Why Study Accounting?
People have varying reasons as to why they study accounting. According to Don Balla in the article “Top Five “Top Five Lists” of reasons to Study Accounting” (Balla, 2014), these reasons are:
What is accounting?
Accounting has different varying definitions. However, the familiar explanation is that it is the technique of recording financial transactions. According to Harold Averkamp in his article, “what is accounting”, it involves; storing of financial transactions, andsorting out these transactions, retrieving them. Summarizing the transactions, as well as presenting the data obtained in different reports and analysis is also a process of accounting. Accounting has various parts i.e. financial accounting and management accounting among others
Financial accounting only emphasizes on presenting the data recorded in the form of financial statements to be used by people outside the said organization. Balance sheets, as well as, income statements are some of the examples of financial statement. These presented reports must be made without conflicting with the accounting principles (GAAP). The GAAP contains guidelines to writing and presenting financial reports.
Management accounting has the sole purpose of feeding a manager with the necessary information required so that the business keeps being profitable, as explained by Harold Averkamp in his article, “what is accounting”. The reports meant for management is not given to people outside like the rest of the reports. The reports made in management accounting contain data both from the recorded information as well projections and estimates made by using various assumptions. Accounting also has another legal part that deals only with compliance to regulations of the government. Due to technological advancement, various software programs have been developed to help in sorting, recording and storing actions of accounting.
Business organizations
Business is organized in various entities. Businesses are organized into entities depending on various reason. The major entities in which business are organized include:
- Sole proprietorship. In this type of business organization, the owner is a single individual. The sole proprietor is liable to both the profits and the losses of the business.
- Partnership; formed by two or more people coming together to form a business. The owners sign the memorandum of association which will give a guideline on how profits and losses are shared.
- Corporation; are of many types. These include; S corporation, professional corporation, nonprofit corporation and a regular corporation among others.
- Limited liability company; the owner’s personal liability for the business debts is limited even if he manages the business.
- Professional Limited Liability Company; these are formed by professionals who are state licensed. (Lunt, 2009).
The above listed entities of business organization have their advantages and disadvantages. The various entities of business organization have already set standards of operation. In partnerships, for example, there are various guidelines to the way through which the business’s profits and losses, for example, are to be shared among the partners. The simplest organization of business is a sole proprietorship.
Accounting Principles and Concepts
There are various set rules of conduct that govern accounting. The principles describe the procedures to be adopted by accountants universally as they record transactions in accounting. Accounting principles are categorized as accounting concepts and accounting conventions. Accounting concepts include:
- Entity Concept; this concept states that a business unit is a body corporate that has separate legal entity different from its owners.
- Dual Aspect Concept; all transactions in the business involve two aspects. The two aspects are; for every benefit received, there is a benefit given out. The concept can be summarized by; Capital + liability = assets and Assets = Equities (Capital).
- Accounting Period concept; profits and losses are determined and analyzed for a suitable accounting period, instead of determining them over a long period.
- Going Concern Concept; the concept implies an assumption that there is no time, in the operating period of the business, which the concerns of the business will stop.
- Cost concept; the concept implies that all the assets purchased must be recorded in accounting books using the price they were bought at.
- Money measurement concept; accounting transactions are recorded in money terms.
- Matching concept; this concept ascertains the profit of a business periodically.
- Realization concept; the concept defines revenue as the receivables, gross inflow of cash or other considerations that arise from the sale of goods.
- Accrual concept; revenue recognition is based on its realization.
- Rupee Value Concept; rupee is constant. (Pingle, 2013)
Accounting conventions include;
- Convention of Disclosure; all accounting statements should be prepared in an honest manner.
- Convention of conservation; the convention emphasizes that the uncertainties, as well as the risks in business transactions, must be given appropriate considerations.
- Convention of Consistency; accounting procedures, policies, as well as methods should not be changed.
- Convention of Materiality; all material events are given considerations in the process of preparing financial statements.
Use of the accounting equation to record the business transaction
The accounting equation is: Assets = capital + Liability. At all times, the equation should balance itself, what is on the right should be equal to what is in the left. This equation enables all transactions to be recorded in an appropriate journal. This process is referred to as double-entry bookkeeping. An account is used in accounting to summarize and categorize increases and reductions, and also used in balancing assets, dividend, liability, expenses and stockholders’ equity item. All the accounting transactions must be entered by an entry with equal debits and credits.
What do Financial Statement Record?
