Introduction to Financial

Accounting and Techniques

Nature of accounting
Wherever money is involved, accounting is
required to account for it.
Accounting is often called the language of
business.

Nature of accounting
Business is about money - and managers, owners
and other interested parties need to keep track of
Where the money came from
Where it is now
Where it will be in the future

But that doesnt tell us what accounting is

Required
a) What is accounting?
b) Why do you need to learn about the world of
accounting?

Nature of accounting
Accounting is the process of identifying,
measuring, recording and communicating
economic transactions (Collis and Hussey, 2007,
p. 5)
Identifying economic transactions of the business and
not the personal affairs of the owners or managers
Measuring the economic transactions in monetary
terms
Recording them in the accounting system
Communicating them to users by producing financial
statements that summarise the information

Definition of Accounting
American Institute of Certified Public
Accountants (AICPA) which defines 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 a financial character and interpreting the
results thereof.

Two main branches of accounting

Financial accounting is a branch of accounting
concerned with classifying, measuring, and
recording the economic transactions of an entity in
accordance with established principles, legal
requirements and accounting standards. It is
primarily concerned with communicating a true and
fair view of the financial performance and financial
position of an entity to external parties

Two main branches of accounting

Management accounting is a branch of accounting
concerned with collecting, analysing and interpreting
quantitative and financial information. It is primarily
concerned with communicating information to
management for planning, controlling and decision
making

Objective of Accounting

To keeping systematic record

To establish the results of the operation
To ascertain the financial position of the business
To portray the liquidity position
To protect business properties
To facilitate rational decision making
To satisfy the requirements of law

Importance of Accounting
Owners
Owners, being businessmen, always keep an eye on the
returns from the investment.

Management
The management is interested in financial accounting to
find whether the business carried on is profitable or not.
Eyes and ears

Importance of Accounting
Creditors
Creditors are the persons who supply goods on credit, or
bankers or lenders of money.
Profit and Loss Account and Balance Sheet are nerve
centers to know the soundness of the firm.

Employees
The demand for wage rise, bonus, better working
conditions etc. depend upon the profitability of the firm
and in turn depends upon financial position.

Importance of Accounting
Investors
This group is eager to go through the accounting which
enables them to know the safety of investment.

Government
To know the earnings for the purpose of taxation

Consumers
Research Scholars
Accounting information, being a mirror of the financial
performance of a business organization, is of immense
value to the research scholar who wants to make a study
into the financial operations of a particular firm.

Functions of Accounting
Record Keeping Function
The primary function of accounting relates to recording,
classification and summary of financial transactionsjournalisation, posting, and preparation of final
statements.
Facilitates decision making programme for future
activities.

Managerial Function
The variations of actual operations with pre-determined
standards and their analysis is possible only with the help
of accounting.

Functions of Accounting
Legal Requirement function
Auditing is compulsory and its not possible without
accounting for registered firms.
Accounting is a base and with its help various returns,
documents, statements etc., are prepared.

Language of Business
Various transactions are communicated only through
accounting.
It shows real and true position of the firm or the business.

Advantages of Accounting
Complete record of business transactions
It gives information about the profit or loss made by
the business at the close of a year and its financial
conditions
It provides useful information for making economic
decisions
It facilitates comparative study of current years
profit, sales, expenses etc., with those of the
previous years

Advantages of Accounting
Ability to utilise enterprise resources effectively in
achieving primary enterprise goals
It provides users with factual and interpretive
information about transactions and other events
which are useful for predicting, comparing and
evaluation the enterprises earning power.
It helps in complying with certain legal formalities
like filing of income tax and sales-tax returns

Limitations of Accounting
Due to historical nature It does not reflect the current
financial position or worth of a business
Accounting is limited to monetary transactions only,
excludes qualitative elements like management,
reputation, employee morale, labour strike etc.
Facts recorded in financial statements are greatly
influenced by accounting conventions and personal
judgments of the Accountant or Management.
Cost concept is found in accounting. Money value is
bound to change often from time to time

Meaning of Debit and Credit

Recording of transactions require a thorough
understanding of the rules of debit and credit
relating to accounts.
Both debit and credit may represent either increase
or decrease, depending upon the nature of account.
Dr is used for debit and Cr is used for credit.

