Financial

Accounting for

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Management
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Third EdiTion
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PARESH SHAH
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Consultant
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 3
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 Forewords

It gives me great pleasure to write this foreword as I have the privilege of knowing Dr Paresh Shah, for more than three decades
now. Our association started as co-students of doctoral programme under Professor I. M. Pandey of IIM, Ahmedabad. Later
on it has continued as professional colleagues in academia.
I feel glad to learn that his book entitled Financial Accounting for Management—a third edition—is forthcoming which itself
is an attestation of the quality and acceptance of the two previous editions. We use his books for teaching accounting courses at
G. H. Patel Post Graduate Institute of Management, Sardar Patel University, Gujarat since the 1st edition published in 2007.

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Financial Accounting for Management, 2nd edition was a fantastic outcome covering the complexity of accounting involved

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by removing the complexity from the mind of students and readers at large. He has developed an innovative approach in
discussing the core concepts of accounting in a learner friendly mode.

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In this third edition, I understand that he has enriched further, based on his feedback from teaching and conducting the
workshops at a number of management development programmes, faculty development programmes, and regular management
courses during this period.
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Readers of financial reports often get nervous about understanding the concepts such as revenue recognition, measurement,
and recording of economical events that take place within a firm and with outsiders. Strangely, such references almost invariably
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describe the profit of the firm.
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Once the sensitivity of profit and profitability is appreciated, it is clear that a managerial decision policy is needed to
understand the impact of recording of economical events, in turn its recording as an accounting event, and presentation in
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financial statements. Paresh has approached this key issue, by considering non-commercial and commercial background of
participants. His approach has been that of detailed reasoning and straightforward through the application of an accounting
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equation rather than using complication of Debit and Credit treatment.

Paresh’s book is being published at the right time as I have a feeling that there is really no better book for non-commerical
background as well as commercial students. He has made an attempt to explain and elaborate the financial accounting in
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simple language without going through the technical processes and jargons.
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All those who work for competitive advantage realize the need for informed managerial decisions and therefore will welcome
this contribution by Paresh.
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Wishing all the best for this edition, and I expect this edition too will succeed as the second edition.
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With best wishes,

Prof. (Dr) P.K. Priyan

Professor (Finance)
G.H. Patel Post Graduate Institute of Business Management
MBA Department
Sardar Patel University, Vallabh Vidyanagar
Gujarat

It is indeed a pleasure to write the foreword for the books authored by Prof. (Dr) Paresh Shah, which are referred in various
courses taught at PDPU and at EDII.
Financial Accounting as a subject faced a key issue, especially for non-commercial and commercial based students and
that is to understand the complication of accounting procedures. Dr Shah made detailed reasoning to answer the question

© Oxford University Press. All rights reserved.

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 FOREWORDS  v

‘Why?’ This has been converted into modern approach of accounting through the first two editions of Financial Accounting
for Management, which makes the participants understand the recognition, measurement, and recording of economic events
without going into the complication of Debit and Credit, through the application of accounting equation.
This edition of the book is enriched due to his rich teaching experience and also as an outcome of conducting workshops,
number of management development programmes, faculty development programmes, and regular management courses.
Dr Shah’s third edition of the book is relevant in the present time as I believe there is really no good book for students in this
subject at national and international levels. This book explains financial accounting in a simple language without going through
the technical processes and jargons and makes the subject understandable and application oriented.
Dr Shah’s other books on Financial Management and Management Accounting are also well conceptualized and blended
with caselets and cases covering practical applications. Management Accounting by Dr Shah is a text and reference book
for the subject of Principles of Finance and Costing at PDPU.
All those who desire to work with the competitive advantage have realized the need for informed managerial decisions and
will welcome this contribution to academia.

Wishing all the best for this edition,

With best wishes,

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Prof. (Dr) D.M. Parikh
Professor and Dean, FoET

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Pandit Deendayal Petroleum University, Gandhinagar
Gujarat

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It gives me great pleasure to write this foreword as I have the privilege of knowing Dr Paresh Shah over a decade as he has been
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associated with us as faculty member of our postgraduate management programme and Master of Business Administration
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programme.
Som-Lalit, a name which has been synonymous in the area of management education in the state of Gujarat for more than
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two decades, has imbibed a philosophy of research, creativity, innovation, and empathy in its institute resulting in unlocking
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the potential of the students and faculty members of the institute.

As educators, our focus has been on grooming the students towards holistic development by providing learning based on
knowledge dissemination through practical understanding of current socio-economic-financial-technological developments
and advancements. To achieve our academic excellence level, we use the world’s best academic books. In this endeavour, we
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have adopted the books authored by Dr Paresh Shah, Financial Accounting for Management (Manac-I) and Management
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Accounting (Manac-II), published by Oxford University Press. We also use two other books authored by him—Financial
Management and Forex Management.
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Being an educationalist for over three decades, I would like to share some of my thoughts from my own perspective
and also based on reactions of the student and reader community at large. The books authored by him are being highly
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appreciated by the student community in addition to the teaching faculty in the institutions of SLERF. The books provide
in­depth knowledge in simple and lucid language, and free from complicated arithmetical formulas, etc.
My final words: Use of books authored by Dr Paresh Shah will bring enlightenment in understanding and using the
language of business and it will surely bring the prosperity of knowledge, and in turn wealth to all readers and students.
Again, I extend commendation to Paresh for making his talent available in preparing manuscripts on highly complex and
technical subjects.

With Best Wishes,

Pragnesh K. Shastri
Managing Trustee
Som-Lalit Education and Research Foundation, Ahmedabad
Gujarat

© Oxford University Press. All rights reserved.

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 Preface to the Third Edition

Financial accounting is an integral part of the study of from published annual reports of several corporates, to
accountancy. The scope of accounting encompasses not only provide better insights into practices adopted in financial
recording of financial transactions of companies but also accounting.
information that facilitates decision-making. This in turn
inspired business schools across the world to include separate Key Features

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courses on financial accounting. It has been acknowledged ∑ Uses modern approach of accounting throughout the

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by academicians and professionals alike that the worth of book (except for indicating debit and credit terms as per
financial accounting has only increased over the years and is traditional approach)

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expected to never lose its importance. ∑ Focuses on the concepts, principles, and practices that
facilitate the development of accounting skills for effective
About the Book
decision-making
An attempt has been made to make the third edition of
Financial Accounting for Management the most interesting,
relevant, and comprehensible financial accounting text
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∑ Provides objective type questions, numerical solved
illustrations, and self-evaluation exercises
∑ Contains conceptual and business application cases at
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available in the market. The objective of the current edition
the end of the chapters
of the book is to prepare readers, students, and participants
∑ Focuses on the latest development in the Indian taxation
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of management development programmes to succeed as future

business or non-business managers and/or entrepreneurs. This system and its impact, like GST and Indian income tax
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book introduces the concepts in a lucid way and is developed provisions

with an intention to enhance the analytical capability of the
readers.
New to the Third Edition
∑ New chapter on Modern Approach of Accounting
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Readers cannot understand financial statements in

isolation. They must look at them in the context of a firm’s ∑ Full-fledged chapter on Regulatory Framework on
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environment. I have learnt through experience that the Accounting and Reporting
way to teach financial accounting is to keep reinforcing the ∑ Discussions on IFRS norms, Indian Accounting
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business relevance of accounting. This can be done by teaching Standards (Ind AS), deferred tax assets and deferred tax
examples from real-life situations and/or companies. As in
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liabilities, GST accounting

the previous editions, every attempt has been made to build ∑ Revised and updated content in existing chapters
each chapter around the most recent cases and events from ∑ Specific discussion on goodwill valuation
real-life Indian companies.
In the latest edition of the book, accounting procedures Coverage and Structure
such as transaction analysis, journalizing, and posting The book is divided into five parts, comprising 20 chapters.
are given due consideration wherever appropriate, by
considering state-of-the-art technology combined with Part I: Fundamentals of Accounting
the modern approach of accounting. Readers can develop The first part starts with an introduction to accounting and
a better understanding of the economic consequences of a deals with different kinds of economic resources and claims
firm’s transactions by summarizing those transactions into in Chapter 1. This chapter further explains the cyclical nature
journal entries and columnar accounts format, instead of of business activities, in addition to the importance of ethics
the traditional T-accounts format. Effort has been made to in accounting. Chapter 2 provides the fundamentals of
include the latest guidelines on IFRS, Ind AS, Ministry of understanding the modern approach of accounting, in addition
Corporate Affairs, ICAI, etc. for presentation of financial to the traditional approach of accounting. The important
statements, in addition to GST accounting. accounting concepts, their vertical presentation from
Most of the original chapters have been realigned, management and legal points of view, and utility of balance
revised, and updated. This edition also contains extracts sheet are covered in detail in Chapter 3. Chapter 4 deals with

© Oxford University Press. All rights reserved.

