Financial Accounting

Financial accounting can be defined as an INFORMATION SYSTEM that provides information about the
results of a business' performance and its economic position to its stakeholders.

Accounting For Management
Goals Of Managerial Accounting
Planning: it communicates organisations goals to employees aiding coordination to various
functions. financial plan is budget. (the accounting people are expected to do things that are
much more strategic and much more forward looking)
Control: ensuring that the organisation operates in the intended manner to achieve goals. It is to
evaluate performance of managers and operations.
Directing operational activities: How much financial and physical resources.
Decision making: Choosing the best among available alternatives.
Meaning of Accounting
Accounting is the science of recording, classifying, & summarizing in a significant manner & in
terms of money, transactions and events which are of a financial character and interpreting the
results thereof to permit informed judgments and decisions by users of the information.
Although earlier accounting was recognized as a system of analyzing & maintaining the records
of business transactions.
But now accounting has acquired a role which highlights its social importance.
Difference Between Accounting & Book-Keeping
Book-keeping is a small part of accounting process
Book-keeping is only concerned with recording transactions and keeping records
Accounting aims at designing an information system
Accounting as an information System

Users of Accounting Information

Users of Accounting Information
Management: Directors, Managers, Officers, Dept. Heads,
To Assess Profitability, Liquidity & Solvency, Controlling Function
Users With Direct Fin. Interest: Shareholders, Creditors, Employees, Suppliers
For Investment & Credit Decisions, Pay-Off and Supply Continuity Decisions
Users With Indirect Fin. Interest: Customers, Taxation Authorities, Financial Analysts, Brokers,
Underwriters, Labour Unions, General Public, Press, NGOs
Assessing Taxes, Protecting Investors & Public, Measuring Social and
Environmental Responsibility, Negotiating Labor Agreements
CUSTOMER of Accounting Information
Accounting
Recording of Data
Processing of
Data
Communication
of Data
Information
Needs
Information
Decision
Makers
Manage
ment
Users With
Indirect
Financial
Interest
Users With
Direct
Financial
Interest
Customer Interest of the Customer
Equity investors (existing and potential) They are interested whether buy, hold or sell the
shares in hand and also enable them in payment
of dividends
Loan creditors i.e, existing and potential holders
of debentures and loan stock, and providers of
short-term loans
The amount will be paid when due and for
continuation of the business
Employees (existing, potential and past) Interested in stability and profitability for
employment opportunities, remuneration and
retirement benefits
Business contacts including customers, trade
creditors, competitors and potential take-over
bidders
Whether the payment of loan will be made in due
dates and enable sustainability of business for
future business with the enterprise
Government, including tax authorities,
government departments and local authorities
Interested in allocation of resources and also to
regulate the activities of an enterprise and
determining tax policies and as a basis for
national income
Public, including tax payers, ratepayers and
environmental groups
Trends and recent development in the prosperity
of the entity and range of its activities


Process of Accounting

Managerial Accounting as value addition tool to organization


Interpreting
Evaluating
Reporting & Securing
(P/L Account,
Balance Sheet,
Cash Flow Statement)
Processing & Classifying (Ledger)

Recording/Book-Keeping
(Journalizing)
Pro active participation in decision making and planning
Assist in directing & controlling operations
Motivating managers to achieve goals
Measuring performance of activities
Achieving competitiveness in the long run
(You want to be on the team. You want to be the business consultant. You want to be thought of as a
value adding department or just someone who closes the books of accounts)
Accounting Principles
Cost Principle
Dual Aspect Principle
Accrual Principle
Conservatism Principle
Matching Principle
Consistency Principle
Materiality Principle
Full Disclosure Principle
Cost Principle
The cost principle requires that the assets be recorded in the books of accounts at the price at
which they were purchased i.e. acquisition cost/historical cost
Thus, historical cost is recognized as the appropriate valuation basis for recording of the
purchase of all goods & services, expenses, costs & equities
Business transactions are normally measured in terms of the actual prices or costs at the time
the transaction occurs
Dual Aspect Principle
The accountant records events/transactions affecting the wealth of a particular entity
Since the business entity is treated as a separate economic unit for accounting purposes, it is
important to know that how does a transaction affect the wealth of the business
Liabilities = Sources of Wealth
Assets = Uses of Wealth
For every single business transaction a double impact is recorded, one on the sources of
wealth and the other on the uses of wealth
The sources of wealth must be equal to the use of wealth. Any business transaction which is
done actually affects both, sources of wealth & uses of wealth in a way that both liabilities
and assets are equal
Accrual Principle
Accrual principle emphasizes on those transactions which have cash consequences for the firm
but involve no cash at the moment
Accrual = recording those transactions which have cash impact & also which have no
immediate cash impact
Thus, Accrual takes into consideration the timing of recording of cash transactions & non-cash
transactions
Conservatism Principle
This principle is often summarized as record all probable losses but do not record probable
profits
The principle of conservatism is necessary to be followed to present the true picture of a
firms performance in the periodic financial statements in front of the shareholders (owners)
Matching Principle
The essence of matching principle lies in the fact that costs/expenses of producing the product
must be recorded in the period when the related revenues are earned (not necessarily
realized)
For example, when goods are sold in a particular year and revenue is earned, the cost of
producing the same goods must be recorded in the books of accounts of the same year
Consistency Principle
For the purpose of uniformity & comparability of financial statements of various periods, it is
required that the accounting policies be adopted in a uniform manner
Accounting policies might be altered by the business entity only if the adoption of the new
policies lead to better and more clear presentation of firms financial condition
Materiality Principle
Events should only be reported in the financial statements if they are material and may have
significant impact on the performance of the firm & its financial position
Information which can have an impact on the decision of the investors to invest in the firm are
a must to be presented
Full Disclosure Principle
The principle of full disclosure requires that a business enterprise should provide all relevant
information to external users for the purpose of sound economic decisions
This concept implies that no information of substance or of interest to the average investors
will be omitted or concealed from being disclosed in an entitys financial statements

