The history of accounting has been around for almost as long as money itself. Accounting history dates back to ancient civilisations in Mesopotamia, Egypt, and Babylon. For example, during the Roman Empire, the government had detailed records of its finances. However, modern financial reporting as a profession has only been around since the early 19th century.
Luca Pacioli is considered “The Father of Accounting and Bookkeeping” due to his contributions to the development of accounting as a profession. An Italian mathematician and friend of Leonardo da Vinci, Pacioli, published a book on the double-entry system of bookkeeping in 1494.
By 1880, the modern profession of accounting was fully formed and recognised by the Institute of Chartered Accountants in England and Wales. This institute created many of the systems with which accountants practice today. The formation of the institute occurred in large part due to the Industrial Revolution. Merchants not only needed to track their records but sought to avoid bankruptcy as well.
What Is the Purpose of Accounting?
Financial reporting is one of the key functions of almost any business. It may be handled by a bookkeeper or an accountant at a small firm or by sizable finance departments with dozens of employees at larger companies. The reports generated by various streams of financial reporting, such as cost accounting and managerial accounting, are invaluable in helping management make informed business decisions.
The financial statements that summarise a large company’s operations, financial position, and cash flows over a particular period are concise and consolidated reports based on thousands of individual financial transactions. As a result, all professional accounting designations are the culmination of years of study and rigorous examinations combined with a minimum number of years of practical experience.
What Is Accounting?
The process of recording financial transactions pertaining to a business. The financial reporting includes summarising, analysing, and reporting these transactions to oversight agencies, regulators, and tax collection entities. The financial statements used in accounting are a concise summary of financial transactions over an accounting period, summarising a company’s operations, financial position, and cash flows.
What Are the Different Types of Accounting?
Accountants may be tasked with recording specific transactions or working with specific sets of information. For this reason, there are several broad groups that most accountants can be grouped into.
Just as managerial accounting helps businesses make decisions about management, cost accounting helps businesses make decisions about costing. Essentially, cost-financial reporting considers all of the costs related to producing a product. Analysts, managers, business owners, and accountants use this information to determine what their products should cost. In cost accounting, money is cast as an economic factor in production, whereas in financial accounting, money is considered to be a measure of a company’s economic performance.
Financial accounting refers to the processes used to generate interim and annual financial statements. The results of all financial transactions that occur during a financial reporting period are summarised in the balance sheet, income statement, and cash flow statement. The financial statements of most companies are audited annually by an external CPA firm.
For some, such as publicly traded companies, audits are a legal requirement. However, lenders also typically require the results of an external audit as part of their debt covenants. Therefore, most companies will have annual audits for one reason or another.
While financial accountants often use one set of rules to report the financial position of a company, tax accountants often use a different set of rules. These rules are set at the federal, state, or local level based on what return is being filed. Tax accounts balance compliance with reporting rules while also attempting to minimise a company’s tax liability through thoughtful strategic decision-making. A tax accountant often oversees the entire tax process of a company: the strategic creation of the organisation chart, the operations, the compliance, the reporting, and the remittance of tax liability.
Managerial accounting uses much of the same data as financial accounting, but it organises and utilises information in different ways. Namely, in managerial accounting, an accountant generates monthly or quarterly reports that a business’s management team can use to make decisions about how the business operates. Managerial accounting also encompasses many other facets of financial reporting, including budgeting, forecasting, and various financial analysis tools. Essentially, any information that may be useful to management falls under this umbrella.
Why Accounting Is Important
Accounting is a back-office function where employees may not directly interface with customers, product developers, or manufacturing. However, financial reporting plays a key role in the strategic planning, growth, and compliance requirements of a company.
- Accounting is necessary for company growth. Without insight into how a business is performing, it is impossible for a company to make smart financial decisions through forecasting. Without financial reporting, a company wouldn’t be able to tell which products are its best sellers, how much profit is made in each department, and what overhead costs are holding back profits.
