B.Com. - I Financial Accounting

 

Financial Accounting-I

 

Unit-1 Basics of Accounting

 

Ø  History of Development of Accounting

 

            When a man started living in groups and business activities started, money was not in use Barter system was used for exchange of goods and there was no need of accounting. With the development of trade and commerce, money was introduced and need for accounting also developed.

The system of accounting developed in India for account keeping is known as Bahikhata system or Deshi Nama system. During the Maurya period in Indian history, Chanakya in his book Arthashashtra devoted a separate chapter on accounting, in which he discussed the method of keeping accounts about expends and profit and also adopt the checking of accounting.

Accounting was simple in the initial stage. There were no elaborate books of account. In the modern times, even financial accounting system could not meet the requirements of changing times and hence two important branches of accounting, viz. Cost Accounting and Management Accounting developed.

 

Ø  Definition of Accounting

 

            According to AICPA “Accounting is an art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events, which are in part at least, of financial character and interpreting the reasons thereof ”

 

Ø  Characteristics of Accounting

 

(1)   It is an Art

(2)   It is a Science

(3)   Only Financial Transactions

(4)   Recorded in terms of Money

(5)   Recorded in Special Books

(6)   Records made with particular period

(7)   Records are correctly made and Continuous

(8)   Even service transactions are recorded

 

Ø  Advantages of Accounting

 

(1)   Maintains complete record of all transactions

(2)   Gives information of various types of expenses and incomes

(3)   Shows the true and fair financial position of business

(4)   Comparison of result with other firms

(5)   Helps in controlling and detecting frauds and

(6)   Useful For taking decision of business

Ø  Limitations of Accounting

 

(1)   It requires more labour and time which results is more expensive

(2)   Accounting does not non-monetary transactions

(3)   Accounting does not consider changes in prices

(4)   In accounting transactions are recorded in terms of money

(5)   Certain accounting policies differs from one business unit to another

 

Ø  Methods of Keeping Accounts

(1)   Double Entry Book-keeping

(2)   Single Entry System

(3)   Indian System or Bahi-khata System

 

Ø  Various Branches of Accounting

(1)   Financial Accounting

(2)   Cost Accounting

(3)   Management Accounting

 

Ø  Accounting Concepts and Conventions

 

(1)   Business Entity Concept

(2)   Money Measurement Concept

(3)   Going Concern Concept

(4)   Cost Concept

(5)   Realisation

(6)   Accrual Concept

(7)   Matching Concept

(8)   Periodicity Concept

(9)   Dual Aspect Concept

(10)     Consistency

(11)     Conservatism

(12)     Materiality

(13)     Disclosure

 

Ø  Accounting Policies

 

(1)   Method of depreciation, depletion and amortization

(2)   Treatment of expenditure during construction

(3)   Conversion of foreign currency items

(4)   Valuation of inventories

(5)   Treatment of goodwill

(6)   Valuation of investments

(7)   Treatment of retirement benefits

(8)   Recognition of profit on long term contracts

(9)   Valuation of fixed assets

(10)     Treatment of contingent liabilities

Unit-2 Accounting Process

 

Ø  Accounting Cycle

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ø  Types of Transactions

 

(1)   Economic Transactions

Forms of Economic Transactions

 

                                                                                                                      

 

Exchange of Goods for          Exchange of Cash for                Exchange of Debts for

 

 

 

 

 

 

 

(2)   Non-economic Transactions

Ø  Types of Accounts with Rules

Accounts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ø  Accounting Equation Method or Balance Sheet Method

           

            Every transaction has two effects, one effect is on assets and the other effect is on Liabilities. It means that when a transaction takes place an asset increases or decreases and liabilities increases or decreases.

Assets = Liabilities + Capital

            The equation always remains true. It means that every transaction has one effect on one side of the equation and the other effect on the other side of the equation or both the effects may be on the same side, then one asset increases and some other asset decreases. Thus, both the sides of the equation are always equal.

            This method is also known as a Balance Sheet Method because both the effects of a transaction are shown on two sides of the Balance Sheet.

 

Journal

 

Ø  Meaning of Journal

            ‘A Journal is a book of account in which business transactions are recorded in their two-fold aspect for the first time, in the order of their happenings.’

