Financial Accounting Mohammed Nadeem

Chapter: - 01 Theoretical Framework of Financial Accounting M.Com, MBA, KSET

Meaning of Book-Keeping
Book-keeping is art of recording business transaction in the books of accounts,
in an orderly manner. The recording of business transaction is done by a person
called is called book keeper.

Objectives of Book-Keeping
1. To have a permanent record of all business transactions.
2. To find out the profit or loss during particular period.
3. To ascertain the financial position as on a date.
4. To know how much he owes to another’s and how much others owe him.
5. To knows his incomes, expenses, losses, gains, assets and liabilities.

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

Definition of Accounting
According to American institute of certified public accountants, “accounting
is the art of recording, Classifying and summarizing in a significant manner in terms
of money transaction and events which are in part at least of a financial character
and interpreting the result thereof”.

The process of accounting contents the following steps

1. Recording transaction: - In accounting, each and every business transaction is
properly recorded .It usually done on daily basis. At the time of recording, only
the financial aspect alone is taken into account.

2. Classifying transaction: - It is the process of classifying or grouping the similar

items under one head. This work is performed after recording the transaction in
journal. In accounts, this type of work is technically known as “Posting” or
Ledger Entry”.

3. Summarizing the transactions: - It refers to presenting the classified data in a

readable and understandable form. In involves preparation of financial
statements which include Income statement and Balance Sheet.

4. Interpreting the transactions: - The financial data recorded is analyzed and

interpreted in such a manner that the end users can make a meaningful
judgment about the financial condition of the business.

5. Communication of results: - Having done all the steps above, the net results
should be communicated to the proper person for decision making purpose.
Financial Accounting Mohammed Nadeem
Chapter: - 01 Theoretical Framework of Financial Accounting M.Com, MBA, KSET

Meaning of Accountancy
Accountancy is the practice of recording, classifying, and reporting
on business transactions for a business. It provides feedback to management
regarding the financial results and status of an organization.

Book-keeping vs. Accounting

Sl.
Book-keeping Accounting
No.
Book-keeping consists of recordingAccounting concerns itself with
01 financial transactions in a logical
summarizing of such recorded financial
fashion transactions
It is the basis of the process of Accounting is the basis for the Business
02
accounting Language
Financial statements are not a partPreparing financial statements is the
03
of the bookkeeping ultimate aim of accounting
Managers do not take decisions on Accounting records are used to assist
04
the basis of bookkeeping records managers in making decisions
Accounting has branches such as Cost
Bookkeeping does not have any
05 Accounting, Management Accounting,
branches
etc.
06 It is done by bookkeepers, who do
Accountants, on the other hand, require
not require any special skill or
special accounting knowledge and skills
knowledge

Objectives of Accounting
1. To maintain full and systematic records of business transactions: - Accounting
is the language of business transactions. The main objective of accounting is to
maintain a full and systematic record of all business transactions.

2. To ascertain profit or loss of the business: - Business is run to earn profits.

Whether the business earned profit or incurred loss is ascertained by accounting
by preparing Profit & Loss Account or Income Statement.

3. To depict financial position of the business: - A businessman is also interested

in ascertaining his financial position at the end of a given period. For this
purpose, a position statement called Balance Sheet is prepared in which assets
and liabilities are shown.

4. To provide accounting information to the interested parties: - Apart from

owner of the business enterprise, there are various parties who are interested in
accounting information. These are bankers, creditors, tax authorities, prospective
investors, researchers, etc. Hence, one of the objectives of accounting is to make
Financial Accounting Mohammed Nadeem
Chapter: - 01 Theoretical Framework of Financial Accounting M.Com, MBA, KSET

the accounting information available to these interested parties to enable them to

take sound and realistic decisions. The accounting information is made available
to them in the form of annual report.

5. To know the solvency position:- By preparing the balance sheet, management

not only reveals what is owned and owed by the enterprise, but also it gives the
information regarding concern’s ability to meet its liabilities in the short run
(liquidity position) and also in the long run (Solvency position) as and when they
fall due.

