Overview of

Financial Accounting

Prasanna Kulkarni
Chartered Accountant
 OVERVIEW OF THE
FINANCIAL ACCOUNTING INFORMATION SYSTEM

INPUT INFORMATION (MONETARY) OF

TRANSACTIONS AND EVENTS

PROCESSING CLASSIFICATION
RECORDING
SUMMARISING
REPORTING

OUTPUT PROFIT AND LOSS ACCOUNT

BALANCE SHEET
 IN DEPTH VIEW OF THE
FINANCIAL ACCOUNTING INFORMATION SYSTEM

INPUT
INFORMATION (MONETARY) OF TRANSACTIONS AND
EVENTS

MONETARY : ONLY INFORMATION CAPABLE OF BEING

EXPRESSED IN MONETARY TERMS IS
ACCEPTED AS INPUT

TRANSACTION : EXCHANGE OF MONEY OR MONEY’S

WORTH

EVENTS : IF INFORMATION ABOUT EVENTS CAN BE

EXPRESSED IN MONETARY TERMS
 IN DEPTH VIEW OF THE
FINANCIAL ACCOUNTING INFORMATION SYSTEM

PROCESSING
CLASSIFICATION: TYPIFICATION OF THE TRANSACTIONS
ACCORDING TO THE ACCOUNTS
AFFECTED

RECORDING : STEP 1 : BOOKS OF PRIME ENTRY

STEP 2 : LEDGER POSTING

SUMMARISING : PREPARATION OF TRIAL BALANCE

REPORTING : PREPRATION OF THE

PROFIT AND LOSS CCOUNT
BALANCE SHEET
 IN DEPTH VIEW OF THE
FINANCIAL ACCOUNTING INFORMATION SYSTEM

OUTPUT
PROFIT AND LOSS ACCOUNT:

IT IS USUALLY PREPARED FOR A YEAR AND IS LIKE A MOVIE

OF THE PERFORMANCE DURING THAT YEAR.

BALANCE SHEET :

IT PROVIDES A SNAPSHOT OF THE FINANCIAL POSITION

AT THE END OF THE YEAR.
 TYPES OF ACCOUNTS

TYPE NATURE EXAMPLE

ASSETS PROPERTY OR RIGHT LAND, BUILDING,

MACHINERY, PATENTS,
DEBTORS
LIABILITIES DEBT OR OBLIGATION BANK LOAN,
DEBENTURES,
CC/OD, CREDITORS
INCOME MONEY RECD. OR SALES, FEES RECD.,
RECEIVABLE FOR SALE PROCESSING
OF GOODS OR SERVICES CHARGES, ETC.
EXPENSES MONEY PAID OR SALARY,TRAVELLING,
PAYABLE FOR PROF. FEES,
PURCHASE OF GOODS ELECTRICITY, ETC.
OR SERVICES
CAPITAL OWNERS’ STAKE CAPITAL INTRODUCED
 TYPES OF ACCOUNTS
(ANOTHER CLASSIFICATION)

TYPE NATURE Rule EXAMPLE

Personal Accounts of Debit the receiver Mr. P’s account,
(Assets or persons Credit the giver XYZ Ltd. account,
liabilities) etc.
Real Accounts of Debit what comes in Building account,
(Assets) properties Credit what goes out furniture account,
cash account,
bank account,etc.
Nominal Accounts of Debit all expenses and losses Salary, wages,
(Income income or Credit all incomes and gains printing and
or expenses stationery,
expenses) electricity
charges, etc.
 Major Account Classifications

Assets
Assets are
are Liabilities
Liabilities are
are debts
debts
resources
resources owned
owned owed
owed toto outsiders
outsiders
by
by the
the business.
business. (creditors).
(creditors).
Cash Accounts
Supplies payable
Building Notes payable
Accounts Wages payable
receivable
 Major Account Classifications
Liabilities
Liabilities are
are often
often identified
identified
Assets are on
on the
the balance
balance sheet
sheet
Liabilities by
by
are titles
titles
debts
Assets are Liabilities are debts
resources owned
resources owned that
that include
include
owed payable
payable
to ..
outsiders
owed to outsiders
by
by the
the business.
business. (creditors).
(creditors).
Cash Accounts
Supplies payable
Building Notes payable
Accounts Wages payable
receivable
 Major Account Classifications
Owner’s
Owner’s Revenues
Revenues are are Expenses
Expenses are are the
the
equity
equity isis the
the increases
increases inin using
using upup of
of assets
assets
owner’s
owner’s right
right toto owner’s
owner’s equity
equity asas or
or consuming
consuming of of
the
the assets
assets ofof the
the aa result
result of
of selling
selling services
services to
to
business.
business. services
services or
or generate
generate revenue.
revenue.
Chris Clark, products.
products. Rent Expense
Capital Fees Earned Salary Expense
Chris Clark, Fares Earned Utilities
Drawing Commission Expense
Revenue
 Double-Entry
Double-Entry Accounting
Accounting
“ Double-entry accounting is based on a simple
concept: each party in a business transaction
will receive something and give something in
return. In bookkeeping terms, what is received
is a debit and what is given is a credit. The T
account is a representation of a scale or
balance.”

