Plain English accounting targeting the basic accounting concepts that define accounting
Accounting is an ancient art indeed, with archaeological evidence identifying an accounting system being widely used in the Near East from about 8,000 BC to 3,000 BC.  In the 21st century, our accountants are proud to declare their accounting system as the “language of business”. Now that may well be the case, but the rest of us don’t quite understand why that language has to be so foreign and at times, so mysterious. This series looks to demystify the accounting definition and the basic accounting concepts to allow the users of accounting information, like entrepreneurs, to extract the maximum value from its outputs and processes.
Accounting for Entrepreneurs
This training session is targeted at non-accountants who have no intention of ever becoming an accountant. Whilst specifically developed for intending and practicing entrepreneurs, other non-financial managers and investors may also find the training session beneficial.
Key Words – Accounting Definitions
At the completion of this training session, you will be able to:
- Define the role, function and purpose of accounting.
- Explain the key benefits of the accounting function for the entrepreneur
- Explain the difference between a bookkeeper and an accountant.
- Describe the differences between the two main branches of accounting
Introduction – Define Accounting
Whilst many things in life change, it appears that some elements of accounting don’t. Take for instance the 500 year old concept of ‘double entry bookkeeping’ that was first published and practiced in 1494 by a Venetian monk, Luca Pacioli. We still use his system today, in fact accounting as an organized method for record-keeping has been around for almost as long as the industries of trade and business. Many of the principles established hundreds of years ago are still used as the basis for all our accounting functions today. A comprehensive knol on The History of Accounting Part I is provided by Christine Errico and talks about this very issue.
This session is a foundation stone on which all future Basic Accounting Concepts will be built (see Basic Accounting Concepts 2 – Debits and Credits). It is essential then, that you fully understand this session that covers the nature, purpose and rationale of accounting. Now, entrepreneurs are by nature exceptional readers of market changes and emerging opportunities but if they can also add a workable understanding of accounting to their skill set they can become exceptional exploiters of those opportunities as well. Unfortunately, ‘hard-nosed’ business acumen is not always an entrepreneur’s natural skill but they can enhanced this acumen significantly with a full understanding of accounting concepts and its processes.
What you will need
- It is advisable to open a blank page of your word processor and save it as “Basic Accounting Concepts” or you could just use a pen and note paper or write the activity outcomes into a designated exercise book.
- It is also advisable to have a 2nd web browser or tab open so that you can complete the research activities without exiting this training session.
Session – Accounting Definition
PART 1 – What is accounting?
- Professors of Accounting may call it “The language of business.”
- Economists may define it as the practical application of economic theory in that it measures income and values assets.
- Corporate managers may define it as a set of timely gauges that helps them actually manage the organisation
- Labor unions may see it as a monitor of an organisations activities and performance, particularly in relation to the benefits secured by employees Vs owners.
- A Board of Directors or a Chief Executive Officer (CEO) may see accounting as a data process and reporting system that provide the information needed for sound financial or economic decision making for their organisation.
- Banks and other providers of loan funds may see it as a process of providing reports showing the financial position of an organisation in relation to the assets owned, amounts owed to others and monies invested as well as the profitability of the organisation’s operations in relation to repaying the loan with interest.
- Governments may see it as a way of making organisations accountable to the general community by way of taxation contributions and transparency in the outcomes from their decision making.
- Potential investors may see it as a method of evaluating an organisation’s effectiveness in relation to industry benchmarks and the investor’s required returns.
- Investors in some failed enterprises may sadly call it a method of fooling some of the people, some of the time with what has been dubbed ‘Creative Accounting’.
One final point to make here, is that accounting is not an end in itself. It is not art to be hung in a museum as a ‘beautiful set of numbers’. Accounting is a means to an end i.e. it provides the most relevant and reliable information possible to allow for the real work to be done – the making of the best possible decisions.
- an information process that identifies, classifies and summarises the financial events that take place within an organisation and
- a reporting system that communicates relevant financial information to interested persons which allows them to assess performance, make decisions and/or control the economic resources in the organisation.
- Research the internet to find the website of an “accounting association” based in your country.
- Search the site to find their definition of accounting and write it down.
- Use underlying or coloring to identify the two main parts identified in the summary definition above.
PART 2 – How does the accounting function benefit the entrepreneur?
Success in any business needs a potent combination of both innovative problem solving (value creation) and business acumen (value maintenance and control). Accounting won’t help much with the former but it is the central pillar on which business acumen is built. Entrepreneurs by nature rely heavily on their innovative insights but the successful ones also know how and when to apply business acumen in their decisions via the reality checks and the more objective results provided by the accounting function.
- The most obvious one is the help in preparing our financial records for tax assessment purposes. This is usually annually for income tax but laws in some countries require more frequent reporting due to value added taxes and employee withheld taxes. Depending on your business structure and industry, you may also be required to provide your financial information to government agencies or even some trade associations under membership rules.
- Another common use of the accounting function for entrepreneurs is in the preparation of financial forecasts. This may be in the preparation of a business plan/proposal or when applying to a funder for a loan or selling a share of the business to an investor/partner. You must still tell the written and oral story of the business but by providing your assumptions to an accountant, they can translate that story into a language that is understood by all in common. Hence, accounting has come to be known as the “language of business”
- It helps you calculate the break even for your planned venture. This is a critical number for an entrepreneur to both know and be able to reasonably defend to any interested stakeholder.
- The accounting function helps keep you ‘in the game’. Entrepreneurs by nature live in the future because that’s where they believe their reward will materialize, trouble is, the vast majority of people want to be paid in the present. The accounting function with its cash flow modelling and profit reporting can assist the entrepreneur in ensuring that they actually make it to their future reward.
