Q. Define Accounting. Explain its advantages and disadvantages.
Ans. MEANING OF ACCOUNTING: Accounting is the art of recording, classifying, summarising and communicating financial information to users for correct decision making. It gives information on:
(i) resources available
(ii) how the available resources have been employed
(iii) the results achieved by their use.
Since accounting is a medium of communication, it is called The language of business.
DEFINITION OF ACCOUNTING: According to American Institute of Certified Public Accountants (A.I.C.P.A.), “Accounting is the art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events which are, in part atleast, of a financial character, and interpreting the results thereof.”
ADVANTAGES OF ACCOUNTING: Accounting offers the following advantages:
i) Useful in Management of Business: Management needs a lot of information for the efficient running of the business. All such information is provided by the accounting which helps the management in planning, decision making and controlling. For example management would like to know whether the sales are increasing or decreasing and also the speed of increase in the cost of production. All such information is provided by the accounting, which helps the management in estimating the future sales and expenses.
ii) Provides Complete and Systematic Record: Business transactions have grown in size and complexity and it is not possible to remember each and every transaction. Accounting keeps a prompt and systematic record of all the transactions and summarizes them in order to provide a true picture of the activities of the business entity.
iii) Information Regarding Profit or Loss: Accounting reports the net result of business activities of an accounting period. The Profit & Loss Account prepared at the end of each accounting period discloses the net profit earned or loss suffered during that period. The information regarding profit is of great use to the owners and various other interested parties.
iv) Information Regarding Financial Position: Accounting reports the financial position of the business by preparing a Balance Sheet at the end of each accounting period.
v) Evidence in Legal matters: Properly maintained accounts, supported by authenticated documents are accepted by the courts as a firm evidence.
vi) Facilitates Comparative Study: By keeping a systematic record, accounting helps the owners to compare one year's costs, expenses, sales and profit etc. with those of other years. Such a comparison provides the useful informations on the basis of which important decisions can be taken more judiciously.
vii) Facilitates in Assessment of Tax Liability: Properly maintained records will be of great help when the firm is assessed to income tax or sales tax. Such records when audited are trusted by the taxation authorities.
viii) Facilitates Sale of Business: If a business entity is being sold, the accounting information can be utilised to determine the proper purchase price.
ix) Helpful in Raising Loans: Accounting information is of great help while raising loans from banks or other financial institutions. Such institutions before sanctioning loan screen various financial statements of the firm such as final accounts, fund flow statement, cash flow statement etc.
x) Helpful in Prevention and Detection of Errors and Frauds.
DISADVANTAGES OF ACCOUNTING: Accounting provides valuable information. However, it has certain limitations which must be kept in mind while using such information. These limitations are as follows:
i) Omission of Qualitative Informations: Accounts contain only those informations which can be expressed in terms of money. Qualitative aspects of business units are completely omitted from the books as these cannot be expressed in monetary terms. Thus, changes in management, reputation of the business, cordial management-labour relations, firm’s ability to develop new products, efficiency of the management, satisfaction of fim’s customers etc. which have a vital bearing on the profitability of the firm are all ignored and omitted from being recorded because all of these are qualitative in nature.
ii) Based on Historical Costs: Accounts are prepared on the basis of historical costs (i.e., the original costs) and as such the figures given in financial statements do not show the effect of changes in price level. The assets remain undervalued in many cases particularly land and building. The outcome this practice is that balance sheet values of assets are not helpful in estimating the true financial position of the business.
iii) Influenced by Personal Judgements: Accounting is as yet an exact science and accountant has to exercise his personal judgement in respect of various items. For example, it is extremely difficult to predict with any degree of accuracy the actual useful life of an asset which is needed for calculating depreciation. The same is true about method of valuation of stock and making provision for doubtful debts. Different persons are bound to have different opinions in respect of such things and hence it will result in ascertainment of different figure of profit or loss of a business by different persons. Hence the figure of profit cannot be taken as an exact figure.
iv) Based on Accounting Concepts and Conventions: Accounts are prepared on the basis of a number of accounting concepts and conventions. Hence, the profitability and the financial position disclosed by it may not be realistic. For example, fixed assets are shown in the balance sheet according to the ‘going concern concept’. This means that the fixed assets are shown at their cost and not at their market value. The values realised on their sale may be more or less than the values stated in the balance sheet.
v) Incomplete Information: Accounting statements provide only the incomplete information because the actual profit or loss of a business can be known only when the business is closed down.
vi) Affected by Window Dressing: Window dressing refers to the practice of manipulating accounts, so that the financial statements may disclose a more favourable position than the actual position. For example, the purchases made at the end of the year may not be recorded or the closing stock may be over-valued. Hence, correct decisions cannot be taken on the basis of such financial statements.
vii) Unsuitable for Forecasting: Financial Accounts are only a record of past events. Continuous changes take place in the demand of the product, policies adopted by the firm, the position of the competition etc. As such, the financial analysis based on past events may not be of much use of forecasting.