Scale or Balance T account

Left Side Right Side

Receive Give
Luca Pacioli DEBIT CREDIT
Developer of
Double-Entry Receive Give
Accounting DEBIT CREDIT
Rules of Debit / Credit Income
Statement Accounts
Expense Accounts Revenue Accounts
Debit for Credit for Debit for Credit for
increases decreases decreases increases
(+) (-) (-) (+)
 Income Statement Accounts
Debits Credits
Revenue accounts…… Decrease (-) Increase (+)
Expense accounts…… Increase (+) Decrease (-)
 WHERE DO THEY ULTIMATELY GO?

ASSETS BALANCE SHEET

LIABILITIES BALANCE SHEET

INCOME PROFIT AND LOSS ACCOUNT

EXPENSES PROFIT AND LOSS ACCOUNT

CAPITAL BALANCE SHEET

MAIN BOOKS OF ACCOUNT
(BOOKS OF PRIME ENTRY)

NAME OF BOOK TYPES OF TRANSACTIONS ENTERED

CASH BOOK ALL CASH TRANSACTIONS
BANK BOOK ALL BANK TRANSACTIONS
PURCHASE REGISTER CREDIT PURCHASE TRANSACTIONS
SALES REGISTER CREDIT SALE TRANSACTIONS
JOURNAL ALL OTHER TRANSACTIONS
 IMPORTANT CONCEPTS
IN ACCOUNTING
BUSINESS ENTITY A business is treated as an entity separate from
its owner
MONEY MEASUREMENT All information is measured in terms of money

COST CONCEPT What is recorded is the ‘cost’ and not the ‘market
value’
GOING CONCERN An enterprise is presumed to continue its
(FUNDAMENTAL operations indefinitely
ACCOUNTING
ASSUMPTION)
CONSISTENCY Accounting policies are presumed to be
(FUNDAMENTAL consistently applied from year to year
ACCOUNTING
ASSUMPTION)
ACCRUAL Expenses are recorded when they are incurred
(FUNDAMENTAL and not when money is paid
ACCOUNTING Incomes are recorded when the legal right to
ASSUMPTION) receive it arises and not when money is received
 IMPORTANT CONCEPTS
IN ACCOUNTING
PRUDENCE Anticipate no profit but provide for all possible
(CONSERVATISM) losses
DUAL ASPECT Sources of funds(capital + outside liabilities)
always equal uses of funds(assets)

ACCOUNTING PERIOD Economic information about enterprises is

provided for specific time periods
(typically for a year)
MATCHING Costs are reported as expenses when associated
revenue is reported.
DISCLOSURE All information relevant to users of financial
statements should be provided

MATERIALITY All information significant for users of financial

statements should be reported
THE FINANCIAL STATEMENTS
(OUTPUTS OF THE FINANCIAL ACCOUNTING SYSTEM)

THE BALANCE SHEET: IT PROVIDES A SNAPSHOT

OF THE FINANCIAL POSITION AT THE END OF THE
YEAR BY COMMUNICATING INFORMATION ABOUT
ASSETS, LIABILITIES AND OWNERS’ EQUITY.

THE PROFIT & LOSS A/C.: IT MEASURES

PROFITABILITY BY SUMMARIZING REVENUES,
EXPENSES AND NET INCOME(OR NET LOSS).

THE CASH FLOW STATEMENT: IT SHOWS THE NET

INCREASE (OR DECREASE) IN CASH IN A YEAR.IT
SHOWS THE FLOW OF CASH INTO AND OUT OF
THE COMPANY AND EXPLAINS THE CHANGES IN
CASH POSITION BETWEEN TWO BALANCE SHEET
DATES.
VERTICAL BALANCE SHEET
SOURCES OF FUNDS

