NIFT

Introduction
Financial Accounting
 Nature and Scope
Every business has profit motive. It has transactions of
financial in nature, such as purchasing goods, selling
goods, incurring expenses and receiving income. These
transactions are financial in nature and aims at
generating revenue or income thereby affecting the
profit of the business. (non-financial or non-economic
transactions do not have profit motive but they have
service motive and are performed to honour our social,
cultural, emotional, religious and patriotic commitments
and satisfaction, eg, cooking by mothers for their
families, nursing sick children by their parents).
Accounting is concern with only the financial or
economic transactions of the business.
 Accounting transactions are both money and money-
worth transactions. Credit transactions are known as
money-worth transactions. Business transactions are
classified as assets, liabilities, capital, revenue and
expenses. The Income statement (also called as the
Trading & Profit and Loss a/c) is prepared to ascertain the
profit or loss of the business. The Position statement
(also called as the Balance Sheet) is prepared to assess
the value of assets and liabilities of the business. These
two statements are collectively called the Financial
statements (also called as the final a/c) which reflect the
actual performance and the financial health of the
business.
 Therefore, Accounting is an art of identifying, classifying,
recording, summarising and interpreting business
transactions of financial in nature.
All financial transactions which have documentary proof/
evidence are identified as business accounting transactions.
The elements of the transactions are classified as assets,
liabilities, capital, revenue and expense. These transactions
are recorded in the appropriate books of accounts. Income
statements are prepared to ascertain profit or loss of the
business during the accounting year. Position statements
are prepared to ascertain assets and liabilities of the
business (summarising ). Finally, the results of the business
transactions are communicated to the concerned and
interested parties (interpreting).
 Basic accounting terminology
Assets :- things of value that the business owns are known as
assets. Assets may be :-
1. fixed assets these assets are acquired for long term use in the
business , they are not meant for resale and they increase the profit
earning capacity of the business. Eg. land & building, plant &
machinery, furniture & fixture, vehicles etc.
2. current assets - also known as circulating, fluctuating or floating
assets. Assets which can be converted into cash within a period of
one year are called current assets. Eg. Cash in hand, cash at bank,
debtors, bills receivable, stock, prepaid expenses etc.
3. tangible assets assets which can be seen, touched and felt,
which have physical existence are tangible assets. Eg. land,
machinery, stock, furniture, cash etc.
 4. intangible assets - these are assets which have no physical
existence and can neither be seen, touched or felt but they have
value. Eg. goodwill, trademarks, patents etc.
5. wasting assets assets whose value goes on declining with the
passage of time. Eg. Mines.
6. fictitious assets these are not really assets in the true sense but
are called assets on legal and technical grounds. They have no
physical form and have no real value. These assets are deferred
revenue expenditure (you have to spend now but you will get the
benefits in the subsequent years). Eg. advertising expenses,
preliminary expenses, loss on issue of shares etc.
7. liquid assets assets which can be converted into cash
immediately or at short notice. Eg. all current assets except stock
and prepaid expenses are liquid assets.
 Liabilities :- these are obligations or debts payable
(have to pay) by the business. Eg. capital, creditors,
bills payable, outstanding expenses etc.
Capital :- it that part of wealth which is used for further
production. (simply capital is the investment of the
owner in the business). Capital maybe in cash or in
kind. Capital maybe :-
1. fixed capital it is the amount invested in acquiring
fixed assets.
2. working capital it is the amount of capital available
for the day-to-day running/working of the business.
 Revenue :- in accounting it means the amount realised
or receivable from the sale of goods. Amount received
from sale of assets or borrowing loan is not revenue. It
should be concerned with day-to-day activities of the
business and should be regular in nature.
Expenses :- they are the cost incurred by the business in
the process of earning revenues. Generating income is
the foremost objective of every business. It has to use
certain goods and services to produce the articles ,sold
by it. Payment for these goods and services is called
expenses.
 Meaning of GAAP
The business today is large in size and complex in nature. There are
various groups who are interested in the performance of the
business such as shareholders, debenture holders, investors,
employees and consumers. In this way, accounting is required to
report and present the facts of the business in such a way, which
can meet the different requirements of the different groups.
Therefore, it is necessary that the language and terminology of
accounting may be standardised so that there may be uniformity in
the presentation of accounts. The idea requires scientific study,
analysis and presentation of accounts.
