Accounting — Meaning and Scope of Accounting

Figure 1: Accounting is the language of business — essential for recording, classifying, and summarising financial transactions.

Learning Outcomes

Understand the meaning and significance of accounting.
Understand the meaning of book-keeping and the distinction of accounting with book-keeping.
Appreciate the evolutionary process of accounting as a social science.
Explain sub-fields of accounting.
Identify the various user groups for whom accounting information is to be generated.
Understand the relationship of Accounting with Economics, Statistics, Mathematics, Law and Management.
Explain the limitations of accounting.
Appreciate the enlarged boundary of accounting profession and the areas where in a chartered accountant plays an important role of rendering useful services to the society.

1.1 Introduction

Every individual performs some kind of economic activity. A salaried person gets salary and spends to buy provisions and clothing, for children's education, construction of house, etc.
A sports club formed by a group of individuals, a business run by an individual or a group of individuals, a company running a business in telecom sector, a local authority like Calcutta Municipal Corporation, Delhi Development Authority, Governments, either Central or State, all are carrying some kind of economic activities.
Not necessarily all the economic activities are run for any individual benefit; such economic activities may create social benefit i.e. benefit for the public, at large.
Such economic activities are performed through transactions and events. Transaction is used to mean 'a business, performance of an act, an agreement' while event is used to mean 'a happening, as a consequence of transaction(s), a result.'

KNOWLEDGE NUGGET

Transaction: A business, performance of an act, an agreement
Event: A happening, as a consequence of transaction(s)
Accounting deals with measurement of economic activities involving inflow and outflow of economic resources

Example 1

An individual invests ₹2,00,000 for running a stationery business. On 1st January, he purchases goods for ₹1,15,000 and sells for ₹1,47,000 during the month of January. He pays shop rent for the month ₹5,000 and finds that still he has goods worth ₹15,000 in hand. The individual performs an economic activity. He carries on a few transactions and encounters with some events. Is it not logical that he will want to know the result of his activity?

COMPUTATION OF SURPLUS

Goods sold	₹1,47,000
Goods in hand	₹15,000
Total	₹1,62,000
Less: Goods purchased	₹1,15,000
Shop rent paid	₹5,000
Surplus	₹42,000

Earning of ₹42,000 surplus is an event; also having the inventories in hand is another event, while purchase and sale of goods, investment of money and payment of rent are transactions.
Similarly, a municipal corporation got government grant ₹500 lakhs for adult education; it spent ₹250 lakhs for purchasing literacy kits, paid ₹200 lakhs to the tutors and is left with a balance of ₹50 lakhs. These are also transactions and events.
Similarly, the Central Government raised money through taxes, paid salaries to the employees, and spent on various developmental activities. Whenever receipts of the Government are more than expenses it has surplus, but if expenses are more than receipts it runs in deficit.

ACCOUNTING AS LANGUAGE OF BUSINESS

Everybody wants to keep records of all transactions and events
Accounting deals with measurement of economic activities
Accounting has universal application for recording transactions and events
Accounting is called the language of business

1.2 Meaning of Accounting

The Committee on Terminology set up by the American Institute of Certified Public Accountants formulated the following definition of accounting in 1961:

DEFINITION (AICPA, 1961)

"Accounting is the art of recording, classifying, and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the result thereof."

As per this definition, accounting is simply an art of record keeping. The process of accounting starts by first identifying the events and transactions which are of financial character and then be recorded in the books of account.
This recording is done in Journal or subsidiary books, also known as primary books.
After the transactions and events are recorded, they are transferred to secondary books, i.e., Ledger. In ledger, transactions and events are classified in terms of income, expense, assets and liabilities according to their characteristics and summarised in Profit and Loss Account and Balance Sheet.
Essentially the transactions and events are to be measured in terms of money. Measurement in terms of money means measuring at the ruling currency of a country.

