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Parts of accounting
Role of Financial Accounting
Users of Accounting Information
Fundamental Accounting Assumptions
Financial vs Management Accounting
Financial accountancy (or financial accounting) is the field of accountancy concerned with the
preparation of financial statements for decision makers, such as stockholders, suppliers, banks,
employees, government agencies, owners and other stakeholders.
Financial accounting is the process of summarising financial data, which is taken from an
organisation's accounting records and publishing it in the form of annual or quarterly reports, for
the benefit of people outside the organisation.
Financial accountancy is governed not only by local standards but also by international accounting
Parts of accounting
STAGE 3 LEDGER
ASCERTAINMENT OF THE FINANCIAL POSITION OF BUSINESS
Businessman is not only interested in knowing the result of the business in terms of profits or loss for a particular period
but is also anxious to know that what he owes (liability) to the outsiders and what he owns (assets) on a certain date. To
know this, accountant prepares a financial position statement of assets and liabilities of the business at a particular point
of time and helps in ascertaining the financial health of the business.
SYSTEMATIC RECORDING OF TRANSACTION
Basic objective of accounting is to systematically record the financial aspects of business transaction i.e. book-keeping.
These recorded transactions are later on classified and summarized logically for the preparation of financial statements
and for their analysis and interpretation.
ASCERTAINMENT OF RESULT OF ABOVE RECORDED TRANSACTIONS
Accountant prepares profit and loss account to know the result of business operations for a particular period of time. If
revenue exceed expenses then it is said that business running under loss. The profit and loss account helps the
management and different stakeholders in taking rational decisions.
PROVIDING INFORMATION TO THE USERS FOR RATIONAL DECISION-MAKING
Accounting as a ‘language of business’ communicates the financial result of an enterprise to various
stakeholders by means of financial statements. Accounting aims to meet the financial information needs
of the decision-makers and helps them in rational decision-making.
TO KNOW THE SOLVENCY POSITION
By preparing the balance sheet, management not only reveals what is owned and owed by the enterprise,
but also it gives the information regarding concern’s ability to meet its liabilities in the short run
(liquidity position) and also in the long-fun (solvency position) as and when they fall due.
Role of financial accounting
Financial accounting generates some key documents, which includes profit and loss account,
patterning the method of business traded for a specific period and the balance sheet that provides a
statement, showing mode of trade in business for a specific period.
It records financial transactions showing both the inflows and outflows of money from sales, wages
Financial accounting empowers the managers and aids them in managing more efficiently by
preparing standard financial information, which includes monthly management report tracing the
costs and profits against budgets, sales and investigations of the cost.
It provides legal information to stakeholders such as financial accounts in the form of trading, profit
and loss account and balance sheet.
It shows the mode of investment for shareholders.
It provides business trade credit for suppliers.
It notifies the risks of loan in business for banks and lenders.
Financial accounting is based on several principle s known as Generally Accepted Accounting Principles
(GAAP) .These include the business entity principle, the objectivity principle, the cost principle and the
Business entity principle
Every business requires to be accounted for separately by the proprietor. Personal and business-related
dealings should not be mixed.
The information contained in financial statements should be treated objectively and not shadowed by
The information contained in financial statements requires it to be based on costs incurred in business
The business will continue operating and will not close but will realise assets and discharge liabilities in
the normal course of operations.
Maintaining systematic records
It is a primary function of accounting to keep a proper and chronological record of transactions and
events, which provides a base for further processing and proof for checking and verification purposes. It
embraces writing in the original/subsidiary books of entry, posting to ledger, preparation of trial balance
and final accounts.
Meeting legal requirements
Accounting helps to comply with the various legal requirements. It is mandatory for joint stock
companies to prepare and present their accounts in a prescribed form. Various returns such as income
tax, sales tax are prepared with the help of the financial accounts.
Protecting and safeguarding business assets
Records serve a dual purpose as evidence in the event of any dispute regarding ownership title of any
property or assets of the business. It also helps prevent unwarranted and unjustified use. This function is
importance, for it makes the best use of available resources.
Facilitates rational decision-making
Accounting is the key to success for any decision-making process. Managerial decisions based on facts
and figures take the organisation to heights of success. An effective price policy, satisfied wage structure,
collective bargaining decisions, competing with rivals, advertisement and sales promotion policy etc all
owe it to well set accounting structure. Accounting provides the necessary database on which a range of
alternatives can be considered to make managerial decision-making process a rational one.
Records only monetory aspects
One of the major limitations of financial accounting is that it does not take into account the nonmonetary facts of the business like the competition in the market, change in the value for money etc.
No clear idea of operating efficiency
You will agree that, at times, profits may be more or less, not because of efficiency or inefficiency but
because of inflation or trade depression. Financial accounting will not give you a clear picture of
operating efficiency when prices are rising or decreasing because of inflation or trade depression.
