Financial Accounting

Financial accounting is concerned with recording and processing all transactions with outsiders and events affecting the financial position of the firm. This leads to the preparation of the annual profit and loss account and the balance sheet.

Double Entry System of Accounting

Accounting records can be prepared under any on of the following systems

a) single entry system

Under this system only the personal aspects of the transactions are recorded in the books and the impersonal aspects are ignored. It is not based on the ‘dual’ aspect concept and is incomplete, inaccurate and unscientific.

b) Double entry system

It is the most common system of keeping records whereby the two aspects of every transaction – the giving aspect and the receiving aspect are recorded in the books of accounts. Each aspect will be recorded in one account and this method of writing every transaction in two accounts is known as Double entry system of book keeping. This is the most scientific, complete and accurate system of accounting.

Advantages of double entry system

• It provides a complete record of every transaction whether it relates to the personal or impersonal accounts.
• It provides an arithmetical check on the records as the total of debit entries must be equal to the total credit of all entries.
• The amount owing to outsiders and the amount due to the business can be ascertained with the help of personal accounts.
• The profit and loss account can be prepared with the help of nominal accounts which is helpful to the business to ascertain the operating results of the business.
• It helps to prepare the balance sheet of the business which is helpful to ascertain the financial position of the business on a particular day.
• It helps to reduce the occurrence of the errors and frauds and when occurred can be deducted easily. It can work with the help of internal check system.

Disadvantages of double entry system

• This system requires the maintenance of a number of books of accounts which is not practical in small concerns.
• The system is costly because a number of records are to be maintained.
• There is no guarantee of absolute accuracy of the books of account in spite of agreement of the trial balance.

Accounting Terms

• Assets are the properties owned by a trader, kept for using them for business purposes.
• Liabilities are debts owing to others by the trader.
• Capital is a liability of a business due to the proprietor. It represents the owners fund employed in the business.
• Transaction refers to the transfer money or money’s worth from one account to another account.
• Goods refers to the commodities bought by the trader for the purpose of resale
• Fixed assets are the properties kept by the owners of a business firm for use in business and not for resale. For example land, building, plant, fixtures, equipments and so on.
• Current assets are the assets meant for conversion into cash. For example stock in hand, debtors, cash in hand and at bank and so on.
• Account is a summary of transactions affecting a person, an asset, profit or loss etc.,

Debtor and Creditor

Debtor is a person who owes money to the business
Creditor is a person to whom the business owes money.

Debit and Credit:

Every transaction, at least affects two accounts in the opposite directions. The account which receives the benefit is debited and the account which gives the benefit is credited.

Journal is a book of first entry. Business transaction are recorded first in the journal as and when they take place. Then, they are recorded in the ledger accounts.

Journalizing is the act of entering the transactions in the journal.

Ledger is the main book of account. It contains all the accounts of business in well arranged form.

Posting refers to the entering the transactions in appropriate ledger accounts.

Trial balance is a list of ledger balances as on the last date of accounting period. If the total of debit balances and that of credit balances are equal, then it is understood that recording are done in all the books correctly and accurately.

Rules for Debit and Credit:

Personal accounts: Debit the receiver, Credit the giver

Real accounts: Debit what comes in, Credit what goes out

Nominal accounts: Debit all expenses and losses, Credit all incomes and gains

Personal Accounts:

These accounts record a business dealing with persons or firms. The person receiving something is given debit and the person giving something is given cedit.

Real Accounts:

These are the accounts of assets. Assets entering the business is given debit and asset leaving the business is given credit.

Nominal Accounts:

These account deal with expenses, incomes, profits and losses. Accounts of expenses and losses are debited and accounts of incomes and gains are credited.

Subsidiary books

In small business firms, the volume of transactions is also small and hence, all of them can be recorded in one subsidiary book namely, the journal. But in large business houses since the number of transactions if large, it is impossible to enter them in one subsidiary book. Therefore, it is desirable to sub-divide the transactions according to their nature. And it is customary to keep each division of transactions in one book. The book in which the transactions are entered at first time are known as subsidiary books.

Kinds of subsidiary books:

• Cash book to record cash receipts and payments.
• Purchase book for recording credit purchase of goods.
• Sales book or day book for recording all goods sold on credit
• Purchases Returns book for recording all goods sold on credit.
• Purchsess Returns book or Returns outwards book for recording all purchses returned to the creditors.
• Sales returns book or Returns Inwards book for recording all sales returned by the custoemers.
• Bills receivables book to keep record of bills received from customers.
• Bills payable book to keep record of bills payable to creditors.
• Journal proper to keep a record of those transactions for which there is no separate book.

Journal, Ledger and Trial Balance

The stages in book-keeping are,

• Recording the transactions in subsidiary books or books of prime entry
• Posting the entries into the appropriate accounts in the main book called ledger.
• Preparing the Trial balance, thereby profit and loss account and Balance sheet.

Journal

Journal is derived from the French word “Jour” which means a day. Journal, therefore, means daily record of business transactions. Journal is a book of original entry because transactions is first written in the journal from which it is posted to ledger at any convenient time.

Ledger

The ledger is the main book of account. The Journal is a subsidiary book. The word subsidiary means ‘giving additional help to.’ The journal helps a businessman to take the various transactions to the right place. i.e. to the appropriate accounts. The journal is the base, the ledger is the middle. The Balance sheet and Profit and loss account can be prepared from the main book of account, namely Ledger.

The entries are posted under appropriate accounts. All similar transactions must be brought together. Transactions relating to cash are grouped under cash account. Similarly the transactions with customers and suppliers (debtors and creditors) are grouped under appropriate personal accounts. Ledger is the main book of the business containing personal, Real and Nominal accounts of the business.

Trial Balance

The balances standing in the various accounts in the ledger at the end of a period are listed down in the form of a statement, showing debit balances in one column and credit balances in the other, known as a Trial balance.

The Trial Balance is nothing but a summary of the various transactions entered in the books of accounts and its preparation is based on the rule that ‘for every debit there is a corresponding and equal credit’.

Trial balance is automatically Calculated in Tally!