BBA Semester 1(NEP) New Syllabus.

Unit 1 Chapter 1
Financial and Management Accounting.

Financial Accounting
Financial Accounting is defined as the science and art of recording and classifying
business transactions and making significant summaries for the determination of year-
end profit or loss and their effect on owner’s capital, assets and liabilities. The American
Institute of certified Public Accountants has defined financial accounting as “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 results thereof”. Financial accounting is thus concerned with the
compilation and communication of financial information.

OBJECTIVES OF FINANCIAL ACCOUNTING

An analysis of the above definition brings out clearly the objectives and functions of
financial accounting. The following may be listed out as its main objectives:
• To ascertain the operating results of the enterprise.
• To reveal the financial position of the business and
• To enable control over the operations as well as the resources of the business.

FUNCTIONS OF FINANCIAL ACCOUNTING

An analysis of the above definition brings out the following functions of accounting:
1. Recording: This is the basic function of accounting. It is essentially concerned
with not only ensuring that all business transactions of financial character are in
fact recorded but also that they are recorded in an orderly manner. Recording is
done in the book “Journal”. This book may be further sub-divided into various
subsidiary books such as Cash Journal (for recording cash transaction), Purchases
Journal (for recording credit purchases of goods), Sales Journal (for recording
 credit sales of goods), etc. The number of subsidiary books to be maintained will
be according to the nature and size of the business.
2. Classifying: Classification is concerned with the systematic analysis of the
recorded data, with a view to group transactions or entries of one nature at one
place. The work of classification is done in the book termed as “Ledger”. This
book contains on different pages individual’s account heads under which all
financial transactions of similar nature are collected. For example, there may be
separate account heads for Travelling Expenses, Printing and Stationery,
Advertising, etc. All expenses under these heads after being recorded in the
Journal will be classified under separate heads in the Ledger. This will help in
finding out the total expenditure incurred under each of the above heads.
3. Summarizing: This involves presenting the classified data in a manner which is
understandable and useful to the internal as well as external end –users of
accounting statements. This process leads to the preparation of the following
statements, viz. Trial Balance, Income Statement and Balance Sheet.
4. Interpretation: This is the final function of accounting. The recorded financial
data are interpreted in a manner that the end-users can make a meaningful
judgment about the financial condition and profitability of the business
operations. The data are also used for preparing the future plans and framing of
policies for executing such plans.

NEED FOR ACCOUNTING

Accounting has rightly been termed as the language of the business. The basic function
of a language is to serve as a means of communication. It communicates the results of
business operations to various parties who have some stake in the business viz., the
proprietor, creditors, investors, government and other agencies. Though accounting is
generally associated with business, it s not only business which makes use of accounting
but persons like housewives, Government and other individuals also make use of
accounting. For example, a housewife has to keep a record of the money received and
spent by her during a particular period. She can record her receipts of money on one page
of her “household diary”, while payments for different items such as milk, food, clothing,
house rent, education, etc. on some other page or pages of her diary in a chronological
order. Such a record will help her in knowing about:
(i) The sources from which she received cash and the purposes for which it was utilized.
(ii) Whether her receipts are more than her payments or vice-versa?

(iii) The balance of cash in hand or deficit, if any, at the end of a period.
The need for accounting is all the more great for a person who is running a business. He
must know:

(i)What he owns?

(ii) What he owes?

(iii) Whether he has earned a profit or suffered a loss on account of running a business?
(iv)What is his financial position i.e., whether he will be in a position to meet all his
commitments in the near future or he is in the process of becoming a bankrupt.

PARTIES INTERESTED IN FINANCIAL ACCOUNTING INFORMATION

Accounting is of primary importance to the proprietors and the managers. However, the
following other persons are also interested in the accounting information.
1. Proprietors: A business is done with the objective of making profit. Its
profitability and financial soundness are, therefore, matters of prime importance
to the proprietors who have invested their money in the business.

2. Managers: In a sole proprietary business, usually the proprietor is the manager.

In case of a partnership business, they, therefore, act both as managers, since either
some or all the partners participate in the management of the business and as
owners. In case of joint stock companies, the relationship between ownership and
management becomes all the more remote. In most cases the shareholders act
merely as suppliers of capital and the management of the company passes into the
hands of professional managers. The accounting disclosures greatly help them in
knowing about what has happened and what should be done to improve the
profitability and financial position of the enterprise in the period to come.
 3. Creditors: Creditors are the persons who have extended credit to the company.
They are also interested in the financial statements because they will help them in
ascertaining whether the enterprise will be in a position to meet its commitment
towards them both regarding payment of interest and principal.

4. Prospective investors: A person who is contemplating an investment in a

business will like to know about its profitability and financial position.
5. Government: The Government is interested in the financial statements of
business enterprises on account of taxation, labour and corporate laws. If
necessary, the Government may ask its officials to examine the accounting records
of a business.

6. Employees: The employees are interested in the financial statements on account

of various profit-sharing and bonus schemes. Their interest may further increase
in case they purchase shares of the companies in which they are employees.

7. Citizen: An ordinary citizen may be interested in the accounting records of the

institutions with which he comes in contact in his daily life e.g. Bank, temple,
public utilities such as gas, transport and electricity companies. In a broader sense,
he is also interested in the accounts of a Government Company, a public utility
concern, etc., as a voter and a tax payer.

BOOK-KEEPING AND ACCOUNTING

Some people take book-keeping and accounting as synonymous terms, but they are
different from each other. Book-keeping is mainly concerned with recording of financial
data relating to the business operations in a significant and orderly manner. A book-
keeper may be responsible for keeping all the records of a business only of a minor
segment, such as a portion of the Customers’ accounts in a departmental store. A
substantial portion of the Book-Keeper’s work is of a clerical nature and is increasingly
being accomplished through the use of mechanical and electronic devices.
Accounting is primarily concerned with designing the systems for recording, classifying
and summarizing the recorded data and interpreting them for internal and external end
users. Accountants often direct and review the work of the book-keepers. The larger the
firm, the greater is the responsibility of the accountant. The work of an accountant in the
beginning may include some book-keeping. An accountant is required to have a much
higher level of knowledge, conceptual understanding and analytical skill than what is
required for a book-keeper.

LIMITATIONS OF FINANCIAL ACCOUNTING

The financial accounting is mainly concerned with the preparation of final accounts i.e
Profit and Loss Account and Balance Sheet. The modern 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-ordinating
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 below:

1. Historical Nature: Financial accounting is historical in nature in the sense that 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, the
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 total receipts only. The information is not recorded product-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 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 this information, so it is not
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 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 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 the profits at the end of a 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 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 labour 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 studies before taking a final
decision. Financial accounts cannot provide necessary information for taking
important decisions 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 b 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 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. Despite 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 basic needs. 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 profits may be shown to save takes or for not paying bonus to workers, etc.
The possibility of manipulating financial accounts reduces their reliability.