Meaning of Accounting

The present age is the age of trade business and commerce. After

Globalisation, liberalization, and privatization, business is increasing

day by day and becoming complex also. An organization cannot

remember all its dealing for long. Therefore, it becomes necessary to

keep a written record of all business transactions day by day, this lead

to the development of accounting. Let us understand the meaning of

basic accounting.

Meaning of Accounting

Lucas Pacioli is considered to be the Father of modern bookkeeping.

The only recording of financial transactions in bookkeeping is not

enough to achieve the commercial objective, but also it is important to

know the financial result.

It is necessary that the recorded transaction is collected, classified and

summarised. This work is done by accounting. After identifying the

financial transaction, through the basic accounting process, these are

recorded properly in a systematic manner in the books. The meaning

of accounting can be made clearer by understanding its process and

components.

Browse more Topics under Introduction To Accounting

● Basic Terms in Accounting

● Qualitative Characteristics, Objectives, and Roles of

Accounting

● Accounting as a Source of Information

Understand more about Accounting as a Source of information here in

detail

Process of Accounting

Accounting is a systematic process of identifying recording measuring

classify verifying some rising interpreter and communicating financial

information. It reveals profit or loss for a given period and the value

and the nature of a firm’s assets and liabilities and owners’ equity.

In other words, accounting is a practice and body of knowledge

concerned primarily with

● Method for recording transactions,

● Keeping a financial record,

● Performing internal audit

● Reporting and analyzing financial information to the

management and

● Advising on taxation matters.

Definitions of Accounting

Some prominent definitions of accounting to help us better understand

the meaning of basic accounting.

● According to the Committee of Terminology of American

Institute of Certified Public Account:” Accounting is the art of

recording, classifying summarising in a significant manner and

in terms of money, transaction, and events which are, in part at

least of a financial character and interpreting the results

thereof.”

● According to Bierman and Drebin:” Accounting may be

defined as identifying, measuring, recording and

communicating of financial information.”

Therefore accounting can be defined as” the process of recording,

summarising, reporting and analyzing required financial information

relating to the economic events of an organization to the interested

users for making decisions.”

Components of Basic Accounting

1. Recording

The primary function of accounting is to make records of all

transactions that the firm enters into. For the purpose of recording, the

accountant maintains a set of books. Their procedures are very

systematic. Nowadays, the computer has been deployed to

automatically account for transactions as they happen.

2. Summarising

Recording of transactions creates raw data. Sentences of road 8000 of

little used to in organization for decision making. Pages and pages of

raw data are of little use to an organization for decision making. For

this reason, the accountant classifies data into categories.

3. Reporting

Management is answerable to the investors about the company’s state

of affairs. The operations that are being financed with the money of

owners, it needs to be periodically updated to them. For this reason,

there are periodic reports annually summarising the performance of all

four quarters which are sent to them.

In the form of financial statements reporting is done. To ensure that

there is no misleading financial reporting, these financial statements

are also regulated by government bodies.

Learn more about Qualitative Characteristics, Objectives, and Roles

of Accounting here in detail

4. Analyzing

Lastly, accounting entails conducting an analysis of the result. After

results have been summarised and reported, a meaningful conclusion

needs to be drawn. Management must find out its positive and

negative points. Accounting helps in doing so by means of

comparison. It is common factors to compare profit, cash, sales, and

assets, etc. with each other to analyze the performance of the business.

Thus accounting is a language of business. It communicates the

performance of the business with various end-users who are interested

to know about the business. Accounting provides quantitative

information of financial nature to both management and other users so

that they can take a proper decision about the business.

Basic Accounting: Science or Art?

Expert’s opinion differs on the issue of whether accounting is a

science or an art. Some considered accounting is as science and some

others as art. It is not made very clear by the definition or the meaning

of accounting either.

Science means a systematic body of knowledge which is based on

definite rules and principles and establishes is the relationship between

cause and effect. On the other hand, Art is a technique that helps in

achieving the desired goals in the best possible manner.

Accounting is a Science

Accounting has its own principles holes and techniques. On the basis

of these principles of injections recorded systematically in order to

know the results of a business. That’s why it is regarded as a science.

