Through this post, you can learn what accounting mainly responsible for and get the sense of where accounting likely involves in most of your life, as an accountant, business owner and individual.
Accounting extends into virtually every walk of life. You’re doing accounting when you make entries in your checkbook and when you fill out your income tax return, even if you are not an accountant.
When you sign a mortgage on your home, you should understand the accounting method the lender uses to calculate the interest amount charged on your loan each period.
Individual investors need to understand accounting basics in order to figure their return on invested capital. And it goes without saying that every organization, profit-motivated or not, needs to know how it stands financially.
Here’s a quick sweep to give you an idea of the range of accounting:
- Accounting for organizations and accounting for individuals
- Accounting for profit-motivated businesses and accounting for nonprofit organizations (such as hospitals, homeowners’ associations, churches, credit unions, and colleges)
- Income tax accounting while you’re living and estate tax accounting when you die
- Accounting for farmers who grow their products, accounting for miners who extract their products from the earth, accounting for producers who manufacture products, and accounting for retailers who sell products that others make
- Accounting for businesses and professional firms that sell services rather than products, such as the entertainment, transportation, and healthcare industries
- Past-historical-based accounting and future-forecast-oriented accounting (budgeting and financial planning)
- Accounting where periodic financial statements are legally mandated (public companies are the primary example) and accounting where such formal accounting reports are not legally required
- Accounting that adheres to historical cost mainly (businesses) and accounting that records changes in market value (mutual funds, for example)
- Accounting in the private sector of the economy and accounting in the public (government) sector
- Accounting for going-concern businesses that will be around for some time and accounting for businesses in bankruptcy that may not be around tomorrow.
- What else?
Accounting is necessary in a free-market, capitalist economic system. It’s equally necessary in a centralized, government-controlled, socialist economic system. All economic activity requires information. The more developed the economic system, the more the system depends on information. Much of the information comes from the accounting systems used by the businesses, institutions, individuals, and other players in the economic system.
Some of the earliest records of history are the accounts of wealth and trading activity. The need for accounting information was a main incentive in the development of the numbering system we use today. The history of accounting is quite interesting (but beyond the scope of this book). Taking a Peek into the Back Office.
[Info_Box]Every business and not-for-profit entity needs a reliable bookkeeping system.[/Info_Box]
Keep in mind that accounting is a much broader term than bookkeeping:
Accounting encompasses the problems in measuring the financial effects of economic activity. Furthermore, accounting includes the function of financial reporting of values and performance measures to those that need the information. Business managers and investors, and many other people, depend on financial reports for information about the performance and condition of the entity.
Bookkeeping refers to the process of accumulating, organizing, storing, and accessing the financial information base of an entity, which is needed for two basic purposes:
- Facilitating the day-to-day operations of the entity
- Preparing financial statements, tax returns, and internal reports to managers
Bookkeeping (also called “recordkeeping“) can be thought of as the financial information infrastructure of an entity. Of course the financial information base should be complete, accurate, and timely. Every recordkeeping system needs quality controls built into it, which are called internal controls or internal accounting controls.
Accountants design the internal controls for the bookkeeping system, which serve to minimize errors in recording the large number of activities that an entity engages in over the period. The internal controls that accountants design are also relied on to detect and deter theft, embezzlement, fraud, and dishonest behavior of all kinds. In accounting, internal controls are the ounce of prevention that is worth a pound of cure.
Most people don’t realize the importance of the accounting department in keeping a business operating without hitches and delays. That’s probably because accountants oversee many of the back-office functions in a business—as opposed to sales, for example, which is front-line activity, out in the open and in the line of fire. Go into any retail store, and you’re in the thick of sales activities. But have you ever seen a company’s accounting department in action?
Folks may not think much about these back-office activities, but they would sure notice if those activities didn’t get done. On payday, a business had better not tell its employees, “sorry, but the accounting department is running a little late this month; you’ll get your checks later.” And when a customer insists on up-to-date information about how much he or she owes to the business, the accounting department can’t very well say, “Oh, don’t worry, just wait a week or so and we’ll get the information to you then”.
In a for profit-organization, typically, the accounting department is responsible for the following 6 (six) main areas:
The total wages and salaries earned by every employee every pay period, which are called gross wages or gross earnings, have to be calculated. Based on detailed private information in personnel files and earnings-to-date information, the correct amounts of income tax, social security tax, and several other deductions from gross wages have to be determined.
Stubs, which report various information to employees each pay period, have to be attached to payroll checks. The total amounts of withheld income tax and social security taxes, plus the employment taxes imposed on the employer, have to be paid to provincial (state) and the national (federal) government agencies on time.
Retirement, vacation, sick pay, and other benefits earned by the employees have to be updated every pay period. In short, payroll is a complex and critical function that the accounting department performs. Many businesses outsource payroll functions to companies that specialize in this area.
Area#2. Cash Collections
All cash received from sales and from all other sources has to be carefully identified and recorded, not only in the cash account but also in the appropriate account for the source of the cash received.
The accounting department makes sure that the cash is deposited in the appropriate checking accounts of the business and that an adequate amount of coin and currency is kept on hand for making change for customers.
Accountants balance the checkbook of the business and control who has access to incoming cash receipts.
[Info_Box]In larger organizations, a treasury department is responsible for some of the cash flow and cash handling functions, particularly the management activities.[/Info_Box]
Area#3. Cash Payments (disbursements)
In addition to payroll checks, a business writes many other checks during the course of a year — to pay for a wide variety of purchases, to pay property taxes, to pay on loans, and to distribute some of its profit to the owners of the business, for example.
The accounting department prepares all the checks for the signatures of the business officers who are authorized to sign checks. The accounting department keeps all the supporting business documents and files to know when the checks should be paid, makes sure that the amount to be paid is correct, and forwards the checks for signature.
Area#4. Procurement and Inventory
Accounting departments usually are responsible for keeping track of all purchase orders that have been placed for inventory (products to be sold by the business) and all other assets and services that the business buys — from postage stamps to forklifts.
A typical business makes many purchases during the course of a year, many of them on credit, which means that the items bought are received today but paid for later. So this area of responsibility includes keeping files on all liabilities that arise from purchases on credit so that cash payments can be processed on time.
The accounting department also keeps detailed records on all products held for sale by the business and, when the products are sold, records the cost of the goods sold.
Area#5. Property Accounting
A typical business owns many different substantial long-term assets called property, plant, and equipment — including office furniture and equipment, retail display cabinets, computers, machinery and tools, vehicles (autos and trucks), buildings, and land.
Except for relatively small-cost items, such as screwdrivers and pencil sharpeners, a business maintains detailed records of its property, both for controlling the use of the assets and for determining personal property and real estate taxes. The accounting department keeps these property records.
Area#6. Tax Liability
Although a tax man pay conduct all taxation affairs, accountant is the one who record it on the book. In a broader scope, all tax liabilities comes from transactions conducted in the accounting area.
It is suffice to say that the accuracy of tax liabilities depends on accuracy of accounting transactions. In other words, a tax man figure out company’s tax liability by making use of the accounting transactions.
Therefore, a tax man won’t be able to make tax planning, reporting and filing, without a good recordkeeping.
The accounting department may be assigned other functions as well, but this list gives you a pretty clear idea of the back-office functions that the accounting department performs. Quite literally, a business could not operate if the accounting department did not do these functions efficiently and on time. One important point I want stress here is that, to do all these back-office functions well, the accounting department must design a good bookkeeping system and make sure that it is accurate, complete, and timely.