Accounting is not a one-off activity but a process. Financial information on transactions, investments and others for businesses or individuals are established, recorded, classified, and summarised to generate data that support business decision-making.
For businesses and individuals to comply with financial regulations and tax laws, it is essential to understand their financial condition, performance, and cash flows. Delivering accurate and timely financial data that may be used to allocate resources, develop budgets, and decide on investments is accounting’s primary goal.
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Why is accounting important?
Accounting is one of the most discussed subjects in business. This means that accounting is essential. There are several reasons for this state.
Financial management:
Accounting gives a clear picture of income, expenses, and overall financial situation, which helps both individuals and businesses manage their finances. This information enables informed spending, saving, investing, and debt management decisions.
Compliance:
Accounting helps people and businesses comply with financial regulations and tax laws by providing accurate and timely financial reports and statements. Failure to comply with financial and tax laws may result in fines, penalties, interest, and legal implications.
Decision-making:
The financial information provided by accounting enables allocating resources, making investments, and expanding our business. It aids in identifying profitable business opportunities and developing long-term successful strategic decisions.
Stakeholders’ relations:
Businesses have stakeholders. Accounting is essential to build credibility and trust with stakeholders such as banks, creditors, debtors, and investors. For example, accounting provides information on finances that can be utilised to locate and keep investors, get loans, and establish goodwill with creditors.
Performance evaluation:
The financial reports and statements produced using accounting evaluate a business’s financial health, which helps assess its performance. Using this information, one can identify the business strengths and shortcomings and make the necessary improvements.
Accounting generally provides individuals and organisations with the financial information needed to assess their financial performance, make informed decisions, and comply with tax and financial regulations.
Those are some of the benefits of accounting. Businesses have many operations, each requiring different reporting. This means that there are variations in accounting.
What are the different accounting types?
There are several variations of accounting, each with a distinct purpose. There are many accounting categories:
Financial accounting:
This is the most common type of accounting and comprises the compilation of financial statements for external audiences, such as regulators, creditors, and investors. Delivering accurate and reliable financial data that can be used to make credit and investment decisions is the main objective of financial accounting.
Managerial accounting:
This type of accounting is focused on providing financial data to internal stakeholders, including managers, executives, and employees so that they can make informed decisions about business operations. Budgeting, forecasting, and cost analysis are all aspects of managerial accounting and the production of internal reports.
Tax accounting:
This type specialises in preparing tax returns and providing tax-related guidance. Tax accountants ensure that individuals and businesses follow all applicable tax laws and regulations and that their tax liabilities are minimal.
Auditing:
Auditing examines financial records and statements for correctness and compliance with accounting regulations. Auditors independently assess individuals’ and businesses’ internal controls and financial performance.
Forensic accounting:
This is concerned with looking into financial fraud, embezzlement, and other financial crimes. Forensic accountants use accounting concepts and practices to identify fraudulent activity and present evidence in court.
Cost accounting:
This type of accounting includes the measurement, analysis, and reporting of costs incurred in producing and selling goods and services. Cost accountants are responsible for determining the cost of goods sold, setting product prices, and determining the profitability of various goods and services.
Above are some of the most common accounting variations. Each accounting type performs a specific task and provides financial information to various stakeholders. By knowing the many types of accounting, individuals and organisations can choose the best accounting services for their needs.
Difference between bookkeeping and accounting
Even though accounting and bookkeeping are frequently used interchangeably, there are some critical differences between the two:
Scope:
A component of accounting, bookkeeping is the methodical recording of financial transactions. Accounting covers a more comprehensive range of activities, such as financial analysis, data interpretation, and report generation.
Timing:
The primary goal of bookkeeping is to capture events as they occur by entering invoices and payments into a ledger to produce financial data. Accounting requires the study of financial data to make informed judgments and to provide financial reports that can be used to evaluate performance and make strategic decisions.
Skills required:
The ability to accurately record transactions and balance accounts and a foundational understanding of accounting and mathematics are requirements for bookkeeping. Accounting requires a greater understanding of financial ideas and principles such as forecasting, budgeting, and financial analysis.
