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Financial Accountancy

Written By Admin on Wednesday, January 16, 2013 | 9:53 AM




Financial accountancy (or financial accounting) is the field of accountancy concerned with the preparation of financial statements for decision makers, such as stockholders, suppliers, banks, employees, government agencies, owners, and other stakeholders. The fundamental need for financial accounting is to reduce principal-agent problem by measuring and monitoring agents' performance and reporting the results to interested users.
Financial accountancy is used to prepare accounting information for people outside the organization or not involved in the day to day running of the company. Managerial accounting provides accounting information to help managers make decisions to manage the business.
Objective of Financial Accounting (FA):
The objective of financial accounting is to collect accurate, systematic, and timely financial data and other financial information, and to compile and consolidate it in an organized and systematic way, according to the principles and rules of accounting, for reporting purpose.
The financial managers use these reports to assess the financial position of the company through various financial management tools and then the financial position can be compared to, or benchmarked against, the industry norms. The four different financial statements used for the purpose of reporting and analysis are

1. Balance Sheet
2. P/L or Income Statement
3. Cash Flow Statement
4. Statement of Retained Earnings (or Shareholders’ Equity Statement)
In financial accounting, assets are recorded on
the basis of historical costs in the balance sheet, i.e., the assets are recorded at their original purchase price. Of course, the depreciation on the asset is duly subtracted from its original value as the asset remains in use of the business.
However, in financial management, book value is seldom used and financial managers consider the market value and the intrinsic value of assets.
Market value may be defined as the value currently prevailing in the market or the value at which the sellers are ready to sell, and buyers are ready to buy a particular asset.
Intrinsic value or the fair value is calculated by summing up the discounted future cash flowsObjective of Financial Accounting (FA):
The objective of financial accounting is to collect accurate, systematic, and timely financial data and other financial information, and to compile and consolidate it in an organized and systematic way, according to the principles and rules of accounting, for reporting purpose.
The financial managers use these reports to assess the financial position of the company through various financial management tools and then the financial position can be compared to, or benchmarked against, the industry norms. The four different financial statements used for the purpose of reporting and analysis are

