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Financial Accounting

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Financial Accounting (Mgt-101)
VU
Lesson-5
Learning Objective
This lecture will cover
o  Classification of accounts into Assets, Liabilities, Income and Expenses, and
o  Rules of Debit and Credit for these classes.
Account
An accounting system keeps separate record of each item like assets, liabilities, etc. For example, a
separate record is kept for cash that shows increase and decrease in it.
This record that summarizes movement in an individual item is called an Account.
Classification of Accounts
We have studied following classification of accounts:
o  Assets,
o  Liabilities,
o  Income,
o  Expenses
o  Expenses can be further divided into capital and revenue expenses.
We have already studied about these classifications in different lectures but to refresh your memory
we will gather them at one place.
Assets and liabilities
ASSETS
Assets are the properties and possessions of the business to pay in future. Can be amount
payable for material purchased, expenses etc.
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).
LIABILITIES
Liabilities are the debts and obligations of the business.
Liability is the obligation of the business to provide a benefit or asset on a future date.
Asset is a right to receive and liability is an obligation to pay, therefore, these are opposite to each
other.
Accounting Equation
Assts are created out of capital invested plus liability to third party.
Income & Expenses
INCOME
Income / Revenue is the value of goods or services that a business charges from its customers. or
The reward / return received from the resources committed in the business.
EXPENSES
15
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Financial Accounting (Mgt-101)
VU
Expenses are the costs incurred to earn the revenue.
The resources spent and the efforts made to earn the income, when translated in money terms are
the expenses of the business
Profit and loss
Profit
Profit is the excess of income over expenses in a specific period.
Loss
Loss is the excess of expenses over income in a specific period.
Capital and Revenue expenditure
Capital expenditure
 It is the expenditure to create an asset that helps in generating future income and its life is more than
12 month. For example machinery purchased, furniture purchase etc
Revenue expenditure
It is the day to day expenses whose benefit is drawn immediately. For example salary of the
employee and rent of the building etc.
Rules of Debit and Credit
From our discussion up to this point, we have established following rules for Debit and Credit:
Any account that obtains a benefit is Debit.
OR
Anything that will provide benefit to the business is Debit.
Both these statements may look different but in fact if we consider that whenever an account
benefits as a result of a transaction, it will have to return that benefit to the business then both the
statements will look like different sides of the same picture.
For credit
Any account that provides a benefit is Credit.
OR
Anything to which the business has a responsibility to return a benefit in future is Credit.
As explained in the case of Debit, whenever an account provides benefit to the business the
business will have a responsibility to return that benefit at some time in future and so it is Credit.
Rules of Debit and Credit for Assets
Similarly we have established that whenever a business transfers a value / benefit to an account and
as a result creates some thing that will provide future benefit; the `thing' is termed as Asset.
By combining both these rules we can devise following rules of Debit and Credit for Assets:
o  When an asset is created or purchased, value / benefit is transferred to that account, so it is
Debited
i.
Increase in Asset is Debit
o  Reversing the above situation if the asset is sold, which is termed as disposing off, for say
cash, the asset account provides benefit to the cash account. Therefore, the asset account is
Credited
ii.
Decrease in Asset is Credit
16
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Financial Accounting (Mgt-101)
VU
Rules of Debit and Credit for Liabilities
Anything that transfers value to the business, and in turn creates a responsibility on part of the
business to return a benefit, is a Liability. Therefore, liabilities are the exact opposite of the assets.
o  When a liability is created the benefit is provided to business by that account so it is
Credited
iii.
Increase in Liability is Credit
o  When the business returns the benefit or repays the liability, the liability account benefits
from the business. So it is Debited
iv.
Decrease in Liability is Debit
Rules of Debit and Credit for Expenses
Just like assets, we have to pay for expenses. From assets, we draw benefit for a long time whereas
the benefit from expenses is for a short run.
Therefore, Expenditure is just like Asset but for a short run.
Using our rule for Debit and Credit, when we pay cash for any expense that expense account
benefits from cash, therefore, it is Debited.
o  Now we can lay down our rule for Expenditure:
v.
Increase in Expenditure is Debit
o  Reversing the above situation, if we return any item that we had purchased, we will receive
cash in return. Cash account will receive benefit from that Expenditure account. Therefore,
Expenditure account will be credited
vi.
Decrease in Expenditure is Credit
Rules of Debit and Credit for Income
Income accounts are exactly opposite to expense accounts just as liabilities are opposite to that of
assets.
Therefore, using the same principle we can draw our rules of Debit and Credit for Income
vii.
Increase in Income is Credit
viii.
Decrease in Income is Debit
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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