What Is Accounting? Types, Concepts, and Best Practices

Accounting is a process in which a company records all its business transactions and analyzes data to determine its financial stability and make informed business decisions. It involves recording the financial transactions like buy and sell of products and services, business expenses like paying to employees, contractors, goods, etc. This information is then used to make important decisions about the business.

Without proper accounting, you won’t know about your business performance, what products or services bring profits, and improve how the business operates. Accurate accounting enables a business to plan better financial strategies for business growth, secure investment, and meet regulatory compliance. It also helps you understand what changes to make to reduce expenses and increase profitability.  

In accounting terms, financial statements accurately summarize a company’s transactional records over a period, including its cash flows, financial status, and operations. Accounting results are reported to stakeholders, like investors, management, and creditors, and even to tax collectors and regulators. 

Accounting helps an organization measure its financial performance and stability, plan budgeting, improve operations and financial decisions, and meet compliance with applicable laws and regulations. Smaller organizations hire a professional accountant with years of experience to manage advanced and complex accounting processes, while larger organizations have a dedicated finance team to handle accounting. 

Why Is Accounting Important?

Accounting is important to understand and plan business growth, tracking payments, securing funds, making data-driven decision and ensure compliance.

• Business Growth: Accounting enables an organization to record and manage cash flow, track all its assets, expenses, revenue, profits, and liabilities, and oversee financial stability.
• On-time Transactions: Without proper accounting, you won’t be able to track your debts or payments to collect, affecting business relationships and finances. With on-time, accurate transactions, you can collect payments or clear your dues effectively and strengthen financial stability. 
• Securing Funds: Investors and lending institutions require proof that your business is worth their investments. By showing financial statements, you can enable lenders to measure your company’s financial health and grant funds.  
• Better Decision-Making: Accounting in business lets you communicate financial reports to internal and external stakeholders responsible for making key decisions like tax planning, running operations, budgeting, investments, cost-reduction, etc.
• Ensuring Compliance: Reporting your yearly income correctly and on time helps avoid penalties due to non-compliance with authorities like IFRS, HMRC, or GAAP. With the help of tax planning software, businesses can prepare tax returns and ensure compliance with tax laws.

History of Accounting

Accounting is not a new concept; its origins can be traced back to thousands of years when ancient civilizations existed. One of its earliest pieces of accounting evidence was found in ancient Mesopotamia, while early auditing forms were found in Babylonia and Egypt and bookkeeping in Iran. During the reign of Emperor Augustus, in-depth financial data was accessible to the Roman Empire.

In the medieval world, many accounting concepts similar to today’s appear to have originated from the Middle East. Double-entry bookkeeping by the Jewish communities is an example. In 1494, Luca Pacioli, an Italian mathematician, first published a book on double-entry bookkeeping.

Summa de arithmetica

In the 19th century, accounting started becoming a profession. Today, almost every company has an accountant or a finance department with accounting employees like a VP of finance, a finance controller, a chief financial officer (CFO), etc. to handle accounting. 

Types of Accounting

Different types of accounting include financial, managerial, cost, tax, forensic accounting, credit, governmental and international accounting.

Financial Accounting

Financial accounting is a process of creating correct financial statements like cash flow statements, income statements, profit or loss statements, and balance sheets, summarizing each financial transaction over a given accounting period. 

Most organizations present financial statements annually to an external auditor for review and compliance. Companies also send their accounting information to lenders or investors to let them measure business performance and secure funding. 

Managerial Accounting

The data used is similar in managerial and financial accounting. However, managerial accounting helps an organization’s internal staff or management team make informed business decisions. It includes different accounting aspects like financial analysis, budgeting, planning, and forecasting. 

Unlike financial accounts, which organizations usually do once a year, managerial accounting can happen once every month or quarter. It helps the management review reports and make better strategies. 