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 PREFACE TO THE THIRD EDITION  vii

a detailed analysis of income statement in the vertical format. foreign branch accounting in Chapter 18. It also discusses
It also discusses the cash conversion cycle. the different ways of quotations of foreign exchange rates,
hedging transactions, and treatment of exchange differences.
Part II: Recognition and Types of Transactions Chapter 19 deals with the legal and regulatory aspects of
This part starts with Chapter 5 that introduces the readers to accounting. Topics such as IFRS, Ind AS, and GAAP are
the concept of objectively verifiable evidence, in addition to the explained in this chapter. Chapter 20, the last chapter of the
concepts of receipt and capital maintenance. It also explains the book, is about contemporary accounting concepts such as
modus operandi of electronic banking. Chapter 6 is dedicated inflation accounting, human resource accounting, and forensic
to revenue and expense recognition and its measurements in accounting.
addition to relationship between assets and expenses. Chapter 7
takes the readers through the concept of analysing transactions Acknowledgements
wherein it explains topics such as journal proper, fundamentals I would first like to thank members of FCA, ACMA, MIMA
of accounting as per modern approach of accounting, errors in (practicing chartered accountants) for their comments on the
accounting, and suspense account. topics of GST accounting, deferred tax assets, and deferred
Chapter 8 discusses the concept of non-current assets and tax liabilities accounting, in addition to the legal aspects of
their writing off values over a period of time based on time accounting and reporting.
phenomenon, capacity phenomenon, and funds management I would like to provide my gratitude to the following

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phenomenon. Additionally, different goodwill valuation individuals for the valuable comments and remarks in

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methods are covered in this chapter. The management of their respective forewords: Prof. (Dr) P.K. Priyan, MBA
current assets in the form of cash balance, bank balance, and Department, Sardar Patel University, Vallabh Vidyanagar,

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their different types are discussed in Chapter 9. Chapter 10 is Gujarat; Prof. (Dr) D.M. Parikh, Pandit Deendayal
on receivables and inventory valuation, and discusses topics Petroleum University, Gandhinagar, Gujarat; and Pragnesh
such as accounting of uncollectible receivables, receivable K. Shastri, Som-Lalit Education and Research Foundation,
and inventory measurement, controlling of inventories,
costing of inventories, and valuation of stock and its
impact on financial statements. A critical discussion and
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Ahmedabad.
I would also like to thank Dr Somen Saha, Indian Institute
of Public Health, Gandhinagar (IIPHG); Dr Srinivas
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accounting treatments related to capital and liabilities and Deshpande, Principal, Gadag Institute of Medical Sciences,
its presentations in  financial statements of corporates are Karnataka; Prof. (Dr) Janardhan Pawar, Principal and
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discussed in Chapter 11. Professor, Tuljaram Chaturchand College of Arts, Science

and Commerce, Baramati, Maharashtra; Prof. (Dr) Rakesh
Part III: Financial Statements
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Patil, Dean, Professor and Head (MBA), Sandip Institute

Part III starts with Chapter 12 that deals with the need of
of Technology and Research Centre, Nashik, Maharashtra;
bank reconciliation statements and their preparation as part
Prof. (Dr) Rajesh Rathore, Professor and Dean, Faculty
of internal control management, and identification of causes
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of Commerce and Management, Madhav University,

of differences in the balance as per the firm’s record as against
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Abu Road, Rajasthan; and Prof. Vivek A. Bale, Assistant

the banker’s record. Chapter 13 deals with the different types of
Professor, Tuljaram Chaturchand College of Arts, Science
entries used in preparing financial statements, and the concept
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and Commerce, Baramati, Maharashtra.

of worksheet and its utility. It also elaborates upon GST
Without the blessings of Saraswati Mataji, Sadguru P.P.
accounting and its impact. Chapter 14 discusses accounting
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Panyaspravar Shree Vinitchandravijayji Ganivarya Maharaj,

from incomplete records. The modus operandi to find out and my (late) mother Lilavatiben, it would not have been
missing figures are covered in this chapter. possible for me to write this third edition of the book.
Part IV: Analytical Accounting I am immensely grateful to my best friend and wife,
This part begins with Chapter 15 discussing the concepts Trupti, for her selfless sacrifice and unstinted support, and
of average due date, account current, and negotiable the significant suggestions and views she provided from
instruments. Bills of exchange and promissory notes are time to time. I am also extremely thankful to my son, Fenil,
explained in this chapter. The analytical aspects of financial daughter-in-law, Roma, and my grandchildren for supporting
statements, such as common size statements, comparative me in my endeavour. I lack words to express my deep sense of
financial statements, and financial ratio analysis are covered sincere gratefulness and indebtedness to my esteemed guru,
in Chapter 16. Chapter 17 discusses the concept of cash flow Prof. (Dr) I.M. Pandey, Professor of Finance, and Ex-Dean of
statement for manufacturing firms and financial enterprises. Indian Institute of Management, Ahmedabad, for his profuse
It also explains both the methods of preparation of cash flow and perpetual praise and pep, and constant motivation and
statements. encouragement to me towards becoming a moulded researcher
and teacher of management.
Part V: Special Topics I deeply appreciate the painstaking efforts of the editorial
The last part begins by explaining foreign exchange team at Oxford University Press, India, who have played a
accounting for import–export transactions in addition to pivotal role in making the book more reader-friendly.

© Oxford University Press. All rights reserved.

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 viii  PREFACE TO THE THIRD EDITION

While using information from a number of books and the book. You can send your feedback at my email IDs
research publications, certain errors and omissions may profpareshshah@[Link] and paresh@[Link].
have crept in. I would be happy to receive your comments,
suggestions, and feedback for the further improvement of
Paresh Shah

The publisher and the author would like to thank the following reviewers for their valuable feedback:
• Prof. Pinky Agarwal, ITM Group of Institutions, Kharghar, Maharashtra
• Prof. Geetanjali (Renold) Pinto, ITM Group of Institutions, Kharghar, Maharashtra
• Dr Anju Motwani, N.L. Dalmia Institute of Management Studies and Research, Mumbai, Maharashtra

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• Prof. Khushboo Vora, N.L. Dalmia Institute of Management Studies and Research, Mumbai, Maharashtra

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• Dr Nitin Gupta, Lovely Professional University, Jalandhar, Punjab

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Praise for the Previous Editions

Financial Accounting for Management is an excellent book, balancing accounting mechanics, concepts, and practices with
sufficient coverage of accounting standards and regulatory framework. It is an indispensable book for serious management
students.
– Prof. (Dr) P.K. Priyan, Corporation Bank Chair, Sardar Patel University

© Oxford University Press. All rights reserved.

Prelims_F.indd 8 15-Apr-19 11:26:13 AM

 Contents

Forewords iv
Preface to the Third Edition  vi

PART I  FUNDAMENTALS OF ACCOUNTING

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1. Introduction to Accounting 2 2. Modern Approach of Accounting 17
Introduction 2 Introduction 17

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Forms of Business Organization 3 Modern Approach of Accounting 18
Bookkeeping 4 Accounting Events and Transactions 19
Bookkeeping, Accounting, and Accountancy 4
Functions of Accounting 4
Objectives of Accounting 4
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Personal Accounts and Impersonal Accounts 20
Traditional Approach of Accounting 20
Relationship between Books of Original Entry and
Users of Accounting Information 5 Ledger 22
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Limitations of Accounting 5 The Account 22
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Kinds of Accounting Activities 5 3. Balance Sheet 34

Cyclical Nature of Business 6
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Introduction 34
Economic Resources and Claims 6
Accounting Concepts 34
Basic Terminology 7
Balance Sheet 36
Accounting Methods 9
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Marshalling of a Balance Sheet 38

Basic Documents and Records 9
Statement of Changes in Owners’ Equity 40
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Relationship of Accounting with Other Disciplines 9

Role and Activities of an Accountant 10 4. Income Statement 53
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Accounting Personnel 11 Introduction 53

Cash Conversion Cycle/Operating Cycle 54
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Nature of Accounting Function 12

Accounting Standards 12 Accounting Concepts 54
Accounting Standards and Development 13 Other Classifications 58
Organizational Structure of Accounting and Finance Contents of Income Statement 58
Department 13 Presentation of Income Statements 59
Ethics in Accounting and Corporate Relationship between Balance Sheet and Income
Governance 14 Statement 61

PART II  RECOGNITION AND TYPES OF TRANSACTIONS

5. Objectively Verifiable Evidence 74 Business Transactions through Electronic Banking 78

Introduction 74 Debit Note 79
Capital Maintenance 75 Credit Note 79
Receipt 75 Custody of Receipt Books 79
Payment Vouchers 77 Journal Voucher 79

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 x  CONTENTS

6. Revenue and Expense Recognition 83 Other Intangible Assets 158

Introduction 83 Other Situations 158
Capital and Revenue 83 Reduction in Value or Write off 161
Revenues 84 Depletion Cost 162
Construction 87 Amortization Cost 162
Other Categorization of Sales of Goods and Depreciation Expenses 162
Services 90 Life of an Asset 164
Revenue Measurement 94 Depreciation Methods 164
Expenses 94 Depreciation Methods Based on Life in Terms of Time
Expense Measurement 96 Phenomenon 164
Revenue Expense as Capital Expense 96 Depreciation Methods Based on Life in Terms of Capacity
Assets as Expenses 96 Phenomenon 167
Concept of GST and Its Impact 100 Depreciation Methods Based on Precautionary
Phenomenon 167
Accounting of Revenue 102
Depreciation Methods Based on Life in Terms of Funds
Accounting of Expenses 104
Management Phenomenon 168

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7. Analysing Transactions 113 Revaluation Method 170

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Introduction 113 Inflation and Depreciation 170
Mechanics of Accounting 114 Selection of Depreciation Method 172

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Voucher System 114 Recording Depreciation 173
Journal Proper or Books of Original Entry 114 Depreciation Impact on Profit
Journal Proper Book 115
Fundamentals of the Account 116
Ledger 116
s ity Measurement 174

9. Current Assets—Cash and Bank 186

Introduction 186
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Posting 117 Voucher System 186
Balancing an Account 117 Cash Book, Bank Book, and Their Types 187
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Trial Balance 117 Transactions with Bank 188

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Errors in Accounting 129 Treatment of Discounts 188

Suspense Account 130 Types of Cash Book 189
Distinction between Subsidiary and Principal Petty Cash Book 197
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Books 131
10. Current Assets—Receivables and Inventory 203
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8. Non-current Assets 149 Introduction 203

Introduction 149 Receivables 204
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Acquisition Cost of Fixed Assets 149 Uncollectible Amounts of Receivables 204

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Capitalization of Borrowing Costs 150 Provision for Sales Allowance or Discount 205

Component Accounting 150 Inventory 206
Spare Parts 151 Objectives of Inventory Measurement 206
Basket Purchases or Group Purchases 151 Material Valuation 206
Economical and Physical Life 151 Stock Verification 207
Tangible Assets 151 Physical Inventory of Stock 207
Regenerative Assets 152 Costing Inventories or Inventories Pricing 209
Intangible Assets 152 Freight Costs 209
Goodwill 152 Accounting Standard (Ind AS 2)—Valuation of
Research and Development Costs 156 Inventories 210
Software Costs 158 Goods and Services Tax (GST) 210
Patents 158 Inventory Methods 211
Copyrights 158 Departures from the Cost Concept 214
Leasehold and Leasehold Improvements 158 Non-historical Cost Methods 215
Trademark and Trademark Names 158 Valuation of Stock and Final Accounts 216

© Oxford University Press. All rights reserved.

