Table Of ContentFUNDAMENTALS OF
ACCOUNTING
FOUNDATION
STUDY NOTES
FOUNDATION : PAPER -
The Institute of Cost Accountants of India
CMA Bhawan,12, Sudder Street, Kolkata - 700 016
2
First Edition : January 2013
Revised Edition : April 2013
Second Edition : December 2014
Published by :
Directorate of Studies
The Institute of Cost Accountants of India (ICAI)
CMA Bhawan, 12, Sudder Street, Kolkata - 700 016
www.icmai.in
Printed at :
Repro India Limited
Plot No. 02, T.T.C. MIDC Industrial Area,
Mahape, Navi Mumbai 400 709, India.
Website : www.reproindialtd.com
Copyright of these Study Notes is reserved by the Insitute of Cost
Accountants of India and prior permission from the Institute is
necessary for reproduction of the whole or any part thereof.
Syllabus
Paper 2: Fundamentals of Accounting (FOA)
Syllabus Structure
A
Fundamentals of Financial Accounting
60%
B
Fundamentals of Cost & Management Accounting
40%
ASSESSMENT STRATEGY
There will be written examination paper of three hours
OBJECTIVES
To gain comprehensive understanding of all aspects relating to financial statements, principles,
procedures of accounting and their application to different practical situations
Learning Aims
The Syllabus aims to test the student’s ability to:
l
Understand and explain the conceptual framework of Accounting
l
Prepare Accounts for various entities under different situations
l
Acquire basic concepts of Cost & Management Accounting relevant for managerial decision
making
Skill sets required
Level A: Requiring the skill levels of knowledge and comprehension
Section A : Fundamentals of Financial Accounting
60%
1.
Accounting Process
2.
Reconciliation Statement
3.
Accounting for Depreciation
4.
Preparation of Final Accounts
5.
Accounting for Special Transactions
A
60%
B
40%
Section B: Fundamentals of Cost & Management Accounting
40%
6.
Fundamentals of Cost Accounting
7.
Preparation of Cost Statements
8.
Fundamentals of Management Accounting – basic knowledge and its
application
Section A : Fundamentals of Financial Accounting [60 marks]
1.
Accounting Process
(a) Theoretical Framework ( meaning, scope and usefulness of Accounting; Generally Accepted
Accounting Principles, Concepts and Conventions)
(b) Capital and Revenue transactions- capital and revenue expenditures, capital and revenue receipts
(c) Measurement, Valuation and Accounting estimates
(d) Double entry system, Books of prime entry, Subsidiary Books
(e) Recording of Cash and Bank transactions
(f)
Preparation of Ledger Accounts
(g) Preparation of Trial Balance- interpretation and usefulness
(h) Rectification of Errors
(i)
Opening entries, Transfer entries, Adjustment entries, Closing entries
2.
Reconciliation Statements
(a) Bank Reconciliation Statement
(b) Receivables / Payables Reconciliation Statement
(c) Stock Reconciliation Statement
3.
Accounting for Depreciation
(a) Depreciation Policy
(b) Methods, computation and Accounting treatment
4.
Preparation of Final Accounts:
(a) Of a Profit making concern (for sole proprietorship concern and partnership firm only)
(i)
Preparation of Trading Account, Profit & Loss Account and Balance Sheet
(ii)
Accounting treatment of bad debts, reserve for bad and doubtful debts, provision for
discount on debtors and provision for discount on creditors
(b) Of a Not-for-Profit making concern
(i)
Preparation of Receipts and Payments Account;
(ii)
Preparation of Income and Expenditure Account
(iii) Preparation of Balance Sheet
(c) Under Single Entry System including conversion of single entry into double entry system (basic
level)
(i)
Concept of Single Entry System and preparation of Statement showing Profit and Loss ,
Statement of Affairs
(ii)
Conversion of Single Entry System into Double Entry System of Accounting
5.
Accounting for Special Transactions
(a) Bills of Exchange
(b) Consignment
(c) Joint Venture
(d) Sale of goods on approval or return basis
Section B: Fundamentals of Cost & Management Accounting[40 marks]
6.
Fundamentals of Cost Accounting
(a) Cost and Management Accounting – Generally Accepted Cost Accounting Principles
(b) Accounting for Material cost (including Accounting of Inventory – LIFO, FIFO, Weighted Average
Cost)
(c) Accounting for Labour costs, Direct Expenses and Overheads
7.
