Basics about the Financial Accounting

Introduction of Financial Accounting

Accounting is the process of classifying, recording and reporting an enterprise's business transactions over a period of time. Financial Accounting is branch of accounting that is primarily concerned with the preparations of Financial Statements, based on the business transactions, and communication of the same to person interested in the information.

Financial management helps in determining the results (i.e. Profit or Loss) of business operations during the particular period and the financial position of the enterprise on a date at the end of the period.

Objectives of Financial Accounting

The Objective of Financial Accounting is to keep a record of all business transactions so that: 

• The Profit earned or Loss sustained by the business during the accounting period can be determined
• The financial position of the business at the end of the accounting can be ascertained 
• The Financial information required by the  owners of business, government and other interested parties such as employees or investors can be provided.

Advantages of Financial Accounting

1. Record of Business Transactions 
2. Determination of Profit and Loss
3. Determination of Financial Position
4. Track Progress of Business
5. Compliance with Legal Requirement
6. Documentary Evidence

Limitations of Financial Accounting

• Records Monetary Transactions only, and avoid Non-Monetary Transactions (i.e. transactions that can't be expressed in terms of Money) 
• Does not provide the exact results (because estimates are used in the accounting, thus information in some cases are at best approximate).
• Does not reflect the Present value of the Business.
• Does not provide timely information

Systems of Accounting

1. Single Entry System

It is a System of Accounting under which only one aspect of the transaction is recorded. It is usually used by small concerns which have very few transactions. 

The Single Entry System is considered an incomplete and unscientific system of entry, as all business transactions are not recorded under it. Usually only cash, bank, and a few debtors and creditors accounts are maintained under this system.

2. Double Entry System

The Double Entry System of accounting is more specific ad systematic method of accounting and hence is popularly used by big and small organistaions all over the world. 

This system is based on the premise that every business transaction has two aspects, i.e. the receiving aspect or debit aspect, and the giving aspect or the credit aspect. Each of these aspects of every transaction affects two accounts in opposite ways (increase or decrease in Monetary Terms). Therefore, under this system, a complete record of both the aspects of every transaction (i.e., debit and credit) is maintained.

Accounting Equation 
The Double Entry system of accounting is based on accounting equations where the relationship between assets, liabilities and capital can be expressed in the form of an equation. The Accounting Equation signifies that the total of the assets of the business is always equal to the total of its liabilities and capital (owner's equity).

The Accounting Equation is: Assets = Liabilities + Capital

Classification of Accounts 

The essential function of the Accounting is to record Transaction to ascertain the financial status of a company as on a particular date.
The usual transactions of a business are:

• Purchase of goods, either as raw material for further processing or as finished goods for resale 
• Payment of expenses incurred towards business 
• Sale of  goods or services 
• Receipts, in cash or by cheque
• Other payments, in cash or by cheque

In order to record transactions, ledger accounts are created. The Accounts can be classified into three types: Real, Personal and Nominal.
Real Account
Real Accounts are accounts maintained as assets owned or possessed by the business. It include both tangible (things that can be touched) and intangible (things that can't be touched) accounts. Example: building, Furniture, Cash, Purchases, Sales, Goodwill, etc. 
Personal Account 
Personal Accounts are the accounts of persons with whom the business is required to deal with. 
Nominal Accounts
Nominal Accounts are accounts where income and expenses are recorded. Example sales, rent expenses, salary expenses etc.

Note: All those Accounts which are not personal (i.e. real and nominal) are called Impersonal Accounts.

Accounting Principles

Accounting is considered as the language of business. In other words, Accounting is the language used by the Business Enterprises to communicate its financial position with the World. So, this language must be understood by all and there are certain uniform guidelines and standards that are followed as a part of the accounting practice. Such rules of actions are adopted universally, while recording accounting transactions and preparing accounting statements, such rules are called Generally Accept Accounting Principles (GAAP).
The Accounting Principles are designed to ensure that Financial Statements are:

• Accurate: i.e., free from errors related to contents and principles.
• Reliable: i.e., represent the information that user consider it to represent.
• Timely: i.e., available when required to support the decision-making.
• Relevant: i.e., applicable to the purpose required.

