2.  Accounting - a process of identifying, recording, summarizing, and reporting economic information to decision makers in the form of financial statements  Financial accounting - focuses on the specific needs of decision makers external to the organization, such as stockholders, suppliers, banks, and government agencies

3.  The accounting system is a series of steps performed to analyze, record, quantify, accumulate, summarize, classify, report, and interpret economic events and their effects on an organization and to prepare the financial statements.

4.  Accounting systems are designed to meet the needs of the decisions makers who use the financial information.  Every business has some sort of accounting system. ◦ These accounting systems may be very complex or very simple, but the real value of any accounting system lies in the information that the system provides.

5.  Accounting information is useful to anyone who makes decisions that have economic results. Managers want to know if a new product will be profitable. Owners want to know which employees are productive. Investors want to know if a company is a good investment. Creditors want to know if they should extend credit, how much to extend, and for how long. Government regulators want to know if financial statements conform to requirements.

6.  Fundamental relationships in the decision- making process: Event Accountant’s analysis & recording Financial Statements Users

7.  The major distinction between financial and management accounting is the users of the information. ◦ Financial accounting serves external users. ◦ Management accounting serves internal users, such as top executives, management, and administrators within organizations.

8. The primary questions about an organization’s success that decision makers want to know are: What is the financial picture of the organization on a given day? How well did the organization do during a given period?

9. Accountants answer these primary questions with three major financial statements.  Balance Sheet - financial picture on a given day  Income Statement - performance over a given period  Statement of Cash Flows - performance over a given period

10.  Annual report - a document prepared by management and distributed to current and potential investors to inform them about the company’s past performance and future prospects. ◦ The annual report is one of the most common sources of financial information used by investors and managers.

11.  The annual report usually includes: ◦ a letter from corporate management ◦ a discussion and analysis of recent economic events by management ◦ footnotes that explain many elements of the financial statements in more detail ◦ the report of the independent auditors ◦ a statement of management’s responsibility for preparation of the financial statements ◦ other corporate information

12.  What are the different sections of the Balance Sheet?

13. The balance sheet (also called statement of financial position or statement of financial condition) is a snapshot of the financial status of an organization at a point in time.

14. Assets are economic resources that are expected to benefit future activities of the organization. Liabilities are the entity’s economic obligations to others. Owners’ equity is the excess of the assets over the liabilities.

15. Shareholders’ equity Paid-incapitalRetainedearnings The owners’ equity of a corporation is called shareholders’ equity.

16. Sections of the balance sheet:  Assets - resources of the firm that are expected to increase or cause future cash flows (everything the firm owns)  Liabilities - obligations of the firm to outsiders or claims against its assets by outsiders (debts of the firm)  Owners’ Equity - the residual interest in, or remaining claims against, the firm’s assets after deducting liabilities (rights of the owners)

17. The balance sheet equation: Assets = Liabilities + Owners’ Equity or Owners’ Equity = Assets - Liabilities

18.  Balance Sheet ◦ Assets = Liabilities + Equity  Income Statement (also called Statement of Operations, Earnings Statement, Profit/Loss (or P&L) Statement ◦ Revenues - Expenses = Net income (or Net Earnings)  Statement of Changes in Stockholders’ Equity ◦ Beginning of period total equity + Stock issued + Net income - Dividends = End of period total equity  Statement of Cash Flows ◦ Cash inflow - Cash outflow = Net cash flow 1- 17

19. Different categories of users need different kinds of information for making decisions. These users can be divided into : Internal Users; and External Users.

20. These are the persons who manage the business, i.e. management at the top, middle, and lower levels. Their requirements of information are different because they make different types of decisions.

21. The top level is more concerned with planning; the middle level is concerned equally with planning and control; and the lower level is concerned more with controlling operations. Information is supplied on different aspects, e.g. cash resources, sales estimates, results of operations, financial position, etc.

22. All persons other than internal users come in the group of external users. External users can be divided into two groups:  those having direct interest; and  those having indirect interest in a business organization.

23. The main sources of information for external users are annual reports of business organizations, which state the financial position and performance and give the auditor’s report, director’s report and other information.

