What is accounting?
/Accounting is the systematic recordation of the financial transactions of a business. The recordation process includes setting up a system of record keeping, tracking transactions within that system, and aggregating the resulting information into a set of financial reports. These three aspects of accounting are broken down into more detail below.
Record Keeping System
The system of record keeping for accounting requires the use of a standard set of accounting policies and procedures, as well as standardized forms. The procedures should incorporate controls designed to ensure that assets are used as intended. The record keeping system is commonly built around a commercially available, off-the-shelf accounting software package. The overall system will likely need to be designed around the software, to ensure that all features of the software are fully employed.
Transaction Tracking
A separate procedure is needed to collect information about each type of business transaction. For example, separate systems are needed to process customer orders, bill customers, and collect cash from customers. Transaction tracking occupies the bulk of the time of the accountant.
Financial Reporting
Several accounting frameworks, most notably GAAP and IFRS, mandate a specific manner in which business transactions must be treated in the accounting records and aggregated into the financial statements. The result is an income statement, balance sheet, statement of cash flows, and supporting disclosures that describe the results of a reporting period and the financial position of the reporting entity at the end of that period.
In short, the meaning of accounting covers a broad range of activities, but can be aggregated into a data collection system, the ongoing collection of data into that system, and the reporting of information from that system.
Why is Accounting Important?
Accounting is an essential business function. Without it, an organization would have a difficult time earning a profit or keeping itself operational. Here are the key reasons why accounting is important to a business:
Tracks obligation status. The accounting department tracks what obligations are outstanding and when they are to be paid.
Tracks receivable status. The accounting department bills customers, tracks when these billings are due for payment, and then pursues payment.
Provides insights. The accounting department creates responsibility reports that show budget versus actual information for all managers. The controller also discusses any concerns or opportunities with other department managers.
Supports borrowings. Lenders want to see accurate financial statements before they will loan a business money, which are provided by the accounting department.
Collects and pays taxes. The accounting department collects sales taxes from customers and the employee share of payroll taxes from employees, and forwards them to the government. It also completes tax forms, remits tax payments to the government for the firm’s own taxes, and generally ensures that the business is in compliance with all government tax laws.
Provides financial statements. The accounting department provides financial statements and related footnotes to the investment community, lenders, creditors, and the government, as needed.
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Accounting vs. Auditing
The meaning of accounting can be erroneously expanded to include internal auditing and external auditing. Internal auditing involves the testing of systems to see if they operate as intended, and so falls outside of the traditional definition of accounting. External auditing involves the examination of accounting records to see if the auditor can attest to the fairness of the information presented in the financial statements; again, this task falls outside of the traditional definition of accounting.
In effect, accounting involves the recordation and reporting of business transactions, while auditing is concerned with ensuring that these transactions were accounted for and reported correctly.