We as common people often hear the sentence- accounting is the language of business. But what exactly does it imply?
The phrase was first used by Warren Buffet, the CEO of Berkshire Hathaway, as a part of an interview of CNBC.
Lexically, language is defined a mean for facilitating communications between human beings, whether spoken or written. Accounting facilitates communicating information about a business, making it an integral part of conducting any business properly.
Accounting uses various accepted theories of the subject, infield of business to ensure that its financial position can be evaluated properly.
Let us take a look at how accounting helps in conducting a business and consequently gauge its income and financial position.
What does the term accounting imply?
We use the term “account” to mean answering for responsibility. A person who manages a business is answerable to many people like owners, various government agencies, labour unions etc. In turn managers of different government agencies are responsible for answering to taxpayers, executive officers, board members etc. Thus accounting in a way stands for communicating important information within any organisation.
To communicate information effectively, it was required to develop a specific system. With accounting system, it becomes easier for any organisation to collect, process and eventually report the data to respective people.
Even though the essence of accounting is same, there is a dissent among different authors regarding its precise definitions. However, the following points can definitely sum up what the term “accounting” implies:
- The collective acts of gathering, analyzing, reporting, interpreting as well as projecting important information relating to finance.
- A system through which an organization’s quantified information is communicated to the designated people.
- The process, through which economic information about any organisation is identified, measured and communicated to people to help them make informed decisions about it.
From above three instances it can be concluded that there are two salient features of accounting. They are:
- It is connected to any transaction or event concerned with money.
- There are different stages to the process of transaction.
Let us now elaborate on the two salient features.
What does connected to any transaction mean?
Accounting must always be related to a monetary event that involves a transaction. Also, it must be possible to measure the transaction in terms of money.
Alternatively speaking, it is not possible to integrate the principles of accounting into any transaction that does not take place in monetary terms. Any other instances of events like winning a game cannot be measured in terms of money and thus do not have any relevancy in accounting.
What are the various stages in the process of transaction?
There are four important stages of every transaction. They are:
- Recording it:
The first thing to do about any transaction is to record it in a chronological fashion in a book of accounts.
The process of recording is incomplete without classifying various transactions of similar nature together in records.
After all the data is recorded and classified, they are summarised and then presented to the persons concerned.
- Interpreting it:
The entire accounting data is then analyzed and interpreted to find out real position of the concern.
All of the above stages adhere to some accounting rules and principles. To apply accounting effectively to a business, one must be familiar with all different principles of accounting.
Thus the entire system above can be attributed to why accounting is called the “language” of business. It effectively summarises the entire process of communication the financial aspects of any business within an organisation.
Now, accounting can also be classified into different branches.
Let us have a look!
What are the different branches of accounting?
Accounting, to meet its ever increasing demand in various fields, has been classified into several branches. The following are the various subfields that accounting is divided into:
Perhaps the most important branch of accounting used for the purpose of conducting a business, financial accounting can be defined as the means of reporting the financial information of an organisation to the people concerned.
Financial accounting helps to establish the profit or loss incurred by any business organisation within a specific period of time and report it to various people concerned with the business like investors, creditors and potential investors.
The various transaction information is presented in the form of financial statements, adhering to the Generally Accepted Accounting Principles or GAAP.
The various principles laid down by GAAP are formed from the agreements formed between different accounting theories and their practice that change occasionally to comply to the needs of people making decisions.
In financial accounting the records and financial statements are prepared of the past year and presented in the current year. For instance, the financial statement for an organisation of the year 2018 will be presented in 2019 to evaluate its performance in the previous year.
Management accounting is the branch of accounting that aids the managers of a business in the process of decision making. The process consequently also helps in fulfilling the goals of the organisation.
Deviating from financial accounting, managerial accounting does not follow GAAP. Instead its reports are based on the method of cost-benefits analysis. Also, in the year 2014, the Chartered Institute of Management Accountants (CIMA) formed the Global Management Accounting Principles or GMAP, to put forward the rules to be practiced in Managerial accounting.
Unlike financial accounting, managerial accounting reports are created for the future. For instance, the budgetary goals for the year 2019 will be prepared in the year 2018, with the time span for each reports being variable.
Also, managerial accounting reports may include information that might be both of financial and non financial categories.
Cost accounting is the branch of accounting that deals with the process of recording, classification, analyzing, summarization as well as allocation of costs that are associated with any process in a business. Cost accounting also helps to form a plan about the process through which the costs can be controlled.
