The document discusses key concepts in financial accounting including accounting definitions, functions, principles, statements, and accounts. It provides details on accounting processes like recording, classifying, summarizing transactions, and analyzing financial data to interpret business performance and financial position. The main financial statements - trading account, profit and loss account, and balance sheet - are introduced as outputs of the accounting system that communicate results to stakeholders.

1. FINANCIAL ACCOUNTING
Accounting is a business language which elucidates the various kinds of transactions during
the given period of time.
Accounting is referred as “The Language of Business”. The basic function of a
language is to communicate others. Here, Accounting performs this function. It communicates
the result of business operations to the various parties viz., the proprietor, creditors, investors,
Government and other agencies.
American Institute of Certified Public Accountants Association (AICPA) defines the term
accounting as "Accounting is the process of recording, classifying, summarizing in a
significant manner of transactions which are in financial character and finally results are
interpreted."
An analysis of the definition brings out the following functions of accounting:
1. RECORDING:
Recording is done in the book of journal.
2. CLASSIFYING:
Classification is concerned with the systematic analysis of the recorded data,
With a view to group transactions or entries of similar nature. The work of
classification is done in the book termed as “LEDGER”
3. SUMMARIZING:
After classifying the data, the process of summarizing leads to the
preparation of the following statements:
 Trail balance
 Income statement
 Balance sheet
4. DEALS WITH FINANCIAL TRANSACTIONS:
Accounting records only those transactions and events in terms of money
which are of a financial character. Transactions which are not of a financial
character are not recorded in the books of account.
5. ANALYSIS AND INTERPRETS:
The recorded financial data is analyzed and interpreted in a manner that the
businessman can make a meaningful judgment about the financial position
and profitability of the business operations.
6. COMMUNICATES:
The accounting information are communicated by way of preparation and
distribution of accounting reports, income statement, balance sheet,
accounting ratios, graphs, diagrams and fund flow statement, etc.
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2. Accounting is a combination of various functions
RECORDING
CLASSIFYING
SUMMARIZING
DEALS WITH FINANCIAL
TRANSACTIONS
ANALYSIS & INTERPRETS
COMMUNICATES
Qualities of Accounting:
 In accounting, transactions which are non- financial in character cannot be recorded
 Transactions are recorded either individually or collectively according to their groups.
 Users should be able to make use of information.
UTILITY OF THE FINANCIAL STATEMENTS
The financial statements are found to be more useful to many people immediately after
presentation only in order to study the financial status of the enterprise in the angle of their own
objectives.
 To Management
 To Shareholders, Security Analysts and Investors
 To Lenders
 To Suppliers
 To Customers
 To Govt., and Regulatory Authorities
 To Promote Research and Development
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3. To Management
The financial statements are most inevitable (unavoidable) for the management to take rational
decisions to maintain the sustainability in the business environment among the other competitors.
To Shareholders, Security Analysts and Investors
The information extracted from the financial statements are processed by the above mentioned
people to identify not only the financial status but also to determine the qualities of getting appropriate
rate of return out of the prospective investment.
To Lenders
The lenders do study about the business enterprise through the available information of its
financial statements normally before lending. The aim of the study is to analyze the status of the firm for
the worthiness of lending with reference to the payment of interest periodicals and the repayment of the
principal.
To Suppliers
The suppliers are in need of information about the business fleeces before sale of goods on credit.
The Suppliers are very cautious in supplying the goods to the business houses based on the various
capacities of themselves. The most important capacity required as well as expected from the buyer firms
is that prompt repayment of dues of the credit purchase from the suppliers. This quality of prompt
payment could be known through culling out the information from the balance sheet. It mainly plays
pivotal role in answering the status inquiries about the buyer
To Customers
The legal relationship of the transferability of ownership of the products is obviously understood
through financial information available in the statements. The agreement of warranty and guarantee is
tested through the financial status of the enterprise.
To Govt., and Regulatory Authorities
The taxes to be paid to the central and state govts on the revenues only through presentation of
information.
To Promote Research and Development
For research and development, the amount of investment required is voluminous, which has to be
mobilized from either internally or externally to the requirement of the future prospects of the enterprise.
