2. Accounting
Development of Accounting
As old as money
Indian history derives its importance from Chankyas Arthshastra
Modern System accounting owes its origin to Pacoili, Italy 18 Century.
3. Accounting may be defined as the process of recording, classifying,
summarising, analysing and interpreting the financial transactions and
communicating the results thereof to the persons interested in the
information.
4. Functions Of Accounting: Functions of accounting is to provide quantitative
information, primarily of financial nature, about economic entities, that are needed
to be useful in making economic decisions.
Accounting may be defined as the process including the following steps.
1. Recording: Basic function of accounting. Recording in orderly manner is
important. And this is done in the book called “Journal”.
2. Classifying: Systematic analysis of recorded data with a view to group transaction
or entries of one nature at one place. And the book is termed as “Ledger”.
3. Summarizing: Presenting the classified data in a manner understandable by
internal and external users. To do so we prepare “Trial Balance”, “Income
statement” and “balance Sheet”.
4. Dealing with financial transactions only
5. 5. Analysis And interpretation: The recorded data is then analysed and
interpreted in a manner that the end users can make meaningful judgements
with the help of them.
6. Communicating: Communication in proper form and person plays
important role.
6. Financial accounting is an essential process for any business, and
one that needs to be carried out with diligence. Financial
accounting is required by law, and comes in the form of a set of
mandatory documents that registered companies must put
together and present, generally in their annual report.
7. Definition: Financial accounting is a branch of accounting wherein an
organisation records, summarises, and reports their business
transactions over a certain time period.
Financial accounting is summarised and presented in the form
of financial statements, which include a balance sheet, an income
statement, a cash flow statement, and sometimes a statement of
retained earnings. These statements are used to inform stakeholders,
creditors, tax authorities, and regulators of an organisation’s financial
activity and performance, and can be used to identify malpractice and
fraud.
8. Objectives of financial Accounting:
Compliance with Statutory Requirements.
Safeguarding of Interest of Various Stakeholders.
Helps in the Measurement of Profit and Loss of Business.
Presentation of Historical Records.
Focus on External Transaction of Business.
9. Users Of Accounting Information:
Proprietors
Managers
Creditors
Prospective Investors
Government
Employees
Citizen
10. It is well established that accounting, especially financial accounting is of
absolute importance. Whether it is the management of the company or other
external stakeholders, they depend on these financial statements for their dose
of information about a firm’s financial transactions and position. However,
accounting is not a perfect science yet. Let us take a look at some limitations of
accounting.
Measurability
One of the biggest limitations of accounting is that it cannot measure
things/events that do not have a monetary value. If a certain factor, no matter
how important, cannot be expressed in money it finds no place in accounting.
No Future Assessment
The financial statements show the financial position of the firm on the date of
preparation. The users of the statement are more interested in the future of the
company in the short term and long term. However, accounting does not make
any such estimates. And due to the dynamic nature of the business
environment, a lot can change between such dates. Auditors sometimes do
disclose the important events occurring after the balance sheet date to rectify
these limitations of accounting.
11. Historical Costs
Accounting often uses historical costs to measure the values. This fails to take into
consideration factors such as inflation, price changes, etc. This skews the relevance
of such accounting records and information. This is one of the major limitations of
accounting.
Accounting Policies
There is no global standard in accounting policies. In India, we follow the
Accounting Standards. Americans follow the GAAP and then there are the
international standards, namely the IFRS. And if a global company operates in more
than one country, there may be confusion.
Not all accounting policies follow the same line of thinking, and conflicts may arise
due to this. It has long been said that the whole world must agree on uniform
accounting policies but this has not happened yet.
12. Estimates
Sometimes in accounting estimation may be required as it is not possible to establish
exact amounts. But these estimates will depend on the personal judgment of the
accountant. And estimates are extremely subjective in nature. They are basically a
person’s guess of future events. In accounting, there are many cases where such
estimates need to be made like provision of doubtful debt, methods of depreciation,
etc.
