The role of accounting in business and types of accounting
What is accounting?
Accounting is an integral part of business operations since the communication of financial information to all the important stakeholders depends on accounting.
Accounting serves all the stakeholders from owners to managers and investors; whoever is affected by the financial performance of the company and is interested in the financial information.
This is also the main purpose of accounting - to provide the stakeholders all the necessary financial information that can help them make better business decisions.
However, the stakeholders cannot understand the financial information unless it is presented in an understandable format. This is what the accountants do.
The accountants ensure that the financial information is available and understandable. They make sure that the managers and other stakeholders can understand the financial information and use it to make important financial decisions.
They work with individuals and firms to help them have the financial information they need to deal with and resolve business related problems and challenges.
Today businesses have lots of financial data at hand and a lot of the accounting related task is performed by automated software and with the help of information technology.
However, analyzing, interpreting and communicating the financial data is the complex part of the job.
Accountants need to present everything clearly to managers across the firm from various functions.
From marketing to sales and customer service, managers across various functions need the financial data to make critical business decisions.
Business owners, CEOs and other executives also need this financial data to make key decisions.
Accounting can be understood as the process of measuring and summarizing business activities, interpreting the financial information and communicating the results to the managers and other leading decision makers.
Fields in Accounting: (Accounting types)
There are two main fields in accounting. They are management accounting and financial accounting.
The management accountants work to serve the internal needs of an organization and present information and financial analysis to the internal decision makers for making crucial decisions.
The financial accountants on the other hand provide financial information to individuals and groups both inside and outside the organization to help them assess the firms’ financial performance.
In simpler words, management accounting helps with the general operations of the business and financial accounting helps the internal and external stakeholders know how well the business is doing.
Management accounting plays a crucial role in helping the managers perform their tasks and bear their responsibilities.
The format for reporting financial information in management accounting is quite flexible since people across a wide variety of functions use this information.
Management accountants provide information in a wide variety of formats ands mostly their reports are tailored to the needs of individual managers.
The main purpose of these reports is to presents relevant and accurate information in a timely manner that it can help the managers make important financial decisions in a timely manner.
To prepare, analyze and communicate financial information, the accountants work with individuals from various departments like HR, marketing, customer service, supply chain and other areas.
What financial accounting does is to prepare the company’s financial documents including income statement, balance sheet, cash flow statements and the statement of owner’s equity.
It prepares the financial documents that summarize the company’s past performance and evaluates its current performance or financial condition.
The financial accountants follow the Generally Accepted Accounting Principles (GAAP), which is a set of uniform rules including the basic principles of financial reporting issued by FASB (Financial Accounting Standards Board), an independent agency.
The users of these reports would like to have these reports prepared according to GAAP since that ensures the accuracy of the presented information.
Sometimes users compare the financial reports of one company with that of another in the same industry to compare the financial performance of the two.
The main aim of GAAP is to improve the clarity, consistency and comparability of financial reporting.
The companies that are headquartered in the US follow GAAP. The SEC (Securities and Exchange Commission) requires the publicly traded companies in the US to regularly file GAAP compliant financial reports to remain publicly listed on the US stock exchanges.
Investors need to be cautious when analyzing a company’s financial reports and if the report is not GAAP compliant, it cannot be completely reliable. If not for GAAP, comparing the financial performance of two companies even within the same industry would have been extremely difficult.
The businesses that are headquartered outside the US follow a different set of rules or accounting principles called IFRS (International Financial Reporting Standards). The IFRS is issued by the International Accounting Standards Board (IASB).
IFRS differs from the US GAAP in several crucial ways. For example, the IFRS sets stricter rules in terms of calculating the costs of inventory.
However, experts of accounting believe that there will finally be a single set of rules to govern accounting worldwide including that for the US-based and non-US firms.
Who are the users of financial accounting information?
The information generated from managerial accounting is used by the internal users who are inside the firm, mainly the managers of the firm. On the contrary, the users of information and reports generated by financial accounting include both internal and external users.
Following are the main users of financial accounting information:
Owners and managers:
The financial accounting information is most useful for the owners and managers of a business. The financial reports summarize the outcomes of a company’s financial activities during a specific period and work as report cards for the business owners and managers.
The owners and managers can know if the company has earned profits during that specific period or not. Apart from it, these reports also provide important information about the company’s financial condition during that period of time. If the company did not do financially well, the owners and managers can take preventive or corrective action based on the financially reports.
Investors and creditors:
The investors and creditors are interested in knowing how well the company is doing since they provide the money the company needs to operate.
The investors on this financial information to make smart investment decisions. It is not possible to make smart decisions without having accurate financial information.
Even leading investors like Warren Buffet advise people to learn all the accounting they can in order to become smart investors.
Investors and creditors study the financial health of a company based on financial reports of a firm to make decisions about continued investment.
There are several government agencies that require companies to provide financial reports periodically.
For example, the publicly owned companies or the ones that are traded on the stock exchange are required to provide annual and quarterly reports to the SEC.
Apart from the SEC, there are other government agencies that also require the companies to provide accurate financial reports like the local, state and federal taxing agencies.
Other external users:
There are also several other external users that are interested in the company’s financial information. For example, the suppliers and vendors that are doing business with the company are also interested in knowing about the financial health of the firm in order to know if further business with the company will be profitable.
Similarly, other groups like employees and labor unions are also interested in knowing about the financial health of the company and use the financial accounting information for making decisions.