3.
Definition of accounting
4.
Scope and functions of accounting
5.
Groups interested in accounting information
6.
The profession of accounting
7.
Specialized accounting fields
8.
Nature and meaning of accounting principles
9.
Accounting concepts
10.
Accounting conventions
11. Summary
12.
Key words
13.
Self assessment questions
1.1.3.1 Evolution Of Accounting
Accounting is as old as money itself. It has evolved, as have medicine,
law and most other fields of human activity in response to the social and
economic needs of society. People in all civilizations have maintained
various types of records of business activities. The oldest known are
clay tablet records of the payment of wages in babylonia around 600 b.c.
accounting was practiced in india twenty-four centuries ago as is clear
from kautilya’s book ‘arthshastra’ which clearly indicates the existence and
need of proper accounting and audit.
For the most part, early accounting dealt only with limited aspects
of the financial operations of private or governmental enterprises.
Complete accounting system for an enterprise which came to be called
as “double entry system” was developed in italy in the 15th century. The
first known description of the system was published there in 1494 by a
franciscan monk by the name luca pacioli.
The expanded business operations initiated by the industrial
revolution required increasingly large amounts of money which in turn
resulted in the development of the corporation form of organizations.
As corporations became larger, an increasing number of individuals and
institutions looked to accountants to provide economic information about
these enterprises. For e.g. Prospective investors and creditors sought
information about a corporation’s financial status. Government agencies
required financial information for purposes of taxation and regulation.
Thus accounting began to expand its function of meeting the needs of
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relatively few owners to a public role of meeting the needs of a variety of
interested parties.
1.1.3.2 Book Keeping And Accounting
Book-keeping is that branch of knowledge which tells us how
to keep a record of business transactions. It is considered as an art of
recording systematically the various types of transactions that occur in a
business concern in the books of accounts. According to spicer and pegler,
“book-keeping is the art of recording all money transactions, so that
the financial position of an undertaking and its relationship to both its
proprietors and to outside persons can be readily ascertained”. Accounting
is a term which refers to a systematic study of the principles and methods
of keeping accounts. Accountancy and book-keeping are related terms; the
former relates to the theoretical study and the latter refers to the practical
work.
1.1.3.3 Definition Of Accounting
Before attempting to define accounting, it may be made clear that
there is no unanimity among accountants as to its precise definition.
Anyhow let us examine three popular definitions on the subject:
Accounting has been defined by the american accounting association
committee as:
“the process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by users of the
information”. This may be considered as a good definition because of its
focus on accounting as an aid to decision making.
The American Institute of Certified and Public Accountants Committee
on terminology defined accounting as:(AICPAC DEFINITION)
“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 ”. of all definitions available, this is the most acceptable one
because it encompasses all the functions which the modern accounting
system performs.
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Another popular definition on accounting was given by american
accounting principles board in 1970, which defined it as:
“accounting is a service society. Its function is to provide quantitative
information, primarily financial in nature, about economic entities that
is useful in making economic decision, in making reasoned choices among
alternative courses of action”.
This is a very relevant definition in a present context of business
units facing the situation of selecting the best among the various alternatives
available. The special feature of this definition is that it has designated
accounting as a service activity.
1.1.3.4 Scope And Functions Of Accounting
Individuals engaged in such areas of business as finance,
production, marketing, personnel and general management need not be
expert accountants but their effectiveness is no doubt increased if they
have a good understanding of accounting principles. Everyone engaged
in business activity, from the bottom level employee to the chief executive
and owner, comes into contact withaccounting. The higher the level of
authority and responsibility, the greater is the need for an understanding
of accounting concepts and terminology.
A study conducted in united states revealed that the most common
background of chief executive officers in united states corporations was
finance and accounting. Interviews with several corporate executives drew
the following comments:
“…… my training in accounting and auditing practice has been extremely
valuable to me throughout”. “a knowledge of accounting carried with it
understanding of the establishment and maintenance of sound financial
controls- is an area which is absolutely essential to a chief executive
officer” .
Though accounting is generally associated with business, it is
not only business people who make use of accounting but also many
individuals in non-business areas that make use of accounting data and
need to understand accounting principles and terminology. For e.g. An
engineer responsible for selecting the most desirable solution to a technical
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manufacturing problem may consider cost accounting data to be the
decisive factor. Lawyers want accounting data in tax cases and damages
from breach of contract. Governmental agencies rely on an accounting data
in evaluating the efficiency of government operations and for approving
the feasibility of proposed taxation and spending programs. Accounting
thus plays an important role in modern society and broadly speaking all
citizens are affected by accounting in some way or the other.
Accounting which is so important to all, discharges the following vital
functions:
1.Keeping Systematic Records:
This is the fundamental function of accounting. The transactions
of the business are properly recorded, classified and summarized into final
financial statements – income statement and the balance sheet.
