ACCOUNTING Definition and Meaning of Accounting: The American Institute of Certified Public Accountants has defined accounting as "the art of recording, classifying and summarising, in a significant manner and in terms of money, transactions and events which are, in part at least, ofa financial character, and interpreting the results thereof’, According to the American Accounting Association, “Accounting is the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information”. Smith and Ashburne defined accounting as “the science of recording and classifying business transactions and events, primarily of financial character, and the art of making significant summaries, analyses and interpretations of those transactions and events, and communicating the results to persons who must make decisions or form judgements." According to A.W. Johnson, "Accounting may be defined as the coilecti_n, compilation and systematic recording of business transactions in terms of money, the preparation of financial reports, the analysis and interpretation of these reports and use of these reports for the information and guidance of management". In the words of Bierman and Derbin, "Accounting may be defined as the identifying, measuring, recording and communicating of financial information". According to Robert N. Anthony, "An accounting system is a means of collecting, summarising, analysing and reporting in monetary terms information about business". From the above definitions, it is clear that accounting is (i) identifying and measuring business transactions in terms of money, (ii) recording, in terms of money, business transactionsof financial chara al ¢! ‘single book of originé oe of original entry entries foun A Fi soon after their occurrence: Seesece At erry called the journal OF O°.” asi) tated the subsidiary POO is tin the journal or subsidiary ithe book of final entry, ing, at the eters classifying the Cm counts in the ledger, riate te j resenti arising O° Pion found in the into approP? edger accounts t and loss account Chest ting the fi interpreting ‘om the financ’ conclusions communicating financial sta decisions. In S! recording, class analysing communicating t} decision-making. users for: Essential Aspects oF Fe: From the defi that accounting has mai essential aspects are: 1. Identifying: Identifying is and interpr tion for its like the hrough financial statement balance sheet, (7) analysing and nts (i-€: jal statement! Naar the interpretations of the the end-users for making Soun measuring, hne results of the interpre atures of Accounting: mition and meaning of accounting, it iS clear ny essential aspects OF features. Those ing an essential aspect of accounting. Ident ess transactions to be recordes means determining the busin‘ the books of account. 2. Measuring: Measuring ii s another essential aspect of accounting. the value of business transactions Measuring means expressing in terms of mont 3. Recording: Recording i ey. essential aspect of accounting. s another in terms of money, business Recording means entering, they occur, either in a single book of transactions, as and when fl or in several books of original original entry called the journé led the subsidiary books. In short, recording means entry call recording of busi entry. iness transactions in the book or books of original ; ing up of cessary ledger accounts ng is anot Summarising me ca transaction: financial po: means the accounts ts like the loss account and the balance sheet at the end oft ne year. In short, it means the prepa financial statements. 6. Analysis and interpretation: Analysis and inter srpretation is yet another essential as| eecquateg) Analysis and interpretation means eRe of the information found in the financial statements in as manner, comparison of the re-arranged inter-related figures, ey ne ore et acne oa reper ge and the solvency of the business and the fut Pearce future prospects of the 7. Communicating: Communicating is the last essential aspect of accounting. Communicating means communicating the results of interpretation of financial statements to the end-users for decision-making. Differences between Book-keeping and Accounting: In the context of the study of the meaning of accounting, it is desirable to know the distinction between book keeping and accounting.no ees ae Qe WUE, aLe aU. Objectives of Accounting: Accounting has certain objectives. The important objectives of accounting are: 1. The primary objective of accounting is to keep a systematic record of all the business transactions of the business. 2. Another important objective of accounting is to ascertain the profit of the business during the accounting year, by preparing the profit and loss account or income statement, and to measure the performance of the business. 3. Another important objective of accounting is to ascertain the financial position (i.e., the assets, liabililies and the owners’ capital) of the business. 