Paper: 02, Accounting & Financial Analysis

Module: 2 Branches of Accounting, Advantages & Limitation of Accounting, Uses of

Accounting Information

Prof. S P Bansal
Principal Investigator Vice Chancellor
Maharaja Agrasen University, Baddi

Prof YoginderVerma
Co-Principal Investigator Pro–Vice Chancellor
Central University of Himachal Pradesh. Kangra. H.P.

Dr. O.P Verma

Paper Coordinator Department of Commerce
Himachal Pradesh University shimla

Dr S.S Narta
Content Writer Prof & Director UCBS
Himachal Pradesh University Shimla
Items Description of Module

Subject Name Management

Paper Name Accounting & Financial Analysis

Module Title Branches of Accounting, Advantages & Limitation of

Accounting, Uses of Accounting Information

Module Id Module No- 2

Pre- Requisites Different branches of accounting

Objectives To gain understanding on the various branches of

accounting

Keywords Accounting, Accrual, Reliable, Relevant, interested users

QUADRANT I

1. Module-2: Definition, Objectives, Functions and Nature of Accounting

2. Learning Objectives
3. Introduction
4. Meaning of Accounting
5. Branches of Accounting
6. Basis of Accounting
7. Advantages of Accounting
8. Uses of Accounting Information
9. Limitations of Accounting
10. Summary
LEARNING OBJECTIVES:

After going through the module, students may be able to gain understanding on the various branches
of accounting. Along with this, the advantages and disadvantages are also made clear in the module,
along with some of the uses of accounting information.

INTRODUCTION:

Business transactions are the evidence of the operations of the business with the outside world, and to
keep a record of with whom the business is dealing with, from where it is purchasing its raw
materials, from whom they are borrowing loans and advances, who are the customers of the business
and the profits earned and losses incurred, accounting principles are followed. And these set of
accounting information serves as a base for the decision making concerning the business.

Accounting is a process which starts after the completion of Book Keeping, in other words after the
transactions are recorded, classified and summarised, the next step of communicating it to the
interested users for their uses begins. There are many users of accounting information and it is used
up for many different purposes as well. The existence of Accounting dates back to 4500 B.C. where
the sale and purchase of items was recorded on the clay tablets. With the passage of time, new
dimensions were added in the field of accounting and it was used up as a service activity, the main
function being supplying the quantitative information about economic activities of the business.

MEANING OF ACCOUNTING:

According to A.I.C.P.A., “Accounting may be defined 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.”

Basically, accounting is the art and science of communicating the reliable, accurate, understandable
information to the management and other users for the purpose of making decisions affecting the
working of business. Accounting is a process requiring skill and expertise, divided into various
branches, having benefits to the business and affected by some of the limitations as well.

BRANCHES OF ACCOUNTING:

The technological advancements and globalisation has resulted in an overall rise in the scale of
operations of business, and the environment with which the business had to deal, also expanded. As a
result, the need for more relevant, accurate and more reliable information increased, which ultimately
gave rise to the special branches of accounting.

Accounting is divided into different branches:

1. Financial Accounting
2. Cost Accounting
3. Management Accounting
1. FINANCIAL ACCOUNTING
This branch of accounting is concerned with keeping a record of all the financial transactions of
the business and finding out the profit earned and loss incurred, during an accounting year, and
also depicting the profitability as well as the financial position of the business.
The main statements under financial accounting are the Income and Expenditure Statement
(which includes all the revenue transactions, and judges the profitability) and Balance Sheet
(prepared to know the financial position).
Financial accounting discloses:
▪The profit and loss earned by the business
▪The financial position of the business
▪The financial information required by the management

Financial accounting is not free from any limitations. It is because of the following limitations that the
cost accounting and management accounting arose.

