1.1

BASICS OF FINANCIAL ACCOUNTINGDr. Makesh K.G

LEARNING

Rules of Accounting

Basic Accounting Processes

Documents in Accounting

Class Room Etiquette

Ask Doubts Carry Doubts

DO DO NOT

Very Attentive Sleep, Talk, Dream

Punctual Skip Classes

Constructive Negative

Use Resources Ignore Resources

FOUNDATION TO ACCOUNTING

Pr imary TargetStudents with NO Accounting backgroundStudents with background expected to be positive

Importance of Foundati onSemester 1: Financial AccountingSemester 2: Cost and Management AccountingSemester 3: Financial Management 1 [Common Paper]

1: May change with University Syllabus

O b j e c ti v e s o f t h e C o u r s e

● Familiarize with accounting terminologies

● Acquaint with Accounting Processes

● Appreciate the need for accounting

● Develop Expertise in Accounting activities

MEANING AND TYPES OF ACCOUNTING

Simply means recording business activitiesSystematic method

Types of Accounting● Financial Accounting● Management Accounting● Cost Accounting

N e e d fo r A c c o u n ti n g

● is the “Language of Business”

● Means of Communication of business results

● Not limited to corporate uses

● Housewives, government etc. uses it

● Probably every layman uses it, may be sub-consciously

● Part of common life

Note for Non-Commerce Students

You are Not learning a new subject, rather a new LANGUAGE

Remember how much you persevered

Commit yourself with relentless efforts

N e e d fo r A c c o u n ti n g

…be better off than this !!

● How would a typical home-maker’s accounts diary look like?

TOTAL 12,000 8,300

A c c o u n ti n g i n D a i l y L i fe

Items Receipts Payments

SalaryGroceriesElectricity BillStationeries Home repairsCash gifts from relativesClothing

10,000--------

2,000--

--500300

2,0003,000

--2,500

Balance -- 3,700TOTAL 12,000 12,000

D e fi n i ti o n o f A c c o u n ti n g

“The art of recording, classifying and summarizing the transactions in a business, in terms of money”

FUNCTIONS OF ACCOUNTINGRecording ●Classifying ●

Summarizing ●Analyzing ●

Interpreting ●Communicating ●

INTRODUCTION

Knowing 2 aspects are important for a business

● Is the business PROFITABLE ?…It may be making losses or profits

● How good is its FINANCIAL POSITION ?…It may be getting richer or poorer

I N T R O D U C T I O N

● How to know if business is Profitable?For a period, prepare

PROFIT and LOSS ACCOUNTKnown as Period Statement

● How to know if businesses’ Financial Position is good?On a date, prepare

BALANCE SHEETKnown as Position Statement

BALANCE SHEET

Shows the Financial Position of the firm2 items are included:ASSETS

Economic resources owned by businessUsed in business for productive purposes

LIABILITIESObligations owed to other partiesBurden on business

Assets and Liabilities should be Equal

S t r u c t u r e o f B a l a n c e S h e e t

LIABILITIES Rs. ASSETS Rs.

Capital --Long term Loan --Reserves --Provision --

Plant &Machinery --Land & Building --Stock --Investments --

Creditors --Bills Payable --Advance Income --Outstanding Expense --Overdraft --

Debtors --Bills Receivable --Accrued Income --Advance Expense --Cash --

TOTAL -- TOTAL --

PROFIT AND LOSS ACCOUNT

Shows Profits/Losses of business [Bottom line]2 items are included:INCOMES

Objective for which business is runGenerated from major activity

EXPENSESSuffered for generating income

Difference of Income and expense gives Profits/Losses

S t r u c t u r e o f P r o fi t a n d Lo s s A c c o u nt

EXPENSES Rs. INCOME Rs.

