Module-I

Chapter – 1
Financial Accounting:
An Overview
 What is
• Accounting is a processAccounting?
of keeping
records of transactions in systematic
way.
• According to 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 financial character, and
interpreting the result thereof”
Why Accounts are Prepared?

For record keeping

To provide information
Account
To control

To study the performance

Evaluation / History of Accounting
The seeds of accounting were
Accounting is as Accounting practices in India could be
most likely first sown in Babylonia
old as money and Egypt around 4000 B.C. traced back to a period of Chankya

‘Munims’ accountant of ancient times

The history of accounting is Egyptians, Romans and Chinese used

as old as civilization.
one or other forms of accounting
Evolution/History of accounting
Separation of ownership from management created the
need for accounting

A move from simple book keeping to accounting in

19th century
Company form of
business organization
pushed the demand of Emerged in response to
accounting social and economic need
of the society
Accounting was
practiced without a
uniform methodology or
theory
Evolution of accounting

Cost Government
The concept has
accountancy accounting –
broadened to include
has emerged as
Macro
recording, processing,
accounting
classifying, a separate
Increased demand
for financial summarizing,
branch of
disclosures by all Need for analyzing, evaluating
the stakeholders and providing the accountancy
more
like shareholders,
transparency information required
suppliers,
for making decisions
employees,
customers,
government etc.
Accounting is an information Book keeping is just a process of
system designed to fulfill the recording transactions and
need of decision makers keeping records

Accounting includes
budgeting, strategic planning,
cost analysis, auditing, income
tax preparation, performance Book keeping is a
measurement, evaluation, small and simple part

control, preparing of accounting

management reports for

decision making etc.

Accounting V/s Book-Keeping

 Accounting as an Information System

A system contain three

activities: Input, Processing and
Output

As an information As an information
system accounting links system, accounting
plays important role of
accountant, financial providing the
statements and external information required for
making business
users decisions
 Accounting as an information system

Decision
Accounting
Makers

Info

Info
rm a

rma
tion
tion
Ne
ed s
Data
Business Communication
Recording of Processing of
Activities and (As financial
Data Data
transactions statements)

Accounting as an information system in business and economic decision making

Accounting as a language
Two important components
of any language are
• Symbols and
Language of business • Rules

Means of
communicating
information about
the business
 User of
Management
Accounting or managers

Users with Users with

direct financial indirect financial
interest interest
 Users of Accounting
Information

• Includes different managers

• Accounting provides information to the management

for planning, controlling and decision making.

• One of the most important users of accounting

information

MANAGEMENT OR MANAGERS
 Users of Accounting
Information
• Creditors requires accounting information to make sound
credit decisions, i.e. whether to lend money to a company
• Includes existing and potential investors and creditors
• Investors would be interested in past performance and
earning potential and growth prospects in future
• Creditors would be interested in knowing the ability of
company to meet its debt obligations in future
• Other users with direct financial interest are employees and
suppliers
USERS WITH DIRECT FINANCIAL INTEREST
 Users of Accounting
Information
Includes

• customers

• tax authorities

• government agencies

• labor unions

• financial analyst and advisers.

USERS WITH INDIRECT FINANCIAL INTEREST

 Three Main Branches of Accounting

01 Financial Accounting

02 Cost Accounting

03 Management Accounting
 Financial Accounting

Concerned with providing

information to external users

Oriented towards preparation of It involves recording, classifying

summarized statements, that and summarizing the effects of
communicates the financial position internal events and external
and performance during the specific transactions
time period
 Financial Accounting – Scope and Nature

Accounting Accounting Users of financial

01 Content 02 03 04 Measurement 05
system principles accounting system
unit
Journals, ledgers, Known as generally
Different
trial balance, accepted accounting Accounting Includes
financial
financial principles (GAAP) measures all the internal and
statements that
statements, are helps in preparation transactions in external users
communicate
prepared using of financial terms of money
useful information
double entry statements
to decision makers
system
 Limitation of Financial Accounting
04 Accounts can be

03 Does not provide

manipulated

detailed cost
information
02
Does not set up proper
system of controlling
material or supplies
05 Does not provide separate information for
01 different departments or territories
Provide
historical data
06
Recording and accounting for wages and labor is not carried out for
different departments or jobs

07 Does not provide a system to evaluate the performance of departments and

employees working in departments
 Management Accounting

Managers

Management
Accountant
Financial
Statements
 Management Accounting
Management accountant performs very important
function of fulfilling information need of mangers by
extracting the required information from financial
statements

Management accounting provides both historical and estimated data

which management uses in evaluating and controlling performances
and in planning future operations
 SIMILARITIES BETWEEN FINANCIAL
ACCOUNTING AND MANAGEMENT
ACCOUNTING

