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What is 'Accounting'

Accounting is the systematic and comprehensive recording of financial

transactions pertaining to a business, and it also refers to the process of
summarizing, analyzing and reporting these transactions to oversight agencies
and tax collection entities. Accounting is one of the key functions for almost any
business; it may be handled by a bookkeeper and accountant at small firms or by
sizable finance departments with dozens of employees at large companies.

BREAKING DOWN 'Accounting'

The reports generated by various streams of accounting, such as cost accounting
and management accounting, are invaluable in helping management make
informed business decisions. While basic accounting functions can be handled
by a bookkeeper, advanced accounting is typically handled by qualified
accountants who possess designations such as Certified Public Accountant
(CPA) in the United States, or Chartered Accountant (CA), Certified General
Accountant (CGA) or Certified Management Accountant (CMA)inCanada.

Creating Financial Statements

The financial statements that summarize a large company's operations, financial

position and cash flows over a particular period are concise statements based on
thousands of financial transactions. As a result, all accounting designations are
the culmination of years of study and rigorous examinations combined with a
minimum number of years of practical accounting experience.

Generally Accepted Accounting Principles

In most cases, accountants use generally accepted accounting principles (GAAP)

when preparing financial statements. GAAP is a set of standards related to
balance sheet identification, outstanding share measurements and other
accounting issues, and its standards are based on double-entry accounting, a
method which enters each expense or incoming revenue in two places on a
company's balance sheet.

Example of Double Entry Accounting

To illustrate double-entry accounting, imagine a business issues an invoice to

one of its clients. An accountant using the double-entry method enters a credit
under the accounts receivables column and a debit under the balance sheet's
revenue column. When the client pays the invoice, the accountant debits
accounts receivables and credits revenue. 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 ledger.

Financial Accounting Versus Management Accounting

Financial accounting refers to the processes accountants use to generate the

annual accounting statements of a firm. Management accounting uses much of
the same processes but utilizes information in different ways. Namely, in
management accounting, an accountant generates monthly or quarterly reports
that a business's management team can use to make decisions about how the
business operates.

Financial Accounting Versus Cost Accounting

Just as management accounting helps businesses make decisions about

management, cost accounting helps businesses make decisions about costing.
Essentially, cost accounting 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
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Double Entry

Double entry is the fundamental concept underlying present-day bookkeeping

and accounting. Double-entry accounting is based on the fact that every financial
transaction has equal and opposite effects in at least two different accounts. It is
used to satisfy the equation Assets = Liabilities + Equity, in which each entry is
recorded to maintain the relationship.

BREAKING DOWN 'Double Entry'

In the double-entry system, transactions are recorded in terms of debits
and credits. Since a debit in one account will be offset by a credit in another
account, the sum of all debits must therefore be exactly equal to the sum of all
credits. The double-entry system of bookkeeping or accounting makes it easier
to prepare accurate financial statementsdirectly from the books of account and
detect errors.

Types of Accounts

Bookkeeping and accounting are a way of recording business transactions in

monetary terms. A business transaction is an exchange of financial interests
between at least two economic entities that in bookkeeping and accounting are
expressed as accounts. There are a total of seven different types of accounts that
all business transactions can relate to: assets, liabilities, equities, revenue,
expenses, gains and losses. In essence, bookkeeping and accounting track
changes of the amount of money in each of the seven accounts as a company
conducts its business activities.
Debit and Credit

The terms "debit" and "credit" in bookkeeping and accounting simply denote an
increase or decrease to the balance of a referenced business account. Using
"debit" and "credit" to record increases or decreases of account balances
conforms with the underlying occurrence in business transactions. The exchange
of financial interests involving two or more business accounts inevitably leads to
increases and/or decreases among those accounts. Rules in bookkeeping and
accounting dictate that a debit to the accounts of assets, expenses or losses and
a credit to the accounts of liabilities, equities, revenue or gains both increase the
balance of each of those accounts. A debit decreases the account balance for
liabilities, equities, revenue or gains, and a credit decreases the asset, expense
or loss account balances.

Double Entry

The fundamental concept of double entry derives from the use of debit and credit
to record business transactions. The total debits always equal the total credits.
Customarily, in bookkeeping and accounting, the asset, expense and loss
accounts are listed on the left side of a bookkeeping sheet, and the liability,
equity, revenue and gain accounts are listed on the right side, with the two sides
maintaining the same total balance. A debit to one or more accounts must be
accompanied by a credit to at least one account, equally increasing or decreasing
the balance on each side. Other times, a debit to either side is balanced out by
an equal credit to the same side.

