What is Accounting?
The main objective of every business is to earn a profit. But at the end of every month, quarter and year a business owner needs to answer some very specific questions: How much did I make? How much stock is sitting in the warehouse? Who owes me money and who do I owe? Can I afford to expand?
You cannot answer any of those reliably from memory. You need a complete, systematic record of every transaction — and a way to summarise that record into reports. That system is accounting.
The 7 Functions of Accounting
Every accounting system, from a shopkeeper's notebook to an enterprise ERP, performs the same seven functions in the same order:
- Identifying — picking out the financial transactions from source documents (invoices, cash memos, agreements, receipts) and measuring them in rupees.
- Recording — writing down every identified transaction in chronological order in the journal or subsidiary books.
- Classifying — grouping similar transactions together into ledger accounts (all cash transactions in the Cash A/c, all sales in the Sales A/c, and so on).
- Summarising — using the classified data to prepare the trial balance, Profit & Loss account, and Balance Sheet.
- Analysing — establishing relationships between figures (gross profit margin, current ratio, debtor days) to find financial strengths and weaknesses.
- Interpreting — explaining what the analysis actually means for the business owner.
- Communicating — sharing the final reports with the people who need them: the owner, lenders, tax authorities, investors.
Steps 2 through 5 — recording, classifying, summarising and analysing — are fully automated inside iAccounting. You upload an invoice or type a transaction; the software handles every step from journal entry to balance sheet automatically.
See all automated features →The Accounting Cycle
These functions repeat every accounting period in a continuous loop called the accounting cycle:
| Step | Activity | Output |
|---|---|---|
| 1. Transaction | A financial event occurs — a sale, purchase, payment, receipt. | Source document (invoice, voucher) |
| 2. Journal Entry | The transaction is recorded chronologically as a debit to one account and a credit to another. | Journal book |
| 3. Posting | The journal entry is transferred to individual ledger accounts. | General ledger |
| 4. Trial Balance | At period end, total debits and credits are listed to verify arithmetical accuracy. | Trial balance |
| 5. Financial Statements | From the trial balance, the Trading A/c, P&L A/c, Balance Sheet and Cash Flow are prepared. | Final accounts |
The cycle then restarts with the next transaction and continues for as long as the business exists.
Book-keeping vs Accounting vs Accountancy
These three words get used interchangeably but they mean different things:
- Book-keeping covers the first four functions — identifying, measuring, recording and classifying. It is routine, clerical work that can be done by a junior staff member.
- Accounting begins where book-keeping ends. It covers summarising, analysing, interpreting and communicating. It needs analytical skill and is usually done by qualified accountants.
- Accountancy is the body of knowledge — the principles, conventions and standards — that governs both book-keeping and accounting.
| Basis | Book-keeping | Accounting |
|---|---|---|
| Objective | Maintain systematic records | Ascertain results & financial position |
| Phase | Recording phase | Summarising phase |
| Stage | Primary — basis for accounting | Secondary — starts where book-keeping ends |
| Skill | Routine, no special skill | Analytical, needs expertise |
| Who does it | Junior staff (book-keepers) | Senior staff (accountants) |
Objectives of Accounting
- Keep systematic records of every business transaction so nothing is omitted or fraudulent.
- Calculate profit or loss for the period through the Trading and Profit & Loss account.
- Ascertain the financial position of the business through the Balance Sheet — a snapshot of assets, liabilities and capital.
- Provide information to interested parties — owners for decision-making, banks for loans, tax authorities for compliance, and investors for valuation.
Branches of Accounting
Accounting has grown into three specialised disciplines:
- Financial accounting — recording transactions and preparing financial reports for external users like banks, shareholders and tax authorities. This is what most people mean when they say "accounting".
- Cost accounting — analysing the cost of producing each unit or service so management can price correctly and control expenses.
- Management accounting — pulling data from financial and cost accounting to support internal decisions: budgeting, pricing, capital expenditure, performance review.
Advantages & Limitations of Accounting
What accounting gives you:
- Protection of business assets through proper records
- Evidence for tax assessments — proper books are your defence in any audit
- A reliable record that replaces memory
- Year-over-year comparison to spot trends
- Bankable financials when applying for a loan
- A basis for valuing the business if you ever sell
What accounting cannot do:
- Capture qualitative factors — staff quality, customer goodwill, industrial relations
- Prevent "window dressing" if the owner deliberately manipulates entries
- Reflect inflation — assets sit at historical cost even when their market value has tripled
- Be 100% exact — depreciation, bad debts and stock valuation all involve estimates
Three Types of Accounting Information
| Information | Statement | What it tells you |
|---|---|---|
| Profit or Surplus | Profit & Loss Account | How much you earned or lost during the period |
| Financial Position | Balance Sheet | Where you stand on assets, liabilities and capital on a specific date |
| Cash Flow | Cash Flow Statement | How cash moved in and out during the period |
Continue Learning
Build on this lesson with these related tutorials: