accounting meaning in essay

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What is Accounting and Why it Matters For Your Business

Reviewed by

March 4, 2022

This article is Tax Professional approved

When you start a business, you’ve suddenly got all kinds of new responsibilities. One of the most important? Business accounting.

But what exactly is accounting? What value does it provide your business? And how much time is it going to require?

The good news is that with the right people, tools, and resources, accounting doesn’t have to be a black hole for your time.

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In this post, we’ll cover the basics of accounting, from budgets to other accounting functions. But if you want to jump straight to the how-to, you can download our free guide to small business accounting .

A simple definition of accounting

Accounting is how your business records, organizes, and understands its financial information.

You can think of accounting as a big machine that you put raw financial information into—records of all your business transactions, taxes, projections, etc.—that then tells you a story about the financial state of your business.

Accounting is how you get a clear picture of your financial position. It tells you whether or not you’re making a profit, what your cash flow is, what the current value of your company’s assets and liabilities is, and which parts of your business are actually making money.

Accounting vs. bookkeeping

Accounting and bookkeeping are both part of the same process: keeping your financial records in order. However, bookkeeping is more concerned with recording everyday financial transactions and operations, while accounting puts that financial data to good use through analysis, strategy, and tax planning.

The accounting cycle

Accounting begins with recording transactions. Business transactions—any activity or event that involves your business’s money—need to be put into your company’s general ledger . Recording business transactions this way is part of bookkeeping.

Bookkeeping is the first step of what accountants call the “ accounting cycle ”: a process designed to take in transaction data and spit out accurate and consistent financial reports.

The accounting cycle has six major steps:

• Analyze and record transactions. Collect any invoices, bank or credit statements, and receipts from business transactions.
• Post journal entries to the ledger. It’s time to take those documents and start making journal entries for your transactions. Journal entries include three components of a transaction: when it happened, what it was for, and how much it was. Some businesses use single-entry accounting where only the expense or revenue is entered. But more common is double-entry accounting, which records each transaction in two accounts: where money is coming from and where it’s going.
• Prepare an unadjusted trial balance. At the end of a reporting period, list all of your business’s accounts and figure out their balances.
• Prepare adjusting entries at the end of the period. When you need to update entries you’ve already made, you prepare adjusting entries. For example, if a client is late on paying an invoice and you offer a 5% discount to help them pay, you would enter the discount as an adjusting entry, as opposed to changing the entry you’ve already made.
• Prepare an adjusted trial balance . After entering in adjusting entries, you’re left with an adjusted trial balance. This information is now ready to be turned into financial statements.
• Prepare financial statements. Finally, all the information you’ve collected is converted into your financial statements. This final step includes summarizing all your financial information into succinct reports for easy review.

Accounting software takes your accounting information and automates most of these rules and processes, so we’re going to skip over the gritty details of the accounting cycle and talk about the end product: financial statements.

Suggested reading: A Beginner’s Guide to The Accounting Cycle

Financial statements

Financial statements are reports that summarize how your business is doing financially.

There are three main types of financial statements: the balance sheet , income statement , and cash flow statement . Together, they tell you where your business’s money is and how it got there.

Let’s say you’re a self-employed surfing instructor who bills clients for surfing lessons. Financial statements can tell you what your most profitable months are, how much money you’ve spent on supplies, and what the total value of your business is.

Accounting software can help you generate financial statements easily, or you can have a bookkeeper do it for you.

Suggested reading: The ROI of Hiring a Bookkeeper

Generally accepted accounting principles (GAAP)

Every company is different, but in order to make accurate financial comparisons between companies, we need a common language to describe each of them. That’s what generally accepted accounting principles (GAAP) are: a series of standards and procedures that accountants at all companies must adhere to when preparing financial statements.

A non-governmental body called the Financial Accounting Standards Board sets the GAAP. While there are no laws enforcing these standards, most lenders and business partners in the United States will require that you adhere to GAAP. If you’re in Canada, you’ll use a different system called International Financial Reporting Standards, or IFRS .

