Introduction
According to Ladhe (2012), accounting is concerned with the recording, reporting and analysis of the financial statements of a business entity. The preparation of the financial statements is normally guided by some rules and regulations. For example, there are generally accepted accounting principles which are mostly used in the US. The person in charge of the preparation of the financial statements is referred to as the accountant. Accounting is a very important aspect since it provides information to the various stakeholders in the organization.
Accounting is very instrumental in the organization in that it provides important information to all the stakeholders in the organization. Some of the stakeholders who make use of the financial information include: investors, creditors, management, prospective shareholders, and customers. Moreover, it has been adduced that there are two broadly used accounting techniques namely accrual accounting and cash-basis of accounting.
In accrual accounting, the financial transactions are recorded when they occur and not necessarily when they have been paid for in cash (Shubita 2012). In the cash basis accounting basis, we put transactions in the accounting books when they are settled fully. The difference in the approach of the two methods creates a room for fraud in that the management of the company can take advantage of those loopholes to misrepresent the financial information. It must also be noted that the manner in which financial statements are prepared varies with the type of business entity in question (Ladhe 2012).
This paper is intended to provide information on the role of accounting in the organizations as well as the various techniques that are used in the preparation of the financial statements. Additionally, the paper will also touch on the users of the information contained in the financial statements. The information will also deal with how the financial information is used in various contexts, for example, public, profit and non-profit making organizations.
The Origin of accounting
Nelson (2012) contends that accounting is one of the oldest professions in the world. This can be supported by the assertion that even during the prehistoric times people had to account for items like food and clothing that would be used during the cold spell. Additionally, there is some evidence to show that accounting was used even during the early civilizations, for example, during the Babylonian Empire and in the Code of Hammurabi. However, the issue that helped to underscore the importance of accounting was the advent of taxation. This was to help the government to keep better records that could help it to administer the taxation process. However, the Italian renaissance contributed immensely to the field of accounting, in particular the double entry system. This can partly be attributed to the fact that Venice was the cradle of business in Europe. For this reason, the traders in Venice started to practice double entry accounting to account for their wares.
Around that time, Fra Luca Pacioli wrote a book to help solve accounting issues that were being experienced. The book has become very popular and is believed to be in use for the next 500 years. The book was referred to as the “Summa de Arithmetica, Geometria, Proportioni et Proportionalita” and it had a section dealing with the double entry concept. The book was first published in Guternberg, and it was later translated into other languages including English, German, Russia, and Dutch. This effectively made Pacioli very famous and secured his place as the father of accounting (Nelson 2012).
However, Holzmann & Zeff (2012) argue that Pacioli did not invent the double entry system, but he described the process as it was being practiced by the traders in Venice. Some of the aspects that were highlighted in that book included the use of memorandums, journals, as well as ledgers. The ledgers that were described by Pacioli had assets, receivables and inventories, liabilities, expense, capital and income accounts. Furthermore, he proposed the accounting entries that could be made at the year end. Some of his other assertions included using a trial balance to show whether the entries in the ledger had been made using the double entry system. Other issues which had been mentioned in the book include certification of books, cost accounting and ethics.
That book by Pacioli would provide guidance to the accountants for the next 500 years. The trial balance that is used currently was invented in 1868, while the income statement was developed prior to the Second World War. During the 1980s, there arose a need to have financial statements containing the relevant information on the financial position of a business entity. It must be noted that the double entry system relies on historical information. Therefore, the system might not be very useful for the current business entities which require information at the touch of a button. Consequently, there has arisen a need for integrating information technology with accounting. As a result, some software has been come up with to help in preparing the financial statements of companies. Examples of such systems include Oracle and SAP.
It is apparent that accounting has evolved from the prehistoric time up to the present. Additionally, the double entry concept as practiced today is seen to have originated from the traders in Venice during the Italian renaissance.
Branches of accounting
According to Beke (2012), there are three branches of accounting namely financial accounting, management accounting and cost accounting. Financial accounting is concerned with the preparation of financial statements, whose information is used by the various stakeholders in the business entity. The financial statements that are prepared in financial accounting are mainly intended for the outsiders like the creditors, investors and banks. The major aim for the preparation of the financial statements is to show the financial position of the business entity.
On the other hand, cost accounting is concerned with the establishment of the cost of the product. In this way, the company is going to be in a better position to control the cost and maximize the profit. The other branch of accounting is the management accounting, which is intended to provide crucial information to the management. More importantly, it is concerned with the presentation of the financial statements in a way that can help the management in making prudent decisions.
The various branches of accounting are very important for the business. Therefore, the adoption of any approach should be informed by the users of the financial information. If the financial reports are meant to be used by the external users, the correct approach would be the financial accounting. On the other hand, if the users of the financial information are in the management team, the correct approach to adopt is the management accounting.
Contemporary financial accounting and management accounting
Financial accounting, as stated by Illiano (2012), follows the accounting standards, which are the general guidelines. In some jurisdictions like the USA, the accountants must follow the generally accepted accounting standards (GAAP),but in the other parts of the world the accountants use the International financial reporting standards (IFRS). The use of those regulations is meant to ensure consistency in the preparation of the financial statements to enable easier comparison of the financial statements.
However, management accounting is intended to meet the internal needs of the business. For this reason, management accounting does not follow the external accounting standards. The major purpose of management accounting, therefore, is to provide information that is needed by the management. Such information can be used by the management in making decisions concerning the business entity. It must also be appreciated that most small organizations do not make use of management accounting. Nonetheless, majority of the large organization make use of management accounting.
It is apparent that there are some differences between financial accounting and management accounting. One of the major differences is that financial accounting is concerned with the generation of financial reports that can provide information to the external users. Management accounting, however, is intended to provide information that can be used by the management in the decision making process. Again, financial accounting tells more about the financial strength of a company. However, management accounting is concerned with only a few segments in the business entity.
