Chapter 1 : Basic Understanding of Financial Accounting

Very Short Question Answer

What is cash basis of accounting?

When transactions are recorded on the basis of actual flow of cash in and out of the business, it is known as cash basis of accounting. Under this method, incomes are recorded when they are received and expenses are recorded when they are paid.

Define financial accounting.

Financial accounting is the process of preparing financial statements that companies use to show their financial performance and position to people outside the company, Including investors, creditors, suppliers, and customers.

Write any two objectives of financial accounting.

Its main objectives of financial accounting are:

1. To maintain the records of transactions: Financial accounting maintains the proper records of all the transactions according to specified rules for future reference.
2. To ascertain the operating results: Financial accounting ascertains the operating results i.e., the difference between revenue and expenditure for a specific period of time. It is done by preparing trading and profit and loss account.

Write any two limitations of financial accounting.

The following are the limitations of financial accounting.

1. Historical in nature: Financial accounting is historical in nature since it records the past transactions.
2. Not flexible: Financial accounting is not flexible since it strictly follows the GAAP, accounting standard and concerned acts.

Show the relationship between book keeping, accounting and accountancy.

Bookkeeping is an art and science of making records of day-to-day financial transactions of a business in appropriate books of account. Accounting begins when bookkeeping ends. Besides bookkeeping, accounting includes preparation of financial statements such as income statement, balance sheet, statement of cash flow as well as their analysis and interpretation. Accountancy is a profession or subject. It consists of bookkeeping, accounting, and auditing. In this way, bookkeeping, accounting and accountancy are closely related to each other.

List out the users of accounting information.

The users of accounting information may broadly be classified into two groups as internal and external.

1. Internal users: The internal users of accounting information are different levels of management such as board of directors, managers, accountant and others.
2. External users: There are various users of accounting information outside a company such as investors/shareholders, lenders, suppliers, rating agencies and security analyst, employees and trade union, customers, etc.

Differentiate between cash and accrual basis of accounting.

Cash basis of accounting:  When transactions are recorded on the basis of actual flow of cash in and out of the business, it is known as cash basis of accounting. Under this method, incomes are recorded when they are received and expenses are recorded when they are paid.

Accrual basis of accounting:  When incomes and expenses are recorded as they occur, regardless of whether or not cash in hands has actually changed, it is known as accrual basis of accounting. Accrual basis of accounting provides a more accurate measure of company’s profitability during accounting period and more accurate picture of a company’s assets and liabilities at the end of accounting period.

Long Question Answer

“Financial accounting is a specialized branch of accounting that keeps track of a company’s financial transactions,” discuss.

Accounting is a process of identifying, measuring, recording, classifying, summarizing, analyzing, and interpreting the financial transactions and communicating the results thereof to the persons interested in such information. Accounting is also known as Language of Business since it communicates the financial information about the business to the users.

There are mainly three branches of accounting: They are:

Cost accounting: Cost accounting is mainly concerned with recording, analyzing and reporting the cost of a business.

Management accounting: Management accounting is primarily concerned with providing financial information to the management. It enables management to discharge its functions properly, mainly related to forecasting and budgeting, control over costs and revenue decisions.

Financial accounting: Financial accounting is the oldest form of accounting. Generally, the term accounting refers to financial accounting. It is a branch of accounting that is related to recording, summarizing, and presenting financial transactions through financial statements such as an income statement, balance sheet and statement of cash flow. Income statement is prepared to ascertain operating results i.e. profit and loss incurred during a particular period of time. Similarly, the balance sheet is prepared to know the financial position on a given date. Likewise, a cash flow statement is prepared to know the position of cash flow during a particular period of time. Thus, financial accounting is a specialized branch of accounting that keeps track of a company’s financial transactions.

Discuss the concept, features and objectives of financial accounting.

Financial accounting is a branch of accounting that is related to recording, summarizing, and presenting financial transactions in financial statements such as income statement, balance sheet and statement of cash flow.

The following are the main features of financial accounting.

