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Meaning of Financial Accounting

Accounting refers to the art of recording business transactions. Earlier Accounting was considered as a system

of recording day to day transactions but now days it is considered as the language of the business and also the

information system of the business. The businessman is interested in knowing the progress of his businesswhich can be judged only with the help of proper Accounting.

Definition of Financial Accounting

American Institute of certified ublic of Accountant

Accounting is the art of recording! classifying and summari"ing in an significant manner and in terms ofmoney! transactions and e#ents which are of financial character and interpreting the result there of.$

According to American Accounting Association

%Accounting is the process of Identifying! Measuring and communicating information to the #arious parties.$

&haracteristics of Accounting

Financial Accounting is the process in which business transactions are recorded systematically in the various books ofaccounts maintained by the organization in order to prepare financial statements. These financial statements are basicallyof two types: First is Profitability Statement or Profit and oss Account and second is !alance Sheet.

Following are the characteristics features of Financial Accounting:"# $onetary Transactions: %n financial accounting only transactions in monetary terms are considered. Transactions note&pressed in monetary terms do not find any place in financial accounting' howsoever important they may be frombusiness point of view.(# )istorical *ature: Financial accounting considers only those transactions which are of historical nature i.e. thetransaction which have already taken place. *o futuristic transactions find any place in financial accounting' howsoeverimportant they may be from business point of view.+# egal ,e-uirement: Financial accounting is a legal re-uirement. %t is necessary to maintain the financial accounting and

prepare financial statements there from. %t is also obligatory to get these financial statements audited.# /&ternal 0se: Financial accounting is for those people who are not part of decision making process regarding theorganization like investors' customers' suppliers' financial institutions etc. Thus' it is for e&ternal use.1# 2isclosure of Financial Status: %t discloses the financial status and financial performance of the business as a whole.3# %nterim ,eports: Financial statements which are based on financial accounting are interim reports and cannot be thefinal ones.4# Financial Accounting Process: The process of financial accounting gets affected due to the different accounting policiesfollowed by the accountants. These accounting policies differ mainly in two areas: 5aluation of inventory and 6alculationof depreciation.

urpose of Financial Accounting

The purpose of accounting can be summari"ed in the following manner'

(. Ascertain the results of operations during a period). Ascertain the financial position.

*. Maintaining a control o#er assets+. lanning in respect of cash

,. ro#iding information to ta- authorities and other go#ernment agencies.

. To properly match income with e-penses./. To pro#ide a reliable set of data with which to prepare financial reports for analysis purposes 0for owners!

lenders! in#estors! etc1.

2. To pro#ide a reliable set of data with which to report income for ta- purposes

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3bjecti#es and Functions of Financial Accouting.

(. To keep systematic record of business Transactions.

). To calculate profit and loss.*. To disclose the financial position.

+. To pro#ide information to #arious parties.

,. To facilitate decision making.

4ook keeping Accounting and Accountancy

4ook 5eeping' It is mainly concerned with record keeping and maintenance of books of accountingwhich is routine and clerical in nature. Identify! Measuring! recording and classifying the transaction in

ledger.

Accounting'Accouting starts where book6keeping ends. Accouting include the following acti#ities.

7ummari"ing the classified transactions in the form of 89 A:& and balance 7heet.

Analy"ing and interpreting the summari"ed results.

&ommunicating the information to #arious parties.

Accountancy

It is a subject which gi#es us knowledge! how to do Accouting. It pro#ides us a systematic knowledge of

Accounting. %Accounting refers to the entire body of the theory and practice of Accouting.$

;sers of Accounting Information

Internal users

(. 3wners

). Managers

*. In#estors

+. &reditors and Financial Institution

,. Employees

. . ublic

9imitations of Accounting

Financial accounting is the only branch of accounting and it is not prefect. There are large numbers o

limitations which open new way to use other tools of accounting.

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1. Financial accounting is of historical nature

Net effect of transactions are recorded in financial accounting which has happened in past. These accounts is

just postmortem of all events of business in past .These record does not help for future planning and other

managerial decisions. Financial accounting shows the profitability of business but it is failure to tell that is it

good or bad. Financial accounting is also failure to know the reasons of low profitability position

2. Financial accounting deals with overall profitability

Accounts of business are made by a way which shows only overall profitability .It does not shows net profit per

product , or per department or according to job . Thus to find difficult to all activities which do not give profit.

