Tag: Audit Trail

The basic objective of Accounting is the preparation of financial statements is a way that they give a true and fair view of the operating results and the financial position or the business to its various users, namely investors, creditors, management Government, trade unions, research institutions etc. These financial statements are prepared based on certain accounting concepts and conventions. The money measurement concept is a basic attribute of accounting. The money measurement concept states that only those business transactions that are capable of being expressed in terms of money can be recovered in the books of account. It also assumes that the monetary unit used for recording the transaction is stable in nature.

Inflation accounting is a term describing a range of accounting models designed to correct problems arising from historical cost accounting in the presence of high inflation and hyperinflation. Inflation accounting may be described as an attempt to portray financial performance of business enterprises on the basis of current prices. Special accounting techniques, which can be used during periods of high inflation. Inflation accounting requires statements to be adjusted according to price indexes, rather than rely solely on a cost accounting basis. Companies operating in countries experiencing hyperinflation may be required to update their statements periodically, in order to make them relevant to current economic and financial conditions.

Role

• Facilitates reasonable comparison: It facilitates a fair inter-period comparison of business profits by bringing all expenses and income to current value. All financial statements such as Balance sheet and Profit and loss account shows present values in place of historical values which makes comparison a reasonable task.
• Presents true condition: Inflation accounting presents true condition of company by adjusting all price level changes taking place in its financial statements. It depicts fair view of company’s financial position by reflecting all changes as per the current price index.
• Remove distortions: This branch of accounting helps in removing all distortions arising due to historical data. It makes accounting records reliable by updating all the data and matching current revenues with current expenses.
• Check on Mis-leading deeds: Inflation accounting keep an eye over the misleading deeds of Historical cost concepts depicting higher profits and higher taxes, thereby resulting in more wages being demanded by workers seeing the high profits. When all adjustments as per the price level accounting is made, these kind of demand will not arise.
• Improve decision making: It is an efficient tool with management which assist in efficient decision making. Inflation accounting provides reliable from of data that is adjusted to current price level. After adjustments, balance sheet exhibits fair position which helps managers in taking right decisions.
• Inbuilt automatic mechanism: Inflation accounting has an inbuilt and automatic mechanism for making adjustments as per the price level changes in company’s book of accounts. It compares revenues and expenses at current cost for reflecting realistic position.

Importance & Objectives

• Exhibits true position: Inflation accounting exhibits true financial status of company by reflecting all books of accounts at current price. It adjusts all record in accordance with current price index for determining real profitability.
• Avoids profit overstatement: This branch of accounting keeps a check on financial statements of companies for avoiding any overstatements of profits. All expenses and income are mentioned at current values which prevents overstatement of business income.
• Calculate right depreciation: Inflation accounting charges correct amount of depreciation by calculating it on present value instead of historical value. Charging right depreciation facilitates business in easy replacement of assets.
• Easy profit comparison: It enables firms in easy comparison of their inter-periods performance for determining their profitability. Inflation accounting adjust effects of prices changes on all expenses and incomes listed in financial statements that avoids distortion of historical data.
• Provides correct information: Inflation accounting provides correct information to shareholders and workers based on present price level. There may be a chance of higher dividend and higher wages being demanded by these people in absence of such information.

Need

Inflation, especially when it is prolonged and high, reduces considerably the meaningfulness and use of the corporate accounts because the various amounts in current rupee values may not signify proportionate real amounts, as the real worth of the rupee varies in different years. Moreover, arithmetical operations involving different amounts in rupees having different real worth become quite misleading. To make the accounts more meaningful, all items should be expressed in values relating to common year. This is attempted through inflation accounting, the following reasons usually being advanced in its favor.

• It helps to correct the usually distorted picture of the financial operations and condition of a company presented by the conventional system of accounts.
• It facilitates inter-company comparisons since inflation hits different firms in different degrees.
• It also facilitates inter-period comparisons of the performance of firm.
• Correct measurement of income is possible only with inflation accounting.
• When some nominal value in the accounts forms the basis of government action, e.g., taxation based on profits, MRTP Act measures based on nominal value acting as proxy for relevant variables, determination of controlled price on the basis of nominal profits and so on, inflation may cause unfair decisions by the government, unless the relevant nominal value is adjusted for inflation.

Merits

• Basis of depreciation. The correct amount of depreciation is when it is charged on the current values (inflated values), and thus the replacement of assets will be more reasonable.
• Realistic view. Inflation accounting enables the company to present a realistic view of its profitability as current revenues are matched to current costs.
• Check on payment of dividends out of capital. Inflation accounting enables companies to maintain capital by checking payment of dividends and taxes out of capital (due to inflated profit calculated based on historical cost accounting).
• Reasonable comparison of profitability. When financial statements consider inflation accounting, the profitability of two plants purchased on two dates can be known concretely. This is because they are calculated based on current value and not on historical cost.
• True and fair balance sheet. The company’s financial position, as shown by the balance sheet, will be true and fair if it keeps a meaningful balance of various effects of inflation accounting in mind.
• Check on misleading deeds. In inflation accounting, higher wage and salary demand is less likely to arise, more and more prospective entrepreneurs will not come to open their units, and unwanted competition will be checked.
• Wrong matching concepts. Assets purchased in the past are depreciated at the original cost or historical cost concept, while all other revenues and expenses are shown on current prices against matching accounting concept.
• Safety of owner’s equity. Inflation accounting records fixed asset values according to their current values. Hence, the owner’s capital valuation will show its correct value.

