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Part of the Series Guide to Accounting CURRENT ARTICLEAccounting Theories and Concepts
Accounting Methods: Accrual vs. Cash
Accounting Oversight and Regulations
Public Accounting: Financial Audit and Taxation
Accounting Systems and Record Keeping
Accounting for Inventory
Accounting is the process of recording financial transactions pertaining to a business. The accounting process includes summarizing, analyzing, and reporting these transactions to oversight agencies, regulators, and tax collection entities. The financial statements used in accounting are a concise summary of financial transactions over an accounting period, summarizing a company's operations, financial position, and cash flows.
Accounting is one of the key functions of almost any business. A bookkeeper or an accountant may handle it at a small firm. At larger companies, there might be sizable finance departments guided by a unified accounting manual with dozens of employees.
The reports generated by various streams of accounting, such as cost accounting and managerial accounting, are invaluable in helping management make informed business decisions.
The financial statements that summarize a large company's operations, financial position, and cash flows over a particular period are concise and consolidated reports based on thousands of individual financial transactions.
As a result, all professional accounting designations are the culmination of years of study and rigorous examinations combined with a minimum number of years of practical accounting experience.
The history of accounting has been around almost as long as money itself. Accounting history dates back to ancient civilizations in Mesopotamia, Egypt, and Babylon. For example, during the Roman Empire, the government had detailed records of its finances. However, modern accounting as a profession has only been around since the early 19th century.
Luca Pacioli is considered "The Father of Accounting and Bookkeeping" due to his contributions to the development of accounting as a profession. An Italian mathematician and friend of Leonardo da Vinci, Pacioli published a book on the double-entry system of bookkeeping in 1494.
By 1880, the modern profession of accounting was fully formed and recognized by the Institute of Chartered Accountants in England and Wales.
This institute created many of the systems by which accountants practice today. The formation of the institute occurred in large part due to the Industrial Revolution. Merchants not only needed to track their records but sought to avoid bankruptcy as well.
The Alliance for Responsible Professional Licensing (ARPL) was formed in August 2019 in response to a series of state deregulatory proposals making the requirements to become a CPA more lenient. The ARPL is a coalition of various advanced professional groups including engineers, accountants, and architects.
Accountants may be tasked with recording specific transactions or working with specific sets of information. For this reason, there are several broad groups that most accountants can be grouped into.
Financial accounting refers to the processes used to generate interim and annual financial statements. The results of all financial transactions that occur during an accounting period are summarized in the balance sheet, income statement, and cash flow statement. The financial statements of most companies are audited annually by an external CPA firm.
For some, such as publicly traded companies, audits are a legal requirement. However, lenders also typically require the results of an external audit annually as part of their debt covenants. Therefore, most companies will have annual audits for one reason or another.
Managerial accounting uses much of the same data as financial accounting, but it organizes and utilizes information in different ways. Namely, in managerial accounting, an accountant generates monthly or quarterly reports that a business's management team can use to make decisions about how the business operates.
Managerial accounting also encompasses many other facets of accounting, including budgeting, forecasting, and various financial analysis tools. Essentially, any information that may be useful to management falls under this umbrella.
Just as managerial accounting helps businesses make management decisions, cost accounting helps businesses make decisions about costing. Essentially, cost accounting considers all of the costs related to producing a product.
Analysts, managers, business owners, and accountants use this information to determine what their products should cost. In cost accounting, money is cast as an economic factor in production, whereas in financial accounting, money is considered to be a measure of a company's economic performance.
While financial accountants often use one set of rules to report the financial position of a company, tax accountants often use a different set of rules. These rules are set at the federal, state, or local level based on what return is being filed.
Tax accounts balance compliance with reporting rules while also attempting to minimize a company's tax liability through thoughtful strategic decision-making.
A tax accountant often oversees the entire tax process of a company: the strategic creation of the organization chart, the operations, the compliance, the reporting, and the remittance of tax liability.
While basic accounting functions can be handled by a bookkeeper, advanced accounting is typically handled by qualified accountants who possess designations such as Certified Public Accountant (CPA) or Certified Management Accountant (CMA) in the United States.
In Canada, the three legacy designations—the Chartered Accountant (CA), Certified General Accountant (CGA), and Certified Management Accountant (CMA)—have been unified under the Chartered Professional Accountant (CPA) designation.