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 CONTENTS  xi

Errors in Inventory 217 Surrender of Shares 241

Obsolete and Damaged Items 217 Preference Shares 241
Accounting for Changing Prices 218 Long-term Borrowed Funds 245
Debentures 245
11. Capital and Liabilities 226
Loans from Banking and Financial Service
Introduction 226 Sectors 253
Classification of Liabilities 226 Repayment of Borrowed Funds 253
Current Liabilities 227 Divisible Profit 253
Owners’ Equity 227 Statement of Retained Earnings 255
Company 228 Interest on Capital 256
Characteristics of a Company 228 Interest on Drawings 256
Types of Companies 229 Bonus Issue of Shares 256
Share Capital of a Company 230 Rights Issue 259
Shares of a Company 230 Employee Stock Option Plan 260
Issue of Shares 232 Employee Stock Purchase Scheme 263
Forfeiture of Shares 239 Private Placement of Shares 263

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Issue of Shares for Consideration Other Buyback of Shares 263

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than Cash 241
Disclosure of Share Capital in Corporate Balance
Preferential Allotment 241 Sheet 265

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PART III  FINANCIAL STATEMENTS
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12. Bank Reconciliation Statement 270 Balance Sheet 305
Income Statement and Balance Sheet—The
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Introduction 270
Meaning and Objective of a Bank Reconciliation Linkage 306
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Statement 271 Company Final Accounts 313

Need for a Bank Reconciliation Statement 271 A Company’s Balance Sheet and a Firm’s Balance
Causes of Difference 271 Sheet 313
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Utility of Bank Reconciliation Statement 272 Form of Income Statement 313

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Preparing a Bank Reconciliation Statement 272 Forms of Preparing Balance Sheet and Income
Extracts from Cash Book and Pass Book 275 Statement  313
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Limitations of Financial Accounting 318

13. Preparation of Financial Statements 285 Accounting for Non-profit-seeking or Not-for-profit
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Introduction 285 Organizations 318
Objectives of Preparation of Financial Statements 285 Accounting of Educational Institutions 324
Procedural Aspects for Preparation of Financial Accounting of Hospitals 324
Statements 286 Accounting for Service Organization 324
Adjustment Entries 286 Farm Accounting 324
Types of Adjusting Entries 288 Account of Professional Persons 325
Worksheet 295
Closing Entries 295 14. Accounting from Incomplete Records 341
Cost of Goods Sold 297 Introduction 341
Trading Account 297 Difference between Double-entry System and Single-entry
Income Statement 299 System 342
Deferred Tax Liabilities and Assets 300 Advantages of Single-entry System 342
GST Accounting 302 Disadvantages of Single-entry System 342
Statement of Retained Earnings or Profit and Loss Computation of Profit or Loss 343
Appropriation Account 304 Calculation of Missing Figures 345

© Oxford University Press. All rights reserved.

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 xii  CONTENTS

PART IV  ANALYTICAL ACCOUNTING

15. Average Due Date, Account Current, and Common Size Statements 390
Negotiable Instruments 362 Trend Analysis 393
Introduction 362 Ratio Analysis 395
Average Due Date 362
17. Cash Flow Statement 425
Account Current 366
Introduction 425
Negotiable Instruments  367
Cash Flow Statements as per Companies Act, 2013 426
Accounting Treatement 370
Cash Flows 426
Accommodation Bills  373
Cash Flow Statement for Manufacturing Firm 427
16. Analysis and Interpretation of Financial Format of Cash Flow Statement for Financial
Statements 381 Enterprise 430
Introduction 381 Advantages of Cash Flow Statement 430
Types of Financial Statements 382 Limitations of Cash Flow Statement 431
Analysis and Interpretation of Financial Statements 382 Free Cash Flow 435

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Comparative Financial Statements 387

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Analytical Measurement 436

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PART V  SPECIAL TOPICS

18. Foreign Exchange Accounting 452

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19. Regulatory Framework on Accounting
and Reporting 470
Introduction 452
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Foreign Denominated Transactions 453 Introduction 470
Exchange Rates and Currency Transactions 453 Development of Financial Reporting 470
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Direct and Indirect Methods of Exchange Generally Accepted Accounting Principles (GAAP) 471
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Rates 453 Accounting Standards 472

Translation 454 Ind AS Issued by Ministry of Corporate Affairs 473
Accounting Standards 455 Ind AS 473
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Exchange Gain/Loss 455 International Financial Reporting Standards (IFRS) 506

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Provision for Changes in Exchange

Rates 456 20. Contemporary Accounting 516
Forward Exchange Rate 459 Inflation Accounting 516
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Hedging Transactions 461 Systems of Inflation Accounting 5118

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Depreciation 462 Human Resource Accounting 526

Translations of Foreign Currency 462 Environment Accounting 528
Net Investment in Foreign Equity 463 Forensic Accounting 528
Foreign Branch Accounts 463 Computerized Accounting 529

Appendix A: Comparative Study of IFRS and Ind AS  534

Appendix B: Comparative Analysis of Ind AS and Existing Standard  535
Index 537

© Oxford University Press. All rights reserved.

Prelims_F.indd 12 15-Apr-19 11:26:13 AM

 2  FINANCIAL ACCOUNTING FOR MANAGEMENT

CHAPTER

Introduction to Accounting

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Learning Objectives INTRODUCTION

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A business is the activity of making, buying, selling, or supplying

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After studying this chapter, you will understand goods or services for money. It involves the investment of money
∑∑ development of business enterprise and accounting and earning reasonable returns on it. A business enterprise may
function in the form of a (a) proprietorship, (b) partnership,
∑∑ different forms of business organization
∑∑ difference between bookkeeping, accounting, and
accountancy
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(c) company, or (d) cooperative. It may be involved in pur-
chasing and selling activities, producing goods, or providing
services. Irrespective of the nature of the business, an enterprise
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∑∑ functions, objectives, users, and limitations of accounting has to invest capital. The business must be kept completely
∑∑ kinds of accounting activities separate from its owners. If the business has acquired money,
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it owes an equal amount to its owners.

∑∑ cyclical nature of business activity
Using this capital, the enterprise can acquire assets. The
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∑∑ economic resources and claims economic resources employed by an enterprise are called assets.
∑∑ basic documents and records for validating transactions They may be in the form of plant and machinery, furniture and
∑∑ relationship of accounting with other disciplines fitting, land and building, motor vehicles, stock-in-trade, amount
d

receivable from customers, etc. A business can acquire two types

∑∑ role and activities of an accountant
or

of assets—fixed assets, which are permanently held, and current

∑∑ job descriptions of accounting positions assets, which are currently held and change constantly.
∑∑ important accounting standards It is necessary to keep a record of pro-
xf

Accounting is the
∑∑ importance of ethics in accounting and corporate governance language of business. duction, sales, profits, etc., of any busi-
O

ness activity. The business activity may

∑∑ organizational structure of accounts and the finance be related to production, trade, or service and may involve
department some expenditure and returns. It is necessary to have proper
records of such transactions to avoid confusion. The record-
keeping activity of a business is known as bookkeeping. In
fact, accounting is known as the language of business. Luca
Pacioli, a Franciscan monk and Renaissance mathemati-
cian, is considered to be the father of the modern system of
accounting known as the double-entry system of bookkeeping
and accounting (Weygandt, 2006). The double-entry system
involves making at least two entries for every transaction. The
sum of all debits should always equal the sum of all credits.
According to Pacioli (1494), ‘Books should be closed each
year, especially in a partnership, because frequent accounting
makes for long friendship.’
People around the world use some form of accounting
­everyday. Customers account for the money they spend; stu-
dents plan for their educational expenses; and organizations use

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 INTRODUCTION TO ACCOUNTING  3

accounting to track performance of their operating activities. employee is compensated in the form of salary, or wages, or
Accounting is a diverse, dynamic, and service-based discipline. contractual payment.
An accountant’s responsibility is to provide reliable and relevant Organizations can be broadly classified as for-profit or
information that is useful in making intelligent business decisions. non-profit. The main purpose of organizations or firms in the
Accounting is a Accounting is also a measurement dis- first category is to earn a profit. Non-profit organizations
service-based cipline. It measures results, and guides have objectives other than generating profit. No part of the
discipline. managers and external users to make organization’s income is distributed to its members, directors,
relevant business decisions. or officers. Non-profit organizations include schools, chari-
According to the American Institute of Certified Public ties, clinics and hospitals, legal aid societies, volunteer services
Accountants (AICPA), accounting is ‘the art of recording, organizations, and professional associations. The bookkeeping
classifying, and summarizing in a significant manner and system, necessary to monitor funds, is similar in both profit-
in terms of money; transactions and events which are, in making and non-profit making organizations.
part, at least, of a financial character, Forms or structures created for the smooth running of a
Accounting is a and ­interpreting the results thereof.’ The business or a profession are of the following types (Fig. 1.1).
measurement various attributes of accounting are as
discipline.
follows: Business structure
1. Events and transactions of a financial nature are recorded

s
while the events of a non-financial nature cannot be Proprietorship Partnership Company LLP Cooperative

es
recorded. society
2. The record should reflect the importance of the transac-

Pr
FIG. 1.1  Various business structures
tions so recorded both individually and collectively, which
includessummarization, thereby making it amenable to
Sole Proprietorship
analysis.
3. The users of the financial statements should be able to
obtain the message encompassed in such financial state-
s ity
In this structure, only one person takes all decisions related
to the functioning of the business, such as purchase of goods,
ments, and it is the knowledge of accountancy which sale of goods, management of finance, and recruitment of staff.
er
enables the user to understand the contents of the finan- The sole proprietor or the one person is solely responsible for
cial statements. the profit or loss of the business.
iv

Accounting is the process of recording financial transactions

Partnership
Un

in a proper format. It then analyses, classifies, and reports these

financial transactions to the user. Accounting also provides Partnership is the relation between persons who have agreed to
financial information by preparing reports and statements. share the profits of a business carried on by all or any of them
acting for all. In this structure, two or more than two persons
d