It is one of the most important branches of accounting for any business because it helps management to form an idea about how to optimize their business practices, based on cost efficiency.
Cost accounting gives manager detailed information about cost which helps them to exercise control over the current operations in business alongside future plans.
Even though they might seem similar in nature, there is a degree of difference between financial accounting and cost accounting. They are:
- Financial accounting deals with current and accounting period status of an organization in the form of balance sheet, profit and loss. Cost accounting deals with helps to calculate costs of service or production and helps to control cost and reduce it.
- In financial accounting, the cost is divided according to nature of transactions like insurance, salaries, repairs, cost of travel etc. In cost accounting transactions are classified on the basis of activities, functions, products, process etc. which aids to formulate an idea about the internal workings of an organisation.
- With financial accounting, financial statements are usually prepared for the government, investors, external parties and creditors. In cost accounting, transaction reports are prepared for the managers and respective persons of an organisation who are responsible for its financial planning.
- Financial accounting presents a statement based on concrete views of transactions including the profit and loss of a specific period of time. Cost accounting is based on analysis and combines various assessments of the costs, consequently contributing to a result.
Auditing or especially financial audit is an integral part of conducting any business. It is the branch of accounting that deals with examining and evaluating the financial statements in any organization.
It is a conventional service that is conducted by designated people known as auditors who disclaim and express opinions on the presented financial statements. Auditing follows GAAP as a way to present financial position, cash flow, various operation results etc. Auditors also need to find out instances where GAAP has not been complied with in financial statements of the organisation.
Tax accounting refers to everything related with taxes. In the US, tax accounting includes preparing, analysing and presenting tax payments and returns. For the US, tax accounting does not follow GAAP, but has its own set of principles of accounting for calculating tax returns. There are different types of business ownerships with each of them having different rates of taxation.
These are the various branches of accounting, with financial, managerial and cost accounting playing extremely important roles in conducting a business effectively.
How is accounting in business presented?
We have already established that accounting provides important quantitative information about a business to stakeholders, creditors, investors etc. The information helps the concerned people to make important short and long term decisions that can help the business to perform better.
The information is presented in three main statements. These are:
- Income statement:
Income statement or profit and loss account presents the net income that is generated or the total loss incurred by an organisation or company within a particular period.
- Cash flow statement:
A cash flow statement is prepared to feature changes in income statement and balance sheet that affect cash flow. It is computed to feature cash flow in operating an organisation.
- Balance sheet:
Balance sheet helps to determine position of a business on a particular date. It shows various assets and liabilities of business with capital being the excess of assets over liabilities.
With these three statements (together known as financial statements), a business can have enough quantitative information to set various short and long term goals.
Importance of accounting in business:
Accounting is an integral part of any business. In the ever evolving business environment, it can often become difficult to present clean accounting records. But it is crucial for any organisation to have proper accounting records because of the following reasons:
- Helps to assess the business’ performance:
Accounting records presented by a business helps to reflect on its financial position. Balance sheets and profit and loss accounts as a part of financial statements help to evaluate the performance of the said enterprise as well. Also, keeping track of the records help to analyse variance between the accounting date from previous and current periods.
- Helps to keep track of cash flow:
The capital and cash requirements of a business can be effectively determined through financial statements prepared by an accounting system.
- Helps to prepare long term goals:
Accounting statements are pivotal for creating a budget and set goals for future. Most companies project their business trends on the basis of data produced in the past.
- Makes business statutory compliant:
Accounting in business helps to record the liabilities in business which needs to be paid within a particular time frame. Some of these liabilities include pension fund, provident fund, income tax etc. By keeping track of these liabilities and making sure that they are paid within the proper time frame, organisations make sure that they are statutory compliant.
- Miscellaneous information:
Maintaining a proper accounting system also helps to make keeping track of various quantitative and qualitative reports. These reports make conducting day to day business much easier.
Thus these are a few reasons why maintaining a proper accounting system is important for a business. After all, like we have established before, accounting is the language of business which helps communicating within an organisation about various financial matters much easier.
Michelle Johnson, is a Certified Public Accountant (CPA) with an MBA degree from the Columbia Business School in New York City. She now works in the accounting division of a prestigious company in NYC and often writes for various local business journals and magazines, like the CPA journal. She has been working in the field of accounting for over 10 years now. She helps to present the subject in a simplified fashion which resonates easily with her readers.