Popular in Course
verified elite notetaker
Popular in Accounting
This 237 page Document was uploaded by an elite notetaker on Friday December 18, 2015. The Document belongs to a course at a university taught by a professor in Fall. Since its upload, it has received 43 views.
Reviews for Financial-Management
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 12/18/15
This page intentionally left blank Copyright © 2007, NewAge International (P) Ltd., Publishers Published by NewAge International (P) Ltd., Publishers All rights reserved. No part of this ebook may be reproduced in any form, by photostat, micro film, xerography, or any other means, or incorporated into any information retrieval system, electronic or mechanical, without the written permission of ublisher. All inquiries should be emailed to firstname.lastname@example.org ISBN (13) : 978-81-224-2548-2 PUBLISHINGFORONE WORLD NEWAGE INTERNATIONAL(P) LIMITED, PUBLISHERS 4835/24,Ansari Road, Daryaganj, New Delhi - 110002 Visit us atwww.newagepublishers.com Dedicated to Almighty : LORD SHIVA, ALLAH & PRABHU YISHU MASIH with whose blessings this book is published This page intentionally left blank Preface Management in India increasingly realises the use of accounting informat˝ion for efficient management of business enterprises. Accounting is the science of measurement, analysis˝ and communication. The designing of accounting systems, generating information and transmitting it to the˝ management has expanded the scope of accounting and financial management. This book has been written with a specific aim i.e., to cater to the nee˝ds of I.T. professionals (especially MCA students) of U.P. Technical University as well as other universities also. I.T. comprises of Hardware part, Software part, and Information part. When ˝we talk of business application software, we need to recognize and understand business infor˝mation because problem recognition is the first step of software development. Accounting and Financial mana˝gement are said to be the language of business because it enables the user to recognize and understand comp˝lexities associated with business information. This generates the need for study of Accounting and Financi˝al management for I.T. professionals. This book has been written from system’s point of view to facilitate I.T. professionals. A system comprises of three components as shown below: INPUT PROCESSING OUTPUT DATA DATA Framework Accounting as system takes business transactions/events as input data and process it within ˝the framework of accounting principles and theories leading to generation of˝ a number of reports (output data) which in turn acts as input data for financial managemeFinancial management as system process it within the framework of external environment and takes financial decisio˝ns (output data) viz. financing decisions, investment decisions and dividend decisions. This book is also intended to assist beginners of management courses lik˝e B.B.A., B.Com. etc. and non-finance executives at work enabling them to understand business info˝rmation (published in form of annual reports) and complexities associated with business organization. Furthermore, I am extremely grateful to my godfather Dr. Girish Bihari (Ex-DGP, UP), CMD–IISE for his kind support and to New Age International Publishers, New Delhi for publishing this book so nicely a˝nd elegantly. I convey my sincere thanks to my parents, my younger brother ‘Raju’˝ and my lovely friend for their support and encouragement. Last but not least, I shall appreciate receiving comments and suggestion˝s from readers for the improvement of the book. Dr. Y.P. Singh Lucknow (India) Email: email@example.com Contents Part-I: Financial Accounting CHAPTER–I: ACCOUNTING AND FINANCIAL MANAGEMENT — A CONCEPTUAL FRAMEWORK 1.1 Introduction 1 1.2 Need for Accounting and Role of Accountant 5 1.3 Defining Accounting 8 1.4 Accounting Information 9 1.5 Branches of Accounting 10 1.6 Difference between FA, MA and CA System 11 1.7 Accounting Information System (AIS) 12 1.8 Users of Accounting Information 14 1.9 Steps in Accounting Process 16 1.10 Limitations of Accounting 17 1.11 Accounting and Financial Management — Inter-relationship 18 1.12 Organization Structure for Accounting and Finance Activity 20 1.13 Utility of Accounting and Financial Management for IT Professionals 21 Exercises 22 CHAPTER–II: BOOK-KEEPING 2.1 Introduction 23 2.2 Types of Books of Account 23 2.3 Book-keeping Process 25 2.4 Types of Errors during Book-keeping Process 49 2.5 Data Flow Diagram (DFD) for Book-keeping Process 49 Exercises 54 CHAPTER–III: FINAL ACCOUNTS (Financial Statements) 3.1 Introduction to Final Accounts 57 3.2 Preparation of Final Accounts — An Introduction 58 3.3 Preparation of Final Accounts for Sole Proprietorship Concern 58 3.4 Difference between Trial Balance and Balance Sheet 74 3.5 Difference between Trading Account and Manufacturing Account 75 3.6 Difference between Trading Account and Profit and Loss Account 75 3.7 Difference between Income Statement and Balance Sheet 76 3.8 Accounting Theory Framework 83 3.9 Final Accounts for Partnership Firm 92 3.10 Final Accounts for Companies 97 Exercises Part-II: Management & Cost Accounting CHAPTER–IV: RATIO ANALYSIS 4.1 Introduction 110 4.2 Concept of Ratios 110 4.3 Types of Ratios 110 4.4 Measurement and Interpretation of Ratios 112 4.5 Application of Ratios 120 4.6 Methodology for Ratio Analysis 121 4.7 Du-Pont Chart for Ratio Analysis 121 4.8 Advantages of Ratio Analysis 128 4.9 Limitations of Ratio Analysis 128 Exercises 129 CHAPTER–V: FUND FLOW STATEMENT (FFS) 5.1 Introduction 135 5.2 Preparation of Fund Flow Statement (FFS) 135 5.3 Difference between FFS and CFS (Cash Flow Statement) 167 5.4 Difference between FFS and Income Statement 168 5.5 Difference between FFS and Balance Sheet 168 Exercises 169 CHAPTER–VI: COST ACCOUNTING 6.1 Fundamentals of Cost 171 6.2 Cost Accounting 172 6.3 Absorption Costing and Marginal Costing 176 6.4 Inventory Management 178 Exercises 181 Part-III: Financial Mangement