- Information
- AI Chat
Unit 01 - Financial Accounting - Introduction
Master's in Business Administration (MBA001)
Manipal University Jaipur
Recommended for you
Students also viewed
Related documents
- Unit 15 - Standard Costing
- Unit 13 - Internal and External Business Communication - Writing Business Reports
- Unit 15 - Employment Communication - Group Discussions and Interviews
- Unit 11 - External Business Communication - Writing Business Letters
- Unit 12 - Other Forms of External Business Communication
- Unit 10 - IBC - Electronic Media and Shareholder Communication.pdf
Related Studylists
financial accountingPreview text
Unit 1 Financial Accounting – Introduction
Structure: 1 Introduction Objectives 1 Meaning and definition of Accounting, Book-Keeping, and Accounting Accounting Definitions of accounting Book-keeping 1 Accounting Process 1 Objectives of Accounting 1 Differences Between Book-Keeping, and Accounting 1 Users of Accounting Information 1 Limitations of Accounting 1 Basic Terminologies 1 Summary 1 Glossary 1 Terminal Questions 1 Answers 1 Case Study
1 Introduction
All of you, at some point of time, would have visited a grocery shop or a medical shop. You might have wondered how the owner maintains the record of all the transactions done during a particular period of time, say a year. You might have also wondered why the owner has to maintain records, how is it beneficial, and whether maintaining records is mandatory? As against this, imagine the role of a business organisation. It provides goods that range from simple safety pins to fighter aircrafts. Those who are in service industry provide various services such as transportation services, hospitality services, developing complex software programs, etc.
To make a sound decision, a business enterprise needs accounting information. This information is also needed by government agencies, regulatory bodies, analysts, and individuals at various point of time and at different levels.
Accounting is one of the oldest, structured management information system. It has evolved in response to the social and economic needs of society. Accounting, as an information system, is concerned with identification, measurement, and communication of economic information of an organisation to its users who may need the information for rational decision making. The accounting system is a means to provide relevant and reliable financial information to all the interested parties.
In this unit, we will understand the meaning of accounting, book-keeping, accountancy, and the steps involved in accounting process. We will also discuss the various objectives of accounting, the differences between book- keeping, accountancy, and accounting along with how accounting information is used by various stake holders. We will also focus on the basic terminologies used in accounting.
Objectives: After studying this unit, you should be able to:
define book-keeping, accountancy, and accounting
describe the accounting process
explain the objectives of accounting
distinguish between book-keeping and accounting
analyse the informational requirements of various users of accounting
information and also the limitations of accounting.
explain the basic terminologies used in this subject
1 Meaning and Definition of Accounting, book keeping
1.2 Accounting It is the application of various accounting principles and methods in book- keeping. It explains ‘why to do’ and ‘how to do’ various aspects of accounting. It tells us why and how to prepare the books of accounts and how to summarise the accounting information.
1.2 Definitions of accounting The earlier definitions of Accounting emphasised on the recording aspect. One such definition was given by American Institute of Certified Public Accountants (AICPA) in 1941.
goods, or services are transferred from one person or account to another person or account, it is known as a transaction.
- Measuring – This means expressing the value of events and transactions in terms of money (Rupees in India). Measuring has become an important challenge for the accountants and the business entities. This is due to the following reasons: a) Changing nature of business activities – The complexity of today’s business models has also changed the way accounting needs to be done. Technology enabled services like web designing and financial services like wealth management are the thriving businesses. The nature of such business activities is such that it becomes difficult to measure the transactions in terms of money. b) Business crossing international borders – All business entities today, whether small or big, have transactions crossing the borders. They have spending or earnings and payables and receivables in foreign currencies. Measuring such transactions is a big challenge as they have to be translated into home currency before they can be recorded.
Figure 1: depicts the process of accounting.
Recording – The next process after measuring the transactions is the recording. It deals with recording of identified transactions and events in a systematic manner in the books of original entry in accordance with the principles of accountancy. The book in which transactions are first recorded is called the Journal.
Classifying – All the recorded transactions do not make any sense unless they are processed and presented in a manner that is useful to the intended user. The functions of classifying and summarising serve this purpose. Classifying deals with periodic grouping of transactions of similar nature. For this purpose, a separate book called Ledger is maintained. It is a book where transactions of similar nature are maintained at one place. The transactions that appear in the books of original entry (Journal) are transferred to appropriate places in the book of final entry (Ledger) by a process called Posting. For example, all purchases of goods made for cash or on credit on different dates are brought to purchases account.
