NATURE AND SCOPE OF FINANCIAL ACCOUNTING
QUESTION: What is Financial Accounting? What are its objects?
Financial Accounting is a system which involves the identification of transactions and events which are financial in nature; ensuring measurement of transactions in the monetary terms; recording the transactions in the journal; classifying the entries in ledger, summarizing the entries in final accounts i.e. Trading Account and Profit and Loss Account and Balance Sheet; analyzing and interpreting the results and communicating the results to the users of the accounting information.
ACCORDING TO APB (Accounting Principles Board)
“Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.”
The Objectives Of Accounting are as follows:
KEEPING SYSTEMATIC RECORDS OF BUSINESS TRANSACTIONS
This is one of the main Objectives of Accounting ie. to keep the systematic records of Accounting Transactions. This is so because human memory is limited. It is impossible to memorize all the transactions of the business. That is why transactions are recorded in the books of accounts i.e. Journal, Subsidiary Books, Ledger etc. as per the rules of double entry system. Also the accounts are closed each year and Trading and Profit and Loss Account and Balance Sheet is prepared. Complete records prepared helps in avoiding any kind of fraud, misappropriation and omission.
PROTECTION OF BUSINESS PROPERTIES
Accounting aims at providing protection to the business properties from unauthorized, unjustified and unwarranted use as it provides the following information to the accountants:
- How much capital is invested in the business by the proprietor?
- How much the business has to pay to others?
- How much the business has to recover from others?
- How much the business has in the form of Fixed Assets, Cash in hand, Cash at bank, Stock of raw materials, work-in-progress and finished goods?
The information about these matters helps the proprietor in assuring that the funds of the business are not necessarily kept idle or under-utilized.
TO ASCERTAIN OPERATIONAL PROFIT OR LOSS
One of the objectives of Accounting is to ascertain the true profit or loss of the firm at the end of the financial year. For this purpose, the Trading and Profit & Loss Account is prepared. The preparation of Trading Account helps in knowing about:
- How much goods are there in the stock?
- How much goods are sold or remain unsold?
- To what extent the firm is incurring on the direct expenses?
- What is the Gross Profit or Gross Loss for the year?
Similarly, preparation of Profit and Loss Account gives information about:
- How much the firm is spending by way of Advertisement, Insurance, Trading Expenses, Electricity, Stationery etc.?
- How much firm is earning through commissions, discount, interest etc.?
If the indirect expenses are more than the indirect incomes, there is net loss to the firm. And if the indirect incomes are more than the indirect expenses, there is net profit to the firm.
Profit and Loss Account, thus, will help the management, investors, creditors etc. in knowing whether running of the business has proved to be remunerative or not. In case, it has not proved to be remunerative or profitable, the cause of such a state of affairs is investigated and necessary remedial steps are taken.
ASCERTAIN FINANCIAL POSITION OF BUSINESS
To know about the profit and loss of the firm is not enough. A businessman must also know about the financial position of his firm. He must know where he stands, what he owes and what he owns? For this purpose, Balance Sheet or Position Statement is prepared at the end of the year.
Balance Sheet is a statement that shows the capital, assets and liabilities of the firm. From this, the owner can easily take a view of the following information:
- How much the business has to recover from others i.e. Debtors?
- How much the business has to pay to others i.e. Creditors?
- What is the amount of capital invested in the business?
- What constitutes the assets of the firm?
All this is helpful to provide the clear view of Profitability, Liquidity and Solvency position of the firm.
TO FACILITATE RATIONAL DECISION MAKING
Accounting is related to identification, collection, recording, classifying, summarizing, analyzing, interpreting and communicating the accounting information. The information is reported to the required levels of management at required points of time to facilitate rational decision making.
AAA (American Accounting Association) has also stressed on this point:
“Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of information.”
To take the best decisions is not an easy task. But still all efforts are taken by the management to improve the decision making process.
PROVIDE INFORMATION TO VARIOUS PARTIES
Another main objective of accounting is to communicate the accounting information t various interested parties like owners, investors, creditors, banks, employees, research scholars and government authorities’ etc. the information helps them in taking sound and judicious decisions about the business entity.
OTHER OBJECTIVES
Apart from the above mentioned objectives, there are also some other Objectives of Accounting, which are as follows:
- To know the exact reasons leading to net profit or loss.
- To ascertain the progress of the business from year to year.
- Prevention and Detection of errors and frauds.