It is not so much the maths of accounting and its subsidiary bookkeeping that students find most difficult, because accounting is no more than addition, subtraction and sometimes applying a percentage. It is rather the 'why' of accounting/bookkeeping that students find most difficult to understand.
Sadly, most textbooks on accounting/bookkeeping focus on the 'how' of accounting/bookkeeping, often neglecting the 'why'. This book is a compilation of answers provided by Peter Baskerville regarding basic accounting concepts. As a teacher of bookkeeping and accounting for many years at a technical college, Peter sets out to explain the 'why' of basic accounting concepts in layman's terms that even entry level students can understand.
The answers have been grouped and ordered according to standard learning process in accounting but focusing on explaining 'why' accounting operates the way that it does. Peter explains the background and first principles that underpin each concept which provides students with an understanding that provides meaning to the process and application of accounting/bookkeeping.
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This book is most helpful for students of accounting/bookkeeping as a guide and reference resource to help explain the basic accounting concept and why they are important in the process and application of accounting/bookkeeping.
Introduction to accounting
What is accounting?
Accounting is a financial recording and reporting system. Accounting identifies and classifies financial transactions and then summaries them into financial reports. Financial reports communicate relevant financial information to interested persons called stakeholders. This information allows stakeholders to make decisions about the use of the economic resources of the business.
The definition of accounting
Simple definition: accounting is a system that provides numeric information about the finances of an accounting entity i.e. business or enterprise. Another definition states that accounting is the systematic recording, reporting, and analysis of the financial transactions of a business. Others define accounting as a tool for recording, reporting and evaluating, in monetary terms, the transactions, events and situations that impact on an enterprise.
The American Accounting Association which defines accounting as: The process of identifying, measuring and communicating information to permit judgment and decision by users of accounts.
Analyzing the definition of accounting
So what is accounting? Some say that accounting is the language of business. Looking closely at the various definitions we can identify a few key aspects of accounting;
Accounting is a system that operates for as long as the accounting entity exists
Accounting is only interested in the financial or monitory transactions of the accounting entity
The initial phase of accounting deals with identifying, collecting, measuring, classifying and recording financial transactions
A secondary phase in accounting deals with calculating, summarizing, reporting and evaluating the financial information
In accounting, there is an intention to communicate the financial information of the accounting entity to decision makers
Finally, accounting deals with the maintenance and storage of the financial results.
It is important to note, that accounting is not an end in itself. In other words, it was not like art to be hung in a museum as a "beautiful set of numbers " . Accounting is a means to an end. This means that accounting is a process that it provides the most relevant and reliable financial information possible so that the real work can be done - making of the best possible decisions about the use of economic resources.
Summary - Definition of accounting
In summary we can see from these definitions, that accounting can be divided into two broad elements:
Accounting is an information process that identifies, classifies and summaries the financial events and transactions that impact on a business and
Accounting is a reporting system that communicates relevant financial information to interested persons (stakeholders). This information allows stakeholders to assess performance, make decisions and/or control the economic resources of an enterprise.
What is the difference between accounting and accountancy?
In terms of semantics, wWhere accounting is the action or process of keeping financial accounts, accountancy describes the duties of an accountant who is the person whose job is to keep, inspect and interpret financial accounts.
Always on Time
Marked to Standard
In regards to business, accountancy is the collective actions and tasks performed by businesses to record financial transactions and produce reports that allows the stakeholders (managers, investors, funders, owners) of the business to make informed decisions about the financial resources under their control. A business is primarily interested in accountancy for the following reasons:
Compliance: Tax laws require a business to report to the government on their revenue and income. Accountancy provides a process for this compliance requirement to be met.
Funding: Banks, investors and finance institution require reports on the financial performance and position of a business before they invest or loan funds to the business. Accountancy provides these reports in the form of an Income Statement and a Balance Sheet.
Financial performance: A key function of management is to ensure that the business will endure. Accountancy provides a reporting mechanism by way of an Income Statement that details the revenue, expenses and resulting profit that managers can use to make informed decisions to ensure the sustainability of the business.
Budgeting and control: Financial information provided by the accountancy system allows managers to prepare budgets that become a benchmark for performance and a means of controlling the finances under their control.
Comparison: Accountancy, because it is universally applied using accounting standards, provides a means of comparison between businesses. This comparison provides benchmarks by which the performance of a business can be judged (under or over performing) relative to an industry average, previous periods or against the entire business world.
Where did accounting start?
The accounting system we use today started with the merchants of Venice in Italy over 500 years ago.
History of accounting
The renaissance period in Italy begun in about 1450. There was a huge increase in trade during the renaissance period. This increase in trade also helped develop the banking systems. Sophisticated societies like Venice, developed an accounting system to accurately record their complex financial dealings. The merchants of Venice were the ones who used this accounting system extensively.
Luca_Pacioli The_Father_of_Accounting Guidobaldo, the Duke of Urbino, asked a Franciscan friar and mathematician to help with the management of the his financial affairs. The franciscan friar and mathematician was Luca Pacioli (1446-1517). Luca was the first person to codify and publish the Venetian accounting system in his book titled , "The Collected Knowledge of Arithmetic, Geometry, Proportion and Proportionality" (translated). The book was published in 1494. This is about the same time that Columbus discovered America. Luca's book was one of the earliest books ever published on the Gutenberg press.
