ACCOUNTING
INTRODUCTION:
Accounting is a
business language. We can use this language to communicate financial
transactions and their results. Accounting is a comprehensive system to
collect, analyze, and communicate financial information.
Definition
of Accounting:
In
1941 The American Institute of Certified Public Accountant has defined
Financial Accounting as:
“The art of
recording, classifying and summarizing in a significant manner and in terms of
money, transactions and events which in part at least of a financial character
and interpreting the results thereof.”
In 1966, The American Accounting
Association (AAA) defined accounting as ‘the process of identifying, measuring and
communicating economic information to permit informed judgments and decisions
by users of information.”
Objectives and Scope of Accounting:
As an information
system, the basic objective of accounting is to provide useful information to
the interested group of users, both external and internal. The necessary
information, particularly in case of external users, is provided in the form of
financial statements, viz., profit and loss account and balance sheet. Besides
these, the management is provided with additional information from time to time
from the accounting records of business. Thus, the primary objectives of
accounting include the following:
- To keep systematic records: Accounting is done to keep systematic record of financial transactions. The primary objective of accounting is to help us collect financial data and to record it systematically to derive correct and useful results of financial statements.
- To Calculate the Profit and Loss: The owners of business are keen to have an idea about the net results of their business operations periodically, i.e. whether the business has earned profits or incurred losses. Thus, another objective of accounting is to ascertain the profit earned or loss sustained by a business during an accounting period which can be easily workout with help of record of incomes and expenses relating to the business by preparing a profit or loss account for the period.Profit represents excess of revenue (income), over expenses
4. To Depict of Financial Position:Accounting also aims at ascertaining the financial position of the business concern in the form of its assets and liabilities at the end of every accounting period. A proper record of resources owned by business organization (Assets) and claims against such resources (Liabilities) facilitates the preparation of a statement known as balance sheet position statement.
5. To fulfill compliance of Law: Business entities such as companies, trusts, and societies are being run and governed according to different legislative acts. Similarly, different taxation laws (direct indirect tax) are also applicable to every business house. Everyone has to keep and maintain different types of accounts and records as prescribed by corresponding laws of the land. Accounting helps in running a business in compliance with the law.
6. To Providing Accounting Information to its Users: The accounting information generated by the accounting process is communicated in the form of reports, statements, graphs and charts to the users who need it in different decision situations. As already stated, there are two main user groups, viz. internal users, who needs timely information on cost of sales, profitability, etc. for planning, controlling and decision-making and external users who have limited authority, ability and resources to obtain the necessary information and have to rely on financial statements (Balance Sheet, Profit and Loss account). Primarily, the external users are interested in the following:
•
Investors and potential investors-information on the risks and return on
investment;
• Unions
and employee groups-information on the stability, profitability and
distribution of wealth within the
business;
• Lenders
and financial institutions-information on the creditworthiness of the company
and its ability to repay loans and pay interest;
•
Suppliers and creditors-information on whether amounts owed will be repaid when
due, and on the continued existence of the business;
•
Customers-information on the continued existence of the business and thus the
probability of a continued supply of products, parts and after sales service;
•
Government and other regulators- information on the allocation of resources and
the compliance to regulations;
• Social
responsibility groups, such as environmental groups-information on the impact
on environment and its protection;
•
Competitors-information on the relative strengths and weaknesses of their
competition and for comparative and benchmarking purposes. Whereas the above
categories of users share in the wealth of the company,competitors require the
information mainly for strategic purposes.
Accounting Process:
Accounting cycle refers to the specific tasks involved in completing an
accounting process. The length of an accounting cycle can be monthly,
quarterly, half-yearly, or annually. It may vary from organization to
organization but the process remains the same. The following chart shows the
basic steps in an accounting cycle:
With the help of accounting process, we can
determine the profit or loss of the business on a specific date. It also helps
us analyze the past performance and plan the future courses of action.
- Collecting & analysing documents.
- Posting in journal.
- Ledger.
- Trail Balance
- Adjustment Entrie
- Adjustment Trail Balance
- Preparation of Financial Statements
- Post closing entrie
- Post closing trail balance
Qualitative
Characteristics of Accounting Information
Qualitative
characteristics are the attributes of accounting information which tend to
enhance its understandability and usefulness. In order to assess whether
accounting information is decision useful, it must possess the characteristics
of reliability, relevance, understandability and comparability.
Reliability
Reliability
means the users must be able to depend on the information. The reliability of
accounting information is determined by the degree of correspondence between
what the information conveys about the transactions or events that have
occurred, measured and displayed. A reliable information should be free from error
and bias and faithfully represents what it is meant to represent. To ensure
reliability, the information disclosed must be credible, verifiable by
independent parties use the same method of measuring, and be natural and
faithful.