Not helpful in price fixation
In financial accounting, costs are not available as an aid in determining prices of the products, services,
production order and lines of products.
Provides only historical information
Financial accounting is mainly historical and tells you about the cost already incurred. As financial data
is summarised at the end of the accounting period it does not provide day-to-day cost information for
making effective plans for the coming year and the period after that.
No analysis of losses
It fails to provide complete analysis of losses due to defective material, idle time, idle plant and
equipment. In other words, no distinction is made between avoidable and unavoidable wastage.
Inadequate information for reports
It does not provide adequate information for reports to outside agencies such as banks, government,
insurance companies and trade associations.
Users of accounting information
for analyzing the organization's performance and position and taking appropriate measures to improve
the company results.
for assessing company's profitability and its consequence on their future remuneration and job security.
for analyzing the viability and profitability of their investment and determining any future course of
for determining the credit worthiness of the organization. Terms of credit are set by creditors according to the assessment
of their customers' financial health. Creditors include suppliers as well as lenders of finance such as banks.
for analyzing the feasibility of investing in the company. Investors want to make sure they can earn a reasonable return on
their investment before they commit any financial resources to the company.
• Regulatory Authorities
for ensuring that the company's disclosure of accounting information is in accordance with the rules and regulations set in
order to protect the interests of the stakeholders who rely on such information in forming their decisions.
FUNDAMENTAL ACCOUNTING ASSUMPTION
The Accounting Standard (AS-1) ‘Disclosure of Accounting Policies’ issued by Institute of Chartered Accountants of India, which states that there
are three fundamental accounting assumptions:
The enterprise is normally viewed as a going concern, i.e. as continuing operations for the foreseeable future. It is assumed that the enterprise has
neither the intention nor the necessity of liquidation.
If an enterprise is not a going concern -Valuation of its assets and liabilities on historical cost becomes irrelevant and as a consequence its
profit/loss may not give reliable information.
It is assumed that accounting policies are consistent from one period to another. This adds the virtue of comparability to accounting data. If
comparability is lost the relevance of accounting data for users judgment and decision making is gone.
Revenues and cost are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the
financial statements of the periods to which they relate. This assumptions is the core of accrual accounting system.
Generally Accepted Accounting Principles (GAAP)
These are diverse in nature but based on a few basic principles as advocated by all GAAP rules. These
principles include consistency, relevance, reliability and comparability. GAAP ensures that all
companies are on a level playing field and that the information they present is consistent, relevant,
reliable and comparable.
International Financial Reporting Standards (IFRS)
These are issued by the International Accounting Standards Board (IASB), a committee comprising of 14
members, from nine different countries, which work together to develop global accounting standards.
The aim of committee is to build universal standards that are translucent, enforceable, logical, and of
FINANCIAL VS MANAGEMENT ACCOUNTING
Backward looking: focuses mostly on
reporting past performance.
Forward looking: includes estimates and
predictions of future events and transactions.
Emphasis on reliability of the information.
Can include many subjective estimates
Provides general purpose information used by Provides many reports tailored to specific users.
investors, stock analysts and regulators.
Provides a high-level summary of the
Can provide a great deal of detail.
Auditing is a systematic and independent examination of data, statements, records, operations and
performance (financial or otherwise) of an enterprise for a stated purpose.
In any auditing situation, the auditor perceives and recognises the propositions before him for
examination, collects evidence, evaluates the same and on this basis , formulates his judgment which is
communicated through his audit report.
Primary objective –as per Section 227 of the Companies Act 1956, the primary duty (objective) of the auditor is to report to the owners whether the balance
sheet gives a true and fair view of the Company’s state of affairs and the profit and loss A/c gives a correct figure of profit of loss for the financial year.
Secondary objective – it is also called the incidental objective as it is incidental to the satisfaction of the main objective. The incidental objective of auditing
• Detection and prevention of Frauds, and
• Detection and prevention of Errors.
Detection of material frauds and errors as an incidental objective of independent financial auditing flows from the main objective of determining whether or not
the financial statements give a true and fair view. As the Statement on auditing Practices issued by the Institute of Chartered Accountants of India states, an
auditor should bear in mind the possibility of the existence of frauds or errors in the accounts under audit since they may cause the financial position to
Fraud refers to intentional misrepresentation of financial information with the intention to deceive. Frauds can take place in the form of manipulation of accounts,
misappropriation of cash and misappropriation of goods. It is of great importance for the auditor to detect any frauds, and prevent their recurrence. Errors refer to
unintentional mistake in the financial information arising on account of ignorance of accounting principles i.e. principle errors, or error arising out of negligence of
accounting staff i.e. Clerical errors.