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Lecture Sheet
Financial Accounting
Chapter: 01

Introduction
1. Definitions of Accounting:
Accounting is the art and science of recording business transaction and interpreting
and communicating the result of the transaction to the interested parties.
Accounting is an information system that identifies, records and communicates the
economic events of an organization to interested users

*Accounting is the process of identifying, measuring and communicating economic

information to permit informed judgment and decisions by the users of the

information.
AAA (Anerican Accourting Associatinn

. s uí åccountiag Enloriatiö.n:
Beocase accounting communicates financial information, accounting is often called the
language of business." The information that a user of financial information needs depends
upon the kinds of decisions the user makes. The difference in the decisions divide the users of
financial information into two broad groups:
a. Internal users and
b. External users.

a. Internal users: Internal users of acounting information are managers who plan.

organize. and run a business. These include marketing managers, production

supervisors, finance directors, and company officers. Internal users need detailed

inforniation on a timely basis. For internal +epets, accounting provides internal

reports.
deeisi
 b. External users: There are several types of external users of accounting information.
Investors (owners) use accounting information to make decisions to buy, hold or sell
stock. Creditors such as suppliers and bankers use accounting information to evaluate

the risks of granting credit or lending money. The information needs and question of
others external users very considerably. Taxing authorities, such as the Internal
Revenue Service, want to know whether the company complies with the tax laws.
Regulatory agencies, such as the Securities and Exchange Commission and the
Federal Trade Commission want to know whether a company is operating within
prescribed rules. Customers are interested in whether the company will continue to
honor product warranties and support its product lines. Labor unions want to know
whether the owners can pay increased wages and benefits. Economic planners use

accounting information to forecast economic activity.

3. Branch of accounting:
a. General Accounting (Financial Accounting)
b. Specialized fields of Accounting:
i. Cost Accounting
ii. Management Accounting
ii. Tax Accounting
iv. Industrial Accounting
. National Income Accounting
vi. Integrated Accounting
vii. Inflationary Accounting
viii. Budgetary Accounting
ix. Economic Development Accounting
x. Social Accounting
xi. Auditing
xii. Responsibility Accounting
xii. Human Resource Accounting
xiv. Government Accounting
xv. Mechanized Acounting etc.

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 counting:
e
m branches of Accounting are:
a. Financial accounting:
b. Managerial accounting:
c. Cost accounting:
d. Human resource
accounting;
e.
Govemmental accounting etc.
a. Financial Accounting: The field of
accounting that provides economic and Financial
information for investors, creditors and
other external users.
b.
Management Accounting: The field of
accounting that provides economic and financial
information for managers and other
internal users. So. Managerial (management)
accounting is those
accounting which collect information from Financial accounting and
then analysis the information and take decision.
c. Cost Accounting: In general word, cost accounting is the
process of recording,
ascertaining & analyzing the costs involved in business. a
running
The field of
accounting that
provides economic and financial information to interested
users about the costs involved in particular job or
activity or work.
d. Human Resource
Accounting: The filed of
accounting that provides economic and
financial information to interested
mainly management authorities about inflows &
users

outflows of human their skill, efficiency,

resources.,
productivity & profitability etc.
Governmental Acounting: The field of
accounting that provides economic and financial
information to interested users about Governmental
budget, their earnings and expeditors,
their policies etc.
5. Meaning of Financial Accounting or General Accounting:
Financial accounting is the area of
accounting that provides economic and financial
information for investors. creditors and others external users. It
provides a record of business
transactions in financial terms and also the periodical
preparation of financial statements from
these records fremttese Oeneral
accounting can also be called financial Accounting. The
object of financial accounting is to ascertain the result (profit or loss) of business
operations
during the particular period ànd to state the financial position (Balance sheet) as on a date at

the end of the period.