1. Controlling the costs is not possible in case of financial accounting, as the costs are determined
only at the end of accounting year. And nothing can be done to control the costs after their
determination at the end of the year.
2. It records only the quantitative information. If an item cannot be measured in terms of money, it
will not form a part of the accounts, even though it is important to the business.
3. Financial accounting is historical in nature and records the transactions that had taken place
during the year and does not records what will happen in the near future. It does not provide
information on what should be done to improve the efficiency of the business.
4. Final accounts may be manipulated according to the requirements of the concern. It may result
into overstating or understating the accounts. Increase in profits, may be faked to attract more
investors to the business, despite of their good dividend paying capacity. And as a result, the
overall reliability of the accounts will deteriorate.

2. COST ACCOUNTING
Business enterprise works to earn maximum possible profits, at the least possible cost. Incurring
minimum costs in the aim of every enterprise, and they work to control the costs and this
necessitated the emergence of cost accounting as one of the special branch of accounting. This
branch of accounting has been developed due to the limitations of the financial accounting. And
aims to analyse the expenditure/cost incurred in every activity and therefore makes efforts to
control the costs. It should be noted that Cost means Expenditure incurred, and not the Price of
the Product.
The costing terminology of I.C.M.A, London defines cost accounting as “the process of
accounting for cost from the point at which expenditure is incurred or committed to the
establishment of its ultimate relationship with cost centres and cost units. In its widest usage, it
embraces the preparation of statistical data, the application of cost control methods and the
ascertainment of the profitability of activities carried out or planned.”
Cost accounting basically deals with the analysis and determination of costs well in advance,
presentation of costs for controlling them and finally making decisions. It acts as an aid to the
management in fixing prices, framing future production policies, providing cost data for making
different period comparison etc.
It is also affected by few limitations:
1. There is a chance of subjectivity creeping in, in terms of valuation of closing stock, depreciation
etc.
2. All the items of expenses and incomes are not taken into consideration, basically the items of pure
financial nature.
3. It often fails to meet the informational need which is essential for various managerial functions.

It is because of these limitations that the concept of management accounting arose, and came into use.

3. MANAGEMENT ACCOUNTING
Although cost accounting provides information to the management regarding the costs involved
and suggests measures to reduce the costs to the lowest, but still it lacks certain points as
discussed above, which led to the emergence of management accounting. The information
regarding the socio-economical issues and the statistical data is far beyond the scope of financial
and cost accounting, therefore it paved the way towards management accounting.
Management accounting means the system of presenting the accounting information in such a
way, so as to help the management in framing the policies, controlling, and carrying out the day to
day functions more effectively and ultimately achieving the organisational goals.
According to the Anglo-American Council on Productivity, “Management Accounting is the
presentation of accounting information in such a ways as to assist management in the creation of
policy and the day to day operation of an undertaking.”
Management accounting is not only limited to cost accounting but covers other areas as well. The
scope of management accounting is wide spread, and relates to a number of fields such as:
1. Budgeting and Forecasting
2. Inventory Control
3. Internal Audit
4. Reporting to Management
Importance of management accounting includes:
1. Increase in Efficiency
2. Effective managerial control
3. Increase in profitability
4. Rational decision making

QUICK REVISION:

▪ Accounting is the art and science of communicating the reliable, accurate, understandable
information to the management and other users for the purpose of making decisions.
▪ Accounting is divided into three branches: financial, cost and management accounting.
▪ Financial Accounting is concerned with keeping a record of all the financial transactions of the
business and finding out the profit earned and loss incurred, during an accounting year.
▪ Cost Accounting aims to analyse the expenditure/cost incurred in every activity and therefore
makes efforts to control the costs.
▪ Management Accounting means the system of presenting the accounting information in such a
way, so as to help the management in framing the policies, controlling, and carrying out the day to
day functions more effectively and ultimately achieving the organisational goals.
BASIS OF ACCOUNTING:

For the purpose of recording the transactions, there are three approaches which can be used by the
accountants, and are accepted worldwide:

1) Cash Basis: the actual cash receipts and actual cash payments are recorded under the cash basis
of accounting. Transactions on credit are not taken into consideration, and not recorded in the
books, till the cash is actually received or paid. For Example: the Receipts and Payment Account
prepared by the Non- Profitable Institutes (schools, hospitals, charitable houses etc).

