MEANING, OBJECTIVES, SCOPE AND NATURE OF ACCOUNTING

CHAPTER 01 – MEANING, OBJECTIVES, SCOPE AND NATURE OF ACCOUNTING

TOPIC 01– MEANING OF ACCOUNTING

Accounting is the systematic process or an art of recording, classifying, summarizing, analyzing and communicating all the financial transactions/information or events to the end users which are expressed in terms of money only.

TOPIC 02– CHARACTERISTICS OF ACCOUNTING

  • Accounting is an art as well as science
  • Recording of financial transcation only
  • Recording in terms of money.
  • Classifying
  • Summarising
  • Interpretation of results
  • Communicating
  1.  Accounting is an art as well as science: It’s a science because it relies on a systematic body of knowledge, principles, and rules to ensure accuracy and consistency in financial reporting.It’s an art because it requires judgment, skill, and experience in applying these principles to complex financial situations, especially in areas like estimations and disclosures.
  2. Recording of Financial Transaction: Accounting exclusively deals with transactions that have a financial impact on an organization, excluding non-financial events.
  3. Recording in terms of Money: All financial transactions are recorded and expressed in monetary units, providing a common measure for comparison and analysis.
  4. Classifying: Similar transactions are grouped together into specific accounts (e.g., sales, expenses, assets) to simplify analysis and reporting.
  5. Summarising: Similar transactions are grouped together into specific accounts (e.g., sales, expenses, assets) to simplify analysis and reporting.
  6. Interpretation of the results: Beyond just presenting numbers, accounting involves analyzing and interpreting these financial statements to understand trends, assess  performance, and identify areas for improvement.
  7. Communicating: Finally, the interpreted financial information is communicated to various stakeholders (e.g., management, investors, creditors, government) to aid their decision-making processes.

 TOPIC 03– ACCOUNTING CYCLE

The accounting cycle is a systematic, sequential series of steps that accountants follow to identify, record, process, and report the financial transactions of a business during a specific accounting period.

TOPIC 04– OBJECTIVES OF ACCOUNTING

  • KEEP SYSTEMATIC RECORD OF BUSINESS TRANSACTION
  • CALCULATE PROFIT & LOSS
  • KNOW THE EXACT REASONS LEADING TO NET PROFIT OR LOSS
  • ASCERTAIN THE FINANCIAL POSITION OF THE BUSINESS
  • ASCERTAIN PROGRESS OF BUSINESS FROM YEAR TO YEAR
  • PREVENT & DETECT ERRORS AND FRAUDS
  • PROVIDE INFORMATIONS TO VARIOUS PARTIES

 

  1. KEEP SYSTEMATIC RECORD OF BUSINESS TRANSACTIONS: To accurately and chronologically record every financial event that affects the business. This ensures that a complete and reliable history of all transactions is available, reducing reliance on memory and preventing omissions.
  2. TO CALCULATE PROFIT & LOSS: To determine the financial performance of the business over a specific accounting period. This involves matching revenues earned with expenses incurred to calculate the net profit or loss.
  3. KNOW THE EXCAT REASONS LEADING TO NET PROFIT OR LOSS: To provide data that can be analyzed to evaluate how efficiently a business is using its resources and managing its costs. Helps management identify areas for improvement, reduce waste, and enhance overall productivity.
  4. ASCERTAIN THE FINANCIAL POSITION OF THE BUSINESS: To present a clear picture of the business’s financial health at a specific point in time. This is done through the Balance Sheet, which lists assets ,liabilities, and owner’s equity.
  5. ASCERTAIN THE PROGRESS OF BUSINESS YEAR TO YEAR: To provide relevant, reliable, and timely financial information that helps various users make informed economic decisions.
  6. PREVENT AND DETECT ERRORS AND FRAUDS: To establish a system of internal controls and meticulous record-keeping that helps identify and prevent financial errors, misappropriation of assets, and fraudulent activities.
  7. PROVIDE INFORMATION TO VARIOUS PARTIES:
    1. For Management: To make strategic and operational decisions
    2. For Investors: To decide whether to buy, sell, or hold investments.
    3. For Creditors/Lenders: To assess creditworthiness and decide whether to grant loans.
    4. For Government/Regulators: To formulate policies, collect taxes, and ensure compliance.