 

Ø  Characteristics of Journal

 

(1)   Transactions are first recorded in journal and so it is called a book of original entry.

(2)   Transactions are recorded in it from day to day and that too in the order of their happenings.

(3)   There are two columns for recording amount to be debited and credited.

(4)   A detailed description of the transaction is given in this record, which is called ‘narration’.

 

Ø  Importance of Journal

 

(1)   All transactions are systematically recorded in order of dates and time.

(2)   There is no confusion about which account is debit and credit in the ledger.

(3)   It is possible to know the nature and details of the transaction.

(4)   There is no possibility of arithmetic error in the journal

 

Ø  Formation of Journal

 

Date	Particulars	L.F.	Dr.	Cr.

 

Ø  Entries for Various Types of Transactions

 

(a)    Starting a new business with Capital

                  Cash A/c                                             Dr.

                  Goods A/c                                           Dr.

                  Assets A/c                                           Dr.

                  Debtors A/c                                         Dr.

                              To Creditors A/c

                              To taken Loan A/c

                              To Capital A/c

 

(b)   Drawing Transactions

                  Drawings A/c                                      Dr.

                              To Cash A/c

                              To Goods withdrawn A/c

 

(c)    Goods Transactions

(i)     Purchases

      Purchases A/c                                      Dr.

                  To Cash A/c

                  To Supplier’s A/c

(ii)   Sales

      Cash A/c                                             Dr.

      Customer’s A/c                                               Dr.

                  To Sales A/c

(iii) Purchase Returns or Return Outwards

      Supplier’s A/c                                     Dr.

                  To Purchase Returns A/c

(iv) Sales Returns or Return Inwards

      Sales Returns A/c                                Dr.

                  To Customer’s A/c

 

 

 

(d)   Goods going out for Other Reasons

(i)     Goods are burnt or damaged by fire

                        Loss by Fire A/c                                  Dr.

      To Goods Burnt by Fire A/c

 

(ii)   Goods are stolen or lost

                        Loss by Theft A/c                               Dr.

      To Goods Stolen A/c

(iii) Goods given as charity

                        Charity A/c                                         Dr.

      To Goods given as charity A/c

(iv) Goods Distributed as samples

                        Advertisement A/c                              Dr.

      To Goods distributed as samples A/c

(v)   Goods Withdrawn for personal use

                        Drawing A/c                           Dr.

      To Goods withdrawn for personal use A/c    

 

(e)    Discount and Allowance

(i)     Trade Discount:

                  The amount allowed to the retailer off the catalogue price is treated as ‘Trade Discount’. The trade discount is not recorded in the books of account.

(ii)   Cash Discount:

                  The discount is connected with cash receipts and payments, so it is called Cash Discount. Cash discount is calculated on the amount payable or receivable.

 

(f)    Purchase and Sale of Assets

(i)     Purchase of Assets

      Assets A/c                                           Dr.

                  To Cash A/c

(ii) Sale of Assets

      Cash A/c                                             Dr.

                  To Assets A/c

 

(g)   Transactions of Expenses and Incomes

(i)     Expenses

      Expenses A/c                                      Dr.

                  To Cash A/c

(ii) Incomes

      Cash A/c                                             Dr.

                  To Incomes A/c

 

 

 

(h)   Loan taken and Interest on Loan

(i) Loan taken

                  Cash A/c                                             Dr.

                              To Loan A/c

(ii) Interest on loan

      Interest A/c                                         Dr.

                  To Cash A/c   

(i)     Bed Debts

Bed Debts A/c                                                Dr.

                        To Debtors A/c

 

(j)     Bank Transactions

(i) Cash paid into bank

      Bank A/c                                             Dr.

                  To Cash A/c

(ii) Cash withdrawn from bank

      Cash A/c                                             Dr.

                  To Bank A/c

(iii) Payment is made by cheque

      Creditor’s A/c                                     Dr.

                  To Bank A/c

(iv) Cross cheque is received

      Bank A/c                                             Dr.

                  To Giver’s A/c

 

Ledger Posting

 

Ø  Meaning of Ledger

 

A summary of transactions with each person, asset, expense or income shown on a separate page in ledger is called an Account. The book in which such Accounts are prepared is called ledger.

