FINANCIAL ACCOUNTING

Module 1
• Meaning of Accounting
• Art of recording and classifying the business transactions and events which
includes – receipt and payment of cash, purchase and sale of goods on credit,
etc

• The transactions must be in monetary terms • Art of making summaries,

analysis and interpretations of business transactions
• Communication to the external and internal stakeholders for decision
making
Introduction
Accounting or accountancy is the measurement, processing,
and communication of financial and non-financial information about economic
entities such as businesses and corporations.
• Accounting, which has been called the "language of business", measures the
results of an organization's economic activities and conveys this information to a
variety of users, including investors, creditors, management,
and regulators Practitioners of accounting are known as accountants.
• The terms "accounting" and "financial reporting" are often used as synonyms.
History of Accounting

• Accounting has existed in various forms and levels of sophistication

throughout human history. The double-entry accounting system in use
today was developed in medieval Europe, particularly in Venice, and is
usually attributed to the Italian mathematician and Franciscan friar Luca
Pacioli. Today, accounting is facilitated by accounting organizations such
as standard-setters, accounting firms, and professional bodies. Financial
statements are usually audited by accounting firms and are prepared
by generally accepted accounting principles (GAAP). GAAP is set by
various standard-setting organizations such as the Financial Accounting
Standards Board (FASB) in the United States and the Financial Reporting
Council in the United Kingdom. As of 2012, "all major economies" have
plans to converge towards or adopt the International Financial Reporting
Standards (IFRS).
Italian mathematician and Franciscan friar Luca Pacioli
Objectives of accounting

1. Calculation of Profit and Loss

1. Trading A/c ( account) (direct) Gross Profit/Loss
2. Profit& Loss A/c (indirect ) Net Profit /Loss

2. Maintenance of Records of Business Transactions

3. Depiction of Financial Position 3. (Balance sheet) – Positional statement- on

particular date-assets and Liability

4. Providing Accounting Information to its Users

TYPES OF ACCOUNTING (Branches )

1. Financial Accounting

2. Cost accounting

3.Management Accounting
• Financial accounting: it deals with the preparation of financial statements for the
basic purpose of providing information to various interested groups like
creditors, banks, shareholders, financial institutions, government, consumers,
etc. Financial statements, i.e. the income statement and the balance sheet
indicate how the activities of the business have been conducted during a given
period.
•
• Cost accounting: Cost accounting makes elaborate cost records regarding various
products, operations, and functions. It is the process of determining and
accumulating the cost of a particular product or activity. Any product, function,
job, or process for which costs are determined and accumulated, is called cost
centers. The basic purpose of cost accounting is to provide a detailed breakup of
the cost of different departments, processes, jobs, products, sales territories,
etc., so that effective cost control can be exercised. Cost accounting also helps in
making revenue decisions such as those related to pricing, product mix, profit-
volume decisions, expansion of business, replacement decisions, etc.
•
• Management Accounting: Management accounting is ‘tailor-made’ accounting.
It facilitates the management by providing accounting information in such a way
so that it is conducive to policy-making and running the day-to-day operations of
the business. Its basic purpose is to communicate the facts according to the
specific needs of decision-makers by presenting the information in a systematic
and meaningful manner. Management accounting, therefore, specifically helps in
planning and control. It helps in setting standards and in case of variances
between planned and actual performances, it helps in deciding the corrective
action.
Distinction between financial and management accounting

Financial Accounting Management accounting

Outside parties and manager of the business Business managers

Accounts are based on generally accepted Comparison of costs and benefits of

accounting principles proposed action

Concern about adequacy of disclosure. Concern about how reports will affect
Behavioral implications are secondary behavior employee

Past orientation Future orientation

Summary reports regarding the whole entity Detailed reports on the parts of the
entity
Advantages Financial Accounting
Maintenance of business records
Preparation of financial statements
Comparison of result
Acts as legal evidence
Facilitates Raising loans
Facilitates the Ascertainment of value of Business
Assist the Management
Helps in taxation matter
Facilitates control over Assets
Limitation of Financial Accounting

1. Records only monetary transactions

2. No Consideration of price level changes
3. No realistic information
4. Personal bias of accountant affects the accounting statements
Fixed instalment 100000-10%= 90000
1st yr Depreciation =10000
2nd yr =90000-10000=80000 value of asset
Diminishing value =100000*10%=10000– 100000-10000= 90000
90000*10%= 9000----90000-9000=81000

5. Window dressing in the balance sheet

6. Historical in nature
Users of Accounting Information-External
• Prospective Investors

- they are the potential investors

- By reviewing the past and present performance of the business, they decide to invest their
money

• Creditors

- Included suppliers of goods and services on credit and others lending money
- Their welfare is closely related to the progress of the business as they can analyse the paying
- Off the capacity of the business

• Government
- It needs information for taxation and other purposes e.g. sales tax, income tax, excise duty, etc.