Luca does not claim to invent the accounting system. He does however, present the accounting system in a way that others can easily understand. Luca Pacioli was also a colleague of Leonardo da Vinci. Leonardo helped Luca illustrate his second most important manuscript De Divina Proportione ("Of Divine Proportions"). Leonardo Da Vinci mentions Pacioli many times in his notes. For Luca's great contribution, most accountants today regard Luca Pacioli as the "Father of Accounting".
First accounting textbook
The accounting system is described in only one section of Luca's five section book. This one section contained 36 short chapters on the Venetian accounting system. Luca's book was the only accounting text book available for the next hundred years. Most of the principles and processes described in this book have been continuously followed by accountants right up to today. The system Luca described has become known as the 'double entry accounting ' system.
Many concepts from Luca's 1494AD book, are still practised today. These include;
The accounting cycle
The use of journals and ledgers
Duality of financial transactions i.e. debits equaling credits 'double entry bookkeeping '
The formation of account groups including assets (including receivables and inventories), liabilities, Owners equity, income/revenue, and expenses
Year end closing entries
The trial balance, which Luca believed should be used to prove a balanced ledger.
What was accounting like before double entry bookkeeping?
The double entry bookkeeping system that we practice today is itself a reasonably old system being first used extensively by the Venetian merchants 500 years ago and codified in 1494 by the Italian Friar and mathematician Luca Pacioli.
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Accounting systems did exist before Luca codified the double entry bookkeeping system and it has become known as primitive accounting. Some of these primitive accounting systems date back more than 7,000 years to the time of ancient Babylon, Assyria and Sumeria. Over time, these primitive accounting systems led to the invention of numerical systems and the accounting principles that we use today. In fact it has been difficult for comparative philologists in their study of language to distinguish where accounting and number systems started and then separated into uniquely different fields.
Accounting (or the method of counting) goes back to the dawn of intelligence among human beings. Different parts of the world developed their own counting systems with the majority of races using their fingers and toes in helping them to count, and hence the bases of their systems were five or ten or twenty. For example, the Mexicans used 20 as their number base. The Peruvians, who employed knotted strings, called quipus, had a decimal system as did the early Greeks. Chinese, the Tibetans, and the Hottentots used the concepts of ears and hands respectively to denote two and Brazilians generally count by the joints of the fingers, and consequently count in lots of three.
Further developments in numbers and accounting:
Pebbles and twigs: Developments in numbers and accounting (apart from the human body) began as pebbles and twigs where each pebble or twig in a bag represented an animal or item of economic value.
Bollae and token: Another primitive accounting system used over 3,000 years ago to keep track of goods after they were shipped or to calculate inventory, was a clay ball called a bollae. Bollaes were round or cylindrical shaped clay objects that could either be hollow or solid. The variety of differently shaped tokens inserted inside the hollow bollae (or inserted into the outside of the bollae) would represent the different items being shipped.
Clay tablets: Over time the tokens and bollae evolved into symbols and eventually writing. Sellers would imprint their tokens onto clay tablets as a form of accounting. Some token imprints didn't transfer well onto the clay tablets, and so many merchants began drawing the token symbols onto the clay tablets instead. This drawing of token symbols became the first documented accounting system in history, and it greatly contributed to the development of the organized numbering systems that are used today.
Abacus: The abacus is another primitive accounting system that was invented in China and subsequently spread throughout the world. The abacus consists of a wooden frame with wires that have beads threaded through them. Adding, subtracting, multiplying or dividing calculations were achieved by sliding the beads across the wires. So not only could merchants perform complex calculations they could also keep the results of these calculations on their abacus as a record of the financial transactions.
What is the difference between financial and management accounting?
Financial accounting prepares a limited number of prescribed financial reports in accordance with statutory standards and the needs of external stakeholders. Financial accounting summarizes the consequences of past decisions on the performance of the business as a whole. Management accounting prepares an unlimited number of financial reports in accordance with business requirements and the needs of management. Management accounting analyses the performance of units within the business by comparing results with preset budgets and so assists management in their future planning and control functions.
Users of financial information
Every organisation has a wide range of stakeholders who are interested in the financial performance or activities of that organisation. Stakeholders are simply any person(s) who are directly or indirectly affected by the activities of the organisation.
Financial Vs Management accounting For example, business managers need accounting information to assist them in making sound decisions concerning the organisation. Investors watch the profits in the hope of dividends. Creditors and lenders are watchful of the organisation's ability to meet its financial obligations. Governmental agencies need information to ensure the correct tax was collected and to regulate business activities. Brokers and business analysts use financial information to form an opinion on investment recommendations. Employees chose successful companies that enhance their career prospects, and they often have bonuses or share options that are tied to enterprise performance. This a but a small sample of people that are interested in the financial information of an organisation.
Now for simplicity in reporting purposes, accountants group these stakeholders into 2 main user group:
External users who are not directly involved in the day-to-day of organisational activities like Governmental agencies, lenders, investors (Owners), creditors, suppliers, customers, trade associations and society at large.
