INTRODUCTION TO FINANCIAL ACCOUNTING AND ITS TERMS

➢ Accounting

Accounting is the art of recording, classifying and summarising the economic information in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.

➢ Functions of Accounting

1) Identifying: The first step in accounting is to determine what to record, i.e., to identify

the financial events which are to be recorded in the books of accounts. It involves

observing all business activities and selecting those events or transactions which can be

considered as financial transactions.

2) Recording: A transaction will be recorded in the books of accounts only it is considered

as an economic event and can be measured in terms of money. Once the economic events

are identified and measured in economic terms they will be recorded in the books of

accounts in monetary terms and in chronological order.

3) Classifying: Once the financial transactions are recorded in journal or subsidiary books,

all the financial transactions are classified by grouping the transactions of one nature at

one place in a separate room.

4) Summarising: It is concerned with presentation of data and it begins with balance of

ledger accounts and the preparation of trial balance with the help of such balances.

5) Communication: The main purpose of accounting is to communicate the financial

information the users who analyse them as per their individual requirements. Providing

financial information to its users is a regular process.

➢ Objectives of Accounting

1) To keep systematic and complete records of financial transactions in the books of

accounts according to specified principles and rules to avoid the possibility of omission

and fraud.

2) To ascertain the profit earned or loss incurred during a particular accounting period

which further help in knowing the financial performance of a business.

3) To ascertain the financial position of the business by the means of financial statement i.e.

balance sheet which shows assets on one side and Capital & Liabilities on the other side.

4) To provide useful accounting information to users like owners, investors, creditors,

banks, employees and government authorities etc who analyze them as per their

requirements.

5) To provide financial information to the management which help in decision making,

budgeting and forecasting.

6) To prevent frauds by maintaining regular and systematic accounting records.

➢ Advantages of Accounting

1) It provides information which is useful to management for making economic decisions.

2) It helps owners to compare one year’s results with those of other years to locate the

factors which leads to changes.

3) It provides information about the financial position of the business by means of balance

sheet which shows assets on one side and Capital & Liabilities on the other side.

4) It helps in keeping systematic and complete records of business transactions in the books

of accounts according to specified principles and rules, which is accepted by the Courts

as evidence.

5) It helps a firm in the assessment of its correct tax Liabilities such as income tax, sales tax,

VAT, excise duty etc.

6) Properly maintained accounts help a business entity in determining its proper purchase

Price.

➢ Limitations of Accounting

1) It is historical in nature; it does not reflect the current worth of a business. Moreover, the

figures given in financial statements ignore the effects of changes in price level.

2) It contains only those information’s which can be expressed in terms of money. It ignores

qualitative elements such as efficiency of management, quality of staff, customer’s

satisfactions etc.

3) It may be affected by window dressing i.e. manipulation in accounts to present a more

favorable position of a business firm than its actual position.

4) It is not free from personal bias and personal judgment of the people dealing with it. For

example, different people have different opinions regarding life of asset for calculating

depreciation, provision for doubtful debts etc.

5) It is based on various concepts and conventions which may hamper the disclosure of

realistic financial position of a business firm. For example, assets in balance sheet are

shown at their cost and not at their market value which could be realised on their sale.

➢ Book Keeping - The Basis of Accounting

Book keeping is the record-making phase of accounting which is concerned with the

recording of financial transactions and events relating to business in a significant and

orderly manner. Book Keeping should not be confused with accounting. Book keeping is

the recording phase while accounting is concerned with the summarizing phase of an

accounting system. 

Difference between Accounting and Book Keeping

➢ Types of accounting information

Accounting information can be categorized into following:

1) Information relating to profit or loss i.e. income statement, shows the net profit of

business operations of a firm during a particular accounting period.

2) Information relating to Financial position i.e. Balance Sheet. It shows assets on one side

and Capital & Liabilities on the other side. Schedules and notes forming part of balance

sheet and income statement to give details of various items shown in both of them.

➢ Subfields/Branches of Accounting

1) Financial Accounting: It is that subfield/Branch of accounting which is concerned with

recording of business transactions of financial nature in a systematic manner, to ascertain

the profit or loss of the accounting period and to present the financial position of the

Business.

2) Cost Accounting: It is that Subfield/Branch of accounting which is concerned with

ascertainment of total cost and per unit cost of goods or services produced/ provided by a

business firm.

3) Management Accounting: It is that subfield/Branch of accounting which is concerned

with presenting the accounting information in such a manner that help the management in

planning and controlling the operations of a business and in better decision making.

➢ Qualitative Characteristics of Accounting Information

Accounting information is useful for interested users only if it poses the following

characteristics:

1) Reliability: Means the information must be based on facts and be verified through source

documents by anyone. It must be free from bias and errors.

2) Relevance: To be relevant, information must be available in time and must influence the

decisions of users by helping them to form prediction about the outcomes.

3) Understandability: The information should be presented in such a manner that users can

understand it well.

4) Comparability: The information should be disclosed in such a manner that it can be

compared with previous year’s figures of business itself and other firm’s data.

More Accounting MCQs