1. Balance Sheet
2. P/L or Income Statement
3. Cash Flow Statement
4. Statement of Retained Earnings (or Shareholders’ Equity Statement)
In financial accounting, assets are recorded on the basis of historical costs in the balance sheet, i.e.,
the assets are recorded at their original purchase price. Of course, the depreciation on the asset is duly subtracted from its original value as the asset remains in use of the business.
However, in financial management, book value is seldom used and financial managers consider the market value and the intrinsic value of assets.
Market value may be defined as the value currently prevailing in the market or the value at which the sellers are ready to sell, and buyers are ready to buy a particular asset.
Intrinsic value or the fair value is calculated by summing up the discounted future cash flows
THE IMPORTANCE OF FINANCIAL INFORMATION.
A. Financial information is the HEART OF BUSINESS MANAGEMENT.
1. Most of us know almost nothing about accounting from experience.
2. However, you have to know something about accounting if you want to understand business.
3. It is almost impossible to run a business effectively without being able to read, understand, and analyze accounting reports and financial statements.
B. Accounting reports and financial statements are as revealing of the HEALTH OF A BUSINESS as pulse rate and blood pressure reports are in revealing the health of a person.
II. WHAT IS ACCOUNTING?  
A. ACCOUNTING is the recording, classifying, summarizing, and interpreting of financial events and transactions to provide management and other interested parties with the information they need to make good decisions.
1. FINANCIAL TRANSACTIONS include buying and selling goods and services, acquiring insurance,
using supplies, and paying taxes.
2. An ACCOUNTING SYSTEM is the methods used to record and summarize accounting data into reports.
B. PURPOSES OF ACCOUNTING:
1. To help managers evaluate the financial condition and the operating performance of the firm so they may make better decisions.
2. To report financial information to people outside the firm such as owners, suppliers, and the government.
C. Accounting is the measurement and reporting of financial information to various users regarding the economic activities of the firm.
III. AREAS OF ACCOUNTING.
A. Accounting has been called the LANGUAGE OF BUSINESS, but it also is the language used to report financial information about nonprofit organizations.
B. MANAGERIAL ACCOUNTING.
1. MANAGERIAL ACCOUNTING   is used to provide information and analyses to managers within the organization to assist them in decision making.
2. Managerial accountants:
a. MEASURING AND REPORT COSTS of production, marketing, and other functions.
b. PREPARING BUDGETS.
c. Checking whether or not units are STAYING WITHIN THEIR BUDGETS.
d. DESIGNING STRATEGIES TO MINIMIZE TAXES.
3. A CERTIFIED MANAGEMENT ACCOUNTANT is a professional accountant who has met certain educational and experience requirements and been certified by the Institute of Certified Management Accountants.
C. FINANCIAL ACCOUNTING.
1. The information provided by FINANCIAL ACCOUNTING is used by people OUTSIDE of the organization (owners and prospective owners, creditors and lenders, employee unions,
customers, governmental units, and the general public.)
a. These external users are interested in the organization’s profits and other financial information.
b. Much of this information is contained in the company’s ANNUAL REPORT, a yearly statement of the financial condition and progress of an organization covering a one-year period.
2. It is critical for firms to keep accurate financial information.
a. A PRIVATE ACCOUNTANT is one who works for a SINGLE COMPANY OR ORGANIZATION.
b. A PUBLIC ACCOUNTANT is one who provides services for a fee to a NUMBER OF COMPANIES.
c. PUBLIC ACCOUNTANTS help firms by:
1. Designing an accounting system for a firm.
2. Helping select the correct computer and software to run the system.
3. Analyzing the financial strength of an organization.
3. The accounting profession assures users of financial information that financial reports of organizations are accurate.
a. The independent Financial Accounting Standards Board (FASB) defines what are generally accepted accounting principles (GAAP) that accountants must follow.
b. If financial reports are prepared "in accordance with GAAP," users know the information is reported professionally.
4. A CERTIFIED PUBLIC ACCOUNTANT (CPA) is an accountant who has passed a series of examinations established by the American Institute of Certified Public Accountant (AICPA) and met the state’s requirements for education and experience.
D. AUDITING.
1. AUDITING is the job of reviewing and evaluating the records used to prepare the company’s
financial statements.
a. Internal accountants often perform INTERNAL AUDITS.
b. Public accountants also conduct INDEPENDENT AUDITS of accounting records.
2. An INDEPENDENT AUDIT is an evaluation and unbiased opinion about the accuracy of company financial statements.
3. An accountant who has a bachelor’s degree, experience in internal auditing, and has passed an exam can earn standing as a CERTIFIED INTERNAL AUDITOR.
E. TAX ACCOUNTING.
1. Federal, state, and local governments require submission of tax returns that must be filed at specific times and in a precise format.
2. TAX ACCOUNTANTS are accountants trained in tax law and are responsible for preparing tax returns and developing tax strategies.
3. As the burden of taxes grows, the role of the tax accountant becomes more important.
IV. ACCOUNTING VERSUS BOOKKEEPING.
A. BOOKKEEPING is the recording of business transactions.
1. Bookkeeping is PART OF ACCOUNTING, but ACCOUNTING GOES FAR BEYOND the mere recording of data.
2. Accountants CLASSIFY, SUMMARIZE, INTERPRET, and REPORT DATA to managers.
3. They suggest strategies for improving the financial condition of the company.
B. WHAT BOOKKEEPERS DO.
1. The first task of bookkeepers is to DIVIDE ALL THE PAPERWORK INTO MEANINGFUL CATEGORIES.
2. Then they RECORD THE DATA from the original transaction documents (sales slips, etc.) into record books called JOURNALS.
3. A JOURNAL is the FIRST PLACE transactions are recorded.
C. DOUBLE-ENTRY BOOKKEEPING is the concept of writing each transaction
in two places.
1. Bookkeepers can check one list against the other to make sure they add up to the same amount.
2. In double-entry bookkeeping, two entries in the journal are required for each company transaction.
D. A LEDGER is a specialized accounting book in which information from accounting journals is accumulated into specific categories and posted so that managers can find all the information about one account in the same place.
E. THE SIX-STEP ACCOUNTING CYCLE.
The ACCOUNTING CYCLE results in the preparation of the financial statements: the balance sheet and the income statement.
Step 1 ANALYZING AND CATEGORIZING DOCUMENTS.
Step 2 PUTTING THE INFORMATION INTO JOURNALS.
Step 3 POSTING THAT INFORMATION INTO LEDGERS. (These first three steps are continuous.)
Step 4 PREPARING A TRIAL BALANCE   (summarizing all the data in the ledgers to see that the figures are correct and balanced.)
Step 5 PREPARING AN INCOME STATEMENT AND BALANCE SHEET.
Step 6 ANALYZE THE FINANCIAL STATEMENTS AND DETERMINE FINANCIAL HEALTH OF COMPANY.
V. UNDERSTANDING KEY FINANCIAL STATEMENTS.
A. A FINANCIAL STATEMENT is the summary of all transactions that have occurred over a particular period.
1. These indicate a firm’s financial health and stability.
2. Two key financial statements are:
a. The BALANCE SHEET, which reports the firm’s financial condition on a specific date.
b. The INCOME STATEMENT, which reports revenues, expenses, and profits (or losses) for a period of time.
3. The balance sheet is a snapshot, while
the income statement is a motion picture.
B. BALANCE SHEET.
1. A BALANCE SHEET is the financial statement that reports a firm’s financial condition at a specific time.
2. The term balance sheet implies that the report shows a balance between two figures.
3. The balance sheet shows a balance between a company’s assets and its liabilities and owners equity; or: assets = liabilities + owners’ equity
C. THE FUNDAMENTAL ACCOUNTING EQUATION.
1. The FUNDAMENTAL ACCOUNTING EQUATION is: assets = liabilities + owners’ equity
2. The fundamental accounting equation is the BASIS FOR THE BALANCE SHEET.
3. The assets are equal to, or are balanced with, the liabilities and owners’ equity.
D. THE ACCOUNTS OF THE BALANCE SHEET.
1. ASSETS are economic resources owned by the company.
a. Assets include productive, tangible items that help generate income, as well as intangibles of value.
b. LIQUIDITY refers to how fast an assets can be converted into cash.
2. CURRENT ASSETS can be converted to cash within one year.
3. FIXED ASSETS (such as equipment, buildings, and land) are relatively permanent.
4. INTANGIBLE ASSETS (such as patents and copyrights) include items of value such as patents and copyrights that have no real physical form.
E. LIABILITIES AND OWNER’S EQUITY.
1. LIABILITIES are what the business owes to others.
a. CURRENT LIABILITIES are payments due in one year or less.
b. LONG-TERM LIABILITIES are payments not due for one year or longer.
c. ACCOUNTS PAYABLE are monies owed for merchandise and
services purchased on credit but not paid for yet.
d. NOTES PAYABLE, are short-term or long-term promises for future payment.
e. BONDS PAYABLE are money loaned to the firm that it must pay back.
2. EQUITY.
a. The value of things you own (assets) minus the amount of money you owe others (liabilities) is called EQUITY.
b. The value of what stockholders own in a firm (minus liabilities) is called STOCKHOLDERS’ EQUITY (or SHAREHOLDERS’ EQUITY.)
c. The formula for OWNERS’ EQUITY is assets minus liabilities.
d. Businesses not incorporated identify this as a CAPITAL ACCOUNT.
e. For corporations, the OWNERS’ EQUITY account records the owners’ claims to funds they have invested in the firm plus earnings kept in the business and not paid out.
F. THE INCOME STATEMENT.
1. The INCOME STATEMENT is the financial statement that shows a firm’s profit after costs, expenses, and taxes.
2. It summarizes all of the resources that have come into the firm (revenue), all the resources that have left the firm, and the resulting net income or loss.
3. NET INCOME or NET LOSS are the revenues left over.
4. The income statement reports the results of operations over a particular period of time.
5. The INCOME STATEMENT’S FORMULA: revenue cost of goods sold = gross margin (gross profit) gross margin (gross profit) net income before taxes net income before taxes taxes = net income (or loss)
6. The income statement includes valuable financial information for stockholders and employees.
7. The income statement is arranged
according to accepted accounting principles (GAAP)): revenue cost of goods sold gross margin operating expenses net income before taxes taxes net income (or loss)
G. REVENUE is the value of what is received for goods sold, services rendered, and other financial sources.
1. There is a difference between revenue and sales.
2. Most REVENUE comes from SALES, but OTHER SOURCES OF REVENUE include rents earned, interest earned, and so forth.
3. Net income can also be called NET EARNINGS, or NET PROFIT.
H. COST OF GOODS SOLD (COST OF GOODS MANUFACTURED.)
1. COST OF GOODS SOLD (COST OF GOODS MANUFACTURED) measures the cost of merchandise sold or cost of raw materials or parts and supplies used for producing items for resale.
2. The cost of goods sold includes the purchase price plus any costs associated with obtaining and storing the goods.
3. GROSS MARGIN (GROSS PROFIT) is how much the firm earned by buying and selling or making and selling merchandise.
4. In a service firm, there may be no cost of goods sold.
5. In either case, the gross margin doesn’t tell you everything—you must subtract expenses.
I. OPERATING EXPENSES.
1. EXPENSES are costs involved in operating a business, such as rent, utilities, and salaries.
2. OPERATING EXPENSES include rent, salaries, supplies, utilities, insurance, and depreciation of equipment.
3. After all expenses are deducted, the firm’s net income before taxes is determined.
4. After allocating for taxes, you get to the bottom line, the NET INCOME (or perhaps NET LOSS)
the firm incurred from operations.
5. Businesses need to keep track of how much money they earn, spend, how much cash they have on hand, and so on.
J. The Importance of CASH FLOW ANALYSIS.
1. CASH FLOW is simply the difference between cash flowing in and cash flowing out of the business.
2. The number one financial cause of small-business failure today is INADEQUATE CASH FLOW.
a. Businesses often get into cash flow problems when they are growing quickly, borrowing heavily, and receiving payment from customers slowly.
b. They are selling their goods and services, but aren’t getting paid in time to turn around and pay their own bills.
c. In order to meet the demands of customers, more and more goods are bought on credit.
d. When the credit limit has been reached, the bank may refuse the loan.
e. Too often, the company goes into bankruptcy because there was no cash available when it was most needed.
3. By keeping a SKILLED BANKER informed about sales, profits, and cash flow, a small-business person makes sure of good financial advice and a more ready source of funds.
K. THE STATEMENT OF CASH FLOWS
1. In 1988, the Financial Accounting Standards Board required that the statement of cash flows replace the statement of changes in financial position.
2. The STATEMENT OF CASH FLOWS reports cash receipts and disbursement related to the firm’s major activities:
a. OPERATIONS - Cash transactions associated with running the business.
b. INVESTMENTS - Cash used in or provided by the firm’s investment activities.

