WHAT IS ACCOUNTING?

 Accounting is the process of keeping track of all financial transactions within a business, such as any money
coming in and money going out.

Accounting: Explanation
To explain and understand the above definition clearly, let’s consider it in parts.

The first thing to note about accounting is that it is an art, not a science. It is a practical subject concerned more with
doing things than theorizing about them.

Accounting is the art of recording, classifying, and summarizing transactions and events. In the first place, we maintain
the records of transactions by writing various accounting books like journals and ledgers, etc.

These records are then classified into suitable headings and groups. This classification is important because all
information must be seen in a proper perspective to be meaningful.

After the basic records have been suitably classified into groups, the information provided by the groups is summarized
into accounting statements (e.g., statements showing the calculation of profit and loss or the business’s financial
position).

The preparation of such summarized financial statements is frequently the ultimate aim of keeping records and
classifying them.

Another important fact is that such records, classifications, and summaries are made for both transactions and events.

A transaction is any business dealing or activity in which a business unit (or a person) is involved that causes a change
in its financial position (e.g., purchase or sale of goods).

An event, on the other hand, is an occurrence to which a business unit may not be a direct party, but may still be
affected by it.

An example is the devaluation of a currency. An importer or an exporter is usually affected by devaluation without being
directly involved in the decision to devalue the currency.

If an event has a financial implication for a business unit, it must make a record of such an event.

Again, the records, classifications, and summaries are made for only those transactions and events that are of a
financial nature or character. All accounting records are basically financial records.

If a transaction or an event does not have a financial implication, it will not be recorded in the accounting books.

For example, placing a purchase order is a transaction but it has no financial implication until the goods are actually
delivered by the supplier to the buyer.

Hence, accounting records are made only after the goods have been physically received. As a case in point, the
devaluation of the US dollar may have no financial implication for a small trader who has no import or export dealings.

Therefore, in this case, no record of the event must be maintained.

All records are made in a significant manner and in terms of money. It is important that these records must be made in
a significant (i.e., organized and methodical) manner in order to be of any real use to a business unit.

Again, all accounting records are made in terms of money—not in terms of quantity or weight.

While additional or subsidiary records may be kept by some businesses in terms of quantity, the basic accounting
records are all kept in terms of money.

Thus, a motor vehicle account will show the value of a motor vehicle owned by a business, not its make or mileage, etc.
Similarly, in the purchase account, we show only the monetary value of purchases, not the quantity, type, etc. of goods
purchased.

The last part of the definition from the AICPA shown above is concerned with the interpretation of the results made
available by accounting records and summaries.

Financial statements must be explained to the people concerned so that they can understand the contents and the
message conveyed. This is, therefore, an important aspect of the accounting process; without it, records would have
limited, if any, value.
 For the purpose of interpreting and explaining the accounts, a number of tools or techniques can be utilized.

Need for Accounting

A business exists to earn a suitable return (or profit) on the investment allocated to it. It is so because money obtained
from shareholders and long-term creditors comes at a cost.

The cost for shareholders’ money is to be equated with their expectations. A business will, therefore, aim at a return
that satisfies the shareholders’ expectations as well as the legal requirements of the creditors.

The expenses incurred to run a business and the income earned is recorded in accounting. Accounting converts
business transactions in money terms, classifies and records transactions in the books of accounts, and summarizes
transactions.

This shows the profit earned (or loss sustained) during a period. It also shows the company’s financial position (in
terms of assets, liabilities, and proprietor’s interest) at the end of the period.

Without accounting, a business cannot identify how much has been spent, why it has been spent, and what results
have been achieved in the form of earnings made through increasing these expenses.

Accounting, therefore, serves as the eyes and ears of a company. With accounting information, businesses can
evaluate the direction they are heading in and, accordingly, determine whether the journey will lead to a happy or sad
end.

WHO NEEDS ACCOUNTING??

All business organizations are in need of accounting. Individuals, sole traders, Partnerships, companies, corporations—
all cannot survive without keeping proper accounts.

