UNIT - IV

INTRODUCTION TO FINANCIAL ACCOUNTING

INTRODUCTION TO ACCOUNTING

Accounting is the science of recording and classifying business transactions and events
primarily of financial character, and the art of making significant summaries, analysis and
interpretations of those transactions and events, and communicating the results to persons who
must make decisions or form judgment.

Significance of accounting:

1. Maintain its own records of business

2. Monitor the business activities
3. Calculate profit or loss for a given period
4. Fulfill legal obligations
5. Show financial position for a given period
6. Communicate the information to the interested parties

Accounting terms

⮚ Business transactions: any exchange of money or money worth is called business

transaction. Events like purchase and sale of goods, receipts and payments of cash for
services.
⮚ Debtor : a debtor is a person who owes something to the business.
⮚ Creditor: a creditor is a person to whom something is owings by the business
⮚ Capital : it is the amount invested by the proprietor in the business. For the business,
capital is a liability towards the owner. Sometimes it is called owner equity i.e, owners
claim against the assets. Owner’s equity or capital is always equal to assets minus
liabilities.
⮚ Drawing: it is the value of cash or goods withdrawn from the business by the owner for
his personal uses.
⮚ Goods : it includes all commodities or articles in which a trader deals.
⮚ Assets : these are the material things or possessions or properties of the business
including the amount due to it. Examples are cash and bank balances, land and buildings,
plant and machinery.
⮚ Liabilities : the term liabilities denote the amount which the business owes to others such
as loan from bank, creditors for goods supplied, for outstanding expenses.
DOUBLE ENTRY SYSTEM:

Every transaction has two aspects. When we receive something, we give something else
in return. For example, when we purchase goods for cash, we receive goods and give cash in
return. Similarly when goods are sold on credit, goods are given and the customer becomes a
debtor. This method of writing every transaction in two accounts is known as Double entry
systems of accounting.

Stages of double entry system:

1. All transactions are first recorded in a journal or books of original entry known as
subsidiary books as and when they take place.
2. All entries in the journal or subsidiary books are posted in the ledger.
3. All the accounts are closed or balanced and final accounts are prepared.

Advantages of double- entry book – keeping

1. Information about every account: under double entry systems, both aspects of a
transaction are being recorded in the books of accounts. Hence information about every
account is available in the books of account as all accounts are to be found in the ledgers
under the double entry system.
2. Helps to know the receivables and payables: it helps to know how much is owed to the
creditors and how much is due from the debtors, also it focuses on the bills payable and
receivables.
3. Arithmetical accuracy: the arithmetical accuracy can be ascertained by preparing a
statement of debits and credits called trial balance and this is possible because both debit
aspects and credit aspects of every transaction are recorded.
4. Helps to locate errors: trial balance can reveal the errors that creep in account while
recording the business information.
5. Helps to ascertain profit / loss: the profit and loss statement can be prepared without
much difficulty under a double entry system.
6. Helps to know the financial position: double entry system helps to prepare a balance
sheet that reveals the financial position of the business as on a particular date.
7. Monitoring and auditing is made easier: with a double entry system the scope for frauds
and misappropriations is less, provided a proper internal audit system is in place.
Accounting rules:

Personal Account: These are the accounts of natural persons such as Ram account, Gopal
account,Artificial person such as Uday Ltd, Syndicate Bank and a Representative personal
account.

Real Accounts: accounts relating to properties or assets of a trader are known as real accounts. It
includes tangible assets such as buildings, furniture,. Cash, etc and also intangible assets such as
goodwill, trade marks, patent rights.

Nominal Accounts : account dealing with expenses, losses, gains and incomes are called
nominal accounts, eg. Salaries, wages commission account etc.

JOURNAL
Journal means a daily record of business transactions. Journal being a book of original
entry. The transaction is first written in the journal from which it is posted to the ledger. The
transactions will be recorded as and when they occur and in the order in which they occur.