Advantages:
▪ is realistic in nature.
▪ is simple to use and verifiable.

Demerits:
▪ does not depict the true profit and loss of the enterprise.
▪ does not follow the matching principle of accounting.
▪ ignores the credit transactions, hence incomplete results.

2) Accrual Basis: the drawbacks of cash basis of accounting paved the way for the development of
accrual basis by the accountants. Under this system the costs and revenue are recognised in the
same accounting year in which they occur, rather than when they are actually paid. This does not
violate the matching concept of accounting. For example: the raw materials consumed are
matched against the cost of goods sold.

Advantages:
▪ is more scientific as compared to the cash basis of accounting.
▪ gives a complete picture of the financial transactions of the business.
▪ does not violates the matching concept of accounting.

Demerits:
▪ is not as simple as cash basis.
▪ net profit or loss cannot be reached at quickly, as lots of adjustments are required.

3) Hybrid/ Mixed Basis: the accountant tried to club in both the basis of accounting and come up
with one, where the advantages of both the basis are used up. Under hybrid system, Incomes are
recorded on cash basis, whereas expenses are taken on accrual basis of accounting.

ADVANTAGES OF ACOUNTING:

Accounting is the language of the business, it means it acts as a means of communication with the
outside world and discloses the financial activities to the users. The accounting information so
presented serves various benefits to the organisation:
1) Acts as a memory replacement: accounting information is a replacement of the human memory,
as it is quite difficult to remember each and every transaction by the businessman, therefore
accounting has served as a replacement to the human memory.
2) Comparative Study: accounting helps the owners to judge the profits, sales, expenses of the
company in one accounting year, as compared to that of the previous year. And also, helps in
finding any kind of differences or changes between the two period figures.
3) Provides assistance to different parties: accounting information provides the information to
different classes of users and helps them in taking the decisions concerning the business affairs.
4) Complete Record: accounting is a process of recording, classifying, summarising and
communicating the business transactions to the interested users, who are directly or indirectly
related to the business. Therefore accounting provides a complete set/ record of the business
transactions in a systematic manner.
5) Supplying information about financial activities: accounting provides information about the
financial activities i.e. the profits earned and losses incurred are disclosed by the accounting
information. Moreover, the basic function of accounting is also to reveal the financial activities to
the owners and managers of the business.
6) Complying legal formalities: tax assessment is made easy with the help of accounting
information, means accounting information helps the owners of the business in deciding the
amount of taxes to be paid and also helps in fulfilling other formalities of income tax and sales tax
returns.
7) Evidence in Court: if the accounts are maintained properly, they will act as proper evidence in the
court, in case of any disputes. It is because the transactions when recorded, are entered in with
proper proof and in a systematic order.

USES OF ACCOUNTING INFORMATION:

Accounting information is presented by the accountants, so that it is used by different users. It is

utilised by the interested parties, who are directly or indirectly related to the business, for their own
benefit respectively. The way how different parties utilise the accounting information is stated below:

1) Owners: owners use up the accounting information to judge the financial position of its concern,
and find out if profits were earned or losses were incurred in the previous year. Owners need
information for the study of past performance and considering the future prospects.
2) Investors: before putting their money in the business, investors access the financial efficiency,
profit earning capacity, dividend paying capacity and solvency of the firm. The investors are
interested to know that whether the firm is growing steadily, and whether the value of its shares is
increasing.
3) Government: government utilises the accounting information for studying the performance of a
particular unit, income, and expenditure in order to impose tax and excise duty on the company.
4) Creditors/ Suppliers: banks, suppliers and financial institutions use accounting information to
judge the credit paying capacity of the enterprise, interest paying capacity. By judging so, they are
able to actually decide whether to grant loans/ credit to the institute.
5) Managers: the managers of the enterprise use accounting information to plan, control, evaluate the
performance and for decision making regarding the affairs of business.
6) Employees: employees are the assets of an organisation, they are concerned with the profits of the
business because they are paid salaries, bonus etc from the profits. And the profits of the
organisation are judged from the accounting information.
7) Research Scholars: students involved in the research work, often use up the published accounting
information for the purpose of analysing the financial position and hence proving their thesis.