Demerits

Complicated process

Inflation accounting is a very complicated technique as it involves a lots of adjustments to be done in financial statements. Too many calculations and unwanted adjustments are to be made which becomes a difficult task for a common man.

Never ending process

Major limitation with inflation accounting is that the price changing is a never ending process and continues for infinity. Adjusting of financial statement at every point of time whenever inflation or deflation occurs becomes a tedious task.

Theoretical concept

Inflation accounting is merely a theoretical concept as under it window dressing of accounting concepts is done as per the suitability of individuals.

Situation in Deflation

During deflationary periods, it may lead to an overstatement of business profits which is harmful. Prices fall suddenly at the times of deflation, making adjustments to the price level at this time will lead to lesser depreciation being charged by the company thereby causing an exaggeration of profits.

Expensive technique

This accounting process is a very expensive technique. Small businesses cannot afford to implement it in their process.

Investment property is property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both. [IAS 40.5]

Examples of investment property: [IAS 40.8]

• Land held for long-term capital appreciation
• Land held for a currently undetermined future use
• Building leased out under an operating lease
• Vacant building held to be leased out under an operating lease
• Property that is being constructed or developed for future use as investment property.

The following are not investment property and, therefore, are outside the scope of IAS 40: [IAS 40.5 and 40.9]

• Property held for use in the production or supply of goods or services or for administrative purposes
• Property held for sale in the ordinary course of business or in the process of construction of development for such sale (ias 2 inventories).
• Property being constructed or developed on behalf of third parties (ias 11 construction contracts).
• Owner-occupied property (ias 16 property, plant and equipment), including property held for future use as owner-occupied property, property held for future development and subsequent use as owner-occupied property, property occupied by employees and owner-occupied property awaiting disposal.
• Property leased to another entity under a finance lease.

Scope of Ind AS 40: Investment Property

1) Ind AS 40 should be applied in the recognition, measurement and disclosure of investment property.

2) This Standard doesn’t apply to:

a) Biological assets are also related to agricultural activity (see Ind AS 41 ‘Agriculture’ and Ind AS 16 ‘Property, Plant and Equipment).

b) Mineral rights and mineral reserves and minerals such as oil, natural gas and similar non-regenerative resources.

Recognition in Ind AS 40 

General principle

An owned investment is property shall be recognized as an asset when, and only when:

a) Probably, the future economic benefits associated with the investment property will flow to the entity.

b) The expense of the investment property can be reliably measured.

This general principle is used to consider whether capitalization is appropriate both in respect of the cost incurred in a initially to acquire or construct an owned investment property. The costs incurred subsequently will be  add to, replace part of, or service a property.

An investment property which is hold by a lessee as a right-of-use asset shall be recognized following Ind AS 116.

Subsequent costs

Day-to-day servicing costs:

Under the recognition principle set out above, an entity does not recognize the costs of the day-to-day servicing of such property in the carrying amount of an investment property.

Rather, these costs are recognized in the profit or loss as incurred. Costs of daily servicing are primarily the cost of labour and consumables and might be including the cost of minor parts. The purpose of these expenditures can be often described as for the ‘repairs and maintenance of the property.

Replacement costs:

Parts of investment properties might have been acquired through replacement. Under the recognition principle, an entity recognizes costs incurred to mainly replace parts of original property in the carrying amount in investment property. if they meet the recognition criteria. The carrying value of those parts that are replaced is derecognized following the derecognition provisions of this Standard.

Measurement of Recognition

Measurement at recognition: General

An owned type investment property should be basically measured initially at its cost. Transaction costs are mainly included in the initial measurement.

Cost Inclusions:

The cost of a purchased investment property also comprises its purchase price and any of directly attributable expenditure. The professional fees for legal services, property transfer taxes and other transaction costs.

Cost Exclusions:

The cost of an investment property isn’t increased by:

a) Start-up costs cannot be necessary for bringing the property for the condition which is necessary. It is capable of been operating in the manner which the intended by management.

b) Operating losses which are incurred before the investment property is achieving the planned level of occupancy.

c) Abnormal value of wasted material, labor or other resources can be incurred in constructing or developing the property.

2) Deferred payments

If payment for an investment property is delay then its cost will be cash price equivalent. The distinction between this amount and the total payments can be recognized as interest expense throughout the credit.