Internal users who are directly involved in daily activities of the organisation like a Board of directors, Chief executive officer (CEO), entrepreneurs, Chief financial officer (CFO) , Vice presidents, employees and Line managers like Business unit managers, Plant & Store managers.
In general, accounting information and financial reports designed for external users is prepared under Financial Accounting standards whereas Managerial Accounting provides accounting information to internal users according to their specific needs. Now while the reporting styles in each branch are vastly different, the underlying objective is the same - to satisfy the information needs of the user.
Financial accounting is focused on producing a limited set of specific prescribed financial statements in accordance with generally accepted accounting principles (GAAP). The central outputs from financial accounting are audited financial statements. These financial statements include the balance sheet and income statement which provide a scorecard by which the overall past performance of a business can be judged by outsiders.
This branch of accounting targets those external stakeholders that have an interest in the reporting enterprise, but who are not involved in the day-to-day operations of the business. The reports produced by this branch are used for so many different purposes that it is often called "general-purpose accounting"Â. In addition to the financial statements, external stakeholders also have access to financial reporting via press releases that are sent directly to investors and creditors or via the open communications of the internet.
The emphasis in financial accounting is on summaries of financial consequences of past activities and decisions. So, only summarized data is prepared, that covers the entire organization. The data prepared must be objective, precise and be verifiable, usually by an outside auditor. This style of reporting must follow the generally accepted accounting principles that are set by peak accounting bodies in conjunction with government agencies. The numbers used in financial accounting are historical in nature.
Now whilst appearing set in stone, financial statements are actually based on estimates, judgments, and assumptions. This is why financial statements usually include "notes to the accounts" which are the explanations from management that help explain and interpret the numerical information. A more specialised area of financial accounting is Tax Accounting.
Managerial accounting deals with information that is not made public and is used for internal decision making only. These reports are far more detailed than financial accounting and can cover performances and activities by departments, products, customers, and employees. It is an accounting system that helps management achieve the goals and objectives of the organisation with an emphasis on the measurement, analysis, communication and the control of financial and non-financial information.
This branch of accounting is primarily interested in assisting the organisation's department heads, division managers, and supervisors make better decisions about the day-to-day operations of the business and in particular, those relating to the planning and control decisions
The essential data is conveyed in a wide variety of reports and is specifically targeted at those who direct and control the organisation. These reports help to promote more efficient and effective plan making, resources organizing, personnel directing, motivating and performance evaluation, and operations control.
Unlike financial accounting, there are no external rules governing management accounting. The emphasis in this branch is on making decisions that affect the future with results being compared to budgets, activity-based costing, financial planning or to industry benchmarks. These reports are delivered frequently and in a timely way according to the requirements of management. Most reports are analytical in nature with a heavy emphasis on variances in the key indicators that monitor the financial performance of the business unit. A more specialised area of management accounting is Cost Accounting.
Summary of Financial Vs Management accounting
Below is a table that summarizes the difference between financial Vs management accounting:
Number of financial reports
Limited number - specifically the Balance Sheet and Income statement
Unlimited number - set by the needs of management
Rules governing the preparation of financial reports
Government backed accounting standards (i.e. GAAP)
Are audited financial reports required?
Financial reports are primarily prepared for ...
External stakeholders not involved in the day-to-day operations
Internal stakeholders who are involved in the day-to-day operations
Are financial reports made public?
Financial information in reports contains ...
Detailed performances and activities of business units, products, customers or employees.
Financial information in reports emphasizes ...
Objectivity, preciseness and is verifiable
Analytical that identify variances in key performance indicators
Financial reports assist stakeholders with ...
Evaluation, assessment and investment decisions
Planning, resource allocation and control decisions
Frequency of financial report preparation.
Typically half-yearly and annually according to statutory requirements
Typically daily, weekly, monthly according to the needs of management
Financial performance is compared with ...
Pre-set budgets and industry benchmarks
Emphasis of financial performance.
Historical, being a consequence of past activities and decisions
Analytical, to in making future decisions
A specialized area
What is the purpose of accounting?
The purpose of accounting is to provide financial information about economic entities in the form of financial statements and other reports. Financial statements allows internal and external stakeholders make evaluations about the performance of the business and its management. This evaluation permits stakeholders to make informed judgments and decisions about the entity and their engagement with the entity.
Stakeholders are all the people who are affected in different ways by the activities of an enterprise. Each stakeholder is interested in gaining knowledge about the financial position and performance of the enterprise. Financial statements provide this information and help stakeholders make economic decisions in relation to their involvement with the enterprise. The accounting information system is designed to produce financial statements that fulfills the key purposes and objectives of accounting, namely:
1 - to provide a management information system (MIS) that:
records the business transactions created from business activities in a systematic manner the record keeping function
as the language of business, communicates to managers and other stakeholders financial information that identifies the profitability, viability and financial position of the business
assists managers in their decision making and control activities that protect the property of the business from unjustified and unwarranted use
enables management to plan short term and long term business activities by analyzing historical financial information to predict future outcomes communicated via budgets and strategic plans.
2 - to enable organisations to comply with the statutory requirements of governments and other institutions. (i.e. Stock Exchanges). Compliance relates to providing financial information as basis for taxation, corporate regulations, industrial relations and environmental assessment.
