Financial Accounting

Chanderprabhu Jain College of Higher Studies & School of Law
Plot No. OCF, Sector A-8, Narela, New Delhi – 110040
(Affiliated to Guru Gobind Singh Indraprastha University and Approved by Govt of NCT of Delhi & Bar Council of India)
Semester: I Semester
Name of the Subject:
FINANCIAL ACCOUNTING

The Need for Accounting
Accounting information can be used to assess past financial performance of a
company and help predict its future performance.All kinds of organizations—
government agencies, nonprofit organizations, and others —rely on accounting to
gauge their progress.
The accounting process begins with a transaction.A transaction is any event that
affects the financial position of an organization and requires recording. Many
concepts, conventions, and rules determine what events a company records as
accounting transactions and how accountants measure the financial impact of each
transaction.Financial statements are used to summarize the recorded accounting
transactions

Meaning of Accounting
Definition by the American Accounting Association (Year 1966):
“The process of identifying, measuring and communicating economic information to
permit informed judgments and decisions by the users of accounting”
Accounting is the systematic and comprehensive recording of financial transactions
pertaining to a business, and it also refers to the process of summarizing, analyzing and
reporting these transactions to oversight agencies and tax collection entities.
Accounting is one of the key functions for almost any business; it may be handled by a
bookkeeper and accountant at small firms or by sizable finance departments with
dozens of employees at large companies

Accounting – Classification
Financial Accounting
Cost Accounting
Management Accounting

Nature of Accounting
•The accounting system is a series of steps performed to analyze, record,
quantify, accumulate, summarize, classify, report, and interpret economic events
and their effects on an organization and to prepare the financial statements.
Accounting systems are designed to meet the needs of the decisions makers who
use the financial information.
•Every business has some sort of accounting system.These accounting systems
may be very complex or very simple, but the real value of any accounting system
lies in the information that the system provides.

OBJECTIVES OF FINANCIAL ACCOUNTING
To report the financial condition of a business at a point in time.
To report changes in the financial condition of a business over a period of time.
First, record the economic events affecting a business.
Second, summarize the impact of these events in a report called financial
statements.
Generally Accepted Accounting Principles (GAAP)

FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING
Financial accounting is primarily concerned with the recording & reporting
of economic data and activities for a business to external parties
Managerial accounting uses both financial accounting and estimated data to
aid management in running day-to-day operations and in planning future
operations.
Accountants employed by a business firm or a not-for-profit organization are
said to be employed in private accounting.

Accounting as an Aid to Decision Making
Accounting information is useful to anyone who makes decisions that have
economic results.
•Managers want to know if a new product will be profitable.
•Owners want to know which employees are productive.
•Investors want to know if a company is a good investment.
•Creditors want to know if they should extend credit, how much to extend,
and for how long.
•Government regulators want to know if financial statements conform to
requirements

Four financial statements
Balance sheet
Income statement (profit/loss)
Statement of cash flows
Statement of changes in equity.
Elements of financial statements
The information in the financial statements is organized into 10 categories called
elements.
The elements include: assets, liabilities, equity, contributed capital, revenue,
expenses, distributions, net income, gains and losses

The Basic Accounting Equation
.
Assets = Liabilities + Owners' Equity
This is a mathematical equation which must balance. The balance sheet
is an expanded expression of the accounting equation.
Assets are valuable resources that are owned by a firm.
They represent probable future economic benefits and arise as the
result of past transactions or events.
Liabilities are present obligations of the firm.
They are probable future sacrifices of economic benefits which arise as
the result of past transactions or events.
Owners' equity represents the owners' residual interest in the assets of
the business. Residual interest is another name for owners' equity

Accounting Principles
These principles can be classified into two categories
(i) Accounting concepts; and
Accounting Concepts
Business Entity Concept
Money Measurement Concept
Cost Concept
Going Concern Concept
Dual Aspect Concept
Realisation Concept
Accrual Concept
Accounting Period Concept
Revenue Match Concept
(ii) Accounting conventions.
Consistency
Disclosure
Conservatism
Materiality

