Archives for Financial Accounting Basics

What is the difference between accounting and accountancy?

Posted by  on Friday, December 5th 2014     
Accounting-purpose

Accounting purpose

Accounting Vs Accountancy

Accounting is the action or process of keeping financial accounts. Accountancy describes the duties of an accountant, the person whose job is to keep, inspect and interpret financial accounts.

In relation to business, accountancy is, in effect, the total of all actions taken by a business to:

  • to record financial transactions
  • to produce reports that allow stakeholders (such as managers, investors, funders, owners) of the business to make informed decisions about the financial resources under their control.

The main reasons why a business has a vital interest in accountancy are listed below.

  • Government compliance: Tax laws require a business to report to the government on its revenue and income. Accountancy provides a process to meet this requirement.
  • Funding: Banks, investors and finance institutions require reports on the financial performance and position of a business before they invest in, or loan funds to, that business. Accountancy provides these reports in the form of an Income Statement and a Balance Sheet.
  • Financial performance: A prime function of management is to ensure that the business will endure. Accountancy provides a reporting mechanism (by way of an Income Statement) that details a business’s revenue, expenses and resulting profit. Managers can use this statement to make informed decisions to ensure the sustainability of the business.
  • Budgeting and control: Financial information provided by the accountancy system allows managers to prepare budgets that become a benchmark for performance and a means of controlling the finances under their control.
  • Comparison: Accountancy, because it is universally applied using accounting standards, allows businesses to be compared. This comparison provides benchmarks by which the performance of a business can be judged (that is, under- or over-performing) relative to either an industry average, previous periods or against the entire business world.
category: Financial Accounting Basics
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What is accounting?

Posted by  on Friday, November 28th 2014     

What is accounting?

Accounting is a financial recording and reporting system (see Figure 1).

Accounting identifies and classifies financial transactions; it then summarises these financial transactions into financial reports. Financial reports communicate relevant financial information to interested persons called stakeholders. This information allows stakeholders to decide how to best use the economic resources of the accounting entity (that is, the business or enterprise).

Figure 1 The accounting system

Definition of accounting

Here is a simple definition:

Accounting is a system that provides numeric information about the finances of an accounting entity.

Here is another definition:

Accounting is the systematic recording, reporting and analysis of the financial transactions of a business.

Yet another definition is as follows:

Accounting is a tool for recording, reporting and evaluating—in monetary terms—the transactions, events and situations that impact on an enterprise.

The American Accounting Association defines accounting as: the process of identifying, measuring and communicating information to permit judgment and decision by users of accounts.

An even simpler definition is this: accounting is the language of business.

KeyFACTS

  • Accounting is a system that operates for as long as the accounting entity exists.
  • Accounting is interested only in the financial or monetary transactions of the accounting entity.
  • The first phase of accounting is to identify, collect, measure, classify and record financial transactions; a second phase is to calculate, summarise, report and evaluate financial information.
  • The intent of accounting is to communicate the financial information of the accounting entity to decision makers.
  • Accounting deals with maintaining and storing financial results.

Accounting is not an end in itself. It is not, like art in a museum, to be displayed as a ‘beautiful set of numbers’ (even if you hear businesspeople speaking this way). Accounting is primarily a means to an end. This means that accounting is a process.

Accounting provides the most relevant and reliable financial information possible so that the real work of an accounting entity (for example, a business) can be done. The real work is to make the best possible decisions about how to use the economic resources of the entity.

Summary—definition of accounting

Based on the above definitions and conclusions, accounting can be divided into two broad elements:

1.   Accounting is an information process that identifies, classifies and summaries the financial events and transactions that impact on a business.

2.   Accounting is a reporting system that communicates relevant financial information to interested person (stakeholders). This information allows stakeholders to assess performance, make decisions about and/or control the economic resources of a financial entity.

category: Financial Accounting Basics
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When people do “accounting by hand”, what do they include on the paper?

Posted by  on Friday, November 28th 2014     

My read of the expression ‘accounting by hand’ is that it is the description of the way an enterprise’s financial transactions were recorded before the arrival of computerised accounting some 30+ years ago. What people recorded on paper when doing ‘accounting by hand’ was all the financial transactions of the enterprise.

Accounting by hand

Accounting by hand

Now the initial information recorded included all the details relating to all the financial transactions that took place in the enterprise (i.e. date, description, accounts with the amounts allocated to the appropriate debit and credit columns). This information was recorded by hand in the journals or the ‘day book’ as it was called.

