2. Accounting is basically a language of
business.
By definition accounting is a systematic
process of recording, classifying,
summarizing and reporting financial
information of an organization & to
communicate that information to users of
financial statements
RECORDING, CLASSIFYING, SUMMARIZING AND REPORTING ARE THE
STEPS OF ACCOUNTING CYCLE AND WILL BE DISCUSSED LATER
3. ORGANIZATION/ENTITY/BUSINESS:
Is where people are working together to achieve a common goal
Organization can be business organization or non-business
organization
1. Non business organization:
Any legal entity organized and operated for collective public or
social benefits
E.g. Shaukat Khanum , Edhi center, Akhuwat foundation
These organizations prepare income and expenditure accounts
2. Business organization:
Any legal activity undertaken with the intention to earn profit but
result could be profit or loss
4. Types of business:
A. By nature: B. By status:
1. Retailor 1. Sole trader
2. Manufacturer 2. Partnership
3. Service provider 3. Company
1. Sole Trader:
● Single ownership/ proprietorship
● Return: profit or loss belongs to single owner
● Two financial statements are required SPL and SOFP
● Accounting status: Separate entity
● Legal status: single unit or unlimited liability
Unlimited liability means that owner will have to pay personally if the business is at loss
Separate Entity Concept: States that we should always separately record the transaction of
business and its owners
It is not mandatory for sole trader to prepare financial statements and to keep full accounting
records as audit regimes apply only to companies and LLP’s. Unincorporated business’s are
exempt whatever their size is.
5. 2. Partnership: Is an association of two or more persons
Minimum 02 & maximum 20 partners can make a partnership business or
firm
A partner can be an active partner or in-active/ sleeping / dormant / silent
partner
● Return of partners is as per partnership agreement in their profit or loss
sharing ratio
● Clauses of partnership agreement
1. Profit sharing ratio 2. Admission/ retirement / death of partners etc.
● Two financial statements are required SPL and SOFP (optional)
● Accounting status: Separate entity
● Legal status: Single unit with unlimited liability
In 2018 concept of unlimited liability LLP became applicable in Pakistan.
Before that all partners were jointly and severally liable for profit or loss of
partnership
6. 3. Company: A company is owned by shareholders and run by directors
Directors can be executive or non-executive directors appointed by shareholders
in annual General meeting
Return of share holders is known as dividend
● 05 financial statements are required to prepare by a company
1. Statement of profit & loss and other comprehensive income
2. Statement of financial position
3. Statement of changes in equity
4. Statement of cash flows
5. Notes to the accounts
● Accounting status: Separate entity
● Legal status: Separate entity with Limited Liability
Limited Liability means that owners are legally liable for debts only to the
amount of capital invested
7. Limited Liability Company can be categorized as:
1. Public Limited Company
2. Private Limited Company
1. Public Limited Company:
● Shares issued to general public
● Can be formed by at least 7 persons
● There is no maximum limit for share holders
● Two directors are required
● Public limited companies are of two types
1. Quoted / Listed companies: Listed on stock exchange
2. Un quoted / Unlisted companies: Not listed on stock exchange
8. Limited Liability Companies
2. Private Limited Company:
● Prohibits any invitation to public. Shares are restricted to friends and family
● Can be formed by at least 02 persons
● There is a maximum limit of 200 shareholders
● Two directors are required
● A company limited by shares is also a private company having one
shareholder who is also a director of company
9. Financial Statements: Management of a company are responsible
for the preparation of financial statements
1. Statement of Financial position: Shows the financial position of a business at a particular point
in time ( AS AT )
2. Statement of profit & loss & other comprehensive income : Reports on financial performance of
an entity over a period of time ( FOR THE YEAR ) with no opening or closing balances
Users of Financial Statements:
1. Owners / Shareholders / potential share holders
2. Trade receivables / Trade creditors
3. Lenders
4. Government or tax authorities
5. Employees
6. General public
7. Legal advisors
8. Financial Analyst
9. Trade unions etc.
10. Comparison between Financial Accounting and Management
Accounting
Financial Accounting Management Accounting
1. Financial reports are prepared mainly for external
users
1. Financial reports are prepared mainly for internal
users
2. Reports are prepared annually, semi annually,
quarterly
2. Prepared mostly on monthly basis
3. Financial reporting is generally required by law 3. Management reporting is not required by law
4. Financial reports reflects past performance and
current position
4. Management reports reflects past, present and
future
5. Reports are prepared in accordance with IAS’s and
and IFR’s
5. No standard involved
11. Accounting Transaction: An exchange of interest between two or more parties
An event ( measurable in terms of money) that changes financial position of
business entity
Although event can be monetary (buying or selling) or non-monetary (delivering
lecture in a meeting) Event can be internal or external
For a transaction to be recorded;
1. There must be written evidence that transaction has taken place
2. It must be possible to measure the effect of transaction in terms of money
Accounting only records financial results of a business transaction
Money Measurement Concept: Accounting records deal with only items to which monetary value can be
assigned
Nature of Transaction:
1. Cash Transaction: In which cash is directly involved
2. Credit Transaction: in which credit period is involved e,g 30, 60, 90 days. Almost every large
organization has credit control department to manage credit transactions
Parties to credit transactions:
1. Trade Receivables / Trade debtors: A person who owes money to business
2. Trade Payables / Trade creditors: A person to whom business owes money
12. Elements of Financial Statements:
1. Assets
2. Liabilities
3. Capital
4. Income
5. Expenses
1. Asset: Is defined as;
● Present economic resource controlled by the entity
● As a result of a past event
● An economic resource is a right that has the potential to produce economic benefit
Substance over Form:
Commercial reality should be reflected in financial statements rather than its legal form. That
is why control is important than ownership
For example Land owned by you but you cannot control it because of Government restriction
in that area is not an asset
Risk and rewards have been transferred but no owner ship of car is an asset
13. Types of Assets:
1. Current assets/Short term assets/Trading assets
2. Non-current assets/Long term assets/Non-trading assets/Fixed assets
1. Current Assets: Assets acquired for short term use
E.g. Closing stock/inventory, trade receivables, cash at bank, cash in hand
2. Non-current assets: Assets acquired for long term use. They are of two
types
A. Tangible fixed assets: Having physical existence e.g. Land, building, plant
and machinery, Furniture and fixture (IAS-16)
B. Intangible Fixed assets: Having no physical existence e.g. Goodwill,
software IAS-38
14. 2. Liability:
Liability is defined as;
● Present obligation of an entity to transfer an economic resource
● As a result of a past event
● An obligation is a duty or responsibility that the entity has no practical ability to avoid
Types of Liabilities:
1. Non-current Liabilities or Long-term liabilities: A liability to be repaid in more than 12
e.g. 5
year bank loan
2. Current Liabilities: A liability to be repaid in one year e.g. Trade creditors, short term bank
bank
overdraft
15. 3. Capital
Generic Definition: Anything invested by the owner into business
Standard Definition: Residual interest in assets of a business after deducting all its liabilities
Capital can also be defined as a special kind of liability of business towards its owners
Related to separate entity concept that owner’s activities shall not be intermingled with business
activities . When owner withdrew anything from business for his personal use it will be charged
as expense and will reduce capital in SOFP
Assets – Liabilities = Capital
Drawings
16. Expenses
Expenses are the costs incurred by the business in the course of trading
E.g. Rent, repair and maintenance, utility bills, office salaries etc.
Goods bought for resale are typically known as purchases and are expenses for the
business because it is a regular activity to carry on a business
Whereas, Closing stock are the goods left at end of the day and will generate benefit in future so
is recorded as current asset in SOFP.
Expenses are recorded when incurred not when cash is paid & incomes are recorded when
earned not when cash is received
Accrual Concept
17. Revenue/Income
Revenue or income are the amounts that a business earn from selling goods or providing
services to its customers. E.g. Sales, commission, consultancy etc.
