Introduction to Financial Accounting

Financial accounting is a specialized branch of accounting that

keeps track of a company's financial transactions. Using
standardized guidelines, the transactions are recorded,
summarized, and presented in a financial report or financial
statement such as an income statement or a balance sheet.
Companies issue financial statements on a routine schedule. The
statements are considered external because they are given to
people outside of the company, with the primary recipients being
owners/stockholders, as well as certain lenders. If a
corporation's stock is publicly traded, however, its financial
statements (and other financial reportings) tend to be widely
circulated, and information will likely reach secondary recipients
such as competitors, customers, employees, labor organizations,
and investment analysts.
It's important to point out that the purpose of financial
accounting is not to report the value of a company. Rather, its
purpose is to provide enough information for others to assess the
value of a company for themselves.

Because external financial statements are used by a variety of

people in a variety of ways, financial accounting has common
rules known as accounting standards and as generally accepted accounting
principles (GAAP). In the U.S., the Financial Accounting Standards
Board (FASB) is the organization that develops the accounting
standards and principles. Corporations whose stock is publicly
traded must also comply with the reporting requirements of the
Securities and Exchange Commission (SEC), an agency of the
U.S. government.

Nature of Accounting:

We know Accounting is the systematic recording of financial transactions and

presentation of the related information of the appropriate persons. The basic features of
accounting are as follows:
1. Accounting is a process: A process refers to the method of performing any specific job
step by step according to the objectives, or target. Accounting is identified as a process as
it performs the specific task of collecting, processing and communicating financial
information. In doing so, it follows some definite steps like collection of data recording,
classification summarization, finalization and reporting.

2. Accounting is an art: Accounting is an art of recording, classifying, summarizing and

finalizing the financial data. The word ‘art’ refers to the way of performing something. It
is a behavioral knowledge involving certain creativity and skill that may help us to attain
some specific objectives. Accounting is a systematic method consisting of definite
techniques and its proper application requires applied skill and expertise. So, by nature
accounting is an art.

3. Accounting is means and not an end: Accounting finds out the financial results and
position of an entity and the same time, it communicates this information to its users. The
users then take their own decisions on the basis of such information. So, it can be said
that mere keeping of accounts can be the primary objective of any person or entity. On
the other hand, the main objective may be identified as taking decisions on the basis of
financial information supplied by accounting. Thus, accounting itself is not an objective,
it helps attaining a specific objective. So it is said the accounting is ‘a means to an end’
and it is not ‘an end in itself.’

4. Accounting deals with financial information and transactions; Accounting records the
financial transactions and date after classifying the same and finalizes their result for a
definite period for conveying them to their users. So, from starting to the end, at every
stage, accounting deals with financial information. Only financial information is its
subject matter. It does not deal with non-monetary information of non-financial aspect.

5. Accounting is an information system: Accounting is recognized and characterized as a

storehouse of information. As a service function, it collects processes and communicates
financial information of any entity. This discipline of knowledge has been evolved out to
meet the need of financial information required by different interested groups.
Scope of Accounting:

Accounting has got a very wide scope and area of application. Its use is not confined to
the business world alone, but spread over in all the spheres of the society and in all
professions. Now-a-days, in any social institution or professional activity, whether that is
profit earning or not, financial transactions must take place. So there arises the need for
recording and summarizing these transactions when they occur and the necessity of
finding out the net result of the same after the expiry of a certain fixed period. Besides,
the is also the need for interpretation and communication of those information to the
appropriate persons. Only accounting use can help overcome these problems.

In the modern world, accounting system is practiced no only in all the business
institutions but also in many non-trading institutions like Schools, Colleges, Hospitals,
Charitable Trust Clubs, Co-operative Society etc.and also Government and Local Self-
Government in the form of Municipality, Panchayat.The professional persons like
Medical practitioners, practicing Lawyers, Chartered Accountants etc.also adopt some
suitable types of accounting methods. As a matter of fact, accounting methods are used
by all who are involved in a series of financial transactions.

The scope of accounting as it was in earlier days has undergone lots of changes in recent
times. As accounting is a dynamic subject, its scope and area of operation have been
always increasing keeping pace with the changes in socio-economic changes. As a result
of continuous research in this field the new areas of application of accounting principles
and policies are emerged. National accounting, human resources accounting and social
Accounting are examples of the new areas of application of accounting systems.

Financial Accounting Limitation

Supplies Insufficient Information:
Financial accounting provides the information about the financial activities
as a whole and not individual-wise, i.e., it does not record information
relating to product-wise, department-wise etc.