c. FINANCING - Cash raised from the issuance of new debt or equity capital or cash used to pay business expenses, past debts, or company dividends.
3. Accountants analyze all of the cash changes that have occurred from operating, investing, and financing and determine the firm’s net cash position.
4. The CASH FLOW ANSWERS QUESTIONS such as:
a. How much cash came into the business from current operations?
b. Was cash used to buy stocks, bonds, or other investments?
c. Were some investments sold that brought in cash?
d. How much money came in from issues stock?
VI. APPLYING ACCOUNTING KNOWLEDGE.
A. The major functions of recording transactions and preparing financial statements have largely been assigned to computers, but how you record and report data is also important.
B. DEPRECIATION.  
1. Companies are permitted to write-off the cost of assets using DEPRECIATION as a business operation expense.
2. Companies may choose from a number of techniques for calculating DEPRECIATION.
3. Each technique results in a DIFFERENT NET INCOME.
4. Accountants can offer financial advice and recommend ways of legally handling investments, depreciation, and other accounts.
C. HANDLING INVENTORY.
1. INVENTORIES are a critical part of a company’s financial statements and important in determining a firm’s cost of goods sold.
2. FIFO is the accounting technique for calculating cost of inventory based on FIRST IN, FIRST OUT.
3. LIFO is the accounting technique for calculating cost of inventory based on LAST
IN, FIRST OUT.
4. The American Institute of Certified Public Accountants (AICPA) insists that complete information about the firm’s financial operations be provided in financial statements. CONCEPT CHECK
VII. ACCOUNTING AND BUDGETING PROCESS.
A. A BUDGET IS A FINANCIAL PLAN.
1. A BUDGET sets forth management’s expectations for revenues and, based on those financial expectations, allocates the use of specific resources.
2. Financial statements form the basis for the budgeting process because past financial information is what is used to project future financial needs and expectations.
3. Using accurate financial information to make strategic business decision is critical.
B. Accountants often assist the financial managers in determining the organization’s future financial needs.
C. The budget process is an opportunity to plan to improve the management of business.
D. Financial statements must be prepared according to legal and accepted accounting principles; this process cannot be compromised.
VIII. THE IMPACT OF COMPUTER TECHNOLOGY IN ACCOUNTING.
A. Financial information and transactions may be recorded by hand or in a computer system.
1. Most companies use computers since computers greatly simplify the task.
2. As a business grows, the number of accounts a firm must keep and the reports that must be generated expand in scope.
3. Many small-business accounting packages address the specific accounting needs of a small business.
B. Computers can record and analyze data and print out financial reports.

