Introduction to Accounting

Chapter 1 

Introduction to Accounting

1.1 What is Accounting?

Definition

Accounting is the process of recording and summarizing financial information in a useful way.

Introduction

Explanation

Even if you’re new to accounting, you may have noticed some use of accounting in your daily life. My mom for example is the chief accountant of our family. At the start of each month, she prepares a budget that lists all expected

payments and income for the month. She then records all payments

and receipts in her personal diary such as groceries, utilities, taxes

and so on. Tracking home expenses against the monthly budget helps

her avoid overspending and also gives her peace of mind knowing

where the money was spent in case she forgets. She keeps all the

invoices and bank statements in a shoe box. Once every year my

Mom files her taxes and this is where all her hard work in maintaining

the financial record pays off as she has all the required information

on her finger tips (and a shoe box). Even though my mom doesn't

know, she is performing basic functions of an accountant to manage

the home finances.

Accounting is just a more formal and efficient version of such

processes in the context of a business. Businesses use accounting to

keep their financial information organized which helps them in

making sense of their financial data and also keeps them compliant of

financial regulations.

1.2 Components of Accounting/ Accounting Careers

Accounting consists of 2 parts:

1. Book-keeping

2. Analysis

 Book-keeping, which is also known as financial accounting, is

the process of recording and summarizing financial

information. Book-keeping involves the recording of

transactions (e.g. sales, purchases, and expenses) which are

then summarized and presented in the form of financial

statements which show the overall health of the business. 

Book-keeping helps to organize the financial data which

facilitates the effective management of the business by

providing key information such as:

 How much they owe to suppliers, tax authorities, banks,

employees and others?

 How much each customer owes the business?

 How much capital is invested by the owners in the

business?

 How profitable is the business?

Bookkeeping is the backbone of an accounting system and

forms the basis of analysis in management accounting.

 Management accounting, also known as managerial

accounting, provides information to management for analysis,

decision making, planning and control of the business. For

example, information relating to investment decisions,

budgeting and performance measurement.

Importance of Accounting

Record

Organizations need to have a reliable and systematic way of

recording financial information. Accounting is necessary to ensure

that those running the business have a reliable record of financial

transactions.

Legal

Accounting helps organizations to determine their financial rights and

obligations. Without proper accounting, it would be very difficult for

a business to calculate, for example, the exact amount a supplier

needs to be paid taking into account cost of purchase, discounts,

sales tax, withholding tax, duties, refunds, etc.. Accounting is

therefore necessary for a business to fulfill its legal obligations and

asserting its own legal rights.

Maintaining accounting records and preparing financial statements is

also often a legal responsibility for businesses above a certain size.

Performance

Accounting information is summarized to produce financial

statements. Financial Statementsprovide an overview of the financial

activities of a business during a period (e.g. cash flow, income and

expenses during the year) as well as information about its financial

position on a specific date (e.g. amount of cash and inventory at the

end of the year).

Financial Statements help owners in assessing the performance and

position of their business which can guide their investment

decisions (e.g. whether they should invest more in the business,

diversify or dispose their investment).

Planning and Control

Accounting helps organizations to plan their finances by developing

budgets and forecasts. Variance analysis provides a mechanism for

the monitoring of expenses incurred by organizations by comparison

with the budgeted expenditure. This process helps organizations in

planning their finances ahead and controlling any deviations from the

budget.

Decisions

Accounting provides a basis for managerial decisions. Examples of

such decisions include:

 Investment Appraisal

 Make or Buy decisions

 Pricing Decisions

 Limiting factors analysis

Summary

Accounting is a reliable process for recording, organizing and

analyzing financial information which helps in the effective

management of the business.

1.2 Accounting careers

Although there are many other specialties, the four major areas of

accounting are:

 Public accounting

 Management accounting

 Governmental accounting

 Internal auditing

Public Accounting

Public accounting covers a wide range of services, including preparing

and issuing the public financial reports for a company, providing

business consulting services or personal financial planning services,

and preparing tax returns.

