Financial Accounting

Introduction The purpose of accounting is to provide the information that is needed for sound economic decision making. The main purpose of financial accounting is to prepare financial reports that provide information about a firm’s performance to external parties such as investors, creditors, and tax authorities. Managerial accounting contrasts with financial accounting in that managerial accounting is for internal decision making and does not have to follow any rules issued by standard-setting bodies. Financial accounting, on the other hand, is performed according to Generally Accepted Accounting Principles (GAAP) guidelines. In a manufacturing organisation, it provides information to management about the cost of manufacturing a product, the cost of performing a job, the cost of sales and the profit earned or loss incurred etc. Similarly, in a commercial organisation, it provides information about the profit or loss and also the increase or decrease in the assets and liabilities of the organisation. It also provides data for proper budgetary control. In the case of government, accounting helps the various levels of management, in the preparation of plans and exercise of proper financial control. By providing data about the expenditure incurred on, various activities, it helps budget planners to determine in advance, the taxes to be levied and also the areas, where the cut in expenditure is possible. Again, it helps the management in proper monitoring and implementation of plans, schemes. Thus, accounting is an useful aid to management in performing its various managerial functions analyze, effectively. Organized set interpret, of manual and to and computerized accounting record, classify, present accurate and methods, procedures, and controls established gather,

summarize,

timely financial data for management decisions. The accounting system of a company consist of following elements: 1. Journal 2. Ledger 3. Trial Balance 4. Profit and Loss A/c 5. Balance Sheet.

Monetary For an accounting record to be made it must be able to be expressed in monetary terms. but rather that the assets will be used in future operations. and records the difference as a cost of operations (depreciation expense. Going Concern Accounting assumes that an entity will continue to operate indefinitely. This concept also allows businesses to spread (amortize) the cost of an asset over its expected useful life. This concept implies that financial statements do not represent a company’s worth if its assets were to be liquidated. shows the value as a net amount. financial statements show only a limited picture of the business.The elements are explained in detail in the following pages. Even in proprietorships and partnerships. Cost An asset (something that is owned by the company) is entered into the accounting records at the price paid to acquire it. For this reason. Consider a situation where there is a labor strike pending or the business owner’s health is failing. these situations have a huge impact on the operations and financial security of the company but this information is not reflected in the financial statements. Eleven Key Accounting Concepts Entity Accounts are kept for entities and not the people who own or run the company. Because the “worth” of an asset changes over time it would be impossible to accurately record the market value for the assets of a company. the accounts for the business must be kept separate from those of the owner(s).) Objectivity . The cost concept does recognize that assets generally depreciate in value and so accounting practice removes the depreciation amount from the original cost.

bank statement. etc…). the matching principle requires that revenues and related expenses be recorded in the same accounting period. This ensures . Realization Revenues are recognized when they are earned or realized. method of accounting for inventory) it must use that same method for all subsequent events.The objectivity concept states that accounting will be recorded on the basis of objective evidence (invoices. The reasons for accounting in this manner are so that financial statements do not overstate the company’s financial position. Matching To avoid overstatement of income in any one period. Consistency Once an entity decides on one method of reporting (i.e. If you bill $20. receipts.000 of services in a month. Accounting chooses to err on the side of caution and protect investors from inflated or overly positive results. The rule is to recognize revenue when it is reasonably certain and recognize expenses as soon as they are reasonably possible. Realization is assumed to occur when the seller receives cash or a claim to cash (receivable) in exchange for goods or services. Conservatism This requires understating rather than overstating revenue (income) and expense amounts that have a degree of uncertainty. This concept is related to conservatism in that revenue (income) is only recorded when it actually occurs and not at the point in time when a contract is awarded. This can be a fiscal year (Mar 1 – Feb 28). Time Period This concept defines a specific interval of time for which an entity’s reports are prepared. natural year (Jan 1 – Dec 31). This means that accounting records will initiate from a source document and that the information recorded is based on fact and not personal opinion. in order to accurately represent the income for the month you must report the expenses you incurred while generating that income in the same month. or any other meaningful period such as a quarter or a month.

Materiality Accounting practice only records events that are significant enough to justify the usefulness of the information.that differences in financial position between reporting periods are a result of changed in the operations and not to changes in the way items are accounted for. each time a sheet of paper is used. . the asset “Office supplies” is decreased by an infinitesimal amount but that transaction is not worth accounting for. Technically.

