Introduction

To
Financial Accounting

1
Introduction to Accounting

 Accounting is the language of Business,

 Its basic function is to communicate the

operating results of business .

 To various interested parties.

e.g. owners, creditors, investors, governments

and other agencies.

2
 Introduction to Accounting

A language has to perform following three

basic functions :
 To act as a medium of communication
 To help in understanding the existing
literature
 To facilitate additions to the already
existing literature

3
 Introduction to Accounting
 Accounting has been performing all these roles.

 Every language has a grammar , syntax etc Similarly

Accounting also has its principles, Standards,
conventions etc

 The system of recording and analysing business

transactions is based on the double entry system of
bookkeeping

 All financial statements are prepared based on basic

principles like Accounting Standards (IAS) or Generally
Accepted Accounting Principles (GAAP) ,accounting
conventions and practices etc 4
Definition of Accounting

Accounting is “the art of recording,

classifying and summarizing in a
significant manner and in terms of
money, transactions and events which
are, in part at least, of a financial
character and interpreting the result
thereof.”

5
Meaning of Accounting
 Accounting is an Art
 Involves Recording, Classifying and
Summarizing Records
 Transaction in Terms of Money
 Deals with Financial Transactions
 Interpretation
 involves Communication
 A Means and Not an End

6
 Objectives and Functions
 The primary or basic objective of accounting is to supply the
necessary information to the users and analysts for taking
futuristic decisions
 Provides necessary information about the financial activities to
the interested parties
 Provides necessary information about the efficiency or otherwise
of management with regard to the proper utilization of scarce
resources
 Provides necessary information for making predictions (financial
forecasting)
 Facilitates to evaluate the earning capacity of a firm by supplying
the statement of financial position, the statement of periodical
earning, together with the statement of financial activities to
various interested parties
7
 Objectives and Functions

 Facilitates in decision-making with regard to the changes in the

manner of acquisition, utilization, preservation and
distribution of scarce resources
 Facilitates in decision-making with regard to the replacement of
fixed assets and expansion of the firm
 Provides necessary data to the government to enable it to
take proper decisions concerning to duties, taxes, price
control etc.
 Devices remedial measures for the deviations of the actual
from the budgeted performance
 Provides necessary data and information to managers for
internal reporting and formulation of overall policies

8
Classification of Accounting

Accounting

Financial Cost Management

Accounting Accounting Accounting

9
 Classification of Accounting
 Financial Accounting
 Involves recording, classifying and summarizing
transactions of financial nature. The primary intention
is to prepare financial statements for revealing
operating results and financial position of an
enterprise.
 Cost Accounting
 It shows classification analysis of cost on the basis of
functions, processes, products etc. it also deals with
cost computation, cost saving and cost control.
 Management Accounting
 Deals with processing of data generated from
financial accounting and cost accounting for
managerial decision making. 10
 Basic Terms in Accounting
Capital
 Capital generally refers to the amount invested in an enterprise by its owners.
For example, paid up share capital in a corporate enterprise. Capital also
refers to the interest of owners in the assets of an enterprise
Assets
 Assets refer to the tangible objects or intangible rights owned by an
enterprise and carrying probable future benefits.
Liability
 Liability is the financial obligation of an enterprise other than owners’ funds
Revenue
 Gross inflow of cash, receivables or other considerations arising in the course
of ordinary activities of an enterprise’s resources yielding interest, royalties
and dividends.
 Revenue is measured by the charges made to customers or clients for goods
supplied and services rendered to them and by the charges and rewards
arising from the use of resources by them.

11
 Basic Terms in Accounting
Cost of Goods Sold
It is the cost of goods sold during an accounting period
 Cost of materials
 Labour and factory overheads
Profit
 Selling and administrative expenses are normally excluded
 Profit is a general term for the excess of revenue over related
cost. When the result of this computation is negative, it is
referred to as loss.
Deferred Expenditure
 The expenditure for which payment has been made or a liability
incurred but which is carried forward on the presumption that it
will be a benefit over a subsequent period or periods. It is also
referred to as deferred revenue expenditure.
Expenditure
 Expenditure includes incurring a liability, disbursement of cash
or transfer of property for the purpose of obtaining assets, 12
goods or services.
Basic Terms in Accounting

Sales Turnover
 Sales turnover includes the total amount for which sales are
affected or services rendered by an enterprise. The terms
gross turnover and net turnover (or gross sales and net
sales) are sometimes used to distinguish the sales aggregate
before and after deduction of returns and trade discounts
Inventory
 Inventory includes tangible property held for sale in the
ordinary course of business, or in the process of the
production for such sale, or the consumption in the
production of goods or services for sale, including
maintenance supplies and consumables other than
machinery spares.

