Accounting - a process of identifying,

recording, summarizing, and reporting

economic information to decision makers in
the form of financial statements

Financial accounting - focuses on the

specific needs of decision makers external
to the organization, such as stockholders,
suppliers, banks, and government agencies

The accounting system is a series of steps

performed to analyze, record, quantify,
accumulate, summarize, classify, report, and
interpret economic events and their effects on
an organization and to prepare the financial
statements.

Accounting systems are designed to meet

the needs of the decisions makers who use
the financial information.

Every business has some sort of accounting

system.
These accounting systems may be very complex
or very simple, but the real value of any
accounting system lies in the information that the
system provides.

 Accounting

information is useful to
anyone who makes decisions that
have economic results.
Managers want to know if a new product will be
profitable.
Owners want to know which employees are productive.
Investors want to know if a company is a good
investment.
Creditors want to know if they should extend credit,
how much to extend, and for how long.
Government regulators want to know if financial
statements conform to requirements.

Fundamental relationships in the decisionmaking process:

Event

Accountants
analysis &
recording

Financial
Statements

Users

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.

The primary questions about an organizations

success that decision makers want to know
are:
What is the financial picture of the organization
on a given day?
How well did the organization do during a
given period?

Accountants answer these primary

questions with three major financial
statements.
Balance Sheet - financial picture on a given
day
Income Statement - performance over a
given period
Statement of Cash Flows - performance over
a given period

Annual report - a document prepared by

management and distributed to current and
potential investors to inform them about the
companys past performance and future
prospects.
The annual report is one of the most common
sources of financial information used by investors
and managers.

The annual report usually includes:

a letter from corporate management
a discussion and analysis of recent economic events
by management
footnotes that explain many elements of the financial
statements in more detail
the report of the independent auditors
a statement of managements responsibility for
preparation of the financial statements
other corporate information

 What

are the different sections

of the Balance Sheet?

The balance sheet (also called statement of

financial position or statement of financial
condition) is a snapshot of the financial
status of an organization at a point in time.

Assets are economic resources that

are expected to benefit future
activities of the organization.

Liabilities are the entitys economic

obligations to others.
Owners equity is the excess
of the assets over the liabilities.

The owners equity of a corporation

is called shareholders equity.

Shareholders equity
Paid-in
capital

Retained
earnings

Sections of the balance sheet:

Assets - resources of the firm that are
expected to increase or cause future cash
flows (everything the firm owns)
Liabilities - obligations of the firm to outsiders
or claims against its assets by outsiders (debts
of the firm)
Owners Equity - the residual interest in, or
remaining claims against, the firms assets
after deducting liabilities (rights of the
owners)

The balance sheet equation:

Assets = Liabilities + Owners

Equity
or
Owners Equity = Assets Liabilities

Balance Sheet

Assets = Liabilities + Equity

Income Statement

(also called Statement of

Operations, Earnings Statement, Profit/Loss (or P&L)
Statement

Revenues - Expenses = Net income

(or Net Earnings)

Statement of Changes in Stockholders

Equity

Beginning of period total equity + Stock issued +

Net income - Dividends = End of period total
equity

Statement of Cash Flows

Cash inflow - Cash outflow = Net cash flow

1- 17

Different categories of users need

different

kinds

of

information

for

making decisions. These users can be

divided into :
Internal Users; and
External Users.

These are the persons who manage

the business, i.e. management at the
top, middle, and lower levels. Their
requirements

of

information

are

different because they make different

types of decisions.

The top level is more concerned with

planning;
the
middle
level
is
concerned equally with planning and
control; and the lower level is
concerned more with controlling
operations. Information is supplied on
different aspects, e.g. cash resources,
sales estimates, results of operations,
financial position, etc.

All persons other than internal users

come in the group of external users.
External users can be divided into two
groups:

those having direct interest; and

those having indirect interest

in a business organization.

The main sources of information for

external users are annual reports of
business organizations, which state
the financial position and performance
and
give
the
auditors
report,
directors report and other information.

Investors and creditors are the

external users having direct interest.
Tax authorities, regulatory agencies,
customers,
labour
unions,
trade
associations,
stock
exchanges,
investors, etc are indirectly interested
in the companys financial strength, its
ability to meet short-term and longterm obligations, its future earning

These are economic resources of an

enterprise that can be usefully
expressed in monetary terms. Assets
are things of value used by the
business in its operations.

