Chapter-1: The Conceptual Foundation of Accounting Level: BBA \ 1st semester | Financial Accounting
1. Who are the users of accounting information? For what purposes do they need such information? Explain.
Ans: Accounting is a systematic process and an art of recognizing, measuring, classifying, summarizing and communicating the ecomoic information to permit informed judgment and decision making by its users. Thus, the accounting information is to be communicated to the various users who have at least some level of stake over the performance of the organization. Users are those who are somehow related to the organization or its performance. Accounting information system basically used by two types of users which are known as internal users and external users. They are briefly explained below.
The Management: The users who are inside the organization ow who are directly involved in the day to day operation of organization. They are the custodians or watch dog of the business resources and use the accounting information for different purposes like planning, organizing, staffing, leading, controlling, decision making etc. For example, if a department supervisor wants to find out if monthly expenditure are more or less than the budget amount, a report can be generated to provide answer. The accounting information is very important in measuring the actual performance with the set standards and to provide feedback to initiate a corrective action.
Shareholders and Potential Shareholders: The existing investors and the likely to be investors in future of the firm need accounting information because they always seek that weather or not to invest or continue to invest in the business by watching the performance regarding profitability and its trend, financial position, dividend payout ratio, market value per share etc.
Financial Institutions and Other Creditors: Financial statements can help to the facilitators of the external equity in business to make decision regarding whether or not to invest their money. Bond holders need accounting information because they purchase a bond and the amount completely depends on company’s ability to pay back it. Similarly, before leading money a bank needs information that will help it to determine the company’s ability to pay back its periodic interests and the principle at maturity.
Government Agencies: Government agencies are the regulating authorities which need accounting information mainly for two purposes. The first, various taxes (which are revenue sources to the government) are imposed on them depending on their scope and performance. The next, weather the organization is obeying the legal procedures or not in its all aspects of performance like registration, renewal, licensing, adherence with standards etc.
Suppliers and Customers: In the same way the suppliers also relay on the firm’s performance to provide the supplies on credit, possibility of bad debts or continuity of their market. Customers can build up a trustworthy relationship with a financially sound supplier and can expect a credit facility or discount schemes. They can also be trusted in the supplies of quality goods or services.
General Public: The general public at large also need accounting information because they also directly or indirectly related with the business organization in the issues such as employment generation, increase in level of income, contribution to the national economy, environment protection, products or services availability, gender issues, protection of rights and interests etc.
Other external users: Other users may be the various employee unions or pressure groups who always try to lobby their views for their group interests, the researchers who rely the data of the business and the brokers who use the accounting information as the base for the prediction of share market price and invest or influence to invest others.
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2. What is meant by the phrase Generally Accepted Accounting Principles.
Ans: Modern accounting is based on certain assumption for keeping systematic records of financial transactions. The Generally Accepted Accounting Principles (GAAP) refers the basic assumptions, conventions, rules, procedures or system of financial accounting and reporting which are subject to an audit by an independent auditor. The basic principle behind the GAAP is to make all financial reports reported by any of the firm from any nook and corner of the world comparable to each other. Without accounting concept, we cannot keep systematic and proper account. GAAP are formulated by the concerned authoritative bodies of a nation and are hence, consistent with the international level. The important Generally Accepted Accounting Principles (GAAP) are explained below.
i. Business entity concept: According to this concept, the business organization and the owner of the business said to have their separate identities and are to be treated as different entities. So, business transactions are recorded in the book of account of business organization only and not in the books of account of its owner. Any business transaction should not be affected by a personal transaction of the owner and a business transaction should not be mixed with the owner’s personal transaction.
ii. Money measurement concept: Money measurement concept explains the fact that account records only activities which can be expressed or measured in money value. In other words, the activities which cannot be measured in money value are not included.
iii. Going concern concept: According to this concept, business is an on going process. So the transactions are also assumed to be continuous. Because of non-stop process, long-term costs are treated as assets and short-term costs are treated as expenses. It is called a going concern concept.
iv. Cost concept: Actually this concept is related with going concern concept, According to this concept, the cost of goods services are recognized when it is included and not when cash is paid for it. Assets are to be recorded at their costs. Only expired costs are expenses.
v. Accounting period concept: According to going concern concept, the business entity exists up to an indenfinite period of time and continues its business operations. Due to this principle the need of accounting period has been developed. Thus according to this princple, the indefinitie business life is to be divided in some frequent and equal intervals called accounting periods so as to know about how the organization is going on. The financial statements are to be prepared at the end of each accounting period. They show the profit or loss, financial position or cash flow situation under different business activities of the organization during the accounting period which are very much useful for the various users of accounting information.
vi. Matching concept: In this concept, revenue should be recognized at the time when it is actually earned no matter whether it is actual receipt is not. The expenses incurred for a particular period should be matched with the revenue earned by the business in that period so as to ascertain the profitability situation.
