FINANCIAL

ACCOUNTING

Recommended Books

Meigs & Meigs, Bettner, Whittington, Financial Accounting

M.A. Ghani, Principles of Accounting

Walter and Charles, Financial Accounting, Prentice Hall

Dak Patel, Financial Accounting Fundamentals, CIMA Publishing.

Business Definition

Any activity undertaken for the purpose of earning profit

Commercial enterprise, profession, or trade operated for the purpose of earning a profit by providing a
product or service; also called business enterprise. Businesses are created by Entrepreneurs who put
money at risk to promote a particular venture for the purpose of a profit. They vary in size from a oneperson Sole Proprietorship to an international Corporation having billions of dollars in assets and
thousands of employees.

Profit: The amount of money earned over and above the amount spent to keep the business
operating is called profit.
Loss: Businesses that have more operating costs than earnings operate at a loss.

Business Types:
Service
Merchandizi Manufacturi
Business
ng Business ng Business
USES
Capital &
Capital &
Capital, Labor
:
Labor
Labor
& Materials
Operating
Operating
Operating
HAS:
Costs
Costs
Costs
Provide
Buy and sell Make and sell
TO:
Services at a
finished
finished
fee
products
products
FOR:
Profit Operating
Profit
Operating
Costs:
cost are the Profit
recurring
expenses which are related to the operation of a
business, or to the operation of a device, component,
piece of equipment or facility.
(Fixed Cost Vs Variable Cost Vs Semi Fixed4
Variable Cost)

Business Forms
1. Sole Proprietorship: A business owned by one person is called a Sole Proprietorship.
This form of business organization is common for small retail stores, restaurants, farms,
and service organizations etc. According to law, the owner is responsible for the debts of
the business (unlimited liability) and owns the right to enjoy the profits.
2. Partnership: A business owned by two or more persons voluntarily acting as partners
(co-owners) is called a partnership. Partnerships, like sole proprietorships, are widely
used for small businesses. Partners in the business are responsible for the debts of the
business (unlimited liability). (Partnership Act 1932; Partnership Deed; Min 2, Max 20 partners).
3. Corporation/Company: A corporation is the only type of business organization
recognized under the law as an entity separate from the owners. Here owners have
limited liability upto their investment in form of shares. Ownership of a corporation is
divided into transferrable shares of capital stock and the owners are called stockholders.
(Companies Ordinance 1984).
PRIVATE COMPANY -Private company has following restriction while these restrictions does not apply to other companies.(1) It cannot have members more
than 50 excluding those are the employees of the company (2) It cannot invite the general public to subscribe the share of the company (3) It restricts
freely transfer of share. (Minimum members 2, maximum 50)
PUBLIC COMPANY - Companies Ordinance define the public company as a company that is not a private company. It means every company that is
registered in Pakistan either it is a private company or a public company. (Minimum members 7, maximum No limit)

Book Keeping
The Art of recording Business Transactions in books in a regular
and systematic manner

The art and science of recording business transactions in such a

systematic way as a trader may know the result of his trade at the end
of a certain period and may also prove the accuracy of such record.
The science and art of correctly recording business dealings in a set
of books with a view to having a permanent record of transactions and
the financial result thereof.

Transaction: Any dealing between two persons or things is a

transaction. It may relate to purchase and sale of goods, receipt and
payment of cash and rendering of services by one party to another.
(Cash Vs Credit transactions)
6

Book Keeping
Book Keeping - Types:
1. Single Entry Book-keeping
In a single entry book keeping system, transactions are recorded one
after another in a book which typically has columns for the account
used and the analysis of what was bought.
2. Double Entry Book-keeping
Double entry book keeping system is the system of recording
transactions having two fundamental aspects- One involving the receiving of a benefit
- & the other to giving the benefit
in the same set of books

Single Entry Book Keeping

Single Entry Book Keeping

Double Entry Book Keeping

10

What is Accounting?

-Accounting is simply the means by which we measure and

describe economic activities. Whether we are managing a
business, making investments, or deciding how to spend our
money, we are working with accounting concepts & accounting
information.
-Accounting often is called the Language of Business because it
is so widely used to describe all types of business activities. Costs,
prices, sales volume, profits, and return on investment- all are
accounting measurements.
-It is used to gather and communicate financial information about
an organization. This information is
used by owners and
managers to make decisions that will build and improve the
business
- Accounting usage is not limited to business world only, it is also
used by government organizations and non-profit organizations.
Individuals use accounting information to manage their personal
financial affairs and to file income tax.
11

Financial Information Needed?

How much cash does the business have?
How much money do customers owe the business?
What is the cost of the merchandise sold?
How much did the volume of sales increase?
What is the amount owed to suppliers?
How much profit has the firm made?
12

Accounting System & Decision Makers:

Accounting System
Collection & Processing of
Financial information about
an organization & reporting
of that information to
decision makers

Financial Accounting
System
Preparation of four basic
Financial Statements and
related disclosures

External Decision
Makers
Investors, creditors,
suppliers
And customers etc.

