Financial Accounting is a combination of two words Finance and Account, so it is a branch of accounting that keeps company financial transactions. Here the transactions (Monetary) are recorded and presented to the third party for decision-making purposes. Financial Accounting is reported at the end of the year.
Basic Accounting terms
- Credit:- A credit is an increase in liabilities or decrease in asset and is written as Cr in Journal Entry.
- Debit:- A Debit is an increase in asset or decrease in liabilities and is written as Dr in Journal Entry.
- Journal Entry:- Here the transactions (only business related) are recorded on a daily basis.
- Assets:- Assets are those which add value (money or profit) to your business. It is written left of balance sheet. There are two types of Assets like Current assets (Cash) and fixed assets (machine, equipment or tools). E.g. of Assets: Cash, Investment, Office Equipment, Machinery, Real estate, Company-owned vehicles etc.
- Liabilities:– This is obligation (credit) which your business have to fulfill. It is written right of Balance sheet. There are two types of Liabilities like Current Liabilities (credit to be paid within a year) and Long-term Liabilities (credit to be paid after a year). E.g. of Liabilities- Bank debt, Mortgage debt, Money due to suppliers, wages owed, taxes owed.
- Equity: – Equity is the portion of the company that is owned by the investors and owners Equity= Assets-Liabilities.
- Revenue:- Revenue is the amount a company receives from selling goods or gives services to the customers and client.
- Account Payable: – Also called the Current liability account. Here the company have to record the amount (which has to be given in future) for the service or goods taken from the third party.
- Account Receivable:- Also called the Current Asset account. Here the company have to record the amount (which has to be taken in future) for the service or goods given to the third party.
- Depreciation: — It is the reduction of recorded amount of fixed asset (Buildings, Furniture, Machine, office equipment etc.) in a systematic manner until the value of an asset becomes zero or negligible.
- Expense:- Expense is the money spent in order to generate revenues. Types of Expenses are-Operating, Non-Operating Expenses, Cost of Goods sold, Financial Expenses etc.
- Book Value: – Book Value is also called the net book value. It is the difference between total assets and total liabilities of a company.
- Income Statement:- The Income Statement is the financial statement used for reporting a company’s financial performance over a specific accounting period.
Ancient Text of India about Financial Accounting
Arthashastra (written by Kautilya) had a broad subject on Accounting. According to the book, The Financial year of accounting is fixed in between July to June period and must be full process for closure and audit the same.
The Accountant should present the full accounts to the head office mid-July and delayed on the process will have to face financial penalties.
Receipts are classified as current, last balance, and accidental. Expenditure is of two kinds-daily and profitable expenditures.
Kautilya also suggested that Auditor and Accountants should have to pay high salary so that they can be ethical. He suggested that Accounting and Auditing must functions independently and should be reported separately to the king.
He also stated about the rewards and punishment for honest and fraudulent people (accountants or auditors who misrepresent financial statement). Checks were done daily and periodically.
Indian Accounting Standards
Indian Accounting Standard (Ind-AS) is the accounting standard for Indian companies.
It is issued under the supervision of Accounting Standards Boards which in 1977.
ASB is a committee under ICAI. It consists of government bodies, academicians, other professional bodies.
Some of the Indian Accounting Standards are:
- Ind AS 107— Financial Instruments: Disclosures
- Ind AS 109— Financial Instruments
- Ind AS 110— Consolidated Financial Statements
- Ind AS 1 — Presentation of Financial Statements
Objectives of Financial Accounting
The main objectives of Financial Accounting is to prepare an accurate financial account for a specific period known as financial statement.
The financial statement is the Income Statement, the Balance sheet and the statement of cash flows.
The company’s financial statement provides important information to investors, shareholders and loan creditor. It is used by management to manage the current operations and the future activities of the firm.
Elements of Financial Statement
Note: Definition is given above on Basic Accounting terms
Types of Financial Accounting
There are two types of Financial Accounting.
- Cash Accounting: It records transactions made by an employee of an organization. For e.g. If an employee went for an official trip, he will take a hotel for stay, eat meal, transportation. After the transaction is made, they will take a receipt of their expense and report all transactions to their manager. The money is reimbursed once they are approved.
Cash Transaction does not appear on financial accounting but they can still be logged to show proof that a transaction is occurred.
- Accrual Accounting: It records all transactions like credit, debit or any other forms of payment made by employees, where cash is included. Account Payable and Account Receivable comes under this category.
It gives clear pictures of organization cash flow and helps in determining whether you have current assets or liabilities.
Financial Accounting Principles
Accounting requires strong work ethics and details to give an accurate report expenses. There are 9 basic principles of Financial accounting which need to follow to get accurate expenses.
- Economic Entity assumption:- Here Business is treated as a separate entity. Only Business related transaction is recorded in an entry book. Owner’s personal transaction is separate and is not mentioned. Thus, Business and Owner’s are separate entity.
- Monetary Unit assumption:- Financial transaction is done in INR. If the transaction is done abroad, the Monetary is converted to INR. Accountant do not take inflation into account when documenting financial transactions.
- Cost principle: – Document all complex and ongoing financial activities over a distinct period so that the stakeholders have a full understanding about the capital spent over a period of time.
- Full-disclosure principle:- All important financial information must be disclosed to lenders or investors in a financial statement.
- Going concern principle: – You have to carry all financial obligation and liquidate in the near future. It must be clearly mentioned on all financial statements, if you decided to liquidate it.
- Matching principle:-You have to use accrual accounting instead of cash accounting to record transactions and that company expenses must align with revenue.
- Revenue Recognition Principle:- Revenues are accrued by a company when a service is conducted for them. For e.g. A company can earn Rs.50,000 in revenue but he only receive Rs.10,00 in cash.
- Materiality:- If a cash amount is irrelevant, then you can violate an accounting principle. For e.g.: If you buy a printer for Rs.5000 for a highly profitable billion rupees company. The printer will be used for 5 years. The Matching Principle says to record the expense for 5 years (e.g. Rs. 1000 each year). Here the Materiality violates the Matching principle and expense the entire cost of Rs.5,000 in the year it is purchased.
- Conservatism: It exhibit potential future losses but not future gains. It helps in analyzing financial activity and potential threats that could appear on future financial statements.
Financial Accounting is important in smooth running of business as it keeps records of your daily and ongoing expenses which helps in making short term and long-term decision. It helps in observing the business whether it is in profit or loss. It also provides important information to the top management so that they can manage the operation and can take decision on their future activities.