Chapter 01

Introducing Financial
Accounting

1-1

C1

Importance of
Accounting
Accounting
Accounting

is a
system that

Identifies
Identifies
Records
Records

Relevant
Relevant

informatio
n
that is

Reliable
Reliable
Comparable
Comparable

Communicate
Communicate
ss
about
about an
an
organizations
organizations
business
business
activities.
activities.
1-2

C1

Accounting Activities

Identifying
Business
Activities

Recording
Business
Activities

Communicati
ng Business
Activities

1-3

C2

Users of Accounting
Information
External
Users

Lenders

Consumer
Shareholder Groups
External
s
Government Auditors
s

Customers

Internal Users

Managers

Sales Staf

Officers

Budget
Officers

Internal
Auditors

Controllers
1-4

C2

Users of Accounting
Information
External
Users

Internal Users

Financial accounting
provides external users
with financial statements
(shareholders, lenders,
etc.).

Managerial accounting
provides information needs
for internal decision makers
(officers, managers, etc.).
1-5

Opportunities in
Accounting

C2

Financial
Financial
Preparation
Preparation
Analysis
Analysis
Auditing
Auditing
Regulatory
Regulatory
Consulting
Consulting
Planning
Planning
Criminal
Criminal
investigation
investigation

AccountingAccountingrelated
related

Managerial
Managerial

Taxation
Taxation

General
Preparation
General
Preparation
accounting

accounting
Planning
Planning
Cost
accounting

Cost accounting
Regulatory
Regulatory
Budgeting
Investigation
Budgeting
Investigation
Internal
auditing
ss
Internal auditing
Consulting
Consulting
Consulting
Consulting
Controller

Enforcement
Controller
Enforcement
Treasurer
Legal
Treasurer
Legal
Strategy
services
Strategy
services
Lenders

FBI
investigators

Lenders
FBI investigators
Estate
Estateplans
plans
Consultants

Market
researchers

Consultants
Market researchers
Analysts

Systems
Systemsdesigners
Analysts
designers
Traders

Merger
services
Merger services
Traders
Directors

Business
Directors
Businessvaluation
valuation
Underwriters

Forensic
Underwriters
Forensicaccountant
accountant
Planners

Litigation
Planners
Litigationsupport
support
Appraisers

Entrepreneurs
Appraisers
Entrepreneurs
1-6

C4

Generally Accepted Accounting

Principles
Financial
Financial accounting
accounting practice
practice is
is governed
governed
by
by concepts
concepts and
and rules
rules known
known as
as generally
generally
accepted
accepted accounting
accounting principles
principles (GAAP).
(GAAP).
Relevant
Relevant
Information
Information

Afects
Afects the
the decision
decision
of
of its
its users.
users.

Reliable
Reliable
Information
Information

Is
Is trusted
trusted by
by
users.
users.

Comparable
Comparable
Information
Information

Used
Used in
incomparisons
comparisons
across
across years
years &
&
companies.
companies.

1-7

C4

Setting Accounting
Principles

In
In the
the United
United States,
States, the
the Securities
Securities and
and Exchange
Exchange
Commission,
Commission, aa government
government agency,
agency, has
has the
the legal
legal
authority
authority to
to establish
establish reporting
reporting requirements
requirements and
and
set
set GAAP
GAAP for
for companies
companies that
that issue
issue stock
stock to
to the
the
public.
public.
The
The Financial
Financial Accounting
Accounting
Standards
Standards Board
Board is
is the
the
private
private group
group that
that sets
sets both
both
broad
broad and
and specific
specific
principles.
principles.
International Accounting Standards Board (IASB) issues in
onal standards that identify preferred accounting practices
ther countries. More than 100 countries now require or pe
panies to prepare financial reports following IFRS standard
1-8

Assets

A1

Accounts
Accounts
Receivabl
Receivabl
ee
Vehicle
Vehicle
ss
Store
Store
Supplie
Supplie
ss

Cash
Cash

Resources
Resources
owned
owned or
or
controlled
controlled
by
by aa
company
company

