CHAPTER 1

Introduction to Financial Accounting

Accounts is broadly classified into three subjects, they are:1} Financial Accounting.
2} Cost Accounting, and
3} Financial Management
Meaning of all the three terms are explained below:Financial Accounting:- A field of accounting that treats money as a means of measuring economic performance instead of as a factor
of production. It encompasses the entire system of monitoring and control of money as it flows in and out of an organization as
assets and liabilities, and revenues and expenses. Financial accounting gathers and summarizes financial data to prepare financial
reports such as balance sheet and income statement for the organization's management, investors, lenders, suppliers, tax
authorities, and other stakeholders.
Cost Accounting:- A method of accounting in which all costs incurred in carrying out an activity or accomplishing a purpose are
collected, classified, and recorded. This data is then summarized and analyzed to arrive at a selling price, or to determine where
savings are possible. In contrast to financial accounting (which considers money as the measure of economic performance) cost
accounting considers money as the economic factor of production.
Financial Management:- Financial Management means planning, organizing, directing and controlling the financial activities such as
procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the
enterprise.
Financial accounting is a process of analyzing the business transaction, recording the business transaction in an appropriate books
of accounts, and getting the results out of that and communicating to the people who are linked to the company.
In simple terms to understand Financial accounting It is analyzing or identifying the day to day business transaction, recording
those transaction in the books with proper proof for each and every entry which is been recorded in the books of accounts.
There are three in financial transactions which help us to understand the profit or loss or financial position of the company. They are
as follows:1} Trading and Profit and Loss account or Revenue Account
2} Balance Sheet, and
3} Cash Flow Statement.
Explanation of three financial statements are as follows:1} Trading and Profit and Loss Account or Revenue Statements:- The trading account is an account which shows merely the result
of trading (i.e, buying and selling of goods) called gross profit or gross loss. In other words, it is the account which shows merely the
result of buying and selling of goods, i.e, gross profit or gross loss on trading, without taking into account the indirect expenses ad
indirect incomes of the business.
The profit and loss account is an account which shows the net profit or net loss (i.e, the ultimate or final profit or loss) of a business
for a particular trading period. The net profit or net loss is the profit earned or loss suffered after charging all business expenses. It is
the final profit or loss of a business.
2} Balance Sheet:- The trading and profit and loss account or the Revenue Accounts shows only the net profit or net loss of a
business for a certain trading period i.e for One year. However, a trader likes to know not only the net profit or net loss of his
business for a certain trading period, but also the financial position of his business at the end of the trading period. For this purpose,
he prepares a statement of his assets and liabilities (including the capital) as on the closing date of the trading period. The
statement of assets and liabilities prepared on the last date of the trading period is known as the Balance Sheet. In short,
a balance sheet is a list of assets and the liabilities of a business.
3} Cash Flow Statement:- The cash flow statement throws light on the sources from which the cash has been generated and the
uses to which it has been put. The statement brings to light whether the generation of cash is from the companys operating
activities or is it from its financial activities. To understand the importance of cash flow all we have to do is to ask ourselves a
question. Can I spend if I do not have cash in my pocket? The answer obviously is no. The same applies to a company also.
The cash flow statement is generally divided among operating activities, investment activities and financing activities. The cash
inflows and outflows pertaining to each of these activities are arrived at to understand the contribution of each of these activities
towards the net cash inflow or outflow of the company.
Assets and Liabilities:Assets refer to properties owned by a concern and debts (i.e., amounts) due to a concern from other parties.
Liabilities refer to amounts owned by a business to other parties, either for the purchases of goods on credit or for the purchase of
assets on credit or for the loans borrowed or for the services received on credit.
Note:- Detailed explanation of different types of assets and liabilities will be given in chapter 3 of this subject.

