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Subject :Accounting for Managers Updated by:Dr. Mahesh Chand Garg

Course Code : CP-104
Lesson No. : 1

FINANCIAL ACCOUNTING : MEANING, NATURE AND ROLE

OF ACCOUNTING

STRUCTURE
1.0 Objective

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1.1 Introduction
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1.2 Origin and Growth of Accounting

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1.3 Meaning of Accounting

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1.4 Distinction between Book-Keeping and Accounting

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1.5 Distinction between Accounting and Accountancy

1.6 Nature of Accounting
1.7 Objectives of Accounting
1.8 Users of Accounting Information
1.9 Branches of Accounting
1.10 Role of Accounting
1.11 Limitations of Accounting

1.12 Systems of Accounting

1.13 Summary

1.14 Keywords

1.15 Self Assessment Questions

1.16 Suggested Readings

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1.0 OBJECTIVE

After reading this lesson, you should be able to

(a) Define accounting and trace the origin and growth of accounting.

(b) Distinguish between book-keeping and accounting.

(c) Explain the nature and objectives of accounting.

(d) Discuss the branches, role and limitations of accounting.

1.1 INTRODUCTION

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Accounting has rightly been termed as the language of the business.
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The basic function of a language is to serve as a means of communication

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Accounting also serves this function. It communicates the results of business

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operations to various parties who have some stake in the business viz., the
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proprietor, creditors, investors, Government and other agencies. Though

accounting is generally associated with business but it is not only business which
makes use of accounting. Persons like housewives, Government and other
individuals also make use of a accounting. For example, a housewife has to keep a
record of the money received and spent by her during a particular period. She can
record her receipts of money on one page of her "household diary" while payments
for different items such as milk, food, clothing, house, education etc. on some
other page or pages of her diary in a chronological order. Such a record will help
her in knowing about :

(i) The sources from which she received cash and the purposes for which it
was utilised.

(ii) Whether her receipts are more than her payments or vice-versa?

(iii) The balance of cash in hand or deficit, if any at the end of a period.
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In case the housewife records her transactions regularly, she can

collect valuable information about the nature of her receipts and payments. For
example, she can find out the total amount spent by her during a period (say a
year) on different items say milk, food, education, entertainment, etc. Similarly
she can find the sources of her receipts such as salary of her husband, rent from
property, cash gifts from her relatives, etc. Thus, at the end of a period (say a
year) she can see for herself about her financial position i.e., what she owns and
what she owes. This will help her in planning her future income and expenses (or
making out a budget) to a great extent.

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The need for accounting is all the more great for a person who is
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running a business. He must know : (i) What he owns? (ii) What he owes? (iii)
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Whether he has earn a profit or suffered a loss on account of running a business?

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(iv) What is his financial position i.e. whether he will be in a position to meet all
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his commitments in the near future or he is in the process of becoming a bankrupt.

1.2 ORIGIN AND GROWTH OF ACCOUNTING

Accounting is as old as money itself. However, the act of accounting

was not as developed as it is today because in the early stages of civilisation, the
number of transactions to be recorded were so small that each businessman was
able to record and check for himself all his transactions. Accounting was practised
in India twenty three centuries ago as is clear from the book named "Arthashastra"
written by Kautilya, King Chandragupta's minister. This book not only relates to
politics and economics, but also explain the art of proper keeping of accounts.
However, the modern system of accounting based on the principles of double entry
system owes it origin to Luco Pacioli who first published the principles of Double
Entry System in 1494 at Venice in Italy. Thus, the art of accounting has been
practised for centuries but it is only in the late thirties that the study of the subject
'accounting' has been taken up seriously.
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1.3 MEANING OF ACCOUNTING

The main purpose of accounting is to ascertain profit or loss during

a specified period, to show financial condition of the business on a particular
date and to have control over the firm's property. Such accounting records are
required to be maintained to measure the income of the business and communicate
the information so that it may be used by managers, owners and other interested
parties. Accounting is a discipline which records, classifies, summarises and
interprets financial information about the activities of a concern so that intelligent

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decisions can be made about the concern. The American Institute of Certified
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Public Accountants has defined the Financial Accounting as "the art of recording,
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classifying and summarising in as significant manner and in terms of money

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transactions and events which in part, at least of a financial character, and

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interpreting the results thereof". American Accounting Association defines

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accounting as "the process of identifying, measuring, and communicating economic

information to permit informed judgements and decisions by users of the
information.

From the above the following attributes of accounting emerge :

(i) Recording : It is concerned with the recording of financial transactions in

an orderly manner, soon after their occurrence In the proper books of accounts.

(ii) Classifying : It Is concerned with the systematic analysis of the recorded

data so as to accumulate the transactions of similar type at one place. This function
is performed by maintaining the ledger in which different accounts are opened to
which related transactions are posted.

(iii) Summarising : It is concerned with the preparation and presentation of

the classified data in a manner useful to the users. This function involves the
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preparation of financial statements such as Income Statement, Balance Sheet,

Statement of Changes in Financial Position, Statement of Cash Flow, Statement
of Value Added.

(iv) Interpreting : Nowadays, the aforesaid three functions are performed by

electronic data processing devices and the accountant has to concentrate mainly
on the interpretation aspects of accounting. The accountants should interpret the
statements in a manner useful to action. The accountant should explain not only
what has happened but also (a) why it happened, and (b) what is likely to happen

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under specified conditions.
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1.4 DISTINCTION BETWEEN BOOK-KEEPING AND ACCOUNTING

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Book-keeping is a part of accounting and is concerned with the

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recording of transactions which is often routine and clerical in nature, whereas

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accounting performs other functions as well, viz., measurement and

communication, besides recording. An accountant is required to have a much
higher level of knowledge, conceptual understanding and analytical skill than is
required of the book-keeper.

An accountant designs the accounting system, supervises and checks

the work of the book-keeper, prepares the reports based on the recorded data and
interprets the reports. Nowadays, he is required to take part in matters of
management, control and planning of economic resources.

1.5 DISTINCTION BETWEEN ACCOUNTING AND ACCOUNTANCY

Although in practice Accountancy and Accounting are used

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

1.6 NATURE OF ACCOUNTING

The various definitions and explanations of accounting has been

propounded by different accounting experts from time to time and the following

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aspects comprise the nature of accounting :
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i) Accounting as a service activity

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Accounting is a service activity. Its function is to provide quantitative

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information, primarily financial in nature, about economic entities that is intended

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to be useful in making economic decisions, in making reasoned choices among

alternative courses of action. It means that accounting collects financial
information for the various users for taking decisions and tackling business issues.
Accounting in itself cannot create wealth though, if it produces information which
is useful to others, it may assist in wealth creation and maintenance.

(ii) Accounting as a profession

Accounting is very much a profession. A profession is a career that

involve the acquiring of a specialised formal education before rendering any
service. Accounting is a systematized body of knowledge developed with the
development of trade and business over the past century. The accounting education
is being imparted to the examinees by national and international recognised the
bodies like The Institute of Chartered Accountants of India (ICAI), New Delhi in
India and American Institute of Certified Public Accountants (AICPA) in USA