Controlling Cost not Possible:

In financial accounting control of cost is not possible since the costs are
known at the end of the financial year or a specified period of time whether
the expense or cost has already been incurred, i.e., nothing can be done to
control either the account of expense or the cost. In other words, if it is even
found that a particular cost is more, it is not possible to control it.

But the same is possible only when the cost accounting system is being
introduced.

Historic in Nature:
Since the financial accounting records all transactions relating to a
particular period, it is rather historic in nature. In short, present financial
information relating to a past period and not for the future although all
financial decisions are taken on the basis of past financial data.

Recording Actual Cost:

The financial accounting records the actual cost only, the historical cost of
the assets. The value of assets may be changed, but record only the cost of
acquisitions of such assets. In other words, financial accounting does not
record the price fluctuations or change in price level. As a result it does not
present the correct information.

Difficulty in Price Fixation:

We know that the total cost of a product can be obtained only when all
expenses relating to a product have been incurred. That is why it is not
possible to ascertain the price of the product in advance for the purpose of
estimated selling price. As total cost (i.e., fixed cost, variable cost, direct
cost and indirect cost of a product) depends on many factors, all such
factors cannot be supplied by financial accounting.

Technical Subject:
Since financial accounting is a technical subject, it is not possible for a
common man to understand it. Without the proper knowledge of principles
and conventions of accounting it is not possible to analyse the financial
data to take any financial decision. Naturally, it has got little value to a
person who is not conversant with the subject.

Unanimity about Accounting Principles:

Although there is IASC (International Accounting Standard Committee),
the accountants differ in their opinion on the application of accounting
principles in the same matter.

For example, some accountants prefer to use FIFO method for valuing
inventory whereas others prefer to use LIFO or some other method; or,
some accountants prefer to use Straight-line Method of depreciation but
others prefer to use Diminishing Balance Method etc.

Not Possible to Evaluate Accounting Principles:

Whether the existing accounting principle is sound/correct or not, that
cannot be evaluated, i.e., actual performance cannot be compared with the
budgeted figure as we can do in case of Standard Costing/Budgetary
Control. In other words, the actual result cannot be compared with the
budget.

Financial accounting presents only the result of the business through profit
and financial positions, i.e., the rate of profitability. But the profit may be
affected by many of outside factors which are not recorded by financial
accounting.

Supply Quantitative Information:

Financial accounting supplies quantitative information only through
absolute figures which do not present always the required information
although they are needful to the users. But relative financial information
are more important and informative.

May be Manipulated:
Financial accounting may be manipulated, i.e., it may be presented as per
desire of the management. For example, profit sometimes may be reduced
in order to evade tax and to avoid bonus to the employees. On the contrary,
more profit may be shown in order to raise fresh equity shares or to pay
more dividend to attract the shareholders and others.

Uses of Financial Accounting Information

Accounting has been called the language of business and is used in many
different situations. Cost accounting is used to streamline manufacturing
operations. Managerial accounting is used to compile data necessary for sound
management decisions. Financial accounting is used to report the financial
result of a company’s operations. Public companies are required to report their
results to the public while private companies report to their owners. In either
case financial statements are created and the results are analyzed. That
process is financial accounting.

Income Statement
Financial accounting is used to report the outcome of business operations in
monetary form. To do this the accounting department uses financial accounting
techniques to create an income statement. The income statement is also called
the profit and loss statement. As the name indicated it reports whether or not
the company had a profit or a loss over a given period of time. Public
companies report and publish their income statements with the Securities and
Exchange Commission (SEC). Private companies perform the same procedures
but they do not publish the outcome.

Balance Sheet
Financial accounting is also used to determine a companies financial position
for a specific period in time. This process is repeated monthly, quarterly and
annually. The accounting department creates a balance sheet which provides
the financial position of the company at a given time. The balance sheet
contains the status of the companies asset, liability and equity accounts. This
information is critical in determining liquidity, solvency and the future viability of
the business continuing operations.

Cash Flow
Different businesses in different industries have varying monthly cash needs.
However, using financial accounting, the accounting department, has the ability
to create cash flow statements. Used for managerial accounting as well, cash
flow statements examined over a period of time can generate a history of cash
fluctuations. This data can be used to report the company’s cash position and
going concern theory. The going concern theory is a test of whether a company
can continue operations.
Financial Ratios
Financial ratios are computed when the financial statements are created. These
ratios tell an investor or manager how well positioned an organization is to
continue operations. These ratios determine a company’s liquidity. Liquidity is
the measure of a company’s ability to pay their short term debt when it comes
due. Solvency is the measure of how well a company will be able to meets its
long term debt obligations. These ratios are critical in determining the health
and long term vitality of a company since the financial statements only report for
a certain period.

