Businesses have life cycles that affect the way they are managed and how their information is processed. Something common to all stages of a business's life cycle is the need for an accounting system and controls over such a system.
An enterprise's accounting system encompasses procedures and policies to protect assets against loss when processing transactions and provides reliable financial records.The most obvious function of accounting is to keep track of assets and liabilities through continuous recording of changes in items such as cash, accounts receivable, inventory, capital equipment, accounts payable and debt.
Accounting generates information for assessing a business's financial position and performance through the balance sheet and statements of profit and loss and cash flow; for meeting operational requirements, such as maintaining desired inventory levels or preserving the continuity of customer service or production; and for systematic assessment of performance in many key areas.
The three premises inherent in accounting are:
- The entity. A business undertaking is treated for accounting purposes as a separate entity distinct from the parties that provide capital. (In business operations, planning and formulating goals, however, the owner-manager and the business are inseparable.)
- The going concern. In the absence of evidence to the contrary, a business is treated as continuing in operation indefinitely. (Otherwise, assets would be valued at liquidation value rather than cost.)
- The matching of revenues and costs. Depending on the accounting principles in effect, income must be recognized when earned or collected. (Accounting principles used for managing a business need not always be the same as those for income-tax purposes.)
Accounting is a concept; an accounting system is the body of records and procedures that implement that concept. The basic records for a manual or computerized accounting system include journals, ledgers and registers. Automated accounting systems need not be exceptionally complex. Computerization can range from the simplest electronic spreadsheets from a microcomputer to very complex proprietary accounting packages from large, mainframe computers.
From these records are compiled operating financial statements as well as specialized reports.
Accounting is usually thought of as a record-keeping activity; as such, it is distinct from the activities it records.
The modern concept of an accounting system, however, tends to override this distinction. Thus, for example, ordering merchandise and dispensing funds are considered accounting-system procedures even though these activities aren't of a record-keeping nature.
To understand accounting systems, think in terms of groups of related functions that are basic to the operation of a business. Among these are purchasing goods or services, selling to and collecting from customers, controlling production and inventory and paying salaries.
These groups of related functions are often termed cycles, because they are carried out continuously and each depends on a particular set of procedures that must be performed in a certain sequence.
The three most typical cycles are:
- Revenue cycle. Sales of goods, billing and cash collections.
- Buying cycles. Payroll, purchasing and cash disbursements.
- Production cycle. Production of goods or services, labor and overhead charges.
The accounting system should generate a series of financial reports, schedules and statements. The basic requirements for reporting financial information apply equally to hand-posted accounting systems and to computer-processed data; they should be timely and accurate, and they should include the data necessary to manage a business.
Financial reports, schedules and statements should be tailored for each specific circumstance. The data for the reports should come directly from the accounting records. In most instances, comparisons should be made with planned or budgeted amounts to indicate the direction of business activity.
In addition to the balance sheet, income statement and statement of cash flow, reports could include profitability by product line, accounts receivable, inventory, cash, production and costs variances, sales backlog and labor turnover.
In the broadest sense, accounting is the "language of business."