Accounting is commonly known as the "language of business". It is a means through which information about a business entity is communicated. Through the financial statements – the end-product reports in accounting – it delivers information to different users to help them in making decisions.
Meet Mr. Carter.
Mr. Carter started a printing business. He invested $100,000 of personal savings to start the company's operations. After a month, he wants to know how much the business made. He also wants to know what happened to his money.
Without a way of recording the activities of the business, we will not be able to answer his questions. Surely we can tell him, "Mr. Carter, we made a lot this month!", but we need proof! And he needs the figures!
We can easily answer Mr. Carter's questions if we kept track of the company's transactions. If we used $30,000 of the $100,000 we had at the beginning to buy printers and pay the bills, then we'd have $70,000 cash left. If we collected $50,000 from our customers, then we would have $120,000. Easy, right?
Now, that's just a tiny bit of what accounting can do. Imagine we have thousands of transactions! And, there's a lot more to accounting than just recording. How much income did we make? How much do we owe our creditors? Is this a good investment? So on, and so forth.
Technical definitions of accounting have been published by different accounting bodies. The American Institute of Certified Public Accountants (AICPA) defines accounting as:
"the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of financial character, and interpreting the results thereof."
Though I am not a fan of technical definitions, studying the statement above will give us a better understanding of accounting. Let's break it down.
Accounting is considered an art because it requires the use of skills and creative judgment. One has to be trained in this discipline to be able to perform accounting functions well.
Accounting is also considered a science because it is a body of knowledge. However, accounting is not an exact science since the rules and principles are constantly changing (improved by standard-setting bodies).
Recording pertains to writing down or keeping records of business transactions. Classifying involves grouping similar items that have been recorded. Once they are classified, information is summarized into reports which we call financial statements.
For example, hiring an additional employee is qualitative information with no financial character. Hence, it is not recorded. However, the payment of salaries, acquisition of an office building, sale of goods, etc. are recorded because they involve financial value.
They are assigned amounts when processed in an accounting system. Using one of the examples above, it is not enough to record that the company paid salaries for April. It must include monetary figures – say for example, $20,000 salaries expense.
Interpreting results is part of the phases of accounting. Information is useless if they cannot be interpreted and understood. The amounts, figures, and other data in the financial reports have meanings that are useful to the users.
By studying the definition alone, we learned some important concepts in accounting. It also gave us an idea of what accountants do.
The simple things we do and encounter everyday can actually be related to some level of accounting. You make budgets, count change and check the receipts from the supermarket. You may also have listed things you spent your money on at one point in your life.
We are surrounded by business – from managing our own money to seeing profit statements of big corporations. And where there is business, there sure is accounting.
Accounting is an art. It requires skills and professional judgment that are developed through study and practice. Nonetheless, it is a body of knowledge hence also a science.
Accounting comprises 4 phases: a) recording, b) classifying, c) summarizing, and d) interpreting, financial information arising from business transactions & events.
We actually encounter or apply accounting in our daily lives – in budgeting, computing household expenses, checking bank balances, counting change, and many more.