Accounting: Objectives, Characteristics, Advantages, Disadvantages and Role of Accounting
The American Institute of Certified Public Accountants(AICPA) defines accounting as an art of recording, classifying, and summarising the transactions and events that are in monetary terms efficiently and effectively and interpreting the results. The main aim of the accounting process is the ascertainment of an organization’s operation’s net results and financial position so that the firm can communicate the same with the interest parties or users of Accounting Information. The nature of Accounting is dynamic and analytical and hence, requires special abilities and skills in an individual to interpret the information better and effectively.
The accounting process involves summarising, analysing, and reporting these transactions to supervisors, regulators, and tax collectors. Financial statements used in accounting are like a summary of financial transactions for an accounting period, summarising a company’s operations, and cash flows.
Objectives of Accounting:
Following are the objectives of accounting:
1. Record: The basic role of accounting is to maintain a systematic, complete, accurate, and permanent record of all business transactions that can be searched and checked at any time. Reliable financial records are the backbone of any accounting system, without which all other accounting objectives will be compromised.
2. Planning: Organisations must plan how they intend to allocate their limited resources (eg, cash, labour, materials, machinery, and equipment) for competitive needs in the future. An effective way to do this is to use different forms of budgets. Budgets allow organisations to plan ahead by anticipating business needs and resources. Budgeting helps in coordinating various segments of the organisation.
3. Decision: Accounting helps managers make a number of business decisions and create policies to make organisational processes more efficient. Examples of management decisions that are based on accounting information include: What price should be charged for products and services to achieve maximum profit; Which products should be produced when resources such as cash, labour, or materials are scarce to maximise profit, etc.
4. Performance: Accounting helps determine how well a business is doing by summarising financial information into quantifiable indicators (e.g., sales revenue, profit, costs, etc.). It is important for organisations to have a reliable source for measuring their KPIs so that they can improve by comparing their past performance and their competition.
5. Liquidity: Poor cash management is often the reason for the failure of many businesses. Accounting helps businesses determine how much cash and other liquid resources they have available to pay their financial obligations. This information is essential for working capital management and helps organizations reduce the risk of bankruptcy by early detection of financial bottlenecks.
6. Financing: Accounting information is necessary to secure finances. Whether an organisation is applying for a bank loan or shareholder investment, it will need to provide historical financial records (e.g., profit or loss for the last five years) as well as financial projections (e.g., projected sales for the next 3 years).
7. Management: One of the key objectives of an accounting system is to place sufficient internal controls in an organisation to protect its valuable resources. Business assets (e.g., cash, buildings, inventory, etc.) are susceptible to loss due to theft, fraud, error, obsolescence, damage, and mismanagement. Accounting ensures that these risks are reduced to an acceptable level by implementing various controls across the organisation. For example, an organisation’s accounting policy may require that payments above a certain threshold be approved by a senior member of management to ensure accuracy and minimise the risk of fraudulent payment.
8. Responsibility: Accounting provides a basis for evaluating the performance of a business over a period of time, which promotes accountability at several levels of the organisation. Shareholders can ultimately hold directors accountable for the overall performance of their company based on the accounting information disclosed in the financial statements.
9. Users: The role of accounting is not limited to the informational needs of the company’s employees and investors. Accounting today fulfils the information needs of a diverse group of stakeholders, each with their own information requirement.
Main Characteristics of Accounting:
The following attributes or characteristics can be derived from the definition of accounting:
1. Reliability: Reliability can be defined as the ability to trust. Accounting helps in providing reliable information to businesses. Reliable information should be free of errors and distortions, and should correctly represent what it purports to represent. To ensure some reliability, the published facts should be credible, neutral, and verifiable through unbiased events using an identical measurement approach.
2. Relevance: Relevant information is recorded and presented in the process of accounting. For relevant information, facts must be available in a timely manner, they must assist in forecasting and feedback, and should influence customer choices by: (a) helping them form a prediction about the outcome of a past, current or future event; ane b) confirming or correcting the previous ratings.
3. Clarity: Accounting helps in providing clear information about all business transactions. It is an art of recording, classifying, and summarising accounting information.
4. Comparability: With proper accounting, records relating to various costs, sales, gross and net profit, etc., can be compared. As such, accounting helps in inter-company and intra-company comparisons.