2.Protecting The Business Properties:
The second function of accounting is to protect the properties
of the business by maintaining proper record of various assets and thus
enabling the management to exercise proper control over them.
3.Communicating The Results:
As accounting has been designated as the language of business, its
third function is to communicate financial information in respect of net
profits, assets, liabilities, etc., to the interested parties.
4.Meeting Legal Requirements:
The fourth and last function of accounting is to devise such a
system as will meet the legal requirements. The provisions of various laws
such as the companies act, income tax act, etc., require the submission of
various statements like income tax returns, annual accounts and so on.
Accounting system aims at fulfilling this requirement of law.
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It may be noted that the functions stated above are those of financial
accounting alone. The other branches of accounting, about which we
are going to see later in this lesson, have their special functions with the
common objective of assisting the management in its task of planning,
control and coordination of business activities. Of all the branches of
accounting, management accounting is the most important from the
management point of view.
As accounting is the language of business, the primary aim of
accounting, like any other language, is to serve as a means of communication.
Most of the world’s work is done through organizations – groups of people
who work together to accomplish one or more objectives. In doing its work,
an organization uses resources – men, material, money and machine and
various services. To work effectively, the people in an organization need
information about these sources and the results achieved through using
them. People outside the organization need similar information to make
judgments about the organization. Accounting is the system that provides
such information.
Any system has three features, viz., input, processes and output.
Accounting as a social science can be viewed as an information system,
since it has all the three features i.e., inputs (raw data), processes (men
and equipment) and outputs (reports and information). Accounting
information is composed principally of financial data about business
transactions. The mere records of transactions are of little use in making
“informed judgments and decisions”. The recorded data must be sorted
and summarized before significant analysis can be prepared. Some of
the reports to the enterprise manager and to others who need economic
information may be made frequently; other reports are issued only at
longer intervals. The usefulness of reports is often enhanced by various
types of percentage and trend analyses. The “basic raw materials” of
accounting are composed of business transactions data. Its “primary end
products” are composed of various summaries, analyses and reports.
The information needs of a business enterprise can be outlined and
illustrated with the help of the following chart:
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Chart Showing Types Of Information
Information
Non-quantitative Quantitative
Information Information
Accounting Non- accounting
Information Information
Operating Financial Management
Cost
Information Information Information Information
The chart clearly presents the different types of information
that might be useful to all sorts of individuals interested in the business
enterprise. As seen from the chart, accounting supplies the quantitative
information. The special feature of accounting as a kind of a quantitative
information and as distinguished from other types of quantitative
information is that it usually is expressed in monetary terms.
In this connection it is worthwhile to recall the definitions of
accounting as given by the american institute of certified and public
accountants and by the american accounting principles board.
The types of accounting information may be classified into four
categories: (1) operating information, (2) financial accounting information
(3) management accounting information and (4) cost accounting
information.
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Operating Information:
By operating information, we mean the information which is
required to conduct the day-to-day activities. Examples of operating
information are: amount of wages paid and payable to employees,
information about the stock of finished goods available for sale and each
one’s cost and selling price, information about amounts owed to and owing
by the business enterprise, information about stock of raw materials, spare
parts and accessories and so on. By far, the largest quantity of accounting
information provides the raw data (input) for financial accounting,
management accounting and cost accounting.
Financial Accounting:
Financial accounting information is intended both for owners and
managers and also for the use of individuals and agencies external to the
business. This accounting is concerned with the recording of transactions
for a business enterprise and the periodic preparation of various reports
from such records. The records may be for general purpose or for a special
purpose. A detailed account of the function of financial accounting has
been given earlier in this lesson.
Management Accounting:
Management accounting employs both historical and estimated
data in assisting management in daily operations and in planning for
future operations. It deals with specific problems that confront enterprise
managers at various organizational levels. The management accountant
is frequently concerned with identifying alternative courses of action
and then helping to select the best one. For e.g. The accountant may help
the finance manager in preparing plans for future financing or may help
the sales manager in determining the selling price to be fixed on a new
product by providing suitable data. Generally management accounting
information is used in three important management functions: (1) control
(2) co-ordination and (3) planning. Marginal costing is an important
technique of management accounting which provides multi dimensional
information that facilitates decision making.
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Cost Accounting:
The industrial revolution in england posed a challenge to
the development of accounting as a tool of industrial management.
This necessitated the development of costing techniques as guides to
management action. Cost accounting emphasizes the determination and
the control of costs. It is concerned primarily with the cost of manufacturing
processes. In addition, one of the principal functions of cost accounting
is to assemble and interpret cost data, both actual and prospective, for the
use of management in controlling current operations and in planning for
the future.
All of the activities described above are related to accounting and
in all of them the focus is on providing accounting information to enable
decisions to be made. More about cost accounting can be gained in unit v.
