1.2.1 Objectives of Accounting
The objectives of accounting can be stated as follows :
1 'To maintain systematic records: Accounting is used to maintain systematic record of all financial transactions like purchast and sale of goods, cash receipts and cash payments, etc. It is also used for recording various assets and liabilities of the business,
2 To ascertain net prufit or net loss of the business: A businessnian would be interested in periodically findirig the net result of his business operations i.e., whether the business has earned profit or incurred some loss. A proper record of al1,income intf expenses helps in preparing a Pi-ofit and Loss Account and ascertain the net result of business operations during a particular period.
3 To ascertain the financial positio~l of the business: The businessman is also interested in ascertaining the financial position of his business at the end of a particular period i.e., how much it owns and how much it owes to others. He would als~ like to know what happened to his capital, whether it has increased or decreased or remained . constant. A systematic record of assets and liabilities facilitates the preparation of a position statement called Balance Sheet which provides the necessary information. '
4 To provide accounting information to interested parties: Apart from owners there are various parties who are interested in the dccounting inforniation. These are: bankers, creditors, tax authorities, prospective investors etc. ~hey'need such information to assess the profitability and the financial soundness of the business. The accounting information is communicated to them in the form of an annual report.
1.2.2 Definition and Scope.of Accounting
The subject of 'Accounting' has been defined in different ways by different authorities. So,
it is very difficult to define the subject through a single definition. However, the following
definitions would give a general understanding of the subject.
According to the American,Accounting Association "Accounting is the process of
identifying, measuring and communicating econqnic information to permit informed
judgements and decisions by users of the information". This definition stresses three aspects
viz., identifying, measuring, and communicating econoinic information.
In the words of the Committee on Terminology, appointed by the American Institute of
Certified Public Accountants, "Accounting is 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 a financial character and intelpreting the results thereof'. This is a
popular definition of accounting and it outlines fully the nature and scope of acconnting
activity.
You know a business is generally started with the proprietor's funds known as capital. The
proprietor may also borrow some funds from hanks end other agencies. These fundb are
utilised to acquir!: the assets needed for the business and also to carry out'various business
activities. In the process a number of transactions take place. The accountant.has to identify
the transactions to be recorded, measure them in terms of money, and record them in
appropriate books of account. Then he has to classify them under separate heads of account,
prepare a summary in the forrrl of Profit and Loss Account and Balance Sheet, and analyse,
interpret and communicate the results to the interested parties. This is the sum and substance
of accounting. The scope of accounting can, therefore, be outlined as follows :
1 Accounting is concenled with the transactions and events which are of a financial
character. Such transactio~is have to be identified by the accountant. He can do so with
the help of various bills and receipts.
2 Having identified the transactions, they should be measured orpxpressed in terms of
money, if not expressed already. ~ver~ transaction is recorded in books only in terms of
money and not in terms of physical quantities.
3 The transactions which are identified and measured are to be recorded in a book called
- 'Journal' or in one of its sub-divisions.
4 The recorded transactions have to be classified with a view to group transactions of
similar nature at one place. This work is done in a separate book called 'Ledger'. In the
ledger, a separate account is opened for each item so that all transactions relating to it
can be brought at one place. For example, salaries paid at different times are brought
under 'Salaries Account'.
5 The transactions which are recorded and classified will resdt in a mass of financial
data. It is, therefore, necessary to summarise such data periodically (at least once a year)
in a significant mid meaningful fonn. This is done in the form of a Profit and Loss
Account which reveals profit or loss, and a Balance Sheet which indicates the financial
position of the business.
6 The summarised results have to be analysed and interpreted with the help of statistical
tools like ratios, averages, etc., and examined critically. Later on, this data will be
communicated in the form of reports to the interested parties.
Look at Figure 1.1 and note the activities involved in accounting which starts with
identifying the transactions to be recorded and ends with communicating the results to
,owners, management and the other interested who use them for decision making.
