What Is Accounting ? | Definition | Sreps Of Accounting | Functions | Objectives | Limitations | Branches | Accounting Principle | Accounting Concepts


Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the users of the information.

Accounting is the language of business and it is used to communicate financial information.  In order for that information to make sense, accounting is based on fundamental concepts.

Accounting is the systematic recording, reporting, and analysis of financial transactions of a business.

·         Recording: This is the basic function of accounting. It is essentially concerned with not only ensuring that all business transactions of financial character are in fact recorded but also that they are recorded in an orderly manner. Recording is done in the book "Journal".
·         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. The work of classification is done in the book termed as "Ledger".
·         Summarizing: This involves presenting the classified data in a manner which is understandable and useful to the internal as well as external end-users of accounting statements. This process leads to the preparation of the following statements: (1) Trial Balance, (2) Income statement (3) Balance sheet.
·         Analysis and Interprets: This is the final function of accounting. The recorded financial data is analyzed and interpreted in a manner that the end-users can make a meaningful judgment about the financial condition and profitability of the business operations. The data is also used for preparing the future plan and framing of policies for executing such plans.
·         Communicate: The accounting information after being meaningfully analyzed and interpreted has to be communicated in a proper form and manner to the proper person. This is done through preparation and distribution of accounting reports, which include besides the usual income statement and the balance sheet, additional information in the form of accounting ratios, graphs, diagrams, funds flow statements etc.


  • Keeping systematic record of business transactions.
  • Protecting properties of the business.
  • Communicating the results to various parties interested in or connected with the business.
  • Meeting legal requirements.

         Timely and accurate picture of performance
         Generate financial reports for management, lenders, creditors
         Facilitate filing of tax returns
        (sales and payroll taxes more important than income tax)
         Prevent and detect fraud, waste and theft


Bookkeeping is the art of recording the business transactions in the books of accounts in a systematic manner.


  • Accounting provides only limited information because it reveals the profitability of the concern as whole.
  • Accounting considers only those transactions which can be measured in terms of money or quantitatively expressed. Qualitative information is not taken into account.
  • Accounting provides limited information to the management.
  • Accounting is only historical in nature. It provides only a post mortem record of business transactions.


Financial accounting- information gathered is intended both for internal (e.g. managers) and external (e.g. banks and other creditors, government agencies, investment advisers, etc.) parties. Information recording is subject to certain ground rules internationally known as Generally Accepted Accounting Principles (GAAP).

Management accounting- information gathered is primarily for the use of internal management. Such information is used for management planning and control.

Cost accounting- It is the formal accounting system setup for recording cost. It is a systematic procedure for determining the unit cost of output produced or service rendered.


Established by human, ‘a general law or rule adopted or professed as a guide to action; a settled ground or basis of conduct and practice’.

