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Chapter 01

Introducing Financial Accounting



Importance of Accounting
is a Accounting
system that Identifies

Relevant information that is Communicates


about an organizations business activities.



Accounting Activities
Identifying Business Activities Recording Business Activities

Communicating Business Activities



Users of Accounting Information

Internal Users External Users

Lenders Shareholders Governments

Consumer Groups External Auditors Customers

Managers Officers Internal Auditors

Sales Staff Budget Officers Controllers



Users of Accounting Information

External Users

Internal Users

Financial accounting provides external users with financial statements (shareholders, lenders, etc.).

Managerial accounting provides information needs for internal decision makers (officers, managers, etc.).


Opportunities in Accounting
Financial Managerial
General accounting Cost accounting Budgeting Internal auditing Consulting Controller Treasurer Strategy Lenders Consultants Analysts Traders Directors Underwriters Planners Appraisers

Preparation Planning Regulatory Investigations Consulting Enforcement Legal services Estate plans FBI investigators Market researchers Systems designers Merger services Business valuation Forensic accountant Litigation support Entrepreneurs

Preparation Analysis Auditing Regulatory Consulting Planning Criminal investigation



Generally Accepted Accounting Principles

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).
Relevant Information Affects the decision of its users.
Is trusted by users.

Reliable Information

Comparable Information

Used in comparisons across years & companies.



Setting Accounting Principles

In the United States, the Securities and Exchange Commission, a government agency, has the legal authority to establish reporting requirements and set GAAP for companies that issue stock to the public.
The Financial Accounting Standards Board is the private group that sets both broad and specific principles.

The International Accounting Standards Board (IASB) issues international standards that identify preferred accounting practices in other countries. More than 100 countries now require or permit companies to prepare financial reports following IFRS standards.


Cash Accounts Receivable Notes Receivable


Resources owned or controlled by a company


Store Supplies




Accounts Payable Notes Payable

Creditors claims on assets

Taxes Payable Wages Payable



Contributed Capital Retained Earnings

Owners claim on assets



Income Statement
Net income is the difference between Revenues and Expenses.

Scott Company Income Statement For Month Ended December 31, 2011 Revenues: Consulting revenue Expenses: Salaries expense Net income

3,000 800 2,200

The income statement describes a companys revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.


Balance Sheet
The Balance Sheet describes a companys financial position at a point in time.
Scott Company Statement of Retained Earnings For Month Ended December 31, 2011 Retained Earnings, Dec. 1, 2011 Plus: Net income Less: Dividends Retained Earnings, Dec. 31, 2011 $ 2,200 500 1,700

Scott Company Balance Sheet December 31, 2011 Assets $

Cash Supplies Equipment

9,700 1,200 16,000

Total assets


Liabilities Accounts payable Notes payable Total liabilities Equity Common stock Retained earnings Total liabilities and equity

1,200 4,000 5,200 20,000 1,700





Cost accounting is concerned with recording, classifying and summarizing costs for determination of costs of products or services, planning, controlling and reducing such costs and furnishing of information to management for decision making


Accounting for determination and control of costs.


The Institute of Cost and Management Accountant,

England (ICMA) has defined Cost Accounting as the process of accounting for the costs from the point at which expenditure incurred, to the establishment of its ultimate relationship with cost centers and cost units. In its widest sense, it

embraces the preparation of statistical data, the application of cost control

methods and the ascertainment of the profitability of activities carried out or planned.

Cost Accounting = Costing + Cost Reporting + Cost Control.

Cost means the amount of expenditure ( actual or notional) incurred on, or attributable to, a given thing.


Ascertainment of costs Estimation of costs Cost control

Cost reduction
Determining selling price Facilitating preparation of financial and other statement Providing basis for operating policy

Cost means the amount of expenditure incurred on a particular thing. Costing means the process of ascertainment of costs. The application of cost control methods and the ascertainment of the



profitability of activities carried out or planned.

COST CONTROL: Cost control means the control of costs by management. Following are the
aspects or stages of cost control.

JOB COSTING: It helps in finding out the cost of production of every order and thus helps in
ascertaining profit or loss made out on its execution. The management can judge the profitability of each job and decide its future courses of action.

BATCH COSTING: Batch costing production is done in batches and each batch consists of a
number of units, the determination of optimum quantity to constitute an economical batch is all the more important.

1. What is Financial Management?

Process of: Running your business Recording money coming in and out Using reports to: Understand how your business is doing Make decisions

Six Ways Financial Management Helps Your Business Succeed

2. Manage Customers and Sales. Know and understand your customers through consolidated records. 3. Production. Obtain goods and services. Apply for and establish credit with your vendors.

