Financial Accounting (I B.Com)

1. SAIVA BHANU KSHATRIYA COLLEGE, ARUPPUKOTTAI.
Department of Commerce,
Dr. K. SUDHAGARAN M.Com., M.Phil., Ph.D., AssociateProfessor,
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FINANCIALACCOUNTING –BASICS
STUDY NOTES
BUSINESS TRANSACTION
 The activities that related with creation, development and management of business are
known as business transaction.
 The business transactions are the dealings of the business with itself, with its
customers, creditors, another business, government and with other third parties.
 Transaction involves transfer of money or money’s worth..
 Thus exchange of money, goods & services between the parties is known to have
resulted
in a transaction.
BOOKS OF ACCOUNTS
Transactions should be properly recorded in the appropriate note books. Such note
books are known as books of accounts or accounting records.
BOOK KEEPING
It is necessary to record all the transactions very systematically & scientifically so that
the financial relationship of a business with other persons may be properly understood, profit
& loss and financial position of the business may be worked out at a particular date. The
procedure to record all these transactions is known as “Book-keeping”.
In other words the book keeping may be defined as an activity concerned with the
recording of financial data relating to business operations in an orderly manner. Book
keeping is the recording phase of accounting.
“Book keeping is the science and art of correctly recording in the books of account of all
those business transactions that result in the transfer of money or money’s worth”
R.N.CARTER.
ACCOUNTING
Accounting is a systematic record of daily events of a business.
Accounting means the management which is concerned with the ascertaining and analyzing
of business results.
Accounting is based on an efficient system of book keeping.

2. Accounting is the analysis & interpretation of book keeping records. It includes not only the
maintenance of accounting records but also the preparation of financial & economic
information which involves the measurement of transactions & other events relating to entry.
“Accounting is the process of identifying, measuring and communicating economic
information to permit informed judgments and decision by users of information” – American
Accounting Association.
“ The art of recording, classifying and summarizing in a 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 ” – Institute of Certified Public Accountants.
ACCOUNTING vs BOOK KEEPING :
Points of Difference Book Keeping Accounting
1.object
To prepare original books
of accounts, trial balance and
final accounts.
To record, classify, summarise, analyse
and interpret the business
transactions
2. scope It has limited scope. It has a wide scope and covers book-
keeping plus analysis and interpretation.
3. Level of work
It is restricted to clerical
work and is done by lower
levels of management.
It is concerned with all levels of
management. Lower level, Medium
level, and Top level.
4. Mutual
dependence
It has to depend on
accounting for making the
accounting records more
useful..
It has depend on bookkeeping
for getting the required information for
making them useful planning, control
and decision making
5. Result of the
Business
It shows the net result and
financial position of the
business.
It analyses the operating results and
financial position of the business.

3. Objective of accounting
Aim of accounting.
l. To maintain accounting records.
2. To calculate the results of operation (either profit or loss).
3. To ascertain the exact financial(value) position of status.
4. To ascertain the growth of business.
5. To provide genuine information about the whole activities of the business to the owners.
6.To provide useful information to investors and creditors to take decision about
investment
and lending.
7. To provide information regarding accounting policies.
8. To effectively direct and control over all human and material resources.
9. To control over assets like building machines furniture etc.
10. To calculate the dues - To ascertain how much amount has to pay.
11. To cover over borrowing (liabilities).
l2. To make comparative study - Assessment of progress (present year with previous year).
13. To identify Do's and Don’ts by way of analysing.
14, To fix the selling price (Cost + profit)
15, To determine Tax (Sales tax, Income tax. etc.,)
16. To make use of information for the statutory requirement.
17. To produce accounts as evidence in courts.