• Consumers - To analyze the exercise of better control over the cost of production and this in
turn improves the image and reputation of the business

• Research Scholars - To analyze the financial operations

 Bookkeeping
Bookkeeping is the recording, on a day-to-day basis, of the
financial transactions and information pertaining to the
business.

Double-entry bookkeeping
The double entry system of bookkeeping is based on the fact that every transaction has
two parts, which therefore affects two ledger accounts. Every transaction involves
a debit entry in one account and a credit entry in another account.
• If debits do not equal the corresponding sum of credits, then an error has occurred.

SYSTEMS OF RECORDING
1. Single Entry System- personal accounts are recorded ie debit or credit) no
complete record of transactions.
2. Double entry system - records both the debit and credit aspects of the
transaction.
Advantages of Single-Entry System
• Simple And Easy
• Economy
• Easy to Calculate Profit
• Suitable for Small Business.

Disadvantages of the Single-Entry System

• Incomplete System of Accounting
• Unsystematic and Unscientific System
• No True Profit or Loss
• No True Financial Position
• No Arithmetical Accuracy
• Unacceptable to Tax Authorities
• Chance of Fraud and Errors
• Unsuitable for Planning and Control
• Not Suitable For Large Business Firms
 Difference between Single and Double entry system
Nature Single entry system Double entry system
Definition incomplete and unscientific perfect, complete and scientific
system of book-keeping. system of book-keeping.
Transactions
records single aspect (debit or records both the debit and credit
Recorded
credit) of the transaction. aspects of the transaction.
Accounts maintains personal accounts of maintains personal, real and nominal
Maintained debtors, creditors and a cash accounts
Special No need for specialized Requires specialized knowledge and
skills knowledge skills.
Used by used by small business firms and used by both small and big business
partnership firms. firms.
Trail cannot be prepared because of can be prepared by using debit and
Balance incomplete record of transactions. credit aspects
Detection of
very tough. Detection of errors can be easily done
Errors
Nature of
less costly costly and complex work is involved
Cost
Final
Not possible. Possible
Accounts
 Bookkeeping v/s Accounting
Bookkeeping Accounting
Definition Bookkeeping is mainly related to Accounting is the process of
identifying, measuring, and summarizing, interpreting, and
recording, financial transactions communicating financial
transactions which were classified
in the ledger account
Decision Making Management can't take a decision Depending on the data provided
based on the data provided by by the accountants, the
bookkeeping management can take critical
business decisions
Objective To keep the records of all financial To gauge the financial situation
transactions in proper and and further communicate the
systematic way information to the relevant
authorities
Preparation of Financial statements are not Financial statements are prepared
Financial prepared as a part of this process during the accounting process
Statements
Skills Required Bookkeeping doesn't require any Accounting requires special skills
special skill sets due to its analytical and complex
nature
Analysis The process of bookkeeping does Accounting uses bookkeeping
not require any analysis information to analyze and
Rules of Double Entry – Examples
Personal A/c
Krishna commenced business with a capital of Rs 1,00,000

Krishnas Capital a/c Cash a/c

↓ ↓
Person Tangible Aspect (Asset)
↓ ↓
Personal A/c Real A/c
↓ ↓
Giving benefits Coming in
↓ ↓
Credit Debit
[Credit the benefit giver] [Debit what comes in]
Real A/c Example
Bought Furniture for cash 10,000.

Furniture a/c Cash a/c

↓ ↓
Tangible Aspect (Asset) Tangible Aspect (Asset)
↓ ↓
Real A/c Real A/c
↓ ↓
Coming in Going out
↓ ↓
Debit Credit
[Debit what comes in] [Credit what goes out]
Nominal A/c

Paid Rent to the shop owner Anand Rs. 5,000

Rent Paid a/c Cash a/c
↓ ↓
Expenditure Tangible Aspect (Asset)
↓ ↓
Nominal a/c Real a/c
↓ ↓
Expense Going out
↓ ↓
Debit Credit
[Debit all expenses/losses] [Credit what goes out]
Accounting Cycle
The accounting cycle is a collective process of identifying, analyzing, and recording the
accounting events of a company.
Accounting Equation:

• The accounting equation displays that all assets are either financed by borrowing money
or paying with the money of the company’s shareholders. Thus, the accounting equation
is:

Assets = Liabilities + Capital.

Assets -Liabilities = Capital.
Assets - Capital =Liabilities.

