Understanding the Core of Accounting: Three Essential Activities [Note with PDF]
Every day, countless things happen that impact businesses, whether it’s a small corner shop or a large corporation. These events, known as economic events, can be anything from selling a product to paying employee salaries.
To make sense of all these activities, businesses rely on accounting, which acts like a language that helps us understand a company’s financial health.
What Does Accounting Do?
Accounting’s main job is to keep track of, organize, and make sense of a company’s financial activities. It’s like having a detailed logbook that records everything happening financially in the company.
This process enables businesses to see where they are financially, which in turn allows them to make smart decisions.
The Three Pillars of Accounting
The accounting process is built on three fundamental activities:
- Identification
- Recording
- Communication
Let’s explore each one in detail.
1. Identification: Spotting the Important Financial Events
Think of identification as the detective work of accounting. It’s all about pinpointing the economic events that matter to a business. These events have a direct impact on a company’s finances.
Examples:
- Buying goods to sell.
- Paying wages to employees.
- Providing a service.
- Paying out dividends to investors.
- Accounting for the wear and tear of equipment (depreciation).
2. Recording: Keeping a Detailed Financial Diary
Once important financial events are identified, the next step is recording. This is where the accounting process transitions from identifying transactions to actually recording them in a specific book.
What does recording involve?
- Monetary Measurement: All economic events are measured in monetary terms. For example, every transaction is noted with its exact cost and price.
- Systematic Recording: Transactions are recorded in a systematic and chronological way. Think of this like a diary that records events in the order they happen.
- Classification and Summarization: In addition to recording, the accounting process also groups and organizes similar events. This makes it easier to understand what’s going on at a glance. For example, all sales data is categorized and summarized.
3. Communication: Sharing the Financial Story
The final step is communicating all of this financial information to those who need to know. Without communication, all the work of identifying and recording is pointless. This step involves creating reports that can be easily understood by interested parties.
How is communication achieved?
- Financial Statements: These are like reports cards for businesses, and are one of the most common ways of communicating information. They provide a snapshot of the company’s financial position at a particular point in time.
- Standardized Reports: To ensure that the financial information is clear and easy to interpret, standardized report formats are used.
- Analysis and Interpretation: Simply presenting the numbers isn’t enough; accounting also involves analyzing and interpreting what the numbers mean. This includes using tools like ratios, percentages, graphs, and charts. This analysis helps to make the information meaningful by explaining what the reported information is, and what its significance and limits are.
The Big Picture
Accounting is the process that identifies, measures, and communicates economic information to interested parties.
This process makes numerous transactions simpler and easier to understand. By compiling this data and then presenting it in a meaningful way, accounting helps everyone understand what is happening financially in a company.
Real-World Example
Let’s consider Tyra International as our example company. Throughout a set period, they document all of their sales transactions. These are then reported in the company’s financial statements. The data is not simply displayed as a list but presented in a way that clearly illustrates the company’s overall sales performance.
This is the power of accounting: to simplify complex financial activities into understandable and valuable information.
By following these three key activities, businesses are able to keep track of their financial health, make smart decisions, and ensure that all stakeholders are well-informed.
Test Your Knowledge
Now that you’ve learned about the three essential activities of accounting, let’s test your understanding:
1. What are the three fundamental activities of accounting?
- a) Planning, Organizing, Controlling
- b) Identification, Recording, Communication
- c) Budgeting, Forecasting, Reporting
- d) Analyzing, Summarizing, Interpreting
Get Answer
b) Identification, Recording, Communication
2. Which of the following is an example of an economic event that would be identified in the accounting process?
- a) A change in management
- b) The purchase of a new company vehicle
- c) A company-wide employee meeting
- d) A news article about the company
Get Answer
b) The purchase of a new company vehicle
3. What does the recording activity in accounting involve?
- a) Identifying key economic events
- b) Creating financial reports
- c) Measuring, systematically recording, classifying, and summarizing transactions
- d) Communicating information to interested parties
Get Answer
c) Measuring, systematically recording, classifying, and summarizing transactions
4. Why is communication important in the accounting process?
- a) To keep the accounting department busy
- b) To ensure financial information is shared with relevant parties
- c) To record all financial transactions
- d) To ensure that the economic events are properly identified
Get Answer
b) To ensure financial information is shared with relevant parties
5. What are the tools used in the communication phase to analyze the reported information?
- a) Diaries and notebooks
- b) Spreadsheets and word processors
- c) Ratios, percentages, graphs, and charts
- d) Phone calls and emails
Get Answer
c) Ratios, percentages, graphs, and charts
You can also read:
- What is accounting? Objective, importance, and History of Accounting.
- Why is accounting called the language of business?
- What are the steps of the accounting cycle?
- 3 Golden rules of Accounting
