Financial Accounting

1
Lecture 01
What is Accounting
Accounting is a system of recording, reporting, analyzing,
verifying, and summarizing business and financial
transactions for a business.
Financial Accounting
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Lecture 01
What is Financial Accounting?
It is the maintenance of daily record of ALL financial
transactions in such manner that it would help in the
preparation of suitable information regarding the
financial affairs of a business or an individual.
Why is Financial Accounting Needed?
The need for recording the financial transactions arises
because the individual or business wishes to know what
is the performance and to assist the person in making
decisions related to the business.
Financial Accounting
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Lecture 01
Identifying
Business
Activities
Recording
Business
Activities

Communicating
Business
Activities
Accounting Activities
Financial Accounting
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Lecture 01
Users of Accounting Information
External Users
Lenders
Shareholders
Governments

External Auditors
Customers
Internal Users
Managers
Officers
Internal Auditors
Sales Staff
Budget Officers
Financial Accounting
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Lecture 01
What Are Transactions?
In accounting or business terms any dealing between two
persons involving money or a valuable thing is called
transaction.
Human beings are social animals and are bound to adopt a
community living style. Living in a community essentially
means that people interact with other people and are
dependant on each other to fulfil their needs.
Every person cannot fulfil all his needs like food, clothing,
housing etc. on his own. He therefore, depends on other
people to provide him with some of his needs in return to
him providing others with some of theirs.
This means that to get something on has to give something in
return. Every instance where one gives something to get
something is called a transaction.
Financial Accounting
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Lecture 01
What is Debit and Credit.
We know that two parties or rather two accounts are
concerned in each transaction, one of them must be debtor
and other creditor. The following rules are applied for
debiting and crediting accounts:

1. Personal accounts. Debit the account of the person
receiving and credit the account of the person giving.
2. Real Account. Debit the account of property or thing
coming in and credit the account of that going out.
3. Nominal Account. Debit the account of all expenses and
losses and credit the account of all gains.

Financial Accounting
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Lecture 01
Rules of Debit and Credit for Assets
Similarly we have established that whenever a business
transfers a value / benefit to an account and as a result
creates some thing that will provide future benefit; the
thing is termed as Asset.
By combining both these rules we can devise following rules
of Debit and Credit for Assets:
When an asset is created or purchased, value / benefit is
transferred to that account so it is Debited
i. Increase in Asset is Debit
Reversing the above situation if the asset is sold, which is
termed as disposing off, for say cash the asset account
provides benefit to the cash account. Therefore, the asset
account is debit
ii. Decrease in Asset is Credit
Financial Accounting
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Lecture 01
Rules of Debit and Credit for Liabilities
And anything that transfers value to the business, and in turn
creates a responsibility on part of the business to return a
benefit, is a Liability. Therefore, liabilities are the exact
opposite of the assets.
When a liability is created the benefit is provided to
business by that account so it is Credited
iii. Increase in Liability is Credit
When the business returns the benefit or repays the
liability, the liability account benefits form the business so
it is Debited
iv. Decrease in Liability is Debit
Financial Accounting
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Lecture 01
Rules of Debit and Credit for Expenses
Just like assets we have to pay for expenses. From assets we
draw benefit for a long time whereas the benefit from
expenses is for a short run.
Therefore Expenditure is just like Asset but for a short run.
Using our rule for Debit and Credit, when we pay cash for
any expense that expense account benefits from cash
therefore it is Debited.
Now we can lay down our rule for Expenditure:
i. Increase in Expenditure is Debit
Reversing the above situation if return any item that we
had purchased we will receive cash in return. Cash
account will receive benefit from that Expenditure
account. Therefore Expenditure account will be credited
ii. Decrease in Expenditure is Credit
Financial Accounting
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Lecture 01
Rules of Debit and Credit for Income/Owners Equity
Income accounts are exactly opposite to expense accounts
just as liabilities are opposite to that of assets.
Therefore using the same principle we can draw our rules of
Debit and Credit for Income
iii. Increase in Income is Credit
iv. Decrease in Income is Debit