Accounting Principles can be classified into two categories

  1. Accounting Concepts
  2. Accounting Conventions


Accounts are kept for entities and not the people who own or run the company.  Even in proprietorships and partnerships, the accounts for the business must be kept separate from those of the owner(s).
For an accounting record to be made it must be able to be expressed in monetary terms.  For this reason, financial statements show only a limited picture of the business.  Consider a situation where there is a labor strike pending or the business owner’s health is failing; these situations have a huge impact on the operations and financial security of the company but this information is not reflected in the financial statements. 
Going Concern
Accounting assumes that an entity will continue to operate indefinitely.  This concept implies that financial statements do not represent a company’s worth if its assets were to be liquidated, but rather that the assets will be used in future operations.  This concept also allows businesses to spread (amortize) the cost of an asset over its expected useful life. 
An asset (something that is owned by the company) is entered into the accounting records at the price paid to acquire it.  Because the “worth” of an asset changes over time it would be impossible to accurately record the market value for the assets of a company.  The cost concept does recognize that assets generally depreciate in value and so accounting practice removes the depreciation amount from the original cost, shows the value as a net amount, and records the difference as a cost of operations (depreciation expense.)  Look at the following example:
Truck                           $10,000           purchase price of the truck
Less depreciation        $  1,000           amount deducted as a depreciation expense
Net Truck:                   $  9,000           net book-value of the truck
The $9000 simply represents the book value of the truck after depreciation has been accounted for.  This figure says nothing about other aspects that affect the value of an item and is not considered a market price.
Dual Aspect
This concept is the basis of the fundamental accounting equation: 
Assets = Liabilities + Equity
  1. Assets are what the company owns.
  2. Liabilities are what the company owes to creditors against those assets
  3. Equity is the difference between the two and represents what the company owes to its investors/owners. 
All accounting transactions must keep this equation balanced so when there is an increase on one side there must be an equal increase on the other side or an equal decrease on the same side. 
The objectivity concept states that accounting will be recorded on the basis of objective evidence (invoices, receipts, bank statement, etc…). This means that accounting records will initiate from a source document and that the information recorded is based on fact and not personal opinion. 
Time Period
This concept defines a specific interval of time for which an entity’s reports are prepared.  This can be a fiscal year (Mar 1 – Feb 28), natural year (Jan 1 – Dec 31), or any other meaningful period such as a quarter or a month.
This requires understating rather than overstating revenue (income) and expense amounts that have a degree of uncertainty.  The rule is to recognize revenue when it is reasonably certain and recognize expenses as soon as they are reasonably possible.  The reasons for accounting in this manner are so that financial statements do not overstate the company’s financial position.  Accounting chooses to err on the side of caution and protect investors from inflated or overly positive results. 
Revenues are recognized when they are earned or realized.  Realization is assumed to occur when the seller receives cash or a claim to cash (receivable) in exchange for goods or services.  This concept is related to conservatism in that revenue (income) is only recorded when it actually occurs and not at the point in time when a contract is awarded.  For instance, if a company is awarded a contract to build an office building the revenue from that project would not be recorded in one lump sum but rather it would be divided over time according to the work that is actually being done.  
To avoid overstatement of income in any one period, the matching principle requires that    revenues and related expenses be recorded in the same accounting period.  If you bill $20,000 of services in a month, in order to accurately represent the income for the month you must report the expenses you incurred while generating that income in the same month. 
Once an entity decides on one method of reporting (i.e. method of accounting for inventory) it must use that same method for all subsequent events.  This ensures that differences in financial position between reporting periods are a result of changed in the operations and not to changes in the way items are accounted for.  
Accounting practice only records events that are significant enough to justify the usefulness of the information.  Technically, each time a sheet of paper is used, the asset “Office supplies” is decreased by an infinitesimal amount but that transaction is not worth accounting for. 
By understanding and applying these principles you will be able to read, prepare, and compare financial statements with clarity and accuracy.  The bottom-line is that the ethical practice of accounting mandates reporting income as accurately as possible and when there is uncertainty, choosing to err on the side of caution. 


  • Convention of Disclosure: The disclosure of all material information is one of the important accounting conventions. According to this conventions all accounting statements should be honestly prepared and all facts and figures must be disclosed therein. The disclosure of financial information is required for different parties who are interested in welfare of that enterprise. Convention of disclosure is required to be kept as per the requirement of the companies Act and Income Tax Act.
  • Convention of conservatism: This convention is closely related to the policy of playing safe. This principle is often described as “anticipate no profit, and provide for all possible losses”. Thus this convention emphasis that uncertainties and risks inherent in business transactions should be given proper consideration.
  • Convention of Consistency: The convention of consistency implies that accounting policies, procedures and methods should remain unchanged for preparation of financial statements from one period to another. In order to measure the operational efficiency of a concern, this convention allows a meaningful comparison in the performance of different period.
  • Convention of Materiality: It defined as “the characteristic attaching to a statement fact, or item whereby its disclosure or method of giving it expression would be likely to influence the judgment of a reasonable person”.


