Financial Accounting

Meaning and scope of accounting

 Financial Accounting

Earlier the accounting was considered simply as a process of recording

business transactions and the role of accountant as that of book keeper. But
accounting is now considered as the tool of management providing vital
information concerning the organization’s future. Accounting today is thus
more of an information system rather than a mere recording system.

According to American Institute of Certified Public Accountant:-

“accounting is the art of recording, classifying and summarizing in
significant manner and in terms of money, transaction and events which are ,
in part, at least of financial character and interpreting the result thereof.”

According to American Accounting Association defined accounting as “

Accounting is the process of identifying , measuring and communicating
economic information to permit informed judgment and decisions by users
of the information”.
 Financial Accounting

Thus accounting may be defined as the process of recording , classifying ,

summarizing , analyzing and interpreting the financial transactions and
communicating the results thereof to the person interested in such
information.

Function of accounting

Identifying recording classifying summarizing Dealing with Analyzing & communica

& financial interpreting ting
measuring transaction
 Financial Accounting

1. Identifying and measuring:-Accounting identifies transaction and

events of a specific entity. A transaction is an exchange in which
each participant receives or sacrifice values. e.g. purchase of raw
material
An event whether internal or external is a happening of consequences to
an entity. E.g. use of raw material for production.
An entity means an economic unit that perform economic activities.
E.g. Reliance Industrial Ltd.

2. Recording:- this is the basic function of accounting. It is not

only concerned with recording of transactions but also that
they are recoded in orderly manner. Recording is done in the
book called “Journal”. This book may be further sub-divided
into various subsidiary books. The number of subsidiary books
vary according to the size and nature of the business.
 Financial Accounting

3. classifying:-classifying is concerned with the systematic analysis of

recorded data, with a view to group transaction or entries of one
nature at one place. The work of classification is done in the book
termed as “Ledger”. All expenses under these heads after being
recorded in the journal will be classified under separate heads in the
ledger. This will help in finding out the total expenditure incurred
under each of the above head.

4. Summarizing:- this involves presenting the classified date in a

manner which is understandable and useful to the internal as well as
external end users of accounting statements. This process leads to
preparation of the following statement.
i- Trail Balance ii. Income statement iii balance sheet
 Financial Accounting

5. Dealing with financial transaction:-accounting record only those

transactions and events which are in terms of financial character.
Transactions which are of not a financial character are not recorded
in the books of accounts. E.g. if a company has got a team of
dedicated and trusted employees , it is of great use to the business
but since it is not of financial character and capable of being
expressed in the terms of money, it will not be recorded in the books
of business
6. Analyzing and interpreting:- this is the final function of
accounting . The recoded 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 business
operations.
7. Communication:- the accounting information after being
meaningfully analyzed and interpreted has to be communicating in
proper form and manner to the proper person.
 Financial Accounting

This is done through preparation and distribution of accounting report,

which include beside the usual income statement and balance sheet,
additional information in the form of accounting ratios, graphs,
diagram, funds flow statement etc

Relationship between Accountancy, Accounting and Book

keeping:-
Book –keeping is the part of accounting & Accounting is the
part of Accountancy.

Accountancy
Accounting

Book keeping
 Financial Accounting

Book keeping and accounting:-

Some people take book keeping an accounting as synonymous terms,

but they are different from each other.

Book keeping is mainly concerned with recording of financial data

relating to the business operations in a significant and orderly
manner. A book keeper may be responsible for keeping all the
records of business or only of a minor segment, such a position of
customers accounts in departmental store.