1.2.3 Book-keeping, Accounting and Accountancy
According to G.A. Lee, the accounting system has following two stages :
i) the making of routine records, in prescribed form and according to set rules, of all
events which affect the financial state of the organisation; and
ii) the summarisation from time to time of the information contained in the records, its
presentation in a significant form to interested parties, and its interpretation as an aid tq
decision making by these parties.
Stage (i) is called Book-keeping and stage (ii) is called Accounting.
Book-keeping is thus a narrow term concerned mainly with the maintenance of the books of
account and covers the first four activities listed in the scope of accounting viz., identifying
the riansactions and events to be recorded, measuring them in terms of money, recording
them in the books of prime entry, and posting them into ledger. Accounting, on the other
hand, is concerned with summarising the recorded data, interpreting the financial results and
communicating them to all interested parties. In other words, accounting starts where bookkeeping ends. But in practice, the accountants also direct and review the work of bookkeepers and therefore the term accounting is generally used in a broader sense covering all
the accounting activities, Thus, Book-keeping is regarded as a part of Accounting.
The term 'Accountancy' refers to a systematised knowledge of accounting and is regarded
as an academic subject like economics, statistics, chemistry, etc. It explains 'why to do' and
'how to do' of various'aspects of accounting. In other words, while Accounting refers to the
actual process of preparing and presenting the accounts, Accountancy tells us why and how
to prepare the books of account and how to summarise the accounting information and
communicate it to the interested parties. Thus, Accountancy is a science (a body of
systematised knowledge) whereas Accpunting is the art of putting such knowledge into
practice.
In general usage, however, Accountancy and Accounting are used as synonyms (meaning
the same thing). But, of late, the term accounting is becoming more and more popular.
1.2.4 Parties Interested in Accounting Information
You have learnt that many people are interested in examining the financial information
provided in the form of a Profit and Loss Account and a Balance Sheet. This helps them
a) to study the present position of business,
b) to compare its present performance with that of its past years, and
c) to compare its performance with that of similar enterprises.
Now let us see who such parties are and how accounting information is useful to them.
Owners: Owners contribute capital and assume the risk of business. Naturally, they are
interested in knowing the amount of profit earned by the business and so also its financial
position. If, however, the management of the business is entrusted to paid managers, the
owners also use the accounting information to evaluate the performance of the managers.
Managers: Accounting information is of immense use to managers. It helps them to plan,
control and evaluate all business activities. They also need such information for making
various deci'sions.
Lenders: Initially the funds are provided by the owners. But, when the business requires
more funds, they are usually provided by banks and other lenders of money. Before lending ;
money they would like to know about the solvency (capacity to repay debts) of the
enterprise so as to satisfy themselves that their money will be safe and the repayments will
be made on time.
Creditors: Those who supply goods and services on credit are called creditors. Like
lenders, they too want to know about credit worthiness of the enterprise. This helps them to
determine the limits up to which credit can be granted.
Prospect Investors: A person who wants to become a partner in a firm or a person who
wants to become a shareholder of a company, would like to know how safe and rewarding
the proposed investment would be.
Tax Authorities: Tax authorities of the Government arejnterested in the financial . .'
statements so as to assess the tax . liability - of the enterprise.
Era~ployees: The e~nployees of the enterprise are also interested in knowing the state of
iffairs of the organisation in which they are working, so as to know how safe their is-+ ~terests
are in that organisation.
1.2.5 Branches of Aecouasting
Accounting as we know it today has evolved over many centuries in response to the
changing economic, social and political conditions. The econonlic development and
technological improvements have resulted in an increase in the scale of operations and the
advent of the company form of business organisation. This has made the nlalragcment
function more and more complex and increased the impoi~ance of accourlting hformatio~i.
This gave rise to special branches of accounting. These are briefly explained below.
Financial accounting: The pulpose of this branch of accounting is to keep a record of all
financial transactions so that
a) the profit earned or loss incurred by the business during an accounting period can be
worked out,
b) the financial position of the business.as at the end of the accounting period can be
ascertained, and
c) the financial information required by the inaliagement and other interested parties can
be provided.