NATURE OF ACCOUNTING
Accounting is art of recording, classifying, 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.
The Nature of Accounting can be defined in two ways:

 Quantitative Attributes of Accounting

 Qualitative Attributes of Accounting     

QUALITATIVE ATTRIBUTES OF ACCOUNTING

The fundamental nature of financial statements is to provide true and fair view of the state of affairs and profit
or loss for the period. Qualitative attributes simplifies and expands on the financial figures to ensure easy
understanding and comparability of results. The Qualitative Attributes that describe the Nature of Accounting
are as follows:

RELIABILITY
Reliability implies that the information must be factual and verifiable. The accounting information has said to
have verifiability if such information can be verified from source documents such as cash memos, purchase
invoices, sales invoices, correspondence, agreement, property deeds and other similar documents.

In order to be relied upon, the financial information requires the following attributes:

 Neutrality
 Substance over form i.e. accounting should be based on financial reality and not merely on legal
form.
 Prudence
 Completeness

 RELEVANCE
Accounting information depicted by financial statements must be relevant to the objectives of enterprise.
Unnecessary and irrelevant information should not be included in financial statements.
The INTERNATIONAL ACCOUNTING STANDADRDS BOARD (IASB) says that information is relevant
“When it influences the economic decisions of users by helping them evaluate past, present or future events
or confirming or correcting their past evaluations.”

The relevance of information is affected by its nature and materiality. If an item or event is material, it is
probably relevant to the users of financial statements.

For Example: The information regarding the rate of dividend paid by a company in previous years is relevant
information for the investors since it provides a basis for forecasting future dividends.

UNDERSTANDABILITY
Accounting information should be presented in such a simple and logical manner that they are understood
easily by their users such as investors, lenders, employees etc. A person who does not have any knowledge
of accounting terminology should also be able to understand them without much difficulty.

This can be done by giving relevant explanatory notes to explain the information given in financial
statements. General topics which can be included in the explanatory notes are Method of depreciation,
method of valuation of inventory, description of contingent liabilities, explanation of reserves, disclosure of
events occurring after balance sheet date etc, These explanatory notes make the financial statements more
useful and understandable.

COMPARABILITY
Comparability is very useful quality of the accounting. The financial statements should contain the figures of
previous year along with the figures of current year so that the current performance can be compared with the
past performance. Similarly, the financial statements should be prepared in such a way that the profitability
and financial position of the concern may be compared with the other concerns of the similar type.

Comparison reveals the strong and weak points of the business entity. Comparison is possible when the
different firms in the same industry adopt the same accounting principles from year to year.

For Example: If diminishing balance method of charging depreciation is selected, it should not be changed
from year to year. Similarly, the method of valuation of stock should also be consistently the same from year
to year.

FAITHFUL REPRESENTATION
Accounting aims at preparing those financial statements that depict the true and fair view of profitability,
liquidity and solvency position of an enterprise. Application of appropriate Accounting Standards normally
results in financial statements portraying true and fair view of information of an enterprise.

QUANTITATIVE ATTRIBUTES OF ACCOUNTING

The Quantitative attributes explaining Nature of Accounting are as follows:

ACCOUNTING IS AN ART AS WELL AS SCIENCE

Accounting is an Art of recording, classifying, summarizing, analyzing and interpreting the accounting records
with a view to ascertain the net profit/ loss and financial position of the business.

Accounting as a Science is an organized body of knowledge that contains some underlying principles and
rules that are followed while maintaining accounts. However, Accounting is not a pure science as it does not
establish cause and effect relationship.
 RECORDING OF FINANCIAL TRANSACTIONS ONLY
Accounting records only those transactions and events that are expressed in monetary terms or in
quantitative form. For instance, the transactions like sale of goods for ₹5,000 will be recorded in the books of
accounts.

However, there are so many events which are very important for business but cannot be recorded in the
books of accounts because such events cannot be expressed in quantitative or monetary form. For example:
Loyalty of Employees, Resignation by an able and experienced manager, Strike by employees, Quarrel
between employee and employer etc. but these events have a large impact and direct bearing on the
business of the firm.

RECORDING IN TERMS OF MONEY

The accounting records only those transactions which can be expressed in terms of money only. It implies
that a business man will not record the purchase of 5 chairs and 5 tables, he will record the purchase of 5
chairs costing ₹2,500 and 5 tables costing ₹5,000.

Also the recording is done in the book of the journal which is the primary book of recording the transactions in
the chronological order.

