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:

1. Financial Transactions:
   Accounting begins with managing various financial transactions such as sales, purchases, and expenses, often symbolized by relevant icons or figures.
2. 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.
3. Measurement:
   Only transactions that can be quantified in monetary terms are recorded. Events without measurable financial value are excluded from accounting.
4. 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.
5. Classifying:
   Recorded financial transactions are grouped based on their nature and compiled into separate accounts, a process called the preparation of the Ledger.
6. 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.
7. 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:

1. Management:
   Managers require timely information on aspects like cost of sales and profitability to plan, control, and make strategic decisions.
2. Investors and Potential Investors:
   Financial data provides insights into the risks and returns associated with investments, helping investors assess the viability of their decisions.
3. 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.
4. Lenders and Financial Institutions:
   Lenders evaluate the creditworthiness of the business and its ability to repay loans or meet interest obligations through financial statements.
5. Suppliers and Creditors:
   Suppliers use financial information to gauge the company’s ability to settle outstanding payments and ensure long-term business viability.
6. Customers:
   Financial statements assure customers of the organization’s continuity, securing the future supply of products, parts, or after-sales services.
7. Government and Regulatory Bodies:
   Authorities rely on financial data to monitor resource allocation and ensure compliance with legal and regulatory standards.
8. 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.
9. Competitors:
   Competitors utilize accounting data to benchmark against industry standards and identify the relative strengths and weaknesses of their rivals.

Users of Financial Statements

1. 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.
2. 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

Objectives of Accounting

1. Maintaining Systematic Records:
   The primary goal of accounting is to systematically document business transactions. This involves first recording all financial transactions in the Journal and subsequently transferring them to the Ledger.
2. Error and Fraud Prevention:
   Accounting serves as a tool to prevent and detect potential errors or fraudulent activities within an organization.
3. Profit and Loss Determination:
   One of the key roles of accounting is to determine the profit or loss incurred during a specific period through the preparation of financial statements like the Trading Account and Profit and Loss Account.
4. Assessing Financial Position:
   Accounting aims to evaluate the financial position of a business by analyzing its assets and liabilities at the end of each accounting period.
5. Providing Financial Information:
   Accounting facilitates the regular provision of financial information to its users, such as stakeholders, regulators, and other interested parties, aiding them in making informed decisions.

Advantages of Accounting

1. Provides Information on Financial Performance:
   Accounting delivers factual insights into a business's financial performance over a specific period, such as the profit earned or loss incurred, as well as the financial position at a given point in time.
2. Assists Management:
   By offering detailed financial reports, accounting helps management in planning, decision-making, and exercising control over the business operations.
3. Facilitates Comparative Analysis:
   Systematic record-keeping and regular preparation of reports enable businesses to make meaningful comparisons across different periods or with other entities.
4. Aids in Tax Settlement:
   Well-maintained accounting records simplify the settlement of various tax liabilities, including income tax, GST, and more.
5. Supports Loan Procurement:
   Financial statements, derived from accurate accounting, play a crucial role in securing loans from banks and financial institutions, as they assess the financial health of the business.
6. Enhances Decision-Making:
   Accounting provides valuable financial data that supports informed decision-making by the management team.
7. Replaces the Need for Memory-Based Accounting:
   Systematic records eliminate the dependency on memory for tracking transactions, allowing for quick and easy reference as needed.
8. Provides Evidence in Legal Cases:
   Properly maintained accounting records serve as documentary evidence in court during disputes or legal proceedings.
9. Facilitates Business Sale:
   When selling a business, accounting records help determine an accurate and fair purchase price for the entity.

Limitations of Accounting

1. Lack of Precision:
   Accounting is not entirely free from personal bias or judgment, which can impact the accuracy of financial statements.
2. Historic Valuation of Assets:
   Accounting records assets based on their historical cost minus depreciation, which may not reflect their current market value.
3. Excludes the Impact of Price Level Changes:
   Since financial statements are prepared using historical costs, changes in the value of money or inflation are not accounted for.
4. Ignores Qualitative Aspects:
   Accounting focuses solely on monetary transactions and does not account for qualitative factors such as employee satisfaction or customer relationships.
5. Window Dressing:
   Financial statements can be manipulated to present a more favorable picture of the business's financial position than what actually exists.