1.1.3.5
Groups Interested In Accounting Information:
OR
USERS OF ACCOUNTING INFORMATION:
There are several groups of people who are interested in the
accounting information relating to the business enterprise. Following are
some of them:
Shareholders:
Shareholders as owners are interested in knowing the profitability
of the business transactions and the distribution of capital in the form of
assets and liabilities. In fact, accounting developed several centuries ago
to supply information to those who had invested their funds in business
enterprise.
Management:
With the advent of joint stock company form of organization the
gap between ownership and management widened. In most cases the
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Potential Investors:
An individual who is planning to make an investment in a business
would like to know about its profitability and financial position. An
analysis of the financial statements would help him in this respect.
Creditors:
As creditors have extended credit to the company, they are much
worried about the repaying capacity of the company. For this purpose they
require its financial statements, an analysis of which will tell about the
solvency position of the company.
Government:
Any popular government has to keep a watch on big businesses
regarding the manner in which they build business empires without regard
to the interests of the community. Restricting monopolies is something
that is common even in capitalist countries. For this, it is necessary that
proper accounts are made available to the government. Also, accounting
data are required for collection of sale-tax, income-tax, excise duty etc.
Employees:
Like creditors, employees are interested in the financial statements
in view of various profit sharing and bonus schemes. Their interest may
further increase when they hold shares of the companies in which they are
employed.
Researchers:
Researchers are interested in interpreting the financial statements
of the concern for a given objective.
Citizens:
Any citizen may be interested in the accounting records of business
enterprises including public utilities and government companies as a voter
and tax payer.
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1.1.3.6 The Profession Of Accounting
Accountancy can very well be viewed as a profession with
stature comparable to that of law or medicine or engineering. The rapid
development of accounting theory and techniques especially after the
late thirties of 20th century has been accompanied by an expansion of
the career opportunities in accounting and an increasing number of
professionally trained accountants. Among the factors contributing to this
growth has been the increase in number, size and complexity of business
enterprises, the imposition of new and increasingly complex taxes and
other governmental restrictions on business operations.
Coming to the nature of accounting function, it is no doubt a
service function. The chief of accounting department holds a staff position
which is quite in contra - distinction to the roles played by production or
marketing executives who hold line authority. The role of the accountant
is advisory in character. Although accounting is a staff function performed
by professionals within an organization, the ultimate responsibility
for the generation of accounting information, whether financial or
managerial, rests with management. That is why one of the top officers of
many businesses is the financial controller. The controller is the person
responsible for satisfying other managers’ demands for management
accounting information and for complying with the regulatory demands
of financial reporting. With these ends in view, the controller employs
accounting professionals in both management and financial accounting.
These accounting professionals employed in a particular business firm
are said to be engaged in private accounting. Besides these, there are also
accountants who render accounting services on a fee basis through staff
accountants employed by them. These accountants are said to be engaged
in public accounting.
1.1.3.7 Specialised Accounting Fields
As in many other areas of human activity, a number of specialized
fields in accounting also have evolved besides financial accounting.
Management accounting and cost accounting are the result of rapid
technological advances and accelerated economic growth. The most
important among them are explained below:
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Tax Accounting:
Tax accounting covers the preparation of tax returns and the
consideration of the tax implications of proposed business transactions
or alternative courses of action. Accountants specializing in this branch of
accounting are familiar with the tax laws affecting their employer or clients
and are up to date on administrative regulations and court decisions on
tax cases.
International Accounting:
This accounting is concerned with the special problems associated
with the international trade of multinational business organizations.
Accountants specializing in this area must be familiar with the influences
that custom, law and taxation of various countries bring to bear on
international operations and accounting principles.
Social Responsibility Accounting:
This branch is the newest field of accounting and is the most
difficult to describe concisely. It owes its birth to increasing social
awareness which has been particularly noticeable over the last three
decades or so. Social responsibility accounting is so called because it not
only measures the economic effects of business decisions but also their
social effects, which have previously been considered to be immeasurable.
Social responsibilities of business can no longer remain as a passive chapter
in the text books of commerce but are increasingly coming under greater
scrutiny. Social workers and people’s welfare organizations are drawing the
attention of all concerned towards the social effects of business decisions.
The management is being held responsible not only for the efficient
conduct of business as reflected by increased profitability but also for what
it contributes to social well-being and progress.
Inflation Accounting:
Inflation has now become a world-wide phenomenon. The
consequences of inflation are dire in case of developing and underdeveloped
countries. At this juncture when financial statements or reports are based
on historical costs, they would fail to reflect the effect of changes in
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purchasing power or the financial position and profitability of the firm.
Thus, the utility of the accounting records, not taking care of price level
changes is seriously lost. This imposes a demand on the accountants for
adjusting financial accounting for inflation to know the real financial
position and profitability of a concern. Thus emerged a future branch
of accounting called inf