Accounting Principles are broadly classified into:

• Accounting Concepts 
• Accounting Conventions 

ACCOUNTING PRINCIPLES
Accounting Concepts	Accounting Conventions
Money measurement Concept Separate Entity Concept Going Concern Concept Cost Concept Dual Aspect Concept Periodicity Concept Objective Evidence Concept Matching Concept Realisation Concept Legal Aspect Concept Accrual Concept	Convention of Consistency Convention of Full Disclosure Convention of Conservatism Convention of Materiality

Accounting Concepts

Accounting Assumptions are the premise or notions on which the accounting process is based. Also called Accounting Concepts, these assumptions form the basis of systematic accounting practices. The following are some important accounting concepts:
1. Money Measurement Principles: In accounting, all transactions are measured by using a common unit of measurement, which is Money. Under this concept, only those Transactions or events which can be measured or expressed in terms of money can be expressed. 
2. Separate Entity Concept: The business entity concept views the business as an entity, separate from its owners, i.e. business is assumed to have a distinct entity (existence) other than the existence of its proprietors. Personal transaction of the owner is considered as separate from the accounts of the Business.
3. Going-Concern Concept: The Going-Concern Concept, also known as the Continue of Activity Concept, assumes that a business concern will continue to exist for a long period. Thus, transactions are on the assumption that a business will remain in operation long enough for all its current plans to be carried out.
4. Cost Concept: As per Cost Concept or the Historical Cost Concept, Cost of Assets should be recorded at their original acquisition cost (Cost Price). This is an Accounting Concept which is used only for Fixed Assets.
5. Dual-Aspect Concept: Under the Dual-Aspect Concept, both the Debit or Credit aspect of the transactions is recorded.
6. Periodicity Concept: Periodicity Concept also known as the Time Interval Concept, requires Business Enterprise to produce financial statements at set time interval. As per this concept, the Financial Statements are generated at relatively short periods such as year or quarter, so that the performance can b measured or compared.

7. Objective Evidence Concept: According to the Objective Evidence Concept, all accounting entries should be evidenced and supported by business documents, such as invoice, vouchers and so on.

8. Matching Concept: According to Matching Concept, the revenue that is reported must be set off against the expenses incurred to generate revenue during the Accounting Period. This gives a true picture of Profit earned during the period. 

9. Realisation Concept: The Realisation Concept deals with how revenue is recognised by a business. Revenue is recognised when goods and services are delivered in quantities/amounts that are reasonably certain to be realized.

10. Legal Aspect Concept: According to Legal Aspect Concept, all accounting records and statements must confirm to legal requirements, i.e., accounting records should be maintained and statement should be prepared as prescribed by law.

11. Accrual Concept: Under Accrual Concept of accounting revenue is recognised only when earned rather than when due or collected, and expense when incurred rather than paid. Thus the transactions are recorded on the basis of income earned or expenses incurred, irrespective of actual receipts and payments.

Accounting Conventions 

1. Consistency: According to convention of consistency, accounting practices and policies of a business entity must be consistent from one period to another. 

2. Full disclosure: According to the Full Disclosure Convention, accounts should prepare in such a way that all material information, including facts and figures, is clearly disclosed. The disclosure of financial information is useful to different parties interested in the progress and developments of an enterprise. 

3. Conservatism: The convention of Conservatism is related to the policy of playing safe. It states that uncertainties and risks inherent in business transactions should be given proper consideration.

4. Materiality: Under the Convention of Materiality any item should be regarded important (i.e. material) if there is reason to believe that its knowledge would influence the decision of the user of the information. 

Different Phases of Accounting Cycle

1. Recording of Financial Transaction: Transactions are recorded in the book of original entry called Journal Entry. 

2. Classifying the Financial Transactions: The recorded transactions are next posted to the ledger.

3. Summarising the Financial Transactions: Once the postion is complete, reports like Trial Balance, Profit & Loss Account, and Balance Sheet are prepared.

4. Analysis of the Results: After preparation of reports financial performance ad position of the company is anlysed.

  

Writer: Mr. Krishan Kumar Saini 

Today we have learnt Basics about the Financial Accounting. Hope this lesson is helpful for you.