Financial accounting
MBA 1st Sem
Unit : - 1
Bookkeeping and Accounting
• Bookkeeping is the systematic recording and is the part of
accounting that records transactions and business events
in the form of journal entries in the accounting system.
• Accounting is the art of recording, classifying and
summarizing in a significant manner and in terms of
money, the transactions and events which are, in part at
least of a financial character and interpreting the results
thereof.”
• Bookkeeping and accounting are often heard being used
interchangeably, however, accounting is the overall
practice of managing finances of a business or individual,
while bookkeeping refers more specifically to the tasks
and practices involved in recording the financial activities.
Bookkeeping System
There are two types of bookkeeping i.e.
Single entry and Double entry system of bookkeeping.
Single Entry system of Bookkeeping
➢ Under this system both debit and credit aspects of transaction are not recorded.
➢ Only Personal accounts & cash book are opened.
➢ Under this system balance sheet is not prepared.
➢ It is improper system of bookkeeping.
Double Entry system of Bookkeeping The double entry system of bookkeeping is based on the
fact that every transaction has two aspects, which therefore affects two ledger accounts. Every
transaction involves a debit* entry in one account and a credit** entry in another account.
Each and Every debit aspect has its equal and corresponding credit aspect and vise versa.
➢ Based on principle of duel aspect of each transaction.
➢ For correct presentation both of them should be recorded.
➢ Requires maintenance of records of assets, liabilities, revenues and expenditure.
➢ Impact of each transaction can be seen or measured.
➢ Total assets are equal to total equities.
Accountants often use T-accounts to visualize the debit and credit effects on the accounts'
balances.
*To debit an account means to enter an amount on the left side of the account.
**To credit an account means to enter an amount on the right side of an account.
Classification of Accounts
• Concept of Debit & Credit (Golden Rules)
• PERSONAL ACCOUNT : Personal Account: Personal accounts are
accounts relating to persons or organisations with whom the business
has transactions. E.g Customer, Supplier, Money lenders etc.
Debit the Receiver
Credit the Giver Debit
• REAL ACCOUNT : Real accounts refer to accounts in which property
and possession are recorded. E.g Land, Building, Plant & Machinery,
Vehicle Cash, Bank etc.
Debit what comes in
Credit what goes out
• NOMINAL ACCOUNT :Nominal accounts are revenue, expenses,
gains, and losses. E.g. Wages, Salary, Discount etc .
Debit all Expenses and Losses
Credit all Incomes and Gains
Accounting Concepts and Conventions
• These generally accepted accounting principles lay down accepted assumptions
and guidelines and are commonly referred to as accounting concepts.
• Accounting Concepts:
1. Business entity
2. Money Measurement
3. Going Concern
4. Cost concept
5. Objectivity
6. Accruals/matching
7. Realization
8. Periodicity
9. Dual aspect
• Accounting Conventions:
I. Materiality
II. Accounting for Conservatism
III. Consistency
IV. Accounting for full Disclosure
Accounting Concepts
1. Business Entity: The business and its owner(s) are two separate existence
entity. Any private and personal incomes and expenses of the owner(s) should
not be treated as the incomes and expenses of the business. Economic Entity -
company keeps its activity separate from its owners and other businesses. –
• Example: Insurance premiums for the owner’s house should be excluded
from the expense of the business.
2. Money Measurement: All transactions of the business are recorded in
terms of money and it provides a common unit of measurement. –
• Example: Market conditions, technological changes and the efficiency of
management would not be disclosed in the accounts.
3. Going Concern Concept: The business will continue in operational existence
for the foreseeable future. Financial statements should be prepared on a
going concern basis unless management either intends to liquidate the
enterprise or to cease trading, or has no realistic alternative but to do so.
• Example: Possible losses form the closure of business will not be
anticipated in the accounts.
Accounting Concepts
4. Cost Concept: Assets should be shown on the Balance sheet at the cost of
purchase instead of current value. –
• Example: The cost of fixed assets is recorded at the date of acquisition cost.
The acquisition cost includes all expenditure made to prepare the asset for its
intended use. It included the invoice price of the assets, freight charges,
insurance or installation costs.
5. Objectivity: The accounting information should be free from bias and capable
of independent verification. The information should be based upon verifiable
evidence such as invoices or contracts. –
• Example: The recognition of revenue should be based on verifiable evidence
such as the delivery of goods or the issue of invoices.
6. Accruals/Matching: Revenues are recognized when they are earned, but not
when cash is received. Expenses are recognized as they are incurred, but not
when cash is paid. The net income for the period is determined by subtracting
expenses incurred from revenues earned. Matching - efforts (expenses) should
be matched with accomplishment (revenues) whenever it is reasonable and
practicable to do so. –
• Example: Expenses incurred but not yet paid in current period should be
treated as accrual/accrued expenses under current liabilities.
Accounting Concepts
7. The Realization concept: This concept holds to the view that profit can
only be taken into account when realization has occurred. Generally, sales
revenue arising from the sale of goods is recognized when the goods are
delivered to the customers. Revenue Recognition - generally occurs
(1)when realized or realizable and (2) when earned. –
• Example: Profit is earned when goods or services are provided to
customers. Thus it is incorrect to record profit when order is received,
or when the customer pays for the goods.
