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Basics of Financial

Accounting

Managerial Decision
Making
Management means
Optimum utilisation of available scarce resources
For achieving given objectives of the organisation.

Single

Multiple

These have to be achieved within a reasonable


period of time, using the available (both present
and potential) resources, including man-power,

Managers have to have:


The most appropriate or optimum use of these

resources,
Considering
Their total availability,
Their total demand and
Cost of availing and using these
For the highest possible degree of achievement

of the given objectives.

Considerations for managerial


decision making

Quantitative criteria
Non- Quantitative criteria

Quantitative criteria
In terms of:
-

cost
price & profit
income
investment, etc.

Non- Quantitative
criteria
In terms of satisfaction &
dissatisfaction of:
-

labour & other employees


customers & society
suppliers
shareholders, etc.

Problems for decision


making

1. Fixing Sales price

2. Managing cost of production


3. Accepting a special order
4. Make-or-buy problem
5. Sell or process further
6. Fixing prices of joint products
7. Controlling cost and revenue
8. Minimum quantity to produce & profit planning
9. To take up a project involving capital expenditure

Sources of information
for decision making
I) Sources of Quantitative

Information
II) Sources of Non-Quantitative

Information

Sources of Quantitative
Information
a) Financial Accounts
b) Cost Accounts
c) Outside Sources

Sources of Non-Quantitative
Information
Information about
Economic,
Social,
Political,
Technological,
Geographical and
Demographic
conditions

FROM

Surveys,
Reports,
Researches, etc.
conducted by
government and
non-government
organisations.

Accounting

Accounting is as
old as money.

Accounting is defined as
the process of identifying,
measuring and
communicating economic
information to facilitate
informed judgements and
decisions by users of the

Accounting vs. Book


keeping
BOOK KEEPING

ACCOUNTANCY

1. Book-keeping is

1. Accounting begins

the basis of
accounting.
2. In book-keeping
statements showing
net results and
financial position
are not prepared.
3. It is mechanical
in nature and does
not require special

where book-keeping
ends.
2. Here net results and
financial positions are
recorded.
3. It requires special
skills and ability to
analyse and interpret.

Classification of
Accounting
1. Financial Accounting
2. Cost Accounting
3. Management Accounting
4. Human Resource Accounting
5. Social Responsibility Accounting
6. Environmental Accounting

Parties Interested in
Accounting
Information
1. Owners
2. Investors

3. Creditors
4. Lenders

Contd
5. Employees or workers
6. Managers
7. Government
8. Researchers

Financial
Accounting
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 results thereof.

Features Of
Accounting
1. It records transactions of financial

character.
2. It records transactions in terms of
money.
3. Accounting is an art of recording and
classifying business transactions.
4. Summarizing
5. Analysis and interpretation of results.

Functions of
Accounting
1. Keeps a systematic & permanent record of all

financial transactions of the business.


2. Keeps a record of incomes & expenses to find

out the net result quickly.


3. Keeps a record of assets and liabilities so as to

gain knowledge about the net position of the


business.
4. Keeps track of all changes in values of assets &

liabilities.

Contd
5. Facilitates control on expenses.
6. Helps in making decisions.
7. Provides information for meeting legal
requirements like tax returns, etc.

ADVANTAGES OF
ACCOUNTING
Helps in the payment of tax

Helps in remembering.

Acts as a proof in the court of law.

Helps in the sale of business.

Helps in the realisation of debts.

LIMITATIONS OF
ACCOUNTING
Financial accounting is not
absolutely exact and accurate.

It does not show what the


business is worth.

It does not present the whole


picture.

Window dressing is possible in


Balance sheets.

No effect of inflationary trends are

Qualitative Characteristics of
Accounting Information

understandability
usefulness
reliability.

Understandability
The accountant prepares financial

statements according to accepted


practices, generating information
that is believed to be
understandable.
Decision makers must interpret
accounting information and use it in
making decisions

Usefulness /
Relevance
To be useful, accounting

information must be relevant and


reliable.
Relevance means the information
can affect the outcome of a decision.
Provides

feedback.
Helps predict future conditions.
Is timely.

Reliability
Must represent what it is meant to

represent.
Must be credible.
Must be verifiable by independent
parties using the same methods of
measuring.
Must be neutral

Accounting
Process
Recording
Classifying
Summarizing
Analysis
Interpretation

of financial transactions.

Accounting
Assumptions
Separate entity assumption - the business is an
entity that is separate and distinct from its owners,
so that the finances of the firm are not co-mingled
with the finances of the owners.
Going concern assumption - the business is
going to be operating for the foreseeable future.
Monetary unit / Money Measurement
assumption only those transactions that are
capable of being expressed in terms of money are
included in the accounting records.

Contd.

Fixed time period / Accounting period


assumption information is prepared and
reported periodically (quarterly, annually,
etc.). Also referred to as periodicity
assumption.

Accounting Principles
The basic assumptions of accounting result
in the following accounting principles:
Historical cost principle
Assets are reported and presented at their
original cost
No adjustment is made for changes in market
value.
Accountants are very conservative in this
sense.
Costs never are written up.

Matching principle - matching of revenues

and expenses in the period earned and


incurred
Revenue recognition principle - revenue is
realized (reported on the books as earned)
when everything that is necessary to earn the
revenue has been completed.
Dual aspect principle every transaction
entered into by a firm will have two aspects
Verifiable objective principle it holds that
accounting should be free from personal bias.
All accounting transactions should be
evidenced and supported by business

Conventions That Help in the


Interpretation of Financial
Information
Comparability
Consistency
Materiality
Conservatism
Full disclosure
Cost-benefit.

