ASSIGNMENT

Unit I: Introduction of Accounting

1.Explain financial accounting, cost accounting and management accounting with

examples.

Financial accounting is a specialized branch of accounting that keeps track of a

company's financial transactions. It is concerned with recording and processing
all business transactions and events in the books of accounts. It includes profit
earned and loss incurred and will provide the information for accounting year.
As mentioned earlier, financial accounting deals with the preparation of
financial statements for the basic purpose of providing information to various
interested groups like creditors, banks, shareholders, financial institutions,
government, consumers, etc. Financial statements, i.e. the income statement and
the balance sheet indicate the way in which the activities of the business have
been conducted during a given period of time. Financial accounting is charged
with the primary responsibility of external reporting. The users of information
generated by financial accounting, like bankers, financial institutions, regulatory
authorities, government, investors, etc. want the accounting information to be
consistent so as to facilitate comparison. Therefore, financial accounting is based
on certain concepts and conventions which include separate business entity,
going concern concept, money measurement concept, cost concept, dual aspect
concept, accounting period concept, matching concept, realization concept and
conventions of conservatism, disclosure, consistency, etc. All such concepts and
conventions would be dealt with detail in subsequent lessons.

The significance of financial accounting lies in the fact that it aids the
management in directing and controlling the activities of the firm and to frame
relevant managerial policies related to areas like production, sales, financing,
etc. However, it suffers from certain drawbacks which are discussed in the
following paragraphs. • The information provided by financial accounting is
consolidated in nature. It does not indicate a break-up for different departments,
processes, products and jobs. As such, it becomes difficult to evaluate the
performance of different subunits of the organisation. • Financial accounting
does not help in knowing the cost behaviour as it does not distinguish between
fixed and variable costs.
• The information provided by financial accounting is historical in nature and as
such the predictability of such information is limited.

The management of a company has to solve certain ticklish questions like

expansion of business, making or buying a component, adding or deleting a
product line, deciding on alternative methods of production, etc. The financial
accounting information is of little help in answering these questions.

The limitations of financial accounting, however, should not lead one to believe
that it is of no use. It is the basic foundation on which other branches and tools
of accounting analysis are based. It is the source of information, which can be
further analysed and interpreted according to the tailor-made requirements of
decision-makers

Cost Accounting: It is concerned with the cost of each product produced by the
firm. It basically involve estimating the cost in advance and detailed analysis. It
also help in cost controlling.

Cost accounting makes elaborate cost records regarding various products,

operations and functions. It is the process of determining and accumulating the
cost of a particular product or activity. Any product, function, job or process for
which costs are determined and accumulated, are called cost centres.

The basic purpose of cost accounting is to provide a detailed breakup of cost of

different departments, processes, jobs, products, sales territories, etc., so that
effective cost control can be exercised.

Cost accounting also helps in making revenue decisions such as those related to
pricing, productmix, profit-volume decisions, expansion of business,
replacement decisions, etc.

The objectives of cost accounting, therefore, can be summarized in the form of

three important statements, viz, to determine costs, to facilitate planning and
control of business activities and to supply information for short- and long-term
decision. Cost accounting has certain distinct advantages over financial
accounting. Some of them have been discussed succeedingly. The cost
accounting system provides data about profitable and non-profitable products
and activities, thus prompting corrective measures. It is easier to segregate and
analyse individual cost items and to minimize losses and wastages arising from
the manufacturing process. Production methods can be varied so as to minimize
costs and increase profits. Cost accounting helps in making realistic pricing
decisions in times of low demand, competitive conditions, technology changes,
etc.

Various alternative courses of action can be properly evaluated with the help of
data generated by cost accounting. It would not be an exaggeration if it is said
that a cost accounting system ensures maximum utilization of physical and
human resources. It checks frauds and manipulations and directs the employer
and employees towards achieving the organisational goal.
Managerial Accounting: It is drawn from financial accounting and cost
accounting. It helps managers to make a decisions related to performance
improvement, forecasting, budgeting, cost control and acquisition, revenue
generation etc.