Opening Stock --Purchases --Wages --Direct Expenses --

Closing Stock --Sales --Discount Received --Interest received --

Discount Allowed --Bad-debts --Depreciation --Postage, Telegram --Provision --

TOTAL -- TOTAL --

PROFITS --

E xe rc i s e

● Prepare a Balance Sheet from the following figures

CashOverdraftMachineCreditorsBills ReceivableLoanOutstanding Expense

10060

1206040

20040

InvestmentsBuildingBills PayableCapitalStockAdvance IncomeReserve

50703040601080

E xe rc i s e

● Prepare a Profit and Loss A/c from the following figures

Opening stockBad debtsInterest receivedDepreciationDiscount allowedProvision for bad-debtsWages

30104020102050

Closing stockPurchasesSalesDirect expensesDiscount receivedPostageSalaries

50200320

40203060

PROCESS OF ACCOUNTING

Initiated by a business transactionTransaction should be:

● Financial in nature ● Supported by Documentary evidence

……like bills, invoice, cheques etc.Now recorded in books of accounts

S T E P S I N P R O C E S S O F A C C O U N T I N G

●Identify financial

transactionAuthenticate by

documents

Record in JournalPost to Ledger

Make Adjustment Entries

Prepare Trial Balance

Prepare Final Accounts

BASIS OF ACCOUNTING

2 bases of accounting ● CASH BASIS ● ACCRUAL BASIS

C A S H B A S I S O F AC C O U N T I N G

Make entries when: ● CASH is paid for Expense ● CASH is received for income

Profits will be based on cash flows

Cash inflow Less: Cash Outflow = Cash Profits

Method followed by professionals like doctors, lawyers

Cash received as Consultation FeeLess: Cash paid as staff salary

1000850

CASH PROFITS 150

A C C RUA L B A S I S O F A C C O U N T I N G

Make entries when: ● Expense is incurred – whether paid out or not ● Income is earned – whether received or not

PERIOD is very importantIncludes CASH and CREDIT transactions

Profits will NOT be based on cash flowsIncome Less: Expense = Profits

Method followed by large corporate houses

A C C RUA L B A S I S O F A C C O U N T I N G

Accounting period is Jan. 1 to Dec. 31, 2012The following transactions happened in the period:

Cash received as Fees in 2012: Rs. 10,000Fees for 2012, not yet received: Rs. 2000Fees for Jan 1- Dec. 31, 2013, received in 2012: Rs. 1500

What is the income of 2012 ?

ACCOUNTING EQUATION

Based on DUAL ASPECT principle of accountingMeans all transaction has 2 aspects

● Debit Aspect, and ● Credit Aspect

The equation is:Capital + Liabilities = Total Assets

Capital: owed to the ownerLiability: owed to others

A C C O U N T I N G EQ UAT I O N

Holds good at all times

Started business with Rs. 10,000


CapitalLiability

10,0000

Cash 10,000

TOTAL 10,000 TOTAL 10,000



Took bank loan of Rs. 5,000


CapitalLoan

10,0005000

Cash 15,000




Bought Building for Rs. 8,000


CapitalLoan

10,0005000

BuildingCash

8,0007,000




Bought goods for Rs. 3000


CapitalLoan

10,0005,000

BuildingGoodsCash

8,0003,0004,000




Bought goods for Rs. 1000 on CREDIT


CapitalLoanCreditors

10,0005,0001,000

BuildingGoodsCash

8,0004,0004,000




Repaid Loan Rs. 2,000


CapitalLoanCreditors

10,0003,0001,000

BuildingGoodsCash

8,0004,0002,000


TYPES OF ACCOUNTS

Account : is a special statement dealing with one item

eg. Machine AccountTalks about every thing happening to machine

Traditional Classification of Accounts● PERSONAL ACCOUNT● REAL ACCOUNT● NOMINAL ACCOUNT

T Y P E S O F AC C O U N T S

● PERSONAL ACCOUNTNatural Person: Mr. X, Creditor, DebtorArtificial Person: BankRepresentative Person: Capital

● REAL ACCOUNTTangible: Machine, LandIntangible: Patent, Trademark

● NOMINAL ACCOUNTExpenses, Losses: Wages, SalariesIncomes, Gains: Interest received


