Definition
Accounting is the organized process of recording a business’s financial transactions, summarizing and analyzing that information, and producing reports (financial statements) that show operations, financial position, and cash flows over a set period. These reports are used internally by managers and externally by regulators, lenders, and tax authorities.
Short history (summary)
– Recordkeeping as a practice dates back to ancient civilizations and the Roman Empire.
– The double-entry bookkeeping system was popularized in Europe in the late 15th century; Luca Pacioli is often credited with formalizing that method.
– The modern professional structures (chartered and certified accountancy bodies) emerged during and after the Industrial Revolution to standardize practice and reduce business failures.
Core types of accounting (what each does)
– Financial accounting: Produces periodic statements (balance sheet, income statement, cash-flow statement) that summarize all transactions for outside users such as investors, lenders, and regulators. Publicly traded companies are generally required to have annual external audits.
– Managerial accounting: Produces internal reports (monthly, quarterly, ad hoc) to help management with decisions, budgeting, and forecasting.
– Cost accounting: Focuses on the costs of producing goods or services to inform pricing, product-mix, and efficiency choices.
– Tax accounting: Applies tax laws and rules for filing and compliance; aims to meet reporting obligations while legally managing tax liabilities.
Why accounting matters
– It creates a factual basis for decisions (pricing, investment, financing).
– It supports regulatory compliance and tax reporting.
– It enables lenders and investors to assess creditworthiness and performance.
– It underpins audits and formal assurance of financial information.
Typical responsibilities of accountants
– Record and classify business transactions.
– Prepare and reconcile financial statements.
– Produce management reports, budgets, and forecasts.
– Calculate and prepare tax filings and compliance documents.
– Support audits and implement internal controls.
– Analyze costs and performance metrics for operational improvements.
Skills commonly required
– Familiarity with accounting principles and financial statement structure.
– Proficiency in spreadsheets and accounting software.
– Analytical and numerical literacy.
– Attention to detail and internal-control awareness.
– Communication skills to explain results to non-accountants.
Careers and credentials
– Roles range from bookkeepers and staff accountants to senior management (controller, CFO) and specialized tax or cost accountants.
– Professional qualifications (examples): Certified Public Accountant (CPA) and Certified Management Accountant (CMA) in the U.S.; Chartered Professional Accountant (CPA) in Canada; chartered bodies in the U.K. and elsewhere.
– Large firms in public accounting (the so-called Big Four) provide audits, tax, and advisory services globally.
Accounting standards and oversight
Accounting practice follows rules set by standard-setters and professional bodies so information is comparable and reliable. External audits by independent firms are commonly required for public companies and often requested by lenders.
Simple step-by-step accounting cycle (high level)
1. Capture transactions (sales, purchases, receipts, payments).
2. Record entries in journals or software.
3. Post to ledgers (summarize by account).
4. Prepare a trial balance to check arithmetic.
5. Adjust entries (accruals, deferrals, depreciation).
6. Produce financial statements.
7. Close temporary accounts and prepare for the next period.
8. Arrange audit/review if required.
Short checklist for setting up basic accounting for a small business
– Choose an accounting method (cash vs. accrual) and document it.
– Establish a chart of accounts (consistent account names and numbers).
– Select accounting software or bookkeeping system.
– Implement basic internal controls (separation of duties, bank reconciliations).
– Schedule monthly closes and reconciliations.
– Prepare annual financial statements and tax filings; plan for external audit if needed.
Worked numeric example (mini bookkeeping and statements)
Assumptions and transactions for a new small company in one short period:
1) Owner invests $1,000 cash into the business.
2) Business buys inventory for $600 cash.
3) Business sells the inventory for $1,000 on credit.
4) Customer pays the $1,000 invoice in cash.
5) Business pays $100 in operating expenses in cash.
Step-by-step balances:
– After (1): Cash = $1,000; Equity (capital) = $1,000.
– After (2): Cash = $400 (1,000 − 600); Inventory = $600.
– After (3): Accounts receivable = $1,000; Inventory = $0; Revenue recorded = $1,000; Cost of goods sold (COGS) = $600 → preliminary profit = $400.
– After (4): Cash = $1,400 (400 + 1,000); Accounts receivable = $0.
– After (5): Cash = $1,300 (1,400 − 100); Operating expense = $100 → final net income = $300 (1,000 − 600 − 100).
Resulting simple financials:
– Income statement: Revenue $1,000 − COGS $600 − Operating expense $100 = Net income $300.
– Balance sheet (end of period): Assets: Cash $1,300; Liabilities $0. Equity: Capital $1,000 + Retained earnings (net income) $300 = $1,300. Assets = Liabilities + Equity (1,300 = 0 + 1,300).
Notes on methods: cash vs. accrual
– Cash method records transactions when cash moves.
– Accrual method records revenue when earned and expenses when incurred, regardless of cash timing. (Choose one method consistently and follow applicable rules.)
Major software and tools
The profession widely uses specialized accounting packages and spreadsheets to record and report transactions, automate reconciliations, and produce management reports. (Selection depends on company size and reporting needs.)
Further reading (reputable sources)
– Investopedia — Accounting: https://www.investopedia.com/terms/a/accounting.asp
– Financial Accounting Standards Board (FASB): https://www.fasb.org
– American Institute of CPAs (AICPA): https://www.aicpa.org
– Institute of Chartered Accountants in England & Wales (ICAEW): https://www.icaew.com
– Internal Revenue Service (IRS) — Business Taxes: https://www.irs.gov/businesses
Brief educational disclaimer
This explainer is for educational purposes and does not constitute personalized tax, accounting, or investment advice. For decisions that affect your business or personal finances, consult a qualified accountant or tax professional.