Financial Accoun ng – Full Notes with Examples

UNIT I – Introduc on to Accoun ng

1. Meaning of Accoun ng

Accoun ng is the systema c process of iden fying, recording, classifying, summarizing,

interpre ng, and communica ng financial transac ons of a business. It's o en called the
"language of business" because it provides vital financial informa on to various
stakeholders like management, investors, creditors, and government authori es to help
them make informed decisions.

2. Func ons of Accoun ng

 Recording: The process of capturing and documen ng all business transac ons in a
chronological order. This is the first step, commonly known as bookkeeping, done in
a Journal.

 Classifying: Grouping similar transac ons into a single account. This is done by
transferring entries from the Journal to the Ledger. For example, all cash transac ons
are put into a "Cash Account."

 Summarizing: Condensing the classified data into a concise and understandable

form. This involves preparing the Trial Balance, Profit & Loss Account, and Balance
Sheet.

 Analysis & Interpreta on: Studying the summarized data to understand the financial
performance and posi on of the business. This o en involves calcula ng financial
ra os and iden fying trends.

 Communica on: Presen ng the financial informa on to internal and external users
in the form of financial reports.

Example: A shopkeeper wants to know how much profit he made last year. Accoun ng
helps him by preparing a Profit & Loss Account which summarizes all his sales and expenses,
ul mately revealing the Net Profit.

3. Accoun ng Concepts (with Examples)

These are the fundamental assump ons and rules that govern how accoun ng is done.

 Business En ty Concept: The business is treated as separate and dis nct from its
owner.

o Example: If Nai k invests ₹50,000 into his business, the business records it as
"Capital" (a liability to the owner), not as personal money.
  Going Concern Concept: It is assumed that the business will con nue to operate for
the foreseeable future.

o Example: Assets like machinery are recorded at their cost and depreciated
over their useful life, rather than at their liquida on value (what they would
sell for if the business closed down).

 Money Measurement Concept: Only transac ons that can be expressed in monetary
terms are recorded in the books of account.

o Example: The efficiency of a manager is important but cannot be directly

recorded in the books, whereas their salary can.

 Dual Aspect Concept: Every financial transac on has two effects. For every debit,
there is an equal and corresponding credit. This is the basis of double-entry
bookkeeping.

o Example: When a business purchases machinery for ₹20,000 cash, two

accounts are affected: the "Machinery Account" increases, and the "Cash
Account" decreases by the same amount.

 Accrual Concept: Income and expenses are recognized when they are earned or
incurred, regardless of when cash is received or paid.

o Example: A business earns ₹5,000 in commission but hasn't received the

cash. According to the accrual concept, this income should be recorded in the
books.

4. Classifica on of Accounts (Golden Rules)

Accounts are classified into three types. The "Golden Rules" of accoun ng dictate how to
debit and credit each type of account.

Type of
Rule of Debit Rule of Credit Example
Account

Personal The Receiver The Giver Ram's A/c, Bank A/c, Capital A/c

Real What Comes In What Goes Out Cash, Building, Machinery

All Expenses & All Incomes & Rent, Salary, Commission,

Nominal
Losses Gains Interest

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Example Journal Entries:

  Paid Rent ₹2,000: Rent is a nominal account (expense), Cash is a real account (goes
out).

o Rent A/c Dr. ₹2,000

o To Cash A/c ₹2,000

 Received Commission ₹1,500: Cash is a real account (comes in), Commission is a

nominal account (income).

o Cash A/c Dr. ₹1,500

o To Commission A/c ₹1,500

5. Accoun ng Cycle: A Step-by-Step Example

The accoun ng cycle is the complete sequence of steps followed to record, classify, and
summarize business transac ons.