CHAPTER–VII: FINANCIAL MANAGEMENT 7.1 Defining Financial Management 188 7.2 Functions of Financial Management or Role of Finance Manager 188 7.3 Financial Management and Management Accounting 191 7.4 Objective of Financial Management 191 7.5 Scope of Financial Management 193 7.6 Basic Financial Concepts 195 7.7 Capital Budgeting Decision 201 7.8 Advantages and Disadvantages of Equity Shares, Preference shares and Debentures 205 Exercises 217 Appendix 219 lPresent and Future value table This page intentionally left blank Accounting and Financial Ma1agement Part – I Financial Accounting This page intentionally left blank Accounting and Financial Management 3 Chapter–1 Accounting and Financial Management A Conceptual Framework LEARNING OBJECTIVES In this chapter we will study: Introduction Need for Accounting and Role of Accountant q Important terms Defining Accounting—Traditional and Modern View Accounting Information Branches of Accounting Difference between Financial Accounting, Management Accounting and Cost Accounting Accounting Information System—Information flow chart Users of Accounting Information Steps in Accounting Process Limitations of Accounting Accounting and Financial Management—Inter-relationship Organisation Structure for Accounting and Finance Activity Utility of Accounting and Financial Management for Information Technology Professionals. 4 Accounting and Financial Management for I.T. Professionals 1.1 INTRODUCTION l Organizations play an important role towards economic development. l There are different types of organizations engaged in trading and manufacturing of goods/services. l On the basis of motive, there may be two categories of organizations. Organizations Profit motive Non-profit motive All business organizations Social organizations like club, trust, have profit motive church, government hospital, and (The intention is to earn profit government schools have non-profit (profit = revenue – cost)) motive (The intention is to earn revenue just to meet the cost of meeting the objectives i.e., no profit no loss.) l Both category of organizations (stated above) need money to fulfil their objectivi.e., to sustain and to grow. l There are two aspects of money (Fund). Measurement of money Management of money l In a very limited sensemeasurement of moneymeans how much money has been invested and where i.e., record-keeping whereas,management of moneymeans from where the money will come in and where it will go i.e., procurement of fund (Financing decision) and utilization of fund (In˝vestment decision). Thus, l Accounting is concerned Financial Management is with measurement of money. concerned with management of money. Accounting and Financial Management 5 ‘Measurement of money’ in a broad ‘Management of money’ in a broad sense sense means systematic record-keeping includes all the financial decisions starting i.e., maintaining books of accounts from planning to controlling financial popularly known as book-keeping to activities under external/environmental generate such information which helps the factors (micro and macro both). interested groups/individuals in decision- making process i.e., planning and controlling future activities. Thus, in a nutshell, Accounting is Thus, in a nutshell Financial Management is a decision-making system whose information-generating system whose objective is planning, analysis and objective is to collect, process and report financial data of an organization to all the controlling financial decisions under interested parties (internal and external external environmental factors (micro level both) for decision-making i.e., planning and macro level both). and controlling financial activities. A/C: Business Accounts FM: Business Finance Business Accounting transactions/ Book-keeping information : acts as input data events, which Process Ledgers/ are of financial Reports/ nature Statements (Input data) (Output data) Accounting theory framework: principles/ rules/standards Planning, analysis & controlling financial etc. activities related to financial decisions External (Environmental) factors include micro level (Industrial) and macro level (National & Financial Decisions viz. International) factors. Financial decision, investment decision and dividend decision (Output data) 6 Accounting and Financial Management for I.T. Professionals 1.2 NEED FOR ACCOUNTING AND ROLE OF ACCOUNTANT 1.2.1 Need for Accounting Accounting helps in knowing: l What is the result of business operation after a certain inti.e., profit/loss? l Financial health: Will the organization be able to meet commitments/obligations in the near future? l What is fund/cash position? l What the organization owns i.e., assets to the organization. l What the organization owes i.e., liabilities of the organization. and many more things, which help in decision-making process. This create˝s need for accounting. Now, before going into details of accounting, first have a look on importan˝t terms frequently used in accounting. This will help in clear understanding of accounting concept ˝and process. 1.2.2 Role of Accountant With the help of proper accounting system, accountant helps the managemen˝t in three ways: l Record-keeping/book-keeping l Attention-directing l Problem-solving q Accountant in his record-keeping role maintains books of account. q Accountant in his attention-directing role generates different statutory and non-statutory routine accounting information to bring the attention of management towards stre˝ngth and weakness of the organization concerned. q Accountant in his problem-solving role helps the management by providing˝ crucial information i.e., non-routine information and number of alternate options to solve partic˝ular problem related to financial decisions (Financing, Investment and Dividend decision). SOME IMPORTANT TERMS AND DEFINITIONS Assets Assets mean what an organization owns. In other words, anything which enables a business enterprise to get cash or a benefit in future, is an asset. Classification of assets Assets Intangible