Accounting- Meaning, Procedure, Type, Objectives, Functions

Accounting has a universal application for recording transactions and events and presenting suitable information to aid decision-making regarding any type of economic activity ranging from a family function to functions of the national government.

For more information about transactions, see Understanding Transactions: Types, Importance, and Examples

For more information about economic activity, see Economic Activity: Definition and Examples

The aim of accounting is to meet the information needs of the rational and sound decision- makers, and thus, called the language of business.

What is Accounting?

It 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.

For more information about money, see Money: Definition, Functions, and Examples

This recording is done in Journal or subsidiary books, also known as primary books.

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 the profit and loss account and balance sheet.

For more information about Ledger, see Understanding Ledger: Definition, Types, and Examples

It provides quantitative information, primarily of a financial nature, about economic entities, that are needed to be useful in making economic decisions.

It is the language of business, communicating through the financial statements the financial results and performance of an enterprise, to various users of such financial statements. 

Accounting Procedure

It follows a specific procedure known as the accounting cycle. It works in the following manner:

1. Identification of Transactions: The first step is identifying financial transactions, like sales or expenses, that need to be recorded.
2. Recording of Transactions: These transactions are recorded in a journal using a double-entry system, meaning each transaction affects at least two accounts (e.g., an asset and a liability).
3. Posting to Ledger: The journal entries are posted to individual accounts in the ledger, which classifies and summarizes the financial data.
4. Trial Balance: A trial balance is prepared to ensure that total debits equal total credits.
5. Adjustment Entries: Adjustments are made for any accruals or deferrals, like depreciation or prepaid expenses.
6. Financial Statements: Once the data is adjusted, the financial statements are prepared. These include (a) Income Statement (Profit and Loss Account): It shows revenue, expenses, and profit or loss of the business. (b) Balance Sheet: It shows a snapshot of assets, liabilities, and equity at a particular point. (C) Cash Flow Statement: It tracks the flow of cash into and out of the business.
7. Closing Entries: Temporary accounts, such as revenue and expense accounts, are closed at the end of the accounting period.

For more information about Accounting Procedure/Accounting Cycle , see Complete Guide to the Accounting Cycle: Steps, Examples and Importance

Types of Accounting

Financial Accounting

It covers the preparation and interpretation of financial statements and communication to the users of accounts.

The final step of financial accounting is the preparation of the Profit and Loss Account and the Balance Sheet.

Financial accounting generally uses the double entry system.

It implements the principles of the Accounting Standards (AS) to maintain their financial records.

Various accounting techniques are used to maintain these financial records via journals, ledgers, trial balance etc. 

The financial statements used in accounting are a concise summary of financial transactions over an accounting period, summarizing a company’s operations, financial position, and cash flows. 

Accounting principles and standards, such as US GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards), are standards that are widely adopted in financial accounting.

Management Accounting

The different ways of grouping information and preparing reports as desired by managers for discharging their functions are referred to as management accounting.

It encompasses many other facets of accounting, including budgeting, forecasting, and various financial analysis tools. Essentially, any information that may be useful to management falls under this umbrella.

Management accounting is concerned with the preparation and presentation of accounting, and controlling information, in a form that assists management in the formulation of policies and in decision-making on the various matters connected with routine or the non-routine operations of a business enterprise. 

Cost Accounting

Cost Accounting is concerned with the application of costing principles, methods and techniques for ascertaining the costs, with a view to controlling them, and assessing the profitability and efficiency of the enterprise.

It is the process of tracking, analyzing and understanding the costs involved in a specific business activity. It includes all direct and indirect expenses associated with your business’s day-to-day operations. 

Cost accounting helps businesses make decisions about costs. It considers all of the costs related to producing a product.

It ends with the preparation of periodical statements and reports for ascertaining and controlling costs.

Corporate Accounting

Corporate accounting refers to the specialized branch of accounting that focuses on recording, analyzing, and reporting financial transactions specific to companies and large businesses.

It involves preparing financial statements, managing tax obligations, handling audits, and ensuring compliance with laws and regulations.

