UNIT 1 NATURE AND SCOPE OF

ACCOUNTING
Structure
1.0 Objectives
1.1 Introduction
1.2 Need for Accounting
1.3 Objectives of Accounting
1.4 Definition and Scope of Accounting
1.5 Book-Keeping, Accounting and Accountancy
1.6 Users of Financial Accounting Information
1.7 Accounting as an Information System
1.8 Branches of Accounting
1.9 Advantages of Accounting
1.10 Limitations of Accounting
1.11 Bases of Accounting
1.11.1 Cash Basis of Accounting
1.11.2 Accrual Basis of Accounting

1.12 Qualitative Characteristics of Accounting Information

1.13 Functions of Accounting
1.14 Let Us Sum Up
1.15 Key Words
1.16 Some Useful Books
1.17 Answers to Check Your Progress
1.18 Terminal Questions

1.0 OBJECTIVES
After studying this unit, you should be able to:
 explain the need for accounting;
 identify the objectives of accounting;
 describe accounting as an information system;
 outline the scope and bases of accounting;
 distinguish between book-keeping, accounting and accountancy;
 identify the parties interested in accounting information;
 describe the functions and important branches of accounting;
 describe the advantages and limitations of accounting; and
 state the qualitative characteristics of accounting. 1
Theortical Framework
1.1 INTRODUCTION
In this unit, we shall discuss the functions, branches, advantages, limitations,
and bases for accounting. In this unit, we also intend to elaborate on the
need for accounting and then discuss the nature, scope and importance of
accounting.

1.2 NEED FOR ACCOUNTING

Let us elaborate on need for accounting. Suppose you are given ten rupees
to purchase vegetables and asked to account for the amount. You have
purchased the vegetables— 1 kg of tomatoes for Rs. 4, 1 kg of potatoes
for Rs. 3, and 1 kg of brinjalsfor Rs. 2. The total amount spent is Rs. 9
and the balance of amount with you is Re 1. Thus, you have rendered the
account for Rs. 10. This is one time affair. Therefore, you could remember
what you have spent.

Suppose, you are given Rs. 2,000 and asked to manage the home for a month
and render the account for the money at the end of the month. You will
be purchasing groceries, milk, vegetables, paying for electricity, school/
college fees, etc. You will be spending almost everyday. In that case, is
it possible to remember all the payments you are making everyday and render
account at the end of the month? No, it is not possible to remember, especially
when the number of payments is more. Not only that, it is not even advisable
to depend on memory. Therefore, it is better to write down (or record)
whatever payments you have made. Further, it is advisable to obtain receipts
or bills for the payments you have made, so that you can render the account,
beyond doubt.

The above example is a simple one, where you have one receipt of money
i.e., Rs. 2,000 and a number of payments. But the case of business is different.
In business, you may have to purchase and sell hundreds and thousands of
times over a period of time. You will have a number of receipts and a
number of payments (known as transactions). Will it be possible for you
to remember hundreds and thousands of transactions which have taken place
in your business, that too over a period of time, say a year? It is not humanly
possible to remember all transactions which have taken place in business
over a period of time. Even if you remember all the transactions, you will
find it impossible to calculate the net effect of all such transactions i.e.,
profit. It, therefore, becomes necessary to record all the transactions that
have taken place in business.

As the size of the business grows, it becomes necessary to employ people

to assist the businessman. In such cases, theft of goods or cash is possible
or all the sale proceeds may not be put into the cash box. Hence, it becomes
necessary to maintain accounting records for the purpose of control,
especially when outsiders are employed. It can, thus, be seen that there is
need for proper accounting records even in case of a sole proprietorship
concern. It is all the more important in the case of other forms of business
organisation.

In case of a partnership firm, all the partners may or may not be actively
participating in the day-to-day management of the business. It is, therefore,
necessary to record all the transactions in order to satisfy all the partners.
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In case of a company, it is not possible for the owners (shareholders) who Nature and Scope of
are too large in number to take part in the day-to-day management of the Accounting
company. Generally, the management of the company is entrusted to paid
managers. Hence, there is a need for recording all transactions.