In 1970, the Accounting Principles Board (APB) of American Institute of Certified Public Accountants (AICPA) enumerated the functions of accounting as follows:

FUNCTION OF ACCOUNTING (APB, 1970)

"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."

Thus, accounting may be defined as the process of recording, classifying, summarising, analysing and interpreting the financial transactions and communicating the results thereof to the persons interested in such information.

1.2.1 Procedural Aspects of Accounting

On the basis of the above definitions, procedure of accounting can be basically divided into two parts:

Generating financial information
Using the financial information

Generating Financial Information

Recording — This is the basic function of accounting. All business transactions of a financial character, as evidenced by some documents such as sales bill, pass book, salary slip etc. are recorded in the books of account. Recording is done in a book called "Journal".
Classifying — Classification is concerned with the systematic analysis of the recorded data, with a view to group transactions or entries of one nature at one place. The book containing classified information is called "Ledger".
Summarising — It is concerned with the preparation and presentation of the classified data in a manner useful to the internal as well as the external users of financial statements. This process leads to the preparation of the financial statements.
Analysing — The term 'Analysis' means methodical classification of the data given in the financial statements. It is concerned with the establishment of relationship between the items of the Profit and Loss Account and Balance Sheet.
Interpreting — This is the final function of accounting. It is concerned with explaining the meaning and significance of the relationship as established by the analysis of accounting data.
Communicating — It is concerned with the transmission of summarised, analysed and interpreted information to the end-users to enable them to make rational decisions.

BOOK-KEEPING vs ACCOUNTING

The first two procedural stages (Recording & Classifying) along with the preparation of trial balance are covered under Book-keeping
The preparation of financial statements and its analysis, interpretation and communication to the various users are considered as Accounting stages

1.3 Evolution of Accounting as a Social Science

History & Development of Accounting

Accounting finds its roots as early as around 4000 BC, where Egyptians used some form of accounting for their treasuries.
Babylonia, known as the city of commerce, used accounting for business to identify the losses that took place due to frauds and lack of efficiency.
Greece used accounting to divide the revenues received among treasuries, maintaining receipts, payments and balance of government financial transactions.
Romans used memorandum or daybook where receipts and payments were recorded (700 B.C to 400 A.D).
China used sophisticated form of government accounting as early as 2000 B.C.
Accounting practices in India could be traced back to a period where, Kautilya, a minister in Chandragupta's kingdom wrote a book named Arthashashtra, which also described how accounting records had to be maintained.
Luca Pacioli, a Franciscan friar, wrote Summa de Arithmetica, Geometria, Proportion at Proportionality in Venice (1494) — considered as the first book on double entry bookkeeping. He used the terms Debit (Dr.) and Credit (Cr.).

LUCA PACIOLI — FATHER OF ACCOUNTING

Wrote Summa de Arithmetica (1494)
First book on double entry bookkeeping
Used terms Debit (Dr.) and Credit (Cr.)
Wrote: "All entries have to be double entries, that is if you make one creditor, you must make some debtor"

Phases of Accounting Evolution

Phase 1 — Stewardship Accounting: Aided the stewards to discharge their stewardship function. The wealthy men employed stewards to manage their property; the stewards in turn rendered an account periodically of their stewardship.
Phase 2 — Financial Accounting: Emerged with the concept of joint stock company and divorce of ownership from the management. Financial statements give periodic performance report by way of Profit and Loss Account and financial position by way of Balance Sheet.
Phase 3 — Management Accounting: Accounting information was generated to aid management decision-making in particular. This is the development of 20th Century.
Phase 4 — Social Responsibility Accounting: In the formative process, aims at accounting for the social cost incurred by business as well as the social benefit created by it.

1.4 Objectives of Accounting

Systematic recording of transactions — Basic objective of accounting is to systematically record the financial aspects of business transactions, i.e., book-keeping.
Ascertainment of results of above recorded transactions — Accountant prepares Profit and Loss Account to know the results of business operations for a particular period of time.
Ascertainment of the financial position of the business — Accountant prepares a financial position statement popularly known as Balance Sheet.
Providing information to the users for rational decision-making — Accounting as a 'language of business' communicates the financial results of an enterprise to various stakeholders.
To know the solvency position — Balance sheet gives information regarding concern's ability to meet its liabilities in the short run (liquidity position) and also in the long-run (solvency position).