Management accounting is ‘tailor-made’ accounting. It facilitates the

management by providing accounting information in such a way so that it is
conducive for policy making and running the day-to-day operations of the
business. Its basic purpose is to communicate the facts according to the specific
needs of decision-makers by presenting the information in a systematic and
meaningful manner. Management accounting, therefore, specifically helps in
planning and control. It helps in setting standards and in case of variances
between planned and actual performances, it helps in deciding the corrective
action. An important characteristic of management accounting is that it is
forward looking. Its basic focus is one future activity to be performed and not
what has already happened in the past. Since management accounting caters to
the specific decision needs, it does not rest upon any well-defined and set
principles. The reports generated by a management accountant can be of any
duration– short or long, depending on purpose. Further, the reports can be
prepared for the organisation as a whole as well as its segments.

2. Explain cash basis and accrual basis of accounting along with advantages and
disadvantages.

Transactions are recorded in the books of account following either

• Cash Basis of Accounting
• Accrual/ Mercantile Basis of Accounting

Cash Basis - Cash Basis Of Accounting Cash is a method in which income is

recorded when cash is received, and expenses are recorded when cash is paid
out.

Advantages: It is simple as adjustment entries are not required. This approach

is more objective as very few estimates and judgments are required. This basis
of accounting is suitable for those enterprises where most of the transactions
are on a cash basis.

Disadvantages: It does not give a true and fair view of the profit or loss and the
financial position of an enterprise because it ignores outstanding and prepaid
expenses

Accrual/ Mercantile Basis of Accounting - Accrual Basis of Accounting is

based on 'accrual concept‘ Revenue is recognized (recorded) when earned
Expenses are recognized when incurred. Under this system Income earned and
expenditure incurred is recognized irrespective of cash received or cash paid.

Advantages: It is more scientific compared to Cash Basis. This basis of

accounting shows a complete picture .This system discloses correct profit or loss
for a particular period and also exhibits true financial position of the business on
a particular day. It reflects correct profit or loss during the accounting period.

Disadvantages: This system is not as simple as Cash Basis of Accounting. The

accounting process under this basis is too elaborate. A quick appraisal of the
profit/loss is Financial accounting is a specialized branch of accounting that keeps track of
a company's financial transactions. It is concerned with recording and processing all
business transactions and events in the books of accounts. It includes profit earned and loss
incurred and will provide the information for accounting year. not possible because
many adjustments are required to ascertain the true financial position of the
business.

3. Explain accounting concepts with its types in detail.

The more important accounting concepts are briefly described as follows:

1.Separate Business Entity Concept - In accounting we make a distinction

between business and the owner. All the books of accounts records day to day
financial transactions from the view point of the business rather than from that
of the owner. The proprietor is considered as a creditor to the extent of the
capital brought in business by him. For instance, when a person invests Rs. 10
lakh into a business, it will be treated that the business has borrowed that much
money from the owner and it will be shown as a ‘liability’ in the books of
accounts of business. Similarly, if the owner of a shop were to take cash from the
cash box for meeting certain personal expenditure, the accounts would show
that cash had been reduced even though it does not make any difference to the
owner himself. Thus, in recording a transaction the important question is how
does it affects the business? For example, if the owner puts cash into the
business, he has a claim against the business for capital brought in. In so-far as a
limited company is concerned, this distinction can be easily maintained because
a company has a legal entity like a natural person it can engage itself in
economic activities of buying, selling, producing, lending, borrowing and
consuming of goods and services. However, it is difficult to show this distinction
in the case of sole proprietorship and partnership. Nevertheless, accounting still
maintains separation of business and owner. It may be noted that it is only for
accounting purpose that partnerships and sole proprietorship are treated as
separate from the owner (s), though law does not make such distinction. In fact,
the business entity concept is applied to make it possible for the owners to
assess the performance of their business and performance of those whose
manage the enterprise. The managers are responsible for the proper use of
funds supplied by owners, banks and others.

