UNIT - V

INTRODUCTION TO FINANCIAL ACCOUNTING

CONCEPTS
Definition of Accounting:

American Institute of Certified Public Accountants (AICPA): “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.”
CLASSIFICATION OF BUSINESS TRANSACTIONS

All business transactions are classified into three categories: 1.Those relating to persons
2.Those relating to property(Assets) 3.Those
relating to income & expenses
Thus, three classes of accounts are maintained for recording all business transactions. They are:
1.Personal accounts
2.Real accounts
3.Nominal accounts

1. Personal Accounts :Accounts which are transactions with persons are called “Personal Accounts” .
A separate account is kept on the name of each person for recording the benefits received from ,or given to the person
in the course of dealings with him.
E.g.: Krishna’s A/C, Gopal’s A/C, SBI A/C, Nagarjuna Finanace Ltd.A/C, ObulReddy & Sons A/C , HMT Ltd.
A/C, Capital A/C, Drawings A/C etc.

2. Real Accounts: The accounts relating to properties or assets are known as “Real Accounts”
.Every business needs assets such as machinery , furniture etc, for running its activities .A separate account is
maintained for each asset owned by the business .
E.g.: cash A/C, furniture A/C, building A/C, machinery A/C etc.

3. Nominal Accounts :Accounts relating to expenses, losses, incomes and gains are known as “Nominal
Accounts”. A separate account is maintained for each item of expenses, losses, income or gain.
E.g.: Salaries A/C, stationery A/C, wages A/C, postage A/C, commission A/C, interest A/C, purchases A/C, rent
A/C, discount A/C, commission received A/C, interest received A/C, rent received A/C, discount received A/C.

Before recording a transaction, it is necessary to find out which of the accounts is to be debited and which is to be
credited. The following three different rules have been laid down for the three classes of accounts….

1. Personal Accounts: The account of the person receiving benefit (receiver) is to be debited and the account of
the person giving the benefit (given) is to be credited.

Rule: “Debit----The Receiver

Credit- -The Giver”

2. Real Accounts: When an asset is coming into the business, account of that asset is to be debited .When an asset

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Rule: “Debit----What comes in
Credit- -What goes out”
is going out of the business, the account of that asset is to be credited.

3. Nominal Accounts: When an expense is incurred or loss encountered, the account representing the expense or
loss is to be debited . When any income is earned or gain made, the account representing the income of gain is to
be credited.

Rule: “Debit----All expenses and losses

Credit- -All incomes and gains”

JOURNAL

JOURNAL: The word Journal is derived from the Latin word ‘journ’ which means a day. Therefore, journal
means a ‘day Book’ in day-to-day business transactions are recorded in chronological order.

Journal is treated as the book of original entry or first entry or prime entry. All the business transactions are
recorded in this book before they are posted in the ledges. The journal is a complete and chronological(in order of
dates) record of business transactions. It is recorded in a systematic manner. The process of recording a
transaction in the journal is called “JOURNALISING”. The entries made in the book are called “Journal Entries”.

The proforma of Journal is given below.

Date Particulars L.F. no Debit Credit

RS. RS.

1998 Jan 1 Purchases account to cash 10,000/- 10,000/-

account(being goods
purchased for cash)

LEDGER

All the transactions in a journal are recorded in a chronological order. After a certain period, if we want to know
whether a particular account is showing a debit or credit balance it becomes very difficult. So, the ledger is
designed to accommodate the various accounts maintained the trader. It contains the final or permanent record of
all the transactions in duly classified form. “A ledger is a book which contains various accounts.” The process of
transferring entries from journal to ledger is called “POSTING”.

Posting is the process of entering in the ledger the entries given in the journal. Posting into ledger is done
periodically, may be weekly or fortnightly as per the convenience of the business. The following are the
guidelines for posting transactions in the ledger.

1. After the completion of Journal entries only posting is to be made in the ledger.
2. For each item in the Journal a separate account is to be opened. Further, for each new item a new
account is to be opened.
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 3. Depending upon the number of transactions space for each account is to be determined in the
ledger.
4. For each account there must be a name. This should be written in the top of the table. At the end of
the name, the word “Account” is to be added.
5. The debit side of the Journal entry is to be posted on the debit side of the account, by starting with
“TO”.
6. The credit side of the Journal entry is to be posted on the debit side of the account, by starting with
“BY”.

Proforma for ledger: LEDGER BOOK

Particulars account

Date Particulars Lfno Amount Date Particulars Lfno amount

TRAIL BALANCE

A trail 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 trail 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 trail balance.

DEFINITIONS: SPICER AND POGLAR :A trail 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 trail 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 trail balance is a list of balances of the ledger accounts’ and cash book of a business concern at any given date.

