MEANING OF ACCOUNTING?

 

» MEANING OF ACCOUNTING
» NEED AND IMPORTANCE OF ACCOUNTING
» BOOK KEEPING
» BRANCHES OF ACCOUNTING
» BASIC ACCOUNTING CONCEPTS
» DOUBLE ENTRY SYSTEM
» PREPARATION OF FINAL ACCOUNTS

MEANING OF ACCOUNTING

Accounting refers to the actual process of preparing and presenting the accounts. In other words, it is the art of putting the academic knowledge of accountancy into practice. American Accounting Association defines accounting as “the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information.”

NEED AND IMPORTANCE OF ACCOUNTING

When a person starts a business, whether large or small, his main aim is to earn profit. He receives money from certain sources like sale of goods, interest on bank deposits, etc. He has to spend money on certain items like purchase of goods, salary, rent, etc. These activities take place during the normal course of his business. He would naturally be anxious at the year end, to know the progress of his business. Business transactions are numerous, that is it not possible to recall his memory as to how the money had been earned and spent. At the same time, if he had noted down his incomes and expenditures, he can readily get thee required information. Hence, the details of business transactions have to be recorded in a clear and systematic manner to get answers easily and accurately for the following questions at any time he likes.

1. What has happened to his investment?

2. What is the result of the business transactions?

3. What are the earning and expenses?

4. How much amount is receivable from the customers and to whom the goods have been sold on credit?

5. How much amount is payable to the suppliers on account of credit purchases?

6. What are the nature and value of the assets possessed by the business concern?

7. What are the nature and value of liabilities of the business concern?

These and several other questions are answered with the help of accounting. The need for recording business transactions in a clear and systematic manner is the basis which gives rise to book-keeping.

BOOK KEEPING

Book–keeping is that branch of knowledge which tells us how to keep a record of business transactions. It is often routine and clerical in nature. It is important to note that only those transactions related to business which can be expressed in terms of money are recorded. The activities of book-keeping include recording in the journal, posting to ledger and balancing the accounts.

DEFINITION OF BOOK KEEPING

R.N. Carter says, “book-keeping is the science and art of correctly recording in the books of account all those business transactions that result in transfer of money or money’s worth.”

MEANING OF BOOK KEEPING

Book-Keeping: Is a part of accounting and is concerned with record keeping or maintenance of books of accounts. It is often routine and clerical. Book-keeping is an act of keeping permanent records of the financial transactions of a business in a systematic and orderly manner. The financial transactions of the business are identified, recorded and classified in different books. In modern entities, records of financial transactions are maintained under a double entry system. The double entry system has been recognized as a systematic and complete system for recording financial transactions. Double entry system recognizes that every financial transactions has two aspects. It then records two aspects of a transaction simultaneously in two separate accounts with equal amounts. It provides the aspects of a transaction with their names of debit and credit. Thereafter, with the help of ledger accounts, profit and loss account and the balance sheet are prepared to ascertain the profit and loss and the financial position of the business. Thus, the double-entry system is the most systematic and complete system of book-keeping. Therefore double entry system is the technique or method of book-keeping which recognizes the fact that every financial transaction has two aspects and records two aspects of each transaction simultaneously in two separate account giving their names 'debit' and 'credit' respectively.

OBJECTIVES OF BOOK KEEPING

1. To have permanent record of all the business transactions.

2. To keep records of incomes and expenses in such a way that the net profit or net loss may be calculated.

3. To keep records of assets and liabilities in such a way that the financial position of the business may be ascertained.

4. To keep control on expenses with a view to minimize the same in order to minimize the profit.

5. To know the names of the customer and the amount due from them.

6. To know the names of the suppliers and the amount due to them.

7. To have important information for legal and tax purpose.

BRANCHES OF ACCOUNTING

Increased scale of business operations has made the management function more complex. This has given rise to specialized branches in accounting. The main branches of accounting are Financial Accounting, Cost accounting, and Management accounting.

FINANCIAL ACCOUNTING

It is connected with recording of business transactions in the books of accounts in such a way that operating result of a particular period and financial position on a particular date can be known. The accounting system concerned only with the financial state of affairs and financial results of operations is known as Financial Accounting. It is the original form of accounting. It is mainly concerned with the preparation of financial statements for the use of outsiders like creditors, debenture holders, investors and financial institutions. The financial statements i.e., the profit and loss account and the balance sheet, show them the manner in which operations of the business have been conducted during a specified period.

