1. What Is Accounting?

Accounting is the process of recording financial transactions pertaining to a

business. The accounting process includes summarizing, analyzing, and
reporting these transactions to oversight agencies, regulators, and tax
collection entities. The financial statements used in accounting are a concise
summary of financial transactions over an accounting period, summarizing a
company's operations, financial position, and cash flows.

2. How Accounting Works

Accounting is one of the key functions of almost any business. It may be
handled by a bookkeeper or an accountant at a small firm, or by sizable
finance departments with dozens of employees at larger companies. The
reports generated by various streams of accounting, such as cost accounting
and managerial accounting, are invaluable in helping management make
informed business decisions.

The financial statements that summarize a large company's operations,

financial position, and cash flows over a particular period are concise
and consolidated reports based on thousands of individual financial
transactions. As a result, all professional accounting designations are the
culmination of years of study and rigorous examinations combined with a
minimum number of years of practical accounting experience.1

3. Types of Accounting
Accountants may be tasked with recording specific transactions or working
with specific sets of information. For this reason, there are several broad
groups that most accountants can be grouped into.

 Financial Accounting
Financial accounting refers to the processes used to generate interim and
annual financial statements. The results of all financial transactions that
occur during an accounting period are summarized in the balance
sheet, income statement, and cash flow statement. The financial statements
of most companies are audited annually by an external CPA firm.

For some, such as publicly-traded companies, audits are a legal

requirement.6
 However, lenders also typically require the results of an external audit annually as part of their debt
covenants. Therefore, most companies will have annual audits for one reason or another.

 Managerial Accounting
Managerial accounting uses much of the same data as financial
accounting, but it organizes and utilizes information in different ways.
Namely, in managerial accounting, an accountant generates monthly or
quarterly reports that a business's management team can use to make
decisions about how the business operates. Managerial accounting also
encompasses many other facets of accounting, including budgeting,
forecasting, and various financial analysis tools. Essentially, any
information that may be useful to management falls underneath this
umbrella.

 Cost Accounting
Just as managerial accounting helps businesses make decisions about
management, cost accounting helps businesses make decisions about
costing. Essentially, cost accounting considers all of the costs related to
producing a product. Analysts, managers, business owners, and accountants
use this information to determine what their products should cost. In cost
accounting, money is cast as an economic factor in production, whereas in
financial accounting, money is considered to be a measure of a company's
economic performance.

 Tax Accounting
While financial accountants often use one set of rules to report the financial
position of a company, tax accountants often use a different set of rules.
These rules are set at the federal, state, or local level based on what return is
being filed. Tax accounts balance compliance with reporting rules while also
attempting to minimize a company's tax liability through thoughtful strategic
decision-making. A tax accountant often oversees the entire tax process of a
company: the strategic creation of the organization chart, the operations, the
compliance, the reporting, and the remittance of tax liability.

4. The Accounting Profession

While basic accounting functions can be handled by a bookkeeper, advanced
accounting is typically handled by qualified accountants who possess
designations such as Certified Public Accountant (CPA) or Certified
Management Accountant (CMA) in the United States.78
In Canada, the three legacy designations—the Chartered Accountant (CA),
Certified General Accountant (CGA), and Certified Management Accountant
(CMA)—have been unified under the Chartered Professional Accountant
(CPA) designation.9

A major component of the accounting professional is the "Big Four". These

four largest accounting firms conduct audit, consulting, tax advisory, and other
services. These firms, along with many other smaller firms, comprise the
public accounting realm that generally advises financial and tax accounting.

Careers in accounting may vastly difference by industry, department, and

niche. Some relevant job titles may include:

 Auditor (internal or external): ensures compliance with reporting

requirements and safeguarding of company assets.
 Forensic Accountant: monitors internal or external activity to
investigate the transactions of an individual or business.
 Tax Accountant: strategically plans the optimal business composition
to minimize tax liabilities as well as ensures compliance with tax
reporting.
 Managerial Accountant: analyzes financial transactions to make
thoughtful, strategic recommendations often related to the
manufacturing of goods.
 Information and Technology Analyst/Accountant: maintains the
system and software in which accounting records are processed and
stored.
 Controller: oversees the accounting functions of financial reporting,
accounts payable, accounts receivable, and procurement

5. The Accounting Rules

In most cases, accountants use generally accepted accounting
principles (GAAP) when preparing financial statements in the U.S. GAAP is a
set of standards and principles designed to improve the comparability and
consistency of financial reporting across industries. Its standards are based
on double-entry accounting, a method in which every accounting transaction
is entered as both a debit and credit in two separate general ledger accounts
that will roll up into the balance sheet and income statement.11

In most other countries, a set of standards governed by the International

Accounting Standards Board named the International Financial Reporting
Standards (IFRS) is used.12
Tax accountants overseeing returns in the United States rely on guidance
from the Internal Revenue Service. Federal tax returns must comply with tax
guidance outlined by the Internal Revenue Code (IRC).13 Tax accounts may
also lean in on state or county taxes as outlined by the jurisdiction in which
the business conducts business. Foreign companies must comply with tax
guidance in the countries in which it must file a return.