Every business transaction affects two accounts. It is a columnar book. one Journal Book is maintained in which all the transactions are recorded. These are debited or credited according to the rules of debit and credit. therefore journal is divided into various types of books called Special Journals in which transactions are recorded depending upon the nature of transaction i. Every transaction can be recorded in journal. therefore it will be practically `difficult to record if the number of transactions is large. To take the benefit of division of labor. But in case of big business houses as the transactions are quite large in number. Applying the principle of double entry one account is debited and the other account is credited. revenue and expenses. This process of recording transactions in the journal is’ known as ‘Journalizing’. capital. Format of journal is given below: Date Particulars L/F Debit Amount Credit Amount Classification Of Journal Journal is a book in which transactions are recorded in chronological order/ date wise. It is the book in which transactions are recorded for the first time. In small business houses generally. Format of Journal Every page of Journal has the following format. Business transactions of financial nature are classified into various categories of accounts such as assets. Journal is also known as ‘Book of Original Record’ or ‘Book of Primary Entry’. Transactions when recorded in a Journal are known as entries.e.Journal Journal is a book of accounts in which all day to day business transactions are recorded in a chronological order i. Each column is given a name written on its top. liabilities. Journal can be classified into various special journals and Journal . in the order of their occurrence. all cash transactions in Cash Book and so on. all credit sales in Sales Book.e. applicable to the specific accounts. journal should be divided into number of journals.

Such returns are known as Sales Returns. Therefore. II. (v) Sale Returns Journal Sometimes.. in this journal. when the goods are sold to the customer and they are not satisfied with the goods. Journal Proper This journal is meant for recording all such transactions for which no special journal has been maintained in the business. (iii) Sales Journal This journal is meant for recording all credit sales of goods made by the firm.proper. they are also recorded in a separate Book which is known as Sales Returns or Returns Inward Journal/Book. are not entered in the Sales Journal. machinery. typewriter. which do not find their place in the special journals. etc. stationery. the goods are not as per the specifications. Cash Sales are recorded in the Cash Book and not in the Sales Book. we will record only cash purchases of machinery. all cashreceipts and all cash payments of the ‘business. (iv) Purchase Returns Journal Whenever. they may return these goods to the businessman. Similarly. because in the Cash Book. Rent outstanding. . will be recorded in the General Journal such as (i) Outstanding expenses – Salaries outstanding. Just like Purchase Returns. These returns are entered in a book known as Purchase Returns Book. purchases of other things like machinery. etc. if Machinery is purchased on credit. In this journal. It is also known as Returns Outward Journal Book. many other transactions. These journals are explained below : (i) Cash Journal/Cash Book Cash Journal or Cash Book is meant for recording all cash transactions i. it will be recorded in the journal proper. all such transactions are recorded which do not occur frequently and for these transactions no special journal is required. Special journals are also known as special purpose books. (ii) Purchases Journal This journal is meant for recording all credit purchases of goods only as Cash purchases of goods are recorded in the Cash Book.e. the buyer may return these goods to the supplier. are not recorded. etc. For example. Goods means articles meant for trading or the articles in which the business deals. This book he1ps us to know the balance of Cash in hand at any point of time. Credit Sale of items other than the goods dealt in like sale of old furniture.

(v) Interest on Capital (vi) Depreciation (vii) Credit Purchase and Credit Sale of fixed Assets – Machinery.(ii) Prepaid expenses – Prepaid Rent. interest received in advance. (iv) Accrued Incomes – Commission yet to be received. . (viii) Bad debts. Salaries paid in advance (iii) Income received in advance – Rent received in advance. (ix) Goods taken by the proprietor for personal use. etc. Furniture. interest yet to be received.

Ledger While journal lists transactions in chronological order. Format of Ledger A ledger has 2 sides – Debit and Credit. .accounts to which debit and credit transactions are transferred. The posting of a journal entry to the ledger accounts is purely a mechanical process using information already in the journal entry and requiring no additional analysis. its format does not facilitate the tracking of individual account balances. It looks as follows: Date Particualrs J/F Amount Date Particualrs J/F Amount Because the general ledger is organized by account. Journal Folio and Amount. Each side of the ledger account is sub divided into 4 columns – Date. The ledger is used for this purpose. The journal ledger is a collection of T. it allows one to view the activity and balance of any account at a glance. Particulars. The action of recording a debit or credit in the ledger is referred to as Posting. Both sides of the account look similar and the account looks symmetrical about the center.

From these books items are posted in the ledger in their respective accounts. at the end of the accounting year these accounts are balanced. However. The totals of these columns if tally it is presumed that ledger has been maintained correctly. Purchases Book. etc. Total of the two columns are if equal. it means the ledger posting is arithmetically correct. Sales Book. Trial Balance may be defined as a statement which contains balances of all ledger accounts on a particular date. debit column and credit column which contain debit balances of accounts and credit balances of accounts respectively.Trial Balance At first the transactions are entered in the Journal and Special Purpose Books like Cash Book. Trial Balance consists of a debit column with all debit balances of accounts and credit column with all credit balances of accounts.e. This statement is called Trial Balance. To check the accuracy of posting in the ledger a statement is prepared with two columns i. Finally. Format of Trial Balance: Particulars Debit Amount Particulars Credit Amount . Trial Balance proves only the arithmetical accuracy of posting in the ledger.

