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Financial Accounting

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Financial Accounting (Mgt-101)
VU
Lesson-4
Learning Objective
The objective of this lecture is to develop an understanding in the students about the basic concepts
like:
o  The separate business entity,
o Single and double entry book-keeping,
o  Debit and Credit
o  The dual aspect of a transaction,
o  Accounting equation
Separate Entity Concept
In accounting, `The Business' is treated independently from the persons who own it.
This means, although anything owned by the business belongs to the owners of the business and
anything owed by the business is payable by the owners but for accounting purposes, we assume
that the business is independent from its owners.
This means, if the business purchases a machine or piece of equipment, business will own and
obtain benefit from that equipment. Likewise, if the business borrows money from `someone' it will
have to repay the money. This `someone' includes even the owner of the business.
This treatment of the business independently from its owners is called the `Separate Entity
Concept'. We will discuss this concept again in detail when we study the different types of business
entities.
Single Entry Book-Keeping
This is the conventional style of keeping records
In single entry book keeping system, as it is clear from the name, only one aspect of the
transaction is recorded.
This actually is not a system but is a procedure by which small business concerns, like retailers and
small shopkeepers, keep record of their sale / income.
In this system, there are usually two to three registers "Khata". In one register cash received from
customers is recorded, whereas the other one is a person-wise record of goods sold on credit "Udhar
Khata". There may or may not be a register of suppliers to whom money is payable.
That means, only one aspect of transaction i.e. either cash receipt or the fact that money is
receivable from someone is recorded.
Double Entry Book-Keeping
The concept of double entry is based on the fact that every transaction has two aspects i.e. receiving
a benefit and giving a benefit.
The accounting system that records both the aspects of transaction in books of accounts is called
double entry system.
The account that receives the benefit is debited and the account that provides the benefit is credited.
`Debit' and `Credit' are denoted by `Dr' and `Cr' respectively.
The ultimate result of the system is that for every Debit (Dr) there is an equal Credit (Cr).
Single & Double Entry Book-Keeping Distinguished
The double entry system is a more sophisticated, comprehensive and reliable form of single entry
book keeping system.
Single entry system records only one aspect of the transaction such as:
o  Cash received from sale is recorded in cash register only,
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Financial Accounting (Mgt-101)
VU
Goods sold on credit are recorded in the individual's account only,
o
When cash is received from the customer, to whom something was sold on credit, the
o
receipt may just be recorded in the account of individual only.
o
Double entry system records both the aspects of the transaction;
o  When good are sold on cash the two aspects of the transaction are ­ the seller has sold
goods and received cash against them. The goods sold are benefit transferred to the
purchaser (Credit) whereas the cash against the goods is benefit received (Debit).
o  When the goods are sold on credit the benefit given is the same i.e. goods sold but the
benefit received is not cash but a right to receive cash from the customer. Therefore, in this
case Debit is given to customer's account instead of cash.
o  When cash is received from the customer the right to receive cash ceases. So, the benefit
received is cash and benefit transferred is the right to receive cash. Here cash will be debited
and customer will be credited.
Adopting the double entry accounting system can, therefore, have following benefits:
o  Every transaction has equal Debit and Credit; hence the total of all Debit accounts will be
equal to the total of all Credit accounts at any given time. This serves as a quick test of
mathematical accuracy of book keeping.
o  Since all aspects of transactions are recorded, therefore, the books are more informative. In
the example discussed, the trader, if he keeps double entry books, will know the exact figure
of total sale, cash in hand and receivable from customers from their respective accounts at
any desired time.
Debit and Credit
We have used two terms in our above discussion Debit and Credit. What do these terms mean?
Debit and Credit are two Latin words and as such it is difficult to say what do these mean.
But we can develop an understanding as to what does these terms stand for.
DEBIT
 It signifies the receiving of benefit. In simple words it is the left hand side.
CREDIT
 It signifies the providing of a benefit. In simple words it is the right hand side.
Debit and Credit will be explained in details and with examples in our future discussions.
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Financial Accounting (Mgt-101)
VU
Dual Aspect of Transactions
We have just said that for every debit there is an equal credit.
This is also called the dual aspect of the transaction i.e. every transaction has two aspects, debit and
credit and they are always equal.
This means that every transaction should have two-sided effect.
For example Mr. A starts his business and he initially invests Rupees 100,000/- in cash for his
business. Out of this cash following items are purchased in cash;
o  A building for Rupees 50,000/-;
o  Furniture for Rupees 10,000/-; and
o  A vehicle for Rupees 15,000/-
This means that he has spent a total of Rupees 75,000/- and is left with Rupees 25,000 cash. We will
apply the Dual Aspect Concept on these events from the viewpoint of business.
When Mr. A invested Rupees 100,000/-, the cash account benefited from him. The event will be
recorded in the books of business as,
DEBIT
Cash
Rs.100, 000
CREDIT
Mr. A
Rs.100, 000
Analyse the transaction. The account that received the benefit, in this case is the cash account, and
the account that provided the benefit is that of Mr. A.
