Theoretical Framework | Meaning and Scope of Accounting | Financial Accounting Notes | B.Com 1st Sem | CBCS Pattern

Financial Accounting Notes
B.Com 1st Sem CBCS Pattern

Unit – 1: Theoretical Framework

Part A: Meaning and Scope of Accounting

Table of Contents

1. Meaning, Features and Objectives of Book-keeping

2. Meaning, Features and Objectives of Accounting

3. Advantages and Disadvantages of Accounting

4. Functions of Accounting

5. Process / Steps of Accounting

6. Difference between book-keeping and accountancy

7. Users of Accounting Information

8. Accounting Information – Meaning, Qualitative Characteristics and Types

9. Meaning and Types of Transactions

10. Meaning of Events, Difference between Transactions and events

11. Source Documents – Meaning, Features and Types

12. Branches of Accounting

13. Meaning and Types of Assets and Liabilities

14. Single entry and double entry system of accounting

15. Bases of accounting – Cash, Accrual and Hybrid

 Meaning of Book keeping

Book keeping is an activity concerned with the recording of financial data relating to business operation in a significant and orderly manner.

According to the R.N carter “Book – keeping is the science and arts of correctly recording in the book of accounts all those business transactions that result in the transfer of money or money’s worth “.

Thus we can say that it is an art of recording business transaction in a systematic manner in the book of business.

Features of Book Keeping

a)      Book Keeping is both science and an art of recording business transactions.

b)      It involves the recording of pecuniary (Relating to or consisting of money) transactions.

c)       Recording of transaction is done in proper set of books.

d)      Book keeping keeps the books of different assets and liabilities in systematic manner which helps in knowing the financial position.

e)      It assists in financial planning, budgeting and forecasting.

Objectives of Book- keeping:  A businessman records the transaction in a set of book in order to ascertain the following objects:           

a)      To have a permanent records of each transaction of the business.

b)      To show the financial effect on the entity of each transaction recorded.

c)       To help in preparation of financial statements which assist in knowing the operating efficiency of the firm.

d)      To assist in knowing the financial position of the business on a particular data.

e)      To detect and prevent frauds and errors by keeping records of all transactions in systematic manner.

Meaning of Accounting

Accounting is the analysis and interpretation of book-keeping records. It includes not only maintains of accounting records but also the preparation of financial statements which helps in analysis and interpretation of business transactions and events.

According to the American institute of certified public accounts” The arts of recordings, classifying and summarizing in a significant manner and in terms of money transaction and events which in parts, at least of a financial charter and interpreting the result there of”.

In the words of R.N. Anthony, “Accounting is a means of collecting, summarizing, analyzing and reporting in monetary terms the information of business.”

Features of Accounting:              

a)      It is an art of recording of transactions.

b)      Accounting’s main feature is also classifying all business transactions.

c)       Summarising of business transactions by preparing trial balance.

d)      It helps in interpretation of financial results.

The mean objectives of accounting are as follow:

a)      To keep systematic and authentic records of all the financial transaction of a business.

b)      To ascertain the net profit or loss suffered on account of carrying the business by preparing profit and loss account.

c)       To ascertain the financial position of business on a particular date by preparing balance sheet.

d)      To determine the tax liability of the business.

e)      To assist the management in taking various important managerial decisions.

The main advantages of accounting are mentioned below:

a)      Accounting helps in keeping a systematic and permanent record of business transactions and events.

b)      Accounting information is used by the management in taking various managerial decisions.

c)       It shows the financial position of business on a particular data.

d)      Accounting data are accepted by the tax authorities as authentic and reliable. Hence they can be used as the basis for discharging tax liabilities.

e)      Accounting supplies financial data which are accepted by the insurance company as reliable figure for settlement of insurance claim.

Following are the limitations of accounting:

a)      According to records only those transactions which can be measured in monetary terms. There may be certain important non-monitory transaction but are not recorded.

b)      Accounting information is historical in nature and does not provide timely information.

c)       Effects of price level changes are not considered while preparing financial statements.

d)      Personal bias of accountant affects the accounting statement.

e)      Accounting information is in summary form and detailed analysis of financial transactions during a particular is not possible.

