basic financial accounting notes and summary
TRANSCRIPT
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Table of Contents 1. Introduction ....................................................................................................................................... 2
2. What is accounting? .................................................................................................................... 3
3. Early History of Accounting ........................................................................................................ 3
4. Double Entry Bookkeeping ......................................................................................................... 4
5. Chartered Accountant and the Industrial Revolution .......................................................... 6
6. The Present: Financial Accounting ........................................................................................... 6
7. Management Accounting ............................................................................................................ 8
8. Other forms of accounting .......................................................................................................... 9
9. Summary: The importance of Accountancy ............................................................................... 11
10. Reference ................................................................................................................................. 12
Bibliography ........................................................................................................................................ 12
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Abstract
Accountancy is a key language in the field of business as the benchmark of most
business begins with the figures such as its income statement, statement of financial
position and statement of cash flows. With the invention of accounting software used
in all industry, people tend to forget the roots of the discipline that existed before the
information age. As a result, it is necessary to revisit the past to understand the
reasons the origins of the accounting methods today. In this report, we will explore
the history of accounting through its stages of development.
1. Introduction
Purpose of Study
This report is an assignment we have to perform for our undergraduate program at
the Universiti Tunku Abdul Rahman from the unit Financial Accounting Framework I.
Our task is to explore the development of the accounting field in its history and to
understand the importance of accountancy.
Through this report, we hope to address the following issues:
a) What is accounting?
b) Why is accounting important?
c) Who invented the accounting and the double entry system?
d) What are the underlying assumptions that govern accounting?
e) Differentiate between financial accounting and management accounting?
f) Who needs financial and management accounting?
g) What is the purpose of financial and management accounting?
Another purpose of this study is to improve our report writing skills and other soft
skills competency. It is also necessary for us to understand the purpose of
accountancy as a field so that we could relate it the lectures we have taken in our
university.
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2. What is accounting?
One of the definitions of Accounting is the information science of collecting,
classifying and using financial data for organization and individual. In other words,
source documents such as invoices from financial transactions are collected and
stored in systematically in ledgers. In these ledgers, information is classified to
according to different accounts, whether it affects the assets, capital, liability,
revenue or the expenses accounts. Once it is classified, an income statement and
statement of financial position (a summary of all transactions) is created to be used
to assess a company’s financial situation by different users, be it internal or external
users. Without accounting, it is an impossibility to have a foundation on how short
term or long term financial decisions could be made.
3. Early History of Accounting
The most amazing thing about accounting is that it is never “invented” by anyone in
particular. At the very least, there is no historical proof that specifically states an
individual inventor. The only hint we have to its origins is from Ancient Egypt 5300
years ago (Wiley, 2013). Ancient Egyptian used bookkeeping (known as the
recording part of accounting) to make sure whether the inventory of goods in royal
stock houses are correct. It is interesting to note that the penalty for any mistakes is
severe during those times. Compared to today, we also have laws that govern
financial misrepresentation. These records are considered to be amazingly detailed
are they have the owners, amount and supplier of the goods inscribed into them. It is
not very much different from what we have in our ledgers today.
Apart from Ancient Egypt, accounting also traces back to Mesopotamia that kept
records using clay tablets. Ancient Greece was already using accounting as a
primitive banking system that loaned money and provide money transfer using
affiliate banks in other cities. In ancient Rome, government and banking accounts
were used by head of families.
Moving on to the 1st century, the Roman Empire used the accounting system
extensively by Emperor Augustus. The roman government needs detailed
accounting report to quantify public expenditure that contains distribution to the
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people, passing of lands and money to army veterans, religious facilities,
entertainment (gladiator games) and subsidies to the treasury. The inscription of the
deeds of Emperor Augustus actually has financial record up to 40 years (Wikipedia,
2014)! Records kept in such a manner are considered as accounting system that has
been practiced with great discipline during those times. Augustus’ method of using
accounting to make decision is basically financial accounting we are familiar with
today.
