INTRODUCTION TO FINANCIAL

ACCOUNTING
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ACCOUNTING
 Accounting is the information system that measures
business activities, processes data into reports, and
communicates results to decision makers.
 a process of identifying, recording, summarizing, and

reporting economic information to decision makers in the

form of financial statements.
 Definitions of Accounting

 “The process of identifying, measuring, and communicating

economic information to permit informed judgments and

decisions by users of the information.” —American
Accounting Association (AAA

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BASIS FOR BOOKKEEPING ACCOUNTING
COMPARISON

Meaning Bookkeeping is an activity of Accounting is an orderly

recording the financial recording and reporting of the
transactions of the company in financial affairs of an
a systematic manner. organization for a particular
period.

What is it? It is the subset of accounting. It is regarded as the language of

business.
Decision Making On the basis of bookkeeping Decisions can be taken on the
records, decisions cannot be basis of accounting records
taken.

Preparation of Not done in the bookkeeping Part of Accounting Process

Financial process
Statements

Tools Journal and Ledgers Balance Sheet, Profit & Loss

Account and Cash Flow
Statement

Methods / Sub- Single Entry System of Financial Accounting, Cost

fields Bookkeeping and Double Entry Accounting, Management
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System of Bookkeeping Accounting, Human Resource
Accounting, Social Responsibility
Accounting.
OBJECTIVES OF FINANCIAL
ACCOUNTING

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 To know the results of business – via profit and loss account
or income and expenditure account
 To ascertain the financial position of the business – the
extent of assets and liabilities at any point of time through
preparation of balance sheet
 To ensure control over the assets – important in prevention
of frauds, misappropriation and losses
 To facilitate proper management of cash – surplus fund can
be used in profitable ventures and deficiency of cash can be
overcome by preparing for funds from bankers etc
 To provide requisite information – information to the govt
and tax authorities with great ease, as and when needed

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ACCOUNTING AS AN AID TO
DECISION MAKING
Accounting helps in decision making by
showing where and when money has been
spent, by evaluating performance, and by
showing the implications of choosing one
plan instead of another.
 Fundamental relationships in the decision-

making process:
Accountant
’s analysis Financial
Event and Users
statement
recording

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BRANCHES OF ACCOUNTING

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BRANCHES OF ACCOUNTING

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USERS OF ACCOUNTING
INFORMATION
External Internal
Users Users

Shareholder
Managers
s

Lenders Dept Heads

Budget
Government 8
officers
SOME DEFINITIONS TO
REMEMBER:
Assets
 What is an asset?
 It is something a company owns which has

future economic value.

– land
– building
– equipment
– goodwill

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SOME DEFINITIONS TO
REMEMBER
 Liability
 What is a liability?

 It is something a company owes.

– money
– service
– product

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SOME DEFINITIONS TO
REMEMBER:
Revenues
 What are revenues?
 They are amounts received or to be received

from customers for sales of products or

services.
– sales
– performance of services
– rent
– interest
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SOME DEFINITIONS TO
REMEMBER:
Expenses
 What are Expenses?
 They are amounts that have been paid or will

be paid later for costs that have been

incurred to earn revenue.
– salaries and wages
– utilities
– supplies used
– advertising
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SOME DEFINITIONS TO
REMEMBER:
Owner’s Equity
 What is owner’s equity?
 It is what’s left of the assets after liabilities

have been deducted.

– the same as net assets
– the owner’s claim on the entity’s assets

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SOME DEFINITIONS TO
REMEMBER:
 Inventory - goods held by a firm for resale to
customers
 Account payable - a liability that results from

the purchase of goods or services on account

 Compound entry - a transaction that affects

more than two accounts

 Creditor - one to whom money is owed

 Debtor - one who owes money

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THE BASIC ACCOUNTING
EQUATION
 Accounting data is represented by the
following relationship among the assets,
liabilities and owners’ equity of a business:
 Assets = Liabilities + Owners’ Equity

 The equation must be in balance after every

recorded transaction in the system.