Objectives and Limitations of Accounting

 Qualitative Characteristics of Accounting Information

1. Reliability:
   Reliable accounting information ensures users can depend on its accuracy and truthfulness. The reliability is determined by how well the information aligns with the actual transactions or events it represents, as well as how accurately these are measured and displayed.
2. Relevance:
   Relevant information must be timely, provide value in making predictions, and offer feedback. It helps users by:

• Assisting in predicting the outcomes of past, present, or future events.
• Confirming or revising their prior evaluations of such events.

    3. Understandability:
Accounting information should be presented in a manner that is easy for decision-makers to interpret and understand. Effective communication plays a crucial role, as the clarity of the message determines whether users can accurately grasp its meaning.

   4. Comparability:
Beyond being relevant and reliable, financial information should allow users to compare different aspects of a business over various time periods or with other entities. This characteristic is essential for making informed evaluations and decisions.

The Role of Accounting

Role of Accounting can be explained in brief as under:

1. As a Language:
   Accounting is often regarded as the language of business. It serves as a medium to communicate crucial financial information about enterprises effectively.
2. As a Historical Record:
   It acts as a chronological record of an organization’s financial transactions, capturing the actual amounts involved and preserving the financial history of the business.
3. As a Reflection of Current Economic Reality:
   Accounting helps in assessing an entity’s income, reflecting changes in wealth over time and providing insights into its economic standing.
4. As an Information System:
   It functions as a system that connects the information provider (accountant) with information users (external stakeholders), enabling effective communication through organized financial data.
5. As a Commodity:
   Specialized financial information is viewed as a valuable service in today’s society. Accountants, equipped with the expertise to provide such information, play a critical role in meeting the demand for reliable data.

Branches of Accounting

1. Management Accounting:
   This branch focuses on aiding management in making informed policy decisions and evaluating the outcomes of these decisions. It provides critical data and insights to support strategic planning and operational efficiency.
2. Cost Accounting:
   Cost accounting specializes in analyzing and tracking expenditure to determine the costs of products or services. This helps businesses establish accurate pricing strategies, control expenses, and provide valuable costing data for managerial decision-making.
3. Financial Accounting:
   The primary objective of financial accounting is to maintain a comprehensive record of financial transactions. It serves three critical purposes:

• Calculating the profit or loss incurred by the business over a specific accounting period.
• Evaluating the financial position of the business by assessing its assets and liabilities at the end of the accounting period.
• Supplying essential financial information to management and other stakeholders for effective decision-making.

Objectives and Limitations of Accounting

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Then from there the transactions are recorded in the Journal, which is classified on the basis of similarity of transactions usually called subsidiary journals like; Purchases Day Book, Sales Day Book, Purchases Returns Book, Sales Returns Book, Bills Receivable Book, Bills Payable Book, Cash Book further taking the forms of simple cash book, double column cash book, triple column cash book, petty cash book, multi column cash book, etc. and Journal proper.

The next stage is, when entries passed in journal are further posted in Ledger. Ledger is set of accounts: real, personal as well as nominal accounts.

After posting all the journal entries to ledger, ledger accounts are balanced and from all the balances a summary statement known as Trial Balance is prepared to check the arithmetical accuracy of records.

Trial Balance is used to prepare the Final Accounts. From Trial Balance all the nominal accounts are taken to prepare Manufacturing account, Trading account and Profit and Loss account respectively as the case may be, and all the real and personal accounts are taken to prepare the Balance sheet.

Closing Balance Sheet of one accounting year becomes the Opening Balance Sheet of the next Accounting year. Then, next year transactions enter the accounting process and this cycle continues, making it Accounting Cycle.

Final accounts i.e. Trading Account, Profit and Loss Account and Balance Sheet are further analyzed with the help of accounting tools and techniques and then conclusions are drawn and then communicated to the interested parties for decision making.

                                                         CHART SHOWING ACCOUNTING PROCESS:

Accounting Cycle

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Basic Accounting Terms

One thing is sure that if a student understands all these terms, he will be able to study this subject easily and happily.

Entity is the basic unit for which accounting records are to be prepared.

e.g. Mohan Garments, Ankit Bros., Tata Ltd.

Capital is anything (cash, bank balance, stock etc.) invested by the proprietor in his business.

Liability is the amount owed by the business to the outsiders.

e.g. Loans, creditors, bank overdraft, outstanding expenses, Income received in advance.

