An Introduction to Accounting: Understanding Its Meaning and Functions

Introduction of Accounting

Accounting is the language of business. Every business main motive is to earn profit. Every businessman wants to know about the position of business time to time whether on daily, monthly or annual basis, how much profit firm earned or losses occurred.  how much stock they have in their warehouse, how much is business liabilities, how much is owed to them and by whom, etc. In order to attain such information, it is essential to keep a complete and systematic record of each and every business transaction entered into during the year.

Meaning of Accounting

Accounting is a systematic process of identifying, measuring, recording, classifying, summarizing, interpreting and communicating financial information that is useful in making business decisions.

1. In 1941, the American Institute of Certified Public Accountants (AICPA) had defined 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”
2. In 1966, the American Accounting Association (AAA) defined accounting as “The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of information”

In simple terminology, accounting refer to the process of recording the financial information, preparing the summary, preparing reports thereafter and sharing the reports to its users.

What is Accounting?

Accounting is a process that keeps a record of financial aspects. It is a process through which information related to the exchange of money within any organization or business is recorded in written form.

In any business or small shop, there are sales and purchases, and it becomes difficult to remember them. Therefore, when we keep a written record of these in a diary or a computer, it is called Accounting.

The benefit of accounting is that it helps us know about money transactions — what we have to receive and what we have to pay. It also helps us know about the profit or loss in our business. Along with this, it helps us understand how much capital has been invested in the business.

Definition of Accounting by R.N. Anthony “Nearly every business enterprise has accounting system. It is a means of collecting, summarizing, analyzing and reporting in monetary rems, information about business” 

Functions of Accounting

1. Identifying - The first function of accounting is to identify financial transactions and events from source documents such as invoices, cash memos, and agreements. Record only those transactions that can be measured in monetary terms. For example, the purchase of goods for cash or on credit is recorded, whereas non-financial events such as changes in managerial policies or employee appointments are not recorded.
2. Recording - Once transactions are identified, the next step is to record them systematically and chronologically. In other words, recording in journal only those transactions are recorded in accounting which are of a financial character. Every transaction is first entered in a journal or subsidiary book to ensure that all financial activities are properly documented and traceable. In simple words, its basic function to record in orderly manner which is written in journals or subsidiary books such as cash journals, credit purchase journals, credit sales etc. 
3. Classifying - The recorded transactions are then classified to group similar types of transactions together in one place, usually in ledger accounts. In simple words classification is the process of grouping the transactions of one nature at one place in a separate account. That’s why its function is also known as posting to the ledger, this helps in organizing financial data. To ensure the mathematical accuracy of these accounts, a trial balance is prepared. In simple words, it is systematic analysis of recorded data which is grouping of transactions and entries, ledger preparation individual accounts and heads. 
4. Summarising - Summarising is the art of presenting the classified data in such a manner which is understandable and useful to management and other users of such data. The classified data is summarised to produce financial statements such as the Trial Balance, Profit and Loss Account and the Balance Sheet. These summaries provide a clear picture of the business’s financial performance and position, making the information useful to various stakeholders. In simple words, it presenting the classified information which is useful to the stakeholders – trial balance, income statement, balance sheet 
5. Analysing - Analysis involves studying the relationship between various items in the Profit and Loss Account and the Balance Sheet. The main purpose is to assess the financial strengths and weaknesses of the business. Analysis forms the foundation for proper interpretation and decision-making.
6. Interpreting - Interpretation explains the significance and implications of the analysed financial data. It helps users understand what the figures actually mean and assists in making informed decisions about the business’s operations and future strategies.
7. Communicating - This final function of accounting is to communicate the summarized, analysed, and interpreted information to interested parties such as owners, investors, creditors, and management. It involves Preparation and distribution of accounting reports such as income statement, balance sheet, crucial ratios, new initiatives, innovations, market trends etc. Effective communication ensures that all stakeholders are well-informed about the financial status and performance of the business. 