Cash vs. Accrual

You can do your business accounting on a cash or accrual basis. The difference between the two comes down to timing.

Cash basis is the most basic accounting. On a cash basis, you only record transactions when money changes hands. If you receive an invoice on the 10th but don’t pay it until the 15th, the transaction is recorded on the 15th.

With accrual basis, you record transactions twice: when they occur and when they’re paid. For the invoice above, you record the expense on the 10th and the payment on the 15th as two separate transactions.

The method you use depends on what you need from your business finances. Cash basis is simpler and easier to stay on top of, while accrual offers greater insights for more detail-oriented business owners.

Most small businesses have more basic accounting needs, which means cash basis is often the right fit.

Suggested reading: Cash Basis Accounting vs. Accrual Accounting

The different types of accounting

Financial accounting.

Every year, your company will generate financial statements that people outside of your company—people like investors, lenders, government agencies, auditors, potential buyers, etc.—can use to learn more about your business’s financial health and profitability.

Preparing the company’s annual financial statements this way is called financial accounting. If you’re looking to hire a financial accountant, start with looking into how much an accountant costs .

Managerial accounting

Managerial accounting (or management accounting) is similar to financial accounting, with two important exceptions:

• The statements produced by managerial accounting are for internal use only.
• They’re generated much more frequently—often on a quarterly or monthly basis.

If your business ever grows to the point where you need to hire an accountant full-time, most of their time will be taken up by managerial accounting. You’ll be paying them to produce reports that provide regular updates on the company’s financial health and help you interpret those reports.

This is somewhat similar to the work a financial analyst might do, although a financial analyst will also look at past and current trends in the larger economy, not just your business, to inform their recommendations.

Tax accounting

Tax accounting is designed to make sure that you don’t pay more income tax than you are legally required to by the IRS. An example of this is when your accountant provides you with recommendations for how to get the most out of your tax return.

Tax accounting is regulated by the Internal Revenue Service (IRS), and the IRS legally requires that your tax accounting adhere to the Internal Revenue Code (IRC).

Cost accounting

Whenever you’re trying to figure out how to increase your margin or deciding if raising prices is a good idea, you’re doing cost accounting.

Cost accounting involves analyzing all of the costs associated with producing an output (whether it be a physical product or service) in order to make better decisions about pricing, spending, and inventory.

Cost accounting is often a prerequisite of managerial accounting because managers use cost accounting reports to make better business decisions. It also feeds into financial accounting since costing data is often required when compiling a balance sheet.

Credit accounting

Credit accounting involves analyzing all of a company’s unpaid bills and liabilities to make sure that a company’s cash isn’t constantly tied up in paying for them.

Credit accounting can be one of the most difficult kinds of accounting to do well, in part because it’s a difficult subject to be critical about. Talking about debts can be a sensitive, but necessary, conversation.

Why accounting matters for your small business

Accounting helps you plan for growth.

Every great journey begins with a roadmap. When you’re planning your company’s growth, it’s essential to set goals. What should your profits look like one year from now? How about in five years?

Keeping up with your accounting helps you stay on top of your business finances. That information is essential to assess how quickly your business is developing and guide future decision making. Without accurate reporting, you won’t have the full financial picture.

Has your cost of goods sold increased? Are margins thinner? Are your growth goals reasonable? Without financial statements, you won’t have an objective answer.

Accounting is essential for securing a loan

Up-to-date financial statements are essential if you want to fund your small business with a loan.

For instance, suppose you want to apply for a Small Business Association (SBA) loan through one of the big banks. You’ll need to provide, on average, three years of financial statements, plus a one-year cash flow projection . It’s virtually impossible to deliver any of these if you don’t have an accounting system in place.