COST ACCOUNTING

Cost accounting relates to collection, classification, and ascertainment of the cost of production or job undertaken by the firm. Cost accounting is used to compute the unit cost of a manufacturer's products in order to report the cost of inventory on its balance sheet and the cost of goods sold on its income statement. This is achieved with techniques such as the allocation of manufacturing overhead costs and through the use of process costing, operations costing, and job-order costing systems. Cost accounting assists management by providing analysis of cost behavior, cost-volume-profit relationships, operational and capital budgeting, standard costing, variance analyses for costs and revenues, transfer pricing, activity-based costing, and more. According to the Chartered Institute of Management Accountants, London, cost accounting is the process of accounting for costs from the point at which its expenditure is incurred or committed to the establishment of the ultimate relationship with cost units. In its widest sense, it embraces the preparation of statistical data, the application of cost control methods and the ascertainment of the profitability of the activities carried out or planned.

MANAGEMENT ACCOUNTING

It relates to the use of accounting data collected with the help of financial accounting and cost accounting for the purpose of policy formulation, planning, control, and decision making by the management. It is an accounting for the management i.e., accounting which provides necessary information to the management for discharging its functions. According to the Anglo-American Council on productivity, “Management accounting is the presentation of accounting information is such a way as to assist management in the creation of policy and the day-to-day operation of an undertaking.” It covers all arrangements and combinations or adjustments of the orthodox information to provide the Chief Executive with the information from which he can control the business e.g. Information about funds, costs, profits etc. Management accounting is not only confined to the area of cost accounting but also covers other areas such as capital expenditure decisions, capital structure decisions, and dividend decisions as well.

“Any form of accounting which enables a business to be conducted more efficiently can be regarded as Management Accounting” – The Institute of Chartered Accountants of England and Wales.

“Management Accounting is the presentation of accounting information in such a way as to assist management in the creation of policy and in the day-to-day operations of an undertaking” – The Anglo American Council on Productivity Report.

“Management Accounting includes the methods and concepts necessary for effective planning, for choosing among alternative business performances” – The American Accounting Association.

Financial accountancy (or financial accounting) is the field of accountancy concerned with the preparation of financial statements for decision makers, such as stockholders, suppliers, banks, employees, government agencies, owners, and other stakeholders. The fundamental need for financial accounting is to reduce principal-agent problem by measuring and monitoring agents’ performance and reporting the results to interested users.

Financial accountancy is used to prepare accounting information for people outside the organization or not involved in the day to day running of the company. Managerial accounting provides accounting information to help managers make decisions to manage the business.

In short, Financial Accounting is the process of summarizing financial data taken from an organization’s accounting records and publishing in the form of annual (or more frequent) reports for the benefit of people outside the organization.

Financial accountancy is governed by both local and international accounting standards.

BASIC ACCOUNTING CONCEPTS

Financial accountants produce financial statements based on Generally Accounting Principles of a respective country.

Financial accounting serves following purposes

• Producing general purpose financial statements.

• Provision of information used by management of a business entity for decision making, planning and performance evaluation.

• For meeting regulatory requirements.

Management accounting is concerned with the provisions and use of accounting information to managers within organizations, to provide them with the basis to make informed business decisions that will allow them to be better equipped in their management and control functions.

In contract to financial accountancy information, management accounting information is

• Usually confidential and used by management, instead of publicly reported.

• Forward-looking, instead of historical.

• Pragmatically computed using extensive management information systems and internal controls, instead of complying with accounting standards.

This is because of the different emphasis: Management accounting information is used within an organization, typically for decision-making.

DOUBLE ENTRY SYSTEM

Double Entry System: There are numerous transaction in a business concern. Each transaction, when closely analyzed, reveals two aspects. One aspect will be “receiving aspect” or “incoming aspect” or “expenses/loss aspect.” This is termed as the ”debit aspect.” The other aspect will be “giving aspect” or “outgoing aspect “or“ income/gain aspect.” This is termed as the “credit aspect”. These two aspects namely “debit aspect” and “credit aspect” forms the basis of double entry system.

Definiton of Double Entry System: According to J.R. Batliboi, “every business transaction has a two-fold effect and that it affects two accounts in opposite directions and if a complete record were to be made of such transactions, it would be necessary to debit one account and credit another account. It is this recording of the two fold effect of every transaction that has given rise to the term double entry system.”

FEATURES OF DOUBLE ENTRY SYSTEM:

• Every business transaction affects two accounts.

• Each transaction has two aspects i.e., debit and credit.

• It is based upon accounting assumption concept and principles.

• Helps on preparing trial balance which is a test of arithmetical accuracy in accounting.

• Preparation of final accounts with the help of trial balance.

