Bookkeeping and accounting are essential parts of accounting. In fact, they are considered as the base upon which the modern accounting system is built. In this article, I’ll share with you everything you need to know to understand the basics of bookkeeping and accounting.
Meaning of Bookkeeping
Bookkeeping is an act of making routine records of day-to-day transactions of a business in a prescribed form and according to a set of rules.
- Is an act of keeping a permanent record of all day-to-day financial transactions of a business in a systematic way.
- Is concerned only with a recording of financial transactions but not an interpretation of financial transactions.
- Is the recording phase of accounting and includes primary information on business transactions.
- Can also be defined as an act of making routing records of day-to-day transactions of a business in a prescribed form and according to a set of rules
Objectives of Bookkeeping
- To Identify the Financial Transactions: Bookkeeping helps to identify monetary transactions that take place in the business organization. Such monetary transactions are incurred in the day-to-day business activities of the organization. Bookkeepers support identifying such monetary transactions and keeping them aside from other events.
- To Record the Financial Transaction: After the identification and separation of financial transactions, another important objective of bookkeeping is to maintain a permanent record of all the financial transactions. It is initially recorded in a journal voucher.
- To Classify the Transactions: One of the major objectives of bookkeeping is to classify and group financial transactions on the basis of their common nature. It helps to know the number of transactions incurred under different heads of account.
- To Find Out Operating Results and Financial Position: The main objective of bookkeeping is to get the operating result and financial position of the business organization for a specified period of time. For the operating result, the trading account and profit and loss account is prepared, and for the financial position, the balance sheet is prepared.
Meaning of Accounting
Accounting is broader than bookkeeping. It records, classifies, and summarizes the transactions of a business with a view to ascertain its financial position at the end of the period.
- The meaning of accounting is broader than that of bookkeeping.
- Bookkeeping is only a part of accounting, whereas accounting is a whole.
- Accounting includes not only bookkeeping but also other activities.
- It records, classifies, and summarizes the transactions of a business with a view to ascertaining its profit or loss for the period and its financial position at the end of the period.
- It also interprets and communicates information about the financial position of the business.
- It is also called the “language of business.”
Also, you might be asked:
Who is the father of accounting and why? Luca Pacioli is known as the father of accounting. It is because he gave the concept of the double-entry system of accounting.
Features of Accounting
- Science and Art: Accounting is both a science and an art. It is a science because it represents a systematic body of knowledge based on a set of principles, and it is an art because it involves practical work in which one can fully exercise judgment.
- Process: Accounting is a process of systematic recording classifying and summarizing financial transactions and interpreting financial information to the users.
- Financial Transactions: Accounting deals only with financial information. Any information which is not expressed in monetary terms is not considered in accounting.
- Information System: Accounting is an information system and language of the business. It uses financial transactions as input, processes them, and provides financial information as its output to the decision-maker.
- Function: Accounting is a function. It, therefore, identifies and gathers financial transactions, classifies and summarizes them, and interprets and reports their results to the users.
Objectives of Accounting
There are several objectives of accounting. Some of them are as follows:
- To keep a complete and systematic record.
- To ascertain true profit and loss.
- To show the financial position.
- To analyze and interpret the financial information.
- To make the information available to various users.
Scope of Accounting
The scope implies the field or area that accounting covers. Since accounting is necessary for all human activities, the field of accounting is very wide. The scope of accounting are:
- Non-Government Organization
Limitations of Accounting
Accounting is an important tool for making financial decisions for the business. It is important to the investor, government, creditor, manager, etc. However, it has some drawbacks or limitations too. The major limitations of accounting are as follows:
- Recording Only Monetary Items: As per the accounting principles, every business organization maintains the records of only monetary transactions in the books of account. Business activities are also affected by non-monetary activities as well. However, the effect of those activities is not recorded in the books of accounts.
- Ignoring Time Value of Money: The value of money for today and tomorrow does not remain the same. Every business organization maintains its books of accounts at historical cost, ignoring current cost. Therefore, accounting fails to exhibit the exact financial position of a business due to ignoring the time value of money.