Functions of accounting:

a)      Record Keeping Function: The primary function of accounting relates to recording, classification and summary of financial transactions-Journalisation, posting, and preparation of final statements. These facilitate to know operating results and financial positions.

b)      Managerial Function: Decision making programme is greatly assisted by accounting. The managerial function and decision making programmes, without accounting, may mislead.

c)       Legal Requirement function: Auditing is compulsory in case of registered firms. Auditing is not possible without accounting. Thus accounting becomes compulsory to comply with legal requirements.

d)      Language of Business: Accounting is the language of business. Various transactions are communicated through accounting. There are many parties-owners, creditors, government, employees etc., who are interested in knowing the results of the firm and this can be communicated only through accounting.

Process/Steps of Accounting

Accounting starts with identification of business transactions and events and ends with analysis, interpretation and communication of financial statements. A brief summary of process of accounting is given below:

a)         Identification of business transactions and events of an entity.

b)        Measurement of identified transactions and events in the terms of money.

c)         Recording of all business transactions in journal.

d)        Classification of transactions recorded in journal by preparing ledgers for each aspect of transaction.

e)        Summarising the ledgers in trial balance to check arithmetical accuracy and in financial statements i.e., profit and loss account and balance sheet to know operating efficiency and financial position.

f)          Analysis and interpretation of financial statements to know the financial strength and weakness of the business unit.

g)         Last but not the least; communicate the financial statements after proper analysis and interpretation in a proper form and manner to the proper person.

Difference Between book keeping and accountancy

Basis of Difference

Book – Keeping

Accountancy

a.    Functions

Its function is to identify and record business transaction.

The function of accounting is the recording, classifying, summarizing, interpreting business transaction and communicating result.

b.   Transactions

Recording of transactions in books of original entry in done in case of book keeping.

In accountancy, these recorded transactions are examined in order to find out their accuracy.

c.    Analysis and interpretation

Analysis and interpretation of business transactions in not required in case of book keeping.

Analysis and interpretation of financial statements are done to judge the financial strength and weakness of the business unit.

d.   Income Statement and Balance Sheet

Preparation of trading, Profit & loss account and balance sheet is not possible in book keeping.

Preparation of trading, profits and loss account and balance sheet is included in it.

e.   Special skill and knowledge

It does not require special skill and knowledge.

It requires special skill and knowledge.

Users of accounting information:

Users of Financial Statements

Users of accounting information may be categorised into: (1) Internal Users; and (2) External Users.

(1) Internal Users:

(i) Owners: Owners contribute capital in the business and they are always exposed to risk. In view of risk involved, the owners are always interested in knowing the profitability and financial strength of the company.

(ii) Management: Managers has the responsibility to not only safeguard the owner’s investment but also to increase the value of business. Financial statements help the management to find out the overall as well as segment-wise efficiency of the business. It helps them in decision making as well as in controlling and self evaluation.

(iii) Employees and Workers: Employees and workers are entitled to bonus at the yearend besides the salary and wages which is directly linked with the profits of the enterprise. Therefore, the employees and workers are interested in financial statements.

(2) External Users:

(i) Banks and Financial Institutions: Banks and Financial Institutions provide loans to the businesses. They watch the performance of the business to ensure the safety and recovery of the loan advanced.

(ii) Investors and Potential Investors: Investors uses financial statements to assess the earning capacity of the enterprise and ensure the safety of their investment.

(iii) Creditors: Creditors supply goods and services on credit. Before granting credit, Creditors satisfy themselves about the creditworthiness of the business. The financial statement helps them in making such assessment.

(iv) Government authorities: The government makes use of financial statements to compile national income accounts and other information. The information so available to it enables the government authorities to assess tax liability of the firm.