Types of Accounts
Business transactions have been classified into three
categories:
(i) Transactions relating to persons => Personal Accounts
(ii) Transactions relating to properties and assets => Real
Accounts
(iii) Transactions relating to incomes and expenses =>
Nominal Accounts

Types of Accounts
Personal Accounts
Accounts recording transactions with a person or group of
persons
(a) Natural persons: An account recording transactions
with an individual human being is termed as a natural
persons personal account.
(b) Artificial or legal persons: An account recording
financial transactions with an artificial person created by
law or otherwise is termed as an artificial person, personal
account
(c) Groups/Representative personal Accounts: An account
indirectly representing a person or persons is known as
representative personal account.

Types of Accounts
The rule for personal accounts is:
Debit the receiver
Credit the giver

Types of Accounts
Real Accounts
Accounts relating to properties or assets are known as
Real Accounts, A separate account is maintained for each
asset
(a) Tangible Real Accounts: These accounts represent
assets and properties which can be seen, touched, felt,
measured, purchased and sold.
(b) Intangible Real Accounts: These accounts represent
assets and properties which cannot be seen, touched or
felt but they can be measured in terms of money.

Types of Accounts
The rule for Real accounts is:
Debit what comes in
Credit what goes out

Nominal Accounts
Accounts relating to income, revenue, gain expenses and
losses are termed as nominal accounts. These accounts are
also known as fictitious accounts as they do not represent
any tangible asset.

The rule for Nominal accounts is:

Debit all expenses and losses
Credit all incomes and gains

Distinction Between Book-keeping

and Accounting

Branches of Accounting
Financial accounting;
Cost accounting; and
Management accounting.

Branches of Accounting
Financial accounting
The accounting system concerned only with the
financial state of affairs and financial results of
operations
Mainly concerned with the preparation of financial
statements for the use of outsiders
The profit and loss account and the balance sheet, show
them the manner in which operations of the business have
been conducted during a specified period.

Branches of Accounting
Cost accounting
Cost accounting involves the techniques for:
determining the costs of products, processes, projects, etc.
in order to report the correct amounts on the financial
statements, and
Assisting management in making decisions and in the
planning and control of an organization.
Cost accounting seeks to determine the cost of unit
produced and sold or the services rendered by the
business unit with a view to exercising control over these
costs to assess profitability and efficiency of the
enterprise.

Branches of Accounting
Management accounting
Accounting which provides necessary information to the
management for discharging its functions
Management accounting is the presentation of accounting
information is such a way as to assist management in the
creation of policy and the day-to-day operation of an
undertaking
Management accounting is not only confined to the area
of cost accounting but also covers other areas (such as
capital expenditure decisions, capital structure decisions,
and dividend decisions) as well.

Financial Statements
Financial Statements include:
Trading and Profit and Loss Account or Income Statements
Balance Sheet

An Income Statement has two parts,

Trading Account - It reveals gross profit or gross loss and
Profit and Loss Account - It reveals net profit or net loss.

Trading Account
Trading Account
Trading Account is the first stage in the process of
preparing final accounts.
Trading account shows the gross profit or gross loss during
an accounting year.

Trading Account
Features of Trading Account
It is the first stage in the preparation of final accounts of a
trading concern
It records only net sales and direct cost of goods sold
The balance of this account discloses the gross profit or
gross loss
The balance of this account is transferred to the Profit and
Loss Account

Trading Account
Purpose of the Trading Account
The Trading Account is prepared to know the gross profit
or gross loss during the accounting period.
The account is based on matching the selling price of
goods and services with the cost of goods sold and
services render.

Trading Account
Contents of a Trading Account
Items shown on the debit side of the Trading Account
Opening Stock - refers to the closing stock of the previous
year.
This item is usually put as the first item on the debit side of
the Trading Account.
In case of a trader, the opening stock consists of different
types of finished goods.
For the manufacturing concern, the opening stock consists
of raw materials; work - in - process and finished goods.