All the information contained in the journals was then transferred (posted) by hand into the general ledgers which grouped the transactions by their common and shared attributes (assets, liabilities, owners equity, revenue and expenses). Posting included further notations by hand in the journal to explain where the information from the journal went to.

After the general ledger where checked for accuracy with a trial balance (being prepared by hand), the accountant was then able to prepare the financial statements by hand which grouped the appropriate accounts to calculate the COGS and Gross Margin. Follow Peter Baskerville on Quora

category: History of Accounting
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Debits & Credits – History and definitions

Posted by  on Monday, December 9th 2013     

category: Debits and Credits, History of Accounting
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The history and definition of ‘Debits and Credits’ in accounting.

Posted by  on Saturday, March 31st 2012     

History of Debits and Credits

‘Debits and credits’ is a financial transaction classification system that was first used by the Venetian merchants in Italy in the 15th century. While it was widely used by the Venetian merchants, its took a mathematician by the name of Luca Pacioli to document and publish this system in a book.

The book Luca wrote to codify the Venetian method of bookkeeping in 1494 was one of the first published by Gutenberg on his innovative printing press. Today Luca is revered widely as ‘The father of accounting’ . Luca’s book explained the whole bookkeeping system of which Debits and Credits were a key part. The overall system that he documented has come to be known as the “Double- entry bookkeeping” system. Now while this system was developed over 500 years ago, its principles and processes are still followed by today’s accountants and bookkeepers the world over.

Latin terms – “Credre” and “Debere”

It is interesting to note that the concept of negative numbers was not generally accepted in mathematics in the 1500s when Luca first codified the double-entry bookkeeping system. This may further explain why he used “Debits and Credits” rather than + and – which is the system that the accounting software of today uses to process financial transactions. Still, let’s not get any more confused other than point out that a lot has changed in the world in past 500 years, but the double-entry bookkeeping system is not one of them.

Luca’s book was written in the vernacular of the age – Latin. So the terms he used for Debit and Credit in his book were “Credre” and “Debere” . In Latin the word “Credre” means “to entrust” and “Debere” means “to owe”. These Latin meanings give us our first glimpse into the underlying principles that the “Debit and Credit” classification system seeks to maintain. These principles will be explained in greater detail later in the series of articles on this topic. It is also clear that we got the Debit abbreviation of “Dr.” from the Latin, because unlike the Latin term, there is no ‘r’ in the English term Debit.

The evolving English language

Other confusions that cloud the understanding of “Debits and Credits” for most accounting students, is the fact that English as an evolving language has developed many different meanings for the terms “Debits and Credits” other than the ones originally coined by Luca in 1494. In fact, look at most dictionaries and you will discover over 10 different meanings for the term credit apart from the one we use in accounting. Some students even try and assimilate the terms Debit with debt, yet the two terms have no similarity in meaning even though they may have similar sounding tones.

Definition of ‘Debits and Credits’ in accounting

The very important point for accounting students to understand is that the Debits and Credits in accounting has its own special meaning and that meaning is not to be assimilated with any other English meanings of the terms.

The definition of “Debits and Credits” that this series of presentations will adhere to is:

Debits and Credits is a classification method that is used for coding the financial transactions of a business and recording them in the bookkeeping system.

In essence, this series will show that the Debits and Credits method captures and records the flow of economic resources that take place in a financial transaction as economic resources transfer from a source (credit) to a destination (debit). The Debit and Credits classification method also ensures that the accounting equation, which is the foundation stone on which the entire double-entry bookkeeping system is build, remains in balance after each transaction is recorded.

Summary – Debits and Credits

In summary then we can say that:

  • “Debits and Credits” are a key component of a 500 year old double-entry bookkeeping system.
  • “Debits and Credits” are English terms that were translated from the Latin “Credre‟ and “Debere‟
  • English has evolved to create many different meanings for the terms “Debit and Credit” in the 500 years since they were first coined.
  • The meaning of “Debits and Credits’ in accounting is unique to accounting and is not to be assimilated with other meanings of these terms.
  • Debits and credits is a classification method that is used for coding the financial transactions of a business and recording them in the bookkeeping system.
  • Debits and Credits reflects the flow of economic resources that takes place in a financial transaction as the economic resources transfer from a source (Credit) to a destination (Debit).
  • The Debits and credits system ensures that the accounting equation remains in balance after each new transaction entry.

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category: History of Accounting
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