4, Yet another objective of accounting is to communicate financial information to the various interested users, viz., the internal users like the various levels of management and the external users like the owners, long-term lenders, short-term lenders, creditors, customers, employees, Government, etc. Role or Functions of Accounting: Accounting performs a number of functions. Its main functions are: 1. The basic function of accounting is to keep a systematic record of the financial transactions of the business. In accounting, business transactions are properly recorded, classified into appropriate accounts and summarised into financial statements like the income staiement or profit and loss account and the position statement or balance sheet.Financial Accounting cation, 2, Just as a language is used as a means of cn ey accounting is used to communicate the financi about the profit or loss and the financi ‘business to the interested parties. It is accounting is regarded as the language of information system. in this context, it is desirable to know the various users of accounting information. ‘The various parties who are interested in the financial information or accounting information communicated by accounting can be classified into two broad categories. viz.. () internal users and (ii) external users. Internal Users: Internal users of accounting information refer to various levels of management, viz., top level, middle level and bottom level management of the business enterprise. The different levels of management need accounting or financial information for decision-making and planning. The management is particularly interested in information about the liquidity (Le. term solvency (Le., financial soundness), operational efficiency (i.., effective utilisation of resources) and profitat relation to turnover nd investments for making decisions and for planning the course of action to be taken. External Users: fe External users are of two types, viz., (a) direct users and (b) indirect users. {a) Direct Users: Direct users refer to users of accounting information who are directly concerned with’ the business concern. Direct users iaclude the following persons: (i) Owners or Shareholders: ‘The owners of a business, who have invested capital in the .. business, are naturally interested in accounting information to ‘now the return they would get on the capital invested. They. _ would also be interested in knowing the financial stability or f business or an Joining a par information perform or Debentui the ability of the debentures and ig-term loans, an y and other long-term loans, when ihe eae (iv) Banks and Other Short-term Lender: Commercial banks ; and other short- interested in financial information about the to know its short-term solvency or liquidity the concer to repay the short-term loans wl (v) Creditors: Creditors (i.e., suppliers of : Le... goods and services on credit) of a fone Pe eres the financial information Soa the meer to know the ability of the cor ees erat meer to repay its short- (vi) Customers: the purchasers of goods and services on . who wish to maintain long-term contracts with the concern, will be interested in the finasetl, information about the concer to know its financial strength and stability. (vii) Employees: The employees of a concern would like to have accounting information about the financial stability of their concern to get a clear idea about the security of their jobs. They are also interested8 terprise, as their capacity of thelr ent Tree on other monetary ben in knowing the saiaries, allow: the earnings of th (viii) Government: The Government is interested in pe ng taxes. The business concern for the purpose o| ch concern a information about eac res accounting informant egulating the ts of ev fhe acco 1g the prices of pro activities of each concern. (b) Indirect Users: oe Indirect users refer to users of accou are not directly concerned with a business com users include the following persons: (@ Consumers: ‘The consumers of the products of. the financial information about a concern products produced by the concern and the profit m concern to decide about the amount of price cuts whi demand. (Gi) Stock Exchanges: Stock exchanges are interested in the financial information about companies, whose securities are listed in stock exchanges, to ascertain the performance and the prospects of those companies for protecting the interests of investors. ii) Security or Investment Analysts: Security or investment analysts are interested in the financial statements of a company to advise their clients whether to buy, hold or sell the securities of that company. (iv) Economists and Researchers: Economists and researchers are interested in the accounting information contained in the financial statements of business concerns for their study and research. (v) General Public: i «7 Even the general public are interested in the financial Statements of a concern to know its progress and its sov ing information who cern. Indirect ‘a concer are interested in to know the costs of fit made by the ich they can contribution (i.e., the contribution made by the con welfare of the society at large). Ps cern for the 6 ework 9 3. Accounti. business, By m, ‘ng Protects the properties and assets of the ing pro s s. It accounting records are called the eyes and ears of business, 4. The pro purposes. means, accounting ans, ting meets requirements by maintaining proper records, 5. Every busi between the curr uous record of business activities, and thereby, hel i 5 ’, helps the business enterprise t. a meaningful comparison of its current year's activities aink the activities of the previous years. > true that accounting performs many useful fun: But it is not free from limitations. It suffers from the foll limitations: 1. In accounting, only monetary transactit i.e. transactions which can be expressed in eres theseey irs recorded. Non-monetary events or transactions (i.e., events or transactions which cannot be expressed in terms of money), such as the team-spirit found in the business, the ill-health of the eneral manager of the concern, etc. are not recorded, however important they may be to the business. That means, accounting gives information only about the quantitative facts of the business, and completely ignores she qualitative aspects of the business. mien accounting does not