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What is Accounting?

Accounting is a process of accumulating, summarizing and communicating financialinformation. Financial information can be of different types and serve different purposes, but it all comes from the same function – accounting.

Types of Accounting

Accounting provides information to several groups of people and for different purposes.As a result, there are several kinds of accounting:



Financial accounting

provides information to external users. Such external userscan be investors, creditors, banks, regulatory bodies (i.e., Securities and ExchangeCommission, Internal Revenue Service, etc.). The information is usually in theform of financial statements (see more on the financial statements below).



Managerial accounting

provides information to internal users. Such internalusers include a company’s managers and employees. The informationaccumulated and presented by managerial accounting function includes salesfigures, gross margin analysis, cost information broken down by product line, etc.As a rule, managerial accounting information provides more detail than thefinancial accounting information and sometimes includes confidential data notavailable to external users.



Tax accounting

can be distinguished as another kind. Tax accounting dealsmainly with calculation of taxes (i.e., income taxes, sales and use taxes, etc.).Because rules regulating calculation of taxes are different from those governingfinancial statements preparation and presentation, tax accounting should be performed separately and in parallel to financial and managerial accounting.Usually, there is a tax department with a company that deals with tax accounting, but works closely with the financial accounting department.See more on

Accounting

Cash vs. Accrual Accounting

Two approaches to recording accounting events and transactions exist.One approach is based on cash flows and therefore called

cash-basis accounting

. Cash basis accounting implies that any transaction should be recorded in accounting recordswhen cash movement (i.e., payment or receipt) takes place. For example, when acompany sells a product on account, no transaction is recorded in accounting books.Only when cash is received from the customer, will the company record the salestransaction. Cash-basis accounting is not permitted under the US Generally AcceptedAccounting Standards (US GAAP), which are rules for financial accounting andreporting. However, cash-basis accounting is

generally permitted by the Internal

Revenue Service

for tax accounting purposes (with some exceptions which are beyondthis introductory accounting lecture).The other approach is based on the time a transaction takes place regardless of when cashrelated to the transaction is exchanged. This approach is called

accrual-basisaccounting

. Returning to the example of a sales transaction, the revenue will berecognized by the company when the goods are delivered to the customer and not whenthe customer pays for the goods. The accrual-basis accounting is required by the USGAAP in preparing financial statements.

T-Accounts, Debits, Credits and Journals

All transactions are recorded in accounts. Accounts have three parts – header, left sideand right side. Because the accounts resemble the letter T, they are called T-accounts.The left side of a T-account is called

debit

and the right side is called

credit

.T-accounts are sometimes drawn to understand the relationship between differentaccounts. Most of the time, however, accounting information is posted directly toaccounting journals that accumulate information about specific types of transactions. For example, a journal where all sales are recorded is called a

sales journal

.See more on

T-Accounts, Debits, and Credits

Bookkeeping, Accounting, and Financial Statements

The accounting process starts when transactions are posted to the accounting recordscalled journals. The recording process may be manual or automated.The

manual process

means that a bookkeeper records transactions into paper journals asthey occur or at the end of a day, week, or month, depending on frequency. The manual process is not used widely any more.The

automated process

involves use of the accounting software, where a bookkeeper can enter all transactions, again daily, weekly, and monthly or as needed. Due to theefficiency increase with the automated process, it is the most used nowadays.

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The process of entering the transactions into journals (whether on paper or in accountingsoftware) represents

bookkeeping

.The next step in the process is summarization and presentation of the financialinformation. Again, this may be completed manually or automatically with help of accounting applications. This process is known as

accounting