Faculty: Mr.

Atul Stanley Hermit

Financial Accounting & Analysis

Unit 1: Meaning & Scope of

Accounting
 FA & A, Atul Stanley Hermit

 Business transactions are in large numbers and increasingly

complex; require proper and written recording…This
systematic recording of transactions is basic accounting.
 For any business organization, earning profits is a primary /
main objective. Accounting process helps determine the
profit/loss and overall business performance for a particular
duration.
 Accounting helps analyse past performance and plan future
course of action; enabling anticipation of financial future for
business.
 A book-keeper records financial transactions as per certain
accounting principles and standards; prescribed by
accounting profession and depending upon size, nature,
volume, and other constraints of an organization.
 FA & A, Atul Stanley Hermit

 Accounting involves the ‘systematic and comprehensive

recording of financial transactions pertaining to a business’.
 It is the process of accurately recording, classifying,
summarizing, analyzing and reporting the various business
transactions.
 Accounting information is extensively used by owners,
customers, oversight agencies, regulators and tax collection
and other entities, to understand the business performance.
 Accounting also tries to explains how a business
organization records, organizes and reports these
transactions to various stakeholders.
 Importantly, just the systematic & accurate recording of
financial transactions (achieved through bookkeeping
process) not enough for a business to achieve its commercial
objective (earning profits). For this purpose, business also
needs to importantly ascertain its financial result
(profit earned / loss incurred).
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 Here, a business entity may use specific accounting

methodologies to analyze its income and expense items as
well as its assets and liabilities situation to determine its
financial position and performance. The scope and methods
of accounting may, however, differ from entity to entity.
 As such, accounting helps to translate the working of
business reports for the purpose of tracking assets,
liabilities, expenses, income, and equity capital.
 Basic knowledge of accounting is important to understand
the financial terms and to participate in the business world.
 FA & A, Atul Stanley Hermit

 Concept of bookkeeping emerged (before 2000 BC) with

early societies starting to use the barter system and needing
to record the agreements regarding goods/service
transactions.
 Earliest evidence of accounting comes from Mesopotamian
civilizations (including ancient Egypt and Babylon) more than
7,000 years ago, with primitive record-keeping of details of
trading transactions involving animals, livestock, and crops.
 In India, philosopher and economist Chanakya wrote
Arthashastra during the Mauryan Empire around second
century B.C. The book contained advice and details on how
to maintain record books for accounts.
 FA & A, Atul Stanley Hermit

 In 1494 AD, Luca Pacioli (an Italian

mathematician) first described the system of
double-entry bookkeeping used by Venetian
merchants… He laid the foundation for modern
accounting by creating an independent record
that provided a clearer picture of an entity’s
financial activities: the financial statement.
 Later, accounting ledgers were compiled by hand
Luca Pacioli - the
and used either a single / double entry system. Father of modern
bookkeeping
 Railroads and emergence of corporations
stimulated the establishment of professional
accounting firms.
 At present, accounting is a very well developed
area of expertise and profession with detailed
guidelines, laws and regulations. Computers are
extensively used to take up accounting work.
 FA & A, Atul Stanley Hermit

Scope of Accounting is wide and extends to business, trade,

government, banks & financial institutions, investors, individuals,
families & every other aspect of life.
Subject of accounting is usually studied in detail under the below main
areas:
 Financial Accounting: has as its main objective the ascertainment of
profit / loss for a given period and to show the financial position of the
business on a particular date with adequate control over the firm’s
property. Financial accounting records are utilized to share useful
information with various stakeholders.
 Cost Accounting: has as its primary aim the ascertainment of costs
relating to various activities of the business and to have cost control.
Carefully recorded and summarised cost data enables the management
to effectively control current business operations while planning for the
future.
 Management Accounting: provides the firm’s management with
important information that enables effective and correct decision-
making by them. This accounting information also helps in the discharge
of important management functions such as planning, organizing,
controlling as well as evaluation of business performance.
 FA & A, Atul Stanley Hermit