4. Various terminology used in the Accounting
1) Assets: An asset may be defined as anything of use in the future operations of the
enterprise & belonging to the enterprise. E.g., land, building, machinery, cash etc.
2) Equity: In broader sense, the term equity refers to total claims against the enterprise. It is
further divided into two categories.
i. Owner’s Claim = Capital
ii. Outsider’s Claim = Liability
Capital: The excess of assets over liabilities of the enterprise. It is the difference between the
total assets & the total liabilities of the enterprise. e.g.,: if on a particular date the assets ofthe
business amount to Rs.1.00 lakhs & liabilities to Rs. 30,000 then the capital on that date
would be Rs.70,000/-.
Liability: Amount owed by the enterprise to the outsiders i.e. to all others except the owner.
e.g.,: trade creditor, bank overdraft, loan etc.
Accounting Equation : Assets = Equity That means,
Assets = Liabilities + Capital (or) Capital = Assets - Liabilities
3)Revenue: It is a monetary value of the products or services sold to the customers during
the period. It results from sales, services & sources like interest, dividend &commission.
4)Expense/Cost: Expenditure incurred by the enterprise to earn revenue is termed as
expense or cost. The difference between expense & asset is that the benefit of the former is
consumed by the business in the present whereas in the latter case benefit will be available
for future activities of the business. e.g., Raw material, consumables & salaries etc.
5)Drawings: Money or value of goods belonging to business used by the proprietor for his
personal use.
6)Owner: The person who invests his money or money’s worth & bears the risk of the
business.
7)Sundry Debtors: A person from whom amounts are due for goods sold or services
rendered or in respect of a contractual obligation. It is also known as debtor, trade debtor,
accounts receivable.
8)Sundry Creditors: It is an amount owed by the enterprise on account of goods purchased
or services rendered or in respect of contractual obligations. e.g., trade creditor, accounts
payable.

5. ACCOUNTING CYCLE
The following is the complete cycle of Accounting
a)The opening balances of accounts from the balance sheet & day to day business
transaction of the accounting year are first recorded in a book known as journal.
b)Periodically these transactions are transferred to concerned accounts known as ledger
accounts.
c)At the end of every accounting year these accounts are balanced & the trial balance is
prepared.
d) Then the final accounts such as trading & profit & loss accounts are prepared.
e)Finally, a balance sheet is made which gives the financial position of the business at the
end of the period.
Transaction  Journal  Ledger  Trial Balance 
Trading A/c  Profit & Loss a/c  Balance Sheet .
FUNCTIONS OFACCOUNTING IN AN ACCOUNTING CYCLE :
Accounting cycle refers to a complete sequence of accounting procedures. It also refers to
the functional order of the Accounting for a particular accounting period.
1. Identifying - It denotes the identification of the business transactions.
2.Recording - All transactions should be recorded in the Journal or books of original
entry
known as subsidiary books.
3. Classifying - All entries in the Journal should be posted to the appropriate.
4. Summarising - Next stage is to prepared trial balance and final accounts with a view to
ascertaining the profit or loss
.
5. Analysing - Analysing the obtained results is the next stages of accounting.
6. Interpreting - After analyzing the accounts the next stage is interpreting.
7. communicating - That results are communicated to all the departments.

6. CLASSIFICATION OFACCOUNTS :
ACCOUNTS
/
Personal
Impersonal
/
Real Nominal
Personal Accounts:
Accounts recording transactions relating to individuals or firms or company are known as
personal accounts. Personal accounts may further be classified as:
(i) Natural Person’s personal accounts:
The accounts recording transactions relating to individual human beings e.g.,Anand’s a/c,
Ramesh’s a/c, Pankaj a/c are classified as natural persons’personal accounts.
(ii) Artificial Persons’ Personal accounts:
The accounts recording transactions relating to limited companies,bank, firm, institution,
club, etc., Delhi Cloth Mill; M/s Sahoo & Sahoo; Hans Raj College; Gymkhana Club are
classified as artificial persons’ personal accounts.
(iii) Representative Personal Accounts:
The accounts recording transactions relating to the expenses and incomes are classified as
nominal accounts. But in certain cases (due to the matching concept of accounting) the
amount, on a particular date, is payable to the individuals or recoverable from individuals.
Such amount (i) relates to the particular head of expenditure or income and (ii)represent
persons to whom it is payable or from whom it is recoverable. Such accounts are classified as
representative personal accounts e.g., “wages outstanding account”, pre-paid Insurance
account, etc.
Real Accounts:
The accounts recording transactions relating to tangible things (which can be touched,
purchased and sold) such as goods, cash, building, machinery etc., are classified as tangible
real accounts. Whereas the accounts recording transactions relating to intangible things
(which do not have physical shape) such as goodwill, patents and copy rights, trade marks
etc., are classified as intangible real accounts.
Nominal Accounts:
The accounts recording transactions relating to the losses, gains, expenses and incomes e.g.
Rent, salaries, wages, commission, interest, bad debts etc., are classified as nominal accounts.

