What Is Accounting?

If you are just starting to learn accounting, it is essential to understand what it is.

Let us think about the business, which performs certain business transactions. In respect of business, we can say that accounting is a system, the purpose of which is to provide information about the business transactions. This information is provided to certain entities or individuals, who are called the users of the accounting information.  They make certain decisions and judgments about the business based on the accounting information provided.

Accounting is a service having two purposes:

  • provide information about business
  • provide safeguard over the assets of the business

Accounting is a process of:

  • analyzing,
  • recording, and
  • summarizing,

financial data of a particular business activity.

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Also it is important to understand that analysis, recording and summary of financial data and the process of these activities does fall under the concept of accounting. Quite often accounting is mixed with bookkeeping, whereas bookkeeping is simple and cover only activities of only recording economic events, which occurred while business was operating.

As accounting process covers various activities with the financial data, the question is what is financial data?

Financial Data

Financial data – actual business transactions (for example, sale of goods, provision of services, purchase of assets).

If we talk about accounting information, how we can understand what is it?  The accounting information is a financial data and that financial data reflects business transactions, which happened during the certain period of time (i.e. accounting period). This financial data must be expressed in terms of money, so any business transaction is recorded and is expressed in terms of money.  Why do we need such expression?

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Let’s assume we want to compare apple with the orange and if we do not have their value in money terms, we cannot compare them because we have different qualities.

We cannot say which is more valuable, because we do not have the basis for comparison. This is why we need to express their value in terms of money. Only afterwards we will be able to compare them and see which is more valuable and which has higher or lower cost.

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The same relates to the comparison of certain businesses. If we want to compare the results of operations of different companies, we only can do that, if we have accounting information, which is expressed in terms of money.  Then we will be able to compare the results and see, which business performed better comparing to the others.




The next step is to understand that accounting is a process and that process covers certain steps.

Accounting is a Process

Those steps represent Accounting Cycle, which is a process of analyzing, summarizing and recording transactions. Financial data basically covers business transactions, which happened in the business. Business transactions in order to be analyzed during the accounting process must have an impact on the financial results of the business. And examples can be: sale of goods, provision of services, purchase of assets.

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Transactions must be supported by certain source documents, which are analyzed and are used as a basis recording transactions.

Source Documents

Source document is a document, which states the nature of a transaction and all the details and only based on those documents transactions can be recorded and included into the accounting information.  This is needed in order to have a proof of that to certain transaction happened and also to be able to trace that transaction after some period of time.  Source documents also allow to get information about the particular transaction, if such information is needed at later times after it occurred.

Purpose of this process is to prepare financial statements and have an accurate and timely accounting data, based on which interested parties (owners, creditors, suppliers, customers, employees, governmental institutions and other) can judge on the results the business has achieved during a particular period of time, on the assets the business possesses and on the financial means used to finance these assets, i.e. liabilities and owners’ equity.

Accounting Cycle

 Process of Financial Accounting is divided into 7 major steps, which compose Accounting Cycle:

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Business transactions are recorded in the books of prime entry. Afterwards transactions are analysed in the books of prime entry and the totals are posted to the General Ledger Accounts. At last transactions are summarized in the Financial Statements (Balance Sheet and Income Statement)

Historic Data

Considering financial accounting process, it is essential to understand, that it uses past events and transactions, which already happened. Financial accounting is not aimed to provide predictions about future business operations. However financial statements and data contained there are used extensively for forecasting purposes.

Accounting Roles

Financial accounting has two major roles.

One is pure informational, which means that financial accounting provides information for its users for decision making purpose.

The other important role of the financial accounting is economic. It is essential to understand that plenty of business transactions are based on the accounting information. Provision of debt, purchase of goods, supply of raw materials, acquisition of company shares and many other transactions are substantiated by the financial statements and information contained in them. Additionally wealth of business and its managers, exposure of the business to taxes and regulations is also based on the accounting data and financial reports.

Therefore it important to ensure the accounting information is complaint to Generally Accepted Accounting Principles.

Accounting Types

It is necessary to understand the difference between Financial and Management Accounting. The table below explains area of each accounting type:

Types of accounting

Financial accounting
Management accounting

Covers reporting results and financial position of a business. Its primary task is not related to provision of information towards improvement of business efficiency and its management, but is to satisfy information needs of interested parties not involved in business management. Only historical information is provided by financial accounting in the strict forms of the reports

Covers provision of information to the management of the business for business planning and controlling purposes. Includes not only historical, but also future (forecasted) information. No strict form of the reports are used

After business transactions are recorded, analysed and summarized Financial Statements are prepared. There are three main types of Financial Statements, i.e. Balance Sheet, Income Statement and Cash Flow Statement.

Users of Financial Statements

Business is a complex system, in which several groups have specific interests. Objective of Financial Statements – provide information on financial position, performance and change in financial position of a business to a wide range of users to make economic decisions.

Who are those users?  The users can be investors, creditors, employees, suppliers, customers of the business, also different governmental institutions, stacks, authorities, statistical bodies and any entity or individual, who are interested in the results of the business and they use their accounting information.

Such users can be divided into several groups depending on the reasons for which they need Financial Statements of a particular business.

Users of accounting data and financial statements

Management

Responsible for day to day business management. Need information on financial situation of business, i.e. current and expected in the future

Shareholders

Use information to assess performance of the management

Trade partners (suppliers, customers)

Suppliers selling goods need information on security of their sales and payments. Customers buying goods need information on security and stability of their purchases

Creditors

Need an assurance that loans granted to the business and interest on the loans will be paid on time

Taxation authorities

Use information for assessment of taxes, including sales tax

Employees

Need assurance on security of their jobs, future career perspectives

Financial analysts and advisors

Use information to provide services to clients (investors, credit agencies)

Government and its institutions

Use information to allocate resources, for statistical purposes

Public

Businesses are members of public. They contribute to local economy, employment, usage of local resources, environment. Information is used to evaluate such contribution

Each of these groups has a direct relationship to the business and in order to be able to perform its functions adequately they need certain information on the business. Such information they derive from the Financial Statements, which are prepared by Accounting System.