Concept of Accounting:

Accounting is a means of communicating the results of business

operations to various parties interested in or connected with the
business viz., the owners, creditors, investors, banks and financial
institutions, Government and other agencies. Hence, it is rightly
called as the language of business.

Accounting is not only associated with business, but also with

everybody, who is interested in keeping an account of the monetary
transactions. Generally the term ‘accounting’ refers to financial
accounting.

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The American Institute of Certified Public Accountants has defined

accounting as “the art of recording, classifying and summarising 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”. This definition is in keeping with the enlarged
scope of accounting.

in the words of Smith and Ashburne, “Accounting is the science of

recording and classifying business transactions and events,
primarily of a financial character, and the art of making significant
summaries, analysis and interpretation of those transactions and
events and communicating the results to persons who must make
decisions or form judgement.
Attributes of Accounting:

The above definitions bring out the following as the

attributes of accounting.
1. Accounting is both an art and science:
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Analysis, interpretations and communication of financial results are

the art of accounting requiring special knowledge, experience and
judgment. As a science, accounting is governed by certain
principles, concepts, conventions and policies. But it is not an exact
science like other physical sciences; rather it is an exacting science.

2. It involves recording, classifying, and summarizing:

Recording means systematically writing down in account books the
transactions and events reasonably soon after their occurrence.

Classifying is the process of grouping of transactions or entries of

one nature at one place. This is done by opening accounts in a book
called ledger. Summarizing involves the preparation of reports and
statements from the classified data [i.e., ledger]. This involves the
preparation of final accounts.

3. It records transactions in terms of money:

This provides a common measure of recording and increases the
understanding of the state of affairs of the business.

4. It records only those transactions and events, which are

financial in character.
Non-financial events, howsoever important they may be for the
business, are not recorded in accounting.
5. It is the art of interpreting the results of operations

Main Objectives of Accounting:

From the definitions of accounting, the following may be
listed out as the main objectives of accounting:
1. To ascertain the operating results of the enterprise;

2. To reveal the financial position of the business; and

3. To enable control over the operation as well as the resources of

the business.

Functions of Accounting:
The following are the major functions of accounting:
(a) Keeping Systematic Records:

As a language of business, accounting is to report the results of most

business events. Hence, its main function is to keep a systematic
record of these events. This function embraces recording
transactions in journal and subsidiary books like cashbook, sales
book etc., posting them to ledger accounts and ultimately preparing
the financial statements [final accounts].
(b) Communicating the Results:

The second main function of accounting is to communicate the

financial facts of the enterprise to the various interested parties like
owners, investors, creditors, employees, government, and research
scholars, etc.

The purpose of this function is to enable these parties to have better

understanding of the business and take sound and realistic
economic decisions.

(c) Meeting the Legal Requirements:

Accounting aims at fulfilling the legal requirements, especially of

the tax authorities and regulators of the business. It discharges this
function in accordance with certain fundamental truths and
uniform enforcement of generally accepted accounting principles.

(d) Protecting the Properties of the Business:

Accounting helps protecting the property of the business.

(e) Planning and Controlling the Business Activities:

Accounting also helps planning future activities of an enterprise and

controlling its day-to-day operations. This function is done mainly
to promote maximum operational efficiency.

Users of Accounting Information

The progress and reputation of any business firm is built upon the
sound financial footing. There are a number of parties who are
interested in the accounting information relating to business.
Accounting is the language employed to communicate financial
information of a concern to such parties.

According to Slawin and Reynolds, “Conceptually, accounting is the

discipline that provides information on which external and internal
users of the information may base decisions that result in the
allocation of economic resources in society”. That is, users of
accounting information may be grouped into two classes, viz.,
internal users and External users.

(A) Internal Users:

Internal users of accounting information are those persons or
groups which are within the organization.

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Following are such internal users:

1. Owners:

The owners provide funds or capital for the organization. They

possess curiosity in knowing whether the business is being
conducted on sound lines or not and whether the capital is being
employed properly or not.

Owners, being businessmen, always keep an eye on the returns from

the investment. Comparing the accounts of various years helps in
getting good pieces of information. Properly kept accounts are good
proof in dispute, they determine the amount of goodwill and
facilitate in assessing various taxes.

2. Management:

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The management of the business is greatly interested in knowing
the position of the firm. The accounts are the basis; the
management can study the merits and demerits of the business
activity. Thus, the management is interested in financial accounting
to find whether the business carried on is profitable or not. The
financial accounting is the “eyes and ears of management and
facilitates in drawing future course of action, further expansion etc.”

3. Employees:

Payment of bonus depends upon the size of profit earned by the

firm. The more important point is that the workers expect regular
income for the bread. The demand for wage rise, bonus, better
working conditions etc. depend upon the profitability of the firm
and in turn depends upon financial position. For these reasons, this
group is interested in accounting.

(B) External Users:

External users are those groups or persons who are outside the
organization for whom accounting function is performed.