Accumulated Depreciation
 Accumulated depreciation includes the total up-to-date of the
periodic depreciation charges on depreciable assets. 13
 Basic Terms in Accounting
Prior Period Item
 Prior period item is a material change or credit that arises in the current
period as a result of errors or omissions in the preparation of financial
statements of one or more prior periods.

Accounting Policies
 Accounting policies include the specific accounting principles and methods
of applying those principles adopted by an enterprise in the preparation and
presentation of financial statements.

Cash Basis of Accounting

 Cash basis of accounting is the method of recording transactions by which
revenue, costs, assets and liabilities are reflected in the accounts in the
period in which actual receipts or actual payments are made.

Accrual Basis of Accounting

 Accrual basis of accounting is the method of recording transactions by which
revenue, costs, assets and liabilities are reflected in the accounts in the
period in which they accrue. The accrual basis of accounting includes
considerations relating to deferrals, allocations, depreciation and
amortization. This basis is also referred to as mercantile basis of accounting.
14
 Basic Terms in Accounting

Book Value
 Book value is the amount at which an item appears in the
books of account or financial statement. It does not refer to
any particular basis on which the amount is determined. For
example, cost, replacement value etc.
Goodwill
 Goodwill is an intangible asset arising from business
connection or trade name or reputation of an enterprise.
Sundry Creditor
 Sundry creditor is the amount owed by an enterprise on
account of goods purchased or services received, or in
respect of contractual obligations. It is also termed as trade
creditor or account payable. 15
Basic Terms in Accounting

Sundry Debtor
 Sundry debtors are persons from whom amounts are due for
goods sold or services rendered, or in respect of contractual
obligations. These are also termed as debtor, trade debtor
and account receivable.
Contingent Asset
 Contingent asset is an asset, the existence, ownership or
value of which may be known or determined only on the
occurrence or non-occurrence of one or more uncertain future
events.
Contingent Liability
 Contingent liability is an obligation relating to an existing
condition or situation which may arise in future depending on
the occurrence or non-occurrence of one or more uncertain
future events.
16
Financial Accounting:-

The Recording Process

 The
The Recording
Recording Process
Process

Steps in the The Recording

The Trial
The Account Recording Process
Balance
Process Illustrated

Debits and Journal Summary Limitations of a

credits Ledger illustration of trial balance
Expansion of journalizing Locating errors
basic equation and posting
Use of dollar
signs
 The Account
Record of increases and decreases
Account in a specific asset, liability, equity,
revenue, or expense item.
Debit = “Left”
Credit = “Right”

An Account can Account Name

be illustrated in a Debit / Dr. Credit / Cr.

T-Account
form.
 Double Entry System
 Record at least one debit and one credit per transaction
 Total of debits must equal total of credits
 The accounting equation must always stay in balance

ASSETS = LIABILITIES + STOCKHOLDER’S EQUITY

 EXPANDED BASIC EQUATION AND
DEBIT/CREDIT RULES AND EFFECTS

Basic Equation

Assets = Liabilities + Stockholders’

Equity
Expanded Basic Equation
Retained
Assets = Liabilities + Common + Earnings + Revenues
Stock
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
+ - - + - + - + - +

- Dividends - Expenses
Dr. Cr. Dr. Cr.
+ - + -
 Debits and Credits Summary
Balance Sheet Income Statement

Asset = Liability + Equity Revenue - Expense

Debit

Credit
The Accounting Cycle
1. Record transactions in general journal using double-
entry system.
2. Post transactions to general ledger
3. Prepare trial balance to prove equality of debits and
credits in ledger.
4. Analyze adjustments and complete worksheet
5. Prepare financial statements like income statement,
retained earnings statement, balance sheet
6. Record adjusting and closing entries in general journal
7.
8. Post adjusting and closing entries to general ledger
9. Prepare post-closing trial balance to prove equality of
debits and credits in the ledger after closing.
Steps in the Recording Process
1. Analyze each transaction into its debit and credit
parts.