1.1.Special Considerations

Accountants often leverage software to aid in their work. Some accounting

software is considered better for small businesses such as QuickBooks,
Quicken, FreshBooks, Xero, SlickPie, or Sage 50. Larger companies often
have much more complex solutions to integrate with their specific reporting
needs. This includes add-on modules or in-home software solutions. Large
accounting solutions include Oracle, NetSuite, or Sage products.

1.2. The Accounting Cycle

Financial accountants typically operate in a cyclical environment with the
same steps happening in order and repeating every reporting period. These
steps are often referred to as the accounting cycle, the process of taking raw
transaction information, entering it into an accounting system, and running
relevant and accurate financial reports. The steps of the accounting cycle are:

1. Collect transaction information such as invoices, bank statements,

receipts, payment requests, uncashed checks, credit card statements,
or other mediums that may contain business transactions.
2. Post journal entries to the general ledger for the items in Step 1,
reconciling to external documents whenever possible.
3. Prepare an unadjusted trial balance to ensure all debits and credits
balance and material general ledger accounts look correct.
4. Post adjusting journal entries at the end of the period to reflect any
changes to be made to the trial balance run in Step 3.
5. Prepare the adjusted trial balance to ensure these financial balances
are materially correct and reasonable.
6. Prepare the financial statements to summarize all transactions for a
given reporting period.

1.3. Cash Method vs. Accrual Method of Accounting

Financial accounts have two different sets of rules they can choose to follow.
The first, the accrual basis method of accounting, has been discussed above.
These rules are outlined by GAAP and IFRS, are required by public
companies, and are mainly used by larger companies.

The second set of rules follow the cash basis method of accounting. Instead
of recording a transaction when it occurs, the cash method stipulates a
transaction should be recorded only when cash has exchanged. Because of
the simplified manner of accounting, the cash method is often used by small
businesses or entities that are not required to use the accrual method of
accounting.

Imagine a company buys $1,000 of inventory on credit. Payment is due for

the inventory in 30 days.

 Under the accrual method of accounting, a journal entry is recorded

when the order is placed. The entry records a debit to inventory (asset)
for $1,000 and a credit to accounts payable (liability) for $1,000. When
30 days has passed and the inventory is actually paid for, the company
posts a second journal entry: a debit to accounts payable (liability) for
$1,000 and a credit to cash (asset) for $1,000.
 Under the cash method of accounting, a journal entry is only recorded
when cash has been exchanged for inventory. There is no entry when
the order is placed; instead, the company enters only one journal entry
at the time the inventory is paid for. The entry is a debit to inventory
(asset) for $1,000 and a credit to cash (asset) for $1,000.

The difference between these two accounting methods is the treatment of

accruals. Naturally, under the accrual method of accounting, accruals are
required. Under the cash method, accruals are not required and not recorded.

2. Why Accounting Is Important

Accounting is a back-office function where employees may not directly
interface with customers, product developers, or manufacturing. However,
accounting plays a key role in the strategic planning, growth, and compliance
requirements of a company.

 Accounting is necessary for company growth. Without insight into

how a business is performing, it is impossible for a company to make
smart financial decisions through forecasting. Without accounting, a
company wouldn't be able to tell which products are its best sellers, how
much profit is made in each department, and what overhead costs are
holding back profits.
 Accounting is necessary for funding. External investors want
confidence that they know what they are investing in. Prior to private
funding, investors will usually require financial statements (often
audited) to gauge the overall health of a company. The same rules
pertain to debt financing. Banks and other lending institutions will often
require financial statements in compliance with accounting rules as part
of the underwriting and review process for issuing a loan.
 Accounting is necessary for owner exit. Small companies that may
be looking to be acquired often need to present financial statements as
part of acquisition or merger efforts. Instead of simply closing a
business, a business owner may attempt to "cash-out" of their position
and receive compensation for building a company. The basis for valuing
a company is to use its accounting records.
 Accounting is necessary to make payments. A company naturally
incurs debt, and part of the responsibility of managing that debt is to
make payments on time to the appropriate parties. Without positively
fostering these business relationships, a company may find itself with a
key supplier or vendor. Through accounting, a company can always
know who it has debts to and when those debts are coming due.
 Accounting is necessary to collect payments. A company may
agree to extend credit to its customers. Instead of collecting cash at the
time of an agreement, it may give a customer trade credit terms such as
net 30. Without accounting, a company may have a hard time keeping
track of who owes it money and when that money is to be received.
 Accounting may be required. Public companies are required to issue
periodic financial statements in compliance with GAAP or IFRS. Without
these financial statements, a company may be de-listed from an
exchange. Without proper tax accounting compliance, a company may
receive fines or penalties.