Excerpt from Chapter One

What Is Accounting?

The purpose of accounting is to provide information that will help you make correct financial decisions. The accountant’s job is to provide the information needed to run a business as efficiently as possible while maximizing profits and keeping costs low.
Quick Tip
Finding an Accountant: Hiring a professional and ethical accountant to aid in your business operations can be critical to the success of your company.Meet with a few accountants before making a final choice so that you know your options and can select one whose experience and work style will be best suited to your needs and the needs of your business. Local chapters of your state societies of CPAs offer referral services that can help with this.

Accounting plays a role in businesses of all sizes. Your kids’ lemon­ade stand, a one-person business, and a multinational corporation all use the same basic accounting principles. Accounting is legislated; it affects your taxes; even the president plays a role in how accounting affects you.

Accounting is the language of business. It is the process of record­ing, classifying, and summarizing economic events through certain documents or financial statements. Like any other language, account­ing has its own terms and rules. To understand how to interpret and use the information accounting provides, you must first understand this language. Understanding the basic concepts of accounting is essential to success in business.

Different types of information furnished by accountants are shown in figure 1.1 on the next page.

Figure 1.1: Types of Information Provided by Accountants

• Information prepared exclusively by people within a company (managers, employees, or owners) for their own use.
• Financial information required by various government agencies such as the Internal Revenue Service (IRS), Securities and Exchange Commission (SEC), and the Federal Trade Commission (FTC).
• General information about companies provided to people out­side the firm such as investors, creditors, and labor unions.

Accounting and Bookkeeping

Bookkeeping procedures and bookkeepers record and keep track of the business transactions that are later used to generate finan­cial statements. Most bookkeeping procedures have been system­atized, and, in many cases, can be handled by computer programs. Bookkeeping is a very important part of the accounting process, but it is just the beginning. There is currently no certification required to become a bookkeeper in the United States.

Accounting is the process of preparing and analyzing financial state­ments based on the transactions recorded through the bookkeeping process. Accountants are usually professionals who have completed at least a bachelor’s degree in accounting, and often have passed a profes­sional examination, like the Certified Public Accountant Examination, the Certified Management Accountant Examination, or the Certified Fraud Auditor Examination.

Accounting goes beyond bookkeeping and the recording of economic information to include the summarizing and reporting of this informa­tion in a way that is meant to drive decision making within a business.

Who Uses Accounting Information?

In the world of business, accounting plays an important role to aid in making critical decisions. The more complex the decision, the more detailed the information must be. Individuals and companies need dif­ferent kinds of information to make their business decisions.
Let’s start with you as an individual. Why would you be interested in accounting? Accounting knowledge can help you with investing in the stock market, applying for a home loan, evaluating a potential job, balancing a checkbook, and starting a personal savings plan, among other things.

Managers within a business also use accounting information daily to make decisions, although most of these managers are not accoun­tants. Some of the decisions they might make for which they will use accounting information are illustrated in figure 1.2

Figure 1.2: Areas in Which Managers Use Accounting Information

• Marketing (Which line of goods should the company emphasize?)
• Production (Should the company produce its goods in the United States or open a new plant in Mexico?)
• Research and Development (How much money should be set aside for new product development?)
• Sales (Should the company expand the advertising budget and take money away from some other part of the marketing budget?)
Without the proper accounting information these types of decisions would be very difficult, if not impossible, to make.

Bankers continually use accounting information. They are in the business of taking care of your money and making money with your money, so they absolutely must make good decisions. Accounting is fundamental to their decision-making process. Figure 1.3 looks at some of the decisions bankers make using accounting information.

Figure 1.3: Areas in Which Bankers Use Accounting Information

• Granting loans to individuals and companies
• Investing clients’ money
• Setting interest rates
• Meeting federal regulations for protecting your money
Government agencies such as the Internal Revenue Service (IRS), the Securities and Exchange Commission (SEC), the Federal Trade Commission (FTC), and the Bureau of Alcohol, Tobacco, and Firearms (ATF) base their regulation enforcement and compliance on the accounting information they receive.

Accountability in Accounting

A business’s financial statements can also be of great interest to other members of the local or national community. Labor groups might be interested in what impact management’s financial decisions have on their unions and other employees. Local communities have an interest in how a business’s financial decisions (for example, layoffs or plant closings) will impact their citizens.
As the economy becomes more complex, so do the transactions within a business, and the process of reporting them to various users and making them understandable becomes more complex as well. A solid knowledge of accounting is helpful to individuals, managers, and business owners who are making their decisions based on the information accounting documents provide.

Financial Statements

Accountants supply information to people both inside and outside the firm by issuing formal reports that are called financial statements.

The financial statements are usually issued at least once a year. In many cases they are issued quarterly or more often where neces­sary. A set of rules, called Generally Accepted Accounting Principles (GAAP), govern the preparation of the financial statements. Generally Accepted Accounting Principles has been defined as a set of objec­tives, conventions, and principles to govern the preparation and presentation of financial statements. These rules can be found in volumes of documents issued by the American Institute of Certified Public Accountants (AICPA), the Financial Accounting Standards Board (FASB), the Internal Revenue Service (IRS), the Securities and Exchange Commission (SEC), and other regulatory bodies. In chapter 2 we look at some of the overriding principles of accounting as they apply to all businesses and individuals.