Accounting in a very simple sense is maintaining a record of varied activities. Thus, Accounting is some things that are used almost by everyone in their daily lives. In our lifestyle, we maintain a record of varied transactions or activities.
For example, a student who gets monthly pin money may keep a record of his various expenses i.e. what proportion he spent on buying books or pens, what proportion he spent together with his friends or what proportion he has saved.
Similarly, a housewife may keep a track of quantities of varied grocery items like pulses, rice, vegetables, flour, etc. Thus, the activities associated with keeping a record of some activities or transactions are covered under the top accounting.
Evolution of Accounting
What does one think, accounting is one thing that is evolved in modern times? No, it’s been in use for the past. The roots of Accounting are often traced long back in civilization. Around 4000 B.C., in Babylonia and Egypt, payment of wages and taxes were recorded on clay tablets. As history claims that Egyptians kept the record of gold and valuable deposits and withdrawal from the treasuries.
These records were reported on a day to day by the in-charge of treasuries to the wazir, who wont to forward the monthly reports to the king. Babylonia and Egypt used this method to rectify and take away errors, frauds, and inefficiency from the records. Around 2000 B.C., China used a classy sort of accounting.
In Greece, accounting was wont to maintain total receipts and total payments and to balance government accounts. In Rome, around 700 B.C., receipts and payments were recorded within the daybook and were posted within the ledger at the top of the month. In 1494, Luca Pacioli wrote the book Summa de Arithmetica Geometria Proportioni et Proportionality. In this, he explained the terms debit and credit, which are utilized in accounting so far.
In India, around twenty-three centuries ago, Kautilya wrote the book Arthshastra, which described how accounting records had to be maintained. Book Keeping emerged during the Barter system when there was no cash system and trade was carried by exchanging goods and services. At that point, transactions were kept in individual ledgers, and that they are often provided as evidence just in case of a dispute.
Afterward, when currency and numbers were introduced then the only entry system of bookkeeping was evolved, where one column is maintained and every one the transactions whether paid or received are recorded therein column. within the 15th Century when Luca Pacioli explained the double-entry system, bookkeeping became more efficient as transactions were recorded separately within the debit and credit column which provided a transparent image of the financial position of the firm.
Earlier, Munshi JI or Munim JI used to play the role of accountants. They want to keep account of varied activities of varied people which is usually referred to as Bahi. At that point, the number of transactions wasn’t so huge and maybe easily recorded within the books.
Development of Accounting
In past, around 4000 B.C., accounting was used for recording wages and salaries, deposits and withdrawals of valuable goods (such as gold and silver) from the treasures of the king. Afterward, it was used to record the receipts and payments and balance of government financial transactions. During 1500 A.D., accounting was employed by business firms for recording transactions associated with the business. In 1800 A.D., accounting was wont to record transactions and also to supply information to varied users of monetary data.
During ancient times, accounting was merely concerned with the recording of financial transactions i.e. bookkeeping. But with the passage of time, the role of accounting has changed. In today’s world, the role of accounting is extended to provide relevant information to various users. With the passage of time, as the scope of business increased, their expenditure on different activities, in turn, increased which lead to a large number of transactions. To memorize the huge and complicated transactions is beyond human capacity.
Therefore, it becomes necessary to record them properly in the books in a systematic manner so that the exact position at the end of the day can be easily ascertained. For this, there arises a need for a sophisticated system that has been fulfilled by Accounting. Therefore, in the modern world, the area of accounting has broadened and is no more limited to the recording of transactions only. Accounting has evolved with the passage of time.
Thus, Accounting, in simple terms, is the recording of various transactions, that took place during a particular period, in the books of accounts in a systematic and proper manner. Accounting, nowadays, is just not limited to recording transactions in the books but also to convey useful information to its users.
Meaning of Accounting
Accounting may be a process of identifying the events of monetary nature, recording them in Journal, classifying them in their respective ledgers, summarising them in Profit and Loss Account and Balance Sheet, and communicating the results to its users like proprietors, government, creditors, investors, etc.
According to the American Institute of Certified Public Accountants, 1941, “Accounting is that the art of recording, classifying and summarizing during a significant manner and in terms of money; transactions and events which are, partially a minimum of, of a financial character, and interpreting the results thereof.”
In the words of Bierman and Derbin, “Accounting may be defined as identifying, measuring, recording and communication of financial information.” In the opinion of Smith and Ashburne, “Accounting is the science of recording and classifying business transactions and events, primarily of a financial character, and therefore the art of creating significant summaries, analysis and interpretations of these transactions and events and communicating the results to persons who must make decisions or form judgment.”