 Accounting is one of the key functions for almost any

business. It may be handled by a bookkeeper or an
accountant at a small firm, or by sizable finance departments
with dozens of employees at larger companies.
 Accountant is a professional who performs accounting
functions such as record keeping classification and
summarization, account analysis, auditing, and financial
statement analysis. Accountants work with accounting firms
or internal account departments with large companies. They
may also set up their own, individual practices.
 Advanced accounting is typically handled by qualified
accountants who possess designations such as Chartered
Accountants (CA) in India, Certified Public Accountant (CPA) in
the United States, or Chartered Accountant (CA), Certified
General Accountant (CGA) or Certified Management
Accountant (CMA) in Canada.
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The main users of the accounting information for a

business firm are:
 Firm itself
 Owners & Promoters
 Prospective Investors
 Suppliers / Vendor Partners
 Customers
 Government Ministries & Departments
 Regulatory Agencies
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1. Transactions: include the exchange of goods & services of monetary value, between two or more
parties.
2. Goods: include all tangible articles, commodities, merchandize in which the business deals and which
are held by business. Goods can be in form of purchases, sales, purchase returns, sales returns and
inventory (stock).
3. Services: include provision of an activity or the performance of a task with a commercial purpose.
4. Asset (A): Anything the company owns that has monetary value. These are usually listed in order of
liquidity, from cash (the most liquid) to land (least liquid).
◦ Fixed Assets: Fixed (or non-current) assets provide benefits to a company for more than one
year—for example, land and machinery
◦ Current Assets: Current assets are assets that will be used within one year. For example, cash,
inventory, and accounts receivable.
5. Liability (L): All debts that a company has yet to pay are referred to as Liabilities. Common liabilities
include Accounts Payable, Payroll, and Loans.
Liabilities can be:
o Non-Current Liabilities: are for the long term and include: (1) Internal (usually Equity Capital) and External (Debt).
o Current Liabilities: are for the short term and can include recurring liabilities such as accounts payable.
6. Balance Sheet : A financial statement that reports on all of a company’s assets, liabilities, and equity.
As suggested by its name, a balance sheet abides by the equation, Assets = Liabilities + Equity.
7. Equity (E): It is that portion of the company that is owned by the investors and owners Equity denotes
the value left over after liabilities have been removed. i.e. Equity = Assets - Liabilities.
8. Inventory: Inventory is the term used to classify the assets that a company has purchased to sell to its
customers that remain unsold. As these items are sold to customers, inventory account will lower.
 FA & A, Atul Stanley Hermit

