UNIT – 7

INTRODUCTION TO FINANCIAL ACCOUNTING

Accounting Definition: Accounting is a process of identifying, measuring and
communicating economic information to permit informed judgments and
decisions by the users of the information.
Accounting Concepts:
1) Business Entity Concepts: Every business has a separate and distinct legal
entity. Business records are separated from its owners, proprietors. Also, there
should be clear distinction between personal transactions and business
transaction.
2) Money measurement Concepts: Only the transactions that can be expressed
in terms of money are recorded in the books of account.
3) Going Concern Concept: Every business enterprise will continue to operate
forever. It not going to be liquidated or closed down in near future due to the
death of owners or insolvency. Because of this assumption, the market price of
assets become irrelevant and the concept of depreciation of fixed assets is
exists.
4) Cost Concept: The asset is recorded at the cost at which they are acquired
i.e. market values are ignored. The assets are shown as original cost less
depreciation.
5) Realization/Accrual Concepts: The revenue is generated when actual sale is
realized. For example, when a firm sells goods on March 31st 2009 on credit and
if it receives cash from customer on April 22nd 2009 then the sale revenue is
recognized in the month of April 2009.
6) Accounting Period Concept: Accounts are to be prepared for a defined period
i.e. economic life of an enterprise must be divided into intervals called period
accounting.
7) Matching Concept: The expenses of a given period must be related to the
revenue during that period only.
8) Dual Aspect Concept: Every transaction has dual effects in the books i.e. it is
recorded in the assets side as well as in the liability side.
Accounting Conventions:
1) Full Disclosure: The financial statement must disclose all the necessary and
relevant information off course the information should be reliable also.
2) Consistency: Standard practices, rules and policies of accounting should be
followed consistently over the years.
3) Materiality: Only the material information should be recorded. Immaterial or
information that is not at all useful must not be recorded.
4) Conservatisms (Prudence): This is the policy of safe playing i.e. in the books
no profit are anticipated but all possible losses are accounted.
Accounting Terminology:
1) Business: It is an activity which involves exchange of goods or services with
the intension of earning income and profit.
2) Business transaction: Any exchange of money or money’s worth as goods
and services between two parties is called business transaction.
a) Cash transaction: when payment for business activity is made immediately, it
is called a cash transaction.
b) Credit transaction: When payment is postponed to a future date, it is called
credit transaction.
3) Capital: It is the amount invested by the proprietor in the business
4) Drawings: It is the value of cash or goods with drawn from the business by the
owner for his personal use.
5) Goods: It reefers to commodities, articles, things in which a trader deals.
6) Debtor: A debtor is a person who owes something/money to the business
7) Creditor: A creditor is a person to whom the business owes money.
8) Expenses: It is the amount spent in conducting business activities. It is the
expenditure, in return for some benefit.
9) Loss: A loss is an expenditure without any benefit to the concern
10) Income: It refers to the earnings of a business. It includes the sales of
goods, interest received, commission received etc.
11) Debit: The left hand side of the account
12) Credit: The right hand side of the account
13) Asset: All such items that have value are known as assets. It refers to what
a business owns, namely its plant, machinery, furniture, land and so on.
14) Tangible fixed assets: Tangible fixed assets can be touched and seen.
Example are plant, machinery. etc.
15) Intangible fixed asset: such fixed assets that cannot be seen or touched are
called intangible fixed assets. Ex: Trade mark, Patent rights
16) Current Asset: Current assets are expected to be realized in cash or
consumed during business operations.
17) Bills Receivable: These refer to the acceptances received from the
customers or business parties to pay an agreed amount of money. Acceptances
received are called bills receivable.
18) Liabilities: What the firm has to pay legally, they are called liabilities. In other
words, it refers to what the firm owes to outsiders.
19) Bills Payable: The acceptances given to the suppliers of goods or other
business parties to pay an agreed amount of money are called bills payable.
Acceptances given are called bills payable. Bills payable constitute part of
current liabilities.
20) Overdraft: The facility sanctioned by a banker to a customer to draw more
than what is deposited in the account, subject to a maximum limit of money is
called overdraft. It may be for a short period or for a long period.
21) Outstanding expenses: These refer to the expenses yet to be paid.
22) Current liability: Current liabilities are those which are payable in the near
future say less than an year.
23) Sales: Sales refer to the value of goods or services sold during a given
accounting period sales may be cash or credit sales. In credit sales, the debtor
promises to pay the firm at a future date.
24) Purchases: Purchases refer to the value of goods or services purchased
during a given accounting period. Purchases may be cash purchases or credit
purchases. In credit purchases, the firm agrees to pay the amount to the supplier
at a future date.
25) Double-entry Book Keeping: This is a system of book-keeping where for
every debit, there is a corresponding credit.
Types of Account and its rules:
1) Personal Accounts: Personal accounts indicate about the persons and firms.
Rule: Debit the Receiver
Credit the Giver
2) Real Account: Real accounts indicates about all assets
Rule: Debit what comes in
Credit what goes out
3) Nominal Account: Nominal accounts indicate about expenses, losses,
incomes and gains.
Rule: Debit all losses and expenses
Credit all incomes and gains
Journal: This called the “Book of prime entry. The word journal is derived from
the Latin word journ, which means a day. Hence, journal is also termed as a
daybook wherein the day-to-day transactions are recorded in chronological order.
Journal Entry: The process of recording the business transactions in the journal
is know as journalizing to divide business transactions into two aspects and
recording I the journal is called journal entry. The first one is debit aspect and
second one is credit aspect.
Problems:
1) Journalizing the transactions given below in the books of Prasad.
Date Particulars
2008
Jan 1 Prasad commenced business with cash Rs.30,000
2 Cash sales Rs.4,000
4 Bought machinery RS.15,000
7 Sold goods to Raju Rs.10,000
9 Purchased goods from Ramana Rs.8,000
10 Goods returned by Raju Rs.5,000
12 Paid for stationery Rs.1,000
14 Carriage expenses Rs.500
15 Bought furniture for proprietor’s residence and paid cash Rs.7,000
 17 Sold goods to Krishna for cash Rs.3,000
22 Received discount Rs.800
24 Paid for wages Rs.1,200
25 Deposited cash with bank Rs.10,000
30 Goods return to Ramana Rs. 2,000

