MEANING AND SCOPE OF ACCOUNTING SSeS 1, NEED FOR ACCOUNTING accounting is primarily concerned with the money transactions of a business organization. A businessman who invests money in a business firm would like to know at the end ofa year whether his firm has made profit or incurred loss. He would also like to know the position of his assets (resources) and liabilities (owings) as on a particular date and also whether his capital in the business has increased or decreased? A business organization of even small or medium size deals with many customers, many suppliers of goods and services and many employees of the firm, The net result is that the businessman has to record thousands of transactions relating to purchases and sales of goods for cash or on credit or both, payments of salaries and payments for other items such as rent, electricity, stationery efc.. It is impossible to remember all the transactions in mind. Hence there is always a need to record these transactions on time and in a systematic manner so as to get the necessary information without much difficulty, Even a very small trader like Panwala (a person selling betel leaves) selling more than a thousands betels a day in a crowded market needs accounting. The business firm is also ‘answerable to income tax department for its annual income which can be calculated only by due process of accounting work. tional institutions (such as schools Similarly non-business organisations like educat ] 0 itself and its agencies 4nd colleges) hospitals, social clubs and even governmen L like Municipal, Corporations, Transport Corporations (e.g. Delhi Transport Corporation), Railways erc, also record transactions involving MOSS. In fet whenever there are money transactions financial accounting Is needed. Although Aecounting is used by many non-business enterprises yet the growth of nail *counting is closely associated with the development of busines ENePrS ‘he introduction of i " duction of money for their transactions. f or help to human memory, 0 Thus, orivi ; » Oral ccounting, was developed as an aid 9 ee transactions so as t0 help @ have g san it 4 permanent and systematic records of business FANSEE OV i. teimately businessman to know easily and readily his business UNA TT iion of his "bled the businessman to know the profit of 103s and te fills * business firm, Over a period’of time, it was realised by bu (llig Introduction to Financial Accounting accounting or financial information could also be used for decision making. It was also noticed that accounting or financial information presented in the form of income statement (or profit and loss account) and balance sheet was also useful to a number of outsiders stich as investors, creditors bankers, employees efc, for making various types of decisions relating to different business enterprises, Thus the need for accounting information has made accounting an information system or language ‘of business to communicate financial information about the business to different types of persons who are or may be interested in the affairs of business enterprises, 2. DEVELOPMENT OF ACCOUNTING It cannot be said exactly how the accounting originated. But in all probability, the system of book-keeping resulted from the need for keeping records of financial transactions. Among the earlier known records are those of Egyptians and Babylonians, from approximately 3000 B.C., who recorded on clay tablets such transactions as payments of wages and taxes. Historical evidence indicates that in ancient Egypt the storehouses were the primary reason for record keeping. These storehouses constituted the country’s treasury (a place where wealth is kept) and contained gold, livestock, grains, textiles and other properties. The treasurer was in charge and he was required to give a report each day to the wazir (the prime minister), who in turn, reported monthly to the King the position of the treasury. The country was divided into districts and each district was under the control of a governor. An important function of he governor was to keep records of the properties in the district. In respect of Babylonia, accounting was done on thousands of clay tablets. Orville Keister in his article on Commercial Record Keeping in Ancient Mesopotamia, in Accounting Review April 1963, reports that the most common record found is the receipts tablets in which the following information was recorded, namely : (i) the amount and kind of money or goods received (ii) the name of the person giving the item (iii) the name of the recipient and (iv) the date. There was an expenditure tablet which recorded the outflows of the entity consisting of a list of money and properties that were expended as a result of internal use, purchases, loss and so on. Income and production were also recorded. Wilmer Green, in his book : History and Survey of Accounting (Standard Text Press, 1930), states that in Greece, the government apportioned to the various treasuries the revenues that were received. The accounting records consisted of beginning (opening) balance, receipts, expenditures and ending balance. An annual inventory was also taken and financial statements prepared to show the sources of income and expenditures. In Rome, most of the book-keeping records were made on wax tablets which were destructible; there is therefore little historical evidence of accounting in the Roman period. However from the records that-are available, it found that there was a memorandum or day book in which were recorded receipts and expenditures, and a codex accepti et expeus, similar to a cash ledger into which were posted monthly, the entries made in the day book. So we have accurate knowledge of the wealth maintained in the treasuries, but little information relating to the persons who actually owned them. . ‘The main factors that encouraged the development of book-keeping were * emergence of written languages, the art of paper making, printing and rediscovery of Hindu-Arabic numerical system which had originally been made known in a bookMeaning and Scope of Accounting 413 written in 1202 by Leonardo Fibon: of ‘The evolution of double entry booking becomes evident, however, when accounts were required to be submitted ip others and not solely for the private information of the trader. ‘The emergence of banking system, partnership firms as well as large number of business transactions on account of industrial revolution have contributed for an orderly mechanism of ook keeping Emergence of Double Entry Book-Keeping : While accounting did not ori in Italy, its geographical location facilitated the formal dev. recording business transactions known as double-ent jo accounting. Raymod de Roover, in his a Before Pacioli, in accounting Review, 1938, p. | ‘elopment of a system of ry book-keeping, a forerunner Characteristics of Book-keeping 46, explained : “Double-entry was born whén people came to see that you could not take something out of one pigeonhole without putting it into another. this is simple but it took a long time before the mechanics of it understood.” Apparently were fully Luca Pacioli’s book : Summa de Arithmetia Geometria Proportioni et Proportionatita |Review of Artihmetic, Geometry and Proportions| in 1494 