Reporting:
The systematic recording of financial transactions is known as bookkeeping. Accounting involves the analysis of financial data to generate various financial reports, such as income statements, balance sheets, and cash flow statements.
Bookkeeping is a more technical process focused on documenting financial transactions, whereas accounting covers a broader range of tasks that necessitates better comprehension of financial concepts and analysis.
Accounting provides a complete view of financial performance and is essential for making wise business decisions, even though bookkeeping and accounting are essential for managing finances.
Accounting processes use a double-entry system to get a complete view of financial performance.
What is double-entry accounting?
A double-entry accounting system involves recording each financial transaction in two accounts, a debit account and a credit account, to ensure the accuracy and completeness of financial information. This approach is based on the notion that every transaction has two effects on an individual or organisation’s financial position: it raises one account and lowers another.
For instance, when business money from a customer who owes money, the account for cash is increased (debit), while the account for accounts receivable is decreased (credit). Similarly, the inventory account is increased (a debit), and the accounts payable account is enhanced (a credit) when a business purchases merchandise on credit.
Double-entry accounting ensures that the accounting equation Assets = Liabilities + Equity is always balanced by recording transactions in two accounts. As a result, all assets must always have a value equivalent to their respective counterparts in liabilities and equity.
This sounds like a lot of work. But double-entry accounting has many benefits to any business.
Benefits of Double-entry accounting
Accuracy:
Double-entry accounting requires that each transaction be recorded in two accounts, resulting in complete and accurate documentation of every transaction.
Transparency:
Double-entry accounting makes tracking and analysing financial data easier by giving a thorough audit trail of each financial transaction.
Compliance:
Generally, Accepted Accounting Principles (GAAP) and other accounting regulations are adhered to by firms using double-entry accounting.
Decision-making:
Businesses can use the accurate and reliable financial data provided by double-entry accounting to plan their budgets, make investments, and expand.
These are some of the benefits of double-entry accounting. It is essential for managing financial data and ensuring that financial records are complete and accurate.
Businesses buy and sell on a cash or credit basis. This creates a time problem for revenue recognition and cost recording.
The solution is a Cash and accrual basis of accounting.
Cash and accrual basis of accounting
Cash and accrual basis accounting are two methods of accounting used to record financial transactions in accounting. The significant difference between the two accounting basis is the time of revenue recognition and cost recording:
Cash basis accounting:
Transactions are recorded using the cash basis of accounting when cash is received or spent. Expenses and revenue are documented when money is paid out or received. This method is clear-cut and easy to apply.
Still, it does not accurately reflect an individual’s or business’s financial performance because income and expenses are not recorded when incurred or when they are earned.
Accrual basis accounting:
This accounting basis requires that records transactions when costs or revenue are incurred, regardless of whether cash has been received or distributed. Revenue is recognised when earned, and expenses are recognised when incurred, even if payment has yet to be sent or received.
This strategy provides a more accurate picture of a company’s financial situation despite requiring more complex record-keeping and accounting procedures.
Differences between cash and accrual basis of accounting
The choice to employ cash or accrual basis accounting depends on the organisation’s size, the nature of the transactions, and the reporting requirements.
Timing:
Cash basis accounting records income and expenses as they are received or paid out, as opposed to accrual-basis accounting, which records revenue and expenses as they are produced or incurred.
Complexity:
Cash-basis accounting is less complicated and easier to use than accrual-basis accounting, necessitating more complex record-keeping and accounting procedures.
Accuracy:
While accrual basis accounting provides a more accurate picture of a company’s financial performance, cash basis accounting may not accurately reflect income and costs in the period they were created or incurred.
Compliance:
While cash basis accounting usually is only used by small organisations, most large organisations, especially those with inventory, are typically required to use it.
Even though cash basis accounting may be more straightforward but provides a more accurate view of a company’s financial situation, accrual basis accounting is often used for larger businesses.