Date Particular LF Debit credit

Cash a/c----------------------------DR 20,000

To ram a/c 20,000

 ( narration )

Where: ledger folio . in this column the pages numbers on which the various accounts appear in
the ledger are entered.
Narration : an explanation of the entry in the particular column.
Note : Dr mean a amount transfer to debit column

Ledger:

Ledger is a book in which various accounts such as personal, real and nominal accounts are
opened. Every transaction is first recorded in the journal, and from it, transferred to the
concerned account in the ledger. This process of transferring the transaction from the journal to
the ledger is called posting.

Dr ledger a/c Cr

Date Particular JF Amount Date Particular JF Amount

Note:

Dr means debit side it is always start with TO, Cr means credit side it is always start with By

Balancing an account: after all transactions have been posted and the various accounts prepared
they are balanced. The procedure for balancing ledger accounts is as follows.

1. Take the totals of the two sides of the account on a rough sheet.
2. Ascertain the difference between the totals of two sides . the difference is called
“balance”
3. Enter the difference in the amount column of the side showing less total. If the credit side
total is less , write in the particulars column on the credit side of the account , By balance
c/d. Similarly if the debit side is less , write on the debit side of the account To balance
c/d.
TRIAL BALANCE

The first step in the preparation of final accounts is the preparation of trial balance. In the
double entry system of book keeping, there will be credit for every debit and there will not be
any debit without credit. When this principle is followed in writing journal entries, the total
amount of all debits is equal to the total amount of all credits.

A trial balance is a statement of debit and credit balances. It is prepared on a particular date with
the object of checking the accuracy of the books of accounts. It indicates that all the transactions
for a particular period have been duly entered in the book, properly posted and balanced. The
trial balance doesn’t include stock in hand at the end of the period. All adjustments required to be
done at the end of the period including closing stock are generally given under the trial balance.

DEFINITIONS:

SPICER AND POGLAR :A trial balance is a list of all the balances standing on the ledger
accounts and cash book of a concern at any given date.

J.R.BATLIBOI:

A trial balance is a statement of debit and credit balances extracted from the ledger with a view
to test the arithmetical accuracy of the books.

Thus a trial balance is a list of balances of the ledger accounts’ and cash book of a business
concern at any given date

PROFORMA FOR TRIAL BALANCE:

Trial balance for MR…………………………………… as on …………

N NAME OF ACCOUNT DEBIT CREDIT

O AMOUNT(RS.) AMOUNT(RS.)
(PARTICULARS)
FINAL ACCOUNTS:

In every business, the business man is interested in knowing whether the business has
resulted in profit or loss and what the financial position of the business is at a given time. In
brief, he wants to know (i)The profitability of the business and (ii) The soundness of the
business.

The trader can ascertain this by preparing the final accounts. The final accounts are prepared
from the trial balance. Hence the trial balance is said to be the link between the ledger accounts
and the final accounts. The final accounts of a firm can be divided into two stages. The first stage
is preparing the trading and profit and loss account and the second stage is preparing the balance
sheet.

1. Trading account
2. Profit and loss account
3. Balance sheet.

Trading account

Trading account is a part of a Profit and Loss Account . A trading account is prepared for
ascertaining Gross profit or gross loss. The difference between the sales and the cost of the
goods sold is gross profit. Cost of goods sold can be ascertained by adding opening stock ,
purchases, direct expenses for purchase of goods and deduction there from closing stock and
sales.

PROFORMA OF TRADING ACCOUNT

Trading account of ------------- for the year ended 31 march ----

Particular Amount Particular Amount

To opening stock Xxxx By Sales
xxxxx Xxxx
To Purchase Less; Sales return
xxxx Xxxx xxxxx
Less: purchase return
xxxx

To carriage inwards Xxx By closing stock Xxxx

To wage Xxxx
To freight , duty clearing charges Xxxx
To fuel and power Xxxx
To coal, gas, and water Xxxx
To motive power Xxxx
To factory rent Xxxx
To manufacturing expenses Xxxx
To direct expenses Xxxx
To factory lighting Xxxx
To gross profit Xxxx
Xxxxxxx xxxxxxx

PROFIT AND LOSS ACCOUNT

Profit and loss account is prepared to ascertain the net profit or net loss of the business
for a particular period. All indirect expenses such as management and office expenses, financial
expenses, selling and distribution expenses are taken on the debit side. Gross profit and other
items of incomes such as interest received , discount received, etc. are taken on the credit side.
The difference between two sides is either net profit or net loss which is transferred to the capital
account.

