Bookkeeping • Advisory • Training
Intro to Accounting
The Intro to Accounting lesson is designed to give you a basic understanding of the "why" behind the accounting profession as a whole. It provides a brief overview of the accounting industry, reviews what the purpose of accounting is, and introduces the concept of accounting rules or standards.
What is Accounting?
Branches, Roles, and Job Titles of Accounting
What is the Purpose of Accounting?
What is an Economic Entity?
Who are the Users of Financial Information?
Who Makes the Rules for Accounting?
A Short History Lesson
What is GAAP?
Why are Financial Reports Needed?
Accounting Industry Overview
What is Accounting?
Broadly speaking, accounting is the management and use of financial information.
Branches, Roles, and Job Titles of Accounting
The accounting industry can be thought of as having several branches of accounting; and, there are numerous roles or job titles within those branches. The designation of branches, roles, and job titles within the accounting industry relate to the type of financial information that is being managed and how it is being used.
Examples: Branches of Accounting
Each branch of accounting essentially focuses on, or specializes in, a particular area of financial information management and usage. For example, some common branches or categories of accounting include:
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Tax Accounting: Focused on tax planning and tax compliance.
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Manages the financial information of individuals and economic entities in order to plan for and compute tax obligations, and file tax returns.
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Audit Accounting: Focused on compliance.
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Manages the financial information of economic entities in order to form an opinion about the accuracy and completeness of their financial accounting reports, methods and controls.
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Forensic Accounting: Focused on legal issues, fraud, claims, and disputes.
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Financial Accounting: Focused on current and historical financial accuracy and profitability; providing external parties with general-purpose financial reports.
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Manages the financial information of economic entities in order to provide current and potential owners, investors, creditors, and lenders with useful information for decision making purposes. These decisions generally involve deciding whether or not to allocate resources to the entity via investing, extending credit, or lending. The focus of the information contained in these general-purpose financial reports is the entity's financial "position and performance over time". In general, "external parties" use this financial information to make decisions "about the entity" as opposed to making decisions "for the entity".
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Managerial Accounting: Focused on current and future financial planning and analysis; providing internal parties with special-purpose financial reports.
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Manages the financial information of economic entities in order to provide the current management team with useful information to be used for strategic decision making purposes. Management accounting is used to analyze how the entity has performed in the past (to analyze changes in the entity's position and performance over time) in an effort to (or with the purpose of) guide strategic decisions about the future. These "internal parties" generally use this financial information to make decisions "for the entity" as opposed to making decisions "about the entity".
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Cost Accounting: Focused on cost details, including the allocation of overhead.
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A type of managerial accounting that manages the financial information of economic entities with a focus on evaluating the details of costs for the purpose of understanding the underlying cost makeup of a specific manufactured good or service performed.
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Project Accounting: Focused on progress and performance of individual projects.
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A type of managerial accounting that manages the financial information of economic entities with a focus on evaluating the progress and performance (revenue and costs) of a specific project within the entity.
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Entity Type Accounting, such as Small Business Accounting; Non-Profit (or Not-for-Profit) Accounting; Governmental Accounting:
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Accounting standards and best practices that are relevant to a specific type of entity. Manages the financial information of a specific type of economic entity, with a focus on the accounting standards, best practices, and needs that are relevant to that specific type of entity.
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Industry Type Accounting, such as Construction Accounting; Oil & Gas Accounting:
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Accounting standards and best practices that are relevant to a specific industry.
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Bookkeeping: Focused on the day-to-day accounting activities that support an entity's operations; sometimes called Operational Accounting.
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Manages the financial information of an economic entity in order to support the day-to-day operations of that entity.
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This is not an exhaustive list; it is just meant to give you an idea of some of the most commonly known branches or categories of accounting. Other branches include public accounting, private accounting, fiduciary accounting, and more.
Keep in mind that depending on the entity, a person can be responsible for performing duties that would fall under many of these different branches. For example, in a small business a single person could be responsible for all of the accounting duties, including producing internal and external reports (Financial & Managerial Accounting), evaluating manufacturing costs or project performance (Cost & Project Accounting), as well as performing the day-to-day or operational accounting tasks (Bookkeeping).
Examples: Roles and Job Titles of Accounting
Accounting roles or job titles denote what aspect of the accounting process a person is responsible for or is involved in. For example, some common roles or job titles include:
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Bookkeeper; Full Charge Bookkeeper:
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Accounting roles that are typically responsible for carrying out some, or all, of the day-to-day operational accounting functions such as accounts payable, accounts receivable, payroll processing, inventory tracking, and cash flow management.
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Accounting Clerk; Accounts Payable or Receivable Specialist; Payroll Specialist; Inventory Specialist:
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Staff level accounting roles that are typically responsible for a particular subset of accounting tasks that are generally thought of as "bookkeeping" in nature, or that support the day-to-day operations of an entity.