In small business houses, the recording of transactions is generally done in the book of Journal whereas in
big business houses the recording of transactions is done in the subsidiary books such as:

 Cash Book
 Purchase Book
 Sales Book
 Purchase Return Book
 Sale Return Book
 Bills Receivable Book
 Bills Payable Book
 Journal Proper

The number of subsidiary books to be maintained depends upon the nature and size and needs or
requirements of the business.

CLASSIFYING THE TRANSACTIONS

One of the Features of Accounting is that it classifies all the transactions recorded in the book of the Journal.
Classification refers to grouping the transactions of same nature at one place, in a separate account.
Classification of transactions is done in the books of ‘Ledger’. All the accounts related to creditors, debtors,
capital, assets, liabilities, incomes and expenses are separately opened in the Ledger Book. Example:
Wages Account, Ram Account, Advertisement Account, Cash Account, Bank Overdraft Account etc.

SUMMARISING THE TRANSACTIONS

Summarizing is the art of presenting the classified data in a manner which is understandable and useful to
management and other users of such data. It involves:

 Balancing of Ledger Accounts

 Preparation of Trial Balance
 Preparation of Trading and Profit & Loss A/c
 Preparation of Balance Sheet

Trial Balance is a summary of all the ledger accounts and is maintained to check the arithmetical accuracy of
accounts. Trading Account is prepared to find out the Gross Profit or Gross Loss while Profit & Loss Account
helps in knowing Net Profit or Net Loss. Balance Sheet prepared at the end of accounting year helps in
knowing the financial position of the concern. It shows the Profitability, Solvency as well as Liquidity position
of the business.
 ANALYSING
Analyzing is concerned with the establishment of relationship between the various items or groups of items
taken from Income Statement or Balance Sheet or both. Purpose of analysis is to identify he financial
strengths and weaknesses of the enterprise. It provides the base for analysis.

INTERPRETATION OF RESULTS
Another feature of accounting is interpretation of results. Interpretation of results is concerned with explaining
the meaning and significance of the relationship so established by the analysis. Interpretation of results
requires high degree of knowledge and skills. The accountant should answer:

 What has happened?

 Why is happened?
 What is likely to happen under specified conditions? 

COMMUNICATING THE RESULTS

Accounting is so featured that it will provide the analyzed and interpreted results to its users such as
Management, Employees, Creditors, Research Scholars, Debtors, Financial Institutions, Competitors,
Bankers, Income Tax Authorities etc. The results are communicated by preparing final accounts, ratios,
graphs, diagrams, charts, fund flow statement, cash flow statement etc.

DIFFERENCE BETWEEN COST ACCOUNTING AND FINANCIAL ACCOUNTING

The difference between cost accounting and financial accounting is as follows:

COST ACCOUNTING
Cost Accounting is an art or process of recording, analyzing and classifying of expenditure for the purpose of product
costing or service costing, ascertainment of profitability, operational planning and cost control. It is a forward looking
approach which is related to the recording, analyzing and classifying of expenditure with the objective of ascertaining
the total and per unit cost of product or service.
FINANCIAL ACCOUNTING
Financial accounting is the branch of accounting, which keeps all the records of monetary transaction and events and
reports the financial information to parties interested at the end of the financial year. The financial statements prepared
are statement of profit and loss and position statement i.e. balance sheet.

HISTORY AND ORIGIN OF ACCOUNTING..

FATHER OF ACCOUNTING-Luca Pacioli- (c. 1447 – 1517) was the first person to publish detailed material on the
double-entry system of accounting. He was an Italian mathematician and Franciscan friar who also collaborated with
his friend Leonardo da Vinci (who also took maths lessons from Pacioli).

Everyone needs an accountant, or so the saying goes. But why would that be? Accounting’s history can be
traced back thousands of years to the cradle of civilisation in Mesopotamia and is said to have developed
alongside writing, counting and money. The early Egyptians and Babylonians created auditing systems, while
the Romans collated detailed financial information.
Some of the first accountants were employed around 300 BC in Iran, where tokens and bookkeeping scripts were
discovered. Around the first millennium the Phoenicians invented an alphabetic system for bookkeeping, while the
ancient Egyptians may have even assigned someone the role of comptroller.

