Uniathena -ATHENA GOBAL EDUCATION

COURSE: BASICS OF ACCOUNTING

ACCOUNTING FUNDAMENTALS
Lesson 1: Accounting and its Significance
Accounting is a systematic way of recognizing, recording, measuring, classifying, analyzing and
communicating financial information with a purpose of revealing Profit or loss incurred in the
given period and position of assets and liabilities of the business.
According to the American Institute of Certified Public Accountants (AICPA) – "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 financial character, and interpreting the
results thereof."
Importance of accounting
Identifying- select transactions and events: the sale by apple of an iPhone
Recording- input, measure, and log: keep a chronological log of transactions
Communicating- Prepare, analyze and interpret: prepare reports such as financial statements.
Basically, accounting is the language of finance conveying the information about the financial
position of the company to the user of financial statements and furthermore facilitating the
decision-making process.
Accountancy is the flow or process of communicating financial transactions about a business
entity.
Generally, it is a communication in the form of financial statements like Balance sheet, income
statement, cash flow etc. also we can say that it is an information system that identifies, measures
and communicates the economic/business information of an entity to its users who need the
information for decision making.
Accounting identifies financial transactions and business events of a specific entity.
Objectives of Accounting
To Keep a Systematic Record of Financial Transactions
The primary objective of accounting is the recording of financial transactions that are made
within the firm. This process of recognizing and recording financial transactions can also be
referred to as bookkeeping.
To Determine the Results of the Operation/Production
Accounting is required in every business to estimate and determine the final outcome of any
operational or production activities.
To Interpret the Liquidity Position

There are various ratios used in accounting to calculate the measure of liquidity, such as; current
ratio and quick ratio.

To Facilitate Business Decision-Making

Accountancy provides your investors and creditors with the structure of analysis to assess the
financial position, solvency and creditworthiness of a business and hence, facilitates the decision
making process.

To Comply with the Requirements of Law

Accounting and bookkeeping are required in every business to keep the necessary records and
documentation required by the law.
Significance of Accounting
Accounting plays a vital role in running a business because it helps you track income and
expenditures, ensure statutory compliance, and provide investors, management, and government
with quantitative financial information which can be used in making business decisions.
The significance of accounting is to record and report on financial information regarding the
performance, financial position, and cash flows of a business. 

The Primary Significance of Accounting are as Follows:

 It helps in evaluating in performance of the business

 It helps in monitoring working capital and regulated the Cash flow management
 It ensures statutory compliance promptly.
 It helps to create a budget and future projections
 It helps in filing financial statements
Lesson 2: Financial Accounting
Financial Accounting is a specialized branch of accounting that keeps track of a company's
financial transactions. The transactions are recorded, summarized, and presented in a
financial report using standardized guidelines.
It deals with the procurement of funds and their effective utilization in the business. It remains a
focal point of all activities and concerned with the raising of funds, deciding capital structure,
utilization of fundraised (capital budgeting, portfolio, working capital, etc.), making provision
for refund when money is not required in the business (dividend distribution or repayment of the
loan, etc.), deciding the most profitable investment, etc.
Financial Accounting has common rules known as Accounting standards such as Generally
Accepted Accounting Principles (GAAP) and International Financial Reporting Standards
(IFRS).
Some Related Areas of Financial Accounting
Double Entry and Financial Accounting
Double-Entry Bookkeeping is a way of bookkeeping where every financial entry to an account
requires a corresponding entry to a different account. Every financial transaction affects two
accounts in financial accounting.
Accrual Basis of Accounting and Cash Basis of Accounting
The Accrual Basis of Accounting makes a distinction between the actual receipt of cash and the
right to receive cash as regards revenue and actual payment of cash and obligation to pay cash as
regards expenses. Revenue is recognized when realized, and expenses are recognized when they
become due and payable irrespective of the time of actual cash receipt or cash payment.

The Cash Basis of Accounting is accounting where all receipts of cash and expenses are
recognized when they are received or paid.
Financial Statements
Financial Statements are the documents prepared by every entity, whether profit-making or not.
They are the documents prepared by the entity to evaluate and identify their financial
position of the business.