Financial statements prepared by accounting for external stakeholders give insights into the following:
the accountability of the managers i.e. have the finances of the enterprise been appropriately used to benefit the enterprise rather than the personal interests of the managers?
the capital position of the enterprise i.e. the amount of money distributed to the owners and the amount of capital remaining to settle the debts of the enterprise (loan funds, creditors)
the valuation of an enterprise's equity i.e. to provide enough information for others to assess the value of an enterprise from their perspective.
the financial strength i.e. the enterprise's ability to pays its current bills as they become due, the debt to equity ratio and interest cover.
the financial sustainability i.e. its profitability, its return on investment or return on assets employed, the efficiency of the asset use by management.
The role of accountants and bookkeepers
Why do we need accounting?
I'm sure I don't need to explain what would happen if we removed air from the system, but let me tell you what would happen if the accounting function was removed from the business and the economic system.
A government's ability to raise income and other taxes from business would disappear Governments could still raise taxes in other ways but it would be far from equitable and hardly substantial enough to provided the community services we all enjoy today. Getting businesses to use the accounting system to prepare income statements for tax purposes, ensures the equitable raising of taxes based on an entity's ability to pay it i.e. a % of profits. History teaches that widespread inequality in society will eventually lead to revolution and anarchy.
Investors would be literally flying blind and would withhold vital capital required for businesses to survive and grow Banks, investors and finance institution require verifiable and accurate reports on the financial performance and position of a business before they can trust, invest or provide loan funds to the business. Accountancy provides these reports in the form of an Income Statement and a Balance Sheet and makes transparent the financial performance and position of a business and its management decisions. No accounting = no investment/trust = no capitalist economy.
Business owners and managers could not track their current financial performance in an accurate and timely way A key function of business management is to ensure that the business will endure. Accountancy provides a reporting mechanism by way of an Income Statement that details the revenue, expenses and resulting profit that managers can use to make informed decisions to ensure the sustainability of the business. No accounting = ill informed decisions = poor use of resources and the failure of the business to survive.
Banks as the core component of the global financial system could not facilitate the means of economic exchange and trade between entities would cease. Businesses would not offer credit, turning the efficiency of our current system back to the dark ages of barter and localized subsistence living.
Business and economic planners would have no instruments with which to fly Financial information provided by the accountancy system allows managers to prepare budgets that become instruments, gauges and benchmarks of performance and a means of controlling the finances under their control. No accounting = no ability to plan = the end of economic growth and development.
Comparisons that promote productivity, improved performance and are the key drivers in maximizing the use of the world's limited resources would disappear Accountancy, because it is universally applied using international accounting standards, provides a means of comparison between businesses. This comparison provides benchmarks by which under or over performances of a business can be judged relative to an industry average, previous periods or against the entire business world.
Furthermore, the three key reports produced by the accounting system provide answers to the following fundamental questions that go to the heart of a business' ability to survive.
Are we currently profitable? Does the business continue to have the capacity to endure and which way is the profit trending? ... Answered by last month's operating profit compared with previous month's and displayed on the Profit & Loss Statements created by the accounting system.
Can we pay our bills as they fall due? Can the business remain solvent into the near future and avoid litigation and loss of essential resource supply? ... Answered by the Cashflow forecast produced by analyzing the Profit and Loss Statement and changes to the Balance Sheet created by the accounting system.
What is the financial strength of the business? What is it's net worth and how much value has the business created for the owners? ... Answered by the value of the owner's equity section of the Balance Sheet.
What is the difference between a bookkeeper and an accountant?
Bookkeeping is a task oriented function that routinely and systematically records the organisation 's day to day financial transactions. Accounting is more results oriented than bookkeeping in that it is involved more with the interpretation and use of accounting information than with its actual preparation.
Definition of accounting
Quite often the terms bookkeeper and accountant are used interchangeably. Now while they both play a role in the accounting process, they each perform quite different functions.
Revisiting the definition of accounting will help us understand these differences. Now accounting consists of two key elements. It is;
an information process that identifies, classifies and summarises the financial events that take place within an organisation
a reporting system that communicates relevant financial information to interested persons which allows them to assess performance, make decisions and/or control the economic resources in the organisation.
Now, as a rule, bookkeepers only do the first element while accountants, who could do both, generally do the second. This is because accountants are uniquely specialised professionals whose time would be poorly invested in tasks that a computer + accounting software + a competent bookkeeping person could easily perform.
Bookkeeping is generally the tedious, clerical and exacting role in the accounting system. These days bookkeepers use computer and accounting software to do much of this work. Bookkeeping is a task oriented function that routinely and systematically records the organisation 's day to day financial transactions. The bookkeeper function is performed primarily by skilled clerical personnel who may or may not have had any formal accounting training. They will however, have a basic knowledge of the 'double entry system' which ensures that financial transactions are recorded correctly.
Bookkeepers are required to classify transactions into the correct ledger accounts as previously determined by the accountant and business owner. A final check in the bookkeeping process is called a 'trial balance'. This summary makes sure that the financial transactions have been correctly recorded. At this point the bookkeeper usually hands the system over to the accountant who performs the second element of the accounting function the analysis and reporting.