Management Decisions
Decisions require information. Making a decision without a basis or intelligence
on the subject matter is called gambling. All of the financial accounting tools
mentioned here are used to make solid management decisions. Decisions on
whether to borrow to cover cash needs, invest surplus cash and expand
production or possible the production line. This financial data is instrumental in
these decisions.

Compliance
Financial reporting is required by all public US companies. This process is
complex and time consuming. However, it is easier to explain. Quarterly and
annually public companies report their results and publish their outcomes with
the SEC, mentioned earlier in this article. This is the most obvious use of
financial accounting data.
Scope Of Management Accounting

The scope or field of management accounting is very wide and broad based and it
includes a variety of aspects of business operations. The main aim of
management accounting is to help management in its functions of planning,
directing, controlling and areas of specialization included within the admit of
management accounting. The scope of management accounting can be studied as
follows:

1. Financial Accounting

Financial accounting forms the basis for analysis and interpretation for
furnishing meaningful data to the management. The control aspect is based on
financial data and performance evaluation, on recorded facts and figures. So,
management accounting is closely related to financial accounting in many
respects.

2. Cost Accounting

Cost accounting is the process and techniques of ascertaining cost. Planning,

decision making and control are the basic managerial functions. The cost
accounting system provides the necessary tool for carrying out such functions
efficiently. The tools includes standard costing, inventory management, variable
costing etc.

3. Budgeting And Forecasting

Budgeting means expressing the plans, policies and goals of the firm for a
definite period in future. Forecasting on the other hand, is a prediction of what
will happen as a result of a given set of circumstances. Forecasting is a judgement
whereas the budgeting is an organizational object. These are useful for
management accounting in planning.

4. Inventory Control

Inventory is necessary to control from the time it is acquire till its final disposal
as it involves large sum. For controlling inventory, management should
determine different level of stock. The inventory control technique will be helpful
for taking managerial decisions.

5. Statistical Method

Statistical tools not only make the information more impressive, comprehensive
and intelligible but also are highly useful for planning and forecasting.

6. Interpretation Of Data

Analysis and interpretation of financial statements are important part of

management accounting. After analyzing the financial statements, the
interpretation is made and the reports drawn from this analysis are presented to
the management. Interpreting the accounting data to the authorities in the
management is the principal task of management accounting.\

7. Reporting To Management

The interpreted information must be communicated to those who are interested

in it. The report may cover Profit and Loss Account, Cash Flow and Funds Flow
statements etc.
8. Internal Audit And Tax Accounting

Management accounting studies all the tax matters to assist the management in
investment decisions vis-a-vis tax planning as a resource to enjoy tax relief.

Internal audit system is necessary to judge the performance of every

department. Management is able to know deviations in performance through
internal audit. It also helps management in fixing responsibility of different
individuals.

9. Methods Of Procedures

This includes maintenance of proper data processing and other office

management services. It may have to deal with filing, copying, duplicating,
communicating and management information system and also may have to
report about the utility of different office machines.

Nature of Management Accounting

1. No Fixed Norms Followed

In financial accounting, we follow different norms and rules for creating ledgers
and other account books. But there is no need to follow fixed norms in
management accounting. Management accounting tool may be different from
one organization to other organization. Using of different tools of management
accounting is fully dependent on the persons who are using it. So, business
policy of each organization affects rules and regulation of applying management
accounting.

2. Increase in Efficiency
It is the nature of management accounting that it is used for increasing in the
efficiency of organization. It scans the points of inefficiency through analysis of
accounting information. By taking action for improving, organization
can increase the efficiency.

3. Supplies Information not Decisions

Management accountant supplies accounting facts and information and also
provides interpretation, but decision making is fully dependent on higher
authorities. Management accounting is just guide.

4. Concerned with Forecasting

It is the temperament of management accounting that it is fully concerned with
forecasting. In management accounting, historical accounting information is
analyzed through common size financial statement, ratio analysis, fund flow
analysis and accounting data tendency for knowing the probability of next fact.
So, all these things are especially useful for forecasting.

These forecasting may be related with following things

a) sales forecasting
b) production forecasting
c) earning forecasting
d) cost forecasting