BCA - II SEMESTER (ACCOUNTING AND FINANCIAL MANAGEMENT) Unit I

UNIT - 1 

Meaning and objectives of accounting

Accounting is the process of recording, summarizing, and communicating financial transactions and information to stakeholders such as investors, creditors, and management. The main objectives of accounting are to provide financial information that is useful for decision-making, planning, and control.

More specifically, the objectives of accounting are:

1. Record-keeping: To record and maintain a systematic and accurate record of all financial transactions in a company.

2. Financial reporting: To prepare and present financial statements that accurately reflect the financial position, performance, and cash flows of a business to stakeholders.

3. Analysis and interpretation: To analyze and interpret financial data to assist stakeholders in making informed decisions about the business.

4. Planning and budgeting: To assist in the development of financial plans and budgets that guide the business's future activities.

5. Control: To provide a system of internal controls that helps management to monitor and control the business's financial operations and prevent fraud and error.

6. Compliance: To comply with legal and regulatory requirements such as tax laws, financial reporting standards, and accounting principles.

In summary, accounting plays a vital role in the success of any organization, as it provides financial information that is essential for making informed business decisions and managing financial resources effectively.

Accounting Principles - Concepts And Conventions

Accounting principles, concepts, and conventions are the fundamental guidelines and rules that govern the field of accounting. They help to ensure that financial statements are accurate, reliable, and consistent across different companies and industries.

Here are some of the key accounting principles, concepts, and conventions:

1. Accrual basis: This principle requires that transactions and events are recorded in the accounting records when they occur, regardless of when cash is exchanged. This provides a more accurate representation of the financial performance and position of a business.

2. Going concern: This concept assumes that a business will continue to operate indefinitely, unless there is evidence to the contrary. This concept underpins the preparation of financial statements, as it assumes that the business will continue to operate in the foreseeable future.

3. Materiality: This convention states that financial information should only be disclosed if it is significant enough to influence the decisions of users of the financial statements.

4. Consistency: This concept requires that accounting policies and methods are applied consistently from one period to the next, so that financial statements are comparable over time.

5. Prudence: This convention requires that uncertain items are treated conservatively, by recognizing losses and expenses as soon as possible, but delaying the recognition of gains and revenues until they are certain.

6. Historical cost: This convention requires that assets and liabilities are recorded at their original cost, rather than their current market value.

7. Entity concept: This concept requires that the business is considered as a separate entity from its owners, and that its financial statements reflect only the transactions and events that relate to the business itself.

In summary, accounting principles, concepts, and conventions are essential to the field of accounting, as they provide a consistent framework for recording, reporting, and interpreting financial information.

Branches of Accounting

Accounting is a broad field that encompasses several branches or disciplines. Here are some of the main branches of accounting:

1. Financial Accounting: This branch of accounting is concerned with the preparation of financial statements that summarize a company's financial performance and position for external stakeholders, such as investors, creditors, and regulatory agencies. It involves recording, classifying, and summarizing financial transactions according to accounting principles, concepts, and standards.

2. Management Accounting: This branch of accounting is concerned with providing financial information and analysis to internal stakeholders, such as managers and decision-makers. It involves the preparation of budgets, forecasts, and cost-benefit analyses, as well as the monitoring and control of financial performance.

3. Tax Accounting: This branch of accounting is concerned with the preparation of tax returns and compliance with tax laws and regulations. It involves understanding and applying tax laws and regulations, calculating tax liabilities, and minimizing tax liabilities through tax planning.

4. Auditing: This branch of accounting involves the examination and evaluation of a company's financial statements and internal controls by an independent auditor. It involves the verification of financial information, the detection of fraud and errors, and the provision of an opinion on the reliability of the financial statements.

5. Forensic Accounting: This branch of accounting involves the investigation and analysis of financial information for legal purposes, such as fraud investigation, dispute resolution, and litigation support.

