MTA – II (09): FINANCIAL MANAGEMENT AND ACCOUNTING.-module 4

# Financial Accounting:

Accounting Meaning: Financial accounting is a specialized branch of accounting that keeps track of a company's financial transactions. Using standardized guidelines, the transactions are recorded, summarized, and presented in a financial report or financialstatement such as an income statement or a balance sheet.

Objectives:

The Objectives of Financial Statements

In 1973, the American Institute of Certified Public Accountants, or AICPA, released a study entitled "The Objectives of Financial Statements." The study concluded that financial statements were primarily useful for helping multiple parties make economic decisions.

The AICPA further described financial accounting as the proper method for delivering the final accounts. The final accounts were primarily intended for those with only limited access to information about a given business enterprise.

Systems

Financial accounting is a specialized branch of accounting that keeps track of a company's financial transactions. Using standardized guidelines, the transactions are recorded, summarized, and presented in a financial report or financialstatement such as an income statement or a balance sheet.

and Classification

In order to keep a proper record of the two aspects of a transaction, due to Double Entry System being followed, accounts may be classified as :

1.       Personal Accounts

The accounts which relate to an individual, firm, company or an institution are called Personal Accounts. Account of Mohan, Account of Ram, Drawings Account, Capital Account, etc. are examples of Personal Accounts.

·         Rule : “Debit the receiver and Credit the giver”

It means - Debit that person's account who receives something from the business and credit that person's account that person's account who gives something to the business.

·         Objective :

Object of preparing a personal account is to ascertain as to how much amount a personal account owes to the business, that is, how much amount is due to be received from him and how much amount is owed to a personal account from the business, that is, how much amount is payable to him

2. Real Accounts

The accounts of all those things whose value can be measured in terms of money and which are the properties of the business are termed as Real Accounts. Such as cash account, furniture account, machinery account, building account, Goodwill account, etc.

·         Rule : “Debit what comes in Credit what goes out”

According to this rule, whenever any property comes into the business it is debited and when it goes outside the business it is credited.

·         Objective :

These accounts represent various properties owned by a business in terms of money and indicate the financial position of the business.

3. Nominal Accounts

These accounts include the accounts of all expenses and incomes. For example salaries paid, rent paid, discount allowed, bad debts, Commission received, interest received discount received, etc.

·         Rule : “Debit the expenses and losses and Credit the income and gains”

·         Objective :

Nominal accounts are those accounts which are in name only and which do not really exist. The accounts are open simply to explain the nature of head for which cash has been paid in the absence of nominal accounts it will be very difficult for the management to know the amount paid separately on account of salary, rent, commission, etc. As such the nominal accounts provide information regarding the following :-

(i) Amount spent on various heads in a particular period;

(ii) Income received on various heads in a particular period.

Accounting Equations

From the large, multi-national corporation down to the corner beauty salon, every business transaction will have an effect on a company's financial position. The financial position of a company is measured by the following items:

1. Assets (what it owns)
2. Liabilities (what it owes to others)
3. Owner's Equity (the difference between assets and liabilities)

The accounting equation (or basic accounting equation) offers us a simple way to understand how these three amounts relate to each other. The accounting equation for a sole proprietorship is:

Assets = Liabilities + Owner’s Equity

The accounting equation for a corporation is:

Assets = Liabilities + Stockholder’s Equity

Assets are a company's resources—things the company owns. Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and goodwill. From the accounting equation, we see that the amount of assets must equal the combined amount of liabilities plus owner's (or stockholders') equity.

Liabilities are a company's obligations—amounts the company owes. Examples of liabilities include notes or loans payable, accounts payable, salaries and wages payable, interest payable, and income taxes payable (if the company is a regular corporation). Liabilities can be viewed in two ways:

(1) as claims by creditors against the company's assets, and
(2) a source—along with owner or stockholder equity—of the company's assets.

Owner's equity or stockholders' equity is the amount left over after liabilities are deducted from assets:

Assets - Liabilities = Owner's (or Stockholders') Equity.

Owner's or stockholders' equity also reports the amounts invested into the company by the owners plus the cumulative net income of the company that has not been withdrawn or distributed to the owners.

If a company keeps accurate records, the accounting equation will always be "in balance," meaning the left side should always equal the right side. The balance is maintained because every business transaction affects at least two of a company's accounts. For example, when a company borrows money from a bank, the company's assets will increase and its liabilities will increase by the same amount. When a company purchases inventory for cash, one asset will increase and one asset will decrease. Because there are two or more accounts affected by every transaction, the accounting system is referred to as double-entry accounting.

A company keeps track of all of its transactions by recording them in accounts in the company's general ledger.Each account in the general ledger is designated as to its type: asset, liability, owner's equity, revenue, expense, gain, or loss account.

Double Entry System

What is the double entry system?

The double entry system of accounting or bookkeeping means that every business transaction will involve two accounts (or more). For example, when a company borrows money from its bank, the company's Cash account will increase and its liability account Loans Payable will increase. If a company pays $200 for an advertisement, its Cash account will decrease and its account Advertising Expense will increase.

Double entry also allows for the accounting equation (assets = liabilities + owner's equity) to always be in balance. In our example involving Advertising Expense, the accounting equation remained in balance because expenses cause owner's equity to decrease. In that example, the asset Cash decreased and the owner's capital account within owner's equity also decreased.

A third aspect of double entry is that the amounts entered into the general ledger accounts as debits must be equal to the amounts entered as credits.