Preparation of Cost Statements
(a) Cost Data collection, Cost Sheet formats,
(b) Preparation of Cost Sheets (historical cost sheets and estimated cost sheets)
8.
Fundamentals of Management Accounting
(a) Marginal Costing and Break-even analysis – basic knowledge
(b) Application of Marginal Costing for decision-making
FUNDAMENTALS OF ACCOUNTING
Study Note 1 : Accounting Process
1.1
Introduction
1.1
1.2
Definitions
1.2
1.3
Book-Keeping
1.4
1.4
Accounting Cycle
1.5
1.5
Basic Accounting Terms
1.6
1.6
Generally Accepted Accounting Principles
1.10
1.7
Accounting Concepts and Conventions
1.10
1.8
Events & Transactions
1.14
1.9
Voucher
1.14
1.10
Double Entry System
1.14
1.11
The Concepts of “Account”, “Debit” & “Credit”
1.15
1.12
Types of Accounts
1.16
1.13
The Accounting Process
1.17
1.14
Accounting Equation
1.19
1.15
Accrual Basis & Cash Basis of Accounting
1.20
1.16
Capital & Revenue Transaction
1.23
1.17
Accounting Standards
1.30
1.18
Double Entry System, Books of Prime Entry, Subsidiary Books
1.33
1.19
Trial Balance
1.52
1.20
Measurement, Valuation & Accounting Estimates
1.60
1.21
Opening entries, Closing entries, Transfer entries and Rectification entries
1.75
Study Note 2 : Reconciliation Statements
2.1
Bank Reconciliation
2.1
2.2
Receivable Reconciliation
2.16
2.3
Payable Reconciliation
2.17
2.4
Stock Reconciliation
2.18
Study Note 3 : Depreciation Accounting
3.1
Introduction
3.1
3.2
Certain Usful Terms
3.1
3.3
Causes of Depreciation
3.2
3.4
Characteristics of Depreciation
3.3
3.5
Objective of and Necessity for providing Depreciation
3.3
3.6
Factors to be Consider for Calculating the Actual Depreciation
3.3
3.7
Methods of Charging Depreciation
3.4
3.8
Provision for Depreciation Account
3.12
3.9
Disposal of an asset
3.13
Content
3.10
Profit or Loss on sale of assets - Method of Depreciation Calculation
3.15
3.11
Change of Method - Prospective and Retrospective
3.16
3.12
Application of AS 6 - Depreciation Accounting
3.21
3.13
Application of AS 10 - Accounting for Fixed Asset
3.23
Study Note 4 : Preparation of Final Accounts
4.1
Introduction
4.1
4.2
Preparation of Financial Statements
4.1
4.3
Bad Debts
4.35
4.4
Preparation of Financial Statement of Non-Trading Concern
4.48
4.5
Preparation of Financial Statement under Single Entry System
including Conversion of Single Entry into Double Entry System
4.72
Study Note 5 : Accounting for Special Transactions
5.1
Bill of Exchanges
5.1
5.2
Consignment Accounting
5.26
5.3
Joint Venture Accounts
5.41
5.4
Sales of goods on approval or return basis
5.54
Study Note 6 : Fundamentals of Cost Accounting
6.1
Introduction
6.1
6.2
Generally Accepted Cost Accounting Principles (GACAP) &
6.2
Cost Accounting Standards (CASs)
6.3
Definitions
6.14
6.4
Methods of Costing
6.17
6.5
Cost & Cost Object
6.19
6.6
Cost Organization
6.25
6.7
Costing System
6.26
6.8
Cost Determination
6.26
Study Note 7 : Preparation of Cost Statements
7.1
Cost Statements - Introduction
7.1
7.2
Cost Accumulation
7.1
7.3
Cost Collection
7.2
7.4
Cost Sheet Formats & Preparation
7.3
Study Note 8 : Fundamentals of Management Accounting
8.1
Marginal Costing-Introduction
8.1
8.2
Concept of Contribution, P/V Ratio and Break-Even Point
8.3
8.3
Concept of Margin Of Safety (MOS)
8.4
8.4
Cost - Volume - Profit Relationship (CVP Analysis)
8.5
8.5
Application of Marginal Costing for Decision Making
8.7
FUNDAMENTALS OF ACCOUNTING I 1.1
Study Note - 1
ACCOUNTING PROCESS
1.1 INTRODUCTION
Business is an economic activity undertaken with the motive of earning profits and to maximize the
wealth for the owners. Business cannot run in isolation. Largely, the business activity is carried out by
people coming together with a purpose to serve a common cause. This team is often referred to as an
organization, which could be in different forms such as sole proprietorship, partnership, body corporate
etc. The rules of business are based on general principles of trade, social values, and statutory framework
encompassing national or international boundaries. While these variables could be different for different
businesses, different countries etc., the basic purpose is to add value to a product or service to satisfy
customer demand.