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Accountant; Staff Accountant; Junior Accountant; Senior Accountant:
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Staff level accounting roles that could be responsible for a wide range of accounting tasks, but are usually assigned a particular subset of accounting tasks depending on what team they are on within the accounting department.
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Controller; Accounting Manager:
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Management level accounting roles that are typically responsible for providing guidance and support to the accounting department with a focus on ensuring financial accuracy and current state cash flow management.
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CFO:
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Executive level role that is typically responsible for providing strategic management of the finance and accounting functions with a focus on financial planning and future state cash flow management.
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This is not an exhaustive list; it is just meant to give you an idea of some of the most commonly known roles and job titles in accounting. The actual duties assigned to a role or job title can vary greatly depending on the entity's size, organizational structure, management style, or industry.
Examples: Licensure and Certifications of Accounting
Some accounting titles can indicate if the person has earned a certain licensure or certification. For example, some common licenses and certifications include:
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CPA: Certified Public Accountant -- This is a state "License"
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This is a designation given to someone who has met the state licensing requirements, which includes passing a multi-part exam, and fulfilling education and experience requirements. A CPA is therefore legally allowed to practice public accounting, which can include tax preparation, audit, and attestation activities.
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CMA: Certified Management Accountant -- This is an industry recognized "Certification"
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This is a designation given to someone who has met the certification requirements, which includes passing the multi-part exam, and fulfilling the education and experience requirements. This certification is a way for a person to "prove" they have a specific knowledge or skill set.
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EA: Enrolled Agent -- This is a Federal "License"
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This is a designation given to someone who has met the Federal licensing requirements, which includes passing a multi-part exam. An Enrolled Agent is legally allowed to perform tax preparation services.
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Accounting Purpose
What is the Purpose of Accounting?
The purpose of accounting is to provide people with useful information about an economic entity, primarily for decision making purposes. In general, financial information is conveyed through various financial reports.
What is an Economic Entity?
An Economic Entity is something that exists separate from other things (entity) and that exchanges goods & services that are measured in money (economic).
Economic = "Measured in Money" >>> Entity = "Exists Separate from Other Things"
An Entity is something that "exists separately and distinctly from other things". Specifically, in accounting, economic entities exist separately and distinctly from their owners, investors, donors, and constituents. It exists on its own.
An Economic Entity "engages in the exchange of resources (i.e. goods & services) that are measured in money". This is why the information accounting manages is considered "financial" in nature.
Generally speaking, there are three types of economic entities in accounting terms; and, the defining characteristics are their operating purpose and, to some extent, their source of resources.
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Business Entities:
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Carry out activities "to provide value to customers with the intent to make a profit"
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Using resources that were "contributed by owners as an investment" who expect to receive a return on that investment
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Not-for-Profit Entities:
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Carry out activities "for the betterment of society (advocating a political or social cause) without the intent to make a profit"
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Using resources that were "contributed by donors a donation"
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Government Entities:
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Carry out activities "for the betterment of society (advocating a political or social cause) without the intent to make a profit"
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Using resources that were "derived from constituents as levied by taxes, fees, or charges".
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Who are the Users of Financial Information?
There are many types of people that use financial information about an economic entity for many different purposes.
In general, these users can be categorized as being either external or internal to the company. For example, some common users and their common purposes are:
External: External users generally make decisions "about the company"; these people are looking at a company from the "outside".
This group of users can use standardized and highly summarized "general-purpose" reports to make decisions.
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Owners / Investors: Make decisions about providing resources to an economic entity as an investment, with the expectation of receiving a return on that investment
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Donors: Make decisions about providing resources to an economic entity as a donation, generally with no expectation of a return of any kind.
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Constituents: Make decisions about how effectively the economic entity has used funds to represent the constituent's values
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Lenders / Creditors: Make decisions about providing resources to an economic entity as a loan or on credit
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Regulating Agencies: Make decisions about the compliance obligations of the economic entity
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Analysts: Make decisions about an economic entity's historical performance with the general purpose of predicting future performance
Internal: Internal users generally make decisions "for the company"; these people are looking at a company from the "inside".
This group of users can also use "general-purpose" reports for certain decisions but will often need detailed "special-purpose" reports to make decisions.
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Managers / Executives: Make decisions about operations and allocating resources within the economic entity
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Staff Employees: Make decisions about carrying out their assigned operating tasks
Note that a single person can be more than one type of user. For example, a member-managed single-member LLC has only one "owner" who has "invested" in the company, and that person also "manages" the company's operations.
Accounting Rules
Who Makes the Rules for Accounting?
In the United States, the collection of rules (more appropriately called "standards") that guide the practice of accounting is called Generally Accepted Accounting Principles (GAAP). Currently, GAAP is primarily set by the Financial Accounting Standards Board (FASB).
