BASICS OF

FINANCIAL ACCOUNTING

Account
It is a unit of information that represents
business records.
There are five types of accounts: Asset,
Liability, Equity, Revenue and Expense.

Accounting
It is concerned with the use of which the
records are put, their analysis and
interpretation.
It is the process of recording business
activities that make changes to accounts.
Sales of products, Revenue from services
earned, Buying products and/or services and
so on.

Attributes of Accounting
It is the art of recording business transactions.
It is the art of classifying business
transactions.
The transactions or events of a business must
be recorded in monetary terms.
It is the art of summarizing financial
transactions.
The results should be communicated to users.

Functions

Systematic record of business transactions.

Protecting the property of business.
Communicating results to users.
Compliance with legal requirements.

Users of Accounting Information

Owners
Creditors (Suppliers)
Investors
Employees
Government
Public
Research Scholars / Agencies
Managers

Branches of Accounting
Financial Accounting (Record keeping)
Cost Accounting (Price fixation & Operating
efficiency)
Management Accounting (Analysis for
decision making)

Advantages

Replacement of Memory
Evidence in court
Tax purpose
Comparative study
Sale of business
Assistance to the insolvent
For various parties

Limitations

Records only monetary transactions

Effect of price level changes not considered
No realistic information
Personal bias of accountant affects the
accounting statements
Permits alternative treatments (LIFO, FIFO)
No real test for managerial performance
Historical in nature

Accounting Terminology
Business: An organization created with the objective of
making a profit from the sale of goods or services.
Book keeping: The act of systematically recording the
financial transactions affecting a business.
Book Value: The net amount (original value plus or minus
any adjustments such as depreciation) showed in the
accounts for an asset, liability, or owners' equity item.
Calendar Year: An entity's reporting year, covering 12
months.
Transactions: Exchange of goods or services between
businesses or individuals. Can also be other events having
an economic impact on a business.

Accounting Terminology
Journal: A book or original entry in a double-entry
bookkeeping system. The journal lists all transactions and
indicates the accounts to which they are posted.
Journal Entry: A recording of a transaction where debits
equal credits.
Ledger: A summary statement of all the transactions
relating to a person, asset, expense or income which have
taken place during a given period of time and show their
net effect.
Trial Balance: A listing of all account balances that provides
a test of whether total debits equals total credits.
Revenues: Increases in a company's resources from the
sale of goods or services.

Accounting Terminology
Balance sheet: A balance sheet is an itemized
statement which lists the total assets and the total
liabilities of a given business to show its net worth at a
given moment in time (like a snapshot).
Capital: Property or money used and owned by a
business and used to acquire future income or
benefits.
Debtor: A debtor is a person who owes money. The
amount due from his is called debt.
Creditor: A person to whom money is owing or payable
is called a creditor.
Credit: An entry on the right side of a ledger account.

Accounting Terminology
Goods: This includes all articles, commodities or
merchandise in which the business deals. Thus, cloth
would be goods for a dealer in cloth; furniture would be
goods for a dealer in furniture and so on.
Assets: Economic resources owned or controlled by a
person or company.
Net Assets: The difference between assets and liabilities.
Liquidity: The availability of cash or ability to obtain it
quickly. Also used to determine debt repayment ability.
Goodwill: An intangible asset that exists when a business is
valued at more than the fair market value of its net assets.
Interest: The cost of the use of money.

Accounting Terminology
Current Assets: Current assets are those assets of a company that
are expected to be converted to cash, sold, or consumed during
the normal operating cycle of the business (usually one year).
Examples are cash, accounts receivable, short-term investments,
US government bonds, inventories, and prepaid expenses.
Current Liabilities: Liabilities to be paid within one year of the
balance sheet date.
Drawings: Any amount or goods withdrawn by the owner of a
business for personal use is called drawings.
Bad Debt: An uncollectible Account Receivable.
Loss: A loss is expenditure without any benefit to the concern. On
the other hand, expense is incurred to result in some benefit.
Thus, amount spent on lighting is an expense but loss due to fire is
loss.

Accounting Terminology
Income: It is an inflow of assets which results in an increase in the
owners equity.
Expenditure: Expenditure takes place when an asset or service is
acquired. Expenditure will include both payment of a sum
immediately and a promise to pay it at a future date.
Expense: An expenditure whose benefit is finished or enjoyed
immediately such as salaries, rent, etc.
Turnover: It means total trading income from cash sales and credit
sales.
Net worth: It means assets minus outside liabilities. Profits of a
business increase net worth whereas losses reduce the net worth of
a business.
GAAP - Refer to Generally Accepted Accounting Principles.

