11 The Production Theory
Dr S.S Narta
LEARNING OBJECTIVES:
After going through the module, students may be able to understand the meaning and definition of accounting. And also knowledge will be gained regarding the objectives, functions and nature of accounting.
INTRODUCTION:
Earning adequate profits is the basic necessity for the smooth functioning and long term survival of any business. Without profits no firm can think of running its functions smoothly. For the purpose of earning profits, business houses deals with the monetary transactions either by selling the goods (manufactured on its own or purchased) or by purchasing the items (on cash or credit). This sale and purchase of products in the market leads to either profits or losses, which needs to be carefully recorded in the books of accounts, so as to keep a record of the same for communication purposes, both to the insiders and the outsiders. This recorded information is used up by the management in taking financial decisions, controlling and deciding upon the budgets. And it will be available only when recorded properly by following a set devised system. This system is known as Book Keeping and Accounting.
Book keeping merely deals with the process of recording, classifying and summarizing business transactions, which are measurable in terms of money. Accounting on the other hand is concerned with the interpretation of the recorded transactions, for the use of the management as well as the outside users. Accounting is not only used in the field of business but has spread its wings to various other fields, and has gained importance for providing adequate, accurate and timely information to the users of the financial data.
MEANING OF ACCOUNTING:
Before understanding the meaning of accounting, let us understand the concept of book keeping. Book Keeping, as the name suggests is the art of keeping a record of transactions in the books. It is the process of recording, classifying and summarising the monetary transactions in the books of accounts, in a systematic manner, so as at the end of accounting year a clear picture of the profits earned and the losses incurred throughout the year, are portrayed in front of the management.
Accounting, is not confined only to the recording of transactions in the books, but extends far beyond, and analyses, interprets the information for the benefit of management. Accounting is not a new system, its existence is believed as early as 4500 B.C., in the civilizations of Babylonia and Assyria, where the transactions were recorded for the payment of wages and taxes on clay tablets. Accounting has evolved since ages and now with the advancement in social and economic environment, its use has been expanded and new dimensions are added up to the accounting discipline.
In simple terms, accounting refers to the science of classifying the business transactions and events with a main purpose of communicating the results to persons who are involved in decision making process. It deals with presenting the accounting information in simpler terms, so as to help the management and the outside users in making judgements. Accounting is considered as a language of business, which is understandable by everyone. Basically the main aim of accounting is to ascertain the profit and loss of the business for an accounting year, to disclose the financial position of the business, measuring income of the firm and communicating the summarised information, so that it can be used up by the managers, owners and other related parties.
DEFINITIONS OF ACCOUNTING:
Accounting is considered as an important part for any business house. The entire structure of business is based on the concept of accounting, as without accounting the business will not survive. Accounting has several definitions by different authors and books. However, certain definitions are mentioned below.
According to A.I.C.P.A., “Accounting 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 thereof.”
This definition is widely accepted by majority of accounting professionals and organisations worldwide. Other definitions are as follows:
In the words of H. Chakravorty, “Accounting is the science of recording, classifying and summarizing transactions so that relation with outsiders is exactly 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.”
According to Taylor and Shearing, “Accounting 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 specified period.”
According to Warren Reeve Fess,” Accounting is an information system that provides reports to stakeholders about the economic activities and conditions of a business.”
From the above definitions, following points are highlighted:
1) Accounting discloses the nature and amount of incomes.
2) Only the transactions of financial character are disclosed.
3) It is the art of summarizing the business transactions.
4) The economic activities carried out by business are disclosed, along with the financial condition.
5) Importance is laid on the communication of information to the persons who are to make the important decisions.
METHODS OF ACCOUNTING:
Accounting deals with the recording, analysing and interpreting the accounting information to the interested users (both inside and outside). Business transactions can be recorded in the books, by two ways:
1) Single Entry: Business organisations if follow this system, prepare only cash book and personal accounts of debtors/ creditors. Therefore complete record maintenance is not possible and trial balance cannot be prepared.
2) Double Entry: it maintains a two-fold effect of benefit giving and receiving aspects. It means that the record of equal debit and equal credit is maintained. In India, business transactions are recorded by the way of double entry system, hence depicting the debit and credit of every transaction.