Accounting is primarily concerned with designing the system for

recording , classifying and summarizing the recorded date and
interpreting them for internal and external end users. Accountants of
direct and review the work of book-keepers. The larger the firm the
greater is the responsibility of accountant.
 Financial Accounting
S. Basis of Book-keeping
No distinction
1 Scope Book-keeping involves-
1. Identifying transactions
2. Measuring the identified
transactions
3. Recording the measured
transactions
4. Classifying the recorded
transactions
2 Stage Book- keeping is primary
stage
3 Basic objective The basic objective of book-
keeping is to maintain
systematic records of
financial transactions
Accounting
Accounting in addition to book-
keeping involves-
1. Summarizing the classified
transactions,
2. Analyzing the summarized
results
3. Communicating and
interpret the information to
the interested parties.
Accounting is the secondary
stage. It starts where book-
keeping ends.
The basic objective of
accounting is to ascertain net
results of operation and
financial position and to
communicate the information
to the interested parties.
 Financial Accounting

S. Basis of Book-keeping Accounting

No distinction
4 Who perform Book-keeping is done by Accounting work is done by
junior staff. senior staff.
5 Knowledge level It is not required to have It is required to have higher
higher level of knowledge level of knowledge than that of
than that of accountant book-keeper.
6 Analytical skill The book-keeper may or may An accountant is required to
not possess analytical skill have analytical skill.
7 Nature of job The job of book keeper is The job of accountant is
often routine and clerical in analytical nature.
nature
8 Designing of It does not cover designing of It covers the designing of
accounting accounts system accounting system
system
9 Supervision & The book-keeper does not An accountant supervises and
checking supervise and check the check the work of an
work of an accountant accountant.
 Financial Accounting

Objective of financial accounting

Keep systematic Protect business Ascertain Ascertain the Facilitate

records properties operational financial rational
profit and loss position of decision making
business

The following are the objective of financial accounting:-

1. To keep the systematic records:- written records are always better
than oral records. Written records can be used by different persons for
different decision making purposes and serve as evidence of
transaction. Thus accounting is done to keep a systematic record of the
financial transactions.
2. To protect the business properties:- accounting provides the
protection to the business properties from unjustified and unwarranted
use. This is possible because financial accounting provide the
information like how much amount the proprietor has invested, how
 Financial Accounting

The business has to pay to others? How much the business is to recover
from others? How much the business has in the form of fixed assets,
cash, stock. All these information helps the proprietor in assuring the
fund of the business are not unnecessarily kept idle or under utilized.
3. To ascertain the operational profit and loss:- to measure the
financial performance of an enterprise , the results of operation are
ascertained by preparing an income statement which shows the
matching of current cost with the current revenue during a particular
accounting period. A systematic record of income and expenses
facilitates in the preparation of Income statement.

4. To ascertain the financial position:- to evaluate the financial strength

and weakness of the an enterprise, the financial position is ascertained
by making Profit and Loss Account-which gives the information
regarding the profit earned or loss suffered by the company during the
accounting period. Whereas the preparation of Balance sheet provides
the information regarding the assets and liabilities of the business on a
particular date.
 Financial Accounting

5. To facilitate in rational decision making:-accounting includes the

task of collection, analyzing and reporting the information at the
required point of time and to the required level of authority, in order to
facilitates rational decision making.

Advantage of accounting:-

Following are the advantage of accounting:-

1. Facilitates to replace memory:- human memory is limited .

Accounting facilitates to replace the memory by maintaining the
complete record of financial transactions.
2. Facilitate to comply with legal requirements:- it facilitates to comply
with the legal requirements which requires an enterprise to maintain
books of accounts. E.g. the sec-209 of companies Act1956 requires a
company to maintain proper books of accounts on accrual basis, sec-
44AA of Income Tax Act-1961 requires certain persons to maintain
specific books of accounts.
 Financial Accounting

3. Facilitates to ascertain net result of operations:-accounting

facilitates to ascertain net results of operation by preparing Income
statement.
4. Facilitates to ascertain financial position:- accounting facilitates
financial position by preparing position statement.
5. Facilitates the user to take decisions:-it facilitates the users –
creditors, investors, employees, public, tax authorities to take decisions
by communicating information to them.
6. Facilitates the Comparative study:-facilitates the comparative study
in following 4 ways:- i) comparison of actual figure with the standard
or budgeted figures for the same period or same time. ii) comparison of
actual figure of one period with those of another period for the same
firm, comparison of actual figure of one firm with those of another
standard firm belonging to the same industry, comparison of the actual
figure of one firm with those of industry to which the firm belong.
7. Assist the management:-assist the management in planning and
controlling the business activities and taking decisions.
 Financial Accounting