Suggested reading: What to Prepare When Applying for a Business Loan

You need accounting to attract investors or sell your business

You may not be planning to court investors or sell your business right now, but it’s a good idea to leave your options open. And the best way to do that is to put a proper accounting system in place now.

Potential investors, stakeholders, or buyers will expect accounting records vetted by a CPA (Certified Public Accountant) that prove your business is profitable and on track for growth.

Accounting helps you get paid

When a customer owes you money, it appears as Accounts Receivable (AR) on your balance sheet , which is generated automatically by your accounting software or manually by you or your accountant.

The balance sheet tells you how much of your AR you’ve already pocketed during the month and how much is still outstanding.

By referring to your balance sheet, you can track how effectively you’re collecting payment. Then you can put in place processes—like harder payment deadlines or better follow-up with clients—to make sure you get your hands on the money you’ve earned when you need it.

Accounting helps you stay on top of your debts

If your business owes debts to a variety of sources, like credit cards, loans, and accounts payable, you’ll have to jump into multiple accounts to check what you’re left owing.

The balance sheet shows everything you owe in one place. It also shows all your bank account balances so you can reference both at the same time. It’s the perfect report to review to make sure you have the cash available to tend to your debts and plan future payments.

Accounting keeps you out of jail (or at least saves you from fines)

As your business grows, it can be difficult to keep track of all your tax information reporting obligations. What’s more, if there are mistakes in your financial reports, you run the risk of misreporting your income. Either mistake could land you in hot water with the IRS and other regulators.

Solid accounting gives you complete, accurate financial records , which reduces your risk of breaking tax laws and the chance of an audit . And, when you have an accountant filing your taxes for you, you can be sure they’ll be done accurately and on time.

Accounting helps you pay the right amount of taxes (and not a dollar more)

If you don’t pay your tax bill in full, the IRS will fine you . But they won’t give you a gold star for paying too much.

You can tell you’re paying too much in taxes if your business consistently receives large tax refunds.

Remember: a tax refund isn’t free cash from the IRS. It’s money you’ve overpaid the government that you could’ve used to invest in your business instead.

Refunds are often the result of miscalculated quarterly estimated tax payments . To calculate quarterly estimated tax payments accurately, you need to predict your income. It’s almost impossible to do so without reliable financial records produced through accurate accounting.

Suggested reading: The Top 19 Self-Employment Tax Deductions

What an accountant does

An accountant does more than just year-end tax preparation. A skilled CPA will save you time by communicating your company’s financial state to you in clear language, while anticipating your financial needs.

Accounting professionals like CPAs or tax advisors can also provide you with knowledge and insight that are simply inaccessible to non-accountants. These experts can offer guidance on tax deductions you didn’t know you qualified for, tax rules you didn’t know you were breaking, and best practices picked up while working for other companies in your industry.

If those are tips your business can benefit from right now, it might be time to hire an accountant .

Suggested reading: How to Find an Accountant

Accounting solutions

Small business accounting software has made big advancements as more people take the entrepreneurial path.

The self-service software you use is now almost equal to the accounting software used in firms all over the world. There are now a wide array of options available—which one is best for you depends on your business’s accounting needs.

Freshbooks offers integrated invoicing that makes it simple to manage your accounts receivable and your accounting in one place. Automated bank reconciliation will import all transactions from your business bank accounts, but you will have to review and categorize each one. Their time-tracking functionality also makes it easy for freelancers who bill by the hour. Freshbooks is a good fit for someone generating a lot of invoices with a low number of transactions.

Intuit makes both Quickbooks and a payroll processor, and allows you to bundle both for one monthly cost. The payroll service automates payroll taxes, checks, and all year-end forms, but the accounting platform is mostly manual. While the tool is powerful and can help a skilled user navigate multiple aspects of running a business, it takes a good amount of know-how to get the most out of it.

If you prefer a completely hands-off approach to bookkeeping and accounting, Bench might be right for you. Connect your business bank accounts to have transactions automatically imported, categorized, and reviewed by your personal bookkeeper.

