FINANCIAL

ACCOUNTING.
Contact hr -4

TARGET GROUP:
BUSINESS
MANAGEMENT.
 CHAPTER-ONE
Overview of Financial Accounting .
What Is Financial Accounting?
Financial accounting is a specific branch of
accounting involving a process of recording,
summarizing, and reporting the quantifiable
transactions resulting from business operations over
a period of time.
These transactions are summarized in the
preparation of financial statements including the
balance sheet, income statement, and cash flow
statement that record a company’s operating
performance over a specified period.
Financial accounting is the framework that dictates
the rules, processes, and standards for financial
 Cnt..
• Non-profits, corporations, and small
businesses use financial accountants to
prepare their books and records and
generate their financial reports.
• Financial reporting occurs through the use of
financial statements, such as the balance
sheet, income statement, statement of cash
flow, and statement of changes in
shareholder equity.
• Financial accounting differs from managerial
accounting, as financial reporting is for
reporting to external parties, while
managerial accounting is for internal
 Cont…
• Financial accounting may be performed under the
accrual method (recording expenses for items that
have not yet been paid) or the cash method (only
cash transactions are recorded).
• Financial accounting utilizes a series of established
principles. Which accounting principles are used
depends on the regulatory and reporting
requirements of the business.
• It is a primary responsibility of a registered
company to review the performances, progress and
needs for improvement of the firm over a financial
year.
• Financial Accounting is the process of documenting,
analyzing and reporting every transaction of a
business or an organization, in order to assess the
 Cont’…
• There are a set of guidelines to be followed
according to the Financial Accounting
Standards Board (FASB), US/IFRS( IASB).
• The records of the transactions are done using
the Double-entry method where an amount is
entered twice as credit and debit
Financial Vs Management Accounting
 Managerial accounting is the one done in the
view of notifying the managers, directors and
authorities of an organization regarding the
everyday operations, present and future trends
in the market, assumptions and plans to be
made for the future. The audience is internal.
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• However, financial accounting is a
documentation of every transaction for the
audience outside the organization as well like
competitors, investor and bankers.
• It has strict guidelines to be followed according
to US GAAP/ IFRS whereas managerial
accounting has no mandatory guidelines.
Importance of Financial Accounting
 Financial accounting is important to track and
analyze performances and transactions of a
business over a period of time.
 It is used to compare reports so that
stakeholders and investors can decipher and
use the data to make better decisions in the
future.
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• It provides clarity in internal and external
communication regarding the sources and
destinations of finances in the company.
• Financial accounting is the process of preparing
financial statements that companies’ use to
show their financial performance and position
to people outside the company, Including
investors, creditors, suppliers, and customers.
• This is one of the most important distinctions
from managerial accounting, which by contrast,
involves preparing detailed reports and
forecasts for managers inside the company.
• In a business, every transaction affects at least
two accounts. The double-entry accounting
format records both effects of a transaction.
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Conceptual Framework for Financial
Reporting
 Conceptual Framework establishes the
concepts that underlie financial reporting.
Need for a Conceptual Framework
 Rule-making should build on and relate to an
established body of concepts.
 Enables IASB to issue more useful and
consistent pronouncements over time.
Overview of the Conceptual
Framework
 Three levels: First Level = Objectives of
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• Second Level = Qualitative
Characteristics and Elements of Financial
Statements
• Third Level = Recognition, Measurement,
and Disclosure Concepts
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Basic Objective of Financial Accounting.
 To provide financial information about the
reporting entity that is useful to present
and potential equity investors, lenders, and
other creditors in making decisions about
providing resources to the entity.
 Provided by issuing general-purpose
financial statements.
 Assumption is that users need reasonable
knowledge of business and financial
accounting matters to understand the
information.
Qualitative Characteristics of
Accounting Information.
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 Qualitative Characteristics of Accounting
Information.
• IASB identified the Fundamental Qualitative
Characteristics of accounting information
that distinguish better (more useful)
information from inferior (less useful)
information for decision-making purposes.
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Qualitative Characteristics.
 Fundamental Quality—
Relevance

To be relevant, accounting information

must be capable of making a difference in
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Financial information has predictive value if it

has value as an input to predictive processes
used by investors to form their own expectations
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Relevant information also helps users

confirm or correct prior expectations.
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Information is material if omitting it or

misstating it could influence decisions that
users make on the basis of the reported
financial information.
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Fundamental Quality—Faithful
Representation.

