Introduction to accounting

What is accounting? Let’s share a little story of a ten year old kid named Ricardo. On every birthday, he used to get different gifts from his relatives, but on his tenth birthday, he got a cash gift of $100 from his father along with a promise that from now onwards, he will be given monthly pocket money as well if he uses his money well. Ricardo was a smart boy! Whenever he spent some money on something, he used to check the remaining balance and did all the calculations in his mind about how much he has spent on various items. That’s how he was always in control of his pocket money and was never out of cash even at the end of the month.

All these years, Ricardo was doing the accounting for his pocket money, all in his mind. After several years, that little boy became a very successful businessman with over 50 outlets of premium quality clothing over the country. What do you think, was he still able to do the accounting in his mind? Of course not! Although, he used the same concept for keeping track of the finances of his business as he used to do with his pocket money, but as the quantum and complexity of business transactions increased enormously, it was impossible to do the accounting in his mind. The secret for his success was that his basics of accounting were perfect. He developed a sound accounting/finance department with dedicated staff and equipped them with relevant resources such as computers, accounting software etc. so that all the business transactions are recorded efficiently. By doing so, he was able to achieve following:

  • Keep track of the income and expenses.
  • Keep track of the funds available with him at all times.
  • He was able to make well informed decisions about his business.

So, to sum up, following is a comprehensive definition of accounting:

Accounting is the process of recording business transactions in an organized manner in order to retrieve this financial information and present it in a useful manner in the form of various reports representing the financial performance and financial position of the business.

Types of accounting

There are two major types of accounting which are defined below:

Financial accounting

Financial accounting is the process of recording business transactions in an organized manner following standardized guidelines such as International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP), and then presenting this information in the form of various reports. Financial accounting’s primary objective is to keep track of an entity’s historical financial data and the preparation of financial statements which are used by both, internal and external stakeholders.

Management accounting

Management accounting or managerial accounting is the process of recording, evaluating, and presenting financial information in an organized way. As the name “Management Accounting” suggests, the financial information is prepared for and presented to the management for internal uses such as decision making, short and long term planning and controlling the activities. It is also focused on the analysis of future projections.