give a complete story¥ BASIS OF ACCOUNTING OR ACCOUNTING SYSTEM Meaning of Accounting System: Accounting system refers to the way in which or the basis on which business transactions are recorded in the books of accounts of a business, and the annual results (i.e., net profit or net loss and the financial position) of the business are ascertained. Classification of Accounting Systems: From the point of view of the types of transactions recorded in the books of account, there are three systems or bases of accounting, viz., (1) cash system of accounting, (2) accrual system or mercantile system of accounting and (3) Mixed system or hybrid system of accounting. © 1. CASH SYSTEM OF ACCOUNTING Cash system of accounting is a system of accounting under which entries for recording the transactions of a business are made only when cash is actually received or actually paid for those transactions. No entry is made for recording the transactions, when merely the right to receive cash for the transactions or the obligation to pay cash for the transactions arises. In short, cash system of accounting is a system of accounting under which only actual cash receipts and actual cash payments are recorded in the books of accounts, and credit transactions are not recorded until cash is actually received or actually paid for them. As only the items of cash received and cash paid are recorded under this system, .this system is known as cash system of accounting.Under the cash system of accounting, eietiayare Tecognised, i.e., considered to be earned, only w! Bised “i actually received in cash, and expenses are recogni an ia considered to be incurred, only when they are actually Loa cash. That means, under the cash system, the incomes for a particular year are taken to be only those incomes which Be actually received in cash during that year, and the expenses lor a year are taken to be only those expenses which are actually paid in cash during that year. As such, under the cash system, the profit or loss for a particular year is ascertained by taking into account only the items of incomes which have been actually received in cash and the items of expenses which have been actually paid in cash during that year. The items of incomes which are receivable, but have not been received (Le., accrued incomes) will not be considered. Similarly, the items of expenses which are payable, but have noi been paid in cash (i.e., outstanding expenses) also will not be considered. But the items of incomes which are not receivable, but have been received in cash (i.e., pre-received incomes) will be taken into account. Similarly, the items of expenses which are not payable, but have been paid in cash (i.e., prepaid expenses) also will be t: aken into account, Therefore, under the cash system of accounting, the difference between the total incomes received in cash and the total expenses paid in cash during theyear (i.e., irrespective of the fact whether those incomes received and expenses paid relate to the current year, previous year or next year) will be the profit or loss for a particular accounting year: Cash system of accounting is in use in small business organisations, say, small retail stores, where most of the transactions take place in cash. It is also followed by Non-trading organisations like clubs, educational institutions, hospitals. charitable institutions, etc. Certain Professional men like d loci lawyers, chartered accountants, engineers and noe consultants also keep their accounts on cash system, Even Government accounts are based on cash system, Advantages of Cash System of Accounting: Cash system of accounting has certain advantages, Th, 1. It is a very simple system of accounting, ree ey ies : a + underTheoretical Framework "BID: this system, to ascertain the profit or loss for an accounting year, no adjustments are needed for outstanding and prepaid expenses, and outstanding and pre-received incomes. 2. This system of accounting is less costly. 3. This system is quite suitable for small retail shops where most of the transactions take place in cash, and for non-trading concerns and professional men. Disadvantages of Cash System of Accounting: Cash system of accounting suffers from a number of drawbacks. They are: 1. Under this system of accounting, the correct profit or loss of the business cannot be determined, because no adjustments are made for outstanding incomes and outstanding expenses. and incomes received in advance and prepaid expenses. 2. Under this system, the profit or loss will be distorted from year to year, because this system involves the shifting of incomes and expenses of one year to another year, which will result in under-statemenk of profit in one year and over-statement of profit * in another year. 3. Under this system, the true financial position of the enterprise cannot be ascertained, as no adjustments are made for outstanUing incomes and outstanding expenses and pre- received incomes (i.¢., incomes received in advance) and prepaid expenses. 4. This system is against the generally accepted accounting principle, viz., the accrual concept. 5. This system is not suitable for big business concerns where there are a large number of credit transactions. 6. This system cannot be adopted by joint stock companies whose accounts are required to be prepared under the accrual concept as per the Companies Act. 2. ACCRUAL SYSTEM OR MERCANTILE SYSTEM OF ACCOUNTING Accrual system of accounting recognises the fact that, ifa transaction has accrued (i.e., taken place), its legal consequence cannot be avoided (i.e., the amount of that transaction has to be received or paid), and so, it should be