QUICK REVISION:

▪ The accounting transactions can either be recorded on cash basis, accrual basis or hybrid basis.
▪ Accounting acts as a replacement to the human memory.
▪ Accounting maintains a complete record of the financial affairs of the company.
▪ It serves as evidence in the court and helps in complying with the legal formalities.
▪ Accounting information is utilised by the owners, employees, managers, investors, creditors and
government for different purposes.

LIMITATIONS OF ACCOUNTING:

Following are some of the limitations affecting accounting:

1) Only monetary transactions are recorded: accounting records only the transactions that are
capable of being presented in terms of money, and does not include the events of non monetary
nature, even though it is of great importance to the business. Example: Strikes by the labour,
efficiency of the R&D department.
2) Personal biasness involved: accountants are involved in the process of recording the accounting
information, it may be affected by his personal biasness, such as, he may select any way of
depreciating the machinery, valuing the stock and treating deferred revenue expenditure. The
judgement of accountant will definitely affect the preparation and presentation of accounting
information.
3) Historical in Nature: the information supplied is on the basis of the already prepared Profit and
Loss account and Balance Sheet. This means that only the information about already happened
events is disclosed and no information about future is presented. Hence, accounting is historic in
nature.
4) Allows different treatments: Accounting allows different treatments within Generally Accepted
Accounting Concepts (GAAP). An accountant for example, can either use the LIFO (last in first
out) method or FIFO (first in first out) method in order to value the closing stock. Applying
different methods might lead to different results and as a result the comparable quality of
information might get lost.
5) Changes in price are not considered: accounting transactions are recorded in the books of
accounts at cost basis, whereas the effect of changes in price level is not considered and not
recorded in the books. As a result comparing the data of various years becomes quite difficult.
QUICK REVISION:

▪ Accounting is concerned with recording only the monetary transactions.

▪ The personal biasness of the accountant can be involved in the accounting information.

▪ Accounting is historical in nature and does not take into consideration the changes in price.

▪ It allows the use of different treatments therefore the comparable quality of information might get
lost.

SUMMARY:

The fast changing social, economic, legal and political environment demands for more advancements
in the working efficiency of the business houses, and the business in order to keep up to the pace of
fast advancing environment, needs to develop fast and expand its area of operations. For which the
business transacts with large number of clients in an accounting year therefore leading to a large
amount of transactions in one complete year. Moreover, the owners at the completion of the year are
keen in finding out about the net profits or losses, the financial strength of the company, and solvency
position of the firm. The information is provided to them in the form of accounting information,
which is prepared by the expertise accountants with care and accuracy.

The act of recording, classifying and communicating the information to the owners of the business is
termed as accounting. Unlike Book Keeping, it is not only concerned with recording the monetary
transactions in the books of accounts, but is involved in communicating the information to the
managers and the owners in a reliable, understandable and comparable manner, so that the available
information is used up for decision making or for comparing the figures with previous year figures,
and making the rational decisions accordingly.

Accounting requires skill, knowledge and expertise, and also in such a dynamic environment the need
for dividing the accounting into branches arose. Accounting is classified into financial accounting,
cost accounting and management accounting. Financial accounting involves disclosing the financial
position of the business, cost accounting is concerned with finding the costs and steps to reduce them
to the minimum, whereas management accounting refers to modifying the information in such a way
that it becomes capable for the managers to take any decision, based upon the supplied information.
The accounting information is used by the owners, investors, government and employees for different
purposes.

It helps in comparative evaluation of the data, acts as evidence in the court, replaces the human
memory and supplies information about the financial activities of the business. Apart from the
benefits, it has some limitations such as, personal biasness is involved, only monetary transactions are
included, is historical in nature and ignores the changes in the prices.