Accounting – Its Role Past and Present
By: Michael Russell
To begin with let's examine the old concept of accounting. The age old concept of accounting is that of historical accounting. The accountant recorded the expenses, sales and income at the end of the period. Typically for the historical accounting process only two statements were important. First priority is the Profit or Loss Account statement for ascertaining the profit or loss of a business for the period; usually for a year. Normally if the business was doing well, the incomes would be more than the expenses and the Profit and Loss account statement would show a profit. Secondly the Balance Sheet showed the list of assets owned or monies to be received by the business, which was counterbalanced by a list of liabilities owed by the business. In a profitable business, the total value of assets would be substantially more than the liabilities, and the difference between the assets and liabilities would be shown on the liabilities side as the capital and reserves of the owner of the business.
In order to derive a correct picture of the profit or loss for the current period, the accountant had to ensure that only current period expenses or incomes were taken into the Profit and Loss account. Accounting conventions were gradually developed to apportion future period or past period expenses, and income that was reflected in the Balance Sheet during the current period. Assets purchase for a certain value were considered to have a life of certain number of years. Hence, the value of the asset was shown in the Balance Sheet statement. The total value of the asset divided by the life of the asset would give us the expense value of the asset for a particular year - known as depreciation and shown in the Profit & Loss Account − while at the same time reducing the value of the asset in the Balance Sheet statement. Similarly future period expenses or advance payments had to be shown in the Balance Sheet for the current period and reflected in the Profit and Loss account statement of the relevant period in the future.
But with fast progress and competitive environment in business, accounting has transformed into a more dynamic and management oriented role and historical nature of accounting though necessary has been relegated to secondary role. The Profit and Loss Account and Balance Sheet is now mostly useful from the tax man's and shareholder's perspective. But from a number of ratios derived from these two statements would give the shareholder the pulse of the health of the business as a whole.
In its transformed role, accounting has taken on the task of timely management information for running the business effectively so that analysis of figures, forecasts, projected costs and sales etc. are absolutely necessary for the management to function effectively. A number of statements which provide the important accounting information such as Cash Flow, Sources and Analysis of Funds, Budgeting, Cost Centre analysis, Forecasting etc. are some of the important management information related statements.
A typical business will evaluate many aspects of its business using accounting and economic principles. One area of focus would be the various types of capital and ownership, and types of monetary capital employed in the business specifically. Investment in capital employed would be further bifurcated into fixed assets and their nature, current assets and their nature. Interpretation of accounts using Profit and Loss Account and Balance Sheet ratios for the company as a whole and departmental wise would enable the management to work out added values and long term business trends.
Capital gearing ratios ascertain the proportion of share capital to Loan Capital should help management decide whether one or the other ought to be more or less.
Goal oriented businesses have to determine the profit target say 15% as a return on capital employed and then direct the business to achieve that goal. The goal of course has a limiting factor of production or sales and hence preparation of sales and production targets are also necessary. Eventually if the management finds that the profit margin is insufficient to meet yield on capital employed, then either the sales target has to be enhanced or economies of production have to be effected to meet the profit margin.
To determine and to pursue their goals, detailed budgets must be prepared and management has to keep an eye on deficit and deviations measured to remain alert and repair the damage as soon as possible. In summary, it would be appropriate to say that accounting today has a multi dimensioned role and is primarily focused on meeting the company management's focus on sales and profit. Hence it has both a management accounting and financial accounting perspective for survival and flourishing of the business today.