Reports prepared in 04 Both try to

quantify the
02 01
management Both are
result of Both deal Both are part of
accounting and concerned with
economic with
total accounting
financial accounting financial economic
are based on same
activates events information system
statements,
database revenues, and

05 expenses, assets, 03
transactions
liabilities and
cash flows.
Financial Accounting and Management Accounting
Difference
POINT OF DIFFERENCE FINANCIAL ACCOUNTING MANAGEMENT ACCOUNTING

Mainly external to the business Mainly internal to the business

1. Primary users of information
enterprise enterprise

2. Accounting Method Uses double entry system Does not use double entry system

Bound to Generally Accepted Not bound to Generally Accepted

3. Accounting Principles Accounting Principles (GAAP) Accounting Principles (GAAP)
Financial Accounting and Management Accounting
Difference
POINT OF DIFFERENCE FINANCIAL ACCOUNTING MANAGEMENT ACCOUNTING

Only monetary transactions are Monetary as well as non monetary

4. Unit of measurement
considered transactions are considered

Financial accounting data and

Management accounting reports are
5. Time span statements are prepared for
prepared as and when they are
a definite period on regular
needed
basis

6.Historical v/s futuristic Futuristic Orientation

Historical orientation
orientation
 Principal Financial Statements
MAJOR F
I
Profit and Loss Account
N
A
Balance Sheet N
C
I
Statement of Changes in Financial A
Position (SCFP)
L
S TAT E M E N T S
 Profit and Loss Account
Presents the result of operation
of enterprise for a period of
time
Indicates different sources Shows net profit or net income
of revenue and types of of an entity for a period of time
expenses
INCOME
STATEMENT
Indicates how successful an Net profit or income is
organization is in achieving the difference between
its profit goal revenues and expenses
When
Revenue > Expenses = P&L account shows profit
Revenue < Expenses = P&L account shows loss
 Balance Sheet
Also known as Statement of Financial Position

Shows financial position of

Shareholder’s equity is the business on certain date
shareholder’s claim on the assets

Indicates firms investing and

Liabilities are outsider’s financing activities at a point
claim on the assets of time

Assets are economic

resources and provides Provides information about
future benefit to the firm assets, liabilities and capital
Statement of Changes in Financial Position
(SCFP)
Cash based SCFP is
popularly known as cash
flow statement
It provides overview of
cash inflows and cash
outflows
It covers all items that
increases or decreases the
cash of business enterprise
A statement of changes in
financial position (SCFP)
shows where the financial
resources (Funds) have come
from (sources) and where
they have gone (Uses)
SCFP is prepared on
• Working capital basis
and
• Cash basis
Working capital based
SCFP explain increase or
decrease in working capital
for a specific period of time
Principal Financial Statements

Profit and Loss Account Financial Performance

(Profitability)

Balance Sheet Financial Position

(Solvency)

Statement of Changes in Sources and Uses of Funds

Financial Position (Liquidity)
 Forms of Business Organization

Company

Sole proprietorship

Partnership

There are three basic forms of business organizations

 Features Sole Proprietorship Partnership Company
Not a separate legal
1. Legal Status Not a separate legal entity Separate Legal entity
entity
Change in any one
2. Transfer of Sale by owner to a new Transfer of ownership
partner’s share creates
ownership person or entity through sale of shares
new
3. Duration or Limited by desire or Limited by desire or Indefinite, possibly
life death of proprietor death of partners unlimited
Unlimited, owner's Unlimited, except as Limited to investment
4. Ownership personal assets can be provided in Limited made by the
risk or liability used to pay business Liability Partnership Act shareholders in
liabilities 2008 company

5. Accounting Separate economic

Separate economic unit Separate economic unit
treatment basis unit

6. Ownership
Are in same hands Are in same hands Are in different hands
and management
 Limited Liability Partnership

L im
ited
Li abi
Company lity
Sepa
rate
Exist
ence

LLP
ct ure
St ru
rs hi p
ners
a r tne y ow
P tb
e n
ge m
a na
Partnership M

LLP is a partnership firm with limited liability of its partners

 01 04
Combines the features of company Law relating to partnership is
and partnership firm generally not applicable to LLP

02 05
It is a body corporate incorporated In LLP liability of partner is
under the LLP act 2008 limited only to his agreed
contribution

03 06
No limit on maximum number of In LLP liability of partner is
partners limited only to his agreed
contribution
 07 10
Partners are not liable for the acts LLP has no share capital
of LLP / Liability of partners is
limited

08 11
LLP can own and hold the property, A written agreement is entered
employ people and enter into into between the partners of LLP
contract in its own name

09 12
An LLP has members but no Has complete flexibility as to its
directors and shareholders internal structure and
functioning