For centuries accounting was supposed to be a book-keeping activity. With changing business environment, the role of accountant has evolved from mere book-keeper to an important member of decision-making team whose role is to provide important financial information of the business. So, the accounting definition has also evolved over the period of time.
Accounting Definition
Accounting can be defined as the process of identifying, measuring, recording and communicating the required information relating to the economic events of an organisation to the interested users of such information.
To better understand the above definition, let’s understand some key elements of definition:
- Organisation
- Economic Events
- Identification, Measurement, Recording and Communication
- Interested users of information
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Organisation
Organisation refers to business enterprise, which works either for profit or for non-profit motive. For example, Reliance Industries, Tata Consultancy Services, Tata Motors etc. Depending upon its size and level of business operations, the organisation can be sole-proprietary concern, partnership firm, company, cooperative society, municipal corporation, local authority or any other association of persons.
Economic Events
Every business organisation involves economic events. For example, Suppose Tata Motors starts a manufacturing plant in Gujarat to manufacture Electric Cars. It requires land, plant and machinery, installation of machinery, raw material, labours etc. These all are events which consists of number of financial transaction such as buying/leasing land, purchasing machinery, transportation of machinery, site preparation for installation of machinery, purchasing of raw material, hiring of labour and staff etc. An economic event is defined as a happening of consequence to a business organisation which consists of transactions and which are measurable in monetary terms.
There are two types of economic events:
- External Events: An event involving transactions between an outsider and an organisation is called External Event. For example, Tata Motors makes monthly payment to landlord, payment made to vendors for purchase of machinery etc. In this example, landlord and vendors are not working in Tata Motors. They are outsiders for the organisation. Therefore, any transaction with outsider is an external event.
- Internal Events: An economic event that occurs entirely between the internal wings of an enterprise is called Internal Event. For example, Tata Motors establishes various departments for smooth working of organisation like stores department, manufacturing department, sales department etc. When stores department supplies raw material to manufacturing department, it is delivering some value to manufacturing department. Therefore, it is an example of economic event within organisation which is an internal event. Similarly, paying wages to employees is an internal event as employees are internal people which works for the organisation.
Identification, Measurement, Recording and Communication
- Identification: Identification means determining which transactions to record i.e., determining which events are to be recorded. It involves observing activities and selecting those events related to the organisation that are financial in nature. For example, Tata Motors purchases machinery, appoints Managing Director, purchases raw material, sell cars, adopts managerial policies etc, these all are events. But only those events are recorded in books of account which involved some financial transactions. So, appointing Managing Director and adopting managerial policy is not recorded in books of account as it does not have any direct financially measurable value. However, purchasing machinery and raw material are recorded in books of account because these is financial transaction involved in these events.
- Measurement: Measurement means quantification of business transactions into financial terms by using monetary unit, viz. rupees and paise as a measuring unit. The events which cannot be measured in financial terms are not recorded in books of account. So, events like appointment of Managing Director, adoption of managerial policies are not shown in the books of accounts
- Recording: Recording is process of recording identified and measured economic events in books of account in monetary terms in a chronological order. Recording is done in such a way that necessary financial information is summarised can be made available as and when required.
- Communication: Once the economic events are identified, measured and recorded, the important information is generated and communicated to the management and other users. The information is communicated through the accounting reports, so that the users of information can assess the financial position and performance of firm. The accounting information system should be designed in such a way that the right information is communicated to the right person at the right time
Interested users of information
Accounting is a means by which necessary financial information about business enterprise is communicated. Many users need financial information in order to make important decisions.
The users of financial information can be divided into two broad categories:
- Internal Users: The internal users are mainly management people, who needs timely information on cost of sales, profitability, etc. for planning, controlling and decision-making. The internal users include Chief Executive, Financial Officer, Vice President, Business Unit Managers, Plant Managers, Store Managers, Line Supervisors, etc
- External Users: The external users are external to the organisation. They have limited authority, ability and resources to obtain the necessary information and have to rely on financial statements. The external users include Investors, Unions, Employee groups, Lenders, Financial institutions, Suppliers, Creditors, Customers, Government, Regulators, Social responsibility groups, Competitors etc.
Other Important Definition of Accounting
The other important definitions of accounting are:
- American Institute of Certified Public Accountants (AICPA)
In 1941, The American Institute of Certified Public Accountants (AICPA) had defined accounting as the art of recording, classifying, and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof’.
- American Accounting Association (AAA)
In 1966, the American Accounting Association (AAA) defined accounting as ‘the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of information’.
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