(v) Consumers: Customers have an interest in information about the continuance of an enterprise, especially when they have a long-term with the enterprise. Sometime, prices of some products are fixed by the government, so it needs accounting information to fix fair prices so that consumers and producers are not exploited.

Accounting Information – Meaning, Qualitative Characteristics and Types

Accounting Information is a set of financial data indicating an organization's resources, revenues, debts or expenses. Accounting information must possess the following qualitative characteristics:

a)      Reliability: Reliability means the users must be able to depend on the information.

b)      Relevance: To be relevant, information must be available in time, must help in prediction and feedback.

c)       Understandability: Understandability means decision-makers must interpret accounting information in the same sense as it is prepared and conveyed to them.

d)      Comparability: The users of the accounting information must be able to compare various aspects of an entity over different time period and with other entities.

e)      Timeliness: Timeliness is how quickly information is available to users of accounting information. The less timely (thus resulting in older information), the less useful information is for decision-making. Timeliness matters for accounting information because it competes with other information.

Types of accounting information: Accounting information is presented in the following form:

a)      Income statement (Trading and Profit & Loss account)

b)      Position Statement (Balance Sheet)

c)       Statement of Changes in financial statement (Cash flow and funds flow statement)

d)      Vale added Statement.

e)      Social performance report etc.

Transactions and Events

Transaction: Transaction means the exchange of money or money’s worth from one account to another account. Events like purchase and sale of goods, receipt and payment of cash for services or on personal accounts, loss or profit in dealings etc., are the transactions”. It is an economic activity of the business that causes a change in an organization’s financial position or net worth, resulting from normal business activity.

The following are the characteristics of transaction.

a)      There must be two parties in a transaction.

b)      The events must be measurable in terms of money.

c)       The event involves the transfer of property or service.

d)      The event must charge the financial position of a person or an institution.

e)      Change may be qualitative or quantitative.

Types of transaction: Transactions may be classified on the following basis:

a)      On the basis of mode of payment:

1.       Cash transaction

2.       Credit transaction

3.       Paper transaction

b)      On the basis of exchange:

1.       Exchange transaction

2.       Non-Exchange transaction

c)       On the basis of entity involved:

1.       External transaction

2.       Internal transaction.

Event: An event is a happening indicating a business transaction requiring a journal entry to be passed. Only monetary events are regarded as transactions. So, all transactions are events though all events are not transactions.

Difference between transaction and event

Transaction

Event

1. It is the consequence of exchange.

2. It can be internal as well as external.

3. It is an economic activity.

4. All transactions are events.

5. It can involve more than two parties.

1. It is consequence of occasion.

2. It is always internal activity.

3. It is a historical activity.

4. All events are not transactions.

5. Only one party is involved.

Source Documents – Meaning, Features and Types

A source document is a written document that provides details of a transaction and the evidence that the transaction has taken place.

Features of Source Documents: Source documents contain the following information:

Ø  Date of transaction.

Ø  Names and addresses of parties involved in the transaction.

Ø  Description of the goods or services.

Ø  Amount involved.

Ø  Terms and conditions related to trade discounts, cash discount and other details related to delivery.

Ø  Signature of the concerned parties

Types of Source Document: Invoice, Credit note, Debit note, Payment voucher, Cheque counterfoil, Bank statement, Cash memo

The branches of accounting are:

a)      Financial accounting;

b)      Cost accounting; and

c)       Management accounting.

a)      Financial Accounting: It is the original form of accounting. It is mainly concerned with the preparation of financial statements for the use of outsiders like creditors, debenture holders, investors and financial institutions.

b)      Cost Accounting: It is that branch of accounting which is concerned with the accumulation and assignment of historical costs to units of product and department, primarily for the purpose of valuation of stock and measurement of profits.

c)       Management Accounting: It is an accounting for the management i.e., accounting which provides necessary information to the management for discharging its functions.