OBJECTIVES OF ACCOUNTING
 To keep systematic records
 To protect the business operations from the loss
 To ascertain the operational profit or loss
 To ascertain the financial position of the business
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4. ACCOUNTING PRINCIPLES
The transactions of the business enterprise are recorded in the business language, which routed
through accounting. The entire accounting system is governed by the practice of accountancy. The
accountancy is being practiced through the universal principles which are wholly led by the concepts and
conventions.
The entire principles of accounting are on the constructive accounting concepts and conventions
Accounting Concepts Accounting Conventions
Accounting Principles
ACCOUNTING CONCEPTS
The following are the most important concepts of accounting:
 Money Measurement concept
 Business Entity concept
 Going Concern concept
 Matching concept
 Accounting Period concept
 Duality or Double Entry concept
 Cost concept
Money Measurement Concept
This is the concept tunes the system of accounting as fruitful in recording the transactions and
events of the enterprise only in terms of money. The money is used as well as expressed as a denominator
of the business events and transactions. The transactions which are not in the expression of monetary
terms cannot be registered in the book of accounts as transactions.
 Recording of transactions are only in terms of money in the process
Business Entity Concept
This concept treats the owner as totally a different entity from the business. To put in to nutshell
"Owner is different and Business is different". The capital which is brought inside the firm by the owner,
at the commencement of the firm is known as capital. The amount of the capital, which was initially
invested, should be returned to the owner considered as due to the owner; who was nothing but the
contributory of the capital.
 Owner and business organizations are two separate entities
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5. Going Concern Concept
The concept deals with the quality of long lasting status of the business enterprise irrespective of the
owners' status, whether he is alive or not. This concept is known as concept of long-term assets. The fixed
assets are bought in the intention to earn profits during the season of the business. The assets which are
idle during the slack season of the business retained for future usage, in spite of that those assets are
frequently sold out by the firm immediately after the utility leads to mean that those assets are not fixed
assets but tradable assets. The fixed assets are retained by the firm even after the usage is only due to the
principle of long lastingness of the business enterprise. If the business disposes the assets immediately
after the current usage by not considering the future utility of the assets in the firm which will not
distinguish in between the long-term assets and short-term assets known as tradable in categories.
 Accounting concept for long lastingness of the business enterprise
Matching Concept
This concept only makes the entire accounting system as meaningful to determine the volume of
earnings or losses of the firm at every level of transaction; which is an outcome of matching in between
the revenues and expenses. The worth of the transaction is identified through matching of revenues which
are mainly generated from the sales volume and the expenses of the firm at every level.
 Concept of fusion in between the expenses and revenues
Accounting Period Concept
Though the life period of the business is longer in span, which is classified into the operating periods
which are smaller in duration. The accounting period may be either calendar year of Jan-Dec or fiscal
year of April-Mar. The operating periods are not equivalent among the trading firms, which means that
the operating period of one firm may be shorter than the other one. The ultimate aim of the concept is to
nullify the deviations of the operating periods of various traders in the trading practice.
According to the Companies Act, 1956, the accounting period should not exceed more than 15
months.
 Concept of uniform accounting horizon among the firms to evade deviations
Duality or Double entry accounting concept
It is the only concept which portrays the two sides of a single transaction. The law of entire
business revolves around only on mutual agreement sharing policy among the players.
 Concept of mutual agreement and sharing of benefits
Cost Concept
It is the concept closely relevant with the going concern concept. Under this concept, the
transactions are recorded only in terms of cost rather than in market value. Fixed assets are only entered
in terms of the purchase price which is a original cost of the asset at the moment of purchase. The
depreciation is deducted from the original value which is the initial purchase price of the asset will
highlight the book value of the asset at the end of the accounting period.
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6. ACCOUNTING CONVENTIONS
Accounting conventions are bearing the practical considerations in recording the transactions of the
business enterprise in systematic manner.
Convention of consistency
Convention of conservatism
Convention of disclosure
Convention of consistency
The nature of recording the transactions should not be changed at any cause or moment. It should
be maintained throughout the life period of the firm. If a firm follows the straight line method of charging
the depreciation since its inception should be followed without any change. The firm should not alter the
method of charging the depreciation from one method to another. The change cannot be entertained. If
any change has to be incorporated, the valid reason for change should be emphasized.