Financial Statements Consists of:

 Balance Sheet
 Income statement
 Cash Flow statement
 Statement of changes in equity
 Notes to Accounts

Financial Reporting

Financial Reporting is the communication of financial information to the users of financial

statements and disclosure of the performance of the business over the financial year.

Users of Financial Statements

 Stakeholders
 Management
 Employees
 Suppliers
 Lenders
 Government

Importance of Financial Accounting

Financial Accounting is the most important for all business enterprises. It plays a vital role in the
accounting of sufficient fund acquisition, utilization, and increment of profitability of the
business and maximization of value of the organization and ultimately, the shareholder's wealth.
  Estimating the Requirement of Funds

Both for long-term purposes, i.e. investment in fixed assets, and for the short term, i.e. for
working capital. Forecasting the requirement of funds involves the use of techniques of
budgetary control and long-range planning.

 The Decision Regarding Capital Structure

Once the requirement of the fund has been estimated, a decision regarding various sources
from which these funds would be raised has to be taken. A proper balance has to be made
between the loan funds and their own funds. i.e. Debt and Capital

 Investment Decision

The investment of funds in a project has to be made after careful assessment of various
projects throughfi. Assets management policies are to be laid down regarding various items of
current assets, e.g., receivable in coordination with a sales manager, inventory in coordination
with the production manager, etc.

 Financial Negotiation
Financial accounting plays a significant role in carrying out negotiations with the financial
institutions, banks, and public depositors for raising funds on favorable terms.

 Cash Management

The finance manager lays down the cash management and cash disbursement policies to
supply adequate funds to all units of the organization and to ensure that there is no excessive
cash.

 Fulfilling Tax Obligations

Proper financial accounting and financial decisions can actually help you in fulfilling tax
obligations in a more efficient way and provide you with tax savings if appropriately managed.

 Planning For the Future

Financial accounting helps in constant review of the financial performance of the various
units of organization generally in terms of return and investment. Such review helps the
management in seeing how the funds have been utilized in various divisions and plan
accordingly for the future through an analysis of fund flow, cash flow, and ratio analysis.

Lesson 3: Managing Accounting

Accounting is the process of accounting for cost which begins with the recording of income and
expenditure or the bases on which they are calculated and ends with the preparation of periodical
statements and reports for ascertaining and controlling costs. The emergence of management accounting
is due to the limitations of financial accounting to meet the informational needs of the management.

The Institute of Cost and Management Accountants, London, has defined Management Accounting
as: "The application of professional knowledge and skill in the preparation of accounting information in
such a way as to assist management in the formulation of policies and the planning and control of the
operation of the undertakings.

"Similarly, according to the American Accounting Association: "It includes the methods and
concepts necessary for effective planning for choosing among alternative business actions and for
control through the evaluation and interpretation of performances."
Objectives of Management Accounting

 Ascertainment of Cost

Management accounting provides cost ascertainment and information to the management

promptly, thereby enabling it to take necessary corrective action on time.

 Determination of Selling Price

Business enterprises run on a profit-making basis. It is, thus, necessary that revenue should be
higher than the expenditure incurred in producing goods and services from which the
revenue is to be derived. Cost and management accounting provides data regarding the
necessary product or services.

 To Determine Price

Management accounting provides information that enables the management to fix

remunerative selling prices for various items of products and services in different
circumstances.

 To Make Decisions

Most of the decisions in a business undertaking involve correct statements of the likely effects on profits
and management accounting is of vital help in this respect.

 Budgeting

Budgeting is done to ensure that a practicable course of action can be chalked out and the actual
performance corresponds with the estimated or budget performance. The preparation of the
budget is one of the significant objectives of management accounting.
Management Accounting is Beneficial in the Following Areas

 Planning
 Decision Making
 Problem Identification
 Curtailment of loss during the offseason
 Strategic Management
 Measuring efficiency
 Cost control and cost reduction
 Pricing
 Budgeting
ACCOUNTING STANDARD

Accounting Standard

An Accounting Standard is a common set of principles, standards and procedures that

define the basis of financial accounting policies and practices. Accounting standards seek to
describe the accounting principles, the valuation techniques and the methods of applying the
accounting principles in the preparation and presentation of financial statements so that they give
an accurate and fair view. Accounting standards improve the transparency of financial reporting
in all countries. 