Solution:

Journal Entries in books of Prasad for year ending 30th June 2008
L Debit Credit
Date Particulars
F Rs. Rs.
Cash A/C Dr 30,000
2008
To Capital A/C 30,000
June 1
(Being business Commenced)
Cash A/C Dr 4,000
2 To Sales A/C 4,000
(Being goods sold for cash)
Machinery A/C Dr 15,000
4
To Cash A/C 15,000
Raju A/C Dr 10,000
7 To Sales A/C 10,000
(Being goods sold to raju for cash)
Purchases A/C Dr 8,000
9 To Ramana A/C 8,000
(Being goods purchases from Ramana)
Sales returns A/C Dr 5,000
10 To Raju A/C 5,000
(Being goods returned by raju)
Stationery A/C Dr 1,000
12 To Cash A/C 1,000
(Being Stationery purchased for cash)
Carriage Expenses A/C Dr 500
14 To Cash A/C 500
(Being carriage expenses paid)
Drawings A/C Dr 7,000
15 To Cash A/C 7,000
(Being goods used for his personal use)
Cash A/C Dr 3,000
17 To Sales A/C 3,000
(Being goods sold for cash)
 Cash A/C Dr 800
22 To Discount received A/C 800
(Being discount received)
Wages A/C Dr 1,200
24 To Cash A/C 1,200
(Being wages paid by cash)
Bank A/C Dr 10,000
25 To Cash A/C 10,000
(Being cash deposited with bank)
Ramana A/C Dr 2,000
30 To Purchase returns A/C 2,000
(Being goods return to Ramana)
2) Journalise the following transactions, post them in the ledger and balance the
accounts on 31st January.
1. John sarted business with a capital of RS.10,000
2. He purchased goods from Mohan on credit of Rs.2,000
3. He paid cash to Monhan Rs.1,000
4. He sold goods to Suresh Rs.2,000
5. He received cash from Suresh RS.3,000
6. He further purchased goods from Mohan Rs.2,000
7. He paid cash to Monhan Rs.1,000
8. He further sold goods to Suresh Rs.2,000
9. He received cash from Suresh Rs.1,000
Solution:
Journal Entries
Particular L.F
Date Debit Credit
Rs. Rs.
Cash A/C Dr 10,000
1 To Capital A/C 10,000
(Being commencement of business)
Purchase A/C Dr 2,000
2 To Monhan A/C 2,000
(Being purchase of goods on Credit)
Mohan A/C Dr 1,000
3 To Cash A/C 1,000
(Being paymen of cash to Mohan)
Suresh A/C Dr 2,000
4 To Sales A/C 2,000
(Being goods sold to suresh)
Cash A/C Dr 3,000
5 To Suresh A/C 3,000
(Being cash received from Suresh)
Purchase A/C Dr 2,000
6 To Mohan A/C 2,000
(Being purchase of goods from Mohan)
Mohan A/C Dr 1,000
7 To Cash A/C 1,000
(Being payment of cash to Mohan)
 Suresh A/C Dr 2,000
8 To Sales A/C 2,000
(Being goods sold to suresh)
Cash A/C Dr 1,000
9 To Cash A/C 1,000
(Being cash received from Suresh)
Ledger: The ledger is the principal book of accounts where similar transaction
relating to a particular person or thing is recorded.
It is book of final entry. All business transactions are first recorded in journal
and final recorded in the ledger. The process of transferring the transactions
from journal to the ledger is called as posting.

