Introduction to Financial Accounting

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Introduction to Financial Accounting


By Md. Mizanoor Rahman



Chapter Outline


  1. Introduction
  2. Learning Objectives
  3. Meaning, History ,Scope and Objectives
    1. Meaning of Accounting
    2. History of Accounting
    3. Scope of Accounting
    4. Objects of accounting
  4. Importance and Use of Accounting in daily life
    1. Necessity and importance of accounting
    2. Use of accounting in day-to-day life
  5. Let's Sum Up
  6. Key Points
  7. Glossary
  8. Practice Test
  9. Answers to SAQ
  10. References and Further Readings





Introduction


Everyday we, generally, exchange money and goods in our private and family life and also in institutions. These acts of giving and taking result in monetary changes to respective parties in every case. It is necessary to keep record of accounts of monetary transactions to know how much money has come in or how much money has gone out, what are the sources the income from or what purpose the expenditure has been incurred for. Even we need to keep records of transactions to know whether the income has increased or the expenditure has increased. We shall also keep records of transactions to know how much we owe to others and how much others owe us. Each and every person of the society is required to keep some accounts. In the stream of social and economic activities of today, each and every person or institution in accountable to some one or to other for his or its economic activities or the wealth acquired, income earned and the expenditure incurred. Different types of transactions occur in business. Without maintaining proper accounts, it is neither possible to ascertain profit or loss of the business nor to know the financial position of the business at any particular date. This chapter will describe meaning, evaluation ,scope and objects of financial accounting. It also discusses importance and use of accounting in daily life. Let's go through the entire chapter and know introduction to financial accounting.





Learning Objectives
After reading this chapter, you are expected to learn about:


  • Define accounting;
  • Describe history of accounting in short;
  • Discuss the scope of accounting;
  • List the objects of accounting; and
  • Describe the importance of accounting in the daily life.





Meaning, Evaluation, Scope and Objectives


Accounting has become a dicipline now-a-days. It passed a long historical process. Now it implicates our daily lifes, business and social life. Let's discuss all one by one.

Meaning of Accounting


Definition of Accounting: Accounting is both the science and art of correctly recording in books of accounts all those business transactions that result in the transfer of money or money’s worth. It may also be defined as the art of recording mercantile transactions in a regular and systematic manner; the art of keeping accounts in such a manner that a man may ascertain correct result of his business activities at the end of a definite period and also can know the true state of affairs of his/her business and properties by an inspection of his/her books.

Accounting has been defined as, “the art of recording, classifying and summarizing in a significant manner in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results there of. ” This definition has given by the AICPA. Now we do the following activity:


Activity
List the key points from the definition -








Now, let's discuss this definition carefully, we could understand the following points. Hopefully you already noted all of them in your activity.

‘Art’ is a part of our knowledge that helps us to attain our objectives. In business, our object is to know the financial results. That is we can know by way of recording, classifying and summarizing the business transactions in the best way.

‘Recording’ transactions in various meaningful ways, as required according to the size of the organization.

‘The art of classifying’- grouping of transactions or entries of the same nature at one place.

‘ The art of summarizing’ business transactions, because it has to prepare at least two summarized statements – (1) Trading and profit & loss Account (to ascertain profit or loss of that organization) or Income & Expenditure Account (in case of non trading concerns) and (2) Balance sheet (It shows the position of assets and liabilities of an organization at a certain date) to make the classified business activities understandable to the proprietors, management and other interested parties.

‘ Summarizing in a significant manner’ – means that summarizing must be done in such a way as to create a definite sense and must suit the purpose for which it is done i.e. should be user friendly.

‘In terms of money’ – because money is the measuring yardstick. [for comparison of values of different assets of the same concern, comparison with various years result and with other organizations]

Transactions and events which are, in part at least, of financial character’- Accounting deals with only financial transactions and events that are able to change the financial position of that organization; not any non-financial transactions and events)


Transactions may refer to an act of performance, an exchange, a transfer etc. For the purposes of Accounting only such acts of financial character, capable of being measured in terms of money, are worth considering.

‘ Interpreting the results’ – Accounting not only creates data through recording, classifying and summarizing transactions and events, but also uses them by interpreting through interpretation of results the persons interested can know the trends of the results, the better of the alternatives, product-mix, comparative advantages etc. The management, investors and other parties interested in the business also interpret the accounting information for there own purpose and in different angles.

We discuss this definition part by part to have a comprehensive understanding in accounting.

More definitions of Accounting:

American Accounting Association (AAA): AAA defines “ Accounting refers to the process of identifying measuring and communicating economic information to permit informed judgement and decisions by users of the information.”