Information about the business is required for both internal and external use.
For example, the management needs a lot of information (for their internal
use) for planning, controlling and evaluating the operations of the business.
Information is also needed by some outsiders, banks, creditors, etc. For
example, it is required for filing sales tax, income tax, and other tax returns
with appropriate tax authorities. When a firm approaches the bank for loan
or the creditors for supply of goods on credit, the bank or creditors like
to know the firm’s financial position (whether it is financially sound or not)
and its profit earning capacity. The question is how to obtain all such
information. A systematic accounting record is the only answer.

Accounting is necessary in not only business organisations, but also ‘non-

business’ organisations like schools, colleges, hospitals, libraries, etc.

1.3 OBJECTIVES OF ACCOUNTING

From the above discussion, the objectives of accounting can be stated as
follows:

i) To keep systematic records: Accounting is done tokeep a systematic

record of financial transactions, like purchase of goods, sale of goods,
cash receipts and cash payments. Systematic record of various assets
and liabilities of the business is also to be maintained.

ii) To ascertain the net effect of the business operations i.e., profit
or loss of business: Weknow that the primary objective of business
is to make profit and the businessman is very much interested in knowing
the same. A proper record of income and expenses facilitates the
preparation of the profit and loss account (income statement). The profit
and loss account reveals the profit earned or loss incurred by the
business firm during a particular period.

iii) To ascertain the financial position of the business: The businessman

is not only interested in knowing the operating results, but also interested
in knowing the financial position of his business i.e., where it stands.
In other words, he wants to know when the business owes to others
and what it owns and what happened to his capital – whether the capital
increased or decreased or remained constant. A systematic record of
various assets and liabilities facilitates the preparation of a statement
known as ‘balance sheet’ (position statement) which answers these
questions.

iv) To provide accounting information to interested parties: Apart from

the owners, there are various other parties who are interested in knowing
about the business firm, such as the management, the bank, the creditors,
the tax authorities, etc. For this purpose, the accounting system has to
furnish the required information.

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Theortical Framework Check Your Progress A
1. Give five points in support of the need for accounting.
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2. State the main objectives of accounting.
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3. What is profit?
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4. What do you understand by ‘Financial Position?
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1.4 DEFINITION AND SCOPE OF ACCOUNTING

