Chapter 1

Introduction

Mentor: Arpan Shrestha

Meaning and concepts of Accounting

Accounting is the process of identification, measurement, documentation, recording,

classification, summarization, interpretation, evaluation and communication to (stakeholder)
interested people or organization.

Accounting is the broader term which includes recording of financial transaction through
journal entries, classification of financial transaction through ledger, summarization of ledger
balance in trial balance, interpretation of the result and communicating to interested people and
institutions that are directly and in directly related with organization. In other words, accounting
is the process of measurement and communication of economic activities which supplies
information to permit judgement and decision users.
 Transaction
Identification
From the figure it is clear that
Measurement
Documentation
accounting is the process of
Recording identifying, recording, classifying,
Communication Journal Entry
Subsidiary Book and summarizing the financial
transaction and interpreting and
analyzing the summarized
transaction and finally
Classification
Interpretation and
Posting into Ledger
communicating the result to the
evaluation
Balancing of ledger
stakeholder.
Summarization
Trial Balance
Trading and P/L account
Balance sheet
Function and Objectives of Accounting

The functions and Objectives of accounting are as follows

1. To keep complete and systematic record: The first function and basic objective of
accounting is to keep complete and systematic record of all financial transaction for future
reference. It records financial transactions in final and then after these transactions are
posted in ledger as per specific rules and principles.

2. To summarize the transaction: Every business firm are established to earn profit and also
growth of business depends upon profit. It is another objectives of accounting to determine
profit or loss by earning trading and profit and loss account of the business for the particular
period of time.
3. To analyze and interpret the financial information: Determination of profit and loss is
nor enough for business form. Accounting analyses and interprets the result the business to
draw conclusion. With the help of the conclusion, the parties find out the financial position
of the business organization.

4. To depict the financial position: A concern, whether trading or non-trading should know
true financial position. For this purpose it prepares a balance sheet at the end of every year
which informs about the positions of assets, liabilities and capital and also reflects the
riskiness of business.

5. To help determination of tax liability: Tax is paid out of profit and the profit is ascertained
through income statement. Accounting provides necessary financial information to tax
authorities and government authorities to determine the tax liability of business.
Limitation of Accounting

From the management of the company to the management of other stakeholders,

financial accounting is highly important. The process of management is greatly
dependent on the financial statements. These statements provide management
with a comprehensive idea about the financial status of the company, its
investment, position, and transaction. However, it is important to understand that
there are certain limitations of financial accounting which do not reveal the true
balance sheet of the firm.
The Various Limitations of Accounting
Besides studying accounting, it is also important to understand the limitations of accounting. These
limitations have been discussed below:

1. Historical Costs - To measure the values, accounting considers historical costs. However, this
process does not allow considering important areas of accounting like inflation, price changes and
similar things as such. Further, this reduces the importance of accounting information and records.
Hence, historical costs are considered to be one of the important limitations of accounting.

2. Estimates - Another important limitation of accounting is estimation. The reason behind is that not
all accounting can be done to establish the exact amount and hence it is essential to estimate. But the
drawback in such a scenario is that the accountant makes the estimation based on his or her
judgment. This estimation is extremely subjective as they are based on the assumption of future
events. Such estimation results in doubtful debts and often at times leads to depreciation.
3. Verifiability - The correctness of the financial statement or for that matter an audit, cannot be
guaranteed. The verification of the statements depends only on the judgment and ability of the
auditor and hence creates plenty of limitations in accounting.

4. Measurability - Events or things that do not have monetary value cannot be measured in
accounting. Such events or things include management, reputation, loyalty, and dedication which
cannot be expressed in money and therefore has no place in accounting. These important
qualities are responsible for the growth of the organization but they cannot be measured and put
in financial statements. Thus it becomes one of the important limitations of financial accounting.

