Why Should We Study Accounting?

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Introduction to Double Entry Book-Keeping:

Every person performs some economic activities; the word ‘person’ is used here to mean individual, a family, commercial or non-commercial organisations, Central Government or State Governments or Local Self-Governments and any other body engaged in economic activities. Accounting is a language by which economic activities are translated and communicated to those who have interest about such economic activities and results thereof. Every person wants to know the result of his economic activities, i.e., whether such economic activities increase or decrease his wealth. More commonly if we are engaged in commercial operations always we want to know prof it or loss. Accounting is a discipline that systematically records all economic activities performed by a person and gives result thereof.

Accounting is not only necessary for business activities. This is essential for all types of economic activities, be it a business or non-business activity, and accounting serves the purposes of different user-groups.

An example may be given to highlight the use of accounting even in a family. Family members earn by different means: may be by way of salary, doing business, performing agricultural activities. A family spends for purchasing foodstuffs and clothings, paying school fees and for similar other items. At the end of the month, the family members may be interested to know the surplus that they have created which can be invested in a bank or elsewhere for future needs or for creation of family assets like building, car or furniture.

Take another example of a school; it collects fees from the students, makes payments to the teachers, purchases various stationery items. The school author­ity is interested to know surplus lying with it after a month or after a session that can be used for creation of assets for the school like building, swimming pool, playground, library books etc.

Take the third example of a Government; it collects taxes from its citizens and it deploys such money for payment of salaries to the employees and for financing various developmental activities for its citizens.

Lastly, take an example of a business woman; Terazzo invests money, purchases merchandise and sells such merchandise keeping a margin. She should know what profit she has earned or what loss she has sustained at the end of a particular period, and she also wants to see her financial position, i.e., what she owes to others, what others owe to her and what assets she has owns.

Accounting is a discipline emerged to answer all such questions and has emerged as an information system for economic activities. In the present society no one can think of performing economic activities without accounting. In many cases accounting for economic activities is made mandatory by legislations. For example, maintenance of accounts is statutorily required for a company. For sole-proprietorship and partnership firms maintenance of accounts becomes necessary for tax purposes. Accounting aids economic activities and economic activities of the society also flourish due to emergence of accounting.

Definition of Accounting:

Back in 1941 the Committee on Terminology of the American Institute of Accountants (presently American Institute of Certified Public Accountants or AICPA) gave the following definition of accounting: “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.”

This definition looked accounting from a narrow angle. Accounting is not simply a discipline that records, classifies and summarizes transactions and events as and when they occur and interprets the results of such recording, classifying and summarizing processes. Accounting has a much broader dimension. In fact, it is tuned up now-a-days to provide meaningful information to the users.

The American Accounting Association (AAA) formulated the following definition in 1966:

“Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.”

The Accounting Principles Board of the AICPA (U.S.A.) gave the following definition of accounting in 1970:

“Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about eco­nomic entities that is intended to be useful in making economic decisions.”

Many accounting academicians criticize all these definitions because these definitions explain what accountants do, but failed to state clearly the nature and scope of accounting. Presumably, anyone involved in the functions mentioned in these definitions are accountants. Regarding the first definition, the usual criticism is that financial analysts interpret accounting statements, but they are not accountants. About the second definition, it is said that economists also provide economic information, but they are not accountants. And about the third definition, it is said that the expression “to provide quantitative information, primarily of financial nature”, does not explain precisely accounting function. For example, Stock Exchange Authorities provide daily quotation of share prices which is quantitative information of financial nature but certainly these are not accounting information. So definition of accounting is somewhat inexact and its boundary is yet to be earmarked.

Despite the criticisms stated above the definition of the AAA (second definition) is widely accepted and seems to be more close to the prevailing accounting practices.

Entity, Transactions and Events:

Entity means an economic unit that performs economic activities. It may be an individual, a group of individuals, a business or non-business enterprise, a branch oradivision thereof, a Government either Central, State or local and similar other organisations.

An event is a happening of consequence to an entity. It may be an internal event that occurs within the entity, such as use of raw materials for production. Also it may be an external event that involves interaction between an entity and its environment, such as purchase of raw materials from other entity. Many events may arise out of combination of internal and external factors.