PROFORMA FOR TRAIL BALANCE:

Trail balance for MR…………………………………… as on …………
NO NAME OF ACCOUNT DEBIT CREDIT
(PARTICULARS) AMOUNT(RS.) AMOUNT(RS.)

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 Double-entry bookkeeping: It is an accounting method where every transaction is recorded in at least
two accounts, ensuring that for every debit, there's a corresponding credit, and the total debits always
equal the total credits.
Here's a more detailed explanation:
 Every Transaction Affects Two Accounts:
In double-entry bookkeeping, each financial transaction is recorded in at least two different accounts.
 Debits and Credits:
One account is debited (increased or decreased depending on the account type), and another account is
credited (increased or decreased depending on the account type).
 Balancing the Equation:
The fundamental principle is that the total debits must always equal the total credits, maintaining the
accounting equation (Assets = Liabilities + Equity).
 Example:
If a business buys equipment for cash, the "Equipment" account (an asset) is debited (increased), and the
"Cash" account (also an asset) is credited (decreased).
 Importance:
Double-entry bookkeeping helps to ensure accuracy and balance in financial records, making it easier to
track and understand a company's financial position.

 Accounting concepts

Accounting concepts are the basic assumptions on which accounting operates. These are the following
accounting concepts as discussed below:

1. The business entity concept: According to this, the business and owner are separate entities. Business
transactions are recorded in the books of accounts from the company’s point of view, and not the owner’s.
The owners are considered separate from their business’s point of view and are regarded as creditors to
the extent of their capital.
2. The money measurement concept: According to this, transactions and events are measured in monetary
terms in the books of accounts of the enterprise.
3. The going concern concept: Under this concept, it is assumed that the business will continue for an
indefinite period, and there is no intention to close the business or cut down its operations significantly.
4. The accounting period concept: According to the accounting period concept, the life of an enterprise
can be broken into smaller periods, usually termed accounting periods, so that its performance is
measured at regular intervals.
5. The cost concept: According to this concept, an asset is recorded in the books of account at the price paid
to acquire it, and the cost is the basis for all following accounting of the asset.
6. The dual concept: According to the dual aspect concept, every business transaction entered into by the
organisation has two aspects, a debit and an equal creditor amount. For every debit, there will be an equal
amount of credit.
7. The revenue recognition concept: According to this concept, revenue is determined to have been
realised when a transaction has been written in the books and the obligation to receive the amount has
been ascertained.

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8. The matching concept: Here, it is ascertained that every cost incurred to earn the revenue should be
recognised as an expense in the accounting period when revenue is earned. In a given accounting period,
expenses are matched with the revenue earned.
9. The accrual concept: A transaction is said to be accrued if a transaction is recorded at the time when it
takes place and not at the time when the settlement takes place.
10. The verifiable objective concept: The verifiable objective concept states that accounting should be free
from personal bias.

 Accounting conventions

The guidelines that are followed to prepare financial statements are called accounting conventions. These
are as follows:

1. Full disclosure: Convention of full disclosure states that there should be complete reporting on the
financial statements of all important information relating to affairs of the business. All the material facts
are to be disclosed.
2. Consistency: Convention of consistency states that accounting practices, once selected and adopted,
should be followed consistently year after year for a better understanding and comparability of the
accounting information.
3. Prudence concept or conservatism concept: This convention states that we should not anticipate a
profit before its realisable but provide for all possible losses which might occur in the course of business.
4. Materiality concept: The materiality concept relates to the relative information of an item or an event.
An item is considered material when such knowledge of that could influence the decision of an investor.

Trail Balance
Specimen of trial balance

1 Capital Credit Loan

2 Opening stock Debit Asset
3 Purchases Debit Expense
4 Sales Credit Gain
5 Returns inwards Debit Loss
6 Returns outwards Debit Gain
7 Wages Debit Expense
8 Freight Debit Expense
9 Transport expenses Debit Expense
10 Royalities on production Debit Expense
11 Gas, fuel Debit Expense
12 Discount received Credit Revenue
13 Discount allowed Debit Loss
14 Bas debts Debit Loss
15 Dab debts reserve Credit Gain