Financial statements have their uses to several segments of the society who are called STAKEHOLDERS. They are as follows:1} Shareholders:- Shareholders needs financial statements of the company to know is the company giving them profit or loss for the
investment of share into business.
2} Creditors:- Financial statements provide vast amounts of useful information regarding a business, such as its cash position, debt
level, sales performance and expenses. A business' creditors use its financial statements in various ways to review and assess the
business. By ensuring that its financial statements are accurate, a business can provide useful information to help expedite credit
decisions. Each financial statement provides a creditor with a different set of data with which to make a decision about extending
credit or to evaluate the credit-worthiness of an existing customer.
3} Suppliers or Vendors:- Many suppliers do ask for financial statements to determine their risk in working with you. If you order
supplies from them and you pay them for those supplies before they ship to you that is usually not a problem. But if you expect them
to ship products to you before you pay(which means that they are extending credit to you)they want to be sure that you are credit
worthy and that you will be able to pay them for the products you ordered.
4} Local; State and Central Government Bodies:- Government bodies need financial statements of business to levy various taxes.
For eg. Sales tax, Income Tax, Excises Duties, etc.
5} Investment Advisors or SEBI:- The idea that investment advisors need to be regulated is not at all a subject of debate. In the US,
Investment Advisors Act was passed in 1940. UK carried out several changes in the regulation of financial advisors from 2012.There
are many other countries, which regulate investment advisors also called as financial planners. In India, the need to regulate
investment advisors originated from many factors out of which two are very important factors which are as follows:a) Holding advisors accountable for what they suggest to the client and;
b) Ensuring that advisory business is not mixed with selling of financial products.
With a view to make financial advisory business more accountable, SEBI came out with Investment Advisors Regulation. From 21
October 2013 only those who had registered under the regulation with SEBI would be able to offer investment advisory services.
Meaning of SEBI:- 'SECURITIES AND EXCHANGE BOARD OF INDIA - SEBI' The regulatory body for the investment market in
India. The purpose of this board is to maintain stable and efficient markets by creating and enforcing regulations in the marketplace.
It is a statutory body that controls the Indian capital market.
6} Investment Analysts:- Financial Analyst is a person who performs financial analysis at a micro and macro level to understand the
financial health of a company and offer suitable recommendations. Financial analysis covers fundamental analysis, ratio analysis,
financial modeling and valuation. The financial analyst is also known as an investment analyst, an equity analyst, a research analyst
or a securities analyst.
7} Workers and Employees:- Workers or Employees need the financial statements to know is the company earning profit or
incurring loss. With the help of the financial statement Employees and Workers will know if their jobs in the organization are secured
or will they be kicked out of the company in the name of recession.
8} Researchers and Development Team:- R and D team needs to know the financial statements of the company to research on the
new products and process which company is planning to take up in future.
9} Students of Finances:- Students needs to know the financial statements to analyze and study or learn or understand the financial
statement reports prepared by the company. For eg, Students who are doing CA or MBA in Finance will be needing this report to
analyze.
10} Customers:- When a company is giving orders to any supplier. In that case the company will be seeing the suppliers financial
statement. To understand and analyze will the supplier be able to complete the order on time which the company will be giving to the
supplier.
Limitation:
Reflects and records only monetary values of all transactions and hence quantitative measurements; hence qualitative
aspects are ignored.

On account of inflation value of rupee fluctuates and decreases; but no adjustments made in the accounts.
Scope and Importances:A financial accounting system provides summarized and categorized information about the company's performance and state of
affairs mainly for external decision makers, allowing them to answer questions:
Is the company earning satisfactory income?

How does the company compare in size and profitability with competitors?

Will the company be able to pay its debts when they become due?

GAAP:Financial accounting is governed by rules or guidelines collectively called Generally Accepted Accounting Principles (GAAP).

Many of these are mandatory by law of the country.

Those that are not mandatory, have considerable persuasive force.
Primary agency responsible for GAAP in India is the Standards Board of the Institute of Chartered Accounts of India.

Concepts:Accounting concepts means the rules or the principles that govern accounting. The fundamental accounting rules that must be
followed by all concerns. Accounting concepts means the necessary assumptions on which accounting is based. We can say
concepts are like the grammer for any language.
1} ENTITY CONCEPTs:- According to this concept the business is different from the person doing business. It simply means that
the business man and business or organizations are different person.
2} HISTORICAL COST CONCEPT:- It means that the assets should be recorded and valued only at cost and not at realizable value
or market value, in the normal course of business.
3} ONGOING CONCERN CONCEPT:- According to this concept, the business has permanent life, it will continue for very long
period of time. It will not be closed at the end of the year. For eg: business started from your grandfather then transferred
to your father and then to you. So, it goes on and on and on.
4} ACCOUNTING PERIOD CONCEPT:- This concept is also known as periodicity concept. According to this concepts the
calculation of profit or loss made cannot be postponed indefinitely or till the business is closed. Therefore, the accounting period is
to be separated as per one year.
5} MONEY MEASUREMENT CONCEPT:- According to this concept, only such transactions are recorded which can be expressed in
terms of money. Which means if there is any event that cannot be recorded in terms of money. Well not be recording such
transactions.
6} COST ATTACH CONCEPT:- This concept is also known as Cost Merge Concept. In order to produce any goods or article it is
necessary to purchase raw-materials, and thereafter process it to get the finished goods. In this process the services of various
factors are required. These factors are also called the factors of production.
7} VERIFIABLE OBJECTIVE EVIDENCE CONCEPT:- According to this concept all accounting transactions should have
documentary poor. These documents may be purse orders, delivery challans, invoice or bills, vouchers, pass book, cheque books,
correspondence, agreements etc. These supporting documents form the basis for accounting entries. These are the evidence which
help the auditors to verify the books of accounts.
8} ACCRUAL CONCEPTS:- According to this concepts we have to record the expenses for the given period say one year even if the
said expenses is paid or not.
9} MATCHING COST AND REVENUE CONCEPs:- It means the expenses and revenue has to be matched to determine income for
a particular period. This is one of the most important concept of accountancy. This concept is related to accounting period concepts.
Once the accounting period is determined then with in that period the revenue and its related cost are matched.
10} DUAL ASPECT CONCEPT:- According to this concept every transaction has two aspects. This is followed in double entry bookkeeping system. Every entry must have minimum two effects.
Note:- Sir will be explaining Dual Aspect Concept in the Chapter 2.
Conventions:Conventions are the customers or traditions which help the preparation of accounting statements. They make the accounting
statements clear and meaningful. They represent the usage or methods generally accepted and customarily used. These are the
rules employed or followed by common consents.
{1} Conventions of Consistency:- This convention indicates that the procedure selected by the company must be followed
consistently every year. The financial statements will be comparable only if the procedure is followed consistently.
There are several methods of charging depreciation or reducing the cost of fixed assets such as machinery. Depreciation
can be calculated using Straight Line Method or Written Down Value Method etc. Once the company decides to follow one particular
method then it must follow the same method year after year. In the same way there are different methods of valuation of stock such
as FIFO (First In First Out) or LIFO (Last In First Out) or Average price, etc. The company may adopt any of the methods of
valuation of stock but it must be followed consistently.
FIFO:- The products which are first produced will be sold first.
LIFO:- The products which are produced last will be sold first.

