Accounting is a system for recording, summarizing, and reporting financial transactions for a business.

Finance is the study and management of money, credit, banking, and investments. It can also refer to the
money or liquid resources of a business, group, individual, or government.

Financial management is the process of planning, organizing, directing, and controlling a business's financial
resources to achieve its goals.

Kinds of Accounts and Golden Rules:

1. Personal Account is a general ledger account that pertains to individuals. It can be natural persons -
such as humans, or artificial persons, like corporations, firms, associations, and so on.
"Credit the giver and Debit the Receiver."
2. Real Account is a normal ledger account that can record all the assets and liabilities.
"Debit what comes in - credit what goes out."
3. Nominal Account is a normal ledger account that records all income, expenses, profits, and losses for a
business.
"Credit all income and debit all expenses."

The accounting equation

states that assets always equal liabilities plus owner's equity. It shows the relationships between a business's
assets, liabilities, and owner's equity. Assets are resources owned, liabilities are debts owed to creditors, and
owner's equity is the owners' claim to or investment in the assets.

GAAP stands for generally accepted accounting principles, which set the standard accounting rules for
preparing, presenting, and reporting financial statements in the U.S. (Financial Accounting Standards Board)

o The goal of GAAP is to ensure that a company's financial statements are complete, consistent, and
comparable.
o GAAP is used mainly in the U.S., while most other countries follow the international financial reporting
standards (IFRS). The international financial reporting standards (IFRS), set by the International
Accounting Standards Board (IASB)
o One key difference between GAAP and IFRS is the treatment of inventory. IFRS rules ban using last-in,
first-out (LIFO) inventory accounting methods, whereas GAAP permits LIFO. Both systems accept the
first-in, first-out (FIFO) and weighted average-cost methods.

 Principle of Regularity: GAAP-compliant accountants strictly adhere to established rules and

regulations.
 Principle of Consistency: Consistent standards are applied throughout the financial reporting
process.
 Principle of Sincerity: GAAP-compliant accountants are committed to accuracy and impartiality.
 Principle of Permanence of Methods: Consistent procedures are used in the preparation of all
financial reports.
 Principle of Continuity: Asset valuations assume the organization's operations will continue.
 Principle of Periodicity: Reporting of revenues is divided by standard accounting periods, such as
fiscal quarters or fiscal years.
 Principle of Materiality: Financial reports fully disclose the organization's monetary situation.
 Principle of Utmost Good Faith: All involved parties are assumed to be acting honestly.

Accounting concepts are fundamental principles and assumptions that guide the preparation and presentation
of financial statements. Here are some key accounting concepts along with examples:

1. Business Entity Concept

  Meaning: The business is treated as a separate entity from its owner(s) and other businesses.

 Example: If a business owner invests $10,000 into their business, it is recorded as the business's
capital, not the owner's personal money.

2. Money Measurement Concept

 Meaning: Only transactions that can be measured in monetary terms are recorded in accounting.

 Example: Employee skills or brand reputation are not recorded in financial statements as they can’t be
precisely measured in money terms.

3. Going Concern Concept

 Meaning: Assumes the business will continue to operate indefinitely unless stated otherwise.

 Example: If a company buys a building, it records the cost as an asset, not an expense, since it assumes
it will use the building for several years.

4. Cost Concept

 Meaning: Assets are recorded based on their purchase price, not their current market value.

 Example: If a business buys land for $50,000, it records the land at $50,000 even if the value increases
to $60,000 over time.

5. Dual Aspect Concept

 Meaning: Every transaction has two aspects, a debit and a credit, which keeps the accounting equation
balanced (Assets = Liabilities + Owner’s Equity).

 Example: If a business takes a loan of $5,000, assets increase by $5,000, and liabilities also increase by
$5,000.

6. Accounting Period Concept

 Meaning: Financial statements are prepared for a specific period, such as monthly, quarterly, or yearly.

 Example: A company prepares an annual financial report to summarize income and expenses over the
year, showing its financial performance.

7. Accrual Concept

 Meaning: Revenues and expenses are recorded when they are earned or incurred, not when cash is
exchanged.

