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Financial Accounting - Role of Accounting, Objectives of Accounting - Limitations of Accounting

Updated on January 12, 2015
Financial Accounting - Role of Accounting, Objectives of Accounting - Limitations of Accounting
Financial Accounting - Role of Accounting, Objectives of Accounting - Limitations of Accounting | Source

Role of Accounting

Accounting is not an end in itself; it is a means to an end. It assists by providing quantitative financial information that can be helpful for the users in making better decisions regarding their business. Accounting also describes and analyses the mass of data of an organisation through measurement, classification, and as well summation, and simplifies that data into reports and statements, which show the financial situation and results of operations of that organisation. Accounting as an information system gathers processes and carries information about an organisation to a wide variety of interested investors or other parties.

Differences between Accounting and Book-Keeping

Book keeping generally involves only the collection of business transactions (transactions) and is therefore, just one part of the process of accounting. About the accounting, this involves the complete accounting process, i.e. identification, measurement, collection, and communication. These days, much of the book keeping function is processed by the computer and other technology.

Objectives of Accounting

The basic aim of accounting is to give information to the interested parties to enable them all to make important business decisions. The required information, particularly in the case of external parties, is given in the basic financial statements: Profit and loss statement and the Balance sheet.

Besides the said sources of information, the internal parties, officers and other staff of the company, can get additional information from the records of organisation. Thus the primary objectives of accounting can be stated as :

  1. Maintenance of Records of Business transactions
  2. Calculation of Profit or Loss
  3. Processing of Financial Position
  4. Provide Information to the Parties

Maintenance of Records of Business

First record, then pay; if there is an error, trace it from the records and correct the same. Human memory is limited and that is true. Even the most intelligent personnel cannot accurately recollect what he might have come across in the daily operations. He need not bother of stress his memory for no reason, if proper and quite records of all business transactions are kept completely. Also, records can be used by different personnel for different decision-making purposes.

Calculation of Profit or Loss

Making profit is the sole purpose of any business. The information related to the profits are available from the profit and loss statement. Profit is calculated by taking out expenses from the associated revenues. Profit is a measure of the performance of the organisation.

Depiction of Financial Position

A balance sheet reflects the financial position of an organisation. It is a statement of assets and liabilities. It shows the assets owned by an organisation and depicts the liabilities against the assets. The balance of assets minus the external liabilities shows the capital.

Provide Information to the Parties

Generation of information is not an end in itself. It is a means to facilitate the dissemination of information among different user groups. Therefore, communication of information is the essential function of accounting. Accounting information is communicated in the form of reports, statements, graphs and charts to the internal and external users who need it in different decision situations.

Internal users: The officers and staff of an enterprise need useful and timely information for making different types of business decisions. A major objective of accounting is to provide management with relevant and reliable information. For example, some of the questions a manager might ask are:

  • How much profit did the company make during the last accounting period?
  • Is the return to share holders adequate?
  • How can it be improved?
  • Does the company have enough cash on hands to pay debts when they fall due?
  • What are the projected cash needs in the next quarter?
  • Which are the most profitable products?
  • What is the cost of manufacturing each product?
  • Which costs exceed the budget?
  • How much money should be borrowed to expand the business?

External users: The outside users have limited authority, ability or resources to obtain information. Unlike internal users, they have to rely on financial statements (Balance sheet, Profit and Loss statement) as their principal source of information about an enterprise's economic activity. Primarily the external users are interested in the following:

The amount and the time when they are likely to receive cash in the future from dividend, interest etc.
Reliable information about economic resources (assets) and obligations (liabilities) of a business enterprise in order to evaluate its strengths and weaknesses, and its financial position in general.
Information about the performance and the earning power of the business enterprise.
Any other information relevant to the users needs.

Limitations of Accounting

Accounting records relate to the transactions that are completed, which provide fairly good account of the transaction of the business organisation. However, for decision-making we need the information, which relates not only to past but also about present and future. Financial accounting makes provision for financial information but it does not provide non-financial information such as behavioral and socio-economic. If the objective of accounting reports is to influence the behavior through decision-making then it must provide the data concerning the behavior and outcome of human activity to facilitate performance evaluation. Therefore, the accounting information does not fully meet different types of information-requirements of varied decision making situations. Accounting provides stewardship information and not decisional information.

© 2009 Dilip Chandra


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