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Accounting has been around since the beginning of civilization. Accountancy participated in the development of cities, trade, and the concepts of wealth and numbers. The importance of accounting cannot be overemphasized. Equally important are the standards used to guild the application of accounting practice. Without principles and standards, financial reporting would not fairly present the financial position of a company. Accounting has changed and evolved vastly over time and continues to change.
In this assignment, I will define accounting and the different processes of accounting records. I will also Distinguish between Financial Accounting and Management Accounting and outline the advantages and disadvantages, with examples.
The beginning of civilization occurred during the transition from hunter-gatherer to farmer. Farming led to crop surplus and therefore the need to trade and barter. Â Jericho, the oldest city known to historians was the first known trading center for surplus goods. Personal wealth created the need to keep track of inventories. Ancient bookkeepers used small clay balls called tokens to count and keep track of existing wealth. These tokens were used as evidence of transactions. Over time, the tokens were used to make impressions in clay along with pictures which represented the first attempts at accounting. These events took place around 5000 B.C. (Giroux)
Evidence suggests that double entry bookkeeping developed in Italy around 1200 B.C. The first book written on double entry bookkeeping was written by Luca Pacioli in 1494. (Smith) Pacioli was referred to as the father of accounting, but he did not actually invent the system he described. He simply wrote about the business practices used by merchants in Venice at the time. Many of his writings were used for several centuries. With the development of technology, wealth, and trade came the need to adequately account for the complexity involved.
2.0 What is accounting ?
Accounting a subsection of Accountancy. It is a service activity. Its function is to provide information,Â primarily financial in nature, about economic entities that is expected to be useful in making economic decisions, in making reasoned choices among alternative courses of action.Â
Accounting, is often called "The language of Business"
A statement of basic accounting theory defines accounting as the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information. (Evanson, Illinois:American Accounting Association,1966)Â
Accounting is the art of recording, summarizing, reporting and analyzing financial transactions. That is the systematical record of day to day events to know about profit, assets and liabilities. Accounting is about accountability. Most organizations are externally accountable
In some way for their actions and activities. They will produce reports on their activities that will reflect their objectives and achievements to people to whom they are accountable.
Purpose and Functions of Accounting.
Â To provide quantitative, financial information about economic entities to statement users so that they could make informed judgment and better decision.Â
2.1 UseRs of Accounting Information
Accounting is an information system that measures business activities, processes information into reports and communicates the reports to decision makers. A key product of this information system is a set of financial statements-the documents that report financial information about amenity to decision makers. These reports tell us how well an entity is performing in terms ofÂ profits and losses and where it stands in financial terms.
We have two types of users of accounting. That is internal users and external users. Some examples of users of accounting are as follows:-
They use accounting figures to
Suppliers - decide if they can give credit facilities to the firm, when supplying materials
-Short term; determine if the amount due by the firm will be paid on time and if more money can be given on credit.
-long term- determine if capital and interest will be paid in due time
Bank and Financial Institutions will used accounting figures to decide on overdraft, loan or lease facilities.
Contractors-decide whether they will continue to work for the firm and the possibility of more works if the company is expanding.
Government - will decide on allocation of resources. If the activities have to be regulated and also determine taxation policies.
Customers - keep themselves update about the company. That is if the firm is going on good figures, they react to market demands. For instance they might will develop new products.
Investors - to judge prospects on their investment and decide what to do with their shares. That is selling them if he feels that the price of his share might fall due to poor performance of the firm, retain or buy more if the shareholder feels that the company will continue to grow
Potential investors - to decide if buying shares of that firm will be fruitful or not
Short term solvency
Long term solvency
Activity (effective utilization)
Profitability in relation to turnover
Profitability on investment
Employees - to know the strength and prosperity of the company. To evaluate the capacity to pay remuneration, retirement benefits and employment opportunities.
Tax Authorities: assess the tax liabilities of the enterprise
Public: determine how the company will affect the locality, for instance employment, local suppliers, trends or developments as per Corporate Social Responsibility.
2.2 Branches of Accounting
General Accounting or Financial AccountingÂ
It is concerned with the recording ofÂ transactions for a business or other economic unit and the periodic preparation ofÂ statements from these records.
Is a service practice who examines records, statements and express an opinion regarding their fairness of accounts.
Cost AccountingÂ emphasizes the determination and the control of costs particularly the costs of manufacturing processes and of the manufactured products.
Management Accounting is concerned with the application of appropriate techniques and concepts in processing the historical and projected economic data of an entity, to assist management in setting up reasonable economic objectives and in making rational decisions towards the attainment of these objectives.
Tax Accounting includes the preparation of tax returns and the consideration of the tax consequences of proposed business transactions.