Following are such external users:

1. Creditors:

Creditors are the persons who supply goods on credit, or bankers or

lenders of money. It is usual that these groups are interested to
know the financial soundness before granting credit. The progress
and prosperity of the firm, to which credits are extended, are largely
watched by creditors from the point of view of security and further
credit. Profit and Loss Account and Balance Sheet are nerve centres
to know the soundness of the firm.
2. Investors:

The prospective investors, who want to invest their money in a firm,

of course wish to see the progress and prosperity of the firm, before
investing their amount, by going through the financial statements of
the firm. This is to safeguard the investment. For this, this group is
eager to go through the accounting which enables them to know the
safety of investment.

3. Government:

Government keeps a close watch on the firms which yield good

amount of profits. The state and central Governments are interested
in the financial statements to know the earnings for the purpose of
taxation. To compile national accounts the accounting is essential.

4. Consumers:

These groups are interested in getting the goods at reduced price.

Therefore, they wish to know the establishment of a proper
accounting control, which in turn will reduce the cost of production,
in turn less price to be paid by the consumers. Researchers are also
interested in accounting for interpretation.

5. Research Scholars:

Accounting information, being a mirror of the financial

performance of a business organization, is of immense value to the
research scholar who wants to make a study into the financial
operations of a particular firm.

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To make a study into the financial operations of a particular firm
the research scholar needs detailed accounting information relating
to purchases, sales, expenses, cost of materials used, current assets,
current liabilities, fixed assets, long-term liabilities and
shareholders’ funds which is available in the accounting records
maintained by the firm.

6. Financial Institutions:

Bank and financial institutions that provide loan to the business are
interested to know credit-worthiness of the business. The groups,
who lend money need accounting information to analyses a
company’s profitability, liquidity and financial position before
making a loan to the company. Further, they keep constant watch
on the operating results and financial position of the business
through accounting data.

7. Regulatory Agencies:

Various Government departments such as Company law

department, Reserve Bank of India, Registrar of Companies etc.
require information to be filed with them under law. By examining
this accounting information they ensure that concerned companies
are following the rules and regulation
Accounting Principles
Obviously, if each business organisation conveys its information in its own
way, we will have a babel of unusable financial data.
Personal systems of accounting may have worked in the days when most
companies were owned by sole proprietors or partners, but they do not
anymore, in this era of joint stock companies.
These companies have thousands of stakeholders who have invested
millions, and they need a uniform, standardised system of accounting by
which companies can be compared on the basis of their performance and
value.
Therefore, accounting principles based on certain concepts, convention,
and tradition have been evolved by accounting authorities and regulators
and are followed internationally.
These principles, which serve as the rules for accounting for financial
transactions and preparing financial statements, are known as the
“Generally Accepted Accounting Principles,” or GAAP.
The application of the principles by accountants ensures that financial
statements are both informative and reliable.
It ensures that common practices and conventions are followed, and that
the common rules and procedures are complied with. This observance of
accounting principles has helped developed a widely understood grammar
and vocabulary for recording financial statements.
However, it should be said that just as there may be variations in the usage
of a language by two people living in two continents, there may be minor
differences in the application of accounting rules and procedures
depending on the accountant.
For example, two accountants may choose two equally correct methods for
recording a particular transaction based on their own professional
judgement and knowledge.
Accounting principles are accepted as such if they are (1) objective; (2)
usable in practical situations; (3) reliable; (4) feasible (they can be applied
without incurring high costs); and (5) comprehensible to those with a basic
knowledge of finance.
Accounting principles involve both accounting concepts and accounting
conventions. Here are brief explanations.
Accounting Concepts
1. Business entity concept: A business and its owner should be
treated separately as far as their financial transactions are concerned.
2. Money measurement concept: Only business transactions
that can be expressed in terms of money are recorded in accounting,
though records of other types of transactions may be kept separately.
3. Dual aspect concept: For every credit, a corresponding debit is
made. The recording of a transaction is complete only with this dual
aspect.
4. Going concern concept: In accounting, a business is expected
to continue for a fairly long time and carry out its commitments and
obligations. This assumes that the business will not be forced to stop
functioning and liquidate its assets at “fire-sale” prices.
5. Cost concept: The fixed assets of a business are recorded on the
basis of their original cost in the first year of accounting. Subsequently,
these assets are recorded minus depreciation. No rise or fall in market
price is taken into account. The concept applies only to fixed assets.
6. Accounting year concept: Each business chooses a specific
time period to complete a cycle of the accounting process—for example,
monthly, quarterly, or annually—as per a fiscal or a calendar year.
7. Matching concept: This principle dictates that for every entry of
revenue recorded in a given accounting period, an equal expense entry
has to be recorded for correctly calculating profit or loss in a given
period.
8. Realisation concept: According to this concept, profit is
recognised only when it is earned. An advance or fee paid is not
considered a profit until the goods or services have been delivered to
the buyer.