Accounting Principles are concepts and conventions

I. Basic Accounting Concepts: Accounting concepts mean and include necessary

assumptions or postulates or ideas that are used in accounting practice and the
preparation of financial statements.

II. Accounting Conventions: The Accounting Convention implies that those customs,
methods, and practices are to be followed as a guideline for the preparation of
accounting statements.
Show the Accounting Equation based on the following transactions

₹
(i) Raj commenced business with cash 70,000
(ii) Purchased goods on credit 14,000
(iii) Withdrew for Private use 1,700
(iv) Goods purchased for cash 10,000
(v) Paid wages 300
(vi) Paid to creditors 10,000
(vii) Sold goods on credit for 15,000
(viii) Sold goods for cash (cost price was Purchased motorcycle 4,000
for cash ₹ 3,000)

(ix) Purchased furniture for 500​

Modifying Principles

To maintain uniformity and consistency in books of accounts, certain rules or principles have
been evolved which are generally accepted by the accounting profession. These rules are
known by different names such as principles, concepts, conventions,
postulates, assumptions, and modifying principles.

Modifying Principles

The important modifying principles are:

1. Cost-Benefit
2. Materiality
3. Consistency.
4. Prudence or conservatism
5. Timeliness
Materiality Concept -All the material items should be reported properly in
the financial statements. Material items are considered as those items
whose inclusion or exclusion results in significant changes in the decision-
making for the users of business information.
For example, we do not show stationery items etc. are as assets. Purchase of Stationery in an
accounting period is an expense of that period, whether we consume it or not.
• X (giver)sells goods to Y (receiver) on credit
• A/c of X (personal a/c)
• Y’s A/c debit in X book
• Y’s book—X’s A/c credit
• Drawings A/c-- Personal A/c.
• owner takes over goods /cash for personal use
• Capital A/c =Personal A/c.
• Bank OD (over Draft) =Personal A/c.
• Outstanding Salary(O/S) =Personal A/c.
• Bank A/c =Personal A/c.
• Real A/c- A/c’s of Asset– any physical thing/ right– money value
• Debtor (Dr.) person who owes money
• Creditor (Cr.) To whom money is payable (Liability)
• Purchase - Real A/c
• Stock- Real A/c
• Goodwill - Real A/c
• Patent - Real A/c
• B/R (Bills Receivable)- Real A/c
• Furniture ( goods) sold – cash comes (debit)
• furniture (sale/Purchase) – goes out (credit)
GAAP
Generally Accepted Accounting Principles (GAAP): Generally Accepted Accounting
Principles refer to the rules or guidelines adopted for recording and reporting business
transactions to bring uniformity in the preparation and presentation of financial
statements. These principles are also referred to as concepts and conventions. From
the practical viewpoint, the various terms such as principles, postulates, conventions
modifying principles, assumptions, etc. have been used interchangeably and are
referred to as basic accounting concepts, in the present book.
Accounting Principles are the general rules and guidelines to guide an accounting
professional as to how to work. These are the general rules.
• And policies are adopted by firms, companies, or any such entities for their working,
which suits to them.
• Like in the case of depreciation, some might adopt SLM Method while others WDV.
These are policies and principles are the guidelines.
Accounting Policies are the norms, rules, directions, and methods that a business
decides for itself. Policies are not universal, they can differ from one organization to
another. Accounting policy for an organisation basically defines “their” way of
accounting for transactions.

Accounting Principles are concepts and conventions

Basic Accounting Concepts: The basic accounting concepts are referred to as the
fundamental ideas or basic assumptions underlying the theory and practice of
 FINANCIAL ACCOUNTING Semester II

Module 1

INTRODUCTION Accounting is a system meant for measuring business activities, processing of

information into reports, and making the findings available to decision-makers. The documents, which
communicate these findings about the performance of an organisation in monetary terms, are called
financial statements. Usually, accounting is understood as the Language of Business.

In 1941, The American Institute of Certified Public Accountants (AICPA) defined accounting as 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 financial character, and interpreting the results thereof.

In 1966, the American Accounting Association (AAA) defined accounting as ‘the process of identifying,
measuring and communicating economic information to permit informed judgments and decisions by users
of information’.

In 1966, the American Accounting Association (AAA) defined accounting as ‘the process of identifying,
measuring and communicating economic information to permit informed judgments and decisions by users
of information’.

In 1970, the Accounting Principles Board of AICPA also emphasized that the function of accounting is to
provide quantitative information, primarily financial in nature, about economic entities, that is intended to
be useful in making economic decisions. Accounting can therefore be defined as the process of identifying,
measuring, recording and communicating the required information relating to the economic events of an
organization to the interested users of such information.

