Accounting involves recording, classifying, and summarizing financial transactions and events. The objectives of accounting include maintaining business records, ascertaining profit/loss, determining financial position, and providing information to internal and external users. The fundamental accounting equation shows that assets equal liabilities plus capital. Key accounting concepts include money measurement, entity, going concern, cost, dual aspect, periodicity, prudence, and realization. Accounting conventions include matching revenues and expenses, consistency, and materiality.

1. Unit 1
Basics of Financial Accounting
Dr. Priyanka Zala

2. What is Accounting?
Recording,
classifying
Summarizing
Communicating
financial
Information
to
various
users

3. ACCOUNTING:-
In 1941, the American institute of certified public
accountant (AICPA) defined accounting as follows:-
 “Accounting is the art of recording, classifying and
summarising in significant manner and in terms of money,
transactions and events which are in part at least of a
financial character and interpreting the results thereof.”.

4. Objectives of Accounting:
1. Maintaining Business Records
Record financial transactions
- Trading account
- Profit and Loss account
- Balance Sheet
2. Ascertaining Profit/Loss
3. Ascertaining the Financial Position

5. 4. Facilitating Management
- Management often requires financial information for
decision- making, effective control, budgeting and
forecasting
5. Providing Accounting information to the users

6. Need for Financial Accounting
1. Needed for understanding profitability of the business
2. Records and reveal the financial position of the business
3. It helps understand overall efficiency of the business
4. It provides appropriate numerical information to the
creditors.
5. It is required to be submitted to various government
departments for payment of taxes such as income tax, sales
tax, excise duty etc.
6. It helps management of the business for taking appropriate
decision at right time

7. The Need for Accounting
Managers, investors, and other internal groups
want the answers to two important questions:
How well did
the organization
perform? Where does
the organization
stand?

8. The Need for Accounting
Accountants answer these questions
with three major financial statements:
Income
statement
Balance
sheet
Statement of
cash flows

9. Difference between Book Keeping and Accountancy
Points Book-Keeping Accountancy
Definition Book-Keeping is a process of
recording day to day business
transactions in books of
original entry and posting them
into ledger
Accountancy is an art and
science of preparing summary
statements and interpreting the
results thereof
Basis The basis of book-keeping is a
transaction
The basis of accounting is
book-keeping
Scope The book- keeping has a
limited scope.
The scope of accountancy is
wide and includes book-
keeping and goes further than
recording transactions
Requires special skills Any person who knows the
rule of double entry can
prepare books of accounts. It
does not require expert
knowledge.
It involves analysis and
interpretation so requires
special skill and expert
knowledge.

10. Difference between Book Keeping and Accountancy
Points Book-Keeping Accountancy
Useful for policy decision
making
It is not very useful for
managerial decisions.
It analyses and interprets
accounts, it can draw useful
conclusions from it.
It is very useful for
managerial decisions.
Development There is no scope of
development or any
changes in book-keeping
It has developed very fast
with the changing times.
Ex. Cost Accounting,
Management Accounting,
Human Resource
Accounting.

11. Internal and External Users of Accounting
Information
Internal
Users -
Management
Creditors
Current
and
Potential
Owners
Government
Agencies
Suppliers
Trade
Organizations
Financial
Analysts
Banks

12. Fundamental Accounting Equation
It shows,
(i) Assets and Liabilities of a firm are equal
(ii) It is based on the dual aspect of concept of accounting
Ex. A started business by bringing cash of Rs. 10,00,000
Cash comes in--------- Increase in assets
Capital provided by the owner--------- Capital of the owner increases

13. It can be expressed as:
Assets = Liabilities + Capital (A=L+C or A=C+L)
OR
Liabilities = Assets – Capital (L+A-C)
OR
Capital = Assets –Liabilities (C=A-L)

14. Types of Transactions
Economic Transactions
- Those transactions in which money is exchanged or such things
or services are exchanged which can be measured in terms of
money are called economic transactions
Non- Economic Transactions
- Those transactions in which money is not exchanged or there is
an exchange of such things which cannot be measured in money
are called non-economic transactions.

