Financial accounting is a specialized branch of accounting that involves recording, summarizing, and reporting a company's financial transactions over a specific period. This process results in the preparation of financial statements, which provide a detailed view of the company's financial health ...
Financial Accounting and Analysis
Prof. Padmini Srinivasan
Week 1 Handout
READING MATERIAL FOR WEEK 1
Introduction to Financial Accounting
1.1 Introduction
All organizations, irrespective of the legal status – proprietorship, partnership, incorporated
company, statutory corporation or trust and whether they exist for profit or not for profit, are
formed with a view to achieve certain goals (objective, purpose or vision as you may choose).
In order to impart direction and greater certitude to achieving the result, organizations prepare
plans. It is said that all plans, in order to succeed, have to be controlled and all controls, in order
to be effective, have to be planned. This implies that the actual performance should be
measured, compared with the plans and deviation suitably dealt with. The action taken may
involve either correcting the performance or modifying plans or both. Further, there are several
stakeholders of business who will need financial information for decision making. For this
purpose, organizations have to measure the performance and this is achieved through the
accounting system. The objective of financial accounting is to provide relevant, reliable and
timely information for decision making.
1.2 What is accounting?
Accounting is a systematic process that is concerned with measurement and reporting of
transactions and events occurring in an organization. Financial reports that are generated
provide information that will enable the stakeholders to take decisions.
1.3 Users of Accounting Information
Who are the users of accounting information? What information will the stakeholders look for?
Let us understand through a small situation.
John, a young graduate, wants to start a laundry service. He needs $100,000 to buy the
equipment. He has $50000. For the remaining capital, he decides to take a loan from a bank
and approaches ABV Bank. When approached by John, the bank manager says that in order to
process the application, he needs details of the project and the return expected at the end of
every year during the life of the car. Why did the bank manager ask John for the project details?
The bank manager will sanction the loan only if he is convinced of the financial viability of the
project. These stakeholders need information about the firm in order to decide whether to deal
with it and if so, to what extent.
There are several users of accounting information. Let us briefly discuss them.
• Investors: They provide capital to the firm. Hence, they need information to assess the
inherent risk of loss of capital and the return their investment in the firm is likely to
yield. They also need information to buy, sell or hold these investments.
, Financial Accounting and Analysis
Prof. Padmini Srinivasan
Week 1 Handout
• Lenders: They are interested in ascertaining the ability of the firm to service their loans
over the entire term of the loan by paying interest and repaying installments on the due
dates.
• Suppliers and other creditors: They would like to assess the ability of the firm to pay
amounts owed to them within the credit period allowed to the firm. Normally, the
interest of the trade creditors is over shorter periods as compared to lenders.
• Customers and employees: They would like to know if the firm represents a stable
source of supply/employment.
• Government: The government is interested in information that will help it to assess the
taxes that can be collected from the firm, regulate the businesses in general, draft tax
and economic policies, and prepare national income statistics.
• Public: Members of the public are interested in assessing the economic benefits and
costs arising from factors such as employment of people from the locality, patronage to
local suppliers and hazards to environment.
1.4 Accounting System
Is there a formal process or a system to do accounting? Let us explain.
Accounting System is similar to any other information system and has three components,
namely input, process and output as outlined below.
The Accounting System
INPUT PROCESS OUTPUT
DOUBLE ENTRY Financial
MONETARY
SYSTEM OF Reports
TRANSACTION
AND EVENTS ACCOUNTING
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