Financial Accounting

Accounting

 Auditors and Regulators

 Process of recording financial information
 Shows the position and performance of the company
Accounting

 Book Keeping or keeping records of financial

transactions
 To understand the flow of cash
 Providing financial information to users(
shareholders, managers, competitors, govt,
debtholders, SEBI(Securities and exchange Board of
India), public, potential investors)
 Company’s Websites, Annual Report, Money control
 Meeting of BOD
 Hiring an accountant today for a monthly salary of rs 20,000
and will start working from oct 2020
 Taking admission into MBA programme
 Booking a room in a hotel on phone
 Booking flight ticket
 Buying insurance
 Employee has worked and salary has not been given(F)
 Purchase of new phone worth rs 40000 from friend but yet
not paid
 What is Financial Accounting

 Accounting is a system for recording information

about business transactions to provide summary
statements of a company's financial position and
performance to users who require such information
 Three types of Accounting
 Financial accounting- Standardized reports for external
stakeholders
 Managerial accounting- for internal decision making
 Tax accounting- for tax purposes
 Types of Accounting

 Cost
and management accounting: internal decision
making

 Financial
Accounting: for outsiders (Schedule 3 of
companies Act 2013)
 Balance Sheet
 Income Statement or P/L Account
 Cash Flow Statement
 Statement of Changes in Equity
 Introduction to Financial Accounting

Imagine for a moment that you were at home for the summer and
decided to start a business with your mother, a housewife, to sew
ladies garments and sell them in the neighborhood. With mother's
contribution of ₹9,000(share capital) and a bank loan of
₹20,000(liabilies) you purchased a peddle sewing machine for
₹21,000(Assets), cloth lengths and the material for ₹8,000(current
asset). During May and June, you were able to sell finished goods
amounting to ₹16,000(sales). At the end of June, you had raw material
₹1,500(Inventory, current assets) in stock, cash balance ₹14,000(current
asset), interest due ₹500(current liability) and ₹2,000 to be received for
garments sold on credit.
 Introduction to Financial Accounting

 Accounting is the process of identifying, measuring,

and communicating economic information to permit
informed judgments and decisions. Put more simply,
accounting is the “language of business.”
 Basic Assumptions of Accounting

• Economic Entity
1
• This assumption states that the financial activities of a business can be
separated from the financial activities of the business’s owner.
• Time Period
2
• Accountants assume that economic information can be meaningfully
captured and communicated over short periods of time.
• Monetary Unit
3
• Accountants assume that the Rupee is the most effective means to
communicate economic activity.
• Going Concern
4 • Accountants assume that a company will continue to operate into the
foreseeable future.
 Financial Reporting Requirements

 SEBI – the regulator

 Indian GAAPs and IFRS..Ind GAAP
 Reporting requirements for public and private sector
companies
 Why GAAPs are required…to bring uniformity in
reporting
 Cash accounting vs accrual accounting
 On Maruti Suzuki's income statement, in , one can
find the following four descriptions: 1) Maruti Suzuki
India Limited, 2) amounts in millions, 3) Fiscal Year
Ended March 31, 2019. Which assumption does each
description best relate?
 On Maruti Suzuki's income statement, in , one can
find the following four descriptions: 1) Maruti Suzuki
India Limited, 2) amounts in millions, 3) Fiscal Year
Ended March 31, 2019. Which assumption does each
description best relate?
 1) Maruti Suzuki India Limited- Economic entity,
 2) Amounts in millions -Monetary unit,
 3) Fiscal Year Ended March 31, 2013 -Time period
 Balance Sheet Equation
 Total Assets = Total Equity + Total Liabilities
 A = E +L
 Assets: Something owned by Business
 Usage of funds by the business
 Current and Non Current
 Used by the business to earn profits
Examples: Land, Buildings, furniture, machinery, Inventory, Debtors(Account
Receivables), Cash in hand or Bank, Marketable Securities, Inventory, Goodwill,
Loose tools, Investments(short term and Term Investments), Prepaid Insurance
and expenses, Vehicles,
Reporting Profitability: The Income statement

One of the first

questions any
business wants to
know is whether
they are
profitable.