Importance of Accounting Standards
The users of the financial statements need an assurance that the entities
preparing their financial statements follow the accepted standards while
presenting their financial information in the financial statements

LIST OF ACCOUNTING STANDARDS ISSUED SO FAR
AS 1-Disclosure of Accounting Policies
AS 2-Valuation of Inventories
AS 3-Cash flow Statements
AS 4-Contingencies and Events Occurring After the Balance Sheet Date
AS 5 -Net Profit or Loss for the Period, Prior Period Items and Changes in
Accounting Policies
AS 6-Depreciation Accounting
AS 7-Accounting for Construction Contracts
AS 8-Accounting for Research and Development
AS 9-Revenue Recognition
AS 10-Accounting for Fixed Assets
AS 11-Accounting for the Effects of Changes in Foreign Exchange Rates
AS 12-Accounting for Government Grants

CONT..
AS 13-Accounting for Investments
AS 14-Accounting for Amalgamations
AS 15-Accounting for Retirement Benefits in the financial Statements of Employers
AS 16-Borrowing Costs
AS 17-Segment Reporting
AS 18-Related Party Disclosures
AS 19-Leases
AS 20-Earnings Per Share
AS 21-Consolidated Financial Statements
AS 22-Accounting for Taxes on Income
AS 23-Accounting for Investments in Associates in Consolidated Financial Statements
AS 24-Discontinuing Operations
AS 25-Interim Financial
AS 26-Intangible Assets
AS 27-Financial Reporting of Interests in Joint Ventures
AS 28-Impairment of Assets
AS 29-Provisions, contingent Liabilities and Contingent Assets

Classification of Accounts
 Personal Account
Real Account
Nominal Account

Personal Account
Definition & Examples of accounts:-
 Personal Account: Personal accounts are accounts relating to persons or
organisations with whom the business has transactions.
E.g Customer, Supplier, Money lenders etc.

Real Accounts
Real Accounts: Real accounts refer to accounts in which property and possession
are recorded.
E.g Land, Building, Plant & Machinery, Vehicle Cash, Bank etc.

Nominal Accounts
 Nominal Accounts: Nominal accounts are revenue, expenses, gains,
and losses.
E.g. Wages, Salary, Discount etc .

Journal - Meaning
A journal is often referred to as Book of Prime Entry or the book of original
entry. In this book transactions are recorded in their chronological order. The
process of recording transaction in a journal is called as ‘Journalisation’. The
entry made in this book is called a ‘journal entry’

Functions of Journal
• Analytical Function
• Recording Function
• Historical Function

Advantages of Journal
• Chronological Record
• Minimising the possibility of errors
• Narration
• Helps to finalise the accounts

GOLDEN RULES
• Personal Accounts: ‘Debit the receiver and credit the giver’
• Real Accounts: ‘Debit what comes in and credit what goes out’
• Nominal Accounts: ‘Debit all expenses and losses and credit
all incomes and gains’ from extent to include gains’

Sub – Division of Journal
• Cash Journal/Cash Book
The sub types of cash book:
- Single Column Cash Book
- Two (Double) Column Cash Book
- Three Column Cash Book
• Petty Cash Book
• Purchase Journal
• Purchase Return Journal
• Sales Journal
• Sales Return Journal

Concept of Debit & Credit(Golden Rules)
For Personal Accounts :Debit the receiver and credit the giver.
E.g. Furniture has been purchased from Godrej & Boyce Ltd on
credit of Rs.2,00,000/-
Journal Entry:
Furniture A/C Dr. Rs.2,00,000/-
To Godrej & Boyce Ltd Cr. Rs.2,00,000/-

Concept of Debit & Credit
(Golden Rules)
For Real Accounts: Debit what comes in and credit what goes out.
A vehicle has been purchased of Rs. 8,00,000/- by cheque.
Journal Entry:
Vehicle A/C Dr. Rs.8,00,000/-
To Bank Cr. Rs.8,00,000/-

Concept of Debit & Credit
(Golden Rules)
For Nominal Accounts: Debit all expenses (and loses) and Credit all
incomes(and gain).
E.g Telephone bill amounting to Rs.25,000/- paid by cheque.
Telephone Expense A/c Dr. Rs.25000/-
To Bank A/c Cr. Rs. 25000/-

