Concept of Accounting

Before understanding accounting, we must first know the concept of Book Keeping. Bookkeeping is the art and skill of recording transactions. It evolved as each and every transaction could not be memorized by an individual. It was just limited to record-keeping. Its concept got expanded to accounting with the development of the double-entry system. Accounting is a broader concept than bookkeeping. Bookkeeping remains the base for accounting. Accounting added more dimensions to bookkeeping to transform it into a modern concept. It can also be said that wherever bookkeeping ends, accounting starts.

Accounting is the art of recording and presenting transactions. It is the task of bookkeeping, recording and preparing accounts, subsidiary books and other statements of a business. Accounting can be regarded as a system of identifying, explaining, recording, summarizing, analyzing, interpreting and reporting transactions. In other words, accounting is mainly maintaining a journal, ledger, cashbook, subsidiary books and other books showing the behavior of transactions and documents justifying such behavior. Similarly, accounting can also be understood as a wholistic process from primary record-keeping to final statement preparation of monetary, economic and financial events and transactions

Key Definitions

Defined By	Definition
R.N. Anthony	“Accounting system is a means of collecting, summarizing, recording and reporting in monetary terms the information of the business”
American Institute of Certified Public Accountants (AICPA)	“Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transaction and event which are, in part at least, of a financial character and interpreting the results thereof”

From the above discussions and definitions:

• Accounting  is related to financial transactions only
• Its primary function is identifying and recording transactions
• It maintains journal, ledger, cashbook etc. of transactions
• It is supported by documents validating the transactions
• It summarizes, analyzes and interprets recorded transactions using different tools
• It is a process from identifying to communicating information of transactions as a whole

Accounting as A System

Accounting is concerned with identifying, recording and systematically presenting transactions. Hence, it can also be regarded as an accounting system itself. This concept of accounting system can be elucidated as below:

INPUT -Bills -Receipts -Order Slips -Memos -Vouchers

PROCESS -Journals -Ledger -Subsidiary Books -Cash Book -Trial Balance

OUTPUT -Trading Account -PL Account Balance Sheet -Cash Flow Statement

Bookkeeping Vs. Accounting

Bookkeeping is the recording of the transaction. It can be regarded as the foundation of accounting. Despite being so, there are key differences between bookkeeping and accounting. Such differences have been mentioned below:

Basis of Differences	Book Keeping	Accounting
Meaning	It is a recording of financial transactions daily	It is a systematic process of recording, classifying, summarizing and communicating financial information
Objective	Its objective is to record financial transactions safely and made them available at the time of need	Its objective is to figure out the financial position and communicate such information to concerned parties
Skills Required	No special skill is required. Limited knowledge is required for bookkeeping	It requires special skill and qualification due to its complex analytical nature
Stage	Bookkeeping is the primary stage for identifying and recording transactions	It is the second stage occurring after the point where bookkeeping ends
Preparation	It is concerned with the preparation of Journal and Ledger only	It is concerned with the preparation of Trial Balance, Income Statement, Balance Sheet, Cash Flow Statement etc.
Decision Making	Management cannot take decisions based on data provided by bookkeeping	Management can take decisions based on financial position figured out by accounting
Financial Position	Bookkeeping cannot show the true financial position of a business	Accounting can figure out the actual and accurate financial position of business
Branches	Bookkeeping does not have any branches	Accounting has branches such as cost accounting, financial accounting, management accounting,etc.

Functions of Accounting

Accounting has different functions to perform. Since it is a process of identifying and communicating information of a transaction, it has to perform multiple functions. The key functions of accounting have been mentioned below:

• Recording Function: Accounting identifies and records transactions of financial nature in a systematic manner. It uses journal, ledger, cashbook, subsidiary book etc. to record such transactions.
• Preparation Function: Accounting performs a key function of preparing financial statements. The major financial statements prepared are Trading Account, Profit and Loss Account, Income Statement, Balance Sheet and Cash Flow Statement.
• Legal Compliance Function: It maintains all the records and prepares financial statements within the prescribed guidelines of prevailing laws and bylaws. It must meet accounting standards, reporting standards and tax regulations too.
• Measurement Function: It measures the performance of any business. Such measurement is done through different accounting tools. This also measures planned or past performance with the current performance of the business.
• Communicating Function: Accounting communicates the true financial position of the business with its concerned parties. Such concerned parties include management, employees, investors, debtors, creditors, banks etc.
• Forecasting Function: Accounting can forecast the future position of the business based on past performance. This includes predicting future sales, expenses, profit/loss etc. using different accounting and statistical tools.
• Decision-Making Function: Accounting provides all vital information to the management. Such information is provided later requires analysis and interpretation. This helps the management to make the right decision for future perspectives.

