Accounting: Definition, Importance, Process, Evolution and Branches [Notes with PDF]
Accounting is often seen as a complex topic, but at its core, it’s a systematic way of tracking and making sense of financial transactions. Think of it as the language of business; it helps you understand where your money is coming from and where it’s going.
In this guide, we’ll break down the key concepts of accounting, its importance, and how it all works, so you don’t need to visit other websites for a complete overview.
What is Accounting?
At its simplest, accounting is a process of recording, classifying, and explaining financial transactions. It’s like keeping a detailed diary of all the money-related activities of a business or organization.
More formally, accounting measures and reports financial information about an organization’s economic activities to various users. This information is crucial for understanding the company’s performance, position, and cash flow.
“Accounting is the process used to measure and report to various users relevant financial information regarding the economic activities of an organization or unit.”
Financial Accounting Standard Board (FASB)
Why is Accounting Important?
Accounting is essential for several reasons, and it isn’t just for large corporations. It’s useful for anyone who manages money. Here are the primary reasons why accounting is important:
- Financial Snapshot: Accounting provides a clear picture of a company’s financial health, including its profits, losses, assets, liabilities, and equity.
- Performance Evaluation: It helps in determining how well a business is performing by tracking income and expenses.
- Cost Control: By recording costs accurately, accounting helps in identifying areas where a company can reduce expenses.
- Fraud Prevention: Proper accounting practices are critical for detecting and preventing fraud and forgery.
- Informed Decisions: Accounting information helps businesses and other interested parties to make better financial decisions.
- Historical Analysis: It allows comparisons of financial data from previous years to make future plans.
- Resource Tracking: For non-profit organizations, accounting tracks the flow of funds and account balances.
- Government Compliance: Accounting helps in managing taxes and ensuring smooth government operations.
- Accessing Credit: Well-maintained accounting records can help a company secure loans.
- Financial Stability: Proper accounting helps a company control costs, prevent waste, and become more financially stable.
The Three Core Steps of the Accounting Process
The accounting process involves three main stages:
1. Identification:
This first step involves recognizing transactions using authentic documents such as invoices, vouchers, and cash memos. In other words, it is the primary purpose of accounting and involves gathering the key input for accounting, which is the transaction.
2. Recording:
This is where transactions are recorded; this is also known as bookkeeping. It includes analyzing the transaction to determine debits and credits, recording the transactions in a journal, and transferring them to a ledger.
3. Communication:
This step focuses on creating various financial reports and communicating the needed information to the relevant parties.
You can also read: Why is accounting called the language of business?
The Evolution of Accounting: A Brief History
Accounting has evolved alongside civilization; here’s a brief overview of its development:
1. Development Period (Pre-1494):
- Stone Age: People used images, symbols, and cave engravings for bookkeeping.
- Ancient Age: Tying ropes and cutting marks on walls or bamboo were used to keep accounts.
- Exchange Age: People calculated exchanges of goods using methods like ground painting or wooden carvings. The abacus was used in China during this period.
- Money Age: Currency was introduced as a medium of transaction.
2. Pre-Analytical Period (1494-1800):
- Trade expanded rapidly during this period.
- Luca Pacioli, an Italian mathematician, is considered the father of accounting, as he laid the foundation for accounting with the discovery of debit and credit.
3. Analytical Period (1800-1950):
- Modern accounting started to emerge.
- Accounting research and new theories began.
4. Current Period (Post-1950):
Significant changes in accounting practices, with the emergence of accounting standards and various branches of accounting.
Brief history of accounting
You can also read:
- Role of accounting in developing accountability and values.
- Relationship of accounting with other subjects.
Luca Pacioli: The Father of Accounting
Luca Pacioli, an Italian mathematician, is known as the “father of accounting” and bookkeeping. In 1494, he published Summa de Arithmetica, Geometria, Proportioniet Proportionlita, which included a 27-page essay on bookkeeping.
This book explained the double-entry system, which is still the basic principle of bookkeeping today.
You can also read: Short Questions and Answers-Basic Accounting
What is Bookkeeping?