Cost Accounting

Cost accounting helps to analyze and understand all the costs (direct and indirect) associated with their everyday processes, including products and services. It also includes labor costs, money spent on equipment and tools, etc. 

If you are a product-based company, you will be able to understand the total cost of a given product. This will help you price your product well. You can also conduct a cost-benefit analysis to understand whether the product is profitable. 

• If it’s profitable, you can direct your resources and maximize the profits
• If it’s not profitable, you can discontinue the product.

Tax Accounting

Tax accountants help you handle tax processes, including filing taxes and returns correctly. This ensures you pay the required taxes on time to the applicable authority. Tax accounting involves various taxation rules to meet the requirements of the local, state, and federal authorities. 

Forensic Accounting

Forensic accounting is analyzing the financial records of a business or individual to look for any proof of crimes. It needs skills like investigation, auditing, and accounting. 

Organizations like law enforcement agencies, banks, insurance service providers, etc. hire forensic accountants to find proof of crimes like financial fraud from financial records and present them in court cases. 

Credit Accounting 

In credit accounting, all liabilities and unpaid bills of an organization are analyzed, ensuring no outstanding bills remain. 

Governmental Accounting

Governmental accounting involves recording, organizing, and managing a government’s financial transactions like income, expenses, loans, etc. Since the government is responsible for its taxpayers and citizens, government accounting ensures the revenue collected from them is utilized properly.

International Accounting

International accounting refers to recording and reporting transactions between different countries, tracking global financial information, and comparing accounting practices and standards across countries. It aims to ensure consistency in accounting and ease of conducting business across the globe.

Key Concepts in Accounting

Let’s understand the key concepts in accounting like equation, going concern, accruals, consistency, revenue, double-entry bookkeeping, expenses, debit, credit and depreciation.

The Accounting Equation

The accounting equation means that an organization’s total assets equal its total shareholders’ equity and all the company’s liabilities. It ensures that your balance sheet stays balanced, which means each debit side entry has a corresponding credit side entry. 

Accounting equation:

Total company assets = company liabilities shareholders equity 

Going Concern

In accounting, “going concern” applies to a financially stable company with adequate resources to run its operations indefinitely and is consistently making profits. The company will be considered a going concern until it produces proof that it has become financially unstable, bankrupt, or no longer can sustain operations. 

Accruals

Accruals in accounting are all expenses or revenues influencing an organization’s net income registered on its income statement. Liabilities and non-cash assets come under accruals, this is why accruals also impact the organization’s balance sheet. 

Accrual accounts examples: Accounts receivable and payable, accrued tax liabilities and interest earned, etc. 

Consistency

According to the consistency concept, a business should continue using a single accounting method consistently. This brings better clarity and accuracy in the financial records. Auditors also benefit from this concept while comparing the results from two accounting periods. 

Example: If you’ve chosen your accounting method as cash, it should reflect it in all your financial statements, such as income statements, balance sheets, and cash flow statements. You shouldn’t change the accounting method in different statements. 

Financial Statements

In accounting, financial statements refer to records such as balance sheets, cash flow statements, income statements, etc. These records provide information about a company’s financial stability, revenues, profits, cash flows, shareholder equity, assets, liabilities, etc. 

Organizations use financial statements to analyze their financial positions and make decisions accordingly. Tax authorities and government agencies use financial statements to ensure taxes are paid correctly, while investors, banks, etc. use these records to make better investment decisions. 

Double-Entry Bookkeeping

In double-entry accounting or bookkeeping, you must record a financial transaction in a minimum of two accounts as a credit or debit. Also, the amounts of credit and debit must be equal to ensure zero accounting errors.  

Revenue

The amount of money a business earns by selling its products/services is revenue. 

Revenue = sales price x units sold

For example, if you are selling a product for USD 10, and a total of 50 units are sold, your revenue would be = 10 x 50 (USD)

              Revenue = 500 USD 

Revenue is different from net income, which you will get by subtracting all the costs from revenue. In an income statement, revenue is termed as “sales”. 

