Fundamentals of Financial Accounting

Nature of Accounting: Accounting is a language of business. It records business transactions taking place during the accounting period and at the end of the period (the year); it shows the result of the transactions in the form of final Accounts (consisting of at least P&L A/C and Balance sheet. Definition of Accounting: Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least, of a financial character and interpreting the results thereof”. Functions of Accounting: 1) Keeping systematic records. 2) Protecting properties of the business. 3) Communicating the results. 4) Meeting legal requirements. 5) Depiction of the financial position. 6) Providing effective control over business. Limitation of Accounting: 1) Incomplete information. 2) In exactness. 3) Showing valueless Assets. 4) Manipulation. 5) Ignorance about the present value of Business. 6) Making information available to various group. Book-Keeping: Book Keeping is the proper and systematic keeping of books of Accounts. Book keeping starts from the identification of business transactions. These transactions must be supported by the documents and they must be financial in nature. Double Entry Book-Keeping: Business transactions are recorded in the books of Account on the basis of double entry system. The system is based upon the fact that there are two aspects of every business transaction. Every transaction involves at least two persons, parties or accounts. Advantages: 1) Complete records of every transaction. 2) Reliable information at a glance. 1

3) Scrutinising and verification of information. 4) Knowledge of gross profit/loss. 5) Knowledge of net profit/loss. 6) Knowledge of assets and liabilities of the business. 7) Comparative studies. 8) Detection of fraud. Disadvantage: 1) Error of commission. 2) Error of principle. 3) Compensating Errors. Basic Terms of Accounting: 1) Assets: The valuable things owned by the business are known as assets. In other words, these are the properties owned by the business. Classification of Asset a) Fixed Assets. b) Floating Assets. c) Fictitious Assets. d) Intangible Assets. e) Liquid Assets. 2) Capital: It is that part of wealth which is used for further production and thus capital consists of all current assets and fixed Assets. Capital need not necessarily be in cash. It may be in kind also. Kinds of capital a) Fixed capital. b) Working capital. 3) Liability of equity: It is the properties and creditors claim against the assets of the business. Classification of Liability: a) Owners liability: • Capital. • Profit earned. • Retained earning. • Undistributed profit. • Interest on capital. b) Liability to creditor’s: • Creditors for goods. • Creditors for loan. • Creditors for expenses.


4) Goods: Articles purchased for sale by the business or for use in the manufacture of certain other goods as raw material are known as Goods. Goods are the Commodities, in which the business deals. 5) Purchase: In its routine business, the firm has to either purchase finished goods for sale or purchase raw material for the manufacture of the article being sold by the firm. The acquisition of these articles is purchases. 6) Sales: The ultimate end of the goods purchased or manufactured by the business in their sales. It includes both cash and credit sales. 7) Stock: The goods available with the business for sale on a particular date are termed as stock. 8) Revenue: Revenue in accounting means the amount realized or receivable from the sale of goods. 9) Expenses: Generating income is foremost objective of every business. The firm has to use certain goods and services to produce articles, sold by it payment for these goods and services is called “Expenses”. 10) Debtors: The term “Debtors” represents the persons or parties who have purchased goods on credit from us and have not paid for the goods sold to them. They still owe to the business. 11) Creditors: In addition to cash purchase the firm has to make credit purchases also. The sellers of goods on credit to the firm are known as its creditors for goods. Creditors are the liability of the business. Accounting Concept: 1) Entity concept 2) Dual aspect concept 3) Going concern concept 4) Accounting period concept 5) Money measurement concept 6) Cost concept The concept of Debit and Credit: Every accounting transaction has got two sides the “Debit” and a “Credit”. These are the two signs used in accounting to present and report the financial effect of every transaction. Debit means decrease in proprietor’s equity and credit means increase in proprietor’s equity.


Type of accounts: 1) Personal Accounts 2) Real Accounts 3) Nominal Accounts


Rules of Accounts: 1) Personal Accounts 2) Real Accounts 3) Nominal Accounts

: “Debit the receiver Credit the giver”. : “Debit what comes in Credit what goes out” : “Debit all expenses or losses Credit all income or gain”.

Journal: Journal is a book of prime record for small firms. Ledger: A ledger is a set of accounts. In other words, ledger is a book in which various accounts (personal, real and nominal) are opened. Eq Cash book, purchase Books, Sales books, B/R books, B/P books etc. Posting: Posting is the process of entering in the ledger the information given in the journals (both special and general) posting from the journal or book is done periodically, may be weekly or fortnightly or monthly as per the convenience of the business. Trial Balance: Trial Balance is a statement, prepared with the debit and credit balances of ledger accounts to test the arithmetical accuracy of the books. It may also be prepared with debit and credit totals of ledger account and also with the balances and totals of ledger accounts. Final Accounts: There are three following stages of preparing final Accounts of a Trading concern. 1) Trading Account 2) Profit & loss account 3) Balance sheet.