Dr Cash A/C Cr
Date Particulars JF Amount Date Particulars JF Amount
Jan-1 To Capital A/C 10,000 Jan-3 By Mohan A/C 1,000
Jan-5 To Suresh A/C 3,000 Jan-7 By Mohan A/C 1,000
Jan-9 To Suresh A/C 1,000 Jan-31 By Balance c/d 12,000
14,000 14,000
Feb-1 To Balance b/d 12,000

Dr Capital A/C Cr
Date Particulars JF Amount Date Particulars JF Amount
Jan-31 To Balance c/d 10,000 Jan-3 By Cash A/C 10,000

10,000 10,000
Feb-1 By Balance b/d 10,000

Dr Purchase A/C Cr
Date Particulars JF Amount Date Particulars JF Amount
Jan-2 To Mohan A/C 2,000
Jan-6 To Mohan A/C 2,000 Jan-31 By Balance c/d 4,000
4,000 4,000
Feb-1 To Balance b/d 4,000

Dr Mohan A/C Cr
Date Particulars JF Amount Date Particulars JF Amount
Jan-3 To Cash A/C 1,000 Jan-2 By Purchases A/c 2,000
Jan-7 To Cash A/C 1,000 Jan-6 By Purchases A/C 2,000
Jan-31 To Balance c/d 2,000 Jan-31
4,000 4,000
Feb-1 To Balance b/d 4,000
Dr Suresh A/C Cr
Date Particulars JF Amount Date Particulars JF Amount
Jan-4 To Sales A/C 2,000 Jan-5 By Cash A/C 3,000
Jan-8 To Suresh A/C 2,000 Jan-9 By Cash A/C 1,000

4,000 4,000

Dr Sales A/C Cr
Date Particulars JF Amount Date Particulars JF Amount
Jan-31 To Balance c/d 4,000 Jan-4 By Suresh A/C 2,000
Jan-8 By Suresh A/C 2,000
4,000 4,000
Feb-1 To Balance b/d 4,000
Trial Balance: After posting the accounts in the ledger, a statement is prepared
to show separately the debit and credit balances. Such a statement is called as
the trial balance. Trial balance is prepared to verify the arithmetical accuracy
whether the total debit and credit are equal or not.

3) From the following information prepare the trial balance

Sl.No. Particulars Amount
1 Capital 42,100
2 Furniture 800
3 Discount received 800
4 Bad debts 1,000
5 Drawings 900
6 Purchases 17,620
7 Rent Paid 1,120
8 Sales 35,320
9 Creditor 1,800
10 Sales returns 400
11 Purchases returns 600
12 Advertisement 500
13 Salaries 1,800
14 Investments 1,125
15 Discount allowed 100
16 Cash in hand 14,175
17 Cash at bank 41,600
18 Discount received 520
Solution:
TRIAL BALANCE
Debit Credit
Sl.No Particulars LF
Amount Amount
1 Capital - 42,100
2 Furniture 800 -
3 Discount received - 800
4 Bad debts 1,000 -
5 Drawings 900 -
6 Purchases 17,620 -
7 Rent Paid 1,120 -
8 Sales - 35,320
9 Creditor - 1,800
10 Sales returns 400 -
11 Purchases returns - 600
12 Advertisement 500 -
13 Salaries 1,800 -
14 Investments 1,125 -
15 Discount allowed 100 -
16 Cash in hand 14,175 -
17 Cash at bank 41,600 -
18 Discount received - 520
81,140 81,140
Final Accounts: Final accounts mean accounts which are prepared at the final
stage to give the financial position of the business. The financial position is
judged by means of preparing a balance sheet of the business. The balance
sheet is prepared from the trading and profit and loss account or income
statement. Thus the final account is constituted with income statement and
balance sheet. These are
1. Trading Account
2. Profit and Loss Account/Income statement
3. Balance Sheet

