Accounting is the process of recording all the business's financial transactions. This includes summarizing, analyzing, and reporting these transactions to oversight agencies, regulators, as well as tax collection entities. The financial statements used in accounting provide a concise summary of a company's operations, financial position, and cash flows over a given accounting period.

What Is Accounting

• Accounting is a necessary function for decision making, cost planning, and measuring economic performance, regardless of the size of the business.

• A bookkeeper can handle basic accounting needs, but for larger or more complex accounting tasks, a Certified Public Accountant (CPA) should be consulted.

• Managerial accounting and cost accounting are two important types of accounting for businesses. Managerial accounting assists management teams in making business decisions, whereas cost accounting assists business owners in determining the cost of a product.

• When preparing financial statements, professional accountants adhere to a set of standards known as the Generally Accepted Accounting Principles (GAAP).

• Strategic planning, external compliance, fundraising, as well as operations management all rely heavily on accounting.

How the Accounting Works

Accounting is one of the most important and essential business functions. It may be handled by a bookkeeper or accountant in a small business, or by large finance departments with dozens of employees in larger organizations. The reports generated by various accounting streams, like the cost accounting and managerial accounting, are indispensable for assisting management in making well-informed business decisions.

The financial statements that summarize the operations, financial position, and cash flows of a large company during a specific time period are concise and consolidated reports based on thousands of individual financial transactions. Consequently, all professional accounting designations are the result of years of study, rigorous examinations, and a minimum number of years of practical accounting experience.

Origins of Accounting

The history of accounting dates back nearly as far as the history of money. Ancient civilizations in Mesopotamia, Egypt, and Babylon are the origins of accounting history. During the Roman Empire, for instance, the government kept detailed financial records. However, accounting as a modern profession has only existed since the early nineteenth century.

Due to his contributions to the development of accounting as a profession, Luca Pacioli is known as "The Father of Accounting and Bookkeeping." Pacioli, an Italian mathematician and Leonardo da Vinci's friend, published a book on the double-entry accounting system in 1494.

The Institute of Chartered Accountants in England and Wales officially recognized the modern accounting profession by 1880. This institute developed a number of the current accounting systems. The Industrial Revolution was largely responsible for the establishment of the institute. In addition to keeping track of their records, merchants sought to avoid bankruptcy.

The ARPL (Alliance for Responsible Professional Licensing) was established in  August 2019 in response to a series of state deregulatory proposals that would loosen CPA licensing requirements. The ARPL is a coalition of various advanced professional groups, including accountants, architects, and engineers.

Types of Accounting

Accountants may be tasked with documenting particular transactions or working with particular data sets. As a result, the majority of accountants can be categorized into several broad categories.

Financial Accounting

Financial accounting is the process of generating interim and annual financial statements. In the balance sheet, income statement, and cash flow statement, the outcomes of all financial transactions that occur during an accounting period are summarized. The majority of companies have their financial statements audited annually by an independent CPA firm.

For some entities, such as publicly traded corporations, audits are required by law. As part of their debt covenants, lenders typically also require the results of an external audit annually. Consequently, the majority of businesses will conduct annual audits for one reason or another.

Managerial Accounting 

Managerial accounting utilizes a substantial amount of the same data as financial accounting, but organizes and uses the data differently. In managerial accounting, specifically, an accountant generates monthly or quarterly reports that a company's management team can use to make operational decisions. In addition to budgeting, forecasting, and various financial analysis tools, managerial accounting encompasses numerous other accounting facets. Essentially, any information that management may find useful falls under this category.

Cost Accounting

Just as managerial accounting assists businesses in making management-related decisions, cost accounting assists businesses in making cost-related decisions. Cost accounting essentially considers all costs associated with the production of a product. This data is used by analysts, managers, business owners, and accountants to determine the prices of their products. In cost accounting, money is viewed as an economic factor in production, whereas in financial accounting, it is a measure of an organization's economic performance.

Tax Accounting

While financial accountants frequently use one set of rules to report a company's financial position, tax accountants frequently use a different set. Depending on the type of return being filed, the federal, state, or local government establishes these rules. Tax accounts strike a balance between compliance with reporting rules and minimizing a company's tax liability through strategic decision-making. Typically, a tax accountant oversees the entire tax process of a business, including the strategic creation of the organizational chart, operations, compliance, reporting, and payment of tax liability.