A transaction is a particular kind of external event that involves transfer of something of value between two entities. So all external events are not transac­tions. The transaction is an exchange in which each participant receives or sacrifices value.

Objectives of Accounting:

Objectives of accounting flows from its definition. The following are considered as its main objectives:

(i) Identification of transactions and events and measure­ment thereof;

(ii) Classification of transactions and events into appropriate heads;

(iii) Recording of classified transactions and events;

(iv) Preparation of reports and statements necessary to communicate to the users of accounts;

(v) Providing information relating to social cost incurred by the entity and social benefit created.

These objectives are carried out through various sub-fields of accounting.

Branches of Accounting:

Important branches of accounting are:

1. Financial Accounting:

The aim of this branch is to ascertain the profit or loss made during the period and to maintain financial control over firm’s property.

Financial accounting is the original form of accounting, and its aim is to establish the net result of the transactions entered into during a period, and to state the financial position of the concern at a particular date.

Financial accounting is a legal necessity, and is also necessary from tax requirements, safe­guarding shareholders, and is a stock exchange requirements.

Objectives:

Main objectives of financial accounting are:

(i) To maintain records of business.

(ii) Calculation of profit or loss.

(iii) To know the financial health of the firm.

(iv) To make financial information available to various groups and users, like owners, managers, investors, creditors, employees, government officials, research scholars etc.

Advantages:

1. Assist management to perform their functions,

(a) To help management in planning for next year regarding sales, output, expenses etc.

(b) To help management in decision making.

(c) To help management in controlling as to whether the work done is according to plan, and the cost is reasonable.

2. Provide systematic record of financial information.

3. Help in analysing and conducting comparative studies.

4. Help in correct settlement of Income Tax, Sales Tax and other taxes.

5. Help at the time of insolvency, amalgamation, bifurcation, or sale of business.

Source Documents (Supporting Documents):

Financial Accounting record contain financial information. All transactions should be evi­denced by documentary evidence. The business document is called source document or support­ing document, as it is an evidence in support of a transaction.

Most common source documents are:

1. Cash Memo:

This document results from cash transactions.

2. Invoice or Bill:

This is prepared when the business transactions relating to purchase or sale of goods are made on credit.

3. Receipt:

It is prepared and issued by a firm as a proof of receiving the cash.

4. Pay-in-slip:

It is a form used in banks for depositing the money.

5. Cheque.

6. Debit and Credit Notes.

Ledger:

Ledger is the book which contains accounts. This is most important book of accounts, and is called ‘Principal Book’, since final information pertaining to the financial position of a business emerges from this.

Ledger is defined as a “book which contains in a summarised and classified form a permanent record of all transactions.” The form of each account in the ledger is given below.

2. Cost Accounting:

The aim of this branch is to ascertain the cost incurred for carrying out the various activities and to enable management to exercise cost control.

In the current days of competition, it is necessary that a business concern should have utmost efficiency and minimum possible wastages and losses. In the past when manufacturers were limited and there was great shortage of goods, consumers have to buy whatever was offered to them and at a price which the sellers demand. But now wide range of choice is available to the consumers and it is the quality, utility and the price which help in taking the decision to buy.

Therefore, it is necessary that a business concern must continuously try to improve the quality of their products and utilities and to bring down costs and prices. There­fore, cost accounting helps the management of the business concern to constantly measure their performance objectives.

Cost accounting provides detailed analysis of the expenses incurred by a concern and the management can pin-point various weak spots and can know the places of losses. Having known the point of problem it becomes easy to take preventive steps.

Accounting as an Information System:

The term ‘system’ may be defined a set of elements which operate together in order to attain a goal. A system does not consist of random sets of elements but elements which may be identified as belonging together because of a common goal.

A system contains three activities:

(i) Input,

(ii) Processing of input, and

(iii) Output.

A business organisation is regarded as an open system which has a dynamic interplay with its environment from which it draws resources and to which it consigns its product and services.

Accounting comprises a series of activities linked together among themselves. The accounting activities form a progression of steps, beginning with observing, then collecting, recording, analysing and finally communicating information to its users.

In other words, accounting process involves the accumulation, analysis, measurement, interpretation, classification, and summarisation of the results of each of the many business transaction that affected the entity during the year.