The business man is always interested in knowing his net income or net profit.Net profit
represents the excess of gross profit plus the other revenue incomes over administrative, sales,
Financial and other expenses. The debit side of the profit and loss account shows the expenses
and the credit side the incomes. If the total of the credit side is more, it will be the net profit. And
if the debit side is more, it will be net loss.

PROFORMA OF PROFIT AND LOSS ACCOUNT

Profit and loss of --------------- for the year ended 31 march xxx

Particular Amount Particular Amount

To Salaries By gross profit Xxx
xxx Xxx
Add : outstanding salaries
xxx
To Rent Xxx By Discount receive Xxx
To Discount allowed Xxx By Interest receive Xxx
To Office expenses Xxx By Commission receive Xxx
To Rate and tax Xxx
To Lighting Xxx
To Printing and stationery Xxx
To Postage and telegrams Xxx
To Telephone charges Xxx
To Legal expenses Xxx
To Telephone charges Xxx
To Audit fee Xxx
To General expenses Xxx
To Advertisement Xxx
To Insurance xxx
To interest on capital Xxx
To depreciation on assets( machinery Xxx
, building , furniture, land.etc)
To repair Xxx
To carriage outward Xxx
To written off bad debts Xxx
To travelling expenses Xxx
To interest on loan Xxx
To net profit Xxx
Xxxxxx xxxxxx

BALANCE SHEET:
The second point of final accounts is the preparation of the balance sheet. It is prepared
often in the trading and profit, loss accounts have been compiled and closed. A balance sheet
may be considered as a statement of the financial position of the concern at a given date.

DEFINITION: A balance sheet is an item wise list of assets, liabilities and proprietorship of a
business at a certain state.

J.R.botliboi: A balance sheet is a statement with a view to measure the exact financial position of
a business at a particular date.

Thus, a Balance sheet is defined as a statement which sets out the assets and liabilities of
a business firm and which serves to ascertain the financial position of the same on any particular
date. On the left-hand side of this statement, the liabilities and the capital are shown. On the
right-hand side all the assets are shown. Therefore, the two sides of the balance sheet should be
equal. Otherwise, there is an error somewhere.

PROFORMA OF BALANCE SHEET

Balance sheet of Mr.------------------------------ for the year ending on 31 march xxxxx

Liabilities Amoun Assets Amount

t
Capital Plant and machinery
xxxx Xxx Xxx
Add: interest on capital Less: depreciation on plant machinery
xxxx xxx
Net profit Xxx
xxxx Building
Xxx xxx Xxx
------
 Less : depreciation on building
Xxxx xxx
Less: drawings Land
xxxx xxx
Net loss Less ; depreciation on land
xxxx xxx
Sundry creditor xxx Sundry debtor
xxx Xxx
Less : written of bad debts
xxx
Bank overdraft Xxx Cash in hand Xxx
Outstanding expenses Xxxx Cash at bank Xxx
Reserves Xxx Investment Xxx
Long term loans Xxx Bill receivable Xxxx
Bill payable Xxx Prepaid expenses Xxx
Prepaid expenses Xxx
Vehicle Xxx
Closing stock Xxx
Xxxxx xxxxx

Advantages: The following are the advantages of final balance .

1. It helps in checking the arithmetical accuracy of books of accounts.

2. It helps in the preparation of financial statements.
3. It helps in detecting errors.
4. It serves as an instrument for carrying out the job of rectification of entries.
5. It is possible to find out the balances of various accounts at one place.

