What is Accounting?
Definition: Accounting is the process of identifying and recording business events as well as presenting and communicating this financial information to end-users in a meaningful way. In other words, accounting is more than just recording the debits and credits of transactions. Accounting is really a system or process of recording information and displaying it to people in an understandable way, so that they can make decisions based on the financial information.
Accounting is the process of recording financial transactions pertaining to a business. The accounting process includes summarizing, analyzing, and reporting these transactions to oversight agencies, regulators, and tax collection entities. The financial statements used in accounting are a concise summary of financial transactions over an accounting period, summarizing a company’s operations, financial position, and cash flows.
The primary function of accounting is to make records of all the transactions that the firm enters into. Recognizing what qualifies as a transaction and making a record of the same is called bookkeeping. Bookkeeping is narrower in scope than accounting and concerns only the recording part. For the purpose of recording, accountants maintain a set of books. Their procedures are very systematic. Nowadays, computers have been deployed to automatically account for transactions as they happen.
Recording for transactions creates raw data. Pages and pages of raw data are of little use to an organization for decision making. For this reason, accountants classify data into categories. These categories are defined in the chart of accounts. As and when transactions occur, two things happen, firstly an individual record is made and secondly the summary record is updated.
For instance a sale to Mr. X for Rs 100 would appear as:
- Sale to Mr. X for Rs 100
- Increase the total sales (summary) from 500 to 600
Management is answerable to the investors about the company’s state of affairs. The owners need to be periodically updated about the operations that are being financed with their money. For this reason, there are periodic reports which are sent to them. Usually the frequency of these reports is quarterly and there is one annual report which summarizes the performance of all four quarters. Reporting is usually done in the form of financial statements. These financial statements are regulated by government bodies to ensure that there is no misleading financial reporting.
Lastly, accounting entails conducting an analysis of the results. After results have been summarized and reported, meaningful conclusions need to be drawn. Management must find out its positive and negative points. Accounting helps in doing so by means of comparison. It is common practice to compare profits, cash, sales, assets, etc with each other to analyze the performance of the business.
What Does Accounting Mean?
The accounting process starts with identifying a business event or transaction. First, we can to identify something to record before we can record it. : ) For example, assume Sally purchases a truck from Bob’s Auto Mart for $10,000 and signs a 3-year $8,000 note payable. This purchase is a business transaction that can be measured and changed the accounting equation. Thus, it must be recorded.
After we identify a transaction that needs to be recorded, we record a journal entry in a double entry accounting system. In this case, Sally would record a debit of $10,000 to the vehicle asset account and a credit of $8,000 to the notes payable account, and a credit of $2,000 to the cash account. Both debits and credits are always recorded to reflect every business transaction.
Accounting doesn’t just stop when the journal entry has been recorded. The entire purpose of accounting is to provide useful information to end-users. Not that we have financial information, the journal entries, we have to present them in a way that makes sense to investors, creditors, and anyone else who is looking to make decisions about the company. The accounting process culminates in the creation of the general purpose financial statements. These reports communicate the financial position of a company to decision makers and end-users.
Identifying, recording, and communicating financial information to end-users is the essence of accounting.
Why does Accounting Matter?
Accounting is tremendously important because it is the language of business, and it is at the root of making informed business decisions. Without accounting, managers would not know which products were successful, which business decisions were the right ones, and whether the company was earning money. It would not know how much to pay in taxes, whether to lease or buy an asset, or whether to merge with another company. In short, accounting doesn’t just count the beans, it measures a company’s success at meeting its goals and it helps investors understand how efficiently their economic resources are being used. This is why companies must be proficient in accounting in order to make good decisions.
Accounting can be controversial, in that accounting rules and methods are sometimes subject to interpretation or can appear to distort a company’s true performance. This is another important reason that effective leaders and managers must thoroughly understand the accounting impact of their decisions.
Requirements for Accounting
In most cases, accountants use generally accepted accounting principles (GAAP) when preparing financial statements in the United States. GAAP is a set of standards and principles designed to improve the comparability and consistency of financial reporting across industries. Its standards are based on double-entry accounting, a method in which every accounting transaction is entered as both a debit and credit in two separate general ledger accounts that will roll up into the balance sheet and income statement.
Types of Accounting
Financial accounting refers to the processes used to generate interim and annual financial statements. The results of all financial transactions that occur during an accounting period are summarized into the balance sheet, income statement, and cash flow statement. The financial statements of most companies are audited annually by an external CPA firm. For some, such as publicly traded companies, audits are a legal requirement. However, lenders also typically require the results of an external audit annually as part of their debt covenants. Therefore, most companies will have annual audits for one reason or another.
Managerial accounting uses much of the same data as financial accounting, but it organizes and utilizes information in different ways. Namely, in managerial accounting, an accountant generates monthly or quarterly reports that a business’s management team can use to make decisions about how the business operates. Managerial accounting also encompasses many other facets of accounting, including budgeting, forecasting, and various financial analysis tools. Essentially, any information that may be useful to management falls underneath this umbrella.
Just as managerial accounting helps businesses make decisions about management, cost accounting helps businesses make decisions about costing. Essentially, cost accounting considers all of the costs related to producing a product. Analysts, managers, business owners and accountants use this information to determine what their products should cost. In cost accounting, money is cast as an economic factor in production, whereas in financial accounting, money is considered to be a measure of a company’s economic performance.
Accounting Information Systems
An accounting information system is a part of an organization’s information system that focuses on processing accounting data. Many corporations use artificial intelligence-based information systems. Banking and finance industry is using accounting information system as fraud detection. Retail industry is using accounting information system for customer services. Accounting information system is also used in cybersecurity industry. It involves computer hardware and software systems and using statistics and modeling.
Tax accounting in the United States concentrates on the preparation, analysis and presentation of tax payments and tax returns. The U.S. tax system requires the use of specialised accounting principles for tax purposes which can differ from the generally accepted accounting principles (GAAP) for financial reporting. U.S. tax law covers four basic forms of business ownership: sole proprietorship, partnership, corporation, and limited liability company. Corporate and personal income are taxed at different rates, both varying according to income levels and including varying marginal rates (taxed on each additional dollar of income) and average rates (set as a percentage of overall income).
Accounting information is summarized to produce financial statements. Financial Statements provide an overview of the financial activities of a business during a period (e.g. cash flow, income and expenses during the year) as well as information about its financial position on a specific date (e.g. amount of cash and inventory at the end of the year).
Financial Statements help owners in assessing the performance and position of their business which can guide their investment decisions (e.g. whether they should invest more in the business, diversify or dispose their investment).
Planning and Control
Accounting helps organizations to plan their finances by developing budgets and forecasts. Variance analysis provides a mechanism for the monitoring of expenses incurred by organizations by comparison with the budgeted expenditure. This process helps organizations in planning their finances ahead and controlling any deviations from the budget.