Meaning and Concept of
Accounting
Introduction
The Process of
accounting starts with the establishment of a business unit. The propriter (owner)
is interested in earning profit and accouinting helps the propriter to find out
whether the business has earned the profit or loss. But all this is not
possible without proper recording of affairs of the business. Here accounting
serves as an information system, it records the business transaction and
communicates economic information about the business to a wide variety of users
including propriter. The
modern system of accounting based on the principles of double entry system owes
it origin to Luca Pacioli who first published the principles of Double Entry
System in 1494 at Venice in Italy. In his book, he used the present day popular
terms of accounting Debit (Dr.) and Credit (Cr.).Debit comes from the Italian
debito which comes from the Latin debita and debeo which means owed to the
proprietor.Credit comes from the Italian credito which comes from the Latin
‘credo’ which means trust or belief (in the proprietor or owed by the
proprietor. In explaining double entry system, Pacioli wrote that ‘All entries…
have to be double entries, that is if you make one creditor, you must make some
debtor’.
Meaning
of Accounting:
The American Institute
of Certified Public Accountants (AICPA) had defined accounting as the art of
recording, classifying, and summarizing in a significant manner and in terms of
money, transactions and events which are, in part at least, of financial
character, and interpreting the results thereof.
The American Accounting Association (AAA)
defined accounting as ‘the process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users of
information’.
Accounting can
therefore be defined as the process of identifying, measuring, recording and
communicating the required information relating to the economic events of an
organisation to the interested users of Information.
From the above
the following attributes of accounting emerge:
Identification: It means determining what
transactions to record, i.e., to identity events which are to be recorded. It
involves observing activities and selecting those events that are of considered
financial character and relate to the organisation.
Measurement: It means
quantification (including estimates) of business transactions into financial
terms by using monetary unit, viz. rupees and paise as a measuring unit. If an
event cannot be quantified in monetary terms, it is not considered for
recording in financial accounts.
Recording:
Once the economic events are identified and measured in financial terms, these
are recorded in books of account in monetary terms and in a chronological
order.
Classifying: It Is concerned
with the systematic analysis of the recorded data so as to accumulate the transactions of similar type at one
place. This function is performed by maintaining the ledger in which different
accounts are opened to which related transactions are posted.
(iii) Summarizing:
It is concerned with the preparation and presentation of the classified
data in a manner useful to the users. This function involves the preparation of
financial statements such as:
(a)Income
Statement
(b)Balance Sheet
(c)Statement of
Changes in Financial Position
(d)Statement of
Cash Flow etc.
(e)Comparative
statement
Communication:
The economic events are identified, measured and recorded in order that the
pertinent information is generated and communicated in a certain form to
management and other internal and external users. The information is regularly
communicated through accounting reports.
Interpreting: The
accountants interpret the statements in a manner useful to the users. The
accountant should explain not only what has happened but also (a) why it
happened, and (b) what is likely to happen.
Economic
Events: Business organisations involves economic events. An
economic event is known as a happening of consequence to a business
organisation which consists of transactions and which are measurable in
monetary terms. For example, purchase of Plant & Machinery.
Organisation
: Organisation
refers to a business enterprise, whether for profit or not-for profit motive.
Depending upon the size of activities and level of business operation, it can
be a sole-proprietor concern, partnership firm, cooperative society, company,
local authority, municipal corporation or any other association of persons.
Interested Users of Information: Many users need financial information in order to make important decisions. These users can be divided into two broad categories:
Internal users and External users.
Internal users includes-Chief Executive, Financial Officer,Vice President,Business Unit Managers,Plant Managers, Store Managers, Line Supervisors, etc
External users includes-present and potential Investors (shareholders), Creditors (Banks and other Financial Institutions, Debentureholders and other Lenders,Tax Authorities, Regulatory Agencies, Securities Exchange Board of India, Labour Unions, Trade Associations.
Why do the Users Want Accounting Information?
• The shareholders use them to see if they are
getting a satisfactory return on their investment.
• The managers use the information to evaluate the
performance and financial analysis of
their company with the industry.
• The
creditors (lenders) want to know liquidity and ability of the company to pay
its debts.
• The prospective investors use them to assess
whether or not to invest their money in the company.
• The
government and regulatory agencies require
the information for the payment of various taxes such as Value Added Tax (VAT),
Income Tax (IT), Customs and Excise duties.
Qualitative
Characteristics of Accounting Information:
Qualitative characteristics are the
attributes of accounting information which tend to enh
ance its understandability and
usefulness. it must possess the following attributes:
Reliability:
The
reliability of accounting information is determined by the degree of
correspondence between what the information conveys about the transactions or
events that have occurred, measured and displayed. A reliable information
should be free from error and bias and faithfully represents what it is meant
to represent.