OBJECTIVES OF ACCOUNTING:
The main objectives of accounting include:
1) To depict the profit/loss for a particular period: Accounting tells about the efficiency of the business. Every businessman is keen to depict the net profit or loss for its business, which can be calculated with the help of income and expenses by preparing profit and loss account.
2) To maintain record of Business Transactions: It is very difficult for the businessman to summarise the numerous amount of different transactions, so in order to avoid this, proper record of transactions is kept in the books of accounts. The recorded information verifies the information so recorded and acts as an evidence for the financial transactions.
3) To depict true financial position: One of the objective of accounting is to find the correct financial position of business in the form of assets and liabilities, presented in a balance sheet, prepared at the end of every accounting year.
4) To disclose the liquidity position: Financial reporting provides information about the liquidity position of an enterprise, and how it spends the cash, how much cash it borrows and other resource distributions, and factors that may affect the liquidity and solvency of an enterprise.
5) To help making rational decision making: Accounting records provide a well record of financial information which help the businessman in making proper decisions about the business, by the help of the presented information.
6) To fulfil the requirement of Law: All the Companies, societies, public trusts etc are required to maintain accounts as per the law, such as Companies Act, Societies Act, Income Tax Act etc. Hence, business houses keep a record of the financial transactions by the way of accounting records.
7) To provide accounting information to its users: The accounting process is involved in generating the accounting information, which is communicated to the interested users, belonging to different users such as investors, management, suppliers and creditors etc. it is prepared in such a way, so as to help the users for taking important decisions regarding the business.
8) To disclose the creditworthiness of business: Business houses operate through the finances which they generate by different means. One of the ways is by the way of investments made by investors in the business. Investors will invest only if they are satisfied by the working of the business and have an assurance that it will generate enough profits. This assurance is gained by looking at the past accounting records, which help in building trust upon the management.
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ACCOUNTING AS AN INFORMATION SOURCE:
As discussed earlier, the main objective of accounting is to provide information to the interested users, for making useful decisions. The main aim of accountants is usually to enhance the quality of the financial data and make it understandable and useful for its users. In order to make sure that the accounting information is useful in decision making, following characteristics must be possessed in the accounting information:
1) Reliable: reliable information is one which is true and correct, and the users can blindly depend upon the information. The information should be free from biasness, error and truly represent what it is supposed to depict about the financial position.
2) Relevance: it refers to the importance of the information communicated. It means that the information must be available on time, and help in proper predictions and decision making.
3) Comparable: accounting information is said to be comparable when the users can easily compare various aspects of information over different time periods as well as with other entities. It should be noted that the accounting information must belong to a common period.
4) Understandable: information is said to be understandable when the decision makers are able to interpret it in the same sense, as the information was prepared and conveyed to them. It is the duty of the accountants to present the information in the most accurate, clear and understandable manner without any biasness and error.
FUNCTIONS OF ACCOUNTING:
Accounting is the language of business, as a man is incomplete without language, business is incomplete without accounting, and if the transactions are not recorded then by no means they can be communicated to the users. Some of the functions are discussed under:
1) Proper record of business transactions: Keeping a systematic record of the business monetary transactions, posting them to the ledger and preparing final accounts for each accounting year, is considered as the main function of accounting.
2) Analysis and Interpretation: the recorded information is analysed and interpreted properly so that the end users can make a proper use of the data and judge about the financial conditions and profitability of business.
3) Communication of results to the interested users: Accounting is concerned with supplying the meaningful information to the interested users like creditors, owner, suppliers, employees, government, public etc about the financial activities of the business.
4) Protecting business property: Accounting is concerned with protecting the business property, by keeping a systematic record of the assets of the company, so that they are not misused by anyone.
5) Assistance to Management: Decision making process is concerned with the management and they can take appropriate decisions only when assisted with proper accounting information. Decisions relating to budget making, ratio analysis, dividend declaration etc can be taken easily with the help of accounting information.
6) Fulfilling legal requirement: All the registered companies are required to get its accounts audited from time to time, by a registered auditor. Auditing means checking for the validity and accuracy of the financial transactions. For checking the accuracy, proper evidence is required, such as records, documents, statements, which is prepared with the help of accounting.
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NATURE OF ACCOUNTING:
Accounting, as we all know is the medium of communication between the business and the outside world. The recorded information is presented accurately in front of the management so it can be studied and decoded accordingly for the purpose of decision making. The nature of accounting information is as follows:
1) Accounting as a Process: the word process means method of performing any job step by step, as per some pre determined objectives. Accounting as well is known to be a process, as it performs a step by step task of collecting, processing and communicating the information, keeping in frame certain objectives.