Thus, accounting is the art of preparing significant summaries,

analysing and interpreting transactions and activities, and collaborate to take all decisions related to the business. They
or

communicating the results to those who frame judgements cooperate with each other to perform business or professional
and take decisions. activities as co-owners, and are jointly responsible for the profit
xf

or loss of the business. The profits are shared in a certain ratio

among them as per agreement.
O

FORMS OF BUSINESS ORGANIZATION

Company
Human activities are broadly categorized into economic
It is an association of persons, who contribute money to the
activities (employment, business, or professional practice) or
common share capital of the company or joint stock. The
non-economic activities (religious rituals, cultural and social
company appoints managers or directors to run the activities
work, etc.). related to the business. It is a separate legal entity and has a
Economic activities can be of three types: business activities, limited liability of persons who have contributed to the com-
professional practice, or employment. mon share capital.
A business may involve trading (buying and selling of fin-
ished goods), manufacturing (changing the shape of the raw Limited Liability Partnership (LLP)
material into a usable form), or providing a service. A business LLP is a new type of corporate structure. It combines the flex-
earns profits from the activities undertaken. ibility of a partnership and of a limited liability company. It
A professional may be described as a person who provides provides the benefits of a company to its partners and at the
personal services of specialized and expert nature and charges same time does not put restrictions on them for organizing
fees from the client for the service(s) rendered. internal management, as applicable in case of a company. On
Employment refers to the work performed by a person for account of flexibility in its management and operations, an
someone else according to the contract between them. This LLP is useful for small and medium enterprises in the service
gives rise to an employer–employee relationship, where the sector, in particular.

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 4  FINANCIAL ACCOUNTING FOR MANAGEMENT

Cooperative Societies FUNCTIONS OF ACCOUNTING

A particular group of persons with a common purpose may An entity (also referred to as an enterprise, firm, or organiza-
collaborate with one another and work together in order to tion) is a specific unit (i.e., individual, firm, or institution) for
achieve financial and/or social goals. Such a structure ­represents which the accountant records and reports economic informa-
a united, collective front for the benefit of all members. tion. As mentioned earlier, the boundaries of an accounting
entity are distinct and separate from those of the owners,
BOOKKEEPING creditors, managers, and employees.
An accountant records and reports financial information for
Bookkeeping is an activity concerning the recording of an entity. For example, Lakhina Traders is a business entity
financial data related to business operations in a signifi- owned by Mr Sharma. The financial statements of Lakhina
cant and orderly manner. It is the record-making phase of Traders will report the effect of the event on the entity, not
accounting. Accounting is based on a careful and efficient on its owner. Accounting measures the resources held by an
bookkeeping system. The terms ‘accounting’ and ‘book- entity by
keeping’ are often used synonymously. In fact, bookkeep-
ing is complementary to the accounting process. While ∑∑ ascertaining the claims and interest in the said entity;
bookkeeping is the systematic recording ∑∑ measuring the resources and changes in these resources;
Bookkeeping is the
of financial and economic transac- ∑∑ assigning the changes to specified period of times in terms

s
record-making phase
tions, accounting is the analysis and of money;

es
of accounting.
interpretation of bookkeeping records. ∑∑ communicating information about an entity; and
∑∑ fulfilling the statutory requirements, particularly in respect

Pr
of income tax, sales tax, etc.
BOOKKEEPING, ACCOUNTING, AND
From the above, it becomes clear that accounting accumulates
ACCOUNTANCY
Bookkeeping is a part of accounting that deals with record-
keeping or maintenance of books of accounting which is often
s ity
data systemically and supplies the necessary information to
the user of financial statements. The user can take proper deci-
sions based on the financial information about an entity for a
er
routine and clerical in nature. It covers the following: specified period. This indicates that maintaining accounts is
∑∑ Identifying the transactions and events not the primary objective of an entity. Its primary objective
iv

∑∑ Ceasuring the identified transactions and events is to take decisions on the basis of financial facts presented
∑∑ Recording the identified and measured transactions and by accounting statements. Thus, accounting is not an end in
Un

events in proper books of accounts itself, but is a means to an end.

∑∑ Classifying the recorded transactions and events in a ledger
d

Accounting refers to the actual process of preparing and OBJECTIVES OF ACCOUNTING

presenting the accounts of an enterprise. In addition to the
or

aforementioned functions of bookkeeping, accounting covers The primary objectives of accounting are as follows.
the following: 1. Have a permanent record of each transaction and to show
xf

∑∑ Summarizing the classified transactions and events in the the financial effects on the business.
O

form of income statements and position statements 2. Ascertain the combined effects of all the transactions
∑∑ Analysing and interpreting the summarized results made during an accounting period on the financial posi-
∑∑ Communicating the interpreted information to the inter- tion of the business.
ested parties 3. Evaluate the earning capacity of the enterprise by supply-
ing a statement of its financial position. A statement of
Accountancy refers to a systematic knowledge of account- periodic earnings together with a statement of financial
Accounting is the ing. It explains the reasons and the activities is provided to the internal and external users of
process of preparing processes of accounting. Accountancy the information.
and presenting the explains the method of preparing the 4. Provide necessary information about the efficiency or
accounts. books of accounts, and summarizing and otherwise of the management regarding proper utilization
communicating accounting information. of resources.
An event can be considered as an accounting event if it 5. Provide necessary information for financial forecasting,
satisfies the following four conditions: formulation of overall policies, and devising remedial
1. There must be two parties. measures for the deviations between the actual and pro-
2. One of the parties must have fulfilled the obligations. jected (or budgeted) performance.
3. It should be measurable in acceptable monetary terms, 6. Provide necessary data to the government for taking
as per law of the land. proper decisions related to duties, taxes, price control,
4. It should be legal, moral, and ethical. etc.

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 INTRODUCTION TO ACCOUNTING  5

USERS OF ACCOUNTING INFORMATION which assets were purchased and the current replacement cost.
The balance sheet, thus, may not show a true picture of the
Accounting information is used for making better investment financial affairs of an enterprise on a particular date.
and credit decisions. The demand for accounting informa- Measurement unit  Money as a measurement unit is not
tion of any entity comes from both outside and inside the stable but it changes in value. Unless changes in price levels
organization. are considered in the measurement of income, the accounting
Outside Users information will not show true results.
Accounting information is used by investors and other capi- Personal judgement  Accounting information is not without
tal providers outside the organization. For those outside the personal influence or bias of the accountant. In measuring
organization, financial accounting reports constitute most of income, an accountant makes a choice between different meth-
the financial information concerning the organization’s status ods of inventory valuation, depreciation methods, provision
and performance. for doubtful debts, etc.
Capital markets  Investors who participate in capital markets Estimates  Accounting data are sometimes based on esti-
need accounting information to make investment decisions. mates, and these estimates may be inaccurate. For example,
Investors may include equity shareholders, preference share- the actual useful life of an asset cannot be accurately
holders, debenture holders, brokers, etc. estimated for the purpose of providing and calculating
depreciation.

s
Financial institutions  Funding institutions such as banks,
Inexact information  Accounting does not provide informa-

es
state and/or central financial institutions need accounting
information for credit appraisal. tion to analyse losses incurred due to factors, such as idle plant
and machinery, seasonal fluctuations in volume of business,

Pr
Government institutions  They determine the taxes owed by
etc. It is also difficult to have detailed information regarding
the enterprise to implement a regulatory framework and to
costs relating to different departments, processes, products,
formulate economic policies.
Special interest groups  Creditors, labour unions, consumer
action groups, competing businesses, financial advisers, and
s ity
jobs in the production divisions, etc. Cost control is one of the
most important objectives of a firm and it cannot be achieved
by using accounting processes alone.
the general public seek accounting information about an
er
enterprise to further their own interests.

Inside Users KINDS OF ACCOUNTING ACTIVITIES

iv

Accounting information is used internally by operating, mar- Due to growing business complexities and advanced decision
Un

keting, and financial managers within an organization. The processes, different kinds of accounting have been developed
information provided by accounting assists the management to serve different objectives.
in making pricing, product, and investment decisions. Financial accounting  It deals with recording and summariz-
d

Managers  Financial information is required to control ing economical events and preparing financial statements in
or

the  resources of the enterprise, and to direct resources to accordance with accepted accounting practices. Hence, it is
the most promising products, sub-units, and activities of the
also known as stewardship accounting.
xf

business.
Employees  They are interested in the financial performance Cost accounting  It deals with the computation of aggregate
O

of their company as it is their source of income. Decisions costs of the products manufactured and/or services provided
regarding wage increases and bonuses also drive employees by using the same set of information used by financial account-
to be on the look out for financial information. ing. In cost accounting, the production processes are broken
down into financial values to calculate cost.
LIMITATIONS OF ACCOUNTING Taxation accounting  It involves preparing records and
reports necessary for filling tax returns to local, state, and
The limitations of accounting are as follows. central govern-ment authorities.
Financial nature  The accountant measures only those events
Management accounting  It relates to the use of financial
that are of a financial nature, that is, are capable of being
and cost data for the purpose of evaluating the performance
expressed in terms of money. Non-monetary events, however,
significant and important, are not measured or recorded in of the enterprise, reviewing the existing policies, and making
accounting. decisions about new policies.
Historical costs  Accounting contains information related to In India, taxation accounting is merged with financial account-
historical costs. It does not provide day-to-day information ing, and cost accounting is merged with management accounting.
about costs and expenses. For example, fixed assets are shown Figure 1.2 depicts the pictorial presentation of the linkage
at historical cost. This value may change over time, and hence between the sub-fields of accounting and the users of account-
there may be a great difference between the original cost at ing information.