‘A book of accounts in which all accounts relating to persons, goods, assets, expenses and income are kept is known as Ledger’.

 

Ø  Importance of Ledger

 

            It gives following information relating to business:

(1)   What are the total sales and purchases during a particular period of time?

(2)   What are the expenses and incomes of the business and of which types?

(3)   What are the assets owned by a business on a particular day?

(4)   What is the amount of profit or loss made during a particular period?

(5)   What is the financial position of the business on a particular day of the year?

(6)   How much amount the business owes to others and to whom?

(7)   All important information required for managerial decision making.

 

Ø  Difference between Journal and Ledger

 

Journal	Ledger
(1) A book of accounts in which       transactions are first recorded is called a journal. (2) It is a book of original entry. (3) A short description of every transaction recorded. (4) Both the debit and credit effects of a transaction are written at the same time and date.	(1) It is a book of accounts in which summary of transactions are written in separate accounts. (2) It is the principal book of accounts. (3) No such description of transactions entered. (4) One effect of a transaction is given in one account and the other effect in some other account.

 

Ø  Formation of a Ledger Account

Dr.                                                                                                                                     Cr.

Date	Particulars	J.F.	Amount		Date	Particulars	J.F.	Amount

 

Subsidiary Books

 

Ø  Meaning of Subsidiary Books

            Subsidiary books are those books of original entry which are kept in addition to journal, to record similar types of transactions which are of repetitive nature and sufficiently large in number.

 

Ø  Advantages of Subsidiary Books

 

(1)   More persons writing accounts

(2)   Ease in posting and audit works

(3)   Possibility of errors and frauds reduced

(4)    Information available promptly

(5)   Saving of time and energy

(6)   Entrusting responsibility

(7)   More accuracy

(8)   Computer accounting

 

Ø  Subsidiary Books

(1)   Purchases Book or Invoice Book or Bought Book

(2)   Sales Book or Day Book or Sold Book

(3)   Purchase Return Book or Returns Outward Book

(4)   Sales Return Book or Returns Inward Book

(5)   Bills Receivable Book

(6)   Bills Payable Book

(7)   The Cash Book

(8)   The Proper Journal

Formation of Purchases Book

Date	Name of the Suppliers	Inward Inv. No.	L.F.	Amount
	Total			________

 

Formation of Sales Book

Date	Name of the Customers	Outward In. No.	L.F.	Amount
	Total			________

 

Formation of Purchases Returns Book

Date	Name of the Suppliers	Debit Note No.	L.F.	Amount
	Total			________

 

 

Formation of Sales Returns Book

Date	Name of the Customers	Credit Note No.	L.F.	Amount
	Total			________

 

Cash Book

 

Ø  Meaning of Cash Book

 

            “Cash book is that sub-division of journal in which only cash transactions are recorded and is divided into two parts called Receipts and Payments”.

 

Ø  Importance of Cash Book

 

(1)   Cash book acts as both a book of original entry and cash account of the ledger.

(2)   As cash balance and bank balance are found daily in the cash book.

(3)   If any difference is found between cash on hand and cash balance as per cash book, it may be investigate without delay.

(4)   There is no need to open separate bank account.

(5)   The work of writing it can be entrusted to some trust worthy and responsible person.

 

Ø  Types of Cash Book

 

(1)   Simple Cash Book or One-column Cash Book

Dr.                                                                                                                                      Cr.

Date	Receipts	Rec. No.	L.F.	Amount		Date	Payments	Voucher No.	L.F.	Amount

 

(2)   Two-column Cash Book

      There are three types of Two-column Cash Book

(i)     Cash Book with Cash and Discount Columns.

(ii)   Cash Book with Cash and Bank Columns.

(iii) Cash Book with Bank and Discount Columns.

Dr.                                                                                                                                      Cr.

Date

Receipts

Rec. No.

L.F.

Disc- ount

Cash

Date

Payments

Vou- cher No.

L.F.

Disc- ount

Cash

 

(3)   Three-column Cash Book

Dr.                                                                                                                                      Cr.

Date

Rece- Ipts

Rec. No.

L.F.

Disc- ount

Cash

Bank

Date

Paym- ents

Vou- cher No.

