Theoretical Framework - Meaning and Scope of Accounting
Financial Accounting Notes BCOM 2nd SEM NEP 2023
Unit – 1: Theoretical Framework
Part A:
Meaning and Scope of Accounting
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Table of Contents |
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1. Meaning, Features and Objectives of Book-keeping 2. Meaning, Features and Objectives of Accounting 3. Advantages and Disadvantages of Accounting 4. Functions of Accounting 5. Process / Steps of Accounting 6. Difference between book-keeping and accountancy 7. Users of Accounting Information 8. Accounting
Information – Meaning, Qualitative Characteristics and Types 9. Meaning and Types of Transactions 10. Meaning of Events, Difference between Transactions and events 11. Source
Documents – Meaning, Features and Types 12. Branches of Accounting 13. Meaning and Types of Assets and Liabilities 14. Single entry and double entry system of accounting 15. Bases of accounting – Cash, Accrual and Hybrid |
Meaning
of Book keeping
Book keeping is an activity concerned with the recording of financial data relating to business operation in a significant and orderly manner.
According
to the R.N carter “Book – keeping is the science and arts of correctly
recording in the book of accounts all those business transactions that result
in the transfer of money or money’s worth “.
Thus we
can say that it is an art of recording business transaction in a systematic
manner in the book of business.
Features
of Book Keeping
a) Book
Keeping is both science and an art of recording business transactions.
b) It
involves the recording of pecuniary (Relating to or consisting of money)
transactions.
c) Recording
of transaction is done in proper set of books.
d) Book
keeping keeps the books of different assets and liabilities in systematic
manner which helps in knowing the financial position.
e) It assists
in financial planning, budgeting and forecasting.
Objectives
of Book- keeping: A businessman records the transaction in a set of book in order to
ascertain the following objects:
a)
To have a
permanent records of each transaction of the business.
b)
To show the
financial effect on the entity of each transaction recorded.
c)
To help in
preparation of financial statements which assist in knowing the operating
efficiency of the firm.
d)
To assist in knowing
the financial position of the business on a particular data.
e)
To detect and prevent
frauds and errors by keeping records of all transactions in systematic manner.
Meaning of Accounting
Accounting is the
analysis and interpretation of book-keeping records. It includes not only
maintains of accounting records but also the preparation of financial
statements which helps in analysis and interpretation of business transactions
and events.
According to the
American institute of certified public accounts” The arts of recordings,
classifying and summarizing in a significant manner and in terms of money
transaction and events which in parts, at least of a financial charter and
interpreting the result there of”.
In the words of
R.N. Anthony, “Accounting is a means of collecting, summarizing, analyzing and
reporting in monetary terms the information of business.”
Features
of Accounting:
a)
It is an art of recording of transactions.
b)
Accounting’s main feature is
also classifying all business transactions.
c)
Summarising of business transactions by
preparing trial balance.
d)
It helps in interpretation of financial
results.
The mean objectives of accounting are as follow:
a)
To keep
systematic and authentic records of all the financial transaction of a business.
b)
To ascertain the
net profit or loss suffered on account of carrying the business by preparing
profit and loss account.
c)
To ascertain the
financial position of business on a particular date by preparing balance sheet.
d)
To determine the tax
liability of the business.
e)
To assist the
management in taking various important managerial decisions.
The main advantages of accounting are mentioned below:
a)
Accounting helps
in keeping a systematic and permanent record of business transactions and
events.
b)
Accounting
information is used by the management in taking various managerial decisions.
c)
It shows the
financial position of business on a particular data.
d)
Accounting data
are accepted by the tax authorities as authentic and reliable. Hence they can
be used as the basis for discharging tax liabilities.
e)
Accounting
supplies financial data which are accepted by the insurance company as reliable
figure for settlement of insurance claim.
Following are the limitations of accounting:
a)
According to
records only those transactions which can be measured in monetary terms. There
may be certain important non-monitory transaction but are not recorded.
b)
Accounting
information is historical in nature and does not provide timely information.
c)
Effects of price
level changes are not considered while
preparing financial statements.
d)
Personal bias of
accountant affects the accounting statement.
e)
Accounting information is in summary form and
detailed analysis of financial transactions during a particular is not
possible.
