Introduction to Financial Accounting

Dr. Mehul Raithatha

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ACCOUNTING

• Is the language of business

• Performance is reported and evaluated in

financial terms

• Knowledge is useful for personal

investment and tax planning as well

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IMPORTANCE OF ACCOUNTING

• It assists in management

• Helps in planning, organisation and

control of business

• Leads to increase in efficiency of

business

• Maximizes Profit

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Inputs Processing Outputs Users

Business Accounting Financial Investors,

transactions principles statements lenders etc.

and events and procedures and reports

Accounting as an Information System

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USERS OF FINANCIAL STATEMENTS

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STREAMS OF ACCOUNTING: FINANCIAL ACCOUNTING

• Recording of Financial Transactions

• Reporting of Financial Results

• Preparation of Financial Statements

• Targeted to External Users

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STREAMS OF ACCOUNTING: COST ACCOUNTING

• Recording of Costs

• Analysis of Costs

• Preparation of Cost Statements

• Targeted to Internal Users

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STREAMS OF ACCOUNTING: MANAGEMENT ACCOUNTING

• Recording of Financial and other data

• Analysis of Financial and other information

• Preparation of Statements for Managerial

Decisions

• Targeted at Internal Users - All levels of

Management

• As a broader concept encompasses Financial

and Cost Accounting

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FINANCE FUNCTION

• Accounting involves the creation of financial records of

business transactions, flows of finance, the process of

creating wealth in an organisation and the financial

position of a business at a particular moment in time.

• Finance is the lifeblood of economy without which business

cannot run successfully. Sufficient funds at the required time

are the key to success.

• In terms of Husband and Dockery, “Finance is the agent that

directs the flow of economic activity and facilitates its

smooth operation.”

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ACCOUNTING AS AN ACADEMIC DISCIPLINE

• An academic discipline, or field of study, is a branch of

knowledge that is taught and researched.

• Disciplines are defined and recognised by the academic

journals in which research is published, and the learned

societies and academic departments or faculties to which

their practitioners belong.

• Accounting has generally been oriented towards practical

knowledge as opposed to theoretical abstractions.

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MANAGERIAL vs . FINANCIAL ACCOUNTING

Internal

Users

External

Users

ACCOUNTING SYSTEM

(accumulates all accounting data)

Managerial Accounting

Information for decision

making, and control

of an organization’s

operations.

Financial Accounting

Published financial

statements and other

financial reports.

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AUDITING AND INTERNAL CONTROL

As per the Standards on Auditing (SA) 200

issued by the ICAI, “Auditing is the

independent examination of financial

information of any entity, whether profit

oriented or not, and irrespective of its size or

legal form, when such an examination is

conducted with a view to expressing an

opinion thereon.”

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BASIC PRINCIPLES WHICH GOVERN AUDITING

• Integrity

• Objectivity and Independence

• Confidentiality

• Skill and Competence

• Planning

• Audit evidence

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INTERNAL CONTROL

• Internal control is a process affected by an

organisation to provide reasonable assurance

regarding the effectiveness and efficiency of

operations, reliability of financial reporting and

compliance with related rules and regulations.

• Internal control system comprises accounting

controls as well as administrative controls.

FORMS OF BUSINESS ORGANIZATION

• Sole Proprietorship

• Hindu Undivided Family

• Partnership

• Company

• Co-operative Society

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SOLE PROPRIETORSHIP

• It is a business owned and

usually carried on by a

single person known as

proprietor.

• When the ownership and

management of business

are in control of one

individual, it is known as

sole proprietorship.

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SOLE PROPRIETORSHIP (ADVANTAGES vs. DISADVANTAGES)

• Ease of formation

• Better Control

• Prompt Decision Making

• Retention of Business Secrets

• Personal Attention to Consumer Needs

• Limited life

• Unlimited liability

• Limited Financial Resources

• Limited Capacity of Individual

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HINDU UNDIVIDED FAMILY • Hindu Undivided Family (HUF) business is a form of business

organisation found only in India. In this form of business, all

the members of a Hindu undivided family own the business

jointly. The affairs of business are managed by the head of the

family, who is known as the “KARTA” (can be male or

female).

• HUF business comes into existence as per the Hindu

Inheritance Laws of India. The membership is limited up to

three successive generations. Thus, an individual, his

child(ren) and his grandchild(ren) become the members of a

HUF by birth. They are called Co-parceners. A daughter can

also be a coparcener.

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PARTNERSHIP

• A partnership is a relationship between the persons

who have agreed to share the profits. It is a business

owned and carried on by a group of people.

• Each member of such a group is individually known as

partner and collectively the members are known as a

partnership firm.

• These firms are governed by the Indian Partnership

Act, 1932. Registration of partnership is not

compulsory. But since registration entitles the firm to

several benefits, it is considered desirable.

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PARTNERSHIP (ADVANTAGES vs. DISADVANTAGES)

• Ease of formation

• Less regulations

• Sharing of Risk

• No corporate income tax

• Unlimited liability

• Difficult to raise capital

• Lack of Harmony

LIMITED LIABILITY PARTNERSHIP

• Limited Liability Partnership (LLP) can be formed by any two

or more person, associated for carrying on a lawful business

with a view to profit, may by subscribing their names to an

incorporation document and filing the same with Registrar.

