Advantages and limitations of accounting Lesson Note
This SS1 ACCOUNTING lesson note covers Advantages and limitations of accounting for First Term, Week 3.
Learning Objectives
- By the end of the lesson, students should be able to:
- Recapitulate the features of accounting information.
- Recall the strengths and weaknesses of accounting.
- Explain the accounting process cycle in the correct order.
- Justify why the accounting process cycle follows a particular order.
Lesson Note
A. Introduction
Accounting helps a business owner to record, organise and understand the financial activities of the business. It provides information that helps people make good decisions. However, accounting also has some limitations.
B. Meaning of Accounting
Accounting is the process of recording, classifying, summarising, analysing and communicating the financial activities of a business.
C. Features of Good Accounting Information
Good accounting information should have the following features:
Accuracy: It should be correct and free from major errors.
Relevance: It should provide information that is useful for making decisions.
Reliability: Users should be able to depend on the information.
Understandability: The information should be easy to understand.
Comparability: It should allow users to compare the performance of a business over different periods.
Timeliness: The information should be available when it is needed.
Completeness: Important financial information should not be left out.
D. Advantages of Accounting
The major advantages of accounting include:
Proper record keeping: Accounting keeps a permanent record of business transactions.
Determines profit or loss: It helps the business owner know whether the business made a profit or suffered a loss.
Shows financial position: It helps to show what the business owns, owes and the owner’s interest in the business.
Helps decision-making: Accounting information helps managers and owners make better business decisions.
Helps to control expenses: Records can help the owner identify unnecessary spending.
Helps in planning: Past financial information can be used to plan for the future.
Prevents fraud: Proper records can make it easier to detect some forms of fraud and errors.
Useful to outsiders: Banks, investors, government and other interested persons can use accounting information to assess the business.
Helps in obtaining loans: Financial records may be required when a business applies for a loan.
Helps to compare performance: A business can compare its current performance with previous years.
E. Limitations of Accounting
Although accounting is useful, it has some weaknesses:
It deals mainly with money: Things that cannot easily be measured in money may not appear in the accounting records.
It may contain errors: Mistakes can occur when transactions are recorded or calculated.
It uses estimates: Some accounting figures, such as depreciation, may be based on estimates.
It does not show everything about a business: Factors such as employee morale, customer loyalty and good management may not be fully shown in the accounts.
It can be affected by personal judgement: Accountants may have to make decisions when applying certain accounting rules.
It can be expensive: Keeping proper accounting records may require trained staff, computers and accounting software.
It may not show the current value of some assets: Some assets may be recorded using accounting values rather than their current market values.
Past information may not predict the future: Accounting records mainly show what has happened in the past and may not always tell exactly what will happen in the future.
Fraud may still occur: Proper accounting records can reduce fraud but cannot completely prevent it.
It may be difficult for some people to understand: Financial statements can contain technical terms and figures that may be confusing to people without accounting knowledge.
F. Accounting Process Cycle
The accounting process is a series of steps followed to turn business transactions into useful financial information.
The steps are:
1. Identifying transactions
The business first identifies transactions that have a financial effect, such as buying goods, selling goods, paying rent or receiving money.
2. Recording transactions
The transactions are recorded in the appropriate books of original entry, such as the sales journal, purchases journal and cash book.
3. Posting to the ledger
The information recorded in the books of original entry is transferred to the appropriate ledger accounts.
4. Preparing the trial balance
The balances from the ledger accounts are listed in a trial balance to check whether the total debit balances are equal to the total credit balances.
5. Making adjustments
Necessary adjustments are made for items such as depreciation, accrued expenses, prepaid expenses and closing inventory.
6. Preparing financial statements
The adjusted information is used to prepare financial statements such as the income statement and statement of financial position.
7. Analysing and interpreting the information
The financial information is examined to understand the performance and financial position of the business.
8. Making decisions
The information is then used by owners, managers and other users to make appropriate business decisions.
G. Correct Order of the Accounting Process Cycle
Identify transactions → Record transactions → Post to ledger → Prepare trial balance → Make adjustments → Prepare financial statements → Analyse and interpret → Make decisions
Why the Steps Must Follow This Order
The steps follow this order because each stage depends on information obtained from the previous stage.
For example, a transaction must first take place before it can be recorded. The recorded information is then posted to the ledger. The ledger balances are needed to prepare the trial balance. After checking and adjusting the figures, the financial statements can be prepared. Finally, the information can be analysed and used for decision-making.
Therefore, changing the order may result in incomplete, inaccurate or misleading accounting information.
Summary
Accounting is useful because it helps a business keep records, determine profit or loss, know its financial position and make decisions. However, accounting has limitations because it mainly deals with financial information and may involve errors, estimates and personal judgement.
The accounting process follows a logical order from identifying transactions to making decisions. Each step provides information needed for the next step.
Evaluation
Objective Questions
1. Accounting helps a business to determine its ______. A. colour B. profit or loss C. location D. age
2. Which of the following is a feature of good accounting information? A. Confusion B. Relevance C. Secrecy D. Guessing
3. One major limitation of accounting is that it mainly deals with information that can be measured in ______. A. kilograms B. metres C. money D. litres
4. Which of the following comes first in the accounting process? A. Preparing financial statements B. Identifying transactions C. Preparing a trial balance D. Making decisions
5. Transactions are recorded before they are ______ to the ledger. A. posted B. deleted C. destroyed D. ignored
6. The trial balance is prepared mainly from the ______. A. ledger accounts B. invoices only C. bank statement only D. receipts only
7. Which of the following is an advantage of accounting? A. It prevents all fraud completely. B. It helps in decision-making. C. It predicts the future perfectly. D. It records non-financial matters completely.
8. Which of the following may require estimation in accounting? A. Depreciation B. Cash received C. Cash paid D. Sales invoice
9. Financial statements are prepared after necessary ______ have been made. A. advertisements B. adjustments C. purchases D. interviews
10. The final purpose of accounting information is to help users make ______. A. decorations B. decisions C. drawings D. uniforms
Theory Questions
1a. What is accounting?
1b. State five features of good accounting information.
2a. Mention five advantages of accounting.
2b. State five limitations of accounting.
2c. What is meant by the accounting process cycle?
List the steps involved in the accounting process in their correct order.
Why must transactions be identified before they are recorded?
Explain why a trial balance is prepared.
State three reasons why accounting information is useful to a business.
Why can accounting not show every important thing about a business?