Capital and Revenue Receipts
• Capital Receipts comprise of Contributions of capital into the business by the
proprietor, partners or shareholders
• any sums received from debenture holders,
• any loans and
• Sale proceeds of any fixed assets & long term investments

Revenue Receipts or income
are the outcome of firm’s activity in the accounting period; – money
received on sale of goods in trade or on rendering of services. • Examples:
Sales, commission and fees received, interest /dividend on investments

Distinction Between Capital and Revenue Receipts
Capital Receipts Includes amounts realized by sale of fixed assets or by issue of share or
debentures. It is a receipt in substitution of a source of income. It is a receipt in
substitution of an income
Amount received for surrender of certain rights under an agreement is a capital receipt,
because a capital asset is being given up in the form of these rights.
Revenue Receipts Includes amount realized by sale of goods or rendering services
Amount received as compensation under an agreement for the loss of future receipts is
a revenue receipt

Classification of income •
Capital income is an income which does not relate to operations of the business or which
does not grow out of or pertain to the running of the business proper. Capital profits are
profits earned on account of sale of fixed assets or in connection with share capital
Capital Profits / Capital Income • Examples: Share premium, sale of a fixed asset for a
value more than that for which it was purchased.eg. Capital gain of Rs 150,000 arises
when building bought for Rs. 200,000 is sold for Rs. 350,000.
Revenue income is an income which arises out of and in the course of regular operations
of the business concern • Revenue profits appear in the Profit and Loss Account •
Revenue profit and revenue income are synonymous. Revenue profits are those earned in
the ordinary course of business Examples: Profit made on sale of goods, income received
from letting out of the business property, dividends received on business investments,
etc.

Classification of Expenditure
Capital Expenditure Such expenditure is either incurred for acquisition of a fixed asset
(tangible or intangible) or permanent improvement or addition or substitution or
extension to an asset to increase the earning capacity of the business enterprise.
Capital Expenditure is any expenditure which is incurred for the purpose of long term
advantage Examples of Capital Expenditure 1. Purchase of permanent tangible asset –
such as plant and machinery, office equipment, furniture 2. All sums spent up to the
point an asset is ready for use – including expenditure on its purchase, receipt or
erection
Revenue Expenditure • It is an expenditure on consumable items, on services and on
goods acquired for resale. These are expenses whose benefit expires within the year
of expenditure and which are incurred to maintain the earning capacity of existing
assets. Revenue Expenditure Revenue items generally include: • The cost of materials
used in manufacturing goods intended for resale. • Wages paid in connection with the
production of goods meant for sale.

Depreciation
Fixed assets like plant and machinery etc. are used in the business for the purpose of
production or providing services. With the passage of time and utilization, value of
such fixed assets decreases Value of portion of fixed assets utilized for generating
revenue must be charged during a particular accounting year to ascertain the true
cost. This portion of cost of fixed asset allocated is called depreciation.
Depreciation means reduction in value of asset or in the utility due to passage of time,
natural wear and tear, exhaustion of the subject matter.

Objectives of Providing for Depreciation
To ascertain the true results of operations
To present true and fair value of the fixed asset
To accumulate funds for the replacement of the asset

Factors in measurement
Estimation of exact amount of depreciation is not easy.
Generally following factors are considered in calculation of depreciation
1. Cost of asset including expenses for installation etc.
2. Estimated useful life of the asset.
3. Estimated scrap value (if any) at the time of useful life of the asset

Methods of providing depreciation
1) Straight Line method (SLM)
2) Reducing Balance Method RBM
3) Machine Hour Method
4) Production Units Method

Straight Line method
In this method, an equal amount is written off every year during the working life of
the asset to nil or its residual value at the end of its useful life.
SLM: The underlying assumption of this method is that the particular asset
generates equal utility during its lifetime
Depreciation = Cost of Asset-Scrap Value
Useful Life

Reducing Balance Method
Under this method, a fixed percentage of diminishing value of the asset is written off
each year. The annual charges of the depreciation decrease from year to year.
Written Down Value (WDV)= (Acquisition Cost – Depreciation)
Depreciation= WDV*Depr Rate
RBM: The main advantage of this method is that total charge to total revenue is uniform
when the depreciation is high, repairs are negligible and as the repairs increases
the burden of depreciation gets lesser and les

Machine Hour Method
Where it is possible to keep a record of the actual running hours of each machine,
depreciation may be calculated on the basis of hours worked.
The machine hour rate of depreciation is calculated after estimating the total
numbers of hours that machine would work during its whole life.
Under machine hour method Depreciation is calculated for each hour the
machine works.

