Financial Accounting: Importance and Scope | Management Optional Notes for UPSC PDF Download

Scope of Financial Accounting

The scope of financial accounting encompasses the following aspects:

• Information for External Decision Makers: Financial accounting provides summarized and categorized information about the organization's performance and state of affairs, primarily for external decision makers. This includes details on whether the company is earning a profit.
• Objectives: The main objectives of financial accounting involve preparing profit and loss accounts and balance sheets for reporting to owners and external parties. The goal is to offer useful information through general-purpose reports to investors, creditors, and other users for making informed investments and economic decisions.
• Reports to Owners and External Parties: Financial accounting produces general-purpose reports, such as profit and loss accounts and balance sheets, which are aimed at providing information on management performance. These reports help assess the effectiveness of resource utilization and the overall operation of the enterprise.
• End Product: Financial Statements: The end product of the financial accounting system is financial statements that furnish valuable information to decision makers. Examples include profit and loss accounts. The accounting techniques employed in financial accounting are based on the double-entry system.
• Measuring Business Transactions: Financial accounting measures general business transactions, economic resources, financial obligations, and changes in them, all expressed in terms of monetary units within the societal context in which the organization operates.
• Internal Use by Management: While financial accounting primarily serves external decision makers, management also uses financial statements for internal purposes. Financial statements are analyzed to make decisions that impact the financial status of the firm.

Importance of Financial Accounting

Financial accounting holds significant importance for various types of companies, and its relevance is often overlooked by small-business owners. Key aspects of its importance include:

• Recording Transactions (Bookkeeping): Financial accounting, also known as bookkeeping, is crucial for recording business transactions. Small companies utilize financial accounting to document business activities in the company's ledger. The double-entry system ensures that each transaction affects two accounts, providing a systematic approach to tracking business operations.
• Ledger Maintenance: Small-business owners adopt accounting procedures to maintain a ledger, and financial accounting, employing the double-entry method, ensures a meticulous recording of transactions. This method helps in organizing and understanding the company's activities.
• Communication with External Parties: Financial accounting plays a pivotal role in communicating information to external parties not directly involved in the business. Financial statements, representing the final results of business transactions, are provided to external stakeholders. These statements allow external parties to assess the business's growth and performance against their expectations.
• Analysis for Internal Users: Financial accounting is not only valuable for external communication but also for internal use. Internal users within the business, such as management, benefit from financial accounting to analyze competitors and evaluate investment opportunities. The standardized rules of financial accounting enable business owners to compare different businesses using the same method of analysis.
• Comparative Analysis: Financial accounting provides a standard method of analysis applicable to every business. This uniformity facilitates the comparison of various businesses against one another. Small-business owners can use ratios derived from financial statements to assess their business's performance relative to competitors.
• Adaptability and Development: Financial accounting adapts and develops in response to changes in the economic environment and new ideas generated by special businesses. It supplements, extends, and evolves accounting practices, contributing to the completeness of the financial accounting system.
• Integration with Advanced Financial Accounting: Advanced financial accounting complements the social and economic development by supplementing, extending, and developing accounting practices. It incorporates changes in the business landscape and economic environment, reflecting new ideas and enhancing accounting supervision.

Drawbacks of Financial Accounting

Financial accounting, despite its widespread use, has several drawbacks and limitations:

• Alternative Treatments: Financial accounting allows for alternative treatments of certain items. While it adheres to "generally accepted accounting principles," there are often multiple principles for the treatment of a single item. This flexibility can lead to different interpretations and choices within the framework of accepted principles.
• Impact of Personal Judgments: Despite the convention of objectivity in accounting, personal judgments play a role, especially in making estimates for certain events. Precision in future estimates is challenging, and the element of subjectivity may affect the objectivity of financial accounting.
• Exclusion of Non-Monetary Information: Financial accounting focuses solely on transactions and events that can be expressed in monetary terms. Non-monetary information, no matter how significant, is overlooked and not recorded. This limitation narrows the scope of information provided by financial accounting.
• Lack of Timely Information: Financial accounting is designed to provide information in the form of statements (Balance Sheet and Profit and Loss Account) for a specific period, typically one year. As a result, the information supplied is historical, offering a post-mortem analysis of the past. Businesses often require more timely information for planning and decision-making.
• Limited Detailed Analysis: Financial accounting provides an aggregate view of financial transactions over a specific period. While it enables an overall analysis of business activity during the accounting period, it lacks detailed information on costs, revenues, and profits for each product. This limitation restricts the depth of analysis required for proper business operation.
• Inability to Reflect Present Business Value: The balance sheet presented in financial accounting showcases the position of the business as of a particular date, based on the going concern concept. Assets are valued under the presumption of a longer business life. However, the balance sheet does not reveal the present value of each asset if sold today, as it assumes the business will continue indefinitely.

Conclusion

In conclusion, financial accounting is a crucial method for conveying financial details to external entities, providing valuable insights into a business's financial performance. It operates within the realm of accounting that employs money as a metric for financial evaluation, overseeing and managing the inflow and outflow of funds within a company. This financial flow is documented through statements like the balance sheet, income statement, and cash flow statement.