assets Tangible assets (Are intangible in nature.g., (Are tangible in nature e.g., Plant, Trademark, Goodwill, Machinery, Land, Building etc.) Patents etc.) Fixed assets Current assets Accounting and Financial Management 7 l Fixed Assets: Assets that are acquired for relatively long periods for carrying on the˝ business of the enterprise and not meant for resale, e.g., land, building, plant, and machinery etc. l Current Assets (CA): Assets which are either in the form of cash or can be converted into ca˝sh within one year/short period i.e., get converted into cash within one operating cycle of business e.g., Cash, Inventories, Debtors, Bills Receivable, etc. l Liquid/Quick Assets: Assets, which are immediately convertible into cash without much loss, ˝e.g., debtors, marketable securities, stamps etc. i.e., except stock, all CA are liquid assets. Liabilities Liabilities mean what the organization owes. In other words, it is an amount, which a business owes ˝and has to return or account for. For example, loan from banks, trade creditors, etc. Classification of liabilities Liabilities Long-term liability Short-term liability/Current liability (Having long-term maturity period) (Having short-term maturity period usually less than one year e.g., Trade creditors, Bank overdraft etc. Inside liability Outside liability (Permanently remains (Payment is made over a period with organization of time e.g., Loan from banks, e.g., Owner’s capital A/c) Debenture capital etc.) Capital: It refers to the amount invested by the proprietor in business enterprises. Revenue: It means income of a recurring nature from any source related to busine˝ss. Capital Expenditure: An expenditure, which has been incurred for the purpose of obtaining a l˝ong- term advantage for the business, e.g. expenditure incurred for purchase of fixed assets. Revenue Expenditure: It denotes the cost of services and things used for generating revenue.˝ In other words, all items of expenditure, whose benefit expires within a year or ˝which have been incurred merely to maintain the business or to keep the assets in good working condition˝, is taken as revenue expenditure. For example, salaries and wages paid to employees, depreciation of busin˝ess assets, maintenance expenses of motor vehicle, etc. Revenue expense is different from loss. An expense is supposed to bring some benefit to the firm, whereas a loss brings no benefit to the firm. For example, ˝loss by theft, loss by fire, etc. While calculating the income or the profit of a business for a particular peri˝od, the revenue earned during that period is to be matched with the expense incurred in earning that revenu˝e (matching concept). Deferred Revenue Expenses: A revenue expenditure whose benefit is to continue for period of two or more years. Such expenditure is written off not in one year but over a period of two or three years. For example, expenditure incurred on heavy advertisement, preliminary expend˝iture, etc. Creditor: Any person who gives credit is a creditor. The supplier supplying goods on credit is creditor. Creditor is one to whom the business owes. Owner is a creditor under ‘˝Separate Entity Concept’. Debtor: A person who owes money to the business is called a debtor. He is a customer to whom goods are sold on credit. 8 Accounting and Financial Management for I.T. Professionals Solvent: A person who is in a position to pay his debts as they become due. Insolvent: A person who is not in a position to pay his debts as they become due. ˝The dues from an insolvent debtor are known as Bad Debts. Reserve for Bad Debt: A reserve from the profit of the organization is created for bad and doubtful debts. It is a buffer for anticipated loss (under conservatism). Shares: Shares represent ownership securities. l In case of joint stock companies, owner’s capital is divided into very small fractions say Rs. 5/-, Rs. 10/-, Rs. 20/- etc. each fraction is termed as Shares. l The person (natural or legal) who purchases/subscribes these shares ar˝e known as shareholders. l Whatever shareholder receives against their investment is known as divi˝dend. This may be in form of cash or kind. l Shareholders act as part owner to the concern organization because they possess voting right. The extent of ownership depends upon the extent of share holding. Voting right means right to vote, which in turn means right to elect board of directors, which constitute the ap˝ex body of concerned organization. Debentures: Debentures represent creditorship securities. l In case of joint stock companies, a part of debt capital is divided into˝ very small fractions say Rs. 5/-, Rs. 10/-, Rs. 20/- etc. each fraction is termed as Debentures. l The person (natural or legal) who purchases/subscribes these debenture˝s are known as debenture holders. l Debenture holder receives interest against their investment. l Debenture holder act as creditors to the organization concerned because they have legal right to receive interest and principal repayment at the end of maturity, depending upon the nature of debenture. 1.3 DEFINING ACCOUNTING There are two views in this regard viz. 1. Traditional view 2. Modern view 1.3.1 Traditional View Traditionally i.e., up to first decade of 20hcentury, accounting was merely restricted to book-keeping leading to preparation of income statement and balance sheet only, referred as financial statements (Audited financial statements are statutory requirement demanded by gov˝ernment for the purpose of income tax liability). l Income statement presents summary of all the expenses and incomes during˝ the financial year st st (1 April to 31 March). l Balance sheet presents what the organization owns i.e. assets and what the organization owes i.e. liabilities at a particular point of time, usually at the end of financi˝al i.e. on 31sMarch. 