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The Nature of Accounting
Аccounting is recording, measurement, and interpretation of financial information. It is the system a business uses to measure its financial performance. Accounting is called the language of business because it communicates financial information about an organization.
The basic purpose of accounting is to provide decision makers with information useful in making economic decisions. People both inside and outside an organization rely on accounting information to help them make informed financial decisions. Accounting is important to business for two reasons: it helps managers plan and control a company’s operation, and it helps outsiders evaluate the business. Because outsiders and insiders use financial information in different ways, accounting has two distinct areas. The area of accounting concerned with preparing financial information for users outside the company (such as stockholders, creditors, and the government) is called financial accounting. The area of accounting concerned with preparing data for use by managers within the organization is known as management accounting. The users need information that is accurate, objective, consistent over time, and comparable to information supplied by other companies. Thus published financial documents must be prepared according to basic standards, known as generally accepted accounting principles (GAAP).
The major users of accounting information are:
A) Management uses accounting information in planning, controlling, and evaluating business operations. Armed with accounting information, managers are better equipped to make business decisions
B) Investors and shareholders are concerned with a company’s profit potential. They judge the wisdom of buying, holding, or selling their financial interests on the basis of accounting data.
C) Creditors (suppliers, bankers, and other lenders) want to know whether a business is creditworthy
D) Other groups with indirect interest. Government agencies regulate and tax businesses; they are interested in a business tax accounting. Labor union officials use accounting data in contract negotiations. Taxing authorities must determine a company’s tax liability.
During the accounting process, sales, purchases, and other transactions are recorded and classified into individual accounts. These accounts are later summarized in statements that make it possible to evaluate a company’s past performance, present condition, and future prospects.
The accounting process may be diagrammed as follows:
The terms accounting and bookkeeping are often mistakenly used interchangeably. This confusion is understandable because the accounting process includes bookkeeping but it also includes much more.
Bookkeeping is just one part of the accounting process. Bookkeepers deal with taxes, cash flow, which includes cash receipts and cash disbursements, sales, purchases, and different business transactions of the company. Bookkeepers first record all the appropriate figures in books of original entry, or journals. At the end of a period, usually a month, the totals of each book of original entry are posted into the proper page of the ledger, a book or computer program with separate files for each account. The ledger shows all the expenditures and all the earnings of the company. On the basis of all the totals of each account in the ledger, the bookkeeper prepares a trial balance. Trial balances are usually drawn up every quarter.
Accounting, on the other hand, involves the entire accounting process, including measuring, analyzing, and communicating the results of economic activities. The accountant’s responsibility is to analyze and summarize the data in the ledger and the trial balance. These account data are used by the accountant to prepare financial statements. The accountant is to determine the ways in which the business may grow in future. No expansion or reorganization is planned without the help of the accountant. The work of accountants is rather complicated; special training allows them not only to record and interpret financial information, but even to develop sophisticated accounting systems necessary to classify and analyze complex financial information.