Accounting may seem like a complicated matter, and it can be, but the idea is quite simple.
- Accounting literally means the recording of financial transactions within an organization.
Businesses, nonprofits and government agencies all have one thing in common
So what are these Transactions?
Transactions describe the physical act that a business, nonprofit or government agency goes through during its day to day operations.
For example, ABC Construction Company is a company that builds and pours foundations from concrete for residential homes.
ABC Construction Company has transactions that could include employees working (labor expense), materials are purchased (cost of goods sold or expense), work trucks are purchased (fixed assets) and gasoline is used to fill these trucks (expense).
What is double-entry accounting?
Each transaction impacts at least two functions (or “accounts”) of a business. This is called “double-entry accounting”.
For instance, if a truck is purchased for ABC Construction Company for all cash, then the bank account decreases but the company’s fixed asset account increases to account for the new truck.
There can be more than two accounts that are impacted, but there will always be at least two.
What are the Financial Statements?
Once these transactions are “accounted for”(or recorded), these transactions need to be stored, categorized, summarized so that they may be presented in a report for its intended users.
These reports are called “Financial Statements”and are presented for many reasons.
Why are Financial Statements important?
The number one reason for accounting is to present useful information for decision making for creditors, lenders and investors.
These are an integral part of managerial decision making to ensure that business goals and profits are being met. In other words,
Business owners should read, understand, and interpret their own financial statements.
Garbage In, Garbage Out:
For the data in the Financial Statements to be useful, the information needs to be Relevant and Reliable, as well as Comparable and Consistent.
Accounting professionals are able to take all the transactions and ensure that they are presented fairly and accurately in the financial statements.
What these words mean is that each financial statement should be:
- Relevant – impact the decision.
- Reliable – trustworthy, verifiable and void of bias.
- Comparable – to compare Company’s Financials in similar industry.
- Consistent – to compare the same Company’s’ Financials from one time period to the next.
Accounting Rules and Regulations:
Accounting professionals are experts when it comes to the various rules and regulations that guide the industry.
Each industry is guided by rules and regulations that they need to follow. Home Builders, for example, have zoning and planning regulations they must follow.
The accounting industry is no different, except that the rules accountants follow apply to EVERY business that is in operations, at least externally speaking.
That is to say, there are two main reasons for accounting:
- To provide information and explanation to insiders or to outsiders.
Insiders are managers, owners and department heads.
- To use financial reporting to make better decisions based on current, accurate data.
Outsiders are creditors, lenders investors, and regulatory agencies (such as the IRS and FASB).
The rules vary depending on if you are presenting the company's financial data to insiders or outsiders, but there are still rules to follow.
It can get very complicated very quickly, and choosing an expert accountant, CPA or CMA, helps to ensure these rules are understood and observed.
This publication is designed to provide information of federal tax and accounting laws and/or regulations. It is presented with the understanding that the author is not rendering legal or accounting services.
This text is not intended to address every situation that arises or provide specific, strategic tax and/or accounting planning advice. This text should not be used solely to answer tax and/or accounting questions and you should consult additional sources of information, as needed, to determine the solution to tax and/or accounting questions.
This text has been prepared with due diligence. However, the possibility of mechanical or human error does exist and the author accepts no responsibility or liability regarding this material and its use. This text is not intended or written by the practitioner to be used and cannot be used by a taxpayer or tax return preparer, for the purpose of avoiding penalties that may be imposed.