Functions of accounting:
a)
Record Keeping
Function: The primary function of accounting relates to recording,
classification and summary of financial transactions-Journalisation, posting,
and preparation of final statements. These facilitate to know operating results
and financial positions.
b)
Managerial Function: Decision
making programme is greatly assisted by accounting. The managerial function and
decision making programmes, without accounting, may mislead.
c)
Legal Requirement
function: Auditing is compulsory in case of registered firms. Auditing is
not possible without accounting. Thus accounting becomes compulsory to comply
with legal requirements.
d)
Language of
Business: Accounting is the language of business. Various transactions are
communicated through accounting. There are many parties-owners, creditors,
government, employees etc., who are interested in knowing the results of the
firm and this can be communicated only through accounting.
Process/Steps of Accounting
Accounting
starts with identification of business transactions and events and ends with
analysis, interpretation and communication of financial statements. A brief
summary of process of accounting is given below:
a)
Identification of business transactions and
events of an entity.
b)
Measurement of identified transactions and
events in the terms of money.
c)
Recording of all business transactions in
journal.
d)
Classification of transactions recorded in
journal by preparing ledgers for each aspect of transaction.
e)
Summarising the ledgers in trial balance to
check arithmetical accuracy and in financial statements i.e., profit and loss
account and balance sheet to know operating efficiency and financial position.
f)
Analysis and interpretation of financial
statements to know the financial strength and weakness of the business unit.
g)
Last but not the least; communicate the
financial statements after proper analysis and interpretation in a proper form
and manner to the proper person.
Difference Between book keeping and accountancy
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Basis of Difference |
Book –
Keeping |
Accountancy |
|
a.
Functions |
Its function is to identify and record
business transaction. |
The function of accounting is the
recording, classifying, summarizing, interpreting business transaction and
communicating result. |
|
b.
Transactions |
Recording of transactions in books of
original entry in done in case of book keeping. |
In accountancy, these recorded
transactions are examined in order to find out their accuracy. |
|
c.
Analysis and
interpretation |
Analysis and interpretation of
business transactions in not required in case of book keeping. |
Analysis and interpretation of
financial statements are done to judge the financial strength and weakness of
the business unit. |
|
d.
Income
Statement and Balance Sheet |
Preparation of trading, Profit &
loss account and balance sheet is not possible in book keeping. |
Preparation of trading, profits and
loss account and balance sheet is included in it. |
|
e.
Special skill
and knowledge |
It does not require special skill
and knowledge. |
It requires special skill and
knowledge. |
Users of accounting information:
Users of
Financial Statements
Users of accounting information may be
categorised into: (1) Internal Users; and (2) External Users.
(1) Internal
Users:
(i) Owners:
Owners contribute capital in the business and they are always exposed to
risk. In view of risk involved, the owners are always interested in knowing the
profitability and financial strength of the company.
(ii) Management:
Managers has the responsibility to not only safeguard the owner’s
investment but also to increase the value of business. Financial statements
help the management to find out the overall as well as segment-wise efficiency
of the business. It helps them in decision making as well as in controlling and
self evaluation.
(iii) Employees
and Workers: Employees and workers are entitled to bonus at the yearend
besides the salary and wages which is directly linked with the profits of the
enterprise. Therefore, the employees and workers are interested in financial
statements.
(2) External
Users:
(i) Banks
and Financial Institutions: Banks and Financial Institutions provide loans
to the businesses. They watch the performance of the business to ensure the
safety and recovery of the loan advanced.
(ii) Investors
and Potential Investors: Investors uses financial statements to assess the
earning capacity of the enterprise and ensure the safety of their investment.
(iii) Creditors:
Creditors supply goods and services on credit. Before granting credit,
Creditors satisfy themselves about the creditworthiness of the business. The
financial statement helps them in making such assessment.
(iv) Government
authorities: The government makes use of financial statements to compile
national income accounts and other information. The information so available to
it enables the government authorities to assess tax liability of the firm.
(v) Consumers: Customers have an interest in information about the continuance of an enterprise, especially when they have a long-term with the enterprise. Sometime, prices of some products are fixed by the government, so it needs accounting information to fix fair prices so that consumers and producers are not exploited.
