PRINCIPLES OF ACCOUNTING (AC1025) TUTE-02 By: M.

Aadhil Hussain

Chapter 2: Accounting in Context

What is accounting?

Accounting is concerned with the provision of information about the position and performance of an
enterprise that is useful to a wide range of potential users in making decisions.

It can also be said that Accounting is the process of producing financial information about a business that
will enable those with rights to that information to make informed economic decisions.
“An Economic Decision” relates to how scarce resources should be best used.

For example: An investor, who is an example of someone with rights to information about a business will
need to assess whether or not to invest his money in Company A or Company B.

The Functions of Accounting?

Historically accounting information was used to measure and record financial transactions and provide
information for stewardship purposes.
But with the change in the role of accounting, it now serves the following functions.

1. Recording: Enables a means of recording data, so as to be able to produce reports or for use in
calculation.

2. Classification: Assists in categorizing data (E.g.: Assets, Expenses, Income, Liability and Capital).

3. Measurement: Quantify data (E.g.: How much profit a business has earned).

4. Stewardship: Enables owners to determine how funds entrusted to managers have been used by
them.

5. Information for Decisions: Assists in making decisions about the future.

6. Monitoring and Control: Enables management to monitor performance and take corrective action if
necessary.

7. Performance Evaluation and Compensation: Provide information on the performance of different

individuals and parts of the business in order to determine how much managers and employees should
be rewarded.

8. Communication: Provide a means by which information is transmitted to users. For example, to

external users via the financial statements.
PRINCIPLES OF ACCOUNTING (AC1025) TUTE-02 By: M.Aadhil Hussain

Who uses Accounting Information?

Businesses, mainly companies produce financial statements, because in addition to the legal
requirement to do so, they are assumed to be useful to a range of users’.
The main group of users and their information needs are summarized below.

1. Shareholders : Includes potential shareholders, who are considering buying or selling shares. They are
interested in the value of the company, the profits, dividends and cash flows.

2. Creditors and Suppliers: Including potential lenders and suppliers, who are interested in the cash flow
of the business, such that the business will be able to meet its liabilities and pay creditors on time.

3. Employees: Interested in the future prospects of the company, whether they will survive and prosper
and be able to pay wages and salaries.

4. Competitors: To compare their results with those of their rivals.

5. Managers and Directors: Mainly interested in annual financial statements and even more interested in
monthly statements. They may also want specially produced internal management information on a
regular basis.

The difference between Financial Accounting and Management Accounting

Financial Accounting: is concerned with the preparation of accounting information for the needs of
users who are external to the business. Financial accounting is therefore part of financial reporting.

1. Prepared on a periodic basis (most companies publish their financial statements only once a year, in
their annual report) while public companies listed on a stock exchange are likely to be required to
produce interim accounts, either half-yearly or quarterly

2. Based on past events, transactions and historic data

3. Comprised primarily of financial information
4. Governed by rules and regulations.

Management Accounting: is concerned with the preparation of accounting information for the needs of
users who are internal to the business.

1. Prepared frequently, as and when it is needed (most large businesses will prepare some information
on a monthly basis and many use daily accounting information).
2. More likely to contain forward-looking information (such as forecasts and budgets).
3. More likely to incorporate non-financial information (such as quantities of products sold or numbers
of customer complaints).
4. Not regulated (managers are free to produce whatever information they need in whatever format is
most helpful to them, subject to available data and technology).
PRINCIPLES OF ACCOUNTING (AC1025) TUTE-02 By: M.Aadhil Hussain

End of Chapter Questions

Quiz 1

Which of the following are not functions of accounting?

A Recording
B Classification
C Easy to use
D Stewardship

Quiz 2

Which of the following is not a feature of financial accounting?

A Prepared for internal purposes only

B Legal requirement
C Prepared on a periodic basis
D Prepared using historical figures

Quiz 3

Which of the following is not a purpose of management information in a company?

A To provide records of current and actual performance

B To compare actual performance with planned performance
C To help management with decision making
D To inform customers about the company’s products

Quiz 4

According to IASB the principal objective of financial reporting is to:

A Meet the requirements of the tax authorities

B Provide information useful to investors and lenders
C Provide a list of balances to check the accuracy of records
D Record every transaction individually