Meaning of Financial Accounting Accounting refers to the art of recording business transactions.

Earlier Accounting was considered as a system of recording day to day transactions but now days it is considered as the language of the business and also the information system of the business. The businessman is interested in knowing the progress of his business which can be judged only with the help of proper Accounting. Definition of Financial Accounting American Institute of certified ublic of Accountant Accounting is the art of recording! classifying and summari"ing in an significant manner and in terms of money! transactions and e#ents which are of financial character and interpreting the result there of.$ According to American Accounting Association %Accounting is the process of Identifying! Measuring and communicating information to the #arious parties.$ &haracteristics of Accounting
Financial Accounting is the process in which business transactions are recorded systematically in the various books of accounts maintained by the organization in order to prepare financial statements. These financial statements are basically of two types: First is Profitability Statement or Profit and oss Account and second is !alance Sheet. Following are the characteristics features of Financial Accounting: "# $onetary Transactions: %n financial accounting only transactions in monetary terms are considered. Transactions not e&pressed in monetary terms do not find any place in financial accounting' howsoever important they may be from business point of view. (# )istorical *ature: Financial accounting considers only those transactions which are of historical nature i.e. the transaction which have already taken place. *o futuristic transactions find any place in financial accounting' howsoever important they may be from business point of view. +# egal ,e-uirement: Financial accounting is a legal re-uirement. %t is necessary to maintain the financial accounting and prepare financial statements there from. %t is also obligatory to get these financial statements audited. .# /&ternal 0se: Financial accounting is for those people who are not part of decision making process regarding the organization like investors' customers' suppliers' financial institutions etc. Thus' it is for e&ternal use. 1# 2isclosure of Financial Status: %t discloses the financial status and financial performance of the business as a whole. 3# %nterim ,eports: Financial statements which are based on financial accounting are interim reports and cannot be the final ones. 4# Financial Accounting Process: The process of financial accounting gets affected due to the different accounting policies followed by the accountants. These accounting policies differ mainly in two areas: 5aluation of inventory and 6alculation of depreciation.

urpose of Financial Accounting The purpose of accounting can be summari"ed in the following manner' (. Ascertain the results of operations during a period ). Ascertain the financial position. *. Maintaining a control o#er assets +. lanning in respect of cash ,. ro#iding information to ta- authorities and other go#ernment agencies. .. To properly match income with e-penses. /. To pro#ide a reliable set of data with which to prepare financial reports for analysis purposes 0for owners! lenders! in#estors! etc1. 2. To pro#ide a reliable set of data with which to report income for ta- purposes

3bjecti#es and Functions of Financial Accouting.

(. ). *. +. ,. To keep systematic record of business Transactions. To calculate profit and loss. To disclose the financial position. To pro#ide information to #arious parties. To facilitate decision making.

4ook keeping Accounting and Accountancy 4ook 5eeping' It is mainly concerned with record keeping and maintenance of books of accounting
which is routine and clerical in nature. Identify! Measuring! recording and classifying the transaction in ledger. Accounting' Accouting starts where book6keeping ends. Accouting include the following acti#ities. 7ummari"ing the classified transactions in the form of 89 A:& and balance 7heet. Analy"ing and interpreting the summari"ed results. &ommunicating the information to #arious parties.

Accountancy
It is a subject which gi#es us knowledge! how to do Accouting. It pro#ides us a systematic knowledge of Accounting. %Accounting refers to the entire body of the theory and practice of Accouting.$

;sers of Accounting Information Internal users (. ). *. +. ,. .. /. 2. >. 3wners Managers In#estors &reditors and Financial Institution Employees <o#ernment =esearchers &ustomers ublic

9imitations of Accounting
Financial accounting is the only branch of accounting and it is not prefect. There are large numbers of limitations which open new way to use other tools of accounting.

1.

Financial

accounting

is

of

historical

nature

Net effect of transactions are recorded in financial accounting which has happened in past. These accounts is just postmortem of all events of business in past .These record does not help for future planning and other managerial decisions. Financial accounting shows the profitability of business but it is failure to tell that is it good or bad. Financial accounting is also failure to know the reasons of low profitability position.