2.Money Measurement Concept - In accounting, only those business

transactions are recorded which can be expressed in terms of money. In other
words, a fact or transaction or happening which cannot be expressed in terms of
money is not recorded in the accounting books. As money is accepted not only as
a medium of exchange but also as a store of value, it has a very important
advantage since a number of assets and equities, which are otherwise different,
can be measured and expressed in terms of a common denominator. We must
realise that this concept imposes two severe limitations. Firstly, there are
several facts which though very important to the business, cannot be recorded
in the books of accounts because they cannot be expressed in money terms. For
example, general health condition of the Managing Director of the company,
working conditions in which a worker has to work, sales policy pursued by the
enterprise, quality of product introduced by the enterprise, though exert a great
influence on the productivity and profitability of the enterprise, are not
recorded in the books. Similarly, the fact that a strike is about to begin because
employees are dissatisfied with the poor working conditions in the factory will
not be recorded even though this event is of great concern to the business. You
will agree that all these have a bearing on the future profitability of the
company. Secondly, use of money implies that we assume stable or constant
value of rupee. Taking this assumption means that the changes in the money
value in future dates are conveniently ignored. For example, a piece of land
purchased in 1990 for Rs. 2 lakh and another bought for the same amount in
1998 are recorded at the same price, although the first purchased in 1990 may
be worth two times higher than the value recorded in the books because of rise
in land prices. In fact, most accountants know fully well that purchasing power
of rupee does change but very few recognise this fact in accounting books and
make allowance for changing price level.

3. Dual Aspect Concept - Financial accounting records all the transactions and
events involving financial element. Each of such transactions requires two
aspects to be recorded. The recognition of these two aspects of every
transaction is known as a dual aspect analysis. According to this concept every
business transactions has dual effect. For example, if a firm sells goods of Rs.
5,000 this transaction involves two aspects. One aspect is the delivery of goods
and the other aspect is immediate receipt of cash (in the case of cash sales). In
fact, the term ‘double entry’ book keeping has come into vogue and in this
system the total amount debited always equals the total amount credited. It
follows from ‘dual aspect concept’ that at any point of time owners’ equity and
liabilities for any accounting entity will be equal to assets owned by that entity.
This idea is fundamental to accounting and could be expressed as the following
equalities: Assets = Liabilities + Owners Equity …(1) Owners Equity = Assets-
Liabilities …(2) The above relationship is known as the ‘Accounting Equation’.
The term ‘Owners Equity’ denotes the resources supplied by the owners of the
entity while the term ‘liabilities’ denotes the claim of outside parties such as
creditors, debenture-holders, bank against the assets of the business. Assets are
the resources owned by a business. The total of assets will be equal to total of
liabilities plus owners capital because all assets of the business are claimed by
either owners or outsiders.

4. Going Concern Concept -Accounting assumes that the business entity will
continue to operate for a long time in the future unless there is good evidence to
the contrary. The enterprise is viewed as a going concern, that is, as continuing
in operations, at least in the foreseeable future. In other words, there is neither
the intention nor the necessity to liquidate the particular business venture in the
predictable future. Because of this assumption, the accountant while valuing the
assets does not take into account forced sale value of them. In fact, the
assumption that the business is not expected to be liquidated in the foreseeable
future establishes the basis for many of the valuations and allocations in
accounting. For example, the accountant charges depreciation on fixed assets. It
is this assumption which underlies the decision of investors to commit capital to
enterprise. Only on the basis of this assumption accounting process can remain
stable and achieve the objective of correctly reporting and recording on the
capital invested, the efficiency of management, and the position of the enterprise
as a going concern. However, if the accountant has good reasons to believe that
the business, or some part of it is going to be liquidated or that it will cease to
operate (say within six-month or a year), then the resources could be reported
at their current values. If this concept is not followed, International Accounting
Standard requires the disclosure of the fact in the financial statements together
with reasons.

5. Accounting Period Concept -This concept requires that the life of the
business should be divided into appropriate segments for studying the financial
results shown by the enterprise after each segment. Although the results of
operations of a specific enterprise can be known precisely only after the
business has ceased to operate, its assets have been sold off and liabilities paid
off, the knowledge of the results periodically is also necessary. Those who are
interested in the operating results of business obviously cannot wait till the end.
The requirements of these parties force the businessman ‘to stop’ and ‘see back’
how things are going on. Thus, the accountant must report for the changes in the
wealth of a firm for short time periods. A year is the most common interval on
account of prevailing practice, tradition and government requirements. Some
firms adopt financial year of the government, some other calendar year.
Although a twelve month period is adopted for external reporting, a shorter
span of interval, say one month or three month is applied for internal reporting
purposes. This concept poses difficulty for the process of allocation of long term
costs. All the revenues and all the cost relating to the year in operation have to
be taken into account while matching the earnings and the cost of those
earnings for the any accounting period. This holds good irrespective of whether
or not they have been received in cash or paid in cash. Despite the difficulties
which stem from this concept, short term reports are of vital importance to
owners, management, creditors and other interested parties. Hence, the
accountants have no option but to resolve such difficulties.

