Objectives and Limitations of Accounting
Meaning of Accounting:
Accounting is a systematic process that involves identifying, measuring, recording, and communicating crucial information about an organization’s economic events to its interested stakeholders. It plays a pivotal role in providing quantitative data—primarily financial in nature—about economic entities, aimed at aiding informed economic decisions.
Definitions of Accounting:
According to the American Accounting Association (AAA):
"Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information."
The American Institute of Certified Public Accountants (AICPA) defines accounting as:
"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."
Functions of Accounting
The functions of Accounting can be explained on the basis of the activities undertaken during the Accounting Process followed:
- Financial Transactions:
Accounting begins with managing various financial transactions such as sales, purchases, and expenses, often symbolized by relevant icons or figures. - Identification:
The first step is identifying which financial events should be recorded in the books of accounts. This involves observing all business activities and selecting transactions that are classified as financial. - Measurement:
Only transactions that can be quantified in monetary terms are recorded. Events without measurable financial value are excluded from accounting. - Recording:
Transactions considered as economic events are documented in monetary terms, following a chronological order. This step, known as the preparation of a Journal, ensures organized bookkeeping. - Classifying:
Recorded financial transactions are grouped based on their nature and compiled into separate accounts, a process called the preparation of the Ledger. - Summarizing:
The next function involves summarizing data, beginning with ledger balances and preparing a Trial Balance. The Trial Balance serves as a foundation for creating financial statements, commonly known as Final Accounts i.e. the Trading Account, Profit & Loss Account, and Balance Sheet. - Analyzing:
Financial analysis involves examining and interpreting financial data to assess performance, trends, and overall health. This includes reviewing:
- Income Statement: Evaluating revenue, expenses, and profit for a specific period.
- Balance Sheet: Analyzing assets, liabilities, and equity at a particular point in time.
- Cash Flow Statement: Tracking cash inflows and outflows across operational, investing, and financing activities
8. Communication or Reporting:
The ultimate aim of accounting is to deliver financial information to users like stakeholders, regulators, and tax authorities. This regular communication helps them analyze the data for their specific needs and make informed financial decisions.
Objectives and Limitations of Accounting
Accounting as a Source of Information
(Need of Accounting Information by different users)
Accounting serves as a vital source of qualitative information—primarily financial in nature—about economic entities. This information is crucial for making sound economic decisions and caters to a diverse group of users, as detailed below:
- Management:
Managers require timely information on aspects like cost of sales and profitability to plan, control, and make strategic decisions. - Investors and Potential Investors:
Financial data provides insights into the risks and returns associated with investments, helping investors assess the viability of their decisions. - Unions and Employee Groups:
Information on financial stability, profitability, and wealth distribution assists unions and employees in negotiations and understanding the organization’s well-being. - Lenders and Financial Institutions:
Lenders evaluate the creditworthiness of the business and its ability to repay loans or meet interest obligations through financial statements. - Suppliers and Creditors:
Suppliers use financial information to gauge the company’s ability to settle outstanding payments and ensure long-term business viability. - Customers:
Financial statements assure customers of the organization’s continuity, securing the future supply of products, parts, or after-sales services. - Government and Regulatory Bodies:
Authorities rely on financial data to monitor resource allocation and ensure compliance with legal and regulatory standards. - Social Responsibility Groups:
Groups such as environmental organizations review financial information to assess the company’s impact on the environment and its commitment to sustainable practices. - Competitors:
Competitors utilize accounting data to benchmark against industry standards and identify the relative strengths and weaknesses of their rivals.
Users of Financial Statements
- Internal Users:
Internal users include owners, shareholders or investors, employees, and management. They rely on financial statements to make informed decisions regarding the organization’s operations and strategies. - External Users:
External users consist of entities such as regulatory agencies, labor unions, stock exchanges, the public, and others. These users depend on financial information to understand the organization's financial standing and compliance.
Objectives and Limitations of Accounting