Financial Accounting

Financial Accounting : It is the process of recording, summarizing and reporting the myriad of
transaction resulting from business operations over a period of time. The transactions are summarized
into financial statements.

Types of Accounts : There are mainly four types of accounts in accounting : Real, Personal, Nominal
accounts and Valuation accounts. Personal accounts are classified under three subcategories:
Artificial, Natural and Representative. Failure in identifying an account correctly as either a real,
personal or nominal, in most cases, will render journal entries incorrect.

 Real Account : All assets of a firm, which are tangible or intangible fall under this category.
For Real Accounts, Golden Rule – Debit what comes in, Credit what goes out.
 Nominal Account : An account that is related to expenses, losses, gains and incomes. Debit all
expenses and losses, Credit all incomes and gains
 Personal Account : Accounts that are related to individuals, firms and entities. Eg. Debtors,
Creditors of the Firm, Suppliers etc. Golden Rule – Debit the receiver, Credit the Giver. Further
divided into :
o Natural : Deal’s with the creations of nature ie. humans
o Artificial : Entities created artificially under the law ie. firms
o Representative : Accounts representing a person or group directly or indirectly. Eg.
Prepaid Accounts are representative etc.
 Valuation Account : Contra (Adjunct) Account. Valuation account offsets the gross amount of
an account to arrive at a net balance. Eg. Allowance for Doubtful Accounts, Accumulated
Depreciation etc.

Double Entry System : Every business transactions has an impact on two accounts simultaneously ie,
principle of debit and credit.

Accounting Principles :

 Matching : Expenses should be recorded during the period in which they are incurred,
regardless of when the transfer of cash occurs.
 Duality : Accounting principle that recognizes the dual nature of impact of a transaction on
the cash flow ledger of a balance sheet ie. the role of both debit and credit in any given
transaction. Eg. A company raises debt funding from a bank, cash (asset) is debited and loan
payable (liability) is credited.
 Materiality : Materiality states that items that are large enough to impact financial decisions
in an organization may be considered for the purpose of financial reporting. All important
matters are to be disclosed as they impact the decisions of stakeholders who use the financial
 Money Measurement : Only transactions that have a monetary impact are to be considered
for the purpose of financial reporting. Only record transactions that can be recorded in terms
of money.
 Going Concern : A business is to be regarded as an entity that exists for perpetuity.
 Conservatism : Record expenses and liabilities as soon as possible, but record assets and
incomes/revenues only when sure about them.
 Consistency : Once an accounting principle has been adopted, it should be treated as the
benchmark, until a significantly better accounting principle comes along.
 Accrual Principle : Accounting transactions should be recorded in the period in which they
occur, rather than the period in which their cash - flows are realized.

showing the net of debit. Journal : A log in which all the financial transactions of the organization are noted chronologically. It serves as a self .For detailed definitions and more principles : http://www.accountingtools. Flow in the accounting cycle : Journal Entry – Ledger – Trial Balance – Financial Statement .check before transferring the final contents into the financial statement. Eg. major columns being Date. credit and balance for various pages of the journal. The journal uses a shorthand notation to record transactions. Debit Amount. Contingency Principle etc. Trial Balance : It is a listing of ledger accounts with their respective debit and credit balances. Accounts (From Debit Account to Credit Account ALWAYS).com/basic-accounting- principles such as Cost Principle. Credit Amount. Below : Ledger : Contains detailed accounting transactions.

Credit when Increase  Capital/Shareholders’ Equity Account . liabilities and shareholder’s equity at a particular point in time. Credit when Decrease  Liabilities Account .Debit when Decrease. credit all revenues/incomes and gains  For Real Accounts : Debit what comes in.Debit when Decrease. Credit when Decrease Balance Sheet : Statement that showcases the assets. financial condition and cash – flows.Financial Statement : It is a form of record of an organization’s financial results. Credit when Increase  Revenue Account .Debit when Increase. Credit the Giver  For Nominal Accounts : Debit all expenses and losses. Credit when Increase  Expense Account . the accounts are classified into categories :  Assets Account – Debit when Increase. Below : Accounting Equation : Assets = Liabilities + Shareholders’ Equity . Financial Statements are useful as they :  Determine the ability of a business to raise capital and effectively utilize the capital  Determine whether a business can pay back its borrowings  Track financial results and determine profitability  Derive financial ratios that indicate financial health of the business  Disclosures and assumptions 3 Golden Rules of Accounting : The golden rules of accounting are as follows :  For Personal Accounts : Debit the Receiver. Credit what goes out Modern Rule of Accounting : In the modern approach. Eg. Its represents the financial condition of the company at a given point in time.Debit when Decrease. Shows a company’s sources of funding (shareholders’ equity and liabilities) and the utilization of these funds in terms of the assets that the company owns under various heads.