1. Cash Flow. Track the money going in and out of your business.

6. Funding. To be considered for a loan or investment, youll need complete financial statements. 5. Insight and Decision Making. Make informed decisions and price your product or service for profitability with financial reports

4. Compliance. Report your companys incomes, expenses, and payroll accurately to the IRS.

The Functions of Management

Planning Acting Controlling


Primary Users
Financial Investors Creditors Government authorities (IRS, SEC, etc.)

Management Internal managers of the business

Purpose of Information
Financial Management Help investors, Help managers creditors, and plan and control others make business investment, credit, operations and other decisions

Accounting and Book-keeping

Accounting is the language of business to communicate the business results to various groups of persons interested in the business.

Accounting may be defined as the identifying, measuring, recording and communicating of financial information.
Bierman and Derbin

According to J.R. Batliboi Book-keeping may be defined as the science as well as the art of

recording business transactions under appropriate

The purpose of accountancy is to facilitate business and economic development

Basic Accounting Terms -1

Transaction : Every financial change which occurs in the business is a
transaction. In other words, a transaction refers to any monetary or financial event or activity (i.e., an activity having value measurable in terms of money) which changes the financial position of the business.
All events may not be measurable in terms of money, but every transaction is measurable in terms of money. An event may or may not cause a change in the financial position of the business. On the other hand a transaction necessarily causes a change in the financial position of the business.

Basic Accounting Terms - 2

Capital : The amount of money or moneys worth invested by
the proprietor into his business at the time of the commencement of business is called capital. Capital is also defined as owners equity i.e., owners claims against the assets of the business.

Assets : Means enough or sufficient economic resources

owned by a business concern for carrying on the business. According to Finney and Miller Assets are future economic benefits, the rights of which are owned or controlled by an Organisation or individuals.

Basic Accounting Terms - 3

Liabilities : Mean the claims of outsiders against the business
concern which bind the business concern to others. Examples are loans borrowed, bank overdraft, creditors, bills payable, etc.,.

Net worth : Means the excess of the total assets of a business

over its total liabilities at any particular point of time. called owners capital. It is the net value of assets that belongs to the owner. It is also

Debtor : A debtor is a person who owes money to the business.

He owes money to the business because he has received some benefit from the business. A debtor constitutes an asset for the business.

Basic Accounting Terms - 4

Creditor : A creditor is a person to whom the business owes
money. The business owes money to him, because he has given some benefit to the business. A creditor constitutes a liability for the business.

Goods : Goods refers to merchandise, commodities, products,

articles, things in which a trader deals. In other words, they refer to commodities or things meant for resale.

Basic Accounting Terms - 6

Revenue : Revenue or income is the earning of a business
from the sale of goods or from the rendering of services to

customers during an accounting period.



Revenue from sale of goods, interest on investments, royalty received, discount received, etc.,

Expenses : Expenses are the costs incurred in connection

with the earnings of revenue. In other words expense is the cost of the things or services for the purpose of generating income. Examples are repair expenses, cost of goods

purchased, salary and wages, interest, etc.,

Basic Accounting Terms -7

Loss : Loss refers to money or moneys worth given up without getting
any benefit in return. Loss occurs accidentally or involuntarily. In the Income Statement, any Examples are loss of goods by fire, loss of machinery in accident, damages paid to others, etc.,. expenditure amount in excess of Income is also termed as LOSS.

Profit : Profit is the excess of revenues over the expenses of a given

period of time, usually a year. Profit results in increase in owners

Some Accounting Terminologies

Net Worth : The net worth of an enterprise represents the excess of book value of all assets over the outside liabilities. It represents the interest of the shareholders in the enterprise. It is normally equivalent to the net equity i.e., Share capital plus Reserves plus Retained profits less Unabsorbed losses or Expenses. Contingent Liability : Liabilities which are dependent on a condition which exists at the balance sheet date, where the Salary outcome will be confirmed only on the occurrence or non-

occurrence of one or more uncertain future events.

Some Accounting Terminologies

Generally Accepted Accounting Principles (GAAP) : Many countries have got their own GAPP. These are ground rules

covering financial accounting, prescribed by Financial

Accounting Standard Board, USA, that attempt to strike a balance between the criterion of relevance on one hand and the criteria of objectivity and feasibility on the other.

Distinctions One should invariably know

Capital Expenditure and Revenue Expenditure : Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment is capital expenditure. On the other hand, expenditure incurred for running and maintaining the assets or purchasing goods for resale is revenue expenditure.

Revenue Expenditure involving cash outgo is Cash Expenditure. Examples are Salary and wages, Repair expenses, interest, etc., . Revenue Expenditure charged to P&L A/c but not involving cash outgo is Non-cash expenditure. Examples are Deprecation and Return on Equity or Profit.