Course: Basics of Accounting

Do I Know My
Students?

Q. Your Graduation is:-

(a) BBA or B.Com. Or Graduation with
Accountancy
(b) B. Tech or BE or BSC with Maths
(c) BA or Others
Accounting is called the Language of Business
 What is accounting?

• The language of business

– Measures financial aspects of a business

– Communicates this information to decision

makers

1- 4
 Accounting Activities

 Identifying  Recording
Business Business
Activities Activities

Communicating
Business
Activities

1-5
 What is Accounting?
is a
Accounting Identifies
system that

Records

information
Relevant Communicates
that is

Reliable
about an
organization’s
Comparable business activities.
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 Introduction
• Accounting - a process of identifying, recording,
summarizing, and reporting economic
information to decision makers in the form of
financial statements
• Financial accounting - focuses on the specific
needs of decision makers external to the
organization, such as stockholders, suppliers,
banks, and government agencies
 Definition of Accounting
American Institute of Certified Public Accounts (AICPA) has defined
accountings as:
“Accounting is the art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions and events which
are, in parts at least of a financial character and interpreting the result
thereof”.
 The Nature of Accounting
• The accounting system is a series of steps
performed to analyze, record, quantify,
accumulate, summarize, classify, report, and
interpret economic events and their effects on an
organization and to prepare the financial
statements.
 The Nature of Accounting
• Accounting systems are designed to meet the
needs of the decisions makers who use the
financial information.
• Every business has some sort of accounting
system.
– These accounting systems may be very complex or
very simple, but the real value of any accounting
system lies in the information that the system
provides.
 Do you know
Accounting

Q. Accounting:-
(a) Identifies Information
(b) Records Information
(c) Summaries Information
(d) All of these
 Do you know
Accounting Really?

Q. Accounting:-
(a) Identifies Economic Information
(b) Records Technical Information
(c) Summaries Emotional Information
(d) All of these
Financial and Management Accounting
• The major distinction between financial and
management accounting is the users of the
information.
– Financial accounting serves external users.
– Management accounting serves internal users,
such as top executives, management,
and administrators within
organizations.
Financial and Management Accounting
The primary questions about an organization’s
success that decision makers want to know are:

What is the financial picture of the organization

on a given day?

How well did the organization do during a given

period?
 Do you know Branches
of Accounting

Q. Management Accounting is for:-

(a) Shareholders
(b) Directors
(c) All of these
(d) None of these
The Need for Accounting

Managers, investors, and other internal groups

want the answers to two important questions:

How well did

the organization
perform?
Where does
the organization
stand?
 Financial Statements

Accountants answer these questions

with three major financial statements:

Income Balance
statement sheet

Statement of
cash flows
 Financial Statements
Accountants answer these primary questions
with three major financial statements.
• Balance Sheet - financial picture on a given day
• Income Statement - performance over a given
period
• Statement of Cash Flows - performance over a
given period
 Four Basic Financial Statements
• Balance Sheet
– Assets = Liabilities + Equity

• Income Statement (also called Statement of Operations,

Earnings Statement, Profit/Loss (or P&L) Statement
– Revenues - Expenses = Net income (or Net Earnings)
• Statement of Changes in Stockholders’ Equity
– Beginning of period total equity + Stock issued + Net
income - Dividends = End of period total equity
• Statement of Cash Flows
– Cash inflow - Cash outflow = Net cash flow

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 Balance Sheet

Assets are economic resources that

are expected to benefit future
activities of the organization.

Liabilities are the entity’s economic

obligations to others.

Owners’ equity is the excess

of the assets over the liabilities.
 Balance Sheet

The owners’ equity of a corporation

is called shareholders’ equity.

Shareholders’ equity

Paid-in Retained
capital earnings
 The Balance Sheet
Sections of the balance sheet:
• Assets - resources of the firm that are expected to
increase or cause future cash flows (everything the
firm owns)
• Liabilities - obligations of the firm to outsiders or
claims against its assets by outsiders (debts of the
firm)
• Owners’ Equity - the residual interest in, or
remaining claims against, the firm’s assets after
deducting liabilities (rights of the owners)
 The Balance Sheet
The balance sheet equation:

Assets = Liabilities + Owners’ Equity

or
Owners’ Equity = Assets - Liabilities
 Do you Know Financial
Statements?

