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PART I
ACCOUNTING ENVIRONMENT
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Accounting
Nature and Scope
Information about the transactions and events of a business is recorded and presented in the form of reports that are used by various interested parties who are stakeholders, such as shareholders, investors, creditors, and lenders. This is the most common concept of accounting. It is also known as the ‘language of the business’ as it communicates the result of business operations to various stakeholders, that is, the proprietor, creditors, investors, regulators, government, and other agencies.
Meaning of Accounting
The term ‘accounting’ refers to the processes that accountants carry out — of aggregating and shaping information into financial reports that are meaningful to users of those reports. According to the American Institute of Certified Public Accountant (1941), ‘accounting is the art of recording, classifying and summarizing in 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’. If we look at accounting in the narrow perspective of only recording business transactions, then it is known as ‘bookkeeping’.
Every user uses this information for various purposes. Managers need accounting information to make sound leadership decisions. Investors use it for making profits. Creditors are always concerned about the entity’s ability to repay its obligations. Governmental units need information for tax and regulation purpose. Analysts use accounting data to recommend investment strategies. Employees need the information for evaluating the company’s growth for their own well being.
FUNCTIONS OF ACCOUNTING
(a) Recording — This is the basic function of accounting. It is essentially concerned with ensuring that all business transactions (of a financial character) are recorded in an orderly manner, in the book or journal. This book may be further sub-divided into various subsidiary books, such as Cash Journal (for recording cash transactions), Purchases Journal (for recording credit purchase of goods), and Sales Journal (for recording credit sales of goods). The number of subsidiary books to be maintained depends on the nature and size of the business.
(b) Classifying — It is concerned with analysing recorded data, and grouping transactions or entries of similar nature at one place, in a ‘ledger’. This book contains individual account heads, under which all financial transactions of similar nature are placed for calculating and finding out the total balance. For example: there may be separate account heads for Office Expenses and/or Sales.
(c) Summarising — This involves presenting the classified data in a manner which is understandable and useful to the end users of accounting information. This process leads to the preparation of the following statements:
(i) Trial Balance, (ii) Income Statement and (iii) Balance Sheet.
(d) Analysing and Interpreting — The recorded financial data is analysed and interpreted in a manner that helps the users make a meaningful judgment about the profitability and financial health of the business.
(e) Communicating — The accounting information in the end has to be communicated in a proper form to all end users. This is done by preparing and distributing various accounting reports.
BRANCHES OF ACCOUNTING
The diversity of interested parties and their needs results in various forms of accounting, mentioned in the following section.
Financial Accounting
It is the original form of accounting and is mainly concerned with the preparation of financial statements of Profit and Loss Accounts and Balance Sheets for various stakeholders, which include shareholders, debenture holders, creditors, banks and financial institutions. These reports are prepared under the relevant accounting principles and standards set by the respective standard-setting bodies. Financial accounting is external in nature.
Management Accounting
Management accounting provides necessary information to the management for taking various decisions, such as expansion of a business, buyouts or takeovers. All these decisions require additional information — what are business resources? What are financial strengths and...