The Accounting Profession

In the United States, a bookkeeper can handle basic accounting functions, but qualified accountants with designations such as Certified Public Accountant (CPA) or Certified Management Accountant (CMA) typically handle advanced accounting.

Certified General Accountant (CGA), The Chartered Accountant (CA), and Certified Management Accountant (CMA) designations have been merged into the Chartered Professional Accountant (CPA) designation in Canada.

The "Big Four" are a major component of the accounting profession. These four largest accounting firms provide audit, consulting, and tax advisory services, among others. These firms, along with a multitude of smaller firms, make up the public accounting sector, which typically provides financial and tax accounting advice.

Accounting careers can vary significantly by industry, department, and specialty. Some applicable job titles include:

Internal or external auditor:

This auditor ensures adherence to reporting requirements and protection of company assets.

Forensic Accountant:

This accountant monitors internal or external activity to investigate the financial transactions of a person or business.

Tax Accountant:

This accountant strategically plans the optimal business structure to minimize tax liabilities and ensures tax reporting compliance

Managerial Accountant:

Analyzes financial transactions in order to make strategic, often manufacturing-related recommendations.

Information and Technology Analyst/Accountant:

This accountant maintains the system and software used to process and store accounting records.

Controller:

This accountant manages accounting functions including financial reporting, accounts payable, accounts receivable, and procurement.

The Accounting Standards

When preparing financial statements in the United States, accountants use generally accepted accounting principles (GAAP) in the majority of cases. GAAP is a set of principles and standards designed to increase the comparability and uniformity of financial reporting across industries. Its standards are based on double-entry accounting, in which every accounting transaction is recorded as both a debit and a credit in two separate general ledger accounts that will roll up to the balance sheet and the income statement.

In the majority of other nations, the International Financial Reporting Standards (IFRS), which are governed by the International Accounting Standards Board, are used.

In the United States, tax accountants who oversee returns rely on guidance from the Internal Revenue Service. Internal Revenue Code tax regulations must be followed when filing federal tax returns (IRC). State and local taxes may also be reflected in tax accounts, depending on the jurisdiction in which the business operates. Foreign corporations must adhere to the tax regulations of the countries in which they must file tax returns.

Special Considerations

Accountants frequently utilize software to facilitate their work. Some accounting software, such as QuickBooks, Quicken, FreshBooks, Xero, SlickPie, or Sage 50, is deemed superior for small businesses. Typically, larger companies have much more complex solutions to integrate with their reporting requirements. This includes add-on modules and home-based software applications. Large accounting solutions consist of Oracle, NetSuite, and Sage software.

The Accounting Cycle

Every reporting period, financial accountants typically operate in a cyclical environment with the same steps occurring in the same order. Accounting cycle refers to the process of entering raw transaction data into an accounting system and generating relevant and accurate financial reports. These are the stages of the accounting cycle:

1. Collect transaction data from invoices, bank statements, receipts, uncashed checks, payment requests, credit card statements, and other documents that may contain business transactions.

2. Post journal entries to the general ledger for the items from Step 1, reconciling whenever possible with external documents.

3. Prepare an unadjusted trial balance to ensure that all debits and credits are in balance and that all significant accounts in the general ledger are accurate.

4. Post adjusting journal entries at the end of the accounting period to reflect any adjustments to the trial balance generated in Step 3.

5. Prepare the trial balance with adjustments to ensure that these financial balances are materially accurate and reasonable.

6. Prepare financial statements that provide a summary of all transactions for the reporting period.

Accounting Methods: Cash Method vs. Accrual Method

Financial accounts have the option to adhere to two distinct sets of rules. The first, the accrual basis method, has been discussed previously. These rules are outlined by GAAP and IFRS, are obligatory for public companies, and are primarily utilized by larger businesses.

The second set of rules adheres to the cash accounting method. The cash method stipulates that a transaction should only be recorded when cash has been exchanged. Due to its simplicity, the cash method is frequently utilized by small businesses and other entities that are not required to use the accrual method of accounting.

Imagine a business purchases $5,000 worth of inventory on credit. Payment for the inventory is due within 30 days.