Trading Account
Purchases and Purchases returns - The purchases account
will show a debit balance, showing the gross amount of
purchases made of the materials. This refers to the goods
purchased, both cash and credit purchases, for resale.
Remember, the purchases of assets which are meant for
permanent use in business such as machinery, furniture
etc., are not included in the purchases.
The purchases returns account will show a credit balance
showing the returns of materials to the suppliers.
To Purchase
Rs. 3,00,000
Less: Purchases Returns
Rs. 10,000
Rs. 2,90,000

Trading Account
Items shown on the debit side of the Trading Account
Besides the Purchases returns, the following entries should
also be deducted:

Goods taken by the proprietor for his personal use

Goods given as charity
Goods given by way of samples
Direct Expenses - Direct expenses are those expenses which are
incurred on the goods purchased till they are brought to the place
of business for sale.
Examples of such expenses are freight inward, insurance, customs
(import) duty, clearing charges, octroi duty, cartage etc. In a
manufacturing business, besides the above, expenses incurred for
purposes of production such as wages, power and fuel, factory rent,
etc. are also direct expenses.

Trading Account
Items shown on the Credit Side of the Trading Account
Sales and Sales Returns - The Sales account always has a
credit balance indicating the total sales made during the
year.
The sales returns account has always a debit balance
showing the total of the amount of goods returned by
customers. The net of the two amounts is called ' net sales'
and is entered on the credit side of the Trading Account.
The Sales Tax or Value Added Tax (VAT) charged is not a
part of the sales revenue.
Sales Tax or VAT charged is to be deposited with
Government.

Trading Account
If sales are inclusive of tax, the tax amount must be
deducted from the sales amount.

Closing Stock - Closing Stock refers to the stock of unsold

goods at the end of the current accounting period. Usually
there is no account to show the value of goods lying in the
godown at the end of the year. However, to correctly
ascertain the grow profit, the closing stock must be taken
and valued.

Balancing of Trading Account: Gross

Profit or Gross Loss
After recording the items in the respective sides of the Trading
Account, the balance is calculated to determine Gross Profit
or Gross Loss.
If the total of the credit side is more than that of the debit
side, the excess is Gross Profit.
If the total of the debit side is more than that of the credit
side, the excess is Gross Loss.
Gross Profit is transferred to the credit side of the Profit and
Loss Account and Gross Loss is transferred to the debit side of
the Profit and Loss Account.

Balancing of Trading Account: Gross

Profit or Gross Loss
After recording the above items in the respective sides of the
Trading Account, the balance is calculated to ascertain Gross
Profit or Gross Loss.
If the total of the credit side is more than that of the debit
side, the excess is Gross Profit.
If the total of the debit side is more than that of the credit
side, the excess is Gross Loss.
Gross Profit is transferred to the credit side of the Profit and
Loss Account and Gross Loss is transferred to the debit side of
the Profit and Loss Account.

Balancing of Trading Account: Gross

Profit or Gross Loss
Closing Entries for Trading Account
Preparation of a Trading Account requires recording entries to
transfer the balance of accounts of all the concerned items to
the Trading Account.
These entries are called Closing Entries as after recording the
entries these accounts are closed.

Balancing of Trading Account: Gross

Profit or Gross Loss
Closing Entries for Trading Account

General Format of Trading Account

Points to remember
Trading Account shows Gross Profit or Gross Loss
Gross Profit can be presented in the form of an equation as Gross Profit = Net Sales - Cost of Goods Sold
Where
Net Sales = Total Sales - Sales Returns
Cost of Goods Sold = Opening Stock + Net Purchases + Direct
Expenses - Closing Stock
Net Purchases = Total Purchases - Purchases Returns

Carriage Inward is debited to the Trading Account and

Carriage Outward to the Profit and Loss Account
Return Inwards are deducted from Sales whereas Return
outwards are deducted from the Purchases in the Trading
Account.

Illustration: Trading A/C

Prepare a Trading Account for the year ending March 31,
2015 from the following balances as at March 31, 2015
Details
Rs.
Details
Rs.
Opening Stock
Wages
10,000
5000
Sales (inclusive of sales Tax) 1,70,000 Returns Outwards 8,000
Freight
500
Purchases
1,00,000
Carriage Inwards
1,000
Returns Inwards
5,000
Sales Tax paid
15,000
Octroi Duty
2,500

Closing Stock is valued at Rs. 20,000 as at March 31, 2015

Trading Account
For the year ending March 31, 2015
Dr.
Details
To Opening Stock

To Purchases A/C
1,00,000
Less: Returns Outwards
8,000
To Wages
To Carriage Inwards
To Freight
To Octroi Duty
To Profit & Loss A/C
(Gross Profit)

Rs.
10,000

Cr.
Details
By Sales A/C
1,70,000
Less: sales Tax
15,000
------------1,55,000
Less: Returns Inwards 5,000

Rs.

