Chapter 5: Business Accounting
5.1 Meaning, Objectives, and Importance of Business Accounting
Business Accounting is the systematic process of identifying, measuring, recording, classifying, summarizing, and interpreting financial transactions of a business enterprise that can be expressed in monetary terms, in order to ascertain its operating result (Profit or Loss) for an accounting period and present its true financial position (Assets, Liabilities, and Equity) on a specific date.
Objectives and Importance of Business Accounting
- Systematic and Permanent Record: Replaces limited human memory by maintaining chronological and classified records of all monetary transactions in Journal and Ledger books.
- Ascertainment of Profit or Loss: Prepares the Trading and Profit & Loss Account (Income Statement) at the end of the fiscal year to determine net operating profit or loss.
- Depiction of True Financial Position: Prepares the Balance Sheet showing total Assets, Liabilities, and Owner’s Capital.
- Information to Internal and External Stakeholders: Communicates reliable financial reports to owners, management, banks, investors, creditors, employees, and tax authorities.
- Assessment of Tax Liability: Provides audited financial evidence for assessing Income Tax and Value Added Tax (VAT).
- Prevention and Detection of Errors and Fraud: Double-entry bookkeeping and Trial Balance verification help detect arithmetic and accounting errors.
5.2 Branches / Types of Accounting Methods
Business organizations utilize three primary branches of accounting based on user needs:
1. Financial Accounting
The foundational branch of accounting concerned with recording historical monetary transactions in the Journal, posting to Ledgers, preparing a Trial Balance, and drafting Final Accounts (Income Statement and Balance Sheet) at the end of the fiscal year.
- Primary Users: External stakeholders (shareholders, banks, creditors, Inland Revenue Department) as well as owners.
2. Cost Accounting
The specialized branch of accounting that records, classifies, and allocates expenditure on raw materials, direct labor, and factory/office overheads to determine the total cost and per-unit cost of manufacturing a product or rendering a service.
- Objectives: Ascertaining exact cost per unit, controlling wastage and unnecessary costs, and fixing a competitive selling price.
3. Management Accounting
The branch of accounting that collects, analyzes, and interprets data from both Financial Accounting and Cost Accounting (using tools like ratio analysis, budgeting, break-even analysis, and cash flow forecasting) to assist internal management in planning, controlling, and policy decision-making.
Differences Between Financial Accounting and Cost Accounting
| Basis of Difference | Financial Accounting | Cost Accounting |
|---|---|---|
| 1. Main Objective | To ascertain the overall net profit/loss and financial position of the business as a whole. | To ascertain the exact total and per-unit cost of goods/services and control production costs. |
| 2. Target Users | Prepared primarily for external users (investors, banks, tax offices) and owners. | Prepared exclusively for internal management and production executives. |
| 3. Legal Compulsion & Format | Mandatory for registered businesses; must follow formats prescribed by the Companies Act, Tax Law, and NAS/NFRS. | Voluntary in most businesses; formats are flexible and designed according to management needs. |
| 4. Reporting Period | Financial statements are prepared periodically, usually once at the end of the fiscal year. | Cost sheets and variance reports are prepared continuously (daily, weekly, monthly, or per job/batch). |
| 5. Nature of Transactions | Records external monetary transactions with outside parties based on historical actual figures. | Records internal movement and consumption of materials, labor hours, and overheads (both historical and estimated/standard costs). |
5.3 Accounting Standards: NAS and NFRS in Nepal
Concept and Need of Accounting Standards
Accounting Standards are authoritative written policy documents, rules, and principles issued by a national or international accounting body governing the recognition, measurement, treatment, presentation, and disclosure of accounting transactions in financial statements.
- Why Accounting Standards Are Necessary:
- Brings uniformity and consistency in financial statements across different organizations.
- Enhances comparability (inter-firm and intra-firm comparisons across years).
- Prevents manipulation, window-dressing, and accounting fraud.
- Increases transparency, reliability, and international credibility for domestic and foreign investors.
Nepal Accounting Standards (NAS) & Nepal Financial Reporting Standards (NFRS)
- Accounting Standards Board (ASB), Nepal: Established by the Government of Nepal in 2002 A.D. (2059 B.S.) through an amendment to the Nepal Chartered Accountants Act, 1997 (2053 B.S.) to formulate accounting standards in Nepal, while ICAN pronounces and enforces their compliance.
- Nepal Accounting Standards (NAS): The national benchmarks and rules formulated by ASB Nepal that business and public entities in Nepal must follow when preparing financial statements.
- Nepal Financial Reporting Standards (NFRS): Implemented since 2013 A.D. (2070 B.S.) in full convergence with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). NFRS is mandatory for multinational companies, commercial banks and financial institutions (BFIs), insurance companies, state-owned enterprises, and public listed companies that issue shares to the public. (For smaller entities, NFRS for SMEs and NAS for Micro Entities apply.)
5.4 Chart of Accounts in Business Accounting
A Chart of Accounts is a systematic, coded list of all accounts maintained in an organization’s general ledger, classified according to their financial nature so transactions can be recorded accurately and computerized easily. Every Chart of Accounts is organized into five fundamental account groups:
| Account Group | Code Series (Typical) | Nature, Meaning, & Examples | Normal Balance |
|---|---|---|---|
| 1. Assets Account | 1000 Series | Economic resources owned by the business that provide future economic benefit. Includes Non-Current/Fixed Assets (Land & Building, Plant & Machinery, Furniture, Goodwill, Patents) and Current Assets (Cash in hand, Cash at bank, Inventory/Stock, Sundry Debtors, Bills Receivable, Prepaid Expenses). | Debit (Dr.) |
| 2. Liabilities Account | 2000 Series | Financial obligations or debts owed by the business to external parties. Includes Long-Term Liabilities (Bank Loans, Debentures, Bonds) and Current Liabilities (Sundry Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses, Advance Income). | Credit (Cr.) |
| 3. Shareholders’ Equity / Capital Account | 3000 Series | Owner’s residual claim on business assets (Equity = Assets - Liabilities). Includes Owner’s Capital, Ordinary/Preference Share Capital, Reserves, and Retained Earnings. | Credit (Cr.) |
| 4. Revenue / Income Account | 4000 Series | Inflows earned from primary business operations and other sources. Includes Sales Revenue, Service Fee Revenue, Commission Received, Interest Received, Rent Received, Discount Received. | Credit (Cr.) |
| 5. Expenses Account | 5000 Series | Costs incurred to generate revenue and operate the business. Includes Purchases, Wages, Salaries, Office Rent, Depreciation, Insurance, Electricity/Water, Advertisement, Bad Debts, Interest Paid. | Debit (Dr.) |
5.5 CDC Textbook Exercises & SEE Practice Questions
Group A: Very Short Answer Questions (1 Mark Each)
- What is Business Accounting?
- Write the full forms of NAS, NFRS, GAAP, and ICAN.
- Why is Cost Accounting used in a manufacturing business?
- What is a Chart of Accounts?
- For which organizations has NFRS been made mandatory in Nepal?
Group B: Short Answer Questions (5 Marks Each)
- Define Business Accounting and explain any four objectives of maintaining business accounts.
- Differentiate between Financial Accounting and Cost Accounting in five points.
- What are Accounting Standards? Describe Nepal Accounting Standards (NAS) and Nepal Financial Reporting Standards (NFRS).
- Explain the five main categories of accounts under a Chart of Accounts with examples of each.
Worked answers to these exercises are in Chapter 5 Solutions.