MEANING AND DEFINITION OF ACCOUNTING

Accounting is the process of recoding, classifying, suari!ing the financial transaction

and e"ents and counicating the inforation to its users #ho need it for decision a$ing%

According to Aerican Institute of Certified &u'lic accountant(AIC&A) : Accounting is the art of
recoding, classifying and summarizing in a significant manner and in terms of money, transaction and
events which are in part at least ,of a financial character and interpreting the results thereof.
Accounting &rinciple *oard (A&*) has given the definition of accounting as follows: 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 decision.
In simple accounting is an information system which communicates the information to its users to
enable them to make right decision. If you analyze the above definition it reveals some insight about
the nature and characters of accounting
+% Accounting is an art of recording, classifying and suari!ing financial data
,% Accounting inforation is useful for the purpose of decision a$ing
-% Accounting is .uantities in nature% Thus it discloses the inforation #hich can 'e
.uantified%
/% It does not re"eal .ualitati"e inforation li$e eotions of eployees etc%
0% As it is recorded inforation, it is necessarily related to the past data%
1% Transactions are recorded in ters of oney%
FUNCTION OF ACCOUNTING
Discuss function of Accounting
If anyone analyzes the definition of accounting, it clearly revel the functions of accounting.
Accounting is more like a step by step process. !unctions of accounting are generally fall under the
following categories:

+% 2ecording
,% Classifying
-% 3uari!ing
/% Analy!ing
0% Interpreting
1% Counicating

2ecording4 "ecoding is the basic function of accounting. Accounting start when the first data is
entered in the books of accounting. "ecording is done in the book called #$ournal% in a chronological
manner.
Classifying4 It is concerned with classification of recorded transaction so as to group the similar
transaction at one place. It is done in the book termed as &edger in which different accounts are
opened and all financial transaction of similar nature are recoded at one place under individual
accounts. !or e'ample all transaction related to creditor named as $ohn is put under his account.
3uari!ing4 (ummarizing means presenting the classified recorded transaction in a order which
is use neat and can easily be understood by the users of accounting.
Analy!ing4 The recorded financial information is analyzed to make useful interpretation. The term
)analysis )means methodological of the data given in financial statements. !or e'ample all items
relating to #*urrent Assets% are put at one place while all items relating to #*urrent &iabilities% are
put at another place.
Interpreting4 Interpreting means e'plaining the meaning and significance of the data. It is
necessary to interpret the statement in a manner useful to the users. It is to remember that
interpretation requires analysis and analysis is useless without interpretation. Interpretation aims
to draw meaningful conclusion from the information and use it for decision making.
Counicating4 Accounting is incomplete without a proper communication. Accounting
information has to be communicated in a proper form and manner to the concerned people.
*ommunication is done by preparation and distribution of accounting reports for the users of
financial statements to make decision. +reparation of ,alance sheets, Income statement, *ash !low
statements, etc. is the e'ample of communication tools generally used.


DI3CU33 O*5ECTI6E3 AND 7IMITATION OF ACCOUNTING
O'8ecti"e of Accounting
Accounting keeps systematic record of all the transaction and events which are used to the users of
accounting in the decision making process. !ollowing are the main ob-ectives of Accounting:

To $eep records4 human memory has a limitation. Accounting replaces that limitation of
human memory by keeping all the records of financial transaction in a systematic manner.
To ascertain financial health of 'usiness4 .ith the help of accounting data we prepare
the ,alance sheet. ,alance sheet is statements of assets and liabilities of the business on a
particular time. This ,alance sheet helps to determine the health of the business by
calculating assets and liability ratio.
Financial result of 'usiness4 Accounting helps to maintain systematic record of various
revenues and e'penses of a particular period. The profit and loss account is prepared at the
end of the accounting periods to ascertain the net profit earned or loss incurred by the
enterprise.
In decision a$ing4 As we know that accounting serves as an information system for
helping to arrive at a decision. (o all the data and interpretation of accounting ultimately
helps to take healthy decision.
7iitation of Accounting
.e have already discussed the ob-ectives of Accounting. /ow we will discuss the limitation or
shortcomings of Accounting. The ma-or limitations of Accounting include the followings:
2ecords only Financial Transactions4 Accounting records only financial transaction and
events. It ignores qualitative information.
Contradictory principles4 Accounting based on certain principles which appear to be
contradictory. !or e'ample, according to the principle of conservatism, inventory is valued
at the cost or market price whichever is lower. Accordingly the inventory may be valued on
cost basis in one year and at market price in another year but it violets the principle of
consistency.
Changes in price le"el ignores4 Accounting information is e'pressed in terms of money
and it is assumed that the monetary unit is stable overtime. It ignores the price levels
changes in case of financial statements prepared on historical basis. !or e'ample fi'ed
assets are recorded at the cost less depreciation. Their value may change over time.
9istorical in nature4 The information provided by accounting is historical in nature. The
transaction and events are recorded after it has taken place. !inancial statements are
prepared at the end of the accounting periods. (o the information includes in the financial
statements is -ust past records.
3u'8ecti"e choice4 It is not free from bias and depends sometimes on a number of
estimates, personal -udgments, etc. The accountant faced with a number of alternative
choices like choice in the methods of depreciation, valuation of inventory, etc. It is based on
the sub-ective choice which lacks ob-ectivity.
:indo# Dressing4 In accounting there is a lot of room for window dressing. The
management may enter wrong figures to artificially inflate or deflate the figure of profits,
assets and liabilities and thus financial statements may not reveal true and fair view of
financial data. !or e'amples accountant may postpone purchase of some items or convert
long term liabilities into short term loans to present a good picture on a particular date.
U3E23 OF ACCOUNTING INFO2MATION4
Accounting information is useful for various parties. Accounting sets to satisfy the needs of a wide
range of users. The ma-or users of accounting information are:




The users of accounting information include the present and potentials investor, creditors,
managements, suppliers, ta' authorities, government and public as well as.
+% In"estors4 ,oth present and potentials investor need the information to -udge the prospect of
present and potentials investment in the business. +resent investor need the information in
order to decide whether they should continue in the presents or not. !uture investors may
require the information to determine whether they should buy the shares of company or make
investment somewhere else.
,% Creditors4 *reditors are the person who owes money to the business. ,oth short term and
long term creditors need the information. &ong term creditors are interested in both the
solvency and liquidity of the business. 0n the other hand short term creditors are interested to
determine whether the amount owing to them will be paid when due.
-% Eployees4 The interest of the employees in accounting information is related to that they
want more salary and other monetary incentives like bonus, overtime payments, etc. They are
interested in financial statements on account of various profit and bonus schemes negotiation
with the management.
/% Managers4 1anagers or management are the main internal users of accounting information.
1anagers need the information for making various decisions. 1anagers need the information
to protect the property of business from fraud, mismanagement, to make specific decision, to
plan for future, to measure the performance.
0% Custoers4 *ustomers are interested to -udge the profitability and solvency of the business
for knowing the ability of the company to survive so that they are supplied with to goods on
regular basis. (trong financial background also implies quality products and more money on
innovation of products.
1% Go"ernents4 2overnment needs the information for various regulatory purposes. They are
interested in the accounting information on account of ta'ation, labor and corporate
laws. 3ifferent agencies like "egistrar of *ompany, *ompany &aw ,oard, and 1inistry of
!inance use the information for framing policies for the betterment of the economy.
