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Accounting - a process of identifying,

recording, summarizing, and reporting


economic information to decision makers in
the form of financial statements
Financial accounting - focuses on the specific
needs of decision makers external to the
organization, such as stockholders, suppliers,
banks, and government agencies
The accounting system is a series of steps
performed to analyze, record, quantify,
accumulate, summarize, classify, report, and
interpret economic events and their effects on
an organization and to prepare the financial
statements.
Accounting systems are designed to meet the
needs of the decisions makers who use the
financial information.
Every business has some sort of accounting
system.
These accounting systems may be very complex or
very simple, but the real value of any accounting
system lies in the information that the system
provides.
Accounting
information is useful to
anyone who makes decisions that
have economic results.
Managers want to know if a new product will be
profitable.
Owners want to know which employees are productive.
Investors want to know if a company is a good
investment.
Creditors want to know if they should extend credit, how
much to extend, and for how long.
Government regulators want to know if financial
statements conform to requirements.
Fundamental relationships in the decision-
making process:

Accountants
Financial
Event analysis & Users
Statements
recording
The major distinction between financial and
management accounting is the users of the
information.
Financial accounting serves external users.
Management accounting serves internal users, such
as top executives, management,
and administrators within
organizations.
The primary questions about an organizations
success that decision makers want to know are:

What is the financial picture of the organization


on a given day?
How well did the organization do during a given
period?
Accountants answer these primary questions
with three major financial statements.
Balance Sheet - financial picture on a given
day
Income Statement - performance over a given
period
Statement of Cash Flows - performance over
a given period
Annual report - a document prepared by
management and distributed to current and
potential investors to inform them about the
companys past performance and future
prospects.
The annual report is one of the most common
sources of financial information used by investors
and managers.
The annual report usually includes:
a letter from corporate management
a discussion and analysis of recent economic events by
management
footnotes that explain many elements of the financial
statements in more detail
the report of the independent auditors
a statement of managements responsibility for
preparation of the financial statements
other corporate information
What are the different sections of
the Balance Sheet?
The balance sheet (also called statement of
financial position or statement of financial
condition) is a snapshot of the financial
status of an organization at a point in time.
Assets are economic resources that
are expected to benefit future
activities of the organization.

Liabilities are the entitys economic


obligations to others.

Owners equity is the excess


of the assets over the liabilities.
The owners equity of a corporation
is called shareholders equity.

Shareholders equity

Paid-in Retained
capital earnings
Sections of the balance sheet:
Assets - resources of the firm that are
expected to increase or cause future cash
flows (everything the firm owns)
Liabilities - obligations of the firm to
outsiders or claims against its assets by
outsiders (debts of the firm)
Owners Equity - the residual interest in, or
remaining claims against, the firms assets
after deducting liabilities (rights of the
owners)
The balance sheet equation:

Assets = Liabilities + Owners


Equity
or
Owners Equity = Assets -
Liabilities
Balance Sheet
Assets = Liabilities + Equity

Income Statement (also called Statement of Operations,


Earnings Statement, Profit/Loss (or P&L) Statement
Revenues - Expenses = Net income (or Net Earnings)
Statement of Changes in Stockholders Equity
Beginning of period total equity + Stock issued +
Net income - Dividends = End of period total
equity
Statement of Cash Flows
Cash inflow - Cash outflow = Net cash flow

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Different categories of users need different
kinds of information for making decisions.
These users can be divided into :

Internal Users; and

External Users.
These are the persons who manage the
business, i.e. management at the top,
middle, and lower levels. Their requirements
of information are different because they
make different types of decisions.
The top level is more concerned with
planning; the middle level is concerned
equally with planning and control; and the
lower level is concerned more with
controlling operations. Information is
supplied on different aspects, e.g. cash
resources, sales estimates, results of
operations, financial position, etc.
All persons other than internal users come
in the group of external users. External
users can be divided into two groups:
those having direct interest; and
those having indirect interest
in a business organization.
The main sources of information for external
users are annual reports of business
organizations, which state the financial
position and performance and give the
auditors report, directors report and other
information.
Investors and creditors are the external
users having direct interest. Tax authorities,
regulatory agencies, customers, labour
unions, trade associations, stock exchanges,
investors, etc are indirectly interested in the
companys financial strength, its ability to
meet short-term and long-term obligations,
its future earning power, etc for making
various decisions.
These are economic resources of an
enterprise that can be usefully expressed in
monetary terms. Assets are things of value
used by the business in its operations.
Fixed Assets
Current Assets
Fixed Assets are assets held on a long-
term basis.
e.g. Land, Building, Machinery, Plant,
Furniture and Fixtures, etc.
Current Assets are assets held on a
short-term basis.
e.g. Debtors, Bills receivable,
Stock(Inventory), Cash and Bank
balances, etc.
These are obligations or debts that the
enterprise must pay in money or services at
some time in the future.