Italian roots
But the father of modern accounting is Italian Luca Pacioli, who in 1494 first described the system of double-entry
bookkeeping used by Venetian merchants in his Summa de Arithmetica, Geometria, Proportioni et Proportionalita.
While he was not the inventor of accounting, Pacioli was the first to describe the system of debits and credits in journals
and ledgers that is still the basis of today's accounting systems.
With the onset of the industrial revolution in 1760, there was a proliferation of companies and the need for more
advanced accounting systems. The development of corporations also created larger groups of investors, and more
complex structures of ownership, all requiring accounting systems to adapt.
The different types of accounting
 Financial accounting
 Managerial accounting
 Cost accounting
 Tax accounting
 Auditing

1. Financial accounting
Financial accounting involves capturing and summarizing all of a business’s financial transactions and creating reports
to provide a clear overview of those business transactions. Financial accountants also generate financial records that
provide valuable information about a company’s fiscal health, such as balance sheets, cash flow statements, and
income statements. Financial accounting is always focused on past performance, not the future.

2. Managerial accounting
The management accounting method is used by businesses to gain greater insights into a company’s operations. Since
managerial accounting is strictly focused on providing accounting information for internal use, it doesn’t have to stick to
the same strict GAAP guidelines as financial accounting. Rather, it focuses on things like financial analysis, budgeting,
and cost analysis.

By analyzing past financials and forecasting future outcomes—for example, how much a company could cut
expenditures by switching software providers—managerial accountants provide business owners with the data they
need to make savvy business decisions. Generally, the emphasis is on strategic management, risk management, or
performance management. It depends on what kind of data business owners and investors want.

3. Cost accounting
Cost accounting is technically considered a subcategory of management accounting. It focuses specifically on a
company’s cost of doing business. This is used explicitly for internal purposes, helping determine how to reduce costs
and increase profit margins. Companies may hire cost accountants to determine how to streamline overall operations.

Cost accounting is particularly useful in manufacturing environments. It takes into account various expenditures,
including fixed costs and variable costs, from commercial rent to materials and labor expenses. The aim is to ensure
that the cost needed to produce a good (the cost per unit) is reasonable. If not, business owners can strategize on how
to improve this figure.

There are different types of cost accounting methods, each with its own focal point. For example, activity-based cost
accounting considers all activity needed to produce a company’s goods or services, while lean accounting focuses on
eliminating waste. Meanwhile, standard cost accounting compares the actual cost of producing goods to the total costs
theoretically needed to produce those goods, and marginal cost accounting calculates fluctuations in the cost of
production.

4.Tax accounting
Tax accounting focuses on ensuring a business, nonprofit, or individual is abiding by all relevant tax laws and
regulations that may apply to them. Tax accountants operate according to guidelines set forth by the Internal Revenue
Code (IRC), which helps ensure a level playing field across all taxpayers in the U.S.

When working with a business, a tax accountant’s primary aim is to ensure the entity is accurately calculating and
reporting its tax liabilities. Proper tax preparation can help a company avoid errors on their tax paperwork, which can
result in getting an audit from the IRS—a time-consuming and potentially costly process that small businesses want to
avoid.

A tax accountant will have in-depth knowledge of applicable tax laws, which vary at the state and federal levels, and
can help business owners navigate these complex guidelines. A tax accountant can also support future tax planning,
finding ways to avoid unnecessary tax burdens. For example, if a business owner isn’t claiming all possible expenses,
they’re paying more taxes than needed. Claiming additional deductions will lower the company’s overall profits,
resulting in a lower tax bill.

5. Auditing
Auditing is a type of accounting that provides an independent analysis of a business’s financial activity. By objectively
tracking and reporting all activities, auditing ensures that the company is abiding by relevant regulations and best
practices. Auditors are never directly involved in the organization that they audit. After reviewing financial records, they
create an in-depth audit report detailing their findings.

An audit can be external or internal. Internal auditors aim to determine how effective a business’s current accounting
processes are. This can help a company improve financial planning by identifying potential wasted resources, mitigate
the risk of fraud, and avoid mismanagement. External auditing involves reviewing a company’s formal financial
statements, ensuring that they’re prepared in line with GAAP.