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January 06, 2023

What is accounting?

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When you start the business, your responsibilities expand dramatically. Bookkeeping has become one of the essential types of work. But what is accounting? What is its role in the company? How long does this type of work take? The good news is that with the right people, modern tools, and resources, bookkeeping will no longer be the black hole of your work hours. In this article, we will take a closer look at accounting, the chronology of its development, and the regulations of work.

The definition of accounting

Accounting is a term used to describe consolidating financial data to make it clear and understandable to all stakeholders and shareholders. The main task of bookkeeping is to register and inform about the fiscal manipulations of the company and the movement of capital.

Implementing accounting standards increases the reliability of financial documents, including the income statement, capital flows, retained earnings, etc. All stakeholders and shareholders can evaluate the company’s performance thanks to standardized entries. All financial reports must be accurate, transparent, and reliable.

History of accounting

Accounting appeared many millennia ago. Historians trace its development up to the first civilizations. Experts have found evidence bookkeeping appeared about five thousand years ago in ancient Mesopotamia. It has evolved along with the ability of people to write, count and use money.

Historians have found signs of basic bookkeeping in ancient Iran, and the Egyptians of that era even had a primitive audit system. The Roman emperor Augustus had comprehensive records of his finances throughout his life; he was in power from 27 BC. to 14 AD.

The father of the bookkeeper is the Italian mathematician Luca Pacioli, who, in 1494, wrote a book about double-entry accounting, outlining managerial and financial procedures.

Accounting as a profession originated in the early 19th century. In 1880 in England, local professional bodies established the Institute of Chartered Accountants in England and Wales. Such an alliance has created various financial systems modern bookkeepers successfully use.

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What is the importance of accounting?

Accounting is a vital part of any business as it deals directly with the company’s finances; in particular, spending and income arise during day-to-day activities and investments. This data may be lost, misrecorded, or cataloged incorrectly without proper recording. Let’s discuss other benefits of bookkeeping:

  • Ensures the company’s growth: without understanding the peculiarities of the company’s work, it will be difficult to make reasonable decisions with forecasting. Accounting allows you to determine which products or services of the enterprise are in the highest demand, how much profit each team generates, and how overhead costs are.
  • Helps leverage additional funding: investors need to be sure they understand what they are investing money in. Before the start of external financing, sponsors ask to show financial statements to assess the company’s current position.
  • Successful payment management: any company has arrears, and part of debt management is making payments on time; otherwise, the firm risks being left without critical suppliers or other counterparties. Thanks to bookkeeping, the organization always knows to whom it has arrears and in what amount.

It is critical to record and account any transaction correctly; otherwise, the company’s management may form a false idea about the volume of cash flow and profit. It can lead to severe problems; that is, it will not be able to pay its debts, or funds set aside for investment may not be available. Incorrectly filling out reports can result in legal problems and significant fines.

What is accounting?

Main principles of accounting

Principles of accounting are the regulations that firms must adhere to when planning and creating financial statements. The United States has GAAP, which stands for Generally Accepted Accounting Principles.

When developing GAAP, experts sought to ensure that a single set of regulations guided all companies. GAAP describes accounting terms, assumptions, and methods and deals with various assets, liabilities, and financial reporting topics.

Such standards rely on the double entry method, where each operation is shown on the debit and credit of two ledger chapters that are included in the balance sheet.

Standardization is designed to make it easier for business owners, investors, and government organizations to understand the essence of financial documents.

Other countries, including Canada, Mexico, and Australia, follow the regulations set by the IFRS (International Financial Reporting Standards) foundation based in London.

Basic types of accounting

Contrary to popular belief, accountants do more than pay taxes. They are also tasked with logging different transactions and working with a specific database. Therefore, there are a few groups in which most professionals can be combined:

  • Financial accounting involves recording, summarizing, and reporting on the movement of capital arising from business transactions over time. Such insights are vital during preparing accounts, e.g., income statements and balance sheets. They display the financial achievements of the organization for the selected moment.
  • Managerial accounting involves using specific economic data to make strategic fees and decisions about business needs. The information that is collected in the course of management bookkeeping includes insights from all business teams. It is crucial in highly competitive areas of cash flow analysis, sales, budgeting, and investment.
  • Tax accounting establishes specific rules based on laws that taxpayers must follow when filing tax returns. Such bookkeeping focuses on taxes rather than the company’s annual financial statements. It allows you to monitor the inflow and outflow of the capital of individuals and legal entities.
  • Cost accounting controls the total manufacturing expenses of the business; it estimates fixed and variable costs at each stage of production. Managers and bookkeepers utilize this data to define the value of products.