1,50,000

92,000

By closing stock

20,000

5000
1,000
500
2,500
59,000
1,70,000

1,70,000

Example
Prepare trading account of Sivika for the year ending
31-3-2014.
Opening stock = Rs. 4,00,000
Purchases = Rs. 43,00,000
Carriage inward = Rs. 2,60,000
Wages = Rs. 1,20,000
Credit sales = Rs. 72,00,000
Cash sales = Rs. 18,00,000
Sales returns = Rs. 15,80,000
Purchase returns = Rs. 50,000
Closing stock = Rs. 5,00,000

Solution
Trading Account
For the year ending March 31, 2014

Dr.

Cr.

Example
Prepare Trading Account of Lakshmi Corp. for the year
ending 31 March, 2016 from the following information:
Opening Stock = Rs. 80,000
Purchases = Rs. 8,60,000
Freight Inward = Rs. 52,000
Wages = Rs. 24,000
Sales = Rs. 14,40,000
Purchase Returns = Rs. 10,000
Sales Returns = Rs. 3,16,000
Closing Stock = Rs. 1,00,000
Import duty = Rs. 30,000

Solution
Trading Account
For the year ending March 31, 2016

Dr.

Cr.

From the under mentioned balances obtained at the end of 31March 1999, prepare Trading account.

Stock of goods on 1-4-98 = Rs. 12,50,000

Stock of goods on 31-3-99 = Rs. 23,75,000
Purchases
Cash = Rs. 18,50,000
Credit = Rs. 41,25,000

Sales
Cash = Rs. 25,50,000
Credit = Rs. 57,50,000

Returns to suppliers = Rs. 25,000

Returns by customers = Rs. 30,000
Duty and clearing charges = Rs. 50,000

Profit and Loss Account

After preparing the Trading Account, the Profit and Loss
Account is prepared.
It is prepared to calculate the net profit or net loss of the
business for a given accounting period.
A Profit and Loss Account is an account into which all gains
and losses are collected in order to ascertain the excess of
gains over the losses or vice versa - Prof. Carter

Need:
To Ascertain Net Profit/Loss
Comparison with the Previous Year's Profit/Loss
Control over Expenses

Profit and Loss Account

Features of Profit and Loss Account
It is the second stage in the preparation of the final accounts
It relates to a particular accounting period and is prepared at
the end of that period.
This account is credited with the gross profit and income from
other sources and debited with indirect expenses and losses
The balance of this account is the net profit or net loss
The capital of the owner is increased or decreased by the
balance of this account (Net Profit or Net Loss).

Items of Profit and Loss Account:

Expenses and losses shown on the debit side of the Profit
and Loss Account can be classified as follows:
Administration and Office Management Expenses Administration expenses include the following

1. Establishment Expenses
2. Office salaries
3. Office rent and rates
4. Lighting
5. Printing and Stationery
6. Postage and Telephone Charges
7. Legal Expenses
8. Audit Fee
9. General or Trade Expenses

Items of Profit and Loss Account:

Expenses and losses shown on the debit side of the Profit
and Loss Account can be classified as follows:
Selling and Distribution Expenses - These will comprise the
following:

1. Salesmen's salaries and commission

2. Commission of Agents, 3. Advertising
4. Warehousing Expenses, 5. Packing Expenses
6. Freight and Carriage on Sales
7. Export Duties
8. Maintenance of Vehicles for distribution of goods and their running
expenses
9. Insurance of Finished Goods, Stock and Goods in Transit

Items of Profit and Loss Account:

Expenses and losses shown on the debit side of the Profit and
Loss Account can be classified as follows:
Financial Expenses - These are those expenses which are
incurred in respect of arranging Finance for business.
a. Interest on Loan b. Interest on Capital and c. Discount Allowed.

Abnormal Losses - Abnormal loss such as stock loss by fire not

covered by insurance, loss on sale of fixed assets, loss by theft,
cash defalcation, etc., may occur during the accounting period.
Abnormal losses are treated as extraordinary expenses and
debited and shown separately in the Profit and Loss Account.