6. Cost Accounting: This branch of accounting involves the identification and measurement of costs associated with producing goods or services. It involves the allocation of costs to products or services, the analysis of cost behavior, and the identification of opportunities for cost reduction.

In summary, the branches of accounting vary in their focus and purpose, but they all share the common goal of providing accurate and useful financial information for decision-making and performance evaluation.

Accounting Cycle

The accounting cycle is a sequence of steps that are followed in the process of recording, processing, and reporting financial transactions and information. The accounting cycle typically includes the following steps:

1. Analyzing and recording transactions: This step involves identifying and analyzing financial transactions and events, and recording them in the appropriate journal or ledger.

2. Posting to the general ledger: This step involves transferring the transaction information from the journal to the general ledger, where accounts are maintained for each type of transaction.

3. Preparing an unadjusted trial balance: This step involves preparing a summary of all the balances in the general ledger accounts to ensure that the total debits and credits are equal.

4. Adjusting entries: This step involves making adjustments to the accounts to reflect any accrued revenues or expenses, prepaid expenses, depreciation, or other adjustments needed at the end of the accounting period.

5. Preparing an adjusted trial balance: This step involves preparing a summary of all the balances in the general ledger accounts after adjusting entries have been made, to ensure that the total debits and credits are still equal.

6. Preparing financial statements: This step involves preparing the income statement, balance sheet, and statement of cash flows, based on the adjusted trial balance.

7. Closing the books: This step involves closing the temporary accounts (revenue, expenses, gains, losses) at the end of the accounting period and transferring their balances to the retained earnings account.

8. Preparing a post-closing trial balance: This step involves preparing a summary of all the balances in the general ledger accounts after the closing entries have been made, to ensure that the total debits and credits are equal.

The accounting cycle is a continuous process that starts over again with the analysis and recording of new transactions in the next accounting period. By following the accounting cycle, businesses can ensure that their financial information is accurate, reliable, and consistent over time.

In Brief ,

step-by-step description of the accounting cycle:

1. Analyzing and recording transactions
2. Posting to the general ledger
3. Preparing an unadjusted trial balance
4. Making adjusting entries
5. Preparing an adjusted trial balance
6. Preparing financial statements
7. Closing temporary accounts and transferring their balances to the retained earnings account
8. Preparing a post-closing trial balance

Accounts are used to record and classify financial transactions in accounting. Here are the main types of accounts:

1. Asset Accounts: These accounts represent economic resources that are owned or controlled by the business, such as cash, accounts receivable, inventory, and property, plant, and equipment.

2. Liability Accounts: These accounts represent obligations or debts owed by the business to external parties, such as accounts payable, loans, and taxes payable.

3. Equity Accounts: These accounts represent the residual interest in the assets of the business after deducting liabilities, such as capital, retained earnings, and dividends.

4. Revenue Accounts: These accounts represent the inflow of economic resources resulting from the sale of goods or services, such as sales revenue and interest revenue.

5. Expense Accounts: These accounts represent the outflow of economic resources incurred in the process of generating revenue, such as salaries and wages, rent, and utilities.

6. Contra Accounts: These accounts are used to offset or reduce the balance of another account, such as the contra asset account for accumulated depreciation, or the contra equity account for treasury stock.

Accounts can also be classified as real accounts or nominal accounts, depending on the nature of the account. Real accounts represent tangible assets, liabilities, or equity, while nominal accounts represent revenue, expenses, gains, and losses.

Basic terms of accounting that are important to understand:

1. Assets: Resources that a company owns or controls, which have economic value and can be used to generate future cash flows.

2. Liabilities: Obligations or debts that a company owes to external parties, which require future payment or settlement of some kind.

3. Equity: The residual interest in the assets of a company after deducting liabilities, representing the owners' or shareholders' claim on the company's assets.