2. Enter each transaction into a general journal

(book of original entry).

3. Transfer (post) journal information to the

appropriate accounts in the general ledger (book of
accounts).
Analyzing Transactions—A Review
1. Determine each account effected in the transaction.

2. Determine whether each account should be

increased or decreased.

3. Determine the classification of each account (asset,

liability, equity, revenue, expense).

4. Based on steps 1,2, & 3, determine whether to

debit or credit each effected account.
The General Journal
Transactions are initially recorded in chronological
order in a journal before being transferred to the
accounts.

Every journal contains:

* Spaces for dates
* Account titles and explanations
* References
* Two amount columns (debit and credit)
Journalizing a Transaction
 Separate journal entries are made for each
transaction
 A complete entry consists of:
1. The date of the transaction

2. The accounts and amounts to be

debited and credited

3. Brief explanation of the

transaction.
TECHNIQUE OF JOURNALIZING
 Technique of Journalizing
 The date of the
transaction is entered in
the date column.
 The account to be debited
is entered against the left-
hand margin with the
dollar amount entered in
the debit amount column.
 The account to be
credited is entered
indented from the left-
hand margin with the
dollar amount entered in
the credit column.
 A brief explanation of the
transaction is written
indented further in from the
creditedaccount title
 A space is left between
journal entries to make the
journal easier to read.
 The Ref. Column is left
blank at the time the journal
entry is made. This column
is used at the time of
posting to the ledger only.
Simple vs. Compound Journal Entries
 Simple Journal Entry:
Only two accounts (one debit and one credit)
are entered.

 Compound Entry:
Three or more accounts are required in one
journal entry.
 COMPOUND JOURNAL ENTRY
Illustration

2002
July 1 Delivery Equipment 14,000
Cash
8,000 Accounts Payable
6,000
(Purchased truck for cash with
balance on account)

3
1 2

Inaacompound
In compoundentry,
entry,the
thetotal
totaldebit
debitand
and
creditamounts
credit amountsmust
mustequal
equal
The Ledger
The entire group of accounts maintained by a company:

 Assets (i.e. cash, land, supplies, equipment)

 Liabilities (i.e. accounts payable, notes payable,

interest payable, salaries payable)
 Revenue (i.e. service revenue)

 Expenses (i.e. salaries expense, supplies expense)

 Stockholder’s Equity (Retained Earnings,

Capital Stock, Dividends)
 POSTING A JOURNAL ENTRY

GENERAL JOURNAL J1
Date Account Titles and Explanation Ref. Debit Credit
2002
Sept. 1 Cash 101 15,000
Common Stock 311 15,000
( issued shares of stock for
cash)
GENERAL LEDGER
CASH NO. 101
Date Explanation Ref. Debit Credit Balance
2002
Sept. 1 J1 15,000 15,000

COMMON STOCK NO. 311

COMMON STOCK
Date Explanation Ref. Debit Credit Balance
2002
Sept. 1 J1 15,000 15,000
Posting a Journal Entry
1. Date of the transaction being posted

2. Amount in the appropriate debit or credit column of the

account

3. Journal page number in the Ref. Column

4. Place the account number* in the general journal Ref.

Column.

* Account numbers are assigned and a chart of

accounts is kept for the ledger.
 CHART OF ACCOUNTS

Most
Mostcompanies
companieshave
haveaachart
chartof
ofaccounts
accountsthat
that
lists
liststhe
theaccounts
accountsandandthe
theaccount
accountnumbers
numbers
which
whichidentify
identifytheir
theirlocation
locationin
inthe
theledger.
ledger.
The Trial Balance
Proves the equality of debits and credits recorded in the ledger.

1. A trial balance is a list of accounts and their balances at a

given time.

