Basics of Accountancy

BASICS OF ACCOUNTANCY

FINANCIAL ACCOUNTING

In accounting. the two terms namely: Accounting  and Financial Accounting are used interchangeably. But accounting is a tree while financial accounting is one of its branches. All accounting work in the beginning was in nature of financial accounting which was used to record business transactions for a certain period usually called accounting period. Then, these transactions were classified and summarized in the form of profit and loss account to calculate or found out profit or loss for the accounting period which is generally of one year. Financial accounting also helps to know the financial position of the business enterprise as on the last date of the accounting period in the form of assets possessed or owned by it and the liabilities owing to others. The statement showing the financial position is technically called the balance sheet.

ACCOUNTING AS AN INFORMATION SYSTEM

Accounting is often referred to as the language of business. The primary aim or purpose of a language is to serve as a means of communication. Accounting is used to communicate financial and other information to people, organisations, governments etc., about various aspects of business and non business enterprises. The accounting is therefore, also an information system. In today's society, many persons and agencies outside the management are involved in the economic life of an organisation. These persons frequently require financial or accounting information to make reasoned choices among alternatives uses of scarce or limited resources in the conduct of business and economic activities. For example shareholders must have financial information in order to measure management's performance and to evaluate their own investments. Potential investors need financial data in order to compare prospective investments. Creditors must consider the financial strength of the business before granting loans. Also labour unions, financial analysts and economists often expect a considerable amount of financial data. 

THE USERS OF ACCOUNTING INFORMATION

(i)Internal users:-They are directly involved in running and managing the business enterprise such as officers, and partners and owners or sole traders. They need accounting information for the efficient running of the business enterprise .Their needs are met from the use of income statement, balance sheet and cash-flow statement.

(ii)External users:- Persons, individuals or organisations, who have some present or future interest in the economic activities of the business enterprise are external users. They are not part of management team. They make use of published annual reports which contain income statement, balance sheet and cash flow statement. 

FUNCTIONS OF ACCOUNTING

Financial accounting performs the following major functions:-

(i)Maintaining systematic records:- Business transactions are properly recorded, classified under appropriate accounts and summarized into financial statements -income statement and the balance sheet.

(ii)Communicating the financial results:- Accounting is used to communicate financial information in respect of net profits, assets, financial liabilities etc., to the interested parties.
(iii)Meeting legal needs:- The provisions of various laws such as companies act, i.e., annual accounts, income tax returns, returns for sales tax purposes and so on. 
(iv)Protecting business assets:- Accounting maintains proper records of various assets and thus enables the management to exercise proper control over them with the help of following information regarding them: (a) How much is the balance of cash in hand and cash at bank? (b) What is the position of inventories? (c) How much money is owed by the customers? (d) What is the position of various fixed assets and how these are being used? (e) How much money is owing to the creditors? 
(v)Accounting assists the management in the task of planning, control, and coordination of business activities
(vi)Stewardship or trusteeship:- In the case of limited companies, the management is entrusted with the resources of the enterprise. The mangers are expected to act true trustees of the funds and the accounting helps them to achieve the same.
(vi)Fixing responsibility:- Accounting helps in the computation or calculations of the profits of different departments of an enterprise. This would help in fixing the responsibility of each departmental head

ADVANTAGES OF ACCOUNTING

(i)Maintenance of records rather than memory:- All business transactions are systematically recorded in various books of accounts. It is not possible to do any kind of business by just remembering the transactions which have grown in size and have become complex and difficult. Human memory is limited by its very nature. Hence business transactions must be recorded early in the books of accounts., so that necessary information about them is available in time and free from bias. 

(ii)Preparation of financial statements:- When business transactions are maintained in a proper manner, it becomes possible to prepare two basic financial statements, namely:-(a) The income statement to ascertain the profit or loss for an accounting period. (b) The balance sheet to ascertain the financial position of the business as on the last date of the accounting period, that is, the position of assets, liabilities and owner's capital on the date.

(iii)Comparison of results:- A properly recorded accounting information is very helpful to compare the profit amount and financial position of one year with those of previous years. It is called intra-firm comparison

(iv)Assistance to management:- The accounting information helps the management to plan its future activities by preparing budgets in respect of sales, production, expenses, cash,etc. Accounting helps in coordination of various activities in different departments by providing financial details of each department. 

(v)As legal evidence:- Systematically recorded accounting information provides documentary evidence in a court of law for disputes regarding the amount owing to the creditors and recovery of money from debtors. 

(vi)Raising loans:- Accounting is of great help to lenders who want to give loans to any business enterprise.

LIMITATIONS OF ACCOUNTING

(i)No recording of non- monetary transactions:- Financial accounting records only those transactions which are expressed or measured in money only. It means there is no place for non-monetary transactions though these events are important for the efficient or smooth running of the business enterprise.

(ii)No information about the present value of the business:- Assets are recorded on the basis of cost concept. It means, for recording purpose, original cost is the basis for the new assets and book-value for the used assets.

(iii)Window dressing:- Sometimes the accountant may resort to 'window dressing' in the balance sheet by showing items like debtors or stock without providing provision for doubtful debts and obsolescence. In such a case balance sheet cannot give true and fair view of the financial position of the business enterprise. 

(iv)Unrealistic accounting information:- Accounting information may not be realistic even when financial statements are prepared on the basis of basic accounting concepts and conventions. 
(v)Lack of consistency:- Accountants have to follow certain generally accepted accounting principles for recording the business transactions. If these principles are not followed year after year, the accounting information may become inconsistent.

BASES OF ACCOUNTING

Cash basis of accounting

Under this basis, income is calculated on the basis of cash transactions only while the credit transactions are ignored. Similarly expenses are recorded only when they are paid in cash. So the income or profit is the excess of cash receipts in respect of sale of goods, services and other income resulting from sale of properties in cash over actual cash payments in respect of purchase of goods, properties and expenses say, on rent, salaries, stationary, electricity, etc.

ADVANTAGES:-

(i) This basis is simple to use and does not require technical knowledge of accountancy. 

(ii) There is no scope for estimates or personal judgement because cash transactions are recorded only when actual cash is received or paid. 

(iii) This basis is suitable for business firms having most of the transactions in cash.

DISADVANTAGES:-

(i) Cash basis does not give a true and fair view of profit and loss and the financial position of the business enterprise. The reason is that it does not take into consideration outstanding expenses, prepaid expenses, unearned income and income received in advance which may play more important role in some cases in the calculation of actual profit and loss.

(ii) There is no scope for matching principle because the purchase of fixed asset is treated as complete expense in the year of purchase rather than the periods which benefit from the use of fixed assets.

(iii) There is enough possibility of manipulating the profit figure. It may either by delaying payments or making payments earlier than the due date. Similarly receipts or income may be postponed or collected early. 

(iv) As capital and revenue items are treated at par , there is no consistency in the profit or loss figure of different accounting periods. 

(v) Cash basis of accounting is not recognized by the Companies Act.

Accrual basis of accounting:-

Under accrual basis of accounting, only revenue items are taken into account for income determination and capital expenditures are ignored. Income revenue is recognized when it is earned and not when the money is received actually later on. Similarly expenses are recognized when due or incurred and not when actual payments are made for them