Introduction to Financial Accounting

Definition of Financial Accounting

Financial Accounting is a systematic process of
recording, classifying and summarising financial data
with the object of finalisation, interpretation and
presentation of the same. It is a service activity that
collects, processes and communicates financial
information of an enterprise.


Importance of Financial Accounting
1. It helps the owners and management to ascertain the profit
or loss of the concern for a particular accounting period by
maintaining systematic record of revenue and expenses.
2. It helps the owners and management to assess the financial
position of the concern (i.e. the amount of assets and
liabilities) on any particular date of accounting period.
3. It provides necessary financial information to the different
interested parties, such as investors, employees, government,
financial institutions, creditors, researchers etc.
4. It supplies information to the owners and management for
taking important business decisions like dividend policy,
price-fixation, investment, payment of bonus etc.
5. It helps in framing future plans and formulating polices by
providing necessary financial information.
Scope of Financial Accounting
Its use is not only restricted to the business world, in all spheres of
the society and in all professions it has immense utility. In the
present world accounting system is practised not only in business
houses but also in many non-profit making concerns like school,
college, hospital, club, charitable society etc. Local government
(Municipality and Panchayet) also take recourse to accounting
system to record financial information. The professional persons
like Doctors, Lawyers, Chartered Accountant etc. also adopt the
accounting system. In short accounting system adopted by all of
them who are involved in a series of financial transactions.

Other Branches of Accounting are Management Accounting, Cost
Accounting, Human Resource Accounting, Social Accounting,
Inflation Accounting, Responsibility Accounting etc.


1. Event: Monetary and Non-Monetary

2. Transaction

3. Transaction Vs. Event

4. Book Keeping Vs. Accounting





Accounting Cycle
Accounting Cycle refers to the aggregation of the different
stages involved in accounting process. Accounting functions
can be made in a cyclical order and in a recurring manner .


Recording of
transactions in
to journal and
other primary
books
Making posting
in to Ledger
Accounts
consisting of
Personal, Real
and Nominal
Accounts
Balance Sheet consisting of
Personal and Real
Account

Profit and Loss Account
consisting of Nominal
Account
Preparation
of Trial
Balance
Account:

An account is the code or language in which accountants record and
supplies information. In short it is the classified summary of the
recorded transactions.

Classification of Account:

1. Personal Account:
a. Natural Person (e.g. Ram , Shyam)
b. Artificial Person (e.g. Firm, Association, Banks, Club etc.)
c. Representative personal (e.g. Outstanding liabilities for Rent,
Salaries etc.)
2. Impersonal Account:
a. Real Account (e.g. Plant, Machinery, Furniture, Goodwill etc.)
b. Nominal Account (e.g. Rent, Salary, Dividend, Baddebts etc.)





System of Accounting
Double Entry System

This system was invented by the Italian merchant Luco
Pacioli in 1494 AD. According to this system every
transaction has two fold aspects, i.e. one party giving the
benefit and other party receiving the benefit and every
transaction is divided in to two sides, debit and credit. In
short one account is to be debited and another account is to
be credited for every transaction. Every transaction affects
two accounts in opposite direction.

Single Entry System
Advantages of Double Entry System

1. Under this system both personal and impersonal
accounts are to be opened to keep complete record of
business transaction.
2. It provides a check on the arithmetical accuracy
through Tial Balance.
3. It reveals net results of business operation through
Trading and Profit and Loss Account.
4. Under this system financial position can be known
through Balance Sheet.
5. Since errors and frauds can be detected under this
system, so it reduce the chance of commiting fraud.

Debit Vs. Credit

Debit:
The term Debit comes from the Latin word Debitum. An
entry made on the left hand side of an account that increases
either the assets or the expenditures of the organisation.

Credit:
The term Credit comes from the Latin word Credere. An
entry made on the right hand side of an account that
increases a liability, revenue or equity item or a decrease an
asset or expense.

Debtor Vs. Creditor

Application of Golden Rules (Rules for Ascertaining Debit
and Credit )
Personal Account:
a. Debit = the Receiver / the person receiving the benefit
b. Credit = the Giver / the person sacrifices the benefit

Real Account:
a. Debit = What comes in
b. Credit = What goes out

Nominal Account:
a. Debit = All Expenses and Losses
b. Credit = All Incomes and Gains



Journal
Concept:

The term Journal has come from the French word Jour means
day. The process of recording transactions is called Journal. It is
a primary entry book where transactions are recorded first.

Classification of Journal:
1. General Journal It is the easiest type of journal which keeps
records of transactions in chronological order.

1. 2. Special Journal It is sub-divided in to cash book, Sales
Day Book, Purchase Day Book, Bills Receivable Book, Bills
Payable Book, Returns Inward Book, Returns Outward Book
etc.
Format of General Journal



Journal Entry
The recording of the transaction into journal is called
Journal Entry.

There are two types of Journal Entries Simple Journal
Entry and Compound Journal Entry.
Ledger


When the recorded transactions are posted from journal
on permanent basis in a summarised and classified form
in different accounts is called a Ledger.

In other words it is a book of final entry which contains
records of all transactions permanently in a summarised
and classified form.

Format of Ledger
Trial Balance
Concept:

Trial Balance is a statement which is prepared to check the
arithmetical accuracy of the book of accounts on a particular
date of accounting period. It contains all the personal, real and
nominal accounts balances. The debit and credit column total
of the trial balance must be equal.

Format of Trial Balance


Advantages / Utilities of Preparing Trial Balance:


1. It provides arithmetical accuracy of the book of
accounts.
2. It summarises the result of all transactions during an
accounting period.
3. It provides information for preparing final accounts
(i.e. Trading Account, Profit and Loss Account and
Balance Sheet).
4. It reduce the chance of commiting fraud.
Errors cannot be detected by Trial Balance

1. Error of Omission

2. Error of Commission

3. Error of Principle

4. Error of Misposting

5. Compensating Error


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