INTRODUCTION TO FINANCIAL

ACCOUNTING
 Need for ACCOUNTING
• As you are aware, every trader generally starts
business for purpose of earning profit.

• While establishing business, he brings own

capital, Then he purchases machinery, furniture,
raw materials and other assets.

• He starts buying and selling of goods, paying for

salaries, rent and other expenses, depositing
and withdrawing cash from bank. Like this he
undertakes innumerable transactions in
business.
  Observe the following transactions of small
trader
• Purchase of raw materials from Sri Ram 5000.
• Goods sold for cash 6000
• Sold gods to Sham on credit 3000
• Advertising expenses 100
• Stationary expenses 150
• Withdrawal for personal use 200
• Rent paid through cheque 500
• Salaries paid 200
• Received cash from Sham 3000
 
• The number of transactions in an organization
depends upon the size of the organization
• In small organizations, the transactions generally
will be in thousands and in big organizations they
may be in lakhs.
• It is humanly impossible to remember all these
transactions. Further, it may not be possible to
find out the final result of the business without
recording and analyzing these transactions. 
• Accounting came into practice as an aid to
human memory by maintaining a systematic
record of business transactions.
 DEFINITION OF ACCOUNTANCY

o “Accountancy is the science of RECORDING

and CLASSIFYING business transactions and
events, primarily of financial character and the
art of making significant SUMMARIES,
ANALYSIS & INTERPRETATIONS of those
transactions and events, & COMMUNICATING
the results to persons who make decisions or
form judgments”
Smith & Ashburne
• American Institute of Certified Public
Accountants (AICPA): “The 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 a
financial character and interpreting the results
thereof.”
• Thus, accounting is an art of identifying,
recording, summarizing and interpreting
business transactions of financial nature.
Hence accounting is the Language of
Business.
USERS OF ACCOUNTING INFORMATION
 Objectives of Accountancy
• To keep permanent, accurate and complete
record of business transactions
• To maintain records of incomes and expenses
and losses in such a way that, the Net
profit/Loss for any specified period is
ascertained
• To maintain records of Assets and Liabilities
and in such a way that, the Financial position
of the business at any point is ascertained
• To provide information for legal & tax
purposes.
 Accounting Principles
• Accounting principles are general rules
adopted in accounting
• These principles enables standardization in
recording & reporting of financial information
• Accounting principles may be defined as those
rules of conduct or procedures which are
adopted by the accountants universally while
recording the accounting transactions.
Accounting Concepts
Accounting Conventions
 Double entry system of Accounting
• According to this system of Accounting every
transaction has two fold aspect.
i.e., One party receiving benefit &
Other party giving benefit
• Every transaction is divided in to two aspects
Debit & Credit.
• The basic principle of Double entry system is
FOR EVERY DEBIT THERE IS CORRESPONDING
CREDIT OF EQUAL VALUE.
 Basic Books of Accounts
• An account is a summary of the record of all
the transactions relating to particular Person,
Asset, expense or gain.
An account has two sides
• left side of the account is called Debit side
• right side of the account is called Credit side
 CLASSIFICATION OF BUSINESS TRANSACTIONS
All business transactions are classified into
three categories:
• 1.Those relating to persons
• 2.Those relating to property Assets)
• 3.Those relating to income & expenses
 Thus, three classes of accounts are
maintained for recording all business
transactions. They are:
• 1.Personal accounts
• 2.Real accounts
• 3.Nominal accounts
• 1.Personal Accounts :Accounts relating to
persons & artificial persons are called
“Personal Accounts” .
• A separate account is kept on the name of
each person for recording the benefits
received from ,or given to the person in the
course of dealings with him.
E.g.:
• Krishna’s A/C,
• Gopal’s A/C,
• Nagarjuna Finances Ltd.A/C,
• 2.Real Accounts: The accounts relating to
properties or assets are known as “Real
Accounts” .
• Every business needs assets such as machinery ,
furniture etc, for running its activities .A separate
account is maintained for each asset owned by
the business .
• E.g.:
• Cash A/C
• Furniture A/C
• Building A/C
• Machinery A/C etc.
• 3.NominalAccounts:Accounts relating to
expenses, losses, incomes and gains are
known as “Nominal Accounts”. A separate
account is maintained for each item of
expenses, losses, income or gain.
• E.g.: Salaries A/C, Stationery A/C, Wages A/C,
Postage A/C, Commission A/C, Interest A/C,
Purchases A/C, Rent A/C, Discount A/C,
Commission received A/C, Interest received
A/C,Rent received A/C, Discount received A/C.
 Basic Accounting rules
• Before recording a transaction, it is necessary
to find out which of the accounts is to be
debited and which is to be credited. The
following three different rules have been laid
down for the three classes of accounts….
• 1.Personal Accounts: The account of the
person receiving benefit (receiver) is to be
debited and the account of the person
giving the benefit (given) is to be credited.
 
