What Is Accounting?
Accounting is the process of systematically recording, measuring, and communicating information about financial transactions.
At its highest level, accounting sets up the basics of record keeping and and a process to track financial accounts according to the following classifications:
- Assets. These are items owned, purchased, or acquired which have economic value. Note that assets usually include cash and intangible items such as goodwill and patents.
- Liabilities. These are obligations of the business, to be paid at a later date.
- Equity. This is found by simply subtracting liabilities from assets.
- Revenue. This is the amount received from customers in exchange for the goods or services provided. Revenue may be recognized by the company under an accrual or cash basis.
- Expenses. This is the cost associated with producing the product or service or the assets spent or consumed during a given timeframe.
- Transactions. These are the financial movements and events within the classifications above.
- Reporting. Once all of the above business transactions settle, it is the controller’s role to present the net profit or loss for a given timeframe.
What Are the Most Common Accounting Conventions?
The four primary types of accounting conventions are: conservatism; consistency; full disclosure; and materiality.
- Conservatism is the convention by which the lower-value transaction is recorded whenever two values are available within a transaction. Using this convention means there should always be a provision for losses and that profit should never be overestimated.
- Consistency is the convention that calls for the use of the same accounting principles from one period to the next so that the exact same measurements are applied to calculate profit and loss.
- Materiality requires that all material facts should be recorded and that accountants should record important data while omitting unimportant information.
- Full disclosure conventions entail the discovery of all information, both favorable and not, that are all made publicly available to creditors, debtors, and all interested parties without exception.
Who Uses Accounting Information?
Anyone who makes business decisions uses accounting information to guide them. Accounting is significantly 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.
Accounting shows 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.
Financial vs. Managerial Accounting
There are two general kinds of accounting: financial and managerial.
- Financial accounting is the recording and communication of economic information in accordance with Generally Accepted Accounting Principles (GAAP) and is primarily for external users.
- Managerial accounting is the recording and communication of economic information that may or may not be in accordance with GAAP and is for internal users. Other accounting specialty areas exist, such as tax accounting, oil and gas accounting, or forensic accounting.
How the Accounting Cycle Works
The summation of these accounting basics is the accounting cycle. The sequence of steps starts when a transaction occurs and ends with its entry in financial reporting.
The Financial Accounting Standards Board (FASB), the Securities and Exchange Commission (SEC), the IRS, and other regulatory bodies all set accounting standards and requirements for accounting frequency and presentation.
Difference Between Bookkeepers and CPAs
Certified Public Accountants, or CPAs, are in the business of financial accounting. Bookkeepers are in a different discipline of the same financial sector and are responsible for recording transactions.
Accounting is important in compiling, classifying, measuring, recording, and outlining financial data. Bookkeeping, handling a smaller scope of tasks, is primarily responsible for the recording of financial transactions.