TOPIC 05– FUNCTIONS OF ACCOUNTING

  • Maintaining complete & Systematic Records
  • Preparation of Financial Statement
  • Communicating financial results to various Parties
  • Protecting the Assets of Business
  • Providing Assistance to Management
  • Trusteeship
  • Compliance of legal Needs
  • Fixing Responsibility
  1. Maintaining complete & systematic Records: The practice of meticulously documenting all financial transactions and events of a business in an organized and comprehensive manner. This involves following accounting principles, rules and accounting standards.
  2. Preparation of Financial Statements: The classified data from the ledger is then summarized in a meaningful and understandable form for users. This summarization typically involves preparing:
    1. Profit and Loss Account (Income Statement): Prepared to ascertain the net profit or net loss of the business for a specific accounting period.
    2. Balance Sheet: A statement that shows the financial position (assets, liabilities, and capital) of the business on a specific date.
  3. Communicating financial Results to various parties: This function is to communicate the analyzed and interpreted financial information to various interested users.
    • These users can be internal (management) or external (owners, investors, creditors, government, employees, etc.) who rely on this information for their respective decisions. This is done through various Reports and the financial statements themselves.
  4. Protecting the Assets of Business: Another function of accounting is to maintain proper records of various assets such as Cash in hand, bank balance, inventory, debtors etc. It enables the management to keep proper control over them.
  5. Providing Assistance to Management: By providing timely information, accounting assists the management in the task of planning, controlling, and decision
  6. Trusteeship: The management is expected to act as trustee of the Company’s funds and the accounting assists them to control the resources properly.
  7. Compliance of Legal Needs: Businesses are subject to various legal and regulatory requirements, including tax laws (e.g., income tax, GST), company acts, and accounting standards (e.g., GAAP, IFRS).
    • Accounting ensures that all financial reports comply with these regulations, helping to avoid legal issues, penalties, and building trust with authorities and the public.
  8. Fixing Responsibility: Another function of accounting is to determine the profitability of each department of an enterprise. It facilitates the fixing of responsibility of each department head.

TOPIC 06– BOOK KEEPING, ACCOUNTING & ACCOUNTANCY DIFFERENCE

Book Keeping: Bookkeeping is the foundational process of recording, classifying, and organizing the financial transactions of a business or individual. It’s the systematic documentation of every financial event, such as sales, purchases, payments, and receipts.

Accounting: While bookkeeping is the recording aspect, accounting is a much broader and more comprehensive discipline that encompasses the entire process of identifying, measuring, recording, classifying, summarizing, analyzing, interpreting, and communicating financial information of an economic entity. Accounting starts where book keeping ends.

Accountancy: While often used interchangeably with “accounting,” the term “accountancy” typically refers to the profession or the body of knowledge and principles that govern accounting practices.

TOPIC 07– Distinction between Book keeping & Accounting

Basis Bookkeeping Accounting
Scope Limited; focuses on recording daily transactions. Broad; encompasses recording, classifying, summarizing, analyzing, interpreting, and communicating financial information.
Stage The first stage of the accounting process. The second stage; starts where bookkeeping ends.
Objective To systematically record all financial transactions to maintain accurate and up-to-date records. To ascertain financial performance and financial position, and provide information for decision-making.
Nature of Job Clerical and routine; focuses on data entry and record maintenance. Analytical and interpretive; involves preparing reports, analyzing trends, and providing financial advice.
Who Performs Bookkeeper Accountant
Knowledge Level Requires basic knowledge of accounting principles and record-keeping rules. Requires advanced knowledge of accounting principles, standards (GAAP/IFRS), financial analysis, and tax laws.
Analytical Job Minimal; primarily focused on accuracy of recording. High; involves in-depth analysis of financial data to derive insights and support strategic decisions.