8. Facilitates control over assets:- it facilitates control over assets by

providing information regarding cash balance, bank balance, debtors,
fixed assets, stock etc.
9. Facilitates the settlement of tax liability:-it facilitates the settlement
of tax liability with authorities by maintaining proper books of
accounts in systematic manner.
10. Facilitates the ascertainment of value of business:-it facilitates the
ascertainment of value of business in case of transfer of business to
another entity.
11. Facilitates raising loan:- it facilitates raising loan from the lenders by
providing them historical and projected financial statement.
12. Act as legal evidence:-proper books of accounts maintained in
systematic manner act as legal evidence in case of dispute.
 Financial Accounting

Limitation of accounting:-

Following are the limitations of accounting:-

1. Ignore the qualitative elements:-accounting is concerned with
monetary matters only, the qualitative element like quality of
management, quality of labor, public relations are ignored.
2. Not free from bias:-in many situations the accountant has to make a
choice out of various alternatives, e.g. choice of method of
depreciation, method for valuation of inventory. Since the subjectivity
is inherent in personal judgment , the financial statement therefore not
free from bias.
3. Estimated position and not real position:- financial statement is
prepared on a going concern basis as against liquidation basis, they
report only the estimated periodic result and not true results since the
true result can be ascertained only on liquidation basis.
4. Ignore the price level changes in case of financial statement
prepared on historical costs:-
 Financial Accounting

4. Ignore the price level changes in case of financial statement

prepared on historical costs:- in case of financial statement prepared
on historical costs, the fixed assets are shown in balance sheet at
historical cost less depreciation and not at the replacement value which
is far higher than the value stated in Balance sheet. The analysis of
such financial statement will not yield strictly comparable results
unless the price level changes are taken into account.
5. Danger of window dressing:-when the management decides to enter
wrong figures to artificially inflate or deflate the figure of the profits,
assets and liabilities , the income statement fails to provide true and
fair view of the results of operations and balance sheet fails to provide
true and fair view of financial position to the enterprise.
 Financial Accounting
S. Basis of Financial accounting
No distinction
1 Objectives It is designed to supply
information in the form
of profit and loss
account and balance
sheet to external parties
2 Analysis of It portrays the position of
performance business as whole. The
financial statement like
income statement and balance
sheet reports on overall
performance or status of the
business. It deals with
aggregates.
3 Data used Financial accounting is
concerned with monetary
records of past events. It is the
post-mortem analysis of past
activities.
Management accounting
It is designed for internal use by
the management.
It directs its attention to the
various divisions, departments
of the business and report about
the profitability, performance etc
of each of them. It provides the
detail analytical data .
It is an accounting for future and
it supplies data both for present
and future duly analyzed and in
detail.
 Financial Accounting
S. Basis of Financial accounting
No distinction
4 Monetary It records only transactions in
measurement monetary term.
5 Periodicity of The period of reporting is
reporting much longer in financial
accounting as compared to
management accounting. The
income statement and the
balance sheet are prepared
yearly .
6 Nature It is more objective.
Management accounting
Management is interested in
both financial as well as
non financial matters to
take decisions,
management accounting
takes both into
consideration.
Management require
information of regular interval,
it emphasize on furnishing quick
information and at
comparatively short interval.
It is more subjective. It is based
on judgment rather than on
measurement.
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S. Basis of Financial accounting Management accounting

No distinction
7 Legal It is compulsory for every Not compulsory to install a
compulsion business on account of system for management
legal provisions of one accounting.
or other act