Financial Accounting, Cost Accounting and Management Accounting
1.1 Introduction
Accounting is a very old science which aims at keeping records of various transactions. The accounting is
considered to be essential for keeping records of all receipts and payments as well as that of the income
and expenditures. Accounting can be broadly divided into three categories.
Financial Accounting, aims at finding out profit or losses of an accounting year as well as the assets and
liabilities position, by recording various transactions in a systematic manner.
Cost Accounting helps the business to ascertain the cost of production/services offered by the organization
and also provides valuable information for taking various decisions and also for cost control and cost
reduction.
Management Accounting helps the management to conduct the business in a more efficient manner.
The scope of management accounting is broader than that of cost accounting. In other words, it can be
said that the management accounting can be considered as an extension of cost accounting. Management
Accounting utilises the principles and practices of financial accounting and cost accounting in addition
to other modern management techniques for efficient operation of a company. The main thrust in
management accounting is towards determining policy and formulating plans to achieve desired
objectives of management. Management Accounting makes corporate planning and strategies effective
and meaningful.
In the present chapter all these concepts are discussed in detail in order to make the concepts more clear.
1.2 Financial Accounting
Financial Accounting aims at finding the results of an accounting year in terms of profits or losses and
assets and liabilities. In order to do this, it is essential to record various transactions in a systematic
manner. Financial Accounting is defined as, ‘Art and science of classifying, analyzing and recording
business transactions in a systematic manner in order to prepare a summary at the end of the year to find
out the results of the concerned accounting year.’ The definition given above is self explanatory, however
for understanding clearly, the following terms are explained below.
A Business transactions :- A transaction means an activity, a business transaction means any activity
which creates some kind of legal relationship. For example, purchase and sale of goods, appointing
an employee and paying his salary, payment of various expenses, purchase of assets etc.
B Classification of transactions :- Before recording any transaction, it is essential that it is to be classified.
A transaction can be classified as cash transaction and credit transaction. Similarly transactions
of receiving income and payment of expenditure can be segregated. Even in case of expenditure,
transactions involving revenue expenditure and capital expenditure can be segregated.
C Recording of transactions :- The essence of financial accounting is recording of transaction. In
accounting language, recording of the transaction is known as entry. There are well defined rules
for recording various transactions in books of accounts. As per the rules of financial accounting,
each and every transaction is recorded at two places and hence it is called as ‘Double Entry’ system
of accounting.
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Cost and Management Accounting
D Summary of transactions :- After recording all transactions, it is essential to prepare a summary of
them so as to draw meaningful conclusions. The summary will help in finding out the Profit/Loss
of a particular year and also ascertaining Assets and Liabilities on a particular date. In fact, the very
purpose of financial accounting is to know the results of a particular year. From this angle, the process
of preparing the summary is extremely important.
1.2.1 Concepts and conventions of Financial Accounting :- There are some well defined concepts and
conventions of financial accounting system. Concepts can also be termed as ‘principles’ while
conventions are those which have been followed over a period of time and are accepted as
norms to be followed in financial accounting systems. The concepts and conventions of financial
accounting are explained in the following paragraphs.
1.2.2 Concepts of Financial Accounting:- The following are the concepts of financial accounting.
A. Separate Entity :- This concept implies that the businessman is different from business. Thus
if X starts his business known as X and Sons, X as a person shall be different from his firm,
i.e. X and Sons. Actually in Law, separate entity concept is recognized only in the case of
joint stock companies registered under Companies Act, 1956. In case of partnerships and sole
proprietorship business, separate entity concept is not recognized under Law. However in
accounting, separate entity concept is recognized and the accounting entries are passed in
the books of the business and not in the books of the proprietor as such. Thus when X starts
his business and invests his own money as capital, it is shown as liability in the Balance Sheet
of the business. On the other hand, if the proprietor incurs any private expenditure from the
resources of the business, it is shown as recoverable in the books of accounts of the business.
Thus the principle of separate entity is applied in practice.
B. Double Entry :- This principle can be called as ‘Heart’ of the entire accounting mechanism.
Double entry means a transaction is recorded at two places in the books of accounts, the
reason being that any transaction has two fold effects and hence it is to be recorded at two
places. The following example will clarify the point.
1. If goods are purchased for cash, the cash goes out and goods come in. Thus one effect is
the cash going out and the second effect is that goods come in.
2. When goods are sold for cash, the first effect is that the cash comes in and the second one
is that the goods are going out.
3. In case of credit transactions like purchase of goods, one effect is that goods come in and
the person from whom the goods are purchased becomes the creditor of the business.
Thus in double entry system, each and every transaction has the two fold effects. There is
another system of recording the transactions, which is known as single entry system. In single
entry system, every transaction is recorded only once and hence no double effect is given.
There are very few organizations where single entry system is still implemented. However
the double entry system is now being accepted everywhere.
C. Money Measurement Concept :- Another important concept of financial accounting is the
money measurement concept. This concept means that only the transactions which are
capable of being expressed in monetary terms will be recorded in the books of accounts. In
other words, transactions which cannot be expressed in monetary terms cannot be recorded
