Introduction
Accounting is aptly called the
language of business. This designation is applied to accounting because it is
the method of communicating business information. The basic function of any
language is to serve as a means of communication. Accounting duly serves this
function. The task of learning accounting is essentially the same as the task
of learning a new language. But the acceleration of change in business
organisation has contributed to increase the complexities in this language.
Like other languages, it is undergoing continuous change in an attempt to
discover better means of communications. To enable the accounting language to
convey the same meaning to all stakeholders, it should be made standard. To
make it a standard language certain accounting principles, concepts and
standards have been developed over a period of time. This lesson dwells upon
the different dimensions of accounting, accounting concepts, accounting
principles and the accounting standards.
Accounting has been defined by
the American accounting association committee as:
“the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information”. This may be considered as a good definition because of its focus on accounting as an aid to decision making.
The American institute of
certified and public accountants committee on terminology defined accounting
as:
“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 interpreting the results thereof”. of all definitions available, this is the most acceptable one because it encompasses all the functions which the modern accounting system performs.
Another popular definition on
accounting was given by American accounting principles board in 1970, which
defined it as:
“accounting is a service society. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is useful in making economic decision, in making reasoned choices among alternative courses of action”.
This is a very relevant
definition in a present context of business units facing the situation of
selecting the best among the various alternatives available. The special
feature of this definition is that it has designated accounting as a service
activity.
Evolution Of Accounting
For the most part, early accounting
dealt only with limited aspects of the financial operations of private or
governmental enterprises. Complete accounting system for an enterprise which
came to be called as “double entry system” was developed in Italy in the 15th
century. The first known description of the system was published there in 1494
by a Franciscan monk by the name Luca Pacioli.
The expanded business operations
initiated by the industrial revolution required increasingly large amounts of
money which in turn resulted in the development of the corporation form of
organizations. As corporations became larger, an increasing number of
individuals and institutions looked to accountants to provide economic
information about these enterprises. For e.g., Prospective investors and
creditors sought information about a corporation’s financial status. Government
agencies required financial information for purposes of taxation and
regulation. Thus, accounting began to expand its function of meeting the needs
of relatively few owners to a public role of meeting the needs of a variety of
interested parties.
Book Keeping And Accounting
Book-keeping is that branch of
knowledge which tells us how to keep a record of business transactions. It is
considered as an art of recording systematically the various types of
transactions that occur in a business concern in the books of accounts.
According to Spicer and Pegle, “book-keeping is the art of recording all money
transactions, so that the financial position of an undertaking and its
relationship to both its proprietors and to outside persons can be readily
ascertained”. Accounting is a term which refers to a systematic study of the
principles and methods of keeping accounts. Accountancy and book-keeping are
related terms; the former relates to the theoretical study and the latter
refers to the practical work.
Scope and Functions of Accounting
Individuals engaged in such areas
of business as finance, production, marketing, personnel and general management
need not be expert accountants but their effectiveness is no doubt increased if
they have a good understanding of accounting principles. Everyone engaged in
business activity, from the bottom level employee to the chief executive and
owner, comes into contact with accounting. The higher the level of authority
and responsibility, the greater is the need for an understanding of accounting
concepts and terminology.
A study conducted in united
states revealed that the most common background of chief executive officers in
united states corporations was finance and accounting. Interviews with several
corporate executives drew the following comments:
“my training in accounting and auditing practice has been extremely valuable to me throughout”. “a knowledge of accounting carried with it understanding of the establishment and maintenance of sound financial controls- is an area which is absolutely essential to a chief executive officer”.
Though accounting is generally
associated with business, it is not only business people who make use of
accounting but also many individuals in non-business areas that make use of
accounting data and need to understand accounting principles and terminology.
For e.g. An engineer responsible for selecting the most desirable solution to a
technical manufacturing problem may consider cost accounting data to be the
decisive factor. Lawyers want accounting data in tax cases and damages from
breach of contract. Governmental agencies rely on an accounting data in
evaluating the efficiency of government operations and for approving the feasibility
of proposed taxation and spending programs. Accounting thus plays an important
role in modern society and broadly speaking all citizens are affected by
accounting in some way or the other.
Keeping Systematic Records:
This is the fundamental function
of accounting. The transactions of the business are properly recorded,
classified and summarised into final financial statements – income statement
and the balance sheet.
Protecting the Business
Properties:
The second function of accounting
is to protect the properties of the business by maintaining proper record of
various assets and thus enabling the management to exercise proper control over
them.
The second function of accounting
is to protect the properties of the business by maintaining proper record of
various assets and thus enabling the management to exercise proper control over
them.
