WHAT IS ACCOUNTING ?
In accounting literature, the two terms, namely: Accounting and Financial Accounting are used interchangeably. But accounting is a tree while financial accounting is one of its branches. All accounting work, in the beginning, was in the nature of financial accounting which was used to record business transactions for a certain period usually called accounting period. Then, these transactions were classified and summarized in the form of profit and loss account to calculate or find out profit or loss for the accounting period which is generally of one year. Financial Accounting also helps to know the financial position of the business enterprise as on the last date of the accounting period in the form of assets possessed or owned by it (the enterprise) and the liabilities owed to others. The statement showing the Financial Position is technically called the Balance Sheet.
NATURE AND SCOPE OF ACCOUNTING
In the present context, the term ‘nature’ means quality or feature of a subject. And the term ‘scope’ means the things that a particular subject covers or deals with. Thus the nature and scope of accounting simply mean the essential features of accounting and what the accounting covers or deals with.
Essential Features of Accounting: From the above definitions, it is clear that accounting or financial accounting has many essential features which are briefly stated below:
(i) Identifying: It means selecting transactions and events of a specific organisation. In other words, identifying means determining or deciding the business transactions to be recorded in the books of account.
(ii) Measuring: It means expressing the value of business transactions in terms of money. Such transactions are known as financial transactions e.g., the sale of cars by Maruti Suzuki Ltd. or providing of telephone services by Airtel or payment of wages or salaries by Wipro Ltd or collection of money for advertisement by Star TV. channel etc. are examples of financial transactions. On the other hand, the transactions that cannot be measured or expressed in terms of money like the strike by the employees, the efficiency of a sales person or recruitment policy of the management cannot be recorded in the books of account.
(iii) Recording: Once the financial transactions and events are identified that is, recognized, and measured in terms of money, the same are recorded in the books of account. The recording is done on the basis of such documents as purchases and sales bills, (or invoices), bank pass book or bank statements, salary slips and so on.
(iv) Classifying: After the transactions have been properly recorded in general journal or subsidiary books (or journals), these are properly classified. Classification refers to the grouping of transactions (or entries) of the same type (or of like nature) at one place into appropriate headings (called account titles) or in separate accounts. For example, expenses may be grouped into separate accounts such as salaries account, rent account, stationery account etc.
(v) Summarising: Summarising means to bring together a number of classified accounts into one single account. For example, the accounts of various customers are grouped under a single account title as “Debtors’ Account” and similarly the accounts of suppliers are grouped under a single account title as “Creditors’ Account”. All the incomes accounts and expenses accounts are recorded in the profit and loss account to get one figure of either net profit or net loss. Summarising thus involves the presentation of the information found in the ledger accounts in the form of profit and loss account and balance sheet at the end of the accounting period.
(vi) Significant: Accounting information is said to be presented in a significant manner only if the accounting records are useful for making decisions or for judging the performance of some firm or person.
(vii) Interpretation: In fact, interpretation is the main function of the accountants. It means that accountants must be able to explain not only what happened in the past but also why it happened and most important what is likely to happen in future on the basis of certain conditions. Interpretation requires analysis of information available in the financial statements, namely: profit and loss account and the balance sheet.
(viii) Communicating: It simply means communicating the results of the interpretation of financial statements to the ultimate or end-users of the accounting information for making decisions in respect of investments in various enterprises, the supply of goods on credit by sellers or grant of loans to business firms especially by the bankers and so on.
ACCOUNTING AS AN INFORMATION SYSTEM
As noted above, communicating is one of the important features of accounting. It has made accounting as an information system.
Accounting is often referred to as the language of business. The primary aim or purpose of a language is to serve as a means of communication. Accounting is used to communicate financial and other information to people, organisations, Governments etc., about various aspects of business and non-business enterprises. Accounting information is used when Mr A applies for a loan at a bank or when A submits his income-tax returns.
REAL NATURE OF ACCOUNTING
In the foregoing pages, nature of accounting has been explained with the help of traditional definition of accounting along with the recent definitions. While accounting is many things to many people, the real nature of accounting is essentially described as :
(i) An intellectual discipline
(ii) A profession
(iii) A social force
(iv) A tool of social welfare
(v) An aid or help to resource management
Let us explain these points briefly as follows:
(i) An intellectual discipline: The commonly recognised intellectual disciplines are physics, chemistry, mathematics, economics, engineering, electronics, biology, space research, political science and so on. These are concerned with measurements and communication of information. We have noted that accounting information is also based on measurements, (e.g., determination of income and financial position) and it is also an information system. Thus the boundaries of accounting merge readily with the boundaries of economics, engineering, statistics and other physical sciences. When accounting is related to and combined with other disciplines or subjects, it tends to become an intellectual discipline because it becomes more useful than when it stands alone.
(ii) A profession: The development of accounting as a profession is relatively new. The introduction of joint stock company form of business organisation as a result of industrial revolution created the need for an independent audit to ensure that the financial records prepared by the management were reliable.