Accounting Systems is concerned with the creation of accounting and office procedures for the accumulation and the reporting of financial data
Budgetary Accounting represents the plan of financial operations for a period and through accounts and summaries, provides comparisons of actual operations with the predetermined plan
Government AccountingÂ specializes in the transactions of political units with regards to the business aspect of public administration. It mainly focuses on the properÂ custody of government funds and their purposes.
Accounting Education is perhaps the most obvious field of specialization. In addition to teaching, many accounting professors engage in auditing, tax accounting orÂ other areas of accounting.
Internal AuditingÂ deals with determining the operational efficiency of the company regarding protection of the company's assets, accuracy and reliability of the accounting data, and adherence to prescribed managerial policies.
International AccountingÂ include special accounting for international transactions, comparisons of accounting principles in different countries, and harmonization of diverse accounting standards worldwide and tax requirements ofÂ all the countries in which the company does business.
.Not-for-profit AccountingÂ deals with special accounting for charitable organizations,Â religious groups, governmental agencies, schools and cooperatives etc
Though we have different branches of accounting the two main forms of accounting information are financial accounting and managerial accounting. We will discuss about these two branches of accounting in the second part of this assignment.
2.3 BASICS OF ACCOUNTING
Accounting is based on keeping records on sound accounting principles which are as follows:
Systematic classification and recordings in books of accounts
Book- keeping ( recording of events and transactions)
Summarizing the records - trial balance, ledger, profit and loss and balance sheet
Interpreting the financial transactions
2.4 Primary objectives of Accounting
The primary objectives are:
Maintain Accounting records
Calculate the results of operations
Ascertain the financial position
Communicate the information to users
Nearly all companies create end-of-year financial reports, and a new set of books is begun each year. Depending on the nature of the company and its size, financial reports can be prepared at much more frequent (even daily) intervals.
3.0 Processes of accounting records
The processes of accounting records are:
Communicate the financial transactions and events
The function of these processes is to maintain orderly records to establish financial performance and financial situation, and to communicate the accounting information to the concerned parties to which the company is accountable.
Firstly dealings are identified and their required documents are collected. That is identification of transactions and economic events of a specific body. It involves selecting the activities related to a Firm. Invoices from suppliers or payment made to creditors are examples of economic events.
In accounting every recorded transaction of the company needs to be measured in a common unit for instance the country's local currency. In Mauritius, many firms deals with overseas companies. However they have to use a uniform monetary unit when measuring transactions.
Dealings are recorded to provide a history of the organization's financial activities. That is keeping systematic record in proper books of accounts. Recording is done regularly and it enables the company to identify all the dealings of the firm.
After transactions are recorded in account books, they are posted to the appropriate accounts. That is rent in rents account, sales in sales account. Classifying is the analysis of business transactions of similar nature..
After the above processes the information found in financial statements are analyzed make conclusions about the profitability and financial positions of the business. It will then properly presented according to Accounting laws (Trial balance, trading and profit-and-loss account and balance sheet) to make it understandable to internal and external users of the financial data.
Analyzing and Interpreting
The trading and profit-and-loss account and balance sheet are analyzed to draw conclusions on the financial strengths or the weaknesses of the firm. It also helps to determind growth or decrease in sales. These are achieved by calculating various ratios and percentages or by applying other techniques. The information is used for preparing the future objectives and methods for attaining such objectives.
The accounting information is then communicated users or person concerned. This is made by distributing to the users the financial reports. It includes income statement, balance sheet and other additional information in the form of accounting ratios, graphs, diagrams etc. The results of analysis and interpretation must be communicated to the parties who are to make decisions or form judgments so that appropriate decisions may be taken at the right time
4.0 What is financial accounting and Managerial ACCOUNTING?
Though we have different branches of accounting the two main forms of accounting information are financial accounting and managerial accounting.
Talking of accounting, we also need to mention Tax accounting. As the name itself, tax accounting focuses on tax issues. It provides tax information to tax authorities.
Financial and management accounting are both important tools for a business, but serve different purposes. A business uses accounting to determine operational plans in the future, to review past performance and to check current business functions. Management and financial accounting have different users, as investors are not usually involved in the day-to-day operations of the business but are concerned about their investment, whereas managers need information quickly to make daily business decisions.
Financial accounting is used to present the financial health of an organization to its external stakeholders. Board of directors, stockholders, financial institutions and other investors are the audience for financial accounting reports. Financial accounting presents a specific period of time in the past and enables the users to see how the company has performed. Financial accounting reports must be filed on an annual basis, and for publically traded companies, the annual report must be made part of the public record
Financial Accounting is concerned with classifying, measuring and recording the transactions of a business. It is geared towards external users of accounting information. Financial accounting provides information that would be helpful in attracting capital. It shows the financial position of a business at a particular point in time and shows how a business has performed over a specific period. The three main financial statements that help to achieve this aim are the Profit & Loss account, the Balance sheet and the Cash Flow Statement.