Eg.  Investing Activities : Purchase of new equipment. Eg. Prepaid Expenses etc. Copyrights. PBT : Profit before Tax PAT : Profit after Tax EBITDA : Earnings before Interest. It is the monetary obligations of the company towards entities that have funded it without gaining a stake/share of ownership in the company. There are three methods of depreciating the value of a particular asset over its useful life :  Straight Line Method : Depreciation (constant for all years) = Asset Value at Cost/Useful Life. Assets : A tangible or intangible economic resource that contributes to the company’s revenue generation. has a positive economic value and over which the company has complete control. A particular asset is allotted a useful life for the purpose of accounting. Liabilities : One of the sources of funding a company’s activities. The asset’s value is allocated over the useful life of the asset. Lists the cash inflow and outflow elements into three categories :  Operating Activities : Activities that are fall under the purview of the core business activities and are related to the provision of its offerings.Income/P&L Statement : Consolidated statement of incomes and expenditures & profits and losses of the organization over a given period of time (usually 1 year). Patents.. Depreciation and Methods : Reduction in the value of an asset due to wear and tear. Inventory. Land. Revenue is the amount that a company receives by means of its core operating activities. Amortization : Depreciation of an intangible asset is called amortization (Allocation of the cost of an intangible asset over its useful life). Depreciation for Year 2 = Asset Value for Year 2/Useful Life. For Year 2. profits. Eg.  Written Down Value Method : For Year 1. issue and sale of shares. cannot be converted into cash (through sale of the asset) within a period of one year. paying off any dues etc. Loan & Debenture : Loan is the act of giving money against the promise of future repayment of that sum of money along with an additional charge. where its money is coming from and how the money is being spent. Liquid Assets are those that can be converted into cash within a period of one year. income from investments. Debenture is a form of debt . Depreciation for Year 1 = Asset Value at Cost/Useful Life. Shows the company’s ability to generate profit’s by reducing costs and/or increasing revenues. Goodwill etc. Asset Value for Year 2 = Asset Value at Cost – Depreciation for Year 1. Intellectual Property. Cash. Marketable Securities. Land etc. Depreciation is deducted from the Asset Cost each year in the balanace sheet.  Financing Activities : Loans and Debentures raised. Depreciation and Amortization Expenses and Revenues : Expense is the cost a business occurs in order to earn revenue and potentially. Fixed Assets/Non-Current & Liquid/Current Assets : Fixed Assets are those that cannot be converted into cash quickly ie. Tax. Machines. known as interest. Eg. shares bought.Flows Statement : Statement elucidating how the company’s operations are being run. Cash . Net asset Value at the end of useful life is zero. dividends etc. Trade Receivables.