Verifiability
An audit of the financial statements does not guarantee the correctness of such
statements. The auditor can only assure that the statements are free from error to
the best of his judgment.
Errors and Frauds
Accounting is done by humans, so there will always be the scope of human errors.
There is also the fear of possible manipulation of accounts to cover up a fraud. Since
fraud is deliberate, it is that much harder to spot. This is one of the most dreaded
limitations of accounting.
13. Branches Of Accounting: Different Branches to cater different people. Broadly classified
into two categories:
1. Financial Accounting .
2. Management Accounting.
Financial Accounting: Original form of accounting, mainly confined to thr preparation of
financial statements for end users. These statements mainly show the manner in which
operations of the business have been conducted during a specified period.
Management Accounting: It is accounting for management. This provide necessary
information to the management for discharging its functions. Management Accounting
is the application of professional information in such a way as to assist the
management in the formation of policies and in the planning and control of the
operation of the undertaking.
14. Difference Between Management Accounting And Financial Accounting
Financial Accounting Management Accounting
Objectives Designed to supply
information like profit and
loss and balance sheet for
outsiders.
Designed principally for
internal use of
management.
Analysing Performance Portrays the position of
business as a whole.
Management accounting
directs its attention to the
various divisions and
departments indicating
profitability, performance
etc.
Data Used Monetary records of past
event.
It applies accounting for
future and hence supplies
with the detailed analysis
for both present and future
in “Management
Language”.
15. Financial Accounting Management Accounting
Monetary Measurement Only events that are
related to economic
events finds place Money
measured.
Management is also
interested in non-
monetary economic
events.
Periodicity od reporting Yearly or half yearly. Frequent intervals
Precision More Less
Nature Objective Subjective
Legal Compulsion Must Free to do as per need.
16. Accounting Principles: Accounting principles may be defined as those rules
of actions adopted by accountants universally while recording accounting
transactions. These Principles can be classified into two categories.
17. Accounting Concepts: The term concepts include those basic assumptions or
conditions upon which the science of accounting is based. The following are the
important concepts of accounting.
1. Separate Entity Concept: This concept assumes that the organization and
business owners are two independent entities. Hence, the business translation
and personal transaction of its owner are different. The transaction the we
record in the books are from the business point of view and not from the
owners point of view. when the business owner invests his money in the
business, it is recorded as a liability of the business to the owner. Similarly,
when the owner takes away from the business cash/goods for his/her personal
use, it is not treated as a business expense.
2. Going Concern Concept: The Going concept in accounting states that a business
activities will be carried by any firm for an unlimited duration This simply
means that every business has continuity of life. Hence, it will not be dissolved
shortly. This is an important assumption of accounting as it provides a base for
representing the asset value in the balance sheet.
18. For example, the plant and machinery was purchased by a company of Rs. 10 lakhs
and its life span is 10 years. According to the Going concept, every year some amount
of assets purchased by the business will be represented as an expense and the
balance amount will be shown as an asset in the books of accounts. Thus, if an
amount is incurred on an item that will be used in business for several years ahead, it
will not be proper to charge the amount from the revenues of that particular year in
which the item was purchased Only a part of the purchase value is shown as an
expense in the year of purchase and the remaining balance is shown as an asset in
the balance sheet.
3. Money Measurement Concept: The money measurement concept assumes that
the business transactions are made in terms of money i.e. in the currency of a
country. In India, such transactions are made in terms of the rupee. Hence, as per the
money measurement concept, transactions that can be expressed in terms of money
should be recorded in books of accounts. Events or transactions which cannot be
expressed in terms of money do not find place in the books of accounts though they
may be very useful for the business. Example: A group of dedicated employees.
19. 4. Cost Concept: This Concept is closely related to going concern concept.
According to this concept
An asset is ordinarily entered in the accounting records at the price
paid to acquire it, and
this cost is the basis for all subsequent accounting for the assets.