Diagram (Text Representa on):

Transac on → Journal → Ledger → Trial Balance → Adjustments → Final Accounts

Prac cal Example (for Jan 2025):

1. Started business with cash ₹50,000.

2. Purchased goods for cash ₹20,000.

3. Sold goods for cash ₹15,000.

4. Paid Rent ₹2,000.

Step 1: Journal Entries (Recording) | Date | Par culars | L.F. | Debit (₹) | Credit (₹) | |---
-----|-----------------------|------|-----------|------------| | 1 Jan | Cash A/c Dr. | | 50,000 | | | | To
Capital A/c | | | 50,000 | | | (Being business started) | | | | | 2 Jan | Purchases A/c Dr. | |
20,000 | | | | To Cash A/c | | | 20,000 | | | (Being goods purchased) | | | | | 3 Jan | Cash
A/c Dr. | | 15,000 | | | | To Sales A/c | | | 15,000 | | | (Being goods sold) | | | | | 4 Jan |
Rent A/c Dr. | | 2,000 | | | | To Cash A/c | | | 2,000 | | | (Being rent paid) | | | |

Step 2: Ledger Accounts (Classifying) Each account has its own T-shaped format (Debit
and Credit sides). Cash A/c | Dr. Side | Cr. Side | |-----------------------|---------------------------| |
To Capital A/c ₹50,000 | By Purchases A/c ₹20,000 | | To Sales A/c ₹15,000 | By Rent A/c
₹2,000 | | Total ₹65,000 | Total ₹22,000 | | | By Balance c/d ₹43,000 |

Step 3: Trial Balance (Summarizing) The final balance of each ledger account is listed.
The total of the Debit column must equal the total of the Credit column.
Account Debit (₹) Credit (₹)

Cash A/c 43,000

Purchases A/c 20,000

Rent A/c 2,000

Sales A/c 15,000

Capital A/c 50,000

Total 65,000 65,000

The total balances tally, which indicates arithme cal accuracy.

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UNIT II – Prepara on of Financial Statements

1. Trading & Profit and Loss Account

This is a summary of a business's revenues, costs, and expenses over a period of me.

 Trading Account calculates Gross Profit (or Gross Loss) by matching direct costs (like
purchases, wages) against sales.

 Profit & Loss Account calculates Net Profit (or Net Loss) by deduc ng indirect
expenses (like rent, salary) from the Gross Profit.

Example:

 Trial Balance Extract: Opening Stock: ₹10,000, Purchases: ₹50,000, Sales: ₹80,000,
Wages: ₹5,000, Rent: ₹4,000.

 Adjustment: Closing Stock is ₹12,000.

Trading Account for the year ended... | Dr. Side | Cr. Side | |--------------------------|--------------
--------------| | To Opening Stock ₹10,000 | By Sales ₹80,000 | | To Purchases ₹50,000 | By
Closing Stock ₹12,000 | | To Wages ₹5,000 | | | To Gross Profit ₹27,000 | | | Total ₹92,000 |
Total ₹92,000 |

Profit & Loss Account for the year ended... | Dr. Side | Cr. Side | |--------------------------|-------
---------------------| | To Rent ₹4,000 | By Gross Profit ₹27,000 | | To Net Profit ₹23,000 | | |
Total ₹27,000 | Total ₹27,000 |

 Note: Net Profit is transferred to the Capital A/c in the Balance Sheet.
2. Balance Sheet

This statement provides a snapshot of a business’s financial posi on at a specific point in

me. It shows what a business owns (Assets) and what it owes (Liabili es and Capital).

Example: Using the Net Profit of ₹23,000 from the above example and other balances.

 Balances: Cash: ₹20,000, Debtors: ₹15,000, Furniture: ₹10,000, Creditors: ₹8,000,

Capital: ₹37,000.

Balance Sheet as on 31st March 2025 | Liabili es | Assets | |-----------------------------|----------

-----------------| | Capital ₹37,000 | Cash ₹20,000 | | Add: Net Profit ₹23,000 | Debtors
₹15,000 | | Total Capital ₹60,000 | Furniture ₹10,000 | | Creditors ₹8,000 | Closing Stock
₹12,000 | | | | | Total: ₹68,000 | Total: ₹68,000 |

 Note: The Balance Sheet total must always match. This proves the Accoun ng
Equa on (Assets = Liabili es + Capital + Profit).