Balance Sheet Terms

9. Accounts Payable (AP) : include all of the expenses that a business has incurred but has not yet paid. This
account is recorded as a liability on the Balance Sheet as it is a debt owed by the company.
10. Accounts Receivable (AR): include all of the revenue (sales) that a company has provided but has not yet
collected payment on. This account is on the Balance Sheet, recorded as an asset that will likely convert to
cash in the short-term.
11. Accrued Expense: An expense that been incurred but hasn’t been paid.
12. Book Value (BV): As an asset is depreciated, it loses value. The Book Value shows the original value of an
Asset, less any accumulated Depreciation.
Income Statement Terms
13. Cost of Goods Sold (COGS): are the expenses that directly relate to the creation of a product or
service. Not included in this category are those costs (i.e. Indirect costs) that are needed to run the
business. An example of COGS would be the cost of Materials, or the Direct Labor to provide a
service.
14. Depreciation (Dep): is the term that accounts for the loss of value in an asset over time. Generally,
an asset has to have substantial value in order to warrant depreciating it. Common assets to be
depreciated are automobiles and equipment. Depreciation appears on the Income Statement as an
expense and is often categorized as a “Non-Cash Expense” since it doesn’t have a direct impact on a
company’s cash position.
15. Expense (Cost): An Expense is any cost incurred by the business.
16. Gross Margin (GM): is a percentage calculated by taking Gross Profit and dividing by Revenue for the
same period. It represents the profitability of a company after deducting the Cost of Goods Sold.
17. Gross Profit (GP): indicates the profitability of a company in dollars, without taking overhead
expenses into account. It is calculated by subtracting the Cost of Goods Sold from Revenue for the
same period.
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18. Income Statement (Profit and Loss) (IS or P&L): The Income Statement (often referred to as a Profit
and Loss, or P&L) is the financial statement that shows the revenues, expenses, and profits over a
given time period. Revenue earned is shown at the top of the report and various costs (expenses)
are subtracted from it until all costs are accounted for; the result being Net Income.
19. Net Income (NI): is the dollar amount that is earned in profits. It is calculated by taking Revenue
and subtracting all of the Expenses in a given period, including COGS, Overhead, Depreciation, and
Taxes.
20. Net Margin: is the percent amount that illustrates the profit of a company in relation to its
Revenue. It is calculated by taking Net Income and dividing it by Revenue for a given period.
21. Revenue (Sales) (Rev): Revenue is any money earned by the business.
General Terms
22. Accounting Period: is designated in all Financial Statements (Income Statement, Balance Sheet, and
Statement of Cash Flows). The period communicates the span of time that is reported in the
statements.
23. Allocation: describes the procedure of assigning funds to various accounts or periods. For
example, a cost can be Allocated over multiple months (like in the case of insurance) or Allocated
over multiple departments (as is often done with administrative costs for companies with multiple
divisions).
24. Business (or Legal) Entity: This is the legal structure, or type, of a business. Common company
formations include Sole Proprietor, Partnership, Limited Liability Corp (LLC). Each entity has a
unique set of requirements, laws, and tax implications.
25. Cash Flow (CF): is the term that describes the inflow and outflow of cash in a business. The Net
Cash Flow for a period of time is found by taking the Beginning Cash Balance and subtracting the
Ending Cash Balance. A positive number indicates that more cash flowed into the
business than out, where a negative number indicates the opposite.
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26. Chartered Accountant (CA) / Certified Public Accountant (CPA): is a professional designation that an
accountant can earn by passing the CA / CPA exam and fulfilling the requirements for both
education and work experience, which vary with the specific country.
27. Diversification: is a method of reducing risk. The goal is to allocate capital across a multitude of
assets so that the performance of any one asset doesn’t dictate the performance of the total.
28. Fixed Cost (FC): is one that does not change with the volume of sales. For example, rent and
salaries won’t change if a company sells more. The opposite of a Fixed Cost is a Variable Cost.
29. General Ledger (GL): is the complete record of a company’s financial transactions. The GL is used in
order to prepare all of the Financial Statements.
30. Interest: is the amount paid on a loan / line of credit that exceeds repayment of principal balance.
31. Journal Entry (JE): Journal Entries are how updates and changes are made to a company’s books.
Every Journal Entry must consist of a unique identifier (to record the entry), a date, a debit/credit, an
amount, and an account code (that determines which account is altered).
32. Liquidity: refers to how quickly something can be converted into cash. For example, stocks are more
liquid than a house since you can sell stocks (turning it into cash) more quickly than real estate.
33. Material: is the term that refers whether information influences decisions. For example, if a
company has revenue in the millions of dollars, an amount of $0.50 is hardly material. GAAP
requires that all Material considerations must be disclosed.
34. On Credit/On Account: A purchase that happens On Credit or On Account is a purchase that will be
paid at a future time, but the buyer gets to enjoy the benefit of that purchase immediately.
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35. Overheads: are those Expenses that relate to running the business. They do not include expenses that make
the product or deliver the service. For example, Overhead often includes Rent, and Executive Salaries.
36. Payroll: refers to the accounting details that shows payments to employee salaries, wages, bonuses, and
deductions. Often this will appear on the Balance Sheet as a Liability that the company owes if there is
accrued vacation pay or any unpaid wages.
37. Present Value (PV): is a term that refers to the value of an Asset today, as opposed to a different point in
time. It is based on the theory that cash today is more valuable than cash tomorrow, due to the concept of
inflation.
38. Receipts: A Receipt is a document that proves payment was made. A business produces receipts when it
provides its product or service and it receives receipts when it pays for goods and services from other
businesses. Received Receipts should be saved and catalogued so that a company can prove that its incurred
expenses are accurate.
39. Return on Investment (ROI): Originally, this term referred to the profit that a company was making (Return),
divided by the Investment required. Today, the term is used more loosely to include returns on various
projects and objectives. For example, if a company spent $4,000 on marketing, which produced $2,000 in
profit, the company could state that it’s ROI on marketing spend is 50%.
41. Trial Balance (TB): Trial Balance is a listing of all accounts in the General Ledger with their balance amount
(either debit or credit). The total debits must equal the total credits, hence the balance.
42. Variable Cost (VC): These are costs that change with the volume of sales and are the opposite of Fixed Costs.
Variable costs increase with more sales because they are an expense that is incurred in order to deliver the
sale. For example, if a company produces a product and sells more of that product, they will require more
raw materials in order to meet the increase in demand.
 FA & A, Atul Stanley Hermit

The term ‘Principle’ refers to the fundamental belief or a general truth

which once established does not change.
Principles of Accounting are the guidelines or rules to establish the
standards for sound accounting practices and procedures in reporting
the financial status and periodic performance of a business.
The main characteristics of accounting principles are:
 Accounting principles are man made so they do not have the
authoritativeness as universal principles (like physics, chemistry and
other natural sciences). Accounting principles provide the best possible
guidelines to enhance the utility of accounting information.
 Accounting principles continue to be developed and evolved as these are
influenced by dynamic business practices and customs, government
regulations and requirements, etc. These are hence, not in finished /
final form.
 The general acceptance of an accounting principle is usually based on its
relevance, objectivity and feasibility.
Accounting principles can be classified into two main categories:
 Accounting Concepts, and
 Accounting Conventions.
 FA & A, Atul Stanley Hermit