After this processing, accounting then transmits or projects messages to potential decision-makers. The messages are in the form of financial statements, and the decision-makers are the users. Accounting generally does not generate the basic information (raw financial data) rather the raw financial data result from the day-to-day transactions of the enterprise.

As an information system, accounting links an information source or transmitter (generally the accountant), a channel of communication (generally the financial statements) and a set of receivers (external users). When accounting is looked upon as a process of communication, it is defined as “the process of encoding observations in the language of the accounting system, of manipulating the signs and statements of the systems and decoding and transmitting the result.”

Figure 1.1 displays how accounting as an information system helps in business and economic decisions made by user-decision-makers. In this service activity, as shown in Fig. 1.1, accounting assumes a link between business activities and transactions and the decision-makers.

First, accounting measures business activities and transactions through recording data.

Second, the recorded data are processed and stored until needed. The processing can be done in such a manner or format as to become useful information.Alternatively, sometimes, the processed data are further processed or prepared to provide useful information to users.

Thirdly, the processed and prepared information is communicated to users and decision-makers in the forms of financial statements, other statements, reports etc. In this accounting system, business transactions and activities are the input and statements and reports given to decision-makers are the output.

Thus, as an information system accounting has a basic goal, i.e., to provide information. In order to accomplish this goal, the accounting system should be designed to classify financial information on a basis suitable for decision-making purposes and to process the tremendous quantities of data efficiently and accurately.

Also, the information system must be designed to report the results periodically, in a realistic and concise format that is comprehensible to users who generally have only a limited accounting knowledge. Furthermore, the information system must be designed to accommodate the special and complex needs of internal management of the enterprise on a continuing basis.

These internal needs extend primarily to the planning and control responsibilities of the managers of the enterprise. The information output is used by a group of decision-makers, and therefore, it is evident that a decision-oriented information system should produce information which meets the needs of its users.

It should be understood that information, in its most fundamental sense, is an economic good that assists in the allocation of society’s resources—in the distribution of existing wealth and in the formation of productive capital.

Accounting as a Language:

Accounting is often called the “language of business.” It is one means of communicating information about a business. As a new language is to be learnt to converse and communicate, so the accounting is to be learnt and practiced to communicate events about a business. Many accounting writers and researchers, accounting profession have referred to accounting as language of business.

For instance, Yuji Ijiri observes:

“As the language of business, accounting has many things in common with other languages. The various business activities of n firm are reported” in accounting statements using accounting language, just as news events are reported in newspapers, in the English Language.

To express an event in accounting or in English we must follow certain rules. Without following certain rules diligently, not only does one run the risk of being misunderstood but also risks a penalty for misrepresentation, lying or perjury. Comparability of statements is essential to the effective functioning of a language whether it is in English or in Accounting. At the same time, language has to be flexible to adopt to a changing environment.

There are important similarities between a language and accounting.

A language has broadly two components:

(i) Symbols and

(ii) Rules, to make it purposeful.

Symbols are the meaningful units or words identifiable in any language, known as linguistic objects and which are used to convey particular meaning or concepts. The arrangement of symbols in a systematic manner becomes a language. The rules which influence the usage and pattern of the symbols are known as grammar of language or grammatical rules.

In accounting too, there are two components:

(i) Symbols and

(ii) Grammatical rules.

In accounting, numerals and words and debits and credits are accepted as symbols which are unique to the accounting discipline. The grammatical rules in accounting refer to the general set of procedures followed to create all financial data for the business.

Jain draws the ‘similarities between grammatical rules of a language and accounting rules in the following words:

“The CPA (the expert in accounting) certifies the correctness of the application rules as does an accomplished speaker of a language for the grammatical correctness of the sentence. Accounting rules formalize the structure of accounting in the same way as grammar formalizes the inherent structure of a natural language.”

Anthony and Reece also draw the following parallel between accounting and language:

“Accounting resembles a language in that some of its rules are definite whereas others are not. Accountants differ as to how a given event should be reported, just as grammarians differ as to many matters of sentence structure, punctuation and choice of words. Nevertheless, just as many practices are clearly poor English (language), many practices are definitely poor accounting. Languages evolve and change in response to the changing needs of society, and so does accounting.”