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financial accounting and auditing


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financial accounting and auditing objectives importance benefits users

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financial accounting and auditing

  1. 1. CONTENTS  • • • • • • • • • • • • • Financial Accounting Introduction Parts of accounting Accounting cycle Objectives Role of Financial Accounting Importance Principles Benefits Limitations Users of Accounting Information Fundamental Accounting Assumptions Accounting Standard Financial vs Management Accounting  Auditing • Meaning • Objectives
  2. 2. INTRODUCTION  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 standard.
  5. 5. OBJECTIVES  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.
  6. 6. 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.
  7. 7. 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 etc.  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.
  8. 8. IMPORTANCE  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.
  9. 9. PRINCIPLES 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 going-concern principle. Business entity principle Every business requires to be accounted for separately by the proprietor. Personal and business-related dealings should not be mixed. Objectivity principle The information contained in financial statements should be treated objectively and not shadowed by personal opinion.
  10. 10. Cost principle The information contained in financial statements requires it to be based on costs incurred in business transactions. Going-concern principle The business will continue operating and will not close but will realise assets and discharge liabilities in the normal course of operations.
  11. 11. BENEFITS  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.
  12. 12. 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 of paramount 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.
  13. 13. LIMITATIONS  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.
  14. 14.  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.
  15. 15. Users of accounting information  Internal users • Management for analyzing the organization's performance and position and taking appropriate measures to improve the company results. • Employees for assessing company's profitability and its consequence on their future remuneration and job security. • Owners for analyzing the viability and profitability of their investment and determining any future course of action.
  16. 16.  External users • Creditors 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. • Investors 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.
  17. 17. 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:  Going concern 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.  Consistency 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.  Accrual 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.
  18. 18. ACCOUNTING STANDARD  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 high quality.
  19. 19. FINANCIAL VS MANAGEMENT ACCOUNTING FINANCIAL ACCOUNTING 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 business. Can provide a great deal of detail.
  20. 20. Meaning 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.
  21. 21. OBJECTIVES  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 are: • 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 be mis-stated. 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.