Page 14 - DMGT104_FINANCIAL_ACCOUNTING

Financial Accounting

Notes 2. Effect of inflation: In accounting the transactions are recorded at the historical cost.
Accordingly the assets of the business are shown at cost in the balance sheet. Thus the
balance sheet prepared on the basis of historical cost ignores the price-level changes
(inflation). In this way the balance sheet of the business does not present the true and fair
picture of the business.
3. Conflict between accounting principles: In accounting, one accounting principle conflicts
another. For instance, inventory should be valued on the basis of ‘least of the cost and
market price’ as per the principle of the conservatism. If in the first year, inventory is
valued on the basis of cost (being lower than market price) and in the second year at the
market price (being lower than cost), this principle conflicts the accounting principle of
the consistency.

4. Financial statements are affected by personal judgment of the accountants: Personal
decisions of the accountants regarding the adoption of accounting policies, affects the
results of the financial statements. As a result the financial statements lose their objectivity.
5. Financial statements do not reflect the right picture of the business: Sometimes the profit
and loss account of the business does not show the accurate profit/loss and the balance
sheet does not show the true picture of the business because the assets shown in the
balance sheet are shown at the realizable (resalable) value which is wrong. Some worthless
figures are also shown in the balance sheet as preliminary expenses, discount on issue of
shares/debentures, etc.

Self Assessment

Fill in the blanks:

1. …………………… is the process of recording, classifying, summarizing in a significant
manner of transactions which are in financial character and finally results are interpreted.
2. The users of accounting are …………………… and external.

3. Accounting records all the transactions which can be expressed either in …………………….
4. The creditors are interested to know the ………………… of the business.
5. The primary objective of the accounting is to maintain the records of all ……………………
of the business.

1.2 Process of Accounting

Accounting is described as origin for the creation of information and the continuous utility of
information. Now the question is how is this information created? For this, there is a step by
step process, as shown in Figure 1.1.
After the creation of information, the developed information should be appropriately recorded.

Are there any scales/guides available for the recording of information? If yes, what are they?
They are as follows:
1. What to record: Financial Transaction is only to be recorded
2. When to record: Time relevance of the transaction at the moment of recording

3. How to record: Methodology of recording—It contains two different systems of accounting
viz. cash system and accrual system.

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