Fundamentals of

Accounting
Dr Aruna Polisetty
Senior Assistant Professor
SCMS, Nagpur
Sources of the course contents
The following books are duly referred for the compilation of power-point presentation and discussion of case lets:
1. Introduction to Accounting concepts and accounting
principles
2. Accounting Mechanics
3. Depreciation
4. Inventory
5. Preparation of Financial Statements
6. Introduction to Financial Statement Analysis
7. Corporate Accounting
8. Contemporary Issues in Financial Accounting
Introduction
The history of accounting has been around almost as long as money itself. Accounting
history dates back to ancient civilizations in Mesopotamia, Egypt, and Babylon. For
example, during the Roman Empire, the government had detailed records of its
finances.

Luca Pacioli is considered "The Father of Accounting and Bookkeeping" due to his contributions
to the development of accounting as a profession. An Italian mathematician published a book on
the double-entry system of bookkeeping in 1494
By 1880, the modern profession of accounting
was fully formed and recognized by the 
Institute of Chartered Accountants in England
and Wales
.
Meaning and nature of business
transactions

Business is defined as an organized economic activity, wherein the

exchange of goods and services takes place, for adequate consideration.
It is nothing but a method of making money from commercial
transactions. It includes all those activities whose sole aim is to make
available the desired goods and services to society, in an effective
manner.
 The elements of financial statements
What are the Elements of Financial Statements?

The elements of financial statements are the general groupings of line items contained within the statements. These groupings will
vary depending on the structure of the business. Thus, the elements of the financial statements of a for-profit business vary
somewhat from those incorporated into a nonprofit business (which has no equity accounts)

Examples of the Elements of Financial Statements

Assets. These are items of economic benefit that are expected to yield benefits in future periods. Examples are accounts receivable,
inventory, and fixed assets.

Liabilities. These are legally binding obligations payable to another entity or individual. Examples are accounts payable, taxes
payable, and wages payable.

Equity. This is the amount invested in a business by its owners, plus any remaining retained earnings.

Revenue. This is an increase in assets or decreases in liabilities caused by the provision of services or products to customers. It is a
quantification of the gross activity generated by a business. Examples are product sales and service sales.

Expenses. This is the reduction in value of an asset as it is used to generate revenue. Examples are interest expense, compensation
expense, and utilities expense
Objectives of Financial Accounting

Financial accounting needs to fulfil the following objectives:

Providing accounting-related information to all the concerned parties: When we talk
about a large business or organisation, it is not just the owner who is concerned with the
financial position of their entity. There are several other concerned parties like
shareholders, investors, managers, tax officers, auditors, etc., who are concerned with the
company’s finances.
To ascertain profitability: A business can either make a profit or a loss in its operations.
To measure which way the company is going, we need financial accounting.
Keeping systematic records: For the smooth running of any company, it is essential to
maintain a systematic financial record and keep stakeholders abreast of the financial
situation all the time. 
Ascertaining the financial position: To know how much the business owes to other
parties or how much is owed to it, proper financial records need to be maintained. 
Facilitate Rational Decision making
The nature of financial accounting is outlined as follows:
Identifying monetary transactions – First, the transaction has to take place and be identified so
that it can be accounted for. To identify financial transactions, store and check the receipts and
bills of every transaction is a must. Sometimes, the exchange of money is not directly involved,
but it still needs to be identified. This involves depreciation in the value of goods over time,
which forms an important aspect of financial accounting.
Measuring and recording transactions –  The value of transactions has to be measured in terms
of money and those concerned with revenues and expenditures need to be recorded. The
recording is done in journals.
Classifying payments – The huge data needs to be classified in a record known as a ledger. For
example, all salary-related expenses can be classified under one column. Leasing related data can
be classified in another column and so on.
Summarisation –  The larger the corporation, the more complicated the record. Hence, the record
needs to be summarised in a form where it can be easily comprehended.
Analysing, interpretation, and communication: The summarised data needs to be analysed wel
and interpreted so that it can be communicated to the concerned stakeholders so that they have the
full knowledge of the company’s financial position.
 Scope of Accounting
 Reporting the account statement to various stakeholders highlights the scope of accounting. Various parties in
various forms use this information for their benefit and the benefit of the company.
 Financial accounting keeps the company’s various stakeholders updated about its financial health. It should help
each stakeholder make decisions regarding the company’s business. For example, it allows shareholders to
understand the profit-making subsidiaries of the business. To indirect and direct investors, it gives them an idea
of whether the company is worth investing in or not. Employees need to stay updated about it too, so they know
whether the company they are working in is in good financial health or not.
 Reporting to shareholders: Shareholders are entities who invest their money in the business seeking profit from
their investment. Since they have invested their own money in the business, they need to be reported on the
overall financial position of the company involving the number of outstanding loans, assets, expenses, revenue
streams, and so on.
 Reporting to the Public: The companies listed on the stock exchange are the ones in which the general public
can also invest. Since the public also becomes an investor, account statements have to be made public so that
they are fully aware of their investment choices.
 Reporting to Government: It is necessary for tax purposes. Governments need to be aware of the financial
position of the businesses which come under their jurisdiction. 
 Reporting to employees: Employees are indirect stakeholders and they must know about the company’s
financials which helps them stay informed regarding their job security.
 Accounting as an information system (AIS)
 It integrates both insiders & outsiders.
 It integrates with other important functions like marketing, personnel, and production ….
 QUALITATIVE CHARACTERISTICS OF AIS