5. Errors and Frauds - Accounting is done by humans, so there will always be the scope of
human errors. There is also the fear of possible manipulation of accounts to cover up a fraud.
Since fraud is deliberate, it is that much harder to spot. This is one of the most dreaded
limitations of accounting.
Accounting Principles and Concept

1) Accrual Principle

It is one of the important accounting concepts and principles that mandate the recording of
transactions in the time period in which they occur. It is regardless of the time when actual cash
flows for the transactions are received. Through accrual principle, one can gain an accurate
insight into the financial status of a business. Most large-scale businesses adopt an accrual
system to determine the cash flow of the business operations. Along with this, revenues and
related expenses are recorded in the same time period of reporting. Both IFRS and GAAP
support this concept. In case, a business has more than $5 million in revenue, then such
businesses must adopt this system for the purpose of taxation.
2. Consistency principle

According to this principle, when an organization adopts a specific accounting method of

reporting or documentation, then it should stay consistent with the method. The aim of this
basic accounting principle is to make financial statements comparable across industries and
companies. This principle has two issues associated with it. First, the principle is not properly
followed when many people are recording data and compiling reports. To combat this issue,
organizations need to have a set method internally. The second issue is related to switching
between the financial reporting methods. Some organizations do this in order to manipulate the
data to their advantage.
3. Conservatism Principle

The Conservatism principle gives you a realistic perspective of unexpected situations.

According to this principle, one should recognize expenses and liabilities at the early stages
even if there is uncertainty about the outcome. However, the principle recognizes revenues and
assets when there is an assurance of its receival. This principle can be applied to recognizing the
estimates. The conservatism principle is the foundation of lower cost or market rule. As per this
rule, one should record inventory at a lower end of its current market value or at its acquisition
cost.
4. Cost Principle (historical Cost)

The Historical Cost principle is another name for the cost principle. Whenever a business
acquires an asset, its initial value is recorded in its financial reports of the business. This value
might not be improved in the market value of inflation. It is also not updated to reflect any
depreciation or even appreciation. This value is known as the cost principle. As per the
principle, companies keep a record of their tangible assets without reflecting the market value.
Through this principle, companies can assess the actual cost of using financial services for
calculating the historical cost principles of the assets of the company.
5. Matching Principle

The matching principle is a concept in accounting that states that companies must report their
expenses and revenues simultaneously. The revenues and expenses are matched on income
statement for a specific time period. It is a part of the accrual accounting method that provides
an accurate representation of operations on the income statement. This principle is quite useful
for investors as investors can match revenue and expenses to get a better sense of the finances
of a business. Along with the income statement, there is a need to assess the cash flow statement
as well.
6. Materiality Principle

As per the materiality principle, any item that may impact the decision-making process of an
investor must be recorded. These details must be recorded in length in the financial statements
using Generally Accepted Accounting Principles (GAAP). The material principle states that the
accounting standard can be ignored if the end result is small. It is an important principle for
deciding if a transaction should be recorded as a part of closing process.

7. Time Period Principle

There are two main regulatory bodies that develop the principles based on accounting concepts.
GAAP and IFRS develop these principles. US-based companies follow GAAP principles
whereas, outside the US, most countries follow IFRS guidelines. GAAP is static in comparison
with the IFRS. IFRS builds principles to address the evolving financial condition in the world.
8. Full Disclosure Principle

In the Full Disclosure principle, each piece of information should be included in the financial statement
of an entity. This is necessary since it might affect the reader’s perspective of understanding the
statement. It is important to only disclose information about events that have a material impact on the
financial position of an entity. As per the full disclosure principle, it may also include those items that
cannot be quantified. Businesses are also liable to report existing accounting policies and any changes in
them as well.

9. Monetary Unit Principle

According to this principle, business transactions should be recorded only when they can be expressed
as currency. Accountants should avoid recording non-quantifiable entities in the financial accounts.
Whenever a transaction or an event occurs, it is first converted into money. After that, it is recorded into
financial accounts of a business. It ensures that every accounting record is measurable in monetary terms
by currencies.
Concept of Financial Accounting

Financial accounting is the process of organizing and communicating a business's financial

information. All of the financial information within a company is collected and calculated in a
document called a financial statement or report. Accountants typically produce this document at
the end of each quarter, business period or year, depending on the company. Financial
accountants keep track of this data and present their reports to the company's manager or
executive.