220.127.116.11 Book-keeping l Book-keeping means systematic recording of all the financial transaction˝s/events in the book of accounts. Book-keeping is not concerned with disclosing or interpreting the results of the business. l Systematic recording means identifying, measuring, recording, classifyin˝g and summarizing (trial balance only) financial transactions/events, under accounting theory fr˝amework. Note: Accounting theory framework will be discussed later in the book. l Transaction means exchange of money with money’s worth e.g. sale of goods for Rs 10,000. l Event means happenings e.g. loss of stock due to fire worth Rs. 5000. l Books of accounts are the place where financial transaction/events are r˝ecorded. Accounting and Financial Management 9 18.104.22.168 Evolution of Modern Accounting With the passage of time the role of accounting has changed significantly˝ and in present stage it is accepted as an information system, which helps the management in economic decisio˝n-making. In other words, modern Accounting is book-keeping plus much more. The following definiti˝on of accounting arranged in chronological order are evidences regarding changing role of accounting ˝over a period of time: (i) 1941: The American Institute of Certified Public Accountants (AICPA) defined accounting as: “The arts of recording, classifying and summarizing in a significant ˝manner and in terms of money transactions and events, which are in part, at least, of a financial cha˝racter and interpreting the result thereof.” (ii) 1966: The American Accounting Association (AAA) defined accounting as: “˝The process of identifying, measuring and communicating economic information to permit ˝informed judgements and decisions by uses of the information.” (iii) 1970: Accounting Principles Board (APB) and AICPA states: “The function of accounting is to provide quantitative information, primarily financial in nature, about e˝conomic entities, that is intended to be useful in making economic decisions.” 1.3.2 Modern View of Accounting According to this view, accounting is an information generating system. It takes business tran˝sactions/ events as input data, process it which is popularly known as book-keepin˝g process which includes identifying, recording, classifying and summarizing business transactions and events ˝under accounting theory framework and generates output data in the form of statements and reports which he˝lps all the interested parties (internal and external both) in economic decision-making i.e. planning and controlling financial activities. In other words, accounting is book-keeping process which generates infor˝mation known as accounting information to help all the interested parties (internal and external b˝oth) in decision-makini.e. planning and controlling financial activities. Thus, the role of accounting is, information system hereafter referred t˝o Accounting Information System (AIS). Accounting as information system can be presented as shown below: Business Accounting transactions/events, information: which are of financial Book-keeping Ledgers/Reports/ nature process Statements (Output data) (Input data) (Accounting Theory Framework) Both the views on accounting have one thing common i.e., book-keeping. In other words, book- keeping is an essential part of accounting process. But before going int˝o the mechanism involved in various stages of book-keeping process, let us have a look on information genera˝ted by accounting system known as Accounting Information. 10 Accounting and Financial Management for I.T. Professionals 1.4. ACCOUNTING INFORMATION The information generated through accounting system can be categorized i˝n two parts. Accounting Information Statutory Information Non-statutory Information (Demanded by law. In other words, mandatory for all registered organizations, e.g. income statement and balance sheet are statutory information.) Routine Non-routine l Routine information is generated after certain intervals. Examples of routine information are fun˝d flow statement/cash flow statement, annual budget, performance reports, ˝cost sheet etc. l Non-routine information is need-based information generated by accountin˝g system to help in solving specific problem, e.g., marginal cost sheet, zero-based budgeting etc. Thus, accounting helps in knowing (say): (i) The result of business operation i.e. profit/loss through income statement. (ii) The financial position i.e. picture of assets and liabilities through balance sheet. (iii) Fund position/cash position through fund flow statement/cash flow statem˝ent. (iv) Resource utilization position/financial health through ratio analysis. (v) Cost records for different cost centers through cost sheet. And many more things that are required for decision-making process. 1.5. BRANCHES OF ACCOUNTING On the basis of information generated by accounting system, there are three main branches of account˝ing: (i) Financial accounting system (ii) Cost accounting system (iii) Management accounting system. l Financial accounting deals with information numbering ( i) and (ii) mentioned above. l Management accounting deals with information numbering ( iii) and (iv). Whereas l Cost accounting deals with last information mentioned above. 1.5.1 Financial Accounting (FA) FA deals with preparation of Final Accounts/Financial Statements viz. (i) Income Statementto get previous year’s result of business operationi.e., Profit/Loss. Income statement is also termed as Profit & Loss Account (P & L A/c). (ii) Balance Sheet (B/S) to get previous year’s financial position i.e., picture of Assets and Liabilities. 1.5.2 Cost Accounting (CA) Cost accounting deals with present information i.e., determining unit cost at different levels (known as cost centers) of ongoing production. Cost accounting process includes: Accounting and Financial Management 11 (i) Cost determination i.e. costing (ii) Cost analysis i.e. studying behavior of profit with respect to cost and volume. (iii) Cost control i.e. comparison of actual cost with predetermined cost/standard cost. For above-mentioned information, CA system generates: (i) Cost sheet for cost determination. (ii) Report on CVP (Cost-Volume-Profit) analysis/BE (Break-Even) analysis for analyzing behaviour of profits with respect to cost and volume. (iii) Report on variance analysis for determining variances and to take corrective action whenever needed and hence cost control. Note: l Both FA and CA takes input data for further processing from book-keeping syste˝m. l In an organization book-keeping system functions as a part of FA system. In other words, it is not in isolation. 