Relevance: To be relevant,
information must be available in time, must help in prediction and feedback,
and must influence the decisions of users by -prediction ,past evaluations.
Understandability:
Understandability means decision-makers must interpret accounting information
in the same sense as it is prepared and conveyed to them..
Comparability:
The
financial reports are able to compare various aspects of an entity over
different time period and with other entities. Accounting reports must belong
to a common period and use common unit of measurement and format of reporting.
Financial
accounting : The purpose of this branch of
accounting is to keep a record of all financial transactions so that:
(a) The
profit earned or loss can ascertained
(b) The
financial position of the business as at the end of the accounting period can
be ascertained
(c) The
financial information required by the management and other interested parties
can be provided.
Cost
Accounting : The purpose of cost accounting is to
analyse 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 : The purpose of
management accounting is to assist the management in taking rational policy
decisions and to evaluate the impact of its decisons and actions.
Objectives of Accounting:
The primary objectives of accounting include
the following:
1 Maintenance of Records of Business
Transactions: Accounting is used for the maintenance of a systematic record
of all financial transactions in book of accounts. such as purchases, sales,
receipts, payments, etc. that takes place in business everyday. Hence, a proper
and complete records of all business transactions are kept regularly.
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Profit
= Revenue - Expenses |
Depiction of Financial Position:
Accounting also aims at ascertaining the financial position of the business
concern in the form of its assets and liabilities at the end of every
accounting period. A proper record of resources owned by business organization
(Assets) and claims against such resources (Liabilities) facilitates the
preparation of a statement known as balance sheet or position statement.
Basic Terms in
Accounting
Entity: Entity means a reality that has
a definite individual existence. Business entity means a specifically identifiable
business enterprise like Reliance Pvt. Ltd., ITC Limited, etc.
Transaction: A transaction is a event that has
a monetary impact on an entity's financial statements and is recorded as an entry in its accounting records. It can
be a purchase of goods, receipt of money, payment to a creditor, incurring
expenses, etc. It can be a cash transaction or a credit transaction.
Assets:
Assets are economic resources of an enterprise that can be usefully expressed
in monetary terms. Assets can be broadly classified into two types: current and
Non-current
Classification of Assets
Liabilities:
Liabilities are obligations or debts that an enterprise has to pay at some time
in the future. Liabilities are classified as current and non-current
Classification of Liabilities
Capital:
Amount invested by the owner in the firm is known as capital. It may be brought
in the form of cash or assets by the owner for the business entity. Capital is
an obligation and a claim on the assets of business. It is, therefore, shown as
capital on the liabilities side of the balance sheet.
Sales: Total revenues generated from
sale of goods or services is called sale. Sales may be cash sales or credit.
Revenues:These are the amounts of the
business earned by selling its products or providing services to customers,
called sales revenue..
Expenses
:Costs
incurred by a business in the process of earning revenue are known as expenses.
Eg: depreciation, rent, wages, salaries, interest, , light and water,
telephone, etc.
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Revenue
Expenditure:
Capital
Expenditure:
Eg: as purchase of machinery, furniture, etc.
Gain: A profit that arises from events
or transactions which are incidental to business such as sale of fixed assets,
winning a court case, appreciation in the value of an asset.
Loss:
The excess of expenses of a period over its related revenues its termed as
loss. It decreases in owner’s equity.
Discount:
Discount is the deduction in the price of the goods sold. Two types of discount:
(1) Trade
Discount: deduction of agreed percentage of list price at the time selling
goods
(2) Cash Discount. This type of discount is given
when goods are sold on credit and the debtors make the payment within the stipulated period or earlier.
Voucher:
The documentary evidence in support of a transaction is known as voucher. For
example, when we buy goods we get a receipt.
Goods : It refers to the products in
which the business unit is dealing, i.e. in terms of which it is buying and
selling or producting and selling.
Drawings:
Withdrawal of money and/or goods by the owner from the business for personal
use is known as drawings. Drawings reduce the investment of the owners.
Purchases:
Purchases are total amount of goods
procured by a business on credit and on cash, for use or sale.
Stock
:
Stock (inventory) is a measure of something on hand-goods, spares and other
items in a business.
Closing Stock: is the amount of goods
which are lying unsold as at the end of an accounting period is called closing
stock (ending inventory).
Opening
stock :(beginning inventory) is the amount of stock at the
beginning of the accounting period.
Debtors:
Debtors are persons who owe to an enterprise an amount for buying goods and
services on credit. It is shown in the balance sheet as sundry debtors on the
asset side.
Creditors:
Creditors
are persons and/or other entities who have to be paid by an enterprise an
amount for providing the enterprise goods and services on credit. It is shown in the Balance Sheet as sundry
creditors on the liabilities side.
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