Managerial
Accounting System
Preparation of detailed
plans, Forecasts, and
performance reports

Internal Decision
Makers
Managers throughout the
organization

13

Financial Statements:
1. Income Statement: An income statement, which reports the companys
profitability over a recent period of time.
2. Balance Sheet: A balance sheet, which shows the financial position of
the business at a specific date by describing its financial resources and
obligations.
3. Statement of Retained Earnings: This statement is one of the basic
financial statements, and it explains the changes in a company's retained
earnings over the reporting period. It breaks down changes affecting the
account, such as profits or losses from operations, dividends paid, and any
other items charged or credited to retained earnings. The Term Retained
Earning describes only the earnings which were not paid out in form of
dividends.
4. Cash Flow Statement: A statement of cash flows, which summarizes
the companys cash receipts and cash payments over the period of time
covered by the income statement.
14

Parties Interested in
Accounting Information:
1. Owners
2. Creditors
3. Employees
4. Investors
5. Government

15

Accounting Cycle:

16

Generally Accepted Accounting

Principles (GAAP)

Generally accepted accounting principles (GAAP) are a common set of

accounting principles, standards and procedures that companies must
follow when they compile their financial statements.

Defined as the set of accepted industry rules, practices and guidelines

for financial accounting .

Includes the standards, conventions, and rules accountants follow in

recording and summarizing transactions, and in the preparation of
financial statements

NOTE: GAAP is only a set of standards. Although these principles work to improve the
transparency in financial statements, they do not provide any guarantee that a company's
financial statements are free from errors or omissions that are intended to mislead investors.
There is plenty of room within GAAP for unscrupulous accountants to distort figures. So,
even when a company uses GAAP, you still need to scrutinize its financial statements
.
17

Financial
Accounting

Cost
Accounting

Management
Accounting

Primary concern of
financial accounting is
to record, in a
systematic way, money
transactions between
economic entity and
third parties such as
suppliers, customers,
employees, bankers
etc. so that at the end
of the accounting year
results of the whole
year in terms of profit
or loss can be
measured and financial
position on the closing
date can be judged.
Information is

Cost accounting is
collection, processing
and evaluation of
operating data e.g.
costs of products,
operations, processes,
jobs, quantities of
materials consumed,
labour time used etc.
for internal planning
and control as well as
for external reporting.
Production planning
and scheduling,
inventory planning and
management, labour
time and labour cost
budgets are some of

Management
Accounting uses both
financial and cost
information to advice
management in
planning and
controlling the
organization
(decision making).
This decision making
is primarily future
oriented. Past and
current activities are
reported to the
extent that such
information helps
management to plan
for the future.
18

Financial Vs Cost Accounting

Financial Accounting
Provides information to external
users.
Produces general purpose financial
statements.
Must conform to generally
accepted accounting principles.
Provides accounting data in
monetary terms.
Financial statements are prepared
on yearly or half yearly basis.

Cost Accounting
Provides information to internal
users.
Produces special purpose
statements & reports.
Must conform to information needs
of management.
Provides accounting data in
monetary and non-monetary terms.
Cost statements and reports are
prepared more frequently i.e.
weekly and daily basis.
19

Cash Vs Accrual Accounting

The cash method and the accrual method
(sometimes called cash basis and accrual basis)
are the two principal methods of keeping track of a
business's income and expenses.

THE CASH METHOD. The cash method is the

more commonly used method of accounting in
small business. Under the cash method, income is
not counted until cash (or a check) is actually
received, and expenses are not counted until they
are actually paid.
20

Cash Vs Accrual Accounting

Example 1. Your computer installation business finishes a job in

November, and doesn't get paid until three months later in January.
Under the cash method, you would record the payment in January.
Under the accrual method, you would record the income in your
November books.

Example 2. You purchase a new laser printer on credit in May and

pay $1,000 for it in July, two months later. Using the cash method,
you would record a $1,000 payment for the month of July, the month
when the money is actually paid. Under the accrual method, you
would record the $1,000 payment in May, when you take the laser
printer and become obligated to pay for it.

21

Cash Vs Accrual Accounting

THE ACCRUAL METHOD. Under the accrual method,

transactions are counted when the order is made, the
item is delivered, or the services occur, regardless of
when the money for them (receivables) is actually
received or paid. In other words, income is counted
when the sale occurs, and expenses are counted when
you receive the goods or services. You don't have to wait
until you see the money, or actually pay money out of
your checking account, to record a transaction.

