Accounting is often called the language of business. Its purpose is to communicate or report the results of business operations and its various aspects.
When a person does a business then at the end of each year, he wants to know
(i) how much he owns ?
(ii) what he owes ?
(iii) how much he has purchased and sold ?
(iv) what are the total expenses ?
(v) whether he has earned a profit or suffered a loss on account of running a business ?
(vi) how much capital he has invested in the business ?
(vii) what is his financial position?
etc.
To attain above information, it is necessary to keep a systematic record of each and every transaction of the business during the financial year.
According to American Institute of Certified Public Accountants (AICPA) "Accounting is an art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events, which are, in part atleast, of a financial character, and interpreting the results thereof."
On analyzing the above definitions the following characteristics of accounting emerges:
- Accounting is the art of recording and classifying different business transactions.
- The business transactions may be completely or partially of financial nature.
- Generally the business transactions are described in monetary terms.
- In accounting process, the business transactions are summarized and analyzed so as to arrive at a meaningful interpretation.
- The analysis and interpretations thus obtained are communicated to those who are responsible to take certain decisions to determine the future course of business.
The following are the objectives of accounting:
- To record the business transactions in a systematic manner.
- To determine the gross profit and net profit earned by a firm during a specific period.
- To know the financial position of a firm at the close of the financial year by way of preparing the balance sheet
- To facilitate management control.
- To assess the taxable income and the sales tax liability.
- To provide requisite information to different parties, i.e., owners, creditors, employees, management, Government, investors, financial institutions, banks etc.
Accounting suffers from the following limitations:
- Accounting information is expressed in terms of money. Non monetary events or transactions, however important, are completely omitted.
- Fixed assets are recorded in the accounting records at the original cost, that is, the actual amount spent on them plus all incidental charges. In this way the effect of inflation (or deflation) is not taken into consideration. The direct result of this practice is that balance sheet does not represent the true financial position of the business.
- Accounting information is sometimes based on estimates; estimates are often inaccurate.
- Accounting information cannot be used as the only test of managerial performance on the basis of more profits. Profit for a period of one year can readily be manipulated by omitting such costs as advertisement, research and development, depreciation and so on.
- Accounting information is not neutral or unbiased. Accountants calculate income as excess of revenues over expenses. But they consider only selected revenues and expenses. They do not, for example, include, cost of such items as water or air pollution, employee’s injuries, etc.
Accounting like any other discipline has to follow certain principles, which in certain cases are contradictory. For example current assets (e.g., stock of goods) are valued on the basis of cost or market price whichever is less following the principle of conservatism. Accordingly the current assets may be valued on cost basis in some year and at market price in another year. In this manner, the rule of consistency is not followed regularly.