- It’s a reality check. Entrepreneurs know that things change. They know that the real opportunity that emerges if often times not the primary one that they set out to exploit. The accounting function helps you to quickly pick the emerging winners and identify the losers. Sure, entrepreneurs are very persistent people in any race but the smart ones know when to ‘stop flogging a dead horse’ and climb aboard a winner when the objective assessment shows that it is required.
- Once a new venture is trading, the accounting function can help monitor important key indicators like gross profit margin which is the difference between your selling price and cost of producing/buying the product. Your accountant can set you up with many other key indicators which will become the instrument panel by which you guide and direct your enterprise.
- We have seen that accounting is an important function that helps entrepreneurs in both establishing and managing their enterprises. It helps with tax assessment, preparing financial forecasts, calculating your breakeven, it keeps you in the game, it’s a reality check and can be used to create an instrument panel to efficiently manage your new enterprise all the way to success.
- Research the internet to find the website of an accountant in your area.
- Search their site to find the list of services they provide.
- Identify three that match the six outlined above and/or identify one service from their site that is not mentioned above.
PART 3 – What is the difference between a bookkeeper and an accountant?
We hear the two terms of bookkeeper and accountant used so often and interchangeably when dealing with the finances aspects of a business. The reality is that they are two quite distinct roles requiring two quite distinct skill sets.
- the information process that identifies, classifies and summarises the financial events that take place within an organisation and
- the reporting system that communicates relevant financial information to interested persons which allows them to assess performance, make decisions and/or control the economic resources in the organisation.
Now, as a rule, bookkeepers only do the first element whilst accountants, who could do both, generally stick with the second. This is because accountants are uniquely specialised professionals (read expensive) whose time would be poorly invested in tasks that a computer + accounting software + a competent clerk could easily perform.
- The bookkeeper function generally performs the first element of the accounting process being the identification, classifying and recording of the financial transactions for an organisation. It is a daily task orientated role that generally ends at the point of the ‘trial balance’.
- The accountant function on the other hand is results oriented, in that it is more focused on the interpretation of the financial information which results in reports to governments and government agencies as well as to the organisation’s management.
- The two roles are vital parts of a whole and whilst they can be combined into one role they are generally separated due to cost efficiencies and lack of specialised technical skills.
- Read the two descriptions of the bookkeeper and the accountant detailed above.
- Draw a matrix of 6 rows and 2 columns like the one shown.
- Complete the matrix by comparing 5 aspects on which the bookkeeper and the accountant differ in their roles.
PART 4 – What are the different branches of accounting?
Every organisation has a wide range of stakeholders who are interested in the performance or activities of that organisation. Stakeholders are simply any person(s) that are directly or indirectly affected by the activities of the organisation.
- External users who are outside the organisation like Governmental agencies, Lenders, Investors (Owners), Creditors, Suppliers, Customers, Trade associations and society at large.
- Internal users who are inside the organisation like a Board of directors, Chief executive officer (CEO), entrepreneurs, Chief financial officer (CFO) , Vice presidents, employees and Line managers like Business unit managers, Plant & Store managers.
Accounting information and financial reports designed for external users is called Financial Accounting whereas Managerial Accounting provides accounting information to internal users that is most useful in the management of a company. Now whilst the reporting styles in each branch are vastly different, the underlying objective is the same – to satisfy the information needs of the user.
- There are many stakeholders who are interested in the financial performance of an organisation. Each of these would prefer a customised report detailing only their area of concern. Since this is not feasible, accountants have created two branches of financial information reporting:
- financial accounting which prepares highly regulated reports for external stakeholders who are not engaged in the day to day operations of the organisation.
- management accounting which provides customised, appropriate and timely financial information to those internal managers entrusted with the day to day operations of the organisation.
- Both branches still uphold the underlying accounting objective – to satisfy the information needs of the user.
- Read the two descriptions of financial accounting and management accounting detailed above.
- Draw a matrix of 6 rows and 2 columns like the one shown.
- Complete the matrix by comparing 5 aspects on which financial accounting and management accounting differ in their approaches.
Additional Resources – Accounting Definition
1 – For an overview of financial accounting and some basic accounting concepts see: The quick MBA accounting
Questionnaire – Accounting Definition
(A) It’s a reality check
Q6 – Which one of the following is NOT a function usually performed by the accountant?
Q9 – Which one of the following is NOT a characteristic of management accounting?
Conclusion – Accounting Definition
The key learnings from this training session were:
- that accounting can be divided into two elements regarding financial events within an organisation i.e. recording and reporting.
- that there are many benefits for the entrepreneur from the accounting function both in the establishment and the operation of their venture.
- that bookkeepers generally control the accounting process up to the trial balance before accountants take over to prepare the financial statements and the management reports.
- that there are two main branches of accounting (a) Financial accounting that prepares prescribed reports for external stakeholders and (b) Management accounting that prepares customized reports for those engaged directly in the management of the organisation (internal).
Answers to Questionnaire
This topic was covered in PART
|Q2||Report or Summarize||PART 1|
|Q3||(C) it only has to report the good results||PART 2|
|Q5||Trial Balance||PART 3|
|Q6||(B) recording the day to day financial transactions||PART 3|
|Q9||(D) only a limited set of prescribed reports compiled||PART 4|
|Q10||(A) Reported frequently and as required||PART 4|
|Basic Accounting Concepts|
Reference & Image Source
Author: Peter Baskerville