Accounting

What is Accounting?

Accounting is the process of identifying, measuring, collecting, recording, classifying, analyzing, summarizing, and reporting financial statements to the end-users that are related to the organization.

Some definitions of Accounting include the following.

Weygandt, Kieso, and Kimmel defined it as

"An information system that identifies records and communicates the economic events of an organization to interested users."

Bierman and Drebin stated,

"It may be defined as identifying, measuring, recording, and communicating financial information."

According to the AICPA (American Institute of Certified Public Accountants),

"It is the art of recording, classifying and summarizing in a significant manner and terms of money, transactions, and events, which are, in part at least, of a financial character and interpreting the result thereof."

The information collected, classified, summarized, and reported is for the company/firm's stakeholders, who hold an economic interest in the company's financial performance. These stakeholders include investors, creditors, management, and regulators.

Accounting is the first and most important step in assessing a company's financial value. The more accurate and unbiased the information presented, the better for stakeholders' decision-making.

 History Of Accounting

Major events that took place in history:

• 2500 BCE - Evidence is found in ancient civilizations such as Egyptians, Greeks, and Romans, do have accounting systems to keep records.
• 423 BCE - Creation of auditing as a profession to double-check the warehouses, i.e., what comes in and goes out. 
• 1200 - The first requirement for firms to do accounting around Italy.
• 1494 - Luca Pacioli generated terms like 'debit,' ' credit,' and many more. He is known as the 'father of accounting.'
• 1900 - Double entry methods were developed during the Industrial Revolution, which created the CPA (certified public accountant) post.
• 1940 - GAAP was created and applied.
• 1995 - Created several automated systems like Peachtree etc.

Bartering was the primary method of exchanging money during the Middle Ages. Still, as Europe transitioned to a monetary economy in the 13th century, merchants began relying on this to track many transactions.

This was when double-entry began, in which the accountant entered a debit and credit value for each transaction. It was employed as an ad-hoc ordering system by merchants at the time.

It gave them access to real-time data about their enterprises, which they could use to make decisions about expanding their firms as they saw fit. It established the basis for how we use and comprehend it today.

Accountants must now adhere to its rules, auditing regulations, and ethical norms. Accountants and their peers are in charge of the economic monetary ebb and flow. They are not the only ones to blame, but they play a significant role.

Every business, organization, corporation, government, and individual must utilize at least basic accounting principles throughout their lives and frequently in their everyday actions.

It's a vital aspect of the company that has evolved through thousands of years into what we now call modern accounting.

How does Accounting work?

It is one of the most important functions for each kind of business: a bookkeeper or accountant at a small firm or even a bigger company.

It is a tool that will help you "account for" what your business has done, is doing, and hopes to do in the future.  

The reports and facts generated by practicing it are critical in helping the management make an illuminated business decision. 

The financial statements that summarize and analyze a large company's operations, financial position, and cash flows over a particular period are concise, concrete, and consolidated reports based on thousands of other individual financial transactions.

As a result, all the designations in the accounts department are the collective progress of years of study and precise examinations and experiments combined with a minimum number of years of practice.

A bookkeeper can look at primary functions in an organization.

Advanced accounting is usually handled by qualified employees such as Certified Public Accountant (CPA) or Certified Management Accountant (CMA), Certified Management Accountant (CMA), Chartered Accountant (CA), and Certified General Accountant (CGA).

Features & Characteristics Of Accounting

A few of the features are:

Identification of Financial Transactions

Identifying is determining which transactions and events are to be recorded. The process involves identifying the financial transactions that bring change to the firm's resources.

For example, the purchase of raw materials or the sale of finished goods these transactions are identified with the help of bills and receipts as evidence of the transaction. 

Measuring the Identified Transactions

We measure transactions and events in standard measurement units, i.e., the country's currency (money).

For example, you could purchase raw materials, such as 10 tonnes of steel for $25,000 and 1000 bags of cement for $275,000.

Recording

One of the primary functions is recording every financial transaction. In addition, it lays out guidelines for recording transactions in a detailed and systematic manner that firms can use in the future. 

The recording is chronological and can be done by someone who knows the basics and laws of accounts.

Grouping entries do the recording under a single head, making it easy to classify all financial transactions.

For example, journaling the transactions into various books such as purchase journals, sales journals, cash or bank journals, etc.

Classification

Another feature is to classify all financial transactions into different titles or categories. These categories are arranged according to their similarities in one book.

