Financial Accounting

and Reporting
Faculty: Kavitha P
L M Thapar School of Management
BE- MBA: MBA Semester I
Session 4,5 and 6

Quick Recap!
Definition→ Importance Objectives
→AIS→ Users→ Organizational Forms
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Topics to be covered

◉ Basic Organizational Forms

◉ Accounting Principles
◉ Basic Accounting Terms
◉ Accounting Equation

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Session
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Recap.. Forms of Business

Various factors determining the character of business ▪ Secrecy

include:
▪ Legal Aspects
▪ Ease of Formation Depending on these factors mentioned
▪ Capital or Financial Requirements above, there can be seven different forms
of business organizations. They are as
▪ Nature of Liability follows:
▪ Control ▪ Sole Proprietorship
▪ Stability and Continuity ▪ Partnership
▪ Flexibility to Conduct Operations. ▪ Hindu Undivided Family
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▪ Company
▪ LLP (Limited Liability Partnerships)
▪ Co-operative Societies
Sole Proprietorship
“Sole trader is a type of business unit where a person is solely responsible
for providing the capital, for bearing the risk of the enterprise and for the
management of business.” J.L. Hansen
❑ Characteristics
▪ Easy formation and closure
▪ Unlimited Liability
▪ Sole risk bearer and profit recipient
▪ Undivided Control
▪ No separate entity
▪ Lack of business continuity
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Partnership Firms
◉ The Indian Partnership Act, 1932 defines partnership as “the relation
between persons who have agreed to share the profit of the business
carried on by all or any one of them acting for all.”

◉ Formation
▪ Through a legal agreement wherein the terms and conditions
governing the relationship among the partners, sharing of profits
and losses and the manner of conducting the business are
specified-Partnership deed
▪ Business must be lawful and run with the motive of profit. Two
people coming together for charitable purposes will not constitute
partnership.
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◉ Liability: unlimited liability. The partners are jointly and individually

liable for payment of debts.
◉ Risk bearing: The reward comes in the form of profits which are shared
by the partners in an agreed ratio. However, they also share losses in the
same ratio in the event of the firm incurring losses.
◉ Decision making and control: Decisions are generally taken with
mutual consent.
◉ Continuity: Partnership is characterized by lack of continuity of
business since the death, retirement, insolvency or insanity of any
partner can bring an end to the business-Dissolution
The remaining partners may if they so desire continue the business
on the basis of a new agreement

◉ Number of Partners: The minimum number of partners needed

 to start a partnership firm is two. According to section 464 of the
Companies Act 2013, maximum number of partners in a partnership
firm can be 100, subject to the number prescribed by the government. As
per Rule 10 of The Companies (miscellaneous) Rules 2014, at present
the maximum number of members can be 50.
◉ Mutual agency: Every partner is both an agent and a principal. He is an
agent of other partners as he represents them and thereby binds them
through his acts. He is a principal as he too can be bound by the acts of
other partners.

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Types of Partners
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Hindu Undivided Family (HUF)

▪ Joint Hindu family business is a specific form of business organization

found only in India.
▪ the business is owned and carried on by the members of the Hindu
 Undivided Family (HUF).
▪ It is governed by the Hindu Law.
▪ The basis of membership in the business is birth in a particular family
and three successive generations can be members
in the business.
▪ The business is controlled by the head of the family who is the
eldest member and is called karta. All members have equal ownership
right over the property of an ancestor and they are known as co
parceners.

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Hindu Undivided Family (HUF)

▪ Formation: For a joint Hindu family business, there should be at least two
members in the family and ancestral property to be inherited by them.
The business does not require any agreement as membership is by birth.
It is governed by the Hindu Succession Act, 1956.
 ▪ According to the Hindu Succession (Amendment) Act, 2005, the
daughter of a coparcener of a Joint Hindu Family shall, by birth,
become a coparcener
▪ Liability: The liability of all members except the karta is limited to their
share of co-parcenery property of the business. The karta, however, has
unlimited liability.
▪ Control: The control of the family business lies with the karta. ▪
Continuity: The business continues even after the death of the karta as the
next eldest member takes up the position of karta, leaving the
business stable.

