Introduction to Financial Accounts

BOOK - KEEPINGBOOK - KEEPING Book keeping is the art and science ofBook keeping is the art and science of recording, recording, classifying and classifying and summarizing summarizing business transactions in money or business transactions in money or

money’s worth accurately and money’s worth accurately and systematically so that the businessman systematically so that the businessman may be able to know his profit or loss may be able to know his profit or loss during a specific period and also his during a specific period and also his financial position on a particular date. financial position on a particular date.

ACCOUNTINGACCOUNTING MEANINGMEANINGAccounting extends far beyond the actual making Accounting extends far beyond the actual making

of records. Accounting is concerned with the use of records. Accounting is concerned with the use to which these records are put, their analysis and to which these records are put, their analysis and interpretation. interpretation.

Accounting is a wider term and includes the Accounting is a wider term and includes the recording, classifying and summarizing of recording, classifying and summarizing of business transactions in term of money, the business transactions in term of money, the preparation of financial reports, the analysis and preparation of financial reports, the analysis and interpretation of these reports for the information interpretation of these reports for the information and guidance of managementand guidance of management

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American Institute of Certified Public American Institute of Certified Public

Accounts {AICPA}Accounts {AICPA} has defined financial has defined financial accounting as “ the art of recording, accounting as “ the art of recording, classifying and summarizing in a significant classifying and summarizing in a significant manner in terms of money transactions and manner in terms of money transactions and events which in a part, at least of a financial events which in a part, at least of a financial character and interpreting the results thereof.” character and interpreting the results thereof.”

IS ACCOUNTING A SCIENCE OR AN IS ACCOUNTING A SCIENCE OR AN ART?ART?

Accounting is both a science and an art. Accounting is both a science and an art.

Science is a systematical body of knowledge Science is a systematical body of knowledge based on based on

certain principles certain principles which have universal application.which have universal application. establishes cause and effect relationship establishes cause and effect relationship based on observation, experimentsbased on observation, experiments

Art is the application ofArt is the application of knowledge knowledge comprising of some accepted theories, comprising of some accepted theories,

principles, rules, concepts and principles, rules, concepts and conventions. conventions. the more we practice an art the more the more we practice an art the more expert we become in it. expert we become in it.

OBJECTS OF ACCOUNTINGOBJECTS OF ACCOUNTING

1. To ascertain whether the business 1. To ascertain whether the business operations have been profitable or not.operations have been profitable or not.

Accounting helps us to know whether a Accounting helps us to know whether a business has earned profit or suffered loss business has earned profit or suffered loss during the accounting period. It will give us during the accounting period. It will give us an idea of efficiency of the business. To an idea of efficiency of the business. To determine profit or loss of the accounting determine profit or loss of the accounting period , a Trading and Profit and Loss period , a Trading and Profit and Loss Account is prepared.Account is prepared.

2. To ascertain the financial position of the 2. To ascertain the financial position of the business.business.

Balance Sheet or Position Statement is Balance Sheet or Position Statement is prepared to give an idea of the financial prepared to give an idea of the financial position of the business on a particular date. position of the business on a particular date. The financial position of an enterprise is The financial position of an enterprise is indicated by its assets on a given date and its indicated by its assets on a given date and its liabilities on that date. Excess of assets over liabilities on that date. Excess of assets over liabilities represent the capital and is liabilities represent the capital and is indicative of the financial soundness of an indicative of the financial soundness of an enterprise.enterprise.

3. To generate information.3. To generate information.

Accounting records generate such Accounting records generate such information which may be helpful to various information which may be helpful to various persons in persons in planning, control, evaluation of performance planning, control, evaluation of performance and decision making.and decision making.

FUNCTIONS OF ACCOUNTINGFUNCTIONS OF ACCOUNTING

1. Systematic record of business transactions.1. Systematic record of business transactions.

To keep systematic record of business To keep systematic record of business transactions, post them to the ledger and transactions, post them to the ledger and ultimately to prepare the final accounts.ultimately to prepare the final accounts.

2. Protecting the property of the business. A complete record of the assets of the

concern is available without any difficulty and therefore are not put to wrong use .

3. Communicating results to interested 3. Communicating results to interested partiesparties

This function requires to supply the This function requires to supply the meaningful information about the financial meaningful information about the financial activities of the business to the various parties activities of the business to the various parties i.e. owners, creditors, investors, employees, i.e. owners, creditors, investors, employees, government, public, research scholars and the government, public, research scholars and the managers at the right time.managers at the right time.

4. Compliance with legal requirements.4. Compliance with legal requirements.

The accounting system must be such which The accounting system must be such which may be able to comply with the legal may be able to comply with the legal requirements. Under various enactments a requirements. Under various enactments a businessman is required to file various businessman is required to file various statements e.g. income tax return, return for statements e.g. income tax return, return for sale tax purposes etc.sale tax purposes etc.

