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Does the term “Accounting” scare you? We see many hands raised and the cliché explanations running in the mind. That it involves playing with so many numbers, contains many concepts, as well as sub-branches. That adds to the confusion all the more!
We heard you and decided to come up with a handy blog which introduces you to the world of accounting in the most comprehensible manner. From the modern definition of accounting, its history, and types to the role of accounting in business to what it takes to be an accountant; we will dive deep into the subject.
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Accounting, as many already know, is a vital aspect of any business; irrespective of its size and industry. With well-maintained accounting books, the organization not only knows where it stands but also finds it easy to plan for the future. But before we head to those complex principles, let’s first start with the basics.
What is the definition of accounting? - A Simple Meaning of Accounting
Accounting is the way in which a business will record, understand, and organize all their finance-related data, and not necessarily in that order.
You can think of accounting as a process through which you can get a clearer picture of the financial status of your business. All it requires is a well-organized critical piece of information, such as transactions of business, projections, and taxes.
It is like the way mothers handle the household budget - keeping track of the expenses based on the income in hand to avoid overspending and make a better plan. Not to forget, the art of continuously adapting to the unexpected/sudden financial needs for a better foothold in the future. Makes sense?
Coming back to business accounting, it helps you ascertain -
• Whether your business is making profits
• Which parts are bringing in more revenues
•What current values your assets and liabilities hold
• And what is the cash flow?
Moreover, it assists in complying with financial regulations, requirements, tax planning, and strategies significantly.
Got the concept? Now, let’s understand the evolution of accounting in brief.
What is the History of Accounting?
If you think Accounting is a fairly modern concept humans invented, then brace yourself for the surprise. Accounting has been around for over 7,000 years ago!
Such ancient records of accounting have been discovered in Mesopotamia. Then civilizations indulged in record keeping of goods sold and received. The transactions also included crops, livestock, and animals. These traces of ancient activities also existed in Egypt and Babylon.
In fact, the Roman government, too, had a tryst with accounting. They recorded details of land and money grants and even the construction of temples and other structures.
A Wave of Change
Then fast forward to 1494 - a year that was witnessing an early phase of the monetary economy in Medieval Europe. Luca Pacioli, an Italian mathematician, published the book called “Summa de Arithmetica, Geometria, Proportioni et Proportionalita” in the same year. The book introduced the double-entry bookkeeping system and formed the roots of the future of this concept.
Also known as the Father of Accounting, Pacioli founded the idea of what we today recognize as a balance sheet. It not only lets you determine what is coming in and going out of a company but also informs of its holistic financial health.
Later in the 18th century, the Industrial Revolution saw the rise of modern accounting practice transformed out of Pacioli’s bookkeeping principles. In 1887, the formation of the American Association of Public Accountants took place to set ethical accounting and auditing standards for government and private firms, both profits and nonprofits.
The year 1896 witnessed the sanction of the certified public accountant license. The year 1934 saw the establishment of the U.S. Securities and Exchange Commission. Fast forward to the 21st century, and we now have modern software and advanced systems to handle the accounting needs. The technological evolution has enhanced the efficiency of an accountant, taking over the monotonous, recurring tasks.
What’s more interesting is, these technologies are evolving with each passing day. Thus, the future of accounting seems even brighter than now.
Understanding how has accounting changed over the years felt like a time trip. Now, it’s time to shift the focus back to the basic accounting principles.
What are the Basics of Accounting?
We are living in an era of modern accounting with a variety of tools and professional help at our disposal. However, it doesn’t discard the need for you to understand the basics of business accounting concepts.
Imagine a scenario where your hired accounting professional or consultant passes you all the necessary documents after completion of work. Now, if you have no knowledge of what those files contain, will you be able to comprehend your firm’s financial stature? Or take a better financial call? No. That’s why it is crucial to familiarize yourself with the following accounting basics:
› Income statement
It is a financial statement that depicts the profitability of your business. It represents the net profit or loss that your company has incurred during a specific accounting period. Remember, the income statement will subtract all the expenses that occurred during that particular reporting period.
