Assignment 1 Introduction to Accounting and

Finance

I Define ‘Accounting’.

Definition of Accounting

According to the 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

ii. Explain the primary objectives of accounting.”.

i. To keep Systematic Records: A business is involved in various
business transactions on a daily basis and accounting keeps track of
these transactions by recording them in books of accounts. ii. To
Ascertain the Results of the Operation: Accounting ascertains any
profit earned or loss incurred by a business during a particular
period through Trading Profit and Loss account or an Income and
Expenditure account. These accounts match the revenue earned by
the business with the expenditure during the same period to
calculate the profit or loss. iii. To ascertain the financial position of
the business: A business’ financial statements reflect its financial
position with regard to cash, assets, liabilities, capital, etc. They help
the business owner to determine the health of his enterprise. iv. To
portray the liquidity position: A business obtains and spends cash for
numerous purposes such as lending, repayment of loans, capital
transactions, paying cash dividends to shareholders and distribution
of resources among owners. This information, along with other
factors that determine an entity’s liquidity and solvency, is portrayed
in financial reports. v. To protect business properties: Accounting
keeps an updated record of the business’ assets and liabilities to
prevent false claims against the entity’s properties. vi. To facilitate
rational decision – making: Financial statements and records help a
business owner analyse different aspects of his business and
decision-making. vii. To satisfy the requirements of law: Laws, such
as, the Companies Act, Societies Act, Sales Tax Act, Income Tax Act,
etc. which govern business operations required by companies, public
trusts, and other business entities to maintain up to date accounts.

ii. Discuss the limitations of accounting.

Accounting has the following limitations:

1. Record keeping: Accounting helps in maintaining records of financial transactions only.

Any actions, dealings or events that have a non-financial nature do not fall in accounting.
Sometimes these may include information that directly or indirectly influence the financial
health of the business. Management skills, variation in consumer preferences, or any other
changes in the Human Resources may not be recorded in accounting but are, nonetheless,
very important factors in running a business.

2. Accuracy of information generated by accounting system: Financial health of a business,

including revenues, losses, assets and liabilities, are analysed by Accounting. During the
analysis accountants rely on both real and assumed estimates. The methods of determining
depreciation and valuating stocks may differ from business to business as each has their
own standard practices and provisions.

3. Value of assets: The true market value of the assets is not normally reflected in balance
sheets. The assets shown on the balance sheet have their costs adjusted according to the
conventional rules of accounting. Furthermore, many assets enlisted in a balance sheet do
not have any real market value at all. These assets may include patents, goodwill,
preliminary expenses, etc. When these assets are shown on the balance sheet, the final
results may appear dubious.

4. Window dressing: Many firms adopt actions described as window dressing practices in
order to increase profits in the short term. These actions may include postponing the
maintenance of plant and machinery, which will decrease costs and increases profitability in
the short term but, such a strategy can lead to a complete disruption in production and
operations when the machinery breaks down.

5. Changing price levels: Accounting measures of performance and evaluation of financial

position may not be accurate due to changing prices and changes in the value of assets.
Additional information based on the current replacement value of assets is required to get a
closer estimate.

iii. What types of activities are includeed in data evaluation?

Data creation and collection provides the basis for financial statements and accounting
records. Historic data refers to the transactions that have already occurred. In the past,
accounting relied more on historic data rather than predicting for the future.

Once data is collected, it is recorded in the books of original entry, which is also called
journals and ledgers, in accordance with Generally Accepted Accounting Principles. These
principles provide a framework and standards according to which data has to be recorded.
The recording and processing of data can be manual, mechanical, or electronic.

Data evaluation controls the business activities through budgets and standard costs,
evaluating the performance of the business, analysing financial statements, analysing cash
flows, and choosing alternative courses of action for decision-making process. Evaluation of
data is one of the most important business activities.

The analytical and interpretative aspect of accounting has a wide range of internal and
external uses, from producing snap answers to elaborate reports based on extensive
research. It also includes capital project analysis, budgetary projections, financial forecasts,
and research based analysis for reorganization, takeovers, and mergers.

Audit is the verification of financial transactions as recorded in account books and the
authentication of financial statements. Professional accountants and auditors are hired for
auditing the financial accounts of businesses to keep track of financial flows and point out any
lapses or fraud.

Data reporting can be internal or external. Internal data reporting is the communication of
financial statements, analysis, and evaluation to the management for decision-making.
External data reporting communicates the business’s financial position and its earnings to
outside parties such as the government, shareholders, regulatory bodies, other businesses, etc.
The primary purpose of Accounting Theory is to match the costs (efforts) and revenues
(accomplishments) of a business within a particular period. However, modern day accounting
has moved beyond the sole purpose of record keeping and emphasizes on evaluation and
forecasting of financial information.
Outline the main functions of accounting considering the following
groups;

 Lenders

 Employees

 Customers Please suggest information that each one is likely to need

from accounting statements and reports.
Employees: Business organisation has moved beyond just maximising profits for
shareholders to ensuring the welfare of its employees. The economic and social role of
managers has undergone a shift as management theories have progressed. There is a
realisation that a satisfied and highly motivated workforce is the most efficient and
productive as well. Industrial democracy where there is greater participation of employees
in managerial decision-making and more emphasis on employee feedback has taken the
place of a more autocratic managerial style which focussed on maximising output.
Therefore, employees are considered important users of the company’s financial
information, as their input is required for matters such as settlement of wages, bonuses,
output benchmarks, and profit sharing.

