WHAT IS ACCOUNTING?
"The art of recording, classifying and summarizing in significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the result thereof"
This is the definition for accounting given by the American Institute of Certified Public Accountants.
Now we are going to break this definition, piece by piece and make it easily digestible. whether you are from a commerce background or not, this will now make your day.
ACCOUNTING IS AN ART:
The definition begins by stating that, accounting is an ART. Yes, accounting is an art, because it does not have a fixed rule to be followed. It requires skill, judgement and an understanding of the nature of transactions and while recording, classifying and summarizing them appropriately.
All important transactions happening in your business should be recorded with an appropriate amount, date and procedure. Hence, Accounting involves recording all those important transactions happening in your business on day to day basis. Therefore, the first and foremost thing you do in accounting is Recording them as and when they occur.
You start a Company called Finger Foods Pvt Ltd. Your business is to buy potatoes, make French Fries and sell them to your customers. Now, here comes the first transaction in your business, you buy 10 Kgs of Potatoes from a supplier for Rs.10/kg on 1st January 2018. You buy the potatoes and pay the money. Now, it is time to record what you have spent. A layman would record it as as the one shown in Illustration 1 in the image below. Now that you are trying to follow a proper accounting procedure and maintain proper accounts for your business, you must record the transaction as shown in Illustration 2 in the image below.
Classifying the transactions properly is another important aspect of accounting. It is in fact, as important as recording it. An Accountant is responsible for classifying them properly into an expense, a revenue, an asset or a liability. The profit or loss numbers go haywire if the classification is not proper. Thus, properly classifying each transaction under appropriate heads is very important.
Monthly rentals for your office premises is an expense but the amount you had spent to buy a Machinery will not be treated as an expense. It has to be taken to the Asset account which will go to the Balance Sheet. We will be learning how to make correct classification in detail in other posts.
After recording all the transactions, at the end of each period, say end of the year, an accountant summarizes all the transactions which happened throughout the year in a concise manner which can be easily understood by the the management and other users.
The next phrase in the definition is "... in terms of money, transactions and events.."
IN TERMS OF MONEY, TRANSACTIONS AND EVENTS
WHAT ARE TRANSACTIONS?
A Transaction is a performance of an act or an agreement in business. In the above example, purchasing 10 kgs of potatoes is a transaction. After making the French Fries, of about 5 Kgs, you sell 3 kgs of French Fries to your buyer. Now, selling 3 Kgs of French Fries is a transaction. You are now left with 2 Kgs of French Fries unsold, which is your stock. This is now the Event. Hence a Transaction is an act and Event is the result of any such act. All transactions and events are recorded in accounting.
OF FINANCIAL CHARACTER
It is important to note here that, only transactions in financial or partly financial nature is recorded. Transactions which are not financial and cannot be measured in terms of money are not recorded in accounting books. Therefore, every transaction must involve some amount of money and measurable in terms of money.
If Finger Foods Pvt Ltd appoints Mr.Rohit as its Manager, it does not record "appointment of Mr.Rohit as Manager" in its accounting books. But, after that, it records the salary paid to Mr.Rohit every month in its accounting books. Hence to record the transactions in the accounting books, it must involve some money or money equivalents.
INTERPRETING THE RESULTS THEREOF
After recording, classifying and summarizing transactions and events of financial nature, the company finally interprets its performance for the period, say a year, at the end of such period.
After recording all sales, purchases, expenses like rentals, salaries etc, Finger Foods Pvt Ltd, would finally arrive at the profits made by the company at the end of each accounting period and interprets, analyses and draws conclusions on the performance of its business. This is done by interpreting the profit or loss made and whether it is sufficient for the business to survive and grow. With this ends the process of accounting according to the definition.
For further questions on Accounting Definitions, write to firstname.lastname@example.org