Accounting Standards Deal with the Issues of:

 Recognition of events and transactions in the financial statements,

 Measurement of these transactions and events,
 Presentation of these attractions and events in the financial statements in a manner that
is meaningful and understandable to the reader, and
 Disclosure requirements which should be there to enable the public at large and the
stakeholders and the potential investors, in particular, to get an insight into what these
financial statements are trying to reflect and thereby facilitating them to take prudent and
informed business decisions.

In the United States, the Generally Accepted Accounting Principles form the set of
accounting standards widely accepted for preparing financial statements. 

International companies follow the International Financial Reporting Standards, which are set by
the International Accounting Standards Board and serve as the guideline for non-U.S. GAAP
companies that are reporting financial statements.

Significance of Accounting Standards

Generally Accepted Accounting Principles – GAAP

The phrase "Generally Accepted Accounting Principles" (or "GAAP") consists

of three valuable sets of rules:

 The basic accounting principles and guidelines,

 The detailed rules and standards issued by the Financial Accounting Standards Board
(FASB) and its predecessor the Accounting Principles Board (APB), and
 The generally accepted industry practices.

If a company distributes its financial statements to the public, it is required to follow

generally accepted accounting principles in the preparation of those statements.

International Financial Reporting Standards – IFRS

International Financial Reporting Standards (IFRS) are a set of international

accounting standards stating how particular types of transactions and other
events should be reported in financial statements. IFRS are issued by the
International Accounting Standards Board (IASB).

They specify precisely how accountants must maintain and report their accounts.
IFRS was established to have a common accounting language, so business and
accounts can be understood from company to company and country to country.

The Setting of Accounting Standards has the Following Advantages

  Standards reduce to a reasonable extent or eliminate together confusing variations in the
accounting treatments used to prepare financial statements.
 There are certain areas where vital information is not statutorily required to be disclosed.
Standards may call for disclosure beyond that required by law.
 Provides reliability and uniformity in accounting
 The setting of accounting standards helps in prevention of frauds and manipulations in
accounting.

GAAP and IFRS

IFRS VS GAAP

IFRS is considered to be more principle-based than GAAP. Differences exist between IFRS
and other countries' Generally Accepted Accounting Principles (GAAP) that affect the way a
financial ratio is calculated.

Another difference between IFRS and GAAP is the specification of the way inventory is
accounted for. There are two ways to keep track of this, First In First Out (FIFO) and Last In
First Out (LIFO). FIFO means that the most recent inventory is left unsold until older
inventory is sold; LIFO means that the most recent inventory is the first to be sold. IFRS
prohibits LIFO, while American standards and others allow participants to use either freely.
Key differences
Convergence

The convergence of accounting standards refers to the goal of establishing a single set of
accounting standards that will be used internationally, and in particular, the effort to reduce the
differences between the US Generally Accepted Accounting Principles (US GAAP), and the
International Financial Reporting Standards (IFRS). 

BASIC ACCOUNTING PRINCIPLES

Basic Accounting Principles & Guidelines

To maintain uniformity and consistency in preparing and maintaining books of accounts,

specific rules or principles have been evolved. These rules and principles are classified as
concepts, principles, theory, and conventions. The main objective of these Basic Accounting
Principles and Guidelines is to maintain uniformity and consistency in accounting records.
These concepts constitute the basis and a fundamental framework of accounting.

Following are the Various Accounting Concepts, Principles, and Guidelines discussed in
Various Sections:
  Business Entity Concept

This concept assumes that, for accounting purposes, the business/economic entity and its owners
are two separate independent entities. Therefore, the personal transactions of its owner are
separated from the transactions of the business.

For Example: when the owner invests money in the business, it is recorded as liability of the
business to the owner.