Average Price:- The products which are not produced First nor Last will be sold first i.e, the products which are in between First and
Last production.
{2} Convention of Materiality:- This convention puts a check on unnecessary disclosure in the financial accounts. The financial
statements should not be unnecessarily bulky with all unwanted details. The Companies Act, 1956 requires a separate disclosure of
items of income and expenses if it exceeds 1% of the total revenue of the company.
{3} Convention of Disclosure:- This means that accounts must be prepared honestly. They must give all material
information. The accounting statements must give full and fair information to the proprietors, creditors, investors
and others. This convention is more important in case of big business like the Joint Stock Companies. This is
because the owners and the managers are different. The shares of the companies are also traded in the stock
exchanges. So, the investors must get full information.
As per the Companies Act of 1956, requires that the accounts of the company must give a true and fair
view of the state of affairs of the company and it must be certified by the auditors. The act also prescribes the form
in which the profit and loss account and the Balance Sheet.
{4} Convention of Conservatism:- This is one of the oldest conventions of accountancy. In olden days Balance Sheet
was considered as one of the most important documents. It established the valuation of assets.
Conservatism in short means the policy of playing safe. According to this convention while preparing
accounts we must not take into account any profits unless they are realized. However, we must provide for all
anticipated losses.
"The importance of accounting is that it is the universal language of business, and a basic understanding of it is
necessary for almost any job in the business world."
Forms of Organization:Companies Act 1956 - It is an act to consolidate and amend the law relating to companies and certain other associations. It
regulates the formation, functioning, the winding up of the companies and also the relationship between the company, government
and public.
The various forms of organization are as follows:{1} Proprietorship Firm:( a ) Sole proprietorship is a form of business entity where a single individual handles the entire business organization. He is the
sole recipient of all profits and bearer of all loses. There is no separate law that governs sole proprietorship.
( b ) Partnership is the relation between persons who have agreed to share the profits of the business carried on by all or any one
of them acting for all. It is governed by the Indian Partnership Act 1932.
( c ) Joint Hindu Family is a form of business organization wherein the members of a family can only own and manage the business.
It is governed by Hindu Law.
( d ) Unlimited Company is a form of business organization under which the liability of all its members is unlimited. The personal
assets of the members can be used to settle the debts. It can at any time re-register as a limited company under section 32 of the
Companies Act.
Private Ltd Company:A private company has the following features:
Restricts the right of the shareholders to transfer their shares.

Has a minimum of 2 and maximum of 50 members.

Does not invite public to subscribe to its share capital

Must have a minimum paid up capital of Rs. 1 lakh or such a higher amount which may be prescribed from time to time.
Public Ltd Company:A public Ltd company has the following characteristics:
It allows the shareholders to transfer their shares.

Has a minimum of 7 members, and for maximum there is no limit.

It invites the general public to subscribe to its shares

Must have a minimum paid up capital of Rs 5 lakh or such a higher amount as may be prescribed from time to time.
Co-operatives:-

Co-operatives is a form of voluntary organization, wherein the members work together for the promotion of the interests of its
members. There is no restriction to the entry or exit of any member. It is governed by Cooperative Societies Act 1912.

Banking Companies:Banking Companies are similar to Joint Stock Companies. But the maintenance of Books of Accounts and preparation of Balance
Sheet etc, are governed by Banking Regulations Act.
Insurance Companies:In case of Insurance Companies the main source of revenue is the premium collected by the Insurance Company. But the entire
premium collected cannot be treated as income because there is a contingency of claim. There are provisions in the Insurance Act
regarding how much portion of the premium can be taken to revenue and how much to be kept in reserve.
Non-Trading Organization:Non trading organizations are formed with the objective of promoting art, culture, sports etc. Such organizations are not formed with
the objective of making profit. Hence they do not prepare profit and loss accounts instead they prepare an Income and Expenditure
accounts and Balance Sheet.
Joint Stock Companies (Limited Company):In case of Joint Stock Companies the share capital is contributed by large number of investors who are spread out throughout the
country or even the globe. Their liability is limited to the extent of the face value of shares subscribed by them. The preparation of
accounts like profit and loss account, balance sheet etc, are governed by the provisions in the Companies act.