Basics of financial accounting for technical folks

When we are working on Oracle Financials, we need to know basics of financial accounting to interact with business users, understand their requirements and deliver better solution. This knowledge also helps us appreciate the intention behind data model and UI. Below information I've gathered from internet and some I learnt from my CA teammates. Note that this item is very basic and just enough for us to perform our day to day tasks; not a comprehensive document

Accounting - Definition

Accounting may be defined as the art of

recording,

classifying,

summarizing,

analyzing and Interpreting

the financial transactions and communicating the results thereof to the persons interested in such information

Why Accounting

To know

• What business owns?
• What business owes?
• Whether the business has made profit or it is under loss?
• What is the financial position? Can we make investment and expand the business or we need to raise more money by loan?
• Which segment in the business is making profits and where losses are seen?

Recording Financial Transactions

• Also called as Book Keeping
• Enter each and every financial activity in a “Book”
• Enter these data in an orderly, easy to understand manner
• Each entry in this book will be called as “Journal”
• Depending on from where this Journal data has originated, you may give different names, like Sales Journal, Purchase Journal, Contra Journal etc

Classifying Financial Transactions

• Ability to group financial transactions of same nature at one place
• Categorize each journal entry
• Eg: Having separate accounting head for each item
• Eg: Salary Expense, Income from Services, VAT Tax liability etc

Account Types

• 1. Assets:
  • Assets are Tangible and Intangible items of Value that the business owns.
    Eg: Cash
    Cars
    Buildings
    Machinery
    Furniture
    Debtors (money to be received from customers)
    Stock/Inventory
    2. Liabilities:
    Liabilities are those items which are owed by the business to bodies outside of the business.
    Eg: Loans to Banks
    Creditors (Money owed to Suppliers)
    Bank Overdrafts
    Tax to Government
  • 3. Revenue:

    Revenue are the Items from where the business is making money from.

    Eg: Revenue from BPO

    Revenue from Package Implementation

    Revenue from Software Services

    Revenue from Products
  • 4. Expense:

    Expense are the Items where Business is spending money.

    Eg: Salary Expense

    Travel Expense

    Marketing Expense

    Computer Purchase Expense

    Software maintenance expense
  • 5. Owner’s Equity:
    Owner’s equity is the capital invested by the Owner and Profit (or Loss) to date.
    
    
    Accounting Equation
  • Assets – Liabilities = Owner’s Equity

    = Capital + Retained Earning

    = Capital + Revenue – Expense

    Assets + Expense = Capital + Revenue + Liability                                                              

    LHS = RHS

    Debit (Dr) = Credit (Cr)

    
    

    Accounting Rules

    
    
    
  •  

    Account Type	Increasing	Decreasing
    Assets	Dr	Cr
    Liability	Cr	Dr
    Revenue	Cr	Dr
    Expense	Dr	Cr
    Owner's equity	Cr	Dr

  • 
    

 Balance Sheet

• • The Balance sheet shows a snapshot of the Business’s net worth at a given point in time.

    
    
  • 
    

  • 				XYZ Company
    				Balance Sheet
    				31-Mar-11
    Assets					Liabilities
    Current Assets:					Current Liabilities
    	Cash	Rs	50000			Loan Payable	Rs	150000
    	Accounts Receivable	Rs	75000			Accounts Payable	Rs	50000
    	Total Current Assets	Rs	125000		Total Liabilities		Rs	200000
    Fixed Assets:
    	Land	Rs	200000		Owner's Equity
    	Vehicle	Rs	100000			Capital	Rs	150000
    	Total Fixed Assets	Rs	300000			Retained Earning	Rs	75000
    Total Assets		Rs	425000		Total of Capital and Liability		Rs	425000

    Profit and Loss Account
  • P&L statement shows the current financial year’s net operating profits broken down into various sales and expenses
  •  

    	Sales
    		Income from Software services	Rs	100000
    		Income from Products	Rs	150000
    	Total Sales		Rs	250000
    	Expenses
    		Marketing Expense	Rs	50000
    		Salary	Rs	100000
    	Total Expenses		Rs	150000
    	Total Profit/Loss			100000
    		Tax Paid	Rs	25000
    	Profit After Tax		Rs	75000

  • Accounting Methods
  • 1. Cash based Accounting:

    Record the transaction only when the company receives/pays cash. Even if the sale is done today, and company receives the payment after 15 days, transaction will be entered only after 15 days

    Generally followed in small businesses

    
    

    2. Accrual Based Accounting

    Record the transaction as soon as the financial even has happened ie as soon as sale is done, record the income, as soon as purchase is done record expense irrespective of when the company receives/pays money

    
    

    All large organizations follow this accounting method

    This is the norm for all listed companies