1. Chapter Introduction 2. Accounting: Objectives and Limitations 3. Functions of Accounting 4. Different systems of Accounting 5. Emerging Role of Accounting 6. Role of Accountants 7. Accounting Personnel
1. Chapter Introduction:
Accounting is often called the language of business. Its purpose is to communicate or report the results of business operations and its various aspects.
It is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.
2. Accounting: Objectives and Limitations:
According to American Institute of Certified Public Accountants (AICPA), “Accounting is the 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.”
American Accounting Association (AAA) has defined accounting as “the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information.”
On analyzing the above definitions the following characteristics of accounting emerges:
i. Accounting is the art of recording and classifying different business transactions.
ii. The business transactions may be completely or partially of financial nature.
iii. Generally the business transactions are described in monetary terms.
iv. In accounting process, the business transactions are summarized and analyzed so as to arrive at a meaningful interpretation.
v. The analysis and interpretations thus obtained are communicated to those who are responsible to take certain decisions to determine the future course of business.
Objectives of Accounting:
The following are the objectives of accounting:
a. To record the business transactions in a systematic manner.
b. To determine the gross profit and net profit earned by a firm during a specific period.
c. To know the financial position of a firm at the close of the financial year by way of preparing the balance sheet
d. To facilitate management control.
e. To assess the taxable income and the sales tax liability.
f. To provide requisite information to different parties, i.e., owners, creditors, employees, management, Government, investors, financial institutions, banks etc.
Limitations of Accounting:
Accounting suffers from the following limitations:
i. Accounting information is expressed in terms of money. Non monetary events or transactions, however important, are completely omitted.
ii. Fixed assets are recorded in the accounting records at the original cost, that is, the actual amount spent on them plus all incidental charges. In this way the effect of inflation (or deflation) is not taken into consideration. The direct result of this practice is that balance sheet does not represent the true financial position of the business.
iii. Accounting information is sometimes based on estimates; estimates are often inaccurate.
iv. Accounting information cannot be used as the only test of managerial performance on the basis of more profits. Profit for a period of one year can readily be manipulated by omitting such costs as advertisement, research and development, depreciation and so on.
v. Accounting information is not neutral or unbiased. Accountants calculate income as excess of revenues over expenses. But they consider only selected revenues and expenses. They do not, for example, include, cost of such items as water or air pollution, employee’s injuries, etc.
vi. Accounting like any other discipline has to follow certain principles, which in certain cases are contradictory. For example current assets (e.g., stock of goods) are valued on the basis of cost or market price whichever is less following the principle of conservatism. Accordingly the current assets may be valued on cost basis in some year and at market price in another year. In this manner, the rule of consistency is not followed regularly.
3. Functions of Accounting
Various Functions of Accounting are:
a. Recording: Accounting records business transactions in terms of money. It is essentially concerned with ensuring that all business transactions of financial nature are properly recorded. Recording is done in journal, which is further subdivided into subsidiary books from the point of view of convenience.
b. Classifying: Accounting also facilitates classification of all business transactions recorded in journal. Items of similar nature are classified under appropriate heads. The work of classification is done in a book called the ledger.
c. Summarizing: Accounting summarizes the classified information. It is done in a manner, which is useful to the internal and external users. Internal users interested in these informations are the persons who manage the business. External users of information are the investors, creditors, tax authorities, labor unions, trade associations, shareholders, etc.
d. Interpreting: It implies analyzing and interpreting the financial data embodied in final accounts. Interpretation of the data helps the management, outsiders and shareholders in decision making.
4. Different systems of Accounting
The following are the basic systems of recording business transactions:
i. Cash Basis Accounting: According to this system, only actual cash receipts and payments are recorded in the books. The credit transactions are not recorded at all, till actual cash is received or paid. Thus, if purchases are made in the year 2002 on credit and payment for purchases is made in the year 2003, such purchases shall be considered to be an expense of the year 2003 and shall not be recorded in the year 2002. This system of accounting is mostly followed by non-trading organizations, professionals like lawyers, doctors, chartered accountants, etc.
ii. Mercantile or Accrual System: According to this system, all the business transactions pertaining to the specific period, whether of cash or credit nature, are recorded in the books. This system of accounting is based on accrual concept, which states that revenue is recognized when it is earned and expense is recognized when obligation of payment arises. Actual movement of cash is irrelevant. Mercantile system of accounting is widely followed by the industrial and commercial undertakings because it takes into account the effects of all transactions already entered into.
iii. Mixed System: Mixed system is modified form of pure-cash-basis accounting. Because of the fact that pure cash basis would result in balance sheet and income statement with limited use, it necessitates the need of mixed accounting in which some items (especially sales and period costs are treated on cash basis and some items (especially product costs and long-lived assets) are treated on accrual basis.
