Financial Accounting – Comprehensive Class Notes

(Units I–IV)
Prepared for: Naitik Wadhwa | Prepared on: August 18, 2025

What’s inside:
• Complete coverage of Unit I–IV per syllabus.
• Detailed theory with definitions, principles, and managerial implications.
• Schedule III orientation for corporate statements; non-corporate formats included.
• Comparison tables: Shares vs Debentures, Indian GAAP/Ind AS vs US GAAP, Amalgamation vs
Absorption, Internal vs External Reconstruction, Error types, Basis of Accounting.
• Diagram: Accounting Cycle overview.
Unit I: Introduction to Financial Accounting
UNIT I: INTRODUCTION TO FINANCIAL ACCOUNTING
1) Meaning & Scope
Financial accounting is the systematic process of identifying, measuring in monetary terms,
recording, classifying, summarizing, and communicating an entity’s financial transactions to users
such as owners, investors, lenders, regulators, and management. It focuses on historical data
expressed in terms of money, enabling performance evaluation and stewardship.
2) Nature (Key Characteristics)
• Dual Aspect: Every transaction affects at least two accounts (debit and credit).
• Monetary Measurement: Only transactions measurable in money are recorded.
• Historical Orientation: Records past transactions, though it increasingly informs forward-looking
decisions.
• Periodicity: Financial performance is measured for defined periods (monthly, quarterly, annually).
• Objectivity & Verifiability: Based on evidence (vouchers, invoices, contracts).
• Accrual Basis & Matching: Revenues recognized when earned, expenses when incurred, matched
to the same period.
• Going Concern: Assumes the entity will continue operating for the foreseeable future.
• Consistency: Similar accounting methods used from period to period for comparability.
3) Functions
• Record: Journalizing and posting to ledger.
• Classify: Grouping transactions into accounts (assets, liabilities, equity, income, expenses).
• Summarize: Trial balance, income statement (P&L;), balance sheet, and cash flow statement.
• Analyze & Interpret: Ratios, trends, common-size analysis.
• Communicate: Reports and notes to accounts for stakeholders.
• Comply: Legal, tax and regulatory reporting.
• Safeguard Assets: Through internal controls, audit trails, authorization, and reconciliation.
4) Usefulness (Managerial & External)
• Planning & Budgeting: Past data informs sales, production, and cash budgets.
• Performance Measurement: Profitability, liquidity, solvency, and efficiency analysis.
• Credit & Investment Decisions: Lenders/investors assess risk and return.
• Legal & Tax Compliance: Statutory reporting, GST/TDS, corporate filings.
• Cost Control: Variance analysis, standard costing inputs (though primarily cost accounting).
5) Branches of Accounting (Overview)
• Financial Accounting: External reporting; statutory focus.
• Cost Accounting: Product/process costing, cost control, inventory valuation.
• Management Accounting: Decision support—budgets, forecasts, capital budgeting, CVP analysis.
• Tax Accounting: Direct and indirect tax computation and compliance.
• Social & Environmental (Green) Accounting: Reporting externalities and sustainability impacts.
• Governmental & Non-profit Accounting: Fund-based statements, budgetary control.
6) Relationship with Business Functions & Financial Issues
• Planning: Sales forecasts, master budgets, capital budgeting; issues—revenue realism, cost
estimation, resource constraints.
• Production: Material, labor, overhead costs; issues—capacity utilization, wastage, inventory holding
costs, depreciation.
• Marketing: Pricing, discounts, credit sales, ad spend; issues—bad debts, warranty liabilities,
customer acquisition cost.
• Procurement: Vendor selection, credit terms, purchase returns; issues—cash cycle length, supplier
concentration risk.
• Information Technology: ERP/accounting systems; issues—implementation cost, data integrity,
cybersecurity, audit trails, compliance with audit requirements.
7) Accounting Concepts & GAAP (Key Principles)
• Entity Concept: Business is distinct from owners.
• Going Concern, Money Measurement, Periodicity.
• Accrual & Matching: Recognize revenue when earned and expenses when incurred to match with
related revenues.
• Prudence (Conservatism): Do not anticipate profits; provide for expected losses.
• Materiality: Focus on information that influences user decisions.
• Cost (Historical Cost) vs Fair Value (in some standards).
• Consistency & Comparability: Uniform methods to enable analysis.
• Substance over Form: Reflect economic reality over legal form (especially under IFRS/Ind AS).
8) Indian GAAP, Ind AS, IFRS, and US GAAP – An Overview
• Indian GAAP (Accounting Standards—AS): Historically rule-focused; now many companies follow
Ind AS (converged with IFRS).
• Ind AS (Converged IFRS): Principle-based, emphasizes fair value, substance over form, and
extensive disclosures.
• IFRS: Global, principle-based standards issued by IASB; aim for comparability and transparency.
• US GAAP: Detailed, industry-specific guidance; tends to be more rules-based, with extensive
codification (ASC).
9) Classification of Accounts & Golden Rules
• Personal Accounts: Natural, Artificial, Representative. Rule—Debit the Receiver, Credit the Giver.
• Real Accounts: Assets. Rule—Debit what comes in, Credit what goes out.
• Nominal Accounts: Incomes/Expenses. Rule—Debit all expenses and losses; Credit all incomes
and gains.
10) Accounting Equation & Impact of Transactions
Core identity: Assets = Liabilities + Equity (Capital).
Example impacts:
• Owner invests cash: Assets ↑ (Cash), Equity ↑ (Capital).
• Buy machinery for cash: Asset exchange—Cash ↓, Machinery ↑ (total assets unchanged).
• Credit purchase: Assets ↑ (Inventory), Liabilities ↑ (Creditors).
• Pay rent: Assets ↓ (Cash), Equity ↓ (Expense → reduces profit).
11) Accounting Cycle (Narrative to accompany diagram)
• Identify & analyze transactions → Source documents.
• Journalize → Chronological record.
• Post to ledger → Classified by account.
• Unadjusted Trial Balance → Check arithmetic accuracy.
• Adjusting entries → Accruals, prepayments, depreciation, provisions.
• Adjusted Trial Balance → Basis for statements.
• Prepare financial statements → P&L;, Balance Sheet, (Cash Flow for companies), Notes.
• Closing entries → Transfer nominal account balances to retained earnings; prepare post-closing TB.
• Reversing entries (optional) → For simplifying the next period.