1.5.3 Management Accounting (MA) MA deals with all those information, which helps in decision-making proc˝ess i.e. planning and controlling financial activities. In an organization, MA is common to both FA and CA because all those information, which are generated by FA and CA system are useful in decision-making process and comes under th˝e preview of MA system e.g. l CVP analysis and variance analysis of CA system also form part of MA sys˝tem. l Fund Flow Statement (FFS) of FA system also form part of MA system. Because it presents the flow of fund through business organization during financial year and is of great help in assessing fund ˝position. Apart from above information which are common to both FA system and CA system, there are some information exclusively generated by management accountants e.g. (i) Projected statements like: A-Projected income statement to estimate coming year’s target profit. B-Projected balance sheetto estimate coming year’s target financial posit(.assets and liabilities). C-Projected FFS/CFS to estimate coming year’s target fund/cash position. (ii) Developing budget and budgetary control system for the purpose of budgeting. (iii) Marginal costing techniques for short-term decision-making purposes. 1.6 DIFFERENCE BETWEEN FA, MA AND CA SYSTEM Financial Accounting (FA) Management Accounting (MA) Cost Accounting (CA) 1. Financial accounting 1. Cost accounting is conc- 1. Management accounting is concerned with prep- is concerned with acco- erned with cost determin- aration of financial state- unting done by manage- ation i.e. costing, cost ment i.e. income state- ment itself that help the analysis and cost control. ment and balance sheet. top-level management in decision-making. 2. Financial accounting is 2. Management accounting 2. Cost accounting is also governed by certain acco- has no such restrictions. regulated by certain unting principles, conc- The management as per rules and formats. The epts and accounting stan- its requirement prepares techniques used for dards etc. it. The tools used for cost control is standard Contd... 12 Accounting and Financial Management for I.T. Professionals Financial Accounting (FA) Management Accounting (MA) Cost Accounting (CA) costing/variance anal- management accounting are–ratio analysis, cash ysis. flow and funds flow analysis etc. 3. Financial accounting 3. Management accounting 3. Cost accounting takes takes raw information takes input data from input data from book- from book-keeping sys- financial accounting as well keeping system i.e. from tem. as cost accounting system. the various vouchers. 4. The auditing power of 4. Management accounting 4. Cost accountants, audit financial statement rests does not require auditing cost accounting inform- with public accountant but can be reviewed by a ation. e.g. C.A. in India. senior executive. Note: Position of MA system with respect to FA and CA system: MA system is common to both FA and CA system. Exclusive Information Common Information FA MA CA 1.7 ACCOUNTING INFORMATION SYSTEM (AIS) 1.7.1 Information Flow Chart (Level 1) Business Accounting transactions/events, Book-keeping information: which are of financial process Ledgers/reports/ nature statements (Input data) (Output data) (Accounting Theory Framework) 1.7.2 Information Flow Chart (Level 2) There are 4 sub-fields/components of accounting: (i) Book-keeping system (ii) FA system (iii) CA system (iv) MA system Accounting and Financial Management 13 B A FA 3 1 2 Book 5 keeping MA CA 4 D C Explanation to above-mentioned symbols 1 – Business transactions/events, which are of financial nature (must be su˝pported by source documents like cash memo, invoice etc), which acts as input data for book-keeping˝ system. 2 – Output generated by book-keeping system which acts as input data for all˝ the main branches of accounting viz. FA system, CA system and MA system. This output consists of different ledger books and trial balance. 3 – Statutory financial accounting reports generated by FA system, which acts as input data for MA system. Statutory financial accounting reports consists of financial sta˝tementis.e. income statement and balance sheet. 4 – Cost accounting reports like various cost sheets showing unit cost at di˝fferent level of production, which in turn acts as input data for MA system. 5 – Output information generated by MA system fulfilling needs of internal, ˝as well as external users having direct/indirect interest in the organization concee.g. statement of ratios, fund flow statement/cash flow statement. A – Accounting theory framework for processing of book-keeping consists of a˝ccounting standards, conventions and concepts. B – Framework of statutory laws and acts like company law, partnership act, SEBI act etc. under which processing of FA system takes place. C – Framework of predetermined formats, procedures and assumptions under whi˝ch processing of CA system takes place. D – Framework of relevant factors (external as well as internal factors) w˝ithin which processing of management accounting system takes place. Processing of book-keeping, FA, CA and MA systems are as follows: l Processing of book-keeping system includes identifying, recording, class˝ifying and summarizing (trial balance only) the business transactions/events, which are of fi˝nancial nature. l Processing of FA system includes preparation of financial statementi.e. income statement and balance sheet. l Processing of CA system includes classification, allocation, recording, ˝summarizing and reporting current and prospective costs i.e. preparation of various cost sheets showing unit cost at different level of production i.e. (i) Cost determination (ii) Cost analysis (iii) Cost control 14 Accounting and Financial Management for I.T. Professionals l Processing of MA system includes: (a) Analysis and interpretation of financial statements generated by FA system (b) Analysis of cost records/cost sheet in the light of financial stateme˝nts (c) Analysis and interpretation of variance analysis (d) Developing cost control techniques. (e) Developing different budgets (f) Developing short-term decision-making techniques etc. 1.7.3 Information Flow Chart (Level 3) (See on next page) 1.8 USERS OF ACCOUNTING INFORMATION Different users, for making their decisions require accounting information.