Accounting has been defined as "the language of business" because it is the basic tool for recording, reporting, and evaluating economic events and transactions that affect business enterprises. Accounting processes document all aspects of a business's financial performance, from payroll costs, capital expenditures, and other obligations to sales revenue and owners' equity. An understanding of the financial data contained in accounting documents, then, is regarded as essential to reaching an accurate picture of a business's true financial well being. Armed with such knowledge, businesses can make appropriate financial and strategic decisions about their future; conversely, incomplete or inaccurate accounting data can cripple a company, no matter its size or orientation. Accounting's importance as a barometer of business health—past, present, and future—and a tool of business navigation is reflected in the words of the American Institute of Certified Public Accountants (AICPA), which defined accounting as a "service activity." Accounting, said the AICPA, is intended "to provide quantitative information, primarily financial in nature, about economic activities that is intended to be useful in making economic decisions—making reasoned choices among alternative courses of action."
A business's accounting system contains information potentially relevant to a wide range of people. In addition to business owners, who rely on accounting data to gauge their enterprise's financial progress, accounting data can communicate relevant information to investors, creditors, managers, and others who interact with the business in question. As a result, accounting is sometimes divided into two distinct subsets—financial accounting and managerial accounting —that reflect the different information needs of these end users. Financial accounting is a branch of accounting that provides people outside the business—such as investors or loan officers—with qualitative information regarding an enterprise's economic resources, obligations, financial performance, and cash flow. Managerial accounting, on the other hand, refers to accounting data used by business owners, supervisors, and other employees of a business to gauge their enterprises's health and operating trends.
Generally accepted accounting principles (GAAP) are the guidelines, rules, and procedures used in recording and reporting accounting information in audited financial statements. Various organizations have influenced the development of modern-day accounting principles. Among these are the AICPA, the Financial Accounting Standards Board (FASB), and the Securities and Exchange Commission (SEC). The first two are private sector organizations; the SEC is a federal government agency.
The AICPA played a major role in the development of accounting standards. In 1937 the AICPA created the Committee on Accounting Procedures, which issued a series of Accounting Research Bulletins (ARB) with the purpose of standardizing accounting practices. This committee was replaced by the Accounting Principles Board (APB) in 1959. The APB maintained the ARB series, but it also began to publish a new set of pronouncements, referred to as Opinions of the Accounting Principles Board. In mid-1973 an independent private board, the FASB, replaced the APB and assumed responsibility for the issuance of financial accounting standards. The FASB remains the primary determiner of financial accounting standards in the United States. Comprised of seven members who serve full-time and receive compensation for their service, the FASB identifies financial accounting issues, conducts research related to these issues, and is charged with resolving the issues. A supermajority vote (i.e., at least five to two) is required before an addition or change to the Statements of Financial Accounting Standards is issued.
The Financial Accounting Foundation is the parent organization to the FASB. The foundation is governed by a 16-member Board of Trustees appointed from the memberships of eight organizations: AICPA, Financial Executives Institute, Institute of Management Accountants, Financial Analysts Federation, American Accounting Association, Securities Industry Association, Government Finance Officers Association, and National Association of State Auditors. A Financial Accounting Standards Advisory Council (approximately 30 members) advises the FASB. In addition, an Emerging Issues Task Force was established in 1984 to provide timely guidance to the FASB on new accounting issues.
The SEC, an agency of the federal government, has the legal authority to prescribe accounting principles and reporting practices for all companies issuing publicly traded securities. The SEC has seldom used this authority, however, although it has intervened or expressed its views on accounting issues from time to time. U.S. law requires that companies subject to the jurisdiction of the SEC make reports to the SEC giving detailed information about their operations. The SEC has broad powers to require public disclosure in a fair and accurate manner in financial statements and to protect investors. The SEC establishes accounting principles with respect to the information contained within reports it requires of registered companies. These reports include: Form S-X, a registration statement; Form 10-K, an annual report; Form 10-Q, a quarterly report of operations; Form S-K, a report used to describe' significant events that may affect the company; and Proxy Statements, which are used when management requests the right to vote through proxies for shareholders.
An accounting system is a management information system that is responsible for the collection and processing of data useful to decision makers in planning and controlling the activities of a business organization. The data processing cycle of an accounting system encompasses the total structure of five activities associated with tracking financial information: collection or recording of data; classification of data; processing (including calculating and summarizing) of data; maintenance or storage of results; and reporting of results. The primary—but not sole—means by which these final results are disseminated to both internal (in-company) and external users such as creditors and investors is the financial statement.
The elements of accounting are the building blocks from which financial statements are constructed. According to the FASB, the primary financial elements that are directly related to measuring performance and the financial position of a business enterprise are as follows:
Financial statements are the most comprehensive way of communicating financial information about a business enterprise. A wide array of users—from investors and creditors to budget directors—use the data contained in financial statements to guide their actions and business decisions. Financial statements generally consist of the following:
Notes to financial statements are considered an integral part of a complete set of financial statements. Notes typically provide additional information at the end of the statement and concern such matters as depreciation and inventory methods used in the statements, details of long-term debt, pensions, leases, income taxes, contingent liabilities, methods of consolidation, and other matters. Significant accounting policies are usually disclosed as the initial note or as a summary preceding the notes to the financial statements.
