DMGT104_FINANCIAL_ACCOUNTING.pdf - Financial Accounting DMGT104 FINANCIAL ACCOUNTING Copyright \u00a9 2012 K.K.Verma All rights reserved Produced Printed by

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Unformatted text preview: Financial Accounting DMGT104 FINANCIAL ACCOUNTING Copyright © 2012 K.K.Verma All rights reserved Produced & Printed by EXCEL BOOKS PRIVATE LIMITED A-45, Naraina, Phase-I, New Delhi-110028 for Lovely Professional University Phagwara SYLLABUS Financial Accounting Objectives: To develop conceptual knowledge about the preparation and use of financial statements. S. No. Description 1. Introduction to Accounting: Book-Keeping & its importance, Accounting- Meaning, Importance, Difference between Book Keeping and Accounting, Accrual Basis and Cash basis of Accounting. 2. Generally Accepted Accounting Principles: Accounting Concepts and Conventions, Accounting terminology. 3. Accounting Standards and Accounting Policies, Accounting Standard-1. Accounting Equation, Accounting Cycle. 4. Preparation of Journal, Ledger and Balancing. 5. Subsidiary Books: Cash Book and other subsidiary books. Trial Balance: Different types of errors disclosed and not disclosed by Trial Balance. 6. Financial Statements: Capital & Revenue Expenditure and Receipts, Accounting Standard-9, Profit & Loss Account (with adjustments) & Balance Sheet. 7. Depreciation, Provisions and Reserves, Accounting Standard-6. 8. Bank Reconciliation Statement. 9. Corporate Financial Statements: Nature, types, uses and limitations. 10. Role of Computers in Accounting including introduction to Tally. CONTENTS Unit 1: Introduction to Accounting 1 Unit 2: Principles of Accounting 23 Unit 3: Accounting Standards 41 Unit 4: Accounting Equation and Accounting Cycle 50 Unit 5: Preparation of Journal, Ledger and Balancing 60 Unit 6: Subsidiary Books 88 Unit 7: Trial Balance 115 Unit 8: Financial Statements 144 Unit 9: Analysis and Interpretation of Financial Statements 198 Unit 10: Accounting and Depreciation for Fixed Assets 213 Unit 11: Bank Reconciliation Statement 251 Unit 12: Corporate Financial Statements 264 Unit 13: Computerised Accounting 276 Unit 14: Introduction to Tally 286 Unit 1: Introduction to Accounting Unit 1: Introduction to Accounting Notes CONTENTS Objectives Introduction 1.1 1.2 1.3 1.4 1.5 Meaning and Definition of Accounting 1.1.1 Characteristics of Accounting 1.1.2 Objectives of Accounting 1.1.3 Need of Financial Accounting 1.1.4 Scope of Accounting 1.1.5 Users of Accounting Information 1.1.6 Importance and Advantages of Accounting 1.1.7 Limitation of Accounting Process of Accounting 1.2.1 Cash System 1.2.2 Accrual System 1.2.3 Values Book-keeping 1.3.1 Definition 1.3.2 Importance of Book-keeping 1.3.3 Difference between Book-keeping and Accounting Methods of Accounting 1.4.1 Single Entry 1.4.2 Double Entry Types of Accounts 1.5.1 Personal Accounts 1.5.2 Real Accounts 1.5.3 Nominal Accounts 1.6 Accounting Terminology 1.7 Accounting Cycle 1.7.1 Distinction between Book-keeping and Accounting 1.8 Summary 1.9 Keywords 1.10 Review Questions 1.11 Further Readings LOVELY PROFESSIONAL UNIVERSITY 1 Financial Accounting Notes Objectives After studying this unit, you will be able to: Understand needs and objectives of accounting Know branches of accounting Know users and difference between book-keeping and accounting Describe meaning, importance and rules of double entry system Introduction Accounting is a business language which elucidates the various kinds of transactions during the given period of time. Accounting is broadly classified into three different functions viz. Recording Classifying and Summarizing American Institute of Certified Public Accountants Association defines the term accounting as follows “Accounting is the process of recording, classifying, summarizing in a significant manner of transactions which are in financial character and finally results are interpreted.” The main object of a business house is to earn profit. Accounting is the medium of recording the business activities and it considered as a language of business. To find out the results of a business, the information relating to the cost of the products and revenues from the products is collected. Then the costs and revenues are compared to find out the profit or loss of the business. If volume of sales of the products is high and the number of transaction of the business is very high, it is impossible to keep all these transactions in the mind of a business man. Thus a need of recording of all these business transactions rose. The recording of business transactions or activities is done through a process of accounting. There is an old quotation of a well known author of accounting Prof. R.R. Gupta, First write or record before one deliver the goods or renders the services and if there is any disagreement in future, use the writing or record as an evidence to resolve the misunderstanding or rectifying the errors. Today the business activities are recorded not only to find out the profit or loss of the business, but are also to judge the financial position of the business. Accounts of the business are prepared from the point of view of owner and also serve the purpose of outsiders. Creditors and investors want to know how safe their investment is—Labours in conducting the negotiations for wages and government to determine the economic policies etc. Thus accounts of a business are the evidence on the basis of which the financial decisions are taken. ! Caution Accounting is not an equivalent function to book keeping. Accounting is broader in scope than the book keeping; the earlier cannot be equated to the latter. 