Convention of conservatism
The conservatism won’t give any emphasis on the anticipation of the firm; instead it gives paramount
importance to all possible un eventualities of the firm without considering the future profits.
Convention of disclosure
According to this convention, the entire status of the firm should be highlighted / presented in detail
without hiding anything; which has to furnish the required information to various parties involved in the
process of the firm.
BRANCHES OF ACCOUNTING
Accounting may be classified mainly into THREE categories; viz;
 Financial accounting
 Management accounting
 Cost accounting
FINANCIAL ACCOUNTING
Financial accounting is concerned with the recording of transactions for a business
enterprise or other economic unit and the periodic preparation of various reports from such
records. The reports may be for general purpose or specific purpose. The reports provide useful
information for the owners, share holders, creditors, banks and other agencies.
MANAGEMENT ACCOUNTING
It is accounting for the management i.e., accounting which provides necessary
information to the management for discharging its function.
Management accounting is the application of professional information in such a way as to
assist the management in the formation of policies and in the planning and control of the
operations of the business.
COST ACCOUNTING
Cost accounting emphasizes the determination and the control of costs. It is concerned
with the cost of manufacturing process and of manufactured products and also giving importance
of distribution costs.
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7. Classification of Accounts:
The entire process of accounting brought under three major segments; which are broadly grouped
into two categories.
The entire accounts of the enterprise are broadly classified into two categories viz.; Personal
Accounts and Impersonal Accounts. The Impersonal accounts are further classified into two categories
viz.; Real accounts and Nominal accounts.
ACCOUNTS
PERSONAL ACCOUNTS IMPERSONAL ACCOUNTS
REAL ACCOUNTS NOMINAL ACCOUNTS
Personal Accounts
It is an account which deals with a due balance either to or from these individuals on a particular
period. It is an account normally reveals the outstanding balance of the firm to individuals e.g. suppliers
or outstanding balance from individuals e.g. customers. This is the only account which emphasizes the
future relationship in between the business firm and the individuals
.
Real Accounts
It is a major classification which highlights the real worth of the assets. This is the account
especially deals with the movement of assets. It is an account not only reveals the value and movement of
the assets taking place in between the firm and also other parties due to any transactions.
Nominal Accounts
This is an account deals with the amount of expenses incurred or incomes earned. It includes all
expenses and losses as well as incomes and gains of the enterprise. This nominal account records the
expenses and incomes which are not carried forwarded to near future.
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8. ACCOUNTING RULES
PERSONAL Debit the Credit the
ACCOUNTS Receiver Giver
REAL Debit What Credit What
ACCOUNTS comes in goes out
NOMINAL Debit all the
expenses
Credit all
incomes
ACCOUNTS and losses and gains
JOURNAL ENTRY
It is an entry systematically recorded to the tune of golden rules of accounting in the journal book
is known as journal entries.
TRIAL BALANCE
The statement (summary) of accounting balances and their names for the specified accounting
period to the tune of principle of grouping transactions, known as Trial Balance.
Trial Balance is a list of accounting balances and their names; of the enterprise during the
specified period which includes debit and credit balances of the various balanced ledger accounts out of
the journal entries.
Purposes of preparing the Trial Balance:
 To prepare a statement of disclosure of final accounting balances of various ledger accounts on a
particular date
 To prepare a statement of cross checking device of accounting while in the process of posting of
entries which mainly on the basis of Double entry accounting principle. It facilitates the
accountant to have systematic posting of entries
 It facilitates the enterprise for the preparation of Trading & Profit and Loss Accounts for the year
ended…………….. and the Balance sheet as on dated ………………..
 It provides the birds' eye view of accounting balances of various ledger accounts during the
specified period.
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9. TRADING ACCOUNT
This is first financial statement prepared by the owner of the enterprise to determine the gross profit
during the year through the matching concept of accounting.
The gross profit of the enterprise is calculated through the comparison of purchase expenses,
manufacturing expenses, and other direct expenses with the sales.
It is prepared normally for one year in accordance with accounting period concept i.e., operating cycle of
the enterprise which should not exceed 15 months with reference to the Companies Act 1956.