Financial accounting sorts this information into three main statements. An income statement
describes the company's profits and losses throughout that period. A balance sheet provides
information about the overall financial status of the company. Finally, a cash flow statement
describes how much money the company has earned and spent during that period.
The main functions of financial accounting involve:

• Recording and summarizing a company's transactions and financial activity

• Creating official financial reports at the end of each quarter

• Communicating the financial status of the company to relevant parties

• Informing a company's decision-making processes

The objectives of Financial accounting are
1. Record Financial Transactions: Financial accounting’s main goal is to record a company’s
money-related activities. It’s like keeping a detailed diary of where the money comes from
and where it goes.

2. Provide Clear Financial Picture: It aims to create financial statements like balance sheets
and income statements. These documents give a clear snapshot of how much money the
company has, how much it owes, and how much it’s making.

3. Ensure Accuracy: Financial accounting strives to ensure all the numbers are correct.
Imagine balancing your cheque book to avoid errors – it’s like that but on a larger scale.

4. Comply with Regulations: Companies must follow rules and laws when reporting their
financial information. Financial accounting ensures that the company plays by the rules, like
a referee in a game.
5. Help Decision-Making: Financial accounting data is used by company leaders and
investors to make smart decisions. It’s like having a map to choose the best route on a
journey.

6. Attract Investors: Companies use financial statements to show potential investors how well
they do. It’s like a report card that can convince others to invest in the business.

7. Evaluate Performance: Financial accounting lets you compare the company’s performance
over time. It’s like looking at your grades from last year to see if you’re improving.

8. Assess Financial Health: It helps determine if the company is financially healthy or in

trouble. It’s like going to the doctor for a check-up to ensure everything’s okay.

9. Facilitate Accountability: Financial accounting holds everyone in the company accountable

for their financial actions. It’s like tracking who spent what in a shared household budget.
10. Support Transparency: It encourages companies to be open and honest about their
financial situation, which builds trust with customers, investors, and the public. It’s like
having an open book policy so everyone can see what’s happening.
Cost Accounting

Cost Accounting refers to the classifying, recording and appropriate allocation of expenditure
for the purpose of determining the costs of products or services. It also helps in the presentation
of arranged data for the control purposes and guidance to the management. Cost accounting
deals with the production, selling and distribution costs. It involves the ascertainment of the
cost of every job, order, product, process or service.

The various Objectives of Cost Accounting are

1. Fixing Selling Price

Cost accounting allows managers to understand the cost of each product. With the right data of
cost accounting, the organization can fix a particular selling price per unit of production. In case
an organization deals with a particular service, they can fix the charges for it rightly.
2. Making a Foundation of Total Cost

Making a foundation of cost is the main objective of cost accounting. With the help of a specific
foundation of the cost, a company can understand the level of production it can do at a time.
Moreover, it can divide the total cost and theoretically fragmentize the capital into different
sections of productions like job, process, organization, etc.

3. Determining the Profitable Products

As per the aims of cost, accounting is concerned. It helps an organization to understand

profitable products. If a company deals with several products, it can run a session of cost
accounting and select the specific ones that give proper profits. This way, it can minimize the
chances of a loss.
4. Making a Foundation of Total Cost

Making a foundation of cost is the main objective of cost accounting. With the help of a specific
foundation of the cost, a company can understand the level of production it can do at a time.
Moreover, it can divide the total cost and theoretically fragmentise the capital into different
sections of productions like job, process, organisation, etc.

5. Determining the Profitable Products

As per the aims of cost, accounting is concerned. It helps an organisation to understand

profitable products. If a company deals with several products, it can run a session of cost
accounting and select the specific ones that give proper profits. This way, it can minimise the
chances of a loss.
6. Helps in Proper Decision-making

Decision-making is a vital attribute on which the fate of a business organization depends. Cost
accounting results act as first-hand information depending on which the board can decide the
future moves of the company,

The managerial board of a specific organization has the right to make decisions about the
productions of a company as they are experienced and know the production style of the
company.