According to A.W. Johnson:
“Accounting may be defined as the collection, compilation and systematic recording of business transactions in terms of money, the preparation of financial reports, the analysis and interpretation of these reports and the use of these reports for the information and guidance of management.”

Weygandt, Kieso & Kimmel:
“Accounting as an information system that identifies, records and communicates the economic events of an organization to interested users.”

This definition views accounting as an information system that identifies and records the financial transactions, ascertains the results and provides information to the various interested users in the users desirable way or according to their needs. Basically accounting is not a recording procedure. It is an information device or tools that works to provide information to interested users to rationalize their decision-makings.


Activity
Draw a flow-chart on accounting definition.








The modern view of Accounting is, “Accounting seen as a service activity.” It is a link between business activities and decision-makers.

First, accounting records data on business activity for future use. Second, through data processing, the data are stored until needed, then processed in such a way a to become useful information. Third, the information is communicated, through reports, to those who can use it in making decisions.

A. W. Johnson defined accounting as the collection, compilation and systematic recording of business transactions in terms of money, the preparation of financial reports, the analysis and interpretation of these reports for the information and guidance of management.

You will find two terms: Bookkeeping and Accounting. These two are not same. Bookkeeping is the art of recording transactions. This is elementary part. Accounting deals with constructive part of bookkeeping. In fact, bookkeeping is complementary to the Accounting process. Where bookkeeping is the systematic recording of financial and economic transactions, Accounting is the analysis and interpretation of bookkeeping records.


History of Accounting


The history of accounting is as old as the history of human civilization. This journey of accounting has started on the very day on which the human being has started living in caves. At that age, occupation of mankind was the collection of fruits and roots and preying of birds and beasts for their livelihood. Then people used to keep record of their preyed beasts by drawing lines on the stones inside the cave, snatching on the bark of trees or making knots with the help of creepers.

Gradually man started to live in the societies on plain lands by leaving caves and started agriculture. They started to keep record of their produced crop by marking off on the wall of their houses and making knots with the help of ropes. Step by step the societies expanded .The demand of mankind started increasing .Exchange system started .Men started to satisfy their mutual needs by exchange of goods .Then, in ancient India and Europe man stared to keep accounts by marking on the back of the door panel, drawing marks on the mud-wall with color or marking on the wood-sticks.

In courts of time, money was introduced as medium of exchange and monetary activities of man further expanded. Professional merchant classes emerged. Trading started between persons, institutions at home and abroad in cash and on credit. Writing accounts of all total purchase and total sales and total assets and total liabilities were started.

Modern accounting was born in the fifteenth century with the development and rapid expansion of trade and commerce. An Italia priest and philosopher, Luca Pacioli by name, felt the necessity of specific principles for maintaining accounts and in 1494 included a section on accounting in his book entitled, “Summa De Arithmetica Geometria Proportiona Proportionalitate”. In that section he explained the basic principles of Double –Entry System of Bookkeeping. Though the present day system of keeping accounts was first introduced in the city of Venice in the Republic of Italy, the use of double entry system of book-keeping came into practice in different parts of the world within a short time. Since then different methods of keeping accounts are being practiced on the basis of modern accounting following the double entry system invented by Lucal De Pacioli. With the progress of science, technology and trade and commerce, much improvement has taken place in the technique of accounting and continuous efforts are in process for its further improvement.

Scope of Accounting


The scope of field of accounting is very wide. Accounting is needed not only by business class but also by non-business class. Starting from the private life of a man, the fincnacial activities of school, college, club, society, hospitals and government institutions come within the purview of accounting. The jurisdiction of accounting also includes the financial activities of professionals including doctors, engineers and layers. The monetary transactions which take place in the private life of a man are recorded properly in the books of accounts; it becomes possible to ascertain his receipts and expenditure as well as personal assets and properly in the books of accounts, it becomes to ascertain his receipts and expenditure as well as his personal assets and liabilities. When the financial transactions of a business. It is essential to maintain accounts of non-profit organizations like school, college, hospital, club, society etc. In the same way, it is necessary to keep accounts of professionals like service-holders, doctors, lawyers, actors/actress etc. to ascertain their incomes and calculation of income-tax on the basis of those incomes. Maintaining accounting is practiced to determine the income and expenditure of different government offices and public bodies as well as to run those offices and organizations properly. By preparing and evaluating national plan and budget with the help of accounting it is possible to know the development and deterioration of the country. Hence, in a nutshell, we can say that the scope of accounting is wide enough to cover all the fields of the society.