Accounting cares about the economic activities of the business. Thus, transactions that can be measured in terms of money are recorded in Accounting. Transactions like the purchase of machinery, payment of salaries, wages, purchase of raw material, sale of goods, etc. all are examples of economic events.
Economic events can be classified as external events and internal events. If a transaction occurs between an outsider and the organization it is termed as an external event like purchases made from suppliers, sales made to customers, etc. When a transaction occurs internally i.e. from one department to another or within the organization then it is termed as an internal event like a supply of raw material to the other department. From the above definitions, it can be inferred that in accounting only transactions of financial nature are recorded.
Financial transactions are those transactions that involve the flow of cash. Accounting is popularly regarded as a communication link between the business and its various users or language of the business. This is because accounting provides important and vital information to its external as well as internal users.
Characteristics of Accounting
Given below are the various characteristics of accounting that can be derived from the meaning of accounting.
Financial Nature Transactions: Accounting is the process of identifying and recording the events and transactions of financial character. Financial nature transactions are those transactions that can be measured in terms of money or which involve a flow of cash. There may be events that are not financial in nature but are significant for a business. For example, honesty and dedication of an employee is an important factor that cannot be recorded in the books. So, accounting records only financial nature transactions and events. Thus, transactions of non-financial nature are not recorded even if they have a substantial effect on the business.
Art also as Science: Art may be a method of achieving the planned goals. Accounting, in reference to art, maybe a process, of identifying, recording, classifying, and summarising financial transactions with the assistance of which a business is able to do its desired goals. It helps in knowing the profitability and financial status of a business. On the other hand, science is an organized and systemized body of knowledge based on some basic principles. In a similar sense, accounting is also like science as it is based on certain basic accounting principles and standards.
Measurement in terms of Money: In accounting, all the business transactions are recorded in terms of a standard unit i.e. money. this suggests that the transactions which can’t be measured in terms of cash won’t be recorded within the books albeit they need considerable effects on the earnings of a business.
Recording: Accounting may be a process of recording business transactions within the books of accounts. All the financial transactions are first recorded in the Journal or in case of bulky transactions recording is made in various subsidiary books such as Cash Book (a book for recording cash transactions), Purchase Book (a book for recording transactions associated with credit purchases), Purchase Return Book (a book for recording transactions associated with the return of credit purchases), etc and Journal Proper (transactions which cannot be recorded in any above books).
Classification: Transactions of comparable nature are classified into different categories consistent with their nature. This means transactions of comparable nature are collected and recorded at one place that’s within the ledger book. For example, all the transactions related to sales are recorded in the Sales Account.
Summarisation: In accounting, financial data is presented in such a manner that it can be easily understood and utilized by its various users such as management, investors, creditors, etc. To fulfill this, Trial Balance, Trading and Profit and Loss Account, Statement of Profit or Loss (in case of companies), and Balance Sheet are prepared. All these statements help the users for an easy understanding of the financial data of a business.
Analysis and Interpretation of Results: The results of a business are interpreted and presented in such how that the users of monetary statements can easily realize the performance of the business in terms of profitability and solvency. It also helps them in assessing the financial status of the business.
Communication: within the last, accounting helps in communicating the financial results of a business to its various interested parties who can use the knowledge as per their distinctive needs.
Role of Accounting
The role of accounting has changed over the amount of your time. In the modern world, the role of accounting is not only limited to record financial transactions but also to provide information to the management so that it can be used as a basic framework for decision making, providing relevant information to various users, and assist in both short-run and long-run planning. The role of accounting within the times is given below.
Provides assistance to management: Management uses accounting information for short-term and long-term planning of business activities, to predict the future conditions, prepare budgets and various control measures.
Helps within the comparative study: within the times, accounting information helps us to understand the performance of the business by comparing the present year’s profit thereupon of the previous years and also with other firms in the same industry.
Substitute of memory: In the modern world, every business involves a large number of transactions and it is beyond human capability to memorize each and every transaction. Hence, it’s necessary to record transactions within the books of
accounts.
Information to end-users: Accounting plays an important role in recording, summarising, and providing relevant and reliable information to its users, in the form of financial data that helps in decision making.
Branches of Accounting
In modern days, the scope of accounting is not confined only to the ascertainment of profits or losses of a business during a particular accounting period. Rather, its scope has widened to other areas as well such as providing useful information to the management which helps them in decision making and drafting their future plans. So, in order to fulfill the various requirements of management, accounting can be classified into different branches. These are as follows:
Financial Accounting: it’s mainly concerned with identifying the transactions of monetary nature and their recording within the books, classifying, summarising, and communicating the business results. The main focus of this branch of accounting is to determine the profit or loss of a business by preparing a Trading and Profit and Loss Account. This also helps in assessing the financial position at the top of an accounting period by preparing the record. It also provides useful information to the management and to various other parties interested in the business. Financial accounting starts with a recording of business transactions in the books and ends with preparing the financial statements of the business.
