Management and Financial Accounting

390 Pages·2009·2.19 MB·English

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Management and Financial Accounting
Subject: MANAGEMENT AND FINANCIAL ACCOUNTING
Credits: 4

SYLLABUS

Introduction to Financial Accounting
Introduction, Scope and Objectives, Branches of Accounting, Accounting Principles and Standards.

Financial Accounting Framework
Journalizing Transactions: Recording of Transaction, Advantages of Journal, Classification of Accounts and its
Rules, Compound Entries; Ledger: Introduction, Posting and its Rules; Trial Balances: Trial Balance
Preparation, Errors Disclosed by Trial Balance, Methods of Allocating Errors in Trial Balance.

Basic Principles of Preparing Final Account
Capital Expenditure; Revenue Expenditure; Deferred Revenue Expenditure; Capital Receipts; Income
Statements: Profit and Loss Statement; Balance Sheet; Final Accounts: Adjustments.

Concept of Management Accounting
Principles, Functions and Scope of Management Accounting; its Limitations; Management Accountant:
Functions; Basic Cost Concepts; Components of Total Cost; Elements of Cost and Cost Sheet; Methods,
Systems and Techniques of Costing.

Tools of Financial Analysis
Budgets: Introduction, Advantages and Disadvantages, Essentials of Budgetary Control, Budget Manual and its
Working, Budget Key Factor; Fixed and Flexible Budgets; Functional and Master Budgets: Sales and Cash
Budget; Zero Based and Incremental Budgets.

Suggested Reading:
1. Financial Accounting: A Managerial Perspective, HPH by Narayanswamy, Publisher: Prentice Hall of India
Private Limited
2. Financial Accounting for Business Managers, by Bhattacharyya, Ashish K Publisher: Prentice Hall of India
Private Limited
3. Financial Accounting for Management: Text & Cases by Subhash Sharma, Publisher: Macmillan India
Limited
4. Management Accounting - Concepts & Applications by Kothari G, Publisher: Macmillan India Limited.
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INTRODUCTION TO ACCOUNTING
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Structure

1.1 Introduction
1.2 Definition of Accounting
1.3 Accounting a Means and Not an End
1.3.1 Objectives and Functions
1.3.2 Branches of Accounting
1.3.3 Distinction between Book Keeping and Accounting
1.3.4 Users of Accounting Information
1.3.5 Advantages and Limitations of Accounting
1.3.6 Bases of Accounting
1.3.7 Basic Terms in Accounting
1.4 Accounting Principles and Standards
1.5 System of Book – Keeping
1.6 Summary
1.7 Review Questions

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1.1 INTRODUCTION
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Dear students, let me introduce to you this entire subject which is scoring and fruitful in
many ways. So let’s start… In this unit our objective is to get acquainted with the basic need,
development & definition of basic terms. The accounting records maintained help various
interested parties in variety of manner. For some persons, it will be informative whereas for
others it may take crucial investment decisions based on the accounting information.
Accounting is the language of the business, the basic function of which is to serve as a means
of communication. If you ask to whom does it communicate the results of business operations
then the various interested parties are owners, creditors, investors, governments and other
agencies. Any language has three important jobs to perform: To act as a medium of
communication; to help in understanding the existing literature; to make additions to the
already existing literature. Accounting has been performing all these roles. As a language it is
responsible for preparing financial statements with its own syntax. The syntax of the
accounting language comprises of the total system of recording and analyzing business
transaction called Double Entry System of Book-Keeping, the basic principles on which it is
based like Accounting Standards or Generally Accepted Accounting Principles (GAAP).