3. Absence of full disclosure of facts

In financial accounting we record only those activities and transactions which we can show or describe in

money. There are many other facts of business which are non financial and non monetary like efficient

management, demand of products of firm, good relations in industry, good working environments which can not

be known by financial accounting

4. Financial reports are interim report of business

Financial statements made by financial accounting is the interim report of firms all business work but financia

position and profitability which are shown in it is not fully true . !ue to adopting cost concept, all transactions

are recorded on it real cost but by changing in the time" it is the need of time to adjust cost of assets and

liabilities according toinflationof market. #ecause, financial accounting does not records according to inflationso its result does not show true position of business

5. Incomplete nowledge of costs

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From cost point of view, financial accounting is incomplete. In financial accounting, accountant does not

calculate each and every products total cost. $o, financial accounting does not help to determine the price of

product of business

!. "o provision of cost control

Financial accounting does not help business organi%ation for controlling the cost. #ecause, there is no provision

of controlling cost in it. In financial accounting, we write cost, if we paid any e&penses. Thus there is no

provision of improvement in financial accounting. '&cept this, there is no any other way to inspect all e&penses.

#. Financial statements are affected from personal $udgment

(any events of financial statements are affected from personal judgment of accountant. (ethod of calculating

depreciation, rate of provision of doubtful debts and stock valuation method are decided by accountant. Thus

financial statements do not show true and fair view of business.

#ranches of Accounting

Three branches of accounting are as follows:

Financial Accounting:

The main object of Financial Accounting is to find out the profitability and to provide information about financialposition of the concern. It presents a general idea of the working of the business and permits management to controlin general way the major functions of a business, vi. finance, administration, production and distribution. !utFinancial Accounting does not give details.

Cost Accounting:

The main objects of "ost Accounting are to find out the cost of goods produced or services rendered by business. Italso helps the management to detect and control all leakages, defective works, and wastage in tools and stores.

Management Accounting:

The primary objective of #anagement Accounting is to supply relevant information at appropriate time to themanagement to enable it to take the decisions and effect control.

Human Resource Accounting

$uman resource Accounting is the process of identifying and measuring data about human resources andcommunicating this information to various parties.

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Social responsibility Accounting

!usiness is the part of the society so every business has some social responsibility. %ocial responsibility accounting isthe process of Identifying, measuring and communicating social effects of business transactions and effects.

Accounting and other disciplines (Refer to Financial Accounting Dr. R. !upta"

Accounting and #conomics

Accounting and statistics

Accounting and Mathematics

Accounting and Management

Accounting and $a%

Generally Accepted Accounting Principle (GAAP)

Accounting &oncept 0please read this in =.5

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The Accounting cycle

Accounting cycle refers to the cycle which starts with the recording of opening entries in

journal and ends with the preparation of final accounts.

9edger

?ournal Trial 4alance

Final Accounting

?3;=@A96666666 4ooks of original entry

?ournal means recording of transactions in a chronological order. The books in

which a transaction is recorded for the first time from a source document are called

%4ooks of original entry$ It is one of the basic books of original entry in which

transactions are originally recorded in day to day order according to double entry

system.

The subsidiary book may be as under' 0lease read this in detail in Dr. =.5.

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Rules of debit and credit

Debit amount should be shown on the left side of an account and credit amount should be on the right side of an

amount.

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In#entory aluation

AAAAAn inventory valuationallows a company to pro#ide a monetary #alue for items that

make up their in#entory. In#entories are usually the largest current asset of a business! and

proper measurement of them is necessary to assure accurate financial statements. If in#entory is

not properly measured! e-penses and re#enues cannot be properly matched and a company

could make poor business decisions.

Inventory accounting systems

The two most widely used in#entory accounting systems are the periodic and the perpetual.

Perpetual:The perpetual in#entory system reBuires accounting records to show the

amount of in#entory on hand at all times. It maintains a separate account in the subsidiary

ledger for each good in stock! and the account is updated each time a Buantity is added or

taken out.