L.F.

Date

Disc- ount

Cash

Bank

 

Ø  Contra Transactions

(1)   When cash is paid into the bank

            Bank A/c                                             Dr.

                        To Cash A/c

(2)   When cash is withdrawn from the bank

            Cash A/c                                             Dr.

                        To Bank A/c

 

Final Accounts

 

Trading Account of _____________

for the year ended on ___________

Dr.                                                                                                                                      Cr.

Particulars	Rs.		Particulars	Rs.
To Opening stock To Purchases                      ---- Less : Purchase Returns     ---- To Expenses relating to Purchases To Wages To Carriage Inward To Railway Freight To Excise duty To Octroi To Custom duty To Unloading charges To Demurrage To Clearing charges To Dock charges To Gross Profit (transferred to P & L A/c)	________		By Sales                              ---- Less :                                   ---- By Goods Burnt by fire By Goods Stolen By Goods given away in charity By Goods given as samples By Goods drawn for personal use By Closing Stock By Gross Loss (if any) (transferred to P & L A/c)	________

 

 

Profit & Loss Account of _____________

for the year ended on ___________

Dr.                                                                                                                                      Cr.

Particulars	Rs.		Particulars	Rs.
To Gross Loss (transferred from Trading A/c) To Administrative Expenses: Salary Provident fund contribution Taxes Rent Electricity Postage and Telegram Printing and Stationery Insurance Premium Audit fee Legal Expenses To Selling Expenses : Advertisement Discount Allowed Salesmen’s Salaries Commission Showroom expenses Traveling expenses Bad debts To Distribution Expenses : Carriage Outward Packing expenses Delivery van expenses To Financial Expenses : Interest on Capital Interest on Loan Interest on Bank Overdraft Bank charges To Misc. Expenses & losses : Depreciation on assets Loss by theft, charity or fire Loss on sale of assets To Net Profit  (transferred to Capital A/c)	________		By Gross Profit (transferred from Trading A/c) By Incomes : Interested received Dividend received Rent received Discount received Commission received Brokerage received Sale of old newspapers Apprentice premium Bad debts recovered Interest on loan Interest on drawings By Net Loss (if any) (transferred to Capital A/c)	________

 

 

Balance Sheet of _____________

as on ___________

 

Liabilities	Rs.		Assets	Rs.
Capital Add : Net Profit Add : Increase in Capital Add : Interest on Capital Less : Net Loss Less : Drawings Less : Interest on drawings Reserve fund Bank Overdraft Bank Loan Sundry Creditors Bills Payable Prepaid Income Unpaid expenses Provident fund	________		Goodwill Land and Building Factory Plant and Machinery Land on lease Furniture and Fittings Vehicles Patent, Trademark etc. Investments (Government securities, Shares or Debentures etc.) Sundry Debtors Bills receivable Closing Stock Stationery stock Cash on hand Bank balance Loan given Prepaid expenses Income due but not received Deferred Revenue expenses	________

 

 

 

 

 

 

Unit-3 Final Accounts of Non Trading Organization

 

Ø  Difference between the Final Account of Trading and Non-trading Organization

 

Points	Trading concerns	Non-trading concerns
(1)   Trading       Results	A trading concern prepares a trading account to ascertain gross profit or loss.	A non-trading concern does not prepare this account.
(2)   Financial Result	A trading concern prepares a profit and loss account.	A non-trading concern prepares an Income and Expenditure account.
(3)   Sources of Income	The main source of incomes of a trading concern is sales.	Its income from subscription, entrance fees, donations, interest on investment.
(4)   Net profit or Loss	Its defined net profit or net loss.	Its defined Excess of Income or Excess of Expenditure.
(5)   Capital	The excess of assets of trading concern is known as Capital.	The excess of assets of non-trading concern is known as Capital Fund.
(6)   Basis of preparing A/c	Accounts maintain on mercantile basis.	Accounts maintain on cash basis.