Q. Which amongst these is wrong:-

(a) Assets = Liabilities + Owners’ Equity
(b) Owners’ Equity = Asset -Liabilities
(c) Liabilities = Asset - Owners’ Equity
(d) None of these
 Annual Report
• Annual report - a document prepared by
management and distributed to current and
potential investors to inform them about the
company’s past performance and future
prospects.
– The annual report is one of the most common
sources of financial information used by investors
and managers.
 Annual Report
• The annual report usually includes:
– a letter from corporate management
– a discussion and analysis of recent economic events
by management
– footnotes that explain many elements of the financial
statements in more detail
– the report of the independent auditors
– a statement of management’s responsibility for
preparation of the financial statements
– other corporate information
 Do you know Annual
Report?

Q. Which statement is true:-

(a) Annual Report consists Financial Statements?
(b) Financial Statements consists Annual Report
(c) All of these
(d) None of these
 The Users of Accounting Information

DECISION MAKERS

MANAGEMENT THOSE WITH DIRECT THOSE WITH INDIRECT

FINANCIAL INTEREST FINANCIAL INTEREST
Finance
Operations and Investors Tax Authorities
Production Creditors Regulators
Marketing Labor Unions
Human Resources Customers
Information Systems Economic Planners
Accounting
 Users of Accounting Information

Different categories of users need different kinds of information

for making decisions. These users can be divided into :

•Internal Users; and

•External Users.
 Internal Users

These are the persons who manage the business, i.e.

management at the top, middle, and lower levels. Their
requirements of information are different because they make
different types of decisions.
 Internal Users continue…

The top level is more concerned with planning; the middle level
is concerned equally with planning and control; and the lower
level is concerned more with controlling operations.
Information is supplied on different aspects, e.g. cash resources,
sales estimates, results of operations, financial position, etc.
 External Users

All persons other than internal users come in the group of

external users. External users can be divided into two groups:
· those having direct interest; and
· those having indirect interest in a business organization.
 External Users continue…

The main sources of information for external users are annual

reports of business organizations, which state the financial
position and performance and give the auditor’s report,
director’s report and other information.
 External Users continue…

Investors and creditors are the external users having direct

interest. Tax authorities, regulatory agencies, customers, labour
unions, trade associations, stock exchanges, investors, etc are
indirectly interested in the company’s financial strength, its
ability to meet short-term and long-term obligations, its future
earning power, etc for making various decisions.
 Users of Accounting
Information
Internal Users
External Users

•Lenders •Consumer Groups •Managers •Sales Staff

•Shareholders •External Auditors •Officers •Budget Officers
•Governments •Customers •Internal Auditors •Controllers
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 Users of Accounting
Information

External Users Internal Users

Financial accounting provides Managerial accounting provides

external users with financial information needs for internal
statements (shareholders, decision makers (officers,
lenders, etc.). managers, etc.).
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Users and Uses of Financial Information

Internal
Users

Illustration 1-1
Questions that internal
users ask

LO 2
Users and Uses of Financial Information

External
Users

Illustration 1-2
Questions that external
users ask
LO 2
Users of Financial Statements
• Investors
– Need information about the profitability, dividend yield
and price earnings ratio in order to assess the quality
and the price of shares of a company
• Lenders
– Need information about the profitability and solvency of
the business in order to determine the risk and interest
rate of loans
• Management
– Need information for planning, policy making and
evaluation
• Suppliers and trade creditors
– Need information about the liquidity of business in order
to access the ability to repay the amounts owed to them
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• Government
– Need information about various businesses for statistics
and formulation of economic plan
• Customers
– Interested in long-tem stability of the business and
continuance of the supply of particular products
• Employees
– Interested in the stability of the business to provide
employment, fringe benefits and promotion opportunities
• Public
– Need information about the trends and recent
development

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 Do you know
users of
Accounting?
Q. Which of the following statements is true?
a) I want to invest in shares of RIL. I am an internal user.
b) I have invested in shares of RIL. I am an internal user.
c) I have iphone. I am an internal user of apple.

d) I am director of Apple. I am an internal user.

Limitations of conventional
financial statements
• Companies may use different
methods of valuation, cost calculation
and recognizing profit
• The balance sheet does not reflect
the true worth of the company
• Financial statements can only show
partial information about the
financial position of an enterprise,
instead of the whole picture
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