Financial Accounting

Introduction to accounting

•Meaning and definition of Accounting •Features of Accounting•Functions of Accounting•Objects of accounting•Importance of accounting•Uses of accounting•Uses and users of accounting information•The scope of and inter-relationship between Financial, cost & management accounting

Introduction to Accounting Introduction to Accounting

is the language of business.is the language of business.

Accounting...

Communicates the results of

operation and financial position of a

business to various stakeholders

Communicates the results of

operation and financial position of a

business to various stakeholders

Accounting

A process of identifying, recording,

summarizing, and reporting economic

information to decision makers in the form of

financial statements.

Definitions of Accounting

“Accounting is an 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)

Definitions of Accounting

• “The process of identifying, measuring,

and communicating economic information

to permit informed judgements and

decisions by users of the information.”

—American Accounting Association (AAA)

FEATURES OF ACCOUNTINGFEATURES OF ACCOUNTING 1.It is the art of recording business transactions.2.It is the art of classifying business transactions.3.The transactions and events must be recorded in

monetary transactions and events.4.It is the art of summarizing financial transactions.5.It is the art of analysis and interpretation of these

transactions.6.The results of these transactions must be

communicated to the concerned persons. 

Functions of Accounting

• Recording

• Classifying

• Summarising

• Deal with financial transactions

• Interpretation

• Communicating

1. Deals with financial transactions : Accounting records only those transactions and events, which are of a financial character.

2. Recording : This is the basic function of Accounting. It is essentially concerned with not only ensuring that all business transaction of financial character are in fact recorded but also that they are recorded in an orderly manner. Recording is done in the book called “Journal”.

Functions of Accounting

Contd…

3. Classifying : Classification is concerned with the systematic analysis of the recorded data, with view to group transactions or entries of one nature at one place .The work of classification is done in the book called “Ledger”.

Functions of Accounting

Contd…

4. Summarizing : This involves presenting the classified data in a manner, which is understandable and useful to the internal as well as external end –users of accounting statements. This process leads to the preparation of the following statement :-

Trial Balance

Trading Account

Profit and Loss Account

Balance Sheet 

Functions of Accounting

Contd…

5. Analysis and Interpretation : This is the final function

of accounting. The recorded financial data is analyzed

and interpreted in a manner that the end-users can make

a meaningful judgment about the financial condition

and profitability of the business operations.

Functions of Accounting

Recording

Classifying

Summarizing

Journal

Ledger

Trial Balance

Preparation of Financial Statements

Process of Accounting

Objects Of Accounting

1. To maintain systematic records of the business 2. To ascertain profit or loss of the business .3. To ascertain the financial position of the concern

-Nature and value of assets -Nature and extent of liabilities

4. To facilitate rational decision-making:To make information available to various groups and

users at a particular time to facilitate rational decision-making.

Accounting

Management

Users with indirect financial interest

Users with direct financial interest

IMPORTANCE OF ACCOUNTING

1.     Management or managers

Directors, officers of the company, managers, dept. heads and supervisors

Decisions:

•Assessing profitability

•Financial performance in terms of plans & goals,

•Making plans and policies

IMPORTANCE OF ACCOUNTING

2.     Users with direct financial interest

Present and potential shareholders, creditors, employees, suppliers

Decisions:

•Share investment decision,

•Credit decisions,

•Assessing company status and prospects,

•Approving supply decisions

IMPORTANCE OF ACCOUNTING

3.     Users with indirect financial interestCustomers, taxation authorities, financial analysts and advisors, brokers, labour unions, consumer group, general public, press etc.)

Decisions:• Assessing tax• Protecting investors and public interest• Advising on investment decisions• Setting economic policies• Measuring social and environmental protection

programme• Negotiation of labour agreements.

IMPORTANCE OF ACCOUNTING

EXTERNAL USERS

Financial AccountingFinancial Accounting

• Security analysts & Investors

• Creditors/suppliers• Government & regulatory

authorities• customers• Competitors• Researchers • Taxing authorities

Users of Accounting InformationUsers of Accounting InformationUsers of Accounting InformationUsers of Accounting Information

EXTERNAL USERS

Financial AccountingFinancial Accounting• investors• creditors• regulators• customers• competitors

• owners• managers• employees

INTERNAL USERS

Financial AccountingFinancial Accounting

• Security analysts & Investors

• Creditors/suppliers• Government & regulatory

authorities• customers• Competitors• Researchers • Taxing authorities

Users of Accounting InformationUsers of Accounting InformationUsers of Accounting InformationUsers of Accounting Information

External usersmake decisionsabout the entity.

External usersmake decisionsabout the entity.

Internal usersmake decisionsfor the entity.

Internal usersmake decisionsfor the entity.