Objectives of accounting

• Maintenance of Records of Business Transactions: Accounting is used for the maintenance of a

systematic record of all financial transactions in book of accounts. Even the most brilliant executive or
manager cannot accurately remember the numerous amount of varied transactions such as purchases, sales,
receipts, payments, etc. that takes place in business every day. Hence, proper and complete records of all
business transactions are kept regularly. Moreover, the recorded information enables verifiability and acts
as evidence.

• Calculation of Profit and Loss: The owners of business are keen to have an idea about the net results of
their business operations periodically, i.e. whether the business has earned profits or incurred losses. Thus,
another objective of accounting is to ascertain the profit earned or loss sustained by a business during an
accounting period which can be easily workout with help of record of incomes and expenses relating to the
business by preparing a profit or loss account for the period. Profit represents excess of revenue (income),
over expenses. If the total revenue of a given period is Rs 6,00,000 and total expenses are Rs. 5,40,000 the
profit will be equal to Rs. 60,000(Rs. 6,00,000 – Rs. 5,40,000). If however, the total expenses exceed the
total revenue, the difference reflects the loss.
 • Depiction of Financial Position: Accounting also aims at ascertaining the financial position of the
business concern in the form of its assets and liabilities at the end of every accounting period. A proper
record of resources owned by business organization (Assets) and claims against such resources (Liabilities)
facilitates the preparation of a statement known as balance sheet position statement.

• Providing Accounting Information to its Users: The accounting information generated by the accounting
process is communicated in the form of reports, statements, graphs and charts to the users who need it in
different decision situations. As already stated, there are two main user groups, viz. internal users, mainly
management, who needs timely information on cost of sales, profitability, etc. for planning, controlling and
decision-making and external users who have limited authority, ability and resources to obtain the
necessary information and have to rely on financial statements (Balance Sheet, Profit and Loss account)

TYPES OF ACCOUNTING (Branches )

viz, Financial Accounting, cost accounting and Management Accounting. Financial accounting is primarily
concerned with the preparation of financial statements whereas management accounting covers areas such
as interpretation of financial statements,

1. Financial accounting: it deals with the preparation of financial statements for the basic purpose of
providing information to various interested groups like creditors, banks, shareholders, financial institutions,
government, consumers, etc. Financial statements, i.e. the income statement and the balance sheet indicate
the way in which the activities of the business have been conducted during a given period of time.

2. Cost accounting: Cost accounting makes elaborate cost records regarding various products, operations
and functions. It is the process of determining and accumulating the cost of a particular product or activity.
Any product, function, job or process for which costs are determined and accumulated, are called cost
centres. The basic purpose of cost accounting is to provide a detailed breakup of cost of different
departments, processes, jobs, products, sales territories, etc., so that effective cost control can be exercised.
Cost accounting also helps in making revenue decisions such as those related to pricing, product-mix,
profit-volume decisions, expansion of business, replacement decisions, etc.

3. Management accounting: Management accounting is ‘tailor-made’ accounting. It facilitates the

management by providing accounting information in such a way so that it is conducive for policy making
and running the day-to-day operations of the business. Its basic purpose is to communicate the facts
according to the specific needs of decision-makers by presenting the information in a systematic and
meaningful manner. Management accounting, therefore, specifically helps in planning and control. It helps
in setting standards and in case of variances between planned and actual performances, it helps in deciding
the corrective action.

Distinction between financial and management accounting

Financial accounting Management accounting

Outside parties and manager of the business Business managers
Accounts are based on generally accepted accounting Comparison of costs and benefits of proposed
principles action
 Concern about adequacy of disclosure. Behavioral Concern about how reports will affect
implications are secondary behavior employee
Past orientation Future orientation
Summary reports regarding the whole entity Detailed reports on the parts of the entity

Advantages Financial Accounting:

1. Maintenance of business records: All financial transactions are recorded in a systematic manner in the
books of accounts so that there is no need to reply on memory. Human memory is limited by its very nature.
Accounting helps to overcome this limitation.
2. Preparation of financial statements: Systematic records enables the accountants to prepare the financial
statements trading and profit and loss account to ascertain profit or loss during a particular accounting
period and balance sheet to state the financial position of the business on a particular date.
3. Comparison of result: Systematic maintain of business record enables the accountant to compare profits
of one year with those of earlier years to know the significant facts about the change.
4. Acts as legal evidence: Proper books of accounts maintained in systematic manner act as legal evidence
in case of disputes.
5. Facilitates Raising loans: Accounting facilitates raising loans from lenders by providing them required
financial information.
6. Facilitates the Ascertainmentof value ofBusiness: Accounting facilitates the ascertainment of value of
business in case of transfer of business to another entity.
7. Assist the Management: Accounting assists the management in taking managerial decisions. For
Example, Projected cash flow statement facilitates the management to know future receipts and payment
and to take decision regarding anticipated surplus or shortage of funds.
8. Helps in taxation matter: Accounting facilitates the settlement of tax liability with the authorities by
maintaining proper books of accounts in systematic manner.
9. Facilitates control over Assets: Accounting facilitates control over assets by providing information
regarding cash balance, Bank balance, stock debtors, fixed assets, etc.