2. Helps uncover errors in journalizing and posting

3. Steps for preparing a trial balance:

a. List the account titles and their balances.

b. Total the debits and credit columns.

c. Prove the equality of the columns.

 A TRIAL BALANCE

PIONEER ADVERTISING AGENCY

Trial Balance
October 31, 2002
The total debits Debit Credit
Cash must equal the total Rs. 15,200
Advertising Supplies credits. 2,500
Prepaid Insurance 600
Office Equipment 5,000
Notes Payable Rs. 5,000
Accounts Payable 2,500
Unearned Revenue 1,200
Common Stock 10,000
Dividends 500
Service Revenue 10,000
Salaries Expense 4,000
Rent Expense 900
Rs. 28,700Rs. 28,700
 LIMITATIONS OF A
TRIAL BALANCE
 A trial balance does not prove that all transactions have been
recorded or that the ledger is correct.
 Numerous errors may exist even though the trial balance
columns agree.
 The trial balance may balance even when:
1 a transaction is not journalized,
2 a correct journal entry is not posted,
3 a journal entry is posted twice,
4 incorrect accounts are used in journalizing or posting,
5 offsetting errors are made in recording the amount of the
transaction.
Financial Statements
 This tutorial illustrates how to prepare three
basic financial statements
1.The Income Statement
2.The Statement of Retained
Earnings
3.The Balance Sheet

The purpose of these statements is

to help users make better decisions.
 Order of Preparation

Income
Income
Statement
Statement
Statement
Statementof
ofRetained
Retained
Earnings
Earnings Balance
BalanceSheet
Sheet
Net Beginning
BeginningRetained
Retained
Netincome
income Earnings
Earnings
++ Net
Netincome
income
–– Dividends
Dividends
Ending
Endingretained
retainedearnings
earnings Ending
EndingBalance
Balance
Retained
Retained
Earnings
Earnings
 Example Problem
Cash 5,000 Sales 100,000

Utility Expense 8,000 Buildings 65,000

Common Stock 45,000 Accounts Payable 12,000

Supplies 4,000 Cost of Goods Sold 58,000

Interest Expense 5,000 Additional Paid in 20,000

Capital

Bonds Payable 40,000 Supplies Expense 3,000

Salaries Expense 16,000 Accounts 10,000

Receivable
Inventories 45,000 Retained Earnings 5,000 (beg. bal.)

Income Tax Rate 30%

Step One
 Classify the accounts as assets, liabilities,
equity, revenue or expenses.
 Assets
Cash 5,000 Sales 100,000

Utility Expense 8,000 Buildings 65,000

Common Stock 45,000 Accounts Payable 12,000

Supplies 4,000 Cost of Goods Sold 58,000

Interest Expense 5,000 Additional Paid in 20,000

Capital
Bonds Payable 40,000 Supplies Expense 3,000

Salaries Expense 16,000 Accounts 10,000

Receivable
Inventories 45,000 Retained Earnings 5,000 (beg. bal.)

Income Tax Rate 30%

 Assets, Liabilities,
Cash 5,000 Sales 100,000

Utility Expense 8,000 Buildings 65,000

Common Stock 45,000 Accounts Payable 12,000

Supplies 4,000 Cost of Goods Sold 58,000

Interest Expense 5,000 Additional Paid in 20,000

Capital
Bonds Payable 40,000 Supplies Expense 3,000

Salaries Expense 16,000 Accounts 10,000

Receivable
Inventories 45,000 Retained Earnings 5,000 (beg. bal.)

Income Tax Rate 30%

 Assets, Liabilities, Equity
Cash 5,000 Sales 100,000

Utility Expense 8,000 Buildings 65,000

Common Stock 45,000 Accounts Payable 12,000

Supplies 4,000 Cost of Goods Sold 58,000

Interest Expense 5,000 Additional Paid in 20,000

Capital
Bonds Payable 40,000 Supplies Expense 3,000

Salaries Expense 16,000 Accounts Receivable10,000

Inventories 45,000 Retained Earnings 5,000 (beg. bal.)