7. (Rules of debit and credit )ACCOUNTING RULES
1. Personal accounts : Debit the receiver
Credit the giver
2. Real accounts : Debit what comes in
Credit what goes out
3. Nominal accounts : Debit expenses and losses
Credit incomes and gains
USERS OF ACCOUNTING:
I Internal Users of Accounting Information:
The internal users comprise of owners, management and employees.
Owners: The sole trader or partners or shareholders who have provided the capital of a
business unit are interested in its performance and progress.
Management: Sole traders and partners usually manage their own business. But companies
are
managed by paid professionals.
Employees: The work force is interested in the profitability of the business which affects
their bonus, incentives and working conditions. Labour unions use the
accounting data their bargaining strategies with the management.
II. External Users of Accounting Information:
Various outside groups and individuals make use of accounting information for their own
purposes.
suppliers of goods and services, commercial banks, public deposit
Creditors &
Financiers:
holders ,
debenture holders etc., are included in this category.
Potential investors: Those who are interested in investing their surplus funds should know
about the financial condition of a business unit while making their
investment decisions.
consumers:
Tax authorities:
Those who use the products and services of a firm are interested in
knowing the justification for the prices charged to them.
Accounting information helps them in computing Sales tax.Income tax
etc., to be collected from business units.
Performance of business units in different industries helps theGovernment:
government
in policy formulation for development of trade and industry.
Research Scholars: The published financial statements are especially used by researches to
evaluate the performance of individual firms, industries, and trade.

8. ACCOUNTING CONCEPTS
1.Business Entity Concept:
This concept implies that the business is distinct from the owners. If the owner takes cash or
goods from the business, the drawings account is debited and cash or goods account is
credited otherwise the personal & business transactions will get mixed up and the accounting
statements become confused.
Assets = Liabilities + Capital
2.Money Measurement Concept:
All recording of accounting are done in terms of standard currency of the country where the
business is setup. All the transactions and events which are expressed in terms of money are
recorded in the books of account.
3.Cost Concept:
Usually all the transactions will be recorded as cost in books. However, at the end of every
year the accountant show the reduced value of the assets, after providing for depreciation.
This approach is preferred because it is difficult & time consuming to ascertain the market
values.
4.Dual Aspect Concept:
This concept explains that each transaction has two fold effect, the receiving of the benefit
the giving of the benefit. The receiving aspect is termed as debit and giving aspect is termed
as credit. For every debit there will be corresponding credit. A famous elictus says that every
receiver is also a giver and every giver also a receiver.
Liabilities (Equities) = Assets (Or) Capital + Outsider Liabilities = Assets
5.Going Concern Concept:
It is assumed that the business will continue for a long time. With this assumption fixed
assets are recorded in the books at their original cost. Keeping this assumption in view
prepared expenses are not treated as the expenses of the year in which they are incurred. It is
assumed that the business derives and benefit out of it in the year to come.
6.Material Concepts:
Under this concept the trader recording important about the commercial activities in the form
of financial statements. If any unimportant information is to be given for the sake of clarity. It
will be given as footnotes.
7.Matching Cost Concept:
The concept deals with matching of cost, first being the revenue recognition, determining net
income from business operations, all costs which are applicable to revenue of period should
be charged against that revenue.

9. ACCOUNTING CONVENTIONS
1.Conservation:
This convention warns the trader not to take unrealized income into account i.e., why the
practice of valuing stock at cost or market price whichever is lower is in vague. This is the
policy of playing safe. It takes into consideration all prospective losses but leaves all
prospective profits.
2.Consistency:
The methods or principles followed in the preparation of various accounts should be followed
in the year to come. It means that there should be consistency in the methods or principles
followed or else the results of one year cannot be continently compared with that of another.
3.Disclosure:
This concept deals with the convention that all information which is of material importance
should be disclosed in the accounting statements. The Company’s Act 1956 makes it
compulsory to provide all the information in the prescribed form.
SYSTEMS OF RECORDING
I. Single Entry System:
Under single entry system, only personal aspects of transactions are recorded.
This method takes no note of the impersonal aspects of the transactions other than cash.
This system ignores the two fold aspect of each transaction as considered in double entry
system.
It offers no check on the accuracy of the posting and no safeguard against fraud.
It does not provide any check over the recording of cash transactions. So it is called as
imperfect accounting.
II. Double entry system:
The double entry system was formulated by Lucas Pacioli,an Italian in the 15th century
(1494)
The double-entry book-keeping system is a scientific system of book-keeping. Double-entry
system has its own set of principles and rules. Under those principles and rules, two aspects
of every financial transaction are recorded.A systematic technique is followed in recording
financial transaction in double-entry book-keeping system. It records financial transactions in
a systematic and chronological order with suitable narration of the financial transaction.
Indian (Deshi Nama) system:
This is the Indian system. It differs from region to region; community to community and
from business to business. Under this system books are written in regional languages such as
Muriya, Sarafi etc. Books are called “Bahis”.It is older than double entry system and is
complete in itself.