Diagram: Accounting Cycle

Unit II: Preparation of Financial Statements
UNIT II: PREPARATION OF FINANCIAL STATEMENTS (NON-CORPORATE & CORPORATE)
1) Trial Balance (TB)
Purpose: Verify arithmetic accuracy of postings; provides balances for statement preparation.
Types:
• Total Method: Totals of debits/credits of ledger accounts.
• Balance Method: Lists debit/credit balances—most common.
If TB does not tally, a Suspense Account may be used until errors are rectified.
2) Types of Errors & Their Effect on Trial Balance
• Error of Omission: Entire transaction omitted—TB still tallies but profit is misstated.
• Error of Commission: Wrong amount/posting/ledger—TB may or may not tally.
• Error of Principle: Wrong classification (capital vs revenue)—TB tallies, affects profit and assets.
• Compensating Errors: Multiple errors offset—TB tallies.
Rectification:
• Before Finalization: Pass correcting journal entries.
• After Finalization: Use Profit & Loss Adjustment Account (if prior-period) and rectify.
3) Non-Corporate Financial Statements
A) Trading Account → Calculates Gross Profit = Sales − (COGS).
B) Profit & Loss Account → Calculates Net Profit after operating and non-operating items.
C) Balance Sheet → Position statement listing assets, liabilities, and capital at a date.
Common Adjustments: Closing stock, outstanding/prepaid expenses, accrued income, depreciation,
interest, provisions for doubtful debts, goods on approval, abnormal loss, drawings, etc.
Minimum Presentation: Clear classification into current vs non-current items aids analysis.
4) Corporate Financial Statements (Schedule III of Companies Act, 2013)
• Balance Sheet (Division I for AS; Division II for Ind AS) with major heads: Equity & Liabilities (Share
Capital, Reserves & Surplus, Borrowings, Other Liabilities); Assets (Non-current and Current).
• Statement of Profit and Loss: Revenue from operations, other income, total expenses by nature (or
function under Ind AS), finance costs, depreciation, tax, profit, and other comprehensive income (Ind
AS).
• Cash Flow Statement (mandatory for most companies except certain small entities).
• Notes to Accounts: Significant accounting policies and detailed notes (contingent liabilities,
commitments, related parties, EPS, segments if applicable).
• Disclosures: Managerial remuneration, CSR expenditure (where applicable), auditor’s remuneration,
etc.
Unit III: Company Accounts & Business Combinations
UNIT III: COMPANY ACCOUNTS & BUSINESS COMBINATIONS
1) Shares – Key Concepts
• Equity Shares: Residual ownership, voting rights, variable dividends.
• Preference Shares: Preferential dividend (fixed rate) and preferential capital repayment; may be
cumulative/non-cumulative, redeemable/irredeemable (subject to law), participating/non-participating,
convertible/non-convertible.
Issue of Shares: At par/premium (Securities Premium utilization as per law); discount generally
prohibited except specific cases (e.g., sweat equity, ESOP accounting under Ind AS).
Calls in Arrears & Calls in Advance: Interest implications and disclosure.
Forfeiture & Reissue: For non-payment; amount forfeited transferred to Capital Reserve on reissue.
2) Debentures (Bonds) – Key Concepts
• Nature: Long-term borrowings with fixed interest; no ownership/voting.
• Types: Secured/Unsecured, Registered/Bearer, Redeemable/Irredeemable,
Convertible/Non-convertible.
• Issue: At par/premium/discount; discount amortized.
• Interest: Charged to Profit & Loss; tax-deductible; TDS compliance.
• Redemption: Sinking fund, purchase in open market, conversion into shares, or lump-sum
redemption.
3) Shares vs Debentures – Comparison (see detailed table in this PDF)
Core difference: Shares = ownership & dividends (variable, not obligatory); Debentures = loan &
interest (fixed, obligatory).
4) Amalgamation, Absorption, and Reconstruction – Concepts
• Amalgamation: Two or more companies combine to form a new entity; assets and liabilities pooled.
• Absorption: One company acquires another; the acquirer continues.
• External Reconstruction: Transfer of business to a new company formed for restructuring; old
company wound up.
• Internal Reconstruction: Capital reorganization within the same company (e.g., reduction of share