An example is income received from investments. 3) The Appropriation Account.g. as discussed above. A profit and loss account starts with the TRADING ACCOUNT and then takes into account all the other expenses associated with the business. . The figure at the end of this section is the Gross Profit. this can then be used for comparison ie judging how well the business is doing compared to itself in the past. This assumes that the information recording is accurate. These further costs and revenues are from any other activities not directly related to trading. This shows how the profit is ‘appropriated’ or divided between the three uses mentioned above. categorising costs between “cost of sales” andoperating costs. Describe how the profit or loss arose – e. it might be buying goods wholesale and selling them retail. including overheads. Uses of the Profit and Loss Account. 1) The main use is to monitor and measure profit. This might be buying raw materials and selling finished goods. either through incompetence or deliberate fraud. compared to the managers’ plans and compared to other businesses. 2) Once the profit(loss) has been accurately calculated. It has three parts. 1) The Trading Account. This records the money in (revenue) and out (costs) of the business as a result of the business’ ‘trading’ ie buying and selling. 2) The Profit and Loss Account proper This starts with the Gross Profit and adds to it any further costs and revenues.Profit And Loss Account The purpose of the profit and loss account is to: • • Show whether a business has made a PROFIT or LOSS over a financial year. Significant problems can arise if the information is inaccurate.

because there is little point in the managers fooling themselves (unless fraud is going on) but public accounts are routinely ‘fixed’ to create a good impression out to the outside world. Internal accounts are rarely ‘fixed’. .3) There are ways to ‘fix’ accounts. you can usually (not always) spot these ‘fixes’ and take them out to get a true picture. If you understand accounts.

make up the cornerstone of any company's financial statements. For example. how to analyse it and how to read it. Assets Current assets have a life span of one year or less. it is important that you understand how the balance sheet is structured. and it represents a source of funding for the business. meaning they can be converted easily into cash. . liabilities and owners' equity (net worth). must equal (or balance out) each other. The makeup of a retailers inventory typically consists of goods purchased from manufacturers and wholesalers. Cash. Owners' equity. is the amount of money initially invested into the company plus any retained earnings. Such assets classes are: cash and cash equivalents. work-in-progress goods and the company's finished goods. Lastly. based on the following equation. which then are held in this account until they are paid off by the clients. Assets are what a company uses to operate its business. inventory represents the raw materials. Depending on the company. Cash equivalents are very safe assets that can be are readily converted into cash such as US Treasuries. together with the income statement and cash flow statement. the exact makeup of the inventory account will differ. referred to as shareholders' equity in a publicly traded company. the most fundamental of current assets. also includes non-restricted bank accounts and checks. Accounts receivable consists of the short-term obligations owed to the company by its clients. If you are a shareholder of a company. The main formula behind balance sheets is: assets = liabilities + shareholders' equity This means that assets. that a balance sheet is a snapshot of the company's financial position at a single point in time. while its liabilities and equity are two sources that support these assets. How the balance sheet works The balance sheet is divided into two parts that. It is important to note. or the means used to operate the company. a manufacturing firm will carry a large amount of raw materials. reveals a company's assets. The balance sheet. Companies often sell products or services to customers on credit.Balance Sheet A balance sheet. while a retail firm caries none. are balanced by a company's financial obligations along with the equity investment brought into the company and its retained earnings. also known as a "statement of financial position". accounts receivable and inventory.

Liabilities On the other side of the balance sheet are the liabilities. They can refer to tangible assets such as machinery. such as the latest interest payment on a 10-year loan. such as accounts payables. for instance. This account represents a company's total net worth. these retained earnings will be transferred from the income statement onto the balance sheet into the shareholder's equity account. at the end of the fiscal year. expected to be turned into cash within a year and/or have a life-span of over a year. These are the financial obligations a company owes to outside parties. computers. patents or copyright.the value of a brand name. within one year. should not be underestimated. Like assets. along with the current portion of longer term borrowing. Long-term liabilities are debts and other non-debt financial obligations. If. such as goodwill. Depreciation is calculated and deducted from most of these assets. are those assets that are not turned into cash easily. In order for the balance sheet to balance. Shareholders' equity Shareholders' equity is the initial amount of money invested into a business. they can be both current and long-term. a company decides to reinvest its net earnings into the company (after taxes). . This is comprised of both shorter term borrowings. total assets on one side have to equal total liabilities plus shareholders' equity on the other. Current liabilities are the company's liabilities which will come due. which are due after a period of at least one year from the date of the balance sheet. they are often the resources that can make or break a company . Non-current assets also can be intangible assets. buildings and land. or must be paid.Non-current assets. While these assets are not physical in nature. which represents the economic cost of the asset over its useful life.

Sales return Journal 5. Sales Journal 4. Profit and loss account 10. cost concept. It follows the April – March accounting period i. They supply to almost all the retailers in the district. Cash Book 6. It follows various accounting concepts and conventions. realisation concept. entity concept. . its accounting period starts from 1st April and ends on 31st March every year. It follows the convention of going concern.e. monetary concept. Journal Proper 7. matching concept.Accounting System of Marathawada Textiles Marathawada textiles is located in Nanded. They are into wholesale business of shirting and suiting. Purchase Return Journal 3. The books of accounts maintained by the company are: 1. consistency concept and materiality concept. Trial Balance 9. Purchase journal 2. Ledger 8. Balance Sheet.

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