Fundamentals of Accounting Concept of Accounting:

1. DEPARTMENT OF MANAGEMENTDEPARTMENT OF MANAGEMENT
STUDIESSTUDIES
EMBAEMBA ProgramProgram
Course # E-506Course # E-506
Fundamentals of AccountingFundamentals of Accounting

2. BASIC CONCEPTSBASIC CONCEPTS
Concept of AccountingConcept of Accounting:: Accounting is aAccounting is a
service activity designed to accumulate,service activity designed to accumulate,
measure, and communicate economicmeasure, and communicate economic
information about organizations forinformation about organizations for
decision making purposes.decision making purposes.

3. The American Accounting AssociationThe American Accounting Association
(AAA) has defined accounting as “(AAA) has defined accounting as “thethe
process of identifying, measuring, andprocess of identifying, measuring, and
communicating economic information tocommunicating economic information to
permit informed judgments and decisionspermit informed judgments and decisions
by the users of accounting informationby the users of accounting information.”.”

4. THE ACCOUNTING EQUATIONTHE ACCOUNTING EQUATION
ConceptConcept:: An algebraic equation thatAn algebraic equation that
expresses the relationship between assetsexpresses the relationship between assets
( resources), liabilities (obligations), and( resources), liabilities (obligations), and
owners’ equity. The equation is expressedowners’ equity. The equation is expressed
as under:as under:
Assets =Assets = LiabilitiesLiabilities ++ Owners’ Equity.Owners’ Equity.

5. Elements of EquationElements of Equation
Assets:Assets: Economic resources that are owned orEconomic resources that are owned or
controlled by an enterprise as a result of pastcontrolled by an enterprise as a result of past
transactions or events, and that are expected totransactions or events, and that are expected to
have future economic benefits.have future economic benefits.

6. Elements of Equation (continued)Elements of Equation (continued)
Liabilities:Liabilities: Obligations of an enterprise to payObligations of an enterprise to pay
cash or other economic resources in return forcash or other economic resources in return for
past, current, or future benefits. They representpast, current, or future benefits. They represent
claims against assets. In equation form it can beclaims against assets. In equation form it can be
expressed as:expressed as:
LiabilitiesLiabilities = Assets –= Assets – Owners’ Equity.Owners’ Equity.

7. Elements of Equation (continued)Elements of Equation (continued)
Owners’ EquityOwners’ Equity:: The ownership interestThe ownership interest
in the assets of an enterprise. It representsin the assets of an enterprise. It represents
the “net equity” of the business which isthe “net equity” of the business which is
the amount of net assets available after allthe amount of net assets available after all
obligations are satisfied. In equation formobligations are satisfied. In equation form
it can be expressed as:it can be expressed as:
Owners’ EquityOwners’ Equity = Assets –= Assets – Liabilities.Liabilities.

8. TRANSACTIONTRANSACTION
Concept of Transaction:Concept of Transaction: Exchanges of goodsExchanges of goods
and services for money. Transactions affect theand services for money. Transactions affect the
assets, liabilities, owner’s equity, revenues, andassets, liabilities, owner’s equity, revenues, and
expenses of an organization. Transactions involve:expenses of an organization. Transactions involve:
 Two partiesTwo parties
 Exchange of goods and servicesExchange of goods and services
 Value of exchanges is measurable in terms of moneyValue of exchanges is measurable in terms of money
 Transactions cause change to financial position of anTransactions cause change to financial position of an
organization.organization.

9. AssetsAssets
1. Cash1. Cash
2. Accounts Receivable2. Accounts Receivable
3. Notes Receivable3. Notes Receivable
4. Merchandise Inventory4. Merchandise Inventory
5. Supplies on Hand5. Supplies on Hand
6. Prepaid Expenses6. Prepaid Expenses
(a)(a) Prepaid rentPrepaid rent
(b)(b) Prepaid wages/ salaryPrepaid wages/ salary
(c)(c) Prepaid insurancePrepaid insurance

10. 7. Equipment7. Equipment
8. Building8. Building
9. Land9. Land

11. LiabilitiesLiabilities
1. Accounts Payable1. Accounts Payable
2. Notes Payable2. Notes Payable
3. Other Payables3. Other Payables
(a) Rent payable(a) Rent payable
(b) Wages payable(b) Wages payable
(c) Salaries payable(c) Salaries payable
(d) Interest payable(d) Interest payable
(e) Fees payable(e) Fees payable

12. Owner’s EquityOwner’s Equity
1. Owner’s Initial Capital1. Owner’s Initial Capital
2. Owner’s Additional Capital2. Owner’s Additional Capital
3. Net Income from business3. Net Income from business

13. Reasons of Equity IncreaseReasons of Equity Increase
1. Additional Investment1. Additional Investment
2. Revenue from sales or service rendering2. Revenue from sales or service rendering
3. Net income from business3. Net income from business

14. Reasons of Equity DecreaseReasons of Equity Decrease
1. Withdrawals1. Withdrawals
2. Expenses2. Expenses
3. Net loss from business3. Net loss from business

15. Definition of an AccountDefinition of an Account
An account is a tool of recording financial transactionsAn account is a tool of recording financial transactions
of a business. An account has four elements. These are:of a business. An account has four elements. These are:
1.1. A title;A title;
2. A code number2. A code number
3. Two wings3. Two wings
4. A balance4. A balance

16. Types of AccountsTypes of Accounts
Accounts
Personal
Accounts
Real
Accounts
Nominal
Accounts
Assets Liabilities Expenses Revenues

17. ACCOUNTING INFORMATION
The information generated through accounting
system can be categorized in two parts:
Accounting Information
Statutory Information
Non- statutory
Information
Routine Non-routine

18. Statutory Information:Statutory Information: Information requiredInformation required by law.
In other words, mandatory for all registered
organizations. Income Statement and Balance Sheet
are statutory information.
Non-statutory Information: Information that all non
registered organizations are not required to provide
is non-statutory information.

