Overview of Financial Accounting

1. FINANCIAL
ACCOUNTING
Presented By:-
AJEET KUMAR VERMA
D.S.V.V.Haridwar

2. UNIT –I
Overview - Meaning and
Nature of Financial
Accounting, Scope of
Financial Accounting,
Financial Accounting &
Management Accounting,

3. Introduction
In all activities (whether business activities or non business
activities) and in all organizations (whether business organizations
like a manufacturing entity or trading entity or non - business
organizations like schools, colleges, hospitals, libraries, clubs,
temples, political parties) which require money and other economic
resources, accounting is required to account for these resources.
In other words, wherever money is involved, accounting is required
to account for it.
Accounting is often called the language of business. The basic
function of any language is to serve as a means of communication.
Accounting also serves this function

4. Book Keeping
“Book - keeping is the art of recording business
transactions in a systematic manner” .
A.H.Rosenkamph.
“Book - keeping is the science and art of correctly
recording in books of account all those business
transactions that result in the transfer of money or
money’s worth”. R.N.Carter

5. Objectives of Book keeping
i) Book - keeping provides a permanent record of each transactions.
ii) Soundness of a firm can be assessed from the records of assets
and abilities on a particular date.
iii) Entries related to incomes and expenditures of a concern
facilitate to know the profit and loss for a given period.
iv) It enables to prepare a list of customers and suppliers to
ascertain the amount to be received or paid.
v) It is a method gives opportunities to review the business policies
in the light of the past records.
vi) Amendment of business laws, provision of licenses, assessment
of taxes etc., are based on records

6. Definition of Accounting
American Institute of Certified Public Accountants (AICPA) which defines
accounting as
“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 a financial
character and interpreting the results thereof”
Accounting, as an information system is the process of identifying, measuring
and communicating the economic information of an organization to its users who
need the information for decision making. It identifies transactions and events of
a specific entity. A transaction is an exchange in which each participant receives
or sacrifices value (e.g. purchase of raw material). An event (whether internal or
external) is a happening of consequence to an entity (e.g. use of raw material for
production). An entity means an economic unit that performs economic activities

7. Characteristics of Accounting
Accounting is the art of recording of financial
transaction of business.
Classifying and summarizing of recorded data is
done in accounting.
Data are recorded in terms of money.
Accounting is a science also.
Analyzing and interpretation of the result is done in
accounting.

8. Objectives of Accounting
Objective of accounting may differ from business to business depending upon their specific requirements. However, the following
are the general objectives of accounting
i) To keeping systematic record: It is very difficult to remember all the business transactions that take place. Accounting
serves this purpose of record keeping by promptly recording all the business transactions in the books of account.
ii ) To ascertain the results of the operation: Accounting helps in ascertaining result i.e., profit earned or loss suffered in
business during a particular period. For this purpose, a business entity prepares either a Trading and Profit and Loss account or
a n Income and Expenditure account which shows the profit or loss of the business by matching the items of revenue and
expenditure of the some period.
iii) To ascertain the financial position of the business: In addition to profit, a businessman must know hi s financial
position i.e., availability of cash, position of assets and liabilities etc. This helps the businessman to know his financial strength.
Financial statements are barometers of health of a business entity.
iv) To portray the liquidity position: Financial reporting should provide information about how an enterprise obtains and
spends cash, about its borrowing and repayment of borrowing, about its capital transactions, cash dividends and other
distributions of resources by the enterprise to owners and about other factors that may affect an enterprise’s liquidity and
solvency.
v) To protect business properties: Accounting provides up to date information about the various assets that the firm
possesses and the liabilities the firm owes, so that nobody can claim a payment which is not due to him
vi) To facilitate rational decision making: Accounting records and financial statements provide financial information which
help the business in making rational decisions about the steps to be taken in respect of various aspects of business.
vii) To satisfy the requirements of law: Entities such as companies, societies, public trusts are compulsorily required to
maintain accounts as per the law governing their operations such as the Companies Act, Societies Act, and Public Trust Act etc.
Maintenance of accounts is also compulsory under the Sales Tax Act and Income Tax Act

9. Importance of Accounting
Owners
Management
Creditors
Employees
Investors
Government
Consumers
Research Scholars

10. Need of Financial Accounting
A well known author of Accounting, [Prof. R.R. Gupta, Principal, Poddar
College, Nawalgarh(Rajasthan)] wrote in …..
”First write/record before one delivers goods or renders the services and if there
is any disagreement in future, use the writing or record as an evidence to resolve
the misunderstanding or rectifying the error.”
Recording of business transactions is necessary from owners’ point of view and
other interested party as well.
The persons included in the second category are the suppliers of the materials,
products and services to the business, the government and the society at large.
The creditors (suppliers who are willing to take their payment later) are
interested to know whether the business will be able to pay them later (solvency
of the business) whereas the government wants to know whether the business
has paid whatever was due to them in terms of taxes, fees, etc.