1. SHAREHOLDERS’ FUNDS
(A) CAPITAL
(B) RESERVES AND SURPLUS

2. LOAN FUNDS
(A) SECURED LOANS
(B) UNSECURED LOANS
APPLICATION OF FUNDS

1. FIXED ASSETS
(A) GROSS BLOCK
(B) LESS: DEPRECIATION
(C) NET BLOCK
(D) CAPITAL WORK IN PROGRESS

2. INVESTMENTS
3. CURRENT ASSETS, LOANS AND ADVANCES
(A) INVENTORIES
(B) SUNDRY DEBTORS
(C) CASH AND BANK BALANCES
(D) LOANS AND ADVANCES
LESS :
CURRENT LIABILITIES AND PROVISIONS
(A) CURRENT LIABILITIES
(B) PROVISIONS
NET CURRENT ASSETS
MISCELLANEOUS EXPENDITURE
PROFIT AND LOSS ACCOUNT(MODIFIED)
NET SALES
LESS : COST OF GOODS SOLD
GROSS PROFIT
LESS : OPERATING EXPENSES
OPERATING PROFIT (PBIT)
LESS : INTEREST
PROFIT BEFORE TAX (PBT)
LESS : TAX
PROFIT AFTER TAX (PAT)
LESS : PREFERENCE DIVIDEND (IF ANY)
PROFIT FOR EQUITY SHAREHOLDERS
LESS : EQUITY DIVIDEND
RETAINED PROFIT (CARRIED TO BALANCE SHEET)
 
TERMS USED IN FINANCIAL ANALYSIS
 
NET WORTH ( SHAREHOLDERS’ FUNDS)
= SHARE CAPITAL + RESERVES & SURPLUS - FICTITIOUS
ASSETS
 
CAPITAL EMPLOYED
= NET WORTH + TOTAL DEBT- INVESTMENTS
THE USER GROUPS :
TRADE CREDITORS:
SUPPLIERS OF GOODS / SERVICES ON CREDIT. THEY ARE
INTERESTED IN THE SHORT TERM LIQUIDITY POSITION.

SUPPLIERS OF LONG TERM DEBT:

THESE ARE BANKS/ FINANCIAL INSTITUTIONS .THEY WANT
TO ENSURE LONG TERM SOLVENCY, PROFITABILITY, DEBT
SERVICING ABILITY, AND SURVIVAL OF THE BORROWER.

INVESTORS:
THEY MAY BE LAY-MEN OR PROFESSIONAL PORTFOLIO
MANAGERS. THEY ARE INTERESTED IN PRESENT AND FUTURE
EARNING ABILITY AND RISK.
THE USER GROUPS:

MANAGEMENT:
THEY WANT TO ENSURE THAT RESOURCES ARE EFFECTIVELY
AND EFFICIENTLY USED AND THAT THE FINANCIAL CONDITION
IS SOUND.

OTHERS:
THESE MAY BE INVESTMENT CONSULTANTS, GOVT.
DEPARTMENTS LIKE SALES TAX, INCOME TAX, EXCISE, ETC. TO
ENSURE THAT TAXES AND DUTIES ARE PAID ON TIME.
(DESIRABLE) CHARACTERISTICS OF
FINANCIAL STATEMENTS

DISCLOSURE: ALL INFORMATION PERTINENT TO THE

USERS SHOULD BE DISCLOSED

MATERIALITY: ALL INFORMATION THAT IS LIKELY TO

INFLUENCE THE DECISION OF THE USERS SHOULD BE
DISCLOSED

UNDERSTANDABILITY: A LAYMAN SHOULD BE

ABLE TO UNDERSTAND THE INFORMATION

COMPARABILITY: THE FINANCIAL STATEMENTS SHOULD

BE COMPARABLE ACROSS ENTERPRISES
(THIS CONCEPT PRIMARILY CREATED THE NEED FOR
ACCOUNTING STANDARDS)
 ACCOUNTING STANDARDS

THE NEED:

TO HARMONISE THE DIVERSE ACCOUNTING

POLICIES AND PRACTISES

TO ACHIEVE UNIFORMITY IN THE PRESENTATION OF

FINANCIAL STATEMENTS

(SOURCE: PREFACE TO THE STATEMENTS OF ACCOUNTING

STANDARDS—ICAI)
SOME EXAMPLES OF ALTERNATIVE
ACCOUNTING POLICIES AND PRACTICES

DEPRECIATION : STRAIGHT LINE , WDV, ETC.

INVENTORY : FIFO / LIFO / WEIGHTED AVERAGE

CONSTRUCTION
CONTRACTS : COMPLETED CONTRACTS
PERCENTAGE COMPLETION

AMALGAMATION : PURCHASE METHOD

POOLING OF INTERESTS

GOVT. GRANTS : CAPITAL APPROACH

INCOME APPROACH
THANK YOU