Accounting is often called the ‘language of business’ because accounting is the means by which the financial information of business is communicated to users.
It provides reports to users about the economic activities and conditions of business. Based on information from accounting, decision-makers take actions that affect subsequent business activities.
What is Accounting?
Accounting has been defined as the process of identifying, measuring, recording and communicating economic information to permit informed judgments and economic decisions by users of the information.
Under this process, the following steps are involved.
- Identification of events and transactions with financial character i.e., economic transactions.
- Measurement of economic transactions in terms of money.
- Recording financial effects of economic transactions in order of its occurrence.
- Classifying effects of economic transactions.
- Preparing an organized statement known as trial balance.
- Summarisation of financial data is presented in reports and financial statements
Communication is the final part of the accounting process. Communication can be described as the process of preparing and distributing accounting reports to potential users of accounting information.
Role of Accounting in Business
The role of accounting in business is to provide information for managers to use in operating the business. In addition, accounting provides information to other users in assessing the economic performance and condition of the business.
Sub-fields of Accounting:
The three important sub-fields of the accounting are:
It is commonly known as Accounting. The American Institute of Certified Public Accountants defines accounting as
“an art of recording, classifying and summarizing 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.”
In financial accounting, we use the double-entry system of bookkeeping to record business transactions.
This system is based on the principle of duality, which means that every economic event has two aspects—such as effort and reward, sacrifice and benefit, source and use—that offset, or balance, each other.
All accounting systems, no matter how sophisticated, are based on the principle of duality.
In the double-entry system,
- Each transaction must be recorded with at least one debit and one credit, and
- The total amount of the debits must equal the total amount of the credits.
Remember: Total debits = Total Credits
Under financial accounting, three basic financial statements are prepared at the end of the accounting period.
- Statement of Profit and Loss
- Balance Sheet
- Statement of Cashflows
These are often called general-purpose financial statements because they provide general information for use by all external users.
They serve as a source of information about the business for the management and other interested parties.
Statement of Profit and Loss tells about the performance of the business during an accounting period. It reflects the financial results (profit or loss) of the business during the accounting period.
Balance Sheet tells about the financial position of the business at the end of the accounting period. The financial position is reflected by the assets of the entity, its liabilities or debts, and the equity of the owner.
The statement of cash flows acts as a bridge between the income statement and balance sheet by showing how money moved in and out of the business.
The group of people in a business organization who manage it on a day-to-day basis. This group is referred to in broad terms as management, which is a collective term for all those persons who have responsibilities for making judgments and decisions within an organization.
Because this group of users is so broad, and because of the vast amount of information potentially available, a new branch of accounting has developed, called management accounting, to serve the particular needs of management.
There are three important functions of management;
- Decision making
To be effective, each of these functions requires the application of communication and motivation skills. Managers require the skills to motivate those for whom they are responsible, creating a sense of teamwork.
The communication process is a vital part of creating a sense of teamwork and ensuring that all the players understand the role they play in achieving targets.
They must also be motivated to want to achieve the targets. Management accounting has a particularly important role in that process of communication and motivation.
Cost accounting is an internal reporting system for a company’s own management for decision making. Cost accounting primarily deals with the collection, analysis of relevant cost data for interpretation and presentation for various problems of management.
It assists the management of the company in the following ways;
- It provides accurate cost data.
- Accumulation and utilization of cost data for cost control so that the costs are kept at a minimum level under efficient operating conditions.
- It develops, Estimates/Budgets/Norms/Standards for management control over costs ie., control of material cost, control of lab cost and control of overheads.
- It enables the management to determine and analyze the cots sales and profit of a business and to compare the operating costs of different products, services, divisions/ departments cost centers and other units of activity in order to evaluate the operating efficiency.
- By matching of cost and revenue, it helps management to ascertain the profitability accurately even at short intervals.
- By distinguishing the fixed and variable items of costs, it helps management in decision-making such as make or buy decisions operation by manual or machines, continue or discontinue a product etc.
- It also helps management in the areas of planning, policy-making pricing, production planning, product- mix, sales-mix. plant replacement and expansion/ diversification etc., for the purpose of profit maximization.
Users of Accounting Information
The users of accounting information can be divided into two groups:
- Internal users
- External users
Internal users of accounting information include managers and employees.