Communication is quick and reliable—the Bench platform allows you to send messages straight to your bookkeeper or set up a call to go over any financial questions that might come up. Our premium package even includes tax filing, which makes all accounting tasks completely automated. Learn more about how Bench can help .

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Essay on Accounting: Meaning, Functions, Importance, Principles and Limitations

Essay on Accounting :- 1. Introduction to Accounting 2. Meaning of Accounting 3. Functions 4. Importance 5. Systems 6. Principles 7. Concepts 8. Accounting Conventions 9. Limitations.

• Essay on the Limitations of Accounting

Essay # 1. Introduction to Accounting:

Several thousand years ago when human beings first developed the need to accumulate information about economic resources such as land, livestock and other personal property, accounting got originated. It emerged as an information system formulated for accountability in the exchange of goods and services.

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With the invention of money there was an ease in the manner in which commodities and services were exchanged. Money became a unit of measurement. Throughout history accounting profession has continued to grow in response to the ‘financial information needs’ of individuals and societies.

Accounting is a function of economic and social development. It is the language of business. It records business transactions on a monetary basis in a set of books in a scientific manner. Cash plays a vital role in all types of business activities. One party pays it and the other party receives it. Even in non-cash transactions, cash has to be paid or received in future. Accounting provides information in a classified and a summarized form as financial statements.

It comprises Trading Account, Profit and Loss Account, and Balance Sheet. Account is that aspect of accountability that accounts for the purpose for which cash is paid or received. Trading Account and Profit and Loss Account are prepared to ascertain the profits earned or losses incurred for a particular period. The balance sheet shows the financial position of a business as at a particular point of time.

Accountants are the practitioners of accountancy. They are information specialists who collect, process and report economic information about specific financial events for business and non-business activities. Today, we observe several million individuals engaged in professional accounting activities and several billions dependent on such information. Thus, accounting has a wide scope in the spectrum of economic and social development of any country, be it developed, developing or backward.

ADVERTISEMENTS: (adsbygoogle = window.adsbygoogle || []).push({}); Accounting 2. Meaning of Accounting:

Accounting is considered as ‘the language of business’. It is the language employed to communicate financial information of the business to various parties interested in such information. When an event is to be reported (say in English, Hindi, Kannada), certain rules are followed diligently so that what is communicated is understood by the readers appropriately.

Similarly, in accounting also the events of the business are to be communicated to the users by following certain set of rules diligently, so that the firm does not run into the risk of being misunderstood. Accounting language has two important components – (1) symbols in the form of ‘Debit and Credit’ and (2) grammatical rules in the form of generally accepted accounting principles (GAAP).

Accounting stems from ‘book-keeping’ the science and art of correctly recording in books of account all those business transactions that result in the transfer of money or money’s worth. Accounting relates to the work of maintaining various books of accounts, say, journal proper, subsidiary books, ledger, etc., which are generally done by junior employees as and when the transactions take place.

For this reason these books are called Books of Original Entry. Though the original records are maintained in a systematic way, they cannot by themselves provide information for judgement (decision) unless they are analysed and interpreted. Therefore, accounting comes into the picture.

Examining the cited definitions, we can infer that book-keeping is concerned with recording aspect. On the other hand, being comprehensive in nature, accounting includes book-keeping and spreads its tentacles to the analysis and interpretation of the data recorded. In fact, accounting designs proper system for recording the transactions.

The modern system of accounting is based on ‘double-entry principle’. Being scientific in character, double-entry principle of accounting has definite objectives to fulfill. It prescribes the process through which the objectives can be achieved. Accounting is a macro system.

In its micro system it includes several branches in the form of Financial Accounting, Cost and Management Accounting and others such as Government Accounting, HR Accounting, Inflation Accounting, Environmental Accounting, Farm Accounting, etc.

