What is accounting?

Accounting is the process of recording, reporting and interpreting financial information pertaining to an organization.

According to American Institute of Certified Public Accountants:

Accounting is the 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.

If we analyse this definition, we get the following components:

  • It is about recording transactions
  • Transactions should be only of financial nature
  • The recorded transactions are then classified according to set rules
  • Results are then interpreted for people who are interested in this information



Difference between Book-keeping and Accounting

Book keeping is mainly concerned with record keeping or maintenance of books of account. It includes identifying the financial transactions, measuring them in terms of money, recording them in the books of original entry and then classifying them into ledger.

Accounting is more than Book-keeping. Apart from the standard practices of Book-keeping it involves summarizing the classified information in the form of Profit and Loss Account and Balance Sheet, drawing meaningful information from them and communicating this information with the interested parties i.e. stakeholders.

 

‘Booking keeping’ is a part of accounting as it only involves recording of economic events.


Purpose of Accounting

The main purpose of accounting is

  • To keep a systematic record of business transactions
  • To calculate Profit and Loss
  • To ascertain the financial position of the business
  • To provide financial information to different users of this information.

Who are users of accounting information?

These stakeholders or users might include

  • Owner/Shareholders: How much profit?
  • Managers: How business performed and how they can improve the performance in future
  • Employees: To know the profits so that they could demand better wages?
  • Investors: Is it safe and profitable to invest in the business?
  • Suppliers: Will the business be able to pay for their supplies?
  • Government: How much tax should be collected?
  • Lenders: It is safe to lend money to the business?

Types of Accounting

Financial Accounting: It is about recording business transactions in a systematic manner, to ascertain the profits or losses of the business by preparing Profit and Loss Account and Balance Sheet.

Cost Accounting: It involves finding out the total cost and unit cost of goods and services produced by the business.

Management accounting: Accounting table and formats may not make sense to a person other than an accounting. This is where Management accounting comes in. It is presenting the accounting information in a manner which a layman manager could understand. It involves ratio analysis, budgets, cash flows etc.
We will be covering some parts of Management accounting in Analysis of Final Accounts section.