10. Advantages of Single entry system
Single entry bookkeeping and accounting have the great advantage of simplicity over double
entry bookkeeping and accounting.
The single entry approach is readily understood by all people with little or no financial or
accounting background.
For many small companies, the single entry approach can be implemented without the
involvement of a trained bookkeeper or accountant.
The single entry approach does not require complex accounting software. Single entry system
can be created and maintained easily in a written notebook or a very simple spreadsheet.
Disadvantages of Single entry system
Single entry system is an incomplete system of recording financial transactions.
Single entry system is not based on the concept of duality.
Single entry accounting provides insufficient records and insufficient control.
Error checking system is absent in a single entry system.
Single entry system cannot ascertain the true financial position of the business.
Single entry system cannot ascertain the true amount of profit or loss of the business
Advantages of Double entry System
1)Scientific system: This system is the only scientific system of recording business
transactions. It helps to attain the objectives of accounting.
2) Complete record of transactions: This system maintains a complete record of all
business transactions.
3)A check on the accuracy of accounts: By use of this system the accuracy of accounting
book can be established through the device called a Trail balance.
4) Ascertainment of profit or loss: The profit earned or loss suffered during a period can be
ascertained together with details by the preparation of Profit and Loss account.
5)Knowledge of the financial position of the business: The financial position of the firm
can be ascertained at the end of each period, by the preparation of balance sheet.
6) Full details for purposes of control: This system permits accounts to be prepared or kept
in as much detail as necessary and, provides significant information for the purposes of
control etc.
7) Comparative study is possible: Results of one year may be compared with those of the
previous year and reasons for the change may be ascertained.
8)Helps management in decision making: The management may be also to obtain good
information for its work, especially for making decisions.
9) No scope for fraud: The firm is saved from frauds and misappropriations.
Disadvantages of Double entry System
•Double-entry bookkeeping system is complex and harder to understand.
•The overall cost of maintaining the double-entry system can be high, especially if
companies
have books of accounts maintained at different places.
•Significant amount of time is required to be spent on recording and maintaining double-
entry
books of accounts, as every entry needs to be entered twice and cross-checked.

11. •In case an entire financial transaction is not recorded in the books of accounts, the error of
omission cannot be detected and the trail balance will still tally despite the mistake.
Differences between Single entry and Double entry System
The following are the differences between single entry and double entry system:
1. Meaning
Single entry system is an incomplete system of recording financial transactions. Double entry
system is a complete system of recording and reporting financial transactions.
2. Duality
Single entry system is not based on the concept of duality. Double entry system is based on
the concept of duality.
3. Accounts
Single entry system maintains only personal accounts of debtors and creditors and cash book.
Double entry system all personal, real and nominal accounts.
4. Trial Balance
Single entry system can not prepare a trial balance and hence, arithmetical accuracy of books
of accounts can not be checked. Double entry system prepares trial balance and hence,
arithmetical accuracy of the books of accounts can bechecked.
5. Profit or Loss
Single entry system can not ascertain the true amount of profit or loss of the business as it
does not maintain nominal accounts. Double entry system ascertains true profit or loss of the
business as it maintains all nominal accounts.
6. Financial Position
Single entry system can not ascertain the true financial position of the business because it
does not maintain real accounts except cash book. Double entry system ascertains financial
position of the business as it maintains all personal and real accounts.
7. Suitability
Single entry system is suitable to a small business where only limited number of transactions
are performed. Double entry system is suitable for a large business.
8. Tax Purpose
Single entry system is not acceptable for the purpose of assessment of tax. Double entry
system is acceptable for the purpose of assessment of tax.