Accounting is an Art

Every businessman records a business transaction in the books of

accounts as per rules, according to the nature of the business and

determine the results after analyzing, so it’s an art. Thus it is clear

from the above discussion that accounting has the elements of both

science and art.

Solved Example for You

Q: The first step in the accounting process is_______.

a. Summarising

b. Interpreting

c. Recording

d. None of the above

Ans: The correct answer is C. Maintaining proper and fine accounts

has become very essential today, as a result, of increasing

complementation in the business world. Every business organization

is, therefore, supposed to maintain fine accounts comprising of all the

financial transactions, financial as well as nonfinancial information.

We all know that any accounting involves a fine recording,

summarizing, proper classification as well as the interpretation and

communication of financial information. Every business has to be

recorded first so that the other processes can be carried out effectively.

Therefore the first step in the accounting process is recording.

Basic Terms of Accounting

In accounting, many technical words are commonly used. Therefore, it

is essential to know their meaning, without which knowledge of

accounting subject will be incomplete. Commonly used terms such as

business, purchase, purchase return, trade etc are explained here.

1. Business

Any legal action that is done in order to earn income or profit is called

business. It includes the production of goods and services, purchase

and sale of goods and services, banking, insurance, education

transportation, and any other trading activity etc.

Capital= Assets – Liability

2. Trade

Purchase and sale of goods and services in order to earn profit is

called trade.

Browse more Topics under Introduction To Accounting

● Meaning of Accounting

● Qualitative Characteristics, Objectives, and Roles of

Accounting

3. Profession

Any work done in order to earn profit which necessarily requires prior

training and education is called a profession. For example doctors,

lawyers, engineers etc..

4. Proprietor

The person who invests capital in the business and entitled to have all

profits and losses of the business is called proprietor or owner of the

business. The nature of proprietor depends upon the type or nature of

the business organization. In a sole trade business, sole trader is a

proprietor, in a partnership firm, partners or proprietor and in

company shareholders are proprietors.

5. Capital

The amount of cash, goods or assets which is initially invested by

proprietor while commencing business is called capital. It is invested

to earn profits. In other words, the excess of assets over liability is

capital.

6. Assets

All the resources of business having economic value are called assets.

These resources help the business to earn a profit and have future

value. These are important for running a business and are in the

possession of businessman. These are of two types: –

a. Fixed assets

The assets which are used by business for a long time are called fixed

assets or non-current assets. These are continued to be used by the

business for a period of more than one year. For example:- land

,building ,plant, machinery ,furniture ,vehicle etc.

b. Current assets

The assets which are used up in one year or easily get converted into

cash in one year are called current assets. For example:- raw material,

finished goods, debtors, cash balance and bank balance etc.

7. Liabilities

The amount which business owes to others is called its liabilities.

There is a certain amount which business is under obligation to pay.

There are two types of liabilities: –

a. Long-term liabilities

Those liabilities which are usually payable after a period of 1 year.

Long-term loans from Financial Institutions, debentures issued by

companies etc.

b. Short-term liabilities

These are those which are payable within one year. For example

creditors, bank overdrafts etc.

8. Drawings

The amount of cash or goods which is withdrawn by proprietor from

business for its private uses is called drawings. It reduces the capital of

the business.

9. Goods

The things which are bought and sold by business are called goods.

Goods maybe raw material work in progress of finished goods. In

accounting, when goods are purchased it is written as purchases.

When goods are sold it is written as sales. It is written as a stock if

remain unsold at the end of the year.

10. Purchases

Goods bought for resale are called purchases. This may be in form of

raw material or finished goods. Purchase of assets is not called

purchases because assets are not purchased for resale.

11. Sales

When purchase goods are sold in order to earn a profit are called sales.

When goods are sold for cash it is called cash sales and goods sold on

credit are called credit sales.

12. Purchase return

Goods once purchased by the business, are returned back due to any

reason is called purchase return or return outwards.

13. Sales return

Goods once sold to the customer when are returned back by them due

to any reason then such goods are called as sales returns or return

inwards.