› Balance sheet
A balance sheet is a financial statement that shows your business assets, liabilities, as well as equity, at the end of a financial period. It makes it easier to ascertain your organization’s financial standing and its ability to sustain further.
› Profit and loss (P&L) statement
It is a statement that represents the expenses and income of your business for a particular financial term. It can be monthly, quarterly, half-yearly, or yearly. It is synonymous with the income statement.
› Cash flow statement
Also known as the statement of cash flow, it is another key financial statement that summarizes the cash inflow and outflow for a specified duration. The statement analyzes your entity’s financing, operating, and investing activities to present an accurate cash position at the given time.
This statement complements the balance sheet and income statement.
› Bank reconciliation
Bank reconciliation is a process that reconciles the balance in your entity's book of accounts with that of your most recent bank statement. In case of any differences between the two, there has to be a thorough assessment and rectification.
In addition to the above accounting basics, there are some basic accounting terms you cannot afford to ignore. We have made a list of them below for your convenience.
What are the Accounting Terms?
› Accounts payable (AP)
Accounts Payable is the amount your business owes to the vendors, suppliers, or creditors. In other words, it is an expense you have incurred but have not paid yet. In the balance sheet, AP is considered a liability.
› Accounts receivable (AR)
An opposite of AP, Accounts Receivable refers to the money that people owe to your business for the goods or services offered by you. It is an income for your business which is not yet received. Hence, AR would fall on the asset side in your balance sheet.
An asset is anything with an economic value that your business owns - both tangible and intangible. You can think of assets as resources with the capability of generating profit or value in the future. While property can be your tangible asset, goodwill, copyrights, and patents will make for intangible ones.
Assets are further divided into:
• Fixed assets - Fixed assets are assets having long-term utilization and value. For instance: land, building, machinery, equipment, plant, and furniture.
• Current assets - Current assets are assets that have easy cash conversion or usability up to a year. Examples include inventory, cash, cash equivalents, account receivable, and raw material.
Accruals are debts and credit that you have registered but not fulfilled. It includes the recording of a sale your business has carried out already but hasn’t received its payment and the expenses which are still unpaid.
Capital is the financial assets your company possesses. It refers to the initial investment amount for starting a business or funds obtained from financial sources for business expansion. Funds in your business deposit accounts are your capital. Always remember that capital does NOT comprise liabilities and assets.
Working capital, on the other hand, refers to the capital utilized to manage the day-to-day operations of a business. You get working capital after subtracting current liabilities from current assets.
› Credit (CR)
Credits decrease your assets or expense accounts and increase your liabilities or equity accounts. Credit entries fall on the right side of an account. Easy way to remember: credit is what goes out.
› Cash flow (CF)
It indicates the outflow and inflow of cash in your business. You can also find the Net Cash Flow by deducting the “ending balance of cash” from the “beginning balance of cash” for a specific period. If the Net Cash Flow shows a positive number, then it means your business experienced more cash inflow. If that number is negative, then that indicates more cash outflow.
› Cost of goods sold (COGS)
Also known as Cost of Sales, the Cost of Goods Sold is direct expenses related to the production of your business goods or deliveries of services. The best examples are the cost of the raw materials and labor for producing goods or offering a service.
COGS is a vital aspect of any business. Keeping a close check on COGS can help you boost your profits without having to improve sales.
› Debit (DR)
Debits are the opposite of credits. A debit entry will increase your expense or assets account and decrease your equity or liabilities account. An account contains debit entries on its left side. Easy way to remember: Debit is what comes in.
› Depreciation (Dep)
The term Depreciation denotes the drop in the value of your fixed business assets over time. Large fixed assets, such as building, equipment, and automobiles, tend to wear off as time passes, and may not generate the same value they had when you purchased them. So what depreciation does is, it represents the decline in those assets’ recorded cost, systematically, till its value becomes zero.
Depreciation is essential because it is directly connected with the significant assets that boost your ability, as a business, of making money.
Equity represents the number of assets you will invest in your business minus all the liabilities attached to it. The simplest way to understand it is through the equation:
Equity = Assets - Liabilities. What you get is the section of the entity that the owners and investors own.