22

Assets Vs Liabilities

ASSETS
Assets are economic resources that are owned by a
business and expected to benefit future operations.
Assets may have definite physical form, such as
buildings, machinery, or an inventory of merchandize. On
the other hand, some assets exist not in physical or
tangible form, but in the form of valuable legal claims or
rights, e.g. bank accounts, amounts due from customers
i.e. accounts receivable, and trademarks.
(Cost Vs Objective Principle)

23

Classification of Assets
The properties and possessions of a business are called the Assets and they are
classified into following classes:
(1) Fixed Assts: These are assets which are acquired not for sale but for permanent use
in the business e.g. land and buildings, plant and machinery, furniture etc.
(2) Current/ circulating or Floating Assets: These denote those assets which are held for
sale or to be converted into cash after some time e.g. Sundry Debtors, Bills
Receivable, Stock of Goods etc.
(3) Liquid Assets: These are those assets which are with us in cash or easily convertible
into cash e.g. Cash in hand, Cash at bank, Investments etc.
(4) Wasting Assets: The assets that depreciate through wear and tear, whose values
expire with lapse of time or that become exhausted through working are known as
Wasting assets. This is a sub-class of Fixed assets e.g. Plant and Machinery, etc
(5) Intangible or Fictitious Assets: These are assets which have no physical existence,
which can neither be seen with eyes not touched with hands. They do not represent
anything valuable. These include Insurance prepaid, goodwill
(6) Outstanding Assets: Expenses paid in advance, i.e. prepaid expenses, and income
earned but not received are known as outstanding assets.

24

Assets Vs Liabilities
LIABILITIES: Liabilities are debts. The person or organization
to whom the debt is owned is called a creditor.

All businesses haves liabilities; even the largest and most successful
companies purchase merchandize, supplies, and services on account.
The liabilities arising from such purchases are called accounts payable.
Many businesses borrow money to finance expansion or the purchase
of high-cost assets. When taking out a loan, the borrower usually must
sign a formal note payable. A note payable is a written promise to repay
the amount owed by a particular date, and usually calls for the payment
of interest as well.

Accounts payable, in contrast with notes payable, involve no written

promises and generally do not call for interest payments. In essence, a
note payable is a more formal arrangement. Both accounts payable and
notes receivable are listed in balance sheet separately.
25

Classification of Liabilities
The liabilities of a business are classified as follows:

Fixed Liabilities: These are the liabilities which are not payable
immediately or in the near future. These liabilities are payable after a
long period. Long term loans, capital of the proprietor are the
examples of such kind of liabilities.

Current Liabilities: These are the liabilities which are payable

immediately or in the near future, such are creditors, Bank loans etc.

Outstanding Liabilities: Outstanding expenses and unearned income

are known as outstanding liabilities.

26

OWNERS EQUITY or CAPITAL

The owners equity in a corporation is called stockholders equity.

Owners equity represents owners claim to the assets of the
business. Because creditors claims have legal priority over those
of the owners, owners equity is a residual amount. Owners are
entitled to whats left after the claims of the creditors have been
satisfied in full. Therefore, owners equity is always equal to total
assets minus total liabilities.

Increases in owners equity: The owners equity in a business comes from the
two sources

Investment by the owners

Earnings from profitable operation of the business.

Decrease in owners equity:

Distribution of cash or other assets by the business to its owners (termed dividends)
Losses from unprofitable operation of the business.

27

Capital Stock

The caption capital stock in the balance sheet of a

corporation represents the amount invested in a
business by its owners.
When the owners of a corporation invest cash or other assets
in the business, the corporation issues in exchange shares of
capital stock as evidence of the investors ownership equity.
The basic unit of capital stock is called a share, but a
corporation may issue capital stock certificates in
denominations of 1 share, 100 shares, or any other number.
The number of shares owned by an individual investor
determines the extent of his or her ownership of the
corporation.

28

Capital Stock Share Certificate

29

Accounting Equation

The Accounting Equation

(Assets = Liabilities + Owners Equity)

A fundamental characteristic of every balance sheet is that

the total figure for assets always equals the total of liabilities
plus owners equity.
The listing of assets shows us what things the business
owns; the listing of liabilities and owners equity tells us who
supplies these resources to the business and how much
each group supplied.
Therefore, the total claims of the creditors plus the claims of
the owners equal the total assets of the business.

30

Accounting Equation

The Accounting Equation

(Assets = Liabilities + Owners Equity)

A fundamental characteristic of every balance sheet is that

the total figure for assets always equals the total of liabilities
plus owners equity.
The listing of assets shows us what things the business
owns; the listing of liabilities and owners equity tells us who
supplies these resources to the business and how much
each group supplied.
Therefore, the total claims of the creditors plus the claims of
the owners equal the total assets of the business.

31

Accounting Equation
Class Illustration 1: Compute the missing amount in each
of the following three lines.
Assets

Liabilities

$558,000
?
$907,500

=
=
=

$135,000
$135,000
?

Owners

Equity
a.
b.
c.

?
$375,000
$62,500

32