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1.2 DEFINITION OF ACCOUNTING
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To start with we can say that, accounting is concerned with the processes of recording,
sorting, and summarizing data resulting from business operations and events. The definition
is given by the American Institute of Certified Public Accountants which clearly brings out
the meaning and function of accounting. According to it accounting is: “The art of recording,
classifying and summarizing in a significant manner and in terms of money, transactions and
events which are, in part at least, of a financial character and interpreting the result thereof.”
Now as you have read the aforesaid definition now let’s perceive what it means to say:
Accounting is an art: Accounting classifies as an art, as it helps in attaining our aim of
ascertaining the financial results. Analysis & interpretation of financial data are the art of
accounting, requiring special knowledge, experience and judgment.

It involves recording, classifying and summarizing: recording means systematically writing
down the transactions and events in account books soon after their occurrences, classifying is
the process of grouping transactions or entries of one nature at one place. This is done by
opening accounts in a book call ledger. Summarizing involves the preparation of reports &
statements from the classified data (ledger) understandable and useful to management and
other interested parties. This involves preparation of final accounts. It records transaction in
the terms of money: This provides a common measure of recording and increases the
understanding of the state of affairs of the business.

Deals with financial transaction: It records only those transaction and events, which are of
financial character. If a transaction has no financial character then it will not be measured in
the terms of money and will not be recorded. Interpretation: It is the art of interpreting the
results of operations to determine the financial position of the enterprise, the progress it has
made and how well it is getting along. Accounting involves communication: The results of
analysis and interpretation are communicated to management and to other interested parties.

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1.3 ACCOUNTING – A MEANS AND NOT AN END
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After analyzing properly the information supplied by the accounting statements the users of
the same take decision for the future activities. Since accounting supplies the necessary
information, it performs, in fact, a service function and, at the same time, it is sued to
represent economic position of an entity. Therefore, it becomes clear that keeping of accounts
is not the primary objective of either a person or an entity. On the contrary, the primary
objective is to take decision on the basis of financial facts presented by accounting
statements. Thus, the understanding of accounts is not the basic objective; it only helps to
realize a specific objective. As such, accounting is not an end in itself but a means to an end.
It is essentially a service function designed to provide relevant information concerning an
entity for those who are interested in interpreting and using that information.

1.3.1 Objectives and Functions
As you have already seen above that, the primary or basic objective of accounting is to
supply the necessary information to the users and analysts for taking futuristic decisions, so
let’s have a look at its other objects and functions, they are:

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• Providing necessary information about the financial activities to the interested parties
• Providing necessary information about the efficiency, or otherwise, of the
management regarding the proper utilization of the scarce resource.
• Providing necessary information for predictions (financial forecasting)
• Facilitates to evaluate the earning capacity of the firm by supplying a statement of
financial position, a statement of periodical earning together with a statement of
financial activities to the various interested person.
• Facilitates decisions regarding the changes in the manner of acquisition, utilizations,
preservation and distribution of the scarce resources.
• Facilitates decisions regarding replacement of fixed assets and expansion of the firm
• Provides necessary data to the government for taking proper decisions relating to
duties, taxes and price control etc.
• Devices remedial measure for the deviations between the actual and budgeted
performance.
• Provides necessary data and information to the managers for internal reporting and
formulation of overall policies.

1.3.2 Branches of Accounting
• Financial Accounting: Accounting as discussed above, deals with recording,
classifying and summarizing business events, which have already occurred and is,
therefore, historical in nature. That's why it is called Historical Accounting or Post-
mortem Accounting or more popularly financial Accounting. Its aim is to develop
information about income and financial position on the basis of business events,
which have taken place during a period of time. Information provided by financial
accounting system about financial results and financial position on historical basis is
significant but not sufficient for smooth, orderly and efficient running of the business.
Management needs more information for planning and control of the business
activities. The answer lays in two more forms of accounting namely, Cost Accounting
and Management Accounting.

• Cost Accounting: It deals with detailed study of cost with reference to cost
ascertainment, cost reduction and cost control. The emphasis is no historical costs as
well as future decision-making costs.

• Management Accounting: It provides information to the management not only about
cost but also about revenue, profits, investments etc. to enable managers to discharge
their functions of managing the business more efficiently and effectively. Thus, it
provides required database to managers to plan and control the activities of business
enterprises.