2) Accounting as an Art: Art simply means the applying of knowledge, involving some type of creativity and skill which helps in attaining the goals and some specific objectives. Similarly, accounting requires special skill, techniques and expertise in collecting, processing and communicating the data to the management in a reliable, accurate and understandable manner. So, accounting can be considered as an art as well.
3) Accounting as a Science: Science, based on certain set principles, universally acceptable, is a systematic body of knowledge. It establishes a cause and effect relationship, and is based on observations and experiments. Accounting may be said to be a science as it involves in recording, classifying, summarising and communicating the business affairs to the outside world. Which is done keeping in mind the pre determined principles, rules and standards, like double entry system is followed for recording the monetary transactions. As in accounting the cause and effect relationship is never studied, which is the main principle of science, therefore it can be considered that accounting is a science, but cannot be termed a pure science.
4) Accounting as an Information System: Information System is a collection of information which is stored, to be used up in future, accounting as well is an information system as it a storehouse of quantitative, reliable, accurate and communicable information, which is collected, processed and communicated to its respective users.
5) Accounting as a mean/way to attain objectives: Accounting in itself is not the final stage, or an objective to be attained. Basically, accounting is performed so as to attain certain specific objective of making the management and investors independent enough take their own decisions, by supplying useful financial information by the way of accounting. So it can be said that accounting is performed, to fulfil certain objectives, and is not an end but a mean/way to an end.
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SUMMARY:
It is evident that if a business is incorporated, then its primary objective would be to function smoothly and earn profits for carrying out its operations. Earning profits involve sale and purchase of goods and services with the market as a whole. This would not only lead to the generation of profits but sometimes business houses have to face losses, loss of stock etc. And at the end of accounting year businessman are interested in knowing how exactly they performed throughout the accounting year, and this information to them is provided in the form of final accounts, in a set system of Book Keeping and Accounting. Book Keeping is primarily concerned with only recording the monetary transactions in a systematic order (using single entry or double entry system), as and when they occur,classifying them into their sub groups, and summarizing the recorded information. Accounting starts where book keeping ends, accounting deals in communicating the summarized data to the interested users (management and outsiders), so that they can take appropriate decisions concerning the business.
Accounting is not a new system, its existence is believed as early as 4500 B.C., in the civilizations of Babylonia and Assyria, where the transactions were recorded for the payment of wages and taxes on clay tablets. And now in today’s rapidly changing business environment, accounting is not confined to just record keeping, but has shifted its dimensions towards more areas. In simple terms, accounting is the language of business involved in communicating the understandable and reliable information to the interested users. The information so presented must be reliable, understandable, easily communicable and relevant for the appropriate use. Accounting is performed with the main objectives of depicting the profit/loss for a particular period, recording business transactions, depicting true financial and liquidity position, help management in making rationale decision, fulfilling the legal requirements and thereby providing accounting information to the interested parties.
As far as the nature of accounting is concerned, it is a process continuously involved in recording, classifying, summarising and reporting the information. Is an art as it involves skills and expertise in performing the function of accounting, a science as it is based on certain principles, schedules and rules, and a mean to attain certain set objectives, and is not merely an end in itself. Hence, concluding that accounting is a never ending process, which is performed by the accountants with required expertise and skill, to provide the reliable, relevant and understandable information to the users, to be used up by the management for making decisions concerning the business. And by the investors in deciding, whether to invest in the business or not, after going through the information provided by the way of accounting.
Few Suggested Readings:
- Tulsian . P.C (2014) “Financial Accounting” Pearson Education India.
- Lal, Jawahar and Seema Srivastava (2004) “Financial Accounting” S.Chand (G/L) & Company Ltd.
- Goyal, V.K. and Ruchi Goyal (2012) “Financial Accounting” PHI.
- Maheshwari, S.N., Suneel K Maheshwari and Sharad K Maheshwari(2012) “Financial Accounting” Vikas Publishing House Pvt Ltd.
- Monga, J.R. “Avanced Financial Accounting” Mayoor Paperbacks.
- Bhattacharyya Asish K., (2012)” Essentials of Financial Accounting” PHI.
- A Students Guide to IFRS (2012), Kaplan Publishing.