Corporate accounting covers activities such as balance sheet preparation, income and cash flow statements, budgeting, financial planning, and internal controls.

Payroll Accounting

Payroll accounting refers to the process of recording and managing all financial transactions related to employee compensation.

This includes calculating wages, salaries, bonuses, overtime, and deductions such as taxes, retirement contributions, and insurance premiums.

Payroll accounting ensures that employees are paid accurately and on time while also maintaining compliance with tax regulations and labor laws.

It involves maintaining payroll records, filing tax reports, and preparing payroll-related financial statements.

Effective payroll accounting is essential for managing a company’s workforce costs and maintaining good employee relations.

Social Responsibility Accounting

Social responsibility accounting is concerned with accounting for social costs incurred by the enterprise and social benefits created.

Human Resource Accounting

Human resource accounting is an attempt to identify, quantify and report investments made in human resources of an organisation that are not presently accounted for under conventional accounting practice.

So, It is ‘the process of identifying and measuring data about human resources and communicating this information to interested parties.

Tax Accounting

It deals with preparing tax returns and planning for future tax obligations. It helps individuals and businesses comply with tax laws.

Other Accounting Types

Basic Accounting

Basic accounting refers to the fundamental principles and processes used to record, classify, and summarize financial transactions.

It involves tracking income, expenses, assets, and liabilities to provide a clear picture of a business’s financial health.

Accrual Accounting

Accrual accounting is a method of accounting where revenues and expenses are recorded when they are earned or incurred, regardless of when the cash is actually received or paid.

For example, under accrual accounting, a sale is recorded when a product is delivered, even if payment is received later.

This method helps businesses match income with the expenses incurred to generate that income, giving a clearer view of financial performance.

Inventory Accounting

Inventory accounting refers to the process of tracking and valuing a company’s inventory, which includes raw materials, work-in-progress, and finished goods.

This involves recording the costs associated with acquiring, producing, and storing these items, as well as determining the value of inventory on hand for financial reporting purposes.

Inventory accounting uses methods like First-In, First-Out (FIFO), Last-In, First-Out (LIFO), and weighted average cost to calculate inventory value.

Proper inventory accounting helps businesses manage costs, determine profitability, and prepare accurate financial statements.

Manufacturing Account

A manufacturing account is a financial statement prepared by manufacturing companies to calculate the cost of goods produced during a specific period.

It summarizes the direct costs associated with production, such as raw materials, labor, and factory overheads.

The manufacturing account helps in determining the total cost of manufacturing products, which is then transferred to the trading account to calculate the gross profit.

The key components of a manufacturing account include opening and closing stock of raw materials, work-in-progress, and the cost of production.

Revaluation Account

A revaluation account is a financial statement used to record any changes in the value of a company’s assets or liabilities, typically during events such as revaluation of assets in a partnership, merger, or acquisition.

This account is created to adjust the book value of assets to reflect their current market value, ensuring that the financial statements provide an accurate representation of the company’s worth.

Gains or losses from revaluation are recorded in this account. It is often used during the restructuring of a business or changes in ownership to ensure fair asset valuation for all parties involved.

Imprest Account

An imprest account is a small, fixed amount of cash set aside by a business for minor, day-to-day expenses such as office supplies, travel, or petty cash needs.

It operates on a replenishment system, where the fund is periodically topped up to its original amount after expenditures are documented.

The imprest system ensures that there is always a specific amount of cash available for small expenses, and each payment is recorded for tracking purposes.

This method simplifies the management of small cash transactions and helps prevent misuse of funds by maintaining clear accountability.

HUF Account

A HUF account refers to an account opened by a Hindu Undivided Family (HUF), which is a legal entity recognized under Indian law.

A HUF consists of family members descended from a common ancestor, including the head of the family (called the Karta) and co-parceners (family members).

A HUF account is typically used to manage the family’s finances, including income from assets like property, investments, or a family business.

The income generated by the HUF is taxed separately from individual members’ incomes, allowing for potential tax benefits.

The Karta operates the account on behalf of the family, and transactions benefit the entire HUF.