Limitation of Financial Accounting

1. Records only monetary transactions: Financial accounting records only those transactions which can be
measured in monetary terms. It has no place for recording non-monetary or non-financial transactions,
thought these matter also have a significant role in affecting the soundness of the business for example,
efficiency of the management, political situation, Government Policy, market competition etc. do effect
the financial result and financial position of a business, but these are not at all recorded in accounting.
2. No Consideration of price level changes: Accounting accepts the cost concept and hence does not
consider the change in the price level from time to time. This is a very serious limitation of financial
accounting.
3. No realistic information: Accounting information may not be realistic as an accounting statement is
prepared by following basic concepts and conventions. For example, the Going concern concept gives us
as idea that the business will continue and assets are to be recorded at cost but the book value, which the
asset is showing may not be actually realizable.
4. Personal bias of accounting affects the accounting statements: Accounting statement is influenced by
the personal judgment of the accountant. He may select any method of depreciation valuation of stock and
 treatment of deferred revenue expenditure, such judgment is based on integrity and competence of the
accountant and will affect the preparation of accounting statement.
5. Window dressing in balance sheet: When an account resorts to window dressing in the balance sheet the
balance sheet cannot exhibit the true and fair view of the state of affairs of the business.

Accounting as an information system (AIS) is a system of collecting, storing and processing financial
and accounting data that are used by decision makers. An accounting information system is generally a
computer-based method for tracking accounting activity in conjunction with information technology
resources. The resulting financial reports can be used internally by management or externally by other
interested parties including investors, creditors and tax authorities. Accounting information systems are
designed to support all accounting functions and activities including auditing, financial accounting &
reporting, managerial/ management accounting and tax. The most widely adopted accounting information
systems are auditing and financial reporting modules.

Bookkeeping
Bookkeeping is the systematic recording and organising of financial transactions in a company.
Bookkeeping is the recording, on a day-to-day basis, of the financial transactions and information
pertaining to a business. It ensures that records of the individual financial transactions are correct, up-to-
date and comprehensive. Accuracy is therefore vital to the process.

Recording transactions
In principle, transactions must be recorded daily into the books or the accounting system. For each
transaction, there must be a document that describes the business transaction. This could include a sales
invoice, sales receipt, a supplier invoice, a supplier payment, bank payments and journals. These
accompanying documents provide the audit trail for each transaction and are an important part of
maintaining accurate records in the event of an audit.

Double-entry bookkeeping
The double entry system of bookkeeping is based on the fact that every transaction has two parts, which
therefore affects two ledger accounts. Every transaction involves a debit entry in one account and
a credit entry in another account. This serves as a kind of error-detection system: if, at any point, the sum
of debits does not equal the corresponding sum of credits, then an error has occurred.

SYSTEMS OF RECORDING There are three methods of recording of entries which are explained as
under:

Single Entry System: This system ignores the two fold aspect of each transaction as considered in double
entry system. Under single entry system, merely personal aspects of transaction i.e. personal accounts are
recorded. This method takes no note of the impersonal aspects of the transactions other than cash. It offers
no check on the accuracy of the posting and no safeguard against fraud and because it does not provide any
check over the recording of cash transactions, it is called as “imperfect accounting”.

Double entry system: The double entry system was first evolved by Luca Pacioli, who was a Franciscan
Monk of Italy. With the passage of time, the system has gone through lot of developmental stages. It is the
only method fulfilling all the objectives of systematic accounting. It recognizes the two fold aspect of every
business transaction.