Objects of accounting


The principal object of accounting is to keep permanent record of all monetary transactions effected by a person ort enterprise during a definite period and ascertainment of results of those transactions at the end of the said period,. The main objects of accounting are enumerated bellow:

  1. Proper recording of transactions: The first and foremost object of accounting is to keep record of monetary transactions in a systematic manner.
  2. Determination of results: Every person or institution is always interested to know the results of his/its monetary transactions at the end of a definite period. So, ascertainment of result of financial transactions is an important object of accounting.
  3. Ascertainment of financial position: another object of accounting is the ascertainment of debtors and creditors, assets and liabilities and the overall financial position.
  4. Supplying financial information: another important object of accounting is to make available all sorts of financial reports and statement to all parties interested in the affairs of the concerned institution as soon as possible after preparing those reports and statements.
  5. Defalcation prevented: Another special object of accounting is the prevention of defalcation of money made through fraud by the officials of the institution as well as control of expenditure.
Importance and Use of Accounting in daily life


Accounting has become part of our daily activities as it implicates monitary transactions of life. People spend money, invest money for future; all these require proper accounting. Let's discuss the matter in details.

Necessity and importance of accounting


The necessity and importance of accounting is limitless or unbounded to men in their day-to-day personal life, family-life, and intuitional life. The necessity of accounting is described bellow:
(a) Institutional Necessity

Use of accounting in day-to-day life


Accounting: whether Science or Arts
There is a great controversy whether accounting is science or arts. According to some scholars accounting is science, someone is describing accounting as arts. But actually accounting is a composition of both science and arts.

Why accounting is ‘Science’:
Science refers systematic process. In scientific activities it follows certain rules-Observation, analysis, taking actions and then evaluation of activities. Like scientific activities before taking any action accounting observes the activities, analysis the various alternatives, choosing the best alternatives and taking feed back to evaluate the performance. So accounting is termed as science

Nature of Accounting Information:
The following characteristics are pre-requisite for events and transactions to become accounting information:

1. Accounting Information must be able to change the financial position of an organization. Two type of change may occur:

(a) Net change: The events or transactions that change the position of assets and liabilities of the organization, is called the net change.
Example:

Salary Tk.2000 paid to Mr. Ahmed.










(b) Structural change: The events or transactions that change the structure of assets and liabilities of the organization.
Example:

Equipment purchased at Tk.10, 000.










2. Accounting information must be measured in terms of money.

3. There must be two parties related with accounting activities/transactions. (Dual aspect of accounting i.e. the interchange between two parties will complete a transaction.)

4. Accounting information must be self sufficient and independent from one another.

5. Any invisible events that change the financial position of an organization may be termed as financial transactions.



Self-Assessment Questions (SAQs) - 1
1. The art or science which teaches the technique of recording and explaining financial transaction is called:
A. recording transactions
B. bookkeeping
C. accounting
D. bookkeeping and accounting


2. The origin of modern accounting was in _________

A. England
B. India
C. Italy
D. America


3. Who is the father of modern accounting?

A. L C Cooper
B. A W Johnson
C. Luca Pacioli
D. R. N Carter


4. Which year indicates the period of origin of double entry system of bookkeeping?

A. 1414
B. 1394
C. 1494
D. 1449


5. What was the name of the book written by Luca Pacioli?

A. Accounting in ancient Italia
B. The modern concept on accounting
C. Summa de Arithmetica Geometria Proportionate Proportinalita
D. Accounting in the past


6. The history of accounting is:

A. a new discipline
B. invention of science
C. as old as the human civilization
D. a new achievement of social science


7. The principal object of bookkeeping is:

A. keeping written records of transaction
B. keeping written records of expenditure
C. ascertainment of financial results
D. ascertainment of debit and credit


8. The fields and scope of accounting are-

A. confined within business field only
B. extended over individual life only
C. extended over all fields of society
D. like individual life and business fields



Results



Key Points

The key points of this chapter are as follows:

  1. Transactions
  2. Accounts
  3. Expenditures
  4. Economic activities
  5. Luca Pacioli
  6. Summa De Arithmetica Geometria Proportiona Proportionalitate





Glossary


‘Business transactions’ – has been defined as any act that alters the financial position of a concern, where such alteration can be measured in terms of money.

Event – Financial & Non-Financial but only financial events are considered.





Practice Test


Essay type questions

  1. Define accounting.
  2. Explain the objects of accounting.
  3. Explain the necessity of accounting in a business organization.




Answers to SAQs

1.B

2.C

3.C

4.C

5.C

6.C

7.A

8.D





References and Further Readings


American Institute of certified Public Accountants (AICPA)* Committee on Terminology, Accounting Terminology Bulletin NO.1. Review and Resume

American Accounting Association (AAA):




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