Public Accounting

Public accounting refers to the branch of accounting where accountants provide services to a variety of clients, including individuals, businesses, and government entities.

These services often include auditing financial statements, tax preparation, consulting, and advisory services.

Public accountants work for accounting firms or as independent practitioners, helping clients ensure compliance with financial regulations, optimize tax strategies, and maintain accurate financial records.

Public accounting plays a key role in fostering trust and transparency in financial reporting, and professionals in this field are often certified, such as Certified Public Accountants (CPAs).

Hedge Accounting

Hedge accounting is an accounting method used to manage the volatility in financial statements that can arise from fluctuations in the value of assets or liabilities.

It aligns the recognition of gains and losses from hedging instruments, such as derivatives, with the underlying hedged item.

This means that when a hedging instrument is used to offset the risk of changes in the value of an asset or liability, the effects of the hedging instrument are recorded in the same period as the associated gains or losses on the hedged item.

The goal of hedge accounting is to provide a more accurate representation of a company’s financial performance and risk exposure by minimizing the impact of market fluctuations.

To qualify for hedge accounting, specific criteria must be met, including documentation of the hedging relationship and the effectiveness of the hedge in offsetting risks.

Cash Accounting

Cash accounting is an accounting method where revenues and expenses are recorded only when cash is actually received or paid.

Under this approach, income is recognized when cash is received from customers, and expenses are recognized when cash is paid out for goods or services.

Cash accounting provides a clear view of cash flow, as it reflects the actual cash on hand at any given time.

However, it may not provide a complete picture of a company’s financial health, as it does not account for outstanding invoices or liabilities.

Consequently, larger businesses often prefer accrual accounting, which offers a more comprehensive view of financial performance by recognizing income and expenses when they are incurred, regardless of cash movement.

Contra Account

A contra account is an account that is used to reduce the balance of a related account in financial reporting.

It has a balance that is opposite to the normal balance of the account it offsets.

For example, in a balance sheet, a contra asset account, such as Accumulated Depreciation, reduces the value of the corresponding asset account, like Equipment.

Similarly, a contra liability account, like Discount on Bonds Payable, reduces the balance of a bond payable account.

Contra accounts are important for providing a clearer picture of a company’s financial status by showing the net value of assets or liabilities.

They help in ensuring accurate reporting of financial information and maintain transparency in financial statements.

Objectives of Accounting

Systematic recording of transactions:- The basic objective of accounting is to systematically record the financial aspects of business transactions, i.e., bookkeeping.

Ascertainment of financial results:- The accountant prepares profit and loss accounts to know the results of business operations for a particular period of time. If revenue (Sales) exceeds expenses then it is said that business is running profitably but if expenses exceed revenue, then it can be said that business is running under loss.

Ascertainment of the financial position:- To know the liability and assets on a certain date, an accountant prepares a financial position statement popularly known as a Balance Sheet. The balance sheet is a statement of assets and liabilities of the business at a particular point of time and helps in ascertaining the financial health of the business.

Information to the users for decision-making:- Accounting communicates the financial results of an enterprise to various stakeholders by means of financial statements, which helps them in rational decision-making.

Solvency position Knowledge:- By preparing the balance sheet, management not only reveals what is owned and owed by the enterprise, but also it gives the information.

Functions of Accounting

The main functions of accounting are as follows:

• Measurement: It measures the past performance of the business entity and depicts its current financial position.
• Forecast: It helps in forecasting future performance and financial position of the enterprise using past data and analysing trends.
• Decision-making: It provides relevant information to the users of accounts for their rational decision-making.
• Comparison: It assesses performance achieved in relation to targets and discloses information regarding accounting policies and contingent liabilities.
• Control: It also identifies weaknesses in the operational system and provides feedback regarding the effectiveness of measures adopted to check such weaknesses.
• Government Regulation and Taxation: It provides the necessary information to the government to exercise control of the entity as well as in the collection of tax.

Bookkeeping

Bookkeeping is an activity concerned with the recording of financial data relating to business operations in a significant and orderly manner.

The essential idea behind maintaining book-keeping records is to show the correct position regarding each head of income and expenditure.