1.1 Meaning and Definition of Accounting Accounting is treated as the language of business. It records all the transactions which can be measured in money and have occurred in a particular period. Accounts of a business provide useful information to its users. 2 LOVELY PROFESSIONAL UNIVERSITY Unit 1: Introduction to Accounting There are many definitions of accounting. Some of the most important definitions are given below: 1. As per Robert N. Anthony – “Accounting system is a means of collecting, summarizing, analyzing and reporting, in monetary terms, information about the business”. 2. The American Accounting Association (AAA) has defined accounting as, “the process of identifying, measuring and communicating economic information to permit informal judgments and decisions by users of information”. 3. The Committee on Terminology of American Institute of Certified Public Accountants gave a generally accepted definition of accounting – “Accounting is 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.” Notes On the basis of above definitions we conclude that accounting is a science as well as an art of recording of activities of the business which can be measured in money and analyzing and interpreting them. 1.1.1 Characteristics of Accounting On the basis of above definitions, the characteristics of accounting may be drawn as follows: 1. Accounting is the art of recording of financial transactions of the business: All those transactions of business which are financial in nature are recorded in accounting and those which are not of financial nature are not recorded in accounting. As the honesty of the workers cannot be measured in money, it cannot be recorded into accounting. 2. Classifying and summarising of recorded data is done in accounting: In accounting the financial transactions are recorded in the journal. With the help of journal, the recorded data are classified into ledger under appropriate heads. Then with the help of ledger the trial balance and financial statements are prepared. 3. Data are recorded in terms of money: In accounting, the financial data are recorded in a definite term i.e. money. No other unit is accepted to record the business transaction. If there is sale of 100 articles at the rate of 50 per article, only the monetary value of these articles i.e. 5,000 (100 x 50) is recorded. 4. Accounting is a science also: On account of recording of business transactions in a systematic manner, it is also called a science. First the business transactions are recorded in the primary books i.e. journal, for classification the ledger is prepared. With the help of ledger the trail balance, profit and loss account and balance sheet is prepared. Profit and loss account is prepared after a period to find the result of the business and balance sheet to know the financial position of the business. 5. Analysing and interpretation of the results is done in accounting: It not only record classifies and summaries the business data but also analyse and interprets the results for the future decisions. On the basis of data forecasting regarding profit, sales, etc., may be done. 1.1.2 Objectives of Accounting The main purpose of book-keeping and accounting is to furnish the necessary financial data to the persons interested in the business. These persons can be the internal users of the business and external users of the business. Among the internal users all the managers at lower, middle and top level are included. While among the external users, investors, creditors, government and LOVELY PROFESSIONAL UNIVERSITY 3 Financial Accounting Notes public are included. The financial statements are supplied to the external users for the necessary information. In brief, following are the objectives of accounting: 1. To maintain the systematic records of the business: The primary objective of the accounting is to maintain the records of all transactions of the business. As the memory of human being is very limited and short, it would be very difficult to remember all the transactions especially if there is a huge amount of transaction. So it is very necessary to record all business transactions properly to determine the amount of profit or loss and the financial position of the business on a particular date. 2. To ascertain the profit or loss of the business: The main objective of the business is to earn a profit. Exact profit can be ascertained with the help of financial accounting which helps to determine the net profit or loss of the business over a period. For the determination of the amount of profit or loss, a trading and profit and loss account is prepared at the end of a period. If there is excess of revenue for a period over the expenses incurred to earn that revenue, it is said to be a profit. And if there is excess of expenses over the revenue, it is said to be a loss. In the case of profit the management can take the decisions relating to selling price and output etc. In the case of loss, the causes of such a loss are investigated and remedial action is taken by the management. 