11. What are the purposes of preparing financial statements?
Accounting provides necessary information for decisions to be taken initially
and it facilitates the enterprise to pave way for the implementation of actions.
It exhibits the financial track path and the position of the organization.
Being business in the dynamic environment, it is required to face the ever
changing environment. In order to meet the needs of the ever changing
environment, the policies are to be formulated for the smooth conduct of the
business.
It equips the management to discharge the obligations at every moment.
Obligations to customers, investors, employees, to renovate/restructure and
so on.

12. Scope of Accounting
The Scope of accounting is divided into following
two parts:
1. Branches of Accounting
2. Accounting as a science or an art

13. Branches of Accounting
The main objectives of accounting are to record the
business transactions and to provide thenecessary
information to the internal and external users of the
financial statements.
Financial Accounting:
 It is the original form of accounting. It refers to the
recording of daily business financial transaction. Recording
of the transaction is done in such a way that the profit of the
business may be ascertained after a definite period and the
picture of the financial position of the business may be
presented.

14. Cost Accounting: As the name indicates, this accounting is
related with the ascertainment of cost of the product in a period.
Under this system, record of raw materials used in production,
wages and labor paid and other expenses incurred on production
are kept to control the costs
Management Accounting: The accounting which provides
the necessary information to the management is called
management accounting. Under this, the analysis and
interpretation of the accounts, prepared by financial accounting,
are done in a manner so that the managers may forecast, plan for
future and frame the policy.

15. Tax Accounting: Under tax accounting, the accountants
prepare the accounts as per the provisions of taxation. The
accounts prepared as per taxation provisions may differ
from the accounts prepared as per financial accounting.
Inflation Accounting: The financial statements are
prepared on the basis of historical cost which do not present
the true picture of the financial position and correct profit
or loss of the business due to inflation. Thus the fresh
financial statements are prepared keeping in mind the price
level changes under inflation accounting.

16. Human Resource Accounting: Human Resource Accounting means
the accounting for human being as now in an organization human being is
treated as an asset like other physical assets. It is recorded in the books like
other assets. HRA deals with the measurement of costs on recruiting,
selecting, hiring, training, placing and development of the employees in
one side and on the other side it deals with the present economic value of
the employees. For the determination of the value of human being different
methods are used under HRA.
Responsibility Accounting: Responsibility accounting is a special
technique of management under which accountability is established
according to the responsibility delegated to the

17. Accounting as Science or an Art
Accounting is both the science and art.
Study of science is based on some principles and it is systemized. It is a
science because the business transactions are recorded on the basis of
some principles and journal of transaction, ledger posting, trial balance
and preparation of final statements are done in a sequence.
Art is the creation of practical applications and rules for the completion
of any work. On the basis of it, accounting is an art as we do not only
study principles of accounting but also we learn to apply these
principles in practice to record the business transaction.
Thus accounting is both science and art.

18. Functions of Accounting

19. Importance and Advantages of Accounting
Appropriate and adequate accounting system plays a vital role for the
successful operation of the business. It also helps in the determination of
cost of production, controlling internal as well as external activities of the
business, forecasting of profit, cost and sales, etc. Accounting is also useful
in locating the errors, distribution of dividend and bonus to shareholders.
 Thus, accounting is being used as a means to achieve the objective of the
business. The other advantages of the accounting are as follows:
 Replacement of human memory
 Helpful in the determination of financial results and presentation of
financial position
 Helpful in assessing the tax liability
 Helpful in the case of insolvency
 Helpful in the valuation of business
 Helpful in the valuation of goodwill and shares
 Accounting makes comparative statement possible
 Raising of funds become easy

20. Limitations of Accounting
Recording of monetary items only
Effect of inflation (a general and progressive
increase in prices )
Conflict between accounting principles
Financial statements are affected by
personal judgment of the accountants
Financial statements do not reflect the right
picture of the business

21. Methods of Accounting
 Business transactions are recorded in two different ways.
 Single Entry
 It is incomplete system of recording business transactions. The business organization
maintains only cash book and personal accounts of debtors and creditors. So the
complete recording of transactions cannot be made and trail balance cannot be
prepared
 Double Entry
 It this system every business transaction is having a twofold effect of benefits giving
and benefit receiving aspects. The recording is made on the basis of both these aspects.
Double Entry is an accounting system that records the effects of transactions and other
events in at least two accounts with equal debits and credits.
 The modern system of book keeping is based on the double entry system.
 The father of this system is the Lucas Pacioli. He gave the details of this system in his book
“De Compute Set Scripturise” in Italy in 1494 A.D. As per this system every transaction of
the business has double aspects/double effect. Therefore, every transaction must be
recorded at two places or accounts. If in a transaction someone is a giver, some other will
be a receiver.
 This system of accounting is also called Mercantile System or Western System of
Accounting. This system is so organized, accurate, complete and scientific that it is now
adopted universally. In the words of Keller, M.J. Keller in – Intermediate Accountancy,
“The most common system of accounting data for an enterprise is the double entry
system. As the name implies, the entry made for each transaction is composed of two
parts, a ‘debit’ and a ‘credit’.

