Financial Accounting

Module 1

An Overview

Financial Accounting

An overview, Accounting concepts, principles, accounting standards. Ledger posting, Trial Balance.

Definition And Meaning Of Accounting

The American Institute of Certified Public Accountants (1941) defines Accounting is the art of recording, classifying and summarising in 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.
Accounting As An Information Cycle

Input

Process

Output

Accountancy, Accounting And Book-keeping

IMPORTANCE OF ACCOUNTING
1. Facilitates to replace memory and comply with legal requirements 2. Facilitates to ascertain net result of operations and also to know the financial position 3. Facilitates the users to take effective decisions 4. It is helpful in a comparative study 5. It assists the management 6. It facilitates to have control over assets 7. It facilitates the settlement of tax liability 8. It facilitates raising of loans 9. It acts as a legal evidence 10. It facilitates ascertainment of value of business.
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SCOPE OF ACCOUNTING

Identifying Measuring Recording Classifying Summarising Analysing Interpreting

6

Communication

Accounting Principles

Accounting principles are a body of doctrines commonly associated with the theory and procedures and as a guide for selection of conventions or procedures where alternatives exist.

These principles are classified into two categories:

1. Accounting Concepts

2. Accounting Conventions

TYPES OF ACCOUNTING
Accounting

Financial Accounting

Cost Accounting

Management Accounting

Social Responsibility Accounting

ACCOUNTING CONCEPTS

Concept means a general notion, a theory or belief held by person or group of persons. The term concepts includes those basic assumptions or conditions upon which the science of accounting is based. 1. 2. 3. 4. 5. 6. 7. Business entity concept Money measurement concept Cost concept Going concern concept Dual aspect concept Realisation concept Accrual concept
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ACCOUNTING CONVENTIONS A convention means a custom or an established usage formed or adopted by an agreement. The term conventions includes those customs or traditions which guide the accountant while preparing the accounting statements. 1. 2. 3. 4. Convention of consistency Convention of full disclosure Convention of conservatism Convention of materiality

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Accounting Standards The Accounting standards bring uniformity in the preparation and presentation of financial statements and aids in comparison of different financial statements of companies in the same or different industries.

Procedure for framing Accounting Standards

The International Accounting Standards are issued by the IASC These Standards are received by ICAI assigned to ASB The Accounting standards are issued under the authority of the council of ICAI. So far the ASB of ICAI has issued 28 Accounting standards as shown below:

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Accounting Standard
AS-1 AS2(Revised) AS3(Revised) AS4(Revised) AS5(Revised) AS6(Revised) AS7(Revised)

Title
Disclosure of Accounting Policies Valuation of inventories Cash Flow Statements Contingencies and Events occurring after Balance Sheet Date Net Profit or Loss, prior period items and changes in Accounting policies Depreciation Accounting Accounting for construction contracts

Mandatory for Accounting period beginning on or after 1.4.1991 1.4.1999 1.4.2001 1.4.1995 1.4.1996 1.4.1995 1.4.2003

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AS-8 AS-9 AS-10 AS-11(Revised) AS-12 AS-13 AS-14 AS-15

Accounting for Research and Development Revenue Recognition Accounting of Fixed Assets Accounting for the effect of changes in foreign exchange rates Accounting for Government Grants Accounting for Investments Accounting for Amalgamations Accounting for retirement benefits in the financial statements of employers

1.4.1991 1.4.1991 1.4.1991 1.4.1995 1.4.1994 1.4.1995 1.4.1994 1.4.1995

AS-16
AS-17

Borrowing costs
Segment reporting

1.4.2000
1.4.2001

13

AS-18
AS-19 AS-20 AS-21 AS-22 AS-23 AS-24 AS-25 AS-26

Related Party Disclosures

Leases Consolidated Financial Statements Earnings per share Accounting for taxes on income Accounting for investments in consolidated finance statements Discounting operations Interim financial reporting Intangible assets

1.4.2001
1.4.2001 1.4.2001 1.4.2001 1.4.2001 1.4.2002 1.4.2004 1.4.2002 1.4.2003

14

AS-27 AS-28 AS-29

Financial reporting of interest in joint ventures Impairment of Assets Provisions, Contingent Liabilities and Contingent Assets

1.4.2002 1.4.2004 1-4-2004

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USERS OF FINANCIAL STATEMENTS

1. 2. 3. 4. 5. 6. 7. 8.