PERSONAL ACCOUNTS

Mr. X : Natural Person

Creditor : Natural Person

Debtor : Natural Person

Capital : Representative Person

Bank : Artificial Person

Drawings : Representative Person 1

1 Drawings can be of Cash [capital] or goods


REAL ACCOUNTS

Plant, Machine : Physical Asset

Land, Building : Physical Asset

Copyright, Patent, Trademark : Intangible Asset

Cash : Physical Asset


NOMINAL ACCOUNTS

Salaries, Wages, Rent : Expense

Carriages IN/OUT : Expense

Interest Received : Income

Interest, Dividend Paid : Income


What type of Account is Purchases Account ?

● PurchasesGoods bought for sale in course of business

● Purchase ReturnsGoods returned to supplier due to poor quality

● SalesGoods sold in course of business

● Sales ReturnsGoods returned by customer due to poor quality

● All four related to GOODS which are Assets● All are REAL ACCOUNTS


What type of Account is Pre-Paid Rent Account ?

Obviously RENT is a NOMINAL Account

● Outstanding ExpenseExpense Incurred, Not Yet Paid off

● Advance ExpenseExpense Not Yet Incurred, but already Paid off

● Accrued IncomeIncome Earned, Not Yet Received

● Advance IncomeIncome Not Yet Earned, but Received already

● All four are PERSONAL ACCOUNTSRule: Pre-fix Added to Nominal account: becomes Personal account

RU L E S O F D E B I T A N D C R E D I T

● PERSONAL ACCOUNTCREDIT the Giver, DEBIT the Receiver

● REAL ACCOUNTCREDIT what Goes Out, DEBIT what Comes In

● NOMINAL ACCOUNTCREDIT all Incomes/Gains, DEBIT all Expenses/Losses


Capital Contributed by Owner

● 2 things happen:

1. Owner gives Capital 2. Money comes In

● 2 accounts are affected:1. Owners’ Capital Account: Personal Account2. Cash Account: Real Account

● Rules of Debit/Credit:1. Owner’s Account: Personal a/c: GIVER: CREDIT the Giver

2. Cash Account: Real a/c: COMES IN: DEBIT what Comes In


Bought Machinery

● 2 things happen:

1. Machine Comes In 2. Cash Goes Out

● 2 accounts are affected:1. Machine Account: Real Account2. Cash Account: Real Account

● Rules of Debit/Credit:1. Machine Account: Real a/c: COMES IN: DEBIT what Comes In 2. Cash Account: Real a/c: GOES OUT: CREDIT what Goes Out

MAINTENANCE OF ACCOUNTS

Transactions are recorded as:

JOURNALBook of Original EntryChronological order – cluttered with different types

LEDGERPosted from JournalHomogenous group

JOURNAL ENTRY

JOURNAL : Book of Original Entry

Started business with capital Rs. 10,000

Bought machine for Rs. 5,000

Date Particulars Debit CreditJan. 1 Cash account Dr.

To Capital account10,000

10,000

Date Particulars Debit CreditJan. 5 Machine account Dr.

To Cash account5,000

5,000

J O U R N A L E N T RY

Started business with capital Rs. 20,000Bought Goods for Rs. 10,000Deposited into Bank Rs. 5,000Sold Goods for Rs. 12,000Bought furniture for Rs. 2,000 paid by chequePaid telephone charges Rs. 200Withdrew cash for personal use Rs. 500Withdrew goods for personal use Rs. 1,000

COMPOUND JOURNAL ENTRY

One transaction affects more than 2 accounts

eg. Paid to Ram Rs. 1000, and he allowed a discount Rs. 100

3 accounts are affected:1. Cash Account: Goes Out – CREDIT2. Ram’s Account: Recipient – DEBIT3. Discount Received Account: Income – CREDIT

Date Particulars Debit Credit

Jan. 5 Ram’s a/c Dr. To Cash a/c

To Discount Received a/c

1,000900100

C O M P O U N D J O U R N A L E N T RY

Prepare compound journal entry

1. Customer owing Rs. 1000 offered payment; on payment allowed discount of Rs. 150

2. Paid for Salaries [Rs. 500] and Telephone charges [Rs. 200]

POSTING TO LEDGER

LEDGER : homogeneous Set of items

All causes of cash coming in and going out are recorded hereDebit Side: cash coming inCredit Side: cash going out

Debit Cash Account CreditDate Item Rs. Date Item Rs.

