Financial Accounting- An Overview
Faculty: K.S.Ranjani
Email: ksranjani99@gmail.com
Course Objective:
To orient students to accounting, make them aware of the basic concepts in accounting,
enabling them to understand the accounting process and understanding Financial
Statements
Contents to be covered
Introduction to Accounting, Origin of Accounting, Definition
Basic Accounting concepts, Balance Sheet
Basic Accounting concepts, The Income Statement
Other concepts of Income- Accrual and Cash
Accounting Records and Systems-Accounting Process- Transaction Analysis
Introduction to Accounting, Origin of Accounting, Definition
Accounting is basically an information system- Why do we need this system? What
purpose would it serve? Who would benefit?
How does accounting provide for operating information, financial accounting
information, management accounting information and tax accounting information?
Definition:
According to American Accounting Association, accounting is the “process of
identifying , measuring, and communicating economic information to permit informed
judgements and decisions by users of the information”.
Functions of Accounting:
Recording/Book keeping: The first level of capturing data and recording them is the
process of book keeping. The recording is done in a book and is called as journal.
Classifying: This involves analysis of the data with the objective of grouping transactions
or entries of one nature at one place. This is done through a “ledger”. The book of
primary data is a journal and classified data is called ledger.
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Summarising: the data that have been recorded and classified, would by now appear in
groups- ie. Similar transactions involving similar heads of accounts will be recurring and
they could be summarized and organized into a Trial Balance.
Analysis: The Trial Balance is the summation of the data in a more organized form. This
in turn facilitates the data to be converted into an Income Statement and Balance Sheet.
Interpreting Accounting also interprets the recorded financial data in a manner that the
end users can make a meaningful judgement of the financial position and profitability of
the business.
The foundation of Accounting consists of Generally Accepted Accounting
Standards(GAAP) and in the Indian context, Accounting Standards(AS). These have
evolved over a period of time on principles of objectivity, relevance and feasibility.
Numerical Examples for preparation of Income Statement and Balance Sheet:
1. X bought 500 pens. The cost of each pen is Rs.50/- He sold 486 pens at Rs.62/-
per pen. Calculate the profit made by X.
2. Assume that he paid a servant Rs.500/- for shop assistance and calculate the
revised profit.
3. Assume that X would have otherwise been able to earn a salary of Rs.2000/- that
he could not earn because he was busy selling pens. Calculate the revised profit.
4. Ram had Rs.10,00,000/- with him on 1st of January. He bought a house worth
Rs.5,00,000/- and a car for Rs.1,50,000/-(Tata Nano, of course). Try to make his
Balance Sheet.
Basic Accounting concepts, Balance Sheet
Accounting Principles:
Accounting Principles are important because accounting is used as an information
system. Hence it is important that there is consistency and uniformity in the process of
preparation of the accounts. Mr.Arun, for example, may be sitting in Lucknow and
preparing a set of accounts. Mr.Joshi, may be doing it from Ahmedabad. But can they
report the same transaction in two different ways? If they did it, then can a third person
understand what the transaction means? Can he take any meaningful decision based on
the report?
This is why there is a need to have accounting principles, so as to ensure that there is a
Basic concepts that would assist us in preparation of Balance Sheet are:
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Money Measurement- You can only record transactions that are measurable in monetary
terms-For eg. If Aishwarya Rai is on the Board of your company, you cannot “account”
for it.
Entity Concept- Business is different from the person owning/ running it
Going Concern concept- A business is assumed to continue its operations for an
indefinite period of time
Cost concept- Assets are recorded at historical cost, not on any other basis
Dual Aspect concept- All transactions carry a dual impact on the accounting
records-“own “ and “owe” or “debit “ and “credit” Therefore Assets= Liabilities
+Owners’ equity
Basic Accounting concepts, The Income Statement
Basic concepts that would help us prepare income statement are:
Accounting Period-Accounting transactions measured for a period of time
Conservatism concept- Account for possible expenses but only for income which is
certain
Realization The amount to be recognized as revenue should be reasonably certain to be
realized
Matching concept –When a given event affects both revenues and income , both should
be recognized in the same accounting period
Consistency- The same set of Accounting principles should be applied across various
accounting periods, unless there are sound reasons to change the same
Materiality Events without significance need not be recorded- only those events that will
justify the work of recording them need to be recorded
Other concepts of Income- Accrual and Cash
Accrual basis uses the matching concept and measures income for a period as the
difference between the revenues recognized in the period and the expenses that are
matched with those revenues.
Cash basis accounting records transactions on actual collection and disbursement of cash.
It is rare to come across this form of accounting. This is not recognized by law either.
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Recognising income and accounting for expenses in such a way as to postpone income
tax liability is the Income Tax Accounting. Tax can only be postponed. It is not legally
possible to avoid taxes.
Accounting Records and Systems-Accounting Process- Transaction
Analysis
Types of Accounts- Personal, Real and Nominal
Personal Account- transactions between persons
Rule: Debit the Receiver
Credit the Giver
Real Account- Land, Building etc-Transactions that bring about tangible or real items.
Rule: Debit what comes in
Credit what goes out
Nominal Account- Transactions that are cash transactions and are identified by the name
Rule: Debit all expenses and losses
Credit all income and gains
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