OBJECTIVES OF ACCOUNTING — SUMMARY

Systematic recording of transactions
Ascertainment of results (Profit/Loss)
Ascertainment of financial position (Balance Sheet)
Providing information for rational decision-making
To know solvency position

1.5 Functions of Accounting

Measurement: Accounting measures past performance of the business entity and depicts its current financial position.
Forecasting: Accounting helps in forecasting future performance and financial position of the enterprise using past data and analysing trends.
Decision-making: Accounting provides relevant information to the users of accounts to aid rational decision-making.
Comparison & Evaluation: Accounting assesses performance achieved in relation to targets and discloses information regarding accounting policies and contingent liabilities.
Control: Accounting also identifies weaknesses of the operational system and provides feedbacks regarding effectiveness of measures adopted.
Government Regulation and Taxation: Accounting provides necessary information to the government to exercise control on the entity as well as in collection of tax revenues.

1.6 Book-keeping

Book-keeping is an activity concerned with the recording of financial data relating to business operations in a significant and orderly manner.
It covers procedural aspects of accounting work and embraces record keeping function.
Book-keeping procedures are governed by the end product, the financial statements.
The term 'financial statements' means Profit and Loss Account, Balance Sheet and cash flow statements including Schedules and Notes forming part of Accounts.
A book-keeper may be responsible for keeping all the records of a business or only of a minor segment.
Accounting is based on a careful and efficient book-keeping system.

1.6.1 Objectives of Book-keeping

Complete Recording of Transactions — It is concerned with complete and permanent record of all transactions in a systematic and logical manner.
Ascertainment of financial Effect on the Business — It is concerned with the combined effect of all the transactions made during the accounting period upon the financial position of the business as a whole.

1.7 Distinction between Book-keeping and Accounting

S. No.	Book-keeping	Accounting
1.	It is a process concerned with recording of transactions.	It is a process concerned with summarising of the recorded transactions.
2.	It constitutes as a base for accounting.	It is considered as a language of the business.
3.	Financial statements do not form part of this process.	Financial statements are prepared in this process on the basis of book-keeping records.
4.	Managerial decisions cannot be taken with the help of these records.	Management takes decisions on the basis of these records.
5.	There is no sub-field of book-keeping.	It has several sub-fields like financial accounting, management accounting etc.
6.	Financial position of the business cannot be ascertained through book-keeping records.	Financial position of the business is ascertained on the basis of the accounting reports.

1.8 Sub-fields of Accounting

Financial Accounting — Covers the preparation and interpretation of financial statements and communication to the users of accounts. It is historical in nature.
Management Accounting — Concerned with internal reporting to the managers of a business unit. It includes cost accounting which deals with cost ascertainment and cost control.
Cost Accounting — The process of accounting for cost which begins with the recording of income and expenditure and ends with the preparation of periodical statements and reports for ascertaining and controlling costs.
Social Responsibility Accounting — Concerned with accounting for social costs incurred by the enterprise and social benefits created.
Human Resource Accounting — An attempt to identify, quantify and report investments made in human resources of an organisation that are not presently accounted for under conventional accounting practice.