˝ These users may be classified as: Users of Accounting Information (i) Internal users (ii) External users (Management at all levels) (a) Direct users (Interest) (b) Indirect users (Interest) (owners/shareholders, (regulatory agencies, researchers, banks, investors, creditors, employees, government agencies, labour unions, customers, lenders, management trade associations, public and others) and tax authorities) (i) Internal users: Top, middle and bottom level of management executives are the internal us˝ers of accounting information. They need it for making decisions. These users a˝re interested in the profitability, operational efficiency and financial soundness of the business. The top-level management is concerned with accounting information related to planning,˝ the middle level is interested in planning and controlling and the lower level with operatio˝nal affairs. (ii) External users: External users may have direct interest or indirect interest. (a) External users having direct interest:The existing and the prospective creditors and investors have direct interest in the accounting information. The sources of infor˝mation for external users are financial statements and reports of Directors and Auditors. Investors assess the financial soundness and net worth of the business s˝o that they may decide about buying, selling or holding investment in the business. Creditors, ˝such as banks, lenders, debenture holders and financial institutions assess the risk involved in˝ granting loans, servicing of the existing loans to the business. (b) External users having indirect interest: These users such as department of company affairs, registrar of joint stock companies, sales tax and income tax authorities˝, labour unions, prospective customers, creditors, stock exchange’s trade associations and others who are interested in the affairs of the business. They have to make their own decision on the basis˝ of the financial reports of the business. Accounting and Financial Management 15 (E) Bo(oPkrmeerysgecynstfrngClassifyiCost determination (costing) (Cost Accounting (CA)) (D) Co(sSteadtarllcs)triance Coastalysss/isEaVaPlysis) (C) Types ofBBuddgettry controll costing) Profit Planniqg q q ( ) ()abisnoatosntngsting ( ) Budgeting ( ) Costing techniques (B) ⋅⋅⋅⋅⋅ormation Flow Chart (Level 3) (Management Accounting (MA)) 1.7 (Short-term decision-making techniques) AninltrisaatdtFinanalaslstrCtisenatosis/fund flow (A) (Jopunaalynbtroyo/ks) (Lesecorndatrryy/books) Prep. of trial balance • • • TransactionRecording ofClassifying the transactione : In: Informat: Information flow exclusive to cost accountingd management acco˝untingcountin˝g (Financial (A)(B)(C)(D)(E)) 16 Accounting and Financial Management for I.T. Professionals A brief description of some users having direct interest is as follows 1. Shareholders (owners): Shareholders have direct interest in the affairs of organization and therefore they are interested in accounting information, because rate and amount o˝f dividend depends on residual income. Residual income is reported in income statement. 2. Long-term creditors: The examples of long-term creditors are banks, financial institutions a˝nd debenture holders who provide long-term funds to the organization. They are concerned with the debt servicing and interest payment as and when due. Thus, they are interested in accounting information as accounting inform˝ation reveals financial health of the organization. 3. Government: Government is interested in collection of the tax revenue and tax is co˝mputed on the basis of income, generated by the organization. Thus, government is interested in income statement. 4. Short-term creditors: The example of short-term creditors is suppliers; banks and banks provi˝ding overdraft facility etc. Short-term creditors e.g. suppliers are interested in their bills. Timely payment of bills depends upon liquidity position of the organization and liquidity position is represented by the accounting information and thus, accounting information is important˝ for short-term creditors. 5. Employees: Receive the benefits in the forms of salaries, perks, allowances etc. w˝hich in turn is dependent on profit position which is represented by income statement. 6. Management: Utilizes the available resources [5M i.e. man, money, material, machine, method + time + I.T.] of the organization. The prime responsibility of management is optimum utilizatio˝n of resources. The position of resources utilized is calculated using accoun˝ting information and therefore, management uses accounting information for the purpose of performance evaluation. 1.9 STEPS IN ACCOUNTING PROCESS 1. Identifying business transactions/events which are of financial natur˝e 2. Measuring transactions/events 3. Recording of transactions/events (Journal entry) 4. Classifying transactions/events (Ledger entry) 5. Summarizing transactions/events (Trial balance, Income statement and Balance sheet) 6. Analyzing and interpreting transactions/events. 7. Communication/reporting transaction/events Prepare statutory reports Prepare other reports as required b˝y the management Send to Internal users External users Accounting and Financial Management 17 Note: l Accounting Cycle: Step 1 to step 5 constitutes accounting cycle. Put differently, accounting cycle starts from identifying and recording of transaction and ends with summa˝rizing transactions i.e., preparation of financial statements (Income statement and B/S). Transactions (Vouchers) Accounting cycle Trading, Profit and Loss A/c and Balance Sheet Journal Trial Balance Ledger l Accounting Period: The time period in completing accounting cycle is known as accounting period and in India it is of one-year duration (1st April to 31st March of nex˝t year). 