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NOTES OF FINANCIAL MANAGMENT PROJECT
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FINANCIAL ACCOUNTINGPAPER CODE: BBA-103
NOTES
UNIT-I
Meaning and scope of accounting, nature of financial accounting principles, basis of accounting;
accounting process – from recording of business transaction to preparation of trial balance
Q1: Define accounting.
Ans: : In 1941, The American Institute of Certified Public Accountants (AICPA) had defined accounting as the art
of recording, classifying, and summarizing 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’.
In 1966, the American Accounting Association (AAA) defined accounting as ‘the process of identifying, measuring
and communicating economic information to permit informed judgments and decisions by users of information’.
Q2: Enumerate main objectives of accounting.
Ans: Objectives of Accounting
1. Maintenance of Records of Business Transactions
2. Calculation of Profit and Loss
3. Depiction of Financial Position
4. Providing Accounting Information to its Users
Q3: Define trial balance
Ans: A trial balance is a statement showing the balances, or total of debits and credits, of all the accounts in the
ledger with a view to verify the arithmetical accuracy of posting into the ledger accounts. Trial balance is an
important statement in the accounting process. Which shows final position of all accounts and helps in preparing the
final statements? The task of preparing the statements is simplified because the accountant can take the account
balances from the trial balance instead of looking them up in the ledger. It is normally prepared at the end of an
accounting year. However, an organization may prepare a trial balance at the end of any chosen period, which may
be monthly, quarterly, half yearly or annually depending upon its requirements.
Long types Questions:
Q6: Define accounting and state its objectives. Describe the role of accounting in the modern world.
Ans: Meaning of Accounting In 1941, The American Institute of Certified Public Accountants (AICPA) had
defined accounting as the art of recording, classifying, and summarizing 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’.
With greater economic development resulting in changing role of accounting, its scope, became broader. In 1966,
the American Accounting Association (AAA) defined accounting as ‘the process of identifying, measuring and
communicating economic information to permit informed judgments and decisions by users of information’.
In 1970, the Accounting Principles Board of AICPA also emphasized that the function of accounting is to provide
quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in
making economic decisions.
Accounting can therefore be defined as the process of identifying, measuring, recording and communicating the
required information relating to the economic events of an organization to the interested users of such information.
In order to appreciate the exact nature of accounting, we must understand the following relevant aspects of the
definition:
a. Economic Events
b. Identification, Measurement, Recording and Communication
c. Organization
d. Interested Users of Information
1. Economic Event: A business organization involves economic events. An economic event is known as a
happening of consequence to a business organization which consists of transactions and which are
measurable in monetary terms. For example, purchase of machinery, installing and keeping it ready for
manufacturing is an event which comprises number of financial transactions such as buying a machine,
transportation of machine, site preparation for installation of a machine, expenditure incurred on its
, installation and trial runs. Thus, accounting identifies bunch of transactions relating to an economic event.
If an event involves transactions between an outsider and an organization, these are known as external
events. The following are the examples of such transactions:
a. Sale of Reebok shoes to the customers.
b. Rendering services to the customers by Videocon Limited.
c. Purchase of materials from suppliers.
d. Payment of monthly rent to the landlord.
An internal event is an economic event that occurs entirely between the internal wings of an enterprise,
e.g., supply of raw material or components by the stores department to the manufacturing department,
payment of wages to the employees, etc.
2. Identification, Measurement, Recording and Communication: Identification: It means determining what
transactions to record, i.e., to identity events which are to be recorded. It involves observing activities and
selecting those events that are of considered financial character and relate to the organization. The business
transactions and other economic events therefore are evaluated for deciding whether it has to be recorded in
books of account. For example, the value of human resources, changes in managerial policies or
appointment of personnel are important but none of these are recorded in books of account.
3. Measurement: It means quantification (including estimates) of business transactions into financial terms by
using monetary unit, viz. rupees and paisa as a measuring unit. If an event cannot be quantified in monetary
terms, it is not considered for recording in financial accounts. That is why important items like the
appointment of a new managing director, signing of contracts or changes in personnel are not shown in the
books of accounts.
4. Recording: Once the economic events are identified and measured in financial terms, these are recorded in
books of account in monetary terms and in a chronological order. Recording is done in a manner that the
necessary financial information is summarized as per well-established practice and is made available as and
when required.