It has also been said that financial accounting generates historical information while management accounting is used to forecast the future, thereby helping in the decision making process. Closely related to this is the fact that the information used in financial accounting must be exact and verifiable. This is in sharp contrast to the management accounting where there are a lot of estimations (Wang 2012).
The users of financial information
Moore (2012) argues that there are various stakeholders that make use of the financial information contained in the financial statements. One such person is the owner of the business entity. The owner uses the financial information in order to assess the performance of the firm. The other users of the financial information are the suppliers. For this reason, the supplier will use that information to evaluate the ability of the business to pay up its financial obligations, in respect of the products and services supplied to them.
Another user of the financial information is the bank. The bank will use the financial statement to assess the ability of the business to service any loan that may be extended to it. The tax authority uses the financial information to assess the amount of tax that a given company is liable to pay in a given financial period. Some of the taxes that are payable by the company may include income tax, sales tax, and property taxes among others. Income tax is based on the taxable income while sales tax is based on the sales revenue. Additionally, property tax is based on the estimated value of the buildings, equipment, and stock. The financial information is also used by the regulating authorities. For this reason, the regulating authorities will use the financial information to assess whether the business entity complies with the laid down rules and regulations. For example, in the USA, the Securities and Exchange Commission ensures that all the publicly listed company presents their financial information in the right way. For this reason, the investors are not likely to be misled by financial statement that is presented in a fraudulent way. It can be seen, from the foregoing, that the role of the regulating authorities is to ensure that investors are not misled into making investments in a company, which is on the verge of collapse.
The other users of the financial information are the customers. The reason for this is that they need to assess whether the business is going to be in existence in the foreseeable future. Moreover, the customers will need to know whether the business can replace the merchandises which are covered with the warrant issued by the company. If the company does not have favorable prospects, it might not be in a position to honor its obligations to its customers as and when they fall due.
Employees also make use of the financial information to negotiate for better salaries. For this reason, favorable financial information indicates the ability of the company to pay better salaries to its employees. At the same time, there are those employees who belong to a profit sharing plan. Consequently, the financial information could have an effect on their income.
It is important for the accountants to ensure that they present the correct financial information that reflects the true and fair view position of the company. This is the only way in which the users of the financial position can access the right information that can help them in making the right decisions.
Role of accounting within organizations
Accounting plays a major role in business in that it helps in the computation of profit or loss that the business has made in respect of a particular financial period. This information will be instrumental in enabling the business to determine the amount of tax to pay. In addition, the information can be used by investors to determine whether to invest in the company or not. The information contained in the financial statements is used to compute the financial ratios. These ratios can be used as the basis for decision making process by the investors. At the same time, these ratios can provide the owners of the business with the current state of financial health of the business entity (Cheffi & Beldi 2012).
In as much as the success of the company is dependent on factors that are beyond its control, it is also true that the company can benefit greatly by the prudent use of its resources. This prudent management of resources can be facilitated by the process of accounting. In addition, accounting provides information regarding the ability of the business to invest in additional ventures. Accounting is also used to establish the efficiency of the operations of the business as well as identification of the relationship between the various aspects of business such as marketing activity and sales, as well as the number of staff and the performance of the company.
It has also been postulated that accounting plays a major role in improving the prospects of the business, for example, by having a good budgeting process, which is a component of a good accounting process. Accounting has also been referred to as the language of the business as it is used to present the financial position of the company, which is the most important aspect of the business.
Accounting techniques
Haylock (2012) is of the view that accounting techniques can be defined as a set of rules that are used as a guide to the accountant in the determination of when and how to record the financial transactions. It has been postulated that the accounting technique selected for the business can influence aspects such as the tax liability as well as the ability of the business to access additional financing from the financial institutions. There are two major accounting techniques namely- cash method and accrual method.
Using the cash method, the accountant records revenue in the year to which they belong. Moreover, expenses are recorded when they have been paid for in cash. On the other hand, using the accrual method, income is recorded when it has been earned and not necessarily when it has been paid in cash. Additionally, expenses are put in the books when they are incurred irrespective of whether the cash is paid for them or not. However, it must be appreciated that some items may require the use of either of the two techniques. For instance, if the accountant wants to show the amount of income correctly, he may be required to use the accrual method when recording purchases and sales.
It must also be appreciated that once the business has selected either of the two methods, it must use it consistently to allow for comparability of the financial statements for different accounting periods. The accounting technique used by the business can only be changed after the correct authorization has been sought from the relevant body.
Conclusion
It can be seen that accounting practice dates back to even before the prehistoric periods. That was when accounting was used to account for the material that would be needed during the cold season. There are two major accounting method that are used namely-cash basis method and the accrual method. However, the most widely used accounting method especially for the big companies is the accrual method. Accounting is subdivided into three branches namely-financial accounting, cost accounting, and management accounting.
Financial accounting is mainly used in the preparation of the financial information to the external users. On the other hand, management accounting is used to present financial information to the management for the purpose of decision making. There are various users of the financial information that is presented by the accountants. The users of financial information include: the management, the owners, the customers, the bank, the regulating authorities and the government.
The role of accounting is such that it helps the business to attain the profitability objectives. Accounting does this by facilitating the proper management of the resources owned by the business entity. Furthermore, it is used to gauge the financial health of the business. This can provide the necessary indications that can help the owner or the management to determine the best course of action. It must also be noted that financial statements are prepared in accordance with either the Generally Accepted Accounting Standards or the International Financial Reporting Standards. These standards ensure that there is uniformity regarding the preparation of the financial statements. This is instrumental in that it allows the comparability of the information presented in the financial statements.
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