Accountants deal with the big picture. They set up the overall structure and design for both the financial information capture and the appropriate financial reporting functions. Accounting is more results oriented than bookkeeping in that it is involved more with the interpretation and use of accounting information than with its actual preparation.
Accountants are responsible for reporting to governments and statutory requirements. These reports include the preparation of the Statement of Financial Performance and the Statement of Financial Position. They also work to prepare reports and give advice that assists business managers in the development of their enterprises. Advice ranges from evaluating the efficiency of the business operations, resolving complex financial reporting issues, cash flow and profit forecasting, auditing to check the accuracy of the information, tax planning and lawful tax minimisation and redesigning the business accounting systems to ensure maximum efficiency. Generally accountants need to be highly qualified with a university degree plus membership of a peak accounting body that is maintained by the accountant's continuous professional development.
Why do we need accountants?
I can't speak for why others might need an accountant, but here are some reasons why I need one:
I need someone who is appropriately qualified to spend the time to understand aninterpret the 70,000 pages of tax law and then apply it to my business. I don't have the time nor the expertise to do that and I am happy to pay an accountant to ensure that:
I comply with the law and avoid penalties, legal costs and potential criminal charges
I can structure my business and transactions in a tax effective way to ensure that I don't overpay tax expense which may be compromised by simply getting the timing of payments and signing of agreements in the wrong order.
I can spend my time doing what I do best which is building my business and not spending it being involved with something where I have no expertise.
I need an accountant to help me fully understand the financial performance and position of my business on a continual basis. Qualified accountants have significant experience in business and can help set up a specialized chart of accounts and management information system that helps identify under performing aspects of the business. Their networks give them access to industry benchmarks which they can use to identify these areas of under performance in my business.
I need credibility when I apply for bank loans and when I am seeking investment partners. Accountants give these external parties confidence, particularly if the accountant has prepared the financial statements according to GAAP and is prepared to give assurances to that fact. Accountants can also 'talk the language' that financiers and investors speak. If they are not at the negotiation table there is a big chance you will not be able to communicate your message and your access to funds becomes limited.
Of course, I don't need an accountant anymore to 'keep my books'. Computerized accounting systems have allowed many businesses to do their own bookkeeping and the vast majority of accountants are happy with this development because they can now spend so much more of their time giving you the value added advice and analysis that you really need.
For me, my accountant is always my first appointed and primary ongoing adviser in business. I have always saved more money from my accountant's advice than I have ever paid for their service.
What advice do you have for someone who is interested in working in the accounting field but not sure where to get started?
Firstly I am not a qualified accountant. Wray Rives is a qualified accountant and also an active Quora participant. It may be prudent for you to get his opinion on this question as well.
I studied accountancy at university as part of a degree in business and quickly saw its value in contributing to the success of my entrepreneurial dreams. I don't have the temperament to be an accountant but I did see the value of financial/accounting skills for entrepreneurs in regard to financial modeling in business plans, structuring corporate/accounting entities, keeping your own books with computerized bookkeeping, understanding financial statements, adopting managerial accounting in regard to cashflow budgets, accessing finance options and conducting valuation analysis. See my answer on this at Which specialty within accounting is more beneficial to a career in entrepreneurship Tax or Audit? So, I didn't work directly in a recognized accountancy field but I have embrace accountancy skills in all my entrepreneurial endeavors and in my advisory roles.
If you are interested in working in any of the specialized accounting fields you must begin with an understanding of accounting/finance theory via a formal education. If you wish to eventually become a qualified accountant (rather than just acquire the accounting skills as I have) you will need to firstly complete a accounting/business/finance degree at a university and then complete additional specialized accounting studies as required by the professional accounting association that you may be required to join. Check with the peak accounting body in your country in regard to their membership requirements before choosing your formal education pathway.
Specialized fields of accounting
Bookkeeping, which is a sub set of accounting, could be performed by a para professional who has completed a formal vocational education (Diploma or certificate level) at a college. To work in the bookkeeping field you don't generally need to complete a degree or belong to one of the peak accounting bodies. You would though need to be able to apply your formal education to the implementation and maintenance of leading industry computerized accounting packaged.
Financial accounting jobs primarily prepare financial reports for shareholders, government agencies/departments, stock exchanges and corporate regulators and require current membership in one of the peak accounting bodies. In Australia these bodies are represented as CA (Charted Accountants) and CPA (Certified Practicing Accountants). This field requires current and complete knowledge of tax law and accounting standards which your membership of the peak professional accounting body provides. Auditing is a specialized role in financial accounting that also requires membership of a peak accounting body.
Management Accounting is primarily interested in assisting the organisation's department heads, division managers, and supervisors make better decisions about the day to day operations of the business and in particular, those relating to the planning and control decisions. The emphasis in this field is on making decisions that affect the future with results being compared to budgets, activity based costing (cost accounting), financial planning or to industry benchmarks. These reports are analytical in nature with a heavy emphasis on variances in the key indicators that monitor the financial performance of the business unit. Experience counts significantly in getting jobs in this field but entry generally requires, as a minimum, a degree in accountancy/finance.
