Accounting an introduction

Financial AccountingAn Introduction

Mahesh Chandra Sharma

Associate Professor

Department of Commerce

Shaheed Bhagat Singh Eve. College

(University of Delhi)

India

Prof. Mahesh Chandra Sharma

Definition of Accounting According to The American Institute of

Certified Public Accountants (AICPA), “Accounting is 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.”


Characteristics of Accounting

1) Identifying the business transactions and events, which are of financial nature (to be recorded in accounting books)

2) Recording the transactions and events in the primary book – Journal, in terms of money

3) Classifying the transactions into ledger accounts.4) Summarising – Trial Balance, Income Statement

and Balance Sheet and Cash flow Statement5) Data is presented in significant manner (as per

rules and principles of accounting)6) Analysis and interpretation of financial

statements.


Accounting as Information System

A system is a set of elements which operate together to achieve a predetermined a goal.

Accounting is referred as a language of business. Primary aim of a language is a means of communication.

Accounting as information system involves collecting, storing and processing financial and accounting data that is used by decision-makers.



Accounting is used to communicate information of financial character to various interested parties in proper formats.

At present, an accounting information system is generally a computer-based method for tracking accounting activity in conjunction with information technology resources.



InputBusiness

transactions and events(collecting

information)

ProcessRecording, classifying

and summurising

OutputIncome

StatementBalance Sheet

Cash Flow Statement


Parties Interested in Financial Statements

Parties Areas of Interest1. Owners

or Investors(i) Profitability , (ii) Financial position, (iii) Future

prospects or growth potential

2. Management

(i) Short term and long term solvency (ii)Profitability in relation to turnover and investment (iii) Liquidity of the concern

3. Employees

(i) Profitability, (ii) Cash position

4. Suppliers and other creditors

(i) Financial position (ii)Profitability

5. Lenders (i) Financial position and (ii) Profitability

6.Government and their agencies

(i) Profitability (ii)Growth (iii) Financial position(iv) Estimating national income

7. Researchers

(i) Profitability, (ii) Growth, (iii) Financial position and (iv) Future prospects


Qualitative Charactistics of Accounting Information

Understandability

Relevance

Reliability

Comparability


Understandability Accounting information should be readily

understandable by the users. To have the accounting characteristics of

understandability, the accounting information must be presented in a manner that users can understand the same without having expert knowledge in financial analysis.

Users are expected to have the reasonable knowledge of the business and economic activities.


Relevance

Accounting information must be relevant for decision making.

The information must have predictive value and feedback value.

Relevance of an information is affected by its nature and materiality. For example, information in respect of previous year results by a company is relevant since it would provide a basis to the investors for forecasting results in future years and also provides a feedback on past performance.

Two factors are important in determining relevance. Different users may have different opinion as to

what is relevant? Whose needs should be given priority.

Profitability of a firm’s product lines may be relevant to outsiders but harmful to the interests of the owners.


Reliability Accounting information must be reliable. Reliability of information means that it is verifiable, free

from material error and bias. It can be depended by the users.

To be verifiable means that the records can be verified with the details of information which can be obtained from the source documents such as cash receipts, bills, cash memos or invoices or any other supporting voucher.

Accounting information is considered free from bias if it is not influenced by personal judgement of the accountant.

To be reliable information contained in the financial statements must be complete within the principles of materiality and cost.


Comparability

Accounting information should be comparable with similar information either for the same enterprise or for the other enterprises.

Comparable information will reveal trends and also relative strong and weak points in a single company.

Users should be informed of the economic policies employed in the preparation of financial statements. Comparability is possible when the different enterprises in the same industry use the same accounting principles and methods from year to year. This is also known as uniform practices.

When accounting information is based on consistency principle or convention the financial statements permit the meaningful analysis of the trends within the company.

Accounting principles and methods can be changed on account of changes in the accounting environment. In such a case, the change and its effect on the financial position and performance should be disclosed.


Functions of Accounting

Maintaining systematic records

Communicating the financial results

Meeting legal needs

Protecting business assets

Assisting the managers

Stewardship or trusteeship

Fixing responsibility


Advantages of Accounting

(1) Replacement of memory

(2) Assessing the performance and financial

position of the business.

(3) Comparative study of results

(4) Planning

(5) Decision making


Advantages of Accounting (Contd.)

(6) Controlling.

(7) Provides information to interested parties

(8) Evidence in courts

(9) Assessment of tax-liability

(10) Prevention of errors and fraud

(11) Assessing value of business

(12) Raising loans


Limitations of Accounting

1) Incomplete information – Non-monetary items

and events are not shown

2) Inexactness – some information is estimated

3) Personal influence of accountant

4) Assets may not be shown at their real value

5) Effect of price level changes not considered

6) Window dressing


Branches of Accounting Financial Accounting, Cost Accounting Management Accounting Taxation Accounting Human Resource Accounting National Accounting Social Accounting - Inflation Accounting Forensic Accounting


Bases of Accounting Cash Basis

Accrual Basis


Cash Basis Under the cash basis, revenues are recorded

when cash is received and expenses are recorded when cash is paid for them.

No entry is made when revenue or expenses become due.

This basis is not compatible with accounting principles and therefore, is not commonly used.


Accrual Basis Under accrual basis, revenue and expenses are

recorded in the period in which they becomes due, rather when they are received or paid.

Revenues are recorded in the period in which they are earned rather than in the period in which cash is actually received.

Expenses are recorded in the period in which they have been accrued rather than in the period in which they are paid.

This method is compatible with the matching principle of accounting and more appropriate for the calculation of profit or loss of the business.