Financial Accounting is mainly confined to the preparation of financial statements and their
communication to the interested parties.
Cost Accounting: The purpose of cost accounting is to urtllyse tlie expenditure so as to
ascertaii.; the cost of varioi~s products manufactured by the finn ant! fix the prices. It also
helps in controllir~g the costs and providi~~g necessary costing information to management
for decision ~iraking.
Management Accounting: The purpose of management accounting is to assist tlie
management in tnking rational policy decisions and to evaluate the impact of its decisio~ls
and actions. Examples of such decisions arc: pricing decisions, make or buy decisions,
capital e~~enditure'decisions, etc. This branch of accourlting is primarily concerned with
providing the necessary accounting information about funds, costs, profits, etc., to the
management which may hklp them in such decisions and also in planning and cor~trollir~g
business operations.
1.2.6 Advantages of Accouning
1 Replaces memory: Since all the financial events are recorded in the books, there is no
need to rely on memory. The books of account will serve as historial records. Any
information required at any time call be easily had from these records.
2 Provides control over assets: Accouiiting provides infomlation regclrdirig cash in hand.
cash at bank, the stock of goods, the amounts receivable.from various parties and the
amounts invested in various other assets. Information about such matters help the
owners and the management to make use of the assets in thc best possiblk way.
3 Facilitates the preparation of financial statements: With the help of information
contained in the accounting records the 1)rofit and Loss account arid the Balance Sheet
can be easily prepared. These firimcinl statements enable the businessman to know the
net result of business operations during the accounting pe~iod and the financial position
of the business as at the end of tl~e accounting period.
4 Meets the information requirements: Various i~iterested parties such as owners,
lenders, creditors, etc., get the necessary information at frequent intervals which help
them in their decision making.
5 Facilitates a eonlparnfive study: With the help of accounting information one can
compare the present perfonnance of the enterprise with that of its past and with that of
similar organisations. This enables the managelllent to draw useful conclusio~ls about
the business and lnake efforts to improve the performance.
6 Assists the management in many other ways: The accounting illformation provided
to the mallagement helps them in taking rational decisions and in platlning and
controlling all business activities.
7 Difticult to conceal fraud or thefk: It is difficult to conceal fraud, theft, etc. because of
the periodic balancing of books of account. Further, in big organisations the book- ,
keeping work is divided among many persons which minirnises the chances for
committing fraud.
8 Tax matters: The Ciovemment levies various taxes such as customs duty, excise duty,
sales tax, and income tax. Properly maintained accounting records will help in the
settlement of all tax matters with the tax authorities.
9 Ascertaining value of business: In the event of sale of a business firm, the accounting
records will help in ascertaining the correct value of business.
10 Acts as reliable evidence: Systematic record of business transactions is generally
treated by courts as good evidence in case of disputes.
1.2.7 Limitations of Accounting
The accounting information is used by various parties who form judgement about the
profitability and the financial soundness of a business on the basis of such information. It is,
therefore, necessary to know about the limitatio~~s of accounting. These are as fullows:
1 They do not record transactions and events which are not of a financial character. Hence,
they do not reveal a complete picture because facts like quality of human resources,
licences possessed, Iocational advantage, business contacts, etc. do not find any place in
books of account.
2 The data is historical in nature. The accountants adopt historical cost as the basis in
valuing and reporting all assets and liabilities. They do not reflect current values. It is
quite possible that items like land and buildings may have much more value than what is
stated in the balance sheet.
3 Facts recorded in financial statements are greatly influenced by accounting conventions
and personal judgements. Hence, they do not reveal the true picture. In many cases,
estimates may be used to deternine the value of various items. For example, debtors are
estimated in terms of collectibility, inventories are based on marketability, and fixed
assets are based on useful working life. All these estimates are materially affected by
personal judgements.
4 Data provided in the financial statements is insufficient for proper analysis and decision
!naking. It only provides information about the overall profitability of the business. No
infoimation is given about the cost and profitability of different activities.
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