15. Forms of Economic Transactions
Forms of Economic
Transactions
Exchange of Goods
for
(1) Assets
(2) Services
Exchange of Cash for
(1) Goods
(2) Services
(3) Assets
(4) Debts
Exchange of Debts
for
Debt

16. Assets
Assets are property or legal rights owned by an individual or
business to which money value can be attached.
Types of Assets
1. Fixed Assets
2. Currents Assets
3. Tangible Assets
4. Intangible Assets
5. Wasting Assets
6. Fictitious Assets

17. Liabilities
Liabilities mean the amount which the business owes to the
outsiders.
Ex. Creditors, bank overdraft, bills payable, banks, debenture
holders etc.
1. Long term liabilities
2. Short term liabilities/ Current liabilities

18. Systems of Accounting
1. Cash system of accounting
It is a system in which accounting entries made only when
cash is received or paid. No entry is made when a payment or
receipt is merely due.
Ex. Government system of accounting
2. Mercantile or Accrual System of accounting
It is a system in which accounting entries are made on the basis
of amounts having become due for payment or receipt.

19. Example
A firm closes its books on 31st December each year. A sum of Rs. 500 has
become due for payment on account of rent for the year 2016. The amount
has however, been paid in January ,2017.
Cash System of Accounting- No entry
Mercantile System of Accounting-
O/s Rent a/c Dr.
To Mr. A’s a/c
A’s a/c Dr.
To Cash a/c

20. Accounts
Personal
Debit
Receiver
Credit
Giver
Real
Debit
What
comes in
Credit
What goes
out
Nominal
Debit
Expenses
and Losses
Credit
Gains and
Income

21. PERSONAL ACCOUNTS
 Natural Personal Accounts:- The term ‘Natural Persons’ means persons who are
creation of God. For example, mohan, Sohan, Abha etc.
 Artificial Personal Accounts:- These accounts include accounts of corporate bodies
or institutions which are recognised as persons in business dealings. For example:-
the account of a Limited company, the account of a Co-operative Society, the
account of a Club, the account of Government, the account of an Insurance
Company etc.

22.  Representative Personal Accounts:- These are accounts which represent a
certain person or group of persons. For example:- if the rent is due to the
landlord, an outstanding rent account will be opened in the books.
 “RULE:-”
 DEBIT THE RECEIVER CREDIT THE GIVER

23. REAL ACCOUNTS
 Tangible Real Accounts:- Tangible Real accounts are those which relate to such
things which can be touched, felt, measured etc. Examples:- building account,
furniture account, stock account, etc.
 Intangible Real Accounts:- These accounts represents such things which cannot be
touched. Of course, they can be measured in terms of money. Ex. Patents account ,
goodwill account, etc.

24. “RULE”:-
DEBIT WHAT COMES IN CREDIT WHAT GOES OUT

25. NOMINAL ACCOUNTS
 Nominal Accounts are recording transactions of business connected with
expenses, incomes, profit or losses etc. are known as Nominal Account. For
example, Rent Account, Salaries Account, and Interest Account, etc.
“RULE:-”
DEBIT ALL EXPENSES AND LOSSES CREDIT ALL GAINS AND INCOMES

26. Summary
 PersonalAccount:
 RealAccount:
 NominalAccount:
Debit the Receiver Credit
the Giver Debit what comes
in Credit what goes out
Debit all expenses and losses
Credit all incomes and gains
Debit the Receiver Credit
the Giver Debit what comes
in Credit what goes out
Debit all expenses and losses
Credit all incomes and gains

27. Types of Expenses and Incomes
Revenue Expenses:-
Revenue expenses are the expenses, the benefit of which will
not be available for more than one accounting year.
It does not lead to an increase in the profit earning capacity of
the business but it is incurred to carry on the normal activities of
the business.
Ex. Salary, wages, Rent, Depreciation, Insurance Premium,
Taxes and Legal Expenses

28. Capital Expenditure:
Capital expenditure is the expenses incurred for getting long
term benefits. The benefit of such expense is available for a
number of years.
These expenses are incurred to enhance the profit earning
capacity of the business.
Examples:
Purchase of land or any other fixed assets
Cost of addition or extensions to existing assets
Expenditure incurred on putting an asset into working condition

