FUNDAMENTALS OF ACCOUNTING

1. UNDERSTANDING THE
NATURE,
MEANING OF ACCOUNTING
Dr. Pooja Mathur

2. DEFINITION
• 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”.

3. MEANING OF ACCOUNTING
Accounting is all about the process that helps to record,
summarize, analyze, and report data that concerns financial
transactions. Let’s understand the components a little better to
understand the true meaning of accounting.
• Recording: The first and foremost function that accounting
looks forward to achieving is the recording of the different
transactions that are made within the firm. This can also be
referred to as book-keeping which is a process of recognizing
the transactions and setting them up as records.
– Book-keeping is only concerned with the recording segment and
nothing else. Accounting maintains a few books for the cause of
recording. The maintenance of the procedure happens in a
systematic manner.

4. MEANING OF ACCOUNTING
• Summarizing: Raw data is generally the result of recording transactions.
However, these raw data are not of much significance to the organization.. As a
result of this, the accountants divide these raw data into several categories. So
the recording of the transactions is then followed up by summarizing.
• Reporting :The affairs in any company are the responsibility of the
management. The owners must know about the various operations happening
within the firm using their money. Therefore, to take care of this, owners receive
reports. They receive these reports quarterly and at the end, they receive an
annual report that summarizes all their performances.
• Analyzing : Finally, there is an analysis of all the results so far. After recording
and summary, it is very important to draw conclusions. It is the responsibility of
the management to check for the positive and negative points.
Therefore, to analyze all of this, accounting introduces the concept of comparison.
Comparing profits, sales, equity, and so on with one another to determine and
analyze the performance and growth of an organization.

5. NATURE OF ACCOUNTING
• Accounting as a service activity: Accounting is a service activity. Its function is
to provide quantitative information, primarily financial in nature, about economic
entities that is intended to be useful in making economic decisions, in making
reasoned choices among alternative courses of action
• Accounting as a profession: Accounting is very much a profession. A profession
is a career that involve the acquiring of a specialized formal education before
rendering any service. Accounting is a systematized body of knowledge developed
with the development of trade and business over the past century.
• Accounting as a social force: Under the changing business environment the
discipline of accounting and the accountant both have to watch and protect the
interests of other people who are directly or indirectly linked with the operation of
modern business. The society is composed of people as customer, shareholders,
creditors and investors.

6. NATURE OF ACCOUNTING
• Accounting as a language: Accounting is rightly referred the "language of business". It
is one means of reporting and communicating information about a business. As one has
to learn a new language to converse and communicate, so also accounting is to be
learned and practiced to communicate business events.
• Accounting as science or art : Science is a systematized body of knowledge. It
establishes a relationship of cause and effect in the various related phenomenon. It is
also based on some fundamental principles. Accounting has its own principles e.g. the
double entry system, which explains that every transaction has two fold aspect i.e. debit
and credit. It also lays down rules of journalizing. Art requires a perfect knowledge,
interest and experience to do a work efficiently. Accounting is an art as it also requires
knowledge, interest and experience to maintain the books of accounts in a systematic
manner. Everybody cannot become a good accountant.
• Accounting as an information system: Accounting discipline will be the most useful
one in the acquisition of all the business knowledge in the near future. You will realise that
people will be constantly exposed to accounting information in their everyday life.
Accounting information serves both profit-seeking business and non-profit organisations..

7. STAGES OF ACCOUNTING
• The transactions of a business that have, at least in part, a
financial character are identified and recorded.
• The recording is done in a manner which identifies the different
classes and types of transactions.
• The resulting records are summarized in such a way that the
owners or other interested parties in the business can see the
overall effects of all the transactions. The statements prepared
by the summarizing process are known as financial statements
which will show the profit or loss made by the business over a
period of time and the total capital employed in the business.
Such financial statements are used by management to make
business decisions.

8. BRANCHES OF ACCOUNTING
• Financial Accounting: It is concerned with record-keeping directed
towards the preparation of trial balance, profit and loss account and
balance sheet.
• Cost Accounting: Cost accounting is the process of accounting for
costs. It is a systematic procedure for determining the unit cost of
output produced or services rendered. The main functions of cost
accounting are to ascertain the cost of a product and to help the
management in the control of cost.
• Management Accounting: Management accounting is primarily
concerned with the supply of information which is useful to the
management in decision-making, increasing efficiency of business
and maximizing profits.

9. BOOK-KEEPING
• Book-keeping is mainly concerned with recording of financial
data relating to the business operations in a significant and
orderly manner. It is concerned with the permanent record of
all transactions in a systematic manner to show its financial
effect on the business.
• It covers procedural aspects of accounting work and includes
record keeping function. It is the science and art of correctly
recording in books of account all those business transactions
that result in the transfer of money or money’s worth. It is
mechanical and repetitive.

