Financial Accounting is the recording and reporting of all activities and transactions that affect the money resources of a business. Accounting is based on basic universal concepts commonly known as accounting principles to maintain consistency in recording business transactions.
Basics of Financial Accounting
Dual Aspect:
The dual aspect concept sets up the basis of accounting equation that derive financial statements. Accounting rests on the accounting equation Assets = Capital + Liabilities. Business transactions impact debits and credits of an account in equal amount.
Business Entity:
The business entity states that a business enterprise is an entity distinct from its owners. Accounts drawn for the business are separate from owner's personal financial dealings. The owner and business are treated as a single entity, legally. For accounting purposes, they are two separate entities.
Going Concern:
According to this concept, a business is expected to continue for an indefinite period of time. This assumption enables the business to spread the cost of an asset over the period of its economic life. It is not essential to calculate the current costs of assets each time financial statements are prepared. Assets are disclosed at cost less depreciation and not the current market price.
Accounting Period:
For accounting purposes, the lifetime of the business is divided into arbitrary periods of fixed length, usually one year. At the end of each period, two main financial statements are prepared. First, the profit and loss account showing the profit and loss made during that period. Second, the balance sheet showing the position of a business as on a particular day.
Cost Concept:
The cost concept states that assets acquired by the organization are recorded at their cost of acquisition. This value is the basis for subsequent transactions such as charging depreciation. A balance sheet shows assets valued at their original cost less accumulated depreciation.
Money Measurement:
The money measurement concept proposes to record transactions that can be attributed in terms of monetary value. Therefore, transactions such as strike in the enterprise or good management practices cannot be recorded in the financial statements.
Matching Concept:
The matching concept ensures that all revenues and costs are recorded in the appropriate statement at the appropriate time. The income and expenses should be matched and dealt within the financial statements for the period to which they relate, irrespective of the period in which the cash was actually received or paid.
Recording Accounting Information
Accounting is the process of recording the incomes and assets of a business to determine profits and analyze progress. It should be made sure that the recorded information is accurate in order to do a correct analysis. The basic presumption accounting is based on is that every business transaction affects two accounts.
Business Transaction Path
The business transaction path has the following in order to be followed:
Business Transaction:
A business transaction is a single business event or exchange within or between groups for the purpose of business.
Journal:
A journal is a book of account used to record a condensed and grouped statement of the daily transactions.
Ledger:
A ledger is a book that contains the summary of accounts. All the debits and credits from a journal are transferred to the ledger.
Trial Balance:
A trial balance tests a ledger to discover whether the debits and credits balance. The equality shows that the items were correctly posted.
Preparing Financial Statements
The basic objective of financial accounting is to prepare financial statements. One prepares financial statements in form of profitability statements and balance sheets. Profitability statements comprise of accounts such as manufacturing and trading account, profit and loss account, and profit and loss appropriation account.
Balance sheets determine the health of the business at a specific point of time. The profitability statements show the business activities between two subsequent balance sheets. These statements are linked by profit that is determined in the profitability statements.
Before the financial statements are prepared, the values in the trial balance are matched. This activity ensures that all transactions are accurately posted in the ledger accounts. Depending on the nature of the item, all the trial balance values are posted in either the trading account, the profit and loss account or the balance sheet. All expenses and incomes find a place in the trading and profit and loss account. All assets and liabilities are recorded in the balance sheet.
The trial balance may not reflect transactions that occur after the preparation of the trial balance. Therefore, to show the effect of these transactions, one needs to post adjustment entries in the financial statements.
