Financial and Cost Accounting

BE (Software Engineering)
2nd Year
Session: Fall 2022
Topics:
i. Introduction of Accounting.
ii. Structure of accounting.
iii. Classification of accounting frameworks.
iv. Accounting principles.
v. Accounting Cycle.
Introduction of Accounting:
Accounting may be defined as the process of analyzing, classifying, recording, summarizing, and
interpreting business transactions. One of the key aspects of the process is keeping “running
totals” of “things.” Examples of items a business might keep track of include the amount of cash
the business currently has, what a company has paid for utilities for the month, the amount of
money it owes, its income for the entire year, and the total cost of all the equipment it has
purchased. You want to always have these running totals up to date so they are readily available
to you when you need the information.

There are many items that businesses keep records of. Each of these accounts fall into one of
five categories.

1. Assets: Anything of value that a business owns

2. Liabilities: Debts that a business owes; claims on assets by outsiders

3. Owner’s equity: Worth of the owners of a business; claims on assets by the owners

4. Revenue: Income that results when a business operates and generates sales

5. Expenses: Costs associated with earning revenue

Double Entry System:

Double-entry bookkeeping is a method of recording transactions where for every business

transaction, an entry is recorded in at least two accounts as a debit or credit. In a double-entry
system, the amounts recorded as debits must be equal to the amounts recorded as credits.
Definitions:

Business: Production & distribution of goods and services for earning profit.

Categories:

a) Services Business
b) Merchandising/ Trading Business
c) Manufacturing Business

Business Organization:

a) Sole-proprietorship (1)
b) Partnership from 2 to 20
c) Company. (i) Private Co. from 2 to 50 (ii) Public Co. from 7 to no limit

Business Entity:

The business entity concept states that the transactions associated with a business must be
separately recorded from those of its owners or other businesses.

Fundamental Accounting Equation:

Asset= Liabilities + Owner’s Equity + Revenue – Expense

Classification of Assets: Convertibility

If assets are classified based on their convertibility into cash, assets are classified as
either current assets or fixed assets.

1. Current Assets

Current assets are assets that can be easily converted into cash (typically within a year).
Current assets are also termed liquid assets and examples of such are:

 Cash
 Short-term deposits
 Accounts receivables
 Merchandise Inventory
 Marketable securities
 Office supplies

2. Fixed or Non-Current Assets

Non-current assets are assets that cannot be easily and readily converted into cash. Non-current
assets are also termed fixed assets, long-term assets, or hard assets. Examples of non-current
or fixed assets include:

 Land
 Building
 Machinery
 Equipment
 Intangible Assets:

Intangible assets are assets that lack physical existence. Examples of intangible assets include:

 Goodwill
 Patents
 Brand
 Copyrights
 Trademarks

Classification of Liabilities:

Current liabilities are those that are due within a year. These primarily occur as part of regular
business operations. Due to the short-term nature of these financial obligations, they should be
managed with consideration of the company’s liquidity. The most common current liabilities are:

 Accounts payable: These are the yet-to-be-paid bills to the company’s vendors.
 Interest payable: Interest expense that has already been incurred but has not been
paid.
 Income taxes payable: The income tax amount owed by a company to the government.
The tax amount owed must generally be payable within one year. Otherwise, the tax owed
would be classified as a long-term liability.
 Bank account overdrafts: effectively, a type of short-term loan provided by a bank
when a payment is processed with insufficient funds available in the bank account.
 Accrued expenses: Expenses that have been incurred but no supporting documentation
(e.g., invoice) has been received or issued to the company by the vendor
 Deferred revenue: (also called unearned revenue). Generated when a company receives
early payment for goods and/or services that have not been delivered or completed yet.

Types of Equity Accounts

#1 Common Stock

 Common stock represents the owners’ or shareholder’s investment in the business as a

capital contribution. This account represents the shares that entitle the shareowners to
vote and their residual claim on the company’s assets. The value of common stock is
equal to the par value of the shares times the number of shares outstanding. For
example, 1 million shares with $1 of par value would result in $1 million of common share
capital on the balance sheet.