Investment property acquired through exchange of another asset.

One or more investment properties might be acquired by exchange for a non-monetary asset.  Assets or any combination of monetary and or non-monetary assets. The cost of such an investment property can be measured at fair value unless:

a) The exchange transaction lacks commercial substance.

b) The fair value of nor the asset which is received nor the asset is given up is reliably measurable.

The acquired asset can be measured in this way, even if an entity cannot be immediately derecognizing the asset which is given up. If the acquired asset cannot be measured at fair value, its cost is measured at the carrying amount of the asset given up.

An entity can determine whether AS an exchange transaction has commercial substance by mainly considering the extent to which company future cash flows are expected to change due to the transaction. An exchange transaction can be commercial substance if:

a) The arrangement (risk, amount and timing) of the cash flows of the asset is received differs from the mainly in configuration of the cash flows of the asset transferred.

b) The entity mainly which is specific amount of the portion of the entity’s operations can be affected by the transaction changes resulting from the exchange.

c) The difference between (a) or (b) is significant which is relative to measuring a fair value of any assets exchanged.

To mainly determine whether you seen an exchange transaction has commercial substance. The which has entity-specific value of the portion of the entity’s operations affected by the transaction, as mentioned earlier, shall reflect the post-tax cash flows. The result of this analysis may be clear without an entity having to perform detailed calculations.

The fair value of any asset which can be reliably measurable if:

a) The fluctuation in the range of reasonable, fair value measurements cannot be significant for that asset.

b) The probabilities of the various can be estimated within the range can be reasonably assessed and used when measuring fair value.

Suppose the entity can measure reliably the fair value of either the asset received or the asset is given up. In case, the fair value of any asset which is given up mainly to used or to measure cost unless the fair value. The asset received is more clearly evident.

An investment property can be held by a lessee as a right-of-use asset should be measured initially at its cost following Ind AS 116.

MEASUREMENT AFTER RECOGNITION

Accounting Policy

An entity that shall adopt as its an accounting policy the cost model to all of its investment property.

Cost Model:

After initial recognition, an entity shall measure investment property:

(a) Following Ind AS 105, Non-current Assets which is Held for Sale and Discontinued Operations if it mainly meets any of the criteria. To be classified as a held for sale. It is included in a disposal group that is classified as held for sale.

(b) Following Ind AS 116 if it is held by a lessee as a right-of-use asset and is not held for sale following Ind AS 105.

(c) Following the requirements in Ind AS 16 for cost model in all other cases.

Entities are required to measure the fair value of investment property for disclosure even though they must follow the cost model. An entity can be encouraged but is not required for measuring the fair value of an investment property.

Based on a valuation by any independent valuer mainly who holds a recognized and a relevant professional qualification. Recent experience in location and a category of the investment property being valued.

Procedure for Issuing an Accounting Standard

Broadly, the following procedure is adopted for formulating Accounting Standards:

(i) The ASB determines the broad areas in which Accounting Standards need to be formulated and the priority in regard to the selection thereof.

(ii) In the preparation of Accounting Standards, the ASB will be assisted by Study Groups constituted to consider specific subjects.

(iii) The draft of the proposed standard will normally include the following:

• Objective of the Standard,
• Scope of the Standard,
• Definitions of the terms used in the Standard,
• Recognition and measurement principles, wherever applicable,
• Presentation and disclosure requirements.

(iv) The ASB will consider the preliminary draft prepared by the Study Group and if any revision of the draft is required on the basis of deliberations, the ASB will make the same.

(v) The Exposure Draft of the proposed Standard will be issued for comments by the members of the Institute and the public. The Exposure Draft will specifically be sent to specified bodies (as listed above), stock exchanges, and other interest groups, as appropriate.

(vi) After taking into consideration the comments received, the draft of the proposed Standard will be finalised by the ASB and submitted to the Council of the ICAI.

(vii) The Council of the ICAI will consider the final draft of the proposed Standard, and if found necessary, modify the same in consultation with the ASB. The Accounting Standard on the relevant subject will then be issued by the ICAI.

(viii) For a substantive revision of an Accounting Standard, the procedure followed for formulation of a new Accounting Standard, as detailed above, will be followed.

(ix) Subsequent to issuance of an Accounting Standard, some aspect(s) may require revision which are not substantive in nature. For this purpose, the ICAI may make limited revision to an Accounting Standard. The procedure followed for the limited revision will substantially be the same as that to be followed for formulation of an Accounting Standard, ensuring that sufficient opportunity is given to various interest groups and general public to react to the proposal for limited revision.

Compliance with the Accounting Standards:

While discharging their attest functions, it will be duty of the members of the Institute to ensure that the Accounting Standards are implemented in the presentation of financial statements covered by their audit reports.

In the event of any deviation from the Standards, it will also be their duty to make adequate disclosures in their reports so that the users of such statements may be aware of such deviations.