Cost Accounting: It is another branch of accounting that is concerned with ascertaining the cost of production and its various elements. It is a process of classifying, recording, and ascertaining costs that provide relevant information for controlling the costs in the future and removing inefficiencies from the production process.
Management Accounting: This branch of accounting helps in presenting the financial data and results in such an easy manner so that vital and useful information can be easily and clearly available to the management. Management uses this information for drafting their future plans and their decision-making. In other words, it can be said that management accounting is a process of accounting under which management uses the information provided by financial and cost accounting for drafting future policies, controlling, organizing, and decision-making process.
Tax Accounting: This branch of accounting is a technique of accounting that is used for tax purposes. Tax accounting helps in handling the tax problems with a business-like computation of tax liabilities, filing tax returns, etc.
Social Responsibility Accounting: This is one of the important branches of accounting that studies the effects of business decisions on society. It is basically concerned with analyzing and interpreting the contribution of business to society. A business can contribute to society by generating employment, carrying out business without adversely affecting the environment, making customer-friendly products, etc.
Accounting Process or Phases of Accounting
Phases of accounting are as follows:-
Identifying financial transactions: First of all, transactions that are of financial nature i.e. transactions that can be measured in terms of money, are to be identified.
Recording financial transactions: In the next step, financial nature transactions are recorded in the books of accounts. Thus, transactions of financial nature are recorded in Journal.
Classifying financial transactions: Accounting transactions once recorded are classified by collecting similar transactions and posting them to Ledger i.e. book or account which records transactions of similar nature. For example, all the transactions associated with Sales are recorded under one account i.e. Sales Account.
Summarising: Accounting transactions are recorded, classified, and summarised in a way that can be useful for the users of accounting information. Thus, to make information useful, Trial Balance, Trading Account, Profit and Loss Account or Statement of Profit or Loss (in case of Companies) and Balance Sheet are prepared. All these statements help the users for an easy understanding of the financial data of a business.
Analysis and Interpretation of Results: Results from Financial Statements are analyzed and interpreted in a meaningful manner. Such that, those are often employed by the users of monetary information so as to assess the financial performance of the business.
Communication: Finally, the results of financial statements are communicated to the various interested parties who can use the information as per their distinctive needs.
Process of Accounting or Phases of Accounting can also be termed as Functions of Accounting or Accounting Cycle.
Objectives of Accounting
The following are the varied objectives or needs of accounting.
Recording Business Transactions Systematically: Accounting aims at recording a huge number of business transactions in the books of accounts in a systematic and organized manner. This systematic record of transactions helps in eliminating the chances of errors and frauds in the business that can take place while carrying out business activities.
Determining Profit or Loss: Every business is curious about knowing its net leads in terms of profits or losses for a specific accounting period. It is ascertained by preparing the income statements for an accounting period. Income statements include Trading Account and Profit and Loss Account. These statements record various items of revenues and expenses of the business. The difference between revenues and expenses is considered profit or loss during the year.
Assessment of Financial Position: Determining only the profits or losses from the business activities is not enough. It is also very important for a business to know about its financial position i.e. strengths and weaknesses of the business. This can be easily assessed by preparing a Balance Sheet at the end of an accounting period. A Balance Sheet is a statement showing various assets and liabilities of a business prepared for a particular accounting period.
Assistance to Management: One of the important objectives of accounting is to assist the management by providing them with vital and relevant information. Management uses this information for their effective decision making, formulating
plans, efficient control of business activities, etc.
Assessment of Progress of Business: Accounting helps in comparing the results of two or more periods. This successively helps in assessing the trend of growth and progress of the business.
Detection and Prevention of Errors and Frauds: there’s always an opportunity for errors and frauds within the business while completing its activities. The chances of their occurrence are minimized to a great extent by maintaining a systematic record of various business transactions.
Communicating Accounting Information: a crucial step within the accounting process is to speak the financial and accounting information to its various users including both internal and external users. This assists the users to know and interpret the data in a meaningful and appropriate manner with no ambiguity.
Functions of Accounting
Record of Transactions: Accounting provides a systematic record of the financial transactions of a business. This is because the records so maintained follow a well-developed system of principles and conventions which render uniformity and authenticity to them. For example, Furniture was purchased for cash. This is a financial transaction because here the exchange of an asset (i.e. Furniture) is taking place in lieu of cash. Hence, this will be recorded in the books of accounts and will provide evidence of the purchase.