The early history of accounting proves that a valid monetary system must have
existed thousands of years ago. Civilization at that time must be using certain tokens
that have numerical values as to judge the value of different object. If early
civilization used the barter system to trade, then it must be mathematically
impossible to create an accounting system in the first place because barter system
could not precisely placed a fixed value on any object. Therefore, accounting system
must have been developed naturally though the courses of history along with a
monetary system, a writing system and mathematical skills.
4. Double Entry Bookkeeping
The greatest achievement in the history of accounting is without doubt the invention
of the Double entry bookkeeping system in the 14th century (700 years ago or
roughly 4600 years after Ancient Egypt). This system is known for having a
corresponding entry into an account for each entry in another account. The entries
are known in Latin as debit (the one who owes) and credit (the one who trust)
respectively.
The double entry system serves to accompany the golden rule of accounting which
is the following equation:
𝐴𝑠𝑠𝑒𝑡 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 + 𝑂𝑤𝑛𝑒𝑟′𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
The beauty of this both the double entry and the accounting equation is whenever
the sum of debit and credit does not equal in value, it means an error must have
occurred somewhere during recording. However, this system is not error-proof as
wrongly credited or debited accounts as well as complete reversal of entries will not
show up in the trial balance.
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Although the meaning of debit and credit usually refer to debtor and creditor. The
only thing both of these term means is that debit belongs to the left side of the
transaction and credit belongs to the right side of the transaction (Epstein, 2014). All
this becomes clear when journal entries from source documents are recorded in a
ledger which usually has a T shaped format.
Example of a T format Ledger (Notice that Debit is named Dr on the left side and
Credit is named Cr on the right side) Source: www.accounting-basics-for-
students.com
In double entry, there is one person who can be specifically pinpointed as to the first
user of the double entry system. That person’s name is Benedikt Kotruljević. The first
recorded history of the description of double entry bookkeeping was done by
Benedikt in 1458 in his work: Book on the Art of Trade (Mariotti, 2013). However, the
credit has to be given to the merchants of Venice (alla viniziana) for the widespread
use of the method (Gleeson-White, 2013). This is because the person that
documented that rules of double entry was an Italian monk named Luca Pacioli, a
collaborator of Leonardo da Vinci. This also means that the double entry system was
a discovery of the Renaissance era.
What Luca Pacioli did was simply to record a full description of the rules of double
entry in his book named Summa de Arithmetica, Geometrica, Proportioni et
Proportionalita (Dumar, 2015). His contribution exposes the double entry system to
the world on large scale. For this very reason, he is called “The father of accounting”
although he does not take credit for being the inventor of it. Its importance is later
highlighted when accounting becomes necessary during the Industrial Revolution of
the 19th Century.
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5. Chartered Accountant and the Industrial
Revolution
Chartered accountants are pioneers of the professional accounting body. They were
first established in Britain, 1854 (Wikipedia, 2015). They were granted a royal charter
from Queen Victoria. In effect, the profession of accountancy is recognized as a
profession of great respectability.
During the Industrial Revolution, London became the financial centre of the world.
There was a surge in demand for accountants due to the increment of limited liability
companies, large scale manufacturing and logistics, high speed global transactions.
In additions calculations necessary for asset depreciation, inventory valuation and
legislation of Company laws makes accounting an integral part of the finance and
business world.
Around this time, there was a man called Josiah Wedgwood that pioneered cost
accountancy (University of South Australia, 2013). His clerk from pottery
manufacturing business had been embezzling funds from the company. After
replacing the clerk, he hired a new one that does weekly accounts review. From
those reviews, he was able to calculate detailed costs for materials and labour,
which are used to calculate overhead cost and economies of scale. This would later
be known as cost accounting in the modern industry, it will serve as the foundation
for management accounting.
