Financial Accounting Complete E-notes (REVISION eNotes)
LUCKNOW UNIVERSITY
BCOM SEM I
DEFINITION OF ACCOUNTING
Accounting: Accounting is the art of recording, classifying, summarizing in a significant manner, transactions and events which are of financial character, and interpreting the results thereof.
Based on the above definition, ACCOUNTING PROCESS can be explained:
The Accounting process starts with the identification of the Financial transactions (events or transactions which can be measured in terms of money), then recording them in the form of Journal Entries (eg. Cash Book, Sales Journal, Purchase Journal, Purchase Return Journal, Sales Return Journal etc.), then the transactions are classified and posted them into ledger, then the transactions are summarized in the Trial Balance, Profit/Loss Account and Balance Sheet. After that we Analyse & Interpret them and finally the information is being used by the various parties interested in the enterprise.
NATURE AND SCOPE OF ACCOUNTING
Identifying the Transaction and Events: Accounting identifies transaction and event, which can be expressed ion term of money and bring change in the financial position of a business unit.
Measuring the identified Transaction and Events: Accounting measures the transaction and events in term of money.
Recording: It is the process of entering the transaction and events in the books of original entry in the chronological manner e.g, date wise.
Classifying: It is the process of posting of entries in the ledger so that transaction of similar type are accumulated at one place.
Summarizing: It is concerned with the preparation of Financial Statement such as Income Statement, Balance Sheet and Cash Flow Statement.
Interpreting: Interpreting is the last stage of accounting process. It is concerned with explaining the meaning and significance of the relationship established by the analysis. In fact, interpretation is the main function of accountant in the present condition since the routine work of recording, classifying and summarizing business transaction business transaction can be easily handled by the electronic devices like computers.
Communicating: It is concerned with the transmission of summarized, analyzed and interpreted information to the user to enable them to make reasoned decisions.
Objectives of Accounting
✓ To keep systematic record of business transactions
✓ To calculate profit or loss
✓ To know the exact reasons leading to net profit or net loss
✓ To ascertain the financial positions of the business✓ To ascertain the progress of the business
✓ from year to year
✓ To prevent and detect errors and frauds
✓ To provide information to various parties
Advantages of Accounting
✓ Helpful in Management of Business (Planning, Decision Making and Controlling)
✓ Provide Complete and Systematic Records
✓ Information Regarding Profit or Loss
✓ Information Regarding Financial Position
✓ Enables Comparative Study
✓ Helpful Assessment of Tax Liability
✓ Evidence in Legal Matters
✓ Facilitates Sale of Business
✓ Helpful in Raising Loans
✓ Helpful in Prevention and Detection of Errors and Fraud
ACCOUNTING PRINCIPLES
It is defined as those rules of action or conduct which are adopted by the accountants universally while recording accounting transaction. These principles can be classified into two categories:
1) Accounting Concepts.
2) Accounting Conventions
The term ‘concepts’ includes those basic assumptions or conditions upon which the science of accounting is based
The following are the important accounting concepts:
1) SEPARATE ENTITY CONCEPT.
2) GOING CONCERN CONCEPT.
3) MONEY MEASUREMENT CONCEPT.
4) COST CONCEPT.
5) DUAL ASPECT CONCEPT.
6) ACCOUNTING PERIOD CONCEPT.
7) PERIODIC MATCHING OF COST AND REVENUE CONCEPT
8) REALISATION CONCEPT
Separate Entity Concept
In accounting business is considered to be a separate and distinct entity from its owners.
Going Concern Concept:-
The Concept Of Going Concern assumes that a business firm would continue to carry out its operations indefinitely . for a fairly long period of time and would not be liquidated in the foreseeable future
Money Measurement Concept:-
As per this concept accounting involves and records only monetary transactions.transactions measurable in terms of money
Cost Concept
The cost concept requires that all assets are recorded in the book of accounts at their purchase price.
Dual Aspect Concept:-
Every business transaction has a dual effect. The duality concept is commonly expressed in terms of fundamental accounting equation, which is as follows:-
Assets=Liabilities + Capital
Accounting Period Concept:-
According to this concept, the life of the business is divided into appropriate segments for studying the results shown by the business after each segment.
Periodic Matching Of Cost And Revenues Concept:-
It states that expenses incurred in an accounting period should be matched with revenues during that period.
Revenue Recognition(realization) Concept:-
The concept of revenue recognition requires that the revenue for a business transaction should beincluded in the accounting records only when it is realized
Accounting Convention
The term ‘conventions’ includes those customs or traditions which guide the accountant while preparing the accounting statements.