1. It is possible to have CONTINUOUS AUDITING, testing the accuracy and reliability of financial statements, because of computers.
2. Software programs allow even novices to do sophisticated financial analyses.
C. COMPUTERS DO NOT MAKE FINANCIAL DECISIONS BY THEMSELVES.
1. They are a TOOL to help accountants determine the best strategies.
2. Small-business owners should hire or consult with an accountant before they get started in business.
3. Computers help make accounting work less monotonous.
D. The work of an accountant requires training and very specific competencies.
E. Everyone needs to speak the language of accounting to succeed in business.
IX. USING FINANCIAL RATIOS.
A. Accurate financial information forms the basis of the financial analysis performed by accountants.
1. FINANCIAL RATIOS are helpful in analyzing the actual performance of the company compared to its financial objectives.
2. They also provide insights into the firm’s performance compared to other firms in the industry.
B. LIQUIDITY RATIOS measure the company’s ability to pay its short term debts.
1. These short-term debts are expected to be repaid within one year.
2. The CURRENT RATIO is the ratio of a firm’s current assets to its current liabilities.
a. current ratio = current assets current liabilities
b. The ratio should be compared to competing firms within the industry.
3. The ACID-TEST RATIO (or QUICK RATIO) measures the cash, marketable securities, and receivables of the firm, to its current liabilities.

