Financial accounting is the art of identifying , measuring recording ,classifying ,analysing and communicating the information to the required users . It can also be termed as IMRCAC.
It is a complete process in which we maintain a records of what transaction happens for how much amount and then we used to analyses it and calculate the profits.
In this process the first step includes the identifying the transaction whether it is a business transaction or not ,after that we used to find out that the transaction are in monetary terms or not accounting does not record the non-monetary transactions after measurement we used to record that in the book which is known as journal entry or book of first entry because every transaction first happens is recorded in this book only after that we used to transfer them to their particular ledgers and we find out the balances for that accounts and post them to trial balance which helps us to prepare our financial statements which are necessary to calculate the profit or loss .Lastly we used to prepare our final statements which include Trading account ,Profit and Loss account and balance sheets . Balance sheet is the most important part of the accounting because it helps us to find out the exact position of a firm at the end of year. Accounting is always done on the basis of financial year .The financial year starts from 1st of April till 31st of march .It is a process by which companies record their transactions of business and calculate the profits .
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ACCOUNTING PRINCIPLES
The process of Accounting follows some basic principles which is known as Generally Accepted Accounting Principles {GAAP} to maintain a common standard for accounting for all the firms. The basic principles are :
GOING CONCERN PRINCIPLEThis principle states that a business should run for an continuous period or for an long period or a minimum of 12 months at least it should not be conducted for the short time.
IMPORTANCE
There are various principles which are based on this principle .
For ex dual entry or accrual concept which states that we should record both the aspects of transaction whether cash or credit. So if the business follows this going concern concept then only the accrual concept can be followed because if a business will shut down in a short duration of time it can’t record the accrued transactions and also all the pending payments which leads to record them as bad debts or expenses depends on the nature of the expenditure at the time of closure of business.
There is an another importance of this concept is that it helps the investors and other users to make their decisions of investing as the company is going to run for a longer period of time.
The concept of depreciation and amortization also works on this principle also because if a business is not lasting for an long period how will you charge the depreciation on assets for that business and same goes with amortization that how you will amortization for an short span of time.
But since every coin has two faces there are some disadvantages too for this concept like:
DISADVANTAGES
If a company is facing financial distress then this concept will no longer will valid. In that case company have to file for bankruptcy and to liquidate it’s assets.
The another disadvantage of this concept is that the company always records the assets on cost or at the time of liquidation it will be valued at market value which will create the chaos .
ACCRUAL PRINCIPLE
The Accrual principle of accounting states that any accounting transaction should be recorded in the same financial period or accouting period in which they occur rather than in which their cash flow occur . For Ex. If we had done a sales of rs.10000 but the customer didn’t gave the payment at the time of the sale then also that transaction will be recorded as credit sales .
Advantages
It helps us to reduce the errors and disperencies as each and every activity is recorded timely.
It also helps us in getting a clear image of our available resources which help us to plan our future
It helps the business in realising true profit by getting the clear image of all the transactions
Disadvantages
But since it has to record both the aspects it requires more time and skill
Accrual accounting may shows a business generating profits but the cash has not been received yet . It can portray the business as profitable even when it lacks the fund to finance its operations .
3. COST PRINCIPLE
This principle states that a business should record the assets on the price at which they had been purchased or acquired . There will be no change is been recorded on the basis of market value . this principle is also known as historical cost concept as the amount at which the asset is acquired. This principle helps in calculation of depreciation because the depreciation will always be accurate if only we will calculate it on the price it has been acquired . This principle is not valid on intangible assets such as trademark ,copyright etc. because these assets used to be built over time so there is not an exact initial cost of that asset .
EXCEPTIONS OF THIS PRINCIPLE
Liquid assets that can convert into cash within a period of one year should record at market value
Receivables are always recorded at their net realizable value.
Liquid assets that can convert into cash within a period of one year should record at market value
Advantages
This principle eases the financial record keeping as we don’t have to change the value of asset according to market again and again
It helps an auditor to easily audit the data as he don’t have to calculate the amount on changeable values again and again
Disadvantages
I does not shows the fair value of asset
It does not consider inflation
It does not consider market value so sometimes it may cause loss due to huge difference between market value and historical value
CONSISTENCY CONCEPT
This principle states that all the accounting treatments should be done by following a single standard method until or unless it is required by law to change. It helps to prevent the manipulation in accounts and maintain a consistency .
For Ex. If a machine has been charged the depreciation by SLM method then that method should be used for the upcoming years till the shelf life of machine to charge depreciation.
Advantages
It helps an accountant or the users of the information to understand it easily .
It also eases the auditing process.
When same methods or procedures used over a period the management get to better understanding and helps in decision making.
It helps in comparing the financial statements as same methods followed are easily comparable.
Disadvantages
It forces the management to use the same methods and procedures but with the change in demand and time it is very much needed to do the changes as technology is also changes to a rapid pace.
It lacks the flexibility when faced by various economic fluctuations.
5.FULL DISCLOSURE PRINCIPLE
It states that the company should record or disclose all the relevant and necessary information in the books of accounts . This principle helps the stakeholders or the users of financial information for decision making . The principle does not says to reflect each and every information instead it says to record all the material information that have a impact on financial position or results of company.
This increases the transparency and reduces the fraudulent activities.
It has a dual effect also as it helps in contracts and binds both the parties to disclose all the relevant information .
Advantages
Helps in preventing legal problems.
Helps in decision making.
Builds client confidence .
Help in safeguarding from frauds .
Disadvantages
When financial information is not disclosed properly investors will loose interest hence it will lead to lack if investment .
It can also create insecurity among clients and employees.
It may create legal problems.
It can also create problems in correcting the mistakes if any.
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