2.

Financial

accounting

deals

with

overall

profitability

Accounts of business are made by a way which shows only overall profitability .It does not shows net profit per product , or per department or according to job . Thus to find difficult to all activities which do not give profit. 3. Absence of full disclosure of facts

In financial accounting we record only those activities and transactions which we can show or describe in money. There are many other facts of business which are non financial and non monetary like efficient management, demand of products of firm, good relations in industry, good working environments which can not be known by financial accounting.

4. Financial reports are interim report of business

Financial statements made by financial accounting is the interim report of firm s all business work but financial position and profitability which are shown in it is not fully true . !ue to adopting cost concept, all transactions are recorded on it real cost but by changing in the time" it is the need of time to adjust cost of assets and liabilities according to inflation of market. #ecause, financial accounting does not records according to inflation so its result does not show true position of business.

5.

Incomplete

nowledge

of

costs

From cost point of view, financial accounting is incomplete. In financial accounting, accountant does not calculate each and every product s total cost. $o, financial accounting does not help to determine the price of product of business.

!. "o provision of cost control

Financial accounting does not help business organi%ation for controlling the cost. #ecause, there is no provision of controlling cost in it. In financial accounting, we write cost, if we paid any e&penses. Thus there is no provision of improvement in financial accounting. '&cept this, there is no any other way to inspect all e&penses.

#.

Financial

statements

are

affected

from

personal

$udgment

(any events of financial statements are affected from personal judgment of accountant. (ethod of calculating depreciation, rate of provision of doubtful debts and stock valuation method are decided by accountant. Thus, financial statements do not show true and fair view of business.

#ranches of Accounting
Three branches of accounting are as follows: Financial Accounting: The main object of Financial Accounting is to find out the profitability and to provide information about financial position of the concern. It presents a general idea of the working of the business and permits management to control in general way the major functions of a business, vi . finance, administration, production and distribution. !ut Financial Accounting does not give details. Cost Accounting: The main objects of "ost Accounting are to find out the cost of goods produced or services rendered by business. It also helps the management to detect and control all leakages, defective works, and wastage in tools and stores. Management Accounting: The primary objective of #anagement Accounting is to supply relevant information at appropriate time to the management to enable it to take the decisions and effect control. Human Resource Accounting $uman resource Accounting is the process of identifying and measuring data about human resources and communicating this information to various parties.

Social responsibility Accounting !usiness is the part of the society so every business has some social responsibility. %ocial responsibility accounting is the process of Identifying, measuring and communicating social effects of business transactions and effects.

Accounting and other disciplines (Refer to Financial Accounting Dr. R. Accounting and #conomics Accounting and statistics Accounting and Mathematics Accounting and Management Accounting and $a%

!upta"

Generally Accepted Accounting Principle (GAAP)

Accounting &oncept 0please read this in =.5 <upta in detail1

4usiness entity concept Money measurement concept <oing concern concept &ost concept Dual aspect concept =e#enue recognition principle Matching rinciple Accounting period assumption

Accounting con#entions &onser#atism &onsistency Materiality concept Full disclosure principle

The Accounting cycle Accounting cycle refers to the cycle which starts with the recording of opening entries in journal and ends with the preparation of final accounts. 9edger
?ournal Trial 4alance

Final Accounting

?3;=@A96666666 4ooks of original entry ?ournal means recording of transactions in a chronological order. The books in which a transaction is recorded for the first time from a source document are called %4ooks of original entry$ It is one of the basic books of original entry in which transactions are originally recorded in day to day order according to double entry system. The subsidiary book may be as under' 0 lease read this in detail in Dr. =.5. <upta1 (. &ash book ). urchase 4ook *. 7ales book +. urchase return book ,. sales =eturn book .. bills recei#able book /. ?ournal proper &lassification of Accounts 0<o through Dr. =.5 <upta FA book1 ersonal Account =eal Account @ominal Account