SUB-FIELDS OF ACCOUNTING

Financial Accounting — Historical — Profit & Loss, Balance Sheet
Management Accounting — Internal reporting — Decision-making
Cost Accounting — Cost ascertainment and control
Social Responsibility Accounting — Social costs and benefits
Human Resource Accounting — Quantify and report human resources

1.9 Users of Accounting Information

Investors — They provide risk capital to the business. They need information to assess whether to buy, hold or sell their investment.
Employees — Growth of the employees is directly related to the growth of the organisation. They are interested to know the stability, continuity and growth of the enterprise.
Lenders — They are interested to know whether their loan-principal and interest will be paid back when due.
Suppliers and Creditors — They are interested to know the ability of the enterprise to pay their dues, that helps them to decide the credit policy.
Customers — Customers are concerned with the stability and profitability of the enterprise because their functioning is more or less dependent on the supply of goods.
Government and their agencies — They regulate the functioning of business enterprises for public good, allocate scarce resources, control prices, charge excise duties and taxes.
Public — The public at large is interested in the functioning of the enterprise because it may make a substantial contribution to the local economy.
Management — Management as whole is also interested in the accounts for various managerial decisions.

USERS OF ACCOUNTING INFORMATION

Internal Users: Management
External Users: Investors, Employees, Lenders, Suppliers, Creditors, Customers, Government, Public

1.10 Relationship of Accounting with Other Disciplines

(a) Accounting and Economics

Economics is viewed as a science of rational decision-making about the use of scarce resources.
Accounting is viewed as a system, which provides data to the users to permit informed judgement and decisions.
Accounting overlaps economics in many respects. It contributed a lot in improving the management decision-making process.
Economists think that value of an asset is the present value of all future earnings. Accountants developed the workable valuation base — the acquisition cost.
At the macro-level, accounting provides the database over which the economic decision models have been developed.

(b) Accounting and Statistics

Accounting information is very precise; it is exact to the last paisa. For decision-making purposes such precision is not necessary and hence, the statistical approximations are sought.
Statistics is concerned with the typical value, behaviour or trend over a period of time.
Statistical methods are helpful in developing accounting data and in their interpretation.
Time series and cross-sectional comparison of accounting data is based on statistical techniques.

(c) Accounting and Mathematics

Double Entry book-keeping can be converted in algebraic form.
Knowledge of arithmetic and algebra is a pre-requisite for accounting computations and measurements.
Calculations of interest and annuity are examples of such fundamental uses.
With the advent of the computer, mathematics is becoming a vital part of accounting.

(d) Accounting and Law

An economic entity operates within a legal environment.
All transactions with suppliers and customers are governed by the Contract Act, the Sale of Goods Act, the Negotiable Instruments Act, etc.
Very often the accounting system to be followed has been prescribed by the law. For example, the Companies Act has prescribed the format of financial statements for companies.

(e) Accounting and Management

Management is a broad occupational field, which comprises many functions.
Accountants are well placed in the management and play a key role in the management team.
A large portion of accounting information is prepared for management decision-making.

1.11 Limitations of Accounting

The factors which may be relevant in assessing the worth of the enterprise don't find place in the accounts as they cannot be measured in terms of money. The Balance sheet cannot reflect the value of certain factors like loyalty and skill of the personnel.
Balance Sheet shows the position of the business on the day of its preparation and not on the future date.
Accounting ignores changes in some money factors like inflation etc.
There are occasions when accounting principles conflict with each other.
Certain accounting estimates depend on the sheer personal judgement of the accountant, e.g., provision for doubtful debts, method of depreciation adopted.
Financial statements consider those assets which can be expressed in monetary terms. Human resources although the very important asset of the enterprise are not shown in the balance sheet.
Different accounting policies for the treatment of same item adds to the probability of manipulations.

LIMITATIONS OF ACCOUNTING — KEY POINTS

Non-monetary factors not recorded
Balance sheet shows position on a specific date only
Ignores inflation
Subjectivity in accounting estimates
Human resources not valued
Different policies allow manipulation

1.12 Role of Accountant in the Society

Goethe had called the accountant's profession as 'the fairest invention of the human mind'.
At the core of all types of learned profession, there is the desire of public good and of finding the best way to serve society.
An accountant with his education, training, analytical mind and experience is best qualified to provide multiple need-based services to the ever growing society.