;% General &u'lic4 2eneral public may be interested in the accounts of the business for social
obligation of business. The public is interested in pollution abatement, community welfare
program, ecological benefits or hazards out of operation of the business. +ublic is interested to
know how the national resource are being utilized by the organization and their contribution in
the economy.
MEANING OF ACCOUNTING &2INCI&7E3
Meaning of accounting &rinciple and Features of accounting &rinciples
Accounting +rinciples have been defined by the Canadian Institute of Chartered
Accountant as # the body of doctrine commonly associated with the theory and procedures
of accounting serves as an e'planation of current practices and as a guide for the
selectionof conventions or procedures where alternatives e'its. "ules governing the
formation of accounting a'ioms and the principles derivedfrom them have arisen from
common e'perience, historical precedents statements by individuals and professional
bodies and regulations of 2overnment agencies.
Aerican Institute of Certified &u'lic Accountant (AIC&A) has defined Accounting
principles as follows:
#4.. the principles which get substantial authoritative support becomes a part of 2enerally
accepted Accounting +rinciples. They are accepted because they are useful%
In very simple Accounting +rinciple is nothing but the rules regarding how to record, prepare,
discloses and present the accounting information and take correctives steps in order to make the
accounting statements acceptable to Accounting bodies.
3efinition of Accounting
Accounting operates within a broad socioeconomic environment, and so, the knowledge required of
the accountant cannot be sharply compartmentalized.It is therefore, difficult to discuss one area
without relating to other areas of knowledge. .e place a great emphasis on the conceptual
knowledge. The accountant should not only know but he should understand.
!rom the above it is clear that to define accounting as such, is rather difficult. 1any accountants have
defined Accounting in very many languages. 5owever, we can consider the following definitions:
6.5.*hakravorty: #Accountancy is the science of recording, classifying and summarizing transactions
so that relation with outsiders is e'actly determined and result of operation during a particular period
can be calculated, and the financial position as the end of the period may be shown.
7.A.I.*.+.A.: 8Accountancy may be defined as the art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions and events, which are in part, at least of
financial character, and interpreting the results thereof8.
9.Taylor and (hearing: 8Accounting may be defined as the art and science of recording business
transactions in a methodological manner so as to show: :a; the true state of affairs of a business of a
particular period of time and, :b; the surplus or deficiency which has accrued during a specific period.8
!rom the above definition, we can say that accounting helps us to have some information regarding
the following:
6.The nature and amount of incomes.
7.The nature and amounts of e'penses.
9.The nature and amounts of possible losses.
<.The nature and amounts of actual losses.
=.The size and volume of capital employed.
>.The increase or decrease in the volume of capital employed.
?.The nature and values of assets owned.
@.The nature and values of liabilities outstanding.
A.The specific amounts due to the business and their nature.
6B.The specific amounts due to the business and their nature.
66.The specific amounts due to be paid to the government and their nature.
67.The reports regarding the interpretations of the financial results.
Features of Accounting &rinciples4
Accounting principles comprise a set of rules, concept and guidelines.
These rules, concepts and guidelines are very useful in the preparation of financial
accounting reports.
Accounting principles are fast evolving and keep on changing according to the
requirement of the business.
2ele"ance, ob-ectivity and feasibility: Accounting principle must meet the three criterions.
"elevance means suitable for the circumstances under consideration. 0b-ectivity means
accounting principles should not be influence by sub-ective choices and personal bias of the
accountant. !easibility means it should be possible to use the principle which will draw
implication and fits to the needs.
These principles are not hard and core. Thus they lack universal applicability and
authoritativeness.
GAA&
GAA&< Generally Accepted Accounting &rinciple
Accounting information is used by various groups such as shareholders, investor,
managements, public, 2ovt. to know the affair of business activities.
Therefore 2AA+ laid down the fundamental principles of accounting which brings uniformity,
acceptability, credibility and usability of accounting information. 2AA+ stands for 2enerally
Accepted Accounting +rinciple. It is the general agreement which instructs how data should
be recorded in the books of accounting.
*enefits of GAA&4
6. It makes accounting process more logical and scientific.
7. It makes accounting consistence across various organization
9. It brings uniformity in the accounting process, system, procedure and practices.
<. It provides fair financial image of the organization
=. It helps to determine revenue of a business.
>. It forces organization to follow some all accepted rules and guideline in accounting.

