Financial Accounting Notes

Meaning of Financial Accounting

Financial accounting is the oldest form of accounting. In fact, financial accounting is the main accounting. It is related to recording, summarizing, and presenting financial transactions in financial statements such as income statement, balance sheet and statement of cash flow.

It is said that financial accounting is historical in nature. Why? Because it records the past transactions. So, some times we say it is historical accounting. The main objective of financial accounting is to communicate financial statements to the final users.

Features of financial accounting

It records the financial transactions only, i.e. it records that transactions of only which can be expressed in monetary terms. For example, it records the purchase of goods for cash. It does not record the morale of the employees.
Regular Process: Financial accounting is a regular process. So, it is carried out continuously.
Analyzer and interpreter of results: It records the transactions but also analyzes and interprets the results.
Historical in nature: As expressed above, it records the past transactions only.
Based on 'General Accepted Accounting Principles' (GAAP): It is based on generally accepted accounting principles. Statements are prepared and presented uniformly by help of financial accounting.

Objectives of Financial Accounting

The main objectives are mentioned below:

To maintain proper records of financial transactions for future reference. These transactions are recorded in personal, real and nominal accounts.
To find out the operating results i.e., profit earned or loss suffered during a specific period of time. It is achieved by preparing an income statement.
To outline the financial position of the business on a particular date. For this a balance sheet is prepared.
To avail information to users: It provides information to the stakeholders who are interested in the activities of the organization directly or indirectly. Here users may be investors, creditors, government and society.
To help in determining tax liability: Financial accounting gives information about how much tax the organization has to pay to the government.

Importance and functions of financial accounting

Maintains a complete record of all types of transactions. Because of this, we do not have to memorize every transactions in our mind.
It informs profit or loss in business during a particular period of time. Profit and Loss Account or income statement can be used to find out whether the business has made a profit or a loss.
In the financial accounting, with the help of balance sheet, one can find out financial position of the organization on a particular date.
Financial accounting keeps track of all types of business transactions. Its records are scientific and systematic which helps in detecting and preventing frauds and mistakes.
Financial accounting provides information to the management (internal user) and other external users about the position of an organization.External users like bank, creditors, government offices rely on the financial statements as the source of information for decision making.

Scope of Financial accounting (where is financial accounting applicable?)

Scope or application of financial accounting can be expressed as below:

For Business Organizations: It is useful for business organizations to determine their profit or loss, financial positions, cash flow positions of the organization.
For Non-for-profit Organizations: Educational institutions, clubs, hospitals, and social organizations are normally non-for-profit organizations which are mainly established to provide services to the public. They also have to prepare income and expenditure account, balance sheet and cash flow statements and should communicate these statements to the general public.
For Government organizations: The government accounting also needs financial accounting to keeps proper records, use, and control of financial resources.
For Non-Governmental Organizations: The non-governmental organizations generally get funds from national and international sources as a donation which is utilized to development of nation. They also need to maintain accounting system to keep records of these resources properly.
For professionals and individuals: Professionals who are engaged in personal skills like medical skills, engineering skills, accounting skills, research etc. Professionals need financial accounting for tax purpose and similarly, individuals need for personal financial decisions.

Limitations of Financial Accounting

Financial accounting is significant for management but it suffers from the some limitations.

Excludes qualitative elements: Management reputation, employee morale, and labour strike are some example of qualitative elements of organization. These elements are excluded in financial accounting system and focuses on monetary transactions only.
No considerations for price level changes: We know that, the value of money changes often time to time but the financial accounting does not consider the changes. This is the main limitation of financial accounting.
Ignorance of objective factors: The personal judgement of an accountant extremely affects the figure of balance sheet. Prevailing of this in accounting is known as subjective factors and other objective factors are ignored.
Difficult in cost controlling: Financial account alone cannot assign the cost of product at each stage of production, cannot classify direct and indirect cost and controllable and uncontrollable costs.
Limited analysis of losses: Losses due to idle plant and equipment, losses due to seasonal fluctuation in volume of business, etc. cannot be analyzed by financial accounting.
Limited information provider for decision making: Management can not take some important decisions about improvement in products, dropping of a product, expansion of business and alternative methods of productions with the help of financial accounting.
Limitation of Controlling system for materials and supplies: Financial accounting has a limited controlling system of materials and supplies. If a manufacturing organization does not consider this controlling system it may increase the misuse of resources, increase volume of scrap and defectiveness in products.