1) Trading Account: Trading account shows the effect of buying selling of

goods/services during an accounting period. The statement indicates gross profit
or gross loss
Gross profit = Net sales – Cost of goods sold

Proforma:
Dr Trading A/C Cr
Particulars Amount Amount Particulars Amount Amount
To Opening Stock ------- By Sales ------
To Purchases ------- Less: Sales ------ -----
Returns
Less: Purchase ------- --------
Returns
To Wages By Closing stock
------- ------
To Freight
-------
To Carriage inwards
-------
To Gross Profit
-------
(Transfer to P/L A/C)
------- --------
2) Profit and Loss Account: Profit and loss account shows net profit or net loss
for the end of a given period.
From the gross profit or gross loss transferred from trading account,
deduct all expenses relating to office, selling and distribution departments. Add
all non-operating income such as commission or rent received, interest received
etc.
Proforma:
Dr Profit and loss A/C Cr
Expenses and losses Amount Amount Incomes and Profits Amount Amount
To Salaries ----- By Gross Profit -------
To Rent ----- By Discount -------
Received
To Insurance -----
By Commission
To Carriage outwards ----- -------
Received
To Telephone charges -----
By Profit on sale of
To Depreciation ----- fixed asset -------
To Bad debts -----
To Advertising -----
To Lighting -----
To Interest on Loan -----
To Discount allowed -----
To Samples -----
To Net Profit -----
(Transfer to B/S)
------- --------
3) Balance Sheet: It shows the financial positions of the business on a
particular date. On left hand side of balance sheet shows total liabilities and on
the right hand side total assets of business is shown. The balance sheet of a
company shall be either in a horizontal form or a vertical form. Horizontal form is
most widely accepted by the company.
Proforma:

Dr Balance Sheet Cr
Liabilities Amount Amount Assets Amount Amount
Capital ----- Plant ------
Add: Net profit ----- Less: Depreciation ------ --------
------
Less: Drawing ------ -------- Machinery ------
Less: Depreciation ------ --------
Over draft --------
Sundry creditors -------- Furniture -------
Bills payable -------- Less: Depreciation ------- --------
Outstanding expenses --------
Stock --------
Sundry Debtors --------
Less: Bad debts -------- --------

Bills receivable --------

Cash in hand --------
Cash at bank --------
Prepaid expenses --------
Total --------- Total ---------
Adjustments:
1) Outstanding Expenses or Accrual Expenses: In of outstanding expense, it
must be added to the concerned account in trading or profit and loss account and
again this item should be shown in the balance sheet liabilities.
2) Prepaid Expenses: In case any of the expenses is prepaid, it must be
deducted from the concerned head in trading or P/L account. Again, it will be
show in balance sheet as an asset.
3) Provision for depreciation: Depreciation refers to the reduction in value of
the asset. It must deduct from the concerned asset. Again, it will be shown in the
profit loss account.
Cost of asset − Scrap value
Depreciation =
life of asset
4) Closing Stock: In case closing stock¸ it must be shown in trading account,
again it is shown in balance sheet asset side.
5) Provision for Bad Debts: A bad debt is debt, which is irrecoverable, and
hence it will be written off as a loss. It must be deducted from debtors and again
it shown in profit and loss account debit side.
6) Income received in advance or Unearned income: This appears as z
deduction from the concerned income in profit and loss account and again in
balance sheet as liability.
Problems:
1) From the following trial balance and adjustments of Suresh, prepare trading and profit
and loss account for the year ending 30th June, 2006 and balance sheet as on that date.
Trial Balance
Particulars Debit Credit
Rs. Rs.
Suresh’s Drawings 14,000
Furniture 5,200
Land and buildings 40,000
Opening Stock 44,000
Debtors 37,200
Purchases 2,20,000
Sales returns 4,000
Discounts 3,200
Taxes and insurance 4,000
General expenses 8,000
Salaries 18,000
Commission 4,400
Carriage 3,600
Bad debts 1,600
Suresh capital 60,000
Bank overdraft 8,400
Creditors 31,600
Rent from tenants 2,000
Sales 3,00,000
Discounts 4,000
Provision for doubtful debts 1,200
Total: 4,07,200 4,07,200
Adjustments:
1. Closing stock Rs.70,000
2. Write off depreciation Rs.10% per annum on land and buildings
3. Taxes yet to be paid Rs.200
4. Prepaid salaries Rs.1,000
5. Provision for bad debts Rs.600
6. Rent received in advance Rs.1000
 Solution:
Dr Trading A/C of Mr.Suresh for year ending of 30th June, 2006 Cr
Particulars Amount Amount Particulars Amount Amount
To Opening Stock 44,000 By Sales 3,00,000
To Purchases 2,20,000 Less: Sales 4,000 2,96,000
Returns
Less: Purchase ------- 2,20,000
Returns By Closing stock
3,600 70,000
To Carriage
98,400
To Gross Profit
(Transfer to P/L A/C)

