Nature and Scope of Accounting

Introduction Accounting has rightly been termed as the language of the business. The basic function of a language is to serve as a means of communication, accounting also serves this function. It communicates the results of business operations to various parties who have some stake in the business. In all activities and organizations which require money and other economic resources, accounting is required to account for these resources. In other words, wherever money is involved, accounting is required to account for it. 1-1

Definition of Bookkeeping and Accounting • Book- keeping is the science and art of correctly recording in books of account all those business transactions that result in the transfer of money or money’s worth. It includes recording of journal, posting in ledgers and balancing of accounts. All the records before the preparation of trial balance is the whole subject matter of book- keeping. • A transaction is an exchange in which each participant receives or sacrifices value (e.g. purchase of raw material). An event (whether internal or external) is a happening of consequence to an entity (e.g. use of raw material for production). An entity means an economic unit that performs economic activities 1-2

Definition of Bookkeeping and Accounting • Accounting is a discipline which records, classifies, summarizes and interprets financial information about the activities of a concern so that intelligent decisions can be made about the concern. • American Accounting Association defines accounting as "the process of identifying, measuring, and communicating economic information to permit informed judgement and decisions by users of the information. 1-3

Branches of Accounting • Financial Accounting: The accounting system concerned only with the financial state of affairs and financial results of operations and it is the origin form of accounting. • Cost Accounting: In view of the limitations of financial accounting in respect of information relating to the cost of individual products, cost accounting was developed. • Management Accounting: It is an accounting for the management i.e., accounting which provides necessary information to the management for discharging its functions of creating policy and the day to day activities. 1-4

Nature of Accounting 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. Very much a profession: • A profession is a career that involves the acquiring of a specialized formal education before rendering any service. Accounting is a systematized body of knowledge developed with the development of trade and business over the past century Social force: • Under the changing business environment the discipline of accounting and the accountant both have to watch and protect the interests of other people who are directly or indirectly linked with the operation of modern business. 1-5

Nature of Accounting A language: • Accounting is rightly referred the "language of business". It is one means of reporting and communicating information about a business. Science or Art: • Science is a systematized body of knowledge. It establishes a relationship of cause and effect in the various related phenomenon. It is also based on some fundamental principles. • An information system: • Accounting discipline will be the most useful one in the acquisition of all the business knowledge in the near future. You will realize that people will be constantly exposed to accounting information in their everyday life. Accounting information serves both profit-seeking business and non-profit organisations. 1-6

Objectives of Accounting To keep systematic records To protect business properties To ascertain the operational profit or loss To ascertain the financial position of the business To facilitate rational decision making Information System 1-7

Functions of Accounting Record Keeping Function: • The primary function of accounting relates to recording, classification and summary of financial transactions- journalisation, posting, and preparation of final statements. Managerial Function: • Decision making programme is greatly assisted by accounting • Legal Requirement function: • Auditing is compulsory in case o f registered firms. Auditing is not possible without accounting. • Language of Business: • Accounting is the language of business. Various transactions are communicated through accounting. 1-8

Types of Accounting 1-9

• Types of Accounting Personal Accounts: • Accounts recording transactions with a person or group of persons are known as personal accounts. These accounts are necessary, in particular, to record credit transactions. The rule for personal accounts is: Debit the receiver and Credit the giver. Real Accounts: • Accounts relating to properties or assets e.g., Cash Machinery, Building, etc., Real accounts can be further classified into tangible and intangible. The rule for Real accounts is: Debit what comes in and Credit what goes out Nominal Accounts: • Accounts relating to income, revenue, gain, expenses and losses are termed as nominal accounts. These accounts are also known as fictitious accounts as they do not represent any tangible asset. Debit all expenses and losses and Credit all incomes and gains • • 1-10

Accounting Principles • It refers, to certain rules, procedures and conventions which represent a consensus view by those indulging in good accounting practices and procedures. The accounting principle is considered to be relevant and useful to the extent that it increases the utility of the records to its readers. Though accounting principles are denoted by various terms such as concepts, conventions, doctrines, tenets, assumptions, axioms, postulates, etc., but it can be classified into two groups, i.e., Accounting Concepts and Conventions. 1-11

Accounting Principles Accounting Concepts Accounting Conventions Separate Business Entity Materiality/Disclosure Money Measurement Conservatism Dual Aspect Consistency Going Concern Accounting Period Cost Matching Accrual Realisation 1-12

Characteristics of Useful Information 1-13

Users of Accounting Information 1-14

Systems of Accounting • Accounting on ‘Cash basis: • Under cash basis accounting, entries are recorded only when cash is received or paid. Government system of accounting is mostly on cash basis. • Accrual Basis of Accounting or Mercantile System: • Under accrual basis of accounting, accounting entries are made on the basis of amounts having become due for payment or receipt. Incomes are credited to the period in which they are earned whether cash is received or not. Similarly, expenses and losses ere detailed to the period in which, they arc incurred, whether cash is paid or not. • Mixed or Hybrid Basis of Accounting: • When certain items of revenue or expenditure are recorded in the books of account on cash basis and certain items on mercantile basis, the basis of accounting so employed is called ‘hybrid basis of accounting’. Such a method could be adopted because of uncertainty with respect of quantum, amount and time of receipt of such incentives and drawbacks. 1-15