The business activities require resources (which are limited & have multiple uses) primarily in terms of
material, labour, machineries, factories and other services. The success of business depends on how
efficiently and effectively these resources are managed. Therefore, there is a need to ensure the
businessman tracks the use of these resources. The resources are not free and thus one must be careful
to keep an eye on cost of acquiring them as well.
As the basic purpose of business is to make profit, one must keep an ongoing track of the activities
undertaken in course of business. Two basic questions would have to be answered:
(a) What is the result of business operations? This will be answered by finding out whether it has made
profit or loss.
(b) What is the position of the resources acquired and used for business purpose? How are these
resources financed? Where the funds come from?
The answers to these questions are to be found continuously and the best way to find them is to record all
the business activities. Recording of business activities has to be done in a scientific manner so that they
reveal correct outcome. The science of book-keeping and accounting provides an effective solution. It
This Study Note includes
1.1
Introduction
1.2
Definitions
1.3
Book-Keeping
1.4 Accounting Cycle
1.5
Basic Accounting Terms
1.6
Generally Accepted Accounting Principles
1.7
Accounting Concepts and Conventions
1.8
Events and Transactions
1.9 Voucher
1.10 Double Entry System
1.11 The Concepts of “Account”, “Debit” and “Credit”
1.12 Types of Accounts
1.13 The Accounting Process
1.14 Accounting Equation
1.15 Accrual Basis & Cash Basis of Accounting
1.16 Capital & Revenue Transactions
1.17 Accounting Standards
1.18 Double Entry System, Books of Prime Entry, Subsidiary Books
1.19 Trial Balance
1.20 Measurement, Valuation & Accounting Estimates
1.21 Opening entries, Closing entries, Transfer entries and Rectification entries
Accounting Process
1.2 I FUNDAMENTALS OF ACCOUNTING
is a branch of social science. This study material aims at giving a platform to the students to understand
basic principles and concepts, which can be applied to accurately measure performance of business.
After studying the various chapters included herein, the student should be able to apply the principles,
rules, conventions and practices to different business situations like trading, manufacturing or service.
1.2 DEFINITIONS
Definition of Accounting
Definition by the American Institute of Certified Public Accountants (Year 1961):
“Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events which are, in part at least, of a financial character, and interpreting
the result thereof”.
Definition by the American Accounting Association (Year 1966):
“The process of identifying, measuring and communicating economic information to permit informed
judgments and decisions by the users of accounting”.
(a) Objectives of Accounting
(i) Providing Information to the Users for Rational Decision-making
The primary objective of accounting is to provide useful information for decision-making to
stakeholders such as owners, management, creditors, investors, etc. Various outcomes of business
activities such as costs, prices, sales volume, value under ownership, return of investment, etc. are
measured in the accounting process. All these accounting measurements are used by stakeholders
(owners, investors, creditors/bankers, etc.) in course of business operation. Hence, accounting is
identified as ‘language of business’.
(ii) Systematic Recording of Transactions
To ensure reliability and precision for the accounting measurements, it is necessary to keep a
systematic record of all financial transactions of a business enterprise which is ensured by book-
keeping. These financial records are classified, summarized and reposted in the form of accounting
measurements to the users of accounting information i.e., stakeholder.
(iii) Ascertainment of Results of above Transactions
‘Profit/loss’ is a core accounting measurement. It is measured by preparing profit and loss account
for a particular period. Various other accounting measurements such as different types of revenue
expenses and revenue incomes are considered for preparing this profit and loss account. Difference
between these revenue incomes and revenue expenses is known as result of business transactions
identified as profit/loss. As this measure is used very frequently by stockholders for rational decision-
making, it has become the objective of accounting.
For example, Income Tax Act requires that every business should have an accounting system
that can measure taxable income of business and also explain nature and source of every item
reported in Income Tax Return.
(iv) Ascertain the Financial Position of Business
‘Financial position’ is another core accounting measurement. Financial position is identified by
preparing a statement of ownership i.e., Assets and Owings i.e., liabilities of the business as on
a certain date. This statement is popularly known as balance sheet. Various other accounting
measurements such as different types of assets and different types of liabilities as existed at a
particular date are considered for preparing the balance sheet. This statement may be used by
various stakeholders for financing and investment decision.