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GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES
 What is the primary objective of financial
Accounting and Reporting?

To provide information useful for

making investment and
lending decisions

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GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES AND BASIC CONCEPTS
 If every accountant used his or her own rules
for recording transactions, the financial
statements would be useless in making
comparisons.
 Therefore, accountants have agreed to apply

a common set of measurement principles (a

common language) to record information for
financial statements. Otherwise, decision
makers could not use or compare financial
statements.

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ACCOUNTING:
PRINCIPLES AND CONCEPTS
 Accountants follow professional guidelines
 The rules that govern accounting are called

GAAP (generally accepted accounting

principles).
 Generally accepted accounting principles

(GAAP) - a term that applies to the broad

concepts or guidelines and detailed practices
in accounting, including all the conventions,
rules, and procedures that make up accepted
accounting practice at a given time
 Securities And Exchange Commission (SEC)
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 Financial Accounting Standards Board (FASB)
STANDARD SETTING BODIES
 International Accounting Standards Board
(IASB) - an organization representing over
143 accountancy boards from 104 countries
that is developing a common set of
accounting standards to be used throughout
the world
 Interest in harmonizing accounting standards

around the world by eliminating differences

in accounting principles has grown.
– Investors are committing more of their
money worldwide.
 Many multinational companies voluntarily

issue their financial statements in conformity 19

with the IASB standards.

ACCOUNTING CONCEPTS &
CONVENTIONS
 Business entity
 Money Measurement/stable monetary unit
 Going Concern
 Historical Cost
 Prudence/conservatism
 Materiality

 Objectivity

 Consistency

 Accruals/matching

 Realization

 Uniformity

 Disclosure 20

 Relevance
 BUSINESS ENTITY
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BUSINESS ENTITY
 Meaning
 The business and its owner(s) are two separate
existence entity
 Any private and personal incomes and expenses
of the owner(s) should not be treated as the
incomes and expenses of the business

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 Examples
 Insurance premiums for the owner’s house should
be excluded from the expense of the business
 The owner’s property should not be included in the
premises account of the business
 Any payments for the owner’s personal expenses
by the business will be treated as drawings and
reduced the owner’s capital contribution in the
business

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 MONEY MEASUREMENT
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MONEY MEASUREMENT

 Meaning
 All transactions of the business are recorded in
terms of money
 It provides a common unit of measurement
 Examples
 Market conditions, technological changes and the
efficiency of management would not be disclosed
in the accounts

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 GOING CONCERN CONCEPT
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GOING CONCERN
 Meaning
 The business will continue in operational
existence for the foreseeable future
 Financial statements should be prepared on a
going concern basis unless management either
intends to liquidate the enterprise or to cease
trading, or has no realistic alternative but to do
so

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 Example
 Possible losses form the closure of business will
not be anticipated in the accounts
 Prepayments, depreciation provisions may be
carried forward in the expectation of proper
matching against the revenues of future periods
 Fixed assets are recorded at historical cost

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 HISTORICAL COST
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HISTORICAL COST
 Meaning
 Assetsshould be shown on the balance sheet at
the cost of purchase instead of current value
 Example
 Thecost of fixed assets is recorded at the date of
acquisition cost. The acquisition cost includes all
expenditure made to prepare the asset for its
intended use. It included the invoice price of the
assets, freight charges, insurance or installation
costs

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 PRUDENCE/CONSERVATISM
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PRUDENCE/CONSERVATISM

 Meaning
 Revenues and profits are not anticipated. Only
realized profits with reasonable certainty are
recognized in the profit and loss account
 However, provision is made for all known expenses
and losses whether the amount is known for
certain or just an estimation
 This treatment minimizes the reported profits and
the valuation of assets

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 Example
 Stock valuation sticks to rule of the lower of cost
and net realizable value
 The provision for doubtful debts should be made
 Fixed assets must be depreciated over their useful
economic lives

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 MATERIALITY
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MATERIALITY

