What is Accounting? Definition, Types & Importance

Accounting is the process of recording, compiling, examining, and reporting all financial transactions of an organization. Accounting helps organizations and businesses keep track of their transactions and financial health so they can make informed financial projections. It is a very important part of ensuring business success by tracking performance over time.

In this blog, we will cover all information about accounting, such as what it is, its types, key aspects, core principles, history, and more. We will also discuss why accounting is important and a non-negotiable for organizations of all sizes.

What is Accounting?

Accounting helps keep track of money and provides a clear picture of how well an organization is doing financially. The process of accounting has multiple steps:

1. Recording financial transactions
2. Compiling the records into various books of accounts
3. Analyse the financial information
4. Derive interpretations and find patterns
5. Communicate the information to various stakeholders

Key Aspects of Accounting 

To understand accounting and what it does better. Here are the key aspects and core functions of accounting that everybody involved in the finances of a company should know.

• Recording – This aspect of accounting is also known as bookkeeping. It systematically identifies and records all financial transactions, such as sales, purchases, payments, and receipts, chronologically in a journal.
• Classifying – This aspect classified all transactions into specific categories to simplify data. For example, sales transactions go to the sales revenue account. 
• Summarizing – The classified data is summarized into comprehensive financial reports that are easy to understand. It helps in preparing financial statements such as the Balance Sheet, Income Statement, and Cash Flow Statement.
• Analyzing – Accountants analyze the summarized data to assess financial performance, evaluate trends, and measure profitability to offer insights into how different numbers impact the business.
• Reporting – The financial information derived from analysis is presented to various stakeholders in a clear and concise format. They equip different parties with the knowledge to make informed financial decisions.

Accounting is an indispensable part of any organization. Let’s understand why accounting is so important. 

Importance of Accounting

Accounting is important because it helps stakeholders understand an organization’s financial performance and whether it is making the most efficient use of its money.

It helps stakeholders know if the organization is making the most efficient use of money, whether the business is making profits or if it is running on losses.

Accounting also helps with compliance, since most businesses are legally required to disclose their statements of accounts to a regulatory body like SEBI or the SEC.

History of Accounting

Accounting goes back to ancient times when civilizations felt the fundamental need to record transactions, track resources, and manage wealth. Early forms of record-keeping can be traced back to clay tablets or leaves used in ancient India, Egypt, and Rome.

The first major development in accounting happened in the 15th century with double-entry bookkeeping. This system established that every financial transaction has two equal and opposite effects in different accounts. This foundational principle provided an error-checking mechanism that is relevant to modern accounting practices.

By the 20th century professionalization of accounting became common. Various regulatory bodies and standardized principles were established to ensure transparency in financial reporting.

Today, accounting continues to evolve, embracing digital transformation, automation, artificial intelligence, and sophisticated data analytics. It has moved beyond record-keeping and has become a strategic business function that allows businesses to make informed decisions.

Types of Accounting

Depending on the kind of transaction, objective and need of the hour, there are different kinds of techniques that accountants use.

1. Financial Accounting
2. Managerial Accounting
3. Tax Accounting
4. Cost Accounting
5. Social Accounting

Let’s understand the different types in more detail:

Financial Accounting

Financial accounting focuses on preparing financial reports for external shareholders of the business, like investors, creditors, regulators and the general public.

Its objective is to prepare the three main financial statements: the Income Statement, Balance Sheet and Cash Flow Statement.

Managerial Accounting

Managerial accounting focuses on communicating financial information to managers and executives, so they have access to relevant, timely financial information and can make well-informed decisions.

Managerial Accountants work closely with other teams like marketing, operations, and finance, to ensure that financial information is shared and used effectively throughout the company.

Tax Accounting

Tax accounting deals with the preparation and filing of tax returns and compliance with tax laws and regulations. Its primary objective is to minimize an organization’s tax liability by taking advantage of tax deductions, credits, and other incentives tax authorities offer. It also focuses on ensuring that businesses pay the correct amount of taxes to avoid penalties.

