1.

Introduction

Over the centuries, accounting was mainly focused on recording financial

transactions. However, in today's fast-changing business environment,
accountants have had to reassess their roles.

Today, accounting goes beyond just keeping records and making financial
reports. Accountants now work in exciting new fields like forensic accounting
(solving crimes like computer hacking and online money theft), e-commerce
(creating web-based payment systems), financial planning, and environmental
accounting. This shift happened because accounting can provide crucial
information for managers and others to make better decisions. Over time,
accounting has become so important that it's now seen as an information system
that gathers and shares economic data about an organization with various users
who rely on it to make decisions.

In other words, Accounting aims to provide information that helps people make
smart decisions. That's why it's often called the language of business.

2. Definition of Accounting

In 1941, the American Institute of Certified Public Accountants (AICPA)

described accounting as the skill of recording, organizing, and summarizing
transactions and events that have financial value, all in terms of money, and
making sense of the results.

As the economy grew and changed, the role of accounting expanded. In 1966,
the American Accounting Association (AAA) defined accounting as the
process of identifying, measuring, and sharing economic information so that
people can make informed decisions.

In 1970, the Accounting Principles Board of the AICPA emphasized that

accounting's main job is to provide useful financial information about businesses
to help in making economic decisions.

So, accounting can be simply defined as the process of identifying,

measuring, recording, and sharing information about an organization's financial
activities with those who need it.

In order to appreciate the exact nature of accounting, we must understand the

following relevant aspects of the definition:
1. Economic Events
2. Process of Accounting
 3. Organisation
4. Users of Accounting Information

These are discussed next one by one.

2.1. Economic Events

An economic event refers to any activity or transaction that affects a company's

financial statements. These events involve the exchange or movement of value,
such as money, goods, or services, and they are recorded in the company's
books because they have an impact on its financial position.

Examples of economic events include:

 Sales: Selling products or services to customers.

 Purchases: Buying goods or services for the business.
 Payments: Paying salaries, rent, or other expenses.
 Investments: Putting money into new assets, like equipment or stocks.

These events are classified into external events and internal events.

1. External Events
If an event involves transactions between an outsider and an organisation, these
are known as external events. For example, sale of merchandise to the
customers, Rendering services to the customers by the Company, purchase of
materials from suppliers, monthly rent payments etc.

2. Internal Events
An internal event is an economic event that occurs entirely between the internal
wings of an enterprise, e.g., supply of raw material or components by the stores
department to the manufacturing department, payment of wages to the
employees, etc.
2.2. Process of Accounting

The characteristics and essence of accounting can be illustrated by examining its

procedural aspects. The process of accounting can be divided into 2 parts
involving following steps.

I. Generating financial information

Step 1: Recording all the financial transactions of business nature in primary
books such as Journal, Cashbook, Purchase book, Sales Book, etc.
Step 2: Classifying the above recorded data with a view to group together
information of similar nature at one place to put information in compact and
useable form. The book containing classified information are called ledgers.
Step 3: Summarizing all the classified data in a useful manner for preparing and
presenting the financial statements at the end of the year.

II. Using the financial information

Step 4: Analysing the financial statements with the help of various tools and
techniques.
Step 5: Interpreting the information made available after analysing the financial
statements into simple meaningful information.
Step 6: Communicating the summarized, analysed and interpreted information to
the end user for rational decision making.
Thus, accounting may be defined as the process of recording, classifying,
summarising, analysing and interpreting the financial transactions and
communicating the results thereof to the persons interested in such information.

2.3. Organisation

An organization refers to the business entity itself, which could be for-profit or

not-for-profit. Depending upon the size of activities and level of business
operation, it can be a sole-proprietary concern, partnership firm, cooperative
society, company, local authority, municipal corporation or any other association
of persons.

2.4. Users of Accounting Information

Many users need financial information in order to make important decisions.

These users can be divided into two broad categories: internal users and
external users.

Internal Users
1. Owners-Shareholders
Owners and shareholders are the primary stakeholders of a company. They
provide capital and have a vested interest in the financial health and performance
of the business.

Owners rely on accounting information to assess the profitability, liquidity, and

overall financial position of the company. They use financial statements such as
the balance sheet, income statement, and cash flow statement to evaluate the
return on their investment, make investment decisions, and assess the
company's ability to generate future profits and dividends.

2. Management
Internal management, including executives and operational managers, is
responsible for making strategic decisions and managing day-to-day operations.