3. Analyze the role of computerized automated system in accounting for the business of 21st century.
Ans: The computers are important equipment in recording and processing information. Computers are vine of the development of new technology. The development of information technology became possible due to the computers. The accounting work also cannot be imagined nowadyas. In absence of computer, the computers may play a very important role in accounting in the following ways.
- Speedy and accuracy: Computers process the information in a very speedy way as compare to the manual system. For example report which may takes more than one month with manual system can be made within a second if properly ordered. The more reliable and accurate information can also be obtained with the computers due to the less chances of errors.
- Economy: The computer is regarded as more economy because the cost of its goes on decreasing with high level of output which is just reverse to the manual system. Moreover, the storage capacity of computers also support to comparatively reduce the cost.
- High and expandable storage: Computer have a high storage capacity. Thoursand of documents, requiring more than one store room can be compacted inside a singile computer with the help of memory card, hard drice or other devices. Also that, the storage capacity of computers can be managed or added according to the requirement with a minimum cost.
- Diligent and versatile work: Computers can perform all the works equal carefully without having tired and errorlessly which is impossible through human beings. The files, folders or search engine can greatly support in work efficiency and effectiveness. There may also have many options to locate and correct the errors and more adaptable options.
- Automated, prompt information and best decision making: Computers are the automated engines which perform most works automatically with very nominal human efforts of commands. They can provide very prompt information as they are backed by the system of input, processing, and output as and when required. The prompt information about something provides the best option in decision making.
4. What are the three forms of business organizations? Briefly describe each of them with their relative advantages and disadvantages.
Ans: Business entity can be classified in different ways on the basis of their differential shareholders, on the basis of liability of shareholders, on the basis of ownership composition etc. On the basis of legal procedure requirement also, the entities can be classified as osle trading, partnerships and companies.
Sole Proprietorship Organizations: In sole proprietorship or also called sole trading concern, the ownership of the business is solely owned by a single individual investing the whole capital by oneself. There exists a sole management and control thus, risk and responsibility also remains undivided profit or losses are not shares. In sole trading business, the owner has the unlimited liability. The sole trading business may enjoy the following benefits:
- Less complex legal process in registration and dissolution
- Very prompt and quick decision making
- Sole ownership on the profit earned
- Operational flexibility and effective management.
Partnership Organizations: The partnership firms are formed by two or more persons with the material understanding to each other. Capital is invested by the partners on the basis on their partnership deed. Management and control is done by all or one for all and profit and loss is shared on the basis of either by capital contribution ratio or according to the agreement made among partners. The major benefits of partnership business are as follows:
- Easy formation
- More capital adequacy in comparison to sole trading
- Shared liability
- Effective management and high chance of good decision.
Joint Stock Company: A company is formed by the voluntary association as the persons for the accomplishment of a common objective having a separate legal existence and perpetural succession. The required capital in company is collected by issuing the transferable shares. the joint stock company can further be classified as private limited and public limited. Private limited company is featured with limited number of shareholders and the public limited company is feature with the large number of shareholders. The advantages of Joint Stock Company can be viewed as below:
- Limited liability
- Capital adequacy
- Perpetual succession
- Transferability of shares
- Good decision making
- The effective and democratic management system
5. What is the accounting information system? Explain the role of accounting information systems in modern business houses.
Ans: Accounting is an information system which measures, processes, and communicates financial information of an organization. The business activities are identified and measured in terms of money, which are then processed and finally communicated to the various groups of users. Without accounting, the financial transactions and events having financial implications to the organization are just data. They are converted to information by the accounting processing system.
AAA (American Accounting Association) had defined accounting as “the process of identifying, measuring and communicating economic information to permit informed judgment and decisions by the users of the information.”
