With the help of accounting records the business is able to ascertain the profit or loss and the financial position of the business at the end of a given period and communicate such information to all interested parties. The function of accounting is to provide quantitative information, primarily of financial nature, about economic entities, that is needed to be useful in making economic decisions.
The meaning of accounting was given by the American Institute of Certified Public Accountants (AICPA) in 1961 when it defined accounting as:
"Accounting is the art of recording, classifying and 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”
American Accounting Association (AAA) has defined Accounting as:
“Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information”.
There are three branches of accounting:
1. Financial Accounting: Financial Accounting is concerned with recording financial transactions, summarizing and interpreting them and communicating the results to users. It shows the profit or loss of a particular period & the position of the business on a particular date.
2. Cost Accounting: It helps in finding out the cost of production of a product manufactured or services rendered and helps the management in decision making.
3. Management Accounting: Management Accounting is concerned with generating accounting information relating to funds, costs, profits, etc. as it enables the management in decision making.
1. To keep systematic records: Accounting is done to keep a systematic record of financial transactions, like purchase of goods, sale of goods, cash receipts and cash payments.
2. To ascertain the operational profit or loss: Accounting helps in determining the net profit earned or loss suffered on account of running the business. This is done by keeping a proper record of revenues and expenses of a particular period.
3. To ascertain the financial position of the business: The businessman is not only interested in knowing the operating result, but also interested in knowing the financial position of his business i.e., where it stands. In other words, he wants to know what the business owes to others and what others owe to business.
4. To facilitate rational decision making: Apart from the owners, there are various other parties who are interested in knowing about the position of business, such as tax authorities, the management, the bank, the creditors, etc. The required information is furnished to all these parties through accounting system.
1. Financial accounting permits alternative treatment: Accounting is based on concepts and it follows “Generally Accepted Principles” but there exist more than one principle for the treatment of any one item. This permits alternative treatments within the framework of Generally Accepted Principles. For example, the closing stock of a business may be valued by any one of the following methods: FIFO (First-in-First-out), LIFO (Lastin-First-out), Average Price, Standard Price etc., but the results are not comparable.
2. Financial accounting is influenced by personal judgments: Accounting is influenced by personal judgments as one accountant may consider the life of a particular asset say 5 years whereas another accountant may consider the life of that asset say 6 years and the method of charging the depreciation on asset by both the accountants may also be different.
3. Financial accounting ignores non-monetary information: Financial accounting does not consider the transactions of non-monetary nature. For example, extent of competition faced by the business, technical innovations possessed by the business, loyalty and efficiency of the employees, etc. are the important matters in which management of the business is highly interested but accounting is not tailored to take note of such matters.
4. Financial accounting does not provide timely information: Financial accounting is designed to supply information in the form of statements (Balance Sheet and Profit and Loss Account) for a period normally one year. The business requires timely information at frequent intervals to enable the management to plan and take correct action wherever the performance is not as per plans.