20ME803- Financial Management & Engineering Economics

Module-2

Accounting & Accounting Principles

1. Meaning and Scope of Accounting- Accounting is the language of business. The main
objective of accounting is to safeguard the interests of the business, its proprietors and
others connected with the business transactions. This is done by providing suitable
information to the owners, creditors, shareholders, Government, financial institutions, and
other related agencies.

2. Definition of Accounting- The American Accounting Association defines accounting as

"the process of identifying, measuring and communicating economic information to permit
informed judgements and decisions by the users of the information." According to AICPA
(American Institute of Certified Public Accountants) it is defined as "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 result
thereof."

3. Steps of Accounting- The following are the important steps to be adopted in the
accounting process:
I. Recording: Recording all the transactions in subsidiary books for the purpose of
future record or reference. It is referred to as "Journal."
II. Classifying: All recorded transactions in subsidiary books are classified and posted
to the main book of accounts. It is known as "Ledger."
III. Summarizing: All recorded transactions in the main books will be summarized for
the preparation of Trail Balance, Profit and Loss Account and Balance Sheet.
IV. Interpreting: Interpreting refers to the explanation of the meaning and
significance of the result of financial accounts and balance sheet so that parties
concerned with business can determine the future earnings, ability to pay interest,
liquidity, and profitability of a sound dividend policy.

4. Purpose of Accounting- The basic objectives of accounting are to find out the operational
results (Profit or Loss) and financial position of the organization. Through accounting, the
required records are maintained to achieve the above objectives. Accounting is done to
keep a systematic record of all the financial transactions. It is virtually not possible to
remember all financial transactions. Many think the role of accounting is limited to
recording transactions in books of accounts. With the pace of computerization, the role of
accounting for recording the transactions has diminished. Importance of analysis of
accounts, along with control and achievement of the objectives of the firm has occupied
more importance. Now a days, the combined role of accounting and finance has assumed
more importance than the individual role of accounting.

5. Definition of Bookkeeping- Bookkeeping may be defined as "the art of recording the

business transactions in the books of accounts in a systematic manner." A person who is
responsible for and who maintains and keeps a record of the business transactions is known

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

as Bookkeeper. His work is primarily clerical in nature. On the other hand, Accounting is
primarily concerned with the recording, classifying, summarizing, interpreting the
financial data and communicating the information disclosed by the accounting records to
those persons interested in the accounting information relating to the business.

6. Limitations of Accounting
a. Accounting provides only limited information because it reveals the profitability of
the concern.
b. Accounting considers only those transactions which can be measured in terms of
money or quantitatively expressed. Qualitative information is not considered.
c. Accounting provides limited information to the management.
d. Accounting is only historical in nature. It provides only a postmortem record of
business transactions.

7. Branches of Accounting- The main function of accounting is to provide the required

information for different parties who are interested in the welfare of that enterprise
concerned. To serve the needs of management and outsiders various new branches of
accounting have been developed. The following are the main branches of accounting:
➢ Financial Accounting: Financial Accounting is prepared to determine
profitability and financial position of a concern for a specific period.
➢ Cost Accounting: Cost Accounting is the formal accounting system set up for
recording costs. It is a systematic procedure for determining the unit cost of output
produced or service rendered.
➢ Management Accounting: Management Accounting is concerned with the
presentation of accounting information to the management for effective decision
making and control.

8. Accounting Principles- Various accounting systems and techniques are designed to meet
the needs of the management. The information should be recorded and presented in such a
way that management is able to arrive at the right conclusions. The aim of the management
is to increase profitability and losses. To achieve the objectives of the concern, it is essential
to prepare the accounting statements in accordance with the generally accepted principles
and procedures. The term principles refer to the rule of action or conduct to be applied in
accounting. Accounting principles may be defined as "those rules of conduct or procedure
which are adopted by the accountants universally, while recording the accounting
transactions." The accounting principles can be classified into two categories:
➢ Accounting Concepts.
➢ Accounting Conventions.
1. Accounting Concepts- Accounting concepts mean and include necessary assumptions or
postulates or ideas which are used to accounting practice and preparation of financial
statements. The following are the important accounting concepts:
• Entity Concept.
• Dual Aspect Concept.
• Accounting Period Concept.
• Going Concern Concept.
• Cost Concept.

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

• Money Measurement Concept.

• Matching Concept.
• Realization Concept.
• Accrual Concept.
• Rupee Value Concept
• Accounting Conventions
2. Accounting Convention- It implies that those customs, methods, and practices to be
followed as a guideline for preparation of accounting statements. The accounting
conventions can be classified as follows:
• Convention of Disclosure.
• Convention of Conservatism.
• Convention of Consistency.
• Convention of Materiality.