Objective of Accounting

1. Maintain complete and systematic records - The transactions that are taking place are systematically recorded and then posted to the ledger and after ledgering, financial statements are prepared and in the financial statements, profit and loss account and balance sheet are created so that we can get information about the financial position of the business.
2. Communicating the financial result to various parties - Accounting's another role is to communicate financial results to various parties, including both internal and external parties. In this, we share financial information, which helps them make better decisions, such as information about assets or liabilities. It helps internal business people communicate how much profit or loss the business is making.
3. Protecting the assets of the business - It means that the assets whether it is cash in hand or cash at bank or inventory or stock, debtor, all these are our assets. The goods or services provided on credit to the debtor are due and money is due from them, they are protected by maintaining them properly.
4. Providing assistance to management -  Accounting is to help management through accounting so that they can make good decisions or control things.
5. Compliance of legal needs - Whatever accounts we have maintained, we can also use them legally. There are different provisions or laws like company act, income tax act, goods and service tax act, a businessman can submit his different statements like annual account and GST return etc. If required, the balance sheet and profit and loss account can also be submitted or seen in the court.
6. Fixing responsibility - In this, we fix different employees by giving them different responsibilities. We divide their work by creating separate departments like purchase department, sales department. By creating separate departments in this way, their heads become responsible for them. In this way, those workers or employees do their work well because there is pressure from their heads on them. This work is done well and the business also works smoothly. Its result is also seen in the output of the company.

Branches of Accounting

1. Financial Accounting – Is the branch of accounting which records financial transactions and events, summarizes and interprets them before communicating the results to the users.
2. Cost Accounting – Is the branch of accounting concerning with ascertaining cost of products, operations, processes or activity with an objective of reducing and controlling cost.
3. Management Accounting – Is the branch of accounting concern with generating information which helps the management in decision making.

Types of Accounting

There are three types of accounting:

1. Personal Accounts – The accounts related to any person, company, or organization are called Personal Accounts.
2. Real Accounts – The accounts related to any asset or property are called Real Accounts.
3. Nominal Accounts – The accounts in which income and expenses are recorded are called Nominal Accounts.

Difference between Bookkeeping vs. Accounting

Bookkeeping	Accounting
It is concerned with identifying financial transaction, measuring them in money terms, recording them and classifying them	In accounting we also do summarizing the recorded transactions, interpreting them and communicating the results.
Objective to maintain systematic records of financial transactions.	Objective  to ascertain net results of operation & financial position and communicate information to interested parties
Bookkeeping is the first step to accounting.	Accounting begins where bookkeeping ends.
Routine Job	Analytical & Dynamic Job
Not required special skill	It requires special skill and ability
Vouchers and other supporting documents are necessary as evidence to record the business transactions.	Bookkeeping works as the basis for accounting information.
It is enough to have elementary Knowledge of accounting to do bookkeeping.	For accounting, advanced and in depth knowledge and understanding is required.

Various Users of Accounting Information

Accounting information is mainly used by two types of users— internal and external users of the organization.

1. Internal Users - These peoples are worked inside the business so they denoted as an internal user and they use the accounting information to make decisions.
• Owners: They contribute capital to the business so they use accounting information such as accounting reports to know how much profit the business is earning and to check its financial position.
• Managers: They use accounting information to plan, control, and make decisions for the smooth functioning of the business. Accounting information helps management to determining selling price, cost, investment.
• Employees: Employees interested in the company’s financial performance because it can affect their job security, salaries, and bonuses which is linked to profit deposit EPF and ESI.
2. External Users - These peoples or organizations are outsider for the business who also need accounting information.
• Banks and Investors: Banks and investors use business financial statements to decide whether to lend money or invest in the business. In simple terms accounting information helps to bank safety and recovery of loan provided and investor do not have direct control, risk of investment.
• Consumers: Customers may look at financial information to check the stability and reliability of a company before dealing with it also reduced cost of product, cost control.
• Creditors: Suppliers and other creditors they use accounting data to know if the business can pay its debts on time in simple terms they use accounting information for creditworthiness of business.
• Government: The government uses accounting information to determine taxes and the data also help to make economic and regulatory policies. In simple terms, it helps government to make policy decisions and assess correct taxes. 
• Public: The general public may be interested in the company’s substantial contribution of business to economy, employment, and community development.

Limitations of accounting

1. Accounting is not fully exact – some estimates are made for ascertaining profit or loss for example – estimating the useful life of asset etc.
2. Accounting ignores the qualitative elements – honest employee, quality of management etc.
3. Accounting ignores the effect of price level changes – it presumes that value of money remains stable, statements are prepared historical cost.
4. Accounting may lead to window dressing – manipulation of a/c can conceal vital facts and present financial statement to show a better position than actual. 

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