1.12.1 Areas of Service

Maintenance of Books of Accounts — An accountant is able to maintain a systematic record of financial transactions.
Statutory Audit — Every limited company is required to appoint a chartered accountant as their auditor. Auditing is not confined to the accounts of companies.
Internal Audit — A management tool whereby an internal auditor thoroughly examines the accounting transactions and also the system.
Taxation — An accountant can handle taxation matters of a business or a person and can represent before tax authorities.
Management Accounting and Consultancy Services — Management accountant performs an advisory function. He is largely responsible for internal reporting to the management.
Financial Advice — An accountant who knows about finances, taxation and family problems is well placed to give such advice.

1.12.2 Chartered Accountant in Industry

An accountant works with the functional departments and translates the organisation's aims in terms of financial expectations.
A qualified accountant will be able to play an important role in performing important functions of a business relating to accounting, costing and budgetary control, estimating and treasury.

1.12.3 Chartered Accountant in Public Sector Enterprises

Both in the developed and developing countries, public sector enterprises have become a special feature of the national economy.
It is the duty of the accountants to prepare the accounts and reports of these public corporations in such a way that they enable the general public to know how far the items appearing in the various types of records and financial statements justify their existence.

1.12.4 Chartered Accountant in Framing Fiscal Policies

Accountants have a positive role to play in the determination of proper fiscal policies and advancement of trade, commerce and industry.
They should develop new techniques and prepare themselves for new fields of service towards their commitment to the concept of the public goods and services.

1.12.5 Chartered Accountant and Economic Growth

In the present times accountants should conceive their duties as broadly as the conditions might require and do not restrict them to only literal compliance of the law.
Accountants have to accept a positive role and do their best to encourage efficiency in individual business units and encourage those social objectives which form the main foundation of a welfare state.

Summary

"Accounting is the art of recording, classifying, and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the result thereof."
Accounting procedure can be basically divided into two parts:
- Generating financial information
- Using the financial information
The objectives of accounting can be given as follows:
- Systematic recording of transactions
- Ascertainment of results of above recorded transactions
- Ascertainment of the financial position of the business
- Providing information to the users for rational decision-making
- To know the solvency position
The main functions of accounting are:
- Measurement
- Forecasting
- Decision-making
- Comparison & Evaluation
- Control
- Government Regulation and Taxation
Objectives of Book-keeping:
- Complete Recording of Transactions
- Ascertainment of Financial Effect on the Business
The various sub-fields of accounting are:
- Financial Accounting
- Management Accounting
- Cost Accounting
- Social Responsibility Accounting
- Human Resource Accounting
The various users of accounting information:
- Investors, Employees, Lenders, Suppliers and Creditors, Customers, Government and their agencies, Public, Management
Accounting is closely related with several other disciplines — Economics, Statistics, Mathematics, Law and Management.

Test Your Knowledge

True and False

1. There is no difference between book keeping and accounting, both are same. False
2. Management Accounting covers the preparation and interpretation of financial statements and communication to the users of accounts. False
3. Financial accounting is concerned with internal reporting to the managers of a business unit. False
4. Customers of business should not be considered as users of accounts prepared by business. They are not interested to know performance of the business. False
5. Summarising is the basic function of accounting. All business transactions of a financial characters evidenced by some documents such as sales bill, pass book, salary slip etc. are recorded in the books of account. False
6. Balance sheet shows the position of the business on the day of its preparation and not on the future date. True
7. Objectives of book-keeping are complete recording of transactions & ascertainment of financial effect on the business. True

