Introduction to Accounting

Welcome to Learn At Ur Desk! Today, we are going to learn the very first lesson of course named Financial Accounting i.e. “Introduction to Accounting.”

First, let's see what we are going to learn in this lesson!

Overview:

In this lesson, we are going to focus on the following topics:

1.    What is Accounting?

2.    What is meant by Bookkeeping?

3.    What is the difference between Bookkeeping and Accounting?

4.    What are the main objectives of Accounting?

5.    What are the various functions of Accounting?

6.    Who are the users of Accounting Information?

7.    What are the advantages of Accounting?

8.    What are the limitations of Accounting?

9.    What are the various Branches of Accounting?

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INTRODUCTION

Business is an economic activity and Finance/Money is regarded as the lifeblood of the business. Business’s main objective is to earn a profit. But How do you know if the business is earning profit or incurring losses? The solution to this problem is very simple and that is by “Accounting”. Therefore, every business has to keep a systematic record of its business transaction to achieve its objectives and to know the financial position of the business.

MEANING AND DEFINITION OF ACCOUNTING

Accounting is the process of identifying, measuring and communicating the economic/financial information of an organization for decision-making to its users.

According to American Institute of Certified Public Accountant (AICPA) “Accounting is the art of recording, classifying, analyzing and summarizing in a significant manner and in terms of money transactions and events which are in part at least, of a financial character and interpreting the result thereof.”

According to the American Accounting Association (AAA), “Accounting is the process of identifying, measuring and communicating information to permit judgement and decisions by the users of accounts.”

BOOKKEEPING VS. ACCOUNTING

Bookkeeping means recording of daily business transaction in a systematic manner. Accounting is a wider term and includes besides bookkeeping, preparation of financial statements and their analysis and interpretation. The process of accounting begins where the bookkeeping process ends.

The distinction between bookkeeping and accounting are as under:

Book-keeping	Accounting
1.    It is the recording phase of an accounting system.	1.    It is recording, classifying, summarizing, analyzing and interpreting business transactions.
2.    It has a limited scope of only recording business transactions in original books of accounts.	2.    It has a wider scope and includes bookkeeping and analysis, interpretation of business information.
3.    It does not require special skill or knowledge so, clerks or lower level of management performs this task.	3.    It requires special skill and knowledge. Senior staff and accountants with a higher level of knowledge do it.
4.    It does not give a complete picture of the financial conditions of the business.	4.    It is critically analyses, interprets the business transactions, and shows the complete picture of the financial condition of the business.
5.    It does not help in complying with legal formalities.	5.    Legal formalities can comply with the help of accounting.
6.    It does not provide any information for taking managerial decisions.	6.    It provides information for taking managerial decisions.
7.    It has no branches.	7.    It has several branches like cost accounting, management accounting etc.

OBJECTIVES OF ACCOUNTING

The main objectives of Accounting are as follows:

1.    To maintain a systematic record of business transactions.

2.    To ascertain profit or loss of the business.

3.    To ascertain the financial position of the business.

4.    To provide financial information to various parties.

5.    To know the solvency position of the business

6.    To plan future business development activities.

FUNCTIONS OF ACCOUNTING

The following are the basic functions of Accounting:

1.    Identifying the Transactions and Events: First, Accounting identifies transactions and events of a specific entity. A transaction is an exchange in which each participant receives or sacrifice value. An event is a happening of consequences to an entity. An entity means an economic unit that performs economic activities.

2.    Recording: This is the basic function of accounting. All business transactions of a financial character, as evidenced by some documents such as sales bills, passbook, salary slip etc. are recorded in the books of accounts generally known as ‘Journal’. Recording business transaction in the book known as “journal”.

3.    Classifying: It is concerned with systematic analysis of the recorded data, with a view to group transactions or entries of one nature at one place, so at to put information in a computable usable form. The books containing classified information generally known as ‘Ledger’, in which different accounts are open.

4.    Summarizing: This function involves the preparation of financial statements such as income statement, balance sheet, statement of cash flow and statement of value-added.

5.    Analyzing: The term ‘analysis’ means the methodical classification of the data given in the financial statements. Its purpose is to identify the financial strengths and weakness of the enterprise. It provides the basis for interpretation.

6.    Interpreting: It is concerned with explaining the meaning and significance of the relationship so established by the analysis. The recorded financial data analyzed and interpreted in a manner that will enable the end-user to make a meaningful judgment about the financial condition and profitability of business operations.

7.    Communication: It is concerned with the transmission of summarized, analyzed and interpreted information to the users to enable to make reasonable decisions. Through preparation and distribution of accounting reports, which include besides the usual profit & loss account and the balance sheet, additional information are also submitted in the form of accounting ratios, graphs, diagrams, fund flow statement etc. for decision-making.

USERS OF ACCOUNTING INFORMATION

1.    Internal users (primary users)

Internal users are the persons, who are directly involved in managing and operating the business enterprise such as the managing and operating the business enterprise such as or the partners, managers and officers. These persons need accounting information for the efficient and smooth running of business enterprise.