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7. Systems u

Double Entry
System: the two
a.
of systematic accounting. It recognizes
all the objective
method fulfilling
It is the only a generally accepted
system.
transaction. Double entry system is
business
fold aspect of every Luca Pacioli in
1494.
first described and evolved by
was
the double entry

and accounting. Double entry

underlying present-day bookkeeping
The fundamental concept effects
transaction has equal and opposite
financial
the fact that every
accounting is based
on
+
Assets= Liabilities
satisfy the equation
diferent accounts. It is used to
in at least two
so as to maintain the relationship.
is recorded
Equity, whereby each entry
transaction
means that every business
bookkeeping
The double entry system of accounting
or

borrows money from its

(or more). For example, when a company
will involve two accounts will
account Loans Payable
Cash account will increase and its liability
bank, the company's and its
account will decrease
for an advertisement, its Cash
increase. If a company pays $200
inc:ease.
account Advertising Expense will

the accounting equation (assets

=
liabilities + owner's equity) to
Double entry also allows for

balance. In our example involving Advertising Expense, the accounting equation

always be in
owner's to decrease. In that example, the
remained in balance because expenses
cause equity
account within owner's equity also decreased.
asset Cash decreased and the owner's capital

A third aspect of double entry is that the amounts entered into the general ledger accounts as

to the amounts entered as credits.

debits must be equal .

system, ransactions are recorded in terms of debits and credits. Since a

In the double entry

debit in one account will be offset by a credit in another account, the sum of all debits must

therefore be exactly equal to the sum of all credits. The double-entry system of bookkeeping
or accounting makes it easier to accurately prepare financial statements directly from the
books of account and detect errors.
 Single Entry System: considered in double e n t r y
transaction as
b. of each
two Told aspect personal
ignores
the transaction i. e.
This svstem aspect of
merely personal
single entry system of the transaction
Svstem.
Under
no note of
the impersonal aspect
m e t h o d takes
recorded. This and no safeguard against
accounts are of the posting
check on the accuracy
cash. It offers no transaction.
others than
check over the recording of cash
becauseit does not provide any
fraud
it is called as "imperfect accounting."
Therefore,

Equation:
8. Meaning of accounting The total
of double entry system is the accounting equation.
A common expression
more
be expressed in the from
of
always equal to the total equities. This may
assets of a firm are

equation
A=E

Where A denotes Assets and E denotes Equities.

and indicate the source of the assets. The source may
Equities are the claims against the assets

themselves or outsiders e.g. ovners invest fund in business and creditors lend
be the owner

claims, equities divided

the business. Due to the difference in the nature of these
are
money to

into claims of creditors and claims of owners. Hence the fundamental equation can be

expressed to:

A=L+C
Where L denotes creditors' Claims (i. e liabilities) and C denotes owners' claims (i. e.
capital). In others words, L denotes creditors equity and C denotes owners' equity.

Finally it can be said that the fundamental accounting equation is:

Assets (A)= Liabilities (L)+ Owner's Equity (E or C)

 of Assets,
Liabilities and Owner's Equity:
9. Meaning

Acsets: Assets are resources owned by a business. They are used in carrying out such
a.

consumption and exchange. The common characteristic possessed hy

activities as production,
all assets is the capacity to proVide future services or benefits. In a business enterprise, that

service potential or future economic benefit eventually results in cash inflows (receipts) to the

enterprise.
claims assets. That is, liabilities are existing debts and
b. Liabilities: Liabilities are against
obligation. For example, business of all size usually borrow money and purchase merchandise
on credit, Campus Pizza, for instance, purchases cheese, sausage, flour and beverages on

has
credit from suppliers. These obligations are called accounts payable. Campuses Pizza also
truck.
a note payable to first National Bank for the money borrowed to purchase the delivery

Pizza may also have wages payable to employees and sales and real estate taxes
Campus
the local government. All of these persons or entities to whom Campus Pizza owes
payable to
money are its creditor' s.
claim total assets is known as owner's equity. It is
c. Owens's Equity: The ownership on

liabilities. Here is why: The assets of a business are supplied

equal to total assets minus total
To find out what belongs to owners, we subtract the
or claimed by either creditor's or owners.