The positive number here will help your business attract more investors as well as buyers. Moreover, it will enhance your goodwill in the market.
In simple words, expenses are nothing but the cost of managing a business. It includes any purchase your business makes or money it spends to generate or expand revenues. There are four primary expenses you need to know:
a. Fixed expense
Expenses, like rent and salaries, are examples of fixed expenses. They are consistent and remain unaffected from market fluctuations or sales.
b. Variable expense
The expenses that tend to vary with the performance, market trends, or production of the entity are known as variable expenses, for example, raw materials.
c. Operating expense
These are the expenses that are essential for a business to continue, for instance, rent, marketing, and inventory cost.
d. Accrued expense
Accrued expenses are the expenses that you have not paid for yet but recorded. It comes under Accounts Payable.
› Fiscal year
It is a fixed time period your organization will follow for accounting purposes. You may follow the regular calendar year as your fiscal year or may also define a custom fiscal year depending on your accountant’s availability to generate financial statements.
› Generally Accepted Accounting Principles (GAAP)
The Generally Accepted Accounting Principles are commonly accepted guidelines for carrying out financial reporting and accounting activities. Think of as a set of rules for a better comparison of financial reports of a business. Compliance with GAAP holds tremendous importance for any publicly-listed entity since lenders and investors tend to depend on it for the decision-making process.
Anything that your business owes (to a lender, vendor, supplier, or a bank) is termed as a liability. Liabilities can be short-term or long-term. Examples include loans, credit card balance, taxes, and payroll.
Revenue is the amount you get for offering your services or products. It is vital to note that revenue is the total amount of money your business gains before deducting any expenses.
› General ledger (GL)
A general ledger contains a complete record of financial transactions of your organization. It is a critical book that is necessary to create financial statements.
› Return on Investment (ROI)
Return on Investment refers to a financial ratio that lets you calculate the benefit of an investment in relation to the investment cost. In other words, it is an approximate measure of the profitability of your investment.
There is a formula to calculate ROI:
ROI = Net Profit / Cost of Investment
Liquidity stands for how fast you can convert something (assets to be precise) into cash. For instance, stocks have more liquidity than your land because you can sell them off more rapidly than the latter.
Overheads are expenses you incur for running your business. However, do not confuse it with expenses for producing a product or delivering a service. Both are different. Overheads are not directly related to product or service creation. Examples of overhead costs consist of rent, supplies, repairs, phone bills, travel expenses, advertising, interest, etc.
After these basic terms of accounting, we can move forward to unravel what role accounting plays in a business setup.
How does Accounting Work in Business?
The prime requirement of flawless financial information for stakeholders forms the roots of the purpose of accounting. These stakeholders include investors, management, creditors, and even the governments as companies have to be compliant with all the predefined regulations.
So what accounting operations do here is, measure and summarize an entity’s activities and present them in precise financial reports. The people who do this critical job are none other than accountants. They make interpretations of the collected and processed financial data and reports easier. Besides, they suggest ways you can best utilize all the financial information that lies before you to solve complicated financial issues.
It is because of the availability of such insightful data that the stakeholders can make more effective business decisions. To keep the business afloat as well as plan for its constructive expansion.
Apart from that, accounting can -
• Help in a thorough assessment of business performance
• Become a handy tool for budget formation and future predictions
• Assist in complying with government rules and regulations that tend to vary depending on the geographical locations
• Spearhead the financial statement filing procedures with various authorities
Now that we’ve discovered how the accounting plays a major role in a business, it is apt to explore the various branches of accounting.
What are the Types of Accounting?
While accounting itself makes for an integral part of any business, whether small or large, it has several subdivisions, each with distinct specializations. Each such accounting branch focuses on a particular aspect for problem-solving and ease of business operations.