5. Communication: The economic events are identified, measured and recorded in order that the pertinent
information is generated and communicated in a certain form to management and other internal and
external users. The information is regularly communicated through accounting reports. These reports
provide information that are useful to a variety of users who have an interest in assessing the financial
performance and the position of an enterprise, planning and controlling business activities and making
necessary decisions from time to time. The accounting information system should be designed in such a
way that the right information is communicated to the right person at the right time. Reports can be daily,
weekly, monthly, or quarterly, depending upon the needs of the users. An important element in the
communication process is the accountant’s ability and efficiency in presenting the relevant information.
6. Organization: Organization refers to a business enterprise, whether for profit or not-for profit motive.
Depending upon the size of activities and level of business operation, it can be a sole-proprietor concern,
partnership firm, cooperative society, company, and local authority, Municipal Corporation or any other
association of persons.
7. Interested Users of Information: Accounting is a means by which necessary financial information about
business enterprise is communicated and is also called the language of business. Many users need financial
information in order to make important decisions. These users can be divided into two broad categories:
internal users and external users. Internal users include: Chief Executive, Financial Officer, Vice
President, Business Unit Managers, Plant Managers, Store Managers, Line Supervisors, etc. External users
include: present and potential Investors (shareholders), Creditors (Banks and other Financial Institutions,
Debenture holders and other Lenders), Tax Authorities, Regulatory Agencies (Department of Company
Affairs, Registrar of Companies, Securities Exchange Board of India, Labour Unions, Trade Associations,
Stock Exchange and Customers, etc. Since the primary function of accounting is to provide useful
information for decision-making, it is a means to an end, with the end being the decision that is helped by
the availability of accounting information.
Objectives of Accounting
As an information system, the basic objective of accounting is to provide useful information to the
interested group of users, both external and internal. The necessary information, particularly in case of
external users, is provided in the form of financial statements, viz., profit and loss account and balance
sheet. Besides these, the management is provided with additional information from time to time from the
accounting records of business. Thus, the primary objectives of accounting include the following:
Maintenance of Records of Business Transactions: Accounting is used for the maintenance of a
systematic record of all financial transactions in book of accounts. Even the most brilliant
executive or manager cannot accurately remember the numerous amount of varied transactions
such as purchases, sales, receipts, payments, etc. that takes place in business every day. Hence,
, proper and complete records of all business transactions are kept regularly. Moreover, the recorded
information enables verifiability and acts as evidence.
Calculation of Profit and Loss: The owners of business are keen to have an idea about the net
results of their business operations periodically, i.e. whether the business has earned profits or
incurred losses. Thus, another objective of accounting is to ascertain the profit earned or loss
sustained by a business during an accounting period which can be easily workout with help of
record of incomes and expenses relating to the business by preparing a profit or loss account for
the period. Profit represents excess of revenue (income), over expenses. If the total revenue of a
given period is Rs 6,00,000 and total expenses are Rs. 5,40,000 the profit will be equal to Rs.
60,000(Rs. 6,00,000 – Rs. 5,40,000). If however, the total expenses exceed the total revenue, the
difference reflects the loss.
Depiction of Financial Position: Accounting also aims at ascertaining the financial position of the
business concern in the form of its assets and liabilities at the end of every accounting period. A
proper record of resources owned by business organization (Assets) and claims against such
resources (Liabilities) facilitates the preparation of a statement known as balance sheet position
statement.
Providing Accounting Information to its Users: The accounting information generated by the
accounting process is communicated in the form of reports, statements, graphs and charts to the
users who need it in different decision situations. As already stated, there are two main user
groups, viz. internal users, mainly management, who needs timely information on cost of sales,
profitability, etc. for planning, controlling and decision-making and external users who have
limited authority, ability and resources to obtain the necessary information and have to rely on
financial statements (Balance Sheet, Profit and Loss account)
Role of Accounting
For centuries, the role of accounting has been changing with the changes in economic development and
increasing societal demands. It describes and analyses a mass of data of an enterprise through
measurement, classification and summarization, and reduces those date into reports and statements, which
show the financial condition and results of operations of that enterprise.
Hence, it is regarded as a language of business. It also performs the service activity by providing
quantitative financial information that helps the users in various ways. Accounting as an information
system collects and communicates economic information about an enterprise to a wide variety of interested
parties.