• 2.Real Accounts: When an asset is coming into
the business, account of that asset is to be
debited .When an asset is going out of the
business, the account of that asset is to be
credited.
• 3. Nominal Accounts: When an expense is
incurred or loss encountered, the account
representing the expense or loss is to be
debited . When any income is earned or gain
made, the account representing the income of
gain is to be credited.
 Summary of Accounting rules
Personal account Rule:
“Debit----The Receiver
Credit---The Giver”
Real account Rule:
“Debit----What comes in
Credit---What goes out”
Nominal account Rule:
“Debit----All expenses and losses
Credit---All incomes and gains”
 
 Journal
• The book in which the business transactions
are recorded in a chronological order, after
analyzing them and classifying the benefits
according to the principles of debit & credit is
called JOURNAL.
• As all the day to day transactions are recorded
in journal, this book is also called as “Day
book” or Daily record”
• All the transactions related to business like
Purchases, Purchase returns, sales, sales
returns, cash receipts, cash payments, loans &
advances taken (given), assets acquired,
salaries paid are first recorded in the book of
JOURNAL.
• Hence Journal is called as
“BOOK OF PRIME ENTRY”.
 JOURNAL ENTRY
• The process of recording the business
transactions in a chronological order in the
journal after analyzing, classifying &
identifying them as Dr and Cr is called entry.
• All the transactions are recorded in the book
of Journal are in the form of Entry.
• For easy identification of the transaction a
brief description is given under each entry
with in brackets. (Narration)
 Journalize the following transactions
1. Ram commenced business with Rs 50,000
2. Purchase furniture for cash Rs 3,000
3. Purchase machinery from Manoj on credit
Rs 40,000
4. Received cash from pavan Rs 8,000 on
account
5. Paid rent to land lord Rs 5,000
 Journalize the following transactions
• Jan 1 Raja commenced business with Rs
50,000
• Jan 2 Deposited in bank Rs 40,000
• Jan 5 Purchased goods from Krishna on credit
Rs 10000
• Jan 7 Sold goods to ram on credit 8,000
• Jan 9 Purchased goods from Mahesh for cash
5000
• Jan 12 Sold goods for cash to sailesh 8500
• Jan 15 purchased machinery from ajay
engineering company, payment made by
cheque 20,000
• Jan 18 Issued cheque to Krishna 7500
• Jan 20 Received interest from raja 700
• Jan 22 Cash withdrawn from bank for office
use 2000
• Jan 24 Amount with drawn from bank for
personal use 800
• Jan 27 Loan taken from rajiv varma 15000
• Jan 29 Cash with drawn from office for
personal use 1000
• Jan 30 Goods withdrawn for personal use
2000
• Jan 31 Paid rent to landlord by cheque 600
 Ledger
• Introduction
• Journal cannot give net results of various
transactions related to any account, at a given date
the full information is not made available, with
