FINANCIAL ACCOUNTING
Stakeholders in Business
• Owners, managers, investors, lenders, customers, suppliers,
labour and government have a stake in the business.
• All the stakeholders are involved in decision making of some
kind.
• Accounting provides the economic information needed by
these stakeholders.
Accounting
• Accounting is “ the process of identifying,
measuring and communicating economic
information to permit informed judgments and
decisions by the users of accounts.”
USERS OF ACCOUNTING
INFORMATION
• Internal Users
• Functional Managers
• External Users
• Investors
• Lenders
• Customers
• Suppliers
• Labour Unions
• Government
Framework of Accounting
• Main objective of business is to earn profits.
• Firms must optimally utilize resources to
achieve this objective effectively and efficiently.
• Allocation and use of resources occur at two
levels: Macro and Micro
• At the macro level, a firm competes for
resources with other firms in the capital market
Framework of Accounting
• Capital markets comprise investors: individuals
and institutions.
• Capital markets allocate resources based on
the criterion of efficiency in use that is
measured in terms of profit.
• Only a profitable or a potentially profitable
firm would succeed in obtaining resources
from the capital market
Framework of Accounting
• The capital market allocates resources based on information
about financial performance of the firm.
• Accounting provides information on financial performance
through financial reports or statements (Balance Sheet , Profit
and Loss Account and Cash Flow Statement)
• The part of accounting system that serves to provide financial
information to investors is called Financial Accounting
Framework of Accounting
• After obtaining resources from the capital market,
the firm decides allocation of resources to its various
projects, activities and assets (micro-level allocation).
• The firm decides on micro-level allocation of
resources based on analysis of the related cost and
benefits.
• The part of accounting system that provides this
information to facilitate management decision
making is called Managerial Accounting
Sub-Fields of Accounting
• Managerial Accounting
• Provides information for use by owners and managers for
• Setting organizational goals
• Measuring performance
• Making decisions (entering new markets, making new
products)
• No specific format
• Uses both historical information and future projections
Sub-Fields of Accounting
• Financial Accounting
• Preparation of financial statements for use by managers and
external stakeholders
• Provides information about
• Operating activities
• Investing activities
• Financing activities
• Financial statements prepared in specific format
• Uses historical information
Accounting Terms
• Assets are economic resources that are controlled by an
entity and whose cost (or fair value) at the time of acquisition
could be objectively measured.
• A resource is an economic resource if it provides future
benefits to the entity
• An Asset can be (i) cash or something convertible into cash,
(ii) goods expected to be sold and cash received from them
and (iii) items to be used in future activities that will generate
cash flows.
• Land and Building, Plant and Machinery, Furniture and
Fixtures, Inventories, Debtors and Cash Balance are examples
of assets.
Accounting Terms
Liability
A business generally raises financial resources from both its
owners and outside parties.
Both of them have a claim on the assets of the business for
the money invested by them.
Liabilities are claims to assets of parties other than owners.
Loans, bonds, Creditors, Unpaid Expenses are examples of
liabilities.
Accounting Terms
Capital / Owners’ Equity
Owners’ equity generally refers to an amount invested in an
enterprise by the owners.
It is also used to refer to the interest of owners in the assets of
an enterprise.
This consists of the amounts originally invested by the owners
and the retained earnings (profits retained within the business)
Accounting Terms
Revenue
• Revenue is the gross inflow of cash, receivables
or other consideration arising in the course of
the ordinary activities of an enterprise from the
sale of goods, from rendering of services and
from the use by others of enterprise resources
yielding interest, royalties and dividends.
Accounting Terms
Cost
• Cost is a monetary measurement of the amount of resources
used for some purpose.
Expense
• A cost relating to the operations of an accounting period (e.g.
salaries) or to the revenue earned during the period (e.g. cost
of goods sold) or the benefits of which do not extend beyond
that period.
Accounting Terms
• Goods
• The term ‘Goods’ means the property in which the business
deals.
• Goods are purchased by a business for resale and not for use
in the business.
• For example, furniture acquired for resale by a furniture
dealer will be treated as goods and furniture acquired by such
dealer for use in his office will be treated as an asset.
Accounting Terms
• Debtors (Accounts Receivable)
• Debtor means a person who owes money to the business for
goods purchased from the business.
• Creditors (Accounts Payable)
• Creditor means a person to whom the business owes money
for goods purchased by the business from that person.
Financial Statements
• Information to users of accounting information is provided in
the form of financial statements that arrange assets,
liabilities, revenue and expenses in different ways.
• Every business enterprise generally prepares three financial
statements:
• income statement,
• balance sheet, and
• statement of cash flows.
Income Statement
• The income statement (or statement of profit and loss)
reports the result of operations of the business during the
accounting period.
• It matches the expenses for the accounting period with the
revenues earned and reports the resulting net income (profit
or loss).
• The income statement is of particular use to investors, lenders
and creditors.
Balance Sheet
The balance sheet reports the financial position
of the business at a particular point of time,
generally at the end of the accounting period.
It shows the amount of assets owned by the
business and the claims on these assets.
Statement of Cash Flows
• The statement of cash flows provides information about the
cash receipts and cash payments during an accounting
period.
• Particularly, it shows the sources from which cash is
received, the uses to which cash is put and the change in the
cash balance during the accounting period. The activities of a
business are classified as:
• Operating activities
• Financing activities
• Investing activities
Accounting Equation
The claims on the assets belong to the providers of
resources to buy the assets, i.e., the owners and
creditors/lenders.
As the business cannot spend more on buying assets
than the resources it has, the following relationship
(also called the accounting equation) always holds.
Assets = Owners’ Capital + Liabilities
Form of Financial Statements
• A business can be organized as sole-proprietorship (having a
single owner), a partnership (with two or more owners or
partners), or a company (having a large number of owners or
shareholders).
• Only companies are required by law to keep the prescribed set of
books and to present their financial statements in the prescribed
form.
• Other forms of business organization need to maintain their
accounts in a manner that enables determination of their income
for income tax purposes.
Frequency of Financial Statements
• Normally, companies are required to prepare annual
as well as quarterly financial statements.
• The quarterly financial statements are also known as
interim financial statements.
• Other forms of business organizations are not
required to prepare interim financial statements for
external reporting.
Generally Accepted Accounting Principles (GAAP)
• Generally accepted accounting principles (GAAP) are a set of conventions,
rules and procedures that define the accepted accounting practice at a
particular time.
• These result from broad agreement on the theory and practice of accounting
at a particular time.
• The purpose of GAAP is to ensure that the information provided in the
financial statements is reliable and understandable to the users.
• The users should be able to meaningfully compare the current performance of
a business entity with its past performance and with the performance of other
business entities.
Generally Accepted Accounting Principles (GAAP)
• The GAAP keep changing from time to time as
the circumstances or the information needs of
the users change.
• In India, the sources of Indian GAAP consist of
the Companies Act, 2013, Indian accounting
standards and the pronouncements of the
accounting profession.