14. Stock

These are those goods which are left unsold in the business at the end

of the year. The goods unsold at the end of the accounting year are

called closing stock. The same stock is called opening stock at the

beginning of a new accounting year.

15. Revenue

These are the amount received by a business for selling goods or

services. This amount is received from day to day business activity in

the form of rent, interest, commission, discount, dividend etc.

16. Expenses

The cost which business incurs for producing goods and services or

for using services is called expenses. These include payments made

for wages, salaries, freight, advertisement, rent, insurance etc. In other

words, we can say that the cost of earning revenue is an expense.

17. Expenditure

The amount which is paid for increasing profit earning capacity of

business is called expenditure. It is of long period nature.

18. Income

That amount which increases the capital of the business is called

income. The excess of revenue over expenses is also called income.

Income= Revenue- Expenses

19. Loss

When expenses incurred are more than revenue then this excess of

expenses is called loss. This reduces the capital of the business.

20. Gain

It is a monetary receipt as a result of business transaction. The excess

of revenue over the expenses is called gain.

21. Cost

Total of direct or indirect expenses which are incurred for the

production of goods and services is called cost. Like the cost of raw

material cost of labor and cost of other services used to make the

article is called its total cost.

22. Discount

Concession a rebate allowed by a businessman 2 its customer is called

a discount. it may be of two types: –

a. Trade discount

When a trader allows a concession to its customers on the list price, it

is known as trade discount. It is not recorded in the books. It is stated

in the invoice.

b. Cash discount

When a trader allows a concession to the customer to make payment

in cash or by cheque, it is known as cash discount. It is recorded in the

books. When cash discount is allowed customer is required to pay the

less due amount, so it encourages the customer to pay as early as

possible.

23. Debtor

The person, firm or an organization who takes goods or services on

credit from the business are called debtors of the business. In other

words, the person, firm or an organization who owes money or

Money’s worth to the business is called debtor.

24. Creditors

The person, firm or an organization from whom goods or services are

purchased on credit by the business are called creditors of the

business. The business owes money to them. The amount payable to

creditors is a liability of the business.

25. Receivables

The total amount which is to be received in business is called

receivables.

26. Payables

The total amount which is to be paid by the business is called

payables.

27. Entry

Recording of the transaction in account books is called making an

entry or the record of a transaction in books is called an entry.

28. Turnover

The total amount of cash and credit sales during a particular period is

called turnover.

29. Insolvent

A person is said to be insolvent when he or she is incapable to meet all

his or her liabilities. Such a person has more liability than assets.

30. Bad debts

The amount which could not be recovered from debtors due to his

insolvency or disability to pay is called bad debts.

31. Vouchers

The written document through which financial transactions are

recorded in the books is called voucher.

32 Account

A list of all transactions relating to a person, property, income

expenses is called into account. It is a tabular statement containing all

the transaction of same nature at one place under a common heading

in a systematic manner.

33 Debit and credit

Every account has two sides. Left side is called the debit side and the

right side is called the credit side. In short, it is Dr. and Cr.

34 Commission

In a business activity, a remuneration is paid to the agent for his

services, is called commission.

Solved Example for You

Q1. That person to whom we sold goods on credit is called

a. Debtors

b. Creditors

c. proprietor

d. none the of above

Answer: a) Debtors

Qualitative Characteristics, Objectives and Roles of Accounting

Accounting can be defined as a systematic process of identifying,

recording, measuring, classifying, verifying, summarizing,

interpreting and communicating financial information. Let us see more

about the meaning and roles of accounting in business.

Characteristics of Accounting

The characteristics of accounting can be broadly classified into the

following categories-

● Primary characteristics

● Secondary characteristics

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Learn the Basics terms of

Accounting here.

Primary Characteristics of Accounting

The following are the primary characteristics of accounting as

follows-

● Relevance: Relevance in accounting is closely related to the

concept of useful information. It means that the information

must be capable of making a difference in taking various

decisions by the users. The information gathered by users

relevant for one purpose may not be necessarily relevant for

other purposes. The relevant information also reduces

decision-makers uncertainty about future acts.