Types of accounting career jobs
Public Accounting Firms: These are accountants who work in a partnership to provide accounting services to individuals, businesses and government. The 'big 4' in this area are PricewaterhouseCoopers, Deloitte and Touché, KPMG and Ernst & Young. A public accounting career will give you a good start in your career. It is here where you can gain foundation knowledge before moving into a more specialist area. These firms will require candidates to have a degree in accounting/finance as they will generally assist employees in qualifying for peak body membership.
Government: Government accountants may work at any level of government and will be responsible for preparing budgets, tracking costs and analyzing government initiatives. Prospects for advancement in government jobs are generally good due to the size of the organisation. The slow paced, non innovative bureaucratic environment and political decision making are some of the downsides of employment here. To gain entry, governments generally like candidates to have 5+ years of 'big 4' industry experience.
Corporations: Businesses of all sizes usually have an accountant or accounting department that prepares financial statements, tracks costs, handles tax returns, and works on major transactions. The work is more dynamic and prospects are good. Like governments, corporations are looking for industry experience and generally ask for peak body membership in job ads.
Independent: Working as a self employed accountant means creating your own business. However, while you benefit from good customer contact, independence, and good returns, you are in a more vulnerable position when business is not so good. Again, peak body membership is often considered a prerequisite for clients choosing between competing accounting service offerings.
Entrepreneurship: Like myself, you may choose at the completion of your studies to pursue your own entrepreneurial dreams and simply use your accounting/finance skills and understanding to build and manage your own business outside of the accounting practice option. A person armed with these skills could be a valuable founding member of any startup team.
Summary ... if you wish to work in any field of accountancy, start with a formal education, preferably an accounting/finance degree at a university.
Accounting concepts, principals and conventions
What are the accounting concepts and conventions?
Accounting concepts and conventions guide accountants when reporting on the financial performance and position of a business.
Introduction to accounting concepts and conventions
While accounting deals almost exclusively with numbers, it is not a science of completely objective measurements or assessments. Accounting also involves a level of subjective judgement because values are involved, and anyone in business will tell you that value are definitely 'in the eye of the beholder'. Either way, in order for the stakeholders of a business to make sound decisions, they will need financial information that as accurately as possible reflects the "true and fair view" of the financial performance and position of the business.
To best support the application of the "true and fair view" approach, accounting has adopted over many decades certain concepts and conventions that guide accountants in the preparation of the financial statements for a business. These concepts and conventions are sometimes called assumptions or principles. Still, whatever we call them or however they may be grouped, it is important that these concepts and conventions be appropriately applied by those who are given the responsibility for preparing the financial statements of a business. Following is a list of concepts, conventions, assumptions and/or principles that need to be applied in this regard.
Accounting assumptions, principles and conventions
'Separate accounting entity' assumption The Accounting Entity convention states that the business is an entity (perceived to have its own existence) separate from its owner. Therefore business records should be separated and kept distinct from the personal records of the business owner(s). This is also known as the Economic Entity concept or Separate Business Entity Principle.
"Going Concern" assumption Accountants assume, unless there is evidence to the contrary, that a company is not going broke and will continue its operation for an indefinite period of time or at least into the foreseeable future. This concept also allows businesses to spread (amortize) the cost of fixed asset over its expected useful life.
'Monetary measurement' assumption Accountants do not account for items unless they can be quantified in monetary terms. (i.e. either that money was exchanged to acquire it or a market exists that would be prepared to exchange money for it). A business may have other valuable resources like (workforce skill, morale, market leadership, brand recognition, quality of management) but these do not get recorded in the financial statements because they cannot be quantified in monetary terms.
'Time Period' assumption This convention allows for the performance evaluation of a 'going concern' business to be broken up into specific period of time such as a month, a quarter or a year. This is also known as the accounting period convention. This short time period of assessment allows internal and external users to make adjustments to their strategy in relation to the business. Also using this time period concept, the accountant and other users can compare like to like financial results over a similar period of time.
'Historical cost' This convention requires that the assets of a business be recorded in the ledger accounts at the actual price paid to acquire them. Under this concept no account is taken of the changing values of these assets in the market place.
'Matching principle or Accruals' Expenses should be "matched" against revenues that they enabled and should be recorded in the same period in which the revenue is earned. This approach is supported by the accrual accounting method. To do this, accountants need to prepare accruals at the end of each reporting period to take account of expenses incurred but for which there is no source document. These are part of the end of period adjustments.
'Realization of income' principle With this convention, accountants recognize financial transactions (and any profits arising from them) at the point of sale or at the transfer of legal ownership. This may be different from the point when cash actually changes hands.
'Full Disclosure' This concept requires that financial statements provide sufficient information to help users of the information make knowledgeable and informed decisions about the business.
'Materiality' Accountants only record events that are significant enough to justify the usefulness of the information. Only items that are deemed significant for a given size of operation should be recorded. Accountants are guided to ignore insignificant details otherwise the accounts will be burdened down with minute details.
'Prudence/Conservatism' The rule is to recognize revenue only when it is reasonably certain of happening and recognize expenses as soon as they are incurred (whether paid or not). Accounting in this manner ensures that financial statements do not overstate the company 's financial position. As a rule, accounting chooses to err on the side of caution and to protect investors from acting on inflated or overly positive results.