Faithful representation means that the

numbers and descriptions match what
really existed or happened.
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Completeness means that all the

information that is necessary for faithful
representation is provided.
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Neutrality means that a company cannot

select information to favor one set of
interested parties over another.
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An information item that is free from

error will be a more accurate (faithful)
representation of a financial item.
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Enhancing Qualities

Information that is measured and

reported in a similar manner for different
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Verifiability occurs when independent

measurers, using the same methods,
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Timeliness means having information

available to decision-makers before it loses
its capacity to influence decisions.
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Understandability is the quality of

information that lets reasonably
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Assumptions in Financial
Reporting
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Principles in Financial Reporting
MEASUREMENT PRINCIPLES
 IFRS generally uses one of two measurement
principles, the historical cost principle or the fair
value principle.
 Selection of which principle to follow generally
relates to trade-offs between relevance and
faithful representation.
1. HISTORICAL COST PRINCIPLE
 The historical cost principle (or cost principle,
dictates that companies record assets at their
cost. This is true not only at the time the asset is
purchased but also over the time the asset is
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2.FAIR VALUE PRINCIPLE- The fair value principle
indicates that assets and liabilities should be
reported at fair value (the price received to sell an
asset or settle a liability).
Fair value information may be more useful than
historical cost for certain types of assets and
liabilities.
For example, certain investment securities are
reported at fair value because market price
information is often readily available for these types
of assets.
In choosing between cost and fair value, two
qualities that make accounting information useful
for decision-making are used—relevance and
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• In determining which measurement principle to
use, the factual nature of cost figures are
weighed versus the relevance of fair value.
• In general, most assets follow the historical cost
principle because market values are
representationally faithful.
• Only in situations where assets are actively
traded, such as investment securities, is the fair
value principle applied.
REVENUE RECOGNITION PRINCIPLE
• The revenue recognition principle requires that
companies recognize revenue in the accounting
period in which the performance obligation is
satisfied.
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• In a service company, revenue is recognized
at the time the service is performed.
• In a merchandising company, the
performance obligation is generally satisfied
when the goods transfer from the seller to
the buyer . At this point, the sales transaction
is complete and the sales price established.
EXPENSE RECOGNITION PRINCIPLE
• The expense recognition principle (often
referred to as the matching principle,
dictates that efforts (expenses) be matched
with results (revenues). Thus, expenses
follow revenues.
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FULL DISCLOSURE PRINCIPLE
• The full disclosure principle requires that
companies disclose all circumstances and
events that would make a difference to
financial statement users.
• If an important item cannot reasonably be
reported directly in one of the four types of
financial statements, then it should be
discussed in notes that accompany the
statements.
Cost Constraint.
 The cost constraint relates to the fact
that providing information is costly.
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• In deciding whether companies should be
required to provide a certain type of
information, accounting standard-setters
weigh the cost that companies will incur
to provide the information against the
benefit that financial statement users will
gain from having the information
available.
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Basic Elements of Financial
Statements.
The elements of the financial statements will
be assets, liabilities, net assets/equity,
revenues and expenses.
Asset- A resource controlled by the entity as a
result of past events and from which future
economic benefits are expected to flow to the
entity.
Liability-A present obligation of the entity
arising from past events, the settlement of
which is expected to result in an outflow
from the entity of resources embodying
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Equity-The residual interest in the assets of
the entity after deducting all its liabilities.
Income-Increases in economic benefits during
the accounting period in the form of inflows or
enhancements of assets or decreases of
liabilities that result in increases in equity,
other than those relating to contributions from
equity participants.
Expenses-Decreases in economic benefits
during the accounting period in the form of
outflows or depletions of assets or incurrences
of liabilities that result in decreases in equity,
other than those relating to distributions to
equity participants.
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Recognition, Measurement, and Disclosure
Concepts.
 These concepts explain how companies should
recognize, measure, and report financial elements
and events.

ASSUMPTIONS
Constraints

Cost
 Economic entity
 Going concern
 Monetary unit
 Periodicity
 Accrual
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Assumptions.
1. Economic Entity – company keeps its
activity separate from its owners and other
business unit.
2.Going Concern - company to last long
enough to fulfill objectives and commitments.
3. Monetary Unit - money is the common
denominator.
4. Periodicity - company can divide its
economic activities into time periods.
5. Accrual Basis of Accounting –
transactions are recorded in the periods in
which the events occur.
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Basic Principles of Accounting
 Measurement Principles
 Historical Cost- is generally thought to be
a faithful representation of the amount paid
for a given item.
 Fair value- is defined as “the price that
would be received to sell an asset or paid to
transfer a liability in an orderly transaction
between market participants at the
measurement date.”
 IASB has given companies the option to
use fair value as the basis for measurement
of financial assets and financial liabilities.
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Revenue Recognition Principle
 When a company agrees to perform a
service or sell a product to a customer, it
has a performance obligation.
 Requires that companies recognize
revenue in the accounting period in which
the performance obligation is satisfied.
 Expense Recognition - Outflows or
“using up” of assets or incurring of
liabilities during a period as a result of
delivering or producing goods and/or
rendering services.
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 Expense Recognition Procedures for
Product and Period Costs.
Full Disclosure Principle
 Providing information that is of sufficient
importance to influence the judgment
and decisions of an informed user.
Provided through:
 Financial Statements
 Notes to the Financial Statements
 Supplementary information
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Summary of the Structure