Thus, the accounting information system has great significant for making decision in modern business organizations.
Figure: Accounting as and information system
The accounting information plays a very important role in the competitive modern business environment. Modern business entities cannot remain aloof from the information systems in today’s complex business context. Information system collects and preserves the data about the business process that can be used to generate meaningful reports for decision makes to make plans, to implement plans, to control performance and to compare the performance with the stated plan or goals to the organization. Computers are used to operate the accounting system which helps to handle the volumes of data in the accounting cycle accurately and promptly. Internalization and globalization of business have also increased the importance of accounting information system to meed and beet the globally competing business houses.
6. How do you get advantages using computers in financial accounting?
Ans: Business activities can be classified in three ways as discussed below:
Operating Activities: Operating activities are those activities of the business which are related to day to day business operation. In other word, those activities which result the cash inflow or outflow in connection with the purchase and sale of trade-able item of business. The operating activities include cash revenues earned from the sale of merchandise inventory and expenses incurred in connection with purchase merchandise inventory or other expenses incurred to make that item into a saleable condition. The operating activities thus, normally, related to items in the income statement, current liabilities and current assets section of the balance sheet. The cash inflows under operating activities are receipts from customers like, sales, receive or accounts receivables etc. and cash outflows under this are payment to suppliers and employees e.g. purchase, payment of account payables, payment of salary, payment for other operating activities taxes, interest etc. The cash flow under operating activities cash be computed through direct method as explained above or indirect method in which non-cash transactions of income statement are considered thus started from net income for the period.
Financing Activities: The financing activities of a business are related to the raising of fund required in the business and use of that fund in repayment, redemption or payment of divided. Financing activities include comparative changes in cash or cash equivalents in the current year with last year in the liabilities and shareholders equity section of balance sheet other than current liabilities. The financing activities which inflow cash may be an issue of share capital, issue of departure, bonds or long-term notes, borrowings or load from bank etc. and the activities which outflow cash may be payment of divided, redemption of
Investing Activities: The investing activities of the business entity are those which are related to the purchase or sale of physical business assets, investments or intangible assets. In other words, the investing activities include all the activities which either inflow or outflow the cash in business and are related to the assets side of the balance sheet other than current assets. The cash payment made in those assets which are not directly related to the operation but are supposed to generate some revenue from their intended use or operation and cash receipts form the disposal of such assets are included in this activity. The investing activities which may increase the cash balance in business are cash disposal of plant, properties equipment, sales of shares, debentures, bonds etc. from another company, sale of patent, trademark or goodwill, interest or dividend from another company etc. and the investing activities which may reduce the cash balance in business are acquisition of plant properties and equipment in cash, purchase of shares, debentures, bonds or other documents of another business, purchase of patents, trademarks copyright goodwill etc.
Write Short Notes On:
Accounting as a communication
Ans: The shareholders and other stakeholders are those who have at least some level of stake over the performance of the organization directly or indirectly. Financial statements are the principal means of communicating important accounting information to the various internal and external users. Accountants report about its stock of resources in the form of a balance sheet and the flows are
The balance sheet communicates the resources of an organization and claim of the shareholders over those resources in
The income statement communicates profitability situation of the organization during and accounting period. The net income is the excess of incomes over expenses and the net loss is the excess of expenses over incomes. This statement reflects the operating performance of the organization and deals with the tradable items.
The statement if changes in owner’s equity communicates the changes in equity over the reporting period. This statement starts with beginning equity and adjusts it for events that increase equity i.e. investments by the owner and net income, and decrease equity i.e. net loss and owner withdrawals.
The statement of retained earnings communicates the retained earnings balance of a company after adjusting any additions to it on account of net income and deductions by way of distributions of dividend. It shows the accumulated or retained deductions by way of distributions of dividend. It shows the accumulated or retained profit after distributions of dividend to the owners for their capital contribution or the earnings distributable to owners in another word.
The statement of cash flows reflects the number of cash receipts and disbursed by the firm in different business activities which are classified as operating, investing, and financing. The statement of cash flows describes the sources and uses of cash for an accounting period. It also reports the amount of cash at both the beginning and end of a period. It simply shows the cash increases and decreases during a year due to different activities in comparison with last year.
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