Periodic:In the periodic in#entory system! sales are recorded as they occur but the

in#entory is not updated. A physical in#entory must be taken at the end of the year to

determine the cost of goods sold.

=egardless of what in#entory accounting system is used! it is good practice to perform a

physical in#entory at least once a year.

Inventory valuation metods ! perpetual (Refer "r# R#$ Gupta)

The perpetual system records re#enue each time a sale is made. Determining the cost of goods

sold reBuires taking in#entory. The most commonly used in#entory #aluation methods under a

periodic system are'

(. first6in first6out 0FIF31

). last6in first6out 09IF31

*. A#erage cost or weighted a#erage cost.

""e"epreciation

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%eaning of "epreciation

Assets are of two typeCs current assets and fi-ed assets. &urrent assets are those which are

easily con#erted into cash with in a period of one year! without losing its #alue so there is no

need of charging depreciation on these assets. Fi-ed assets are those assets which are used

for the business for the longer period of time so depreciation is charged on these assets.

Depreciation means reduction in the #alue of fi-ed assets due to wear and tear! due to usage!

e-piry of time and due to obsolescence.

"efinitions of depreciations

According to=.@.&arter! %"epreciation is a gradual and permanent decrease in the #alue

of an asset from any cause.$

&auses of depreciation

'ear tear of goods due to its continues use

*piry of time: Assets are losses tere valve +it te passage of time#For e.g. Theprice of the car depends on its model.

,bsolescence: -ecnology canges are so faster# As a result old tecni.ues become

obsolete#

&aracteristics or features of "epreciation

Depreciation is charged in case of fi-ed assets For e.g. 4uilding! plant and Machinery

Depreciation causes continuous fall in the #alue of asset

Depreciation occurs due to the use of an asset.

Depreciation is a charge against re#enue of an asset.

Depreciation does not depend on the fluctuations in the market #alue of asset.

Total depreciation of an asset cannot e-ceed its depreciable #alue.

A

%e%etods of &arging "epreciationThere are #arious methods of charging depreciation

7traight 9ine Method' This method is known as fi-ed installment method.

It is the simplest method of charging depreciation. An eBual amount of

depreciation is charged on each accounting period. It is not affected by use

of asset.

Depreciation &ost of the asset6 7crap alue:Estimated 9ife of the asset

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Ad#antages

The amount of depreciation does not change o#er its useful life.

The calculation is #ery simple

It matches cost and re#enue

;nder this method book #alue of the asset is eBual to its scrap #alue atthe e-piry of its useful life.

)# 'ritten do+n value %etod-is metod is also /no+n as diminising balance metod and reducing balance

metod# In tis metod te iger depreciation is carged on first year and gradually

decreases as every year# -e amount of depreciation varies year to year in tis metod

Annual depreciation0 "epreciation rate1 boo/ value at te beginning of te year

"epreciation0 cost of asset2 scrap value3 stimated life of an asset

Advantages

igher depreciation is charged in the initial years

An asset becomes old the amount of depreciation also goes on decreasing

This method is logical in sense that the asset become old the amount of depreciation

also goes on decreasing.

"ifference bet+een straigt and +ritten do+n value metod (Refer to "r# R$ Gupta)

&hapter' &apital and re#enue

E#ery businessman is interested to know how much profit he has earned or

how much loss he has incurred during a year. rofit and loss can be calculatedby preparing income statement or profit and loss account which is prepared

under final account at the end of e#ery account year. For the preparation of

final accounts! it is necessary to know the difference between capital

e-penditure and re#enue e-penditure

&lassification of Income

Income can be classified into two categories'

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&apital income3capital profit' Those incomes which do not earned on

account of an account of ordinary course of business. These incomes arise

on account of a sale of fi-ed asset.

For e.g. a fi-ed asset costing =s. ( sold for ()! so the capital profit

:capital income in this case is =s. ). 7imilarly when a company issues its

shares at a premium! so the premium money is transferred to capital reser#e

account.

=e#enue Income:re#enue rofit' These are those incomes which are earned

during the course of business. These incomes are transferred to 89 account.

For e.g. &ommission recei#ed! profit on sale of goods! interest recei#ed on

securities etc.