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 6  FINANCIAL ACCOUNTING FOR MANAGEMENT

CYCLICAL NATURE OF BUSINESS Investing cycle  An investing cycle indicates investing activities
like the purchase of fixed or long-term or non-current assets.
Business transactions or events form a sequence of connected These expenditures are made to generate future income and
and regularly repeated patterns of activity. Although these cash flows for the entity.
patterns or cycles vary from one business to another, broadly Operating cycle  The operating cycle is the average time
they involve
between the purchase of assets or services and the final
∑∑ receiving assets from owners and creditors; cash realization from that purchase. Figure 1.3 illustrates
∑∑ purchasing assets (including traded items for resale) or the concept of the financial cycle and the operating cycle.
materials to produce saleable goods and/or services; Usually the operating cycle is much shorter than a financial
∑∑ selling goods or services; cycle. The operating cycle may exist for a year or even for
∑∑ collecting cash or assets equivalent to cash-in-kind from a few days.
customers; and
∑∑ repaying creditors their dues.
ECONOMIC RESOURCES AND CLAIMS
Financial cycle  A financial cycle is the time between the receiving
of assets from owners and creditors and the repayment of Economic resources are the factors of production or services
assets to owners and creditors. In business, the owners are used in the fulfillment of the objectives of a firm. They can be
repaid when the entity closes down. divided into human resources, such as labour and professional,

s
es
Outside Users
Financial

Pr
Capital markets
Records and accounting
Transaction Financial
Economic activity Bookkeeping including
and events classified data institutions
s ity taxation
accounting
Governments
Creditors
Competitors
Labour unions
er
Cost and
Public
management
iv

accounting
Inside Users
Un

Accounting Information Managers

for decisions management Other
employees
Management
d
or

FIG. 1.2  Accounting system

Source: Adapted from C.A.P.E-I., the Institute of Chartered Accountants of India, p.8.
xf
O

Purchase of
non-current Convert material
assets Purchase of raw into finished product
materials, stores,
and spares
Funds from owners
Pay expenses, e.g.,
and suppliers of
salaries, wages, etc.
funds, i.e., lenders
Financial and Funds or financial Operating
Investment cycle resources cycle

Store the product

Pay in the godown
dividends Pay Collect the funds
interest from customers
Repayment to Sell the product
lenders to the customer

FIG. 1.3  Financial and operating cycle

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 INTRODUCTION TO ACCOUNTING  7

and non-human resources such as land, plant, property and If it avails loans from bank(s) or friends and associates, then
equipment, financial resources and technology, etc. these will also be considered as the liability of RuPaltm.
Economic claims arise out of contractual formal or infor-
mal relationships between parties, involving firm or enterprise Drawings
or entity and outsiders. A firm’s resources, that is, assets are An owner invests funds in a firm in order to generate profits.
claimed by an outsider (banks in case of bank loan, suppliers The profit is earned over a period of time, such as a year. The
in case of credit purchases, etc.), and/or by the owners of an owner may withdraw a fixed amount each week or month for
entity (promoters, equity shareholders in case of company, living expenses or for other personal use. These withdrawals do
partners in case of partnership firm, etc.). not constitute the salary of the firm’s owner in the legal sense.
When an owner uses a withdrawn amount, both the assets and
the capital of the firm may reduce. To exercise control over
BASIC TERMINOLOGY
these withdrawals, a separate account referred to as drawings
Due to the growing need of the spread of accounting infor- in the name of the person is used. For example, to record the
mation among its users and in order to bring uniformity in drawings of Raja Kapoor, the owner of Raja Associates, an
treatment of economic events in the books of accounts, the account referred to as Raja Drawings account will be main-
knowledge of the following terminologies is important. These tained in the books of the proprietory concern. Drawings are
also referred to as withdrawals.
terminologies can be applied in both profit-making and not-

s
for-profit organizations. Assets

es
Capital Resources such as land, building, plant and machinery, fur-

Pr
The owner’s interest in the assets of the firm, after paying off niture, and vehicles owned by the firm with an intention to be
liabilities towards third parties, is known as capital. Capital used in the operating activities of the firm are known as assets
of the firm. The assets may be of tangible or intangible form,
consists of the owner’s contribution in the start up of the
firm’s activities, additional amount brought subsequently by
the owner to the firm, and also the profit (excess of income
s ity
which provide value to a firm.
Assets that possess a physical form are known as tangible
assets, for example, land, plant, machinery, etc. Intangible
over expenses) retained in the firm. It is known as capital on
er
the date of balance sheet. Capital is also referred to as equity assets are not present in the physical form, but are valuable as
or net worth. they generate cash for a business. Some of the most common
iv

When an owner invests personal funds in the business, intangible assets are legal claims or rights, such as patents,
such an investment is recorded in an account that carries the goodwill, etc.
Un

owner’s name and is referred to as the capital account. In case

Goods or Merchandise
of corporate entities, such an account is known as a share capi-
tal account, a corpus fund account, or an equity share capital A business firm earns revenue by selling goods. Merchandise
d

account. For example, Raja Kapoor’s account balance (as refers to the aggregate of the items, commodities, or goods
or

proprietor of the firm) in the books of Raja Associates indicates that are either sold in the same form or converted into sale-
the capital balance, that is, the sum of capital contributed by able products by the firm. For example, if Home Furniture
purchases chairs for sale to its customer, the chairs constitute
xf

Raja Kapoor at the time of start up of the firm, new capital

introduced by Raja Kapoor, and profit gained from the busi- goods of Home. However, if the chairs are purchased by
O

ness activities less the withdrawals by Raja Kapoor since the Alia Grocery Stores, they would be referred to as that firm’s
start up of the firm. fixed assets. To consider another example, if Home Furniture
purchases wooden pieces to manufacture dining tables, these
Equity wooden pieces will be referred to as goods of the firm. Goods
Equity refers to the right, claim, or interest in the assets of the are expected to be sold within a year or during the course of
firm by the owner or promoters or partners or shareholders. one business cycle. Consequently, the merchandise not sold
It is also known as contributed capital of an entity. during this period is reported as inventory and is considered
as part of current assets.
Liabilities
Liability represents the claim or right to be paid off by a firm, Revenue, Income, or Turnover
irrespective of the performance of the firm. If a firm fails to Revenue refers to the cash and cash equivalent received or
pay its liabilities, then the law recognizes the right of the debtor receivable for goods and commodities supplied, services ren-
party to force recovery even by selling the firm’s assets to dered, or the right given to the other party for utilization of
secure the money due. For example, when RuPaltm Enterprises the resources of the firm. The revenue generated by a firm for
purchased stocks for its business from Orange Acetech on a the regular operating activities is known as business income.
credit period of three months, the date of receipt of goods till For example, a grocery shopkeeper earns revenue by the sale
the date Orange is paid off is known as liability for RuPaltm. of consumable items, such as food, soaps and detergents, and

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 8  FINANCIAL ACCOUNTING FOR MANAGEMENT

cosmetics. The amount received on sale of goods is known as on Monday, based on the future relationship between Packing
sale income. In the case of a practicing chartered accountant, Maker Stores and Jeeyu, the latter, will be treated as a Debtor
the service fees charged from a client is covered under consul- in the books of Packing Maker Stores.
tancy income or service income. If the firm is transferring the
right to use the shop floor to a third party, and earns rental Creditors
income, it is known as other income or rental income. Revenue When a firm receives support in the form of cash or in kind
is also referred to as turnover. from another firm or any other legal entity, then the provid-
ing firm or legal entity becomes the giver to the firm and is
Expenses called the creditor. The firm is bound to return the cash or
When a payment is made or undertaken to be made for the equivalent in kind as agreed upon to the lending or providing
services rendered by a third party, a firm, or a legal entity, no firm. Hence, it is considered as a future liability. For example,
further future benefits can be availed from the third party. Packing Maker Stores has delivered 30 boxes of packing mate-
This payment is referred to as an expense. For example, the rial to Jeeyu as on Monday, and Jeeyu agreed to pay `150 on
peon of Jeevan Software has paid `50 as auto fare for going to Wednesday as consideration of receipt of the boxes of packing
and returning from the bank for official work. This `50 will be material. It means that as on Monday, based on the future
considered as conveyance expense, because no future benefit relationship between Packing Maker Stores and Jeeyu, the
will be available from this auto fare. specified amount is payable by Jeeyu to Packing Maker Stores.

s
If an expense cannot provide future benefit, it is known as Hence, Packing Maker Stores would be treated as a creditor

es
revenue expense. If an expense creates scope for future benefits, in the books of Jeeyu.
it is known as capital expense.
Loss

Pr
Discount When the sales revenue is lesser than the cost of goods sold, the
It is the concession in the amount payable offered by the seller difference is called gross loss. When the sum of sales revenue
to the buyer on the market price or listed price of the product.
In business, the discount allowed by a firm is of two types:
trade discount and cash discount.
s ity
including the other revenues is lower than the sum of the cost
of goods sold and other administrative, selling, and distribu-
tion expenses, it is called net loss.
er
Trade discount Profit
It is offered by the seller to the retailer on the listed or printed When the sales revenue is greater than the cost of goods sold,
iv

price in order to enable the latter to earn profit. It is also some- the difference is called gross profit. When the sum of sales
times offered by the seller to the customer, with an intention
Un

revenue including the other revenues is greater than the sum

to maintain the relationship or to sell a bulk quantity. Trade of cost of goods sold and other administrative, selling, and
discount being part of sales promotion efforts is not recorded distribution expenses, it is called net profit.
in the account books. Trade discount is allowed in a business
d

transaction irrespective of whether it involves cash or credit Cost of Goods Sold

or

transaction. The cost of goods sold is equal to the sum of the cost of opening
stock of raw materials, work-in-progress, and finished goods
Cash discount
xf

and the cost of purchase of raw materials and/or finished

It is a type of financing cost undertaken by the seller, with the goods, from which the sum of the cost of closing stock of raw
O

intention to recover the money early in the transaction. It is materials, work-in-progress, and finished goods are deducted.
a mechanism to encourage the prompt payment of money by In addition to the above, the sum of the directly identifiable
customers, so that for the seller, financing from bankers and expenses necessary to complete the operating cycle are added
financial institutions is reduced and bad debts avoided. Bad to the cost of goods sold. In other words, it takes into account
debt refers to the failure to recover moneys due from custom- the operating expenses, such as wages, power and fuel, inward
ers. This is a type of financing cost and is recorded separately freight expenses, etc. involved in bringing the goods to a sale-
in the account books. able condition.
Debtors Expenditure
When a firm pays a person or another firm cash or cash equiva- Assets, goods, or commodities purchased by a firm consider-
lent with future relationship in mind, such as to receive the ing the long-term benefits that they provide to the firm, are
paid amount back in cash or kind, then the receiving party of called long-term assets or fixed assets. The amount expended
the transaction is known as the debtor for the person or the or agreed to be expended in future in addition to the expense
firm. For example, Packing Maker Stores delivered 30 boxes incurred to make the asset workable is referred to as capital
of packing material to Mr Jeeyu Kumar as on Monday, and expenditure.
Jeeyu agreed to pay `150 on Wednesday as consideration for When the amount expended or agreed to be expended in
purchase of the boxes of packing material. This means that as future is not concerned with the value addition of the fixed