Creditors (short term & long term) Investors (present & potential) Management Employees Tax Authorities Customers Government and their agencies Public

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Double Entry System Of Book-keeping

The main principle involved in Double Entry system is the duality transactions i.e., for every debit, there is an equal and opposite credit.
Total Debits = Total Credits

Principles Of Double Entry System

Classifications of accounts under double entry system

Traditional classification of Accounts

Personal Accounts Names of individuals, firms, companies and other entities

Real Accounts Assets And Liabilities

Nominal Accounts Expenses, losses and incomes and gains

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Assets: Resources, things or rights or value owned by a business Liability: Claims of others against a business / Assets owned by the business to the outsiders Expenses:An expenditure in return for which a benefit is received. Loss: An expenditure in return for which no benefit is received. Income: Refers to the earnings of a business for the expenses incurred Profit: Refers to the earnings of a business for no expenses incurred or proportionally meagre expenses incurred

Rules for debit and credit under traditional classification

Type of Account
Personal Account Real Account Nominal Account

Debit
The receiver What comes in All expenses and losses

Credit
The giver What goes out All incomes and gains
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ACCOUNTING CYCLE
Step 1 Journalising

Step 6 Position Statement

Step 2 Posting

Final Accounts

Step 5 Income Statement

Step 3 Balancing

Step 4 Trial Balance

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Records Maintained By An Organisation

The books of accounts maintained by an organisation may be classified into two as

a.
b.

Books of Prime / Original Entry

Books of Second entry / Final entry

Books of Prime / Original Entry 1. Journal 2. Cash Book 3. Subsidiary Books

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JOURNAL / DAY BOOK

Journal is a daily record of each business transaction. It is also called a day book and it is used for recording all day to day transactions in the order in which they occur. Format of a Journal

Date

Particulars

Ledger Debit Credit Rs. Rs. Folio

. Dr To. (Being)

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CASH
Debit:

BOOK

All Cash receipts and Bank receipts and Discount Allowed

Credit: All Cash payments and Bank payments and Discount

Received.

The cashbook is classified into 4 types viz., 1. Single column cash book 2. Two columnar cash book 3. Three columnar cash book 4. Petty cash book

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Tips to decide whether a cash transaction or not

23

In a purchase or a sale:

If there is no mention about the payment made, No name of the party given, but the amount is given, then It is a cash transaction Ex: If there is the name of the party and no mention about the payment, then it is a credit transaction If name of the party given and payment in cash or credit then it is a cash transaction.
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LEDGER Also called as General Ledger, this is a principal book that contains all the accounts i.e., accounts of Assets liabilities, capital, revenue and expenses. The entries from the books of original entry are transferred to this book. Hence it is also called as a book of final entry. There are a number of accounts in a general ledger. All similar transactions are grouped under one account.
Dr
Date Particulars Folio Amount Rs. -------Date Particulars Folio

Cr
Amount Rs.

To Balance b/d (Opening balance)

By Balance c/d (Closing balance)

--------

The opening and closing balances will appear only in case of assets, liabilities and capital accounts but not in case of incomes and expenditures.
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Format of a single column cash book

Dr
Date Particulars To Balance b/d (Opening balance) L.F. Amount Rs. Date Particulars L.F.

Cr
Amount Rs.

