Financial Accounting an Introduction: Essential Guide for BCA, MCA, BBA, MBA

Table of Contents

1. Introduction to Financial Accounting
2. Basic Accounting Concepts
3. Types of Accounting
4. Data Entry Accounting
5. The Accounting Trail
6. Financial Statements and Their Nature
7. The Accounting Equations
8. Glossary

Introduction to Financial Accounting

Financial accounting is like keeping a diary of your money. Just as you write down what you spend and earn, businesses use financial accounting to keep track of their money.

Here’s a simple breakdown:

1. Recording Transactions: Imagine you buy a pen for ₹10. In financial accounting, this transaction would be recorded, showing that you spent ₹10 on a pen.
2. Tracking Income and Expenses: Businesses use financial accounting to track how much money they make (income) and how much they spend (expenses) to see if they are making a profit or loss.
3. Making Financial Statements: Financial accountants prepare statements like the Income Statement and Balance Sheet. The Income Statement shows how much money the business made or lost over a period, while the Balance Sheet shows what the business owns (assets) and owes (liabilities) at a specific time.
4. Following Rules: Financial accounting follows specific rules and principles, such as the principle of recording transactions at their original cost, to ensure accuracy and consistency.
5. Helping in Decision Making: Financial accounting helps businesses and individuals make informed decisions by providing clear and accurate financial information.

Financial accounting is like a financial diary for businesses, helping them keep track of their money and make smart financial decisions.

Basic Accounting Concepts

1. Entity Concept: 

This concept says that a business is treated as a separate entity from its owners. Just like you have your money and the school has its own, a business also keeps its money separate from the owner's personal money.

Another Example: Imagine you have a piggy bank for your savings. Your piggy bank is like a separate entity from you. Just like that, a business keeps its money separate from the owner's personal money.

2. Cost Concept: 

According to this concept, assets are recorded at their cost price. For example, if a business buys a machine for ₹10,000, it will be recorded in the books at ₹10,000 even if its value increases in the future.

Another Example:  If you buy a mobile phone for ₹10,000, you will record it in your expenses as ₹10,000, even if its value changes later.

3. Going Concern Concept: 

This concept assumes that a business will continue to operate for the foreseeable future. It's like when you start a project, you plan to finish it; similarly, a business plans to keep operating.

Another Example: When you start a school project, you plan to finish it. Similarly, a business plans to keep running and growing.

4. Money Measurement Concept: 

This concept states that only those transactions which can be expressed in terms of money are recorded in the books. For instance, you can record how much you spent on a new bicycle, but you can't record your happiness from riding it.

Another Example: You can record how much you spent on buying a cricket bat, but you can't record the fun you had playing cricket with it.

5. Dual Aspect Concept: 

According to this concept, every transaction has two aspects: a give and a take. For example, when you buy something, you give money (give aspect) and get the product (take aspect).

Another Example: When you buy a cricket bat, you give money and take the bat. Every transaction has these two aspects: giving and taking.

4. Accrual Concept: 

This concept says that transactions are recorded when they occur, not when the money actually changes hands. For example, if you buy groceries on credit, it's recorded immediately, even though you pay later.

Another Example: If you buy a book on credit, you record the purchase immediately, even though you will pay for it later.

5. Matching Concept: 

This concept matches the revenues of a period with the expenses incurred to earn those revenues. It's like when you sell lemonade, you subtract the cost of the lemons and cups to know how much you earned.

Another Example: When you sell lemonade, you subtract the cost of lemons and cups from the money you earned to know your profit.

6. Conservatism Concept: 

This concept suggests that while recording transactions, a business should be cautious and not overstate its profits or assets. For example, if there's doubt about the value of an asset, it's better to record it at a lower value.

Another Example: If you're not sure about the value of something you bought, it's better to record it at a lower value to be safe.

7. Materiality Concept: 

According to this concept, only significant transactions need to be recorded in detail. For example, if you buy a pencil, it's not necessary to record it because it's not a significant expense.