Expenses

To make revenue, a company spends money on running its operations to build products and services. Here, expense is the company’s operational cost. It includes employee wages, equipment costs, factory leases, supplier payments, power costs, etc.

Debit

In a balance sheet, a debit is a financial record that either increases assets or decreases liabilities. A debit happens when you pay money or spend from an account. Debits are entered on the ledger’s left in a double-entry bookkeeping system. 

“Debit” has Latin origins, derived from the word “debitum”, meaning “something that’s due”. It’s usually abbreviated as “dr” for debtor. 

Credit

Opposite to debits, credits balance debits. A credit in a financial record either causes an increase in liabilities or a decrease in assets. Credits are entered on the ledger’s right in the double-entry bookkeeping system. 

“Credit” is taken from “Creditum”, a Latin word, meaning something that can be trusted or given a loan to. It’s usually abbreviated as “cr” for creditor. 

Example for credit and debit: Suppose you purchase a software application for $100 for your business. You’ll record $100 as a debit for the software (asset) in your account while $100 as a credit in your accounts payable account (liability). Also, if you buy the software with cash, you’ll create two asset account types – credit for the paid cash and edit for the software.  

Depreciation

The accounting practice that lets a business spread its physical assets’ costs over an accounting period is called depreciation. It helps you understand the value of your assets over a given time and is done for accounting and taxation. Organizations do it frequently, aiming to move the asset costs from balance sheets to income statements. 

For example, a business can depreciate the cost of its heavy machinery to match the costs to associated revenue in year one. It will help the business write-off the machinery’s value over the reporting period. 

Accounting Best Practices 

The following are standard accounting best practices followed by the majority of businesses and accountants.

Maintain Accurate and Timely Records

Review your bank statements, accounts, and other financial records regularly and update them with time. It will help you validate transactions and run accounting processes smoothly without discrepancies like fraud, inaccuracies, and errors.  

Use Reliable Accounting Software

To accelerate the process and ensure fewer errors and human-led mistakes, you can automate accounting with reliable accounting software like QuickBooks, Zoho Books, FreshBooks, etc. These tools will help you review and update financial records quickly and offer analytics to make better accounting strategies. 

Implement Strong Internal Controls

Set up robust internal controls in your organization so that your accounting information stays private and processes run smoothly. A good practice is to segregate duties based on an employee’s role and access permissions. A single person should not have complete authority over a given process. For example, you can designate one employee to process an invoice while another authorizes the transaction. 

Reconcile Accounts Regularly

To verify that financial records accurately match balances and transactions, it’s important to reconcile your financial accounts, bank statements, etc. It helps detect accounting errors and fraud. 

Prepare and Review Financial Statements

Prepare and organize your financial statements and review them periodically so that you don’t miss anything. Keeping your records correct and properly organized helps when applying for loans, securing investments, and filing taxes.  

Ensure Compliance with Accounting Standards

Know the accounting rules and regulations applicable in your region and comply with them. It will help you avoid penalties as a result of non-compliance, file taxes and returns on time, and preserve your organization’s reputation. 

Manage Cash Flow Effectively

Analyze how cash is flowing in and out of your organization. Detect areas where you can optimize cash flow and save money without compromising operational quality. Doing this will help you figure out what projects were financially successful and adjust financial decisions accordingly. 

Plan for Taxes

Plan for taxes from the beginning of a financial year, not at the last moment which leads to mistakes and penalties. Instruct your accountant to regularly track expenses and record transactions to be able to file taxes accurately and on time.  

Budget and Forecast

Find out your business’s current financial stability to predict your future requirements. Instead of dealing with unexpected costs in the future, start planning your budget. Keep your budgeting realistic, considering cash flow in the present and future. 

Outsource When Necessary

If you are a small business without a dedicated financial department to handle growing accounting and compliance needs, you can outsource some processes to a company such as a payroll service provider. They will process timely, accurate payrolls for you with compliance. 

