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Accounting or accountancy is an art of recording business transaction. It refers to the process of identifying, measuring and communicating economic information, for judgment and decision making. It also involves knowing about what amount of money there were; were used and also that will be used in transaction.
Accounting began because people needed to record business transactions so as to know if they were financially successful, how much they owned and how much they owed. Accounting main objective is to let people and organization know if they are making profit or a loss and how much cash they have in the business so as to continue for the foreseeable future. There is evidence that accounting was practiced in ancient times in Egypt, China, Greece, and Rome. But today's accounting differs completely from the one which people in ancient time were using. Today there exist two types of accounting standards; Financial Accounting and Management Account.
Financial accounting is all about bookkeeping and preparation of financial statement. In financial accounting, these are the two main components. The information that is produced by financial accounting is usually historical, backwards looking and for the use of decision makers external to the organization to whom the information is related.
Management accounting is the process of preparing management reports and accounts that provide accurate, timely financial and statistical information required by managers to make day -to-day and short terms decisions.
ACCOUNTING FUNCTION AND ITS USERS
Accounting deals with business transaction. Business transactions are events that have financial effects on a business. For example buying and selling of goods or services, paying bills, etc.
Accounting also consists of five essential basic functions, which are recording, classifying, summarizing, analyzing and communicating. If those functions are not being done by the users of accounting therefore his financial statement will not show a true and fair view at the end of the financial year.
The purpose of accounting is to accumulate information and reports on financial information about performance, financial position, and cash flows of a business. This information is accumulated in accounting records with accountingÂ transactions, which are recorded either through such standardized business transactions asÂ customerÂ invoicingÂ orÂ supplier invoices, or through more specialized transactions, known asÂ journal entries. Once it has been stored it is transfer to the financial statements which consist of the income statement, the statement of financial position, the cash flow statement and the statement of retained earnings.
THE USERS OF ACCOUNTING
As I mentioned earlier there are two types of accounting that is financial and managerial accounting. But each of them has their own users.
Users of accounting information can be developing in two types, which are for internal users and external users. Internal users of accounting information role is to plan, organized and run confidence inside an organization, they are the one who works for the company. It includes marketing managers, the financed directors, supervisors, human resource, personal and company officers.
External users of accounting information; the main ones are investors and creditors. Investors make the use of accounting information to make decision and the creditors such as suppliers use information to evaluate the risk granting credit of laundering money. We should note that these are the two main types of external users and in every firm there should the two of them. There are also some more examples of external users that are the labor union, the customers, the tax authorities, regulatory agencies, economic planners, and stakeholder (they are the one who have certain interest within the company).
THE PROCESS OF ACCOUNTING
Accounting has a primary objective, which is to provide information for decision making. For example a car company, by using accounting he knows about the number of cars sold in a month, he can calculate its depreciation value and therefore he can determine if he can purchase more. In other words if a business record what he sold, to whom, the date it was sold, the price at which it was sold , and the date it received payment from the customers, along with similar data concerning the purchases it made. Certain information could be produced summarizing what had taken place. The profitability of the business and the financial status of the business could also be identified, at any particular point in time.
Every business needs accounting records because there are the only records of a firm's financial position. It helps to memorize and provides objective evidence of activities performed, events occurred, results achieved, or statement made. That is why there is eight accounting process that helps firm's for their accounting records to be accurate and précised.
The first accounting process starts with identifying. Only transaction that belongs to the business is being recorded. Those which concern the business entity are included in the process. For example if the owner withdraws money for his personal use this does not have anything to do with the entity. The transactions identified are then analyzed to determine the accounts affected and the amount to be recorded.
Â Business owners use written documents to track specific information relating to financial transactions. These documents classify transactions and usually include specific information regarding economic events. Business owners also use this information to have a historical record of business transactions. Once each transaction is identified and classified, the information is recorded in the company general ledger.
All transactions should have the same common measuring units. It deals with recording transactions using the country currency. Accountants use these measurements to report information to internal and external users. Financial accounting measurement are typically recorded at historical cost or adjusted to current market values through adjusting entries. ManagementÂ accounting uses measurements to calculate the cost of materials used or the number of labor hours needed to produce goods or services. Accountants use specialÂ cost allocationÂ methods when calculating managementÂ accountingÂ measurements.