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Ch_1_F.indd 8 10-Apr-19 2:23:31 PM

 INTRODUCTION TO ACCOUNTING  9

asset, but supports the firm’s business activities on a day-to- recorded in chronological order. If the same type of transac-
day basis, it is termed as revenue expenditure. For example, tions takes place a large number of times, then subsidiary
payment of wages to workers for delivery of sold goods to books can be maintained. Subsidiary books are specialized
customer’s premises is known as revenue expenditure. If the books of original entry, and are explained in Chapters 6 to 8.
worker is paid for installation of a newly purchased machine,
then it is known as capital expenditure. Capital expenditure is Account
capitalized. This means that the expense is booked as the value An account is an accounting record that accumulates the
of a tangible or intangible asset of the firm. An asset provides activity of a specific item or nature of transaction and yields
benefits of its use over a longer period of time, that is, more the balance of the specific nature of transactions. An account
than one year or one accounting period. In the said example, is the standardized record in which all the changes in each of
if the expenditure on installation of machine is not incurred, entity’s assets, liabilities, capital, income, and expenses are
the machine cannot be made operational and put into effective collected. The amount in an account at any time is called the
and productive use over a long period. balance of an account.
An account can take a variety of forms and accounts are
traditionally shown the form of T; while in the present era, as
ACCOUNTING METHODS per modern approach it is maintained in a columnar way, as
Cash basis accounting (also known as cash accounting) and explained and used throughout this book.

s
accrual basis accounting (also known as accrual accounting)
Ledger or Principal Books of Accounts

es
are the two principal methods of keeping track of an enter-
prise’s income and expenses. The accounting record in which all the accounts of the entity
Accrual basis accounting is the method of recording busi- are kept is called the ledger in which the individual accounts are

Pr
ness events or activities when they occur rather than when summed up to produce the aggregate amount entered in the bal-
cash is received or paid. Thus, accrual accounting recognizes ance sheet and income statement. In short, a ledger refers to a
revenue and expense when goods are sold or when services
are performed rather than when cash is received or paid.
Cash basis accounting records only cash receipt and payments,
s ity
book or register in which financial transactions are permanently
recorded after being summarized and classified. A ledger helps
in preparing a trial balance, after which the final statement is
and recognizes income increases and decreases when cash is prepared. A ledger is also known as a principal book.
er
received and paid.
Accrual basis accounting is superior to cash basis for measur- Trial Balance
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ing the performance of a business because it ties income mea- A trial balance is a listing of accounts and their balances at a
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surement to sales. In contrast, cash basis accounting is influenced specific point of time, which constitutes the first step towards
by many factors that may have little to do with the performance the preparation of financial statement of an entity. A trial bal-
of the entity. Cash basis accounting is not permitted by accepted ance is generally prepared at the end of the accounting period
accounting principals, income tax authorities, etc. for preparing the financial statements. It is done with the objec-
d

tive of checking the arithmetic accuracy of ledger positions.

or

BASIC DOCUMENTS AND RECORDS

RELATIONSHIP OF ACCOUNTING WITH
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Following are the important objectively verifiable evidences

to establish the validity of the transactions recorded in the OTHER DISCIPLINES
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books of accounts. Accounting is closely related to several other disciplines, and

Voucher thus, to acquire a good knowledge in accounting, one should
understand the relevance of these disciplines. Accountants
An accounting transaction is an economic event that affects should have a working knowledge of related disciplines, so
an entity’s assets, liabilities, or owner’s equity at the time of that they can understand such overlapping areas and apply
occurrence of an event. The transaction between a firm or the knowledge of other disciplines in their own work.
entity and an external party is an external transaction, whereas
the transaction within a firm or entity is internal transaction. Accounting and Economics
For such transactions, documentary evidence is prepared, Economics is viewed as a science of rational decisions. It deals
which is known as voucher. with the efficient use of scarce resources for satisfying human
A voucher refers to an authorized consent of the payments wants. Accounting is viewed as a system that provides data
made, or agreed upon to make payments of funds or receipts, for informed judgement and decisions. Some non-accounting
or agreed upon to receive funds. data are also relevant for decision-making.
Books of Original Entry or Journal Accounting and Statistics
The accounting transactions are recorded from the vouchers The use of statistics in accounting can be appreciated better in
to the original books of accounts or journals. Transactions are the context of the nature of accounting records. Accounting

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 10  FINANCIAL ACCOUNTING FOR MANAGEMENT

information is very precise; it is exact to the last paisa. How- ROLE AND ACTIVITIES OF AN
ever, for the purpose of decision-making, such precision is not
necessary and hence approximations are sought. ACCOUNTANT
In accounts, all values are important because they are The training of accountants in assessing the financial
related to business transactions. As against this, statistics implications of alternative courses of action, working
involves the typical value, behaviour, or trend over a period of with multiple constituencies, establishing systems and
time, or the degree of variation over a series of observations. controls, and behaving in a responsible and credible man-
Therefore, whenever a need arises for generalization of rela- ner, prepares them to play critical roles in organizations.
tionships, statistical methods are applied in accounting data. The following statements list the activities of an account:
Statistical methods are helpful in developing and interpret-
ing accounting data. For example, time series and cross-sec- 1. An accountant is engaged in accounts keeping.
tional comparisons of accounting data are based on statistical 2. An accountant is a functionary who aids in control.
techniques. Regression analysis is useful in forecasting, bud- 3. An accountant keeps the conscience of an organization.
geting, and cost control; significance tests are used in budget 4. An accountant is a professional whose primary duties
analysis and standard cost variances. Multiple discriminant include information management for internal and exter-
analysis is commonly used to identify the causes of sickness in nal use.
a business firm. Therefore, the study and application of statisti- 5. An accountant is a financial adviser.
cal methods would add an extra edge to the accounting data. 6. An accountant produces an income statement and a bal-

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ance sheet for an accounting period, and maintains all

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Accounting and Mathematics supporting evidence and classified facts that lead to final
Double-entry bookkeeping can be converted into algebraic accounting statements.

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form. In fact, the first known book on accounting was part 7. An accountant verifies, authenticates, and certifies the
of a treatise on algebra. accounts of an entity.
8. An accountant provides necessary information for vari-
Knowledge of arithmetic and algebra is a prerequisite for
accounting computations and measurements. Calculation of
interest and annuity are examples of such fundamental uses.
s ity ous managerial decisions.
Primary role  Statement (1) defines the primary role of an
Mathematical techniques are commonly used to calculate ac- countant. Statement (6) echoes almost a similar pro-
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depreciation, installments payment transactions, loan repay- file, but extends an accountant’s role to the production of
ment and replacement amount, lease rentals, etc. Accounting ­financial statements. The work implied in these statements
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data can also be presented in ratio form. is that of score-keeping and the person performing such
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activity is known as a financial accountant (or maintenance

Accounting and Law accountant).
A business entity operates within a legal environment. All Decision-maker  Statements (2) and (8) illustrate the account-
transactions with suppliers and customers are governed by the ant’s role in decision-making and the management control
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Contract Act, the Sale of Goods Act, the Negotiable Instru- process. These roles involve directing attention and solving
or

ments Act, etc. The entity itself is created and controlled by problems. The functionary may be designated as a manage-
laws. For example, a partnership business is controlled by the ment accountant (or controller, as in the USA).
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Partnership Act. A company is created and controlled by the Tax planner  Statement (5) underlines a narrow, specific role
Companies Act. of an accountant. In view of high corporate tax in India, tax
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Every country has a set of economic, fiscal, and labour laws. planning assumes a vital role in financial management. By
Laws of the land guide economic transactions and events. planning the operations of the enterprise in a particular man-
Often the accounting system followed is prescribed by the law. ner, the tax adviser attempts to minimize the liability of the
For example, the Companies Act has prescribed the format of firm by availing the concessions and incentives provided by
financial statements. Banking, insurance, and electric supply the applicable tax laws.
undertakings have to produce financial statements as p­ rescribed External verifier  Statement (7) stresses the audit, corporate
by the respective legislations controlling such entities. watchdog, or certification role of the accountant who is not
an employee of a business but who performs an external
Accounting and Management verification of the accounts. Such a functionary is a trained
Management is a broad field, which comprises many functions and qualified professional, and has an educational status and
and encompasses applications of many disciplines. Accoun- prescribed code of conduct. Chartered accountants in India,
tants play a key role in the management team. A large portion England and Wales, and certified public accountants in the
of accounting information is prepared for decision-making by USA belong to this category of accountants.
the management. Although the management relies on other Conscience-keeper  Statement (3) defines the role of an
data sources, accounting data are the basis for making crucial account-ant as a conscience-keeper. He/she is seen as a person
decisions. An accountant is in a better position to understand whose mission is to protect and promote the interests of the
and use such data. enterprise. An accountant sees to it that none of the staff carries

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 INTRODUCTION TO ACCOUNTING  11

work in an unethical way, or in a manner prejudicial to the objective of a statutory audit is to ensure that the financial
long-term legitimate interests of the enterprise. statements prepared by the management give a true and fair
Manager of information  Statement (4) defines an accountant view of the company’s business, and are free of discrepan-
as a professional and underlines his/her pre-occupation with cies resulting from frauds and errors. The internal auditor is
management of information for internal use (management responsible for performing and monitoring activities, designing
accounting) and for external use (financial accounting). and operating the system of internal control, auditing the data
Accounting as an information system has made it easier to reported to the directors of the company, and assisting external
comprehend the role of an accountant. Information manage- auditors. The head of the internal audit reports directly either
ment is not necessarily associated with the sophisticated (or to the chief executive or to the audit committee of the board
high-technology) areas of computers. Small firms may ‘man- of directors.
age’ information without a substantial degree of mechaniza- An internal audit includes continuous verification of entries
tion or automation. Often, the role of accounting in a small appearing in the books of accounts with the original vouchers
business is not properly recognized. It is widely known that a and proper accounting assets. Further, it attempts to ensure
large number of small businesses fail and do not survive beyond that the policies and procedures regarding financial matters are
a few years. One of the main reasons for the failure is the lack being complied with. Internal auditing is also concerned with
of an adequate information system to help managers control administering the system of internal checks so that mistakes,
costs, forecast cash needs, and plan growth. Organizations innocent or intentional, are prevented from taking place.