• Social Responsibility Accounting: It involves accounting of social costs incurred by
the enterprises and social benefits created by it reporting thereof.

1.3.3 Distinction between Book-Keeping and Accounting

Book-keeping differs from accounting in the following respects:
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Basis of Book-keeping Accounting
Distinction
1. Scope Book-keeping involves: Accounting in addition to Book-
(a) Identifying the keeping involves:
transactions; (a) Summarizing the classified
(b) Measuring the identified transactions;
transaction; !b) Analyzing the summarized
(c) Recording the measured results;
classifying the recorded (c) Interpreting the analyzed results;
transactions. (d) Communicating the interpreted
information to the interested parties.
2. Stage Book-keeping is primary Accounting is the secondary stage.
stage. It starts where Book-keeping ends.
3. Basic The basic objective of Book- The basic objective of accounting is
keeping is to maintain to ascertain net results of operations
systematic records of and financial position and to
financial transactions. communicate information to the
interested parties.
4. Who Performs Book-keeping work is Accounting work is performed by
performed by junior staff. senior staff.
5. Knowledge The Book-keeper is not The accountant is required to have
Level required to have higher level higher level of knowledge than that
of knowledge than that of an of Book-keeper.
accountant.
6. Analytical The Book-keeper may or may The accountant is required to
Skill not possess analytical skill. possess analytical is nature.
7. Nature of Job The job of a book-keeper is The job of an accountant is
often routine and clerical in analytical is nature.
nature.
8. Designing of It does not cover designing of It covers designing of accounting
Accounting accounts system. system.
System
9. Supervision The Book-keeper does not An accountant supervises and
and Checking supervise and check the work checks the work of a book-keeper.
of an accountant.

1.3.4 Users of Accounting Information
1. Owners: Owner(s) refers to a person or group of persons who have supplied capital
for running the business. It refers to Individual in case proprietor partners in case of
partnership firm and shareholders in case of Joint Stock Company. Information needs
of shareholders have assumed great significance in the corporate business world
because of separation of ownership and management in case of joint stock companies.
Owners are interest in the financial information to know about safety of amount
invested and return on amount investment.

2. Managers: For managing business profitably, information about financial results and
financial position is needed by management. By providing this information,
accounting helps managers in efficient and smooth running of a business enterprise.

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3. Investors: Prospective investors would like to know about the past performance of
the business enterprise before making investment in that concern. By analyzing
historical information provided by accounting records, they can arrive at a decision
about the expected return and the risk involved in investing in a particular business
enterprise.

4. Creditors and Financial Institutions: Whosoever is extending credit or loan to a
business enterprise, would like to have information about its repaying capacity,
credit worthiness etc. Analyzing and interpreting the financial statements of the
business enterprise can obtain the required information.

5. Employees: Employees are concerned about job security and future prospects. Both
of these are intimately related with the performance of the business enterprise. Thus
by analyzing financial statements they can draw conclusions about their job-security
and future prospects.

6. Government: Government policies relating to taxation, providing subsidies etc. are
guided by relevance of the industry in the economic development of the country and
the past performance of the industry. Information about past performance is provided
by the accounting system. Collection of taxes is also based on accounting records.

7. Researchers: Researchers need financial information for testing hypothesis and
development of theories and models. The required information is provided by
accounting system.

8. Customers: Customers who have developed loyalties to a business are certainly
interested in the continuance of the business. They certainly want to know about the
future directions of the enterprise with which they are associating themselves. The
way to information about the enterprise is through their financial statements.