There are 8 types of accounting. Let’s have a look at them in detail:
1. Financial accounting
2. Cost accounting
3. Tax accounting
4. Managerial accounting
6. Forensic accounting
7. Fiduciary accounting
8. Governmental accounting
1. Financial accounting
Financial accounting is a branch of accounting that oversees financial transactions of a company. It is a process of putting together financial reports or statements by recording, reporting, and summarizing your firm’s transactions utilizing the standard guidelines. For instance, financial accounting is used to compile your entity’s income statement or a balance sheet.
It is important to note that financial accounting concentrates on past performance, not the future. It lets you have an accurate look at your business performance over a specific period through financial statements.
As a business, you have to prepare these financial statements on a routine basis for all the involved stakeholders (people outside the company), such as lenders or investors. If your firm is a publicly-listed one, then your financial statements would have an even wider circulation, reaching to your customers, shareholders, employees, and even competitors and market analysts.
Financial accounting does not focus on reporting a company’s value. Instead, it aims at providing sufficient information for others to assess it.
2. Cost accounting
Cost accounting refers to a type of accounting that concerns with the cost of doing business. It is a subset of managerial accounting which we will look at in the #4 point.
Businesses practice cost accounting for internal use. Contrary to the general perception that this type of accounting is worthy only in a manufacturing business, service-based entities can also benefit from it to gain better cost control.
So what does cost accounting involve?
It assesses both fixed and variable costs of your organization, for example, rent, labor, overhead, shipping, and raw materials. Such detailed assessments not only assist in highlighting where you are spending your money but also point out critical break-even points.
Also, the regular analysis of cost against the budget helps identify the loopholes in your activities. All of it put together enables the management to enhance their decision-making process when it comes to future cost management.
3. Tax accounting
Tax accounting concerns itself with everything related to taxes, right from tax planning to tax returns. This branch of accounting comes under the regulations of ICR (Internal Revenue Code) that requires corporations and individuals to comply with the latest tax rules.
Tax accounting involves accurate tax calculations, tax return preparations and filing, as well as tax planning and strategizing. Moreover, it helps in finding ways to lower tax liabilities legally and assessing the outcomes of tax decisions.
The purpose of tax accounting, for a business, is to track the funds coming in and going out to ascertain the taxable spending. For an individual, it is about their income, along with the losses and gains of the investments, and qualifying deductions to prepare a flawless tax portfolio.
4. Managerial accounting
Managerial or management accounting deals with the identification, analysis, interpretation, and communication of financial information to the management of a business. It covers multiple aspects, such as financial analysis, forecasting and budgeting, cost analysis, performance, and risk management.
Unlike Financial Accounting, this type of accounting has users only within the organization. Moreover, managerial accounting techniques do not need to follow the general accounting standards. Besides, there are no restrictions on the presentations of this information to end-users (managers in this case).
Forward-looking in nature, managerial accounting presents well-documented financial information, including costs and sales revenue, to the decision-makers; the availability of such data only improves the quality of pivotal decisions. At the same time, it ensures the decisions are in alignment with business goals. It also leads to the formation of enhanced business policies and internal operations.
Auditing refers to the independent activity of analyzing whether your organization’s financial activities are in compliance with the general accounting principles and standards. Auditing has two subcategories: Internal and External.
Internal Audits assess the internal controls of your business - whether it is about accounting techniques or corporate governance. It also includes the evaluation of departmental duties, approval processes, and management policies. The purpose of these evaluations is to boost organizational efficiency and profitability.
External Audits is a type of auditing where an independent authority will evaluate your firm’s financial statements to establish its fairness.
6. Forensic accounting
Forensic accounting can be best described as an amalgamation of accounting, auditing, as well as investigative processes. This branch of accounting comes handy when there is a need to investigate the financial activities of a business or an individual in cases of fraud, disputes, or court matters. Police departments, banks, and attorneys tend to rely on forensic accounting in such cases.
Forensic accounting helps scrutinize financial transactions, collect and analyze data, and present findings in a complete report to arrive at a logical conclusion.
7. Fiduciary accounting
Fiduciary accounting refers to handling accounting activities of a fiduciary - an entity or a person acting on behalf of the other. In other words, fiduciary accounting involves the recording of transactions that are linked with an estate entity or a trust. It also includes the issuance of periodic status reports of that entity. This kind of accounting covers aspects like trust accounting, estate accounting, and receivership.