4. Revenue: The inflow of economic resources resulting from the sale of goods or services.

5. Expenses: The outflow of economic resources incurred in the process of generating revenue.

6. Net Income: The amount by which revenue exceeds expenses in a given period, also known as profit.

7. Balance Sheet: A financial statement that reports the company's assets, liabilities, and equity at a specific point in time.

8. Income Statement: A financial statement that reports the company's revenue, expenses, and net income over a specific period of time.

9. Cash Flow Statement: A financial statement that reports the company's cash inflows and outflows over a specific period of time.

10. General Ledger: The central location where all financial transactions are recorded, maintained, and summarized.

Understanding these basic terms is crucial to understanding and interpreting financial information, and is essential for effective financial decision-making.

What is personal, real and nominal account

Personal, Real, and Nominal accounts are three types of accounts in accounting:

1. Personal Accounts: Personal accounts are accounts that represent individuals, organizations, or groups to whom the business owes money or who owe money to the business. Examples of personal accounts include accounts receivable, accounts payable, and capital accounts. Personal accounts are classified as real accounts because they represent tangible economic resources.

2. Real Accounts: Real accounts are accounts that represent tangible assets, liabilities, or equity. Examples of real accounts include cash, property, plant, and equipment, inventory, and accounts payable. Real accounts are classified as real accounts because they represent tangible economic resources.

3. Nominal Accounts: Nominal accounts are accounts that represent revenue, expenses, gains, and losses. Examples of nominal accounts include sales revenue, salaries and wages expense, rent expense, and interest revenue. Nominal accounts are classified as nominal accounts because they represent amounts that are subject to change over time, and they are closed at the end of the accounting period.

Understanding these three types of accounts is important because it helps to ensure that financial information is properly classified and recorded. It also helps in preparing accurate financial statements and making informed business decisions.

The Golden Rule in accounting refers to the fundamental principle of double-entry bookkeeping, which states that every financial transaction has two equal and opposite effects on the accounting equation. The accounting equation states that assets equal liabilities plus equity.

The Golden Rule requires that for every debit entry made to an account, there must be an equal credit entry made to another account. In other words, the total debits must always equal the total credits.

For example, when a company purchases inventory with cash, the Golden Rule requires that the inventory account is debited (increased) for the cost of the inventory, and the cash account is credited (decreased) for the same amount of cash paid. This transaction affects two accounts, and the total debits must equal the total credits.

The Golden Rule is an important principle of accounting because it ensures that all financial transactions are properly recorded and balanced, which is essential for accurate financial reporting and decision-making.

GOLDEN RULE OF PERSONAL ACCOUNT

The Golden Rule of personal accounts is a fundamental principle in accounting that explains how to record transactions related to personal accounts. The rule is as follows:

"For personal accounts, debit the receiver and credit the giver."

This rule implies that when a transaction involves a personal account, such as accounts receivable or accounts payable, the account will either receive money or pay money. If the personal account is receiving money, it will be debited, and if the personal account is paying money, it will be credited.

For example, when a business sells goods to a customer on credit, the accounts receivable account is debited because the customer is receiving the goods and owes the business money. On the other hand, when a business purchases goods from a supplier on credit, the accounts payable account is credited because the business owes money to the supplier.

The Golden Rule of personal accounts is an essential concept in accounting because it helps ensure that transactions related to personal accounts are recorded accurately and consistently. It also facilitates the preparation of financial statements and analysis of financial performance.

GOLDEN RULE OF REAL ACCOUNT

The Golden Rule of real accounts is a fundamental principle in accounting that explains how to record transactions related to real accounts. The rule is as follows:

"For real accounts, debit what comes in and credit what goes out."

This rule implies that when a transaction involves a real account, such as an asset, liability, or equity account, it will either increase or decrease the value of that account. If the account is increasing, it will be debited, and if the account is decreasing, it will be credited.

For example, when a business purchases a new piece of equipment for cash, the equipment account is debited because the asset has come into the business. On the other hand, when a business pays off a loan, the loan account is credited because the liability is going out of the business.

