Advantages of Accounting
Accounting is a process that involves recording the financial transactions related to business. The process includes summarizing, analyzing and reporting these transactions to regulators. Agencies and tax collection entities. While there are too many benefits in accounting, it also has some disadvantages.
Advantages and Disadvantages of Accounting Information
Maintenance of Business Records: Records of all the transactions related to a business for a particular period in the book of accounts.
Preparation of Financial Statements: Financial statements like Profit and loss account, Cash flow statement, and Balance Sheets are prepared with the recorded transactions.
Comparison of Results: The financial statements facilitate the comparison of business results of a year with the other one easily.
Decision Making: Ultimately, it becomes easier for the decision making authorities to make a decision or plan for future activities.
Evidence in Legal Matters: Thus prepared records to become evidence in the court of law.
Provides Information to Related Parties: Proper Accounting records make financial information available for the owners, employees, customers, government etc.
Helps in Taxation Matters: Accounting information helps the tax authorities for settlement of taxation matters.
Valuation of Business: Accounting information helps in measuring the value of the business in case of sale of an entity.
Replacement of Memory: Recording of accounting information replaces the necessity to memorize records.
Disadvantages of Accounting
Records in Terms of Money: Since the transactions that are measurable in terms of money can only be recorded, non-financial transactions are not given effect in the book of accounts.
Records Based on Estimates: Certain data are based on estimates and of the accuracy of records may not be possible.
Records may be Biased: Since the accountant’s influence affects the accounting information, it may be biased.
Records at the Original Cost: The balance sheet may not disclose the exact financial status of the company due to the difference between the original cost and replacement cost due to the various aspects.
Manipulation of Accounts: The accountant may manipulate the profits of the business.
Money as a Measurement Unit Changes in Value: Since the value of money keeps changing, the accounting information will not show the true economic position of the company.
Advantages and Limitations of Accounting
What are the advantages of Accounting?
The major advantages of accounting are complete and systematic records, determination of selling price, valuation of the business, helps in raising a loan, evidence in the court of law, in compliance of the law, inter-firm or inter-firm comparison.
There are benefits of accounting like controlling budgets, forecasting revenues, major business decisions, tracking business expenses, record-keeping for financial institutions for taxation, monitoring business growth, etc. that contribute to the better economic growth of the business. The limitations of accounting standards are shown as an image below.
[Image will be uploaded soon]
What are the advantages of Final Accounts?
Preparing final accounts supports the trader to value the profitability of business at the end of a particular period, on comparing the gross profit with the sales of the company. To know the financial position and value of a business, the management prepares financial statements.
FAQs on Accounting: Merits and Demerits Simplified
1. What is accounting, explained in simple terms?
In simple terms, accounting is the systematic process of recording, summarising, analysing, and reporting a business's financial transactions. Its primary goal is to provide accurate and useful financial information to various stakeholders, such as owners, managers, investors, and government agencies, to help them make informed decisions.
2. What are the main advantages or merits of maintaining accounting records for a business?
Maintaining proper accounting records offers several significant advantages for a business. These include:
- Complete and Systematic Record: It ensures all financial transactions are recorded in an orderly manner, replacing the need to rely on memory.
- Performance Assessment: It helps in preparing financial statements like the Profit and Loss Account, which reveals the profitability of the business.
- Financial Position: The Balance Sheet, prepared from accounting records, shows the financial health of the business on a specific date.
- Facilitates Decision-Making: Management can use the financial data to plan future activities, prepare budgets, and make strategic decisions.
- Comparative Study: It allows for the comparison of financial results from one year to another, helping to analyse trends.
- Legal Evidence: Properly maintained records are accepted as evidence in a court of law.
- Assistance in Taxation: It helps in the correct calculation and settlement of tax liabilities like GST and income tax.
3. What are the key limitations or demerits of accounting?
Despite its many benefits, accounting has certain limitations that users must be aware of. The main demerits are:
- Ignores Non-Monetary Transactions: Accounting only records transactions that can be measured in money, ignoring important qualitative aspects like employee skill or customer satisfaction.
- Based on Estimates: Certain figures are based on estimates (e.g., provision for doubtful debts), which can affect the accuracy of financial statements.
- Influence of Personal Bias: The accountant's personal judgment in choosing accounting methods can influence the results.
- Based on Historical Cost: Assets are recorded at their original purchase price and not their current market value, which may not reflect the true financial position of the business.
- Potential for Manipulation: Accounts can be manipulated to present a better (or worse) financial picture, a practice known as 'window dressing'.
- Ignores Price Level Changes: It assumes the value of money is constant, ignoring the effects of inflation or deflation.
4. Why is accounting often referred to as the 'language of business'?
Accounting is called the 'language of business' because it communicates the financial results and health of a company to its stakeholders. Just like a language uses words and grammar to convey meaning, accounting uses debits, credits, and standardized financial statements (like the Balance Sheet and Income Statement) to tell the story of a company's performance and position. It translates complex business activities into a format that is understandable and useful for decision-making.
5. How can accounting information sometimes be biased or manipulated, even when rules are followed?
Accounting information can be biased or manipulated due to several factors. Firstly, accounting involves personal judgment. For example, an accountant must choose a method for asset depreciation or estimate the lifespan of an asset, which can affect profit figures. Secondly, the practice of 'window dressing' allows management to manipulate financial statements to show a more favourable position. This can be done by delaying expenses or booking future revenue in the current period to mislead investors or lenders.
6. What is the importance of using 'historical cost' in accounting, and what is its main drawback?
The importance of using historical cost (the original purchase price of an asset) is that it provides an objective and verifiable value. This cost can be easily proven with purchase documents, making the financial records reliable. However, its main drawback is that it does not reflect the asset's current market value. During periods of inflation, the value shown in the Balance Sheet can be significantly lower than the asset's real worth, potentially presenting a misleading picture of the company's financial position.