Notes
Notes
Receivabl
Receivabl
ee

Land
Land

Buildings
Buildings
Equipment
Equipment
1-9

Liabilities

A1

Accounts
Accounts
Payable
Payable

Notes
Notes
Payable
Payable

Creditors
Creditors
claims
claims on
on
assets
assets
Taxes
Taxes
Payable
Payable

Wages
Wages
Payable
Payable
1-10

Equity

A1

Retained
Retained
Earnings
Earnings

Contribut
Contribut
ed
ed Capital
Capital

Owners
Owners
claim
claim on
on
assets
assets

Dividends
Dividends
1-11

P2

Income Statement
Net income is
the diference
between
Revenues and
Expenses.
The income statement describes a
companys revenues and expenses
along with the resulting net income
or loss over a period of time due to
1-12

P2

Balance Sheet
The
The Balance
Balance Sheet
Sheet
describes
describes aa companys
companys
financial
financial position
position at
at aa
point
point in
in time.
time.

1-13

COST ACCOUNTING
INTRODUCTION

COST ACCOUNTING MEANING

Cost accounting is concerned with
recording, classifying and summarizing
costs for determination of costs of
products or services, planning,
controlling and reducing such costs and
furnishing of information to
management for decision making

COST ACCOUNTING - INTRODUCTION

Accounting for determination and control of costs.

COST ACCOUNTING:

The Institute of Cost and Management

Accountant, England (ICMA) has defined Cost Accounting as the

process of accounting for the costs from the point at which
expenditure

incurred,

to

the

establishment

of

its

ultimate

relationship with cost centers and cost units. In its widest sense, it
embraces the preparation of statistical data, the application of
cost control methods and the ascertainment of the profitability of
activities carried out or planned.

Cost Accounting = Costing + Cost Reporting +

Cost Control.

COST - MEANING
Cost means the amount of
expenditure ( actual or notional)
incurred on, or attributable to, a
given thing.

OBJECTIVES OF COST ACCOUNTING

Ascertainment of costs

Estimation of costs

Cost control

Cost reduction

Determining selling price

Facilitating preparation of financial and other

statement

Providing basis for operating policy

COST TERMINOLOGY:
COST:

Cost means the amount of expenditure incurred on a particular thing.

COSTING:

Costing means the process of ascertainment of costs.

COST ACCOUNTING:

The application of cost control methods and the

ascertainment of the profitability of activities carried out or planned.

COST CONTROL: Cost control means the control of costs by management.

Following are the aspects or stages of cost control.

JOB COSTING:

It helps in finding out the cost of production of every order

and thus helps in ascertaining profit or loss made out on its execution. The
management can judge the profitability of each job and decide its future
courses of action.

BATCH COSTING: Batch costing production is done in batches and each

batch consists of a number of units, the determination of optimum quantity to
constitute an economical batch is all the more important.

1. What is Financial Management?

Process of:
Running your
business
Recording money
coming in and out
Using reports to:
Understand how
your business is
doing
Make decisions

Six Ways Financial Management

Helps Your Business Succeed
2. Manage Customers and Sales.
Know and understand your customers
through consolidated records.
1. Cash Flow.
Track the money
going in and out of
your business.

YOUR
BUSINESS
6. Funding.
To be considered for
a loan or investment,
youll need complete
financial statements.
5. Insight and Decision Making.
Make informed decisions and price your product or
service for profitability with financial reports

3. Production.
Obtain goods and
services. Apply for and
establish credit with
your vendors.
4. Compliance.
Report your
companys incomes,
expenses, and payroll
accurately to the IRS.

The Functions of
Management
Planning

Acting

Feedback

Controlling

Primary Users
Financial
Investors
Management
Creditors
Internal
Government
managers of
authorities
the business
(IRS, SEC, etc.)

Purpose of Information
Financial
Management
Help investors, Help managers
creditors, and
plan and
others make
control
investment,
business
credit, and
operations
other decisions

Accounting and Book-keeping

Accounting is the language of business to communicate the business
results to various groups of persons interested in the business.

Accounting may be defined as the identifying,

measuring, recording and communicating of
financial information.
Bierman and Derbin

According to J.R. Batliboi Book-keeping may be

defined as the science as well as the art of
recording business transactions under appropriate
accounts."
The purpose of accountancy is to facilitate business and economic
development

Basic Accounting Terms -1

Transaction : Every financial change which occurs in
the business is a transaction.