Accounting has been defined in different ways by different authorities on
the subject. Accounting is a comprehensive discipline and it is difficult to
explain satisfactorily through any single definition. However, two definitions
are given below. This should help you to understand the nature and scope
of accounting.
The American Accounting Association defines Accounting as the process of
identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of the information. This definition
stresses three aspects viz., identifying, measuring and communicating economic
information.
In the words of the Committee on Terminology appointed by the American
Institute of Certified Public Accountants, ‘‘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 financial character
and interpreting the results thereof ’’. This is a popular definition of
accounting and it outlines the nature and scope of accounting activity.
A business is generally started with proprietor’s funds i.e., capital. The
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proprietor may also acquire additional funds from outsiders like banks and Nature and Scope of
Accounting
creditors. These funds are utilised to acquire the assets needed for business
and also to carry out other business activities. In the process many
transactions and events take place. The accountant has to identify all such
transactions and events, measure them in terms of money, and record them
in appropriate books of account. Then, he has to classify them under separate
heads of accounts, summarise periodically in the form of Profit and Loss
Account and Balance Sheet; and analyse, interpret and communicate the
results thereof to the interested parties. Accounting can thus be broadly
defined as follows;
Accounting is the process of identifying, measuring, recording, classifying,
summarising, analysing. interpreting, and communicating the financial
transactions and events in monetary terms.
The above definitions clearly bring out the scope of accounting. This can
now be outlined as follows:
1. Accounting is concerned with financial transactions and events which
bringabout a change in the resources (or wealth) position of the business
firm. Such transactions have to be identified first, as and when they
occur. It is not difficult because, there will be proof in the form of
a bill or receipt (called vouchers). With the help of these bills and
receipts, identification of a transaction is easy. For example, when you
purchase something you get a bill, when you make payment, you get
a receipt.
2. These transactions are to be measured or expressed in terms of money,
if not done already. Generally, this problem will not arise, because
the statement of proof expresses the transaction in terms of money. For
example, if ten books are purchased at the rate of Rs. 20 each, then
the bill is prepared for Rs. 200. But, if an event cannot be expressed
in monetary terms, it will not come under the scope of accounting.
3. The transactions which are identified and measured are to be recorded
in a book called journal or in one of its sub-divisions.
4. The recorded transactions are to be classified with a view to group
transactions of similar nature at one place. The work of classification
is done in a separate book called ledger. In the ledger, a separate account
is opened for each item so that all transactions relating to it can be
brought to one place. For example, all payments of salaries are brought
to salaries account.
5. The recording and classification of many transactions will result in a
mass of financial data. It is, therefore, necessary to summarise such
data periodically (at least once a year), in a significant and meaningful
form. The summarisation is done in the form of profit and loss account
which reveals the profit made or loss incurred, and the balance sheet
which reveals the financial position.
6. The summary results will have to be analysed, interpreted (critically
explained) and communicated to interested parties. Accounting information
is generally communicated in the form of a ‘report’. Big organisations
generally present printed reports, called published accounts. 5
Theortical Framework
1.5 BOOK-KEEPING, ACCOUNTING AND
ACCOUNTANCY
Very often you will come across terms like bookkeeping, accounting, and
accountancy in the literature on accounting. We propose to explain them in the
following paragraphs:
You know Accounting involves a series of activities, as listed out in the scope
of accounting. These activities are; (1) identifying, (2) measuring. (3)
recording, (4) classifying, (5) summarising, (6) analysing, (7) interpreting,
and (8) communicating, the financial transactions and events. –
Book-keeping is a narrow term, which means record keeping or maintaining
books of account. It only covers the first four activities (1 to 4 above) of
accounting.
The term ‘Accountancy’ refers to a systemiatised knowledge of accounting and
is regarded as an academic subject like economics; statistics, chemistry, etc.
It explains ‘why to do’ of various aspects of accounting. In other words, when
accounting refers to the actual process of preparing and presenting the accounts,
Accountancy tells us why and how to prepare the books of account and how
to summarise the accounting information and communicate it to the interested
parties. Thus Accountancy is a science, a body of systematised knowledge,
whereas Accounting is the art of putting such knowledge intopractice.
In general usage, however, Accountancy and Accounting are used as synonyms
(meaning the same thing). But, of late, the term accounting is becoming more
and more popular.
Cheek Your Progress B
1. Define accounting.
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2. What do you mean by book-keeping?
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3. What is accountancy?
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4. Accounting involves a series of activities. List them. Nature and Scope of
Accounting
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1.6 USERS OF FINANCIAL ACCOUNTING

INFORMATION
You have learnt that many groups of people are interested in accounting
information which may help them:
i) to understand the present position of the enterprise
ii) to compare its present performance with that of its past years
iii) to compare its present performance with that of similar enterprises.
Now, let us see who such parties are and how accounting information is
useful to various parties.
Owners: Ownerscontribute capital and assume the risk of business. Naturally,
they are interested to know the amount of profit earned by the business and
so also its financial position. If however, the management of the business is
entrusted to paid managers, the owners also use the accounting information to
evaluate the performance of the managers.
Managers: Accounting information, supplemented by other information, is of
immense use to managers. It helps them to plan, control and evaluate the
operations of the business. They also need such information for various decision-
making.
Lenders : The funds are provided by the owners initially, but if the business
requires more funds they are provided by banks and other lenders of money.
Before they lend money, they would like to know the solvency (i.e.., capacity
to repay debts) of the enterprise, so as to satisfy themselves that their money
will be safe and that they can expect repayment on time.
Creditors: Those who supply goods and services on credit are called creditors.
Like lenders, they too want to know about solvency of the enterprise, so as
to decide whether credit can be granted or not.
Prospective investors: A person who wants to become a partner in a
partnership concern or a person who wants to become a shareholder of a
company, would like to know how safe and rewarding the proposed investment
would be.
Tax authorities: Tax authorities of the Government are interested in the financial
statements so as to assess the tax liability of the enterprise.
Employees: The employees of the enterprise are also interested in knowing
the state of affairs of the organisation in which they are working, so as to know
how safe their interests are in that organisation.