Monetary Measurement Concept

This concept assumes that all business transactions must be measured in terms of money. As per
this concept, transactions that can be expressed in terms of money are recorded in the books
of accounts and taken into accounting. But the transactions which cannot be expressed in
monetary value are not recorded.

For Example, sincerity, the loyalty of employees are not recorded in the books of accounts
because they cannot be expressed or measured in terms of money.

This concept states that a business entity will continue to carry on its business activities for
an infinite period. Every business has the continuity of life and considered that it wouldn't be
dissolved or liquidated in the future. On this same basis, depreciation is charged on a fixed
asset. In the absence of this concept, the cost of a fixed asset will be treated as an expense in the
year of its purchase.

It is an essential principle of accounting because it provides the basis for showing the value of
assets in the Balance sheet/Statement of Financial Position.

 Accounting Period Concept

All the transactions are recorded in the books of accounts on the assumption that profits on
these transactions are to be ascertained for a specified period. This is known as the
accounting period concept or Period concept. Thus, this concept requires the timely
preparation of the Balance Sheet and Income statement over a regular interval of time.

 Historical Cost Concept

This principle states that all assets are recorded in the books of accounts at their purchase price,
which includes the cost of acquisition, transportation, and installation and not at its market price.
It helps in calculating depreciation on fixed assets.

 Matching Concept

The matching concept states that the revenue and the expenses incurred to earn the revenues
must belong to the same accounting period. So, once the revenue is realized, the next step is to
allocate it to the relevant accounting period.

 Revenue Realization Concept

This concept states that revenue from any business should be included in the accounting
records only when it is realized. For Example; Selling goods is the realization of revenue;
receiving orders is not. Revenue is said to have been realized when cash has been received to the
right to receive cash on the sale of goods or services, or both have been created.

 Materiality
This principle talks about the material items and their treatment in accounting. Material items
are those items in financial statements which affect the decision of users of financial
statements. The materiality depends upon the nature and size of the entity's business. For
Example: For a small entity, the purchase of a laptop worth $500 may be a material item but for
a real estate company that transacts in millions of dollars, the purchase of a laptop may not be a
material item and thus insignificant.

FINANCIAL INFORMATION, USERS, AND FINANCIAL STATEMENTS

Financial Information

Financial Information is the data and facts related to the financial transactions of the
company. The users of financial information are bound to keep it confidential and secure.
Financial information is diverse and may have various facets, depending on the reviewer
and the objective of the study. Many corporate data summaries provide bits of financial
information that management relies on to make decisions and steer operating activities to
financial success. Data sets incorporating financial information include budgets, pro forma
reports, production worksheets, and financial statements.

Uses of Financial Information

  Provides information about results of operations carried out in the course of
business.
 Helps in decision-making regarding the use of resources.
 Helps us understand the overall condition of the business.
 Helps us understand the present situation of our financial resources.
 They are used in the selection of an appropriate source of funds and financing.
 They are used in the analysis regarding cost reduction and evaluation of profits.
 Helps in comparison and analysis of business activities using various ratios.

Financial Statements

Financial Statements are the financial documents of data and information produced and
presented to the users of financial statements. The general purpose of financial statements is
to provide information about the financial position, financial performance, and cash flows
of an entity that is useful to a wide range of users in making economic decisions. To meet
that objective, financial statements provide information about an entity's:

 Assets and Liabilities

 Owner's Equity
 Income and expenses, including gains and losses
 Contributions by and distributions to owners (in their capacity as owners)
 Cash flow and fund flow

Different Financial Statements

 Balance Sheet

A Balance Sheet shows the position of assets and liabilities of the business as of the date. It
records the total assets, liabilities, and equity (net worth) of a business as of a specific day. 

 Income Statement

The Income Statement, also known as the Profit and Loss Account, shows the net results of
operations during the financial year. Business revenue, expenses, and the resulting profit or
loss over a given period of time are detailed in the Income Statement. 
  Cash Flow Statement

The Cash Flow statement shows the position of cash flows from investing, operating, and
financing activities. Cash is the lifeblood of a small business – if the business runs out of cash,
the chances are good that the business is out of business.