• Limited Liability Partnership (LLP) is a separate legal entity.

• Liability of the partners is limited to their agreed contribution

in the LLP.

• A firm, private company and unlisted public company is

allowed to be converted into LLP in accordance with

Provisions of the LLP Act 2008.

• The Indian Partnership Act 1932 is not applicable to LLPs.

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Company

Unlimited Limited

Private Public

Unlisted Listed

COMPANY / CORPORATION

Company form of business

organisation is a voluntary

association of persons to carry on

business. Normally, it is given a

legal status and is subject to certain

legal regulations. It is an

association of persons who

generally contribute money for

some common purpose. The money

so contributed is the capital of the

company.

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COMPANY / CORPORATION (Contd.)

• The persons who contribute capital are its members. The proportion of capital to which each member is entitled is called his share, therefore members of a joint stock company are known as shareholders and the capital of the company is known as share capital.

• The companies are governed by the Indian Companies Act, 1956. The Act defines a company as an artificial person created by law, having separate entity, with perpetual succession and a common seal.

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COMPANY (ADVANTAGES vs. DISADVANTAGES)

• Unlimited life

• Professional Management

• Limited liability

• Ease of raising capital

• High possibility of wealth maximization

• Dividend Tax burden

• High cost of set-up and report filing

• More regulation

CO-OPERATIVE SOCIETY

• Any ten persons can form a co-operative society. It functions

under the Co-operative Societies Act, 1912 and other State

Co-operative Societies Acts. A co-operative society is

entirely different from all other forms of organisation

discussed above in terms of its objective. The co-operatives

are formed primarily to render services to its members.

• Every member has a right to take part in the management of

the society. Each member has one vote. Generally the

members elect a committee known as the Executive

Committee to look after the day to day administration and the

said committee is responsible to the general body of

members.

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CO-OPERATIVE SOCIETY (Contd.)

• The liability of the members is limited to the

extent of capital contributed by them.

• Registration of a society under the Co-

operative Societies Act is a must. Once it is

registered, it becomes a body corporate and

enjoys certain privileges just like a joint stock

company.

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CO-OPERATIVE SOCIETY (Contd.)

Objectives

Rendering service rather than earning profit

Mutual help instead of competition

Self help in place of dependence

Privileges

Perpetual succession

Own common seal

Own property

Can enter into contracts

Can sue others

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VARIOUS TYPES OF CO-OPERATIVES

• Consumer Co-operatives

• Producers Co-operatives

• Producers Co-operatives

• Marketing Co-operatives

• Housing Co-operatives

• Credit Co-operatives

• Forming Co-operatives

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CO-OPERATIVE SOCIETY (ADVANTAGES vs. DISADVANTAGES)

• Democratic management

• Assistance from the government

• Elimination of middlemen’s profit

• Fairly stable life

• Limited capital

• Lack of managerial talent

• Lack of motivation

• Lack of secrecy

• Dependence on the government

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Institutional Environment in India Ministry of Corporate Affairs

National Advisory Committee on Accounting Standards

Securities and Exchange Board of India

Institute of Chartered Accountants of India

Central Board of Direct Taxes

Reserve Bank of India

Insurance Regulatory and Development Authority

Comptroller and Auditor-General of India

International Organizations

International Accounting Standards Board

International Federation of Accountants

International Organization of Securities Commissions

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Accounting, Capital Market, and Corporate Governance

The capital market

Signalling and capital market

Corporate governance Accounting disciplines managerial actions

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The Accounting Equation

Economic Resources = Claims

Assets = Liabilities + Equity

Capital + Revenues – Expenses – Drawings – Dividends

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Assets

Probable future economic benefits

What a business owns

Examples

Cash

Financial investments

Land

Buildings

Plant and machinery

Patents and copyrights

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Liabilities Probable future sacrifices of economic

benefits

What a business owes

Contractual, statutory, or constructive

Examples Loans payable

Salaries payable

Warranty obligations

Pensions payable

Income tax payable

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Equity

Residual interest of owners

Examples Share capital

Share premium

Revenues

Expenses

Dividends

Retained profit

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Financial Statements

Profit and loss account

Statement of financial performance Revenues; Expenses

Balance sheet

Statement of financial position Assets; Liabilities; Equity

Cash flow statement

Statement of cash receipts and cash payments Activities: Operating; Investing; Financing

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Fields of Accounting Activity Public accounting

Auditing

Tax

Management advisory services

Small business services

Private accounting Management accounting

Internal auditing

Information systems

Government accounting Central

State

Local

Not-for-profit accounting

Accounting as an academic discipline

ETHICAL ISSUES IN ACCOUNTING

• Accounting involves the systems that gather and transform

the information, and involves decision-making about the

future based on that information.

• Different accountants, given a complex set of circumstances,

will probably arrive at several different income or valuable

figures.

• Considering fiduciary responsibility of an accountant

(particularly auditors), their behaviour should be driven by

ethical values.

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FRAUDS IN FINANCIAL STATEMENTS

• Recording fictitious revenue—revenues not actually

earned

• Concealment of liabilities and expenses

• Fraudulent asset valuation

• False statement of the inventory available

• Under provisioning for depreciation

• Showing day-to-day expenses as capital expenditure

• Paying salary to ghost employees

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