1.10 LIMITATIONS OF ACCOUNTING Accounting is helpful for business in assessing it’s worth i.e., profit or loss, assets and liabilities. It enables the business in deciding its future line of action on the basis of infor˝mation supplied. Though logical conclusions can be derived from accounting, it can never be taken as gra˝nted that the facts supplied by accounting are cent percent true. They may be false, biased and manipula˝ted. Accounting has the following limitations: 1. Record-keeping: Accounting records only those transactions/events, which are financial ˝in nature. Transactions/events of non-financial nature do not find place in accounti˝ng. Certain very important information such as competency of the management, exit of top-level exec˝utive, change in consumers preferences etc. are not recorded in accounting, though they affect the financial soundness of the business. 2. Accuracy of information generated by accounting system: Accounting assesses profit or loss and financial position (picture of asset and liability) of the organization concerned on the basis of both the real and assumed estimates. Accountants make the valuation of s˝tock, determine the method of depreciation and maintain various reserves and provisions. Different firms have their own different methods of making provisions, so the results of the business will change˝ with the change in the practice. 3. Value of assets: The balance sheet does not show the market value of the assets in the o˝rdinary sense of the word. It usually shows assets, costs adjusted according to ˝the conventional rules of accounting. Again there are certain assets, which do not have real value˝, but they are shown in our 18 Accounting and Financial Management for I.T. Professionals balance sheet. These assets are like goodwill, patents, preliminary expe˝nses, discount on issue of shares etc. Showing these assets in the book of accounts make the result˝s doubtful. 4. Window dressing: Window dressing practices that will improve profitability in the short ru˝n may be utilized by the management. Such practices may take the form of postp˝oning the maintenance of plant and machinery, which will decrease costs and increase profitability in the short run,˝ but which would affect the company severely when machine breakdown occurs and production i˝s interrupted. 5. Changing price levels: Changing price levels and changes in the current values of assets can produce distortions in accounting measures of performance and financial ˝position. It is desirable that additional information on the basis of current replacement values b˝e provided. 1.11 ACCOUNTING AND FINANCIAL MANAGEMENT—INTER-RELATIONSHIP 1.11.1 Defining Financial Management Financial management is concerned with management of fund. It may be defined as “acquisition of fund at optimum cost and its uti˝lization with minimum financial risk.” 1.11.2 Accounting and Financial Management—Inter-relationship (See diagrammatic presentation on next page) 1.11.3 Difference between Accounting System and Financial System Accounting system Financial system (i) It is information generating system. ( i) It is decision-making system. (ii) It is governed by certain laws and ( ii) It is governed by external factors Accounting theory framework relevant to organization concerned. (iii) The role of accounting system is: ( iii) The role of financial system is planning (a) Score-keeping and controlling financial decision viz: (b) Attention directing (a) Financing decision (c) Problem solving (b) Investment decision (c) Dividend decision. (iv) It takes input data from business ( iv) It takes input data from information transactions/event, which are of generated by different branches of financial character. accounting incorporating relevant industrial and economic factors. Accounting and Financial Management 19 (Output) Plannfinancial decisions Further concerned) processing Financial system – Internalevel relevant for organization (Exat industry level and at economy (Output) statements Ledgers/reports/ Accounting and Financial ManagemProcessingrelationship (Accounting theory framework) Accounting system – event(Input) Transactions/ 20 Accounting and Financial Management for I.T. Professionals 1.11.4 Financial Decisions and Management Accounting l Financial decisions are of two types viz.: (i) Short-term decision, also known as working capital decision. (ii) Long-term decision, also known as capital budgeting decision/project dec˝ision/capital expenditure decision. l Difference between S.T. decision and L.T. decision are as follows: S.T. Decision (W.C. decision) L.T. Decision (Capital budgeting decision ) (i) Do not involve substantial capital ( i) Involve substantial capital outlay. outlay. (ii) Operating profit/short term-sources ( ii) Separate/special financing is required. are sufficient to meet financing requirement. (iii) Reversible in nature (iii) Irreversible in nature. (iv) Short-term effect i.e. benefits are ( iv) Long-term effect i.e. benefits are realized realized immediately/within short over a period of time i.e. up to the life of period (Revenue nature). the project (Capital nature). () No time lag between cost and benefits ( v) L.T. decisions involve time lag between and hence time value of money concept cost and benefits and hence time value is not required for cost-benefit of money concept is required for cost- analysis. benefit analysis. Note: Time value of money concept refers to change in value of money due to cha˝nge in time. l Planning and controlling financial decisions are complex in nature. l The management accounting provides tools/techniques for planning and con˝trolling financial decisions. Few examples are listed below: - (i) Projected statements of final accounts (ii) Cash flow/fund flow analysis (iii) Ratio analysis (iv) Variance analysis (v) Budgeting etc. 1.12 ORGANIZATION STRUCTURE FOR ACCOUNTING AND FINANCE ACTIVITY In an organization, accounting and finance activity is divided into two categori˝es viz: l Assets management l Funds management In case of joint stock companies, the organization structure for accounting and finance activity is as follows: Accounting and Financial Management 21 Director (Finance) Controller deals with Treasurer deals with assets management funds management Controller is responsible for Treasurer is responsible entire accounting activity viz.: for cash and near cash 1. Financial accounting, management resources viz.: accounting and cost accounting. 