6. Cost Concept - The term ‘assets’ denotes the resources land building,
machinery etc. owned by a business. The money values that are assigned to
assets are derived from the cost concept. According to this concept an asset is
ordinarily entered on the accounting records at the price paid to acquire it. For
example, if a business buys a plant for Rs. 5 lakh the asset would be recorded in
the books at Rs. 5 lakh, even if its market value at that time happens to be Rs. 6
lakh. Thus, assets are recorded at their original purchase price and this cost is
the basis for all subsequent accounting for the business. The assets shown in the
financial statements do not necessarily indicate their present market values. The
term ‘book value’ is used for amount shown in the accounting records. The cost
concept does not mean that all assets remain on the accounting records at their
original cost for all times to come. The asset may systematically be reduced in its
value by charging ‘depreciation’, which will be discussed in detail in a
subsequent lesson. Depreciation has the effect of reducing profit of each period.
The prime purpose of depreciation is to allocate the cost of an asset over its
useful life and not to adjust its cost. However, a balance sheet based on this
concept can be very misleading as it shows assets at cost even when there are
wide difference between their costs and market values. Despite this limitation
you will find that the cost concept meets all the three basic norms of relevance,
objectivity and feasibility.

7. The Matching concept - This concept is based on the accounting period

concept. In reality we match revenues and expenses during the accounting
periods. Matching is the entire process of periodic earnings measurement, often
described as a process of matching expenses with revenues. In other words,
income made by the enterprise during a period can be measured only when the
revenue earned during a period is compared with the expenditure incurred for
earning that revenue. Broadly speaking revenue is the total amount realised
from the sale of goods or provision of services together with earnings from
interest, dividend, and other items of income. Expenses are cost incurred in
connection with the earnings of revenues. Costs incurred do not become
expenses until the goods or services in question are exchanged. Cost is not
synonymous with expense since expense is sacrifice made, resource consumed
in relation to revenues earned during an accounting period. Only costs that have
expired during an accounting period are considered as expenses. For example, if
a commission is paid in January, 2002, for services enjoyed in November, 2001,
that commission should be taken as the cost for services rendered in November
2001. On account of this concept, adjustments are made for all prepaid
expenses, outstanding expenses, accrued income, etc, while preparing periodic
reports.

8. Accrual Concept - It is generally accepted in accounting that the basis of

reporting income is accrual. Accrual concept makes a distinction between the
receipt of cash and the right to receive it, and the payment of cash and the legal
obligation to pay it. This concept provides a guideline to the accountant as to
how he should treat the cash receipts and the right related thereto. Accrual
principle tries to evaluate every transaction in terms of its impact on the
owner’s equity. The essence of the accrual concept is that net income arises from
events that change the owner’s equity in a specified period and that these are
not necessarily the same as change in the cash position of the business. Thus it
helps in proper measurement of income.

9. Realisation Concept – Realisation is technically understood as the process of

converting non-cash resources and rights into money. As accounting principle, it
is used to identify precisely the amount of revenue to be recognised and the
amount of expense to be matched to such revenue for the purpose of income
measurement. According to realisation concept revenue is recognised when sale
is made. Sale is considered to be made at the point when the property in goods
passes to the buyer and he becomes legally liable to pay. This implies that
revenue is generally realised when goods are delivered or services are rendered.
The rationale is that delivery validates a claim against the customer. However, in
case of long run construction contracts revenue is often recognised on the basis
of a proportionate or partial completion method. Similarly, in case of long run
instalment sales contracts, revenue is regarded as realised only in proportion to
the actual cash collection. In fact, both these cases are the exceptions to the
notion that an exchange is needed to justify the realisation of revenue.