Financial Accounting

Meaning Financial Accounting

Investors and creditors are often called external users
because they are people outside of the organization
who use the company financial information to make
decisions. The most common form of financial
information issued to external users by companies is a
general purpose set of financial statements.
Definition of Financial Accounting
Financial accounting is the area of accounting that
focuses on providing external users with useful
information. In other words, financial accounting is a
way of reporting business activity and financial
information to investors, creditors, and other people
outside the business organization.
A field of accounting that treats money as a means of
measuring economic performance instead of as a factor of
production. It encompasses the entire system of monitoring
and control of money as it flows in and out of an
organization as assets and liabilities, and revenues and
expenses.
Financial accounting gathers and summarizes financial data
to prepare financial reports such as balance sheet and income
statement for the organization's management, investors,
lenders, suppliers, tax authorities, and other stakeholders.
Accounting rules and principles
Debit the Receiver and Credit the Giver
Example: Goods worth 1000 bucks sold to Mr. Smith
from Mr. John. In this transaction, Mr. Smith is the
receiver of goods, he is called receiver and his account
is to be debited in the books of business. Mr. John is
the giver of goods, he is called giver and his account is
to be credited in the books of business.
Accounting rules and principles
Debit What Comes in and Credit What Goes out
Example: Goods sold on cash for 1500 bucks. In this
transaction cash, an assets for business comes into the
business on sales of goods, and therefore cash account
is to be debited in the books of business. On the other
side, goods, an assets of business goes out of the
business on sale and therefore goods account is to be
credited in the books of business.
Accounting rules and principles
Debit All Expenses and Loss and Credit all Income
and Gains
Example: (1) Paid 50 bucks as a commission to our
agent, here commission which is paid to an agent is
business expense and it is to be debited in the books of
business. (2) Received 100 bucks as interest on our
fixed deposit, here interest which is received is
business income and therefore it is to be credited in the
books of business.
Accounting Concepts & Conventions
Accounting Concepts Accounting Conventions
• Separate Business Entity Concept • Convention of Materiality
•Money Measurement Concept •Convention of Conservatism
•Dual Aspect Concept •Convention of consistency
•Going Concern Concept
•Accounting Period Concept
•Cost Concept
•The Matching Concept
•Accrual Concept
•Realization Concept
Accounting Concept: Separate Business
Entity Concept
 A business and its owner should be treated separately
as far as their financial transactions are concerned.
Accounts can be kept only for Entities, which are
different from the persons who are associated with
these entities
Ex. Sole Proprietary, Partnership firm, Company
This is one of the most Important and fundamental
accounting principle with which Double entry
system of accounting has evolved.
Money Measurement Concept
Only business transactions that can be expressed in
terms of money are recorded in accounting, though
records of other types of transactions may be kept
separately.
Dual Aspect Concept
For every credit, a corresponding debit is made. The
recording of a transaction is complete only with this
dual aspect.
Going Concern Concept
In accounting, a business is expected to continue for a
fairly long time and carry out its commitments and
obligations. This assumes that the business will not be
forced to stop functioning and liquidate its assets at
“fire-sale” prices
Accounting Period Concept
Each business chooses a specific time period to
complete a cycle of the accounting process—for
example, monthly, quarterly, or annually—as per a
fiscal or a calendar year.
Cost Concept
The fixed assets of a business are recorded on the basis
of their original cost in the first year of accounting.
Subsequently, these assets are recorded minus
depreciation. No rise or fall in market price is taken
into account. The concept applies only to fixed assets.
The Matching Concept
This principle dictates that for every entry of revenue
recorded in a given accounting period, an equal
expense entry has to be recorded for correctly
calculating profit or loss in a given period.
Accrual Concept
Accruals concept. Revenues are recognized when
earned, and expenses are recognized when assets are
consumed. This concept means that a business may
recognize sales, profits and losses in amounts that vary
from what would be recognized based on the cash
received from customers or when cash is paid to
suppliers and employees. Auditors will only certify
the financial statements of a business that have been
prepared under the accruals concept.
Realization Concept
According to this concept, profit is recognised only
when it is earned. An advance or fee paid is not
considered a profit until the goods or services have
been delivered to the buyer.
Accounting Conventions
The term “conventions” includes those customs or
traditions which guide the accountants while preparing
the accounting statements. The following are the
important accounting conventions.
CONVENTION OF DISCLOSURE:
Full disclosure entails the revelation of all information, both favorable
and damaging to a business enterprise, and which are of material value to
creditors and debtors.
the disclosure of all significant information is one of the important
accounting conventions. It implies that accounts should be prepared in
such a way that all material information is clearly disclosed to the reader.