3. To present the financial position of the business: The objective of the accounting is not only recording of the financial transactions of the business and determination of profit or loss but also to present the financial position of the business. To present the financial position, financial accounting helps in the preparation of balance sheet. Balance sheet is the statement of assets and liabilities of the business. It also gives the information about the borrowed capital as well as owned capital along with different assets such as fixed assets, current assets and miscellaneous. Balance sheet is the reflector of the financial position of a business (solvency and insolvency). 4. To provide the financial information to the various users: One more objective of the accounting is to provide the required financial information to the different users - internal as well as external users. Internal users of the financial statements are owners, shareholders, management and external users of the financial statements are debenture holders, creditors, investors, employees, government, etc. 5. For Decision Making: These days accounting has taken upon itself the task of collection, analysis and reporting of information at the required points of time to the required levels of authority in order to facilitate rational decision-making. 1.1.3 Need of Financial Accounting A well known author of Accounting, [Prof. R.R. Gupta, Principal, Poddar College, Nawalgarh (Rajasthan)] wrote in …..”First write/record before one delivers goods or renders the services and if there is any disagreement in future, use the writing or record as an evidence to resolve the misunderstanding or rectifying the error.” Recording of business transactions is necessary from owners’ point of view and other interested party as well. The persons included in the second category are the suppliers of the materials, products and services to the business, the government and the society at large. The creditors (suppliers who are willing to take their payment later) are interested to know whether the business will be able to pay them later (solvency of the business) whereas the government wants to know whether the business has paid whatever was due to them in terms of taxes, fees, etc. Did u know? What are the purposes of preparing financial statements? 1. 4 Accounting provides necessary information for decisions to be taken initially and it facilitates the enterprise to pave way for the implementation of actions. LOVELY PROFESSIONAL UNIVERSITY Unit 1: Introduction to Accounting 2. It exhibits the financial track path and the position of the organization. 3. Being business in the dynamic environment, it is required to face the ever changing environment. In order to meet the needs of the ever changing environment, the policies are to be formulated for the smooth conduct of the business. 4. It equips the management to discharge the obligations at every moment. 5. Obligations to customers, investors, employees, to renovate/restructure and so on. Notes 1.1.4 Scope of Accounting The Scope of accounting is divided into following two parts: 1. Branches of Accounting 2. Accounting as a science or an art Branches of Accounting The main objectives of accounting are to record the business transactions and to provide the necessary information to the internal and external users of the financial statements. In order to achieve the above objectives, the accounting is classified into followings branches: 1. Financial Accounting: It is the original form of accounting. It refers to the recording of daily business financial transaction. Recording of the transaction is done in such a way that the profit of the business may be ascertained after a definite period and the picture of the financial position of the business may be presented. 2. Cost Accounting: As the name indicates, this accounting is related with the ascertainment of cost of the product in a period. Under this system, record of raw materials used in production, wages and labour paid and other expenses incurred on production are kept to control the costs. 3. Management Accounting: The accounting which provides the necessary information to the management is called management accounting. Under this, the analysis and interpretation of the accounts, prepared by financial accounting, are done in a manner so that the managers may forecast, plan for future and frame the policy. 