Difference between Single entry system and Double entry system

Single entry system Double entry system

Definition Double entry system is a perfect,
Single entry system is an incomplete and
complete and scientific system of book-
unscientific system of book-keeping.
keeping.
Transactions It only records single aspect (debit or It records both the debit and credit
Recorded credit) of the transaction. aspects of the transaction.
Accounts Maintained It maintains personal accounts of debtors, It maintains personal, real and nominal
creditors and a cash book for the recording accounts for the recording of
of transactions. transactions.
Special skills The person who is responsible for book-
There is no need for specialized knowledge
keeping in double entry system should
to maintain books in single entry system.
possess specialized knowledge and skills.
Used by The Double entry system is can be used
Single entry system is mainly used by small
by both small and big business firms for
business firms and partnership firms.
recording the transactions.
Trail Balance In this system, Trail Balance cannot be Trail Balance can be prepared by using
prepared because of incomplete record of debit and credit aspects of the recorded
transactions. transactions.
Detection of Errors Detection of errors in the books prepared Detection of errors can be easily done in
by single entry system is very tough. double entry system.
Nature of Cost Single entry method of book-keeping is Double entry method of book-keeping is
less costly and is considered as the simple costly and complex work is involved in
way of recording transactions. the recording of transactions.
Final Accounts Preparation of trading and profit & loss Trading and Profit & Loss accounts are
accounts for knowing the financial position prepared to ascertain the financial
of the firm is not possible. position of the firm.
Bookkeeping vs Accounting

Bookkeeping Accounting
Definition Bookkeeping is mainly related to Accounting is the process of summarizing,
identifying, measuring, and recording, interpreting, and communicating financial
financial transactions transactions which were classified in the ledger
account
Decision Making Management can't take a decision based on Depending on the data provided by the
the data provided by bookkeeping accountants, the management can take critical
business decisions

Objective The objective of bookkeeping is to keep the the objective of accounting is to gauge the
records of all financial transactions proper financial situation and further communicate the
and systematic information to the relevant authorities

Preparation of Financial statements are not prepared as a Financial statements are prepared during the
Financial part of this process accounting process
Statements
Skills Required Bookkeeping doesn't require any special Accounting requires special skills due to its
skill sets analytical and complex nature
 Analysis The process of bookkeeping does not Accounting uses bookkeeping information to
require any analysis analyze and interpret the data and then
compiles it into reports
Types Basically there are two types of The accounting department does preparations
bookkeeping - Single entry and double of a company's budgets and plans loan
entry bookkeeping proposals
Bookkeepers and Bookkeepers are required to be accurate in Accountants with sufficient experience and
Accountants their work and knowledgeable about education can obtain the title of Certified
financial topics. Bookkeepers' work is Public Accountant (CPA)
usually overseen by an accountant

Advantages of Single Entry System

1. Simple And Easy: A single-entry system is simple to understand and easy to maintain as it has no fixed set of
principles to follow while recording financial transactions.

2. Economy: A single-entry system is an economical system of recording financial transactions. It does not require
hiring skilled accounting personnel to record financial transactions of the business. Further, it does not require a
large number of books to record the limited number of financial transactions.

3. Easy to Calculate Profit: Under a single entry system, the amount of profit can be determined easily. The amount
of profit or loss of the period can be determined by making a comparison between the amounts of closing capital and
opening capital.

4. Suitable for Small Businesses: The single-entry system is a simple, easy, and economical system. It is suitable
for small businesses because they cannot afford the cost of a double-entry system. Besides, small business is not
required to maintain their books of accounts under a double-entry system.

Disadvantages of Single-Entry System

1. Incomplete System of Accounting: it ignores dual aspects (debit and credit) of transactions. It also ignores nominal
accounts and real accounts. So, it is an incomplete system of recording transactions.

2. Unsystematic and Unscientific System: it does not follow proper accounting rules and principles to record the financial
transactions. So, it is an unsystematic and unscientific system of recording transactions that cannot be taken as an authentic
source.

3. No True Profit or Loss: Trial balance, trading account, and profit and loss account cannot be prepared with the help
of a single-entry system. So, the correct profit or loss amount cannot be obtained in the absence of this account.
4. No True Financial Position: A balance sheet cannot be prepared with the help of a single entry system because it
ignores real accounts. So, the true financial position of the firm cannot be revealed in the absence of a balance sheet.
5. No Arithmetical Accuracy: This system ignores debit and credit principles of accounting. So, the trial balance cannot
be prepared with only one aspect of the transaction. Therefore, arithmetical accuracy is not possible in the absence of trial
balance.

6. Unacceptable to Tax Authorities: Because of incompleteness, unscientific and lack of accuracy, tax authorities and
other business agencies do not rely on single entry system.

7. Chance of Fraud and Errors: There is very high chance of occurrence of frauds and errors under single entry system
because of lack of proper internal check system.

8. Unsuitable for Planning and Control: It does not provide accurate and adequate information to the management. So,
it does not support top level management for future planning and effective control.
10. Not Suitable For Large Business Firms

BASIS OF ACCOUNTING SYSTEM

• Cash or receipt basis is the method of recording transactions: under which revenues and costs and assets
and liabilities are reflected in accounts in the period in which actual receipts or actual payments are made.
“Receipts and payments account” in case of clubs, societies, hospitals etc., is the example of cash basis of
accounting.
• Accrual or mercantile basis is the method of recording transactions by which revenues; costs, assets and
liabilities are reflected in accounts in the period in which they accrue. This basis includes considerations
relating to outstanding; prepaid, accrued due and received in advance.
• Hybrid or mixed basis is the combination of both the basis i.e. cash as well as mercantile basis. Income
is recorded on cash basis but expenses are recorded on mercantile basis.