The Golden Rule of real accounts is an essential concept in accounting because it helps ensure that transactions related to real accounts are recorded accurately and consistently. It also facilitates the preparation of financial statements and analysis of financial performance.

GOLDEN RULE OF NOMINAL ACCOUNT

The Golden Rule of nominal accounts is a fundamental principle in accounting that explains how to record transactions related to nominal accounts. The rule is as follows:

"For nominal accounts, debit all expenses and losses, and credit all incomes and gains."

This rule implies that when a transaction involves a nominal account, such as an expense, revenue, or gain/loss account, it will either increase or decrease the value of that account. If the account is an expense or loss account, it will be debited, and if the account is an income or gain account, it will be credited.

For example, when a business pays rent expense, the rent expense account is debited because an expense has been incurred. On the other hand, when a business sells goods and earns sales revenue, the sales revenue account is credited because income has been earned.

The Golden Rule of nominal accounts is an essential concept in accounting because it helps ensure that transactions related to nominal accounts are recorded accurately and consistently. It also facilitates the preparation of financial statements and analysis of financial performance.

BOOK - KEEPING

Bookkeeping is the process of recording and organizing financial transactions of a business in an orderly and systematic manner. It involves identifying, measuring, recording, classifying, summarizing, and interpreting financial information that is relevant to the business.

The main objective of bookkeeping is to maintain accurate and up-to-date records of a company's financial transactions. This information is used to prepare financial statements, including the balance sheet, income statement, and cash flow statement, which provide an overview of the company's financial performance.

Bookkeeping involves various tasks, including:

1. Recording financial transactions: This involves documenting all financial transactions that occur in a business, including sales, purchases, expenses, and payments.

2. Classifying transactions: This involves categorizing financial transactions into different accounts, such as revenue, expenses, assets, and liabilities, to help organize and analyze financial information.

3. Posting transactions: This involves entering financial transactions into the general ledger, which is a central repository of all the financial transactions of a business.

4. Reconciling accounts: This involves comparing financial records to ensure that the information is accurate and complete, and identifying any discrepancies that need to be corrected.

5. Generating financial reports: This involves preparing financial statements and other reports to provide an overview of the financial performance of the business.

Overall, bookkeeping is an essential part of accounting and is important for ensuring that a business maintains accurate financial records and meets its financial reporting obligations.

SOURCE DOCUMENTS

Source documents are the original records of a transaction that provide evidence of the transaction's occurrence. They are used as a basis for recording financial transactions in a company's accounting system. Source documents can be in various forms, such as paper documents, electronic records, or even verbal communications.

Examples of source documents include:

1. Invoices: These are bills that are issued by a vendor to a customer for goods or services provided. Invoices provide information on the amount due, the date of the transaction, and the terms of payment.

2. Receipts: These are documents that provide proof of payment, such as a cash register receipt, a credit card receipt, or a bank deposit slip.

3. Purchase orders: These are documents that are used to request goods or services from a supplier. Purchase orders typically include the quantity, description, price, and delivery date of the requested items.

4. Checks: These are documents that are used to transfer money from one account to another. Checks typically include information on the payee, the amount of the transaction, and the date of the transaction.

5. Contracts: These are legal agreements between two parties that outline the terms of a transaction or relationship. Contracts may include information on the scope of work, the payment terms, and the duration of the agreement.

Source documents are important because they provide evidence of the occurrence of a transaction and help ensure that financial transactions are accurately recorded in a company's accounting system. By keeping accurate and complete records of source documents, a business can help ensure that its financial records are reliable and provide an accurate representation of its financial performance.

USERS OF ACCOUNTING

Accounting is used by a wide range of stakeholders in business, including:

1. Business owners: Accounting is used by business owners to monitor the financial health of their business, make informed decisions, and plan for the future.

2. Investors: Investors use accounting information to evaluate a company's financial performance and determine whether to invest in the company.