Chart Of Accounts

A listing of each account a company owns, along with the account type
and account balance, shown in the order the accounts appear in the
company’s financial statements. “Chart of accounts” is the official accounting
term for the display of this information, which includes both balance-sheet
accounts and income-statement accounts. The chart of accounts shows assets,
liabilities, equity, revenues and expenses, all in one place and broken down into
subcategories. Each chart in the list is assigned a multidigit number to help
identify the account type (e.g. all asset accounts might start with the number 1).

BREAKING DOWN 'Chart Of Accounts'

For a small corporation, the chart of accounts might include a checking account,
savings account, petty cash balance, accounts receivable, undeposited funds,
inventory assets, prepaid insurance, vehicles, buildings, stockholders’ equity, the
company credit card, accounts payable, payroll liabilities and more. Even a small
company could have dozens of accounts in its chart of accounts. The larger and
more complex the company, the larger and more complex the chart of accounts
will be, but accounting software makes it easy to categorize accounting entries
correctly and maintain an accurate and organized chart of accounts.

Reporting requirements can affect how a company structures its chart of

accounts, but it is important to keep the chart of accounts the same from year to
year to make accurate comparisons of the company’s finances across time.

Here is a way to think about the chart of accounts as it relates to your own
finances that might help you better understand how it relates to a business. Say
you have a checking account, a savings account and a certificate of deposit
(CD) at the same bank. When you log in to your account online, you’ll typically go
to an overview page that shows the balance in each account. Similarly, if you use
an online program that helps you manage all your accounts in one place,
like Mint or Personal Capital, what you’re looking at is basically the same thing
as a company’s chart of accounts. You can see all your assets and liabilities, like
your checking account, savings account, certificates of deposit, credit
cardaccounts, student loans, auto loans and anything else, all on one page.

Account Statement

An account statement is a periodic summary of account activity with a beginning

date and an ending date. The most commonly known are checking
account statements, usually provided monthly, and brokerage account
statements, which are provided monthly or quarterly. Monthly credit card bills are
also considered account statements.

BREAKING DOWN 'Account Statement'

Account statements refer to almost any official summary of an account, wherever

the account is held. Insurance companies may provide account statements
summarizing paid-in cash values, for example. Statements can be generated for
most any type of accounts that represent ongoing transactions where funds are
repeatedly exchanged. This can include online payment accounts such as
PayPal, credit card accounts, brokerage accounts, and savings accounts. Utility
companies, as well as telephone and subscription television service providers,
usually generate account statements for their customers, detailing their usage
and any overages during the payment cycle. Such statements typically list debits
paid, incoming funds or credits received by the account holder, and fees
associated with maintaining the account. For example, certain types of savings
accounts might incur regular maintenance fees unless a certain minimum
balance of funds is maintained in the account. Cable television subscriptions may
include state taxes and other surcharges that are included with providing regular

How Account Statements Are Used

Account statements should be scrutinized for accuracy, and historical statements

are critical for budgeting. A credit or loan account statement, for example may
show not only the outstanding balance due but the interest rate charged on that
debt and any fees that have been added during the payment cycle. This can
include late charges for payments not received by their due date, overdraft fees
when bank account holders overspend. The statement may also list financial
information that relates to the account holder such as their credit score, or the
estimated time it will take to completely pay off a debt via installment payments.
Alerts and notices to the account holder may also appear on these statements,
calling attention to matters with the account that need to be addressed, such
unusual charges that should be reviewed and verified. Anomalous items on an
account statement may be a sign the account has been compromised, perhaps
through a stolen credit or debit card or through identity thieves who gained
access to account information. For example, an account holder or the financial
institution might spot a charge for concert tickets or a luxury item that seem out
of the ordinary. Account holders may be able to dispute such out-of-place
charges and file a claim that they did not make the purchase themselves.

General Ledger

A general ledger is a company's set of numbered accounts for its accounting

records. The ledger provides a complete record of financial transactions over the
life of the company. The ledger holds account information that is needed to
prepare financial statements and includes accounts for assets, liabilities, owners'
equity, revenues and expenses.

