FOUNDATIONS OF ACCOUNTING

1.INTRODUCTION TO ACCOUNTING
2.BASIC RULES OF ACCOUNTING
3.ACCOUNTING PROCESS
4.INTRODUCTION TO BASIC FINANCIAL STATEMENTS

BY
ACA BHUVANA
CA,CMA,CGMA,M.COM

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HISITORY OF ACCOUNTING
 In India, Chanakya in his Arthashastra has emphasized the existence and need
of proper accounting and auditing.
 Luca Pacioli who is regarded as ‘Father of Accounting’.
 He described the double entry accounting systems,by emphasising debit
must equal credit.
 In recent years changes in technology have also brought a remarkable change
in the field of accounting. The concept of accounting has changed.
 This history is written mostly in quantitative terms.
 Accounting is the language of the business.
 The basic function of a language is to serve as a means of communication.
 Accountings also service this function.
 It communicates the results of the business operations to various parties who
have some stake in the business viz., the proprietor, creditors, investor,
Government and other agencies.(Stakeholders) .

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 NEED FOR ACCOUNTING
 The person who is running the business must know.
 What he owns
 What he owes
 Whether he has earned a profit or suffered a loss on account of running business?
 What is his financial position i.e., is whether he will be in a position to meet all his
commitments in the near future or he is in process of becoming bankrupt.

 For example, a housewife has to keep a record of the money received and spent by her
during a particular period.
 Such record will help her in knowing about:
 The sources from which she received cash and the purpose for which it was utilised.
 Weather her receipts are more than her payment or vice-versa (R>P)
 The balance of cash in hand or deficit, if any at the end of a period.

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 IMPORTANCE OF ACCOUNTING
 Accounting provides valuable financial information that enables us to make informed
and better decisions.
 You need to know your financial position before you would be able to spend wisely.
 You need to determine your Net income = All Income -All expenses.
 According to Gandhi, you will be able to manage your money by keeping track of it.
 Similarly for business, they need accounting information to help them run their business
effectively and efficiently.
 Proper financial information helps business to take the right decisions.
 It helps to
 maintain its own records of business
 monitor the business activities
calculate profit or loss for a given period
fulfill legal obligations
show financial position for a given period
communicate the information to the interested parties(Stake holders).

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MEANING AND DEFINITION OF ACCOUNTING
 It is the process of recording financial transactions pertaining to a business.
The accounting process includes summarizing, analyzing and reporting these
transactions to users of financial information.
There are four components in accounting
 Recording written records of journalising and posting business transactions;
 Summarising - preparing the financial statements;
 Analysing - examining the results to determine the financial position and
performance; and
 Interpreting - using the financial statements to make judgments and decisions.
 The accounting systems process inputs into outputs of financial statements (e.g.
Income Statement and Balance Sheet).

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BASIC FINANCIAL STATEMENTS
There are four basic financial statements.

1) Statement of profit or loss: Statement of profit or loss reports the

financial performance of an entity in the form of revenues and expenses
including the profit and loss of the business entity, it is also called as
income statement.
2) Balance Sheet: Balance Sheet reports the financial position of a
business entity. It contains information on the entity’s assets, liability and
owner’s equity.
3)Statement of Changes in Owner’s Equity: Statement of changes in
owner’s equity reports how the owner’s equity has changed over the
reporting period. It reports how opening capital has increased through
net income, and how it decreased through net losses and drawings.
4) Cash Flow Statement: Cash flow statements show the in-flow and
out-flow of cash of an organisation according to three main activities
which are operating, investing and financing.

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ELEMENTS OF FINANCIAL STATEMENTS
 The Financial Statements contain five main elements
and these five elements of financial statements are:
1. Assets,
2. Liabilities,
3. Equities,
4. Revenues, and
5. Expenses

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1. Assets:
These are the resources owned and control by the entity as the result of past events and
from which the future economic benefits are expected to flow the entity.
Examples are: Land &Building; Cash Balance; Bank Balance, Closing stocks etc.
2. Liabilities:
These are the present obligations arising from the past events, the settlement of which is
expected to result in an outflow from entity resources embodying economic benefit.
Examples are: Bank Loan, Bank overdraft, Tax payable, salaries payable etc.
3. Owner’sEquity:
It represents the shareholders stake in the company ,identified on a company balance
sheet.
Owner’s equity = Assets – Liabilities
4.Revenue : This is increase in the economic benefits during the accounting period in
the form of inflows or enhancements of assets or decrease of liabilities that result in
increases in equity, other than those relating to contributions from equity participants.
Examples are: Revenues from sale of goods or services, interest incomes from banks.
5.Expenses: Operating Expenses or Administration Expenses
These are the decreased in economic benefits during the accounting period in the form
of outflows or depreciation of assets or incurred of liabilities that result in decreases in
equity, other than those relating to distributions to equity participants.
Examples are: Cost of goods sold; Salaries expenses; Depreciation; Interest Expenses;
Tax expenses; Utility expenses; Transportation Cost; Marketing Expenses; Rental
Expenses etc 8
.
Other glossary of accounting:

Accounting period: The period for which accounts are maintained. Normally it is a
period of one year.
Account: Financial record in T shaped format, under double entry bookkeeping dealing
with financial transactions. It shows the summary of transaction relating to a asset, a
expense, a revenue, a person etc
Debit side: the left side of the account
Credit side: the right side of the account
Double entry bookkeeping: A system of maintaining accounts where every debit will
have an equal and opposite credit. It means for every debit there should be a
corresponding credit
Transactions: Involves exchange of money or Money’s worth between two parties. They
may be cash transaction or credit transactions
Journal: The first book in which transactions are recorded as they take place in a
chronological order. It is also called daybook. Recording entries in Journal is called
journalizing.

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Assets: All such items that have value are known as assets. Assets refer to what a
business owns, namely its plant, machinery, furniture, land and so on. Assets maybe
tangible or intangible
Current assets: Assets that are expected to be realized in cash within the accounting
period or expected to be consumed during business operation. For example cash in
hand, cash at Bank, stock, debtors, expenses paid in advance( prepaid expenses),
incomes yet to be received, short term Investments, bills receivables and so on .
Debtors: Debtors are those who owe to the business. These arise during credit sales.
Debtors are part of current assets.
Creditors: Creditors are those to whom the business owes money. These arise during
credit purchases. Creditors are the part of current liabilities.
Capital: The amount contributed by the owners of the business.
Liabilities: What the firm owes to outsiders.
Bill payables: The acceptance given to the suppliers of goods or other business parties
to pay an agreed amount of money
Overdraft: The facility sanctioned by a Banker to a customer to draw more than what is
available in the account, subject to a maximum limit.
Accrued or Outstanding expenses: The expenses that are incurred but not paid for.
Ex .Outstanding salaries or rent.
Current Liabilities: Those amounts which are payable in the in the near future
(generally less than a year). For example, creditors, bills payables, bank overdraft and
outstanding expenses.
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Sales: The value of goods and services sold during a given accounting period. Sales
may be cash or credit.
Sales returns: The goods returned by customer with a complaint about damage or
defect. Sales returns are also called return inwards .
Net sales: Sales minus sales returns( net sales= sales- sales returns)
Purchases: Value of goods or services purchased during a given accounting period.
Purchase returns: Goods returned by the firm to the suppliers of goods with a
complaint. purchase returns are also called return outwards.
Net purchases: Total purchase minus purchase returns. (Net purchases= purchases -
purchase returns)
Drawings: The money drawn by the owner from his funds invested as capital in the
business of a firm. It may also refer to the value of goods used by the owner for his
personal use.
Revenue expenditure: The expenditure incurred on day to day running of the
business, including the expenditure to maintain the assets of the business Ex: wages,
salaries, rent for factory, insurance, depreciation etc.
Revenue receipts: Receipts from customers for the goods supplied or fee received from
them towards the services provided to them in the ordinary course of business. Ex: Rent
received, Commission received etc.
Capital expenditure: The expenditure incurred to acquire a asset, tangible or
intangible.
Capital receipts: The receipts from owners of the business. Also include proceeds from
sales of fixed assets such as machinery or furniture.
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 QUIZ

1.Another name for the balance sheet is

Statement Of Operations Statement Of Financial Position

2.The balance sheet heading will specify a

Period Of Time Point In Time

3.Which of the following is a category or element of the balance sheet?

Expenses Gains
Liabilities Losses

4.Which of the following is an asset account?

Accounts Payable Prepaid Insurance Unearned Revenue

5.What is the normal balance for an asset account?

Debit Credit

6.What is the normal balance for liability accounts?

Debit Credit

7.What is the normal balance for stockholders' equity and owner's equity
accounts?
DebiT Credit 12
8.What is the normal balance for contra asset accounts?
Debit Credit

9.Which of the following would not be a current asset?

Accounts Receivable Land
Prepaid Insurance Supplies

10.Which of the following would normally be a current liability?

Note Payable Due In 5 Years Trade payables

11.The third line of the balance sheet at the end of the year should
begin with "For the Year Ended".
True False

12.Which of the following is NOT a revenue account?

Advertising rent received
insurance rebate commission received

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13.How is net profit calculated?
gross profit - expenses
gross profit + expenses
cost of goods sold + expenses
sales – expenses

14.If a company has sales of $50,000 and cost of goods sold of $44,000.
How much is gross profit?
$60,000
$6,000
$94,000
$4,000

15.Which of the following appears in both the TPL and Balance Sheet?
opening stock
closing stock

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