Reference study Materials

Definition of Accounting

Definition by the American Institute of Certified Public Accountants (Year 1961):

“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 result thereof”.
Definition by the American Accounting Association (Year 1966):
“The process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by the users of accounting”.

Objectives of Accounting

(i) Providing Information to the Users for Rational Decision-making

The primary objective of accounting is to provide useful information for decision-making to
Stakeholders such as owners, management, creditors, investors, etc. Various outcomes of
business activities such as costs, prices, sales volume, value under ownership, return of
investment, etc. are measured in the accounting process. All these accounting measurements are
used by stakeholders (owners, investors, creditors/bankers, etc.) in course of business operation.
Hence, accounting is identified as ‘language of business’.

(ii) Systematic Recording of Transactions

To ensure reliability and precision for the accounting measurements, it is necessary to keep a
systematic record of all financial transactions of a business enterprise which is ensured by
bookkeeping.
These financial records are classified, summarized and reposted in the form of accounting
measurements to the users of accounting information i.e., stakeholder.

(iii) Ascertainment of Results of above Transactions

‘Profit/loss’ is a core accounting measurement. It is measured by preparing profit and loss
account for a particular period. Various other accounting measurements such as different types of
revenue expenses and revenue incomes are considered for preparing this profit and loss account.
Difference between these revenue incomes and revenue expenses is known as result of business
transactions identified as profit/loss. As this measure is used very frequently by stockholders for
rational decision making, it has become the objective of accounting.
For example, Income Tax Act requires that every business should have an accounting system
that can measure taxable income of business and also explain nature and source of every item
reported in Income Tax Return.

(iv) Ascertain the Financial Position of Business

‘Financial position’ is another core accounting measurement. Financial position is identified by
preparing a statement of ownership i.e., Assets and Owings i.e., liabilities of the business as on
a certain date. This statement is popularly known as balance sheet. Various other accounting
measurements such as different types of assets and different types of liabilities as existed at a
particular date are considered for preparing the balance sheet. This statement may be used by
various stakeholders for financing and investment decision

(V) To Know the Solvency Position

Balance sheet and profit and loss account prepared as above give useful information to
stockholders regarding concerns potential to meet its obligations in the short run as well as in the
long run.

Function of Accounting
The main functions of accounting are as follows:
(a) Measurement: Accounting measures past performance of the business entity and depicts its
current financial position.
(b) Forecasting: Accounting helps in forecasting future performance and financial position of
the
enterprise using past data.
(c) Decision-making: Accounting provides relevant information to the users of accounts to aid
rational decision-making.
(d) Comparison & Evaluation: Accounting assesses performance achieved in relation to targets
and discloses information regarding accounting policies and contingent liabilities which play an
important role in predicting, comparing and evaluating the financial results.
(e) Control: Accounting also identifies weaknesses of the operational system and provides
feedbacks regarding effectiveness of measures adopted to check such weaknesses.
(f) Government Regulation and Taxation: Accounting provides necessary information to the
Government to exercise control on die entity as well as in collection of tax revenues.

Accounting – Classification
The various sub-fields of the accounting are:

Financial Accounting Determining the financial results for Stewardship Accounting

the period and the state of affairs on
the last day the accounting period.
Cost Accounting Information generation for Controlling Control Accounting
operations with a view to maximizing
efficiency and profit.
Management Accounting Accounting to assist management in Decision Accounting
planning and decision making.
(a) Financial Accounting
It is commonly termed as Accounting. The American Institute of Certified Public Accountants
defines Accounting as “an art of recoding, 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.”
(b) Cost Accounting
According to the Chartered Institute of Management Accountants (CIMA), Cost Accountancy is
defined as “application of costing and cost accounting principles, methods and techniques to the
science, art and practice of cost control and the ascertainment of profitability as well as the
presentation of information for the purpose of managerial decision-making.”
(c) Management Accounting
Management Accounting is concerned with the use of Financial and Cost Accounting
information to managers within organizations, to provide them with the basis in making
informed business decisions that would allow them to be better equipped in their management
and control functions.

Steps/Phases of Accounting Cycle

The steps or phases of accounting cycle can be developed as under:

(a) Recording of Transaction : As soon as a transaction happens it is at first recorded in

subsidiary book.
(b) Journal : The transactions are recorded in Journal chronologically.
(c) Ledger : All journals are posted into ledger chronologically and in a classified manner.
(d) Trial Balance : After taking all the ledger account closing balances, a Trial Balance is
prepared at the end of the period for the preparations of financial statements.
(e) Adjustment Entries : All the adjustments entries are to be recorded properly and adjusted
accordingly before preparing financial statements.
(f) Adjusted Trial Balance : An adjusted Trail Balance may also be prepared.
(g) Closing Entries : All the nominal accounts are to be closed by the transferring to Trading
Account and Profit and Loss Account.
(h) Financial Statements : Financial statement can now be easily prepared which will exhibit
the true financial position and operating results.

Important Terminologies
(i) Transaction: It means an event or a business activity which involves exchange of money or
money’s worth between parties. The event can be measured in terms of money and changes the
financial position of a person e.g. purchase of goods would involve receiving material and
making payment or creating an obligation to pay to the supplier at a future date. Transaction
could be a cash transaction or credit transaction. When the parties settle the transaction
immediately by making payment in cash or by cheque, it is called a cash transaction. In credit
transaction, the payment is settled at a future date as per agreement between the parties.

(ii) Goods/Services: These are tangible article or commodity in which a business deals. These
articles or commodities are either bought and sold or produced and sold. At times, what may be
classified as ‘goods’ to one business firm may not be ‘goods’ to the other firm. e.g. for a machine
manufacturing company, the machines are ‘goods’ as they are frequently made and sold. But for
the buying firm, it is not ‘goods’ as the intention is to use it as a long term resource and not sell
it. Services are intangible in nature which are rendered with or without the object of earning
profits.
(iii) Profit: The excess of Revenue Income over expense is called profit. It could be calculated
for each transaction or for business as a whole.
(iv) Loss: The excess of expense over income is called loss. It could be calculated for each
transaction or for business as a whole.

(v) Asset: Asset is a resource owned by the business with the purpose of using it for generating
future profits. Assets can be Tangible and Intangible. Tangible Assets are the Capital assets
which have some physical existence. They can, therefore, be seen, touched and felt, e.g. Plant
and Machinery, Furniture and Fittings, Land and Buildings, Books, Computers, Vehicles, etc.