Building purchased ­ The building account benefited from cash account
DEBIT
Building
Rs.50, 000
CREDIT
Cash
Rs.50, 000
Furniture purchased ­ The furniture account benefited from cash account
DEBIT
Furniture
Rs.10, 000
CREDIT
Cash
Rs.10, 000
Vehicle purchased ­ The vehicle account benefited from cash account
DEBIT
Vehicle
Rs.15, 000
CREDIT
Cash
Rs.15, 000
Basic Principle of Double Entry
We can devise the basic principle of double entry book-keeping from our discussion to this point.
"Every Debit has a Credit" which means that "All Debits are always equal to All Credits".
Assets
Assets are the properties and possessions of the business.
Properties and possessions can be of two types, one that have physical existence (called
tangible) and the other that have no physical existence (called intangible).
o  Tangible Assets ­ Furniture, Vehicle etc.
o  Intangible Assets ­ Right to receive money, Good will etc.
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Financial Accounting (Mgt-101)
VU
Accounting Equation
From the example that we just discussed, if the debits and credits are added up, the situation will be
as follows:
DEBITS
Cash
Rs.100, 000/-
Building
50,000/-
Furniture
10,000/-
Vehicle
15,000/-
CREDITS
Mr. A
Rs.100, 000/-
Cash
75,000/-
The total Equation becomes:
DEBITS
=
CREDITS
Cash  + Building + Furniture + Vehicle
=
Cash + Mr. A
100000 + 50000  + 10000
+ 15000
=
75000 + 75000
Cash on Left Hand Side is Rupees 100,000/- and on Right Hand Side it is Rs.75, 000/-. If it is
gathered on the Left Hand Side it will give a positive figure of Rupees 25,000/- (which you will
notice is our balance of cash in hand). Now the equation becomes:
DEBITS
=
CREDITS
Cash
+ Building
+ Furniture+ Vehicle
=
Mr. A
25,000+ 50,000 + 10,000  + 15,000
=
100,000
Keeping the entity concept in mind we can see that the business owns the building, furniture,
vehicle and cash and will obtain benefit from these things in future. Any thing that provides benefit
to the business in future is called `Asset'.
Similarly the business had obtained the money from Mr. A and this money will have to be returned
in form of either cash or benefits. Any thing for which the business has to repay in any form is
called `Liability'.
So cash, building, furniture and vehicle are the assets of the business and the amount received from
Mr. A for which the business will have to provide a return or benefit is the liability of the business.
Therefore, our equation becomes:
Assets
=
Liabilities
The liabilities of the business can be classified into two major classes i.e. the amounts payable to
`outsiders' and those payable to the `owners'. The liability of the business towards its owners is
called `Capital' and amount payable to outsiders is called liability. Therefore, our accounting
equation finally becomes:
Assets
=
Capital
+
Liabilities
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Table of Contents:
  1. Introduction to Financial Accounting
  2. Basic Concepts of Business: capital, profit, budget
  3. Cash Accounting and Accrual Accounting
  4. Business entity, Single and double entry book-keeping, Debit and Credit
  5. Rules of Debit and Credit for Assets, Liabilities, Income and Expenses
  6. flow of transactions, books of accounts, General Ledger balance
  7. Cash book and bank book, Accounting Period, Trial Balance and its limitations
  8. Profit & Loss account from trial balance, Receipt & Payment, Income & Expenditure and Profit & Loss account
  9. Assets and Liabilities, Balance Sheet from trial balance
  10. Sample Transactions of a Company
  11. Sample Accounts of a Company
  12. THE ACCOUNTING EQUATION
  13. types of vouchers, Carrying forward the balance of an account
  14. ILLUSTRATIONS: Ccarrying Forward of Balances
  15. Opening Stock, Closing Stock
  16. COST OF GOODS SOLD STATEMENT
  17. DEPRECIATION
  18. GROUPINGS OF FIXED ASSETS
  19. CAPITAL WORK IN PROGRESS 1
  20. CAPITAL WORK IN PROGRESS 2
  21. REVALUATION OF FIXED ASSETS
  22. Banking transactions, Bank reconciliation statements
  23. RECAP
  24. Accounting Examples with Solutions
  25. RECORDING OF PROVISION FOR BAD DEBTS
  26. SUBSIDIARY BOOKS
  27. A PERSON IS BOTH DEBTOR AND CREDITOR
  28. RECTIFICATION OF ERROR
  29. STANDARD FORMAT OF PROFIT & LOSS ACCOUNT
  30. STANDARD FORMAT OF BALANCE SHEET
  31. DIFFERENT BUSINESS ENTITIES: Commercial, Non-commercial organizations
  32. SOLE PROPRIETORSHIP
  33. Financial Statements Of Manufacturing Concern
  34. Financial Statements of Partnership firms
  35. INTEREST ON CAPITAL AND DRAWINGS
  36. DISADVANTAGES OF A PARTNERSHIP FIRM
  37. SHARE CAPITAL
  38. STATEMENT OF CHANGES IN EQUITY
  39. Financial Statements of Limited Companies
  40. Financial Statements of Limited Companies
  41. CASH FLOW STATEMENT 1
  42. CASH FLOW STATEMENT 2
  43. FINANCIAL STATEMENTS OF LISTED, QUOTED COMPANIES
  44. FINANCIAL STATEMENTS OF LISTED COMPANIES
  45. FINANCIAL STATEMENTS OF LISTED COMPANIES