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Financial Accounting - I – MGT101 VU

Lesson # 1

BASIC CONCEPTS OF ACCOUNTING

Learning Objective

The objective of this lecture is to introduce the subject of “Financial Accounting” to the
students and give them an idea as to how did accounting develop?

What is Financial Accounting?

It is the maintenance of daily record of All financial transactions in such a manner that it would
help in the preparation of suitable information regarding the financial affairs of a business or an
individual.

Why is Financial Accounting needed?

The need for recording financial transactions arises because the individual or business wants to
know the performance of the business and to assist the person in making decisions related to
the business.

What are Transactions?

In accounting or business terms, any dealing between two persons involving money or a
valuable thing is called transaction.

Human beings are social animals and are bound to adopt a community living style. Living in a
community, essentially means that people interact with other people and are dependant on each
other to fulfil their needs. Every person cannot fulfil all his needs like food, clothing, housing
etc. on his own. He, therefore, depends on other people for his needs, in return to this providing
others with some of theirs. It means that one will fulfil his needs from others and will provide
others the things of their need in return. Every instance where one ‘gives something’ to ‘get
something’ is called a transaction.

How did it develop?

Nearly all developments happen because of human being’s need for the same. Accountancy is
no different.
There was times when goods were bartered or exchanged. But when the concept of money was
introduced, it became a little more difficult.

What is a Budget?

Budget is a plan of income, expenses & other financial operation for a future period.

Concept of Costing

A person making or producing any thing must not only know how much it costs to make but
also to help in determining the selling price. It is necessary that the person not only knows the
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Financial Accounting - I – MGT101 VU
cost of what is being produced but also the cost of each component which has gone into
production. The control of the costs being incurred is also necessary otherwise the same can
exceed the estimates. All this is only possible if the costs and data relating to production is
properly recorded and analysed. It is an exercise that only carries out by the Accountant.

Impact of IT on Accounting

The old “Munshi,” who kept record of the financial dealings was the original accountant. But
he is now of no use, as he lacks the capability for analysing the information recorded and
forecasting financial information.
In fact, there is no need for any expert in writing of books. Information Technology has taken
over. But some one has to tell the Software developer how books are written?
The need for an Accountant who is well versed in the art of writing up books still remains. The
role has changed. Information Technology software can now produce the reports and analysis
but need the expert to interpret all of this remains.
The need for the professional to describe this has not yet been overtaken by Information
Technology.

Barter Trading and Barter Transactions

Trading one commodity or service for another commodity or service is called ‘Barter
trading’.
OR
Every transaction where goods are exchanged for goods is called a ‘Barter Transaction’.

Since every person cannot produce every thing that he needs. Therefore, he needs to give / sell
what he produces in order to get / buy what he wants?

In early days when ‘money’ was not introduced, people used to exchange goods for goods. This
kind of trade, where goods are exchanged for goods, is called barter trade.

In fact, in barter trade, value of one commodity is quoted in terms of other commodity, for
example the price of 10 kg of wheat may be equal to 2 meters of cloth or 5 litres of milk.
Although, there is no involvement of money but still every commodity has a value, which
means that you have to give a specific quantity of one commodity to buy a specific quantity of
another commodity.

Money Measurement Concept

With the passage of time, the trading volumes and types of commodities available in the market
are increased and it became difficult to exchange commodity with other commodity. That is
why the concept of cash / money is introduced and people started valuing all goods / services in
terms of a common commodity called money. Now the price of 10 kg wheat would be Rupees
60 instead of 2 meters of cloth. Similarly, the price of 2 meters of cloth and 5 litres of milk
would also be Rupees 60.
In accounting, every transaction that is worth recording is recorded in terms of money. In other
words any event or item that cannot be translated in terms of money is not recorded in books of
accounts.

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Financial Accounting - I – MGT101 VU
Cash and Credit Transactions

Translating every transaction in terms of money does not always mean that the money changes
hands, the same time at which the transaction takes place. It may be paid before or after the
goods are exchanged.

When the money value of an item being purchased is paid, at the same time when the item is
exchanged. The transaction is said to be a cash transaction or in other words, if the value of
transaction is met in cash at the time of the transaction such kind of transaction is said to be
cash transaction.

On the other hand, if the payment is delayed to a future date, the transaction is termed as a
credit transaction.

Different Types of Business Organizations

1. Sole Proprietorship

According to D.W.T. Stafford, “It is the simplest form of business organization, which is
owned and controlled by one man”

Sole proprietorship is the oldest form of business organization which is owned and controlled
by one person. In this business, one man invests his capital himself. He is all in all in doing his
business. He enjoys the whole of the profit. The features of sole proprietorship are:

• Easy Formation
• Unlimited Liability
• Ownership
• Profit
• Management
• Easy Dissolution

2. Partnership

According to Partnership Act, 1932, “Partnership is the relation between persons who have
agreed to share the profits of a business carried on by all or any of them acting for all.”

Partnership means a lawful business owned by two or more persons. The profit of the business
shared by the partners in agreed ratio. The liability of each partner is unlimited. Small and
medium size business activities are performed under this organization. It has the following
features:

• Legal Entity
• Profit and Loss Distribution
• Unlimited Liability
• Transfer of Rights
• Management
• Number of Partners

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Financial Accounting - I – MGT101 VU
3. Joint Stock Company

According to S. E. Thomas, “A company is an incorporated association of persons formed


usually for the pursuit of some commercial purposes”

A joint stock company is a voluntary association of persons created by law. It has a separate
legal entity apart from its members. It can sue and be sued in its name. In the joint stock
company, the work of organization begins before its incorporation by promoters and it
continues after incorporation. The joint stock company has the following feature:

• Creation of Law
• Separate Legal Entity
• Limited Liability
• Transferability of shares
• Number of Members
• Common Seal

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