10. DIFFERNCE BETWEEN BOOK-KEEPING AND
ACCOUNTING
Book-keeping Accounting
It is concerned with the recording of transactions. It is concerned with the summarizing of the recorded
transactions.
The work of book-keeping is mainly routine and
clerical in nature and is increasingly being done
by computers.
The work of accountant requires higher
level of knowledge, conceptual understanding and
analytical skill.
Book-keeping constitutes the base for accounting. Accounting starts where book keeping ends.
Book-keeping is done in accordance with basic
accounting concepts and conventions.
The methods and procedures for accounting for
analysis and interpretations for financial reports may
vary from firm to firm.
Financial statements do not form part of book-
keeping.
Financial statements are prepared in accounting
process from the book-keeping records.
Financial position of the business cannot be
ascertained through book-keeping records.
Financial position of the business is ascertained on the
basis of accounting reports.

11. DISTINCTION BETWEEN ACCOUNTING AND
ACCOUNTANCY
• Although in practice Accountancy and Accounting are used
interchangeably yet there is a thin line of demarcation between them.
• The word Accountancy is used for the profession of accountants -
who do the work of accounting and are knowledgeable persons.
• Accounting is concerned with recording all business transactions
systematically and then arranging in the form of various accounts and
financial statements. And it is a distinct discipline like economics,
physics, astronomy etc.
• The word accounting tries to explain the nature of the work of the
accountants (professionals) and the word Accountancy refers to the
profession these people adopt.

12. OBJECTIVES OF ACCOUNTING
• Maintaining Record: As we mentioned, accounting is the spoken language of
transactions. The human brain cannot store endless information. And so
accounting takes the charge of keeping the records of all the transactions made
within a firm.
• Profit and Loss : Business is directly proportional to profits. It is all about earning
profits. The accounting chart of profit and loss determines whether there is a profit
or loss made in the business. The income and expenditure decide profit and loss.
• Utility of Resources :Resources are a very crucial part of any organization and for
a firm to function smoothly, they play a significant role. The records hold the
responsibility to report to the firm about the different activities along with its timing.
Hence, it becomes easy for the management to take note of the details before
putting in the money.

13. OBJECTIVES OF ACCOUNTING
• Estimation of Financial Position: A business person is not only
interested in knowing the Profit and Losses of his business but he
also wants to know how much he owes to his creditors and how
much he has to pay to his debtors. For this purpose, he prepares
a statement in which all such details are recorded. This statement
is known as Balance sheet. With the help of Balance sheet
Financial position of the business can be Understood.
• Helps in Decision Making :With the help of all the records that
have been maintained by following Accounting Procedures,
Decisions can be made with all those information which eventually
helps in the smooth functioning of the organisation.

14. FUNCTIONS OF ACCOUNTING
• Keeping Systematic Records
• Protecting and Controlling Business Properties
• Ascertaining the Operational Profit/Loss
• Ascertaining the Financial Position of the Business
• Facilitating Rational Decision Making

15. HISTORICAL FUNCTIONS OF ACCOUNTING
The historical functioning of accounting involves keeping accurate records of all
the past transactions made in the business. This type of functioning of
accounting includes:
• Recording the financial transactions and maintain a journal to keep them all.
• It is important to classify and separate the records and the ledger.
• Preparation of brief summary takes place for quick reviews.
• This type of accounting gives the net result other than just keeping the
records.
• The preparation of the balance sheet takes place to determine the financial
position of the business.
• The analyzed data and records are then used for other purposes.
• The last step is to communicate the obtained financial information to the
interested sectors, for instance, owners, suppliers, government, researchers,
etc.

16. MANAGERIAL FUNCTIONS OF ACCOUNTING
In an organization, the management committee looks for all kinds of
decision making. To ensure that the decisions are smooth and
beneficial for everyone, they do an evaluation of the past records
provided by accounting. These are managerial functions. The five
managerial functions of accounting are:
• Formation of plans in addition to controlling the financial policies.
• Besides that, a budget is prepared to estimate the total expenditure
for future activities.
• Also, cost control is made possible by comparing the cost with
the efficiency of the work.
• The accounting also provides the necessary information during the
evaluation of employee’s performance.
• To check for fraud and errors is what the workability of the whole
procedure depends on.