UNIT III – Company Accounts & Amalgama on

1. Shares vs. Debentures

Companies can raise capital by issuing shares (ownership) or debentures (borrowing).

Feature Shares Debentures

Represents borrowed capital (a

Nature Represents ownership in the company
loan)

Return Dividend (variable) Interest (fixed)

Vo ng
Yes (for equity shares) No
Rights

Not repayable during the company's life Repayable a er a specified

Repayment
(equity) period

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Example: Issue of Shares A company issues 10,000 equity shares of ₹10 each at par.

 Journal Entry:

o Bank A/c Dr. ₹1,00,000 (10,000 shares * ₹10)

o To Share Capital A/c ₹1,00,000

o (Being 10,000 equity shares issued at par)

2. Amalgama on, Absorp on & Reconstruc on

 Amalgama on: Two or more companies (A and B) merge to form a completely new
company (C).

 Absorp on: One company (A) takes over another exis ng company (B). The acquiring
company (A) con nues to exist, while the target company (B) ceases to exist.

 Reconstruc on: The financial structure of a company is re-organized without

liquida on.

o Internal Reconstruc on: Reorganizing capital within the same company.

o External Reconstruc on: A new company is formed to take over an exis ng

one.

Example: Purchase Considera on (Amalgama on) Company A's Assets are ₹1,50,000
and Liabili es are ₹40,000. Company B buys Company A for ₹1,10,000. The amount paid
(₹1,10,000) is the Purchase Considera on.

 Journal Entry in the books of Company B (the new company):

o Assets A/c Dr. ₹1,50,000

o To Liabili es A/c ₹40,000

o To Purchase Considera on A/c ₹1,10,000

o (Being assets and liabili es of Company A taken over)

UNIT IV – IT, Ethics & Contemporary Issues

1. IT in Accoun ng

The use of technology to perform accoun ng func ons has revolu onized the industry.

 Need: Speed, accuracy, real- me repor ng, and automa on.

 So ware: Tally, SAP, QuickBooks, Oracle. These ERP (Enterprise Resource Planning)
systems integrate various business func ons.

 Usefulness: Automated ledger pos ng, instant financial statement genera on,
payroll management, and GST compliance.

Example:

 Instead of manually recording a purchase invoice in a journal, an accountant enters

the data into Tally. The so ware automa cally posts it to the Purchases A/c,
Creditors A/c, and updates the stock, all at once.
2. Ethics in Accoun ng

Accountants are bound by a code of ethics to ensure the integrity of financial informa on.

 Key Principles:

o Integrity: Being straigh orward and honest in all professional and business
rela onships.

o Objec vity: Avoiding bias, conflict of interest, or undue influence.

o Professional Competence: Maintaining the knowledge and skill required to

ensure clients receive competent professional service.

o Confiden ality: Not disclosing confiden al informa on without proper

authority.

o Professional Behavior: Complying with relevant laws and regula ons.

Example:

 An accountant is pressured by management to hide some expenses to inflate the

company's profit. Adhering to the principle of integrity and objec vity, the
accountant should refuse to manipulate the financial statements, as doing so would
be unethical and a viola on of their professional duty.

3. Contemporary Issues in Accoun ng

 Human Resource Accoun ng: Valuing and repor ng the cost and value of
employees.

o Example: A company like Infosys can disclose the value of its intellectual
capital by quan fying its investment in employee training and development.

 Green Accoun ng: Incorpora ng environmental costs and benefits into accoun ng.

o Example: A manufacturing company's financial statements may include the

cost of pollu on control equipment or the cost of cleaning up an oil spill.

 Social Accoun ng: Repor ng on a company's social welfare ac vi es and their

impact on society.

 Sustainability & Integrated Repor ng: A modern approach that combines financial,
environmental, and social performance informa on to provide a holis c view of a
company's value crea on. This is o en referred to as the "triple bo om line": Profit,
People, Planet.