Chapter 1: Meaning & Objectives of Accounting
1. Meaning of Accounting
Accounting is often called the language of business.
Definition by Smith and Ashburne: "Accounting is the science of recording,
classifying business transactions and events, primarily of a financial character, and the
art of making significant summaries, analysis and interpretations of those transactions
and events and communicating the results to persons who must make decisions or
form judgement."
2. Characteristics of Accounting
Art as well as Science:
o It is an art of recording, classifying, and summarizing business transactions to
determine net profit and financial position.
o It is a science because it's an organized body of knowledge based on specified
principles and accounting standards.
Recording of Financial Transactions only: Only transactions and events of a
financial character are recorded.
Recording in terms of Money: Each transaction is recorded in monetary terms.
Classifying: Grouping transactions of a similar nature into separate accounts.
Summarizing: Presenting classified data in an understandable and useful manner for
management.
Interpretation of the Results: Presenting business results (e.g., through Trading and
Profit & Loss Account and Balance Sheet) for interested parties.
Communicating: Sharing financial data with users for their analysis.
3. Objectives of Accounting
To keep a systematic record of business transactions.
To calculate profit or loss.
To know the exact reasons for net profit or net loss.
To ascertain the financial position of the business (through Balance Sheet).
To ascertain the progress of the business from year to year.
To prevent and detect errors and frauds.
To provide information to various parties (owners, investors, creditors, banks,
employees, government).
4. Functions of Accounting
Maintaining complete and systematic records.
Communicating financial results to various parties.
Preparation of financial statements (Profit & Loss Account and Balance Sheet).
Protecting the assets of the business.
Providing assistance to management in planning, controlling, and decision-making.
Compliance of legal needs (e.g., Companies Act, Income Tax Act, GST Act).
Trusteeship: Assisting management in controlling company funds as trustees.
Fixing responsibility: Determining the profitability of each department.
5. Book-Keeping, Accounting, and Accountancy
Book-Keeping:
o Mainly concerned with record-keeping or maintenance of books of accounts.
o Includes: Identifying financial transactions, measuring them in money,
recording them in original entry books, and classifying them into ledgers.
o "Book Keeping is an art of recording business dealings in a set of books." -
J.R. Batliboi
o Primary stage.
o Routine and clerical job performed by junior staff with limited knowledge.
Accounting:
o Starts where book-keeping ends.
o Includes: Summarizing classified transactions (P&L, Balance Sheet),
analyzing and interpreting summarized results, and communicating
information to interested parties.
o Secondary stage.
o Analytical in nature, performed by senior staff with higher knowledge and
analytical skills.
Accountancy:
o Refers to a systematic knowledge of accounting, including principles and
techniques.
o "Accountancy refers to the entire body of the theory and practice of
accounting." - Kohler
o Much wider in scope; includes both book-keeping and accounting.
o Includes the decision-making function based on information from book-
keeping and accounting.
7. Nature of Accounting
Interested Users: Internal (e.g., CEO, financial officer, plant managers) and External
(e.g., investors, creditors, government).
Economic Events: Records only economic events measurable in terms of money.
Organization: Refers to a business enterprise (sole proprietorship, partnership,
company).
Identification: Determining which financial transactions relate to the organization.
Measurement: Quantifying business transactions in monetary units.
Recording: Recording business transactions chronologically according to rules.
Communication: Communicating recorded events to internal and external users
through reports.
8. Users of Accounting Information & Their Needs
Internal Users:
o Owners: To know profitability and financial soundness.
o Management: For efficient business running.
External Users:
o Potential Investors: To judge safety and reward of investment.
o Short-term Creditors: For creditworthiness information.
o Long-term Creditors: To judge repayment ability and lending decisions.
o Employees: To assess ability to pay wages and bonuses.
o Tax Authorities: For assessment of Income Tax, GST.
o Government & Agencies: To form policies, allocate resources, provide
subsidies.
o Social Responsibility Groups: For information on environmental impact and
actions.
o Public: As providers of employment and amenities.
o Competitors: To know strengths, weaknesses, and for comparisons.
10. Limitations of Accounting
Influenced by personal judgement (e.g., estimating asset life for depreciation).
Based on accounting concepts and conventions, which may not always be realistic.
Incomplete information; actual profit/loss only known upon business closure.
Omission of qualitative information (cannot be expressed in money).
Based on historical costs, ignoring price level changes.
Affected by "window dressing" (manipulating accounts for a favorable view).
Unsuitable for forecasting (records past events).
11. Qualitative Characteristics of Accounting Information
Reliability: Factual and verifiable from source documents.
Relevance: Capable of making a difference in decisions; helps users make decisions.
Understandability: Presented simply and logically for easy comprehension by users.
Comparability: Financial statements should include previous year's figures for
comparison.
Faithful Presentation: Financial statements should show a true and fair view of
profitability, financial position, and cash flows.
12. Role of Accounting (in a rapidly changing business environment)
Role of a Language
Role of Historical Record
Role of Determining the Net Profit
Role of Determining the Financial Position
Role of Information System
Role of Service Provider