 Reliability – Accurate and free from bias, faithful representation, completeness

 Relevance – Should be relevant if it influences the decision making
 Understandability
 Comparability: being able to compare either over a period of time or between two or more entities.
 Accounting Principles
Accounting concepts

 Accounting principles are the rules and guidelines that companies and other bodies must follow when reporting financial
data. These rules make it easier to examine financial data by standardizing the terms and methods that accountants must
use. Principles are categorized into Accounting Concepts & Conventions.
 Accounting Concepts: Basic assumptions and conditions
 Separate entity concept (if he invests it’s a liability, withdraws it’s a drawing)
 Going Concern concept (business continues fairly for a long period of time)
 Money measurement concept (records only monetary transactions)
 Cost concept ( Cost becomes the basis: the assets are recorded at a cost irrespective of market value)
 Dual aspect concept (every business transaction has a dual effect)
 Accounting period concept (Financial year, Calendar year)
 Matching concept (based on the accounting period, expenses should match with revenues)
 Realisation concept (revenue is recognised when the sale is made)
 The accrual concept is based on when revenue and expenses are incurred, while the revenue recognition
concept is based on when revenue is earned. The accrual concept is used to prepare financial statements,
while the revenue recognition concept is used to determine when revenue should be recorded.
 Accounting Conventions
 Conservatism: Playing it safe is both an accounting principle and convention. It tells accountants to err on the
side of caution when providing estimates for assets and liabilities. That means that when two values of a
transaction are available, the lower one should be favored. The general concept is to factor in the worst-case
scenario of a firm’s financial future.
 Consistency: A company should apply the same accounting principles across different accounting cycles. Once
it chooses a method it is urged to stick with it in the future, unless it has a good reason to do otherwise. Without
this convention, investors' ability to compare and assess how the company performs from one period to the next
is made much more challenging.
 Full disclosure: Information considered potentially important and relevant must be revealed, regardless of
whether it is detrimental to the company.
 Materiality: Like full disclosure, this convention urges companies to lay all their cards on the table. If an item
or event is material, in other words important, it should be disclosed. The idea here is that any information that
could influence the decision of a person looking at the financial statement must be included.
 Accounting standards
 The international accounting standards committee (IASC) came
into existence on 29th June 1973.
 [16 accounting bodies from 9 nations {founder members} signed
the agreement for its formation]
 The standards bring uniformity in the approach and presentation of
results.
 Between 1973 and 2000, the IASC issued several accounting
standards known as (IASs)
 Now International accounting standard board (IASB) has taken
over IASC. 15 full-time members responsible for the development
of IFRS.
The objectives of the IASB Foundation are:
 To develop, in the public interest, a single set of high-quality, understandable, enforceable
and globally accepted financial reporting standards based upon clearly articulated
principles. These standards should require high-quality, transparent and comparable
information in financial statements and other financial reporting to help investors, other
participants in the world’s capital markets and other users of financial information make
economic decisions
  to promote the use and rigorous application of those standards
  in fulfilling the above objectives, take into account, as appropriate, the needs of a range of
sizes and types of entities in diverse economic settings
  to promote and facilitate the adoption of International Financial Reporting Standards
(IFRSs), being the standards and interpretations issued by the IASB, through the
convergence of national accounting standards and IFRSs.
 Meaning & Objectives of IFRS
 IFRS is a set of international accounting standards developed by the IASB,
providing the mode of reporting particular types of transactions and events
in financial statements.