PROFIT & LOSS ACCOUNT
It is a second statement of accounting in connection with the earlier to determine the Net
profit/loss of the enterprise out of the early found Gross profit/loss. This is an accounting statement
matches the administrative, selling and distribution expenses with the gross profit and other incomes of
the enterprise.
This is an account prepared for one operating cycle of the firm i.e. 12 months in period. The transactions
are recorded in accordance with golden rules of nominal account. In the profit & loss account, the
expenses and losses are debited and incomes and gains are credited. The reason for bringing down the
gross loss /gross profit of the trading account into the debit and credit side of Profit & Loss A/c
respectively, are only to the tune of nominal accounting ruling with reference to debit all expenses and
losses and credit all incomes and gains.
BALANCE SHEET
Balance sheet is the third financial statement which reveals the financial status of the enterprise
through the total amount of resources raised and applied in the form of assets. This is the fundamental
statement of the firm which explores the firm financial stature through the resources mobilized and
investments applied i.e. Liabilities and Assets respectively. From the early, according to double entry
concept or Duality concept, the balance sheet can be divided into two distinct sides, known as liabilities
and assets.
Account: A record that holds the results of financial transactions.
Accountant's Equation: The equation that is the basis of the Balance Sheet: Assets =
Liabilities + Owners' Equity.
Accounting: A service that oversees, measures, and evaluates financial information for decision
making purposes.
Accounts Payable: Amounts due from your business to your creditors. Generally these are short
term liabilities (30-120 days), and are shown under the Current Liabilities section in the Balance
Sheet.
Amount owed to a CREDITOR for delivered goods or completed services.
Accounts Receivable: Amounts due to your business from your customers. Generally these
amounts are short term receivables (30-120 days), and are shown under Current Assets section in
the Balance Sheet.
Claim against a DEBTOR for an uncollected amount, generally from a completed
transaction of sales or services rendered.
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10. Bad Debt: An uncollectible Account Receivable.
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).
Bank Reconciliation: Verification that your bank statement and your checkbook balance.
Bad Debt: All or portion of an ACCOUNT, loan, or note receivable considered to be
uncollectible.
Balance Sheet: Basic financial statement, usually accompanied by appropriate disclosures that
describe the basis of accounting used in its preparation and presentation of a specified date the
entity's assets, liabilities and the equity of its owners. Also known as “statement of financial
condition”.
Bond: One type of long term promissory note, frequently issued to the public as a security
regulated under federal securities laws or state blue sky laws. Bonds can either be registered in
the owner's name or are issued as bearer instruments.
Book Value: Amount, net or contra account balances, that an asset or liability shows on the
balance sheet of a company. also known as carrying value.
Budget: Financial plan that serves as an estimate of future cost, revenues or both.
Current Asset: Asset that one can reasonably expect to convert into cash, sell, or consume in
operations within a single operating cycle, or within a year if more than one cycle is completed
each year.
Current Liability: Obligation whose liquidation is expected to require the use of existing
resources classified as current assets, or the creation of other current liabilities.
Depreciation: Expense allowance made for wear and tear on an asset over its estimated useful
life.
Intangible Asset: Asset having no physical existence such as trademarks and patents.
Inventory: Tangible property held for sale, or materials used in a production process to make a
product.
Investment: Expenditure used to purchase goods or services that could produce a return to the
investor.
Journal: Any book containing original entries of daily financial transactions.
Ledger: Any book of accounts containing the summaries of debit and credit entries.
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11. Lease: Conveyance of land, buildings, equipment or other assets from one person (lessor) to
another (lessee) for a specific period of time for monetary or other consideration, usually in the
form of rent.
Leasehold: Property interest a lessee owns in the leased property.
Ledger: Any book of accounts containing the summaries of debit and credit entries.
Lessee: Person or entity that has the right to use property under the terms of a lease.
Lesser: Owner of property, the temporary use of which is transferred to another (Lessee) under
the terms of a lease.
Letter of Credit: Conditional bank commitment issued on behalf of a customer to pay a third
party in accordance with certain terms and conditions. The two primary types are commercial
letters of credit and standby letters of credit.
Liability: debts or obligations owed by one entity (debtor) to another entity (creditor) payable in
money, goods, or services.