FINAL ACCOUNTS -- ADJUSTMENTS

We know that business is a going concern. It has to be carried on indefinitely. At the end
of every accounting year. The trader prepares the trading and profit and loss account and balance
sheet. While preparing these financial statements, sometimes the trader may come across certain
problems .The expenses of the current year may be still payable or the expenses of the next year
have been prepaid during the current year. In the same way, the income of the current year is still
receivable and the income of the next year has been received during the current year. Without
these adjustments, the profit figures arrived at or the financial position of the concern may not be
correct. As such these adjustments are to be made while preparing the final accounts.
The adjustments to be made to final accounts will be given under the Trial Balance. While
making the adjustment in the final accounts, the student should remember that “every adjustment
is to be made in the final accounts twice i.e. once in trading, profit and loss account and later in
balance sheet generally”. The following are some of the important adjustments to be made at the
time of preparing of final accounts:-

1. CLOSING STOCK :-

(i)If closing stock is given in Trial Balance: It should be shown only in the balance sheet “Assets
Side”.

(ii)If closing stock is given as adjustment :

1. First, it should be posted at the credit side of “Trading Account”.

2. Next, shown at the asset side of the “Balance Sheet”.

2.OUTSTANDING EXPENSES :-

(i)If outstanding expenses given in Trial Balance: It should be only on the liability side of
Balance Sheet.

(ii)If outstanding expenses given as adjustment :

1. First, it should be added to the concerned expense at the

debit side of profit and loss account or Trading Account.
2. Next, it should be added at the liabilities side of the
Balance Sheet.

3.PREAPID EXPENSES :-

(i)If prepaid expenses are given in Trial Balance: It should be shown only in the assets side of
the Balance Sheet.

(ii)If prepaid expense given as adjustment :

1. First, it should be deducted from the concerned expenses at the debit side of profit and
loss account or Trading Account.
2. Next, it should be shown at the assets side of the Balance Sheet.
4.INCOME EARNED BUT NOT RECEIVED [OR] OUTSTANDING INCOME [OR] ACCRUED
INCOME :-

(i)If incomes given in Trial Balance: It should be shown only on the assets side of the Balance
Sheet.

(ii)If incomes outstanding given as adjustment:

1. First, it should be added to the concerned income at the credit side of the profit and loss
account.
2. Next, it should be shown at the assets side of the Balance sheet.

5. INCOME RECEIVED IN ADVANCE: UNEARNED INCOME:-

(i)If unearned incomes given in Trial Balance : It should be shown only on the liabilities side of
the Balance Sheet.

(ii)If unearned income given as adjustment :

1. First, it should be deducted from the concerned income in the credit side of the profit and
loss account.
2. Secondly, it should be shown in the liabilities side of the
Balance Sheet.

6.DEPRECIATION:-

(i)If Depreciation given in Trial Balance: It should be shown only on the debit side of the profit
and loss account.

(ii)If Depreciation given as adjustment

1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deduced from the concerned asset in the Balance sheet assets side.

7.INTEREST ON LOAN [OR] CAPITAL :-

(i)If interest on loan (or) capital given in Trial balance :It should be shown only on debit side
of the profit and loss account

(ii)If interest on loan (or)capital given as adjustment :

 1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be added to the loan or capital in the liabilities side of the Balance
Sheet.
8.BAD DEBTS:-

(i)If bad debts are given in Trial balance :It should be shown on the debit side of the profit and
loss account.

(ii)If bad debts given as adjustment:

1. First, it should be shown on the debit side of the profit and loss account.
2. Secondly, it should be deducted from debtors in the assets side of the Balance Sheet.

9.INTEREST ON DRAWINGS :-

(i)If Interest on drawings given in Trial balance: It should be shown on the credit side of the
profit and loss account.

(ii)If interest on drawings given as adjustments :

1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be deducted from capital on liabilities
side of the Balance Sheet.

10.INTEREST ON INVESTMENTS :-

(i)If Interest on the investments given in Trial balance :It should be shown on the credit side of
the profit and loss account.

(ii)If interest on investments given as adjustments :

1. First, it should be shown on the credit side of the profit and loss account.
2. Secondly, it should be added to the investments on assets side of the Balance Sheet.