In the initial years, the Standards will be recommendatory in character and the Institute will give wide publicity among the users and educate members about the utility of Accounting Standards and the need for compliance with the above disclosure requirements. Once an awareness about these requirements Is ensured, steps will be taken, in course of time, to enforce compliance with the accounting standards.

The adoption of Accounting Standards in our country and disclosure of the extent to which they have not been observed will, over the years, have an important effect, with consequential improvement in the quality of presentation of financial statements.

Rights and Duties of a Pledger

Rights

• The pledger has a right to claim back the security pledged on repayment of the debt with interest and other charges.
• The pledger has a right to receive a reasonable notice in case the pledgee intends to sell the goods and in case he does not receive the notice he has a right to claim any damages that may result.
• In case of sale, the pledgor is entitled to receive from the pledgee any surplus that may remain with him after the debt is completely paid off.
• The pledgor has a right to claim any accruals to the goods pledged.
• If any loss is caused to the goods because of mishandling or negligence on the part of the pledgee, the pledgor has a right to claim the same.

Duties

• A pledgor must disclose to the pledgee any material faults or extraordinary risks in the goods to which the pledgee may be exposed.
• A pledgor is responsible to meet any extraordinary expenditure incurred by the pledgee for the preservation of the goods.
• Where the pledgee has exercised his right of sale of goods, any shortfall has to be made good by the pledgor.
• The pledgor is liable for any loss caused to the pledgee because of defects in his (pledgor’s) title the goods.

Rights and duties of a Pledgee

Essential Elements of the Pledge:

According to Section 172 of the Indian Contract Act, 1872, the following conditions are to be satisfied to constitute a pledge.

a) Delivery of goods,

b) Such delivery of goods is as security for payment of debt and

c) The subject matter must be movable property.

a) Delivery of Goods: To constitute a pledge, there must be bailment of goods, that is the delivery of goods from one person (borrower in case of loan) to the another person (the person giving loan). Such delivery of the possession of the goods may be actual or constructive.

Rights of Pledgee:

Sections 173 to 176 deals about the rights of the pledgee.

• Right to retain the pledged goods.
• Right to recover extraordinary expenses from the pledger.
• Right to sue and sell the pledged property.

The account current is a detailed statement detailing the financial performance of an individual insurance agent’s business over a specified period. These statements form the basis for the reconciliation of accounts between the insurer and the agent. The account current is the basis for the paper trail as premiums paid by policyholders travel between insurance provider, agencies, and agents.

An account current lays out the financial components of an insurance agent’s business in detail. The statement is usually comprehensive in that it specifies premium and claim performance at the individual policy level. The accounting also typically shows summary transaction information as a record of balances owed. These balances are due either to the insurance agent or the insurer depending on the balance of claims paid, the premiums that are written, the premiums returned, and commissions.

Summary items on the account current may include gross premiums, agency commissions, the net payable amount on the current statement, and payments made or received between each submittal of the accounting.

Individual line item columns per policy may include the name of the agent underwriting the policy, the policy number, the name of the insured party, the date of policy underwriting, and the premium amount for the insurance policy. Other items include the percentage of an agent’s commission, the actual dollar amount of the commission, and the net amount due to the insurer for that specific policy.

Situations when account current is prepared are:

• A consignee of goods can also prepare an Account Current, if the latter is to settle the account at the end of the consignment & interest is chargeable on outstanding balance.
• It is prepared when frequent transactions regularly take place between two parties. An example is of a manufacturer who sells goods frequently to a merchant on credit and receives payments from him in instalments at different intervals and charges interest on the amount which remains outstanding.
• It is prepared when two or more persons are in joint venture and each co-venture is entitled to interest on their investment. Also, no separate set of book is maintained for it.
• An Account Current also is frequently prepared to set out the transactions taking place between a banker and his customer.

Rent

Rent is a payment made by a tenant or user to a landlord or property owner in return for the right to use or occupy a property for a defined period. It is typically associated with leasing agreements, where individuals or businesses agree to pay a set amount for the temporary use of real estate or physical assets. Rent can apply to various types of properties, including residential homes, commercial buildings, agricultural land, and equipment, allowing tenants to benefit from the use of these assets without owning them.

Features of Rent:

1. Periodic Payment

Rent involves a recurring payment made at regular intervals, typically monthly, quarterly, or annually, depending on the terms of the lease agreement. The consistency of these payments makes rent predictable for both the tenant (lessee) and the landlord (lessor), providing the tenant access to the property while generating steady income for the owner.

2. Fixed or Variable Amount

Rent can be fixed or variable. In a fixed rent agreement, the tenant pays a set amount throughout the lease period. In variable rent agreements, the payment may fluctuate based on external factors, such as inflation, property market rates, or performance metrics (as seen in percentage leases for commercial properties). Variable rent is commonly used in long-term leases or commercial agreements where future conditions are uncertain.