Classification of accounts

Classification of accounts

Personal Impersonal

Real Nominal

Personal Accounts: Accounts recording transactions relating to individuals or firms or company are
known as personal accounts. Personal accounts may further be classified as:

(i) Natural Person’s personal accounts: The accounts recording transactions relating to individual human
beings e.g., Anand’s a/c, Ramesh’s a/c, are classified as natural persons’ personal accounts.

(ii) Artificial Persons’ Personal accounts: The accounts recording transactions relating to limited
companies, bank, firm, institution, club, etc.,

(iii) Representative Personal Accounts: The accounts recording transactions relating to the expenses and
incomes are classified as nominal accounts. But in certain cases (due to the matching concept of
accounting) the amount, on a particular date, is payable to the individuals or recoverable from individuals.
Such amount (i) relates to the particular head of expenditure or income and (ii) represent persons to whom
it is payable or from whom it is recoverable. Such accounts are classified as representative personal
accounts e.g., “wages outstanding account”, pre-paid Insurance account, etc.

Real Accounts: The accounts recording transactions relating to tangible things (which can be touched,
purchased and sold) such as goods, cash, building, machinery etc., are classified as tangible real accounts.
Whereas the accounts recording transactions relating to intangible things (which do not have physical
shape) such as goodwill, patents and copy rights, trade marks etc., are classified as intangible real accounts.

Nominal Accounts: The accounts recording transactions relating to the losses, gains, expenses and
incomes e.g. Rent, salaries, wages, commission, interest, bad debts etc., are classified as nominal accounts.
Rules of debit and credit (classification based)
 1. Personal accounts : Debit the receiver

Credit the giver (supplier)

2. Real accounts: : Debit what comes in

Credit what goes out

3. Nominal accounts : Debit expenses and losses

Credit incomes and gains

Accounting Cycle
The accounting cycle is a collective process of identifying, analyzing, and recording the accounting events
of a company. The series of steps begin when a transaction occurs and end with its inclusion in the financial
statements. Additional accounting records used during the accounting cycle include the general ledger and
trial balance.

Accounting Equation:
The accounting equation displays that all assets are either financed by borrowing money or paying with the
money of the company’s shareholders. Thus, the accounting equation is:

Assets = Liabilities +Shareholder Equity.

The balance sheet is a complex display of this equation, showing that the total assets of a company are
equal to the total of liabilities and shareholder equity. Any purchase or sale by an accounting equity has an
equal effect on both sides of the equation, or offsetting effects on the same side of the equation. The
accounting equation is also written as

Liabilities = Assets – Shareholder Equity and Shareholder Equity = Assets – Liabilities.

• Assets: This is the value of the items that a company owns, they may be tangible or intangible but belong

to the company.

• A liability: This is a term for the total value that a company is required to pay in the short term or the long

term.

• Shareholders’ Equity: Shareholder’s Equity is the amount of money a company has raised through its
issue of shares. Alternatively, it is also the amount of retained earnings of a company. As the shareholders
invest their money in the company, they are required to be paid with some amount of returns, which is why
this is a liability in the company’s account books.
Hence, the total assets should always be equal to the total liabilities in a balance sheet, which fundamental forms the
basis of the whole accounting system of any company when it follows the double-entry bookkeeping system.
Generally Accepted Accounting Principles (GAAP): Generally Accepted Accounting principles refer to
the rules or guidelines adopted for recording and reporting of business transactions in order to bring
uniformity in the preparation and presentation of financial statements. These principles are also referred to
as concepts and conventions. From the practicality view point, the various terms such as principles,
postulates, conventions modifying principles, assumptions, etc. have been used interchangeably and are
referred to as basic accounting concepts, in the present book.
Accounting Principles are the general rules and guidelines to guide an accounting professional as to how
work. These are the general rules.

And policies are adopted by firms, companies or any such entities for their working, which suits to them.

Like in case of depreciation, some might adopt SLM Method while other WDV. These are policies and
principles are the guidelines.

Accounting Policies are the norms, rules, directions, methods that a business decides for themselves.
Policies are not universal, they can differ from one organisation to another. Accounting policy for an
organisation basically defines “their” way of accounting for transactions.

Accounting Principles are concepts and conventions

Basic Accounting Concepts: The basic accounting concepts are referred to as the fundamental ideas or
basic assumptions underlying the theory and practice of financial accounting and are broad working rules
of accounting activities.