Management uses accounting data for various purposes, including strategic

planning, budgeting, performance evaluation, and decision-making. Financial
reports provide insights into revenue generation, cost management, profitability
analysis, and cash flow management. Management relies on accounting
information to monitor financial performance, identify areas for improvement,
allocate resources effectively, and set future goals and targets.
External Users
1. Employees
Employees are interested in the financial stability and viability of the company, as
it impacts job security, compensation, and career advancement opportunities.

Employees may use financial statements to assess the company's financial

health, stability, and growth prospects. They may also analyze financial data to
evaluate the company's ability to honor employee benefits, salaries, and other
obligations.

2. Banks and Financial Institutions (FIs)

Banks and financial institutions provide financing and credit facilities to
businesses and individuals.

Lenders use financial statements to assess the creditworthiness and risk profile
of a company before extending loans or credit facilities. They analyze financial
ratios, liquidity positions, and debt levels to evaluate repayment capacity and
determine the terms and conditions of lending.

3. Potential Investors
Potential investors, including individual investors, institutional investors, and
venture capitalists, evaluate investment opportunities based on financial
performance and growth potential.

Investors analyze financial reports to assess the company's profitability, liquidity,

solvency, and valuation metrics. They use financial data to make investment
decisions, estimate future cash flows, and evaluate the company's risk-return
profile.

4. Creditors
Creditors, such as suppliers and trade creditors, extend credit to the company in
the form of trade credit or loans.

Creditors use financial statements to assess the creditworthiness and repayment

capacity of the company. They analyze financial ratios, working capital positions,
and payment histories to evaluate credit risk and determine credit terms.

5. Government and Regulatory Bodies

Government agencies and regulatory bodies oversee financial reporting
standards, taxation laws, and regulatory compliance.
Regulatory authorities use financial reports to ensure compliance with accounting
standards, taxation laws, and disclosure requirements. They monitor financial
statements to detect fraud, assess corporate governance practices, and protect
investor interests.

6. Public
The general public, including customers, suppliers, and competitors, may have
an interest in the financial affairs and reputation of the company.

Stakeholders outside the organization may use financial information to assess

the company's stability, ethical practices, and reputation. They may analyze
financial reports to evaluate product quality, customer satisfaction, and corporate
social responsibility initiatives.

7. Researchers
Researchers, academics, and industry analysts conduct studies and research
projects to analyze financial markets, trends, and business performance.

Researchers use financial data for academic research, market analysis, and
trend forecasting. They may analyze financial statements to identify patterns,
correlations, and anomalies in financial data and contribute to the advancement
of knowledge in accounting and finance.

3. Qualitative Characteristics of Accounting Information

Qualitative characteristics are the attributes of accounting information which tend

to enhance its understandability and usefulness.

In order to ensure usefulness, the accounting information must possess following

qualitative characteristics:

1. Reliability
Information should be free from error and bias and should faithfully represent
what it is meant to represent. Information should be such that users can depend
on it to take informed decisions. To ensure reliability, the information must be
credible and verifiable by independent parties.

2. Relevance
For information to be relevant, it should be timely, help with predictions and
feedback, and impact decisions by:
(a) helping predict what will happen in the past, present, or future; and/or
(b) confirming or correcting past judgments.

3. Understandability
Understandability means decision-makers must interpret accounting information
in the same sense as it is prepared and conveyed to them. Accountants should
present the comparable information in the most intelligible manner without
sacrificing relevance and reliability.

4. Comparability
It is important that the users can compare various aspects of an entity over
different time period, known as intra-firm comparison and with other entities in
the industry, known as inter-firm comparison.To be comparable, accounting
reports must belong to a common period and use common unit of measurement
and format of reporting.

5. Substance over Form

It means that the economic substance of transactions and events must be
recorded in the financial statements rather than just their legal form. It is done in
order to present a true and fair view of the affairs of the entity. For example, if a
firm has sold its land and building, received the consideration and handed over
the possession to the buyer, it should be recorded as sale of land and building in
the books of the firm. This recognition cannot be postponed for mere procedural
formality pending, such as registration of sale deed.

6. Neutrality
Neutrality means that financial information should be presented fairly and
impartially, without bias or favoritism. Neutrality ensures that financial information
is trustworthy and gives all users a clear, unbiased view of a company’s financial
health.

4. Branches of Accounting

The apparently divergent needs of internal and external users of accounting

information have resulted in the development of sub-disciplines within the
accounting discipline namely, financial accounting, cost accounting and
management accounting.
1. Financial Accounting
Financial Accounting covers the presentation and interpretation of financial
statements and communicating it to the users of accounts. It relates to the past
period or we can say, it is historical in nature, as its records transactions which
have already occurred. It serves the stewardship function. In other words,
financial accounting ensures that the management of resources is transparent
and accountable to stakeholders, demonstrating how resources are utilized and
managed. It is monetary in nature because it focuses on recording, measuring,
and reporting financial transactions in terms of money.

