Accounting - Three Major Areas

There are three major functional areas in accounting, which need to be considered in modern day accounting for any business. The three are financial, cost and management accounting.

The first area, namely financial accounting, is primarily useful for ascertaining the results of the business on a periodical basis; for example, one year. This will help to determine the future course of action in the long term. In economical terms, financial accounting treats money as a factor of production.

Cost and management accounting are tools to enable management to take decisions on a day-to-day basis. Cost and management accounting are not useful for their own sake. These two functions assist management in the conduct of the business along with other key factors involved in running of the business. Key factors could be demand, supply, competition, availability of raw material, logistics etc.

The second area, namely cost accounting, seeks to ascertain the value of direct costs and indirect costs involved in production . From this value, management can make an informed decision regarding the improvement of production performance. In economic terms, cost accounting is a measure of economic performance. This information gives management a clear indication of economic performance of the production resources of the business.

Costing also helps the sales manager in setting prices. But since costing is a measure of economic performance, it cannot be considered as an absolutely accurate basis for setting prices. This is because selling prices are more of an economic decision. It would not be amiss to mention here that prices depend basically on market factors. Prices depend more on demand, supply and competition and less on costs. For example, high demand coupled with lack of competition would mean that business could charge higher prices for its products, well above the costs.

The third area, namely management accounting, is closely interrelated with costing accounting. Although it has evolved from cost accounting, management accounting has a broader role to play in management decisions. It measures economic performance of the business enterprise as a whole, vis-a-vis the economic environment in which the business operates. This function of accounting seeks to combine the financial and cost information in a broader aspect.

Finally, management accounting is instrumental in assisting and advising management in making important business decisions. It makes management aware of the economic implications and consequences of their decisions. In economic terms, it implies a close study of money as an economic resource, while simultaneously treating it as a measure of economic performance. This enables management to measure it as an economic factor of production, e.g. the rate of return on capital employed.

It is thus seen that accounting has a distinct role to play in three different areas, which are equally vital. With the advent of computerised accounting, it has become very easy for management to monitor the accounting information on the tips of its fingers. Financial accounting programs enable financial statements and various cost and MIS statements to be produced almost instantly at push of a button. Now, only the laborious part of accounting is data entry. Financial managers must ensure that meaningful data is input into the system to produce meaningful information. Proper categorisation must be done, and keying errors avoided at all costs, ensuring providing accurate financial information to management.

Accounting guidelines and procedures

The world of accounting follows certain guidelines and procedures that compose of acceptable accounting practice at a given time. These set of guidelines and procedures are known as GAAP which means generally accepted accounting principles. The basics of accounting principles are as follows.

Adequate Disclosure

This accounting principle states that all relevant information which would affect the understanding and evaluation or assessment of the user of the accounting entity should be disclosed in the financial statements.

Consistency Principle
As the name, consistency, implies, there should be consistence. Firms should use the same accounting method from period to period in order to attain comparability over time within a single enterprise. Nevertheless, companies are allowed to change as long as it is justifiable and be disclosed in the financial statements.

Expense Recognition Principle
In this principle, it is stated that expenses should be recognized in the accounting period wherein goods and services are used up to generate revenue and not when the entity pays for those services and goods.

Historical Cost
This principle states that purchased assets should be recorded at their actual cost and not what management thinks they are worth as at reporting date.

Materiality
It should be noted that financial reporting is only concerned with information that is significant enough that will likely affect assessments and decisions. Materiality is dependent on the size and nature of the item judged in the particular situations of its omission. Upon deciding as to whether an item or collection of items is material, the nature as well as the size of the item is assessed together. Either of the nature of the item or the size may be the determining factor, depending on the circumstances.

Objectivity Principle
Records and statements in accounting are based on the most reliable information available in order for them to be as accurate and as useful as possible. Information that is considered reliable may be verified and confirmed by independent observers. It is mainly ideal in accounting that all records are based on information, which flows from activities that are documented by objective evidence. Without the objectivity principle, accounting records may be based on opinions and impulses that may be subject to dispute.

Revenue Recognition Principle
In revenue recognition principle, revenue is to be recognized in the accounting period when services are rendered or performed or when goods have been delivered.

Definition of Accounting

There are several definitions of accounting.

Accounting may be defined as
(1) a service activity wherein its primary function is to supply quantitative information essentially financial in nature that is all about economic entities which may be significantly useful in decision making for top management.

Another definition Accounting may also be defined as
(2) the art of recording, classifying and summarizing in a considerable manner and in terms of money, business transactions, activities and events, which are part of a financial character and later on interpreting the results of the reports.

Another definition of accounting is
(3) the process of identifying, measuring and communication economic information to allow knowledgeable judgments and decisions by all users of the information.