What is Accounting?

Accounting is the process of recording and summarizing financial information in a useful way.

You may have already noticed the use of some form of accounting in your daily life.

My mom for example is the chief accountant and treasurer of our house. She keeps a simple diary to
record major home expenses such as grocery, utilities, fees and so on. It gives her peace of mind
knowing where she has spent the monthly income. The diary also serves as a reminder in case she
forgets whether she has already paid someone. She keeps all the receipts in a folder. At the start of each
month, she prepares a small budget that lists all major payments expected to be made in the following
month. Even though my mom doesn't realize, she is basically performing functions of accounting to
manage the home finances.

Accounting, what we normally refer to, is a more formal, efficient and effective version of such processes
in a business context.

Importance of Accounting
Accounting provides a basis for decisions through the process of recording, summarizing and
presenting historical and prospective information.

The recording part of accounting, often known as book-keeping and financial accounting, is obviously
crucial to ensure that those running a business have a formal record of business transactions in order for
them to know basic information such:
 How much they owe to suppliers, tax authorities, banks, employees and others?
 How much each customer owes the business?
 How much capital is invested by the owners in the business?
 How profitable is the business?

Such information is necessary for a business to fulfill its legal obligations and asserting its own legal
rights. Without proper accounting, it would be very difficult for a business to determine for example the
exact amount (net of any discounts, VAT, etc.) it needs to pay a certain supplier (who could be one of
dozens of suppliers for that business) from whom they may have made several purchases in last month
alone. Organizations need to have a reliable way of recording information relating to transactions and that
is where accounting is so vital.
Historical accounting information is summarized to produce financial statements. Financial Statements
provide an overview of financial activities of a business during a period (e.g. income and expenses) as
well as information relating to its financial positionon a certain date (e.g. the amount of cash and
inventory). Financial Statements help owners in assessing the performance and position of their business
can guide their investment decisions (e.g. whether they should invest more in the business, diversify or
dispose their investment).
Read: Purpose of financial statements

Maintaining accounting records and preparing financial statements is often a legal responsibility for most
businesses above a certain size.
Read: What are financial statements?
Accounting nowadays is no longer concerned only with historical information. Budgeting, appraisal and
analysis based on prospective information has become an important aspect of management accounting.

Management accounting is concerned with providing information to managers fordecisions, planning and
control of business. Examples of such information include:
 Variance Analysis
 Investment Appraisal
 Relevant Cost Analysis
 Limiting Factor Analysis
 Ratio Analysis
Accounting has evolved into different specialties to address the diverse information needs of its users.
Objectives of Accounting
Accounting provides the basis for management decisions and accountability through the process of
recording, summarizing and presenting historical and prospective information.

Key objectives of accounting can be summarized as follows.

Recording
The most basic role of accounting is to record and summarize business transactions and balances. This
process is often referred to as 'book-keeping' and is fundamental in managing any business.
Business transactions and balances once recorded can be summarized in the form offinancial
statements. Financial statements provide key information relating to a business such as:
 How much capital has been invested in the business
 How have the funds been utilized in the business
 The amount of profit or loss in a period
 How much the business owes to others (i.e. liabilities)
 The amount of cash, receivables, inventory and other assets
Such information is not only useful for managers (e.g. to keep track of the financial health and profitability
of the business) but is also important for other stakeholders as discussed in the article: users of financial
statements.

Planning
Organizations need to plan how they intend to allocate their limited resources (e.g. cash, labor, materials,
machinery and equipment) towards competing needs in the future. An effective way of doing so is by
using various forms of budgets.

Budgeting is a major component of managerial accounting. Budgets enable organizations to plan for the
future by anticipating business needs and resources. It also helps in coordinating the different business
segments of an organization.
Decision-Making
A key role of accounting is to provide information and analysis for management decision and control.

Examples of such analysis include:

 Variance Analysis
 Investment Appraisal
 Disinvestment Decisions
 Make or Buy Decisions
 Limiting Factor Analysis
 Ratio Analysis

Accountability
Accounting provides a basis for analysis of the performance over a period of time which
promotes accountability across several tiers of an organization.
Shareholders can ultimately hold the directors responsible for the overall performance of their company
through performance appraisal on the basis of accounting information published in the financial
statements.
Introduction to Accounting
Accountancy is the process of communicating financial information about a business entity to users such
as shareholders and managers (Elliot, Barry & Elliot, Jamie: Financial accounting and reporting).
Accounting has been defined as:
the art of recording, classifying, and summarizing in a significant manner and in terms of money,
transactions and events which are, in part at least, of financial character, and interpreting the
results thereof.(AICPA)

Users of Accounting Information - Internal & External

Accounting information helps users to make better financial decisions. Users of financial information may
be both internal and external to the organization.

Internal users (Primary Users) of accounting information include the following:

 Management: for analyzing the organization's performance and position and taking appropriate
measures to improve the company results.
 Employees: for assessing company's profitability and its consequence on their future
remuneration and job security.
 Owners: for analyzing the viability and profitability of their investment and determining any future
course of action.
Accounting information is presented to internal users usually in the form of management accounts,
budgets, forecasts and financial statements.
External users (Secondary Users) of accounting information include the following:
 Creditors: for determining the credit worthiness of the organization. Terms of credit are set by
creditors according to the assessment of their customers' financial health. Creditors include
suppliers as well as lenders of finance such as banks.
 Tax Authourities: for determining the credibility of the tax returns filed on behalf of the company.
 Investors: for analyzing the feasibility of investing in the company. Investors want to make sure
they can earn a reasonable return on their investment before they commit any financial resources
to the company.
 Customers: for assessing the financial position of its suppliers which is necessary for them to
maintain a stable source of supply in the long term.
 Regulatory Authorities: for ensuring that the company's disclosure of accounting information is
in accordance with the rules and regulations set in order to protect the interests of the
stakeholders who rely on such information in forming their decisions.

Bookkeeping is the recording of financial transactions, and is part of the process

of accounting in business.[1] Transactions include purchases, sales, receipts, and payments by an
individual person or an organization/corporation. There are several standard methods of
bookkeeping, such as the single-entry bookkeeping system and the double-entry bookkeeping
system, but, while they may be thought of as "real" bookkeeping, any process that involves the
recording of financial transactions is a bookkeeping process.

Bookkeeping is usually performed by a bookkeeper. A bookkeeper (or book-keeper) is a person

who records the day-to-day financial transactions of a business. He or she is usually responsible for
writing the daybooks, which contain records of purchases, sales, receipts, and payments. The
bookkeeper is responsible for ensuring that all transactions whether it is cash transaction or credit
transaction are recorded in the correct daybook, supplier's ledger, customer ledger, and general
ledger; an accountant can then create reports from the information concerning the financial
transactions recorded by the bookkeeper.

The bookkeeper brings the books to the trial balance stage: an accountant may prepare the income
statement and balance sheetusing the trial balance and ledgers prepared by the bookkeeper.