In other words, a

transaction refers to any monetary or financial event

or activity (i.e., an activity having value measurable in
terms of money) which changes the financial position
of the business.
All events may not be measurable in terms of money, but every
transaction is measurable in terms of money. An event may or
may not cause a change in the financial position of the business.
On the other hand a transaction necessarily causes a change in
the financial position of the business.

Basic Accounting Terms - 2

Capital : The amount of money or moneys worth invested by
the proprietor into his business at the time of the
commencement of business is called capital. Capital is also
defined as owners equity i.e., owners claims against the
assets of the business.

Assets : Means enough or sufficient economic resources

owned by a business concern for carrying on the business.
According to Finney and Miller Assets are future economic
benefits, the rights of which are owned or controlled by an
Organisation or individuals.

Basic Accounting Terms - 3

Liabilities : Mean the claims of outsiders against the business
concern which bind the business concern to others.
Examples are loans borrowed, bank overdraft, creditors,
bills payable, etc.,.

Net worth : Means the excess of the total assets of a business

over its total liabilities at any particular point of time.

It is

the net value of assets that belongs to the owner. It is also

called owners capital.

Debtor : A debtor is a person who owes money to the business.

He owes money to the business because he has received some
benefit from the business. A debtor constitutes an asset for
the business.

Basic Accounting Terms - 4

Creditor : A creditor is a person to whom the business owes
money. The business owes money to him, because he has
given some benefit to the business. A creditor constitutes a
liability for the business.

Goods : Goods refers to merchandise, commodities, products,

articles, things in which a trader deals. In other words, they
refer to commodities or things meant for resale.

Basic Accounting Terms - 6

Revenue : Revenue or income is the earning of a business
from the sale of goods or from the rendering of services to
customers during an accounting period.

Examples

are

Revenue from sale of goods, interest on investments, royalty

received, discount received, etc.,

Expenses : Expenses are the costs incurred in connection

with the earnings of revenue. In other words expense is the
cost of the things or services for the purpose of generating
income.

Examples are repair expenses, cost of goods

purchased, salary and wages, interest, etc.,

Basic Accounting Terms -7

Loss : Loss refers to money or moneys worth given up without getting
any benefit in return. Loss occurs accidentally or involuntarily.
Examples are loss of goods by fire, loss of machinery in accident,
damages paid to others, etc.,.

In the Income Statement, any

expenditure amount in excess of Income is also termed as LOSS.

Profit : Profit is the excess of revenues over the expenses of a given

period of time, usually a year. Profit results in increase in owners
capital.

Some Accounting Terminologies

Net Worth : The net worth of an enterprise represents
the excess of book value of all assets over the outside
liabilities. It represents the interest of the
shareholders in the enterprise. It is normally
equivalent to the net equity i.e., Share capital plus
Reserves plus Retained profits less Unabsorbed losses
or Expenses.
Contingent Liability : Liabilities which are dependent on a
condition which exists at the balance sheet date,

Salary

where the outcome will be confirmed only on the

occurrence or non-occurrence of one or more uncertain
future events.

Some Accounting Terminologies

Generally Accepted Accounting Principles (GAAP) : Many
countries have got their own GAPP. These are ground
rules covering financial accounting, prescribed by
Financial Accounting Standard Board, USA, that
attempt to strike a balance between the criterion of
relevance on one hand and the criteria of objectivity
and feasibility on the other.

Distinctions One should invariably know

Capital Expenditure and Revenue Expenditure :
Funds used by a company to acquire or upgrade physical
assets such as property, industrial buildings or
equipment is capital expenditure. On the other hand,
expenditure incurred for running and maintaining the
assets or purchasing goods for resale is revenue
expenditure.

Revenue Expenditure involving cash outgo is Cash

Expenditure. Examples are Salary and wages, Repair
expenses, interest, etc., . Revenue Expenditure
charged to P&L A/c but not involving cash outgo is
Non-cash expenditure. Examples are Deprecation and
Return on Equity or Profit.