Outline About Nature and Scope
Before understanding the nature and scope of financial accounting, it is crucial to understand the need for it. Suppose you earn Rs 1 lakh a month. You would make a detailed budget to spend this money. You will put some money in your bank, other savings instruments and investments. With the rest, you’d draw up a list of discretionary and non-discretionary items to buy.
Making a list or recording this is important so that you can keep a track of your expenditure, savings, and earnings. Now, imagine a large company which might have multiple sources of income, investment and savings. Without proper accounting, it is very difficult to keep a track of all the money coming in and going out of the system.
Objectives of Financial Accounting
Financial accounting needs to fulfil the following objectives:
- Providing accounting-related information to all the concerned parties: When we talk about a large business or organisation, it is not just the owner who is concerned with the financial position of their entity. There are several other concerned parties like shareholders, investors, managers, tax officers, auditors, etc., who are concerned with the company’s finances.
- To ascertain profitability: A business can either make a profit or a loss in its operations. To measure which way the company is going, we need financial accounting.
- Keeping systematic records: For the smooth running of any company, it is essential to maintain a systematic financial record and keep stakeholders abreast of the financial situation all the time.
- Ascertaining the financial position: To know how much the business owes to other parties or how much is owed to it, proper financial records need to be maintained.
Nature of Accounting
Accounting can be defined as the act of classifying and summarising money-related matters in a detailed manner that can be easily interpreted. This definition highlights both the nature and scope of financial accounting.
To start a business, the initial investment is made by the proprietor, which is referred to as the capital. The additional funds can be raised through loans, investments, etc. Now using this money, assets are bought and additional expenditures are made. All this is done with the target to generate profit for the organisation. The fund transfers between different parties and money infusion in the business need to be recorded formally so that all the concerned stakeholders are well informed about the financial health of the company.
The nature of financial accounting is outlined as follows:
Identifying monetary transactions – First, the transaction has to take place and be identified so that it can be accounted for. To identify financial transactions, store and check the receipts and bills of every transaction is a must. Sometimes, the exchange of money is not directly involved, but it still needs to be identified. This involves depreciation in the value of goods over time, which forms an important aspect of financial accounting.
- Measuring and recording transactions – The value of transactions has to be measured in terms of money and those concerned with revenues and expenditures need to be recorded. The recording is done in journals.
- Classifying payments – The huge data needs to be classified in a record known as a ledger. For example, all salary-related expenses can be classified under one column. Leasing related data can be classified in another column and so on.
- Summarisation – The larger the corporation, the more complicated the record. Hence, the record needs to be summarised in a form where it can be easily comprehended.
- Analysing, interpretation, and communication: The summarised data needs to be analysed well and interpreted so that it can be communicated to the concerned stakeholders so that they have the full knowledge of the company’s financial position.
Scope of Accounting
Reporting the account statement to various stakeholders highlights the scope of accounting. Various parties in various forms use this information for their benefit and the benefit of the company.
- Financial accounting keeps the company’s various stakeholders updated about its financial health. It should help each stakeholder make decisions regarding the company’s business. For example, it allows shareholders to understand the profit-making subsidiaries of the business. To indirect and direct investors, it gives them an idea of whether the company is worth investing in or not. Employees need to stay updated about it too, so they know whether the company they are working in is in good financial health or not.
- Reporting to shareholders: Shareholders are entities who invest their money in the business seeking profit from their investment. Since they have invested their own money in the business, they need to be reported on the overall financial position of the company involving the number of outstanding loans, assets, expenses, revenue streams, and so on.
- Reporting to the Public: The companies listed on the stock exchange are the ones in which the general public can also invest. Since the public also becomes an investor, account statements have to be made public so that they are fully aware of their investment choices.
- Reporting to Government: It is necessary for tax purposes. Governments need to be aware of the financial position of the businesses which come under their jurisdiction.
- Reporting to employees: Employees are indirect stakeholders and they must know about the company’s financials which helps them stay informed regarding their job security.
Conclusion
Over time, the scope of financial accounting has widened. Earlier limited to shareholders and a few selected entities, today it involves reporting to communities, employees, and the general public. It also helps prevent financial frauds and scams that shake the foundation of the economy. Accounting is the art of identifying, recording, classifying, analysing and interpreting the financial information of a company, which is then used to fulfil certain objectives.