The FASB is not a government agency; it is an independent private-sector organization that has been designated as the primary accounting standards setter for public companies by the U.S. Securities and Exchange Commission (SEC). However, the FASB establishes GAAP for both public and private non-governmental entities with the oversight and guidance of the SEC, and with substantial input from the American Institute of Certified Public Accountants (AICPA), as well as their advisory boards.
GAAP >> Primarily Set by FASB>> As Designated by the SEC
Although all companies benefit from adhering to GAAP guidance, from a legal standpoint companies that do not fall under the jurisdiction of the SEC (essentially, private companies) are not required to follow GAAP. The FASB recognizes that small private companies often have fewer resources and less accounting expertise which makes following some of the more complex areas of GAAP difficult. The FASB's Private Company Council (PCC) addresses this by identifying GAAP alternatives specifically for private companies.
A Short History Lesson
After the 1929 stock market crash that resulted in the Great Depression, the U.S. government passed laws meant to regulate the exchange of securities (stocks and bonds). The U.S. Securities and Exchange Commission (SEC) is the federal agency that administers those laws. The mission of the SEC is to "protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation" (SEC.gov). In that effort, one of the things that the SEC was given the authority to do was to establish standards of financial accounting practices and reporting for public entities (generally speaking, those that have issued publicly traded stocks or bonds); however, the SEC has largely delegated that authority to the private sector. Meaning, the SEC generally does not directly set accounting standards; instead, they provide oversight and guidance to the organization that does.
Initially, the American Institute of Certified Public Accountants (AICPA) issued standard setting guidelines via their Committee on Accounting Procedure (CAP), and then via their Accounting Principles Board (APB). Later, the FASB was created and was designated as the primary accounting standards setter. All of these "issued accounting standards" essentially represent the generally accepted principles (i.e. the foundational beliefs) that guide how to account for, or document, the diverse financial events that affect economic entities. Thus, the accumulation of these standards is called the Generally Accepted Accounting Principles (GAAP).
Prior to FASB, there was no efficient way to reference the many documents that made up GAAP. So, the FASB developed the Accounting Standards Codification (ASC) which organized GAAP by topic, subtopic, section, and paragraph; and, the FASB also developed the Codification Research System (CRS) which allows for easy access to a searchable online database. Each topic, subtopic, section, and paragraph has an identifying number; meaning, accounting guidance can be referenced using the ASC number. For example, ASC 310-10-35-47 refers to the "receivables" topic, the "overall" subtopic, the "subsequent measurement" section, and the "loans and trade receivables not held for sale" paragraph.
What is GAAP?
GAAP can be thought of as the official rules of accounting in the United States.
GAAP stands for Generally Accepted Accounting Principles, which is an accumulation of many "accounting standards" that guide accounting practices and financial reporting.
Accounting standards essentially dictate how to document the financial items (events, transactions, and circumstances) that a company performs or experiences in the course of operating. This documented information can then be included in various financial reports.
Thus, GAAP accounting standards essentially guide financial reporting.
Why are Financial Reports Needed?
Who needs financial reports, and for what purpose?
The basic purpose of all financial reports is to provide people with useful information that can be used to make decisions. Naturally, the types of decisions being made, and by whom, will affect what is considered "useful information". In reality, there are many different types of financial reports, and they are used by an array of people for a variety of reasons.
Generally speaking, the "users of financial information" can be broadly categorized into two groups; external users and internal users:
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External Users: People who DO NOT work for the company -- Primarily Investors, Lenders, Creditors
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These people make decisions "about the company" and are looking at a company from the "outside". External users can use standardized and highly summarized "general-purpose" reports as they are typically making decisions about investing in, lending to, or extending credit to the company.
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Internal Users: People who work for the company -- Primarily Executives, Managers, Staff Employees
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These people make decisions "for the company" and are looking at a company from the "inside". Internal users can also use "general-purpose" reports for certain decisions, but often need detailed "special-purpose" reports in order to make decisions about how to operate the company.
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One of the main reasons for the establishment of accounting standards is to protect the public interest; meaning, the primary focus of the FASB (and thus GAAP) is to protect the investors, lenders and creditors that are supplying companies with resources. So, accounting standards primarily relate to how financial information is distributed to the primary external users through "general-purpose" reports. Although accounting standards essentially dictate how to document a company's financial activities that eventually allows for the creation of both internal and external financial reports, GAAP only dictates how external reports should be created. Internal reports can be produced in any way that is deemed useful to the internal users.
The information that is included in both external and internal reports, and how that information is displayed (formatted), is largely dependent upon who needs the information, why they need it, and what decisions they're making. The company is responsible for implementing processes (administrative and operational) that facilitate both external and internal financial reporting.