On the other hand, management accounting is a system designed uniquely for the company management team. It provides current and accurate information to managers of the company to make decisions concerning the day-to-day operations of a business. It is not based on past performance, but on current and future trends. Because managers often have to make operation decisions in a short period of time in a fluctuating environment, management accounting relies mainly on forecasting of markets and trends. The information is used for planning of future goals of the company. It also helps to evaluate internal performance of the company.
4.1 Differences between Financial and Managerial accounting.
The users of Financial accounting is mainly external persons as it describes the whole organisation. For example shareholders, creditors, Banks and other financial institutions. A management accounting system produces information that covers part of the organization or a specific department that is used within an organization, by managers and employees for decision making.
Financial accounts are supposed to be in specific format. This will simplify matters when trying to compare accounts of different companies. On other hand there is no special format for managerial accounting.
Financial accounting helps in making investment decision but Management Accounting helps managers to record, plan and control activities.
Financial accounting focuses on history where as management accounting focuses on past and actual performances as well as future.
Financial accounts are prepared by accountants but managerial accounting is prepared by officers of different departments. They coordinate data and produce management accounts.
Financial accounts are for a specific and well defined period. For example annually or semi annually for large companies. However management accounts can be prepared whenever it is needed. It can be daily, weekly or monthly.
Preparing financial reports is mandatory for limited companies. It has to be filed with competent authorities while there are no legal requirements to prepare reports on managerial accounting.
Financial accounts are mostly concerned with monetary items but managerial accounts can be both monetary and non monetary items. For example stock counts or output.
4.2 Objectives of Financial Accounting versus Managerial objectives
The main objective of financial accounting is to disclose the final result of the firm and identify financial condition of the business on a particular date. On the other hand the main objective of managerial accounting is to help management by providing to them information which they use to plan, evaluate and control the business.
4.3 Advantages and disadvantages of Financial Accounting.
Access to Information
Among the most significant advantages of financial accounting is the information it reveals about a business. This information is useful to not only leaders who use data about revenue, expenses, assets and equity to make decisions for the future, but also to investors who examine the results of financial accounting, known as financial statements, to decide which businesses to invest in. Financial accounting allows business leaders to alter their budgets and plans for the future to address new financial problems or take advantage of the financial strengths that accounting reveals to grow or gain competitive advantages within an industry.
Government regulations require businesses to perform financial accounting, which means that the processes has the added advantage of keeping a business in line with regulatory agencies and free from fines or disciplinary action. Financial accounting information is an element of transparency and business ethics, requiring honest and accurate information for investors, competitors and market analysts to review. Businesses also need information from financial accounting, such as profits after expenses and the value of tax-deductible spending, to complete their annual business income tax returns.
Financial accounting is an expensive part of doing business, especially for large businesses. For a small business, owners need to devote time to accounting, which takes away from the time they can spend working with employees or devoting their talents to the business' products and services directly. Large businesses employ accounting departments that consist of specialists who earn professional salaries and require benefits, offices and equipment to perform their jobs. This means that a business needs to use the information it gains from financial accounting to its own financial benefit or risk losing money in the process.
Financial accounting also can pose disadvantages to a business by disrupting the timing of its operations. This is particularly true when a business chooses the wrong type of accounting for its activities, or fails to update its accounting methods to keep pace with its growth. For example, cash method accounting only enters transactions once they are completed, which works well for small businesses but cannot account for the outstanding payments and accounts receivable that a large business is likely to have. A large business that use cash method accounting instead of accrual method accounting risks losing track of major components of its financial picture, while a small business that employs the accrual method takes on unnecessary complication and expense.
4.4 Advantages of Management Accounting
Since it is focused on making future decisions with the help of past financial data, it is forward looking and therefore progressive in nature. Managerial accounts are meant for internal users like management and therefore it is not necessary that it is made by following strict guidelines which is the case with financial accounting. It is flexible in nature and therefore it can be prepared anytime and they are not required to be made yearly they can be made monthly or on weekly basis. Management accounting takes all the data and then present it in such a way that a proper analysis about the feasibility and profitability of any business decision can be made.
4.5 Disadvantages of Management accounting
It is dependent on cost accounting and financial accounts and therefore the accuracy of it is also dependent on how accurate that data is. This it is one of the limitations as far as its usability is concerned. It can also be affected by the bias of top management and therefore it is likely that they may be pulled in such a way so as to benefit themselves rather than shareholders. Since it does not follow accounting principles, it cannot be compared with other companies reports and hence accurate evaluation about the management may not be possible on the basis of management accountancy.
As we can clearly see accounting is very important in every aspects of life and corporate lives. Without accounting it will not be possible to get exact figures to analyse, compare or even improve. Accounting is based on several principles and ways to process accounting data. These accounting processes are a chain of tasks that needs to be done and respected during the accounting year to get accurate and desired results.