#2 Preferred Stock

 Preferred stock is quite similar to common stock. The preferred stock is a type of share
that often has no voting rights, but is guaranteed a cumulative dividend. If the dividend is
not paid in one year, then it will accumulate until paid off.
 Example: A preferred share of a company is entitled to $5 in cumulative dividends in a
year. The company has declared a dividend this year but has not paid dividends for the
past two years. The shareholder will receive $15 ($5/year x 3 years) in dividends this
year.
What is an Accounting Framework?

An accounting framework is a published set of criteria that is used to measure, recognize,

present, and disclose the information appearing in an entity's financial statements. An
organization's financial statements must have been constructed using a recognized
framework, or else auditors will not issue a clean audit opinion for them.

The most commonly-used accounting frameworks are generally accepted accounting

principles (GAAP) and international financial reporting standards (IFRS). GAAP is used by
entities in the United States, while IFRS is used in most other parts of the world. These two
frameworks are designed to be broad-based and therefore applicable to most types of
businesses.

The ultimate goal of any set of accounting principles is to ensure that a company's financial
statements are complete, consistent, and comparable. This makes it easier for investors to
analyze and extract useful information from the company's financial statements, including trend
data over a period of time. It also facilitates the comparison of financial information across
different companies.

The Basic Accounting Concepts

There are a number of conceptual issues that one must understand in order to develop a
firm foundation of how accounting works. These basic accounting concepts are noted below.

Accruals Concept

Revenue is recognized when earned, and expenses are recognized when assets are
consumed. This concept means that a business may recognize revenue, profits and losses in
amounts that vary from what would be recognized based on the cash received from
customers or when cash is paid to suppliers and employees. Auditors will only certify the
financial statements of a business that have been prepared under the accruals concept.

Conservatism Concept/ Going Concern

Revenue is only recognized when there is a reasonable certainty that it will be realized,
whereas expenses are recognized sooner, when there is a reasonable possibility that they
will be incurred. This concept tends to result in more conservative financial statements.

Consistency Concept

Once a business chooses to use a specific accounting method, it should continue using it on
a go-forward basis. By doing so, financial statements prepared in multiple periods can be
reliably compared.
What Is the Accounting Cycle?

The accounting cycle is a basic, eight-step process for completing a company’s bookkeeping
tasks. It provides a clear guide for the recording, analysis, and final reporting of a business’s
financial activities.

The 8 Steps of the Accounting Cycle

Step 1: Identify Transactions

The first step in the accounting cycle is identifying transactions. Companies will have many
transactions throughout the accounting cycle. Each one needs to be properly recorded on the
company’s books.

Step 2: Record Transactions in a Journal

The second step in the cycle is the creation of journal entries for each transaction. Point of sale
technology can help to combine steps one and two, but companies must also track their
expenses. The choice between accrual and cash accounting will dictate when transactions are
officially recorded.

Step 3: Posting

Once a transaction is recorded as a journal entry, it should post to an account in the general
ledger. The general ledger provides a breakdown of all accounting activities by account. This
allows a bookkeeper to monitor financial positions and statuses by account

Step 4: Unadjusted Trial Balance

At the end of the accounting period, a trial balance is calculated as the fourth step in the
accounting cycle. A trial balance tells the company its unadjusted balances in each account. The
unadjusted trial balance is then carried forward to the fifth step for testing and analysis.

Step 5: Worksheet

Analyzing a worksheet and identifying adjusting entries make up the fifth step in the cycle. A
worksheet is created and used to ensure that debits and credits are equal. If there are
discrepancies then adjustments will need to be made.

In addition to identifying any errors, adjusting entries may be needed for revenue and expense
matching when using accrual accounting.

Step 6: Adjusting Journal Entries

In the sixth step, a bookkeeper makes adjustments. Adjustments are recorded as journal
entries where necessary.
Step 7: Financial Statements

After the company makes all adjusting entries, it then generates its financial statements in the
seventh step. For most companies, these statements will include an income statement, balance
sheet, and cash flow statement.

Step 8: Closing the Books

Finally, a company ends the accounting cycle in the eighth step by closing its books at the end
of the day on the specified closing date. The closing statements provide a report for analysis of
performance over the period.

After closing, the accounting cycle starts over again from the beginning with a new reporting
period. Closing is usually a good time to file paperwork, plan for the next reporting period, and
review a calendar of future events and tasks.