FinancialÂ accountingÂ measurements are different than managementÂ accounting measurements. Assets, liabilities, debt financing and equity investments are all same accountingÂ items needed for a periodic measurement. External users make investment decisions based on the information included in financial statements; GAAP (generally accepted accounting principles) is used to present financial information in similar methods across business industries. According to the GAAP there are certain principles and laws that companies should adopted.
Companies are required by GAAP to record statement of financial position information using aÂ value accountingÂ measurement. This measurement technique forces companies to value assets and equity investment at the current market rate at which these items can be sold in an open market. These measurement methods may need to be disclosed on the company's financial statements using disclosures or footnotes. These explanations allow investors to understand how the company values its balance sheet items and if the company has accurately applied GAAP. Incorrectly appliedÂ accountingÂ measurements can lead to misstated financial statements; investors or banks may be unwilling to invest in these companies because of the accountingÂ improprieties.
Recording transactions is the physical process of entering financial data into the company's general ledger. Small businesses may use manual or automated accounting ledgers in their business operations. Manual accounting requires business owners to maintain several paper ledgers for recording financial transactions. Accounting software provides business owners with an electronic process for recording transactions and maintaining financial information. Recording transactions may require business owners to prepare journal entries based on financial transaction documents.
All transaction is made in a chronological order. Therefore accountants make use of the journal which known as the book of original entry. The journal is a book in which business transactions are being recorded using the double entry bookkeeping system. It contains at least two accounts (one debited and one credited). For example transactions that occur frequently such as sales, purchases and cash receipts.
Classification is the process of identifying accounting transactions and assigning those transactions to an appropriately numbered account. A company's classification system is recorded on what is known as a statement of financial position. Certain financial information must be reported by law. Classification organizes and facilitates this reporting process. The classification system helps guide bookkeepers as to where various company transactions should go, saving time and improving accuracy in reporting.
All transaction will be posted to the ledger. The ledger is a collection of account that shows the changes made to each account as a result of past transactions, and their current balances. This is the core of classifying phase. For example all journal entries made to cash would be transferred into cash account in the ledger. All increases and decreases in cash will be entered into one ledger account.
Summarizing in accounting means to check the arithmetical accuracy of the ledger and to check before passing all the data in the financial statement. That is firstly we need to prepare a trial balance to check the equality of the debit and credit side. Which means the debit balance should equal to the credit balance. All account balances are extracted from the ledger and arranged in one report. However there are errors which should be corrected. These errors are those which affect the trial balance such as double posting or failure to record a transaction.
At the end of the accounting period, some expenses may have been incurred but not yet recorded n the journals. Some income may have been earned but not entered in the books. Thus adjusting entries and prepared to have the account updated before they are summarizes into the financial statement.
When accounts are already up to date and equality between debits and credits has been tested, the financial statements are the end products of an accounting system. All are summarize in the financial statement. And for a company a financial statement should include the income statement, the statement of changes in equity, the statement of financial position, the statement of cash flows.
At the end of each transaction all the accounts are closed. Income statement account is closed to prepare it for the next accounting period. This is where accountant make an analysis for decision making whether the business may continue for the foreseeable future (the going concern concept) or no longer continue operation. It is both for internal management and external users such as investors, creditors and analysts make the use of the financial statement to evaluate the company's profitability, liquidity and solvency.
The most common methods used for analyzing the financial statement are trend analysis, common size statements, and ration analysis. For example liquidity ratio or acid test ratio. These methods include calculations and comparisons of the results to historical company data, competitors, or industry averages to determine the relative strength and performance of the company being analyzed.
Accounting interpretation is a statement that clarifies how accounting standards should be applied. Accounting interpretations are issued by accounting standards groups, such as the Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB). Interpretations are generally not requirements, but rather outline as best practices and give further explanation. Besides, accountants are required to follow the accounting standards that are in place.