9. Public: An enterprise affects the public at large in many ways such as a provider of
employment to a number of persons, being a customer to many suppliers, a provider
of amenities in the locality or a cause of concern to the public due to pollution etc.
Hence, public at large is interested in knowing the future directions of enterprise and
the only window to peep inside the enterprise is their financial statements.
Above-mentioned list of group of users of accounting information is not exhaustive. Anyone
having an interest in the business enterprise can use information for decision-making.
1.3.5 Advantages and Limitations of Accounting

The advantages of accounting are as follows:

1. Facilitates to Replace Memory: Accounting facilitates to replace human memory by
maintaining compete record of financial transactions. Human memory is limited by its
very nature. Accounting helps to overcome this limitation.

2. Facilitates to Comply with Legal Requirements: Accounting facilitates to comply
with legal require an enterprise to maintain books of accounts. For example, Sec. 209
of The Companies Act 1956, requires a company to maintain proper books of
accounts on accrual basis, Sec 44AA of The Income Tax 1961 requires certain
persons to maintain specified books of accounts.

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3. Facilitates to Ascertain Net Result of Operations: Accounting facilitates to
ascertain net results of operations by preparing Income Statement.

4. Facilitates to Ascertain Financial Position: Accounting facilitates to ascertain
financial position by preparing Position Statement.

5. Facilitates the Users to Take Decisions: Accounting facilitates the users (i.e., Short-
term Creditors, Long-term Creditors, Present Investors, Potential Investors, Employee
groups, Management, General Public, Tax Authorities) to take decisions by
communicating accounting information to them.

6. Facilitates a Comparative Study: Accounting facilitates a comparative study in the
following four ways:

• Comparison of actual figures with standard or budgeted figures for the same
period and the same firm;
• Comparison of actual figures of one period with those of another period for the
same firm (i.e. Intra-firm Comparison);
• Comparison of actual figures of one firm with those of another standard firm
belonging to the same industry (i.e. Inter-firm Comparison); and
• Comparison of actual figures of one firm with those of industry to which the
firm belong (i.e. Pattern Comparison).

7. Assist the Management: Accounting assists the management in planning and
controlling business activities and in taking decisions. For example, Projected Cash
Flow Statement facilitates the management to know future receipts and payments and
to take decision regarding anticipated surplus or shortage of funds.

8. Facilitates Control over Assets: Accounting facilitates control over assets by
providing information regarding Cash Balance, Bank Balance, Debtors, Fixed Assets,
Stock etc.

9. Facilitates the Settlement of Tax Liability: Accounting facilitates the settlement of
tax liability with the authorities by maintaining proper books of accounts in
systematic manner.

10. Facilitates the Ascertainment of Value of Business: Accounting facilitates the
ascertainment of value of business in case of transfer of business to another entity.

11. Facilitates Raising Loans: Accounting facilitates raising loans from lenders by
proving them historical and projected financial statements.

12. Acts as Legal Evidence: Proper books of accounts maintained in systematic manner
act as legal evidence in case of disputes.

The Limitations are as follows: The financial accounting is mainly concerned with the
preparation of final accounts, i.e. Profit and Loss Account and Balance sheet. The business
has become so complex that mere final accounts information is not sufficient in meeting
information needs. The management needs information for planning; controlling and co-
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coordinating business activities. It is because of the limitations of financial accounting that
cost accounting and management accounting have developed. Some of the limitations of
financial accounting are discussed as follows:

1. Historical Nature: Financial accounting is historical in nature in the sense that it is a
record of all those transactions, which have taken place in the business during a
particular period of time. The impact of future uncertainties has no place in financial
accounting. As management needs information for future planning, financial
accounting can only give information about what has happened and not about what
will happen. It does not suggest what should be done to increase the efficiency of the
concern.

2. Provides Information About the Concern as a Whole: In financial accounting,
information is recorded for the whole concern. One can find information about total
expenses and total receipts only. The information is not recorded product-wise
process-wise, department-wise or any other line of activity. It is essential to record
information activity-wise so as to be helpful for cost determination and cost control
purposes.

