Introduction to Accounting Basic Concepts, Purpose, Importance

25/01/2022 1 By indiafreenotes

Accounting is concerned with providing information to external users. It refers to the preparation of general-purpose reports for use by persons outside a business enterprise, such as shareholders (existing and potential), creditors, financial analysts, labour unions, government authori­ties, and the like. Financial accounting is oriented towards the preparation of financial statements which summarise the results of operations for selected periods of time and show the financial position of the business at particular dates.

Purpose

  1. To maintain full and systematic records of business transactions

Accounting is the language of business transactions. Given the limitations of human memory, the main objective of accounting is to maintain ‘a full and systematic record of all business transactions.

  1. To ascertain profit or loss of the business

Business is run to earn profits. Whether the business earned profit or incurred loss is ascertained by accounting by preparing Profit & Loss Account or Income Statement. A comparison of income and expenditure gives either profit or loss.

  1. To depict financial position of the business

A businessman is also interested in ascertaining his financial position at the end of a given period. For this purpose, a position statement called Balance Sheet is prepared in which assets and liabilities are shown.

Just as a doctor will feel the pulse of his patient and know whether he is enjoying good health or not, in the same way by looking at the Balance Sheet one will know the financial health of an enterprise. If the assets exceed liabilities, it is financially healthy, i.e., solvent. In the other case, it would be insolvent, i.e., financially weak.

  1. To provide accounting information to the interested parties

Apart from owner of the business enterprise, there are various parties who are interested in accounting information. These are bankers, creditors, tax authorities, prospective investors, researchers, etc. Hence, one of the objectives of accounting is to make the accounting information available to these interested parties to enable them to take sound and realistic decisions. The accounting information is made available to them in the form of annual report.

Importance

Prevention and Detection of Fraud

Avoidance and detection of frauds or errors is important role played by financial accounting. It records all financial data fairly which is used by management for analysis purposes. This data acts as proof and reduces the chances of any frauds or errors.

Maintain Business Record

Financial accounting records each and every transaction of business organization. It systematically maintains a proper book of accounts of all monetary transactions. Unlike human memory which has a limited capacity to remember things, financial accounting can record large amounts of transactions.

Present true Financial Position

Financial accounting reveals and interprets the true financial position of organizations. It records each financial aspect and supplies it from time to time to the internal management team. Managers get the real ideas of all financial resources of the organization regularly through data supplied by financial accounting. It helps them in making proper decisions for managing the overall financial position.

Comparison of Result

Financial accounting helps in comparing the performance of business organizations. It systematically records and stores financial data for many accounting years. This way comparison of present data with previous year’s data can be easily done.

Helps in preparing Financial Statements

Preparation of financial statements is a must for knowing the true profit or loss and real worth of the organization. Financial accounting supplies all relevant accounting data for the preparation of financial statements like profit and loss account and balance sheet.

Acts as legal Evidence

Financial accounting serves as legal evidence of all data and helps in settling of all business disputes. It prepares and maintains systematic books of accounts of all financial transactions which can be used for avoiding any confusion or misunderstanding.

Assists the Management

Managers depends on financial accounting for various data for taking managerial decisions. It provides the full information’s regarding all cash flows in an organization. They can easily anticipate any surplus or deficit of funds in an organization and take decisions accordingly.