Accounting records can be prepared under any one of the following system:
  1. Single Entry System
  2. Double Entry System

Under this system, all transactions relating to a personal aspect are recorded in the books of accounts but leave all impersonal transactions. Single Entry system is based on the Dual Aspect Concept and is incomplete and inaccurate


There are numerous transactions in a business concern. Each transaction, when closely analyzed, reveals two aspects. One aspect will be “receiving aspect” or “incoming aspect” or “expenses/loss aspect”. This is termed as the “Debit aspect”. The other aspect will be “giving aspect” or “outgoing aspect” or “income/gain aspect”. This is termed as the “Credit aspect”. These two aspects namely “Debit aspect” and “Credit aspect” form the basis of Double Entry System. The double entry system is so named since it records both the aspects of a transaction.

In short, the basic principle of this system is, for every debit, there must be a corresponding credit of equal amount and for every credit, there must be a corresponding debit of equal amount.

According to J.R.Batliboi “Every business transaction has a two-fold effect and that it affects two accounts in opposite directions and if a complete record were to be made of each such transaction, it would be necessary to debit one account and credit another account. It is this recording of the two fold effect of every transaction that has given rise to the term Double Entry System”.


  • Every business transaction affects two accounts.
  • Each transaction has two aspects, i.e., debit and credit.
  • It is based upon accounting assumptions concepts and principles.
  • Helps in preparing trial balance which is a test of arithmetical accuracy in accounting.
  • Preparation of final accounts with the help of trial balance.


  • Scientific system: This is the only scientific system of recording business transactions. It helps to attain the objectives of accounting.
  • Complete record of transactions: This system maintains a complete record of all business transactions.
  • A check on the accuracy of accounts: By the use of this system the accuracy of the accounting work can be established by the preparation of trial balance.
  • Ascertainment of profit or loss: The profit earned or loss occurred during a period can be ascertained by the preparation of profit and loss account.
  • Knowledge of the financial position: The financial position of the concern can be ascertained at the end of each period through the preparation of balance sheet.
  • Full details for control: This system permits accounts to be kept in a very detailed form, and thereby provides sufficient information for the purpose of control.
  • Comparative study: The results of one year may be compared with those of previous years and the reasons for change may be ascertained.
  • Helps in decision making: The management may be able to obtain sufficient information for its work, especially for making decisions. Weaknesses can be detected and remedial measures may be applied.
  • Detection of fraud: The systematic and scientific recording of business transactions on the basis of this system minimizes the chances of fraud.


Transactions can be divided into three categories.
  • Transactions relating to individuals and firms
  • Transactions relating to properties, goods or cash
  • Transactions relating to expenses or losses and incomes or gains.

Therefore, accounts can also be classified into Personal, Real and Nominal. The classification may be illustrated as

I. Personal Accounts: The accounts which relate to persons. Personal accounts include the following.
1.      Natural Persons: Accounts which relate to individuals. For example, Mohan’s A/c, Shyam’s A/c etc.
2.      Artificial persons: Accounts which relate to a group of persons or firms or institutions. For example, HMT Ltd., Indian Overseas Bank, Life Insurance Corporation of India, Cosmopolitan club etc.
3.      Representative Persons: Accounts which represent a particular person or group of persons. For example, outstanding salary account, prepaid insurance account, etc. The business concern may keep business relations with all the above personal accounts, because of buying goods from them or selling goods to them or borrowing from them or lending to them. Thus they become either Debtors or Creditors.

The proprietor being an individual his capital account and his drawings account are also personal accounts.

II. Impersonal Accounts: All those accounts which are not personal accounts. This is further divided into two types. Real and Nominal accounts.
1.      Real Accounts: Accounts relating to properties and assets which are owned by the business concern. Real accounts include tangible and intangible accounts. For example, Land, Building, Goodwill, Purchases, etc.
a.       Tangible Real Accounts
b.      Intangible Real Accounts.
2.      Nominal Accounts: These accounts do not have any existence, form or shape. They relate to incomes and expenses and gains and losses of a business concern. For example, Salary Account, Dividend Account, etc.


Type of Account
Personal account
Real account
Personal account
Outstanding salary
Personal (Representative) account
Real account
Nominal account
Interest paid
Nominal account
Indian Bank
Personal (Legal Body) account
Discount received
Nominal account
Real account
Personal account
Personal account
Murugan Lending Library
Personal account
Nominal account
Real account


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