3. Not Helpful in Price Fixation: Financial accounting is not helpful in fixing prices of
products. The cost of a product can be obtained only when all expenses have been
incurred. It is not possible to determine the price in advance. The concern may be
required to quote a price for the supply of goods in the near future (for submitting
tenders, etc.) Financial accounting cannot supply all these information’s, so it is
helpful in price determination, Price fixation requires information about variable and
fixed costs, direct and indirect costs. Indirect expenses are estimated on the basis of
past records for price determination purposes.

4. Cost Control not Possible: Cost control is not possible in financial accounting. The
cost figures are known only at the end of a financial period. When the cost already
been incurred then nothing can be done to control it. There is no technique in financial
accounting, which can help to ascertain whether the cost is more or less while the
expenses are being incurred. There is no procedure to assign responsibility for higher
costs, if any. The costing process requires a constant review of actual costs from time
to time and this thing is not possible in financial accounting.

5. Appraisal of Policies not Possible: It is not possible to evaluate various policies and
programs in financial accounting. There is no technique for comparing actual
performance with budgeted targets. Whether the work is going on as per schedule or
not, cannot be determined. The only criterion for determining efficiency is to see
profits at the end of financial period. The profitability is the only yardstick for
evaluating managerial performance. Profits of an enterprise are influenced by a
number of outside factors also, so it is not a reliable test for ascertaining efficiency of
the management.

6. Only Actual Costs Recorded: Financial accounting records only actual cost figures.
The amount paid for purchasing materials, property or other assets is recorded in
account books. The prices of goods and assets go on varying from time to time. The
present prices of assets may be absolutely different from the recorded costs. Financial
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accounts do not record price level changes. The recorded costs cannot provide correct
information or exact values of assets.

7. Not Helpful in Taking Strategic Decisions: Management is to take strategic
decisions like replacement of labor by machinery, introduction of a new product,
discontinuation of an existing line of production, expansion of capacity, etc. The
impact of these decisions and cost involved will have to be ascertained in anticipation.
Various alternative suggestions are to be studied before taking a final decision.
Because information is recorded for the whole concern and it is available only when
the event has taken place.

8. Technical Subject: Financial accounting is a technical subject. The recording of
transactions and making their use requires knowledge of accounting principles and
conventions. A person who is not conversant with accounting subject has little utility
of financial accounts.

9. Quantitative Information: Financial accounting records only that information which
can be quantitatively measured. Anything which cannot be quantitatively measured
will not form a part of financial accounting even though it is important for the
business. The policies and plans of the government have a direct bearing on the
working of the working of the business. It is essential to determine the impact of
government decisions on the entrepreneurial policies. Financial accounts will avoid
qualitative factors because they cannot be quantitatively measured.

10. Lack of Unanimity about Accounting Principles: Accountants differ on the use of
accounting principles. In spite of the efforts of International Accounting Standards
Committee, there is a lack of unanimity on the use of accounting principles and
procedures. The methods of valuing inventory and methods of charging depreciation
are the most controversial issues on which unanimity has not been possible. The
preference for the use of different accounting principles brings in an element of
subjectivity and human biased ness. The use of different accounting methods reduces
the usefulness and reliability of accounts.

11. Chances of Manipulation: There are chances of using financial accounts to suit the
whims of management. The over-valuation or under-valuation of inventory may
change the figures of profits. More profits may be shown to get more remuneration,
issue more dividends or to raise the prices of company’s shares. Less profit may be
shown to save taxes for not paying bonus to workers, etc. The possibility of
manipulating financial accounts reduces their reliability.

1.3.6 Bases of Accounting
The income of business belongs to owner and is a direct result of matching of revenues of a
period and expenses of the same period. It is always calculated at the end of the period and,
hence, is an ex-post or actual income. The matching of revenues and expenses of a period can
be done on the following three bases called Bases of Accounting:

• Accrual Bases: Under this base, the incomes as well as expenses are considered on
the bases of their occurrence in an accounting period and not on the bases of their
actual receipts/ payments. Hence, revenues are recognized if they belong to the
period, irrespective of the fact whether received in cash or not expenses are
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