🎯 Learning Objectives
- Understand the meaning and need of accounting 📖
- Identify internal and external users of accounting information 👥
- Learn the objectives and role of accounting 🎯
- Understand the basic terms used in accounting 🧾
🧾 What is Accounting?
Accounting is the art of recording, classifying, summarising and communicating financial transactions. It helps businesses to keep track of their money and to make smart decisions!
In modern times, accounting is not just recording numbers — it provides information for better decision-making. Today, accountants also work in cool areas like forensic accounting, e-commerce 💻, and environmental accounting 🌎.
📜 History of Accounting
Accounting has an ancient history! It started around 4000 B.C. in Babylon and Egypt, where records were kept on clay tablets.
In India 🇮🇳, Kautilya (Chanakya) wrote about accounting in his book "Arthashastra" over 2300 years ago!
In 1494, Luca Pacioli published the first book on double-entry bookkeeping in Venice, Italy 🇮🇹. That’s why he’s called the 'Father of Accounting'.
💼 Basic Concepts in Accounting
📍 Economic Events
Anything that impacts the business financially, like buying goods or paying salaries, is an economic event!
📍 Identification, Measurement, Recording, and Communication
- Identify the financial events 🕵️♂️
Find and select only those activities that are financial — like selling goods, buying materials, or paying salaries. Not everything is recorded — for example, hiring a new manager isn't an accounting transaction. Only money-related activities go into the books!
- Measure them in money terms 💵
Measurement is about using the right tools to collect accurate data. It helps you track progress and make sure you're on the right path.
- Record them properly in the books 📖
Recording data is the process of capturing information accurately for future analysis or reference. It involves documenting key metrics, observations, or events in a clear and organized manner. Well-maintained records are crucial for tracking changes, identifying patterns, and making informed decisions.
- Communicate reports to users 📊
Clear and effective communication is vital in conveying information to all stakeholders. It involves delivering messages in a way that is easily understood, ensuring the proper flow of information. Whether written, verbal, or non-verbal, communication is the backbone of successful collaboration and decision-making.
📘 Accounting Information
📦 Why Do Users Want Accounting Information?
- Owners/Shareholders: To check if their investment is giving good returns and if the business is financially healthy.
- Managers/Directors: To compare performance internally and with other companies. It helps them know if the company is earning enough and staying solvent.
- Creditors/Lenders: They want to know if the company can repay loans on time (liquidity check).
- Investors: To decide whether or not to invest money in the company.
- Government Agencies: Departments like Income Tax, RBI, etc., need accounting data for taxes and compliance.
📚 Accounting as a Source of Information
Accounting is a step-by-step process that starts with recording transactions and ends with creating financial statements. The main goal is to share helpful information so users can make decisions.
🔍 Importance of Accounting Information
- Helps in making smart economic decisions 💰
- Useful for people who depend on financial statements 📊
- Helps predict how much cash will come in or go out and when ⏳
- Shows how well management is using resources to achieve goals 🎯
- provide factual and interpretative information by disclosing underlying assumptions on matters subject to interpretation, evaluation, prediction, or estimation; and
- provide information on activities affecting the society.
Test Your Understanding – I
(a) Information in financial reports is based on
(b) Internal users are the of the business entity.
(c) A would most likely use an entity’s financial report to determine loan eligibility.
(d) The Internet has assisted in decreasing the involved in providing information.
(e) users are groups outside the business entity.
(f) Information is said to be relevant if it is
(g) The process of accounting starts with and ends with .
(h) Accounting measures business transactions in terms of units.
(i) Events should be recorded in order.
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Management Accounting
Management accounting deals with the provision of necessary accounting information to people within the organisation to enable them in decision-making, planning and controlling business operations. Management accounting draws the relevant information mainly from financial accounting and cost accounting which helps the management in budgeting, assessing profitability, taking pricing decisions, capital expenditure decisions and so on. Besides, it generates other information (quantitative and qualitative, financial and non-financial) which relates to the future and is relevant for decision-making in the organisation.
Such information includes: sales forecast, cash flows, purchase requirement, manpower needs, environmental data about effects on air, water, land, natural resources, flora, fauna, human health, social responsibilities, etc.
As a result, the scope of accounting has become so vast, that new areas like human resource accounting, social accounting, responsibility accounting have also gained prominence.
Many people in today’s society think of an accountant as simply a glorified bookkeeper. But the role of an accountant is continually changing. Discuss in the classroom what really the role of accounting is?
1.2.1 Qualitative Characteristics of Accounting Information
Qualitative characteristics are the attributes of accounting information which tend to enhance its understandability and usefulness. In order to assess whether accounting information is decision useful, it must possess the fundamental qualitative characteristics of relevance and faithful representation, and be enhanced by characteristics such as comparability and understandability, as well as verifiability and timeliness.
Reliability
Reliability means the users must be able to depend on the information. The reliability of accounting information is determined by the degree of correspondence between what the information conveys about the transactions or events that have occurred, measured and displayed. A reliable information should be free from error and bias and faithfully represents what it is meant to represent. To ensure reliability, the information disclosed must be credible, verifiable by independent parties using the same method of measuring, and be neutral and faithful.
Relevance
To be relevant, information must be available in time, must help in prediction and feedback, and must influence the decisions of users by:
- helping them form prediction about the outcomes of past, present or future events; and/or
- confirming or correcting their past evaluations.
Understandability
Understandability means decision-makers must interpret accounting information in the same sense as it is prepared and conveyed to them. The qualities that distinguish between good and bad communication in a message are fundamental to the understandability of the message. A message is said to be effectively communicated when it is interpreted by the receiver of the message in the same sense in which the sender has sent. Accountants should present the comparable information in the most intelligible manner without sacrificing relevance and reliability.
🔄 ComparabilityComparability means users can compare financial reports of a business over time or with other businesses. It helps identify trends and differences. To ensure comparability, financial statements must use the same time period, format, and measurement unit.
🧠 Test Your Understanding – II
You are a senior accountant at Ramona Enterprises Ltd. What three steps would you take to make financial statements more understandable and useful?
- Use simple and clear language in reports.
- Ensure consistency in format and units.
- Provide complete and reliable data.
Hint: Focus on qualitative features like comparability, understandability, reliability, and relevance.
🎯 Objectives of Accounting
Accounting helps maintain detailed records of all financial transactions like sales, purchases, payments, etc. These records are useful for future reference, legal proof, and decision-making. It ensures accuracy and keeps business data organized.
Business owners use accounting to know if they’re making profits or losses. Regular profit & loss calculations help in tracking performance and planning growth strategies.
📊 Qualitative Characteristics of Accounting Information
📘 1.4 Role of Accounting
For centuries, the role of accounting has been changing with the changes in economic development and increasing societal demands. It describes and analyses a mass of data of an enterprise through measurement, classification, and summarisation, and reduces those data into reports and statements, which show the financial condition and results of operations of that enterprise.
Hence, it is regarded as a language of business. It also performs the service activity by providing quantitative financial information that helps the users in various ways. Accounting as an information system collects and communicates economic information about an enterprise to a wide variety of interested parties. However, accounting information relates to the past transactions and is quantitative and financial in nature, it does not provide qualitative and non-financial information.
Note: These limitations of accounting must be kept in view while making use of the accounting information.