FINANCIAL ACCOUNTING FOR BUSINESS

BASIC THEORY

Meaning of Accounting
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’.

Economic Events
Business organizations involve 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. Examples of such
transactions:
• Sale of merchandise to the customers.
• Rendering services to the customers by ABC Limited.
• Purchase of materials from suppliers.
• 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.

Identification, Measurement, Recording, Classification and Communication

Identification : It means determining what transactions to record, i.e., to identify 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.

Measurement : It means quantification (including estimates) of business transactions into financial terms by using
monetary units, viz. rupees and paise 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.
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.

Classification : It involves separating transactions on the basis of some commonality and grouping them together
under certain heads for ease of use of the financial statements.

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.

Organization
Organization refers to a business enterprise, whether for profit or not-for-profit motive.

Interested Users of Accounting 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.
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.

External Users
● Investors and potential investors-information on the risks and return on investment;
● Unions and employee groups-information on the stability, profitability and distribution of wealth within the
business;
● Lenders and financial institutions-information on the creditworthiness of the company and its ability to
repay loans and pay interest;
● Suppliers and creditors-information on whether amounts owed will be repaid when due, and on the
continued existence of the business;
● Customers-information on the continued existence of the business and thus the probability of a continued
supply of products, parts and after sales service;
 ● Government and other regulators- information on the allocation of resources and the compliance to
regulations;
● Social responsibility groups, such as environmental groups-information on the impact on environment and
its protection;
● Competitors-information on the relative strengths and weaknesses of their competition and for comparative
and benchmarking purposes. Whereas the above categories of users share in the wealth of the company,
competitors require the information mainly for strategic purposes.
● Public-to know if the organization is making profits or losses and how that affects their community or
society

Internal Users
● Management-timely information on cost of sales, profitability, etc. for planning, controlling and
decision-making
● Employees-to know how the profits or losses affect their salaries and incentives

Sub disciplines in accounting

Financial accounting assists in keeping a systematic record of financial transactions,the preparation and presentation
of financial reports in order to arrive at a measure of organizational success and financial soundness. It relates to the
past period, serves the stewardship function and is monetary in nature. It is primarily concerned with the provision of
financial information to all stakeholders.

Cost accounting assists in analyzing the expenditure for ascertaining the cost of various products manufactured or
services rendered by the firm and fixation of prices thereof. It also helps in controlling the costs and providing
necessary costing information to management for decision-making.

Management accounting deals with the provision of necessary accounting information to people within the
organization to enable them in decision-making, planning and controlling business operations. Management
accounting draws the relevant information mainly from financial accounting and cost accounting which helps the
management in budgeting, assessing profitability, taking pricing decisions, capital expenditure decisions and so on.
Qualitative Characteristics of Accounting Information
Qualitative characteristics are the attributes of accounting information which tend to enhance its understandability
and usefulness.

Reliability
Reliability means the users must be able to depend on the information. The reliability of accounting information is
determined by the degree of correspondence between what the information conveys about the transactions or events
that have occurred, measured and displayed. A reliable information should be free from error and bias and faithfully
represent what it is meant to represent.

Relevance
To be relevant, information must be available in time, must help in prediction and feedback, and must influence the
decisions of users by :
(a) helping them form prediction about the outcomes of past, present or future events; and/or
(b) confirming or correcting their past evaluations.

Understandability
Understandability means decision-makers must interpret accounting information in the same sense as it is prepared
and conveyed to them. A message is said to be effectively communicated when it is interpreted by the receiver of the
message in the same sense in which the sender has sent.

Comparability
It is not sufficient that the financial information is relevant and reliable at a particular time, in a particular
circumstance or for a particular reporting entity. But it is equally important that the users of the general purpose
financial reports are able to compare various aspects of an entity over different time periods and with other entities.
To be comparable, accounting reports must belong to a common period and use a common unit of measurement and
format of reporting.

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.
Maintenance of Records of Business Transactions
Accounting is used for the maintenance of a systematic record of all financial transactions in books of accounts. A
proper and complete record 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.

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 organizations
(Assets) and claims against such resources (Liabilities) facilitates the preparation of a statement known as balance
sheet position statement.