Basic Concepts: Overview of Financial Accounting

very individual who wants good returns and wants to invest in good company studies the
financial accounting of the particular company in which he is willing to invest. Thus we
can say that financial accounting plays an important role in the decision making of an
individual.
Financial accounting communicates the information about a business or
organization, which proves beneficial to the investors to get clear picture of its future
prospects from the point of view of investments. Financial statements are useful to the
outsiders namely to the investors, shareholders , lenders etc . as shareholders,
investors had already invested in the company and its their right to know where is their
money or funds been utilized.
Financial accounting mainly deals with the summary of the financial transactions that
takes place in an organization or business. It also deals with the analyzing and reporting
of the financial transactions from time to time. Financial accounting proves helpful to the
shareholders, present investors, future investors, banks, employees, government
agencies etc. In short, we can say that financial accounting is useful to such people who
are willing to do business, investments with a particular company or an organization. It
is one of the oldest method and is also used to know whether the organization has
gained profit or loss during the particular and previous financial years. It provides
periodical reports to businessmen.
It clearly states all the financial transactions such as outstanding amounts, operating
costs, petty cash of the business. It is compulsory whenever the company wants finance
or loans from banks.
Double entry book-keeping is the accounting technique used to record each and
every financial transactions. Basically, double entry means that every transactions have
two effects. In double entry one entry is passed on debit side and other on credit side.
And both this amounts should match at the end.
Also, financial accounting follows the accrual basis of accounting, which means that the
revenues are recorded only when they are earned and not when the revenue is received
in terms of money. Likewise, the same is the case with expenses i.e. expenses are
considered when they are incurred and not when they are paid in actual.

By following the accrual basis of accounting, the organization or business assets,

liabilities, profits and other financial details are more clearly visible from the economic
point of view.
FINANCIAL STATEMENTS:
There are various financial statements that are included in the financial accounting.
They are as follows;

1. INCOME STATEMENT:
The income statement is one of the major and most important statements from the point
of view of the accountants, business owners and shareholders.
The income statement provides the clear picture of the profit earned by the company in
specified period of time. This time span can be a week, month, quarter, half yearly and
also a year as per the convenience of the company. It is similar to profit and loss
statement.
The income statement mainly includes revenues, gains, expenses, losses. This helps
the lenders, borrowers to know whether the company has earned profit or loss.

If,
NET REVENUES & GAINS NET LOSS = POSITIVE , then at the bottom of the
income statement it is mentioned as NET INCOME.

If,
NET REVENUES & GAINS - NET LOSS = NEGATIVE , Then at the bottom of the
income statement it is mentioned as NET LOSS.

2. BALANCE SHEET:
The balance sheet gives the snapshot of the companys financial position during the
particular financial year.
The balance sheet comprises of 3 main components namely

Assets

liabilities

stockholders equity

The fundamental accounting equation of balance sheet is:

ASSETS = LIABILITIES + EQUITY
This concept or equation is used since past centuries as it states what all business
assets are owned either by creditors or owners.
The assets are those things that company owes. It consists of prepaid insurance,
land,cash, accounts receivable, inventory, prepaid insurance, building, machinery,
vehicles, goodwill, patent, other equipments etc.
While, the liabilities consists of the outstanding or expenses that are due till date, ie.
accounts payable, interest payable, wages payable, etc.

3. STATEMENT OF CASH FLOW:

This is the main and important financial statement than other statements such as
balance sheet, income. It gives detailed information about the cash generated and cash
utilizes during the financial year. The period of statement is choosen and differ from
company to company.

Operating activities, investing activities, financing

information are the main components of the cash flow.

activities and

supplemental

4. STATEMENT OF STOCKHOLDERS EQUITY:

The statement of stockholders equity mainly refers to the ownership and contribution of
each and every stockholder. It is also called as net worth or equity of the
stockholders. The main components of the stockholders equity are as follows:

Prefered Stock :- This means those investments that are voluntarily preferred by
the stockholders. The stockholders receive a divided after a certain period of time
as per the companys policies ie quarterly, half yearly or yearly and are usually
recorded at par value.