However, accounting information relates to the past transactions and is quantitative and financial in nature,
it does not provide qualitative and nonfinancial information. These limitations of accounting must be kept
in view while making use of the accounting information.
Q7: ‘The accounting concepts and accounting standards are generally referred to as the essence of financial
accounting’. Comment?
Ans: Generally Accepted Accounting Principles (GAAP): Generally Accepted Accounting principles refer to the
rules or guidelines adopted for recording and reporting of business transactions in order to bring uniformity
in the preparation and presentation of financial statements. These principles are also referred to as concepts
and conventions. From the practicality view point, the various terms such as principles, postulates,
conventions modifying principles, assumptions, etc. have been used interchangeably and are referred to as
basic accounting concepts, in the present book.
Basic Accounting Concepts: The basic accounting concepts are referred to as the fundamental ideas or basic
assumptions underlying the theory and practice of financial accounting and are broad working rules of
accounting activities.
Business Entity: This concept assumes that business has distinct and separate entity from its owners. Thus,
for the purpose of accounting, business and its owners are to be treated as two separate entities. Every
business requires to be accounted for separately by the proprietor. Personal and business-related dealings
should not be mixed.
Money Measurement: The concept of money measurement states that only those transactions and
happenings in an organization, which can be expressed in terms of money are to be recorded in the book of
accounts. Also, the records of the transactions are to be kept not in the physical units but in the monetary
units.
, Going Concern: The concept of going concern assumes that a business firm would continue to carry out its
operations indefinitely (for a fairly long period of time) and would not be liquidated in the near future. The
business will continue operating and will not close but will realize assets and discharge liabilities in the
normal course of operations Principles derived from tradition, such as the concept of matching. In any
report of financial statements (audit, compilation, review, etc.), the preparer/auditor must indicate to the
reader whether or not the information contained within the statements complies with GAAP.
Accounting Period : Accounting period refers to the span of time at the end of which the financial
statements of an enterprise are prepared to know whether it has earned profits or incurred losses during that
period and what exactly is the position of its assets and liabilities, at the end of that period.
Cost Concept: The cost concept requires that all assets are recorded in the book of accounts at their cost
price, which includes cost of acquisition, transportation, installation and making the asset ready for the use.
To illustrate, on June 2005, an old plant was purchased for Rs. 50 lakh by Shiva Enterprise, which is into
the business of manufacturing detergent powder. An amount of Rs. 10,000 was spent on transporting the
plant to the factory site. In addition, Rs. 15,000 was spent on repairs for bringing the plant into running
position and Rs. 25,000 on its installation. The total amount at which the plant will be recorded in the
books of account would be the sum of all these, i.e. Rs. 50,50,000.
Dual Aspect: This concept states that every transaction has a dual or two fold effect on various accounts
and should therefore be recorded at two places. The duality principle is commonly expressed in terms of
fundamental accounting equation, which is : Assets = Liabilities + Capital
Revenue Recognition: Revenue is the gross in-flow of cash arising from the sale of goods and services by
an enterprise and use by others of the enterprise resources yielding interest royalties and dividedness. The
concept of revenue recognition requires that the revenue for a business transaction should be considered
realized when a legal right to receive it arises.
Matching: The concept of matching emphasizes that expenses incurred in an accounting period should be
matched with revenues during that period. It follows from this that the revenue and expenses incurred to
earn these revenue must belong to the same accounting period.
Full Disclosure: This concept requires that all material and relevant facts concerning financial
performance of an enterprise must be fully and completely disclosed in the financial statements and their
accompanying footnotes.
Consistency: these concepts state that accounting policies and practices followed by enterprises should be
uniform and consistent one the period of time so that results are compostable. Comparability results when
the same accounting principles are consistently being applied by different enterprises for the period under
comparison, or the same firm for a number of periods.
Conservatism: This concept requires that business transactions should be recorded in such a manner that
profits are not overstated. All anticipated losses should be accounted for but all unrealized gains should be
ignored.
Materiality: This concept states that accounting should focus on material facts. If the item is likely to
influence the decision of a reasonably prudent investor or creditor, it should be regarded as material, and
shown in the financial statements
Objectivity: According to this concept, accounting transactions should be recorded in the manner so that it
is free from the bias of accountants and others.
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