Objectives Of Accounting

In this tutorial, we will learn about the objectives of accounting, maintaining a complete and systematic record of all transactions, and analyzing the financial position of a business.

Every individual or a business concern is interested to know the results of financial transactions, and their results are ascertained through the accounting process.

The objectives can be given as follows:

Systematic recording of transactions:

The fundamental accounting objective is to record transactions, i.e., book-keeping systematically. These transactions are later on classified and summarized logically for the preparation of financial statements.

However, in every business, there are numerous business transactions, and the management can’t keep in mind in all business transactions.

Ascertainment of results of the above-recorded transactions:

The main motive of recording transactions is to ascertain whether the firm is running under profit or loss. The ascertainment of profit earned or loss sustained by the business enterprise, all incomes and expenses are to be worked out and presented in a separate statement called manufacturing, trading and profit, and loss account.

Ascertainment of the financial position:

The business is not only interested in knowing the results but also the financial situation of the firm, i.e., what he owes (Liability) and what he owns (Assets) on a specific date. Its balance sheet depicts an organization’s financial position.

The resources owned by an enterprise (assets) and claims against such resources (liabilities) are shown in the balance sheet.

Providing information to users to make rational decisions:

The accounting communicates the essential details about the organization to the internal users, i.e., the management or the proprietor, and to the external users such as investors, clients, government, and other agencies.

To know the solvency position:

The balance sheet not only depicts the reveals that what is owed or owned by the enterprise but also gives information regarding the concern’s ability to meet its liabilities in the short run known as solvency position.

Functions of Accounting:

Functions of accounting are related to those statements which provide information of economic entity mainly measurable regarding money that uses in deciding for the plan of action from various alternatives. The main functions of accounting are as follows:

Measurement:

Accounting measures the past performance of the entity or firm and depicts its current financial position.

Forecasting:

Accounting helps forecast future performances and the financial position of an enterprise using past data. Budgets and forecasts help the business to deal with potential problems proactively and avoid foreseeable bottlenecks in business resources.

Decision-Making:

It provides relevant information to the users of accounts to aid rational decision making.

It cannot plan without making decisions and has to choose among competing objectives and methods to carry out the goals. Similarly, organizing, managers need to decide on organization structure and on specific actions to be taken on day-to-day operations.

Comparison & Evaluation:

Accounting assesses the performance achieved with targets and discloses information regarding the accounting policies, which play an essential role in predicting, comparing, and evaluating the financial results.

Control:

Accounting checks the weak and vulnerable areas of the operational system and fixes them for better and more productive results.

It helps in the control function by producing performance reports and control reports which highlight variances between expected and actual performances.

Government Regulation & Taxation:

Accounting provides the government with the necessary information on the collection of revenues and controlling the business.

Procedural Aspects Of Accounting

In this tutorial, we will learn about the procedural aspects of accounting, which divided into generating financial information and using the financial report.

The first two procedural stages of generating financial information and the preparation of trial balance covered under bookkeeping. In contrast, the development of financial statements and its analysis, interpretation, and communication with various users considered as accounting stages.

Based on the above definitions, the procedure of accounting can divide into two parts:

Generating financial information
They are using the financial report.
Generating Financial Information

Recording:

It’s the primary function of accounting. All business transactions having a financial character or say which are in terms of money are to be evidenced by some documents; for example, sales recorded in the sales book and purchases are to log in the purchase book. Primarily recording is done in the journal, which further divided into several subsidiary books according to the size and nature of the business carried by the firm.

Classifying:

It’s the systematic analysis of the recorded data by putting transactions of the same nature in one place so that the information is compact and easy to understand. The book containing classified information is a ledger. It has different pages for different accounts; for example, there may be separate accounts for Sales, Purchases, Rent, Repairs, etc. It helps to find the amount of expenditure incurred over each head.

Summarizing:

It’s concerned with the presentation of the detailed data in a manner that is useful to the internal and external users of the firm. It leads to the preparation of the Trial balance, Profit & Loss Account, Balance Sheet, and Cash-Flow Statement.

Analyzing:

It’s concerned with the systematic classification of data in the financial statements. They simplify the data summarized so that they are easy to understand. For example, they are putting all fixed assets at one place and current holdings in one place so that it is easy to analyze the portion of fixed and existing assets in the firm.

Interpreting:

The accounting finally ends after interpreting the actual meaning and significance of the analyzed data. It is explained so that the external or third-party users of the accounts or potential investors can make a judgment.

Communicating:

It’s concerned with the transmission of the summarized, analyzed, and interpreted information to end-users so that they can make rational decisions.

P.S The first two procedural stages of the process of generating financial information along with the preparation of trial balance are part of book-keeping.

