MGT101 Handouts Set 2

Lesson-1

The objective of this lecture is to introduce the subject “Financial Accounting” to the students and give them an idea as to how did accounting develop.

What is Financial Accounting?

It is the maintenance of daily record of ALL financial transactions in such manner that it would help in the preparation of suitable information regarding the financial affairs of a business or an individual.

Why is Financial Accounting Needed?

The need for recording financial transactions arises because the individual or business wants to know the performance and to assist the person in making decisions related to the business.

What Are Transactions?

In accounting or business terms, any dealing between two persons involving money or a valuable thing is called transaction. Human beings are social animals and are bound to adopt a community living style. Living in a community, essentially means that people interact with other people and are dependant on each other to fulfil their needs. Every person cannot fulfil all his needs like food, clothing, housing etc. on his own. He, therefore, depends on other people to provide him with some of his needs, in return to him providing others with some of theirs. This means that to get something on has to give something in return. Every instance where one ‘gives something’ to ‘get something’ is called a transaction.

How Did it Develop?

Nearly all developments happen because of human being’s need for the same. Accountancy is no different. Times when goods were bartered or exchanged. When the concept of money was introduced, it became a little more difficult. o Example of the Shepherd. o Budgeting – the old custom of keeping separate “Potlees” by the elders for household and other expenses. Today’s Business budgeting is on the same lines. o

What is a Budget?

Budget is a plan of income, expenses & other financial operation for a future period.

Concept of Costing.

A person making or producing any thing must not only know how much it costs to make but also to help in determining the selling price. It is necessary that the person not only knows the cost of what is being produced but also the cost of each component which has gone into production The control of the costs being incurred is also necessary otherwise the same can exceed the estimates. All this is only possible if the costs and data relating to production is properly recorded and analysed. An exercise that the Accountant only can carry out.

Impact of IT on Accounting.

The old “Munshi,” who kept record of the financial dealings was the original accountant. But he is now of no use, as the need for analysis of information recorded and forecasting based there on, is a capability the “Munshi” lacks. In fact, there is no need for any expert in writing of books. Information Technology has taken over. But some one has to tell the Software developer how books are written. The need for an Accountant who is well versed in the art of writing up books still remains. The role has changed. Information Technology software can now produce the reports and analysis but the expert to interpret all of this remains. The need for the professional to describe this has not been overtaken by Information Technology.

Barter Trading and Barter Transactions.

Trading one commodity or service for another commodity or service is called ‘Barter Trading’. Every transaction where goods are exchanged for goods is called a ‘Barter Transaction’. Since every person cannot produce every thing that he needs. Therefore, he needs to give / sell what he produces to get / buy what he wants. In early days when ‘money’ was not invented, people used to exchange goods for goods. This kind of trade, where goods are exchanged for goods, is called barter trade. In fact, in barter trade, value of one commodity is quoted in terms of other commodity, for example the price of 10 kg of wheat may be 2 meters of cloth or 5 litres of milk. Although, there is no involvement of money but still every commodity has a value, which means that, you have to give a specific quantity of one commodity to buy a specific quantity of another commodity

Money Measurement Concept.

With the passage of time, the trading volumes and types of commodities available in the market increased and it became increasingly difficult to exchange commodity with commodity. That is why the concept of cash / money came in and people started valuing all goods / services in terms of a common commodity called money. Now the price of 10 kg wheat would be Rupees 60 and not 2 meters of cloth. Similarly the price of 2 meters of cloth and 5 litres of milk would also be Rupees 60. In accounting, every transaction that is worth recording is recorded in terms of money. In other words any event or item that cannot be translated in terms of money is not recorded in books.

Translating every transaction in terms of money does not always mean that the money changes hands, the same time at which the transaction takes place. It may be paid before or after the goods are exchanged. When the money value of an item being purchased is paid, at the same time the item is exchanged. The transaction is said to be a cash transaction. On the other hand, if the payment is delayed to a future date, the transaction is termed as a credit transaction.

Lesson-2

The evolution of accounting started in the previous lecture continues with a slight emphasis on how actual record keeping started. In addition, some basic concepts like capital, profit, and budget are introduced.

Different Types of Business Entities

Commercial Organizations (Profit Oriented)

o Sole proprietor o Partnership o Limited companies

Non-Commercial Organizations (Non-Profit Oriented)

o NGO’s (Non-government Organizations) o Trusts o Societies

The Basic Concept of Record Keeping

We can maintain a diary of transactions and note the daily transactions like sale, purchase etc. in it.

Problems Faced in Maintaining Diary of Transactions

How will we come to know the income and expenses from various sources?

We only have a sheet / page on which daily transactions are listed. We do not know which product is selling better and which is not.

Available Alternate

One can go through all the transactions at the end of the month and note the different types of transactions on different pages. So that every page gives total for a different type of transaction like sales of different products and expenses of different types