3. Lenders: Lenders use accounting information to evaluate the creditworthiness of a company and determine whether to lend money to the company.

4. Managers: Managers use accounting information to make operational and strategic decisions, monitor performance, and evaluate the effectiveness of their strategies.

5. Regulators: Regulators use accounting information to ensure that companies comply with relevant laws and regulations, such as tax laws and financial reporting requirements.

6. Employees: Employees use accounting information to monitor their own performance, evaluate the financial health of the company they work for, and make decisions related to their own financial well-being.

Overall, accounting is a fundamental aspect of business that is used by a diverse range of stakeholders to monitor financial performance, make informed decisions, and plan for the future.

ACCOUNTING STANDARDS

Accounting standards are a set of guidelines and rules that are established by accounting bodies or government agencies to ensure consistency and transparency in financial reporting. These standards provide a common language and framework for financial reporting and help ensure that financial statements are reliable, accurate, and comparable across different companies and industries.

The most widely used accounting standards are the International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles (GAAP). These standards cover a wide range of topics, including:

1. Financial statement presentation: This includes guidelines on how financial statements should be structured and presented, such as the format of the balance sheet, income statement, and cash flow statement.

2. Revenue recognition: This includes guidelines on how companies should recognize revenue, such as when it should be recognized and how it should be measured.

3. Inventory valuation: This includes guidelines on how companies should value inventory, such as the cost of goods sold and the inventory holding costs.

4. Leases: This includes guidelines on how companies should account for leases, such as how to classify leases as operating or finance leases.

5. Financial instruments: This includes guidelines on how companies should account for financial instruments, such as debt securities and equity investments.

6. Consolidation: This includes guidelines on how companies should consolidate the financial statements of subsidiaries, joint ventures, and other entities that they control.

By following accounting standards, companies can ensure that their financial statements are accurate, reliable, and comparable to those of other companies. This helps investors, lenders, and other stakeholders make informed decisions based on a company's financial performance.

In India, the Institute of Chartered Accountants of India (ICAI) is the governing body that sets accounting standards. The ICAI issues Accounting Standards (AS) that are based on the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). The ICAI has also issued Ind AS, which are converged with IFRS.

The Ministry of Corporate Affairs (MCA) in India has made it mandatory for certain companies to comply with the Indian Accounting Standards (Ind AS), which are based on IFRS. Ind AS is applicable to certain companies based on their size, turnover, and nature of business. For example, listed companies and certain other companies with a net worth exceeding a prescribed threshold are required to comply with Ind AS.

The Securities and Exchange Board of India (SEBI) also requires listed companies to comply with certain disclosure requirements related to financial reporting. SEBI guidelines aim to improve transparency and comparability in financial statements of listed companies.

In addition to the ICAI, the Ministry of Corporate Affairs, and SEBI, other regulatory bodies in India also have a role in setting accounting standards. For example, the Reserve Bank of India (RBI) sets accounting standards for banks and financial institutions.

Overall, the accounting standards in India are evolving to be more in line with international standards, with a focus on transparency, comparability, and accuracy in financial reporting.

International Accounting Standards

IAS stands for International Accounting Standards, which are a set of accounting standards developed and issued by the International Accounting Standards Board (IASB). The IAS were first introduced in 1973 and were designed to provide a framework for international financial reporting that would be consistent, transparent, and comparable across different countries and industries.

The IAS were subsequently replaced by International Financial Reporting Standards (IFRS) in 2001, which are now the globally accepted accounting standards for financial reporting. However, some of the older IAS are still in use in certain jurisdictions, and the IASB continues to issue new accounting standards and updates to existing standards.

The IASB is an independent, private sector organization that develops and promotes the use of international financial reporting standards. The IASB works with national standard-setters and other organizations to develop and maintain high-quality accounting standards that are used by companies and organizations around the world.