Leverage Technology and Automation

If you use accounting software, you can integrate it with automation software (such as payment processing software) to save more time. Leveraging technology will enhance your accounting process’ efficiency and reduce risks and potential errors. 

Maintain a Paperless Office

Maintaining a paperless office will prevent huge paperwork with many errors. It will also be easier for you to track and update records and keep up with changing compliance requirements. 

Establish Clear Policies and Procedures

Setting up clear policies and procedures in your organization allows everyone in your team to be on the same page. It provides a framework for every employee regarding operations, terms and conditions, payments, and so on. This eliminates confusion and guesswork and streamlines processes. 

Stay Informed About Industry Trends

Technologies and concepts around accounting are changing, thus, keeping up with them is vital. Keep learning and trying new methods and tools and optimize your accounting processes. 

Accounting Standards

Accounting standards can vary from one country to another. 

In the US, if you prepare a financial statement, accountants mostly follow Generally Accepted Accounting Principles (GAAP). GAAP involves certain principles of accounting and standards to enhance financial reports’ consistency and comparability across various industries. Also, the Internal Revenue Service (IRS) governs tax returns in the US. 

In many countries like the EU, India, Russia, Canada, Australia, Brazil, etc., the International Financial Reporting Standards (IFRS) governs accounting standards. 

Accounting Cycle

Accounting is usually done in a cyclic process, where the same steps and requirements repeat in each reporting period. The accounting cycle usually refers to these steps:

• Collecting transaction data like bank statements, invoices, etc. 
• Entering the data into accounting software/system
• Generating financial reports/statements

Challenges in Accounting

Some of the challenges in accounting are:

• Hiring talent: Companies find it challenging to find and retain suitable talents that can take on highly responsible and accuracy-demanding roles like accountants, CFOs, etc. Rigorous interviews, relevant experience, and good compensation can improve the chances of talent acquisition.   
• Cash flow: Many companies deal with cash flow challenges due to heavy spending on tools and technology to meet growing needs and operational inefficiencies. Optimize your expenses and operations, and clear due invoices to improve cash flow. 
• Remote work: More employees now prefer hybrid or remote work. However, remote work can bring challenges like data breaches and financial fraud. Securing networks and using safer technologies can help. 
• Regulatory changes: Keeping up with frequently changing regulatory requirements such as GAAP, IFRS, etc., is a huge challenge for companies. Understanding the Golden Rules of Accounting, staying informed of these changes, and adjusting your financial reporting accordingly will help. 

What are the Popular Accounting Software for Small Businesses?

QuickBooks, FreshBooks, Xero and Wave are popular accounting software for small businesses, freelancers, consultants and self-employed.

Is Accounting a Good Career to Learn?

Accounting is one of the best career options to pursue across the globe. Accounting professionals are vital for almost every business to manage their money, expenses, cash flow, and other related areas. 

Although accounting software and solutions have automated many accounting processes, organizations still need accounting professionals for analytical tasks and making better financial decisions instead of data-centric tasks. 

In the accounting profession, you can choose different roles, such as:

• Chief financial officer (CFO)
• Accountant 
• Bookkeeper
• VP of finance 
• Finance Controller 

Qualifications/certifications needed for accounting: Bachelor’s or Master’s degree in Accounting, Chartered Accountant (ACA) for the UK, Certified Public Accountant (CPA) for the US, etc. 

Some of the biggest accounting companies are PwC, Deloitte, KPMG, etc. Accounting professionals may also join the government, public accounting organizations, or Internal Auditing Agencies. 

According to the US Bureau of Labor Statistics, the job outlook for accountants is likely to increase by 4% between 2022-32. As of May 2023, the median wage yearly for auditors and accountants was $79,880. 

What is the Difference Between Bookkeeping and Accounting?

The following table explains the differences between bookkeeping and accounting.