a. acid-test ratio = cash + marketable securities + receivables current liabilities
b. This ratio is important to firms that have difficulty converting inventory into quick cash.
C. LEVERAGE (DEBT) RATIOS refer to the degree to which a firm relies on borrowed funds in its operations.
1. The DEBT TO OWNERS’ EQUITY RATIO measures the degree to which the company is financed by borrowed funds that must be repaid.
a. debt to owners’ equity ratio = total liabilities owners’ equity
b. A ratio above 1 (or 100%) would show that a firm actually has more debt than equity.
2. It is important to compare ratios to other firms in the same industry.
D. PROFITABILITY (PERFORMANCE) RATIOS measure how effectively the firm is using its various resources to achieve profits.  
1. Management’s performance is often measured by using profitability ratios.
2. A new Accounting Standards Board rule went into effect at the end if 1997 requiring companies to report their quarterly earning per share two ways: basic and undiluted.
3. BASIC EARNINGS PER SHARE (BASIC EPS) measures the amount of profit earned by a company for each share of common stock it has outstanding.
a. Earnings help to stimulate growth and pay for stockholders’ dividends.
b. basic earnings per share = net income after taxes #shares common stock outstanding
4. DILUTED EARNINGS PER SHARE (DILUTED EPS) measures the amount of profit earned by a company for each share of outstanding common stock, but also takes into consideration stock options, warrants, preferred
stock, and convertible debt securities which can be converted into common stock.
5. RETURN ON SALES is calculated by comparing a company’s net income with its total sales.
a. return on sales = net income net sales
b. Firms use this ratio to see if they are doing as well as other companies they compete against in generating income from sales.
6. RETURN ON EQUITY measures how much was earned for each dollar invested by owners.
a. It is calculated by comparing a company’s net income with its total owner’s equity.
b. return on equity = net income after taxes total owners’ equity
c. The higher the risk involved in an industry, the higher the return investors expect on their investment.
7. These and other profitability ratios are vital measurements of company growth and management performance.
E. ACTIVITY RATIOS measure the effectiveness of the firm’s management in using the assets that are available.  
1. INVENTORY TURNOVER RATIO measures the speed of inventory moving through the firm and its conversion into sales.
a. inventory turnover ratio = cost of goods sold average inventory
b. The more efficiently a firm manages its inventory, the higher the return.
c. A lower than average inventory turnover ratio often indicates obsolete merchandise on hand or poor buying practices.
d. Inventory control is needed to ensure proper performance
F. Finance professionals use several other specific ratios to learn more about a firm’s financial condition.
Financial accountancy is governed by both local and
international accounting standards.