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Theortical Framework
1.7 ACCOUNTING AS AN INFORMATION
SYSTEM
Accounting is part of an organization’s information system, which includes
both financial and non-financial data. Accounting is the process of identifying,
measuring and communicating economic information to permit judgment and
decisions by users of the information. The main objective of accounting is
to provide information to the users. Accounting is also required to serve
some broad social obligations since the accounting information is used by
a large body of people such as customers, employees, investors, creditors
and government.

Accounting is commonly divided into (1) Financial Accounting, and (2)

Managerial Accounting. Financial accounting refers to the preparation of general
purpose reports for use by persons outside an organization. Such users
include shareholders, creditors, financial analysts, labour unions, government
regulations etc. External users are interested primarily in reviewing and
evaluating the operations and financial status of the business as a whole.

Managerial accounting, on the other hand, refers to providing of information

to managers inside the organization. For example a production manager may
want a report on the number of units of product manufactured by various workers
in order to evaluate their performance. A sales manager might want a report
showing the relative profitability of two products in order to pinpoint selling
efforts. The financial reports are available from the libraries or company
themselves whereas managerial accounting reports are not widely distributed
outside because they often contain confidential information. The following figure
shows that accounting is part of an organization system which includes both
financial and non financial data:

Accounting as an information system

Uses of Accounting Information

Accounting provides information for the following three general uses:-

1) Managerial decision making: Management is continuously confronted with

the need to make decisions. Some of these decisions may have immediate effect
while the others have in the long run. Decisions regarding the price of the product
like make or buy the product or to drop it, to expand its area of operations
etc., are some of the examples of decisions making. Management Accounting
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provides necessary information to arrive at right conclusions. Nature and Scope of
Accounting
2) Managerial planning, control and internal performance evaluation:
Managerial accounting plays an important role in the planning and control. By
assisting management in the decision making process, information is provided
for establishing the standard. Accounting also provides actual results to compare
with projections.

For example, where a marketing manager is given a target of sales revenues

of Rs. 10 crores, the amount of Rs. 10 crores will serve as a standard
for evaluating the performance of the marketing manager. If annual sales
revenues vary significantly from Rs. 10 crores, steps will be taken to
ascertain the causes for the difference. When the factors leading to the
variance are not under the control of the marketing manager, then the
marketing manager would not be held responsible for it. On the other hand
the cause for variance is under the control of marketing manager then he
will be held responsible in evaluating the performance of marketing manager.
Accounting provides necessary information to measure the variance in the
actual performance.

3) External financial reporting: Accounting has always been used to supply

information to those who are interested in the affairs of the company. Various
laws have been passed under which financial statements should be
prepared in such way that required information is supplied to shareholders,
creditors, government etc. For example, the investors may be interested in
the financial strength of the business, creditors may require information about
the liquidity position, government may be interested to collect details about
sales, profit, investment, liquidity, dividend policy, prices etc. in deciding
social and economic policies. Information is required in accordance with
generally accepted accounting principles so that it is useful in taking
important decisions.