Rules of debit and credit

Debit amount should be shown on the left side of an account and credit amount should be on the right side of an amount. <olden =ules of accounting

a) Personal Account: Debit the recei#er! credit the gi#er. b) Real Account: Debit what comes in! credit what goes out. c) Nominal Account: Debit all e-penses and losses! credit all income and gains Ad#antages of journal &hronological record' it record the transaction in the order in which they occur. E-planation of transaction' Each journal entry which gi#es a brief e-planation of the transaction. =ecording the both aspects' debit and credit of a transaction are recorded in the journal. Limitations of Journal
&lassification of accounts does not pro#ided in the journal! only recording is possible 9ack of a#ailability of information of the accounts The book may become bulky as it handled by one person.

9edger Accounting is a process! after recording entries to the journal! it is posting to the ledger! from the journal! and transactions are transferred to book ledger. This process is known as posting to the ledger. According to 9& cropper' %The book which contain a classified and permanent record of all the transactions of a business is called the ledger.

In#entory Aaluation

AAAAAn inventory valuation allows a company to pro#ide a monetary #alue for items that make up their in#entory. In#entories are usually the largest current asset of a business! and proper measurement of them is necessary to assure accurate financial statements. If in#entory is not properly measured! e-penses and re#enues cannot be properly matched and a company could make poor business decisions.

Inventory accounting systems

The two most widely used in#entory accounting systems are the periodic and the perpetual.

Perpetual: The perpetual in#entory system reBuires accounting records to show the amount of in#entory on hand at all times. It maintains a separate account in the subsidiary ledger for each good in stock! and the account is updated each time a Buantity is added or taken out. Periodic: In the periodic in#entory system! sales are recorded as they occur but the in#entory is not updated. A physical in#entory must be taken at the end of the year to determine the cost of goods sold.

=egardless of what in#entory accounting system is used! it is good practice to perform a physical in#entory at least once a year.

Inventory valuation met ods ! perpetual (Refer "r# R#$ Gupta)

The perpetual system records re#enue each time a sale is made. Determining the cost of goods sold reBuires taking in#entory. The most commonly used in#entory #aluation methods under a periodic system are' (. first6in first6out 0FIF31 ). last6in first6out 09IF31 *. A#erage cost or weighted a#erage cost.

""e"epreciation

%eaning of "epreciation Assets are of two typeCs current assets and fi-ed assets. &urrent assets are those which are easily con#erted into cash with in a period of one year! without losing its #alue so there is no need of charging depreciation on these assets. Fi-ed assets are those assets which are used for the business for the longer period of time so depreciation is charged on these assets. Depreciation means reduction in the #alue of fi-ed assets due to wear and tear! due to usage! e-piry of time and due to obsolescence. "efinitions of depreciations According to =.@.&arter! %"epreciation is a gradual and permanent decrease in the #alue of an asset from any cause.$ &auses of depreciation 'ear ( tear of goods due to its continues use )*piry of time: Assets are losses t ere valve +it t e passage of time# For e.g. The price of the car depends on its model. ,bsolescence: -ec nology c anges are so faster# As a result old tec ni.ues become obsolete#

& aracteristics or features of "epreciation

A Depreciation is charged in case of fi-ed assets For e.g. 4uilding! plant and Machinery Depreciation causes continuous fall in the #alue of asset Depreciation occurs due to the use of an asset. Depreciation is a charge against re#enue of an asset. Depreciation does not depend on the fluctuations in the market #alue of asset. Total depreciation of an asset cannot e-ceed its depreciable #alue.

