Principles of Accounting

BS ECONOMIC AND FINANCE

PART-I
Understanding Principles of Accounting:

Chapter Outline
•What Is Accounting and Who Uses Accounting Information?
•Who Are Accountants and What Do They Do?
•Tools of the Accounting Trade
•Financial Statements
•Analyzing Financial Statements
•International Accounting
What is accounting?
The language of business.

A means to communicate financial information.

A way to convey information about a business to users.

Definition:
What Is Accounting?

“An art of recording, classifying, summarizing, and interpreting the

results”,

“Accounting is a comprehensive system for collecting, analyzing and

communicating financial information”
In short,
Accounting information system (AIS) is an organized means by which
financial information is identified, measured, recorded and retained for
use in accounting statements and management reports.

Person who manages all of a firm’s accounting activities (chief

accounting officer
 Benefit
• Accounting allows a company to analyze the financial
performance of the business by looking at net profit.
Functions of Accounting:
1. Record keeping:
Systematic record of financial transactions such as payment, receipts,
credits etc. and report to the interested parties/users
2. Protect Business Parties:
To protect the assets from the unwanted and unjustified use
3. Legal Requirement Function:
As per the provision of Law businessman has to file various statements
e.g. income tax return, sales tax return, etc
4. Communicating the Results:
To highlight the true position of the business entity to the various
external and internal users.
USERS / Parties interested in accounting
Who uses accounting information?
Internal Users
• Owners
To make Decisions
• Managers
External Users
• Investors
• Creditors
• Suppliers
• Banks
• Government (tax assessment)
• Customers
Motive of the Users of Accounting Information

Users Purpose
• Business Managers (for the analysis of the costs)
• Employees and Unions (for the welfare of the employees)
• Investors and Creditors (for the lending and for investment)
• Tax Authorities (for the for the tax purpose)
• Government Regulatory Agencies (to provide infrastructure facilities)
Who Are Accountants and What Do They Do?
• Accountant
The person in charge of accounting, and this individual is typically
required to follow a set of rules and regulations.
Branches of Accounting
Accounting has three main divisions:

1. Financial accounting

2. Management accounting

3. Cost Accounting

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1. Financial accounting
The financial statements are prepared for external users. Like creditors, banks, and
other financial institutions and etc.

Objective:
To show the financial position of the business entity .
For example: Profit and loss

It includes:
Revenues, earnings, assets, etc.

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Financial Statements
• Balance sheets supply detailed information about the accounting equation factors:
Assets:
-Current Assets
-Fixed Assets
-Intangible Assets
Liabilities:
-Current Liabilities
-Long-Term Liabilities
Owners’ Equity:
-Common Stock
-Paid-in Capital
-Retained Earnings
Income statement (or Profit-and-loss statement)
Income statement (or Profit-and-loss statement) lists a firm’s annual
revenues and expenses so that a bottom line shows annual profit or loss.
Three major categories:
Revenues
Cost of Goods Sold
Gross Profit (or Gross Margin)
Operating Expenses
Operating and Net Income
Statement of cash flows
Statement of cash flows describes a firm’s yearly cash receipts and cash
payments.
Three activities:
Cash Flows from Operations
Cash Flows from Investing
Cash Flows from Financing
Why are financial statements analyzed?
Which type of transactions are included in it?
short or long-term, for estimating the risk in investing in a firm.
 Profitability Ratio Financial ratio for measuring a firm’s potential
earnings
 Activity Ratio Financial ratio for evaluating management’s use of a
firm’s assets
Solvency ratios, both short- and long-term, estimate risk.
Liquidity ratio measures a firm’s ability to pay its immediate debts
Current Ratio
Working Capital
2. Cost Accounting:

To Examine the cost of a product

That provide help a business manager to take rational decision about

to launch a new product, modify the existing product, and to control
the cost of product.
What is the Budget?

Detailed statement of estimated receipts and expenditures for a future

period of time
Short-Term Solvency Ratios Liquidity Ratio
Short-Term Solvency Ratios Liquidity Ratio Solvency ratio measuring a
firm’s ability to pay its immediate debts Current Ratio Solvency ratio
that determines a firm’s credit worthiness by measuring its ability to pay
current liabilities.
Short-Term Solvency Ratios Working Capital
• Short-Term Solvency Ratios Working Capital Difference between a
firm’s current assets and current liabilities Quick (or Acid-Test) Ratio
Solvency ratio for determining a firm’s ability to meet emergency
demands for cash Quick Asset Cash plus assets one step removed from
cash (marketable securities and accounts receivable) Quick assets
$7,050 2,300 26,210 650 1.59 Current liabilities $21,935 24
Long-Term Solvency Ratios Debt Ratio
• Long-Term Solvency Ratios Debt Ratio Solvency ratio measuring a
firm’s ability to meet its long-term debts Debt-to-Owners’ Equity
Ratio (or Debt-to-Equity Ratio) Solvency ratio describing the extent to
which a firm is financed through borrowing Debt A firm’s total
liabilities Debt $61,935 0.56 Owners'equity $111155 , 25
Profitability Ratios Net Profit Margin
• Profitability Ratios Net Profit Margin (or Return on Sales)
Profitability ratio indicating the percentage of its income that is a
firm’s profit Net income $12,585 0.049 4.9% Sales $256,425 Return
on Equity Profitability ratio measuring income earned for each dollar
invested Net income $12,585 11.3% T otalowners'equity $111155 , 26
Profitability Ratios Earnings Per Share
Profitability Ratios Earnings Per Share Profitability ratio measuring the
size of the dividend that a firm can pay shareholders Net income
$12,585 $1.57per share Number of common shares outstanding 8,000
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Activity Ratios Inventory Turnover Ratio
• Activity Ratios Inventory Turnover Ratio Activity ratio measuring the
average number of times that inventory is sold and restocked during
the year Cost of goods sold Cost of goods sold Average inventory
(Beginning inventory Ending inventory) /2 $104,765 4.8 times ($22,380
$21,250)/2 28
3. Management accounting

 It is the reproduction of financial accounts. Primarily for internal

purposes.
 Provide the information to the management to enable them take
decisions and control activities.