It is concerned with a complete and permanent record of all transactions in a systematic and logical manner to show their financial effect on the business.

It is concerned with the combined effect of all the transactions made during the accounting period upon the financial position of the business as a whole.

Distinction between Book-Keeping and Accounting

Users of Financial Information

Following are the various users of accounting information:

• Investors
• Employees
• Lenders
• Suppliers and Creditors
• Customers
• Government and its agencies
• Public
• Management

Example of Accounting in Action

Let’s consider a small business called XYZ Café.

• Transaction 1: The café sells $5,000 worth of food and drinks. This transaction increases the cafe’s cash (asset) and increases sales revenue (income).Journal Entry:
  • Debit Cash: $5,000
  • Credit Sales Revenue: $5,000
• Transaction 2: The café purchases new kitchen equipment worth $2,000 on credit. This increases the café’s equipment (asset) and its accounts payable (liability).Journal Entry:
  • Debit Equipment: $2,000
  • Credit Accounts Payable: $2,000
• Transaction 3: At the end of the month, the café pays off a $1,000 portion of its accounts payable for the kitchen equipment.Journal Entry:
  • Debit Accounts Payable: $1,000
  • Credit Cash: $1,000

Now, let’s see how these transactions impact the café’s financial statements:

• Income Statement:
  • Revenue: $5,000 (from food and drink sales)
  • Expenses: $0 (no operational expenses recorded in this example)
  • Net Income: $5,000 (Revenue – Expenses)
• Balance Sheet:
  • Assets:
    • Cash: $4,000 ($5,000 in sales – $1,000 paid for equipment)
    • Equipment: $2,000
    • Total Assets: $6,000
  • Liabilities:
    • Accounts Payable: $1,000 (original $2,000 – $1,000 paid)
    • Total Liabilities: $1,000
  • Equity: $5,000 (Assets – Liabilities)

Role of Technology in Modern Accounting

With the advancement of technology, accounting has evolved significantly. Automation, cloud computing, and artificial intelligence (AI) have transformed traditional accounting practices.

Key Technologies Impacting Accounting

1. Cloud Accounting: Cloud-based accounting software allows businesses to access financial data from anywhere at any time.
2. Automation and AI: Automation reduces the manual workload by handling repetitive tasks like invoice processing, bank reconciliation, and payroll. AI-powered systems can analyze financial data and provide insights, predict future financial trends, and even detect fraudulent activities.
3. Blockchain: Blockchain technology offers a transparent and secure way of recording transactions, reducing the risk of fraud and human error.
4. Data Analytics: Accountants now use advanced data analytics tools to gather insights from large volumes of financial data.

Benefits of Technology in Accounting

• Efficiency: Automating repetitive tasks saves time.
• Accuracy: Automation reduces human error.
• Real-Time Access: Cloud-based systems allow businesses to access and update financial information in real time.
• Cost Savings: Technology cuts the costs related to data entry and other clerical work.

Future of Accounting

The future of accounting is likely to be heavily influenced by automation, AI, and blockchain. As businesses continue to digitize their operations, the demand for real-time financial data and predictive analytics will increase.

Some of the important trends that will shape the future of accounting include:

1. AI-Driven Decision-Making: As AI technology becomes more advanced, it will assist in financial decision-making by analyzing large data sets and predicting trends.
2. Increased Automation: The automation of accounting processes will continue to grow, handling tasks such as transaction recording, tax preparation, and even audits.
3. Blockchain for Transparent Accounting: Blockchain technology will likely become more widely used in financial reporting and auditing. For more information about Blockchain Technology, see What is blockchain?
4. Global Accounting Standards: As businesses operate globally, the need for unified accounting standards will increase. International Financial Reporting Standards (IFRS) may gain more prominence.

Conclusion

Accounting is the backbone of any business, providing the financial insights necessary for decision-making, compliance, and growth.

As technology continues to evolve, accounting will become even more automated, accurate, and data-driven.

Whether for a small business or a large multinational corporation, accounting remains a vital tool in managing financial health and ensuring long-term success.