited in the ne't line preceded by the word MoM at
a few spaces towards the right in particular column, and the amount to be credited in the
credit amount column against the name of the account.
.rite narration <brief description of the transaction= within brackets in the ne't line in
particular column.
E-ample.
@et us consider the following transactions and prepare 4ournal entries in the format shown above.
i. -urchased goods on credit from 2r. N for 76)),))) on C Lan 6))O
ii. &old goods to 2r. 3 for cash 78)),))) on 86 Lan 6))O
iii. -urchased furniture for office purpose 7 6),))) on 6( Lan 6))O
iv. -aid 78)),))) to 2r. N in full settlement of his dues on B) Lan 6))O
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;ate -articulars @.1.
Ao
;ebit amount Credit amount
C Lan 6))O
-urchases Account
o 2r. N Account
<0eing purchase of goods on credit
from 2r. N=
6)),)))
6)),)))
86 Lan 6))O Cash Account
o &ales Account
<0eing sale of goods to 2r. 3 for
cash=
8)),)))
8)),)))
6( Lan 6))O 1urniture Account
o Cash Account
<0eing furniture purchased for cash=
6),)))
6),)))
B) Lan 6))O
2r. N Account
o Cash Account
<0eing paid 2r. N in full settlement
of his dues=
8)),)))
8)),)))
,llustration: ,
Lournalize the following transactions and prepare a cash ledger.
8. /am invests /s. 8), ))) in cash.
6. $e bought goods worth /s. 6))) from shyam.
B. $e bought a machine for /s. ())) from @akshman on account.
C. $e paid to @akshman /s. 6)))
(. $e sold goods for cash /s.B)))
D. $e sold goods to A on account /s. C)))
E. $e paid to &hyam /s. 8)))
>. $e received amount from A /s. 6)))
,llustration ,,
Lournalize the following transactions and post them into @edgers
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Lan 8. Commenced business with a capital of /s. 8))))
,, 6. 0ought 1urniture for cash /s. B)))
,, B. 0ought goods for cash from G0 /s. ())
,, C. &old goods for cash to A /s. 8)))
,, (. -urchased goods from C on credit /s.6)))
,, D. 9oods sold to ; on credit /s. 8())
,, >. 0ought machinery for /s. B))) paying Cash
,, 86. -aid trade e'penses /s. ()
,, 8>. -aid for Advertising to Apple Advertising @td. /s. 8)))
,, 8O. Cash deposited into bank /s. ())
,, 6). /eceived interest /s. ())
,, 6C. -aid insurance premium /s. 6))
,, B). -aid rent /s. ())
,, B). -aid salary to - /s.8)))
L#DG#)
@edger is the secondary .oo7 of accounts all business transactions are recorded in the
first instance in the 4ournal, but they must find their place ultimately in the accounts in the ledger
in a duly classified form. his ledger are also called final entry .oo7. J/ ransferring of all
4ournals in to accounts by using accounting principles is called ledger.
1ormat of ledger
,llustration
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By
By
By
By
By
,NT)%D+CT,%N T% ,NAL ACC%+NT
,NT)%D+CT,%N