ADVERTISEMENTS: (adsbygoogle = window.adsbygoogle || []).push({}); Accounting 3. Functions of Accounting:

Functions of accounting may be broadly classified into four categories:

1. Historical Function:

The primary function of accounting is historical in nature, i.e., to maintain a correct record. It includes recording, classifying, summarizing, analysing and interpreting the recorded data of an enterprise (an accounting unit). The major objective of this function is to report at regular intervals to owners/shareholders, management and other interested parties in a desired form and format through financial statements.

2. Managerial Function:

The major purpose of this function is to maximize operational efficiency. In this form it helps in planning future activities, controlling day-to-day operations by comparing actual results with predetermined standards. In short, accounting helps in decision making.

3. Legal Function:

From the viewpoint of accountability, accounting should satisfy the legal requirements of Accounting Standards Board (ASB) as well as the government. For example, audit is compulsory for ensuring compliance of standards.

4. Communicating Function:

Accounting, as a language of business, should be in a position to communicate the information to the users of information say, owners/shareholders, management, creditors, employees, consumers, investors, government, etc.

Accounting 4. Importance of Accounting and its Users:

The importance of accounting is unique as it is useful not only to the internal users but also to the external users (direct and indirect users). The importance of accounting can be understood in the popular use of this systematic information by the interested parties (i.e., the data processed in the form and format meaningful to the user). This systematic information is used by interested persons for decision making.

However, there is no unanimity in different countries as to who these interested parties are. For example, Accounting Standards Board (ASB) of USA in its Statement of Financial Accounting Concepts (SFAC) No.1 states that ‘Present and potential investors, creditors and others are the users’. The Corporate Report (1975) London lists all types of users who need accounting information. The Stamp Report (1980) Canada states that because of broader accountability concept in Canada, the range of users is also broader.

However, the International Accounting Standards Committee (IASC) lists investors, employees, lenders, suppliers and other trade creditors, customers, government and their agencies, public and management as users in its framework (1989). Taking into consideration the above list of users, categorization is made as users of information having direct interest and users of information having indirect interest.

1. Users having Direct Interest:

The users having direct interest in accounting information are considered to be owners and potential owners/management, shareholders and potential shareholders, creditors and potential creditors, suppliers and potential suppliers, employees and consumers, government and tax authorities.

They are briefly discussed in the following list:

(a) The owners/shareholders provide funds to an enterprise in the form of capital. Hence, they are interested in accounting information to know whether the business is conducted on sound lines, whether the capital is used properly, whether it is in a position to provide best of the returns on their investment and whether the business is run on legal and ethical norms.

The income statement and the statement of affairs prepared from time to time should be in accordance with the accounting standards so that comparability and decision making become easier.

(b) The management is interested in financial accounting to determine whether the business is profitable, whether the position is sound and whether it has competitive advantage. Financial accounting, being the eyes and ears of management, facilitates decision making in relation to expansion, diversification, etc., and framing of suitable policies for future.

(c) The creditors are interested in the financial soundness of a business. They may be suppliers of goods on credit, lenders of money, bankers and others who would support the enterprise by providing credit facilities. Their main interest is security for credit, apart from income. They carefully scrutinize the income statement and position statement from time to time in addition to watching the business operations closely from outside by means of disciplined enquiry.

(d) The investors/prospective investors (apart from shareholders) are interested to know how far their investment is safe or is going to be safe. They examine carefully the statements of income and position to assess the soundness of the business. Altogether they are interested in the safety of their investment along with returns.

(e) The consumers are interested to get the goods at a fair price (comparatively reduced price). They are much interested to know the control mechanism adopted by the enterprise so that cost reduction is made possible.

(f) The employees are interested in accounting of the enterprise so as to assess the profitability which would be the basic factor for determining higher wages, bonus, better working conditions, etc. The sound financial position of the enterprise encourages them to contribute their best to the firm.

(g) The government (central, state and local bodies) is interested in accounting of the enterprise to know the earnings based on which taxes could be collected to formulate revenue. Further, for compiling ‘national income’ accounting prepared on the basis of accountability becomes essential.