Production Unit Method
Under this method depreciation is determined by comparing annual
production with the estimated total production. The amount of
depreciation is computed by the using following formula:
Depreciation for the period=
depreciable Production during the period
amount X Estimated total production

Provision
A provision is a liability which can not be measured with a substantial
degree of accuracy. A liability is a present obligation of the enterprise
arising from past events, the settlement of which is expected to result in
an outflow of resources.
Where the liabilities are known but amount s cannot be precisely
determined, we estimate for liability and provide for it.
The principle of conservatism supports making of provisions for probable
liabilities.

What is a Debenture?
 Meaning :-
Debenture is an ‘instrument’ in writing for a ‘fixed period’ given by a
company acknowledging the liability for total amount received as a
result of issue of debenture and agreeing thereby to pay the money
raised after the expiry of stipulated period at a certain rate of interest.

 Need for issue of debentures :-
A company for its extension & development may require to raise funds
without increasing its share capital so, a may invite the public by open
declaration to lend money for a fixed period at a ‘declared rate’ to be paid
on such money.
 In law, a debenture is a document that either creates a debt or
acknowledges it. In corporate finance, the term is used for a medium- to
long-term debt instrument used by large companies to borrow money. In
some countries the term is used interchangeably with bond, loan, stock or
note.
 Debentures are generally freely transferable by the debenture holder.
Debenture holders have no rights to vote in the company's general
meetings of shareholders, but they may have separate meetings or votes
e.g. on changes to the rights attached to the debentures. The interest paid
to them is a charge against profit in the company's financial statements.

Types of Debentures
Debenture can be classified as under:
1. From security point of view:-
 Secured or Mortgage debentures : These are the debentures that
are secured by a charge on the assets of the company.
 These are also called mortgage debentures.
 The holder’s secured debentures have the right to recover their principal a
mount with unpaid amount
of interest on such debentures out of the assets mortgaged
by the company. In India, debentures must be secured.

i. Secured debentures can be of two types :
 (a) First mortgage debentures : The holders of such debentures
have a first claim on the assets charged.
 b) Second mortgage debentures : The holders of such debentures have a seco
nd claim on the assets charged.
ii. Unsecured debentures: Debentures which do not carry any
security with regard to the principal amount or unpaid interest are called
unsecured debentures. These are called simple debentures.
2) On the basis of redemption:
(i) Redeemable debentures : These are the debentures which are
issued for a fixed period.The principal amount of such debenture
is paid off to the debenture holders on the expiry of such period.
These can be redeemed by annual drawings or by purchasing from
the open market

ii) Non-redeemable debentures : These are the debentures which are not
redeemed in the life time of the company. Such debentures are paid back only
when the company goes into liquidation.
On the basis of Records
i) Registered debentures: These are the debentures that are
registered with the company.
The amount of such debentures is payable only to those debenture holders
whose name appears in the register of the company.
ii) Bearer debentures : These are the debentures which are not
recorded in a register of the company. Such debentures are
transferrable merely by delivery. Holder of these debentures is
entitled to get the interest

On the basis of convertibility
i) Convertible debentures : These are the debentures that can be
converted into shares of the company on the expiry of pre-decided
period. The term and conditions of conversion are generally
announced at the time of issue of debentures.
Non-convertible debentures : The debenture holders of such debentures cannot
convert their debentures into shares of the company
On the basis of priority
First debentures : These debentures are redeemed before other debentures.
Second debentures : These debentures are redeemed after the redemption of first
debentures