%e %et ods of & arging "epreciation

There are #arious methods of charging depreciation 7traight 9ine Method' This method is known as fi-ed installment method. It is the simplest method of charging depreciation. An eBual amount of depreciation is charged on each accounting period. It is not affected by use of asset. Depreciation D &ost of the asset6 7crap Aalue:Estimated 9ife of the asset

Ad#antages The amount of depreciation does not change o#er its useful life. The calculation is #ery simple It matches cost and re#enue ;nder this method book #alue of the asset is eBual to its scrap #alue at the e-piry of its useful life. )# 'ritten do+n value %et od
- is met od is also /no+n as diminis ing balance met od and reducing balance met od# In t is met od t e ig er depreciation is c arged on first year and gradually decreases as every year# - e amount of depreciation varies year to year in t is met od Annual depreciation0 "epreciation rate1 boo/ value at t e beginning of t e year "epreciation0 cost of asset2 scrap value3 )stimated life of an asset Advantages Eigher depreciation is charged in the initial years An asset becomes old the amount of depreciation also goes on decreasing This method is logical in sense that the asset become old the amount of depreciation also goes on decreasing. "ifference bet+een straig t and +ritten do+n value met od (Refer to "r# R$ Gupta)

&hapter' &apital and re#enue

E#ery businessman is interested to know how much profit he has earned or how much loss he has incurred during a year. rofit and loss can be calculated by preparing income statement or profit and loss account which is prepared under final account at the end of e#ery account year. For the preparation of final accounts! it is necessary to know the difference between capital e-penditure and re#enue e-penditure &lassification of Income Income can be classified into two categories'

 &apital income3capital profit' Those incomes which do not earned on account of an account of ordinary course of business. These incomes arise on account of a sale of fi-ed asset. For e.g. a fi-ed asset costing =s. (FFFFF sold for ()FFFF! so the capital profit :capital income in this case is =s. )FFFF. 7imilarly when a company issues its shares at a premium! so the premium money is transferred to capital reser#e account. =e#enue Income:re#enue rofit' These are those incomes which are earned during the course of business. These incomes are transferred to 89 account. For e.g. &ommission recei#ed! profit on sale of goods! interest recei#ed on securities etc. &lassification of receipts (. &apital E-penditure ). =e#enue E-penditure 4 &apital e*penditure refers to e-penditure the benefits of which are not fully deri#ed in one year but for se#eral years. E-amples for capital e-penditure are acBuisition of assets for the purpose of earning e-penditure resulting in long term benefits. E-penses like preliminary e-penses! =esearch and de#elopment e-penditure are taken to the asset side of the balance sheet and shown under miscellaneous e-penditure. ) Revenue )*penditure' it is that e-penditure which is a#ailed by the firm only in that particular year in which the e-penditure incurred. E-amples are =aw material! repairs! depreciation! rent! and wages. 7uch e-penses are debited to 8 9 account for the calculation of @et profit and @et profit is added to capital account in the balance sheet. * deferred revenue e*penditure: "R) is t at e-penditure which is primarily re#enue in nature but the amount spent is so large that the benefits are a#ailed beyond the accounting period in which the e-penditure was incurred. It is a fictitious asset although year as deferred re#enue e-penditure. E.g. hea#y e-penditure incurred on ad#ertised! E-penses at a time of formation of a company! such as discount on issue of shares! underwriters commission.

&lassification of Receipts &apital receipts =e#enue receipts &apital receipts' &= is those receipts which either cause increase in the liabilities of the firm or cause reduction in the asset of the firm. These receipts are non6recurring in nature and are not related to ordinary course of business. For e.g. cash recei#ed from the sale of fi-ed asset or in#estments! issue of shares of debentures! capital contribution by the proprietor. Revenue Receipts' re#enue is that receipt which neither cause increase in the liabilities of the firm nor cause reduction in the assets of the firm. These receipts are recurring in nature and related to the normal course of the business. It is recei#ed by selling of goods and ser#ices. The money recei#ed from sale of goods 8 ser#ices! commission! rent! interest! di#idend is e-ample of re#enue receipts. =e#enue receipts are credited to rofit and loss account. &A ITA9I7ED EG E@DIT;=E These are that e-penditure which is incurred on the asset as an important factor such as installation charges or construction of an asset or any e-penditure with the help of which can increase the earning capacity of business. These e-penses become the asset of the firm and not charge to 8 l account. "ifference bet+een capital and revenue e*penditure please refer "r# R$ Gupta "ifference bet+een t e capital e*penditure and capital e*penditure refer "r# R$ gupta boo/ Revenue Recognition
=e#enue means the amount which is recei#ed by the firm by selling its goods and ser#ices. %=e#enue I the gross inflow of cash! recei#ables or other consideration arising in the acti#ities of enterprise from the sale of goods and from rendering of ser#ices. Revenue includes all t e receipts a1 4y sale of goods b1 4y rendering of ser#ices c1 =e#enue is the amount of commission