To… By…

P O S T I N G TO L E D G E R

Debit Cash Account CreditDate Item Rs. Date Item Rs.Jan 1 To Capital 1000 By…

Date Particulars Debit CreditJan. 1 Cash account Dr.

To Capital account1000

1000

Debit Capital Account CreditDate Item Rs. Date Item Rs.

To.. Jan 1 By Cash 1000

P O S T I N G TO L E D G E R

Prepare a Cash Account and find the cash balance

Jan.1: Started business Rs. 10,000Jan.9: Bought goods Rs. 5,000Jan.17: Deposited into bank Rs. 2,000Jan.22: Paid to Mr. X Rs. 500Jan.31: Received from Mr. Y Rs. 1,000

B A L A N C I N G A L E D G E R

Balancing figure equates Debit and Credit columnsShows how much Cash is at hand

Debit Cash Account CreditDate Item Rs. Date Item Rs.Jan. 1Jan. 31

To CapitalTo Mr. Y

10,0001,000

Jan. 9Jan. 17Jan. 22

By PurchasesBy BankBy Mr. X

5,0002,000

500


Feb. 1--

To Balance b/d--

3,500--

-- -- --

Debit Cash Account CreditDate Item Rs. Date Item Rs.Jan. 1Jan. 31

To CapitalTo Mr. Y

10,0001,000

Jan. 9Jan. 17Jan. 22Jan. 31

By PurchasesBy BankBy Mr. XBy Balance c/d

5,0002,000

5003,500


TRIAL BALANCE

Made of balances drawn out from ledger accountsTo check arithmetical accuracy of accountsPrepared towards end of a periodPrepared before P&L and B/S

TRIAL BALANCEParticulars Debit Credit

CashCapitalMachinePurchasesSales

6,000--

5,0003,000

--

10,000----

4,000TOTAL 14,000 14,000

T R I A L B A L A N C E

Prepare a Trial Balance

Statement of Ledger balancesParticulars Rs. Particulars Rs.

CashCapitalMachinePurchases

4,00010,000

6,00012,000

DebtorsCreditorsBankSales

3,0006,0005,000

14,000


Prepare Journal, Ledgers, Trial Balance, and final accounts as on Jan 31.

1 Jan. Started business with Rs. 25,0005 Jan. Bought Building for Rs. 12,00010 Jan. Bought goods for Rs. 10,00020 Jan. Paid wages for Rs. 5,00025 Jan. Sold entire goods for Rs. 20,000


Prepare Journal, Ledgers, Trial Balance, and final accounts as on Jan 31.

1 Jan. Started business with Rs. 50,0005 Jan. Bought Machine for Rs. 25,00010 Jan. Bought Goods for Rs. 20,000 on credit20 Jan. Paid wages for Rs. 5,00025 Jan. Sold Goods [costing Rs. 15,000] Rs. for Rs. 30,000 on

creditDEBTORS A/C DRTO SALES

ADJUSTMENT ENTRIES

Needed due to peculiar itemsAdjustments to accounts to make it more realistic

Why……?Some items are known only after preparing Trial BalanceMeans……………Some items NOT included in Trial BalanceMake entries, Modify Trial BalanceThen prepare Final accounts

A D J U S T M E N T E N T R I E S

• Closing Stock• Outstanding Expense• Prepaid Expenses• Accrued Income• Advance Income• Depreciation• Bad debts• Provision for bad debts• Provision for Discount on Debtors• Reserve for discount on Creditors• Interest on Capital• Interest on Drawings


● CLOSING STOCKRemember:Opening stock given INSIDE the Trial BalanceClosing stock given OUTSIDE the Trial BalanceBoth Opening and Closing Stock will NEVER be inside Trial

Balance together…………………………….If one is in, the other is out

Date Particulars Debit CreditDec. 31 Closing stock Dr.