Capital and Revenue Expenditure • The main purpose of accounting is to ascertain the true results of the business in terms of profit and loss during a particular accounting period. The profit or loss of a business can be ascertained by matching business revenues against the cost of the same period. The emphasis is clearly on the same period. Therefore, a clear understanding between capital and revenue (expenditures and receipts) is necessary for the correct ascertainment of profit or loss. It may be noted that revenue items are included only in income statement or profit or loss account and capital items form part of balance sheet figures. 1-16

Capital and Revenue Expenditure Before the preparation of final accounts, it is essential to understand clearly the distinction between the capital and revenue expenditures. Capital expenditure is that expenditure which results in acquisition of an asset or which results in an increase in the earning capacity of a business. Another test of a capital expenditure is that the benefit of such expenditure lasts for a long period of time. Obvious examples of capital expenditures are money paid for land, buildings, machinery, furniture, patents, goodwill, reduce working expenses, etc. Expenditure which does not result increase in capacity or in reduction of day to day expenses is not capital expenditure, unless there is a tangible asset to show for it. 1-17

Capital and Revenue Expenditure All sums spent up to the point an asset ready for use should also be treated as capital expenditure. Examples are: fees paid to lawyer for drawing a purchase deed of land, overhauling expenses of second hand machinery, cartage paid for bringing machinery to the factory from supplier’s premises and money spent to install a machinery; even interest on loans taken to acquire fixed assets but only for the period before the asset becomes operational. • Expenses whose benefit expires within the year of expenditure and which are incurred to maintain the earning capacity of existing assets are termed as revenue expenditure. 1-18

Capital and Revenue Expenditure Amounts paid for wages, salary, carriage of goods, repairs, rent and interest, etc., are items of revenue expenditure. Depreciation on fixed assets is also a revenue expenditure. To the extent the materials are used up, they will be revenue expenditure. Similarly, cost of goods sold is revenue expenditure. Costs incurred to acquire an asset are capital but costs incurred to keep them in working condition or to defend their ownership are revenue. 1-19

Capital and Revenue Expenditure • Fee paid to a lawyer for checking whether all the papers are in order before land is purchased is capital expenditure. • But if later a suit is filed against the purchaser, the legal costs will be of revenue type. 1-20

Deferred Revenue Expenditure • There are certain expenses which may be in the nature of revenue but their benefit may not be consumed in the year in which such expenditure has incurred; rather the benefit may extend over a number of years. All such expenditures which are basically in the nature of revenue expenditure, e.g., heavy advertising expenditure incurred in introducing a new line or developing a new market. Charges of these expenses are deferred because such expenses benefit more than one accounting period. 1-21

Deferred Revenue Expenditure • If the expenditure can be ear- marked as being in respect of a specified object, the expenditure should be written off during the life of that object, e.g. heavy accidental losses, such as loses arising from a fire or an earthquake; the loss may be spread over a few years. • The deferred revenue expenditure not yet written off is shown on the assets side of the balance sheet. • Thus, deferred revenue expenditure is revenue in character but — the benefit of which is not exhausted in the same year, or is applicable either wholly or in part of the future years, or is accidental with heavy amount and it is not prudent to charge against the profit of one year 1-22

Capital Expenditure and Deferred Revenue Expenditure The main feature of capital expenditure is that results in a benefit which will accrue to the business enterprise for a long time, say 10 or 15 years. Deferred revenue expenditure also results in a benefit which will accrue in future period but generally for 3 to 5 years. The capital expenditure or the resulting asset is usually capable of being reconverted into cash though may be at a loss. This is not possible in the case of deferred revenue expenditure. At times, heavy loss such as loss due to earthquake is treated as deferred revenue expenditure in the sense that they are written off over a period of 3 to 5 years. Such a loss cannot be treated as capital expenditure 1-23

Capital and Revenue Receipts • Capital receipts comprise of payments or contributions into the business by the proprietor, partners or other shareholders towards the capital of the firm and also any sum received from debenture holders, any loans and the proceeds of sale of any fixed assets of a business enterprise. • Capital receipts and expenditure have no bearing on the profit or loss for the accounting period. • Revenue receipts is the outcome of a firm’s activity in the accounting period, part of its rewards for offering goods or services to the public e.g. sales, commission, fees received for services, interest on investment, etc. • Revenue receipts must be set off against the revenue expenses in order to calculate the profit or loss of the business in an accounting period. 1-24

Capital and Revenue Profits While preparing the final accounts distinction has to be made between capital profits and revenue profits. Revenue profits are earned in the ordinary course of business. They appear in the profit or loss account and are available for distribution as profit, or for creating reserves and funds, or for being used in the business. However, capital profits, are those which are earned as a result of selling some fixed assets, or in connection with raising capital for the firm. For instance, a building purchased for TZS150 was subsequently sold for TZS175, this TZS25 will be profit of capital nature. Similarly when a company issues its shares of the face value TZS10 for TZS15 each, it is said that shares have been issued at premium which is capital profit. 1-25

Capital and Revenue Losses Revenue losses are the losses which arise during the normal course of business whereas capital losses are those which occur when selling fixed assets or raising share capital. • If a building purchased for TZS 50 is sold for TZS 45, there will be capital loss of TZS 5. Similarly when shares of the face value of TZS100 are issued at TZS95 i.e. at a discount of TZS5, the amount of discount will be capital loss. Treatment of capital losses is not different from that of capital profits. Just as capital profits are not shown in profit and loss account, similarly capital losses are not shown in the profit and loss account. They are shown in the balance sheet on the asset side. 1-26

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Filed Under: technology on Wednesday, February 7, 2018