Accounting Concepts refer to the basic assumptions and

rules which work as the basis for recording of business
transactions and preparing accounts in a uniform and
consistent manner.
Since all the accounting concepts have been developed over
the years based on actual experience, these are universally
accepted rules.
1. Business Entity Concept: For the purpose of accounting of
the financial transactions, a business and its owner should
be treated as two separate & independent entities.
As such, financial transactions of a business are to be kept
separate from those of its owners. This concept thus helps
avoid the recording of any personal financial transactions
of the owner in business's financial statements.
 FA & A, Atul Stanley Hermit

2. Money Measurement Concept: Only business transactions that

can be expressed in terms of money are to be recorded in
accounting. Records of other types of transactions may be
maintained separately.
3. Going Concern Concept: In accounting, a business is expected
to continue for a fairly long time duration and carry out its
commitments and obligations. The business will not be forced
to stop functioning and liquidate its assets in near future.
The financial statements of business are prepared on the
assumption that the business will remain in operation in future
and the revenue and expense (particularly the expense
incurred on fixed assets) recognition may be deferred to a
future period (comprising of a number of years).
4. Accounting Period Concept: Each business chooses a specific
time period to complete a cycle of the accounting process—for
example, monthly, quarterly, or annually—as per a fiscal
(financial) or a calendar year... This enables evaluation of a
business (profit/loss & position of assets & liabilities for a
particular time duration.
 FA & A, Atul Stanley Hermit

5. Accounting Cost Concept: In accounting, the fixed assets of a

business are recorded on the basis of their original (historical)
cost. After the first year, these assets are recorded at cost less
depreciation. No rise or fall in market price is taken into
consideration when reporting their cost. The concept applies
mainly to fixed assets.
6. Matching Concept: As per this concept, for revenue transaction
recorded in a particular accounting period, the transactions for
expenses incurred (to earn the above revenue) should be
recorded to correctly calculate profit or loss in that given
period... The expenses related to revenue should be
recognized in the same accounting period in which the
revenue was recorded/recognized.
7. Revenue Recognition Concept: As per this concept, revenue
should be recorded in the books of accounts only when it has
actually been received or there is a significant claim of the
business to receive it from the other party. An anticipated
income or an income received in advance should not be
recognized.
 FA & A, Atul Stanley Hermit

8. Accrual Concept: This concept implies that the final

accounts should incorporate all the expenses and revenue
that is relevant for the current accounting year, whether
settled in cash or not.
9. Dual Aspect Concept: As per this concept, every monetary
transaction affects a minimum of two accounts/aspects and
the value wise magnitude of this effect on both the
accounts is equal. Hence, for every credit, a corresponding
debit of the exactly the same value is made. The recording
of a transaction is complete only with this dual aspect.
Dual Aspect Concept forms the basis for the double entry
system of accounting.
 FA & A, Atul Stanley Hermit

 Accounting Conventions are guidelines used to help

companies determine how to record certain business
transactions that have not yet been fully addressed by
accounting standards... These procedures and
principles are not legally binding but are generally
accepted by accounting bodies.
 The main difference between accounting concepts and
conventions is that accounting concepts are officially
recorded (as rules), whereas accounting conventions
are not officially recorded and are followed as generally
accepted guidelines.
 FA & A, Atul Stanley Hermit

1. Conservatism: As per the conservatism convention, profit

should never be overestimated, and there should always be a
provision for losses... Also, when two different values of the
same (expected revenue) transaction are available, the lower-
value transaction is to be recorded.
Conservatism convention also states that while revenue is to be
recognized only when there is a reasonable certainty that it will
be realized, expenses are to be recognized sooner, when there
is a reasonable possibility that these will be incurred. This
concept tends to result in more conservative financial
statements.
2. Consistency: The consistency convention prescribes the use of
the same accounting principles from one period of an
accounting cycle to the next, so that the same standards are
applied to calculate profit and loss.
Once a business chooses to use a specific accounting method,
it should continue using it on a go-forward basis. By doing so,
financial statements prepared in multiple periods can be reliably
compared.
 FA & A, Atul Stanley Hermit