Common Stock :- Common stock is always valued at par or stated value of the
stockholders investment.

Additional paid-up capital :- Additional paid-up capital is that capital which is

received from investors and is always equal to capital stock + paid- in capital,
also known as contributed capital.

Retained Earnings :- Retained earnings is that total net income or loss, less the
amount distributed to the shareholders in the form of a dividend since the
establishment of the company.

ROLE OF FINANCIAL ACCOUNTING IN THE BUSINESS ORGANIZATION:

As we know that the main purpose of financial accounting is to summarize the financial
activity of the business, which proves helpful for the investors, creditors, bankers etc.
Hence, financial accounting plays the following role:
1. Investing Decisions:
Investment decision totally depends upon the balance sheet, statement of cash flow,
statement of income etc. All these statements are maintained according to a particular
format and standard i.e. Financial Accounting Standard Board (FASB).

Unless and until the financial information is provided to the investors, they do not
approach to invest in any company. Hence it is very important to show the clear picture
and details of companys history, its current financial status and future estimation,
bonds, stocks etc which satisfies the investors.

2. Corporate Governance:
Financial accounting proves beneficial to its financial managers and finance department
to make budgets, understand the market demand, efficiency, analyze the performance
etc. With the help of and on the basis of financial accounting the financial managers set
the goals and design the long term and short term strategies accordingly.

3. Lending Decisions:
The lenders i.e. the banks and other financial institutions need to study the various
financial ratios like debt to equity, interest earned, profit earned etc. inorder to lend the
money or sanction the loan.
As, lending a huge amount is a high risk, financial accounting helps to provide
assurance and helps in taking decision whether to lend or not.

VARIOUS CONCEPTS OF FINANCIAL ACCOUNTING:

1. BUSINESS ENTITY CONCEPT:
This concept means that even though an individual as a sole proprietor starts the
business, his business is considered as a separate entity. So, it is necessary to record
the business accounts transactions separately than the proprietors personal accounts.

2. MONEY MEASUREMENT CONCEPT:

In this concept, all the transactions are considered in terms of money.

3. REALIZATION CONCEPT:
In this concept, the revenue is generated only when the sale occurs in actual.

4. MATCHING CONCEPT:
In this the cost incurred is matched with the revenue generated.

CONVENTIONS OF FINANCIAL ACCOUNTING:

There are mainly three types of conventions:

1. Convention of conservation
2. Convention of consistency
3. Convention of material disclosure

COST ACCOUNTING:

Cost accounting is that process which is mainly concerned with collecting, analyzing,
summarizing and evaluations of various courses of action. it determines the total cost
that is incurred in producing a particular unit of an item. It ultimately advices the
management to take corrective measures and actions related to cost efficiency and
control. This ultimately helps the management to take further action related to cost
reduction or cost cutting.
The cost accountings primary function is to assist the managers in decision making.
Cost accounting is undertaken in all types of industries like manufacturing, trading,
service etc.
There are mainly two types of costs viz:
1. Fixed Cost : Fixed cost is that cost which remains fixed even though change in
other things.

eg. Depriciation of machinery, vehicles,cost of equipments, tooling, rent etc.

1. Variable Costs: Variable cost is that cost which varies directly according to the
change in the quantity or volume that is produced.
eg. labour charges, raw material, electricity etc.

ELEMENTS OF COSTS:
The basic and important cost elements are as follows:
1. Raw Materials: With the help of raw material the final product is produced. thus,
we can say that it is the base for the producing the final product.

2. Labour: For undertaking any course of action, labour or manpower is required.

So, labour is considered as one of the element of costs.

