Financial and Managerial Accounting -MBA

Chapter-IIntroduction to Accounting

Contents

What is Accounting Definition of Accounting Importance of Accounting Accounting Activities Users of Accounting Information Financial and Management Accounting Accounting concepts and Conventions Accounting Standards International Accounting Standards International Financial Reporting Standards (IFRS)

What is Accounting?

Everybody needs to control his/her own financial performance and financial position!

What is your financial position today? What about your financial performance in 2014? Also companies need to control and convey their

financial performance and position Accounting sets the rules to do this!

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Definition of Accounting The American Institute of Certified Public

Accountants (AICPA) defines – Accountancy as “the art of recording, classifying, and

summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof”.

According to the American Accounting Association - Accounting is “the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information”.

IdentifiesIdentifies

RecordsRecords

CommunicatesCommunicatesRelevantRelevant

ReliableReliable

ComparableComparable

Importance of Accounting

AccountingAccountingis a

system that

information

that is

to help users make better decisions.

to help users make better decisions.

Identifying Business Activities

Recording Business Activities Communicating

Business Activities

Accounting Activities

Why Accounting?

• Informational requirement of a number of stakeholders in the business can use accounting information.– Internal Stakeholder

• Owners• Management• Employees

– External Stakeholders• Investors• Banks/Lenders• Suppliers/Creditors• Government/ Tax department• NGOs/ Industry associations• Researchers

• Accounting is the tool for providing financial information to various

stakeholders.

Users of Accounting Information

External Users

•Lenders

•Shareholders

•Governments

•Consumer Groups

•External Auditors

•Customers

Internal Users

•Managers

•Officers

•Internal Auditors

•Sales Staff

•Budget Officers

•Controllers

Cont’d…

External Users

Financial accounting provides external users with financial

statements.

Internal Users

Managerial accounting provides information needs for internal decision

makers.

FINANCIAL AND MANAGEMENT ACCOUNTING

Financial accounting: It is the maintenance of daily record of all financial transactions in such a manner that it would help in the preparation of suitable information regarding the financial affairs of a business or an individual.

Why is Financial Accounting needed? The need for recording financial transactions

arises because the individual or business wants to know the performance of the business

and to assist the person in making decisions related to the business.

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Objectives of Financial Accounting The purpose of accounting can be summarized in the

following manner Ascertain the results of operations during a period Ascertain the financial position. Maintaining a control over assets Planning in respect of cash Providing information to tax authorities and other

government agencies. To properly match income with expenses. To provide a reliable set of data with which to prepare

financial reports for analysis purposes (for owners, lenders, investors, etc).

Cost Accounting

• Cost accounting is an essential part of management accounting.

• Cost accounting, through its various techniques, reveals efficiency of various divisions, departments and products.

• It also provides information regarding cost of products process and jobs through different methods of costing.

• Management accounting makes use of all this data by focusing it towards managerial decisions.

Management Accounting

• Management Accounting of the Anglo-American to productivity – “ Management Accounting may be defined as “the presentation of accounting information in such a way as to assist the management in the creation of the policy and day-to-day operation of an undertaking”

• The Institute of Chartered Accountants of England has defined it –“Any form of accounting which enables a business to be conducted more efficiently can be regarded as Management Accounting”.

Objectives of Management Accounting The compilation of plans and budgets covering all aspects of the

business e.g., production, selling, distribution research and finance.

The systematic allocation of responsibilities for implementation of plans and budgets.

The analysis of all transactions, financial and physical, to enable effective comparisons to be made between the forecasts made and actual performance.

The presentations to management, at frequent intervals, of up-to-date information in the form of operating statements.

The statistical interpretation of such statements in a manner which will be of utmost assistance to management in planning future policy and operation.

Differences Between Financial & Management Accounting

ACCOUNTING CONCEPTS AND CONVENTIONS

• Accounting concepts:• The term ‘concept’ is used to denote

accounting postulates, i.e., basic assumptions or conditions upon the edifice of which the accounting super-structure is based.

• The following are the common accounting concepts adopted by many business concerns.

1. Business Entity Concept

• Meaning– The business and its owner(s) are two separate existence

entity.– Any private and personal incomes and expenses of the

owner(s) should not be treated as the incomes and expenses of the business.

• Examples– Insurance premiums for the owner’s house should be

excluded from the expense of the business– The owner’s property should not be included in the

premises account of the business– Any payments for the owner’s personal expenses by the

business will be treated as drawings and reduced the owner’s capital contribution in the business 18

2. Money Measurement Concept

• Meaning– All transactions of the business are recorded in

terms of money– It provides a common unit of measurement– People started valuing all goods / services in

terms of a common commodity called money.• Examples– Market conditions, technological changes and

the efficiency of management would not be disclosed in the accounts.