1. Cash management 2. Taxation (tax planning) 2. Receivables management 3. Reporting and auditing. (credit policy etc.) 3. Insurance (premium and claims etc.) 4. Loan matters. Note: In case of medium and small-sized organization, financial controller cum chief accountant is responsible for the entire activities of finance and accounts department˝. 1.13 UTILITY OF ACCOUNTING AND FINANCIAL MANAGEMENT FOR I.T. PROFESSIONALS I.T. professionals interact with two things viz. 1. Hardware–which includes computer and telecommunication media like phone, V-SAT etc. 2. Software–which includes customized software developed as per management’s requirement and existing software to manage database of the concerned organization using appropriate package. Thus, the problem, from software point of view, before every I.T. professional at business organizations is two fold viz. l Developing application software for different functional areas like production, marketing, purchase, finance, MIS etc. as per requirement of management. l Managing database of the concerned organization and make them available to right person at right time. Needless to say for both type of problems stated above, I.T. professionals at work must have at least basic knowledge of accounting and financial management because accountin˝g and financial management are language of business, which makes communication possible. It is impo˝rtant to note that without an understanding of accounting and financial management, one cannot underst˝and the complexities associated with business organization. IT professionals, therefore, equipped with knowledge of acco˝unting and financial management can understand not only the complexities associated with busi˝ness organization but can recognize the problem which helps in developing Data Flow Diagram (DFD) and Enti˝ty Relation Diagram (ER- Diagram) easily, which are essential to software development. Furthermore, clear understanding of database of the concerned organization leads to efficient management of database, which is possible only when I.T. professionals at work have proper knowledge of accounting and financial management because all the financial database rests with a˝ccounts and finance department using definite format and terminology. 22 Accounting and Financial Management for I.T. Professionals Exercises Q. 1. Explain the term Management Accounting and state what you understand to ˝be its main objectives. Q. 2. Distinguishbetween: l Financial Accounting l Cost Accounting l Management Accounting Q. 3. How does the accounting information assists management in the solution o˝f strategic business problems? Q. 4. “Accounting as an aid to management in solving tactical business prob˝lems”. Comment. Q. 5. Financial accounting has the basic objective of providing financial info˝rmation to the parties outside the business. Parties inside the business also need information ˝of monetary character and otherwise. Which system of accounting provides this information, and˝ what information is generated for the guidance of the managers to take decisions? Q. 6. Distinguishbetween: l Accounting system and l Financial system. Q. 7. Explain the limitations of accounting information. Q. 8. Describe the users of accounting information. Q. 9. Describe the utility of Accounting and Financial Management for Informat˝ion Technology (I.T.) professionals. Book-Keeping 23 Chapter–2 Book-Keeping LEARNING OBJECTIVES In this chapter we will study : Introduction Types of Books of Account Book-keeping Process Types of Error During Book-keeping Process Data Flow Diagram (DFD) for Book-keeping Process q Important terms 24 Accounting and Financial Management for I.T. Professionals 2.1 INTRODUCTION Book-keeping means maintaining books of accounts. 2.2 TYPES OF BOOKS OF ACCOUNT Types of Accounts Personal A/c (Concerned with persons (Natural or Legal ), e.g. customers, creditors, debtors, Real A/c Nominal A/c owners, banks, firms, etc.) (Related to assets) Organizations act as legal person. Tangible A/c Intangible A/c (These accounts relate to things (They represent things, which than can be touched, felt, cannot be touched, but they can measured, etc. It could be fixed be measured in terms of money, or current in nature, e.g. cash, e.g. Patents A/c, Goodwill A/c building, furniture, stock etc.) etc.) These accounts deal with expenses and losses, income and gains. For example, rent, lighting, insurance, dividends or income received or expenses for services received by the firm etc. 2.2.1 Ground Rule for Entry in Books of Account Personal A/c Real A/c Dr. Cr. Dr. Cr. (The receiver) (The giver) (What comes in) (What goes out) Book-Keeping 25 Nominal A/c Dr. Cr. (All expenses and (All income and losses) gains) The above ground rule for entry in books of account leads to following a˝nother set of rules: Liability Asset Dr. Cr. Dr. Cr. (Decrease) (Increase) (Increase) (D)ecrease Expense Income Dr. Cr. Dr. Cr. (Increase) (D)ecrease (Decrease) (I)crease 2.3 BOOK-KEEPING PROCESS The steps involved in book-keeping process are as follows: Step 1: Identifying financial transactions/events (Vouchers) Step 2: Recording of transactions/events (Journals) Step 3: Classifying transactions/events (Ledgers)
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'