Assets and Liabilities and Its Types

Assets: Any physical thing or right owned that has money value is an asset. In other words, an asset is that expenditure which results in acquiring of some property or benefits of a lasting nature. Assets can be broadly classified into three types:

a)      Fixed Assets

b)      Current Assets         

c)       Fictitious Assets

a)      Fixed Assets are assets held on a long-term basis usually for more than one year, such as land, buildings, machinery, plant, furniture and fixtures. These assets are used for the normal operations of the business. Fixed assets are further classified into three parts:

Tangible assets: It refers to those assets which can be touched and seen. For example, vehicle, plant and machinery, equipments.etc.

Intangible assets: It refers to those assets which cannot be touched and seen. For example, goodwill, trademark, patents, copyright etc.

Wasting assets or Depleting assets: It refers to those assets which exhausted in value by way of depletion. For example, Oil well, coal mines.

b)      Current Assets are assets held on a short-term basis such as debtors (accounts receivable), bills receivable (notes receivable), stock (inventory), temporary marketable securities, cash and bank balances.

c)       Fictitious assets: It refers to those assets which do not have any physical form and realisable value such as preliminary expenses, discount on issue of shares etc.

Liabilities: It means the amount which the firm owes to outsiders except the proprietors. In the words of Finny and Miller, “Liabilities are debts; they are amounts owed to creditors; thus the claims of those who ate not owners are called liabilities”. In simple terms, debts repayable to outsiders by the business are known as liabilities. Liabilities are classified as

a)      long-term liabilities or Fixed liabilities

b)      Short-term liabilities or current liabilities

c)       Contingent liabilities.

a)      Long-term liabilities are those that are usually payable after a period of one year, for example, a term loan from a financial institution or debentures (bonds) issued by a company.

b)      Short-term liabilities are obligations that are payable within a period of one year, for example, creditors, bills payable, bank overdraft.

c)       Contingent Liabilities are those which may or may not become payable in future. For example, financial cases pending, guarantee given, bills discounted from bank etc.

System of Accounting

                1. Single Entry    2. Double Entry

                1. 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.

                2. Double Entry: 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. Under this system all accounts i.e., Personal, real and nominal accounts are maintained. It is a complete system of recording business transactions.

Advantages of Double Entry System

a)      Scientific system: This system is the only scientific system of recording business transactions. It helps to attain the objectives of accounting.

b)      Complete record of transactions: This system maintains a complete record of all business transactions.

c)       A check on the accuracy of accounts: By the use of this system the accuracy of accounting book can be established through Trail balance.

d)      Ascertainment of profit or loss by the preparation of Profit and Loss Account.

e)      Knowledge of the financial position of the business through the preparation of balance sheet.

Disadvantages of Double Entry System

a)      It requires expert knowledge: Book-keeping requires specialized knowledge, so it cannot be prepared by a layman.

b)      It is a very lengthy process: As it record transactions in two stage viz. journalizing and ledger posting, it requires a larger number of books.

c)       It is expensive: It is expensive because an expert is to be employed for this Purpose. It, therefore, involves additional expense.

d)      Errors of omission: If a transaction is omitted to be recorded in the books of accounts, it cannot be detected by double entry system because they do not affect a trial balance.

BASES OF ACCOUNTING: There are three bases of accounting in common usage which are:

1. Cash basis

2. Accrual or Mercantile basis

3. Mixed or Hybrid basis.

Accounting on ‘Cash basis’: Under cash basis of accounting, entries are recorded only when cash is received or paid. No entry is passed when a payment or receipt becomes due. Government system of accounting is mostly on cash basis.

Accrual Basis of Accounting or Mercantile System: Under accrual basis of accounting, accounting entries are made on the basis of amounts having become due for payment or receipt. Incomes are credited to the period in which they are earned whether cash is received or not. Similarly, expenses and losses are detailed to the period in which, they are incurred, whether cash is paid or not. The profit or loss of any accounting period is the difference between incomes earned and expenses incurred, irrespective of cash payment or receipt.

Mixed or Hybrid Basis of Accounting: When certain items of revenue or expenditure are recorded in the books of account on cash basis and certain items on mercantile basis, the basis of accounting so employed is called ‘hybrid basis of accounting’.

 

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