 (1 )1 *1 +1

&EA=A&TE=7TI&7 3F =EAE@;E7 They arise from the firmCs principles business acti#ities such as sale of goods They are recurring in nature =e#enue leads to increase in owners capital =e#enues are related to specific period.

As per the A76>! =e#enue recognition is mainly concerned with the timings of recognition of recognition of re#enue in the statement of profit and loss of an enterprise. For re#enue recognition firm uses the accrual system of accounting means the re#enue should be recogni"ed on that date when the goods are deli#ered by the firm.

Ne*t & apter Provisions and Reserves %eaning of Provisions 5c edule 6I of t e companies Act7 489: define t e term provision as ;any amount +ritten off or retained by +ay of providing for depreciation7 rene+als in value of assets7 or retained by providing for any /no+n liability of + ic t e amount cannot be determined +it substantial accuracy#< A1 ro#isions include: - e amount +ritten off or retained by +ay of providing for depreciation# =) - e amount retained by +ay of providing by +ay of providing for any /ind of liability of + ic t e amount cannot be determined )#g# provision for repairs Providing for doubtful debts Provision for "epreciation Provision is made for /no+n liability Reserves

Reserve is t e amount set aside out of profit# Reserves mean undistributed profits# >or e#g# general reserve7 sin/ing fund reserve7 debenture redemption reserve# Importance3ob?ectives of Reserve
To strengthen the financial position of business. To make di#idend uniform from year to year To pro#ide funds for the e-pansion Making legal reBuirement such as in#estment reser#e reBuired by income ta- law. d1 To meet unforeseen losses

-ypes of Reserves There are two types of reser#es A1 =e#enue reser#e' =e#enue reser#e is that reser#e which is created out of re#enue profits a#ailable for distribution! payable as di#idend. =e#enue reser#e classified into two categories (1 <eneral reser#e' This is not specific type for e.g. &ontingency =eser#e. )1 7pecific reser#e' It can be only use for specific purpose for e.g. di#idend eBuali"ation reser#e 41 &apital =eser#e' capital reser#e are those reser#e which are created out of capital profit For e.g. premium on issue of shares and debentures! profit on sale of fi-ed assets! profit on re#aluation of fi-ed assets and liabilities. &1 7ecret =eser#e' These are those reser#es which are not shown in the balance sheet. These reser#es make the position strong of a business. Difference between re#enue reser#e and capital reser#e and pro#ision and reser#e 0refer Dr. =5 gupta book A76.0=e#ised1 Depreciation Accounting 0=efer Dr. =5 <upta1 page )>( and )>)

Accounting concept of income and economist concept of income &oncept of Income

The accountant and economist follow different approaches as to the measurement of income. In economics the term capital refers to all those assets which are used for the production of products consist of not only tangible assets such as machinery! building! land but also

intangible assets such as human skills! technology and research and de#elopment etc. According to accountant both current and fi-ed assets constitute the capital of business enterprise. Accounting concept of Income According to the accountant #iew the net income for an accounting period can be defined as increase in the re#enues recogni"ed during the period >eatures Eistorical #alue is the basis of accounting concept Measurement of income is done by the matching cost with re#enues It o#erlooks the unreali"ed gains:losses in the #alue of the assets. )conomist concept of income According to the economist! the income refers to the cyclic profits deri#ed from the use of capital. & aracteristics 4# Income is based on the current #alues not on the historical cost which is used in accounting concept of income. @# Income is measured by comparison of the #alue of capital at two different dates. A# It considers unreali"ed gains in the #alue of fi-ed assets B# Income is deri#ed from capital 9# #alue of capital is resulting from #alue of income.