capital, writing off accumulated losses).
5) Purchase Consideration (PC) – Determination
• Net Assets Method: PC = Agreed value of net assets (Assets taken over − Liabilities assumed).
• Net Payment Method: Sum of payments made (cash, shares, debentures).
• Intrinsic Value/Share Exchange method in acquisitions.
6) Accounting Treatment (High-level)
• Under legacy AS-14: Pooling of interests (for merger) and Purchase method (for purchase).
• Under Ind AS 103 (IFRS-aligned): Acquisition method—recognize identifiable assets and liabilities
at fair value; recognize goodwill or gain from bargain purchase; transaction costs expensed;
contingent consideration recognized at fair value.
• Inter-company Transactions & Holdings: Eliminate inter-company balances, unrealized profits in
inventory/PPE; account for NCI (non-controlling interest) in consolidated statements.
7) Internal vs External Reconstruction – Differences (see table)
Unit IV: IT Applications, Ethics, and Contemporary Issues
UNIT IV: IT APPLICATIONS, ETHICS, AND CONTEMPORARY ISSUES
1) Information Technology in Accounting
• Scope: Master data (ledgers, stock items), voucher entry (sales, purchases, receipts, payments,
journals), automated posting, and reporting (TB, P&L;, Balance Sheet, Cash Flow).
• Software Packages: Tally, SAP, Oracle, Microsoft Dynamics—integrate inventory,
receivables/payables, GST, payroll, and banking.
• Benefits: Speed, accuracy, audit trail, real-time dashboards, consolidation across branches,
drill-down to vouchers, scenario analysis.
• Risks: Data security, access controls, backup/disaster recovery, change management, segregation
of duties, system overrides.
• Tally Usefulness (illustrative):
– Masters: Ledgers, stock groups/items, tax ledgers.
– Vouchers: Sales/Purchase, Contra, Payment, Receipt, Journal, Debit/Credit Notes.
– Reports: Day book, Ledger analysis, TB, P&L;, Balance Sheet, GST returns, aging analysis.
– Managerial Implications: Credit policy enforcement, reorder levels, variance checks, expense
controls, and MIS for decisions.
2) Ethics in Accounting and Business
• Fundamental Principles (IESBA/ICAI-aligned): Integrity, Objectivity, Professional Competence and
Due Care, Confidentiality, Professional Behavior.
• Typical Threats: Self-interest, self-review, advocacy, familiarity, intimidation.
• Safeguards: Independent reviews, rotation, Chinese walls, enhanced disclosures, audit committees,
internal controls, whistleblower mechanisms.
• Corporate Codes of Ethics: Tone at the top, conflict-of-interest policy, gifts/hospitality rules,
related-party protocols, ESG commitments.
• Ethical Dilemmas Examples: Revenue cut-off pressure; provisioning disputes; aggressive
capitalization; insider information. Resolution approach—identify stakeholders, refer to code,
escalate, document rationale.
3) Contemporary Issues in Accounting & Reporting
• Human Resource Accounting (HRA): Recognizing and reporting value of human assets;
methods—cost-based (acquisition/training costs), value-based (present value of future earnings).
Limitations—measurement subjectivity.
• Price Level Accounting (Inflation Accounting): Current Purchasing Power (CPP) and Current Cost
Accounting (CCA) to adjust for inflation; improves comparability over time.
• Social Accounting: Reporting social costs/benefits (community development, employee welfare).
• Green Accounting (Environmental): Costs of pollution control, carbon reporting, restoration
liabilities, asset retirement obligations.
• CSR Reporting (overview): Policy, projects, spends, and impact reporting as per applicable law;
board oversight and disclosures in annual report.
• Sustainability Reporting: Typically guided by frameworks like GRI; covers economic, environmental,
and social metrics.
• Integrated Reporting (): Connectivity of information across six capitals—financial, manufactured,
human, intellectual, social & relationship, natural. Focus on strategy, governance, performance, and
prospects.
Comparison: Shares vs Debentures
Basis Shares (Equity/Preference) Debentures (Bonds)
Nature Ownership interest; residual claim on assets after creditors. Loan capital; creditor claim with p