17. USERS OF ACCOUNTING INFORMATION
Accounting is the discipline that provides information on which external and
internal users of the information may base decisions that result in the
allocation of economic resources in society
 External Users of Accounting Information : External users are those
groups or persons who are outside the organisation for whom accounting
function is performed. Following can be the various external users of
accounting information:
• Investors, Those who are interested in investing money in an organization are
interested in knowing the financial health of the organization of know how safe
the investment already made is and how safe their proposed investment will be.
• Creditors. Creditors (i.e. supplier of goods and services on credit, bankers and
other lenders of money) want to know the financial position of a concern before
giving loans or granting credit. They want to be sure that the concern will not
experience difficulty in making their payment in time i.e. liquid position of the
concern is satisfactory.

18. USERS OF ACCOUNTING INFORMATION
• Members of Non-profit Organisations. Members of non-profit organisations
such as schools, colleges, hospitals, clubs, charitable institutions etc. need
accounting information to know how their contributed funds are being utilised
and to ascertain if the organisation deserves continued support or support
should be withdrawn keeping in view the bad performance depicted by the
accounting information and diverted to another organisation. ‘
• Government. Central and State Governments are interested in the
accounting information because they want to know earnings or sales for a
particular period for purposes of taxation.
• Consumers. Consumers need accounting information for establishing good
accounting control so that cost of production may be reduced with the
resultant reduction of the prices of goods they buy.
• Research Scholars. Accounting information, being a mirror of the financial
performance of a business organisation, is of immense value to the research
scholars who wants to make a study to the financial operations of a particular
firm.

19. USERS OF ACCOUNTING INFORMATION
Internal Users of Accounting Information. Internal users of
accounting information are those persons or groups which are
within the organisation. Following are such internal users :
 Owners. The owners provide funds for the operations of a business
and they want to know whether their funds are being properly used or
not. They need accounting information to know the profitability and
the financial position of the concern in which they have invested their
funds.
 Employees. Employees are interested in the financial position of a
concern they serve particularly when payment of bonus depends
upon the size of the profits earned. They seek accounting information
to know that the bonus being paid to them is correct.

20. USERS OF ACCOUNTING INFORMATION
 Management. Management is the art of getting work done through others, the
management should ensure that the subordinates are doing work properly.
Accounting information is an aid in this respect because it helps a manager in
appraising the performance of the subordinates.
The most important functions of management are planning and controlling.
Preparation of various budgets, such as sales budget, production budget, cash
budget, capital expenditure budget etc., is an important part of planning function
and the starting point for the preparation of the budgets is the accounting
information for the previous year.
Controlling is the function of seeing that programmes laid down in various budgets
are being actually achieved i.e. actual performance ascertained from accounting is
compared with the budgeted performance, enabling the manager to exercise
controlling case of weak performance.
Accounting information is also helpful to the management in fixing reasonable
selling prices. In a competitive economy, a price should be based on cost plus a
reasonable rate of return.

21. LIMITATIONS OF ACCOUNTING
• Measurability: One of the biggest limitations of accounting is that it cannot measure
things/events that do not have a monetary value. If a certain factor, no matter how
important, cannot be expressed in money it finds no place in accounting. Some very
important qualities like management, loyalty, reputation, etc find no place on
the balance sheet or the income statement.
• No Future Assessment : The financial statements show the financial position of the
firm on the date of preparation. The users of the statement are more interested in the
future of the company in the short term and long term. However, accounting does not
make any such estimates. And due to the dynamic nature of the business
environment, a lot can change between such dates. Auditors sometimes do disclose
the important events occurring after the balance sheet date to rectify these limitations
of accounting.

22. LIMITATIONS OF ACCOUNTING
• Accounting Policies : There is no global standard in accounting policies. In
India, we follow the Accounting Standards. Americans follow the GAAP and then
there are the international standards, namely the IFRS. And if a global company
operates in more than one country, there may be confusion. Not all accounting
policies follow the same line of thinking, and conflicts may arise due to this. It has
long been said that the whole world must agree on uniform accounting policies
but this has not happened yet.
• Historical Costs : Accounting often uses historical costs to measure the values.
This fails to take into consideration factors such as inflation, price changes, etc.
This skews the relevance of such accounting records and information. This is
one of the major limitations of accounting.

23. LIMITATIONS OF ACCOUNTING
• Estimates : Sometimes in accounting estimation may be required as it is not
possible to establish exact amounts. But these estimates will depend on the
personal judgment of the accountant. And estimates are extremely subjective in
nature. They are basically a person’s guess of future events. In accounting,
there are many cases where such estimates need to be made like provision of
doubtful debt, methods of depreciation, etc.
• Verifiability : An audit of the financial statements does not guarantee the
correctness of such statements. The auditor can only assure that the
statements are free from error to the best of his judgment .
• Errors and Frauds: Accounting is done by humans, so there will always be the
scope of human errors. There is also the fear of possible manipulation of
accounts to cover up a fraud. Since fraud is deliberate, it is that much harder to
spot. This is one of the most dreaded limitations of accounting.