Accounting is a system of gathering, summarizing, and communicating financial information for a business firm, government, or other organization. Accounting, also called accountancy, enables decision makers to interpret financial information and use the results in planning for the future.
Business people often call accounting the “language of business” because they use accounting data in communicating about a firm’s activities. Information provided by accountants helps managers and other executives understand the results of business transactions and evaluate the financial status of their organization. With this knowledge, managers can make informed decisions about such matters as production, marketing, and financing. Charities, churches, colleges, government agencies, and other nonprofit organizations also use accounting to keep track of their finances.
Accounting is closely related to a record-keeping process called bookkeeping. Bookkeeping deals mainly with recording and analyzing financial information. Accountants carry out these activities but also design and install information systems, perform audits, interpret financial statements, and prepare tax returns.
Financial reports
In the United States and many other countries, publicly owned businesses are required by law to issue financial reports. These reports are used by investors; officials of banks, government agencies, and labor unions; and others interested in a firm or its industry. Accountants prepare the reports, which provide summaries of a company’s financial condition. Firms within a country use similar accounting procedures so that the reports can be compared. These procedures are called generally accepted accounting principles (GAAP). Such principles tend to vary somewhat from country to country. The Financial Accounting Standards Board (FASB), a group of professional accountants, establishes generally accepted accounting principles for the United States.
The most important financial reports include balance sheets, income statements, and statements of cash flows. A balance sheet shows a company’s assets, liabilities, and net worth. An income statement is a report of a firm’s revenue and expenses during a certain period. The bottom line of an income statement shows whether the company had a net profit or a net loss for that period. A statement of cash flows shows the amounts of money flowing into a company and out of it as a result of its operating, investing, and financing activities.
Organizations that do not seek a profit need many of the same kinds of financial reports. For example, private schools must keep track of their tuition income and their expenses. A government agency may wish to compare the cost of a program with the benefits.
Fields of accounting
Accountants may be classified by the type of organization for which they work. For example, business accountants are employed by all types of companies. A small firm may have one general accountant who handles all financial records. But a large corporation may have many accountants for the various duties involved.
Organizations or individuals may hire professional public accountants for occasional tasks or special accounting services. In the United States, most public accountants have passed a state examination and obtained a license to practice as a certified public accountant (CPA). Such accountants are called chartered accountants in Canada, the United Kingdom, and some other countries. Many CPA’s in the United States work for one of the four large public accounting firms that dominate the nation’s accounting industry. These four firms, which provide a wide variety of services, are Deloitte Touche Tohmatsu; EY (formerly known as Ernst & Young); KPMG International; and PricewaterhouseCoopers.
Most accountants specialize in a field of accounting. The major fields include financial accounting, management accounting, tax accounting, auditing, and management consulting services.
Financial accounting
involves the preparation of a business’s financial statements, mainly for users outside the business. These reports are used by owners and potential owners of a business and by people who have loaned a company money. Some government agencies that regulate business and the stock market require companies to submit financial statements to them.
Management accounting
helps managers plan and control a company’s operations. Accountants prepare budgets to express management’s goals in financial terms. After a budget has been adopted, performance reports compare actual results with the budget. Cost accountants help management keep track of how much it costs a company to make the product, or provide the service, it sells.
Tax accounting
consists of preparing tax returns for organizations or individuals and determining the taxes involved in proposed business transactions. Tax accountants suggest ways to save money on taxes. They must have a thorough knowledge of the tax laws that affect their clients or employers. They also must know the details of court rulings in a wide variety of tax cases.
Auditing
involves the examination of an organization’s financial statements and records. Auditors from outside the organization ensure that the organization’s financial statements present information fairly and that they follow generally accepted accounting principles. People use such statements in deciding which companies to invest in and lend money to.
Internal auditors are employees of an organization who make sure that the organization follows the accounting procedures management wants. They also strive to increase efficiency and reduce waste.
Management consulting services
consist of a variety of activities that many accountants perform. These services include the design and installation of computerized financial information systems, assistance in setting up employee pension plans, and the planning of an individual’s personal finances.
The history of accounting
Accounting dates back to the earliest known civilizations of the Middle East and Central America. As these civilizations advanced, skilled people called scribes performed many of the accounting functions. They put business transactions in writing and assured compliance with commercial agreements. As commerce developed and economic systems became more complex, the need for accounting grew. Explanations of many bookkeeping techniques appeared in 1494 in Summa de Arithmetica, Geometria, Proportioni et Proportionalita, a mathematics book written by the Italian monk Luca Pacioli.
The later development of accounting largely paralleled the evolution of big business in industrialized countries. As commercial and industrial activity accelerated, the need for detailed and accurate financial information became increasingly important.
Following the stock market crash of 1929, the U.S. Congress passed legislation to address problems in financial reporting and in the regulation of securities (stocks and bonds). The Securities Exchange Act of 1934 established the Securities and Exchange Commission (SEC), a federal agency that administers and enforces securities laws.
In the early 2000’s, a series of corporate failures related to faulty or dishonest accounting practices occurred. In November 2001, Enron Corporation, a U.S.-based energy company, revealed that it had overstated its earnings by several hundred million dollars. In June 2002, WorldCom Inc., a U.S.-based communications company, announced that it had improperly concealed billions of dollars of expenses. Both Enron and WorldCom filed for bankruptcy soon after their announcements. The failures led to criminal investigations and charges of fraudulent accounting practices. Many of the charges focused on Arthur Andersen, an accounting firm that worked with both Enron and WorldCom. Arthur Andersen admitted to destroying documents that might have been significant to the Enron investigations. In June 2002, a federal jury convicted Arthur Andersen of obstruction of justice. However, the Supreme Court of the United States overturned the conviction in May 2005.
In July 2002, Congress passed the Sarbanes-Oxley Act, in response to the accounting scandals. The act’s numerous provisions included the establishment of a new oversight board to monitor the accounting industry. The act also prohibited auditing firms from engaging in certain nonauditing services for corporate clients. In addition, it required executives of public corporations to certify the accuracy of financial information given to shareholders.
