I n t r o d u c t i o n t o Ac c o u n t i n g

It is not easy to provide a concise definition of accounting since the word has a broad
application within businesses and applications. The American Accounting Association
define accounting as follows: "the process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users of the
information. This definition is a good place to start. Let's look at the key words in the
above definition:
It suggests that accounting is about providing information to others. Accounting
information is economic information ! it relates to the financial or economic activities of
the business or organisation.
Accounting information needs to be identified and measured. This is done by way of a
"set of accounts"# based on a system of accounting known as double-entry
"bookkeeping. The accounting system identifies and records "accounting
transactions".
The "measurement" of accounting information is not a straight!forward process. It
involves making $udgments about the value of assets owned by a business or liabilities
owed by a business. It is also about accurately measuring how much profit or loss has
been made by a business in a particular period. As we will see# the measurement of
accounting information often re%uires subjective judgment to come to a conclusion.
The definition identifies the need for accounting information to be communicated. The
way in which this communication is achieved may vary. There are several forms of
accounting communication &e.g. annual report and accounts# management accounting
reports' each of which serve a slightly different purpose. The communication need is
about understanding who needs the accounting information# and what they need to know.
Accounting information is communicated using financial statements.
What is the purpose of financial statements?
There are two main purposes of financial statements:
&(' To report on the financial position of an entity &e.g. a business# an organisation')
&*' To show how the entity has performed &financially' over a particularly period of time
&an "accounting period"'.
The most common measurement of "performance" is profit.
It is important to understand that financial statements can be historical or relate to the
future.
Accountability
(
Accounting is about Accountability. +ost organisations are e!ternally accountable in
some way for their actions and activities. They will produce reports on their activities that
will reflect their ob$ectives and the people to whom they are accountable.
The table below provides e,amples of different types of organisations and how
accountability is linked to their differing organisational ob$ectives:
-rganisation -b$ectives Accountable to &e,amples'
Private or public
company
&e.g. ./# Tesco'
! +aking of profit
! 0reation of wealth
! 1hareholders
! -ther stakeholders &e.g.
employees# customers# suppliers'
Charities
&e.g. 1ave the 0hildren'
! Achievement of charitable
aims
! +a,imise spending on
activities
! 0harity commissioners
! 2onors
Local Authorities
&e.g. Leeds 0ity
0ouncil'
! /rovision of local services
! -ptimal allocation of
spending budget
! Local electorate
! 3overnment departments
Public services (e.g.
transport, health)
&e.g. 4ational 5ealth
1ervice# /rison 1ervice'
! /rovision of public service
&often re%uired by law'
! 5igh %uality and reliability of
services
! 3overnment ministers
! 0onsumers
Quasi-governmental
agencies
&e.g. 2ata /rotection
6egistrar# 1cottish Arts
0ouncil'
! 6egulation or instigation of
some public action
! 0oordination of public sector
investments
! 3overnment ministers
! 0onsumers
All of the above organisations have a significant role to play in society and have multiple
stakeholders to whom they are accountable. All re%uire systems of financial
management to enable them to produce accounting information.
"ow accounting information helps businesses be accountable
As we have said in our introductory definition# accounting is essentially an "information
process" that serves several purposes:
/roviding a record of assets owned# amounts owed to others and monies invested)
/roviding reports showing the financial position of an organisation and the profitability
of its operations)
5elps management actually manage the organisation)
*
/rovides a way of measuring an organisation's effectiveness &and that of its separate
parts and management')
5elps stakeholders monitor an organisations activities and performance)
7nables potential investors or funders to evaluate an organisation and make decisions
There are many potential users of accounting information# including shareholders#
lenders# customers# suppliers# government departments &e.g. Inland 6evenue 89# Internal
6evenue 1ervice 81A'# employees and their organisations# and society at large. Anyone
with an interest in the performance and activities of an organisation is traditionally called
a stakeholder. :or a business or organisation to communicate its results and position to
stakeholders# it needs a language that is understood by all in common. 5ence# accounting
has come to be known as the "language of business"
There are two broad types of accounting information:
&(' :inancial Accounts: geared toward e,ternal users of accounting information)
&*' +anagement Accounts: aimed more at internal users of accounting information )
Although there is a difference in the type of information presented in financial and
management accounts# the underlying ob$ective is the same ! to satisfy the information
needs of the user. These needs can be described in terms of the following overall
information ob$ectives:
$ollection
0ollection in money terms of information relating to transactions
that have resulted from business operations
%ecording and
$lassifying
6ecording and classifying data into a permanent and logical form.
This is usually referred to as "&ook-keeping"
'ummarising
1ummarising data to produce statements and reports that will be
useful to the various users of accounting information ! both
e,ternal and internal
Interpreting and
$ommunicating
Interpreting and communicating the performance of the business to
the management and its owners
(orecasting and
)lanning
:orecasting and planning for future operation of the business by
providing management with evaluations of the viability of
proposed operations. The key forecasting and planning tool is the
"&udget"
The process by which accounting information is collected# reported# interpreted and
actioned is called "(inancial *anagement". Taking a commercial business as the most
common organisational structure# the key ob$ectives of financial management would be
to:
&(' 0reate wealth for the business
&*' 3enerate cash# and
;
&;' /rovide an ade%uate return on investment bearing in mind the risks that the business
is taking and the resources invested
In preparing accounting information# care should be taken to ensure that the information
presents an accurate and true view of the business performance and position. To impose
some order on what is a sub$ective task# accounting has adopted certain conventions and
concepts which should be applied in preparing accounts.