The adoption of IFRS by companies and organizations around the world has helped to increase transparency and comparability in financial reporting, making it easier for investors, analysts, and other stakeholders to evaluate companies' financial performance and make informed decisions. 

Capital and Revenue Items

One of the major aspects of preparing a correct financial statement is to distinguish revenue and capital in regard to revenue income, revenue expenditure, revenue payments, revenue profits, and revenue losses of the company with capital income, capital receipts, capital profit, or capital losses.

In fact, without differentiating, we cannot think of correctness of a financial statement. Ultimately, it will mislead the end results where no one can conclude anything. As per this principle, a revenue item should be recorded in the Trading and Profit & Loss account and a capital item should be recorded in the Balance-Sheet of respective firm.

Capital Expenditure

Capital expenditure is the expenditure incurred to acquire fixed assets, capital leases, office equipment, computer equipment, software development, purchase of tangible and intangible assets, and such kind of any value addition in business with the purpose to enhance the income. However, to decide nature of the capital expenditure, we need to pay attention on −

• The expenditure, which benefit cannot be consumed or utilized in the same accounting period, should be treated as capital expenditure.

• Expenditure incurred to acquire Fixed Assets for the company.

• Expenditure incurred to acquire fixed assets, erection and installation charges, transportation of assets charges, and travelling expenses directly relates to the purchase fixed assets, are covered under capital expenditure.

• Capital addition to any fixed assets, which increases the life or efficiency of those assets for example, an addition to building.

Revenue Expenditure

Revenue expenditure is the expenditure incurred on the fixed assets for the ‘maintenance’ instead of increasing the earning capacity of the assets. Examples of some of the important revenue expenditures are as follows −

• Wages/Salary

• Freight inward & outward

• Administrative Expenditure

• Selling and distribution Expenditure

• Assets purchased for resale purpose

• Repairs and renewal expenditure which are necessary to keep Fixed Assets in good running and efficient conditions

Revenue Expenditure Treated as Capital Expenditure

Following are the list of important revenue expenditures, but under certain circumstances, they are treated as a capital expenditure −

• Raw Material and Consumables − If those are used in making any fixed assets.

• Cartage and Freight − If those are incurred to bring Fixed Assets.

• Repairs & Renewals − If incurred to enhance life of the assets or efficiency of the assets.

• Preliminary Expenditures − Expenditure incurred during the formation of a business should be treated as capital expenditure.

• Interest on Capital − If paid for the construction work before the commencement of production or business.

• Development Expenditure − In some businesses, long period of development and heavy amount of investment are required before starting the production especially in a Tea or Rubber plantation. Usually, these expenditure should be treated as the capital expenditure.

• Wages − If paid to build up assets or for the erection and installation of Plant and Machinery.

Deferred Revenue Expenditure

Some non-recurring and special nature of expenditure for which heavy amount incurred and benefit for the same will spread in up-coming years, to be treated as capital expenditure and will be shown as the assets of the firm. Part of the expenditure should be debited to Profit & Loss account every year. For example, if heavy amount paid for the advertisement of a product, which benefits are expected to be received in next four years, then it should be debited as ¼ of the part in Profit & Loss account as the revenue expenses and balance ¾ will be shown as the assets in the Balance-Sheet.

Capital and Revenue Profit

The premium received on issue of shares, and the profit on sale of fixed assets are the major examples of capital profit and should not be treated as revenue profit. Capital profit should be transferred to the capital reserve account, which is used to set off capital losses in future if any.

Capital and Revenue Receipts

Sale of fixed assets, capital employed or invested, and loans are the example of capital receipts. On the other hand, sale of stock, commission received, and interest on investment received are the main examples of revenue receipts. Revenue receipts will be credited to the profit and loss account and on the other hand, capital receipts will affect the Balance-sheet.

Capital and Revenue Losses

Discount on issue of shares and losses on sale of fixed assets are the capital loss and would be set off against the capital profits only. Revenue losses on normal business activity are part of the profit and loss account.