The record-keeping function is done in Journal and subsidiary books also called as primary books. Every proper record-keeping system includes suitable classification of transactions and events as well as their summarization for future reference.
After the transactions and events are recorded in the books of prime entries, they are transferred to secondary books of account i.e. Ledger. In ledger transactions and events are classified in terms of incomes, expenses, assets and liabilities according to their characteristic and then summarised in the profit and loss account and balance sheet. These are also known as the fundamentals of accounting.
“The function of accounting is to provide quantitative information, primarily of financial nature, about economic entities, that is needed to be useful in making economic decisions.”Accounting Principles Board of American Institute of Certified Public Accountants (AICPA)
Fundamentals of Accounting or Procedural Aspects of Accounting
A. Generating financial information and
B. Using the financial information
Generating Financial Information
Generating financial information is concerned with preparing financial information which has several stages right from recording transactions. Following steps are involved in generating financial information:
- Recording – This is the first and foremost function of accounting. All business transactions having financial nature, as evidenced by some sort of documents like sales bill, purchase bill, bank pay-in-slip etc. are recorded in the books of account. The recording is done in the prime book of entry i.e. Journal. It may further be categorised in subsidiary books.
- Classifying: – Classification is concerned with the systematic analysis of the recorded data, with a view to group transactions of similar nature so as to make the data more comparable and useful. The book containing classified information is called “Ledger.”
- Summarising: – Summarising is concerned with the preparation and presentation of the classified data in a manner useful to the internal as well as external users of the financial statement. Under this process following financial statements are prepared:
- Profit & Loss A/c or Income Statment: This is the first financial statement prepared and shows revenue and expenses of the entity. This statement is used to calculate net profit or loss.
- Statement of Changes in Equity: This is the second statement prepared, and details the changes in equity from the beginning to the end of the reporting period. The essential purpose of the statement is to provide a comprehensive summary of all changes in equity, including those not included in the income statement.
- Balance Sheet: this statement follows on from the statement of changes in equity and is a statement of the entity’s assets, liabilities and equity. You will notice how the accounting equation holds true within the Balance Sheet (i.e. A = L + E). You will also notice how Assets and Liabilities are separated in the Balance Sheet as current and non-current and we will explore these types of distinctions.
- Cash –Flow Statement: A cash flow statement helps to identify actual cash inflows and outflows which took place during the financial year. The figures available in the income statement and balance sheet reflect a gross position which includes both cash and non-cash substances.
- Analysing: – The figures given in the financial statements do not help anyone unless they are presented in simplified form. For making them useful, some sort of analysis is required. Here analysis refers to the methodical classification of the data given in the financial statement. For instance, all items relating to fixed assets are given in one place while current assets are shown separately in the Balance Sheet.
- Interpreting: – This is the final function of accounting. It is related with explaining the meaning and significance of the relationship established by the analysis of accounting data. Simply it means the presentation of the result in literal terms.
- Communicating: – It is directed toward the transmission of summarised, analysed and interpreted information to the end-users to make the decisions. This is done by preparation and distribution of accounting reports which consist apart from final accounts, the accounting ratios, graphs, charts etc.
Using Financial Information
Once the financial information is ready, it must be used by the users of accounting information. Following are some basic users of financial information such as:
- Owners of the business
- Customer and Public