Financial Accounting
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Lecture 01
Single Entry Book-Keeping
In single entry book keeping system, as is clear from the
name, only one aspect of the transaction is recorded.
This actually is not a system but is a procedure by which
small business concerns, like retailers and small
shopkeepers, keep record of their sale / income.
In this system there are usually two to three registers
Khata. In one register cash received from customers is
recorded whereas the other one is a person-wise record of
goods sold on credit Udhar Khata. There may or may not
be a register of suppliers to whom money is payable.
Which means that only one aspect of transaction i.e. either
cash receipt or the fact that money is receivable from
someone is recorded.
Financial Accounting
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Lecture 01
Double Entry Book-Keeping
The concept of double entry is based on the fact that every
transaction has two aspects i.e. receiving a benefit and
giving a benefit.
The accounting system that records both the aspects of
transaction in the same books of accounts is called
double entry system.
The account that receives the benefit is debited and the
account that provides the benefit is credited.
Debit and Credit are denoted by Dr and Cr
respectively.
The ultimate result of the system is that for every Debit (Dr)
there is an equal Credit (Cr).
Financial Accounting
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Lecture 01
Systems of Accounting
1. Cash system of accounting: It is a system in which accounting entries
are made only when cash is received or paid. No entry is made when a
payment or receipt is merely due. For example, the rent for December
1985 has not been paid till January 10
th
1986. Under cash basis, rent
expense for the month of December will not be recorded as payment
has not been made. Government system of accounting is mostly on the
cash system.

2. Accrual system of accounting: It is a system in which accounting
entries are made on the basis of amount having become due for
payment or receipt. This system recognizes the factors that if a
transaction or an event has occurred, its consequences cannot be
avoided and therefore, should be brought into book in order to present
a meaningful picture of profit earned or loss suffered.
Financial Accounting
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Lecture 01
Branches of Accounting
1. Financial accounting: It s the original form of accounting. It is mainly
confined to the preparation of financial statements for the use of
outsiders like creditors, banks and financial institutions etc. the chief
purpose of financial accounting is to calculate profit or loss made by
the business during the year and exhibit financial position of the
business as on a particular case.

2. Cost accounting: Function of cost accounting is to ascertain the cost
of a product and to help the management in the control of cost.

3. Management accounting: It is accounting for the management for
example accounting provides necessary information to the
management for discharging its functions. It is the reproduction of
financial accounts in such a way as well enable the management to
take decisions and to control activities.
Financial Accounting
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Lecture 01
Functions of Accounting
1. Record Keeping Functions: The primary function of
accounting is to keep a systematic record of financial
transactions, journalisation, posting and preparing of final
statements. The purpose of this function is to report
regularly to the interested parties by means of financial
statements.

2. Protect Business Properties: The second function of
accounting is to protect the property of the business from
unjustified and unwarranted use. The accountant thus has
to design such a system of accounting which will protect
its assets from an unjustified and unwarranted use.


Financial Accounting
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Lecture 01
Functions of Accounting
3. Legal Requirement Function: The third function of
accounting is to devise such as system as well meet the
legal requirements. Under the provision of law, a
businessman has to file various statements for example,
income tax returns, return for sales tax purpose etc.
Accounting system aims at fulfilling the requirement of
law. Accounting is a base, with the help of which various
returns, documents, statements etc.. Are prepared.

4. Communicating the results: Accounting is the language
of business. Various transactions are communicated
through accounting. There are many parties owners,
creditors, government, employees etc. who are interested
in knowing the results to interested parties. The accounting
show shows a real and true position of the firm or the
business.