:or financial accounts# the regulation or control of what kind of information is prepared
and presented goes much further. 89 and international companies are re%uired to comply
with a wide range of Accounting 'tandards which define the way in which business
transactions are disclosed and reported. These are applied by businesses through their
Accounting )olicies.
+he main financial accounting statements
The purpose of financial accounting statements is mainly to show the financial position
of a business at a particular point in time and to show how that business has performed
over a specific period.
The three main financial accounting statements that help achieve this aim are:
,-. +he profit and loss account for the reporting period
,/. A balance sheet for the business at the end of the reporting period
,0. A cash flow statement for the reporting period
A balance sheet shows at a particular point in time what resources are owned by a
business &"assets"' and what it owes to other parties &"liabilities"'. It also shows how
much has been invested in the business and what the sources of that investment finance
were.
It is often helpful to think of a balance sheet as a "snap-shot" of the business ! a picture
of the financial position of the business at a specific point. <hilst this is a useful picture
to have# every time an accounting transaction takes place# the "snap!shot" picture will
have changed.
.y contrast# the profit and loss account provides a perspective on a longer time!period. If
the balance sheet is a "digital snap!shot" of the business# then think of the profit and loss
account as the "2=2" of the business' activities. The story of what financial transactions
took place in a particular period ! and &most importantly' what the overall result of those
transactions was.
>
4ot surprisingly# the profit and loss account measures "profit?. Profit is the amount by
which sales revenue (also known as "turnover" or "income") eceeds "epenses" (or
"costs") for the period being measured.
8seful link: http:@@www.answers.com@library@7ncyclopediaAofA1mallA.usiness
Financial Statements for Corporations
:inancial statements are reports that summariBe the financial condition of an organiBation
on a specific date. Three principal types of financial statements are the Income 1tatement#
which tracks the organiBationCs income over time) the .alance 1heet# which is used to
view the organiBationCs net worth at a particular time) and the 0ash :low 1tatement#
which reports how much cash the organiBation has on hand.
Income statement: The Income 1tatement figures net income# or the bottom line.
4et income is calculated by adding all business revenue# and then subtracting all costs
and e,penses of operating the business. 4et income is also referred to as net profit. An
Income 1tatement is an e,tremely useful tool for a small corporation# and can be used for
pro$ections# ta, purposes# to evaluation your corporation# and to attract investors. An
e,cellent way to understand your corporationCs financial condition is to compare the
numbers on your Income 1tatement with the budget for the same time period.
Although an Income 1tatement can be simple and include only revenues# e,penses# and
net income# more detail can be very helpful and ultimately serve as a chart of accounts
for the corporation.
9ey components in an Income 1tatement include:
D 3ross sales &or gross revenues')
D 6eturns and allowances)
D 0osts of goods sold)
D 1elling# general# and administrative e,penses)
D Income ta,es)
D 4et income &or net profit'
Balance sheet: The .alance 1heet shows the corporationCs financial condition as of
a specific date. It shows what the business owns &assets' and what it owes &liabilities'.
The difference between the two represents the corporationCs e%uity &net worth'. +ore
than one period of time can be shown on a .alance 1heet to demonstrate increase &or
decrease' in net worth.
There are three ma$or types of assets:
E
D $urrent assets1 Those assets which you e,pect to convert into cash within one year.
They include: cash# investments# accounts receivable# and inventories.
D (i!ed assets1 /roperty# plant# and e%uipment items that are e,pected to last longer than
one year. A dollar amount is usually stated for items in this category.
D2ther assets1 These are long term assets# and include: deposit on a lease# and
intangible items such as good will.
Liabilities are the corporationCs debts and generally fall into two categories# including
D $urrent liabilities1 .usiness debts that are due within one year. The portion of long!
term debt due within one year should also be included under current liabilities.
D 3ong-term liabilities1 .usiness debts that are due one year and beyond the date of the
.alance 1heet.
4et worth1 4et worth or ownerCs e%uity is the corporationCs net worth# and consists of
capital that was invested in the corporation and accumulated earnings that have been left
in the corporation. Invested capital e,ists in the form of cash or other assets transferred to
the corporation. 6etained earnings are the corporationCs accumulation of profits and
losses over time# which earnings are reduced when the owners take money or profits from
the corporation in the form of dividends or a draw.
$ash flow statement1 The cash flow statement tracks the corporationCs cash position
over time. A traditional cash flow statement is broken down into three ma$or categories:
operating activities# investment activities# and financing activities. The statement is used
to show the cash position during the current period# the desired period# and sets forth the
increase or decrease in cash and percentage change between the two periods.
=arious types of financial statements are available for review at All.usiness.com.
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