Accountancy (profession)[1] or accounting (methodology) is the measurement, statement or provision of assurance about financial information primarily used by managers, investors, tax authorities and other decision makers to make resource allocation decisions within companies, organizations, and public agencies. The terms derive from the use of financial accounts.

Accounting (Definition) is a service activity. Its function is to provide quantitative information primarily financial in nature, about economic entities, that is intended to be useful in making economic decisions, and in making reasoned choices among alternative courses of action. [2]

It is also the discipline of measuring, communicating and interpreting financial activity. Accounting is also widely referred to as the "language of business".[3]
Financial accounting is one branch of accounting and historically has involved processes by which financial information about a business is recorded, classified, summarised, interpreted, and communicated; for public companies, this information is generally publicly-accessible. By contrast management accounting information is used within an organisation and is usually confidential and accessible only to a small group, mostly decision-makers. Tax Accounting is the accounting needed to comply with jurisdictional tax regulations.
Practitioners of accountancy are known as accountants. There are many professional bodies for accountants throughout the world. Many allow their members to
use titles indicating their membership or qualification level. Examples are Chartered Certified Accountant (ACCA or FCCA), Chartered Accountant (FCA, CA or ACA), Management Accountant (ACMA, FCMA or AICWA), Certified Public Accountant (CPA) and Certified General Accountant (CGA or FCGA).
Auditing is a related but separate discipline, with two sub-disciplines: internal auditing and external auditing. External auditing is the process whereby an independent auditor examines an organisation's financial statements and accounting records in order to express an opinion as to the truth and fairness of the statements and the accountant's adherence to Generally Accepted Accounting Principles (GAAP), or International Financial Reporting Standards (IFRS), in all material respects. Internal auditing aims at providing information for management usage, and is typically carried out by auditors employed by the company, and sometimes by external service providers.
Accounting/accountancy attempts to create accurate financial reports that are useful to managers, regulators, and other stakeholders such as shareholders, creditors, or owners. The day-to-day record-keeping involved in this process is known as bookkeeping.

