What is Accounting?
Accounting is the activity of keeping track of the financial affairs of a business or organization. Accounting helps to show and communicate the economic performance and position of a business to various users, such as owners, managers, investors, lenders, regulators, and tax authorities.
Accounting has a long and rich history that goes back to ancient civilizations. The earliest evidence of accounting comes from Mesopotamia, where people used clay tokens and tablets to keep records of goods traded and received, animals, livestock, and crops. Accounting also developed in other parts of the world, such as Egypt, Babylon, China, India, Greece, and Rome.
The modern accounting profession emerged in the 19th century with the rise of industrialization, commerce, and capitalism. The need for more accurate and reliable financial information led to the development of accounting standards, principles, methods, and techniques. One of the pioneers of modern accounting was Luca Pacioli, an Italian mathematician and friend of Leonardo da Vinci. Pacioli published a book on the double-entry system of bookkeeping in 1494, which is still widely used today.
Accounting has evolved over time to meet the changing needs and demands of businesses and society. Accounting has become more complex and sophisticated with the advancement of technology, globalization, regulation, and competition. Accounting also plays a vital role in social and environmental issues, such as sustainability , corporate social responsibility , ethics , and governance .
What are the principles of Accounting?
The principles of accounting are the rules and guidelines that accountants must follow when preparing and presenting financial information. They ensure that the accounting information is accurate, consistent, and comparable across different entities and periods. Some of the most common accounting principles are:
- Accrual principle:This principle states that transactions and events should be recorded when they occur, not when cash is exchanged. This means that revenues are recognized when earned and expenses are recognized when incurred, regardless of cash flow .
- Consistency principle:This principle states that accounting methods and policies should be applied consistently from one period to another , unless there is a valid reason to change them . This means that financial statements can be compared over time and show a true picture of the business performance and position.
- Conservatism principle:This principle states that accounting should be cautious and avoid overstating assets or income or understating liabilities or expenses . This means that uncertainties and risks should be taken into account and potential losses should be recognized sooner than potential gains.
- Cost principle:This principle states that assets and liabilities should be recorded at their original cost, not their current market value. This means that historical costs are used as a basis for measuring and reporting financial information, unless there is evidence of impairment or obsolescence.
- Economic entity principle: This principle states that the accounting records of a business should be kept separate from those of its owners or other related parties . This means that personal transactions and assets are not mixed with business transactions and assets , and vice versa .
- Full disclosure principle: This principle states that accounting should provide all relevant and material information that users need to understand the financial statements . This means that any significant facts or events that affect the financial position or performance of the business should be disclosed in notes or supplementary schedules .
- Going concern principle: This principle states that accounting should assume that the business will continue to operate in the foreseeable future, unless there is evidence to the contrary. This means that assets and liabilities are valued on the basis of their expected use and settlement, not their liquidation value.
- Matching principle: This principle states that accounting should match revenues with the expenses incurred to generate them in the same period . This means that income statement shows the net result of the business activities for a given period , and balance sheet shows the accumulated effects of past transactions on the assets and liabilities of the business .
Accounting vs Bookkeeping
Bookkeeping and accounting are both related to the financial transactions of a business , but they have some differences in their scope and functions . Bookkeeping is the process of recording and organizing the financial transactions of a business , such as sales , purchases , payments , receipts , etc . Accounting is the process of analyzing , summarizing , and reporting the financial information of a business , such as income statement , balance sheet , cash flow statement , etc .
Some of the main differences between bookkeeping and accounting are :
- Objective:The objective of bookkeeping is to keep a systematic record of financial activities and transactions chronologically . The objective of accounting is to provide relevant and reliable information for decision making and performance evaluation .
- Skills:Bookkeeping requires basic skills in data entry , arithmetic , and organization . Accounting requires advanced skills in analysis , interpretation , problem-solving , and communication .
- Output:The output of bookkeeping is the books of accounts , such as journals and ledgers . The output of accounting is the financial statements , such as income statement , balance sheet , cash flow statement , etc .
- Standards:Bookkeeping follows certain rules and procedures for recording transactions . Accounting follows certain principles and standards for preparing and presenting financial statements .
- Scope: Bookkeeping is a part of accounting and has a narrower scope than accounting . Accounting starts where bookkeeping ends and has a broader scope than bookkeeping .