Although various kinds of accounting focus on different classes of business, all these areas follow specific standards and stick to the facts. The main characteristic of bookkeeping is to serve the public interest by providing truthful reports on the company’s financial position. Regardless of their position and the reporting standards used, accountants must be accurate in their job.

Fundamental methods of accounting

Accountants may keep records on a cash basis or an accrual mechanism. The main distinction between these accounting methods is in time.

The cash method is the basic accounting algorithm for which a specialist must record transactions when transferring money. If you received an invoice on the 8th and made a payment on the 12th, you must register the transaction on the 12th.

When using the accrual method, it is necessary to register operations twice: at their implementation and during the payment moment. In the example above, you enter expenses on the 8th and payments on the 12th as separate transactions.

The choice of method depends on your goals. The cash algorithm is easier to control, while the accrual method provides more information for business owners who want to maintain sight of all details.

What are the three groups of accounts?

According to the double-entry bookkeeping system, three types of accounts help display journal entries correctly. Different types have their own rules to identify the debit and credit aspects. Let’s discuss the main groups of accounts:

  • Personal accounts contain operations related to individuals or companies with which your organization has direct transactions. They may include persons, legal entities, and representatives.
  • Real accounts manage assets, property, or possessions; they can be tangible or intangible, including cars, buildings, patents, goodwill, etc. Such balance sheet items do not reset at the end of the financial year unless assets are sold.
  • An organization’s expenses, losses, income, or profits are associated with nominal accounts. They are temporary, as they are displayed in the profit and loss statement of the firm in the column net profit / net loss and are closed at the end of the financial year.

It is essential to understand what kind of accounts you are dealing with because if you misclassify a transaction, you risk making an incorrect journal entry. An organization’s financial data becomes unreliable if debit and credit rules are misused for different accounts. Recording standards depend on the exact classification.

What is accounting?

Golden rules of accounting

There are three golden rules of bookkeeping. They refer to the specific kinds of accounts listed above and how transactions are debited and credited.

Debits and credits are needed to balance the ledger. Their mechanism of action is as follows: when recording a transaction for each debit entry, you need to make another credit entry for the same amount. It means debit and credit balance each other. Golden rules help bookkeepers understand how these concepts relate to different types of records:

  • Real accounts: debit what comes in and credit what goes out. Such a rule applies to company assets, including buildings, furniture, land, equipment, etc.
  • Personal accounts: debit the recipient and credit the donor. The regulation applies to transactions involving individuals or legal entities, e.g., banking procedures.
  • Nominal accounts: debit all expenses and losses, credit income and profits. Such a standard is relevant for payroll, sales, purchases, and commissions.

Proper bookkeeping is paramount when it comes to meeting standards. With good bookkeeping discipline, it will be easier for any company to achieve regulatory compliance. Now that you clearly understand the golden rules, you know what kind of transactions belong to which account. All journal entries for monetary procedures must be accurate and up to date.

The career of accountants

Accountants work in companies in various industries, building careers in both small businesses and international corporations. Most firms in 2022 would not be able to operate without bookkeepers, as these professionals inform the current economic state of the company. Below, we have compiled a list of professions an accountant can engage in:

  • Auditor: monitors invoices and controls the accurate recording of data.
  • Forensic specialist: examines financial insights to determine fraud.
  • Tax accountant: deals with the preparation and registration of tax documentation
  • Budget analyst: analyzes the expense items of the balance sheet and identifies ways to make the business more efficient.
  • Chief financial officer: oversees the company’s finances and assists the heads of other divisions in making decisions.

Qualified employees can also work for themselves, starting small businesses and providing financial services. Advanced accounting programs make it easier to keep records, but remember the human factor because the interpretation of the results requires the participation of a professional. It is good if a specialist in the field of finance receives an accounting degree from a reputable institution.

A CPA or «Chartered Public Accountant» is considered an expert and earns a higher salary than a regular bookkeeper. Getting CPA status is not easy; the exact requirements vary by state. All states require a four-part exam.

Final words

Accounting is how your company records, organizes and interprets financial data.

You can think of bookkeeping as a giant machine that feeds raw economic data about transactions, taxes, and forecasts to get a story about the company’s current state.

Accounting helps you comprehend whether you will profit or lose over a certain period, your cash flow, the total value of assets and liabilities, and which products or services bring the most profit to the business.

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Author: Charles Lutwidge

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