And the other stages, including Interpreting, communicating is covered in Accounting.

Using financial information

In earlier times, it considered that accounting is to be done only for the business and the proprietor, but changing social relationships diluted the more initial thinking. It’s now believed that besides the owner or the management, the users of the accounts such as potential investors, money lenders, customers, government, and other such agencies must be communicated well with the financial information of the business.

But, as the other users might not be aware of accounting technicalities, the information is supposed not to be stressful so that that layman couldn’t understand. The information should also be free from biases. The users of accounts should understand not only the financial results depicted by accounting figures but also should be able to assess it’s reliability and compare it with the other alternative opportunities and the experience.

Now, who are those users?

They can categorize as

Internal Users such as Employees, Managers, Board of Directors, Officers, Partners, etc.
External Users such as Government, Lenders, Suppliers, Potential Investors, etc.

Qualitative characteristics of financial statements

In this tutorial, we will learn about the qualitative characteristics of financial statements. The information must be relevant to the needs of the users, which is when the info influences their economic decisions.

Qualitative characteristics are the attributes that make the information provided in financial statements useful to users. The following are the essential qualitative characteristics of the financial statements:

Understandability:

The users must readily understand the essential quality of the financial statements. For this, it has been assumed that users have sufficient knowledge of the business and economic activities.

Relevance:

It is useful; a financial statement must have information relevant to the users, i.e., the data presented in the balance sheet may have concern and significance to the account’s user, so that they can make rational decisions accordingly. And no such item is left out which can manipulate the figures of the profit and loss.

Reliability:

User accounts make decisions by seeing the balance sheet and profit & loss statement, so it must be accurate, and the information must be reliable. Any misleading figure can cause a significant loss, and it is considered as fraud or misrepresentation.

Comparability:

Users must be able to compare the financial statements of two different fiscal years to identify trends in financial position, past performance, and cash flows. They must also analyze the financial statements of two various enterprises to evaluate the economic situation, performance, and cash flows.

Materiality:

The relevance of information is affected by its materiality. Information is material if it is a misstatement (i.e., omission or erroneous statement) could influence the economic decisions of users taken based on the financial report. Materiality depends upon the size and nature of the error, judged in the particular circumstances. It is a cut-off instead of being and qualitative characteristic.

Faithful Representation:

Maybe reliable, information must represent the transactions and other events faithfully. For example, a balance sheet must accurately describe the liabilities “owed” by the enterprise and assets “owned” by the enterprise. Most of the financial transactions or events are subject to some risk of being less faithful representation, such as goodwill. Every firm builds goodwill internally over time; however, it is difficult to measure that goodwill reliably. There always a risk of being less faithful representation.

Substance Over Form:

If the information is presented faithfully, then they should be recorded and accounted for and presented with their substantial and economic reality, not merely their legal form. For example, the benefits or rights in immovable property transfer, but the documentation is pending, and then the recording of acquisition would in substance represent the transaction entered.

Neutrality:

May be reliable, the information should remain free from bias. Financial statements are not neutral if, by selecting or presenting information, influence decision making and the final judgment.

Prudence:

The financial statement must be prudent, i.e., judgment about the future losses which are to be guarded and the uncertain gains—the creations of reserves and provisions made due to prudence.

Full, fair, and adequate disclosure:

The financial statements of an enterprise must disclose the fair, the whole, and the proper information to the internal and external users, which will help them to make reasonable and rational decisions.

The principle of full disclosure implies that all the essential items are recorded and disclosed in financial statements in detail. This concept is widely used in organizations due to the separation of ownership and management. According to this, the Companies Act, 2013, came out with the Perform of the balance sheet, profit, and loss account.

Completeness:

The financial statement to be reliable must be complete within the bounds of materiality and cost. An omission in the financial statement can cause the information to be false, misleading, unreliable, and deficient in its relevance. Thus, data is present faithfully, so the transactions and events are to be recorded by their substance over their legal form.

For example, a company has sold its machinery, but it still uses it by making so arrangements with the buyer of the mechanism. Undoubtedly, it is a legal transaction, but the economic reality is that the company is still deriving profit from the machinery which has no record on the balance sheet.

May be reliable, the balance sheet should be free from bias and be neutral to avoid future uncertainties; the financial statements are to made with prudence, i.e., creating required provisions and reserves.

Relationship of Accounting with other Disciplines

In this tutorial, we will learn about the relationship of accounting with other disciplines of accounting when one has a strong conceptual understanding of other interconnected disciplines.

The other regulations which accounting increasingly seen to interact with are Economics, Mathematics, Statistics, Law, and Management.