It includes the following:

i)     Owners: For analyzing the viability and the profitability of their investment and determining any future course of action.

ii)   Management: For analyzing the organisation’s performance and position and responding appropriately, to improve the company results.

iii) Employees: For assessing the company’s profitability and its consequence on their future remuneration and job security.

2.    External users (secondary users)

Individual or organisation, which have present or future interest in the business enterprise, but not part of the management, is called as external users of accounting.

It includes the following:

i)     Creditors: For determining the creditworthiness of the organisation. Creditors according to the assessment of their customer’s financial health set terms of credit. Creditors include suppliers as well as lenders of finance such as banks.

ii)   Investors: For analyzing the feasibility of investing in the company. An investor wants to make sure; they can earn a reasonable return on their investment before they commit any financial resources to the company.

iii) Customers: For assessing the financial position of its suppliers, which is necessary for them to maintain a stable source of supply in the long-term.

iv)  Tax authorities: For determining the credibility of the tax returns filed on behalf of the company.

v)    Regulatory authorities: For ensuring that the company’s disclosure of accounting information is following the rules and regulations set to protect the interest of the stakeholders, who rely on such information informing their decisions.

ADVANTAGES OF ACCOUNTING

Here are some of the advantages of Accounting:

1.    Helpful in the management of the business: Accounting assists the management in planning and controlling business activities and in taking a decision.

2.    Provide complete and systematic record: Accounting is a complete and systematic recording of all business transactions, so the limitation of humans that cannot keep all transactions in mind can overcome by accounting because every business transaction is recorded and analyses through it.

3.    Enables comparative study: Proper books of accounts records relating to various expenses, sales, gross profit and net profit, etc., which further used to compare. As such, accounting helps in inter-firm and intra-firm comparison.

4.    Helpful raising loan: Accounting information is of great help while raising loans from banks like IDBI, ICICI etc. these financial institutions lend money based on profitability and soundness of the business enterprise. The profitability and soundness of business measured by the Income Statement (trading and P & L a/c) and Balance Sheet.

5.    Helpful in the assessment of tax liability: Accounting facilitates the settlement of tax liability with the authorities by systematically maintaining proper books of accounts.

6.    Evidence in the court of law: Proper books of accounts maintained in a systematic manner act as legal evidence in case of disputes. The business transactions are recorded in the books of accounts supported by authenticated documents viz., vouchers etc. Thus, accounts act as evidence in the court of law.

7.    Information regarding the financial position: Accounting reports the financial position of the business by preparing a balance sheet at the end of each accounting period. Balance sheet discloses the position of assets and their values on the one hand and liabilities and capital on the other hand.

8.    Valuation of business: In case of sale of business or conversion of one business into another true and fair value of the business is calculated or determined through accounting. The balance sheet shows the value of asset and liabilities of the business, which can be used to calculate its net worth.

LIMITATIONS OF ACCOUNTING

Despite many advantages, there are some limitations of accounting. They are as follows:

1.    Based on Historical cost: Accounts are prepared based on historical cost (i.e., original cost) and as such, the figures given in financial statements do not show the effect of changes in the price level. Accounting is historical in nature and reflects the past position of business organization.

2.    Records only monetary transactions: Accounting provides only incomplete information as accounting records only those transactions, which can be express and measured in term of money.

3.    Window dressing: Window dressing refers to the practice of manipulating accounts, so that financial statements may disclose a more favourable position than the actual position.

4.    Estimated position and not real position: Accounting follows various generally accepted accounting principles. Sometimes, the records prepared in accounting fail to show a true and fair position of profitability and financial soundness of the business enterprise.

5.    The omission of qualitative information: Since, the accounting is confined to the monetary matters only the qualitative element like the quality of management, quality of labour force, public business unit ate completely omitted from the books, as these cannot be expressed in monetary terms.

6.    Unsuitable for forecasting: Financial accounts are only a record of past events and transactions, but there is a continuous change in the demand of the product, price of the product, the position of competition, etc. that is why financial analysis based on past events may not be of much use for forecasting.

BRANCHES OF ACCOUNTING

The various branches of Accounting are as follows:

1.    Financial Accounting: It is primarily concerned with providing financial information about the business enterprise to all its stakeholders. It deals with recording, classifying and summarizing business events.

2.    Cost Accounting: It is concerned with the process of accounting and controlling the cost of units produced or service rendered by the business enterprise.

3.    Management Accounting: It is concerned with internal reporting of information to management for planning and controlling operations, decision making and formulating long-term plans.

4.    Social Responsibility Accounting: It is concerned with the process of identification, measurement and communicating about the contribution made by the business enterprise to the society.

5.    Human Resources Accounting: It is concerned with the process of identifying and reporting the investments made in the human resources of an organization that are presently unaccounted for in the conventional accounting practice.

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Coming Up Next – Basic Theories of Accounting.

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