 Meaning
 Immaterial amounts may be aggregated with the
amounts of a similar nature or function and need
not be presented separately
 Materiality depends on the size and nature of the
item

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 Example
 Small payments such as postage, stationery and
cleaning expenses should not be disclosed
separately. They should be grouped together as
sundry expenses
 The cost of small-valued assets such as pencil
sharpeners and paper clips should be written off to
the profit and loss account as revenue
expenditures, although they can last for more than
one accounting period

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 OBJECTIVITY
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OBJECTIVITY
 Meaning
 The accounting information should be free from
bias and capable of independent verification
 The information should be based upon verifiable
evidence such as invoices or contracts

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 Example
 The recognition of revenue should be based on
verifiable evidence such as the delivery of goods
or the issue of invoices

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 CONSISTENCY
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CONSISTENCY
 Meaning
 Companies should choose the most suitable
accounting methods and treatments, and
consistently apply them in every period
 Changes are permitted only when the new method
is considered better and can reflect the true and
fair view of the financial position of the company
 The change and its effect on profits should be
disclosed in the financial statements

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 Examples
 If a company adopts straight line method and
should not be changed to adopt reducing balance
method in other period
 If a company adopts weight-average method as
stock valuation and should not be changed to
other method e.g. first-in-first-out method

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 ACCRUALS/MATCHING
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ACCRUALS/MATCHING

 Meaning
 Revenues are recognized when they are earned,
but not when cash is received
 Expenses are recognized as they are incurred, but
not when cash is paid
 The net income for the period is determined by
subtracting expenses incurred from revenues
earned

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 Example
 Expenses incurred but not yet paid in current
period should be treated as accrual/accrued
expenses under current liabilities
 Expenses incurred in the following period but paid
for in advance should be treated as prepayment
expenses under current asset
 Depreciation should be charged as part of the cost
of a fixed asset consumed during the period of use

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PROBLEMS IN THE RECOGNITION OF
EXPENSES
 Normally, expenses represents resources
consumed during the current period. Some
costs may benefit several accounting
periods, for example, development
expenditures, depreciation on fixed assets.

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RECOGNITION CRITERIA FOR
EXPENSES
 Association between cause and effect
 Expenses are recognized on the basis of a
direct association between the expenses
incurred on the basis of a direct
association between the expenses incurred
and revenues earned
 For example, the sales commissions should
be accounted for in the period when the
products are sold, not when they are paid

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 Systematic allocation of costs
 When the cost benefit several accounting
periods, they should be recognized on the
basis of a systematic and rational allocation
method
 For example, a provision for depreciation
should be made over the estimated useful
life of a fixed asset
 Immediate recognition
 Ifthe expenses are expected to have no
certain future benefit or are even without
future benefit, they should be written off in
the current accounting period, for example,
stock losses, advertising expenses and
research costs 48
 REALIZATION
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REALIZATION

Meaning
 Revenues should be recognized when the
major economic activities have been
completed
 Sales are recognized when the goods are
sold and delivered to customers or services
are rendered

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RECOGNITION OF REVENUE
 The realization concept develops rules for the
recognition of revenue
 The concept provides that revenues are
recognized when it is earned, and not when
money is received
 A receipt in advance for the supply of goods
should be treated as prepaid income under
current liabilities
 Since revenue is a principal component in the
measurement of profit, the timing of its
recognition has a direct effect on the profit

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RECOGNITION CRITERIA FOR
REVENUES
 The uncertain profits should not be
estimated, whereas reported profits must be
verifiable
 Revenue is recognized when
1. The major earning process has
substantially been completed
2. Further cost for the completion of the
earning process are very slight or can be
accurately ascertained, and
3. The buyer has admitted his liability to
pay for the goods or services provided
and the ultimate collection is relatively
certain
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 Example
 Goods sent to our customers on sale or return
basis
 This means the customer do not pay for the goods
until they confirm to buy. If they do not buy, those
goods will return to us
 Goods on the ‘sale or return’ basis will not be
treated as normal sales and should be included in
the closing stock unless the sales have been
confirmed by customers

