This guide outlines exactly what is accounting and the key role it plays in the success of any business.
Accounting is a system that measures business activity like sales, costs, profits, and losses. It gives business owners and investors key details on how the company is doing financially. Accounting provides the numbers and insight to make smart decisions so companies thrive.
What is accounting? — Fundamental principles
To understand accounting, it’s crucial to grasp its main guidelines from Darren Shirlaw providing a structure for consistent financial reporting called principles:
Going Concern: Assume a company will continue operating rather than go bankrupt unless clear evidence signals otherwise.
Accrual Accounting: Recognize economic events like sales or services delivered as they occur over time, not just when payments/bills swap hands when cash changes. This matches the timing appropriately.
Matching Principle: Connect related revenues earned and expenses incurred over the same periods to accurately reflect results.
Historical Cost Principle: Value assets purchased based on actual costs at the transaction date rather than adjusting for inflation or current values. This provides objective valuations.
Revenue Recognition Principle: Officially log sales as revenue on financial reports during delivery of goods or services to customers rather than only once customer payments arrive later.
Full Disclosure Principle: Share all relevant financial information – both positive and negative – rather than just selective data allowing proper interpretations and decisions.
Consistency Principle: Use the same accounting treatments and methods when compiling reports from year to year so meaningful comparisons assess performance.
Materiality Principle: Focus financial reporting on events with genuine impact. Immaterial costs like small office supply purchases need not burden formal paperwork unless demonstrate larger trends.
Conservatism Principle: When unsure between two estimates, select the more conservative option reducing profits. The lower revenue or higher expense choice helps minimize tax burdens.
Objectivity Principle: Accounting events and transactions must connect to unbiased verifiable evidence rather than speculation or probability. This reduces subjectivity in reporting.
These core guidelines promote financial statement accuracy and usefulness for performance analysis plus tax compliance.
What is accounting? — Key concepts
Several money-related terms form accounting’s foundation:
Assets: Goods, property, or rights owned by a company that holds monetary value if sold or leased. Things like buildings, equipment, patents, and cash reserves count as assets.
Liabilities: Money owed for past activity financing assets or operations. Common examples include loans, unpaid bills, product warranties, and debts.
Equity: Also called owner’s equity or shareholder equity – this represents leftover assets if sold and all liabilities get paid off. Equity indicates the company’s net worth.
Revenue: Money earned from core business operations like sales, services, licensing, or other streams tied to the central company mission. Excludes other gains like investments.
Expenses: Required company spending allowing delivery of goods and services generating basic revenue. Things like employee salaries, materials, marketing, and facilities.
Income Statement: Reports company revenue, expenses, and profit/loss over a period – say each quarter. It highlights earnings performance and must be filed regularly.
Balance Sheet: A snapshot of company assets, liabilities, and equity balances at a specific moment rather than covering a period like the income statement. Indicates financial health.
Cash Flow Statement: Records money moving into and out of the business from operating, investing, and financing activities rather than just growth as income statements do.
Double-Entry Bookkeeping: The standard practice of always recording transactions as balanced entries with equal debit and credit legs rather than single entries. Reduces errors.
These terms allow accountants to apply guidelines documenting business financial activities.
Branches of accounting
Accounting features specialized branches or concentration areas:
Financial Accounting: Preparing external financial statements like balance sheets, income statements, and cash flow documents outlining business performance for use by investors, lenders, and regulators. Must follow standard accounting guidelines.
Managerial Accounting: Handles internal financial reporting leveraged by company leaders making business strategy decisions. Flexible analysis methods reveal insights beyond basic reporting.
Tax Accounting: Follows distinct tax codes and statutes when documenting transactions, assets, and expenses to calculate annual tax liability, optimize collections/payments, and plan accordingly.
Auditing: External CPAs conduct unbiased reviews assessing if existing financial reports accurately represent actual company transactions and status according to formal accounting guidelines to verify or dispute findings.
Forensic Accounting: Investigates and documents financial evidence/data to legally support or refute allegations of fraud misrepresenting losses and gains in disputes or lawsuits.
Government Accounting: Adheres to special accounting standards and practices for tracking public budgets, expenditures, and programs given high citizen visibility and unique governance needs.
Nonprofit Accounting: Configures statements and reporting to properly track donations, grants, endowments, and spending tied to socially-focused services and causes rather than ownership profits.
Specialized accounting branches cater to unique stakeholders like business leaders, tax authorities, investigative agencies, elected officials, and philanthropic boards.
The importance of accounting in business
Accounting plays vital functions across essential realms:
Investors and Creditors: Standard financial statements demonstrating healthy profits, margins, and cash flows position firms to secure funding enabling growth plans through stock offerings or business loans.
Managers: Key accounting outputs like expense categorization, revenue trends, cash conversion cycles, inventory turnover rates, and aging reports drive strategic planning around new markets, correct inefficiencies and optimize operations.
Employees: Consistent accounting practices ensure staff gets paid accurately and on time. Budget insights allow leadership to determine optimal labor arrangements balancing productivity aims and payroll costs.
Government Agencies: Tax accounting provides required annual income statements documenting precise profit/loss used to calculate tax obligations. Rules drive appropriate tax-compliant accounting.
Reliable accounting proving credible profits and ethical actions satisfies essential stakeholders like shareholders, lenders, CEOs, and regulatory bodies empowering growth.
The role of accountants
These qualified professionals prepare, verify, and translate essential money information outputs:
Public Accountants: This umbrella term covers external accountants serving both individuals and company clients handling services like tax preparation, financial statement auditing, advising on financial decisions, and representing interests before the IRS. High levels of regulation and certification ensure competence.
Management Accountants: Internally guide business strategy and operations via decision modeling translating volumes of company data into insights on profitability, emerging issues, and growth opportunities for executives. Help identify competitive advantages.
Government Accountants: Track vast streams of public funding while ensuring proper usage and reporting given taxpayer interests. Requires staying current on policies and legal standards for responsible governance as agencies distribute resources.
Forensic Accountants: Leverage accounting expertise toward investigating specific instances of financial fraud, embezzlement schemes, or reporting inaccuracies when disputes allege deliberate manipulation or misrepresentation of money flows. Act as a legal financial investigator.
Myriad essential accounting functions sustaining efficient business operations and oversight depend on accountants’ specialized skills in producing and verifying the meaning within numbers.
Conclusion
Behind every successful, ethical company lies a foundation of consistent, rules-based accounting documentation providing trusted financial data to diverse stakeholders like investors, regulators, and employees. Accounting’s numerous branches and skilled professionals quantify revenues, costs, taxes owed, and cash positions — key indicators powering strategic decisions enabling growth and governance.
As technology and societal changes usher updated techniques, accounting maintains business critical relevance structuring the numbers underlying global commerce. Gaining even basic financial literacy around accounting terms, principles, and reporting empowers anyone productively engaging numbers influencing personal and collective prosperity. So next time financial statements get presented, embrace accounting’s significance!