REVENUE: Generation of cash from business related activities e.g. SKANS tuition fee
INCOME: Any other activity for cash generation e.g. car parking outside building
For revenue accrual concept is also applicable
18. Types of Expenditure:
1. Capital Expenditure (non-routine) Recorded in SOFP
2. Revenue Expenditure (routine) Charged to SPL
Capital Expenditure Revenue Expenditure
1. Acquisition of non-current asset 1. Purchase of regular goods
2. Enhancement, improvement, value addition,
upgradation to non-current assets
2. Repair & maintenance of non-current assets
3. Irregular in nature 3. Regular in nature
4. Long term benefit 4. Short term benefit
5. Capitalized 5. Not capitalized
6. Double entry:
Dr. Non-current asset
Cr. Cash / payable
6. Double entry:
Dr. Expense
Cr. Cash
19. Testing Cost: It will be added in cost of non-current asset after deducting sales proceeds of
any good units produced and sold during testing
Training cost: shall never be included in cost of asset as we have no control over employees
but if there is any wage cost directly incidental to non-current asset it will be capitalized
CRUX: All expenditures incurred in bringing NCA to its present condition and location are
capitalized
Example:
Cost of Machine $100
Packing cost $10
Import duty $10
Delivery cost $10
Installation cost $10
Training cost $10
Repair & maintenance $10
Testing cost $15
Units sold in testing SP $05
Calculate cost of asset and prepare double entry?
20. Types of Receipt/Income:
1. Capital Receipt: Inflow from the sale of non-current asset e.g. sale proceeds from the
disposal of machinery. They are recorded in SOFP
2. Revenue Receipt: Inflow from the sale of trading assets or other regular activities e.g.
sales revenue, commission received, dividend received etc. They are recorded in SPL
Example 1:
Machine cost $100
Sale proceeds $150
Profit $50
Identify revenue and capital receipt from above example?
Sale proceeds of $150 is a capital receipt recorded in SOFP & profit of $50 is a capital
income not a capital receipt & will be recorded in SPL
Example 2:
Machine cost $100
Sale proceeds $50
Loss $50
Identify revenue and capital receipt from above example?
Sale proceeds of $50 is a capital receipt recorded in SOFP & loss of $50 is a revenue expense &
will be charged in SPL
21. Short Concepts
Carriage Inwards: is the shipping & handling costs incurred by a company that is receiving goods
from suppliers. Carriage inwards is a revenue expense charged in SPL as purchase cost in cost of
Sales
Carriage outwards: is a delivery expense incurred by a company that is shipping goods to a
customer, it is reported as revenue expense in SPL under operating expense
Extracts of SPL
Sales
less: cost of sales (op. stock + purchases + carriage inwards – closing stock)
= Gross profit
Less: operating expenses:
Carriage outwards etc.
= Net profit
22. Case 01: capital expenditure of $100 recorded
as revenue expenditure $100
Impact:
Rectification:
Expenses Profit Non-current assets Net assets
Overstated by $100 Understated by $100 Understated by $100 Understated by $100
Expenses Profit Non-current assets Net assets
Decrease by $100 Increase by $100 Increase by $100 Increase by $100
23. Case 01: Revenue expenditure of $100
recorded as Capital expenditure $100
Impact:
Rectification:
Expenses Profit Non-current assets Net assets
Understated by $100 Overstated by $100 Overstated by $100 Overstated by $100
Expenses Profit Non-current assets Net assets
Increase by $100 Decrease by $100 Decrease by $100 Decrease by $100
25. Phases of Accounting Cycle
1. Recording:
Transactions are initially recorded in books of prime entry. A written evidence
or proof is required for recording known as source document. Books of prime
entry are of two types
A. General Journal: It records unusual or non-routine transactions of business
for example sale and purchase of NCA, loan taken by business, capital
introduced etc. It is part of double entry book keeping.
B. Day books: It records routine or day to day transactions of business e.g.
sale & purchase of regular goods, salaries, rates and rent expense, dividend
or interest received etc. It is part of single entry book keeping.
26. Phases of Accounting Cycle
2. Classifying:
Transactions are classified in general ledger as total of day books are posted to ledger
Accounts. General ledger is a book of T-accounts. At year end, balance of T-accounts are
Calculated.
3. Summarized:
Listing of all the closing balances extracted from General ledger into trial balance
Trial balance is an internal check of mathematical accuracy of double entry. Trial balance is
not part of double entry book keeping. Trial balance does not confirm the accuracy of
records. It might contain some errors which does not effect equality. Trial balance is always
equal because of double entry. Errors of trial balance are rectified in Journal Voucher also
known as transfer journal to prepare adjusted trial balance & then financial statements are
prepared. Transactions are finally summarized in financial statements
4. Interpreting: From final reports,
● Future planning ● Decision making ● Budgeting