(i) The general public is interested in the accounting of a firm from the point of view of the firm’s social responsibility. In addition, it may comprise prospective lenders, investors, consumers who would closely watch the financial progress of the enterprise.

(j) The researchers are equally interested in accounting of an enterprise. They utilize the data for their research purposes to interprete and suggest new ways of maintaining accounts based on standard measurement, usefulness and decision making.

Thus, the importance of accounting is recognized by its users and with the fact that accountability cannot be established without accounting.

2. Users having Indirect Interest:

The users having indirect interest in accounting information are considered to be financial analysts, stock exchanges, lawyers, regulatory authorities, registration authorities, financial press and reporting agencies, trade associations and labour unions. These users are generally agencies which help/protect such persons or potential persons having a direct interest in them.

Table 6.1 provides decision usefulness of accounting information.

• 101 Accounting Basics Strong foundation on fundamental concepts and the accounting process
• FIN Financial Accounting Financial accounting and reporting, financial statements, IFRS and GAAP
• MNG Managerial Accounting Managerial/management accounting topics to aid in decision-making
• DIC Accounting Dictionary Accounting terms defined and carefully explained
• MIS Misc Articles Miscellaneous topics about anything accounting
• References +
• 1 What is accounting?
• 2 Purpose of accounting
• 3 Users of financial statements
• 4 Types / branches of accounting
• 5 Areas of practice
• 6 Types and forms of business

What is accounting?

Accounting is commonly known as the "language of business". It is a means through which information about a business entity is communicated. Through the financial statements – the end-product reports in accounting – it delivers information to different users to help them in making decisions.

A Simple Illustration

Meet Mr. Carter.

Mr. Carter started a printing business. He invested $100,000 of personal savings to start the company's operations. After a month, he wants to know how much the business made. He also wants to know what happened to his money.

Without a way of recording the activities of the business, we will not be able to answer his questions. Surely we can tell him, "Mr. Carter, we made a lot this month!", but we need proof! And he needs the figures!

We can easily answer Mr. Carter's questions if we kept track of the company's transactions. If we used $30,000 of the $100,000 we had at the beginning to buy printers and pay the bills, then we'd have $70,000 cash left. If we collected $50,000 from our customers, then we would have $120,000. Easy, right?

Now, that's just a tiny bit of what accounting can do. Imagine we have thousands of transactions! And, there's a lot more to accounting than just recording. How much income did we make? How much do we owe our creditors? Is this a good investment? So on, and so forth.

Accounting Definition

Technical definitions of accounting have been published by different accounting bodies. The American Institute of Certified Public Accountants (AICPA) defines accounting 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."

Though I am not a fan of technical definitions, studying the statement above will give us a better understanding of accounting. Let's break it down.

1. Accounting is considered an art

Accounting is considered an art because it requires the use of skills and creative judgment. One has to be trained in this discipline to be able to perform accounting functions well.

Accounting is also considered a science because it is a body of knowledge. However, accounting is not an exact science since the rules and principles are constantly changing (improved by standard-setting bodies).

2. Accounting involves interconnected "phases"

Recording pertains to writing down or keeping records of business transactions. Classifying involves grouping similar items that have been recorded. Once they are classified, information is summarized into reports which we call financial statements.

3. Concerned with transactions and events having financial character

For example, hiring an additional employee is qualitative information with no financial character. Hence, it is not recorded. However, the payment of salaries, acquisition of an office building, sale of goods, etc. are recorded because they involve financial value.

4. Business transactions are expressed in terms of money

They are assigned amounts when processed in an accounting system. Using one of the examples above, it is not enough to record that the company paid salaries for April. It must include monetary figures – say for example, $20,000 salaries expense.

5. Interpreting the results

Interpreting results is part of the phases of accounting . Information is useless if they cannot be interpreted and understood. The amounts, figures, and other data in the financial reports have meanings that are useful to the users.