3. Time-Bound Usage

Rent payments grant the right to use a property or asset for a specific period. Whether the lease term is short-term (e.g., a few months) or long-term (e.g., several years), the tenant’s right to occupy or use the property is temporary and must end or be renegotiated at the lease expiration.

4. Legal Agreement

Rent is governed by a legal agreement, typically a lease or rental contract, that outlines the terms and conditions of the arrangement. This contract specifies the rent amount, payment schedule, tenant rights, property maintenance responsibilities, and conditions for termination. Both parties are legally bound to follow the terms of the agreement.

5. Use of Property or Asset

Rent provides the tenant with the right to use the property or asset without owning it. The rented property could be residential (such as an apartment or house), commercial (like office space or retail stores), industrial, or even non-real estate assets like equipment and vehicles. The tenant pays rent in exchange for the usage rights.

6. Ownership Rights

Despite the tenant’s right to use the property, ownership remains with the landlord or property owner. The rent agreement does not transfer ownership; instead, it gives the tenant temporary possession and usage rights. At the end of the lease, the property reverts fully to the owner.

7. Return on Investment for Landlords

For property owners, rent serves as a return on investment. Landlords or lessors earn income through rent payments, which help cover costs like property maintenance, taxes, and mortgage payments while providing profit. Rent agreements ensure that the property owner continues to benefit from their asset without selling it.

8. Security Deposits

Most rental agreements include a security deposit, paid by the tenant at the beginning of the lease. This deposit provides protection to the landlord against potential damages or breaches of contract. At the end of the lease term, if no damages or unpaid rent exist, the security deposit is usually refunded to the tenant.

Royalty

Royalty refers to a payment made by one party (the licensee) to another (the licensor) for the right to use a specific asset, such as intellectual property, natural resources, or a product. This payment is typically a percentage of revenue or a fixed amount based on the usage of the asset. Royalties are common in industries like music, publishing, mining, and technology, where creators, landowners, or patent holders grant others the right to utilize their work or property in exchange for ongoing payments. The royalty agreement outlines the terms, including the rate and duration of payments.

Features of Royalty:

1. Payment for Use of Intellectual Property or Assets

The primary feature of royalty is that it represents payment for the right to use an asset, intellectual property (IP), or natural resource. The licensee pays the licensor for the ability to use their asset, whether it’s a patented technology, creative work, or natural resource like oil or minerals. The royalty ensures that the licensor is compensated for the use of their property.

2. Ongoing Payments

Royalties are generally recurring payments made over the duration of the agreement, rather than a one-time fee. These payments could be periodic (monthly, quarterly, or annually) or based on usage, such as a percentage of revenue, sales, or production. The recurring nature of royalties provides ongoing income for the licensor.

3. Percentage-Based or Fixed Payments

Royalty payments are often percentage-based, calculated as a percentage of the licensee’s sales or revenue generated from the use of the asset. In other cases, a fixed payment is agreed upon, where the licensee pays a set amount regardless of sales. The type of royalty payment depends on the terms of the contract.

4. Specific Duration

Royalty agreements typically have a fixed duration, outlining the time period during which the licensee can use the asset. After the expiration of the agreement, the licensee must either renew the contract or stop using the asset, depending on the licensor’s terms.

5. Limited Rights for Licensee

The licensee is granted limited rights to use the asset, but ownership remains with the licensor. The royalty agreement specifies the scope of these rights, such as geographic limitations, product restrictions, or time limits. The licensee cannot claim ownership of the asset, only the right to use it.

6. Advance Royalties and Recoupment

In some agreements, the licensee may be required to pay advance royalties before the asset is used. These advance payments are often recouped over time through future royalty earnings. If the royalties generated exceed the advance, the excess is paid to the licensor.

7. Minimum Guaranteed Royalties

Many royalty agreements include a minimum guaranteed royalty (MGR), ensuring that the licensor receives a minimum payment regardless of the actual sales or production figures. If the actual royalties based on sales fall short of the MGR, the licensee must still pay the guaranteed minimum amount.

8. Protection for Intellectual Property

Royalty agreements help protect the intellectual property or asset owned by the licensor. They ensure that the licensee uses the asset legally and compensates the owner for its use. The licensor retains ownership rights and the ability to control how the asset is used, ensuring the protection of its value.

Key differences between Rent and Royalty

Accounting is the process of recording, classifying, summarizing, and interpreting financial transactions to provide useful information for decision-making. It relies on key principles such as the double-entry system, which ensures that every transaction affects at least two accounts, maintaining balance. Key concepts include accrual accounting, matching revenue with expenses, and the preparation of financial statements like the balance sheet, income statement, and cash flow statement. Accounting aims to provide transparency and accuracy, enabling businesses to track their performance, manage resources, and comply with legal and regulatory requirements.

Definition of Accounting:

• 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.”