● Reliability: Reliable information is required to form judgments

about the earning potential and financial position of a business

firm. Reliability differs from item to item. There are many

factors affecting the reliability of information such as

uncertainties inherent in the subject-matter and accounting

measurements.

Browse more Topics under Introduction To Accounting

● Meaning of Accounting

● Basic Terms in Accounting

● Accounting as a Source of Information

Secondary Characteristics of Accounting-

The following are the secondary characteristics of accounting as

follows-

● Comparability: Comparability means that the users should be

able to compare the accounting information of an enterprise of

the period either with that of other periods, known as an

intra-firm comparison or with the accounting information of the

other enterprises, known as an inter-firm comparison.

● Understandability: Understandability means that the

information provided through the financial statements must be

presented in a manner that the users are able to understand it.

Objective of Accounting

The following are the main objectives of accounting:-

To keep Systematic Records

The main objective of accounting is to keep a systematic record of

financial transactions which helps the users to understand the day to

day transactions in a systematic manner so as to gain knowledge about

overall business.

To Protect Business Properties

Accounting provides protection to business properties from unjustified

and unwarranted use. Information about the above matters helps the

proprietor in assuring that the funds of the business are not necessarily

kept idle or underutilized.

Ascertain Profit

Another objective of accounting is that it helps in ascertaining the net

profit earned or loss suffered on account of carrying the business

which is done by keeping a proper record of all books of accounts

with respect to revenues and expenses of a particular period.

Ascertain the Financial Position

The accounting also helps the businessman to know about his

financial position. This objective is served by the Balance Sheet or

Position Statement. The Balance Sheet is a statement of assets and

liabilities of the business on a particular date. It serves as a tool for

ascertaining the financial health of the business.

Facilitate Decision Making

Accounting also helps in the collection, analysis, and reporting of

information at the required points of time to the required levels of

authority in order to facilitate rational decision-making.

Information System

Another objective of accounting is that it can be defined as accounting

functions as an information system for collecting and communicating

economic information about the business enterprise. This information

helps the management in taking appropriate decisions.

Roles of Accounting

Accounting plays an important and useful role in developing the

information for various types of users. The major roles of accounting

in different areas are as follows-

● Since the increased volume of business results in a large

number of transactions and no businessman can remember

everything. Therefore accounting records reduce the necessity

of remembering various transactions.

● Another role of accounting records is that it should be prepared

on the basis of uniform practices will enable a business to

compare results of one period with another period.

● The various different authorities have their opinion according

to which, they believe that the facts contained in the set of

accounting books are maintained according to generally

accepted accounting principles which will help in better

understanding for users of financial information.

● Those accounting records which are supported by proper and

authenticated vouchers are good evidence in a court of law.

● Another concerned role is that if a business is to be sold as a

going concern, then the various values of different assets which

are shown by the balance sheet will help in bargaining proper

price for the business.

Solved Example

Q: True & Fair profit or loss of a company is known by:

a. Preparing Trial Balance

b. After preparing Vouchers

c. Preparing Trading and Profit and Loss A/c

d. None of the above

Ans: The correct option is C. We can only ascertain the profit or loss

of the company after arriving at the Net Profit which is obtained in the

Profit and Loss A/c. The Trading A/c gives us the operating profit.

Arriving at the profit figure is one of the most important roles of

accounting.

Accounting as a Source of Information

Accounting is regarded as the language of a business. It is used as a

means of communication between a business organization and its

shareholders. The accounting process is a source of information, it

uses business data and processes it to generate relevant information.

Let us have a look.

Accounting as a Source of Information

Accounting is the management information system of any

organization and is concerned with providing necessary information to

the management, i.e it is a source of information. In the account, every

step involves either generation or processing accounting information.

It serves as a means as well as an end of providing information to all

stakeholders who need information to make a proper decision.

Learn the meaning of accounting

here.

Accounting serves following purposes relating to generating and

processing information:-

● The accounting records business transaction which is the

source of generating information.

● Proper accounting system makes information more reliable.

● Accounting ensures it is a reliable source of information.

● Accounting works as a management information system to the

organization. It helps the management to manage the

organization in a proper way.