3. Materiality: The materiality convention requires the

recording of all of the material facts, in accounting.
Accountants should ensure that all of the important data has
been recorded in totality.
Further, financial transactions should be recorded when not
doing so might result in altering the decisions made by user
of the business's financial statements. This convention
hence advocates the recording of even relatively small-size
transactions, so that the financial statements are able to
represent comprehensive financial results, financial position,
and cash flows of a business.
4. Full disclosure: The full disclosure convention involves the
revelation / disclosure of all information (including the
aspects the disclosure of which is detrimental to the
business) which is of relevance and material value to the
various stakeholder (mainly the creditors and debtors).
 FA & A, Atul Stanley Hermit

An important impact of the Dual Aspect Concept is that the total of the
assets for a business is equal to its total liabilities after every
transaction that is called accounting equation.
The accounting equation is as follows:
Total Liabilities = Total Assets
i.e. Owner’s Capital + External Liabilities = Total Assets

The accounting equation can be used as a yardstick to testify the

accuracy of books of accounts. The balance sheet of a business can be
prepared in a logical manner by adopting the accounting equation.
While using this equation, different accounting transactions can be
grouped into six main segments:
 Expenses
 Losses
 Assets
 Revenue
 Profits
 Liability
 FA & A, Atul Stanley Hermit

 Book Keeping can be defined as the activity or occupation of

keeping records of the financial affairs of a business.
 Bookkeeping is the recording of financial transactions, as an
important part of the process of accounting.
 Hence, Book Keeping can be looked upon as the start of an
accounting process which allows a business / firm to
produce useful accounting information about its sales,
expenses, assets, liabilities and equity.... Examples of
accounts include Sales, Rent Expense, Wages Expense, Cash,
Loans Payable, etc.
 The purpose of bookkeeping is to create a record of financial
transactions that can be summarized for various uses.
Bookkeeping systems range from the most basic, such as the
check register used to record checks and deposits, to the
complex systems of ledgers and journals used by large
corporations.
 FA & A, Atul Stanley Hermit

Difference Book Keeping Accounting

Accounting is concerned with
Book Keeping is concerned
classifying, summarizing,
with identifying, measuring &
Meaning interpreting / analysing and
recording financial
communicating financial
transactions.
transactions.
To measure the financial
To keep complete record of all
performance & situation and
Objective financial transactions in a
communicate the same to the
systematic & proper way.
relevant authorities.
It is difficult for management
Important business decisions
Decision to take decision solely based
are taken by management
Making on the book keeping records &
based on the accounting data.
data.
Financial statement are not Financial statements are
Financial
prepared as part of book prepared under the accounting
Statements
keeping. process.
 FA & A, Atul Stanley Hermit

Difference Book Keeping Accounting

Accounting requires the
Book Keeping does not require
Skill attainment of specific skills and
any specific skill-set or
Required knowledge due to its analytical
professional knowledge.
& complex nature.
Accounting uses the book
Book Keeping process does keeping data to analyse &
Analysis
not require any analysis interpret it into meaningful
information as reports.
There are two types of book
keeping practices – single Accounting is mainly based on
Types
entry book keeping & double- double-entry book-keeping.
entry book keeping.
Book Keepers need to be
Accountant need to acquire
Book accurate in their work &
professional certification and
Keepers & knowledgeable about financial
experience before they take up
Accountants topics. Work of book keepers
their work & practise.
is overseen by accountants.
 FA & A, Atul Stanley Hermit

 Depreciation refers to a reduction in the value of an asset

over time, due its regular usage and more importantly
because of normal wear and tear.
 Depreciation is an accounting method of allocating the cost
of a tangible asset over its useful life and is used to account
for declines in value. Businesses depreciate long-term assets
for both tax and accounting purposes.
 The monetary value of an asset decreases over time due to
use, wear and tear or obsolescence. This decrease is
measured as depreciation. ... Machinery, equipment are
some examples of assets that are likely to depreciate over a
specific period of time.
 In accounting, a proper provision (reserve) has to be made
for depreciation of fixed assets to enable a replacement after
an asset’s useful life is over.
 FA & A, Atul Stanley Hermit

 Three main input points for depreciation calculation:

 Original Cost of Asset
 Useful Life
 Salvage Value
1. Straight Line Depreciation Method: is the simplest method
depreciation method and involves simple allocation of an even
rate of depreciation every year over the useful life of the asset.
Annual Depreciation expense = (Asset cost – Residual Value) /
Useful life of the asset
2. Diminishing Balance Method: involves the calculation of the
depreciation amount for a particular time duration as a
percentage of the residual value of the asset at the beginning of
that time period.
Annual Depreciation expense = Residual Asset Cost at the year
beginning *Fixed Depreciation Percentage