• Accounting Standards Board (ASB):

“The process of identifying, measuring, and communicating financial information to permit informed judgments and decisions by users of the information.”

• American Accounting Association (AAA):

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

• Kohler (Eric L. Kohler):

“Accounting is a systematic recording of business transactions in such a way as to show the outcome of business activities and the financial position of an entity.”

• Anthony and Reece:

“Accounting is a means of collecting, summarizing, analyzing, and reporting in monetary terms, information about the business for the purpose of decision-making.”

• Robert N. Anthony:

“Accounting is the process of measuring and reporting the economic activities of an organization for decision-making purposes.”

• Horngren (Charles T. Horngren):

“Accounting is a service activity that provides quantitative financial information about economic entities to be used in making economic decisions.”

• International Financial Reporting Standards (IFRS):

“Accounting is the practice of preparing financial statements that are used by the stakeholders of an organization, including shareholders, creditors, employees, and regulators, to make informed financial decisions.”

Objectives of Accounting:

1. Systematic Record Keeping

One of the fundamental objectives of accounting is to maintain a systematic and complete record of financial transactions. This ensures that all business activities, such as sales, purchases, income, and expenses, are recorded in a structured manner. These records provide a historical account of the business’s financial activities, which can be referred to when making decisions, preparing financial statements, or conducting audits.

2. Ascertainment of Financial Position

Accounting aims to ascertain the financial position of a business by preparing a balance sheet. The balance sheet is a snapshot of the company’s assets, liabilities, and equity at a specific point in time. It helps stakeholders evaluate the financial strength and liquidity of the business, understand what it owns and owes, and assess its financial health.

3. Determination of Profit or Loss

Another key objective of accounting is to determine the profit or loss of a business over a specific accounting period. By preparing the income statement, also known as the profit and loss statement, businesses can identify how much revenue they have generated and what expenses were incurred. This helps evaluate operational efficiency and profitability, which is crucial for management and investors.

4. Facilitating Decision Making

Accounting provides crucial financial data that aids in informed decision-making. Business owners, managers, and investors use accounting information to make strategic decisions, such as expanding operations, reducing costs, or investing in new ventures. Financial data also helps in evaluating past performance and forecasting future trends, making it easier to set goals and allocate resources.

5. Ensuring Statutory Compliance

One of the key objectives of accounting is to ensure that businesses comply with various statutory and regulatory requirements. Governments, tax authorities, and regulatory bodies require businesses to maintain accurate financial records and submit periodic financial statements. Accounting helps ensure that businesses meet these legal obligations, such as paying taxes, filing annual reports, and complying with financial reporting standards like GAAP or IFRS.

6. Providing Information to Stakeholders

Accounting serves as a communication tool between a business and its stakeholders. Financial statements and reports generated by accounting provide relevant information to shareholders, creditors, employees, and other stakeholders about the financial health and performance of the business. This transparency fosters trust and confidence among investors and helps them make informed decisions.

7. Controlling Financial Activities

Another important objective of accounting is to aid in controlling financial activities. Accounting provides a framework for tracking expenses, managing cash flow, and comparing actual financial performance with budgeted figures. This helps businesses monitor financial activities and ensure that resources are being used efficiently and effectively, avoiding unnecessary costs or overspending.

Purpose of Accounting:

1. Recording Financial Transactions

The primary purpose of accounting is to record all financial transactions systematically. Businesses engage in numerous transactions daily, such as sales, purchases, and payments. Accounting ensures that these transactions are documented in a structured way, which serves as the foundation for preparing financial reports and tracking financial performance. Accurate records also help in auditing and reviewing financial activities.

2. Maintaining Financial Control

Accounting plays a critical role in maintaining financial control over business operations. By tracking revenue, expenses, assets, and liabilities, accounting ensures that businesses can monitor their financial resources effectively. This helps in controlling costs, managing budgets, and identifying any discrepancies or inefficiencies in resource allocation, allowing management to take corrective actions when necessary.

3. Measuring Business Performance

One of the key purposes of accounting is to measure the financial performance of a business over a given period. By preparing income statements and other financial reports, accounting helps businesses assess how well they are performing. These reports provide insights into profitability, revenue growth, and expense management, enabling stakeholders to evaluate whether the business is meeting its financial objectives.

4. Facilitating Decision Making

Accounting provides relevant financial information that aids in decision-making for management and other stakeholders. It allows businesses to analyze past performance, forecast future trends, and make informed decisions regarding expansion, investments, and cost control. This financial data helps in setting realistic goals and improving overall business strategy.

5. Ensuring Legal Compliance

One of the primary purposes of accounting is to ensure that businesses comply with legal and regulatory requirements. Businesses are required to follow accounting standards, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), and comply with tax laws and financial reporting regulations. Accounting ensures that financial records are maintained accurately to meet these obligations.

