Theoretical framework of Accounting introduction

 Theoretical Framework of Accounting

Introduction

It is the oldest form of accounting that aided stewards to discharge their stewardship function. The wealthy and rich would employ stewards to manage their property and the stewards, in turn, rendered an account periodically. This stewardship accounting was the root of the financial accounting system. Luca Pacioli at Venice in Italy is supposed to be the inventor of the present system of accounting though he did not claim it. It is also evident from the facts that historians found records of debit and credit dating back to the 12th century.

In 1494, he published 'Principles of double-entry book-keeping and it was capable of recording not only cash transactions but also all types of mercantile transactions systematically. In his book, he used the present-day popular terms of accounting i.e. Debit (Dr) and Credit (Cr). These were the terms used in Italian terminology. Debit comes from the Italian ‘debito’ which comes from the Latin ‘debeo’ which means owed to the proprietor. Credit comes from the Italian ‘credito’ which comes from the Latin ‘credo’ which means trust or belief in the proprietor.

According to Pacioli, ‘All entries have to be double entries that are if you make one creditor, you must make some debtor for the equal amount’.

Meaning of Accounting

Accounting can be defined, as the process of identifying, measuring, recording, and communicating the required information relating to the economic events of an organization to the interested users of such information.

According to The American Institute of Certified Public Accountants (AICPA) ‘Accounting is 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 a financial character, and interpreting the results thereof.

According to The American Accounting Information (AAI), ‘The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of such information.’

Objectives of Accounting

Various objectives of accounting are:

(i) Systematic recording of transactions The basic objective of accounting is to record the business transactions in a systematic manner with the help of book-keeping.

(ii) Ascertainment of profit or loss If the transactions are systematically recorded, one can easily find the profit or loss of a business. If the sum of revenue items exceeds the sum of the expense items,  the result is profit or loss in the case of vice-versa.

(iii) Ascertainment of financial position Apart from knowing profit and loss, a business enterprise intends to know the amount being owed to the outsiders and proprietor (liabilities) and what it owns (assets). For this purpose, a statement of assets and liabilities is prepared at the end of an accounting year.

(iv) Providing information to the stakeholders Accounting is the language of the business and it communicates to the stakeholders (users) by providing financial statements in the form of profit and loss account and balance sheet.

Characteristics of Accounting

Following are the characteristics of accounting:

(i) Transactions or/and events that are of economic or financial nature are only recorded in accounting. e.g. efficiency or honesty of the employees cannot be recorded because it cannot be measured in terms of money though it affects the total profits of the business.

(ii) Only such events are recorded which are measured in terms of money no other unit is used to record such transactions. e.g. if a merchant sells 10 kg of edible oil and 15 kg of Basmati rice to a customer, then the merchant has to record these transactions only in terms of monetary value and not in terms of quantity sold.

(iii) Accounting is the art of classifying the data systematically. After all the transactions are recorded properly, all such data are also classified under appropriate heads.

(iv) Accounting is a science because every business transaction is recorded in a systematic manner.

(v) The purpose of accounting is not only recording transactions but also of analyzing and interpreting data for taking certain important future decisions.

Functions of Accounting

The main functions of accounting are as follows:

(i) Maintaining systematic records The primary function of accounting is to maintain the systematic records of business transactions, post them to the ledger, and prepare the final accounts.

(ii) Communicating the financial results for decision-making Accounting is used to communicate financial information to various interested users for rational decision-making.

(iii) Meeting government regulation The accounting system should comply with legal requirements. The various governing laws such as the Companies Act, Income Tax and Sales Tax Acts requires the submission of statements or returns , annual accounts, income tax return, sales tax returns, etc.

(iv) Protecting business assets Accounting helps the management to exercise proper control over the assets of the business by maintaining proper records of various assets.

(v) Assistance to management Accounting assists the management in the task of planning, controlling and co-ordination of business activities.

 (vi) Stewardship or trusteeship The management is entrusted with the resources of the enterprise, in case of companies. The management is expected to act as the trustee of the company’s funds and accounting helps to achieve the same.

(vii) Control Accounting helps in maintaining control as it helps in identifying the weaknesses in the system and provides feedback to check such weaknesses.