is the first book on double entry book-keeping.to be published. Pacioli, an Italian Franciscan monk, was a teacher and writer of mathematics and theology. The whole of his book is not on book keeping. Part of the book is on arithmetic, algebra and geometry: Part I Section 9 under the title of Particularis de computis et. scripturis [Particulars of Reckenonings and Their Recording or Details of Accounting and Recording] contains the essential elements of the double entry accounting system that is still in use today. The terms we employ today debit and credit were mentioned by him as debito (owed to) and credito (owed by), which came from the latin debeo and credo. The word debeo has the meaning of “owed to me, the Proprietor and word credo means the trust or believe” which is based on the fact that in business a creditor must trust or believe in the integrity of the proprietor. In explaining the double entry system, Pacioli said : “All entries... have to be double entries, that is, if you make one creditor, you must make someone debtor.” Inhis book, Pacioli states that to be successful every merchant needs three things: the sufficient cash or credit, good book-keepers and an accounting system to view the business affairs at a glance, He discusses, three books in the Summa : the memoraudum, the journal and the ledger . After discussing the basics of book-keeping, Pacioli devotes the next 10 chapters of Sumuma to specialised accounting procedures. « final eight chapters deal with the process of closing and balancing of the books. Interestingly, Pacioli never discusses financial statements, which are prepared Communicate the result of business activities to interested users, The reason *ems to be that the businesses were closely contralled by owners who could {amine business records themselves. However he did advocate an annual “lancing to determine the success or failure of the business and to find errors, Puring Paciol’s time, two other accounting concepts emerged, namely : the money- netsurement concept and the accounting period concept. In conclusion, it RY be stated that income in the fifteenth century meant the difference between Sh received from customers and cash paid to employees and other suppliers of Sand services, presently known as cash basis of accounting.14 Introduction to Financial 4g Coy Accounting has not remained static. It is changing in response to ch, Mn business environment. The economic power began to shift from Italy g "aM Be i since the beginning of fifteenth century to eighteenth century, The 1 Eagan Revolution brought about significant changes in business activities and leds ‘ological advances not only provided new machinery bu ei in nditures as well. Cost accounting system had to be ever tit accounting. Techn oped new types of expe! ; analyse and control the financial operations or activities of new and Ba ly ae aoa raring processes. Government laws Tike Companies Act have Brough ee sages in business environment and this has led tothe growth of accounting sen cena auditing, tax accounting, social accounting, human resource account srnagement accounting and so on. Thus the profession of aecountng has evolve, aaresne needs of people it serves in an ever changing and increasingly comple sit cromomie and legal environments, It must be emphasised that accounting i not crnct science. Its always in the process of change to meet the needs ofthe usen nd adapting itself to types of environments in which it operates. 3. MEANING AND SCOPE OF ACCOUNTING The meaning of accounting covers its nature and the term nature means its qualiy or feature, And the term ‘scope? means the things that a particular subject covers or deals with. Thus the nature and scope of accounting simply means the essential features of accounting and what the accounting covers or deals with. The nature and scope of accounting was explained in 1961 by Institute of Certified Public Accountants (AICPA) in the following definition which is also known as the traditional definition of accounting : “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 a financial character and interpreting the results thereof.” In addition to the above definition, the nature and scope of accounting has been fuer explained by other professional institutes and eminent authors of books on accounting the American asunder: _ Smith and Ashburne defined accounting as : ‘ “The science of recording and classifying business transactions and events, primarily of financial character and the art of making significant summaries analyses and interpretations of those transactions and events 3 communicating the result to the persons who must make decisions or for™ judgements,” Jn the words of Bierman and Darbin : ceounting may be defined as the identifying, measuring, recordin and communicating of financial information.” ; unting Association + eee is the process of identifying, measuring and communicatitg mic information to permit informed judge sions by of the isformation.” med judgements and decisi According to the American AcMeaning and Scope of Accounting 1s ssential Features of Accounting : From the above definitions, it is clear that accounting or financial accounting has many essential features which are briefly stated below (i) Identifying : It means selecting transactions and events of a specific organisation. In other words, identifying means determining or deciding the business transactions to be recorded in the books of account, (ji) Measuring : It means expressing the value of business transactions in terms of money. Such transactions are known as financial transactions e.g., sale of cars by Maruti Suzuki Ltd. or providing of telephone services by Airtel or payment of wages or salaries by Wipro Ltd or collection of money for advertisement by Star T.V. channel etc. are examples of financial transactions. On the other hand, the transactions that cannot be measured or expressed in terms of money like strike by the employees, efficiency of a sales person or recruitment policy of the management cannot be recorded in the books of account. Recording : Once the financial transactions and events are identified that is, recognized, and measured in terms of money, the same are recorded in the books of account. Recording is done on the basis of such documents as purchases and sales bills, (or invoices), bank pass book or bank statements, salary slips and so on. Recording means entering financial or business transactions as and when they occur or take place either in a single book of account called general journal or in several (i.