To Trading and P&L a/c--

--


● OUTSTANDING EXPENSEExpense Incurred, Not yet paid in Cash

Wages paid Rs. 5,000

Accountant comes to know that Wages of Rs. 1000 is NOT yet paid

Extract of Trial BalanceParticulars Debit Credit

CashWages

--5,000

5,000--

TOTAL 5,000 5,000


● OUTSTANDING EXPENSE ……………. continuedPass Adjustment entry

Date Particulars Debit CreditDec. 31 Wages a/c Dr.

To Outstanding Wages a/c1000

1000

Extract of Trial BalanceParticulars Debit Credit

CashWagesOutstanding Wages

--6,000

5,000--

1000TOTAL 6,000 6,000


● OUTSTANDING EXPENSE ……………. continuedImpact on Final Accounts

Dr. Profit and Loss Account Cr.Expense Rs. Income Rs.

Wages paidAdd: O/S wage

50001000 6000

Balance SheetLiability Rs. Asset Rs.

Outstanding Wages 1000


● PROVISION FOR BAD-DEBTSThe following points are important:

1. Provision is a PREPAREDENESS to meet FUTURE bad debts

2. Is done at year-end, taking from P & L

3. Is created by DEBIT-ing the current year’s P & L Account

4. Taken to Liability side of current year’s Balance Sheet

5. Available to meet NEXT YEAR’S bad debts

6. NOT available for current year’s bad debts

7. Current year’s Bad debt is charged to P & L as usual

8. Next year’s bad debt is charged to Provision for Bad Debts

9. Replenishment to Provision happens from P&L year on


● Provision for Bad-Debts……CREATION in current year

Dr. Profit and Loss Account [Current Year] Cr.Expense Rs. Income Rs.

To Bad debtsTo Provision for B/D

xxxxxx

Balance Sheet [Current Year] Liability Rs. Asset Rs.

Provision for B/D xxx Debtors xxx


● Provision for Bad-Debts…CHARGE of BAD DEBTS next year

Dr Provision for B/D [Next Year] Cr.Expense Rs. Income Rs.

To Bad DebtsTo Closing balance

xxxxxx

By Opening balanceBy P & L

xxxxxx

Balance Sheet [Next Year] Liability Rs. Asset Rs.

Provision for B/D xxx Debtors xxx

CLOSING ENTRIES

Trial balance is prepared from ledger balances

All ledgers are closed: ● At year-end ● After preparing Trial Balance

Balances in ledgers taken either to: ● Profit and Loss account, or ● Balance Sheet

C LO S I N G E N T R I E S

● Ledgers taken to PROFIT AND LOSS ACCOUNT

Following ledgers are closed by transferring balances to P&L: ● All NOMINAL Accounts ● All GOODS Accounts [6 types]

Dr. Expense Account Cr.Item Rs. Item Rs.

To Cash 1000 By Balance 1000

TOTAL 1000 TOTAL 1000

Taken to Trial Balance


● Ledgers taken to PROFIT AND LOSS ACCOUNT

Following ledgers are closed by transferring balances to P&L: ● All NOMINAL Accounts ● All GOODS Accounts [6 types]

Dr. Expense Account Cr.Item Rs. Item Rs.

To Cash 1000 By P and L 1000

TOTAL 1000 TOTAL 1000


● Ledgers taken to BALANCE SHEET

Following ledgers are CARRIED to next year by transferring balances to Balance Sheet ● All REAL Accounts ● All PERSONAL Accounts

Dr. Machine Account Cr.