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3. Dual Aspect Concept

• According to this basic concept of accounting,every transaction has a two-fold aspect, Viz.,1. giving certain benefits and 2. receiving certain benefits. The basic principle of double entry system is that every debit has a corresponding and equal amount of credit. This is the underlying assumption of this concept.

4. Going Concern Concept• Meaning– The business will continue in operational existence for the

foreseeable future.– Financial statements should be prepared on a going

concern basis unless management either intends to liquidate the enterprise or to cease trading, or has no realistic alternative but to do so.

• Example – Possible losses form the closure of business will not be

anticipated in the accounts.– Prepayments, depreciation provisions may be carried

forward in the expectation of proper matching against the revenues of future periods.

– Fixed assets are recorded at historical cost.

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5. Historical Cost Concept

• Meaning– Assets should be shown on the balance sheet

at the cost of purchase instead of current value.

• Example– The cost of fixed assets is recorded at the date

of acquisition cost. – The acquisition cost includes all expenditure

made to prepare the asset for its intended use.– It included the invoice price of the assets,

freight charges, insurance or installation costs.22

6. Accruals/Matching Concept• Meaning– Revenues are recognized when they are earned, but not when

cash is received.– Expenses are recognized as they are incurred, but not when cash

is paid.– The net income for the period is determined by subtracting

expenses incurred from revenues earned.• Example– Expenses incurred but not yet paid in current period should be

treated as accrual/accrued expenses under current liabilities.– Expenses incurred in the following period but paid for in

advance should be treated as prepayment expenses under current asset .

– Depreciation should be charged as part of the cost of a fixed asset consumed during the period of use. 23

6.Realization Concept

• Meaning:-• Revenues should be recognized when the major economic

activities have been completed.• Sales are recognized when the goods are sold and delivered to

customers or services are rendered.• Example:-– Goods sent to our customers on sale or return basis– This means the customer do not pay for the goods until

they confirm to buy. If they do not buy, those goods will return to us.

– Goods on the ‘sale or return’ basis will not be treated as normal sales and should be included in the closing stock unless the sales have been confirmed by customers .

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ACCOUNTING CONVENTIONS

• I- Consistency: • The convention of consistency refers to the

state of accounting rules, concepts, principles, practices and conventions being observed and applied constantly, i.e., from one year to another there should not be any change.

• If consistency is there, the results and performance of one period can he compared easily and meaningfully with the other.

– II- Disclosure– Financial statements should be prepared to reflect a

true and fair view of the financial position and performance of the enterprise

– All material and relevant information must be disclosed in the financial statements.

– III - Conservation:– This convention warns the trader not to take

unrealized income into account i.e., why the practice of valuing stock at cost or market price whichever is lower is in vague.

– This is the policy of playing safe. It takes into consideration all prospective losses but leaves all prospective profits.

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What is GAAP??• GAAP is the abbreviation of Generally Accepted Accounting Principle.

• GAAP are the common set of accounting principles, standards and procedures that companies use to compile their financial statements.

• GAAP are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information.

Cont’d…

•In USA, GAAP standard are set by Financial Accounting Standards Board (FASB).

•Outside the US, the equivalent of GAAP is IAS - International Accounting Standards - which is maintained by the International Accounting Standards Board (IASB).

•In India, GAAP standards are set by the Institute of Chartered Accountants of India (ICAI). ICAI continually updates GAAP as new accounting issues and concerns arise.

Why GAAP??•GAAP are imposed on companies so that investors have a minimum level of consistency in the financial statements they use when analyzing companies for investment purposes.

•GAAP cover such things as revenue recognition, balance sheet item classification and outstanding share measurements.

• Companies are expected to follow GAAP rules when reporting their financial data via financial statements.

• If a financial statement is not prepared using GAAP principles, be very wary!

ACCOUNTING STANDARDS

• Accounting Standards are formulated with a view to harmonize different accounting policies and practices in use in a country.

• The objective of Accounting Standards is, therefore, to reduce the accounting alternatives in the preparation of financial statements within the bounds of rationality, thereby ensuring comparability of financial statements of different enterprises with a view to provide meaningful information to various users of financial statements to enable them to make informed economic decisions.

INTERNATIONAL ACCOUNTING STANDARDS

• The objectives of IASC included promotion of the International Accounting Standards for worldwide acceptance and observance so that the accounting standards in different countries are harmonized.

• In 1973, the International Accounting Standards Committee (IASC) was established.

• It may be mentioned here that the IASC has been reconstituted as the International Accounting Standards Board (IASB).

• In recent years, need for international harmonization of Accounting Standards followed in different countries has grown considerably as the cross-border transfers of capital are becoming increasingly common.

• International Accounting Standards (IASs) were issued by the IASC from 1973 to 2000.

• The IASB replaced the IASC in 2001. • Since then, the IASB has amended some IASs and has proposed to amend

others, has replaced some IASs with new International Financial Reporting Standards (IFRSs), and has adopted or proposed certain new IFRSs on topics for which there was no previous IAS.