If fact this audit function is also known as ‘attest function’ was mainly responsible for the development of accounting as a profession. Other functions are management consultancy, cost consultancy and tax services. So we have professional accountants in the form of chartered accountants, cost and works accountants, financial analysts, tax consultants etc., to make accounting as a profession.
(iii) A social force: The expansion of large scale modern business has been possible only with the help of adequate financial information system. The separation of ownership and management in joint stock company form of business organization is possible only if the reliable financial information is supplied to owners from time to time. In fact, accounting facilitates ownership by remote control. Accounting information is also useful in the price determination of products, regulation of stock markets, fixation of rates in public utilities like railways etc.
(iv) A tool of social welfare: The social welfare concept of accounting is related to the effect of financial information on all individuals making the society. Accounting information is used by various groups of individuals like investors, creditors, trade unions, government etc. It must be ensured that various users of accounting information are not treated differently in the supply of financial information.
(v) Aid in resources management: The accounting is generally related to commercial or profit making activities. However, we find in practice that individuals or persons, both in private business and in public sector enterprises engage in transactions, which may be recorded, classified and summarized and yet may have no profit motive. The accountant may serve any social unit large or small; private or public; profit making or not. He serves it by recording the resources at its disposal, who owns these resources, any change that occurs in a number of resources from time to time. Thus accountancy provides an important aid in resource management.
Accountancy is the theory and practice of accounting.” Accountancy is also described as the discipline which analyzes the art and principles of recording all monetary transactions are known as accountancy.
Thus accountancy is not separate from accounting. It is not the process of doing accounting work. It is a discipline or a body of knowledge or subject of study which explains the art and principles of recording financial or business transactions.
Accountancy explains, why books of account are to be maintained and the form in which these books of account should be maintained for various business transactions like cash books, purchase book, sales book, return inwards and return outwards books and how to prepare the principal financial statements like profit and loss account, balance sheet and cash-flow statement. Accountancy also lays down the procedure for interpretation of accounting information with the help of comparative balance sheets and income statement, ratio analysis and cash-flow statements and also how to communicate the results and interpretation of financial information to the ultimate users of the accounting information for making different types of decisions like investments, grant of loans and supply of goods on credit. It must be made clear that accounting is a part of the concept of accounting.
The main features of accountancy are summed up as under:
(i) It is a discipline, that is, a body of knowledge or a subject of study e.g. chartered accountancy and cost accountancy.
(ii) It prescribes or lays down the rules in respect of recording, classifying, summarizing and interpreting the financial information.
(iii) It is also concerned with the basic concepts or conventions for recording the business transactions leading to the preparation of the financial statements and the interpretation of operating results (profit or loss) and the financial position.
(iv) Accountancy is a wide term which includes both book-keeping and accounting.
(v) Accountancy is also the practice of accountants like chartered accountants, tax accountants, cost accountants and so on.
DIFFERENCE BETWEEN BOOK-KEEPING AND ACCOUNTING
Book-keeping may be defined as a science as well as the art of recording business transactions under appropriate accounts.” Book-keeping is also defined as the art of recording business transactions in a systematic manner.
The substance of the above stated and some other definitions are that Book-keeping is the process of recording business transactions, in proper books of account in a systematic manner so as to find out the profit or loss and the financial position of the business enterprise.
A comparison of the respective definitions of book-keeping and accounting would show the following points of difference between the two:
Single Entry System
Single Entry System of Bookkeeping is the oldest method of maintaining financial records in which an entry is made for every financial transaction. In this system, the corresponding opposite entry is not made because the transactions are recorded only once. Full record keeping of transactions is not done due to a single entry of every transaction. It mainly keeps track of the transactions relating to cash receipts and disbursements.
Double Entry System
Double Entry System is the scientific method of keeping financial records. This system is based on the principle of duality, i.e. every transaction has a dual aspect. Each transaction affects two accounts at the same time, in which one account is debited while the other is credited.
Example: Suppose Mr Kamal has purchased goods of Rs.1000 for cash from Mr Prashant, so here, on one hand, he has received goods and on the other hand the cash is given to Mr Prashant So, you should have noticed that the goods have been acquired by giving up cash. Therefore, as its name signifies, this system records both the aspects of a single transaction, i.e. the increase in goods with the simultaneous decrease in cash.
Key Differences between Single Entry System and Double Entry System
The following are the major differences between single entry system and double entry system of bookkeeping:
1. The bookkeeping system in which only one aspect of a transaction is recorded, i.e. either debit or credit, is known as Single Entry System. Double Entry System is a system of keeping records, whereby both the aspects of a transaction are captured.
2. Single Entry Transaction is simple and easy whereas Double Entry System is complex as well as it requires expertise in accounting for maintaining records.
3. In single entry system, incomplete records are maintained while in double entry system complete recording of transactions is there.
4. In single entry system comparison between two accounting periods is very difficult. Conversely, we can easily compare two accounting periods in the double entry system.
5. Single Entry System maintains personal and cash accounts. On the other hand, personal, real and nominal accounts are kept in Double Entry System.
6. The Single Entry system is best suited for small enterprises, but big organisations prefer Double Entry System.
7. Frauds and embezzlement are easy to identify in double entry system which cannot be located in single entry system.