29. Difference between Revenue and Capital Expenditure
Revenue Expenses Capital Expenses
The benefits of these expenses are
available only for the current
The benefit of these expenses extends for
more than one year
It is incurred to maintain the fixed assets
in good condition
It is incurred for acquiring the fixed assets
intended for use in the business
It does not increase the earning capacity of
the business
It increases the earning capacity of the
business
It is shown in trading and profit and loss
account
It is shown in the balance sheet

30. Deferred Revenue Expenditure
These are expenses which are basically revenue in nature but
their benefits is not exhausted in one accounting year.
Examples;-
Preliminary expenses
Discount on issue of debentures and shares
Deferred advertisement expenses

31. Capital and Revenue Incomes
Revenue Income/Receipts
Revenue income are generated out of routine business
transactions or operating transactions
Examples:-
Cash received on account of sales
Collection from debtors
Discount received
Interest and dividend received on investments

32. Capital Income/Receipts
Capital receipts are those receipts which are generated
out of capital transactions.
Example:
Sale of fixed assets
Issue of shares and debentures

33. Difference between Capital and Revenue Receipt
Revenue Income Capital Income
It represents income such as sale of goods interest
received, dividend received
It represents capital brought in by the proprietor which
is not or recurring nature
They are recurring They are non-recurring in nature
They are gains to the concern They are not gains to the concern

34. Meaning and types of reserves
A reserve is an amount of money set aside until it is needed for some
particular purpose.
According to Institute of Chartered Accountant of India (ICAI),
the term Reserve means; “that portion of earnings, receipts or
other surplus of an enterprise (whether capital or revenue)
appropriated by the management for a general or specific purpose
other than a provision for depreciation or diminution in the value
of asset or for a known liability.”

35. Types of Reserves
1. Revenue Reserves:-
These reserves are created out of revenue Profits of the business.
a. Specific Reserves: These reserves are created out of revenue profits for a
specific purpose.
Ex. Dividend Equalization Reserve, Debenture Redemption Reserve
b. General Reserves:
These are the reserves created only to strengthen the financial position of
the business and to keep the funds available for any future contingency or
expenditure that may be required.
Ex. Contingency Reserve, Undistributed balance of the P & L account

36. 2. Capital Reserve
These reserves are created out of the capital profits.
Ex. 1. Profit on sale of fixed assets
2. Premium on issue of shares or debentures
3. Profit on redemption of debentures
4. Surplus on revaluation of fixed assets or fixed
liabilities

37. 3. Secret Reserves:
Secret Reserves are the reserves the existence of which does not
appear on the face of the Balance Sheet.
In such a situation, net assets position of the business is stronger
than that disclosed by the balance sheet
Ex.
1. Excessive depreciation of an asset, or excessive over-
valuation of a liability
2. Complete elimination of an asset or under- valuation of an
asset
3. Charging capital expenditure to revenue
4. Permanent appreciation in a fixed asset

38. Accounting Principles
Accounting principle may be defined as ‘those rules of conduct or
procedure which are adopted by the accountants universally, while
recording the accounting transactions.’
Accounting
Principle
Accounting
concepts
Accounting
Conventions

39. Accounting Concepts
The term concept refers to assumptions and
conditions on which accounting system is based.

40. 1.Money Measurement Concept:-
 Each transaction and event must
be expressible in monetary terms.
If an event cannot be expressed in
monetary terms, it cannot be
considered for accounting
purposes.
 Ex.:- Business got a team of
dedicated and trusted employees.

41. 2. The Entity Concept:-
 Business is considered to be a separate entity from the
proprietor.
 A business entity may be in the form of sole
proprietorship, partnership or corporate entity.

42. Ex.
 (1) When one person invests Rs. 10,000 into business it will be
deemed that the proprietor has given that much of money to the
business, which will be shown as a liability in the books of the
business.
 (2) Profits are shown as liabilities of the firm as they are payable
to the owners.
 (3) Withdrawals/ drawings

43. It is common for the owner to draw money or
goods from the firm for personal use anytime.
According to the Accounting Entity concept,
we must record the event even though he is the
owner of the firm.
What do you
call this?
Click me!