Generally Accepted Accounting Principles (GAAP) are the set of
rules and practices that are followed while recording transactions
and preparing the financial statements. GAAP build sound
theoretical foundation of accounting.
 Basic accounting concepts
These concepts are the foundation of systematic and proper
accounting.
1. Business entity :- in accounts we distinguish between the
business and its proprietors (owners). The business is
assumed to have a distinct entity (existence) other than the
existence of its proprietors. So when we record business
transactions, we record them from the business point of view
and not from the proprietor. The capital introduced by the
proprietor in his own business is considered as a liability for
the business. Capital is a liability because the business has
borrowed funds from its own proprietor instead of borrowing
it from outside sources.
 2. Going concern :- we assume that the business will
be carried on indefinitely, that is why, it purchases
fixed assets in its own name. According to this
concept, the business is always assumed to have
perpetual life (never ending/eternal).
3. Money measurement :- in accounting we identify
and record only those business transactions which
are financial in nature. Accounting transactions must
have their monetary value. The worth of the
transaction must be measured in terms of money.
 4. Cost (historical cost) :- according to this concept all business
transactions must be recorded in the books of accounts at
their monetary cost of acquisition (buying). The concept is
called historical because the balance of assets and liabilities is
carried forward from year to year at its acquisition cost
irrespective of any increase or decrease in the market value of
the assets.
5. Accounting period :- strictly speaking the profits of the
business can be calculated only at the end of its life, and since
the business has perpetual life so we will have to wait for a
very long period to calculate the profits earned. Practically it
will be too late to wait for the results, so the life span of
accounting should be split into shorter and convenient period.
At present accounting periods are regarded as twelve months.
 Sole proprietorship and partnership form of business
organisations can choose their own accounting period,
this period can be the calendar year 1st Jan to 31st Dec
or the assessment year 1st April to 31st March or any
year but it cannot exceed twelve months. But for a
company it is required by law that the accounting year
must be the financial year 1st April to 31st March.
6. Dual aspect :- every business transaction has a double
effect ie. there are two sides of every transaction. Every
business transaction will affect either the asset and/or
capital and /or liability of the business.
 7. Revenue recognition :- this concept explains when we should
assume revenue to have been earned. It will enable us to identify
the period for which the revenue has been earned. According to the
accounting period concept revenue must be concerned with the
specific accounting period. We can determine the revenue as
realised on the following basis :
i. Sales basis
ii. Cash basis
iii. Production basis
Accounting is the historical record of transactions. It records what
has happened, it does not anticipate events. That is why, in most
cases we determine revenue on sales basis. Revenue is supposed to
be realised if actual payment has been received or customers
promises to make payment has been received.
 8. Matching :- earning reasonable/maximum profit is the
aim of every business. It has been the duty of
accountants all over the world to evolve a principle of
calculating exact and accurate profit. The result of these
efforts was the introduction of the principle of matching
cost and revenue. According to this concept income can
be calculated by matching revenue with the costs of the
business.
9. Full disclosure :- accounting must disclose all material
information, ie, information capable of changing the
results of the business. It should be honestly prepared,
free from any bias, favour or prejudice. Figures should
not be manipulated.
 10. Consistency :- as the business is a going concern,
important conclusions are drawn by comparing
accounting statements of the current year with those
of the previous years. Accurate comparisons can be
made if the methods and practices of recording and
presentation does not change. The convention of
consistency does not mean that the business cannot
switch over to better and up-to-date methods, but if
the business changes from their previous practices
and methods, the fact should be disclosed with
reasons.
 11. Conservatism/ prudence :- according to this concept,
while preparing the books of accounts we should provide
and account for any anticipated and future losses but we
cannot record future gains and profits. Application of this
principle is evident from the following facts :
i. valuation of stock/investment at cost or market price
whichever is lower
ii. Creation of investment fluctuation fund
iii. Maintaining provision for bad and doubtful debts
iv. Showing depreciation on fixed assets and not
appreciation
v. ignoring discount on creditors.
 12. Materiality :- this follows the principle of full
disclosure that accounting should disclose all the
material information.
13. Objectivity :- every business record must be
based and supported by documentary evidences.
Receipts, bills, invoices, cash memos, salary bills etc
are some of the vouchers used as documentary
evidences for recording business transactions.
According to this concept, accounting should be
definite, verifiable and free from manipulations and
personal bias.