It should 'e noted that Classification of Accounting &rinciples is 'ased on GAA&4
ACCOUNTING CONCE&T3 4

"ules of accounting that should be followed in preparation of all accounts and financial statements.
The four fundamental concepts are :
:6; Accruals concept: revenue and e'penses are recorded when they occur and not when the cash is
received or paid outC
:7; Consistency concept: once an accounting method has been chosen, that method should be used
unless there is a sound reason to do otherwiseC
:9; Going concern: the business entity for which accounts are being prepared is in
good condition and will continue to be in business in the foreseeable futureC
:<; &rudence concept (also conser"ation concept): revenue and profits are included in
the balance sheet only when they are realized :or there is reasonable DcertaintyD of realizing them;
but liabilities are included when there is reasonable DpossibilityD of incurring them.
0ther concepts include
:=; Accounting e.uation: total assets equal total liabilities plus ownersD equityC
:>; Accounting period4 financial records pertaining only to a specific period are to be considered in
preparing accounts for that periodC
:?; Cost 'asis: asset value recorded in the account books should be the actual cost paid, and not
the assetDs current market valueC
:@; Entity: accounting records reflect the financial activities of a specific business or organization, not
of its owners or employeesC
:A; Full disclosure: financial statements and their notes should contain all relevant dataC
:6B; 7o#er of cost or ar$et "alue: inventory is valued either at cost or the market
value :whichever is lower;C
:66; Maintenance of capital: profit can be realized only after capital of the firm has been restored to
its original level, or is maintained at a predetermined levelC
:67; Matching: transactions affecting both revenues and e'penses should be recognized in the same
accounting periodC
:69) Materiality: minor events may be ignored, but the ma-or ones should be fully disclosedC
:6<) Money easureent: the accounting process records only activities that can be e'pressed
in monetary terms :with some e'ceptions;C
:6=; O'8ecti"ity: financial statements should be based only on verifiable evidence, including an audit
trailC
:6>; 2eali!ation: any change in the market value of an asset or liability is not recognized as a profit
or loss until the asset is sold or the liability is paid offC
:6?; Unit of easureent: financial data should be recorded with a common unit of
measure :dollar, pound sterling, yen, etc.;.
Also called accounting conventions, accounting postulates, or accounting principles.
Introduction to the Accounting E.uation
!rom the large, multinational corporation down to the corner beauty salon, every business
transaction will have an effect on a companyDs financial position. The financial position of a company is
measured by the following items:
6. Assets :what it owns;
7. &iabilities :what it owes to others;
9. 0wnerDs Equity :the difference between assets and liabilities;
The accounting e.uation :or basic accounting equation; offers us a simple way to understand how
these three amounts relate to each other. The accounting equation for a sole proprietorship is:
The accounting equation for a corporation is:
Assets are a companyDs resourcesFthings the company owns. E'amples of assets include cash,
accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and
goodwill. !rom the accounting equation, we see that the amount of assets must equal the combined
amount of liabilities plus ownerDs :or stockholdersD; equity.
&iabilities are a companyDs obligationsFamounts the company owes. E'amples of liabilities include
notes or loans payable, accounts payable, salaries and wages payable, interest payable, and income
ta'es payable :if the company is a regular corporation;. &iabilities can be viewed in two ways:
:6; as claims by creditors against the companyDs assets, and
:7; a sourceFalong with owner or stockholder equityFof the companyDs assets.
O#ner=s e.uity or stoc$holders= e.uity is the aount left o"er after lia'ilities are deducted
fro assets:
Assets - Liabilities = Owner's (or Stockholders') Equity.
0wnerDs or stockholdersD equity also reports the amounts invested into the company by the owners
plus the cumulative net incoe of the company that has not been withdrawn or distributed to the
owners.
If a company keeps accurate records, the accounting equation will always be 8in balance,8 meaning
the left side should always equal the right side. The balance is maintained because every business
transaction affects at least two of a companyDs accounts. !or e'ample, when a company borrows
money from a bank, the companyDs assets will increase and its liabilities will increase by the same
amount. .hen a company purchases inventory for cash, one asset will increase and one asset will
decrease. ,ecause there are two or more accounts affected by every transaction, the accounting
system is referred to as dou'le<entry accounting.
A company keeps track of all of its transactions by recording them in accounts in the
companyDs general ledger.Each account in the general ledger is designated as to its type: asset,
liability, ownerDs equity, revenue, e'pense, gain, or loss account.
.e created a visual tutorial to demonstrate how a variety of transactions will affect the accounting
equation and the financial statements. It is available in AccountingCoach &2O along with e'am
questions that pertain to the accounting equation.
*alance 3heet and Incoe 3tateent
The 'alance sheet is also known as the statement of financial position and it reflects the accounting
equation. The balance sheet reports a companyDs assets, liabilities, and ownerDs :or stockholdersD;
equity at a specific point in time. &ike the accounting equation, it shows that a companyDs total
amount of assets equals the total amount of liabilities plus ownerDs :or stockholdersD; equity.
The incoe stateent is the financial statement that reports a companyDs revenues and e'penses
and the resulting net income. .hile the balance sheet is concerned with one point in time, the income
statement covers atime interval or period of time. The income statement will e'plain part of the
change in the ownerDs or stockholdersD equity during the time interval between two balance sheets.
E>aples
In our e'amples in the following pages of this topic, we show how a given transaction affects the
accounting equation. .e also show how the same transaction affects specific accounts by providing
the -ournal entry that is used to record the transaction in the companyDs general ledger.
0ur e'amples will show the effect of each transaction on the balance sheet and income statement.
0ur e'amples also assume that the accrual 'asis of accounting is being followed.
net income
This is the bottom line of the income statement. It is the mathematical result of revenues and gains
minus the cost of goods sold and all expenses and losses (including income tax expense if the
company is a regular corporation) provided the result is a positive amount. If the net amount is a
negative amount, it is referred to as a net loss.