Communicating the Results:
As accounting has been designated
as the language of business, its third function is to communicate financial
information in respect of net profits, assets, liabilities, etc., to the
interested parties.
Meeting Legal Requirements:
The fourth and last function of
accounting is to devise such a system as will meet the legal requirements. The
provisions of various laws such as the companies act, income tax act, etc.,
require the submission of various statements like income tax returns, annual
accounts and so on. Accounting system aims at fulfilling this requirement of
law. It may be noted that the functions stated above are those of financial
accounting alone. The other branches of accounting, about which we are going to
see later in this lesson, have their special functions with the common
objective of assisting the management in its task of planning, control and
coordination of business activities. Of all the branches of accounting,
management accounting is the most important from the management point of view. As
accounting is the language of business, the primary aim of accounting, like any
other language, is to serve as a means of communication. Most of the world’s
work is done through organisations – groups of people who work together to
accomplish one or more objectives. In doing its work, an organisation uses
resources – men, material, money and machine and various services. To work
effectively, the people in an organisation need information about these sources
and the results achieved through using them. People outside the organisation
need similar information to make judgements about the organisation. Accounting
is the system that provides such information.
Any system has three features,
viz., input, processes and output. Accounting as a social science can be viewed
as an information system, since it has all the three features i.e., inputs (raw
data), processes (men and equipment) and outputs (reports and information).
Accounting information is composed principally of financial data about business
transactions. The mere records of transactions are of little use in making
“informed judgements and decisions”. The recorded data must be sorted and
summarised before significant analysis can be prepared. Some of the reports to
the enterprise manager and to others who need economic information may be made
frequently; other reports are issued only at longer intervals. The usefulness
of reports is often enhanced by various types of percentage and trend analyses.
The “basic raw materials” of accounting are composed of business transactions
data. Its “primary end products” are composed of various summaries, analyses
and reports.
Chart Showing Types of Information
Operating Information:
By operating information, we mean
the information which is required to conduct the day-to-day activities.
Examples of operating information are: amount of wages paid and payable to
employees, information about the stock of finished goods available for sale and
each one’s cost and selling price, information about amounts owed to and owing
by the business enterprise, information about stock of raw materials, spare
parts and accessories and so on. By far, the largest quantity of accounting
information provides the raw data (input) for financial accounting, management
accounting and cost accounting.
Financial Accounting:
Financial accounting information
is intended both for owners and managers and also for the use of individuals
and agencies external to the business. This accounting is concerned with the
recording of transactions for a business enterprise and the periodic
preparation of various reports from such records. The records may be for
general purpose or for a special purpose. A detailed account of the function of
financial accounting has been given earlier in this lesson.
Management Accounting:
Management accounting employs
both historical and estimated data in assisting management in daily operations
and in planning for future operations. It deals with specific problems that
confront enterprise managers at various organisational levels. The management
accountant is frequently concerned with identifying alternative courses of
action and then helping to select the best one. For e.g. The accountant may
help the finance manager in preparing plans for future financing or may help
the sales manager in determining the selling price to be fixed on a new product
by providing suitable data. Generally, management accounting information is
used in three important management functions: (1) control (2) co-ordination and
(3) planning. Marginal costing is an important technique of management
accounting which provides multi-dimensional information that facilitates
decision making.
Cost Accounting:
The industrial revolution in England
posed a challenge to the development of accounting as a tool of industrial
management. This necessitated the development of costing techniques as guides
to management action. Cost accounting emphasises the determination and the
control of costs. It is concerned primarily with the cost of manufacturing
processes. In addition, one of the principal functions of cost accounting is to
assemble and interpret cost data, both actual and prospective, for the use of
management in controlling current operations and in planning for the future.
Groups Interested In Accounting Information
There are several groups of
people who are interested in the accounting information relating to the
business enterprise. Following are some of them:
Shareholders:
Shareholders as owners are
interested in knowing the profitability of the business transactions and the
distribution of capital in the form of assets and liabilities. In fact,
accounting developed several centuries ago to supply information to those who had
invested their funds in business enterprise.
Management:
With the advent of joint stock
company form of organisation, the gap between ownership and management widened.
In most cases the shareholders act merely as renders of capital and the
management of the company passes into the hands of professional managers. The
accounting disclosures greatly help them in knowing about what has happened and
what should be done to improve the profitability and financial position of the
enterprise.
Potential Investors:
An individual who is planning to
make an investment in a business would like to know about its profitability and
financial position. An analysis of the financial statements would help him in
this respect.