Cost Accounting

Cost accounting helps businesses analyse spending and make the most efficient use of money. Various cost accounting methods provide insight into the cost of production or service. Managers and executives use cost accounting to make informed decisions about pricing, product mix, and production processes.

Social Accounting

Social accounting is the process of measuring and reporting an organization’s social and environmental performance and impacts. It goes beyond just financial numbers and takes into account the broader effects of the organization’s actions on society, the environment, and stakeholders. The goal of social accounting is to encourage organizations to consider not only their economic success but also their contributions to social well-being and environmental stewardship.

How Does Accounting Work?

Every single financial transaction by the company is recorded in the books of accounts. At the end of the accounting period, the accountant prepares reports that summarize the company’s financial performance during that period. These statements are then used to make decisions to improve or maintain the financial performance of the company.

Accounting Process

There are two ways of recording the movement of money. The generally accepted and widely used method is the double-entry system. There are many advantages of this method over the single-entry system.

Read more: Single Entry System & Double Entry System

In India, Accounting is regulated by the ASB and the Institute of Chartered Accountants of India (ICAI). The ASB determines a standard format for accounting to be followed in India. The ICAI ensures that this format is followed properly.

Businesses in India and most of the world follow a standard flow of accounts through various “books”. 

Who Uses Accounting Information?

Accounting is valuable because it offers information to a number of external and internal parties involved in a business that can impact strategies and profitability. Here is the list of who actually uses the accounting information and for what purpose.

Internal Users

• Management – Uses financial data to make operational decisions, set budgets, plan for the future, and evaluate the performance of different business segments.
• Employees – May use financial reports to assess the company’s profitability and stability for job security, compensation negotiations, etc.
• Owners & Shareholders – Use information to gauge the return on their investment and oversee the business’s direction.

External Users

• Current & Prospective Investors – Use financial statements to evaluate a company’s profitability, financial health, and future growth potential.
• Creditors & Lenders – Banks and other financial institutions use accounting data to assess a company’s creditworthiness and its ability to repay loans.
• Government & Regulatory Bodies – Tax authorities use financial information to assess tax liabilities. Regulatory agencies use them to ensure compliance with financial reporting standards.
• Suppliers – Use financial information to assess a customer’s ability to pay for goods and services before entering into supply agreements or extending credit.

Cash vs Accrual Method

There are two ways of recording financial transactions as used by accountants: the cash method and the accrual method of accounting. Let’s understand both.

Important Terms & Key Components of Accounting

Here are some of the most important accounting terms you should know that an accountant tracks to maintain proper records. 

• Assets – Resources owned by the business that have future economic value.
• Liabilities – Financial obligations or debts of the business, settled by transferring economic value.
• Equity – The residual interest of the owners in the assets of the business after deducting all its liabilities. 
• Revenue – The gross inflow of cash or other consideration arising from the activities of an enterprise, such as the sale of goods, rendering of services, etc..
• Expenses – Costs incurred by the business in the process of earning revenue. 
• Debit – An entry recorded on the left-hand side of an account. It typically increases assets and expenses, and decreases liabilities, equity, and revenue.
• Credit – An entry recorded on the right-hand side of an account. It typically decreases assets and expenses, and increases liabilities, equity, and revenue. 

Accounting for Small Businesses

While larger businesses and MNCs have sophisticated accounting tools and finance teams to handle their financial reporting requirements, smaller, newer businesses may find it difficult.

Luckily, there is plenty of accounting software to help businesses with their accounting requirements. Zoho, Tally and Quickbooks automatically generate accounting statements from the financial information provided.

With accounting software, however, the initial entry of financial transactions is manual – this becomes an issue since growing businesses make thousands of transactions every day. In such cases, the automation has to begin right from the moment the transaction is made.

Current Accounts like the ones powered by RazorpayX offer direct integrations with accounting software so that every single transaction made by the business is automatically entered into the software of choice.

Learn More

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