There are two primary kinds of accountants: private accountants, who are employed by a business enterprise to perform accounting services exclusively for that business, and public accountants, who function as independent experts and perform accounting services for a wide variety of clients. Some public accountants operate their own businesses, while others are employed by accounting firms to attend to the accounting needs of the firms' clients. The largest U.S. accounting firms, commonly referred to as the Big Five, are Arthur Andersen & Co., Deloitte and Touche, Ernst & Young, KPMG Peat Marwick, and Price WaterhouseCoopers.
A certified public accountant (CPA) is an accountant who has (1) fulfilled certain educational and experience requirements established by state law for the practice of public accounting and (2) garnered an acceptable score on a rigorous three-day national examination. Such people become licensed to practice public accounting in a particular state. These licensing requirements are widely credited with maintaining the integrity of the accounting service industry, but in recent years this licensing process has drawn criticism from legislators and others who favor deregulation of the profession. Some segments of the business community have expressed concern that the quality of accounting would suffer if such changes were implemented, and analysts indicate that small businesses without major in-house accounting departments would be particularly impacted.
The accounting profession was changing in a variety of other ways by the late 1990s. "The accounting profession is at a critical juncture in its development with many of its longstanding traditions being challenged by an evolving workplace and workforce," according to Patricia M. Flynn, John D. Leeth, and Elliott S. Levy in an article for CPA Journal. "In recent years, the profession has experienced a changing work environment, characterized by an expanding scope of services, rising costs, technological changes, organizational restructuring, and increased specialization." One of the most noticeable changes has been a major influx of women into the traditionally male-dominated profession.
The AICPA is the national professional organization of CPAs, but numerous organizations within the accounting profession exist to address the specific needs of various subgroups of accounting professionals. These groups range from the American Accounting Association, an organization composed primarily of accounting educators, to the American Women's Society of Certified Public Accountants.
Accounting professionals play an important role in the success of all kinds of businesses. But they are perhaps most valuable for new ventures and small businesses. "A good accountant is the most important outside advisor the small business owner has," according to the Entrepreneur Magazine Small Business Advisor. "The services of a lawyer and consultant are vital during specific periods in the development of a small business or in times of trouble, but it is the accountant who, on a continuing basis, has the greatest impact on the ultimate success or failure of a small business."
While some small businesses are able to manage their accounting needs without benefit of in-house accounting personnel or a professional accounting outfit, the majority choose to enlist the help of accounting professionals. There are many factors for business owners and managers to consider when seeking an accountant, including personality, services rendered, standing in the business community, and fees.
The nature of the business in question is also a consideration in choosing an accountant. Businesses that are not expected to expand rapidly have little need of a national accounting firm, but business ventures that require investors or call for a public stock offering can benefit from association with a respected, established accounting firm. Many owners of growing companies select an accountant by interviewing several prospective accounting firms and requesting proposals that will, ideally, detail the firm's public offering experience within the industry, describe the accountants who will be handling the account, and estimate fees for auditing and other proposed services.
Of course, business owners and managers can make matters much easier both for the company and the accountant by maintaining proper accounting records throughout the year. Well-maintained and complete records of assets, depreciation, income and expense, inventory, and capital gains and losses are all necessary for the accountant to conclude his work; gaps in a business's financial record only increase the accountant's time (and his or her fees for services rendered).
Many businesses, noted Ian Duncan in CMA Magazine, see accounting primarily as a "paperwork burden. It is often delegated to the firm's external accountant, and it is designed primarily to meet government reporting and taxation requirements." But Duncan and many others contend that firms should recognize that accounting information can be a valuable component of a company's management and decision making systems, for financial data provide the ultimate indicator of the failure or success of a business's strategic and philosophical direction.
[ Charles Woelfel ,
updated by Laurie Collier Hillstrom ]
Cornish, Clive G. Basic Accounting for the Small Business: Simple, Foolproof Techniques for Keeping Your Books Straight and Staying Out of Trouble. Self-Counsel Press, 1993.
Duncan, Ian D. "Making the Accounting System All That It Can Be." CMA Magazine 67, no. 5 (June 1993): 30.
Financial Accounting Standards Board. Statements of Financial Accounting Concepts. Chicago: Irwin, 1987.
Flynn, Patricia M., John D. Leeth, and Elliott S. Levy. "The Accounting Profession in Transition." CPA Journal 67, no. 5 (May 1997): 42 +.
Fuller, Charles. The Entrepreneur Magazine Small Business Advisor. New York: Wiley, 1995.
Meigs, Robert F., et al. Accounting: The Basis for Business Decisions. 11th ed. Boston: Irwin/McGraw-Hill, 1999. Weinstein, Grace W. The Bottom Line: Inside Accounting Today. New York: New American Library, 1987.