4. Tax Accounting: Under tax accounting, the accountants prepare the accounts as per the provisions of taxation. The accounts prepared as per taxation provisions may differ from the accounts prepared as per financial accounting. 5. Inflation Accounting: The financial statements are prepared on the basis of historical cost which do not present the true picture of the financial position and correct profit or loss of the business due to inflation. Thus the fresh financial statements are prepared keeping in mind the price level changes under inflation accounting. 6. Human Resource Accounting: Human Resource Accounting means the accounting for human being as now in an organization human being is treated as an asset like other physical assets. It is recorded in the books like other assets. HRA deals with the measurement of costs on recruiting, selecting, hiring, training, placing and development of the employees in one side and on the other side it deals with the present economic value of the employees. For the determination of the value of human being different methods are used under HRA. 7. Responsibility Accounting: Responsibility accounting is a special technique of management under which accountability is established according to the responsibility delegated to the LOVELY PROFESSIONAL UNIVERSITY 5 Financial Accounting Notes various levels of management. Management information and reporting system is instituted to give adequate feedback in terms of the delegated responsibility. Under this system, units of an organization, under a specified authority in a person, are developed as responsibility center and evaluated individually for their performance. Accounting as Science or an Art Accounting is both the science and art. Study of science is based on some principles and it is systemized. It is a science because the business transactions are recorded on the basis of some principles and journal of transaction, ledger posting, trial balance and preparation of final statements are done in a sequence. Art is the creation of practical applications and rules for the completion of any work. On the basis of it, accounting is an art as we do not only study principles of accounting but also we learn to apply these principles in practice to record the business transaction. Thus accounting is both science and art. 1.1.5 Users of Accounting Information There are two types of persons interested in financial statements: (1) Internal users, and (2) External users. 1. 2. 6 Internal Users: These are: (a) Shareholders, (b) Management, and (c) Trade unions employees, etc. (a) Shareholders are interested to know the welfare of the business. They can know the operational results through such financial statements and the financial position of the business. (b) Management is interested to take important decisions relating to fixing up the selling prices and making future policies. (c) Trade unions and employees are interested to know the operational results because their bonus etc. is dependent on the profit earned by the business. Financial statements also help in their negotiations for wages/salaries. External Users: The following are most important external users of financial statements: (a) Investors: They are interested to know the earning capacity of business which can be known through financial statements. They can also know the financial soundness of the business through financial statements. (b) Creditors, Lenders of Money etc.: The creditors and lenders of money etc. can also know the financial soundness through financial statement. They have to see two things (i) Regularity of income and (ii) solvency of the business so that their investment is risk free. (c) Government: Government is interested to formulate laws to regulate business activities and also law relating to taxation etc. Financial statements help while computing National Income statistics etc. (d) Taxation authorities: Financial statements provide information relating to operational results as well as financial position of the business. Tax authorities decide the amount of tax as per financial statement. It is very useful to other taxation authorities such as sales tax etc. (e) Stock Exchanges are meant for dealing in share/securities. Purchase and sale of such shares and securities are possible through stock exchanges which provide financial information about each company which is listed with them. LOVELY PROFESSIONAL UNIVERSITY Unit 1: Introduction to Accounting (f) Consumer: Consumer is interested in information on the continued existence of the business and thus probability of the continued supply of the products, parts and after sale services. They ensure continuous existence of a business, especially in case of durable products which require after sales service and spare parts. Notes 1.1.6 Importance and Advantages of Accounting Appr...
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