6. The Present: Financial Accounting
In the present, accounting is recognized as a respectable career choice for aspiring
students across the world. The ACCA (Association of Chartered Certified
Accountants) is the largest and fastest growing global professional body in the world
with history of over 100 years. With presence in over 170 countries including
Malaysia, the ACCA is evidence that the holder has the necessary skills and
knowledge needed to work in sectors such as banking, auditing, consulting, taxation
and law (EY, n.d).
Within these sectors accounting could be divided in several forms as follow:
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a) Financial accounting
b) Management accounting
c) Auditing
d) Tax Accounting
e) Forensic Accounting
Financial accounting is the accounting that uses money to measure economic
performance. It contains a system to measure the inflow and outflow of cash and
naturally, being derived from the double entry system, it measures the changes in
the organizations assets, liabilities and equity. Financial accounting is mainly used to
summarize financial data in a method where it is easier to understand so that
relevant users can analyse the well beings of an organization. The organization’s
performance is reflected in the income statement, statement of financial position and
the statement of cash flows.
The number of users for financial accounting is large and that makes it the most
important form of accounting in the history of accountancy. After all, it is the original
reason why accountancy was created in the first place, to provide information on
how an organization fares compared to others. Internally, or the users of financial
accounting in the organization are managers, shareholders and employees.
Managers need to review financial reports to track of their financial position so they
can decide on their strategy for the future. Shareholders need to see whether the
management are running the business well or not. Employees use financial reports
to gauge whether the company can provide them financial safety.
Externally, the government, creditors, customers, and potential investors are users of
financial accounting as well. The government needs financial data to see whether
taxation is according to law or not. Creditors need to make sure they can trust
debtors to repay their short term debt. Customers would like to see whether their
supply of goods would be disrupted or not while potential investors need to
understand the company’s past performance to justify their investment.
Due to the number of users that rely on financial accounting, financial reports have to
follow a certain guidelines known as generally accepted accounting principles
(GAAP). This is because there is a need for organizations to have a certain level of
consistency in their reports so as to not mislead investors to making the wrong
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decision. Although that is being said, but there are still many rooms for unscrupulous
accountants to distort figures (Investopedia, n.d.). Therefore, investors still have to
be careful when reading accounting figures.
The 4 underlying assumptions when using the GAAP are business entity, going
concern, monetary unit principle and time period principle. Business entity assumes
to separate the owners’ personal expenses from the business expenses. This is the
reason why Drawings are recorded in a separate ledger instead of the expenses
ledger. Going concern is to assume that the business will last forever. So, assets are
usually carried at a value above liquidation value as long as the asset is being used
efficiently. The monetary unit principle assumes only transactions that can be
expressed in terms of a currency can be recorded in the books. The time period
principle divides the company financial records into standard time periods such as
monthly, quarterly or annually to compare data within the same time period.
Besides assumptions, there are also certain principles to have to be followed in the
guidelines namely the historical cost principle, revenue recognition principle,
matching principle and full disclosure principle. Historical cost is to record assets
based on book value rather than market value. Revenue recognition is to practice
conservatism by recording revenue only when it is recognizable and when it is
earned. Matching is to correspond expenses with their respective revenue. For
example, cost of goods sold is charged at revenue but administrative expenses are
charge at gross profit. Lastly, full disclosure states that information should be
sufficient to make judgement from financial statements.
All of financial accounting contrasts with management accounting, especially in three
aspects concerning the users, its function and its relation with GAAP.
7. Management Accounting
Unlike financial accounting that has a history that goes way back to the Renaissance
era, management accounting emerged from the Industrial Revolution roughly 150
years ago (Caplan, 2007). Industrial engineers needed a standard to control cost of
productions in terms of input of materials, labour and machine time. This eventually
lead to the development of cost accounting, and then finally to management
accounting.
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In management accounting, the figures helps manager to understand how much
their products cost, how their company make its profits, and how to plan for the
profits and growth. This planning involves the future through budgeting processes
(Holtzman, 2013).
