What is Accounting ?

Accounting is a system meant for measuring business activities, processing of information into reports and making the findings available to decision-makers. The documents, which communicate these findings about the performance of an organisation in monetary terms, are called financial statements. Usually, accounting is understood as the Language of Business. However, a business may have a lot of aspects which may not be of financial nature. As such, a better way to understand accounting could be to call it The Language of Financial Decisions.

Accounting involves the collection, recording, classification and presentation of financial data for the benefit of management and outside agencies such as shareholder, creditors, investors, government and other interested parties. Accounting has been defined in different ways by different authorities on the subject.

The following are some of the important definitions of accounting:

Based on the above definitions, we can summarise the functions of accounting as:

• Identifying financial transactions,
• Recording of transactions which are financial in character,
• Classification of transactions,
• Summarising the transactions which also includes preparation of trail balance, income statements and balance sheet,
• Interpretation of financial results, and
• Communicating the interpreted financial results in a proper form and manner to the proper person.

Evolution of Accounting 

Evolution of Accounting as per Indian mythology Chitra Gupta is responsible for maintaining accounts in God’s court. A book on  Arthashasthra written by Kautilya who was a minister in Chandra Gupta’s kingdom twenty three centuries ago mentions about the accounting practices in India. It describes how accounting records have to be maintained. In China and in Egypt accounting was used for maintaining revenue records of the government treasury.

A book on Arithmetica  Geometrica, Proportion at Proportionality (Review of Arithmetic and Geometric proportion) by an Italian Luca Pacioli is considered as the first authentic book on double entry book keeping. In his book he used the present day popular terms of accounting Debit (Dr.) and Credit (Cr). He also discussed the details of memorandum, journal, ledger and specialised accounting procedures. He also stated that, “all entries have to be double entries, i.e. if you make one creditor you must make some debtor.

Book-keeping

Recording of business transactions in a systematic manner in the books of account is called book-keeping. BookKeeping is concerned with recording of financial data. This may be defined as.

“The art of keeping a permanent record of business transactions is book keeping”.

Accounting involves not only book keeping but also many other activities. In 1941, the American Institute of Certified Public Accountants (AICPA) defined as

“The art of recording, classifying, summarising, analysing and interpreting the business transactions systematically and communicating business results to interested users is accounting”

The American Accounting Association defined accounting as :

“It is the process of identifying, measuring, recording and communicating the required information relating to the economic events of an organisation to the interested users of such information.

In order to appreciate the nature of accounting it is necessary to understand the following relevant aspects of the definition of accounting:

Economic events

 It is the occurring of the consequence to a business organisation which consists of transactions that are measurable in monetary terms. Purchase of a Machinery, installing and keeping it ready for manufacturing is an economic event which consists of a number of financial transactions. These transactions are

(a) buying the machine,

(b) transporting the same,

(c) preparing the site for its installation and

 (d) incurring expenditure on installing the same

Identification, Measurement, Recording and Communication

Identification implies determining what transactions are to be recorded i.e. items of financial character are to be recorded. For example, goods purchased for cash or on credit will be recorded. Items of non-financial character such as changes in managerial policies, etc. are not recorded in the books of accounts.

Measurement means quantification of business transactions into financial terms by using monetary unit. If an event cannot be quantified in monetary terms, it is not considered fit for recording in the books of the firm. That is why important items like appointment, signing of contracts, etc. are not shown in the books of accounts.

Recording : Having identified and measured the economic events in financial terms, these are recorded in the books of accounts in monetary terms and date wise. The recording of the business transactions is done in such a manner that the necessary financial information is summarized as per well established accounting practice.

Communication :

 The economic events are identified, measured and recorded in such a manner that the necessary relevant information is generated and communicated in a certain form to the management and other internal and external users of information. The financial information is regularly communicated through accounting reports.

 Organisation : refers to a business enterprise whether for profit or not for profit motive.

 Interested users of information. Many users need financial information to make important decisions. These users can be investors, creditors, labour unions, Trade Associations, etc.

Organisation :

refers to a business enterprise whether for profit or not for profit motive.

Interested users of information.