Long-term liabilities

Short-term liabilities
Long-term liabilities are those that are
usually payable after a period of one year.

e.g. A term loan from a financial institution,


debentures (bonds) issued by a company.
Short-term liabilities are obligations that
are payable within a period of one year.

e.g. Creditors, bills payable, overdraft from


a bank for a short period.
Investment by the owner for use in the firm
is known as capital. Owners equity is the
ownership claim on total assets. It is equal
to total assets minus total liabilities.
These are the amounts the business earns
by selling its products or providing services
to customers. Other titles and sources of
revenue common to many businesses are:
sales, fees, commission, interest, dividends,
royalties, rent received, etc.
These are costs incurred by a business in
the process of earning revenue. Generally,
expenses are measured by the cost of
assets consumed or services used during an
accounting period. The usual titles of
expenses are: depreciation, rent, wages,
salaries, interest, costs of heat, light and
water, telephone, etc.
Purchases are total amount of goods
procured by a business on credit and for
cash, for use or sale. In a trading concern,
purchases are made of merchandise for
resale with or without processing.
In a manufacturing concern, raw materials
are purchased, processed further into
finished goods and then sold. Purchases
may be cash purchase or credit purchase.
Sales are total revenues from goods or
services sold or provided to customers.
Sales may be cash sales or credit sales.
Stock (Inventory) is a measure of
something on hand goods, spares and
other items in a business.

It is called stock on hand.


In a trading concern, the stock on hand is
the amount of goods which have not been
sold on the date on which the balance sheet
is prepared. This is also called closing
stock.
In a manufacturing concern, closing stock
comprises raw materials, semi-finished
goods and finished goods on hand on the
closing date.

Similarly, opening stock is the amount of


stock at the beginning of the accounting
year.
Debtors are persons and/or other entities who
owe to an enterprise an amount for receiving
goods and services on credit.

The total amount standing against such persons


and/or entities on the closing date, is shown in the
Balance Sheet as Sundry Debtors on the asset
side.
Creditors are persons and/or other entities who
have to be paid by an enterprise an amount for
providing the enterprise goods and services on
credit.

The total amount standing to the favour of such


persons and/or entities on the closing date, is
shown in the Balance Sheet as Sundry Creditors
on the liability side.
Accounting principles can be subdivided into
two categories:

Accounting Concepts; and

Accounting Conventions.
Accounting principles can be subdivided into
two categories:

Accounting Concepts; and

Accounting Conventions.
Accounting Concepts
Accounting Conventions
The term concept is used to connote
accounting postulates, that is necessary
assumptions and conditions upon which
accounting is based. The term convention
is used to signify customs and traditions as
a guide to the presentation of accounting
statements.
Accounting Concepts
Business Entity Concept
Money Measurement Concept
Cost Concept
Going Concern Concept
Dual Aspect Concept
Realization Concept
Accounting Period Concept
Accounting Conventions
Convention of Consistency
Convention of Disclosure
Convention of Conservation
Accounting Concepts
The term concept is used to connote
accounting postulates, that is necessary
assumptions and conditions upon which
accounting is based.
Business is treated as a separate entity or
unit apart from its owner and others. All the
transactions of the business are recorded in
the books of business from the point of view
of the business as an entity and even the
owner is treated as a creditor to the extent
of his/her capital.
In accounting, we record only those
transactions which are expressed in terms
of money. In other words, a fact which can
not be expressed in monetary terms, is not
recorded in the books of accounts.
Transactions are entered in the books of
accounts at the amount actually involved.
Suppose a company purchases a car for
Rs.1,50,000/- the real value of which is
Rs.2,00,000/-, the purchase will be recorded
as Rs.1,50,000/- and not any more. This is
one of the most important concept and it
prevents arbitrary values being put on
transactions.
It is persuaded that the business will exists
for a long time and transactions are
recorded from this point of view.
Each transaction has two aspects, that is,
the receiving benefit by one party and the
giving benefit by the other. This principle is
the core of accountancy.
For example, the proprietor of a business
starts his business with Cash Rs.1,00,000/-,
Machinery of Rs.50,000/- and Building of
Rs.30,000/-, then this fact is recorded at
two places. That is Assets account (Cash,
Machinery & Building) and Capital accounts.
The capital of the business is equal to the
assets of the business.
Thus, the dual aspect can be expressed as
under