As financial transactions continue to evolve, new situations develop that may not have been foreseen by the existing accounting standards. In this case, accounting boards may choose to issue an interpretation outlining the recommended practices for accounting as questions arise. If new changes are particularly significant, the standards themselves may be adjusted so that compliance is required.
Accounting, the language of business, has its own rules and definitions that seem odd to individuals with no financial background. Accountants need to communicate the meaning behind the numbers in a way that is clear, understandable and that makes sense to non financial individuals.
The most important use of accounting data is to communicate meaningful information, allowing management to make good decisions. To be effective, accounting information must make sense and be understood. Or else, it is just a list of numbers with no real significance. Many businesses use templates for internal reports to communicate information in a matter that is familiar and easy to use by management. For example, departments may get actual budget reports every month, using the same format, facilitating understanding and analysis. That is why accountant are here to help in those decisions.
As well as listening is also very important. If an accountant cannot understand what is being said, he will miss crucial information. Listening and understanding are significant skills because they allow accountant to know about client's expectations and better serve them. When an accounting professional listens and empathizes, he creates trusts within the clients.
For the investors as well communication is very important, it helps them to know how a business is doing financially. Usually this type of information is communicated through standard reports, such as balance sheets and income statements, compiled using generally accepted accounting principles. A balance sheet shows assets, including cash, liabilities and owners equity. An income statement presents income and expenses of a business at a certain point in time. Both statements are compiled the same way every month or period, allowing for comparability and analysis, from an investor point of view. Many investors may also want to see cash flow statements with information about money coming in and going out in a business. They may also request special reporting.
Advantages of these eight accounting process
These eight accounting process help accountants and managers;
To avoid zero entries
That is every transaction that happens in the business should be recorded in the book of prime entry. This is in accordance with the GAAP.
To help to reconcile account
To avoid loss of information
To help in comparing different period of account so as to make proper and accurate decision. For example to know whether the business may continue operation for the foreseeable future.
To monitor profit and expenses
To maintain financial control of the business
To control inventory/ stock
For example they verify if there is any wastage or stock left in the business.
To avoid fraud and errors.
Thus as a bookkeeper you need to complete your task by applying these eight processes so that you can avoid fraud and errors, manipulate the transactions , closed all account at the end of each accounting period and then starts a with a positive goodwill in the business. According to the GAAP every business should applied all rules and regulations of accounting standards.
FINANCIAL ACCOUNTING V/S MANAGEMENT ACCOUNTING
The only similarity between them is that both use the same information which is extracted from the accounting information system. But they do differ from each other.
In financial accounting money is mostly use as a means of measuring economic performance. Whereas in management account only detail that concerns the financial position of the business are being used.
Management accounting is all about assembling cost appropriately so that businesses can take appropriate decisions. Management accountants are primarily involved in establishing the costs incurred in producing the output of a business and in maintaining a budgeting system that provides managers with capability to plan and control activity and so meet the objectives of the organization.
Management accountants are also involved in preparing any information of a financial nature that managers and other decision makers require and which is not considered a part of the role of the financial accountant. Their work can be very much more different than that of a financial accountant, and they are not link with any rules and regulations concerning either how they perform calculations or how they present information.
Planning and control
Management accounts are used to help management record, plan and control the activities of a business and to assist in the decision-making process.Â They can be prepared for any period (for example, many retailers prepare daily management information on sales, margins and stock levels).So as to assess future decisions.
Financial accounts describe the performance of a business over a specific period and the state of affairs at the end of that period.Â The specific period is often referred to as the "Trading Period" and is usually one year long and also the period-end date as the "statement of financial position end ".
Rules and Regulations
Financial accounting statements prepared for external users must acts in accordance with the generally accepted accounting principles (GAAP). External users must have some assurance that the reports have been prepared in accordance with a common set of rules and regulations. These rules and regulations improve comparability and help reduce fraud and errors, but they do not necessarily lead to the type of reports that would be most useful in internal decision making. For example, if management is considering selling land to open a new store, they need to know the current market value of the land. However, GAAP requires that the land be stated at its original, historical cost on financial reports. The more relevant data for the decision the current market value is ignored under GAAP.