Asset is the property of the business.

e.g. Cash, bank, stock, debtors, bills receivable, land, plant and machinery, building, furniture, computer, transport vehicles, go-down.

Equity means claim on something. It can be owner's equity or creditor's equity.

Capital is called owner's equity and

Liability is called creditor's equity.

Assets can be fixed assets or Current assets.

Fixed assets are kept for doing the business and not for re-sale.

e.g. Land &building, plant& machinery, furniture.

Current assets are kept for running day to day activities of the business.

e.g. cash, bank, stock, debtors, bills receivable, prepaid expenses.

Assets can be tangible assets or intangible assets.

Tangible assets are assets with physical existence.

e.g. Land & building, plant& machinery, furniture.

Intangible assets are assets without physical existence.

e.g. Goodwill, copyrights, trademarks, patents.

Liabilities can be current or non-current.

Current liabilities are the liabilities to be paid within a period of one year.

e.g. bank overdraft, outstanding expenses, creditors, bills payable.

Non-Current liabilities, popularly known as long term liabilities are to be paid after one year.

e.g. Loans for long term, debentures issued.

Liabilities can be internal or external.

Internal liabilities are to be paid by the business to its proprietor.

e.g. capital.

External liabilities are to be paid by the business to the outsiders.

e.g. liabilities towards outsiders.

Revenues are the total receipts out of sale of goods and/or services by the business.

e.g. sale of goods and services sold.

Goods are the articles in which the business deals.

e.g. computers for computer dealer, furniture for furniture dealer.

Purchases are purchase of goods for use or for resale.

Expenses are the total costs incurred by the business to generate Revenues.

e.g. salaries, wages, rent, electricity charges, water charges, audit fees, stationery, conveyance charges .

Loss is reduction in owner's equity or capital due to any reason .

e.g. loss of furniture by fire, loss of goods by theft.

Income is increase in the capital due to any reason.

Profit is the excess of revenues over costs for the same accounting period.

Gain is profit of irregular and non-recurrent nature.

Accounting period is the normal period of twelve months for which accounting records are to be prepared.

e.g. It can be calendar year i.e.1st January to 31st December or government financial year i.e. 1st April to 31st March next year.

Drawings mean anything taken out of the business, by the proprietor for his private use.

e.g. cash taken for party celebration at home, goods taken for household use.

Debtors are the persons who have purchased goods or services from the business on credit and the payment is due from them.

Creditors are the persons from whom goods or services have been purchased by the business on credit and the payment is due to be made.

More Accounting Terms

Bills receivable is a credit instrument accepted by the debtor, against which the payment is to be received by the business on a future date.

Bills payable is a credit instrument accepted by the business, to be paid on a future date.

Depreciation is the permanent, gradual, decrease in the book value of a fixed asset due to its normal and continuous use.

Appreciation is the increase in the book value of assets.

Bad debts Debtors becoming irrecoverable become bad debts.

Insolvent Person not in a position to repay his liabilities is said to be insolvent.

Account is the summary of transactions relating to a particular item of the business.

Transaction is the event affecting the position of goods, services and assets, liabilities and capital.

Transaction may be:

Cash transaction affects the position of cash/ bank balance of the business i.e. increasing or/and decreasing cash or/and bank balance.

e.g. purchased goods for cash, sold goods payment received by cheque.

Credit transaction creates debtor-creditor relationship.

e.g. sold goods to Ankit on credit payment will be received after two months.

Non-cash Transaction affecting the business but not affecting the cash/bank/debtor/creditor etc.

e.g. charging depreciation on building, appreciation in the value of land.

Stock Goods remaining unsold are called stock or inventory.

e.g. furniture, cement, garments.

Outstanding expenses are the expenses due but not paid.

e.g. salaries outstanding, wages outstanding.

Prepaid expenses are the expenses paid in advance.

e.g. salaries prepaid, wages prepaid.

Accrued income is the income that has been earned but not received.

e.g. accrued commission, rent accrued.

Income received in advance is the income which has not been earned but has been received.

e.g. rent received in advance, commission received in advance.

Trade discount is the discount on quantity of sales or purchases.

Cash discount is the discount to encourage early payments/collection.

Objectives and Limitations of Accounting

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Accounting Principles and Concepts

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