Also Read: FINANCIAL ACCOUNTING CHAPTERWISE NOTESUNIT 1
1. Preparation of Trial Balance and Preparation of Financial Statements
UNIT 2
Part A: Accounting for Partnership
UNIT 3
UNIT 4
Some other Important Chapters
Accounting Information – Meaning, Qualitative Characteristics and Types
Accounting Information is a set of financial data
indicating an organization's resources, revenues, debts or expenses. Accounting
information must possess the following
qualitative characteristics:
a)
Reliability: Reliability means the users must be able to depend on the
information.
b)
Relevance: To be relevant, information must be available in time, must
help in prediction and feedback.
c)
Understandability: Understandability means decision-makers must
interpret accounting information in the same sense as it is prepared and
conveyed to them.
d)
Comparability: The users of the
accounting information must be able to compare various aspects of an entity over different time period and
with other entities.
e)
Timeliness: Timeliness is how quickly information is
available to users of accounting information. The less timely (thus resulting
in older information), the less useful information is for decision-making.
Timeliness matters for accounting information because it competes with other
information.
Types of accounting information: Accounting
information is presented in the following form:
a) Income statement
(Trading and Profit & Loss account)
b) Position
Statement (Balance Sheet)
c) Statement
of Changes in financial statement (Cash flow and funds flow statement)
d) Vale added
Statement.
e) Social
performance report etc.
Transactions and Events
Transaction:
Transaction means the exchange of money
or money’s worth from one account to another account. Events like purchase and
sale of goods, receipt and payment of cash for services or on personal
accounts, loss or profit in dealings etc., are the transactions”. It is an
economic activity of the business that causes a change in an organization’s
financial position or net worth, resulting from normal business activity.
The following are
the characteristics of transaction.
a)
There must be two
parties in a transaction.
b)
The events must
be measurable in terms of money.
c)
The event
involves the transfer of property or service.
d)
The event must
charge the financial position of a person or an institution.
e)
Change may be
qualitative or quantitative.
Types of transaction: Transactions may be classified on the following basis:
a)
On the basis of mode of payment:
1.
Cash transaction
2.
Credit transaction
3.
Paper transaction
b) On the basis of exchange:
1.
Exchange transaction
2.
Non-Exchange transaction
c) On the basis of entity involved:
1.
External transaction
2.
Internal transaction.
Event: An event is a happening indicating a
business transaction requiring a journal entry to be passed. Only monetary
events are regarded as transactions. So, all transactions are events though all
events are not transactions.
Difference between transaction and event
|
Transaction |
Event |
|
1. It is the consequence of exchange. 2. It can be internal as well as external. 3. It is an economic activity. 4. All transactions are events. 5. It can involve more than two parties. |
1. It is consequence of occasion. 2. It is always internal activity. 3. It is a historical activity. 4. All events are not transactions. 5. Only one party is involved. |
Source Documents – Meaning, Features and Types
A source document is a
written document that provides details of a transaction and the evidence that
the transaction has taken place.
Features of Source Documents: Source documents contain the following
information:
Ø
Date of
transaction.
Ø
Names and
addresses of parties involved in the transaction.
Ø
Description of
the goods or services.
Ø
Amount involved.
Ø
Terms and
conditions related to trade discounts, cash discount and other details related
to delivery.
Ø
Signature of the
concerned parties
Types of Source Document: Invoice, Credit
note, Debit note, Payment voucher, Cheque counterfoil, Bank statement, Cash
memo
The branches of accounting are:
a)
Financial accounting;
b)
Cost accounting; and
c)
Management accounting.
a)
Financial
Accounting: It is the original form of accounting. It is mainly concerned with
the preparation of financial statements for the use of outsiders like
creditors, debenture holders, investors and financial institutions.
b)
Cost Accounting: It is that
branch of accounting which is concerned with the accumulation and assignment of
historical costs to units of product and department, primarily for the purpose
of valuation of stock and measurement of profits.
c)
Management
Accounting: It is an accounting for the management i.e., accounting which
provides necessary information to the management for discharging its functions.
Assets and Liabilities and Its Types
Assets: Any physical thing or right owned that has money
value is an asset. In other words, an asset is that expenditure which results
in acquiring of some property or benefits of a lasting nature. Assets can be broadly classified into three types:
a)
Fixed Assets
b)
Current Assets
c)
Fictitious Assets
a)
Fixed Assets are
assets held on a long-term basis usually for more than one year, such as land,
buildings, machinery, plant, furniture and fixtures. These assets are used for
the normal operations of the business. Fixed assets are further classified into
three parts:
Tangible
assets: It refers to those assets which can be touched and seen. For example,
vehicle, plant and machinery, equipments.etc.