Pure cash basis approach would change the cost of acquisition of inventories from the profit of that year in which the acquisition costs are paid rather than in the year in which inventories are sold. Similarly cost of acquisition of fixed assets would reduce the profits when paid in cash rather than in later periods when these long-lived items are used, thus misleading the results of financial operation.
5. Emerging Role of Accounting
Q. Explain briefly the meaning of
- Financial Accounting (Dec. 99, Jan. 01)
- Management Accounting (June 00)
- Social Responsibility Accounting (Dec. 00, June 01)
- Human Resource Accounting (June 03)
Financial Accounting (Jan 01) :
Financial or traditional accounting consists of the classification, recording, and analysis of the transactions of a business in a subjective manner according to the nature of expenditure so as to enable the presentation at periodic intervals, of statements of profit or loss of the business and, on a specified date, of its financial state of affairs. The day-to-day transactions journalized or recorded in subsidiary books are posted in the various ledgers and at the end of the accounting period, a Profit and Loss Account and a Balance Sheet are prepared. The emphasis is on the ascertainment and exhibition of the profits earned or losses incurred by the business rather than on the aspects of planning and control and decision making.
Financial accounting safeguards the interests of the business and its proprietors and other connected with it by providing suitable accounts and information to various parties, such as the shareholders or partners, present and prospective creditors and the Government. The accounts are kept in a manner so as to meet the provisions of the Companies Act and to present correct figures to income tax, excise and other authorities. These accounts show how gainfully the resources of the business were employed.
Management Accounting (June 00)
Management accounting includes all those accounting services by means of which assistance is rendered to the management at all levels, in formulation of policy, fixation of plans, control of their execution, and measurement of performance. Management accounting is primarily concerned with the supply of information which is useful to the management in decision making for the efficient running of the business and thus, in maximizing profit. Management account employs various techniques, which include standard costing, budgetary control, marginal costing, break-even and cost-volume-profit analysis, uniform costing and inter-firm comparison, ratio accounting, internal audit, and capital project assessment and control.
Social Responsibility Accounting (Dec. 00, June 01)
Social responsibility accounting is a new phase in the development of accounting and owes its birth to increasing social awareness, which has been particularly noticeable over the last two decades or so. Social responsibility accounting widens the scope of accounting by considering the social effects of business decisions, in addition to the economic effects. Several social scientists, statesmen and social workers all over the world have been drawing the attention of their governments and the people in their countries to the dangers posed to environment and ecology by the unbridled industrial growth. The role of business in society is increasingly coming under greater scrutiny. The management is being held responsible not only for efficient conduct of business as expressed in profitability, but also for what it contributes to social well being and progress. There is a growing feeling that the concepts of growth and profit as measured in traditional balance sheets and income statements are too narrow to reflect the social responsibility aspects of a business.
Human Resource Accounting (June 03) :
It is another new field of accounting which seeks to report and emphasize the importance of human resources in a company’s earnings. It is based on the fact that the only real long lasting asset which an organization possesses is the quality 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.”
Q. How does management Accounting differs from Financial Accounting? Explain briefly, how management accounting helps the management of a company in making its decisions. (Dec. 02)
Financial or traditional accounting consists of the classification, recording, and analysis of the transactions of a business in a subjective manner according to the nature of expenditure so as to enable the presentation at periodic intervals, of statements of profit or loss of the business and, on a specified date, of its financial state of affairs. The day-to-day transactions journalized or recorded in subsidiary books are posted in the various ledgers and at the end of the accounting period, a Profit and Loss Account and a Balance Sheet are prepared. The emphasis is on the ascertainment and exhibition of the profits earned or losses incurred by the business rather than on the aspects of planning and control and decision making.
Management accounting includes all those accounting services by means of which assistance is rendered to the management at all levels, in formulation of policy fixation of plans and control of their execution, and measurement of performance. Management accounting is primarily concerned with the supply of information which is useful to the management in decision making for the efficient running of the business and thus, in maximizing profit. Management account employs various techniques, which include standard costing, budgetary control, marginal costing, break-even and cost-volume-profit analysis, uniform costing and inter-firm comparison, ratio accounting, internal audit, and capital project assessment and control.
Difference
- Financial accounting depicts the past position of the concern, while management accounting stresses at future.