Ascertaining the results of the business: To ascertain how well the business is doing we prepare certain financial statements. They are called statements because they are prepared for a certain period which is usually a year. It is important to prepare them because they provide conclusive evidence that a business is doing well. We prepare the following as our financial statements:
- Profit and Loss Account: It is the income statement of the business and tells about whether a profit or loss has been incurred during the accounting year.
- Balance Sheet: As we know, a business owns certain items and also borrows funds from outsiders. The position of these assets (i.e. owned by the business) and liabilities (i.e. owes to outsiders) is determined by the balance sheet.
Compliance with the law: Accounting provides the desired record needed to pay for indirect and direct taxes as per the law. A well-maintained record is accepted by the authorities without a dispute and ensures compliance with the law. For e.g.: An income tax return (i.e. statement declaring the revenues or incomes) can be prepared only when all transactions generating the revenues have been recorded as and when they have occurred.
Providing information to the users: Accounting provides the desired information to the users like shareholders, government, employees, etc.
Helps with the Managerial Decisions: All important decisions related to the business are taken by the managers just like parents make decisions for their kids when they are small. These decisions are taken after deliberation and are supported by the information provided through accounting. For example, the decision to increase the price of goods being sold will depend on the previous year’s revenue that we want to increase.
Benefits of Accounting
Given below are the main benefits of accounting.
Financial Results of Business: the most advantage of accounting is that it helps in determining internet results of a business in terms of profits or losses and divulges the financial status of the business at the top of an accounting period.
Organized and Systematic Records: It is beyond the human capacity to memorize a large number of business transactions. Accounting helps in recording such a large number of transactions in a well-organized manner which minimizes the probability of erroneous and faulty results.
Assistance to Management: Accounting helps the management in effective deciding, efficient control on cash management policies, preparing budget and forecasting, etc. by providing them with useful information in an organized
manner. Information that is provided by accounting helps the management in planning, controlling, and decision making.
Provides Comparative Study: Accounting helps in maintaining the financial data of a business in a systematic manner for each of the years. This enables the comparison of business performance of one year with another year and finding the reasons for the deviation between the two.
Determining the Tax Liability: a scientific record of business activities helps in ascertaining the tax liabilities of a business. Acts as Evidence: In case of disputes, a systematic record of business transactions can be produced as evidence in the court of law.
Helps in Selling the Business: just in case an individual decides to sell his/her business, then properly maintained accounts help in determining the acceptable price at the time of selling off business.
Helps in Obtaining Loans: Before granting a loan to a business enterprise, the banks and financial institutions are interested in knowing the profitability and stability of a business. This information is often easily fetched by properly maintained financial statements of the business.
Drawbacks of Accounting
Although accounting has several benefits it has certain drawbacks as well which are discussed below.
Based on Personal Judgement: Even though all the business transactions entered in the books are based on proofs but still there are certain transactions that are recorded on the individual judgment of the accountants. For example, a method for valuation of stock may differ from person to person. Similarly, the method of providing depreciation can be varied. This will lead to different financial results by different people and hence the profit so ascertained cannot be considered as
accurate or exact.
Ignores Qualitative Aspects of Transaction: In accounting, only those transactions are recorded in the books which are capable of being measured in terms of money. The qualitative aspects of transactions are ignored even if they have a significant impact on the business.
Ignores Changes in Price Level: The items are recorded in the books of accounts at their historical costs. It doesn’t take into consideration the changes within the price index of the things within the market. Thus, the financial results disclosed by such financial statements fail to reveal truth financial position of the business.
Based on Accounting Concepts and Conventions: The accounts of a business are maintained by following various accounting concepts and conventions. Hence, the net results shown by the accounts are not considered reliable.
Window Dressing: Window dressing implies showing false business results as compared to actual results. The accountant may adopt a practice of showing the manipulated figures within the accounts so as to point out a far better financial position of the business. In such a situation, financial statements fail to reveal the true and actual financial position of the business.
Forecasting not Possible: Accounting is based on past events and transactions and does not take into consideration the rapid changes in the market such as changes in the demand for products, changes in the cost of raw materials, etc. Thus, it is not appropriate for making forecasting.
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Business Entity Concept
According to the business entity concept, a business may be a separate entity from its owners. This basically means personal transactions of the owners of the business are to be treated separately from the business transactions.
Money Measurement Concept
According to the money measurement concept, only the transactions that are measurable in money terms are to be recorded in the books of accounts of the business.
Revenue Recognition Concept
According to the concept of revenue recognition, revenue is to be recognized only when rewards and benefits associated with the items sold and services provided are transferred
Prudence or Conservatism Concept
The concept of Prudence states that “One shall not anticipate profit but shall always provide for all prospective losses”. This makes sure that the assets and incomes aren’t overstated,