Assignment No.2 By Financial Maestros

Contributors:

Introduction part : Gagandeep Gupta MB-131(C)

Discussion part : Ankur Bhalla MB-65(B)

Conclusion part : Ajay Kumar MB-4(A)

Topic - Accounting Fundamentals

Introduction

The systematic recording , reporting and analysis of financial transactions of a business is called accounting. The person in charge of accounting is known as an accountant, and this individual is typically required to follow a set of rules and regulations, such as the Generally Accepted Accounting Principles. Accounting allows a company to analyze the financial performance of the business, and look at statistics such as net profit.

According to Smith and Ashburn, “Accounting is a means of measuring and reporting the results of economic activities.”

FUNDAMENTAL ACCOUNTING EQUATION

The foundation of that system continues to serve the modern business world well, and is the entrenched cornerstone of even the most elaborate computerized systems. The nucleus of that system is the notion that a business entity can be described as a collection of assets and the corresponding claims against those assets. The claims can be divided into the claims of creditors and owners (i.e., liabilities and owners' equity). This gives rise to the fundamental accounting equation:

Assets = Liabilities + Owners' Equity

ASSETS: Assets are the economic resources of the entity, and include such items as cash, accounts receivable (amounts owed to a firm by its customers), inventories, land, buildings, equipment, and even intangible assets like patents and other legal rights and claims.

LIABILITIES: Liabilities are amounts owed to others relating to loans, extensions of credit, and other obligations arising in the course of business.

OWNERS' EQUITY: Owners' equity is the owner's "interest" in the business. It is sometimes called net assets, because it is equivalent to assets minus liabilities for a particular business. Who are the "owners?" The answer to this question depends on the legal form of the entity; examples of entity types include sole proprietorships, partnerships, and corporations. A sole proprietorship is a business owned by one person, and its equity would typically consist of a single owner's capital account.

BRANCHES OF ACCOUNTING

Accounting has three main forms of branches, viz, financial accounting, cost accounting, and management accounting. These forms of accounting have been developed to serve different types of objectives:-

Financial Accounting:

It is the original form of accounting. It is mainly confined to the preparation of financial statements for the use of outsiders like creditors, banks and financial institutions etc. The main objective of Financial Accounting is to find out the profitability and to provide information about financial position of the concern. It presents a general idea of the working of the business and permits management to control in general way the major functions of a business, viz. finance, administration, production and distribution. But Financial Accounting does not give details.

Cost Accounting:

The main objective of Cost Accounting is to find out the cost of goods produced or services rendered by business. It also helps the management to detect and control all leakages, defective works, and wastage in tools and stores.

Management Accounting or Managerial Accounting:

It is accounting for management. i.e., accounting which provides necessary information to the management for discharging its functions. It is the reproduction of financial accounts in such a way as will enable the management to take decisions and to control various business activities. The primary objective of Management Accounting is to supply relevant information at appropriate time to the management to enable it to take the decisions and effective control.

DISCUSSION

ACCOUNTING INFORMATION

Accounting is a set of concepts and techniques that are used to measure and report financial information about an economic unit. The economic unit is generally considered to be a separate enterprise. The information is potentially reported to a variety of different types of interested parties. These include business managers, owners, creditors, governmental units, financial analysts, and even employees. Employees want to work for successful companies to further their individual careers, and they often have bonuses or options tied to enterprise performance. Accounting information about specific entities helps satisfy the needs of all these interested parties.

Functions of Accounting:

There are the important functions of accounting.

1) Record Keeping Function:

The primary function of accounting is to keep a systematic record of financial transaction – preparing journals, posting and preparation of final statements. The purpose of this function is to report regularly to the interested parties by means of financial statements.

2) Protect Business Property:

The second function of accounting is to protect the property of business from unjustified and unwanted use. The accountant thus has to design such a system of accounting which protects its assets from an unjustified and unwanted use.

3) Legal Requirement Function:

The third function of accounting is to devise such a system as will meet the legal requirements. Under the provision of law, a business man has to file various statements e.g., income tax returns, returns for sales tax purpose etc. Accounting system aims at fulfilling the requirements of law. Accounting is a base, with the help of which various returns, documents, statements etc., are prepared.

4) Communicating the Results:

Accounting is the language of business. Various transactions are communicated through accounting. There are many parties - owners, creditors, government and employees etc, who are interested in knowing the results of the firm. The fourth function of accounting is to communicate the results to interested parties. The accounting shows a real and true position of the firm of the business.

BASIS OF ACCOUNTING

Ø Cash Basis Accounting

Under cash basis accounting revenues are recognized and earned only when cash is received irrespective of when and how the services were performed or goods delivered.

To put it in different terms, the cash basis of accounting asks you to take into consideration all those incomes/gains that have been received in cash or other assets and expenses/losses that have been paid out in cash or other assets during the accounting period in consideration.

Ø Accrual or Mercantile Basis Accounting

Under accrual or mercantile basis accounting, revenues are recognized and earned when they are realized or realizable irrespective of when the cash is received.

To put it in different terms, the accrual basis of accounting asks you to take into consideration all those incomes/gains and expenses/losses pertaining to the accounting period for which you are trying to ascertain the profits and losses irrespective of whether the incomes are received in cash or not and the expenses are paid out in cash or not .

Ø Hybrid System of Accounting

This is not a system of accounting on its own. It is a combination of the Cash Basis Accounting and Accrual Basis Accounting. This system is based on the concept of conservatism.

Under the hybrid system of accounting, incomes are recognised as in Cash Basis Accounting i.e. when they are received in cash and expenses are recognised on accrual basis i.e. during the accounting period in which they arise irrespective of when they are paid.

What Basis/system to follow?

The basis of accounting to be followed is dependent on the attitude and outlook of the organisation. If organisations have a conservative attitude, they may adopt the hybrid system of accounting.

The traditional accounting systems used to adopt the cash basis of accounting. Organisations which are to abide by the various regulations imposed by the various acts under which they are regulated are mostly required to adopt the Mercantile System of Accounting which is supposed to reveal the information relating to the organisation in a more appropriate manner than the cash basis of accounting.

CONCLUSION

In concluding, it can be argued that without the essential framework that the accounting doctrines offer we could expect an abundance of misleading and inconsistent information. However putting things back into perspective everything leads to choices. Choices that accountants and managers make when faced with decisions of recording information. As seen a manager or a accountant may choose to take the conservative method approach and understate the net assets and profit. While on the contrary another manager might choose to take a more radical approach and capitalise expenditure. In either case when making these choices, accountants and manager must keep in mind the various conventions which clearly set out the parameters when classifying assets. Finally whichever method or approach a manager or accountant will adopt they must not change it from period to period. This will allow a true reflection of the profit trend of a company over time

The accounting treatment for securitised assets in the originator's (lender's) books is another grey area. Off-balance sheet treatment of such assets (their removal from the originator's balance sheet) is one of the major attractions of securitisation. Without this, securitisation would lose its real benefit. If securitisation involves outright sale/transfer of assets where "without-recourse" securities are issued by the originator, the relative assets could perhaps straightaway go off the balance sheet with a suitable explanatory note if deemed necessary. For other variants of securitisation where only beneficial (not legal) interest in the asset may be transferred, where securities issued may be with "part recourse" to the originator appropriate accounting norms would need to be clearly evolved.

Submitted to: Mr. Gurdeepak Singh

Submitted by: Financial Maestros