Accounting Principles

Various accounting systems and techniques are designed to meet the needs of the management. The
information should be recorded and presented in such a way that management is able to arrive at
right conclusions. The ultimate aim of the management is to increase profitability and losses. In order
to achieve the objectives of the concern as a whole, it is essential to prepare the accounting statements
in accordance with the generally accepted principles and procedures

I. Accounting Concepts

II. Accounting Conventions.

I. Accounting concepts Accounting concepts mean and include necessary assumptions or postulates or
ideas which are usedto accounting practice and preparation of financial statements. The following are the
important accounting concepts:

1) Entity Concept;
2) Dual Aspect Concept;
3) Accounting Period Concept;
4) Going Concern Concept;
(5)Cost Concept;
6) Money Measurement Concept;
(7) Matching Concept;
8) Realization Concept;
9) Accrual Concept;
10) Rupee Value Concept.
II. Accounting Conventions: Accounting Convention implies that those customs, methods and practices
to be followed as a guideline for preparation of accounting statements. The accounting conventions can be
classified as follows:
(1) Convention of Disclosure.
(2) Convention of Conservatism.
3) Convention of Consistency
4)Convention of Materiality
 KEYWORDS

Creditor (Cr.): Amount owned by an enterprise on account of goods purchased or services received.

Debtor (Dr.): Persons from whom amounts are due for goods sold or services rendered.

Reserve: The portion of earnings of an enterprise appropriated by the management for a general or specific purpose.

Provision: Amount retained by way of providing for any known liability the amount of which cannot be determined
with substantial accuracy.

Balance Sheet-B/S

Profit and Loss Account –P&L A/c

Modifying Principles of Accounting

To build the accounting information valuable to different interested parties, the fundamental assumptions and
concepts conversed before have been customized. If the cost is more than the profit derived, then the principle should
be modified. There should be elasticity in adopting a principle and the advantage out of the principle should
overweigh the cost of implementing the principle.

These modifying principles are described below;

Cost-Benefit Principle

According to this principle, the cost of applying an accounting principle should be fewer than profit. This modifying
principle states that the expenditure of applying a principle should not be further than the profit derived from it. If
the expenditure is further than the profit then that principle should be modified. According to this principle, the cost
of applying an accounting principle should be less than benefits
For example, if your business owns material goods, such as real estate or vehicles, those should be planned as the
historical costs of the property, not the present reasonable market value of the property.

▪ Materiality Principle

Non-relevant information is not to be shown in the financial statements. The concept of materiality requires that in
accounting we should focus on material facts. The materiality principle necessitates all comparatively appropriate
information should be disclosed in the financial statements. Efforts should not be wasted in recording and presenting
those facts, which are irrelevant in the purpose of income of the business. Non-relevant information is not to be
shown in the financial statements. Inconsequential and irrelevant information are whichever left out or merged with
other items. Accountant judges an item on the basis of the implication of the article and therefore records the
transaction.

▪ Consistency Principle

Consentience usually requires that a company use similar accounting principles and reporting practice through time.
As per this principle, accounting information should permit comparisons over a period of time as well as with the
working of other enterprises. The spire of the consistency principle is to protect the comparability of financial
statements. The system, observations, ideas and principles used in accounting should be constantly practical and
applied year after year. Comparisons of financial results of the industry among diverse accounting stage can be
important and consequential only when reliable practices were followed in determining them. It means that the
business should follow the similar accounting policies constantly so that, comparison of accounts becomes rational
and meaningful.

For example, an investor wants to estimate the economic performance of a firm in the current year as compared to
that in the previous year.

▪ Conservatism Concept

The concept of conservatism also known as prudence. It provides direction for recording transactions in the book of
accounts and is based on the strategy of playing safe. When there’s more than one suitable method to record a
transaction, the principle of conservatism instructs the accountant to decide the alternative that’s superlative for the
business they’re working with. The perception states that a conscious approach should be followed in ascertaining
income so that profits of the entity are not overstated.

▪ Industry Practice

As there are dissimilar types of industries, each kind of industry has its own individuality and features. There might
be regular industries or non-seasonal industries. A business should follow the accounting principles and policies of
the industry to which it belongs. Every industry adopts the principles and conjecture of accounting to perform its
own activities. Some industries adopt the principles, concepts, and conventions in a customized method. Therefore,
the assessment of one firm with another firm is important.

The accounting performs which has for all time prevailed in the industry should be followed by similar types of
industries. e.g., Electric supply companies, Insurance companies maintain their accounts in a particular method.

Please Refer reference text Books and Class notes