Summarising – The end objective of any business is to make profit. To know if this objective was achieved, it is necessary to summarise all the transactions that occurred and are recorded. This requires analysing total expenses or losses, total income or gain, total assets, and total liabilities. This function involves the preparation of financial statements such as income statement, balance sheet, statement of changes in financial position, and cash flow statement.
Analysing – It deals with the establishment of relationship between the various items or group of items taken from income statement or balance sheet or both. Its purpose is to identify the financial strengths and weaknesses of an enterprise. It involves using various tools like Ratio Analysis, Fund Flow Analysis, Cash Flow Analysis, etc. (discussed in subsequent units).
Interpreting – This step explains the importance of all the datas in a manner that the end users of financial statements can make a meaningful judgment about the financial position and profitability of the business.
Communicating – It deals with communicating the analysed and interpreted data in the form of financial reports or statements to the
Activity 1:
Visit futureaccountant Under Academy click on financial accounting to get study notes on (1) The need for accounting (2) Basic purpose of Accounting and (3) The objective of accounting and much more.
1 Objectives of Accounting
Accounting involves the following functions and objectives:
Accounting assists in systematic recording of all business events or transactions.
Accounting measures the financial performance of an enterprise.
Accounting facilitates reporting of results to both internal and external users. The management requires information for internal purpose at various levels of operations.
Accounting is required to fulfil the statutory requirements of various regulatory bodies such as Registrar of Companies, Securities Exchange Board of India (SEBI) income tax authorities, and the Government.
Accounting helps in internal control by holding the concerned persons responsible for any errors, lapses, or under performances.
Self Assessment Questions
- The financial performance of an enterprise is ascertained by preparing income statement, balance sheet, and cash flow statement. (True/False)
- Expand SEBI.
- Mention any five stakeholders of a business.
1 Distinction between Book-keeping and Accounting
Table 1 shows the difference between book-keeping and Accounting.
Table 1: Difference between Book-Keeping and Accounting Book-keeping Accounting
It is a process of identifying, measuring, recording, and analysing the transactions in books of accounts
It involves summarising the classified transactions, interpreting the analysed results, and communicating the information to the users of financial statement
Adopts principles of accounting for recording
Analysing and interpreting requires skill, knowledge, and experience
Book-keeping is the first stage of accounting process
Accounting follows book-keeping. It is the second stage
The objective is to prepare final accounts and balance sheet in a systematic manner at the end of accounting period
The objective is to ascertain net results of financial operations and communicate the results to all stakeholders in a manner they understand
Account executives who perform this function may not require higher level of knowledge
Accountants who perform this function need higher analytical skills to interpret the data and to take appropriate decisions
The job is routine and clerical in nature
The job is non-routine but analytical in nature
1 Users of Accounting Information
Accounting reports are designed to meet the common information needs of most decision makers. These decision makers are broadly classified into the following eight groups.
- Investors
- Lenders
- Regulators, Rating Agencies, and Security Analyst
- Management
- Employees, Trade Unions, and Tax Authorities
- Customers
- Government and Regulatory Agencies
- Public
and which are not? Do the company’s financial statements depict true position? Employees trade unions
Employees like industrial and office workers, Trade unions, Federations of Trade unions
Is the company going to survive for long so that we can have job security? Has the company’s financial performance been stable so that we can expect regular or prompt payment? How much wage increment and bonus can our employer afford? Can we expect Employee Stock Option Plan? Can our company provide benefits like group insurance? Can our company honour future obligations like pension, gratuity, etc.? Creditors Suppliers of materials, services, and utilities Trade financiers Short-term lenders
Will the company continue to be or become a major source of business for us? Can the company make payment for purchases on time? Can the company pay back to us on time? Customers Past, present, and prospective customers
Is the company going to survive for long so that we can comfortably depend on the company for supplies? Can the company be depended upon for spares and accessories also? Is the company’s position good enough to honour warranty obligations? Government and Regulatory authorities
Income tax officers Customs officers Ministry of finance Ministry of Corporate affairs Securities and Exchange Board of India Reserve Bank of India Stock Exchanges Pollution Control Board
Is the company paying all the taxes promptly? Is the company abiding to all the legal requirements? Is the company reporting its financial information as per statutory and professional requirements?