Liquid Assets: Cash, cash equivalents, and marketable securities.
Liquidation: Winding up an activity by distributing its assets to the appropriate parties and
settling its debts.
Long-Term Debt: Debt with a maturity of more than one year from the current date.
Loss: Excess of expenditures over revenue for a period or activity.
Margin: Excess of selling price over the unit cost.
Marketable Securities: Stocks and other negotiable instruments which can be easily bought and
sold on either listed exchanges or over the counter markets.
Prepaid Expense: Cost incurred to acquire economically useful goods or services that are
expected to be consumed in the revenue earning process within the operating cycle.
Tangible Asset: Assets having a physical existence, such as cash, land, buildings, machinery, or
claims on property, investments or goods in process.
Working Capital: Excess of current assets over current liabilities.
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12. Assets: Economic resources owned or controlled by a person or company. An Asset is a property
of value owned by a business. Physical objects and intangible rights such as money, accounts
receivable, merchandise, machinery, buildings, and inventories for sale are common examples of
business assets as they have economic value for the owner. Accounts receivable is an unwritten
promise by a client to pay later for goods sold or services rendered.
Assets are generally listed on a balance sheet according to the ease with which they can
be converted to cash. They are generally divided into three main groups:
 Current
  Fixed
  Intangible
Current Asset
A current asset is an asset that is either:
 Cash – includes funds in checking and savings accounts
 Marketable securities such as stocks, bonds, and similar investments
 Accounts Receivables, which are amounts due from customers
  Notes Receivables, which are promissory notes bycustomers to pay a definite
sum plus interest on a certain date at a certain place.
 Inventories such as raw materials or merchandise on hand
 Prepaid expenses – supplies on hand and services paid for but not yet used (e.g.
prepaid insurance)
In other words, cash and other items that can be turned back into cash within a year are
considered a current asset.
Fixed Assets
Fixed assets refer to tangible assets that are used in the business. Commonly, fixed assets
are long-lived resources that are used in the production of finished goods. Examples are
buildings, land, equipment, furniture, and fixtures. These assets are often included under the title
property, plant, and equipment that are used in running a business. There are four qualities
usually required for an item to be classified as a fixed asset. The item must be:
 Tangible
  Long -lived
  Used in the business
  Not be available for sale
Certain long-lived assets such as machinery, cars, or equipment slowly wear out or
become obsolete. The cost of such as assets is systematically spread over its estimated useful
life. This process is called depreciation if the asset involved is a tangible object such as a
building or amortization if the asset involved is an intangible asset such as a patent. Of the
different kinds of fixed assets, only land does not depreciate.
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13. Intangible Assets
Intangible Assets are assets that are not physical assets like equipment and machinery but
are valuable because they can be licensed or sold outright to others. They include cost of
organizing a business, obtaining copyrights, registering trademarks, patents on an invention or
process and goodwill. Goodwill is not entered as an asset unless the business has been
purchased. It is the least tangible of all the assets because it is the price a purchaser is willing to
pay for a company’s reputation especially in its relations with customers.
Liabilities
A Liability is a legal obligation of a business to pay a debt. Debt can be paid with money,
goods, or services, but is usually paid in cash. The most common liabilities are notes payable and
accounts payable. Accounts payable is an unwritten promise to pay suppliers or lenders specified
sums of money at a definite future date.
Current Liabilities
Current liabilities are liabilities that are due within a relatively short period of time. The
term Current Liability is used to designate obligations whose payment is expected to require the
use of existing current assets. Among current liabilities are accounts payable, notes payable, and
accrued expenses. These are exactly like their receivable counterparts except the debtor-creditor
relationship is reversed.
Accounts Payable is generally a liability resulting from buying goods and services on
credit
Suppose a business borrows $5,000 from the bank for a 90-day period. When the
money is borrowed, the business has incurred a liability – a Note Payable. The bank may
require a written promise to pay before lending any amount although there are many credit
plans, such as revolving credit where the promise to pay back is not in note form.
On the other hand, suppose the business purchases supplies from the ABC Company for
$1,000 and agrees to pay within 30 days. Upon acquiring title to the goods, the business has a
liability – an Account Payable – to the ABC Company.
