You are on page 1of 10

Financial Accounting-1

Definitions:
*Accounting is an information system that identifies, records, and communicates the economic events of an organization to interested users. *Accounting is an information system that identifies, measures, processes and communicates financial information about an economic entity to permit informed judgments and decisions by the users of information. *Accounting is the art of controlling a business by keeping accurate bookkeeping records, measuring and interpreting the financial results of the business by using the information in these records and communicating the results to management and other interested parties. Geoffrey Whitehead. Accounting is a Language of Business: Language is a means of communicating our feeling, emotion, views, ideas and willing etc. Accounting is a language of business because it is the accounting through which business speak about its: feeling (profitability & solvency) Emotion (degree of profitability and solvency) Views (better/worse business prospect) Willing (future business plans)
Language around the world has its own worlds, terms, grammars and principles. Like that accounting has its own words (accounts receivable & payable etc) ,terms (Debit & credit), grammar (Double Entry System), principles (historical cost etc).

Finally, accounting writes the financial history of business. Accounting perform the responsibility of communicating financial information of a business to a group of divergent users. This information acts as guideline to make reasonable choices among alternatives uses of scarce resources in conducting business. So, accounting is called language of business.

Conceptual Framework of Accounting :


The conceptual framework is like a constitution incorporating & elaborating some fundamental & key aspects of accounting process. Very precisely it can be described as a coherent system of interrelated objectives & fundamentals that can be lead to consistent standards& that prescribes the nature, function & limits of financial accounting & financial statements.

Need for Conceptual Framework:


To issue more useful and consistent standards over time. Increase financial statement users understanding of and confidence in financial reporting. It enhance comparability among companies financial statements. New and emerging problems should be more quickly solved by reference to an existing framework of basic theory.

Objective Of Accounting:
o o o It provide information useful in making investment financing and operating decision, It provide information useful in judging the amounts, timing and certainty of future cash flows, It supplies information about the resources of the business the claims on the resources and the changes on the resources during an accounting period.

Qualitative Characteristics of Accounting Information:


1. Primary Qualities: a) Relevance: Accounting information is relevant if it o Is timely o Helps users form predictions about the future, and o Provides feedback about the results of decisions. b) Reliability: Information is reliable if it Is verifiable; Is neutral; and Has representational faithfulness.
2

2. Secondary Qualities: a) Comparability: Information that has been measured and reported in a similar manner for different enterprises is considered comparable. Comparable information will reveal the relative strengths and weakness in a single company through time and between two or more companies at the same point in time. b) Consistency: When an entity applies the same accounting principles and reporting practices to similar events through time, the entity is considered to be consistent in its use of accounting techniques.

Parts of Financial Statement

* Income Statement (profit & loss account) * Balance sheet (statement of position) * Statement of cash flows * Statement of change in owners equity * Statement of retained earnings. Generally accepted accounting principles The accounting profession has developed standards/principles that are generally accepted and are universally practiced. This common set of standards/principles, assumptions and constraints are called Generally Accepted Accounting Principles.

Accounting Assumptions
* Monetary unit assumption * Economic Entity Concept * Going Concern Assumption * Time Period/ Periodicity Assumption

Accounting Principles
Historical Cost Matching Principle Revenue Recognition Principle Full Disclosure Principle.

Constraints
Constrain is anything that prevent you to get what you want more *Cost-benefit relationship *Materiality *Prudence / Conservatism Concept.

Accounting Equation:
The basic accounting equation is: Assets (A) = Liabilities (L) + Owners Equity (O/E) Assets (A) = L+ (O/E + Revenues Expenses) Assets: Assets are resources owned by a business. Liabilities: Liabilities are creditor ship claims on total assets. Owners Equity: O/E is the ownership claim of total assets.

Elements of Accounting Equation:


Current Assets: Cash and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within one year or the operating cycle, whichever is longer. Examples: Cash/bank, Accounts receivable or Debtors, Notes receivables /Creditors, Supplies/Stationery, Prepaid expenses, Accrued revenues, Inventories/Stock, Short-term investment.

Fixed Tangible Assets:


Plant assets are tangible resources that are used in the operations of a business and are not intended for sale to customers. They are called property, plant, and equipment of fixed assets. Examples: Land, Buildings, Plant/Equipment/Machineries, Office furniture & fixtures, Store furniture, Leased property, Long-term investment.

Fixed Intangible Assets


Rights, privileges, and competitive advantages that result from the owner- ship of long-live assets that do not posses physical substance. Examples: Goodwill, Patents, Copyrights, Franchises, Trademarks, Trade-name, Secret processes, Organization costs.

Fictitious Assets
Intangible assets shown in the balance sheet but have no market value or realizable value. Example: Preliminary expenses, Share discount, deferred expenses.

Liabilities
Current Liabilities: A current liability is a debt/obligations that can reasonably expected to be paid: (1) from existing current assets or through the creation of other current liabilities, and (2) Within one year or the operating cycle, whichever is longer. Examples: Accounts payable, Unearned revenue, Income taxes payable, Accrued expenses, Other liabilities.