6. Providing Financial Information to Stakeholders

Accounting serves as a means of communicating financial information to stakeholders such as investors, creditors, regulators, and employees. Stakeholders rely on accurate financial statements to assess the viability and performance of a business. Accounting ensures that financial data is presented transparently, enabling stakeholders to make informed decisions about their involvement with the company.

7. Supporting Planning and Budgeting

Accounting aids in planning and budgeting by providing historical financial data that helps businesses forecast future financial outcomes. Accurate accounting records allow businesses to create budgets, set financial targets, and allocate resources efficiently. Effective planning based on solid accounting data helps businesses prepare for future challenges and opportunities, ensuring long-term financial stability.

Importance Accounting:

1. Accurate Financial Records

Accounting ensures the maintenance of accurate and systematic records of all financial transactions. These records are essential for tracking the business’s performance, assets, liabilities, income, and expenses. Without proper accounting, businesses would struggle to monitor their financial health, making it difficult to assess profitability or identify financial risks. Accurate records are also required for audits, reviews, and evaluations by management and external parties.

2. Decision-Making Support

Accounting provides vital financial data that supports effective decision-making. Business owners, managers, and investors rely on accounting information to evaluate past performance, forecast future trends, and make strategic decisions about resource allocation, investments, and cost management. It helps businesses assess whether they should expand, cut costs, or adjust their operations. Good accounting enables businesses to base their decisions on data, reducing the risk of poor judgment.

3. Compliance with Legal and Regulatory Requirements

One of the key importance of accounting is ensuring compliance with legal and regulatory obligations. Governments and regulatory bodies require businesses to maintain proper financial records and submit periodic financial statements. These statements help in calculating taxes, ensuring regulatory compliance, and adhering to accounting standards like Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). Non-compliance can result in legal penalties, fines, or damage to the company’s reputation.

4. Performance Evaluation

Accounting helps in evaluating a company’s performance over a specific period. By comparing financial results (like profit margins, expenses, or revenue growth) with past records or industry standards, businesses can measure their efficiency and financial success. This performance evaluation enables businesses to understand how well they are achieving their goals and where improvements are needed, aiding in setting realistic financial targets for future growth.

5. Facilitating Access to Finance

A business’s ability to access external financing depends heavily on its accounting practices. Investors, banks, and other financial institutions require clear and transparent financial statements to assess a company’s creditworthiness and profitability before granting loans or investments. Proper accounting ensures that financial statements accurately reflect the business’s financial status, boosting its credibility with potential lenders or investors.

6. Fraud Detection and Prevention

Effective accounting systems play a crucial role in detecting and preventing fraud. By maintaining proper internal controls and regularly reconciling accounts, businesses can identify discrepancies or suspicious activities that may indicate fraud or theft. Regular audits, supported by good accounting practices, help safeguard a company’s financial resources and maintain its integrity.

Balancing accounts is an essential process in accounting that involves calculating the difference between the debit and credit sides of an account and determining the balance at the end of a given period. This process ensures that the accounts are accurate and in harmony with the accounting principles. Balancing an account helps to create clarity regarding the financial position of an entity at any point in time.

In the double-entry system, every transaction involves both a debit and a credit. Balancing an account helps verify whether the debits and credits are correctly posted and whether the final account reflects the correct amount. Here’s a step-by-step explanation of the process with an example:

Steps for Balancing an Account:

1. Identify the Accounts:
   • Determine which accounts are involved in the transactions.
   • For each account, examine whether it is a real, personal, or nominal account.
2. Posting Transactions:
   • In accounting, every transaction involves a debit entry to one account and a credit entry to another.
   • For example, if the company receives cash from a customer, cash (an asset) will be debited, and accounts receivable (a liability) will be credited.
3. T-Account Format:
   • T-accounts are commonly used to visualize and understand the debits and credits for each account. The left side (debit) is used for recording increases in assets and expenses, while the right side (credit) is used for recording increases in liabilities, equity, and income.
4. Totaling the Debits and Credits:
   • After posting all transactions, total the debits and credits for the account. The larger of the two totals will determine whether the account has a debit or credit balance.
5. Determining the Balance:
   • If debits exceed credits: The account will have a debit balance.
   • If credits exceed debits: The account will have a credit balance.
   • The difference between the two sides is the balance of the account, which is carried forward to the next period or used for preparing financial statements.
6. Balancing the Account:

To balance the account, find the difference between the debit and credit totals. Add this difference on the opposite side, ensuring that the totals on both sides are equal.

Example of Balancing an Account

Let’s say a company has a Cash account, and we will balance it after recording several transactions over a month. The transactions are:

• January 1st: Received cash of $10,000 from a customer.
• January 5th: Paid rent of $1,000 in cash.
• January 10th: Received cash of $5,000 from a customer.
• January 15th: Paid $2,000 for supplies in cash.