Understandability
Understandability
means decision-makers must interpret accounting information in the same sense
as it is prepared and conveyed to them. The qualities that distinguish between
good and bad communication in a message are fundamental to the understandability
of the message. A message is said to be effectively communicated when it is
interpreted by the receiver of the message in the same sense in which the
sender has sent. Accountants should present the comparable information in the
most intangible manner without sacrificing relevance and reliability.
Comparability
It is not
sufficient that the financial information is relevant and reliable at a
particular time, in a particular circumstance or for a particular reporting
entity.
But it is
equally important that the users of the general purpose financial reports are
able to compare various aspects of an entity over different time period and
with other entities. To be comparable, accounting reports must belong to a
common period and use common unit of measurement and format of reporting.
Classification
of Accounts
It is necessary to know the classification of accounts and their
treatment in double entry system of accounts. Broadly, the accounts are
classified into three categories:
Ø
Personal
accounts
Ø Real accounts
o
Tangible
accounts
o
Intangible
accounts
Ø Nominal accounts
Let us go through them each of them one by one.
Personal
Accounts
Personal accounts may be further classified into three categories:
1.
Natural Personal Account:
An
account related to any individual like David, George, Ram, or Shyam is called
as a Natural Personal Account.
2.
Artificial Personal Account: An account related to any artificial person like M/s ABC
Ltd, M/s General Trading, M/s Reliance Industries, etc., is called as an Artificial
Personal Account.
3.
Representative Personal Account :
Representative personal account represents a group of account. If
there are a number of accounts of similar nature, it is better to group them
like salary payable Financial Accounting
Real Accounts:
Every
Business has some assets and every asset has an account. Thus, asset account is
called a real account. There are two type of assets:
·
Tangible assets are touchable assets such as plant, machinery, furniture,
stock, cash, etc.
·
Intangible assets are non-touchable assets such as goodwill, patent, copyrights,
etc.
Accounting treatment for both type of assets is same.
Nominal Accounts:
Since
this account does not represent any tangible asset, it is called nominal or
fictitious account. All kinds of expense account, loss account, gain account or
income accounts come under the category of nominal account. For example, rent
account, salary account, electricity expenses account, interest income account,
etc.
Accounting
Conventions
We
will discuss the following accounting conventions in this section:
1.
Convention of Consistency
2.
Convention of Disclosure
3.
Convention of Materiality
4.
Conservation of Prudence
Convention
of Consistency:
To
compare the results of different years, it is necessary that accounting rules,
principles, conventions and accounting concepts for similar transactions are
followed consistently and continuously. Reliability of financial statements may
be lost, if frequent changes are observed in accounting treatment. For example,
if a firm chooses cost or market price whichever is lower method for
stock valuation and written down value method for depreciation to fixed
assets, it should be followed consistently and continuously.
Consistency
also states that if a change becomes necessary, the change and its effects on
profit or loss and on the financial position of the company should be clearly
mentioned.
Convention of
Disclosure:
The
Companies Act, 1956, prescribed a format in which financial statements must be
prepared. Every company that fall under this category has to follow this
practice. Various provisions are made by the Companies Act to prepare these
financial statements. The purpose of these provisions is to disclose all
essential information so that the view of financial statements should be true
and fair. However, the term ‘disclosure’ does not mean all information. It
means disclosure of information that is significance to the users of these
financial statements, such as investors, owner, and creditors.
Convention of
Materiality:
If the
disclosure or non-disclosure of an information might influence the decision of
the users of financial statements, then that information should be disclosed.
For better
understanding, please refer to General Instruction for preparation of Statement
of Profit and Loss in revised scheduled VI to the Companies Act, 1956:
1. A
company shall disclose by way of notes additional information regarding any
item of income or expenditure which exceeds 1% of the revenue from operations
or Rs1,00,000 whichever is higher.
2. A
Company shall disclose in Notes to Accounts, share in the company held by each
shareholder holding more than 5% share specifying the number of share held.
Conservation or
Prudence:
It is a
policy of playing safe. For future events, profits are not anticipated, but
provisions for losses are provided as a policy of conservatism. Under this
policy, provisions are made for doubtful debts as well as contingent liability;
but we do not consider any anticipatory gain.
Accounting
Systems
There are two systems of accounting followed:
Ø
Single
Entry System
Ø Double Entry System
Single
Entry System:
Single
entry system is an incomplete system of accounting, followed by small
businessmen, where the number of transactions is very less. In this system of
accounting, only personal accounts are opened and maintained by a business
owner. Sometimes subsidiary books are maintained and sometimes not. Since real
and nominal accounts are not opened by the business owner, preparation of
profit & loss account and balance sheet is not possible to ascertain the
correct position of profit or loss or financial position of business entity.
Double
Entry System:
Double
entry system of accounts is a scientific system of accounts followed all over
the world without any dispute. It is an old system of accounting. It was
developed by ‘LucoPacioli’ of Italy in 1494. Under the double entry
system of account, every entry has its dual aspects of debit and credit. It
means, assets of the business always equal to liabilities of the business.