3. Expenses / Overheads: These are those expenses which are indirectly related to
the production. Also, some overheads are fixed while some are variable.They
include:

Administration overheads

Selling overheads

Production or works overheads

salaries

Rent

Depreciation

other fixed expenses.

CLASSIFICATION OF COSTS:
The costs are classified on various basis. They are as follows:
1. By Element:
There are mainly three elements of costs viz. material, labour and expenses/overheads.
2. By Nature:
It mainly consists of two types of costs i.e. Direct Cost and Indirect Costs.
3. By Functions:
It includes production, administration, selling and distribution, R&D, etc.
4. By Behaviour:
In this there are three types ie. fixed cost, variable cost and semi- variable costs.
5. By controlability:
This consists of two types viz, controllable and uncontrollable costs.
6. By Time:
It includes historical and Predetermines costs.
7. By decision making:
This costs itself is related to decision making. They include:

Marginal Costs

opportunity Costs

differential costs

Relevant costs

Replacement costs

ROLE OF COST ACCOUNTING IN BUSINESS ORGANIZATION:

The cost accounting plays the following role in every business organization:
1. Decision Making:
The cost accounting helps the management in taking important decisions which proves
beneficial for the organization.

2. Planning:
Planning is considered to be one of the important function in each and every
organization. Planning is concerned with forecasting or estimating of the future financial
performance and position of the business. future forecasting helps to know the future
cash flows, expenses that will be incurred, profit and loss is also estimated.
Cost accounting helps to undertake short-term and long-term planning with regards to
the budgeting, cost-volume-profit analysis etc.

3. Monitoring And Control:

Cost accounting helps to continuously monitor the costs that are incurred from time to
time.This ultimately helps in controlling the costs if it is exceeding than the estimated at
a certain point of time. This helps the business organization to identify where the cost is
incurring more.

4. Implementation :
With the help of cost accounting, the managers can implement new methods or
techniques in order to control the costs if at a particular point it is exceeding than
expected.
MANAGEMENT ACCOUNTING:

Management accounting deals with the process of tracking internal costs and preparing
management reports, accounts which provides exact and accurate information from time
to time. It also provides data in the form of statistics which is needed by the managers
for taking day to- day decisions. also, it helps to make short- term decisions.
In management accounting, the reports are made for the organization according to the
convenience or requirement i.e. weekly, monthly, quarterly etc. for the various
departments, executives and officers.
This report gives information about the availability of cash, accounts payable,
receivable, inventory, outstanding debts etc of the business organization.

TYPES OF MANAGEMENT ACCOUNTING:

The American Institute Of Certified Public Accountants stated that there are mainly
three types of management accounting namely,
1.

Strategic Management:

This helps in doing strategic planning for the betterment of the organization.
2.

Risk Management:

This is related to identifying, measuring and also managing the risks that may occur in
the business.
3.

Performance Management:

In this the performance of the organization is examined and necessary steps are taken
to improve the performance by making necessary changes wherever required.
Management accounting is used by businesses, non- profit organizations, government
offices and also by individual proprietors.

Management accounting includes combination of three components ie. financial

accounting, management accounting and auditing. Organizations require management
accounting as it helps to know how efficiently the estimated budget works.

ROLE OF MANAGEMENT ACCOUNTING IN BUSINESS ORGANIZATION:

The management accounting plays the following important role.
1.

Planning:

Management accounting helps in the planning process and both long-term and shortterm plans can be made and implemented from time to time as per the requirement.
2.

Controlling:

Controlling is the comparison between achieved and planned performance.Managers

are warned and asked to work as per the need of and hour.
3.

Organizing:

With the help of management accounting, the activities that are to be undertaken are
identified and are organized properly as per the requirement in the organization.
4.

Communicating:

In this the hierarchy is developed within the departments which helps to have smooth
and proper channel of communication with each and every employee and department.
5.

Motivating:

Due to future planning, managers are identify the requirement and can motivate their
subordinated in order to get the expected results.