 

TOPIC 08–Distinction between Accounting & Accountancy

Basis Accounting Accountancy
Meaning The process of identifying, measuring, recording, classifying, summarizing, analyzing, interpreting, and communicating financial information of an economic entity. The profession or the systematic body of knowledge that governs accounting practices. It’s the field of study, the discipline, and the set of principles, standards, and theories that accounting adheres to.
Scope Narrower, practical focus. Broader, theoretical & professional focus
Relation It depends on Book keeping. It depends both on Book keeping & Accounting.
Function To generate financial reports that reflect the financial performance and position of a business. It provides data for decision-making. To establish and evolve the principles, standards, and practices that ensure financial information is reliable, relevant, and comparable.

 

TOPIC 09–Scope or Branches of Accounting

 The field of accounting is incredibly diverse, offering a wide range of specializations and career paths. These “scopes” or “branches” cater to different needs of businesses, individuals, and organizations. Here are the main branches of accounting:

  1. FINANCIAL ACCOUNTING
  2. COST ACCOUNTING
  3. MANAGEMENT ACCOUNTING
  4. TAX ACCOUNTING
  5. SOCIAL RESPONSIBILITY ACCOUNTING
  • Financial Accounting: This is perhaps the most well-known branch. It focuses on preparing financial statements for external users like investors, creditors, government agencies, and the general public.
    • To provide a fair and transparent view of an organization’s financial performance and financial position over a specific period. It adheres strictly to generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS) for consistency and comparability.
  • Cost Accounting: Often considered a subset of managerial accounting, cost accounting specifically deals with the recording, analyzing, and reporting of costs associated with producing goods or services.
    • To help management control costs, set prices effectively, and make decisions about production efficiency, inventory valuation, and profitability of specific products or services. It delves into direct costs and indirect costs.
  • Management Accounting: This branch focuses on providing financial and non-financial information to internal users (management) within an organization. To assist management in planning, controlling, and decision-making. Unlike financial accounting, it’s not bound by GAAP/IFRS and can be tailored to the specific needs of management. It involves budgeting, forecasting, cost analysis, performance evaluation, and strategic planning.
  • Tax Accounting: This branch deals with tax laws and regulations. To prepare tax returns for individuals and businesses, ensure compliance with tax authorities, and provide tax planning advice to minimize tax liabilities legally.
  • Social Responsibility Accounting: Also known as Social Accounting, Corporate Social Reporting, or Sustainability Accounting is a branch of accounting that focuses on identifying, measuring, analyzing, and reporting an organization’s social and environmental performance, alongside its traditional financial performance.

 In essence, it goes beyond the monetary aspects of a business to assess and communicate its impact on society and the environment. It acknowledges that businesses are not just economic entities but also have significant social and environmental footprints.

TOPIC 10–Nature of Accounting

  1. Economic Events: Accounting is fundamentally driven by economic events. These are the occurrences that affect the financial position of a business and can be measured in monetary terms. The very purpose of accounting is to capture, classify, and summarize these events to provide a clear financial picture.
  2. Identification, Measurement, Recording & Communication:
      • Identifying: Recognizing economic events and transactions that can be measured in monetary terms. This involves looking for proof like bills and receipts.
      • Measuring: Assigning monetary values to identified transactions. If something cannot be expressed in monetary terms, it generally isn’t recorded in accounting.
      • Recording: Systematically writing down financial transactions in books like journals (original entry) and ledgers (classified entries).
      • Communication: The recorded events are communicated to management and other internal and external users regularly through accounting reports.
  3. Organisation: Accounting treats the business as a separate entity from its owners. This means that only the economic events related to the business itself are recorded in its books, not the personal transactions of the owners. This concept is fundamental to accurately portraying the financial health of the organization.
  4. Interested Users of Information: Accounting is an information system designed to serve the diverse needs of various users, both internal and external to the organization. The way accounting information is presented and the level of detail vary depending on the user group.