Financial statements are the formal financial activities records of the business. Different financial statements report different financial activities. According to Veechi Curtis and LenleyAveris in their article “What’s included in a Financial Statement”, these financial statements include;
- Balance sheet; this financial statement records the business ownership equity, assets and liabilities at a particular time.
- Income statement; this financial statement, over a period, records the business’s expenses, income and profits. The Income statement, due to its continuous use in recording profits and losses, is also known as a profit and loss statement.
- A Statement of cash flows; this statement reports the cash flow activities of a business. The cash flow statement specifically reports the business’s activities of investing, operating and financing. Cash flow statements vary depending on the scale of operation of the business. Large businesses have complex cash flow statement while small businesses have simple cash flow statement.
- Trial Balance report; this financial statement lists balances of credit and debit in general ledger account at a specific time.
How are Financial Statements recorded?
Financial statements are prepared through a particular sequence. The sequence is important because information obtained in one will be used in the next statement. The sequence for preparing financial statements is; from the income statement to the statement of retained earnings to the balance sheet and finally to the cash flows. The data obtained in the income statement is used in making the statement of retained earnings. After the statement of retained earning has been prepared, the information there is used to prepare a balance sheet. Finally, the cash flows statement is prepared using information from earlier statements.
Summary
The International Accounting Standard 1 (IAS 1) identifies consistency as among the four fundamental assumptions in accounting. The consistency concept ascertains that the methods of accounting that are used in one accounting period should be similar to the methods used for transactions. (Pingle, 2013)The similarity should be materially. However, there certain unique situations in which businesses may have varying methods, and thus in a sense not follow the concept of consistency. If a business is to use varying methods, it is necessary for the business to have a good reason. The internationally recognized standards of financial reporting are usually not unreasonably fixed. The financial accounts can often at times depart from the assumption of consistency. (Hanif, 2003)This may happen when; the nature of operations of the business varies in a material way. It can also happen when there is a new fairer method that has been identified. Departing from consistency assumption can also result when there is a required change in presentation by the International Financial Reporting Standard.
The consistency concept has various impacts on accounting. The concept of consistency strengthens the characteristics of financial statement. These characteristics, for example, include; reliability and comparability. The consistency concept has enabled the accounting report to be reliable. The report will give accurate information, and thus depending on the report will not lead to any risks. The comparability part of the report makes it easier to identify a trend in the financial situation of a business. The comparability characteristic of the report will make it easy to make projections for the next accounting period. The financial statements of a specific business can be compared easily since the consistency assumption makes it possible to treat the accounts, in the same way, using similar methods.
The concept of consistency has also made accounting presentation to be fair. The use of similar methods all through the process of making reports makes it hard for finance officers to skew the financial position of a business. (Stice, 2007) If consistency concept is not applied, businesses would only select the method that will represent their financial position. This would mean giving wrong information to potential investors in the said business. It would also mean giving wrong information to lending institutions such as banks. (Pingle, 2013) This is not accepted in the ethics of business. The act of giving false information is also contradicting the prudence principle. The above observations explain the importance of using consistency convention in financial accounting.
Reference
D. Victor, (Jan 17th 2010). Consistency Concepts in Accounting. Inside Business 360 Retrieved from 13th Nov From: http://www.insidebusiness360.com/index.php/consistency-concept-in-accounting-14855/
Don Balla, (2014) Top Five “Top Five Lists” of reasons to Study Accounting, John Brown University: Accounting Major. Retrieved on 13th Nov from: http://www.jbu.edu/majors/accounting/top_five_reasons_to_study_accounting/
Harold Averkamp. Q & A: What is accounting. Accounting Coach. Retrieved on 13th Nov 2014 from: http://www.accountingcoach.com/blog/what-is-accounting
Henry Lunt, (2009). Fundamentals of financial Accounting. Elsevier Publishers.
Janet Hunt. What is the Sequence for Preparing Financial Statements? Demand Media. Retrieved on 13th Nov 2014 from: http://smallbusiness.chron.com/sequence-preparing-financial-statements-30950.html
Michael Pingle, (2013). Basic Accounting Concepts: A Beginner’s Guide. Xlibris Publishers.
Mukherje, Hanif, (2003). Financial Accounting. Cengage Learning.
Veechi Curtis, LenleyAveris. Book Keeping For Dummies (Australia/ New Zealand Edition) 2nd Australian & New Zealand Ed. Retrieved From: http://www.dummies.com/how-to/content/bookkeeping-for-dummies-cheat-sheet-australiannew-.html
W. Albrecht, James Stice, (2007). Accounting: Concepts and Applications. Cengage Learning.