 Statement of Changes in Equity

It shows the changes in equity investment in the reporting period. Also known as the Statement
of Retained Earnings, it details the movement in owners' equity over a period. Shareholders'
equity is the amount that shows how the company has been financed with the help of common
shares and preferred shares.

 Note to Accounts

These are the explanatory notes which explain various adjustments in the financial
statements and the basis of preparation of accounts. These are an integral part of accounts.

Users of Financial Statements

 Shareholders and Investors: To know the position of their investment in the business.
 Management: To evaluate the business operations and their own performance.
 Employees: To demand bonus and other prerequisites (benefits) as a matter of claiming
their rights.
 Trade Creditors and Suppliers: To identify the creditworthiness of the business.
 Lenders: To know whether the business can repay the debts.
 Government: To identify the taxable income and impose the tax.

FINANCIAL DECISION MAKING 

Financial Decision-Making should be focused to maximize the wealth of the firm. Financial
decision-making has the main objective to manage funds in such a way that it ensures their
optimum utilization and their procurement in a manner that the risk, cost, and control are
balanced correctly in a given situation.

Types of Financial Decisions

  According to the Inter-American Investment Corporation (IIC), the role of the Financial
Managers in the decision-making process can be divided into four main areas:

Investment Decisions

The investments of funds, in a project, have to be made after careful assessment of various
projects through capital budgeting. Asset management policies are to be laid down regarding
various sources from which these funds would be raised and to be taken.

In the investments area, the Financial Manager is responsible for defining the optimal size of
the company. In this regard, it is essential to have a market study in place and be clear on the
objectives that the company needs to meet. It is essential to have correctly studied the demand,
technology and equipment, financing methods, and human resources available. 

 Financing Decisions

Defining a financing strategy is essential to the continuity of the business over the long
term. Access to financing is closely related to maintaining a constant inflow of capital since the
savings margin will not allow operations to continue for much longer without the support of
additional liquidity. The Financial Manager must define several aspects of the financing
strategy.

 Asset Management
Asset management is one of the main aspects for a company to meet its obligations
adequately and in turn, to position itself to meet the objectives or growth targets that have
been laid out. In other words, the Financial Manager must stipulate and assure that the existing
assets are managed in the most efficient way possible. The finance manager lays down the
cash management and cash disbursement policies to supply adequate funds to all units of the
organization and to ensure that there is no excessive cash.

 Dividend Policy

One of the most critical financial decisions that a Financial Manager must make is related to the
company's dividend policy. It concerns how much of the company's earnings will be paid out
to shareholders. Specifically, it is necessary to determine if generated earnings will be
reinvested in the company to improve operations or if they will be distributed among
shareholders.

The finance manager is concerned with the decision as to how much to retain and what
portion to pay as dividends depending on the company's policy. The trend of earnings, trend
of share market prices, requirement of funds for future growth, cash flow situation is to be
considered.

The Objective of Financial Decision Making

An entity's financial decision making may often have the following as its objectives:

 The maximization of the entity's Profit

 The maximization of the entity's value/wealth

Wealth Maximization vs. Profit Maximization

The maximization of Profit is often considered as an implied objective of the business. To

achieve these various objective types of financing decisions may be taken. Sometimes, the
decision-makers even opt for the policies yielding unreasonably high profits in the short run,
which may prove to be unhealthy for the growth, survival, and overall interest of the business.
The wealth of an entity is the market price of the entity's stock. It takes into account present
and prospective future earnings per share, the timing, and risk of these earnings, the dividend
policy of the business entity, and other factors in the decision-making process.

Therefore, the wealth maximization objective of the entity is superior to its profit maximization
objective due to the following reasons:

 The wealth maximization objective considers all future cash flows, dividends, earnings
per share, risk of decision, etc. whereas the profit maximization objective does not
consider it.
  A business entity with a wealth maximization objective usually pays a dividend
regularly, whereas a business entity with a profit maximization objective may refrain
from paying regular dividends.

Wealth maximization should be the primary objective of the business. However, profit
maximization can be considered as a part of the wealth maximization strategy.