FUNDAMENTALS OF ACCOUNTING I 1.3
(v) To Know the Solvency Position
Balance sheet and profit and loss account prepared as above give useful information to
stockholders regarding concerns potential to meet its obligations in the short run as well as in the
long run.
To Know the Solvency Position
Ascertain the Financial Position of Business
Ascertainment of Results of above Transactions
Systematic Recording of Transactions
Providing Information to the Users for Rational
Decision-making
Function of Accounting
The main functions of accounting are as follows:
(a) Measurement: Accounting measures past performance of the business entity and depicts its
current financial position.
(b) Forecasting: Accounting helps in forecasting future performance and financial position of the
enterprise using past data.
(c) Decision-making: Accounting provides relevant information to the users of accounts to aid rational
decision-making.
(d) Comparison & Evaluation: Accounting assesses performance achieved in relation to targets
and discloses information regarding accounting policies and contingent liabilities which play an
important role in predicting, comparing and evaluating the financial results.
(e) Control: Accounting also identifies weaknesses of the operational system and provides feedbacks
regarding effectiveness of measures adopted to check such weaknesses.
(f) Government Regulation and Taxation: Accounting provides necessary information to the
government to exercise control on die entity as well as in collection of tax revenues.
Accounting – Classification
The various sub-fields of the accounting are:
ACCOUNTING
Financial
Accounting
Cost
Accounting
Management
Accounting
1.
Financial Accounting
Determining the financial results for
the period and the state of affairs on
the last day the accounting period.
Stewardship Accounting
2.
Cost Accounting
Information generation for Controlling
operations with a view to maximizing
efficiency and profit.
Control Accounting
3.
Management Accounting
Accounting to assist management in
planning and decision making.
Decision Accounting
Accounting Process
1.4 I FUNDAMENTALS OF ACCOUNTING
(a) Financial Accounting
It is commonly termed as Accounting. The American Institute of Certified Public Accountants defines
Accounting as “an art of recoding, classifying and summarizing in a significant manner and in terms
of money, transactions and events which are in part at least of a financial character, and interpreting
the results thereof.”
(b) Cost Accounting
According to the Chartered Institute of Management Accountants (CIMA), Cost Accountancy is defined
as “application of costing and cost accounting principles, methods and techniques to the science,
art and practice of cost control and the ascertainment of profitability as well as the presentation of
information for the purpose of managerial decision-making.”
(c) Management Accounting
Management Accounting is concerned with the use of Financial and Cost Accounting information to
managers within organizations, to provide them with the basis in making informed business decisions
that would allow them to be better equipped in their management and control functions.
Difference between Management Accounting and Financial Accounting
The significant difference between Management Accounting and Financial Accounting are :
Management Accounting
Financial Accounting
1.
Management
Accounting
is
primarily
based on the data available from Financial
Accounting.
1.
Financial Accounting is based on the
monetary transactions of the enterprise.
2.
It provides necessary information to the
management to assist them in the process
of
planning,
controlling,
performance
evaluation and decision making.
2.
Its main focus is on recording and classifying
monetary transactions in the books of
accounts and preparation of financial
statements at the end of every accounting
period.
3.
Reports
prepared
in
Management
Accounting are meant for management
and as per management requirement.
3.
Reports as per Financial Accounting are
meant for the management as well as for
shareholders and creditors of the concern.
4.
Reports may contain both subjective and
objective figures.
4.
Reports should always be supported by
relevant figures and it emphasizes on the
objectivity of data.
5.
Reports are not subject to statutory audit.
5.
Reports are always subject to statutory audit.
6.
It evaluates the sectional as well as the
entire performance of the business.
6.
It ascertains , evaluates and exhibits the
financial strength of the whole business.
1.3 BOOK-KEEPING
As defined by Carter, ‘Book-keeping is a science and art of correctly recording in books-of accounts
all those business transactions that result in transfer of money or money’s worth’.
Book-keeping is an activity concerned with recording and classifying financial data related to business
operation in order of its occurrence.
Book-keeping is a mechanical task which involves:
•
Collection of basic financial information.
•
Identification of events and transactions with financial character i.e., economic transactions.
•
Measurement of economic transactions in terms of money.
FUNDAMENTALS OF ACCOUNTING I 1.5
•
Recording financial effects of economic transactions in order of its occurrence.
•
Classifying effects of economic transactions.
•
Preparing organized statement known as trial balance.