19. Routine information is generated after certain
intervals. Examples of routine information are
fund flow statement/cash flow statement, annual
budget, performance reports, cost sheet etc.
Non-routine information is need-based information
generated by accounting system to help in solving
specific problem, e.g., marginal cost sheet, zero-based
budgeting etc.

20. USERS OF ACCOUNTINGUSERS OF ACCOUNTING
INFORMATIONINFORMATION
Different users, for making their decisions require
accounting information. These users may be classified
as:
1. Internal Users
2. External Users:
(a) External users with direct interest
(b) External users with indirect interest

21. Users of Accounting InformationUsers of Accounting Information
Users of Accounting
Information
Internal Users External Users
External Users
with
Direct Interest
External Users
with
Indirect Interest

22. 1. Internal users: Top, middle and bottom level of
management executives are the internal users of accounting
information. They need it for making decisions. These users
are interested in the profitability, operational efficiency and
financial soundness of the business. The top-level
management is concerned with accounting information
related to planning, the middle level is interested in planning
and controlling and the lower level with operational affairs.

23. 2. External users: External users may have direct interest or
indirect interest and again be classified as:
(a) External users with direct interest: The existing
and the prospective creditors and investors have direct interest in
the accounting information. The sources of information for external
users are financial statements and reports of Directors and Auditors.
Investors assess the financial soundness and net worth of the business
so that they may decide about buying, selling or holding investment in
the business. Creditors, such as banks, lenders, debenture holders and
financial institutions assess the risk involved in granting loans, servicing
of the existing loans to the business.

24. (b) External users with indirect interest: These users such as
department of company affairs, registrar of joint stock
companies, sales tax and income tax authorities, labor unions,
prospective customers, creditors, stock exchange’s trade
associations and others who are interested in the affairs of
the business. They have to make their own decision on the
basis of the financial reports of the business.
First exam will be up to users of accounting information

25. BRANCHES OF ACCOUNTING
On the basis of information generated by accounting
system, there are three main branches of accounting:
(i) Financial accounting system
(ii) Cost accounting system
(iii) Management accounting system.

26. 1. Financial Accounting (FA)
FA deals with preparation of Final Accounts/Financial
Statements viz.
(i) Income Statement to get previous year’s result of business
operation i.e., Profit/Loss. Income statement
is also termed as Profit & Loss Account (P & L A/c).
(ii) Balance Sheet (B/S) to get previous year’s financial
position i.e., picture of Assets and Liabilities.

27. 2. Cost Accounting (CA)
Cost accounting deals with present information
i.e., determining unit cost at different levels
(known as cost centers) of ongoing production.
Cost accounting process includes:
(i) Cost determination i.e. costing
(ii) Cost analysis i.e. studying behavior of profit with
respect to cost and volume.
(iii) Cost control i.e. comparison of actual cost with
predetermined cost/standard cost.

28. 3. Management Accounting (MA)
MA deals with all those information, which helps in
decision-making process i.e. planning and controlling
financial activities. In an organization, MA is common to
both FA and CA because all those information,
which are generated by FA and CA system are useful in
decision-making process and comes under the
preview of MA system e.g.

29. CVP analysis and variance analysis of CA system also
form part of MA system.
Fund Flow Statement (FFS) of FA system also form part
of MA system. Because it presents the flow
of fund through business organization during financial
year and is of great help in assessing fund position.
Apart from above information which are common to
both FA system and CA system, there are some
information exclusively generated by management
accountants e.g.

30. (i) Projected statements like:
A- Projected income statement to estimate coming year’s target
profit.
B- Projected balance sheet to estimate coming year’s target
financial position. (i.e. assets and liabilities).
C-Projected FFS/CFS to estimate coming year’s target
fund/cash position.
(ii) Developing budget and budgetary control system for the
purpose of budgeting.
(iii) Marginal costing techniques for short-term decision-
making purposes.

31. Need for Accounting
Accounting helps in knowing:
1.What is the result of business operation
after a certain interval i.e., profit/loss?
2. Financial health: Will the organization be
able to meet commitments/obligations in
the near future?

32. 3. What is fund/cash position?
4. What the organization owns i.e., assets to
the organization.
5. What the organization owes i.e., liabilities
of the organization.
and many more things, which help in
decision-making process. This creates need
for accounting.

33. Accounting CycleAccounting Cycle
The sequential and related steps that are requiredThe sequential and related steps that are required
to perform to complete the accounting processto perform to complete the accounting process
is known as accounting cycle. The steps include:is known as accounting cycle. The steps include:
1. Analyze transaction by examining source1. Analyze transaction by examining source
documents.documents.
2. Journalize transactions in the Journal2. Journalize transactions in the Journal
3. Post journal entries to the accounts in the3. Post journal entries to the accounts in the
Ledger.Ledger.

34. 4. Take a trial balance of the accounts to measure4. Take a trial balance of the accounts to measure
arithmetic accuracyarithmetic accuracy
5. Prepare a Work Sheet.5. Prepare a Work Sheet.
6. Prepare financial statements:6. Prepare financial statements:
(a) Income Statement; and(a) Income Statement; and
(b) Balance Sheet(b) Balance Sheet
7. Journalize and post adjusting entries.7. Journalize and post adjusting entries.
8. Journalize and post closing entries.8. Journalize and post closing entries.
9. Take a post-closing trial balance.9. Take a post-closing trial balance.