¢., more than one) books of original entry called subsidiary books especially in a big enterprise or firm where number of. transactions is quite large and all transactions cannot be recorded in general joumal. For example, cash and bank transactions are recorded in cash book; credit purchases of goods in purchases book; credit sales of goods in sales book; purchases returns book is used for returns of goods purchased on credit while sales returns book is meant for recording returns of goods sold on credit. The following basic features of recording process in any book of account, are as follows : (a) Recording must be done in proper book(s) of account. (b) Recording must be done in an orderly manner i.e., date-wise and under proper headings technically called account titles such as cash account, purchase account, sales account and so on. (c) Recording must be done as early as possible, that is, in a timely manner. (iY) Classifying : After the transactions have been properly recorded in general journal or subsidiary books (or journals), these are properly classified. Classification refers to grouping of transactions (or entries) of same type (or of like nature) at one place into appropriate headings (called account titles) or in separate accounts. For example, expenses may be grouped into Separate accounts such as salaries account, rent account, stationery account ete,1.6 2) wi) wii) Introduction to Financial Accouming ‘The classifying process requires posting (transfer) of accounts to ledger from the general journal or subsidiary books (i.e. books of original entry), Thus classification implies preparation of the ledger accounts for transactions recorded in the original books: of account. In fact recording and classification are so closely related that it is difficult to maintain accounting records without some system of classification. Summarising : Summarising means to bring, together a number of classified accounts into one single account. For example, the accounts of various customers are grouped under a single account title as “Debtors? Account” and similarly the accounts of suppliers are grouped under a single account title as “Creditors’ Account”. All the incomes accounts and expenses accounts are recorded in the profit and loss account to get one figure of either net profit or net loss. Summarising thus involves the presentation of the information found in the ledger accounts in the form of profit and loss account and balance sheet at the end of the accounting period. ‘Thus the art of summarizing involves the preparation of final accounts, like profit and loss account to find out net profit or net loss, balance sheet to know the financial position (assets minus lial ies) and cash flow- statement from the classified data in a manner useful to the owner(s) and outside users of the accounting information. Significant: Accounting information is said to be presented in a significant manner only if the accounting records are useful for making decisions or for judging the performance of some firm. or person. Interpretation : In fact, interpretation is the main function of the accountants. It means that accountants must be able to explain not only what happened in the past but also why it happened and most important what is likely to happen in future on the basis of certain conditions. Interpretation requires analysis of information available in the financial statements, namely: profit and loss account and the balance sheet. Thus interpretation means rearrangement of various items of assets and liabilities and also of incomes and expenses items in a suitable manner. Comparison of past and present items in the financial statements, use of various Ratios and analysis of past trends can be used as important tools for interpretation of past recorded information and future results. - Communicating : It simply means communicating the results of interpretation of financial statements to the ultimate or end-users of the accounting information for making decisions in respect of investments in various enterprises, supply of goods on credit by sellers or grant of loans to business firms especially by the bankers and so on. 4, ACCOUNTANCY Erie Kohler states ; “Accountancy is the theory and practice of accounting.” Accountancy is also described as; the discipline which analyses the art and principles of recording all monetary transactions is known as accountancy. ‘Thus accountancy is not separate from a ounting, It is not process of doingMeaning and Scope of Accounting 7 counting work. It is a discipline or a body of knowledge or subject of study which a fg explains the art and principles of recording financial or business transactions. Accountancy explains, why books of account are to be maintained and the form in which these books of account should be maintained for various business transactions ike cash books, purchase book, sales book, return inwards and return outwards pooks and how to prepare the principal financial statements like profit and loss account, balance sheet and cash-flow statement. Accountancy also lays down the procedure for interpretation of accounting information with the help of comparative balance sheets and income statement, ratio analysis and cash-flow statements and also how to communicate the results and interpretation of financial information to the ultimate users of the accounting information for making different types of decisions like investments, grant of loans and supply of goods on ¢redit. It must be made clear that accounting is a part of the concept of accounting. The main features of accountancy are summed up as under ; (i) It is a discipline, that is, a body of knowledge or a subject of study e.g., chartered accountancy and cost accountancy. (ii) It prescribes or lays down the rules in respect of recording, classifying, summarizing and interpreting the financial information. (iii) It is also concerned with the basic concepts or conventions for recording the business transactions leading to the preparation of the financial statements and the interpretation of operating results (profit or loss) and the financial position. (iv) Accountancy is a wide term which includes both book-keeping and accounting. (¥) Accountancy is also the practice of accountants like chartered a iccountants, tax accountants, cost accountants and so on.ya 6, DIFFERENCE BETWEEN BOOK-KEEPING AND ACCOUNTING Before we make a distinction between book-keeping and accounting, it is appropriate to define the term book-keeping. According to J.R. Batliboi : “Book-keeping may be defined as a science as well as the art of recording business transactions under appropriate accounts.” In the words of A J Favell : “Book-keeping is the recording of financial transactions of a business in a methodical manner so that information on any point in relation to them may be quickly obtained.” Book-keeping is also defined as the art of recording business transactions in a systematic manner. The substance of the above stated and some other definitions is that Book-keeping is the process of recording business transactions, in proper books of account in a systematic manner so as to find out the profit or loss and the financial position of the business enterprise. A comparison of the respective definitions of book-keeping and accounting would show the following points of difference between the two : Bases of Book Keeping Account difference (i) Nature of Book-keeping is : Accounting is concerned not only work (a) the process of identifying orreco- | with the recording of business gnizing the business transactions | transactions but also : (b) expressing the value of transactions (a) summarising ofclassi-fied in money terms transactions in the form of (c) recording of business transactions profit and loss accountand in books of original entry and balance sheet. (d) classifying or grouping business | (b) analyzing and interpreting transactions