Is the company conducting operations as per statutory requirements with respect to method, safety, and environment concerns? Is the company overcharging consumers by virtue of its monopoly position? The Public Local community Political parties Social activists Public affairs groups Consumer groups Environments activists
Is the company conducting operations as per statutory requirements with respect to method, safety, and environment concerns? Are the company’s operations and promotion methods used having a negative influence on the society? Does the company exploit local suppliers and labour? Does the company earn profits by compromising on the product quality? Does the company take adequate pollution control measures? Does the company deter competition in the industry? Does the company earn profits by undue exploitation of the natural resources causing imbalances and disrupting the life of local community?
(Source: Adapted from Financial Accounting, Management perspective by R. Narayaswamy. 3/e pp 15, PHI)
Activity 2: The following is the abstract of annual report of Sundaram Clayton Limited for the year 2008 – During the year under review, the vehicle industry registered a negative growth of 2%. While the medium/heavy commercial vehicles segment recorded a negative growth of 1%, the light commercial vehicle segment registered a growth of 13%. Car segment achieved a positive growth of 14% and two wheeler segments suffered a negative growth of 5%.
sheet at historical cost less accumulated depreciation and not at their original cost.
Window dressing Accounting policies can be manipulated to present a picture of the financial statements in a way that we desire, rather than the actual one. This is called window dressing. The reasons for window dressing can be to project an image of low risk, or to promote a perception that management is competent and thereby attract investors and lenders, get higher credit rating and also to increase managerial compensation.
The following types of manipulations are normally resorted to by the company for the purpose of window dressing.
- Inflate the sales for the current year by advancing the sales from the following year.
- Alter the ‘other income’ figure by playing with non-operational items.
- Fiddle with the method and rate of depreciation.
- Fiddle with the method of inventory valuation.
- Defer certain discretionary expenses to the following year.
- Make inadequate provisions for contingent liabilities.
- Make extra provisions in prosperous periods and write them back in lean periods.
(Source: Dr. Prasanna Chandra ‘Managing Investments’)
Self Assessment Questions
- Accounting grossly lacks ____________ elements.
- The exact picture of the financial situation can be ascertained only on the ________ of an enterprise.
- The danger of ___________ arises when the management decides to incorporate wrong figures to artificially inflate revenue or deflate losses or when there is a threat of hostile takeover.
- Accounting ignores the price level changes when financial statements are prepared on __________.
1 Basic Terminologies
To understand the subject of Accounting, a proper understanding of the following terms is essential.
- Transaction: It is transfer of money, goods, or service from one person or account to another person or account. There are cash transactions, credit transactions, and paper transactions. In all cash transactions, cash is paid or received immediately. In credit transactions, there is a promise to pay or receive cash at a future date. In paper transactions, there is no cash inflow or outflow, but adjustment is made only in the records. (Bad debts of previous year are written off; depreciation provided on fixed assets, etc.).
- Capital: Funds brought in to start a business, by the owner or owners. In the case of a company, capital is collected by issue of shares. Share: A share in a company is one of the units into which the total capital of the company is divided.
- Assets: An asset is a resource legally owned by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. For example, land and buildings, plant and machinery, furniture and fixtures, cash in hand and at bank, debtors and stock, etc. are regarded as assets. Assets are classified based on the purpose for which an asset is held. Assets may be fixed, current, liquid, or fictitious.
- Fixed assets are those which are held for use in the production or supply of goods and services and not for resale in the normal course of business. For example, land, plant and machinery are fixed assets. An exception to this is, for a land developer, land is considered as current asset because the developer is involved in buying and selling of land.
- Current assets are those which are held or receivable within a year or within the operating cycle of the business. They are intended to be converted into cash within a short period of time. For example, stock in trade, debtors, bills receivable, cash at bank, etc.
- Liquid assets are those which can be easily converted into cash. For example, cash in hand, cash at bank, marketable investments, etc.
- Purchases return or returns outward: Goods returned by a business to its suppliers out of the purchases already made from them are called purchase returns.
- Sales returns or returns inward: Goods returned to a business by its customers out of the sales already made to them are called sales returns.
- Opening stock: Unsold goods lying in a business at the beginning of a year are called opening stock.
- Closing stock: Unsold goods lying in a business at the end of a year are called closing stock.
Inventory: Inventory refers to goods held by a business for sale in the ordinary course of business or for consumption in the production of goods or service for sale. It includes stock of raw materials, stock of work in progress and stock of finished goods.
Drawings: It refers to cash, goods, or any other asset withdrawn by the proprietor from his or her business for his or her personal or domestic use. In short, amount the owner withdraws from his or her business for living and personal expenses.
Debtor: A debtor is a person who owes money to the business. A debtor may be of four types.
- Trade debtor is a person who owes money to the business for the goods supplied to him or her on credit.
