Introduction To Accounting

Accounting

Accounting as the art of recording, classifying, and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof (AICPA)

Book Keeping

Book keeping is the recording of financial transactions, and is part of the process of accounting in business

Accountancy

Accountancy is the practice of managing and maintaining business finances

Accounting Includes

  • Identifying of business transaction – Classify transactions Economic transaction or Non Economic
  • Recording of business transactions  –  Only Financial Transactions
  • Verifying of business transactions  –  Whether all the transactions recorded correctly or not ? Auditing
  • Summarizing the recorded transactions – To Get Meaningful result 
  • Interpreting of the information – Analysing the Result for decision making
  • Communication of Financial Information – Share the information with all the stakeholders.

Objectives of Accounting

  1. Systematic Recording of Transactions by way of Journal, Ledger and Trial Balance
  2. Ascertainment of Results by way of preparing Manufacturing, Profit and Loss Account
  3. Ascertainment of Financial position by way of Balance sheet
  4. Communication of information to users

Advantages of Accounting

  • Ascertainment of Financial Positions
  • Ascertainment of Amount Due To / Due From Business
  • Ascertainment of Progress of the business
  • Maintenance of Permanent Records of the business
  • Helpful to the management

Limitations of Accounting

  • Does not provide complete information
  • Does not give exact information
  • Accounting figures may be manipulated
  • Does not show the real financial position 

Branches of Accounting

  1. Financial Accounting : This is one of the oldest branch of accounting. Financial Accounting deals with recording, summarizing and reporting financial position. 
    1. Key functions include – Preparation of Financial Statements – Profit and Loss, Balance Sheet, Cash Flow etc. 
    2. These statements must be prepared as per the local accounting rules and principles. 
    3. These are statutory requirement
  1. Management Accounting: Basic function of Management accounting is to Provide information to management for decision making.
    1. Management may look for reports in different way. 
    2. Management reporting is majorly focusing on providing information to management for decision making in its planning, budgeting and forecasting. 
    3. Having Management Accounting team is optional. It is not statutory requirement
  2. Cost Accounting: Cost Accounting concerned with an ascertainment of cost for the particular 
  3. tasks or events.
    1. Cost Accounting is more focused on ascertainment of cost for the particular tasks or events. 
    2. Allocation of common expenses.  
    3. This helps management in bringing in cost control in manufacturing or service delivery areas
  4. Auditing: Auditing deals with Examination and verification of company accounts and Internal Control. There are two types of Audit – Internal Audit and External Audit.  External audit is conducted by external party to confirm that the financial statements prepared as per the statutory requirement. Intern Audit is to have better internal control to minimize or eliminate fraudulent transactions.
  5. Tax Accounting: Tax accounting will be carried out based on the rules and regulation formulated by the Income Tax authority of the country

Accounting Information

Basic Purpose of Accounting is to provide information to investors and decision makers.

Types of Accounting Information

  1. Financial Information: Information will be generated trhough Financial Accounting process. Eg: Profit and Loss Account, Balance Sheet, Cash Flow Statement etc
  2. Operational Information: Information will  be genrated through Cost Accounting process Eg. Cost per unit of production, marginal cost, variance analysis
  3. Management Information: Information will be generated through Management Accounting process. Eg. Cash forecasting, Budgeting, Comparitive Analysis etc.

Qualitative Characteristics of Accounting Information

The Financial Accounting Standard Board (FASB), US created the Qualitative Characteristics of Accounting Information.  These characteristics describe what userfull information is and how it relates to financial decision making

  1. Relevance: 

According to FASB all the relevant information which affects investor’s decision making must be included in the financial statements.

Example:

  • Breakdown of the glass wall corporate office due to strike – Is this information Relevant in decision making??? Certainly it is not relevant.

Let’s see few relevant examples

  • Company’s Most successful CEO is vacating office in next financial year
  • Production stopped due to major machinery breakdown.
  • Major Law suite company is going through, where the liability is huge

Three main attributes of Relevant accounting information

Predictive Value: It means, Financial statement have capability to use for prediction, forecast and projections

Feedback Value: Financial statement must have earlier predictions and actual results.  This information gives certainty of occurring current predictions in future date.

Timeliness:  Financial statement must have relevant numbers for the current period.  If statement contains company performance of 10 years back in the current statement it is not relevant.

  1. Reliability

Reliability refers to the trustworthiness of the data

User of the information must be able to depend on the information.

Reliability of accounting information will be based on the certainty of correctness of the base data. If the data recorded under good internal control environment then it is more reliable data. 

The FASB described three attributes that all financial information has : Verifiability, Faithfulness and Neutrality

Verifiability: Financial information is verifiable when multiple, independent measures are used to come up with the same result. In other words, auditors and other third parties can measure and evaluate the company’s financial statement accounts and end up with the same result

Faithfulness: Representational faithfulness simply means that the financial statements represent reality or what actually happened during the year

Neutrality:  Neutrality requires that management prepare completely unbiased financial statements.

  1. Comparability

Information obtained through accounting system must be in the form of comparable with previous year records or industry competitors.

 There should be standard methods of principles should be used year on year and statutorily accepted rules and conventions should be used to compare with industry competitors

  1. Consistency

Principles and convention used in the accounting process should be consistent year on year.  

If the method of costing used in first year is different in subsequent year, then result will not be having comparable value. So, it is necessary to have consistency in usage accounting convention