What is Accounting?
Accounting is the systematic process of recording, classifying, summarizing, and interpreting financial transactions of an entity such as a business, government department, or non-profit organization.
In simple terms, accounting tells the financial story of an organisation, helping stakeholders understand how money is earned, spent, saved, or invested.
This definition highlights four essential activities:
- Recording (Bookkeeping)
- Classifying (Posting into ledgers)
- Summarizing (Preparing statements)
- Interpreting (Analysis for decision-making)
Branches of Accounting
Accounting is the systematic recording, analysis, and reporting of financial information. Over time, it has developed into various branches, each serving a specific purpose. Accounting can be broadly classified into Traditional (Core) Branches and Modern / Specialized Branches.
A. Traditional / Core Branches of Accounting
These are the fundamental branches that form the backbone of accounting practices:
| Branch | Purpose | Users | Examples |
|---|---|---|---|
| Financial Accounting | Rrecording and summarizing all financial transactions to produce financial statements | mainly used by external stakeholders such as investors, banks, and government authorities | Profit & Loss Account, Balance Sheet |
| Cost Accounting | Measures and controls production or service costs for efficiency | Internal management | Standard Costing, Cost Variance Analysis |
| Management Accounting | Provides financial and non-financial data to support managerial decisions | Management | Budgeting, Ratio Analysis, Forecasting |
| Government Accounting | Manages and records government receipts and expenditures | Government officials, auditors | Public Accounts, Budget Reports |
| Tax Accounting | Ensures compliance with tax laws and calculates tax obligations | Businesses, government | Income Tax Accounting, GST Reporting |
B. Modern / Specialized Branches of Accounting
With evolving business needs and regulatory requirements, several specialized branches have emerged:
| Branch | Purpose | Users | Examples |
|---|---|---|---|
| Forensic Accounting | Detects fraud, financial misconduct, and irregularities | Auditors, law enforcement | Fraud investigations, Embezzlement cases |
| Social Accounting / CSR Accounting | Measures social and environmental impact of business activities | Government, NGOs, public | CSR Reports, Sustainability Reporting |
| Human Resource Accounting (HRA) | Assigns monetary value to employee skills, knowledge, and experience | Management | Employee valuation, Training cost analysis |
| Environmental Accounting | Records costs related to environmental protection and sustainability | Management, Government | Pollution control costs, Green finance accounting |
| Accounting Information Systems (AIS) | Accounting Information Systems (AIS) use computerized tools to record, process, and report financial data | supporting organizations as well as IT and finance teams | ERP software, Tally, QuickBooks, |
| International Accounting | Standardizes accounting for cross-border trade and multinational operations | MNCs, Auditors | IFRS-compliant Financial Statements |
| Fiduciary Accounting | Manages assets held by one party on behalf of another | Trustees, Executors, Guardians | Trust Fund Accounting, Estate Management |
| Project Accounting | Tracks costs, revenues, and budgets for individual projects | Project managers, Finance teams | Construction Project Budgets, IT Project Cost Reports |
| Auditing / Audit Accounting | Verifies accuracy and compliance of financial records | Internal & external auditors | Statutory Audits, Internal Audits |
Objectives of Accounting
Accounting is more than just recording numbers—it is a systematic process that provides accurate and meaningful financial information to aid decision-making, planning, and accountability in any organization.
1. Systematic Recording of Financial Transactions
The primary purpose of accounting is to maintain a systematic and organized record of all financial transactions. This ensures that every business activity is properly documented and can be easily retrieved when needed.
Example: Recording sales, purchases, payments, and receipts in the books of accounts.
2. Determination of Profit or Loss
Accounting helps evaluate the financial performance of an organization over a specific period. By preparing the Profit and Loss Account, a business can determine whether it has made a profit or suffered a loss during a specific period.
Example: Comparing revenue from sales with expenses such as salaries, rent, and raw materials.
3. Ascertainment of Financial Position
Accounting provides a clear view of the organization’s financial position through the Balance Sheet. It summarizes assets, liabilities, and owners’ equity, revealing the net worth of the business.
Example: A company with assets of ₹50 lakh and liabilities of ₹30 lakh has a net worth of ₹20 lakh.
4. Facilitation of Decision-Making
Accounting delivers reliable financial information that enables managers and stakeholders to make informed decisions. It supports key business decisions related to investments, pricing, budgeting, and expansion.
Example: A manager can decide whether to expand production based on profitability trends.
5. Ensuring Legal and Regulatory Compliance
Proper accounting ensures that a business complies with laws, tax regulations, and other statutory requirements. It also provides audit-ready financial records for verification and reporting purposes.
Example: Filing GST returns or preparing financial statements in accordance with regulatory standards.
6. Promoting Accountability and Transparency
Accounting promotes responsible management of resources entrusted by owners, investors, or other stakeholders. It ensures transparency in the use and monitoring of funds.
Example: Organizations can accurately track and report expenditures through proper accounting practices.
7. Assisting in Planning and Budgeting
Accounting information forms the foundation for effective planning and budgeting. It aids in resource allocation, financial forecasting, and strategic decision-making.
Example: Preparing a budget for production costs or allocating funds for specific projects.
8. Facilitating Comparison and Analysis
Accounting enables comparison of financial performance over different periods. It supports trend analysis, ratio analysis, and performance evaluation to identify strengths and weaknesses.
Example: Comparing this year’s sales with the previous year to assess growth or operational efficiency.
Accounting as an Information System
Accounting is often described not just as a method of recording financial transactions but as an information system. This means it is a structured process that collects, processes, and communicates financial information to various users to support decision-making and control.