Users of Accounting InformationUsers of Accounting InformationUsers of Accounting InformationUsers of Accounting InformationUsers of Accounting Information

Uses Of Accounting

• Ascertaining the operation profit or loss

• Ascertaining the financial position of the

business

• Keeping systematic records

• Protecting and controlling business

properties

• Facilitating rational decision-making

• Planning and control operations.

• Compliance with the legal requirements

• Making information available to various groups

and users at a particular time.

• Evidence in court in case of dispute

Uses Of Accounting

• Substitute of memory

• Settlement of taxation liability

• Comparative study

• Sale of business

• The amount ,size and causes of increase or decrease of capital

Uses Of Accounting

LIMITATIONS OF ACCOUNTING

1. Records only monetary transactions

2. Effects of price level accounting is not considered

3. No realistic information due to concepts and

convention followed

4. Personal bias of accountant affects accounting

statements

5. Permits alternative treatment: Lack of uniformity in

accounting principles

LIMITATIONS OF ACCOUNTING

6. No real test of managerial performance as it can be

manipulated.    

7. Historical in nature

8. Not helpful in price fixation

9. Cost control not possible

10. Technical subject

Branches of Accounting

Financial accounting

Management accounting

Cost accounting

Financial Accounting

Its focus is on reporting to external parties.

It provides financial statements based ongenerally accepted accounting principles.

It measures and records business transactions in order to prepare financial statements

Scope of Financial Accounting

1. Recording of information

2. Classification of data .

3. Making summaries

4. Dealing with financial transactions .

5. Interpreting financial information .

6. Communicating results

7. Making information more reliable .

Cost Accounting

It provides information for both management accounting and financial accounting.

It measures and reports financial and nonfinancial data.

It is the process of accounting for costs

Scope of Cost Accounting

1. Analysis and ascertainment of costs

2. Presentation of costs for cost reduction & cost control

3. Planning

4. Accumulation and utilization of cost data

5. Preparation of budgets and implementation of budgetary control

6. Ascertaining profitability of each product

7. Providing useful data to the management for taking decisions

Management Accounting

It measures and reports financial and non-financial

information that helps managers make decisions to

fulfill the goals of an organization.

Scope of Management Accounting

● Financial Accounting

● Interpretation of data

● Cost Accounting

● Control procedures & methods

● Financial Management

● Internal audit

● Budgeting & forecasting

● Tax accounting

● Inventory Control

● Office services

● Reporting to management

Basis Financial Accounting

Cost Accounting Management Accounting

Objects Record transactions & determine financial position & profit or loss.

Ascertainment, allocation, accumulation and accounting for cost

To assist the management in decision-making & policy formulation.

Nature Concerned with historical data.

Concerned with both past and present recorded(historical in nature).

Deals with projection of data for the future (futuristic in nature)

Principle Followed

Governed by GAAP

Certain principles followed for recording costs.

No set principles are followed in it.

Data used

Qualitative aspects are not recorded

Only quantitative aspect is recorded.

Uses both quantitative and qualitative concepts.

Differences Between Financial, Cost & Management Accounting

Basis Financial Accounting

Cost Accounting Management Accounting

Reporting frequency

Generally at end of year

As & when desired by management

As & when desired by management

Publication Published in case of companies

NOT published NOT published

Information recorded

Monetary transactions ONLY

Both monetary and non-monetary information.

Both monetary and non-monetary information

Forms of Account

Accounts are prepared to meet the legal requirements.

These are generally kept Voluntarily to meet the requirements of the management.

These are generally kept Voluntarily to meet the requirements of the management.

Differences Between Financial, Cost & Management Accounting

DEFINITIONS OF BASIC TERMS IN ACCOUNTING

DEFINITIONS OF BASIC TERMS IN ACCOUNTING

Any exchange of money or money’s worth as goods and services between two parties is called a business transaction

An event which can be expressed in terms of money

May relate to purchase and sale of goods, receipt and payment of cash and rendering of services by one party to another.

Transactions may be:

I. Cash transaction: When payment is made immediately

II.Credit transaction: When payment is postponed to a future date

Business Transactions

• These are resources owned by the business which are expected to give benefits in the future.

• Assets may be fixed assets or current assets

• Assets include:– land– building– equipment– goodwill

Assets

It is any physical thing or right owned which has money value.

• These are amounts owed by the enterprise to the outsiders i.e. to all others except the owner

• These are claims of outsiders on assets of the firm.

Liability

• It is the claim of owners on the assets of an enterprise.

• It is the excess of assets over liabilities i.e. it is what’s left of the assets after liabilities have been deducted.

• Also known as networth

Capital (Owner’s Equity)

• They are amounts received or to be received from customers for:– sales of products or – performance of services or – in return of use of the firm’s assets by

outsiders.

• Revenues include the following– Sales proceeds– fees for performance of services– rent– interest

Revenues

• An expense is the amount incurred in the process of earning revenue.