Apart from managing productions, inventory management is part of management
accounting as well. Companies prefer to keep low inventories on hand to reduce
write down of redundant inventories. A good reason for this is when natural disaster
strikes, the amount of losses incurred could be reduced.
Management accounting is concerned with providing information solely to the
managers that runs an organization. Because of this, there are usually highly
detailed in respect to the cost, individual product details, raw materials and the
number of production lines. Meanwhile, financial accounting is highly summarized for
external users as they do not need to be too detailed information relative to the
manufacturing process of a specific company. The information revealed in financial
accounting is profit by market segments but never to each and every product sold by
the company.
Financial Accounting caters mostly to external user, but management accounting is
only used internally. Management accounting is to be kept a secret to maintain
competitive advantages for the organization as it reveals the cost of manufacturing a
product. Management accounting must also be forward looking as managers need to
plan a budget to decide for future productions. Financial accounting only relies on
past figures to make decisions.
Due to the fact that it does not have to be presented to external users, management
accounting does not have to follow the guidelines presented in GAAP. It does not
even have an existing general guideline to follow for any organization. Thus, most
large corporation develop their own unique rules and measurements that efficiently
and effectively minimizes their production costs.
8. Other Forms of Accounting
Besides the 2 main fields of accounting today, students could also pursue auditing.
Auditing is simply an unbiased examination on the state of the organization. As
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exploiting financial information has much personal gains for certain individuals,
auditing exists to validate the authenticity of the information published by
accountants. There are two types of auditor, external and internal.
Internal audit are employee that belong to the organization. They advise senior
management on various aspects of the business by performing audits on both
financial and non-financial risks. This means that they not only audit financial
statements but also the company’s operations. These auditors provide better value
to the organization by improving how the company runs.
External auditors are independent bodies that focus solely on financial reports as
appointed by company shareholders. They are not part of the management. Their
primary job is to perform annual audit of financial statements as required by law to
see whether they reflect the true value of the company’s financial position. Therefore,
they should not have any financial interest with their clients.
Examples for external auditors are the big four well known firms of Deloitte Touche
Tohmatsu Limited, PricewaterhouseCoopers, Ernst & Young, and KPMG.
On the other sides, there are two very specialized field of accounting known as tax
accounting and forensic accounting.
Tax accounting exists by focusing on methods to file tax returns and planning for
future tax liabilities. Because tax laws are different from each country, there are
some people who would like to focus on doing tax accounting as their main
occupation.
The most interesting of all forms of accounting is the forensic accounting. Forensic
points to being suitable to be used for law purposes. These accountants investigate
frauds and provide testimonies in the court trails. They are trained to look beyond
numbers and face the realities in real world business situation.
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9. Summary: The Importance of
Accountancy
Imagine a world without the knowledge of accountancy, a world which is not
bounded by figures, it will be chaotic because entrepreneurs could not make
decisions, profits and losses will be unclear, and people are able provide wrong or
inaccurate information to attract more investors.
In the business world, all economic decisions or top management decisions are
depend on financial statements provided by accountant. Goals and objectives of an
organisation will be clear and achievable by having a proper financial statements.
The information and consultation provided by accountants will affect users’ decisions.
Hence, the information and consultation of accountants must be genuine and
trustable.
Next, accounting is the most effective way of data recording. All data are integrated
together and it is organized, analysed, interpreted and communicated to the end
users. End users such as investors use this informative platform to make economic
decisions to invest in respective company then government uses these records of
companies to make fiscal and monetary policies.
In conclusion, accountancies are said to be an important part in the wold economies.
The economy in the world are full of data, numbers, figures and the most important
item: money. By having accountancy, financial data could be analysed in easier way
which helps out people around the world. In addition, accounting also determines the
efficiency of businesses. All the descriptions above show that accounting is
important.
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10. Reference
Bibliography
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