- Financial accounting keeps a record of very large number of daily business transactions and prepares various financial statements according to accounting principles and standards. In management accounting there is no such compulsion. It lays emphasis on analysis and standards.
- Management accounting provides data to managers to help them in making decisions about the future. To the contrary, financial accounting aims at meeting the requirements of outside parties who have financial stake in the business.
- Financial accounting is mandatory for all joint stock companies and business organizations but this is not the case with management accounting.
Interested Groups
There are various parties interested in the financial statements. Accounting information is useful to various internal & external users listed below:
- Shareholders: Since shareholders have invested in the company so they are interested in the financial statements.
- Creditors: Creditors may be short-term or long-term. The main concern of the creditors is focused on the credit worthiness of the firm and its ability to meet its financial obligations. They are therefore concerned with the liquidity of the firm, its profitability and financial soundness.
- Management: Management requires accounting information for planning, organizing, and control purposes. The emphasis on efficient & effective management of organizations has considerably extended the demand for accounting information.
- Employees: The importance of harmonious industrial relations between management & employees cannot be over-emphasized. The employees have a stake in the outcomes of several managerial decisions. Greater emphasis on industrial democracy through employee participation in management decisions has important implication for the supply information to employees. Matters like settlement of wages, bonus, & profit sharing rest on adequate disclosure of relevant facts.
- Government: Government uses financial information for compiling statistics concerning calculation of profitability, taxes, computation of national income, and determination of the industrial growth.
- Stock Exchanges: Several stock exchanges also require accounting information for listing of securities.
- Consumers & Others: Consumer organizations, media, welfare organizations and public at large are also interested in condensed accounting information in order to appraise the efficiency and social role of the enterprises in different sectors of the economy.
6. Role of Accountants
Role of Accountants in Modern Business Organization:
Accounting is an age-old profession. In old days of accounting, the main function of an accountant was to maintain the records of the business. However over the years, the role of an accountant has undergone a sea change. With the inception of joint stock company form of an organization, the profession of accountancy has come to be recognized as one of the lucrative professions. Accountants can be broadly divided into two categories namely, Accountants in public practice and Accountants in employment. Accountants in public practice (practicing chartered accountants) are members of the Institutes of Chartered Accountants of India. The accountant renders valuable service to the society in the following manner:
1. Writing up Accounts for Preparing Financial Statements: Professional accountants offer services for writing up accounts and preparing financial statements. By maintaining proper books of accounts and records he assists management to a great extent in the field of planning, decision-making and controlling. A systematic record also enables the business to compare one year’s results with those of other years.
2. Audit of Accounts: Conducting of audit is one of the most important functions of a professional accountant where his specialized training, skills and judgement are most often called into play. Audit satisfies the users of financial statements that the accounting information contained in these statements is true and reliable and that accounts have been prepared in accordance with the accounting standards. It, thus, adds credibility to financial statements prepared by the business. He also points out the shortcoming and suggests ways to overcome them.
3. Role as Management Accountant: A management accountant helps the management in planning and control of organizational activities and their performance evaluation.
4. Help to government, Revenue Department and Tax Payer: Chartered accountant plays an important role in ensuring that the Government gets its proper share of taxes and at the same time the tax payer is not exploited. Chartered accountant is instrumental in preparing the financial statements of the enterprise. He also prepares the returns for tax purposes. He also appears before the tax authorities on behalf of the taxpayer. He also does the work of certification of documents in many cases.
5. Role as Cost Accountant: As a cost accountant, he maintains the costing records and ascertains the cost of product or service. He provides costing information introduces cost control and cost reduction methods and assists the management in fixing appropriate selling prices.
6. Role in Merger, Liquidation, etc: The services or advice of chartered accountants are frequently sought in the formation, merger or liquidation of limited companies. They are called upon to undertake investigation for achieving greater efficiency in management and find out the reasons for increase of decrease in profits. They act as executors and trustees under a will or trust deed to carry out the administration of the estate or settlements.
7. Accounting Personnel
Finance is the life blood of business. Procuring financial resources and their judicious utilization are the two important activities of financial management which is a specialized function. The finance manager has to strike a balance between the current needs of the enterprise for cash and the needs of the shareholders for adequate return. The financial management of a large company is usually the responsibility of the finance director who may be in place of or in addition to the controller. Often finance manager and controller are inter-changeable terms and only one of these two positions may be found in a company. The finance manager is also concerned with implementing the financial policy of the board of directors, managing liquidity, preparation of budgets, administration of budgetary control system, managing profitability, etc.