BREAKING DOWN 'General Ledger'

Using a general ledger is part of a system used by accountants to create the
firm’s financial statements. Transactions are posted to the general ledger
accounts, and the accountant generates a trial balance, a report listing all the
accounts and each account’s balance. The trial balance is adjusted by posting
additional entries, and the adjusted trial balance is used to generate the financial
How a Double Entry System Works

A general ledger is used by businesses that employ the double-entry

bookkeeping method, which means that each financial transaction affects at least
two general ledger accounts and each entry has a debit and a credit transaction.
Double-entry transactions are posted in two columns, with debit postings on the
left and credit entries on the right, and the total of all debit and credit entries must
balance. If a client pays a $200 invoice, for example, the cash account is
increased with a $200 debit and the accountant credits $200 to accounts
receivable. The amount posted as debits and credits are equal.

Factoring in the Balance Sheet

The balance sheet is one of four major financial statements. Cash and accounts
receivable are balance sheet accounts, and the balance sheet formula is stated
as (assets – liabilities = equity). The double-entry system also states that that
amounts posted to the left of the equal sign in the formula must equal the total on
the right. In this example, one asset account (cash) is increased by $200, while
another asset account (accounts receivable) is reduced by $200. The net result
is that both the increase and the decrease affect the left-hand side of the
equation, and the equation remains in balance.

Examples of Income Statement Transactions

Another important financial report is the income statement. The income statement
formula is (revenue – expenses = net income, or profit). This formula must also
stay in balance so that the financial statements are accurate. It is possible for a
transaction to impact both the balance sheet and the income statement. For
example, assume that a company bills a client for $500 and posts a $500 debit
(increase) to accounts receivable and a $500 credit (increase) to revenue. Debits
and credits both increase by $500, and the totals stay in balance.

An accountant is a professional person who performs accounting functions such
as audits or financial statement analysis. Accountants can either be employed
with an accounting firm, a large company with an internal accounting department,
or can set up an individual practice. Accountants are given certifications by
national professional associations, after meeting state-specific requirements,
although non-qualified persons can still work under other accountants, or

BREAKING DOWN 'Accountant'

Accountants must abide by the ethical standards and guiding principals of the
region where they practice such as IFRS or GAAP. The most common
accounting designations are Chartered Accountants (CA), Certified Management
Accountants (CMA), and Certified General Accountants (CGA). Other
Designations include Certified Internal Auditor (CIA), Public Accountant (PA),
and Certified Public Accountant (CPA). A Certified Internal Auditor doesn't have
to receive any license in order to practice, and neither do Certified Management

Accountants can have more than one designation and may preform multiple types
of accounting duties. The type of educational background and designation that
an individual has will determine their professional duties. Accountants have
bachelor’s degrees, and they have to get a certificate which can take up to a year
to obtain depending on the type of certification being pursued and in which state.

In the U.S., requirements for accountants can acquire these certificates and
licenses vary from state to state. The one requirement that is uniform in every
state is the passing of the Uniform Certified Public Accountant Examination, an
exam that is written and graded by the national organization the American
Institute of Certified Public Accountants.

Legal Requirements

Certified public accounts have a legal responsibility to their clients to be honest

and to avoid negligence in their duties. CPA’s have real influence over their
clients, and their judgments and work can affect not just an individual, but an
entire company, their employees, board, and investors. Accountants can be liable
for paying uninsured losses to creditors and investors in the case of a
misstatement, negligence, or fraud. Accountants have two different types of
liability: common law and statutory law. Common law liability includes
negligence, fraud, and breach of contract, while statutory law includes any state
or federal securities laws.


The first professional association for accountants, the American Association of

Public Accountants, was formed in 1887, and CPA’s were first licensed in 1896
when cost accounting, and accounting in general became of real importance. It
grew as a profession during the industrial revolution as businesses grew and
shareholders and bondholders who weren’t necessarily a part of the company but
were monetarily invested wanted to know more about its financial wellbeing.

After the start of the Great Depression and the formation of the Securities and
Exchange Commission (SEC), the agency required all publicly traded companies
to issue reports written by accredited accountants. Since the turn of the 19th
century and the reforms put in place the Great Depression, accountants are a
ubiquitous and large part of any business.

Capital Account

A capital account shows the net change in physical or financial asset ownership
for a nation and, together with the current account, constitutes a nation's balance
of payments. The capital account includes foreign direct investment (FDI),
portfolio and other investments, plus changes in the reserve account. A capital
account may also refer to an account showing the net worth of a business at a
specific point in time.

