What Is Accounting?

Table of Contents

What Is Accounting?

Let me tell you directly: accounting is the process of recording financial transactions for a business or large organization. It involves summarizing, analyzing, and reporting these transactions to oversight agencies, regulators, and tax entities. The financial statements in accounting provide a concise summary of transactions over a period, outlining operations, financial position, and cash flows.

Key Takeaways

No matter the business size, accounting is essential for decision-making, cost planning, and measuring economic performance. You can use a bookkeeper for basics, but for advanced tasks, bring in a Certified Public Accountant (CPA). Managerial accounting aids in business decisions, while cost accounting determines product pricing. In the U.S., accountants adhere to generally accepted accounting principles (GAAP) for financial statements. Overall, accounting supports strategic planning, compliance, fundraising, and operations management.

Understanding Accounting

Accounting is a core function in nearly every business. At small firms, a bookkeeper or accountant might handle it; larger ones have finance departments with dozens of employees following a unified manual. The reports from cost and managerial accounting are crucial for informed decisions. Financial statements consolidate thousands of transactions into summaries of operations, position, and cash flows. Professional accounting designations require years of study, exams, and practical experience.

History of Accounting

Accounting dates back to ancient civilizations like Mesopotamia, Egypt, and Babylon, almost as long as money itself. The Roman Empire kept detailed financial records. Modern accounting as a profession started in the early 19th century. Luca Pacioli, an Italian mathematician, is the 'Father of Accounting' for his 1494 book on double-entry bookkeeping. By 1880, the profession was formalized with the Institute of Chartered Accountants in England and Wales, driven by the Industrial Revolution's need for record-keeping to avoid bankruptcy.

Different Types of Accounting

Accountants handle specific transactions or information sets, falling into broad groups. Financial accounting generates interim and annual statements, summarizing transactions in balance sheets, income statements, and cash flow statements. Most companies undergo annual audits by external CPA firms, often required for public trading or loans. Managerial accounting uses similar data but for internal reports to guide operations, including budgeting and forecasting. Cost accounting focuses on production costs to set product prices, treating money as an economic factor. Tax accounting follows specific rules to minimize liability while ensuring compliance, overseeing the full tax process.

Careers in Accounting

Basic functions can be managed by bookkeepers, but advanced work requires qualified accountants with designations like CPA or CMA in the U.S., or unified CPA in Canada. The 'Big Four' firms—Ernst & Young, KPMG, PricewaterhouseCoopers, Deloitte—handle audits, consulting, and tax services. Careers vary by industry and include auditors ensuring compliance, forensic accountants investigating transactions, tax accountants minimizing liabilities, managerial accountants providing recommendations, IT accountants maintaining systems, and controllers overseeing financial functions.

Accounting Standards

Accountants in the U.S. use GAAP for financial statements, based on double-entry accounting where transactions are debits and credits in ledgers. Other countries use IFRS from the International Accounting Standards Board. Tax accountants follow IRS guidance and the Internal Revenue Code, plus state or local rules, and foreign companies comply with their jurisdictions.

Major Accounting Software Platforms

Accountants use software like QuickBooks, FreshBooks, Xero, or Sage 50 for small businesses. Larger companies integrate complex solutions like Oracle, NetSuite, or Sage products with add-on modules.

The Accounting Cycle

Financial accountants follow a cycle: collect transactions, post to the general ledger, prepare an unadjusted trial balance, post adjustments, prepare an adjusted trial balance, and generate financial statements. This repeats every period.

Cash Method vs. Accrual Method

Accrual accounting, required by GAAP and IFRS for public companies, records transactions when they occur. Cash accounting records only when cash exchanges, simpler for small businesses. For example, buying inventory on credit records immediately under accrual but only on payment under cash; accruals are key in accrual but absent in cash.

Why Accounting Is Important

Accounting supports growth through performance insights for forecasting. It's key for funding, as investors and lenders require statements. For exits, it provides valuation records. It ensures timely payments and collections, and public companies must comply to avoid penalties.

Example of Accounting

In double-entry, sending an invoice debits accounts receivable and credits sales revenue. Payment credits accounts receivable and debits cash, balancing the books.

Explain Like I'm Five

Accounting tracks a company's money and records spending. Statements show management, investors, and tax authorities how finances are managed, following uniform standards for objective views.

Responsibilities of an Accountant

Accountants maintain accurate records, compile transactions into statements, perform audits, and prepare reports.

Skills Required for Accounting

Attention to detail, logical thinking, and some math skills are essential, aided by computers.

Why Accounting Is Important for Investors

It provides reliable financial information for markets, transparency for executives, and regulatory compliance.

The Bottom Line

Accounting organizes transactions and meets regulations, requiring knowledge for strong salaries across industries.

What Is Accounting?

Highlights