By studying the definition alone, we learned some important concepts in accounting. It also gave us an idea of what accountants do.

The simple things we do and encounter everyday can actually be related to some level of accounting. You make budgets, count change and check the receipts from the supermarket. You may also have listed things you spent your money on at one point in your life.

We are surrounded by business – from managing our own money to seeing profit statements of big corporations. And where there is business, there sure is accounting.

Accounting is an art. It requires skills and professional judgment that are developed through study and practice. Nonetheless, it is a body of knowledge hence also a science.

Accounting comprises 4 phases: a) recording, b) classifying, c) summarizing, and d) interpreting, financial information arising from business transactions & events.

We actually encounter or apply accounting in our daily lives – in budgeting, computing household expenses, checking bank balances, counting change, and many more.

More under Introduction to Accounting

• 1 What is Accounting
• 2 Purpose of Accounting
• 3 Users of Financial Statements
• 4 Types / Branches of Accounting
• 5 Areas of Practice
• 6 Types and Forms of Business

Introduction to Accounting

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on June 08, 2023

Fact Checked

Why Trust Finance Strategists?

Table of Contents

Accounting: definition.

The American Institute of Certified Public Accountants (AICPA) published perhaps the most comprehensive definition of accounting:

Accounting is 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 a financial character, and interpreting the results thereof.

Accounting: Explanation

To explain and understand the above definition clearly, let’s consider it in parts.

The first thing to note about accounting is that it is an art, not a science. It is a practical subject concerned more with doing things than theorizing about them.

Accounting is the art of recording, classifying, and summarizing transactions and events. In the first place, we maintain the records of transactions by writing various accounting books like journals and ledgers , etc.

These records are then classified into suitable headings and groups. This classification is important because all information must be seen in a proper perspective to be meaningful.

After the basic records have been suitably classified into groups, the information provided by the groups is summarized into accounting statements (e.g., statements showing the calculation of profit and loss or the business’s financial position).

The preparation of such summarized financial statements is frequently the ultimate aim of keeping records and classifying them.

Another important fact is that such records, classifications, and summaries are made for both transactions and events.

A transaction is any business dealing or activity in which a business unit (or a person) is involved that causes a change in its financial position (e.g., purchase or sale of goods).

An event, on the other hand, is an occurrence to which a business unit may not be a direct party, but may still be affected by it.

An example is the devaluation of a currency. An importer or an exporter is usually affected by devaluation without being directly involved in the decision to devalue the currency.

If an event has a financial implication for a business unit, it must make a record of such an event.

Again, the records, classifications, and summaries are made for only those transactions and events that are of a financial nature or character. All accounting records are basically financial records.

If a transaction or an event does not have a financial implication, it will not be recorded in the accounting books.

For example, placing a purchase order is a transaction but it has no financial implication until the goods are actually delivered by the supplier to the buyer.

Hence, accounting records are made only after the goods have been physically received. As a case in point, the devaluation of the US dollar may have no financial implication for a small trader who has no import or export dealings.

Therefore, in this case, no record of the event must be maintained.

All records are made in a significant manner and in terms of money. It is important that these records must be made in a significant (i.e., organized and methodical) manner in order to be of any real use to a business unit.

Again, all accounting records are made in terms of money—not in terms of quantity or weight.

While additional or subsidiary records may be kept by some businesses in terms of quantity, the basic accounting records are all kept in terms of money.

Thus, a motor vehicle account will show the value of a motor vehicle owned by a business, not its make or mileage, etc. Similarly, in the purchase account, we show only the monetary value of purchases , not the quantity, type, etc. of goods purchased.

The last part of the definition from the AICPA shown above is concerned with the interpretation of the results made available by accounting records and summaries.

Financial statements must be explained to the people concerned so that they can understand the contents and the message conveyed. This is, therefore, an important aspect of the accounting process; without it, records would have limited, if any, value.