8. Governmental accounting
Governmental accounting is a process of collecting, recording, categorizing, interpreting, and summarizing the financial transactions of all kinds of government organizations. The list includes state, county, federal, and municipal government offices.
The primary focus in governmental accounting is on budgets because all the government agencies, as well as those who receive government funds, are accountable to the taxpayers. Moreover, they have to adhere to the intended applications of such budgeted resources.
Governmental accounting has emerged, thanks to the distinct needs of the governments in terms of accounting standards and operations. It incorporates all spending, transfers, and receipts. In simpler words, this type of accounting keeps the records of a government entity’s funds and a detailed account of where they are being used.
Understood various types of accounting? Now, allow us to enlighten you on what it takes to be an accountant and how you can be a good accountant.
What is An Accountant?
A person who is responsible for performing accounting functions is known as an accountant. They may work independently, be a part of an organization’s internal accounting department, or join an accounting entity as a professional that caters to businesses and individuals as clients.
The job description of an accountant encompasses many layers. From recording financial transactions of an entity to generating performance reports and financial statements, accountants are at the core of any business. In addition to that, they are responsible for salary distribution to the workforce and handling taxes. If that wasn’t enough, accountants have to stay updated about the latest in accounting standards to ensure business processes demonstrate full compliance with the set regulations.
Because it is such an expansive field, it becomes too much for a single accountant to handle everything. Therefore, there are plenty of specializations for handling different kinds of accounting functionalities. We will see that in the next segment.
The bottom line, however, remains that the role of an accountant is very responsible and compelling, no matter which type of accounting they handle. One single mistake and corporations and individuals may suffer irreparable damages.
How to Become An Accountant?
Before we begin exploring the steps to become an accountant, we can’t stop but wonder how this field never ceases to lose its demand. After all, as long as people will keep earning money, they would need professionals to help them handle it.
That’s probably one of the reasons why hundreds of thousands of youngsters across the world want to enter the world of accounting. It is a respectable and highly specialized domain that also pays well!
Ways you can be a good accountant:
› Get a degree:
A Bachelor's degree in Accounting is the way to go to kickstart your career as an accountant. If you can earn that from a reputed college or university, it scales up your chances of job hunting.
› Join a valued internship program:
Practical work experience always places you higher than your peers and exposes you to the working of the industry. Thus, it makes sense to intern at an accounting firm.
Most internships are paid (even small stipends count). If it’s unpaid, they often offer certifications and a letter of recommendation. Some go a step further and hire their interns as full-time employees. So, make sure you show up every day and give it your best shot.
› Opt for advanced degree:
A Master’s degree in Accounting can open up a whole new world of possibilities for an accountant. Alternatively, you can select one accounting niche, such as finance or taxation, and pursue a major in that. Doing so can get you senior-level job opportunities in banks and MNCs post the course completion.
› Prepare for recognized certifications:
Earning recognized certifications in accounting from authorized entities can act as a career boost. From certified public accountant to financial analyst, chartered accountant, and internal auditor, the choices are many to suit your preference and interest levels.
› Apply for jobs:
Once you have the degree, it is easier to get an entry-level accounting job in a company. If you have a specialized degree, you will have more avenues with better pay at your disposal.
› Keep learning
Accounting is an evolving profession. The technological innovation is also contributing to its evolution. Not to forget, the revisions in accounting standards and practices at regular intervals. Hence, it is imperative for accountants to keep up with these changes and trends to stay relevant.
Now that we have seen how one can become an accountant, next on the list is to find out different types of accounting jobs.
What are the Types of Accountants?
1. Tax accountant
Tax accountants are qualified professionals who are experts in researching, studying, and interpreting government tax laws. With this knowledge, they assist their clientele, both individual professionals and businesses, with preparations and filing of tax returns.
Moreover, tax accountants can advise on the ways you can save money on your taxes and assets, without breaking any law. They ensure your tax portfolio is in line with the government tax requirements at all times. That includes adapting to the tax rules as and when they change. In case of any tax-related legal disputes, consider professional tax accountants as your saviors.