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16 Commission received Credit Revenue
17 Repairs Debit Expense
18 Rent Debit Expense
19 Salaries Debit Expense
20 Loan Taken Credit Loan
21 Interest received Credit Revenue
22 Interest paid Debit Expense
23 Insurance Debit Expense
24 Carriage outwards Debit Expense
25 Advertisements Debit Expense
26 Petty expenses Debit Expense
27 Trade expenses Debit Expense
28 Petty receipts Credit Revenue
29 Income tax Debit Drawings
30 Office expenses Debit Expense
31 Customs duty Debit Expense
32 Sales tax Debit Expense
33 Provision for discount on debtors Debit Liability
34 Provision for discount on creditors Debit Asset
35 Debtors Debit Asset
36 Creditors Credit Liability
37 Goodwill Debit Asset
38 Plant, machinery Debit Asset
39 Land, buildings Debit Asset
40 Furniture, fittings Debit Asset
41 Investments Debit Asset
42 Cash in hand Debit Asset
43 Cash at bank Debit Asset
44 Reserve fund Credit Liability
45 Loan advances Debit Asset
46 Horse, carts Debit Asset
47 Excise duty Debit Expense
48 General reserve Credit Liability
49 Provision for depreciation Credit Liability
50 Bills receivable Debit Asset
51 Bills payable Credit Liability
52 Depreciation Debit Loss
53 Bank overdraft Credit Liability
54 Outstanding salaries Credit Liability
55 Prepaid insurance Debit Asset
56 Bad debt reserve Credit Revenue
57 Patents & Trademarks Debit Asset
58 Motor vehicle Debit Asset
59 Outstanding rent Credit Revenue

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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.
TRADING ACCOUNT
The first step in the preparation of final account is the preparation of trading account. The main purpose
of preparing the trading account is to ascertain gross profit or gross loss as a result of buying and selling the
goods.
Trading account of MR……………………. for the year ended ……………………

Particulars Amount Particulars Amount

To opening stock To Xxxx By sales xxxx

purchases xxxx Less: returns xxx Xxxx
By closing stock
Less: returns xx Xxxx Xxxx

To carriage inwards To Xxxx

wages Xxxx
To freight Xxxx
To customs duty, octroi Xxxx

To gas, fuel, coal,

Water Xxxx

To factory expenses
To other man. Expenses Xxxx
To productive expenses To Xxxx
gross profit c/d

Xxxx Xxxx

Xxxx

Xxxx

Finally, a ledger may be defined as a summary statement of all the transactions relating to a person , asset,
expense or income which have taken place during a given period of time. The up-to-date state of any account can
be easily known by referring to the ledger.

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PROFIT AND LOSS 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 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.

PROFIT AND LOSS A/C OF MR…………………….FOR THE YEAR ENDED…………

PARTICULARS AMOUNT PARTICULARS AMOUNT
TO office salaries TO Xxxxxx By gross profit b/d Interest Xxxxx
rent,rates,taxes Xxxxx received Discount received Xxxxx
TO Printing and stationery TO Xxxxx Commission received Xxxx
Legal charges Income from Xxxxx
Audit fee Xxxx investments
TO Insurance Xxxx Dividend on shares
TO General expenses TO
Xxxx Miscellaneous Xxxx
Advertisements TO Bad
Xxxxx investments Xxxx
debts
Xxxx Rent received
TO Carriage outwards TO
Xxxx xxxx
Repairs
Xxxx
TO Depreciation
Xxxxx
TO interest paid
Xxxxx
TO Interest on capital TO
Xxxxx
Interest on loans TO
Xxxx
Discount allowed TO
Xxxxx
Commission
Xxxxx
TO Net profit------------
Xxxxx
(transferred to capital a/c)

xxxxxx Xxxxxx

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 BALANCE SHEET

The second point of final accounts is the preparation of 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.

BALANCE SHEET OF ………………………… AS ON …………………………………….

Liabilities and capital Amount Assets Amount

Creditors Bills Xxxx Cash in hand Cash Xxxx

payable Xxxx at bank Bills Xxxx
Bank overdraft Xxxx receivable Xxxx
Loans Mortgage Xxxx Debtors Closing Xxxx
Reserve fund Xxxx stock Investments Xxxx
Capital xxxxxx Xxxx Furniture and fittings Xxxx
Add: Plats&machinery Land & Xxxx
Net Profit xxxx buildings Patents, tm
------- ,copyrights Xxxx
xxxxxxx Goodwill Xxxx
--------
Prepaid expenses Xxxx
Outstanding incomes
Less:
Drawings xxxx Xxxx
--------- Xxxx
Xxxx Xxxx

XXXX XXXX

.
FINAL ACCOUNTS -- ADJUSTMENTS
:-
1. CLOSING STOCK :-

(i) If closing stock is given in Trail 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 Trail Balance: It should be only on the liability side of Balance Sheet.

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(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 given in Trial Balance: It should be shown only in 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] ACCURED 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 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 Trail 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 Trail 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 Trail 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 debit side of the profit and loss account.
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 2. Secondly, it should added to the loan or capital in the liabilities
side of the Balance Sheet.

8.BAD DEBTS:-

(i) If bad debts given in Trail 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 Trail 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 Trail 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.

Note: Problems to be solved on final accounts

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