These answers can be found

in the Income Statement.
Different Terms in Income statement
An income statement reports a company’s
revenues and expenses.
Matching Principle – Expenses should be recorded in the
period resources are used to generate revenues
Revenue – An Expense – A
increase in decrease in
resources Terms resources
resulting from resulting from
the sale of the sale of
goods or goods or
services services
Revenue Recognition Principle – A revenue should be
recorded when a resource has been earned
 Expense: revenue expenses and capital expenses
 Capital expenses:
 are incurred to buy capital assets(furniture,
 One time large purchase that helps in generating revenues
for the business
 Are consumed over multiple operating cycles
 Are not traded by the business
 Are recognised over multiple accounting period
 Are not accounted in the I/S
 Revenues Expenses:
 on going operating expenses
 Expenses are recognised over one operating cycle(rent,
salaries, interest, electricity bills, cost of goods sold,
selling and administrative expenses)
 Are reported in the I/S
 Income Statement

 Income statement
 reports increases in shareholders' equity due to operations over
a period of time.
 Net income is made up of revenues(sales from goods+
services) minus expenses, and It is often used for net income,
earnings and net profits.
 All the income statement items are based on accrual accounting
principles
recognition of revenues and expenses are going to be tied to
business activities, not to cash flows
 Revenue

 Cash + Credit
 Revenues (sales) are generated from doing the
business
Amount received from customer and service provided
 Accrual Concept

 Revenues are recognized when goods and services are

provided, not necessarily when the cash is received. 16000
 Expenses are recognized in the same period as the
revenues they helped to generate, not necessarily when
cash is paid. 10000
 net income net cash flow.
 Revenue

 Revenue is an increase in shareholder's equity from

providing goods or services.
 Revenue is recognized:
 When it is earned (goods or services are provided)
 It is realized (payment for the goods and services is either
received in cash or something that can be converted to a known
amount of cash.)
 These are called the revenue recognition criteria.
 Expenses

 Costs incurred for generating revenues

Outstanding expenses
 Include salaries of the employees
 Cost of running a business
 Depreciation (cost of using the assets)
 Expenses
 Expenses
 are decreases in shareholders' equity that arise in the process of
generating revenues.
 They're recognized when either the related revenues are recognized
or (Product cost)
 when they're incurred if they're difficult to match with
revenues. (period cost) or (SGNA)
 The underlying recognition concept is:
Matching principle
Conservatism principle: recognize anticipated losses immediately,
but recognize anticipated gains only when they're realized.
 Purchased goods = 100 * 10 = 1000 Rs
 Sold off during one accounting period = 50
 Cost of goods sold = 50*10 = 500
 SP of one good = 15RS
 Sales = 15*50 = 750 Rs
 Expense = 500 rs
 Basic Structure of Income Statement

Revenues – Expenses = Net Income or Net Loss

Reported over a specific period, like for the year
ended December 31, 2010
Reporting Financial Position: The Balance Sheet
and Related Terms
An important
issue for any
business is its
current financial
position. What
does the business
own? What does it
owe?

These answers can be found

in the Balance Sheet.
Reporting Financial Position: The Balance Sheet
and Related Terms

Asset: An economic
resource that is Cost principle: Liability: An obligation
objectively The principle that of a business that results
measurable, that assets should be from a past transaction
results from a prior recorded and and will require the
transaction, and that reported at the sacrifice of economic
will provide future cost paid to resources at some future
economic benefit. acquire them. date.

Equity: The difference between a Contributed capital: The

company’s assets and liabilities, resources that investors
representing the share of assets contribute to a business in
that is claimed by the company’s exchange for ownership
owners. interest.
 Assets:
 it must be acquired in a past transaction or exchange,
 the value of its future benefits can be measured with a
reasonable degree of precision
 Liability:
 the obligation is based on benefits or services received currently
or
 in the past and second the amount and timing of payment is
reasonably certain
 Assets: land, machinery, cash, prepaid expenses,
goodwill, inventory, debtors, investments
 Liabilities & Equity: capital, bank loan, outstanding
expenses, debt, overdraft
 Asset accounts

 Assets are what an enterprise owns

Land: Land owned by the enterprises

Building: The building account records acquisition of building

used by an enterprises to carry out its operations

Equipment: a business owns many equipments as plant and

machinery, office equipment as photocopier
 Asset accounts

 Assets are what an enterprise owns

 Prepaid expenses: Sometimes a business pays for service before they have
been received or used.

 Inventory: Raw material, WIP and Finished Goods

 Debtors: Business enterprises often sell goods and services on credit so that
customers can pay after the specified period of credit.

 Bills receivable: A bill receivable is a legal document containing an acceptance

to pay a certain sum of money at a specified date.
Asset accounts

 Assets are what an enterprise owns

 Cash: The cash account shows receipt and payment of cash owns.
The Cash includes coins, currency,

 Bank balances: The bank shows the bank balances. Cheques in

hand
 Liabilities
 Owners’ equity accounts
 Share Capital or Owner’s Capital: Proprietary firm and Partnership firms
use an Owner’s capital where companies have Share capital account.