ISSUE OF DEBENTURES
 Byissuingdebenturesmeansissueofacertificatebythecompanyunder
itssealwhichisanacknowledgmentofdebttakenbythecompany.
 Theprocedureofissueofdebenturesbyacompanyissimilartothatofthe
issueofshares.AProspectusisissued,applicationsareinvited,andletters
ofallotmentareissued.Onrejectionofapplications,applicationmoneyis
refunded.Incaseofpartialallotment,excessapplicationmoneymaybe
IssueofDebenturetakesvariousformswhichareasunder
adjustedtowardssubsequentcalls.
 Debentures issued for cash
 Debentures issued for consideration other than cash
 Debentures issued as collateral security:
 Further, debentures may be issued
 i) at par (ii) at premium, and(iii) at discount

 OVER SUBSCRIPTION
 Company if receives applications for number of debentures that exceed the
number of debentures offered for subscription, it is called over subscription.
There can be following treatment of the excess application money
received :
 (a) The total amount of excess number of applications is refunded in case
the applications are totally rejected.
 (b) The amount of excess application money is totally adjusted towards
amount due on allotment and calls
--- in case partial allotment is made,
--- the excess amount is adjusted towards sums due on allotment and rest of
the amount is refunded.

ISSUE OF DEBENTURES AT PREMIUM AND AT DISCOUNT
Debentures are said to be issued at premium when these are issued at a value
which is more than their nominal value. For example, a debenture of Rs 100 is
issued at Rs 110. This excess amount o f Rs 10 is the amount of premium. The
premium on the issue of debentures is credited to the Securities Premium A/c as
per section 78 of the Companies Act, 1956.
ISSUE OF DEBENTURES AT DISCOUNT
When debentures are issued at less than their nominal value they are said to be
issued at discount . For example, debenture of Rs 100 each is issued at Rs 90 per
debenture. Companies Act,1956 has not laid down any conditions for the issue of
debentures at a discount as have been laid down in case of issue of shares at
discount. However, there should be provision for issue of such debentures in the
Articles of Association of the Company

ISSUE OF DEBENTURES FOR CONSIDERATION OTHER THAN CASH
When a company purchases some assets and issues debentures as a payment for
the purchase, to the vendors it is known as issue of debentures for consideration
other than cash. Debentures can be issued to vendors at par, at premium and at
discount

ISSUE OF DEBENTURES AS COLLATERAL SECURITY
Collateral security means security given in addition to the principal security. It is a
subsidiary or secondary security. Whenever a company takes loan from bank or
any financial institution it may issue its debentures as secondary security
which is in addition to the principal security. Such an issue of debentures is
known as ‘issue of debentures as collateral security’. The lender will have a right
over such debentures only when company fails to pay the loan amount and the
principal security is exhausted. In case the need to exercise this right does not
arise debentures will be returned back to the company. No interest is paid on the
debentures issued as collateral security because company pays interest on loan

Accounting treatment of debentures
A – Issue of Debenture ‘at Par’
When company receives application money of debentures
1st journal Entry
Bank account Debit
Debenture Application Account Credit
2nd Journal Entry
When company accepts the applications
Debenture Application Account Debit
Debenture Account Credit
3rd Journal Entry
When Allotment money of debenture due
Debenture Allotment Account Debit

4th Journal Entry
When Allotment money of debenture received
Bank Account Debit
Debenture Allotment Account Credit
5th Journal Entry
When Call money of debenture is payable
Debenture Calls Account Debit
6th Journal Entry
When Call money of debenture is received
Bank Account Debit
Debenture Calls Account Credit

B- When Company issue of debenture ‘at premium’
If premium is receivable with application money
1st Journal Entry
When amount of application received with premium
Bank Account Debit
Debenture Application account Credit

 2nd Journal Entry
Debenture Application Account Debit
Security premium Account credit
If premium receivable on allotment then
Debenture Allotment account debit
Security Premium Account Credit
And allotment money received with premium
Bank account Debit

When Debenture Issued At discount
Debenture Allotment Account Debit
Discount on Issue of Debenture Account Debit
When discounted amount of debenture is received
Bank Account Debit

Financial Accounting

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