This branch of accounting aims to record all financial transactions so that:

(a) the profit or loss for the business during an accounting period can be
determined,
(b) the financial position of the business at the end of the accounting period can
be assessed, and
(c) financial information needed by management and other stakeholders can be
provided.
2. Cost Accounting
Cost accounting assists in analysing the expenditure for ascertaining the cost of
various products manufactured or services rendered by the firm and fixation of
prices thereof. It also helps in controlling the costs and providing necessary
costing information to management for decision-making.

3. Management Accounting
Management accounting provides essential accounting information to internal
stakeholders to support decision-making, planning, and control of business
operations. It primarily utilizes data from financial accounting and cost accounting
to assist in budgeting, evaluating profitability, setting prices, making capital
expenditure decisions, and more. Additionally, management accounting
generates both quantitative and qualitative information, covering financial and
non-financial aspects, that is forward-looking and critical for organizational
decision-making. This includes forecasts of sales, cash flow projections,
purchase requirements, manpower needs, and environmental data related to air,
water, land, natural resources, flora, fauna, human health, and social
responsibilities.

The purpose of management accounting is to support management in making

informed decisions and assessing the effects of those decisions and actions.

5. Objectives of Accounting

As an information system, the main goal of accounting is to provide valuable

information to both internal and external users. For external users, this
information is presented through financial statements, such as the profit and loss
account and balance sheet. Additionally, management receives supplementary
information from the business's accounting records.
 The primary objectives of accounting include:

1. Maintaining Records of Business Transactions

Accounting systematically records all financial transactions in the books. Since it
is challenging for even the most capable executive or manager to remember
every transaction—such as purchases, sales, receipts, and payments—keeping
accurate and comprehensive records is essential. These records provide
verifiability and serve as evidence.

2. Calculating Profit and Loss

Business owners need to know periodically whether their business is profitable or
has incurred losses. Accounting helps determine the profit or loss for a given
period by tracking income and expenses and preparing a profit and loss account.
Profit is calculated as the excess of revenue over expenses. For example, if
revenue is Rs. 10,00,000 and expenses are Rs.7,40,000, the profit is Rs.
2,60,000 (Rs. 10,00,000 - Rs.7,40,000). If expenses exceed revenue, the result
is a loss.

3. Depicting Financial Position

Accounting also determines the business’s financial position at the end of each
accounting period, showing its assets and liabilities. A detailed record of assets
(resources owned by the business) and liabilities (claims against these
resources) allows the preparation of a balance sheet, which reflects the
business’s financial position.

4. Providing Accounting Information to Users

The accounting information produced is shared with users in various formats,
including reports, statements, graphs, and charts. Internal users, mainly
management, need timely data on costs, profitability, and other aspects for
planning and decision-making. External users, who have limited access to
detailed information, rely on financial statements.

Key external users include:

 Investors and Potential Investors: Interested in risks and returns on their

investments.
 Unions and Employee Groups: Seek information on the business’s stability,
profitability, and wealth distribution.
 Lenders and Financial Institutions: Evaluate the company's creditworthiness and
ability to repay loans.
 Suppliers and Creditors: Need to know if amounts owed will be repaid and if the
business will continue to operate.
 Customers: Look for assurance that the business will continue to supply products
and services.
 Government and Regulators: Monitor resource allocation and compliance with
regulations.
 Social Responsibility Groups: Concerned with the business’s environmental
impact and protection efforts.
 Competitors: Use the information for strategic planning and benchmarking
against their own performance.

Each of these users requires accounting information for different purposes,

ranging from investment decisions to competitive analysis.

6. Role of Accounting

Over the centuries, the role of accounting has evolved alongside economic
development and shifting societal needs. Accounting involves measuring,
classifying, and summarizing vast amounts of data from an enterprise, and then
presenting this data in reports and statements that reflect the organization’s
financial status and operational results. Because of this, accounting is often
called the "language of business." It also provides valuable quantitative financial
information that assists users in various ways. As an information system,
accounting gathers and shares economic information about an enterprise with
many interested parties. However, since accounting primarily deals with past
transactions and focuses on quantitative financial data, it does not offer
qualitative or non-financial information. These limitations should be considered
when using accounting information.

Different Roles of Accounting

Accounting plays a multifaceted role in the business world, adapting to various
needs and functions.