Public accounting includes several types of accounting:

 Financial accounting involves preparing a company's public

financial statements.

 Forensic accounting involves examining financial records

looking for fraud and other illegal activities or reconstructing

missing financial records.

 Tax accounting focuses on individual and business taxes,

typically with the intent of limiting the tax obligation as much

as possible.

 External auditing involves the review of financial statements to

determine that they were prepared correctly.

New accountants who go to work for a public accounting firm may

serve as staff auditors who analyze and verify activities in specific

assigned client accounts. This is sometimes considered the "grunt

work" of auditing, and it doesn’t usually involve any interaction with

clients.

Similarly, tax staff accountants with accounting firms do most of the

tax return preparation and research without interacting with clients.

Experienced accountants can move into senior positions, taking on

more responsibility, and eventually move into management positions

if a firm thinks the accountant has partner potential.

Management positions include Audit Manager, Tax Manager, and

Management Services/Consulting Manager. Only about two percent

of accountants in a public accounting firm eventually become a

partner, according to the American Institute of CPAs.

With experience, public accountants may go on to work in areas like

personal financial planning, sometimes starting their own practice.

Some accountants take on roles in forensic accounting, specializing in

detecting and preventing fraud.

Management Accounting

Management accounting is also called managerial, cost, corporate,

industrial, or private accounting. Management accountants have an

internal business role that supports business managers in making

business decisions. Management accountants prepare detailed

reports and forecasts for managers inside the company. These

reports are not intended for public review.

Management accountants track and analyze internal financial

information by designing, implementing, and managing internal

financial management systems that assist with performance

management, strategic management, and risk management.

Within management accounting are different approaches. For

example, project accounting (or job cost accounting) tracks finances

by project and prepares financial reports specific to these projects.

Resource consumption accounting is a new approach to management

accounting developed in Germany in 2000. This approach is principle-

based and not tied to a specific method, according to the Resource

Consumption Accounting Institute.

New accountants who take jobs in corporations often begin as junior

internal auditors or as staff accountants in areas such as financial

accounting and reporting, management accounting, or tax

accounting.

Junior internal auditors make sure the company has accurate records

and adequate controls to protect against fraud and waste by

examining and evaluating financial and information systems, internal

controls, and management procedures.

Financial accounting and reporting staff accountants typically have

responsibilities in an assigned area, such as payroll, receivables,

payables, general ledger, treasury management, asset management,

or financial statements.

Management staff accountants collect detailed cost data and may

prepare preliminary cost analyses and reports that are then

presented to management and executive leadership.

Junior tax accounting staff members prepare tax returns or related

schedules for review, keeping information current and tax deductions

maximized throughout the tax year.

As accountants gain experience, they can move into senior positions

in any of the areas, taking on more responsibility and more

complicated tasks. Accountants may eventually move into

management positions as Financial Accounting & Reporting

Managers, Management Accounting Managers, Tax Managers, or

Internal Audit Managers.

Other types of accounting jobs within corporations include the

Assistant Controller, who assists in supervising the day-to-day

collection and interpretation of accounting data, and the Controller,

who is the chief accounting executive.

An accountant could also become the Chief Financial Officer (CFO)

who advises the President or CEO in matters related to financial

strategy and financial reporting.

Government Accounting

The umbrella term governmental accounting refers to any type of

accounting use to keep and examine the financial records of

government agencies and to audit private businesses and individuals

who engage in activities subject to government regulations or

taxation. Thus, governmental accounting may include the methods of

financial accounting, tax accounting, or other types of accounting.

Government agencies sometimes use fund accounting, which is a way

to separate resources into categories in order to track the source and

use of these funds. Fund accounting is used as a way for a

government agency or division to be transparent and responsible in

their management of the tax dollars used to fund the agency or

division. Fund accounting is also often used by non-profit

organizations.

