Summary based on the 9th edition of Accounting: What the numbers mean by Marshall, McManus, Viele

Chapter 1: Financial accounting: present and past

What is accounting?

Accounting is the process of identifying, measuring and communicating economic information about an organization, with the purpose of taking and assessing decisions based on this information.

Accountants often use the term entity instead of organization, because it involves more than just the organization.

This definition of accounting can be showed in the following diagram:

Accounting is the process of

Identifying                             Economic information           To make and assess

Measuring                                  of an entity                       decision based on this

Communicating                                                                        information

But who use this accounting information? The users of this information are the management of the organization, the owners/investors/shareholders, the creditors of the organization, the employees and various government agencies involved in the regulation and taxation for organizations.

The decisions taken by the users refer to the profit of the organization, investment and credit issues, employment characteristics and the compliance of laws. Financial statements support these decisions, because they communicate important financial information about the entity.

Accounting falls into six major categories:

1. Financial accounting
2. Management accounting / Business administration
3. Control / public reports
4. Internal audits
5. Governmental and non-profit accounting
6. Income tax reporting

Financial accounting

Financial accounting refers to the process that results from the preparation and reporting of financial statements of an entity. Financial statements reflect the financial position of an entity at a certain moment in time, the results of the operations over a given period, the cash flow activities for the same period and other information related to the financial resources, obligations and interests of the owners and the management of the entity.

Financial reporting focuses mainly at the external user. The financial statements are aimed at individuals who are not in the position to be aware of the day-to-day financial and operational activities of the entity. Financial accounting focuses primarily on the historic results of the performance of an entity.

Accounting procedures are used for accumulating the financial performance of the numerous activities of the entity. These procedures are part of the financial accounting process.

Management accounting / Business administration

Management accounting focuses on the use of economic and financial information for planning and controlling purposes of the entity’s activities and supports the decision-making process of the entity’s management.

Business administration is a subpart of management accounting that is related to the identification and accumulation of products, processes or cost of services.

Management accounting and business administration are focused internally, as opposed to financial accounting, which is focused externally.

Control / public reports

Many entities have their financial statements examined by an independent third party. Public reports agencies provide these control services.

An annual report shows the financial statements and clarifications, together with a detailed discussion and analysis by management.

Internal audits

Organizations with multiple plant locations or activities related to many financial transactions, often hire professional accountants for the internal control.

Governmental and non-profit accounting

Government agencies at municipal, state and federal level and non-profit entities such as universities, hospitals and voluntary health and welfare organizations, are required to meet the same accounting standards as other reporting entities.

Income tax reporting

The growing complexity of federal, state, local and foreign income tax rules have led to a demand for professional accountants who are specialized in the various aspects of taxation.

How did accounting develop?

Recently, accounting developed in response to the needs of users of financial statements of financial information, to support the decisions and judgments based on this information.

Financial accounting standards are established by various organizations throughout the years. These standards grew more and more complex over time. As a result, there is a growing interest in harmonizing U.S. financial accounting standards by using international financial accounting standards, which tend to be more general and were developed from general principles.

The “Securities & Exchange” committee, the “Financial Accounting Standards Board” (FASB) and the “International Accounting Standards Boards” are working on a project that will merge existing financial accounting standards as soon as possible. At this moment, the FASB is the standard setting for financial accounting. One feature often associated with the accounting profession, is that the accountant is aware of the ethical code.

Integrity, objectivity, independence and competence are different characteristics of ethical behaviour required of a professional accountant. High standards of ethical behaviour are suitable for all people, but professional accounts have a special responsibility, because a lot of people rely the information they provide when they make decisions.

Integrity means being honest and sincere in transactions and