Basis of Accounting
Cash basis
Actual cash receipts and payments
are recorded.
Credit transactions are not recorded.

Basis of Accounting
Accrual basis
The income whether received or not but has been
earned or accrued during the period forms part of
the total income of the period.
The firm has taken benefit of a particular service,
but has not paid within that period, the expenses
will relates to the period in which the service has
been utilized and not to the period in which
payment for it is made.

Basis of Accounting
Mixed basis
Combination of cash and accrual basis.

System of Accounting
Single Entry System: This system has no
complete record of business transactions done
during a specified period.
Double Entry System: One account is given
debit while the other account is given credit
with an equal amount.

Classification of Accounts
Personal
Accounts

Natural
Persons
Accounts

Artificial
Persons
Accounts

Impersonal
Accounts

Representative
Persons
Accounts

Real
Accounts

Tangible Real
Accounts

Nominal
Accounts

Intangible Real
Accounts

Types of Accounts
Natural Persons Personal Account: An account recording
transactions with an individual human being is known as a
natural persons Personal Account. (eg. Krishna account)
Artificial Persons Personal Account: An account recording
financial transactions with an artificial person created by
law or otherwise is called an artificial persons personal
account. (eg. VSL College)
Representative Persons Personal Account: An account
indirectly representing a person or persons is known as a
representative account. (eg. Salaries account)
Tangible Real Account: An asset which can be touched,
seen, and measured. (eg. Machinery Account)
Intangible Real Account: An asset which cant be touched
physically but can be measured in value. (eg. Goodwill)

Rules of Double Entry System

Accounts
Personal
Real
Nominal

Rules
Debit the receiver
Credit the giver
Debit what comes in
Credit what goes out
Debit all expenses and losses
Credit all incomes and gains

Accounting cycle
Recording monetary transactions in a systematic manner

Journal entries

Ledger

Trial balance

Trading and Profit & Loss Account

Balance Sheet

Accounting Concepts
Business entity concept: The Business is distinct from the
persons who own it.

Going concern concept: It assumes that the business will

continue for a long time.
Cost concept: All the transactions will be recorded at cost in the
books. It means deducted depreciation from the assets yearly.
Dual aspect concept: Each transaction is twofold affect.
Money measurement concept: The transactions should be
recorded in monetary aspect only. We should not record the
transaction in kilograms, quintals, meters, liters, etc.

Accounting Concepts
Accounting period concept: Measuring the profit, incomes or
expenses of the period only are to be considered. Usually the
period is one year (12 months).
Realization concept: If the revenue is recognized too early or too
late, the company would not project the right financial position. It
would look more profitable or less profitable than what it actually
is.
Matching concept: Expenses incurred for a period are matched
with the revenues for the same period to arrive as a reasonably
correct measurement of the net income or the net loss. The
difference between revenues and expenses is a measure of how
effectively management has utilized the firms resources.
Objective evidence concept: All accounting transactions should be
evidenced and supported by object documents.

Accounting Conventions
Convention of disclosure: Accounts should be prepared
in such a way that all material information is clearly
disclosed to the users.
Convention of consistency: An accounting method or
procedure once chosen should be followed consistently
from year to year.

Convention of conservatism: Any business while

recording the transactions should anticipate no profits
but provide for all possible losses.
Convention of materiality: Only those events should be
recorded which have a significant bearing and
insignificant things should be ignored. There is no
formula for identifying material and immaterial events.
It depends on the accountant discretion.

JOURNAL, LEDGER &

TRIAL BALANCE

Source Documents
Cash Memo: When goods are sold or purchased for
cash, the firm receives or gives cash memos which
provide details regarding cash transactions.
Invoice or Bill: This document is prepared when goods
are sold or purchased on credit.
Receipt: When a firm receives cash from customers it
issues a receipt which is a proof for receiving cash.
Pay in Slip: This is a form available from a bank for
depositing cash or cheque in a bank account.
Contd

Source Documents
Cheque: It is a document in writing drawn upon a
specified banker and payable on demand.
Debit Notes: For the party from whom the
money is recoverable this document becomes
debit note.
Credit Note: For the party who is to recover the
amount the document becomes credit note.
When goods returned from the customer, a
proper credit note should be sent to him.

Journal
The word journal is derived from the Latin
word Journ which means a day.
Journal means a day book where in day-to-day
business transactions are recorded in a
chronological order.
The process of recording a transaction in the
journal is called Journalisation.
The entries made in the book are called
journal entries.