-------

By Balance c/d (Closing balance)

-------

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Illustration: I. Single column cash book 2007 June 1. Balance as on 31/5 2. Purchases made 3. Cash drawn from Bank 4. Cash paid towards salary 5. Purchased goods from Kishan & co. on credit 6. Rent payable 7. Cash deposited into Bank

42,000 12,000 5,000 8,000 8,000 5,000 20,000

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Soln:

Single Column Cash Book

Date

Particulars

LF Amount Date 42,000 5,000

Particulars

1/6/07 To balance b/d 3/6/07 To Bank

2/6/07 By Purchases 4/6/07 By Salary 7/6/07 By Bank By balance c/d

LF Amoun t 12,000 8,000 20,000 7,000

47,000

47,000

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JAN 1 : Opening cash balance Rs 5,000 JAN 4 : Rent paid Rs 2,000 JAN 6 : Interest received Rs 3,000 JAN 15 : Cash purchases Rs 4,000 JAN 25 : Cash sales Rs 8,000 JAN 31 : Salaries paid Rs 2,000

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Format of a single column cash book

Dr
Date Particulars L.F. Amount Rs.
5,000 3,000 8,000

Cr
Date
JAN JAN JAN JAN 4 15 31 31

Particulars
By By By By Rent Purchase a/c Salaries a/c Balance c/d

L. F.

Amount Rs.
2,000 4,000 2,000 8,000 ----------16,000 -----------

JAN 1 To Balance b/d JAN 2 To Interest JAN 25 To Sales

----------16,000 ----------To Balance b/d 8,000

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Format of a double column cash book

Dr
Date Particulars
L. F Discoun t Rs.

Cr
Cash Rs. Date Particulars
L. F
Discount Rs.

Cash Rs.

To Balance b/d (Opening balance)

------

By Balance c/d (Closing balance)

------

OR
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Format of a double column cash book

Dr
Date Particulars
L. F
Discount

Cr
Rs.

Bank Rs. ------

Date

Particulars

L. F

Discount Rs.

Bank Rs.

To Balance b/d (Opening balance)

By Balance c/d (Closing balance)

------

OR
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Format of a double column cash book

Dr
Date Particulars
L. F

Cr
Cash Rs. Bank Rs.
------

Date

Particulars

L. F

Cash Rs.

Bank Rs.

To Balance b/d (Opening balance)

By Balance c/d (Closing balance)

------

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PROBLEM
Two Columnar Cash Book with discount and cash columns: 2006 October Opening balance Paid salary Purchased goods Purchases made from Shreya & co. Cash sales Sales made to Rajinikanth & co. To Shreya returned 20% of goods due to damage, paid to 18,000/- in full Settlement of the account. Received from Rajinikanth 48,000/- in full settlement after he made returns 10,000/Deposited into Bank

80,000 10,000 12,000 25,000 1,15,000 60,000

3,000

34

Solution:
Date Particulars L Discount F allowed Cash Date Particulars L F Discount Cash received

To balance b/d To sales To Rajinikanth & co.

2,000

80,000 1,15,000 48,000

By Salary By Purchases By Shreya & co. By Bank By balance c/d

10,000 12,000
2,000 18,000 3,000 2,00,000 2,000 2,43,000

2,000
Working Note: Shreya & co. Puchases (-)Returns 20% Payable (-)Paid Discount received

2,43,000

25,000 5,000 20,000 18,000 2,000

Rajinikanth & co. Sales (-)Returns Receivable (-)Received Discount allowed

60,000 10,000 50,000 48,000 2,000

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JAN 1 : Cash Balance Rs 5,000 JAN 6 : Sold Goods to Mahesh Rs 4,000 JAN 8 : Purchased Goods from Mukesh Rs 3,000 JAN 15 : Cash Received from Mahesh Rs 3,900 in full settlement JAN 20 : Paid to Mukesh Rs 2,850 in full settlement JAN 25 : Sold Goods to Suresh Rs 3,000 JAN 31 : Received Cash from Suresh Rs 2,900
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double column cash book

Dr
Date Particulars
L . F Disco unt Rs.

Cr
Cash Rs.
5,000 3,900 2,900 --------11,800 ---------

Date

Particulars

L.F

Disco unt Rs.

Cash Rs.
2,850 8,950

To Balance b/d To Mahesh To Suresh

100 100 ------200 -------

By Mukesh By Balance c/d

150

--------11,800 ---------

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Format of a three columnar cash book

Dr
Date Particulars L. F Disc ount Rs.
Cash Bank Rs.

Cr
Date Particulars L. F Disc o-unt Rs.
Cash Rs. Bank Rs.