 Example: If a company completes a service worth $1,000 in December but receives payment in
January, it records the revenue in December.

8. Matching Concept

 Meaning: Expenses should be matched with the revenues they help generate in the same period.

 Example: If a company sells products in January and incurs manufacturing costs in December, the costs
are recorded in January, aligning them with revenue.

9. Revenue Recognition: Revenue is the gross in-flow of cash arising from the sale of goods and services by an
enterprise and use by others of the enterprise resources yielding interest royalities and divididends. The
concept of revenue recognition requires that the revenue for a business transaction should be considered
realised when a legal right to receive it arises.
Accounting Conventions

1. Conservatism (Prudence) Convention

 Meaning: Accountants should record expenses and liabilities as soon as possible, but only recognize
revenues when they are assured. This approach minimizes the chance of overstating profits.

2. Consistency Convention

 Meaning: The same accounting methods and principles should be consistently applied from period to
period. This consistency allows financial statements to be comparable across different periods.

3. Full Disclosure Convention

 Meaning: All material information (anything that could affect the decision-making of users) should be
disclosed in the financial statements. This transparency provides a complete view of the company’s
financial status.

4. Materiality Convention

 Meaning: Accountants should focus on significant items that could impact financial decisions and
ignore trivial details. This concept ensures that time and resources are used effectively.

5. Objectivity Convention

 Meaning: Financial information should be based on objective, verifiable evidence and free from
personal bias. This approach promotes reliability and credibility in financial reporting.

Debits and Credits in Accounting

Debits and credits are the fundamental building blocks of double-entry bookkeeping. They represent the two
sides of every financial transaction.

Debits (DR)

 Increases: Assets and Expenses

 Decreases: Liabilities, Equity, and Revenue

Credits (CR)

 Increases: Liabilities, Equity, and Revenue

 Decreases: Assets and Expenses

Asset is a resource that has value and can be used to generate economic benefit for its owner

Liabilities are obligations or debts that an enterprise has to pay at some time in the future. They represent
creditors’ claims on the firm’s assets.

Capital: Amount invested by the owner in the firm is known as capital.

Sales are total revenues from goods or services sold

Expenses: Costs incurred by a business in the process of earning revenue are known as expenses. expenses
are:

depreciation, rent, wages, salaries, interest, cost of heater, light and water, telephone, etc.
Expenditure Spending money or incurring a liability for some benefit, service or property received is called
expenditure. Purchase of goods, purchase of machinery, purchase of furniture, etc. are examples of
expenditure. If the benefit of expenditure is exhausted within a year, it is treated as an expense (also called
revenue expenditure). On the other hand, the benefit of an expenditure lasts for more than a year, it is treated
as an asset (also called capital expenditure) such as purchase of machinery, furniture, etc

Profit The excess of revenues of a period over its related expenses during an accounting year is profit.

Gain is a general increase in the value of an asset or property. A gain arises if the current price of something is
higher than the original purchase price.

Loss is the excess of expenses of a period over its related revenues

Discount is the deduction in the price of the goods sold.

Voucher The documentary evidence in support of a transaction is known as voucher. For example, if we buy
goods for cash, we get cash memo, if we buy on credit, we get an invoice; when we make a payment we get a
receipt and so on.

Drawings Withdrawal of money and/or goods by the owner from the business for personal use is known as
drawings. Drawings reduces the investment of the owners.

Purchases are total amount of goods procured by a business

Stock is the goods which are lying unsold as at the end of an accounting period is called closing stock (trading
concern). In a manufacturing company, closing stock comprises raw materials, semi-finished goods and finished
goods on hand on the closing date. Similarly, opening stock (beginning inventory) is the amount of stock at the
beginning of the accounting period.

Debtor is an individual or entity that owes money to another party.

Creditor is an individual or entity that has lent money

Journal Entry: A journal entry is the initial record of a financial transaction in the accounting system. Each entry
records which accounts are affected, with a debit and credit to balance the transaction. Purpose: Journals
provide a chronological record of all business transactions.