Advantages of Accounting
1. Accounting helps to maintain the business records in a systematic manner.
2. It helps in the preparation of financial statements.
3. Accounting information is also used to compare the result of current year
with the previous year to analyze the changes.
4. It helps the managers in the decision making process.
5. It provides information to other interested parties such as shareholders,
creditors, investors, customers, government, employees etc.
6. It helps in taxation matter
7. Accounting information can be produced as evidence in the legal matter.
8. It helps in valuation of business.

Limitations of Accounting
1. The items expressed in monetary terms are recorded in the accountings
whereas the items which are nonmonetary nature not recorded.
2. Sometimes accounting data are recorded on the basis of estimates and which
could be inaccurate.
3. Fixed assets are recorded as the original cost.
4. Value of money does not remain stable so accounting value does not show
true financial results.
5. Accounting can be manipulated and biased

Users of Accounting Information

1. Owners: - Owners invest capital to start and run business with the primary
objective to earn profit. They need accurate financial information to know what
they have earned or lost during a particular period of time. On the basis of this
information they decide their future course of actions such as expansion or
contraction of business.

2. Management: - Management uses accounting information for evaluating and

analyzing organization’s financial performance and position, to take important
decisions and appropriate actions to improve the business performance in terms
of profitability, financial position and cash flows.
Financial Accounting Mohammed Nadeem
Chapter: - 01 Theoretical Framework of Financial Accounting M.Com, MBA, KSET

3. Investors: - Investors use this information to know how their funds are used by
the management and the expected performance of business in future in terms of
profitability and growth. On the basis of this information, they decide whether to
increase or decrease investment in corporation in future.

4. Creditors: - Creditors are individuals or financial institutions that normally

lend money to businesses and earn interest income on it. They need accounting
information to assess the financial performance and position and to have a
reasonable assurance that the business to whom they are going to lend money
would be able to return the principal amount as well as pay interest there on.

5. Suppliers: - Suppliers are business individuals or organizations that normally

sell merchandise or raw materials to other businesses on credit. They use
accounting information to have an idea about the future creditworthiness of the
business and to decide whether or not to continue providing goods on credit.

6. Employees: - They are interested in financial information because their present

and future is tied up with the success or failure of the business. The success and
profitability of business ensures job security, better remuneration, job promotion
and retirement benefits.

7. Banks and Financial Institutions: - Banks and Financial Institutions expect

financial statement of a concern, when company approach the bank for financial
assistance like Loans, cash credits, overdraft, etc.

8. Government: - Government agencies use financial information of businesses for

the purpose of imposing taxes and regulations.

9. Researchers Scholars: - At present, research scholars also use the accounting

information extensively for the purpose of their research work.

10. General public: - General public also uses accounting information of business
organizations. For example, accounting information is:
i. A source of education for students of accounting and finance.
ii. A source of valuable data for those researching on organizational impacts on
individuals and economy as a whole.
iii. A source of information for the people looking for job opportunities.
iv. A source of information about the future of a particular enterprise.

Branches of Accounting
1. Financial Accounting: It is that branch of accounting, which involves the
recording of the transactions, inclined towards the preparation of trial balance
and final accounts.

2. Cost Accounting: Cost account is the accounting discipline, which deals with
costs, i.e. the unit costs of the goods produced and services provided. It helps the
Financial Accounting Mohammed Nadeem
Chapter: - 01 Theoretical Framework of Financial Accounting M.Com, MBA, KSET

management of the organization in fixing the price, controlling costs and

providing relevant information for the purpose of decision making.

3. Management Accounting: The accounting system which supplies the necessary

information to the management, for rational decision making. The information
may be concerned with funds, costs, profits and losses and so forth. This
information is helpful in determining the effect of the decisions and analyzing the
performance of the entity.

4. Tax Accounting: The accounting system that deals with the tax return and its
payment, instead of preparation of final accounts of the enterprise, is called tax
accounting.