Intangible
assets: It refers to those assets which cannot be touched and seen. For
example, goodwill, trademark, patents, copyright etc.
Wasting
assets or Depleting assets: It refers to those assets which exhausted in value
by way of depletion. For example, Oil well, coal mines.
b)
Current Assets
are assets held on a short-term basis such as debtors (accounts receivable),
bills receivable (notes receivable), stock (inventory), temporary marketable
securities, cash and bank balances.
c)
Fictitious
assets: It refers to those assets which do not have any physical form and
realisable value such as preliminary expenses, discount on issue of shares etc.
Liabilities: It means the amount which the firm owes to
outsiders except the proprietors. In the words of Finny and Miller, “Liabilities
are debts; they are amounts owed to creditors; thus the claims of those who ate
not owners are called liabilities”. In simple terms, debts repayable to
outsiders by the business are known as liabilities. Liabilities are classified as
a)
long-term liabilities
or Fixed liabilities
b)
Short-term
liabilities or current liabilities
c)
Contingent
liabilities.
a)
Long-term
liabilities are those that are usually payable after a period of one year, for
example, a term loan from a financial institution or debentures (bonds) issued
by a company.
b)
Short-term
liabilities are obligations that are payable within a period of one year, for
example, creditors, bills payable, bank overdraft.
c)
Contingent
Liabilities are those which may or may not become payable in future. For example,
financial cases pending, guarantee given, bills discounted from bank etc.
System of Accounting
1. Single
Entry 2. Double Entry
1.
Single Entry: It is incomplete system of recording business transactions. The
business organization maintains only cash book and personal accounts of debtors
and creditors. So the complete recording of transactions cannot be made and
trail balance cannot be prepared.
2.
Double Entry: Double Entry is an accounting system that records the effects of
transactions and other events in at least two accounts with equal debits and
credits. Under this system all accounts i.e., Personal, real and nominal
accounts are maintained. It is a complete system of recording business
transactions.
Advantages
of Double Entry System
a)
Scientific system: This system is the only
scientific system of recording business transactions. It helps to attain the
objectives of accounting.
b)
Complete record of transactions: This system
maintains a complete record of all business transactions.
c)
A check on the accuracy of accounts: By the
use of this system the accuracy of accounting book can be established through
Trail balance.
d)
Ascertainment of profit or loss by the
preparation of Profit and Loss Account.
e)
Knowledge of the financial position of the
business through the preparation of balance sheet.
Disadvantages
of Double Entry System
a) It
requires expert knowledge: Book-keeping requires specialized knowledge, so it
cannot be prepared by a layman.
b) It is a
very lengthy process: As it record transactions in two stage viz. journalizing
and ledger posting, it requires a larger number of books.
c) It is
expensive: It is expensive because an expert is to be employed for this
Purpose. It, therefore, involves additional expense.
d) Errors of
omission: If a transaction is omitted to be recorded in the books of accounts,
it cannot be detected by double entry system because they do not affect a trial
balance.
BASES OF ACCOUNTING: There are three bases of accounting in common usage which are:
1. Cash
basis
2. Accrual
or Mercantile basis
3. Mixed
or Hybrid basis.
Accounting on ‘Cash basis’: Under cash
basis of accounting, entries are recorded only when cash is received or paid.
No entry is passed when a payment or receipt becomes due. Government system of
accounting is mostly on cash basis.
Accrual Basis of Accounting or Mercantile
System: Under accrual basis of accounting, accounting entries are made on
the basis of amounts having become due for payment or receipt. Incomes are
credited to the period in which they are earned whether cash is received or
not. Similarly, expenses and losses are detailed to the period in which, they
are incurred, whether cash is paid or not. The profit or loss of any accounting
period is the difference between incomes earned and expenses incurred, irrespective
of cash payment or receipt.
Mixed or Hybrid Basis of Accounting: When certain items of revenue or expenditure are recorded in the books of account on cash basis and certain items on mercantile basis, the basis of accounting so employed is called ‘hybrid basis of accounting’.
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