The ledger is a collection of individual accounts where all journal entries related to a particular account (e.g.,
Cash, Accounts Receivable) are posted or transferred. Purpose: Ledgers help track changes in each account's
balance over time and serve as the basis for preparing a trial balance.

A trial balance is a list of all ledger account balances at a specific date. The debit and credit totals are summed
to ensure they are equal, confirming that entries in the ledger are balanced. Purpose: Trial balances help
detect errors in bookkeeping and ensure accuracy before financial statements are prepared.

Trading and Profit & Loss Account (Income Statement)

 Definition: The trading account calculates gross profit by deducting the cost of goods sold from net
sales. The profit and loss account then adds other incomes and deducts expenses, resulting in net
profit or net loss.

 Purpose: The income statement provides insight into the company’s profitability over a specific period
by summarizing revenue and expenses.

 Relationship to Trial Balance: Account balances for revenues and expenses are taken from the trial
balance to prepare the income statement.
Balance Sheet

 Definition: The balance sheet shows the financial position of the company at a specific date. It lists
assets, liabilities, and owner’s equity, following the accounting equation (Assets = Liabilities + Equity).

 Purpose: It provides a snapshot of the company’s financial health, showing what it owns and owes.

 Relationship to Income Statement: The net profit or loss from the income statement is added to the
owner’s equity in the balance sheet.

Cash Flow Statement

 Definition: The cash flow statement records the cash inflows and outflows over a period, divided into
operating, investing, and financing activities.

 Purpose: It provides insight into the cash position and liquidity of the business, indicating how cash is
generated and used.

 Relationship to Income Statement and Balance Sheet: Cash flow is linked to the income statement
through net profit (adjusted for non-cash items like depreciation) and to the balance sheet through
changes in asset and liability accounts that impact cash.

Fund Flow Statement

 Definition: A fund flow statement (or statement of changes in financial position) shows the inflows and
outflows of funds within a business over a specific period. It highlights changes in working capital and
identifies sources and uses of funds.

 Purpose: This statement is used to analyze the financial structure of a business, showing how funds are
generated and used. It helps assess a company's ability to manage its financial resources and indicates
long-term financial health.

 Example: If a company issues new shares, the cash received would appear as a source of funds, while
purchasing new machinery would be listed as a use of funds.

 Difference from Cash Flow Statement: Unlike the cash flow statement, which focuses on cash, the
fund flow statement covers broader working capital components, like debt and equity changes, and is
not limited to cash-based transactions.

LIFO (Last-In, First-Out)

 Definition: LIFO is an inventory valuation method where the last items added to inventory are assumed
to be sold first.

FIFO (First-In, First-Out)

 Definition: FIFO is an inventory valuation method where the first items added to inventory are
assumed to be sold first.

Cost of Goods Sold (COGS)

  Definition: COGS represents the direct costs associated with producing the goods or services a
business sells during a period. It includes expenses directly tied to production, like raw materials, labor,
and manufacturing overhead, but excludes indirect expenses like distribution or administrative costs.

 Formula: COGS=Opening Inventory+Purchases+Direct Expenses−Closing Inventory

Operating expenses

Selling and distribution exp

Office and admn exp

Other exp
Current liabilities are obligations that a company must pay within one year, typically from current assets.
Examples: Accounts payable, short-term loans, accrued expenses, and unearned revenue.

Current assets are assets that are expected to be converted into cash or used up within one year. They are
highly liquid and include cash, accounts receivable, and inventory.

Working capital is the difference between a company’s current assets and current liabilities. It represents the
liquidity available to meet short-term obligations.

Capital refers to the financial resources invested by owners or shareholders in a business. It represents the
initial funds and retained earnings used for business activities.

Accounts receivable (AR) is the amount owed to a business by its customers for goods or services sold on
credit.

Accounts payable (AP) represents the amount a company owes to suppliers or vendors for goods or services
received on credit.

Debtors are individuals or entities that owe money to the company, usually for goods or services provided on
credit.

Creditors are individuals or entities to whom the company owes money for goods or services received on
credit.

Bad debts are amounts owed to a business that are unlikely to be collected, typically due to customer
insolvency or non-payment.