Advantages of Accounting
The main benefits of accounting include:
1. A complete and systematic record: Accounting is based on generally accepted principles and a scientific way of presenting business transactions in books of accounts. Accounting as such is the complete and systematic recording of all business transactions. The limitation of people not being able to remember all transactions can be overcome by accounting because every business transaction can be recorded and analysed through it.
2. Determination of the selling price: The main function of management is decision-making. Accounting helps and guides management in making decisions about setting the selling price, deducting costs, increasing sales, etc.
3. Valuation of the enterprise: In the case of the sale of a business or conversion of one business to another, the actual and fair value of the business is calculated. Through accounting, the correct picture can be displayed on the balance sheet, and thus the purchase price can be determined. A balance sheet shows the value of a business’s assets and liabilities, which can be used to calculate its net worth.
4. It helps in obtaining a loan: For further expansion, the business must have sufficient funds. Sometimes due to lack of funds, the business cannot do well. In these cases, additional funds can be obtained by borrowing from some financial institutions, like banks, IDBI, ICICI, etc. These financial institutions lend money based on the profitability and reliability of the business. Profitability and reliability can be measured using the Profit and Loss Statements and the Balance Sheet, the final results of the accounting process.
5. Evidence in court: Business transactions are recorded in accounting books supported by certified documents, viz. vouchers, etc. Accounts can thus be used as evidence in court.
6. In accordance with the law: Every business has to deal with various government departments, like Income Tax, Sales Tax, Customs and Excise, etc. Various regular returns need to be filed with these departments. Accounting helps in the preparation and filing of such returns.
7. Inter-company or intra-company comparison: A trading account and a profit and loss account show the net profit or net loss incurred by the business. With proper accounting, records relating to various costs, sales, gross and net profit, etc., can be compared. As such, accounting helps in inter-company and intra-company comparisons. Comparing the accounts of two different companies for the same year is known as inter-company comparison and comparing two different periods for the same company is known as an intra-company comparison. The company’s performance is then compared with predetermined goals, and any deficiencies can be corrected accordingly.
8. Facilitates auditing: Depending on the size, nature, and type of business, certification of the books of account, known as an audit, is mandatory. The audit certificate issued by the accounting auditor is a clean document of the organisation, which proves that there are no irregularities in the organisation.
9. Effective management: Accounting facilitates proper management feedback. As such, it helps the management in planning as well as controlling the various activities of the enterprise. It also helps the management to evaluate the performance of the company and take timely measures to eliminate management deficiencies.
Disadvantages of Accounting
1. Does not guarantee accuracy: Accounting records all financial transactions with past value. It does not take into account the fair or market value of assets and liabilities. Values are easy to manipulate.
2. Actual value of items: Financial account does not show the actual value of assets. It shows the past value of assets. Depreciation can be charged in any way and at any rate.
3. Accounting ignores the qualitative element: It records all financial transactions that are in monetary form but doesn’t consider qualitative factors, i.e., emotions, employees, relationships and public relations.
4. Accounts can be manipulated: Accounts can be manipulated to avoid tax and show a false position to investors. By making small changes to the account, the financial statements can be manipulated.
5. Costly for a small business: A small business does not have a lot of finances, so it is very expensive for them to get proper accounting tools, and get it audited by a chartered accountant.
6. Business Privacy: There is no privacy for those who prepare the accounts, as they have to show it to the general public including your competitors.
Role of Accounting in business
1. Evaluates business performance: Financial situation of a business can be represented with the help of Accounting statements. Once you have a clear idea of what is going on in your business financially, you can easily plan your future tasks accordingly. You will be able to track expenses effortlessly, further allowing you to allocate the budget accordingly.
2. Create budget projections: Accounting also helps in creating future projections that have the power to make or break the business. It helps to evaluate business trends and projections to keep the operations profitable. Thus, it’s important to have a well-structured accounting process.
3. Maintain financial statements: Accounting also helps in preparing financial statements. Every business must file its financial statements for tax purposes. If you have proper records of your business finances, you can easily handle all scenarios and achieve your goals.
4. Ensure compliance with the law: Businesses need legal compliance to ensure their accounting system is validated against various laws and regulations. All liabilities, such as income tax, sales tax, pensions, employee funds, etc., can be easily dealt with if we have a structured accounting system.
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