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PROBLEMS IN THE RECOGNITION OF
REVENUE
 Normally, revenue is recognized when there is
a sale
 The point of sales in the earning process is
selected as the most appropriated time to
record revenues
 However, if revenue is earned in a long and
continuous process, it is difficult to determine
the portion of revenue which is earned at each
stage
 Therefore, revenue is permitted to be recorded
other than at the point of sales

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 EXCEPTIONS TO RULE OF SALES
RECOGNITION
1. Long-term contracts
 Owning to the long duration of long-term
contracts, part of the total profit
estimated to have been arisen from the
accounting period should be included in
the profit and loss account
2. Hire Purchase Sale
 Hire purchase sales have long collection
period. Revenue should be recognized
when cash received rather than when the
sale (transfer of ownership) is made
 The interest charged on a hire purchase
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sale constitutes the profit of transaction
3. Receipts from subscriptions
- A publisher receives subscriptions before it
sends newspapers or magazines to its
customers
- It is proper to defer revenue recognition
until the service is rendered.
- However, part of subscription income can
be recognized as it is received in order to
match against the advertising expenses
incurred

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 DISCLOSURE
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DISCLOSURE
 Meaning
 Financial statements should be prepared to
reflect a true and fair view of the financial
position and performance of the enterprise
 All material and relevant information must be
disclosed in the financial statements

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 UNIFORMITY
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UNIFORMITY
 Meaning
 Different companies within the same industry
should adopt the same accounting methods and
treatments for like transactions
 The practice enables inter-company comparisons
of their financial positions

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 RELEVANCE
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RELEVANCE

 Meaning
 Financial statements should be prepared to meet
the objectives of the users
 Relevant information which can satisfy the needs
of most users is selected and recorded in the
financial statement

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ACCOUNTING PERIOD CONCEPT
 Monitor the performance of the organization
periodically

 One accounting period will be considered

 Calculating accounts for more than one

accounting period will be tedious
12/18/2024 Dr. Amit Gupta
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WHAT IS FINANCIAL ACCOUNTING
A method to communicate financial
information to interested external parties.

• Users include capital providers, regulators,

customers, suppliers, employees, etc

• Capital suppliers include debt and equity

providers

• Financial accounting is used for both

prediction and control 65
FUNCTIONS OF ACCOUNTING
 Recording
 Classifying

 Summarizing

 Deal with financial transactions

 Interpretation

 Communicating

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FUNCTIONS OF ACCOUNTING
1.Deals with financial transactions :
Accounting records only those transactions
and events, which are of a financial character.
2. Recording : This is the basic function of
Accounting. It is essentially concerned with not
only ensuring that all business transaction of
financial character are in fact recorded but
also that they are recorded in an orderly
manner. Recording is done in the book called
“Journal”.

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 Classifying :
Classification is concerned with the systematic
analysis of the recorded data, with view to
group transactions or entries of one nature at
one place .The work of classification is done in
the book called “Ledger”.

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 Summarizing : This involves presenting the
classified data in a manner, which is
understandable and useful to the internal as
well as external end –users of accounting
statements. This process leads to the
preparation of the following statement :-
 Trial Balance

 Trading Account

 Profit and Loss Account

 Balance Sheet

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 Analysis and Interpretation : This is the
final function of accounting. The recorded
financial data is analyzed and interpreted in
a manner that the end-users can make a
meaningful judgment about the financial
condition and profitability of the business
operations.

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THE RECORDING PROCESS
The sequence of steps in recording transactions:

Documentatio
Transaction Journal entry
n

Fiananci
Trial al
Legder
balance stateme
nt
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THE RECORDING PROCESS
 The process starts with source documents,
which are the supporting original records of any
transaction.
– Examples are sales slips or invoices, check
stubs, purchase orders, receiving reports, and
cash receipt slips.
 In the second step, an analysis of the

transaction is placed in the book of original

entry, which is a chronological record of how
the transactions affect the balances of
applicable accounts.
- The most common example is the general
journal - a diary of all events (transactions) in an 72

entity’s life.
JOURNAL
What is a journal?
It is a list in chronological order of all the
transactions for a business.
1 Identify transaction from source documents.
2 Specify accounts affected.
3 Apply debit/credit rules.
4 Record transaction with description.