- Recording Only Past Events: Accounting maintains the records of past events only. It determines the operating results and financial position of the business based on historical or pst data. Such past information and result are used for making business decisions and developing future plans, policies, and programs.
- Failure in Maintaining Secrecy: Maintaining secrecy is essential to secure success in the business. But a group of accountants is involved in day-to-day accounting work. They know all the transactions, results, and performance of the business. Secrecy regarding business performance is hard to maintain in accounting.
- No Future Assessment: The financial statements show the operating result and financial position of the firm on the date of preparation. The users of such statement are more interested in the future of the business in the short term and long term. However, the accounting does not make any assessment of the business about the future.
Accounting Process or Cycle
The sequence of the steps to be followed in accounting activities is known as the accounting process. The accounting process forms a cycle. The sequential steps of accounting activities are taken in a cyclical order. The cyclical order starts from the beginning of financial transactions till financial results are derived by preparing final accounts at the end of the accounting year. This cycle follows the same order every year.
The accounting process or cycle has the following steps:
- Identifying and Collecting the Financial Transactions: A business organization may carry out several transactions. Financial and non-financial transactions are identified and seperated, and only the financial transactions are recorded in accounts. If a transaction has no financial character, such transaction cannot be measured in terms of money, so no record is made.
- Recording of Financial Transactions: It is the second phase of accounting process in which recording of transactions in a book called “journal” is made. This book is further sub-devided into various subsidiary books such as cash book, purchase book, sales book, etc.
- Classifying Financial Transactions: In this phase accounting, the recorded data are sorted so that the data can be meaningful to the users. This sorting of data is known as classifying. To foster an easy location, transactions of the same nature are grouped into one place. This process is achieved by opening accounts in a book called “ledger.”
- Summarizing Financial Transactions: All the financial transactions are summarized by preparing trial balance in this step. The trial balance is a statement of debit or credit balance of all the ledger accounts. Preparation of trial balance helps to prepare final accounts.
- Analysis and Interpretation: In order to provide meaningful information, the summarized data are to be analyzed and interpreted so that judgement about profitability, liquidity, solvency, efficiency, and growth potential of the business may be made.
- Communicating the Result of Business Operation and Financial Position: In the last step, the result of business operations such as profits or losses and the company’s financial position are communicated to the users. Those users include the owners, creditors and managers who need financial information for decision making purpose.
Branches of Accounting
On the basis of the nature of activities, there are mainly three branches of accounting. They are:
1. Financial Accounting
Financial accounting is also known as formal accounting. It deals with recording, classifying, and summarizing financial activities and presenting them to related stakeholders. It helps to know about the profitability and financial position of the business.
- Financial Accounting is the primary part among accounting disciplines and also known as formal accounting.
- It deals with recording, classifying, and summarizing financial activities and presenting them to the related stakeholders like management , shareholders, governments, investors, etc.
- It helps to know about the profitability and the financial position of the business at the end of the financial year.
2. Management Accounting
Management accounting is the use of accounting techniques for providing information to help all levels of management in planning and controlling the activities of the business to enable decision making.
- It is the use of accounting techniques for providing information to help all levels of management in planning and controlling the activities of business to enable decision-making.
- The purpose of management accounting is to assist the management in taking rational policy decisions and to evaluate the impact of its decisions and actions.
- Management accounting not only includes cost accounting but also covers other areas such as capital expenditure decisions, capital structure decisions, dividend decisions, etc.
3. Cost Accounting
Cost accounting deals with the accumulation, recording, classification, analysis, allocation, summarization, interpretation, reporting, and control of current and future prospective of costs.
Its purpose is to analyze the expenditure, so as to ascertain the cost of various products manufactured by the firm and fix the selling prices of the product.
- It deals with the accumulation, classification analysis, recording, allocation, summarization, interpretation, reporting and control of current and future prospective of costs.
- It provides detailed information of cost associated with products, operations, process, jobs or functions.