Objectives of Accounting

After understanding the concept and function of accounting, we must understand that it is focused on some specific things. These are the objectives of accounting which have been mentioned as under:

• To Maintain Record of Business: The main objective of accounting is to identify the transactions of financial nature and record them inappropriate books of account. This ensures systematic recording of transactions and makes them available as and when needed.
• To Calculate Profit or Loss: Another objective of accounting is to calculate profit or loss on the basis of available financial information for a specific period. It is done by preparing a Trading/Manufacturing Account (to determine gross profit or gross loss) and Profit and Loss Account (to determine Net profit or net loss). Such calculation can be done by preparing an Income Statement also which is a combined version of Trading/Manufacturing Account and Profit & Loss Account.
• To Depict the Financial Position: The determination of the financial health of a business is another objective of accounting. To do so, a report in the form of a Balance Sheet is prepared. This shows the resources owned and owed by the business. A balance sheet shows the strengths and weaknesses of the business depicted by variables such as assets, liabilities, equities, reserves etc.
• To Communicate the Results: Accounting is a language through which all business events and transactions are communicated. It communicates information to all the concerned parties such as management, employeers, debtors, creditors, customers, government, the general public etc. about the financial position and health of the business.
• To Help Determine Tax Liability: A business has to pay tax to the government as per prevailing law. Such tax liability is calculated based on financial information and reports provided by the business to the tax authority and government agencies.
• To Forecast Future: Accounting aims at forecasting the future position of the business. This is done based on available past information using different analytical and forecasting tools. This is estimating future revenue, expenses, profit/loss etc.
• To Facilitate Management Decision Making: Accounting also focuses on facilitating management decision-making. For such decision-making, the results, findings and conclusions from analysis and interpretation done by accounting are used.

The Accounting Process

Accounting can also be viewed as a process through which transactions are recorded till the information is communicated to its user. In this context, the accounting goes through the following process:

• Identification of Financial Transaction:

In accounting, only those transactions which are of financial nature are considered for the recording. Any transaction having no financial character cannot be measured in terms of money. So, such transactions are not considered under accounting.

• Recording:

After identifying transactions having financial nature, they are recorded primarily in a book called Journal. This book is further sub-divided into various subsidiary books such as cashbook, purchase book, sales book, purchase return book, sales return book etc.

• Classifying:

The record of transactions could be huge and more than thousands of pages. In such a case, finding out the detail of a specific transaction may be difficult. To overcome such difficulties, transactions of the same nature are grouped into one place. This is done by opening an account in a book called Ledger. Similar transactions relating to a particular account for a given period are allotted in one place in the ledger.

• Summarising:

The classified records in the ledger may run into hundreds of pages. This is more time-consuming for the user of the accounting information to go through all of these pages. Therefore, summarizing is done to present classified records shortly and concisely without compromising the usefulness of such classified records. This is done through the preparation of the Trading Account, Profit & Loss Account and Balance Sheet.

• Analysis and Interpretation:

Such summarized information is analyzed and interpreted using different tools and techniques. This is done to find the financial strength and weaknesses of the business. For this, a relationship of different variables is estimated and made them comparable.

• Communicating:

Recording, classifying, summarizing, analysis and interpretation are worth no value if the finding and conclusion are not communicated to the user of the financial information. Hence, communicating is the way of passing such information. This is done through an annual report.

The Accounting Principles

There are certain rules, regulations, norms, values and standards to be followed while using an accounting system. These are the accounting principles. These are general guidelines to be used at the time of accounting practice. They are developed based on logic, experience and research. These are subject to change depending upon the need of time, long practice, law etc. Such principles are based on the following key concepts:

• The Business Entity Concept which assumes the business as a separate artificial person, different than its owner
• Money Measurement Concept which assumes only those transactions and events which can be measured in terms of money are considered for accounting
• Going Concern Concept which believes any business started once goes on for a long period of time, even perpetual
• Accounting Period Concept stating accounting for a specific period mostly one year is done after which final report is prepared

Based on these concepts, different principles of accounting have been set. This ensures the general acceptability of such principles. The key principles of accounting have been stated below:

• The Revenue Principle:

Revenue results from the sale of goods and services. According to this principle, only those income and revenue which have been realized in cash or some valuable consideration or resulted in some legal obligations are recorded. All the revenue either received in cash or due during a specific period is considered while preparing the financial statements. Expected sales and revenues are not recorded.

• Cost Principle:

This principle states that an asset has to be recorded at its actual cost, not the purchase price. This means while recording the cost of the asset purchase price along with any additional costs such as transportation should be recorded. This total value is used to reduce the value of the asset throughout its useful life through a process called ‘Depreciation’. Similarly, in the case of expenses, all the expenses whether paid in cash or not should be recognized and recorded in the accounting process.

• Matching Principle:

According to this principle, revenue earned and expenses incurred during a particular period of time are matched to determine the profit/loss situation of the business. If revenue exceeds the cost, the result is net profit. On the other hand, if the cost exceeds revenue, the result is a net loss.

• Dual Aspect Principle:

This principle proclaims that every transaction hasa two-fold effect. This is known as the dual aspect or duality of a transaction. The system of recording under such duality is called Double Entry Book Keeping System. According to this principle, the relationship between assets, liabilities and owner’s equity is given as Assets = Liabilities + Owner’s Equity. Every transaction consists of both aspects in the above-mentioned equation.

• The Verifiable Objective Principle:

This principle stresses the fact that every transaction must be supported by facts and figures, evidence and must be accounted for such objective evidence. This means all the accounting transactions should be supported and confirmed by documentary evidence. Such supporting documents could be bills, invoices, memos, vouchers, receipts etc.

• Full Disclosure Principle:

As per this principle, sufficient disclosure of necessary and all important information is necessary while preparing financial statements. All the items of revenue and expenditure are required to be disclosed as accurately as possible. All the items of the Profit and Loss Account and Balance Sheet should be disclosed transparently. While doing so, items not required or confidential to disclose should be disclosed with care and concern.