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What is Accounting?

Accounting is popularly known as the “language of business”. It is the recording of all financial transactions of a business or organization. It is the system which records, summarizes, and analyzes an economic entity’s financial transactions. The key to the success of every business is the effective communication of this information. As proper accounting is important to many companies and businesses, it is properly regulated and formalized. It should be systematic, and follow standardized principles. The people who rely on the financial information are of two types that include, internal users, such as company’s managers and employees, and external users, such as investors, labor unions, financial analysts, banks and government agencies. The users depend upon the accounts to know the answers to the following questions such as what is the balance owed by the customers, is company making any profits, how much debt does the company have or should the company invest more money to expand?

It plays a very important role in facilitating all forms of economic activity in the private, public and non -profit sectors. Accounting information is used by business owners and managers, in both large and small companies to see how their business is doing. It is also used by government entities to track tax revenues.

What is the purpose of Accounting?

It is clear that its main purpose is to provide information to different users for making economic decisions. Another purpose includes recording, reporting, summarizing, and interpreting economic data. In order to do this, an accounting system is designed. After the system has been designed, various reports are issued and then the decisions according to the reports are made for different departments. According to the American Institute of Certified Public Accountants (AICPA), “Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions, in making reasoned choices among alternative courses of action”.

What are the types of Accounting Information ?

The different types of information provided by accounting reports are as follows:

1.Cash flows: The financial statements shows the inflows and outflows of cash in the different activities of the business such as operating, investing, and financing activities.

2.Financial position: This accounting information tells you about the entity’s total assets, entity’s liabilities and entity’s capital by answering the questions such as how much resource does the entity currently have or how much does the entity owe third parties?

3.Solvency and liquidity: Solvency refers to the entity’s ability to pay obligations when they become due. Liquidity pertains to its ability to meet short-term obligations.

4.Results of operations: This provides the profit that is generated by the company for a particular period of time i.e. for a year, for a quarter, for a month etc. It is measured by deducting all expenses from all income and the resulting income that we get is known as net income.

5.Other information: The financial statements also provide qualitative, quantitative, and financial information.

Who are the “users of financial statements”?

As we have discussed earlier that the main objective of accounting is to provide information to ‘users of financial statements’ for decision-making. But do you know who are these “users of financial statements”?

The users of this information include the owners and investors, management, suppliers, lenders, employees, customers, the government, and the general public. Let us discuss them in detail:

1.Owners and investors: Financial information is used by stockholders of corporations to help them make decisions on what to do with their investments (shares of stock), i.e. hold, sell, or buy more. In similar way, financial information is also used by small business owners to find if the business is making any profits or whether they should drop it or continue it.

2.Management: Management includes the owners in small businesses .However, in huge organizations, management consists of hired professionals who are responsible for operating the business or a part of the business. They also act as agents of the owners.The questions and business decisions such as do we have enough cash? How much supply will we have to purchase? require analysis of accounting information.

3.Lenders: Lenders of funds such as banks and other financial institutions are interested in the company’s ability to pay liabilities upon maturity.

4.Government: Governing bodies of the state, especially the tax authorities, are interested in an entity’s financial information for taxation purpose. In general, the state would like to know how much the taxpayer makes to determine the tax due thereon.

5.Employees: Employees want to know about the company’s profitability and want to the confirm if the company will be able to pay salaries and provide employee benefits.

Internal and External Users:

The users can also be  classified into internal and external users. Internal users are managers who use accounting information in making decisions related to the company’s operations. External users, on the other hand, are not involved in the operations of the company but hold some financial interest.

What are the types of Accounting ? 

Due to the developments in economic, industrial, and technological sectors different fields in accounting have also emerged. The types of accounting include: financial accounting, managerial accounting, cost accounting, auditing, taxation, AIS, fiduciary, and forensic accounting.

1. Financial Accounting: It consists of recording and classifying business transactions, and also to present financial statements to be used by internal and external users.

2. Managerial Accounting: It  provides information that can be used by internal users, the management.

3. Cost Accounting: It is also sometimes seen as a subset of management accounting, and consists of recording, presenting, and analysis of manufacturing costs. It is very useful in manufacturing businesses because they have the most complicated costing process.

4. Auditing: The main purpose of external auditing is to include the examination of all financial statements by an independent party so that there is fairness of presentation. Internal auditing, on the other hand, focuses on evaluating the adequacy of a company’s internal control structure.

5. Tax Accounting: It helps clients in following the rules that are set by tax authorities such as tax planning and preparation of tax returns.

6. Fiduciary Accounting: It includes handling of accounts that are managed by a person who is entrusted with the custody of property of or for the benefit of another person.

Through Accounting, information about any business entity is communicated. And therefore, accountants must present an organization’s financial information in clear and concise reports.

To read about other topics like Bills of Exchange and more, keep following us here!

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