 Retained Earnings (Reserves & Surplus): The profit earned by a company

less dividends paid belongs to company’s shareholders. Dividends are
distribution of assets that reduces the retained profits of a company.

 Long Term Debt:

 Bonds/Debentures
 Loan from FIs/Banks
 Liabilities

Bills payable: A bill payable is a legal document signifying an

obligation to pay a certain sum of money at specified date.
Creditors/Accounts Payable : The creditors account shows increase
and decrease in amount owed to outsiders.
Unearned revenue/advances from the customers: Amount received
from customers for services to be provided.
Short term liability: Wages payable, Tax payable, Interest payable
Long term liability: These include a wide variety of debentures, loans
from banks
Secured and unsecured liabilities: Liabilities may be secured or
unsecured. Secured liabilities are backed by assets.
 Stockholders' equity:
 is the residual claim on assets after settling claims of creditors.
 it's assets minus liabilities
 It's also called, shareholders' equity, owners' equity, net worth,
net assets, net book value
 The other source Stockholder's Equity is Retained earnings
which arise from operating the business. Retained earnings is
the accumulation of main income which is revenues
minus expenses less any dividends that have been paid out since
the start of the business.
 Stockholders’ Equity

 Assets-liabilities=SE
 Funds raised by selling shares or ownership rights
 Also contains retained earnings
 RE= Revenues(sales)-expenses
 Assets = Liabilities+ Equity+ RE- dividends
 Assets = Liabilities + Equity + Revenues – expenses
– dividends (extended balance sheet equation)
 Assets = liabilities + equity
 Assets- liabilities=equity
 ASSETS-Liabilities = Equity+ profit
 Assets – Liabilities = Equity + Revenues- Expenses
 Assets – Liabilities = Equity + Revenues- Expenses- dividends
 Assets+ expenses + dividends = equity + revenues + liabilities

 Assets – Liabilities = Equity + RE

Fundamental Bookkeeping Equations
Review Exercise – Preparation of Balance Sheet

Imagine for a moment that you were at home for the summer
and decided to start a business with your mother, a housewife,
to sew ladies garments and sell them in the neighborhood.
With mother's contribution of ₹9,000 and a bank loan of
₹20,000 you purchased a peddle sewing machine for ₹21,000,
cloth lengths and the material for ₹8,000. During May and
June, you were able to sell finished goods amounting to
₹16,000. At the end of June, you had raw material ₹1,500 in
stock, cash balance ₹14,000, interest due ₹500 and ₹2,000 to be
received for garments sold on credit.
Balance Sheet Example
Format of Balance Sheet and Income Statement as per
Schedule 3 of Companies Act 2013
BASIC ACCOUNTING EQUATION

Assets = Liabilities + Equity

 Reporting Equity: The
Statement of Retained Earnings

 A statement of retained earnings shows the change in a

company’s retained earnings over a specific period of time.
Basic Structure of the Statement of Retained Earnings
Statement of Retained Earnings Example
Linking the Income Statement and the Balance Sheet

The
Stateme
nt of
Retained
Earnings
links the
income
statemen
t and the
balance
sheet.
 EXTENDED ACCOUNTING EQUATION

Assets = Liabilities + Capital + Retained Earnings

Assets = Liabilities + Capital + Net Profit -Dividends

Assets = Liabilities + Capital + Revenues - Expenses –Dividends

Assets + Expenses +Dividends = Liabilities + Capital + Revenues

 If the assets of a business are $240,000 and the liabilities are
$80,000, how much is the owners’ equity?
 (2) If the owners’ equity in a business is $160,000 and the
liabilities are $130,000, how much are the assets?
 (3) A company reported monthly revenues of $129,000 and
expenses of $85,000. What is the result of operations for the
month?
 (4) If the beginning balance of retained earnings is $100,000,
revenue is $75,000, expenses total $50,000, and the company pays
a $10,000 dividend, what is the ending balance of retained
earnings?
 Rules of Debits and Credits

 Every transaction must at least have one debit and at

least one credit
 Debits must be equal to credits for all transactions
 No negative numbers are allowed
 Analysing Transactions and Journal Entries

 Steps in analysing transactions

 Identify the specific account(asset, liability equity, revenue
or expense)
 Identify increase or decrease in account
 Debit the account or credit the account
 Account and Account balances

 Normal Balance – Debit or Credit

 T- Form – Debits on left and credits on right
 Account Balance: Difference between sum of the
debits and sum of the credits