For example, all the payments received will show the receipts in the cash or memo book.

It assists in classifying all similar transactions under one heading, which makes finding transactions much easier. For example, the book in which the opening of the accounts is completed is called a ledger.

The process of classifying the transactions and putting them into a ledger is known as posting.

Summaries

It is well known for providing summaries and conclusions of related and complex financial statements, such as cash flow, fund flow, and balance sheets.

These are concluded and presented to the stakeholders and the public.

These statements and conclusions are advantageous for investors in making investing decisions.

Statements such as a profit and loss statement and balance sheet are presented as the company's mirror, and the summaries are taken as critical statements.

Validation

The organization's statements are prepared by a certified auditor for the department or even a company bookkeeper and can be audited to confirm their validity. 

Each system entry is related to the financial matters of the company.

Interpretation

Any well-informed person can interpret a summary or conclusion of the financial statement. The interpretation is general and does not vary from person to person or auditor to auditor. 

The interpretation can be analyzed and summarized, and the person can find out about the industry's performance and whether the industry's financial position is good or bad.

Is accounting a science or an art?

It is both an art and a science. It is an art as it records, classifies, and summarizes the financial transactions that help understand a business's profitability and financial status.

The interpretations are based on the individual's knowledge and skills. 

The word “Art” means a different range of human activities and studies of these activities.

Art is the use of techniques or skills from any field. It is the study of the application of techniques and methods. 

Art is the study of applying the scientific method to practical use. It is an art as the standard rules and principles are involved in an organization's bookkeeping.

Ideas, opinions, and thoughts about whether it is an art or science differ from accountant to accountant.

In science, procedures or methods are not changed. These are rigid; on the other hand, some methods and processes are being followed by accountants laid by IFRS (International Financial Reporting Standards).

It is also a science, structured knowledge based on certain fundamental principles. Specific rules and regulations are followed and are developed by experiments over time. 

A statutory body supervises and proposes guidelines and standards that must be followed while performing accounting and maintenance of books.

Types Of Accounting

Some of the types are:

Financial Accounting

It is considered within the process of compiling information for financial reports for external reporting and stakeholders. 

Financial accountants collaborate with their employees, colleagues, and managers to develop financial plans and find ways to make a company more profitable. 

It is concerned with preparing financial statements, such as the Profit and loss statement and the Balance sheet, and interpreting them for information users.

Managerial Accounting

This keeps track of documents and aids in a company's financial planning. Most of their material is intended for internal stakeholders rather than the general public, i.e., management.

The managers examine and establish a budget to meet the organization's short- and long-term objectives. In addition, managerial accountants are responsible for reviewing past performance to forecast future results.

It mainly deals with money, costs, and budgets.

Cost Accounting

It can be seen as a sub-category of managerial accounting. It oversees all variable and fixed costs to see if output aligns with the cost to produce a product. 

It helps managers make future decisions based on the financial forecast and the progress of production. It is concerned with how unit costs are calculated, which can vary between industries and even similar businesses, and how to allocate overhead.

Direct materials and direct labor are easily tracked, but indirect costs—such as the cost of the machinery, building, utilities, shared staff, etc.— can be allocated in different ways.

Auditing

External auditing is the act of a corporation sending financial documents to a third party for economic feedback. In this case, a third party is a reputable source for determining whether a company's financial statement follows GAAP.

A Certified Public Accountant performs external auditing (CPA). The efficacy of internal processes is determined by internal auditing.

Accounting For Taxation

Businesses filing their tax records each year helps them stay in line with the Internal Revenue Code.

It also helps businesses plan for future tax returns, such as avoiding particular tax loads and comprehending the consequences of specific tax decisions.

Information Systems for Accounting

Accounting information systems (AIS) are the systems that a business uses to gather, store, and process financial data related to accounts.

Many AIS are now developed to interact with other departments, such as connecting Human Resources' hiring process to a newly hired employee's payroll function. This information flow-through procedure reduces the need for manual data entry.

For Forensic Purposes

It is used to look into a person's or a company's financial records.

This purpose is to gather all available data and account for all transactions in financial statements accurately and comprehensively. It is useful when dealing with legal matters, including fraud, claims, and disagreements.

For the General Public

Businesses that advise clients based on their needs are referred to as public accounting.

Auditing, assisting with tax returns, consulting on methods customized to install technology or computer systems, and providing legal counsel are all possibilities.