The following are the important accounting conventions:
1) Convention of Conservatism.
2) Convention of Full Disclosure.
3) Convention of Consistency.
4) Convention of Materiality.
1.Conservatism :- According to this convention, the accountants follows the rule ‘anticipate no profit but provide for all possible losses’ while recording business transactions.
- Full Disclosure:- According to this convention accounting reports should disclose fully and fairly the information they purport to represent.
- Consistency:-
According to this convention accounting practices should remain unchanged from one period to another. - Materiality:- According to this convention the accountant should attach importance to material details and ignore insignificant details
DIFFERENCE BETWEEN CAPTIAL AND REVENUE ITEMS
| CAPTIAL ITEM | REVENUE ITEM |
| It is spent to obtain fixed assets for use in business. | It is spent to running business’ daily routine. |
| It enhance the earning ability of the business. | It help to obtain more profit from business. |
| Its benefits extend to more than one year. | Its benefits extend to only one year. |
| It is debited to an assets account. | It is debited to expense account. |
| It is real account. | It is nominal account. |
| It is shown in Balance Sheet. | It is a part of Profit and Loss account. |
INDIAN ACCOUNTING STANDARDS
Accounting Standards means the standard of accounting recommended by the ICAI and prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards (NACAs) constituted under section 210(1) of Companies Act, 1956.
A ‘Standard’ means a generally accepted model or an ideal.
Thus, accounting standard means generally accepted accounting principles.
Accounting Standards are written documents containing the ‘Generally Accepted Accounting Principles(GAAP)’ issued by ICAI in India.
The main objective of Accounting Standards is to standardise the different accounting policies and practices followed by different business concern.
INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)
IFRS standards are International Financial Reporting Standards (IFRS) that consist of a set of accounting rules that determine how transactions and other accounting events are required to be reported in financial statements. They are designed to maintain credibility and transparency in the financial world, which enables investors and business operators to make informed financial decisions.
IFRS standards are issued and maintained by the International Accounting Standards Board and were created to establish a common language so that financial statements can easily be interpreted from company to company and country to country.
LIST OF IFRS STANDARDS
Conceptual Framework for Financial Reporting
IFRS 1 First-time Adoption of International Financial Reporting Standards
IFRS 2 Share-based Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
IFRS 6 Exploration for and Evaluation of Mineral Resources
IFRS 7 Financial Instruments: Disclosures
IFRS 8 Operating Segments
IFRS 9 Financial Instruments
IFRS 10 Consolidated Financial Statements
IFRS 11 Joint Arrangements
IFRS 12 Disclosure of Interests in Other Entities
IFRS 13 Fair Value Measurement
IFRS 14 Regulatory Deferral Accounts
BENEFITS OF IFRS
IFRS is a unique, high quality, easily understandable global accounting standards. It is also known as “principle based” set of standards which are easy to understand and apply.
Reporting in IFRS could make it easier to raise capital in global market.
This would eliminate cost of restatement into local standards.
It would make the consolidation process easier.
IFRS are being used increasingly worldwide, so it will make the appraisal of potential acquisition targets straighter forward
PARTNERSHIP
Partnership is a form of business in which two or more but not more than twenty people owns a business. It is based on written contract or on an oral agreement. Partnership is the relation between persons who have agreed to share the profit of a business carried on by all or any of them acting for all, persons who have entered into partnership with one another are called individually ‘Partner’ and collectively a‘firm’. – Partnership Act-1932.
Partnership.
S. E. Thomas : “A partnership is an association of people who carry on business together for the purpose of making profit”.
TWO TYPES OF PARTNER
A general partnership consists of two or more people who go into business together and share in the profit. The general partners are involved in the business operations and share liability on the business obligations
LIMITED PARTNERSHIP
A limited partnership consists of two or more general partner and at least one limited partner. The general partner handle the business operations and share in liability. The limited partners contribute but do not get involved in the everyday functions and have only a limited liability.
ADMISSION OF PARTNER
MEANING: Inclusion of a new person as a partner to an existing firm is called admission
of a partner. The new partner who joins the business is called the incoming partner or new partner.
With the admission of a new partner, there is a reconstitution of the partnership firm and all the partners get into a new agreement for carrying out the business of the firm.
The following conditions led to the addition of a new partner:
When the firm is in an expansion mode and requires fresh capital.
When the new partners possesses expertise which can be beneficial for the business expansion of the firm.