- Its purpose is to analyze the expenditure so as to ascertain the cost of various products manufactured by the firm and fix the selling prices of the product.
- It also helps in controlling the costs and providing necessary costing information to management for decision-making.
Bookkeeping vs Accounting
The differences between accounting and bookkeeping are as follows:
|Scope||It involves the entire accounting process.||It involves only record keeping.|
|Stage||Accounting is the secondary stage. It starts when bookkeeping ends.||It is the primary stage. It occurs before the other steps of accounting.|
|Objective||Its basic objective is to ascertain the results of the business.||It is to keep a complete record of the financial transactions.|
|Who Performs||This job is performed by senior staff.||This is performed by junior staff.|
|Knowledge level||The accountant should have a higher level of knowledge than that of a bookkeeper.||The bookkeeper is not required to have a higher level of knowledge.|
|Analytical skill||An accountant is required to have analytical skills.||A bookkeeper may or may not have analytical skills.|
|Nature of Job||It is not of a routine nature.||It is of routine nature.|
|Supervision and Checking||An accountant supervises and checks the work of the bookkeeper.||The bookkeeper doesn’t supervise or check the work of an accountant.|
Ethics is the set of moral principles and rules guiding an individual behavior. It is the basis of determining right or wrong in a given situation. The accounting profession is based on moral values.
Ethics in accounting is concerned with the consideration of moral principles and values while maintaining books of account and preparation of financial reports.
The ethics in accounting are as follows:
- Integrity: It is a state of truthfullness, honesty and acccuracy. It involves straight forwardness and commitment in accounting work by following the accounting principles instead of personal gain. Accountants should maintain integrity in the accounting work.
- Objectivity: It is a state of independence and neutrality in accounting works. It shouldn’t be influenced by the interest of the owners. He should be free from personal biases or interest. Financial figures and results should be taken correctly and should draw the conclusions and make true decisions on accounting issues.
- Professional Competence: Professional competence in accounting is the capability of an accountant to perform the accounting duties in acceptable quality. In another word it is the habitual and careful use of the communication, knowledge, technical skills, emotions, values and reflection in daily accounting practices for the benefit of the concerned stakeholders.
- Professional behavior: An accountant should fulfill the accounting responsibilities with the highest degree of personal and professional standards. He should complete the tasks thoroughly and on time, and maintain his commitments on accounting works.
- Confidentiality: It is the protection of accounting information. An accountant should keep the accounting information confidential. A professinal accountant should maintain his professional confidentiality. He/she should not share accounting information to co-workers, friends, family, etc. He/she should keep the information secret.
Business activities refer to all the economic activities related to producing goods and services to the customer to ensure profit earning through customer satisfaction.
Business activities are classified into three sections:
1. Operating Activities
Operating activities are the daily activities of the company involved in producing and selling its product, generating revenues as well as general administration and maintenance activities.
- They show the effect on revenue and expenses in normal business transactions that affect income statements.
- The normal business transactions involve purchase or production of goods, selling of goods, generating revenue and payment of expenses on cash.
- These activities can be found on a company’s income statement and operating section of cash flow statement.
2. Investing Activities
The purchase and sale of long-term assets and other business investments within a specific reporting period are known as investing activities.
- It involves the investment of funds for long-term returns and sales of securities.
- Purchasing and selling fixed assets and any long-term investment are the main components of investing activities.
- The items of investing activities of the business are shown on the assets side of the balance sheet and investing section of the cash flow statement.
3. Financing Activities
The transactions with creditors to investors used to fund either company operations or expansions are known as financial activities.
- They are the transactions for business events that affect long-term liabilities and equity.
- In other words, they are transactions with creditors to investors used to fund either company operations or expansions.
- Issuing shares, and borrowing funds from investors are major components of financing activities.
- The items of financing activities of the business are shown on the liabilities side of the balance sheet and financing section of the cash flow statement.
If you get any confusion, feel free to drop a comment down below. In the meantime, you can read these articles.