Item Rs. Item Rs.To Cash 1000 By Closing Balance 1000

TOTAL 1000 TOTAL 1000To Opening Balance 1000

A d j u s t m e nt E nt r i e s

1. Bought machine Rs. 50,000, and incurred installation charges Rs. 5,000

2. Bought goods from Mr X, Rs. 50,000, returned goods worth RS. 2,000 being poor in quality

3. Sold goods Rs. 60,000, customer returns goods worth Rs. 1,000 being poor in quality

4. Incurred wages Rs. 15,000, paid only Rs. 12,000

5. Paid insurance premium for next year Rs. 2,500

6. Commission payable to agents is Rs. 2000

7. Create Provision for Bad debts Rs. 5,000

8. Charge bad debts Rs. 1,000 to Provision for bad debts

F i n a l A c c o u n t s

Prepare a Manufacturing Account for year ended 31-12-08

Stock on 1-1-08: Raw Material Work-in-Progress

10,0005,000

Stock on 31-12-08: Raw Material Work-in-Progress

5,00015,000

Purchase of Raw MaterialDirect WagesCarriagesFactory PowerFactory DepreciationFactory Repairs

50,00010,000

2,5002,000

10,0001,500

F i n a l A c c o u n t s

Prepare Manufacturing & Trading Account

Raw Materials purchased in the year Rs. 50,000Sale of finished goods Rs. 1,00,000

Stock on 1-1-08: Raw Material W-in-P Finished Goods

3,5002,000

18,000

Carriage InwardsWagesFactory PowerPacking of Finished GoodsCartage of Finished Goods

1,10027,000

2,0003,0001,000Stock on 31-12-08

Raw Material W-in-P Finished Goods

4,0004,500

28,000

F i n a l A c c o u n t s w i t h A d j u s t m e nt

Pass Journal Entries and create Debtors accountOpening balance of Debtors Rs. 25,000. Following transactions happened in the year:1. Sold goods on credit Rs. 30,0002. Received from Debtors Rs. 18,0003. Debtors worth Rs. 10,000 make payment, and firm allows

them a discount of Rs. 2,0004. Bad debts incurred Rs. 2,5005. Create Provision for Bad debts @ 10% of closing balance of

debtors

Also show the impact of these transactions on P&L Account and Balance Sheet


Closing stock is Rs. 6,000; Wages unpaid is Rs. 2,000; Depreciate machine by 10 %. Prepare final accounts

Particulars Debit CreditCapitalCashWagesOpening stockPurchase and SalesReturnsSalaryMachineDebtors and CreditorsLoan

--10,000

5,0004,000

50,0002,000

15,00015,00020,000

--

20,000------

80,0001,000

----

15,0005,000

TOTAL 1,21,000 1,21,000


a. Closing Stock Rs. 3,000b. Additional Bad Debts Rs. 500

c. Owner withdrew Rs. 5,000 from business

d. Interest on Drawings 10 %e. Interest on Capital 10 %

f. Create Provision for Bad debts at 10 % of debtors

Item Dr. Cr.CapitalDebtorsMachineryPurchasesSalesOpening StockCashSalariesBad-DebtsInterest

--20,00010,00025,000

--3,0009,0002,0001,000

--

30,000------

38,000------

2,000TOTAL 70,000 70,000

Also called Accounting standardsRules universally followed in accountingGoverns the Theory and Procedures in accounting

2 categories of Principles:● ACCOUNTING CONCEPTS● ACCOUNTING CONVENTIONS

ACCOUNTING PRINCIPLES

A C C O U N T I N G P R I N C I P L E S

AC CO U N TI N G CO N C E PTS

1. Separate Entity2. Going Concern3. Money Measurement4. Cost5. Dual Aspect6. Accounting Period7. Matching of Revenue and Cost8. Realization

AC CO U N TI N G CO N V E N TI O N S

1. Conservatism2. Full Disclosure3. Consistency4. Materiality

A C C O U N T I N G P R I N C I P L E S

1.1

Economy & Finance

cash basis of accounting

accounting equation

accounting activities

process of accounting

accounting terminologies

definition of accounting

principle of accounting

financial accounting