44. It is common for the owner to draw money or
goods from the firm for personal use anytime.
According to the Accounting Entity concept,
we must record the event even though he is the
owner of the firm.
DRAWINGS
What about drawings
of goods?

45. 3. GOING CONCERN CONCEPT:-
 It is assumed that the business will continue for a fairly long
time to come.
 An entity is said to be a going concern if it has neither the
intention nor the necessity of the liquidation or curtailing
materially the scale of the operation.
 Ex. Valuation of assets depends on this concept.

46. 4. The Cost Concept
An asset is ordinarily entered in the accounting records
at the price paid to acquire it, and
Ex. If a business buys a plot of land for Rs. 50,000. the
asset would be recorded in the books at Rs. 50,000.

47. 5. Dual aspect Concept:-
 According to this concept every business transaction has a dual effect.
 The entire system of double entry book keeping is based on this
concept.
 Ex. 5 friends form the company by contributing Rs. 2 lakh in cash on
1st January 2008.
Balanceshet of ……….
Liabilities Amount Assets Amount
Capital 10,000,000 cash 10,00,000
10,00,000 10,00,000

48. 6. The periodicity/Accounting period concept:-
 The results of operations of and entity are measured periodically, i.e. in each
accounting period.
 Different business units may follow different accounting periods depending on
convenience.
 Ex. Calendar year, fiscal year.

49. 7. Prudence/conservatism Concept:-
 The rule ‘anticipate no profit but provide for all possible losses’ while
recording business transactions.
 Ex. The inventory is valued ‘at cost or market price whichever is less.’
 Similarly a provision is made for possible bad and doubtful debts out of
current year’s profits.
 But not to create provision for likely discounts to be received earned on
payments to creditors.

50. 8. Realization Concept:-
 According to the realisation concept, revenue should be considered as
being earned/realised on the date when goods are sold or services are
rendered to the customers in consideration for cash or claims to cash (i.e.
debtors).
 Goods lying with customers are shown at cost price and not at the
negotiated price of sale. Thus, the realisation concept prevents the firm
from registering/posting profits on ‘pending’ sales.
 Ex. A businessman receives an order on 1st January, 2014 and supplies
goods on 10th January and he receives payment on 15th January.
 In this transaction, the revenue from sale of goods is recorded on 10th
January but neither at 1st January nor on 15th January.

51. 9. Accrual Concept
•It indicates that the transactions of a particular
period are recorded in the books of accounts even if
they aren’t paid or received in cash.
•Ex. Mr. X is employee of ABC Ltd. his salary for
last month of the year, March 2015 is not paid till
the year end. Same salary will be recorded in the
books as oustanding salary.

52. 10. Verifiable evidence concept
•According to this concept all accounting
transactions should be evidenced and supported by
objective documents.
•Such supporting documents provide the basis for
making accounting entries and for making
verification by the auditor later on.

53. Convention
Accounting convention refers to the customs and traditions
followed by Accountants as guidelines while preparing
accounting statement
1. The Matching convention
2. The consistency convention
3. The Materiality convention

54. 1.Matching Convention
 Matching concept involves two steps in computing net
income,
 (1) To determine the revenues earned in a given accounting
period.
 (2) To determine the expenses/costs incurred to realise
these revenues.
 The expenses recognised in an accounting period, then, are
matched with the revenues recognised in that period.

55. 2. Convention of Consistency
• This principle implies that the basis followed in different
accounting period should be same.
• Method adopted in one accounting year should not be
changed in another year.
• Ex. Stock is valued under FIFO method in an year and it
should not be valued under LIFO method in another year.
If assets are depreciated under diminishing balance method,
it should be continued.

56. 3. Convention of materiality
• Important details of financial status must be informed to all
relevant parties, insignificant facts, which do not influence
any decisions of the investors or any interested group, need
not be communicated.
• EX. When we send statement to a debtor, all details have to
be presented. The same information about the debtors need
not be given in great detail, while sending the information to
the Registrar of companies.

57. 4. Convention of full Disclosure
• According to this principle all significant information about the
business should be disclosed.
• It means that any information of substance or of interest to the
average investors will have to be disclosed in the financial
statements.
• Ex. Liabilities of the business should be stated along with assets.