into proper the business transactions headings (i.e, account titles) (c) communicating the resultsto and posting them in the ledger, theultimate users of accoun- ting information, (ii) Stage Book-keeping is the primary or tirst Accounting is the secondary or siage ol maintaining the books ofaccount. | second Stage of maintai-ning the booksofaccount, In factagcounting begins where book- keeping ends.Meaning, iy Objective and Scope of Accounting Themainobjectiveorihe book-keeping, is to maintain records of busines fransactionsina sys ematic manner 19 The objective of accounting is to find out the profit or loss and financial position of theenterprisea nd communicate the same to users ofaccounting information. hy Tyre of job The book-keeping function is of clerical nature andl can be performed even by electronic devices like The accounting function is of analytical nature and has to beperformed by professi ‘onal staff.computers. Natures * ofstafft The book-keeping function Is performed by junior staf. ‘Accounting is done by senior staff, inal Accounts io Book-keeper does not prepare the final accounts of a business enter prise consisting of income statement, balance sheet and cash-flow statement Accounting is mainly concerned with the preparation of financial statements ofan enterprise. (vii) Basie principles Book-keeping is done in accordance with the basic concepts and con- ventions forall types of organisations The methods and procedures adopted by accountants in the analysis and interpretations of finan statements or reports may not be the same for all the firms. Managerial () Branches (x) Supervision Book-keeping information is not of any use for managerial decisions Book-keeping has no branches Managelment requires accounting records for important managerial decisions such as planning for future projects, liquidity position and so on. But accounting has branches ike financial accounting, management accounting, cost accounting, tax accounting ete. —___| (i) Personal judgement (xi) Conclusions Oli) Art ys, Science Book-keeper has no role in super vising the work of accountant I "Transathioncaie GEN Gc ‘Transactions are recorded in all firms by the book-keeper strictly as per ‘accounting principles Hence there isno scope for personal judgement As book-keeping is done only to Tecord business transactions no conclusions are drawn or derived in the process of book-keeping Book-keeping represents only heart aspect of recording busines Sree alt Accountant may supervise and check the work of book-keeper’ recording work. Methods of reporting analysisand interpretation are not same for all types of enterprises. Hence personal judgement of the Accountantis essentially required. As accounting is primarily concerned with the analysis and interpretation of financial in the process of book-keeping dravvn in accounting, Accounting represents both the seience and art aspects of ‘oriing transactions JG 8. OBJECTIVES OF ACCOUNTIN ; pe i low + The main objectives of accounting are summarised be (i) ii) (iii) (iv) @) nsactions : Only written Ar vo . iness tral Maintaining proper records of busin! formation based on human records or information is always better than the in (aes memory. Moreover, written records can be used by the nae matic resotd information. Accounting helps maintenance of proper and systema J of all business transactions so that financial information on any usiness aspect is easily and readily available. It isnot possible to keep large number of business transactions in human memory. Ascertaining or knowing the profit or loss of the business : This objective of accounting is achieved by preparing profit and loss account or income statement at regular intervals say quarterly, half yearly or annually. Ascertaining the sources of the items of revenue and expenses : The income statement also provides the relevant information in respect of sources of the items of revenue and expenses. Such information enables the users of accounting information to know the reasons for profit or loss. Ascertainment of the financial position of the business : This is done through the assets, liabilities and owner (s)’ capital by preparing the balance sheet at the end of the accounting period. Ascertaining the cash flows : In the case of limited liability companies (joint stock companies), it is necessary to prepare, in most of cases, a cash flow statement. This statement analyses the sources and users of cash in respec! of operating, investing and financial activities. On the basis of past results the management can plan future cash flows from various activities,Me wi) wit) (x) @), (i) (ii) (iii) (iv) ‘nancial accounting performs the following major functions aning and Scope of Accounting iil paning Communicating financial information to various groups of users : Communicating of financial information to various users such as investors, creditors, bankers, employees, government agencies enable them to make important decisions such as investment in securities, grant of loans, raise demand for more wages and to mobilise resources for economic development Ascertaining the position of debtors and creditors : It is a major objective of the accounting to ascertain how much money is to be realised from the customers and how much money is payable to creditors. These are the major components or items of the working capital position in addition to unsold stock of goods in hand. Facilitating research in business operations : The financial analysts or researchers analyse the accounting information by making use of comparative financial statements, various ratios, cash flow statement efc., to know the liquidity, solving, profitability, turnover of debtors and stock of the various business enterprises, Controlling the performance of the business : Accounting discloses the actual performance of business by providing information as to cost of goods sold, sales, profit or loss, the book values of assets and the amount of liabilities. Actual performance can be compared with the planned or targetted performance. Any deviation or departure between the actual performance and planned or standard performance should be analysed and steps can be taken to remove unfavourable causes. However if there is better performance than planned one, the favourable factors can be repeated, or reinforced or strengthened. Meeting legal requirements : The Companies Act, the Income Tax Act, Sales Tax Act, Customs and Excise Laws etc. require maintenance of financial records for various purposes. Accounting achieves this objective by supplying the required information to the government agencies as and when required, 9. FUNCTIONS OF ACCOUNTING Maintaining systematic records : Business transactions are properly recorded, classified under appropriate accounts and summarized into financial statements—income statement and the balance sheet. Communicating the financial results : Accounting is used to communicate financial information in respect of net profits (or loss), assets, financial liabilities etc., to the interested parties. Meeting legal needs : The provisions of various laws such as Companies Act, Income ‘Tax and Sales ‘Tax Acts require the submission of various, Statements, iv., annual accounts, income