Financial Accounting

Meaning of Accounting

It is the process of identifying, measuring, recording, classifying, summarising, analysing, interpreting and communicating the economic information of an organisation to its users who need the information for decision making.

Definition of Accounting

“The art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events, which are, in part at least, of a financial character and interpreting the results thereof”. American Institute of Certified Public Accountants (AICPA)

Functions or Process of Accounting

Identifying the transaction or event

Accounting identifies transactions and events of a specific entity. A transaction is a exchange in which each participant receive or sacrifice value.

Measuring the Identified transaction & events

Accounting measures

the transactions and events in terms of a common measurement unit, that is a ruling currency of a country

Recording

Accounting is concerned with the recording of identified & measured financial transactions in an orderly manner in the proper books of accounts soon after their occurrence.

 

Classifying

 Accounting is concerned with the classification of recorded transactions so as to group the transactions of similar type at one place. This function is performed by maintaining the ledger in which different accounts are opened.

Summarising

Accounting is concerned with the summarization of the classified transactions in a manner useful to the users.

This involves the preparation of financial statements such as Income statements and Balance Sheet.

Analysing

Accounting is concerned with the establishment of relationship between the various elements taken from the Balance sheet or Income Statement or both.

Its purpose is to identify the financial strength or weakness of the enterprise

Interpreting

It is concerned with explaining the meaning and significance of the relationship so established by the analysis.

The accountants should interpret the statements in a manner useful to the users so as to enable the users to take reasonable decisions

Communicating

Communication is concerned with the transmission of summarized, analysed and interpreted information to the users to enable them to make reasonable decisions.

Advantages of Accounting

Advantages of Accounting

Limitations of Accounting

Important Concepts

Accountancy : Accountancy refers to a systematic knowledge of accounting. It tells us how to prepare books of accounts and how to summarise the accounting information and communicate it to the interested parties

Accounting : Accounting refers to the actual process of preparing and presenting the accounts. It is the art of putting the academic knowledge of accountancy into practice. It covers identifying, measuring, recording, classifying, summarising, analysing, interpreting and communicating the economic information.

Book Keeping : It is a part of accounting and is concerned with the record keeping or maintenance of books of accounting which is often routine or clerical in nature.

Relationship Between Accountancy, Accounting & Book Keeping

Accountancy

Accounting

Book Keeping

Trader

Trader

Basis of Accounting

1. Cash Basis of Accounting2. Accrual Basis of Accounting

Cash Basis of Accounting

Cash basis of accounting is a method of accounting where transactions are recorded at the time when physical cash is actually received or paid out.

Accrual Basis of Accounting

Accrual basis of accounting is a method of accounting in which transactions are recorded on the basis of period in which they happen or accrue.

Under the Companies Act 1956, all companies are required to maintain the books of accounts according to the accrual basis of accounting.

Point of Distinction Cash Basis Accrual Basis

Recording of Revenue

Revenues are recorded when they are received, which may be before or after they are earned.

Revenues are recorded when they are earned, which may be before or after they are received.

Recording of Expenses

Expenses are recorded when they are paid, which may be before or after they are incurred.

Expenses are recorded when they are incurred, which may be before or after they are paid

Treatment of Revenue and Expenses in Financial statement

Financial statements reflect revenues and expenses based on when transactions were entered.

Financial statements match revenues to the expenses incurred in earning them

Treatment of Receivable

No receivables are recorded.

A receivable is recorded when payment is not received at the point of sale.

Treatment of Payable

No payables are recorded.

Payables are recorded when payment is not made at the time of purchase.

Point of Distinction Cash Basis Accrual Basis

Methods of Tracking Partial Payment

No method of tracking partial payments is available.

Revenues and expenses are recorded in full, even though partial payments may be made over extended time periods

Recognition under companies Act 1956

This basis is not recognised under the companies act 1956

This basis is recognised under the companies act 1956

Point of Distinction Cash Basis Accrual Basis

Presence of Prepaid/outstanding expenses and accrued/ un-accrued income in Balance sheet

Under this method, Items like prepaid expenses, outstanding expenses, accrued income, un-accrued income are not present in Balance sheet

Under this method, Items like prepaid expenses, outstanding expenses, accrued income, un-accrued income are present in Balance sheet

Treatment of income in case of prepaid expenses and accrued income

Income Statement will show Lower income

Income Statement will show a relatively higher income

Treatment of income in case of outstanding expenses and income received in advance