'Consistency' According to this convention, transaction classification and valuation methods should remain unchanged from one period to the next. This allows for a more meaningful comparisons of financial performance between periods by the stakeholders.
'Dual Aspect' This concept is based on the accounting equation: Assets = Liabilities + Owners Equity. All transactions recorded in the accounts must keep this equation in balance. To do this financial transactions are allocated a both a debit side and a credit side of equal amounts.
'Objectivity' The objectivity concept states that transactions must be recorded on the basis of objective evidence. This means that accounting records will initiate from a source document to ensure that the information recorded is based on fact and not just on personal opinion.
'Substance Over Form' In accounting, real substance takes precedent over legal form; namely we consider the economic or accounting point of view rather than simply the legal point of view when recording transactions. This helps explain the difference between a legal entity and an accounting entity.
What is the accounting entity assumption?
Application of the accounting entity assumption helps produce meaningful and relevant financial reports for decision makers.
An 'entity' is something that is perceived, known or inferred to have its own separate existence. For example, the law recognises people as legal entities because they have their own separate existence. Under the law, this status allows people to sue other legal entities and to also be sued by them.
The law in most countries of the world also recognizes some 'non persons' or 'non living' things as legal entities. Registered companies are a good example of legal entities that while they are â‚¬Ëœnon persons ' and 'non living', they are still recognized legal entities. These 'non person' legal entities are given the same rights and obligations under the law as the individual person. However, not all 'non person' activities are recognized as legal entities. For example, a sole trader's business (i.e. a plumbing business) or a local social club (i.e. a Darts Club) are not recognized as legal entities. This is because under the law they are not perceived to be separate and distinct from the owners or they have not been registered as a separate legal structure.
Accounting however takes the concept of entity one step further than the law. In accounting, every business (including sole traders), becomes its own â‚¬Ëœaccounting entity '. So, while the law does not recognise the sole trading business as a separate legal entity distinct from the owners, accounting does recognize the sole trader's business as a separate 'accounting entity'.
So, the accounting system records the financial affairs of each 'accounting entity' separately, that is;
the owner of the firm as one 'accounting entity'
the firm itself as a separate and distinct 'accounting entity'
Financial transactions are then separated between the business owner's financial affairs and those of the sole trading firm which the owner may well operate. Under the accounting entity assumption then, a business entity, regardless of its legal status, is treated as being separate and distinct from the owners or managers of that business.
Purpose of the accounting entity assumption
One of the key reasons for creating separate 'accounting entities' is that the accounting system can then provide more useful and relevant financial reports that will assist decision making in relation to each specific 'accounting entity'. For example, by separating the owner's financial affairs from the business' financial affairs allows decision makers like financiers and managers to clearly assess the business' financial performance, position and its sustainability.
What is the going concern concept in accounting?
The 'going concern' concept in accounting is an assumption that the business will continue to exist for the foreseeable future. Accountants adopt the 'going concern' concept so they can prepare realistic financial reports. Without the 'going concern' concept, accountants would have to write off all assets in the current period including long term assets that still have an economic benefit for future periods.
Introduction to the 'going concern' concept.
Accounting is based on generally accepted accounting principles (GAAP). These principles summarize the assumptions, practices and concepts that provide the basis for measuring financial values and reporting on the results of business activities. Accounting principles and assumptions greatly influence the reported financial position and performance of a business. One fundamental concept of GAAP is the 'going concern' concept which is also known as the 'going concern' assumption. Note: The term 'concern' is derived from the early 20th century and it means a 'business' or 'enterprise'.
The 'going concern' assumption has been developed from a desire by all stakeholders, to produce financial statements that accurately reflect the financial performance of a business over short and consecutive time periods. The 'going concern' assumption helps accountants allocate costs/revenues that cover multiple reporting periods. See the 'time period' assumption.
'Definition of the 'going concern' concept
The 'going concern' concept directs accountants to prepare financial statements on the assumption that the business is not about to go broke or be liquidated (i.e. where the business closes and sells all the assets for whatever price they can get).
So, unless there is significant evidence to the contrary, accountants will base their valuations and their reporting of financial data on the assumption that the business will remain in existence for an indefinite period.
An indefinite period means the foreseeable future or long enough for the business to meet its objectives and to fulfill its commitments. It is important to note that the 'going concern' concept does not imply or guarantee that the business is profitable and will remain so for the foreseeable future.
So, the 'going concern' concept assumes that the business will remain in existence long enough for all the assets of the business to be fully utilized. Utilized assets means obtaining the complete benefit from their earning potential. (i.e. if you recently purchased equipment costing $5,000 that had 5 years of productive/useful life, then under the going concern assumption, the accountant would only write off one year's value $1,000 (1/5th) this year, leaving $4,000 to be treated as a fixed asset with future economic value for the business). The 'going concern' concept supports the assumption that when a business buys assets like land, equipment, and buildings, it does so with the intent that these assets will produce income over a number of years. In other words, the business did not purchase these assets with the intention to close operations soon after and then resell these assets.
The opposite view to this 'going concern' assumption is that the business will cease trading shortly and that all the assets will be sold off within the current year.