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Joint Stock Companies

▪ A company can be described as an artificial person having a separate
legal entity, perpetual succession and a common seal.
▪ The company form of organization is governed by The Companies Act,
2013.
▪ As per section 2(20) of Act 2013, a company means company
 incorporated under this Act or any other previous company law.
▪ The capital of the company is divided into smaller parts called ‘shares’
which can be transferred freely from one shareholder to another
person (except in a private company)
▪ The shareholders are the owners of the company while the Board of
Directors is the chief managing body elected by the shareholders.

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Joint Stock Companies

▪ Artificial person: A company is a creation of law and exists
independent of its members. Like natural persons, a company can own
property, incur debts, borrow money, enter into contracts, sue and be
sued.
▪ Separate legal entity: From the day of its incorporation, a company
acquires an identity, distinct from its members. Its assets and liabilities
are separate from those of its owners.
 ▪ Perpetual succession: A company being a creation of the law, can be
brought to an end only by law. It will only cease to exist when a specific
procedure for its closure, called winding up, is completed.
▪ Control: The management and control of the affairs of the company is
undertaken by the Board of Directors, which appoints the top
management officials for running the business.

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Joint Stock Companies

▪ Liability: The liability of the members is limited to the extent of the capital
contributed by them in a company. The members can be asked to
contribute to the loss only to the extent of the unpaid amount of share
held by them
▪ Common seal: The company being an artificial person cannot sign its
name by itself. Therefore, every company is required to have its own seal
which acts as official signature of the company. Any document which
does not carry the common seal of the company is not binding on the
company.
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One Person Company (OPC)

◉ Defined u/s 2(62) of the CA, 2013 – One Person Company means a
company which has only one person as a member.

◉ Section 3(1) of the CA, 2013 – OPC (as private company) may be formed for
any lawful purpose by 1 persons.

◉ Section 149(1) of the CA, 2013 – OPC shall have minimum 1 director in its
Board, its sole member can also be director of such OPC.

◉ Single-member: OPCs can have only 1 member or shareholder, unlike other

private companies.

◉ Nominee: A unique feature is that the sole member of the company has to
mention a nominee while registering the company. Since there is only one
member in an OPC, his death will result in the nominee choosing or
rejecting to become its sole member. This does not happen in other
companies as they follow the concept of perpetual succession.
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Types of Companies based on membership

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Limited Liability Partnership

▪ An LLP has the characteristics of both the partnership firm and

 company.
▪ The Limited liability Partnership Act, 2008 regulates the LLP in India. ▪
Minimum two partners are required to incorporate an LLP.
▪ No upper limit on the maximum number of partners of an LLP.
▪ Among the partners, there should be a minimum of two designated
partners who shall be individuals, and at least one of them should be
resident in India.
▪ The rights and duties of designated partners are governed by the LLP
agreement

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Limited Liability Partnership-Features

• It has a separate legal entity just like companies.

• The liability of each partner is limited to the contribution made by
the partner.
 • The cost of forming an LLP is low.
• Less compliance and regulations.
• No requirement of minimum capital contribution.

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Cooperative Societies
▪ The cooperative society is a voluntary association of persons, who join together with the motive of
welfare of the members.
▪ The cooperative society is compulsorily required to be registered under the Cooperative Societies Act
1912.
▪ The process of setting up a cooperative society is simple enough and at the most what is required is
the consent of at least ten adult persons to form a society.
▪ The capital of a society is raised from its members through issue of shares.
▪ The society acquires a distinct legal identity after its registration. 22

Cooperative Societies- Features

▪ Voluntary membership: The membership of a cooperative society is

voluntary.
▪ Legal status: Registration of a cooperative society is compulsory. This
accords a separate identity to the society which is distinct from its
members.
▪ Limited liability: The liability of the members of a cooperative society is
limited to the extent of the amount contributed by them as capital. ▪
Control: In a cooperative society, the power to take decisions lies in the
hands of an elected managing committee. The right to vote gives the
members a chance to choose the members who will constitute the managing
committee.
▪ Service Motive :The cooperative society through its purpose lays
emphasis on the values of mutual help and welfare