1.8 BRANCHES OF ACCOUNTING

Accounting, as we know it today, has evolved over many centuries in
response to the changing economic, social and political conditions. The
development of modern accounting was influenced by a number of factors
such as industrial revolution, growth of large enterprises like companies,
introduction of compulsory audit of companies, legal regulations, establishment
of professional organisations like the Institute of Chartered Accountants of
India, the Institute of Cost and Works Accountants of India, American Institute
of Certified Public Accountants, etc Economic development and technological
improvements have resulted in an increase in the scale of business operations
and the advent of company form of organisation. This has made management
function more and more complex. These factors have increased the
importance of accounting and have given rise to special branches of
accounting. The important branches of accounting are briefly explained
below:
Financial Accounting: The purpose of this branch of accounting is to keep
a record of financial transactions and events so that:
a) the net result of the operations of the business (profit or loss) during an
accounting period can be ascertained; 9
Theortical Framework b) the financial position (assets, liabilities and capital position) of the
business as at the end of the period can be ascertained; and
c) relevant financial information can be provided to management and other
interested parties.
Cost Accounting: The purpose of cost accounting is to analyse the expenditure
so as to ascertain the cost of each product, operation, service, etc. The price
of an article is nothing but the cost plus a certain amount of profit. Unless
cost is known, price cannot be fixed rationally. Cost accounting helps not
only in ascertaining the costs but also assists the management in controlling
the costs.
Management Accounting: The purpose of management accounting is to
assist the management in taking rational policy decisionsand to evaluate the
impact of its decisions and actions. Examples of such decisions are: pricing
decisions, capital expenditure decisions, etc. This branch of accounting is
primarily concerned with presenting information that may be needed by
management in such decision-making.
In this course, we are concerned with financial accounting only.
Check Your Progress C
1. Mr. Agarwala started Agarwala Electricals shop with a capital of Rs.
1,00,000. As this amount is insufficient, he has borrowed Rs. 50,000 from
Syndicate Bank. As he is not keeping good health, he appointed Mr. Ram
Naresh to look after the business on a salary of Rs. 1,000 per month.
Pavan Electrical Works supplies electrical goods to Agarwala Electricals
on credit. Mr. Mirchand, Mr. Sabir and Mr. Wilson are the other persons
working in Agarwals Electricals, as salesmen. Mr. Agarwals wants to
expand the business. He is not in a position to invest more money.
Mr. Shyamlal wants to join as a partner. From this, identify the names
of the following parties and write the answer in theblank space
provided.
Name
i) Business firm ..............................................................
ii) Owner ..............................................................
iii) Manager ..............................................................
iv) Lender ..............................................................
v) Creditor ..............................................................
vi) Prospective Investor ..............................................................
vii) Employees ..............................................................
2. Complete the following sentences:
i) Accounting is the process of identifying, measuring and ………………
economic information to permit informed judgements.
ii) Accounting designed to serve external parties to provide information
relating to the operating activities of the business is termed as
………………………
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 iii) Accounting designed for operational needs of business is termed Nature and Scope of
Accounting
as ……………………………………..
iv) ……………………….. Accounting is more or less compulsory for
every business.

1.9 ADVANTAGES OF ACCOUNTING

The following are the advantages of a properly maintained accounting system:
1) Replaces memory: Since all the financial events are recorded in the
books, there is no need to rely on memory. The books of account will
serve as historical records. Any information required at any time can
be had from these records.
2) Provides control over assets: Accounting provides information regarding
balance of cash in hand and at bank, the stock of goods in hand, the
amount receivable from various parties, the amount invested in various
other assets, etc. Information about these matters help owner(s) and
management to make use of the assets in the best possible way.
3) Facilitates the preparation of financial statements: With the help of
information contained in the accounting records, financial statements viz.,
Profit and Loss Account and Balance Sheet can be easily prepared. These
statements enable the businessman to know the net result of the business
during an accounting period and its financial position.
4) Meets the information requirements: Various interested parties such as
owners, management, lenders, creditors, etc. get the necessary information
at frequent intervals which help them in their decision-making.
5) Facilitates a comparative study: The financial Statements prepared will
enable the enterprise to compare its present position with that of its past,
and with that of similar organisations. This helps them to draw useful
conclusions and improve its performance.
6) Assists the management in many ways: It is possible to identify reasons
for the profit earned or loss suffered. The identification of reasons helps
in taking necessary steps to increase profits further, or to avoid losses.
Accounting information will also help in planning and controlling the activities
of the business.
7) Difficult to conceal fraud or theft: It is difficult to conceal fraud, theft,
etc..as there is an automatic check in the form of periodic balancing of
books of account. Further, in big organisations, the record keeping work
is divided among many persons. so that chances of committing fraud are
minimised.
8) Tax matters : The Government levies various taxes such as customs duty,
excise duty, sales tax, and income tax. Properly maintained accounting
records will help in the settlement of tax matters with the tax authorities.
9) Ascertaining value of business: In the event of sale of a business firm,
the accounting records will help in ascertaining the value of business.

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Theortical Framework
1.10 LIMITATIONS OF ACCOUNTING
The accounting information is used by various parties who form judgments
about the profitability and the financial soundness of a business on the basis
of such information. It is, therefore, necessary to know about the limitations
of accounting. These are as follows:
1. They do not record transactions and events which are not of a financial
character. Hence. They do not reveal a complete picture because facts
like quality of human resources, licences possessed, locational advantage,
business contacts, etc. do not find any place in books of account.
2. The data is historical in nature. The accountants adopt historical cost
as the basis in valuing and reporting all assets and liabilities. They
do not reflect current values, it is quite possible that items like land
and buildings may have much more value than what is stated in the
balance sheet.
3. Facts recorded in financial statements are greatly influenced by
accounting conventions and personal judgements. Hence, they do not
reveal the true picture. In many cases, estimates may be used to
determine the value of various items. For example, debtors are estimated
in terms of collectability, inventories are based on marketability, and
fixed assets are based on useful working life. All these estimates are
materially affected by personal judgements.
4. Data provided in the financial statements is insufficient for proper
analysis and decision making. It only provides information about the
overall profitability of the business. No information is given about the
cost and profitability of different activities.