'Implications of the 'going concern' concept
The 'going concern' concept has significant implications for the valuation of assets and the liabilities of a business. By applying the 'going concern' concept, accountants are able to value and include long term assets in a Statement of Financial Position (Balance Sheet). If the 'going concern' assumption was not applied, the accountant would need to write these assets off as costs within the year of purchase. Applying the 'going concern' concept also allows accountants to properly allocate transactions which overlap two or more consecutive years.
Also, by applying the concept of a 'going concern', accountants are able to record assets at historical costs. Recording assets at historical cost means the accountant does not need to constantly assess the liquidated value of business assets when preparing the financial statements. For example, partly completed manufactured goods like work in progress, would have little value in a liquidation. However, under the 'going concern' concept, work in process assets are recorded at their current costs which would be significantly greater than the liquidated value.
'Going concern' in Company law
Another aspect of 'going concern' affects the directors of companies. This is a slightly different concept to the 'going concern' concept in accounting. Corporation laws generally require directors of companies to make a declaration that their business continues to be a 'going concern'. This means that the directors believe that the business they manage is able to pay its bills as they become due. These directors are required to disclose to the shareholders in the notes to the financial statements, if there are any factors that may put in doubt the company's status as a 'going concern'.
What is the revenue recognition principle?
The revenue recognition principle is a set of guidelines that helps accountants to identify when a revenue event has taken place and how to appropriately record cash exchanges before, during and after the revenue event. The revenue recognition principle also helps determine the accounting period in which the revenue is to be recorded.
Background to the revenue recognition principle
The primary purpose of accounting is to provide the necessary information for sound economic decision making to take place. A key piece of that information is the calculation of net income. (i.e. revenues less expenses). The growth and size of the net income informs decision makers about the sustainability, financial strength and growth capacity of the business. Growth can only be determined by comparing net income results over a series of accounting periods made up of similar durations (i.e. monthly, quarterly or yearly). So, identifying when revenue can be legitimately recorded into the books of the business and the accounting period that it should be recorded against, are important considerations for accountants and decision makers alike. The revenue recognition principle sets out to provide guidance on how the revenue timing issues should be managed and treated in the financial statements. Note: The term recognition means the moment when a financial transaction should be recorded in the bookkeeping system of a business.
The rule underpinning the revenue recognition principle is that revenue should only be recorded in the books of a business when payment is assured (realizable), measurable and revenue has been actually earned (final delivery and completion of work). These rules must be adhered to before an event can be recorded as revenue in the bookkeeping system of a business. In summary:
Revenues are realised when measurable cash or claims to cash (accounts receivable) are received in exchange for goods or services. Revenues are considered realizable when the assets received in such an exchange are readily convertible to cash or have a clear claim to cash.
Revenues are earned when such goods are transfered and services have been provided. i.e. when the revenue generation process has been substantially completed or as soon as the customer has a legal right of ownership over the goods.
The issue with revenue recognition in accounting
Let's look at the following situation to try and understand what the revenue recognition principle sets out to solve.
Blake's Furniture Store issues a purchase order for 20 timber chairs @ $125 each in December and includes a check for $500 as a deposit. According to the agreement, the chairs are to be delivered in January with the remaining $2,000 to be paid in February.
We can see that this financial event takes place over three monthly accounting periods: December, January and February. So, the question remains ... "In what month should the revenue be recorded (recognized) and how much should be recorded?". The answer to this question is determined by the bookkeeping method being used by the business and then applying the revenue recognition principle
There are two bookkeeping methods: the cash accounting method and the accrual accounting method. Large corporations and for profit companies must use the accrual accounting method while small businesses and associations can choose one or the other. Using the cash accounting method to determine when revenue should be recognized is relatively easy because under the cash accounting method revenue is recognized (recorded) when the cash from the customer is actually received. i.e. Revenue = $500 in December and $2,000 in February. On the other hand, the accrual accounting method records the revenue in the month that it was actually earned, without regard to when cash is actually received. Under the accrual accounting method, revenue is earned when either the goods are delivered or the service has been performed/completed. i.e. under the accrual accounting method, the revenue recorded in the books of the business is $2,500 in January. Note: The deposit in December is initially treated as a liability because the deposit money remains owing to the customer until the legal transfer of ownership of the chairs takes place in January with the delivery of the goods.
Types of transactions involving revenue
The revenue recognition principle impacts on the four primary ways that a business can earn revenue:
Revenues from selling inventory these are recognized at the date of the sale but commonly interpreted as the date of delivery. The date is taken from the invoice or cash receipt. Some exceptions involve
Revenues from providing services these are recognized when the service is completed. It is common practice to use the date on the invoice to determine the revenue recognition (recording) date. Another exception involves l
Revenue from granting permission to use the company 's assets (e.g. interest received for borrowed/invested money, rent received for the use of the fixed assets of the business and royalties received for use of intangible assets like patents or copyright) these revenues are recognized at the agreed/negotiated time intervals or as the assets are actually used.
Revenue from selling an asset other than inventory these could be fixed assets that are disposed of during the conduct of a business and are recognized when the sale takes place or when the invoice has been sent.