For the purpose of interpreting and explaining the accounts, a number of tools or techniques can be utilized.

Need for Accounting

A business exists to earn a suitable return (or profit ) on the investment allocated to it. It is so because money obtained from shareholders and long-term creditors comes at a cost .

The cost for shareholders’ money is to be equated with their expectations. A business will, therefore, aim at a return that satisfies the shareholders’ expectations as well as the legal requirements of the creditors .

The expenses incurred to run a business and the income earned is recorded in accounting. Accounting converts business transactions in money terms, classifies and records transactions in the books of accounts, and summarizes transactions.

This shows the profit earned (or loss sustained) during a period. It also shows the company’s financial position (in terms of assets , liabilities , and proprietor’s interest) at the end of the period.

Without accounting, a business cannot identify how much has been spent, why it has been spent, and what results have been achieved in the form of earnings made through increasing these expenses.

Accounting, therefore, serves as the eyes and ears of a company. With accounting information, businesses can evaluate the direction they are heading in and, accordingly, determine whether the journey will lead to a happy or sad end.

Introduction to Accounting FAQs

Who needs accounting.

All business organizations are in need of accounting. Individuals, sole traders, Partnerships, companies, corporations—all cannot survive without keeping proper accounts.

What is the difference between a hobby and a business?

Hobby does not require any kind of organization or formalities at all. It is an activity carried out on a personal level. In a business, one has to maintain proper books of accounts and other records in the format laid down by law.

What is the difference between a cash book and a general journal?

Cash book shows all cash receipts and payments that take place on a day-to-day basis. It presents only cash transactions under the head cash. General Journal is a book of original entry in which all transactions are recorded at the initial stages only. It includes credit and debit entries for each transaction.

What is the difference between an asset and an expense?

An asset increases the wealth of a person, firm, or country whereas an expense reduces it. Expense is an outflow of cash or diminution in the value of an asset. Alternatively, an expense is the cost involved in earning income.

What are the different types of accounting?

There are various ways by which you can account for your money. Here are five major types: full double-entry accounting, single-entry Bookkeeping, internal control accounting, managerial accounting, and Financial Statement reporting.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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• Financial Accounting

What is Accounting? - Meaning and Important Concepts

Accounting has been hailed by many as the “language of business”. There are many quotations like “A pen is mightier than the sword but no match for the accountant” by Jonathan Glancey which tell us about the power and importance of accounting.

The text book definition of accounting states that it includes recording, summarizing, reporting and analyzing financial data . Let us try and understand the components of accounting to understand what it really means:

The primary function of accounting is to make records of all the transactions that the firm enters into. Recognizing what qualifies as a transaction and making a record of the same is called bookkeeping.

Bookkeeping is narrower in scope than accounting and concerns only the recording part. For the purpose of recording, accountants maintain a set of books. Their procedures are very systematic. Nowadays, computers have been deployed to automatically account for transactions as they happen.

Summarizing

Recording for transactions creates raw data. Pages and pages of raw data are of little use to an organization for decision making. For this reason, accountants classify data into categories. These categories are defined in the chart of accounts. As and when transactions occur, two things happen, firstly an individual record is made and secondly the summary record is updated.

For instance a sale to Mr. X for Rs 100 would appear as:

Management is answerable to the investors about the company’s state of affairs. The owners need to be periodically updated about the operations that are being financed with their money. For this reason, there are periodic reports which are sent to them.

Usually the frequency of these reports is quarterly and there is one annual report which summarizes the performance of all four quarters. Reporting is usually done in the form of financial statements. These financial statements are regulated by government bodies to ensure that there is no misleading financial reporting.

Lastly, accounting entails conducting an analysis of the results. After results have been summarized and reported, meaningful conclusions need to be drawn. Management must find out its positive and negative points. Accounting helps in doing so by means of comparison. It is common practice to compare profits, cash, sales, assets, etc with each other to analyze the performance of the business.

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