Income Tax Rate 30%

 Assets, Liabilities, Equity,
Revenues
Cash 5,000 Sales 100,000

Utility Expense 8,000 Buildings 65,000

Common Stock 45,000 Accounts Payable 12,000

Supplies 4,000 Cost of Goods Sold 58,000

Interest Expense 5,000 Additional Paid in 20,000

Capital
Bonds Payable 40,000 Supplies Expense 3,000

Salaries Expense 16,000 Accounts 10,000

Receivable
Inventories 45,000 Retained Earnings 5,000 (beg. bal.)

Income Tax Rate 30%

 Assets, Liabilities, Equity,
Revenues, Expenses
Cash 5,000 Sales 100,000

Utility Expense 8,000 Buildings 65,000

Common Stock 45,000 Accounts Payable 12,000

Supplies 4,000 Cost of Goods Sold 58,000

Interest Expense 5,000 Additional Paid in 20,000

Capital
Bonds Payable 40,000 Supplies Expense 3,000

Salaries Expense 16,000 Accounts 10,000

Receivable
Inventories 45,000 Retained Earnings 5,000 (beg. bal.)

Income Tax Rate 30%

Step Two
 Prepare the Income Statement.
Sales revenue

- Cost of goods sold

Gross profit

- Operating expenses
Income from operations

+/- Non-operating items

Income before taxes

- Income taxes
Net income
 Income Statement
Sales 100,000

- Cost of Goods Sold -58,000

Gross Margin 42,000

- Operating Expenses -27,000

Income from Operations 15,000

- Non-operating Items -5,000

Income before Taxes 10,000

- Income Taxes -3,000

Net Income 7,000

 Income Statement
Sales 100,000

- Cost of Goods -58,000

Sold
Gross Margin 42,000

- Operating -27,000 Operating expenses

Expenses include:
Income from 15,000
Operations Utility expense 8,000
Salaries expense 16,000
- Non-operating -5,000 Supplies expense 3,000
Items
Income before Taxes10,000

- Income Taxes -3,000

Net Income 7,000

 Income Statement
Sales 100,000

- Cost of Goods Sold -58,000

Gross Margin 42,000

- Operating Expenses -27,000

Income from Operations 15,000

Non-operating items
- Non-operating Items -5,000 include:

Income before Taxes 10,000 Interest expense

5,000

- Income Taxes -3,000

Net Income 7,000

 Income Statement
Sales 100,000
- Cost of Goods -58,000
Sold
Gross Margin 42,000

- Operating -27,000
Expenses
Income from 15,000
Operations
- Non-operating -5,000
Items Income taxes = Income
Income before Taxes10,000 before taxes * Income tax
rate

- Income Taxes -3,000 10,000 * 30% = 3,000

Net Income 7,000
Step Three
 Prepare the Statement of Retained Earnings.

Beg. balance, retained

earnings
+ Net income
- Dividends
End. balance, retained
earnings
 Statement of Retained Earnings

Beginning Balance, 5,000

Retained Earnings

+ Net Income +7,000 Net Income is

brought forward
from the Income
- Dividends -0 Statement.

Ending Balance, Retained12,000

Earnings
Step Four
 Prepare the Balance Sheet.
 Balance Sheet
Current Assets: Current Liabilities:
Cash 5,000 Accounts Payable 12,000

Accounts 10,000 Long-term liabilities:

Receivable
Inventories 45,000 Bonds Payable 40,000
Supplies 4,000 Stockholders’ Equity:

Non-Current Common Stock 45,000

Assets:
Buildings 65,000 Additional Paid in Capital 20,000

Retained Earnings 12,000

Total Assets 129,000 Total Liabilities and Equity 129,000

 Balance Sheet
Current Assets: Current Liabilities:
Cash 5,000 Accounts Payable 12,000

Accounts 10,000 Long-term liabilities:

Receivable
Inventories 45,000 Bonds Payable 40,000
Supplies 4,000 Stockholders’ Equity:
End. Bal. is
Non-Current Common Stock 45,000 brought
Assets: forward
from the
Buildings 65,000 Additional Paid in Capital 20,000
Statement
of Retained
Retained Earnings 12,000 Earnings

Total Assets 129,000 Total Liabilities and Equity 129,000

Thank you
58