Accounting Conventions
There are four main conventions in practice in accounting: conservatism;
consistency; full disclosure; and materiality.
Conservatism is the convention by which, when two values of a
transaction are available, the lower-value transaction is recorded. By this
convention, profit should never be overestimated, and there should always
be a provision for losses.
Consistency prescribes the use of the same accounting principles from
one period of an accounting cycle to the next, so that the same standards
are applied to calculate profit and loss.
Materiality means that all material facts should be recorded in
accounting. Accountants should record important data and leave out
insignificant information.
Full disclosure entails the revelation of all information, both favourable
and detrimental to a business enterprise, and which are of material value to
creditors and debtors.

Basic Accounting Terms

Here is a quick look at some important accounting terms.
Accounting equation: The accounting equation, the basis for the
double-entry system (see below), is written as follows:
Assets = Liabilities + Stakeholders’ equity
This means that all the assets owned by a company have been financed
from loans from creditors and from equity from investors. “Assets” here
stands for cash, account receivables, inventory, etc., that a company
possesses.
Accounting methods: Companies choose between two methods—cash
accounting or accrual accounting. Under cash basis accounting, preferred
by small businesses, all revenues and expenditures at the time when
payments are actually received or sent are recorded. Under accrual basis
accounting, income is recorded when earned and expenses are recorded
when incurred.
Account receivable: The sum of money owed by your customers after
goods or services have been delivered and/or used.
Account payable: The amount of money you owe creditors, suppliers,
etc., in return for goods and/or services they have delivered.
Accrual accounting: See “accounting methods.”
Assets (fixed and current): Current assets are assets that will be
used within one year.
For example, cash, inventory, and accounts receivable (see above). Fixed
assets (non-current) may provide benefits to a company for more than one
year—for example, land and machinery.
Balance sheet: A financial report that provides a gist of a company’s
assets and liabilities and owner’s equity at a given time.
Capital: A financial asset and its value, such as cash and goods. Working
capital is current assets minus current liabilities.
Cash accounting: See “accounting methods.”
Cash flow statement: The cash flow statement of a business shows the
balance between the amount of cash earned and the cash expenditure
incurred.
Credit and debit: A credit is an accounting entry that either increases a
liability or equity account, or decreases an asset or expense account. It is
entered on the right in an accounting entry. A debit is an accounting entry
that either increases an asset or expense account, or decreases a liability or
equity account. It is entered on the left in an accounting entry.
Double-entry bookkeeping: Under double-entry bookkeeping, every
transaction is recorded in at least two accounts—as a credit in one account
and as a debit in another.
For example, an automobile repair shop that collects Rs. 10,000 in cash
from a customer enters this amount in the revenue credit side and also in
the cash debit side. If the customer had been given credit, “account
receivable” (see above) would have been used instead of “cash.” (Also see
“single-entry bookkeeping,” below.)
Financial statement: A financial statement is a document that reveals
the financial transactions of a business or a person. The three most
important financial statements for businesses are the balance sheet, cash
flow statement, and profit and loss statement (all three listed here
alphabetically).
General ledger: A complete record of financial transactions over the
life of a company.
Journal entry: An entry in the journal that records financial transactions
in the chronological order.
Profit and loss statement (income statement): A financial
statement that summarises a company’s performance by
reviewing revenues, costs and expenses during a specific period.
Single-entry bookkeeping: Under the single-entry bookkeeping,
mainly used by small or businesses, incomes and expenses are recorded
through daily and monthly summaries of cash receipts and disbursements.
(Also see “double-entry bookkeeping,” above.)
Types of accounting: Financial accounting reports information about
a company’s performance to investors and credits. Management accounting
provides financial data to managers for business development.

Branches of Accounting
FINANCIAL ACCOUNTING

Financial Accounting is based on a systematic method of recording

transactions of any business according to the accounting principles.
It is the original form of the accounting process. The main purpose
of financial accounting is to calculate the profit or loss of a
business during a period and to provide an accurate picture of the
financial position of the business as on a particular date. The Trial
Balances, Profit & Loss Accounts and Balance Sheets of a company
are based on an application of financial accounting. These are used
by creditors, banks and financial institutions to assess the financial
status of the company. Further, taxation authorities are able to
calculate the tax based on these records only.

COST ACCOUNTING

Cost accounting deals with evaluating the cost of a product or

service offered. It calculates the cost by considering all factors that
contribute to the production of the output, both manufacturing and
administrative factors. The objective of cost accounting is to help
the management in fixing the prices and controlling the cost of
production. It also pin points any wastages, leakages and defects
during manufacturing and marketing processes.

MANAGEMENT ACCOUNTING

This branch of accounting provides information to management for

better administration of the business. It helps in making important
decisions and controlling of various activities of the business. The
management is able to take decisions efficiently with the help of
various Management Information Systems such as Budgets,
Projected Cash Flow and Fund Flow Statements, Variance
Analysis reports, Cost-Volume-Profit Analysis reports, Break-Even-
Point calculation, etc.