USERS OF ACCOUNTING USERS OF ACCOUNTING INFORMATIONINFORMATION

Accounting is the language of the business. As Accounting is the language of the business. As the primary aim of a language is to serve as a the primary aim of a language is to serve as a means of communication, accounting is used means of communication, accounting is used to communicate business information. The to communicate business information. The basic objective of accounting is to provide basic objective of accounting is to provide information which is useful for persons inside information which is useful for persons inside the organization and for persons or groups the organization and for persons or groups outside the organization.outside the organization.

(I) External Users of Accounting Information(I) External Users of Accounting Information External users are those groups or External users are those groups or persons who are outside the organization for persons who are outside the organization for whom accounting function is performed.whom accounting function is performed.

1. 1. InvestorsInvestors Those who are interested in investing money Those who are interested in investing money

in an organization are interested in knowing in an organization are interested in knowing the financial health of the organization to the financial health of the organization to know how safe the investment already made know how safe the investment already made is and how safe their proposed investment is and how safe their proposed investment will be. will be.

2. 2. CreditorsCreditors Creditors (i.e., suppliers of goods and Creditors (i.e., suppliers of goods and

services on credit, bankers and other lenders of services on credit, bankers and other lenders of money) want to know the financial position of money) want to know the financial position of a concern before giving loans or granting a concern before giving loans or granting credit. They want to be sure that the concern credit. They want to be sure that the concern will not experience difficulty in making their will not experience difficulty in making their payment in time , i.e. , liquid position of the payment in time , i.e. , liquid position of the concern is satisfactory. concern is satisfactory.

3. 3. Members of non-profit organisationsMembers of non-profit organisations

Members of non-profit organizations such as Members of non-profit organizations such as schools, colleges, hospitals, clubs, charitable schools, colleges, hospitals, clubs, charitable institutions etc, need accounting information to institutions etc, need accounting information to know how their contributed funds are being know how their contributed funds are being utilized and to ascertain if the organisation utilized and to ascertain if the organisation deserves continued support or support should deserves continued support or support should be withdrawn keeping in view the bad be withdrawn keeping in view the bad performance depicted by the accounting performance depicted by the accounting information an diverted to another information an diverted to another organisation,organisation,

4. 4. GovernmentGovernment Central and state governments are interested in Central and state governments are interested in

the accounting information because they want the accounting information because they want to know earnings or sales for a particular to know earnings or sales for a particular period for purposes of taxation.period for purposes of taxation.

Government also need accountingGovernment also need accounting informationinformation for compiling statistics concerning business for compiling statistics concerning business which, in turn helps in compiling nationals which, in turn helps in compiling nationals accounts.accounts.

4. 4. ConsumersConsumers Consumers need accounting information for Consumers need accounting information for

establishing good accounting control so that of establishing good accounting control so that of production may be reduced with the resultant production may be reduced with the resultant reduction of the prices of goods they buy. reduction of the prices of goods they buy.

Sometimes, prices for some goods are fixed by Sometimes, prices for some goods are fixed by the government, so it needs accounting the government, so it needs accounting information to fix reasonable prices so that information to fix reasonable prices so that consumers and manufactures on their consumers and manufactures on their investment shown in the accounting records.investment shown in the accounting records.

(II) (II) Internal Users of Accounting InformationInternal Users of Accounting Information

1. Owners1. Owners

The owners provide funds for the operations The owners provide funds for the operations of a business and they want to know whether of a business and they want to know whether their funds are being properly used or not. their funds are being properly used or not. They need accounting information to know They need accounting information to know the profitability and the financial position of the profitability and the financial position of the concern in which they have invested their the concern in which they have invested their funds. funds.

2. Management 2. Management

Accounting information is an aid in this respect Accounting information is an aid in this respect because it helps a manager in planning, control, because it helps a manager in planning, control, decision making and appraising the performance decision making and appraising the performance of the subordinates. of the subordinates.

Actual performance of the employees can be Actual performance of the employees can be compared with the budgeted performance they compared with the budgeted performance they were expected to achieve and remedial action can were expected to achieve and remedial action can be taken if the actual performance is not up to the be taken if the actual performance is not up to the mark. Thus, accounting information provides mark. Thus, accounting information provides “The eyes and ears and ears to management.”“The eyes and ears and ears to management.”

3. 3. EmployeesEmployees Employees are interested in the financial Employees are interested in the financial

position of a concern they serve particularly position of a concern they serve particularly when payment of bonus depends upon the when payment of bonus depends upon the size of the profits earned. They seek size of the profits earned. They seek accounting information to know that the accounting information to know that the bonus being paid to them is correctbonus being paid to them is correct..

Branches of AccountingBranches of Accounting

1. Financial accounting1. Financial accounting The main purpose of this branch of accounting The main purpose of this branch of accounting

is to ascertain profit or loss during a specific is to ascertain profit or loss during a specific period, to show financial position of the period, to show financial position of the business on a particular date and to have business on a particular date and to have control over the firm’s property. Such control over the firm’s property. Such accounting records are used to impart useful accounting records are used to impart useful information to outsiders and to meet the legal information to outsiders and to meet the legal requirementsrequirements..