1.11 BASES OF ACCOUNTING

There are two bases of accounting: (i) cash basis, and (ii) accrual basis.
These are explained below:

1.11.1 Cash Basis of Accounting

In this system, the accounting entries are made on the basis of cash received
or cash paid. In other words, transactions are recorded only when cash is
received or paid. The incomes earned but not yet received (accrued income)
or the expenses incurred but not yet paid (expenses outstanding) are completely
ignored while preparing the final accounts. For example, rent for the month of
December, 2017 is paid in January, 2018. This is taken into the Profit and
Loss Account of 2018 even though the benefit of that payment (accommodation)
is enjoyed in 2017 itself.

1.11.2 Accrual Basis of Accounting

This system of accounting attempts to record the financial effects of transactions
in the period in which they occur and not in the period in which the amount
is received or paid to the enterprise.
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Accrual accounting is also called ‘Mercantile System of Accounting’. It Nature and Scope of
Accounting
recognises that buying, selling and all other operations of an enterprise during
a period may not coincide with the period during which the related cash
receipts and cash payments take place. In other words, all revenues earned
in a year may or may not have been received in cash in that year. Similarly,
all expenses incurred in a year may or may not have been paid in the same
year. Accrual accounting attempts to relate the revenues and expenses to
year in which they are actually earned or incurred. For example, rent for
the month of December, 2017 is paid in January, 2018. As per the accrual
principle, it would be taken to the Profit and Loss Account of the year 2017
and not 2018. This is more logical because the benefit of payment is enjoyed
in the year 2017 and not in 2018.

The main difference between accrual accounting and cash basis of accounting
is the recognition of revenues, gains, expenses and losses. The objective
of accrual accounting is to account for the effects of transactions and events
to the extent that their financial effects are recognisable and measurable in
the periods in which they occur. The adjustments made in the final accounts
in respect of prepaid expenses (prepaid insurance, salaries paid in advance,
etc.), income received in advance (rent received in advance, interest received
in advance, etc.), income earned but not yet received (interest receivable,
commission receivable, etc.) are based on accrual accounting.

Sometimes, a business adopts a combination of both the above systems. In

that case it is called ‘Mixed or Hybrid System’. For example, the business
may consider income in cash receipt basis and expenses on accrual basis. This
is considered most conservative. In practice, most enterprise adapt the accrual
basis of accounting.

1.12 QUALITATIVE CHARACTERISTICS OF

ACCOUNTING INFORMATION
Business owners can use accounting information to conduct a financial analysis
of business operations. Accounting information often has quantitative and
qualitative characteristics. Quantitative characteristics refer to the calculation of
financial transactions. Qualitative characteristics include the business owner’s
perceived importance of financial information. Business owners often require
financial information when making business decisions. Incorrect or inappropriate
information can hamper decision-making or cause business owners to make
incorrect assessments about their companies. Some of the qualitative characteristics
of accounting information are as follows:

(i) Understandable

Accounting information must be understandable. This is an important qualitative

characteristic for small business owners. Many small business owners do not
have a strong accounting background. Financial information that is too technical
or cannot be understood by a layperson can be ineffective for business owners.
Small business owners often use professional accountants to complete various
accounting functions. Business owners should choose an accountant who can
prepare information in an easily understandable manner. 13
Theortical Framework (ii) Usefulness

Business owners need accounting information that is applicable to the

business decision at hand. They can request financial statements, accounting
schedules, reconciliations or cost-benefit analysis. For example, cost
allocation reports may not provide sufficient information for business owners
who must make a decision on hiring employees. Cost allocation usually refers
to applying business costs to goods or services produced by the company,
which has very little to do with human resources. Business owners should
carefully request and review accounting information to ensure that it provides
the most useful information for the decision-making process.

