Accounting

Accounting is the process by which the profitability and solvency of the company can be measured.

The methods used by a business to keep records of its financial activities and to summarize these activities in periodic accounting reports comprise the accounting system that performs three functions. The first function of an accounting system is creating information that is a systematic record of the daily business activity. It is carried out by means of recording, classifying and summarizing information. Its second function is communicating the summarized information to interested parties. The third function is interpreting the accounting information as it relates to specific business decisions.

In accounting, business activities are associated with transactions. A transaction occurs whenever the firm enters into a legal contract for the acquisition of means of production or the sale of goods and services. Transactions between the firm and its markets – both its supply markets and its selling markets – are defined as external transactions. Transactions within the firm, consisting of the exchanges which occur between the various departments are defined as internal transactions.

The totality of internal transactions forms the subject matter of management or cost accounting which provides information for managers to use for running their company. It is the recording and controlling of all the expenditures of an enterprise in order to facilitate control of separate activities.

The totality of “external transactions” forms the subject matter of financial accounting which is used to deal with the world outside the organization. This external financial accounting reports financial conditions to stockholders, employees, banks and other financial institutions, and to the government, when required. External reporting is especially important to corporations that must send financial statements to owners, potential investors, brokers, stock exchangers, regulatory agencies, tax authorities and others.

Sometimes companies turn to creative accounting that comprises all available accounting procedures and tricks to disguise the true financial position of a company.

The range of those who use accounting information is not limited by businesses only. It also includes:

Individuals. People use accounting information in day-to-day affairs to manage their bank accounts, to evaluate job prospects, to make investments, and to decide whether to rent or to buy a house.

Investors and creditors. Investors provide the money that businesses need to begin operations. To decide whether to help start a new venture, potential investors evaluate what income they can reasonably expect on their investment.

Government regulatory agencies base their regulatory activity on the accounting information they receive from firms.

Tax authorities. Local, state, and federal governments levy taxes on individuals and businesses using the accounting information they present, thus tax accounting is used for calculating an individual’s or a company’s liability for tax.

Non-profit organisations such as churches, most hospitals, government agencies, and colleges, which operate for purposes other than to earn a profit – use accounting information in much the same way that profit-oriented businesses do.

Persons with little knowledge of accounting may fail to understand the difference between accounting and bookkeeping. Bookkeeping means the recording of transactions, the record-making phase of accounting.