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JOURNAL ENTRY
Journal entry - an analysis of the effects of a
transaction on the accounts, usually
accompanied by an explanation of the
transaction
–This analysis identifies the accounts to be
debited and credited.
– date of the transaction
– title of the account debited
– title of the account credited
– amount of the debit and credit
– description of the transaction (narration) 74
TYPES OF JOURNAL ENTRIES:
 Types of journal entries:
– Simple entry - an entry for a transaction that
affects only two accounts
– Compound entry - an entry for a transaction
that affects more than two accounts
 Remember: whether the entry is simple or

compound, the debits (left side) and credits

(right side) must always equal.

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LEDGER ACCOUNTS
 Ledger - a group of related accounts kept
current in a systematic manner
– Think of a ledger as a book with one page
for each account.

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POSTING
 It is the transfer of information from the
journal to the appropriate accounts in the
ledger.

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TRIAL BALANCE
 The purposes of the trial balance:
– To help check on accuracy of posting by
proving whether the total debits equal the
total credits
– To establish a convenient summary of
balances in all accounts for the reparation of
formal financial statements

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TRIAL BALANCE

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INCOME STATEMENT
The income statement, reports the company’s
revenues, expenses, and net income or net
loss for the period.
The Income Statement can be divided into:
•Trading Account
• Profit and Loss Account

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THE BALANCE SHEET
 The Balance sheet shows the financial
position of a company at a particular point in
time.
– The balance sheet is also referred to as the
statement of financial position or the
statement of financial condition.
The left side lists assets – the right side lists
liabilities and owners’ equity

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BASIS OF ACCOUNTING
 Are approaches for
reporting/recognizing revenues and
expenses

 The basis for accounting are as follows:

 Cash basis

 Accrual basis

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CASH BASIS OF ACCOUNTING
 Actual cash receipts and actual cash
payments are recorded
 Revenue reported when cash is received

 Expense reported when cash is paid

 Income = cash receipts – cash payments

 Does not properly match revenues and

expenses

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ACCRUAL BASIS OF ACCOUNTING
 Revenue reported when earned irrespective
of whether received or not
 Expense reported when incurred irrespective

of whether or not cash has been paid

 Properly matches revenues and expenses in

determining net income

 Also referred to as mercantile system of

accounting

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SYSTEM OF BOOK KEEPING
 Book keeping is the art of recording
business transactions in a regular and
systematic manner.
 This recording of transactions may be done

according to any of the following two

systems:-

 1. Single Entry System

 2. Double Entry System

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SINGLE ENTRY
 A single entry system of bookkeeping is
where the transactions of the business affect
only one account, i.e. only one account’s
value will decrease or increase based on the
transaction amount. Under this system, a
cash book is prepared that shows the
payment and receipts of the cash
transactions.
 Under the single entry system of

bookkeeping, the cash book and personal

accounts of creditors and debtors are
maintained, and no other ledger is 86
maintained. Every transaction of the
business is recorded in the cash book without
THE DOUBLE ENTRY SYSTEM
Double-Entry Accounting
“ Double-entry accounting is based on a
simple concept: each party in a business
transaction will receive something and
give something in return. In bookkeeping
terms, what is received is a debit and
what is given is a credit. The T account is
a representation of a scale or balance.”
Each transaction must still be analyzed to
determine which accounts are involved,
whether the accounts increase or decrease,
and how much the balance will change. 87
THE DOUBLE ENTRY SYSTEM

Each transaction is
recorded

One Debit One Credit

Total debits must equal total

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credits.
THANK YOU

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