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which have poor accounting systems often find it difficult to While an internal auditor devotes his/her entire time and

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obtain finance from banks and outside investors. energy to the needs of one company, an external auditor serves
many clients. The primary function of the external auditor is to
safeguard the interests of the shareholders by an independent

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ACCOUNTING PERSONNEL and impartial appraisal of the financial transactions of the
There is hardly any organization that does not have an accoun- company so that he/she could report on the net profit earned
tant. An accountant is involved in a wide range of activities,
particularly in a large and complex organization. The exact
duties of an accountant might differ in different organizations.
s ity
by the company and its financial position. An external auditor
performs the role of an objective outsider. He/she expresses
expert opinions on the financial condition and operating results
Accountants can be broadly divided into two cat- of the client’s business. Apart from shareholders, other parties
er
egories: those who are in public practice and those who such as banks, lending institutions, government agencies, etc.
are in private employment. Public accountants are gener- rely on the fairness of such financial reports in making certain
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ally members of professional bodies like the Institute of decisions about a company. An auditor is bound by a set of
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Chartered Accountants of India (ICAI). In addition to professional regulations which include an examination on tech-
conducting a financial or cost audit (in accordance with nical competence and adherence to a code of ethical conduct.
the requirements of, for example, the Companies Act),
accountants also provide advisory services for designing, Controller
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or improving accounting and management control systems. In some organizations, the chief accountant is known as
or

Accountants in various organizations perform a variety of the controller. The controller is the overall in-charge of
accounting and management control functions. Accountants financial accounting, management accounting, and tax
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at higher levels generally belong to professional accounting accounting activities. He/she is responsible for internal
bodies. Accounting chiefs in different organizations, depending accounting and external reporting. The external reports
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upon their nature of work, are designated as finance officers, include reports to government revenue collection and
internal auditors, chief accountants, or accounts officers. The regulatory bodies, such as the Company Law Board and
term ‘controller’ as the head of the accounting and finance the Department of Income Tax. The controller supervises
function is not very popular in India. Several large organiza- the company’s internal audit and control systems. In addition
tions, both in the public and private sectors, have controllers. to processing historical data, he/she supplies accounting infor-
This section gives the job descriptions of various positions mation to the top management concerning future operations,
available in the field of accounting. in line with the management’s planning and control needs.
Besides, he/she supplies detailed information to managers in
Auditor
different functional areas (such as production and market-
Auditors are accountants in public practice who conduct ing) and at different levels of an organization to assist them
financial and/or cost audit. The auditor examines the books in decision-making. The responsibilities of the controller are
of accounts and reports on the company’s balance sheet, profit as follows:
and loss account, and profit. The auditor in a company is
appointed by the shareholders to whom he/she reports. ∑∑ Designing and operating the accounting system
An internal auditor is an employee of organization in con- ∑∑ Preparing financial statements and reports
trast to an external auditor who is paid a fee for his/her services. ∑∑ Establishing and maintaining systems and procedures
An external auditor is not an employee of a company, and ∑∑ Supervising internal auditing and arranging for external
he/she is appointed to conduct statutory audit. The principal audit

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 12  FINANCIAL ACCOUNTING FOR MANAGEMENT

∑∑ Supervising computer applications capital indicates that the company is unable to meet its short-
∑∑ Overseeing cost control term liabilities with its current assets.
∑∑ Preparing budgets The financial management of a large company is usu-
∑∑ Making forecasts and analytical reports ally the responsibility of the finance director who may be in
∑∑ Reporting financial information to top management place of, or in addition to, the controller. Often the terms
∑∑ Handling tax matters and ensuring other legal compliances ‘finance director’ and ‘controller’ are inter-changeable,
and only one of these two positions may be present in a
Treasurer company. The finance director is concerned with imple-
A treasurer is the custodian and manager of all the cash and menting the financial policy of the board of directors,
near-cash resources of the enterprise. The treasurer handles managing liquidity, preparation of budgets, administration
credit reviews and sets the policy for collecting receivables of budgetary control system, managing profitability, etc.
(from the debtors of the firm, to whom the firm has sold goods Though financial management is regarded as a separate
or services on credit). He/she also handles relationships with area, this function is performed in several countries, including
banks and other lending or financial institutions. The Finan- India, by the accountant (or the financial controller). Several
cial Executive Institute (USA) makes certain distinctions large organizations, however, have a chief financial executive
between the functions of a treasurer and those of a controller besides the chief accountant. Often, finance and accounting
(see Table 1.1). functions are clubbed together in small organizations.

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TABLE 1.1  Distinction between the functions of a controller and a treasurer

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Controller Treasurer NATURE OF ACCOUNTING FUNCTION
Planning and control Provision of capital

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Accounting is a service function and the accountant’s role is
Reporting and interpreting Investor relations advisory in nature. The chief accountant holds a staff posi-
Evaluating and consulting Short-term financing tion except within the accounts department where he/she
Tax administration
Government reporting
Protection of assets
Banking and custody
Credit and collections
Investment
s ity
exerts authority. This is in contradiction to the roles played
by the production or marketing managers who hold line
authority. The role of the accountant is advisory in nature.
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Economic appraisal Insurance He/she works through the authority of the chief execu-
tive. The accountants and or the finance department(s) do
Finance Director
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not exercise direct authority over line departments. In a

Finance is the lifeblood of any business. Procuring financial ­decentralized structure with a number of units and divisions,
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resources and ensuring their judicious utilization are the two the accounts manager, however, exercises functional authority
most important aspects of financial management. Financial over all the accounting staff deployed in different segments.
management includes major decisions concerning investment, There are two facets to the role of an accountant. An
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financing, dividends, and working capital. accountant performs the role of a corporate watchdog for the
Investment decision  It is perhaps the most important deci- top management, and of a helper for the middle and lower
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sion, because it involves the allocation of resources. It deals management. The accountant reports to the higher manage-
with assessing the risks an organization encounters in a busi- ment and performs the score-keeping task of accounting. The
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ness environment. The firm’s strategy in allocating its scarce accountant performs the role of a helper by directing manag-
ers’ attention to problems, and assisting them in solving these
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resources and planning its growth largely determines its value

in the market. problems. Mutual understanding and rapport between the
Financing decision  It deals with determining the optimum accountant and the managers, in the tasks of attention-direct-
financing mix, or capital structure. It examines the various ing and problem-solving, can be enhanced if the accountant
methods by which a firm obtains short-term and long-term and the staff frequently interact with the line managers and
finances through alternative sources. guide them in matters concerned with preparation of budgets
Dividend decision  It involves questions such as how much and control documents. This will instill confidence in line
profit is to be retained and how much is to be distributed as managers regarding the reliability of reports.
dividend.
Working capital  It gives investors an idea of the company’s ACCOUNTING STANDARDS
operational efficiency. The finance director has to strike a
balance between the cash requirements of the enterprise, and At one time, firms and corporates followed different account-
the needs of the shareholders for adequate returns. Working ing policies and practices. It was, therefore, not possible to
capital is calculated as: compare different financial statements to understand out-
comes. With a view to establish reliability and comparability
Working Capital = Current Assets – Current Liabilities of financial statements prepared and presented by firms,
A positive working capital indicates that the company is corporates, business houses, etc., India’s accounting body,
able to pay off its short-term liabilities. A negative working that is, the Institute of Chartered Accountants of India (ICAI)

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 INTRODUCTION TO ACCOUNTING  13

developed the Accounting Standards. Accounting Standards 3. It is useful to have meaningful comparisons of financial
are authoritative guidelines issued by the ICAI regarding statements of different companies situated over the dif-
accounting norms for measurement and treatment of account- ferent places.
ing events and transactions. The traditional debits and credits
of the accounting discipline and the modern approach of Disadvantages of Accounting Standards
accounting equation have evolved to more reliable accounting Some important demerits or disadvantages of the accounting
standards and the Generally Accepted Accounting Principles standards are as follows:
(GAAP). 1. It brings rigidity in the working and does not provide the
The US GAAP are the rules and practices of accounting important flexibility in reporting by a particular firm.
applicable to firms operating in the United States. While pre- 2. The difference is reflected in the treatment of a particular
paring and presenting the financial statements, the US GAAP transaction and its reporting, on account of difference in
are to be followed, by all companies, whether their shares the traditions and legal system among the countries.
are publicly traded or are not traded in the security market. 3. Accounting standards cannot override the law, Act, or
any legal pronouncement.
The Government Accounting Standard Board (GASB) is
4. The choice of better alternative of accounting treatment
mandated to develop accounting standards for local and
is eliminated.
state governments. The local and state governments normally

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operate under a different set of assumptions, principles, and
ACCOUNTING STANDARDS AND

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constraints. Hence, a separate set of accounting standards
have been developed. DEVELOPMENT

