what is accounting

what is accounting

Understanding Accounting Principles

1. Introduction to Accounting

Accounting may thus be seen as a quantitative information system that is based on a particular model of economic reality. This is probably why economics is accepted as its sister-discipline in the management school curriculum. In this context, accounting concepts and conventions are developed to provide meaningful information with the limited data available. Keeping in mind the complexity of any economic entity and the several objectives of accountancy, this system derives its power (or its weakness) from a combination of the abilities of those who prepare data and the users of information who apply accounting pronouncements. We may begin by positing that the attempt to understand the underlying factors that lead to jurisdiction-specific accounting principles will facilitate the learning of students and accounting practitioners. After all, the best starting place for understanding and interpreting accounting information is a comprehensive understanding of the underlying accounting principles. With this in mind, this chapter is devoted to an introduction of the accounting principles and the reasons behind the different accounting treatment allowed by these principles.

Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. A decision may be defined as a selection between two or more alternatives, usually in a setting in which the outcomes are uncertain. Throughout the ensuing discussion, three related aspects of accounting will be brought out in greater relief. First, the accounting system provides useful data to help in making investment and credit decisions. Second, it does so in a time context. All information is dated, and those who use it will do so in ways that have explicit or implicit time frames. Finally, the data may be useful, but other constituents are also relevant for decision-making. In particular, judgment based on knowledge, experience, intuition, and other attributes of the decision-maker will also be invoked.

2. Importance of Accounting

Its functioning encourages business activities. In its absence: “…business and trade on an organized basis would come to a stop. A firm must have a system of accounts to measure whether it is growing or declining in the relevant every aspect of its operation; no matter how simple that system might be. If it has begun, the public may have no way of knowing how much it has earned or lost unless the firm’s profit and loss account is published. In fact… it will become difficult for the firm to secure an extension of credit and common shares. When it becomes increasingly difficult to raise funds by borrowing or the sale of additional capital, the firm’s true development is sapped of its strength.”

Accounting has often been called the language of business, and there are well-defined accounting concepts, principles, and standards to guide the accounting professional in the practical day-to-day performance of his job. Putting aside theories of accounting, of which it has been said, “Dermis summa venenum” – in small doses, accounting properly and effectively carried out can be really useful and, of course, essential to the business enterprise; hence the need to teach and understand accounting principles. In the absence of proper accounting, a corporate firm cannot prepare its published financial statement, and the larger public, investors, creditors, government, and the working force will not be able to assure themselves of the financial position and the progress or otherwise of the business (enterprise).

3. Basic Accounting Principles

It’s important to consider that owners are reliant on companies to act as separate and lucid entities, for it is through this assumption that they concur to invest in a company. This provides shareholders with a valuable trait such as limited liability that safeguards shareholders from a company’s going concern in the outburst of creditor litigation.

Business Entity Principle – The business entity principle states that a company’s financial accounting needs to be supported on the twofold premises that the business should be considered as its own entity and the business entity should be kept separate from its owners and all other entities. This principle enables accountants to distinctly identify all economic activities with an individual business, including marketing transactions between a business and its owners. By scrutinizing a business distinct from its owners and other businesses, the business entity principle aids users in appreciating financial performance exclusively applicable to the business. Users can also conjecture whether a business’s goals are attained in an operative manner. This principle also facilitates the arrangement and arrangement of financial statements, thus representing all the ins and outs from a given business.

These principles are presented in the following sections:

These principles are organized by accounting professionals to keep accounting processes and resulting financial reports similar from one company to another. As finance professionals work within an organization, these principles help guide their decisions. Though other accounting principles and constraints may exist, the fact that they’re widely recognized necessitates incorporating them in the preparation of financial statements to ensure consistency, transparency, and best practices.

The basic accounting principles are usually referred to as the Generally Accepted Accounting Principles (GAAP), and there are at least ten of them. These principles govern the practice of financial accounting.

4. Types of Accounting

Internal audit is another broad area of accounting. The term “audit” is mentioned in the income tax act of India, which requires businesses to have their accounts audited for certain requirements. Internal audits are also useful for verifying the books of accounts during investigations. Allan Sprufger defines internal audit as “the review of an establishment’s records and procedures by the staff of all departments to prevent errors, fraud, waste, and inefficiency. Internal audit is a part of the overall accounting system and involves continuous checking of financial and management transactions throughout the financial year. It is important to ensure that the established authorized and agreed system of internal control checks is being followed properly.”

Management accounting is a vast field of accounting in which costs are analyzed to ensure that they lead to the right decisions. It is important to note that management accounting should guide management in making good decisions, and therefore, they should have a good understanding of the other influences on the financial statements provided by financial accounting. This is where tools like Marginal Costing come into play, providing management with valuable information for decision making. Management accounting is the most recent form of accounting and is highly beneficial for making the right decisions. According to the I.C.M.A, management accounting is defined as “the presentation of accounting information in a way that assists management in policy creation, day-to-day administration, and decision-making to efficiently achieve organizational objectives.”

5. Conclusion

In addition to these basic concepts, accountants rely on several other business assumptions. For one, they typically account for items using historical cost. For another, they assume that the dollar’s changing value won’t alter the basic nature of the business activities being recorded. It’s worth noting that the accounting principles, underlying concepts, and business assumptions form the accounting and reporting rationale for complying with GAAP. If a company doesn’t comply with GAAP procedures, its accounting statements will not be consistent, comparable, or rational. In other words, GAAP helps investors, creditors, and others make more meaningful and informed decisions.

In conclusion, although accounting principles vary, certain basic concepts prevail. Under the business entity concept, for instance, the business and its owner are treated as separate entities. Whenever you record an event in the books, it must be linked to and identified with a particular accounting period. Other essential concepts include continuation of interest and the dual aspect concept. The former requires that the business operate under a going concern assumption; the latter says for every debit, there must be a corresponding credit.