The distinction between book-keeping and accounting is given below:
Distinction between Book-keeping and Accounting
Book-Keeping
Accounting
1.
Output of book-keeping is an input for
accounting.
1.
Output of accounting permit informed
judgments and decisions by the user of
accounting information.
2.
Purpose of book-keeping is to keep
systematic record of transactions and
events of financial character in order of its
occurrence.
2.
Purpose of accounting is to find results of
operating activity of business and to report
financial strength of business.
3.
Book-keeping
is
a
foundation
of
accounting.
3.
Accounting is considered as a language of
business.
4.
Book-keeping is carried out by junior staff.
4.
Accounting is done by senior staff with skill of
analysis and interpretation.
5.
Objects of book-keeping is to summarize
the cumulative effect of all economic
transactions of business for a given period
by maintaining permanent record of each
business transaction with its evidence and
financial effects on accounting variable.
5.
Object of accounting is not only bookkeeping
but also analyzing and interpreting reported
financial information for informed decisions.
1.4 ACCOUNTING CYCLE
When complete sequence of accounting procedure is done which happens frequently and repeated
in same directions during an accounting period, the same is called an accounting cycle.
Steps/Phases of Accounting Cycle
The steps or phases of accounting cycle can be developed as under:
Recording of
Transaction
Journal
Ledger
Closing
Entries
Financial
Statement
Trial
Balance
Adjustment
Entries
Adjusted Trial
Balance
ACCOUNTING CYCLE
Accounting Process
1.6 I FUNDAMENTALS OF ACCOUNTING
(a) Recording of Transaction : As soon as a transaction happens it is at first recorded in subsidiary book.
(b) Journal : The transactions are recorded in Journal chronologically.
(c) Ledger : All journals are posted into ledger chronologically and in a classified manner.
(d) Trial Balance : After taking all the ledger account closing balances, a Trial Balance is prepared at
the end of the period for the preparations of financial statements.
(e) Adjustment Entries : All the adjustments entries are to be recorded properly and adjusted
accordingly before preparing financial statements.
(f)
Adjusted Trial Balance : An adjusted Trail Balance may also be prepared.
(g) Closing Entries : All the nominal accounts are to be closed by the transferring to Trading Account
and Profit and Loss Account.
(h) Financial Statements : Financial statement can now be easily prepared which will exhibit the true
financial position and operating results.
1.5 BASIC ACCOUNTING TERMS
In order to understand the subject matter clearly, one must grasp the following common expressions
always used in business accounting. The aim here is to enable the student to understand with these
often used concepts before we embark on accounting procedures and rules. You may note that these
terms can be applied to any business activity with the same connotation.
(i)
Transaction: It means an event or a business activity which involves exchange of money or money’s
worth between parties. The event can be measured in terms of money and changes the financial
position of a person e.g. purchase of goods would involve receiving material and making payment
or creating an obligation to pay to the supplier at a future date. Transaction could be a cash
transaction or credit transaction. When the parties settle the transaction immediately by making
payment in cash or by cheque, it is called a cash transaction. In credit transaction, the payment
is settled at a future date as per agreement between the parties.
(ii)
Goods/Services : These are tangible article or commodity in which a business deals. These articles or
commodities are either bought and sold or produced and sold. At times, what may be classified as
‘goods’ to one business firm may not be ‘goods’ to the other firm. e.g. for a machine manufacturing
company, the machines are ‘goods’ as they are frequently made and sold. But for the buying
firm, it is not ‘goods’ as the intention is to use it as a long term resource and not sell it. Services are
intangible in nature which are rendered with or without the object of earning profits.
(iii) Profit: The excess of Revenue Income over expense is called profit. It could be calculated for each
transaction or for business as a whole.
(iv) Loss: The excess of expense over income is called loss. It could be calculated for each transaction
or for business as a whole.
(v) Asset: Asset is a resource owned by the business with the purpose of using it for generating future
profits. Assets can be Tangible and Intangible. Tangible Assets are the Capital assets which have
some physical existence. They can, therefore, be seen, touched and felt, e.g. Plant and Machinery,
Furniture and Fittings, Land and Buildings, Books, Computers, Vehicles, etc. The capital assets which
have no physical existence and whose value is limited by the rights and anticipated benefits that
possession confers upon the owner are known as lntangible Assets. They cannot be seen or felt
although they help to generate revenue in future, e.g. Goodwill, Patents, Trade-marks, Copyrights,
Brand Equity, Designs, Intellectual Property, etc.
Assets can also be classified into Current Assets and Non-Current Assets.