 As a Language: Accounting is seen as the business language used to

communicate information about enterprises.
 As a Historical Record: It serves as a chronological record of an organization’s
financial transactions, detailing the actual amounts involved.
 As Current Economic Reality: Accounting helps determine an entity's true income
by showing how wealth changes over time.
 As an Information System: It functions as a process connecting information
sources (such as accountants) to recipients (external users) through
communication channels.
 As a Commodity: Specialized accounting information is a sought-after service in
society, with accountants ready and able to provide it.
  7. Functions of Accounting
 Accounting serves several crucial functions within organizations and
society at large.
 Firstly, it provides a systematic and organized way to record financial
transactions, ensuring accuracy and transparency in business operations.
 Secondly, it facilitates the preparation of financial statements, such as the
income statement, balance sheet, and cash flow statement, which are
essential for assessing the financial health and performance of a company.
 Thirdly, accounting aids in decision-making by providing relevant financial
information to management, investors, creditors, and other stakeholders.
 Additionally, it plays a vital role in compliance with legal and regulatory
requirements, ensuring that businesses adhere to accounting standards
and taxation laws.
 Moreover, accounting serves as a tool for monitoring and controlling
expenses, identifying areas for cost reduction and efficiency improvement.
 Overall, the functions of accounting extend beyond mere bookkeeping to
encompass financial reporting, decision support, compliance, and
managerial control.

The functions of Accounting are as follows:

1. Measuring
Accounting looks at what happened in the past in a business and shows how the
business is doing financially right now.

2. Predicting
Accounting helps guess what might happen in the future by looking at what
happened before and spotting trends.

3. Decision-making
Accounting gives useful info to people using the accounts, helping them make
smart choices about the business.

4. Comparing & Evaluating

Accounting checks how well the business is doing compared to what it wanted to
achieve, and it tells us about the rules used to keep track of money and any
possible problems coming up.

5. Control
Accounting finds any weak spots in how the business operates and tells us if the
things we're doing to fix them are working.

6. Legal Requirements
Courts of law recognize accounting records as credible evidence when they are
meticulously maintained in accordance with established accounting principles
and concepts. Moreover, various laws, including the Companies Act, Income Tax
Act, and GST Act, mandate the timely submission of returns in specified formats
and deadlines. Compliance with these legal requirements hinges on the
systematic and punctual maintenance of accounting records, ensuring that
accurate information is readily available for submission.

8. Limitations of Accounting

The language of accounting has certain practical limitations and, therefore, the
financial statements should be interpreted carefully keeping in mind all various
factors influencing the true picture. The assumptions and conventions, on which
the accounting is based, become the limitations of accounting. The financial
statements are never free from subjectivity factor as these are largely the
outcome of personal judgement of the accountant with regard to the adoption of
the accounting policies.

The limitations of accounting are as follows:

1. Accounting information is expressed in terms of money

Accounting measures only those events that are of financial nature i.e. capable
of being expressed in terms of money. Non-monetary items or events which
cannot be measured are not recorded in accounting.

For example, a company cannot record the value of employee satisfaction or

brand reputation directly in its financial statements because these are not
monetary items.

2. Accounting information is based on estimates

Some accounting data are based on estimates and some estimates may be
inaccurate.
For example, estimating the useful life of machinery or the amount of bad debts
that may occur in the future involves making educated guesses, which may not
always be accurate.

3. Accounting information may be biased

Accounting information is not without personal influence or bias of the
accountant. In measuring income, accountant has a choice between different
methods of inventory valuation, depreciation methods, treatment of capital and
revenue items etc. Hence, due to the lack of objectivity income arrived at may not
be correct in certain cases.

For example, an accountant might choose a depreciation method that minimizes

expenses to make the company's profits appear higher, even if another method
would provide a more accurate reflection of the asset's value.

4. Fixed assets are recorded at the original cost

The values of fixed assets change over time and so there may be a great
difference between the original cost and current replacement cost. Balance sheet
may not show true and fair view of the financial position on a date.

For example, a company purchases machinery for Rs. 50,000, but its market
value increases to Rs. 60,000 over time. However, in the balance sheet, the
machinery will still be reported at its original cost of Rs. 50,000.

5. Accounting can be manipulated

Accounting information may not be used as the only means of testing of
managerial performance, as profits can be manipulated or misrepresented.

For example, a company might delay recognizing expenses or accelerate

recognizing revenue to artificially inflate its profits, giving a false impression of its
financial health.

6. Money as a measurement unit changes in value

The value of money does not remain stable. Unless price level changes are
considered in measurement of income, the accounting information will not show
true financial results.

For example, if a company reports a profit of Rs.100,000 in a year of high

inflation without adjusting for the decrease in the value of money, the real
purchasing power of that profit may be lower than expected.