Accounting: meaning, definitions, objectives, functions and limitations

1. Meaning

Every business enters into transactions: it buys, sells, pays wages, borrows and repays. Accounting is the systematic process of recording those transactions in money terms, classifying them under proper heads, summarising them into statements, and interpreting the results for those who have to take decisions. It is often called the language of business, because the results of a business are communicated to owners, lenders and the State through accounts.

2. Definitions

• American Institute of Certified Public Accountants (AICPA), 1941: “Accounting is 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 a financial character, and interpreting the results thereof.”
• American Accounting Association (AAA), 1966: accounting is “the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information.”

The AICPA definition gives the steps; the AAA definition gives the purpose, which is to serve users. From both, the attributes of accounting are: it deals only with transactions of a financial character; it records them in money; it is both an art and a science; and it ends in interpretation, not merely in records.

3. Book-keeping and accounting distinguished

Book-keeping is the recording part: entering transactions in the journal and subsidiary books and posting them to the ledger. Accounting begins where book-keeping ends.

4. Objectives of accounting

1. Systematic record of all transactions, because memory cannot hold them.
2. Ascertain profit or loss for a period, through the Trading and Profit and Loss Account.
3. Ascertain financial position on a date, through the Balance Sheet: what the business owns and what it owes.
4. Protect the business property by recording what is owed to and by the business, so that fraud and misuse are detected.
5. Supply information to users for decisions.
6. Meet legal requirements: the Companies Act 2013 (section 128 on books of account, section 129 on financial statements), the GST law and the income-tax law all require proper books.

5. Functions of accounting

• Recording — in the journal and subsidiary books, in date order.
• Classifying — posting to ledger accounts, so that all transactions of one kind sit together.
• Summarising — preparing the trial balance and final accounts.
• Analysing and interpreting — working out ratios and trends and explaining what the figures mean.
• Communicating — reporting the results to owners, lenders and authorities.
• Legal compliance and protection of assets — keeping records that satisfy statute and support the business in disputes.

6. Users of accounting information

Internal users: owners and management (planning and control) and employees (bonus, wage claims, job security). External users: investors and shareholders, creditors and banks (credit-worthiness), government and tax authorities, customers, researchers and the public.

7. Branches of accounting

• Financial accounting — records transactions and prepares the final accounts for outsiders. This paper is about it.
• Cost accounting — ascertains and controls the cost of each product or process.
• Management accounting — presents information to management for planning, control and decision-making.
• Others: tax accounting, government accounting, social responsibility accounting.

8. Advantages

Accounts replace memory; they show profit and position; they allow comparison between years and between firms; they are evidence in courts and before tax authorities; they help in raising loans; and they help value the business on sale or admission of a partner.

9. Limitations of accounting

1. Only money transactions are recorded. The skill of the management, a strike, or the loss of a key employee does not appear.
2. Historical cost. Assets are shown at cost, not current value, so the Balance Sheet does not show what the business is worth.
3. Price-level changes ignored. Money is assumed to have a stable value; inflation distorts comparisons over years.
4. Estimates and personal judgment — depreciation, provision for doubtful debts, stock valuation — make the profit partly an opinion.
5. Choice of methods (straight line or written down value; FIFO or weighted average) means two firms with the same facts can report different profits.
6. Window dressing: accounts can be manipulated to show a better position.
7. Past-oriented: accounts tell what happened, not what will happen.

How this is examined

Unit I carries one 10-mark essay and one 6-mark note in the 80-mark paper. Recent essays: “What is accounting? Explain objectives and functions of accounting” (January 2026); “Define accounting. Explain concepts of accounting” and “What is book-keeping? How does it differ from accounting?” (June 2025). Short notes: “Limitations of accounting” (June 2025).

Open with the AICPA definition, word for word, and split it into its four steps. For the book-keeping question the table in section 3 earns most of the marks; add a line that book-keeping is the base and accounting the superstructure. For “objectives and functions”, keep the two lists separate: objectives are what accounting aims at, functions are what the accountant does.