assets. The remainder is the owners claim on the assets-

creditors' Claim (the liabilities) from
Since the claims of creditors must be paid before ownership claims,
the owner's equity.
owner's equity is often referred
to as residual equity .
Luca Pacioli: The Father of Acounting

In 1494, the first book double-entry accounting was published. The author was an Italian
on

friar. Luca Pacioli. His impact on accounting was so great that five centuries
later, accountants
from around the world gathered in the ltalian village of San Sepulcro to celebrate the
anniversary of the book's publication. The first accounting book actually was one of five
sections in Pacioli's mathematics book titled "Everything about Arithmetic, Geometry, and
Proportions." This section on accounting served as the world's only accounting textbook until

well into the 16th century.

Since Pacioli was a Franciscan friar, he might be referred to simply as Friar Luca. While Friar
Luca is often called the "Father of Accounting," he did not invent the system. Instead, he
simply described a method used by merchants in Venice during the Italian Renaissance
period. His system included most of the accounting cycle as we know it today. For example.
he described the use journals and ledgers, and he warned that a person should not go to sleep
at night until the debits equalled the credits! His ledger included assets (including receivables

and inventories), liabilities, capital, income, and expense accounts. Friar Luca demonstrated

year-end closing entries and proposed that a trial balance be used to prove a balanced ledger.

Also, his treatise alludes to a wide range of topics from accounting ethics to cost accounting.

Pacioli was about 49 years old in 1494 just two years after Columbus discovered America -

when he returned to Venice for the publication of his fifth book, Summa de Arithmetica,

Geometria. Proportioni et Proportionalita (Everything About Arithmetic, Geometry and

Proportion). It was written as a digest and guide to existing mathematical knowledge, and

bookkeeping was only one of five topics covered. The Summa's 36 short chapters on

bookkeeping. entitled De Computis et Scripturis (Of Reckonings and Writings) were added

"in order that the subjects of the most gracious Duke of Urbino may have complete

instructions in the conduct of business," and to "give the trader without delay information as

to his assets and liabilities" (All quotes from the translation by J.B. Geijsbeek, Ancient Double
Entry Bookkeeping: Lucas Pacioli's Treatise, 1914).
 Numerous tiny details or DooKeeping techniaue se
forth by Paciol
were followed
for at least the next four in texts
centuries, as
accounting
d nint historian Henry Rand
it, "persisting k Duons On our
coat sleeves, long after their
red "
Perhaps the best proor that
Pacioli's work was
significance had
considered potentially
n a t the of publication was the very fact that it
time significant
Guttenberg had just a quarter-century earlier
was
printed on November 10, 1494.
invented metal type, and it was
still an extremely
expensive proposition to print a book.

Accounting practitioners in
public accounting, industry, and
well as investors, lending institutions, business
not-for-profit organizations, as
firms, and all other users for financial
information are indebted to Luca Pacioli for his monumental role in the
development of
accounting.
 6. Differentiate between Financial accounting and managerial
accounting
Financial accounting Managerial accounting
| 1. UseTS Financial accounting information | Managerial accounting information is for
appears in financial statements that are internal use and provides special
intended primarily for external use. information for the managers of the
company.
2. Rules && Financial accounting provides economic Managerial accounting provides
polices information to its
interested users by economic information to its interested
following some commonly accepted users by not following commonly
rules, polices, concepts and accepted rules, polices, concepts and
assumptions. assumptions rather as per demand.
3. Purpose The main purpose of Financial The main purpose of managerial
accounting is to inform the financial accounting is to help managers in
performance and financial position of decision making by providing useful
the entity to its interested users. information.
4. Focus area Financial accounting focuses on the Managerial accounting focuses on the
company as a whole. parts or segmerts of the company.
5. Obligation It is mandatory to produce financial It is not mandatory to produce financial
statements at the end of the accounting statement at the end of the accounting
period as per the Company Act and period.
other laws.

6. Nature of Financial accounting considers only Managerial accounting considers both

information quantitative information. quantitative and qualitative information.
7. Nature of Financial accounting maintains only Managerial accounting uses past and
records historical records. present information with planning for the
future.