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Accounting
The object of cost accounting is to find out the cost of goods produced or services rendered by a business. It also helps the business in controlling the costs by indicating avoidable losses and wastes.Management AccountingThe object of management accounting is to supply relevant information at appropriate
time to the management to enable it to take decision and effect control.In this web primer, we are concerned only with financial accounting. The objects of financial accounting as stated above can be achieved only by recording the financial transactions in a systematic manner according to a set of principles. The recorded information has to be classified, analyzed and presented in a manner in which business results and financial position can be ascertained.
Uses of Accounting
Accounting plays important and useful role by developing the information for providing answers to many questions faced by the users of accounting information.
(1) How good or bad is the financial condition of the business?
(2) Has the business activity resulted in a profit or loss?
(3) How well the different departments of the business have performed in the past?
(4) Which activities or products have been profitable?
(5) Out of the existing products which should be discontinued and the production of which commodities should be increased.
(6) Whether to buy a component from the market or to manufacture the same?
(7) Whether the cost of production is reasonable or excessive?
(8) What has been the impact of existing policies on the profitability of the business?
(9) What are the likely results of new policy decisions on future earning capacity of the business?
(10) In the light of past performance of the business how it should plan for future to ensure desired results ?
Above mentioned are few examples of the types of questions faced by
the users of accounting information. These can be satisfactorily answered with the help of suitable and necessary information provided by accounting.
Besides, accounting is also useful in the following respects :-
(1) Increased volume of business results in large number of transactions and no businessman can remember everything. Accounting records obviate the necessity of remembering various transactions.
(2) Accounting record, prepared on the basis of uniform practices, will enable a business to compare results of one period with another period.
(3) Taxation authorities (both income tax and sales tax) are likely to believe the facts contained in the set of accounting books if maintained according to generally accepted accounting principles.
(4) Cocooning records, backed up by proper and authenticated vouchers are good evidence in a court of law.
(5) If a business is to be sold as a going concern then the values of different assets as shown by the balance sheet helps in bargaining proper price for the business.
Limitations of Financial Accounting
Advantages of accounting discussed in this section do not suggest that accounting is free from limitations.
Following are the limitations:
Financial accounting permits alternative treatmentsAccounting is based on concepts and it follows " generally accepted principles" but there exist more than one principle for the treatment of any one item. This permits alternative treatments with in the framework of generally accepted principles. For example, the closing stock of a business
may be valued by anyone of the following methods: FIFO (First-in- First-out), LIFO (Last-in-First-out), Average Price, Standard Price etc., but the results are not comparable.
Financial accounting does not provide timely information
It is not a limitation when high powered software application like HiTech Financial Accenting are used to keep online and concurrent accounts where the balance sheet is made available almost instantaneously. However, manual accounting does have this shortcoming.
Financial accounting is designed to supply information in the form of statements (Balance Sheet and Profit and Loss Account) for a period normally one year. So the information is, at best, of historical interest and only 'post-mortem' analysis of the past can be conducted. The business requires timely information at frequent intervals to enable the management to plan and take corrective action. For example, if a business has budgeted that during the current year sales should be $ 12,00,000 then it requires information whether the sales in the first month of the year amounted to $ 10,00,000 or less or more?
Traditionally, financial accounting is not supposed to supply information at shorter interval less than one year. With the advent of computerized accounting now a software like HiTech Financial Accounting displays monthly profit and loss account and balance sheet to overcome this limitation. Financial accounting is influenced by personal judgments'Convention of objectivity' is respected in accounting but to record certain events
estimates have to be made which requires personal judgment. It is very difficult to expect accuracy in future estimates and objectivity suffers. For example, in order to determine the amount of depreciation to be charged every year for the use of fixed asset it is required estimation and the income disclosed by accounting is not authoritative but 'approximation'.
Financial accounting ignores important non-monetary information
Financial accounting does not consider those transactions of non- monetary in nature. For example, extent of competition faced by the business, technical innovations possessed by the business, loyalty and efficiency of the employees; changes in the value of money etc. are the important matters in which management of the business is highly interested but accounting is not tailored to take note of such matters. Thus any user of financial information is, naturally, deprived of vital information which is of non-monetary character. In modern times a good accounting software with MIS and CRM can be most useful to overcome this limitation partially.
Financial Accounting does not provide detailed analysis
The information supplied by the financial accounting is in reality aggregates of the financial transactions during the course of the year. Of course, it enables to study the overall results of the business the information is required regarding the cost, revenue and profit of each product but financial accounting does not provide such detailed information product- wise. For example, if business has earned
a total profit of say, $ 5,00,000 during the accounting year and it sells three products namely petrol. diesel and mobile oil and wants to know profit earned by each product Financial accounting is not likely to help him unless he uses a computerized accounting system capable of handling such complex queries. Many reports in a computer accounting software like HiTech Financial Accounting which are explained with graphs and customized reports as per need of the business overcome this limitation.
Financial Accounting does not disclose the present value of the business
In financial accounting the position of the business as on a particular date is shown by a statement known as 'Balance Sheet'. In Balance Sheet the assets are shown on the basis of "Continuing Entity Concept. Thus it is presumed that business has relatively longer life and will continue to exist indefinitely, hence the asset values are 'going concern values.' The 'realized value' of each asset if sold to-day can't be known by studying the balance sheet.
Basic accounting and bookkeeping are things people do not know enough about. And by not teaching yourself this important discipline you cheat yourself out of knowledge that can assist you in all aspects of your life, both professional and personal.
And if you think that accounting is complex, you're wrong. Although there are some terms you may not understand, the actual math of basic accounting is just an applied version of the math you learned at eight years-old.
There are only two basic concepts you need
to know:
• 1. The Accounting Equation
o Asset = Liabilities + Equity is the equation at the base of all accounting. Every financial transaction can be understood using this equation.
• 2. Double Entry Bookkeeping
o This is the system that ensures the accounting equation always remains in perfect balance.
By the way, if it would help, here is a basic definition of accounting:
Accounting is a system of recording and summarizing financial transactions in such a way that they can later be analyzed or used to communicate with others.
Hopefully, this provides a bit better understanding of what accounting actually is. Because accounting actually really simple. It is just a system that bundles and packages financial information so that it can be used for a variety of individual or business purposes.
Now here's more of what you need to know about the accounting equation and double entry bookkeeping.
The Accounting Equation
Earlier in the article you learned that the basic accounting equation is Asset = Liabilities + Equity. What this really means is that, from an accounting perspective, the value of things you have (assets) is equal to the value of what you owe for the things (liabilities) plus what you, as weird as it sounds, the value you don't owe for (equity).
Here's how the accounting equation works in practice:
Imagine you buy a car (an asset) for $30,000 dollars. If you borrowed $10,000 (a liability) and paid the balance with your own savings, here is what the accounting equation would look like: $30,000 car asset
= $20,000 car loan liability + $10,000 equity in the car.
Transactions can be a lot more complicated than this, but the principles remain the same.
Double Entry Bookkeeping
Double entry bookkeeping is closely related to the accounting equation. In fact, it is double entry bookkeeping that makes the accounting equation always remain in balance.
Here's how it's done.
Remember learning algebra in school? Maybe, maybe not. Anyway, do you remember the rule that what you do on one side of an equation has to be done on the other side? Yes, no?
Well, that's all the 'double' in double entry accounting means. When you put an increase of x dollars on one side, you have to put an increase of x dollars on the other side as well- two entries. That's the rule. In the double entry bookkeeping system, there are at least two entries for every transaction.
Look again at the car example above. See that on one side there is $30,000 of car assets and on the other is a $20,000 car loan and $10,000 of equity? This transaction has three entries yet it still isn't very complex. In double entry bookkeeping all you do is look at what happened in a transaction and ensure that you make proper sense of it.
In the car example, you know what happened. A car was purchased for $30,000 dollars and a $20,000 loan was taken out to pay for it. The other $10,000 was paid by you. 30 = 20 + 10. Simple.
Double entry bookkeeping has some nuances that you can learn later, but those are the basics.
Now...
Learning these two concepts wasn't so hard was it?
Basic
knowledge of accounting and bookkeeping is something you should have. By making an effort to learn this stuff, other money, business, and finance related things will start to make a lot more sense. And that can only be beneficial to you.