tax returns, returns for sales tax Purposes and so on. Protecting business assets : Accounting maintains proper records of112 @) (vi) (ii) Introduction to Financial Accounting various assets and thus enables the management to exercise proper control over them with the help of following information regarding them : (a) How much is the balance of cash in hand and cash at bank? (b) What is the position of inventories? (c) How much money is owed by the customers? (d) How much money is owing to the creditors? (e) What is the position of various fixed assets and how these are being used? ‘Accounting assists the management in the task of planning, control and coordination of business activities. Stewardship or Trusteeship : In the case of limited companies, the management is entrusted with the resources of the enterprise. The managers are expected to act true trustees of the funds and the accounting helps them to achieve the same, Fixing responsibility : Accounting helps in the computation or calculation of the profits of different departments of an enterprise. This would help in fixing the responsibility of each departmental head. 10. ADVANTAGES OF ACCOUNTING There is some overlapping between the functions of accounting and advantages of accounting. Hence a repetition of some of the functions of accounting under the present heading, namely : advantages of accounting which are summarised as under : @ iv) Maintenance of records rather than memory : All business transactions are systematically recorded in various books of accounts. It is not possible at all to do any type of business by just remembering the transactions which have grown in size and have become complex or difficult. Human memory is limited by its very nature. Hence business transactions must be recorded early in the books of account (ie. General journal or special purpose subsidiary books, as the case may), so that necessary information about them is a available in time and free from bias. Preparation of financial statements : When the business transactions are maintained in a proper manner, it becomes possible to prepare two basic financial statements, namely : (a) The income statement (ie, profit and loss account) to ascertain the profit and or loss for an accounting period. (b) ne eee jeeceianl the financial position of the business Beet aueeeTe accounting, period, that is, the position of 5 wner(s)’ capital on that date. Comparison of results : very helpful to compare of one year with those of Not only this, itis also pi with that of another, Iti A properly recorded accounting information is the profit (or loss) amount and financial position Previous years. It is called intra-firm comparison. ossible to compare the financial results of one firm J s called inter-firm comparison. Assistance to management : management to plan its future sales, production, expenses, ca various activities in different The accounting information helps the activities by preparing budgets in respect of ’sh, ete. Accounting, helps in coordination of departments by providing financial detailsfpaning and Scope of Accounting 113 Gi) each department. The managerial contro! is achieved by analyzing in money terms the departures or deviations from the planned activities and by taking corrective Measures oF steps to improve the situation in future. As legal evidence : Systematically recorded accounting information provides documentary evidence in a court of law for disputes regarding the amount owing to the creditors and recovery of money from debtors. Helps in taxation matters : Income tax, sale tax or vat (value added tax) authorities could be convinced about the amount of taxable income, or actual sales, as the case may be, with the help of written records. Ascertainment of value of business : Accounting information can be used to determine the proper price or value of business in case a sole trader, a partnership firm or a company wish to sell its business to any person or entity. Raising loans : Accounting is of great help to lenders who want to give Joans to any business enterprise. Control over assets or properties : Accounting facilitates control over assets or properties of the business enterprise by providing information as to cash and bank balances, stock in hand, sundry debtors, fixed assets etc.. Prevention of errors and frauds : Accounting records are subject to auditing in most of the cases. Auditing helps detection of errors and frauds that have taken place during the year and takes steps to prevent their recurrence (to occur again) future. Communication to external users : Accounting provides valuable financial information to external users like investors, consumers, creditors, government agencies etc., who require such information for various purposes. 11. LIMITATIONS OF ACCOUNTING There is no disadvantage of the accounting. However it is not free from imitations which are outlined as under : @ (ii) No recording of non-monetary transactions : Financial accounting records only those transactions which are expressed or measured in money only. It means there is no place for non-monetary or non-financial transactions though these events are important for the efficient or smooth running of the business enterprise e.g., health of the salesmen, the hard work done by the owners or chairman of the company and so on. Thus accounting, does not provide complete information about all the events of a firm. No information about the present value of the business : Assets. are Tecorded on the basis of cost concept. It means , for recording purpose, original cost is the basis for the new assets and book-value (Griginal cost minus depreciation) for the used assets. In this way market values of the assets are ignored, So the effect of inflation (or deflation): on value of fixed assets is not taken into consideration. The effect of this practice is that the balance sheet does not disclosp.she true financial position lof the business enterprise, thyhd Introduction to Financial Accounting Gii) Use of estimates or personal judgement : Accounting records sometimes do not give exact information since accounting information is based on estimates or personal judgement. For example it is not possible to predict accurately the actual useful life of fixed assets for the purpose of depreciation expenses, Similarly the accountant may select any method of depreciation, valuation of stock and treatment of deferred revenue expenditure. Such Judgement is based on the qualification and credibility of the accountant and may affect the outcome or result of financial statements, (iv) Window dressing : Sometimes the accountant may resort to (or indulge in) “window dressing? (impressive but not real or true) in the balance sheet by showing items like debtors or stock without provision for doubtful debts or obsolescence. In such a case the balance sheet cannot give a true and fair view of the financial position of the business enterprise. (%) Unrealistic accounting information : Accounting information may not be realistic even when financial statements are prepared on the basis of basic accounting concepts and conventions, According to going concern concept, business entity will have indefinite life and thus assets are recorded