Specimen ( final accounts)
Trading, Profit & Loss account for the year ending 31.3.2007 To Opening Stock To Purchase Less Return To Material consumed To Finished goods To Wages Add-Out standing To Fuel To Carriage Inward To Freight To Gas and water To Lighting To Royalties To Gross profit C/D XXX XXX XXX XXX XXX By Sales Less; Return XXX By Goods Destroyed XXX ( by Fire/theft ) XXX By Closing Stock XXX XXX XXX XXX XXX XXX XXX XXX XXX To Salary XXX Add : Out standing XXX To Insurance XXX Less : Prepaid XXX To Advertisement To General expenses To Discount allowed To Rent & Taxes To Carriage outward To Administrative expenses To Selling expenses To Distribution expenses To Traveling expenses To Directors fees To Auditors fees To Preliminary expenses To Sundry expenses To Bad debts To Reserve for bad debts To Miscellaneous expenses To Deprecation To Net profit (Transfer B/S) By Gross profit b/d XXX By Discount received By Interest received XXX By Transfer fees XXX By Profit on sale of Assets XXX By Dividend received XXX By Provision on discount XXX (Creditors) XXX Any other income received XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX


Balance sheet as on 31.03.2007
Liabilities A) Share Capital: 1)Authorized capital 2)Issued & subs capital 3)Called up and paid up share capital XXX Add : Forfeited XXX Less calls in arrears XXX B) Reserve & Surplus: General reserve Capital Reserve Sinking fund Share premium Profit & loss account C) Secured loan: 5% Debenture Add : Interest O/S D) Unsecured loan: Public deposit Other unsecured loan E) Current liabilities & provisions: 1)Current liabilities Sundry creditors Bank O/D Bills payable Outstanding expenses Unclaimed dividend Unexpired discount 2)ProvisionsProvision for taxation Proposed dividend Total XXX XXX Assets A) Fixed assets: Goodwill Land and building Furniture Less : Depreciation Motor van Less : Depreciation Trademarks Patents




B) Investment at cost: Government securities Bonds C) Current assets, loans & advances: 1)Current assetsCash in hand Cash at bank Closing stock Prepaid insurance Loose tools Work in progress Sundry Debtors XXX Less : RDB XXX 2)Loans advanceBills Receivable Fixed deposit D)Miscellaneous expenditure: Preliminary expenses Underwriting commission Subscription of shares








Important adjustment:
Items Particulars 1. Wages outstanding 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. Salary outstanding Insurance prepaid Depreciation First place Trading A/C Add - wages P&L A/C Add-salary P&L – A/C Less-insurance P&L – Debit side Second place B/S – C.L B/S – C.L B/S – C.A B/S – Less from Assets B/S – Less from Drs “ “ B/S – C.A B/S – C.A B/S –less from Cr’s B/S – liability side B/S – less from capital B/S - provision B/S – provision B/S – secured loan

Reserve for bad doubtful debts P&L – Debit side Bad debts Discount on Debtors Closing stock Income accru but not received Discount on creditors Interest on capital Interest on drawing Proposed dividend Provision for taxation Debenture interest out standing “ “ Trading A/C credit side P&L – Income side P&L – Income side P&L – debit side P&L – side P&L – P&L – P&L – Income debit side debit side debit side


Problems in Final Accounts 1. The following is the Trial balance of Sun light Ltd as on 31.03.2007.Prepare Trading & Profit and loss account, Balance sheet. Debit Credit Share capital 100000 Land 10000 Calls in arrears 6400 Building 25000 Machinery 15000 Furniture 3200 Carriage 2300 Wages 21400 Salaries 4600 Bad debts reserve 1400 Sales 80000 Sales return 1700 Bank charges 100 Coal gas water 700 Rent Rates 800 Purchases 50000 Purchase return 3400 Bills Receivable 1200 Gen expenses 1900 Debtors 42800 Creditors 13200 Stocks 25000 Insurance 400 Cash at bank 13000 Cash in hand 2500 Share premium 6000 General reserve 24000 228000 228000

Adjustments 1. Depreciation on Building 2%, Machinary 10%, Furniture 10% 2. Reserve for bad and doubtful debts 5%. Prepaid insurance Rs120 3, outstanding liability. Wages Rs 3200, salaries Rs500, Rent Rs200 4. Closing stock Rs 30000.


2Following is the Trial balance of Sri Krishna company ltd Bangalore as on 31.03.2007

Debit Share capital Stock Purchase Sales Sales return General expenses Wages Salaries Traveling expenses Advertising Rent &taxes Discount received Bank interest Bad debts Building Plant & Machinery Debtors Creditors Loan Cash in hand Reserve fund Preliminary expenses P&L (Credit) 51000 220000

Credit 80000 330000

3800 1800 12000 18700 3200 1550 4900 2200 850 2500 95000 98000 45000 55500 75000 1400 23000 11000 570700 5000 570700

Adjustments;1. Provision for taxation Rs25000 2. Proposed dividend 15% 3. Transfer Rs 10000 to Reserve fund. 4. Closing stock Rs 32000. Prepare Final Accounts