TERMINOLOGY OFTEN USED — SOME BASIC TERMS

The following terms are often used. For proper understanding, they are explained in easy language.
1. Capital: Capital is the amount, initially, invested while commencing the business. Capital
need not be in the form of cash, alone. Capital can be introduced in the form of goods or
any type of assets. Capital = Assets – Liabilities
2. Drawings: Drawings are the amount withdrawn from the business by the proprietor or
partner in a partnership firm. Drawings can be, again, cash or goods. Drawings are reduced
from the capital amount. ‘Drawings’ reduces the balance in the capital account.
3. Turnover: The total amount of sales during a particular period is called ‘Turnover’. The
turnover can be cash sales or credit sales or both.
4. Discount: The allowance or concession granted to a retailer by the wholesaler/dealer is
called ‘discount’. It is of two types: (A) Trade discount (B) Cash discount.
5. Trade discount: Trade discount is allowed by a dealer to the retailer or buyer to induce
him to buy more from him. Normally, the retailer is in the habit of buying say 50 or 100
pieces at the most, at one time. A trade discount is offered both on cash and credit sales.
Net Price = List Price – Trade Discount
6. Cash discount: Cash discount is allowed by the seller to encourage the customer to make
early payment, before the credit period expires.
7. Debtor or Book Debt: The person to whom goods or services are sold on credit is called
‘Debtor’. The amount due from the debtor is called Book Debt. Another name is ‘Accounts
Receivable’.
8. Creditor: The person from whom goods or services are purchased on credit, is called
creditor till the payment due to him is made.
9. Bad Debts: Amount that cannot be recovered from a debtor is called ‘Bad Debt’. Bad debts
result in a reduction of profits of the firm. Bad debts are charged to the Profit and Loss
account. In other words, bad debts are treated as an expenditure, as the amount due to be
received would no longer be received.

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

10. Transaction: Transaction refers to the exchange of goods and services, big or small, like
purchase of machinery or pencil. The exchange of the dealing must be expressed in terms
of money. Transaction can be either in cash or on credit. If the payment is made immediate
to the transaction, it is a cash transaction. If the payment is postponed or deferred to a future
date, it is called a credit transaction.
11. Voucher: Voucher is a written document or paper containing the details of the transaction.
The person who prepares the voucher, normally an accountant, signs it. The person who
verifies or checks the transaction also signs it, in token of its verification. Vouchers are
important instruments for future reference. Vouchers can be a debit voucher or credit
voucher. A voucher is, normally, accompanied by the supporting documents as proof. For
example, a voucher may be supported by the bill. Here, the bill is the evidence of payment.
12. Equity: All claims against the assets of the firm are called ‘Equity’. The claim of the
outsiders is called ‘creditor’s equity’ or liabilities. The claim of the proprietor is called
‘owner’s equity’ or capital.
13. Assets: Assets are the properties owned by the firm. Examples of Assets are Building,
Plant and Machinery, Debtors, Bills Receivable, Goodwill, Preliminary expenses etc.
Assets can be divided into two categories—fixed assets and current assets.
➢ Fixed assets are the assets owned by the firm for the purpose of conducting
business using the fixed assets. Examples are Building, Plant and Machinery etc.
In the normal course, the firm does not sell them.
➢ Current assets are those assets which are held by the firm for the purpose of
carrying on business. Current assets, normally, change their form. Examples are
Cash, Bank, Finished Goods, Debtors, Bills Receivable, Accrued income etc.
Whether an asset is a fixed asset or current asset depends on the nature of the
business that is carried on.
14. Liabilities: Liabilities are the amounts that are payable. Advances or loans received must
be repaid. Till date of repayment, they are liabilities. Goods or services when bought on
credit are shown as creditors, which are also liabilities. A liability is the enforcement
responsibility of a business to pay a certain amount to someone (creditor) to whom the
business owes money, a creditor.
Classification of liabilities
➢ Owner’s equity: this is the interest of the owner in the business. Owner’s equity
can also be expressed by the following equation:
➢ Owner’s equity = Capital + Profit – Drawings.
➢ Long-term liabilities: these are obligations negotiated by a business which are
payable over a period of more than one year.
➢ Current liabilities: these are obligations negotiated by a business which are payable
within one year.
Total assets = Total liabilities (liabilities + owner’s equity)
In other words, the assets and liabilities of a business give us a picture of the financial
position of the business at a certain time.

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

15. Income: The income of a business is the money received from its normal daily operations.
In other words, the business receives value in exchange for goods sold or services rendered.
16. Expenses: An expense is the amount spent by a business during its normal daily operations
(excluding capital expenses) Profit = Income – Expenses
17. Bills Receivable: These refer to the acceptances received from the customers or business
parties to pay an agreed amount of money. Acceptances received are called bills receivable.
Bills receivable form part of current assets.
18. Accrued or Outstanding Expenses: These refer to the expenses yet to be paid. Examples
are outstanding salaries and rent.
19. Debtor: A debtor is a person who owes money to the business, in other words, the business
has sold something to him on credit.
20. Creditor: A creditor is a person to whom the business owes money, in other words, the
business has bought something from him on credit.
21. Debit: The entry made on the debit side of the account is called ‘Debit’. The abridged form
is ‘Dr.
22. Credit: The entry made on the credit side of the account is called ‘Credit’. The abridged
form is ‘Cr’.
23. Entry: The record made in the books of accounts in respect of a transaction, or an event is
called an entry.
24. Books of Account: The registers or books maintained by any business firm or institution
for recording the business transactions are called “Books of Account”.
25. Grouping of items: All the items in a business can be divided into four groups: assets,
liabilities, income, and expenses.
26. Settlement discount received: This refers to the discount the business receives if a debt
to a creditor is paid on time.
27. Settlement discount granted: This refers to the discount granted to a debtor by the
business if the debtor pays his debts to the business on time.