3,66,000 3,66,000

Dr Profit and Loss A/C of Mr.Suresh for year ending of 30th June, 2006 Cr
Expenses and losses Amount Amount Incomes and Profits Amount Amount
To Salaries 18,000 By Gross Profit 98,400
Less: prepaid salaries 1,000 17,000 By Discount 4,000
Received
To Tax and Insurance 4,000 By Provision for 1,200
Add: Outstanding 200 4,200 bad debts
By Rent received 2,000
To General expenses 8,000 Less: Rent received
To Discount allowed 4,000 in advance 1,000 1,000
To Depreciation on
land 1,800
To Bad debts 1600
Add: Bad debts new 200 3,200

To Advertising 4,400
To Commission 62,200
To Net Profit
(Transfer to B/S)
1,04,600 1,04,600
Dr Balance Sheet A/C of Mr.Suresh for year ending of 30th June, 2006 Cr
Liabilities Amount Amount Assets Amount Amount
Capital 60,000 Land & Building 40,000
Add: Net profit 62,000 Less: Depreciation 4,000 36,000
1,22,000
Less: Drawing 14,000 1,08,000 Stock 70,000
Sundry Debtors 37,200
Over draft 8,400 Less: Bad debts 200 37,000
Sundry creditors 31,600
Outstanding Tax 200 Furniture 5,200
Rent received in 1,000 Prepaid Salaries 1,000
advance

Total 1,49,200 Total 1,49,200

 2) The following figures have been extracted from the records of Fancy stores a
proprietary concern as on 31-12-2008.
Furniture 15,000 Insurance 6,000
Proprietors capital 54,000 Rent 22,000
Cash in hand 3,000 Sundry debtors 60,000
Opening stock 50,000 Sales 6,00,000
Fixed deposit 1,34,600 Advertisement 10,000
Drawing 5,000 Postages and Telephone 3,400
Provision for bad debts 3,000 Bad debts 2,000
Cash at bank 10,000 Printing and stationary 9,000
Purchases 3,00,000 General charges 13,000
Salaries 19,000 Sundry creditors 40,000
Carriage inwards 41,000 Deposit from customers 6,000
Prepare trading, profit and loss account and balance sheet after taking into consideration
the following information.
a) Closing stock as on 31st March was Rs.10,000
b) Salary of Rs.2,000 is yet to paid to an employee.

Solution:

Dr Trading A/C of Ms.Fancy Stores for year ending of 31-12- 2006 Cr

Particulars Amount Amount Particulars Amount Amount
To Opening Stock 50,000 By Sales 6,00,000
To Purchases 3,00,000 Less: Sales ------- 6,00,000
Returns
Less: Purchase -------
Returns 3,00,000 By Closing stock
10,000
To Carriage inwards 41,000
To Gross Profit 2,19,000
(Transfer to P/L A/C)

6,10,000 6,10,000
Dr Profit and Loss A/C of Ms.Fancy Stores for year ending of 31-12-2006 Cr
Expenses and losses Amount Amount Incomes and Profits Amount Amount
To Salaries 19,000 By Gross Profit 2,19,000
Add: Outstanding 2,000 21,000 By Provision for 3,000
bad debts
To Insurance 6,000
To Rent 22,000
To Advertising 10,000
To Bad debts 2,000
To Telephone charges 3,400
To Printing & stationery 9,000
To General Charges 13,000
To Net Profit 1,35,600
(Transfer to B/S)
2,22,000 2,22,000

Dr Balance Sheet A/C of Ms.Fancy Stores for year ending of 31-12- 2006 Cr
Liabilities Amount Amount Assets Amount Amount
Capital 54,000 Cash in hands 3,000
Add: Net profit 1,35,600 Cash at bank 10,000
1,89,600 Sundry debtors 60,000
Less: Drawing 5,000 1,84,600 Furniture 15,000
Fixed deposits 1,34,600
Sundry creditors 40,000 Closing Stock 10,000
Outstanding Salaries 2,000
Deposits from 6,000
customers
Total 2,32,600 Total 2,32,600