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Accounting Principles

Accounting principles may be defined as those rules of action or conduct

which are adopted by the accountants universally while recording
accounting transactions.
Accounting Principles are classified as: Accounting Concepts Accounting
Conventions
Important criteria for Principles :
▪ Relevance : The principle is relevant to the extent it results in
information that is meaningful and useful to the user of the accounting
information.
▪ Objectivity : A principle is objective to the extent the accounting
 information is not influenced by personal bias or judgement of those
who provide it.
▪ Feasibility : A Principle is feasible to the extent it can be implemented
without much complexity or cost.

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Accounting Concepts and Conventions comparison

BASIS FOR COMPARISON ACCOUNTING CONCEPT ACCOUNTING CONVENTION

Meaning Accounting concepts refers to Accounting conventions

the rules of accounting which
are to be followed, while
recording business
transactions and preparing
final accounts.
implies the customs or
practices that are widely
accepted by the accounting
bodies and are adopted by the
firm to work as a guide in the
preparation of final accounts.

What is it? A theoretical notion A method or procedure

Set by Accounting bodies Common accounting practices

Concerned with Maintenance of accounts Preparation of financial

statement
 Biasness Not possible Possible

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Accounting Principles

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 Accounting Assumptions and Concepts

1.Business Entity Concept

The concept of business entity assumes that business has a distinct and
separate entity from its owners.
▪ the business and its owners are to be treated as two separate entities. ▪
when a person brings in some money as capital into his business, in
accounting records, it is treated as liability of the business to the owner.
Here, one separate entity (owner) is assumed to be giving money to another
distinct entity (business unit).
▪ when the owner withdraws any money from the business for his
personal expenses(drawings), it is treated as reduction of the owner’s
capital and consequently a reduction in the liabilities of the business.

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2.Money measurement concept

◉ only those transactions and happenings in an organisation which can be
expressed in terms of money such as sale of goods or payment of
expenses or receipt of income, etc., are to be recorded in the book of
accounts.
◉ The records of the transactions are to be kept not in the physical units
but in the monetary unit.
◉ the change in the value of money is not reflected in the book of
accounts, the accounting data does not reflect the true and fair view of
the affairs of an enterprise.

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3.Accounting Period Concept

 ◉ Accounting period refers to the span of time at the end of which the
financial statements of an enterprise are prepared, to know whether it
has earned profits or incurred losses during that period and what
exactly is the position of its assets and liabilities at the end of that
period.
◉ Such information is required by different users at regular interval for
various purposes, as no firm can wait for long to know its financial
results as various decisions are to be taken at regular intervals on the
basis of such information.
◉ The Companies Act 2013 and the Income Tax Act require that the
income statements should be prepared annually
◉ companies whose shares are listed on the stock exchange, are required
to publish quarterly results

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4.Going Concern Concept

 ◉ The concept of going concern assumes that a business firm would
continue to carry out its operations indefinitely, i.e. for a fairly long
period of time and would not be liquidated in the foreseeable future
◉ Implication : An asset may be defined as a bundle of services. When we
purchase an asset, for example, a personal computer, for a sum of
$50,000, what we are buying really is the services of the computer that
we shall be getting over its estimated life span, say 5 years. It will not be
fair to charge the whole amount of $50,000, from the revenue of the year
in which the asset is purchased.

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5.Dual Aspect Concept
◉ This concept states that every transaction has a dual or two-fold effect and should therefore be
recorded at two places. In other words, at least two accounts will be involved in recording a transaction
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Examples.
◉ Ram started business by investing in a sum of $50,00,000.
◉ The amount of money brought in by Ram will result in an increase in the assets
(cash) of business by ` 50,00,000. At the same time, the owner’s equity or capital will
also increase by an equal amount. It may be seen that the two items that got affected
by this transaction are cash and capital account.
◉ Suppose the firm purchase goods worth $10,00,000 on cash.
◉ This will increase an asset(stock of goods) on the one hand and reduce another asset
 (cash) on the other.
◉ if the firm purchases a machine worth $30,00,000 on credit from Reliable
Industries.
◉ This will increase an asset (machinery) on the one hand and a liability (creditor) on
the other.
◉ This type of dual effect takes place in case of all business transactions and is also
known as duality principle

