Financial Statement Analysis, BBA 7th Semester

Lecture No. 1
ACCOUNTING & ACCOUNTING PRINCIPLES

Accounting:
Almost every organization and individual maintains accounts and deals with
accounting. In simple terms, it can be described as a record of Income and
expenditure of a business organization, or budget vs. utilization, in the case of a
government non-commercial organization. In the case of the business entity,
accounting would deal with measuring, recording and communicating the
results of business activities. That is why; Accounting is often called “Language
of Business”.

Purpose of Accounting:
Accounting provides decision-makers with sufficient, relevant information to
make prudent and intelligent business decisions. This information is provided
through accounting reports called financial statements. The whole process is
called “financial reporting”

The purpose of accounting is to organize the financial details of business.

To identify the financial transactions.
To organize the financial data into useful information
To measure the value of these information in terms of money
To analyze, interpret, and communicate the information to persons or
groups, both inside or outside the business.

Financial Statements Generated by a Business:

A business generates four financial statements at the end of its accounting
period:-

1. Income statement: shows operational results of business during/over the

accounting period.
2. Statement of owners’ equity: showing changes in owner’s equity through
profit/additional investment or through losses/drawl by owner.
3. Balance sheet showing financial position at the end of the accounting
period i.e. a picture of what the business owns and what it owes.
4. Statement of cash flows giving a picture of cash inflows (receipts) and
cash outflows (payments) over/during the accounting period. It is
prepared from the two major financial statements viz Income Statement
and Balance Sheet.

Notes to Financial Statements:

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In addition to above, notes containing additional information (financial & non-

financial) about the business are also attached to financial statements.

Accounting Period:
Accounting period is the period of time covered by an Income Statement. It is
usually one year. It can either be calendar year (Jan to Dec) or financial year (July
to June). Financial Statements are prepared at the end of accounting period and
are the end product of accounting process/cycle.

DIFFERENT TYPES OF BUSINESS ORGANIZATIONS

1. Sole Proprietorship
According to D.W.T. Stafford, “It is the simplest form of business organization,
which is owned and controlled by one man”. Sole proprietorship is the oldest
form of business organization which is owned and controlled by one person. In
this business, one man invests his capital himself. He is all in all in doing his
business. He enjoys the whole of the profit. The features of sole proprietorship
are:

Easy Formation
Unlimited Liability
Ownership
Profit
Management
Easy Dissolution

2. Partnership
According to Partnership Act, 1932, “Partnership is the relation between persons
who have agreed to share the profits of a business carried on by all or any of
them acting for all.” Partnership means a lawful business owned by two or more
persons. The profit of the business shared by the partners in agreed ratio. The
liability of each partner is unlimited. Small and medium size business activities
are performed under this organization. It has the following features:

Legal Entity
Profit and Loss Distribution
Unlimited Liability
Transfer of Rights
Management
Number of Partners

3. Joint Stock Company

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According to S. E. Thomas, “A company is an incorporated association of

persons formed usually for the pursuit of some commercial purposes”
A joint stock company is a voluntary association of persons created by law. It
has a separate legal entity apart from its members. It can sue and be sued in its
name. In the joint stock company, the work of organization begins before its
incorporation by promoters and it continues after incorporation. The joint stock
company has the following feature:

Creation of Law
Separate Legal Entity
Limited Liability
Transferability of shares
Number of Members
Common Seal

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

These are ‘Ground rules’ i.e. Principles for preparing financial statements. These
are constantly evolving. These embody accounting concepts, measurement
techniques and standards of presentation of financial statements. These
Accounting Principles enable comparability between various enterprises and of
the operational performance of the same enterprise over many years. These give
reliability to Financial Statements.

Following are some of the Generally Accepted Accounting Principles:

1. Entity principle: specific business entity separate from personal affairs of

the owner(s).
2. Cost principle: valuation and recording of assets at cost.
3. Going-concern assumption: connected with cost principle, assets
acquired for use and not for resale.
4. Objectivity principle: definite, factual basis for assets valuation;
measuring transactions objectively.
5. Stable currency principle: The currency remains more or less stable and
rate of inflation is almost zero.
6. Adequate disclosure concept: facts necessary for proper interpretation of
statements; “subsequent events”, lawsuits against the business, assets
pledged as securities/collaterals, contingent liabilities etc; reflected in
Notes.

ACCOUNT AND ACCOUNTING CYCLE/PROCESS

Account:

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An accounting system keeps separate record of each item like assets, liabilities,
etc. For example, a separate record is kept for cash that shows increase and
decrease in it. This record that summarizes movement in an individual item is
called an Account. Each element/sub-element of the balance sheet is named as
“Account”, having three parts viz title, left side (Debit or Dr) and a right side
(Credit or Cr). Technically, these are also called ‘Ledger Accounts’. The same is
true of Income Statement, which would be discussed later. The Ledger Accounts
are also called T-account, because these are in the shape of the alphabet ‘T’ as
shown below:-

Account Title
Date Particulars Debit Date Particulars Credit

Steps in Accounting Cycle:

The accounting procedures in the accounting cycle may be summarized as
follows

1. Journalize Transactions
2. Post to Ledger Accounts
3. Prepare A Trial Balance
4. End of Period Adjustments
5. Prepare an Adjusted Trial Balance
6. Prepare financial statements
7. Journalize and Post Closing Entries
8. Prepare an After Closing Trial Balance

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