Like any other profession, accounting relies on basic principles, which are the building blocks of the practice. These basic principles guide the practice of various types of accounting, such as tax, forensic, and cost accounting.
Basic accounting principles
Basic accounting principles are foundational guidelines regulating the preparation and presentation of financial information. These guidelines provide a framework for recording, classifying, and summarising financial transactions. This will ensure accuracy, consistency, and transparency in accounting.
The following are the basic principles of accounting:
The principle of consistency:
This principle requires that accounting methods and procedures remain constant from one period to the next. It ensures that financial statements may be used to assess how well a company has performed financially over time and that they are comparable.
The principle of relevance:
Financial information must be relevant to users’ needs to make judgments. It ensures that financial statements include pertinent information for making decisions about a company’s finances and performance.
The principle of materiality:
According to this principle, financial information must be pertinent or significant enough to influence users’ behaviour. It helps to guarantee that financial statements only include essential information relevant to users’ decision-making needs.
The principle of conservatism:
According to this principle, financial information should always be presented conservatively or cautiously. Either overstating assets or income or understating liabilities or expenses helps ensure a company’s financial status and performance are appropriately reflected in its financial statements.
The principle of matching:
According to this principle, expenses must be reported during the same period as the income they generated. It ensures that financial records accurately reflect a company’s profitability by matching expenses to the revenues they contribute to.
The principle of full disclosure:
According to this principle, financial statements must include all relevant information affecting consumers’ choices. Making sure that financial reports are transparent and accurately reflect the status and performance of a company’s finances is made possible.
These foundational accounting principles enable accurate, dependable, and transparent financial reporting by acting as the basis for accounting practices.
Relationship between Accounting and Tax
Accounting and tax law are intertwined and significantly impact how people and businesses handle their money.
Records and information:
Accounting offers documents and information about required finances and is the foundation for tax compliance. Accurate and detailed accounting records, including financial statements like income statements and balance sheets, are necessary for calculating taxable income, deductible expenses, and tax credits.
Up-to-date and accurate accounting records guarantee the correctness, transparency, and compliance of the financial data used for tax purposes.
Accounting practices:
Tax laws and regulations significantly impact accounting practices. Tax laws and regulations specify how financial transactions must be recorded, reported, and declared for tax reasons. Specific standards may apply to the timing and recognition of revenues and expenses, the handling of depreciation, the valuation of inventories, and other accounting activities.
Accountants must stay current on the most recent tax legislation to ensure that financial transactions are recorded per the applicable tax rules and regulations and accurately calculate tax liabilities.
Tax planning strategies:
Tax planning and preparation are essential to accounting. Accountants regularly work closely with individuals and companies to develop tax planning strategies that lower tax payments while maintaining legal compliance. This could involve employing tax planning tools, structuring transactions to reduce taxes, and maximising deductions, credits, and exemptions.
People and enterprises who use solid accounting practices make educated judgments and obtain the financial facts necessary for effective tax planning. They can do this and adhere to the law while maximising their tax positions.
Foundation for tax compliance:
Accounting serves as the foundation for tax compliance as a result, and tax regulations have a significant impact on accounting practices. Furthermore, tax planning involves developing strategies to lower tax liabilities while still abiding by legal standards, is a crucial accounting component.
To effectively manage their finances, maximise their tax positions, and ensure compliance with all relevant tax laws and regulations, people and organisations need to comprehensively understand how accounting and tax are related to one another.
Conclusion
Accounting is documenting, categorising, and compiling financial transactions to provide relevant data to internal and external users. Accounting is necessary for businesses to monitor their financial activities, assess their financial performance, and make long-term plans.
There are many different types of accounting, each with a specific purpose, such as financial accounting, management accounting, and tax accounting. Double-entry accounting is an accounting method that supports consistency and accuracy in financial reporting.
Overall, accounting plays a crucial role in the success of businesses, organisations, and individuals by providing accurate and reliable financial information.
Thank you for reading the post!
Dr Wakaguyu
taxkenya@gmail.com