24. Investors and creditors are the external users having direct interest. Tax authorities, regulatory agencies, customers, labour unions, trade associations, stock exchanges, investors, etc are indirectly interested in the company’s financial strength, its ability to meet short-term and long-term obligations, its future earning power, etc for making various decisions.

25. These are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets are things of value used by the business in its operations.  Fixed Assets  Current Assets

26.  Fixed Assets are assets held on a long- term basis. e.g.Land, Building, Machinery, Plant, Furniture and Fixtures, etc.

27.  Current Assets are assets held on a short-term basis. e.g.Debtors, Bills receivable, Stock(Inventory), Cash and Bank balances, etc.

28. These are obligations or debts that the enterprise must pay in money or services at some time in the future. Long-term liabilities Short-term liabilities

29.  Long-term liabilities are those that are usually payable after a period of one year. e.g. A term loan from a financial institution, debentures (bonds) issued by a company.

30.  Short-term liabilities are obligations that are payable within a period of one year. e.g.Creditors, bills payable, overdraft from a bank for a short period.

31. Investment by the owner for use in the firm is known as capital. Owner’s equity is the ownership claim on total assets. It is equal to total assets minus total liabilities.

32. These are the amounts the business earns by selling its products or providing services to customers. Other titles and sources of revenue common to many businesses are: sales, fees, commission, interest, dividends, royalties, rent received, etc.

33. These are costs incurred by a business in the process of earning revenue. Generally, expenses are measured by the cost of assets consumed or services used during an accounting period. The usual titles of expenses are: depreciation, rent, wages, salaries, interest, costs of heat, light and water, telephone, etc.

34. Purchases are total amount of goods procured by a business on credit and for cash, for use or sale. In a trading concern, purchases are made of merchandise for resale with or without processing. In a manufacturing concern, raw materials are purchased, processed further into finished goods and then sold. Purchases may be cash purchase or credit purchase.

35. Sales are total revenues from goods or services sold or provided to customers. Sales may be cash sales or credit sales.

36. Stock (Inventory) is a measure of something on hand – goods, spares and other items – in a business. It is called stock on hand.

37. In a trading concern, the stock on hand is the amount of goods which have not been sold on the date on which the balance sheet is prepared. This is also called closing stock.

38. In a manufacturing concern, closing stock comprises raw materials, semi-finished goods and finished goods on hand on the closing date. Similarly, opening stock is the amount of stock at the beginning of the accounting year.

39. Debtors are persons and/or other entities who owe to an enterprise an amount for receiving goods and services on credit. The total amount standing against such persons and/or entities on the closing date, is shown in the Balance Sheet as Sundry Debtors on the asset side.

40. Creditors are persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit. The total amount standing to the favour of such persons and/or entities on the closing date, is shown in the Balance Sheet as Sundry Creditors on the liability side.

41. Accounting principles can be subdivided into two categories:  Accounting Concepts; and  Accounting Conventions.

42. Accounting principles can be subdivided into two categories:  Accounting Concepts; and  Accounting Conventions.

43.  Accounting Concepts  Accounting Conventions The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based. The term ‘convention’ is used to signify customs and traditions as a guide to the presentation of accounting statements.

44. Accounting Concepts Business Entity Concept Money Measurement Concept Cost Concept Going Concern Concept Dual Aspect Concept Realization Concept Accounting Period Concept

45. Accounting Conventions Convention of Consistency Convention of Disclosure Convention of Conservation

46. Accounting Concepts The term ‘concept’ is used to connote accounting postulates, that is necessary assumptions and conditions upon which accounting is based.

47. Business is treated as a separate entity or unit apart from its owner and others. All the transactions of the business are recorded in the books of business from the point of view of the business as an entity and even the owner is treated as a creditor to the extent of his/her capital.

48. In accounting, we record only those transactions which are expressed in terms of money. In other words, a fact which can not be expressed in monetary terms, is not recorded in the books of accounts.