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6.Revenue Recognition (Realisation) Concept

◉ The concept of revenue recognition requires that the revenue for a
business transaction should be included in the accounting records only
when it is realised.
Here arises two questions in mind. First, is termed as revenue and the
other, when the revenue is realised.
◉ Revenue is the gross inflow of cash arising from (i) the sale of goods and
services by an enterprise; and (ii) use by others of the enterprise’s
resources yielding interest, royalties and dividends.
 ◉ revenue is assumed to be realised when a legal right to receive it arises,
i.e. the point of time when goods have been sold or service has been
rendered.
◉ credit sales are treated as revenue on the day sales are made and not
when money is received from the buyer.
◉ income such as rent, commission, interest, etc. these are recognized on
time basis.

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7.Historical Cost Concept

◉ The cost concept requires that all assets are recorded in the book of
accounts at their purchase price, which includes cost of acquisition,
transportation, installation and making the asset ready to use.
◉ To illustrate, on June 2005, an old plant was purchased for $50 lakh by
Shiva Enterprise, which is into the business of manufacturing detergent
powder.
■ $10,000 was spent on transporting the plant to the factory site.
$15,000 was spent on repairs for bringing the plant into
 running position
$25,000 on its installation.
■ The total amount at which the plant will be recorded
in the books of account would be the sum of all these, i.e.
` 50,50,000

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8.Matching Concept

◉ It states that expenses incurred in an accounting period should

be matched with revenues during that period.
◉ Revenue is recognised when a sale is complete or service is
rendered rather when cash is received.
◉ an expense is recognized not when cash is paid but when an
asset or service has been used to generate revenue. For
example, expenses such as salaries, rent, insurance are
recognized on the basis of period to which they relate and not
 when these are paid
◉ we should not take the cost of all the goods produced or
purchased during that period but consider only the cost of
goods that have been sold during that year.

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Objective Evidence Concept

◉ accounting transaction should be recorded in an objective

manner, free from the bias of accountants and others. This can
be possible when each of the transaction is supported by
verifiable documents
or vouchers.
◉ Supplements the Historical Cost Concept
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Accounting Conventions
▪ Convention of disclosure: Accounts should be prepared in such a way
that all material information is clearly disclosed to the users.
▪ Convention of consistency: An accounting method or procedure once
chosen should be followed consistently from year to year.
▪ Convention of conservatism: Any business while recording the
transactions should ‘anticipate no profits but provide for all possible
losses’.
▪ Convention of materiality: Only those events should be recorded which
have a significant bearing and insignificant things should be ignored.
There is no formula for identifying material and immaterial events. It
depends on the accountant discretion.

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Accounting Concepts and Conventions
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Accounting Terms
▪ Assets: Assets are economic resources of an enterprise that can be
usefully expressed in monetary terms. Assets are items of value used by
the business in its operations.
 ▪ Assets classified into two types: current and
Non-current
▪ An asset must be:
Acquired in a transaction.
Economic resources (i.e., provide future benefits).
Controlled by the entity.
Objectively measurable cost at time of acquisition.
▪ Book value of assets: recorded value.
▪ Fair value of assets :amount for which asset could be currently
purchased or sold

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Assets categories-Non Current
▪ Long-Term Investments
▪ Investments (stocks, bonds, and long-term notes) intended to be held for a period of time usually
extending beyond one year.
▪ Property, Plant, and Equipment(Fixed Assets)
▪ Assets of a durable nature (tangible, long-lived) that are to be used in the production or sale of goods,
or rendering of services, rather than being held for sale. Also, called fixed assets. Eg: Machinery,
Factory Building, etc.
▪ Carried at Cost (-) Accumulated Depreciation
▪ Intangible Assets
▪ Non-current, non-physical assets of a business, the possession of which
provides uncertain future benefits to the owner. E.g., goodwill,
trademarks, patents, etc.
▪ carried on the BS at cost (-) accu. amortization.
▪ Internally generated intangible assets are not shown as assets 40

Current Assets
Cash and other assets that are expected to be realized in cash or sold or
consumed during the normal operating cycle of the entity or within one year,
whichever is longer, are called current assets.
◉ Although the usual time limit is one year, exceptions occur in
companies whose normal operating cycle is longer than one year.
◉ Tobacco companies and distilleries, for example, include their
inventories as current assets even though tobacco and liquor remain in
 inventory for an aging process that lasts two years or more.