Conclusion
Does the thought of keeping accounts scare you? Does your mind boggle at the mere thought of the records you need to keep? Are you worried the IRS will penalize you for not maintaining your accounts properly? Have no fear! We've charted a three step process that will simplify bookkeeping and accounting for your business. Follow these steps and you won't have to worry about it anymore.
There are two important reasons for maintaining financial records:
o To keep track of the business' income and expenses
o To collect the financial information necessary for filing tax returns
The activity of keeping books is a three step process. By following them, you can easily manage bookkeeping and accounting for your business:
1. Keeping bills and receipts - You must have a record for each and every business transaction that your company is involved in. These records should contain the amount, the date, and other details about that sale or purchase. While you need to store original cash bills in physical form, pretty much all businesses maintain a computerized system of accounts as well. Choose a system that fits your business needs.
2. Summarizing income and expenditure records - Maintain a summary of revenue and expenditure, organized by category and date. Enter it in a ledger,
preferably on a computer. The more sales you make, the more often you should post to your ledger. For example, a busy retail store may need to do this on a daily basis. A slower business with just a few large transactions per month, such as a day care center or dog-sitting service can do this weekly or even monthly. To simplify this process, you can use an accounting software program that will generate ledgers and other necessary financial reports from the basic information that you have entered. Whatever you choose, remember that the cornerstone of bookkeeping and accounting for your business is regularity and completeness.
3. Creating Financial Reports - Financial reports bring together key pieces of financial information about your business. The reports you will need to create regularly are a cash flow analysis, a profit and loss forecast and a balance sheet. This will give you a better understanding of where your business is headed and whether it is making the kind of profit that it is capable of. In short, these statements give you the big picture of your business - do you have adequate cash flowing through your company to pay bills on time, are you able to stick to your planned budget and do you need to revise your earnings estimate? At the end of the year, you will have a clearer understanding of your business' income-making potential and be able to plan ahead for the future.While there is no denying the importance of careful bookkeeping and accounting for your business, it need not be the stuff of nightmares.

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1 comment:

  1. Learn how to find missing figures in the Company cash flow statements and techniques of fixing the missing figures in Cash Flow Statement.

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