To Balance b/d (Opening balance)

------

By Balance c/d (Closing balance)

------

OR
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It is an accounting transaction that involves both CASH account and BANK account
No posting will be done from the CASH BOOK to the LEDGER in case of a contra entry A contra entry is indicated by the letter C which gives a hint to the ledger keeper that no posting is required

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Ex : Cash deposited to bank Credit side of cash book : Amount will be entered in cash column against the words By Bank Debit side of cash book: Amount will be entered in bank column against the words To Cash Ledger folio column : C which represents a contra entry is entered
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Ex : Cash withdrawn from bank Credit side of cash book : Amount will be entered in bank column against the words By Cash Debit side of cash book: Amount will be entered in cash column against the words To Bank Ledger folio column : C which represents a contra entry is entered
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JAN 1 : Paid into Bank Rs 6,000 JAN 2 : Withdrew for private expenses Rs 1,000 JAN 3 : Withdrew from bank Rs 3,000

JAN 4 : Withdrew from bank for private use Rs 1,500

42

Format of a three columnar cash book

Dr
D at e Particulars L.F Disco -unt Rs. Cash Bank Rs. Date Particulars L.F Disco -unt Rs. Cash Rs.

Cr
Bank Rs.

1 3

To Cash a/c To Bank a/c

C C

6000
3000

1 2 3 4

By By By By

Bank a/c Drawings Cash a/c Drawings

C
C

6000 1000
3000 1500

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III. Three Columnar Cash Book On 1st Jan 2001 Raj Opened a Bank account by depositing 6,000/- in cash. All remittances are to be paid to the Bank Date Jan 2 Jan 5 Jan 7 Jan 10 Jan 12 Jan 15 Jan 20 Jan 27 Particulars Goods sold to Mohan for cash 9,250/Settled Harishs account of 200/- at a discount of 5% Received from Shyam a cheque of 725/- discount allowed 25/Purchased Typewriter for 200/- and spent 50/- on its repairs Shyams cheque was returned as dishonoured Received a money order for 25/- from Harish Shyam settled his accounts by means of a cheque for 755/-, 5/for being Interest charge. Purchased Machinery from Rajeev for 5,000/- and paid him by means of a Bank draft purchased from a Bank for 5,005/44

Solution:
Date Particular s 1/1 2/1 7/1 15/1 20/1 20/1 L F Dis allowed Cash Bank Date Particulars 6,000 1/1 5/1 725 10/1 L Dis F received 10 Cash Bank 6,000 190 200 50 725 5,005 2,835 1,750

To Cash c To Sales To Shyam To Harish To Shyam To Intt charge

9,250 25 25

750 10/1 12/1 5 27/1

31/1

By Bank c By Harish By Typewriter By Repairs By Shyam By Machinery By balance c/d

25

9,275

7,480

10

9,275 7,480

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It is a cash book in which all the petty cash expenses incurred daily by an organisation is recorded. Such as postage, cartage, stationery, cleaning charges, etc.

46

47

Petty Cash Book

It is a cash book in which all the petty cash expenses incurred daily by an organisation is recorded.
Dr
Dt Particulars CBF Total Rs.

Cr
Dt Particulars Vr. No Postage Conveyance Wages Business Promotion Total Rs.

48

PETTY CASH BOOK

Record the following petty cash book maintained on the imprest system

1-10-2007 2-10-2007 3-10-2007 4-10-2007 5-10-2007 6-10-2007

cash received from cashier paid for coffee and tea for staff travelling expense by the sales manager subscription for the newspaper purchase of paper and other stationery expenses for taking employees for an outing

Rs 10000 Rs 125 Rs 1200 Rs 100 Rs 250 Rs 4200

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PETTY CASH BOOK Dt 10 /0 7 1 Particu lars C B F Total Rs. D t 10 / 07 2 Particular s Vr . N o 1 Employ ees welfare exp 125 Travell ing exp Newspaper s& stationery postag e Tota l Rs.