5. Social Accounting: This branch of accounting is commonly termed as social

responsibility accounting. It aims at unveiling the facilities provided by the entity
to the society, in terms of medical, housing, education, and so forth.

Accounting Concepts
Definition of Accounting Concept
Accounting Concepts can be understood as the basic accounting assumption,
which acts as a foundation for the preparation of financial statement of an enterprise.
Indeed, these form a basis for formulating the accounting principles, methods and
procedures, to record and present the financial transactions of business.

1. Business entity concept: A business and its owner should be treated separately
as far as their financial transactions are concerned.

2. Money measurement concept: Only business transactions that can be expressed

in terms of money are recorded in accounting, though records of other types of
transactions may be kept separately.

3. Dual aspect concept: For every credit, a corresponding debit is made. The
recording of a transaction is complete only with this dual aspect.

4. Going concern concept: In accounting, a business is expected to continue for a

fairly long time and carry out its commitments and obligations. This assumes
that the business will not be forced to stop functioning and liquidate its assets at
“fire-sale” prices.

5. Cost concept: The fixed assets of a business are recorded on the basis of their
original cost in the first year of accounting. Subsequently, these assets are
recorded minus depreciation. No rise or fall in market price is taken into account.
The concept applies only to fixed assets.
Financial Accounting Mohammed Nadeem
Chapter: - 01 Theoretical Framework of Financial Accounting M.Com, MBA, KSET

6. Accounting year concept: Each business chooses a specific time period to

complete a cycle of the accounting process—for example, monthly, quarterly, or
annually—as per a fiscal or a calendar year.

7. Matching concept: This principle dictates that for every entry of revenue
recorded in a given accounting period, an equal expense entry has to be recorded
for correctly calculating profit or loss in a given period.

8. Realization concept: According to this concept, profit is recognized only when it

is earned. An advance or fee paid is not considered a profit until the goods or
services have been delivered to the buyer.

Accounting Conventions:-
Definition of Accounting Convention
Accounting Conventions, as the name suggest are the practice adopted by an
enterprise over a period of time, that rely on the general agreement between the
accounting bodies and helps in assisting the accountant at the time of preparation of
financial statement of the company.
There are four main conventions in practice in accounting: conservatism;
consistency; full disclosure; and materiality.

1. Conservatism is the convention by which, when two values of a transaction are

available, the lower-value transaction is recorded. By this convention, profit
should never be overestimated, and there should always be a provision for
losses.
2. Consistency prescribes the use of the same accounting principles from one
period of an accounting cycle to the next, so that the same standards are applied
to calculate profit and loss.

3. Materiality means that all material facts should be recorded in accounting.

Accountants should record important data and leave out insignificant
information.

4. Full disclosure entails the revelation of all information, both favorable and
detrimental to a business enterprise, and which are of material value to creditors
and debtors.

Accounting Cycle:-
The accounting cycle refers to the complete sequence of accounting procedure
which is frequently repeated in the same direction during an accounting period.
a. Recording of transactions in the journals or subsidiary books.
b. Posting them into various ledgers accounts
c. Preparing the Trial Balance from the ledger accounts.
d. Preparing Final Accounts
Financial Accounting Mohammed Nadeem
Chapter: - 01 Theoretical Framework of Financial Accounting M.Com, MBA, KSET

Basic Terms:-
1. Capital: - The amount of cash, goods or assets which is initially invested by
proprietor while commencing business is called capital. It is invested to earn profits.

2. Drawings: - The amount of cash or goods which is withdrawn by proprietor from

business for its private uses is called drawings. It reduces the capital of the business.

3. Goods: - The things which are bought and sold by business are called goods.
Goods maybe raw material work in progress of finished goods.

4. Purchases: - Goods bought for resale are called purchases. This may be in form of
raw material or finished goods. Purchase of assets is not called purchases because
assets are not purchased for resale.

5. Purchase return: - Goods once purchased by the business, are returned back due
to any reason is called purchase return or return outwards.

6. Sales: - When purchase goods are sold in order to earn a profit are called sales.
When goods are sold for cash it is called cash sales and goods sold on credit are
called credit sales.