Doubtful debts are amounts owed to a company by debtors that may not be fully collectible, but there is some
expectation of partial recovery.

Accrued expenses/Income are expenses that have been incurred/earned but not yet paid/recieve by the end
of an accounting period.

Deferred income (or unearned revenue) is income received in advance for goods or services yet to be
provided.

Deferred expenses, or prepaid expenses, are expenses paid in advance for goods or services to be received in
the future.

Long-term liabilities are obligations a company expects to settle over more than one year, often used to
finance long-term investments.
Fixed assets are long-term assets used in business operations, not meant for resale. They provide future
economic benefits over multiple periods.

Intangible Assets Non-physical assets with a long-term value, often representing intellectual property or
goodwill. Examples: Patents, trademarks, goodwill, and copyrights.

Debentures are a type of long-term debt instrument issued by a company to raise capital.

Equity shares, represent ownership in a company, giving shareholders voting rights and a share in profits, often
as dividends.

Preference shares are shares that give holders a fixed dividend and priority over equity shareholders for asset
distribution in liquidation, but generally lack voting rights.

Retained earnings are the accumulated net profits kept in the company after dividends are paid, reinvested
into the business.

Reserves are portions of profits set aside for specific purposes or future contingencies, while surplus
represents excess capital.

Provisions are amounts set aside from profits for specific anticipated liabilities or losses. Ex: Provision for bad
debts, provision for tax, and provision for depreciation.

Outstanding Expenses are expenses that have been incurred but have not yet been paid. These are obligations
the company needs to settle in the future and are considered current liabilities on the balance sheet.

Inactive accounts are closed and are not to be used in the future. Dormant accounts are not currently
functional but may be used in the future.

Earnings Per Share or EPS is the amount that the shareholder will earn from the earnings of the company. It is
calculated by the following formula: EPS = Net Income /Average outstanding common shares

Fictitious Assets Fictitious assets are not tangible or realizable assets. They represent expenses or losses not
yet written off, such as preliminary expenses, discount on issue of shares, etc. Although these do not hold real
value, they are shown on the asset side of the balance sheet.

Bank Reconciliation Statement (BRS) is prepared to reconcile the difference between the bank balance as per
company cash book and bank balance as per bank statement. This statement explains discrepancies due to
unrecorded transactions, checks issued but not cleared, etc.

A deferred tax liability represents taxes owed for temporary differences between accounting income and
taxable income, due to methods like depreciation. It’s recorded to balance out the timing difference that
reverses in future years.

Goodwill is an intangible asset representing a company's brand value, customer relations, and reputation. It’s
often calculated when a company is acquired and is the difference between the purchase price and the fair
market value of net assets.

Debit note is issued to inform a seller that goods were returned or services were not satisfactory. It increases
the buyer’s accounts receivable (what the seller owes the buyer).

credit note is issued by the seller to the buyer, acknowledging a reduction in the amount owed by the buyer
due to returned goods or a price adjustment.

Contingent liabilities are potential obligations that depend on the outcome of a future event (e.g., pending
lawsuits, guarantees). They’re not recorded in the books but disclosed in the financial statement notes if the
probability is high.
Sales Return Entry: If goods are returned by the customer:

 Journal Entry: Sales Return Account Dr. To Customer Account

Purchase Return Entry: If goods are returned to the supplier:

 Journal Entry: Supplier Account Dr. To Purchase Return Account

Amortization is the process of spreading the cost of an intangible asset (like patents or goodwill) over its useful
life. For example, patent amortization expense is debited, and accumulated amortization is credited.

Double-Entry Bookkeeping Double-entry bookkeeping is a system where every transaction affects at least two
accounts, with equal and opposite entries in debits and credits. This maintains the accounting equation:
Assets=Liabilities+Equity

Single-Entry Bookkeeping Single-entry bookkeeping is a less complex system where transactions are typically
recorded as single entries in the income statement only. It’s mainly used by small businesses that don’t need to
track assets and liabilities in detail.

