Meaning of Accounting and its 4 Objectives

What is the meaning of Accounting?

Accounting is a process of recording, classifying, summarizing, analyzing, Interpreting business transactions or events of a financial character, and communicating the results thereof to the Users of Financial Statements.

Accounting

Now, let’s analyze the above-mentioned meaning of accounting in detail:

  • On reading above meaning the first thing you will notice that accounting is a process and it includes multiple steps.
  • Recording, classifying, summarizing, analyzing, interpreting, and communicating are 6 Steps of the Accounting process.
  • And you as an accountant should follow these 6 steps for transactions or events of a financial character and it must be related to business (i.e. personal transactions of Owner should not be recorded in Business books and also transactions of non-financial character should not be recorded)

On reading above you must have got the basic idea about the meaning of term accounting. Now, let’s dive deeper and understand above-mentioned 6-steps involved in accounting process one-by-one:-

Steps in accounting procedure

Accounting Procedure
  1. Recording
  2. Classifying
  3. Summarizing
  4. Analyzing
  5. Interpreting
  6. Communicating

Recording

This is a basic function and the first step in the accounting process. You as an accountant will have to record all the business transactions representing financial character based on documentary evidence such as Sales Invoice, Purchase Invoice, Credit note, Debit note, etc. in the primary books of Accounts (i.e. Journal) by passing Journal Entry.

Classifying

In this step, all the transactions recorded in the Primary books of accounts will be analyzed and transactions representing similar character or nature will be grouped and posted in the book called the ledger. Each page of ledger represents an independent account representing the character either of Asset, Liability, Expense, or Revenue.

For example, all transactions related to the salary for the accounting period recorded in the journal will be grouped and posted on the debit side of salary account in ledger book because salary is an expense for the organization.

Now you might be thinking what is the use of posting transactions in the ledger as we have already recorded transactions in journal book? – Posting all transactions in the ledger will help us to know the aggregate amount of transactions related to one particular ledger account which is representing the character of either Expense/Revenue/Asset/Liability.

Summarizing

This step of the process is concerned with the preparation and presentation of above-classified data in a summarized form in such a manner that it enables it to be useful for internal as well as external users of financial statements. In this process you need to prepare following reports :

  1. Trail Balance
  2. Profit and Loss Account
  3. Balance sheet
  4. Cash-flow statement / Fund flow statement

These 4 reports are called as financial statements

Analyzing

Meaning of term “Analysis” is “Detailed examination of element or structure” and the same applies in accounting. All items stated in the above-summarized reports will be analyzed and put into a simplified form. In this step you will try to establish a relationship between items stated in multiple reports and this relationship will be a base for the Interpretation phase of Accounting.

For example: While preparation of Profit and Loss account you must have booked Salary as an expense on accrual basis Now on analyzing this item from balance-sheet you will be able to identify the amount of Salary that is Outstanding for payment but has been shown as an expense in profit and loss account on Accrual basis.

Interpreting

In this step of the accounting process, you will explain the meaning and significance of the relationship established in the previous step by performing analysis of data. You as an accountant will have to explain every minute detail of analysis such as accounting policies followed by organizations, accounting ratio, the liquidity position of organizations, comparison of current accounting period’s profit and loss with the past accounting periods, etc. The financial statement should explain not only what has happened but also why it has happened and what is likely to happen under specific conditions. This interpretation will help users of financial statements to make a wise and meaningful decision.

Communicating

This is the final step of the accounting process. In this step, you will have to transmit the summarized, Analyzed and interpreted accounting data to the Users of financial statements.

What are the Objective of Accounting?

Accounting has following 4 objectives :-

Objectives of Accounting

Consistent Recording of Transactions

This is a basic objective of accounting. All the business transactions should be systematically recorded in books of accounts. These recorded transactions are then classified, summarized, analyzed and interpreted to ascertain the result.

To Ascertain results of the recorded transaction

You as an accountant will have to prepare a profit and loss account at the end of the accounting period to know the results of business operations. If at the end of the accounting period Aggregate amount of expenses exceed the revenue than a business is incurring loss or if aggregate revenue is more than aggregate expenses than a business is making a profit.

To ascertain the financial position of business

Users of Financial statements are not only interested in profit and loss of the current accounting period but they are also interested to know the overall financial position of the business. Financial position is depicted by the statement of asset and liability i.e. Balance sheet. With the help of balance sheet users will be able to ascertain the liquidity position, Solvency position, Contingent liability along with the condition it is contingent upon, etc.

To provide information to the Users of Financial statements

Traditionally, accounting was limited only up to the process of analysis of classified data. But, as per modern definitions accounting also includes communicating information to the users of financial statements and it has become one of the important objectives of accounting. The availability of information will help users to make rational decision-making.

Now you have understood meaning of accounting its time to enhance your knowledge further by reading following article :-

1. Meaning of Bookkeeping and its Objectives

2. Difference between Accounting and Bookkeeping

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