22. Importance of Double Entry System
Double entry system of accounting is a systematic and scientific
system of accounting, so it offers a number of advantages
Complete record of transactions
Ascertainment of profit or loss
Mathematical check on accuracy
Check for fraud
Ascertainment and knowledge of financial position of
the business
Possibility of full control over business
Easy accessibility of information
Possibility of comparative study
Reliable information

23. Steps involved in Double Entry System
Preparation of Journal: Journal is called the book of
original entry. It records the effect of all transactions for the
first time. Here the job of recording takes place.
Preparation of Ledger: Ledger is the collection of all
accounts used by a business. Here the grouping of accounts
is performed. Journal is posted to ledger.
Trial Balance preparation summarizing: It is a
summary of ledge balances prepared in the form of a list.
 Preparation of Final Account: At the end of the
accounting period to know the achievements of the
organization and its financial state of affairs, the final
accounts are prepared.

24. Rules of Double Entry System
As per the principles of the double entry system, each transaction of the
business is recorded at two places. In other words, two entries are made
for every financial transaction of the business.
If someone is giving something in the business, it has two sides – one is
giver and other is receiver.
Mr. Kamlesh started business with cash of 2,00,000.
 In this transaction, one side cash is coming into business and in the other side capital
is being brought by Mr. Kamlesh. Thus:
 Capital = Assets (Cash)
 2,00,000 = 2,00,000
In the next transaction, if a plant of 50,000 is purchased in cash,
 this transaction will also leave two sides. In one side cash is going and in other side
plant is coming. In this situation, the accounting equation will be as follows:
 Capital = Plant + Cash (Assets)
 2,00,000 = 50,000 + ( 2,00,000 – 50,000)

25. Financial Accounting
Is the original form of accounting .
Is mainly confined to the preparation of financial
statements for the use of outsiders like stakeholders,
debenture holders, creditors, banks and financial
institutions.
The financial statements like profit and loss account
and the balance sheet, show them the manner in
which operation of the business have been conducted
during a specified period.

26. Management Accounting
It is accounting for the management accounting which provides necessary information
to the management for discharging its functions.
According to the Chartered institute of management Accountants, London,
“Management accounting is the application of professional information in a such a way
as to assist the management in the formation of policies and in the planning and
control of the operations of undertaking.”
It covers all arrangements and combinations of adjustments of the orthodox
information to provide the chief executive with the information from which he can
control the business information about funds, costs, profits etc.
Management accounting covers various areas such as cost accounting, budgetary
control, inventory control, statistical methods, internal auditing etc.

27. Difference between management accounting and financial
accounting
Both are closely interrelated since management accounting is a large extent
rearrangement of the data provided by financial accounting.
All accounting is financial in the sense that all accounting systems are in
monetary terms an d management is responsible for the contents of the
financial accounting statements.
In spite of such a close relationship between the two, there are certain
fundamental differences.
 1. Objectives: FA is designed to supply information in the form of profit and loss account
and balance sheet to external parties like stakeholders, creditors, banks, investors and
government.
 Information is supplies periodically and usually such in which management is not much
interested.
 Management accounting is designed principally for internal use by the management.

28.  2 Analyzing performance : FA portrays the position of business
as a whole, while MA directs its attention to the various
divisions, departments of the business and reports about the
profitability, performance etc.
 3. Data used : FA concerned with monetary record of past
events. Its postmortem analysis of past activity and therefore
out of date for management action. MA is for future and
therefore it supplies data for present and future .
 4. Monetary measurement : in FA only such economic events
find a place which can be described in money . However the
management is equally interested in non-monetary economic
events like technical innovations , personnel in the
organization, changes in the value of money

29.  Periodicity of reporting : FA longer period compared to MA. Income
statement and balance sheet prepared yearly or half yearly. While
management requires information at frequent intervals.
 Precision: less emphasis on precision in case of management
accounting as compared to FA since the information is meant for
internal consumption.
 Nature: Financial accounting is more objective while management
accounting is more subjective. Management accounting is
fundamentally based on judgment rather than on measurement.
 Legal Consumption : FA has more or less become compulsory for every
business on account of the legal provisions of one or the other act.
However , a business is free to install or not to install a system of
management accounting.
Management account has a flexible approach as compared to rigid
approach in case of financial accounting.
In brief, financial accounting simply shows how the business has moved
in the past while management accounting shows how the business has to
move in the future.