Capital + Liabilities = Assets


or
Capital = Assets Liabilities
Accounting is a historical record of
transactions. It records what has happened.
It does not anticipate events. This is of
great important in preventing business firms
from inflating their profits by recording sales
and income that are likely to accrue.
Strictly speaking, the net income can be
measured by comparing the assets of the
business existing at the time of its
liquidation. But as the life of the business is
assumed to be infinite, the measurement of
income according to the above concept is
not possible. So a twelve month period is
normally adopted for this purpose. This time
interval is called accounting period.
Accounting Conventions

The term convention is used to signify


customs and traditions as a guide to the
presentation of accounting statements.
In order to enable the management to draw
important conclusions regarding the working
of the company over a few years, it is
essential that accounting practices and
methods remain unchanged from one
accounting period to another. The
comparison of one accounting period with
that of another is possible only when the
convention of consistency is followed.
This principle implies that accounts must be
honestly prepared and all material
information must be disclosed therein. The
contents of Balance Sheet and Profit and
Loss Account are prescribed by law. These
are designed to make disclosure of all
material facts compulsory.
Financial statements are always drawn up
on rather a conservative basis. That is,
showing a position better than what it is,
not permitted. It is also not proper to show
a position worse than what it is. In other
words, secret reserves are not permitted.
Keeping systematic records
Protecting properties of the business
Communicating the results
Meeting legal requirements
The first function of accounting is to keep a
systematic record of financial transactions,
to post them to the ledger accounts and
ultimately prepare final statements.
The second important function is to protect
the property of the business. The system
accounting is designed in such a way that it
protects its assets from an unjustified and
unwarranted use.
The fourth and the last function of
accounting is to meet the legal
requirements under the Companies Act,
Income Tax Act, Sales Tax Act and so on.
Recording transactions in subsidiary books.
Classifying data by posting from subsidiary
books to the accounts.
Closing the books and preparation of final
accounts.
Accounts in the names of persons are known as
Personal Accounts
Accounts in the names of assets are known as
Real Accounts
Accounts in respect of expenses and incomes
are known as Nominal Accounts
ACCOUNTS

PERSONAL IMPERSONAL
ACCOUNTS ACCOUNTS

REAL NOMINAL
ACCOUNTS ACCOUNTS
Accounts in the name of persons are known as
personal accounts.
Eg: Babu A/C,
Babu & Co. A/C,
Outstanding Salaries A/C, etc.
These are accounts of assets or properties. Assets
may be tangible or intangible. Real accounts are
impersonal which are tangible or intangible in
nature.
Eg:- Cash a/c, Building a/c, etc are Real
Accounts related to things which we can
feel, see and touch.
Goodwill a/c, Patent a/c, etc Real Accounts
which are of intangible in nature.
These accounts are impersonal, but invisible and
intangible. Nominal accounts are related to those
things which we can feel, but can not see and
touch. All expenses and losses and all incomes
and gains fall in this category.
Eg:- Salaries A/C, Rent A/C, Wages A/C, Interest
Received A/C, Commission Received A/C,
Discount A/C, etc.
Each accounts have two sides the left side and
the right side. In accounting, the left side of an
account is called the Debit Side and the right
side of an account is called the Credit Side. The
entries made on the left side of an account is
called a Debit Entry and the entries made on the
right side of an account is called a Credit Entry.
By: Munawar Hameed