1. Records the financial transactions only: Financial accounting deals with the transactions that can be expressed in monetary terms. For example, it records the purchase of goods for cash but does not record the event related to low morale of the employees.
2. A continuous process: Financial accounting is a continuous process. So, it is regularly.
3. Analysis and interpretation: Besides recording the transactions, financial carried accounting also analyzes and interprets the results thereof.
4. Historic in nature: Financial accounting is historical in nature since it records the transactions only. On the other side, cost and management accounting are direction.
5. Based on Generally Accepted Accounting Principles (GAAP): Financial accounting is based on generally accepted accounting principles. This has enabled the preparation and presentation of financial statements uniformly.

The main objectives of financial accounting are mentioned below:

1. To maintain the records of transactions: The first objective of financial accounting is to maintain the proper records of the financial transactions for future reference.
2. To ascertain the operating results: Another important objective of financial accounting is to ascertain the operating results.
3. To depict the financial position: Financial accounting aims at showing the financial status of the business on a particular date.
4. To avail information to users: Financial accounting aims at availing information to the interested persons or organizations.
5. To help in determining tax liability: Financial accounting provides information to the tax authorities to determine tax to be paid by the organization.

What do you mean by accounting information? Explain in brief the qualitative features of accounting

Accounting information is designed to meet the common information needs of the decision makers. These decisions may include buying, holding or selling the shares of a company. Accounting information shows the ability of the company to pay its employees, determine distributable profit and regulate the activities of the company. Management, investors and lenders are the most common users of accounting information.

The following are the qualitative features of accounting information.

1. Understandability: The accounting information should be comprehensive so that the user can understand it.
2. Relevance: Accounting information should be relevant to the users. For this, it must be capable of making a difference in a decision.
3. Reliability: Accounting information is reliable to the extent that users can depend on it to represent the economic conditions or events that it purports to represent.
4. Comparability: Accounting information about an enterprise is extremely useful if it can be compared to accounting information about other enterprises.
5. Consistency: Consistency means conformity from period to period with unchanging policies and procedures.
6. Materiality: Materiality is the magnitude of an accounting information omission or misstatement that will affect the judgment of someone relying on the information.

Also Read: Financial Accounting Question Bank

Describe the user of accounting information and why do they need such information? Explain.

 The users of accounting information may broadly be classified into two groups as internal and external.

1. Internal users: The internal users of accounting information are different levels of management such as board of directors, managers and accountants and others.
2. External users: Investors/shareholders, lenders, suppliers, rating agencies and security analysts, employees and trade union, customers, government, regulatory agencies, and tax authorities and the public are the external users of accounting information.

 Need of Accounting Information:

The accounting information is very important for the management or the decision making body of an organization. It gives management information regarding the financial position of the business, such as; profit and loss, cost and earnings, liabilities and assets, etc. The needs of accounting information are discussed below.

1. Investors/shareholders: As chief provider of capital, investors are keen to know both the return from their investments and associated risk. Potential investors need information to judge the prospects for their investments.
2. Lenders: Lenders need information about the financial stability of the borrower. They are interested in information that would enable them to determine whether their borrower has the capability to repay the loans along with the interest due on it.
3. Suppliers: Suppliers also rely on the company’s performance to make decisions related to providing supplies on credit, possibility of bad debts and provisions for it.
4. Rating agencies and security analysts: Rating agencies and security analysts need accounting information to analyze the company position.
5. Employees and trade union: Employees may use financial information to find out the future prospects of the company. Trade unions use financial reports to negotiate wage packages, declaration of bonus, and other benefits.
6. Customers: Customers have an interest in the accounting information about the continuation of the company especially when they have established a long-term involvement with or are dependent on the company.
7. Government, regulatory agencies, and tax authorities: Government and regulatory agencies require information to regulate the activities of the company if any. The tax authorities need accounting information of the companies to assess the amount of tax to be imposed depending on their scope and performance.
8. The public: Published financial statements assist the public by providing information about the trends and recent developments of the company.