A guide to the accounting discipline


Role of Accounting

Accounting is not an end in itself; it is a means to an end. It performs the service activity by providing quantitative financial information that helps the users in making better business decisions. Accounting also describes and analyses the mass of data of an enterprise through measurement, classification, and summarization, and reduces that data into reports and statements, which show the financial condition and results of operations of that enterprise. Accounting as an information system collects processes and communicates information about an enterprise to a wide variety of interested parties.

Differences between Accounting and Book-Keeping

Book keeping usually involves only the recording of business transactions (transactions) and is therefore, just one part of the accounting process. Accounting on the other hand, involves the entire accounting process, i.e. identification, measurement, recording, and communication. Now-a-days, much of the book keeping function is performed by the computer and other machines.

Objectives of Accounting

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The basic objective of accounting is to provide information to the interested users to enable them to make business decisions. The necessary information, particularly in the case of external users, is provided in the basic financial statements: Profit and loss statement and Balance sheet.

Besides the above sources of information, the internal users, officers and staff of the enterprise, can obtain additional information from the records of business. Thus the primary objectives of accounting can be stated as :

Maintenance of Records of Business transactions.

Calculation of Profit or Loss

Depiction of Financial Position.

Provide Information to the Users

Maintenance of Records of Business

First record, then pay; if there is an error, trace it from the records. Human memory is short. Even the most brilliant executive or manager cannot accurately remember what he might have observed regarding the daily operations. He need not strain his memory unnecessarily, if proper and complete records of all business transactions are kept regularly. More-over, records can be used by different officials for different decision-making purposes.

Calculation of Profit or Loss

Earning profit is the main purpose for which a business is carried on. This information is available from the profit and loss statement. Profit is calculated by deducting expenses from the associated revenues. Profit is a measure of the performance of the enterprise.

Depiction of Financial Position

A balance sheet depicts the financial position of an enterprise. It is a statement of assets and liabilities. It shows the resources (assets) owned by an enterprise and depicts the claims (liabilities) against the resources. The balance of assets minus the external liabilities shows the capital (owner's equity).

Provide Information to the Users

Generation of information is not an end in itself. It is a means to facilitate the dissemination of information among different user groups. Therefore, communication of information is the essential function of accounting. Accounting information is communicated in the form of reports, statements, graphs and charts to the internal and external users who need it in different decision situations.

Internal users: The officers and staff of an enterprise need useful and timely information for making different types of business decisions. A major objective of accounting is to provide management with relevant and reliable information. For example, some of the questions a manager might ask are:

How much profit did the company make during the last accounting period?

Is the return to share holders adequate?

How can it be improved?

Does the company have enough cash on hands to pay debts when they fall due?

What are the projected cash needs in the next quarter?

Which are the most profitable products?

What is the cost of manufacturing each product?

Which costs exceed the budget?

How much money should be borrowed to expand the business?

External users: The outside users have limited authority, ability or resources to obtain information. Unlike internal users, they have to rely on financial statements (Balance sheet, Profit and Loss statement) as their principal source of information about an enterprise's economic activity. Primarily the external users are interested in the following:

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The amount and the time when they are likely to receive cash in the future from dividend, interest etc.

Reliable information about economic resources (assets) and obligations (liabilities) of a business enterprise in order to evaluate its strengths and weaknesses, and its financial position in general.

Information about the performance and the earning power of the business enterprise.

Any other information relevant to the users needs.

Limitations of Accounting

Accounting records relate to the past transactions, which provide fairly good account of the economic activity of the business enterprise. However, from decision-making viewpoint we need information, which relates not only to past but also about present and future. Financial accounting makes provision for financial information but it does not provide non-financial information such as behavioral and socio-economic. If the objective of accounting reports is to influence the behavior through decision-making then it must provide the data concerning the behavior and outcome of human activity to facilitate performance evaluation. Therefore, the accounting information does not fully meet different types of information-requirements of varied decision making situations. Accounting provides stewardship information and not decisional information.