All business transactions are first recorded in Lournal or &ubsidiary 0ooks. hey are
transferred to @edger and balanced it. he main ob4ect of keeping the books of accounts is to
ascertain the profit or loss of business and to assess the financial position of the business at the
end of the year. he ob4ect is better served if the businessman first satisfies himself that the
accounts written up during the year are correct or at least arithmetically accurate.
.hen the transactions are recorded under double entry system, there is a credit for every debit,
when on a?c is debited: another a?c is credited with e!ual amount. If a &tatement is prepared with
debit balances on one side and credit balances on the other side, the totals of the two sides will be
e!ual. &uch a &tatement is called rial 0alance.
Trail Balance
D#,N,T,%N
rial 0alance can be defined as +a list of all balances standing in the @edger Accounts
and Cash 0ook of a concern at any given time,.
Advantages:
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8. It is the shortest method of verifying the arithmetical accuracy of entries made in the @edger.
If the rial balances agree, it is an indication that the Accounts are correctly written up: but it is
not a conclusive proof.
6. It helps to prepare the rading A?c, -rofit I @oss a?c and 0alance &heet.
B. It presents to the businessman consolidated lists of all @edger 0alances.
Preparation.
here are two methods for preparing the rial 0alance
First ethod.
In this method, @edger Accounts are not balanced. hey are totaled. he debit side totals
and the credit side totals are entered in a separate sheet. he grand total of ;ebit Column will be
e!ual to the grand total of the Credit Column.
Second ethod.
his method is more widely used. In this method, ledger accounts are balanced. he
brought down balances are then brought to a sheet as given bellow.
or"at of the Trail .alance
2articulars De.it
a"ount
2articulars Credit
a"ount
Jpening stock === &ales ===
-urchases === Commission received ===
Carriage inwards === 0ad debts reserve ===
.ages === Interest received ===
All factory e'penses === Commission received ===
2anufacturing e'penses === Interest on drawing ===
1actory rent === ;iscount on creditors ===
Insurance === Capital ===
Jil, water, gas === 0ank loan ===
1uel, coal, power === 0ank over draft ===
E'ercise duty === Income received in advances ===
rade e'penses === Creditors ===
&alaries === 0ills payable ===
/ent I a'es === All other loans ===
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Advertising e'penses === Closing stock ===
0ad debts ===
Insurance ===
/epairs ===
;iscount allowed ===
Commission paid ===
-rinting I &tationary ===
Cash at bank ===
Cash in hand ===
All manufacturing e'penses ===
All depreciations ===
All fi'ed assets ===
All current assets ===
&elling e'penses ===
9eneral e'penses ===
====== ======