Many users need financial information to make important decisions. These users can be investors, creditors, labour unions, Trade Associations, etc.

BRANCHES OF ACCOUNTING

Different branches of accounting came into existence keeping in view various types of accounting information needed by a different class of people viz. owners, shareholders, management, suppliers, creditors, taxation authorities and various government agencies, etc

Financial accounting

It is concerned with recording the transactions of financial character, summarising and interpreting them and communicating the results to the users. It ascertains profit earned or loss incurred during a period (usually one year as accounting year) and the financial position as on the date when the accounting period ends. It can provide financial information required by the management and other parties. The word accounting and financial accounting are used interchangeably. At present we are concerned with financial accounting only.

Cost accounting

It analyses the expenditure so as to ascertain the cost of various products manufactured by the firm and fix the prices. It also helps in controlling the costs and providing necessary costing information to management for decision making.

Management accounting

It is concerned with generating information relating to funds, cost and profits etc. This enables the management  in decision making. Basically, it is meant to assist the management in taking rational policy decisions and to evaluate the impact of its decisions and actions and the performance of various departments.

Tax accounting

This branch of accounting has grown in response to the difficult tax laws such as relating to income tax, sales tax etc. An accountant is required to be fully aware of various tax legislations.

Social accounting

This branch of accounting is also known as social reporting or social responsibility accounting. It discloses the social benefits created and the costs incurred by the enterprise. Social benefits include such facilities as medical, housing, education, canteen, provident fund and so on while the social costs may include such matters as exploitation of employees, industrial interest, environment pollution, unreasonable terminations, social evils resulting from setting up industries etc.

Human resource accounting

It is concerned with human resource of an enterprise. Accounting methods are applied to evaluate the human resources in money terms. It is, therefore, an accounting for the people of the organisation.

National resource accounting

It means the accounting for the resources of the nation as a whole such as water resources, mining, forests etc. It is generally not concerned with the accounting of individual business entities and is not based on generally accepted accounting principles. It has been developed by the economists.

Users of Accounting

The accounting process provides financial data for a broad range of individuals whose objectives in studying the data vary widely.   Three primary users of accounting information were previously identified, Internal users, External users, and Government/ IRS.  Each group uses accounting information differently, and requires the information to be presented differently.

Internal Users

Accounting supplies managers and owners with significant financial data that is useful for decision making. This type of accounting in generally referred to as managerial accounting.

 Some of the ways internal users employ accounting information include the following:

• Assessing how management has discharged its responsibility for protecting and managing the company’s resources
• Shaping decisions about when to borrow or invest company resources
• Shaping decisions about expansion or downsizing

External Users

Typically called financial accounting, the record of a business’ financial history for use by external entities is used for many purposes.  The external users of accounting information fall into six groups; each has different interests in the company and wants answers to unique questions. The groups and some of their possible questions are:

• Owners and prospective owners. Has the company earned satisfactory income on its total investment? Should an investment be made in this company? Should the present investment be increased, decreased, or retained at the same level? Can the company install costly pollution control equipment and still be profitable?
• Creditors and lenders. Should a loan be granted to the company? Will the company be able to pay its debts as they become due?
• Employees and their unions. Does the company have the ability to pay increased wages? Is the company financially able to provide long-term employment for its workforce?
• Customers. Does the company offer useful products at fair prices? Will the company survive long enough to honor its product warranties?
• Governmental units. Is the company, such as a local public utility, charging a fair rate for its services?
• General public. Is the company providing useful products and gainful employment for citizens without causing serious environmental problems?

System of Accounting

Single Entry System

This system is also known as pure entry system. It does not follow the traditional dual recording format. Instead, in a single entry system, only a Cash Book will be maintained. All cash transactions will be recorded in the Cash Book. No other Ledgers find a place in this system. All transactions of personal nature are simply recorded in a rough book.

Double Entry System

This is the more traditional and conventional system for recording transactions in financial accounting. This is a scientific method which has some rules and principles which must be followed. The basic essence of the double entry system is that every transaction will affect two accounts. This is known as the debit and credit rule – every credit entry, there must be a corresponding debit entry.