5. Dual Aspect Concept: This is the basic concept of accounting. According
to this concept every business transaction has a dual effect. The dual
aspect concept indicates that each transaction made by a business
impacts the business in two different aspects which are equal and
opposite in nature. This concept form the basis of double-entry
accounting and is used by all accounting frameworks for generating
accurate and reliable financial statements.
The accounting equation used in this concept is : Assets = Liabilities +
Equity
20. 6. Accounting Period Concept: An accounting period is an established range of
time during which accounting functions are performed, aggregated, and
analysed. An accounting period may consist of weeks, months, quarters,
calendar years, or fiscal years. The accounting period is useful in investing
because potential shareholders analyse a company’s performance through its
financial statements, which are based on a fixed accounting period.
7. Periodic Matching Of Cost and Revenue Concept: Ultimate aim of business
is to make profit. In order to ascertain the profit made by the business during
a period, it is necessary that ‘revenue’ of that period should be matched with
the cost of that period. The term Matching means appropriate association of
related revenues and expenses. Incentives of January for sales in December.
8.Realisation Concept: According to this concept revenue is recognised when a
sale is made. Sale is considered to be made at the time when the property in
goods passes to the buyer and he becomes legally liable to pay.
21. Exceptions to this concept
1. In case of hire-purchase, the ownership transfers when the last instalment is paid.
2. In case of contracts, the contractor is liable to pay only when the whole contract is
completed as per the terms of the contract.
22. Accounting Conventions: Accounting conventions are guidelines used to help
companies determine how to record certain business transactions that have
not yet been fully addressed by accounting standards. These procedures and
principles are not legally binding but are generally accepted by accounting
bodies. The scope and detail of accounting standards continue to widen,
meaning that there are now fewer accounting conventions that can be used.
Accounting conventions are not set in stone, either. Instead, they can evolve
over time to reflect new ideas and opinions on the best way to record
transactions.
The four major conventions that are taken care off are:
24. 1. Conservatism: Based on Playing safe side. Where The accountant follow the
rule of anticipate no profit but provide for all possible losses.
In the initial stage of accounting, certain anticipated profits which were recorded,
did not materialise. This resulted in less acceptability of accounting figures by end
users. On account of this reason, the accountants follow the rules “Anticipate no
profit but provide for all possible losses’.
On account of this convention, the inventory is valued at cost or market price
which ever is less and also a provision is made for possible bad and doubtful debts,
depreciation etc. out of current years profit. This concept effects principally the
category of current assets.
This convention has become the target of serious criticism because it goes against
the convention of full disclosure. It encourages accountants to create secret
reserves in name of bad and doubtful debts. The financial statement in this case
do not deficit a true and fair view of state of business.
25. 2.Full Disclosure: According to this convention accounting reports should disclose
fully and fairly the information they purport to represent. They should be honestly
prepared and sufficiently disclose information which is of material interest to
proprietors, present and potential creditors and investors. This convention is gaining
more importance because most business is running in joint stock companies where
ownership is divorced from management. The company act says that the income
statement and the balance sheet of the company must give a true and fair view of
the state of affairs of the company but also gives the prescribed forms in which these
statements are to be produced.
3. Consistency: According to this convention, accounting practices should remain
unchanged from one period to another. If stock is valued at ‘Cost or market price
whichever is less’, this principle should be followed year after year. Similarly if
depreciation is charged on fixed assets according to the diminishing balance method,
it should be done in same way year after year. This is useful for comparisons as the
ground remain same, however this should not effect the flexibility of recording the
transactions to fullest.
26. 4. Materiality: The convention of materiality states that, to make financial
statements meaningful, only material fact i.e. important and relevant information
should be supplied to the users of accounting information. The question that arises
here is what is a material fact. The materiality of a fact depends on its nature and the
amount involved. Material fact means the information of which will influence the
decision of its user.