S+ND)- D#BT%)S
.hen a trader sells on credit basis, he 0uyers Account in the @edger is debited. 1or each
buyer, there is one @edger a?c. &ome of the buyer accounts may be automatically balanced. 0ut it
is !uite natural that many of these Customers Accounts have a debit balances. .hen we bring
these balances to the rial 0alance, if we are going to write all individual names of customers,
then the rial balance will be too lengthy. herefore, first a list of ;ebtors with their individual
debit balances are prepared and totaled. Instead of writing the individual names of ;ebtors, the
total is written under the heading +&undry ;ebtors, which appears in the rial 0alance.
S+ND)- C)#D,T%)S
here are a number of parties from whom the rader buys goods on credit basis. 1or each one of
them, an Account is opened in the @edger. As in the case of ;ebtors, a @ist of Creditors with the
balances due to them is prepared. In the rial 0alance, instead of writing the individual names of
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Creditors,, the total of the balances of the creditors is written under the heading +&undry
Creditors,
If the rial 0alance agrees, it is an indication that the accounts are correctly written up: but it is
not a conclusive proof. If the trial balance disagrees, then the difference amount is generally
placed in G&uspense Account
/llustration.
he balances e'tracted from the books of &ankar are given below. 1rom the prepare rial
0alance on B8st 2arch B))E.
&ankars Capital B),))), &undry Creditors C,))), &ales B),))), Cash in hand 8,>)), -urchases
6),))), Cash in 0ank D,))), Interest <;r= C)), 0ills /eceivables 88,))), &ales returns 8,))),
0ills -ayable E,))), -urchases /eturns >)), ;iscount earned >)), &undry ;ebtors 8(,))),
.ages E,))), Commission <;r= 8,))), /ent >)), -lant and 2achinery >,))), elephone charges
8,))), 2isc. Income C))
By
,NAL ACC%+NTS
&o far, we have discussed that how the business transactions are recorded in Lournal,
ledger, how to detect, rectify the errors and how to prepare trial 0alance. It is !uite natural that
the businessman is interested in knowing whether his business is running on -rofit or @oss and
also the true financial position of his business. he main aim of 0ookkeeping is to inform the
-roprietor, about the business progress and the financial position at the right time and in the right
way. -reparation of 1inal accounts is highly possible only after the preparation of rial 0alance.
inal Accounts
1inal accounts are done in three steps
By
8. rading A?c
6. -rofit and @oss A?c
B. 0alance sheet
8. rading and -rofit and @oss A?c is prepared to find out -rofit or @oss.
6. 0alance &heet is prepared to find out financial position a if concern.
rading and -I@ A?c and 0alance sheet are prepared at the end of the year or at end of the part.
&o it is called 1inal Account.
/evenue account of trading concern is divided into two5part i.e.
8. rading Account and
6. -rofit and @oss Account.
T)AD,NG ACC%+NT
rading refers buying and selling of goods. rading A?c shows the result of buying and
selling of goods. his account is prepared to find out the difference between the &elling prices
and Cost price. If the selling price e'ceeds the cost price, it will bring 9ross -rofit.
1or e'ample, if the cost price of /s. (),))) worth of goods are sold for /s. D),))) that
will bring in 9ross -rofit of /s. 8),))). If the cost price e'ceeds the selling price, the result will
be 9ross @oss.
1or e'ample, if the cost price /s. D),))) worth of goods are sold for /s. (),))) that will
result in 9ross @oss of /s.8), ))). hus the 9ross -rofit or 9ross @oss is indicated in rading
Account.
,te"s appearing in the De.it side of Trading Account<
8. Jpening &tock" &tock on hand at the commencement of the year or period is termed as the
Jpening &tock.
6. -urchases" It indicates total purchases both cash and credit made during the year.
B. -urchases /eturns or /eturns out words" -urchases /eturns must be subtracted from the total
purchases to get the net purchases. Aet purchases will be shown in the trading account.
By
C. ;irect E'penses on -urchases" &ome of the ;irect E'penses are.
I. .ages" It is also known as productive wages or 2anufacturing wages.
II. Carriage or Carriage Inwards"
III. Jctroi ;uty" ;uty paid on goods for bringing them within municipal limits.
IP. Customs duty, dock dues, clearing charges, Import duty etc.
P. 1uel, -ower, @ighting charges related to production.
PI. Jil, 9rease and .aste.
PII. -acking charges" &uch e'penses are incurred with a view to put the goods in
the &aleable Condition.