regard to value of assets, incomes & expenses.
• This limitation can be overcome by opening a
LEDGER, which shows the net results of different
accounts on given date.
• LEDGER is also called the “Book of final entry”
• From the LEDGER it is not possible to know
the total purchases, sales, rent, salaries paid
etc, this limitation can be over come by
LEDGER.
• LEDGER : It is a book, where the various
accounts pertaining to particular person,
asset, expense are grouped together in one
place in the form of an account.
• The process of transferring the transactions
from JOURNAL to LEDGER is called “POSTING”
• LEDGER is the principal book of business &
hence called “king of books of accounts”
1. Journalize the following transactions, post
them into ledger and balance the accounts.
Jan 1kittu commenced business 1,00,000
Jan 2 purchase goods from Ravi 10,000
Jan 4 sold goods to gopi 20,000
Jan 5 cash purchases 20,000
Jan 7 paid salaries 5,000
Jan 8 sold for cash 15,000
Jan 9 purchased furniture paid by cheque
2,000
Jan 9 brought goods from Sobhan 10,000
Jan 14 cash paid to ravi 9800, discount received 200
Jan 17 received cash from gopi 19,500, discount
allowed 500
Jan 18 deposited with bank 10,000
Jan 20 Paid for advertisement by cheque 700
Jan 22 Stationary expenses 800
Jan 24 Sold old furniture 1,700
Jan 28 Paid cash to shoban 4,000
Jan 26 Received interest through cheque (sent to bank
on the same day) 500
Jan 31 Proprietors personal use 1,000
 Trial Balance
INTRODUCTION
 The Trial Balance contains the debit and credit
balances of all LEDGER accounts, it is very much
useful in preparation of FINAL ACCOUNTS.
 It is a connecting link between the LEDGER & FINAL
ACCOUNTS.
 Trial Balance can be prepared at any time & not
necessarily at the end of a calendar or accounting
year.
 It is the only base for preparation of FINAL
ACCOUNTS
Preparation of Trial Balance
• Your are requested to prepare the Trial
Balance from the Ledger account balances.
capital 65,500 bills payable 4,500
Creditors 18,200 reserve for bad debts 3,250
Debtors 21,350 tax outstanding 1,110
Cash 6,750 interest on investment 2,150
Sales 1,20,000 drawings 1510
Purchases 69,100 fixed deposits 45,000
Cash at bank 7,800 Rent 9,50
Machinery 35,000 Insurance prepaid 4,200
Discount allowed 5,000 Wages 3,150
Discount received 3,200 Salaries outstanding 7,200
Furniture 4,000 bills receivables 21,300.
 Trading Account
• Trading account is prepared at the end of each
accounting period to assess the GROSS
PROFIT/LOSS.
• GROSS PROFIT = Net sales – COGS
• GROSS LOSS = COGS – Net sales
• Net sales = sales – sales returns
• COGS or cost of production or cost of goods
sold = opening stock + purchases + direct
expenses – closing stock
• Direct expense: the following are direct
expenses
carriage inward
wages
cartage or freight
import duty
excise duty
coal, fuel, power
factory expense,
manufacturing expenses.
Particulars amount Particulars amount