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Di-recognition
 Recognition is the process of incorporating in
the balance sheet or income statement an
item that meets the definition of an element
and satisfies the criteria for recognition set
out in.
 Revenue recognition is an aspect of accrual
accounting that stipulates when and how
businesses “recognize” or record their
revenue.
 The principle requires that businesses
recognize revenue when it's earned (accrual
accounting) rather than when payment is
 Con…
 Asset recognition principle, Liability
recognition principle , Income recognition
principle, Expense recognition principle.
 They describe the conditions required
for the recognition of assets, liabilities,
income, and expenses in the financial
statements.
 In financial accounting, discontinued
operations refer to parts of a company's
core business or product line that have
been divested or shut down, and which
are reported separately from continuing
operations on the income statement.
 Con…
 Di-recognition is the removal of all or
part of an asset or liability from the
statement of financial position.
 A company di-recognizes a financial
asset when the contractual rights to the
cash flows from the financial asset have
expired, or it transfers the financial asset
such that it qualifies for di-recognition.
 Exercises
1.The objective of general purpose financial
reporting as described in the Conceptual
Framework is to:
A. Provide information to regulators
B. Support the entity's tax return
C. Meet the information needs of an
entity's stakeholders.
D. Provide financial information about the
reporting entity that is useful to existing
and potential investors, lenders and other
creditors in making decisions relating to
providing resources to the entity.
 Exercise
2. Which of the following does the Conceptual
Framework identify as the primary users of general
purpose financial reports?
A. Employees, investors and trade union
representatives
B. Existing and potential investors, lenders and
other creditors
C. Lenders and other creditors and customers
D. Existing and potential investors, government
agencies and the general public
3. The fundamental qualitative characteristics of
useful financial information are:
A. Comparability and relevance
B. Relevance and reliability
 Exercise
C. Relevance, reliability and comparability
D. Relevance and faithful representation
E. Comparability, relevance and faithful
representation
4. For information to be relevant, it has to
possess:
A. Only predictive value
B. Only confirmative value
C. Both predictive and confirmatory value
D. Either predictive or confirmatory value,
or bot
 Exercise
5. The residual interest in the assets of an entity
after deducting all its liabilities is:
A. Income B. Profit or loss
C. Equity D. Other comprehensive income
6. The Conceptual Framework defines an asset
as:
A. resource controlled by the entity as a result of past
events and from which future economic benefits are
expected to flow to the entity
B. A present economic resource controlled by the entity
as a result of past events
C. A right to receive income or reduce expenses in the
future
D. None of the above
 Exercise
7. What does the Conceptual Framework say
about profit or loss?
A. The statement of profit or loss is the only
source of information about an entity’s
financial performance for the period
B. In principle, all income and expenses are
included in the statement of profit or loss
C. All income and expenses included in
profit or loss arise from ordinary activities of
the entity
D. All of the above
E. None of the above
 Exercise
8.The purpose of the Conceptual Framework
is:
A. To assist the International Accounting
Standards Board to develop IFRS Standards.
B. To assist preparers of IFRS financial
statements to develop consistent accounting
policies when no IFRS Standard applies to a
particular transaction or other event, or when
a Standard allows a choice of accounting
policy.
C. To assist all parties to understand and
interpret IFRS Standards.
D. All of the above
 Exercise
9. It is the process of capturing for inclusion in the
financial statements an item that meets the
definition of the elements.
A. Recognition B. Measurement.
C. Classifying D. Recognition
10.An item is recognized in the financial statements
if
A .It is probable that economic benefits will flow to
or from the entity.
B .It meets the definition of an asset, liability,
equity, income and expense.
C .The entity has ownership of such item.
D .It is probable that economic benefits will flow to
or from the entity and that the cost can be
 Exercise
11.A primary objective of financial reporting is to
A .Assist investors in analyzing the economy.
B. Assist suppliers in determining an appropriate
discount to offer a particular company.
C .Assist investors in predicting prospective cash flows.
D .Assist banks to determine an appropriate interest rate
for their commercial loans.
12. Financial accounting is concerned with
A. General purpose reports on financial position and
results of operations.
B. Specialized reports for inventory management and
control
C. Specialized reports for income tax computation and
recognition.
D. General purpose reports on changes in stock prices
 Exercise
13.Financial accounting can be broadly defined as the
area of accounting that prepares
A) General purpose financial statements to be used by
parties internal to the business enterprise only.
B) Financial statements to be used by investor only.
C) General purpose financial statements to be used by
parties both internal and external to the business
enterprise.
D) Financial statements to be used primarily by
management.
14) In the framework for the Preparation and
Presentation of Financial Statements, which of the
following is an ingredient of reliability
A) Predictive value C) Materiality
B) Understandability D) Verifiability
 Exercise
15) If accounting information is timely and has
predictive and feedback value, then it can be
characterized as
A) Verifiable. C) Reliable
B) Relevant D) Qualitative
16) The accounting assumption that a business
enterprise will not be sold or liquidated in the near
future is known as the
A) Economic entity assumption C) Conservatism
assumption
B) Monetary unit assumption D) Going concern
assumption
17) The Initial measurement basis most commonly adopted by
entities in preparing their financial statements is
A) Historical cost C) Realizable value
B) Current cost D) Present value
 Exercise
18. The matching concept
A) Requires that a debit is matched or posted for every
credit.
B) Is the name applied to the process of associating
expenses with revenues.
C) Treats all costs as being directly related to revenue
generation.
D) Treats all costs as expenses
19. Which of the following is not a characteristic of an
asset?
A) It is expected to provide future economic benefits.
B) It is a resource controlled by the entity.
C) It causes an outflow of economic benefits when it is
settled.
D) It has resulted from a past event
 Exercise
20. Which of the following assumptions means
that money is the common denominator of
economic activity and provides an appropriate
basis for accounting measurement and analysis?
A) Going concern C) Stable monetary
unit
B) Periodicity D) Economic entity
21. A branch of accounting that focuses on
catering to the information needs of internal
users
A)Management accounting C) Auditing
B)Financial accounting D) External
accounting
 Exercise
22) Which of the following best describes
the basic purpose of accounting?
A) To provide information about a reporting
entity that is useful in making economic
decisions.
B) To provide all the information needed by
management in managing the operations
of a reporting entity.
C) To provide information that the creditors
can use in deciding whether to make
additional loans.
D) To provide accountants something to do
END OF

CHAPTER ONE