Suspense Account A suspense account is a temporary account used to record uncertain or ambiguous
transactions until their classification is determined. Once the transaction's nature is clarified, the amount is
reallocated to the appropriate account.
Ratio analysis is a technique used to evaluate the financial performance and health of a company by analyzing
the relationships between various financial variables in its financial statements
Liquidity Ratios measure a company's ability to meet its short-term financial obligations using its most liquid
assets. These ratios help assess the financial health of a company in terms of its capacity to pay off its current
liabilities.

 Current Ratio: Indicates whether a company has enough assets to cover its short-term liabilities.
Formula: Current Ratio=Current Assets/ Current Liabilities

 Quick Ratio Measures a company’s ability to pay off its current liabilities without relying on
inventory sales. Quick Ratio=Current Assets−Inventory/Current Liabilities
 Cash Ratio Shows a company’s ability to cover its current liabilities with only its most liquid assets (cash
and cash equivalents). Cash and Cash equivalents/ Current Liabilities

Profitability ratios are financial metrics that assess a company's ability to generate profits relative to its
revenue, operating costs, balance sheet assets, or shareholders' equity. These ratios provide valuable insights
into a company's financial health and performance.

 Gross Profit Margin: Measures the profitability of a company's core operations. Gross Profit Margin =
(Gross Profit / Net Sales) * 100%
 Net Profit Margin Measures the overall profitability of a company after all expenses, including taxes
and interest, have been deducted. Net Profit Margin = (Net Income / Net Sales) * 100%
 Return on Assets (ROA) Measures how efficiently a company uses its assets to generate profits. ROA
= (Net Income / Average Total Assets) * 100%
 Return on Equity (ROE) Measures how efficiently a company uses its shareholders' equity to generate
profits. ROE = (Net Income / Average Shareholders' Equity) * 100%
 Earnings Per Share (EPS) Measures the amount of profit allocated to each outstanding share of
common stock. EPS = (Net Income - Preferred Dividends) / Number of Outstanding Shares

Solvency Ratios; Solvency ratios assess a company's ability to meet its long-term debt obligations. They reflect
the financial stability and long-term financial health of a company.

 Debt to Equity Ratio Shows the proportion of debt used to finance the company’s assets relative to the
equity. A higher ratio indicates more risk, as the company relies more on debt. Formula:
Debt to Equity Ratio=Total Debt/Shareholder’s Equity
 Interest Coverage Ratio Indicates how easily a company can pay interest on its outstanding debt with
its earnings before interest and taxes (EBIT). A higher ratio implies better financial health. Formula:
Interest Coverage Ratio=EBIT/Interest Expense
 Debt Ratio Measures the proportion of a company’s assets that are financed by debt. A higher ratio
suggests higher financial risk. Debt / Total Asset

Turnover Ratios Turnover ratios measure how efficiently a company uses its assets to generate sales or
revenue. They indicate the speed at which assets are converted into sales.

 Inventory Turnover Ratio Measures how quickly a company sells its inventory within a given period. A
higher ratio indicates efficient inventory management. Formula: Inventory Turnover Ratio=COGS/
Average Inventory
 Receivables Turnover Ratio Indicates how effectively a company collects revenue from its credit sales.
A higher ratio means quicker collection of receivables. Formula:
Receivables Turnover Ratio=Net Credit Sales/Average Accounts Receivable
 Asset Turnover Ratio Measures a company’s ability to generate revenue from its assets. A higher ratio
indicates better asset utilization. Asset Turnover Ratio=Revenue/ Average Total Assets
  Accounts Payable Turnover Ratio Shows how quickly a company pays off its suppliers. A lower ratio
may suggest that the company is taking longer to pay off its short-term liabilities. Formula:
Accounts Payable Turnover Ratio=COGS/Average Accounts Payable

Comparative statement is a financial statement that shows the financial performance of a company over
multiple periods (e.g., year-over-year, quarter-over-quarter). It compares the line items in the financial
statements (like income, expenses, assets, liabilities) for different periods, making it easier to observe trends,
growth, or decline in performance.

Common size statement is a financial statement in which all line items are expressed as a percentage of a
common number (e.g., total revenue for an income statement or total assets for a balance sheet).