It includes:
-Costing,
-budgeting,
-net present value, etc.

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Cash in business through several ways

• Investment by owners
• Investment by creditors (loans)
• Investment in other entities (equity Investment)
• Payments from customers (Sales)
• Repayment of amounts loaned to other entities
• Return on investments (interest and dividend)
• Proceeds from selling assets.

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System of Accounting:
1. Cash system of Accounting:
The accounting entries are made or recorded upon the receipt of cash
are payment made in cash.

2. Accrual System of Accounting:

The accounting entries are made of those amounts which are due for
payment or receipt later on. The entries has effect on profit and loss
of the entity.
Book Keeping Vs Accounting
Book Keeping:
It is the first phase of business data is recorded in different sets which
shall be used as for the preparation various types of reports / account
statements.
Mostly the work of the book keeper is clerical nature.
Accounting:
Accounting is an organized means by which financial information is
identified, measured, recorded and retained for use in accounting
statements.
Accountant who manages all of a firm’s accounting activities direct
and review the work of the book-keepers.
Accounting Cycle:
The Accounting Cycle is complete when the business publishes
financial statements for the period.

The cycle begins with the first financial transactions of the period and
their entry into a journal.

The cycle ends when the organization makes final end-of-period

account adjustments, closes temporary accounts, and publishes
financial statements for the period just ended.
Accounting Cycle:
Financial transactions:
Identifying all transactions. As shown in the table
Revenue Earned Asset purchase Expense

Customer Cash Payment Borrowing Sale Closing

-
Account Receivable - Bad Debt Write Off Dividend Declared

(2)Journal entries:
Recording these transactions in a journal in chronological order.
(means
in the
Dateorder in which the events occurred,Debit
Account from first to last) Credit

6-Feb-2023  101   Cash on hand $1,200  

6-Feb-2023  110      Accounts receivable $1,200
Accounting Cycle
3. Posting to the Ledger,
It is the process of transferring journal entries to their accounts in the
ledger.
Account 101 Cash in Hand
Debit Credit DR-Balance
5,000
6-Feb-2023 1,200 6,200

110      Accounts receivable

Debit Credit DR-Balance
- 6,200
6-Feb-2023 - 1,200 5,000
Accounting Cycle
4. Trial Balance Period
The sum of all debits entries = total credit entries made during the
period.
A mismatch between these sums indicates the presence of a
transaction error somewhere in the system.
In case of mismatch the temporary adjustment accounts are created.
Ledger are then corrected
5. Reporting Period / Summarizing:
To prepare the final accounts with financial reporting and auditing.
Final accounts show the financial position of the firm either it is in
profit or loss during a particular period. For Example trial Balance
Accounting Cycle:
First Stage- Recording of transactions:
Recording of business transactions in the prescribed manner in the Books
of original entry which is known as subsidiary Book or Journal when they
take place.
Second Stage- Classifying:
All the entries of the subsidiary books should be posted in the appropriate
ledger accounts to find out total effect of these transaction in a particular
account. For example Investment Ledger, Borrowing Ledger, Equity
ledger, etc.
Third Stage- Summarizing:
To prepare the final accounts. Final accounts show the financial position of
the firm either it is in profit or loss during a particular period. For Example
trial Balance
Two types of investment in a company

• Equity Investment
Through the issuance of shares

• Debt Investment
Through the loan

Introduction to Accounting 35
The Accounting Equation
• The Accounting Equation Assets = Liabilities + Owners’ Equity

• Asset is any economic resource expected to benefit a firm or an

individual who owns it.
• Liability is a debt owned by a firm to an outside organization or
individual
• Owners’ equity is the amount of money that owners would
receive if they sold all of a firm’s assets and paid all of its
liabilities.
What is GAAP (or Generally Accepted
Accounting Principles)?
• Accepted rules and procedures governing the content and form of
financial reports
What is an Audit?
• Systematic examination of a company’s accounting system to
determine whether its financial reports fairly represent its operations
Book Keeping
• Book Keeping is the art of recording business dealings in a set of
books”. (J.R.Batliboi)
OR
• A systematic record of the daily (and hourly ) events of a business
leading to the presentation of a complete financial picture is known as
Accounting or in its elementary stage as BOOK KEEPING.
• (M.C Shukla).
• Bookkeeping system that balances the accounting equation by
recording the dual effects of every financial transaction
• Bookkeeping is the recording of transactions.
Objects of Book Keeping
• Provided
What is Double-Entry Accounting?
• Bookkeeping system that balances the accounting equation by
recording the dual effects of every financial transaction
Functions of Accounting:
1. Recording Keeping:
It is primary function of accounting