ADVANTAGES OF DOUBLE ENTRY SYSTEM:

1. Scientific system.
2. Complete record of transaction.
3. A check on the accuracy of accounts.
4. Ascertainment of profit or loss.
5. Knowledge of the financial position.
6. Full details for control.
7. Comparative study.
8. Helps in decision-making.
9. Detection of frauds.

PREPARATION OF FINAL ACCOUNTS

The final account of business concern generally includes two parts. The first part is trading and profit and loss account. This is prepared to find out the net result of the business. The second part is the balance sheet which is prepared to know the financial position of the business. However, manufacturing concern, will prepare a manufacturing account prior to the preparation of trading account, to find out the cost of production.

TRADING ACCOUNT

Trading account is a part of final accounts prepared by a business firm which shows gross profitability of business activities during a particular period. In other words, trading account shows total sales, total purchases and all direct expenses relating to purchase and sales. Trading means buying and selling. The trading account shows the result of buying and selling of goods. Trading account is prepared by manufacturing companies and trading companies only because the sales and purchases of goods are done in these types of business firms only. It can be prepared by a business firm on any particular date. It can be prepared on monthly basis or quarterly basis or half yearly basis or yearly basis according to its requirement. For example all the companies registered with stock exchanges furnish monthly details relating to sale, and profits. Therefore these companies have to prepare the Trading account on monthly basis. The trading account shows the income from sales and the direct costs of making those sales. It includes the balance of stocks at the start and end of the year.

ITEMS APPEARING IN THE DEBIT SIDE

1. Opening stock, 2. Purchases, 3. Direct expenses-wages, 4. Carriage inwards, 5. Octroi duty, 6. Custom duty, 7. Dock dues, 8. Clearing charges, 9. Import duty, 10. other expenses, etc.

ITEMS APPEARING IN THE CREDIT SIDE

1. Sales, 2. Closing stock.

You can prepare a Balance Sheet by following the format below:

PROFIT AND LOSS ACCOUNT

After calculating the gross profit or gross loss, the next step is to prepare the profit and loss account. A profit and loss account provides information on a company’s financial position during a specific time period, usually annually or quarterly. It generally gives an outline of revenue, the costs of running the business and the profits or losses generated. Along with the balance sheet, which provides a snapshot of a company’s finances on a certain date, the profit and loss account gives investors the information they need to make informed decisions on their investments. Companies typically issue P&L reports monthly. It is customary for the reports to include year-to-date figures, as well as corresponding year-earlier figures to allow for comparisons and analysis. A profit and loss account shows how much money the business has made (over the period that the accounts cover) and how much money it cost the business to do so. The profit and loss accounts cover an accounting period; usually one year. The profit and loss account is opened with gross profit transferred from the trading account (or with gross loss which will be debited to profit and loss account). After this all expenses and losses (which have not been dealt in the trading account) are transferred to the debit side of the profit and loss account. If there are any incomes or gains, these will be credited to the profit and loss account. The excess of the gain over the losses is called the net profit and that of the loss over the gain is called the net loss. The account is closed by transferring the net profit or loss to capital account of the trader.

ITEMS APPEARING IN THE DEBIT SIDE

1. Office and administrative expenses. 2. Repairs and maintenance expenses. 3. Financial expenses. 4. Selling and distribution expenses.

ITEMS APPEARING IN THE CREDIT SIDE

1. Interest received on investment. 2. Interest received on fixed deposits.3 Discount earned. 4. Commission earned. 5. Rent received.

You can prepare a Balance Sheet by following the format below:

BALANCE SHEET

Balance sheet is defined as, “a statement which sets out the assets and liabilities of a business firm and which serves to ascertain the financial position of the same on any particular date. A balance sheet is one of a business' main financial statements, along with the income statement and cash flow statement. It summarises the financial position of your business at a point in time, by providing a snapshot of how much you own and how much you owe.

A financial report stating the total assets, liabilities, and owners' equity of an organization at a given date, usually the last day of the accounting period. The credit side of the balance sheet states assets, while the debit side states liabilities and equity, and the two sides must be equal, or balance.

Assets include cash in hand and cash anticipated (receivables), inventories of supplies and materials, properties, facilities, equipment, and whatever else the company uses to conduct business. Assets also need to reflect depreciation in the value of equipment such as machinery that has a limited expected useful life.

Liabilities include pending payments to suppliers and creditors, outstanding current and long-term debts, taxes, interest payments, and other unpaid expenses that the company has incurred.

Subtracting the value of aggregate liabilities from the value of aggregate assets reveals the value of owners' equity. Ideally, it should be positive. Owners' equity consists of capital invested by owners over the years and profits (net income) or internally generated capital, which is referred to as "retained earnings"; these are funds to be used in future operations.

You can prepare a Balance Sheet by following the format below: