We hope that the Knowledge Sessions that we have started are benefitting the IBPS PO-2 Interview candidates where we have tried to explain various aspects of the Banking Industry. In continuation with that, today we are covering basics of Financial Accounting, as students are expected to have basic knowledge of accounting, especially from the B.Com and BBA graduate students.
Accounting is a process of measuring, recording and communicating the required information relating to the financial transactions of the organization to the interested parties. It does not provide qualitative and nonfinancial information. This limitation of accounting must be kept in view while making use of the accounting information.
Before we proceed further, let us first define the basic terms that are used in Accounting. This would help us in better understanding of the subject as we go along.
1) Transaction – An event involving some value between two or more entities. It can be a purchase of goods, receipt of money, payment to a creditor, incurring expenses, etc. It can be a cash transaction or a credit transaction
2) Assets – A resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Examples – Cash, Account receivable, inventory, equipment, buildings, real estate
3) Liabilities– Liabilities are obligations or debts that an enterprise has to pay at some time in the future. Examples – Short and long term loans, bills payable, bank overdraft
4) Capital – Amount invested by the owner in the firm is known as capital
5) Sales – Sales are total revenues from goods or services sold or provided to customers
6) Revenue – Revenue includes sales revenue, commission, interest, dividends, loyalties, rent received etc. Revenue is also called income
7) Expenses – Costs incurred by a business in the process of earning revenue are known as expenses. The usual items of expenses are: depreciation, rent, wages, salaries, interest, cost of heater, light and water, telephone, etc.
8) Debtor – Debtors are persons and/or other entities who owe to an enterprise an amount for buying goods and services on credit
9) Creditor – Creditors are persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and services on credit
So, now that we are aware of most of the accounting terms, the major question is why the accounting information is required and what significance it holds for different stakeholders.
1) Owners/Shareholders use them to see if they are getting satisfactory return on their investment and to access the financial health of their company/business
2) Directors/Managers use them to evaluate to performance of the company with respect to their competitors and ensuring that company is generating adequate return
3) Lenders use it to evaluate the ability of the company to pay its debt as they become due
4) Prospective investors use it to assess whether or not to invest in the company or not
5) Government and Regulatory agencies require information for the payment of various taxes and also to satisfy the legal obligations imposed by Company Act 1956 and SEBI from time-to-time.
Primary objectives of accounting include the following:
1) Maintenance of records for business transactions
2) Calculation of profit and loss
3) Depiction of financial position
4) Providing accounting information to its users
Steps involved in the accounting process
The first step involves identifying the transactions to be recorded and preparing the source documents which are in turn recorded in the basic book of original entry called journal and are then posted to individual accounts in the principal book called ledger.
1) Journal – This is the basic book of original entry. In this book, transactions are recorded in the chronological order, as and when they take place.
2) The Ledger – The ledger is the principal book of accounting system. It contains different accounts where transactions relating to that account are recorded.
3) Trial Balance – A trial balance is a statement showing the balances, or total of debits and credits, of all the accounts in the ledger with a view to verify the arithmetical accuracy of posting into the ledger accounts.
Objectives of Preparing the Trial Balance
1) To ascertain the arithmetical accuracy of the ledger accounts
2) To help in locating errors
3) To help in the preparation of the financial statements.
Financial statements are the basic and formal annual reports through which the corporate management communicates financial information to its owners and various other external parties which include – investors, tax authorities, government, employees, etc. They normally refer to:-
1) Balance Sheet: The purpose of balance sheet is to show its resources and obligations for acquiring its resources i.e., assets and liabilities. Balance sheet is a tabular statement of summary of balances (debits and credits) carried forward. Please remember that we can’t know the profit and loss of the company by just looking at its Balance sheet.
2) Profit and Loss Account or Income Statement: The profit and loss account is the accounting report which summarizes the revenues and expenses and ascertains the profit/loss for a specified accounting period.
3) Cash flow statement: ‘Cash Flows’ implies movement of cash in and out of non-cash items. This helps in evaluating the ability of a company to pay dividends and meet obligations (indicating a healthy business).
Reference: NCERT Financial Accounting