Income Statement will show higher income

Income Statement will show a relatively Lower income

Accounting Terms

S.NO TERMS S.NO TERMS1 Entity 16 Bills Receivable2 Event 17 Bills Payable3 Transaction 18 Receivable

4 Sole Proprietor 19 Payable

5 Voucher 20 Expenses

6 Entry 21 Outstanding Expenses

7 Assets 22 Prepaid Expenses8 Liabilities 23 Income9 Capital 24 Accrued Income

10 Drawing 25 Income Received in advance

11 Purchases 26 Revenue12 Sales 27 Net Profit13 Stock 28 Net Loss

14 Trade Debtors 29 Goodwill

15 Trade Creditors 30 Debentures

Entity

An entity means an economic unit that performs economic activities . 

It can be sole proprietorship concern, partnership concern or company etc.

Example : Reliance Industries

Event

An event is any happening that effect the financial statement without any transactions taking place

Accounting events can be either external or internal.

Example : Depreciation, Loss of goods by Fire

Transaction

A Transaction is an exchange in which each participants receives or sacrifices value

Example : Purchase of Raw Materials

Sole Proprietorship

A simple form of business where there is one owner.

It is a simplest, oldest, and most common form of business ownership in which only one individual acquires all the benefits and risks of running an enterprise

Voucher

Voucher is a document which serves as an evidence of a transaction.

The Vouchers act as source document on the basis of which transactions are recorded in the books of accounts

Example : Cash Memos for cash purchase

Entry

Entry is the record made in the books of accounts in respect of a transaction or event.

An entry is passed on the basis of vouchers

Assets

Assets refers to tangible objects or intangible rights of an enterprise which carry future probable benefits

TYPES

Tangible Assets and Intangible AssetsCurrent Assets and Fixed Assets

Liabilities

Liabilities refers to the financial obligations of an enterprise other than owners funds

TYPES

1.Current Liabilities2.Long term Liabilities

Capital

      Capital refers to the amount invested in the enterprise by the proprietor or partner. It is the excess of assets over external liabilities

Drawings

      Drawing refers to the total amount of cash or goods or any other assets withdrawn by the proprietor or partner for personal use

Purchases

        Purchases refers to the total amount of goods obtained by an enterprises for resale or for use in production of goods in the normal course of business

Sales

      The term sales refers to the amount for which the goods are sold or services are rendered.

The sales may be on cash or credit.

For Example : In case 60 units are sold

@ Rs. 5 per unit. Sale = Rs. 300

Stock

Where Stock refers to tangible property held for sale in the ordinary course of business.

It include stock of

raw material, semi-finished goods and finished goods

Trade Debtors

Debtors refers to the person from

whom the amount are due for goods

sold or services rendered on the

credit basis

Trade Creditors

Trade creditors refers to the person to whom the amount are due for goods sold or services rendered on credit basis

Bills Receivable or Account ReceivableBill Receivable is money owed by customers (individuals or corporations) to another entity in exchange for goods or services that have been delivered or used, but not yet paid for.

Bills Payable or Account Payable Bills payable or accounts

payable is money owed by a business to its suppliers .

It is shown as a liability on a company's balance sheet.

Outstanding Expenses

Expenses which have been incurred but not been paid for till the end of the accounting year are known as Accrued expenses or outstanding expenses.

Prepaid Expenses

Holidays

Prepaid expenses are future expenses that have been paid in advance.

A common prepaid expense is six-month premium for insurance on company's vehicles.

Income

Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity,

Accrued Income

Accrued income is income which has been earned but not yet received. Income must be recorded in the accounting period in which it is earned. -

Income received in advancePrepaid income is revenue received in advance but which is not yet earned.

Income must be recorded in the accounting period in which it is earned.

Net Profit

Net Profit means the excess of revenue over expenses

Net Profit = Revenue - Expenses

Net Loss

Net Loss means the excess of expenses over revenue

Net Loss = Expenses - Revenue

Goodwill

Goodwill is seen as an intangible asset on the balance sheet .

Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and any patents or proprietary technology.

Debenture

Debentures are the most common form of long-term loans that can be taken by a company. 

Debentures are usually loans that are repayable on a fixed date at a fixed rate of interest.

Users of accounting

Internal users External users

Management Potential investors

Workers Present investors

Creditors

Customers and general publicTax authorities