Creditors:
As creditors have extended credit
to the company, they are much worried about the repaying capacity of the
company. For this purpose, they require its financial statements, an analysis
of which will tell about the solvency position of the company.
Government:
Any popular government has to
keep a watch on big businesses regarding the manner in which they build
business empires without regard to the interests of the community. Restricting
monopolies is something that is common even in capitalist countries. For this,
it is necessary that proper accounts are made available to the government.
Also, accounting data are required for collection of sale-tax, income-tax,
excise duty etc.
Employees:
Like creditors, employees are
interested in the financial statements in view of various profit sharing and
bonus schemes. Their interest may further increase when they hold shares of the
companies in which they are employed.
Researchers:
Researchers are interested in
interpreting the financial statements of the concern for a given objective.
Citizens:
Any citizen may be interested in
the accounting records of business enterprises including public utilities and
government companies as a voter and tax payer.
The Profession of Accounting
Accountancy can very well be
viewed as a profession with stature comparable to that of law or medicine or
engineering. The rapid development of accounting theory and techniques
especially after the late thirties of 20th century has been accompanied by an
expansion of the career opportunities in accounting and an increasing number of
professionally trained accountants. Among the factors contributing to this
growth has been the increase in number, size and complexity of business
enterprises, the imposition of new and increasingly complex taxes and other
governmental restrictions on business operations.
Coming to the nature of
accounting function, it is no doubt a service function. The chief of accounting
department holds a staff position which is quite in contra - distinction to the
roles played by production or marketing executives who hold line authority. The
role of the accountant is advisory in character. Although accounting is a staff
function performed by professionals within an organization, the ultimate
responsibility for the generation of accounting information, whether financial
or managerial, rests with management. That is why one of the top officers of
many businesses is the financial controller. The controller is the person
responsible for satisfying other managers’ demands for management accounting
information and for complying with the regulatory demands of financial
reporting. With these ends in view, the controller employs accounting
professionals in both management and financial accounting. These accounting
professionals employed in a particular business firm are said to be engaged in
private accounting. Besides these, there are also accountants who render
accounting services on a fee basis through staff accountants employed by them.
These accountants are said to be engaged in public accounting.
Specialised Accounting Fields
As in many other areas of human
activity, a number of specialised fields in accounting also have evolved
besides financial accounting. Management accounting and cost accounting are the
result of rapid technological advances and accelerated economic growth. The
most important among them are explained below:
Tax accounting covers the
preparation of tax returns and the consideration of the tax implications of
proposed business transactions or alternative courses of action. Accountants
specialising in this branch of accounting are familiar with the tax laws
affecting their employer or clients and are up to date on administrative
regulations and court decisions on tax cases.
International Accounting:
This accounting is concerned with
the special problems associated with the international trade of multinational
business organisations. Accountants specialising in this area must be familiar
with the influences that custom, law and taxation of various countries bring to
bear on international operations and accounting principles.
This branch is the newest field
of accounting and is the most difficult to describe concisely. It owes its
birth to increasing social awareness which has been particularly noticeable
over the last three decades or so. Social responsibility accounting is so
called because it not only measures the economic effects of business decisions
but also their social effects, which have previously been considered to be immeasurable.
Social responsibilities of business can no longer remain as a passive chapter
in the text books of commerce but are increasingly coming under greater
scrutiny. Social workers and people’s welfare organisations are drawing the
attention of all concerned towards the social effects of business decisions.
The management is being held responsible not only for the efficient conduct of
business as reflected by increased profitability but also for what it
contributes to social well-being and progress.
Inflation Accounting:
Inflation has now become a
world-wide phenomenon. The consequences of inflation are dire in case of
developing and underdeveloped countries. At this juncture when financial
statements or reports are based on historical costs, they would fail to reflect
the effect of changes in purchasing power or the financial position and
profitability of the firm. Thus, the utility of the accounting records, not
taking care of price level changes is seriously lost. This imposes a demand on
the accountants for adjusting financial accounting for inflation to know the
real financial position and profitability of a concern. Thus emerged a future
branch of accounting called inflation accounting or accounting for price level
changes. It is a system of accounting which regularly records all items in
financial statements at their current values.
Human resources accounting is yet
another new field of accounting which seeks to report and emphasise the
importance of human resources in a company’s earning process and total assets.
It is based on the general agreement that the only real long lasting asset
which an organisation possesses is the quality and calibre of the people
working in it. This system of accounting is concerned with, “the process of
identifying and measuring data about human resources and communicating this
information to interested parties”.
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