 

TOPIC 11–Users/Parties Interested in Accounting Information

Accounting information is used by various groups of people who have contact with the business enterprise. They use accounting information in order to satisy some of their varied needs for information.

These users may be classified into two groups:

  • INTERNAL USERS
  • EXTERNAL USERS
  1. Internal users: These users have direct access to detailed financial information and often require tailored reports that go beyond the summarized financial statements prepared for external parties. The type of accounting that primarily serves internal users is called managerial accounting or cost accounting.
    • OWNERS
    • MANAGEMENT
  2. External users: An external user in accounting refers to any individual or group outside the business entity who uses the financial or accounting information of that company to make informed decisions.
    • POTENTIAL INVESTORS
    • SHORT-TERM CREDITORS
    • LONG-TERM CREDITORS
    • EMPLOYEES
    • TAX AUTHORITIES
    • & THEIR AGENCIES
    • SOCIAL RESPONSIBILITY GROUPS
    • PUBLIC
    • COMPETITORS

 

TOPIC 12–Advantages of Uses of Accounting

      • Helpful in Planning: Accounting information helps in allocating resources efficiently by identifying areas of high expenditure or underperforming segments. Historical data forms the basis for creating realistic budgets, allowing businesses to plan for future revenues and expenses and monitor deviations.
      • Helpful in decision making: Historical financial data helps in identifying trends, evaluating past performance, and forecasting future outcomes, which is crucial for strategic planning and setting realistic goals.
      • Helpful in Controlling: Management would like to see that the cost incurred is reasonable & that no department is overspending. Helpful in Management of Business: Management needs a lot of information for the efficient running of the business. All such information is provided by the accounting which helps the management in the following.
  2. Provides Complete & Systematic Records: Accounting provides a structured way to record all financial transactions. This systematic approach ensures that every penny is accounted for, leaving no room for guesswork. It eliminates the need to rely on memory for complex financial details, providing a reliable and permanent record.
  3. Information Regarding Profit & Loss: The Profit & Loss Account prepared at the end of each accounting period discloses the net profit earned or loss suffered during that period. The information regarding profit is of great use to the owners and various interested parties.
  4. Information Regarding Financial Position: Accounting reports the financial position of business by preparing a balance at the end of each accounting period. The position of assets and their value on the one hand and liability and capital on the other hand.
  5. Enable Comparative Study: By keeping a systematic record accounting help the owners to compare one year’s costs, expenses, sales and profit etc, with those of the year.
  6. Helpful in Assessment of Tax Liability: Properly mentioned record will be of great help when the firm is assessed to income Tax or GST. Such records when audited are trusted by the taxation authorities.
  7. Evidence in Legal Matters: Properly mentioned accounts supported by authenticated documents are accepted by the courts as a firm evidence.
  8. Facilities Sale of Business: If a business entity is been sold, the accounting information can be utilised to determine the proper purchase price.
  9. Helpful in Raising Loans: Accounting information is of great help while raising loans from banks or other financial institutions.
  10. Helpful in Partnership Accounts: Accounting records provide all the information needed at the time of admission of a partner, retirement or death of a partner & dissolution of the firm.
  11. Helpful in Prevention & Detection of Errors & Frauds: Accounting systems incorporate internal controls that help detect and prevent errors, irregularities, and fraudulent activities by ensuring proper authorization, segregation of duties, and reconciliation.

The systematic recording provides a clear audit trail, making it easier for internal and external auditors to verify transactions and identify discrepancies.

