INTRODUCTION
Every individual performs some kind of economic activity. A salaried person gets salary and spends to
buy provisions and clothing, for children’s education, construction of house, etc. A sports club formed
by a group of individuals, a business run by an individual or a group of individuals, a local authority like
Calcutta Municipal Corporation, Delhi Development Authority, Governments, either Central or State, all
are carrying some kind of economic activities. Not necessarily all the economic activities are run for any
individual benefit; such economic activities may create social benefit i.e. benefit for the public, at large.
Anyway such economic activities are performed through ‘transactions and events’. Transaction is used
to mean ‘a business, performance of an act, an agreement’ while event is used to mean ‘a happening, as a
consequence of transaction(s), a result.’
1.2 MEANING OF ACCOUNTING
The Committee on Terminology set up by the American Institute of Certified Public Accountants formulated
the following definition of accounting in 1961:
“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 at least, of a financial character, and interpreting the result
thereof.”
As per this definition, accounting is simply an art of record keeping. The process of accounting starts by
First identifying the events and transactions which are of financial character and then be recorded in the
books of account. This recording is done in Journal or subsidiary books, also known as primary books. Every
good record keeping system includes suitable classification of transactions and events as well as their
summarisation for ready reference. After the transactions and events are recorded, they are transferred to
secondary books i.e. Ledger. In ledger, transactions and events are classified in terms of income, expense,
assets and liabilities according to their characteristics and summarised in profit and loss account and balance
sheet. Essentially the transactions and events are to be measured in terms of money. Measurement in terms
of money means measuring at the ruling currency of a country, for example, rupee in India, dollar in U.S.A.
and like. The transactions and events must have at least in part, financial characteristics. The inauguration
of a new branch of a bank is an event without having financial character, while the business disposed of by
the branch is an event having financial character. Accounting also interprets the recorded, classified and
summarised transactions and events.
However, the above-mentioned de nition does not refiect the present day accounting function. The
dimension of accounting is much broader than that described in the above definition. According to the
above definition, accounting ends with interpretation of the results of the financial transactions and events
but in the modern world with the diversification of management and ownership, globalisation of business
and society gaining more interest in the functioning of the enterprises, the importance of communicating
the accounting results has increased and therefore, this requirement of communicating and motivating
informed judgement has also become the part of accounting as defined in the widely accepted definition
of accounting, given by the American Accounting Association in 1966 which treated accounting as:
“The process of identifying, measuring and communicating economic information to permit informed
judgments and decisions by the users of accounts.”
In 1970, the Accounting Principles Board (APB) of American Institute of Certified Public Accountants (AICPA)
enumerated the functions 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 decisions.”
Thus, accounting may be defined as the process of recording, classifying, summarising, analysing and
interpreting the financial transactions and communicating the results thereof to the persons interested in
such information.
1.2.1 Procedural aspects of Accounting
On the basis of the above definitions, procedure of accounting can be basically divided into two parts:
(i) Generating financial information and
(ii) Using the financial information.
Generating Financial Information
1. Recording – This is the basic function of accounting. All business transactions of a financial character,
as evidenced by some documents such as sales bill, pass book, salary slip etc. are recorded in the books
of account. Recording is done in a book called “Journal.” This book may further be divided into several
subsidiary books according to the nature and size of the business.
2. Classifying – Classification is concerned with the systematic analysis of the recorded data, with a
view to group transactions or entries of one nature at one place so as to put information in compact and usable form. The book containing classified information is called “Ledger”. This book contains
on di erent pages, individual account heads under which, all financial transactions of similar nature
are collected. For example, there may be separate account heads for Salaries, Rent, Printing and
Stationeries, Advertisement etc. All expenses under these heads, after being recorded in the Journal,
will be classified under separate heads in the Ledger. This will help in finding out the total expenditure
incurred under each of the above heads.
3. Summarising – It is concerned with the preparation and presentation of the classified data in a manner
useful to the internal as well as the external users of financial statements. This process leads to the
preparation of the financial statements.
4. Analysing – The term ‘Analysis’ means methodical classification of the data given in the financial
statements. The figures given in the financial statements will not help anyone unless they are in a
simplified form. For example, all items relating to fixed assets are put at one place while all items relating
to current assets are put at another place. It is concerned with the establishment of relationship between
the items of the Profit and Loss Account and Balance Sheet i.e. it provides the basis for interpretation.
5. Interpreting – This is the final function of accounting. It is concerned with explaining the meaning and
significance of the relationship as established by the analysis of accounting data. The recorded financial
data is analysed and interpreted in a manner that will enable the end-users to make a meaningful
judgement about the financial condition and profitability of the business operations. The financial
statement should explain not only what had happened but also why it happened and what is likely to
happen under specified conditions.
6. Communicating – It is concerned with the transmission of summarised, analysed and interpreted
information to the end-users to enable them to make rational decisions. This is done through preparation
and distribution of accounting reports, which include besides the usual profit and loss account and
the balance sheet, additional information in the form of accounting ratios, graphs, diagrams, fund
Flow statements etc.
Using the Financial Information
There are certain users of accounts. Earlier it was viewed that accounting is meant for the proprietor or
owner of the business, but changing social relationships diluted the earlier thinking. It is now believed
that besides the owner or the management of the business enterprise, users of accounts include the
investors, employees, lenders, suppliers, customers, government and other agencies and the public at large.
Accounting provides the art of presenting information systematically to the users of accounts. Accounting
data is more useful if it stresses economic substance rather than technical form. Information is useless and
meaningless unless it is relevant and material to a user’s decision. The information should also be free of any
biases. The users should understand not only the financial results depicted by the accounting figures, but
also should be able to assess its reliability and compare it with information about alternative opportunities
and the past experience. The owners or the management of the enterprise, commonly known as internal users, use the accounting information in an analytical manner to take the valuable decisions for the business.
So the information served to them is presented in a manner difierent to the information presented to the
external users. Even the small details which can a ect the internal working of the business are given in the
management report while financial statements presented to the external users contains key information
regarding assets, liabilities and capital which are summarised in a logical manner that helps them in their
respective decision-making.
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