Class XI

Notes: Financial Accounting
Introduction to Accounting

Meaning of Accounting

Accounting is the process of identifying, measuring, recording and communicating the required information relating to the economic events of an organization to the interested users of such information. Accounting plays important role in providing quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decisions.

Definition of Accounting

“Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.”

-- (Year1966) American Accounting Association(AAA)

“Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.”

--(Year1970)Accounting Principles Board of AICPA(U.S.A)

Process of accounting
  1. Identification of Financial Transactions and Events: Accounting records only those transactions and events which are of financial nature as they bring change in the resources of a firm.

  2. Measuring the Identified Transactions: Accounting measures the transactions and events in terms of a common measurement unit, i.e., the currency of the country.

  3. Recording: Recording is the process of recording business transactions of financial character in the book of original entry, i.e., Journal.

  4. Classifying: Classification is the process of collecting similar transactions at one place by opening accounts in the Ledger Book.

  5. Summarising: This involves presenting the classified data in a manner which is understandable and useful to internal as well as external users of accounting statements.

  6. Analysis and Interpretation: Financial data is analysed and interpreted so that the users of financial data can make a meaningful judgement of the financial performance (profit) and financial position (balance sheet) of the business.

  7. Communicating: Finally, accounting function involves communicating the financial data, i.e., financial statements to its users (internal and external).

    is a systematic knowledge of accounting, i.e., it educates how to maintain the books of accounts.

    It involves journal, ledger, cash book and other subsidiary books, it cannot disclose the results of Business. Book keeping is a part of accounting.

    Basis Book Keeping Accounting
    1. Scope Book Keeping is concerned with indentifying Accounting is concerned with financial transaction; measuring them in money summarising the recorded terms; recording them in the books of accounts transactions, interpreting them and classifying them. Communicating the results
    2. Stage It is primary stage. It is the basis for accounting. It is a secondary stage. It begins where Book Keeping ends.
    3. Objective The objective of book keeping is to maintain Systematic records of financial transactions The objective of accounting is to Ascertain net results of operations Financial position and to Communicate information to the Interested parties.
    4. Nature of Job This job is routine in nature. This job is analytical and dynamic in nature.
    5. Performance junior staff performs this function Senior staff performs this function.
    6. Special skills Book Keeping is mechanical in nature and thus, does not require special skills Accounting requires special skills, ability to analyse and interpret.

Is accounting a science or an art? Accounting is an art of recording financial transactions in a set of books, classifying in desired categories and summarising the information for presentation in a suitable manner to the concerned persons for their benefit. Accounting is also science in the sense that it comprises of rules, principles, concepts, conventions and standards.

Users of financial statements:
  1. Internal users :- (Owners, shareholders, investors, creditors, employees, customers, management.)

  2. External users :- (Regulatory agencies, labor union, stock exchange, public and others)

  1. 1. Financial accounting: (Book Keeping + preparation of financial statement). Financial accounting is that branch of accounting which records financial transactions and events, summarises and interprets them and communicates the results to the users.

  2. Cost accounting: (Determines the unit cost at different level of production). Information relating to the cost of products or services led to the development of a specialized branch, i.e., Cost Accounting.

  3. Management accounting: (It blends financial and cost accounting to get maximum profit at maximum cost). Management Accounting is the most recently developed branch of accounting. It is concerned with generating accounting information relating to funds, costs, profits, etc., as it enables the management in decision-making. We may say that Management Accounting addresses the needs of a single user group, i.e., the management.

  4. Tax accounting: (Sales tax and income tax).

  5. Social responsibility: (Focus on social benefits)
Objectives of Accounting
  1. Record of Financial Transactions and Events: The objective of accountancy is to record financial transactions and events of the organisation in the books of accounts following the principles of accounting in a systematic manner.

  2. Determine Profit or Loss: Another objective of accounting is to determine the financial performance, i.e., profit earned or loss incurred, for the accounting period.

  3. Determine Financial Position: Another objective of accounting is to determine financial position. It is known from the Balance Sheet. Financial position of the business is as relevant for the users of financial statements as is the Income Statement.

  4. Assisting the management: Another objective of accounting is to assist the management by providing financial information to it. The management often requires financial information for decision-making, exercising control, budgeting and forecasting.

  5. Communicating Accounting Information to users: Another objective of accounting is to provide accounting information to users who analyse them as per their individual requirements.

  6. Protecting Business Assets: Another objective of accounting is to have records of assets owned by the business. Accounting maintains record of assets owned by the business which enables the management to protect them and exercise control.
Advantages of accounting are :-
  1. Financial Information about business: Financial performances during the accounting period, i.e., profit or loss and also the financial position at the end of the accounting period is known through accounting.

  2. Assistance to Management: The management makes business plans, takes decisions and exercises control over the affairs on the basis of accounting information.

  3. Replaces Memory: A systematic and timely recording of transactions obviates the necessity to remember transactions. The accounting record provides the necessary information.

  4. Facilities Comparative Study: A systematic record enables a businessman to compare one year’s results with those of other years and locate significant factors leading to change, if any.

  5. Facilities Settlement of Tax Liabilities: A systematic accounting record immensely helps in settlement of income tax, sales tax, VAT and exercise duty liabilities, since it is a good evidence of the correctness of transactions.

  6. Facilities Loans: Loan is granted by the banks and financial institutions on the basis of growth potential which is supported by the performance. Accounting makes available the information with respect to performance.

  7. Evidence in Court: Systematic record of transactions is often accepted by the courts as good evidence.

  8. Facilities sale of business: If someone desires to sell his business, the accounts maintained by him enable the ascertainment of the proper purchase price.

  9. Helps in Decision-Making: Accounting helps in taking a large number of decisions like the amount to be withdrawn by proprietor, the price at which goods should be sold, etc.
Limitations of Accounting are:-
  1. Accounting is not Fully Exact: Although most of the transactions are recorded on the basis of evidence such as sale or purchase or receipt of cash, yet some estimates are also made for ascertaining profit or loss. Examples of these are providing depreciation on the basis of estimated useful life of an asset, possible bad debts etc.

  2. Accounting does not Indicate the Realisable Value: The Balance sheet does not show the amount of cash which the firms may realize by the sale of all the assets.

  3. Accounting Ignores the Qualitative Elements: Since accounting is confined to monetary matters only, qualitative elements like quality of staff, industrial relations and public relations are ignored.

  4. Accounting Ignores the Effect of Price Level Changes: Accounting statements are prepared at historical cost. Money as a measurement unit, changes in value. It does not remain stable.

  5. Accounting may Lead to Window Dressing: The term window dressing means manipulation of accounts so as to conceal vital facts and present the financial statements in such a way as to show better position than what it actually is. In this situation, income statement (i.e., Profit and Loss Account) fails to provide a true and fair view of the result of operations and the balance sheet fails to provide a true and fair view of the financial position of the enterprise.