 

Ø  List of Revenue and Capital items with illustration:

 

Capital	Revenue
Capital Incomes	Revenue Incomes
Donations Legacy Subscription received for a special purpose Proceeds from sale of fixed assets Capital fund Subscription for life membership	Entrance fees Subscriptions from members Interest on investments Locker’s rent Sale of old newspapers Incomes from annual dinner, entertainment programmes, canteen etc. Rent of the hall Proceeds from lectures and entertainment Incomes from other regular activities
Capital Expenditure	Revenue Expenditure
Money spent on purchasing assets Expenses met out of special subscriptions received Expenses that add to or increase the efficiency or earning capacity of assets   Repairs to put the old and dilapidated assets into working condition	Staff salaries, printing and stationery, rent etc. If a canteen is run, then the purchase of food stuffs, cigas, gas, electricity etc. Subscriptions to newspapers and journals Cost of annual dinner or entertainment expenses Loss on sale of fixed assets Expenses incurred in maintaining the assets in good working conditions

 

Ø  Distinction between Receipts and Payments Account and Income and Expenditure Account

 

Receipts and Payments Account	Income and Expenditure Account
1. It is only a summary of cash transactions.   2. The opening balance is cash balance and closing balance is cash on hand. 3. Receipts are entered on the debit side and payments on the credit side. 4. Both revenue and capital items are recorded. 5. It is prepared on cash basis. 6. Balance sheet does not necessarily accompany this account.	1. It is resembles Profit and Loss A/c of trading concern. 2. There is no opening balance. It indicates excess of income or excess of expenditure. 3. Incomes are entered on the credit side and expenses on the debit side. 4. Only revenue income and expenditure are recorded. 5. It is prepared on mercantile basis. 6. It is always accompanied by the Balance sheet.

 

 

Ø  Preparing Income and Expenditure Account from Receipts and Payments Account

 

(1)   Items appearing on the debit side of Receipts and Payments Account will be shown on the credit side of Income and Expenditure Account and vice-versa.

(2)   Opening and closing balances of this account will not be included in the Income and Expenditure Account.

(3)   Capital income and capital expenditure will be excluded in Income and Expenditure Account.

(4)   Items relating to previous year or next year should be eliminated and incomes and expenses relating to the current year only should be shown in Income and Expenditure Account.

(5)   Income due but received as well as expenses due but not paid for the current year must be shown in the Income and Expenditure Account.

(6)   Non-cash items like depreciation, bad debts reserve etc. should be included and shown in Income and Expenditure Account.

 

 

 

 

 

 

Definitions

 

Transaction

            A transaction is an exchange of goods, services and cash, between persons. There are two types of transactions; economic transactions and non-economic transactions. Only economic transactions are recorded in books of account.

 

Goods

            The word ‘goods’ is used for those articles in which the business deals. In other words goods are those things which are bought by a businessman for resale to make profit, e.g. radios are goods for a dealer in radios, machinery goods for a machine dealer.

 

Assets

            Assets are all those things or rights which are owned by the business and have monetary value. They are properties which help to run the business. Business liabilities can be paid with help of assets.

 

Capital

            The amount invested by the proprietor in a business is called. The owner of business may bring not only cash but some other assets also by way of capital. A businessman brings capital when he starts business and he may also bring additional capital whenever more money is needed in business. The amount of capital is credited to a separate account called ‘Capital Account’.

 

Drawings

            It is the value of cash or goods or any other asset withdrawn from business by a proprietor for his personal or domestic use. When the proprietor withdraws money, his capital is reduced. When the proprietor withdraws money from business, he receives the benefit and so his personal account is debited. This personal account of the proprietor is called ‘Drawing Account’.

 

Solvent

            A person is said to be solvent when his assets are more than his liabilities. He is able to pay his debts to the third parties in full, because he has more assets than his debts.

 

Insolvent

            If a person’s liabilities are more than his assets, he is called insolvent. He is not able to pay his debts in full, because the value of his assets is not enough to pay the debts.

 

 

Trade Discount

            When a producer or a wholesaler allows some deduction on the catalogue price to the retailer, it is called trade discount. The seller and purchaser both make entries in books of account for the net amount in the books of account.

 

Cash Discount

            Cash discount is an allowance made by the receiver of cash to the payer for making prompt payment. When a customer makes payment immediately after purchases or within a specified time, then such discount is allowed. Cash discount is always recorded in the books of accounts while trade discount is not recorded.