A major component of the accounting profession is the "Big Four". These four largest accounting firms (Ernst & Young, KPMG, PricewaterhouseCoopers, Deloitte) conduct audit, consulting, tax advisory, and other services. These firms, along with many other smaller firms, comprise the public accounting realm that generally advises financial and tax accounting.
Careers in accounting may vastly differ by industry, department, and niche. Some relevant job titles may include:
As of June 2024, the average Certified Public Accountant in the United States made $199,000 per year.
In most cases, accountants use generally accepted accounting principles (GAAP) when preparing financial statements in the U.S. GAAP is a set of standards and principles designed to improve the comparability and consistency of financial reporting across industries.
Its standards are based on double-entry accounting, a method in which every accounting transaction is entered as both a debit and credit in two separate general ledger accounts that will roll up into the balance sheet and income statement.
In most other countries, a set of standards governed by the International Accounting Standards Board named the International Financial Reporting Standards (IFRS) is used.
Tax accountants overseeing returns in the United States rely on guidance from the Internal Revenue Service. Federal tax returns must comply with tax guidance outlined by the Internal Revenue Code (IRC).
Tax accounts may also lean in on state or county taxes as outlined by the jurisdiction in which the business conducts business. Foreign companies must comply with tax guidance in the countries in which they must file a return.
Accountants often leverage software to aid in their work. Some accounting software is considered better for small businesses such as QuickBooks, Quicken, FreshBooks, Xero, or Sage 50.
Larger companies often have much more complex solutions to integrate with their specific reporting needs. This includes add-on modules or in-home software solutions. Large accounting solutions include Oracle, NetSuite, or Sage products.
Financial accountants typically operate in a cyclical environment with the same steps happening in order and repeating every reporting period. These steps are often referred to as the accounting cycle, the process of taking raw transaction information, entering it into an accounting system, and running relevant and accurate financial reports. The steps of the accounting cycle are:
Financial accounts have two different sets of rules they can choose to follow. The first, the accrual basis method of accounting, has been discussed above. These rules are outlined by GAAP and IFRS, are required by public companies, and are mainly used by larger companies.
The second set of rules follows the cash basis method of accounting. Instead of recording a transaction when it occurs, the cash method stipulates a transaction should be recorded only when cash has been exchanged.
Because of the simplified manner of accounting, the cash method is often used by small businesses or entities that are not required to use the accrual method of accounting.
Imagine a company buys $1,000 of inventory on credit. Payment is due for the inventory in 30 days.
The difference between these two accounting methods is the treatment of accruals. Naturally, under the accrual method of accounting, accruals are required. Under the cash method, accruals are not required and not recorded.
The Securities and Exchange Commission has an entire financial reporting manual outlining the reporting requirements of public companies.
Accounting is a back-office function where employees may not directly interface with customers, product developers, or manufacturing. However, accounting plays a key role in the strategic planning, growth, and compliance requirements of a company.
To illustrate double-entry accounting, imagine a business sending an invoice to one of its clients. An accountant using the double-entry method records a debit to accounts receivables, which flows through to the balance sheet, and a credit to sales revenue, which flows through to the income statement.
When the client pays the invoice, the accountant credits accounts receivables and debits cash. Double-entry accounting is also called balancing the books, as all of the accounting entries are balanced against each other. If the entries aren't balanced, the accountant knows there must be a mistake somewhere in the general ledger.
Accountants help businesses maintain accurate and timely records of their finances. Accountants are responsible for maintaining records of a company’s daily transactions and compiling those transactions into financial statements such as the balance sheet, income statement, and statement of cash flows. Accountants also provide other services, such as performing periodic audits or preparing ad-hoc management reports.
Accountants hail from a wide variety of backgrounds. Generally speaking, however, attention to detail is a key component in accountancy, since accountants must be able to diagnose and correct subtle errors or discrepancies in a company’s accounts. The ability to think logically is also essential, to help with problem-solving. Mathematical skills are helpful but are less important than in previous generations due to the wide availability of computers and calculators.
The work performed by accountants is at the heart of modern financial markets. Without accounting, investors would be unable to rely on timely or accurate financial information, and companies’ executives would lack the transparency needed to manage risks or plan projects. Regulators also rely on accountants for critical functions such as providing auditors’ opinions on companies’ annual 10-K filings. In short, although accounting is sometimes overlooked, it is absolutely critical for the smooth functioning of modern finance.
Accounting is by far one of the most important and prevalent fields in the world today. Its use in organizing business transactions and meeting regulatory requirements makes it a field that requires extensive knowledge and study. As such, accountants make strong salaries and work in a variety of industries.