Another Example: Buying a pencil is a small expense compared to buying a bicycle. Businesses only need to record significant transactions like buying a bicycle, not every small expense like buying a pencil.

8. Consistency Concept: 

This concept states that accounting policies and methods once adopted should be consistently followed from one period to another. Like following the same recipe to bake a cake, a business should use the same method to calculate depreciation each year.

Another Example: Just like using the same recipe to bake a cake, a business should use the same method to calculate depreciation each year to keep its records consistent.

Types of Accounting

Accounting is a way to keep track of money. Different types of accounting help people and businesses manage their money in different ways.

• Financial Accounting: This type of accounting is like a report card for a business. It shows how much money the business has made and spent. For example, if a grocery store wants to know how much profit it made last year, it would use financial accounting.
• Managerial Accounting: This type of accounting helps managers make decisions about a business. For example, if a company wants to know if it should buy new equipment, it would use managerial accounting to see if it can afford it.
• Cost Accounting: This type of accounting tracks how much it costs to make a product or provide a service. For example, if a bakery wants to know how much it costs to make a cake, it would use cost accounting to figure out the cost of ingredients, labour, and other expenses.
• Tax Accounting: This type of accounting helps people and businesses pay their taxes correctly. For example, if a person wants to know how much income tax they need to pay, they would use tax accounting to calculate it.
• Auditing: This type of accounting checks if financial records are accurate. For example, if a company wants to make sure its financial statements are correct, it should hire an auditor to check them.

These types of accounting help people and businesses keep track of their money and make smart financial decisions.

Double Entry Accounting

Double-entry accounting is like keeping a record of all the money coming in and going out of your pocket.

Imagine you have a diary where you write down every rupee you spend and every rupee you earn.

For example, if you buy a book for ₹100, you write down "-₹100" for spending. But, you also write down where that ₹100 came from, maybe you earned it from selling an old toy, so you write "+₹100" for earning.

This way, you always know how much money you have and where it's coming from and going. This is the basic idea behind double-entry accounting.

The Accounting Trail

The Accounting Trail is like a story that shows how money moves in a business. Imagine you have a small shop. You buy things to sell, like toys or snacks. When you buy something, you spend money. This is like the starting point of the trail.

Next, you sell these items to customers. They pay you money, which is like the end of the trail. Along the way, you keep track of everything you buy and sell. This tracking is called accounting. It helps you see if you are making a profit or a loss.

In accounting, you write down all the money you spend and receive. You also note down what you buy and sell, and for how much. This creates a trail of your financial transactions. This trail helps you understand your business's financial health.

For example, if you buy toys for ₹500 and sell them for ₹800, your accounting trail shows that you made a profit of ₹300. This simple example is like a tiny part of the big accounting trail that businesses follow to keep track of their money.

Financial Statements And Their Nature

Financial statements are like report cards for businesses. They show how well a company is doing financially. Just like you have subjects in school, a business has different parts to its financial statements. 

Let's break it down:

1. Balance Sheet (निरंतरता पत्र):

• Think of it as a snapshot of what the business owns (assets) and what it owes (liabilities) at a specific point in time.
• For example, if you have ₹500 in your piggy bank (asset) but owe your friend ₹200 (liability), your balance sheet would show ₹500 in assets and ₹200 in liabilities, with a net worth of ₹300.
• Another Example: Imagine you have a mobile phone (asset) worth ₹10,000 and you owe your friend ₹2,000 for a loan (liability). Your balance sheet would show ₹10,000 in assets and ₹2,000 in liabilities, with a net worth of ₹8,000.
• Formula: Assets = Liabilities + Equity
• If Assets = ₹10,000 and Liabilities = ₹2,000, then Equity = Assets - Liabilities = ₹10,000 - ₹2,000 = ₹8,000.