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Likewise, Indian firms, corporates, companies, and busi- To provide the benefit to all countries of the globe to achieve
ness houses must adhere to the various accounting standards industrialization, to facilitate free flow of capital, merchandise,
developed by the ICAI. In addition, Indian companies have
to follow the regulations prescribed by the Companies Act,
1956. The accounting standards set by ICAI, together with
the legal regulations of the Companies Act, 1956 are known
s ity
goods and commodities, etc., and to achieve the harmoniza-
tion of accounting standards at the international level, the
International Financial Reporting Standards (IFRS) have
been introduced.
er
as Indian GAAPs. ICAI recognized the need for harmo- The Indian Accounting Standards are discussed in Chapter
nization of diverse accounting policies and practices, and 15 (Legal and Regulatory Framework of Accounting and
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constituted an Accounting Standard Board (ASB) in the Auditing) in addition to the applications in respective chapters.
year 1977. The specific accounting standard is mandatory The IFRS is explained in Chapter 18 (Contemporary Issues).
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from the date mentioned in the standard. Mandatory means The comparison between Indian Accounting Standards (Ind
that it is the duty of the member of the ICAI to examine that
AS), US GAAP, and IFRS are discussed in Chapter 18 in
accounting standards are complied by the firm, or company,
addition to the applications in respective chapters.
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or the business entity in the presentation of financial

The Ministry of Corporate Affairs (MCA) have notified
statements.
or

35 Ind AS converged with IFRS which shall be applicable

The main aim of accounting standards is to ensure compa-
to the specified class of companies. (Refer Appendix of this
rability, credibility, and reliability of financial statements of
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the firm. Comparability indicates that the financial statements book)

of firms in the same industry are prepared in a comprehensible Appendix B of this book indicates relationship between
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way, and the same accounting principles and practices are International Accounting Standards/IFRS and correspond-
used in the preparation of financial statements. By providing ing Ind ASs.
uniform guidelines and structure, it creates an environment Appendix C of the book indicates the relationship between
of confidence among the users of the accounting information, Ind AS (as per MCA) and AS (as per ICAI). Brief explanation
and also provides a true and fair view of the financial position of AS is provided in Appendix D of this book. Professional
and performance. chartered accountants’ have to adhere to the AS for profes-
sional ethics and parameters.
Advantages of Accounting Standards The detailed descriptions along with examples for each and
A few advantages offered by accounting standards and its every IFRS are given in Chapter 18 of the book.
implementation are illustrated as follows:
1. It reduces to a reasonable extent or altogether removes ORGANIZATIONAL STRUCTURE OF
confusing variations in the accounting treatment of spe- ACCOUNTING AND FINANCE
cific items of income and expense. DEPARTMENT
2. Accounting standards look into important areas of infor-
mation, which may not be required to be disclosed by law A typical organization chart for the accounting and finance
or statute, but would be useful in fair presentation. department is presented in Fig. 1.4. The person at the helm

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 14  FINANCIAL ACCOUNTING FOR MANAGEMENT

Director (Finance)

General Manager
(Finance)

DGM (Systems and DGM DGM DGM

data processing) (Accounts) (Finacne) (Internal audit)

SM SM
SM SM SM
SM (Liaison work (Capital
(Finance (Tax planning and (Pay roll
(Accounting) with government/ budgeting)
Procurement) tax accounting) accounting)
external auditor)

s
es
Pr
SM SM SM
SM SM
(Management (Management (Routine financial
(Treasury) (Cost accounting)
accounting MIS) audit) audit)

ity
FIG. 1.4  Organization chart for accounting and finance
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er
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of affairs in the accounts and finance department is the ETHICS IN ACCOUNTING AND CORPORATE
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director (finance) who is a member of the board of direc-

GOVERNANCE
tors. One or more than one general manager reports to the
director. Large organizations may have four or five deputy The current world economy has given rise to nearly free move-
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general managers in charge of different areas, such as sys- ment of goods, commodities, services, and capital among the
or

countries across the globe. Hence, the commercial and eco-

tems and data processing, accounts, finance, and internal
nomical world requires the accounting profession to provide
auditing reporting to the general manager. Some multina-
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accurate and timely financial reports, with observance of the

tional companies designate general manager (finance) as highest standards of ethical, moral, and accounting profes-
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president (finance or finance and accounts), and deputy sional code of conducts.
general manager (finance) as vice president (finance). Each Professional accountants who record business transactions
deputy general manager is assisted by a number of senior need to follow the guidelines based on accepted practices in
managers, who look after different components of financial accounting of their country concerned. The code of conduct
accounting, tax planning and administration, management has been defined and enumerated by the governing body of
auditing, etc. professional accountants with the intention to achieve the high-
A management audit is a comprehensive review of the est level of integrity by an accountant. In India, the governing
various sub-systems of the organizations, such as objectives body for financial accounting and auditing is the ICAI, and
for cost and management accounting it is the Institute of Cost
and goals, structure, technical system, personnel policies
Accountants of India (ICAI). The respective code of conduct
(including succession planning), control and coordination
expects the members of the Institute to strictly follow the stan-
policies and procedures, adequacy and effectiveness of com- dards and maintain the highest degree of professional integrity.
munication system, etc. This type of audit is usually done by Integrity means honesty, impartiality, and truthfulness. It aims
a team of people comprising the internal resource persons at the maintenance and fulfilment of professional objectivity
drawn from various functional areas and an external man- during the performance of duties by an accountant in the role
agement consultant. of employee, practice, business, or as an auditor. Objectivity

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Ch_1_F.indd 14 10-Apr-19 2:23:32 PM

 INTRODUCTION TO ACCOUNTING  15

is the state of mind that takes into consideration all aspects long-term sustainable partnership with their stakeholders
relevant to a task undertaken. An accountant, according to efficiently. The principal characteristics of corporate gover-
the guideline of the Institute, should accept or perform work nance are as follows:
according to competence. He/she is required to work with
∑∑ Transparency
skill, care, and diligence.
∑∑ Independence
The ethical codes of the accounting profession have changed
∑∑ Accountability
significantly over time due to two critical tests: first, whether
∑∑ Responsibility
the accounting rules accepted and applied are appropriate and ∑∑ Fairness
reasonable for both the public and the firm who follow them; ∑∑ Social responsibility
second, whether the practice enumerated by accounting rules
are valid over the period or need to be challenged. The financial statements are governed by fundamental
Corporate governance pertains to systems through accounting assumptions of going concern, consistency, and
which companies are directed and controlled, keeping in accrual. Any deviation must be disclosed. An organization is
mind the long-term interest of stakeholders. It is a blend of guided by the following considerations in selecting account-
good legal, regulatory, and voluntary practices that enable ing policies.
companies to attract financial and human capital, perform Prudence  Do not recognize anticipated profits but provide
efficiently, and provide sustainable economic value to all for all acquired losses.

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its stakeholders.
Substance over form  Economic reality and financial consid-

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It aims to align the interests of the company with those
of its stakeholders. The incentive for companies and those eration get preference over legal form in reporting.

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who own and manage them, in adopting global governance Materiality  Financial statements should disclose all mate-
standards, is that these standards help them to achieve a rial items.

ity
SUMMARY
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∑∑ A business consists of investment of a certain amount of money institutions, banks, government, creditors, labour unions,
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in fixed assets and current assets. managers, employees, etc.

∑∑ Luca Pacioli is considered to be the father of accounting.
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– Assets are valuable resources owned by an entity.

∑∑ Accounting is the language of business. ∑∑ Liabilities are measurable, future economic sacrifices arising
∑∑ Accounting is the art of recording, classifying, and summarizing from a company’s obligations to convey assets or perform services.
transactions which are of a financial nature and interpreting the ∑∑ Owners’ equity is the residual balance remaining after total liabili-
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results. ties are deducted from total assets.

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∑∑ Accounting is the art of recording, classifying, and summarizing ∑∑ Accounts are maintained for a business entity.
transactions which are of a financial nature and interpreting the ∑∑ A business entity is a specific unit separate from its owner.
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results. ∑∑ Accrual basis accounting is the method of recording business

∑∑ Bookkeeping is the record-keeping phase of accounting. Account- events or activities when they occur.
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ing refers to the actual process of preparing accounts. Accountancy ∑∑ Cash basis accounting records transactions or business events
refers to a systematic knowledge of accounting. when cash is received and paid.
∑∑ Accounting provides the permanent record of each transaction. ∑∑ Accounting is closely related with several other disciplines such as
– Accounting information is useful to investors, financial economics, statistics, mathematics, law, and management.

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KEYWORDS
Accountancy  It refers to a systematic knowledge of accounting. Bookkeeping  It deals with record-keeping or maintenance of
Accounting  It is the process of recording, analysing, classifying, and books of accounting, which is often routine and clerical in
reporting of economic events in a proper manner. nature.
Accrual basis accounting  It is the method of recording business Cash basis accounting  It records only cash receipts and payments,
events or activities when they occur rather than when cash is recognizes increases or decreases in income only when cash is
received or paid. received and paid.
Assets  Economic resources employed by an enterprise or organi- Cost accounting  It involves the computation of the aggregate costs
zation to accomplish the organization’s goals are called assets. of products manufactured and for services provided.

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 16  FINANCIAL ACCOUNTING FOR MANAGEMENT

Creditors  The individuals, suppliers, and/or institutions who loan Management accounting  It relates to the use of financial and cost
goods and/or services to an entity. data for the purpose of evaluation of performance of the entity,
Entity  An entity is a specific unit for which the accountant records reviewing policies, and planning.
and reports economic information. Owners  Those who have contributed capital for starting an enter-
Liabilities  They are probable, measurable future economic sacrifices prise. Owners have a residual interest in the enterprise.
arising from company’s obligations to provide assets or perform Owner’s equity  It represents the stockholders’ claim on the resources
services to a person or other organizations outside of the company of the business.
at some time in future.

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QUESTIONS
I. Answer the following questions. 5. Discuss briefly the relationship of accounting with economics,
1. Define ‘accounting’. statistics, mathematics, law, and management.
2. Who are the users of accounts? 6. Explain in detail the role of a treasurer and a controller.
3. State briefly the information needs of these users. 7. Explain the nature of the accounting function.

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4. What are the sub-fields of accounting? Distinguish between the

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various sub-fields.

Pr
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REFERENCES s ity
Hawkins, David F. and Jacob Cohen 2002, The Balance Sheet, Weygandt, Jerry J., Donald E. Kieso and Paul D. Kimmel 2006,
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­Harvard Business School Note, pp.101–8. Financial Accounting, 4th edition, Wiley-India, p.5.
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or
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Ch_1_F.indd 16 10-Apr-19 2:23:32 PM