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

28. Credit losses: If a debtor is unable to pay his debt, the amount must be written off as
irrecoverable (credit losses).
29. Depreciation: The amount by which the fixed assets are reduced on an annual basis.
30. Overdraft: The facility sanctioned by a banker to a customer to draw more than what is
deposited in the account, subject to a maximum limit of money is called overdraft. It may
be for a short period or for a long period.
31. Sales: Sales refer to the value of goods or services sold during a given accounting period.
Sales may be cash or credit sales. In credit sales, the debtor promises to pay the firm at a
future date.
32. Sales Returns (Returns Inwards): These refer to the goods returned by customers with a
complaint about damage or defects. Sales returns are also called return inwards.
33. Net Sales: Net sales refer to sales minus sales returns. (Net Sales = Sales – Sales returns)
34. Purchases: Purchases refer to the value of goods or services purchased during a given
accounting period. Purchases may be cash purchases or credit purchases. In credit
purchases, the firm agrees to pay the amount to the supplier (creditor) at a future date.
35. Returns outwards: Returns outwards are damaged items which we send back to the
supplier (creditor), i.e. we are the buyer/we bought. Or These are goods returned by the
firm to the suppliers of goods with a complaint. Purchase returns are also called returns
outwards.
36. Returns inwards: Returns inwards are damaged items which are sent back to us by the
buyer (debtor), i.e. we are the seller/we sold.
37. Settlement discount received: This refers to the discount the business receives if a debt
to a creditor is paid on time.
38. Net Purchases: Purchase minus purchase returns constitute net purchases. (Net Purchase
= Purchases – Purchase Returns)
39. Revenue Expenditure: Revenue expenditure refers to the expenditure incurred on running
the business. It also refers to the expenditure to maintain the assets of the business.
Examples for revenue expenditure are wages and salaries, rent for factory or office,
insurance paid, depreciation on plant or any other fixed assets, purchases of raw materials,
etc.
40. Revenue Receipts: Revenue receipts are those receipts from customers for the goods
supplied or fee received from them towards the services provided to them in the ordinary
course of business. Examples are sales proceeds, rent received, commission received, etc.
41. Capital Expenditure: Capital expenditure is that expenditure incurred to acquire a fixed
asset, tangible or intangible. Examples of capital expenditure are purchase of plants,
furniture, goodwill, etc.
42. Capital Receipts: Capital receipts are the receipts from the sale of fixed assets such as
machinery or furniture. The asset may be sold as and when it is old or is to be replaced.
43. Solvent: A person who can pay his debts as they become due.
44. Insolvent: A person who is not able to pay his debts as they become due. The dues from
an insolvent debtor are known as Bad Debts.
45. Reserve for Bad Debt: A reserve from the profit of the organization is created for bad and
doubtful debts. It is a buffer for anticipated loss (under conservatism).

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

46. Journal: Journal is the first book in which transactions are recorded in a chronological
order (date wise), the moment they take place in business. It is also called ‘daybook’.
47. Shares: Shares represent ownership securities. In the case of joint stock companies, the
owner’s capital is divided into very small fractions, say Rs. 5/-, Rs. 10/-, Rs. 20/- etc. each
fraction is termed as Shares. The person (natural or legal) who purchases/subscribes these
shares are known as shareholders. Whatever shareholders receive against their investment
is known as a dividend. This may be in the form of cash or kind. Shareholders act as part
owner to the concern organization because they possess voting rights. The extent of
ownership depends upon the extent of shareholding. Voting right means right to vote,
which in turn means right to elect board of directors, which constitute the apex body of
concerned organization.
48. Debentures: Debentures represent creditor ship securities. In the case of joint stock
companies, a part of debt capital is divided into very small fractions say Rs. 5/-, Rs. 10/-,
Rs. 20/- etc. each fraction is termed as Debentures. The person (natural or legal) who
purchases/subscribes these debentures are known as debenture holders. Debenture holders
receive interest against their investment. Debenture holders act as creditors to the
organization concerned because they have legal right to receive interest and principal
repayment at the end of maturity, depending upon the nature of debenture.

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

Module-2
Final Accounts

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

Performa for Trading Account:

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

Performa for Profit & Loss Account:

Performa for Balance Sheet:

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan
 20ME803- Financial Management & Engineering Economics

Prepared by: Dr. Ezhil Vannan S, Professor & Head, Dept. of Mechanical Engg. MCE, Hassan