To opening stock Xxxx By sales xxxx

To purchases xxxx Less: returns xxx xxxx
Less: returns xx Xxxx By closing stock Xxxx
To carriage inwards xxxx By goods destroyed by fire xxxx
To wages Xxxx By gross loss
To freight/cartage Xxxx (Transferred to P&L
To customs duty Xxxx account)
To gas, fuel, coal Xxxx
To factory expenses
To other man. Expenses
To productive expenses

To gross profit c/d

(Transferred to P&L
account)
 Profit & Loss account
• It is prepared to ascertain the Net profit/loss
of the firm for the accounting period.
• Net profit can be arrived by deducting the
administrative expenses from the Gross
profit.
• By nature Profit & Loss account is a Nominal
account and should not have opening &
closing balances
• If the total of credit column exceeds the total
of debit column the difference is called net
profit, which is transferred to the capital
account or added to the existing share capital
while preparing the balance sheet.
• Net profit will increase the capital and net loss
will decrease the capital.
PROFIT AND LOSS A/C OF …………………….FOR THE YEAR ENDED…………
Particulars amt Particulars amt
TO office salaries XxxxxxXx By gross profit b/d Xxxxxxx
TO rent, rates, taxes xxxXxxxx By Interest received x
XxxxXxxx Xxxx
TO Printing and stationery By Discount received
XxxxXxxx
TO Legal charges By Commission received Xxx
xXxxxXxx
To Audit fee xXxxxXxx By Income from investments Xxxx
TO Insurance xxXxxxxX By Dividend on shares Xxxx
TO General expenses xxxxXxxx By Rent received xxxxxx
XxxxxXxx
TO Advertisements
xxXxxxxx
TO Bad debts xxxxxxxx
TO Carriage outwards x
TO Repairs Xxxx
TO Depreciation Xxxx
TO interest paid Xxxxx
TO Interest on capital Xxxxx
TO Interest on loans Xxxx
TO Discount allowed Xxxxx
TO Commission
TO Net profit-------
(transferred to capital a/c)
 Balance sheet
• The preparation of Balance sheet is the last
and third stage of Final accounts.
• The balance sheet has to be prepared only
after the preparation of Trading & Profit &
Loss account.
• Trading & Profit & Loss account are prepared
for a period of time where as the Balance
sheet is prepared on a particular point of
time
• “Balance sheet is a Statement prepared on
particular date to reflect the financial position
of the firm with all the assets and liabilities of
the firm”
• Balance sheet is not an account but it is a final
statement of the financial position of a
business on a closing date.
• Assets are shown on the right side, liabilities
including Capital is shown on the left side of
the Balance sheet.
BALANCE SHEET OF ………………………… AS ON …………………………………….
Liabilities amt Assets amt

Creditors Xxx Cash in hand xXxx

Bills payable Xxxx Cash at bank Xxx
Bank overdraft Xxxxx Bills receivable Xxx
Loans Xxxx Debtors Xxx
Mortgage Xxxxx Closing stock Xxx
Reserve fund Xxxxx Investments Xxx
Capital xxxx Furniture and fittings Xxx
+ Additional capital xx Plats&machinery Xxx
+ Interest on capital x Land & buildings Xxx
+ Net profit xxx Goodwill Xxx
Less Prepaid expenses Xxx
Drawings xxx Outstanding incomes xxx
Interest on drawings xx
Net loss xxx
 Capital & Revenue items in Final
Accounts
• The expenditure of the firm has been divided
into Capital expenditure & Revenue
expenditure.
• Items of Revenue expenditure are taken in
trading account & Profit & Loss account.
• Items of Capital expenditure are considered
in Balance Sheet
• Capital Expenditure is an “Expenditure
intended to benefit future periods in contrast
to the Revenue expenditure, which benefits
the current period”
• The transactions of Capital expenditure give
benefits for more than one accounting period
such as acquisition and improvements of
assets.
• Capital expenditure is non recurring in nature.
 Revenue expenditure
• “In Accounting revenue expenditure is synonymous
with expenses”.
• It is incurred for generating revenue in the current
accounting period & its benefits expires within such
period.
• Revenue expenditure is recurring in nature.
• Examples of Revenue expenditure:
Production expenses, selling expenses, financial
expenses etc..
 Deferred Revenue Expenditure
• It is a peculiar type of Revenue Expenditure
that spreads more than one accounting
periods.
• Example of deferred Revenue expenditure:
advertisement
 SUBSIDIARY BOOKS
Introduction
• In a small business concern, the numbers of transactions are
limited.
• These transactions are first recorded in the journal as and
when they take place.
• Subsequently, these transactions are posted in the
appropriate accounts of the ledger.
• Therefore, the journal is known as “Book Of Original Entry”
or “Book of Prime Entry” while the ledger is known as main
book of accounts.
• On the other hand, the transactions in big concern are
numerous and sometimes even run into thousands and lakhs.
It is inconvenient and time wasting process if all the
transactions are going to be managed with a journal.
• Therefore, a convenient device is made. Smaller
account books known as subsidiary books or
subsidiary journals are disturbed to various sections
of the business house.
• As and when transactions take place, they are
recorded in these subsidiary books simultaneously
without delay.
• The original journal (which is known as Journal
Proper) is used only occasionally to record those
transactions which cannot be recorded in any of the
subsidiary books.
 TYPES OF SUBSIDIARY BOOKS
1.Purchases Book
2.Sales Book
3.Purchase Returns Book
4.Sales Returns Book
5.Cash Book
6.Bills Receivable Book
7.Bills Payable Book
8.Journal Proper: This is used to record all the
transactions that cannot be recorded in any of the
above mentioned subsidiary books.