Multiple Choice Questions

1. Which of the following is not a subfield of accounting?	(a) Management accounting. (b) Cost accounting. (c) Book-keeping
2. Purposes of an accounting system include all the following except	(a) Interpret and record the effects of business transaction. (b) Classify the effects of transactions to facilitate the preparation of reports. (c) Dictate the specific types of business enterprise transactions that the enterprises may engage in
3. Book-keeping is mainly concerned with	(a) Recording of financial data. (b) Designing the systems in recording, classifying and summarising the recorded data. (c) Interpreting the data for internal and external users.
4. All of the following are functions of Accounting except	(a) Decision making. (b) Ledger posting. (c) Forecasting.
5. Financial statements are part of	(a) Accounting. (b) Book-keeping. (c) Management Accounting.
6. Financial position of the business is ascertained on the basis of	(a) Records prepared under book-keeping process. (b) Trial balance. (c) Balance Sheet.
7. Users of accounting information include	(a) Creditors/Suppliers (b) Employees (c) All of the above
8. Financial statements do not consider	(a) Assets expressed in monetary terms. (b) Liabilities expressed in monetary terms. (c) Assets and liabilities expressed in non-monetary terms
9. On January 1, Sohan paid rent of ₹5,000. This can be classified as	(a) An event. (b) A transaction. (c) A transaction as well as an event.
10. On March 31, 2022 after sale of goods worth ₹2,000, he is left with the closing inventory of ₹10,000. This is	(a) An event. (b) A transaction. (c) A transaction as well as an event.
11. Which of the following is not a business transaction?	(a) Bought a machine of ₹10,000 for business (b) Paid towards salaries of employees ₹5,000 (c) Paid son's fees from her personal bank account ₹8,000
12. Which qualitative characteristics of accounting information is reflected when accounting information is clearly presented?	(a) Understandability (b) Relevance (c) Comparability

High-Yield Interactive Quiz — Meaning and Scope of Accounting

Q1. Accounting is the art of recording, classifying, and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the result thereof. This definition was given by:

Correct Answer: B. The Committee on Terminology set up by the American Institute of Certified Public Accountants formulated this definition in 1961.

Q2. Which of the following is NOT a sub-field of accounting?

Correct Answer: C. Book-keeping is the recording phase while accounting has several sub-fields like financial accounting, management accounting, cost accounting, etc.

Q3. The first book on double entry bookkeeping was written by:

Correct Answer: B. Luca Pacioli, a Franciscan friar, wrote Summa de Arithmetica, Geometria, Proportion at Proportionality in Venice (1494) — considered as the first book on double entry bookkeeping.

Q4. Which of the following is NOT a user of accounting information?

Correct Answer: D. The main users of accounting information are Investors, Employees, Lenders, Suppliers, Customers, Government, Public and Management.

Q5. Book-keeping is mainly concerned with:

Correct Answer: A. Book-keeping is an activity concerned with the recording of financial data relating to business operations in a significant and orderly manner.

Q6. Which function of accounting is concerned with explaining the meaning and significance of the relationship as established by the analysis of accounting data?

Correct Answer: D. Interpreting is the final function of accounting. It is concerned with explaining the meaning and significance of the relationship as established by the analysis of accounting data.

Q7. The financial position of the business is ascertained on the basis of:

Correct Answer: C. The balance sheet is a statement of assets and liabilities of the business at a particular point of time and helps in ascertaining the financial health of the business.

Q8. Which of the following is a limitation of accounting?

Correct Answer: C. Financial statements consider those assets which can be expressed in monetary terms. Human resources, although a very important asset, are not shown in the balance sheet.

Q9. Social Responsibility Accounting aims at accounting for:

Correct Answer: C. Social Responsibility Accounting is concerned with accounting for social costs incurred by the enterprise and social benefits created.

Q10. A transaction is used to mean:

Correct Answer: B. Transaction is used to mean 'a business, performance of an act, an agreement' while event is used to mean 'a happening, as a consequence of transaction(s), a result.'

Q11. Which of the following is NOT a function of accounting?

Correct Answer: C. Ledger posting is part of book-keeping, not a function of accounting. The main functions of accounting are Measurement, Forecasting, Decision-making, Comparison & Evaluation, Control, and Government Regulation and Taxation.

Q12. The term 'financial statements' means:

Correct Answer: B. The term 'financial statements' means Profit and Loss Account, Balance Sheet and cash flow statements including Schedules and Notes forming part of Accounts.

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