,te"s appearing on the credit side of Trading Account
8. &ales" otal &ales <Including both cash and credit= made during the year.
6. &ales /eturns or /eturn Inwards" &ales /eturns must be subtracted from the otal &ales to get
Aet sales. Aet &ales will be shown.
B. Closing stock" 9enerally, Closing stock does not appear in the rial 0alance. It appears
outside the rial balance. It represents the value of goods at the end of the trading period.
Speci"en or" of a trading A/c
By
By
BALANC,NG % T)AD,NG ACC%+NT
he difference between the two sides of the rading Account indicates either 9ross -rofit
or 9ross @oss. If the total on the credit side is more, the difference represents 9ross -rofit. Jn
the other hand, if the total of the debit side is high, the difference represents 9ross @oss. he
9ross -rofit or 9ross @oss is transferred to -rofit and @oss A?c.
Closing #ntries of Trading A/c
rading A?c is a ledger account. $ence, no direct entries should be made in the trading account.
&everal items such as -urchases, &ales are first recorded in the 4ournal and then posted to the
ledger. he &ame accounts are closed by the transferring them to the trading account. $ence it is
called as closing entries.
Advantages of Trading Account
8. he result of -urchases and &ales can be clearly ascertained
6. 9ross -rofit ratio to &ales could also be easily ascertained. It helps to determine -rice.
B. 9ross -rofit ratio to direct E'penses could also be easily ascertained. And so, unnecessary
e'penses could be eliminated.
C. Comparison of trading account details with previous years details help to draw better
administrative policies.
2)%,T AND L%SS ACC%+NT
rading account reveals 9ross -rofit or 9ross @oss. 9ross -rofit is transferred to credit
side of -rofit and @oss A?c. 9ross @oss is transferred to debit side of the -rofit @oss Account.
hus -rofit and @oss A?c is commenced. his -rofit I @oss A?c reveals Aet -rofit or Aet loss at
a given time of accounting year.
,te"s appearing on De.it side of the 2rofit 9 Loss A/c
By
he E'penses incurred in a business is divided in two parts. i.e. one is ;irect e'penses
are recorded in trading A?c., and another one is Indirect e'penses, which are recorded on the
debit side of -rofit I @oss A?c. Indirect E'penses are grouped under four heads"
8. &elling E'penses" All e'penses relating to sales such as Carriage outwards, ravelling
E'penses, Advertising etc.,
6. Jffice E'penses" E'penses incurred on running an office such as Jffice &alaries, /ent, a',
-ostage, &tationery etc.,
B. 2aintenance E'penses" 2aintenance e'penses of assets. It includes /epairs and /enewals,
;epreciation etc.
C. 1inancial E'penses" Interest -aid on loan, ;iscount allowed etc., are few e'amples for
1inancial E'penses.
,te" appearing on Credit side of 2rofit and Loss A/c<
8. 9ross -rofit is appeared on the credit side of - I @. A?c.
6. Also other gains and incomes of the business are shown on the credit side.
B. ypical of such gains are items such as
a. Interest received,
b. /ent received,
c. ;iscounts earned,
d. Commission earned.
Speci"en or"
By
/llustration
-repare -rofit and @oss Account, from the following balances of 2r. 2urugan for the year
ending B8.86.6))E.
Jffice rent /s. B))), -rinting e'penses /s. 6,6)), a', Insurance /s. 8,C)), ;iscount received
/s. C)), Advertisement /s. B,D)), &alaries /s. >,))), and &tationeries /s. 6,C)), ;iscount
allowed /s. D)), ravelling e'penses /s. 6,D)), 9ross -rofit transferred from the rading A?c
/s. 6(,)))
By
BALANC# S>##T
rading A?c and -rofit I @oss A?c reveals 9.-. or 9.@ and A.- or A.@ respectively,
0esides the -roprietor wants
i. o know the total Assets invested in business
ii. o know the -osition of owners e!uity
iii. o know the liabilities of business.
D#,N,T,%N
he .ord G0alance &heet is defined as +a &tatement which sets out the Assets and @iabilities of
a business firm and which serves to ascertain the financial position of the same on any particular
date.,
Jn the left hand side of this statement, the liabilities and capital are shown. Jn the right hand
side, all the assets are shown. herefore the two sides of the 0alance sheet must always be e!ual.
Capital arrives Assets e'ceeds the liabilities.
%B4#CT,?#S % BALANC# S>##T:
8. It shows accurate financial position of a firm.
6. It is a gist of various transactions at a given period.
B. It clearly indicates, whether the firm has sufficient assents to repay its liabilities.
C. he accuracy of final accounts is verified by this statement
By
(. It shows the profit or @oss arrived through -rofit I @oss A?c.
Speci"en for"at for .alance sheet