7. Sales return:- Goods once sold to the customer when are returned back by them
due to any reason then such goods are called as sales returns or return inwards.

8. Stock: - These are those goods which are left unsold in the business at the end of
the year. The goods unsold at the end of the accounting year are called closing
stock. The same stock is called opening stock at the beginning of a new
accounting year.

9. Revenue: - These are the amount received by a business for selling goods or
services. This amount is received from day to day business activity in the form of
rent, interest, commission, discount, dividend etc.

10. Expenses: - The cost which business incurs for producing goods and services or
for using services is called expenses. These include payments made for wages,
salaries, freight, advertisement, rent, insurance etc.

11. Expenditure: - The amount which is paid for increasing profit earning capacity of
business is called expenditure. It is of long period nature.

12. Income: - That amount which increases the capital of the business is called
income. The excess of revenue over expenses is also called income.

13. Loss: - When expenses incurred are more than revenue then this excess of
expenses is called loss. This reduces the capital of the business.

14. Gain: - It is a monetary receipt as a result of business transaction. The excess of

revenue over the expenses is called gain.
Financial Accounting Mohammed Nadeem
Chapter: - 01 Theoretical Framework of Financial Accounting M.Com, MBA, KSET

15. Cost: - Total of direct or indirect expenses which are incurred for the production
of goods and services is called cost. Like the cost of raw material cost of labor and
cost of other services used to make the article is called its total cost.

16. Discount: - Concession a rebate allowed by a businessman to its customer is

called a discount. It may be of two types: –
a. Trade discount: - When a trader allows a concession to its customers on the
list price, it is known as trade discount. It is not recorded in the books. It is
stated in the invoice.
b. Cash discount: - When a trader allows a concession to the customer to make
payment in cash or by cheque, it is known as cash discount. It is recorded in
the books. When cash discount is allowed customer is required to pay the less
due amount, so it encourages the customer to pay as early as possible.

17. Debtor: - The person, firm or an organization who takes goods or services on
credit from the business is called debtors of the business. In other words, the
person, firm or an organization who owes money or Money’s worth to the
business is called debtor.

18. Assets: - All the resources of business having economic value are called assets.
These resources help the business to earn a profit and have future value. These are
important for running a business and are in the possession of businessman. These
are of two types: –
a. Fixed assets: - The assets which are used by business for a long time are called
fixed assets or non-current assets. These are continued to be used by the
business for a period of more than one year. For example: - land, building,
plant, machinery, furniture, vehicle etc.
b. Current assets: - The assets which are used up in one year or easily get
converted into cash in one year are called current assets. For example: - Raw
material, finished goods, debtors, cash balance and bank balance etc.

19. Liabilities: - The amount which business owes to others is called its liabilities.
There is a certain amount which business is under obligation to pay. There are two
types of liabilities: –
a. Long-term liabilities: - Those liabilities which are usually payable after a
period of 1 year. Long-term loans from Financial Institutions, debentures issued
by companies etc.
b. Short-term liabilities: - These are those which are payable within one year. For
example creditors, bank overdrafts etc.

20. Creditors: - The person, firm or organizations from whom goods or services are
purchased on credit by the business are called creditors of the business. The
business owes money to them. The amount payable to creditors is a liability of
the business.
Financial Accounting Mohammed Nadeem
Chapter: - 01 Theoretical Framework of Financial Accounting M.Com, MBA, KSET

21. Receivables: - The total amount which is to be received in business is called

receivables.

22. Payables: - The total amount which is to be paid by the business is called
payables.

23. Turnover: - The total amount of cash and credit sales during a particular period
is called turnover.

24. Insolvent: - A person is said to be insolvent when he or she is incapable to meet

all his or her liabilities. Such a person has more liability than assets.

25. Bad debts: - The amount which could not be recovered from debtors due to his
insolvency or disability to pay is called bad debts.

26. Commission: - In a business activity, a remuneration is paid to the agent for his
services, is called commission.