49. Transactions are entered in the books of accounts at the amount actually involved. Suppose a company purchases a car for Rs.1,50,000/- the real value of which is Rs.2,00,000/-, the purchase will be recorded as Rs.1,50,000/- and not any more. This is one of the most important concept and it prevents arbitrary values being put on transactions.

50. It is persuaded that the business will exists for a long time and transactions are recorded from this point of view.

51. Each transaction has two aspects, that is, the receiving benefit by one party and the giving benefit by the other. This principle is the core of accountancy.

52. For example, the proprietor of a business starts his business with Cash Rs.1,00,000/-, Machinery of Rs.50,000/- and Building of Rs.30,000/-, then this fact is recorded at two places. That is Assets account (Cash, Machinery & Building) and Capital accounts. The capital of the business is equal to the assets of the business.

53. Thus, the dual aspect can be expressed as under Capital + Liabilities = Assets or Capital = Assets – Liabilities

54. Accounting is a historical record of transactions. It records what has happened. It does not anticipate events. This is of great important in preventing business firms from inflating their profits by recording sales and income that are likely to accrue.

55. Strictly speaking, the net income can be measured by comparing the assets of the business existing at the time of its liquidation. But as the life of the business is assumed to be infinite, the measurement of income according to the above concept is not possible. So a twelve month period is normally adopted for this purpose. This time interval is called accounting period.

56. Accounting Conventions The term ‘convention’ is used to signify customs and traditions as a guide to the presentation of accounting statements.

57. In order to enable the management to draw important conclusions regarding the working of the company over a few years, it is essential that accounting practices and methods remain unchanged from one accounting period to another. The comparison of one accounting period with that of another is possible only when the convention of consistency is followed.

58. This principle implies that accounts must be honestly prepared and all material information must be disclosed therein. The contents of Balance Sheet and Profit and Loss Account are prescribed by law. These are designed to make disclosure of all material facts compulsory.

59. Financial statements are always drawn up on rather a conservative basis. That is, showing a position better than what it is, not permitted. It is also not proper to show a position worse than what it is. In other words, secret reserves are not permitted.

60. Keeping systematic records Protecting properties of the business Communicating the results Meeting legal requirements

61. The first function of accounting is to keep a systematic record of financial transactions, to post them to the ledger accounts and ultimately prepare final statements.

62. The second important function is to protect the property of the business. The system accounting is designed in such a way that it protects its assets from an unjustified and unwarranted use.

63. The fourth and the last function of accounting is to meet the legal requirements under the Companies Act, Income Tax Act, Sales Tax Act and so on.

64. Recording transactions in subsidiary books. Classifying data by posting from subsidiary books to the accounts. Closing the books and preparation of final accounts.

65. Accounts in the names of persons are known as “Personal Accounts” Accounts in the names of assets are known as “Real Accounts” Accounts in respect of expenses and incomes are known as “Nominal Accounts”

66. ACCOUNTS PERSONAL ACCOUNTS IMPERSONAL ACCOUNTS REAL ACCOUNTS NOMINAL ACCOUNTS

67. Accounts in the name of persons are known as personal accounts. Eg: Babu A/C, Babu & Co. A/C, Outstanding Salaries A/C, etc.

68. These are accounts of assets or properties. Assets may be tangible or intangible. Real accounts are impersonal which are tangible or intangible in nature. Eg:- Cash a/c, Building a/c, etc are Real Accounts related to things which we can feel, see and touch. Goodwill a/c, Patent a/c, etc Real Accounts which are of intangible in nature.

69. These accounts are impersonal, but invisible and intangible. Nominal accounts are related to those things which we can feel, but can not see and touch. All “expenses and losses” and all “incomes and gains” fall in this category. Eg:- Salaries A/C, Rent A/C, Wages A/C, Interest Received A/C, Commission Received A/C, Discount A/C, etc.

70. Each accounts have two sides – the left side and the right side. In accounting, the left side of an account is called the “Debit Side” and the right side of an account is called the “Credit Side”. The entries made on the left side of an account is called a “Debit Entry” and the entries made on the right side of an account is called a “Credit Entry”.

71.  By: Munawar Hameed