2. Cost Accounting2. Cost Accounting

The main aim of cost accounting is to The main aim of cost accounting is to ascertain cost relating to the various ascertain cost relating to the various activities of the business and to have control. activities of the business and to have control. The cost accountant is required to assemble The cost accountant is required to assemble and interpret cost data for the use of and interpret cost data for the use of management is controlling current operations management is controlling current operations and in planning for the future. and in planning for the future.

3. Management Accounting It supplies the management significant information

in order to assist the management to discharge its various functions such as planning, control, evaluation of performance and decision making etc.

Advantages of AccountingAdvantages of Accounting

1.1. Replacement of memoryReplacement of memory In a large business it is very difficult for a In a large business it is very difficult for a

businessman to remember all the businessman to remember all the transactions. Accounting provides records transactions. Accounting provides records which will furnish information as and when which will furnish information as and when desired and thus it replaces human memory.desired and thus it replaces human memory.

2. 2. Evidence in court Evidence in court

Properly maintained accounts are often treated Properly maintained accounts are often treated as good evidence in the court to settle a as good evidence in the court to settle a dispute. dispute.

3. Settlement of taxation liability If accounts are properly maintained, it will be of

great assistance to the businessman in settling the income tax and sale tax liability otherwise tax authorities may impose any amount of tax which the businessman will have to pay.

4. 4. Comparative studyComparative study It provides the facility of comparative study It provides the facility of comparative study

of the various aspects of the business such as of the various aspects of the business such as profits, sales, expenses etc. with that of profits, sales, expenses etc. with that of previous year and helps the businessman to previous year and helps the businessman to locate significant factor leading to the locate significant factor leading to the change, if any.change, if any.

5. Sale of business If accounts are properly maintained, it

helps to ascertain the proper purchase price in case the businessman is interested to sell his business.

Limitations of AccountingLimitations of Accounting

1. Records only monetary transactions1. Records only monetary transactions Accounting records only those transactions Accounting records only those transactions

which can be measured in monetary terms. which can be measured in monetary terms. Those transactions which cannot be Those transactions which cannot be measured in monetary terms as conflict measured in monetary terms as conflict between production manager and marketing between production manager and marketing manager, efficient management etc., may be manager, efficient management etc., may be very important for a concern but not very important for a concern but not recorded in the business books.recorded in the business books.

2.2. Effect of price level changes not considered Effect of price level changes not considered

Accounting transactions are recorded at cost in Accounting transactions are recorded at cost in the books. The effect of price level changes is the books. The effect of price level changes is not brought into the books with the result that not brought into the books with the result that comparison of the various years becomes comparison of the various years becomes difficult. For example, the sales to total assets difficult. For example, the sales to total assets in 2005 would be much higher than in 2000 in 2005 would be much higher than in 2000 due to rising prices, fixed assets being shown due to rising prices, fixed assets being shown at cost and not at market price. at cost and not at market price.

3. Personal bias of accountant affects the 3. Personal bias of accountant affects the accounting statementsaccounting statements

Accounting statements are influenced by the Accounting statements are influenced by the personal judgment of the accountant. He may personal judgment of the accountant. He may select any method of depreciation, valuation select any method of depreciation, valuation of stock, amortization of fixed assets, and of stock, amortization of fixed assets, and treatment of deferred revenue expenditure. treatment of deferred revenue expenditure. Such judgment based on integrity and Such judgment based on integrity and competency of the accountant will definitely competency of the accountant will definitely affect the preparation of accounting affect the preparation of accounting statements.statements.

4.No realistic information4.No realistic information

Accounting statements are prepared by Accounting statements are prepared by following basic concepts and conventions which following basic concepts and conventions which may not be realistic e.g going concern concept may not be realistic e.g going concern concept says business will continue and assets are says business will continue and assets are recorded at cost.yet the assets ay not realise their recorded at cost.yet the assets ay not realise their book value.book value.

5.Allows alternative treatments5.Allows alternative treatments

Providing depreciation on stright line or Providing depreciation on stright line or diminishing balance method, valuing stock on diminishing balance method, valuing stock on LIFO or FIFO method.LIFO or FIFO method.

6.Profit no real test of managerial 6.Profit no real test of managerial efficiencyefficiency

Profit may be shown in excess by manipulation Profit may be shown in excess by manipulation of accounts by suppressing costs like of accounts by suppressing costs like depreciation advertisement and research and depreciation advertisement and research and development.development.

7. Historical in nature7. Historical in nature

Information supplied in P&L Account and Information supplied in P&L Account and Balance Sheet is at the end of the year. It only Balance Sheet is at the end of the year. It only gives a view of what has already happened.gives a view of what has already happened.

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