- Accounting is necessary for funding. External investors want confidence that they know what they are investing in. Prior to private funding, investors will usually require financial statements (often audited) to gauge the overall health of a company. The same rules pertain to debt financing. Banks and other lending institutions will often require financial statements in compliance with financial reporting rules as part of the underwriting and review process for issuing a loan.
- Accounting is necessary for owner exit. Small companies that may be looking to be acquired often need to present financial statements as part of their acquisition or merger efforts. Instead of simply closing a business, a business owner may attempt to “cash out” of their position and receive compensation for building a company. The basis for valuing a company is its accounting records.
- Accounting is necessary to make payments. A company naturally incurs debt, and part of the responsibility of managing that debt is to make payments on time to the appropriate parties. Without positively fostering these business relationships, a company may find itself with a key supplier or vendor. Through financial reporting, a company can always know who it has debts to and when those debts are due.
- Accounting is necessary to collect payments. A company may agree to extend credit to its customers. Instead of collecting cash at the time of an agreement, it may give a customer trade credit terms such as net 30. Without financial reporting, a company may have a hard time keeping track of who owes it money and when that money is to be received.
- Accounting may be required. Public companies are required to issue periodic financial statements in compliance with GAAP or IFRS. Without these financial statements, a company may be delisted from an exchange. Without proper tax accounting compliance, a company may receive fines or penalties.
What Types of Careers Are There in this Field?
While basic financial reporting functions can be handled by a bookkeeper, advanced accounting is typically handled by qualified accountants who possess designations such as Certified Public Accountant (CPA) or Certified Management Accountant (CMA) in the United States.
A major component of the financial reporting profession is the “Big Four”. These four largest accounting firms conduct audits, consulting, tax advisory, and other services. These firms, along with many other smaller firms, comprise the public accounting realm, which generally advises on financial and tax accounting.
In Canada, the three legacy designations—the Chartered Accountant (CA), Certified General Accountant (CGA), and Certified Management Accountant (CMA)—have been unified under the Chartered Professional Accountant (CPA) designation.
Careers in accounting may vastly differ by industry, department, and niche. Some relevant job titles may include:
- Auditor (internal or external): ensures compliance with reporting requirements and safeguards company assets.
- Controller: oversees the accounting functions of financial reporting, accounts payable, accounts receivable, and procurement.
- A Forensic Accountant: monitors internal or external activity to investigate the transactions of an individual or business.
- Information and Technology Analyst/Accountant: maintains the system and software in which accounting records are processed and stored.
- A Managerial Accountant: analyses financial transactions to make thoughtful, strategic recommendations often related to the manufacturing of goods.
- Tax Accountant: strategically plans the optimal business composition to minimise tax liabilities as well as ensure compliance with tax reporting.
What Are The Major Software Platforms?
Accountants often leverage software to aid in their work. Some financial reporting software is considered better for small businesses, such as QuickBooks, Quicken, FreshBooks, Xero, SlickPie, or Sage 50. Larger companies often have much more complex solutions to integrate with their specific reporting needs. This includes add-on modules or in-home software solutions. Large accounting solutions include Oracle, NetSuite, or Sage products.
What Are Accounting Standards?
In most cases, accountants use generally accepted accounting principles (GAAP) when preparing financial statements in the U.S. GAAP is a set of standards and principles designed to improve the comparability and consistency of financial reporting across industries. Its standards are based on double-entry accounting, a method in which every accounting transaction is entered as both a debit and a credit in two separate general ledger accounts that will roll up into the balance sheet and income statement.
In most other countries, a set of standards governed by the International Accounting Standards Board, named the International Financial Reporting Standards (IFRS), is used.
Tax accountants overseeing returns in the United States rely on guidance from the Internal Revenue Service. Federal tax returns must comply with tax guidance outlined by the Internal Revenue Code (IRC). Tax accounts may also lean on state or county taxes as outlined by the jurisdiction in which the business conducts business. Foreign companies must comply with tax guidance in the countries in which they must file a return.