Long-term liabilities
Obligations expected to be paid after one year. Examples: Issuance of Bonds, Long-term lease obligations, Long-term notes payable, deferred tax liabilities, other non current liabilities.

Owners Equity
Owners or Shareholders claim in the business assets is known as owners equity. Owners equity represents the claims by the owners of a business on the assets of the entity. Owners equity = Assets Liabilities
5

Examples: Capital invested by the owner in the business. Common stock/Capital, Additional paid in capital, Retained earnings.

Revenues
The gross increase in owners equity resulting from business activities entered into for the purpose of earning income. Revenues means the earning of a business from operating activities. Example: Sales, Service revenue earned (Fees earned, accounting revenue earned etc), Other receipts.,

Expenses
The cost of assets consumed or services used in the process of earning revenue. Examples: Purchase, Salaries, Rent, Supplies expenses, Advertising expenses, Commission paid, Delivery expenses, Freight in/Carriage inward, Freight out/ Carriage outward, Wages, Utility expenses, Insurance expenses.

Practical Problem:1 Mr Jhon opens his accounting office on august1, 2003. During the first month of the operations, the following transactions occurred. Aug-1: Invested 1,00, 0000 Tk. in cash in accounting practice. Aug-3: Paid 7,500 Tk. for August rent of the office space Aug-5: Purchased office equipment on account 32,000Tk. Aug-8: Received from clients 10,000Tk. in advance for service Aug-15: Borrowed 18,000Tk. by issuing a note. Aug-17: Payment the full bill of equipment purchased Aug-20: Performed full service for advance received from customer Aug-24: Performed services for clients of 30,000Tk.and received 60% of it in cash. Aug-31: Paid for monthly expenses: salaries 12,000 and utilities 5,000.

Requirements: Prepare summery of transaction showing the effects in equation for the above transactions. Prepare Income statement, owners equity statement and balance sheet at August 31 for Mr. Jhon & co.

Double entry recording process

Every account must have two sides: Debit (Dr) & Credit (Cr). Double entry system means that both the sides of every account should be recognized and recorded. A system that records in appropriate accounts the dual effect of each transaction.

The basis for double entry system is: Every debit must have its corresponding credit Debit = Credit

Account

An account is the basic storage unit for accounting data. A record of increase and decreases in specific asset, liability, or owners equity items. Types of account: Assets accounts Liabilities accounts Owners equity accounts Revenues accounts Expenses accounts.

Steps in the recording process Analyze each transaction for its effects on the accounts. Enter the transaction information in a journal (book of original entry). Transfer the journal information to the appropriate accounts in the ledger (book of accounts).

Accounting Cycle
The accounting process follows a consecutive way to collect , process and report the effects of economic events that affect an entity during an accounting period. It can be said as accounting cycle which is the sequential process to record significant transaction to find out the financial position of the firm.

Practical Problem:3 Michelle Pfeiffer started his own delivery service, Michelle Pfeiffer deliveries, on June 1, 2001. The following transactions occurred during the month of June. Michelle Pfeiffer invested $3,00,000 cash and accounts receivable $2,00,000 in business. Purchased a used machinery for $60,000. Michelle Pfeiffer paid $10,000 cash and signed a notes payable for the remaining balance. Paid $100 for office rent for the month. Purchased office supplies for $800 on account. Paid $650 for utilities. Paid $2,000 for employees salaries. Borrowed $10,000 from the bank. Purchase office equipment $70,000; paying 10,000 in cash and the balances are on account. Earned revenues of $74,000 of which $20,000 is collected in cash and the balances are due. Withdrew $2,000 in cash for personal use. The payment of 20% of the notes payable in transaction no.(2) The collection of 30% of accounts receivable in the transaction no.(9)
8

Requirements: Record Michelle Pfeiffer June transactions in an expanded accounting equation .Use the description column to provide a brief explanation of each transaction. Prove the Accounting Equation.

Practical Problem:6
Medco started his own delivery service, Medco deliveries, on January 1, 2000. The following transactions occurred during the month of January. January 1: Medco invested $30,000 cash in the business. January 1: Purchased a old van for deliveries for $15,000 for the purpose of deliveries. Medco paid $5,000 cash and signed a notes payable for $10,000. January 3 : Paid cash $1,000 for office rent for the month of January 2003. January 7 : Purchased office supplies for cash $1,000. January 10 : Paid electric bill $500. January 12 : Paid salary of staff for the month $2,000. January 13 : Borrowed $17,000 from the bank. January 17 : Purchase a delivery van for $20,000 on account. January 21 : Earned revenues of $11,000 of which $3,000 is collected in cash and the balances are due. January 24 : Withdrew cash $1,000 from the business for personal use. January 27, Paid $3,500 bills for advertisement. January 29 : Purchased supplies for cash $1,000 January 30: Cash received $2,000 for service of January 21 Requirements: Show the effects of the transactions on the accounting equation using the following format: Assets == Liabilities + Owners Equity Date Cash + Accounts Receivable + supplies+ D. Van = Accounts payable+ Notes payable + Capital Prepare an Income Statement;

Prepare a statement of owners equity; Prepare a Classified Balance Sheet in an account form.

10