2. Income Statement (आय प्रमाणपत्र):

• This statement shows how much money the business made (revenue) and how much it spent (expenses) over some time, like a year.
• For instance, if you earned ₹1000 from your lemonade stand (revenue) but spent ₹200 on lemons and sugar (expenses), your income statement would show a profit of ₹800.
• Another Example: Suppose you run a small bakery. In a month, you earn ₹20,000 from selling cakes and spend ₹10,000 on ingredients and other expenses. Your income statement would show a profit of ₹10,000 for that month.
• Formula: Net Income = Revenue - Expenses
• If Revenue = ₹20,000 and Expenses = ₹10,000, then Net Income = ₹20,000 - ₹10,000 = ₹10,000.

3. Cash Flow Statement (नकद प्रवाह प्रमाणपत्र):

• It tracks the flow of money in and out of the business.
• Using the lemonade stand example, if you started with ₹200 cash, earned ₹1000, but spent ₹700 on supplies and other expenses, your cash flow statement would show an increase of ₹300 in cash.
• Another Example: If you start the month with ₹5,000 cash, earn ₹15,000 from your bakery, but pay ₹8,000 for rent and utilities, your cash flow statement would show an increase of ₹7,000 in cash.
• Formula: Net Cash Flow = Cash Inflows - Cash Outflows
• If Cash Inflows = ₹15,000 and Cash Outflows = ₹8,000, then Net Cash Flow = ₹15,000 - ₹8,000 = ₹7,000.

4. Statement of Changes in Equity (स्वामित्व में परिवर्तन प्रमाणपत्र):

• This statement explains how the owner's equity in the business changes over time.
• For instance, if you invested ₹500 in your lemonade stand, your equity would increase by that amount.
• Another Example: Let's say you initially invested ₹50,000 in your bakery. Later, you decide to invest an additional ₹20,000. Your statement of changes in equity would show an increase of ₹20,000 in your equity.
• Formula: Ending Equity = Beginning Equity + Investments + Net Income - Drawings
• If Beginning Equity = ₹50,000, Investments = ₹20,000, Net Income = ₹10,000, and Drawings (money taken out by the owner) = ₹5,000, then Ending Equity = ₹50,000 + ₹20,000 + ₹10,000 - ₹5,000 = ₹75,000.

The Accounting Equations

The Accounting Equation is like a balance scale for your money. It shows how all the money in a business is divided up. 

Here's how it works:

• Assets are things a business owns that have value, like cash, buildings, or equipment. These are on one side of the scale.
• Liabilities are the debts or obligations a business owes to others like loans or bills to be paid. These are on the other side of the scale.
• Owner's Equity is the owner's claim to the assets of the business. It's what's left over after you subtract liabilities from assets.

So, the equation looks like this:

 Assets = Liabilities + Owner's Equity

Imagine you have a lemonade stand. You buy lemons (an asset) for ₹100. You borrowed ₹50 from your friend (a liability). The rest of the money is your claim (owner's equity). So, your equation is:

 ₹100 (Lemons) = ₹50 (Loan) + ₹50 (Owner's Equity)

It's like saying, "All the money I used to buy lemons equals the money I owe plus what's left for me." That's the Accounting Equation in action!

Glossary

Here are the meanings of some popular words used in financial accounting:

• Assets: These are resources owned by a company that have future economic value, such as cash, inventory, or equipment.
• Liabilities: These are obligations or debts that a company owes to external parties, like loans or accounts payable.
• Equity: This represents the ownership interest in a company, calculated as the difference between assets and liabilities, simply it is your share in any company.
• Revenue: This is the income earned by a company from its normal business operations, such as sales of goods or services.
• Expenses: These are the costs incurred by a company to generate revenue, such as wages, rent, or utilities.
• Profit: This is the financial gain made by a company when its revenue exceeds its expenses.
• Loss: This occurs when a company's expenses exceed its revenue, resulting in a negative financial outcome.
• Balance Sheet: This is a financial statement that shows a company's assets, liabilities, and equity at a specific point in time, providing a snapshot of its financial position.
• Income Statement: Also known as a profit and loss statement, this financial statement shows a company's revenues, expenses, and profits or losses over a specific period.
• Cash Flow Statement: This statement shows how changes in balance sheet accounts and income affect cash and cash equivalents, providing information about a company's operating, investing, and financing activities.