at cost oF book value which may not be actually realisable because of low market value. (i) Accounting information is not natural or unbiased : accountants calculate income as excess of revenues over expenses recorded in monetary terms. Hence they do not include the costs of air pollution, water pollution, employees’ accidental injuries and so on (ii) Lack of consistency : Accountants have to follow certain generally accepted accounting principles for recording the business transactions. If these Principles are not followed uniformly year after year, the accounting information may become inconsistent, For example the stock of ‘goods in hand is valued on the basis of cost or market price whichever is less on the basis of conservatism or prudence principle or convention. Accordingly stock in hand may be valued on cost basis in one year and at market price in another year. In this manner convention of consistency may be violated, (vill) No basis for managerial efficiency : Accounting information cannot be used as the only test of managerial efficiency or managerial performance on the basis of more profits. Profit or income for a period of certain year can be inflated by omitting such expenses as advertisement expenses, cost Of research and development, depreciation expense and so on. (ix) Disclosure of only material items : material items are disclosed in detail. In t though important, are ignored, (x) Historical information only ; Accounting records ‘only past or historical 0 they may not be of much use in the present or current situation. Accounting methods or systems are static and not flexible. In the financial statements only his manner the insignificant items, (xi) Static ; 12, BRANCHES OR DIVISIONS OF ACCOUNTING : : : | Pare Accountants tend to specialise in Various types of accounting work and this hasMean" & and Scope of Accounting 115 ested in the development of different branches of accounting. Some of the aivisions Ww Gi) wi) (vii) (viii) of accounting are given as: Financial accounting : Accounting designed or meant for outsiders (persons other than owners and managers) is known as financial accounting, It is concerned with the recording of business transactions and the periodic preparation of income statement, balance sheet and cash flow statement from such records. In this manner, the financial accounting, is useful for ascertaining profit or loss made for a given period and financial position at the end of the given period and also the sources and uses of cash for the given period. Management accounting : It is concerned with the interpretation of accounting information to guide the management for future planning, decision-making, control, efc., Management accounting, therefore, serves the information needs of the insiders, e.g. owners, managers and employees. Cast accounting : It has been developed to ascertain the costs incurred for carrying out various business activities and to help the management to exercise strict cost control. ‘Tax accounting : This branch of accounting has grown in response to the difficult tax laws such as relating to income tax, sales tax, excise duties, customs duties, etc.. An accountant is required to be fully aware of various tax legislations. Social accounting : This branch of accounting is also known as social reporting or social responsibility accounting. It discloses the social benefits created and the costs incurred by the enterprise. Social benefits include such facilities as medical, housing, education, canteen, provident fund and so on while the social costs may include such matters as extra hours worked by employees without payment, environment pollution, unreasonable terminations, etc. Human resources accounting : It is concerned with the human resources of an enterprise. Accounting methods are applied to evaluate the human resources in money terms so that the society might judge the total work of the business enterprises including, its non-human net assets. It is, therefore, an accounting for the people of the organisation. Unfortunately no objectively verifiable method has been developed for universal application. National accounting means the accounting for the resources of the nation as a whole, It is generally not concerned with the accounting of individual business entities and is not based on generally accepted accounting principles. It has been developed by the economists and the statisticians. Green accounting : The concept of green accounting is related to the calculation of national income in which standard measures of income and output are Gross National Product (GNP) Gross Domestic Product (GDP) Gross National Income (GNP) etc. In’'simple words, Green Accounting is a kind of accounting that tries to take into consideration the environmental costs in the calculation of operating income of an enterprise. It is argued that there is need for a revised method of income determination that includes green accounting because Gross National Product (GDP) ignores environment.(ix) Introduction to Financial Accounting Green accounting takes into consideration not only value of natural resources but also the costs of pollution and depletion of natural resources. The Green Accounting discloses or emphasizes more clearly about the quality of economic growth in terms of sustainable development. Creative accounting : It is the primary duty of the persons in accounting professions, the accountants, to report a true and fair view of the financial statements, namely : the profit and loss account and the balance sheet. Creative accounting is nothing but the manipulation of the operating results and financial position of the company, of course, within the confines (limits) of the accounting standards. It means though accounting standards are followed yet the manipulation is dane by adopting such practices as recognition of premature or fictitious revenues.(e.g. , showing stock at. sale price), reducing the rate of depreciation or artificially increasing the life of the fixed assets and so on. Investors and other users of accounting information must educate themselves about the creative accounting and fraud detection methods.14, THE USERS OF ACCOUNTING INFORMATION There are various groups of people who use accounting information for their different needs. These users of accounting information may be classified into two categories namely, (i) Internal users and (ii) External users. (i) Internal users : They are directly involved in running or managing the business ~ enterprise such as officers, and partners (directors in the case of joint stock companies) and owners or sole traders. They need accounting information for the efficient running of the business enterprise. Their needs are met from the use of income statement (Profit and Loss Account), Balance Sheet and Cash-Flow Statement. Internal users have direct access to lot of private and confidential reports known as internal reports which contain valuable information relating to manufacturing cost of a product, pricing of different products for sale purpose; whether the product should be manufactured or purchased from outside;1.18 Introduction to Financial Accounting. 