● Accounting system generator various information in the form

of different accounts. These documents have to be to true and

fair.

● Accounting shows the performance of any business

organization. Oil anyone who wants to know about the progress

of an organization can only not through the use of accounting.

● Accounting provides information on activities that affect the

society.

As we know all like titles in accounting is done by a person known as

an accountant. An accountant generates accounting information by

observing, screening and recognizing events and transactions in the

business.

He measures and processes information and compile reports

comprising accounting information that is communicated to the users.

Then these are interpreted and uses by management and other user

groups. It is the responsibility of the accountant that the information

provided must be relevant adequate and reliable for decision making.

Browse more Topics under Introduction To Accounting

● Meaning of Accounting

● Basic Terms in Accounting

● Qualitative Characteristics, Objectives, and Roles of

Accounting

Learn Basics terms of

Accounting here.

Users of Accounting Information

Accounting information is used by many parties for making decisions

in business. All those who use accounting information about the

business to make decisions called Users. They are basically users of

accounting information. These are different parties in the business

who have some stake in the business. Users have a stake in the

business in the form of

● Investment in business

● Loans to the business

● Goods sold on credit to the business

● Job in the business.

● Consumers of goods and services produced by the business etc.

But the main purpose of all the users is that all of them want to know

about the performance, progress, and working of the business

organization. The users of accounting information are divided broadly

into two categories:-

1. Internal users

2. External users

Internal Users

These are the parties who have directly involved with the management

and working of the organization. They work with the organization and

have the power to influence the working of an organization. For them

too, accounting is a source of information.

Internal uses include owners, partners, directors, managers, and

employee etc. Different users need different information from the

accounting. It can be discussed in the following manner:

1] Owners/Proprietor/Partners

They want to know about the probability of an organization. These are

interested in getting a good return on their investment. These are all

interested to know how the financial position of the business

organization is. e It is their responsibility to take a decision about the

future policies and performance of the business in the future according

to this data.

2] Management

The success of the management depends on the success of an

organization. The performance of the management is evaluated

according to the profits of a business.

If the business grows, salaries of management staff will also grow.

Management is also responsible to know whether a business is able to

pay its liabilities or not. The management will be interested to know if

the business is showing overall growth and performance of the

business. Their source of information, in this case, will be the

accounts of the company.

3] Employees and Workers

These are interested to know that business is earning profits or not. If

the business is in loss then it is the possibility that some employees

may be removed from a job. These are also interested to know if they

should continue the same organization. This will depend on the future

prospect of an organization.

External Users

All those parties and individual who are not directly involved in the

management and operation of the business now is external users.

These do not have the power to influence the working of the

organization. Such users include investors, creditors, suppliers,

customers, banks, financial institutions, government, existing

shareholders, potential shareholder and supplier of raw materials etc.

Every different user needs a different kind of accounting information.

It can be discussed in the following manner –

1] Bankers/Lenders

These want to know interest on their loans. They will be able to get

interested when the businesses are earning profits. The financial

position of the business is good then it will be able to pay back the

loans.

2] Creditors

These want their money back from the business and it depends upon

the financial position of the business.

3] Customers

These want to know the future policies of the business. If the business

will continue in the future then the demand for customer increases.

4] Government

Government is interested to know how the trade in an industry is

doing in the country. The government departments collect data related

to revenues, sales, production, the number of employees etc. of

business to know the condition of the economy. It is also interesting to

know how much taxes have been paid by the business

5] Society

The business organization uses the resources of society. Therefore

society expects the business to generate employment for them.

Therefore society would like to know how many people are employed

in the business.

Society is also interested to know how many welfare activities are

done by a business organization for them. Societies want to know the

policies of CSR (corporate social responsibility). A successful

business provides a lot of services to the people in the society like

hospitals, schools, thinking water, food to school children, making

road etc.

Thus accounting as the language of business is used to exchange

information between business and its partners.

You can also learn the Roles of

Accounting here.

Solved Example for You

Q1. List down the external users.

Solution :

1. Bankers

2. Consumer

3. Society

4. Creditors

5. Government