Bookkeeping usually involves only the recording of economic events in a business. The task of bookkeeping is to record transactions primarily in the book of accounts and classify the transactions recorded.
Accounting vs. Bookkeeping: What’s the Difference?
Often, people use the terms “accounting” and “bookkeeping” interchangeably, but they have distinct roles. Here’s how they differ:
- Bookkeeping focuses on the recording aspect of accounting. It is the recording step of the accounting process. Bookkeepers record and classify transactions, applying only the initial steps of the accounting cycle.
- Accounting, on the other hand, is a comprehensive system that begins where bookkeeping ends. Accountants use the data recorded by bookkeepers to analyze, interpret, and prepare financial statements, providing important information to users.
The differences between bookkeeping and accounting are as follows:
| Sl No. | Bookkeeping | Accounting |
| 1. | Bookkeeping is the recording step of accounting. | Accounting is a practical system. |
| 2. | The task of bookkeeping is to record transactions primarily in the book of accounts and classify the transactions recorded. | Bookkeeping is the basic level of accounting. |
| 3. | The bookkeeping process involves the application of two steps of the accounting cycle, journalizing and ledger posting. | The accounting process involves the application of all steps of the accounting cycle. |
| 4. | Bookkeeping basically performs three functions: collecting and analyzing transactions, journalizing transactions, and classifying transactions. | The work of accounting begins where the bookkeeping work ends. |
| 5. | Bookkeeping is the basic level of Accounting. | Accounting is the final stage of an accounting system. |
| 6. | The scope of bookkeeping is very narrow. It is just a part of accounting. | The scope of accounting is very large. |
Branches of Accounting
The six important branches or types of accounting are as follows:
1. Financial Accounting:
The main goal of financial accounting is to keep track of a business’s financial transactions and check on the business’s results and financial health on a regular basis.
Financial accounting is the preparation of various financial statements, reports, and statements, as well as the provision of the necessary information to stakeholders.
2. Management Accounting:
This part of accounting is in charge of giving the organization’s management the information they need to make day-to-day decisions, plan for the future, and do other important things.
3. Auditing:
It is the job of this branch of accounting to detect and prevent errors and fraud by checking whether financial transactions have been recorded and financial reports & statements prepared properly.
Certified professional accountants perform independent audits in almost every country around the world.
4. Cost Accounting:
Determining, analyzing, and controlling the production cost of the product or service produced by the manufacturing organization is the main function of cost accounting.
5. Tax Accounting:
The main purpose of tax accounting is to tell management how much income tax and other taxes cost and how those taxes affect different transactions after a certain amount of time has passed.
6. Social Accounting:
Social accounting is the name of a new way of thinking in accounting. The job of this accounting is to determine the income and expenditures of social activities.
Frequently Asked Questions (FAQs)
The primary goal of accounting is to accurately record transactions in the books of accounts. This helps to determine a company’s financial situation and performance.
The identification step is crucial because it is the first step in the accounting process. It involves recognizing financial transactions, which are the main input in accounting. This step uses authentic documents like invoices and vouchers.
Accounting helps in cost reduction by accurately recording costs, which allows businesses to identify areas where they can cut expenses.
Yes, proper accounting practices play a key role in preventing and monitoring fraud and forgery.
Accounting plays a crucial role in ensuring that government operations run smoothly. It helps in managing taxes (VAT, duties, etc.) and allocating funds to various activities.
Bookkeeping is primarily about recording financial transactions. Accounting involves analyzing, interpreting, and reporting the financial information recorded by bookkeepers.
Luca Pacioli is an Italian mathematician known as the “father of accounting” and bookkeeping. He formalized the double-entry bookkeeping system.
The main branches of accounting are financial accounting, management accounting, auditing, cost accounting, tax accounting, and social accounting.
Test Your Knowledge
See how well you’ve grasped the basics of accounting. Choose the best answer for each question.
Conclusion
Accounting is a fundamental part of every business and organization. It provides a clear understanding of financial health, aids in decision-making, and ensures accountability. Whether you’re a small business owner or just want to manage your personal finances better, understanding the basics of accounting is an invaluable skill.
By understanding the core concepts and steps, you can confidently navigate the world of finance and make informed decisions.
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