Proforma of Journal
Date
xx-xx-xxxx

Particulars
Name of the a/c Dr.
To Name of the a/c
(being ______)

L.F. Dr. ()

Cr. ()

xxxx
xxxx

Items in Journal
Date: The first column deals with the date of transaction.
Particulars: In the first line write about debit aspect and
in the second line write about credit aspect. In the third
line write regarding brief explanation of the entry
(narration).
Ledger Folio (L.F.): It denotes page number on which its
journal entry is found.
Debit: Fourth column deals with the amount to be
debited.

Credit: Fifth column deals with the amount to be

credited.

Points to be noted before journalising

Compound journal entry
Cash or credit transaction
Cash discount
Trade discount
Purchase of shares: When shares or securities are
purchased, the entry is made at market value and not at
face value. Brokerage paid on the purchase of such
investment is also added in the amount of investment.

Sale of shares: If shares or securities are sold, the entry

should be passed at market value less brokerage, if any,
paid on such shares.

Points to be noted before journalising

Expenses incidental to the purchase of Fixed
Assets
Insurance of Life Policy (Debited to Drawings a/c)
Goods given as charity

Goods distributed as free samples

Loss of stock by Fire

Interest due on Loans (debited to interest account and

credited to loan account)

Advantages of Journal
It provides a chronological (date wise) order of all
transactions and hence provides permanent
record.
It provides the information of debit and credit in
an entry and an explanation to make it
understandable properly.
It reduces the possibility of error as both aspects
of a business transaction are written side by side.

Ledger
It is a book which contains various accounts. It is
in T form.
It is a summary statement of all the transactions
relating to a person, asset, expense or income
which have taken place during a given period of
time and shows their net effect.
It is designed to accommodate the various
accounts maintained by a trader.
The process of transferring the entries from the
journal into the ledger is called posting.

Proforma of Ledger
Dr.
Date

Particulars
To Name of
Credit a/c

Cash a/c
L.F. Amount () Date

Left side

Particulars
By Name of
Debit a/c

Cr.
L.F. Amount ()

Right side

Posting of ledger
For each item a separate new account is to be
opened.
For each account there must be a name. This
should be written on the top of the account in
the middle.
The debit side of the journal entry is posted to
the debit side of the account by starting with To.
The credit side of the journal entry is posted on
the credit side of the account by starting with
By.

Trial Balance
A list of balances of the ledger accounts at a point of
time is called trail balance.

The balances of all the ledger accounts are extracted

and are written up in a statement known as Trial
Balance and finally totaled up to see if the total of
debit balances is equal to the total of credit balances.
It is a list of ledger account titles and their respective
balances.
As per double entry system, every debit equals to
corresponding equal credit. To prove this, statements
of debits and credits will be prepared by accountant.
This statement is called trail balance.

Proforma of Trial balance

Sl.No.

Name of the Account

Debit ()

Credit ()

Errors
Omission of any entry in a subsidiary book.
A wrong entry in a subsidiary book.
Posting an item to the correct side but in the
wrong account. Purchase from X and credited to
Y.
Compensating errors.
Errors of principles. These errors will not affect
the agreement of the Trial Balance as they arise
from the debiting or crediting of wrong heads of
accounts.

Disagreement of the Trial Balance

An item omitted to be posted from a subsidiary book into the
ledger
Posting of wrong amount to a ledger account.
Posting an amount to the wrong side of the ledger account.
Wrong additions or balancing of ledger accounts.

Wrong totaling of subsidiary books.

An item in the subsidiary book posted twice to a ledger account.
Balance of some accounts written to the wrong side of the Trial
Balance.
An error in totaling the trial balance.

Subsidiary Books
Cash book to record cash receipts and payments.
Simple Cash Book: It makes a record of all the receipts
and payments of cash. All cash received in the form of
coin, notes, cheques, postal orders, bank drafts or
treasury notes will be recorded on the debit side and
payments on the credit side.
Cash Book with Discount Column
Cash Book with Discount and Bank Column (Three
column cash book)

Subsidiary Books
Purchases book is for recording all credit purchases of goods.
Sales book is for recording all goods sold on credit.

Purchases returns book (returns outwards book) for recording

all purchases returned to creditors.
Sales returns book (returns inwards book) for recording all
sales retuned by customers.
Bills Receivable Book to keep a record of bills received from
customers.
Bills Payable Book to keep a record of bills payable to
creditors.
Journal proper to keep a record of those transactions for
which there is no separate book.