Consumers and others: Consumers’ groups and other organisations, which look after welfare
of consumers and public, use information generated by accounting for several reasons.
Through this accounting information, these organisations can analyse and keep a check on
the performance and efficiency of businesses. The information also gives an insight into
social responsibility of businesses. By looking at various accounting information, including
profits and outputs generated by businesses, the consumers’ organisations can also keep a
track of the growth of businesses and find out whether they are in line with the defined
national goals.

It

Legal Requirement function: Registered firms are legally obligated to carry out auditing.
Auditing cannot take place without accounting. Therefore, in order to meet legal
requirements accounting is mandatory. Accounting is a foundation, which can help to
generate returns, documents, statements, etc.

2. Discuss the role of accountants in modern business organisations.

Stewardship Accounting
The basis of financial reporting, which involves recording day - to - day business transactions
in journals, which is also called book-keeping, has its roots in earlier times when wealthy
people hired stewards to maintain accounts and manage their properties. Accounts were
submitted by the stewards to their owners periodically.

Modern day practice of “double entry book-keeping” was introduced by Italian merchants
during the 15th century and was adopted by other European countries during the 19th
century. Therefore, stewardship accounting originated from the need of business owners to
keep a record of their transactions, their properties, the debts they owed, and the money they
lent, etc.

Financial Accounting began as businesses expanded and Joint Stock Companies (companies
which enable the public to buy shares in the business in exchange for a particular percentage
of the company’s earnings) emerged. It was during this time that the need to invest savings
into profitable ventures was recognized and investors started seeking information to help
them with their investment decisions. Financial Accounting gave investors a list of
alternatives to their investment decisions, which helped them minimise the risk of investment.

Financial accounting is based on income statement and balance sheet. A company’s income
statement records the profit or loss made during the year while its balance sheet indicates the
company’s assets and liabilities. Income statement and balance sheet are required for
financial evaluation and projection. As per the law, it is mandatory for companies to maintain
financial statements and disclose information. Generally, companies are unwilling to disclose
more than necessary information, which has led to some governments extending the disclosure
( of information) requirements.

Cost Accounting

Industrial Revolution in England threatened the ability of accounting to act as a tool for
management in making efficient decisions. There was an inclination during that period to
move towards a more scientific approach to management. Therefore, cost accounting was
developed to give industrial management the techniques to minimise costs and attain
efficiency. Cost Accounting incorporates the application of costing principles and methods to
ascertain costs so that management is able to control them and assess the profitability of their
decisions. Cost Accounting became an important aspect of running an efficient enterprise.

Management Accounting Management Accounting took managerial decision-making beyond

the 20th century practice of relying on information from financial statements. Management
Accounting prepares and presents accounting information, which is meant to help the
management in policy formulation and decision-making. It enables management to control
various routine and non-routine operations that affect the business enterprise.
 Management Accounting gives managers the techniques to get information and achieve the
goals that they are accountable for. Therefore, accounting has broadened its horizon from
simply recording and analysing financial statements to providing information that affects
future decisions. While Financial Accounting produces reports that conform to a standard,
generally, accepted framework, management accounting produces internal reports, which do
not have to be according to such guidelines.

Social Responsibility Accounting

Social scientists, social workers, and the society, in general, are laying emphasis on the social
and environmental outcome of industrialization. Businesses are no longer concerned only with
increasing profitability. They have to take into account the fact that they will be held
responsible for the social

impact of their decisions. Social Responsibility Accounting goes beyond evaluating economic
outcomes from business decisions to focus on the social effects as well.

In the last two decades, the harmful effects of industrialisation, on the environment and on
society, have been highlighted therefore businesses cannot be concerned only with maximising
profits by analysing their financial statements and balance sheets. Social Responsibility
Accounting helps management in taking steps that are not only economically profitable but
socially responsible, as well.

Human Resource Accounting

Human Resource Accounting (HRA) identifies and measures data regarding the company’s
human resource and communicates it to interested parties. Hermansson made the first
attempt to include human capital figures in the balance sheet in 1964. With the emergence of
“Knowledge Economy,” in the 1990s, there has been a greater emphasis on recognising human
capital in addition to physical capital.

Human Resource Accounting acknowledges the contribution of a business entity’s employees

and its intellectual assets in increasing profitability. Therefore, HRA accounts for investing in
people, replacement costs of human assets, and the economic value of human resource for the
business. Methods of HRA include assigning costs and economic value to human capital
although it is very hard to express information on an organisation’s human resource in
numbers and figures. HRA is an effective managerial tool that provides managers with
information regarding their employees and helps them make decisions regarding investment
in manpower.

Inflation Accounting
Accounting records original costs of assets in financial statements, which means that increases
in the prices over time are not taken into account, which sometimes results in inaccuracies.
Inflation accounting deals with adjustment of the value of current and fixed assets to the
changes in prices. Ignoring the effect of rising prices causes overstatement of profits and
inflation accounting provides different methods to remove this distortion.