 They include standards and interpretations issued by the IASB and its
predecessor body international accounting standards committee (IASC)
 They comprise
 IFRS
 IAS
 Interpretations developed by the international financial reporting
interpretations committee (IFRIC) or the former standing interpretations
committee (SIC)
 Objectives of IFRS:
A common global language for business affairs
Progressively replacing the different national accounting standards.

Assumptions of IFRS

Accrual basis
Going concern concept

 IFRS is globally accepted

 Over 110 countries used (in US and UK mostly they use GAAP)
 In India, we follow GAAP accounting standards as prescribed by Institute of charted
accountants of India (ICAI)
 Qualitative characteristics
 Understandability; relevance; reliability; comparability
 There are 41 International accounting standards are there, out of
which 12 have been withdrawn, and 29 are in operations. 15 IFRS
standards are there
 DISCLOSURE OF ACCOUNTING POLICIES (The main feature of the standard AS 1 announced ASB,
regarding disclosure of accounting policies are as follows:
 Fundamental accounting assumptions: Going concern: consistency: Accrual
 Accounting Policies:
 Methods of Dep. Depletion and amortisation
 Treatment of expenditure during the construction
 valuation of investments, treatment of retirement benefits; valuation of fixed assets; treatment of
liabilities; recognition of profit of long-term contracts; treatment of goodwill
Accounting Process
Journal (or General Journal)
 The journal, also known as the general journal, is involved in the first phase of accounting because all
transactions are recorded in it, originally in chronological order.
 This is why the general ledger is also called the original book of entries, chronological book, or daybook.
In the journal, two aspects of every transaction are recorded, following the double-entry system of
accounting.
Journal Entry: Definition
 Recording a transaction in the books of accounts is known as making an entry. When a transaction is
recorded in the journal, it is known as a journal entry.
Journalizing: Definition
 Journalizing is the second step in the accounting cycle. The first step is transaction analysis, which
provides the information needed to journalize a transaction. The process of recording in the journal is
called journalizing.
1 . Date
The year, month, and date of the transaction are written in the date column. The year is entered immediately
below the heading. It is written once per page (i.e., it does not have to be repeated for every entry on the page).
2. Description
The description column is used to enter the names of the accounts involved in the transaction. The debit part of
the entry is written first and the credit part is written below the debit part.
It is common to leave some space at the left-hand margin before writing the credit part of the journal entry.
A brief description known as narration is also written in this column below the credit part of the entry.
3. Posting Reference (PR) Ledger Folio (LF)
All journal entries are periodically posted to the ledger accounts. In the posting reference column, the page
number of the ledger account to which the entry belongs is written.
For example, if the cash account is on page number 101 in the ledger, the number 101 should be written in the
posting reference Ledger folio column where the cash account appears in general journal.
4. Debit
This column is used to record the amounts of the accounts being debited.
5. Credit
This column is used to record the amounts of the accounts being credited.
PREPARATION OF JOURNAL
 Subsidiary Books – A Register for Similar Nature Transactions

 In big organizations numerous transactions are going on, and in the midst of these transactions, it is not possible to keep and maintain a record of each
and every business affair. While non-recording any minute transaction can be a havoc which the business will never resort to. This is when the
subsidiary books come into action and play as a saviour. Subsidiary books are nothing but an order of maintenance of recording similar-natured
transactions. Subsidiary books are the subdivisions of Journal. In this content, we will know in detail about these books and types of subsidiary books
with its function.
 Subsidiary Books are the books that record transactions which are similar in nature in an orderly manner. They are also known as special journals or
Daybooks. In big business institutions, recording all the transactions in one journal and posting them into various accounts is difficult. So, the journal is
subdivided into many subsidiary books for the easy and accurate recording of all the transactions. For every type of transaction, there is a separate book.
 Types of Subsidiary Books
 There are basically 8 types of subsidiary books that are used for recording different types of transactions