Return Dividend (variable for equity; fixed for preference; not obligatory). Interest (fixed, obligatory, tax-ded

Voting Rights Equity holders usually have voting rights. No voting rights (except in specif

Security Generally unsecured; backed by company performance. Often secured by charge on asse

Redemption Equity: not redeemable; Preference: redeemable as per law. Redeemable as per terms; may h

Risk/Priority Higher risk; residual claim. Lower risk; priority in interest and

Accounting Impact Dividends appropriated from profits; EPS affected. Interest expensed in P&L; affects

Comparison: Indian GAAP / Ind AS vs US GAAP

Aspect Indian GAAP / Ind AS (IFRS-converged) US G
Philosophy Principle-based (Ind AS); substance over form, fair value emphasis. More

Revenue Recognition Ind AS 115 (IFRS 15) five-step model; contract-based. ASC

Financial Instruments Ind AS 32/107/109 classification, impairment (ECL), hedge accounting (IFRS-like). ASC

Leases Ind AS 116—single lessee model (right-of-use). ASC

Business Combinations Ind AS 103—acquisition method at fair value, goodwill impairment. ASC

OCI/Comprehensive Income OCI items presented; recycling depends on standard. Comp

Presentation (Schedule III) Statutory formats for Indian companies; notes required. No st

Error Types and Effects on Trial Balance

Error Type Description TB Tally? Impact/Rectification
Omission Transaction wholly/partly omitted. May tally Affects P&L/BS; pass entry when detected.

Commission Wrong posting/amount/ledger. May not tally Correct account and amount; adjust suspense

Principle Wrong classification (capital vs revenue). Usually tally Reclassify; affects profit and assets/liabilities.

Compensating Errors offset each other. Tally Identify individually; pass entries.

Internal vs External Reconstruction

Basis Internal Reconstruction External Reconstruction
Meaning Reorganization within same company; capital reduction, write-offs. Formation of a new company to tak

Legal Process Court/NCLT approval often required for capital reduction. Transfer of assets/liabilities; old com

Shareholders Usually continue as shareholders post-restructuring. Get shares in new company as con

Objective Clean up balance sheet; adjust capital to realistic values. Comprehensive reorganization with
Amalgamation vs Absorption
Basis Amalgamation Absorption
Entity Outcome New entity formed; old companies cease. Acquirer survives; acquired company ceases.

Accounting (legacy) Pooling (merger) or purchase method. Purchase method; assets/liabilities taken over.

PC Consideration Share exchange common; may include cash. Cash/ shares/ debentures by acquirer.

Basis of Accounting: Cash vs Accrual vs Hybrid

Basis Cash Basis Accrual Basis Hybrid/Modified
Recognition When cash is received/paid. When earned/incurred, regardless of cash. Mix—some items on ca

Suitability Very small entities, personal finance. Most businesses; statutory reporting. Small entities during tra

Note: These notes are for academic learning and quick revision. For statutory reporting, always refer to the
latest applicable standards and company law requirements.