 

TOPIC 13–Limitations of Accounting

  1. Influenced by personal Judgements: Accounting often involves estimations and subjective judgments. Examples include estimating the useful life of an asset for depreciation, calculating provisions for doubtful debts, or valuing inventory. These estimates are based on the accountant’s judgment and assumptions about future events, which can introduce personal bias and affect the accuracy of financial statements.
  2. Based on Accounting Concepts & Conventions: Accounts are prepared on the basis of the number of accounting concepts & conventions. Hence, the profitability and the financial position disclosed may not be realistic. Example, fixed assets are shown in the balance sheet according to their cost & not at their market value. The values realised on their sale may be more than or less than the values stated in the balance sheet.
  3. Incomplete Information: While accounting data shows what happened e.g., a decline in profit, it doesn’t necessarily explain why it happened. For instance, financial statements won’t tell you if a profit drop was due to poor leadership, ineffective marketing, or increased competition. Deeper analysis and additional information are required to understand the underlying causes.
  4. Omission of Qualitative Information: Accounting primarily records transactions that can be expressed in monetary terms. This means it often overlooks crucial non-financial factors that significantly impact a business’s success, such as employee morale, customer satisfaction, brand reputation, management quality, and innovation. These qualitative elements are vital but are not directly reflected in financial statements.
  5. Based on Historical Costs: Most accounting systems record assets at their historical cost. This approach doesn’t account for changes in the purchasing power of money due to inflation or deflation, nor does it reflect the current market value of assets. This can lead to a distorted view of a company’s true financial position, especially for assets acquired many years ago.
  6. Affected by Window Dressing: There’s a possibility of “window dressing,” where management manipulates financial records to present a more favorable picture of the company’s financial performance than is truly the case. This can involve adopting specific accounting policies or making biased estimations to inflate profits or hide liabilities, misleading stakeholders.
  7. Unsuitable for Forecasting: Accounting is largely backward-looking. It records past transactions and events, providing insights into historical performance. However, it does not inherently predict future events, market changes, or economic trends. While financial data can be used for forecasting, accounting itself doesn’t offer direct foresight into a company’s future prospects.

 

TOPIC 14–Qualitative Attributes of Accounting Information

In accounting, qualitative attributes are the qualities that make financial information useful to users for decision-making. These characteristics are fundamental to financial reporting and are outlined by major accounting standard-setters like the International Accounting Standards Board (IASB).

  1. Reliability
  2. Relevance
  3. Understandability
  4. Comparability
  5. Faithful Presentation
  • Reliability: In accounting, “reliability” is a crucial qualitative attribute of financial information that ensures its trustworthiness and dependability for users. While the term “reliability” itself has evolved in conceptual frameworks with the IASB and FASB, the underlying principles of reliability remain absolutely essential.
  • Relevance: Information is relevant if it is capable of making a difference in the decisions made by users. The information can be used to predict future outcomes. For example, current sales figures might help predict future revenue. The information provides feedback on past evaluations. It confirms or changes previous expectations.

For instance, actual profits confirming or refuting a prior forecast. Relevance is also affected by materiality. Information is material if its omission or misstatement could influence the economic decisions of users. What is material depends on the size and nature of the item.

  • Understandability: Information is understandable if it is classified, characterized, and presented clearly and concisely. It assumes users have a reasonable knowledge of business and economic activities and are willing to study the information with reasonable diligence.
  • Comparability: Information is comparable if it enables users to identify and understand similarities in, and differences among, items. It allows users to compare a company’s financial performance over time (consistency) and with other companies.
  • Consistency: Refers to the use of the same accounting policies and procedures from period to period within a single entity, or among different entities.
  • Faithful Presentation: Financial information must accurately represent the economic phenomena it purpose to represent. It means the numbers and descriptions match what actually existed or happened.

TOPIC 14–Role of Accounting

  1. Role of a Language: Accounting is viewed as a language of business because it prepares reports & statements which communicate information regarding the business enterprise.
  2. Role of Historical Record: Accounting is viewed as chronological record of all financial transactions in the books of accounts according to specific rules.
  3. Role of Determining the Net Profit: It is also regarded as a means of determining the true profit or loss of a business enterprise.
  4. Role of Determining the Financial Position: It is also regarded as a means of showing the financial position of the business by preparation of Balance Sheet
  5. Role of Information System: Accounting is now regarded as an information system because it is capable of providing the kind of information which managers and other interested parties require for taking appropriate decisions.
  6. Role of Service Provider: Accounting is regarded as a service activity because it provides quantitative financial information which is helpful to the users in different ways.

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