Auditors are accounting professionals with the responsibility of ascertaining accuracy in the company’s financial information. From financial statements and fiscal records to accounting books and systems, auditors have to review every detail with unparalleled precision.
If during this review, auditors come across any loopholes or glitches, they make suggestions to resolve the issue. Auditors also help boost a business’s profitability and recommend ways to minimize future risks.
A majority of organizations prefer conducting an external audit at least once a year. That enables them to have a more accurate review of their financial standing since the audit is done by an independent auditor.
3. Forensic accountant
You can think of a forensic accountant as a perfect blend of an accountant and an investigator. Forensic accountants are experts in analyzing financial records to determine the existence of errors or fraudulent activities. They also have to make sure the financial information adheres to the local laws and standards. On top of that, they have to perform a thorough investigation on the available data.
Forensic accountants usually work independently or are a part of the legal, investigation, or a government agency. In legal matters pertaining to financial frauds, these specialized accountants often become crucial witnesses in court to unravel the mystery of funds.
Many forensic accountants choose to pursue the credential of Certified Fraud Examiner (CFE) to boost their careers.
4. Cost accountant
The ultimate purpose of cost accountants is to help businesses gain cost efficiency. For that, cost accounting experts examine each expense that an entity makes in order to prepare better budgets and profitability.
From analyzing labor and material costs to production, shipping, and administration, cost accountants cover every component for a flawless assessment and possible loopholes. They compile the result in precise reports for the management to contemplate on to further enhance the business processes and gain control.
5. Management accountant
The financial health of an organization plays a critical role when making a future roadmap. And it is the responsibility of a qualified management accountant to convey the company’s financial stature to its top leadership.
The primary tasks that a management accountant needs to carry out include planning, risk management, budgeting, profitability analysis, as well as reporting of financial data. These professionals are skilled in accounting, organizing, and easy-to-comprehend presentation of financial information. Furthermore, they can offer sound recommendations on ways to improve a firm’s financial foothold based on their analysis.
6. Staff accountant
Staff accountants can be called general accountants. They report to higher authorities, such as a CPA, and handle a variety of accounting duties for a business. Staff accountants are responsible for:
• Handling subsidiary and general accounts of an entity
• Managing cash
• Generating financial statements
• Analyzing financial records
• Crafting a budget
• Carrying out bank reconciliations
• Managing payroll data
Other than that, staff accountants also look after the compliance of the firm’s financial information with the set regulations. Depending on the type and size of an organization, their duties tend to vary.
7. Investment accountant
As the name suggests, investment accountants are experts in managing the investment aspects of the organization; and whether those investments abide by the state laws. In addition to that, these professionals may also have a say in forming an effective financial strategy for the business.
Investment accountants tend to work with independent asset management or brokerage firms. Or they may choose to become a part of a large corporation’s in-house brigade of accountants. Some also go on to establish their own practice. Thanks to the nature of their specialization, they develop tremendous insights on various investment vehicles, including bonds and stocks.
8. Government accountant
Professionals specializing in government accounting are known as government accountants. They work for the government at a federal, local, or state level. They look after public fund management, system audits, and evaluation of financial information to maintain accuracy.
Furthermore, government accountants play a vital role in planning operations of the agency for a financial year. Maintaining adherence of activities to the established financial regulations also falls under their duties. In addition, they are an active part of creating a budget and investigating possible financial errors.
Accounting, as we learned, is much more than just numbers. It not only lays a foundation for creating a more powerful business strategy but also assists in reviewing its performance. While it is essential for a company to follow the standard financial laws, it also equips the leadership to make efficient predictions based on current data.
What’s even more interesting is the different types of accounting and their extensive scope. You have so many options to select from if you plan to get into this always-in-demand profession.
Whether for better business management or individual asset management and taxation, accounting makes life smoother. And with the advancements in technology, it is continuing to evolve.
What do you think about accounting? Do you manage it on your own or have hired professional accountants? Which type of accounting would you choose as a career? We’d love to know!