Introduction to Financial Accounting – Module 1

Define accounting.
Ans: : In 1941, The American Institute of Certified Public Accountants
(AICPA) had defined accounting as 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 financial character, and interpreting the
results thereof’.
Financial accounting is a specific branch of accounting involving a process of
recording, summarizing, and reporting the myriad of transactions resulting from
business operations over a period of time.
Enumerate main objectives of accounting.
Ans: Objectives of Accounting
1. Maintenance of Records of Business Transactions
2. Calculation of Profit and Loss
3. Depiction of Financial Position
4. Providing Accounting Information to its Users

Define trial balance

Ans: A trial balance is a statement showing the balances, or total of debits and
credits, of all the accounts in the
ledger with a view to verify the arithmetical accuracy of posting into the ledger
accounts.

Basic Accounting Concepts

Business Entity: This concept assumes that business has distinct and separate
entity from its owners. Thus, for the purpose of accounting, business and its
owners are to be treated as two separate entities. Every business requires to be
accounted for separately by the proprietor. Personal and business-related
dealings should not be mixed.

Going Concern: The concept of going concern assumes that a business firm
would continue to carry out its operations indefinitely (for a fairly long period
of time) and would not be liquidated in the near future.

Money Measurement: The concept of money measurement states that only

those transactions and happenings in an organization, which can be expressed in
terms of money are to be recorded in the book of accounts. Also, the records of
the transactions are to be kept not in the physical units but in the monetary units.
Accounting Period: 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.

Cost Concept: The cost concept requires that all assets are recorded in the book
of accounts at their cost price, which includes cost of acquisition, transportation,
installation and making the asset ready for the use.

Matching: The concept of matching emphasizes that expenses incurred in an

accounting period should be matched with revenues during that period. It
follows from this that the revenue and expenses incurred to earn this revenue
must belong to the same accounting period.

Dual Aspect: This concept states that every transaction has a dual or two-fold
effect on various accounts and should therefore be recorded at two places. The
duality principle is commonly expressed in terms of fundamental accounting
equation, which is:
Assets = Liabilities + Capital.

Revenue Recognition: The concept of revenue recognition requires that the

revenue for a business transaction should be considered realized when a legal
right to receive it arises.

Accrual accounting: An accounting method where revenue or expenses are

recorded when a transaction occurs versus when payment is received or made.
The method follows the matching principle, which says that revenues and
expenses should be recognized in the same period.

Verifiable objective: This principle requires that each recorded business

transactions in the books of accounts should have adequate evidence to support
it.

Accounting Conventions

Full Disclosure: This concept requires that all material and relevant facts
concerning financial performance of an enterprise must be fully and completely
disclosed in the financial statements and their accompanying footnotes.

Consistency: These concepts state that accounting policies and practices

followed by enterprises should be uniform and consistent one the period of time
so that results are compostable. Comparability results when the same
accounting principles are consistently being applied by different enterprises for
the period under comparison, or the same firm for a number of periods.

Conservatism: This concept requires that business transactions should be

recorded in such a manner that profits are not overstated. All anticipated losses
should be accounted for but all unrealized gains should be ignored.

Materiality: This concept states that accounting should focus on material facts.
If the item is likely to influence the decision of a reasonably prudent investor or
creditor, it should be regarded as material, and shown in the financial
statements.

Double entry book keeping

Double Entry System of accounting deals with either two or more accounts for
every business transaction.
For instance, a person enters a transaction of borrowing money from the bank.
So, this will increase the assets for cash balance account and simultaneously the
liability for loan payable account will also increase.

Features of Double Entry Accounting system

 A transaction has two-fold aspects i.e., one giving the benefit and the
other receiving the benefit.
 A transaction is divided into two aspects, Debit and Credit. One account
needs to be debited and the other is to be credited.
 Every debit must have its corresponding and equal credit.

Advantages of Double Entry System

 This system increases the Accuracy of the accounting, through the trial
balance device
 Profit and loss suffered during the Year can be calculated with details
 By following this system, the company can keep the accounting records
in detail which eventually helps in controlling
 The recorded details can be used for comparison purpose as well. Details
of the first year can be compared with the second year, deviations found
any during comparison can be worked on.
Accounts are classified into following categories:
 Personal Account: Personal Accounts are the ones that are related with
individuals, companies, firms, group of associations etc.

o Natural Personal Account: These accounts relate to natural

persons such as Veer’s A/c, Ayan’s A/c, Karen’s A/c etc.

o Artificial Personal Account: These accounts relate to companies

and institutions such as Kapoor Pvt Ltd A/c, Booker’s Club A/c
etc.

o Representative Personal Account: Accounts that are a

representative of some person are called as representative accounts.
These include Outstanding Interest A/c, Outstanding Wages A/c,
Prepaid Expense A/c etc.

Golden Rule Related To The Personal Account

Debit the Receiver, Credit the Giver

 Real Account: Real Accounts are the ones that are related with
properties, assets or possessions. These properties can be both physically
existing as well as non physical in nature.

o Tangible Real Account: Tangible Real Accounts are accounts

which have physical existence. In other words, such assets can be
seen, felt or touched. For example, Machinery A/c, Vehicle A/c,
Building A/c etc.

o Intangible Real Account: These are the assets or possessions that

do not have physical existence but can be measured in terms of
money. This means that such assets have some value attached to
them. For example, trademarks, patents, goodwill, copyrights etc.

Golden Rule Related to the real Account

Debit What Comes In, Credit What Goes Out

 Nominal Account: Nominal Accounts relate to income, expenses, losses

or gains. These include Wages A/c, Salary A/c, Rent A/c etc.
Golden Rule Related To The Nominal Account:
Debit All Expenses and Losses, Credit All Incomes and Gains