BASIC ACCOUNTING CONCEPTS
Business Entity/ Separate Entity Concept
Monetary Unit Assumption
Going Concern Assumption
Time Period Assumption
Accrual Concept
Historical Cost Concept
Materiality

Business Entity Concept
In accounting we treat a business or an organization and its owners as two separately identifiable
parties. This concept is called business entity concept.
Businesses are organized either as a proprietorship, a partnership or a company.
In all forms the personal transactions of the owners are not mixed up with the
businesses'.
Example: A doctor has taken a house with three rooms, on rent for Rs. 3,000 per month. He has setup
a clinic in the house and uses one room for the purpose. Under the business entity concept, only 1/3rd
of the rent or Rs. 1,000 should be charged to business, because the other 2 rooms or Rs. 2,000 worth
of rent is expended for personal purposes. He received Rs. 900 bill for electricity. He paid the whole
amount using his business account. Rs. 600 is to be considered a withdrawal because only Rs. 300
(1/3rd) related to business and the other Rs. 600 was for domestic purpose.
Monetary Unit Assumption
Accounting is the language of business and numbers are its letters.
Through accounting we can communicate only those accounting transactions and other events which
can be expressed in monetary units. This is called monetary unit assumption.
Going Concern Assumption
Financial statements are prepared assuming that the company is a going concern which means
that the company intends to continue its business and is able to do so.
The status of going concern is important because if the company is a going concern it has to
follow the accepted accounting standards.
The auditors of the company determine whether the company is a going concern of not at the
date of financial statements.
Time Period Assumption
Although businesses intend to continue in long-term it is always helpful to account
for their performance and position based on certain time periods because it provides
timely feedback and helps in making timely decisions.
Under time period assumption, we prepare financial statements quarterly, half-yearly or
annually. The income statement provides us an insight into the performance of the company
for a period of time.
The balance sheet (also known as the statement of financial position) provides us a snapshot
of the business' financial position (assets, liabilities and equity) at the end of the time period.
The statement of cash flows and the statement of changes in equity provide detail of how the
company's financial position changed during the time period.
Accrual Concept
Business transactions are recorded when they occur and not when the related payments are received
or made. This concept is called accrual basis of accounting and it is fundamental to the usefulness of
financial accounting information.
Example: An airline sells its tickets days or even weeks before the flight is made, but it does not record
the payments as revenue because the flight, the event on which the revenue is based has not
occurred yet.
An accounting firm obtained its office on rent and paid Rs. 120,000 on January 1. It does not record
the payment as an expense because the building is not yet used, completely to the extent of rent
paid. While preparing its quarterly report on March 31, the firm expensed out three months worth of
rent i.e. 30,00 [Rs. 120,000/12*3] because 3 months equivalent of time has expired.
A business records its utility bills as soon as it receives them and not when they are paid, because the
service has already been used. The company ignored the date when the payment will be made.
Historical Cost Concept
Accounting is concerned with past events and it requires consistency and comparability that is
why it requires the accounting transactions to be recorded at their historical costs. This is
called historical cost concept.
Historical cost is the amount of resources given up to acquire the asset or consume the service
or the amount of liability incurred.
In subsequent periods when there is appreciation is value, the value is not recognized as an
increase in assets value except where otherwise required by the standards.
Example: 100 units of an item were purchased one month back for Rs. 10 per unit. The price today is
Rs. 11 per unit. The inventory shall appear on balance sheet at Rs. 1,000 and not at Rs. 1,100.
The company built its ERP in 2008 at a cost of Rs. 40 million. In 2010 it is estimated that the present
value of the future benefits attributable to the ERP is Rs. 1 billion. The ERP shall stand on balance
sheet at its historical costs less accumulated depreciation
The concept of historical cost is important because market values change so often that allowing
reporting of assets and liabilities at current values would distort the whole fabric of accounting,
impair comparability and makes accounting information unreliable.

Materiality
Financial statements are prepared to help the users with their decisions. Hence, all such
information which has the ability to affect the decisions of the users of financial statements is
material and this property of information is called materiality.
In deciding whether a piece of information is material or not requires considerable judgment.
Information is material either due to the amount involved or due to the importance of the
event.
Examples: The government of the country in which the company operates in working on a new
legislation which would seriously impair the company's operations in future. Although there are
no figures involved but the impact is so large that disclosure is imminent.
The remuneration paid to the executives and the directors is material.
The accounting policies are material because they help the users understand the figures.
Four Accounting Terms

Asset
Liability
Expense
Revenue
The Three Principal Financial Statements The End Products of Final Accounting
Profit & Loss Account
Balance Sheet
Cash Flow Statement
Profit & Loss Account
Also known as Income Statement
P/L presents results of operations of a business enterprise over a period of time
It presents the sources and amounts of revenues earned & streams & amounts of different
If the revenues are more and expenses are less there is a net income or net profit
If the revenues are less and the expenses are more the enterprise has incurred net loss
Balance Sheet
Also known as Statement of Financial Position
It shows the financial position of a business enterprise on a certain date
B/S indicates the investing & financing activities of a business enterprise at a point of time &
shows a firms assets, liabilities and shareholders equity usually at the last day of the year
Cash Flow Statement
It summarizes the flow of cash inflows and outflows of the firm over a period of time
It focuses on the items which bring about change in the cash balance of a business enterprise
between two balance sheet dates