What Is the Accounting Cycle?
Financial accountants typically operate in a cyclical environment, with the same steps happening in order and repeating every reporting period. These steps are often referred to as the accounting cycle, the process of taking raw transaction information, entering it into an accounting system, and running relevant and accurate financial reports. The steps of the accounting cycle are:
- Collect transaction information such as invoices, bank statements, receipts, payment requests, uncashed checks, credit card statements, or other mediums that may contain business transactions.
- Post journal entries to the general ledger for the items in Step 1, reconciling them to external documents whenever possible.
- Prepare an unadjusted trial balance to ensure all debits and credit balances and material general ledger accounts look correct.
- Post-adjusting journal entries at the end of the period to reflect any changes to be made to the trial balance run in Step 3.
- Prepare the adjusted trial balance to ensure these financial balances are materially correct and reasonable.
- Prepare the financial statements to summarise all transactions for a given reporting period.
Cash Method vs. Accrual Method of Accounting
Financial accounts have two different sets of rules they can choose to follow. The first, the accrual basis method of accounting, has been discussed above. These rules are outlined by GAAP and IFRS, are required by public companies, and are mainly used by larger companies.
The second set of rules follows the cash basis method of accounting. Instead of recording a transaction when it occurs, the cash method stipulates that a transaction should be recorded only when cash has been exchanged. Because of the simplified manner of accounting, the cash method is often used by small businesses or entities that are not required to use the accrual method of accounting.
Imagine a company buying $1,000 of inventory on credit. Payment is due for the inventory in 30 days.
- Under the accrual method of accounting, a journal entry is recorded when the order is placed. The entry records a debit to inventory (asset) for $1,000 and a credit to accounts payable (liability) for $1,000. When 30 days have passed and the inventory is actually paid for, the company posts a second journal entry: a debit to accounts payable (liability) for $1,000 and a credit to cash (asset) for $1,000.
- Under the cash method of accounting, a journal entry is only recorded when cash has been exchanged for inventory. There is no entry when the order is placed; instead, the company enters only one journal entry at the time the inventory is paid for. The entry is a debit to inventory (asset) for $1,000 and a credit to cash (asset) for $1,000.
- The difference between these two accounting methods is the treatment of accruals. Naturally, under the accrual method of accounting, accruals are required. Under the cash method, accruals are not required and are not recorded.
An Example of Accounting
To illustrate double-entry accounting, imagine a business sending an invoice to one of its clients. An accountant using the double-entry method records a debit to accounts receivable, which flows through to the balance sheet, and a credit to sales revenue, which flows through to the income statement.
When the client pays the invoice, the accountant credits accounts receivable and debits cash. Double-entry accounting is also called balancing the books, as all of the accounting entries are balanced against each other. If the entries aren’t balanced, the accountant knows there must be a mistake somewhere in the general ledger.
What Skills Are Required for Accounting?
Accountants hail from a wide variety of backgrounds. Generally speaking, however, attention to detail is a key component in accounting, since accountants must be able to diagnose and correct subtle errors or discrepancies in a company’s accounts. The ability to think logically is also essential to helping with problem-solving. Mathematical skills are helpful but are less important than in previous generations due to the wide availability of computers and calculators.
What Are the Responsibilities of an Accountant?
Accountants help businesses maintain accurate and timely records of their finances. Accountants are responsible for maintaining records of a company’s daily transactions and compiling those transactions into financial statements such as the balance sheet, income statement, and statement of cash flows. Accountants also provide other services, such as performing periodic audits or preparing ad hoc management reports.
Why Is Accounting Important for Investors?
The work performed by accountants is at the heart of modern financial markets. Without financial reporting, investors would be unable to rely on timely or accurate financial information, and companies’ executives would lack the transparency needed to manage risks or plan projects. Regulators also rely on accountants for critical functions such as providing auditors’ opinions on companies’ annual 10-K filings. In short, although accounting is sometimes overlooked, it is absolutely critical for the smooth functioning of modern finance.