4 whether a new product is to be launched (introduced) or a particular produc, should be discontinued. Persons, individuals or organisations, who have some present (ii) External users : or future interest in the economic activities of the business enterprise are external users. They are not part of management team. They make use of published annual reports which contain income statement, balance sheet and cash-flow statement. The annual reports also contain important information about the activities of the business enterprise. The external users are ; shareholders (investors) of a joint stock company, trade or labour unions of employees, creditors (suppliers of goods and services on credit), customers, government, researchers and so on. Following table indicates some of the users of accounting information and their needs for specific information : Users @ Owners or Need for information Their need for accounting information is mainly concerned with the financial Proprietors or position of the firm, rate of return on the capital employed and efficient Partners utilisation of scarce (limited) resources. Gi) Existing shareholders Gil) Potential investors (Those who intend or want to invest) (iv) Manageme ‘They are interested in the profitability and solvency of the company. They (Present Investors) also want to know whether the profits of the company are in creasing or decreasing whether the company shall pay more dividends in future. On the basis of trends in profitability, they decide whether they should invest more money in the company or they should hold the present number of shares or they should sell out their investments or shares etc.. Basically they will be interested not only in the dividends of the current year only but they are also interested in the information about the dividends paid in the past few years. ‘They can determine that this progress or trend will be ‘maintained in future as well. The statement ofthe chairman ‘ofthe company in the annual reports provides some indication ‘about the future progress of the company. So it is necessary that accounting information helps them whether they should buy the shares of the company or not, With the separation of mana, s ement and ownership in the case of joint stock companies, thy Managers are responsible for carrying on the business activities of an enterprise. They need accounting information — (a) To set targets fpr future periods: (b) To observe and measure the performance of the Various departments within a business enterprises (6) ‘Toevaluate the performance against the targets highlighting the departures or, deviations trot the targets and (d) To take corrective steps if there are shortfalls:Meaning Creditors and short-term lenders {ri Long term lenders (il Employees through (viii) Government(s) (ix) Regulatory Agencies (8) Individuals and and Scope of Accounting 119 In addition, the management also needs information (for all types of business organisations) to review the firm's : (a) Short-term and long term solvency. “(b) Profitability in relation to total sale: (©) Effective utilization of limited resources and (@)__ Profitability in relation to capital employed, so that management can take necessary action to run the business smoothly. Creditors include suppliers of goods and services on credit Short term are generally commercial banks who lend money for short periods. They need accounting information to know whether the borrowing business firm shall be able to pay interest periodically or regularly and also pay back the principal amount on maturity date. Their specificinterestliesin solvency, liquidity and profitability of the business enterprise. This category includes debentureholders, industrial banks non- banking financial institutions etc. They are interested in the regular interest payments on their loans and also the repayment of principal amount when the same is due or repayable. They are therefore interested in profitability, liquidity, interest solvency for payment of loan amount. The availability of cash flow statement in addition to income statement and balance sheet has considerably helped to judge the liquidity position of the enterprise. Employees who are represented by labour unions are interested in more salaries. labour unions overtime payments, bonus, medical facilities etc., are interested in the earning capacity of the firm, Accouting information provides facts and figures about the eaming capacity and thus increases their bargaining power. Financial reports highlight what the management is doing for the welfare of the employees and what they intend to do in future. The economic activities of central, state and local governments are financed through collection of tax: Thus the accounting information about business activities is very helpful in the collection of income tax, value added tax (VAT), sales. tax, goods and services tax (GST) customs duties, excise duties and so on, Each tax requires special accounting information of various business enterprises. Any distortion or manipulation in the accounting information would adversely affect the welfare policies of the government because of less collection of tax. ‘A number of regulatory authorities or agencies like Securities and Exchange Board of India (SEBI), the Insurance Regulatory Authority, the Reserve Bank of India e¢c., need accounting information for the efficient operations ofthe ‘capital markets. People are affected by the economic activities or operation: of @ business enterprise in their localities. ‘The accounting1.20 Introduction to Financial Accountiy information discloses the well-being or prosperity of vaio, M business enterprises and also the type of activities in the localities. Such information would be useful to know ¢ employment opportunities in a local area, Society as a whole affceted by water and air pollution from industrial ativitie The accounting information would disclose how much mone, hasbeen spent to control such pollution. responsibility or green accounting. his is known as socia 15. ROLE OF ACCOUNTANT Accounting profession has attained a stature comparable with that of law or medicine It is therefore held in high esteem in public eyes. Accountant's profession is “the fairest invention of human mind”. The Institute of Chartered Accountants of India is 4 statutorily constituted professional body and its members are known as chartereg accountants . Thus only chartered accountants are truly professional accountants, A chartered accountant with his education, training, analytical mind and experience is best qualified to provide essential services to the ever growing needs of the society in financial matters. The role of accountants in society may be summarised as under : (i) General Financial Accounting : The priniary role of an accountant is to offer his services for maintaining systematic records of financial transactions in order to ascertain the net profit or loss for the accounting period and the financial position as on a particular date. These two-objectives are achieved by preparing respectively the income statement and the balance sheet. (ii) Statutory Audit : Auditing is an important function of a chartered accountant where his specialised knowledge, skill and training are often required. The accountant serves as a link between the preparers