Financial Accounting
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Lecture 01
Accounting Concepts
The term concepts includes those basic assumptions or
conditions upon which accounting is based. The following
are the important accounting concepts:
1. Business entity concept
2. Going concern concept
3. Money measurement concept
4. Cost concept
5. Dual aspect concept
6. Accounting period concept
7. Matching concept
8. Realisation concept
Financial Accounting
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Lecture 01
Definition of book keeping.
The word book or books means books of accounts and
keeping implies maintains in proper form and order. Thus
book keeping may be defined as the art of recording business
transaction in books in a regular and systematic manner.

Some Important terms:
a. Transaction g. Sales
b. Business h. Sales Returns
c. Proprietorship i. Trade discount
d. Capital j. Cash Discount
e. Drawings k. Commission
f. Purchases Returns l. Expenditure
Financial Accounting
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Lecture 01
Cash in Hand and Profit
We have said that profit is what is left of income after
deducting the expenses.
Is it the income received in cash less the expenses paid in
cash? Or do we have to consider other things as well?
It can be explained with the help of following example.
A trader purchases some goods from a supplier for Rs. 1,500
and promises to pay in two weeks time. (Remember credit
transactions from lecture 02).
The same day he sells these to a customer for Rs. 2,000 who
pays Rs. 1,000 and promises to pay the balance amount after
one week.
Now at the end of the day the trader has Rs. 1,000 in his
hand. After one week he will have another Rs. 1,000 and he
will pay Rs. 1,500 after two weeks.
Financial Accounting
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Lecture 01
Cash in Hand and Profit
What is the profit? Is Rs. 1,000 that he has in his hand on
day one is his profit.
The answer is No. He still has to receive Rs. 1,000 and pay
Rs. 1,500 to the supplier plus any other expenses that he may
have incurred in the process of this trade.
His actual profit is Rs. 500 less any other expenses that he
incurs, which is the difference of the total amount that he
receives from customer and the amount that he pays to the
supplier less other expenses.
What we understand form this example is that cash in hand
is not always the profit. To work out the profit we have to
consider the total income and total expenses irrespective of
the fact that actual payment has been made or not.
Financial Accounting
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Lecture 01
Accounting Equation Definition
The dual aspect may be stated as for every debit, there is a
credit. Every transaction should have two fold effect to the
extent of same amount. This concept has resulted in
Accounting Equation which states that at any point of time
the Assets of any entity must be equal (in monetary term) to
the total of equities. The properties owned by a business are
called assets. The right to the properties are called equities.
Equities may be sub divided into two principal types: the
rights of the creditors and the rights of the owners. The
Equity of creditors represent debts of the business and are
called liabilities. The Equity of the owners is called capital,
or proprietorship or owners equity.
Financial Accounting
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Lecture 01
Classification of Accounts
We have to date studied following classification of accounts:
Assets,
Liabilities,
Income,
Expenses
o Expenses can be further divided into capital and
revenue expenses.
We have already studied about these classifications in
different lectures but to refresh your memory we will gather
them at one place.
Financial Accounting
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Lecture 01
Assets, Liabilities
ASSETS
Assets are the properties and possessions of the business.
Properties and possessions can be of two types, one that
have physical existence (called tangible) and the others
that have no physical existence (called intangible).
LIABILITIES
Liabilities are the debts and obligations of the business.
Liability is the obligation of the business to provide a benefit
or asset on a future date.

Asset is a right to receive and liability an obligation to pay,
therefore these are opposite to each other.
Financial Accounting
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Lecture 01
Liabilities
Liabilities are the debts and obligations of the business.
Liability is the obligation of the business to provide a benefit
or asset on a future date.
We have discussed credit transactions. Whenever a person
purchases something on credit he promises to pay for the
goods on a future date. This is his obligation to pay cash at a
future date and thus a liability.
Financial Accounting
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Lecture 01
Income, Expenses
INCOME
Income / Revenue is the value of goods or services that a
business charges from its customers. or
The reward / return received from the resources committed
in the business.
EXPENSES
Expenses are the costs incurred to earn the revenue.
The resources spent and the efforts made to earn the income,
when translated in money terms are the expenses of the
business