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Introduction to Financial Accounts. BOOK - KEEPING. Book keeping is the art and science of recording, classifying and summarizing
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BOOK - KEEPING Book keeping is the art and science of recording, classifying and summarizing business transactions in money or money’s worth accurately and systematically so that the businessman may be able to know his profit or loss during a specific period and also his financial position on a particular date.
ACCOUNTING MEANING Accounting extends far beyond the actual making of records. Accounting is concerned with the use to which these records are put, their analysis and interpretation. Accounting is a wider term and includes the recording, classifying and summarizing of business transactions in term of money, the preparation of financial reports, the analysis and interpretation of these reports for the information and guidance of management
. American Institute of Certified Public Accounts {AICPA} has defined financial accounting as “ the art of recording, classifying and summarizing in a significant manner in terms of money transactions and events which in a part, at least of a financial character and interpreting the results thereof.”
IS ACCOUNTING A SCIENCE OR AN ART? Accounting is both a science and an art. Science is a systematical body of knowledge based on • certain principles • which have universal application. • establishes cause and effect relationship based on observation, experiments
Art is the application of • knowledge • comprising of some accepted theories, • principles, rules, concepts and conventions. • the more we practice an art the more expert we become in it.
OBJECTS OF ACCOUNTING 1. To ascertain whether the business operations have been profitable or not. Accounting helps us to know whether a business has earned profit or suffered loss during the accounting period. It will give us an idea of efficiency of the business. To determine profit or loss of the accounting period , a Trading and Profit and Loss Account is prepared.
2. To ascertain the financial position of the business. Balance Sheet or Position Statement is prepared to give an idea of the financial position of the business on a particular date. The financial position of an enterprise is indicated by its assets on a given date and its liabilities on that date. Excess of assets over liabilities represent the capital and is indicative of the financial soundness of an enterprise.
3. To generate information. Accounting records generate such information which may be helpful to various persons in planning, control, evaluation of performance and decision making.
FUNCTIONS OF ACCOUNTING 1. Systematic record of business transactions. To keep systematic record of business transactions, post them to the ledger and ultimately to prepare the final accounts.
2. Protecting the property of the business. A complete record of the assets of the concern is available without any difficulty and therefore are not put to wrong use .
3. Communicating results to interested parties This function requires to supply the meaningful information about the financial activities of the business to the various parties i.e. owners, creditors, investors, employees, government, public, research scholars and the managers at the right time.
4. Compliance with legal requirements. The accounting system must be such which may be able to comply with the legal requirements. Under various enactments a businessman is required to file various statements e.g. income tax return, return for sale tax purposes etc.
USERS OF ACCOUNTING INFORMATION Accounting is the language of the business. As the primary aim of a language is to serve as a means of communication, accounting is used to communicate business information. The basic objective of accounting is to provide information which is useful for persons inside the organization and for persons or groups outside the organization.
(I) External Users of Accounting Information External users are those groups or persons who are outside the organization for whom accounting function is performed. 1. Investors Those who are interested in investing money in an organization are interested in knowing the financial health of the organization to know how safe the investment already made is and how safe their proposed investment will be.
2. Creditors Creditors (i.e., suppliers of goods and services on credit, bankers and other lenders of money) want to know the financial position of a concern before giving loans or granting credit. They want to be sure that the concern will not experience difficulty in making their payment in time , i.e. , liquid position of the concern is satisfactory.
3. Members of non-profit organisations Members of non-profit organizations such as schools, colleges, hospitals, clubs, charitable institutions etc, need accounting information to know how their contributed funds are being utilized and to ascertain if the organisation deserves continued support or support should be withdrawn keeping in view the bad performance depicted by the accounting information an diverted to another organisation,
4. Government Central and state governments are interested in the accounting information because they want to know earnings or sales for a particular period for purposes of taxation. Government also need accountinginformationfor compiling statistics concerning business which, in turn helps in compiling nationals accounts.
4. Consumers Consumers need accounting information for establishing good accounting control so that of production may be reduced with the resultant reduction of the prices of goods they buy. Sometimes, prices for some goods are fixed by the government, so it needs accounting information to fix reasonable prices so that consumers and manufactures on their investment shown in the accounting records.
(II) Internal Users of Accounting Information 1. Owners The owners provide funds for the operations of a business and they want to know whether their funds are being properly used or not. They need accounting information to know the profitability and the financial position of the concern in which they have invested their funds.
2. Management Accounting information is an aid in this respect because it helps a manager in planning, control, decision making and appraising the performance of the subordinates. Actual performance of the employees can be compared with the budgeted performance they were expected to achieve and remedial action can be taken if the actual performance is not up to the mark. Thus, accounting information provides “The eyes and ears and ears to management.”
3. Employees Employees are interested in the financial position of a concern they serve particularly when payment of bonus depends upon the size of the profits earned. They seek accounting information to know that the bonus being paid to them is correct.
Branches of Accounting 1. Financial accounting The main purpose of this branch of accounting is to ascertain profit or loss during a specific period, to show financial position of the business on a particular date and to have control over the firm’s property. Such accounting records are used to impart useful information to outsiders and to meet the legal requirements.
2. Cost Accounting The main aim of cost accounting is to ascertain cost relating to the various activities of the business and to have control. The cost accountant is required to assemble and interpret cost data for the use of management is controlling current operations and in planning for the future.
3. Management Accounting It supplies the management significant information in order to assist the management to discharge its various functions such as planning, control, evaluation of performance and decision making etc.
Advantages of Accounting 1.Replacement of memory In a large business it is very difficult for a businessman to remember all the transactions. Accounting provides records which will furnish information as and when desired and thus it replaces human memory.
2. Evidence in court Properly maintained accounts are often treated as good evidence in the court to settle a dispute.
3. Settlement of taxation liability If accounts are properly maintained, it will be of great assistance to the businessman in settling the income tax and sale tax liability otherwise tax authorities may impose any amount of tax which the businessman will have to pay.
4. Comparative study It provides the facility of comparative study of the various aspects of the business such as profits, sales, expenses etc. with that of previous year and helps the businessman to locate significant factor leading to the change, if any.
5.Sale of business If accounts are properly maintained, it helps to ascertain the proper purchase price in case the businessman is interested to sell his business.
Limitations of Accounting 1. Records only monetary transactions Accounting records only those transactions which can be measured in monetary terms. Those transactions which cannot be measured in monetary terms as conflict between production manager and marketing manager, efficient management etc., may be very important for a concern but not recorded in the business books.
2. Effect of price level changes not considered Accounting transactions are recorded at cost in the books. The effect of price level changes is not brought into the books with the result that comparison of the various years becomes difficult. For example, the sales to total assets in 2005 would be much higher than in 2000 due to rising prices, fixed assets being shown at cost and not at market price.
3. Personal bias of accountant affects the accounting statements Accounting statements are influenced by the personal judgment of the accountant. He may select any method of depreciation, valuation of stock, amortization of fixed assets, and treatment of deferred revenue expenditure. Such judgment based on integrity and competency of the accountant will definitely affect the preparation of accounting statements.
4.No realistic information Accounting statements are prepared by following basic concepts and conventions which may not be realistic e.g going concern concept says business will continue and assets are recorded at cost.yet the assets ay not realise their book value.
5.Allows alternative treatments Providing depreciation on stright line or diminishing balance method, valuing stock on LIFO or FIFO method.
6.Profit no real test of managerial efficiency Profit may be shown in excess by manipulation of accounts by suppressing costs like depreciation advertisement and research and development.
7. Historical in nature Information supplied in P&L Account and Balance Sheet is at the end of the year. It only gives a view of what has already happened.
