Accounting and Financial Reporting

Accounting refers to systematic recording, classifying and

summarizing of financial transactions and interpreting the
results thereof. Thus, accounting encompasses
financial reporting.
Accounting starts with recording and ends with
presentation of financial information in a manner that
facilitates informed judgments and decisions by users.
• Functions of Accounting System
• Internal routine reporting to managers for cost planning
and cost control of operations, and performance
evaluation of people and activities.
• Internal routine reporting to managers on the profitability
of products, brand categories, customers etc.
• Internal non-routine reporting to managers for strategic
and tactical decisions.
• External reporting through financial statements.
Accounting Trail

Identify a transaction

Recording
Record in Primary Books

Record in Secondary
Books

Prepare Trial Balance

Reporting Prepare Financial

Statements
• Events and Transactions
• An event is a happening of consequence to an
entity.
• An event could be an internal happening or
external happening.
• External events that involve transfer of value
( in monetary terms) between two entities
(within or outside) are called transactions.
• Thus, a transaction is an external event that
affects the financial position of an entity.
• Recording of Transactions: The Double Entry
Principle
• Each transaction has two aspects (or side):
Debit and Credit.
• Every debit has an equal and opposite credit.
• Each transaction should be recorded in such a
way that it affects two sides- debit and credit-
equally.
• Thus, the first and foremost step in recording a
transaction is to identify the debit and credit
elements.
• Basic Accounting Concepts
• An understanding of accounting concepts is vital to understand the
process of accounting.
• Accounting concepts underlying the recording of transactions:
– Entity Concept
– Money Measurement Concept
– Accrual Concept
– Cost Concept
• Accounting concepts underlying financial reporting:
• Going Concern Concept
• Periodicity Concept
• Matching Concept
• Prudence
• Substance over form
• Consistency
• Accounting Concepts: Entity and Money
Measurement
• Entity Concept:
• A business entity is an economic unit distinct
from its owner(s). Such entity owns its assets
and has its own obligations. Only those
transactions and events which affect the
financial position of the business entity will be
recorded in its books of accounts.
• Money Measurement Concept:
• Only transactions and events which are
measurable in monetary terms should be
recorded.
• Accounting Concepts: Accrual and Cost
• Accrual Concept:
• Income and expenses should be recognised as
and when they are earned and incurred,
irrespective of whether money is received or
paid in connection thereof. An alternative of
accrual basis of accounting is cash basis where
transactions are recorded only when cash is
received or paid.
• Cost Concept:
• Assets and liabilities should be recorded at
historical cost. The recent trends in
accounting show that policy makers favour fair
value accounting in place of historical cost
accounting.
• Accounting Concepts: Going Concern and
Periodicity
• Going Concern Concept:
• An entity is said to be a going concern if it has
‘neither the intention nor the necessity of
liquidation or of curtailing materially the scale of
the operations’. The valuation principles of
assets and liabilities depend on this concept.
• Periodicity Concept:
• Accounts are prepared for a defined accounting
period. Such period could be a quarter, half
year, a year or, in exceptional circumstances,
more than one year. This concept is essential to
measure financial performance.
• Accounting Concepts: Matching and Prudence
• Matching Concept:
• While measuring periodic financial results, revenue
earned during an accounting period is matched with
expenses incurred (to earn the revenue) in the same
accounting period. Thus, expenditure incurred during
construction phase should be withheld till the business
starts commercial activity and earns revenue.
• Prudence Concept:
• This concept suggests that all possible expenses and
losses should be estimated and recorded, but
anticipated gains should be ignored. This concept is
also called the concept of ‘conservatism’.
• Accounting Concepts: Substance over form and
Consistency
• Substance over form:
• While recording transactions more emphasis needs to
be given to the substance of the transactions and not
merely to their legal form. A transaction may appear
to be an expense when looked at from legal angle (e.g.,
construction of road by a business entity on land owned
by the municipality), but the substance of the matter
may demand such expense be shown as asset (e.g.,
if such road is primarily used by the business entity for
its business purposes).
• Consistency:
• A business entity frames accounting policies that lay
down rules for presentation of financial statements.
Accounting policies, once framed, should be
consistently followed. However, such policies may be
changed if circumstances so warrant.
• Financial Statements: Objective
• To provide information about the
financial position, performance and
cash flows of an enterprise that is
useful to a wide range of users in making
economic decisions.
• Financial statements do not necessarily
provide non-financial information.
• Financial Statements: Qualitative
Characteristics
• Understandability
• Relevance
• Reliability
– Faithful representation
– Substance over form
– Prudence
– Neutrality
• Comparability
• Financial Statements: Elements
• Elements measuring financial position:
– Assets
– Liabilities
– Equity
• Elements measuring performance:
– Income (includes gains)
– Expenses (includes losses)
• Financial Elements: Definition
• Assets are economic resources controlled by
the enterprise as a result of past events
from which future economic benefits are
expected to flow to the enterprise.
• Liabilities are present obligations of the
enterprise arising from past events, the
settlement of which is expected to result in an
outflow from the enterprise of resources
embodying economic benefits.
• Equity is the residual interest in the assets of
the enterprise after deducting all its liabilities.
• Income is increase in economic benefits during
the accounting period in the form of inflows
or enhancement of assets or decreases of
liabilities that result in increases in equity, other
than those relating to contributions from equity
participants.
• Expenses are decreases in economic benefits
during the accounting period in the form of
outflows or depletion of assets or incurrence of
liabilities that result in decreases in equity,
other than those relating to distributions to
equity participants.
• Corporate Financial Statements
• What are the corporate financial statements?
• Balance Sheet
• Shows the financial position (position of assets,
liabilities and equity) as on the reporting
date.
• Profit & Loss Account
• Shows the financial results (profit or loss) for an
accounting period.
• Cash Flow Statement
• Shows the net increase /decrease in cash and
cash equivalents during the accounting
period.
• Accounting Equation
• The relationship among three elements of the
balance sheet can be expressed through an
equation, known as fundamental accounting
equation:
• Assets (A) = Liabilities (L) + Equity
(E)
• The unique feature of the above equation is that
all transactions will affect the equation in such
a way that the equality will always be
maintained. This happens due to double
entry rule.