&lassification of receipts(. &apital E-penditure

). =e#enue E-penditure

4 &apital e*penditurerefers to e-penditure the benefits of which are not fully

deri#ed in one year but for se#eral years. E-amples for capital e-penditure are

acBuisition of assets for the purpose of earning e-penditure resulting in long term

benefits. E-penses like preliminary e-penses! =esearch and de#elopment

e-penditure are taken to the asset side of the balance sheet and shown undermiscellaneous e-penditure.

) Revenue *penditure' it is that e-penditure which is a#ailed by the firm

only in that particular year in which the e-penditure incurred. E-amples are

=aw material! repairs! depreciation! rent! and wages. 7uch e-penses are

debited to 8 9 account for the calculation of @et profit and @et profit is

added to capital account in the balance sheet.

* deferred revenue e*penditure: "R is tat e-penditure which isprimarily re#enue in nature but the amount spent is so large that the benefits

are a#ailed beyond the accounting period in which the e-penditure was

incurred. It is a fictitious asset although year as deferred re#enue e-penditure.

E.g. hea#y e-penditure incurred on ad#ertised! E-penses at a time of

formation of a company! such as discount on issue of shares! underwriters

commission.

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&lassification of Receipts

&apital receipts

=e#enue receipts

&apital receipts' &= is those receipts which either cause increase in the

liabilities of the firm or cause reduction in the asset of the firm. These receipts

are non6recurring in nature and are not related to ordinary course of business.For e.g. cash recei#ed from the sale of fi-ed asset or in#estments! issue of

shares of debentures! capital contribution by the proprietor.

Revenue Receipts' re#enue is that receipt which neither cause increase in the

liabilities of the firm nor cause reduction in the assets of the firm. These

receipts are recurring in nature and related to the normal course of the

business. It is recei#ed by selling of goods and ser#ices. The money recei#ed

from sale of goods 8 ser#ices! commission! rent! interest! di#idend is e-ample

of re#enue receipts. =e#enue receipts are credited to rofit and loss account.

&AITA9I7ED EGE@DIT;=E

These are that e-penditure which is incurred on the asset as an important

factor such as installation charges or construction of an asset or any

e-penditure with the help of which can increase the earning capacity of

business. These e-penses become the asset of the firm and not charge to 8 l

account.

"ifference bet+een capital and revenue e*penditure please refer "r# R$

Gupta

"ifference bet+een te capital e*penditure and capital e*penditure refer

"r# R$ gupta boo/

Revenue Recognition

=e#enue means the amount which is recei#ed by the firm by selling its goods and ser#ices.

%=e#enue I the gross inflow of cash! recei#ables or other consideration arising in the acti#ities

of enterprise from the sale of goods and from rendering of ser#ices.

Revenue includes all te receipts

a1 4y sale of goods

b1 4y rendering of ser#ices

c1 =e#enue is the amount of commission

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&A=A&TE=7TI&7 3F =EE@;E7

(1 They arise from the firmCs principles business acti#ities such as sale of goods

)1 They are recurring in nature

*1 =e#enue leads to increase in owners capital

+1 =e#enues are related to specific period.

As per the A76>! =e#enue recognition is mainly concerned with the timings of recognition of

recognition of re#enue in the statement of profit and loss of an enterprise.

For re#enue recognition firm uses the accrual system of accounting means the re#enue should

be recogni"ed on that date when the goods are deli#ered by the firm.

Ne*t &apter

Provisions and Reserves

%eaning of Provisions

5cedule 6I of te companies Act7 489 define te term provision as ;any

amount +ritten off or retained by +ay of providing for depreciation7 rene+als

in value of assets7 or retained by providing for any /no+n liability of +ic teamount cannot be determined +it substantial accuracy#eatures

istorical #alue is the basis of accounting concept

Measurement of income is done by the matching cost with re#enues

It o#erlooks the unreali"ed gains:losses in the #alue of the assets.

conomist concept of income

According to the economist! the income refers to the cyclic profits deri#ed from the use of

capital.

&aracteristics4# Income is based on the current #alues not on the historical cost which is used in

accounting concept of income.

@# Income is measured by comparison of the #alue of capital at two different dates.

# It considers unreali"ed gains in the #alue of fi-ed assets

B# Income is deri#ed from capital

9# #alue of capital is resulting from #alue of income.