In both cases, the business has become a debtor and owes money to a creditor. Other
current liabilities commonly found on the balance sheet include salaries payable and taxes
payable.
Another type of current liability is Accrued Expenses. These are expenses that have been
incurred but the bills have not been received for it. Interest, taxes, and wages are some examples
of expenses that will have to be paid in the near future.
Long-Term Liabilities
Long term liabilities are obligations that will not become due for a comparatively long
period of time. The usual rule of thumb is that long-term liabilities are not due within one year.
These include such things as bonds payable, mortgage note payable, and any other debts that do
not have to be paid within one year.
You should note that as the long-term obligations come within the one-year range they
become Current Liabilities. For example, mortgage is a long-term debt and payment is spread
over a number of years. However, the installment due within one year of the date of the balance
sheet is classified as a current liability.
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14. Capital
Capital, also called net worth, is essentially what is yours – what would be left over if
you paid off everyone the company owes money to. If there are no business liabilities, the
Capital, Net Worth, or Owner Equity is equal to the total amount of the Assets of the business.
Financial Statements
In order to manage your business effectively you need reports that tell you how your
business is performing. For example, you may want to know the value of your assets like, Cash
you have on hand, Cash in bank, and Inventory in stock. In addition, you would like to know the
value of your liabilities, loans, income earned, and expenses incurred. Accountants prepare
financial statements that summarize these transactions. Two of the most important reports for
managing your business are Income Statement and the Balance Sheet.
INCOME STATEMENT
An Income Statement is also called a Profit and Loss Report. In addition, the word
Revenue is often used in place of the word Income. An Income Statement is used to inform you
about the income earned, expenses incurred, and the total profit or loss in a particular period.
Two common periods for creating an income statement are monthly and annually.
This report summarizes all Income (or sales), the amounts that have been or will be
received from customers for goods delivered or services rendered to them, and all expenses, the
costs that have arisen in generating revenues. To show the actual profit or loss of a company, the
expenses are subtracted from the revenues to show the net income – profit or the “bottom line”.
BALANCE SHEET
A Balance sheet is like a “snapshot” that gives you the overall picture of the financial
health of a company at one moment in time. This report lists the assets, liabilities, and owner’s
equity in the business. Unlike the income statement, this report is always created to show the
financial status as of a certain date. Two common ending periods to create a balance sheet are the
end of a month and the end of the year.
The Balance Sheet has two sections. The first section lists all the Asset accounts and their
balances. At the end of the list, the totals of all assets are listed. In the second section, the
Liability and Owner’s Equity accounts are listed. There are two sub-totals for the Liability and
the Equity accounts. At the end, there is a combined total of the Liabilities and Owner’s Equity.
As discussed earlier in the accounting equation, the Assets equal the sum of the Liabilities and
the Equities. You will also notice that the Profit from the income statement is listed in the Equity
section of the balance sheet. Some of the important accounts in the balance sheet are:
Current Assets:
Current assets are always listed first and include cash and other items that can be
converted into cash within the following year. This includes funds in checking and savings
accounts.
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15. Accounts Receivable:
Accounts Receivable represents money owed to the business. These usually result from
the sale of merchandise or performance of services for a client on account. The phrase on
account indicates that on the date the goods were sold to the client, or the service performed for
him, the business did not receive full payment. However, it did obtain an asset – the right to
collect payment for merchandise sold or Services performed. The claim a business has against a
credit client is referred to as an Account Receivable. It is an asset because it represents a legal
claim to cash.
Inventory:
Inventories may represent merchandise purchased for resale as well as the raw materials
acquired by a manufacturing firm to put into the product. In the case of a manufacturer, the term
inventories also includes manufacturing supplies, purchased parts, the work that is in process,
and finished goods. Inventory is also an asset account.
Accounts Payable:
When you purchase goods or services on account, you are usually required to pay within
a fixed period of time. These amounts you owe for the goods or services purchased are called
accounts payable. The payment of these purchases is usually due within a relatively short period
of time. Usually this period is one year or less. Typical periods are thirty to sixty days. The
payment for these short-term liabilities requires the use of existing resources like the Cash or The
Checking Account.
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