When the partner in question is a person of reputation and adds goodwill to the firm
Adjustment of Capital and Change in Profit Sharing Ratio Among Existing Partners
Few significant points which require observation during the admission of a new partner are mentioned below :
Sacrificing ratio
New profit sharing ratio
Revaluation of assets and Reassessment of liabilities
Valuation and adjustment of goodwill
Adjustment of partners’ capitals
Distribution of accumulated profits (reserves)
Treatment of Goodwill in the Admission of a Partner
A new partner is entitled to be a part of the future profits of the firm upon being
added to the firm. The act of admitting new partner also leads to the reduction in
the future profit sharing ratio of the existing partners. For this reason a new
partner has to bring extra value apart from capital, this is known as Premium for Goodwill.
Treatment of goodwill on admission of a new partner will be based on the following conditions:
- When the amount for goodwill is paid privately
- When the amount necessary for paying the share of goodwill is brought as cash.
- When share of goodwill is not brought as cash.
New profit sharing ratio : New profit sharing ratio is the ratio in which all partners(including new partner) share the future profit and losses.
Sacrificing Ratio : The ratio in which the old partners sacrifices or surrender their share of profit in favour of incoming partner is called sacrificing ratio.
Sacrificing Ratio = Old Ratio- New Ratio
RETIREMENT OF PARTNER
MEANING: When one or more partners leaves the firm and the remaining partners continue to do the business of the firm, it is known as retirement of a partner. Due to some reasons like old age, poor health, strained relations etc., an existing partner may decide to retire from the partnership.
A partner retires either :
(i) with the consent of all partners, or
(ii) as per terms of the agreement; or
(iii) at his or her own will.
DEATH OF PARTNER
A partnership firm is a type of organisation that is established by two or more individuals with a common objective of revenue generation. The organisation witnesses changes in certain events such as admission of a new partner, retirement or death of an existing partner. In the event of death of a partner, the structure of the partnership is changed in the same way as when a partner retires.
DISSOLUTION OF PARTNER
The term dissolution means breaking up. Dissolution is a situation wherein existing state of arrangement is changed.
TYPES OF DISSOLUTION
DISSOLUTION OF PARTNERSHIP
DISSOLUTION OF FIRM
MEANING OF HIRE PURCHASE
The term ‘hire purchase’ originated in the United Kingdom. Hire Purchase System is a method of purchasing the goods with an arrangement to make payment (of the purchase price) in instalments over time. The purchaser is, therefore, leasing the goods and does not obtain the ownership of the goods until he pays the full amount of the contract. However, physical possession of goods is given by the seller to the buyer immediately after the finalization and signing of the agreement called, hire purchase agreement.
It is also defined as a system by which a buyer pays for a thing in regular instalments while enjoying the use of it. During the repayment period, ownership (i.e., title) of the item does not pass to the buyer. Upon the full payment of the amount/loan, the title passes to the buyer.
Difference between HIRE PURCHASE SYSTEM & INSTALMENT PURCHASE SYSTEM
| BASIS | Hire Purchase System | Instalment Purchase System |
| NATURE OF TRANSACTION | Initially, it is similar to a contract of hire and subsequently, it transforms into sales. | It is an agreement of sale of goods and services from the very beginning |
| Transfer of Ownership | In the case of hire purchase, ownership of goods is transferred to the hirer on payment of all instalments (to the hire vendor). | The title to the goods transfers at the time of signing the agreement |
| Repossession of Goods | On non-payment of any instalment, the seller can take back the goods from the hirer and repossess the goods sold under hire purchase system. | On non-payment of any instalment or all instalments, the seller cannot take back the goods from the buyer. Of course, the seller can take legal action against the buyer. |
| Risk | Risk is on the hire seller till the payment of last instalment. On the payment of all instalments, risk transfers to the hire purchaser. | Risk is not on the seller of goods and services. |
MEANING OF ROYALTY
Royalty mean the sum payable by one person to another person for using right i.e. it is the periodic payment to the owner of some form of privilege or monopoly for being allowed to use such right or privilege. Royalty Account is a nominal account and is closed at the end of every accounting year by transferring it to profit and loss Account.
Definition of Royalty ‘‘Royalty refers to the amount paid by one person to another for granting the some special rights by the former to the latter”.
DIFFERENCE BETWEEN ROYALTY AND RENT
Use- Consideration received from using some tangible assets like building, factory etc. is known as rent. While consideration which is received from using both tangible and intangible assets like patent, copyright etc. is known as royalty.
Basis of payment- Payment of rent is based on period like yearly, half-yearly, monthly , weekly etc. while payment of royalty is based upon the limit of using it like per item, per ton production or sale basis.