and users of financial statements—a trusted link between management and outside people. The external users of financial statements do not have a direct access to the accounting records in which they are interested. For this purpose every limited company is required to appoint a:chartered accountant as an auditor who has the statutory duty to report each year whether the financial statements have been prepared in accordance with the generally accepted accounting principles, accounting standards and legal requirements and they show a true and fait view of the financial position and profit or loss, of the Auditing is not confined to the accounts of the companies, Other organisations may also get their accounts audited because the k law so requires e.g. Cooperative Societies Act, Income Tax Act. This is called the statutory audit. The sole traders or partnership firms may also get their accounts audited, The accountant carefully examines the accounting records from which financial statements were Prepared. This professional role is referred to as the attest function of accounting. The purpose of the Statutory audit is to lend credibility to the financial reports, that is, to assure that they are dependable. (Hi) “Internat Auditing + In addition to an aniual audit by a firm of chartered accountants, many big companies employ a regular staff to constantly check the accounting records prepared and maintained in each department or qHPany branch, This is called internal auditing function of the accountant. he purpose of internal audit is to gnsure that transactions are recorded,Mea wv) ©) ) (vii (vill) ring and Scope of Accounting tat t classified and summarised in accordance with the established accounting procedures and the instructions of the management are being followed throughout the company. Cost Accountancy : A chartered accountant is also trained to maintain costing records to ascertain costs of production and of processes at different levels of operations in the manufacture ofa product, He is also competent to provide costing information for the guidance of management, introduce cost control methods and assist the management in fixing appropriate selling prices. He is competent to provide information required to plan an operation : information to show whether the operation is proceeding according to plan and to remedy (or correct) unfavourable situations or to take advantage of favourable ituations. Budgeting : It means the planning of business activities before they occur. Upon the completion of actual operating activities for a given period, the planned activities are compared with the actual to find out what actually happened. Any differences are thoroughly analysed for corrective actions to bridge the gap between actual and budgeted activities. Many enterprises have within their accounting departments a regular staff for this phase of accounting. Taxation : The Government plays a dominant role in our economy with new and different forms of tax with the result that current and continuing tax information has become an important aspect of business activities. An accountant can handle the taxation matters of a business enterprise or of a Person and he can represent the firm or a person before the tax authorities and settle the tax liability under the Income Tax Act or Sales Tax Act or laws contceming excise and custom duties. Tax services of an accountant include not only preparing and filing of tax ret study of possible tax effects of various fi management may be interested because eve tax implications or effects, Accountants also express their views on tax policy of the Government in order to enlighten the public about the effect of tax Tales on business and the economy in general. Special Company Work : nancial transactions in which Ty major business decision has vestigation : investigation to as of interested pa Chartered accountants are often called upon to carry out scertain the financial position of business for the information i ities in connection with matters such as a new issue of share “pital, the purchase or sale or financing of a business, reconstruction and amalgamations, Other examples are : (a) (0 help management to decide whether 1 is cheaper to ‘Manufacture an article or to buy out from outside 3 (b) to anatttain why profits are falling ; () to ascertain Whether fraud has occurred and if so, its nalure and extent and to suggest remedial measures S SO as to Prevent jts Occurrence in future.1.24 Introduction to Financial Accounting 8 specific field of activity. Presently graphs and charts are being extensively used for communicating accounting information. Whereas the accountant is primarily concerned with the data expressed in money, the field of statistician is not so limited. Accounting and Engineering The engineers provide estimates on new capital proposals associated with the plant and machinery and figures in their report are frequently used in the accounting records, The accountants and engineers must cooperate with each other in bringing about efficiency in production activities. The accountant can help the engineering people by providing details of cost records of various operation so as to explore the possibilities of cost reduction, if any. Accounting and Mathematics The fundamental dual aspect concept of accounting is expressed in the form of a mathematical equation, popularly known as accounting equation. Simple mathematical operations involved in accounting are addition, subtraction, multiplication and division. The knowledge of mathematics (arithmetic and algebra) is in fact the basic requirement for accounting calculations and measurements. For example, computation of depreciation, calculation of cash price in the case of hire purchase system, setting of lease rentals etc., require the use of mathematical calculations. * With the introductions of computers, mathematics has become-an important part of accounting. The use of the techniques of operations research has made the accounting all the more mathematical; knowledge of geometry-and trigonometry is also essential to have a better understanding about the accounting, communication system. Accounting and Management A large number of accounting reports are prepared for management decisions. In fact the accountant is given important positions in the management.teams because he (the accountant) is ina better position to use the accounting information through internal accounting reports and financial statements. The accountant understands more conveniently the accounting data than any other member of management team. The basic objective of the management is to manage the business in a systematic way by allocating responsibilities to implement the plans set by the management. ‘Accounting information can be used in such a manner as to help the management (0 make important decisions in achieving the planned activities. Management accounting, an important branch of accounting, processes accounting date with the help of ratio analysis, and cash flow statement for management decision making. In fact accounting is an essential service function of management because the accountant is in a better position to judge the information requirements of the management ( t