BREAKING DOWN 'Capital Account'

A nation’s capital account calculates the economic activity of a country or region.

A corporation’s capital account is a general ledger account used for recording the
amounts an investor pays to the company and the cumulative amount of the
company’s earnings minus cumulative distributions to the owners. Capital
accounts’ balances are reported in the owners’ equity, partners’ equity
or stockholders’ equity section of the balance sheet.

National Capital Accounts

A nation’s capital account summarizes the country’s overall economic status. The
markets closely monitor the capital account because it shows the overall direction
of the country’s economy and provides buy and sell signals for various industries
or portfolio strategies.

A country’s balance of trade is part of its balance of payments. For example, the
balance of payments in the United States is composed of three subaccounts: the
current account, the capital account and the financial account. Each has its own
types of inflows and outflows.

Economists and analysts utilize the balance of trade in understanding the

strength of a country’s economy in comparison to other countries. For example,
a country with a large trade deficit is typically borrowing money for purchasing
goods and services, whereas a country with a large trade surplus is typically
doing the opposite. The balance of trade may correlate with the country’s political
stability because it is indicative of the level of foreign investment taking place

Corporate Capital Accounts

A corporation holds multiple capital accounts. Paid-in capital accounts such

as common stock, preferred stock or paid-in capital in excess of par report the
amounts the corporation receives when shares of capital stock are issued to
investors. Retained earnings accounts contain the corporation’s cumulative
earnings since formation minus cumulative dividends distributed to stockholders.
The treasury stock account reports the amount the corporation pays to
repurchase its own shares of stock that are not retired.

In a sole proprietorship, one capital account begins with the owner’s original
investment and increases for each year’s earnings minus each year’s
withdrawals. The drawing account, which is a contra account, has a debit balance
equal to the amount of business assets the owner withdraws during the current
accounting year for personal use. At each accounting year’s end, the drawing
account is closed by transferring its debit balance to the capital account. The total
of the balances in the capital accounts must equal the reported total of the
company’s assets minus its liabilitie

Accounting Standar

An accounting standard is a principle that guides and standardizes accounting

practices. The Generally Accepted Accounting Principles (GAAP) is a group of
accounting standards widely accepted as appropriate to the field of accounting
necessary so financial statements are meaningful across a wide variety of
businesses and industries. An accounting standard is a guideline for financial
accounting, such as how a firm prepares and presents its business income,
expenses, assets and liabilities, and may be in accordance to standards set by
the International Accounting Standards Board (IASB).

BREAKING DOWN 'Accounting Standard'

Accounting standards specify when and how economic events are to be

recognized, measured and displayed. External entities such as banks, investors
and regulatory agencies rely on accounting standards to ensure relevant and
accurate information is provided about the entity. Accounting standards relate to
all aspects of an entity’s finances including assets, liabilities, revenue,
expenditures and equity. Specific examples of an accounting standard
include revenue recognition, asset classification, allowable methods
for depreciation, what is considered depreciable, lease classifications and
outstanding share measurement.

History of Accounting Standards

The first accounting standards were developed in the 1930s. They were
established for public entities and included in multiple securities acts that followed
the Great Depression. The initial regulations established were included in
the Securities Act of 1933 and the Securities Exchange Act of 1934. These
technical pronouncements have ensured transparency in reporting and set the
boundaries for financial reporting measures.

Financial Statement Comparability

Accounting standards ensure the financial statements from multiple companies

are comparable. This is because all entities follow the same rules. Without
accounting standards, there is little consistency as to the reporting of financial
information. Accounting standards make the financial statements credible and
allow for more economic decisions based on accurate and concise information.

Overseeing Bodies
The American Institute of Certified Public Accountants (AICPA) developed,
managed and enacted the first set of accounting standards. In 1973, these
responsibilities were given to the Financial Accounting Standards Board
(FASB). As of May 2016, the Financial Accounting Standards Board still
maintains regulation and administration on accounting standards.

Various Standards/Principles

Generally Accepted Accounting Principles are heavily used among public and
private entities in the United States. The rest of the world primarily uses
International Financial Reporting Standards (IFRS). These standards are
required to be used for multinational entities. Accounting standards have also
been established by the Governmental Accounting Standards Board (GASB) for
accounting principles for all state and local governments.