- Board of Directors
- Finance Department
- Other Departments such as Production, Marketing, etc
These users are directly involved in managing and operating the business. They need answers to many questions as follows.
- How much profit is being earned?
- What products should be produced?
- What resources are available?
- What is the most efficient production process
- How much does it cost to reduce carbon emissions from the production process?
- What will be the effect of increasing or decreasing selling prices?
- How much is owing to outsiders?
- Will cash be available to pay debts as they fall due?
- What are the benefits of purchasing an asset as opposed to leasing it?
The area of accounting that provides internal users with information is called management accounting.
External users of accounting information include investors, creditors, customers, and the government. The external users can be divided into three groups:
- Government Organizations
- Non-Government Organizations
Individuals users include;
- Tax consultants
- Financial analytics
Government users include;
- Income Tax Department
- Sales Tax Department
- Custom Department
- Registrar of Companies
- Statistics Department
Non-Government users of accounting information include;
- Stock Exchange
- Share Brokers
- Trade Unions
- Chambers of Commerce
- Trade Associations
These users are not directly involved in managing and operating the business. Questions raised by external users include the following.
- Should I invest money in this business?
- Am I likely to be paid my wages?
- Will the business be able to repay money lent to it?
- What are the company’s earnings prospects?
- Is the business financially sound?
The area of accounting that provides external users with information is called financial accounting.
Objectives of Accounting:
The main objectives of accounting are;
To provide information for decision making
The primary objective of accounting is to provide useful information for decision-making to stakeholders such as owners, management, creditors, investors, etc.
Various outcomes of business activities such as costs, prices, sales volume, value under ownership, the return of investment, etc. are measured in the accounting process.
All these accounting measurements are used by stakeholders (owners, investors, creditors/bankers, etc.) in the course of business operation.
To maintain a complete and systematic record
To ensure reliability and precision for the accounting measurements, it is necessary to keep a systematic record of all financial transactions of a business enterprise which is ensured by bookkeeping.
These financial records are classified, summarized and reposted in the form of accounting measurements to the users of accounting information i.e., stakeholder.
To Ascertain the Results of above Transactions
‘Profit/loss’ is a core accounting measurement. It is measured by preparing profit and loss account for a particular period.
Various other accounting measurements such as different types of revenue expenses and revenue incomes are considered for preparing this profit and loss account.
The difference between these revenue incomes and revenue expenses is known as result of business transactions identified as profit/loss.
As this measure is used very frequently by stockholders for rational decision making, it has become the objective of accounting.
To know the financial position of the business
‘Financial position’ is another core accounting measurement. Financial position is identified by preparing a statement of ownership i.e., Assets and Owings i.e., liabilities of the business as on a certain date. This statement is popularly known as balance sheet.
Various other accounting measurements such as different types of assets and different types of liabilities as existed at a particular date are considered for preparing the balance sheet.
This statement may be used by various stakeholders for financing and investment decision.
Functions of Accounting:
Accounting performs the following functions:
Maintaining systematic records
Business transactions are properly recorded, classified under appropriate accounts and summarized into financial statements– income statement and the balance sheet.
Accounting measures the performance of the business entity and depicts its current financial position.
Accounting helps in forecasting future performance and financial position of an enterprise using past data.
Provides relevant information to the Users of accounts to aid rational decision-making.
Comparison & Evaluation
Assesses performance achieved in relation to targets and discloses information regarding accounting policies and Contingent Liabilities, which play an important role in predicting, comparing and evaluating the financial results.
Identifies weaknesses in the operational system and provides feedback regarding the effectiveness of measures to rectify such weaknesses.
Provides the necessary information to the Government, to exercise control on the entity as well as in the collection of direct and indirect tax revenues.
Qualitative characteristics of Accounting Info
The qualitative characteristics that make the information provided in financial statements useful to users. The four principal qualitative characteristics are:
It is essential that the information provided in financial statements is readily understandable by users. Users are assumed to have a reasonable knowledge of business and economic activities and accounting, and a willingness to study the information with reasonable diligence.
Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations.
The information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully what it either purports to represent or could reasonably be expected to represent.
Comparability means that users must be able to compare the financial statements of an enterprise over time to identify trends in its financial position and performance. Users must also be able to compare the financial statements of different enterprises to evaluate their relative financial position, performance, and changes in financial