The term disclosure does not imply that all information that any one could
desire is to be included in accounting statements. The term only implies
that there is to a sufficient disclosure of information which is of material in
trust to proprietors, present and potential creditors and investors. The idea
behind this convention is that any body who want to study the financial
statements should not be mislead. He should be able to make a free
judgment. The disclosures can be in the way of foot notes. Within the body
of financial statements, in the minutes of meeting of directors etc.
CONVENTION OF MATERIALITY:
Materiality means that all material facts should be recorded in
accounting. Accountants should record important data and leave
out insignificant information.
It refers to the relative importance of an item or even. According
to this convention only those events or items should be recorded
which have a significant bearing and insignificant things should
be ignored. This is because otherwise accounting will be
unnecessarily over burden with minute details. There is no
formula in making a distinction between material and immaterial
events. It is a matter of judgment and it is left to the accountant
for taking a decision. It should be noted that an item material for
one concern may be immaterial for another. Similarly, an item
material in one year may not be material in the next year.
CONVENTION OF CONSISTENCY:
Consistency prescribes the use of the same accounting principles
from one period of an accounting cycle to the next, so that the
same standards are applied to calculate profit and loss.
This convention means that accounting practices should remain
uncharged from one period to another. For example, if stock is
valued at cost or market price whichever is less; this principle
should be followed year after year. Similarly, if depreciation is
charged on fixed assets according to diminishing balance method,
it should be done year after year. This is necessary for the purpose
of comparison. However, consistency does not mean inflexibility.
It does not forbid introduction of improved accounting
techniques. If a change becomes necessary, the change and its
effect should be stated clearly.
CONVENTION OF CONSERVATISM:
This convention means a caution approach or policy of “play safe”.
This convention ensures that uncertainties and risks inherent in
business transactions should be given a proper consideration. If
there is a possibility of loss, it should be taken into account at the
earliest. On the other hand, a prospect of profit should be ignored
up to the time it does not materialise. On account of this reason, the
accountants follow the rule ‘anticipate no profit but provide for all
possible losses’. On account of this convention, the inventory is
valued ‘at cost or market price whichever is less.’ The effect of the
above is that in case market price has gone down then provide for
the ‘anticipated loss’ but if the market price has gone up then
ignore the ‘anticipated profits.’ Similarly a provision is made for
possible bad and doubtful debt out of current year’s profits.
Regulations relating to financial Accounting
GAAP
Accounting Standard
GAAP
Generally accepted accounting principles (GAAP) refer to a
common set of accepted accounting principles, standards,
and procedures that companies and their accountants must
follow when they compile their financial statements.
GAAP Principles
1. Business Entity Assumption
2. Monetary Unit Assumption
3. Accounting Period
4. Historical Cost Concept
5. Going Concern Assumption
6. Full Disclosure Principle
Accounting Standard
An accounting standard is a common set of principles,
standards and procedures that define the basis of financial
accounting policies and practices.
Accounting standards improve the transparency of financial
reporting in all countries.
Accounting standards relate to all aspects of an entity’s
finances, including assets, liabilities, revenue, expenses and
shareholders' equity. Specific examples of an accounting
standard include revenue recognition, asset classification,
allowable methods for depreciation, what is considered
depreciable, lease classifications and outstanding share
measurement.
International Financial Reporting Standards
(IFRS)
International Financial Reporting Standards (IFRS) set
common rules so that financial statements can be
consistent, transparent and comparable around the
world. IFRS are issued by the International Accounting
Standards Board (IASB). They specify how companies
must maintain and report their accounts, defining types
of transactions and other events with financial impact.
IFRS were established to create a common accounting
language, so that businesses and their financial
statements can be consistent and reliable from
company to company and country to country.
Standard IFRS Requirements
IFRS covers a wide range of accounting activities. There are certain
aspects of business practice for which IFRS set mandatory rules.
Statement of Financial Position: This is also known as a balance sheet.
IFRS influences the ways in which the components of a balance sheet
are reported.
Statement of Comprehensive Income: This can take the form of one
statement, or it can be separated into a profit and loss statement and a
statement of other income, including property and equipment.
Statement of Changes in Equity: Also known as a statement of retained
earnings, this documents the company's change in earnings or profit for
the given financial period.
Statement of Cash Flow: This report summarizes the company's financial
transactions in the given period, separating cash flow into Operations,
Investing, and Financing.