(iii) Relevance
Accounting information should relate to a specific time period or contain
information regarding individual business functions. Business owners often
conduct a trend analysis when reviewing financial information. The trend
analysis compares historical financial information to the company’s current
accounting period information. Irrelevant historical information can severely
distort the trend analysis process. For example, reviewing the production
process for budgets requires relevant information on the cost of materials
for budgets. Cost information on the materials to produce COGS would be
irrelevant.
(iv) Reliability
Accounting information must be reliable, so that business owners can be
reasonably assured that accounting information presents an accurate picture of
the company’s financial health. Business owners often use accounting information
to secure external financing for their business. Information that is not reliable
or accurate may cause lenders and investors to question the business’s
management ability. Business owners may also struggle to secure external
financing with poor accounting information.
(v) Comparable
Comparability allows business owners to review their company’s accounting
information against that of a competitor. Business owners use comparison to
gauge how well their companies operate under certain market conditions. Owners
often use the leading company of an industry for the comparison process. These
companies usually have the most efficient and effective business operations. Non-
comparable accounting information can make this a difficult process. For
example, business owners should consider preparing financial statements according
to standard accounting principles. The statements can then be compared to other
company’s financial standard prepared in a similar manner.
(vi) Consistent
Consistency refers to how business owners and accountants record financial
information in a company’s general ledger. Business owners need to ensure that
financial transactions are handled the same way. Inventory purchases should be
recorded the same way as yesterday, today and tomorrow. This helps companies
create accurate historical records and limit the amount of financial accounts or
journal entries included in their general ledgers.
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 Nature and Scope of
1.13 FUNCTIONS OF ACCOUNTING Accounting

Functions of Accounting involves the creation of financial records of business

transactions, flows of finance, the process of creating wealth in an organization,
and the financial position of a business at a particular moment in time. The
progress and reputation of any business big or small is build up on sound
financial footing. There are number of parties who are interested in
accounting information relating to a business. Financial Accounting
communicates financial information of the business concern to various
parties. Financial accounting provides information regarding the status of
a business and results of its operation. Here are the functions of accounting :
(i) Recording
This is the basic function of accounting. It is essentially concerned with
not only ensuring that all business transactions of financial character are
in fact recorded but also that they are recorded in an orderly manner.
Recording is done in the book “Journal”.
(ii) Classifying
Classification is concerned with the systematic analysis of the recorded data,
with a view to group transactions or entries of one nature at one place. The
work of classification is done in the book termed as “Ledger”.
(iii) Summarizing
This involves presenting the classified data in a manner which is understandable
and useful to the internal as well as external end-users of accounting statements.
This process leads to the preparation of the following statements: (1) Trial
Balance, (2) Income statement (3) Balance Sheet.
(iv) Analysis and Interprets
This is the final function of accounting. The recorded financial data is
analyzed and interpreted in a manner that the end-users can make a meaningful
judgment about the financial condition and profitability of the business
operations. The data is also used for preparing the future plan and framing
of policies for executing such plans.
(v) Communicate
The accounting information after being meaningfully analyzed and interpreted
has to be communicated in a proper form and manner to the proper person.
This is done through preparation and distribution of accounting reports, which
include besides the usual income statement and the balance sheet, additional
information in the form of accounting ratios, graphs, diagrams, funds flow
statements etc.

1.14 LET US SUM UP

1. Business has a series of transactions. It is not possible to remember
all the transactions which have taken place over a period of time, and
calculate the net effect of all such transactions i.e., profit or loss. Hence,
the need for accounting takes place. 15
Theortical Framework 2. Information about the business enterprise is required for both internal
and external use. To get the required information, a systematic record
is necessary.
3. The objectives of accounting are: to keep systematic records; to
ascertain the profit or loss and also the financial position; and to provide
accounting information to interested parties for rational decision-making.
4. Accounting is the process of identifying, measuring, recording,
classifying, summarising, analysing, interpreting and communicating
the financial transactions and events.
5. The series of activities mentioned above, explain the nature and outline
the scope of accounting.
6. Book-keeping is a part of accounting. It is the record keeping function
of accounting and is limited upto the classifying stage.
7. Accountancy is the systematic knowledge, while accounting is the practice
of the knowledge i.e., the actual maintenance of books of account and
provide accounting information.
8. Many groups of people like owners, management, lenders, creditors,
investors, tax authorities, employees, etc., are interested in the accounting
information of the enterprise.
9. Changes in economic environment and the increasing complexity of
management function have given rise to specialised fields of accounting such
as financial accounting, cost accounting and management accounting.
10. There are many advantages of a properly maintained accounting system.