he 0alance sheet contains two parts i.e.
8. @eft hand side i.e. the @iabilities
6. /ight hand side i.e. the Assets
ASS#TS:
Assets represent everything which a business owns and has money value. Assets are always
shown as debit balance in the ledger. Assets are classified as follows.
8. Tangi.le Assets: Assets which can be seen and felt by touch are called angible Assets.
angible Assets are classified into two"
By
a. 1i'ed Assets" Assets which are durable in nature and used in business over and
again are known as 1i'ed Assets.
e.g. land and 0uilding, 2achinery, rucks, etc.
b. 1loating Assets or Current Assets" Current Assets are
i. 2eant to be converted into cash,
ii. 2eant for resale,
iii. @ikely to undergo change
e.g. Cash, 0alance, stock, &undry ;ebtors.
6. ,ntangi.le Assets: Assets which cannot be seen and has no fi'ed shape.
E.g., goodwill, -atent.
B. ictitious assets: Assets which have no real value and will appear on the Assets side of
0alance &heet. Are known as 1ictitious assets"
E.g. -reliminary e'penses, ;iscount or creditors.

L,AB,L,T,#S:
All that the business owes to others are called @iabilities. It also includes -roprietors
Capital. hey are known as credit balances in ledger.
Classification of Lia.ilities:
8. Long Ter" Lia.ilities: @iabilities will be redeemed after a long period of time 8) to 8(
3ears
E.g. Capital, @ong erm @oans.
6. Current Lia.ilities: @iabilities, which are redeemed within a year, are called Current
@iabilities or short5term liabilities
E.g. rade creditors, 0?-, 0ank @oan.
B. Contingent Lia.ilities: @iabilities, which have the following features, are called
Contingent liabilities. hey are"
i. Aot actual liability at present
By
ii. 2ight become a liability in future on condition that the contemplated
event occurs.
E.g. @iability in respect of pending suit.
E0uation of Balance Sheet.
8. Capital K Assets * @iabilities
6. @iabilities K Assets * Capital
B. Assets K @iabilities Q Capital.
D,#)#NC# B#TW##N A T),AL BALANC# AND A BALANC# S>##T
/llustration
1rom the following trial balance e'tracted from the books of hiru.Penkatachalam as on
B8.86.)E. -repare <i= rading and -rofit I @oss A?c and <ii= 0alance &heet
rial balance as on B8?86?6))E
By
&tock as on B8.86.)E to /s. 8, )),)))
Solution:
By
,llustration
1rom the following trial balance of &hri &amir , -repare rading a?c, -rofit I loss
a?c and 0alance sheet as on that date after taking into consideration the necessary
ad4ustments
-articulars ;ebit </s= Credit </s=
&tock C()))
-lant I 2achinery E()))
-urchases 66()))
rade charges 8))))
Carriage inwards 6())
Carriage outwards 8())
1ctory rent 8())
;iscount B()
Insurance E))
&undry debtors D))))
Jffice rent
B)))
-rinting I stationary
D))
ravelers salaries 6>))
Advertising 8()))
0ills receivable D)))
;rawings D)))
By
&alaries 8()))
.ages 6))))
1urniture E())
Coal and gas 8)))
Capital E()))
Creditors 8()))
&ales C6)E()
0ad debts provision 6))
0ills payable 6)))
Cash in hand 6)))
Cash at bank 86())
@ABC@D @ABC@D
Additional ,nfor"ation
I. Closing stock amounted to /s. B()))
II. ;epreciate machinery by 8)R I 1urniture by (R
III. /aise the bad debts provision to (R on debtors
IP. Jutstanding factory rent /s. B)) I Jffice rent /s.D))
P. Insurance prepaid /s.8))
Solution : rading account of shir &hamir
Dr Cr
2articulars A"ount A"ount 2articulars A"ount A"ount
o stock C())) 0y sales C6)E()
o purchases 66())) 0y closing stock B()))
o carriage inwards 6())
o factory rent 8())
<Q= Jutstanding B)) 8>))
o wages 6))))
o gross profit 8D8C()
C((E() C((E()
-rofit I @oss account of shir &hamir
Dr Cr
2articulars A"ount A"ount 2articulars A"ount A"ount
0y trade e'penses 8)))) 0y 9ross -rofit 8D8C()
0y carriage outwards 8())
By
0y discount B() 0y provision on bad debts B6))
0y insurance E))
0y office rent B)))
<Q= outstanding D)) BD))
0y printing I &tationary D))
0y travelers salaries 6>))
0y advertising 8()))
0y drawings D)))
0y salaries 8()))
o coal I 9as 8)))
o depreciation on -lant I
2achinery
E())