Entry-level jobs are also available with the federal government, as

well as for state and municipal government agencies. New

accounting hires may serve as junior auditors or staff accountants,

tax examiners who review filed tax returns for accuracy and

adherence to law, or revenue agents who review complex business

income, sales, and excise tax returns. Experienced accountants can

move into senior and management positions in similar roles.

Internal Auditing

Internal auditors provide an independent, objective examination of

an organization's finances. Internal auditors mainly identify financial

mismanagement or fraud or identify ways to improve financial

management and reduce waste.

The Securities and Exchange Commission (SEC) requires all publicly

traded companies to regularly conduct internal audits. Audits are

used to provide investors with an accurate financial picture of

publicly traded companies. Corporate and retail investors use the

information revealed through internal audits to decide which

securities are worth purchasing.

Other Types of Accounting Jobs

Accountants can become educators at the post-secondary level for

community colleges, schools of business, and universities. Earning a

PhD is usually required for college-level professorships in accounting.

Professionals with backgrounds in accounting can also serve as

consultants in any accounting/financial capacity for which they are

qualified, or work in non-profit organizations in jobs that are similar

to those found in the corporate world.

Tax accounting involves keeping records for paying taxes and making

decisions that comply with tax laws. Large multinationals, small

business, non-profits and individuals alike, all may have occasion to

use tax accounting. Regardless of tax status or obligation, all persons

and organizations that generate revenue, receive pay, or accept

funding may benefit from the services of tax accounting

professionals.

1.3 General Principles

What are Generally Accepted Accounting Principles - GAAP

Generally accepted accounting principles (GAAP) refer to a common

set of accepted accounting principles, standards, and procedures that

companies and their accountants must follow when they compile

their financial statements. GAAP is a combination of authoritative

standards (set by policy boards) and the commonly accepted ways of

recording and reporting accounting information. GAAP improves the

clarity of the communication of financial information.

GAAP may be contrasted with pro forma accounting and with the

IFRS standards, which are both considered to be non-GAAP.

GAAP

BREAKING DOWN Generally Accepted Accounting Principles - GAAP

GAAP is meant to ensure a minimum level of consistency in a

company's financial statements, which makes it easier for investors

to analyze and extract useful information. GAAP also facilitates the

cross comparison of financial information across different companies.

These 10 general principles can help you remember the main mission

and direction of the GAAP system.

1.) Principle of Regularity

The accountant has adhered to GAAP rules and regulations as a

standard.

2.) Principle of Consistency

Professionals commit to applying the same standards throughout the

reporting process to prevent errors or discrepancies. Accountants are

expected to fully disclose and explain the reasons behind any

changed or updated standards.

3.) Principle of Sincerity

The accountant strives to provide an accurate depiction of a

company’s financial situation.

4.) Principle of Permanence of Methods

The procedures used in financial reporting should be consistent.

5.) Principle of Non-Compensation

Both negatives and positives should be fully reported with

transparency and without the expectation of debt compensation.

6.) Principle of Prudence

Emphasizing fact-based financial data representation that is not

clouded by speculation.

7.) Principle of Continuity

While valuing assets, it should be assumed the business will continue

to operate.

8.) Principle of Periodicity

Entries should be distributed across the appropriate periods of time.

For example, revenue should be divided by its relevant periods.

9.) Principle of Materiality / Good Faith

Accountants must strive for full disclosure in financial reports.

10.) Principle of Utmost Good Faith

Derived from the Latin phrase “uberrimae fidei” used within the

insurance industry. It presupposes that parties remain honest in

transactions.

Compliance

GAAP must be followed when a company distributes its financial

statements outside of the company. If a corporation's stock

is publicly traded, the financial statements must also adhere to rules

established by the U.S. Securities and Exchange Commission (SEC).

GAAP covers such things as revenue recognition, balance sheet item

classification and outstanding share measurements. If a financial

statement is not prepared using GAAP, investors should be cautious.

Also, some companies may use both GAAP and non-GAAP compliant

measures when reporting financial results. GAAP regulations require

that non-GAAP measures are identified in financial statements and

other public disclosures, such as press releases..