To cash from head cashier

10000

By coffee & tea By travelling exp of manager

125

1200

1200

4 By newspaper 5 By stationery

100

100

250

250

4200

4200

By staff outing

75

75
50

Jan 1, cash received from the chief cashier Rs.200 Jan 3, typing papers Rs. 8 Jan 6, office cleaning Rs.4 Jan 8, postage Rs. 2 Jan 10, cartage Rs. 2 Jan 15, postage Rs. 6 Jan 18, ink Rs 3, typing paper Rs. 10 Jan 20, type writer ribbon Rs. 10 Jan 22, telephone charges Rs. 7 Jan 24, office cleaning Rs. 2 Jan 25, nail polish Rs. 27 Jan 27, telegrams Rs. 25 Jan 29, typing paper Rs. 30

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Dr
Dt Partic ulars CB F To D tal t Rs. 20 0 3 6 8 Particu lars Vr. No Stati Posta oner ge y charg es 8 4 2 4 2 Car tag e Cleanin g

Cr
misce total llane ous 12 4 4

Jan to cash 1 From chief cashier

Typing Clean Post n off clean 10 Cartage 15 Postage 18 Ink, typing paper 20 Typ ribbon

1,2 3 4,5

6 7 8,9 13

2 6

2 6 13

10

10

10

52

Dt

Partic ulars

C B F

Tota D l t Rs.

Particu lars

Vr. No

Stati Posta oner ge y charg es 7

Car tag e

Cleanin g

misce total llane ous 7

22 Telepho 11 ne charges 24 Cleaning 12 25 Nail 13 polish 27 Telegra ms 29 Typing paper 200 58 14 15 30 61 2

2 27 25

2 27 25 30

Fe 1 Fe 1

To bal b/d Cash from chief cashier

Lf bal c/d

44 3

2 4

8 5

27 6

142 58 200

142
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PURCHASES BOOK
This is a subsidiary book in which all the credit purchases made by the organisation is recorded. The monthly total from the purchase book is transferred to the General Ledger to the Purchases Account.

Date

Purchase invoice no.

Name of the supplier

L F

Details Rs. Ps.

Total Amount Rs. Ps.

54

PURCHASE RETURNS BOOK A book in which all the purchase returns (returns outwards) are recorded.
Date Debit Note No. Name of the supplier L F Details Rs. Ps. Total Amount Rs. Ps.

55

SALES BOOK
The credit sales are recorded in this book. The monthly totals are transferred to the sales account in the General Ledger.
Date Sales invoice no. Name of the purchaser L F Details Rs. Ps. Total Amount Rs. Ps.

56

SALES RETURNS BOOK A book of account in which all the sales returns (returns inwards) made by the organisation are recorded.
Date Credit Note No. Name of the Purchaser L F Details Rs. Ps. Total Amount Rs. Ps.

57

Enter the following in subsidiary books. Jan 1: Purchased goods from Sudarshan paid by cheque Rs.15000 3: Sold goods to Bimal Rs.11000. 6: Purchased goods from Satish & co Rs. 12000. Returned goods to him Rs. 700 . 8: Purchased stock worth Rs.42000 from Reliance industries of which only 40% is on cash basis. 10: Sold goods worth Rs.38000 to Karimlal & co allows him a trade discount of 1% . 11: Murugeshan & co supplies stock worth Rs. 64000 and allowed us a trade discount of 1.5% . 12: Returns out of the previous 2 transactions amount to 5% each.

58

Date

Purchas e Invoice No.

Name of the supplier

LF

Amount (Rs)

Total (Rs) Amount

Jan 6 Jan 8 Jan 11

Satish & Co Reliance & Co. Murugesh & Co.

21 12000 23 25200 25 63040

12000 25200 63040

100240 100240

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Date

Debit Note No.

Name of the Party

LF

Amount (Rs)

Total (Rs) Amount

Jan 6 Jan 12

Satish & Co Murugesh & Co.

21 700 25 3152 3852

700 3152 3852

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Date

Invoice No.

Name of the Party

LF

Amount (Rs)

Total (Rs) Amount

Jan 3 Jan 10

Bimal & Co. Karimlal & Co. ( -1%)

32 11000 35 37620 48620

11000 37620 48620

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Date

Credit Note No.