Accounting is a science related to human activities to fulfill demand with limited wealth. It provides all the required financial information to individual buyers and sellers for making an economic decision.

Accounting and Economics: Economics is a view as a science of demand and supply, and accounting is the business’s language, where economics talks about satisfying human wants by efficiently using scarce resources.

Accounting overlaps economics in many aspects. It contributed to improving the decision-making process of management.

Accountants have ideas about income, capital, and value from economists, applying it in practical circumstances.

Accounting and Statistics:

The Accounting information is precise to the point and exact to the last paisa. For decision-making, such precision is not necessary, so a statistical approach comes to the sought.

Statistical presentation by graphs, pie-charts, etc. of the accounting information make is to ascertain the enterprise’s growth. A lot of figures from books of accounts can generalize to a single graph or pie-chart.

Statistics also help in formulating prices, ratios that are to be calculated using statistical tools. Accounting and financial calculations are based on analytical formulae.

Therefore the study of statistics provides an extra edge to accounting.

Accounting and Mathematics:

Double-entry book-keeping can convert in an algebraic form; in fact, the first book on this subject was part of a treatise on algebra.

Knowledge of algebra and arithmetic is an essential requirement for accounting computations and measurements. Calculations of interests, annuity, etc. are examples of such uses.

Presently, graphs and charts extensively used for communicating accounting information. In addition to statistical knowledge in geometry and learning in trigonometry, it seems essential to have a better understanding of the accounting.

Accounting and Law:

An economic entity operates within a legal environment. All transactions with government, suppliers, and customers governed by the contract act, the sales of goods act and the negotiable instruments act, etc.

The entity itself created and operated by-laws and acts. For example, a partnership governed by the Indian Partnership Act. A company created by the Companies Act and also controlled by the law.

Laws guide every transaction and event. Every country has a set of economic policies, fiscal, and labor rules. Very often, the accounting system used has been prescribed by the law. For example, the financial statements made by the company are to be made under the norms, rules, regulations, and standards given by the Companies Act.

Accounting and Management:

Management is a wide-ranging occupational field that incorporates many functions and encompasses many areas or branches of learning. Accountants are well placed in the management and play a vital role in the administration. A large portion of accounting is done to make managerial decisions. Although management relies on other data sources, accounting data are used as essential source documents.

Accounting concepts, principles and conventions

In this tutorial, we will learn about accounting concepts, principles and conventions are as dynamic as today’s business world.

Accounting is the language of business. The financial statements prepared by the accountant communicate financial information to the various stakeholders for decision-making purposes.

Therefore, financial statements made by different firms must be prepared regularly. They should be consistent over time, changing the methods and policies frequently may affect the firm’s position and create utter confusion.

It may define recording, classifying, summarizing, and interpreting the financial transactions and communicating the results thereof to the persons interested in such information.

To avoid confusion and assure uniformity in the preparation of the financial statements accounting process is applied within the conceptual framework of ‘Generally Accepted Accounting Principles’ (GAAP). GAAP is used to describe rules developed for the preparation of financial statements and are called concepts, principles, conventions, and postulates, etc.

They provide standardization to the accounting system as accounting is the backbone of an enterprise and the economy. These concepts, accounting standards are considered as a theory base of accounting.

Accounting Concepts:

Accounting concepts define certain assumptions on which the accounting is done. They are necessary as they provide uniformity and internal logic to accounting. The idea means an idea or nation, which has universal application. The financial transactions which occur daily in an enterprise are done in the light of these concepts. Going concerned, the Entity concept is some of the examples of accounting concepts.

According to this concept, every transaction has two sides, at least. If one account is debited, any other consideration must be credited. Every business transaction involves the duality of effects.

According to this concept, business and its owners are separate entities.
The owner treats as the creditor of the company to the extent of capital contributed by him.
All transactions of the business are recorded in the books of business from the company.
This concept keeps the personal affairs of the owner away from business affairs.
Income or profit is the property of the business unless distributed among the owners.

Accounting Principles:

“Accounting principles are a body of doctrines commonly associated with the theory and procedures of accounting serving as an explanation of current practices and as a guide for the selection of conventions or procedures where alternatives exist.” ‘ ICAI‘

Accounting principles must satisfy the following principles:

They should be based on real assumptions
They must be simple, understandable, and explanatory.
They must reflect future predictions.
They must be informal for the other users.

Accounting Conventions:

Accounting conventions emerge from accounting practices, commonly known as accounting principles, which various organizations adopt over some time.

They are derived from the usage and practices. They are as dynamic as today’s business world, so to improve the quality or productivity of the business enterprises may change these conventions.

This convention describes that accounting principles and methods should remain consistent to enable the management to compare the two; these principles should not change year after year.