Objectives Of Accounting

Some of the objectives are:

1. Maintaining Systematic Records: Its primary goal is to preserve a systematic financial transaction record that allows users to better understand day-to-day activities and the overall organization.
2. To Safeguard Business Assets: It safeguards company assets from unjustifiable and unwarranted use. The above information assists the business owner in ensuring that the money of the company is not held idle or underutilized.
3. Calculate Profit: Another goal is to determine the net profit or loss incurred as a result of conducting business, which is accomplished by maintaining a proper record of all books of accounts concerning revenues and expenses for a given period.
4. Determining your financial situation: It also allows a business owner to understand his financial situation. The Balance Sheet or Position Statement accomplishes this goal. A balance sheet is a statement of a company's assets and liabilities as of a specific date. It is a method for determining a company's financial health.

Functions of Accounting

Some of the functions are:

1. Maintaining Meticulous Records: This enables businesses to track their day-to-day financial operations, such as supplier purchases, product sales, receipts, and payments, accurately and up-to-date.
2. Monitoring Financial Transactions: It may track multiple financial transactions related to payments due to the company to ensure it receives the revenue and remains profitable.
3. Making Payments on Bills: This entails double-checking invoices for accuracy, arranging payment deadlines, and paying the bills that the company owes to numerous vendors and suppliers.
4. Writing Financial Reports: This involves repairing detailed quarterly and annual financial reports about the company's assets, profits, and losses for internal and external stakeholders.
5. Maintaining Fiscal History: It assists with creating, documenting, and storing the fiscal history of the company's transactions and making it available for audits and assessments.
6. Obtaining Business Objectives: An accountant can use financial data to develop and implement comprehensive economic policies and plans that help the company achieve its objectives.
7. Budget Preparation: The accounts department may use company financial data to prepare the overall department and project budgets.
8. Creating Financial Forecasts: This entails examining the company's present financial resources, predicted revenues, and business goals and then utilizing this information to predict future business expansion and growth.
9. Financial Auditing: Accountants can conduct financial audits of a corporation and find any inconsistencies in evaluating financial resources. It can be used to identify a company's financial flaws and strengths, determine how to counteract deficiencies and strengthen forces, and apply relevant measures.
10. Examining Performance: This entails conducting frequent financial evaluations of the company's departments to analyze their performance and make changes to decrease waste, boost productivity, and cut expenses.
11. Observance of Legal Obligations: Accountants ensure that the company follows industry and government taxation, financial reporting, and employee wage standards, regulations, and policies and take corrective measures.
12. Ensuring Vigilance Against Fraud: It includes implementing strong security measures to protect the company assets against data breaches and internal and external fraud.

Advantages of Accounting

Some of the advantages are:

1. Maintenance of Business Records: It records all the financial transactions occurring in the respective year in the books of accounts. 
2. Preparation of Financial Statements: Financial statements like Trading and Profit and Loss Account and Balance Sheet can be prepared quickly if transactions are correctly recorded.
3. Results Comparison: It facilitates comparing the financial results of one year with those of another and with those of other firms in the same industry.
4. Decision Making: The information enables management to plan its future activities, make budgets, and coordinate various activities in various departments.
5. Evidence in Legal Matters: The proper and systematic records of financial transactions act as evidence in a court of law.
6. Provides Information to Related Parties: It quickly makes the organization's financial information available to stakeholders such as owners, creditors, employees, customers, the government, etc.
7. Helps in Taxation Matters: Various tax authorities, such as income and indirect taxes, depend on the accounts maintained by the management to settle taxation matters.
8. Valuation of Business: Accounting information can be utilized to evaluate an entity’s business properly.
9. Replacement of Memory: Proper recording of transactions replaces the need to remember transactions.

Limitations Of Accounting

Some of the limitations are:

1. It is not fully exact: Although all transactions are recorded based on evidence, some are also made to ascertain profit and loss.
2. It does not indicate the realizable value: The Balance sheet does not show the amount of cash the firm may realize by selling all the assets.
3. It ignores the qualitative elements: It is confined to monetary matters only and ignores qualitative elements such as staff quality, industrial relations, public relations, etc.
4. Ignores the effect of price level changes: All the statements in accounts are based on historical costs. Therefore, price level changes are not considered when preparing financial statements.
5. May lead to window dressing: The organization may manipulate the accounts to conceal vital facts and present the financial statements in a way that suggests a better position than it actually is.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Accrued Income
• Balance Sheet
• Calendarization
• Depreciated Cost
• Goodwill