Components of Accounting as an Information System
An Accounting Information System (AIS) is a structured framework designed to collect, process, store, and communicate financial information to support decision-making, planning, and control in an organization. It converts raw financial data into meaningful reports that help managers, investors, and other stakeholders understand the company’s performance and make informed decisions.
1. Input
Input refers to the stage where all financial transactions and events of a business are captured as raw data. This is the foundation of the accounting system because accurate and complete data is essential for producing reliable information.
Examples:
- Sales invoices when products are sold
- Purchase bills when raw materials are bought
- Salary payments to employees
- Loans taken or repayments made
2. Processing
Processing involves organizing, recording, classifying, and summarizing the collected data in a systematic manner to make it meaningful. This step transforms raw data into usable information.
Examples:
- Posting transactions to ledgers and journals
- Calculating totals for accounts
- Preparing trial balances to check the accuracy of records
3. Output
Output is the stage where processed financial information is communicated to users through reports, statements, or summaries. This is the stage that allows stakeholders to understand and act on the information.
Examples:
- Financial statements like Balance Sheet, Profit & Loss Account and Cash flow Statement
- Budget reports for planning
- Cost reports for cost control and efficiency analysis
4. Storage / Database
Storage refers to the systematic organization and retention of financial data for future reference, audit, or analysis. Modern AIS typically store data digitally in secure databases.
Examples:
- Accounting software databases
- Ledgers and journals
- Digital records of invoices and receipts
5. Feedback Mechanism
The feedback mechanism allows the organization to compare actual results with planned or expected results and take corrective actions. This helps improve decision-making and operational efficiency.
Example: Variance analysis in management accounting, where actual expenses are compared with budgeted expenses to identify discrepancies.
Users of Accounting Information
Accounting is not just about recording financial transactions; it is primarily a source of information for various stakeholders. Different users rely on accounting information to make decisions, monitor performance, and evaluate the financial health of an organization.
Accounting information users can be broadly classified into internal users and external users.
1. Internal Users
Internal users are directly involved in the operations of the organization and use accounting information for decision-making, planning, and control.
Key Internal Users:
a) Management / Owners
- Purpose: To make informed decisions regarding production, expansion, investment, pricing, and cost control.
- Example: Managers may analyze the Profit & Loss Account along with budget reports to determine whether to increase production or invest in new projects.
b) Employees / Staff
- Purpose: To understand the organization’s financial stability, performance, and prospects for salary increments, bonuses, or job security.
- Example: Employees may review profit trends or bonus allocations to assess the company’s performance and their benefits.
c) Internal Auditors
- Purpose: To monitor and verify the accuracy of financial records, detect errors or fraud, and ensure compliance with internal policies.
- Example: An internal auditor examines expense accounts to prevent misuse of funds and ensure financial integrity.
2. External Users
External users are not involved in the day-to-day operations but rely on accounting information for evaluation, investment decisions, or legal purposes.
Key External Users:
a) Investors / Shareholders
- Purpose: To assess the profitability, financial stability, and growth potential of the organization before investing or continuing investments.
- Example: Reviewing annual reports and financial statements before buying or holding shares.
b) Creditors / Lenders / Banks
- Purpose: To evaluate the creditworthiness and repayment ability of the business.
- Example: Banks analyze balance sheets and cash flow statements before granting loans or credit.
c) Government / Tax Authorities
- Purpose: To ensure compliance with laws, taxation requirements, and corporate financial obligations.
- Example: Tax departments use accounting information to assess GST, income tax, or corporate tax liabilities.
d) Suppliers / Trade Partners
- Purpose: To determine the ability of the business to pay for goods or services supplied.
- Example: A supplier may review financial statements before offering credit or long-term supply contracts.
e) Regulatory Authorities / Statutory Auditors
- Purpose: To monitor compliance with financial reporting standards, accounting norms, and industry regulations.
- Example: Statutory auditors examine accounts to ensure compliance with laws and accounting standards.
FAq’s
What is accounting?
Accounting is an organized process of recording, classifying, summarizing, and interpreting financial transactions to deliver meaningful information that supports decision-making.
Why is accounting important for a business?
Accounting helps businesses measure financial performance, maintain records, comply with laws, manage resources, and plan for the future.
3. What are the main objectives of accounting?
The key objectives include recording transactions, determining profit or loss, presenting financial position, assisting decision-making, ensuring legal compliance, and maintaining transparency.
4. What is meant by systematic recording of transactions?
It means documenting every financial activity — such as purchases, sales, payments, or receipts — in a structured manner to avoid errors and maintain accuracy.
5. What is financial accounting?
Financial accounting deals with recording business transactions and preparing reports like the Profit & Loss Account and Balance Sheet for external users such as investors and creditors.
6. What is cost accounting?
Cost accounting focuses on calculating, controlling, and analyzing the cost of production. It helps managers reduce wastage and improve efficiency.
7. What is management accounting?
Management accounting provides internal financial insights to managers to help with planning, budgeting, and decision-making.
8. Who are internal users of accounting information?
Internal users include managers, owners, employees, and internal auditors who use financial data to operate and control the business.
9. Who are external users of accounting information?
External users such as investors, lenders, suppliers, government authorities, and regulatory bodies use accounting reports to evaluate the company’s performance and compliance.
10. How does accounting help in decision-making?
Accounting provides accurate financial data (profits, costs, cash flow, trends) that helps managers and stakeholders choose the best strategies for growth, investment, and budgeting.