• They are amounts that have been paid or will be paid later for costs that have been incurred to earn revenue.

• Include:– salaries and wages– Utilities payments – supplies used– advertising

Expenses

• It is excess of revenue over expense

• It is the favourable change in owner’s equity

which results from operations i.e. it is an inflow of

assets or decrease in liabilities resulting in

increase in capital.

Income

• A debtor is a person who owes money.

• The amount due from a debtor as per books of account

is called book debt or Accounts Receivable.

• A trade debtor is a person who owes money as a result

of purchase of goods or services on credit

Trade Debtor(Accounts Receivable)

•A creditor person to whom money is owing or payable.

•A trade creditor is a person who owes to whom money is

owing or payable as a result of purchase of goods or services

on credit

•Accounts Payable is a liability that results from the

purchase of goods or services on account (on credit)

Trade Creditor (Accounts payable )

• Takes place when an asset or service is acquired.

• Include both payment of a sum immediately and a

promise to pay it at a future date.

• An expense is an expenditure whose benefit finishes or

is enjoyed immediately such as salaries, rent, etc.

• An expenditure which will provide benefits in the future

is considered as an asset

• A loss is an expenditure without any benefit to the

concern

Expenditure

Inventory (stock)

• Includes all articles, commodities or merchandise in

which the business deals.

• Includes goods held by a firm for resale to customers

(finished goods) and raw materialsVouchers

• Any written document in support of a business transaction.

Other Definitions to remember:

Total trading income from cash sales and credit sales.

Turnover

:

Drawings

Any amount or goods withdrawn by the owner of the

business for personal use

Other Definitions to remember:

Are approaches for reporting/recognising revenues and expenses

The basis for accounting are as follows:

• Cash basis

• Accrual basis

Basis of AccountingBasis of Accounting

Cash Basis of AccountingCash Basis of Accounting

Actual cash receipts and actual cash payments are

recorded

Revenue reported when cash is received

Expense reported when cash is paid

Income = cash receipts – cash payments

Does not properly match revenues and expenses

Accrual Basis of AccountingAccrual Basis of Accounting

Revenue reported when earned irrespective of

whether received or not

Expense reported when incurred irrespective of

whether or not cash has been paid

Properly matches revenues and expenses in

determining net income

Also referred to as mercantile system of accounting

Book keeping is the art of recording business transactions

in a regular and systematic manner.

This recording of transactions may be done according to any

of the following two systems:-

1. Single Entry System

2. Double Entry System

System Of Book Keeping

i. Income Statement (Profit & Loss

Account)

ii. Balance Sheet

iii. Cash Flow Statement

OVERVIEW OF FINANCIAL OVERVIEW OF FINANCIAL STATEMENTSSTATEMENTS

Income StatementFor the year ended March 31, 2014 (All figures in Rs. ‘000)

Sales   16,000

Less: Cost of Goods Sold 9830

Gross Profit   6170

Less: Operating Expenses   1460 

EBIDTA 4710

Less: Depreciation 700

Operating Profit (EBIT)   4010

Less: Interest Paid   360

Net Profit Before Tax(EBT)   3650

Less: Income Tax @ 30%   1095

Net profit after tax (EAT)   2555

Less: Dividends   200

Retained Earnings   2355

Income StatementIncome Statement

Balance Sheet as at 31 March, 2014Balance Sheet as at 31 March, 2014Liabilities Rs. Assets Rs.

Owners' Equity :   Fixed Assets:  Opening balance of Capital   Land & Buildings  Add/Less: Net Profit   Plant & Machinery  Add capital introduced during the year

  Furniture & Fixtures  

Less: Drawings    Total    Non-Current Liabilities   Current Assets:   Loan from Bank   Stock  

  Trade debtors  Current Liabilities   Cash at Bank    Trade Creditors   Cash in Hand   Bank Overdraft   Investments  

  Intangible Assets   Total   Total  

Balance Sheet as at 31st March, 2014

ParticularsCurrent

YearPrevious

Yr

I. EQUITY AND LIABILITIES    

(1) Shareholder's Funds    

(2) Share application money pending allotment    

(3) Non-Current Liabilities    

(4) Current Liabilities    Total    II.ASSETS    

(1) Non-current assets    

(2) Current assets    Total    

Balance Sheet as at 31 March, 2014Balance Sheet as at 31 March, 2014

  Rs.(in lakhs) Cash flow from Operating Activities 4400    Cash flow from Investing Activities (3600)    Cash flow from Financing Activities 520    Net Increase (Decrease) in Cash and Cash Equivalents 1320    Opening Balance of Cash and Cash Equivalents 360    Closing Balance of Cash and Cash Equivalents 1680

Cash Flow Statement for the year ended March 31st, 2014