The Nature of Accounting

Date: 2015-10-07; view: 468.

Accounting is the system a business uses to measure its financial performance by recording and classifying sales, purchases, and other transactions. Accounting also provides ways to present this information that make it possible to evaluate a company's past performance, present condition, and future prospects.

Accounting is important to business for two reasons: it helps managers plan and control a company's operations, and it helps outsiders evaluate the business. Because these two audiences use accounting information in different ways, accounting has two distinct facets. Financial accounting is concerned with preparing information for the outside world; management accounting is concerned with preparing information for internal use.

Financial accounting.The outsiders who use accounting information have a variety of interests. Suppliers, banks, and other lenders want to know whether the business is creditworthy; investors and shareholders are concerned with the company's profit potential; government agencies are mainly interested in regulating the business and collecting taxes. These users need information that is objective, consistent over time, and comparable to information supplied by other companies. Thus financial accounting statements adhere to certain standard formats and are prepared according to generally accepted accounting principles (GAAP) that have been established and agreed on by the accounting profession over many years.

Management accounting.Management accounting, in contrast, is tailored to the needs of managers in a particular company. Its overall purpose is to help the managers evaluate results and make informed decisions. In a typical company, the management accounting system covers a wide range of financial activities, from recording sales and sending out invoices to helping top management evaluate expenditures on buildings, equipment, and labor.

Thus, of the several available definitions of accounting, the one developed by an American Accounting Association committee is perhaps the best because of its focus on accounting as an aid to decision making. This committee defined accounting as "the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information."