7. To Enhance Communication Among Departmental Managers

When the management team organizes a cost accounting session, the managers of different
departments communicate with each other for the statements and other documents. So, it acts as
one of the positive attributes of the company. It can enhance the inter-relation between the various
departments of the company.
The Management Accounting

Management accounting is that branch of accounting which just provides necessary information
to the concerns for taking right decisions in organizations. The timely reporting of necessary
information is normally carried out by management accountants.

Management accounting is a method of accounting that creates statements, reports, and

documents that help management in making better decisions related to their business’
performance. Management accounting is primarily used for internal purposes.
Objectives of Management Accounting

The main objective of management accounting is to assist the management of a company in

efficiently performing its functions: planning, organizing, directing, and controlling.
Management accounting helps with these functions in the following ways:

1. Provides data: It serves as a vital source of data for planning. The historical data captured
by managerial accounting shows the growth of the business, which is useful in forecasting.

2. Analyzes data: The accounting data is presented in a meaningful way by calculating ratios
and projecting trends. This information is then analyzed for planning and decision-making.
For example, you can categories purchase of different items period-wise, supplier-wise and
territory wise.
3. Aids meaningful discussions: Management accounting can be used as a means of
communicating a course of action throughout the organization. In the initial stages, it
depicts the organizational feasibility and consistency of various segments of a plan. Later, it
tells about the progress of the plans and the roles of different parties to implement it.

4. Helps in achieving goals: It helps convert organizational strategies and objectives into
feasible business goals. These goals can be achieved by imposing budget control and
standard costing, which are integral parts of management accounting.

5. Uses qualitative information: Management accounting does not restrict itself to

quantitative information for decision-making. It takes into account qualitative information
which cannot be measured in terms of money. Industry cycles, strength of research and
development are some of the examples qualitative information that a business can collect
using special surveys.
Differentiate between Management, Financial and Cost Accounting
Management Accounting Financial Accounting Cost Accounting
Purpose Management accounting focuses Financial accounting is Cost accounting is a subset of
on providing information and primarily aimed at providing management accounting that
analysis to internal stakeholders, external stakeholders, such as focuses on tracking and
such as managers, executives, investors, creditors, and analyzing the costs of
and decision-makers. It is used regulatory authorities, with an producing goods or services
for planning, controlling, and accurate and standardized within an organization.
decision support within an representation of a company’s
organization. financial performance and
position.
Audience Internal audience, including External audience, including Typically internal stakeholders
management and employees who shareholders, potential like managers and production
need financial data for investors, lenders, and supervisors who need to
operational decision-making. government agencies. manage and control costs.
Scope It includes not only financial data Focuses solely on financial Concentrates on cost data
but also non-financial information and transactions, related to production processes,
information like customer like balance sheets, income including direct and indirect
satisfaction scores, production statements, and cash flow costs, material costs, labor
efficiency, and market research. statements. costs, and overhead.
 Management Accounting Financial Accounting Cost Accounting
Timeframe Reports are prepared as In accordance with legal and The organization generates
frequently as needed, which regulatory requirements, the reports regularly to actively
can be daily, weekly, or organization prepares financial monitor and control costs within
monthly, depending on statements at regular intervals, its production processes.
internal requirements. typically quarterly and annually.

Regulations Not subject to specific Subject to strict regulatory While it follows management
accounting standards or standards and principles, such as accounting principles, it often
regulations, allowing Generally Accepted Accounting adheres to specific cost
flexibility in designing Principles (GAAP) in the United accounting principles and
management accounting States and International Financial methods designed to allocate
systems. Reporting Standards (IFRS) in costs accurately.
many other countries.

Key Focus Forward-looking, helping Historical data, providing a Analyzing and controlling
with budgeting, cost snapshot of a company’s financial production costs, optimizing
analysis, performance performance and position over a resource utilization, and
evaluation, and strategic specific period, which serves as the improving cost efficiency.
decision-making. basis for evaluating past results.