o depreciation on 1urniture BE(

o prepaid Insurance 8))
o bad5debts provision B)))
o net profit
OC86(

8D8D() 8D8D()
0alance sheet of &hir &hamir
@iabilities Amount Amount Assets Amount Amount
Capital E())) -lant I 2achinery E()))

<Q= Aet -rofit OC86( 8DO86( <5= ;epreciation E()) DE())
0ills payable 6))) &undry debtors D))))

&undry creditors 8())) <5= -rovision for 0ad debts B6)) (D>))
Jutstanding factory rent B)) 0ills receivable D)))
Jutstanding office rent D)) 1urniture E())

By
<5= ;epreciation BE( E86(
-repaid Insurance 8))
Cash in hand 6)))
Cash at bank 86())
Closing stock B()))
8>E)6( 8>E)6(
,nstitute of Chartered Accountants of ,ndia
Council of Institute of Chartered Accountants issues from time5to5time preface to the statements
of accounting standards that defines the various aspects of accounting standards.
8. It established an Accounting &tandards 0oard <A&0= on 66nd April, 8OEE.
6. he function of A&0 is to formulate accounting standards, which are then established by
the Council of Institute of Chartered Accountants.
,ndian Accounting Standards :,ND ASs0
hese are the converged Indian Accounting &tandards <Ind A&s= hosted by 2CA on its website.
he date on which these will come into force is yet to be notified. Any changes in the Ind A& vis.
a vis. corresponding IA&?I1/& are given in Appendi' 8 appearing at the end of each Ind A&.
8. Framework for the Preparation and Presentation of Financial Statements in accordance
with Indian Accounting Standards
6. Ind A& 8)8 First-time Adoption of Indian Accounting Standards
B. Ind A& 8)6 Share based Payment
C. Ind A& 8)B usiness !ombinations
(. Ind A& 8)C Insurance !ontracts
D. Ind A& 8)( "oncurrent Assets #eld for Sale and $iscontinued %perations
E. Ind A& 8)D &'ploration for and &valuation of (ineral )esources
>. Ind A& 8)E Financial Instruments* $isclosures
O. Ind A& 8)> %perating Segments
8). Ind A& 8 Presentation of Financial Statements
88. Ind A& 6 Inventories
86. Ind A& E Statement of !ash Flows
8B. Ind A& > Accounting Policies+ !hanges in Accounting &stimates and &rrors
8C. Ind A& 8) &vents after the )eporting Period
By
8(. Ind A& 88 !onstruction !ontracts
8D. Ind A& 86 Income ,a'es
8E. Ind A& 8D Property+ Plant and &quipment
8>. Ind A& 8E -eases
8O. Ind A& 8> )evenue
6). Ind A& 8O &mployee enefits
68. Ind A& 6) Accounting for .overnment .rants and $isclosure of .overnment Assistance
66. Ind A& 68 ,he &ffects of !hanges in Foreign &'change )ates
6B. Ind A& 6B orrowing !osts
6C. Ind A& 6C )elated Party $isclosures
6(. Ind A& 6E !onsolidated and Separate Financial Statements
6D. Ind A& 6> Investments in Associates
6E. Ind A& 6O Financial )eporting in #yperinflationary &conomies
6>. Ind A& B8 Interests in /oint 0entures
6O. Ind A& B6 Financial Instruments* Presentation
B). Ind A& BB &arnings per Share
B8. Ind A& BC Interim Financial )eporting
B6. Ind A& BD Impairment of Assets
BB. Ind A& BE Provisions+ !ontingent -iabilities and !ontingent Assets
BC. Ind A& B> Intangible Assets
B(. Ind A& BO Financial Instruments* )ecognition and (easurement
BD. Ind A& C) Investment Property
BE. !omparison of IF)S as applicable on 1st April 2311 with Ind AS placed at (!A4s website
By

Financial Accounting

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Unit I Financial Accounting & Analysis

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