Comparability
A decision maker can recognize

similarities, differences, and trends over


different time periods or between different
companies.
Accounting information is more useful if it
can be compared with similar facts about
the same company over several time
periods or about another company for the
same time period.

Consistency
An accounting procedure, once adopted by

a company, remains in use from one period


to the next unless users are informed of the
change.
GAAP requires that the change and its
dollar effect be described in the notes to the
financial statements

Materiality
Materiality refers to the relative importance

of an item or event.
An item is material if users would have
done something differently if they had not
known about the item.
Some accountants follow the 5% or more of
net income rule to judge materiality.

Conservatism
When accountants face major

uncertainties about which accounting


procedure to use, they generally
choose the one that is least likely to
overstate assets and income.
Abuse of the conservatism principle
may lead to financial statements that
are misleading.

Full Disclosure
Full disclosure requires that financial

statements and their notes present all


information that is relevant to the users
understanding of the statements.
Beyond required disclosures, application
of full disclosure is based on professional
judgment.
The demands for full disclosure have
increased in recent years.

Cost-Benefit
Benefits to be gained from providing

accounting information should be greater


than the costs of providing it.
Beyond providing minimum levels of
relevance and reliability, cost-benefit is
based on professional judgment

Accounting
Terminology
CAPITAL: Amount invested by the proprietor in the

firm.

Capital=Assets-Liabilities
LIABILITY: Amount which the firm owes to
outsiders.
Liabilities=Assets-Capital
ASSET: Anything that will enable the firm to get
cash or benefits in the future. Assets can be
classified as follows:
Fixed

assets
Current assets

DEBTORS: A person who owes money to the firm.


CREDITORS: A person to whom the firm owes the

money.
STOCK: The goods lying unsold on a particular

date.
Opening

stock
Closing stock

DRAWINGS: Amount of money or the value of

goods which the proprietor takes for his personal


use.

GROSS PROFIT: The difference between sales

revenue or the proceeds of the goods sold/services


rendered over its direct cost.
NET PROFIT: Profit made after allowing for all

expenses. Incase of expenses being more than


revenue, it is Net Loss.

Classification of
Assets
1. Current assets.
2. Investments.
3. Property, plant, and equipment.
4. Intangible assets.

Current Assets
Cash and other assets that are

reasonably expected to be converted to


cash, sold, or consumed over the next
year or the normal operating cycle of the
business, whichever is longer.

Investments
Investments are assets, usually long

term, that are not used in the normal


operations of the business and that
management does not plan to convert
to cash within the next year.

Property, Plant, and


Equipment
Long-term assets used in the

continuing operation of the business.


Also called fixed, operating, long-lived,

or tangible assets.
Often abbreviated as PP&E.

Intangible Assets
Intangible assets are long-term assets
that have no physical substance but
have a value based on the rights or
privileges that belong to their owner

Other Assets
Other assets are sometimes used for

all owned assets other than current


assets and PP&E.

Classification of
Liabilities
1. Current liabilities.
2. Long-term liabilities

Current Liabilities
Current liabilities are obligations due
to be paid or performed within a year
or within the normal operating cycle of
the business, whichever is longer.

Long-Term
Liabilities
Long-term liabilities are the debts of a
business that fall due more than one year
in the future or beyond the normal
operating cycle, or that are paid out of
non-current assets.

Owners or
Stockholders
Equity
Classification is affected by the form
of business organization:
Sole

Proprietorship.

Partnership.
Corporation

Sole Proprietorship
Owners equity represented
by Owners Capital account.

Partnership
Equity section is entitled
Partners Equity, with one capital
account for each partner.

Corporation
On the Balance Sheet the section is
entitled Stockholders Equity and has two
parts:
1. Contributed Capital, consisting of the
par value and amounts paid-in in excess
of par.
2. Retained Earnings.

The Accounting
Equation
The resources controlled by a
business are referred to as its assets.
For a new business, those assets
originate from two possible sources:
Investors

who buy ownership in the business


Creditors who extend loans to the business

Assets =
Resources

Liabilities + Owners' Equity


Claims on the Resources

Once business operations commence, there will

be income and perhaps additional capital


contributions and withdrawals such as dividends.
Assets =

Liabilities + Owners' Equity


+ Revenues
- Expenses
+ Gains
- Losses
+ Contributions
- Withdrawals

These additional items under owners' equity are


tracked in temporary accounts until the end of the
accounting period, at which time they are closed to
owners' equity.
The accounting equation holds at all times over

the life of the business.

Example
Mike Peddler decides to open a bicycle repair shop. To get

started he rents some shop space, purchases an initial


inventory of bike parts, and opens the shop for business.
Here is a listing of the transactions that occurred during the
first month:
Date
Transaction
Sep 1
Owner contributes $7500 in cash to capitalize the
Sep 8
Sep 15

Sep 18
Sep 25
Sep 28

business
Purchased $2500 in bike parts on account,
payable in 30 days.
Paid first month's shop rent of $1000.Sep17
Repaired bikes for $1100; collected $400 cash;
billed customers for the $700 balance.
$275 in bike parts were used
Collected $425 from customer accounts.
Paid $500 to suppliers for parts purchased

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