Minimum Rent
According to the lease agreement, minimum rent, fixed rent, or dead rent is a type of guarantee made by the lessee to the lessor, in case of shortage of output or production or sale. It means, lessor will receive a minimum fix rent irrespective of the reason/s of the shortage of production.
Right of Recouping
It may contain in the royalty agreement that excess of minimum rent paid over the actual royalty (i.e. shortworkings), may be recoverable in the subsequent years. So, when the royalty is in excess of the minimum rent is called the right of recoupment (of shortworkings).
Right of recoupment will be decided for the fixed period or for the floating period. When the right of recoupment is fixed for the certain starting years from the date of royalty agreement, it is said to be fixed or restricted. On the other hand, when the lessee is eligible to recoup the shortworkings in next 2 or 3 years from the year of its commencement, it is said to be floating.
Shortworking will be shown on the asset side of Balance sheet up to allowable year of recouping after that it will be transferred to profit & loss account (after expiry of allowable period).
INSOLVENCY ACCOUNT
Accounting insolvency refers to a situation where the value of a company’s liabilities exceeds the value of its assets. Accounting insolvency looks only at the firm’s balance sheet, deeming a company “insolvent on the books” when its net worth appears negative.
When a person is unable to pay or settle his debts and his liabilities are greater than his assets. men he is called insolvent after being adjudicated insolvent by a competent court. In legal sense, the term insolvent is applied to a person against whom an order of adjudication has been passed by a competent court. Such an order is passed against such a debtor whose liabilities exceed his assets and who commits an act of insolvency.
DEFICIENCY ACCOUNT
Excess of liabilities over the realisable value of the assets is called deficiency which is shown in list ‘H’. separate account is prepared to explain the reasons for the deficiency as shown by the statement of affairs and to show how the capital contributed by the owner has lost along with the unpaid amount of the creditors. Deficiency account is prepared like the capital account with two sides reversed. Capital and all other items that increase capital (i.e. trading profit, salary, interest on capital) profit on realisation of assets, excess of private assets over private liabilities of the owner, etc. are shown on the left side whereas items which decrease capital, i.e. trading losses, drawings, loss on realisation of assets, speculation losses, etc. are shown on the right side of this account. The amount of deficiency being the excess of losses and drawings over capital and profits is shown on the left hand side of the deficiency account
Insurance Claim for loss of Stock and Loss of Profit
There are several different reasons by which a business may suffer abnormal losses such as fire, theft, burglary, strike, etc. among them most common which destroys or causes severe damage to the assets like plant, machinery, furniture, etc. is fire. So these losses are recovered through insurance so business has to pay there insurance premium at regular intervals. Then only company or business can claim there losses through these insurance policies. So, insurance can be studied under two parts:
- Claim for loss of stock.
- Claim for loss of profit.
TYPES OF FIRE CLAIM
Depending upon the risk covered by an insurance policy, claims against the insurer can be divided as below:
- Claim for Loss of Stock.
- Claim for Loss of Fixed Assets.
- Claim for Loss of Profit
INSURANCE CLAIM FOR LOSS OF PROFIT
The fire not only destroys stock or assets but also causes disturbances to the business and hence, the business concern– suffers reduction in usual profits. But to compensate such loss of profit, Insurance Co. issues a cover but before claiming the loss of profit there is a condition that you should have policy for loss of stock and you have claimed for loss of stock
Claim for Loss of Profit
The Loss of Profit Policy normally covers the following items:
Loss of net profit
Standing charges.
Any increased cost of working.
Gross Profit Net profit +Insured Standing charges OR Insured Standing charges – Net Trading Loss (If any) X Insured Standing charges/All standing charges of business.
Net Profit The net trading profit (exclusive of all capital) receipts and accretion and all outlay properly (chargeable to capital)resulting from the business of the Insured at the premises after due provision has been made for all standing and other charges including depreciation.
Insured Standing Charges Interest on Debentures, Mortgage Loans and Bank Overdrafts, Rent, Rates and Taxes (other than taxes which form part of net profit) Salaries of Permanent Staff and Wages to Skilled Employees, Boarding and Lodging of resident Directors and/or Manager, Directors’ Fees, Unspecified Standing Charges.
BRANCH ACCOUNT
A branch is a separate segment of a business. In order to increase the sales, business houses are requires to market their products over a larger territory and may generally split their business intocertain divisions or parts. These various parts or divisions may be located in different part of the samecity or in different cities of the same country or in different countries in the world. These are known as branches. The head office controls the activities of various branches.