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Categories of Current Assets

◉ Cash consists of funds that are readily available for

disbursement.
◉ Marketable securities are investments that are both readily
marketable and expected to be converted into cash within a
year.
◉ Accounts receivable are amounts owed to the entity by its
customers.
◉ Amounts owed the entity by parties other than customers
would appear under the heading notes receivable or other
receivables rather than as accounts receivable.

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▪ Inventories are the aggregate of those items that are either (1)
held for sale in the ordinary course of business, (2) in process of
production for such sale, or (3) soon to be
consumed in the production of goods or services that will be
available for sale.
▪ Inventory relates to goods that will be sold in the ordinary
course of business.
▪ A truck offered for sale by a truck dealer is inventory. A truck
used by the dealer to make service calls is not inventory; it is
an item of equipment, which is a noncurrent asset.
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◉ Prepaid expenses represent certain assets, usually of an intangible

nature, whose usefulness will expire in the near future.
◉ An example is an insurance policy. A business pays for insurance
protection in advance. Its right to this protection is an asset—an
economic resource that will provide future benefits. Since this right will
expire within a fairly short period of time, it is a current asset. The
amount on the balance sheet is the amount of the unexpired cost of the
future benefit.

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Liabilities
 ▪ Liability is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of
resources representing economic benefits
▪ Reported at amount that would satisfy obligations on Balance Sheet
date.
▪ Long term liabilities
▪ Also called: Long-term debt/Non-current liabilities.
▪ Due beyond upcoming year.
▪ Current Liabilities
▪ Satisfied or extinguished within one year
▪ or normal operating cycle, if longer

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▪ Accounts Payable: Current Liabilities

▪ Suppliers (i.e. vendors) claims for goods or services furnished, but
 not yet paid.
▪ Unsecured.
▪ Notes payable:
▪ Short-term loans.
▪ Formal written note.
▪ Includes amounts owed to financial institutions.
▪ Tax Payable
▪ Owed to government agencies for taxes.
▪ Income taxes often shown separately because of size
▪ Deferred Revenues
▪ Also called unearned revenues or pre-collected revenues.
▪ Advance payment received, but company has not yet performed
service or delivered product.
▪ Accrued Expenses
▪ Earned by outside parties but not yet paid (i.e., unpaid expenses). ▪
Usually no invoice.
▪ Includes interest payable, wages payable
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Owner’s Equity or Capital

 ◉ Capital indicates the amount of financing provided by owners of
the business and earnings.
◉ The investment of cash and other assets in the business by
the owners is called contributed capital.
◉ The amount of earnings (profits) reinvested in the business
(and thus not distributed is called retained earnings
Also know as “Net assets” (i.e., Assets minus Liabilities).
◉ For a corporation:
◉ Shareholders’ or stockholders’ equity .
◉ Shares of stock evidence ownership interest

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Shareholders’ Equity
◉ Two components : Paid-up capital and Retained earnings
◉ Paid-up Capital; A measure of the capital contributed to the
company by its owners. Contribution can be through cash, non cash assets, or valuable services.
Two parts:
◉ Par value (stated value) - a rupee amount printed on each stock certificate
◉ Securities Premium- Paid-in capital in excess of par value - the difference between the total amount
received for the stock and the par value
◉ Retained earnings : Cumulative sum of profits earned from the inception of business –Cumulative
sum of all “dividends” distributed to the owners from the inception of business
A measure of undistributed profits of a business
Beginning RE+ Net income- Dividends during the period =Ending RE 48