Items of Profit and Loss Account:

Incomes and items of profit which are shown on the credit
side of Profit and Loss Account can be divided into the
following groups:
Income from Main Business - These refer to those profits and
incomes which are received from the operations of the main
business.

Gross Profit
Profit on consignment
Profit on Joint Venture and
Commission Receivable

Items of Profit and Loss Account:

Financial and other Incidental Income
Income received from other sources except the main function
of the business comes under this category. These include

Interest on Fixed Deposits

Income from Investment
Rent Received
Interest on Drawings and
Discount Received.

Profit and Loss Account

Balances of the Profit and Loss Account
Net Profit or Net Loss:
The balance in the Profit and Loss Account represents the net
profit or net loss.
If the credit side is more than the debit side, it shows net
profit.
If the debit side is more than the credit side, it shows net loss.
Both (Net Profit or Net Loss) are transferred to the Capital
Account.

Difference between Trading Account and Profit and Loss Account

 Some Terms

Prepare Profit and Loss Account, from the following balances of

Mr. Murugan for the year ending 31.3.2007.

Office rent Rs. 3000

Printing expenses Rs. 2,200
Tax, Insurance Rs. 1,400
Discount received Rs. 400
Advertisement Rs. 3,600
Salaries Rs. 8,000
Stationeries Rs. 2,400
Discount allowed Rs. 600
Travelling expenses Rs. 2,600
Gross Profit transferred from the Trading A/c Rs. 25,000

Profit and Loss Account of Mr. Murugan For the year ending 31.3. 2007

Dr.
Particulars
To Salaries
To Office rent

To Stationeries
To Printing expenses
To Tax, Insurance
To Discount allowed
To Travelling expenses
To Advertisement
To Net Profit (Capital A/c)

Cr.
Amt. (Rs.) Particulars Amt. (Rs.)
8,000
By Gross
25,000
Profit
3,000
By Discount 400
received
2,400
2,200
1,400
600
2,600
3,600
1,600
25,400
25,400

From the following prepare profit and loss account

for the year ended 31-3-2013
Particulars
Gross Profit
Commission received
Interest received
Sundry income
Depreciation
Salaries
Discount (Dr)
Discount (Cr)
Bank charges
Audit fees
Stationery

Dr. Amount (Rs.)

Cr. Amount (Rs.)

9,50,000
5,000
4,000
7,000

10,000
15,000
8,000
12,000
4,000
2,000
400

Profit and Loss account for the year ended 31-3-2013

Particulars

Dr.
Particulars
Amount (Rs.)

To Depreciation

10,000

To Salaries

15,000

Cr.
Amount (Rs.)

To Discount (Dr) 8,000

By Gross Profit
9,50,000
(b/d)
By Commission
5,000
received
By Interest received 4,000

To Bank charges

4,000

By Sundry income

7,000

To Audit fees

2,000

By Discount (Cr)

12,000

To Stationery

400

To Net profit c/d

9,38,600
9,78,000

9,78,000

Manufacturing Account
The main purpose of manufacturing account is to
show:
(i) Cost of goods manufactured; and
(ii) Major items of costs such as raw material consumed,
productive wages, direct and indirect expenses of
production.

Manufacturing Account
Various Items Shown In Manufacturing Account
Debit side items
Raw material consumed
opening stock of raw materials plus Purchases and incidental
expenses of purchase less closing stock of raw materials.

Direct wages and expenses

Indirect factory expenses factory rent, salaries, lighting,
power, heat and fuel, machinery repairs, depreciation and other
factory expenses

Opening work in progress

Sale of Scrap

Manufacturing Account
Various Items Shown In Manufacturing Account
Credit side items
Closing work-in-progress
Sale of scrap
Cost of Finished goods manufactured

Manufacturing Account
From the following balances in the ledger of Mr.
Kannusamy for the year ended 31-3-2002, prepare
manufacturing account.

Opening work-in-progress Rs. 1,00,000

Opening stock of raw materials Rs. 55,000
Purchases of raw materials Rs. 10,00,000
Closing stock of raw materials Rs. 40,000
Carriage on purchases Rs. 10,000
Factory wages Rs. 50,000; Fuel and coal Rs. 45,000
Factory power Rs. 20,000
Depreciation on plant and machinery Rs. 15,000
Factory supervisors salary Rs. 75,000; Closing work-in-progress
20,000

Dr.

Cr.