Name of the Party

LF

Amount (Rs)

Total (Rs) Amount

Jan 12

Karimlal & Co. ( -1%)

35 1881

1881

1881

1881

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JOURNAL PROPER

Those journal entries that cannot be recorded in any of the subsidiary books are recorded in the journal proper. The following are recorded in the journal proper:

a. b. c. d. e.

Opening Entries Closing Entries Transfer Entries Adjustment Entries Rectification Entries

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A trail balance may be simply defined as a statement prepared by putting all debits on one side and all credits on the other side to check the arithmetical accuracy of the ledger balances. In otherwords,the trail balance is a connecting link between the ledger accounts and final accounts.

64

TRIAL BALANCE

It is a statement that shows the balance in all the accounts in a ledger. It contains all the debit and credit balances. A trial balance is a list of debit and credit balances of all the ledger accounts prepared on any particular date to verify whether the entries in the books of accounts are arithmetically correct or not.
Sl. No. Head of Account LF Debit Balance Rs. Ps. Credit Balance Rs. Ps.

65

basically trial balance is a statement or list. It contains all the debit and credit balances. The trail balance is the only base for the preparation of final accounts. Trail balance can be prepared at any time and not necessarily at the end of a calendar or accounting year.

66

Before preparing the final accounts, the accountant should prove/satisfy the arithmetical accuracy and correctness on which the entire final accounts were prepared. The net profit/balance sheet does not resemble true and fair picture which which was prepared from a trail balance which lacks the quality of arithmetical accuracy.

67

To examine the implementation of a double entry book keeping and its principles. To know the arithmetical accuracy. To find the profit of the firm. To find out the errors and mistakes in passing journal entries and their posting. To facilitate the process of the preparation of final accounts.

68

Debit side Assets accounts: land, building, machinery, furniture, debtors, stock, bills receivables etc. Accounts relating to expenses and losses: salaries, wages, rent, carriage, discount, bad debts, depreciation, purchases, return inward.

69

Credit side Liabilities accounts: creditors, loan, mortgage, bills payable, bank overdraft, reserves and funds. Incomes and gain account: interest realised, rent collected, discount received, sales account, returns outward. Capital Account

70

Trail balance can be prepared in two methods. They are total balances method and net balances method. Total balances method: in this method, debit as well as credit sides of all accounts will be summed up and with this totals the trail balance will be prepared. This method is called gross trail balance method. This method is now out of use.

71

Net balances method: this is the most commonly used trail balance. In this method the net balance of the accounts were ascertained on a particular date and arranged in the proforma of trail balance. If these totals of debit and credit agree, we can say the trail balance has arithmetical accuracy.

72

Example: Prepare a trial balance from the following balances of the year 2002. (Dec 05/ Jan 06- 10M)

Capital 28,000 Stock of goods 4000 Motor car 8000 Discount received 400 Bad-debts 400 Sales 40,000 Cash-at-bank 4000 Return inwards 2000 Cash in hand 600 Rent 3500 Discount allowed 300 Carriage 1500

Purchases 15,000 plant 15,000 furniture 5000 wages 8200 creditors 6500 salaries 2800 commission (cr) 600 return outwards 1000 debtors 5600 general expenses 300 interest received 200 advertisement 500

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SOLUTION: DEBIT(ASSETS & EXPENSES) CREDIT (LIABILITIES & REVENUES)

dt
1 2 3

Name of the account

Capital Stock of goods Motor car

LF

Debit
4000 8000

credit
28,000

4
5 6 7 8 9 10 11

Discount received
Bad-debts Sales Cash-at-bank Return inwards Cash in hand Rent Discount allowed 4000 2000 600 3500 300 400

400
40,000

74

dt 12 13 14

Name of the account Carriage

Purchases plant

LF

Debit 1500 15,000 15,000

credit

15
16 17 18 19 20 21

furniture
wages creditors salaries commission (cr) return outwards debtors

5000
8200 6500 2800 600 1000 5600

22

general expenses

300

75

dt
23 24

Name of the account

Interest received
Advertisement

LF Debit
500 76,700

credit
200

TOTAL

76,700

76

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