Cash Book
Purchase Book
Sales Book
Purchase Return Book
Sales Return Book
Bills Receivable Book
Bills Payable Books
Journal Proper
Cash Book
The first and most important subsidiary book is the cash book. It records all the transactions related to cash and bank
receipts and payments. There are 3 types of cash books that are maintained by an organization. They are:
Single Column Cash Book: A single column cash book is like a ledger account. It contains a debit side and a credit
side. All Cash receipts are recorded on the debit side, and all the cash payments are recorded on the credit side of the
cash book.
A trial balance is a financial report showing the closing balances of all accounts in the general ledger at
a point in time. Creating a trial balance is the first step in closing the books at the end of an accounting
period.
The four types of errors in preparation for trial balance, i.e., (i) Errors
of Omission, (ii) Errors of Commission, (iii) Errors of Principle, and 
(iv) Compensating Errors.
 I. Errors of Omission:
 Errors of omission may be caused when recording the transactions in the books of
original entry or when posting to the ledger. Errors of omission arise when a business
transaction is completely or partially omitted to be recorded in the books of accounts.
(i) Complete Omission: Complete omission means the transaction which is completely
omitted to be recorded in the books of original entry and thus cannot be posted in a ledger
or though recorded in the journal/journal proper but omitted to be posted in the ledger
completely. These errors do not affect the agreement of trial balance.
(ii) Partial Omission: Errors of partial omission mean errors of omission other than the
errors of complete omission. In other words, when a transaction is partly recorded in ‘he
books of accounts, it is known as an error of partial omission. These errors hamper the
agreement of trial balance.
 II. Errors of Commission:
Errors of commission mean and include errors caused due to wrong recording of transactions, wrong
casting of the subsidiary books, wrong totaling or balancing of the accounts, wrong posting and wrong
carry forward. These errors may or may not hamper the agreement of trial balance.

 (i) Error of Recording: Error of recording arises when a transaction is recorded in the books
of original entry incorrectly. These errors do not hamper the agreement of trial balance.
 (ii) Error of Casting of Subsidiary Books: Error of casting arises due to wrong totalling of
some subsidiary books, including cash book. These errors hamper the agreement of the trial
balance.
 (iii) Error of Totalling or Balancing of Accounts: Error of balancing arises due to wrong
balancing of some ledger accounts. These errors hamper the agreement of trial balance
 (iv) Error of Posting: Error of posting arises when a transaction is correctly recorded in the
books of original entry including journal but posted wrongly in ledger accounts. These
errors may or may not hamper the agreement of trial balance.
 III. Errors of Principle:
Errors of principle mean and include, errors caused due to violation of generally accepted accounting
principles viz. incorrect allocation between capital and revenue items. It is worth mentioning that proper
allocation between these two items is very important in the sense that improper allocation would lead to wrong
and misleading results through financial statements. These errors would lead to understatement/overstatement
of assets or expenses or liabilities or incomes. These errors do not disturb the agreement of trial balance.

(i) Treating capital items as revenue items and

(ii) Treating revenue items as capital items.

(i) Treating Capital Items as Revenue: In this case, capital items are wrongly treated as
revenue items. These errors do not hamper the agreement of trial balance.
Example 1:Purchase of machinery worth Rs. 23,000 debited to wages.
Example 2:Receipts of Rs. 1, 00,000 on account of a specific fund credited as income of the
business.
(ii) Treating Revenue Items as Capital:In this case, revenue items are wrongly treated as
capital items. These errors do not hamper the agreement of trial balance.
Example 1:Paid Rs. 200 for repair of old machinery but debited to machinery.
 IV. Compensating Errors:
 When two or more errors are committed in such a way that the effect of one error is
compensated by the effect of other, it is known as compensating errors. It is worth
mentioning that the net impact of these errors on the debits and credits of an
account is nil. These errors do not disturb the agreement of trial balance.
 Example 1:
 A sum of Rs. 1,000 was paid to Rohit on 1.1.2011 but was posted in Rohit’s
Account as Rs. 100. Similarly, a sum of Rs. 100 paid to Rohit on 31.3.2011 was
posted in Rohit’s Account as Rs. 1,000. In this case, it can be observed that error of
1.1.2011 was compensated by the error of 31.3.2011.
 Cash Accounting, Accrual Accounting, and Hybrid
Accounting methodologies
 'Cash Accounting' is a very simple method of accounting where sales or payment receipts are recorded in the
period the money is received, and expenses are recorded in the period they are paid.
Hybrid Accounting
 The third methodology is known as 'Hybrid Accounting', and some businesses may decide it is the best one for
their business. It is a blend of Cash Accounting and Accrual Accounting.
Special Rules that must be followed, if the hybrid model is used:
 If you report income using the cash method, you must also report expenses using the cash method;
 If you report income using the accrual method, you must also report expenses using the accrual method;
 If you have inventory, you must use accrual accounting to record sales and purchases.