Accounting: the tool for financial information. Everything you need to know.
According to the Cambridge Dictionary: "accounting is the skill or activity of keeping records of the money a person or organization earns and spends". That definition shows a glimpse of how important accounting is in the modern economies considering that financial information is into every aspect of our lives. In financial terms, accounting is the process of identifying, recognising, recording and reporting transactions and events that cause a change in one's financial position. It is important to notice that most people only mention the transactions part of the definition, but this alone is in many cases wrong. For example, highly important accounts such as depreciation, amortization and provisions are not directly related to monetary tsansactions, but play a huge role in the financial statements of a corporation.
Accounting is the cornerstone of modern financial systems and economies by providing citizens and businesses valuable information that help them take decisions that will change the future. It's the field of expertise that shows in great detail whether you, an organization you support or the country you live in are in a good financial shape. Whether either of you are earning or losing money or you are growing or decreasing your wealth.
Accounting Branches
Accounting is furtherly splitted into 8 main categories:
1. Financial Accounting, 2. Managerial Accounting, 3. Cost Accounting, 4. Auditing, 5. Tax Accounting, 6. Forensic Accounting, 7. Fiduciary Accounting and 8. Accounting Information Systems (AIS).
Financial accounting is by far the most recognisable branch, as many people refer to financial accounting just as accounting. The purpose of financial accounting is to provide information to the users of the financial statements of an entity. The Financial Statements are divided into five reporting documents: Income Statement, Balance Sheet, Cash Flow Statement, Changes in Equity Statement and the Notes. The users of these statements can be internal (stakeholders, managers, employees) or external (creditors, customers, potential investors).
Managerial accounting refers to the internal part of an entity and its goal is to provide managers with valuable financial information in order to achieve better decision-making. Cost accounting focuses on identifying,reporting and allocating costs in different categories and performing measurements that help related personnel to take cost-related decisions. Auditing is the process of examining, analyzing and ensuring that financial information is properly treated and reported in the financial statements. Tax accounting is a branch of accounting that focuses on tax returns and tax payments. Forensic accounting is the field that examines potential financial crimes. Fiduciary accounting records and reports financial information that is associated with trusts or estates. Accounting Information Systems (AIS) is the structure, usually using technological means, that helps entities store, process, retrieve and report financial data.
Useful Accounting Terms
Accounts: are the vehicles that help accountants categorize transactions and events based on their type. There are five categories of accounts: 1. Assets, 2. Liabilities, 3. Equity, 4. Revenue, 5. Expenses. The General Ledger is the place where all these accounts go to.
Financial Statements: as it was written before financial statements consist of the Balance Sheet, the Income Statement, the Cash Flow Statement, the Changes in Equity Statement and the Notes. All of them are accessible to everyone and are usually published quarterly and annually.
Balance Sheet: is the statement that contains an entity's assets, liabilities and equity in a given moment. That means that the information provided by the balance sheet is like a snapshot of a photographer. The most important Accounting Equation (by Luca Pacioli) stems from the balance sheet and states that Assets = Liabilities + Equity.
Income Statement: shows an organization's revenues and expenses in a period of time. It is usually called the Profit and Loss Statement (P&L) or Earnings Statement. Through the P&L, users can get information about the company's profitability margins and growth potential.
Cash Flow Statement: reports exactly why and how much money flowed in and out of the company in a given period. There are three main categories included in the Cash Flow Statement: Cash from Operating Activities, Cash from Investing Activities and Cash from Financing Activities. Using the Cash Flow Statement we can get information about an entity's liquidity and how it uses its money at hand.
Change in Equity: provides information about stakeholding matters, such as increases and decreases of stocks outstanding.
Notes: includes any information that is not in any of the former statements but is important for the users of the financial statements. Accounting methods, further clarifications and valuable supporting information are reported in Notes.
Debits - Credits / Double-Entry Accounting: was firstly introduced by the Italian mathematician Luca Pacioli. The double-entry system suggests that every transaction contains at least two opposite and equal sides. Based on that every accounting entry should have a debit side that is always equal to the credit side. Currently, almost every big corporation in the world uses the double-entry accounting system.
Accounting Principles
IFRS / GAAP: the International Financial Reporting Standards (IFRS) and the Generally Accepting Accounting Principles (GAAP) are sets of accounting rules that ensure that the information that companies include in their financial statements are correctly reported and comparable. IFRS are issued by the International Accounting Standards Board (IASB) , while GAAP is published by the Financial Accounting Standards Board (FASB). These two combined (IFRS- more than 90 countries, GAAP in USA) are used by the biggest part of the corporate world, although there are other sets of principals that are also used such as the Indian Accounting Standards (Ind AS).
Despite the body that issues the accounting principles, there are some of them that are of great importance.
- Revenue Recognition Principle: states that any revenue must be accounted for when the product/service was provided based on the accrual accounting (mostly used), or when cash is earned based on the cash basis.
- Matching Principle: demands that every revenue and every related expense should be accounted for in the same period. In this way, reported revenues match reported expenses.
- Historical Cost Principle: every asset must be reported when it's purchased.
- Full Disclosure Principle: states that the financial statements should be complete and free of misleading information.
- Objectivity Principle: says that accounting data included in the financial statements must be accurate and not contain any personal opinions.
- Going Concern Principle: states that an entity's financial statements are published assuming that the goal of the company is to continue functioning in the foreseeable future.
There are other accounting principles such as the Materiality Principle, Consistency Principle, Monetary Unit Principle Reliability Principle and Time Period Principle.
Summary
Accounting is surely a complex field of expertise that can become overwhelming to someone that doesn't possess the relevant knowledge. But as it is with every other professional field such as medicine, mathematics, history and geography, everyone can learn some basic things about accounting that will help them better understand the modern economies. Accounting is everywhere, from citizens' tax obligations to huge companies' revenues to countries' deficits and it is valuable to know the basic functions of it.