- A loan debtor is a person who owes money to the business for the loan advanced to him or her.
- Debtor for asset sold is a debtor who owes money to the business for any asset sold to him or her on credit.
- Debtor for service rendered is a debtor who owes money to the business for the service rendered to him or her on credit.
Debt: The amount due from a debtor to the business is called a “Debt”. Debt may be of three types:
- Good debt refers to fully recoverable debt.
- Bad debt refers to debt, which is not recoverable.
- Doubtful debt refers to debt whose recovery is doubtful.
Creditors: A creditor is a person to whom the business owes money. A creditor may also be of four types.
- Trade creditor is a person to whom the business owes money for goods purchased from him or her on credit.
- Loan creditor is a person to whom the business owes money for the loan borrowed from him or her.
- Creditor for asset purchased is a creditor to whom the business owes money for any asset purchased from him or her on credit.
- Expenses creditor refers to a creditor to whom the business owes money for any service received from him or her on credit. For example, salaries unpaid, commission unpaid, etc.
Loss: It refers to money or the worth of money given up without any benefit in return. For example, loss of cash by theft, loss of goods by fire, etc. It is a situation where in the expenses of the business exceeds revenues. An expense brings some benefits, but loss does not bring any benefit.
Profit: It is a situation where the revenue of a business exceeds its expenses. In other words, the amount earned is greater than the expenses.
Journal: A journal is a daily record of business transactions. It is a book of original, prime, or first entry in which all the business transactions are first entered in the specified manner in the order of dates. A preliminary record where business transaction is first entered into the accounting system.
Ledger: A ledger is an account book in which all the accounts are maintained. It is the books of final entry as well as principal book of accounts.
Entry: It is the record of a transaction made in any book of account, either in the book of original entry or in the books of final entry.
Narration: It is a brief explanation of a journal entry. It is given below the journal entry, within brackets. It gives the explanation for that particular journal entry.
Posting: Posting is the process of entering the information already recorded in the journal or in any of the subsidiary books in the ledger.
B. Creditors C. Debtors D. Bad debtors 17. A person or entity who has an interest in the economic performance of a business A. Well wisher B. Stake holder C. Legal advisor D. Successors 18. A business owned by a single individual A. Sole proprietary concern B. Partnership C. Body of Individuals D. Company 19. A business owned by two or more individuals A. Sole proprietary concern B. Partnership C. Body of Individuals D. Company 20. A business owned by more than 50 individuals A. Sole proprietary concern B. Partnership C. Body of Individuals D. Company
Activity 3: Visit websites of one or two companies like SBI or RIL and take a cursory look at their Annual Reports. Focus on Financial Highlights, Directors’ Report, Auditors’ Report, and Management Discussion and Analysis.
1 Summary
Let us recapitulate the important concepts discussed in this unit:
- Accounting is the process of identifying the transactions and events, measuring the transactions and events in terms of money, recording them in a systematic manner in the books of accounts, classifying or
grouping them and finally summarising the transactions in a manner useful to the users of accounting information.
- The main objective of accounting is to report financial information to the stakeholders.
- The users of accounting information are investors, lenders, regulators, rating agencies, security analysts, management, employees, trade unions, tax authorities, customers, government, and the general public.
- The information required is provided to them through a statutory document of the company called the Annual Report.
- Accounting has some limitations. But they can be overcome by taking due care.
1 Glossary
Accounting: The process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by the users of the information.
Book-keeping: The process of maintaining the books of accounts based on principles of Accounting.
Stakeholders: Group of people who have some interest in the company directly, indirectly, or monetarily.
1 Terminal Questions
- Explain the process involved in accounting.
- What are the objectives of accounting?
- Distinguish between book-keeping and accountancy.
- How accounting information is used by investors and lenders?
- How do the Government and Regulatory agencies use accounting information to regulate the activities of the firm?
1 Answers
Self Assessment Questions
- identifies, measures
- Summarising, analysing
Unit 01 - Financial Accounting - Introduction
Course: Master's in Business Administration (MBA001)
University: Manipal University Jaipur
- Discover more from:
Recommended for you
Students also viewed
Related documents
- Unit 15 - Standard Costing
- Unit 13 - Internal and External Business Communication - Writing Business Reports
- Unit 15 - Employment Communication - Group Discussions and Interviews
- Unit 11 - External Business Communication - Writing Business Letters
- Unit 12 - Other Forms of External Business Communication
- Unit 10 - IBC - Electronic Media and Shareholder Communication.pdf