Fixed Assets

Current Assets

 Fixed Assets are assets held on a

long-term basis.
e.g. Land, Building, Machinery, Plant,
Furniture and Fixtures, etc.

 Current Assets are assets held on a

short-term basis.
e.g. Debtors, Bills receivable,
Stock(Inventory), Cash and Bank
balances, etc.

These are obligations or debts that the

enterprise must pay in money or
services at some time in the future.
Long-term liabilities
Short-term liabilities

Long-term liabilities are those that are

usually payable after a period of one
year.
e.g. A term loan from a financial institution,
debentures (bonds) issued by a company.

Short-term liabilities are obligations

that are payable within a period of one
year.
e.g. Creditors, bills payable, overdraft
from

a bank for a short period.

Investment by the owner for use in the

firm is known as capital. Owners
equity is the ownership claim on total
assets. It is equal to total assets minus
total liabilities.

These are the amounts the business

earns

by

selling

its

products

or

providing services to customers. Other

titles and sources of revenue common
to many businesses are: sales, fees,
commission,

interest,

royalties, rent received, etc.

dividends,

These are costs incurred by a business

in the process of earning revenue.
Generally, expenses are measured by
the cost of assets consumed or
services used during an accounting
period. The usual titles of expenses
are:
depreciation,
rent,
wages,
salaries, interest, costs of heat, light
and water, telephone, etc.

Purchases are total amount of goods

procured by a business on credit and
for cash, for use or sale. In a trading
concern, purchases are made of
merchandise for resale with or without
processing.
In a manufacturing concern, raw
materials are purchased, processed
further into finished goods and then
sold. Purchases may be cash purchase

Sales are total revenues from goods or

services

sold

or

provided

to

customers. Sales may be cash sales or

credit sales.

Stock (Inventory) is a measure of

something on hand goods, spares
and other items in a business.
It is called stock on hand.

In a trading concern, the stock on

hand is the amount of goods which
have not been sold on the date on
which the balance sheet is prepared.
This is also called closing stock.

In a manufacturing concern, closing

stock comprises raw materials, semifinished goods and finished goods on
hand on the closing date.
Similarly, opening stock is the amount
of stock at the beginning of the
accounting year.

Debtors are persons and/or other entities

who owe to an enterprise an amount for
receiving goods and services on credit.
The total amount standing against such
persons and/or entities on the closing date,
is shown in the Balance Sheet as Sundry
Debtors on the asset side.

Creditors are persons and/or other entities

who have to be paid by an enterprise an
amount for providing the enterprise goods
and services on credit.
The total amount standing to the favour of
such persons and/or entities on the closing
date, is shown in the Balance Sheet as
Sundry Creditors on the liability side.

Accounting principles can be subdivided into

two categories:

Accounting Concepts; and

Accounting Conventions.

Accounting principles can be subdivided into

two categories:

Accounting Concepts; and

Accounting Conventions.

Accounting Concepts

Accounting Conventions

The term concept is used to connote

accounting
postulates,
that
is
necessary assumptions and conditions
upon which accounting is based. The
term convention is used to signify
customs and traditions as a guide to
the
presentation
of
accounting

Accounting Concepts

Business Entity Concept

Money Measurement Concept

Cost Concept

Going Concern Concept

Dual Aspect Concept

Realization Concept

Accounting Period Concept

Accounting Conventions

Convention of Consistency

Convention of Disclosure

Convention of Conservation

Accounting Concepts
The term concept is used to connote
accounting
postulates,
that
is
necessary assumptions and conditions
upon which accounting is based.

Business is treated as a separate

entity or unit apart from its owner and
others. All the transactions of the
business are recorded in the books of
business from the point of view of the
business as an entity and even the
owner is treated as a creditor to the
extent of his/her capital.

In accounting, we record only those

transactions which are expressed in
terms of money. In other words, a fact
which

can

not

be

expressed

in

monetary terms, is not recorded in the

books of accounts.