• A journal entry is recorded under the accrual method of accounting when the order is placed. The entry reflects a $5,000 debit to inventory (an asset) and a $5,000 credit to accounts payable (a liability). When 30 days have passed and the inventory is actually paid for, a second journal entry is recorded: a $5,000 debit to accounts payable (liability) and a $5,000 credit to cash (asset).

• A journal entry is only recorded under the cash method of accounting when cash is exchanged for inventory. There is no journal entry when the order is placed; instead, a single entry is made when the inventory is paid for. The entry consists of a $5,000 debit to inventory (asset) and a $5,000 credit to cash (asset).

The difference between these two accounting methods is how accruals are handled. Naturally, accruals are required under the accrual method of accounting. Accruals are not required or recorded using the cash method.

The Securities and Exchange Commission has a comprehensive manual on financial reporting that details the reporting requirements for public companies.

Why Accounting is Most Important

Accounting is an administrative function in which employees may not interact directly with customers, product developers, or manufacturing. However, accounting is crucial to a company's strategic planning, growth, and compliance requirements.

Accounting is necessary for the growth of a business

Without knowledge of a company's performance, it is impossible for it to make prudent financial decisions through forecasting. Without accounting, a business would be unable to determine which products are its best-sellers, how much profit each department generates, and which overhead expenses are inhibiting profits.

Accounting is required for financing

External investors require assurance that they understand the investment opportunity. Prior to private funding, investors typically require (often audited) financial statements to evaluate the overall health of a company. Similar rules apply to debt financing. As part of the underwriting and review process for loan issuance, banks and other lending institutions frequently require financial statements that comply with accounting standards.

Accounting is required for owner exit

Small businesses that may be interested in being acquired are frequently required to submit financial statements as part of an acquisition or merger effort. Instead of simply shutting down a company, a business owner may attempt to "cash out" of their position and receive compensation for building a business. Accounting records serve as the foundation for valuing a company.

Accounting is required for payment processing

A company will inevitably incur debt, and part of its responsibility to manage this debt is to make timely payments to the appropriate parties. A company could find itself with a key supplier or vendor if it does not cultivate these business relationships. Accounting allows a business to always know who it owes money to and when those debts are due.

Accounting is required for payment collection

A business may extend credit to its customers. Instead of collecting payment in full at the time of the contract, it may offer trade credit terms such as net 30. Without accounting, it may be difficult for a business to keep track of who owes it money and when that money is due.

Accounting might be necessary

Public companies are required to issue financial statements in accordance with GAAP or IFRS on a periodic basis. A company that lacks these financial statements may be delisted from an exchange. In the absence of proper tax accounting compliance, a business may incur fines or penalties.

Example of Accounting

Consider the following scenario to illustrate double-entry accounting: a company sends an invoice to one of its clients. A double-entry accountant debits accounts receivable, which flows to the balance sheet, and credits sales revenue, which flows to the income statement.

When a client pays an invoice, the accountant debits cash and credits accounts receivable. Because all accounting entries are balanced against one another, double-entry accounting is also known as balancing the books. If the entries do not balance, the accountant is aware that there must be an error in the general ledger.

What are the Accountant's Responsibilities?

Accountants assist businesses in keeping accurate data’s and timely financial records. Accountants are responsible for keeping track of the daily transactions of a business and compiling those transactions into financial statements like the balance sheet, income statement, as well as statement of cash flows. Other services provided by accountants include conducting periodic audits and preparing ad hoc management reports.

What skills are necessary for accounting?

Accountants come from a variety of different backgrounds. In general, however, attention to detail is a crucial or important aspect of accountancy, as accountants must be able to identify and rectify subtle errors or discrepancies in a company's financial statements. Additionally, the ability to think logically is essential for problem-solving. Due to the widespread availability and usage of computers and calculators in this generations, mathematical skills are no longer as much crucial as they were in previous generations.

Why Should the Investors Care About Accounting?

The work of accountants lies at the heart of contemporary financial markets. Without accounting, investors would be unable to depend on timely or accurate financial information, and company executives would lack the transparency necessary for risk management and project planning. Regulators rely on accountants for essential functions such as providing auditors' opinions on annual 10-K filings. Accounting is absolutely necessary for the smooth operation of modern finance, despite the fact that it is sometimes overlooked.