1.15 KEY WORDS

Accountancy: The science of measurement of wealth. It is the systematic
knowledge of accounting.
Accounting: Process of identifying, measuring, recording, classifying, summarising
and communicating business transactions and events in terms of money.
Accounting Year : A period of 12 months at the end of which the financial
results of the enterprise are generally ascertained.
Accrual Basis of Accounting: A basis of accounting which takes into account
all incomes, gains, expenses and losses in the year in which they are earned
or incurred, and not when they are received or paid.
Book-keeping: Systematic recording of business transactions in the books of
account.
Balance Sheet: A statement prepared for ascertaining the financial position of
the business as at the end of the accounting period.
Cash Basis of Accounting: A basis of accounting in which accounts are
prepared on the basis of cash received or cash paid. No accruals -are
considered.
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Cost Accounting: A branch of accounting concerned with measurement and Nature and Scope of
Accounting
control of costs.
Financial Accounting: It is primarily concerned with record keeping directed
towards preparation of financial statements and other accounting reports.
Financial Position: Position of assets and liabilities of a business at a
given point of time.
Financial Statements: Summary of accounting information such as Profit
and Loss Account and Balance Sheet.
Final Accounts : Financial statements prepared at the end of the accounting
period for ascertaining the profit or loss and the financial position of the business.
They include Profit and Loss Account and the Balance Sheet.
Management: It is used in two senses:
i) to mean the process of management or managing the business, for
example, the day-to-day management is entrusted to paid managers; and
ii) to mean the persons who are incharge of carrying out the business
activity i.e., managers, for example, management wants this information.
Report has to be submitted to the management.
Management Accounting: It is concerned with the supply of information
which is useful to the management in planning, controlling and decision-
making.
Profit: Excess of income over expenses.
Profit and Loss Account: A statement showing all incomes and expenses
for the accounting period. It is prepared for ascertaining the operational result
of the enterprise.

1.16 SOME USEFUL BOOKS

Bièrman, Harold & Drebin, Allan R., Financial Accounting: An Introduction
(Philadelphia: W.B. Saunders Company, 1998).
Briston, R.J., Introduction to Accountancy & Finance (London: The Macmillan
Press Ltd., 1991).
Maheshwari, S.N., Principles and Practice of Book-Keeping (New Delhi: Arya
Book Depot, 2018).
Matulich, S. & Heitger, L.E., Financial Accounting (New York: McGraw Hill
Book Company, 1990).
Patil, V.A. & Korlahalli, Principles and Practice of Book-Keeping (New Delhi:
R. Chand & Co., 2018).

1.17 ANSWERS TO CHECK YOUR PROGRESS

C 1. i) Agarwala Electricals Shop
ii) Mr. Agarwala
17
Theortical Framework iii) Mr. Ram Naresh
iv) Syndicate Bank
v) Pawan Electrical Works
vi) Mr. Shyamlal
vii) Mr. Mirchand, Mr. Sabir and Mr. Wilson.
2. i) Communicating
ii) Financial Accounting
iii) Management Accounting
iv) Financial

1.18 TERMINAL QUESTIONS

1. Outline the need for accounting and briefly describe the objectives of
accounting.
2. Define accounting and explain its scope.
3. Name the different parties interested in accounting information, and explain
why do they want it.
4. What are the qualitative characteristics of accounting information? Briefly
Explain.
5. Describe the advantages and limitations of accounting.
6. Briefly discuss the functions of accounting.
7. Define accounting. Explain the need for accounting.
8. Write short notes on the following:
a) Book-keeping
b) Accountancy
c) Accounting
9. Distinguish between cash basis and accrual basis of accounting with
examples.

Note : These questions will help you to understand the unit better. Try
to write answers for them. But, do not submit your answers to
the University for assessment. These are for your own practice
only.

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