8. Periodicity: The life of an entity is divided into short economic time
periods on which reporting statements are fashioned. Periodicity -
company can divide its economic activities into time periods. –
• Example: Based on this assumption assets are classified into current
and fixed Assets. Current assets have benefits within twelve months
period and fixed assets have benefits beyond 12 months.
9. Dual Aspect: Transaction has two fold effect: Debit &Credit. Each and
every debit aspect has equal and corresponding credit aspect and vise
versa.
• Accounting Equation: Assets = Capital + Liability Accounting
Accounting Conventions
1. Materiality: Financial statement should separately disclose
significant items for they would influence decisions of users.
Accounting does not serve a useful purpose if the effort of
recording a transaction in a certain way is not worthwhile. In
other words do not waste your time in the elaborate recording
of trivial items.
• e.g. A stock of stationery worth Rs.10 should be treated as an
expense when it was bought.
2. Accounting for Conservatism: The accountant should always
be on the side of safety. The prudence concept means that
normally he will take the figure which will understate rather
than overstate the profit. Provision is made for all known
liabilities. Conservatism means anticipate the expected future
losses
• e.g. Provision for doubtful debts should be deducted from
debtors in balance sheet.
Accounting Conventions
3. Consistency: When a firm has once fixed a method for the
accounting treatment of an item, it will enter all similar items that
follow in exactly the same way. Frequent changes in the accounting
methods would lead to misleading profits calculated from the
accounting records.
• e.g. Depreciation method of certain fixed assets once adopted
should be used in the following years.
4. Disclosure: The financial statements of a firm must include all
information necessary for the formation of valid decisions by the
users. Any information that might be relevant to an investor or
creditor should be disclosed, either in the body of the financial
statements or in the notes attached thereto.
• e.g. Method of Issue of stock (FIFO/LIFO/Weighted average),
Method of Depreciation (SLM/WDV) Method of Valuation of
Goodwill etc..
JOURNAL
Journal is a primary set of books in which daily business transactions are
to be recorded.
• According to Cropper “A journal is a book employ to classify or sort
out transactions in a form convenient for their subsequent entry in
the ledger”.
NECESSITY OF JOURNAL
➢Convenient recording of transaction
➢Maintaining and preserving the identity of transaction ➢Ascertaining
the true nature of transaction
➢Maintaining permanent record of information
FUNCTIONS OF JOURNAL
• To analyze each transaction into debit and credit so as to enable their
posting in the ledger
• To arrange transaction, chronological i.e in order of date.
JOURNAL
ADVANTAGES OF JOURNAL
• Show all necessary information relating to a transaction • Provide
the explanation of the transaction
• Date wise record of all the transaction can be obtained • Help in
locating and preventing the errors
LIMITATIONS OF JOURNAL
• Recording all the transaction in a journal requires:
1. writing down name of account involved
2. individual posting of each account debited and credited
• Does not provide information on prompt basis
• Does not facilitate the internal check system since the journal can
be handled only by one person
• Journal become bulky and voluminous
Ledger Accounts
• General ledger accounts are used to post the economic activities. Posting is the name of
transferring accounts from the book of prime entry to related ledger accounts. When all the
transactions for a given period have been Journalized, the next step is to classify them
according to the account affected.
• Ledger is a Book of Account that keeps separate record for each account. Ledger is the book
of secondary entry. An account in its simplest form is a T-shape. It should be noted that
journal contains a chronological record while Ledger contains a classified record of all
economic activities.
Ledger A/c
(In the book of ……………………)
Date Particular JF Amount Date Particular JF Amount
Total Total
General Ledger Posting and Balancing Process
The process of posting and balancing involves the following Steps:
• The debit part of journal entry is recorded on the debit side of the relevant
account by credit account name (Source).
• The credit part of Journal Entry is recorded on the credit side of the relevant
account by debit account name (Source).
• In the reference column of the general journal the code or page number of ledger
account are noted.
• In the reference column of the ledger account the page number of the journal is
noted.
• Find the total of debit side and find the total of credit side. Put bigger value both
sides in Total.
• Calculate the difference between the two sides. This is the Balance (The balancing
figure between the two sides).
• Write the balance on the smaller side with key words “Balance c/d”. However, the
balance will be known by the larger side i.e. if the debit side is greater than the credit
side, the balance will be known as debit balance and vice versa.
• Bring down the debit balance on the debit side writing the words in Description
column “Balance b/d”. Similarly, bring down the credit balance on the credit side be
writing the words in the Description column “Balance b/d”.
Trial Balance
A trial balance is a bookkeeping worksheet in which the balances
of all ledgers are compiled into debit and credit account column
totals that are equal. A company prepares a trial balance
periodically, usually at the end of every reporting period.
Debit side :
1. All assets
2. All expenses and losses
Credit side :
3. All liabilities
4. All income and profit