Differences :  Voting Rights : Common Stock holders have voting rights in the Annual general meeting of the firm. Call and Notice Money Market. Capital markets usually cater to the raising of capital by sale and purchase of securities with long maturity periods. It is the amount invested in the company by its owners ie. Deferred Tax is an Asset when the company has paid more taxes to the monetary authority than it was supposed to during the previous accounting period. Treasury Bills : Also known as T – bills. Eg. Common vs Preferred Stock : Common Stock and Preferred Stock are securities that represent ownership in a firm.outs are made to the creditor. REPO Market. followed by repayment of the principle amount at the end of the maturity period. they are short term debt obligations issued by the government of a country. Marketable Securities : Securities that can be sold ie. Commercial Papers etc. It is backed by the general creditworthiness of the issuing party. Certificates of Deposits. converted to cash within a year. the net amount that would be returned to all shareholders of the company if the company were liquidated (meaning all its assets were sold to repay its debts). Indigenous Bankers etc. Current & Non – Current Liabilities : Current Liabilities are those debts and obligations of a firm that can be repaid within a period of one year. Periodic interest pay . Long Term Debentures. Deferred Tax : Can either be an asset or a liability. DFHI etc. There are unorganized and organized money markets in India. Bonds : It is a written promise by the issuer (similar to an IOU) that the creditor will be payed after a certain period of time. Bonds with high maturity period etc. Eg. Unorganized Eg. It has a maturity period ranging from a few days to a max of 1 year. the higher will be the interest payout that it gives.term debt obligation. The greater the maturity period of the T – bill. Treasury Bill Market. Trade Payables. .financing that is not secured by collateral or physical assets. T – bills. Order of pay . usually at a discount from the par value.outs in the event of liquidation : (Max Preference) Bonds – Debentures – Secured Loans – Unsecured Loans – Preferred Stock – Equity Shares (Min Preference) Shareholders’ Wealth vs Shareholders’ Capital : Shareholders’ wealth is the market price of the share of the company. Deferred Tax is a Liability when a company has not paid the full amount of taxes owed to the monetary authority during the previous reporting period. National Stock and Bond Exchanges etc. They get to vote on any aspect related to management of the company. Eg. Non – Current Liabilities are those debts and obligations of a firm that can be repaid only after a period of one year. Money Lenders. known as maturity period. Short Term Loans etc. hence making them a short . Shareholders’/Owners’ Equity : The difference between the assets and liabilities of the firm. Shareholders’ Capital is the amount invested by all shareholders in the company. Money Market vs Capital Market : Money market is where highly liquid assets and securities with short maturity periods are traded. Organized Eg. including election of the board of directors. They are unrestricted financial instruments that can be bought or sold on the public stock or bond exchanges. Long Term Loans. Eg.

Yield : The income return on an investment. whereas common stockholders are given dividend pay – outs at rates determined at the time of dividend declaration by the company. Eg. usually for the purpose of expanding the business. Share : A unit of ownership in the firm. Reserves & Surplus : A provision of the profits appropriated to specific purpose. Share Premium : Difference between the trading price of the share and its face value. thus leading to an increase in the share price of the firm and the value of the investment. preferred stockholders get paid prior to common stockholders. Face Value : The original cost of the stock as shown on the stock certificate.on Public Offering. IPO/FPO : Initial Public Offering/Follow . Profit After Tax) that is not paid out as dividend and is hence either re-invested in the core business of the company. taxation.  Dividend Pay . Surplus is the amount that is left in the profit and loss account after providing for dividends. Issue Price : The initial price that the share of the share of a firm is issued in the stock market. It is declared as a percentage of the face value of the firm’s share. Retained Earnings : Retained earnings refers to the portion of net earnings of the firm (ie. Stock split as 2:1. Determined by supply and demand. The number of shares outstanding doubles ie. at a certain percentage of the face value of the share. A person possessing a share of a company is entitled to a proportion in the profits of the firm. or withheld to counteract an eventuality. Double click to begin the slideshow : Capital Club Session 3 Basics of Accountancy Presented By-: Manan Chaudhary Sachin Gopalakrishnan Shorya Gupta . This would halve the market price of the share and thus makes the shares more affordable for potential investors in the market. Interest earned from investing in government T – bills etc. Eg.Outs : Preferred Stockholders are given fixed dividend pay . Interest earned from investing in bonds.  Liquidation : In the event of liquidation of a firm. or used to repay debt. Financial Ratios : Please find the Capital Club PPT on Financial Ratios embedded below. Stock Split is a corporate decision that divides the existing shares of a firm into multiple shares. Initial public offering is the first time that a company lists itself in the stock market for public equity financing. reserves etc. Thus it would potentially lead to a greater demand for shares of the company in the market. Bonus is the issue of free additional shares to the shareholders of the company.outs. Dividend vs Bonus vs Stock Split : Dividend is a pay – out that is issued to the shareholders’ of the company from the net earnings of the firm. Also preferred stockholders are paid prior to common stockholders. A certain number of additional shares are given as a proportion to the number of shares currently held by the shareholder. bonus. Follow – on public offering is when a company that is already listed in the stock exchange issues shares again to investors. Market Price : The price at which the share of the company is trading in the market.