Introduce to Accounting

Introduction to Accounting

It is not easy to provide a concise definition of accounting since the word has a broad application within businesses and applications.

The American Accounting Association define accounting as follows:

"the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information!.

This definition is a good place to start. Let's look at the key words in the above definition:

- It suggests that accounting is about providing information to others. Accounting information is economic information - it relates to the financial or economic activities of the business or organisation.

- Accounting information needs to be identified and measured. This is done by way of a "set of accounts", based on a system of accounting known as double-entry bookkeeping. The accounting system identifies and records "accounting transactions".

- The "measurement" of accounting information is not a straight-forward process. it involves making judgements about the value of assets owned by a business or liabilities owed by a business. it is also about accurately measuring how much profit or loss has been made by a business in a particular period. As we will see, the measurement of accounting information often requires subjective judgement to come to a conclusion

- The definition identifies the need for accounting information to be communicated. The way in which this communication is achieved may vary. There are several forms of accounting communication (e.g. annual report and accounts, management accounting reports) each of which serve a slightly different purpose. The communication need is about understanding who needs the accounting information, and what they need to know!

Accounting information is communicated using "financial statements"

What is the purpose of financial statements?

There are two main purposes of financial statements:

(1) To report on the financial position of an entity (e.g. a business, an organisation);

(2) To show how the entity has performed (financially) over a particularly period of time (an "accounting period").

The most common measurement of "performance" is profit.

It is important to understand that financial statements can be historical or relate to the future.

How accounting information helps businesses be accountable

As we have said in our introductory definition, accounting is essentially an "information process" that serves several purposes:

- Providing a record of assets owned, amounts owed to others and monies invested;

- Providing reports showing the financial position of an organisation and the profitability of its operations

- Helps management actually manage the organisation

- Provides a way of measuring an organisation's effectiveness (and that of its separate parts and management)

- Helps stakeholders monitor an organisations activities and performance

- Enables potential investors or funders to evaluate an organisation and make decisions

There are many potential users of accounting Information, including shareholders, lenders, customers, suppliers, government departments (e.g. Inland Revenue), employees and their organisations, and society at large. Anyone with an interest in the performance and activities of an organisation is traditionally called a stakeholder.

For a business or organisation to communicate its results and position to stakeholders, it needs a language that is understood by all in common. Hence, accounting has come to be known as the "language of business"

There are two broad types of accounting information:

(1) Financial Accounts: geared toward external users of accounting information
(2) Management Accounts: aimed more at internal users of accounting information

Although there is a difference in the type of information presented in financial and management accounts, the underlying objective is the same - to satisfy the information needs of the user.