Transactions are entered in the books

of accounts at the amount actually
involved.
Suppose
a
company
purchases a car for Rs.1,50,000/- the
real value of which is Rs.2,00,000/-,
the purchase will be recorded as
Rs.1,50,000/- and not any more. This
is one of the most important concept
and it prevents arbitrary values being

It is persuaded that the business will

exists for a long time and transactions
are recorded from this point of view.

Each transaction has two aspects, that

is, the receiving benefit by one party
and the giving benefit by the other.
This

principle

accountancy.

is

the

core

of

For example, the proprietor of a

business starts his business with Cash
Rs.1,00,000/-,
Machinery
of
Rs.50,000/and
Building
of
Rs.30,000/-, then this fact is recorded
at two places. That is Assets account
(Cash, Machinery & Building) and
Capital accounts. The capital of the
business is equal to the assets of the

Thus, the dual aspect

expressed as under

Capital + Liabilities = Assets

or
Capital = Assets Liabilities

can

be

Accounting is a historical record of

transactions.
happened.

It
It

records
does

not

what

has

anticipate

events. This is of great important in

preventing
inflating

business

their

profits

firms
by

from

recording

Strictly speaking, the net income can

be measured by comparing the assets
of the business existing at the time of
its liquidation. But as the life of the
business is assumed to be infinite, the
measurement of income according to
the above concept is not possible. So a
twelve month period is normally
adopted for this purpose. This time

Accounting Conventions
The term convention is used to
signify customs and traditions as a
guide

to

the

presentation

accounting statements.

of

In order to enable the management to

draw important conclusions regarding
the working of the company over a few
years, it is essential that accounting
practices
and
methods
remain
unchanged from one accounting
period to another. The comparison of
one accounting period with that of
another is possible only when the

This principle implies that accounts

must be honestly prepared and all
material information must be disclosed
therein. The contents of Balance Sheet
and Profit and Loss Account are
prescribed by law. These are designed
to make disclosure of all material facts
compulsory.

Financial statements are always drawn

up on rather a conservative basis. That
is, showing a position better than what
it is, not permitted. It is also not proper
to show a position worse than what it
is. In other words, secret reserves are
not permitted.

 Keeping systematic records

Protecting
business

properties

Communicating the results

Meeting legal requirements

of

the

The first function of accounting is to

keep a systematic record of financial
transactions, to post them to the
ledger

accounts

and

prepare final statements.

ultimately

The second important function is to

protect the property of the business.
The system accounting is designed in
such a way that it protects its assets
from an unjustified and unwarranted
use.

The fourth and the last function of

accounting

is

to

meet

the

legal

requirements under the Companies

Act, Income Tax Act, Sales Tax Act and
so on.

Recording transactions in subsidiary

books.
Classifying data by posting from
subsidiary books to the accounts.
Closing the books and preparation of
final accounts.

 Accounts in the names of persons are

known as Personal Accounts
Accounts in the names of assets are
known as Real Accounts
Accounts in respect of expenses and
incomes
are
known
as
Nominal
Accounts

ACCOUNTS
PERSONAL
ACCOUNTS

REAL
ACCOUNTS

IMPERSONAL
ACCOUNTS

NOMINAL
ACCOUNTS

Accounts in the name of persons are known

as personal accounts.
Eg: Babu A/C,
Babu & Co. A/C,
Outstanding Salaries A/C, etc.

These are accounts of assets or properties.

Assets may be tangible or intangible. Real
accounts are impersonal which are tangible
or intangible in nature.
Eg:- Cash a/c, Building a/c, etc are Real
Accounts related to things which we
can feel, see and touch.
Goodwill a/c, Patent a/c, etc Real
Accounts which are of intangible in nature.

These accounts are impersonal, but invisible

and intangible. Nominal accounts are
related to those things which we can feel,
but can not see and touch. All expenses
and losses and all incomes and gains fall
in this category.
Eg:- Salaries A/C, Rent A/C, Wages A/C,
Interest
Received
A/C,
Commission
Received A/C, Discount A/C, etc.

Each accounts have two sides the left side

and the right side. In accounting, the left
side of an account is called the Debit Side
and the right side of an account is called the
Credit Side. The entries made on the left
side of an account is called a Debit Entry
and the entries made on the right side of an
account is called a Credit Entry.

By: Munawar Hameed