IASB's Objectives

• (a) to develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world's capital markets and other users make economic decisions;

• (b) to promote the use and rigorous application of those standards; and

• (c) to bring about convergence of national accounting standards and International Accounting Standards and International Financial Reporting Standards to high quality solutions.

The following standards are issued by IASC:• IAS 1: Presentation of Financial Statements.• IAS 2: Inventories• IAS 3: Consolidated Financial Statements Originally issued 1976, effective 1 Jan 1977. Superseded in 1989 by

IAS 27 and IAS 28• IAS 4: Depreciation Accounting Withdrawn in 1999, replaced by IAS 16, 22, and 38, all of which were issued

or revised in 1998• IAS 5: Information to Be Disclosed in Financial Statements Originally issued October 1976, effective 1 January

1997. Superseded by IAS 1 in 1997• IAS 6: Accounting Responses to Changing Prices Superseded by IAS 15, which was withdrawn December 2003• IAS 7: Cash Flow Statements• IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors• IAS 9: Accounting for Research and Development Activities – Superseded by IAS 38 effective 1.7.99• IAS 10: Events After the Balance Sheet Date• IAS 11: Construction Contracts• IAS 12: Income Taxes• IAS 13: Presentation of Current Assets and Current Liabilities – Superseded by IAS 1.• IAS 14: Segment Reporting (superseded by IFRS 8 on 1 January 2008)• IAS 15: Information Reflecting the Effects of Changing Prices – Withdrawn December 2003• IAS 16: Property, Plant and Equipment• IAS 17: Leases• IAS 18: Revenue• IAS 19: Employee Benefits• IAS 20: Accounting for Government Grants and Disclosure of Government Assistance

• IAS 21: The Effects of Changes in Foreign Exchange Rates• IAS 22:Business Combinations – Superseded by IFRS 3 effective 31 March 2004• IAS 23: Borrowing Costs• IAS 24: Related Party Disclosures• IAS 25: Accounting for Investments – Superseded by IAS 39 and IAS 40 effective 2001• IAS 26: Accounting and Reporting by Retirement Benefit Plans• IAS 27: Consolidated Financial Statements• IAS 28: Investments in Associates• IAS 29: Financial Reporting in Hyperinflationary Economies• IAS 30: Disclosures in the Financial Statements of Banks and Similar Financial Institutions – Superseded by

IFRS 7 effective 2007• IAS 31: Interests in Joint Ventures• IAS 32: Financial Instruments: Presentation (Financial instruments disclosures are in IFRS 7 Financial

Instruments: Disclosures, and no longer in IAS 32)• IAS 33: Earnings Per Share• IAS 34: Interim Financial Reporting• IAS 35: Discontinuing Operations – Superseded by IFRS 5 effective 2005• IAS 36: Impairment of Assets• IAS 37: Provisions, Contingent Liabilities and Contingent Assets• IAS 38: Intangible Assets• IAS 39: Financial Instruments: Recognition and Measurement• IAS 40: Investment Property• IAS 41: Agriculture

International Financial Reporting Standards (IFRS)

• International Financial Reporting Standards (IFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries.

• They are a consequence of growing international shareholding and trade and are particularly important for companies that have dealings in several countries.

• The rules to be followed by accountants to maintain books of accounts which is comparable, understandable, reliable and relevant as per the users internal or external.

History

• IAS were issued between 1973 and 2001 by the Board of the International Accounting Standards Committee(IASC).

• On 1 April 2001, the new International Accounting Standards Board (IASB) took over from the IASC the responsibility for setting International Accounting Standards.

• The IASB has continued to develop standards calling the new standards International Financial Reporting Standards (IFRS).

Why do we need IFRSs???

• Company would be better understood in the global market place and consequently would be able to tap world capital markets and potentially reduce its cost of capital.

• The company would be perceived as an international player.

• A common financial reporting language across its various entities, would improve internal communications, and group decision-making

• A company can benchmark itself with its peers across the world, and also enable investors to make that comparison.

Growing importance of IFRS• 7000 EU companies presenting their FS under IFRS• More Than 1100 Chinese companies switch to IFRS• Use of IFRS in ASIA PACIFIC countries Australia Hong Kong,

New Zealand and Philippines are virtually adopting word for word National Standards based on IFRS

• Singapore has Nearly adopted IFRS in word for word in national standard

• India Malaysia Pakistan Srilanka Thailand are close to word to word IFRS adoption in National standards.

• China Indonesia Japan Korea Taiwan and Vietnam National standards are based on IFRS.

• China adopted in 2006 38 new Chinese accounting standard consistent with IFRS with few exception.

End of Chapter

• Time to Clear Things Up--Any Questions?

BY

Dr. Suresh VaddeM.Com, M.Com (FA), MBA, M.Phil, Ph.D

Dept. of Management, Samara University