Cash Account Example in T-Account Format

Explanation of the Balancing Process:

1. Posting Transactions:
   • Jan 1st: A payment of $10,000 from a customer is received, so the Cash account is debited with $10,000.
   • Jan 5th: Rent payment of $1,000 is made, so the Cash account is credited with $1,000.
   • Jan 10th: A payment of $5,000 from a customer is received, so the Cash account is debited with $5,000.
   • Jan 15th: Payment for supplies of $2,000 is made, so the Cash account is credited with $2,000.
2. Totaling the Debits and Credits:
   • Total Debits: $10,000 (from Jan 1st) + $5,000 (from Jan 10th) = $15,000.
   • Total Credits: $1,000 (from Jan 5th) + $2,000 (from Jan 15th) = $3,000.
3. Calculating the Balance:
   • The total debit is $15,000, and the total credit is $3,000.
   • The difference is $15,000 – $3,000 = $12,000. Since the debits are greater, the Cash account has a debit balance of $12,000.

Final Balance:

After the calculations, the Cash account balance is $12,000, indicating that the company has $12,000 in cash at the end of the period. This balance is carried forward to the financial statements and can be used in the preparation of the balance sheet.

Accounting process is a systematic series of steps that businesses follow to identify, record, classify, summarize, and report financial transactions. This process ensures that financial data is accurate, relevant, and useful for decision-making. The accounting process can be broken down into several key stages, each with specific tasks and objectives.

1. Identification of Transactions

The first step in the accounting process is identifying the financial transactions that need to be recorded. A transaction is any event that has a financial impact on the business. This can include sales, purchases, receipts, payments, and any other events that affect the financial position of the business. To accurately identify these transactions, businesses need to gather source documents, such as invoices, receipts, bank statements, and contracts, which serve as evidence of the transaction.

2. Recording Transactions (Journal Entries)

Once transactions have been identified, the next step is to record them in the accounting system. This is done through journal entries, which are detailed records of each transaction that include the date, accounts affected, amounts, and a brief description of the transaction. Journal entries follow the double-entry accounting system, meaning that every transaction impacts at least two accounts—one account is debited, and another is credited. For example, if a business sells a product for cash, the Cash account is debited, while the Sales Revenue account is credited.

3. Posting to the Ledger

After journal entries are recorded, they are posted to the general ledger. The ledger is a collection of accounts that summarizes all financial transactions for a business. Each account in the ledger contains a record of all debits and credits affecting that account over time. For instance, the Cash account will show all cash inflows and outflows, while the Sales Revenue account will reflect total sales. Posting to the ledger allows businesses to maintain a comprehensive record of all financial activities.

4. Trial Balance Preparation

Once all transactions have been posted to the ledger, the next step is to prepare a trial balance. A trial balance is a summary that lists all the accounts and their balances at a specific point in time, with debits and credits tallied. The purpose of the trial balance is to ensure that the total debits equal the total credits, confirming that the accounting records are mathematically accurate. If the trial balance does not balance, it indicates that there may be errors in the journal entries or postings, requiring further investigation.

5. Adjusting Entries

To ensure that financial statements reflect the true financial position of the business, adjusting entries are made at the end of the accounting period. Adjusting entries are necessary for accrual accounting, where revenues and expenses must be recognized in the period they occur, regardless of cash transactions. Common types of adjustments include accruals (recognizing revenue or expenses not yet recorded) and deferrals (adjusting previously recorded revenues or expenses). For example, if a business has incurred expenses but not yet paid for them, an adjusting entry would recognize those expenses in the current period.

6. Adjusted Trial Balance

After making the necessary adjusting entries, an adjusted trial balance is prepared. This trial balance reflects the updated account balances after the adjustments. The adjusted trial balance is crucial as it serves as the basis for preparing the financial statements, ensuring that the financial data is accurate and complete.

7. Financial Statement Preparation

With the adjusted trial balance in hand, businesses can prepare their financial statements. The primary financial statements include the income statement, balance sheet, and cash flow statement.

• Income Statement: This statement summarizes revenues and expenses over a specific period, resulting in net income or loss.
• Balance Sheet: The balance sheet presents the company’s assets, liabilities, and equity at a particular point in time, providing a snapshot of the business’s financial position.
• Cash Flow Statement: This statement outlines the cash inflows and outflows during a specific period, categorized into operating, investing, and financing activities.

8. Closing Entries

After the financial statements have been prepared and reviewed, closing entries are made to reset temporary accounts (like revenues and expenses) for the new accounting period. Closing entries transfer the balances from these temporary accounts to the retained earnings account in the equity section of the balance sheet. This ensures that the new accounting period starts with a clean slate, with only permanent accounts carrying forward their balances.

9. Post-Closing Trial Balance

The final step in the accounting process is preparing a post-closing trial balance. This trial balance includes only permanent accounts (assets, liabilities, and equity) after closing entries have been made. The post-closing trial balance confirms that the books are balanced and ready for the next accounting period.