Branch accounting : Branch accounting is the process through which the accounting system of a branch is maintained.
As stated earlier, under debtors system, the head office simply opens a Branch Account for each branch in which it records all transactions relating to the branch. The Branch Account also helps in ascertaining the profit or loss of the branch.
Goods may be invoiced to a branch at cost or at selling price (also called invoice price). Accordingly, there are two methods of preparing the Branch Account: (0 Cost Price Method, and (ii) Invoice Price Method. Let us now study the preparation of Branch Acoount under both of thew methods.
Branch Accounting MethodsA few unique techniques are used for keeping branch accounts as per the nature and complexity of the business along with the functional independence of the branch. The most widely recognized methods to manage branch account that you need to know are-
- Debtors Method
In debtors system, branch accounting is done in the form of a debtor account. In Head Office’s accounting books, a branch account will be debited with the goods supplied and expenses met by Head Office while the branch account will be credited with all returns and remittances like the Customers Account. It is used for finding out the profit or loss of each brand. - Stock and Debtors Method
The debtors’ method is good for small branches but in other cases when goods are dispatched to the branch at the selling price and the branch does not have the authorization to vary that price. Different accounts opened in this method are- Branch Assets Account, Branch Expense Account, and Branch Stock Account. - Final Accounts Method
In this method, trading, as well as profit and loss accounts are prepared for calculating the gross profit or gross loss along with net profit or a net loss. In the final accounts method, opening stock and goods that are sent to the branch are debited in the trading account, plus closing stock, goods, and sales that are returned by the branch are credited to the trading account. - Wholesale Branches Method
In this way of branch accounting, the goods invoicing is done at the wholesale price to a retail branch. The opening and closing stock of the branch are supposed to be shown at the wholesale price, plus the unrealized profits in closing stock are supposed to be debited as a stock reserve to the head office’s profit and loss account. of head office. In the same very manner, a stock reserve of opening stock is also supposed to be credited to the head office’s profit and loss account.
Two types of branches that are prevalent are-
Dependent Branch
Such branches don’t keep up with independent accounting books and the head office manages their profit and loss statements as well as balance sheets. Just a few information and data like Cash Accounting, Debtors Accounting, and Inventory are managed by branches independently.
Independent Branch
Such branches that keep up with separate books of accounts eventually, and hence their balance sheet and profit and loss financial statements are managed independently. For this situation, the branch office and head office are treated as isolated entities. Branch accounting is preferably used in independent branches.
Voyage Account
The method of accounting followed by shipping companies is known as voyage accounting. Shipping companies prepare their accounts periodically and also prepare the results of each voyage separately. Shipping companies carry goods from one place to another. Some companies carry passengers also in addition to goods from one place to another place.
In order to ascertain the result of operating a ship’s voyage, Voyage Account is prepared. The Voyage Account is a revenue account. It is important to note that there is no difference in the manner of preparing accounts period-wise and voyage-wise.
Accounting Entries- Debit and Credit:
- Bunker Cost:
This is the expenditure incurred on fuel oil, diesel, coal and fresh water used during the voyage. Now-a-days oil and diesel are used in place of coal. The bin or storing place of coal is referred to as bunker. Hence the name bunker costs.
- Port Charges:
Port is used by the shipping companies for loading and unloading of goods and parking of ships, hence the charges paid for these purposes are known as port charges. - Depreciation:
Depreciation of the ship for the period of voyage is calculated and charged to the Voyage Account. - Insurance:
Insurance premium of cargo must be entirely debited to the concerned Voyage Account whereas the insurance charges of the ship are charged proportionately to each voyage on the basis of time of voyage.
Voyage Account is credited usually with the following items:
- Freight:
The amount which is charged by the shipping companies for taking goods or cargo from one place to another is called freight. It is an income. - Primage:
It is additional freight just like surcharge on freight originally collected for the captain of the ship, now-a-days it is treated as income of the shipping company.
- Passage Money:
Fare collected from the passengers travelled in addition to the fare collected for merchandise. - Closing Stocks of Stores, Provisions, Coal, Fuel etc.
Generally, voyage profit represents the excess of voyage incomes earned over the expenses incurred for this purpose. But if, however, the voyage is in progress, the incomes and expenses relating to the unfinished voyage are carried forward to the next year.
Excess of credit side of Voyage Account over its debit side is profit on the voyage. Excess of debit side of Voyage Account over its credit side is loss on the voyage. This profit or loss is transferred to General Profit and Loss Account of the shipping company.
